UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q/A


(Amendment
No. 2)





(Mark
One)


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


For the
quarterly period ended March 31, 2010





 ̈
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE EXCHANGE
  ACT





For the
transition period from to


000-31539


(Commission
file number)





CHINA
NATURAL GAS, INC.


(Exact
name of registrant as specified in its charter)





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





19th
Floor, Building B, Van Metropolis


Tang Yan
Road, Hi-Tech Zone


Xi’an,
710065, Shaanxi Province, China


(Address
of principal executive offices)





(zip
code)





86-29-8832-7391


(registrant
's telephone number, including area code)





N/A


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





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Exchange Act during the past 12 months (or
for such shorter period that the registrant was required to file such reports),
and (2) has been subject to such filing requirements for the past 90
days. Yes 
xNo 
 ̈





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





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check
one):


Large
      accelerated filer   ̈
            Accelerated
      filer  xNon-accelerated
      filer   ̈
            Smaller
      reporting company   ̈


(Do not
check if a smaller reporting company)





Number of
shares of Common Stock outstanding as of May 6, 2010: 21,183,904





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











EXLANATORY
NOTE




This
Amendment No. 2 on Form 10-Q/A (the “Amended Filing”) amends Amendment No. 1 to
the Quarterly Report of China Natural Gas, Inc. (the “Company”) (as amended, the
"Amended 10-Q"), which in turn had amended the Quarterly Report on Form 10-Q for
the quarter ended March 31, 2010, originally filed on May 7, 2010 (the “Original
Filing”).
  As
previously disclosed in the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 2010, in February 2010, the Company obtained a bank loan
in the amount of $17.7 million (the "Loan") and, in connection with the Loan,
Xi'an Xilan Natural Gas Co. Ltd., the Company's variable interest entity,
pledged its equipment and vehicles located within China to secure the Loan (the
"Pledge") and guaranteed the repayment of the Loan (the
"Guarantee").
 
 By August
8, 2010, the Company’s former outside counsel determined that the Pledge was
prohibited by the indenture (the "Indenture") for the Company's 5% guaranteed
senior note issued to Abax Lotus Ltd. ("Abax") dated January 29, 2008 (the
"Senior Notes"). As a result, the Company believed that Abax had the right to
declare a default under the Indenture and could thereafter accelerate the Senior
Notes, which would cause a simultaneous default under the warrant agreement
governing the Company's warrants issued in connection with the Senior Notes,
thereby entitling the warrant holders to require the Company to redeem their
warrants. In view of the potential default under the Indenture and warrant
agreement, the Board, in consultation with management and the Audit Committee,
determined that the Company was required to restate its annual financial
statements for the year ended December 31, 2009 and the quarter ended March 31,
2010 to reclassify from long term liabilities to short term liabilities the
Senior Notes and the fair value of the redeemable warrants (the
“Reclassification”).
  Therefore,
the Company filed a Current Report on Form 8-K on August 19, 2010 to disclose
that its financial statements contained in its Annual Report on Form 10-K for
the year ended December 31, 2009 (the "Annual Report") and the Original Filing
should not be relied upon, and, on August 20, 2010, the Company
filed:
 
 ·
                Amendment
      No. 1 to the Annual Report (as amended, the “Amended 10-K”) to (i) restate
      the financial statements contained therein to make the Reclassification
      and disclose as subsequent events the Loan, the Pledge and the Guarantee
      as well as the initial determination that the Pledge was not permitted
      under the Indenture, (ii) make other amendments to the Annual Report to
      give effect to the foregoing and (iii) amend Part II, Item 9A, Controls
      and Procedures of the Annual Report;
and
 
 ·
                the
      Amended 10-Q to (i) amend Part II, Item 4, Other Information, of the
      Original Filing to disclose the Loan, the Pledge and the Guarantee as well
      as the initial determination that the Pledge was not permitted under the
      Indenture, (ii) restate the financial statements contained therein to make
      the Reclassification, record the Loan as a long term liability and record
      an increase in restricted cash as a result of obtaining the proceeds of
      the Loan; (iii) make other amendments to the Original Filing to give
      effect to the foregoing; (iv) amend Part I, Item 4, Controls and
      Procedures, of the Original Filing; and (v) file the Loan, the Pledge and
      the Guarantee as exhibits to the Amended
10-Q.
 
 Also, in
its Quarterly Report on Form 10-Q for the quarter ended June 30, 2010, the
Company (i) recorded the Senior Notes and warrants, which were described as
redeemable, as current liabilities in the financial statements contained
therein; (ii) made other disclosures in such quarterly report to give effect to
the foregoing; and (iii) disclosed in Part II, Item 4, Other Information, of
such quarterly report the Loan, the Pledge and the Guarantee as well as the
initial determination that the Pledge was not permitted under the
Indenture.
 
 Subsequent
to restating its financial statements and filing the Amended 10-K and Amended
10-Q, management of the Company internally revisited the analysis of whether the
Pledge was indeed prohibited by the Indenture and determined that it was not.
In
late August 2010, the Company engaged the law firm DLA Piper, which had not
previously advised the Company or management on these matters, to review the
Company's analysis, and DLA Piper subsequently confirmed the Company's analysis.
At the request of the Company's independent auditors, the Company engaged
another law firm with no prior relationship to the Company to review the
Company's analysis, and that law firm subsequently confirmed the Company's
analysis. The Company engaged DLA Piper as its regular outside counsel for SEC
reporting and other public company matters in early September 2010.The
Board of Directors of the Company, in consultation with management and the Audit
Committee, determined on September 15, 2010, that none the Loan, the Pledge or
the Guarantee, individually or together, were prohibited by the
Indenture.
 
 The
purpose of this Amended Filing is to reverse all disclosure in the Amended 10-Q
related to the Reclassification and to further amend Part I, Item 4, Controls
and Procedures. With respect to the former, the amendments herein include: (i)
reversal of the reclassification of the Company’s Senior Notes payable and the
fair value of the redeemable warrants from current liabilities back to long
term liabilities, (ii) removal of the statements indicating that the Pledge was
not permitted under the Indenture, and (iii) other amendments to the Amended
10-Q to give effect to the foregoing. The Company is not restating the Amended
10-Q’s restatement of long term liabilities and restricted cash on the Company’s
consolidated balance sheet as of March 31, 2010 or the restatement of financing
activities in consolidated statements of cash flow for the three months ended
March 31, 2010, which restatements were made to record the Loan as a long term
liability and record an increase in restricted cash as a result of obtaining the
proceeds of the Loan, and are described in the Amended 10-Q.
 
 In
accordance with Rule 12b-15 under the Exchange Act, each item of the Original
Filing, as amended by the Amended 10-Q, that is amended by this Amended Filing
is also restated in its entirety, and this Amended Filing is accompanied by
currently dated certifications on Exhibits 31.1, 31.2, 32.1 and 32.2 by the
Company’s Chief Executive Officer and Chief Financial Officer. Except as
described above, this Amended Filing does not amend, update, or change any
items, financial statements, or other disclosures in the Original Filing, as
amended by the Amended 10-Q, and does not reflect events occurring after the
filing of the Original Filing, including as to any exhibits to the Original
Filing, as amended by the Amended 10-Q, affected by subsequent events.
Information not affected by the changes described above is unchanged and
reflects the disclosures made at the time of the Original Filing, as amended by
the Amended 10-Q. Accordingly, this Amended Filing should be read in conjunction
with the Original Filing and our other SEC filings subsequent to the filing of
the Original Filing, including the Amended 10-Q and any other amendments to
those filings. Capitalized terms not defined in the Amended Filing are as
defined by the Original Filing.





China
Natural Gas, Inc.


Index





PagePART
      I.
                      FINANCIAL
      INFORMATION
                      3Item
      1.
                      Financial
      Statements
                      3Notes
      to Consolidated Financial Statements (unaudited)
                      6Item
      2.
                      Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                      27Item
      3.
                      Quantitative
      and Qualitative Disclosures About Market Risk
                      38Item
      4.
                      Controls
      and Procedures
                      39PART
      II.
                      OTHER
      INFORMATION
                      40Item
      1.
                      Legal
      Proceedings
                      40Item
      1A.
                      Risk
      Factors
                      40Item
      2.
                      Unregistered
      Sales of Equity Securities and Use of Proceeds
                      41Item
      3.
                      Defaults
      Upon Senior Securities
                      41Item
      4.
                      (Removed
      and Reserved)Item
      5.
                      Other
      Information
                      41Item
      6.
                      Exhibits
                      41SIGNATURES
                      42





2





PART
I. FINANCIAL INFORMATION


Item
1. Financial Statements





CHINA
NATURAL GAS, INC. AND SUBSIDIARIES





CONSOLIDATED
BALANCE SHEETS


AS
OF MARCH 31, 2010 AND DECEMBER 31, 2009





March
      31,
                            
                            
                            December,
      312010
                            
                            
                            2009(Unaudited)
                              (As
      Restated –
                              See
      Note 2)ASSETSCURRENT
      ASSETS:Cash
      & cash equivalents
                            
                            $
                            30,172,391
                            
                            
                            $
                            48,177,794Restricted
      cash
                            
                            
                            13,203,000
                            
                            
                            
                            -Accounts
      receivable, net of allowance for doubtful accounts of $196,138 and
      $163,280 as of March 31, 2010 and December 31, 2009,
      respectively.
                            
                            
                            1,514,070
                            
                            
                            
                            1,289,116Other
      receivables
                            
                            
                            491,020
                            
                            
                            
                            709,741Other
      receivable - employee advances
                            
                            
                            190,045
                            
                            
                            
                            338,689Inventories
                            
                            
                            874,678
                            
                            
                            
                            841,837Advances
      to suppliers
                            
                            
                            1,302,568
                            
                            
                            
                            596,868Prepaid
      expense and other current assets
                            
                            
                            1,546,556
                            
                            
                            
                            1,076,915Loans
      receivable
                            
                            
                            14,259,240
                            
                            
                            
                            293,400Total
      current assets
                            
                            
                            63,553,568
                            
                            
                            
                            53,324,360INVESTMENT
      IN UNCONSOLIDATED JOINT VENTURES
                            
                            
                            1,467,000
                            
                            
                            
                            1,467,000PROPERTY
      AND EQUIPMENT, NET
                            
                            
                            75,603,216
                            
                            
                            
                            72,713,012CONSTRUCTION
      IN PROGRESS
                            
                            
                            57,102,317
                            
                            
                            
                            52,918,236DEFERRED
      FINANCING COSTS
                            
                            
                            1,234,540
                            
                            
                            
                            1,336,998OTHER
      ASSETS
                            
                            
                            16,937,089
                            
                            
                            
                            15,854,910TOTAL
      ASSETS
                            
                            $
                            215,897,730
                            
                            
                            $
                            197,614,516LIABILITIES AND STOCKHOLDERS'
      EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued liabilities
                            
                            $
                            1,970,228
                            
                            
                            $
                            2,081,261Other
      payables
                            
                            
                            85,082
                            
                            
                            
                            80,788Unearned
      revenue
                            
                            
                            2,199,805
                            
                            
                            
                            1,813,641Accrued
      interest
                            
                            
                            200,509
                            
                            
                            
                            786,052Taxes
      payable
                            
                            
                            2,888,511
                            
                            
                            
                            1,901,577Total
      current liabilities
                            
                            
                            7,344,135
                            
                            
                            
                            6,663,319LONG
      TERM LIABILITIES:Notes
      payable, net of discount $11,946,508 and $12,707,713 as of March 31, 2010
      and December 31, 2009, respectively
                            
                            
                            28,053,492
                            
                            
                            
                            27,292,287Derivative
      liabilities - warrants
                            
                            
                            19,152,570
                            
                            
                            
                            19,545,638Long
      term debt
                            
                            
                            13,203,000Total
      long term liabilities
                            
                            
                            60,409,062
                            
                            
                            
                            46,837,925COMMITMENTS 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, 21,183,904 shares
      issued and outstanding at March 31, 2010 and December 31,
    2009
                            
                            
                            2,118
                            
                            
                            
                            2,118Additional
      paid-in capital
                            
                            
                            79,926,097
                            
                            
                            
                            79,851,251Cumulative
      other comprehensive gain
                            
                            
                            8,675,165
                            
                            
                            
                            8,714,019Statutory
      reserves
                            
                            
                            6,425,074
                            
                            
                            
