UNITED
STATES




SECURITIES
AND EXCHANGE COMMISSION




Washington,
D.C. 20549




FORM
10-Q




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




for the
fiscal quarter ended May 31, 2010




 ̈
            Transition
      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, PRC
                    010010(Address
      of principal executive offices)
                    (Zip
      Code)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 xNo  ̈




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


Yes  ̈No 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  ̈
            Accelerated filer  ̈
            Non-accelerated filer  ̈
            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.


 ̈ Yes     
x No




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




Class
                
                July 14, 2010Common
      Stock, $0.001 par value
                
                45,000,000
      shares







TABLE
OF CONTENTS


PART
      I.
                FINANCIAL
      INFORMATIONITEM
      1.
                Financial
      Statements
                1Consolidated
      Balance Sheets Income at May 31, 2010 and November 30, 2009
                1Consolidated
      Statements of Income For the Six Months Ended May 31, 2010 and May 31,
      2009 (Unaudited)
                2Consolidated
      Statements of Changes For the Six Months Ended May 31, 2010 and May 31,
      2009 (Unaudited)
                3Notes
      to Consolidated Financial Statements
                5ITEM
      2.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations
                22ITEM
      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


i





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,





·
            government
      regulations on coal mining and heat power
  sectors,





·
            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, and





·
            advances in
      technologies





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.


ii




ITEM
1. FINANCIAL STATEMENTS


CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 CONSOLIDATED
BALANCE SHEETS
 
 May
      31,
                  
                  
                  November
      30,2010
                  
                  
                  2009(Unaudited)
                  
                  
                  (Audited)US$
                  
                  
                  US$ASSETSCurrent
      assets:Cash
      and cash equivalents
                  
                  $
                  10,148,451
                  
                  
                  $
                  5,073,645Term
      deposit-restricted
                  
                  
                  7,320,108
                  
                  
                  
                  -Accounts
      receivable, net of allowance for doubtful accounts of $120,782 and
      $120,853, respectively
                  
                  
                  7,770,278
                  
                  
                  
                  4,600,667Other
      receivables
                  
                  
                  4,536,142
                  
                  
                  
                  4,447,272Advance
      to suppliers
                  
                  
                  6,000,416
                  
                  
                  
                  5,511,630Inventories
                  
                  
                  3,995,005
                  
                  
                  
                  5,574,465Total
      current assets
                  
                  
                  39,770,400
                  
                  
                  
                  25,207,679Fixed
      assets:Property,
      plant and equipment
                  
                  
                  51,058,566
                  
                  
                  
                  50,546,862Construction
      in progress
                  
                  
                  4,993,734
                  
                  
                  
                  4,236,28156,052,300
                  
                  
                  
                  54,783,143Less:
      accumulated depreciation and depletion
                  
                  
                  (9,344,274
                  )
                  
                  
                  (7,456,849
                  )Net
      fixed assets
                  
                  
                  46,708,026
                  
                  
                  
                  47,326,294Other
      assets:Investment
      property, net of accumulated depreciation of $188,721 and $166,172,
      respectively
                  
                  
                  1,912,498
                  
                  
                  
                  1,936,278Intangible
      assets, net of amortization of $936,113 and $787,417,
      respectively
                  
                  
                  3,476,360
                  
                  
                  
                  3,627,642Restricted
      cash
                  
                  
                  533,358
                  
                  
                  
                  149,898Other
      long term assets
                  
                  
                  486,077
                  
                  
                  
                  450,021Notes
      receivable
                  
                  
                  13,309,387
                  
                  
                  
                  7,913,100Total
      other assets
                  
                  
                  19,717,680
                  
                  
                  
                  14,076,939TOTAL
      ASSETS
                  
                  $
                  106,196,106
                  
                  
                  $
                  86,610,912LIABILITIES
      AND STOCKHOLDERS’ EQUITYCurrent
      liabilities:Short
      term bank loans
                  
                  $
                  16,104,238
                  
                  
                  $
                  12,012,012Accounts
      payable
                  
                  
                  10,673,206
                  
                  
                  
                  11,489,568Notes
      payable
                  
                  
                  5,856,087
                  
                  
                  
                  -Advance
      from customers
                  
                  
                  9,761,577
                  
                  
                  
                  12,125,187Accrued
      liabilities
                  
                  
                  651,448
                  
                  
                  
                  325,539Other
      payables
                  
                  
                  4,501,405
                  
                  
                  
                  387,729Shareholder
      loans
                  
                  
                  10,073,564
                  
                  
                  
                  9,972,279Current
      portion of deferred income
                  
                  
                  852,888
                  
                  
                  
                  822,930Total
      current liabilities
                  
                  
                  58,474,413
                  
                  
                  
                  47,135,244Deferred
      income, net of current portion
                  
                  
                  6,067,091
                  
                  
                  
                  6,224,033Total
      liabilities
                  
                  
                  64,541,504
                  
                  
                  
                  53,359,277Stockholders’
      equity:Common
      stock (authorized 200,000,000 shares of $0.001 par value; 45,000,000
      shares issued and outstanding, respectively)
                  
                  
                  45,000
                  
                  
                  
                  45,000Additional
      paid-in capital
                  
                  
                  8,655,805
                  
                  
                  
                  8,655,805Paid-in
      capital – stock options
                  
                  
                  315,000
                  
                  
                  
                  315,000Retained
      earnings
                  
                  
                  20,749,751
                  
                  
                  
                  12,542,081Statutory
      reserves
                  
                  
                  8,297,853
                  
                  
                  
                  8,078,765Other
      comprehensive income
                  
                  
                  3,591,193
                  
                  
                  
                  3,614,984Total
      stockholders’ equity
                  
                  
                  41,654,602
                  
                  
                  
                  33,251,635TOTAL
      LIABILITIES AND STOCKHOLDERS’ EQUITY
                  
                  $
                  106,196,106
                  
                  
                  $
                  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 AND OTHER COMPREHENSIVE INCOME
(LOSS)
 (UNAUDITED)
 
 For
      the six months ended
                    May
      31,
                  
                  
                  For
      the three months ended
                    May
      31,2010
                  
                  
                  2009
                  
                  
                  2010
                  
                  
                  2009US$
                  
                  
                  US$
                  
                  
                  US$
                  
                  
                  US$Revenues
                  
                  $
                  41,252,616
                  
                  
                  $
                  9,298,621
                  
                  
                  $
                  20,483,740
                  
                  
                  $
                  4,283,675Cost
      of revenues
                  
                  
                  (25,852,305
                  )
                  
                  
                  (8,924,191
                  )
                  
                  
                  (12,025,898
                  )
                  
                  
                  (4,236,939
                  )Gross
      profit
                  
                  
                  15,400,311
                  
                  
                  
                  374,430
                  
                  
                  
                  8,457,842
                  
                  
                  
                  46,736Operating
      expenses:Selling
      and marketing
                  
                  
                  (2,222,281
                  )
                  
                  
                  (238,153
                  )
                  
                  
                  (1,381,564
                  )
                  
                  
                  (195,516
                  )General
      and administrative
                  
                  
                  (1,731,846
                  )
                  
                  
                  (1,230,144
                  )
                  
                  
                  (628,194
                  )
                  
                  
                  (838,090
                  )Total
      operating expenses
                  
                  
                  (3,954,127
                  )
                  
                  
                  (1,468,297
                  )
                  
                  
                  (2,009,758
                  )
                  
                  
                  (1,033,606
                  )Income
      (loss) from operations
                  
                  
                  11,446,184
                  
                  
                  
                  (1,093,867
                  )
                  
                  
                  6,448,084
                  
                  
                  
                  (986,870
                  )Investment
      income
                  
                  
                  -
                  
                  
                  
                  36,847
                  
                  
                  
                  -
                  
                  
                  
                  2,496Non-operating
      income
                  
                  
                  682,678
                  
                  
                  
                  325,173
                  
                  
                  
                  569,215
                  
                  
                  
                  164,772Finance
      expenses, net
                  
                  
                  (771,001
                  )
                  
                  
                  (198,722
                  )
                  
                  
                  (555,652
                  )
                  
                  
                  (103,334
                  )Government
      subsidies
                  
                  
                  -
                  
                  
                  
