UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-Q





(Mark
One)


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





For the
quarterly period ended September 30, 2009





 ̈
            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 x  No  ̈





Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (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 November 4, 2009:
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









China
Natural Gas, Inc.


Index





PART
      I.
              FINANCIAL
      INFORMATIONItem
      1.
              Financial
      Statements
              
              1Notes
      to Consolidated Financial Statements (unaudited)
              
              4Item
      2.
              Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
              
              20Item
      3.
              Quantitative
      and Qualitative Disclosures About Market Risk
              
              34Item
      4.
              Controls
      and Procedures
              
              34PART
      II.
              OTHER
      INFORMATIONItem
      1.
              Legal
      Proceedings
              
              35Item
      1A.
              Risk
      Factors
              
              35Item
      2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              
              35Item
      3.
              Defaults
      Upon Senior Securities
              
              35Item
      4.
              Submission
      of Matters to a Vote of Security Holders
              
              35Item
      5.
              Other
      Information
              
              35Item
      6.
              Exhibits
              
              35SIGNATURES
              
              36









PART
I. FINANCIAL INFORMATION


Item
1. Financial Statements


CHINA
NATURAL GAS, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


AS
OF SEPTEMBER 30, 2009 AND DECEMBER 31, 2008


September 30,
                          
                          
                          December, 312009
                          
                          
                          2008(Unaudited)ASSETSCURRENT
      ASSETS:Cash
      & cash equivalents
                          
                          $
                          55,931,579
                          
                          
                          $
                          5,854,383Accounts
      receivable
                          
                          
                          1,141,615
                          
                          
                          
                          906,042Other
      receivable - employee advances
                          
                          
                          238,962
                          
                          
                          
                          332,263Inventories
                          
                          
                          1,464,958
                          
                          
                          
                          519,739Advances
      to suppliers
                          
                          
                          1,809,560
                          
                          
                          
                          837,592Prepaid
      expense and other current assets
                          
                          
                          455,586
                          
                          
                          
                          838,294Loan
      receivable
                          
                          
                          293,400
                          
                          
                          
                          293,400Total
      current assets
                          
                          
                          61,335,660
                          
                          
                          
                          9,581,713PROPERTY
      AND EQUIPMENT, NET
                          
                          
                          71,840,861
                          
                          
                          
                          76,028,272CONSTRUCTION
      IN PROGRESS
                          
                          
                          42,124,222
                          
                          
                          
                          22,061,414DEFERRED
      FINANCING COSTS
                          
                          
                          1,439,456
                          
                          
                          
                          1,746,830OTHER
      ASSETS
                          
                          
                          13,350,012
                          
                          
                          
                          8,844,062TOTAL
      ASSETS
                          
                          $
                          190,090,211
                          
                          
                          $
                          118,262,291LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued liabilities
                          
                          $
                          1,412,215
                          
                          
                          $
                          800,013Other
      payables
                          
                          
                          245,397
                          
                          
                          
                          124,151Unearned
      revenue
                          
                          
                          1,741,827
                          
                          
                          
                          944,402Accrued
      interest
                          
                          
                          274,941
                          
                          
                          
                          861,114Taxes
      payable
                          
                          
                          1,942,670
                          
                          
                          
                          1,862,585Total
      current liabilities
                          
                          
                          5,617,050
                          
                          
                          
                          4,592,265LONG
      TERM LIABILITIES:Notes
      payable, net of discount of $13,457,880 and $15,478,395 as
    ofSeptember
      30, 2009 and December 31, 2008, respectively
                          
                          
                          26,542,120
                          
                          
                          
                          24,521,605Redeemable
      liabilities - warrants
                          
                          
                          17,500,000
                          
                          
                          
                          17,500,000Derivative
      liabilities - warrants
                          
                          
                          2,488,070
                          
                          
                          
                          -Total
      long term liabilities
                          
                          
                          46,530,190
                          
                          
                          
                          42,021,605COMMITMENTS
      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, 21,183,904and
      14,600,154 shares issued and outstanding at September 30, 2009 and
      December 31, 2008, respectively
                          
                          
                          2,118
                          
                          
                          
                          1,460Additional
      paid-in capital
                          
                          
                          79,812,871
                          
                          
                          
                          32,115,043Cumulative
      translation adjustment
                          
                          
                          8,700,988
                          
                          
                          
                          8,661,060Statutory
      reserves
                          
                          
                          5,417,413
                          
                          
                          
                          3,730,083Retained
      earnings
                          
                          
                          44,009,581
                          
                          
                          
                          27,140,775Total
      stockholders' equity
                          
                          
                          137,942,971
                          
                          
                          
                          71,648,421TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                          
                          $
                          190,090,211
                          
                          
                          $
                          118,262,291





The
accompanying notes are an integral part of these statements


1


CHINA
NATURAL GAS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME


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


(Unaudited)





Three months ended
                
                
                Nine months endedSeptember 30
                
                
                September 302009
                
                
                2008
                
                
                2009
                
                
                2008RevenueNatural
      gas revenue
                
                $
                15,454,386
                
                
                $
                15,354,461
                
                
                $
                46,140,884
                
                
                $
                40,494,646Gasoline
      revenue
                
                
                1,633,478
                
                
                
                1,187,754
                
                
                
                4,440,892
                
                
                
                3,466,601Installation
      and other
                
                
                3,037,320
                
                
                
                1,858,985
                
                
                
                8,813,594
                
                
                
                5,356,113Total
      revenue
                
                
                20,125,184
                
                
                
                18,401,200
                
                
                
                59,395,370
                
                
                
                49,317,360Cost
      of revenueNatural
      gas cost
                
                
                7,536,188
                
                
                
                6,973,035
                
                
                
                21,773,635
                
                
                
                20,369,778Gasoline
      cost
                
                
                1,534,806
                
                
                
                1,085,311
                
                
                
                4,194,615
                
                
                
                3,208,326Installation
      and other
                
                
                1,336,498
                
                
                
                850,487
                
                
                
                3,797,586
                
                
                
                2,492,650Total
      cost of revenue
                
                
                10,407,492
                
                
                
                8,908,833
                
                
                
                29,765,836
                
                
                
                26,070,754Gross
      profit
                
                
                9,717,692
                
                
                
                9,492,367
                
                
                
                29,629,534
                
                
                
                23,246,606Operating
      expensesSelling
      expenses
                
                
                2,406,462
                
                
                
                2,098,343
                
                
                
                7,062,429
                
                
                
                5,008,631General
      and administrative expenses
                
                
                1,422,300
                
                
                
                968,169
                
                
                
                4,286,620
                
                
                
                2,947,494Total
      operating expenses
                
                
                3,828,762
                
                
                
                3,066,512
                
                
                
                11,349,049
                
                
                
                7,956,125Income
      from operations
                
                
                5,888,930
                
                
                
                6,425,855
                
                
                
                18,280,485
                
                
                
                15,290,481Non-operating
      income (expense)Interest
      income
                
                
                7,248
                
                
                
                13,536
                
                
                
                23,940
                
                
                
                120,297Interest
      expense
                
                
                (68,407)
                
                
                
                (212,774)
                
                
                
                (745,064)
                
                
                
                (1,249,003)Other
      income (expense), net
                
                
                178,728
                
                
                
                (6,786)
                
                
                
                (137,954)
                
                
                
                (17,512)Change
      in fair value of warrants
                
                
                (357,979)
                
                
                
                
                
                
                
                (1,473,762)Foreign
      currency exchange income (loss)
                
                
                280
                
                
                
                (48,605)
                
                
                
                (50,527)
                
                
                
                (101,436)Total
      non-operating expense
                
                
                (240,130)
                
                
                
                (254,629)
                
                
                
                (2,383,367)
                
                
                
                (1,247,654)Income
      before income tax
                
                
                5,648,800
                
                
                
                6,171,226
                
                
                
                15,897,118
                
                
                
                14,042,827Provision
      for income tax
                
                
                1,001,281
                
                
                
                1,034,636
                
                
                
                3,185,220
                
                
                
                2,584,774Net
      income
                
                
                4,647,519
                
                
                
                5,136,590
                
                
                
                12,711,898
                
                
                
                11,458,053Other
      comprehensive incomeForeign
      currency translation gain
                
                
                195,040
                
                
                
                756,316
                
                
                
                39,928
                
                
                
                4,554,040Comprehensive
      income
                
                $
                4,842,559
                
                
                $
                5,892,906
                
                
                $
                12,751,826
                
                
                $
                16,012,093Weighted
      average shares outstandingBasic
                
                
                15,754,696
                
                
                
                14,600,154
                
                
                
                14,985,001
                
                
                
                14,600,154Diluted
                
                
                16,139,820
                
                
                
                14,639,795
                
                
                
                15,035,172
                
                
                
                14,658,419Earnings
      per shareBasic
                
                $
                0.29
                
                
                $
                0.35
                
                
                $
                0.85
                
                
                $
                0.78Diluted
                
                $
                0.29
                
                
                $
                0.35
                
                
                $
                0.85
                
                
                $
                0.78





The
accompanying notes are an integral part of these statements


2


CHINA
NATURAL GAS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR
THE NINE MONTHS ENDED SEPTEMBER 30, 2009 AND 2008


(Unaudited)




Nine Months Ended September 30,2009
                    
                    
                    2008CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                    
                    $
                    12,711,898
                    
                    
                    $
                    11,458,053Adjustments
      to reconcile net income to net cash provided
      by operating activities:Depreciation
      and amortization
                    
                    
                    4,175,175
                    
                    
                    
                    2,295,534Loss
      on disposal of equipment
                    
                    
                    21,372
                    
                    
                    
                    12,265Amortization
      of discount on senior notes
                    
                    
                    280,250
                    
                    
                    
                    555,001Amortization
      of financing costs
                    
                    
                    63,940
                    
                    
                    
                    147,002Stock
      based compensation
                    
                    
                    186,672
                    
                    
                    
                    51,861Change
      in fair value of warrants
                    
                    
                    1,473,762
                    
                    
                    
                    -Change
      in assets and liabilities:Accounts
      receivable
                    
                    
                    (235,396)
                    
                    
                    
                    (1,269,832)Other
      receivable
                    
                    
                    (31,011)Other
      receivable - employee advances
                    
                    
                    93,231
                    
                    
                    
                    (273,759)Inventories
                    
                    
                    (754,309)
                    
                    
                    
                    (194,580)Advances
      to suppliers
                    
                    
                    (971,240)
                    
                    
                    
                    (508,417)Prepaid
      expense and other current assets
                    
                    
                    223,206
                    
                    
                    
                    (783,706)Accounts
      payable and accrued liabilities
                    
                    
                    611,924
                    
                    
                    
                    193,212Other
      payables
                    
                    
                    121,234
                    
                    
                    
                    37,587Unearned
      revenue
                    
                    
                    796,827
                    
                    
                    
                    34,855Accrued
      interest
                    
                    
                    (586,173)
                    
                    
                    
                    350,002Taxes
      payable
                    
                    
                    80,025
                    
                    
                    
                    606,233Net
      cash provided by operating activities
                    
                    
                    18,261,387
                    
                    
                    
                    12,711,311CASH
      FLOWS FROM INVESTING ACTIVITIES:Purchase
      of property and equipment
                    
                    
                    (47,797)
                    
                    
                    
                    (21,693,376)Proceeds
      from sales of equipment
                    
                    
                    41,308
                    
                    
                    
                    -Proceeds
      from short term investments
                    
                    
                    -
                    
                    
                    
                    249,464Additions
      to construction in progress
                    
                    
                    (18,064,065)
                    
                    
                    
                    (16,679,747)Prepayment
      on long term assets
                    
                    
                    (4,434,118)
                    
                    
                    
                    (6,774,616)Proceeds
      from loan receivable
                    
                    
                    -
                    
                    
                    
                    286,740Return
      of acquisition deposit
                    
                    
                    449,970
                    
                    
                    
                    -Payment
      for intangible assets
                    
                    
                    (68,347)
                    
                    
                    
                    -Payment
      for land use rights
                    
                    
                    (455,830)
                    
                    
                    
                    -Net
      cash used in investing activities
                    
                    
                    (22,578,879)
                    
                    
                    
                    (44,611,535)CASH
      FLOWS FROM FINANCING ACTIVITIES:Stock
      issued for cash
                    