                            5,962,695Retained
      earnings
                            
                            
                            53,116,079
                            
                            
                            
                            49,583,189Total
      stockholders' equity
                            
                            
                            148,144,533
                            
                            
                            
                            144,113,272TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                            
                            $
                            215,897,730
                            
                            
                            $
                            197,614,516





3




CHINA NATURAL GAS, INC. AND
SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME


FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009


(Unaudited)




Three Months Ended March 31,2010
                  
                  
                  2009RevenuesNatural
      gas revenue
                  
                  $
                  15,483,629
                  
                  
                  $
                  14,965,819Gasoline
      revenue
                  
                  
                  1,468,816
                  
                  
                  
                  1,174,398Installation
      and others
                  
                  
                  2,414,378
                  
                  
                  
                  2,387,449Total
      revenues
                  
                  
                  19,366,823
                  
                  
                  
                  18,527,666Cost
      of revenuesNatural
      gas cost
                  
                  
                  7,864,654
                  
                  
                  
                  6,746,929Gasoline
      cost
                  
                  
                  1,367,278
                  
                  
                  
                  1,130,057Installation
      and others
                  
                  
                  1,039,923
                  
                  
                  
                  1,017,028Total
      cost of revenues
                  
                  
                  10,271,855
                  
                  
                  
                  8,894,014Gross
      profit
                  
                  
                  9,094,968
                  
                  
                  
                  9,633,652Operating
      expensesSelling
      expenses
                  
                  
                  2,891,790
                  
                  
                  
                  2,580,825General
      and administrative expenses
                  
                  
                  1,817,656
                  
                  
                  
                  1,425,324Total
      operating expenses
                  
                  
                  4,709,446
                  
                  
                  
                  4,006,149Income
      from operations
                  
                  
                  4,385,522
                  
                  
                  
                  5,627,503Non-operating
      income (expense):Interest
      income
                  
                  
                  89,366
                  
                  
                  
                  8,908Interest
      expense
                  
                  
                  -
                  
                  
                  
                  (581,492
                  )Other
      income (expense), net
                  
                  
                  46,569
                  
                  
                  
                  (2,303
                  )Change
      in fair value of warrants
                  
                  
                  393,068
                  
                  
                  
                  197,051Foreign
      currency exchange loss
                  
                  
                  (8,110
                  )
                  
                  
                  (50,788
                  )Total
      non-operating income (expense)
                  
                  
                  520,893
                  
                  
                  
                  (428,624
                  )Income
      before income tax
                  
                  
                  4,906,415
                  
                  
                  
                  5,198,879Provision
      for income tax
                  
                  
                  911,145
                  
                  
                  
                  997,256Net
      income
                  
                  
                  3,995,270
                  
                  
                  
                  4,201,623Other
      comprehensive incomeForeign
      currency translation loss
                  
                  
                  (38,854
                  )
                  
                  
                  (152,115
                  )Comprehensive
      income
                  
                  $
                  3,956,416
                  
                  
                  $
                  4,049,508Weighted
      average shares outstandingBasic
                  
                  
                  21,183,904
                  
                  
                  
                  14,600,152Diluted
                  
                  
                  21,595,038
                  
                  
                  
                  14,600,152Earnings
      per shareBasic
                  
                  $
                  0.19
                  
                  
                  $
                  0.29Diluted
                  
                  $
                  0.19
                  
                  
                  $
                  0.29


4





CHINA NATURAL GAS, INC. AND
SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR
THE THREE MONTHS ENDED MARCH 31, 2010 AND 2009


(Unaudited)




Three Months Ended March 31,2010
                
                
                2009(As Restated –
                  See Note 2)CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                
                $
                3,995,270
                
                
                $
                4,201,623Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
                
                
                1,472,595
                
                
                
                1,389,565Provision
      for bad debt
                
                
                32,847
                
                
                
                -Amortization
      of discount on senior notes
                
                
                -
                
                
                
                170,712Amortization
      of financing costs
                
                
                -
                
                
                
                38,578Stock
      based compensation
                
                
                74,847
                
                
                
                14,842Change
      in fair value of warrants
                
                
                (393,068
                )
                
                
                (197,051
                )Change
      in assets and liabilities:Accounts
      receivable
                
                
                (257,812
                )
                
                
                (41,244
                )Other
      receivable - employee advances
                
                
                148,593
                
                
                
                151,617Inventories
                
                
                (32,830
                )
                
                
                30,812Advances
      to suppliers
                
                
                (705,460
                )
                
                
                151,828Prepaid
      expense and other current assets
                
                
                (167,213
                )
                
                
                (100,912
                )Accounts
      payable and accrued liabilities
                
                
                (111,007
                )
                
                
                304,860Other
      payables
                
                
                4,296
                
                
                
                212,961Unearned
      revenue
                
                
                386,032
                
                
                
                195,435Accrued
      interest
                
                
                (585,543
                )
                
                
                (330,003
                )Taxes
      payable
                
                
                986,599
                
                
                
                44,898Net
      cash provided by operating activities
                
                
                4,848,146
                
                
                
                6,238,521CASH
      FLOWS FROM INVESTING ACTIVITIES:Loans
      to third parties
                
                
                (14,259,140
                )
                
                
                -Repayment
      of loans receivable
                
                
                293,300
                
                
                
                -Purchase
      of property and equipment
                
                
                (253,844
                )
                
                
                (13,484
                )Additions
      to construction in progress
                
                
                (7,425,192
                )
                
                
                (2,552,098
                )Prepayment
      on long term assets
                
                
                (1,047,327
                )
                
                
                (426,913
                )Return
      of acquisition deposit
                
                
                (124,653
                )
                
                
                -Payment
      for intangible assets
                
                
                -
                
                
                
                (35,822
                )Payment
      for land use rights
                
                
                4,722
                
                
                
                -Net
      cash used in investing activities
                
                
                (22,812,134
                )
                
                
                (3,028,317
                )CASH
      FLOWS FROM FINANCING ACTIVITIES:Proceeds
      from long term loan
                
                
                13,198,500
                
                
                
                -Increase
      in restricted cash
                
                
                (13,198,500
                )
                
                
                -Net
      cash provided by financing activities
                
                
                -
                
                
                
                -Effect
      of exchange rate changes on cash and cash equivalents
                
                
                (41,415
                )
                
                
                (6,226
                )NET
      (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS
                
                
                (18,005,403
                )
                
                
                3,203,978CASH
      & CASH EQUIVALENTS, BEGINNING OF PERIOD
                
                
                48,177,794
                
                
                
                5,854,383CASH
      & CASH EQUIVALENTS, END OF PERIOD
                
                $
                30,172,391
                
                
                $
                9,058,361SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Interest
      paid
                
                $
                1,085,543
                
                
                $
                1,084,130Income
      taxes paid
                
                $
                -
                
                
                $
                997,257Non-cash
      transactions for investing and financing activities:Construction
      in progress transferred to property and equipment
                
                $
                4,106,200
                
                
                $
                -Capitalized
      interest - amortization of  discount of notes payable and
      issuance cost
                
                $
                863,662
                
                
                $
                -





5





China
Natural Gas, Inc. and Subsidiaries


Notes
to Consolidated Financial Statements


March
31, 2010


(Unaudited)





Note
1 - Organization





Organization and Line of
Business





China
Natural Gas, Inc. (the “Company” or “CHNG”) was incorporated in the state of
Delaware on March 31, 1999. The Company through its wholly-owned subsidiaries
and variable interest entities, located in HongKong, Shaanxi ,Henan 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, construction of pipeline networks, installation of
natural gas fittings and parts for end-users, and modification of automobiles
services for vehicles to be able to use natural gas.





Recent
Developments





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





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





Note
2 – Restatement of Previously Reported Consolidated Financial
Statement




On August
20, 2010, the Company restated its quarterly consolidated financial statements
as of March 31, 2010. The Company is hereby restating the
August 20, 2010 restatement ofits quarterly consolidated financial
statements as of March 31, 2010 to reverse all disclosure related to the
reported violation of the Indenture for the Company’s 5% Guaranteed Senior Notes
(the “Senior Notes”) issued to Abax Lotus Ltd. (“Abax”).
  The
Company’s Audit Committee made a decision to restate the consolidated financial
statements upon the recommendation of the board of directors and management
following the confirmation by two different independent law firms that the
opinion on which the Company had previously relied – the basis of its conclusion
that it had violated the Indenture – was incorrect. The general nature and scope
of the adjustments are summarized as follows:
  ·
              (1)Reverse of reclassification of
      senior notes payable—— on February 26,
      2010, the Company entered into a bank loan of $17.7 million with Pudong
      Development Bank Xi’an Branch (“SPDB”) (the “Bank Loan”).  The
      loan is secured by the Company’s variable interest entity Xi’an Xilan
      Natural Gas Co., Ltd.’s (“XXNGC”) equipment and vehicles located within
      the PRC.  The Company was entitled to borrow amounts under
      the loan between March 1, 2010 to June 30, 2010. In connection
      with the Bank Loan, XXNGC pledged its equipment and vehicles located in
      PRC to secure the Bank Loan (the “Pledge”) and guaranteed the repayment of
      the Bank Loan.  The original opinion on which the Company relied
      indicated that the Pledge was prohibited by the Indenture for the
      Company’s 5% Guaranteed Senior Note issued to Abax Lotus Ltd., (“Abax”)
      dated January 26, 2008 (the “Senior Notes”).  As a result, the
      Company believed that Abax had the right to declare a default under the
      Indenture and could thereafter accelerate the Senior Notes, and
      consequently, that the Company was required to reclassify from long term
      liabilities to short term liabilities the Senior Notes. Subsequent to the
      August 20, 2010 restatement, management of the Company internally
      revisited the analysis of whether the Pledge was indeed prohibited by the
      Indenture and determined that it was not. The Company engaged two
      additional independent law firms who reviewed and confirmed this
      determination. As a result, the Company reverses the August 20, 2010
      reclassification of the Senior Notes in an amount of $28 million from long
      term liabilities to short term
liabilities.
  ·
              (2)Reverse ofreclassification of fair value
      of the redeemable warrants—— in connection
      with the Senior Notes, the Company issued certain warrants to purchase the
      Company’s common stock pursuant to a Warrant Agreement and Warrant
      Certificates.  Under the terms of the Warrant Agreement, in the
      event of a default under the Indenture for the Senior Notes, the warrant
      holders are entitled to require the Company to redeem the warrants for a
      price equal to the pro rata portion of the aggregate redemption
      price of $17,500,000 applicable to the warrants tendered by such
      holders.  As described above, in connection with the August 20,
      2010 restatement, the Company believed the Pledge was prohibited by the
      Indenture and that Abax had a right to declare an event of default under
      the Indenture. Accordingly, the Company also believed that the warrant
      holders were entitled to require the Company to redeem their warrants and,
      consequently, that the Company was required to reclassify from long term
      liabilities to short term liabilities the fair value of the redeemable
      warrants. As a result of the Company’s conclusion that the Pledge was not
      prohibited by the Indenture, the Company reverses the August 20, 2010
      reclassification of the warrants in an amount of $17.5 million from
      long term liabilities to short term
liabilities.
 
 The
Company is not restating the August 20, 2010 restatement of long term
liabilities and restricted cash on the Company’s consolidated balance sheet as
of March 31, 2010 or the restatement of financing activities in consolidated
statements of cash flow for the three months ended March 31, 2010, which
restatements were made to record the Loan as a long term liability and record an
increase in restricted cash as a result of obtaining the proceeds of the Loan,
and are described in Amendment No. 1 to the Company’s Quarterly Report on Form
10-Q for the quarter ended March 31, 2010.