                  164,145
                  
                  
                  
                  -
                  
                  
                  
                  11,121Non-operating
      expenses
                  
                  
                  (175,511
                  )
                  
                  
                  (757,083
                  )
                  
                  
                  (131,155
                  )
                  
                  
                  (56,418
                  )Income
      (loss) before income taxes
                  
                  
                  11,182,350
                  
                  
                  
                  (1,523,507
                  )
                  
                  
                  6,330,492
                  
                  
                  
                  (968,233
                  )(Provision
      for) benefit from income taxes
                  
                  
                  (2,755,592
                  )
                  
                  
                  24,590
                  
                  
                  
                  (1,908,020
                  )
                  
                  
                  1,666Net
      income (loss)
                  
                  $
                  8,426,758
                  
                  
                  $
                  (1,498,917
                  )
                  
                  $
                  4,422,472
                  
                  
                  $
                  (966,567
                  )Other
      comprehensive income (loss)Foreign
      currency translation adjustment
                  
                  
                  (23,791
                  )
                  
                  
                  79,005
                  
                  
                  
                  (28,256
                  )
                  
                  
                  131,410Total
      comprehensive income (loss)
                  
                  $
                  8,402,967
                  
                  
                  $
                  (1,419,912
                  )
                  
                  $
                  4,394,216
                  
                  
                  $
                  (835,157
                  )Net
      income (loss) per common share basic
                  
                  $
                  0.19
                  
                  
                  $
                  (0.03
                  )
                  
                  $
                  0.10
                  
                  
                  $
                  (0.02
                  )Net
      income (loss) per common share diluted
                  
                  $
                  0.17
                  
                  
                  $
                  (0.03
                  )
                  
                  $
                  0.09
                  
                  
                  $
                  (0.02
                  )Weighted
      average common shares outstanding basic
                  
                  
                  45,000,000
                  
                  
                  
                  45,000,000
                  
                  
                  
                  45,000,000
                  
                  
                  
                  45,000,000Weighted
      average common shares outstanding diluted
                  
                  
                  48,423,445
                  
                  
                  
                  45,000,000
                  
                  
                  
                  48,423,445
                  
                  
                  
                  45,000,000
  The accompanying notes are an integral
part of these consolidated financial statements.
  2
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 CONSOLIDATED
STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
 FOR
THE SIX MONTHS ENDED MAY 31, 2010
 (UNAUDITED)
 
 Additional
                      
                      
                      Paid
      in
                        capital
                      
                      
                      
                      
                      
                      
                      
                      
                      OtherShares
                      
                      
                      Amounts
                      
                      
                      Paid
      in
                        capital
                      
                      
                      Stock
                        options
                      
                      
                      Retained
      Earnings
                      
                      
                      Statutory
                        Reserves
                      
                      
                      Comprehensive
                        income
                      
                      
                      TotalBalance
      as of December 1, 2009
                      
                      
                      45,000,000
                      
                      
                      $
                      45,000
                      
                      
                      $
                      8,655,805
                      
                      
                      $
                      315,000
                      
                      
                      $
                      12,542,081
                      
                      
                      $
                      8,078,765
                      
                      
                      $
                      3,614,984
                      
                      
                      $
                      33,251,635Net
      income for the period
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      8,426,758
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      8,426,758Other
      comprehensive (loss)
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (23,791
                      )
                      
                      
                      (23,791
                      )Allocation
      of statutory reserve
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      -
                      
                      
                      
                      (219,088
                      )
                      
                      
                      219,088
                      
                      
                      
                      -
                      
                      
                      
                      -Balance
      as of May 31, 2010
                      
                      
                      45,000,000
                      
                      
                      $
                      45,000
                      
                      
                      $
                      8,655,805
                      
                      
                      $
                      315,000
                      
                      
                      $
                      20,749,751
                      
                      
                      $
                      8,297,853
                      
                      
                      $
                      3,591,193
                      
                      
                      $
                      41,654,602
 
 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 six months ended
                            May
      31,2010
                          
                          
                          2009US$
                          
                          
                          US$Cash
      flows from operating activities:Net
      income (loss)
                          
                          $
                          8,426,758
                          
                          
                          $
                          (1,498,917
                          )Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
                          
                          
                          2,108,233
                          
                          
                          
                          1,441,566Interest
      accrued on shareholder loans
                          
                          
                          109,348
                          
                          
                          
                          106,433Loss
      on disposal of property, plant and equipment
                          
                          
                          -
                          
                          
                          
                          744,524Gain
      from short term investments
                          
                          
                          -
                          
                          
                          
                          (36,847
                          )Changes
      in operating assets and liabilities:(Increase)
      in term deposit
                          
                          
                          (7,320,108
                          )
                          
                          
                          -(Increase)
      in restricted cash
                          
                          
                          (383,460
                          )
                          
                          
                          -(Increase)
      in accounts receivable
                          
                          
                          (3,048,758
                          )
                          
                          
                          (1,803,791
                          )(Increase)
      in other receivables
                          
                          
                          (88,870
                          )
                          
                          
                          (5,097,545
                          )Decrease
      (increase) in advance to suppliers
                          
                          
                          1,287,107
                          
                          
                          
                          (770,088
                          )Decrease
      (increase) in inventories
                          
                          
                          1,579,460
                          
                          
                          
                          (78,612
                          )(Decrease)
      increase in deferred income
                          
                          
                          (126,984
                          )
                          
                          
                          475,131Increase
      (decrease) in accounts payable
                          
                          
                          198,588
                          
                          
                          
                          (4,133,827
                          )(Decrease)
      increase in advance from customers
                          
                          
                          (2,363,610
                          )
                          
                          
                          838,514Increase
      in accrued liabilities and other payables
                          
                          
                          4,439,585
                          
                          
                          
                          415,551Net
      cash provided by (used in) operating activities
                          
                          
                          4,817,289
                          
                          
                          
                          (9,397,908
                          )Cash
      flows from investing activities:Purchase
      of property, plant and equipment
                          
                          
                          (3,093,625
                          )
                          
                          
                          (2,186,070
                          )Increase
      in construction in progress
                          
                          
                          (1,076,171
                          )
                          
                          
                          (698,877
                          )(Increase)
      in notes receivable
                          
                          
                          (5,396,287
                          )
                          
                          
                          (330,560
                          )Payments
      received on notes receivable
                          
                          
                          -
                          
                          
                          
                          893,563Net
      cash (used in) investing activities
                          
                          
                          (9,566,083
                          )
                          
                          
                          (2,321,944
                          )Cash
      flows from financing activities:Proceeds
      from short term bank loans
                          
                          
                          16,112,495
                          
                          
                          
                          12,011,836Proceeds
      from notes payable
                          
                          
                          5,856,087
                          
                          
                          
                          -Principal
      payments made on short term bank loans
                          
                          
                          (12,011,132
                          )
                          
                          
                          (2,929,716
                          )Advance
      from shareholders
                          
                          
                          513,711
                          
                          
                          
                          4,439,636Repayments
      of shareholders loans
                          
                          
                          (517,651
                          )
                          
                          
                          (594,000
                          )Net
      cash provided by financing activities
                          
                          
                          9,953,510
                          
                          
                          
                          12,927,756Effect
      of exchange rate changes on cash
                          
                          
                          (129,910
                          )
                          
                          
                          33,140Net
      increase in cash and cash equivalents
                          
                          
                          5,074,806
                          
                          
                          
                          1,241,044Cash
      and cash equivalents, beginning of period
                          
                          
                          5,073,645
                          
                          
                          
                          456,802Cash
      and cash equivalents, end of period
                          
                          $
                          10,148,451
                          
                          
                          $
                          1,697,846Supplemental
      disclosure of cash flow informationCash
      paid for interest
                          
