UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549




















(Mark
One)




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




For
the quarterly period ended: September 30, 2010




or




 ̈
            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: 001-31539







CHINA
NATURAL GAS, INC.


(Exact
name of registrant as specified in its charter)







Delaware
            98-0231607(State
      or other jurisdiction of
              incorporation
      or organization)
            (I.R.S.
      Employer
              Identification
      No.)




19th
Floor, Building B, Van Metropolis


35
Tang Yan Road, Hi-Tech Zone


Xi’an,
710065, Shaanxi Province, China


+86-29-8832-7391


(Address,
including zip code, and telephone number, including area code, of registrant’s
principal executive offices)





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




Large accelerated filer  
      o
            Accelerated filer  xNon-accelerated
      filer  o
            Smaller reporting company  o(Do
      not check if a smaller reporting company)





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 the registrant’s common stock as of November 10,
2010 was 21,321,904.








TABLE
OF CONTENTS





PART I.
      FINANCIAL INFORMATIONItem 1.
            Consolidated
      Financial Statements
            
            3Consolidated
      Balance Sheets as of September 30, 2010 (Unaudited) and December 31,
      2009
            
            3Unaudited
      Consolidated Statements of Income and Other Comprehensive Income for the
      three and nine months ended September 30, 2010 and 2009
            
            4Unaudited
      Consolidated Statements of Stockholders’ Equity
            
            5Unaudited
      Consolidated Statements of Cash Flows for the nine months ended September
      30, 2010 and 2009
            
            6Notes
      to Unaudited Consolidated Financial Statements
            
            7Item
      2.
            Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
            
            32Item
      3.
            Quantitative
      and Qualitative Disclosures About Market Risk
            
            50Item
      4.
            Controls
      and Procedures
            
            51PART
      II. OTHER INFORMATIONItem
      1.
            Legal
      Proceedings
            
            52Item 1A.
            Risk
      Factors
            
            52Item
      2.
            Unregistered
      Sales of Equity Securities and Use of Proceeds
            
            53Item
      3.
            Defaults
      Upon Senior Securities
            
            53Item
      4.
            Removed
      and Reserved
            
            53Item
      5.
            Other
      Information
            
            53Item
      6.
            Exhibits
            
            54




2


CHINA
NATURAL GAS, INC.





PART
I—FINANCIAL INFORMATION





Item
1.  Financial Statements





CHINA
NATURAL GAS, INC. AND SUBSIDIARIES
  CONSOLIDATED
BALANCE SHEETS
 AS
OF SEPTEMBER 30, 2010 AND DECEMBER 31, 2009
 September
      30,
                
                
                December
      31,2010
                
                
                2009(Unaudited)ASSETSCURRENT
      ASSETS:Cash
      & cash equivalents
                
                $
                36,340,993
                
                
                $
                48,177,794Accounts
      receivable, net of allowance for doubtful accounts of $298,069
      and$163,280
      as of September 30, 2010 and December 31, 2009,
    respectively
                
                
                1,388,340
                
                
                
                1,289,116Other
      receivables
                
                
                152,828
                
                
                
                709,741Other
      receivable - employee advances
                
                
                304,257
                
                
                
                338,689Inventories
                
                
                942,683
                
                
                
                841,837Advances
      to suppliers
                
                
                2,637,902
                
                
                
                596,868Prepaid
      expense and other current assets
                
                
                4,011,747
                
                
                
                1,076,915Loans
      receivable
                
                
                -
                
                
                
                293,400Total
      current assets
                
                
                45,778,750
                
                
                
                53,324,360INVESTMENT
      IN UNCONSOLIDATED JOINT VENTURES
                
                
                1,497,000
                
                
                
                1,467,000PROPERTY
      AND EQUIPMENT, NET
                
                
                81,451,064
                
                
                
                72,713,012CONSTRUCTION
      IN PROGRESS
                
                
                90,032,715
                
                
                
                52,918,236DEFERRED
      FINANCING COSTS
                
                
                1,029,624
                
                
                
                1,336,998OTHER
      ASSETS
                
                
                17,512,159
                
                
                
                15,854,910TOTAL
      ASSETS
                
                $
                237,301,312
                
                
                $
                197,614,516LIABILITIES AND STOCKHOLDERS'
      EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued liabilities
                
                $
                3,832,686
                
                
                $
                2,081,261Other
      payables
                
                
                109,981
                
                
                
                80,788Other
      payable - related party
                
                
                1,347,300
                
                
                
                -Unearned
      revenue
                
                
                2,220,352
                
                
                
                1,813,641Accrued
      interest
                
                
                135,415
                
                
                
                786,052Taxes
      payable
                
                
                1,870,183
                
                
                
                1,901,577Notes
      payable - current maturities, net of discount $856,949 and $0 as
      ofSeptember
      30, 2010 and December 31, 2009, respectively
                
                
                2,476,384
                
                
                
                -Total
      current liabilities
                
                
                11,992,301
                
                
                
                6,663,319LONG
      TERM LIABILITIES:Notes
      payable, net of discount $9,426,443 and $12,707,713 as ofSeptember
      30, 2010 and December 31, 2009, respectively
                
                
                27,240,224
                
                
                
                27,292,287Derivative
      liabilities - warrants
                
                
                18,037,635
                
                
                
                19,545,638Long
      term debt
                
                
                17,964,000
                
                
                
                -Total
      long term liabilities
                
                
                63,241,859
                
                
                
                46,837,925Total
      liabilities
                
                
                75,234,160
                
                
                
                53,501,244COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      EQUITY:Preferred
      stock, $0.0001 per share; 5,000,000 shares authorized; none
      issued;
                
                
                -
                
                
                
                -Common
      stock, $0.0001 per share; 45,000,000 shares
      authorized,  21,321,904 and 21,183,904 sharesissued
      and outstanding as of September 30, 2010 and December 31, 2009,
      respectively
                
                
                2,132
                
                
                
                2,118Additional
      paid-in capital
                
                
                81,602,751
                
                
                
                79,851,251Cumulative
      other comprehensive gain
                
                
                12,775,770
                
                
                
                8,714,019Statutory
      reserves
                
                
                7,326,855
                
                
                
                5,962,695Retained
      earnings
                
                
                60,359,644
                
                
                
                49,583,189Total
      stockholders' equity
                
                
                162,067,152
                
                
                
                144,113,272TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                
                $
                237,301,312
                
                
                $
                197,614,516
 The
accompanying notes are an integral part of these consolidated financial
statements.
 3
  CHINA
NATURAL GAS, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME
 FOR
THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
 (Unaudited)
 Three
      Months Ended
                  September
      30,
                
                
                Nine
      Months Ended
                  September
      30,2010
                
                
                2009
                
                
                2010
                
                
                2009RevenuesNatural
      gas revenue
                
                $
                17,836,178
                
                
                $
                15,454,386
                
                
                $
                49,540,810
                
                
                $
                46,140,884Gasoline
      revenue
                
                
                1,904,357
                
                
                
                1,633,478
                
                
                
                5,407,013
                
                
                
                4,440,892Installation
      and others
                
                
                2,585,939
                
                
                
                3,037,320
                
                
                
                7,881,073
                
                
                
                8,813,594Total
      revenues
                
                
                22,326,474
                
                
                
                20,125,184
                
                
                
                62,828,896
                
                
                
                59,395,370Cost
      of revenuesNatural
      gas cost
                
                
                9,904,265
                
                
                
                7,536,188
                
                
                
                26,126,909
                
                
                
                21,773,635Gasoline
      cost
                
                
                1,798,825
                
                
                
                1,534,806
                
                
                
                5,076,397
                
                
                
                4,194,615Installation
      and others
                
                
                1,234,189
                
                
                
                1,336,498
                
                
                
                3,525,895
                
                
                
                3,797,586Total
      cost of revenues
                
                
                12,937,279
                
                
                
                10,407,492
                
                
                
                34,729,201
                
                
                
                29,765,836Gross
      profit
                
                
                9,389,195
                
                
                
                9,717,692
                
                
                
                28,099,695
                
                
                
                29,629,534Operating
      expensesSelling
      expenses
                
                
                3,663,654
                
                
                
                2,668,175
                
                
                
                9,610,436
                
                
                
                7,845,784General
      and administrative expenses
                
                
                1,732,058
                
                
                
                1,160,587
                
                
                
                5,463,580
                
                
                
                3,503,265Total
      operating expenses
                
                
                5,395,712
                
                
                
                3,828,762
                
                
                
                15,074,016
                
                
                
                11,349,049Income
      from operations
                
                
                3,993,483
                
                
                
                5,888,930
                
                
                
                13,025,679
                
                
                
                18,280,485Non-operating
      income (expense):Interest
      income
                
                
                49,403
                
                
                
                7,248
                
                
                
                398,790
                
                
                
                23,940Interest
      expense
                
                
                -
                
                
                
                (68,407
                )
                
                
                -
                
                
                
                (745,064
                )Other
      income (expense), net
                
                
                (18,914
                )
                
                
                178,728
                
                
                
                24,624
                
                
                
                (137,954
                )Change
      in fair value of warrants
                
                
                449,820
                
                
                
                (357,979
                )
                
                
                1,508,003
                
                
                
                (1,473,762
                )Foreign
      currency exchange gain (loss)
                
                
                (54,167
                )
                
                
                280
                
                
                
                (96,942
                )
                
                
                (50,527
                )Total
      non-operating income (expense)
                
                
                426,142
                
                
                
                (240,130
                )
                
                
                1,834,475
                
                
                
                (2,383,367
                )Income
      before income tax
                
                
                4,419,625
                
                
                
                5,648,800
                
                
                
                14,860,154
                
                
                
                15,897,118Provision
      for income tax
                
                
                834,783
                
                
                
                1,001,281
                
                
                
                2,719,539
                
                
                
                3,185,220Net
      income
                
                
                3,584,842
                
                
                
                4,647,519
                
                
                
                12,140,615
                
                
                
                12,711,898Other
      comprehensive incomeForeign
      currency translation gain
                
                
                3,302,747
                
                
                
                195,040
                
                
                
                4,061,751
                
                
                
                39,928Comprehensive
      income
                
                $
                6,887,589
                
                
                $
                4,842,559
                
                
                $
                16,202,366
                
                
                $
                12,751,826Weighted
      average shares outstandingBasic
                
                
                21,321,904
                
                
                
                15,754,696
                
                
                
                21,251,882
                
                
                
                14,985,001Diluted
                
                
                21,422,527
                
                
                
                16,139,820
                
                
                
                21,532,612
                
                
                
                15,035,172Earnings
      per shareBasic
                
                $
                0.17
                
                
                $
                0.29
                
                
                $
                0.57
                
                
                $
                0.85Diluted
                
                $
                0.17
                
                
                $
                0.29
                
                
                $
                0.56
                
                
                $
                0.85
    4
 CHINA
NATURAL GAS, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY
 Additional
                
                
                Accumulative
                
                
                Retained
      Earnings
                
                
                TotalCommon
      Stock
                
                
                Paid-in
                
                
                Other
      Comprehensive
                
                
                Statutory
                
                
                
                
                
                Stockholders'Shares
                
                
                Amount
                
                
                Capital
                
                
                Gain
                
                
                Reserve
                
                
                Unrestricted
                
                
                EquityBalance
      as of December 31, 2008
                
                
                14,600,154
                
                
                $
                1,460
                
                
                $
                32,115,043
                
                
                $
                8,661,060
                
                
                $
                3,730,083
                
                
                $
                27,140,775
                
                
                $
                71,648,421Cumulative
      effect ofreclassification
                  of
      warrants
                
                
                
                
                
                
                
                
                
                
                (6,858,54
                )
                
                
                
                
                
                
                
                
                
                
                5,844,239
                
                
                
                (1,014,308
                )Stock
      issuance for cash at $8.75
                
                
                6,583,750
                
                
                
                658
                
                
                
                57,607,155
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                57,607,813Offering
      costs
                
                
                
                
                
                
                
                
                
                
                (3,237,452
                )
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                (3,237,452
                )Options
      issued for services
                
                
                
                
                
                
                
                
                
                
                44,526
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                44,526Stock
      Based Compensation
                
                
                
                
                
                
                
                
                
                
                142,146
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                142,146Cumulative
      translation adjustment
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                39,928
                
                
                
                
                
                
                
                
                
                
                
                39,928Net
      Income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                12,711,898
                
                
                
                12,711,898Transfer
      to statutory reserve
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,687,330
                
                
                
                (1,687,330
                )
                
                
                -Balance
      as of September 30, 2009 (Unaudited)
                
                
                21,183,904
                
                
                $
                2,118
                
                
                $
                79,812,871
                
                
                $
                8,700,988
                
                
                $
                5,417,413
                
                
                $
                44,009,582
                
                
                $
                137,942,972Options
      issued for services
                
                
                
                
                
                
                
                
                
                
                22,008
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                22,008Stock
      Based Compensation
                
                
                
                
                
                
                
                
                
                
                16,371
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                16,371Cumulative
      translation adjustment
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                13,031
                
                
                
                
                
                
                
                
                
                
                
                13,031Net
      Income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                6,118,889
                
                
                
                6,118,889Transfer
      to statutory reserve
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                545,282
                
                
                
                (545,282
                )
                
                
                --Balance
      as of December 31, 2009
                
                
                21,183,904
                
                
                $
                2,118
                
                
                $
                79,851,250
                
                
                $
                8,714,019
                
                
                $
                5,962,695
                
                
                $
                49,583,189
                
                
                $
                144,113,271Exercise
      of stock options
                
                
                138,000
                
                
                
                14
                
                
                
                676,186
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                676,200Options
      issued for services
                
                
                
                
                
                
                
                
                
                
                66,024
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                66,024Stock-based
      compensation
                
                
                
                
                
                
                
                
                
                
                1,009,291
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,009,291Cumulative
      translation adjustment
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                4,061,751
                
                
                
                
                
                
                
                
                
                
                
                4,061,751Net
      Income
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                12,140,615
                
                
                
                12,140,615Transfer
      to statutory reserve
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                
                1,364,160
                
                
                
                (1,364,160
                )
                
                
                --Balance
      as of September 30, 2010 (Unaudited)
                
                
                21,321,904
                
                
                $
                2,132
                
                
                $
                81,602,751
                
                
                $
                12,775,770
                
                
                $
                7,326,855
                
                
                $
                60,359,644
                
                
                $
                162,067,152
    5
 CHINA
NATURAL GAS, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 FOR
THE NINE MONTHS ENDED SEPTEMBER 30, 2010 AND 2009
 (Unaudited)
 Nine
      Months Ended
                    September
      30,2010
                  
                  
                  2009CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                  
                  $
                  12,140,615
                  
                  
                  $
                  12,711,898Adjustments
      to reconcile net income to net cashprovided
      by operating activities:Depreciation
      and amortization
                  
                  
                  4,798,446
                  
                  
                  
                  4,175,175Loss
      on disposal of equipment
                  
                  
                  -
                  
                  
                  
                  21,372Provision
      for bad debt
                  
                  
                  129,167
                  
                  
                  
                  -Amortization
      of discount on senior notes
                  
                  
                  -
                  
                  
                  
                  280,250Amortization
      of financing costs
                  
                  
                  -
                  
                  
                  
                  63,940Stock
      based compensation
                  
                  
                  1,075,315
                  
                  
                  
                  186,672Change
      in fair value of warrants
                  
                  
                  (1,508,003
                  )
                  
                  
                  1,473,762Change
      in assets and liabilities:Accounts
      receivable
                  
                  
                  (200,764
                  )
                  
                  
                  (235,396
                  )Other
      receivable
                  
                  
                  561,238
                  
                  
                  
                  (31,011
                  )Other
      receivable - employee advances
                  
                  
                  40,640
                  
                  
                  
                  93,231Inventories
                  
                  
                  (82,178
                  )
                  
                  
                  (754,309
                  )Advances
      to suppliers
                  
                  
                  (1,993,592
                  )
                  
                  
                  (971,240
                  )Prepaid
      expense and other current assets
                  
                  
                  (2,778,533
                  )
                  
                  
                  223,206Accounts
      payable and accrued liabilities
                  
                  
                  1,681,392
                  
                  
                  
                  611,924Other
      payables
                  
                  
                  27,211
                  
                  
                  
                  121,234Unearned
      revenue
                  
                  
                  363,203
                  
                  
                  
                  796,827Accrued
      interest
                  
                  
                  (650,637
                  )
                  
                  
                  (586,173
                  )Taxes
      payable
                  
                  
                  (69,060
                  )
                  
                  
                  80,025Net
      cash provided by operating activities
                  
                  
                  13,534,460
                  
                  
                  
                  18,261,387CASH
      FLOWS FROM INVESTING ACTIVITIES:Loan
      to third parties
                  
                  
                  (14,259,240
                  )
                  
                  
                  -Repayment
      from loan to third parties
                  
                  
                  14,553,440
                  
                  
                  
                  -Proceeds
      from sales of equipment
                  
                  
                  -
                  
                  
                  
                  41,308Purchase
      of property and equipment
                  
                  
                  (6,557,183
                  )
                  
                  
                  (47,797
                  )Additions
      to construction in progress
                  
                  
                  (22,433,455
                  )
                  
                  
                  (18,064,065
                  )Return
      of acquisition deposit
                  
                  
                  1,618,100
                  
                  
                  
                  449,970Prepayment
      for long term assets
                  
                  
                  (8,323,603
                  )
                  
                  
                  (4,434,118
                  )Prepayment
      for land use rights
                  
                  
                  (1,765,200
                  )
                  
                  
                  (455,830
                  )Payment
      for acquisition of business
                  
                  
                  (3,648,080
                  )
                  
                  
                  -Payment
      for intangible assets
                  
                  
                  (4,882,939
                  )
                  
                  
                  (68,347
                  )Net
      cash used in investing activities
                  
                  
                  (45,698,160
                  )
                  
                  
                  (22,578,879
                  )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from long term loan
                  
                  
                  17,652,000
                  
                  
                  
                  -Stock
      issued from exercise of stock options
                  
                  
                  676,200
                  
                  
                  
                  -Proceeds
      from stock issurance
                  
                  
                  -
                  
                  
                  
                  57,607,813Payment
      for offering costs
                  
                  
                  -
                  
                  
                  
                  (3,237,452
                  )Proceeds
      from related party loan
                  
                  
                  1,323,900
                  
                  
                  
                  -Net
      cash provided by financing activities
                  
                  
                  19,652,100
                  
                  
                  
                  54,370,361Effect
      of exchange rate changes on cash and cash equivalents
                  
                  
                  674,799
                  
                  
                  
                  24,327NET
      (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS
                  
                  
                  (11,836,801
                  )
                  
                  
                  50,077,196CASH
      & CASH EQUIVALENTS, BEGINNING OF PERIOD
                  
                  
                  48,177,794
                  
                  
                  
                  5,854,383CASH
      & CASH EQUIVALENTS, END OF PERIOD
                  
                  $
                  36,340,993
                  
                  
                  $
                  55,931,579SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Interest
      paid, net of capitalized interest
                  
                  $
                  2,629,926
                  
                  
                  $
                  1,014,956Income
      taxes paid
                  
                  $
                  3,012,334
                  
                  
                  $
                  3,176,730Non-cash
      transactions for investing and financing activities:Construction
      in progress transferred to property and equipment
                  
                  $
                  4,143,807
                  
                  
                  $
                  2,199Prepayment
      on long term assets transferred to construction in process
                  
                  $
                  15,924,502
                  
                  
                  $
                  57,756Capitalized
      interest - amortization of  discount of notes payable and
      issuance cost
                  
                  $
                  2,731,695
                  
                  
                  $
                  1,983,698




6


CHINA
NATURAL GAS, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS


(UNAUDITED)





Note
1 - Organization





Organization
and Line of Business





China
Natural Gas, Inc. (the “Company”) was incorporated in the state of Delaware on
March 31, 1999. The Company through its wholly-owned subsidiaries and variable
interest entities, located in Hong Kong, Shaanxi Province, Henan Province and
Hubei Province in the People’s Republic of China (“PRC”), engages in sales and
distribution of natural gas and gasoline to commercial, industrial and
residential customers through fueling stations and pipelines, construction of
pipeline networks, installation of natural gas fittings and parts for end-users,
and conversions of gasoline-fueled vehicles to hybrid (natural gas/gasoline)
powered vehicles at automobile conversion sites.





Recent
Developments





On
September 8, 2009, Shaanxi Xilan Natural Gas Equipment Co., Ltd (“Xilan
Equipment”) increased its registered capital by $26,000,000 from $53,929,260 to
$79,929,260. The Company contributed $10,000,000 and $16,000,000 in registered
capital to Xilan Equipment on September 29, 2009 and January 13, 2010,
respectively.





On
February 5, 2010 and April 23, 2010, Jingbian Liquefied Natural Gas Co., Ltd.
(“JBLNG”) increased its registered capital by $6,026,343 and $11,668,376,
respectively, which was invested by Xi’an Xilan Natural Gas Co., Ltd. (“XXNGC”)
in the form of equipment and cash.