6




The
following tables present the adjustments due to the restatements made herein of
the Company’s previously issued consolidated balance sheet as of March 31,
2010.
  Consolidated
      Balance Sheet
                      March
      31, 2010
                      (Unaudited)Previously
                      Reported
                    
                    
                    Adjustments
                    
                    
                    As
      RestatedASSETSCURRENT
      ASSETS:Cash
      & cash equivalents
                    
                    $
                    30,172,391
                    
                    
                    $
                    -
                    
                    
                    $
                    30,172,391Restricted
      cash
                    
                    
                    13,203,000
                    
                    
                    
                    -
                    
                    
                    
                    13,203,000Accounts
      receivable
                    
                    
                    1,514,070
                    
                    
                    
                    -
                    
                    
                    
                    1,514,070Other
      receivables
                    
                    
                    491,020
                    
                    
                    
                    -
                    
                    
                    
                    491,020Other
      receivable - employee advances
                    
                    
                    190,045
                    
                    
                    
                    -
                    
                    
                    
                    190,045Inventories
                    
                    
                    874,678
                    
                    
                    
                    -
                    
                    
                    
                    874,678Advances
      to suppliers
                    
                    
                    1,302,568
                    
                    
                    
                    -
                    
                    
                    
                    1,302,568Prepaid
      expense and other current assets
                    
                    
                    1,546,556
                    
                    
                    
                    -
                    
                    
                    
                    1,546,556Loans
      receivable
                    
                    
                    14,259,240
                    
                    
                    
                    -
                    
                    
                    
                    14,259,240Total
      current assets
                    
                    
                    63,553,568
                    
                    
                    
                    -
                    
                    
                    
                    63,553,568INVESTMENT
      IN UNCONSOLIDATED JOINT VENTURES
                    
                    
                    1,467,000
                    
                    
                    
                    -
                    
                    
                    
                    1,467,000PROPERTY
      AND EQUIPMENT, NET
                    
                    
                    75,603,216
                    
                    
                    
                    -
                    
                    
                    
                    75,603,216CONSTRUCTION
      IN PROGRESS
                    
                    
                    57,102,317
                    
                    
                    
                    -
                    
                    
                    
                    57,102,317DEFERRED
      FINANCING COSTS
                    
                    
                    1,234,540
                    
                    
                    
                    -
                    
                    
                    
                    1,234,540OTHER
      ASSETS
                    
                    
                    16,937,089
                    
                    
                    
                    -
                    
                    
                    
                    16,937,089TOTAL
      ASSETS
                    
                    $
                    215,897,730
                    
                    
                    
                    
                    
                    
                    $
                    215,897,730LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued liabilities
                    
                    $
                    1,970,228
                    
                    
                    
                    -
                    
                    
                    $
                    1,970,228Other
      payables
                    
                    
                    85,082
                    
                    
                    
                    -
                    
                    
                    
                    85,082Unearned
      revenue
                    
                    
                    2,199,805
                    
                    
                    
                    -
                    
                    
                    
                    2,199,805Accrued
      interest
                    
                    
                    200,509
                    
                    
                    
                    -
                    
                    
                    
                    200,509Taxes
      payable
                    
                    
                    2,888,511
                    
                    
                    
                    -
                    
                    
                    
                    2,888,511Notes
      payable
                    
                    
                    28,053,492
                    
                    
                    (1)
                    (28,053,492
                    )
                    
                    
                    -Redeemable
      liabilities-warrants
                    
                    
                    17,500,000
                    
                    
                    (2)
                    (17,500,000
                    )
                    
                    
                    -Total
      current liabilities
                    
                    
                    52,897,627
                    
                    
                    
                    (45,553,492
                    )
                    
                    
                    7,344,135LONG
      TERM LIABILITIES:Notes
      payable
                    
                    
                    -
                    
                    
                    (1)
                    28,053,492
                    
                    
                    
                    28,053,492Derivative
      liabilities - warrants
                    
                    
                    1,652,570
                    
                    
                    (2)
                    17,500,000
                    
                    
                    
                    19,152,570Long
      term debt
                    
                    
                    13,203,000
                    
                    
                    
                    -
                    
                    
                    
                    13,203,000Total
      long term liabilities
                    
                    
                    14,855,570
                    
                    
                    
                    45,553,492
                    
                    
                    
                    60,409,062COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      EQUITY:Preferred
      stock
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Common
      stock
                    
                    
                    2,118
                    
                    
                    
                    -
                    
                    
                    
                    2,118Additional
      paid-in capital
                    
                    
                    79,926,097
                    
                    
                    
                    -
                    
                    
                    
                    79,926,097Cumulative
      other comprehensive gain
                    
                    
                    8,675,165
                    
                    
                    
                    -
                    
                    
                    
                    8,675,165Statutory
      reserves
                    
                    
                    6,425,074
                    
                    
                    
                    -
                    
                    
                    
                    6,425,074Retained
      earnings
                    
                    
                    53,116,079
                    
                    
                    
                    -
                    
                    
                    
                    53,116,079Total
      stockholders' equity
                    
                    
                    148,144,533
                    
                    
                    
                    -
                    
                    
                    
                    148,144,533TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                    
                    $
                    215,897,730
                    
                    
                    
                    -
                    
                    
                    $
                    215,897,730


7




Note
3 – 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 Chinese Renminbi
(“RMB”); however, the Company’s reporting currency is the United States Dollar
(“USD”); therefore, the accompanying consolidated financial statements have been
translated and presented in USD.





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 statements of the results for the interim period
presented.  Operating results for the period ended March 31, 2010 are not
necessary indicative of the results that may be expected for the year ended
December 31, 2010. The information included in this Form 10-Q should be
read in conjunction with information included in the 2009 annual report filed on
Form 10-K.





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.





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 entities (“VIE”),. All inter-company accounts and transactions have
been eliminated in the consolidation.





8





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 SXNGE as a wholly-owned foreign enterprise
(WOFE). Then through SXNGE, 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 and made retroactive to March
8, 2006. As a result, the Company consolidates the financial results of XXNGC as
VIE .The arrangements consist of the following agreements:





a.
            XXNGC holds the licenses and
      approvals necessary to operate its natural gas business in
      China.





b.
            SXNGE provides exclusive
      technology consulting and other general business operation services to
      XXNGC in return for a consulting services fee which is equal to XXNGC’s
      revenue.





c.
            XXNGC’ shareholders have pledged
      their equity interests in XXNGC to the
  Company.





d.
            Irrevocably granted the Company
      an exclusive option to purchase, to the extent permitted under PRC law,
      all or part of the equity interests in XXNGC and agreed to entrust all the
      rights to exercise their voting power to the person appointed by the
      Company.





On August
8, 2008, the Company through SXNGE entered into an Addendum to Option Agreement
(“Agreement”) with Mr. Qinan Ji, chairman and shareholder of XXNGC, and each of
the shareholders of XXNGC (hereafter collectively referred to as the
“Transferor”), and made retroactive to June 30, 2008. According to the
Agreement, the Chairman and the Shareholders of XXNGC irrevocably grants to
SXNGE an option to purchase each Transferor’s Purchased Equity Interest at $1.00
or the lowest price permissible under the applicable laws at the time that SXNGE
exercises the Option. The Agreement limits XXNGC and the Transferors’ right to
make all equity interest related decisions.





Foreign Currency
Translation





The
Company’s reporting currency is the US dollar.  The functional currency of
PRC subsidiaries is the Chinese Renminbi (“RMB”). Our results of operations and
financial position of the PRC subsidiaries are translated to United States
dollars using the quarter 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 adjustments amount 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 6.82 RMB to
$1.00 at March 31, 2010 and 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 months ended March 31, 2010 and 2009
were 6.82 RMB and  RMB 6.83 to $1.00, respectively.





9





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, 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.





Certain
financial instruments, which subject the Company to concentration of credit
risk, consist of cash. 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 March 31, 2010 and
December 31, 2009, the Company had total deposits of $29,435,016 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.





Restricted
Cash





Restricted
cash represents $13.2 million received by the Company pursuant to the Bank Loan
with SPDB on March 17, 2010.  This cash amount is temporally held by SPDB
due to the pending of loan processing and the Company is not entitled to use
these proceeds as of March 31, 2010.  Due to the short-term nature of the
pending period, the corresponding restricted cash balances have been classified
as current in the consolidated balance sheets.





Accounts
Receivable





Accounts
receivable are netted against an allowance for uncollectible accounts, as
needed.  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 allowance for bad debts of $196,138 and $163,280 as of March 31, 2010
and December 31, 2009, respectively.





Other
Receivables





Other
receivables mainly include security deposits for equipment storage.  This
security deposit will be refunded to the Company after the equipment had
been removed from the storage area for construction.





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 March 31, 2010 and December 31, 2009, no
allowance for the uncollectible accounts was deemed necessary.





Inventories





Inventories
is 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:





March 31, 2010
                    (Unaudited)
                  
                  
                  December
                    31, 2009Materials and
      supplies
                  
                  $
                  453,382
                  
                  
                  $
                  345,611Gasoline
                  
                  
                  421,296
                  
                  
                  
                  496,226Total
                  
                  $
                  874,678
                  
                  
                  $
                  841,837





10





Advances to
Suppliers





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





Loans
Receivable





Loans
receivable consists of the following:




March 31, 2010
                    (unaudited)
                  
                  
                  December
                    31, 2009Shanxi
      Yuojin Mining Company, due on November 30, 2009, extended to November30,
      2010, annual interest at 5.84% (1)
                  
                  $
                  -
                  
                  
                  $
                  293,400Shanxi
      JunTai Housing Purchase Ltd., due on January 10, 2011, annual interest at
      5.84%  (2)
                  
                  
                  4,401,000
                  
                  
                  
                  -Ms.
      Taoxiang Wang, due on February 19, 2011, annual interest at 5.84%
      (3)
                  
                  
                  9,858,240
                  
                  
                  
                  -$
                  14,259,240
                  
                  
                  $
                  293,400





(1)
              This
      Company paid off this loan on March 11, 2010.


(2)
              The applicable interest rate of
      this loan is the People’s Bank of China’s standard one-year rate, 5.31% at
      inception of the loan, which is subject to change with the government
      policy, plus an additional 10% interest rate float. Pursuant to these
      terms, the interest rates were 5.84% at the inception date and March 31,
      2010. This loan is guaranteed by a third-party
      individual.


(3)
            This one-year loan was secured by
      Ms. Taoxiang Wang’s 40% of ownership in Xi’an Demaoxing Real Estate Co. On
      April 22 and April 27, 2010, Ms. Wang repaid $ 5,868,000 and $4,130,962,
      respectively, of which $140,722 was the interest payments.  As of
      April 27, 2010, this loan was paid
off.





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, the investee company is reduced to
zero and no further losses are recorded in the Company’s consolidated financial
statements unless the Company guaranteed obligations of the Investee company or
has committed additional funding. When 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 49% interest in Henan CNPC Kunlun
Xilan Compressed Natural Gas Co., Ltd. (“JV”), which is engaged in building and
operating CNG compressor stations and fueling stations, sell CNG, provide
vehicle conversion services from gasoline-fueled vehicles to hybrid (natural
gas/gasoline) powered vehicles and technical advisory work services in Henan,
PRC. The investment in this company amounted to $1,467,000 at March 31, 2010 and
December 31, 2009.  The JV does not have any operations as of March 31,
2010.





11





The
results of financial position of the JV as of March 31, 2010 are summarized
below:




March 31, 2010
                    (unaudited)
                  
                  
                  December 31,
                    2009Condensed
      balance sheet information:Current
      assets
                  
                  $
                  2,993,878
                  
                  
                  $
                  2,993,878Noncurrent
      assets
                  
                  
                  -
                  
                  
                  
                  -Total
      assets
                  
                  $
                  2,993,878
                  
                  
                  $
                  2,993,878Current
      liabilities
                  
                  
                  -
                  
                  
                  
                  -Noncurrent
      liabilities
                  
                  
                  -
                  
                  
                  
                  -Equity
                  
                  $
                  2,993,878
                  
                  
                  $
                  2,993,878Total
      liabilities and equity
                  
                  $
                  2,993,878
                  
                  
                  $
                  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:





March 31, 2010
                    (unaudited)
                  
                  
                  December 31, 2009Office equipment
                  
                  $
                  478,423
                  
                  
                  $
                  439,055Operating
      equipment
                  
                  
                  63,032,066
                  
                  
                  
                  61,350,503Vehicles
                  
                  
                  2,486,614
                  
                  
                  
                  2,486,614Buildings
      and improvements
                  
                  
                  24,055,153
                  
                  
                  
                  21,414,553Total
      property and equipment
                  
                  
                  90,052,256
                  
                  
                  
                  85,690,725Less
      accumulated depreciation
                  
                  
                  (14,449,040
                  )
                  
                  
                  (12,977,713
                  )Property
      and equipment, net
                  
                  $
                  75,603,216
                  
                  
                  $
                  72,713,012





Depreciation
expense for the three months ended March 31, 2010 and 2009 was $1,470,826
and  $1,389,565, respectively.