                    
                    57,607,813Proceeds
      from senior notes
                    
                    
                    -
                    
                    
                    
                    40,000,000Payment
      for offering costs
                    
                    
                    (3,237,452)
                    
                    
                    
                    (2,122,509)Net
      cash provided by financing activities
                    
                    
                    54,370,361
                    
                    
                    
                    37,877,491Effect
      of exchange rate changes on cash and cash equivalents
                    
                    
                    24,327
                    
                    
                    
                    1,115,706NET
      INCREASE IN CASH AND CASH EQUIVALENTS
                    
                    
                    50,077,196
                    
                    
                    
                    7,092,973CASH
      AND CASH EQUIVALENTS, BEGINNING OF PERIOD
                    
                    
                    5,854,383
                    
                    
                    
                    13,291,729CASH AND
      CASH EQUIVALENTS, END OF PERIOD
                    
                    $
                    55,931,579
                    
                    
                    $
                    20,384,702SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Interest
      paid, net of capitalized interest
                    
                    $
                    1,014,956
                    
                    
                    $Income
      taxes paid
                    
                    $
                    3,176,730
                    
                    
                    $
                    1,203,048





The
accompanying notes are an integral part of these
statements


3





Notes to Consolidated Financial
Statements


September
30, 2009


(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 Shaanxi and Henan 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 March
18, 2008, Shaanxi Xilan Natural Gas Equipment Co., Ltd (“SXNGE”) increased its
registered capital from $30,000,000 to $53,929,260.  The additional
$14,429,260 of registered capital was contributed by China Natural Gas, Inc. on
April 17, 2008 and $9,500,000 of registered capital was contributed by China
Natural Gas, Inc. as a payment to Chemtex International Inc. on January 31,
2008, for the purchase of license, know-how, and design of constructing the
Liquefied Natural Gas (“LNG”) processing plant.





On April
22, 2008, Jingbian Liquefied Natural Gas Co., Ltd. (“JBLNG”) increased its
registered capital by $2,862,000.  JBLNG is 100% owned by Xi’an Xilan
Natural Gas Co., Ltd.





On April
30, 2008, the Industrial and Commercial Administration Bureau approved Xi’an
Xilan Natural Gas Co., (“XXNGC”) to increase registered capital from $8,336,856
to $43,443,640 as an additional contribution by the shareholders of XXNGC under
PRC Law. $15,513,526 was approved by the Industrial and Commercial
Administration Bureau to be transferred out from the surplus reserve and
retained earnings as an increase of registered capital.  Another
$19,593,258 was contributed by SXNGE cumulatively prior to April 30, 2008, which
was previously classified as an intercompany payable in XXNGC and was eliminated
in the consolidated financial statements.  The increase in registered
capital in XXNGC was in compliance with the Addendum to Option Agreement entered
by the Company through SXNGE and XXNGC, Mr. Qinan Ji, chairman and shareholder
of XXNGC, and each of the shareholders of XXNGC (hereafter collectively referred
to as the “Transferor”) on August 8, 2008, and made retroactive to June 30,
2008.  See “Consolidation of Variable Interest Entity” section for
further detail on the Addendum to Option Agreement.





On July
3, 2008, XXNGC formed Henan Xilan Natural Gas Co., Ltd. (“HXNGC”) as a wholly
owned limited liability company, with registered capital of $4,383,000 in Henan
province, PRC.  HXNGC was established for the purpose of natural gas
city gasification engineering design, construction and technical advisory work
services in Henan, PRC.





On
October 2, 2008, China Natural Gas, Inc. (the “Company”) through its
wholly-owned subsidiary, XXNGC, entered into an Equity Ownership Transfer
Agreement (the “Acquisition Agreement”) with Lingbao Yuxi Natural Gas Co., Ltd.
(“LBNGC”) and the shareholders of LBNGC (the “Sellers”).  Pursuant to
the term of the Acquisition Agreement, XXNGC acquired for cash consideration of
approximately $19,604,200 (RMB 134 million), 100% of all outstanding registered
equity interest in LBNGC and all assets held by LBNGC, including the land use
right to 0.44 acres and all of LBNGC’s local business’ exclusive operating
rights. LBNGC owns the exclusive rights to operate CNG fueling stations and
pipelines in Lingbao City. In conjunction with this acquisition, XXNGC has also
secured an abundant supply of natural gas to support its future expansion in the
Henan province. The Acquisition Agreement was fully executed in November,
2008.





Note
2 – Summary of Significant Accounting Policies





Basis of
Presentation





The
accompanying consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of
America.  The Company’s functional currency is the 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 September 30, 2009
are not necessary indicative of the results that may be expected for the year
ended December 31, 2009. The information included in this Form 10-Q should
be read in conjunction with information included in the 2008 annual report filed
on Form 10-K/A.




4


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 subsidiary, Shaanxi Xilan Natural
Gas Equipment Co., Ltd and its 100% variable interest entities (“VIE”), Xi’an
Xilan Natural Gas Co. Ltd., Jingbian Liquefied Natural Gas Co., Ltd., Shaanxi
Xilan Auto Bodyshop Co., Ltd. (“SXABC”), Henan Xilan Natural Gas Co., Ltd., and
Lingbao Yuxi Natural Gas Co., Ltd.  All inter-company accounts and
transactions have been eliminated in the consolidation.





Consolidation of Variable
Interest Entity





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





On
February 21, 2006, the Company formed Shaanxi Xilan Natural Gas Equipment Co.,
Ltd as a wholly-owned foreign enterprise (WOFE). Then through SXNGE, the Company
entered into exclusive arrangements with Xi’an Xilan Natural Gas and its
shareholders that give the Company the ability to substantially influence Xi’an
Xilan Natural Gas’ 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 Xi’an Xilan Natural Gas as variable interest entity .The arrangements consist
of the following agreements:





a.
            Xi’an Xilan Natural Gas 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
      Xi’an Xilan Natural Gas in return for a consulting services fee which is
      equal to Xi’an Xilan Natural Gas’s
  revenue.





c.
            Xi’an Xilan Natural
      Gas’ shareholders have pledged their equity interests in Xi’an Xilan
      Natural Gas 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 Xi’an Xilan Natural Gas 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 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





As of
September 30, 2009 and December 31, 2008, the accounts of the Company were
maintained, and their consolidated financial statements were expressed in
RMB.  Such consolidated financial statements were translated into USD
in accordance with an accounting standard issued by the FASB, 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 are calculated based upon the local
currencies and translated to USD at average translation rates for the period. 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.




5




The
balance sheet amounts with the exception of equity at September 30, 2009, were
translated 6.82 RMB to $1.00 as compared to 6.82 RMB at December 31, 2008. The
equity accounts were stated at their historical rate. The average translation
rates applied to income and cash flow statement amounts for the nine months
ended September 30, 2009 and 2008, were 6.82 RMB and 6.98 RMB to $1.00,
respectively.





Cash and Cash
Equivalents





Cash and
cash equivalents include cash on hand and demand deposits in accounts maintained
with state-owned banks within the PRC and 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 Federal Deposit Insurance Corporation
insured limits for the banks located in the United States. Balances at financial
institutions or state-owned banks within the PRC are not covered by insurance.
As of September 30, 2009 and December 31, 2008, the Company had total deposits
of $16,483,752 and $5,604,383 without insurance coverage.  And as of
September 30, 2009 and December 31, 2008, the Company had deposits in the United
States of $38,692,760 and $1,273,639 in excess of federally insured limits,
respectively. 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.





Accounts
Receivable





Accounts
and other 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’s management has determined that all receivables are collectible and
there is no need for an allowance for uncollectible accounts as of September 30,
2009, and December 31, 2008.





Other Receivable – Employee
Advances





From time
to time, the Company advances predetermined amounts based upon internal Company
policy to certain employees and internal units to ensure certain transactions
are performed in a timely manner. The Company has full oversight and control
over the advanced accounts. As of September 30, 2009 and December 31, 2008, no
allowance for the uncollectible accounts was deemed necessary.





Inventory





Inventory
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. Inventory consists of material used in the construction of
pipelines and material used in repairing and modifying
vehicles.  Inventory also consists of gasoline.





The
following are the details of the inventories:





September 30, 2009
                    (Unaudited)
                  
                  
                  December 31, 2008Materials and
      supplies
                  
                  $
                  838,023
                  
                  
                  $
                  318,069Gasoline
                  
                  
                  626,935
                  
                  
                  
                  201,670$
                  1,464,958
                  
                  
                  $
                  519,739





Advances to
Suppliers





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





Loan
Receivable





Loan
receivable consists of the following:


September 30, 2009
                  (Unaudited)
                
                
                December 31, 2008Shanxi
      Yuojin Mining Company, due on November 26, 2008, extended to November 30,
      2009, annual interest at 6.57%
                
                $
                293,400
                
                
                $
                293,400




6


Property and
Equipment





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





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





The
following are the details of the property and equipment:





September 30, 2009
                      (Unaudited)
                    
                    
                    December 31, 2008Office equipment
                    
                    $
                    415,859
                    
                    
                    $
                    412,490Operating
      equipment
                    
                    
                    59,499,262
                    
                    
                    
                    59,473,283Vehicles
                    
                    
                    2,298,712
                    
                    
                    
                    2,414,756Buildings
      and improvements
                    
                    
                    21,209,086
                    
                    
                    
                    21,190,599Total
      property and equipment
                    
                    
                    83,422,919
                    
                    
                    
                    83,491,128Less
      accumulated depreciation
                    
                    
                    (11,582,058
                    )
                    
                    
                    (7,462,856
                    )Property
      and equipment, net
                    
                    $
                    71,840,861
                    
                    
                    $
                    76,028,272





Depreciation
expense for the three months ended September 30, 2009 and 2008 was $1,390,659
and $937,156, respectively. Depreciation expense for the nine months ended
September 30, 2009 and 2008 was $4,170,241 and $2,295,534,
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 purchase, land use rights requisition cost,
capitalized interest and other construction fees.  No depreciation is
provided for construction in progress until such time as the assets are
completed and placed into service.  Interest incurred during
construction is capitalized into construction in progress. All other interest is
expensed as incurred.





As of
September 30, 2009 and December 31, 2008, the Company had construction in
progress in the amount of $42,124,222 and $22,061,414,
respectively. Interest cost capitalized into construction in progress for
the three months ended September 30, 2009 and 2008, amounted to $1,388,870 and
$990,061, respectively. Interest cost capitalized into construction in
progress for the nine months ended September 30, 2009 and 2008, amounted to
$3,419,796 and $1,672,565, respectively.





Construction
in progress at September 30, 2009 consisted of the following:





No.
                                      
                                      Project Description
                                      
                                      Location
                                      
                                      September 30, 2009
                                        (Unaudited)
                                      
                                      Commencement
                                        date
                                      
                                      Expected
                                        completion
                                        date
                                      
                                      Estimated
                                        additional
                                        cost to
                                        complete1
                                      
                                      Jingbian
      LNG – Phase I
                                      
                                      JBLNG
                                      
                                      $
                                      34,735,672
                                      
                                      Dec-06
                                      
                                      May-10
                                      
                                      $
                                      14,218,0002
                                      
                                      Sa
      Pu mother station
                                      
                                      HXNGC
                                      
                                      
                                      769,413
                                      
                                      Jul-08
                                      
                                      Jun-11
                                      
                                      
                                      6,300,0003
                                      
                                      Zijing
      Energy mother station
                                      
                                      XXNGC
                                      
                                      
                                      4,132,925
                                      
                                      Sep-08
                                      
                                      May-11
                                      
                                      
                                      3,440,0004
                                      
                                      Xi'an
      Cangsheng mother station
                                      
                                      XXNGC
                                      
                                      
                                      1,855,599
                                      
                                      Sep-08
                                      
                                      May-11
                                      
                                      
                                      3,220,0005
                                      
                                      Other
      CIP projects
                                      
                                      XXNGC
                                      
                                      
                                      630,613
                                      
                                      Various
                                      
                                      Dec-09
                                      
                                      
                                      2,050,000$
                                      42,124,222
                                      
                                      
                                      
                                      
                                      
                                      $
                                      29,228,000





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 September 30, 2009, there were
no significant impairments of its long-lived assets.