                          $
                          554,554
                          
                          
                          $
                          276,071Cash
      paid for income taxes
                          
                          $
                          2,346,087
                          
                          
                          $
                          -
 
 The accompanying notes are an integral
part of these consolidated financial statements.
  4
  CHINA
ENERGY CORPORATION
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 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 series of procedures of governmental approvals and corporate actions were
clarified and the Company acknowleged the 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 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 PRC (“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.
  5
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 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 owns 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 based on enhancement of
production 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 May 31, 2010 and for
the three and six month periods ended May 31, 2010 and 2009, have been prepared
in accordance with accounting principles generally accepted 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 subsidiaries, heat power
and 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 and six months
ended May 31, 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 Securities and Exchange Commission, 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 audited 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 AND SIX MONTH PERIODS ENDED MAY 31, 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
January 2010, the Financial Accounting Standards Board (“FASB”) issued
Accounting Standards Update No. 2010-06, “Improving Disclosures about Fair
Value Measurements” (“ASU No.
2010-06”).  ASU No. 2010-06 amends FASB ASC Topic 820, “Fair Value Measurements and
Disclosures”, to require additional information to be disclosed
principally regarding Level 3 measurements and transfers to and from Level 1 and
2.  In addition, enhanced disclosure is required concerning inputs and
valuation techniques used to determine Level 2 and Level 3
measurements.  This guidance is generally effective for interim and
annual reporting periods beginning after December 15, 2009; however,
requirements to disclose separately purchases, sales, issuances, and settlements
in the Level 3 reconciliation are effective for fiscal years beginning after
December 15, 2010 (and for interim periods within such years).  The
update will not have a material impact on the Company’s consolidated results of
operations or financial position.
  In
February 2010, the FASB issued Accounting Standards Update No. 2010-09, “Amendments to Certain Recognition and
Disclosure Requirements” (“ASU No. 2010-09”).  ASU No. 2010-09
amends FASB ASC Topic 855-10, “Subsequent Events”, to remove
the requirement for an SEC filer to disclose the date through which subsequent
events have been evaluated in both issued and revised financial
statements.  This change alleviates potential conflicts between ASC
855-10 and the SEC’s requirements.  The update did not have a material
impact on the Company’s consolidated results of operations or financial
position.
 
 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 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 period presented.
Adjustments resulting from the translation of the Company’s financial statements
are recorded as other comprehensive income.
  7
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 The
exchange rates used to translate amounts in RMB into US dollars for the purposes
of preparing the consolidated financial statements were as follows:
 
 May
      31, 2010
                      
                      May
      31, 2009
                      
                      November
      30,
                        2009Balance
      sheet items, except for the registered capital, additional paid-in
      capital, statutory reserves, retained earnings and other comprehensive
      income, as of period end
                      
                      US$1=RMB
      6.8305
                      
                      US$1=RMB
      6.8278
                      
                      US$1=RMB
      6.8265Amounts
      included in the statements of operations, statements of changes in
      stockholders’ equity and statements of cash flows for the
      period
                      
                      US$1=RMB
      6.8270
                      
                      US$1=RMB
      6.8266
                      
                      US$1=RMB
      6.8330
 For the
six months ended May 31, 2010, a foreign currency translation adjustment of
$23,791 has 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.
 
 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
consolidated 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.
 
 Term
Deposit
 
 Term
deposit represents amounts legally held by a bank which are not available for
the Company’s general use.  These deposits are held as collateral for
issuance of notes to vendors for purchase of coal which generally mature between
three to six months.
 
 Accounts
Receivable
 
 Accounts
receivable is stated at cost, net of an allowance for doubtful accounts. The
Company maintains an allowance 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 collectibility of
individual balances.  In evaluating the collectibility 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 May 31, 2010 and November 30, 2009, the balances
of allowance for doubtful accounts were $120,782 and $120,853, respectively. For
the periods presented, the Company did not write off any accounts receivable as
bad debts.
 8
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
  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 make any inventory adjustments for the six months ended May
31, 2010 and 2009, and year ended November 30, 2009.
 
 Property,
Plant and Equipment
 
 Property,
plant and equipment are recorded at cost, less accumulated depreciation. Cost
includes the price paid to acquire or construct the asset, 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.
 
 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 of the mine, was assessed by the Bureau to be
$3,656,731.  The mine acquisition cost is payable in instalments over
a six year period from the date the mining right was granted.  The
mine acquisition cost is amortized using the UOP method over the productive life
of the mine based on proven and probable reserves.
  9
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 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.
 
 Advance
from Customers
 
 Advance
from customers primarily consists 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 utilizes 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 at least annually for impairment or, 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 six
months ended May 31, 2010 and 2009.
 
 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.
 10
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
  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 a resource compensation fee
of $123,840 and $15,885 for the six months ended May 31, 2010 and 2009,
respectively, which is included in cost of goods sold in the statements of
operations.
  Environmental
Costs
 
 The PRC
has adopted extensive environmental laws and regulations that affect the
operations of the coal mining industry. The potential 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, advance to suppliers and other
receivables, short term bank loans, accounts payable, advance from
customers, accrued liabilities, other payables and shareholder loans. As of May
31, 2010 and November 30, 2009, the carrying values of these financial
instruments approximated their fair values.
 
 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. and therefore, are not subject to U.S. taxes (see Note
13).
 
 The
Company accounts for income taxes in accordance with 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.
 11
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
  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 (Loss) Per Share
 
 The
Company computes net income (loss) per common share in accordance with 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 net income
(loss) per common share is computed by dividing the amount available to common
shareholders by the weighted average number of shares of common stock
outstanding during the period.  Diluted income (loss) per common share
is computed by dividing the amount available to common shareholders by the
weighted average number of shares of common stock outstanding plus the effect
of any dilutive shares outstanding during the
period.  Accordingly, the number of weighted average shares
outstanding as well as the amount of net income (loss) 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:
  SurplusReserveFund: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
issuance is not less than 25% of the registered capital.
 
 Common Welfare Fund:The 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.
 12
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 Non-SurplusReserveFund (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 and Utilization 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 statutory reserve has been recorded as an
appropriation of retained earnings.
 
 The
statutory reserves consist of the following:
 
 May
      31, 2010
                                    
                                    
                                    November
      30, 2009Surplus
      Reserve and Common Welfare fund
                                    
                                    $
                                    2,447,598
                                    
                                    
                                    $
                                    2,447,598Safety
      and Maintenance fund
                                    
                                    
                                    5,850,255
                                    
                                    
                                    
                                    5,631,167Total
      statutory reserves
                                    
                                    $
                                    8,297,853
                                    
                                    
                                    $
                                    8,078,765
 
 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 additional paid-in capital.
 
 Asset
Retirement Cost and Obligation
 
 The
Company has adopted 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.
 13
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 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 will be
limited.
 
 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 94
million (equivalent to U.S. $13.7 million) as of May 31, 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.
  14
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 
 Six
      Months Ended May 31,2010
                                    
                                    
                                    2009Heat
                                    
                                    
                                    Coal
                                    
                                    
                                    
                                    
                                    
                                    Heat
                                    
                                    
                                    CoalPower
                                    
                                    
                                    Group
                                    
                                    
                                    Total
                                    
                                    
                                    Power
                                    
                                    
                                    Group
                                    
                                    
                                    TotalUS$
                                    
                                    
                                    US$
                                    
                                    
                                    US$
                                    
                                    
                                    US$
                                    
                                    
                                    US$
                                    
                                    
                                    US$Sales
      to external customers
                                    
                                    
                                    7,475,617
                                    
                                    
                                    
                                    33,776,999
                                    
                                    
                                    
                                    41,252,616
                                    
                                    
                                    
                                    6,124,333
                                    
                                    
                                    
                                    3,174,288
                                    
                                    
                                    
                                    9,298,621Finance
      expense (income), net
                                    
                                    
                                    177,155
                                    
                                    
                                    
                                    593,846
                                    
                                    
                                    
                                    771,001
                                    
                                    
                                    
                                    109,223
                                    
                                    
                                    
                                    89,499
                                    
                                    
                                    
                                    198,722Depreciation
      and depletion
                                    
                                    
                                    1,358,895
                                    
                                    
                                    
                                    749,338
                                    
                                    
                                    
                                    2,108,233
                                    
                                    
                                    
                                    1,227,834
                                    
                                    
                                    
                                    213,732
                                    
                                    
                                    
                                    1,441,566Segment
      profit (loss)
                                    
                                    
                                    598,615
                                    
                                    
                                    
                                    7,828,143
                                    
                                    
                                    