Construction in
Progress





Construction
in progress (“CIP”) consists of the cost of constructing property and equipment
for the Company’s gas stations and a new project of processing, distribution and
sale of LNG. The major cost of construction in progress relates to 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
March 31, 2010 and December 31, 2009, the Company had construction in progress
in the amount of $57,102,317 and $52,918,236, respectively. Interest cost
capitalized into construction in progress for the three months ended March 31,
2010 and 2009, amounted to $1,363,663 and $858,379, respectively.





12





Construction
in progress at March 31, 2010 consisted of the following:





No.
                            
                            Project Description
                            
                            Location
                            
                            March 31, 2010
                              (unaudited)
                            
                            Commencement
                              Date
                            
                            Expected
                              completion
                              date
                            
                            Estimated
                              additional
                              cost to
                              complete1
                            
                            Jingbian
      LNG (1)
                            
                            JBLNG
                            
                            $
                            45,882,038
                            
                            Dec-06
                            
                            Jun-10
                            
                            $
                            9,873,0002
                            
                            Sa
      Pu mother station
                            
                            HXNGC
                            
                            
                            840,799
                            
                            Jul-08
                            
                            Jun-11
                            
                            
                            6,300,0003
                            
                            Xi'an
      Cangsheng mother station
                            
                            XXNGC
                            
                            
                            1,925,557
                            
                            Sep-08
                            
                            May-11
                            
                            
                            3,220,0004
                            
                            Sanhuanbei
      fueling station
                            
                            XXNGC
                            
                            
                            1,725,563
                            
                            Mar-10
                            
                            May
      -10
                            
                            
                            1,126,6565
                            
                            Sanyao
      fueling station
                            
                            XXNGC
                            
                            
                            1,662,652
                            
                            Mar-10
                            
                            May-10
                            
                            
                            1,085,5806
                            
                            Matengkong
      fueling station
                            
                            XXNGC
                            
                            
                            1,581,766
                            
                            Mar-10
                            
                            May
      -10
                            
                            
                            1,164,7987
                            
                            International
      port
                            
                            XXNGC
                            
                            
                            1,376,406
                            
                            May-09
                            
                            Dec
      -10
                            
                            
                            2,800,0008
                            
                            Other
      CIP projects
                            
                            XXNGC
                            
                            
                            2,107,536
                            
                            Various
                            
                            Various
                            
                            
                            500,000$
                            57,102,317
                            
                            
                            
                            
                            
                            $
                            26,070,034





(1)
            Phase I of the LNG project cost
      $48,963,000 to construct and the additional
      $6,792,038  represent costs incurred in connection with phase II
      and phase III of the LNG
plant





Long-Lived
Assets





The
Company evaluates at least annually, more often when circumstances require, the
carrying value of long-lived assets to be held and used.  Impairment losses
to be 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 March 31, 2010, there were no significant
impairments of its long-lived assets.





Unearned
Revenue





Unearned
revenue represents prepayments by customers for gas purchases and advance
payments on installation of pipeline contracts. The Company records such
prepayment 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 enhance 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, for substantially the
      full term of the financial
instrument.





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





13





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.





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 US dollar, a currency other than the Company’s functional
currency, the Chinese Renminbi.  As a result, the warrants are not
considered indexed to the Company’s own stock, and as such, all future changes
in the fair value of these warrants will be recognized currently in earnings
until such time as the warrants are exercised or expire.





As such,
effective January 1, 2009, the Company reclassified the fair value of these
warrants from equity to liability, as if these warrants were 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 beginning retained earnings and
$1,014,308 to warrant liabilities to recognize the fair value of such warrants.
The fair value of the warrants was $1,652,570 and $2,045,638 on March 31, 2010
and December 31, 2009, respectively. The Company recognized a gain of $393,068
and $197,051 for the three months ended March 31, 2010 and 2009,
respectively.




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





March 31, 2010
                    (unaudited)
                  
                  
                  December 31,
                    2009Annual dividend
      yield
                  
                  
                  -
                  
                  
                  
                  -Expected
      life (years)
                  
                  
                  2.57
                  
                  
                  
                  2.82Risk-free
      interest rate
                  
                  
                  1.34
                  %
                  
                  
                  1.49
                  %Expected
      volatility
                  
                  
                  90
                  %
                  
                  
                  90
                  %





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 our 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 U.S.
Treasury securities according 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 was 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.





14





The
following table sets forth by level within the fair value hierarchy of the
Company’s financial assets and liabilities that were accounted for at fair value
on a recurring basis as of March 31, 2010.




Carrying Value at
                    March
      31, 2010
                  
                  
                  Fair Value Measurement at
                    March 31, 2010(unaudited)
                  
                  
                  Level 1
                  
                  
                  Level 2
                  
                  
                  Level 3Long-term
      debt
                  
                  $
                  13,203,000
                  
                  
                  $
                  -
                  
                  
                  $
                  -
                  
                  
                  $
                  12,530,130Senior
      notes
                  
                  
                  28,053,492
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  35,764,078Redeemable
      liability - warrants
                  
                  
                  17,500,000
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  15,468,681Derivative
      liability - warrants
                  
                  
                  1,652,570
                  
                  
                  
                  -
                  
                  
                  
                  1,652,570
                  
                  
                  
                  -Total
      liability measured at fair value
                  
                  $
                  60,409,062
                  
                  
                  $
                  -
                  
                  
                  $
                  1,652,570
                  
                  
                  $
                  63,762,889




Other
than the table set forth above, the Company did not identify any other assets
and liabilities that are required to be presented on the balance
sheet.




Revenue
Recognition





Revenue
is recognized when services are rendered to customers 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. The 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 his
direct reports) 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 established  by the FASB’s
accounting standard for segment reporting, the Company considers itself to be
operating within one reportable segment.





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
months ended March 31, 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 defines 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.





15





Income
Taxes





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 March 31, 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 and tax. 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. The adoption had no affect on the Company’s consolidated financial
statements.





Local PRC Income
Tax





The
Company’s subsidiary and VIEs 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. The Company’s VIE,
XXNGC, is in the natural gas industry whose development is encouraged by the
government. According to the income tax regulation, any company engaged in the
natural gas industry enjoys a favorable tax rate. Accordingly, except for income
from SXNGE, JBLNG, SXABC, HXNGC, LBNGC and HBXNGC which subjects to 25% PRC
income tax rate, XXNGC’s income is subject to a reduced tax rate of 15%.  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
                    March 312010
                  
                  
                  2009Tax
      provision (credit) at statutory rate
                  
                  
                  34
                  %
                  
                  
                  34
                  %Foreign
      tax rate difference
                  
                  
                  (9
                  )%
                  
                  
                  (9
                  )%Effect
      of favorable tax rate
                  
                  
                  (7
                  )%
                  
                  
                  (10
                  )%Other
      item (1)
                  
                  
                  1
                  %
                  
                  
                  4
                  %Total
      provision for income taxes
                  
                  
                  19
                  %
                  
                  
                  19
                  %





(1)  The
1% represents the $288,192 expenses incurred by CHNG that are not deductible in
PRC for the three months ended March 31, 2010.  The 4% represents the
$926,195 expenses incurred by CHNG that are not deductible in PRC for the three
months ended March 31, 2009.





The
estimated tax savings for the three months ended March 31, 2010 and 2009
amounted to approximately $498,624 and $510,331, respectively. The net effect on
earnings per share had the income tax been applied would decrease basic earnings
per share from $0.19 to $0.17, and the diluted earnings per share from $0.19 to
$0.16 for the three months ended March 31, 2010. For the three months ended
March 31, 2009, the basic and diluted earnings per share would decrease from
$0.29 to $0.26 if the income tax had been applied.





China
Natural Gas, Inc. was incorporated in the United States and has incurred net
operating loss for income tax purpose for the period ended March 31, 2010. 
The estimated net operating loss carry forwards for United States income tax
purposes amounted to $3,574,888 and $3,232,855 as of March 31, 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 2029. Management believes that the realization of the benefits arising
from this loss appear to be uncertain due to Company's limited operating history
and continuing losses for United States income tax purposes. Accordingly, the
Company has provided a 100% valuation allowance at March 31, 2010. Management
reviews this valuation allowance periodically and makes adjustments as
warranted. The valuation allowances were as follow:





16





Valuation allowance
                  
                  For the three
                    months end
                    March 31,2010
                    (unaudited)
                  
                  
                  Year ended
                    December
                    31,2009Balance,
      beginning of period
                  
                  $
                  1,099,171
                  
                  
                  $
                  563,541Increase
                  
                  
                  116,291
                  
                  
                  
                  535,630Balance,
      end of period
                  
                  $
                  1,215,462
                  
                  
                  $
                  1,099,171





The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $34,110,704 as of March 31, 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
U.S. 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 we 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”). All of the Company’s variable interest entity XXNGC’s products that are
sold in the PRC are subject to a Chinese value-added tax at a rate of 13% of the
gross sales price. This VAT may be offset by VAT paid by the XXNGC on raw
materials and other materials included in the cost of producing their finished
product. 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 SXABC are subject to a Chinese VAT at a rate of 6%. This VAT
cannot offset with VAT paid for materials included in the cost of
revenues.





Taxes
Payable





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





March 31, 2010
                    (unaudited)
                  
                  
                  December 31, 2009Value
      added tax payable
                  
                  $
                  810,976
                  
                  
                  $
                  740,772Business
      tax payable
                  
                  
                  -
                  
                  
                  
                  1,540Income
      tax payable
                  
                  
                  2,039,416
                  
                  
                  
                  1,127,961Urban
      maintenance tax payable
                  
                  
                  34,357
                  
                  
                  
                  27,442Income
      tax for individual payable
                  
                  
                  3,762
                  
                  
                  
                  3,862Total
      tax payable
                  
                  $
                  2,888,511
                  
                  
                  $
                  1,901,577





Basic and Diluted Earnings
Per Share





Earnings
per share is calculated in accordance with the FASB’s accounting standard
regarding earnings per share. Basic net earnings per share is based upon the
weighted average number of common shares outstanding. Diluted net earnings per
share is 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 were effective on April 28, 2009.








17





Recently issued accounting
pronouncements





In
January 2010, FASB issued ASU No. 2010-01- Accounting for Distributions to
Shareholders with Components of Stock and Cash. The amendments in this Update
clarify 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 EPS 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 adoption of this ASU did not have a material
impact on its consolidated financial statements.





In
January 2010, FASB issued ASU No. 2010-02 – Accounting and Reporting for
Decreases in Ownership of a Subsidiary – a Scope Clarification. The amendments
in this Update affect accounting and reporting by an entity that experiences a
decrease in ownership in a subsidiary that is a business or nonprofit activity.
The amendments also affect 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 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 adoption of this ASU did not have a material
impact on the Company’s consolidated financial statements.





In
January 2010, 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
clarifies 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. These disclosures 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 to have a material impact on
its consolidated financial statements.





In
February 2010, 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, 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 U.S.
GAAP. The amendment is effective for interim and annual reporting periods in
fiscal year ending after June 15, 2010. The Company does not expect the adoption
of this ASU to have a material impact on the Company’s consolidated financial
statements.





18





In March
2010, 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 to 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 year
beginning after November 15, 2009. The adoption of this ASU did
not have a material impact on the Company’s consolidated financial
statements.





In March
2010, 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 does not expect
the adoption of this ASU to have a material impact on the Company’s consolidated
financial statements.





Reclassification





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





Note
4 – Other Assets





Other
assets consisted of the following:





March 31,
                      2010
                    
                    
                    December 31,
                      2009(unaudited)Prepaid
      rent – natural gas stations
                    
                    $
                    335,487
                    
                    
                    $
                    340,211Prepayment
      for acquiring land use right
                    
                    
                    1,936,440
                    
                    
                    
                    1,936,440Advances
      on purchasing equipment and construction in progress
                    
                    
                    13,104,648
                    
                    
                    
                    12,056,964Refundable
      security deposits
                    
                    
                    1,388,978
                    
                    
                    
                    1,264,283Others
                    
                    
                    171,536
                    
                    
                    
                    257,012Total
                    
                    $
                    16,937,089
                    
                    
                    $
                    15,854,910





All land
in the PRC is government owned.  However, the government grants users land
use rights.  As of March 31, 2010 and December 31, 2009, the Company
prepaid $1,936,440 to the PRC local government 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 prepaid land use
rights.