7


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





●
            Level 2inputs 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 3inputs to the valuation
      methodology are unobservable and significant to the fair value
      measurement.





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 $2,488,070 on September 30, 2009. The Company
recognized a $357,979 loss from the change in fair value of the three months
ended September 30, 2009. The Company recognized a $1,473,762 loss from the
change in fair value of warrants for the nine months ended September 30,
2009.





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:





September 30, 2009
                                
                                
                                January 1, 2009(Unaudited)Annual dividend
      yield
                                
                                
                                -
                                
                                
                                
                                -Expected
      life (years)
                                
                                
                                3.07
                                
                                
                                
                                3.82Risk-free
      interest rate
                                
                                
                                1.45
                                %
                                
                                
                                1.13
                                %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.




8




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 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.





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 September 30, 2009.





Carrying Value at
                          September 30, 2009
                          (Unaudited)
                        
                        
                        Fair Value Measurement at
                          September 30, 2009
                          (Unaudited)Level 1
                        
                        
                        Level 2
                        
                        
                        Level 3Senior
      notes
                        
                        $
                        26,542,120
                        
                        
                        $
                        -
                        
                        
                        $
                        -
                        
                        
                        $
                        35,366,413Redeemable
      liability - warrants
                        
                        
                        17,500,000
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        13,475,197Derivative
      liability - warrants
                        
                        
                        2,488,070
                        
                        
                        
                        -
                        
                        
                        
                        2,488,070
                        
                        
                        
                        -Total
      liability measured at fair value
                        
                        $
                        46,530,190
                        
                        
                        $
                        -
                        
                        
                        $
                        2,488,070
                        
                        
                        $
                        48,841,610





Other
than the derivative liabilities - warrants carried at fair value, 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 establishedby 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 and nine
months ended September 30, 2009 and 2008, 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.




9


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 September 30, 2009 and December 31, 2008, 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 and LBNGC 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
                
                
                For the nine months endedSeptember 30,
                
                
                September 30,2009
                
                
                2008
                
                
                2009
                
                
                2008(Unaudited)
                
                
                (Unaudited)
                
                
                (Unaudited)
                
                
                (Unaudited)Tax
      provision (credit) at statutory rate
                
                
                34
                %
                
                
                34
                %
                
                
                34
                %
                
                
                34
                %Foreign
      tax rate difference
                
                
                (9
                )%
                
                
                (9
                )%
                
                
                (9
                )%
                
                
                (9
                )%Effect
      of favorable tax rate
                
                
                (9
                )%
                
                
                (12
                )%
                
                
                (8
                )%
                
                
                (10
                )%Other
      item (1)
                
                
                2
                %
                
                
                5
                %
                
                
                3
                %
                
                
                5
                %Total
      provision for income taxes
                
                
                18
                %
                
                
                18
                %
                
                
                20
                %
                
                
                20
                %





(1)  The
2% represents $649,484 in expenses incurred by CHNG are not deductible in PRC
for the three months ended September 30, 2009. The 5% represents $1,434,740
expenses incurred by CHNG that are not deductible in PRC for the three months
ended September 30, 2008. The 3% represents $3,774,073 in expenses incurred by
CHNG that are not deductible in PRC for the nine months ended September 30,
2009. The 5% represents $4,013,188 expenses incurred by CHNG that are not
deductible in PRC for the nine months ended September 30, 2008.





The
estimated tax savings for the three months ended September 30, 2009 and 2008,
amounted to approximately $570,006 and $645,717, respectively. The net effect on
earnings per share, had the income tax been applied, would decrease basic and
diluted earnings per share for the three months ended September 30, 2009 and
2008, from $0.29 to $0.25 and $0.35 to $0.31, respectively.





The
estimated tax savings for the nine months ended September 30, 2009 and 2008,
amounted to approximately $1,801,782 and $1,579,140, respectively. The net
effect on earnings per share, had the income tax been applied, would decrease
basic and diluted earnings per share for the nine months ended September 30,
2009 and 2008, from $0.85 to $0.73 and $0.78 to $0.67,
respectively.





China
Natural Gas, Inc. was incorporated in the United States and has incurred net
operating loss for income tax purpose for the period ended September 30, 2009.
The estimated net operating loss carry forwards for United States income tax
purposes amounted to $2,278,525 and $1,657,473 as of September 30, 2009 and
December 31, 2008, 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 September
30, 2009. Management reviews this valuation allowance periodically and makes
adjustments as warranted. The valuation allowances were as follow:





Nine months ended
                
                
                Year endedSeptember 30, 2009
                
                
                December 31, 2008Valuation
      allowance
                
                (Unaudited)Balance,
      beginning of period
                
                $
                563,541
                
                
                $
                322,614Increase
                
                
                211,158
                
                
                
                240,927Balance,
      end of period
                
                $
                774,699
                
                
                $
                563,541




10




The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $27,431,955 as of September 30, 2009, 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.





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.





Recently issued accounting
pronouncements





In
January 2009, the FASB’s accounting standard regarding other investments
providing additional guidance which amended the impairment model to remove the
exclusive reliance on “market participant” estimates of future cash flows used
in determining fair value. Changing the cash flows used to analyze
other-than-temporary impairment from the “market participant” view to a holder’s
estimate of whether there has been a “probable” adverse change in estimated cash
flows allows companies to apply reasonable judgment in assessing whether an
other-than-temporary impairment has occurred. The adoption of this guidance did
not have a material impact on the Company’s consolidated financial
statements.





In April
2009, the FASB’s accounting standard regarding fair value measurements and
disclosures providing additional guidance for estimating fair value when the
volume and level of activity for the asset or liability have significantly
decreased and also includes guidance on identifying circumstances that indicate
a transaction is not orderly for fair value measurements. This guidance shall be
applied prospectively with retrospective application not permitted. The adoption
of this guidance did not have a material impact on the Company’s consolidated
financial statements.





In April
2009, the FASB’s
accounting standard regarding debt and equity securities requires to make the
other-than-temporary impairments guidance more operational and to improve the
presentation of other-than-temporary impairments in the financial statements.
This guidance will replace the existing requirement that the entity’s management
assert it has both the intent and ability to hold an impaired debt security
until recovery with a requirement that management assert it does not have the
intent to sell the security, and it is more likely than not it will not have to
sell the security before recovery of its cost basis. This guidance provides
increased disclosure about the credit and noncredit components of impaired debt
securities that are not expected to be sold and also requires increased and more
frequent disclosures regarding expected cash flows, credit losses, and an aging
of securities with unrealized losses. Although this guidance does not result in
a change in the carrying amount of debt securities, it does require that the
portion of an other-than-temporary impairment not related to a credit loss for a
held-to-maturity security be recognized in a new category of other comprehensive
income and be amortized over the remaining life of the debt security as an
increase in the carrying value of the security. The adoption of this guidance
did not have a material impact on the Company’s consolidated financial
statements.





In April
2009In April 2009, the FASB issuedan accounting standard
thatrequires disclosures about fair value of financial instruments not
measured on the balance sheet at fair value in interim financial statements as
well as in annual financial statements. Prior to this guidance, fair values for
these assets and liabilities were only disclosed annually. This guidance applies
to all financial instruments and requires all entities to disclose the method(s)
and significant assumptions used to estimate the fair value of financial
instruments. The adoption of this guidance did not have a material impact on the
Company’s consolidated financial statements.




11




In May
2009, the FASB updatedan accounting standard
regarding subsequent events providing guidance to establish general standards of
accounting for and disclosures of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. This
accounting standard requires entities to disclose the date through which
subsequent events were evaluated as well as the rationale for why that date was
selected.  The Company adopted this Standard during the second quarter
of 2009. This guidance requires that public entities evaluate subsequent events
through the date that the financial statements are issued. The Company has
evaluated subsequent events through the time of filing these consolidated
financial statements with the SEC on November 9, 2009.





In June
2009, the FASB issued an accounting standard amending the accounting and
disclosurerequirements
for transfers of financial assets.  This guidance is effective for the
Company beginning in 2010. Should the Company’s accounts receivable
securitization programs not qualify for sale treatment under the revised rules,
future securitization transactions entered into on or after January 1, 2010
would be classified as debt and the related cash flows would be reflected as a
financing activity. The Company is currently assessing the impact of the
standard on its securitization programs.





In June
2009, the FASB updated an accounting standard regarding consolidation guidance
which modifies how a company determines when an entity that is insufficiently
capitalized or is not controlled through voting (or similar rights) should be
consolidated. This guidance clarifies that the determination of whether a
company is required to consolidate an entity is based on, among other things, an
entity’s purpose and design and a company’s ability to direct the activities of
the entity that most significantly impact the entity’s economic performance.
This guidance requires an ongoing reassessment of whether a company is the
primary beneficiary of a variable interest entity. This guidance also requires
additional disclosures about a company’s involvement in variable interest
entities and any significant changes in risk exposure due to that involvement.
This guidance is effective for fiscal years beginning after November 15, 2009.
The Company is currently assessing the impact of the standard on its
securitization programs.





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





In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing.  This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation.  This ASU is effective for
fiscal years beginning on or after December 15, 2009, and interim periods within
those fiscal years for arrangements outstanding as of the beginning of those
fiscal years. The Company is currently evaluating the impact of this ASU on its
consolidated financial statements.





Note
3 – Other Assets





Other
assets consisted of the following:





September 30,
                  
                  
                  December 31,2009
                  
                  
                  2008UnauditedPrepaid
      rent – natural gas stations
                  
                  $
                  369,392
                  
                  
                  $
                  272,635Prepayment
      for acquiring land use right
                  
                  
                  1,422,990
                  
                  
                  
                  1,060,675Advances
      on purchasing equipment and construction in progress
                  
                  
                  10,862,520
                  
                  
                  
                  6,427,974Refundable
      security deposits
                  
                  
                  530,783
                  
                  
                  
                  981,083Others
                  
                  
                  164,327
                  
                  
                  
                  101,695Total
                  
                  $
                  13,350,012
                  
                  
                  $
                  8,844,062





All land
in the PRC is government owned.  However, the government grants users
land use rights.  As of September 30, 2009 and December 31, 2008,
the Company prepaid $1,422,990  and $1,060,675, respectively, 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.




12




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.





Note
4 – Senior Notes Payable





On
December 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
      Shaanxi Xilan Natural Gas Equipment Co., Ltd., 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 prepayments 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
                    
                    Prepayment 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
                    %





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




13




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 has 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 gives 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 but was in negotiation with ABAX regarding the
amount of additional interest to be paid as of June 30, 2009, thus the Company
recognized additional interest payment amounted to $203,334 and $406,667 for the
three months and six months ended June 30, 2009, respectively.





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 and recorded
other income of $293,453 accordingly.





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.




The
Company was required to prepare and file a registration statement covering the
sales of all of the shares of common stock issuable upon exercise of the
warrants or incur additional interest of 1% on the Notes.  The
Company’s registration statement was declared effective on May 6, 2008;
therefore, no penalties were incurred.





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 September 30,
2009 and 2008, the Company amortized $11,505 and $24,410 of the aforesaid
issuance costs, net of capitalized interest.  For the nine months
ended September 30, 2009 and 2008, the Company amortized $63,940 and
$147,002 of the aforesaid issuance costs, net of capitalized
interest.





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 September 30, 2009 and 2008, the Company amortized $63,054 and
$95,528 of the aforesaid discounts, net of capitalized interest. For the nine
months ended September 30, 2009 and 2008, the Company amortized $280,250 and
$555,001 of the aforesaid discounts, net of capitalized interest.




