UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION




Washington,
D.C. 20549




FORM
10-Q




xQuarterly report under Section 13 or 15(d) of the Securities Exchange Act
of 1934




for the fiscal quarter ended February 28, 2010




oTransition report under Section 13 or 15(d) of the Securities Exchange
Act of 1934




for the transition period from ______ to______.




Commission
file number: 000-52409




CHINA ENERGY
CORPORATION


(Exact
name of Registrant in its charter)




Nevada
            98-0522950(State
      or other jurisdiction of incorporation or organization)
            (IRS
      Employer Identification No.)No.
      57 Xinhua East Street
              Hohhot,
      Inner Mongolia, People’s Republic of China
            010010(Address
      of principal executive offices)
            (Zip
      Code)+86-0471-466-8870(Registrant’s
      telephone number including area code)




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 preceding 12 months
(or for such shorter period that the registrant was required to file such
reports), and (2) has been subject to such filing requirements for the past 90
days.


Yes xNoo




Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).


Yes oNo x




Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or 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 o
            Accelerated
      filer o
            Non-accelerated filer o
            Smaller
      reporting company x(Do
      not check if a smallerreporting
      company)




Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act.


o Yes     
o No




State the
number of shares outstanding of each of the issuer’s classes of common equity,
as of the latest practicable date:




Class
            
            April
      15, 2010Common
      Stock, $ 0.001 par value
            
            45,000,000
      shares










TABLE
OF CONTENTS


PART
      I.
              FINANCIAL
      INFORMATIONITEM
      1.
              Financial
      Statements
              
              1Consolidated
      Statements of Income For the Three Months Ended February 28, 2010 and
      February 28, 2009 (Unaudited)
              
              2Consolidated
      Statements of Changes For the Three Months Ended February 28, 2010 and
      February 28, 2009 (Unaudited)
              
              3Notes
      to Consolidated Financial Statements
              
              5ITEM
      2.
              Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
              
              23ITEM
      3.
              Quantitative
      And Qualitative Disclosure About Market Risk
              
              32ITEM
      4T
              Controls
      and Procedures
              
              32PART
      II.
              OTHER
      INFORMATIONITEM
      1.
              Legal
      Proceedings
              
              32ITEM
      1A
              Risk
      Factors
              
              32ITEM
      2.
              Unregistered
      Sales of Equity Securities and Use of Proceeds
              
              32ITEM
      3.
              Defaults
      Upon Senior Securities
              
              33ITEM
      4.
              (Removed
      and Reserved)
              
              33ITEM
      5.
              Other
      Information.
              
              33ITEM 6.
              Exhibits
      and Reports on Form 8-K
              
              33Signatures
              
              34







SPECIAL
NOTE REGARDING FORWARD LOOKING STATEMENTS




This
report contains forward-looking statements within the meaning of Section 21E of
the Securities Exchange Act of 1934 (the “Exchange Act”). We have based these
forward-looking statements largely on our current expectations and projections
about future events and financial trends affecting the financial condition of
our business. These forward-looking statements are subject to a number of risks,
uncertainties and assumptions, including, among other things:




·
            general
      economic and business conditions, both nationally and in our
      markets,·
            our
      expectations and estimates concerning future financial performance,
      financing plans and the impact of
competition,





·
            our
      ability to implement our growth strategy,·
            anticipated
      trends in our business,





·
            advances
      in technologies, and·
            other
      risk factors set forth herein.




In
addition, in this report, we use words such as “anticipates,” “believes,”
“plans,” “expects,” “future,” “intends,” and similar expressions to identify
forward-looking statements.




China
Energy Corporation and its subsidiaries the “Company”)  undertake no
obligation to update publicly or revise any forward-looking statements, whether
as a result of new information, future events or otherwise after the date of
this prospectus. In light of these risks and uncertainties, the forward-looking
events and circumstances discussed in this prospectus may not occur and actual
results could differ materially from those anticipated or implied in the
forward-looking statements.








ITEM
1. FINANCIAL STATEMENTS




CHINA
ENERGY CORPORATION AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS





February
      28,
            
            
            November
      30,2010
            
            
            2009(Unaudited)
            
            
            (Audited)US$
            
            
            US$ASSETSCurrent
      assets:Cash
      and cash equivalents
            
            
            3,719,015
            
            
            
            5,073,645Accounts
      receivables, net of allowance for doubtful accounts of $120,865 and
      $120,853, respectively
            
            
            8,897,065
            
            
            
            4,600,667Other
      receivables
            
            
            4,394,330
            
            
            
            4,447,272Advances
      to suppliers
            
            
            6,893,990
            
            
            
            5,511,630Inventories
            
            
            3,050,190
            
            
            
            5,574,465Total
      current assets
            
            
            26,954,590
            
            
            
            25,207,679Fixed
      assets:Property,
      plant and equipment
            
            
            50,354,217
            
            
            
            50,546,862Construction
      in progress
            
            
            4,472,137
            
            
            
            4,236,28154,826,354
            
            
            
            54,783,143Less:
      accumulated depreciation and depletion
            
            
            (8,362,649
            )
            
            
            (7,456,849
            )Net
      fixed assets
            
            
            46,463,705
            
            
            
            47,326,294Other
      assets:Investment
      property, net of accumulated depreciation of $177,520 and $166,172,
      respectively
            
            
            1,925,146
            
            
            
            1,936,278Mining
      right, net of amortization of $829,340 and $787,417,
      respectively
            
            
            3,586,171
            
            
            
            3,627,642Restricted
      cash
            
            
            533,432
            
            
            
            149,898Other
      long term assets
            
            
            429,298
            
            
            
            450,021Notes
      receivable
            
            
            5,989,881
            
            
            
            7,913,100Total
      other assets
            
            
            12,463,928
            
            
            
            14,076,939TOTAL
      ASSETS
            
            
            85,882,223
            
            
            
            86,610,912LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Short
      term bank loans
            
            
            8,790,178
            
            
            
            12,012,012Accounts
      payable
            
            
            9,411,069
            
            
            
            11,489,568Advances
      from customers
            
            
            10,914,989
            
            
            
            12,125,187Accrued
      liabilities
            
            
            388,887
            
            
            
            325,539Other
      payables
            
            
            1,514,834
            
            
            
            387,729Shareholder
      loans
            
            
            10,393,738
            
            
            
            9,972,279Current
      portion of deferred income
            
            
            859,454
            
            
            
            822,930Total
      current liabilities
            
            
            42,273,149
            
            
            
            47,135,244Non-current
      liabilities:Deferred
      income
            
            
            6,348,688
            
            
            
            6,224,033Total
      liabilities
            
            
            48,621,837
            
            
            
            53,359,277Stockholders’
      equity:Common
      stock: authorized 200,000,000 shares of $0.001 par value; 45,000,000
      shares issued and outstanding
            
            
            45,000
            
            
            
            45,000Additional
      paid-in capital
            
            
            8,655,805
            
            
            
            8,655,805Paid
      in capital – stock options
            
            
            315,000
            
            
            
            315,000Retained
      earnings
            
            
            16,358,708
            
            
            
            12,542,081Statutory
      reserves
            
            
            8,266,424
            
            
            
            8,078,765Accumulated
      other comprehensive income
            
            
            3,619,449
            
            
            
            3,614,984Total
      stockholders’ equity
            
            
            37,260,386
            
            
            
            33,251,635TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
            
            
            85,882,223
            
            
            
            86,610,912




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





1


CHINA
ENERGY CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS


(UNAUDITED)





For
      the three months ended
              February
      28,2010
            
            
            2009US$
            
            
            US$Revenues
            
            $
            20,768,876
            
            
            $
            5,014,946Cost
      of revenues
            
            
            (13,826,407
            )
            
            
            (4,687,252
            )Gross
      profit
            
            
            6,942,469
            
            
            
            327,694Operating
      expenses:Selling
      and marketing
            
            
            (840,717
            )
            
            
            (42,637
            )General
      and administrative
            
            
            (1,103,652
            )
            
            
            (392,054
            )Total
      operating expenses
            
            
            (1,944,369
            )
            
            
            (434,691
            )Income
      (loss) from operations
            
            
            4,998,100
            
            
            
            (106,997
            )Other
      income and expensesInvestment
      income
            
            
            -
            
            
            
            34,351Non-operating
      income
            
            
            113,463
            
            
            
            160,401Finance
      expenses, net
            
            
            (215,349
            )
            
            
            (95,388
            )Government
      subsidies
            
            
            -
            
            
            
            153,024Non-operating
      expenses
            
            
            (44,356
            )
            
            
            (700,665
            )Income
      (loss) before income taxes
            
            
            4,851,858
            
            
            
            (555,274
            )(Provision
      for) benefit from income taxes
            
            
            (847,572
            )
            
            
            22,924Net
      income (loss)
            
            
            4,004,286
            
            
            
            (532,350
            )Other
      comprehensive incomeForeign
      currency translation adjustment
            
            
            4,465
            
            
            
            (52,405
            )Total
      comprehensive income (loss)
            
            
            4,008,751
            
            
            $
            (584,755
            )Net
      income (loss) per common  sharebasic
      and diluted
            
            
            0.09
            
            
            $
            (0.01
            )Weighted
      average common shares outstandingbasic
      and diluted
            
            
            45,000,000
            
            
            
            45,000,000




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




2


CHINA
ENERGY CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY


FOR THE THREE
MONTHS ENDED FEBRUARY 28, 2010


(UNAUDITED)





Additional
              
              
              Paid-in
                  Capital
              
              
              
              
              
              
              
              
              Accumulated
      Other
              
              
              TotalCommon
      Stock
              
              
              Paid-in
              
              
              Stock
              
              
              Retained
              
              
              Statutory
              
              
              Comprehensive
              
              
              Stockholders’Shares
              
              
              Amount
              
              
              Capital
              
              
              Options
              
              
              Earnings
              
              
              Reserves
              
              
              Income
              
              
              EquityBalance
      as of November 30, 2009
              
              
              45,000,000
              
              
              $
              45,000
              
              
              $
              8,655,805
              
              
              $
              315,000
              
              
              $
              12,542,081
              
              
              
              8,078,765
              
              
              
              3,614,984
              
              
              
              33,251,635Net
      income
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              4,004,286
              
              
              
              -
              
              
              
              -
              
              
              