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





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





19





Note
5 – Senior Notes Payable





On March
30, 2007, the Company entered into a Securities Purchase Agreement with Abax
Lotus Ltd. (the “Investor”). The Purchase Agreement was subsequently amended on
January 29, 2008, pursuant to which the Company (i) agreed to issue 5.00%
Guaranteed Senior Notes due 2014 (the “Senior Notes”) of approximately
$20,000,000, (ii) agreed to issue to the Investor Senior Notes in aggregate
principal amount of approximately $20,000,000 on or before March 3, 2008 subject
to the Company meeting certain closing conditions, (iii) granted the Investor an
option to purchase up to approximately $10,000,000 in principal amount of its
Senior Notes and (iv) agreed to issue to the Investor seven-year warrants
exercisable for up to 1,450,000 shares of the Company’s common stock (the
“Warrants”) at an initial exercise price equal to $14.7304 per share, subject to
certain adjustments, which adjusted to $7.3652 on January 29, 2009.  On
January 29, 2008, the Company issued $20,000,000 Senior Notes and 1,450,000
warrants pursuant to the Purchase Agreement. On March 3, 2008, the Investor
exercised its first option for an additional $20,000,000 of Senior Notes. On
March 10, 2008, the Company issued $20,000,000 in additional Senior Notes
resulting in total Senior Notes of $40,000,000.





At the
closing, the Company entered into:





·
            An indenture for the 5.00%
      Guaranteed Senior Notes due
2014;





·
            An investor rights
      agreement;





·
            A registration rights agreement
      covering the shares of common stock issuable upon exercise of the
      warrants;





·
            An information rights agreement
      that grants to the Investor, subject to applicable law, the right to
      receive certain information regarding the
  Company;





·
            A share-pledge agreement whereby
      the Company granted to the Collateral Agent (on behalf of the holders of
      the Senior Notes) a pledge on 65% of the Company’s equity interest in
      SXNGE, a PRC corporation and wholly-owned subsidiary of the Company;
      and





·
            An account pledge and security
      agreement whereby the Company granted to the Collateral Agent a security
      interest in the account where the proceeds from the Senior Notes are
      deposited.





In
addition, Qinan Ji, Chief Executive Officer and Chairman of the Board of the
Company, executed a non-compete agreement for the benefit of the
Investor.





The
Senior Notes were issued pursuant to an indenture between the Company and DB
Trustees (Hong Kong) Limited, as trustee, at the closing. The Senior Notes will
mature on January 30, 2014 and will initially bear interest at the stated
interest rate of 5.00% per annum, subject to an increase in the event of certain
circumstances. The Company is required to make mandatory repayments on the
Senior Notes on the following dates and in the following amounts, expressed as a
percentage of the aggregate principal amount of Notes that will be outstanding
on the first such payment date:




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
                  %





20





During
the twelve month period commencing January 30 of the years set forth below, the
Company may redeem the Senior Notes at the following principal
amount:




Year
                  
                  Principal2009
                  
                  $
                  43,200,0002010
                  
                  
                  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
indenture requires the Company to pay additional interest at the rate of 3.0%
per annum of the Senior Notes if the Company has not obtained a listing of its
common stock on the Nasdaq Global Market, the Nasdaq Capital Market or the New
York Stock Exchange by January 29, 2009 and maintained such listing continuously
thereafter as long as the Senior Notes are outstanding. As of January 29, 2009,
the Company had not obtained a listing of its common stock on the market stated
in the agreement. However, the Company obtained a three-month waiver from ABAX
for the additional interest payment. The waiver gave the Company three more
months until April 28, 2009 to achieve the uplisting status. By the end of the
extended period, if the Company was not able to complete the uplisting, the
Company would have to pay additional interest retroactively starting January 30,
2009 in accordance with the terms of the waiver. The Company was approved to be
listed on Nasdaq on June 1, 2009, which passed the wavier period.  In
August 2009, the Company reached an agreement with ABAX that the Company was to
pay additional interest accrued for the period from April 29, 2009, the
expiration date of previous waiver to June 1, 2009, the date of listing. As
such, the Company paid $113,214 additional interest to ABAX in August
2009.





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.




The
Company also entered into an investor rights agreement, pursuant to which, as
long as an investor holds at least 10% of the aggregate principal amount of the
Senior Notes issued and outstanding or at least 3% of the Company’s issued and
outstanding common stock pursuant to the warrants on an as-exercised basis
(“Minimum Holding”), the Company has agreed not to undertake certain corporate
actions without prior Investor approval. In addition, so long as an Investor
owns the Minimum Holding, such Investor shall have a right of first refusal for
future debt securities offerings by the Company and the Company is subject to
certain transfer restrictions on its securities and certain other
properties.





From the
Closing Date and as long as the Investor continues to hold more than 10% of the
outstanding shares of common stock on an as-converted, fully-diluted basis, the
Investor shall be entitled to appoint one of the Company’s board of directors
(the “Investor Director”). The Investor Director shall be entitled to serve on
each committee of the board, except that, the Investor Director shall not serve
on the audit committee unless it is an independent director. Mr. Ji has agreed
to vote his shares for the election of the Investor Director.




In
connection with the issuance of the Securities Purchase Agreement, the Company
paid $2,122,509 in debt issuance costs which is being amortized over the life of
the Senior Notes.  For the three months ended March 31, 2010 and 2009, the
Company amortized $0 and $38,578 of the aforesaid issuance costs, net of
capitalized interest.





21





In
connection with the Securities Purchase Agreement, the Company agreed to issue
to the Investor seven-year warrants exercisable for up to 1,450,000 shares of
the Company’s common stock at an initial exercise price equal to $14.7304 per
share, subject to certain adjustments. The exercise price of the Warrants is
adjusted on the first anniversary of issuance and thereafter, at every six month
anniversary beginning in the fiscal year 2009 if the volume weighted average
price, or VWAP, (as defined therein) for the 15 trading days prior to the
applicable reset date is less than the then applicable exercise price, in which
case the exercise price shall be adjusted downward to the then current VWAP;
provided, however, that in no event shall the exercise price be adjusted below
$7.3652 per share. The exercise price was adjusted to $7.3652 on January 29,
2009. No further adjustments of the exercise price will be required (as that is
the floor price).





The
warrants granted to the Investor on January 29, 2008 are considered derivative
instruments that need to be bifurcated from the original security.  If the
Warrants have not been exercised within the seven year period, then the Investor
can have the Company purchase the 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 March 31, 2010 and 2009, the Company
amortized $761,204 and $634,076 of the aforesaid discounts, of which $761,204
and $463,364, respectively, were capitalized into construction in
progress.





The
warrants have been determined to be derivative liabilities instruments because
there is a required redemption requirement if the holder does not exercise the
Warrants.  However, the warrants are not required to be valued at fair
value, rather, to be at its undiscounted redemption amount of $17.5
million.




Note
6- Long term Loan





The
Company’s long term bank loan as of March 31, 2010 and December 31, 2009 are as
following:





March 31,2010
                    (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
                  
                  $
                  13,203,000
                  
                  
                  $
                  -




On
February 26, 2010, JBLNG entered into a fixed assets loan contract with Pudong
Development Bank Xi’an Branch (“SPDB”), pursuant to which SPDB agreed to lend
$17,676,000 to JBLNG. SPDB transferred $13.2 million to JBLNG on March 17, 2010.
The loan is secured by Xi’an Xilan Natural Gas Co., ltd (“XXNGC”)’s equipments
and vehicles located within PRC. The carrying net value of the asset pledged is
$12,701,756 as of March 31, 2010. XXNGC also entered into a guaranty with SPDB
to guarantee the repayment of the loans. The Company is required to make
mandatory prepayments on the long term loan in the following date and
amounts:




Date
                  
                  Repayment Percentage
                  
                  
                  Repayment AmountMarch
      5, 2012
                  
                  
                  25
                  %
                  
                  $
                  4,401,000March
      5, 2013
                  
                  
                  25
                  %
                  
                  
                  4,401,000March
      5, 2014
                  
                  
                  25
                  %
                  
                  
                  4,401,000





Note
7 – Warrants





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,
      March 31, 2010 (unaudited)
                
                
                1,833,654
                
                
                $
                8.93
                
                
                $
                1,607,507





Following
is a summary of the status of warrants outstanding at March 31,
2010:





Outstanding WarrantsExercise Price
                            
                            Number
                            
                            
                            Average
                              Remaining
                              Contractual
                              Life$
                            7.37
                            
                            
                            1,450,000
                            
                            
                            
                            4.83$
                            14.86
                            
                            
                            383,654
                            
                            
                            
                            2.34$
                            8.93
                            
                            
                            1,833,654
                            
                            
                            
                            4.31





22





Note
8 – 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 100RMB 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 the current salary expense. The total
contribution for the above plan was $190,348 and $47,188 for the three months
ended March 31, 2010 and 2009, respectively.





Note
9 – 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. China
Natural Gas 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, pursuant to the
over-allotment option exercised in full by the underwriter in connection with
its public offering that closed on September 9, 2009.





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





The net
proceeds from the offering was intended to be used for the construction of the
Company's liquefied natural gas facility, the acquisition of CNG fueling
stations, the purchase of CNG trucks and the establishment of a joint venture
company with China National Petroleum Corporation Kunlun Natural Gas Co., Ltd.,
as well as for general working capital purposes.





Note
10 – Statutory Reserve





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





i.
            Making up cumulative prior years’
      losses, if any;





ii.
            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;





iii.
            Allocations to the discretionary
      surplus reserve, if approved in the shareholders’ general
      meeting.





As of
March 31, 2010, the remaining reserve needed to fulfill the 50% registered
capital requirement was approximately $69,720,000





Note
11 – Accounting for Stock-based Compensation





1)
Options from CEO to pay for certain Company’s 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% vest on September 22, 2009, and the remaining 40% vest 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 were recorded
during the three months ended March 31, 2010 and 2009,
respectively.


23


As of
March 31, 2010, $44,016 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 six months.





2) 2009
stock option plan





On March
11, 2009, the board of directors approved by written consent the Company’s stock
option plan for its employees, directors and consultants. Pursuant to the plan,
the total stock option pool will equal to 10% of the Company’s total shares
outstanding as of March 11, 2009. Among the option pool approved, 4% shall be
awarded in 2009 and another 4% shall be awarded in 2010, and 2% reserved for
future awards. For the 2009 stock option award, the CEO and former CFO were
granted total options of 1% and 0.6% of the common shares outstanding, 50%
as Non-qualified Stock Options (NSO) and 50% as Incentive Stock Awards (ISA),
for a vesting period of four years. The Company granted the former CFO, Veronica
Chen, options to purchase 75,000 shares of the Company’s common stock,
representing approximately 0.5% of the Company’s outstanding shares as of March
11, 2009, which forfeited as Veronica Chen resigned as CFO. 5,000 option shares
per year will be granted to each non-executive board member and 6,000 option
shares per year granted to the Audit Committee Chairman. Other senior management
and employees will be granted total options of 2.11% of the Company’s common
shares. On April 1, 2009, the Company issued 243,850 and 75,000 stock
options, respectively pursuant to the Company's 2009 employee stock option
and stock award plan.  The strike price for the options was $4.90 per
share. The stock option has a term of six years and vests evenly over four years
starting one year from the issuance date on an annually basis.





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
U.S. 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 52,838 was recorded during
the three months ended March 31, 2010.





As of
March 31, 2010, $634,074 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 3 years.





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
                  
                  
                  $
                  1,516,747GrantedForfeitedExercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Outstanding,
      March 31, 2010 (unaudited)
                  
                  
                  243,850
                  
                  
                  $
                  4.90
                  
                  
                  $
                  1,197,304


24


Following is a summary of the status of stock options outstanding
at March 31, 2010:





Outstanding Options
                        
                        Exercisable OptionsExercise
                          Price
                        
                        Number
                        
                        Average
                          Remaining
                          Contractual
                          Life
                        
                        Exercise
                          Price
                        
                        Number
                        
                        Average
                          Remaining
                          Contractual
                          Life$
                        4.90
                        
                        
                        
                        243,850
                        
                        
                        
                        5.00
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -





Note
12 – Earnings per Share





Earnings
per share for the years ended March 31, 2010 and 2009 is 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 FASB’s accounting standard.