During
the second quarter of 2010, XXNGC effectively acquired 100% of the assets and
operating rights of four natural gas stations in Xi’an, PRC, for aggregate cash
consideration of $10,502,490.





On May
29, 2010, Hubei Xilan Natural Gas Co., Ltd. (“Hubei Xilan”) agreed to purchase
100% of the equity interests of Hanchuan Makou Yuntong Compress Natural Gas Co.,
Ltd. (“Makou”), a limited liability company formed under the laws of the PRC,
from eight individuals for a purchase price of $3,648,080.  Makou owns
and operates a CNG compressor station in Hanchuan City, Hubei Province, and
purchases natural gas from pipelines, conducts compressing and sells natural gas
on a wholesale basis through tankers to fueling stations in Hubei
Province. In July 2010, Hubei Xilan obtained full control of Makou’s
assets, operations and financial policies.





Note
2- Summary of Significant Accounting Policies





Basis
of Presentation





The
accompanying consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America.
The Company’s functional currency is the PRC Renminbi (“RMB”); however, the
Company’s reporting currency is the United States dollar; therefore, the
accompanying consolidated financial statements have been translated and
presented in United States dollars.





In the
opinion of management, the unaudited consolidated financial statements furnished
herein include all adjustments, all of which are of a normal recurring nature,
necessary for a fair presentation of the results for the interim period
presented. Operating results for the period ended September 30, 2010 are not
necessarily indicative of the results that may be expected for the year ended
December 31, 2010. The information included in this Quarterly Report on Form
10-Q should be read in conjunction with information included in the Company’s
Annual Report on Form 10-K for the year ended December 31, 2009, as
amended.





Use
of Estimates





The
preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities, and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.




7




Principles
of Consolidation





The
accompanying consolidated financial statements include the accounts of China
Natural Gas, Inc. and its wholly-owned subsidiaries, and its 100% variable
interest entity (“VIE”), XXNGC, and XXNGC’s wholly-owned
subsidiaries.  All inter-company accounts and transactions have been
eliminated in the consolidation.





Consolidation
of Variable Interest Entity





In
accordance with Financial Accounting Standards Board’s (“FASB”) accounting
standard regarding consolidation, VIEs are generally entities that lack
sufficient equity to finance their activities without additional financial
support from other parties or whose equity holders lack adequate decision making
ability. All VIEs with which the Company is involved must be evaluated to
determine the primary beneficiary of the risks and rewards of the VIE. The
primary beneficiary is required to consolidate the VIE for financial reporting
purposes.





On
February 21, 2006, the Company formed Xilan Equipment as a wholly foreign owned
enterprise (“WFOE”) under the laws of the PRC. Then, through Xilan Equipment,
the Company entered into exclusive arrangements with XXNGC and its shareholders
that give the Company the ability to substantially influence XXNGC’s daily
operations and financial affairs, appoint its senior executives and approve all
matters requiring shareholder approval. The Company memorialized these
arrangements on August 17, 2007. As a result, the Company consolidates the
financial results of XXNGC as a VIE. The Company’s arrangements with XXNGC
consist of the following agreements:





·
            Consulting Service Agreement,
      dated August 17, 2007. Under this agreement entered into between
      Xilan Equipment and XXNGC, Xilan Equipment provides XXNGC exclusive
      consulting services with respect to XXNGC’s general business operations,
      human resources and research and development. In return, XXNGC pays a
      quarterly service fee to Xilan Equipment, which is equal to XXNGC’s
      revenue for such quarter. The term of this agreement is indefinite unless
      Xilan Equipment notifies XXNGC of its intention to terminate this
      agreement. XXNGC may not terminate this agreement during its term. This
      agreement is retroactive to March 8,
2006.





·
            Operating Agreement, dated
      August 17, 2007. Under this agreement entered into between Xilan
      Equipment, on the one hand, and XXNGC and certain shareholders of XXNGC,
      on the other hand, Xilan Equipment agrees to fully guarantee XXNGC’s
      performance of all operations-related contracts, agreements or
      transactions with third parties, and, in return, XXNGC agrees to pledge
      all of its assets, including accounts receivable, to Xilan Equipment. The
      XXNGC shareholders party to this operating agreement agree to, among other
      things, appoint as XXNGC’s directors, individuals recommended by XXNGC,
      and appoint Xilan Equipment’s senior officers as XXNGC’s general manager,
      chief financial officer and other senior officers. The term of this
      agreement is indefinite unless Xilan Equipment notifies XXNGC of its
      intention to terminate this agreement with 30 days prior notice. XXNGC may
      not terminate this agreement during its term. This agreement is
      retroactive to March 8, 2006.





·
            Equity Pledge Agreement, dated
      August 17, 2007. Under this agreement entered into between Xilan
      Equipment, on the one hand, and XXNGC and certain shareholders of XXNGC,
      on the other hand, to secure the payment obligations of XXNGC under the
      consulting service agreement described above, the XXNGC shareholders party
      to this equity pledge agreement have pledged to Xilan Equipment all of
      their equity ownership interests in XXNGC. Upon the occurrence of certain
      events of default specified in this agreement, Xilan Equipment may
      exercise its rights and foreclose on the pledged equity interest. Under
      this agreement, the pledgors may not transfer the pledged equity interest
      without Xilan Equipment’s prior written consent. This agreement will also
      be binding upon successors of the pledgor and transferees of the pledged
      equity interest. The term of the pledge is two years after the obligations
      under the Consulting Service Agreement have been fulfilled. This agreement
      is retroactive to March 8, 2006.




8




·
            Option Agreement, dated August
      17, 2007. Under this option agreement entered into between Xilan
      Equipment, on the one hand, and XXNGC and certain shareholders of XXNGC,
      on the other hand, the XXNGC shareholders party to this option agreement
      irrevocably granted to Xilan Equipment, or any third party designated by
      Xilan Equipment, the right to acquire, in whole or in part, the respective
      equity interests in XXNGC of these XXNGC shareholders. The option
      agreement can be terminated by Xilan Equipment by notifying XXNGC of its
      intention to terminate this agreement with 30 days prior notice. The
      option agreement is retroactive to March 8,
  2006.





·
            Addendum to the Option
      Agreement, dated August 8, 2008. Under this addendum to the option
      agreement entered into between Xilan Equipment, on the one hand, and XXNGC
      and certain shareholders of XXNGC, on the other hand, the XXNGC
      shareholders irrevocably granted to Xilan Equipment an option to purchase
      the XXNGC shareholders’ additional equity interests in XXNGC (the
      “Additional Equity Interest”) in connection with any increase in XXNGC’s
      registered capital subsequent to the execution of the option agreement
      described above, at $1.00 or the lowest price permissible under applicable
      law at the time that Xilan Equipment exercises the option to purchase the
      Additional Equity Interest. The option agreement can be terminated by
      Xilan Equipment by notifying XXNGC of its intention to terminate this
      agreement with 30 days prior notice. This addendum is retroactive to June
      30, 2008.





·
            Proxy Agreement, dated August
      17, 2007. Under this agreement entered into between Xilan
      Equipment, on the one hand, and XXNGC and certain shareholders of XXNGC,
      on the other hand, the XXNGC shareholders irrevocably granted to Xilan
      Equipment the right to exercise their shareholder voting rights, including
      attendance at and voting of their shares at shareholders meetings in
      accordance with the applicable laws and XXNGC’s articles of association.
      This agreement is retroactive to March 8,
2006.





Foreign
Currency Translation





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





The
balance sheet amounts, with the exception of equity, were translated at the
September 30, 2010 exchange rate of RMB 6.68 to $1.00 as compared to RMB 6.82 to
$1.00 at December 31, 2009. The equity accounts were stated at their historical
rate. The average translation rates applied to income and cash flow statement
amounts for the three and nine months ended September 30, 2010 and 2009, were
RMB 6.80 to $1.00 and RMB 6.82 to $1.00, respectively.





Cash
and Cash Equivalents





Cash and
cash equivalents include cash on hand and demand deposits in accounts maintained
with state-owned banks within the PRC, and private sector banks in Hong Kong and
the United States. The Company considers all highly liquid investments with
original maturities of three months or less at the time of purchase to be cash
equivalents.





The
Company maintains balances at financial institutions which, from time to time,
may exceed Hong Kong Deposit Protection Board (“HKDPB”) insured limits for the
banks located in Hong Kong or may exceed Federal Deposit Insurance Corporation
(“FDIC”) insured limits for the banks located in the United States. Balances at
financial institutions or state-owned banks within the PRC are not covered by
insurance. As of September 30, 2010 and December 31, 2009, the Company had total
deposits of $35,738,594 and $47,459,560, respectively, without insurance
coverage or in excess of HKDPB or FDIC insured limits. The Company has not
experienced any losses in such accounts and believes it is not exposed to any
significant risks on its cash in bank accounts.




9





Accounts
Receivable





Accounts
receivable are netted against an allowance for uncollectible accounts, as
necessary. The Company maintains reserves for potential credit losses on
accounts receivable. Management reviews the composition of accounts receivable
and analyzes historical bad debts, customer concentrations, customer credit
worthiness, current economic trends and changes in customer payment patterns to
evaluate the adequacy of these reserves.





Reserves
are recorded primarily on a specific identification basis in the period of the
related sales. Delinquent account balances are written-off after management has
determined that the likelihood of collection is not probable, and known bad
debts are written off against allowance for doubtful accounts when identified.
The Company recorded an allowance for bad debts in the amount of $298,069 and
$163,280 as of September 30, 2010 and December 31, 2009,
respectively.





Other
Receivable – Employee Advances





From time
to time, the Company advances predetermined amounts based upon internal Company
policy to certain employees and internal units to ensure certain transactions
are performed in a timely manner. The Company has full oversight and control
over the advanced accounts. As of September 30, 2010 and December 31, 2009, no
allowance for the uncollectible accounts was deemed necessary.





Inventories





Inventories
are stated at the lower of cost, as determined on a first-in, first-out basis,
or market. Management compares the cost of inventories with the market value,
and an allowance is made for writing down the inventories to their market value,
if lower. Inventories consist of materials used in the construction of pipelines
and in repairing and modifying vehicles. Inventories also consist of
gasoline.





The
following are the details of the inventories:





September
      30,
              2010
              (unaudited)
            
            
            December
      31,
              2009Materials
      and supplies
            
            $
            438,872
            
            
            $
            345,611Gasoline
            
            
            503,811
            
            
            
            496,226Total
            
            $
            942,683
            
            
            $
            841,837





Advances
to Suppliers





The
Company makes advances to certain vendors for purchases of materials. The
advances are interest-free and unsecured.




10


Loans
Receivable





Loans
receivable consists of the following:





September
      30,
              2010
              (unaudited)
            
            
            December
      31,
              2009Shanxi
      Tuojin Mining Company, due on November 30, 2009, extended to November 30,
      2010, annual interest at 5.84%(1)
            
            $
            -
            
            
            $
            293,400Shanxi
      JunTai Housing Purchase Ltd., due on January 10, 2011, annual interest at
      5.84%(2)
            
            
            -
            
            
            
            -Ms.
      Taoxing Wang, due on February 19, 2011, annual interest at 5.84%(3)
            
            
            -
            
            
            
            -Total
            
            $
            -
            
            
            $
            293,400





(1)
              Shanxi
      Tuojin Mining Company paid off this loan on March 11,
  2010.





(2)
                On
      January 11, 2010, the Company extended a loan of $4,401,000 to Shanxi
      JunTai Housing Purchase Ltd., a third party, with an interest rate of
      5.84% and a term of one year. On May 26, 2010, the Company received the
      loan repayment of $4,488,923 from JunTai Housing Purchase Ltd, including
      the entire principal of $4,401,000 and interest of
  $87,923.





(3)
                  On
      February 20, 2010, the Company extended a loan of $9,858,240 to Ms.
      TaoXiang Wang, a third party individual. On April 22 and April 27, 2010,
      Ms. Wang repaid $5,868,000 and $4,130,962, respectively, of which
      $9,858,240 was the entire principal and $140,722 was
    interest.





Investments
in Unconsolidated Joint Ventures





Investee
companies that are not consolidated, but over which the Company exercises
significant influence, are accounted for under the equity method of accounting.
Whether or not the Company exercises significant influence with respect to an
investee depends on an evaluation of several factors including, among others,
representation on the investee company’s board of directors and ownership level,
which is generally a 20% to 50% interest in the voting securities of the
investee company. Under the equity method of accounting, an investee company’s
accounts are not reflected within the Company’s consolidated balance sheets and
statements of income and other comprehensive income; however, the Company’s
share of the earnings or losses of the investee company is reflected in the
caption “Earnings (loss) on equity investment” in the consolidated statements of
income and other comprehensive income. The Company’s carrying value in an equity
method investee company is reflected in the caption “Investments in
Unconsolidated Joint Ventures” in the Company’s consolidated balance
sheets.





When the
Company’s carrying value in an equity method investee company is reduced to
zero, no further losses are recorded in the Company’s consolidated financial
statements unless the Company has guaranteed obligations of the investee company
or has committed additional funding. If the investee company subsequently
reports income, the Company will not record its share of such income until it
equals the amount of its share of losses not previously recognized.





The
Company’s investment in unconsolidated joint ventures that are accounted for on
the equity method of accounting represents the Company’s 49% interest in Henan
CNPC Kunlun Xilan Compressed Natural Gas Co., Ltd. (“JV”), which is engaged in
building and operating compressed natural gas (“CNG”) compressor stations and
fueling stations, selling CNG, providing vehicle conversion services from
gasoline-fueled vehicles to hybrid (natural gas/gasoline) powered vehicles and
technical advisory work services in Henan Province, PRC. The investment in the
JV amounted to $1,497,000 and $1,467,000 at September 30, 2010 and December 31,
2009, respectively. The JV did not have any operations as of September 30,
2010.


11


The
financial position of the JV as of September 30, 2010 is summarized
below:





September
      30, 2010
              (unaudited)
            
            
            December
      31, 2009Current
      assets
            
            $
            3,055,102
            
            
            $
            2,993,878Noncurrent
      assets
            
            
            -
            
            
            
            -Total
      assets
            
            $
            3,055,102
            
            
            $
            2,993,878Current
      liabilities
            
            
            -
            
            
            
            -Noncurrent
      liabilities
            
            
            -
            
            
            
            -Equity
            
            $
            3,055,102
            
            
            $
            2,993,878Total
      liabilities and equity
            
            $
            3,055,102
            
            
            $
            2,993,878





Property
and Equipment





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





Office
      equipment
            5
      yearsOperating
      equipment
            5-20
      yearsVehicles
            5
      yearsBuildings
      and improvements
            5-30
      years





The
following are the details of the property and equipment:





September
      30,
              2010
              (unaudited)
            
            
            December
      31,
              2009Office
      equipment
            
            $
            516,000
            
            
            $
            439,055Operating
      equipment
            
            
            69,477,224
            
            
            
            61,350,503Vehicles
            
            
            3,171,359
            
            
            
            2,486,614Buildings
      and improvements
            
            
            26,407,134
            
            
            
            21,414,553Total
      property and equipment
            
            
            99,571,717
            
            
            
            85,690,725Less
      accumulated depreciation
            
            
            (18,120,653
            )
            
            
            (12,977,713
            )Property
      and equipment, net
            
            $
            81,451,064
            
            
            $
            72,713,012





Depreciation
expense for the three months ended September 30, 2010 and 2009 was $1,725,861
and $1,390,659 respectively. Depreciation expense for the nine months ended
September 30, 2010 and 2009 was $4,792,833 and $4,170,241
respectively.





Construction
in Progress





Construction
in progress consists of the cost of constructing property and equipment for CNG
fueling stations and liquefied natural gas (“LNG”) projects, a natural gas
infrastructure project in the Xi’an International Port District and other
projects, including technology licensing fees, equipment purchases, land use
rights requisition cost, capitalized interest and other construction fees. No
depreciation is provided for construction in progress until such time as the
assets are completed and placed into service. Interest incurred during
construction is capitalized into construction in progress. All other interest is
expensed as incurred.





As of
September 30, 2010 and December 31, 2009, the Company had construction in
progress in the amount of $90,032,715 and $52,918,236, respectively. Interest
cost capitalized into construction in progress for the three months ended
September 30, 2010 and 2009, amounted to $1,730,719 and $1,388,870,
respectively. Interest cost capitalized into construction in progress for the
nine months ended September 30, 2010 and 2009, amounted to $4,721,416 and
$3,419,796, respectively.




12





Construction
in progress at September 30, 2010 is set forth in the table below. The estimated
additional cost to complete column reflects amounts currently estimated by
management to be necessary to complete the relevant project as it is currently
contemplated to be completed. As of September 30, 2010, the Company was not
contractually or legally obligated to expend the estimated additional cost to
complete these projects, except to the extent reflected in Note 14 to these
consolidated financial statements.





Project
      Description
            
            Location
            
            September
      30,
              2010
              (unaudited)
            
            Commencement
      date
            
            Expected
      completion date
            
            Estimated
      additional cost to completePhase
      I of LNG Project
            
            Jingbian
      County, Shaanxi Province, PRC
            
            $
            61,908,112
            (1)
            December
      2006
            
            December
      2010(2)
            
            $
            6,564,156
            (3)Phases
      II and III of LNG Project
            
            Jingbian
      County, Shaanxi Province, PRC
            
            
            18,151,609
            (4)
            December
      2006
            
            December
      2015
            
            
            224,550,000
            (5)Sa
      Pu Mother Station
            
            Henan
      Province, PRC
            
            
            901,695
            
            July
      2008
            
            June
      2011
            
            
            6,300,000International
      port(6)
            
            International
      Port District, Xi’an, PRC
            
            
            5,051,908
            
            May
      2009
            
            December
      2020
            
            
            299,400,000Other
      projects
            
            PRC
            
            
            4,019,391
            
            Various
            
            Various
            
            
            500,000$
            90,032,715
            
            
            
            
            
            $
            537,314,156





(1)
              Includes
      $54,233,249 of construction cost and $7,674,863 of capitalized interest
      for phase I of the LNG
Project.





(2)
              The
      Company initiated its first test run in July 2010. The remaining aspects
      of the test run, which the Company aims to complete in December 2010,
      include testing the operation of various components and equipment of phase
      I of the plant.





(3)
              Includes
      $4,387,479 of construction cost and $2,176,677 of capitalized interest
      that the Company currently expects to expend to complete test runs and
      satisfy installment payments to contractors. The total expected cost of
      $68,472,238 million is more than the Company anticipated. The increased
      costs to achieve LNG processing capacity of 500,000 cubic meters are
      attributable to unforeseen cost overruns and escalations, including
      increases in material and labor costs incurred to reinforce pilings based
      upon modified engineering analyses, as well as rising land prices, which
      the Company believes resulted from recent energy resource exploration
      activities in nearby areas. Phase I construction has also experienced
      delays due to changes in government policies with respect to tariff
      exemptions for core equipment imported by the Company and related
      additional document requirements of the customs agency of Shaanxi
      Province, and increased international shipment times for ordered equipment
      due to the modification by international shippers of traditional shipment
      routes to avoid pirates along the coast of
  Somalia.





(4)
              Includes
      $15,901,321 of construction cost and $2,250,288 of capitalized interest
      for phase II and phase III of the LNG
project.





(5)
              This
      amount reflects management’s current estimate that an investment in phases
      II and III through December 15, 2015, including an estimated $204.5
      million of construction cost and $20 million of capitalized interest,
      would finance the construction of a facility capable of processing
      3,000,000 cubic meters of LNG per day, or approximately 900 million cubic
      meters per year. The Company has not made a final determination regarding
      the processing capacity for phases II and
III.




13




(6)
              The
      Xi’an International Port District Committee, a local government agency,
      has appointed XXNGC pursuant to a conditional non-binding agreement to be
      the developer of natural gas infrastructure for the Xi’an International
      Port District, a formerly agricultural area that has been zoned for
      urbanization. If XXNGC chooses to proceed with the project, it will be
      responsible for constructing, and all costs related to the construction
      of, a natural gas pipeline network that will service residential,
      commercial and industrial buildings and users, as well as fueling stations
      and related infrastructure. The estimated cost to complete the project of
      $299,400,000 is based upon a third party feasibility study and
      management’s current estimates. The Company is currently the only natural
      gas provider in the surrounding area and expects that it would supply
      natural gas to the International Port District once construction is
      completed. If the Company determines not to proceed further with this
      project, it expects to be able to obtain a refund from subcontractors of
      the $5,051,908 invested as of September 30, 2010 or transfer the
      construction in progress
assets.





Goodwill





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





Intangible
Assets





Intangible
assets mainly consist of operating rights for four natural gas stations acquired
in the second quarter of 2010 and land use rights.





The
operating rights are deemed to have an indefinite useful life as cash flows are
expected to continue indefinitely.  The operating rights will not be
amortized until their useful life is deemed to be no longer indefinite. The
Company evaluates intangible assets for impairment at least annually and
whenever events or changes in circumstances indicate that the assets might be
impaired.