              4,004,286Foreign
      currency translation adjustment
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              4,465
              
              
              
              4,465Appropriation
      of statutory reserves
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              -
              
              
              
              (187,659
              )
              
              
              187,659
              
              
              
              -
              
              
              
              -Balance
      as of February 28, 2010
              
              
              45,000,000
              
              
              $
              45,000
              
              
              $
              $8,655,805
              
              
              $
              315,000
              
              
              $
              16,358,708
              
              
              
              8,266,424
              
              
              
              3,619,449
              
              
              
              37,260,386




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




3


CHINA
ENERGY CORPORATION AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(UNAUDITED)


For
      the three months ended
                February
      28,2010
              
              
              2009US$
              
              
              US$Cash
      flows from operating activities:Net
      profit (loss)
              
              
              4,004,286
              
              
              
              (532,350
              )Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
              
              
              979,126
              
              
              
              788,961Interest
      accrued on shareholder loans
              
              
              51,271
              
              
              
              49,332Loss
      on disposal of property, plant and equipment
              
              
              -
              
              
              
              694,081Gain
      from short term investments
              
              
              -
              
              
              
              (34,351
              )Changes
      in operating assets and liabilities:Increase
      in restricted cash
              
              
              (383,534
              )
              
              
              -Increase
      in accounts receivable
              
              
              (4,296,410
              )
              
              
              (2,413,956
              )Decrease
      in other receivables
              
              
              52,942
              
              
              
              601,771Increase
      in advances to suppliers
              
              
              (243,212
              )
              
              
              (388,999
              )Decrease
      (increase) in inventories
              
              
              2,524,275
              
              
              
              (286,762
              )Increase
      in deferred income
              
              
              161,179
              
              
              
              631,705Decrease
      in accounts payable
              
              
              (2,078,504
              ))
              
              
              (4,116,790
              )Decrease
      in advances from customers
              
              
              (1,210,198
              )
              
              
              (230,923
              )Increase
      in accrual liabilities and other payables
              
              
              1,190,453
              
              
              
              142,165Net
      cash provided by (used in) operating activities
              
              
              751,674
              
              
              
              (5,096,116
              )Cash
      flows from investing activities:Purchase
      of property, plant and equipment
              
              
              (946,503
              )
              
              
              (1,109,368
              )Increase
      in construction in progress
              
              
              (235,856
              )
              
              
              (249,421
              )Increase
      in notes receivable
              
              
              (29,301
              )
              
              
              -Payments
      received on notes receivable
              
              
              1,952,520
              
              
              
              833,022Net
      cash provided by (consumed by) investing activities
              
              
              740,860
              
              
              
              (525,767
              )Cash
      flows from financing activities:Proceeds
      from short term bank loans
              
              
              -
              
              
              
              1,638,733Principal
      payments made on short term bank loans
              
              
              (3,221,834
              )
              
              
              -Advances
      from shareholders
              
              
              887,473
              
              
              
              3,956,173Repayments
      of shareholders loans
              
              
              (518,007
              )
              
              
              (212,352
              )Net
      cash (used in) provided by financing activities
              
              
              (2,852,368
              )
              
              
              5,382,554Effect
      of exchange rate changes on cash
              
              
              5,204
              
              
              
              117,990Net
      change in cash and cash equivalents
              
              
              (1,354,630
              )
              
              
              (121,339
              )Cash
      and cash equivalents, beginning of period
              
              
              5,073,645
              
              
              
              456,802Cash
      and cash equivalents, end of period
              
              
              3,719,015
              
              
              
              335,463
 
 Supplemental
      disclosure of cash flow informationCash
      paid for interest
              
              
              253,914
              
              
              
              230,401Cash
      paid for income taxes
              
              
              478,989
              
              
              
              -


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




4


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)


1. Organization
and Business





Organization
of the Company





China
Energy Corporation (the “Company”) is a Nevada corporation, formed on October
11, 2002 under the name Omega Project Consultations, Inc.  The name was
changed to China Energy Corporation on November 3, 2004.  On November 30,
2004, the Company entered into a share exchange agreement with Inner Mongolia
Tehong Coal Group Co., Ltd. (“Coal Group”), and Inner Mongolia Zhunger Heat
Power Co. Ltd. (“Heat Power”) and their respective shareholders. The transaction
was accounted for as a reverse merger, a procedure that treats the transaction
as though Coal Group had acquired the Company.  Under the accounting for a
reverse merger, the assets and liabilities of the Company, which were nil at the
time, were recorded on the books of Coal Group, the continuing company, and the
stockholders’ equity accounts of Coal Group were reorganized to reflect the
shares issued in this transaction.





The share
exchange agreement, which resulted in the Company’s acquisition of the Coal
Group and Heat Power, was governed by and valid under Nevada law and was not
perfected under the then People’s Republic of China (“PRC”) law.  It
was not until certain changes in PRC law, which became definitive in 2006, that
the Company was made clear that a series of procedures of governmental approvals
and certain additional corporate actions would be condition precedents to that
perfection.





The
Company does not believe the lack of perfection impairs its ability to exercise
control over the Coal Group and Heat Power as it continues to exercise control
over them, consistent with the intent of the original
shareholders.    The Company  controls Coal Group
and Heat Power operating through a series of contractual arrangements as opposed
to through direct record ownership,





The
Company is in the process of completing the necessary actions to meet the
current PRC legal requirements related to the acquisition of Coal Group and Heat
Power.  On July 13, 2009, the Company entered into a framework
agreement which detailed the actions contemplated for the restructuring of the
Company, Coal Group and Heat Power under a “variable interest entity”
(“VIE”) structure to meet the current requirements of applicable PRC
law.





The
framework agreement provides that (i)  the Company will establish a
newly-formed, indirect subsidiary of the Company incorporated in the People’s
Republic of China (“CEC China”), (ii) CEC China will enter an exclusive service
agreement and option agreement with each of Coal Group and Heat Power
(collectively, the “Operating Companies”) and a share pledge agreement with
each of the Operating Companies and certain of their respective PRC Shareholders
(“PRC Shareholders”). The framework agreement also requires the PRC
Shareholders to fully authorize CEC China to exercise all shareholders’ rights
that the PRC Shareholders can exercise in the Operating Companies. By entering
into the framework agreement and subsequently setting up the structure involving
the use of VIEs, the Company will have the control and the economic benefits and
costs of ownership of the Operating Companies consistent with PRC regulatory
requirements.





The
Company contemplates that the restructuring process will be completed during
2010.




5


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)
  Business





The
Company’s business is made up of two segments: Coal Group and Heat
Power.





Coal Group: Coal Group was organized in
China on August 8, 2000 as Inner Mongolia Zhunger Tehong Coal Co., Ltd. The name
was changed in December 2003 to Inner Mongolia Tehong Coal Group Co. Ltd. Coal
Group acquired the rights to  a coal mine in the Inner Mongolia
District from which it produces coal. It also buys, sells, and transports coal,
serving the Inner Mongolia District.  Coal Group has the capacity to
produce approximately up to 800,000 metric tons per year following the
enhancement of the mine’s productions lines, which was completed in August of
2009.





Heat Power:During 2003, Heat Power was
granted a license, to supply heating to the entire XueJiaWan area.  To
provide for this requirement, construction began in 2004 on a thermoelectric
plant, which was completed in September 2006.  Heat Power supplies heating
directly to users and supplies electricity within the XueJiaWan area through a
government controlled intermediary, Inner Mongolia Electric Power Group Co.,
Ltd. (“Electric Power Group”).





Heat
Power obtains its supply of powdered coal required to generate heat production
from Zhunger County Guanbanwusu Coalmine (“Guanbanwusu”). It also obtains its
supply through various other coal mines in the area.





2. Summary
of Significant Accounting Policies





Basis
of Accounting and Presentation





The
unaudited interim financial statements of the Company as of February 28, 2010
and for the three-month periods ended February 28, 2010 and 2009, have been
prepared in accordance with generally accepted accounting principles in the
United States of America and the rules and regulations of the Securities and
Exchange Commission (the “SEC”) which apply to interim financial statements,
including the accounts of China Energy Corporation and its operating company,
Coal Group.  In the opinion of management, such information contains
all adjustments, consisting only of normal recurring adjustments, necessary for
a fair presentation of the results for the periods presented.  The
results of operations for the three months ended February 28, 2010 are not
necessarily indicative of the results to be expected for future quarters or for
the year ending November 30, 2010.





Certain
information and disclosures normally included in the notes to financial
statements have been condensed or omitted as permitted by the rules and
regulations of the SEC, although the Company believes the disclosure is adequate
to make the information presented not misleading. The accompanying unaudited
financial statements should be read in conjunction with the financial statements
of the Company for the year ended November 30, 2009.





6


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)


Basis
of Consolidation





The
consolidated financial statements include the accounts of the Company and Coal
Group and Heat Power.  All significant intercompany accounts and
transactions have been eliminated in consolidation.





A
subsidiary is an entity in which the Company, directly or indirectly, controls
more than one half of the voting power; has the power to appoint or remove the
majority of the members of the board of directors; to cast majority of votes at
the meeting of the board of directors or to govern the financial and operating
policies of the investee under a statute or agreement among the shareholders or
equity holders.





Recently
Issued Accounting Standards





In
December 2007, the Financial Accounting Standards Board (“FASB”) issued SFAS No.
141 (revised 2007), “Business Combinations” (“SFAS 141R”), as codified
in FASB Accounting Standards Codification (the “ASC”) Topic 805, “Business Combinations” (“ASC 805”).  The
objective of ASC 805 is to improve the relevance, representational faithfulness
and comparability of the information that a reporting entity provides in its
financial reports about a business combination and its effects.  To
accomplish this, ASC 805 establishes principles and requirements for how the
acquirer (a) recognizes and measures in its financial statements the
identifiable assets acquired, the liabilities assumed and any non-controlling
interest in the acquiree, (b) recognizes and measures the goodwill acquired in
the business combination or a gain from a bargain price, and (c) determines what
information to disclose to enable users of the financial statements to evaluate
the nature and financial effects of the business combination.  SFAS
141R, now codified in ASC 805, is effective for fiscal years beginning on or
after December 15, 2008.  The Company’s adoption of ASC 805 did not
have a material impact on its consolidated financial statements.