The following demonstrates the calculation for earnings per
share for the years ended March
31, 2009 and 2008:





For the three
                    months ended March 31,2010
                    (unaudited)
                  
                  
                  2009
                    (unaudited)Basic earnings per shareNet
      income
                  
                  $
                  3,995,270
                  
                  
                  $
                  4,201,623Weighted
      shares outstanding-Basic
                  
                  
                  21,183,904
                  
                  
                  
                  14,600,152Earnings
      per share-Basic
                  
                  $
                  0.19
                  
                  
                  $
                  0.29Diluted
      earnings per shareNet
      income
                  
                  $
                  3,995,270
                  
                  
                  $
                  4,201,623Weighted
      shares outstanding-Basic
                  
                  
                  21,183,904
                  
                  
                  
                  14,600,152Effect
      of diluted securities-Warrants
                  
                  
                  411,134
                  
                  
                  
                  -Weighted
      shares outstanding-Diluted
                  
                  
                  21,595,038
                  
                  
                  
                  14,600,152Earnings
      per share-Diluted
                  
                  $
                  0.19
                  
                  
                  $
                  0.29





The
Company had outstanding warrants of 1,833,654 at March 31, 2010 and 2009. 
For the three months ended March 31, 2010, 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 411,134; 383,654 outstanding
warrants were excluded from the diluted earnings per share calculation as they
are anti-dilutive. For the three months ended March 31, 2009, all 1,833,654
outstanding warrants were excluded from the diluted earnings per share
calculation as they are anti-dilutive.


25


Note
13 – Current Vulnerability Due to Certain Concentrations





Concentration
of natural gas vendors:





For the three
                    months ended March 31,2010
                    (unaudited)
                  
                  
                  2009
                    (unaudited)Numbers
      of natural gas vendors
                  
                  
                  3
                  
                  
                  
                  3Percentage
      of total natural gas purchases
                  
                  
                  88
                  %
                  
                  
                  80
                  %





As of
March 31, 2010 and December 31, 2009, the Company has $105,488 and $82,146
payable due to its major suppliers.





The
Company maintains long-term natural gas minimum purchase agreements with one of
its vendors as of March 31, 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. Price
points for natural gas are strictly controlled by the government and have
remained stable over the past three years.





The
Company's operations are carried out in the People’s Republic of China.
Accordingly, the Company's business, financial condition and results of
operations may be influenced by the political, economic and legal environments
in the People’s Republic of China, by the general state of the People’s Republic
of China‘s 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.





Note
14 – Commitments and Contingencies





(a)  Lease
Commitments





The
Company recognizes lease expense on a straight-line basis over the term of the
lease in accordance to FASB’s accounting standard regarding leases. The
Company entered into a series of long-term lease agreements with outside parties
to lease land use rights to the 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.  The Company 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
                  
                  $
                  1,280,191Year
      ending December 31, 2011
                  
                  
                  2,087,346Year
      ending December 31, 2012
                  
                  
                  1,921,385Year
      ending December 31, 2013
                  
                  
                  1,830,217Year
      ending December 31, 2014
                  
                  
                  2,218,208Thereafter
                  
                  
                  34,447,281Total
                  
                  $
                  43,784,628





For the
three months ended March 31, 2010 and 2009, the land use right and office lease
expenses were $430,628 and $392,081, respectively.


26


(b)
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 CIP projects.  The
Company has future commitments as followings:





Year
      ending December 31, 2010
                  
                  $
                  10,343,316Year
      ending December 31, 2011
                  
                  
                  2,143,287Thereafter
                  
                  
                  -Total
                  
                  $
                  12,486,603





(c)
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.





(d) Legal
Proceedings





A former
member of the board of directors filed a lawsuit on June 16, 2008 against the
Company in New York State Supreme Court, Nassau County, in which he has sought,
among other things, to recover a portion of his monthly compensation plus 20,000
options that he alleges are due to him pursuant to a written agreement. After
the plaintiff rejected an offer by the Company that included the options that
plaintiff alleged were due to him, the Company moved to dismiss the complaint.
The judge ordered the Company to issue the 20,000 options to the plaintiff
subject to any restrictions required by applicable securities laws, which was
essentially what the Company had previously offered, and dismissed all of the
plaintiff's remaining claims against the Company. The current board of directors
has complied with the court's decision by tendering an option agreement to the
plaintiff consistent with the court's decision, but the plaintiff has refused to
execute the agreement, and instead has filed an appeal. On March 16, 2010, the
Appellate Division, Second Department, modified the decision and order of the
trial court and dismissed the action in its entirety. Subsequently, the
plaintiff has sought leave to appeal the appellate court's decision in New York
state's highest court.





Note
15 – Subsequent Event





As
disclosed in Note 3, Ms. Taoxiang has paid off the principal of $9,858,240 and
interest of $140,722 as of April 27, 2010.





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





CAUTIONARY
STATEMENT





FORWARD-LOOKING
STATEMENT





The
information in this report contains forward-looking statements. All statements
other than statements of historical fact made in this report are forward
looking. In particular, the statements herein regarding industry prospects and
future results of operations or financial position are forward-looking
statements. These forward-looking statements can be identified by the use of
words such as "believes," "estimates," "could," "possibly," "probably,"
"anticipates," "projects," "expects," "may," "will," or "should" or other
variations or similar words. No assurances can be given that the future results
anticipated by the forward-looking statements will be achieved. Forward-looking
statements reflect management's current expectations and are inherently
uncertain. Our actual results may differ significantly from management's
expectations.





The
following discussion and analysis should be read in conjunction with our
financial statements, included herewith. This discussion should not be construed
to imply that the results discussed herein will necessarily continue into the
future, or that any conclusion reached herein will necessarily be indicative of
actual operating results in the future. Such discussion represents only the best
present assessment of our management.





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 VIE-owned CNG fueling stations. As of March 31, 2010, our VIE
operated 25 CNG fueling stations in Shaanxi province and 12 CNG fueling stations
in Henan province. Our VIE own the CNG fueling stations while we lease the land
upon which our VIE owned CNG fueling stations operate. For the three months
ended March 31, 2010, we sold 40,592,457 cubic meters of CNG through our fueling
stations, compared to 39,294,120 cubic meters for the three ended March 31,
2009. Our VIE also transport, distribute and sell 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.


27


We
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 (37 stations
      as of March 31, 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
      110,713 residential customers as of March 31,
  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 March 31, 2010);
      and





·
            Conversion of gasoline-fueled
      vehicles to hybrid (natural gas/gasoline) powered vehicles at our auto
      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 and have no plans to do so during the
next 12 months. We currently sell our natural gas in two forms: (i) CNG and (ii)
piped natural gas.





On
October 24, 2006, our variable interest entity XXNGC, formed a wholly-owned
subsidiary, SJLNG, for the purpose of constructing a LNG facility to be located
in Jingbian, Shaanxi province. We planned to invest approximately $50 million to
construct this facility, funded through the sale of senior notes to Abax and our
September 2009 equity financing, as well as cash flows from operations. The LNG
plant is under construction and is expected to be completed and fully
operational by the second quarter of 2010. Once completed, the plant is expected
to have a processing capacity of 500,000 cubic meters per day, or approximately
150 million cubic meters on an annual basis.





We had
total revenues of $19,366,823 and $18,527,666 for the three months ended March
31, 2010 and 2009 respectively. We had net income of $3,995,270 and $4,201,623
for the three months ended March 31, 2010 and 2009 respectively.





Factors
Affecting Our Results of Operations





Significant
factors affecting our results of operations are:





Successful
expansion of our CNG fueling station business in our target markets . Our
revenue increased by 4.5% during the three months ended March 31, 2010 from the
three months ended March 31, 2009 largely because of the addition of 2 new
fueling stations added since the third quarter of 2009, as well as the increase
of pipeline natural gas customers. As of March 31, 2010, we operated 37 CNG
fueling stations in total and, in Shaanxi alone, we operated 25 CNG fueling
stations. We believe we are the largest provider of CNG fueling stations in
Xi’an, one of our core target markets for CNG.  As of March 31, 2010, we
operated 12 CNG fueling stations in Henan province, another of our core target
markets. 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 boundaries set by the PRC
central government.  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 than in Henan. 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.


28


Government
policies encouraging the adoption of cleaner burning fuels . Our results
of operations for the periods reviewed 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 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 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. While China's
economy has experienced a slowdown in 2008 and a recovery period in 2009,
Although the government has initiated extensive domestic stimulus spending,
expanded bank lending, increases in the speed of regulatory approvals of new
construction projects and other economic policies, we are currently unable to
predict the overall direction of PRC economy. Our results of operations rely on
the overall success of China’s economy and may be affected by the macro economic
trends.





Taxation





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 March 31, 2010 and the estimated net operating loss carry forwards
for United States income tax purposes amounted to $3,574,888 and $3,232,855 as
of March 31, 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 2029. 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 March 31, 2010.





The
PRC





Our
subsidiary, VIE and its 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. Based on
certain income tax regulations adopted in 2001 to encourage the development of
certain industries, including the natural gas industry, in the western portions
of China such as Shaanxi Province, XXNGC is subject to a reduced tax rate of
15%. Accordingly, except for income from XXNGC, which is subject to the reduced
tax rate of 15%, income from SXNGE, SJLNG, XXABC, HXNGC, LBNGC, and HBXNGC are
subject to the 25% PRC income tax rate. Our effective income tax rate for
the three months ended March 31, 2010 and 2009 were approximately 18.6% and
19.2%, respectively.





Value
Added Tax





Sales
revenue represents the invoiced value of goods, net of a value-added tax
("VAT").  All of our variable interest entity XXNGC's products that are
sold in the PRC are subject to a Chinese VAT at a rate of 13% of the gross sales
price. This VAT may be offset by VAT paid by XXNGC on raw materials and other
materials included in the cost of producing their finished products. XXNGC
records VAT payable and VAT receivable net of payments in its financial
statements. VAT tax returns are filed offsetting the payables against the
receivables.


29


All
revenues from XXABC are subject to a Chinese VAT at a rate of 6%. This VAT
cannot be offset with VAT paid for materials included in the cost of
revenues.





CONSOLIDATED
RESULTS OF OPERATIONS





Three
Months Ended March 31, 2010 Compared to Three Months Ended March 31,
2009





The
following table represents the consolidated operating results for the three
month period ended March 31, 2010 and 2009:





Sales
Revenues





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





March 31,2010
                  
                  
                  March 31,2009
                  
                  
                  Increase in dollar
                    amount
                  
                  
                  Increase in
                    percentageNatural
      gas from filling stations
                  
                  $
                  14,629,610
                  
                  
                  $
                  14,257,925
                  
                  
                  $
                  371,685
                  
                  
                  
                  2.6
                  %Natural
      gas from pipelines
                  
                  
                  854,019
                  
                  
                  
                  707,895
                  
                  
                  
                  146,124
                  
                  
                  
                  20.6
                  %Gasoline
                  
                  
                  1,468,816
                  
                  
                  
                  1,174,398
                  
                  
                  
                  294,418
                  
                  
                  
                  25.1
                  %Installation
                  
                  
                  2,007,774
                  
                  
                  
                  1,901,034
                  
                  
                  
                  106,740
                  
                  
                  
                  5.6
                  %Auto
      conversion
                  
                  
                  406,604
                  
                  
                  
                  486,414
                  
                  
                  
                  (79,810
                  )
                  
                  
                  (16.4
                  )%Total
                  
                  $
                  19,366,823
                  
                  
                  $
                  18,527,666
                  
                  
                  $
                  839,157
                  
                  
                  
                  4.5
                  %




Overall .
Total revenue for the three months ended March 31, 2010 increased to $19,366,823
from $18,527,666 for the three months ended March 31, 2009, an increase of
$839,157 or 4.5 %. This increase was mainly due to the addition of 2 new fueling
stations added in third quarter 2009 and first quarter 2010, respectively, as
well as an increase in the number of residential and commercial pipeline
customers to110,713 as of March 31, 2010 from 98,754 as of March 31, 2009. We
sold natural gas of 44,161,281 cubic meters during the three months ended March
31, 2010, compared to 42,283,144 cubic meters during the three months ended
March 31, 2009. We also sold gasoline of 1,929,034 liters during the three
months ended March 31, 2010, compared to 2,171,232 liters during the three
months ended March 31, 2009. For the three months ended March 31, 2010, 87.5% of
our revenue was generated from the sale of natural gas and gasoline, and the
other 12.5% was generated from our installation and auto conversion
services.


