UNITED
STATES


SECURITIES
AND EXCHANGE COMMISSION


Washington,
D.C. 20549





FORM
10-K/A


(Amendment
No. 1)





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


For the
fiscal year ended December 31, 2009





o
            TRANSITION
      REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934


For the
transition period from ________ to _________





Commission
File Number: 000-31539





CHINA
NATURAL GAS, INC.


(Exact
Name of Registrant as specified in its charter)





Delaware
              
              98-0231607(State
      or other jurisdiction of
                Incorporation
      or organization)
              
              (I.R.S.
      Employer
                Identification
      Number)





19th
Floor, Building B, Van Metropolis


Tang Yan
Road, Hi-Tech Zone


Xi’an,
710065, Shaanxi Province, China


(Address
of principal executive office)





Registrant’s
telephone number, including area code: 86-29-88323325





Securities
registered under Section 12(b) of the Exchange Act: None





Securities
registered under Section 12(g) of the Exchange Act:


Common
Stock, $.0001 par value per share


(Title of
Class)





Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.


Yes  ̈No x





Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.


Yes  ̈No x





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes xNo   ̈





Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K (section 229.405 of this chapter) is not contained herein, and
will not be contained, to the best of the registrant’s knowledge, in definitive
proxy or information statements incorporated by reference in Part III of this
Form 10-K or any amendment to this Form 10-K.  o





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





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





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





The
aggregate market value of the voting and non-voting stock held by non-affiliates
of the registrant, as of June 30, 2009, was approximately $156,805,654. All
executive officers and directors of the registrant have been deemed, solely for
the purpose of the foregoing calculation, to be "affiliates" of the
registrant.





As
of February 28, 2010 there were 21,183,904 shares of the issuer's
common stock, $0.0001 par value per share, issued and
outstanding.







EXLANATORY
NOTE
 
 This
Amendment No. 1 on Form 10-K/A (the “Amended Filing”) amends the annual report
on Form 10-K for the year ended December 31, 2009, originally filed on March 10,
2010 (the “Original Filing”), of China Natural Gas, Inc. (the “Company”). The
purpose of this amendment is to disclose the bank loan entered into by the
Company on February 26, 2010 in the amount of $17.7 million (the “Bank Loan”)
which requires the revision of (i) Part II, Item 8, Financial Statements to
disclose the Bank Loan as a subsequent event in a footnote to the financial
statements and to record  the effects of the Bank Loan which include
the reclassification of the Company senior notes payable and the fair value of
the redeemable warrants and (ii) Part II, Item 9A, Controls and Procedures as a
result of the failure to disclose the Bank Loan.
 
 In
accordance with Rule 12b-15 under the Exchange Act, each item of the Original
Filing that is amended by this Amended Filing is also restated in its entirety,
and this Amended Filing is accompanied by currently dated certifications on
Exhibits 31.1, 31.2, 32.1 and 32.2 by the Company’s Chief Executive Officer and
Chief Financial Officer. Except as described above, this Amended Filing does not
amend, update, or change any items, financial statements, or other disclosures
in the Original Filing, and does not reflect events occurring after the filing
of the Original Filing, including as to any exhibits to the Original Filing
affected by subsequent events. Information not affected by the changes described
above is unchanged and reflects the disclosures made at the time of the Original
Filing. Accordingly, this Amended Filing should be read in conjunction with the
Original Filing and our other SEC filings subsequent to the filing of the
Original Filing, including any amendments to those filings. Capitalized terms
not defined in the Amended Filing are as defined by the Original
Filing.




FORM
10-K


FOR
THE FISCAL YEAR ENDED DECEMBER 31, 2009





INDEX





PagePART
      IITEM
      1.
                  
                  BUSINESS
                  
                  2ITEM
      1A
                  
                  RISK
      FACTORS
                  
                  11ITEM
      1B
                  
                  UNRESOLVED
      STAFF COMMENTS
                  
                  35ITEM
      2.
                  
                  PROPERTIES
                  
                  36ITEM
      3.
                  
                  LEGAL
      PROCEEDINGS
                  
                  37ITEM
      4.
                  
                  SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY HOLDERS
                  
                  37PART
      IIITEM
      5.
                  
                  MARKET
      FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES
                  
                  37ITEM
      6.
                  
                  SELECTED
      FINANCIAL DATA
                  
                  39ITEM
      7.
                  
                  MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATIONS
                  
                  40ITEM
      7A.
                  
                  QUANTITATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
                  
                  63ITEM
      8.
                  
                  FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA
                  
                  64ITEM
      9.
                  
                  CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE
                  
                  65ITEM
      9A.
                  
                  CONTROLS
      AND PROCEDURES
                  
                  65ITEM
      9B.
                  
                  OTHER
      INFORMATION
                  
                  68PART
      IIIITEM
      10.
                  
                  DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
                  
                  68ITEM
      11.
                  
                  EXECUTIVE
      COMPENSATION
                  
                  72ITEM
      12.
                  
                  SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS
                  
                  80ITEM
      13.
                  
                  CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE
                  
                  82ITEM
      14.
                  
                  PRINCIPAL
      ACCOUNTING FEES AND SERVICES
                  
                  82PART
      VITEM
      15.
                  
                  EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES
                  
                  83










STATEMENT
REGARDING FORWARD-LOOKING STATEMENTS





Except
for the historical information contained herein, some of the statements in this
Report contain forward-looking statements that involve risks and uncertainties.
These statements are found in the sections entitled "Business," "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
"Risk Factors." They include statements concerning: our business strategy;
expectations of market and customer response; liquidity and capital
expenditures; future sources of revenues; expansion of our product lines;
addition of new product lines; and trends in industry activity generally. In
some cases, you can identify forward-looking statements by words such as "may,"
"will," "should," "expect," "plan," "could," "anticipate," "intend," "believe,"
"estimate," "predict," "potential," "goal," or "continue" or similar
terminology. These statements are only predictions and involve known and unknown
risks, uncertainties and other factors, including, but not limited to, the risks
outlined under "Risk Factors," that may cause our or our industry's actual
results, levels of activity, performance or achievements to be materially
different from any future results, levels of activity, performance or
achievements expressed or implied by such forward-looking statements. For
example, assumptions that could cause actual results to vary materially from
future results include, but are not limited to: our ability to successfully
develop and market our products to customers; our ability to generate customer
demand for our products in our target markets; the development of our target
markets and market opportunities; our ability to produce and deliver suitable
products at competitive cost; market pricing for our products and for competing
products; the extent of increasing competition; technological developments in
our target markets and the development of alternate, competing technologies in
them; and sales of shares by existing shareholders. Although we believe that the
expectations reflected in the forward-looking statements are reasonable, we
cannot guarantee future results, levels of activity, performance or
achievements. Unless we are required to do so under U.S. federal securities laws
or other applicable laws, we do not intend to update or revise any
forward-looking statements.


1


ITEM
1. BUSINESS





Overview





We are an
integrated natural gas operator in The Peoples’ Republic of China (“China” or
the “PRC”),  primarily involved in the distribution of compressed
natural gas (“CNG”) through our
variable interest entity (“VIE”)-owned CNG
fueling stations. As of December 31, 2009, we operated 24 CNG fueling stations
in Shaanxi province and 12 CNG fueling stations in Henan province. Our VIE
own our CNG fueling stations while we lease the land upon which our VIE-owned
CNG fueling stations operate. For the year ended December 31, 2009, we sold CNG
of 164,343,895 cubic meters through our VIE-owned fueling stations, compared to
149,412,144 cubic meters for the year ended December 31, 2008. We also
transport, distribute and sell piped natural gas to residential and commercial
customers in the Xi’an area, including Lantian County, and the districts of
Lintong and Baqiao, in Shaanxi province through a high pressure pipeline network
of approximately 120 kilometers.





We
operate four main business lines:





·
            Distribution
      and sale of CNG through our VIE-owned CNG fueling stations for hybrid
      (natural gas/gasoline) powered vehicles (36 stations as of December 31,
      2009);





·
            Installation,
      distribution and sale of piped natural gas to residential and commercial
      customers through our VIE-owned pipelines. We distributed and sold piped
      natural gas to approximately 108,423 residential customers as of December
      31, 2009;





·
            Distribution
      and sale of gasoline through our VIE-owned CNG fueling stations for
      gasoline and hybrid (natural gas/gasoline) powered vehicles (eight of our
      CNG fueling stations sold gasoline as of December 31, 2009);
      and





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





We buy
all of the natural gas that we sell and distribute to our customers. We do not
mine or produce any of our own natural gas and have no plans to do so during the
next 12 months. We currently sell our natural gas in two forms: (i) CNG and (ii)
piped natural gas.





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


2





We had
total revenues of $81,066,118, $67,720,659 and $35,392,053 for the years ended
December 31, 2009, 2008 and 2007, respectively.  We had net income of
$18,830,787, $15,190,368 and $9,116,070 for the years ended December 31, 2009,
2008 and 2007, respectively. We had total assets of $197,614,516, $118,262,291
and 53,289,998 as of December 31, 2009, 2008 and 2007,
respectively.





Our
Corporate History and Structure





We were
incorporated in the state of Delaware on March 31, 1999, as Bullet Environmental
Systems, Inc. On May 25, 2000 we changed our name to Liquidpure Corp. and on
February 14, 2002 we changed our name to Coventure International, Inc.
("Coventure").





On
December 6, 2005, Coventure issued an aggregate of 4 million shares to all of
the registered shareholders of XXNGC, and entered into exclusive arrangements
with XXNGC and these shareholders that give us the ability to substantially
influence XXNGC's daily operations and financial affairs, appoint its senior
executives and approve all matters requiring shareholder approval. On December
19, 2005, we changed our name to China Natural Gas, Inc.





On
February 22, 2006, we formed Shaanxi Xilan Natural Gas Equipment Co., Ltd.,
("SXNGE") as a wholly foreign owned enterprise (“WFOE”). We then, through SXNGE
entered into exclusive arrangements with XXNGC and these shareholders that give
us the ability to substantially influence XXNGC's daily operations and financial
affairs, appoint its senior executives and approve all matters requiring
shareholder approval. We memorialized these arrangements on August 17, 2007. As
a result, we consolidate the financial results of XXNGC as a variable interest
entity pursuant to FASB accounting standard.





On
October 24, 2006, XXNGC formed a wholly-owned subsidiary, Shaanxi Jingbian
Liquefied Natural Gas Co., Ltd. (“SJLNG”), a limited liability company organized
under the laws of the PRC to administer the production and sales of
LNG.





On
December 1, 2006, XXNGC formed a wholly-owned subsidiary, Xi'an Xilan Auto Body
Shop Co., Ltd. ("XXABC"), which converts gasoline-fueled vehicles to hybrid
(natural gas/gasoline) powered vehicles.





On July
3, 2008, XXNGC formed a wholly owned subsidiary, Henan Xilan Natural Gas Co.,
Ltd. ("HXNGC"), for the purpose of improving the efficiency of our natural gas
fueling station operations, pipeline construction, engineering design,
construction and technical advisory work services in Henan province. HXNGC also
operates our CNG fueling stations in Henan province.





On
October 2, 2008, XXNGC acquired a 100% equity interest in Lingbao Yuxi Natural
Gas Co., Ltd. ("LBNGC"), which possesses the right to operate CNG fueling
stations and pipelines in the city of Lingbao, from the shareholders of LBNGC,
Zhihe Zhang, who held a 90% ownership interest in Henan, and Lingjun Hu, who
held a 10% ownership interest in Henan.





On
October 27, 2009, XXNGC formed Henan CNPC Kunlun Xilan Compressed Natural Gas
Co., Ltd. (“JV”) as a joint venture with China National Petroleum Corporation
Kunlun Natural Gas Co., Ltd. (“CNPC Kunlun”) in Henan province, PRC. The JV was
established to build and operate CNG compressor stations and fueling stations,
sell CNG, provide vehicle conversion services from gasoline-fueled vehicles to
hybrid (natural gas/gasoline) powered vehicles and technical advisory work
services in Henan, PRC. CNPC Kunlun will hold 51% ownership of the JV, and XXNGC
will hold 49% ownership.


3





On October
27, 2009, CHNG formed Xilan Energy Co., Ltd. (“XEC”) as a wholly owned
limited liability company in Hong Kong.  XEC was established for the
purpose of importing liquid natural gas (“LNG”) into PRC.





On
December 17, 2009, XXNGC formed Hubei Xilan Natural Gas Co., Ltd. (“HBXNGC”) as
a wholly owned limited liability company in Hubei province,
PRC.  HBXNGC was established to construct harbor LNG fueling stations
and ships in Hubei, PRC.





The
following diagram illustrates our corporate and share ownership
structure:











Our
Variable Interest Entity Agreements





The
following is a summary of the agreements we have with our variable interest
entity, XXNGC:





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





Operating
Agreement, dated August 17, 2007. Under this agreement entered into between
SXNGE, on the one hand, and XXNGC and certain shareholders of XXNGC, on the
other hand, SXNGE agrees to act as a guarantor for XXNGC in the contracts,
agreements or transactions in connection with XXNGC’s operation between XXNGC
and any other third party, to provide full guarantee for the performance of such
contracts. XXNGC agrees, as a counter-guarantee, to pledge all of its assets,
including accounts receivable to SXNGE. The XXNGC shareholders party to this
operating agreement agree to, among other things, appoint as XXNGC's director,
individuals recommended by XXNGC and appoint SXNGE's senior officers as XXNGC's
general manager, chief financial officer and other senior officers. The term of
this agreement is indefinite unless SXNGE notifies XXNGC of its intention to
terminate this agreement with 30 days prior notice. XXNGC may not terminate this
agreement during its term. This agreement is retroactive to March 8,
2006.


4





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





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





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





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





Our
Products, Services and Customers





CNG and Gasoline Fueling
Stations





As of
December 31, 2009, our VIE operated 24 CNG fueling stations in the Shaanxi
province and 12 CNG fueling stations in Henan province. Through these VIE-owned
fueling stations, CNG is sold to taxis, buses and private cars that operate with
CNG technology. During the year ended December 31, 2009, we purchased natural
gas at an average cost of RMB1.11/cubic meter and sold each cubic meter for
RMB2.33 net of value added taxes in Shaanxi province and we purchased natural
gas at an average cost of RMB1.19/cubic meter and sold each cubic meter for
RMB2.83 net of value added taxes in Henan province.


5





We
continue to expand our VIE-owned CNG fueling station base by constructing new
stations as well as acquiring existing stations. We can obtain approvals and
construct a CNG fueling station in Shaanxi province in approximately 60 days for
a cost of approximately US$1,300,000 to US$1,500,000. We are evaluating
additional sites for CNG fueling stations in Shaanxi, Henan and in other
regions.





Our VIE
also own three natural gas compressor stations. Two are located in Xi’an:
Hongqing station, acquired in July 2005, near our pipeline; and Changsheng
station, acquired in September 2008. The third station is located in Xianyang
city and was acquired in January 2008. A compressor station compresses natural
gas and allows trucks to transport CNG to fueling stations. We currently have a
daily processing capacity of 250,000 cubic meters of CNG.





We began
to distribute and sell gasoline during the fourth quarter of 2007 in an effort
to support our sales of CNG by attracting more natural gas/gasoline hybrid car
owners through providing a one-stop refueling option for such customers. Our
gasoline facilities were either installed by us at our existing CNG stations or
acquired through our acquisition of CNG fueling stations that have both CNG and
gasoline fueling capability. As of December 31, 2009, we distributed and sold
gasoline at eight of our VIE-owned CNG fueling stations for gasoline and hybrid
(natural gas/gasoline) powered vehicles in Xi'an. During the year ended December
31, 2009, we purchased gasoline at an average cost of RMB4.13/liter and sold
each liter at an average price of RMB4.39/liter net of value added taxes in
Xi'an.





Our Pipeline Distribution
System





Our VIE
own and operate a high pressure pipeline network of approximately 120 kilometers
in the Xi’an area. The network connects to a high pressure government pipeline
network operated by Shaanxi Natural Gas Company, which supplies natural gas
directly from a gas field in the northern region of the province. Our high
pressure pipeline then feeds into city-gate "let-down" stations at Hongqing and
Lantian County, where the pressure is reduced and natural gas is transported
through a network of low-pressure distribution pipes to supply our residential
and commercial customers in Lantian County and the Lintong and Baqiao Districts.
The supply also feeds our compressor stations at Hongqing and Xianyan
where CNG is collected by tankers to supply our CNG fueling
stations.





Each of
our pipeline customers is physically connected to our pipeline network through
Company-installed and maintained piping and natural gas usage gauges. We
generate revenues both from the sale of natural gas to these customers and the
installation and maintenance of this equipment.





We
believe we are currently the sole authorized provider of natural gas to
residential customers in our service areas and the only privately owned company
in Shaanxi province to own and operate this type of high pressure
pipeline.


6





Our Automobile Conversion
Sites





We began
our automobile conversion business during the second quarter of 2007. Our
automobile conversion sites convert gasoline-fueled vehicles to hybrid (natural
gas/gasoline) powered vehicles. As of December 31, 2009, we had four auto
conversion sites, all in the Xi'an area.





Our CNG
Market





As of
December 31, 2009, there were 3,639 buses and 10,646 taxes powered by CNG in
Xi’an, which accounts for approximately 97% and 91% of the total market,
respectively. Each bus uses an average of approximately 100 cubic meters of CNG
per day and each taxi uses an average of approximately 30 cubic meters of CNG
per day (Source:  PRC Ministry of Science and Technology). The PRC
government estimates in its Eleventh Five Year Plan (2006-2010) that current
total demand for CNG as a vehicular fuel in the Xi’an area will reach
approximately 1,070,000 cubic meters per day by 2010. Compared to gasoline and
diesel, we believe natural gas as vehicular fuel is cheaper, cleaner and safer.
The PRC government’s Clean Energy Policy encourages the use of CNG as a
vehicular fuel.





We
estimate that the average CNG station in Xi’an pumped approximately 11,000 cubic
meters of CNG per day in 2009. As of December 31, 2009, there were 73 CNG
fueling stations in Xi’an and we estimate that approximately 803,000 cubic
meters of CNG was pumped per day during 2009, a figure below estimated total
demand. As a result, we believe that there is unmet demand for CNG as vehicular
fuel in the Xi’an area.





As of
December 31, 2009, there were approximately 2,100 buses and 8,900 taxes powered
by CNG in Zhengzhou, which account for approximately 50% and 84% of the market
shares, respectively. (Source: Zhengzhou Evenings). We estimate each bus uses an
average of approximately 100 cubic meters of CNG per day and each taxi uses an
average of approximately 30 cubic meters of CNG per day.





We
estimate that the average CNG station in Henan pumped approximately 11,000 cubic
meters of CNG per day in 2009. As of December 31, 2009, there were 42 CNG
fueling stations in Henan and we estimate that approximately 462,000 cubic
meters of CNG was pumped per day during 2009, a figure below estimated total
demand. As a result, we believe that there is unmet demand for CNG as vehicular
fuel in the Henan area.





While
there are many competitors in the distribution and sale of CNG in China, we
believe we are well positioned in the market through our cooperation with local
natural gas suppliers and our experience in Shaanxi and Henan.





Our Pipeline Network
Customers





As of
December 31, 2009, we had 108,423 customers, including residential and
commercial customers. We continue to expand our customer base in Xi’an's newly
developed business and residential areas including Baqiao, Hongqing and Xihang
as well as Lingbao in Henan Province. Our commercial customers, including the
Xiwei Aluminum Company and the Hungtian Company, use natural gas as a raw
material for their production process. We are not dependent upon any single
customer or group of customers for a material portion of our natural gas sales
or revenues.





Our
pipeline customers purchase natural gas by prepaid cards that can be inserted
into the connection equipment to initiate gas flow.


7





We
entered into agreements with the Xi’an International Port Administrative
Committee (the “Port Committee”) and the town of Tangyu, China, in April 2008
and October 2008, respectively, to provide natural gas to local residents and
businesses. The international port project is estimated to involve the
development of approximately 13.5 square miles of business district and the
investment of up to $30 million over the next several years, based on the Port
Committee’s planning schedule. The Tangyu project involves supplying natural gas
to potentially 50,000 residential and commercial users at a tourist site
undergoing development and expansion. Our agreement with the Port Committee is
currently being challenged by the Xi'an Municipal Administration Commission for
violating an exclusive agreement between the municipal government and Qin Hua
Gas Company, one of our major competitors in our pipeline natural gas business.
We disagree with the Xi'an Municipal Administration Commission's assessment
and are currently in negotiations with it to resolve its
assessment.





Our Liquefied Natural Gas
(“LNG”)
Project





In
September 2007, we began the construction of an LNG processing and distribution
plant in Jingbian, Shaanxi province (the "LNG Project"). We estimate that the
LNG Project will cost approximately $50 million, funded through the sale of
senior notes to Abax and our September 2009 equity financing, as well as cash
flows from operations. We believe we have obtained all the required permits and
approvals to build the LNG plant and expect construction to be completed by the
second quarter of 2010.





During
2009, we made significant progress towards completing the LNG Project and spent
approximately $31 million in constructing our LNG facility, acquiring technology
licenses, prepaying for equipment purchases and acquiring land use rights. We
believe that adding LNG to our product offerings will expand our geographic
sales footprint and improve our revenues and profitability as well as diversify
our revenue and profit structure.





Both CNG
and LNG are natural gas compressed into canisters for convenient transportation,
usually by tank trucks, to locations of distribution or consumption. Typically,
CNG is compressed at 200 kilograms per cubic centimeter and LNG is compressed at
up to 625 times atmospheric pressure per normal cubic meter and must be
transported at sub-zero temperatures. The cost of compressing and processing LNG
is higher than CNG, but LNG can be transported in larger volumes and over longer
distances per tanker and the per unit transportation costs are therefore lower
than CNG.





We
believe we are well positioned in the LNG business because the NDRC has stopped
approving LNG projects based on onshore gas fields that involve the processing
of domestic natural gas supplies since August 2007.





Suppliers





We
purchase our natural gas mainly from four vendors, namely, Shaanxi Natural Gas
Co. Ltd., Petrochina Chang Qing Oil Field Branch, Jiyuan City Yuhai Gas Co.,
Ltd. and Qinshui Lanyan Coal Bed Methane Co., Ltd. Our supply contract with
our largest supplier, Shaanxi Natural Gas Co. Ltd., is renewed on an annual
basis. We have supply agreements with Petrochina Chang Qing Oil Field Branch,
Jiyuan City Yuhai Gas Co., Ltd. and Qinshui Lanyan CoalBed Methane Co., Ltd.
with no minimum purchase requirements. Our procurement price in Henan has
increased from RMB 1.00/cubic meter to RMB 1.30/cubic meter starting June
2009. We do not expect the price to change materially in 2010.


8





On
October 19, 2006, we received a letter from PetroChina Company Limited pursuant
to which PetroChina agreed in principle to supply up to 150 million cubic meters
of natural gas annually to our LNG Project subsidiary subject to the negotiation
of a final agreement once our LNG plant is near completion.





We do not
expect any difficulty in continuing to renew our supply contracts during the
next 12 months.





Intellectual
Property





We have
applied for a service mark on the “Xilan” name, which is used in connection with
all our products and services. XXNGC is currently preparing to apply for the
“CNG” trademark. XXNGC has also applied for the registration of its corporate
name as a trademark under Application No. 5055703. This application has been
published for opposition. If there are no successful oppositions once this
opposition period expires on September 7, 2009, our corporate name will be
registered as a trademark.





Research
and Development





We
incurred $83,708 expense in connection with the experiment of converting diesel
/ gasoline fueled ships to be able to run on natural gas. The funding for all
research and development expenses is expected to come from operating cash
flows.





Governmental
and Environmental Regulation





To date,
we have complied with, or are in the process of renewing, all registrations and
requirements for the issuance and maintenance of all licenses required by the
applicable governing authorities in China. These licenses include:





·
            Xi’an
      Natural Gas Operations License, authorized by the Shaanxi Municipal
      Management Committee, effective from August 18, 2009 to August 17,
      2010.





·
            License
      to Supply, Install Equipment and Maintain Gas Fuel Lines issued by the
      local Gas Fuels for Heating Bureau, an agency of the Ministry of
      Construction and the Xi’an Natural Gas Management Bureau. (License number:
      XIRAN 136)





·
            Safety
      and Inspection Regulation for Special Equipment Safety Inspection
      Standards for High Pressure Pipeline and Technical Safety Inspection
      Regulations from the Shaanxi Quality and Technology Inspection Bureau for
      compressor stations and pressure storage tank system. (Approval letter
      reference: 2004SHAANGUOCHUHAN033)





·
            Annual
      Safety Inspection of Lightning Conductor Equipment approved by the Shaanxi
      Meteorology Bureau. (Certificate number 0005274) The City-gate and
      Compressor Stations are approved by the local office of the Ministry of
      Construction.


9





·
            Business
      license to operate Shaanxi Xilan Natural Gas Equipment Co., Ltd. effective
      from February 22, 2006 to February 21,
2021.





·
            Business
      license to operate Xi’an Xilan Natural Gas Co., Ltd. effective as of
      January 8, 2000.





·
            Business
      license to operate Xi’an Xilan Auto Body Shop Co., Ltd. effective as of
      December 1, 2006.





·
            Business
      license to operate Shaanxi Jingbian Liquefied Natural Gas Co. Ltd.
      effective from October 24, 2006 to October 23,
  2036.





·
            Business
      license to operate Henan Xilan Natural Gas Co. Ltd. effective from July 3,
      2008 to June 25, 2018.





·
            Business
      license to operate Lingbao Yuxi Natural Gas Co., Ltd. effective from June
      13, 2008 to June 12, 2012.





·
            Business
      license to operate Hubei Xilan Natural Gas Co., Ltd. effective from
      December 17, 2009 to December 16,
2010.





·
            Business
      license to operate Xilan Energy Co., Ltd. effective from October 27, 2009
      to October 26, 2010.





·
            Business
      license to operate Henan CNPC Kunlun Xilan Compressed Natural Gas Co.,
      Ltd. effective from October 27, 2009 to October 22,
  2029.





Fuel
service station standards are subject to regulation by the Ministry of
Construction, the General Administration of Quality Supervision and the Bureau
of Inspection and Quarantine of the People's Republic of China. Upon
satisfactory inspection of service stations, certificates will be
issued.





Various
standards must be met for fueling stations, including the handling and storage
of CNG, tanker handling and compressor operation. The Local Ministry of
Construction and the Gas Field Operation Department of the Municipal
Administration Committee regulate these standards. The Municipal Development and
Reform Commission, which issues certificates for the handling of dangerous
chemical agents, carries out inspections.





Standards
for the design and construction of fueling stations must conform to GB50156-2202
and technology standard BJJ84-2000.





Employees





As of
December 31, 2009, we had 868 employees, including, 94 in management, 8 in
sales, and 766 in finance, accounting, and operations. We have not experienced
any industrial actions and we believe we have good relationships with our
employees. We are not a party to any collective bargaining
agreements.


10





Available
Information





Our
website is http://www.naturalgaschina.com/.  We provide free access to
various reports that we file with, or furnish to, the U.S. Securities and
Exchange Commission, or the SEC, through our website, as soon as reasonably
practicable after they have been filed or furnished.  These reports
include, but are not limited to, our annual reports on Form 10-K, quarterly
reports on Form 10-Q, current reports on Form 8-K, and any amendments to those
reports.  Information on our website does not constitute part of
and is not incorporated by reference into this Annual Report on Form 10-K or any
other report we file or furnish with the SEC.  You may also read and
copy any document that we file at the public reference facilities of the SEC in
Washington, D.C. You may call the SEC at 1-800-SEC-0330 for further information
on the public reference rooms. Our SEC filings are also available to the public
from the SEC’s website at http://www.sec.gov.





ITEM
1A. RISK FACTORS





RISK
FACTORS





An
investment in our common stock involves a high degree of risk and uncertainty.
You should carefully consider the risks described below, together with the other
information contained in this prospectus, including the consolidated financial
statements and notes thereto of our Company, before deciding to invest in our
common stock. The risks described below are not the only ones facing our
Company. Additional risks not presently known to us or that we presently
consider immaterial may also adversely affect our Company. If any of the
following risks occur, our business, financial condition and results of
operations and the value of our common stock could be materially and adversely
affected.





Risks
Related to Our Business and the PRC Natural Gas Industry





We
may be adversely affected by the slowdown of China’s economy caused in part by
the recent global crisis in the financial services and credit
markets.





We rely
on demand for natural gas in China for our revenue growth, which is
substantially affected by the growth of the industrial base, increase in
residential and vehicle consumption and the overall economic growth of China.
The growth of China’s economy experienced a slowdown in late 2007. We believe a
number of factors contributed to this slowdown, including appreciation of
the Renminbi against the U.S. dollar and the Euro, which has adversely affected
China’s exports, and tightening macroeconomic measures and monetary policies
adopted by the PRC government aimed at preventing overheating of
China’s economy and controlling China’s high level of inflation. The
slowdown was further exacerbated by the recent global crisis in the financial
services and credit markets, which has resulted in extreme volatility and
dislocation of the global capital markets.





It is
uncertain how long the global crisis in the financial services and credit
markets will continue and the impact this will have on the global economy in
general and the economy of China in particular. We are currently unable to
estimate the impact the slowing of the PRC economy will have on our business as
the impact of the decline in international trade is being offset in part through
domestic stimulus spending, expanded bank lending, increases in the speed of
regulatory approvals of new construction projects and other economic
policies. We do not believe we have experienced reduced demand for natural gas
to date. If the economic downturn continues, our business may be negatively
affected by any decrease in demand for our natural gas products and services.
Reduction in demand for natural gas would have a material and adverse effect on
our financial condition and results of operations. In particular, if customers
of taxis come to rely more on mass transit rather than taxis, a decline in
demand for taxis may result in a decline of CNG as a vehicle fuel which
would adversely affect our revenue and ability to sustain and grow our
operations.


11





We
have benefited from the natural gas procurement and sale prices set by
government authorities.





Natural
gas sales accounted for 76.8%, 82.3% and 79.9% of our revenue for the three
years ended December 31, 2009, 2008 and 2007, respectively. However, the prices
at which we purchase our natural gas supplies and sell our natural gas products
are strictly regulated by the PRC central government, including the National
Development and Reform Commission (“NDRC”), and the local state price bureaus
who have the discretion to set natural gas prices within the boundaries set by
the PRC central government. Our results of operations for the periods reviewed
have benefited from the natural gas procurement and sale prices set by
government authorities. There is no assurance that the government authorities
will continue to set natural gas procurement and sale prices at levels that will
allow us to improve or even maintain our margins. Increased natural gas prices
affect the cost to us of natural gas and will adversely impact our margins in
cases where we are unable to pass on the increased costs to our customers. In
addition, higher natural gas prices may adversely impact the adoption of CNG and
LNG and have a material and adverse effect on our financial condition and
results of operations.





Our
competitors and potential competitors may be larger than us and have greater
financial and other resources than we do and those advantages could make it
difficult for us to compete with them.





We expect
to face intense competition in the natural gas industry, including in both the
CNG and LNG industries. Our current, and potential, competitors include
companies that are part of much larger companies, including state-owned
enterprises. These companies are likely to have greater resources than we do,
including longer operating history, larger customer base, stronger customer
relationships, greater brand or name recognition and greater financial,
technical, marketing, relationship and other resources and may be able to use
these greater resources to enter into the CNG and LNG industries and gain
substantial market share. Competition could result in price reductions, fewer
purchases, reduced gross margins and loss of market share. If we are unable to
remain competitive, we may not be able to establish our LNG business, expand our
CNG business into new provinces or even maintain our current share of the
CNG market in China.





Prices
of natural gas in the PRC are subject to government regulation and can be
subject to significant fluctuations.





Although
regulated by the PRC central government, natural gas prices in China can be
subject to significant fluctuations. Natural gas prices may be increased by the
government for policy or other reasons including in response to changing
national or international market forces, such as changes in domestic and foreign
supplies of natural gas, domestic storage levels, crude oil prices, the price
difference between crude oil and natural gas, price and availability of
alternative fuels, weather conditions, level of consumer demand, economic
conditions, price of foreign natural gas imports, and domestic and foreign
governmental regulations and political conditions. The volatility of natural gas
prices could adversely impact the adoption of CNG vehicle fuel and our
business.


12





Natural
gas operations entail inherent safety and environmental risks that may result in
substantial liability to us.





Natural
gas operations entail inherent risks, including equipment defects, malfunctions
and failures, human error and natural disasters, which could result in
uncontrollable flows of natural gas, fires, explosions, property damage, injury
and death. For example, a competitor of ours in Xi'an providing natural gas to
residences recently experienced an accident resulting in significant property
damage, injury and death. CNG fuel tanks, if damaged or improperly maintained,
may rupture and the contents of the tank may rapidly decompress and result in
death or injury. Also, operation of LNG pumps requires special training and
protective equipment because of the extreme low temperatures of LNG. LNG tanker
trailers have also in the past been, and may in the future be, involved in
accidents that result in explosions, causing loss of life, injury and property
damage. Improper loading of LNG vehicles can result in venting of methane gas,
leading to explosions.





Inherent
in our natural gas pipeline business are a variety of hazards and operational
risks, such as leaks, ruptures and mechanical problems. The location of
pipelines near populated areas, including residential areas, commercial business
centers, industrial sites and other public gathering places, could increase the
level of damage resulting from these risks, including the loss of human life,
significant damage to property, environmental damage, impairment of our
operations and substantial loss to us. The risks associated with our natural gas
businesses may expose us to liability for personal injury, wrongful death,
property damage, pollution and other environmental damage. We may incur
substantial liability and cost if damages are not covered by insurance or are in
excess of policy limits.





We
are dependent on a limited number of suppliers of natural gas, which may affect
our ability to supply natural gas to our customers.





With the
exception of certain compressed and liquid natural gas supplies, we obtain our
supplies of natural gas primarily from four suppliers. The ability to deliver
our product is dependent on a sufficient supply of natural gas and if we are
unable to obtain a sufficient natural gas supply, we may be prevented from
making deliveries to our customers. While we have supply contracts, we do
not control our suppliers, nor are we able to control the amount of time and
effort suppliers put forth on our behalf. It is possible that our suppliers will
not perform as expected and that they may breach or terminate their agreements
with us. Our supply contract with our largest supplier Petrochina Chang Qing Oil
Field Branch. It is possible that, after a review of our supply contract, they
will choose to provide services to a competitor. Any failure to obtain supplies
of natural gas could prevent us from delivering our product to our
customers and could have a material adverse affect on our business and financial
condition.





Our
growth depends in part on environmental regulations and programs mandating the
use of cleaner burning fuels, and modification or repeal of these regulations
may adversely impact our business.





Our
business depends in part on environmental regulations and programs in China that
promote the use of cleaner burning fuels, including natural gas, for vehicles.
In particular, China’s 11th Five-Year Plan (2006-2010) has made the development
of natural gas engines for heavy-load trucks a national key development project.
In order to meet the demand for natural gas, the PRC government has encouraged
private companies to invest in and build the necessary transportation,
distribution and sale infrastructure for natural gas. On February 24, 2005,
China’s State Council issued an opinion encouraging and supporting private
sector businesses to become involved in industries that were previously
controlled by state-owned enterprises, including oil and natural gas
distribution. In 2007, China's State Development and Reform Commission
officially included CNG/gasoline hybrid vehicles in the country's "encouraged
development" category. In addition, local governments, including those in
Chongqing, Hangzhou, Nanjing, Lanzhou and Dongguan have enacted policies
providing subsidies to taxis and buses which covert their gasoline vehicles to
CNG/gasoline hybrid vehicles. Any delay, repeal or modification of these
regulations or programs that encourage the use of natural gas for vehicles could
have a detrimental effect on the PRC natural gas industry, which, in turn, could
slow our growth and materially adversely affect our business.


13





The
infrastructure to support coal, gasoline and diesel consumption is vastly more
developed than the infrastructure for natural gas vehicle and industrial
fuels.





Coal,
gasoline and diesel fueling stations and service infrastructure are widely
available in China. For natural gas vehicle and industrial fuels to achieve more
widespread use in China, they will require a promotional and educational effort
and the development and supply of more natural gas vehicles and fueling
stations. This will require significant continued effort by us as well as the
government, and we may face resistance from oil companies, coal companies and
gasoline station operators. Also, a prolonged economic recession and continued
disruption in the capital markets may make it difficult or impossible to obtain
financing to expand the natural gas vehicle and industrial fuel infrastructure
and impair our ability to grow our business. There is no assurance natural gas
will ever achieve the level of acceptance as a vehicle and industrial
fuel necessary for us to expand our business significantly.





The
expansion of our business into LNG may not be as successful as our CNG business,
or at all.





Although
a similar business to CNG, our expansion into the LNG business entails different
technology and requires us to expand into new markets where permitting,
environmental issues, lack of materials and lack of human resources, among other
factors, could complicate our ability to operate our LNG processing facility and
successfully compete in the LNG segment. In contrast to CNG, the compression and
production costs of LNG are higher than CNG due to LNG's more complicated and
technical process and we may be unable to complete and operate our LNG expansion
successfully due to the advanced technology involved in its production and sale.
In addition, the construction of the LNG processing facility could also create
increased financial exposure through start-up delays, the need for unforeseen
repairs and failure to ramp up to full capacity. If the new plant has higher
than expected operating costs or is not able to produce the expected amounts of
LNG, we may be forced to sell LNG at a price below processing costs and we may
lose money. While we have received a letter from PetroChina Company Limited
pursuant to which PetroChina agreed in principle to supply up to 150 million
cubic meters of natural gas annually to our LNG Project subsidiary subject to
the negotiation of a final agreement once our LNG plant is near completion, we
have not entered into a final agreement. Additionally, if the quality of LNG
produced at the facility does not meet customer specifications, we may be unable
to compete with other LNG producers, which would harm our business. As our
target market for our LNG expansion is outside Shaanxi and Henan, there is no
assurance that we will be able to establish a strong customer base in our LNG
target markets and we currently have not entered into any contracts with
customers for the supply of LNG. While we currently also benefit from the NDRC's
decision in August 2007 to cease approval of LNG projects based on onshore gas
fields that involve the processing of domestic natural gas supplies, there is no
assurance that the NDRC will continue such a moratorium and should the NDRC
resume such approvals, any expansion of our LNG business may be adversely
affected.


14





We
are in the process of constructing only one LNG plant and any prolonged
disruption of the construction or operation of the LNG plant may adversely
affect our business development plans.





We are in
the process of constructing only one LNG production facility. If, for any
reason, the LNG production facility should fail to be completed in a timely
fashion or does not operate according to expectation, it may become difficult
for us to obtain substitute LNG to sell and distribute without interruption and
near our current or target markets at competitive prices. We do not have any
performance guarantees, insurance or indemnification from our contractors,
sub-contractors or technology licensors in connection with the construction of
our LNG production facility, and we may be required to make additional
investments to complete the project. In addition, if our LNG production facility
or our natural gas suppliers are damaged by severe weather, earthquake or
other natural disaster, or otherwise experiences prolonged downtime, our LNG
production will be restricted. If we are unable to supply enough of our own LNG
or purchase it from third parties to meet customer demand, our ability to expand
our business into LNG sales may be impeded and may hinder our growth and our
business may be adversely affected.