All land
in the PRC is owned by the government. However, the government grants the user
“land use rights.” The costs of these rights are being amortized over the
remaining life of the rights using the straight-line method as
follows:





Intangible
      assets
            Estimated
      useful livesLand
      use rights
            30
      years





Long-Lived
Assets





The
Company evaluates the carrying value of long-lived assets to be held and used at
least annually and whenever events or changes in circumstances indicate that the
assets might be impaired. Impairment losses are recorded on long-lived assets
used in operations when indicators of impairment are present and the
undiscounted cash flows estimated to be generated by those assets are less than
the assets’ carrying amounts. In that event, a loss is recognized based on the
amount by which the carrying amount exceeds the fair market value of the
long-lived assets. Loss on long-lived assets to be disposed of is determined in
a similar manner, except that fair market values are reduced for the cost of
disposal. Based on its review, the Company believes that, as of September 30,
2010, there were no significant impairments of its long-lived
assets.




14





Unearned
Revenue





Unearned
revenue represents prepayments by customers for gas purchases and advance
payments on installation of pipeline contracts. The Company records such
prepayments as unearned revenue when the payments are received.





Fair
Value of Financial Instruments





The
accounting standards regarding fair value of financial instruments and related
fair value measurements define fair value, establish a three-level valuation
hierarchy for disclosures of fair value measurement, and provide disclosure
requirements for fair value measures. The carrying amounts reported in the
consolidated balance sheets for current receivables and payables qualify as
financial instruments. Management concluded the carrying values are a reasonable
estimate of fair value because of the short period of time between the
origination of such instruments and their expected realization and if
applicable, their stated interest rate approximates current rates available. The
three levels are defined as follows:





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





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





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





The FASB
accounting standard regarding derivatives and hedging specifies that a contract
that would otherwise meet the definition of a derivative but is both indexed to
the Company’s own stock and classified in stockholders’ equity in the statement
of financial position would not be considered a derivative financial instrument.
This FASB accounting standard also 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
exception.





As a
result of adopting this FASB accounting standard, 383,654 warrants previously
treated as equity pursuant to the derivative treatment exemption are no longer
afforded equity treatment because the strike price of the warrants is
denominated in United States dollars, a currency other than the Company’s
functional currency, the RMB. As a result, the warrants are not considered
indexed to the Company’s own stock, and as such, all future changes in the fair
value of these warrants will be recognized in earnings until such time as the
warrants are exercised or expire.





As such,
effective January 1, 2009, the Company reclassified the fair value of these
warrants from equity to liability, as if these warrants had been treated as a
derivative liability since their issuance in October 2007. On January 1, 2009,
the Company reclassified from additional paid-in capital, as a cumulative effect
adjustment, $5,844,239 to retained earnings at the beginning of the period and
$1,014,308 to warrant liabilities to recognize the fair value of such warrants.
The fair value of the warrants was $537,635 and $2,045,638 on September 30, 2010
and December 31, 2009, respectively. The Company recognized a gain of $449,820
and a loss of $357,979 for the three months ended September 30, 2010 and 2009,
respectively, to reflect the change in fair value of the warrants. The Company
recognized a gain of $1,508,003 and a loss of $1,473,762 for the nine months
ended September 30, 2010 and 2009, respectively, to reflect the change in fair
value of the warrants.





These
common stock purchase warrants do not trade in an active securities market and,
as such, the Company estimates the fair value of these warrants using the
Black-Scholes Option Pricing Model with the following assumptions:





September
      30, 2010
              (unaudited)
            
            
            December
      31, 2009Annual
      dividend yield
            
            
            -
            
            
            
            -Expected
      life (years)
            
            
            2.07
            
            
            
            2.82Risk-free
      interest rate
            
            
            0.44
            %
            
            
            1.49
            %Expected
      volatility
            
            
            86
            %
            
            
            90
            %




15




Expected
volatility is based on historical volatility. Historical volatility was computed
using daily pricing observations for recent periods that correspond to the term
of the warrants. The Company believes this method produces an estimate that is
representative of the Company’s expectations of future volatility over the
expected term of these warrants. The Company has no reason to believe future
volatility over the expected remaining life of these warrants is likely to
differ materially from historical volatility. The expected life is based on the
remaining term of the warrants. The risk-free interest rate is based on United
States Treasury securities with a term equal to the remaining term of the
warrants.





Financial
assets and liabilities are classified in their entirety based on the lowest
level of input that is significant to the fair value measurement. Depending on
the product and the terms of the transaction, the fair value of the derivative
liabilities were modeled using a series of techniques, including closed-form
analytic formula, such as the Black-Scholes Option Pricing Model, which does not
entail material subjectivity because the methodology employed does not
necessitate significant judgment and the pricing inputs are observed from
actively quoted markets.





The
following table sets forth by level within the fair value hierarchy the
Company’s financial assets and liabilities that were accounted for at fair value
on a recurring basis as of September 30, 2010.




Carrying
      Value at
                September
      30,
                2010
              
              
              Fair
      Value Measurement at September 30, 2010
                (unaudited)(unaudited)
              
              
              Level
      1
              
              
              Level
      2
              
              
              Level
      3Long-term
      debt
              
              $
              17,964,000
              
              
              $
              -
              
              
              $
              -
              
              
              $
              17,412,814Senior
      notes
              
              
              29,716,608
              
              
              
              -
              
              
              
              -
              
              
              
              38,052,554Redeemable
      liability - warrants
              
              
              17,500,000
              
              
              
              -
              
              
              
              -
              
              
              
              16,666,352Derivative
      liability - warrants
              
              
              537,635
              
              
              
              -
              
              
              
              537,635
              
              
              
              -Total
      liability measured at fair value
              
              $
              65,718,243
              
              
              $
              -
              
              
              $
              537,635
              
              
              $
              72,131,720


Other
than the assets and liabilities set forth in the table set forth above, the
Company did not identify any other assets or liabilities that are required to be
accounted for at fair value on the balance sheet.





Revenue
Recognition





Revenue
is recognized when services are rendered to customers and when a formal
arrangement exists, the price is fixed or determinable, the delivery is
completed, no other significant obligations of the Company exist and
collectability is reasonably assured. Payments received before all of the
relevant criteria for revenue recognition are satisfied are recorded as unearned
revenue. Revenue from gas and gasoline sales is recognized when gas and gasoline
is pumped through pipelines to the end users. Revenue from installation of
pipelines is recorded when the contract is completed and accepted by the
customers. Construction contracts are usually completed within one to two
months. Revenue from repairing and modifying vehicles is recorded when services
are rendered to and accepted by the customers.





Enterprise
Wide Disclosure





The
Company’s chief operating decision-makers (i.e. chief executive officer and the
employees that directly report to the chief executive officer) review financial
information presented on a consolidated basis, accompanied by disaggregated
information about revenues by business lines for purposes of allocating
resources and evaluating financial performance. There are no segment managers
who are held accountable for operations, operating results and plans for levels
or components below the consolidated unit level. Based on qualitative and
quantitative criteria establishedby the FASB’s
accounting standard for segment reporting, the Company considers itself to be
operating within one reportable segment.




16





Advertising
Costs





The
Company expenses the cost of advertising as incurred or, as appropriate, the
first time the advertising takes place. Advertising costs for the three and nine
months ended September 30, 2010 and 2009, were insignificant.





Stock-Based
Compensation





The
Company records and reports stock-based compensation pursuant to FASB’s
accounting standard regarding stock compensation which requires a
fair-value-based method of accounting for stock-based employee compensation and
transactions in which an entity issues its equity instruments to acquire goods
and services from non-employees. Stock compensation for stock granted to
non-employees has been determined in accordance with this accounting standard as
the fair value of the consideration received or the fair value of equity
instruments issued, whichever is more reliably measured.




Income
Taxes





The
FASB’s accounting standard regarding income taxes requires the recognition of
deferred tax assets and liabilities for the expected future tax consequences of
events that have been included in the financial statements or tax returns. Under
this method, deferred income taxes are recognized for the tax consequences in
future years of temporary differences between the tax bases of assets and
liabilities and their financial reporting amounts at each period end based on
enacted tax laws and statutory tax rates applicable to the periods in which the
differences are expected to affect taxable income. Valuation allowances are
established, when necessary, to reduce deferred tax assets to the amount
expected to be realized. At September 30, 2010 and 2009, there was no
significant book to tax differences. There is no difference between book
depreciation and tax depreciation as the Company uses the same method for both
book depreciation and tax depreciation. A tax position is recognized as a
benefit only if it is “more likely than not” that the tax position would be
sustained in a tax examination, with a tax examination being presumed to occur.
The amount recognized is the largest amount of tax benefit that is greater than
50% likely of being realized on examination. For tax positions not meeting the
“more likely than not” test, no tax benefit is recorded.  Penalties and
interest incurred related to underpayment of income tax are classified as income
tax expense in the year incurred. No significant penalties or interest relating
to income taxes have been incurred during the three and nine months ended
September 30, 2010 and 2009.





Local
PRC Income Tax





The
Company’s PRC subsidiary, XXNGC and XXNGC’s subsidiaries operate in the PRC.
Starting January 1, 2008, pursuant to the tax laws of the PRC, general
enterprises are subject to income tax at an effective rate of 25% compared to
33% prior to 2008. However, under PRC income
tax regulation, any company deemed to be engaged in the natural gas industry
under such regulation enjoys a reduced income tax rate. Thus, XXNGC’s income is
subject to a reduced tax rate of 15%. The Company’s PRC subsidiary and all of
XXNGC’s subsidiaries are not deemed to be engaged in the natural gas industry
under PRC income tax regulation and, accordingly, are subject to a 25% income
tax rate. A reconciliation of tax at the United States federal statutory rate to
the provision for income tax recorded in the financial statements is as
follows:





For
      the three months ended
              September
      30,
            
            
            For
      the nine months ended
              September
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009(unaudited)
            
            
            (unaudited)
            
            
            (unaudited)
            
            
            (unaudited)Tax
      provision (credit) at United States federal statutory rate
            
            
            34
            %
            
            
            34
            %
            
            
            34
            %
            
            
            34
            %Foreign
      tax rate difference
            
            
            (9
            )%
            
            
            (9
            )%
            
            
            (9
            )%
            
            
            (9
            )%Effect
      of favorable tax rate
            
            
            (7
            )%
            
            
            (9
            )%
            
            
            (8
            )%
            
            
            (8
            )%Other
      item (1)
            
            
            1
            %
            
            
            2
            %
            
            
            1
            %
            
            
            3
            %Total
      provision for income taxes
            
            
            19
            %
            
            
            18
            %
            
            
            18
            %
            
            
            20
            %







(1)
              The
      1% represents $276,814 in expenses incurred by the Company that are not
      deductible in the PRC for the three months ended September 30, 2010. The
      2% represents $649,484 in expenses incurred by the Company that are not
      deductible in the PRC for the three months ended September 30, 2009. The
      1% represents $931,830 in expenses incurred by the Company that are not
      deductible in the PRC for the nine months ended September 30, 2010. The 3%
      represents $3,774,073 in expenses incurred by the Company that are not
      deductible in the PRC for the nine months ended September 30,
      2009.




17




The
estimated tax savings for the three months ended September 30, 2010 and 2009
amounted to approximately $445,812 and $570,006, respectively. The net effect on
earnings per share, had the United States federal income tax rate been applied,
would be a decrease in basic and diluted earnings per share for the three months
ended September 30, 2010 and 2009 from $0.17 to $0.15 and $0.29 to $0.25,
respectively.





The
estimated tax savings for the nine months ended September 30, 2010 and 2009
amounted to approximately $1,472,254 and $1,801,782, respectively. The net
effect on earnings per share, had the United States federal income tax rate been
applied, would be a decrease in basic earnings per share for the nine months
ended September 30, 2010 and 2009 from $0.57 to $0.50 and $0.85 to $0.73,
respectively. The net effect on earnings per share, had the United States
federal income tax rate been applied, would be a decrease in diluted earnings
per share for the nine months ended September 30, 2010 and 2009, from
$0.56 to $0.49 and $0.85 to $0.73, respectively.





The
Company was incorporated in the United States and has incurred a net operating
loss for United States income tax purpose for the period ended September 30,
2010. The estimated net operating loss carry forwards for United States income
tax purposes amounted to $3,420,655 and $2,699,276 as of September 30, 2010 and
December 31, 2009, respectively, which may be available to reduce future years’
taxable income. These carry forwards will expire, if not utilized, beginning in
2027 through 2030. Management believes that the realization of the benefits
arising from this loss appear to be uncertain due to the Company’s limited
operating history and continuing losses for United States income tax purposes.
Accordingly, the Company has provided a 100% valuation allowance at September
30, 2010. Management reviews this valuation allowance periodically and makes
adjustments as warranted. The valuation allowances were as follow:




Valuation
      allowance
            
            For
      the nine months ended
              September
      30,
              2010
              (unaudited)
            
            
            For
      the year ended
              December
      31,
              2009Balance,
      beginning of period
            
            $
            917,754
            
            
            $
            563,541Increase
            
            
            245,269
            
            
            
            354,213Balance,
      end of period
            
            $
            1,163,023
            
            
            $
            917,754





The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $41,122,033 as of September 30, 2010, which is included in
consolidated retained earnings and will continue to be indefinitely reinvested
in international operations.  Accordingly, no provision has been made for
United States deferred taxes related to future repatriation of these earnings,
nor is it practicable to estimate the amount of income taxes that would have to
be provided if the Company concluded that such earnings will be remitted in the
future.





Value
added tax





Sales
revenue represents the invoiced value of goods, net of a value-added tax
(“VAT”). The products of the Company’s VIE, XXNGC, and two of XXNGC’s
subsidiaries, Lingbao Yuxi Natural Gas Co., Ltd. (“Lingbao Yuxi”) and Makou,
that are sold in the PRC are subject to a PRC VAT at a rate of 13% of the gross
sales price. This VAT may be offset by VAT paid by XXNGC or Lingbao Yuxi, as
applicable, on raw materials and other materials included in the cost of
producing their finished products. XXNGC recorded VAT payable and VAT receivable
net of payments in the financial statements. The VAT tax return is filed
offsetting the payables against the receivables.





All
revenues from XXNGC’s subsidiary Xi’an Xilan Auto Body Shop Co., Ltd. are
subject to a PRC VAT at a rate of 6%. This VAT cannot offset with VAT paid for
materials included in the cost of revenues.


18


Taxes
Payable





Taxes
payable at September 30, 2010 and December 31, 2009 consisted of the
following:





September
      30,
              2010
              (unaudited)
            
            
            December
      31,
              2009Value
      added tax payable
            
            $
            981,013
            
            
            $
            740,772Business
      tax payable
            
            
            -
            
            
            
            1,540Income
      tax payable
            
            
            844,177
            
            
            
            1,127,961Urban
      maintenance tax payable
            
            
            40,076
            
            
            
            27,442Income
      tax for individual payable
            
            
            4,917
            
            
            
            3,862Total
      tax payable
            
            $
            1,870,183
            
            
            $
            1,901,577





Basic
and Diluted Earnings Per Share





Earnings
per share are calculated in accordance with the FASB’s accounting standard
regarding earnings per share. Basic net earnings per share are based upon the
weighted average number of common shares outstanding. Diluted net earnings per
share are based on the assumption that all dilutive convertible shares and stock
options were converted or exercised. Dilution is computed by applying the
treasury stock method. Under this method, options and warrants are assumed to be
exercised at the beginning of the period (or at the time of issuance, if later),
and as if funds obtained thereby were used to purchase common stock at the
average market price during the period.





All share
and per share amounts used in the Company’s consolidated financial statements
and notes thereto have been retroactively restated to reflect the 1-for-2
reverse stock split, which was effective on April 28, 2009.





Recently
issued accounting pronouncements





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





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





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




19





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





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





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





In April
2010, the FASB issued ASU 2010-13, Compensation—Stock Compensation
(Topic 718): Effect of Denominating the Exercise Price of a Share-Based Payment
Award in the Currency of the Market in Which the Underlying Equity Security
Trades. This update provides amendments to Topic 718 to clarify that an
employee share-based payment award with an exercise price denominated in
currency of a market in which a substantial porting of the entity’s equity
securities trades should not be considered to contain a condition that is not a
market, performance or service condition. Therefore, an entity would not
classify such an award as a liability if it otherwise qualifies as equity. The
amendments in this ASU are effective for fiscal years, and interim periods
within those fiscal years, beginning on or after December 15, 2010. The Company
does not expect the adoption of this ASU will have a material impact on the
Company’s consolidated financial statements.





In April
2010, the FASB issued ASU 2010-17, Revenue Recognition—Milestone Method
(Topic 605): Milestone Method of Revenue Recognition. This update
provides guidance on the recognition of revenue under the milestone method,
which allows a vendor to adopt an accounting policy to recognize all of the
arrangement consideration that is contingent on the achievement of a substantive
milestone (milestone consideration) in the period the milestone is achieved. The
pronouncement is effective on a prospective basis for milestones achieved in
fiscal years and interim periods within those years, beginning on or after June
15, 2010. The Company’s adoption of this ASU did not have a material impact on
its consolidated financial statements.




20





In July
2010, the FASB issued ASU 2010-20, Receivables (Topic 310): Disclosures
about the Credit Quality of Financing Receivables and the Allowance for Credit
Losses. This update provides enhanced disclosures which are designed to
assist financial statement users in assessing an entity’s credit risk exposure
and in evaluating the adequacy of an entity’s allowance for credit losses.
Public entities must apply the disclosure requirements applicable to period-end
balances beginning with the first interim or annual reporting period ending on
or after December 15, 2010. The Company does not expect the adoption of this ASU
will have a material impact on the Company’s consolidated financial
statements.





In
September 2010, the FASB issued Accounting Standard Update 2010-25, Plan Accounting—Defined Contribution
Pension Plans (Topic 962): Reporting Loans to Participants by Defined
Contribution Pension Plans. This ASU clarifies how loans to participants
should be classified and measured by defined contribution plans and how
International Financial Reporting Standards compare to these provisions. The
amendments in this update are effective for fiscal years ending after December
15 2010. The Company does not expect the adoption of this ASU will have a
material impact on the Company’s consolidated financial statements.




Reclassification





Certain
prior period expense amounts have been reclassified from general and
administrative to selling to conform to the current period presentation. These
reclassifications had no effect on net income or cash flows.





Note 3
– Other Assets





Other
assets consisted of the following:





September
      30,
              2010
              (unaudited)
            
            
            December
      31,
              2009Prepaid
      rent – natural gas stations
            
            $
            292,476
            
            
            $
            340,211Goodwill
            
            
            598,800Prepayment
      for acquiring land use right
            
            
            3,772,440
            
            
            
            1,936,440Advances
      on purchasing equipment and construction in progress
            
            
            3,842,239
            
            
            
            12,056,964Refundable
      security deposits
            
            
            2,016,128
            
            
            
            1,264,283Intangible
      assets
            
            
            6,990,076
            
            
            
            257,012Total
            
            $
            17,512,159
            
            
            $
            15,854,910





The
goodwill amount is the excess of the cost the Company paid to acquire 100% of
the equity interests of Makou over the fair value of Makou’s net assets. Annual
impairment testing is performed during the fourth quarter of each year unless
events or circumstances indicate earlier impairment testing is required. No
impairment loss was recognized during the nine months ended September 30,
2010.





All land
in the PRC is government owned. However, the government grants users land use
rights. As of September 30, 2010 and December 31, 2009, the Company prepaid
$3,772,440 and $1,936,440, respectively, to PRC local government authorities to
purchase land use rights. The Company is in the process of negotiating the final
purchase price with the local government and the land use rights have not yet
been granted to the Company. Therefore, the Company did not amortize the amounts
prepaid for land use rights.





Advances
on the purchase of equipment and construction in progress are monies deposited
or advanced to outside vendors or subcontractors for the purchase of operating
equipment or for services to be provided for construction in
progress.




21





Refundable
security deposits are monies deposited with one of the Company’s major vendors
and a gas station landlord. These amounts will be returned to the Company if the
other party terminates the business relationship or at the end of the
lease.





Intangible
assets represent operating rights acquired during acquisition of four natural
gas stations, consisting of following:





September
      30,
              2010
              (unaudited)
            
            
            December
      31,
              2009Operating
      rights
            
            $
            4,966,193
            
            
            $
            -Land
      use rights
            
            
            2,023,883
            
            
            
            257,012Total
            
            $
            6,990,076
            
            
            $
            257,012





Note 4
– Senior Notes Payable





On
December 30, 2007, the Company entered into a securities purchase agreement with
Abax Lotus Ltd. (“Abax”) and, on January 29, 2008, the Company entered into an
amendment to such agreement with Abax (as amended, the “Purchase Agreement”).
Under the Purchase Agreement, on January 29, 2008, the Company sold to Abax
$20,000,000 in principal amount of its 5.0% Guaranteed Senior Notes due 2014
(the “Senior Notes”) and warrants to purchase 1,450,000 shares of its common
stock (the “Abax Warrants”), and on March 3, 2008, the Company issued to Abax an
additional $20,000,000 in principal amount of Senior Notes.