14




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
5 – Warrants





Following
is a summary of the warrant activity:





Warrants
                    Outstanding
                  
                  
                  Weighted Average
                    Exercise Price
                  
                  
                  Aggregate
                    Intrinsic ValueOutstanding,
      December 31, 2007
                  
                  
                  544,242
                  
                  
                  $
                  13.10
                  
                  
                  
                  376,977Granted
                  
                  
                  1,450,000
                  
                  
                  
                  14.74
                  
                  
                  
                  -Forfeited
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Outstanding,
      December 31, 2008
                  
                  
                  1,994,242
                  
                  
                  $
                  14.28
                  
                  
                  
                  -Granted
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Forfeited
                  
                  
                  (160,588
                  )
                  
                  $
                  7.20
                  
                  
                  
                  -Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Outstanding,
      September 30, 2009 (Unaudited)
                  
                  
                  1,833,654
                  
                  
                  $
                  8.93
                  
                  
                  
                  5,842,088





Following
is a summary of the status of warrants outstanding at September 30, 2009
(Unaudited):





Outstanding WarrantsExercise Price
                          
                          Number
                          
                          
                          Average
                            Remaining
                            Contractual
                            Life$
                          7.37
                          
                          
                          1,450,000
                          
                          
                          
                          5.33$
                          14.86
                          
                          
                          383,654
                          
                          
                          
                          2.84$
                          8.93
                          
                          
                          1,833,654
                          
                          
                          
                          4.81





Note
6 – 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 $53,128 and $0 for the three months
ended September 30, 2009 and 2008, respectively.  The total
contribution for the above plan was $134,207and $0 for the nine months ended
September 30, 2009 and 2008, respectively.





Note
7 – 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
8 – 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:




15




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
September 30, 2009, the remaining reserve needed to fulfill the 50% registered
capital requirement totaled $53,257,563.





Note
9 – 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-Sholes 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. $14,842 and $12,965 of compensation expense was recorded during
the three months ended September 30, 2009 and 2008, respectively. $44,527 and
$38,896 of compensation expense were recorded during the nine months ended
September 30, 2009 and 2008, respectively.





As of
September 30, 2009, approximately $88,032 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 one year.





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 CFO were granted
total options of 1% and 0.6% of the common shares outstanding respectively, 50%
as Non-qualified Stock Options (NSO) and 50% as Incentive Stock Awards (ISA),
for a vesting period of four years.  As Richard Wu has resigned as
CFO, the Company granted to his successor, Veronica Chen, options to purchase
75,000 shares (post-split) of the Company’s common stock, representing
approximately 0.5% of the Company’s outstanding shares as of March 11, 2009,
with the same terms and conditions as specified in the stock options
plan.  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 and May 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-Sholes 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 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. $71,073 and $142,146 of compensation expense was recorded during three
months and nine months ended September 30, 2009, respectively.





As of
September 30, 2009, approximately $995,021 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 3.50 years.




16


Following
is a summary of the Stock option activity:


Options
                                          Outstanding
                                        
                                        
                                        Weighted Average
                                          Exercise Price
                                        
                                        
                                        Aggregate
                                          Intrinsic ValueOutstanding,
      December 31, 2007
                                        
                                        -
                                        
                                        
                                        -
                                        
                                        
                                        -Granted
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Forfeited
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Exercised
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Outstanding,
      December 31, 2008
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Granted
                                        
                                        
                                        318,850
                                        
                                        
                                        $
                                        4.9
                                        
                                        
                                        
                                        95,655Forfeited
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Exercised
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -Outstanding,
      September 30, 2009 (Unaudited)
                                        
                                        
                                        318,850
                                        
                                        
                                        $
                                        4.9
                                        
                                        
                                        
                                        2,302,097
  Following
is a summary of the status of stock options outstanding at September 30, 2009
(unaudited):





Outstanding Options
                              
                              
                              Exercisable OptionsExercise
                                Price
                              
                              Number
                              
                              
                              Average
                                Remaining
                                Contractual
                                Life
                              
                              
                              Exercise
                                Price
                              
                              
                              Number
                              
                              
                              Average
                                Remaining
                                Contractual
                                Life$
                              4.90
                              
                              
                              243,850
                              
                              
                              
                              5.50
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -$
                              4.90
                              
                              
                              75,000
                              
                              
                              
                              5.59
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -





Note
10 – Earnings per Share





Earnings
per share for the periods ended September 30, 2009 and 2008 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 periods ended September 30, 2009 and 2008:
                
                For the three months ended
                
                
                For the nine months endedSeptember 30,
                
                
                September 30,Basic earning per share
                
                2009
                
                
                2008
                
                
                2009
                
                
                2008(Unaudited)
                
                
                (Unaudited)
                
                
                (Unaudited)
                
                
                (Unaudited)Net
      income
                
                
                4,647,519
                
                
                
                5,136,590
                
                
                
                12,711,898
                
                
                
                11,458,053Weighted
      shares outstanding-Basic
                
                
                15,754,696
                
                
                
                14,600,152
                
                
                
                14,985,001
                
                
                
                14,600,152Earnings
      per share-Basic
                
                $
                0.29
                
                
                $
                0.35
                
                
                $
                0.85
                
                
                $
                0.78Diluted
      earning per shareNet
      income
                
                
                4,647,519
                
                
                
                5,136,590
                
                
                
                12,711,898
                
                
                
                11,458,053Weighted
      shares outstanding-Basic
                
                
                15,754,696
                
                
                
                14,600,154
                
                
                
                14,985,001
                
                
                
                14,600,154Effect
      of diluted securities-Warrants
                
                
                385,124
                
                
                
                39,641
                
                
                
                50,171
                
                
                
                58,265Weighted
      shares outstanding-Diluted
                
                
                16,139,820
                
                
                
                14,639,795
                
                
                
                15,035,172
                
                
                
                14,658,419Earnings
      per share –Diluted
                
                $
                0.29
                
                
                $
                0.35
                
                
                $
                0.85
                
                
                $
                0.78





17





At
September 30, 2009 and 2008, the Company had outstanding warrants of 1,833,654
and 1,994,242, respectively.  For the three months ended September 30,
2009, the average stock price was greater than the exercise prices of the
1,450,000 warrants which resulted in additional weighted average common stock
equivalents of 385,124; 383,654 outstanding warrants were excluded from the
diluted earnings per share calculation as they are anti-dilutive. For the three
months ended September 30, 2008, the average stock price was greater than the
exercise prices of the 160,588 warrants which resulted in additional weighted
average common stock equivalents of 39,641; 1,833,654 outstanding warrants were
excluded from the diluted earnings per share calculation as they are
anti-dilutive. For the nine months ended September 30, 2009, the average stock
price was greater than the exercise prices of the 1,450,000 warrants which
resulted in additional weighted average common stock equivalents of 50,171;
383,654 outstanding warrants were excluded from the diluted earnings per share
calculation as they are anti-dilutive.  For the nine months ended
September 30, 2008, the average stock price was greater than the exercise prices
of the 160,588 warrants which resulted in additional weighted average common
stock equivalents of 58,265; 1,833,654 outstanding warrants were excluded from
the diluted earnings per share calculation as they are
anti-dilutive.




Note
11 – Current Vulnerability Due to Certain Concentrations





Concentration
of natural gas vendors:


For the three months ended
                            
                            
                            For the nine months endedSeptember 30,
                            
                            
                            September 30,2009
                            
                            
                            2008
                            
                            
                            2009
                            
                            
                            2008(Unaudited)
                            
                            
                            (Unaudited)
                            
                            
                            (Unaudited)
                            
                            
                            (Unaudited)Numbers
      of natural gas vendors
                            
                            
                            4
                            
                            
                            
                            4
                            
                            
                            
                            4
                            
                            
                            
                            4Percentage
      of total natural gas purchases
                            
                            
                            99
                            %
                            
                            
                            97
                            %
                            
                            
                            99
                            %
                            
                            
                            98
                            %





As of
September 30, 2009 and December 31, 2008, the Company has $106,078 and $206,811,
respectively, payable due to its major suppliers.





The
Company maintains long-term natural gas minimum purchase agreements with one of
its vendors as of September 30, 2009. 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
12 – 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 filing 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 and New York, NY.  The minimum future
payment for leasing land use rights and offices is as follows:





Year
      ending December 31, 2009
                    
                    $
                    86,758Year
      ending December 31, 2010
                    
                    
                    1,458,518Year
      ending December 31, 2011
                    
                    
                    1,577,171Year
      ending December 31, 2012
                    
                    
                    1,391,916Year
      ending December 31, 2013
                    
                    
                    1,280,490Thereafter
                    
                    
                    21,923,923Total
                    
                    $
                    27,718,776




18




For the
three months ended September 30, 2009 and 2008, the land use right and office
lease expenses were $411,452 and $256,876, respectively. For the nine months
ended September 30, 2009 and 2008, the land use right and office lease expenses
were $1,209,549 and $630,821 respectively.





(b)
Property and Equipment





In
January 2008, the Company entered into a contract with Chemtex International
Inc. to purchase equipment supply for the LNG plant and storage tank located in
Jingbian County, Shannxi Province China, in the total amount of $13,700,000. On
May 16, 2008, JBLNG entered into an agreement with Hebei Tongchan Import and
Export Co. Ltd. (Hebei) and agreed that Hebei will act as the trade agency for
JBLNG. On June 16, 2008, the Company entered into an equipment supply contract
with Chemtex International Inc. to supply imported equipment for a LNG plant and
a storage tank to be built by Jingbian Xilan LNG Co. Ltd. On September 8, 2008,
the total contract value was reduced from $13,700,000 to $13,l00,000. As of
September 30, 2009, the Company advanced $6,140,000 to the trade agency and the
future commitment for equipment is $6,960,000.





(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)
Capital Commitments





In July
2009, the Company, through its variable interest entity, Xi’an Xilan Natural Gas
Co., Ltd. (“Xi’an Xilan”), has entered into a joint venture agreement with China
National Petroleum Corporation Kunlun Natural Gas Co., Ltd. and a Joint Venture
Company will be established.  The Joint Venture Company will have an
initial registered capital of RMB50,000,000 (approximately $7,350,000) and Xi’an
Xilan has a capital commitment of RMB24,500,000, representing 49% of the Joint
Venture Company’s total registered capital.  As of September 30, 2009,
Xi’an Xilan has not yet made any capital contribution.





(e) Legal
Proceedings





A former
member of the board of directors filed a lawsuit against the Company in the 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 the
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 options 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.  Regardless of the outcome of the appeal, the Company believes that
any liability it would incur will not have a materially adverse effect on its
financial condition or its results of operations, and, accordingly, this matter
has not been reflected on the Company's consolidated financial
statements.





Note
13 – Subsequent event





The
Company has performed an evaluation of subsequent events through November 9,
2009, which is the date the financial statements were issued.


19


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 a
distributor of compressed natural gas ("CNG") in China.. As
of September 30, 2009, we operated 24 CNG fueling stations in Shaanxi province
and 12 CNG fueling stations in Henan province. We own our CNG fueling
stations while we lease the land upon which our CNG fueling stations operate.
For the three and nine months ended September 30, 2009, we sold CNG of
40,420,123 and 120,866,756 cubic meters respectively through our fueling
stations, compared to 40,547,584 and 107,226,877 cubic meters for the three and
nine months ended September 30, 2008. We also transport, distribute and sell
piped natural gas to residential and commercial customers in the Xi’an area,
including Lantian County, and the districts of Lintong and Baqiao, in Shaanxi
province through a high pressure pipeline network of approximately 120
kilometers.
 
 We
operate four main business lines:
 
 ·
              Distribution
      and sale of compressed natural gas through our variable interest
      entity (VIE) owned CNG fueling stations for hybrid (natural gas/gasoline)
      powered vehicles (36 stations as of September 30,
  2009);
 
 ·
              Installation,
      distribution and sale of piped natural gas to residential and commercial
      customers. We distributed and sold piped natural gas to 118,973
      residential customers as of September 30,
2009;
 
 ·
              Distribution
      and sale of gasoline through our VIE owned CNG fueling stations for
      gasoline and hybrid (natural gas/gasoline) powered vehicles (7 of our
      VIE owned CNG fueling stations sold gasoline as of September 30, 2009);
      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, Xi'an Xilan Natural Gas Co.,
Ltd. ("XXNGC"), formed a wholly-owned subsidiary, Shaanxi Jingbian Liquefied
Natural Gas Co., Ltd. ("SJLNG"), for the purpose of constructing a liquefied
natural gas ("LNG") facility to be located in Jingbian, Shaanxi province. We
planned to invest approximately $45 million to construct this facility but are
anticipating now that the total investment increase to approximately
$49.0 million primarily attributed to significant increase in material and
labor costs incurred due to additional engineering reinforcement needs to ensure
project safety, excluding $2.7 million additional payment of land use right
for phase I, phase II and phase III because soaring local land price due to
recent energy resource explorations as well as the cost of $4.5 million to
purchase an additional 8.3 acres of land for the Yulin government’s construction
of an electricity substation, phase II and phase III of the LNG
plant.
 