We
failed to comply with PRC law in our recent contribution of capital to SJLNG and
will be subject to possible fines, penalties and administrative action until the
capital contribution is registered in compliance with PRC law.





In August
2008, the board of directors of XXNGC passed a resolution to increase the
registered capital of SJLNG to RMB118,305,000 through the form of intangible
asset contributions. In September 2008, SJLNG obtained its updated business
license reflecting the increased registered capital. Pursuant to XXNGC's board
resolution, China Natural Gas, Inc. transferred its right to use the two
licenses it obtained relating to the design of our LNG facility directly to
SJLNG as SJLNG's registered capital. However, China Natural Gas, Inc. is not a
shareholder of SJLNG and is therefore not permitted under PRC law to contribute
capital to SJLNG. In addition, PRC law does not allow the contribution of
capital in the form of an intangible asset, such as these two licenses, where
the assets are not owned by the contributor. We are restructuring the capital
contribution as a cash contribution and revising our LNG licenses so that the
licensee is SJLNG and believe this capital contribution and license structure
will comply with PRC law. However, until we have completed this process, the
relevant regulatory authorities may impose fines or penalties, or require us to
cease the operations of SJLNG, until such time as these defects are remedied.
Any such fines, penalties or stop in operations could have a material and
adverse effect on our LNG business in terms of our future growth, financial
condition and results of operations.





We
rely on suppliers of LNG technology.





Due to
the advanced technology involved in the production, loading and transport of
LNG, we have relied on suppliers of LNG technology for the construction of our
LNG plant, and we anticipate we will rely on such suppliers for technology and
know-how in connection with the operation and maintenance of our LNG plant.
There are a limited number of suppliers of LNG technology and we may be unable
to obtain alternate suppliers at acceptable prices, in a timely manner or at
all. If we should lose the assistance of our LNG technology licensors for any
reason, we may be unable to complete or operate our planned LNG plant, which
could have a material and adverse effect on our future growth, financial
condition and results of operations.


15





If
there are advances in other alternative vehicle and industrial fuels or
technologies, or if there are improvements in gasoline, diesel or hybrid
engines, demand for natural gas vehicle and industrial fuels may decline and our
business may suffer.





Technological
advances in the production, delivery and use of alternative fuels that are, or
are perceived to be, cleaner, more cost-effective or more readily available than
CNG or LNG have the potential to slow adoption of natural gas vehicles and
industrial facilities. In addition, advances in gasoline and diesel engine
technology, especially hybrids, may offer a cleaner, more cost-effective option
and make vehicle customers less likely to convert their vehicles to natural gas.
Technological advances related to ethanol or biodiesel, which are increasingly
used as an additive to, or substitute for, gasoline and diesel fuel, may slow
the need to diversify fuels and affect the growth of the natural gas vehicle
market. In addition, hydrogen and other alternative fuels in experimental or
developmental stages may eventually offer a cleaner, more cost-effective
alternative to gasoline and diesel than natural gas. Advances in technology that
slow the growth of or conversion to natural gas vehicles or industrial
facilities or which otherwise reduce demand for natural gas as a vehicle or
industrial fuel will have an adverse effect on our business.





We
may need to raise capital to fund our operations and our failure to obtain
funding when needed may force us to delay, reduce or eliminate our business
development plans.





We may
require additional cash resources in order to carry out our business development
plans, including constructing and acquiring CNG and LNG fueling and compression
stations. If the cost of any such construction or acquisition that our
management deems appropriate is higher than our cash resources, we will need to
seek additional cash resources, and may seek to sell additional equity or debt
securities or borrow under credit facilities. The sale or issuance of additional
equity securities could result in dilution to our shareholders. The incurrence
of indebtedness would result in increased debt service obligations and could
result in operating and financing covenants that would restrict our operations.
If we are unable to raise additional capital on terms favorable to us or at
all, we may have to delay, scale back, or discontinue our planned facility
construction or acquisitions, or obtain funds by entering into agreements on
terms not favorable to us.  We may also not be able to secure or repay
debt incurred to fund facility construction or acquisition, especially if the
construction or acquisition does not result in the benefits we anticipated. As a
result, our future growth, financial condition and results of operations may be
materially and adversely affected.





We
have limited insurance coverage and may incur losses due to business
interruptions resulting from natural and man-made disasters, and our insurance
may not be adequate to cover liabilities resulting from accidents or injuries
that may occur.





The
insurance industry in China is still at an early stage of development. Insurance
companies in China offer limited commercial insurance products. We carry auto
insurance on our vehicles and maintain workers compensation insurance for our
fueling station workers. We do not carry any product liability insurance or
property insurance on our office buildings, fueling stations, other industrial
sites or other property. We believe that current facilities are adequate for
our current and immediately foreseeable operating needs. We do not have any
policies regarding investments in real estate, securities or other forms of
property. We have determined that balancing the risks of disruption or liability
from our business, or the loss or damage to our property, including our
facilities and equipment, the cost of insuring for these risks on the one hand,
and the difficulties associated with acquiring such insurance on commercially
reasonable terms on the other hand, makes it impractical for us to have such
insurance.


16





Should
any natural catastrophes such as earthquakes, floods, or any acts of terrorism
occur in Shaanxi or Henan provinces, where our primary operations are located
and most of our employees are based, or elsewhere, we might suffer not only
significant property damage, but also loss of revenues due to interruptions in
our business operations. In addition, the provision of our services depends on
the continuing operation of our natural gas pipelines and fueling stations,
which are also vulnerable to damage or interruption from natural catastrophes
such as earthquakes and acts of terrorism.





The
occurrence of a significant event for which we are not fully insured or
indemnified, and/or the failure of a party to meet its underwriting or
indemnification obligations, could materially and adversely affect our
operations and financial condition. Moreover, no assurance can be given that we
will be able to maintain adequate insurance in the future at rates we consider
reasonable.





Qinan
Ji, our chairman and chief executive officer, has played an important role in
the growth and development of our business since its inception, and a loss of
his services in the future could severely disrupt our business and negatively
affect investor confidence in us, which may also cause the market price of our
common stock to go down.





Qinan Ji,
our chairman and chief executive officer, has played an important role in the
growth and development of our business since its inception. To date, we have
relied heavily on Mr. Ji’s expertise in, and familiarity with, our business
operations, his relationships within the natural gas industry, including with
our suppliers, and his reputation and experience. In addition, Mr. Ji continues
to be primarily responsible for formulating our overall business strategies and
spearheading the growth of our operations. If Mr. Ji were unable or unwilling to
continue in his present positions, we may not be able to easily replace him and
may incur additional expenses to identify and train his successor. In addition,
if Mr. Ji were to join a competitor or form a competing business, it could
severely disrupt our business and negatively affect our financial condition and
results of operations. Although Mr. Ji is subject to
certain non-competition restrictions during and after termination of his
employment with us, we cannot assure you that such non-competition restrictions
will be effective or enforceable under PRC law. Moreover, even if the departure
of Mr. Ji from our company would not have any actual impact on our operations
and the growth of our business, it could create the perception among investors
or the marketplace that his departure could severely damage our business and
operations and could negatively affect investor confidence in us, which may
cause the market price of our common stock to go down. We do not maintain key
man insurance for Mr. Ji.


17





Failure
to attract and retain qualified personnel and experienced senior management
could disrupt our operations and adversely affect our business and
competitiveness.





Our
continuing success is dependent, to a large extent, on our ability to attract
and retain qualified personnel, including well-trained technicians for the
operation and maintenance of our compressing stations, fueling stations,
pipeline and delivery trucks and experienced senior management. Due to the
intense market competition for highly skilled workers and experienced senior
management and our geographical location, we have faced difficulties locating
experienced and skilled personnel in certain areas, such as engineers, station
and truck operators, administration, marketing, product development, sales,
finance and accounting. We cannot assure you that we will be able to attract or
retain the key personnel that we will need to achieve our business objectives
and if one or more of our key personnel are unable or unwilling to continue to
work for us, we may not be able to replace them within a reasonable period of
time or at all. Our business may be severely disrupted, our financial condition
and results of operations may be materially and adversely affected, and we may
incur additional expenses in recruiting and training additional personnel.
Although our employees and senior management members are subject to certain
non-competition restrictions during and after termination of their employment,
we cannot assure you that such non-competition restrictions will be effective or
enforceable under PRC law. If any of our key personnel joins a competitor or
forms a competing business, our business may be severely disrupted. We have no
key man insurance with respect to our key personnel that would provide insurance
coverage payable to us for loss of their employment due to death or
otherwise.





The
expansion of our business into new provinces may not be as successful as in
Shaanxi and Henan provinces, or at all.





We plan
to expand our business into additional provinces throughout China. However, our
experience in operating CNG fueling stations in Shaanxi and Henan may not be
applicable in other parts of China. We cannot assure you that we will be able to
leverage such experience to expand into other parts of China. When we enter new
markets, we may face intense competition from natural gas operators with
established experience or presence in the geographical areas in which we plan to
expand and from other natural gas operators with similar expansion targets. In
addition, expansion or acquisition may require a significant amount of capital
investment, divert the resources and time of our management and, if we fail
to integrate the new businesses effectively, affect our operating efficiency.
Demand for natural gas and government regulation may also be different in other
provinces. The distribution of natural gas and operations of fueling stations
are highly regulated industries requiring registration for the issuance of
licenses required by various governing authorities in China. Additionally,
various standards must be met for fueling stations, including handling and
storage of natural gas, tanker handling and compressor operation. While we have
benefited from quicker permitting and licensing processes and stable access to
the supply of natural gas in Shaanxi, there is no assurance that we will have
similar success in other provinces. Our failure to manage any of our
planned expansion or acquisitions may have a material adverse effect on our
business, financial condition and results of operations and we may not have the
same degree of success in other provinces that we have had so far to date, or at
all





Growth
in our CNG business may depend on the increased adoption of CNG technology by
buses and private cars and/or the expansion of taxi fleets.





Our
revenue from CNG comes primarily from the sale of CNG as a fuel for vehicles and
we expect this trend will continue. As many of the taxis in our core CNG markets
have adopted CNG technology, growth in our CNG business may depend on the
increased adoption of CNG technology by buses and private cars. If buses and
private cars do not increasingly adopt CNG technology, growth in our CNG
business may be adversely affected.





To expand
our business, we must develop new customers. Whether we will be able to expand
our customer base will depend on a number of factors, including the level of
acceptance and availability of natural gas vehicles, the level of acceptance of
natural gas as a vehicular and industrial fuel, the growth in our target markets
of natural gas infrastructure that supports CNG and LNG sales and our ability to
supply CNG and LNG at competitive prices. The recent and rapid decline in oil,
diesel and gasoline prices may result in decreased interest in alternative fuels
like CNG and LNG. If our potential customers are unable to access credit to
purchase natural gas vehicles it may make it difficult or impossible for them to
invest in natural gas vehicles and the conversion of industrial facilities to
natural gas, which would impair our ability to grow our
business.


18





If
the prices of CNG do not remain sufficiently below the prices of gasoline and
diesel, potential fleet customers will have less incentive to purchase natural
gas vehicles or convert their fleets to natural gas, which would decrease demand
for CNG and limit our growth, including our expansion into LNG .





Natural
gas vehicles cost more than comparable gasoline or diesel powered vehicles
because converting a vehicle to use natural gas adds to its base cost. If the
prices of CNG do not remain sufficiently below the prices of gasoline or diesel,
fleet operators may be unable to recover the additional costs of acquiring or
converting to natural gas vehicles in a timely manner, and they may choose not
to use natural gas vehicles.  Recent and extreme volatility in oil and
gasoline prices demonstrate that it is difficult to predict future
transportation fuel costs. The decline in the price of oil, diesel fuel and
gasoline has reduced the economic advantages that our existing or potential
customers may realize by using less expensive CNG fuel as an alternative to
gasoline or diesel. The reduced prices for gasoline and diesel fuel and
continuing uncertainty about fuel prices, combined with higher costs for natural
gas vehicles, may cause potential customers to delay or reject converting their
fleets to run on natural gas which may limit our growth and cause our business
to suffer.





Our
acquisition and investment in other lines of business may be
unsuccessful.





We intend
to selectively pursue strategic acquisition and investment opportunities which
complement or enhance our current businesses with new product lines or customers
at the appropriate time. However, we may encounter strong competition during the
acquisition or investment process and we may fail to select or value targets
appropriately, which may result in our experiencing difficulty in completing
such acquisitions or investments at reasonable cost or at all. Even if an
acquisition or investment is successful, we may have to allocate additional
capital and human resources to implement the integration of the new line of
business. There is no assurance that such integration will be completed within a
reasonable period of time or at all or that it will generate the expected
economic benefits.





If
we are unable to adequately protect our intellectual property, our business
could be harmed.





We
protect our intellectual property through a combination of trademark laws,
confidentiality procedures and contractual provisions, when appropriate.
Nonetheless, our intellectual property rights may not be successfully asserted
in the future or may be invalidated, circumvented or challenged. Enforcement of
intellectual property rights can lead to costly litigation and counterclaims.
There is a risk that the outcome of such potential litigation will not be in our
favor. Such litigation may be costly and may divert management attention as
well as expend other resources which could otherwise have been devoted to our
business. An adverse determination in any such litigation will impair our
intellectual property rights and may harm our business, prospects and
reputation. In addition, historically, implementation of PRC intellectual
property-related laws has been lacking, primarily because of ambiguities in the
PRC laws and difficulties in enforcement. Accordingly, intellectual property
rights and confidentiality protections in China may not be as effective as in
the United States or other countries, which increases the risk that we may not
be able to adequately protect our intellectual property. Moreover, litigation
may be necessary in the future to enforce our intellectual property rights.
Future litigation could result in substantial costs and diversion of our
management’s attention and resources, and could disrupt our business, as well as
have a material adverse effect on our financial condition and results of
operations. Given the relative unpredictability of China’s legal system and
potential difficulties enforcing a court judgment in China, there is no
guarantee that we would be able to halt the unauthorized use of our intellectual
property through litigation.


19





We
may be subject to intellectual property infringement claims, which may force us
to incur substantial legal expenses and, if determined adversely against us, may
materially disrupt our business.





We cannot
assure you that our intellectual property does not or will not infringe upon
trademarks, valid copyrights or other intellectual property rights held by third
parties. We may become subject to legal proceedings and claims from time to time
relating to the intellectual property of others in the ordinary course of our
business. If we are found to have violated the intellectual property rights of
others, we may be enjoined from using such intellectual property, and we may
incur licensing fees or be forced to develop alternatives. In addition, we may
incur substantial expenses, and may be forced to divert management and other
resources from our business operations, to defend against these third-party
infringement claims, regardless of their merit. Successful infringement or
licensing claims against us may result in substantial monetary liabilities or
may materially disrupt the conduct of our business by restricting or prohibiting
our use of the intellectual property in question.





In
order to comply with PRC laws limiting foreign ownership of Chinese companies,
we conduct our natural gas business through Xi'an Xilan Natural Gas Co., Ltd. by
means of contractual arrangements which may not be as effective as direct
ownership or may be deemed in violation of PRC restrictions on foreign
investment in our industry.





The
government of the PRC restricts foreign investment in natural gas businesses in
China. Accordingly, we operate our business in China through our variable
interest entity, XXNGC.  XXNGC holds the licenses, approvals and
assets necessary to operate our natural gas business in China. We have no equity
ownership interest in XXNGC and rely on contractual arrangements with XXNGC and
its shareholders that allow us to substantially control and operate XXNGC. These
contractual arrangements may not be as effective in providing control over XXNGC
as direct ownership would be. For example, XXNGC could fail to take actions
required for our business despite its contractual obligation to do so. If XXNGC
fails to perform under its agreements with us, we may have to incur substantial
costs and resources to enforce such arrangements and may have to rely on legal
remedies under the law of the PRC, which may not be effective. In addition, we
cannot assure you that XXNGC’s shareholders would always act in our best
interests.





Although
we believe we comply with current regulations of the PRC, we cannot assure you
that the PRC government would agree that our structure or operating arrangements
comply with the PRC’s licensing, registration or other regulatory requirements
with existing policies or with requirements or policies that may be adopted in
the future. If the PRC government determines that our structure or operating
arrangements do not comply with applicable law, it could revoke our business and
operating licenses, require us to discontinue or restrict our operations,
restrict our right to collect revenues, require us to restructure our
operations, impose additional conditions or requirements with which we may not
be able to comply, impose restrictions on our business operations or on our
customers, or take other regulatory or enforcement actions against us that could
be harmful to our business. In addition, the equity pledge in the Equity Pledge
Agreement between SXNGE and XXNGC and XXNGC's shareholders has not been
registered and may be deemed to be unenforceable under PRC law.


20





Other
than the proxy agreement between SXNGE and XXNGC and XXNGC's chairman and
shareholders, which does not contain a choice of law or jurisdictional clause,
our contractual arrangements with XXNGC are governed by PRC law and provide for
the resolution of disputes through arbitration in the PRC. Accordingly, these
contracts would be interpreted in accordance with PRC law and any disputes would
be resolved in accordance with PRC legal procedures. If XXNGC or its
shareholders fail to perform their respective obligations under these
contractual arrangements, we may have to (i) incur substantial costs and
resources to enforce such arrangements, and (ii) rely on legal remedies under
PRC law, including seeking specific performance or injunctive relief, and
claiming damages, which we cannot be sure would be effective. However, the legal
environment in the PRC is not as developed as in the United States and
uncertainties in the Chinese legal system could limit our ability to enforce
these contractual arrangements. In the event that we are unable to enforce these
contractual arrangements, our business, financial condition and results of
operations could be materially and adversely affected.





Our
contractual arrangements with XXNGC may be subject to scrutiny by the Chinese
tax authorities and create a potential double layer of taxation for our
revenue-generating services conducted by XXNGC.





We could
face material and adverse tax consequences if the Chinese tax authorities
determine that our contractual arrangements with XXNGC were not priced at arm’s
length for purposes of determining tax liability. If the Chinese tax authorities
determine that these contracts were not entered into on an arm’s-length basis,
they may adjust our income and expenses for Chinese tax purposes in the form of
a transfer pricing adjustment. A transfer pricing adjustment could result in a
reduction, for Chinese tax purposes, of deductions recorded by XXNGC, which
could adversely affect us by increasing the tax liabilities of XXNGC. This
increased tax liability could further result in late payment fees and other
penalties to XXNGC for underpaid taxes. Any payments we make under these
arrangements or adjustments in payments under these arrangements that we may
decide to make in the future will be subject to the same risk. Prices for such
services will be set prospectively and therefore we do not currently have a
basis to believe that any of the payments to be made under the contracts will or
will not be considered arm’s length for purposes of determining tax
liability.





The
shareholders of XXNGC may have potential conflicts of interest with us, which
may materially and adversely affect our business and financial
condition.





The
shareholders of XXNGC are also beneficial holders of our common shares. They are
also directors of both XXNGC and our company. Conflicts of interests between
their dual roles as shareholders and directors of both XXNGC and our Company may
arise. We cannot assure you that when conflicts of interest arise, any or all of
these individuals will act in the best interests of our company or that
conflicts of interests will be resolved in our favor. In addition, these
individuals may breach or cause XXNGC to breach or refuse to renew the existing
contractual arrangements that allow us to receive economic benefits from XXNGC.
Currently, we do not have existing arrangements to address potential conflicts
of interest between these individuals and our company. We rely on
these individuals to abide by the laws of Delaware, which provides that
directors owe a fiduciary duty to the Company, which requires them to act in
good faith and in the best interests of the Company and not to use their
positions for personal gain. If we cannot resolve any conflicts of interest or
disputes between us and the shareholders of XXNGC, we would have to rely on
legal proceedings, which could result in disruption of our business and
substantial uncertainty as to the outcome of any such legal
proceedings.


21





Certain
shares in XXNGC, our variable interest entity, may be subject to adverse
claims.





Six
individuals have previously claimed to own 1,200,000 shares of XXNGC's common
stock, our main operating company and variable interest entity. They have
claimed that they acquired these shares from other shareholders of XXNGC. Based
on XXNGC's registered capital of RMB69,000,000 when it became a joint stock
limited company in 2004, we believe the 1,200,000 shares represented 1.74% of
XXNGC's outstanding common stock at the time the six individuals claim to have
acquired the 1,200,000 shares of XXNGC. While we and XXNGC dispute their claim
of ownership over the 1,200,000 shares, there is no assurance that XXNGC will
prevail if these six individuals pursued their claim in legal proceedings. If
these six individuals are found to have ownership over these shares, XXNGC's
shareholding structure may change and our revenues from our contractual
arrangements with XXNGC may be reduced.





We
may lose the ability to use and enjoy assets held by XXNGC that are important to
the operation of our business if XXNGC goes bankrupt or becomes subject to a
dissolution or liquidation proceeding.





As part
of our contractual arrangements with XXNGC, XXNGC holds certain of the assets
that are important to the operation of our natural gas business. If XXNGC were
to file for bankruptcy and all or part of its assets become subject to liens or
rights of third-party creditors, we may be unable to continue some or all of our
natural gas operations, which could materially and adversely affect our
business, financial condition and results of operations. If XXNGC undergoes a
voluntary or involuntary liquidation proceeding, its shareholders or
unrelated third-party creditors may claim rights to some or all of these assets,
thereby hindering our ability to operate our natural gas business, which could
materially and adversely affect our business, financial condition and results of
operations.





The
transfer of state-owned assets in China is subject to approval by authorities in
charge of state-owned assets administration and supervision and any failure by
us or prior owners of our projects to comply with PRC laws and regulations in
respect of the transfer of state-owned assets may result in the imposition of
fines or forfeiture of our projects.





As part
of our business development, we have historically and may continue to acquire
assets which were previously state-owned. In particular, XXNGC, our main
operating company and variable interest entity, was previously a state-owned
enterprise. XXNGC was acquired in 2004 by Xi'an Sunway Technology Industry Co.,
Ltd. ("Sunway"), a company in which our chairman and CEO, Mr. Ji, is a
shareholder, and privatized. Mr. Ji, subsequently acquired XXNGC in October
2005. The acquisition of XXNGC by Sunway was approved by the Xi'an Municipal
Administration Committee. However, the transfer price Sunway paid to acquire
XXNGC was not evaluated by licensed appraisers. Under PRC law, the transfer
of state-owned assets is subject to strict procedures and approvals, including
the requirement that the transfer price be evaluated by licensed appraisers. If
a previous transferor of state-owned assets failed to comply with relevant PRC
law, the transfer of the state-owned assets may be reversed by the government or
fines may be levied. In such circumstances, we will have a legal right to
recover our investment in the assets, but we may not be able to recover from the
relevant parties, which could result in a loss of revenues and a significant
increase in operating costs. In addition, because XXNGC is our main operating
company, any reversal of the transfer of XXNGC would have material adverse
effect on our business, financial condition and result of
operations.


22




Acquisition
of state-owned assets involves a public bidding process and failure to win the
bids for our state-owned target companies or equity interests therein may limit
our future growth and the control of our existing projects.





Under PRC
law, we are required to bid for the acquisition of state-owned assets that we
wish to acquire. We typically negotiate the terms of the sale with the
state-owned seller prior to the bidding process. However, we may not be
successful in the bid and may fail to obtain the project as a result. To the
extent we seek in the future to acquire state-owned assets, we will need to
follow this process, and may not be successful in obtaining the target
business.





We
may be required to vacate some of the land upon which our CNG fueling stations
operate.





We
entered into long term lease agreements with third parties to lease certain land
upon which our CNG fueling stations operate. Some of the entities from which we
leased the land may not possess valid title to their properties. In addition, we
have leased land from individual villagers or villager committees and applicable
PRC law may be interpreted as prohibiting such land to be used for
non-agricultural purposes or from being leased to parties other than local
residents or their collective economic organizations. If there are disputes over
the legal title to any of these leased properties or if the relevant authorities
determine that our use of such properties violate PRC law and our leases are
deemed to be invalid under PRC law, we may be required to vacate such sites and
our business, financial condition and results of operations may be adversely
affected.





We
may be subject to fines in connection with the construction of our CNG fueling
stations due to failure to comply with proper procedural
requirements.





According
to relevant PRC laws and regulations in Shaanxi and Henan provinces, contracts
exceeding certain specified amounts relating to the construction of natural gas
stations, such as construction contracts and equipment purchase agreements, must
be obtained through bidding. We, however, did not comply with such bidding
procedures in connection with the construction of any of our CNG fueling
stations. While we believe this is accepted local practice, it is not in
compliance with national and local legal requirements, and as a result, we may
be subject to administrative fines and other penalties as a result of our
failure to comply with these requirements.





Our
business operations are subject to extensive government regulation.





Our
business activities are extensively regulated by policies and other laws and
regulations enacted by the PRC government. Natural gas operations require
approvals, licenses or permits from the relevant central and local government
authorities, some of which may take longer to obtain than others. In addition,
from time to time, the relevant government authorities may impose new
regulations on these activities. The success of our strategy to increase our
natural gas business is contingent upon, among other things, receipt of all
required licenses, permits and authorizations, including, but not limited to,
construction, safety and environmental permits. While we believe we have, or are
in the process of obtaining, all the required licenses, permits and
authorizations material to our business, there is no assurance that changes or
concessions required by our regulatory authorities could also involve
significant costs and delay or prevent the completion of our growth or could
result in the loss of an existing license, permit or authorization, any of which
could have a material adverse effect on our financial condition and results of
operations. Furthermore, to the extent we have failed to obtain any licenses,
permits and authorizations, the relevant government authorities may subject us
to fines, penalties or require us to cease operations.


23




Because
we may rely on dividends and other distributions on equity paid by our current
and future Chinese subsidiaries for our cash requirements, restrictions under
Chinese law on their ability to make such payments could materially and
adversely affect our ability to grow, make investments or acquisitions that
could benefit our business, pay dividends to you, and otherwise fund and conduct
our businesses.





We have
adopted a holding company structure, and our holding companies may rely on
dividends and other distributions on equity paid by our current and future
Chinese subsidiaries for their cash requirements, including the funds necessary
to service any debt we may incur or financing we may need for operations other
than through our Chinese subsidiaries. Chinese legal restrictions permit
payments of dividends by our Chinese subsidiaries only out of their accumulated
after-tax profits, if any, determined in accordance with PRC GAAP. Our Chinese
subsidiaries are also required under Chinese laws and regulations to allocate at
least 10% of their after-tax profits determined in accordance with PRC GAAP to
statutory reserves until such reserves reach 50% of the company’s registered
capital. Allocations to these statutory reserves and funds can only be used
for specific purposes and are not transferable to us in the form of loans,
advances or cash dividends. Any limitations on the ability of our Chinese
subsidiaries to transfer funds to us could materially and adversely limit our
ability to grow, make investments or acquisitions that could be beneficial to
our business, pay dividends and otherwise fund and conduct our
business.





Our
failure to fully comply with PRC labor laws exposes us to potential
liability.





Companies
operating in China must comply with a variety of labor laws, including certain
pension, housing and other welfare-oriented payment obligations. While we intend
to make such payments beginning in July 2009, our failure to make previous
payments may be in violation of applicable PRC labor laws and we cannot assure
you that PRC governmental authorities will not impose penalties on us for
failure to comply. In addition, in the event that any current or former employee
files a complaint with the PRC government, we may be subject to making up the
social insurance payment obligations as well as paying administrative
fines.





Risks
Related to the People’s Republic of China





Adverse
changes in PRC economic and political policies could have a material adverse
effect on the overall economic growth of China, which could reduce the demand
for natural gas and materially and adversely affect our business.





Substantially
all of our assets are located in China and substantially all of our revenue is
derived from our operations in China. Accordingly, our results of operations and
prospects are subject, to a significant extent, to the economic, political and
legal developments in China. The PRC economy differs from the economies of most
developed countries in many aspects, including:


24





·
            the
      level of government involvement;


·
            the
      level of development;


·
            the
      growth rate;


·
            the
      level and control of capital
investment;


·
            the
      control of foreign exchange; and


·
            the
      allocation of resources.





While the
Chinese economy has grown significantly in the past two decades, the growth has
been uneven geographically, among various sectors of the economy and during
different periods. We cannot assure you that the Chinese economy will continue
to grow or to do so at the pace that has prevailed in recent years, or that if
there is growth, such growth will be steady and uniform. In addition, if there
is a slowdown, such slowdown could have a negative effect on our business. Any
measures taken by the PRC government, even if they benefit the overall Chinese
economy in the long-term, may have a negative effect on us. For example, our
financial condition and results of operations may be materially and adversely
affected by government control over capital investments. Although the Chinese
economy has been transitioning from a planned economy to a more market-oriented
economy, a substantial portion of the productive assets in China is still owned
by the PRC government. The continued control of these assets and other aspects
of the national economy by the PRC government could materially and adversely
affect our business. The PRC government also exercises significant control over
Chinese economic growth through allocating resources, controlling payment of
foreign currency denominated obligations, setting monetary policy and providing
preferential treatment to particular industries or companies. Any adverse change
in the economic conditions or government policies in China could have a material
adverse effect on the overall economic growth and the level of investments and
expenditures in China, which in turn could lead to a reduction in demand for
natural gas and consequently have a material adverse effect on our
businesses.





The
PRC legal system embodies uncertainties that could limit the legal protections
available to you and us.





Unlike
common law systems, the PRC legal system is based on written statutes and
decided legal cases have little precedential value. In 1979, the PRC government
began to promulgate a comprehensive system of laws and regulations governing
economic matters in general. The overall effect of legislation since then has
been to significantly enhance the protections afforded to various forms of
foreign investment in China. Our PRC operating subsidiaries are subject to laws
and regulations applicable to foreign investment in China. Our PRC affiliated
entities are subject to laws and regulations governing the formation and conduct
of domestic PRC companies. Relevant PRC laws, regulations and legal requirements
may change frequently, and their interpretation and enforcement involve
uncertainties. For example, we may have to resort to administrative and court
proceedings to enforce the legal protection that we enjoy either by law or
contract. However, since PRC administrative and court authorities have
significant discretion in interpreting and implementing statutory and
contractual terms, it may be more difficult to evaluate the outcome of
administrative and court proceedings and the level of legal protection we enjoy
than under more developed legal systems. Such uncertainties, including the
inability to enforce our contracts and intellectual property rights, could
materially and adversely affect our business and operations. Accordingly, we
cannot predict the effect of future developments in the PRC legal system,
particularly with respect to the natural gas sector, including the promulgation
of new laws, changes to existing laws or the interpretation or enforcement
thereof, or the preemption of local regulations by national laws. These
uncertainties could limit the legal protections available to us and other
foreign investors.


25


The
PRC currency is not a freely convertible currency, which could limit our ability
to obtain sufficient foreign currency to support our business operations in the
future.




The PRC
currency, the “Renminbi” or “RMB,” is not a freely convertible currency. We rely
on the PRC government’s foreign currency conversion policies, which may change
at any time, in regard to our currency exchange needs. We receive substantially
all of our revenues in Renminbi, which is not freely convertible into other
foreign currencies. In China, the government has control over Renminbi reserves
through, among other things, direct regulation of the conversion of Renminbi
into other foreign currencies and restrictions on foreign imports. Although
foreign currencies that are required for current account transactions can be
bought freely at authorized PRC banks, the proper procedural requirements
prescribed by PRC law must be met. At the same time, PRC companies are also
required to sell their foreign exchange earnings to authorized PRC banks
and the purchase of foreign currencies for capital account transactions still
requires prior approval of the PRC government. This substantial regulation by
the PRC government of foreign currency exchange may restrict our business
operations and a change in any of these government policies could negatively
impact our operations, which could result in a loss of profits.





In order
for our PRC subsidiaries to pay dividends to us, a conversion of Renminbi into
U.S. dollars is required. Under current PRC law, the conversion of Renminbi into
foreign currency for capital account transactions generally requires approval
from SAFE and, in some cases, other government agencies. Government authorities
may impose restrictions that could have a negative impact in the future on the
conversion process and upon our ability to meet our cash needs and to pay
dividends to our shareholders. Although, our subsidiaries’ classification as
wholly foreign-owned enterprises, or WFOEs, under PRC law permits them to
declare dividends and repatriate their funds to us in the United States, any
change in this status or the regulations permitting such repatriation could
prevent them from doing so. Any inability to repatriate funds to us would in
turn prevent payments of dividends to our shareholders.





Fluctuations
in exchange rates could result in foreign currency exchange losses.





Because
substantially all of our revenues and expenditures are denominated in Renminbi
and the net proceeds from our capital raising were denominated in U.S. dollars,
fluctuations in the exchange rate between the U.S. dollar and Renminbi affect
the relative purchasing power of these proceeds and our balance sheet and
earnings per share in U.S. dollars. In addition, we report our financial
results in U.S. dollars, and appreciation or depreciation in the value of the
Renminbi relative to the U.S. dollar would affect our financial results reported
in U.S. dollar terms without giving effect to any underlying change in our
business or results of operations. Fluctuations in the exchange rate will also
affect the relative value of any dividend we issue that will be exchanged into
U.S. dollars and earnings from and the value of any U.S. dollar-denominated
investments we make in the future.





Since
July 2005, the Renminbi has no longer been pegged to the U.S. dollar. Although
currently the Renminbi exchange rate versus the U.S. dollar is restricted to a
rise or fall of no more than 0.5% per day and the People’s Bank of China
regularly intervenes in the foreign exchange market to prevent significant
short-term fluctuations in the exchange rate, the Renminbi may appreciate or
depreciate significantly in value against the U.S. dollar in the medium- to
long-term. Moreover, it is possible that in the future, PRC authorities may
lift restrictions on fluctuations in the Renminbi exchange rate and lessen
intervention in the foreign exchange market.


26





Very
limited hedging transactions are available in China to reduce our exposure to
exchange rate fluctuations. To date, we have not entered into any hedging
transactions in an effort to reduce our exposure to foreign currency exchange
risk. While we may decide to enter into hedging transactions in the future, the
availability and effectiveness of these hedging transactions may be limited and
we may not be able to successfully hedge our exposure at all. In addition, our
currency exchange losses may be magnified by PRC exchange control regulations
that restrict our ability to convert Renminbi into foreign
currency.





SAFE
regulations relating to offshore investment activities by PRC residents may
increase our administrative burden and restrict our overseas and cross-border
investment activity. If our shareholders and beneficial owners who are PRC
residents fail to make any required applications and filings under such
regulations, we may be unable to distribute profits and may become subject to
liability under PRC laws.





The PRC
State Administration of Foreign Exchange, or SAFE, has promulgated several
regulations, including Circular No. 75 issued in November 2005 and
implementation rules issued in May 2007, requiring registrations with, and
approvals from, PRC government authorities in connection with direct or indirect
offshore investment activities by PRC residents. These regulations apply to
our shareholders and beneficial owners who are PRC residents.





The SAFE
regulations require registration of direct or indirect investments made by PRC
residents in offshore companies. In the event that a PRC shareholder with a
direct or indirect stake in an offshore parent company fails to make the
required SAFE registration, the PRC subsidiaries of that offshore parent company
may be prohibited from making distributions of profit to the offshore parent and
from paying the offshore parent proceeds from any reduction in capital, share
transfer or liquidation in respect of the PRC subsidiaries. Further, failure to
comply with the various SAFE registration requirements described above could
result in liability under PRC law for foreign exchange evasion.





We have
requested our shareholders and beneficial owners who are PRC residents to make
the necessary applications and filings as required under these regulations and
under any implementing rules or approval practices that may be established under
these regulations. We believe our PRC resident shareholders, including Mr. Ji,
our chairman and chief executive officer, have already completed the
registration process. However, as a result of the recent enactment of the
regulations, lack of implementing rules and uncertainty concerning the
reconciliation of the new regulations with other approval requirements, it
remains unclear how these regulations, and any future legislation concerning
offshore or cross-border transactions, will be interpreted, amended and
implemented by the relevant government authorities. There is a risk that not all
of our shareholders and beneficial owners who are PRC residents will in the
future comply with our request to make or obtain any applicable registration or
approvals required by these regulations or other related legislation. The
failure or inability of our PRC resident shareholders and beneficial owners to
receive any required approvals or make any required registrations may subject us
to fines and legal sanctions, restrict our overseas or cross-border investment
activities, limit our PRC subsidiaries’ ability to make distributions or pay
dividends or affect our ownership structure, as a result of which our
acquisition strategy and business operations and our ability to distribute
profits to you could be materially and adversely affected.


27





We
may have difficulty establishing adequate management, legal and financial
controls in the People’s Republic of China.





The PRC
historically has been deficient in Western style management and financial
reporting concepts and practices, as well as in modern banking, computer and
other control systems. We may have difficulty in hiring and retaining a
sufficient number of qualified employees to work in the PRC. As a result of
these factors, we may experience difficulty in establishing management, legal
and financial controls, collecting financial data and preparing financial
statements, books of account and corporate records and instituting business
practices that meet Western standards.





Because
our assets and operations are located in China, you may have difficulty
enforcing any civil liabilities against us under the securities and other laws
of the United States or any state.





We are a
holding company, and all of our assets are located in the PRC. In addition, our
directors and officers are non-residents of the United States, and all or a
substantial portion of the assets of these non-residents are located outside the
United States. As a result, it may be difficult for investors to effect service
of process within the United States upon these non-residents, or to enforce
against them judgments obtained in United States courts, including judgments
based upon the civil liability provisions of the securities laws of the United
States or any state.





There is
uncertainty as to whether courts of the PRC would enforce:





·
            Judgments
      of United States courts obtained against us or these non-residents based
      on the civil liability provisions of the securities laws of the United
      States or any state; or


·
            In
      original actions brought in the PRC, liabilities against us or
      non-residents predicated upon the securities laws of the United States or
      any state. Enforcement of a foreign judgment in the PRC also may be
      limited or otherwise affected by applicable bankruptcy, insolvency,
      liquidation, arrangement, moratorium or similar laws relating to or
      affecting creditors’ rights generally and will be subject to a statutory
      limitation of time within which proceedings may be
  brought.





PRC
laws and regulations governing our businesses and the validity of certain of our
contractual arrangements are uncertain. If we are found to be in violation, we
could be subject to sanctions. In addition, changes in such PRC laws and
regulations may materially and adversely affect our business.





There are
substantial uncertainties regarding the interpretation and application of PRC
laws and regulations, including, but not limited to, the laws and regulations
governing our business, or the enforcement and performance of our contractual
arrangements with our variable interest entity, XXNGC, and its shareholders. We
are considered a foreign person or foreign invested enterprise under PRC law. As
a result, we are subject to PRC law limitations on foreign ownership of Chinese
companies. These laws and regulations are relatively new and may be subject to
change, and their official interpretation and enforcement may involve
substantial uncertainty. The effectiveness of newly enacted laws, regulations or
amendments may be delayed, resulting in detrimental reliance by foreign
investors. New laws and regulations that affect existing and proposed future
businesses may also be applied retroactively.