In
connection with the Purchase Agreement, on January 29, 2008, the Company entered
into:





·
            an
      indenture with DB Trustees (Hong Kong) Limited, as trustee (the
      “Trustee”), pursuant to which the Senior Notes were issued (the
      “Indenture”);





·
            a
      warrant agreement with Deutsche Bank AG, Hong Kong Branch, as warrant
      agent, pursuant to which the Abax Warrants were
  issued;





·
            an
      investor rights agreement with Abax, pursuant to which, among other
      things, Abax had the right to nominate a director for election to the
      Company’s board of directors so long as Abax held at least 10% of the
      outstanding shares of common stock on an as-converted, fully diluted
      basis. Abax no longer holds such amount of the Company’s common stock and
      therefore no longer has a director nomination
  right;





·
            a
      registration rights agreement with Abax, pursuant to which the Company
      agreed to file a registration statement to register the resale of the
      shares of common stock issuable upon exercise of the Abax Warrants. The
      Company filed a registration statement on Form S-1 (File No. 149719),
      which was declared effective by the Securities and Exchange Commission on
      May 6, 2008, to register the resale of the shares of common stock issuable
      upon exercise of the Abax Warrants;





·
            an
      information rights agreement with Abax, pursuant to which Abax has the
      right to receive certain information regarding the
  Company;





·
            an
      onshore share pledge agreement with DB Trustees (Hong Kong) Limited, as
      pledgee, pursuant to which the Company granted to DB Trustees (Hong Kong)
      Limited, on behalf of the holders of the Senior Notes, a pledge on 65% of
      the Company’s equity interests in its PRC subsidiary;
  and





·
            an
      account pledge and security agreement with DB Trustees (Hong Kong)
      Limited, as collateral agent, pursuant to which the Company granted to DB
      Trustees (Hong Kong) Limited a security interest in the account where the
      proceeds from the Company’s sale of the Senior Notes were
      deposited.




22




The
Senior Notes will mature on January 30, 2014 and have borne interest at a rate
of 5.0% per annum since issuance. On the dates set forth in the table below, the
Company will be required make prepayments of the corresponding percentage of
principal amount (or such lesser principal amount as shall then be outstanding)
in respect of the aggregate outstanding principal amount of the Senior Notes as
of July 30, 2011:





Date
            
            Repayment
              PercentageJuly
      30, 2011
            
            
            8.3333
            %January
      30, 2012
            
            
            8.3333
            %July
      30, 2012
            
            
            16.6667
            %January
      30, 2013
            
            
            16.6667
            %July
      30, 2013
            
            
            25.0000
            %January
      30, 2014
            
            
            25.0000
            %





The
Company has the option to redeem all, but not less than all, of the Senior Notes
at the redemption prices set forth below (in each case expressed as a percentage
of the outstanding unpaid principal amount), plus accrued and unpaid interest,
if redeemed during the twelve month period commencing on January 29 of the years
set forth below:





Year
            
            Principal2010
            
            $
            42,400,0002011
            
            
            41,600,0002012
            
            
            40,800,0002013
      and thereafter
            
            
            40,000,000





Upon the
occurrence of certain events defined in the indenture, the Company must offer
the holders of the Senior Notes the right to require the Company to purchase the
Senior Notes in an amount equal to 105% of the aggregate principal amount
purchased plus accrued and unpaid interest on the Senior Notes
purchased.





The
Company has not made any payments of principal or interest on the Senior Notes,
except as described below.





The terms
of the Indenture obligated the Company to complete a qualifying listing, as
defined therein, by January 29, 2009. As the Company did not complete a
qualifying listing by such date, the Company was obligated to pay to Abax
additional interest at the rate of 3.0% per annum, calculated from and including
January 29, 2009 to the date of its qualifying listing. However, Abax caused the
Trustee to waive the Company’s obligation to pay such additional interest in
February 2009. The waiver extended the deadline for a qualifying listing to May
4, 2009, but provided that if a qualifying listing were not completed by such
date, additional interest of 3.0% per annum would be payable from January 29,
2009 to the date of the Company’s qualifying listing. The Company completed its
NASDAQ listing, which constituted a qualifying listing, on June 1, 2009, after
the extended May 4, 2009 deadline. Therefore, under the terms of the initial
waiver, the Company was required to pay additional interest at a rate of 3.0%
per annum for the period from January 29, 2009 to June 1, 2009, or $406,667.
However, in August 2009, the Company reached an agreement with Abax whereby the
Company agreed to pay Abax $113,214, which reflected additional interest at the
rate of 3.0% per annum for the period from April 30, 2009 to May 31, 2009, and
$50,000, which reflected out-of-pocket expenses incurred by Abax in connection
with a financing transaction proposed in 2008, but never
consummated.





The
indenture limits the Company’s ability to incur debt and liens, make dividend
payments and stock repurchases, make investments, reinvest proceeds from asset
sales and enter into transactions with affiliates, among other things. The
indenture also requires the Company to maintain certain financial
ratios.





In
connection with the issuance of the Senior Notes, the Company paid $2,122,509 in
debt issuance costs, which costs are being amortized over the life of the Senior
Notes. For the three months ended September 30, 2010 and 2009, the Company
amortized $0 and $11,505 of the aforesaid issuance costs, net of capitalized
interest. For the nine months ended September 30, 2010 and 2009, the Company
amortized $0 and $63,940 of the aforesaid issuance costs, net of capitalized
interest.




23





The Abax
Warrants are presently exercisable and have an exercise price of $7.3652 per
share, although Abax has not exercised any of the Abax Warrants.





The Abax
Warrants are considered derivative instruments that need to be bifurcated from
the original security because there is a redemption requirement if the holder
does not exercise the Warrants. If Abax does not exercise the Abax Warrants
prior to their expiration date, January 29, 2015, Abax can require the Company
to repurchase the Abax Warrants for $17,500,000. This amount is shown as a debt
discount and is being amortized over the term of the Senior Notes. For the three
months ended September 30, 2010 and 2009, the Company amortized $851,719 and
$709,454 of the aforesaid discounts, of which $851,719 and $646,400,
respectively, were capitalized into construction in progress. For the nine
months ended September 30, 2010 and 2009, the Company amortized $2,424,321 and
$2,020,515 of the aforesaid discounts, of which $2,424,321 and $1,740,265,
respectively, were capitalized into construction in progress.





Note 5 - Long term
Loan





The
outstanding balance of Company’s long term bank loan as of September 30, 2010
and December 31, 2009 are as follows:





September
      30,
              2010
              (unaudited)
            
            
            December
      31,
              2009Loan
      from Pudong Development Bank Xi’an Branch, due various dates from 2012 to
      2014. Interest at 5.76% for the first year and subject to adjustment after
      the second year, secured by equipment
            
            $
            17,964,000
            
            
            $
            -





The above
loan is secured by XXNGC’s equipment and vehicles located within the PRC. The
carrying net value of the assets pledged is $12,314,211 as of September 30,
2010. Interest expense for the three months and nine months ended in September
30, 2010 were $275,996 and $488,621, respectively, all of which expenses were
capitalized into construction in progress. XXNGC also entered into a guaranty
with the lender to guaranty the repayment of the loans. The Company is required
to make mandatory repayments on the long term loan as follows:





Repayment
      Percentage
            
            
            Repayment
      AmountMarch
      5, 2012
            
            
            25
            %
            
            $
            4,491,000March
      5, 2013
            
            
            25
            %
            
            
            4,491,000March
      5, 2014
            
            
            25
            %
            
            
            4,491,000December
      5, 2014
            
            
            25
            %
            
            
            4,491,000





Note 6
– Warrants





The
following is a summary of the warrant activity:





Warrants
              Outstanding
            
            
            Weighted
      Average Exercise Price
            
            
            Aggregate
      Intrinsic ValueOutstanding,
      December 31, 2008
            
            
            1,994,242
            
            
            $
            14.28
            
            
            $
            -Granted
            
            
            -
            
            
            
            -
            
            
            
            -Forfeited
            
            
            (160,588
            )
            
            
            7.20
            
            
            
            -Exercised
            
            
            -
            
            
            
            -
            
            
            
            -Outstanding,
      December 31, 2009
            
            
            1,833,654
            
            
            $
            8.93
            
            
            $
            4,008,434Granted
            
            
            -
            
            
            
            -
            
            
            
            -Forfeited
            
            
            -
            
            
            
            -
            
            
            
            -Exercised
            
            
            -
            
            
            
            -
            
            
            
            -Outstanding,
      September 30, 2010 (unaudited)
            
            
            1,833,654
            
            
            
            8.93
            
            
            $
            -




24




The
following is a summary of the status of warrants outstanding as of September 30,
2010:





Outstanding
      WarrantsExercise
      Price
            
            
            Number
            
            
            Average
              Remaining
              Contractual
      Life7.37
            
            
            
            1,450,000
            
            
            
            4.3314.86
            
            
            
            383,654
            
            
            
            2.078.93
            
            
            
            1,833,654
            
            
            
            3.86





Note 7
– Defined Contribution Plan





The
Company is required to participate in a defined contribution plan operated by
the local municipal government in accordance with Chinese law and regulations.
The Company contributes RMB 100 per employee per month to the plan. Starting
from 2008, no minimum contribution is required but the maximum contribution
cannot be more than 14% of current salary expense. The total contribution for
the above plan was $59,584 and $53,128 for the three months ended September 30,
2010 and 2009, respectively. The total contribution for the above plan was
$308,367 and $134,207 for the nine months ended September 30, 2010 and 2009,
respectively.





Note
8 – Secondary Public Offering





On
September 9, 2009, the Company completed an underwritten public offering for
5,725,000 shares of its common stock at a price of $8.75 per share. The Company
also granted the underwriters a 30-day option to purchase up to an additional
858,750 shares to cover over-allotments at the public offering
price.





On
September 21, 2009, the Company closed the sale of an additional 858,750 shares
of common stock at the public offering price of $8.75 per share, following the
underwriters’ exercise of the over-allotment option in full.





The net
proceeds, after deducting underwriting discounts and commissions and the
relevant expenses, was approximately $54.4 million.




Note 9
– Statutory Reserve





As
stipulated by the Company Law of the PRC as applicable to PRC companies with
foreign ownership, net income after taxation can only be distributed as
dividends after appropriation has been made for the following:





·
            making
      up cumulative prior years’ losses, if
any;





·
            allocations
      to the “Statutory surplus reserve” of at least 10% of income after tax, as
      determined under PRC accounting rules and regulations, until the fund
      amounts to 50% of the Company’s registered capital;
  and





·
            allocations
      to the discretionary surplus reserve, if approved in the shareholders’
      general meeting.





As of
September 30, 2010, the remaining amount needed to fulfill the 50% registered
capital requirement was approximately $74,651,448.




25





Note
10 – Accounting for Stock-based Compensation





Options
from CEO to pay for certain Company legal expenses





On
September 22, 2007, Mr. Qinan Ji, chairman and shareholder of the Company,
transferred 50,000 of his personally-owned options to the Company’s attorney to
cover certain Company legal expenses. 30% of the options vested on September 22,
2008, 30% vested on September 22, 2009 and the remaining 40% vested on September
22, 2010. Upon termination of service to the Company, the attorney is required
to return all unvested options. These options expire June 1, 2012.





The
Company used the Black-Scholes Option Pricing Model to value the options at the
time they were issued, based on the stock price on its grant date, the stated
exercise prices and expiration dates of the instruments and using a risk-free
rate of 4.10%. The estimated life is based on one half of the sum of the vesting
period and the contractual life of the option. This is the same as assuming that
the options are exercised at the mid-point between the vesting date and
expiration date. $22,008 and $14,842 of compensation expense was recorded
during the three months ended September 30, 2010 and 2009, respectively. $66,024
and $44,527 of compensation expense was recorded during the nine months ended
September 30, 2010 and 2009, respectively.





As of
September 30, 2010, $0 of estimated expense with respect to non-vested
stock-based compensation has yet to be recognized.





2009
Stock Option and Stock Award Plan





On March
11, 2009, the Board approved by written consent the China Natural Gas, Inc. 2009
Employee Stock Option and Stock Award Plan (the “Plan”). Pursuant to the Plan,
there are currently 1,460,000 shares of Company common stock authorized for
issuance and the Company has granted 638,000 stock options as of September 30,
2010, of which 138,000 have been exercised and 75,000 have been cancelled and
are available for reissuance. Thus, there are currently 897,000 shares of
Company common stock available for future issuance under the Plan and 425,000
options outstanding. The exercise price for all of the outstanding options is
$4.90 per share.





The
Company used the Black-Scholes Option Pricing Model to value the options at the
time they were issued, based on the stock price on its grant date, the stated
exercise prices and expiration dates of the instruments and using risk-free
rates. The volatility of the Company’s common stock was estimated by management
based on the historical volatility of the Company’s common stock, the risk free
interest rate was based on Treasury Constant Maturity Rates published by the
United States Federal Reserve for periods applicable to the estimated life of
the options, and the expected dividend yield was based on the current and
expected dividend policy. The Company currently uses the “simplified” method to
estimate the expected term for share option grants as it does not have
sufficient historical experience to provide a reasonable estimate. The Company
will continue to use the “simplified” method until it feels that it has
sufficient historical experience to provide a reasonable estimate of expected
terms. The estimated life is based on one half of the sum of the vesting period
and the contractual life of the option. This is the same as assuming that the
options are exercised at the mid-point between the vesting date and expiration
date. Compensation expense of $186,211 and $1,009,291 was recorded during the
three and nine months ended September 30, 2010, respectively.





During
the nine months ended September 30, 2010, 138,000 shares of stock options have
been exercised at the exercise price of $4.90 for $676,200.





As of
September 30, 2010, $1,862,115 of estimated expense with respect to non-vested
stock-based compensation has yet to be recognized and will be recognized in
expense over the optionee’s remaining weighted average service period of
approximately 2.5 years.




26


The
following is a summary of the stock option activity:





Options
      Outstanding
            
            
            Weighted
      Average Exercise Price
            
            
            Aggregate
      Intrinsic ValueOutstanding,
      December 31, 2008
            
            
            -
            
            
            $
            -
            
            
            $
            -Granted
            
            
            318,850
            
            
            
            4.90
            
            
            
            1,983,247Forfeited
            
            
            (75,000
            )
            
            
            4.90
            
            
            
            466,500Exercised
            
            
            -
            
            
            
            -
            
            
            
            -Outstanding,
      December 31, 2009
            
            
            243,850
            
            
            $
            4.90
            
            
            $
            1,516,747Granted
            
            
            380,850Forfeited
            
            
            (61,700
            )Exercised
            
            
            (138,000
            )
            
            
            -
            
            
            
            -Outstanding,
      September 30, 2010 (unaudited)
            
            
            425,000
            
            
            $
            4.90
            
            
            $
            433,500





The
following is a summary of the status of stock options outstanding at September
30, 2010:





Outstanding
      Options
            
            
            Exercisable
      OptionsExercise
      Price
            
            
            Number
            
            
            Average
              Remaining
              Contractual
      Life
            
            
            Exercise
      Price
            
            
            Number
            
            
            Average
              Remaining
              Contractual
      Life$
            4.90
            
            
            
            425,000
            
            
            
            4.5
      years
            
            
            $
            4.90
            
            
            
            2,750
            
            
            
            4.5
      years





Note
11 – Earnings per Share





Earnings
per share for the three and nine months ended September 30, 2010 and 2009 have
been determined by dividing net income for the periods by the weighted average
number of both basic and diluted shares of common stock and common stock
equivalents outstanding. The following is an analysis of the differences between
basic and diluted earnings per common share in accordance with the FASB’s
accounting standard, and demonstrates the calculation for earnings per share for
the periods ended September 30, 2010 and 2009:





For
      the three months ended
              September
      30,
            
            
            For
      the nine months ended
              September
      30,2010
            
            
            2009
            
            
            2010
            
            
            2009(unaudited)
            
            
            (unaudited)
            
            
            (unaudited)
            
            
            (unaudited)Basic
      earnings per shareNet
      income
            
            $
            3,584,842
            
            
            $
            4,647,519
            
            
            $
            12,140,615
            
            
            $
            12,711,898Weighted
      shares outstanding – Basic
            
            
            21,321,904
            
            
            
            15,754,696
            
            
            
            21,251,882
            
            
            
            14,985,001Earnings
      per share – Basic
            
            $
            0.17
            
            
            $
            0.29
            
            
            $
            0.57
            
            
            $
            0.85Diluted
      earnings per shareNet
      income
            
            $
            3,584,842
            
            
            $
            4,647,519
            
            
            $
            12,140,615
            
            
            $
            12,711,898Weighted
      shares outstanding – Basic
            
            
            21,321,904
            
            
            
            15,754,696
            
            
            
            21,251,882
            
            
            
            14,985,001Effect
      of diluted securities – Warrants
            
            
            -
            
            
            
            385,124
            
            
            
            155,510
            
            
            
            50,171Effect
      of diluted securities – Options
            
            
            100,623
            
            
            
            -
            
            
            
            125,220
            
            
            
            -Weighted
      shares outstanding - Diluted
            
            
            21,422,527
            
            
            
            16,139,820
            
            
            
            21,532,612
            
            
            
            15,035,172Earnings
      per share - Diluted
            
            $
            0.17
            
            
            $
            0.29
            
            
            $
            0.56
            
            
            $
            0.85





The
Company had 1,833,654 outstanding warrants at September 30, 2010 and 2009. For
the three months ended September 30, 2010, all 1,833,654 outstanding warrants
were excluded from the diluted earnings per share calculation as they are
anti-dilutive. For the three months ended September 30, 2009, the average stock
price was greater than the exercise prices of the 1,450,000 warrants which
resulted in additional weighted average common stock equivalents of 385,124;
383,654 outstanding warrants were excluded from the diluted earnings per share
calculation as they are anti-dilutive. For the nine months ended September 30,
2010 and 2009, the average stock price was greater than the exercise prices of
the 1,450,000 warrants which resulted in additional weighted average common
stock equivalents of 155,510 and 50,171, respectively; 383,654 outstanding
warrants were excluded from the diluted earnings per share calculation as they
are anti-dilutive.




27





The
Company had 425,000 outstanding employee stock options at September 30, 2010.
For the three and nine months ended September 30, 2010, the average stock price
was greater than the exercise price of the options which resulted in additional
weighted average common stock equivalents of 100,663 and 125,220,
respectively.





Note
12 – Related Party Transactions





On August
31, 2010, the Company temporarily borrowed $1,347,300 from the JV for working
capital purpose. The borrowing does not have an explicit term, interest or
collateral pledged.  The balance will be due upon
demand.  The following is a summary of related party
balances:





September
      30, 2010
              (unaudited)
            
            
            December
      31, 2009Henan
      CNPC Kunlun Xilan Compressed Natural Gas Co., Ltd.
            
            $
            1,347,300
            
            
            $
            -





Note
13 – Current Vulnerability Due to Certain Concentrations





Concentration
of natural gas vendors:





Three
      months ended September 30,
            
            
            Nine
      months ended September 30,2010
            
            
            2009
            
            
            2010
            
            
            2009(unaudited)
            
            
            (unaudited)
            
            
            (unaudited)
            
            
            (unaudited)Numbers
      of natural gas vendors
            
            
            4
            
            
            
            4
            
            
            
            4
            
            
            
            4Percentage
      of total natural gas purchases
            
            
            88
            %
            
            
            99
            %
            
            
            92
            %
            
            
            99
            %





As of
September 30, 2010 and December 31, 2009, the Company had $120,767 and $82,146
payable due to its major suppliers.





The
Company maintains long-term natural gas purchase agreements with one of its
vendors as of September 30, 2010. There are no minimum purchase requirements by
the Company. Contracts are renewed on an annual basis. The Company’s management
reports that it does not expect any issues or difficulty in continuing to renew
the supply contracts with these vendors going forward.





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 economy. The Company’s business may be influenced by changes in
governmental policies with respect to laws and regulations, anti-inflationary
measures, currency conversion and remittance abroad, and rates and methods of
taxation, among other things.




28





Note
14 – Commitments and Contingencies





Lease
Commitments





The
Company recognizes lease expense on a straight-line basis over the term of the
lease in accordance with the FASB’s accounting standard regarding leases. The
Company has entered into a series of long-term lease agreements with outside
parties to lease land use rights for the Company’s CNG fueling stations located
in the PRC. The agreements have terms ranging from 10 to 30 years. The Company
makes annual prepayments for most lease agreements. The Company has also entered
into two office leases in Xi’an, PRC, one office lease in Jingbian, PRC, one
office lease in Wuhan, PRC and one office lease in New York, NY. The minimum
future payment for leasing land use rights and offices is as
follows:





Year
      ending December 31, 2010
            
            $
            1,013,923Year
      ending December 31, 2011
            
            
            2,287,605Year
      ending December 31, 2012
            
            
            2,087,487Year
      ending December 31, 2013
            
            
            2,001,803Year
      ending December 31, 2014
            
            
            2,405,727Thereafter
            
            
            35,726,814Total
            
            $
            45,523,359





For the
three months ended September 30, 2010 and 2009, the land use right and office
lease expenses were $671,781 and $411,452, respectively. For the nine months
ended September 30, 2010 and 2009, the land use right and office lease expenses
were $1,508,194 and $1,209,549, respectively.