30


Natural Gas from
Fueling Stations . Natural gas revenue from our fueling stations
increased by 2.6% or $371,685, to $14,629,610 during the three months ended
March 31, 2010, from $14,257,925 during the three months ended March 31, 2009,
and contributed to 75.5% of our total revenue, which was the largest among our
four major business lines. During the three months ended March 31, 2010, we sold
40,592,457 cubic meters of compressed natural gas, compared to 39,294,120 cubic
meters during the three months ended March 31, 2009 through our fueling
stations. In terms of average station sales value and volume, in the three
months ended March 31, 2010, we sold approximately $406,378 and 1,127,568 cubic
meters of compressed natural gas per station, compared to approximately $407,916
and 1,122,689 cubic meters in the three months ended March 31, 2009. Unit
selling price remained stable at $0.34 (RMB2.34) and $0.42 (RMB2.83) net of VAT
in Shaanxi and Henan province, respectively, or $0.37 (RMB 2.5) on an average
basis.





Natural Gas from
Pipelines .  Natural gas revenue from our pipelines increased by
20.6%, or $146,124, to $854,019 during the three months ended March 31, 2010,
from $707,895 during the three months ended March 31, 2009, and contributed to
4.4% of our total revenue. As of March 31, 2010, the Company had 110,713
pipeline customers, an increase of 11,959 customers comparing to as of March 31,
2009.  We also sold 3,285,286 cubic meters of natural gas through our
pipelines during the three months ended March 31, 2010, compared to 2,989,024
cubic meters during the three months ended March 31, 2009.





Gasoline .
Revenue from gasoline sales increased by 25.1 %, or $294,418, to $1,468,816
during the three months ended March 31, 2010, from $1,174,398 during the three
months ended March 31, 2009, and contributed 7.6% to our total revenue. The
gasoline revenue increase was due to 41.9% increase of unit sales price from $
0.54 (RMB3.69) per liter in the three months ended March 31, 2009 to $0.77
(RMB 5.23) per liter in the three months ended March 31, 2010, mainly
attributable to the increase of international oil price, partially offset by the
sales volume decrease of 11.9% from 2,171,232 liters to 1,929,034
liters.





Installation
Services . Revenue from installation services increased by 5.6%, or
$106,740 to $ 2,007,774 during the three months ended March 31, 2010, from
$1,901,034 during the three months ended March 31, 2009, and contributed 10.4%
to our total revenue. Installation services to our top four customers
contributed to 28.1%, 26.3%, 19.2% and 17.8% of our installation revenue for the
three months ended March 31, 2010.





Auto Conversion
Services . Revenue from our auto conversion division decreased by 16.4%,
or $79,810,to $406,604 during the three months ended March 31, 2010, from
$486,414 during the three months ended March 31, 2009, and contributed 2.1% to
our total revenue.





Cost
of Revenue





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





March 31, 2010
                  
                  
                  March 31, 2009
                  
                  
                  Increase in dollar
                    amount
                  
                  
                  Increase in
                    percentageNatural
      gas from filling stations
                  
                  $
                  7,272,136
                  
                  
                  $
                  6,244,441
                  
                  
                  $
                  1,027,695
                  
                  
                  
                  16.5
                  %Natural
      gas from pipelines
                  
                  
                  592,518
                  
                  
                  
                  502,489
                  
                  
                  
                  90,029
                  
                  
                  
                  17.9
                  %Gasoline
                  
                  
                  1,367,278
                  
                  
                  
                  1,130,057
                  
                  
                  
                  237,221
                  
                  
                  
                  21.0
                  %Installation
                  
                  
                  798,054
                  
                  
                  
                  722,862
                  
                  
                  
                  75,192
                  
                  
                  
                  10.4
                  %Auto
      conversion
                  
                  
                  241,869
                  
                  
                  
                  294,165
                  
                  
                  
                  (52,296
                  )
                  
                  
                  (17.8
                  )%Total
                  
                  $
                  10,271,855
                  
                  
                  $
                  8,894,014
                  
                  
                  $
                  1,377,841
                  
                  
                  
                  15.5
                  %


31


Overall .
Our cost of revenue consists of the cost of natural gas and gasoline sold,
installation and other costs. Cost of natural gas and gasoline sold consists of
the cost for purchase from our suppliers. Cost of installation and other costs
include certain expenditures for the connection of 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 March 31, 2010 was $10,271,855, an
increase of $1,377,841, or 15.5%, from $8,894,014 for the three months ended
March 31, 2009, mainly attributable to increase in procurement cost in Henan
Province. Our revenue increased by 4.5% during the same period.





Natural Gas from
Fueling Stations . Cost of revenue of our natural gas for our fueling
stations increased by 16.5%, or $1,027,695, to $7,272,136 during the three
months ended March 31, 2010, as compared to $6,244,441 for the three months
ended March 31, 2009. Procurement price for natural gas remained stable at $0.16
(RMB 1.12) in Shaanxi since 2008. In Henan Province, the Company also uses coal
bed methane (‘CBM’) as an alternative in addition to natural gas to supply its
fueling station, as a result the average cost of fueling station revenue in
Henan decreased from $0.22 (RMB 1.55) to $0.14 (RMB 1.0) in July 2008. But due
to the uncertainty involved in the production capacity of CBM as a byproduct of
coal mines as well as increasing demand, average cost of fueling station revenue
in Henan increased to $0.19 (RMB 1.30) in June 2009 and $0.22 (RMB 1.49) in
January 2010. The cost, however, is still significantly below the retail price
at $0.42 (RMB2.83) in Henan Province.





Natural Gas from
Pipelines . Cost of revenue of our natural gas sold through our pipelines
increased by 17.9%, or $90,029 to $592,518 during the three months ended March
31, 2010, as compared to $502,489 during the three months ended March 31, 2009,
which was in line with the sales growth.





Gasoline .
Cost of our gasoline revenue increased by 21.0%, to $1,367,278 during the three
months ended March 31, 2010, from $1,130,057 for the three months ended March
31, 2009. The increase of cost of gasoline revenue was due to the effect of the
increase of average unit cost from $0.52 (RMB 3.55) per liter during the three
months ended March 31, 2009 to $0.71 (RMB 4.87) per liter during the three
months ended March 31, 2010 mainly attributable to the increase of international
oil price, partially offset by the decrease in sales volume.





Installation
Services . Cost of revenue from our installation services increased by
10.4%, or $75,192, to $798,054 during the three months ended March 31, 2010, as
compared to $722,862 during the three months ended March 31, 2009, as a result
of the increase of pipeline customers.





Auto Conversion
Services . Cost of our auto conversion revenue decreased by 17.8%, or
$52,296, to $241,869 during the three months ended March 31, 2010, as compared
to $294,165 during the three months ended March 31, 2009.





Gross
profit





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





March 31, 2010
                  
                  
                  March 31, 2009
                  
                  
                  Increase in
                    dollar amount
                  
                  
                  Increase in
                    percentageNatural
      gas from filling stations
                  
                  $
                  7,357,474
                  
                  
                  $
                  8,013,484
                  
                  
                  $
                  (656,010
                  )
                  
                  
                  (8.2
                  )%Natural
      gas from pipelines
                  
                  
                  261,501
                  
                  
                  
                  205,406
                  
                  
                  
                  56,095
                  
                  
                  
                  27.3
                  %Gasoline
                  
                  
                  101,538
                  
                  
                  
                  44,341
                  
                  
                  
                  57,197
                  
                  
                  
                  129.0
                  %Installation
                  
                  
                  1,209,720
                  
                  
                  
                  1,178,172
                  
                  
                  
                  31,548
                  
                  
                  
                  2.7
                  %Auto
      conversion
                  
                  
                  164,735
                  
                  
                  
                  192,249
                  
                  
                  
                  (27,514
                  )
                  
                  
                  (14.3
                  )%Total
                  
                  $
                  9,094,968
                  
                  
                  $
                  9,633,652
                  
                  
                  $
                  (538,684
                  )
                  
                  
                  (5.6
                  )%


32


We earned a gross profit of $9,094,968 for the three months ended
March 31, 2010, a decrease of $538,684 or 5.6%, compared to $9,633,652 for the
three months ended March 31, 2009. In summary, gross profit decrease was mainly
due to increased cost of fueling station revenue in Henan
Province.





Gross
margin





Gross
margin for natural gas sold through our fueling stations decreased from 56.2% in
the three months ended March 31, 2009 to 50.3% in the three months ended March
31, 2010 due to increased cost of fueling station revenue in Henan
Province.





Gross
margin for natural gas sold through pipelines was 30.6% during the three months
ended March 31, 2010, and increased slightly as compared to 29.0% during the
three months ended March 31, 2009.





Gross
margin for gasoline sales increased from 3.8% during the three months ended
March 31, 2009 to 6.9% during the three months ended March 31, 2010, due to
larger increase in gasoline retail price compared with procurement
price.





Gross
margin for our installation business decreased to 60.3% in the three months
ended March 31, 2010 from 62.0% in the three months ended March 31, 2009 due to
increase of material costs.





Gross
margin for our auto conversion business increased from 39.5% in the three months
ended March 31, 2009 to 40.5% in the three months ended March 31, 2010 due to
improved efficiency.





Due to
higher cost of fueling station revenue in Henan Province, our total gross
margin decreased from 52.0% for the three months ended March 31, 2009 to 47.0%
for the three months ended March 31, 2010.





Operating
expenses





We
incurred operating expenses of $4,709,446 for the three months ended March 31,
2010, an increase of $703,297 or 17.6%, compared to $4,006,149 for the three
months ended March 31, 2009.





Sales and
marketing costs increased $310,965, or 12.0% from $2,580,825 three months
ended March 31, 2009 to $2,891,790 for the three months ended March 31, 2010,
primarily related to increase in depreciation, electricity, and land leasing
expenses associated with existing stations as well as the addition of 2 new
fueling stations in third quarter 2009 and first quarter 2010, respectively. The
increase also reflect costs related to social security benefit for our employees
commensed in the third quarter of 2009 and our continued efforts to obtain new
residential and commercial, and fueling station customers. Transportation cost
per million cubic meters of natural gas during the three months ended March 31,
2010 was approximately $4,010.





General
and administrative expenses increased $392,332, or 27.5% from $1,425,324 for the
three months ended March 31, 2009 to $1,817,656 for the three months ended March
31, 2010, primarily reflecting increase in costs related to market development
initiatives in Hubei Province and other regions, social security benefit for our
employees commenced in the third quarter of 2009, travel expenses for investor
conferences to Beijing, Shanghai and US, as well as stock option expense for the
Company’s employee stock option plan. The increase also reflects the increased
Delaware franchise tax due to the Company’s increased shares outstanding and
asset base.


33


Income
from Operations and Operating Margin





Largely
impacted by the increase in procurement cost and operating expenses, income from
operations decreased by $1,241,981, or 22.1%, to $4,385,522 for the three months
ended March 31, 2010, from $5,627,503 for the three months ended March 31,
2009.  Our operating margin for the three months ended March 31, 2010 was
22.6%, compared to 30.4% for the three months ended March 31, 2009.





Non-Operating
Income (Expense)





Non-operating
income was $520,893 for the three months ended March 31, 2010, compared with
$428,624 loss for the three months ended March 31, 2009, primarily due to the
$393,068 gain associated with change in fair value of the Company’s outstanding
warrants. In addition, the Company capitalized $1,363,662 interest expense for
the three months ended March 31, 2010 while only $858,397 was capitalized for
the same period of 2009.





Provision
for Income Tax





Income
tax was $911,145 for the three months ended March 31, 2010, as compared to
$997,256 for the three months ended March 31, 2009.





Net
Income





Based on
the foregoing, net income decreased to $3,995,270 for the three months ended
March 31, 2010, a decrease of $206,353, or 4.9%, from $4,201,623 for the three
months ended March 31, 2009. Net margin decreased from 22.7% during the three
months ended March 31, 2009 to 20.6% during the three months ended March 31,
2010.





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, the
Company also completed a secondary offering 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.





As of
March 31, 2010, the Company had $30,172,391 of cash and cash equivalents on hand
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,
additions of fueling stations, and market development initiatives.





Net cash
provided by operating activities was $4,848,146 for the three months ended March
31, 2010 compared to net cash provided by operations of $6,238,521 for the three
months ended March 31, 2009. The primary reason for the change was due to the
lower net income, adjusted for non-cash expenses of $1,187,121, and an increase
in working capital of $334,345.