 The LNG
plant was funded through the sale of senior notes to Abax Lotus Ltd. in January
2008 as well as the underwritten public offering in September 2009. When
completed, the plant is expected to have LNG processing capacity of 500,000
cubic meters per day, or approximately 150 million cubic meters on an annual
basis. Phase I of the LNG plant is under construction and is expected to be
completed by May 2010, later than originally planned because
of delays mainly due to macro tariff exemption policy changes and
additional document requirements at Shaanxi Province customs; engineering
reinforcement of plant basis; ocean shipment route change to avoid pirates
in Somali area.  20
 
 We had
total revenues of 20,125,184 and 18,401,200 for the three months ended September
30, 2009 and 2008 respectively and revenues of 59,395,370 and 49,317,360 for the
nine months ended September 30, 2009 and 2008, respectively. We had net income
of 4,647,519 and 5,136,590 for the three months ended September 30, 2009 and
2008 respectively and net income of 12,711,898 and 11,458,053 for the nine
months ended September 30, 2009 and 2008 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 9.37% during the three months ended September 30, 2009 from the
three months ended September 30, 2008 and by 20.44% during the nine months ended
September 30, 2009 from the nine months ended September 30, 2008 largely
because of the addition of 3 new fueling stations added since the third quarter
of 2008, as well as the increase of pipeline natural gas customers. As of
September 30, 2009, we operated 36 CNG fueling stations in total and, in Shaanxi
alone, we operated 24 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 September 30, 2009, 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 who 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.
 
 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.
 
 Taxation
 
 United
States
 
 We are
incorporated in the State of Delaware and are subject to the tax laws of the
United States. Since we do not have any revenue generating act ivies in the
United States, we incurred a net operating loss for income tax purposes for the
period ended September 30, 2009. The estimated net operating loss carry forwards
for United States income tax purposes amounted to $2,278,525 and $1,657,473 as
of September, 2009 and December 31, 2008, 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
September 30, 2009.
 
 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 Xilan Equipment, SJLNG,
XXABC, HXNGC and LBNGC are subject to the 25% PRC income tax rate. Our effective
income tax rate for the three months ended September 30, 2009 and 2008 were
approximately 17.7% and 16.8%, respectively.
  21
 
 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.
 
 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.
 
 Internal
Control Over Financial Reporting
 
 We are
subject to reporting obligations under the U.S. securities laws. The SEC, as
required by Section 404 of the Sarbanes-Oxley Act, adopted rules requiring every
public company to include a management report on such company’s internal control
over financial reporting in its annual report, which contains management’s
assessment of the effectiveness of the company’s internal control over financial
reporting. In addition, an independent registered public accounting firm must
report on our internal control over financial reporting. Based the Company’s
evaluation, management concluded that, due to the identification of a material
weakness in relation to inadequate US GAAP expertise, as disclosed in our Annual
Report on Form 10-K for the year ended December 31, 2008, as amended, and
the fact that the company is still in the process of remediating such material
weakness, as of September 30, 2009, the Company’s disclosure controls and
procedures remained ineffective.
 
 CONSOLIDATED
RESULTS OF OPERATIONS
 
 Three
Months Ended September 30, 2009 Compared to Three Months Ended September 30,
2008
 
 The
following table represents the consolidated operating results for the three
month period ended September 30, 2009 and 2008:
 
 Sales
Revenues
 
 The
following table sets forth a breakdown of our revenues for the period
indicated:
 
 September 30,
                    2009
                  
                  
                  September 30,
                    2008
                  
                  
                  Increase in
                    dollar
                    amount
                  
                  
                  Increase in
                    percentageNatural
      gas from fueling stations
                  
                  $
                  14,789,924
                  
                  
                  $
                  14,756,929
                  
                  
                  $
                  32,995
                  
                  
                  
                  0.2%Natural
      gas from pipelines
                  
                  
                  664,462
                  
                  
                  
                  597,532
                  
                  
                  
                  66,930
                  
                  
                  
                  11.2%Gasoline
                  
                  
                  1,633,478
                  
                  
                  
                  1,187,754
                  
                  
                  
                  445,724
                  
                  
                  
                  37.5%Installation
                  
                  
                  2,415,550
                  
                  
                  
                  1,197,051
                  
                  
                  
                  1,218,499
                  
                  
                  
                  101.8%Auto
      conversion
                  
                  
                  621,770
                  
                  
                  
                  661,934
                  
                  
                  
                  (40,164)
                  
                  
                  
                  -6.1%Total
                  
                  $
                  20,125,184
                  
                  
                  $
                  18,401,200
                  
                  
                  $
                  1,723,984
                  
                  
                  
                  9.4%
 
 Overall.
Total revenue for the three months ended September 30, 2009 increased to
20,125,184 from 18,401,200 for the three months ended September 30, 2008, an
increase of 1,723,984 or 9.4 %. This increase was mainly due to the addition of
3 new fueling stations added since the third quarter of 2008, and an increase in
the number of residential and commercial pipeline customers to 118,973 as of
September 30, 2009 from 92,984 as of September 30, 2008. We sold natural gas of
43,209,817 cubic meters during the three months ended September 30, 2009,
compared to 43,213,532 cubic meters during the three months ended September 30,
2008. For the three months ended September 30, 2009, 84.9% of our revenue was
generated from the sale of natural gas and gasoline, and the other 15.1% was
generated from our installation and auto conversion services.
  22
 Natural Gas from
Fueling Stations. Natural gas revenue from our fueling stations increased
by 0.2% or $32,995, to $14,789,924 during the three months ended September 30,
2009, from $14,756,929 during the three months ended September 30, 2008, and
contributed to 73.5% of our total revenue, which was the largest among our four
major business lines. During the three months ended September 30, 2009, we sold
compressed natural gas of 40,420,123 cubic meters, compared to 40,547,584 cubic
meters during the three months ended September 30, 2008 through our fueling
stations. In terms of average station sales value and volume, in the three
months ended September 30, 2009, we sold approximately $418,622 and 1,144,074
cubic meters of compressed natural gas per station, compared to approximately
$423,000 and 1,180,000 cubic meters in the three months ended September 30,
2008. The reason for the decline in per station sales by 3% in quantity was due
to the construction of main subway lines in Xi'an, which caused certain bus
routes to deviate from our stations as well as enhanced competition in Henan
Province.  Unit selling price was relatively stable at $0.37 (RMB
2.5).
 
 Natural Gas from
Pipelines.  Natural gas revenue from our pipelines increased by
11.2%, or $66,930, to $664,462 during the three months ended September 30, 2009,
from $597,532 during the three months ended September 30, 2008, and contributed
to 3.3% of our total revenue. As of September 30, 2009, the Company had 118,973
pipeline customers, an increase of 25,989 customers comparing to as of September
30, 2008.  We also sold 2,789,694 cubic meters of natural gas through
our pipelines during the three months ended September 30, 2009, compared to
2,665,948 cubic meters during the three months ended September 30,
2008.
 
 Gasoline.
Revenue from gasoline sales increased by 37.5%, or $445,724, to $1,633,478
during the three months ended September 30, 2009, from $1,187,754 during the
three months ended September 30, 2008, and contributed 8.1% to our total
revenue. The gasoline revenue increase was due to the sales volume increased
41.7% from 1,667,783 liters to 2,357,490 liters, offset by 2.67% decrease of
unit sales price from $ 0.6500 (RMB4.86) per liter in the three months ended
September 30, 2008 to $0.6934 (RMB 4.73) per liter in the three months
ended September 30, 2009, affected by the decrease of international oil price.
The increased sales volumes were due to our two stations, Xianning and Kaiyuan,
began operation in the third quarter of 2008.
 
 Installation
Services. Revenue from installation services increased by 101.8%, or
$1,218,499, to $ 2,415,550 during the three months ended September 30, 2009,
from $1,197,051 during the three months ended September 30, 2008, and
contributed 12.0% to our total revenue. The increase of installation sales was
mainly due to the increase of pipeline customers in the newly acquired
subsidiary, Lingbao Natural Gas, Co., since October 2008. Installation services
to our top four customers contributed to 19.2%, 12.6%, 11.6% and 11.3% of our
installation revenue for the three months ended September 30, 2009.
 
 Auto Conversion
Services. Revenue from our auto conversion division decreased by 6.1%, or
$40,164, to $621,770 during the three months ended September 30, 2009, from
$661,934 during the three months ended September 30, 2008, and contributed 3.1%
to our total revenue.
 
 Cost
of Revenue
 
 The
following table sets forth a breakdown of our cost of revenue for the periods
indicated:
 
 September 30,
                    2009
                  
                  
                  September 30,
                    2008
                  
                  
                  Increase /
                    (Decrease) in
                    dollar
                    amount
                  
                  
                  Increase /
                    (Decrease) in
                    percentageNatural
      gas from fueling stations
                  
                  $
                  7,075,387
                  
                  
                  $
                  6,538,493
                  
                  
                  $
                  536,894
                  
                  
                  
                  8.2%Natural
      gas from pipelines
                  
                  
                  460,801
                  
                  
                  
                  434,542
                  
                  
                  
                  26,259
                  
                  
                  
                  6.0%Gasoline
                  
                  
                  1,534,806
                  
                  
                  
                  1,085,311
                  
                  
                  
                  449,495
                  
                  
                  
                  41.4%Installation
                  
                  
                  972,146
                  
                  
                  
                  448,900
                  
                  
                  
                  523,246
                  
                  
                  
                  116.6%Auto
      conversion
                  
                  
                  364,352
                  
                  
                  
                  401,587
                  
                  
                  
                  (37,235)
                  
                  
                  
                  (9.3%)Total
                  
                  $
                  10,407,492
                  
                  
                  $
                  8,908,833
                  
                  
                  $
                  1,498,659
                  
                  
                  
                  16.8%
 
 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 September 30, 2009 was $10,407,492, an
increase of $1,498,659, or 16.8%, from $8,908,833 for the three months ended
September 30, 2008, while our revenue increased by 9.4% during the same
period.
 
 Natural Gas from
Fueling Stations. Cost of revenue of our natural gas for our fueling
stations increased by 8.2%, or $536,894, to $7,075,387 during the three months
ended September 30, 2009, as compared to $6,538,493 for the three months ended
September 30, 2008, mainly due to increased coal bed methane procurement price
in Henan Province from $0.1466 (RMB 1.0) to $0.1906 (RMB 1.3) in June 2009
reflecting enhanced coal bed methane demand brought by newly opened fueling
stations in Henan Province.
  23
 
 Natural Gas from
Pipelines. Cost of revenue of our natural gas sold through our pipelines
increased by 6.0%, or $26,259 to $460,801 during the three months ended
September 30, 2009, as compared to $434,542 during the three months ended
September 30, 2008, which was in line with the sales growth.
 
 Gasoline.
Cost of our gasoline revenue increased by 41.4%, to $1,534,086 during the three
months ended September 30, 2009, from $1,085,311 for the three months ended
September 30, 2008. The increase of cost of gasoline revenue was due to the
increase in sales volume, and the effect of the increase of average unit cost
from $0.6361 (RMB 4.44) per liter during the three months ended September 30,
2008 to $0.6523 (RMB 4.45) per liter during the three months ended September 30,
2009 due to the increasing price of the international fuel market.
 
 Installation
Services. Cost of revenue from our installation services increased by
116.6%, or $523,246, to $972,146 during the three months ended September 30,
2009, as compared to $448,900 during the three months ended September 30, 2008,
as a result of the increase of pipeline customers.
 
 Auto Conversion
Services. Cost of our auto conversion revenue decreased by 9. 3%, or
$37,235, to $364,352 during the three months ended September 30, 2009, as
compared to $ 401,587 during the three months ended September 30,
2008.
 