Property
and Equipment Purchase Commitments





The
Company has purchase commitments for materials, supplies, services and property
and equipment for constructing the LNG plant and other construction projects.
The Company has future commitments as follows:





Year
      ending December 31, 2010
            
            $
            18,931,831Year
      ending December 31, 2011
            
            
            390,717Thereafter
            
            
            -Total
            
            $
            19,322,548





Natural
Gas Purchase Commitments





The
Company has existing long-term natural gas purchase agreements with its major
suppliers. However, none of those agreements stipulate any specific purchase
amount or quota each year, thus giving the Company enough flexibility to
constantly look for lower-cost sources of supply. Therefore, the Company is not
legally bound in purchase commitments by those agreements.





Legal
Proceedings




The
Company and certain of its officers and directors were recently named as
defendants in two putative class action lawsuits alleging violations of the
federal securities laws. The first action,
captioned Vandevelde v. China
Natural Gas, Inc., et al., C.A. No. 10-728, was filed on August 26, 2010
in the United States District Court for the District of Delaware. The second
action, captioned Baranowski
v. China Natural Gas, Inc., et al., Case No. 10-6572, was filed on
September 3, 2010 in the United States District Court for the Southern District
of New York.
The plaintiffs in these actions assert that the Company, Qinan Ji, Zhiqiang
Wang, Donald Yang, David She, Carl Yeung and Lawrence Leighton violated Section
10(b) of the Securities Exchange Act of 1934, and Rule 10b-5 thereunder, when
the Company failed to disclose and properly account for a certain bank loan in
its Annual Report on Form 10-K for the year ended December 31, 2009 and
Quarterly Report on Form 10-Q for the quarter ended March 31, 2010. The
complaints allege that the pledge to secure that loan violated the indenture for
the Senior Notes and the warrant agreement relating to the Abax Warrants, giving
the holder of those notes and warrants the right to declare a default under that
indenture. The complaints further allege that, on August 20, 2010, the Company
amended its Annual Report on Form 10-K for the year ended December 31, 2009 and
Quarterly Report on Form 10-Q for the quarter ended March 31, 2010 to disclose
the loan and restate its financial statements in light of the note and warrant
holder’s right to declare a default under the indenture, and that the
announcement of this news caused the price of the Company’s stock to drop by
twenty percent. The plaintiffs seek damages in an unspecified amount to recover
the losses purportedly suffered by the putative class as a result of that
decline. The complaints also assert claims against the individual defendants as
controlling persons of the Company for violations of Section 20(a) of the
Securities Exchange Act of 1934.




29




Two
putative class members in the Vandevelde action have moved
for appointment as lead plaintiff. After the Court decides those motions,
the putative class member who is appointed lead plaintiff will have an
opportunity to file an amended complaint. Defendants will not be required to
answer or otherwise respond to the complaint until after lead plaintiff either
decides to proceed on the basis of the original complaint or files an amended
complaint.




The
Company currently cannot estimate the outcome of this litigation as of the date
of this report.




Note
15 – Business Combination





On May
29, 2010, Hubei Xilan agreed to purchase 100% of the equity interests of Makou
from eight individuals for a purchase price of $3,648,080.  Makou owns
and operates a CNG compressor station in Hanchuan City, Hubei Province, and
purchases natural gas from pipelines, conducts compressing and sells natural gas
on a wholesale basis through tankers to fueling stations in Hubei
Province. In July 2010, Hubei Xilan obtained full control of Makou’s
assets, operations and financial policies.





Effective
January 1, 2009, the Company adopted the FASB’s accounting standard related
to business combinations, which requires the acquisition method of accounting to
be used for all business combinations and for an acquirer to be identified for
each business combination. This accounting standard requires an acquirer to
recognize the assets acquired, the liabilities assumed and any noncontrolling
interest in the acquiree at the acquisition date, measured at their fair values
as of that date, with limited exceptions. It also requires the acquirer in a
business combination achieved in stages (sometimes referred to as a step
acquisition) to recognize the identifiable assets and liabilities, as well as
the noncontrolling interest in the acquiree, at the full amounts of their fair
values (or other amounts determined in accordance with the
standard).





The
Company’s acquisition of Makou was accounted for in accordance with this
standard and the Company has allocated the purchase price of Makou based upon
the fair value of the net assets acquired and liabilities assumed at the
acquisition date.  The Company estimated the fair values of the assets
acquired and liabilities assumed at the acquisition date in accordance with the
business combination standard issued by the FASB and, except for cash and cash
equivalents, fair value was estimated using Level 3 inputs under the FASB’s
accounting standard related to fair value measurements. Level 3 inputs for the
nonfinancial assets included a valuation report (prepared by a third party
appraisal firm) that primarily utilized a cost approach valuation
technique.





In
accordance with the FASB’s accounting standard related to goodwill and other
intangible assets, indefinite lived intangibles and goodwill are not being
amortized.





The
following table summarizes the net book value and the fair value of the assets
acquired and liabilities assumed at the date of acquisition, which represents
the purchase price allocation at the date of the acquisition of Makou based on a
valuation report prepared by a third party appraisal firm:





Net
      Book Value
            
            
            Fair
      ValueCurrent
      assets
            
            $
            -
            
            
            $
            -Property,
      plant and equipment, net
            
            
            1,241,992
            
            
            
            1,241,992Land
      use rights
            
            
            1,817,567
            
            
            
            1,817,567Other
      non-current assets
            
            
            -
            
            
            
            -Goodwill
            
            
            -
            
            
            
            598,800Total
      assets
            
            
            3,059,559
            
            
            
            3,658,359Total
      liabilities
            
            
            -
            
            
            
            -Net
      assets
            
            $
            3,059,559
            
            
            $
            3,659,359




30




The
Company determined the $3.6 million fair value of the acquired assets of Makou
based on an evaluation by an independent appraisal and the final asset
evaluation by management.  The excess of the purchase price of an
acquired entity over the net of the amounts assigned to assets acquired and
liabilities assumed is recognized as goodwill, and represents intangible values
that Makou has built over its existing profitable business, which do not qualify
for separate recognitions, or other factors. These values include but are not
limited to:





●
            expected
      synergies from expanding our market share in the natural gas
      industry;





●
            the
      existing reputation of the current management
  team;





●
            the
      experience of the work force;





●
            the
      stable relationship with its existing
suppliers





●
            the
      existing operating licenses of shortening our time of starting up a brand
      new mother station.




As a
result, the $0.6 million of goodwill was due to the acquisition purchase price
over the fair value of the assets acquired.  As of September 30, 2010,
the Company did not record any impairment charge from write-downs
of  purchased intangible assets since the Company did not identify any
trends that caused a reduction in expected future cash flows.




Note
16 - Subsequent Event





One of
the Company’s CNG fueling station, Kejiliu Road CNG station in Xi’an City, is
expected to be demolished before the end of 2010 due to government construction.
The Company has agreed with the Xi’an High Tech Industrial Development
Administration Office to accept $97,508 in compensation for this CNG
station.  A loss of $18,087 is expected to be recognized due to this
event.





The
Company has performed an evaluation of subsequent events through the date these
consolidated financial statements were issued to determine whether the
circumstances warranted recognition and disclosure of those events or
transactions in the consolidated financial statements as of September 30,
2010.


31


Item
2.  Management’s Discussion and Analysis of Financial Condition and
Results of Operations





Special
Note About Forward-Looking Statements





This
Quarterly Report contains statements that are forward-looking and, as such, are
not historical facts. Rather, these statements constitute projections, forecasts
and forward-looking statements within the meaning of the Private Securities
Litigation Reform Act of 1995. These statements are not guarantees of
performance. They involve known and unknown risks, uncertainties, assumptions
and other factors which may cause the actual results, performance or
achievements of the Company to be materially different from any future results,
performance or achievements expressed or implied by these statements. Such
statements can be identified by the fact that they do not relate strictly to
historical or current facts. These statements use words such as “believe,”
“expect,” “should,” “strive,” “plan,” “intend,” “estimate,” “anticipate” or
similar expressions. When the Company discusses its strategies or plans, it is
making projections, forecasts or forward-looking statements. Actual results and
stockholders’ value will be affected by a variety of risks and factors,
including, without limitation, the recent crisis in worldwide financial markets,
international, national and local economic conditions, merger, acquisition and
business combination risks, financing risks, geo-political risks, and acts of
terror or war. Many of the risks and factors that will determine these results
and stockholder values are beyond the Company’s ability to control or predict.
These statements are necessarily based upon various assumptions involving
judgment with respect to the future. You should carefully read the risk factor
disclosure contained in “Item 1A. Risk Factors” of our Annual Report
on Form 10-K for the year ended December 31, 2009, as amended, where many
of the important factors currently known to management that could cause actual
results to differ materially from those in our forward-looking statements are
discussed.





All such
forward-looking statements speak only as of the date of this Quarterly Report.
The Company is under no obligation to, nor does it intend to, release publicly
any updates or revisions to any forward-looking statements contained herein to
reflect any change in the Company’s expectations with regard thereto or any
change in events, conditions or circumstances on which any such statement is
based.





Overview





We are an
integrated natural gas operator in The People’s Republic of China (“China” or
the “PRC”), primarily involved in distribution of compressed natural gas (“CNG”)
through our variable interest entity (“VIE”) owned CNG fueling stations. As of
September 30, 2010, our VIE operated 27 CNG fueling stations in Shaanxi Province
and 12 CNG fueling stations in Henan Province. Our VIE owns the CNG fueling
stations while we lease the land upon which our VIE owned CNG fueling stations
operate. For the three and nine months ended September 30, 2010, we sold
42,291,708 and 125,840,032 cubic meters of CNG through our fueling stations,
compared to 40,420,123 and 120,866,756 cubic meters for the three and nine
months ended September 30, 2009. Our VIE also transports, distributes and sells
piped natural gas to residential and commercial customers in the city of Xi’an
in Shaanxi Province, including Lantian County, and the districts of Lintong and
Baqiao, and in the city of Lingbao in Henan Province.





We are
pursuing multiple synergistic avenues of expansion through our VIE, Xi’an Xilan
Natural Gas Co., Ltd. (“XXNGC”) and XXNGC’s subsidiaries, all of which are based
in the PRC. We intend to:





·
            enter
      the liquefied natural gas (“LNG”) business through the construction of a
      LNG production facility in  Jingbian Country, Shaanxi Province,
      and LNG fueling stations in Shaanxi and Hubei
  Provinces;





·
            capitalize
      on opportunities arising from the Yangtze River shipping trade by
      expanding into Hubei Province through the construction of LNG fueling
      stations located in harbors along the Yangtze River, inland LNG fueling
      stations and reserve LNG stations, as well as continued development of
      conversion technology and operations to modify river vessels to run on a
      mixture of LNG and diesel; and





·
            continue
      to grow our CNG business in Shaanxi and Henan Provinces by adding to our
      network of CNG fueling stations, and expand our CNG business into Hubei
      Province.




32




For
additional information regarding these expansion initiatives, see “Recent Developments”
below.





Current
Operations





We
currently operate four main business lines:





·
            distribution
      and sale of compressed natural gas through our VIE owned CNG fueling
      stations for hybrid (natural gas/gasoline) powered vehicles (39 stations
      as of September 30, 2010);





·
            installation,
      distribution and sale of piped natural gas to residential and commercial
      customers through our VIE owned pipelines. We distributed and sold piped
      natural gas to 114,049 residential customers as of September 30,
      2010;





·
            distribution
      and sale of gasoline through our VIE owned CNG fueling stations for
      gasoline and hybrid (natural gas/gasoline) powered vehicles (eight of our
      VIE owned CNG fueling stations sold gasoline as of September 30, 2010);
      and





·
            conversion
      of gasoline-fueled vehicles to hybrid (natural gas/gasoline) powered
      vehicles at our automobile conversion
sites.





We buy
all of the natural gas that we sell and distribute to our customers. We do not
mine or produce any of our own natural gas. We currently sell our natural gas in
two forms: (i) CNG and (ii) piped natural gas.





We had
total revenues of $22,326,474 and $20,125,184 for the three months ended
September 30, 2010 and 2009, respectively, and revenues of $62,828,896 and
$59,395,370 for the nine months ended September 30, 2010 and 2009 respectively.
We had net income of $3,584,842 and $4,647,519 for the three months ended
September 30, 2010 and 2009, respectively, and net income of $12,140,615 and
$12,711,898 for the nine months ended September 30, 2010 and 2009,
respectively.





Recent
Developments





LNG
Business


On
September 2, 2010, we announced the completion of our first LNG fueling station.
The station is located in Hongqing District, Xi'an, and we believe it is the
first LNG fueling station in Shaanxi Province. The LNG fueling station will
initially serve as a working model to showcase the market potential of LNG to
future users rather than to generate revenues.




On June
30, 2010, we commenced the test run of phase I of our LNG plant in Jingbian
County, Shaanxi Province, which, when operational, will have a processing
capacity of 500,000 cubic meters per day, or approximately 150 million cubic
meters on an annual basis. As of September 30, 2010, we had invested $61.9
million in phase I of this project. We expect to invest an additional
approximately $6.6 million in phase I of our LNG plant, including $4.4 million
for construction costs and $2.2 million in capitalized interest, to complete
test runs and satisfy installment payments to contractors. The total expected
cost of $68.5 million is more than we anticipated. The increased costs to
achieve LNG processing capacity of 500,000 cubic meters are attributable to
unforeseen cost overruns and escalations, including increases in material and
labor costs incurred to reinforce pilings based upon modified engineering
analyses, as well as rising land prices, which we believe resulted from recent
energy resource exploration activities in nearby areas. Phase I construction has
also experienced delays due to changes in government policies with respect to
tariff exemptions for core equipment imported by us and related additional
document requirements of the customs agency of Shaanxi Province, and increased
international shipment times for ordered equipment due to the modification by
international shippers of traditional shipment routes to avoid pirates along the
coast of Somalia, both of which prolonged the delivery time for equipment we
ordered from outside China.





In
addition, as of September 30, 2010, we had invested $18.2 million for the
construction of phases II and III of the Jingbian LNG plant. We currently
estimate that an investment in phases II and III of $224.6 million through
December 2015 would finance the construction of a facility capable of processing
3,000,000 cubic meters of LNG per day, or approximately 900 million cubic meters
per year. We have not made a final determination regarding the processing
capacity for phases II and III.





We plan
to begin commercial production of LNG following our completion of the test run
of phase I of the Jingbian LNG plant. The remaining aspects of the test run,
which we aim to complete in December 2010, include testing the operation of
various components and equipment of phase I of the plant. The launch of
operations will serve as a precursor to our forward integration strategy, which
involves the development of our own network of LNG fueling stations in Shaanxi
and Hubei Provinces.




33





Hubei
Province and Yangtze River





In April
2010, we received approval from local government authorities in Hubei Province
to build inland LNG fueling stations, LNG fueling stations in harbors along the
Yangtze River and reserve LNG stations. In addition, during the third quarter of
2010, we completed the acquisition of Hanchun Makou Yuntong Compressed Natural
Gas Co., Ltd. (“Makou”) for a purchase price of $3,648,080. Makou owns and
operates a CNG compressor station in Hanchuan City, Hubei Province, and
purchases natural gas from pipelines, conducts compressing and sells natural gas
on a wholesale basis through tankers to fueling stations in Hubei
Province. We believe the Makou acquisition laid the foundation for
expanding our CNG business into Hubei Province. Makou’s compressor station
currently has sufficient capacity to process 80,000 to 100,000 cubic meters of
natural gas daily and is centrally located near rail lines and arterial
roadways.





We are
also seeking to develop market demand for natural gas in the Yangtze River
shipping industry by leveraging our automobile conversion know-how to develop
conversion technology and operations to modify river vessels to run on a mixture
of LNG and diesel. In August 2010, a tugboat modified by us to operate on 70%
LNG and 30% diesel completed its maiden voyage on the Yangtze River, which we
believe was the first time an LNG-powered ship has navigated China’s domestic
waterways.





Shaanxi
and Henan Provinces





During
the second quarter of 2010, XXNGC effectively acquired 100% of the assets and
operating rights of four CNG fueling stations in Xi’an, Shaanxi Province, for
aggregate cash consideration of $10,502,490, and, during the third quarter of
2010, we closed one CNG fueling station in Shaanxi Province. Accordingly, as of
September 30, 2010, XXNGC operated 27 CNG fueling stations in Shaanxi Province
and 12 CNG fueling stations in Henan Province.





Factors
Affecting Our Results of Operations





Significant
factors affecting our results of operations are:





Successful
expansion of our CNG business.  Our revenue increased by 10.9%
during the three months ended September 30, 2010 from the three months ended
September 30, 2009 and by 5.8% during the nine months ended September 30, 2010
from the nine months ended September 30, 2009 largely due to increased CNG sales
driven by the addition of four new CNG fueling stations in Xi’an in the second
quarter of 2010 and one new CNG fueling station in Xi’an in the third quarter of
2009, and larger piped natural revenue as a result of our acquisition of Makou
in the third quarter of 2010. As of September 30, 2010, we operated 39 CNG
fueling stations in total, with 27 CNG fueling stations in Shaanxi Province
alone. The successful expansion of our CNG fueling station business in Xi’an and
Henan Province has been a significant factor driving our revenue growth and
results of operations for the period reviewed. While we intend to expand into
different provinces, we anticipate the growth of our CNG fueling business in
Xi’an and Henan province will continue to significantly affect our results of
operations as we intend to continue to increase the number of CNG fueling
stations we operate in these areas.





Regulation of
natural gas prices in the PRC.  The prices at which we purchase
our natural gas supplies and sell CNG and pipeline natural gas products are
strictly regulated by the PRC central government, including the National
Development and Reform Commission (“NDRC”), and the local state price bureaus
have the discretion to set natural gas prices within the price band set by the
PRC central government. In the
last two to three years, the trend has been for consumer prices to remain
relatively unchanged and for procurement costs to increase, which has resulted
in lower gross margins for us. In addition, natural gas procurement and
sale prices are not uniform across China and can vary across provinces. For
example, the prices at which we procure and sell CNG and piped natural gas are
lower in Shaanxi Province than in Henan Province. Accordingly, our results of
operations and, in particular, our revenue, cost of revenue and gross profit and
gross margin are affected significantly by factors which are outside of our
control. As we expand our natural gas business into other provinces, we expect
our results of operations to continue to be affected significantly by the
regulation of natural gas prices in the PRC.




34





Government
policies encouraging the adoption of cleaner burning
fuels.  Our results of operations for the periods covered by
this report have benefited from environmental regulations and programs in the
PRC that promote the use of cleaner burning fuels, including natural gas for
vehicles. As an enterprise engaged in the natural gas industry, our VIE, XXNGC,
benefits from a reduced income tax rate of 15% compared to the standard 25%
enterprise income tax rate in the PRC. In addition, the PRC government has
encouraged companies to invest in and build the necessary transportation,
distribution and sale infrastructure for natural gas in various policy
pronouncements such as by officially including CNG/gasoline hybrid vehicles in
the country’s “encouraged development” category. These policies have benefited
our results of operations by encouraging the demand for our natural gas products
and also by lowering our expenses. As we plan to expand into the LNG business,
we anticipate that our results of operations will continue to be affected by
government policies encouraging the adoption of cleaner burning fuels and the
increased adoption of CNG and LNG technology.





The overall
economic growth of China’s economy.We do not export
our products outside China and our results of operations are thus substantially
affected by the growth of the industrial base, the increase in residential,
commercial and vehicular consumption and the overall economic growth of China.
Although the government has initiated extensive domestic stimulus spending,
expanded bank lending, increased the speed of regulatory approvals of new
construction projects and other economic policies, we are currently unable to
predict the overall direction of the PRC economy. Our results of operations will
continue to be impacted by macro-economic trends in China and the global
economy.





Taxation





Our
effective income tax rate for the three months ended September 30, 2010 and 2009
were approximately 18.9% and 17.7%, respectively. Our effective income tax rate
for the nine months ended September 30, 2010 and 2009 were approximately 18.3%
and 20.0%, respectively.





United
States.  We are incorporated in the State of Delaware and are
subject to the tax laws of the United States. We incurred a net operating loss
for income tax purposes for the period ended September 30, 2010, and the
estimated net operating loss carry forwards for United States income tax
purposes amounted to $3,420,655 and $2,699,276 as of September 30, 2010 and
December 31, 2009, respectively, which may be available to reduce future years’
taxable income. These carry forwards will expire, if not utilized, beginning in
2027 through 2030. Our management believes that the realization of the benefits
arising from this loss appear to be uncertain due to our Company’s limited
operating history and continuing losses for United States income tax purposes.
Accordingly, we have provided a 100% valuation allowance at September 30,
2010.





The PRC.Our PRC
subsidiary, XXNGC and XXNGC’s subsidiaries operate in China. Starting January 1,
2008, pursuant to the tax laws of China, general enterprises are subject to
income tax at an effective rate of 25% compared to 33% prior to 2008. However,
under PRC tax regulation, any company deemed to be engaged in the natural gas
industry under such regulation enjoys a reduced income tax rate. Thus, XXNGC’s
income is subject to a reduced tax rate of 15%. Our PRC subsidiary and all of
XXNGC’s subsidiaries are not deemed to be engaged in the natural gas industry
under PRC income tax regulation and, accordingly, are subject to a 25% income
tax rate.