In
December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in
Consolidated Financial
Statements–an amendment of ARB
No.51” (“SFAS
160”), as codified in FASB ASC Subtopic 810-10, “Consolidation” (“ASC
810-10”).   ASC 810-10 requires that non-controlling (or
minority) interests in subsidiaries be reported in the equity section of the
company’s balance sheet, rather than in a mezzanine section of the balance sheet
between liabilities and equity.  Additionally, ASC 810-10 revises the
manner in which the net income of the subsidiary is reported and disclosed in
the controlling company’s income statement and also establishes guidelines for
accounting or changes in ownership percentages and for
deconsolidation.  ASC 810-10 is effective for financial statements for
fiscal years beginning on or after December 15, 2008 and interim periods within
those years.  The Company’s adoption of ASC 810-10 did not to have a
material impact on its consolidated financial statements.





In
April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value
of Financial Instruments” which is codified as FASB ASC Topic 825, “Financial Instruments” (“ASC
825”). The ASC 825 amends SFAS No. 107, “Disclosures about Fair Value of
Financial Instruments,” now codified in ASC 825, to
require disclosures about fair value of financial instruments for interim
reporting periods of publicly traded companies as well as in annual financial
statements.  This issuance also amends APB Opinion No. 28, “Interim Financial
Reporting,” now codified in FASB Topic 270 “Interim Reporting” (“ASC
270”), to require those disclosures in summarized financial information at
interim reporting periods.  FSP FAS 107-1 and APB 28-1, now codified
in ASC 825 were effective for interim reporting periods ending after June 15,
2009, with early adoption permitted for periods ending after March 15,
2009.  The issuance does not require disclosures for earlier periods
presented for comparative purposes at initial adoption. In periods after initial
adoption, it requires comparative disclosures only for periods ending after
initial adoption.  The adoption of ASC 825 did not have a material
effect on the determination or reporting of the Company’s consolidated financial
results.




7


CHINA
ENERGY CORPORATION AND SUBSIDIARIES


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009


(UNAUDITED)


In April
2009, the FASB issued FSP FAS No. 115-2 and FAS No. 124-2, “Recognition and Presentation of
Other-Than-Temporary
Impairments”(“FSP FAS No. 115-2 and
FAS 124-2”), which are codified in FASB Topic 320, “Investments-Debt and Equity
Security” (“ASC
320”).  FSP FAS No. 115-2, now codified in ASC 320 provides additional
guidance designed to create greater clarity and consistency in accounting for
and presenting impairment losses on securities.  This FSP is effective
for interim periods ending after June 15, 2009, but early adoption is permitted
for interim periods ending after March 15, 2009.  The adoption of ASC
320 did not have a significant impact on its consolidated financial
statements.





In April
2009, the FASB released  FSP FAS No. 157-4, “Determining Fair Value When the
Volume and Level of Activity for the Asset or Liability Have Significantly
Decreased and
Identifying Transactions That Are Not Orderly” (“FSP FAS No. 157-4”), now
codified in ASC 820,“Fair
Value Measurements and Disclosures.”  This
issuance  provides additional guidance for estimating fair value in
accordance with ASC 820, when the volume and level of activity for the asset or
liability have significantly decrease with providing guidance on identifying
circumstances that indicate a transaction is not orderly.  ASC 820 was
effective for interim periods ending after June 15, 2009, and the adoption of
ASC 820 did not have a significant impact on its consolidated financial
statements.





In May
2009, the FASB issued SFAS No. 165, “Subsequent Events” (“SFAS 165”), as codified
in FASB ASC 855, “Subsequent Events” (“ASC 855”).  ASC
855 established standards of accounting for and disclosures of subsequent events
which occur after the balance sheet date but before the financial statements are
issued or are available to be issued.  ASC 855 requires the disclosure
of the date through which the subsequent events have been evaluated as well
as whether that date is the date the financial statement were issued or the date
the financial statements were available to be issued.  This guidance
is effective for periods ending after June 15, 2009. In February 2010, the FASB
amended the subsequent events guidance issued in May 2009 to remove the
requirement for SEC filers to disclose a date through which subsequent events
have been evaluated in both issued and revised financial statements. The
amendment is effective upon issuance. The adoption of this guidance did not have
an impact on our consolidated financial condition or results of
operations.





In June
2009, the FASB issued SFAS No. 167, “Amendments to FASB Interpretation
No. 46(R)”
(“SFAS 167”) as codified in FASB ASC 810 “Consolidation” (“ASC 810”), which amends
the consolidation guidance applicable to variable interest entities. The
amendments will significantly affect the overall consolidation analysis under
FASB Interpretation No. 46(R).  This statement is effective as of
the beginning of the first fiscal year that begins after November 15, 2009.
The adoption of ASC 810 did not have a material impact on the Company’s
financial position, results of operations or cash flows.




8


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)




In June
2009, the FASB issued SFAS No. 168, “The Hierarchy of Generally Accepted
Accounting Principles” (“SFAS 168”), as
codified in FASB ASC 105, “Generally Accepted Accounting
Principles”
(“ASC 105”).  ASC 105 established the FASB Accounting Standards
Codification (“the Codification”) as the sources for authoritative U.S. GAAP.
The Codification will supersede all existing non-SEC accounting and reporting
standards under U.S. GAAP for nongovernmental entities.  ASC 105 was
effective for interim and annual periods ending after September 15,
2009.  The adoption of the Codification during the year ended December
31, 2009 did not have a material impact on the Company’s consolidated financial
statements.





Foreign Currency
Translations





Substantially
all Company assets are located in China.  The functional currency for
the majority of the Company’s operations is the Renminbi (“RMB”).  The
Company uses the United States dollar (“US Dollar” or “US$” or “$”) for
financial reporting purposes.  The financial statements of the
Company’s foreign subsidiaries have been translated into US dollars in
accordance with SFAS No. 52, “Foreign Currency Translation,”as codified in ASC 830, “Foreign Currency Matters.”  All asset and liability accounts have been translated using
the exchange rate in effect at the balance sheet date.  Equity
accounts have been translated at their historical exchange rates when the
capital transaction occurred.  Statements of operations amounts have
been translated using the average exchange rate for the year.  Adjustments
resulting from the translation of the Company’s financial statements are
recorded as accumulated other comprehensive income.





The
exchange rates used to translate amounts in RMB into US dollars for the purposes
of preparing the consolidated financial statements were as
follows:





February
      28, 2010
            
            November
      30, 2009Balance
      sheet items, except for the registered and paid-up capital, additional
      paid-in capital, statutory reserve and retained earnings, as of year
      end
            
            US$1=RMB
      6.8258
            
            US$1=RMB
      6.8265Amounts
      included in the statements of operations, statements of changes in
      stockholders’ equity and statements of cash flows for the
    year
            
            US$1=RMB
      6.8276
            
            US$1=RMB
      6.8330





For the
three months ended February 28, 2010, foreign currency translation adjustment of
approximately $4,465 have been reported as accumulated other comprehensive
income in the consolidated statements of changes in stockholders’
equity.





Although
government regulations now allow convertibility of RMB for current account
transactions, significant restrictions still remain.  Hence, such
translations should not be construed as representations that RMB could be
converted into US dollars at that rate or any other rate.




9


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)




The value
of RMB against the US dollars and other currencies may fluctuate and is affected
by, among other things, changes in China’s political and economic conditions.
 Any significant revaluation of RMB may materially affect the Company’s
financial condition in terms of US dollar reporting.





Cash
and Cash equivalents





The
Company considers all demand and time deposits and all highly liquid investments
with an original maturity of three months or less as of the date of purchase to
be cash equivalents.





Accounts
Receivable





Accounts
receivable is stated at cost, net of an allowance for doubtful accounts. The
Company maintains allowances for doubtful accounts for estimated losses
resulting from the failure of customers to make required
payments.  The Company reviews the accounts receivable on a periodic
basis and makes allowances where there is doubt as to the collectability of
individual balances.  In evaluating the collectability of individual
receivable balances, the Company considers many factors, including the age of
the balance, the customer’s payment history, its current credit-worthiness and
current economic trends. As of February 28, 2010 and November 30, 2009, the
balances of allowance for doubtful accounts were $120,865 and $120,853,
respectively. For the periods presented, the Company did not write off any
accounts receivable as bad debts.





Inventories





Inventories
consisted of coal and operating supplies. Inventories are valued at the
lower of cost or market, with cost being determined on the first in, first out
basis.  Provisions are made for excess, slow moving and obsolete
inventory as well as inventory whose carrying value is in excess of market. The
Company did not record any provisions for inventory valuation allowance for the
three months ended February 28, 2010 and year ended November 30,
2009.





Property,
Plant and Equipment





Property,
plant and equipment are recorded at cost, less accumulated depreciation and
amortization. Cost include the prices paid to acquire or construct the assets,
including capitalized interest during the construction period, and any
expenditures that substantially increase the assets value or extend the useful
life of an existing asset.  Depreciation is computed using the
straight line method over the estimated useful lives of property, plant and
equipment, which are approximately five years for electrical and office
equipment, ten years for transportation equipment and pipelines, and 20 to 45
years for buildings.  Leasehold improvements are amortized over the
lesser of their estimated useful lives or the term of the
lease.  Capitalized costs related to assets under construction are not
depreciated until construction is complete and the asset is ready for its
intended use.  Major repairs and betterments that significantly extend
original useful lives or improve productivity are capitalized and depreciated
over the period benefited. Maintenance and repairs are generally expensed as
incurred.  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.




10


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)




Costs of
mine development, expansion of the capacity of or extending the life of the mine
(“Mining Structures”) are capitalized and amortized using the
units-of-production (“UOP”) method over the productive life of the mine based on
proven and probable reserves.  Mining Structure includes the main and
auxiliary mine shafts, underground tunnels, ramps, and other integrant mining
infrastructure.





Investment
Property





Investment
property represents rental real estate purchased by the Company for investment
purposes.  Depreciation is computed using the straight line method
over the estimated useful life of 45 years.  The related rental income
is included in non-operating income in the accompanying consolidated statements
of operations.