 Gross
profit
 
 The
following table sets forth a breakdown of our gross profit for the periods
indicated:
 
 September 30,
                    2009
                  
                  
                  September 30,
                    2008
                  
                  
                  Increase in
                    dollar amount
                  
                  
                  Increase in
                    percentageNatural
      gas from fueling stations
                  
                  $
                  7,714,537
                  
                  
                  $
                  8,218,436
                  
                  
                  $
                  (503,899)
                  
                  
                  
                  -6.1%Natural
      gas from pipelines
                  
                  
                  203,661
                  
                  
                  
                  162,990
                  
                  
                  
                  40,671
                  
                  
                  
                  25.0%Gasoline
                  
                  
                  98,672
                  
                  
                  
                  102,443
                  
                  
                  
                  (3,771)
                  
                  
                  
                  -3.7%Installation
                  
                  
                  1,443,404
                  
                  
                  
                  748,151
                  
                  
                  
                  695,253
                  
                  
                  
                  92.9%Auto
      conversion
                  
                  
                  257,418
                  
                  
                  
                  260,347
                  
                  
                  
                  (2,929)
                  
                  
                  
                  -1.1%Total
                  
                  $
                  9,717,692
                  
                  
                  $
                  9,492,367
                  
                  
                  $
                  225,325
                  
                  
                  
                  2.4%
 
 We earned
a gross profit of $9,717,692 for the three months ended September 30, 2009, an
increase of $225,325 or 2.4%, compared to $9,492,367 for the three months ended
September 30, 2008. In summary, gross profit increase was mainly due to the
increased sales volume of pipeline natural gas with stable unit price and cost;
and the increased installation revenue from new pipeline customers.
 
 Gross
margin
 
 Gross
margin for natural gas sold through our fueling stations decreased from 55.7% in
the three months ended September 30, 2008 to 52.2% in the three months ended
September 30, 2009 due to increased coal bed methane procurement price in Henan
Province from RMB 1.0 to RMB 1.3 in June 2009 reflecting enhanced coal bed
methane demand brought by newly opened fueling stations in Henan
Province.
 
 Gross
margin for natural gas sold through pipelines was 30.7% during the three months
ended September 30, 2009, and increased slightly as compared to 27.3% during the
three months ended September 30, 2008.
 
 Gross
margin for gasoline sales decreased from 8.6% during the three months ended
September 30, 2008 to 6.0% during the three months ended September 30,
2009, due to the decrease of gasoline retail price and increase of gasoline
purchase cost.
 
 Gross
margin for our installation business decreased to 59.8% in the three months
ended September 30, 2009 from 62.5% in the three months ended September 30, 2008
due to increase of material costs.
 
 Gross
margin for our auto conversion business increased from 39.3% in the three months
ended September 30, 2008 to 41.4% in the three months ended September 30, 2009
due to improved efficiency. Due to higher coal bed methane procurement
cost, our total gross margin decreased from 51.6% for the three months ended
September 30, 2008 to 48.3% for the three months ended September 30,
2009.
  24
  Operating
expenses
 
 We
incurred operating expenses of $3,828,762 for the three months ended September
30, 2009, an increase of $762,250 or 24.9%, compared to $3,066,512 for the three
months ended September 30, 2008. Sales and marketing costs increased 14.7 %
from $2,098,343 for the three months ended September 30, 2008 to $2,406,462 for
the three months ended September 30, 2009, primarily due to the $200,190
increase in depreciation expense and $101,678 increase in leasing expense,
as well as $83,997 and $42,286 increase in utility and
marketing expense, respectively, mainly related to the acquisition of
Lingbao Natural Gas, Co. in October 2008 as well as the addition of 3 new
fueling stations added since the third quarter of 2008. In addition, we also
increased our efforts to obtain new residential and commercial customers and
attract customers to our fueling stations. General and administrative expenses
increased 46.9% from $968,169 for the three months ended September 30, 2008 to
$1,422,300 for the three months ended September 30, 2009 mainly due to increase
of $252,485 in depreciation expense, and $130,181 in legal expense, as well
as $59,948 in travel expense,. The transportation cost per million cubic meters
of natural gas during the three months ended September 30, 2009 was
approximately $2,669.
 
 Income
from Operations and Operating Margin
 
 For the
foregoing reasons, income from operations decreased by $536,925, or 8.4%, to
$5,888,930 for the three months ended September 30, 2009, from $6,425,855 for
the three months ended September 30, 2008.  Our operating margin for
the three months ended September 30, 2009 was 29.3%, compared to 34.9% for the
three months ended September 30, 2008.
 
 Non-Operating
Income (Expense)
 
 Our
non-operating expense decreased by $14,499, or 5.7%, to $240,130 for the three
months ended September 30, 2009, from $254,629 for the three months ended
September 30, 2008, primarily due to the reversal of excessive interest expense
of $293,453 previously recognized as penalty interest due to delayed Nasdaq
listing pursuant to the indenture with Abax Lotus, Ltd.
 
 Provision
for Income Tax
 
 Income
tax was $1,001,281 for the three months ended September 30, 2009, as compared to
$1,034,636 for the three months ended September 30, 2008.
 
 Net
Income
 
 Based on
the foregoing, net income decreased to $4,647,519 for the three months ended
September 30, 2009, a decrease of $489,071, or 9.5%, from $5,136,590 for the
three months ended September 30, 2008. Net margin decreased from 27.9% during
the three months ended September 30, 2008 to 23.1% during the three months
ended September 30, 2009. The reduced net margin reflects increased coal bed
methane procurement price as well as increase in operating
expenses.
 
 Nine
Months Ended September 30, 2009 Compared to Nine Months Ended September 30,
2008
 
 The
following table represents the consolidated operating results for the nine month
period ended September 30, 2009 and 2008:
 
 Sales
Revenues
 
 The
following table sets forth a breakdown of our revenues for the period
indicated:
 
 September 30,
                    2009
                  
                  
                  September 30,
                    2008
                  
                  
                  Increase in dollar
                    Amount
                  
                  
                  Increase in
                    percentageNatural
      gas from fueling stations
                  
                  $
                  44,099,167
                  
                  
                  $
                  38,697,495
                  
                  
                  $
                  5,401,672
                  
                  
                  
                  14.0
                  %Natural
      gas from pipelines
                  
                  
                  2,041,717
                  
                  
                  
                  1,797,151
                  
                  
                  
                  244,566
                  
                  
                  
                  13.6
                  %Gasoline
                  
                  
                  4,440,892
                  
                  
                  
                  3,466,601
                  
                  
                  
                  974,291
                  
                  
                  
                  28.1
                  %Installation
                  
                  
                  7,019,593
                  
                  
                  
                  3,549,621
                  
                  
                  
                  3,469,972
                  
                  
                  
                  97.8
                  %Auto
      conversion
                  
                  
                  1,794,001
                  
                  
                  
                  1,806,492
                  
                  
                  
                  (12,491
                  )
                  
                  
                  -0.7
                  %Total
                  
                  $
                  59,395,370
                  
                  
                  $
                  49,317,360
                  
                  
                  $
                  10,078,010
                  
                  
                  
                  20.4
                  %
  25
  Overall.
Total revenue for the nine months ended September 30, 2009 increased to
$59,395,370 from $49,317,360 for the nine months ended September 30, 2008, an
increase of $10,078,010 or 20.4%. This increase was mainly due to the addition
of 10 new fueling stations added since the first quarter of 2008, and an
increase in the number of residential and commercial pipeline customers to
118,973 as of September 30, 2009 from 92,984 as of September 30, 2008. We sold
natural gas of 129,583,633 cubic meters during the nine months ended September
30, 2009, compared to 115,303,300 cubic meters during the nine months ended
September 30, 2008. For the nine months ended September 30, 2009, 85.2% of our
revenue was generated from the sale of natural gas and gasoline, and the other
14.8% was generated from our installation and auto conversion
services.
 
 Natural Gas from
Fueling Stations. Natural gas revenue from our fueling stations increased
by 14.0% or $5,401,672, to $44,099,167 during the nine months ended September
30, 2009, from $38,697,495 during the nine months ended September 30, 2008, and
contributed to74.2% of our total revenue, which was the largest among our four
major business lines. The increase of natural gas revenue was mainly due to the
increase of sales volume generated from our newly added fueling stations. During
the nine months ended September 30, 2009, we sold compressed natural gas of
120,866,756 cubic meters, compared to 107,226,877 cubic meters during the nine
months ended September 30, 2008 through our fueling stations. In terms of
average station sales value and volume, in the nine months ended September 30,
2009, we sold approximately $1,256,029 and 3,442,517 cubic meters of compressed
natural gas per station, compared to approximately $1,292,000 and 3,650,000
cubic meters in the nine months ended September 30, 2008. The reason for the
decline in per station sales by 6% in quantity was due to the construction of
main subway lines in Xi'an, which caused certain bus routes to deviate from our
stations and the new competition in Henan Province. Unit selling price was
relatively stable at $0.37 (RMB 2.5).
 
 Natural Gas from
Pipelines.  Natural gas revenue from our pipelines increased by
13.6%, or $244,566, to $2,041,717 during the nine months ended September 30,
2009, from $1,797,151 during the nine months ended September 30, 2008, and
contributed to 3.4 % of our total revenue. As of September 30, 2009, the Company
had 118,973 pipeline customers, an increase of 25,989 customers comparing to as
of September 30, 2008.  We also sold 8,716,877 cubic meters of natural
gas through our pipelines during the nine months ended September 30, 2009,
compared to  8,076,422 cubic meters during the nine months ended
September 30, 2008.
 
 Gasoline.
Revenue from gasoline sales increased by 28.1%, or $974,291, to $4,440,892
during the nine months ended September 30, 2009, from $3,466,601 during the nine
months ended September 30, 2008, and contributed 7.5% to our total revenue. The
gasoline revenue increase was due to the sales volume increased 39.9% from
5,170,860 liters to 7,236,253 liters, offset by 10.5% decrease of unit sales
price from $0.6705  (RMB4.68) per liter in the nine months ended
September 30, 2008 to RMB $0.6142 (RMB 4.19) per liter in the nine months
ended September 30, 2009, affected by the decrease of international oil price.
The increased sales volume was due to our two stations, Xianning and Kaiyuan,
began operation in September 30, 2008.
 
 Installation
Services. Revenue from installation services increased by 97.8%, or
$3,469,972, to $ 7,019,593 during the nine months ended September 30, 2009, from
$3,549,621 during the nine months ended September 30, 2008, and contributed
11.8% to our total revenue. The increase of installation sales was mainly due to
the increase of pipeline customers in the newly acquired subsidiary, Lingbao
Natural Gas, Co., since January 2009. Installation services to our top four
customers contributed to 12.2%, 8.7%, 7.3% and 6.9% of our installation revenue
for the nine months ended September 30, 2009.
 
 Auto Conversion
Services. Revenue from our auto conversion division decreased by 0.7%, or
$12,491, to $1,794,001 during the nine months ended September 30, 2009, from
$1,806,492 during the nine months ended September 30, 2008, and contributed 3.0%
to our total revenue.
 
 Cost
of Revenue
 
 The
following table sets forth a breakdown of our cost of revenue for the periods
indicated:
 
 September 30,
                    2009
                  
                  
                  September 30,
                    2008
                  
                  
                  Increase /
                    (Decrease) in
                    dollar
                    amount
                  
                  
                  Increase /
                    (Decrease) in
                    percentageNatural
      gas from fueling stations
                  
                  $
                  20,343,004
                  
                  
                  $
                  19,078,470
                  
                  
                  $
                  1,264,534
                  
                  
                  
                  6.6%Natural
      gas from pipelines
                  
                  
                  1,430,631
                  
                  
                  
                  1,291,308
                  
                  
                  
                  139,323
                  
                  
                  
                  10.8%Gasoline
                  
                  
                  4,194,615
                  
                  
                  
                  3,208,326
                  
                  
                  
                  986,289
                  
                  
                  
                  30.7%Installation
                  
                  
                  2,734,125
                  
                  
                  
                  1,389,067
                  
                  
                  
                  1,345,058
                  
                  
                  
                  96.8%Auto
      conversion
                  
                  
                  1,063,461
                  
                  
                  
                  1,103,583
                  
                  
                  
                  (40,122)
                  
                  
                  
                  -3.6%Total
                  
                  $
                  29,765,836
                  
                  
                  $
                  26,070,754
                  
                  
                  $
                  3,695,082
                  
                  
                  
                  14.2%
  26
 
 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 nine months ended September 30, 2009 was $29,765,836, an
increase of $3,695,082, or 14.2%, from $26,070,754 for the nine months ended
September 30, 2008, while our revenue increased by 20.4 % during the same
period.
 