Net cash
used in investing activities increased from $3,028,317 during the three months
ended March 31, 2009 to $22,812,134 for the same period in 2010 primarily due to
loan receivable to third party, prepayment to equipment suppliers and
construction of the LNG plant, and construction addition of fueling
stations during the three months ended March 31, 2010. The Company lent
$14,259,140 to third parties during the first quarter of 2010 with one-year term
at annum interest rate of 5.84%. As of May 7, 2010, $9,858,240 of the loan has
been paid back and $4,400,900 is still outstanding.





The
Company paid $1,369,805 to the LNG processing plant as a prepayment on equipment
as well as addition to construction in progress during the three months ended
March 31, 2010.





Net cash
from financing activities was zero for the three months ended March 31,
2010.  The proceeds from the long term loan of $13.2 million were offset by
the increase in restricted cash of the same amount.  There was no cash
provided by or used in financing activities for the three months ended March 31,
2009.





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.


34


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 the USD will remain stable. 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 March 31, 2010 were $40 million, which we
expect to be incurred in connection with the construction of our LNG facility,
construction or acquisition of additional fueling stations and compressor
stations,  joint-venture cooperation with CNPC Kunlun and to fund the
expansion into Hubei Province. Phase I of the LNG plant is under construction
and is expected to be completed by June 30, 2010.





OUTSTANDING
INDEBTEDNESS





On
December 30, 2007, we entered into a Securities Purchase Agreement (the
"Purchase Agreement") with Abax. The Purchase Agreement was subsequently amended
on January 29, 2008, pursuant to which we (i) agreed to issue 5.00% Guaranteed
Senior Notes due 2014 (the “Senior Notes”) of approximately $20,000,000, (ii)
agreed to issue to Abax Senior Notes in aggregate principal amount of
approximately $20,000,000 on or before March 3, 2008 subject to our meeting
certain closing conditions, (iii) granted Abax an option to purchase up to
approximately $10,000,000 in principal amount of its Senior Notes and (iv)
agreed to issue to Abax seven-year warrants exercisable for up to 2,900,000
shares of our common stock (the “Warrants”) at an initial exercise price equal
to $7.3652 per share, subject to certain adjustments.  On January 29, 2008,
we issued $20,000,000 Senior Notes and 2,900,000 warrants pursuant to the
Purchase Agreement. On March 3, 2008, Abax exercised its first option for an
additional $20,000,000 of Senior Notes. On March 10, 2008, we issued $20,000,000
in additional Senior Notes resulting in total Senior Notes of
$40,000,000.





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 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 $17,676,000 to JBLNG. SPDB transferred $13.2 million to JBLNG on March
17, 2010. 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. The loan is
secured by XXNGC’s equipment and vehicles located within PRC and a guarantee
from XXNGC.





CONTRACTUAL
OBLIGATIONS





Our
contractual obligations are as follows:




Payments due by periodContractual obligations
                    
                    Total
                    
                    
                    Less than
                      1 year
                    
                    
                    1-3
                      Years
                    
                    
                    3-5
                      years
                    
                    
                    More than
                      5 years(in thousands)Long-Term
      Debt Obligations
                    
                    $
                    40,000
                    
                    
                    $
                    -
                    
                    
                    $
                    20,000
                    
                    
                    $
                    20,000
                    
                    
                    $
                    -Long-term
      loan
                    
                    
                    13,203
                    
                    
                    
                    
                    
                    
                    
                    8,802
                    
                    
                    
                    4,401Other
      Long-Term Liabilities Reflected on Company's Balance
    Sheet(1)
                    
                    
                    17,500
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    
                    17,500Total
                    
                    $
                    70,703
                    
                    
                    $
                    -
                    
                    
                    $
                    28,802
                    
                    
                    $
                    41,901
                    
                    
                    $




Note:





(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.


35


COMMITMENTS
AND CONTINGENCIES





Lease
Commitments





We
recognize lease expense on a straight-line basis over the term of the lease in
accordance to FAS 13, “Accounting for leases.” We entered into series of
long-term lease agreements with outside parties to lease land use right to the
self-built natural gas fueling stations located in the PRC. The agreements
have terms ranging from 10 to 30 years. We make annual prepayment for most lease
agreements.  We also entered into two office leases in Xian, PRC and New
York, NY.  The minimum future payment for leasing land use rights and
offices is as follows:





Year
      ending December 31, 2010
                  
                  $
                  1,280,191Year
      ending December 31, 2011
                  
                  
                  2,087,346Year
      ending December 31, 2012
                  
                  
                  1,921,385Year
      ending December 31, 2013
                  
                  
                  1,830,217Year
      ending December 31, 2014
                  
                  
                  2,218,208Thereafter
                  
                  
                  34,447,281Total
                  
                  $
                  43,784,628





For the
three months ended March 31, 2010 and 2009, the land use right and office lease
expenses were $430,628 and $392,081, 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 CIP projects.  The
Company has future commitments as followings:





Year
      ending December 31, 2010
                  
                  $
                  10,343,316Year
      ending December 31, 2011
                  
                  
                  2,143,287Thereafter
                  
                  
                  -Total
                  
                  $
                  12,486,603





Natural
Gas Purchase Commitments





We have
certain effective natural gas purchase agreements with our major suppliers. The
natural gas purchase agreement with Shaanxi Provincial Natural Gas Co., Ltd. has
been renewed annually to date and specifies a maximum amount that can be
purchased but does not specify a minimum amount that must be purchased. Our
natural gas purchase agreements with certain suppliers of coal-bed methane are
of indefinite terms and do not contain either maximum or minimum amounts of
purchase. Without minimum purchase requirements under any of our natural gas
purchase agreements, we have the flexibility to constantly look for lower-cost
sources of supply.





FOREIGN
CURRENCY TRANSLATIONS





As of
March 31, 2010 and December 31, 2009, our accounts were maintained, and our
consolidated financial statements were expressed in RMB.  Such consolidated
financial statements were translated into USD with the RMB as the functional
currency. All assets and liabilities were translated at the exchange rate as of
the balance sheet date, stockholders’ equity were translated at the historical
rates and statement of income and cash flow items were translated at the
weighted average exchange rate for the year. The resulting translation
adjustments are reported under other comprehensive income. Cash flows from
the Company's operations is calculated based upon the local currencies and
translated to USD at average translation rates for the period. As a result,
translation adjustments 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.





The
balance sheet amounts with the exception of equity were translated RMB 6.82 to
$1.00 at March 31, 2010 and 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 months ended March 31, 2010 and 2009,
were RMB 6.82 and RMB 6.83 to $1.00, respectively.


36


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 GAAP requires that
we make 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.





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 (“CIP”) consists of the cost of constructing property and equipment
for the gas stations and a new project of processing, distribution and sale of
LNG. The major cost of construction in progress relates to 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 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. The 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.





Fair
Value of Financial Instruments





The
accounting standards regarding fair value of financial instruments and related
fair value measurements defines fair value, establishes a three-level valuation
hierarchy for disclosures of fair value measurement and enhances 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.


37


·
            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, for substantially 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 doesn’t fluctuate much
at all. Such a price involatility situation 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 whole sale 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 $53,203,000 at March 31, 2010, the $40,000,000 fixed-rate debt is due on
demand. The $13.2 million of flexible-rate debt is due from
2012-2014.We currently have no interest rate
hedge positions in place to reduce our exposure to changes in interest
rates.





Foreign
Currency Exchange Rates Risk





We
operate in China 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 China local
currency are translated into U.S. 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 U.S. dollar. We recorded a $38,854
adjustment to decrease our equity account for the quarter ended March 31, 2010
to reflect the net impact of the fluctuating of Chinese currency against the
U.S. dollar.


38


Item
4. Controls and Procedures





Disclosure
Controls and Procedures (Restated)




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 March 31,
2010 were not effective because the Company failed to implement policies and
procedures that would have prevented the Company's:


·
                failure
      to disclose the Loan, the Pledge and the Guarantee as subsequent events in
      the footnotes to its consolidated financial statements included in the
      Annual Report;
 
 ·
                failure
      to disclose the Loan, the Pledge and the Guarantee in the Original Filing,
      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;
 
 ·
                incorrect
      determination that the Pledge constituted a breach of the Indenture, which
      led the Company to erroneously (i) make the Reclassification and related
      amendments in the Amended 10-K and Amended 10-Q, (ii) disclose in the
      Amended 10-K, the Amended 10-Q and the Quarterly Report for the quarter
      ended June 30, 2010 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 the Quarterly Report for the quarter
      ended June 30, 2010; and
 
 ·
                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 Hanchun Makou Yuntong Compressed Natural Gas Co.,
      Ltd. in the third quarter of
2010.


39




Changes
in internal control over financial reporting




Other
than as disclosed in Amendment No. 2 to the Annual Report, filed on September
30, 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 changes in our internal
control over financial reporting during the quarter ended March 31, 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




A former
member of the board of directors filed a lawsuit on June 16, 2008 against the
Company in New York State Supreme Court, Nassau County, in which he sought,
among other things, to recover a portion of his monthly compensation plus 20,000
options that he alleged were due to him pursuant to a written agreement.
After the plaintiff rejected an offer by the Company that included the options
that plaintiff alleged were due to him, the Company moved to dismiss the
complaint. The judge ordered the Company to issue the 20,000 options to the
plaintiff subject to any restrictions required by applicable securities laws,
which was essentially what the Company had previously offered, and dismissed all
of the plaintiff's remaining claims against the Company. The current board of
directors complied with the court's decision by tendering an option agreement to
the plaintiff consistent with the court's decision, but the plaintiff refused to
execute the agreement, and instead filed an appeal. On March 16, 2010, the
Appellate Division, Second Department, modified the decision and order of the
trial court and dismissed the action in its entirety. Subsequently, the
plaintiff has sought leave to appeal the appellate court's decision in New York
state's highest court.


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 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 occur, our business, financial condition or results
of operations may be adversely affected.


40


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





On
February 26, 2010, the Company through its subsidiary, JBLNG entered into a
fixed assets loan contract with Shanghai Pudong Development Bank Xi’an Branch
(“SPDB”), pursuant to which SPDB agreed to lend the Company up to $17,676,000 at
the annual interest rate of 5.76% (the “Loan”). The Company was entitled to
borrow amounts under the loan between March 1, 2010 and June 30,
2010.





In
addition, in connection with the Loan, XXNGC, the variable interest entity of
the Company, entered into a pledge agreement with SPDB, pursuant to which
XXNGC’s equipment and vehicles located within the PRC were pledged to secure the
repayment of the Loan. XXNGC also entered into a guaranty with SPDB to guaranty
the repayment of the Loan.





As of
March 31, 2010, the Company has obtained $13.2 million of the $17.7 million loan
amount and is required to make mandatory payments on the Loan on dates and in
amounts as follows:





March
      5, 2012
                  
                  $
                  4,419,000March
      5, 2013
                  
                  $
                  4,419,000March
      5, 2014
                  
                  $
                  4,419,000




Item
6.  Exhibits





(a)
Exhibits





Exhibit Number
              
              Description of Exhibit10.1*
              
              Loan
      Contract of Fixed Asset dated February 26, 2010, by the between Jingbian
      Xi’an Xilan Liquefied Natural Gas Co. Ltd. and Xi’an Branch Shanghai
      Pudong Development Bank.10.2*
              
              Mortgage
      Contract of Movables dated February 26, 2010, by and between Xi’an Xilan
      Natural Gas Co. Ltd. and Xi’an Branch Shanghai Pudong Development
      Bank.10.3*
              
              Contract
      of Guarantee dated February 26, 2010, by and between Xi’an Xilan Natural
      Gas Co. Ltd. and Xi’an Branch Shanghai Pudong Development
      Bank.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
      amended31.2**
              
              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
      amended32.1**
              
              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 as
exhibits to the Company’s quarterly report on Form 10-Q filed with the SEC on
August 13, 2010.





**Filed
herewith


41


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.September
      30, 2010
                  By:
                  /s/ Qinan JiQinan
      JiChief
      Executive Officer(Principal
      Executive Officer)September
      30, 2010
                  By:
                  /s/ David SheDavid
      SheActing
      Chief Financial Officer(Principal
      Financial and Accounting
Officer)


42