                                    8,426,758
                                    
                                    
                                    
                                    (1,646,181
                                    )
                                    
                                    
                                    147,264
                                    
                                    
                                    
                                    (1,498,917
                                    )Three
      Months Ended May 31,2010
                                    
                                    
                                    2009Heat
                                    
                                    
                                    Coal
                                    
                                    
                                    
                                    
                                    
                                    
                                    Heat
                                    
                                    
                                    CoalPower
                                    
                                    
                                    Group
                                    
                                    
                                    Total
                                    
                                    
                                    Power
                                    
                                    
                                    Group
                                    
                                    
                                    TotalUS$
                                    
                                    
                                    US$
                                    
                                    
                                    US$
                                    
                                    
                                    US$
                                    
                                    
                                    US$
                                    
                                    
                                    US$Sales
      to external customers
                                    
                                    
                                    2,954,707
                                    
                                    
                                    
                                    17,529,033
                                    
                                    
                                    
                                    20,483,740
                                    
                                    
                                    
                                    2,639,270
                                    
                                    
                                    
                                    1,644,405
                                    
                                    
                                    
                                    4,283,675Finance
      expense (income), net
                                    
                                    
                                    126,323
                                    
                                    
                                    
                                    429,329
                                    
                                    
                                    
                                    555,652
                                    
                                    
                                    
                                    57,288
                                    
                                    
                                    
                                    46,046
                                    
                                    
                                    
                                    103,334Depreciation
      and depletion
                                    
                                    
                                    670,986
                                    
                                    
                                    
                                    458,121
                                    
                                    
                                    
                                    1,129,107
                                    
                                    
                                    
                                    598,236
                                    
                                    
                                    
                                    54,369
                                    
                                    
                                    
                                    652,605Segment
      profit (loss)
                                    
                                    
                                    (47,877
                                    )
                                    
                                    
                                    4,470,349
                                    
                                    
                                    
                                    4,422,472
                                    
                                    
                                    
                                    (1,078,798
                                    )
                                    
                                    
                                    112,231
                                    
                                    
                                    
                                    (966,567
                                    )
 May
      31, 2010
                  
                  
                  November
      31, 2009Heat
                  
                  
                  Coal
                  
                  
                  
                  
                  
                  Heat
                  
                  
                  CoalPower
                  
                  
                  Group
                  
                  
                  Total
                  
                  
                  Power
                  
                  
                  Group
                  
                  
                  TotalUS$
                  
                  
                  US$
                  
                  
                  US$
                  
                  
                  US$
                  
                  
                  US$
                  
                  
                  US$Segment
      assets
                  
                  
                  54,769,439
                  
                  
                  
                  51,426,667
                  
                  
                  
                  106,196,106
                  
                  
                  
                  49,346,842
                  
                  
                  
                  37,264,070
                  
                  
                  
                  86,610,912Construction
      in progress
                  
                  
                  4,300,766
                  
                  
                  
                  692,968
                  
                  
                  
                  4,993,734
                  
                  
                  
                  3,514,152
                  
                  
                  
                  722,129
                  
                  
                  
                  4,236,281Investment
      property, net
                  
                  
                  -
                  
                  
                  
                  1,912,498
                  
                  
                  
                  1,912,498
                  
                  
                  
                  -
                  
                  
                  
                  1,936,278
                  
                  
                  
                  1,936,278
 
 4.
              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:
 
 May
      31, 2010
                          
                          
                          November
      30, 2009Ordos
      City YiYuan Investment Co., Ltd.
                          
                          $
                          1,666,191
                          
                          
                          $
                          1,634,404Hangzhou
      Dayuan Group, Ltd.
                          
                          
                          4,979,281
                          
                          
                          
                          5,428,963Xinghe
      County Haifu Coal Transportation & Sales Co., Ltd.
                          
                          
                          1,841,749
                          
                          
                          
                          1,807,686Wenxiang
      Ding
                          
                          
                          -
                          
                          
                          
                          28,565Yanhua
      Li
                          
                          
                          1,539,126
                          
                          
                          
                          1,025,416Yi
      Ding
                          
                          
                          47,217
                          
                          
                          
                          47,245Total
                          
                          $
                          10,073,564
                          
                          
                          $
                          9,972,279
  15
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 The
shareholder loans are due on demand and part of shareholder loans bore interest
at 5.310%.
 
 May
      31, 2010
                  
                  
                  November
      30, 2009Balance
                  
                  
                  Interest
                    rate
                  
                  
                  Balance
                  
                  
                  Interest
                    rateShareholder
      loans – interest free
                  
                  $
                  1,586,343
                  
                  
                  
                  0
                  %
                  
                  $
                  1,101,226
                  
                  
                  
                  0
                  %Shareholder
      loans – interest bearing
                  
                  
                  6,470,976
                  
                  
                  
                  5.310
                  %
                  
                  
                  6,964,156
                  
                  
                  
                  3.155
                  %Interest
      payable
                  
                  
                  2,016,245
                  
                  
                  
                  
                  
                  
                  
                  1,906,897Total
                  
                  $
                  10,073,564
                  
                  
                  
                  
                  
                  
                  $
                  9,972,279
 
 5.
              Lease
      obligation
 
 The
Company leases an office under an operating lease expiring in the year ending
December 31, 2011. The minimum future annual rent payments under the lease as of
May 31, 2010 are approximated as follows:
  Year
      Ending
              
              
              AnnualNovember
      30,
              
              
              Amount2010
              
              
              $
              43,9212011
              
              
              
              87,8412012
              
              
              
              7,320Total
              
              
              $
              139,082
 
 Rent
expenses charged to operations for the six months ended May 31,
2010 and 2009 were $43,943 and $43,946, respectively.
 
 6. 
  Advances to Suppliers
 
 As is
customary in China, the Company has made advances to its
suppliers.  At May 31, 2010 and November 30, 2009, advances amounted
to $6,000,416 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:
 
 May
      31, 2010
                      
                      
                      November
      30, 2009Loans
      to suppliers and other associated firms
                      
                      $
                      1,439,773
                      
                      
                      $
                      1,332,038Deposit
      funds to secure agreements
                      
                      
                      510,558
                      
                      
                      
                      509,392Employee
      expense advances
                      
                      
                      199,011
                      
                      
                      
                      217,643Government
      subsidies receivable
                      
                      
                      1,464,022
                      
                      
                      
                      1,464,880Heat
      network access fee receivable
                      
                      
                      922,778
                      
                      
                      
                      923,319Total
                      
                      $
                      4,536,142
                      
                      
                      $
                      4,447,272
 16
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 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 May 31, 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:
 
 May
      31, 2010
                      
                      
                      November
      30, 2009Buildings
                      
                      $
                      10,302,813
                      
                      
                      $
                      9,682,139Machinery
      & equipment
                      
                      
                      39,041,597
                      
                      
                      
                      39,322,399Automotive
      equipment
                      
                      
                      984,474
                      
                      
                      
                      919,922Office
      Equipment
                      
                      
                      729,682
                      
                      
                      
                      622,402Construction
      in progress
                      
                      
                      4,993,734
                      
                      
                      
                      4,236,28156,052,300
                      
                      
                      
                      54,783,143Accumulated
      depreciation and depletion
                      
                      
                      (9,344,274
                      )
                      
                      
                      (7,456,849
                      )Fixed
      assets, net
                      
                      $
                      46,708,026
                      
                      
                      $
                      47,326,294
 
 Depreciation
expenses charged to operations for the six months ended May 31,
2010 and 2009 were $1,892,762 and $1,303,472,
respectively.
 
 9.
   Notes Receivable
 
 Certain
loans were made for strategic purposes. Notes receivable, which are
non-interest bearing except as noted below and payable on demand, consist of the
following:
 
 May
      31, 2010
                      
                      
                      November
      30, 2009Inner
      Mongolia XiangRong Investment Management Co., Ltd.
                      
                      $
                      1,378,092
                      
                      
                      $
                      1,378,900Inner
      Mongolia Tehong Investment Co., Ltd.
                      
                      
                      8,017,068
                      
                      
                      
                      3,244,785Inner
      Mongolia Tehong Coal Chemical Co., Ltd.
                      