 Natural Gas from
Fueling Stations. Cost of revenue of our natural gas for our fueling
stations increased by 6.6%, or $1,264,534, to $20,343,004 during the nine months
ended September 30, 2009, as compared to $19,078,470 for the nine months ended
September 30, 2008. The low growth rate for cost of natural gas for our fueling
stations was primarily due to the low procurement price in coal bed methane we
obtained from July 2008 to May 2009 in Henan province that reduced our unit cost
from one of our major supplier by approximately 35%,from $0.2221(RMB1.55) to
$0.1433(RMB1.00), offset by the increase of natural gas procurement price
starting June 2009, from $0.1466(RMB1.00) to $0.1906(RMB1.30). Our overall
average unit cost was reduced by 3.3% during the nine months ended
September 30, 2009.
 
 Natural Gas from
Pipelines. Cost of revenue of our natural gas sold through our pipelines
increased by 10.8%, or $139,323 to $1,430,631 during the nine months ended
September 30, 2009, as compared to $1,291,308 during the nine months ended
September 30, 2008, which was in line with the sales growth.
 
 Gasoline.
Cost of our gasoline revenue increased by 30.7%, or $986,289, to $4,194,615
during the nine months ended September 30, 2009, from $3,208,326 for the nine
months ended September 30, 2008. The increase of cost of gasoline revenue was
due to the increase in sales volume, offset by the effect of the decrease of
average unit cost from $0.6189 (RMB 4.32) per liter during the nine months ended
September 30, 2008 to $0.5790 (RMB 3.95) per liter during the nine months ended
September 30, 2009 due to the decreasing price of the international fuel
market.
 
 Installation
Services. Cost of revenue from our installation services increased by
96.8%, or $1,345,058, to $2,734,125 during the nine months ended September 30,
2009, as compared to $1,389,067 during the nine months ended September 30, 2008,
as a result of the increase of pipeline customers.
 
 Auto Conversion
Services. Cost of our auto conversion revenue decreased by 3.6%, or
$40,122, to $1,063,461 during the nine months ended September 30, 2009, as
compared to $1,103,583 during the nine months ended September 30,
2008.
 
 Gross
profit
 
 The
following table sets forth a breakdown of our gross profit for the periods
indicated:
 
 September 30,
                    2009
                  
                  
                  September 30,
                    2008
                  
                  
                  Increase in
                    dollar amount
                  
                  
                  Increase in
                    percentageNatural
      gas from fueling stations
                  
                  $
                  23,756,163
                  
                  
                  $
                  19,619,025
                  
                  
                  $
                  4,137,138
                  
                  
                  
                  21.1%Natural
      gas from pipelines
                  
                  
                  611,086
                  
                  
                  
                  505,843
                  
                  
                  
                  105,243
                  
                  
                  
                  20.8%Gasoline
                  
                  
                  246,277
                  
                  
                  
                  258,275
                  
                  
                  
                  (11,998)
                  
                  
                  
                  -4.6%Installation
                  
                  
                  4,285,468
                  
                  
                  
                  2,160,554
                  
                  
                  
                  2,124,914
                  
                  
                  
                  98.4%Auto
      conversion
                  
                  
                  730,540
                  
                  
                  
                  702,909
                  
                  
                  
                  27,631
                  
                  
                  
                  3.9%Total
                  
                  $
                  29,629,534
                  
                  
                  $
                  23,246,606
                  
                  
                  $
                  6,382,928
                  
                  
                  
                  27.5%
  27
 
 We earned
a gross profit of $29,629,534 for the nine months ended September 30, 2009, an
increase of $6,382,928 or 27.5%, compared to $23,246,606 for the nine months
ended September 30, 2008. In summary, gross profit increase was mainly due to
the increased sales volume of natural gas from fueling stations with low
procurement price in coal bed methane from July 2008 to May 2009 in Henan; the
increased sales volume of pipeline natural gas with stable unit price and cost;
and the increased installation revenue from new pipeline customers.
 
 Gross
margin
 
 Gross
margin for natural gas sold through our fueling stations increased from 50.7% in
the nine months ended September 30, 2008 to 53.9% in the nine months ended
September 30, 2009, due to lower coal bed methane procurement cost in Henan
Province.
 
 Gross
margin for natural gas sold through pipelines was 29.9% during the nine months
ended September 30, 2009, and increased slightly as compared to 28.2% during the
nine months ended September 30, 2008.
 
 Gross
margin for gasoline sales decreased from 7.5% during the nine months ended
September 30, 2008 to5.6% during the nine months ended September 30, 2009, due
to the decrease of gasoline retail price exceeded the decrease of gasoline
purchase cost.
 
 Gross
margin for our installation and auto conversion businesses were 61.1% and 40.7%
during the nine months ended September 30, 2009, respectively, and remained flat
compared to 60.9% and 38.9% during the nine months ended September 30, 2008. Due
to the low procurement price in coal bed methane from July 2008 to May 2009
in Henan , our total gross margin increased from 47.1% for the nine months ended
September 30, 2008 to 49.9% for the nine months ended September 30,
2009.
 
 Operating
expenses
 
 We
incurred operating expenses of $11,349,049 for the nine months ended September
30, 2009, an increase of $3,392,,924 or 42.6%, compared to $7,956,125 for the
nine months ended September 30, 2008. Sales and marketing costs
increased 41.0% from $5,008,631 for the nine months ended September 30,
2008 to $7,062,429 for the nine months ended September 30, 2009, primarily due
to the $1,061,006 increase in depreciation expense as well as $537,884 and
$304,085 increase in leasing and utility expense, respectively, mainly related
to the acquisition of Lingbao Natural Gas, Co. in October 2008 as well as the
addition of 10 new fueling stations added since the first quarter of 2008. In
addition, we also increased our efforts to obtain new residential and commercial
customers and attract customers to our fueling stations. General and
administrative expenses increased 45.4% from $2,947,494 for the nine months
ended September 30, 2008 to $4,286,620 for the nine months ended September 30,
2009 mainly due to increase of $813,701 in depreciation expense and $276,832
increase in salary expense primarily reflecting the growth of employees, the
recruiting of qualified Chief Financial Officer as well as adjustment of
compensation for our Chief Executive Officer to market rate. The transportation
cost per million cubic meters of natural gas during the nine months ended
September 30, 2009 was approximately $2,536.
 
 Income
from Operations and Operating Margin
 
 For the
foregoing reasons, income from operations increased by $2,990,004, or 19.6%, to
$18,280,485 for the nine months ended September 30, 2009, from $15,290,481 for
the nine months ended September 30, 2008.  Our operating margin for
the nine months ended September 30, 2009 was 30.8%, compared to 31.00% for the
nine months ended September 30, 2008.
 
 Non-Operating
Income (Expense)
 
 Our
non-operating expense increased by $1,135,713, or 91.0%, to $2,383,367 for
the nine months ended September 30, 2009, from $1,247,654 for the nine months
ended September 30, 2008, primarily due to the recognition of $1,473,762
non-operating expense related to change in fair value of the Company’s
outstanding warrants.
 
 Provision
for Income Tax
 
 Income
tax was $3,185,220 for the nine months ended September 30, 2009, as compared to
$2,584,774 for the nine months ended September 30, 2008 which is in line
with the sales growth.
 
 Net
Income
 
 Based on
the foregoing, net income increased to $12,711,898 for the nine months ended
September 30, 2009, an increase of $1,253,845, or 10.9%, from $11,458,053 for
the nine months ended September 30, 2008. Net margin decreased from 23.2% during
the nine months ended September 30, 2008 to 21.4% during the nine months ended
September 30, 2009. The reduced net margin reflects the non-operating expenses
related to fair value change of the Company’s outstanding
warrants.
  28
  LIQUIDITY
AND CAPITAL RESOURCES
 
 Historically,
our primary sources of liquidity have consisted of cash generated from our
operations and debt financing. In 2008, we sold senior notes with a face value
of $40 million to Abax Lotus Ltd. 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
September 30, 2009, the Company had $55,931,579 of cash and cash equivalents on
hand compared to $5,854,383 of cash and cash equivalents as of December 31,
2008. The increase was primarily attributable to the underwritten public
offering in September 2009, the net proceeds of which is approximately $54.4
million.
 
 Net cash
provided by operating activities was $18,262,387 for the nine months ended
September 30, 2009 compared to net cash provided by operations of $12,711,311
for the nine months ended September 30, 2008. The primary reason for the change
was due to the increase in net income, adjusted for non-cash expenses items of
$6,201,171 and change in working capital of $651,682.
 
 Net cash
used in investing activities decreased from $44,611,535 during the nine months
ended September 30, 2008 to $22,578,879 for the same period in 2009 primarily
because of prepayment to equipment suppliers and construction  of
the LNG plant, and construction addition of fueling stations during the
nine months ended September 30, 2008. For the nine months ended September 30,
2009, major cash outflow were primarily to our construction in progress for the
LNG Plant.
 
 We had
net cash of $54,370,361  provided by financing activities for the nine
months ended September 30, 2009, due to the secondary public offering, compared
to net cash provided by financing activities of $37,877,491 during the nine
months ended September 30, 2008.
 
 The
Company paid $18,064,065 to the LNG processing plant as a prepayment on
equipment as well as addition to construction in progress during the nine months
ended September 30, 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.
 
 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
 
 None.
 
 CAPITAL
EXPENDITURES
 
 Our
planned capital expenditures as of September 30, 2009 were $59 million, which we
expect to be incurred in connection with the construction of our LNG facility
joint-venture cooperation with CNPC Kunlun and the acquisition of additional
fueling stations. We planned to invest approximately $45 million to construct
this facility but are anticipating now that the total investment increase to
approximately $49 million primarily attributed to significant increase in
material and labor costs incurred due to additional engineering reinforcement
needs to ensure project safety, excluding $2.7 million additional payment
of land use right for phase I, phase II and phase III because soaring local land
price due to recent energy resource explorations as well as the cost of $4.5
million to purchase an additional 8.3 acres of land use right for the Yulin
government’s construction of an electricity substation, phase II and phase
III of the LNG plant.
 
 Phase I
of the LNG plant is under construction and is expected to be completed by May
2010, later than originally planned because of delays mainly due to macro
tariff exemption changes and additional document requirements at Shaanxi
Province customs; engineering reinforcement of plant basis; ocean
shipment route changes to avoid pirates in Somali
area.
 29
 
 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
                          
                          
                          
                          -
                          
                          
                          
                          13,333
                          
                          
                          
                          26,667
                          
                          
                          $
                          -Other
      Long-Term Liabilities Reflected on Company's Balance Sheet
                          
                          
                          17,500
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          17,500(1)Total
                          
                          
                          57,500
                          
                          
                          
                          -
                          
                          
                          
                          13,333
                          
                          
                          
                          26,667
                          
                          
                          $
                          17,500
 
 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. If
      Abax does not exercise the warrants by January 29, 2015, Abax will be
      entitled to require that we purchase the warrants for $17,500,000 at that
      time.
 
 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, 2009
                  
                  $
                  86,758Year
      ending December 31, 2010
                  
                  
                  1,458,518Year
      ending December 31, 2011
                  
                  
                  1,577,171Year
      ending December 31, 2012
                  
                  
                  1,391,916Year
      ending December 31, 2013
                  
                  
                  1,280,490Thereafter
                  
                  
                  21,923,923Total
                  
                  $
                  27,718,776
 
 For the
three months ended September 30, 2009 and 2008, the land use right and office
lease expenses were $411,452 and $256,876, respectively. For the nine months
ended September 30, 2009 and 2008, the land use right and office lease expenses
were $1,209,549 and $630,821 respectively.
 