Mining
Right





All land
in China belongs to the government.  To extract resources from land,
the Company is required to obtain a mining right.  The Company’s Coal
Group acquired its mining right from the Provincial Bureau of National Land and
Resource in November of 2005.  The price of the mining right, which
represents the acquisition cost to the rights in the mine, was assessed by the
Bureau to be $3,656,731.  The mine rights acquisition cost is payable
in instalments over a six year period from the date the mining right was
granted.  The mine rights acquisition cost is amortized using the UOP
method over the productive life of the mine based on proven and probable
reserves.





Restricted
Cash





Long-term
restricted cash represents the bank deposits placed as guarantee for the future
payments of rehabilitation costs as required by the PRC government. The
long-term deposits carry an interest rate of 0.6% per annum.





Advances
from Customers





Advances
from customers primarily consist of payments received from customers by the Coal
Group and Heat Power prior to the delivery of goods and services.





Deferred
Income





Deferred
income represents reimbursements received by Heat Power from various real estate
development companies for the cost of constructing pipelines to connect to rural
areas being developed.  The income is recognized on a straight line
basis over the estimated useful life of the pipelines of ten years.





Impairment
of Long-lived Assets





The
Company applies SFAS No. 144, “Accounting for the Impairment or Disposal of
Long-Lived Assets” (“SFAS 144”), as codified
in FASB ASC 360, “Property, Plant and
Equipment” (“ASC
360”), which addresses the financial accounting and reporting for the
recognition and measurement of impairment losses for long-lived assets. In
accordance with ASC 360, long-lived assets are reviewed for impairment whenever
events or changes in circumstances indicate that carrying amount of an asset may
not be recoverable. The Company may recognize impairment of long-lived assets in
the event the net book value of such assets exceeds the future undiscounted cash
flows attributable to these assets. If the total of the expected undiscounted
future net cash flows is less than the carrying amount of the asset, a loss, if
any, is recognized for the difference between the fair value of the asset
and its carrying value. No impairment of long-lived assets was recognized for
the three months ended February 28, 2010 and 2009.




11


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)




Recognition
of Revenue





Revenues
from sales of products are recognized when the products are delivered and
the title is transferred, the risks and rewards of ownership have been
transferred to the customer, the price is fixed and determinable and collection
of the related receivable is reasonably assured.





Revenue
associated with sales of coal is recognized when the title to the goods has
been passed to customers, which is the date when the goods are delivered to
designated locations and accepted by the customers.





Heat
Power supplies heat to users directly and supplies electricity through a
government controlled intermediary. Revenue from sales of heat and electricity
represents the amount of tariffs billed for heat and electricity generated and
transmitted to the users and government controlled intermediary,
respectively.





Resource
Compensation Fees





In
accordance with the relevant regulations, a company that is engaged in coal
production business is required to pay a fee to the Inner
Mongolia National Land and Resources Administration Bureau as the
compensation for the depletion of coal resources. Coal Group was required to pay
resource compensation fee of $25,022 and $19,892 for the three months ended
February 28, 2010 and 2009.





Environmental
Costs





The PRC
has adopted extensive environmental laws and regulations that affect the
operations of the coal mining industry. The outcome of environmental liabilities
under proposed or future environmental legislation cannot be reasonably
estimated at present, and could be material. Under existing legislation,
however, Company management believes that there are no probable liabilities that
will have a material adverse effect on the consolidated balance sheets of the
Company.





Fair
Value of Financial Instruments





Financial
instruments include accounts receivable, advances to suppliers and other
receivables short term bank loans, accounts payable, advance from customers,
accrued liabilities, other payables and shareholders’ loan. As of February 28,
2010 and November 30, 2009, the carrying values of these financial
instruments approximated their fair values.




12


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)




Income
Taxes





Coal
Group and Heat Power generate their income in China where Value Added Tax,
Income Tax, City Construction and Development Tax and Education Surcharge taxes
are applicable. The Company, Coal Group, and Heat Power do not conduct any
operations in the U.S.; therefore, are not subject to U.S. taxes.





The
Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income
Taxes,” (“SFAS 109”), now codified as FASB ASC 740, “Income Taxes” (“ASC 740”),
which requires the recognition of deferred income taxes for differences between
the basis of assets and liabilities for financial statement and income tax
purposes.  Deferred tax assets and liabilities represent the future
tax consequence for those differences, which will either be taxable or
deductible when the assets and liabilities are recovered or
settled.  Deferred taxes are also recognized for operating losses that
are available to offset future taxable income.  Valuation allowances
are established when necessary to reduce deferred tax assets to the amount
expected to be realized.





Use
of Estimates





The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect certain reported amounts of assets and
liabilities and disclosures of contingent assets and liabilities at the date of
the consolidated financial statements and the reported amounts of revenues and
expenses during the reporting periods. Actual results could differ from those
estimated.





Net
Income Per Share





The
Company computes net income (loss) per common share in accordance with SFAS No.
128, “Earnings Per Share” (“SFAS 128”), as
codified in FASB ASC 260, “Earnings Per Share” (“ASC
260”) and SEC Staff Accounting Bulletin No. 98 (“SAB 98”).  Under the
provisions of ASC 260 and SAB 98, basic and diluted net income per common share
are computed by dividing the amount available to common shareholders for the
period by the weighted average number of shares of common stock outstanding
during the period.  Accordingly, the number of weighted average shares
outstanding as well as the amount of net income per share are presented for
basic and diluted per share calculations for all periods reflected in the
accompanying consolidated financial statements.





Statutory
Reserves





Pursuant
to corporate law of the PRC, the Company is required to maintain statutory
reserves by appropriating from its after-tax profit before declaration or
payment of dividends.  The statutory reserves, representing restricted
retained earnings, consist of the following funds:




13


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)




Surplus Reserve Fund:The
Company is required to transfer 10% of its net income, as determined under PRC
accounting rules and regulations, to a statutory surplus reserve fund until such
reserve balance reaches 50% of the Company’s registered capital.  The
surplus reserve fund is non-distributable other than during liquidation and can
be used to fund previous years’ losses, if any, and may be utilized for business
expansion or converted into share capital by issuing new shares to existing
shareholders in proportion to their shareholding or by increasing the par value
of the shares currently held by them, provided that the remaining reserve
balance after such issue is not less than 25% of the registered
capital.





Common Welfare Fund:Common
welfare fund is a voluntary fund that the Company can elect to transfer 5% to
10% of its net income, as determined under PRC accounting rules and regulations,
to this fund.  This fund can only be utilized on capital items for the
collective benefit of the Company’s employees, such as construction of
dormitories, cafeteria facilities, and other staff welfare facilities. This fund
is non-distributable other than upon liquidation.





Non-Surplus Reserve Fund (Safety and
Maintenance):According to ruling No. 119 (2004) issued on May 21, 2004,
and amended ruling No. 168 (2005) on April 8, 2005 by the PRC Ministry of
Finance regarding “Accrual andUtilization of Coal Production
Safety Expense”and “Criterion on Coal Mine Maintenance
and Improvement,” the Company is required to
set aside to a safety fund of RMB 6 per ton and RMB 10 per ton of raw coal mined
for 2010 and 2009, respectively, and RMB 10.5 per ton for a maintenance
fund.  As defined under US GAAP, a liability for safety and
maintenance expenses does not exist at the balance sheet date because there is
no present obligation to transfer assets or to provide services as a result of
any past transactions. Therefore, for financial reporting purposes, this
reserve has been recorded as an appropriation of retained earnings.





The
statutory reserves consist of the following:





February
      28,
              2010
            
            November
      30,
              2009Surplus
      Reserve and Common Welfare fund
            
            $
            2,447,598
            
            
            $
            2,447,598Safety
      and Maintenance reserve
            
            
            5,818,826
            
            
            
            5,631,167Total
      statutory reserves
            
            $
            8,266,424
            
            
            $
            8,078,765





14


CHINA
ENERGY CORPORATION AND SUBSIDIARIES


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009


(UNAUDITED)





Stock
Options





Stock
options are accounted for upon issuance at fair market value.  Such
value is determined at the date a commitment is made for issuance.  The
value of options is included in a separate part of stockholders’
equity.  Upon exercise or cancellation, the value of such options is
transferred to paid-in capital.





Asset
Retirement Cost and Obligation





The
Company has adopted SFAS No. 143, “Accounting for Asset Retirement
Obligations.”(“SFAS 143”), now
codified as FASB ASC 410, “Asset Retirement and Environmental
Obligations”(“ASC 410”). ASC 410
generally requires that the Company’s legal obligations associated with the
retirement of long-lived assets are recognized at fair value at the time the
obligations are incurred. Obligations are incurred at the time development of a
mine commences for underground mines or construction begins for support
facilities, refuse areas and slurry ponds. The obligation’s fair value is
determined using discounted cash flow techniques and is accreted over time to
its expected settlement value. Upon initial recognition of a liability, a
corresponding amount is capitalized as part of the carrying amount of the
related long-lived asset.  The related asset is amortized using the UOP
method over the productive life of the mine based on proven and probable
reserves.  The Company
did not incur and does not anticipate incurring any material
dismantlement, restoration and abandonment costs given the nature of its
producing activities and the current PRC regulations surrounding such
activities.





Vulnerability
Due to Operations in PRC





The
Company’s operations may be adversely affected by significant political,
economic and social uncertainties in the PRC. Although the PRC government has
been pursuing economic reform policies for more than twenty years, no assurance
can be given that the PRC government will continue to pursue such policies or
that such policies may not be significantly altered, especially in the event of
a change in leadership, social or political disruption or unforeseen
circumstances affecting the PRCs political, economic and social conditions.
There is also no guarantee that the PRC government’s pursuit of economic reforms
will be consistent or effective.





All of
the Company’s businesses are transacted in RMB, which is not freely convertible.
The People’s Bank of China or other banks are authorized to buy and sell foreign
currencies at the exchange rates quoted by the Peoples Bank of China. Approval
of foreign currency payments by the People’s Bank of China or other institutions
requires submitting a payment application form together with suppliers’
invoices, shipping documents and signed contracts.





Since the
Company has its primary operations in the PRC, the majority of its revenues will
be settled in RMB, not US dollars. Due to certain restrictions on currency
exchanges that exist in the PRC, the Company’s ability to use revenue generated
in RMB to pay any dividend payments to its shareholders outside of China may be
limited.




15


CHINA
ENERGY CORPORATION AND SUBSIDIARIES


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009


(UNAUDITED)




All of
the Company’s bank accounts are in banks located in PRC and are not covered by
protection similar to that provided by the FDIC on funds held in United States
banks.