                      
                      1,674,841
                      
                      
                      
                      761,737QuanYing
      Coal Mine
                      
                      
                      301,886
                      
                      
                      
                      916,311Inner
      Mongolia XinKe Kaolin Fabrication Plant
                      
                      
                      1,639,704
                      
                      
                      
                      1,611,367Inner
      Mongolia Tehong Glass Co.,Ltd., with interest at11.16%
                      
                      
                      297,796
                      
                      
                      
                      -Total
      notes receivable
                      
                      $
                      13,309,387
                      
                      
                      $
                      7,913,100
 17
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 10.
Short Term Bank Loans
 
 The
Company has bank loans collateralized by the investment property and
guaranteed by a related party.  Relevant terms of these bank loans are as
follows:
 
 May 31,2010
                      
                      
                      November 30, 2009Bank
      loan due 3/9/11, with interest at 6.372%
                      
                      $
                      5,856,087
                      
                      
                      $
                      -Bank
      loan due 4/15/11, with interest at 6.372%
                      
                      
                      7,320,108
                      
                      
                      
                      -Bank
      loan due 4/22/11, with interest at 6.903%
                      
                      
                      2,928,043
                      
                      
                      
                      -Bank
      loan due 12/5/09, with interest at 6.696%
                      
                      
                      -
                      
                      
                      
                      1,757,855Bank
      loan due 3/15/10, with interest at 6.372%
                      
                      
                      -
                      
                      
                      
                      8,789,277Bank
      loan due 4/21/10, with interest at 6.372%
                      
                      
                      -
                      
                      
                      
                      1,464,880Total
                      
                      $
                      16,104,238
                      
                      
                      $
                      12,012,012
 
 11.
Fair Value Measurement
 
 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.
 
 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 May
31, 2010.
 
 Notes
receivable:  Valued at the net realizable value which
approximates the fair value.
 
 The
method described above may produce a fair value calculation that may not be
indicative of net realizable value or reflective of future
values.  Furthermore, while the Company believes its valuation methods
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.
 18
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 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 May 31, 2010:
 
 Level
      1
                    
                    
                    Level
      2
                    
                    
                    Level
      3
                    
                    
                    TotalNotes
      receivable
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    13,309,387
                    
                    
                    $
                    13,309,387Total
                    
                    $
                    -
                    
                    
                    $
                    -
                    
                    
                    $
                    13,309,387
                    
                    
                    $
                    13,309,387
 
 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, 2009
                    
                    $
                    7,913,100
                    
                    
                    $
                    7,913,100Purchases,
      sales, issuance and settlements (net)
                    
                    
                    5,396,287
                    
                    
                    
                    5,396,287Balance,
      May 31, 2010
                    
                    $
                    13,309,387
                    
                    
                    $
                    13,309,387
 
 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 $164,145 for the six month periods ended May 31, 2010 and 2009,
respectively, and are included in government subsidies in the accompanying
consolidated statements of operations.
 
 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 May 31, 2010, the Chinese entities had no net operating
losses available for future use as confirmed by the local tax
authority.
 19
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 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:
 
 May
      31, 2010
                      
                      
                      November
      30, 2009Deferred
      tax assets
                      
                      $
                      -
                      
                      
                      $
                      256,010Valuation
      allowance
                      
                      
                      -
                      
                      
                      
                      (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 year ended 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 period ended May 31, 2010:
 
 Six
      months ended
                          May
      31, 2010
                        
                        Income
      Before
                          Income
      Taxes
                        
                        
                        Tax
      Provision
                        
                        
                        Rate
      of
                          TaxAs
      reported on the consolidated statements of
      operations
                        
                        $
                        11,182,350
                        
                        
                        $
                        2,755,592
                        
                        
                        
                        24.6
                        %Gain
      not used in calculation of taxable income on the tax
      returns
                        
                        
                        (159,982
                        )
                        
                        
                        -
                        
                        
                        
                        0.4
                        %As
      calculated with statutory rate
                        
                        $
                        11,022,368
                        
                        
                        $
                        2,755,592
                        
                        
                        
                        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.
 
 The
Company did not file its U.S. federal income tax returns, including, without
limitation, information returns on Internal Revenue Service (“IRS”) Form 5471,
“Information Return of U.S.
Persons With Respect to Certain Foreign Corporations” for the years ended
November 30, 2002 through 2005, and 2008.  The Company was also late
in filing for the years ended November 30, 2006 and 2007. Failure to furnish any
information with respect to any foreign business entity required, within the
time prescribed by the IRS, subjects the Company to certain civil
penalties.  The Company is unable to determine the amount of any
penalties that may be assessed at this time.  Management is of the
opinion that penalties, if any, that may be assessed would not be material to
the consolidated financial statements.
 20
  CHINA
ENERGY CORPORATION AND SUBSIDIARIES
 NOTES
TO THE CONSOLIDATED FINANCIAL STATEMENTS
 FOR
THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2010 AND
2009
 (UNAUDITED)
 In
addition, because the Company did not generate any income in the United States
or otherwise have any U.S. taxable income, the Company does not believe that it
owes U.S. federal income taxes, or in respect to any transactions that the
Company or any of its subsidiaries may have engaged in through May 31, 2010.
However, there can be no assurance that the IRS will agree with this position,
and therefore the Company ultimately could be held liable for U.S. federal
income taxes, interest and penalties.
 
 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)
 
 The
Company did not file the information reports for the years ended November 30,
2004 through 2009
concerning its interests in foreign bank accounts on TD F 90-22.1, “Report of Foreign Bank and Financial
Accounts” (“FBARs”). For not complying with the FBAR reporting and
recordkeeping requirements, the Company is subject to civil penalties up to
$10,000 for each of its foreign bank accounts over the six year periods since
November 30, 2004. The Company does not believe that the failure to file the
FBARs was “willful” and intends to seek a waiver of any penalties. The
Company is unable to determine the amount of any penalties that may be
assessed at this time and believes that penalties, if any, that may be assessed
would not be material to the consolidated financial statements.
  21


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





Overview





Through
Coal Group, we produce coal using the longwall method of mining at the LaiYeGou
coal mine located in the Dongsheng coal field near the Dongsheng district of
Ordos City, Inner Mongolia.  In addition to selling coal we produce at
our mine, Coal Group also buys, sells and transports coal as part of its
expanding proprietary coal trading business.  Each year the PRC
government regulates the amount of coal we and other coal producers are able to
sell by allocating space to coal mines in Inner Mongolia to ship their coal on
rail cars to the port in Qinhuangdao, where regional users come to buy the coal
on the open market. In order to capitalize on excess quota for rail space that
we may have from time to time, commencing in 2008, we began to buy excess coal
from other coal producers in Inner Mongolia and then pay to have that coal
delivered by rail from the other companies’ mines to the Qinhuangdao
port.  Our business of buying and re-selling coal on a proprietary
basis expanded in 2009 as a result of our receipt of additional quota for space
on trains from the local railway bureau.  Due to the increased quota,
we were able to trade more coal.  Parties are awarded additional
quotas based on their successful use of the quota in the previous
year.  Our quota increased from 500,000 tons in 2009 to 840,000 tons
in 2010.  We believe that, given the demand for coal and our past
track record of successfully filling our extra quota, we will be able to grow
our coal trading business through increased quotas granted to us by the local
railway bureau; however, our ability to use any or all of our quota in 2010 will
vary with market conditions and is dependent on our ability to source
commercially acceptable coal purchases and subsequent trades.  Coal
that we produce and sell directly to our customers is customarily transported at
the buyer’s expense and therefore does not count against our quota.





Through
Heat Power, we use our thermoelectric plant to generate and provide heating and
electricity to residential and commercial customers throughout XueJiaWan, the
administrative center of Zhunger, one of the seven counties of
Ordos.





Coal
Group is the major revenue and profit driver of the Company. While the sales
prices of heat and electricity units generated by Heat Power are regulated by
government, sales prices of coal are market driven. Therefore, Coal Group enjoys
a higher gross margin compared to Heat Power.





Coal
Group experiences lower sales volume in Q1 each year due to the Chinese New Year
holidays. Heat Power provides heating from October 15th each year to April 15th
of the next calendar year, resulting in higher sales and profit in Q1, lower
sales in Q2 and Q4, and no sales from heating in Q3 each year.