 Property
and Equipment
 
 On
January 25, 2008, we entered into a contract with Chemtex International Inc.
("Chemtex") to acquire certain exclusive rights relating to the technical
know-how and designing of our LNG plant and LNG storage tank in Jingbian county,
Shaanxi province, China, in the total amount of $9,500,000. On April 13, 2008,
our subsidiary, XXNGC, entered into a contract with Chemtex to purchase
equipment supply for the LNG plant and LNG storage tank in the total amount of
$13,700,000 (the "Chemtex Purchase Agreement"). The $13,700,000 purchase price
was reduced to $13,100,000 under an amendment to the Chemtex Purchase Agreement
with Chemtex in September 2008.  On May 16, 2008, SJLNG entered into
an agreement with Hebei Tongchan Import and Export Co. Ltd. ("Hebei") and agreed
that Hebei will act as the trade agency for SJLNG. On June 18, 2008, XXNGC
amended the April 13, 2008 with Chemtex and assigned Hebei to purchase the
LNG equipment for the LNG plant and LNG storage tank and Hebei succeeded the
rights and obligations of XXNGC under Chemtex Purchase Agreement.
 
 As of
September 30, 2009, we advanced $6,140,000 to Hebei and the future commitment
for equipment is $6,960,000.
 
 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.
  30
 
 Capital
Commitments
 
 In July
2009, the Company, through its variable interest entity, Xi’an Xilan Natural Gas
Co., Ltd. (“Xi’an Xilan”), has entered into a joint venture agreement with China
National Petroleum Corporation Kunlun Natural Gas Co., Ltd. and a Joint Venture
Company will be established.  The Joint Venture Company will have an
initial registered capital of RMB50,000,000 (approximately $7,350,000) and Xi’an
Xilan has a capital commitment of RMB24,500,000, representing 49% of the Joint
Venture Company’s total registered capital.  As of September 30, 2009,
Xi’an Xilan has not yet made any capital contribution.
 
 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.
Regardless of the outcome of the appeal, we believe that any liability we would
incur will not have a materially adverse effect on our financial condition or
our results of operations.
 
 FOREIGN
CURRENCY TRANSLATIONS
 
 As of
September 30, 2009 and December 31, 2008, 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 at September 30, 2009 were
translated RMB6.82 to $1.00 as compared to RMB6.82 at December 31, 2008. The
equity accounts were stated at their historical rate. The average translation
rates applied to income and cash flow statement amounts for the nine months
ended September 30, 2009 and 2008, were RMB 6.82 and RMB 6.98 to $1.00,
respectively.
 
 CRITICAL
ACCOUNTING POLICIES
 
 Our
discussion and analysis of our financial position and results of operations
contained in this Quarterly Report on Form 10-Q is based on our condensed
consolidated unaudited financial statements, contained elsewhere herein. The
preparation of these financial statements in conformity with 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,
2008.
 
 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 service are rendered to and accepted by the
customers.
 
 Accounts
Receivables
 
 Accounts
and other receivables are recorded at net realizable value consisting of the
carrying amount less an allowance for uncollectible accounts, as needed. The
Company allowance for uncollectible accounts is not significant.
 
 We
maintain 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. Our management determined that all receivables are good and there is
no need for a bad debt reserve as of September 30, 2009.
  31
 
 Other
Receivable – Employee Advances
 
 From time
to time, we advance predetermined amounts based upon internal Company policy to
certain employees and internal units to ensure certain transactions to be
performed in a timely manner. We have full oversight and control over the
advanced accounts. Therefore, no allowance for the uncollectible accounts is
needed.
 
 Inventory
 
 Inventory
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
allowance is made for writing down the inventories to their market value, if
lower. Inventory consists of material used in the installation of pipelines and
material used in repairing and modifying of vehicles. Inventory also consists of
gasoline.
 
 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.
 
 ·
              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 regardingderivatives
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.
 
 Unearned
Revenue
 
 Unearned
revenue represents prepayments by customers for gas purchases and advance
payments on installation of pipeline contracts. We record such prepayment as
unearned revenue when the payments are received.
 
 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.
 
 In
January 2009, the FASB’s accounting standard regarding other investments
providing additional guidance which amended the impairment model to remove the
exclusive reliance on “market participant” estimates of future cash flows used
in determining fair value. Changing the cash flows used to analyze
other-than-temporary impairment from the “market participant” view to a holder’s
estimate of whether there has been a “probable” adverse change in estimated cash
flows allows companies to apply reasonable judgment in assessing whether an
other-than-temporary impairment has occurred. The adoption of this guidance did
not have a material impact on the Company’s consolidated financial
statements.
 
 In April
2009, the FASB’s accounting standard regarding fair value measurements and
disclosures providing additional guidance for estimating fair value when the
volume and level of activity for the asset or liability have significantly
decreased and also includes guidance on identifying circumstances that indicate
a transaction is not orderly for fair value measurements. This guidance shall be
applied prospectively with retrospective application not permitted. The adoption
of this guidance did not have a material impact on the Company’s consolidated
financial statements.
  32
 
 In April
2009, the FASB’s
accounting standard regarding debt and equity securitiesrequires  to
make the other-than-temporary impairments guidance more operational and to
improve the presentation of other-than-temporary impairments in the financial
statements. This guidance will replace the existing requirement that the
entity’s management assert it has both the intent and ability to hold an
impaired debt security until recovery with a requirement that management assert
it does not have the intent to sell the security, and it is more likely than not
it will not have to sell the security before recovery of its cost basis. This
guidance provides increased disclosure about the credit and noncredit components
of impaired debt securities that are not expected to be sold and also requires
increased and more frequent disclosures regarding expected cash flows, credit
losses, and an aging of securities with unrealized losses. Although this
guidance does not result in a change in the carrying amount of debt securities,
it does require that the portion of an other-than-temporary impairment not
related to a credit loss for a held-to-maturity security be recognized in a new
category of other comprehensive income and be amortized over the remaining life
of the debt security as an increase in the carrying value of the security. The
adoption of this guidance did not have a material impact on the Company’s
consolidated financial statements.
 
 In April
2009 In April 2009, the FASB issued an accounting standard that requires
disclosures about fair value of financial instruments not measured on the
balance sheet at fair value in interim financial statements as well as in annual
financial statements. Prior to this guidance, fair values for these assets and
liabilities were only disclosed annually. This guidance applies to all financial
instruments and requires all entities to disclose the method(s) and significant
assumptions used to estimate the fair value of financial instruments. The
adoption of this guidance did not have a material impact on the Company’s
consolidated financial statements.
 
 In May
2009, the FASB updatedan accounting standard
regarding subsequent events providing guidance to establish general standards of
accounting for and disclosures of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. This
accounting standard requires entities to disclose the date through which
subsequent events were evaluated as well as the rationale for why that date was
selected.  The Company adopted this Standard during the second quarter
of 2009. This guidance requires that public entities evaluate subsequent events
through the date that the financial statements are issued. The Company has
evaluated subsequent events through the time of filing these consolidated
financial statements with the SEC on November 9, 2009.
 
 In June
2009, the FASB issued an accounting standard amending the accounting and
disclosurerequirements
for transfers of financial assets.  This guidance is effective for the
Company beginning in 2010. Should the Company’s accounts receivable
securitization programs not qualify for sale treatment under the revised rules,
future securitization transactions entered into on or after January 1, 2010
would be classified as debt and the related cash flows would be reflected as a
financing activity. The Company is currently assessing the impact of the
standard on its securitization programs.
 
 In June
2009, the FASB updated an accounting standard regarding consolidation guidance
which modifies how a company determines when an entity that is insufficiently
capitalized or is not controlled through voting (or similar rights) should be
consolidated. This guidance clarifies that the determination of whether a
company is required to consolidate an entity is based on, among other things, an
entity’s purpose and design and a company’s ability to direct the activities of
the entity that most significantly impact the entity’s economic performance.
This guidance requires an ongoing reassessment of whether a company is the
primary beneficiary of a variable interest entity. This guidance also requires
additional disclosures about a company’s involvement in variable interest
entities and any significant changes in risk exposure due to that involvement.
This guidance is effective for fiscal years beginning after November 15, 2009.
The Company is currently assessing the impact of the standard on its
securitization programs.
 
 In August
2009, the FASB issued an Accounting Standards Update (“ASU”) regarding measuring
liabilities at fair value. This ASU provides additional guidance clarifying the
measurement of liabilities at fair value in circumstances in which a quoted
price in an active market for the identical liability is not available; under
those circumstances, a reporting entity is required to measure fair value using
one or more of valuation techniques, as defined. This ASU is effective for the
first reporting period, including interim periods, beginning after the issuance
of this ASU. The Company is currently evaluating the impact of this ASU on its
consolidated financial statements.
 
 In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing.  This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation.  This ASU is effective
for fiscal years beginning on or after December 15, 2009, and interim
periods within those fiscal years for arrangements outstanding as of the
beginning of those fiscal years. The Company is currently evaluating the impact
of this ASU on its consolidated financial statements.
  33
  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 $40 million at September 30, 2009, all of which
bears interest at fixed rates. The $40 million of fixed-rate debt is due on
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 $195,040
adjustment to decrease our equity account for the quarter ended September 30,
2009 to reflect the net impact of the fluctuating of Chinese currency against
the U.S. dollar.
 
 Item
4. Controls and Procedures
 
 Evaluation
of Disclosure Controls and Procedures
 
 The
Company's management has evaluated, under the supervision and with the
participation of the Company's Chief Executive Officer and Chief Financial
Officer, the effectiveness of the design and operations of the Company's
disclosure controls and procedures, as of the end of the period covered by this
quarterly report. Based on this evaluation, management concluded that, due to
the identification of a material weakness in relation to inadequate US GAAP
expertise, as disclosed in our Annual Report on Form 10-K for the year ended
December 31, 2008, as amended, and the fact that the company is still in
the process of remediating such material weakness, as of September 30,
2009, the Company’s disclosure controls and procedures remained
ineffective.
 
 Changes
in internal control over financial reporting
 
 There
have been no changes in our internal control over financial reporting during the
most recently completed fiscal quarter that have materially affected or are
reasonably likely to materially affect, our internal control over financial
reporting. From the second quarter of 2009, the Company has started to
independently completing the consolidation of its financial statements in
accordance with U.S. GAAP through recruiting of U.S. GAAP proficient accounting
personnel. We are also allocating additional resources to train our existing
accounting staff and will continue this effort in the future. Most of the
policies, procedures and practices are already in place and being implemented.
These initiatives include the following:
 
 ·
              Identifying
      and hiring additional personnel with U.S. GAAP and SEC reporting
      experience, including our new CFO Veronica Jing Chen and one ACCA
      (Association of Chartered Certified Accountants) affiliate, and starting
      to independently completing the U.S. GAAP based reporting in the second
      quarter of 2009;
 ·
              Recruiting
      of additional qualified accounting personnel to form a competent SEC
      reporting team;
 ·
              Hiring
      outside consultant to provide training to our finance
      personnel;
 ·
              Based
      on COSO framework, developing the scope of the Company’s internal control
      system and enhancing the internal control function by establishing the
      Company’s internal audit team containing one corporate control director
      and two full time employees;
 ·
              Introducing
      and implementing policies and procedures to effectively control daily cash
      transactions and recording;
 
 The
resulting changes in our internal control over financial reporting were
evaluated and determined to not have materially affected our control structure
for the quarter ended September 30, 2009.
 
 34
  Part
II. OTHER INFORMATION
 
 Item
1. Legal Proceedings
 
 A former
member of the board of directors filed a lawsuit 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 options 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. Regardless of the
outcome of the appeal, the Company believes that any liability it would incur
will not have a materially adverse effect on its financial condition or its
results of operations.
 
 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/A filed on July 20, 2009.
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/A
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.
 
 Item
2.  Unregistered Sales of Equity Securities and Use of
Proceeds
 
 None.
 
 Item
3.  Defaults Upon Senior Securities
 
 None.
 
 Item
4.  Submission of Matters to a Vote of Security Holders
 
 None.
 
 Item
5.  Other Information
 
 None
 
 Item
6.  Exhibits
 
 (a)
Exhibits
 
 Exhibit Number
                  
                  Description of Exhibit31.1*
                  
                  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
herewith
  35
  SIGNATURES
 
 In
accordance with the requirements of the Exchange Act, the registrant caused this
report to be signed on its behalf by the undersigned, thereunto duly
authorized.
 
 China
      Natural Gas, Inc.November
      9, 2009
                  By:
                  /s/
      Qinan JiQinan
      JiChief
      Executive Officer(Principal
      Executive Officer)
 
 November
      9, 2009
                  By:
                  /s/
      Veronica ChenVeronica
      ChenChief
      Financial Officer(Principal
      Financial and Accounting
Officer)
  36