The
Company’s mining operations are subject to extensive national and local
governmental regulations in China, which regulations may be revised or expanded
at any time.  Generally, compliance with these regulations requires
the Company to obtain permits issued by government regulatory
agencies.  Certain permits require periodic renewal or review of their
conditions.  The Company cannot predict whether it will be able to
obtain or renew such permits or whether material changes in permit conditions
will be imposed. The inability to obtain or renew permits or the imposition of
additional conditions could have a material adverse effect on the Company’s
ability to develop and operate its mines.





Reclassifications





Certain
prior year amounts have been reclassified to conform to the current year
presentation.





3. Segment
Reporting





The
Company is made up of two segments of business, Coal Group which derives its
revenue from the mining and purchase and sale of coal, and Heat Power which
derives its revenue by providing heating and electricity to residents and
businesses of a local community.  Each of these segments is conducted
in a separate corporation and each functions independently of the
other.





Except
for the loans made to Heat Power by Coal Group in the principal amount of RMB 99
million (equivalent to $14.5 million) as of February 28, 2010, during the
periods reported herein, there were no other transactions between the two
segments.  There also were no differences between the measurements
used to report operations of the segments and those used to report the
consolidated operations of the Company.  In addition, there were no
differences between the measurements of the assets of the reported segments and
the assets reported on the consolidated balance sheets.





Three
      Months Ended February 28,2010
            
            
            2009Heat
            
            
            Coal
            
            
            
            
            
            Heat
            
            
            CoalPower
            
            
            Group
            
            
            Total
            
            
            Power
            
            
            Group
            
            
            TotalUS$
            
            
            US$
            
            
            US$
            
            
            US$
            
            
            US$
            
            
            US$Sales
      to external customers
            
            
            4,520,910
            
            
            
            16,247,966
            
            
            
            20,768,876
            
            
            
            3,485,063
            
            
            
            1,529,883
            
            
            
            5,014,946Finance
      expense (income), net
            
            
            50,832
            
            
            
            164,517
            
            
            
            215,349
            
            
            
            51,935
            
            
            
            43,453
            
            
            
            95,388Depreciation
      and amortization
            
            
            687,909
            
            
            
            291,217
            
            
            
            979,126
            
            
            
            499,357
            
            
            
            289,604
            
            
            
            788,961Segment
      profit (loss)
            
            
            646,492
            
            
            
            3,357,794
            
            
            
            4,004,286
            
            
            
            (567,383
            )
            
            
            35,033
            
            
            
            (532,350
            )





February
      28, 2010
            
            
            November
      30, 2009Heat
            
            
            Coal
            
            
            
            
            
            Heat
            
            
            CoalPower
            
            
            Group
            
            
            Total
            
            
            Power
            
            
            Group
            
            
            TotalUS$
            
            
            US$
            
            
            US$
            
            
            US$
            
            
            US$
            
            
            US$Segment
      assets
            
            
            51,845,331
            
            
            
            34,036,892
            
            
            
            85,882,223
            
            
            
            49,346,842
            
            
            
            37,264,070
            
            
            
            86,610,912Construction
      in progress
            
            
            3,756,864
            
            
            
            715,273
            
            
            
            4,472,137
            
            
            
            3,514,152
            
            
            
            722,129
            
            
            
            4,236,281Investment
      property, net
            
            
            -
            
            
            
            1,925,146
            
            
            
            1,925,146
            
            
            
            -
            
            
            
            1,936,278
            
            
            
            1,936,278




16


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)
  Shareholder
Loans





Substantial
portions of the cost of construction of the thermoelectric plant and of the
costs of expansion projects at Heat Power and the coal mine were provided by
shareholder loans. Balances are detailed below:





February
      28,
              2010
            
            
            November
      30,
              2009Ordos
      City YiYuan Investment Co., Ltd.
            
            
            1,644,915
            
            
            
            1,634,404Hangzhou
      Dayuan Group, Ltd.
            
            
            4,969,720
            
            
            
            5,428,963Xinghe County Haifu
      Coal Transportation &Sales
      Co., Ltd.
            
            
            1,818,965
            
            
            
            1,807,686Wenxiang
      Ding
            
            
            -
            
            
            
            28,565Yanhua
      Li
            
            
            1,912,888
            
            
            
            1,025,416Yi
      Ding
            
            
            47,250
            
            
            
            47,245Total
            
            
            10,393,738
            
            
            
            9,972,279





The
shareholder loans are due on demand and part of shareholder loans bore interest
at 3.155%.





February
      28, 2010
            
            
            November
      30, 2009Balance
            
            
            Interest
      rate
            
            
            Balance
            
            
            Interest
      rateShareholder
      loans – interest free
            
            $
            1,960,138
            
            
            
            0
            %
            
            $
            1,101,226
            
            
            
            0
            %Shareholder
      loans – interest bearing
            
            
            6,475,432
            
            
            
            3.155
            %
            
            
            6,964,156
            
            
            
            3.155
            %Interest
      payable
            
            
            1,958,168
            
            
            
            
            
            
            
            1,906,897Total
            
            $
            10,393,738
            
            
            
            
            
            
            $
            9,972,279





5. Lease
obligation





The
Company leases an office under an operating leases expiring in the year ending
November 30, 2012. The minimum future annual rent payments under the lease as of
February 28, 2010 are approximated as follows:





Year
      Ending
            
            AnnualNovember
      30,
            
            Amount2010
            
            
            65,9202011
            
            
            87,8932012
            
            
            7,324Total
            
            $
            161,137





Rent
expenses charged to operations for the three months ended February 28,
2010 and 2009 were $21,970 and $20,484, respectively.




17


CHINA
ENERGY CORPORATION AND SUBSIDIARIES


NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS


FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009


(UNAUDITED)







6.
 Advances to Suppliers





As is
customary in China, the Company has made advances to its
suppliers.  At February 28, 2010 and November 30, 2009, advances
amounted to $6,893,990 and $5,511,630, respectively.  There is no interest
due on these advances; the advances are offset against billings as they are made
by the suppliers.





7.
 Other Receivables





Other
receivables consist of the following:





February
      28,
              2010
            
            
            November
      30,
              2009Loans
      to suppliers and other associated firms
            
            $
            1,180,431
            
            
            $
            1,332,038Deposit
      funds to secure agreements
            
            
            510,909
            
            
            
            509,392Employee
      expense advances
            
            
            168,043
            
            
            
            217,643Government
      subsidies receivable
            
            
            1,611,533
            
            
            
            1,464,880Heat
      network access fee receivable
            
            
            923,414
            
            
            
            923,319Total
            
            $
            4,394,330
            
            
            $
            4,447,272





On a
periodic basis, management reviews the other receivable balances and establishes
allowances where there is doubt as to the collectability of the individual
balances.  In evaluating collectability of the individual balances,
the Company considers factors such as the age of the balance, payment history,
and credit-worthiness of the creditor.   The Company considers
all other receivables at February 28, 2010 and November 30, 2009 to be fully
collectible and, therefore, did not provide for an allowance for doubtful
accounts.





8. Fixed
Assets





Fixed
assets, consisting principally of buildings, machinery and equipment and
construction in progress, are summarized as follows:





February
      28,
              2010
            
            
            November
      30,
              2009Buildings
            
            
            9,675,441
            
            
            
            9,682,139Machinery
      & equipment
            
            
            39,046,663
            
            
            
            39,322,399Automotive
      equipment
            
            
            920,017
            
            
            
            919,922Office
      Equipment
            
            
            712,096
            
            
            
            622,402Construction
      in progress
            
            
            4,472,137
            
            
            
            4,236,28154,826,354
            
            
            
            54,783,143Accumulated
      depreciation
            
            
            (8,362,649
            )
            
            
            (7,456,849
            )Fixed
      assets, net
            
            
            46,463,705
            
            
            
            47,326,294





Depreciation
expenses charged to operations for the three months ended February 28, 2010 and
2009 were $904,797 and $665,011, respectively.




18


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)




9.   Notes
Receivable





Certain
loans were made for strategic purposes. Notes receivable, which are non-interest
bearing and payable on demand, consist of the following:





February
      28,
              2010
            
            
            November
      30,
              2009Inner
      Mongolia XiangRong InvestmentManagement
      Co., Ltd.
            
            
            1,379,041
            
            
            $
            1,378,900Inner
      Mongolia Tehong Investment Co., Ltd.
            
            
            1,906,099
            
            
            
            3,244,785Inner
      Mongolia Tehong Coal Chemical Co., Ltd.
            
            
            761,815
            
            
            
            761,737QuanYing
      Coal Mine
            
            
            302,093
            
            
            
            916,311Inner
      Mongolia XinKe Kaolin Fabrication Plant
            
            
            1,640,833
            
            
            
            1,611,367Total
      notes receivable
            
            
            5,989,881
            
            
            $
            7,913,100





10.
Short Term Bank Loans





The
Company has bank loans collateralized by the mining rights.  Relevant
terms of these bank loans are as follows:




February
      28,
              2010
            
            
            November
      30,
              2009Bank
      loan due 12/5/09, with interest at 6.696%
            
            $
            -
            
            
            $
            1,757,855Bank
      loan due 3/15/10, with interest at 6.372%
            
            
            8,790,178
            
            
            
            8,789,277Bank
      loan due 4/21/10, with interest at 6.372%
            
            
            -
            
            
            
            1,464,880Total
            
            $
            8,790,178
            
            
            $
            12,012,012





11.
Fair Value Measurement





SFAS No.
157, as codified in FASB ASC 820 specifies a hierarchy of valuation techniques
based upon whether the inputs to those valuation techniques reflect assumptions
other market participants would use based upon market data obtained from
independent sources (observable inputs).  In accordance with ASC 820,
the following summarizes the fair value hierarchy:





Level 1
Inputs – Unadjusted quoted market prices for identical assets and liabilities in
an active market that the Company has the ability to access.





Level 2
Inputs – Inputs, other than the quoted prices in active markets that are
observable either directly or indirectly.





Level 3
Inputs – Inputs based on prices or valuation techniques that are both
unobservable and significant to the overall fair value
measurements.





ASC 820
requires the use of observable market data, when available, in making fair value
measurements.  When inputs used to measure fair value fall within
different levels of the hierarchy, the level within which the fair value
measurement is categorized is based on the lowest level input that is
significant to the fair value measurement.