Value Added Tax.Sales revenue represents the invoiced value of goods, net of a
value-added tax (“VAT”). The products of our VIE, XXNGC, and two of XXNGC’s
subsidiaries, Lingbao Yuxi Natural Gas co., Ltd. (“Lingbao Yuxi”) and Makou,
that are sold in the PRC are subject to a PRC VAT at a rate of 13% of the gross
sales price. This VAT may be offset by VAT paid by XXNGC or Lingbao Yuxi, as
applicable, on raw materials and other materials included in the cost of
producing their finished products. XXNGC recorded VAT payable and VAT receivable
net of payments in the financial statements. The VAT tax return is filed
offsetting the payables against the receivables.





All
revenues from XXNGC’s subsidiary Xi’an Xilan Auto Body Shop Co., Ltd. are
subject to a PRC VAT at a rate of 6%. This VAT cannot offset with VAT paid for
materials included in the cost of revenues.





35





Results
of Operations for the Three Months Ended September 30, 2010 Compared to Three
Months Ended September 30, 2009





The
following table represents the consolidated operating results for the three
month period ended September 30, 2010 and 2009:





Three
      Months Ended
              September
      30,2010
            
            
            2009(unaudited)
            
            
            (unaudited)RevenueNatural
      gas revenue
            
            $
            17,836,178
            
            
            $
            15,454,386Gasoline
      revenue
            
            
            1,904,357
            
            
            
            1,633,478Installation
      and others
            
            
            2,585,939
            
            
            
            3,037,320Total
      revenues
            
            
            22,326,474
            
            
            
            20,125,184Cost
      of revenuesNatural
      gas cost
            
            
            9,904,265
            
            
            
            7,536,188Gasoline
      cost
            
            
            1,798,825
            
            
            
            1,534,806Installation
      and others
            
            
            1,234,189
            
            
            
            1,336,498Total
      cost of revenues
            
            
            12,937,279
            
            
            
            10,407,492Gross
      profit
            
            
            9,389,195
            
            
            
            9,717,692Operating
      expensesSelling
      expenses
            
            
            3,663,654
            
            
            
            2,668,175General
      and administrative expenses
            
            
            1,732,058
            
            
            
            1,160,587Total
      operating expenses
            
            
            5,395,712
            
            
            
            3,828,762Income
      from operations
            
            
            3,993,483
            
            
            
            5,888,930Non-operating
      income (expense)Interest
      income
            
            
            49,403
            
            
            
            7,248Interest
      expense
            
            
            -
            
            
            
            (68,407
            )Other
      income (expense), net
            
            
            (18,914
            )
            
            
            178,728Change
      in fair value of warrants
            
            
            449,820
            
            
            
            (357,979
            )Foreign
      currency exchange gain (loss)
            
            
            (54,167
            )
            
            
            280Total
      non-operating income (expense)
            
            
            426,142
            
            
            
            (240,130
            )Income
      before income tax
            
            
            4,419,625
            
            
            
            5,648,800Provision
      for income tax
            
            
            834,783
            
            
            
            1,001,281Net
      income
            
            $
            3,584,842
            
            
            $
            4,647,519




36


Sales
Revenues





The
following table sets forth a breakdown of our revenues for the period
indicated:





Three
      months ended
              September
      30,
              2010
              (Unaudited)
            
            
            Three
      months ended
              September
      30,
              2009
              (Unaudited)
            
            
            Change
      in dollar amount
            
            
            Change
      in percentageNatural
      gasNatural
      gas from fueling stations
            
            $
            15,697,918
            
            
            $
            14,789,924
            
            
            $
            907,994
            
            
            
            6.1
            %Natural
      gas from pipelines
            
            
            2,138,260
            
            
            
            664,462
            
            
            
            1,473,798
            
            
            
            221.8
            %Gasoline
            
            
            1,904,357
            
            
            
            1,633,478
            
            
            
            270,879
            
            
            
            16.6
            %Installation
      and othersInstallation
            
            
            2,199,580
            
            
            
            2,415,550
            
            
            
            (215,970
            )
            
            
            (8.9
            %)Automobile
      conversion
            
            
            386,359
            
            
            
            621,770
            
            
            
            (235,411
            )
            
            
            (37.9
            %)Total
            
            $
            22,326,474
            
            
            $
            20,125,184
            
            
            $
            2,201,290
            
            
            
            10.9
            %





Overall.  Total
revenue for the three months ended September 30, 2010 increased to $22,326,474
from $20,125,184 for the three months ended September 30, 2009, an increase of
$2,201,290 or 10.9 %, due to the reasons discussed below. We sold a total of
49,169,035 cubic meters of natural gas during the three months ended September
30, 2010 compared to a total of 43,209,817 cubic meters during the three months
ended September 30, 2009. For the three months ended September 30, 2010, 88.4%
of our revenue was generated from the sale of natural gas and gasoline, and the
remaining 11.6% was generated from our installation and automobile conversion
services.





Natural Gas from Fueling
Stations.  Natural gas revenue from our fueling stations
increased by 6.1%, or $907,994, to $15,697,918 during the three months ended
September 30, 2010 from $14,789,924 during the three months ended September 30,
2009, and contributed 70.3% of our total revenue, the largest of our four major
business lines. The increase in natural gas revenue was primarily due to the
addition of four new fueling stations during the second quarter of 2010 and one
new fueling station in the third quarter of 2009, offset by the closed one
fueling station during the third quarter of 2010. During the three months ended
September 30, 2010, we sold 42,291,708 cubic meters of compressed natural gas
through our fueling stations compared to 40,420,123 cubic meters during the
three months ended September 30, 2009. In the three months ended September 30,
2010, the average revenue of our fuel stations was $402,511 and the average
sales volume was 1,084,403 cubic meters of compressed natural gas per station,
compared to approximately $418,622 and 1,144,074 cubic meters in the three
months ended September 30, 2009. The reason for the decline in per station sales
was primarily due to the construction of main subway lines in Xi’an, which
caused certain bus routes to deviate from our stations and resulted in decreased
sales. During the three months ended September 30, 2009, unit selling price was
$0.34 (RMB 2.33) and $0.46 (RMB 3.10) net of VAT in Shaanxi and Henan Provinces,
respectively, or $0.38 (RMB 2.54) on an average basis,  compared to
unit selling price of $0.34 (RMB 2.33) and $0.42 (RMB 2.83) net of VAT in
Shaanxi and Henan Provinces, respectively, or $0.37 (RMB 2.50) on an average
basis during the three months ended September 30, 2009.





Natural Gas from
Pipelines.  Natural gas revenue from our pipelines increased by
221.8%, or $1,473,798, to $2,138,260 during the three months ended September 30,
2010 from $664,462 during the three months ended September 30, 2009, and
contributed 9.6% of our total revenue.  As of September 30, 2010, we
had 114,049 pipeline customers, an increase of 6,776 customers compared to
107,273 customers as of September 30, 2009. We sold 6,877,328 cubic meters of
natural gas through our pipelines during the three months ended September 30,
2010 compared to 2,789,694 cubic meters during the three months ended September
30, 2009.  The increase was primarily due to the 3,001,780 cubic
meters of natural gas sold through Makou, which started to contribute revenue in
August 2010.





Gasoline.  Revenue
from gasoline sales increased by 16.6 %, or $270,879, to $1,904,357 during the
three months ended September 30, 2010 from $1,633,478 during the three months
ended September 30, 2009, and contributed 8.5% of our total revenue. The
gasoline revenue increase was primarily due to an increase of 9.3% in the unit
sales price from $0.69 (RMB 4.73) per liter in the three months ended September
30, 2009 to $0.76 (RMB 5.15) per liter in the three months ended September 30,
2010 and a 6.2% increase in sales volume from 2,357,490 liters to 2,502,600
liters.





37





Installation
Services.  Revenue from installation services decreased by
8.9%, or $215,970, to $2,199,580 during the three months ended September 30,
2010 from $2,415,550 during the three months ended September 30, 2009, and
contributed 9.9% of our total revenue. We believe the decrease was primarily due
to a slowdown in the property market, which led to a decrease in demand for
installation services.





Automobile Conversion
Services.  Revenue from our automobile conversion division
decreased by 37.9%, or $235,411, to $386,359 during the three months ended
September 30, 2010 from $621,770 during the three months ended September 30,
2009, and contributed 1.7% of our total revenue.  We believe the
decrease was primarily due to an increasing percentage of CNG vehicles that have
already undergone conversion, as well as increased market
competition.





Cost
of Revenue





The
following table sets forth a breakdown of our cost of revenue for the periods
indicated:





Three
      months ended
              September
      30,
              2010
              (Unaudited)
            
            
            Three
      months ended
              September
      30,
              2009
              (Unaudited)
            
            
            Change
      in dollar amount
            
            
            Change
      in percentageNatural
      gasNatural
      gas from fueling stations
            
            $
            8,393,038
            
            
            $
            7,075,387
            
            
            $
            1,317,651
            
            
            
            18.6
            %Natural
      gas from pipelines
            
            
            1,511,227
            
            
            
            460,801
            
            
            
            1,050,426
            
            
            
            228.0
            %Gasoline
            
            
            1,798,825
            
            
            
            1,534,806
            
            
            
            264,019
            
            
            
            17.2
            %Installation
      and othersInstallation
            
            
            992,319
            
            
            
            972,146
            
            
            
            20,173
            
            
            
            2.1
            %Automobile
      conversion
            
            
            241,870
            
            
            
            364,352
            
            
            
            (122,482
            )
            
            
            (33.6
            %)Total
            
            $
            12,937,279
            
            
            $
            10,407,492
            
            
            $
            2,529,787
            
            
            
            24.3
            %





Overall.  Our cost
of revenue consists of the cost of natural gas and gasoline sold, installation
costs and other costs. Cost of natural gas and gasoline sold consists of the
cost for purchases from our suppliers. Cost of installation and other costs
include certain expenditures for connecting our customers to our pipeline
system, and the cost for converting gasoline-fueled vehicles into natural gas
hybrid vehicles.





Our cost
of revenue for the three months ended September 30, 2010 was $12,937,279, an
increase of $2,529,787, or 24.3%, from $10,407,492 for the three months ended
September 30, 2009. The increase was mainly attributable to an increase in
procurement cost in Henan Province. Our revenue increased by 10.9% during the
same period.





Natural Gas from Fueling
Stations.  Cost of revenue of our natural gas for our fueling
stations increased by 18.6%, or $1,317,651, to $8,393,038 during the three
months ended September 30, 2010 compared to $7,075,387 during the three months
ended September 30, 2009. The procurement price for natural gas in Shaanxi
increased from $0.16 (RMB 1.12) per liter in the three months ended September
30, 2009 to $0.17 (RMB 1.14) per liter in the three months ended September 30,
2010.  In Henan Province, the average procurement price for natural
gas increased from $0.19 (RMB 1.30) during the third quarter of 2009 to $0.27
(RMB 1.83) in the third quarter of 2010, as we continued our gradual shift from
coal bed methane as a source of supply for our fueling stations to regular
natural gas due to uncertainty in the market supply of coal bed methane as well
as the increased market demand for both coal bed methane and natural
gas.  The procurement prices in Henan Province, however, remained
significantly below the natural gas retail price of $0.46 (RMB 3.10) in Henan
Province for both the three month period ended September 30, 2009 and the three
month period ended September 30, 2010.




38





Natural Gas from
Pipelines.  Cost of revenue of our natural gas sold through our
pipelines increased by 228.0%, or $1,050,426, to $1,511,227 during the three
months ended September 30, 2010 compared to $460,801 during the three months
ended September 30, 2009, which was in line with the  increase in
sales revenue for natural gas from pipelines.





Gasoline.  Cost of
our gasoline revenue increased by 17.2%, or $264,019, to $1,798,825 during the
three months ended September 30, 2010 from $1,534,806 for the three months ended
September 30, 2009. The increase of cost of gasoline revenue was primarily due
to the increase in average procurement cost per liter of $0.65 (RMB 4.45) during
the three months ended September 30, 2009 compared to $0.71 (RMB 4.86) per liter
during the three months ended September 30, 2010, which we believe was mainly
attributable to an increase in international oil prices.





Installation
Services.  Cost of revenue from our installation services
increased by 2.1%, or $20,173, to $992,319 during the three months ended
September 30, 2010 compared to $972,146 during the three months ended September
30, 2009, mainly due to the increased cost of labor and materials, such as
natural gas pipe fittings and meters.





Automobile Conversion
Services.  Cost of our automobile conversion revenue decreased
by 33.6%, or $122,482, to $241,870 during the three months ended September 30,
2010 compared to $364,352 during the three months ended September 30, 2009,
which was in line with the decrease in sales revenue from automobile conversion
services.





Gross
profit





The
following table sets forth a breakdown of our gross profit for the periods
indicated:





Three
      months ended
              September
      30,
              2010
              (Unaudited)
            
            
            Three
      months ended
              September
      30,
              2009
              (Unaudited)
            
            
            Change
      in dollar amount
            
            
            Change
      in percentageNatural
      gasNatural
      gas from fueling stations
            
            $
            7,304,880
            
            
            $
            7,714,537
            
            
            $
            (409,657
            )
            
            
            (5.3
            %)Natural
      gas from pipelines
            
            
            627,033
            
            
            
            203,661
            
            
            
            423,372
            
            
            
            207.9
            %Gasoline
            
            
            105,532
            
            
            
            98,672
            
            
            
            6,860
            
            
            
            7.0
            %Installation
      and othersInstallation
            
            
            1,207,261
            
            
            
            1,443,404
            
            
            
            (236,143
            )
            
            
            (16.4
            %)Automobile
      conversion
            
            
            144,489
            
            
            
            257,418
            
            
            
            (112,929
            )
            
            
            (43.9
            %)Total
            
            $
            9,389,195
            
            
            $
            9,717,692
            
            
            $
            (328,497
            )
            
            
            (3.4
            %)





We earned
a gross profit of $9,389,195 for the three months ended September 30, 2010, a
decrease of $328,497, or 3.4%, compared to $9,717,692 for the three months ended
September 30, 2009. Gross profit decreased primarily due to increased
procurement costs of natural gas for fueling stations in Henan
Province.





Gross
margin





Gross
margin for natural gas sold through our fueling stations decreased from 52.2% in
the three months ended September 30, 2009 to 46.5% in the three months ended
September 30, 2010, primarily due to increased procurement cost of natural gas
for fueling stations in Henan Province.





Gross
margin for natural gas sold through pipelines was 29.3% during the three months
ended September 30, 2010, as compared to 30.7% during the three months ended
September 30, 2009. The 1.4% decrease was primarily due to increased natural gas
procurement cost in Lingbao.





Gross
margin for gasoline sales was 6.0% during the three months ended September 30,
2009 and 5.5% during the three months ended September 30, 2010, respectively.
The decrease was primarily due to a greater increase in gasoline procurement
price compared with the increase in gasoline retail prices.




39




Gross
margin for our installation business was 54.9% in the three months ended
September 30, 2010 compared to 59.8% in the three months ended September 30,
2009. The decrease of 4.9% was primarily due to increased cost of labor and
materials.





Gross
margin for our automobile conversion business decreased from 41.4% in the three
months ended September 30, 2009 to 37.4% in the three months ended September 30,
2010. The decrease of 4.0% was primarily due to increasing competition and
decreasing conversion price.





Due to
higher procurement cost of natural gas for fueling stations in Henan Province,
our total gross margin decreased from 48.3% for the three months ended September
30, 2009 to 42.1% for the three months ended September 30, 2010.





Operating
expenses





We
incurred operating expenses of $5,395,712 for the three months ended September
30, 2010, an increase of $1,566,950, or 40.9%, compared to $3,828,762 for the
three months ended September 30, 2009.





Sales and
marketing costs increased $995,479, or 37.3%, from $2,668,175 for three months
ended September 30, 2009 to $3,663,654 for the three months ended September 30,
2010, primarily due to a $304,850 increase in depreciation expense, a
$220,730  increase in rental expense, a $134,378  increase
in salaries, as well as a $118,683 increase in electricity costs associated with
the addition of four new fueling stations in the second quarter of 2010 and one
new fueling station in the third quarter of 2009, offset by the disposal of one
fueling station during the third quarter of 2010. The increase also reflects
costs related to social security benefits for our employees that we began to
incur in the third quarter of 2009. Transportation cost during the three months
ended September 30, 2010 was approximately $5,033 per million cubic meters of
natural gas compared to $2,669 per million cubic meters of natural gas for the
three months ended September 30, 2009.





General
and administrative expenses increased $571,471, or 49.2%, from $1,160,587 for
the three months ended September 30, 2009 to $1,732,058 for the three months
ended September 30, 2010, primarily reflecting increases of $213,006 in salaries
related to market development efforts in Hubei Province as well as management
cost in Jingbian Liquefied Natural Gas Co., Ltd. (“JBLNG”), a subsidiary of
XXNGC, $203,010 in legal fees and $100,295 in stock option expense. The increase
of $100,295 in stock option compensation was due to the issuance of 380,850
stock options in May 2010, the fair value of which will be expensed and
amortized over the service period of the employees.





Income
from Operations and Operating Margin





Income
from operations decreased by $1,895,447, or 32.2%, to $3,993,483 for the three
months ended September 30, 2010 from $5,888,930 for the three months ended
September 30, 2009. The decrease was primarily due to an increase in procurement
costs and operating expenses. Our operating margin for the three months ended
September 30, 2010 was 17.9%, compared to 29.3% for the three months ended
September 30, 2009.





Non-Operating
Income (Expense)





Non-operating
income was $426,142 for the three months ended September 30, 2010 compared with
$240,130 for the three months ended September 30, 2009, primarily due to the
$449,820 gain associated with the change in fair value of the Company’s
outstanding warrants.  For the three months ended September 30, 2009,
the Company incurred a $357,979 loss of change in fair value of warrants. In
addition, we capitalized $1,730,719 in interest expense for the three months
ended September 30, 2010 compared to $1,388,870 in capitalized interest expense
for the same period in 2009.





Provision
for Income Tax





Income
tax was $834,783 for the three months ended September 30, 2010 compared to
$1,001,281 for the three months ended September 30, 2009. The decrease was
primarily due to the lower operating income for the three months ended September
30, 2010 compared to the same period in 2009.  In addition, the
non-operating income of change in fair value of warrants for the three months
ended September 30, 2010 was not subject to income tax as we incurred a net
operating loss for income tax purposes for the three months ended September 30,
2010.




40





Net
Income





As a
result of the foregoing, net income decreased to $3,584,842 for the three months
ended September 30, 2010, a decrease of $1,062,677, or 22.9%, from $4,647,519
for the three months ended September 30, 2009. Net margin decreased from 23.1%
during the three months ended September 30, 2009 to 16.1% during the three
months ended September 30, 2010.





Results
of Operations for the Nine Months Ended September 30, 2010 Compared to Nine
Months Ended September 30, 2009





The
following table represents the consolidated operating results for the nine
months ended September 30, 2010 and 2009:





Nine
      Months Ended
              September
      30,2010
            
            
            2009(unaudited)
            
            
            (unaudited)RevenueNatural
      gas revenue
            
            $
            49,540,810
            
            
            $
            46,140,884Gasoline
      revenue
            
            
            5,407,013
            
            
            
            4,440,892Installation
      and others
            
            
            7,881,073
            
            
            
            8,813,594Total
      revenues
            
            
            62,828,896
            
            
            
            59,395,370Cost
      of revenuesNatural
      gas cost
            
            
            26,126,909
            
            
            
            21,773,635Gasoline
      cost
            
            
            5,076,397
            
            
            
            4,194,615Installation
      and others
            
            
            3,525,895
            
            
            
            3,797,586Total
      cost of revenues
            
            
            34,729,201
            
            
            
            29,765,836Gross
      profit
            
            
            28,099,695
            
            
            
            29,629,534Operating
      expensesSelling
      expenses
            
            
            9,610,436
            
            
            
            7,845,784General
      and administrative expenses
            
            
            5,463,580
            
            
            
            3,503,265Total
      operating expenses
            
            
            15,074,016
            
            
            
            11,349,049Income
      from operations
            
            
            13,025,679
            
            
            
            18,280,485Non-operating
      income (expense)Interest
      income
            
            
            398,790
            
            
            
            23,940Interest
      expense
            
            
            -
            
            
            
            (745,064
            )Other
      income (expense), net
            
            
            24,624
            
            
            
            (137,954
            )Change
      in fair value of warrants
            
            
            1,508,003
            
            
            
            (1,473,762
            )Foreign
      currency exchange gain (loss)
            
            
            (96,942
            )
            
            
            (50,527
            )Total
      non-operating income (expense)
            
            
            1,834,475
            
            
            
            (2,383,367
            )Income
      before income tax
            
            
            14,860,154
            
            
            
            15,897,118Provision
      for income tax
            
            
            2,719,539
            
            
            
            3,185,220Net
      income
            
            
            12,140,615
            
            
            
            12,711,898




41


Sales
Revenues





The
following table sets forth a breakdown of our revenues for the period
indicated:





Nine
      months ended
              September
      30,
              2010
              (Unaudited)
            
            
            Nine
      months ended
              September
      30,
              2009
              (Unaudited)
            
            
            Change
      in dollar amount
            
            
            Change
      in percentageNatural
      gasNatural
      gas from fueling stations
            
            $
            45,817,828
            
            
            $
            44,099,167
            
            
            $
            1,718,661
            
            
            
            3.9
            %Natural
      gas from pipelines
            
            
            3,722,982
            
            
            
            2,041,717
            
            
            
            1,681,265
            
            
            
            82.3
            %Gasoline
            
            
            5,407,013
            
            
            
            4,440,892
            
            
            
            966,121
            
            
            
            21.8
            %Installation
      and othersInstallation
            
            
            6,548,907
            
            
            
            7,019,593
            
            
            
            (470,686
            )
            
            
            (6.7
            %)Automobile
      conversion
            
            
            1,332,166
            
            
            
            1,794,001
            
            
            
            (461,835
            )
            
            
            (25.7
            %)Total
            
            $
            62,828,896
            
            
            $
            59,395,370
            
            
            $
            3,433,526
            
            
            
            5.8
            %





Overall.
Total revenue for the nine months ended September 30, 2010 increased to
$62,828,896 from $59,395,370 for the nine months ended September 30, 2009, an
increase of $3,433,526 or 5.8%, due to the reasons discussed below. We sold
139,363,731 cubic meters of natural gas during the nine months ended September
30, 2010 compared to 129,583,633 cubic meters during the nine months ended
September 30, 2009. For the nine months ended September 30, 2010, 87.5% of our
revenue was generated from the sale of natural gas and gasoline, and the
remaining 12.5% was generated from our installation and automobile conversion
services.