28


The PRC
government has broad discretion in dealing with violations of laws and
regulations, including levying fines, revoking business and other licenses and
requiring actions necessary for compliance. In particular, licenses and permits
issued or granted to us by relevant governmental bodies may be revoked at a
later time by higher regulatory bodies. We cannot predict the effect of the
interpretation of existing or new PRC laws or regulations on our businesses. We
cannot assure you that our current ownership and operating structure would not
be found to be in violation of any current or future PRC laws or regulations. As
a result, we may be subject to sanctions, including fines, and could be required
to restructure our operations or cease to provide certain services. Any of these
or similar actions could significantly disrupt our business operations or
restrict us from conducting a substantial portion of our business operations,
which could materially and adversely affect our business, financial condition
and results of operations.





The
new Antimonopoly Law ("AML") may subject our future acquisitions to increased
scrutiny, which could affect our ability to consummate acquisitions on terms
favorable to us or at all.





On August
8, 2006, six PRC government authorities, including the PRC Ministry of Commerce,
the State Administration for Industry and Commerce, and the China Securities
Regulatory Commission, promulgated a rule entitled “Provisions regarding Mergers
and Acquisitions of Domestic Enterprises by Foreign Investors”, or the New
M&A Rule, which became effective on September 8, 2006. The New M&A Rule,
among other things, requires that certain acquisitions of Chinese domestic
enterprises by foreign investors be subject to anti-trust scrutiny by the
Ministry of Commerce and the State Administration for Industry and Commerce. The
AML was adopted by the Standing Committee of the National People’s Congress on
August 30, 2007 and became effective on August 1, 2008. The AML was enacted in
part to guard against and cease monopolistic activities, and to safeguard and
promote orderly market competition. In accordance with the AML, monopolistic
acts shall include monopolistic agreements among business operators, abuse of
dominant market positions by business operators and concentration of business
operators that eliminates or restricts competition or might be eliminating
or restricting competition. On August 3, 2008, the State Council promulgated the
Regulations on the Thresholds for Reporting of Concentration of Business
Operators, or the Reporting Threshold Regulations, which provide specific
thresholds for reporting of concentration of business operators. Under the AML
and the Reporting Threshold Regulations, the parties to an acquisition must
report to the Ministry of Commerce in advance if in the preceding accounting
year the turnover in the aggregate achieved by all the parties to the
transaction exceeds RMB10.0 billion worldwide or RMB2.0 billion within China,
and the turnover achieved by at least two of them respectively exceeds RMB400.0
million within China. However, the Ministry of Commerce has the right to
initiate investigation of a transaction not reaching the above-mentioned
reporting thresholds if the Ministry of Commerce has evidence that the
transaction has or may have the effect of excluding or restricting competition.
The anti-trust scrutiny procedures and requirements set forth in the AML and the
Reporting Threshold Regulations grant the government extensive authority of
evaluation and control over the terms of acquisitions in China by foreign
investors, and their implementation involves significant uncertainties and
risks. To the extent our future acquisitions meet the threshold requirements set
forth in the AML and the Reporting Threshold Regulations, or are deemed by the
Ministry of Commerce to meet the thresholds, we will be subject to anti-monopoly
review. The consummation of our future acquisitions could therefore be much more
time-consuming and complex, and any required approval processes, including
obtaining approval from the Ministry of Commerce, may delay or prevent the
consummation of such acquisitions, and prevent us from attaining our business
objectives.


29





We
may be deemed a PRC "resident enterprise" under the EIT Law and be subject to
PRC taxation on our worldwide income.





The EIT
Law also provides that enterprises established outside of China whose “de facto
management bodies” are located in China are considered “resident enterprises”
and are generally subject to the uniform 25% enterprise income tax rate as to
their worldwide income. Under the implementation regulations to the EIT Law
issued by the State Council, “de facto management body” is defined as a body
that has material and overall management and control over the manufacturing and
business operations, personnel and human resources, finances and treasury, and
acquisition and disposition of properties and other assets of an enterprise. It
remains unclear how the PRC tax authorities will interpret this term. A
substantial number of our management personnel are located in the PRC, and all
of our revenues arise from our operations in China. However, we do recognize
some interest income and other gains from our financing activities outside
China. If the PRC tax authorities determine that we are a PRC resident
enterprise, we will be subject to PRC tax on our worldwide income at the
25% uniform tax rate, which may have a material adverse effect on our financial
condition and results of operations. Notwithstanding the foregoing provision,
the new EIT Law also provides that, if a resident enterprise already invests in
another resident enterprise, the dividends received by the investing resident
enterprise from the invested resident enterprise are exempt from income tax,
subject to certain qualifications. Therefore, if we are classified as a resident
enterprise, the dividends received from our PRC subsidiaries and investee
company may be exempt from income tax. However, due to the short history of the
EIT Law, it is unclear as to (i) the detailed qualification requirements for
such exemption and (ii) whether dividend payments by our PRC subsidiaries and
investee company to us will meet such qualification requirements, even if we are
considered a PRC resident enterprise for tax purposes.





Dividends
we receive from our operating subsidiaries located in the PRC may be subject to
PRC withholding tax.





The EIT
Law provides that a withholding income tax rate of 20% will be applicable to
dividends payable to foreign investors that are “non-resident enterprises” to
the extent such dividends have their source within China unless the jurisdiction
of such foreign investor has a tax treaty with China that provides a different
withholding arrangement. The implementing regulations to the EIT Law
subsequently reduced this withholding income tax rate from 20% to
10%.





We are a
Delaware company and substantially all of our income may be derived from
dividends we receive from our operating subsidiaries located in the PRC. Thus,
dividends paid to us by our subsidiaries in China may be subject to the 10%
withholding income tax if we are considered as a “non-resident enterprise” under
the EIT Law. If we are required under the EIT Law to pay income tax for any
dividends we receive from our subsidiaries, it will materially and adversely
affect the amount of dividends, if any, we may pay to our
shareholders.





30




PRC
regulation of direct investment and loans by offshore holding companies to PRC
entities may delay or limit our ability to use the proceeds of this offering to
make additional capital contributions or loans to our PRC operating
businesses.




Any
capital contributions or loans that we, as an offshore company, make to our PRC
operating businesses, including from the proceeds of this offering, are subject
to PRC regulations. For example, any of our loans to our PRC operating
businesses cannot exceed the difference between the total amount of investment
our PRC operating businesses are approved to make under relevant PRC laws and
their respective registered capital, and must be registered with the local
branch of the State Administration of Foreign Exchange as a procedural
matter. In addition, our capital contributions to our PRC operating businesses
must be approved by the National Development and Reform Commission and the
Ministry of Commerce or their local counterpart and registered with the State
Administration for Industry and Commerce or its local counterpart. We cannot
assure you that we will be able to obtain these approvals on a timely basis, or
at all. If we fail to obtain such approvals, our ability to make equity
contributions or provide loans to our PRC operating businesses or to fund their
operations may be negatively affected, which could adversely affect their
liquidity and their ability to fund their working capital and expansion projects
and meet their obligations and commitments. Furthermore, the State
Administration of Foreign Exchange promulgated a new circular in August 2008
with respect to the administration of conversion of foreign exchange capital
contribution of foreign invested enterprises into RMB. Pursuant to this new
circular, RMB converted from foreign exchange capital contribution can only be
used for the activities within the approved business scope of such foreign
invested enterprise and cannot be used for domestic equity investment or
acquisition unless otherwise allowed by PRC laws or regulations. As a result, we
may not be able to increase the capital contribution of our operating
subsidiaries or equity investee and subsequently convert such capital
contribution into RMB for equity investment or acquisition in
China.





We
may be adversely affected by complexity, uncertainties and changes in PRC
regulation of natural gas businesses and companies, including limitations on our
ability to own key assets.





The PRC
government regulates the natural gas industry including foreign ownership of,
and the licensing and permit requirements pertaining to, companies in the
natural gas industry. These laws and regulations are relatively new and
evolving, and their interpretation and enforcement involve significant
uncertainty. As a result, in certain circumstances it may be difficult to
determine what actions or omissions may be deemed to be a violation of
applicable laws and regulations. Issues, risks and uncertainties relating to PRC
government regulation of the natural gas industry include the
following:





·
            we
      only have contractual control over XXNGC. We do not own it due to the
      restriction of foreign investment in Chinese businesses;
    and


·
            uncertainties
      relating to the regulation of the natural gas business in China, including
      evolving licensing practices, means that permits, licenses or operations
      at our company may be subject to challenge. This may disrupt our business,
      or subject us to sanctions, requirements to increase capital or other
      conditions or enforcement, or compromise enforceability of related
      contractual arrangements, or have other harmful effects on
    us.





The
interpretation and application of existing PRC laws, regulations and policies
and possible new laws, regulations or policies have created substantial
uncertainties regarding the legality of existing and future foreign investments
in, and the businesses and activities of, natural gas businesses in China,
including our business.


31


If
the China Securities Regulatory Commission, or CSRC, or another PRC regulatory
agency determines that its approval was required in connection with this
offering, we may become subject to penalties.





On August
8, 2006, six PRC regulatory agencies, including the CSRC, promulgated the
Regulation on Mergers and Acquisitions of Domestic Companies by Foreign
Investors, or the M&A Rule, which became effective on September 8, 2006. The
M&A Rule, among other things, has certain provisions that require offshore
special purpose vehicles, or SPVs, formed for the purpose of acquiring PRC
domestic companies and controlled by PRC individuals, to obtain the approval of
the CSRC prior to listing their securities on an overseas stock exchange. We
believe, based on the opinion of our PRC legal counsel, Shaanxi Jiarui Law Firm,
that while the CSRC generally has jurisdiction over overseas listings of SPVs
like us, CSRC’s approval is not required for our overseas listing and any future
offerings given the fact that our current corporate structure was established
before the new regulation became effective. However, there remains some
uncertainty as to how this regulation will be interpreted or implemented in the
context of an overseas offering. If the CSRC or another PRC regulatory agency
subsequently determines that its approval was required for our overseas
listing and any future offerings, we may face sanctions by the CSRC or another
PRC regulatory agency. If this happens, these regulatory agencies may impose
fines and penalties on our operations in the PRC, limit our operating privileges
in the PRC, delay or restrict the injection of proceeds from an offering into
our PRC subsidiaries, restrict or prohibit payment or remittance of dividends by
our PRC subsidiaries to us or take other actions that could have a material
adverse effect on our business, financial condition, results of operations,
reputation and prospects, as well as the trading price of our common
stock.





We
may be subject to fines and legal sanctions imposed by SAFE or other Chinese
government authorities if we or our Chinese employees fail to comply with
Chinese regulations relating to employee share options granted by offshore
listed companies to Chinese citizens.





On March
28, 2007, SAFE issued the Application Procedure of Foreign Exchange
Administration for Domestic Individuals Participating in Employee Share Holding
Plan or Share Option Plan of Overseas Listed Company, or the Share Option Rule.
Under the Share Option Rule, Chinese citizens who are granted share options by
an offshore listed company are required, through a Chinese agent or Chinese
subsidiary of the offshore listed company, to register with SAFE and complete
certain other procedures, including applications for foreign exchange purchase
quotas and opening special bank accounts. We and our Chinese employees who have
been granted share options are subject to the Share Option Rule. If we or our
Chinese employees fail to comply with these regulations, we or our Chinese
employees may be subject to fines and legal sanctions imposed by SAFE or other
Chinese government authorities and we may be prevented from further granting
options under our share incentive plans to our employees. Such events could
adversely affect our business operations.


32


Recent
changes in the PRC labor law restrict our ability to reduce our workforce in the
PRC in the event of an economic downturn and may increase our labor
costs.





In June
2007, the National People’s Congress of the PRC enacted the Labor Contract Law,
which became effective on January 1, 2008. To clarify certain details in
connection with the implementation of the Labor Contract Law, the State Council
promulgated the Implementing Rules for the Labor Contract Law, or the
Implementing Rules, on September 18, 2008 which came into effect immediately.
The Labor Contract Law provides various rules regarding employment contracts
that will likely have a substantial impact on employment practices in China. The
Labor Contract Law imposes severe penalties on employers that fail to timely
enter into employment contracts with employees. The employer is required to
pay a double salary to the employee if it does not enter into a written contract
with the employee within one month of the employment, and a non-fixed-term
contract is assumed if a written contract is not executed after one year
of the employment. Additionally, the Labor Contract Law sets a limit of two
fixed-term contracts regardless of the length of each term, after which the
contract must be renewed on a non-fixed-term basis should the parties agree to a
further renewal unless otherwise required by the respective employee. This
requirement curtails the common practice of continuously renewing short-term
employment contracts. The Implementing Rules appear to further tighten this rule
by suggesting that an employee has the right to demand a non-fixed-term contract
upon the completion of the second fixed term regardless of whether the employer
agrees to a contract renewal. A non-fixed-term contract does not have a
termination date and it is generally difficult to terminate such a contract
because termination must be based on limited statutory grounds. The employer can
no longer supplement such statutory grounds through an agreement with the
employee. In addition, the Labor Contract Law requires the payment of statutory
severance upon the termination of an employment contract in most circumstances,
including the expiration of a fixed-term employment contract.





Under the
Labor Contract Law, employers can only impose a post-termination non-competition
provision on employees who have access to their confidential information for a
maximum period of two years. If an employer intends to maintain the
enforceability of a post-termination non-competition provision, the employer has
to pay the employee compensation on a monthly basis post-termination of the
employment. Under the Labor Contract Law, a “mass layoff” is defined as
termination of more than 20 employees or more than 10% of the workforce. The
Labor Contract Law expands the circumstances under which a mass layoff can be
conducted, such as when the company undertakes a restructuring pursuant to the
PRC Enterprise Bankruptcy Law, suffers serious difficulties in business
operations, changes its line of business, performs significant technology
improvements, changes operating methods, or where there has been a material
change in the objective economic circumstances relied upon by the parties at the
time of the conclusion of the employment contract, thereby making the
performance of such employment contract impractical. The employer must follow
specific procedures in conducting a mass layoff. There is little guidance on
what penalties an employer will suffer if it fails to follow the procedural
requirements in conducting the mass layoff. Finally, the Labor Contract Law
requires that the employer discuss the company’s internal rules and regulations
that directly affect the employees’ material interests (such as employees’
salary, work hours, leave, benefits, and training, etc.) with all employees or
employee representative assemblies and consult with the trade union or employee
representatives on such matters before making a final decision.





All of
our employees based exclusively within the PRC are covered by the new laws. As
there has been little guidance and precedents as to how the Labor Contract Law
and its Implementing Rules will be enforced by the relevant PRC authorities,
there remains uncertainty as to their potential impact on our business and
results of operations. The implementation of the Labor Contract Law and its
Implementing Rules may increase our operating expenses, in particular our
personnel expenses and labor service expenses. If we want to maintain the
enforceability of any of our employees’ post-termination non-competition
provisions, the compensation and procedures required under the Labor Contract
Law may add substantial costs and cause logistical burdens to us. Prior to the
new law such compensation was often structured as part of the employee’s salary
during employment, and was not an additional compensation cost. In the event
that we decide to terminate employees or otherwise change our employment or
labor practices, the Labor Contract Law and its Implementing Rules may also
limit our ability to effect these changes in a manner that we believe to be
cost-effective or desirable, which could adversely affect our business and
results of operations. In particular, our ability to adjust the size of our
operations when necessary in periods of recession or less severe economic
downturns such as the recent financial turmoil may be affected. In addition,
during periods of economic decline when mass layoffs become more common, local
regulations may tighten the procedures by, among other things, requiring the
employer to obtain approval from the relevant local authority before conducting
any mass layoff. Such regulations can be expected to exacerbate the adverse
effect of the economic environment on our results of operations and financial
condition.


33


Risks
Related to Corporate and Stock Matters





Qinan
Ji, our chairman and chief executive officer, beneficially owns a significant
percentage of our outstanding common stock and, as a result, he has
significantly greater influence over us and our corporate actions relative to
our public shareholders and his interests may not be aligned with the interests
of other shareholders.





As of
December 31, 2009, our co-founder and chief executive officer, Mr. Ji,
beneficially owned 2,965,799 shares of common stock or approximately 14.0% of
our outstanding shares of common stock. Mr. Ji is an affiliate as defined in
Rule 144 under the Securities Act of 1933, as amended, or the Securities Act,
due to the large size of his shareholding in us and his positions with us as our
chairman and chief executive officer. Rule 144 defines an affiliate of a company
as a person that, directly or indirectly, through one or more intermediaries,
controls or is controlled by, or is under common control with, our company. Mr.
Ji has, and may continue to have, significant influence in determining the
outcome of any corporate transactions or other matters submitted to our
shareholders for approval, including mergers, consolidations and the sale of all
or substantially all of our assets, election of directors and other significant
corporate actions. He may not act in the best interests of our other
shareholders. In addition, without the consent of Mr. Ji, we could be prevented
from entering into transactions that could be beneficial to us. This
concentration of ownership may also discourage, delay or prevent a change in
control of our company, which could deprive our shareholders of an opportunity
to receive a premium for their shares as part of a sale of our company and might
reduce the price of our common stock. These actions may be taken even if they
are opposed by our other shareholders.





The
limited trading volume in our stock may cause volatility in the market price of
our common stock.





Our
common stock is currently traded on a limited basis on the OTCBB under the
symbol, “CHNG.OB” The quotation of our common stock on the OTCBB does not assure
that a meaningful, consistent and liquid trading market currently exists, and in
recent years, such market has experienced extreme price and volume fluctuations
that have particularly affected the market prices of many smaller companies like
us. Our common stock is thus subject to volatility. In the absence of an active
trading market:





·
            investors
      may have difficulty buying and selling or obtaining market
      quotations;


·
            market
      visibility for our common stock may be limited;
  and


·
            a
      lack of visibility for our common stock may have a depressive effect on
      the market for our common stock.





NASD
sales practice requirements may also limit a stockholder’s ability to buy and
sell our stock.





Section
15(g) of the Securities Exchange Act of 1934, as amended, and Rule 15g-2
promulgated thereunder by the SEC require broker-dealers dealing in penny stocks
to provide potential investors with a document disclosing the risks of penny
stocks and to obtain a manually signed and dated written receipt of the document
before effecting any transaction in a penny stock for the investor’s
account.


34


Potential
investors in our common stock are urged to obtain and read such disclosure
carefully before purchasing any shares that are deemed to be “penny stock.”
Moreover, Rule 15g-9 requires broker-dealers in penny stocks to approve the
account of any investor for transactions in such stocks before selling any penny
stock to that investor. This procedure requires the broker-dealer to (i) obtain
from the investor information concerning his or her financial situation,
investment experience and investment objectives; (ii)reasonably determine, based
on that information, that transactions in penny stocks are suitable for the
investor and that the investor has sufficient knowledge and experience as to be
reasonably capable of evaluating the risks of penny stock transactions; (iii)
provide the investor with a written statement setting forth the basis on which
the broker-dealer made the determination in (ii) above; and (iv) receive a
signed and dated copy of such statement from the investor, confirming that it
accurately reflects the investor’s financial situation, investment experience
and investment objectives. Compliance with these requirements may make it more
difficult for holders of our common stock to resell their shares to third
parties or to otherwise dispose of them in the market or otherwise.





Shares
eligible for future sale may adversely affect the market price of our common
stock, as the future sale of a substantial amount of our restricted stock in the
public marketplace could reduce the price of our common stock.





From time
to time, certain of our stockholders may be eligible to sell all or some of
their shares of common stock by means of ordinary brokerage transactions in the
open market pursuant to Rule 144, promulgated under the Securities Act (“Rule
144”), subject to certain limitations. In general, pursuant to Rule 144, a
stockholder (or stockholders whose shares are aggregated) who has satisfied a
six-month holding period may, under certain circumstances, sell within any
three-month period a number of securities which does not exceed the greater of
1% of the then outstanding shares of common stock or the average weekly
trading-volume of the class during the four calendar weeks prior to such sale.
Rule 144 also permits, under certain circumstances, the sale of securities,
without any limitations, by a non-affiliate of our company that has satisfied a
one-year holding period. Any substantial sale of common stock pursuant to Rule
144 or pursuant to any resale prospectus may have an adverse effect on the
market price of our securities.





Stockholders
should have no expectation of any dividends.





The
holders of our common stock are entitled to receive dividends when declared by
the Board of Directors out of funds available. To date, we have not declared nor
paid any cash dividends. The Board of Directors does not intend to declare any
dividends in the near future, but instead intends to retain all earnings, if
any, for use in our business operations. Furthermore, if we decide to pay
dividends, foreign exchange and other regulations in China may restrict our
ability to distribute retained earnings from China or convert those payments
from Renminbi into foreign currencies.





Item
1B. Unresolved Staff Comments.





None


35





ITEM
2. PROPERTIES





Our
principal executive offices are located at 19th Floor, Building B, Van
Metropolis, No. 35 Tangyan Road, Hi-Tech Zone, Xi’an, 710065, Shaanxi province,
People's Republic of China. Our property consists of approximately 818 square
meters, which is rented on an annual basis for $88,225.





We have
additional properties located in Lantian County, the districts of Baqiao,
Lintong and Gaoxin in the city of Xi’an, and the cities of Jiyuan, Kaifung and
Pindingshan, in Henan province. We own a 120km high-pressure underground
pipeline network and two Citygate stations (terminals) with accompanying
buildings and equipment. We lease the main office building where we are
headquartered and all of our CNG fueling station sites. In order to secure
sufficient CNG supply, our VIE also own three mother stations in Xi’an city to
support our stations. As of December 31, 2009, our VIE own and operate 24 CNG
fueling stations in Shaanxi province and 12 CNG fueling stations in Henan
province.





In
February, 2006 we formed our wholly-owned subsidiary, Shaanxi Xilan Natural Gas
Equipment Co., Ltd., which maintains an office in the No. 3 Xianmen St., Lantian
County, Xi’an, Shaanxi province, China. The office consists of approximately
1001 sq. feet, with annual rental payment of $1,106.





On
October 24, 2006, XXNGC formed a wholly-owned subsidiary, Shaanxi
Jingbian Liquefied Natural Gas Co., Ltd., which maintains an office in the
Tongwang Road, Zhangjiapan Town, Jingbian County, China. The office consists of
approximately 3,921 sq. feet, with annual rental payment of $5,214.





On
February 29, 2008, the Company entered into a 62 month lease agreement in
connection with an office located on the 22nd Floor, 370 Lexington Avenue, New
York, New York. The monthly rent during the first year was $6432.





In May
27, 2008, the Company purchased a 412.10-square-meter property in Zhengzhou,
Henan province and uses it as office spaces for the local operations in Henan
province.





In August
2008, the Company purchased a 531.72-square-meter property in Beijing and uses
it as office spaces for local operations in Beijing. Therefore, the Company does
not incur any rent for Henan and Beijing Offices.





In
October 2008, the Company acquired Lingbao Yuxi Natural Gas, Co., Ltd. through
Xi’an Xilan Natural Gas Co., Ltd. Lingbao Yuxi Natural Gas maintains an office
located at Changan Rd. W, Lingbao, Henan province, with annual rent of
approximately $3,314.





In
December, 2009, XXNGC  formed a wholly-owned subsidiary, Hubei
Xilan Natural Gas, Co., which maintains an office in the No. 478 of Hongneng
Manson, Jianshe Avenue,Jianghan District,Wuhan City,Hubei Province, China. The
office consists of approximately 900 square meters, with annual rental
payment of $36,946.





As of
December 31, 2009, our VIE owned 19 trucks and 34 tankers that the Company used
to transport natural gas.


36





The
company considers the properties to be adequate and sufficient for the
requirements of each location. The extent of utilization of such properties
varies from property to property and from time to time during the
year.





Insurance





We carry
auto insurance on our vehicles and maintain workers compensation insurance for
our fueling station workers. We believe this insurance is adequate for our
needs. We do not carry any product liability insurance or property insurance on
our office buildings or other property. We do not carry any third party
liability insurance.





We
believe that current facilities are adequate for our current and immediately
foreseeable operating needs. We do not have any policies regarding investments
in real estate, securities or other forms of property.





We also
carry directors’ and officers' liability insurance with XL Insurance Company
Ltd. with aggregate limit of liability of $15 million to cover our management
and directors in the event that any claim may arise against such insured persons
due to employment related acts. The insurance will expire on October 15, 2010
and is renewed annually.





ITEM
3. LEGAL PROCEEDINGS





A former
member of the board of directors filed a lawsuit on June 16, 2008 against the
Company in New York State Supreme Court, Nassau County, in which he has sought,
among other things, to recover a portion of his monthly compensation plus 20,000
options that he alleges are due to him pursuant to a written agreement. After
the plaintiff rejected an offer by the Company that included the options that
plaintiff alleged were due to him, the Company moved to dismiss the complaint.
The judge ordered the Company to issue the 20,000 options to the plaintiff
subject to any restrictions required by applicable securities laws, which was
essentially what the Company had previously offered, and dismissed all of the
plaintiff's remaining claims against the Company. The current board of directors
has complied with the court's decision by tendering an option agreement to the
plaintiff consistent with the court's decision, but the plaintiff has refused to
execute the agreement, and instead has filed an appeal. Regardless of the
outcome of the appeal, we believe that any liability we would incur will not
have a materially adverse effect on our financial condition or our results of
operations.





ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS





None.





PART
II





ITEM
5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
PURCHASES OF EQUITY SECURITIES





Prior to
June 5, 2009, our common stock was quoted on the Over-the-Count Bulletin Board
(“OTCBB”) under the symbol “CHNG.” On June 5, 2009, we terminated our listing on
OTCBB and listed our common stock on NASDAQ Global Market also under the symbol
“CHNG.” The following table sets forth, for the indicated periods, the high and
low sales prices for our common stock, as reported on NASDAQ, and prior to June
5, 2009, as reported on the OTCBB. The quotations represent inter-dealer
prices without retail markup, markdown or commission, and may not necessarily
represent actual transactions.


37





COMMON STOCK
                        MARKET PRICEHIGH
                      
                      
                      LOWFISCAL
      YEAR ENDED DECEMBER 31, 2009:Fourth
      Quarter
                      
                      $
                      15.62
                      
                      
                      $
                      9.07Third
      Quarter
                      
                      $
                      14.36
                      
                      
                      $
                      8.15Second
      Quarter
                      
                      $
                      18.00
                      
                      
                      $
                      5.02First
      Quarter
                      
                      $
                      6.40
                      
                      
                      $
                      3.00FISCAL
      YEAR ENDED DECEMBER 31, 2008:Fourth
      Quarter
                      
                      $
                      4.08
                      
                      
                      $
                      2.25Third
      Quarter
                      
                      $
                      6.00
                      
                      
                      $
                      3.50Second
      Quarter
                      
                      $
                      7.33
                      
                      
                      $
                      5.15First
      Quarter
                      
                      $
                      7.25
                      
                      
                      $
                      4.75





As of
February 28, 2010 there were approximately 23 holders of record of our common
stock.





Shareholders’ return
on the common stock for the past five years are shown as follows





2009
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2006
                  
                  
                  2005Return
      on equity
                  
                  
                  17.5
                  %
                  
                  
                  24.7
                  %
                  
                  
                  23.7
                  %
                  
                  
                  30.9
                  %
                  
                  
                  12.9
                  %





Dividends





There are
no restrictions in our articles of incorporation or bylaws that prevent us from
declaring dividends. The Delaware General Corporation Law, however, does
prohibit us from declaring dividends where, after giving effect to the
distribution of the dividend:





1. We
would not be able to pay our debts as they become due in the usual course of
business; or


2. Our
total assets would be less than the sum of our total liabilities plus the amount
that would be needed to satisfy the rights of shareholders who have preferential
rights superior to those receiving the distribution.





We have
never paid any cash dividends on our common stock. We currently anticipate that
we will retain any future earnings for use in our business. Consequently, we do
not anticipate paying any cash dividends in the foreseeable future.





The
payment of dividends in the future will depend upon our results of operations,
as well as our short-term and long-term cash availability, working capital,
working capital needs and other factors, as determined by our board of
directors. Currently, except as may be provided by applicable laws, there are no
contractual or other restrictions on our ability to pay dividends if we were to
decide to declare and pay them.





Securities
Authorized for Issuance under Equity Compensation Plan





There has
been no common stock authorized for issuance with respect to any equity
compensation plan as of the fiscal year ended December 31,
2009.


38





Recent
Sales of Unregistered Securities





The
Company did not sell any equity securities that were not registered under the
Securities Act of 1933, as amended, during the quarter ended December 31,
2009.





ITEM
6.  SELECTED FINANCIAL DATA





For the
past five years, the increase in the number of our VIE-owned CNG fueling
stations has not affected our gross margin or per-station based operating margin
since the natural gas cost and retail price remains
stable.  Meanwhile, our selling, general and administrative
expenses also increases in proportion to our scale of operations. Therefore, the
increase in the number of our VIE-owned CNG fueling stations doesn’t materially
affect the comparability of our financial data.




Year ended December 312009
                                                                    
                                                                    
                                                                    2008
                                                                    
                                                                    
                                                                    2007
                                                                    
                                                                    
                                                                    2006
                                                                    
                                                                    
                                                                    2005STATEMENT
      OF OPERATIONS:RevenuesNatural
      gas revenue
                                                                    
                                                                    
                                                                    62,236,342
                                                                    
                                                                    
                                                                    
                                                                    55,746,893
                                                                    
                                                                    
                                                                    
                                                                    28,278,033
                                                                    
                                                                    
                                                                    
                                                                    13,713,145
                                                                    
                                                                    
                                                                    
                                                                    1,687,154Gasoline
      revenue
                                                                    
                                                                    
                                                                    6,384,172
                                                                    
                                                                    
                                                                    
                                                                    4,616,052
                                                                    
                                                                    
                                                                    
                                                                    38,486
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -Installation
      and others
                                                                    
                                                                    
                                                                    12,445,604
                                                                    
                                                                    
                                                                    
                                                                    7,357,714
                                                                    
                                                                    
                                                                    
                                                                    7,075,534
                                                                    
                                                                    
                                                                    
                                                                    5,115,645
                                                                    
                                                                    
                                                                    
                                                                    3,163,545Total
      revenues
                                                                    
                                                                    
                                                                    81,066,118
                                                                    
                                                                    
                                                                    
                                                                    67,720,659
                                                                    
                                                                    
                                                                    
                                                                    35,392,053
                                                                    
                                                                    
                                                                    
                                                                    18,828,790
                                                                    
                                                                    
                                                                    
                                                                    4,850,699Cost
      of revenuesNatural
      gas cost
                                                                    
                                                                    
                                                                    29,478,854
                                                                    
                                                                    
                                                                    
                                                                    27,234,508
                                                                    
                                                                    
                                                                    
                                                                    14,838,997
                                                                    
                                                                    
                                                                    
                                                                    7,663,060
                                                                    
                                                                    
                                                                    
                                                                    1,293,585Gasoline
      cost
                                                                    
                                                                    
                                                                    5,993,207
                                                                    
                                                                    
                                                                    
                                                                    4,277,458
                                                                    
                                                                    
                                                                    
                                                                    34,747
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -Installation
      and others
                                                                    
                                                                    
                                                                    5,432,978
                                                                    
                                                                    
                                                                    
                                                                    3,469,671
                                                                    
                                                                    
                                                                    
                                                                    3,151,331
                                                                    
                                                                    
                                                                    
                                                                    2,054,940
                                                                    
                                                                    
                                                                    
                                                                    1,110,452Total
      cost of revenues
                                                                    
                                                                    
                                                                    40,905,039
                                                                    
                                                                    
                                                                    
                                                                    34,981,637
                                                                    
                                                                    
                                                                    
                                                                    18,025,075
                                                                    
                                                                    
                                                                    
                                                                    9,718,000
                                                                    
                                                                    
                                                                    
                                                                    2,404,037Gross
      profit
                                                                    
                                                                    
                                                                    40,161,079
                                                                    
                                                                    
                                                                    
                                                                    32,739,022
                                                                    
                                                                    
                                                                    
                                                                    17,366,978
                                                                    
                                                                    
                                                                    
                                                                    9,110,790
                                                                    
                                                                    
                                                                    
                                                                    2,446,662Operating
      expensesSelling
      expenses
                                                                    
                                                                    
                                                                    9,566,387
                                                                    
                                                                    
                                                                    
                                                                    7,651,948
                                                                    
                                                                    
                                                                    
                                                                    3,451,161
                                                                    
                                                                    
                                                                    
                                                                    1,308,464
                                                                    
                                                                    
                                                                    
                                                                    474,855General
      and administrative expenses
                                                                    
                                                                    
                                                                    5,541,885
                                                                    
                                                                    
                                                                    
                                                                    4,024,882
                                                                    
                                                                    
                                                                    
                                                                    2,837,768
                                                                    
                                                                    
                                                                    
                                                                    1,287,735
                                                                    
                                                                    
                                                                    
                                                                    500,228Total
      operating expenses
                                                                    
                                                                    
                                                                    15,108,272
                                                                    
                                                                    
                                                                    
                                                                    11,676,830
                                                                    
                                                                    
                                                                    
                                                                    6,288,929
                                                                    
                                                                    
                                                                    
                                                                    2,596,199
                                                                    
                                                                    
                                                                    
                                                                    975,083Income
      from operations
                                                                    
                                                                    
                                                                    25,052,807
                                                                    
                                                                    
                                                                    
                                                                    21,062,192
                                                                    
                                                                    
                                                                    
                                                                    11,078,049
                                                                    
                                                                    
                                                                    
                                                                    6,514,591
                                                                    
                                                                    
                                                                    
                                                                    1,471,579Non-operating
      income (expense):Interest
      income
                                                                    
                                                                    
                                                                    125,287
                                                                    
                                                                    
                                                                    
                                                                    209,502
                                                                    
                                                                    
                                                                    
                                                                    70,697
                                                                    
                                                                    
                                                                    
                                                                    41,109
                                                                    
                                                                    
                                                                    
                                                                    2,131Interest
      expense
                                                                    
                                                                    
                                                                    (747,172
                                                                    )
                                                                    
                                                                    
                                                                    (2,228,244
                                                                    )
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -Foreign
      currency exchange loss
                                                                    
                                                                    
                                                                    (69,077
                                                                    )
                                                                    
                                                                    
                                                                    (397,299
                                                                    )
                                                                    
                                                                    
                                                                    (150,729
                                                                    )
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -Other
      income (expense)
                                                                    
                                                                    
                                                                    (186,805
                                                                    )
                                                                    
                                                                    
                                                                    111,859
                                                                    
                                                                    
                                                                    
                                                                    31,976
                                                                    
                                                                    
                                                                    
                                                                    (79,021
                                                                    )
                                                                    
                                                                    
                                                                    (671
                                                                    )Change
      in fair value of warrants
                                                                    
                                                                    
                                                                    (1,031,330
                                                                    )Total
      non-operating income (expense)
                                                                    
                                                                    
                                                                    (1,909,097
                                                                    )
                                                                    
                                                                    
                                                                    (2,304,182
                                                                    )
                                                                    
                                                                    
                                                                    (48,056
                                                                    )
                                                                    
                                                                    
                                                                    (37,912
                                                                    )
                                                                    
                                                                    
                                                                    1,460Income
      before income tax
                                                                    
                                                                    
                                                                    23,143,710
                                                                    
                                                                    
                                                                    
                                                                    18,758,010
                                                                    
                                                                    
                                                                    
                                                                    11,029,993
                                                                    
                                                                    
                                                                    
                                                                    6,476,679
                                                                    
                                                                    
                                                                    
                                                                    1,473,039Provision
      for income tax
                                                                    
                                                                    
                                                                    4,312,923
                                                                    
                                                                    
                                                                    
                                                                    3,567,642
                                                                    
                                                                    
                                                                    
                                                                    1,913,923
                                                                    
                                                                    
                                                                    
                                                                    1,025,584
                                                                    
                                                                    
                                                                    
                                                                    220,956Net
      income
                                                                    
                                                                    
                                                                    18,830,787
                                                                    
                                                                    
                                                                    
                                                                    15,190,368
                                                                    
                                                                    
                                                                    
                                                                    9,116,070
                                                                    
                                                                    
                                                                    
                                                                    5,451,095
                                                                    
                                                                    
                                                                    
                                                                    1,252,083Other
      comprehensive incomeForeign
      currency translation gain
                                                                    
                                                                    
                                                                    52,959
                                                                    
                                                                    
                                                                    
                                                                    5,184,035
                                                                    
                                                                    
                                                                    
                                                                    2,637,573
                                                                    
                                                                    
                                                                    
                                                                    610,705
                                                                    
                                                                    
                                                                    
                                                                    228,175Comprehensive
      income
                                                                    
                                                                    
                                                                    18,883,746
                                                                    
                                                                    
                                                                    
                                                                    20,374,403
                                                                    
                                                                    
                                                                    
                                                                    11,753,643
                                                                    
                                                                    
                                                                    
                                                                    6,061,800
                                                                    
                                                                    
                                                                    
                                                                    1,480,258Weighted
      average sharesoutstandingBasic
                                                                    
                                                                    
                                                                    16,624,294
                                                                    
                                                                    
                                                                    
                                                                    14,600,154
                                                                    
                                                                    
                                                                    
                                                                    13,100,340
                                                                    
                                                                    
                                                                    
                                                                    11,936,468
                                                                    
                                                                    
                                                                    
                                                                    8,149,735Diluted
                                                                    
                                                                    
                                                                    16,830,907
                                                                    
                                                                    
                                                                    
                                                                    14,645,070
                                                                    
                                                                    
                                                                    
                                                                    13,150,901
                                                                    
                                                                    
                                                                    
                                                                    11,936,468
                                                                    
                                                                    
                                                                    
                                                                    8,149,735Earnings
      per shareBasic
                                                                    
                                                                    
                                                                    1.13
                                                                    
                                                                    
                                                                    
                                                                    1.04
                                                                    
                                                                    
                                                                    
                                                                    0.70
                                                                    
                                                                    
                                                                    
                                                                    0.46
                                                                    
                                                                    
                                                                    
                                                                    0.15Diluted
                                                                    
                                                                    
                                                                    1.12
                                                                    
                                                                    
                                                                    
                                                                    1.04
                                                                    
                                                                    
                                                                    
                                                                    0.69
                                                                    
                                                                    
                                                                    
                                                                    0.46
                                                                    
                                                                    
                                                                    
                                                                    0.15BALANCE
      SHEETS DATA(at
      end of period):PROPERTY
      AND EQUIPMENT, net
                                                                    
                                                                    
                                                                    72,713,012
                                                                    
                                                                    
                                                                    
                                                                    76,028,272
                                                                    
                                                                    
                                                                    
                                                                    32,291,995
                                                                    
                                                                    
                                                                    
                                                                    17,193,728
                                                                    
                                                                    
                                                                    
                                                                    8,267,897Working
      Capital
                                                                    
                                                                    
                                                                    1,868,754
                                                                    
                                                                    
                                                                    
                                                                    4,989,448
                                                                    
                                                                    
                                                                    
                                                                    13,581,900
                                                                    
                                                                    
                                                                    
                                                                    5,289,220
                                                                    
                                                                    
                                                                    
                                                                    (320,253
                                                                    )TOTAL
      ASSETS
                                                                    
                                                                    
                                                                    197,614,516
                                                                    
                                                                    
                                                                    
                                                                    118,262,291
                                                                    
                                                                    
                                                                    
                                                                    53,289,998
                                                                    
                                                                    
                                                                    
                                                                    28,466,351
                                                                    
                                                                    
                                                                    
                                                                    10,911,062Long
      Term Debt
                                                                    
                                                                    
                                                                    2,045,638
                                                                    
                                                                    
                                                                    
                                                                    42,021,605
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    
                                                                    -Stockholders
      ’ Equity
                                                                    
                                                                    
                                                                    144,113,272
                                                                    
                                                                    
                                                                    
                                                                    71,648,421
                                                                    
                                                                    
                                                                    
                                                                    51,207,314
                                                                    
                                                                    
                                                                    
                                                                    25,630,204
                                                                    
                                                                    
                                                                    
                                                                    9,675,550




39


ITEM
7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS





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


40


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





Overview





We are an
integrated natural gas operator in The People’s Republic of China (“China” or
the “PRC”), primarily involved in distribution of compressed natural gas (“CNG”) through our
VIE-owned CNG fueling stations. As of December 31, 2009, our VIE operated 24 CNG
fueling stations in Shaanxi province and 12 CNG fueling stations in Henan
province. Our VIE own the CNG fueling stations while we lease the land upon
which our VIE owned CNG fueling stations operate. For the year ended December
31, 2009, we sold CNG of 164,343,895 cubic meters through our fueling stations,
compared to 149,412,144 cubic meters for the year ended December 31, 2008. Our
VIE also transport, distribute and sell piped natural gas to residential and
commercial customers in the city of Xi’an in Shaanxi Province, including Lantian
County, and the districts of Lintong and Baqiao, and in the city of Lingbao in
Henan Province.