19


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)




Following
is a description of the valuation methodologies used for assets measured at fair
value.  There have been no changes in the methodologies used at
February 28, 2010.





Notes
receivable:  Valued at the net realizable value which
approximates the fair value.





The
method described above may produce a fair calculation that may not be indicative
of net realizable value or reflective of future values.  Furthermore,
while the Company believes its valuation method are appropriate and consistent
with other market participants, the use of different methodologies or
assumptions to determine the fair value of certain financial instruments could
result in a different fair value measurement at the reporting date.





The
following table presents the Company’s assets and related valuation inputs
within the fair value hierarchy utilized to measure fair value on a recurring
basis as of February 28, 2010:





Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalNotes
      receivable
            
            $
            -
            
            
            $
            -
            
            
            $
            5,989,881
            
            
            $
            5,989,881Total
            
            $
            -
            
            
            $
            -
            
            
            $
            5,989,881
            
            
            $
            5,989,881





The
following table presents the Company’s assets and related valuation inputs
within the fair value hierarchy utilized to measure fair value on a recurring
basis as of November 30, 2009:





Level
      1
            
            
            Level
      2
            
            
            Level
      3
            
            
            TotalNotes
      receivable
            
            $
            -
            
            
            $
            -
            
            
            $
            7,913,100
            
            
            $
            7,913,100Total
            
            $
            -
            
            
            $
            -
            
            
            $
            7,913,100
            
            
            $
            7,913,100





The
following table presents a Level 3 reconciliation of the beginning and ending
balances of the fair value measurements using significant unobservable
inputs:





Notes
      Receivable
            
            
            TotalBalance,
      December 1, 2010
            
            $
            7,913,100
            
            
            $
            7,913,100Purchases,
      sales, issuance and settlements (net)
            
            
            (1,923,219
            )
            
            
            (1,923,219
            )Balance,
      February 28, 2010
            
            $
            5,989,881
            
            
            $
            5,989,881





12.
Government Subsidies





Government
subsidies are primarily comprised of financial support provided by the local
government to Heat Power to ensure supply of heat to the XueJiaWan area as the
price for heat charged is regulated and approved by the
government.  The financial support includes revenue subsidies to
compensate for lower government regulated prices charged for heat and cost
subsidies for purchase of coal used in providing heat.  Government
subsidies are intended to be an incentive for Heat Power to supply heat at the
government regulated prices.  Government subsidies amounted to zero
and $153,024 for the three month periods ended February 28, 2010 and 2009,
respectively, and are included in government subsidies in the accompanying
consolidated statements of operations.




20


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)




13. Income Taxes





The
Company is required to file income tax returns in both the United States and
China. Its operations in the United States have been insignificant and income
taxes have not been accrued.  In China, the Company files tax returns for
Heat Power and Coal Group and, although it is part of Coal Group, a separate tax
return is required for the operations of the coal mine.  The laws of China
permit the carryforward of net operating losses for a period of five
years.  At February 28, 2010, the Chinese entities had net operating
losses of $446,417 available for future use. If not used, these carryforwards
will expire in 2013.





Under ASC
740, recognition of deferred tax assets is permitted unless it is more likely
than not that the assets will not be realized.  The Company has recorded
deferred tax assets as follows:





February 28,
              2010
            
            
            November
      30,
              2009Deferred
      tax assets
            
            $
            111,604
            
            
            $
            256,010Valuation
      allowance
            
            
            (111,604
            )
            
            
            (256,010
            )Balance
      recognized
            
            $
            -
            
            
            $
            -





Deferred
tax assets consist primarily of future tax benefits of net operating losses
recognized for Heat Power.  A full valuation allowance has been
established for the periods ended February 28, 2010 and November 30, 2009 since
the Company is unable to determine if and when those benefits will be
realized.





The
following tables reconcile the effective income tax rate with the statutory rate
for the periods ended February 28, 2010:





Three
      months endedFebruary
      28, 2010
            
            Income
      Before
              Income
      Taxes
            
            
            Tax
      Provision
            
            
            Rate
      of TaxAs
      reported on the Consolidatedstatements
      of operations
            
            
            4,851,858
            
            
            
            847,572
            
            
            
            17.5
            %Gain
      not used in calculation oftaxable
      income on the tax returns
            
            
            (1,461,570
            )
            
            
            -
            
            
            
            7.5
            %As
      calculated with statutory rate
            
            
            3,390,288
            
            
            
            847,572
            
            
            
            25
            %





The
Company has adopted Financial Accounting Standards Board Interpretation No. 48,
“Accounting for Uncertainty in
Income Taxes — an
interpretation of SFAS 109.” (“FIN 48”), as codified in ASC
740.  ASC 740 addresses the determination of whether tax benefits
claimed or expected to be claimed on a tax return should be recorded in the
financial statements. Under ASC 740, the Company may recognize the tax benefit
from an uncertain tax position only if it is more likely than not that the tax
position will be sustained on examination by the taxing authorities, based on
the technical merits of the position. The tax benefits recognized in the
financial statements from such a position would be measured based on the largest
benefit that has a greater than fifty percent likelihood of being realized upon
ultimate settlement.  ASC 740 also provides guidance on de-recognition
of income tax assets and liabilities, classification of current and deferred
income tax assets and liabilities, and accounting for interest and penalties
associated with tax positions.




21


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE MONTH PERIODS ENDED FEBRUARY 28, 2010 AND 2009
 (UNAUDITED)




The
Company does not have any accruals for uncertain tax positions as of February
28, 2010.  It is not anticipated that unrecognized tax benefits would
significantly increase or decrease within 12 months of the reporting
date.





14.
Contingency





As is
customary in China, except for auto coverage, Coal Group and Heat Power do not
carry sufficient insurance.  As a result the Company is effectively
self-insuring risk of potential accidents that may occur in the
workplace.  Given the nature of the industry, the Company may be
exposed to risks that could have a material adverse impact on its consolidated
financial statements.





China has
enacted legislation which appears to restrict the ability of entities considered
foreign to China, like the Company, to have ownership interest in operating
companies located in China.  The Company has taken steps to avoid any
potential adverse impact of this legislation.  (See Note
1).




22


ITEM
2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS





History





On
November 30, 2004, we entered into a Share Exchange Agreement with Coal Group
and Heat Power, both Chinese corporations, whereby we acquired all the issued
and outstanding stock of Coal Group and 49% of the issued and outstanding stock
of Heat Power in consideration of 45,000,000 shares of our common stock. The
offers and sales of the shares were exempt from registration under Regulation S
of the Securities Act as they were made to off-shore, non US
residents.





The
remaining 51% of the stock of Heat Power is owned by Coal Group. In September
2003, our President and majority shareholder, Mr. Ding, acquired a 70% interest
in Heat Power. That interest was acquired through a contribution of property
which is used by Heat Power in its operations. The property has been capitalized
at the original cost to Mr. Ding. In February, 2004, Mr. Ding transferred his
equity interest in Heat Power to Coal Group. In March 2004, Coal Group sold 15%
of its interest to another shareholder. In August of 2004, a further 4% interest
was sold to a shareholder with Coal Group owning the remaining 51% . As a result
of the Share Exchange Agreement, Coal Group and the Company together now control
100% of the outstanding capital stock of Heat Power.





Coal
Group and Heat Power thus became our controlled operating companies. The
shareholders of both companies unanimously agreed to enter into the Share
Exchange Agreement for the purposes of restructuring in anticipation of becoming
listed on the OTC Bulletin Board. We were formed by the shareholders of Coal
Group and Heat Power for this purpose and prior to entering into the Share
Exchange Agreement; we had no assets, liabilities or equity and had not issued
any of our shares. As a result of entering into the Share Exchange Agreement;
the shareholders of Coal Group and Heat Power became our shareholders. The
45,000,000 shares issued to the shareholders of Coal Group and Heat Power were
allocated based on the capital contributions or ownership of such shareholders.
The Agreement therefore was a non-arms length transaction.





As a
result of new PRC merger and acquisition regulations, the Company was required
to undergo an application process to convert each of Coal Group and Heat Power
from a domestic PRC company to a Foreign Invested Enterprise (“FIE”) pursuant to
which a FIE business license would be obtained.  The regulations
required the Company, as a foreign investor, to invest cash equity interest into
both operating companies. Accordingly, the Company formulated a plan pursuant to
which it would be able to raise the funds to become an FIE.  As part
of this plan, on December 30, 2007, the Company acquired PPI, a Nevada company
with no assets, liabilities or equity. The Company holds 100% of the issued and
outstanding shares of PPI, or 5,000 common shares with a par value of $ 0.001.On
December 31, 2007, PPI entered into a Trust Agreement with all the registered
shareholders of Coal Group and Heat Power,  pursuant to which all the
shareholders are obligated to hold their interests in Coal Group and Heat
Power  (represented by their registered paid up capital contributions
to date) in trust for PPI, for an eight year term, extendable for another
five  years. In addition, prior to the execution of the PPI Trust
Agreement, controlling shareholders of the Company, including Wenxiang Ding,
Yanhua Li and members of their immediate family, transferred their shares of the
Company to Georgia Pacific Investments Inc. (“GPI”) and Axim Holdings Ltd.
(“Axim”).  to be held in trust with the view that GPI and Axim would
sell the shares in the open market in order to fund a plan to convert Coal Group
and Heat Power into FIEs to raise the mandated cash equity investment under PRC
rules for  FIEs. The sole shareholder and director of each of GPI and
Axim is Yi Ding, son of WenXiang Ding, our President and Chief Executive
Officer. The Company has decided to forgo the FIE plan in favor of  An
alternative structure involving the use of “variable interest entities” or VIEs
to reduce any regulatory risks relating to the foreign ownership structure of
the Company.