Natural Gas fromFueling Stations.Natural gas
revenue from our fueling stations increased by 3.9%, or $1,718,661, to
$45,817,828 during the nine months ended September 30, 2010, from $44,099,167
during the nine months ended September 30, 2009, and contributed 72.9% of our
total revenue, the largest of our four major business lines. The increase in
natural gas revenue was primarily due to the addition of four new fueling
stations during the second quarter of 2010 and one new fueling station in the
third quarter of 2009, offset by the closed one fueling station during the third
quarter of 2010. During the nine months ended September 30, 2010, we sold
125,840,032 cubic meters of compressed natural gas through our fueling stations
compared to 120,866,756 cubic meters during the nine months ended September 30,
2009. In the nine months ended September 30, 2010, the average revenue of our
fuel stations was $1,195,352 and the average sales volume was 3,283,069 cubic
meters of compressed natural gas per station, compared to approximately
$1,256,029 and 3,442,517 cubic meters in the nine months ended September 30,
2009. The reason for the decline in per station sales was primarily due to the
construction of main subway lines in Xi’an, which caused certain bus routes to
deviate from our stations and resulted in decreased sales. During the nine
months ended September 30, 2010, unit selling price was $0.34 (RMB 2.33) and
$0.43 (RMB 2.92) net of VAT in Shaanxi and Henan Provinces, respectively, or
$0.37 (RMB 2.51) on an average basis, compared to $0.34 (RMB 2.33) and $0.42
(RMB 2.83) net of VAT in Shaanxi Province and Henan Province, respectively, or
$0.37 (RMB 2.5) on an average basis during the nine months ended September 30,
2009.





Natural Gas from Pipelines.Natural
gas revenue from our pipelines increased by 82.3%, or $1,681,265, to $3,722,982
during the nine months ended September 30, 2010 from $2,041,717 during the nine
months ended September 30, 2009, and contributed 5.9% of our total revenue. As
of September 30, 2010, we had 114,049 pipeline customers, an increase of 6,776
customers compared to 107,273 customers as of September 30, 2009. We sold
13,523,699 cubic meters of natural gas through our pipelines during the nine
months ended September 30, 201, compared to 8,716,877 cubic meters during the
nine months ended September 30, 2009.  The increase was primarily due
to the 3,001,780 cubic meters of natural gas sold through Makou, which started
to contribute revenue in August 2010.





Gasoline.  Revenue
from gasoline sales increased by 21.8%, or $966,121, to $5,407,013 during the
nine months ended September 30, 2010 from $4,440,892 during the nine months
ended September 30, 2009, and contributed 8.6% of our total revenue. The
increase in gasoline revenue was primarily due to an increase of 25.5% in the
unit sales price from $0.61 (RMB 4.19) per liter in the nine months ended
September 30, 2009 to $0.77 (RMB 5.24) per liter in the nine months ended
September 30, 2010, mainly attributable to the increase in international oil
prices, partially offset by the sales volume decrease of 3.0% from 7,236,253
liters to 7,016,522 liters.





42





Installation
Services.  Revenue from installation services decreased by
6.7%, or $470,686, to $6,548,907 during the nine months ended September 30, 2010
from $7,019,593 during the nine months ended September 30, 2009, and contributed
10.4% of our total revenue. We believe the decrease was primarily due to a
slowdown in the property market, which led to a decrease in demand for
installation services.





Automobile Conversion
Services.  Revenue from our automobile conversion division
decreased by 25.7%, or $461,835, to $1,332,166 during the nine months ended
September 30, 2010 from $1,794,001 during the nine months ended September 30,
2009, and contributed 2.1% of our total revenue.  We believe the
decrease was primarily due to an increasing percentage of CNG vehicles that have
already undergone conversion, as well as increased market
competition.





Cost of
Revenue:





The
following table sets forth a breakdown of our cost of revenue for the periods
indicated:





Nine
      months ended
              September
      30,
              2010
              (Unaudited)
            
            
            Nine
      months ended
              September
      30,
              2009
              (Unaudited)
            
            
            Change
      in dollar amount
            
            
            Change
      in percentageNatural
      gasNatural
      gas from fueling stations
            
            $
            23,512,276
            
            
            $
            20,343,004
            
            
            $
            3,169,272
            
            
            
            15.6
            %Natural
      gas from pipelines
            
            
            2,614,633
            
            
            
            1,430,631
            
            
            
            1,184,002
            
            
            
            82.8
            %Gasoline
            
            
            5,076,397
            
            
            
            4,194,615
            
            
            
            881,782
            
            
            
            21.05Installation
      and othersInstallation
            
            
            2,715,518
            
            
            
            2,734,125
            
            
            
            (18,607
            )
            
            
            (0.7
            %)Automobile
      conversion
            
            
            810,377
            
            
            
            1,063,461
            
            
            
            (253,084
            )
            
            
            (23.8
            %)Total
            
            $
            34,729,201
            
            
            $
            29,765,836
            
            
            $
            4,963,365
            
            
            
            16.75





Overall.  Our cost
of revenue consists of the cost of natural gas and gasoline sold, installation
costs and other costs. Cost of natural gas and gasoline sold consists of the
cost for purchases from our suppliers. Cost of installation and other costs
include certain expenditures for connecting our customers to our pipeline
system, and the cost for converting gasoline-fueled vehicles into natural gas
hybrid vehicles.





Our cost
of revenue for the nine months ended September 30, 2010 was $34,729,201, an
increase of $4,963,365, or 16.7%, from $29,765,836 for the nine months ended
September 30, 2009. The increase was mainly attributable to an increase in
procurement cost in Henan Province. Our revenue increased by 5.8% during the
same period.





Natural Gas from Fueling Stations.Cost of revenue of our natural gas for our fueling stations increased by
15.6%, or $3,169,272, to $23,512,276 during the nine months ended September 30,
2010 compared to $20,343,004 for the nine months ended September 30, 2009. The
increase in the cost of natural gas for our fueling stations was primarily due
to the increase in procurement prices for coal bed methane in Henan Province
from $0.19 (RMB 1.30) during the nine months ended September 30, 2009 to $0.24
(RMB 1.63) during the nine months ended September 30, 2010. The increase was
also a result of the increase in the average procurement price in Henan Province
from $0.19 (RMB 1.30) during the third quarter of 2010 compared to an average
price of $0.27 (RMB 1.83) in the third quarter of 2010, as we continued our
gradual shift from coal bed methane as a source of supply for our fueling
stations to regulation natural gas due to uncertainty in the market supply of
coal bed methane as well as the increased market demand for both coal bed
methane and natural gas. The procurement prices in Henan Province, however,
remained significantly below the natural gas retail price of $0.46 (RMB 3.10) in
Henan Province for both the nine month period ended September 30, 2009 and the
nine month period ended September 30, 2010.





43





Natural Gas from
Pipelines.  Cost of revenue of our natural gas sold through our
pipelines increased by 82.8%, or $1,184,002, to $2,614,633 during the nine
months ended September 30, 2010 compared to $1,430,631 during the nine months
ended September 30, 2009, which was in line with the growth in
sales.





Gasoline.  Cost of
gasoline revenue increased by 21.0% or $881,782, to $5,076,397 during the nine
months ended September 30, 2010 from $4,194,615 for the nine months ended
September 30, 2009. The increase of cost of gasoline revenue was primarily due
to the increase in average procurement cost per liter from $0.58 (RMB 3.95)
during the nine months ended September 30, 2009 to $0.72 (RMB 4.92) per liter
during the nine months ended September 30, 2010, which we believe was mainly
attributable to an increase in international oil prices.  The increase
in the cost of gasoline revenue was partly offset by the decrease in sales
volume.





Installation Services.Cost
of revenue from our installation services decreased by 0.7%, or $18,607, to
$2,715,518 during the nine months ended September 30, 2010 compared to
$2,734,125 during the nine months ended September 30, 2009, mainly due to the
increased cost of labor and materials, such as natural gas pipe fittings and
meters.





Automobile Conversion
Services.  Cost of our automobile conversion revenue decreased
by 23.8%, or $253,084, to $810,377 during the nine months ended September 30,
2010 compared to $1,063,461 during the nine months ended September 30, 2009,
which was in line with the decrease in revenue from automobile conversion
services.





Gross
profit





The
following table sets forth a breakdown of our gross profit for the periods
indicated:





Nine
      months ended
              September
      30,
              2010
              (Unaudited)
            
            
            Nine
      months ended
              September
      30,
              2009
              (Unaudited)
            
            
            Change
      in dollar amount
            
            
            Change
      in percentageNatural
      gasNatural
      gas from fueling stations
            
            $
            22,305,552
            
            
            $
            23,756,163
            
            
            $
            (1,450,611
            )
            
            
            (6.1
            %)Natural
      gas from pipelines
            
            
            1,108,349
            
            
            
            611,086
            
            
            
            497,263
            
            
            
            81.37Gasoline
            
            
            330,616
            
            
            
            246,277
            
            
            
            84,339
            
            
            
            34.3
            %Installation
      and othersInstallation
            
            
            3,833,389
            
            
            
            4,285,468
            
            
            
            (452,079
            )
            
            
            (10.6
            %)Automobile
      conversion
            
            
            521,789
            
            
            
            730,540
            
            
            
            (208,751
            )
            
            
            (28.6
            %)Total
            
            $
            28,099,695
            
            
            $
            29,629,534
            
            
            $
            (1,529,839
            )
            
            
            (5.2
            %)





We earned
a gross profit of $28,099,695 for the nine months ended September 30, 2010, a
decrease of $1,529,839, or 5.2%, compared to $29,629,534 for the nine months
ended September 30, 2009. The decrease in gross profit was primarily due to the
increased cost of fueling station revenue in Henan Province.





Gross
margin





Gross
margin for natural gas sold through our fueling stations decreased from 53.9% in
the nine months ended September 30, 2009 to 48.7% in the nine months ended
September 30, 2010 due to increased procurement costs for natural gas for
fueling stations in Henan Province.





Gross
margin for natural gas sold through pipelines was 29.8% during the nine months
ended September 30, 2010, and decreased slightly as compared to 29.9% during the
nine months ended September 30, 2009.





Gross
margin for gasoline sales increased from 5.5% during the nine months ended
September 30, 2009 to 6.1% during the nine months ended September 30, 2010,
primarily due to a greater increase in gasoline retail price compared with the
increase in procurement prices for gasoline.




44





Gross
margin for our installation business decreased to 58.5% in the nine months ended
September 30, 2010 from 61.1% in the nine months ended September 30, 2009 due to
increased cost of labor and materials.





Gross
margin for our automobile conversion business decreased from 40.7% in the nine
months ended September 30, 2009 to 39.2% in the nine months ended September 30,
2010 due to increasing competition and decreasing conversion price.





Our total
gross margin decreased from 49.9% for the nine months ended September 30, 2009
to 44.7% for the nine months ended September 30, 2010, primarily due to
higher procurement costs for natural gas for fueling stations in Henan
Province,





Operating
Expenses





We
incurred operating expenses of $15,074,016 for the nine months ended September
30, 2010, an increase of $3,724,967, or 32.8%, compared to $11,349,049 for the
nine months ended September 30, 2009.





Sales and
marketing costs increased 22.5% or $1,764,652, from $7,845,784 for the nine
months ended September 30, 2009 to $9,610,436 for the nine months ended
September 30, 2010, primarily due to a $572,081 increase in depreciation
expense, a $278,162 increase in rental expense, $254,723 increase in
transportation expense, and a $225,863 increase in electricity costs, primarily
related to the addition of four new fueling stations in the second quarter of
2010 and one new fueling station in the third quarter of 2009, offset by the
disposal of one fueling station during the third quarter of 2010. The increase
also reflects costs related to social security benefits for our sales employees
that we began to incur in the third quarter of 2009. Transportation cost during
the nine months ended September 30, 2010 was approximately $4,684 per million
cubic meters of natural gas compared to $2,536 per million cubic meters of
natural gas for the three months ended September 30, 2009.





General
and administrative expenses increased $1,960,315, or 56.0% from $3,503,265 for
the nine months ended September 30, 2009 to $5,463,580 for the nine months ended
September 30, 2010, primarily reflecting increases of $852,303 in stock option
expense for the Company’s employee stock option plan, $246,210 in legal fees,
$154,863 in salaries, $129,167 in allowance of bad debt, an increase in costs
related to market development initiatives in Hubei Province and other regions,
an increase in social security benefits for our administrative employees that we
began to incur in the third quarter of 2009, as well as increased Delaware
franchise tax due to our increased outstanding share and asset
base.





Income
from Operations and Operating Margin





Income
from operations decreased by $5,254,806 or 28.7%, to $13,025,679 for the nine
months ended September 30, 2010 from $18,280,485 for the nine months ended
September 30, 2009, primarily due to the increase in procurement cost and
operating expenses.  Our operating margin for the nine months ended
September 30, 2010 was 20.7%, compared to 30.8% for the nine months ended
September 30, 2009.





Non-Operating
Income (Expense)





Our
non-operating income was $1,834,475 for the nine months ended September 30, 2010
compared to non-operating expense of $2,383,367 for the nine months ended
September 30, 2009. The fluctuation is primarily due to the $1,508,003 gain
associated with a change in fair value of our outstanding warrants. For the nine
months ended September 30, 2009, we incurred a $1,473,762 loss on change in the
fair value of our warrants. In addition, we capitalized $4,721,416 in interest
expense for the nine months ended September 30, 2010 compared with $3,419,796 in
capitalized interest expense for the same period in 2009.





Provision
for Income Tax





Income
tax was $2,719,539 for the nine months ended September 30, 2010 compared to
$3,185,220 for the nine months ended September 30, 2009. The decrease was
primarily due to lower operating income for the nine months ended September 30,
2010 compared to the same period in 2009.  In addition, the
non-operating income from the change in fair value of warrants was not subject
to income tax because we had incurred a net operating loss for income tax
purpose for the nine months ended September 30, 2010.




45





Net
Income





Based on
the foregoing, net income decreased to $12,140,615 for the nine months ended
September 30, 2010, a decrease of $571,283, or 4.5%, from $12,711,898 for the
nine months ended September 30, 2009. Net margin decreased slightly to 19.3% in
the nine months ended September 30, 2010 from 21.4% in the nine months ended
September 30, 2009.





Liquidity
and Capital Resources





Historically,
our primary sources of liquidity have consisted of cash generated from our
operations, debt financing and equity offerings. In 2008, we sold senior notes
with a face value of $40 million to Abax Lotus Ltd. In September 2009, we
completed a secondary offering of common stock with gross proceeds of
approximately $57 million. Our principal uses of cash have been, and are
expected to continue to be, for operational purposes as well as for constructing
our LNG plant in Jingbian, Shaanxi Province and other projects.





As of
September 30, 2010, we had $36,340,993 of cash and cash equivalents compared to
$48,177,794 of cash and cash equivalents as of December 31, 2009. The decrease
was primarily attributable to the construction of the LNG plant, the addition of
new fueling stations and market development initiatives.





Net cash
provided by operating activities was $13,534,460 for the nine months ended
September 30, 2010 compared to net cash provided by operations of $18,261,387
for the nine months ended September 30, 2009. The primary reason for the change
was due to lower operating income during the nine months ended September 30,
2010 compared to the same period in 2009, and an increase in working capital of
$3,101,080.





Net cash
used in investing activities increased from $22,578,879 during the nine months
ended September 30, 2009 to $45,698,160 for the same period in 2010 due to
$8,323,603 of prepayments to equipment suppliers, $1,765,200 of prepayments for
land use rights, $22,433,455 of additions to construction in progress primarily
related to the LNG plant, $11,440,122 related to the acquisition of four fueling
stations, and $3,648,080 related to the acquisition of Makou during the nine
months ended September 30, 2010.





Net cash
provided by financing activities was $19,652,100 for the nine months ended
September 30, 2010 compared to net cash provided by financing activities of
$54,370,361 for the nine months ended September 30, 2009. The primary source of
cash flow from financing activities was a bank loan in the amount of $17,652,000
from Shanghai Pudong Development Bank (“SPDB”).





Based on
past performance and current expectations, we believe our cash and cash
equivalents, cash generated from operations, as well as future possible cash
from financing activities; will satisfy our working capital needs, capital
expenditures and other liquidity requirements associated with our
operations.





The
majority of our revenues and expenses were denominated primarily in RMB, the
currency of the People’s Republic of China. There is no assurance that exchange
rates between the RMB and United States dollars will remain stable.
Historically, inflation has not had a material impact on our
business.





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, capital
expenditures or capital resources that are material to our
investors.





Capital
Expenditures





Our
planned capital expenditures as of September 30, 2010 were approximately $271
million through December 2015, the majority of which we expect to be incurred in
connection with phases II and III of the LNG facility in Jingbian, Shaanxi
Province, investment in the Xi’an International Port Administrative Committee
Project, construction or acquisition of additional fueling stations and
compressor stations, and to fund the expansion of our operations in Hubei
Province. The company expects to fund the capital expenditures through cash flow
from operations as well as through potential equity and debt offerings, should
circumstance require.




46





Outstanding
Indebtedness





On
December 30, 2007, we entered into a securities purchase agreement with Abax
and, on January 29, 2008, we entered into an amendment to such agreement with
Abax (as amended, the “Purchase Agreement”). Under the Purchase Agreement, on
January 29, 2008, we sold to Abax $20,000,000 in principal amount of our 5.0%
Guaranteed Senior Notes due 2014 (the “Senior Notes”) and warrants to purchase
1,450,000 shares of our common stock, and on March 3, 2008, we issued to Abax an
additional $20,000,000 in principal amount of Senior Notes.





We are
required to make mandatory prepayments on the Senior Notes on certain dates and
we are subject to customary covenants for financings of this type, including
restrictions on the incurrence of liens, payment of dividends, and disposition
of properties as well as being obligated to maintain certain financial
ratios.





Long-term
loan





On
February 26, 2010, JBLNG entered into a fixed assets loan contract with Shanghai
Pudong Development Bank Xi’an Branch (“SPDB”), pursuant to which the SPDB agreed
to lend $17,964,000 to JBLNG. SPDB transferred $13,473,000 and $4,491,000 to
JBLNG on March 17 and May 28, 2010, respectively. The applicable interest rate
of this loan is the People’s Bank of China’s standard three to five year rate,
5.76% for the first year and subject to adjustment commencing the second year.
The loan period is 58 months from the date of effectiveness of the contract, and
will be repaid annually, with the last repayment no later than December 5, 2014.
The loan is guaranteed by XXNGC and secured by XXNGC’s equipment and vehicles
located within PRC.





Contractual
Obligations





Our
contractual obligations are as follows:





Payments
      due by period
              (in
      thousands)Contractual
      obligations
            
            Total
            
            
            Less
      than
              1
      year
            
            
            1-3
      years
            
            
            3-5
      years
            
            
            More
      than
              5
      yearsLong
      term debt obligations
            
            $
            40,000
            
            
            $
            3,333
            
            
            $
            26,667
            
            
            $
            10,000
            
            
            $
            -Other
      long term liabilities reflected on balance
              sheet(1)
            
            
            17,500
            
            
            
            -
            
            
            
            -
            
            
            $
            17,500
            
            
            
            -Long
      term loan
            
            
            17,964
            
            
            
            -
            
            
            
            8,982
            
            
            
            8,982
            
            
            
            -Total
            
            $
            75,464
            
            
            $
            3,333
            
            
            $
            35,649
            
            
            $
            36,482
            
            
            $
            -





(1)
              The
      $17,500,000 reflects derivative liability related to the embedded put
      option in the 1,450,000 warrants we issued to Abax in January
      2008.  Abax is entitled to require the Company purchase back the
      portion of warrants not exercised upon
  expiration.