We
operate four main business lines:





·
            Distribution
      and sale of compressed natural gas through our VIE owned CNG fueling
      stations for hybrid (natural gas/gasoline) powered vehicles (36 stations
      as of December 31, 2009);





·
            Installation,
      distribution and sale of piped natural gas to residential and commercial
      customers through our VIE owned pipelines. We distributed and sold piped
      natural gas to approximately 108,423 residential customers as of December
      31, 2009;





·
            Distribution
      and sale of gasoline through our VIE owned CNG fueling stations for
      gasoline and hybrid (natural gas/gasoline) powered vehicles (eight of our
      CNG fueling stations sold gasoline as of December 31, 2009);
      and





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





We buy
all of the natural gas that we sell and distribute to our customers. We do not
mine or produce any of our own natural gas and have no plans to do so during the
next 12 months. We currently sell our natural gas in two forms: (i) CNG and (ii)
piped natural gas.





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


41





We had
total revenues of $81,066,118, $67,720,659 and $35,392,053 for the years ended
December 31, 2009, 2008 and 2007, respectively.  We had net income of
$18,830,787, $15,190,368 and $9,116,070 for the years ended December 31, 2009,
2008 and 2007, respectively.





Critical
Accounting Policies





Property
and Equipment





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





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





Construction
in Progress





Construction
in progress (“CIP”) consists of the cost of constructing property and equipment
for the gas stations and a new project of processing, distribution and sale of
LNG. The major cost of construction in progress relates to technology licensing
fees, equipment purchases, land use rights requisition cost, capitalized
interest and other construction fees.  No depreciation is provided for
construction in progress until such time as the assets are completed and placed
into service.  Interest incurred during construction is capitalized
into construction in progress. All other interest is expensed as
incurred.





Revenue
Recognition





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




42


Fair
Value of Financial Instruments





The
accounting standards regarding fair value of financial instruments and related
fair value measurements established a three-level valuation hierarchy for
disclosures of fair value measurement and enhances disclosures requirements for
fair value measures. The carrying amounts reported in the balance sheets for
receivables and current liabilities each qualify as financial instruments and
are a reasonable estimate of fair value because of the short period of time
between the origination of such instruments and their expected realization and
their current market rate of interest.  The three levels are defined
as follows:





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





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





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





FASB
accounting standard regarding derivatives and hedging specifies that a
contract that would otherwise meet the definition of a derivative but is both
(a) indexed to the Company’s own stock and (b) classified in stockholders’
equity in the statement of financial position would not be considered a
derivative financial instrument.  This FASB accounting standard also
provides a new two-step model to be applied in determining whether a financial
instrument or an embedded feature is indexed to an issuer’s own stock and thus
qualifies for the exception.





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





Factors
Affecting Our Results of Operations





Significant
factors affecting our results of operations are:





Successful expansion of our
CNG fueling station business in our target markets. Our revenue increased
by 19.7% during the year ended December 31, 2009, from the year ended December
31, 2008, partially because the newly added fueling stations in 2008 contributed
a full year’s of revenue in 2009, as well as the addition of 1 new CNG fueling
station during 2009. For the year ended December 31, 2008, our revenue increased
by 91.3%, compared to the year December 31, 2007, primarily because of the
addition of 11 new CNG fueling stations during 2008. As of December 31, 2009, we
operated 36 CNG fueling stations in total and, in Shaanxi alone, we operated 24
CNG fueling stations. We believe we are the largest provider of CNG fueling
stations in Xi’an, one of our core target markets for CNG. As of December 31,
2009, we operated 12 CNG fueling stations in Henan province, another of our core
target markets. The successful expansion of our CNG fueling station business in
Xi’an and Henan province has been a significant factor driving our revenue
growth and results of operations for the period reviewed. While we intend to
expand into different provinces, we anticipate the growth of our CNG fueling
business in Xi’an and Henan province will continue to significantly affect our
results of operations as we intend to continue to increase the number of CNG
fueling stations we operate in these areas.


43





Regulation of natural gas
prices in the PRC. The prices at which we purchase our natural gas
supplies and sell CNG and pipeline natural gas products are strictly regulated
by the PRC central government, including the NDRC, and the local state price
bureaus who have the discretion to set natural gas prices within the boundaries
set by the PRC central government. In addition, natural gas procurement and sale
prices are not uniform across China and can vary across provinces. For example,
the prices at which we procure and sell CNG and piped natural gas are lower in
Shaanxi than in Henan. Accordingly, our results of operations and, in
particular, our revenue, cost of revenue and gross profit and gross margin are
affected significantly by factors which are outside of our control. As we expand
our natural gas business into other provinces, we expect our results of
operations to continue to be affected significantly by the regulation of natural
gas prices in the PRC.





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





The overall economic growth
of China’s economy. We do not export our products outside China and our
results of operations are thus substantially affected by the growth of the
industrial base, the increase in residential, commercial and vehicular
consumption and the overall economic growth of China. While China's economy has
experienced a slowdown in 2008 and a recovery period in 2009, Although the
government has initiated extensive domestic stimulus spending, expanded bank
lending, increases in the speed of regulatory approvals of new construction
projects and other economic policies, we are currently unable to predict the
overall direction of PRC economy. Our results of operations rely on the overall
success of China’s economy and may be affected by the macro economic
trends.





Taxation





United
States





We are
incorporated in the State of Delaware and are subject to the tax laws of the
United States. We incurred a net operating loss for income tax purposes for the
years ended December 31, 2009, 2008 and 2007, and the net operating loss carry
forwards for United States income tax purposes amounted to $3,232,855 and
$1,657,473 as of December 31, 2009 and 2008, respectively, which may be
available to reduce future years' taxable income. These carry forwards will
expire, if not utilized, beginning in 2027 through 2029. Our management believes
that the realization of the benefits arising from this loss appear to be
uncertain due to our Company's limited operating history and continuing losses
for United States income tax purposes. Accordingly, we have provided a 100%
valuation allowance at December 31, 2009.


44





The PRC





Our
subsidiary, VIE and its subsidiaries operate in China. Starting January 1, 2008,
pursuant to the tax laws of China, general enterprises are subject to income tax
at an effective rate of 25% compared to 33% prior to 2008. Based on certain
income tax regulations adopted in 2001 to encourage the development of certain
industries, including the natural gas industry, in the western portions of China
such as Shaanxi province, XXNGC is subject to a reduced tax rate of 15%.
Accordingly, except for income from XXNGC, which is subject to the reduced tax
rate of 15%, income from SXNGE, SJLNG, XXABC, HXNGC, LBNGC and HBXNGC are
subject to the 25% PRC income tax rate. Our effective income tax rate for the
years ended December 31, 2009, 2008 and 2007 were approximately 19%, 19% and
17%, respectively.





Value Added
Tax





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





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





Internal
Control Over Financial Reporting





We are
subject to reporting obligations under the U.S. securities laws. The SEC, as
required by Section 404 of the Sarbanes-Oxley Act, adopted rules requiring every
public company to include a management report on such company’s internal control
over financial reporting in its annual report, which contains management’s
assessment of the effectiveness of the company’s internal control over financial
reporting. In addition, an independent registered public accounting firm must
report on our internal control over financial reporting. Our management may
report whether our internal control over our financial reporting is effective
based on internal assessments. Moreover, even if our management concludes that
our internal control over financial reporting is effective, our independent
registered public accounting firm may report that our internal control over
financial reporting is not effective.




45





During
the audit of our internal control over financial reporting as of December 31,
2008, our auditor indentified certain material weaknesses as well as significant
deficiencies. The Company contributed significant resources and remediation
initiative, including:





·
            Identifying
      and hiring additional personnel with U.S. GAAP and SEC reporting
      experience;


·
            Providing
      training to our finance personnel to improve their knowledge of U.S. GAAP
      and SEC reporting requirements;


·
            Holding
      regular meetings of the audit committee and resuming regular communication
      between the committee and our independent registered public accounting
      firm;


·
            Engaging
      Ernst & Young to consult on our internal audit function as well as
      other internal control practices;


·
            Establishing
      anonymous whistleblower systems for reporting violations of our governance
      policies, including policies regarding internal
  controls;


·
            Introducing
      policies and procedures to effectively control daily cash transactions and
      recording;


·
            Putting
      in place a centralized financial reporting software system in our
      headquarters, management centers and operating sites;
  and


·
            Engaging
      external professional consultants to assess the entity level internal
      controls over financial reporting using the COSO internal control
      framework.





These
remediation measures contributed to the improvement of our internal control over
financial reporting. Based on such remediation measures and the management’s
evaluation, we concluded that our internal control over financial reporting
is effective as of December 31, 2009. Our independent registered public
accounting firm also reported to us that based on the criteria set forth by the
Committee of Sponsoring Organizations of the Treadway Commission ("COSO"), our
internal control over financial reporting is effective.


46


Results
of Operations





The
following table sets forth certain information regarding our results of
operations for the years ended December 31, 2009, 2008 and 2007.





Year Ended December 31,2009
                      
                      
                      2008
                      
                      
                      2007RevenuesNatural
      gas revenue
                      
                      $
                      62,236,342
                      
                      
                      $
                      55,746,893
                      
                      
                      $
                      28,278,033Gasoline
      revenue
                      
                      
                      6,384,172
                      
                      
                      
                      4,616,052
                      
                      
                      
                      38,486Installation
      and others
                      
                      
                      12,445,604
                      
                      
                      
                      7,357,714
                      
                      
                      
                      7,075,534Total
      revenues
                      
                      
                      81,066,118
                      
                      
                      
                      67,720,659
                      
                      
                      
                      35,392,053Cost
      of revenuesNatural
      gas cost
                      
                      
                      29,478,854
                      
                      
                      
                      27,234,508
                      
                      
                      
                      14,838,997Gasoline
      cost
                      
                      
                      5,993,207
                      
                      
                      
                      4,277,458
                      
                      
                      
                      34,747Installation
      and others
                      
                      
                      5,432,978
                      
                      
                      
                      3,469,671
                      
                      
                      
                      3,151,331Total
      cost of revenues
                      
                      
                      40,905,039
                      
                      
                      
                      34,981,637
                      
                      
                      
                      18,025,075Gross
      profit
                      
                      
                      40,161,079
                      
                      
                      
                      32,739,022
                      
                      
                      
                      17,366,978Operating
      expensesSelling
      expenses
                      
                      
                      9,566,387
                      
                      
                      
                      7,651,948
                      
                      
                      
                      3,451,161General
      and administrative expenses
                      
                      
                      5,541,885
                      
                      
                      
                      4,024,882
                      
                      
                      
                      2,837,768Total
      operating expenses
                      
                      
                      15,108,272
                      
                      
                      
                      11,676,830
                      
                      
                      
                      6,288,929Income
      from operations
                      
                      
                      25,052,807
                      
                      
                      
                      21,062,192
                      
                      
                      
                      11,078,049Non-operating
      income (expense):Interest
      income
                      
                      
                      125,287
                      
                      
                      
                      209,502
                      
                      
                      
                      70,697Interest
      expense
                      
                      
                      (747,172
                      )
                      
                      
                      (2,228,244
                      )
                      
                      
                      -Other
      income, net
                      
                      
                      (186,805
                      )
                      
                      
                      111,859
                      
                      
                      
                      31,976Chang
      in fair value warrants
                      
                      
                      (1,031,330
                      )
                      
                      
                      -
                      
                      
                      
                      -Foreign
      currency exchange loss
                      
                      
                      (69,077
                      )
                      
                      
                      (397,299
                      )
                      
                      
                      (150,729
                      )Total
      non-operating expense
                      
                      
                      (1,909,097
                      )
                      
                      
                      (2,304,182
                      )
                      
                      
                      (48,056
                      )Income
      before income tax
                      
                      
                      23,143,710
                      
                      
                      
                      18,758,010
                      
                      
                      
                      11,029,993Provision
      for income tax
                      
                      
                      4,312,923
                      
                      
                      
                      3,567,642
                      
                      
                      
                      1,913,923Net
      income
                      
                      
                      18,830,787
                      
                      
                      
                      15,190,368
                      
                      
                      
                      9,116,070Other
      comprehensive incomeForeign
      currency translation gain
                      
                      
                      52,959
                      
                      
                      
                      5,184,035
                      
                      
                      
                      2,637,573Comprehensive
      income
                      
                      $
                      18,883,746
                      
                      
                      $
                      20,374,403
                      
                      
                      $
                      11,753,643


47


Fiscal
Year Ended December 31, 2009 Compared to Fiscal Year Ended December 31,
2008
 
 The
following table represents the consolidated operating results for the years
ended December 31, 2009 and 2008:


Sales
Revenues





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





December 31,
                  2009
                
                
                December 31,
                  2008
                
                
                Increase in dollar
                  Amount
                
                
                Increase in
                  percentageNatural
      gas from fueling stations
                
                $
                59,257,975
                
                
                $
                53,219,853
                
                
                $
                6,038,122
                
                
                
                11.3
                %Natural
      gas from pipelines
                
                
                2,978,367
                
                
                
                2,527,040
                
                
                
                451,327
                
                
                
                17.9
                %Gasoline
                
                
                6,384,172
                
                
                
                4,616,052
                
                
                
                1,768,120
                
                
                
                38.3
                %Installation
                
                
                9,838,812
                
                
                
                4,854,438
                
                
                
                4,984,374
                
                
                
                102.7
                %Auto
      conversion
                
                
                2,606,792
                
                
                
                2,503,276
                
                
                
                103,516
                
                
                
                4.1
                %Total
                
                $
                81,066,118
                
                
                $
                67,720,659
                
                
                $
                13,345,459
                
                
                
                19.7
                %





Overall.
Revenue increased by $13,345,459, or 19.7%, to $81,066,118 for the year ended
December 31, 2009, from $67,720,659 for year ended December 31, 2008. This
increase was mainly due to the newly added fueling stations in 2008 contributing
full year revenue in 2009 as well as the addition of 1 new fueling station
during 2009, and an increase in the number of residential and commercial
pipeline customers to 108,423 as of December 31, 2009, from 96,033 as of
December 31, 2008. We sold natural gas of 176,424,700 cubic meters during the
year ended December 31, 2009, compared to 160,696,902 cubic meters during the
year ended December 31, 2008. For the year ended December 31, 2009, 84.7% of our
revenue was generated from the sale of natural gas and gasoline, and the other
15.3% was generated from our installation and auto conversion
services.





Natural Gas from
Fueling Stations. Natural gas revenue from our fueling stations increased
by $6,038,122, or 11.3%, to $59,257,975 for the year ended December 31, 2009
from $53,219,853 for the year ended December 31, 2008, and contributed to73.1%
of our total revenue, which was the largest among our four major business lines.
The increase of natural gas revenue was mainly due to newly added fueling
stations in 2008 contributing full year revenue in 2009, as well as the addition
of 1 new fueling station during 2009. During the year ended December 31, 2009,
we sold compressed natural gas of 164,343,895 cubic meters, compared to
149,412,144 cubic meters during the year ended December 31, 2008 through our
VIE-owned fueling stations. In terms of average station sales value and volume,
in the year ended December 31, 2009, we sold approximately $1,677,271 and
4,651,681 cubic meters of compressed natural gas per station, remaining flat as
compared to approximately $1,694,001 and 4,755,824 cubic meters in the year
ended December 31, 2008. Unit selling price was stable at $0.37 (RMB
2.5).





Natural Gas from
Pipelines.  Revenue from sales of piped natural gas increased
by $451,327, or 17.9%, to $ 2,978,367 for the year ended December 31, 2009, from
$2,527,040 for the year ended December 31, 2008, and contributed to 3.7% of our
total revenue. Our residential customers of piped natural gas increased to
108,423 as of December 31, 2009, from 96,033 as of December 31, 2008. We also
sold 12,080,805 cubic meters of natural gas through our VIE-owned pipelines
during the year ended December 31, 2009, compared to 11,284,758 cubic
meters during the year ended December 31, 2008.





Gasoline.
Revenue from gasoline sales increased by $1,768,120 to $6,384,172 for the year
ended December 31, 2009 from $4,616,052 for the year ended December 31, 2008,
and contributed 7.9% to our total revenue. The gasoline revenue increase was due
to the sales volume increased 43.5% from 6,891,030 liters to 9,885,482 liters,
offset by 4.0% decrease of unit sales price from $0.67 (RMB 4.65) per liter
in the year ended December 31, 2008 to $0.64 (RMB 4.39) per liter in the
year ended December 31, 2009, due to the decrease of international oil price.
The increased sales volume was due to 3 stations began selling gasoline
since the second half of 2008 and 1 station began selling gasoline in the
first quarter of 2009.


48





Installation
Services. Revenue from our pipeline installation business increased by
$4,984,374, or 102.7%, to $9,838,812 for the year ended December 31, 2009, from
$4,854,438 for the year ended December 31, 2008, and contributed 12.1% to our
total revenue. The increase of installation sales was mainly due to the increase
of pipeline customers in the newly acquired subsidiary, Lingbao Natural Gas,
Co., in Henan Province. During 2009, Lingbao contributed $4,397,403 in
installation revenue. Installation services to our top four customers
contributed to 8.4%, 8.2%, 6.2% and 5.3% of our installation revenue for the
year ended December 31, 2009.





Auto Conversion
Services. Revenue from our automobile conversion business increased by
$103,516, or 4.1%, to $2,606,792 for the year ended December 31, 2009, from
$2,503,276 for the year ended December 31, 2008, and contributed 3.2% to our
total revenue.





We expect
natural gas sales to continue to generate the bulk of our revenue as we intend
to continue to increase the number of CNG fueling stations we operate and the
number of our natural gas pipeline customers as well as begin to process,
distribute and sell LNG once our LNG plant is completed and fully operational,
which we anticipate will occur in 2010. We expect gasoline sales will continue
to comprise a smaller portion of our entire business given that such sales are
primarily designed to support our existing CNG sales to customers with hybrid
fuel vehicles and are not a growth focus for our Company. We also expect revenue
from our pipeline installation and our automobile conversion businesses to
continue to make up a minor portion of our business.





Cost of
revenue





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





December 31,
                  2009
                
                
                December 31,
                  2008
                
                
                Increase /
                  (Decrease) in
                  dollar
                  amount
                
                
                Increase /
                  (Decrease) in
                  percentageNatural
      gas from fueling stations
                
                $
                27,395,962
                
                
                $
                25,420,764
                
                
                $
                1,975,198
                
                
                
                7.8
                %Natural
      gas from pipelines
                
                
                2,082,892
                
                
                
                1,813,744
                
                
                
                269,148
                
                
                
                14.8
                %Gasoline
                
                
                5,993,207
                
                
                
                4,277,458
                
                
                
                1,715,749
                
                
                
                40.1
                %Installation
                
                
                3,888,996
                
                
                
                1,961,300
                
                
                
                1,927,696
                
                
                
                98.3
                %Auto
      conversion
                
                
                1,543,982
                
                
                
                1,508,371
                
                
                
                35,611
                
                
                
                2.4
                %Total
                
                $
                40,905,039
                
                
                $
                34,981,637
                
                
                $
                5,923,402
                
                
                
                16.9
                %





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


49





Our cost
of revenue for the year ended December 31, 2009 was $40,905,039, an increase of
$5,923,402, or 16.9%, from $34,981,637 for the year ended December 31, 2008,
while our revenue increased by 19.7% during the same period.





Natural Gas from
Fueling Stations. Cost of revenue of our natural gas for our VIE-owned
fueling stations increased by 7.8%, or $1,975,198, to $27,395,962 during the
year ended December 31, 2009, as compared to $25,420,764 for the year ended
December 31, 2008. The low growth rate for cost of natural gas for our fueling
stations was primarily due to the low procurement price in coal bed methane we
obtained from July 2008 to May 2009 in Henan province that reduced our unit cost
from one of our major supplier by approximately 35%, from $0.22 (RMB1.55) to
$0.14 (RMB1.00), offset by the increase of natural gas procurement price
starting June 2009, from $0.15(RMB1.00) to $0.19 (RMB1.30). Our overall average
unit cost was reduced by 3.4% during the year ended December 31, 2009.





Natural Gas from
Pipelines. Cost of revenue of our natural gas sold through our VIE-owned
pipelines increased by 14.8%, or $269,148 to $2,082,892 during the year ended
December 31, 2009, as compared to $1,813,744 during the year ended December 31,
2008, which was in line with the sales growth.





Gasoline.
Cost of our gasoline revenue increased by 40.1%, to $5,993,207 during the year
ended December 31, 2009, from $4,277,458 for the year ended December 31, 2008.
The increase of cost of gasoline revenue was due to the increase in sales
volume, offset by the effect of the decrease of average unit cost from $0.62
(RMB 4.28) per liter during the year ended December 31, 2008 to $0.61 (RMB 4.13)
per liter during the year ended December 31, 2009 due to the decreasing price of
the international fuel market.





Installation
Services. Cost of revenue from our installation services increased by
98.3%, or $1,927,696, to $3,888,996 during the year ended December 31, 2009, as
compared to $1,961,300 during the year ended December 31, 2008, as a result of
the increase of pipeline customers.





Auto Conversion
Services. Cost of our auto conversion revenue increased by 2.4%, or
$35,611, to $1,543,892 during the year ended December 31, 2009, as compared to
$1,508,371 during the year ended December 31, 2008.





Gross
profit





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





December 31,
                  2009
                
                
                December 31,
                  2008
                
                
                Increase in
                  dollar amount
                
                
                Increase in
                  percentageNatural
      gas from fueling stations
                
                $
                31,862,013
                
                
                $
                27,799,089
                
                
                $
                4,062,924
                
                
                
                14.6
                %Natural
      gas from pipelines
                
                
                895,475
                
                
                
                713,296
                
                
                
                182,179
                
                
                
                25.5
                %Gasoline
                
                
                390,965
                
                
                
                338,594
                
                
                
                52,371
                
                
                
                15.5
                %Installation
                
                
                5,949,816
                
                
                
                2,893,138
                
                
                
                3,056,678
                
                
                
                105.7
                %Auto
      conversion
                
                
                1,062,810
                
                
                
                994,905
                
                
                
                67,905
                
                
                
                6.8
                %Total
                
                $
                40,161,079
                
                
                $
                32,739,022
                
                
                $
                7,422,057
                
                
                
                22.7
                %


50





We earned
a gross profit of $40,161,079 for the year ended December 31, 2009, an increase
of $7,422,057 or 22.7%, compared to $32,739,022 for the year ended December 31,
2008. In summary, gross profit increase was mainly due to the increased sales
volume of natural gas from fueling stations with low procurement price in coal
bed methane from July 2008 to May 2009 in Henan; the increased sales volume of
pipeline natural gas with stable unit price and cost; and the increased
installation revenue from new pipeline customers.





Gross
margin





Gross
margin for natural gas sold through our VIE owned fueling stations increased
from 52.2% in the year ended December 31, 2008 to 53.8% in the year ended
December 31, 2009 due to due to lower coal bed methane procurement cost in Henan
Province.





Gross
margin for natural gas sold through pipelines was 30.1% during the year ended
December 31, 2009, and increased slightly as compared to 28.2% during the year
ended December 31, 2008.





Gross
margin for gasoline sales decreased from 7.3% during the year ended December 31,
2008 to 6.1% during the year ended December 31, 2009, due to gasoline
retail price decreasing more than purchase cost.





Gross
margin for our installation business increased to 60.5% in the year ended
December 31, 2009 from 59.6% in the year ended December 31, 2008. Gross margin
for our auto conversion business remained flat at 39.7% in the year ended
December 31, 2008 as compared to 40.8% in the year ended December 31,
2009.





Due to
the low procurement price in coal bed methane from July 2008 to May 2009 in
Henan, our total gross margin increased from 48.3% for the year ended December
31, 2008 to 49.5% for the year ended December 31, 2009.





Operating
expenses.





We
incurred operating expenses of $15,108,272 for the year ended December 31, 2009,
an increase of $3,431,442 or 29.4%, compared to $11,676,830 for the year ended
December 31, 2008. Sales and marketing costs increased 25.0% from $7,651,948 for
the year ended December 31, 2008 to $9,566,387 for the year ended December 31,
2009, primarily due to the $1,119,315 increase in depreciation expense as well
as $473,695 and $318,272 increase in leasing and utility expense, respectively,
mainly related to the acquisition of Lingbao Natural Gas, Co. in October 2008 as
well as the newly added fueling stations since 2008. In addition, we also
increased our efforts to obtain new residential and commercial customers and
attract customers to our fueling stations. General and administrative expenses
increased 37.7% from $4,024,882 for the year ended December 31, 2008 to
$5,541,885 for the year ended December 31, 2009 mainly due to increase of
$1,517,003 in depreciation expense and $245,066 increase in salary expense
primarily reflecting the growth of employees, the recruiting of Chief Financial
Officer as well as adjustment of compensation for our Chief Executive Officer to
market rate. The transportation cost per million cubic meters of natural gas
during the year ended December 31, 2009 was approximately
$2,834.


51





Income from operations and
operating margin.





For the
foregoing reasons, income from operations increased by $3,990,615 or 19.0%, to $
25,052,807 for the year ended December 31, 2009 from $21,062,192 for the year
ended December 31, 2008.  Operating margin was 30.9% for the year
ended December 31, 2009, compared to 31.1% for the year ended December 31,
2008.





Non-operating income
(expense).





Our
non-operating expense decreased by $395,085 to $1,909,097 for the year ended
December 31, 2009 from $2,304,182 during the year ended December 31, 2008,
primarily due to interest expense of $747,172 net of capitalized interest of
$4,597,544 during the year ended December 31,2009, compared to interest expense
of 2,228,244 net of capitalized interest of $1,932,931 during the year ended
December 31,2008, as well as the recognition of $1,031,330 non-operating expense
related to change in fair value of the Company’s outstanding
warrants.





Provision for the income
tax.





Income
tax increased by $745,281, or 20.9%, to $4,312,923 for the year ended December
31, 2009, from $3,567,642 for year ended December 31, 2008 primarily due to the
increase in our sale of natural gas and, consequently, income before income
tax.





Net
income.





As a
result of the foregoing, net income increased by $3,640,419, or 24.0%, to
$18,830,787 for the year ended December 31, 2009, from $15,190,368 for the year
ended December 31, 2008. Net margin was 23.2% for the year ended December 31,
2009, compared to 22.4% for the year ended December 31, 2008.





Comparing
Fiscal Years Ended December 31, 2008 and 2007:





The
following table represents the consolidated operating results for the years
ended December 31, 2008 and 2007:





Sales
Revenues





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





December 31,
                
                
                December 31,
                
                
                Increase in dollar
                
                
                Increase in2008
                
                
                2007
                
                
                Amount
                
                
                percentageNatural
      gas from fueling stations
                
                $
                53,219,853
                
                
                $
                26,765,249
                
                
                $
                26,454,604
                
                
                
                98.8
                %Natural
      gas from pipelines
                
                
                2,527,040
                
                
                
                1,512,784
                
                
                
                1,014,256
                
                
                
                67.0
                %Gasoline
                
                
                4,616,052
                
                
                
                38,486
                
                
                
                4,577,566
                
                
                
                11894.1
                %Installation
                
                
                4,854,438
                
                
                
                6,122,453
                
                
                
                (1,268,015
                )
                
                
                (20.7
                )%Auto
      conversion
                
                
                2,503,276
                
                
                
                953,081
                
                
                
                1,550,195
                
                
                
                162.6
                %Total
                
                $
                67,720,659
                
                
                $
                35,392,053
                
                
                $
                32,328,606
                
                
                
                91.3
                %


52


Overall.
Revenue increased by $32,328,606, or 91.3%, to $67,720,659 for the year ended
December 31, 2008, from $35,392,053 for year ended December 31, 2007. This
increase was mainly due to the newly added fueling stations in 2007 contributing
a full year of revenue in 2008, and an increase in the number of residential and
commercial pipeline customers to 96,033 as of December 31, 2008, from 84,500 as
of December 31, 2007. We sold natural gas of 160,696,902 cubic meters during the
year ended December 31, 2008, compared to 92,147,935 cubic meters during the
year ended December 31, 2007. For the year ended December 31, 2008, 89.1% of our
revenue was generated from the sale of natural gas and gasoline, and the other
10.9% was generated from our installation and auto conversion
services.





Natural Gas from
Fueling Stations. Natural gas revenue from our fueling stations
increased by $26,454,604, or 98.8%, to $53,219,853 for the year ended December
31, 2008 from $26,765,249 for the year ended December 31, 2007, and contributed
to78.6% of our total revenue, which was the largest among our four major
business lines. The increase of natural gas revenue was mainly due to adding 11
fueling stations in 2008 compared to 2007. During the year ended December 31,
2008, we sold compressed natural gas of 149,412,144 cubic meters, compared to
83,739,106 cubic meters during the year ended December 31, 2007 through our
VIE-owned fueling stations. In terms of average station sales value and volume,
in the year ended December 31, 2008, we sold approximately $1,694,001 and
4,755,824cubic meters of compressed natural gas per station, remaining flat as
compared to approximately $1,543,998 and 4,889,113 cubic meters in the year
ended December 31, 2007. Average unit selling price increased from $0.32 (RMB
2.42) during the year ended December 31, 2007 to $0.36 (RMB 2.5) during the year
ended December 31, 2008, primarily due to revenue in Henan where selling price
is $0.47 (RMB 2.83), higher than $0.34 (RMB 2.33) in Xi’an, contributing 33.1%
to total volume sold during the year ended December 31, 2008, compared to 18.3%
to total volume sold during the year ended December 31, 2007.





Natural Gas from
Pipelines.  Revenue from sales of piped natural gas increased
by $1,014,256, or 67.0%, to $2,527,040 for the year ended December 31, 2008,
from $1,512,784 for the year ended December 31, 2007, and contributed to 3.7% of
our total revenue. Our residential customers of piped natural gas increased to
96,033 as of December 31, 2008, from 84,500 as of December 31, 2007. We also
sold 11,284,758 cubic meters of natural gas through our VIE-owned pipelines
during the year ended December 31, 2008, compared to 7,403,314 cubic meters
during the year ended December 31, 2007.





Gasoline.
Revenue from gasoline sales increased by $4,577,566 to $4,616,052 for the year
ended December 31, 2008 from $38,486 for the year ended December 31, 2007, and
contributed 6.8% to our total revenue. The gasoline revenue increase was due to
the sales volume increased from 58,649 liters to 6,891,030 liters, offset by
2.2% increase of unit sales price from $0.66 (RMB 4.98) per liter in the
year ended December 31, 2007 to $0.67 (RMB 4.65) per liter in the year
ended December 31, 2008, due to the change of translation rate. The increased
sales volume was due to three stations began selling gasoline in 2007
contributing full year revenue in 2008.


53





Installation
Services. Revenue from our pipeline installation business decreased by
$1,268,015, or 20.7%, to $4,854,438 for the year ended December 31, 2008, from
$6,122,453 for the year ended December 31, 2007, and contributed 7.2% to our
total revenue. The decrease of installation sales was mainly due to the slowing
down properties market in 2008 compared with 2007.





Auto Conversion
Services. Revenue from our automobile conversion business increased by
$1,550,195, or 162.6%, to $2,503,276 for the year ended December 31, 2008, from
$953,081 for the year ended December 31, 2007, and contributed 3.7% to our total
revenue.





Cost of
revenue





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





December 31,
                  2008
                
                
                December 31,
                  2007
                
                
                Increase /
                  (Decrease) in
                  dollar
                  amount
                
                
                Increase /
                  (Decrease) in
                  percentageNatural
      gas from fueling stations
                
                $
                25,420,764
                
                
                $
                13,737,306
                
                
                $
                11,683,458
                
                
                
                85.0
                %Natural
      gas from pipelines
                
                
                1,813,744
                
                
                
                1,101,691
                
                
                
                712,053
                
                
                
                64.6
                %Gasoline
                
                
                4,277,458
                
                
                
                34,747
                
                
                
                4,242,711
                
                
                
                12,210.3
                %Installation
                
                
                1,961,300
                
                
                
                2,574,994
                
                
                
                (613,694
                )
                
                
                (23.8
                )%Auto
      conversion
                
                
                1,508,371
                
                
                
                576,337
                
                
                
                932,034
                
                
                
                161.7
                %Total
                
                $
                34,981,637
                
                
                $
                18,025,075
                
                
                $
                16,956,562
                
                
                
                94.1
                %





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





Our cost
of revenue for the year ended December 31, 2008 was $34,981,637, an increase of
$16,956,562, or 94.1%, from $18,025,075 for the year ended December 31, 2007,
while our revenue increased by 91.3% during the same period.





Natural Gas from
Fueling Stations. Cost of revenue of our natural gas for our VIE owned
fueling stations increased by 85.0%, or $11,683,458, to $25,420,764 during the
year ended December 31, 2008, as compared to $13,737,306 for the year ended
December 31, 2007. The low growth rate for cost of natural gas for our VIE owned
fueling stations was primarily due to the low procurement price in coal bed
methane we obtained from July 2008 in Henan province that reduced our unit cost
from one of our major supplier by approximately 35%, from $0.22 (RMB1.55) to
$0.14 (RMB1.00). Our overall average unit cost was reduced by 4.0% during the
year ended December 31, 2008.


54





Natural Gas from
Pipelines. Cost of revenue of our natural gas sold through our VIE owned
pipelines increased by 64.6%, or $712,053 to $1,813,744 during the year ended
December 31, 2008, as compared to $1,101,691 during the year ended December 31,
2007, which was in line with the sales growth.





Gasoline.
Cost of our gasoline revenue increased to $4,277,458 during the year ended
December 31, 2008, from $34,747 for the year ended December 31, 2007. The
increase of cost of gasoline revenue was due to the increase in sales volume,
offset by the effect of the increase of average unit cost from $0.59 (RMB 4.50)
per liter during the year ended December 31, 2007 to $0.62 (RMB 4.28) per liter
during the year ended December 31, 2008 due to the change of translation
rate.





Installation
Services. Cost of revenue from our installation services decreased by
23.8%, or $613,694, to $1,961,300 during the year ended December 31, 2008, as
compared to $2,574,994 during the year ended December 31, 2007, which was in
line with the sales change.





Auto Conversion
Services. Cost of our auto conversion revenue increased by 161.7%, or
$932,034, to $1,508,371 during the year ended December 31, 2008, as compared to
$576,337 during the year ended December 31, 2007.





Gross
profit





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





December 31,
                  2008
                
                
                December 31,
                  2007
                
                
                Increase in
                  dollar amount
                
                
                Increase in
                  percentageNatural
      gas from fueling stations
                
                $
                27,799,089
                
                
                $
                13,027,943
                
                
                $
                14,771,146
                
                
                
                113.4
                %Natural
      gas from pipelines
                
                
                713,296
                
                
                
                411,093
                
                
                
                302,203
                
                
                
                73.5
                %Gasoline
                
                
                338,594
                
                
                
                3,739
                
                
                
                334,855
                
                
                
                8955.7
                %Installation
                
                
                2,893,138
                
                
                
                3,547,459
                
                
                
                (654,321
                )
                
                
                (18.4
                )%Auto
      conversion
                
                
                994,905
                
                
                
                376,744
                
                
                
                618,161
                
                
                
                164.1
                %Total
                
                $
                32,739,022
                
                
                $
                17,366,978
                
                
                $
                15,372,044
                
                
                
                88.5
                %





We earned
a gross profit of $32,739,022 for the year ended December 31, 2008, an increase
of $15,372,044 or 88.5%, compared to $17,366,978 for the year ended December 31,
2007. In summary, gross profit increase was mainly due to the increased sales
volume of natural gas from fueling stations with low procurement price in coal
bed methane in Henan; the increased sales volume of pipeline natural gas with
stable unit price and cost; and the increased installation revenue from new
pipeline customers.


55





Gross
margin





Gross
margin for natural gas sold through our VIE-owned fueling stations increased
from 48.7% in the year ended December 31, 2007 to 52.2% in the year ended
December 31, 2008 due to due to lower coal bed methane procurement cost in Henan
Province.





Gross
margin for natural gas sold through our VIE-owned pipelines was 28.2% during the
year ended December 31, 2008, and increased as compared to 27.2% during the year
ended December 31, 2008.





Gross
margin for gasoline sales decreased from 9.7% during the year ended December 31,
2007 to 7.3% during the year ended December 31, 2008, due to more decrease
of gasoline retail price than gasoline purchase cost.





Gross
margin for our installation business increased to 59.6% in the year ended
December 31, 2008 from 57.9% in the year ended December 31, 2007. Gross margin
for our auto conversion business increased to 39.7% in the year ended December
31, 2008 from 39.5% in the year ended December 31, 2007.





Operating
expenses





Operating
expenses. The Company incurred operating expenses of $11,676,830 for the twelve
months ended December 31, 2008, an increase of $5,387,901 or 85.67%, compared to
$6,288,929 for the twelve months ended December 31, 2007. Our operating expenses
increased primarily as a result of expenses related to the construction,
acquisition, and operation of 11 new fueling stations in 2008, as well as
continuing expenses related to the identification of possible locations for
additional fueling stations and the governmental licensing and approval process,
as well as the evaluation of existing natural gas fueling stations as potential
acquisition targets. In addition, sales and marketing costs increased in 2008 as
we increased our efforts to obtain new residential and commercial customers and
attract customers to our fueling stations. General and administrative expenses
increased from $2,837,768 in 2007 to $4,024,882 in 2008 due to an increase in
personnel as a result of our growth. In 2008, the transportation cost per
million cubic meters is approximately $3,137.