23





Pursuant
to a VIE restructuring as contemplated by a framework contract entered in June
2009, a newly-formed subsidiary of the Company (“CEC China”), would enter
into a series of contractual arrangements with the registered shareholders of
the operating companies so that the control and the economic benefits and costs
of ownership of the operating companies would flow directly to CEC China through
a series of management and business cooperation agreements. CEC China would also
have the option to purchase the equity interests in Coal Group and Heat Power
held by the registered shareholders. The registered shareholders would pledge
their equity interests in Coal Group and Heat Power as security for their
agreement to comply with provisions of the management and cooperation agreements
and would provide CEC China with a power of attorney to exercise all their
shareholder rights in Coal Group and Heat Power. The contractual arrangements
under the VIE structure are intended to comply with, and be enforceable under,
applicable PRC law, and would adequately reduce any PRC regulatory risk without
the capital contributions necessary under the FIE plan initially proposed by the
Company. In connection with the planned VIE restructuring, the Company and the
registered shareholders have entered into a framework contract in July 2009
pursuant to which the Company and the registered shareholders have agreed to
enter into the aforementioned agreements.





Operating
Companies





Coal
Group





Coal
Group, organized in China on August 8, 2000, produces coal from the LaiYeGou
coal mine located in Erdos City, Inner Mongolia, PRC.  Since the
acquisition of LaiYeGou in 1999, Coal Group’s principal activities consist of
the production of “powered” coal and “lump” coal from raw coal and the sale of
products to heating and power industries, distributors and coking factories for
steel production.  Coal Group also buys, sells, and transports coal,
as part of its proprietary coal trading activities.





Heat
Power





Heat
Power has two distinct operations servicing customers in the XueJiaWan district
in Ordos City, Inner Mongolia.  Heat Power supplies (i) steam heating
and (ii) electricity to end users.  In 2003, Heat Power was granted a
license to supply heating to the entire XueJiaWan district. In order to have
sufficient heating supply, in 2004 Heat Power began construction on a
thermoelectric plant which was completed in September 2006. In conjunction with
the thermoelectric plant, Heat Power also owns and operates 32 heat transfer
stations.





Heat
Power is a regulated utility company and it meets the current regulatory
requirements applicable to such companies.  Heat Power supplies
electricity to its customers through a government controlled intermediary, Inner
Mongolia Electric Power Group Co., Ltd. (“Electric Power
Group”).  Electric Power Group is also subject to regulated utility
company rules and regulations consisting of compliance with safety and
environmental standards. In addition, the prices charged by the Company are
approved by the local government. The government reviews the price of heating
and electricity from time to time as market conditions change. We purchase coal
from suppliers to fuel our boilers at market prices; therefore, we bear the risk
that market prices for raw materials exceed the regulated prices paid by end
users.  We receive governmental subsidies from time to time to offset
this risk.




24





Heat
Power obtains its supply of powdered coal required to generate heat production
principally from Zhunger County Guanbanwusu Coalmine (“Guanbanwusu”), an
unrelated third party vendor. It also obtains coal from various other coal mines
in the area. We do not supply Heat Power with coal for fuel.





In the
XueJiaWan area, hardly anyone owns a domestic heating boiler.  Water
is first heated in the Company’s thermoelectric plant by the high-temperature
steam used for generating electricity, and then piped directly to homes and
public buildings, including private dwellings, factories as well as municipal
facilities, and lastly the water is piped back to the thermoelectric plant to
repeat the process.





Results
of operations – Three Months Ended February 28, 2010





Revenues




The
following is an analysis of our revenues and gross profit, details and analysis
of components of expenses, and variance; for the three months ended February 28,
2010 compared to February 28, 2009.




Three
      Months Ended February 28,2010
              
              
              2009Revenues
              
              $
              20,768,876
              
              
              
              100
              %
              
              $
              5,014,946
              
              
              
              100
              %Cost
      of revenues
              
              $
              13,826,407
              
              
              
              67
              %
              
              $
              4,687,252
              
              
              
              93
              %Gross
      Margin
              
              $
              6,942,469
              
              
              
              33
              %
              
              
              327,694
              
              
              
              7
              %




Coal
Group




For the
three months ended February 28, 2010, revenues for Coal Group were $16,247,966
compared to $1,529,883 in the comparable three months in 2009. The $14,718,083
increase was due to the fact that the production at LaiYeGou coal mine was
partially shut down for the installation of the long wall automatic mining
equipments and normal production resumed in the third quarter in 2009 with the
completion of the installment and adjustment of the equipment.  The
increase of the volume of proprietary trading of coal also contributed to the
increase of revenue from Coal Group as compared to the prior comparable quarter
in 2009. Coal Group produced approximately 156,000 metric tons of coal during
the three months ended February 28, 2010. Coal Group’s business is seasonal in
that sales are low in the first quarter of a year relative to the other three
quarters due to the Chinese New Year holiday. During this time our business is
closed for about two weeks.




Heat
Power




For the
three months ended February 28, 2010, revenues for Heat Power were $4,520,910
compared to $3,485,063 in the comparable three months in 2009.




25




For the
three months ended February 28, 2010, revenues generated by Heat Power from its
electricity operations were $988,074 compared to $911,646 in the comparable
three month period in 2009.  Our revenue during the first quarter from
our electricity operations were as follows:





Electricity
Revenue for Quarter Ended February 28,




Units
      ofpowersupplied
              
              
              RevenueUnit
      Price
              
              
              (1000KW.h)
              
              
              ($)Period
              
              2010
              
              
              2009
              
              
              2010
              
              
              2009
              
              
              2010
              
              
              2009
              
              
              VarianceDecember
              
              
              0.03
              
              
              
              0.03
              
              
              
              11,034
              
              
              
              8,316
              
              
              
              356,283
              
              
              
              249,480
              
              
              
              106,803January
              
              
              0.03
              
              
              
              0.03
              
              
              
              10,550
              
              
              
              9,910
              
              
              
              340,662
              
              
              
              297,300
              
              
              
              43,362February
              
              
              0.03
              
              
              
              0.03
              
              
              
              9,016
              
              
              
              12,162
              
              
              
              291,129
              
              
              
              364,866
              
              
              
              (73,737
              )Total
              
              
              
              
              
              
              
              
              
              
              30,600
              
              
              
              30,388
              
              
              
              988,074
              
              
              
              911,646
              
              
              
              76,428




For the
three months ended February 28, 2010, revenues generated by Heat Power from its
heating supply operations were $3,532,836 compared to $2,573,417 in the
comparable three month period in 2009. The $959,419 increase was due to the
increase of heating area to 2.7 million square meters in the first quarter this
year from 2.1 million square meters in the same period last year.  The
heating area increased due to the continued development of the XueJiaWan
area.  We are expecting this trend to continue for at least through
the end of this fiscal year.  Our revenue during the first quarter
from our heating supply operations were as follows:







Heating
Revenue for Quarter Ended February 28,




Area
      (‘000)sq
      meters
              
              
              RevenueUnit
      Price
              
              
              range)
              
              
              ($)User
              
              2010
              
              
              2009
              
              
              2010
              
              
              2009
              
              
              2010
              
              
              2009
              
              
              VarianceResidential
              
              
              0.43
              
              
              
              0.34
              
              
              
              2,039
              
              
              
              1,440
              
              
              
              2,314,182
              
              
              
              1,464,912
              
              
              
              849,270Commercial
              
              
              0.62
              
              
              
              0.56
              
              
              
              350
              
              
              
              350
              
              
              
              572,398
              
              
              
              587,843
              
              
              
              -15,445Municipal
              
              
              0.62
              
              
              
              0.56
              
              
              
              310
              
              
              
              310
              
              
              
              646,256
              
              
              
              520,662
              
              
              
              125,594Total
              
              
              
              
              
              
              
              
              
              
              2,699
              
              
              
              2,100
              
              
              
              3,532,836
              
              
              
              2,573,417
              
              
              
              959419




We expect
our heating revenue to continuously increase during the next few years as a
result of retaining additional users while the XueJiaWan area is being further
developed.




26





Cost of
Sales





For the
three months ended February 28, 2010, cost of sales increased by approximately
$9,100,000 from the comparable three months in 2009, as a result of changes in
the following expenses:




Three
      Months Ended February 28,2010
              
              
              2009
              
              
              VarianceCoal
      & freight
              
              
              11,097,631
              
              
              
              2,754,548
              
              
              
              8,343,083Heat
      resource rental
              
              
              985,651
              
              
              
              491,620
              
              
              
              494,031Depreciation
      & depletion
              
              
              856,563
              
              
              
              736,837
              
              
              
              119,726Salaries
              
              
              369,503
              
              
              
              176,969
              
              
              
              192,534Utilities
              
              
              173,512
              
              
              
              296,023
              
              
              
              -122,511Operating
      supplies
              
              
              134,524
              
              
              
              159,492
              
              
              
              -24,968Repairs
              
              
              58,368
              
              
              
              12,623
              
              
              
              45,745Other
              
              
              150,655
              
              
              
              59,140
              
              
              
              91,515Total
              
              
              13,826,407
              
              
              
              4,687,252
              
              
              
              9,139,155




For the
three months ended February 28, 2010 our gross margin was 33% compared with 7%
in the 2009 comparable three month period. The increase reflected the fact that
the production at LaiYeGou coal mine was partially shut down due to the
installation of the new mining equipments, and normal production resumed in the
third quarter of last year with the completion of the installation and
adjustment of the equipment. Under normal production conditions, Coal Group has
higher gross margins than Heat Power, and it also contributes more to the total
gross profit of the Company. Gross margin from Heat Power  also
increased because of the expanded heating area.





Utilities,
operating supplies and repairs expenses are expected to increase in line with
revenue.




Selling
Expenses





For the
three months ended February 28, 2010, selling expenses increased by
approximately $798,080 compared to the same period in 2009.  Selling
expenses are expected to increase in line with revenue.




27


Three
      Months Ended February 28,2010
              
              
              2009
              
              
              VarianceTransportation
      & Storage
              
              
              523,536
              
              
              
              -
              
              
              
              523,536Sales
      tax and other expenses
              
              
              227,068
              
              
              
              28,491
              
              
              
              198,577Office
              
              
              61,982
              
              
              
              571
              
              
              
              61,411Salaries
      and wages
              
              
              24,246
              
              
              
              13,575
              
              
              
              10,671Depreciation
              
              
              3,885
              
              
              
              -
              
              
              
              3,885Total
      Expenses
              
              
              840,717
              
              
              
              42,637
              
              
              
              798,080


General
and Administrative Expenses





For the
three months ended February 28, 2010, general and administrative expenses
increased by approximately $711,598 as a result of changes in the following
expenses:




Three
      Months Ended February 28,2010
              
              
              2009
              
              
              VarianceOffice
              
              
              302,588
              
              
              
              55,739
              
              
              
              246,849Professional
      and other fees
              
              
              302,024
              
              
              
              108,307
              
              
              
              193,717Salaries
      and wages
              
              
              262,559
              
              
              
              99,736
              
              
              
              162,823Travel
              
              
              126,938
              
              
              
              38,320
              
              
              
              88,618Depreciation
              
              
              66,306
              
              
              
              41,350
              
              
              
              24,956Repairs
              
              
              29,080
              
              
              
              15,612
              
              
              
              13,468Other
      expenses
              
              
              14,157
              
              
              
              32,990
              
              
              
              -18,833Total
      Expenses
              
              
              1,103,652
              
              
              
              392,054
              
              
              
              711,598




Office.
The increase was attributed to purchasing of office consumables after renovation
of office building in Laiyegou coal mine in 2009.