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 shares of Heat Power is owned by Coal
Group.





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.


22





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.





Pursuant
to a VIE restructuring as contemplated by a framework contract entered in June
2009, a newly-formed subsidiary of the Company (“CEC China”), will 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 will 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.


23





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





Results
of operations – Three Months Ended May 31, 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 May 31, 2010
compared to May 31, 2009:





Coal Group
                
                Three Months Ended May 31,% to total
                
                
                
                
                
                % to total2010
                
                
                revenue
                
                
                2009
                
                
                revenueRevenues
                
                $
                17,529,033
                
                
                
                86
                
                
                
                1,644,405
                
                
                
                38Cost
      of revenues
                
                $
                9,041,968
                
                
                
                44
                
                
                
                965,883
                
                
                
                22Gross
      Profit
                
                $
                8,487,065
                
                
                
                42
                
                
                
                678,522
                
                
                
                16




Heat Power
                
                Three Months Ended May 31,% to total
                
                
                
                
                
                % to total2010
                
                
                revenue
                
                
                2009
                
                
                revenueRevenues
                
                $
                2,954,707
                
                
                
                14
                
                
                
                2,639,270
                
                
                
                62Cost
      of revenues
                
                $
                2,983,930
                
                
                
                15
                
                
                
                3,271,056
                
                
                
                77Gross
      Profit
                
                $
                (29,223
                )
                
                
                (1
                )
                
                
                (631,786
                )
                
                
                (15
                )





Coal
Group




For the
three months ended May 31, 2010, revenues for Coal Group were $17,529,033
compared to $1,644,405 in the comparable three months in 2009. The $15,884,628
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 Trading
                
                Three Months Ended May 31,% to total
                
                
                
                
                
                % to total2010
                
                
                revenue
                
                
                2009
                
                
                revenueRevenues
                
                $
                7,699,181
                
                
                
                38
                
                
                
                1,141,455
                
                
                
                26Cost
      of revenues
                
                $
                5,198,322
                
                
                
                25
                
                
                
                748,247
                
                
                
                17Gross
      Profit
                
                $
                2,500,859
                
                
                
                13
                
                
                
                393,208
                
                
                
                9




Coal Production
                
                Three Months Ended May 31,% to total
                
                
                
                
                
                % to total2010
                
                
                revenue
                
                
                2009
                
                
                revenueRevenues
                
                $
                9,829,852
                
                
                
                48
                
                
                
                502,950
                
                
                
                12Cost
      of revenues
                
                $
                3,843,646
                
                
                
                19
                
                
                
                217,636
                
                
                
                5Gross
      Profit
                
                $
                5,986,206
                
                
                
                29
                
                
                
                285,314
                
                
                
                7


24





Coal
Group produced approximately 227,000 metric tons of coal during the three months
ended May 31, 2010, compared to 12,000 metric tons in the comparable three
months in 2009. Volume of coal sold by our proprietary trading business was
approximately 183,000 metric tons during the three months ended May 31,
2010, compared to 16,000 metric tons in the comparable three months in 2009. We
expect our 2010 annual production volume to be 800,000 metric tons.





Heat
Power




For the
three months ended May 31, 2010, revenues for Heat Power were $2,954,707
compared to $2,639,270 in the comparable three months in 2009.




For the
three months ended May 31, 2010, revenues generated by Heat Power from its
electricity operations were $1,158,751 compared to $1,033,782 in the comparable
three month period in 2009.  Our revenue during the second quarter
from our electricity operations was as follows:





Electricity
Revenue for Quarter Ended May 31,




Units ofpowersupplied
                
                
                RevenueUnit Price ($/KW.h)
                
                
                (1000KW.h)
                
                
                ($)Period
                
                2010
                
                
                2009
                
                
                2010
                
                
                2009
                
                
                2010
                
                
                2009
                
                
                VarianceMarch
                
                
                0.03
                
                
                
                0.03
                
                
                
                9,042
                
                
                
                14,054
                
                
                
                294,221
                
                
                
                421,620
                
                
                
                (127,399
                )April
                
                
                0.03
                
                
                
                0.03
                
                
                
                15,605
                
                
                
                11,171
                
                
                
                502,567
                
                
                
                335,136
                
                
                
                167,431May
                
                
                0.03
                
                
                
                0.03
                
                
                
                11,523
                
                
                
                9,235
                
                
                
                361,963
                
                
                
                277,026
                
                
                
                84,937Total
                
                
                
                
                
                
                
                
                
                
                36,170
                
                
                
                34,460
                
                
                
                1,158,751
                
                
                
                1,033,782
                
                
                
                124,969




For the
three months ended May 31, 2010, revenues generated by Heat Power from its
heating supply operations were $1,795,956 compared to $1,532,403 in the
comparable three month period in 2009. The $263,553 increase was due to the
increase of heating area to 2.7 million square meters in the second 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 second quarter
from our heating supply operations were as follows:





Heating
Revenue for Quarter Ended May 31,




Unit Price
                
                
                Area (‘000)($/sq meters
                
                
                sq meters
                
                
                Revenue/month)
                
                
                range)
                
                
                ($)User
                
                2010
                
                
                2009
                
                
                2010
                
                
                2009
                
                
                2010
                
                
                2009
                
                
                VarianceResidential
                
                
                0.38*
                
                
                
                0.34
                
                
                
                2,039
                
                
                
                1,440
                
                
                
                1,156,772
                
                
                
                923,380
                
                
                
                233,392Commercial
                
                
                0.64
                
                
                
                0.56
                
                
                
                350
                
                
                
                350
                
                
                
                338,961
                
                
                
                322,964
                
                
                
                15,997Municipal
                
                
                0.64
                
                
                
                0.56
                
                
                
                310
                
                
                
                310
                
                
                
                300,223
                
                
                
                286,059
                
                
                
                14,164Total
                
                
                
                
                
                
                
                
                
                
                2,699
                
                
                
                2,100
                
                
                
                1,795,956
                
                
                
                1,532,403
                
                
                
                263,553




*
            This
      price does not include subsidy received from
  government.


25




Cost
of Sales





For the
three months ended May 31, 2010, cost of sales increased by approximately
$7,788,959 from the comparable three months in 2009, as a result of changes in
the following expenses:




Three Months Ended May 31,2010
                  
                  
                  2009
                  
                  
                  VarianceCoal
      & freight
                  
                  $
                  9,557,244
                  
                  
                  
                  2,526,981
                  
                  
                  
                  7,030,263Heat
      resource rental
                  
                  
                  439,518
                  
                  
                  
                  252,528
                  
                  
                  
                  186,990Depreciation
      & depletion
                  
                  
                  1,078,589
                  
                  
                  
                  604,141
                  
                  
                  
                  474,448Salaries
                  
                  
                  297,141
                  
                  
                  
                  217,199
                  
                  
                  
                  79,942Utilities
                  
                  
                  429,795
                  
                  
                  
                  243,488
                  
                  
                  
                  186,307Operating
      supplies
                  
                  
                  156,719
                  
                  
                  
                  102,335
                  
                  
                  
                  54,384Repairs
                  
                  
                  27,397
                  
                  
                  
                  15,537
                  
                  
                  
                  11,860Others
                  
                  
                  39,495
                  
                  
                  
                  274,730
                  
                  
                  
                  (235,235
                  )Total
                  
                  $
                  12,025,898
                  
                  
                  
                  4,236,939
                  
                  
                  
                  7,788,959




For the
three months ended May 31, 2010 our gross margin was 41% compared with 1% 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 equipment, 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 May 31, 2010, selling expenses increased by approximately
$1,186,048 compared to the same period in 2009 as a result
of the expandsion of our proprietary coal trading business. We were
able to expand such business because we were allotted additional space on
trains from the local railway bureau.  Selling expenses are expected
to increase in line with revenue.