Income
tax





Income
tax was $3,567,642 for the twelve months ended December 31, 2008, as compared to
$1,913,923 for the twelve months ended December 31, 2007. The increase in income
tax was attributed to the growth of installation fees and the sale of
natural gas.





Net
Income





Net
Income. Net income increased 66.63% to $15,190,368 for the twelve months ended
December 31, 2008, an increase of $6,074,298, from $9,116,070 for the twelve
months ended December 31, 2007. Increase in net income is attributed to our
material increase in revenues, partially offset by a higher cost of sales and
operating expenses, as well as the non cash expense related to the amortization
of offering cost associated with the $40 million senior notes issued to Abax
Lotus, Ltd. in 2008.


56


Liquidity
and Capital Resources





Historically,
our primary sources of liquidity have consisted of cash generated from our
operations and equity financing. In 2008, we sold senior notes with a face value
of $40 million to Abax. Our principal uses of cash have been, and are expected
to continue to be, for operational purposes as well as for constructing and
acquiring natural gas fueling stations and constructing our LNG
plant.





As of
December 31, 2009, 2008 and 2007, we had $48,177,794, $5,854,383 and,
$13,291,729 of cash and cash equivalents on hand, respectively. The increase in
2009 was primarily attributable to the underwritten public offering in
September 2009, the net proceeds of which is approximately $54.4
million.





Net cash
provided by operating activities was $25,433,922 for the year ended December 31,
2009, compared to net cash provided by operating activities of $20,916,801 for
the year ended December 31, 2008, primarily as a result of the increase in our
net income, adjusted for non-cash expense items and changes in working capital.
Net cash provided by operating activities was $20,916,801 for the year ended
December 31, 2008, compared to net cash provided by operating activities of
$10,476,441 for the year ended December 31, 2007, mainly due to the increase in
net income, adjusted for non-cash expense items and increase in unearned
revenues and taxes payables during the year ended December 31, 2008 offset by an
increase in accounts receivable and prepaid expense and other current
assets.





Net cash
used in investing activities was $37,537,257 for the year ended December 31,
2009, compared to net cash used in investing activities of $67,606,724 for year
ended December 31, 2008, primarily because of prepayment to equipment
suppliers and construction of the LNG plant, and construction of
additional fueling stations during the year ended December 31, 2009. For the
year ended December 31, 2009, major cash outflow were primarily to our
construction in progress for the LNG Plant. Net cash used in investing
activities was $67,606,724 for the year ended December 31, 2008, compared to net
cash used in investing activities of $16,885,340 for the year ended December 31,
2007, primarily due to the equipment purchased in LBNGC and addition of fueling
stations, payments made to equipment suppliers for investments necessary to
construct fueling stations and the LNG facility





Net cash
provided by financing activities was $54,370,359 for the year ended December 31,
2009, compared to net cash provided by financing activities of $37,877,491 for
the year ended December 31, 2008, primarily due to the secondary public offering
in 2009. Net cash provided by financing activities was $37,877,491 for the year
ended December 31, 2008, compared to net cash provided by financing activities
of $13,823,467 for the year ended December 31, 2007, primarily due to the sale
of senior notes with a face value of $40 million we sold to Abax in
2008.





Based on
past performance and current expectations, we believe our cash and cash
equivalents, cash generated from operations, as well as future possible cash
from financing activities, will satisfy our working capital needs, capital
expenditures and other liquidity requirements associated with our operations for
at least the next 12 months.


57





Off-Balance
Sheet Arrangements





We do not
have any off-balance sheet arrangements that have or are reasonably likely to
have a current or future effect on our financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures or capital resources that are material to our
investors.





Capital
Expenditures





Our
planned capital expenditures as of December 31, 2009 were $45 million, which we
expect to be incurred in connection with the construction of our LNG facility,
joint-venture cooperation with CNPC Kunlun and the acquisition of additional
fueling stations. We planned to invest approximately $45 million to construct
our LNG facility but are anticipating now that the total investment increase to
approximately $49 million primarily attributed to significant increase in
material and labor costs incurred due to additional engineering reinforcement
needs to ensure project safety, excluding $2.7 million additional payment
of land use right for phase I, phase II and phase III because soaring local land
price due to recent energy resource explorations as well as the cost of $4.5
million to purchase an additional 8.3 acres of land use right for the Yulin
government’s construction of an electricity substation, phase II and phase
III of the LNG plant.





Phase I
of the LNG plant is under construction and is expected to be completed by the
second quarter 2010, later than originally planned because of delays
mainly due to macro tariff exemption changes and additional document
requirements at Shaanxi Province customs; engineering reinforcement of plant
basis; ocean shipment route changes to avoid pirates in Somali
area.





Outstanding
Indebtedness





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





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


58





Contractual
Obligations





Our
contractual obligations are as follows:


Payments
      due by periodLess
      than
                                                                                  
                                                                                  
                                                                                  1-3
                                                                                  
                                                                                  
                                                                                  3-5
                                                                                  
                                                                                  
                                                                                  More
      thanContractual
      obligations
                                                                                  
                                                                                  Total
                                                                                  
                                                                                  
                                                                                  1
      year
                                                                                  
                                                                                  
                                                                                  Years
                                                                                  
                                                                                  
                                                                                  years
                                                                                  
                                                                                  
                                                                                  5
      years(in thousands)Long-Term
      Debt Obligations
                                                                                  
                                                                                  $
                                                                                  40,000
                                                                                  
                                                                                  
                                                                                  $
                                                                                  40,000
                                                                                  
                                                                                  
                                                                                  $
                                                                                  -
                                                                                  
                                                                                  
                                                                                  $
                                                                                  -
                                                                                  
                                                                                  
                                                                                  $
                                                                                  -Capital
      Lease Obligations
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -Operating
      Lease Obligations(1)
                                                                                  
                                                                                  
                                                                                  32,303
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,583
                                                                                  
                                                                                  
                                                                                  
                                                                                  3,218
                                                                                  
                                                                                  
                                                                                  
                                                                                  3,176
                                                                                  
                                                                                  
                                                                                  
                                                                                  24,326Purchase
      Obligations (2)
                                                                                  
                                                                                  
                                                                                  13,679
                                                                                  
                                                                                  
                                                                                  
                                                                                  11,536
                                                                                  
                                                                                  
                                                                                  
                                                                                  2,143
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -Other
      Long-Term Liabilities Reflected on Company's Balance Sheet
    (3)
                                                                                  
                                                                                  
                                                                                  17,500
                                                                                  
                                                                                  
                                                                                  
                                                                                  17,500
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -Total
                                                                                  
                                                                                  $
                                                                                  103,482
                                                                                  
                                                                                  
                                                                                  $
                                                                                  70,619
                                                                                  
                                                                                  
                                                                                  $
                                                                                  5,361
                                                                                  
                                                                                  
                                                                                  $
                                                                                  3,176
                                                                                  
                                                                                  
                                                                                  $
                                                                                  24,326





(1) The
Company entered into a series of long-term lease agreements with outside parties
to lease land use rights to the self-built Natural Gas filing stations located
in the PRC. The agreements have terms ranging from 10 to 30 years. The Company
makes annual prepayments for most lease agreements.  The Company also
entered into two office leases in Xi’an, PRC, one office lease in Jingbian, PRC,
one office lease in Wuhan, PRC and one office lease in New York,
NY.





(2) The
Company has purchase commitments for materials, supplies, services and property
and equipment for constructing the LNG plant and other CIP
projects.





(3) The
$17,500,000 reflects derivative liability related to the embedded put option in
the 1,450,000 warrants we issued to Abax in January 2008. If Abax does not
exercise the warrants by January 29, 2015, Abax will be entitled to require that
we purchase the warrants for $17,500,000 at that time. Under the
terms of the Warrant Agreement, in the event of a default under the indenture
for the Senior Notes, the warrants holders are entitled to redeem the warrants
for a price equal to the pro rata portion of the aggregate redemption price of
$17,500,000 applicable to the warrants tendered by such holder. As the
redemption requirement of the warrants become due on demand in connection to the
default under the indenture, the Company reclassified the redemption value as a
short term liability





RECENT
ACCOUNTING PRONOUNCEMENTS





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





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


59




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





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




In May
2009, the FASB updatedan accounting standard
regarding subsequent events providing guidance to establish general standards of
accounting for and disclosures of events that occur after the balance sheet date
but before financial statements are issued or are available to be issued. This
accounting standard requires entities to disclose the date through which
subsequent events were evaluated as well as the rationale for why that date was
selected.  We adopted this Standard during the second quarter of 2009.
This guidance requires that public entities evaluate subsequent events through
the date that the financial statements are issued. We have evaluated subsequent
events through the time of filing these consolidated financial statements with
the SEC on March 10, 2010.





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





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


60


In August
2009, the FASB issued an Accounting Standards Update (“ASU”) regarding measuring
liabilities at fair value. This ASU provides additional guidance clarifying the
measurement of liabilities at fair value in circumstances in which a quoted
price in an active market for the identical liability is not available; under
those circumstances, a reporting entity is required to measure fair value using
one or more of valuation techniques, as defined. The adoption of this guidance
did not have a material impact on our consolidated financial
statements.





In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing.  This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation.  This ASU is effective for
fiscal years beginning on or after December 15, 2009, and interim periods within
those fiscal years for arrangements outstanding as of the beginning of those
fiscal years. The adoption of this guidance did not have a material impact on
our consolidated financial statements .





In
November 2009, the FASB issued an ASU regarding accounting for stock dividends,
including distributions to shareholders with components of stock and cash. This
ASU clarifies that the stock portion of a distribution to shareholders that
contains components of cash and stock and allows shareholders to select their
preferred form of the distribution (with a limit on the amount of cash that will
be distributed in total) should be considered a stock dividend and included in
EPS calculations as a share issuance. The adoption of this guidance did not have
a material impact on our consolidated financial statements





In
December 2009, FASB issued ASU No. 2009-16, Accounting for Transfers of
Financial Assets. This Accounting Standards Update amends the FASB Accounting
Standards Codification for the issuance of FASB Statement No. 166, Accounting for Transfers of
Financial Assets—an amendment of FASB Statement No. 140.The amendments
in this Accounting Standards Update improve financial reporting by eliminating
the exceptions for qualifying special-purpose entities from the consolidation
guidance and the exception that permitted sale accounting for certain mortgage
securitizations when a transferor has not surrendered control over the
transferred financial assets. In addition, the amendments require enhanced
disclosures about the risks that a transferor continues to be exposed to because
of its continuing involvement in transferred financial assets. Comparability and
consistency in accounting for transferred financial assets will also be improved
through clarifications of the requirements for isolation and limitations on
portions of financial assets that are eligible for sale accounting. We do not
expect the adoption of this ASU to have a material impact on
our consolidated financial statements.


61


In
December, 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities. This Accounting
Standards Update amends the FASB Accounting Standards Codification for the
issuance of FASB Statement No. 167, Amendments to FASB Interpretation
No. 46(R). The amendments in this Accounting Standards Update replace the
quantitative-based risks and rewards calculation for determining which reporting
entity, if any, has a controlling financial interest in a variable interest
entity with an approach focused on identifying which reporting entity has the
power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance and (1) the obligation to
absorb losses of the entity or (2) the right to receive benefits from the
entity. An approach that is expected to be primarily qualitative will be more
effective for identifying which reporting entity has a controlling financial
interest in a variable interest entity. The amendments in this Update also
require additional disclosures about a reporting entity’s involvement in
variable interest entities, which will enhance the information provided to users
of financial statements. We are currently evaluating the impact of this ASU,
however, we do not expect the adoption of this ASU to have a material impact on
our consolidated financial statements.




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





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





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


62


ITEM
7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK





Natural
Gas Price Risk





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





Interest
Rate Risk





We are
subject to interest rate risk on our long-term fixed-interest rate debt. Fixed
rate debt, where the interest rate is fixed over the life of the instrument,
exposes us to changes in market interest rates reflected in the fair value of
the debt and to the risk that we may need to refinance maturing debt with new
debt at a higher rate. All else being equal, the fair value of our fixed rate
debt will increase or decrease as interest rates change. We had long-term debt
outstanding of $40 million as of December 31, 2009, all of which bears interest
at fixed rates. The $40 million of fixed-rate debt is due 2014. We currently
have no interest rate hedge positions in place to reduce our exposure to changes
in interest rates.





Foreign
Currency Exchange Rates Risk





Because
substantially all of our revenues and expenditures are denominated in Renminbi
and the net proceeds from this offering were denominated in U.S. dollars,
fluctuations in the exchange rate between the U.S. dollars and Renminbi affect
the relative purchasing power of these proceeds and our balance sheet and
earnings per common stock in U.S. dollars. In addition, we report our financial
results in U.S. dollars, and appreciation or depreciation in the value of the
Renminbi relative to the U.S. dollar would affect our financial results reported
in U.S. dollars terms without giving effect to any underlying change in our
business or results of operations. Fluctuations in the exchange rate will also
affect the relative value of any dividend we issue that will be exchanged into
U.S. dollars and earnings from and the value of any U.S. dollar-denominated
investments we make in the future.





Since
July 2005, the Renminbi has no longer been pegged to the U.S. dollar. Although
currently the Renminbi exchange rate versus the U.S. dollar is restricted to a
rise or fall of no more than 0.5% per day and the People’s Bank of China
regularly intervenes in the foreign exchange market to prevent significant
short-term fluctuations in the exchange rate, the Renminbi may appreciate or
depreciate significantly in value against the U.S. dollar in the medium- to
long-term. Moreover, it is possible that in the future, PRC authorities may lift
restrictions on fluctuations in the Renminbi exchange rate and lessen
intervention in the foreign exchange market.


63


Very
limited hedging transactions are available in China to reduce our exposure to
exchange rate fluctuations. To date, we have not entered into any hedging
transactions in an effort to reduce our exposure to foreign currency exchange
risk. While we may decide to enter into hedging transactions in the future, the
availability and effectiveness of these hedging transactions may be limited and
we may not be able to successfully hedge our exposure at all. In addition, our
currency exchange losses may be magnified by PRC exchange control regulations
that restrict our ability to convert Renminbi into foreign
currency.





As of
December 31, 2009 and 2008, our accounts  were maintained, and our
consolidated financial statements were expressed in RMB.  Such
consolidated financial statements were translated into USD in accordance with an
accounting standard issued by the FASB, with the RMB as the functional currency.
All assets and liabilities were translated at the exchange rate as of the
balance sheet date, stockholders’ equity were translated at the historical rates
and statement of income and cash flow items were translated at the weighted
average exchange rate for the year. The resulting translation adjustments are
reported under other comprehensive income. Cash flows from the our operations
are calculated based upon the local currencies and translated to USD at average
translation rates for the period. As a result, translation adjustments amount
related to assets and liabilities reported on the consolidated statement of cash
flows will not necessarily agree with changes in the corresponding consolidated
balances on the balance sheet.




The
balance sheet amounts with the exception of equity at December 31, 2009, were
translated 6.82 RMB to $1.00 as compared to 6.82 RMB at December 31, 2008. The
equity accounts were stated at their historical rate. The average translation
rates applied to income and cash flow statement amounts for the years ended
December 31, 2009, 2008 and 2007, were 6.82 RMB, 6.98 RMB and 7.59 RMB to $1.00,
respectively. Translation adjustments resulting from this process in the amount
of $8,714,019 and $8,661,060 as of December 31, 2009 and 2008, respectively, are
classified as an item of other comprehensive income in the stockholders’ equity
section of the consolidated balance sheets. For the years ended December 31,
2009, 2008 and 2007, other comprehensive income in the consolidated statements
of income and other comprehensive income included translation gains of $52,959
and $5,184,035 and $2,637,573, respectively.





ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA





The
Consolidated Financial Statements of the Company and its subsidiaries as of
December 31, 2009, 2008, and 2007, including the notes thereto, together with
the report of Frazer Frost, LLP (Successor Entity of Moore Stephens Wurth
Frazer and Torbet, LLP) are presented beginning on page F-1 of this
report.





First
                    Quarter
                  
                  
                  Second
                    Quarter
                  
                  
                  Third
                    Quarter
                  
                  
                  Fourth
                    Quarter
                  
                  
                  Full
      YearYear
      EndedDecember
      31,2009Net
      operating revenues
                  
                  
                  18,527,666
                  
                  
                  
                  20,742,520
                  
                  
                  
                  20,125,184
                  
                  
                  
                  21,670,748
                  
                  
                  
                  81,066,118Gross
      profit
                  
                  
                  9,633,652
                  
                  
                  
                  10,278,190
                  
                  
                  
                  9,717,692
                  
                  
                  
                  10,531,545
                  
                  
                  
                  40,161,079Net
      income
                  
                  
                  4,201,623
                  
                  
                  
                  3,862,756
                  
                  
                  
                  4,647,519
                  
                  
                  
                  6,118,889
                  
                  
                  
                  18,830,787Basic
      EPS
                  
                  
                  0.29
                  
                  
                  
                  0.26
                  
                  
                  
                  0.29
                  
                  
                  
                  0.29
                  
                  
                  
                  1.13Diluted
      EPS
                  
                  
                  0.29
                  
                  
                  
                  0.26
                  
                  
                  
                  0.29
                  
                  
                  
                  0.28
                  
                  
                  
                  1.12Year
      Ended December
      31,2008Net
      operating revenues
                  
                  $
                  14,025,674
                  
                  
                  $
                  16,890,486
                  
                  
                  $
                  18,401,200
                  
                  
                  $
                  18,403,299
                  
                  
                  $
                  67,720,659Gross
      profit
                  
                  
                  6,088,476
                  
                  
                  
                  7,665,763
                  
                  
                  
                  9,492,367
                  
                  
                  
                  9,492,416
                  
                  
                  
                  32,739,022Net
      income
                  
                  
                  2,808,571
                  
                  
                  
                  3,512,892
                  
                  
                  
                  5,136,590
                  
                  
                  
                  3,732,315
                  
                  
                  
                  15,190,368Basic
      EPS
                  
                  
                  0.20
                  
                  
                  
                  0.24
                  
                  
                  
                  0.35
                  
                  
                  
                  0.25
                  
                  
                  
                  1.04Diluted
      EPS
                  
                  
                  0.20
                  
                  
                  
                  0.24
                  
                  
                  
                  0.35
                  
                  
                  
                  0.25
                  
                  
                  
                  1.04Year
      Ended December
      31,2007Net
      operating revenues
                  
                  $
                  6,743,576
                  
                  
                  $
                  8,273,309
                  
                  
                  $
                  9,078,089
                  
                  
                  $
                  11,297,079
                  
                  
                  $
                  35,392,053Gross
      profit
                  
                  
                  3,517,359
                  
                  
                  
                  4,143,110
                  
                  
                  
                  4,319,839
                  
                  
                  
                  5,386,670
                  
                  
                  
                  17,366,978Net
      income
                  
                  
                  2,110,326
                  
                  
                  
                  2,745,009
                  
                  
                  
                  1,961,662
                  
                  
                  
                  2,299,073
                  
                  
                  
                  9,116,070Basic
      EPS
                  
                  
                  0.18
                  
                  
                  
                  0.22
                  
                  
                  
                  0.14
                  
                  
                  
                  0.16
                  
                  
                  
                  0.70Diluted
      EPS
                  
                  
                  0.18
                  
                  
                  
                  0.22
                  
                  
                  
                  0.14
                  
                  
                  
                  0.15
                  
                  
                  
                  0.69


64





The
Company’s fiscal year 2009 operating result was impacted by the following
non-operating items:





·
            Expense
      recognized in connection with the change in fair value of warrants in the
      amount of $1,031,330 related to 383,654 warrants previously treated as
      equity, all future changes in the fair value of which will be recognized
      in the income statement as a result of changes in accounting
      standards.


·
            Interest
      expense of $344,190 related to the Company’s $40 million senior notes due
      2014, net of capitalized interest. This charge includes $280,250 in
      amortization of discount on our senior notes, and $63,940 in amortization
      of deferred offering costs. The Company capitalized $4,597,544 of interest
      expense and amortization into construction in progress for fiscal year
      2009.





These two
non-operating charges have a combined effect of $1,375,520 on our net income.
The capitalized interest increases the cost of our long term assets and is
depreciated or amortized over the useful life of these assets.





ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE





There are
no reportable disagreements with our former independent auditors, Moore Stephens
Wurth Frazer and Torbet, LLP, or our current independent auditors, Frazer Frost,
LLP (Successor Entity of Moore Stephens Wurth Frazer and Torbet,
LLP).





ITEM
9A CONTROLS AND PROCEDURES





(a)
Evaluation of Disclosure Controls and Procedures (Restated)




We
maintain disclosure controls and procedures (as defined in Rules 13a-15(e) and
15d-15(e) of the Securities Exchange Act of 1934, as amended (the “Exchange
Act”)) that are designed to ensure that information required to be disclosed in
the reports we file or submit under the Exchange Act is (a) recorded, processed,
summarized and reported within the time periods specified in the rules and forms
of the Securities and Exchange Commission and (b) accumulated and communicated
to management, including our Chief Executive Officer (“CEO”) and Chief Financial
Officer (“CFO”), as appropriate, to allow timely decisions regarding required
disclosure.





The
Company’s management has evaluated, under the supervision and with the
participation of the Company’s Chief Executive Officer and Chief Financial
Officer, the effectiveness of the design and operations of the Company’s
disclosure controls and procedures (as defined in Securities Exchange Act Rule
13a-15(e)), as of the end of the period covered by this annual report. Based on
that evaluation, the Company’s Chief Executive Officer and Chief Financial
Officer originally concluded that the evaluation of the effectiveness of
our disclosure controls and procedures was completed; our disclosure controls
and procedures were effective.




In
connection with the restatement of our financial statements for the year ended
December 31, 2009 and the three months ended March 31, 2010, the Company’s
management has reevaluated, under the supervision and with the participation of
the Company’s Chief Executive Officer and Chief Financial Officer, the
effectiveness of the design and operations of the Company’s disclosure controls
and procedures (as defined in Securities Exchange Act Rule 13a-15(e)), as of
December 31, 2009 and through the date of this filing. Solely as a result of
these material weakness discussed below, the Company’s Chief Executive Officer
and Chief Financial Officer have revised their conclusions regarding the
effectiveness of our internal control over financial reporting as of December
31, 2009. Accordingly, management now concludes that our disclosure controls and
procedures were not effective at a reasonable assurance level as December 31,
2009 and through the date of this filing.
 
 In light
of the material weaknesses referred to below, the Company performed additional
analyses and procedures in order to conclude that its consolidated financial
statements for the year ended December 31, 2009 are fairly presented, in all
material respects, in accordance with GAAP and has undertaken remediation
initiatives as discussed below.
  65





(b)
Management’s Annual Report on Internal Control over Financial Reporting (Restated)




The
Company’s management is responsible for establishing and maintaining an adequate
system of internal control over financial reporting. Internal control over
financial reporting is a process designed to provide reasonable assurance
regarding the reliability of financial reporting and the preparation of
financial statements for external purposes in accordance with generally accepted
accounting principles. A company’s internal control over financial reporting
includes those policies and procedures that (i) pertain to the maintenance of
records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (ii) provide
reasonable assurance that transactions are recorded as necessary to permit
preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial statements; and (iv)
provide reasonable assurance as to the detection of fraud.
 
 Because
of its inherent limitations, a system of internal control over financial
reporting can provide only reasonable assurance and may not prevent or detect
misstatements. Therefore, even those systems determined to be effective can
provide only reasonable assurance with respect to financial statement
preparation and presentation. Further, because of changes in conditions,
effectiveness of internal control over financial reporting may vary over
time.
 
 Due to
the following mentioned material weaknesses or significant deficiencies, we have
revaluated the effectiveness of our internal control over financial reporting as
of December 31, 2009 and through the date of this filing. This evaluation was
performed using the Internal Control – Evaluation Framework developed by the
Committee of Sponsoring Organizations of the Treadway Commission
(“COSO”).
 
 Based on
the management’s evaluation of the effectiveness of internal control over
financial reporting, we have identified the following material weaknesses or
significant deficiencies as of December 31, 2009 and through the date of this
filing, which require the Company to adopt remedial measures.
 
 Key
executives entered into the following material transactions without pre-approval
from the Company’s board of directors:
 
 ·
                Extended
      loans to unrelated third parties in the amount of $14 million in the first
      quarter of 2010;
  ·
                Entered
      into a bank loan agreement in the amount of $17.7 million in February,
      2010; and
  ·
                Acquired
      4 natural gas fueling stations without pre-approval on the final
      acquisition price in the second quarter of
  2010.
 
 The
failure to obtain board pre-approval of the foregoing transactions constitutes a
significant deficiency or material weakness.
 
 In
addition, as a result of the following, management identified further deficiency
in our internal controls over financial reporting and disclosure
controls:
 
 ·
                Failure
      to disclose as a subsequent event for the bank loan of $17.7 million on
      the consolidated financial statements footnotes for the year ended
      December 31, 2009.
  ·
                Understatement
      of restricted cash in the amount of $13.2 million and the understatement
      of  bank loans of $13.2 million in itsconsolidated
      balance sheet as of March 31,
2010.
  ·
                Misclassification
      from short term liabilities to long term liabilities for the senior notes
      payable and fair value of the redeemable warrants in the amount of $45.6
      million in our consolidated balance sheet as of March 31,
      2010.
 
 These
material weaknesses have caused us to restate our consolidated financial
statements as of and for the year ended December 31, 2009 and our consolidated
financial statement as of the quarterly period ended March 31,
2010.
 
 Based on
its assessment, including consideration of the aforementioned material
weaknesses and the criteria discussed above, management has revised its
conclusion relative to the effectiveness of our internal control over financial
reporting as of December 31, 2009. Accordingly, management now concludes that
our internal control over financial reporting was not effective at a reasonable
assurance level as of December 31, 2009 and through the date of this
filing.
 
 Frazer
Frost, LLP, the independent registered public accounting firm that audited the
consolidated financial statements, has issued an attestation report on our
internal control over financial reporting which is included herein.
 
 Management’s
Remediation Initiatives
 
 We are in
the process of hiring to hire external qualified internal control consultants to
recommend and to help implement stronger internal controls surrounding our
approval and authorization policies and procedures and are prepared to establish
policies to remediate such deficiencies and reviewing our financial reporting
process to strengthen controls in terms of preventing omission or improper
disclosures of our consolidated financial statements.
 
 The Audit
Committee has directed management to develop and present to the Committee a plan
and timetable for the implementation of the remediation measures described above
(to the extent not already implemented), and the Committee intends to monitor
such implementation. We believe that the actions described above will remediate
the material weakness control deficiencies we have identified and strengthen our
internal control over financial reporting. As we improve our internal control
over financial reporting and implement remediation measures, we may supplement
or modify the remediation measures described above.
 
 In
addition, the Company continues to reassess its internal controls and procedures
in light of these recent events and is in the process of determining additional
appropriate actions to take to remediate these material weaknesses.
 
 (c)
Changes in Internal Control over Financial Reporting
 
 Our
independent auditor, in connection with the audit of our internal control
over financial reporting as of December 31, 2008, has indentified certain
material weakness as well as significant deficiencies. During 2009, the Company
has made the following remediation efforts accordingly:
  ·
                Identifying and hiring additional
      personnel with U.S. GAAP and SEC reporting
    experience;
 ·
                Providing training to our finance
      personnel to improve their knowledge of U.S. GAAP and SEC reporting
      requirements;
 ·
                Holding regular meetings of the
      audit committee and resuming regular communication between the committee
      and our independent registered public accounting
    firm;
 ·
                Engaging Ernst & Young to
      consult on our internal audit function as well as other internal control
      practices;
 ·
                Establishing anonymous
      whistleblower systems for reporting violations of our governance policies,
      including policies regarding internal
  controls;
 ·
                Introducing policies and
      procedures to effectively control daily cash transactions and
      recording;
 ·
                Putting in place a centralized
      financial reporting software system in our headquarters, management
      centers and operating sites;
and
 ·
                Engaging external professional
      consultants to assess the entity level internal controls over financial
      reporting using the COSO internal control
  framework.
 Except as
described above, there were no changes in its internal controls over financial
reporting in connection with its fourth quarter evaluation that would materially
affected, or are reasonably likely to materially affect, its internal control
over financial reporting.




66




(d)
Independent Registered Public Accounting Firm’s Attestation Report
 
 REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  To the
Board of Directors and Stockholders of
 China
Natural Gas, Inc.
  We have
audited China Natural Gas, Inc. and subsidiaries’ internal control over
financial reporting as of December 31, 2009, based on criteria established in
Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). China Natural Gas, Inc.’s management is responsible
for maintaining effective internal control over financial reporting and for its
assessment of the effectiveness of internal control over financial reporting
included in the accompanying “Management’s Annual Report on Internal Control
over Financial Reporting.”  Our responsibility is to express an
opinion on the company’s internal control over financial reporting based on our
audit.
  We
conducted our audit in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether effective
internal control over financial reporting was maintained in all material
respects. Our audit of internal control over financial reporting included
obtaining an understanding of internal control over financial reporting,
assessing the risk that a material weakness exists, and testing and evaluating
the design and operating effectiveness of internal control based on the assessed
risk. Our audit also included performing such other procedures as we considered
necessary in the circumstances. We believe that our audit provides a reasonable
basis for our opinion.
  A
company’s internal control over financial reporting is a process designed to
provide reasonable assurance regarding the reliability of financial reporting
and the preparation of financial statements for external purposes in accordance
with generally accepted accounting principles. A company’s internal control over
financial reporting includes those policies and procedures that (1) pertain to
the maintenance of records that, in reasonable detail, accurately and fairly
reflect the transactions and dispositions of the assets of the company; (2)
provide reasonable assurance that transactions are recorded as necessary to
permit preparation of financial statements in accordance with generally accepted
accounting principles, and that receipts and expenditures of the company are
being made only in accordance with authorizations of management and directors of
the company; and (3) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s
assets that could have a material effect on the financial
statements.
  Because
of its inherent limitations, internal control over financial reporting may not
prevent or detect misstatements. Also, projections of any evaluation of
effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance
with the policies or procedures may deteriorate.
  In our
report dated March 10, 2010, we expressed an unqualified opinion on the
effectiveness of internal control over financial reporting as of December 31,
2009.  As described in the following paragraph, the Company
subsequently indentified material misstatements in its financial statements,
which caused the annual financial statements to be
restated.  Accordingly, our opinion on the effectiveness of the
Company’s internal control over financial reporting as of December 31, 2009,
expressed herein is different from that expressed in our previous
report.
 
 A
material weakness is a deficiency, or combination of deficiencies, in internal
control over financial reporting, such that there is a reasonable possibility
that a material misstatement of the company’s annual or interim financial
statements will not be prevented or detected on a timely basis. The following
material weaknesses have been identified and included in management’s
assessment. Management has identified material weaknesses because certain
material transactions were entered into without pre-approval from the Company’s
board of directors which resulted in management’s override of its internal
control over financial reporting and disclosure controls. Therefore, these
transactions were not recorded and reported in the consolidated financial
statements. These material weaknesses were considered in determining the nature,
timing and extent of audit tests applied in our audit of the 2009 financial
statements and this report does not affect our report dated March 10, 2010,
except for the effects on the consolidated financial statements of the
restatement described in Note 2 and Note 15, as to which the date is August 19,
2010, on those consolidated financial statements (as restated).
 
 In our
opinion, because of the effect of the material weaknesses described above on the
achievement of the objectives of the control criteria, China Natural Gas, Inc.
and subsidiaries has not maintained effective internal control over financial
reporting as of December 31, 2009, based on criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO).
  We have
also audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), the consolidated balance sheets and the related
consolidated statements of income and other comprehensive income, stockholders’
equity , and cash flows of China Natural Gas, Inc. and subsidiaries, and our
report dated March 10, 2010, except for the effects on the consolidated
financial statements of the restatement described in Note 2 and Note 15, as to
which the date is August 19, 2010, expressed an unqualified
opinion.
  /s/
Frazer Frost, LLP
  Brea,
California
 March 10,
2010, except for the effects of the
 material
weakness described in the sixth paragraph
 above, as
to which the date is August 19, 2010




67






ITEM
9B. OTHER INFORMATION





None.





PART
III





ITEM
10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE.





Below are
the names and certain information regarding our executive officers and directors
as of December 31, 2009:





Name
                
                Age
                
                Position
                
                Held Position SinceQinan Ji
                
                53
                
                Chief
      Executive Officer and Chairman of the Board
                
                2005David
      She(1)
                
                26
                
                Acting
      Chief Financial Officer
                
                2010Zhiqiang
      Wang
                
                70
                
                Director
                
                2006Donald
      Yang
                
                44
                
                Director
                
                2008Carl
      Yeung
                
                31
                
                Director
                
                2008Lawrence
      Leighton
                
                76
                
                Director
                
                2008


(1)
Veronica Chen resigned as the Company’s CFO effective as of January 31, 2010.
David She replaced Ms. Chen as the Company’s acting CFO on February 1,
2010.





Officers
are elected annually by the Board of Directors, at our annual meeting, to hold
such office until an officer's successor has been duly appointed and qualified,
unless an officer sooner dies, resigns or is removed by the Board.





Background
of Executive Officers and Directors





Qinan Ji,
Chairman of the Board of Directors - Mr. Ji joined Xilan as the Chairman of the
Board of Directors in 2005. In 1996, he founded the Anxian Hotel in Weinan City
in Shaanxi province. In 2001, he formed the Xi’an Sunway Technology and Industry
Co., Ltd. He has more than 20 years experience in the energy and petroleum
industries in operational, administrative, management and government relation
roles. He received a Bachelors of Economic Management from Northwestern
University (Shaanxi).


68





David
She, Acting Chief Financial Officer - Mr. She joined China Natural Gas in
February 2008 as Vice President of Finance and was placed in charge of the
Company's New York office. He returned to the Company's headquarters in Xi'an,
China, in December 2008 and was soon promoted to Assistant Chief Financial
Officer. He is succeeding Veronica Jing Chen, who is resigning as Chief
Financial Officer due to family reasons. Mr. She was in charge of several
functions within the Company, including the oversight of quarterly and annual
filings with the U.S. Securities and Exchange Commission, evaluations of the
Company's major acquisition opportunities, and the management of investor
relations. He helped to coordinate the Company's $40 million debt financing in
March 2008 and supervised legal, audit and regulatory reporting issues in the
Company's $57 million underwritten public offering in September 2009. Prior to
joining China Natural Gas, Mr. She served as a securities analyst for West China
Securities in Beijing. He received Bachelor's degrees in Mathematics and
Business Administration from Beijing Institute of Technology as well as a
Master's degree in Finance from State University of New York at
Buffalo.





Zhiqiang
Wang, Vice Chairman of the Board of Directors - Mr. Wang was the former head of
energy industry regulations from 1992 to 2002 as well as the Vice Mayor of the
city of Xi'an, China's largest western city with a population of 8 million, in
which position he was in charge of regulating and licensing the city's energy
and natural gas businesses. From 2002 until his retirement in 2004, Mr. Wang was
the Chief Executive Officer of Xi'an Municipal Government Construction Company
where he was in charge of the city's major construction projects. Mr. Wang
graduated from the Northwestern University of Politics and Law in China in
1962.





Donald
Yang, Director - Mr. Yang is a founding partner and president of Abax Global
Capital (“AGC”), a leading Hong Kong based investment firm focused on Pan-Asian
public and private investments especially in Greater China and Southeast Asia.
He was a Managing Director responsible for Merrill Lynch’s Hong Kong and China
Debt Capital Markets division from 2000 to 2007. Mr. Yang also serves as a
director for Sinoenergy Corporation (Ticker “SNEH”), a NASDAQ listed company.
Mr. Yang holds a MBA degree from Wharton School of Business and a BA degree from
Nankai University in China. Abax, an affiliate of AGC, is the sole investor in
the Company’s $40 million note financing which closed in January 2008. Pursuant
to an investor rights agreement, Abax has the right to appoint one member of the
Company’s Board of Directors.





Carl
Yeung, Director - Mr. Yeung is the Chief Financial Officer of ATA Inc, a China
based, leading provider of computer-based testing and education services in
China listed on the NASDAQ Global Market. Prior to that, Mr. Yeung worked as an
associate and analyst at Merrill Lynch (Asia Pacific) Limited from 2002 to 2006.
Mr. Yeung holds a bachelor’s degree in economics with concentrations in finance
and operations management from Wharton School, University of Pennsylvania, and a
bachelor’s degree in applied science with concentration in systems engineering
from School of Engineering and Applied Sciences, University of
Pennsylvania.





Lawrence
Leighton, Director - Mr. Leighton has had an extensive 40-year international
investment banking career. Beginning at what is now Lehman Brothers, he advised
on financing for the Mexican Government and leading Mexican corporations. As
Director of Strategic Planning for the consumer products company, Norton Simon
Inc, he initiated and executed the acquisition of Avis Rent-a-car. Subsequently,
he was a Limited Partner of Bear Stearns & Co., a Managing Director of the
investment bank of Chase Manhattan Bank and then President and Chief Executive
Officer of the U.S. investment bank of Credit Agricole, the major French Bank.
Among his transactions have been advising Pernod Ricard, the major European
beverage company, on its acquisitions in the United States; and advising
Verizon, the major U. S. telecom company, on its dispositions of certain
European operations. Mr. Leighton received his BSE degree in engineering from
Princeton University and an MBA degree from Harvard Business School. He holds a
commercial pilot’s license with instrument rating.


69


Board
of Directors.





Our
Directors are elected by the vote of a plurality in interest of the holders of
our voting stock and hold office for a term of one year or until a successor has
been elected and qualified.





A
majority of the authorized number of directors constitutes a quorum of the Board
for the transaction of business. The directors must be present at the meeting to
constitute a quorum. However, any action required or permitted to be taken by
the Board may be taken without a meeting if all members of the Board
individually or collectively consent in writing to the action.





There are
no family relationships, or other arrangements or understandings between or
among any of the directors, executive officers or other person pursuant to which
such person was selected to serve as a director or officer.





Our
directors, executive officers and control persons have not been involved in any
of the following events during the past five years:





1. any
bankruptcy petition filed by or against any business of which such person was a
general partner or executive officer either at the time of the bankruptcy or
within two years prior to that time;





2. any
conviction in a criminal proceeding or being subject to a pending criminal
proceeding (excluding traffic violations and other minor offenses);





3. being
subject to any order, judgment, or decree, not subsequently reversed, suspended
or vacated, of any court of competent jurisdiction, permanently or temporarily
enjoining, barring, suspending or otherwise limiting his involvement in any type
of business, securities or banking activities; or





4. being
found by a court of competent jurisdiction (in a civil action), the Commission
or the Commodity Futures Trading Commission to have violated a federal or state
securities or commodities law, and the judgment has not been reversed,
suspended, or vacated.