Professional
and other fees. Professional fees were paid principally to various professionals
including financial advisors, attorneys and accountants. These expenses
significantly increased in the quarter ended February 28, 2010 because the
Company decided to change many of its advisors, requiring that the new advisors
spend time and resources studying and familiarizing themselves with us and our
history in an effort to contribute to our strategic plan going
forward.





Salaries
and wages. Salaries and wages increased due to various factors including
purchase of safety and personal care items for coal mine management and labours,
increase of salary rate and number of employees and etc.





Travel.
The increase of travel expenses increased due to the work of our
advisors.




28





Finance
Expenses





For the
three months ended February 28, 2010 and February 28, 2009, finance expenses
amounted to $215,349, and $95,388, respectively. The interest expense increased
due to the increased loan principal obtained by the Company.





Liquidity
and Capital Resources





As of
February 28, 2010 we had a working capital deficit of approximately
$15,000,000.  We anticipate that the combination of our sales and
collection of accounts receivables, customer deposits and proceeds from bank and
shareholder loans will generate sufficient cash flow to sustain our working
capital needs. However we may require other sources of capital.





We do not
know of any trends, events or uncertainties that are likely to have a material
impact on our short-term or long-term liquidity other than those factors
discussed below.





Sources
of Capital





If
additional capital is needed, we will explore financing options such as
shareholder loans. Shareholders loans are granted from time to time as required
to meet current working capital needs. We have no formal agreement that ensures
that we will receive such loans. We may exhaust this source of funding at any
time.  Shareholder loans are payable on demand and interest is
calculated at the range from zero to 3.155% per annum.





Coal
Group obtained loans from the Agricultural Bank of China equalling 60 million
RMB or $8,790,178 to assist in funding working capital needs. In addition, Coal
Group has unutilized bank credit facilities of $5.9 million as at February 28,
2010.





We may
also receive capital contributions from our shareholders.




29





Cash
Flows





Operating
Activities:





Our cash
flows provided by operating activities was $751,674 for the three months ended
February 28, 2010 as compared to cash flows used in operating activities of
$5,096,116 for the three months ended February 28, 2010. The following
summarizes the inflow and outflow of cash for these periods:


Three
      Months Ended February 28,2010
              
              
              2009Net
      income (loss)
              
              
              4,004,286
              
              
              
              (532,350
              )Depreciation
      and amortization
              
              
              979,126
              
              
              
              788,961Increase
      in accounts receivable
              
              
              (4,296,410
              )
              
              
              (2,413,956
              )Decrease
      in other receivables
              
              
              52,942
              
              
              
              601,771Increase
      in advances to suppliers
              
              
              (243,212
              )
              
              
              (388,999
              )Decrease
      in advances from customers
              
              
              (1,210,198
              )
              
              
              (230,923
              )Decrease
      (Increase) in inventory
              
              
              2,524,275
              
              
              
              (286,762
              )Decrease
      in accounts payable
              
              
              (2,078,504
              )
              
              
              (4,116,790
              )Increase
      in accrual liabilities and other payables
              
              
              1,190,453
              
              
              
              142,165Other
              
              
              (171,084
              )
              
              
              1,340,767Net
      Cash Provided (Consumed) ByOperating
      Activities
              
              
              751,674
              
              
              
              (5,096,116
              )





Accounts
receivable. The increase in accounts receivables are mainly attributable to an
increase in Heat Power’s user fees made on account and not from an extension of
time for accounts receivable from prior periods.





Advances
to suppliers. Advances increased as a result of advances made to suppliers of
materials required for the Heat Power expansion and advance for purchase of coal
and freight from third party suppliers. Prepayment is also a common business
practice in China as it allows for a determined price and in some instances will
grant us discounts on purchases.





Advances
from customers. Advances on sales of coal represent the majority of customer
advances received and it is a normal business practice that ensures that the
customer obtains Coal Group’s products at the market price determined on the
date of purchase. Coal Group’s advances decreased during the first quarter of
2010 as a result of less outstanding orders as of the last day of the
quarter.  The level of advances fluctuates depending upon the level of
rapidity with which Coal Group customers take delivery of their goods at any
given time.  Customer advances received from Heat Power’s users
increased as we continued to lay pipeline for that business segment in
connection with the development of the XueJiaWan area.





Inventory.
Inventory mainly consists of coal for trading purposes. The balance of coal
inventory decreased during the first quarter of 2010 as a result of less
outstanding orders at the cut off time. As advances decrease, inventory is
reduced because pre-paid customers take formal delivery of the goods, thereby
allowing the Company to accrue revenue and decrease inventory to reflect the
goods delivered.





Accounts
payable. The majority of accounts payable were for Heat Power’s purchase of raw
materials for production and constructions, and for Coal Group’s purchase of
coal from third party suppliers for trading. Accounts payable also includes fees
payable to government related to mining, and the decrease of the accounts
payable of the first quarter of 2010 is because we partially paid off the
fees.




30





Other
payables. These amounts consist of accruals made for freight, repairs and
maintenance of heating plants, labour union fees, social insurance, technical
training for our employees and etc.





Investing
Activities:


Our cash
flows provided by investing activities were $740,860 for the three months ended
February 28, 2010 and cash flows consumed by investing activities were $525,767
for the three months ended February 28, 2009.





Financing
Activities:


Our cash
flows consumed by financing activities were $2,852,368 for the three months
ended February 28, 2010 and cash flows provided by financing activities were
$5,382,554 for the three months ended February 28, 2009.





The
outstanding balances and interest rate of shareholder loans at February 28,
2010, were as follows:




Balance
              
              
              Interest
      RateHangzhou
      Dayuan Group, Ltd.
              
              
              4,969,720
              
              
              
              3.155
              %Xinghe County
      Haifu Coal Transportation &Sales
      Co., Ltd.
              
              
              1,818,965
              
              
              
              3.155
              %Ordos
      City YiYuan Investment Co. Ltd.
              
              
              1,644,915
              
              
              
              3.155
              %Yanhua
      Li
              
              
              1,912,888
              
              
              
              -Yi
      Ding
              
              
              47,250
              
              
              
              -Total
              
              
              10,393,738
              
              
              
              -




Material
Commitments




We are
committed to payment of bank loans, shareholder loans and payment of mining
rights as mentioned above. We have title to all our capital assets consisting of
production equipment, automobiles, and office equipment.




Heat
Power’s offices are currently leased on a month to month basis and Coal Group
occupies space purchased in 1998. Coal Group holds title to this property in the
form of a 50 year lease from the Government. There are no amounts
owing.




Heat
Power is obligated to make interest payments on a loan obtained through Coal
Group as mentioned above.




Seasonal
Aspects




Coal
Group’s business is seasonal in that sales are particularly low in the first
quarter of a year, due to the Chinese New Year holiday. During this time our
business is closed for about two weeks.




31




Heat
Power sales level relating to heat generation decreases from April through
October as the climate in the region is high, reducing heating
requirements.




Off
Balance Sheet Arrangements




We have
no off balance sheet arrangements.





ITEM
3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK





Not
applicable to smaller reporting companies.





ITEM
4T CONTROLS AND PROCEDURES





A. Evaluation
of Disclosure Controls and Procedures




As of the
end of the fiscal quarter covered by this report, the Company carried out an
evaluation, under the supervision and with the participation of the Company’s
Chief Executive Officer and Chief Financial Officer of the effectiveness of the
design and operation of the Company’s disclosure controls and procedures. The
Company’s disclosure controls and procedures are designed to provide a
reasonable level of assurance that information required to be disclosed by the
Company in the reports that it files or submits under the Securities Exchange
Act of 1934 is recorded, processed, summarized and reported, within the time
periods specified in the Commission’s rules and forms.  The Company’s
Chief Executive Officer and Chief Financial Officesolely as a result of the
significant weaknesses in internal control over financial reporting described in
our Annual Report on Form 10-K for the fiscal year ended November 30, 2009, the
Company’s Chief Executive Officer and Chief Financial Officer have concluded
that the Company’s disclosure controls and procedures were
ineffective.




B. Changes
in Internal Controls Over Financial Reporting




In
connection with the evaluation of the Company’s internal controls during the
quarter ended February 28, 2010, the Company’s Chief Executive Officer and Chief
Financial Officer have determined that there are no changes to the Company’s
internal controls over financial reporting that have materially affected, or are
reasonably likely to materially effect, the Company’s internal controls over
financial reporting.




PART
II. OTHER INFORMATION




ITEM
1. Legal Proceedings.




None.




ITEM
1A. Risk Factors




Not
applicable to smaller reporting companies.




ITEM
2. Unregistered Sales of Equity Securities and Use of Proceeds
–




None.




32




ITEM
3. Defaults Upon Senior Securities - None.




ITEM
4. (Removed and Reserved).




ITEM
5. Other Information.




None




ITEM
6 Exhibits




(a) Exhibits





Exhibit
      Number
            
            Description31.1
            
            CEO
      Section 302 Certification31.2
            
            CAO
      Section 302 Certification32.1
            
            CEO
      and CAO Section 906 Certification




33


SIGNATURES




In
accordance with the Securities Exchange Act of 1934, this Quarterly Report on
Form 10-Q has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.




CHINA
      ENERGY CORPORATIONDate:
      April 15, 2010By:
            /s/WenXiang
      DingWenXiang
      DingPresident,
      Chief Executive Officer, Director &SecretaryBy:
            /s/ Alex GongAlex
      GongChief
      Financial Officer




34