Commitments
and Contingencies





Lease
Commitments





We
recognize lease expense on a straight-line basis over the term of the lease in
accordance with FASB’s accounting standard regarding leases. We entered into a
series of long-term lease agreements with outside parties to lease land use
rights to our self-built natural gas fueling stations located in the PRC. The
agreements have terms ranging from 10 to 30 years. The Company makes annual
prepayments for most lease agreements. We also entered into two office leases in
Xi’an, PRC, one office lease in Jingbian, PRC, one office lease in Wuhan, PRC
and one office lease in New York, New York in the United States. The minimum
future payment for leasing land use rights and offices is as
follows:





Year
      ending December 31, 2010
            
            $
            1,013,923Year
      ending December 31, 2011
            
            
            2,287,605Year
      ending December 31, 2012
            
            
            2,087,487Year
      ending December 31, 2013
            
            
            2,001,803Year
      ending December 31, 2014
            
            
            2,405,727Thereafter
            
            
            35,726,814Total
            
            $
            45,523,359




47




For the
three months ended September 30, 2010 and 2009, the land use right and office
lease expenses were $671,781 and $411,452, respectively. For the nine months
ended September 30, 2010 and 2009, the land use right and office lease expenses
were $1,508,194 and $1,209,549, respectively.





Property
and Equipment Purchase Commitments





We have
purchase commitments for materials, supplies, services and property and
equipment for constructing the LNG plant and other construction in progress
projects. Our purchase commitments are as follows:





Year
      ending December 31, 2010
            
            $
            18,931,831Year
      ending December 31, 2011
            
            
            390,717Thereafter
            
            
            -Total
            
            $
            19,322,548





Natural
Gas Purchase Commitments





We have
existing long-term natural gas purchase agreements with our major suppliers.
However, none of those agreements stipulate any specific purchase amount or
quota each year, thus giving the Company enough flexibility to constantly look
for lower-cost sources of supply. Therefore, we are not legally bound in
purchase commitments by those agreements.





We
maintain long-term natural gas purchase agreements with one of our vendors as of
September 30, 2010. We have no minimum purchase requirements. Contracts are
renewed on an annual basis. We do not expect any issues or difficulties in
continuing to renew our supply contracts with these vendors going forward. Price
points for natural gas are strictly controlled by the government.




The sales
prices of both pipeline natural gas in Shaanxi Province and vehicular fuel in
Xi’an City have been increased from October 20, 2010, according to new notices
issued by the Shaanxi Province Price Bureau and Xi’an Municipal Price Bureau.
The sales price of pipeline natural gas in Shaanxi Province was increased by RMB
0.23 (US $0.03) per cubic meter for residential terminal use. The sales prices
for commercial and industrial use was increased by RMB 0.35 and RMB 0.55 (US
$0.05 and $0.08) per cubic meter, respectively. Additionally, the sales price of
CNG for vehicular fuel in Xi’an, the capital of Shaanxi Province, was adjusted
to the target ratio of 0.6:1 to the retail price of grade 90 gasoline. The
retail price of CNG was increased by RMB 0.9 (US $0.14) per cubic meter. The
adjusted prices took effect on October 20, 2010.




The sales
prices of vehicular fuel in Kaifeng City and Xuchang City, Henan Province have
been increased from July 20, 2010 and August 1, 2010, respectively, according to
new notices issued by Kaifeng Development and Reform Commission and Xuchang
Development and Reform Commission. The sales price of vehicular fuel in Kaifeng
City was increased by RMB 3.30 (US $0.42) to RMB 3.60 (US $0.46) per cubic
meter. The sales price of vehicular fuel in Xuchang City was increased by RMB
3.20 (US $0.41) to RMB 3.65 (US $0.47) per cubic meter. Additionally, the sale
prices of CNG for vehicular fuel in Kaifeng City was adjusted to the target
ratio of no lower than 0.6:1 to the retail price of grade 90 gasoline. The sale
prices of CNG for vehicular fuel in Xuchang City was adjusted to no lower than
0.6:1 to the retail price of grade 90 gasoline and gradually to the target ratio
of no lower than 0.75:1.





Foreign
Currency Translations





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




48





The
balance sheet amounts with the exception of equity, were translated at the
September 30, 2010 exchange rate of RMB 6.68 to $1.00 as compared to RMB 6.82 to
$1.00 at December 31, 2009. The equity accounts were stated at their historical
rate. The average translation rates applied to income and cash flow statement
amounts for the nine months ended September 30, 2010 and 2009, were 6.80 RMB and
6.82 RMB to $1.00, respectively.





Critical
Accounting Policies





Our
discussion and analysis of our financial position and results of operations
contained in this Quarterly Report on Form 10-Q is based on our condensed
consolidated unaudited financial statements, contained elsewhere herein. The
preparation of these financial statements in conformity with generally accepted
accounting principles requires that we make estimates and assumptions that
affect the reported amounts of assets and liabilities, and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates. There have been no material
changes in the development of our accounting estimates or the assumptions
underlying those estimates, or the accounting policies that we disclosed as our
Critical Accounting Policies in our Annual Report on Form 10-K for the year
ended December 31, 2009, as amended.





Property
and Equipment





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





Office
      equipment
            5
      yearsOperating
      equipment
            5-20
      yearsVehicles
            5
      yearsBuildings
      and improvements
            5-30
      years





Construction
in Progress





Construction
in progress consists of the cost of constructing property and equipment for CNG
fueling stations and liquefied natural gas (“LNG”) project in Jingbian County,
Shaanxi Province, PRC, a natural gas infrastructure project in the Xi’an
International Port District and other projects, including technology licensing
fees, equipment purchases, land use rights requisition cost, capitalized
interest and other construction fees. No depreciation is provided for
construction in progress until such time as the assets are completed and placed
into service. Interest incurred during construction is capitalized into
construction in progress. All other interest is expensed as
incurred.





Revenue
Recognition





Revenue
is recognized when services are rendered to customers and when a formal
arrangement exists, the price is fixed or determinable, the delivery is
completed, no other significant obligations of the Company exist and
collectability is reasonably assured. Payments received before all of the
relevant criteria for revenue recognition are satisfied are recorded as unearned
revenue.  Revenue from gas and gasoline sales is recognized when gas
and gasoline is pumped through pipelines to the end users. Revenue from
installation of pipelines is recorded when the contract is completed and
accepted by the customers. Construction contracts are usually completed within
one to two months.  Revenue from repairing and modifying vehicles is
recorded when services are rendered to and accepted by the
customers.




49





Fair
Value of Financial Instruments





The
accounting standards regarding fair value of financial instruments and related
fair value measurements define fair value, establish a three-level valuation
hierarchy for disclosures of fair value measurement, and provide disclosure
requirements for fair value measures. The carrying amounts reported in the
consolidated balance sheets for current receivables and payables qualify as
financial instruments. Management concluded the carrying values are a reasonable
estimate of fair value because of the short period of time between the
origination of such instruments and their expected realization and if
applicable, their stated interest rate approximates current rates available. The
three levels are defined as follows:





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





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





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





Financial
assets and liabilities are classified in their entirety based on the lowest
level of input that is significant to the fair value measurement. Depending on
the product and the terms of the transaction, the fair value of our notes
payable and derivative liabilities were modeled using a series of techniques,
including closed-form analytic formula, such as the Black-Scholes option-pricing
model, which does not entail material subjectivity because the methodology
employed does not necessitate significant judgment, and the pricing inputs are
observed from actively quoted markets.





FASB
accounting standard regarding derivatives and hedging 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 also 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
exception.





Recent
Accounting Pronouncements





See “Note 2. Summary of Significant
Accounting Policies”in “Item 1. Financial
Statements” herein for a discussion of the new accounting pronouncements
adopted in this Quarterly Report on Form 10-Q.





Item
3.  Quantitative and Qualitative Disclosures About Market
Risk





Natural
Gas Price Risk





Our major
market risk exposure continues to be the pricing applicable to our purchases and
value-added reselling of CNG. Our revenues and profitability depend
substantially upon the applicable prices of natural gas, which in China are
regulated and fixed by central and local governments and do not fluctuate
significantly. Such price stability is expected to continue for operations in
China. We currently don’t have any hedge positions in place to reduce our
exposure to changes in natural gas wholesale and retail prices.





Interest
Rate Risk





We are
subject to interest rate risk on our long-term fixed-interest rate debt. Fixed
rate debt, where the interest rate is fixed over the life of the instrument,
exposes us to changes in market interest rates reflected in the fair value of
the debt and to the risk that we may need to refinance maturing debt with new
debt at a higher rate. All other things being equal, the fair value of our fixed
rate debt will increase or decrease as interest rates change. We had long-term
debt outstanding of $57,964,000 at September 30, 2010, all of which bears
interest at fixed rates. The fixed-rate debt amount of $40,000,000 is due in
2014.  The remaining portion of the outstanding long-term debt, in the
amount of $17,964,000, bears interest at flexible rates, and is due between
2012-2014. We currently have no interest rate hedge positions in place to reduce
our exposure to changes in interest rates.




50





Foreign
Currency Exchange Rates Risk





We
operate using China’s local
currency and the effects of foreign currency fluctuations are largely mitigated
because local expenses in China are also denominated in the same
currency.





Our
assets and liabilities of which the functional currency is the RMB, are
translated into United States dollars using the exchange rates in effect at the
balance sheet date, resulting in translation adjustments that are reflected as
cumulative translation adjustment in the shareholders’ equity section on our
consolidated balance sheets. A portion of our net assets are impacted by changes
in foreign currencies in relation to the United States dollar. We recorded a
$4,061,751 adjustment to increase our equity account for the nine months ended
September 30, 2010 to reflect the net impact of the fluctuating of Chinese
currency against the U.S. dollar.





Item
4. Controls and Procedures





Disclosure
Controls and Procedures





During
and subsequent to the reporting period covered by this report, and under the
supervision and with the participation of our management, including our
principal executive officer and our principal financial officer, we conducted an
evaluation of our disclosure controls and procedures that were in effect at the
end of the period covered by this report. Disclosure controls and procedures is
defined under Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended
(the “Exchange Act”), as those controls and other procedures of an issuer that
are designed to ensure that information required to be disclosed by an issuer in
the reports that it files or submits under the Exchange Act is recorded,
processed, summarized and reported within the time periods specified in the
rules and forms of the Securities and Exchange Commission.  Disclosure
controls and procedures include, without limitation, controls and procedures
designed to ensure that information required to be disclosed by an issuer in the
reports that it files or submits under the Exchange Act is accumulated and
communicated to the issuer’s management, including its principal executive
officer and principal financial officer, as appropriate, to allow timely
decisions regarding required disclosure. Based on their evaluation and
after considering the material weaknesses in our internal control over financial
reporting discussed in Amendment No. 2 to our Annual Report on Form 10-K/A for
the year ended December 31, 2009 under the heading “Management’s Report on
Internal Control over Financial Reporting (Restated),” our principal
executive officer and principal financial officer have concluded that our
disclosure controls and procedures that were in effect on September 30, 2010
were not effective because the Company failed to implement policies and
procedures that would have prevented our:





·
            failure
      to disclose a JBLNG’s loan with SPBD (the “Loan”), XXNGC’s pledge of its
      equipment and vehicles located within the PRC to secure the Loan (the
      “Pledge”) and XXNGC’s guarantee of thee Loan (the “Guarantee”) as
      subsequent events in the footnotes to its consolidated financial
      statements included in our Annual Report on Form 10-K for the year ended
      December 31, 2009;





·
            failure
      to disclose the Loan, the Pledge and the Guarantee in our Quarterly Report
      on Form 10-Q for the quarter ended March 31, 2010, which led to an
      understatement of restricted cash in the amount of $13.2 million and the
      understatement of bank loans in the amount of $13.2 million in the
      consolidated balance sheet included
therein;





·
            failure
      to file a Current Report on Form 8-K within four days after entry into the
      Loan, the Pledge and the Guarantee;
and





·
            incorrect
      determination that the Pledge constituted a breach of the indenture
      governing the Senior Notes (the “Indenture”), which led us to erroneously
      (i) reclassify from long term liabilities to short term liabilities the
      Senior Notes and the fair value of the redeemable warrants issued to Abax
      in connection with the Senior Notes in Amendment No. 1 to our Annual
      Report on Form 10-K/A for the year ended December 31, 2009 (the “Amended
      10-K”) and Amendment No. 1 to our Quarterly Report 10-Q/A for the quarter
      ended March 31, 2010 (the “Amended 10-Q”), (ii) disclose in the Amended
      10-K, the Amended 10-Q and our Quarterly Report on Form 10-Q for the
      quarter ended June 30, 2010 (the “Second Quarter 10-Q”) that the Pledge
      constituted a breach of the Indenture and (iii) classify the Senior Notes
      and warrants as current liabilities instead of long term liabilities in
      our Second Quarter 10-Q; and




51




·
            failure
      to document and communicate to the Board of Directors and all members of
      management the evaluation of disclosure requirements in connection with
      acquisitions of four natural gas stations in the second quarter of 2010
      and the acquisition of Makou in the third quarter of
  2010.





Changes
in internal control over financial reporting





Other
than as disclosed in Amendment No. 2 to the Annual Report on Form 10-K/A for the
year ended December 31, 2009, filed on October 1, 2010, under the headings “Item
9A. Controls and Procedures – Management’s Report on Internal Control over
Financial Reporting (Restated)” and “– Management’s Remediation Initiatives,”
there was no change in our internal control over financial reporting during the
quarter ended September 30, 2010 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial
reporting.





Part
II. OTHER INFORMATION





Item
1.  Legal Proceedings







We and
certain of our officers and directors were recently named as defendants in two
putative class action lawsuits alleging violations of the federal securities
laws. The
first action, captioned Vandevelde v. China Natural Gas,
Inc., et al., C.A. No. 10-728, was filed on August 26, 2010 in the United
States District Court for the District of Delaware. The second
action, captioned Baranowski
v. China Natural Gas, Inc., et al., Case No. 10-6572, was filed on
September 3, 2010 in the United States District Court for the Southern District
of New York.
The plaintiffs in these actions assert that we, Qinan Ji, Zhiqiang Wang, Donald
Yang, David She, Carl Yeung and Lawrence Leighton violated Section 10(b) of the
Securities Exchange Act of 1934, and Rule 10b-5 thereunder, when we failed to
disclose and properly account for the Loan in our Annual Report on Form 10-K for
the year ended December 31, 2009 and Quarterly Report on Form 10-Q for the
quarter ended March 31, 2010. The complaints allege that the Pledge to secure
the Loan violated the Indenture for the Senior Notes and the warrant agreement
relating to the warrants issued to Abax, giving the holder of those notes and
warrants the right to declare a default under the Indenture. The complaints
further allege that, on August 20, 2010, the Company amended its Annual Report
on Form 10-K for the year ended December 31, 2009 and Quarterly Report on Form
10-Q for the quarter ended March 31, 2010 to disclose the Loan and restate its
financial statements in light of the note and warrant holder’s right to declare
a default under the Indenture, and that the announcement of this news caused the
price of our stock to drop by twenty percent. The plaintiffs seek damages in an
unspecified amount to recover the losses purportedly suffered by the putative
class as a result of that decline. The complaints also assert claims against the
individual defendants as controlling persons of the Company for violations of
Section 20(a) of the Securities Exchange Act of 1934.




Two
putative class members in the Vandevelde action have moved
for appointment as lead plaintiff. After the Court decides those motions,
the putative class member who is appointed lead plaintiff will have an
opportunity to file an amended complaint. Defendants will not be required to
answer or otherwise respond to the complaint until after lead plaintiff either
decides to proceed on the basis of the original complaint or files an amended
complaint.




We
currently cannot estimate the outcome of this litigation as of the date of this
report.




Item
1A.  Risk Factors





As of the
date of this filing, there have been no material changes from the risk factors
disclosed in the Company’s Annual Report on Form 10-K for the year ended
December 31, 2009, filed on March 10, 2010. We operate in a changing environment
that involves numerous known and unknown risks and uncertainties that could
materially affect our operations. The risks, uncertainties and other factors set
forth in our Annual Report on Form 10-K may cause our actual results,
performances and achievements to be materially different from those expressed or
implied by our forward-looking statements. If any of these risks or events
occurs, our business, financial condition or results of operations may be
adversely affected.




52





Item
2.  Unregistered Sales of Equity Securities and Use of
Proceeds





None.





Item
3.  Defaults Upon Senior Securities





None.





Item
4.  (Removed and Reserved)





Item
5.  Other Information


53


Item
6.  Exhibits





(a)
Exhibits




Exhibit
                Number
              
              Description
      of Exhibit2.1
              
              Share
      Purchase Agreement made as of December 6, 2005 among Coventure
      International Inc., Xi’an Xilan Natural Gas Co., Ltd. and each shareholder
      of Xi’an Xilan Natural Gas Co., Ltd. (incorporated herein by reference to
      Exhibit 10.1 to the Company's Current Report on Form 8-K filed December 9,
      2005).2.2
              
              Return
      to Treasury Agreement made as of December 6, 2005 between Coventure
      International Inc. and John Hromyk (incorporated herein by reference to
      Exhibit 10.2 to the Company's Current Report on Form 8-K filed December 9,
      2005).2.3
              
              Purchase
      Agreement made as of December 19, 2005 between China Natural Gas, Inc. and
      John Hromyk (incorporated herein by reference to Exhibit 10.1 to the
      Company's Current Report on Form 8-K filed December 23,
    2005).2.4
              
              Form
      of Equity Ownership Transfer Agreement (incorporated herein by reference
      to Exhibit 2.1 to the Company's Current Report on Form 8-K filed December
      31, 2008).3.1
              
              Certificate
      of Incorporation, dated March 31, 1999 (incorporated herein by reference
      to Exhibit 3.(I) to the Company's Registration Statement on Form 10SB
      filed September 15, 2000, SEC File No. 000-31539).3.2
              
              Certificate
      of Amendment of Certificate of Incorporation, dated May 25, 2000
      (incorporated herein by reference to Exhibit 3.(I) to the Company's
      Registration Statement on Form 10SB filed September 15, 2000, SEC File No.
      000-31539).3.3
              
              Certificate
      of Ownership and Merger, dated February 14, 2002 (incorporated herein by
      reference to Exhibit 2 to the Company's Registration Statement on Form
      8-A12B filed June 3, 2009, SEC File No. 001-34373).3.4
              
              Certificate
      of Ownership, dated December 13, 2005 (incorporated herein by reference to
      Exhibit 3 to the Company's Registration Statement on Form 8-A12B filed
      June 3, 2009, SEC File No. 001-34373).3.5
              
              Certificate
      of Amendment of Certificate of Incorporation, dated October 26, 2007
      (incorporated herein by reference to Exhibit 4 to the Company's
      Registration Statement on Form 8-A12B filed June 3, 2009, SEC File No.
      001-34373).3.6
              
              Certificate
      of Amendment of Certificate of Incorporation, dated April 21, 2009
      (incorporated herein by reference to Exhibit 5 to the Company's
      Registration Statement on Form 8-A12B filed June 3, 2009, SEC File no.
      001-34373).3.7
              
              By-Laws
      (incorporated herein by reference to Exhibit 3.(II) to the Company's
      Registration Statement on Form 10SB filed September 15, 2000, SEC File No.
      000-31539).3.8
              
              Amended
      and Restated By-Laws, dated June 14, 2006 (incorporated herein by
      reference to Exhibit 3.1 to the Company's Current Report on Form 8-K filed
      June 16, 2006).3.9
              
              Amended
      and Restated By-Laws, dated September 24, 2008 (incorporated herein by
      reference to Exhibit 7 to the Company's Registration Statement on Form
      8-A12B filed June 3, 2009, SEC File No. 001-34373).31.1*
              
              Certification
      of Principal Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a),
      promulgated under the Securities and Exchange Act of 1934, as
      amended.31.2*
              
              Certification
      of Principal Financial Officer pursuant to Rule 13a-14 and Rule 15d 14(a),
      promulgated under the Securities and Exchange Act of 1934, as
      amended.32.1*
              
              Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 (Chief Executive
  Officer).32.2*
              
              Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 (Chief Financial
  Officer).




*
            Filed
      herewith




54





SIGNATURES





In
accordance with the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.





China
      Natural Gas, Inc.November
      15, 2010
            By:
            /s/
      Qinan JiQinan
      JiChief
      Executive Officer(Principal
      Executive Officer)





November
      15, 2010
            By:
            /s/
      David SheDavid
      SheActing
      Chief Financial Officer(Principal
      Financial and Accounting Officer)




55