Committees
of the Board of Directors





The Board
of Directors has the following standing committees: Audit, Compensation and
Nominating. The Board of Directors has adopted written charters for each of
these committees, copies of which can be found on our website at
www.naturalgaschina.com. Mr. Wang, Mr. Yeung and Mr. Leighton are independent
directors within the meaning set forth in the rules of NASDAQ, as currently in
effect.


70


Audit
Committee





The Audit
Committee consists of Mr. Leighton and Yeung and Wang with Mr. Yeung serving as
the chair. The board of directors has determined that Mr. Yeung is an “Audit
Committee Financial Expert,” as defined in Item 407(d)(5) of Regulation S-K and
Mr. Yeung is an independent director within the meaning set forth in the rules
of NASDAQ, as currently in effect.  The Audit Committee adopted a
charter which provides that the Committee, (i) oversees our accounting,
financial reporting and audit process; (ii) appoints, determines the
compensation of, and oversees, the independent auditors; (iii) pre-approves
audit and non-audit services provided by the independent auditors; (iv) reviews
of the results and scope of audit and other services provided by the independent
auditors; (v) reviews the accounting principles and practices and procedures
used in preparing our financial statements; and (vi) reviews of internal
controls.





The Audit
Committee works closely with management and our independent auditors. The Audit
Committee also meets with our independent auditors on a quarterly basis,
following our auditors’ quarterly reviews and annual audit and prior to our
earnings announcements, to review the results of their work. The Audit Committee
also meets with our independent auditors to approve the annual scope and fees
for the audit services to be performed.





Compensation
Committee





The
Compensation Committee consists of Mr. Leighton and Yeung and Wang with Mr.
Leighton serving as the chair. The Compensation Committee adopted a charter
which provides that the Committee, (i) review and approves corporate goals and
objectives relevant to the CEO’s compensation, evaluation of the CEO’s
performance relative to goals and objectives and sets the CEO’s compensation
annually and (ii) makes recommendations annually to the Board of Directors with
respect to non-CEO compensation.





Nominating
Committee





The
Nominating Committee consists of Mr. Leighton and Yeung and Wang with Mr. Wang
serving as the chair. The Compensation Committee adopted a charter which
provides that the Committee, (i) identify and review candidates for the Board
and recommend to the full Board candidates for election to the Board and (ii)
review from time to time the appropriate skills and characteristics required of
Board members in the context of current composition of the Board.





Code
of Ethics





On June
14, 2006, we adopted a Code of Ethics that applies to all officers, directors
and employees of our Company. A copy of our Code of Ethics is available to you
at no charge upon written request. The written request should be addressed to
our corporate office at 19th Floor, Building B, Van Metropolis, No. 35 Tangyan
Road, High Tech Zone, Xi’an 710065, Shaanxi province, the People’s Republic of
China.


71


COMPLIANCE
WITH SECTION 16(a) OF THE SECURITIES EXCHANGE ACT OF 1934





Section
16(a) of the Securities Exchange Act of 1934, as amended, requires our executive
officers and directors and persons who own more than 10% of a registered class
of our equity securities to file with the Securities and Exchange Commission
initial statements of beneficial ownership, reports of changes in ownership and
annual reports concerning their ownership of our common stock and other equity
securities, on Forms 3, 4 and 5 respectively. Executive officers, directors and
greater than 10% shareholders are required by the Securities and Exchange
Commission regulations to furnish our Company with copies of all Section 16(a)
reports they file.





To the
Company's knowledge, based solely on a review of the copies of the reports
furnished to the Company, all executive officers, directors and greater than 10%
shareholders filed the required reports in a timely manner, except for Zhiqiang
Wang who did not timely file a Form 3 when he was appointed to the Company’s
Board of Directors and David She who did not timely file a Form 3 when he was
appointed as the Company ’s Acting Chief
Financial Officer.





ITEM
11. EXECUTIVE COMPENSATION





COMPENSATION
DISCUSSION AND ANALYSIS





Our
Compensation Committee assists our board of directors in reviewing and approving
the compensation structure of our directors and executive officers, including
all forms of compensation to be provided to our directors and executive
officers.  Our Compensation Committee, which currently consists of
three members, each of whom is independent of management, seeks to ensure
that senior executives of the Company are compensated effectively in a manner
consistent with the strategy of the Company, competitive practice and the
requirements of the appropriate regulatory bodies. Our Compensation Committee
also oversees, reviews and administers all compensation and employee benefit
plans and programs.





Compensation
Philosophy and Objectives





Our
Compensation Committee’s goals regarding executive compensation are primarily to
recruit, hire, retain, motivate and reward the most talented and dedicated
executives possible. In determining what constitutes fair and competitive
compensation for each executive, our Compensation Committee evaluates individual
executive performance with a goal of setting compensation at levels based on the
executive’s general business and industry knowledge and experience while taking
into account our relative performance and our strategic goals.





We review
annually and approve our compensation strategy to help ensure that executives
are rewarded appropriately for their contributions to company growth and
profitability.  During our review of an individual executive’s
compensation, our Compensation Committee considers primarily individual
performance of that executive and internal review of the executive’s
compensation, both individually and relative to other executive
officers.  Our Compensation Committee also considers factors of
corporate performance including our sales, revenue and the current overall
economic situation.  Adjustments to salary levels are typically made
annually as part of our performance review process, as well as upon a change in
job responsibility.  Merit-based increases to salaries are based on
our Compensation Committee’s assessment of the individual executive’s
performance.





Elements
of Compensation





Our
Compensation Committee has structured our executive compensation to motivate
executives to achieve our business goals.  Our executive compensation
consists of the following elements:


72





Base
Salary





For base
salary, we determine executive salaries based on job responsibilities and
individual experience and expect to continue to provide competitive salaries to
our executive officers by conducting our annual review and, if appropriate,
recommending adjustments in salaries based on individual performance during the
prior fiscal year and cost of living adjustments. Our Compensation Committee
believes that any increases in base salary should be based upon a favorable
evaluation of individual performance, which is evaluated by assessing factors
such as the functioning of that executive’s team within the corporate structure,
success in furthering the corporate strategy and goals and individual management
skills, responsibilities and anticipated workload.





Incentive
and Discretionary Bonus Plans





We
currently have no incentive plans in place. Any incentive plan we adopt will be
aimed at attracting and retaining outstanding executive officers capable of
leading our Company to fulfill its business objectives and establish an
appropriate link between executive compensation and achievement of our Company’s
strategic and financial performance goals. We intend for any incentive plan we
adopt to provide rewards to executive officers who, because of the extent of
their responsibilities, can make significant contributions to the success of our
Company by their ability, loyalty and exceptional services.





The
Compensation Committee may award a discretionary bonus to executive officers to
reward outstanding personal achievement during the year. The actual amount of
discretionary bonus is determined following a review of each executive’s
individual performance and contribution to our strategic goals. In March 2009,
the Compensation Committee recommended, and our board of directors approved, an
annual salary of $120,000 and a discretionary bonus of up to $60,000 for Mr.
Qinan Ji, our CEO, for 2009.





Stock
Options





On March
11, 2009, the board of directors approved by written consent the Company’s stock
option plan for its employees, directors and consultants. Pursuant to the plan,
the total stock option pool will equal to 10% of the Company’s total shares
outstanding as of March 11, 2009. Among the option pool approved, 4% shall be
awarded in 2009 and another 4% shall be awarded in 2010, and 2% reserved for
future awards. For the 2009 stock option award, the CEO and CFO were granted
total options of 1% and 0.6% of the common shares outstanding respectively, 50%
as Non-qualified Stock Options (NSO) and 50% as Incentive Stock Awards (ISA),
for a vesting period of four years.  The company granted the former
CFO, Veronica Chen, options to purchase 75,000 shares (post-split) of the
Company’s common stock, representing approximately 0.5% of the Company’s
outstanding shares as of March 11, 2009, which forfeited as Veronica Chen
resigned as CFO. 5,000 option shares per year will be granted to each
non-executive board member and 6,000 option shares per year granted to the Audit
Committee Chairman. Other senior management and employees will be granted total
options of 2.11% of the Company’s common shares. On April 1, 2009 and May 1,
2009, the Company issued 243,850 and 75,000 stock options, respectively,
pursuant to the Company's 2009 employee stock option and stock award
plan.  The strike price for the options was $4.90 per share. The stock
option has a term of six years and vests evenly over four years starting one
year from the issuance date on an annually basis. Please refer to “Note 9.
Accounting for stock-based compensation” in “Item 8. Financial Statements” for
more details.


73





Other
Compensation





Consistent
with our compensation philosophy, we intend to continue to maintain our current
benefits and perquisites for our executive officers; however, the Compensation
Committee in its discretion may revise, amend or add to the officer’s benefits
and perquisites, if it deems it advisable and to the extent permitted by law
and/or the officer's employment agreement. We are required to participate in a
defined contribution plan operated by the local municipal government in
accordance with Chinese laws and regulations. We make annual contributions of
14% of all our employees' salaries to the plan.  Beginning in 2008, no
minimum contribution is required but the maximum contribution cannot exceed 14%
of the current salary expense. In addition, certain employees of our
subsidiaries, including Mr. Ji, our Chairman and Chief Executive Officer, have
pension and healthcare benefits through plans offered by such subsidiaries, as
required by local Chinese laws. In October 2008, we entered into an employment
agreement with our former CFO, Mr. Richard Wu, wherein we agreed to pay Mr. Wu a
$10,000 insurance allowance per year. We do not have any profit sharing plan or
similar plans for the benefit of our officers, directors or employees. However,
we may establish such plans in the future.





We
currently have no plans to change either the employment agreements of our
executive officers as described below (except as required by law or as required
to clarify the benefits to which our executive officers are entitled as set
forth herein) or levels of benefits and perquisites provided
thereunder.





Monitoring
Executive Compensation Program





Our
Compensation Committee monitors our executive compensation program by evaluating
individual performance of that executive and internal review of the executive’s
compensation, both individually and relative to other executive officers. Our
Compensation Committee also considers factors of corporate performance including
our sales, revenue and the current overall economic situation.





Compensation
Committee’s Processes and Procedures for Consideration and Determination of
Executive Compensation





The
Compensation Committee oversees all of our executive compensation policies and
decisions, including the administration and interpretation of our benefit plans.
The Compensation Committee also reviews and approves executive officer
compensation, including, as applicable, salary, bonus, special or supplemental
benefits and other forms of executive officer compensation. The Committee
periodically reviews regional and industry-wide compensation practices and
trends to assess the adequacy and competitiveness of our compensation programs.
The Committee’s membership is determined annually by the full board and includes
only independent directors. The Committee meets as often as it deems
appropriate, but not less frequently than annually.





The board
has delegated authority to the Compensation Committee to review and make
recommendations with respect to compensation matters, but has retained the
authority to approve and take final action on all executive compensation
awards.





Role of
Executive Officers in Compensation Process


74





The
Compensation Committee also solicits appropriate input from Mr. Ji, our chairman
and CEO, regarding base salary and other forms of executive officer compensation
for our other executive officers and the administration of our benefit
plans.





External
Advisors





The
Compensation Committee has not engaged the services of outside advisors to
assist it in fulfilling its duties.





EXECUTIVE
COMPENSATION





The
following table sets forth information regarding compensation awarded or paid
to, or earned by, our principal executive officer and the two individuals who
served as our principal financial officers during the year ended December 31,
2008. No other executive officer of our Company had total compensation exceeding
$100,000 during the year ended December 31, 2008.





Summary
Compensation Table





Summary
Compensation Table


Name
                                    and
                                    Principal
                                    Position(1)
                                  
                                  Year
                                  
                                  Salary
                                    ($)
                                  
                                  
                                  Bonus
                                    ($)
                                  
                                  
                                  Option
                                    Awards
                                    (2)
                                    ($)
                                  
                                  
                                  All
      Other
                                    Compensation
                                    ($)
                                  
                                  
                                  Total
                                    ($)Qinan
      Ji, Chief Executive
                                  
                                  2009
                                  
                                  
                                  120,000
                                  
                                  
                                  
                                  60,000
                                  
                                  
                                  
                                  94,909
                                  
                                  
                                  
                                  
                                  
                                  
                                  274,909Officer
      and Chairman of the Board
                                  
                                  2008
                                  
                                  
                                  15,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  15,0002007
                                  
                                  
                                  15,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  15,000Veronica
      Chen, Chief Financial Officer(3)
                                  
                                  2009
                                  
                                  
                                  71,481
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  
                                  71,481Richard
      P. Wu, Chief Financial Officer(4)
                                  
                                  2009
                                  
                                  
                                  72,917
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  72,9172008
                                  
                                  
                                  47,260
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1,890
                                  
                                  
                                  
                                  49,150Lihong
      Guo, Chief Financial Officer(5)
                                  
                                  2008
                                  
                                  
                                  40,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  40,0002007
                                  
                                  
                                  4,000
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  4,000


75





(1)
Identifies our named executive officers during the specified
period.


(2)
Represents the dollar amount of expense recognized for financial statement
reporting purposes with respect to awards of options to acquire common
stock.  See the notes to our financial statements contained herein for
an explanation of all assumptions made by us in determining the values of our
option awards.


(3) Ms.
Chen was appointed as our CFO on May 1, 2009 and resigned from the position
effective January 31, 2010.


(4) Mr.
Wu was appointed as our CFO on October 23, 2008, and resigned from the position
on March 25, 2009.


(5) Ms.
Guo was appointed as our CFO on December 10, 2007 and resigned from that
position on October 23, 2008.





Employment
Agreements





The
Company signs employment agreements with all of our employees. Our employment
agreements are intended to comply with the current Labor Contract Law of the
PRC. Our employment agreements are typically valid for one year and are
renewable if both the Company and the employee decide to renew the employment
agreement afterwards. In determining whether to renew an employment agreement,
our Company considers primarily individual performance of that executive and our
corporate performance including our sales, revenue, growth and the current
overall economic situation.





In March
2009, our CEO, Mr. Ji, signed a one-year employment contract with the Company
with the following key terms:





·
            Salary
      for 2009 will be $120,000





·
            Discretionary
      bonus of up to $60,000





·
            Contract
      can be renewed on a yearly basis if both the Company and Mr. Ji decide to
      renew the employment agreement





In May
2005, our CEO, Mr. Ji signed a one-year employment contract with the Company
with the following key terms:





·
            Annual
      Salary of $15,000





·
            Contract
      was superseded by the March 2009 agreement described
  above





In May 1,
2009, our former CFO, Ms. Veronica Jin Chen, signed a one-year employment
contract with the Company with the following key term:





·
            Salary
      for the 12-month period commencing on May 1, 2009, will be
      $95,308


76





· Eligible
for up to 0.514% stock option of the Company’s shares outstanding, pending the
Company’s employee stock option plan





· Contract
can be renewed on a yearly basis if both the Company and Ms. Chen decide to
renew the employment agreement





In
October 2008, our former CFO, Mr. Richard Peidong Wu, signed a one-year
employment contract with the Company with the following key terms:





·
            Salary
      for the 12-month period commencing on October 10, 2008, will be
      $250,000





·
            The
      Company will provide an additional $10,000 insurance allowance per
      year





·
            Eligible
      for up to 1.5% stock option of the Company’s shares outstanding, pending
      the Company’s employee stock option
plan





·
            Contract
      can be renewed on a yearly basis if both the Company and Mr. Wu decide to
      renew the employment agreement





In
December 2007, our former CFO, Ms. Lihong Guo, signed a one-year employment
contract with the Company with the following key terms:





·
            Salary
      for 2008 will be $40,000





·
            Contract
      can be renewed on a yearly basis if both the Company and Ms. Guo decide to
      renew the employment agreement





Grants
of Plan-Based Awards


All
      OtherStock
                                
                                All
      OtherAwards:
                                
                                OptionNumber
                                
                                Awards:
                                
                                
                                Exercise
                                
                                
                                Grant
                                
                                
                                Grant
      Dateof
                                
                                Number
      of
                                
                                
                                or
      Base
                                
                                
                                Date
                                
                                
                                Fair
      ValueShares
      of
                                
                                Securities
                                
                                
                                Price
      of
                                
                                
                                Closing
                                
                                
                                of
      StockStock
      or
                                
                                Underlying
                                
                                
                                Option
                                
                                
                                Market
                                
                                
                                andUnits
                                
                                Options
                                
                                
                                Awards
                                
                                
                                Price
                                
                                
                                OptionName
                                
                                Grant
      Date
                                
                                (#)
                                
                                (#)
                                
                                
                                ($/Sh)
                                
                                
                                ($/Sh)
                                
                                
                                Awards($)Ji
      Qinan
                                
                                04/01/2009
                                
                                
                                
                                
                                146,000
                                
                                
                                
                                4.90
                                
                                
                                
                                5.20
                                
                                
                                
                                506,183Veronica
      Chen(1)
                                
                                05/01/2009
                                
                                
                                
                                
                                75,000
                                
                                
                                
                                4.90
                                
                                
                                
                                5.70
                                
                                
                                
                                291,737





(1)
Forfeited as Veronica Chen resigned as CFO effective January 31,
2010.


77





Outstanding
Equity Awards at the Year Ended December 31, 2009


Option
      Awards
                        
                        Stock
      AwardsEquityIncentiveEquity
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        PlanIncentive
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        Equity
                        
                        
                        Awards:Plan
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        Incentive
      Plan
                        
                        
                        Market
      orNumber
      of
                        
                        
                        Number
      of
                        
                        
                        Awards:
                        
                        
                        
                        
                        
                        
                        Number
      of
                        
                        
                        
                        
                        
                        Awards:
                        
                        
                        Payout
      ValueSecurities
                        
                        
                        Securities
                        
                        
                        Number
      of
                        
                        
                        
                        
                        
                        
                        Shares
      or
                        
                        
                        
                        
                        
                        Number
      of
                        
                        
                        of
      UnearnedUnderlying
                        
                        
                        Underlying
                        
                        
                        Securities
                        
                        
                        
                        
                        
                        
                        Units
      of
                        
                        
                        Market
      Value
                        
                        
                        Unearned
                        
                        
                        Shares,
      UnitsUnexercised
                        
                        
                        Unexercised
                        
                        
                        Underlying
                        
                        
                        Option
                        
                        
                        
                        Stock
      That
                        
                        
                        of
      Shares or
                        
                        
                        Shares,
      Units
                        
                        
                        or
      OtherOptions
      (#)
                        
                        
                        Options
      (#)
                        
                        
                        Unexercised
                        
                        
                        Exercise
                        
                        Option
                        
                        Have
      Not
                        
                        
                        Units
      of Stock
                        
                        
                        or
      Other Rights
                        
                        
                        Rights
      ThatExercisable
                        
                        
                        Unexercisable
                        
                        
                        Unearned
                        
                        
                        Price
                        
                        Expiration
                        
                        Vested
                        
                        
                        That
      Have Not
                        
                        
                        That
      Have Not
                        
                        
                        Have
      NotName
                        
                        (Vested)
                        
                        
                        (Unvested)
                        
                        
                        Options
      (#)
                        
                        
                        $ -
                        
                        Date
                        
                        (#)
                        
                        
                        Vested
      ($)
                        
                        
                        Vested
      (#)
                        
                        
                        Vested
      ($)(1)(a)
                        
                        (b)
                        
                        
                        (c)
                        
                        
                        (d)
                        
                        
                        (e)
                        
                        (f)
                        
                        (g)
                        
                        
                        (h)
                        
                        
                        (i)
                        
                        
                        (j)Ji
      Qinan
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        146,000
                        
                        
                        $
                        4.90
                        
                        04/01/2015
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        -Veronica
      Chen(1)
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        
                        75,000
                        
                        
                        $
                        4.90
                        
                        05/01/2015





(1)
Forfeited as Veronica Chen resigned as CFO effective January 31,
2010.





Option
Exercises and Stock Vested





Our
executives did not exercise any stock options or hold any stock awards that
vested during the year ended December 31, 2009.





Pension
Benefits





We have
not adopted any pension benefits plans.





Nonqualified
Deferred Compensation





None of
our executive officers participate in or have account balances in non-qualified
defined contribution plans or other deferred compensation plans maintained by
us.





Severance
and Change of Control Agreements





We do not
have any agreements or arrangements providing for payments to an executive
officer in connection with any termination of the officer's employment or change
of control of our Company.





Director
Compensation





The
Governance and Nominating Committee of the board of directors, which is
comprised of Mr. Lawrence Leighton, Mr. Carl Yeung and Mr. Zhiqiang Wang, are
responsible for evaluating compensation levels and compensation programs for our
board of directors and for making recommendations to the board of directors
regarding appropriate compensation awards for directors. The board of directors'
compensation program is designed to attract, retain and motivate experienced
non-employee (outside) directors, to optimize long-term shareholder value and
reward members of the board of directors based on the extent of their
participation on the board of directors and its committees. Generally, the
Governance and Nominating Committee makes an annual recommendation
regarding the structure of the non-employee director compensation program,
considering the factors described above and considering information regarding
director compensation programs for other comparable companies.


78





During
the year ended December 31, 2009, Mr. Yeung and Mr. Leighton received a director
fee of $3,000 per month. Mr. Wang received an annual director fee of $5,279.
Each of our directors were reimbursed for reasonable expenses incurred in
attending Board and committee meetings. Our chairman and CEO, Mr. Ji, did not
receive any compensation for their services as a director during the year ended
December 31, 2009.





The
following Director Compensation Table summarizes the compensation of our
directors for services rendered to the Company during the year ended December
31, 2009.


FeesEarnedor
      Paid in
                    
                    
                    Stock
                    
                    
                    Option
                    
                    
                    All
      OtherCash
                    
                    
                    Awards
                    
                    
                    Awards
                    
                    
                    Compensation
                    
                    
                    TotalName
                    
                    ($)
                    
                    
                    ($)
                    
                    
                    ($)
      (2)
                    
                    
                    ($)
                    
                    
                    ($)Qinan
      Ji (1)
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    -Zhiqiang
      Wang
                    
                    
                    5,279
                    
                    
                    
                    -
                    
                    
                    
                    3,250
                    
                    
                    
                    -
                    
                    
                    
                    22,614Donald
      Yang
                    
                    
                    36,000
                    
                    
                    
                    -
                    
                    
                    
                    3,250
                    
                    
                    
                    -
                    
                    
                    
                    53,335Carl
      Yeung
                    
                    
                    36,000
                    
                    
                    
                    -
                    
                    
                    
                    3,900
                    
                    
                    
                    -
                    
                    
                    
                    56,802Lawrence
      Leighton
                    
                    
                    36,000
                    
                    
                    
                    -
                    
                    
                    
                    3,250
                    
                    
                    
                    -
                    
                    
                    
                    53,335




(1) Ji
Qinan, our Chief Executive Officer, did not receive any compensation for his
service as a director.





(2)
Details of stock options are as follows:


Number ofsecurities to beissued upon
                          exercise
                        
                        
                        Exercise
                          or Base
                        
                        
                        
                        
                        
                        Grant Date
                          Fair Valueof outstanding
                        
                        
                        Price of
                        
                        
                        
                        
                        
                        of Stockoptions and
                          rights
                        
                        
                        Option
                          Awards
                        
                        
                        
                        
                        
                        and
                          OptionName
                        
                        (#)
                        
                        
                        ($/Sh)
                        
                        Grant
      Date
                        
                        Expiration Date
                        
                        Awards($)Carl
      Yeung
                        
                        
                        6,000
                        
                        
                        
                        4.90
                        
                        04/01/2009
                        
                        04/01/2015
                        
                        
                        20,802Lawrence
      Leighton
                        
                        
                        5,000
                        
                        
                        
                        4.90
                        
                        04/01/2009
                        
                        04/01/2015
                        
                        
                        17,335Donald
      Yang
                        
                        
                        5,000
                        
                        
                        
                        4.90
                        
                        04/01/2009
                        
                        04/01/2015
                        
                        
                        17,335Zhiqiang
      Wang
                        
                        
                        5,000
                        
                        
                        
                        4.90
                        
                        04/01/2009
                        
                        04/01/2015
                        
                        
                        17,335




We did
not pay any other compensation to our directors during the year ended December
31, 2009.


79





Compensation
Committee Interlocks and Insider Participation





During
our fiscal year ended December 31, 2009, Mr. Lawrence Leighton, Mr. Carl Yeung
and Mr. Zhiqiang Wang served as members of our Compensation Committee wherein
management compensation issues generally were reviewed and approved. Mr.
Leighton, Mr. Yeung and Mr. Wang have serve on the Compensation Committee since
their appointment to our board on August 7, 2008. None of the members who served
on our Compensation Committee during the year ended December 31, 2008 was an
officer or employee of our Company during the fiscal year ended December 31,
2009, was formerly an officer of our company, was a promoter of the Company or
has, or will have, a direct or indirect interest in a transaction since the
beginning of the fiscal year ended December 31, 2009, or any currently proposed
transaction, in which our Company was or is to be a participant and the amount
involved exceeds $120,000. During our fiscal year ended December 31, 2009, no
executive officer of our Company served on the board of directors, compensation
committee or other board committee performing equivalent functions of a
compensation committee of another entity that had an executive officer serve on
our board of directors or compensation committee.





Compensation
Committee Report





We, the
Compensation Committee of the Board, have reviewed and discussed the
Compensation Discussion and Analysis contained in this Form 10-K with
management.  Based on such review and discussion, we have recommended
to the Board that the Compensation Discussion and Analysis be included in this
Form 10-K for the year ended December 31, 2009.





Compensation
Committee





Lawrence
Leighton





Carl
Yeung





Zhiqiang
Wang





ITEM
12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
STOCKHOLDER MATTERS





The
following table sets forth certain information, as of February 28, 2010 with
respect to the beneficial ownership of the outstanding common stock by (i) any
holder of more than five (5%) percent; (ii) each of our executive officers and
directors; and (iii) our directors and executive officers as a group. Except as
otherwise indicated, each of the stockholders listed below has sole voting
and investment power over the shares beneficially owned.




Name
      of Beneficial Owner (1)
                      
                      Number
      of
                        Common
                        Stock
                        Beneficially
                        Owned
                      
                      
                      Percentage
                        Of
      Common
                        Stock
                        Outstanding(2)Executive
      Officers and DirectorsQinan
      Ji
                      
                      
                      2,965,799
                      (3)
                      
                      
                      14
                      %Lawrence
      W. Leighton
                      
                      
                      1,000
                      
                      
                      
                      0
                      %All
      officers and directors as a group (1 person)
                      
                      
                      2,966,799
                      (3)
                      
                      
                      14
                      %5%
      holdersXiang
      Ji
                      
                      
                      1,760,000
                      
                      
                      
                      8.31
                      %Heartland
      Advisors
                      
                      
                      1,476,000
                      (4)
                      
                      
                      6.97
                      %Wellington
      Management
                      
                      
                      1,446,730
                      (5)
                      
                      
                      6.83
                      %Xi’an
      Sunway Technology & Industry Co., Ltd
                      
                      
                      1,437,683
                      (3)
                      
                      
                      6.79
                      %Abax
      Lotus Ltd.
                      
                      
                      1,450,000
                      (6)
                      
                      
                      6.41
                      %


80




(1)
Except as otherwise indicated, the address of each beneficial owner is c/o Xi’an
Xilan Natural Gas Co., Ltd., 19th Floor, Building B, Van Metropolis, Tangyan
Road, Hi-Tech Zone, Xi’an 710065, Shaanxi province, China.





(2)
Applicable percentage ownership is based on 21,18,904 shares of common stock
outstanding as of December 31, 2009, together with securities exercisable
or convertible into shares of common stock within 60 days of December 31,
2009 for each stockholder. Beneficial ownership is determined in accordance with
the rules of the Securities and Exchange Commission and generally includes
voting or investment power with respect to securities. Shares of common stock
that are currently exercisable or exercisable within 60 days of
December 31, 2009 are deemed to be beneficially owned by the person holding
such securities for the purpose of computing the percentage of ownership of such
person, but are not treated as outstanding for the purpose of computing the
percentage ownership of any other person.





(3) Of
which 1,437,683 shares are owned by Xi’an Sunway Technology & Industry Co.,
Ltd. Qinan Ji owns 42.1% of Xi’an Sunway and may be deemed to beneficially own
such shares. None of the shares have been pledged as security for any loan or
indebtedness.





(4)
William J. Nasgovitz has shared voting and dispositive power with respect to
such shares as reported in the Schedule 13G/A filed with the SEC on February 10,
2010.





(5)
Robert Toner has shared voting and dispositive power with respect to such shares
as reported in the Schedule 13G filed with the SEC on February 12,
2010.





(6) As
set forth in Schedule 13D filed with the SEC on February 6, 2008.





No
Director, executive officer, affiliate or any owner of record or beneficial
owner of more than 5% of any class of voting securities of the Company is a
party adverse to the Company or has a material interest adverse to the
Company.





Securities
Authorized for Issuance under Equity Compensation Plans





The
following table summarizes the Company’s equity compensation plan information as
of December 31, 2009.


81





Number
      of securitiesremaining
      available forNumber
      of
                              
                              
                              
                              
                              
                              future
      issuance undersecurities
      to be
                              
                              
                              Weighted-average
                              
                              
                              equity
      compensationissued
      upon exercise
                              
                              
                              exercise
      price
                              
                              
                              plans
      (excludingof
      outstanding
                              
                              
                              of
      outstanding
                              
                              
                              securities
      reflected inoptions
      and rights
                              
                              
                              options
      and rights
                              
                              
                              column
      (a))Plan
      Category
                              
                              (a)
                              
                              
                              (b)
                              
                              
                              (c)Equity
      compensation plans approved by
    stockholders
                              
                              
                              318,850
                              
                              
                              $
                              4.90
                              
                              
                              
                              1,141,150Equity
      compensation plans not approved by
      stockholdersTotal
                              
                              
                              318,850
                              
                              
                              $
                              4.90
                              
                              
                              
                              1,141,150





ITEM
13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
INDEPENDENCE.





Transactions
with Related Persons





None.





Review,
Approval or Ratification of Transaction with Related Persons





Although
we have not adopted formal procedures for the review, approval or ratification
of transactions with related persons, we adhere to a general policy that such
transactions should only be entered into if they are on terms that, on the
whole, are no more favorable, or no less favorable, than those available from
unaffiliated third parties and their approval is in accordance with applicable
law. Such transactions require the approval of our board of
directors.





Director
Independence





The Board
has determined that all Board members, excluding Qinan Ji and Donald Yang, are
independent under the applicable NASDAQ rules. The Board has also determined the
members of each committee of the Board are independent under the listing
standards of the NASDAQ Global Select Market. In making these
determinations, the Board considered, among other things, the types and amounts
of the commercial dealings between the Company and the companies and
organizations with which the directors are affiliated.





ITEM
14. PRINCIPAL ACCOUNTANT FEES AND SERVICES





All the
service agreements related with auditors and lawyers need to be approved and
signed by the Company’s Audit Committee. 100% of those services provided were
approved by the Committee.





The
following table shows the fees paid or accrued for the audit and other services
provided by our independent auditors for 2008 and 2009.





Audit
      fees
                
                2008
                
                
                2009Frazer
      Frost, LLP (Successor of Moore Stephen Wurth Frazer and Torbet,
      LLP)*
                
                $
                180,000
                
                
                $
                275,000Kabani
      & Company, Inc.
                
                $
                7,500
                
                
                $
                -Audit-related
      feesTax
      fees**
                
                $
                10,000
                
                
                $
                10,000All
      other feesTotal
      fees paid or accrued to our principal accountants
                
                $
                190,000
                
                
                $
                285,000




82





*The fees
billed for professional services rendered for the audit of the Company’s
internal control over financial reporting, audit of the consolidated annual
financial statements and review of the interim consolidated financial statements
included in quarterly reports and services that are normally provided by our
auditors in connection with statutory and regulatory filings or
engagements.





**The fee
billed for professional services rendered for the preparation of the Company’s
corporate and state tax return.





Our Audit
Committee's policy is to pre-approve all audit and permissible non-audit
services provided by our independent registered public accounting firm. These
services may include audit services, audit-related services, tax services and
other services, Pre-approval is generally provided for up to one year and any
pre-approval is detailed as to the particular service or category of services.
The independent registered public accounting firm and management are required to
periodically report to our Audit Committee regarding the extent of services
provided by the independent registered public accounting firm in accordance with
this pre-approval. None of the services related to Audit-Related Fees, Tax Fees
or All Other Fees described above were approved by our Audit Committee pursuant
to a waiver of pre-approval provisions set forth in applicable rules of the
SEC.





ITEM
15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES





Exhibits:




Number
              
              Description
      of Exhibit2.1
              
              Form
      of Equity Ownership Transfer Agreement (incorporated by reference to same
      exhibit filed with the Company’s Form 8-K filed on December 31,
      2008).3.1
              
              Articles
      of Incorporation (incorporated by reference to same exhibit filed with the
      Company's Form 10SB Registration Statement filed September 15, 2000, SEC
      file no. 000-31539).3.2
              
              Registrant's
      Amended and Restated By-Laws (incorporated by reference to exhibit 3.1
      filed with the Registrant's Form 8K filed June 16, 2006, SEC file no.
      000-31539).10.1
              
              Share
      Purchase Agreement made as of December 6, 2005 among Coventure
      International Inc., Xi’an Xilan Natural Gas Co., Ltd. and each of Xilan's
      shareholders. (incorporated by reference to the exhibits to Registrant’s
      Form 8-K filed on December 9, 2005).10.2
              
              Return
      to Treasury Agreement between Coventure International Inc. and John
      Hromyk, dated December 6, 2005. (incorporated by reference to the exhibits
      to Registrant’s Form 8-K filed on December 9, 2005).10.3
              
              Purchase
      Agreement made as of December 19, 2005 between China Natural Gas, Inc. and
      John Hromyk (incorporated by reference to the exhibits to Registrant’s
      Form 8-K filed on December 23, 2005).10.4
              
              Form
      of Securities Purchase Agreement (incorporated by reference to the
      exhibits to Registrant’s Form 8-K filed on January 12,
    2006).10.5
              
              Form
      of Common Stock Purchase Agreement (incorporated by reference to the
      exhibits to Registrant’s Form 8-K filed on January 12,
    2006).10.6
              
              Form
      of Registration Rights Agreement (incorporated by reference to the
      exhibits to Registrant’s Form 8-K filed on January 12,
    2006).10.7
              
              CNG
      Product Purchase and Sale Agreement between Xi’an Xilan Natural Gas Co.,
      Ltd. and Zhengzhou Zhongyou Hengran Petroleum Gas Co., Ltd. made as of
      July 20, 2006, (translated from the original Mandarin) (incorporated by
      reference to the exhibits to Registrant’s Form 10-KSB filed on April 17,
      2007).10.8
              
              Securities
      Purchase Agreement dated, August 2, 2007, between the Company and the
      Investors named therein (incorporated by reference to the exhibits to
      Registrant’s Form 8-K filed on August 8, 2007).10.9
              
              Registration
      Rights Agreement dated, August 2, 2007, between the Company and the
      Investors named therein (incorporated by reference to the exhibits to
      Registrant’s Form 8-K filed on August 8, 2007).10.10
              
              Consulting
      Services Agreement dated, August 17, 2007, between Shaanxi Xilan Natural
      Gas Equipment Co., Ltd. and Xi’an Xilan Natural Gas Co., Ltd.
      (incorporated by reference to the exhibits to Registrant’s Form 10-QSB
      filed on August 20, 2007).10.11
              
              Operating
      Agreement, dated August 17, 2007, between Shaanxi Xilan Natural Gas
      Equipment Co., Ltd. and Xi’an Xilan Natural Gas Co., Ltd. (incorporated by
      reference to the exhibits to Registrant’s Form 10-QSB filed on August 20,
      2007).
  83
  10.12
              
              Equity
      Pledge Agreement, dated August 17, 2007, between Shaanxi Xilan Natural Gas
      Equipment Co., Ltd. and Xi’an Xilan Natural Gas Co., Ltd. (incorporated by
      reference to the exhibits to Registrant’s Form 10-QSB filed on August 20,
      2007).10.13
              
              Option
      Agreement dated, August 17, 2007, between Shaanxi Xilan Natural Gas
      Equipment Co., Ltd. and Xi’an Xilan Natural Gas Co., Ltd. (incorporated by
      reference to the exhibits to Registrant’s Form 10-QSB filed on August 20,
      2007).10.14
              
              Proxy
      Agreement dated, August 17, 2007, between Shaanxi Xilan Natural Gas
      Equipment Co., Ltd. and Xi’an Xilan Natural Gas Co., Ltd. (incorporated by
      reference to the exhibits to Registrant’s Form 10-QSB filed on August 20,
      2007).10.15
              
              Securities
      Purchase Agreement, dated December 30, 2007, between the Company and Abax
      Lotus Ltd. (incorporated by reference to the exhibits to Registrant’s Form
      8-K filed on January 31, 2008).10.16
              
              Amendment
      to Securities Purchase Agreement, dated January 29, 2008, between the
      Company and Abax Lotus Ltd. (incorporated by reference to the exhibits to
      Registrant’s Form 8-K filed on January 31, 2008).10.17
              
              Indenture,
      dated January 29, 2008, by and among the Company and DB Trustees (Hong
      Kong) Limited, as trustee, relating to the 5.00% Guaranteed Senior Notes
      due 2014 (incorporated by reference to the exhibits to Registrant’s Form
      8-K filed on January 31, 2008).10.18
              
              Warrant
      Agreement, dated January 29, 2008, by and among the Company, Mr. Qinan Ji,
      Deutsche Bank AG, Hong Kong Branch as Warrant Agent and Deutsche Bank
      Luxembourg S.A. as Warrant Agent (incorporated by reference to the
      exhibits to Registrant’s Form 8-K filed on January 31,
    2008).10.19
              
              Equity
      Registration Rights Agreement, dated January 29, 2008, by and between the
      Company and Abax Lotus Ltd. (incorporated by reference to the exhibits to
      Registrant’s Form 8-K filed on January 31, 2008).10.20
              
              Investor
      Rights Agreement, dated January 29, 2008, by and among the Company, its
      subsidiaries, Mr. Qinan Ji, and Abax Lotus Ltd. (incorporated by reference
      to the exhibits to Registrant’s Form 8-K filed on January 31,
      2008).10.21
              
              Information
      Rights Agreement, dated January 29, 2008, between the Company and Abax
      Lotus Ltd. (incorporated by reference to the exhibits to Registrant’s Form
      8-K filed on January 31, 2008).10.22
              
              Onshore
      Share Pledge Agreement, dated January 29, 2008, between the Company and DB
      Trustees (Hong Kong) Limited, as security agent (incorporated by reference
      to the exhibits to Registrant’s Form 8-K filed on January 31,
      2008).10.23
              
              Account
      Pledge and Security Agreement, dated January 29, 2008, by and between the
      Company and DB Trustees (Hong Kong) Limited as Security Agent
      (incorporated by reference to the exhibits to Registrant’s Form 8-K filed
      on January 31, 2008).10.24
              
              Natural
      Gas Purchase Agreement entered by and between Xi' An Xilan Natural Gas
      Co., Ltd. and China Petroleum Co., Ltd., Changqing Branch, dated July 30,
      2006 (incorporated herein by reference to the exhibits to the Registrant’s
      Form 10-K/A filed on July 20, 2009).10.25
              
              Natural
      Gas Purchase Agreement entered by and between Ji Nan Yuhai Natural Gas
      Co., Ltd. and Xi' An Xilan Natural Gas Co., Ltd. dated, February 28, 2008
      (incorporated herein by reference to the exhibits to the Registrant’s Form
      10-K/A filed on July 20, 2009)..
  84
  10.26
              
              Natural
      Gas Supply Agreement between Jincheng Ming Shi Natural Gas Co., Ltd.,
      Jinan Branch, and Xi' An Xilan Natural Gas Co., Ltd. dated, March 20, 2008
      (incorporated herein by reference to the exhibits to the Registrant’s Form
      10-K/A filed on July 20, 2009).10.27
              
              Natural
      Gas Purchase Agreement entered by and between Shaanxi Natural Gas Co.,
      Ltd. and Xi' An Xilan Natural Gas Co., Ltd., dated July 17, 2008
      (incorporated herein by reference to the exhibits to the Registrant’s Form
      10-K/A filed on July 20, 2009).10.28
              
              Independent
      Director Agreement, dated January 1, 2008, by and between China Natural
      Gas., Inc. and Zhiqiang Wang (incorporated herein by reference to the
      exhibits to the Registrant’s Form 10-K/A filed on July 20,
      2009).10.29
              
              Independent
      Director Agreement, dated July 1, 2008, by and between China Natural Gas.,
      Inc. and Carl Yeung (incorporated herein by reference to the exhibits to
      the Registrant’s Form 10-K/A filed on July 20, 2009).10.30
              
              Independent
      Director Agreement, dated August 5, 2008, by and between China Natural
      Gas., Inc. and Lawrence W. Leighton (incorporated herein by reference to
      the exhibits to the Registrant’s Form 10-K/A filed on July 20,
      2009).10.31
              
              Employment
      Agreement, dated October 10, 2008, by and between China Natural Gas., Inc.
      and Richard Peidong Wu (incorporated herein by reference to the exhibits
      to the Registrant’s Form 10-K/A filed on July 20,
2009).10.32
              
              Employment
      Agreement, dated May 10, 2005, by and between China Natural Gas., Inc. and
      Qinan Ji (incorporated herein by reference to the exhibits to the
      Registrant’s Form 10-K/A filed on July 20, 2009).10.33
              
              Equity
      Ownership Transfer Agreement, dated October 2, 2008, by and between Xi'an
      Xilan Natural Gas Co., Ltd., Zhihe Zhang and Lingjun Hu (incorporated by
      reference to the Registrant’s Form 8-K filed on December 31,
      2008).10.34
              
              Joint
      Venture Agreement dated July 22, 2009 by and between Xi’an Xilan Natural
      Gas Co., Ltd. and China National Petroleum Corporation Kunlun Natural Gas
      Co., Ltd. (incorporated by reference to the Registrant’s Form 8-K filed on
      July 28, 2009).10.35
              
              Strategic Cooperation Framework
      Agreement dated as of July 6, 2009 by and between Xi’an Xilan Natural Gas
      Co., Ltd. and China National Petroleum Corporation Kunlun Natural Gas Co.,
      Ltd. (incorporated
      by reference to the Registrant’s Form 8-K filed on July 8,
      2009).14.1
              
              Code
      of Ethics adopted by the Company on June 14, 2006 (incorporated by
      reference to the exhibits to Registrant’s Form 8-K filed on June 16,
      2006).16.1
              
              Letter
      of Moore Stephens Wurth Frazer and Torbet, LLP dated January 7, 2010
      (incorporated by reference to the exhibits to Registrant’s Form 8-K filed
      on January 7, 2010).21.1*
              
              List
      of Subsidiaries. (incorporated by reference to the exhibits to
      Registrant’s Form 10-KSB filed on April 17, 2007).23.1
              
              Written
      consent of Moore Stephens Wurth Frazer and Torbet, LLP (incorporated by
      reference to the exhibits to Registrant’s Form S-3/A filed on July 2,
      2009).
  23.2
              
              Written
      consent of Kabani & Company, Inc. (incorporated by reference to the
      exhibits to Registrant’s Form S-3/A filed on July 2,
  2009).31.1*
              
              Certification
      of Principal Executive Officer pursuant to Rule 13a-14 and Rule 15d-14(a),
      promulgated under the Securities and Exchange Act of 1934, as
      amended31.2*
              
              Certification
      of Principal Financial Officer pursuant to Rule 13a-14 and Rule 15d 14(a),
      promulgated under the Securities and Exchange Act of 1934, as
      amended32.1*
              
              Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 (Chief Executive
Officer)32.2*
              
              Certification
      pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
      the Sarbanes-Oxley Act of 2002 (Chief Financial
Officer)*
      Filed herewith




85





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.