Three Months Ended May 31,2010
                  
                  
                  2009
                  
                  
                  VarianceTransportation
      & Storage
                  
                  $
                  864,642
                  
                  
                  
                  159,745
                  
                  
                  
                  704,897Sales
      tax and other expenses
                  
                  
                  392,623
                  
                  
                  
                  24,347
                  
                  
                  
                  368,276Office
                  
                  
                  82,511
                  
                  
                  
                  5,780
                  
                  
                  
                  76,731Salaries
      and wages
                  
                  
                  37,665
                  
                  
                  
                  5,644
                  
                  
                  
                  32,021Depreciation
                  
                  
                  4,123
                  
                  
                  
                  -
                  
                  
                  
                  4,123Total
                  
                  $
                  1,381,564
                  
                  
                  
                  195,516
                  
                  
                  
                  1,186,048




General
and Administrative Expenses





For the
three months ended May 31, 2010, general and administrative expenses decreased
by approximately $209,896 as a result of changes in the following
expenses:




Six
      Months Ended May 31,2010
                                      
                                      
                                      2009
                                      
                                      
                                      VarianceOffice
                                      
                                      $
                                      166,134
                                      
                                      
                                      
                                      154,891
                                      
                                      
                                      
                                      11,243Professional
      and other fees
                                      
                                      
                                      171,274
                                      
                                      
                                      
                                      377,780
                                      
                                      
                                      
                                      (206,506
                                      )Salaries
      and wages
                                      
                                      
                                      122,210
                                      
                                      
                                      
                                      152,108
                                      
                                      
                                      
                                      (29,898
                                      )Travel
                                      
                                      
                                      70,203
                                      
                                      
                                      
                                      46,831
                                      
                                      
                                      
                                      23,372Depreciation
                                      
                                      
                                      76,109
                                      
                                      
                                      
                                      74,807
                                      
                                      
                                      
                                      1,302Repairs
                                      
                                      
                                      6,466
                                      
                                      
                                      
                                      24,654
                                      
                                      
                                      
                                      (18,188
                                      )Other
                                      
                                      
                                      15,798
                                      
                                      
                                      
                                      7,019
                                      
                                      
                                      
                                      8,779Total
                                      
                                      $
                                      628,194
                                      
                                      
                                      
                                      838,090
                                      
                                      
                                      
                                      (209,896
                                      )




26





Professional
and other fees. Professional fees were paid principally to various professionals
including financial advisors, attorneys and accountants. Fees paid to
professionals decreased significantly for the three months ended May 31, 2010 as
compared to the comparable period in 2009 as a result of due diligence
expenses incurred with the engagement of new service providers in 2009 that did
not reoccur in 2010.




Finance
Expenses





For the
three months ended May 31, 2010 and May 31, 2009, finance expenses amounted to
$555,652, and $103,334, respectively. The interest expense increased because we
borrowed more money from lenders.




Results
of operations – Six Months Ended May 31, 2010





Revenues




The
following is an analysis of our revenues and gross profit, details and analysis
of components of expenses, and variance; for the six months ended May 31, 2010
compared to May 31, 2009.




Coal Group
                
                Six Months Ended May 31,% to total
                
                
                
                
                
                % to total2010
                
                
                revenue
                
                
                2009
                
                
                revenueRevenues
                
                $
                33,776,999
                
                
                
                82
                
                
                
                3,174,288
                
                
                
                34Cost
      of revenues
                
                $
                19,375,642
                
                
                
                47
                
                
                
                2,554,033
                
                
                
                27Gross
      Margin
                
                $
                14,401,357
                
                
                
                35
                
                
                
                620,255
                
                
                
                7




Heat Power
                
                Six Months Ended May 31,% to total
                
                
                
                
                
                % to total2010
                
                
                revenue
                
                
                2009
                
                
                revenueRevenues
                
                $
                7,475,617
                
                
                
                18
                
                
                
                6,124,333
                
                
                
                66Cost
      of revenues
                
                $
                6,476,663
                
                
                
                16
                
                
                
                6,370,158
                
                
                
                69Gross
      Margin
                
                $
                998,954
                
                
                
                2
                
                
                
                (245,825
                )
                
                
                (3
                )




Coal
Group




For the
six months ended May 31, 2010, revenues for Coal Group were $33,776,999 compared
to $3,174,288 in the comparable six months in 2009. The $30,602,711 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 equipment 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 six month period in
2009.





Coal Trading
                
                Six Months Ended May 31,% to total
                
                
                
                
                
                % to total2010
                
                
                revenue
                
                
                2009
                
                
                revenueRevenues
                
                $
                18,101,191
                
                
                
                44
                
                
                
                2,251,210
                
                
                
                24Cost
      of revenues
                
                $
                13,736,357
                
                
                
                33
                
                
                
                2,129,513
                
                
                
                23Gross
      Margin
                
                $
                4,364,834
                
                
                
                11
                
                
                
                121,697
                
                
                
                1


27





Coal Production
                
                Six Months Ended May 31,% to total
                
                
                
                
                
                % to total2010
                
                
                revenue
                
                
                2009
                
                
                revenueRevenues
                
                $
                15,675,808
                
                
                
                38
                
                
                
                923,078
                
                
                
                10Cost
      of revenues
                
                $
                5,639,285
                
                
                
                14
                
                
                
                424,520
                
                
                
                4Gross
      Margin
                
                $
                10,036,523
                
                
                
                24
                
                
                
                498,558
                
                
                
                6





Coal
Group produced approximately 383,000 metric tons of coal during the six months
ended May 31, 2010, compared to 22,000 metric tons in the comparable six months
in 2009. Volume of coal sold by our proprietary trading business is
approximately 353,000 metric tons during the six months ended May 31, 2010,
compared to 33,000 metric tons in the comparable six months in 2009. 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
six months ended May 31, 2010, revenues for Heat Power were $7,475,617 compared
to $6,124,333 in the comparable six months in 2009.





For the
six months ended May 31, 2010, revenues generated by Heat Power from its
electricity operations were $2,146,825 compared to $1,945,428 in the comparable
six month period in 2009. At the same time, revenues generated by Heat Power
from its heating supply operations were $5,328,792 compared to $4,105,820 in the
comparable six month period in 2009. This increase is due to our heating area
expanding to 2.7 million square meters in the second 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.




Cost
of Sales





For the
six months ended May 31, 2010, cost of sales increased by approximately
$16,928,114 from the comparable six months in 2009, as a result of changes in
the following expenses:




Six Months Ended May 31,2010
                  
                  
                  2009
                  
                  
                  VarianceCoal
      & freight
                  
                  $
                  20,654,875
                  
                  
                  
                  5,281,529
                  
                  
                  
                  15,373,346Heat
      resource rental
                  
                  
                  1,425,169
                  
                  
                  
                  744,148
                  
                  
                  
                  681,021Depreciation
      & depletion
                  
                  
                  1,935,152
                  
                  
                  
                  1,340,978
                  
                  
                  
                  594,174Salaries
                  
                  
                  666,644
                  
                  
                  
                  394,168
                  
                  
                  
                  272,476Utilities
                  
                  
                  603,307
                  
                  
                  
                  539,511
                  
                  
                  
                  63,796Operating
      supplies
                  
                  
                  291,243
                  
                  
                  
                  261,827
                  
                  
                  
                  29,416Repairs
                  
                  
                  85,765
                  
                  
                  
                  28,160
                  
                  
                  
                  57,605Other
                  
                  
                  190,150
                  
                  
                  
                  333,870
                  
                  
                  
                  (143,720
                  )Total
                  
                  $
                  25,852,305
                  
                  
                  
                  8,924,191
                  
                  
                  
                  16,928,114




For the
six months ended May 31, 2010 our gross margin was 37% compared with 4% in the
2009 comparable six 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.


28





Selling
Expenses





For the
six months ended May 31, 2010, selling expenses increased by approximately
$1,984,128 compared to the same period in 2009 because we expanded our
proprietary coal trading business since the second fiscal quarter of 2009 as a
result of our receipt of additional space to ship coal on local railcars as
allocated to us by the local railway bureau.  Selling expenses are
expected to increase in line with revenue.