Date:
August
19, 2010





CHINA
      NATURAL GAS, INC./s/
      Qinan Ji
                  /s/
      David SheName:
      Qinan Ji
                  Name:
      David SheTitle:   Chief
      Executive Officer
                    (Principal
      Executive Officer)
                  Title:   Chief
      Financial Officer
                    (Principal
      Financial and Accounting
Officer)




Pursuant
to the requirements of Section 13 or 15(d) of the Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf of the
registrant and in the capacities and on the dates indicated.





/s/
      Qinan Ji
            
            President
      and Chief
              Executive
      Officer and
              Director
      (Principal Executive Officer)
            
            August
      19, 2010Qinan
      Ji/s/
      Zhiqiang Wang
            
            Director
            
            August
      19, 2010Zhiqiang
      Wang/s/
      Donald Yang
            
            Director
            
            August
      19, 2010Donald
      Yang/s/
      David She
            
            Chief
      Financial Officer
              (Principal
      Financial and Accounting Officer)
            
            August
      19, 2010David
      She/s/
      Carl Yeung
            
            Director
            
            August
      19, 2010Carl
      Yeung/s/
      Lawrence Leighton
            
            Director
            
            August
      19, 2010Lawrence
      Leighton


86


CHINA
NATURAL GAS, INC.


AND
SUBSIDIARIES





Index to Financial
Statements





PagesReports
      of Independent Registered Public Accounting Firm
                
                F-2Consolidated
      Balance Sheets as of December 31, 2009 and 2008
                
                F-3Consolidated
      Statements of Income and Other Comprehensive Income for the years ended
      December 31, 2009, 2008 and 2007
                
                F-4Consolidated
      Statements of Stockholders’ Equity
                
                F-5Consolidated
      Statements of Cash Flows for the years ended December 31, 2009, 2008 and
      2007
                
                F-6Notes
      to Consolidated Financial Statements as of December 31,
    2009
                
                F-7 –
      F-35




F-1




REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




To the
Board of Directors and Stockholders of
 China
Natural Gas, Inc.
  We have
audited the accompanying consolidated balance sheets of China Natural Gas, Inc.
and subsidiaries as of December 31, 2009 and 2008, and the related consolidated
statements of income and other comprehensive income, stockholders’ equity, and
cash flows for each of the years in the three-year period ended December 31,
2009. China Natural Gas, Inc.’s management is responsible for these consolidated
financial statements. Our responsibility is to express an opinion on these
consolidated financial statements based on our audits.
  We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
  In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of China Natural Gas, Inc. and
subsidiaries as of December 31, 2009 and 2008, and the results of its operations
and its cash flows for each of the years in the three-year period ended December
31, 2009 in conformity with accounting principles generally accepted in the
United States of America.
  We also
have audited, in accordance with the standards of the Public Company Accounting
Oversight Board (United States), China Natural Gas, Inc. and subsidiaries’
internal control over financial reporting as of December 31, 2009, based on
criteria established in Internal Control—Integrated
Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO), and our report dated March 10, 2010 expressed an
unqualified opinion.
  /s/
Frazer Frost, LLP (Successor Entity of Moore Stephens Wurth Frazer and Torbet,
LLP, see Form 8-K filed on January 7, 2010)
  Brea,
California
 March 10,
2010, except for the effects on the consolidated financial statements of the
restatement described in Note 2 and 15, as to which the date is August 19,
2010




F-2




CHINA NATURAL GAS, INC. AND SUBSIDIARIES





CONSOLIDATED
BALANCE SHEETS


AS
OF DECEMBER 31, 2009 and 2008




2009
                                                                          
                                                                          
                                                                          2008(As Restated
                                                                            see Note 2)ASSETSCURRENT
      ASSETS:Cash
      & cash equivalents
                                                                          
                                                                          $
                                                                          48,177,794
                                                                          
                                                                          
                                                                          $
                                                                          5,854,383Accounts
      receivable, net of allowance for doubtful accounts of $163,280 and $0 as
      of December 31, 2009 and 2008, respectively
                                                                          
                                                                          
                                                                          1,289,116
                                                                          
                                                                          
                                                                          
                                                                          906,042Other
      receivable
                                                                          
                                                                          
                                                                          709,741
                                                                          
                                                                          
                                                                          
                                                                          60,784Other
      receivable - employee advances
                                                                          
                                                                          
                                                                          338,689
                                                                          
                                                                          
                                                                          
                                                                          332,263Inventories
                                                                          
                                                                          
                                                                          841,837
                                                                          
                                                                          
                                                                          
                                                                          519,739Advances
      to suppliers
                                                                          
                                                                          
                                                                          596,868
                                                                          
                                                                          
                                                                          
                                                                          837,592Prepaid
      expense and other current assets
                                                                          
                                                                          
                                                                          1,076,915
                                                                          
                                                                          
                                                                          
                                                                          777,510Loan
      receivable
                                                                          
                                                                          
                                                                          293,400
                                                                          
                                                                          
                                                                          
                                                                          293,400Total
      current assets
                                                                          
                                                                          
                                                                          53,324,360
                                                                          
                                                                          
                                                                          
                                                                          9,581,713INVESTMENT
      IN UNCONSOLIDATED JOINT VENTURES
                                                                          
                                                                          
                                                                          1,467,000
                                                                          
                                                                          
                                                                          
                                                                          -PROPERTY
      AND EQUIPMENT, NET
                                                                          
                                                                          
                                                                          72,713,012
                                                                          
                                                                          
                                                                          
                                                                          76,028,272CONSTRUCTION
      IN PROGRESS
                                                                          
                                                                          
                                                                          52,918,236
                                                                          
                                                                          
                                                                          
                                                                          22,061,414DEFERRED
      FINANCING COSTS
                                                                          
                                                                          
                                                                          1,336,998
                                                                          
                                                                          
                                                                          
                                                                          1,746,830OTHER
      ASSETS
                                                                          
                                                                          
                                                                          15,854,910
                                                                          
                                                                          
                                                                          
                                                                          8,844,062TOTAL
      ASSETS
                                                                          
                                                                          $
                                                                          197,614,516
                                                                          
                                                                          
                                                                          $
                                                                          118,262,291LIABILITIES AND STOCKHOLDERS'
      EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued liabilities
                                                                          
                                                                          $
                                                                          2,081,261
                                                                          
                                                                          
                                                                          $
                                                                          800,013Other
      payables
                                                                          
                                                                          
                                                                          80,788
                                                                          
                                                                          
                                                                          
                                                                          124,151Unearned
      revenue
                                                                          
                                                                          
                                                                          1,813,641
                                                                          
                                                                          
                                                                          
                                                                          944,402Accrued
      interest
                                                                          
                                                                          
                                                                          786,052
                                                                          
                                                                          
                                                                          
                                                                          861,114Taxes
      payable
                                                                          
                                                                          
                                                                          1,901,577
                                                                          
                                                                          
                                                                          
                                                                          1,862,585Notes
      payable, net of discount of $12,707,713 and $0 as of December 31, 2009 and
      2008,respectively
                                                                          
                                                                          
                                                                          27,292,287
                                                                          
                                                                          
                                                                          
                                                                          -Redeemable
      liabilities-warrants
                                                                          
                                                                          
                                                                          17,500,000
                                                                          
                                                                          
                                                                          
                                                                          -Total
      current liabilities
                                                                          
                                                                          
                                                                          51,455,606
                                                                          
                                                                          
                                                                          
                                                                          4,592,265LONG
      TERM LIABILITIES:Notes
      payable, net of discount of $0 and $15,478,395 as of December 31, 2009 and
      2008, respectively
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          24,521,605Derivative
      liabilities - warrants
                                                                          
                                                                          
                                                                          2,045,638
                                                                          
                                                                          
                                                                          
                                                                          17,500,000Total
      long term liabilities
                                                                          
                                                                          
                                                                          2,045,638
                                                                          
                                                                          
                                                                          
                                                                          42,021,605Total
      liabilities
                                                                          
                                                                          
                                                                          53,501,244
                                                                          
                                                                          
                                                                          
                                                                          46,613,870COMMITMENTS AND CONTINGENCIESSTOCKHOLDERS'
      EQUITY:Preferred
      stock, $0.0001 per share; 5,000,000 shares authorized; none
      issued
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          -Common
      stock, $0.0001 per share; 45,000,000 shares authorized, 21,183,904 shares
      and 14,600,154 shares issued and outstanding at December 31, 2009 and
      2008, respectively
                                                                          
                                                                          
                                                                          2,118
                                                                          
                                                                          
                                                                          
                                                                          1,460Additional
      paid-in capital
                                                                          
                                                                          
                                                                          79,851,251
                                                                          
                                                                          
                                                                          
                                                                          32,115,043Accumulative
      other comprehensive gain
                                                                          
                                                                          
                                                                          8,714,019
                                                                          
                                                                          
                                                                          
                                                                          8,661,060Statutory
      reserves
                                                                          
                                                                          
                                                                          5,962,695
                                                                          
                                                                          
                                                                          
                                                                          3,730,083Retained
      earnings
                                                                          
                                                                          
                                                                          49,583,189
                                                                          
                                                                          
                                                                          
                                                                          27,140,775Total
      stockholders' equity
                                                                          
                                                                          
                                                                          144,113,272
                                                                          
                                                                          
                                                                          
                                                                          71,648,421TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                                                                          
                                                                          $
                                                                          197,614,516
                                                                          
                                                                          
                                                                          $
                                                                          118,262,291




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


See
report of independent registered public accounting firm.




F-3




CHINA NATURAL GAS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF INCOME AND OTHER COMPREHENSIVE INCOME


FOR
THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007





Years Ended December 31,2009
                                    
                                    
                                    2008
                                    
                                    
                                    2007RevenuesNatural
      gas revenue
                                    
                                    $
                                    62,236,342
                                    
                                    
                                    $
                                    55,746,893
                                    
                                    
                                    $
                                    28,278,033Gasoline
      revenue
                                    
                                    
                                    6,384,172
                                    
                                    
                                    
                                    4,616,052
                                    
                                    
                                    
                                    38,486Installation
      and others
                                    
                                    
                                    12,445,604
                                    
                                    
                                    
                                    7,357,714
                                    
                                    
                                    
                                    7,075,534Total
      revenues
                                    
                                    
                                    81,066,118
                                    
                                    
                                    
                                    67,720,659
                                    
                                    
                                    
                                    35,392,053Cost
      of revenuesNatural
      gas cost
                                    
                                    
                                    29,478,854
                                    
                                    
                                    
                                    27,234,508
                                    
                                    
                                    
                                    14,838,997Gasoline
      cost
                                    
                                    
                                    5,993,207
                                    
                                    
                                    
                                    4,277,458
                                    
                                    
                                    
                                    34,747Installation
      and others
                                    
                                    
                                    5,432,978
                                    
                                    
                                    
                                    3,469,671
                                    
                                    
                                    
                                    3,151,331Total
      cost of revenues
                                    
                                    
                                    40,905,039
                                    
                                    
                                    
                                    34,981,637
                                    
                                    
                                    
                                    18,025,075Gross
      profit
                                    
                                    
                                    40,161,079
                                    
                                    
                                    
                                    32,739,022
                                    
                                    
                                    
                                    17,366,978Operating
      expensesSelling
      expenses
                                    
                                    
                                    9,566,387
                                    
                                    
                                    
                                    7,651,948
                                    
                                    
                                    
                                    3,451,161General
      and administrative expenses
                                    
                                    
                                    5,541,885
                                    
                                    
                                    
                                    4,024,882
                                    
                                    
                                    
                                    2,837,768Total
      operating expenses
                                    
                                    
                                    15,108,272
                                    
                                    
                                    
                                    11,676,830
                                    
                                    
                                    
                                    6,288,929Income
      from operations
                                    
                                    
                                    25,052,807
                                    
                                    
                                    
                                    21,062,192
                                    
                                    
                                    
                                    11,078,049Non-operating
      income (expense):Interest
      income
                                    
                                    
                                    125,287
                                    
                                    
                                    
                                    209,502
                                    
                                    
                                    
                                    70,697Interest
      expense
                                    
                                    
                                    (747,172
                                    )
                                    
                                    
                                    (2,228,244
                                    )
                                    
                                    
                                    -Other
      income (expense), net
                                    
                                    
                                    (186,805
                                    )
                                    
                                    
                                    111,859
                                    
                                    
                                    
                                    31,976Change
      in fair value of warrants
                                    
                                    
                                    (1,031,330
                                    )
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Foreign
      currency exchange loss
                                    
                                    
                                    (69,077
                                    )
                                    
                                    
                                    (397,299
                                    )
                                    
                                    
                                    (150,729
                                    )Total
      non-operating expense
                                    
                                    
                                    (1,909,097
                                    )
                                    
                                    
                                    (2,304,182
                                    )
                                    
                                    
                                    (48,056
                                    )Income
      before income tax
                                    
                                    
                                    23,143,710
                                    
                                    
                                    
                                    18,758,010
                                    
                                    
                                    
                                    11,029,993Provision
      for income tax
                                    
                                    
                                    4,312,923
                                    
                                    
                                    
                                    3,567,642
                                    
                                    
                                    
                                    1,913,923Net
      income
                                    
                                    
                                    18,830,787
                                    
                                    
                                    
                                    15,190,368
                                    
                                    
                                    
                                    9,116,070Other
      comprehensive incomeForeign
      currency translation gain
                                    
                                    
                                    52,959
                                    
                                    
                                    
                                    5,184,035
                                    
                                    
                                    
                                    2,637,573Comprehensive
      income
                                    
                                    $
                                    18,883,746
                                    
                                    
                                    $
                                    20,374,403
                                    
                                    
                                    $
                                    11,753,643Weighted
      average shares outstandingBasic
                                    
                                    
                                    16,624,294
                                    
                                    
                                    
                                    14,600,154
                                    
                                    
                                    
                                    13,100,340Diluted
                                    
                                    
                                    16,830,907
                                    
                                    
                                    
                                    14,645,070
                                    
                                    
                                    
                                    13,150,901Earnings
      per shareBasic
                                    
                                    $
                                    1.13
                                    
                                    
                                    $
                                    1.04
                                    
                                    
                                    $
                                    0.70Diluted
                                    
                                    $
                                    1.12
                                    
                                    
                                    $
                                    1.04
                                    
                                    
                                    $
                                    0.69




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


See
report of independent registered public accounting firm.




F-4




CHINA NATURAL GAS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS' EQUITY




Accumulative
                          
                          
                          Retained Earnings
                          
                          
                          TotalCommon Stock
                          
                          
                          Additional
                          
                          
                          Other Comprehensive
                          
                          
                          Statutory
                          
                          
                          
                          
                          
                          Stockholders'Shares
                          
                          
                          Amount
                          
                          
                          Paid-in Capital
                          
                          
                          Gain
                          
                          
                          Reserve
                          
                          
                          Unrestricted
                          
                          
                          EquityBalance
      December 31, 2006
                          
                          
                          12,105,093
                          
                          
                          $
                          1,211
                          
                          
                          $
                          18,225,121
                          
                          
                          $
                          839,452
                          
                          
                          $
                          750,886
                          
                          
                          $
                          5,813,534
                          
                          
                          $
                          25,630,204Shares
      issued for cash, at $3.25
                          
                          
                          2,307,693
                          
                          
                          
                          231
                          
                          
                          
                          14,999,769
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          15,000,000Offering
      Costs
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (1,176,533
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (1,176,533
                          )Cashless
      exercise of warrants
                          
                          
                          187,368
                          
                          
                          
                          18
                          
                          
                          
                          (18
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          -Cumulative
      translation adjustment
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          2,637,573
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          2,637,573Net
      Income
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          9,116,070
                          
                          
                          
                          9,116,070Transfer
      to statutory reserve
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          1,051,849
                          
                          
                          
                          (1,051,849
                          )
                          
                          
                          -Balance
      December 31, 2007
                          
                          
                          14,600,154
                          
                          
                          $
                          1,460
                          
                          
                          $
                          32,048,339
                          
                          
                          $
                          3,477,025
                          
                          
                          $
                          1,802,735
                          
                          
                          $
                          13,877,755
                          
                          
                          $
                          51,207,314Options
      issued for services
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          66,704
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          66,704Cumulative
      translation adjustment
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          5,184,035
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          5,184,035Net
      Income
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          15,190,368
                          
                          
                          
                          15,190,368Transfer
      to statutory reserve
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          1,927,348
                          
                          
                          
                          (1,927,348
                          )
                          
                          
                          -Balance
      December 31, 2008
                          
                          
                          14,600,154
                          
                          
                          $
                          1,460
                          
                          
                          $
                          32,115,043
                          
                          
                          $
                          8,661,060
                          
                          
                          $
                          3,730,083
                          
                          
                          $
                          27,140,775
                          
                          
                          $
                          71,648,421Reclassification
      of warrants from equity to derivative liabilities
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (6,858,547
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          5,844,239
                          
                          
                          
                          (1,014,308
                          )Stock
      issuance for cash at $ 8.75
                          
                          
                          6,583,750
                          
                          
                          
                          658
                          
                          
                          
                          57,607,155
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          57,607,813Offering
      costs
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (3,237,452
                          )
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          (3,237,452
                          )Options
      issued for services
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          66,535
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          66,535Stock
      based compensation
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          158,517
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          158,517Cumulative
      translation adjustment
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          52,959
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          52,959Net
      Income
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          18,830,787
                          
                          
                          
                          18,830,787Transfer
      to statutory reserve
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          
                          2,232,612
                          
                          
                          
                          (2,232,612
                          )
                          
                          
                          -Balance
      December 31, 2009
                          
                          
                          21,183,904
                          
                          
                          $
                          2,118
                          
                          
                          $
                          79,851,251
                          
                          
                          $
                          8,714,019
                          
                          
                          $
                          5,962,695
                          
                          
                          $
                          49,583,189
                          
                          
                          $
                          144,113,272




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


See
report of independent registered public accounting firm.




F-5




CHINA
NATURAL GAS, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


FOR
THE YEARS ENDED DECEMBER 31, 2009, 2008 AND 2007




Years Ended December 31,2009
                          
                          
                          2008
                          
                          
                          2007CASH
      FLOWS FROM OPERATING ACTIVITIES:Net
      income
                          
                          $
                          18,830,787
                          
                          
                          $
                          15,190,368
                          
                          
                          $
                          9,116,070Adjustments
      to reconcile net income to net cash provided by operating
      activities:Depreciation
      and amortization
                          
                          
                          5,571,772
                          
                          
                          
                          3,474,905
                          
                          
                          
                          1,639,685Loss
      on disposal of equipment
                          
                          
                          21,373
                          
                          
                          
                          24,806
                          
                          
                          
                          -Amortization
      of discount on senior notes
                          
                          
                          280,250
                          
                          
                          
                          1,004,677
                          
                          
                          
                          -Amortization
      of financing costs
                          
                          
                          63,940
                          
                          
                          
                          227,989
                          
                          
                          
                          -Options
      issued for services
                          
                          
                          66,535
                          
                          
                          
                          66,704
                          
                          
                          
                          -Stock
      based compensation
                          
                          
                          158,517
                          
                          
                          
                          -
                          
                          
                          
                          -Change
      in fair value of warrants
                          
                          
                          1,031,330
                          
                          
                          
                          -
                          
                          
                          
                          -Change
      in assets and liabilities:Accounts
      receivable
                          
                          
                          (387,948
                          )
                          
                          
                          (568,370
                          )
                          
                          
                          290,660Other
      receivable
                          
                          
                          (644,083
                          )
                          
                          
                          247,349
                          
                          
                          
                          36,929Other
      receivable - employee advances
                          
                          
                          (6,425
                          )
                          
                          
                          (55,747
                          )
                          
                          
                          -Inventories
                          
                          
                          (322,099
                          )
                          
                          
                          (267,470
                          )
                          
                          
                          71,226Advances
      to suppliers
                          
                          
                          240,724
                          
                          
                          
                          (125,896
                          )
                          
                          
                          245,514Prepaid
      expense and other current assets
                          
                          
                          (306,445
                          )
                          
                          
                          (642,857
                          )
                          
                          
                          (11,113
                          )Accounts
      payable and accrued liabilities
                          
                          
                          45,888
                          
                          
                          
                          275,929
                          
                          
                          
                          28,531Other
      payables
                          
                          
                          (43,362
                          )
                          
                          
                          63,239
                          
                          
                          
                          (208,669
                          )Unearned
      revenue
                          
                          
                          869,239
                          
                          
                          
                          583,940
                          
                          
                          
                          22,425Accrued
      interest
                          
                          
                          (75,062
                          )
                          
                          
                          861,114
                          
                          
                          
                          -Taxes
      payable
                          
                          
                          38,991
                          
                          
                          
                          556,121
                          
                          
                          
                          (754,817
                          )Net
      cash provided by operating activities
                          
                          
                          25,433,922
                          
                          
                          
                          20,916,801
                          
                          
                          
                          10,476,441CASH
      FLOWS FROM INVESTING ACTIVITIESPayment
      on investment in unconsolidated joint ventures
                          
                          
                          (1,467,000
                          )
                          
                          
                          -
                          
                          
                          
                          -Purchase
      of property and equipment
                          
                          
                          (1,074,066
                          )
                          
                          
                          (43,225,673
                          )
                          
                          
                          (14,180,053
                          )Proceeds
      from sales of equipment
                          
                          
                          41,325
                          
                          
                          
                          194,891
                          
                          
                          
                          -Proceeds
      from (purchases of) short term investments
                          
                          
                          -
                          
                          
                          
                          250,821
                          
                          
                          
                          (229,106
                          )Additions
      to construction in progress
                          
                          
                          (28,020,498
                          )
                          
                          
                          (19,012,750
                          )
                          
                          
                          (519,309
                          )Prepayment
      on long term assets
                          
                          
                          (6,139,766
                          )
                          
                          
                          (5,729,833
                          )
                          
                          
                          (1,914,343
                          )Return
      of acquisition deposit
                          
                          
                          (283,200
                          )
                          
                          
                          -
                          
                          
                          
                          -Payment
      for intangible assets
                          
                          
                          (161,486
                          )
                          
                          
                          (53,826
                          )
                          
                          
                          -Payment
      for land use rights
                          
                          
                          (432,566
                          )
                          
                          
                          (30,354
                          )
                          
                          
                          (42,529
                          )Net
      cash used in investing activities
                          
                          
                          (37,537,257
                          )
                          
                          
                          (67,606,724
                          )
                          
                          
                          (16,885,340
                          )CASH
      FLOWS FROM FINANCING ACTIVITIES:Stock
      issued for cash
                          
                          
                          57,607,813
                          
                          
                          
                          -
                          
                          
                          
                          15,000,000Proceeds
      from senior notes
                          
                          
                          -
                          
                          
                          
                          40,000,000
                          
                          
                          
                          -Payment
      for offering costs
                          
                          
                          (3,237,454
                          )
                          
                          
                          (2,122,509
                          )
                          
                          
                          (1,176,533
                          )Net
      cash provided by financing activities
                          
                          
                          54,370,359
                          
                          
                          
                          37,877,491
                          
                          
                          
                          13,823,467Effect
      of exchange rate changes on cash and cash equivalents
                          
                          
                          56,387
                          
                          
                          
                          1,375,086
                          
                          
                          
                          582,948NET
      (DECREASE) INCREASE IN CASH & CASH EQUIVALENTS
                          
                          
                          42,323,411
                          
                          
                          
                          (7,437,346
                          )
                          
                          
                          7,997,516CASH
      & CASH EQUIVALENTS, BEGINNING OF YEAR
                          
                          
                          5,854,383
                          
                          
                          
                          13,291,729
                          
                          
                          
                          5,294,213CASH
      & CASH EQUIVALENTS, END OF YEAR
                          
                          $
                          48,177,794
                          
                          
                          $
                          5,854,383
                          
                          
                          $
                          13,291,729SUPPLEMENTAL
      DISCLOSURE OF CASH FLOW INFORMATION:Interest
      paid, net of capitalized interest
                          
                          $
                          503,845
                          
                          
                          $
                          902,777
                          
                          
                          $
                          -Income
      taxes paid
                          
                          $
                          4,178,066
                          
                          
                          $
                          2,998,627
                          
                          
                          $
                          2,387,487Non-cash
      transactions for investing and financing activities:Interest
      capitalized to construction in progress from amortization of discount on
      senior notes and financing costs
                          
                          $
                          2,836,324
                          
                          
                          $
                          1,164,618
                          
                          
                          $
                          -Purchase
      of equipment through accounts payable
                          
                          $
                          1,234,603
                          
                          
                          $
                          -
                          
                          
                          $
                          -Construction
      in progress transferred to property and equipment
                          
                          $
                          -
                          
                          
                          $
                          823,464
                          
                          
                          $
                          -Prepayment
      on long term assets transferred to property and equipment
                          
                          $
                          -
                          
                          
                          $
                          405,630
                          
                          
                          $
                          -




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


See
report of independent registered public accounting firm.




F-6




China
Natural Gas, Inc. and Subsidiaries


Notes
to Consolidated Financial Statements


December
31, 2009


Note
1 - Organization





Organization and Line of
Business





China
Natural Gas, Inc. (the “Company” or “CHNG”) was incorporated in the state of
Delaware on March 31, 1999. The Company through its wholly-owned subsidiaries
and variable interest entities, located in Shaanxi and Henan Province in the
People’s Republic of China (“PRC”), engages in sales and distribution of natural
gas and gasoline to commercial, industrial and residential customers,
construction of pipeline networks, installation of natural gas fittings and
parts for end-users, and modification of automobiles services for vehicles to be
able to use natural gas.





Recent
Developments





On
October 27, 2009, the
Companythrough
itsvariable interest
entity,Xi’an Xilan Natural Gas Co., Ltd. (“XXNGC”) formed Henan CNPC
Kunlun Xilan Compressed Natural Gas Co., Ltd. (“JV”) as a joint venture with
China National Petroleum Corporation Kunlun Natural Gas Co., Ltd. (“CNPC
Kunlun”), with registered capital of $7,335,000 in Henan province, PRC. The JV
was established to build and operate compressed natural gas (“CNG”) compressor
stations and fueling stations, sell CNG, provide vehicle conversion services
from gasoline-fueled vehicles to hybrid (natural gas/gasoline) powered vehicles
and technical advisory work services in Henan, PRC. CNPC Kunlun will hold 51%
ownership of the JV, and XXNGC will hold 49% ownership.





On October
27, 2009, CHNG formed Xilan Energy Co., Ltd. (“XEC”) as a wholly owned
limited liability company, with authorized capital of $5,000,000 in Hong
Kong.  XEC was established for the purpose of importing liquid natural
gas (“LNG”) into PRC.





On
December 17, 2009, the
Companythrough
itsvariable interest
entity,Xi’an Xilan Natural Gas Co., Ltd. (“XXNGC”) formed Hubei Xilan
Natural Gas Co., Ltd. (“HBXNGC”) as a wholly owned limited liability company,
with registered capital of $1,467,000 in Hubei province, PRC.  HBXNGC
was established to construct harbor LNG fueling stations and ships in Hubei,
PRC.




Note
2- Restatement of Previously Reported Consolidated Financial
Statement
 
 The
Company has restated its annual consolidated financial statements as of December
31, 2009.
 
 The
determination to restate the aforementioned consolidated financial statements
was made by the Company’s Audit Committee upon the board of directors and
management’s recommendation following the identification of errors related to
the Company’s misclassification from short term liabilities to long term
liabilities for the senior notes payable and fair value of the redeemable
warrants. The general nature and scope of the errors and adjustments are
summarized as follows:
 
 (1)
              Misclassification of senior
      notes payable—— on February 26, 2010, the Company entered into a
      bank loan of $17.7 million with Pudong Development Bank Xi’an Branch
      (“SPDB”) (the “Bank Loan”).  The loan is secured by the
      Company’s variable interest entity Xi’an Xilan Natural Gas Co., ltd
      (“XXNGC”)’s equipment and vehicles located with PRC.  The
      Company was entitled to borrow amounts under the loan between March 1,
      2010 to June 30, 2010. In connection
      with the Bank Loan, XXNGC pledged its equipment and vehicles located in
      PRC to secure the Bank Loan (the “Pledge”) and guaranteed the repayment of
      the Bank Loan.  The Pledge is prohibited by the Indenture for
      the 5% Guaranteed Senior Note issued to Abax Lotus Ltd., (“Abax”) dated
      January 26, 2008 (the “Senior Notes”).  As a result, Abax has
      the right to declare a default under the Indenture after written notice
      and the Company’s 30 days right to cure.  Upon an event of
      default, Abax may accelerate the outstanding indebtedness together with
      all accrued interest thereon and demand immediate
      repayment.  Due to the potential event of default and the
      Company has not received a notice of default from Abax Lotus Ltd. nor has
      the Company received a waiver from Abax Lotus Ltd. waiving this default as
      of the date of this report, the Company did not properly reclassify the
      Senior Notes in an amount of $27.3 million from long term liabilities to
      short term liabilities.
 
 (2)
              Misclassification of fair
      value of the redeemable warrants——in connection with the Senior
      Notes, the Company issued certain warrants to purchase the Company’s
      common stock pursuant to a Warrant Agreement and Warrant
      Certificates.  Under the terms of the Warrant Agreement, in the
      event of a default under the Indenture for the Senior Notes, the warrant
      holders are entitled to require the Company to redeem the warrants for a
      price equal to the pro rata portion of the aggregate redemption price of
      $17,500,000 applicable to the warrants tendered by such
      holders.  Due to the potential event of default and the
      Company has not received a notice of default from Abax Lotus Ltd. nor has
      the Company receive a notice of waiver from Abax Lotus Ltd waiving this
      default as of the date of this report, the Company did not properly
      reclassify the redeemable warrants in an amount of $17.5 million from long
      term liabilities to short term
liabilities.
 
 F-7
 
 The
following tables present the adjustments due to the restatements of the
Company’s previously issued consolidated balance sheet as of December 31, 2009
and the financing activities
 
 Consolidated Balance Sheet December 31, 2009PreviouslyReported
                              
                              
                              Adjustments
                              
                              
                              AsRestatedASSETSCURRENT
      ASSETS:Cash
      & cash equivalents
                              
                              $
                              48,177,794
                              
                              
                              $
                              
                              
                              
                              $
                              48,177,794Accounts
      receivable,
                              
                              
                              1,289,116
                              
                              
                              
                              
                              
                              
                              
                              1,289,116Other
      receivable
                              
                              
                              709,741
                              
                              
                              
                              
                              
                              
                              
                              709,741Other
      receivable - employee advances
                              
                              
                              338,689
                              
                              
                              
                              
                              
                              
                              
                              338,689Inventories
                              
                              
                              841,837
                              
                              
                              
                              
                              
                              
                              
                              841,837Advances
      to suppliers
                              
                              
                              596,868
                              
                              
                              
                              
                              
                              
                              
                              596,868Prepaid
      expense and other current assets
                              
                              
                              1,076,915
                              
                              
                              
                              
                              
                              
                              
                              1,076,915Loan
      receivable
                              
                              
                              293,400
                              
                              
                              
                              
                              
                              
                              
                              293,400Total
      current assets
                              
                              
                              53,324,360
                              
                              
                              
                              
                              
                              
                              
                              53,324,360INVESTMENT
      IN UNCONSOLIDATED JOINT VENTURES
                              
                              
                              1,467,000
                              
                              
                              
                              
                              
                              
                              
                              1,467,000PROPERTY
      AND EQUIPMENT, NET
                              
                              
                              72,713,012
                              
                              
                              
                              
                              
                              
                              
                              72,713,012CONSTRUCTION
      IN PROGRESS
                              
                              
                              52,918,236
                              
                              
                              
                              
                              
                              
                              
                              52,918,236DEFERRED
      FINANCING COSTS
                              
                              
                              1,336,998
                              
                              
                              
                              
                              
                              
                              
                              1,336,998OTHER
      ASSETS
                              
                              
                              15,854,910
                              
                              
                              
                              
                              
                              
                              
                              15,854,910TOTAL
      ASSETS
                              
                              $
                              197,614,516
                              
                              
                              
                              
                              
                              
                              $
                              197,614,516LIABILITIES
      AND STOCKHOLDERS' EQUITYCURRENT
      LIABILITIES:Accounts
      payable and accrued liabilities
                              
                              $
                              2,081,261
                              
                              
                              
                              
                              
                              
                              $
                              2,081,261Other
      payables
                              
                              
                              80,788
                              
                              
                              
                              
                              
                              
                              
                              80,788Unearned
      revenue
                              
                              
                              1,813,641
                              
                              
                              
                              
                              
                              
                              
                              1,813,641Accrued
      interest
                              
                              
                              786,052
                              
                              
                              
                              
                              
                              
                              
                              786,052Taxes
      payable
                              
                              
                              1,901,577
                              
                              
                              
                              
                              
                              
                              
                              1,901,577Notes
      Payable
                              
                              
                              -
                              
                              
                              (1)
                              27,292,287
                              
                              
                              
                              27,292,287Redeemable
      liabilities- warrants
                              
                              
                              -
                              
                              
                              (2)
                              17,500,000
                              
                              
                              
                              17,500,000Total
      current liabilities
                              
                              
                              6,663,319
                              
                              
                              
                              44,792,287
                              
                              
                              
                              51,455,606LONG
      TERM LIABILITIES:Notes
      payable
                              
                              
                              27,292,287
                              
                              
                              (1)
                              (27,292,287
                              )
                              
                              
                              -Derivative
      liabilities - warrants
                              
                              
                              19,545,638
                              
                              
                              (2)
                              (17,500,000
                              )
                              
                              
                              2,045,638Total
      long term liabilities
                              
                              
                              46,837,925
                              
                              
                              
                              (44,792,287
                              )
                              
                              
                              2,045,638TOTAL
      LIABILITIES
                              
                              
                              53,501,244
                              
                              
                              
                              -
                              
                              
                              
                              53,501,244COMMITMENTS
      AND CONTINGENCIESSTOCKHOLDERS'
      EQUITY:Preferred
      stock
                              
                              
                              -
                              
                              
                              
                              
                              
                              
                              
                              -Common
      stock
                              
                              
                              2,118
                              
                              
                              
                              
                              
                              
                              
                              2,118Additional
      paid-in capital
                              
                              
                              79,851,251
                              
                              
                              
                              
                              
                              
                              
                              79,851,251Accumulative
      other comprehensive gain
                              
                              
                              8,714,019
                              
                              
                              
                              
                              
                              
                              
                              8,714,019Statutory
      reserves
                              
                              
                              5,962,695
                              
                              
                              
                              
                              
                              
                              
                              5,962,695Retained
      earnings
                              
                              
                              49,583,189
                              
                              
                              
                              
                              
                              
                              
                              49,583,189144,113,272
                              
                              
                              
                              
                              
                              
                              
                              144,113,272TOTAL
      LIABILITIES AND STOCKHOLDERS' EQUITY
                              
                              $
                              197,614,516
                              
                              
                              
                              
                              
                              
                              $
                              197,614,516
 
 Note
3 – Summary of Significant Accounting Policies




Basis of
Presentation





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




See
report of independent registered public accounting firm.
 F-8




Use of
Estimates





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





Principles of
Consolidation





The
accompanying consolidated financial statements include the accounts of China
Natural Gas, Inc. and its wholly owned subsidiaries, Shaanxi Xilan Natural
Gas Equipment Co., Ltd (“SXNGE”), Xilan Energy Co., Ltd. (“XEC”) and its 100%
variable interest entities (“VIE”), Xi’an Xilan Natural Gas Co. Ltd. (“XXNGC”),
Shaanxi Jingbian Liquefied Natural Gas Co., Ltd. (“SJLNG,”), Shaanxi Xilan Auto
Bodyshop Co., Ltd. (“SXABC”), Henan Xilan Natural Gas Co., Ltd. (“HXNGC”),
Lingbao Yuxi Natural Gas Co., Ltd. (“LBNGC”), and Hubei Xilan Natural Gas Co.,
Ltd. (“HBXNGC”).  All inter-company accounts and transactions have
been eliminated in the consolidation.