Six Months Ended May 31,2010
                  
                  
                  2009
                  
                  
                  VarianceTransportation
      & Storage
                  
                  $
                  1,388,178
                  
                  
                  
                  159,745
                  
                  
                  
                  1,228,433Sales
      tax and other expenses
                  
                  
                  619,691
                  
                  
                  
                  52,838
                  
                  
                  
                  566,853Office
                  
                  
                  144,493
                  
                  
                  
                  6,351
                  
                  
                  
                  138,142Salaries
      and wages
                  
                  
                  61,911
                  
                  
                  
                  19,219
                  
                  
                  
                  42,692Depreciation
                  
                  
                  8,008
                  
                  
                  
                  -
                  
                  
                  
                  8,008Total
                  
                  $
                  2,222,281
                  
                  
                  
                  238,153
                  
                  
                  
                  1,984,128




General
and Administrative Expenses





For the
six months ended May 31, 2010, general and administrative expenses increased by
approximately $501,702 as a result of changes in the following
expenses:




Six
      Months Ended May 31,2010
                                      
                                      
                                      2009
                                      
                                      
                                      VarianceOffice
                                      
                                      $
                                      468,722
                                      
                                      
                                      
                                      210,630
                                      
                                      
                                      
                                      258,092Professional
      and other fees
                                      
                                      
                                      473,298
                                      
                                      
                                      
                                      486,087
                                      
                                      
                                      
                                      (12,789
                                      )Salaries
      and wages
                                      
                                      
                                      384,769
                                      
                                      
                                      
                                      251,844
                                      
                                      
                                      
                                      132,925Travel
                                      
                                      
                                      197,141
                                      
                                      
                                      
                                      85,151
                                      
                                      
                                      
                                      111,990Depreciation
                                      
                                      
                                      142,415
                                      
                                      
                                      
                                      116,157
                                      
                                      
                                      
                                      26,258Repairs
                                      
                                      
                                      35,546
                                      
                                      
                                      
                                      40,266
                                      
                                      
                                      
                                      (4,720
                                      )Others
                                      
                                      
                                      29,955
                                      
                                      
                                      
                                      40,009
                                      
                                      
                                      
                                      (10,054
                                      )Total
                                      
                                      $
                                      1,731,846
                                      
                                      
                                      
                                      1,230,144
                                      
                                      
                                      
                                      501,702




Salaries
and wages. Salaries and wages increased due to purchases of safety
equipment for coal mine workers and management, increases in salaries and
increases in the number of employees
 
 Travel.
Travel expenses increased due to the work of government inspectors conducting
coal mine inspections and our external service providers such as financial
advisors and investor relations consultants.
  Finance
Expenses
 
 For the
six months ended May 31, 2010 and May 31, 2009, finance expenses amounted to
$771,001, and $198,722, respectively. The interest expense increased because we
borrowed more money from lenders.
 
 Liquidity
and Capital Resources
 
 As of May
31, 2010 we had a working capital deficit of approximately
$18,704,013. Please note that although shareholder loans are payable on
demand and therefore classified as short-term loans, we may not need to pay back
the loan within one year. We do not expect the shareholders to demand payment on
such loans this year.  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.




29





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 5.310% per annum.





The
outstanding balances and interest rate of short-term bank loans obtained by the
Company at May 31, 2010, were as follows:




Balance
                
                
                Interest
                  RateBank
      of Communications, due 3/9/11
                
                $
                5,856,087
                
                
                
                6.372
                %HuaXia
      Bank, due 4/15/11
                
                
                7,320,108
                
                
                
                6.372
                %China
      Construction Bank, due 4/22/11
                
                
                2,928,043
                
                
                
                6.903
                %Total
                
                $
                16,104,238





Cash
Flows





Operating
Activities:





Our cash
flows provided by operating activities was $4,817,289 for the six months ended
May 31, 2010 as compared to cash flows used in operating activities of
$9,397,908 for the six months ended May 31, 2009. The following summarizes the
inflow and outflow of cash for these periods:




Six
      Months Ended
                                May
      31,2010
                              
                              
                              2009Net
      income (loss)
                              
                              $
                              8,426,758
                              
                              
                              
                              (1,498,917
                              )Depreciation
      and amortization
                              
                              
                              2,108,233
                              
                              
                              
                              1,441,566(Increase)
      in term deposit
                              
                              
                              (7,320,108
                              )
                              
                              
                              -(Increase)
      in restricted cash
                              
                              
                              (383,460
                              )
                              
                              
                              -(Increase)
      in accounts receivable
                              
                              
                              (3,048,758
                              )
                              
                              
                              (1,803,791
                              )(Increase)
      in other receivables
                              
                              
                              (88,870
                              )
                              
                              
                              (5,097,545
                              )Decrease
      (Increase) in advances to suppliers
                              
                              
                              1,287,107
                              
                              
                              
                              (770,088
                              )Decrease
      (Increase) in inventory
                              
                              
                              1,579,460
                              
                              
                              
                              (78,612
                              )(Decrease)
      Increase in deferred income
                              
                              
                              (126,984
                              )
                              
                              
                              475,131Increase
      (Decrease) in accounts payable
                              
                              
                              198,588
                              
                              
                              
                              (4,133,827
                              )(Decrease)
      increase in advance from customers
                              
                              
                              (2,363,610
                              )
                              
                              
                              838,514Increase
      in accrued liabilities and other payables
                              
                              
                              4,439,585
                              
                              
                              
                              415,551Others
                              
                              
                              109,348
                              
                              
                              
                              814,110Net
      cash provided (used) by operating activities
                              
                              $
                              4,817,289
                              
                              
                              
                              (9,397,908
                              )




Term
deposit: Term deposit represents amounts legally held by a bank which are not
available for the Company’s general use.  These deposits are held as
collateral for issuance of notes to vendors for purchase of coal which generally
mature between three to six months.


30




Accounts
receivable. The increase in accounts receivables is 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 decreased as a result of less advances made for purchase
of coal and freight from third party suppliers. Coal Group’s advances decreased
during the second quarter of 2010 as a result of less outstanding orders as of
the last day of the quarter.





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 second quarter of
2010 as a result of fewer outstanding orders as of the last day of the
quarter.  The level of advances fluctuates depending upon how quickly
Coal Group customers take delivery of their goods at any given
time.
 
 Inventory.
Inventory mainly consists of coal for trading purposes. The balance of coal
inventory decreased during the second 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.
 
 Accrued
liabilities and other payables. These amounts consist of, among others, loans
borrowed from non-financial institutions, accruals made for loan interest,
repairs and maintenance of heating plants, labor union fees, social insurance
and technical training for our employees. Increase in accrual liabilities
and other payables is mainly due to increase in loans borrowed from
non-financial institutions amounting to $2,928,044.




Investing
Activities:


Our cash
flows used in investing activities were $9,566,083 for the six months ended May
31, 2010 and cash flows used in investing activities were $2,321,944 for the six
months ended May 31, 2009.





Financing
Activities:


Our cash
flows provided by financing activities were $9,953,510 for the six months ended
May 31, 2010 and cash flows provided by financing activities were $12,927,756
for the six months ended May 31, 2009.





The
outstanding balances and interest rate of shareholder loans at May 31, 2010,
were as follows:




Balance
                        
                        
                        Interest
                          RateHangzhou
      Dayuan Group, Ltd.
                        
                        $
                        4,979,281
                        
                        
                        
                        5.310
                        %Xinghe County
      Haifu Coal Transportation & Sales Co., Ltd.
                        
                        
                        1,841,749
                        
                        
                        
                        5.310
                        %Ordos
      City YiYuan Investment Co. Ltd.
                        
                        
                        1,666,191
                        
                        
                        
                        5.310
                        %Yanhua
      Li
                        
                        
                        1,539,126
                        
                        
                        
                        -Yi
      Ding
                        
                        
                        47,217
                        
                        
                        
                        -Total
                        
                        $
                        10,073,564
                        
                        
                        
                        -




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


31


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.




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.  Solely 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 May 31, 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.




We may be
subject to legal proceedings, investigations and claims incidental to the
conduct of our business from time to time. We are not currently a party to any
legal proceedings. We are also not aware of any legal proceeding, investigation
or claim, or other legal exposure that could have a material adverse effect on
our business, financial condition or results of operations.




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 Certification10.1
              
              Independent
      Director Agreement of Paul Li10.2
              
              Independent
      Director Agreement of Stephen Markscheid10.3
              
              Independent
      Director Agreement of Brock
Silvers


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


34