Consolidation of Variable
Interest Entity





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





On
February 21, 2006, the Company formed SXNGE as a wholly-owned foreign enterprise
(WOFE). Then through SXNGE, the Company entered into exclusive arrangements with
XXNGC and its shareholders that give the Company the ability to substantially
influence XXNGC’s daily operations and financial affairs, appoint its senior
executives and approve all matters requiring shareholder approval. The Company
memorialized these arrangements on August 17, 2007 and made retroactive to March
8, 2006.  As a result, the Company consolidates the financial results
of XXNGC as VIE .The arrangements consist of the following
agreements:





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





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




See
report of independent registered public accounting firm.
 F-9




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





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





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





Foreign Currency
Translation





As of
December 31, 2009 and 2008, the accounts of the Company were maintained, and
their consolidated financial statements were expressed in RMB.  Such
consolidated financial statements were translated into USD in accordance with an
accounting standard issued by the FASB, with the RMB as the functional currency.
All assets and liabilities were translated at the exchange rate as of the
balance sheet date, stockholders’ equity were translated at the historical rates
and statement of income and cash flow items were translated at the weighted
average exchange rate for the year. The resulting translation adjustments are
reported under other comprehensive income. Cash flows from the Company's
operations are calculated based upon the local currencies and translated to USD
at average translation rates for the period. As a result, translation
adjustments amount related to assets and liabilities reported on the
consolidated statement of cash flows will not necessarily agree with changes in
the corresponding consolidated balances on the balance sheet.




The
balance sheet amounts with the exception of equity at December 31, 2009, were
translated 6.82 RMB to $1.00 as compared to 6.82 RMB at December 31, 2008. The
equity accounts were stated at their historical rate. The average translation
rates applied to income and cash flow statement amounts for the years ended
December 31, 2009, 2008 and 2007, were 6.82 RMB, 6.94 RMB, and 7.59 RMB to
$1.00, respectively.





Cash and Cash
Equivalents





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




See
report of independent registered public accounting firm.
 F-10




Certain
financial instruments, which subject the Company to concentration of credit
risk, consist of cash. The Company maintains balances at financial institutions
which, from time to time, may exceed Hong Kong Deposit Protection Board
(“HKDPB”) insured limits for the banks located in Hong Kong or may exceed
Federal Deposit Insurance Corporation (“FDIC”) insured limits for the banks
located in the United States. Balances at financial institutions or state-owned
banks within the PRC are not covered by insurance. As of December 31, 2009 and
2008, the Company had total deposits of $47,459,560 and $5,604,383 without
insurance coverage or in excess of HKDPB or FDIC or HKDPB insured
limits.   The Company has not experienced any losses in such accounts
and believes it is not exposed to any significant risks on its cash in bank
accounts.





Accounts
Receivable





Accounts
receivable are netted against an allowance for uncollectible accounts, as
needed.  The Company maintains reserves for potential credit losses on
accounts receivable.  Management reviews the composition of accounts
receivable and analyzes historical bad debts, customer concentrations, customer
credit worthiness, current economic trends and changes in customer payment
patterns to evaluate the adequacy of these reserves. Reserves are recorded
primarily on a specific identification basis in the period of the related sales.
Delinquent account balances are written-off after management has determined that
the likelihood of collection is not probable, and known bad debts are written
off against allowance for doubtful accounts when identified. The Company
recorded allowance for bad debts of $163,280 and $0 as of December 31, 2009 and
2008.





Other
Receivable





Other
receivable mainly include security deposit for equipments
storage.  This security deposit will be refunded to the Company after
the equipments are removed from the storage area for construction.





Other Receivable – Employee
Advances





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





Inventory





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




See
report of independent registered public accounting firm.
 F-11




The
following are the details of the inventories:




December
                31, 2009
              
              
              December 31, 2008Materials and
      supplies
              
              $
              345,611
              
              
              $
              318,069Gasoline
              
              
              496,226
              
              
              
              201,670$
              841,837
              
              
              $
              519,739


Advances to
Suppliers





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





Loan
Receivable





Loan
receivable consists of the following:


December31, 2009
                      
                      
                      December 31, 2008Shanxi
      Yuojin Mountain Mining Company, due on November 30, 2009, extended to
      November 30, 2010, annual interest at 5.84%
                      
                      $
                      293,400
                      
                      
                      $
                      293,400





Investments in
Unconsolidated Joint Ventures





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





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





The
Company’s investment in unconsolidated joint ventures that are accounted for on
the equity method of accounting represents the 49% interest in Henan CNPC Kunlun
Xilan Compressed Natural Gas Co., Ltd. (“JV”), which is engaged in building and
operating CNG compressor stations and fueling stations, sell CNG, provide
vehicle conversion services from gasoline-fueled vehicles to hybrid (natural
gas/gasoline) powered vehicles and technical advisory work services in Henan,
PRC. The investment in this company amounted to $1,467,000 and $0 at December
31, 2009 and 2008, respectively.  The JV does not have any operations
as of December 31, 2009.




See
report of independent registered public accounting firm.
 F-12




The results of financial position of theJVas of December 31, 2009are summarized
below:




2009Condensed balance sheet
      information:Current
    assets
                    
                    $
                    2,993,878Noncurrent
      assets
                    
                    
                    -Total
assets
                    
                    $
                    2,993,878Current
      liabilities
                    
                    
                    -Noncurrent
      liabilities
                    
                    
                    -Equity
                    
                    $
                    2,993,878Total liabilities and
      equity
                    
                    $
                    2,993,878





Property and
Equipment





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





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





The
following are the details of the property and equipment:





December 31, 2009
                                          
                                          
                                          December 31, 2008Office equipment
                                          
                                          $
                                          439,055
                                          
                                          
                                          $
                                          412,490Operating
      equipment
                                          
                                          
                                          61,350,503
                                          
                                          
                                          
                                          59,473,283Vehicles
                                          
                                          
                                          2,486,614
                                          
                                          
                                          
                                          2,414,756Buildings
      and improvements
                                          
                                          
                                          21,414,553
                                          
                                          
                                          
                                          21,190,599Total
      property and equipment
                                          
                                          
                                          85,690,725
                                          
                                          
                                          
                                          83,491,128Less
      accumulated depreciation
                                          
                                          
                                          (12,977,713
                                          )
                                          
                                          
                                          (7,462,856
                                          )Property
      and equipment, net
                                          
                                          $
                                          72,713,012
                                          
                                          
                                          $
                                          76,028,272





Depreciation
expense for the years ended December 31, 2009, 2008 and 2007 was $5,565,608,
$3,473,429 and $1,639,685, respectively.




See
report of independent registered public accounting firm.
 F-13




Construction in
Progress





Construction
in progress (“CIP”) consists of the cost of constructing property and equipment
for the Company’s gas stations and a new project of processing, distribution and
sale of LNG. The major cost of construction in progress relates to technology
licensing fees, equipment purchases, land use rights requisition cost,
capitalized interest and other construction fees.  No depreciation is
provided for construction in progress until such time as the assets are
completed and placed into service.  Interest incurred during
construction is capitalized into construction in progress. All other interest is
expensed as incurred.





As of
December 31, 2009 and 2008, the Company had construction in progress in the
amount of $52,918,236 and $22,061,414, respectively. Interest cost
capitalized into construction in progress for the years ended December 31, 2009,
2008 and 2007, amounted to $4,597,544, $1,932,931and $0,
respectively.





Construction
in progress at December 31, 2009 consisted of the following:





No.
                                    
                                    Project Description
                                    
                                    Location
                                    
                                    December 31, 2009
                                    
                                    Commencement
                                      Date
                                    
                                    Expected
                                      completion
                                      date
                                    
                                    Estimated
                                      additional
                                      cost to
                                      complete1
                                    
                                    Jingbian
      LNG (1)
                                    
                                    JBLNG
                                    
                                    $
                                    44,411,503
                                    
                                    Dec-06
                                    
                                    Jun-10
                                    
                                    $
                                    11,150,0002
                                    
                                    Sa
      Pu mother station
                                    
                                    HXNGC
                                    
                                    
                                    814,822
                                    
                                    Jul-08
                                    
                                    Jun-11
                                    
                                    
                                    6,300,0003
                                    
                                    Zijing
      Energy mother station
                                    
                                    XXNGC
                                    
                                    
                                    4,213,074
                                    
                                    Sep-08
                                    
                                    Mar-10
                                    
                                    
                                    513,4504
                                    
                                    Xi'an
      Cangsheng mother station
                                    
                                    XXNGC
                                    
                                    
                                    1,891,584
                                    
                                    Sep-08
                                    
                                    May-11
                                    
                                    
                                    3,227,4005
                                    
                                    Other
      CIP projects
                                    
                                    XXNGC
                                    
                                    
                                    1,587,253
                                    
                                    Various
                                    
                                    Various
                                    
                                    
                                    450,000$
                                    52,918,236
                                    
                                    
                                    
                                    
                                    
                                    $
                                    21,640,850





(1)
            Phase
      I of the LNG project cost $48,963,000 to construct and the additional
      $6,598,503  represent costs incurred in connection with phase II
      and phase III of the LNG plant




See
report of independent registered public accounting firm.
 F-14




Long-Lived
Assets





The
Company evaluates at least annually, more often when circumstances require, the
carrying value of long-lived assets to be held and used.  Impairment
losses to be recorded on long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the assets' carrying amounts.  In that
event, a loss is recognized based on the amount by which the carrying amount
exceeds the fair market value of the long-lived assets.  Loss on
long-lived assets to be disposed of is determined in a similar manner, except
that fair market values are reduced for the cost of disposal.  Based
on its review, the Company believes that, as of December 31, 2009, there were no
significant impairments of its long-lived assets.




Unearned
Revenue





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





Fair Value of Financial
Instruments





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





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





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





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





FASB
accounting standard regarding derivatives and hedging specifies that a
contract that would otherwise meet the definition of a derivative but is both
(a) indexed to the Company’s own stock and (b) classified in stockholders’
equity in the statement of financial position would not be considered a
derivative financial instrument.  This FASB accounting standard also
provides a new two-step model to be applied in determining whether a financial
instrument or an embedded feature is indexed to an issuer’s own stock and thus
able to qualify for the exception.




See
report of independent registered public accounting firm.
 F-15




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





As such,
effective January 1, 2009, the Company reclassified the fair value of these
warrants from equity to liability, as if these warrants were treated as a
derivative liability since their issuance in October 2007. On
January 1, 2009, the Company reclassified from additional paid-in capital,
as a cumulative effect adjustment, $5,844,239 to beginning retained earnings and
$1,014,308 to warrant liabilities to recognize the fair value of such warrants.
The fair value of the warrants was $2,045,638 on December 31, 2009. The Company
recognized a $1,031,330 loss from the change in fair value of warrants for
the year ended December 31, 2009.





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





December31, 2009
                          
                          
                          January 1, 2009Annual dividend
      yield
                          
                          
                          -
                          
                          
                          
                          -Expected
      life (years)
                          
                          
                          2.82
                          
                          
                          
                          3.82Risk-free
      interest rate
                          
                          
                          1.49
                          %
                          
                          
                          1.13
                          %Expected
      volatility
                          
                          
                          90
                          %
                          
                          
                          90
                          %





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





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




See
report of independent registered public accounting firm.
 F-16




The
following table sets forth by level within the fair value hierarchy of the
Company’s financial assets and liabilities that were accounted for at fair value
on a recurring basis as of December 31, 2009.





Carrying Value at
                                  December
                                
                                
                                Fair Value Measurement at
                                  December 31, 200931, 2009
                                
                                
                                Level 1
                                
                                
                                Level 2
                                
                                
                                Level 3Derivative
      liability - warrants
                                
                                
                                2,045,638
                                
                                
                                
                                -
                                
                                
                                
                                2,045,638
                                
                                
                                
                                -Total
      liability measured at fair value
                                
                                $
                                2,045,638
                                
                                
                                $
                                -
                                
                                
                                $
                                2,045,638
                                
                                
                                $
                                -





Other
than the derivative liabilities - warrants carried at fair value, the Company
did not identify any other assets and liabilities that are required to be
presented on the balance sheet.





Revenue
Recognition





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





Enterprise Wide
Disclosure





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




See
report of independent registered public accounting firm.
 F-17




Advertising
Costs





The
Company expenses the cost of advertising as incurred or, as appropriate, the
first time the advertising takes place. Advertising costs for the years ended
December 31, 2009, 2008 and 2007, were insignificant.





Stock-Based
Compensation





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





Income
Taxes





FASB’s
accounting standard regarding income taxes requires the recognition of deferred
tax assets and liabilities for the expected future tax consequences of events
that have been included in the financial statements or tax returns. Under this
method, deferred income taxes are recognized for the tax consequences in future
years of temporary differences between the tax bases of assets and liabilities
and their financial reporting amounts at each period end based on enacted tax
laws and statutory tax rates applicable to the periods in which the differences
are expected to affect taxable income. Valuation allowances are established,
when necessary, to reduce deferred tax assets to the amount expected to be
realized.  At December 2009 and 2008, there was no significant book to
tax differences. There is no difference between book depreciation and tax
depreciation as the Company uses the same method for both book and tax. A tax
position is recognized as a benefit only if it is “more likely than not” that
the tax position would be sustained in a tax examination, with a tax examination
being presumed to occur. The amount recognized is the largest amount of tax
benefit that is greater than 50% likely of being realized on examination. For
tax positions not meeting the “more likely than not” test, no tax benefit is
recorded. The adoption had no affect on the Company’s consolidated financial
statements.





Local PRC Income
Tax





The
Company’s subsidiary and VIEs operate in China. Starting January 1, 2008,
pursuant to the tax laws of China, general enterprises are subject to income tax
at an effective rate of 25% compared to 33% prior to 2008. The Company’s VIE,
XXNGC, is in the natural gas industry whose development is encouraged by the
government. According to the income tax regulation, any company engaged in the
natural gas industry enjoys a favorable tax rate. Accordingly, except for income
from SXNGE, JBLNG, SXABC, HXNGC, LBNGC and HBXNGC which subjects to 25% PRC
income tax rate, XXNGC’s income is subject to a reduced tax rate of
15%.  A reconciliation of tax at the United States federal statutory
rate to the provision for income tax recorded in the financial statements is as
follows:




See
report of independent registered public accounting firm.
 F-18




For
      the years ended
                                          December
      312009
                                        
                                        
                                        2008
                                        
                                        
                                        2007Tax
      provision (credit) at statutory rate
                                        
                                        
                                        34
                                        %
                                        
                                        
                                        34
                                        %
                                        
                                        
                                        34
                                        %Foreign
      tax rate difference
                                        
                                        
                                        (9
                                        )%
                                        
                                        
                                        (9
                                        )%
                                        
                                        
                                        (1
                                        )%Effect
      of favorable tax rate
                                        
                                        
                                        (9
                                        )%
                                        
                                        
                                        (9
                                        )%
                                        
                                        
                                        (17
                                        )%Other
      item (1)
                                        
                                        
                                        3
                                        %
                                        
                                        
                                        3
                                        %
                                        
                                        
                                        1
                                        %Total
      provision for income taxes
                                        
                                        
                                        19
                                        %
                                        
                                        
                                        19
                                        %
                                        
                                        
                                        17
                                        %





(1)  The
3% represents $3,444,173 in expenses incurred by CHNG that are not deductible in
PRC for the year ended December 31, 2009.  The 4% represents
$3,661,932 expenses incurred by CHNG that are not deductible in PRC for the year
ended December 31, 2008.  The 1% represents $949,652 expenses incurred
by CHNG that are not deductible in PRC for the year ended December 31,
2007.





The
estimated tax savings for the years ended December 31, 2009, 2008 and 2007,
amounted to approximately $2,410,928, $2,195,871 and $2,174,806, respectively.
The net effect on earnings per share, had the income tax been applied, would
decrease basic earnings per share for the years ended December 31, 2009, 2008
and 2007, from $1.13 to $0.99, $1.04 to $0.86, and $0.70 to $0.52,
respectively.  The net effect on earnings per share, had the income
tax been applied, would decrease diluted earnings per share for the years ended
December 31, 2009, 2008 and 2007, from $1.12 to $0.98, $1.04 to $0.86, and $0.69
to $0.52, respectively.





China
Natural Gas, Inc. was incorporated in the United States and has incurred net
operating loss for income tax purpose for the period ended December 31,
2009.  The estimated net operating loss carry forwards for United
States income tax purposes amounted to $3,232,855 and $1,657,473 as of December
31, 2009 and 2008, respectively, which may be available to reduce future years'
taxable income. These carry forwards will expire, if not utilized, beginning in
2027 through 2029. Management believes that the realization of the benefits
arising from this loss appear to be uncertain due to Company's limited operating
history and continuing losses for United States income tax purposes.
Accordingly, the Company has provided a 100% valuation allowance at December 31,
2009. Management reviews this valuation allowance periodically and makes
adjustments as warranted. The valuation allowances were as follow:




For the years endedDecember 31,Valuation allowance
                                                      
                                                      2009
                                                      
                                                      
                                                      2008
                                                      
                                                      
                                                      2007Balance,
      beginning of period
                                                      
                                                      $
                                                      563,541
                                                      
                                                      
                                                      $
                                                      322,614
                                                      
                                                      
                                                      $
                                                      -Increase
                                                      
                                                      
                                                      535,630
                                                      
                                                      
                                                      
                                                      240,927
                                                      
                                                      
                                                      
                                                      322,614Balance,
      end of period
                                                      
                                                      $
                                                      1,099,171
                                                      
                                                      
                                                      $
                                                      563,541
                                                      
                                                      
                                                      $
                                                      322,614




See
report of independent registered public accounting firm.
 F-19




The
Company has cumulative undistributed earnings of foreign subsidiaries of
approximately $30,658,764 as of December 31, 2009, which is included in
consolidated retained earnings and will continue to be indefinitely reinvested
in international operations.  Accordingly, no provision has been made for
U.S. deferred taxes related to future repatriation of these earnings, nor is it
practicable to estimate the amount of income taxes that would have to be
provided if we concluded that such earnings will be remitted in the
future.





Value added
tax





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





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





Basic and Diluted Earnings
Per Share




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





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





Recently issued accounting
pronouncements





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




See
report of independent registered public accounting firm.
 F-20




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





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





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




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





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




See
report of independent registered public accounting firm.
 F-21




In August
2009, the FASB issued an Accounting Standards Update (“ASU”) regarding measuring
liabilities at fair value. This ASU provides additional guidance clarifying the
measurement of liabilities at fair value in circumstances in which a quoted
price in an active market for the identical liability is not available; under
those circumstances, a reporting entity is required to measure fair value using
one or more of valuation techniques, as defined. The adoption of this guidance
did not have a material impact on the Company’s consolidated financial
statements.





In
October 2009, the FASB issued an ASU regarding accounting for own-share lending
arrangements in contemplation of convertible debt issuance or other
financing.  This ASU requires that at the date of issuance of the
shares in a share-lending arrangement entered into in contemplation of a
convertible debt offering or other financing, the shares issued shall be
measured at fair value and be recognized as an issuance cost, with an offset to
additional paid-in capital. Further, loaned shares are excluded from basic and
diluted earnings per share unless default of the share-lending arrangement
occurs, at which time the loaned shares would be included in the basic and
diluted earnings-per-share calculation.  This ASU is effective for
fiscal years beginning on or after December 15, 2009, and interim periods within
those fiscal years for arrangements outstanding as of the beginning of those
fiscal years. The adoption of this guidance did not have a material impact on
the Company’s consolidated financial statements .





In
November 2009, the FASB issued an ASU regarding accounting for stock dividends,
including distributions to shareholders with components of stock and cash. This
ASU clarifies that the stock portion of a distribution to shareholders that
contains components of cash and stock and allows shareholders to select their
preferred form of the distribution (with a limit on the amount of cash that will
be distributed in total) should be considered a stock dividend and included in
EPS calculations as a share issuance. The adoption of this guidance did not have
a material impact on the Company’s consolidated financial
statements





In
December 2009, FASB issued ASU No. 2009-16, Accounting for Transfers of
Financial Assets. This Accounting Standards Update amends the FASB Accounting
Standards Codification for the issuance of FASB Statement No. 166, Accounting for Transfers of
Financial Assets—an amendment of FASB Statement No. 140.The
amendments in this Accounting Standards Update improve financial reporting by
eliminating the exceptions for qualifying special-purpose entities from the
consolidation guidance and the exception that permitted sale accounting for
certain mortgage securitizations when a transferor has not surrendered control
over the transferred financial assets. In addition, the amendments require
enhanced disclosures about the risks that a transferor continues to be exposed
to because of its continuing involvement in transferred financial assets.
Comparability and consistency in accounting for transferred financial assets
will also be improved through clarifications of the requirements for isolation
and limitations on portions of financial assets that are eligible for sale
accounting. The Company does not
expect the adoption of this ASU to have a material impact on its consolidated
financial statements.




See
report of independent registered public accounting firm.
 F-22




In
December, 2009, FASB issued ASU No. 2009-17, Improvements to Financial Reporting
by Enterprises Involved with Variable Interest Entities. This Accounting
Standards Update amends the FASB Accounting Standards Codification for the
issuance of FASB Statement No. 167, Amendments to FASB Interpretation
No. 46(R). The amendments in this Accounting Standards Update replace the
quantitative-based risks and rewards calculation for determining which reporting
entity, if any, has a controlling financial interest in a variable interest
entity with an approach focused on identifying which reporting entity has the
power to direct the activities of a variable interest entity that most
significantly impact the entity’s economic performance and (1) the obligation to
absorb losses of the entity or (2) the right to receive benefits from the
entity. An approach that is expected to be primarily qualitative will be more
effective for identifying which reporting entity has a controlling financial
interest in a variable interest entity. The amendments in this Update also
require additional disclosures about a reporting entity’s involvement in
variable interest entities, which will enhance the information provided to users
of financial statements. The
Company is currently evaluating the impact of this ASU, however, the Company
does not expect the
adoption of this ASU to have a material impact on its consolidated financial
statements.




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




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




See
report of independent registered public accounting firm.
 F-23




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





Note 4
– Other Assets





Other
assets consisted of the following:





December 31,2009
                            
                            
                            2008Prepaid
      rent – natural gas stations
                            
                            $
                            340,211
                            
                            
                            $
                            272,635Prepayment
      for acquiring land use right
                            
                            
                            1,936,440
                            
                            
                            
                            1,060,675Advances
      on purchasing equipment and construction in progress
                            
                            
                            12,056,964
                            
                            
                            
                            6,427,974Refundable
      security deposits
                            
                            
                            1,264,283
                            
                            
                            
                            981,083Others
                            
                            
                            257,012
                            
                            
                            
                            101,695Total
                            
                            $
                            15,854,910
                            
                            
                            $
                            8,844,062





All land
in the PRC is government owned.  However, the government grants users
land use rights.  As of December 31, 2009 and 2008, the Company
prepaid $1,936,440 and $1,060,675, respectively, to the PRC local government to
purchase land use rights. The Company is in the process of negotiating the final
purchase price with the local government and the land use rights have not yet
been granted to the Company.  Therefore, the Company did not amortize
the prepaid land use rights.




See
report of independent registered public accounting firm.
 F-24




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





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





Note 5
– Senior Notes Payable





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





At the
closing, the Company entered into:





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





·
            An investor rights
      agreement;





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





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





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





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





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




See
report of independent registered public accounting firm.
 F-25




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




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





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




Year
                      
                      Principal2009
                      
                      $
                      43,200,0002010
                      
                      
                      42,400,0002011
                      
                      
                      41,600,0002012
                      
                      
                      40,800,0002013
      and thereafter
                      
                      
                      40,000,000





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





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




See
report of independent registered public accounting firm.
 F-26




The
indenture limits the Company's ability to incur debt and liens, make dividend
payments and stock repurchases, make investments, reinvest proceeds from asset
sales and enter into transactions with affiliates, among other things. The
indenture also requires the Company to maintain certain financial ratios. 
On
February 26, 2010, JBLNG entered into a fixed assets loan contract (see Note 15)
with Pudong Development Bank Xi’an Branch (“SPDB”), pursuant to which the SPDB
agreed to lend $17,676,000 to JBLNG. This loan is secured by Xi’an Xilan Natural
Gas Co., ltd (“XXNGC”)’s equipments and vehicles located within PRC. The lien
incurred with this loan is in violation of the Indenture of the Senior Notes
with Abax Lotus Ltd. Under the terms of the Indenture for the 5.00% Guaranteed
Senior Notes issued to Abax Lotus Ltd. dated January 20, 2008, the Company and
its subsidiaries including XXNGC, are prohibited from entering into such pledge
of assets and guaranty agreements. As a result, Abax Lotus Ltd. has the right to
declare a default under the Indenture after written notice and the Company has
30 days to cure the default. Upon an event of default, Abax may accelerate the
outstanding indebtedness together with all accrued interest thereon and demand
immediate repayment. As of the date of this report, the Company has not received
a notice of default from Abax Lotus Ltd. nor has the Company received a waiver
from Abax Lotus Ltd waiving this default.  The Company has
reclassified the Abax notes as short term liabilities at this time until this
matter has been resolved with Abax.





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




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




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





In
connection with the issuance of the Securities Purchase Agreement, the Company
paid $2,122,509 in debt issuance costs which is being amortized over the life of
the Senior Notes.  For the years ended December 31, 2009, 2008 and
2007, the Company amortized $63,940, $227,989 and $0 of the aforesaid issuance
costs, net of capitalized interest.





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




See
report of independent registered public accounting firm.
 F-27




The
warrants granted to the Investor on January 29, 2008 are considered derivative
instruments that need to be bifurcated from the original security.  If
the Warrants have not been exercised within the seven year period, then the
Investor can have the Company purchase the Warrants for
$17,500,000.  This amount is shown as a debt discount and is being
amortized over the term of the Senior Notes.  For the years ended
December 31, 2009, 2008 and 2007, the Company amortized $280,250, $1,004,677 and
$0 of the aforesaid discounts, net of capitalized interest.




The
warrants have been determined to be derivative liabilities instruments because
there is a required redemption requirement if the holder does not exercise the
Warrants.  However, the warrants are not required to be valued at fair
value, rather, to be at its undiscounted redemption amount of $17.5
million.  Under the
terms of the Warrant Agreement, in the event of a default under the indenture
for the Senior Notes, the warrants holders are entitled to redeem the warrants
for a price equal to the pro rata portion of the aggregate redemption price of
$17,500,000 applicable to the warrants tendered by such holder. As the
redemption requirement of the warrants become due on demands in connection to
the default under the indenture, the Company has  reclassified the
redemption value as a short term liability.





Note 6
– Warrants





Following
is a summary of the warrant activity:





Warrants
                                      Outstanding
                                    
                                    
                                    Weighted Average
                                      Exercise Price
                                    
                                    
                                    Aggregate
                                      Intrinsic ValueOutstanding,
      December 31, 2007
                                    
                                    
                                    544,242
                                    
                                    
                                    $
                                    13.10
                                    
                                    
                                    $
                                    376,977Granted
                                    
                                    
                                    1,450,000
                                    
                                    
                                    
                                    14.74
                                    
                                    
                                    
                                    -Forfeited
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Exercised
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Outstanding,
      December 31, 2008
                                    
                                    
                                    1,994,242
                                    
                                    
                                    $
                                    14.28
                                    
                                    
                                    
                                    -Granted
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Forfeited
                                    
                                    
                                    (160,588
                                    )
                                    
                                    $
                                    7.20
                                    
                                    
                                    
                                    -Exercised
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -
                                    
                                    
                                    
                                    -Outstanding,
      December 31, 2009
                                    
                                    
                                    1,833,654
                                    
                                    
                                    $
                                    8.93
                                    
                                    
                                    $
                                    4,008,434





Following
is a summary of the status of warrants outstanding at December 31,
2009:





Outstanding WarrantsExercise Price
                                
                                Number
                                
                                
                                Average
                                  Remaining
                                  Contractual
                                  Life$
                                7.37
                                
                                
                                1,450,000
                                
                                
                                
                                5.08$
                                14.86
                                
                                
                                383,654
                                
                                
                                
                                2.59$
                                8.93
                                
                                
                                1,833,654
                                
                                
                                
                                4.56




See
report of independent registered public accounting firm.
 F-28




Note 7
– Defined Contribution Plan





The
Company is required to participate in a defined contribution plan operated by
the local municipal government in accordance with Chinese law and
regulations.  The Company contributes 100RMB per employee per month to
the plan. Starting from 2008, no minimum contribution is required but the
maximum contribution cannot be more than 14% of the current salary expense. The
total contribution for the above plan was $224,949, $112,233 and $122,677 for
the years ended December 31, 2009, 2008 and 2007, respectively.





Note 8
– Secondary Public Offering





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





On
September 21, 2009, the Company closed the sale of an additional 858,750 shares
of common stock at the public offering price of $8.75 per share, pursuant to the
over-allotment option exercised in full by the underwriter in connection with
its public offering that closed on September 9, 2009.





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





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





Note 9
– Statutory Reserve





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




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





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




See
report of independent registered public accounting firm.
 F-29




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





As of
December 31, 2009, the remaining reserve needed to fulfill the 50% registered
capital requirement totaled $62,649,581.





Note
10 – Accounting for Stock-based Compensation





1)
Options from CEO to pay for certain Company’s legal expenses





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





The
Company used the Black-Scholes Option Pricing Model to value the options at the
time they were issued, based on the stock price on its grant date, the stated
exercise prices and expiration dates of the instruments and using a risk-free
rate of 4.10%. The estimated life is based on one half of the sum of the vesting
period and the contractual life of the option. This is the same as assuming that
the options are exercised at the mid-point between the vesting date and
expiration date. $66,535, $66,704 and $0 of compensation expense were recorded
during the years ended December 31, 2009, 2008 and 2007,
respectively.





As of
December 31, 2009, $66,024 of estimated expense with respect to non-vested
stock-based compensation has yet to be recognized and will be recognized in
expense over the optionee’s remaining weighted average service period of
approximately nine months.





2) 2009
stock option plan





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




See
report of independent registered public accounting firm.
 F-30




The
Company used the Black-Scholes Option Pricing Model to value the options at the
time they were issued, based on the stock price on its grant date, the stated
exercise prices and expiration dates of the instruments and using risk-free
rates. The volatility of the Company’s common stock was estimated by management
based on the historical volatility of the Company’s common stock, the risk free
interest rate was based on Treasury Constant Maturity Rates published by the
U.S. Federal Reserve for periods applicable to the estimated life of the
options, and the expected dividend yield was based on the current and expected
dividend policy.  The
Company currently uses the “simplified”method to estimate the expected term
for share option grants as it does not have sufficient historical experience
toprovide a reasonable
estimate.The Company will continue to use the
“simplified”method until it feels that it has
sufficient historical experience to provide a reasonable estimate of expected
terms.  The estimated life
is based on one half of the sum of the vesting period and the contractual life
of the option. This is the same as assuming that the options are exercised at
the mid-point between the vesting date and expiration date. $36,468 of
compensation expense related to Veronica Chen’s 75,000 options was reversed upon
her resignation of employment on January 31, 2010. $158,517 of compensation
expense was recorded during the year ended December 31, 2009.




As of
December 31, 2009, $686,913 of estimated expense with respect to non-vested
stock-based compensation has yet to be recognized and will be recognized in
expense over the optionee’s remaining weighted average service period of
approximately 3.25 years.




Following
is a summary of the stock option activity:





Options
                              Outstanding
                            
                            
                            Weighted Average
                              Exercise Price
                            
                            
                            Aggregate
                              Intrinsic ValueOutstanding,
      December 31, 2007
                            
                            
                            -
                            
                            
                            $
                            -
                            
                            
                            $
                            -Granted
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Forfeited
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Exercised
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Outstanding,
      December 31, 2008
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Granted
                            
                            
                            318,850
                            
                            
                            $
                            4.90
                            
                            
                            $
                            95,655Forfeited
                            
                            
                            75,000
                            
                            
                            
                            4.90
                            
                            
                            
                            466,500Exercised
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            -Outstanding,
      December 31, 2009
                            
                            
                            243,850
                            
                            
                            $
                            4.90
                            
                            
                            $
                            1,516,747




See
report of independent registered public accounting firm.
 F-31




Following
is a summary of the status of stock options outstanding at December 31,
2009:





Outstanding Options
                          
                          
                          Exercisable OptionsExercise
                            Price
                          
                          Number
                          
                          
                          Average
                            Remaining
                            Contractual
                            Life
                          
                          
                          Exercise
                            Price
                          
                          
                          Number
                          
                          
                          Average
                            Remaining
                            Contractual
                            Life$
                          4.90
                          
                          
                          243,850
                          
                          
                          
                          5.25
                          
                          
                          
                          -
                          
                          
                          
                          -
                          
                          
                          
                          -





Note
11 – Earnings per Share





Earnings
per share for the years ended December 31, 2009 and 2008 is determined by
dividing net income for the periods by the weighted average number of both basic
and diluted shares of common stock and common stock equivalents outstanding. The
following is an analysis of the differences between basic and diluted earnings
per common share in accordance with FASB’s accounting standard.





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





For the years endedDecember31,2009
                        
                        
                        2008
                        
                        
                        2007Basic earningsper shareNet income
                        
                        $
                        18,830,787
                        
                        
                        $
                        15,190,368
                        
                        
                        $
                        9,116,070Weighted shares
      outstanding-Basic
                        
                        
                        16,624,294
                        
                        
                        
                        14,600,154
                        
                        
                        
                        13,100,340.Earnings per
      share-Basic
                        
                        $
                        1.13
                        
                        
                        $
                        1.04
                        
                        
                        $
                        0.70Diluted earnings per
      shareNet income
                        
                        $
                        18,830,787
                        
                        
                        $
                        15,190,368
                        
                        
                        $
                        9,116,070Weighted shares
      outstanding-Basic
                        
                        
                        16,624,294
                        
                        
                        
                        14,600,154
                        
                        
                        
                        13,100,340Effect of diluted
      securities-Warrants
                        
                        
                        206,613
                        
                        
                        
                        44,916
                        
                        
                        
                        50,561Weighted shares
      outstanding-Diluted
                        
                        
                        16,830,907
                        
                        
                        
                        14,645,070
                        
                        
                        
                        13,150,901Earnings per share-Diluted
                        
                        $
                        1.12
                        
                        
                        $
                        1.04
                        
                        
                        $
                        0.69




See
report of independent registered public accounting firm.
 F-32




At
December 31, 2009, 2008 and 2007, the Company had outstanding warrants of
1,833,654, 1,994,242 and 544,242, respectively.  For the year ended
December 31, 2009, the average stock price was greater than the exercise prices
of the 1,450,000 warrants which resulted in additional weighted average common
stock equivalents of 206,613; 383,654 outstanding warrants were excluded from
the diluted earnings per share calculation as they are anti-dilutive. For the
year ended December 31, 2008, the average stock price was greater than the
exercise prices of the 160,588 warrants which resulted in additional weighted
average common stock equivalents of 44,916; 1,833,654 outstanding warrants were
excluded from the diluted earnings per share calculation as they are
anti-dilutive. For the year ended December 31, 2007, the average stock price was
greater than the exercise prices of the 160,588 warrants which resulted in
additional weighted average common stock equivalents of 50,561; 383,654
outstanding warrants were excluded from the diluted earnings per share
calculation as they are anti-dilutive.




Note
12 – Current Vulnerability Due to Certain Concentrations





Concentration
of natural gas vendors:


For the years endedDecember31,2009
                  
                  
                  2008
                  
                  
                  2007Numbers
      of natural gas vendors
                  
                  
                  4
                  
                  
                  
                  4
                  
                  
                  
                  3Percentage
      of total natural gas purchases
                  
                  
                  98
                  %
                  
                  
                  98
                  %
                  
                  
                  88.4
                  %





As of
December 31, 2009 and 2008, the Company has $82,146 and $206,811, respectively,
payable due to its major suppliers.





The
Company maintains long-term natural gas minimum purchase agreements with one of
its vendors as of December 31, 2009. There are no minimum purchase requirements
by the Company.  Contracts are renewed on an annual basis. The
Company’s management reports that it does not expect any issues or difficulty in
continuing to renew the supply contracts with these vendors going forward. Price
points for natural gas are strictly controlled by the government and have
remained stable over the past three years.





The
Company's operations are carried out in the People’s Republic of China.
Accordingly, the Company's business, financial condition and results of
operations may be influenced by the political, economic and legal environments
in the People’s Republic of China, by the general state of the People’s Republic
of China‘s economy. The Company's business may be influenced by changes in
governmental policies with   respect to laws and regulations,
anti-inflationary measures, currency conversion and remittance abroad, and rates
and methods of taxation, among other things.




See
report of independent registered public accounting firm.
 F-33




Note
13 – Commitments and Contingencies





(a)  Lease
Commitments





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





Year
      ending December 31, 2010
                    
                    $
                    1,582,822Year
      ending December 31, 2011
                    
                    
                    1,701,475Year
      ending December 31, 2012
                    
                    
                    1,516,221Year
      ending December 31, 2013
                    
                    
                    1,404,794Year
      ending December 31, 2014
                    
                    
                    1,771,514Thereafter
                    
                    
                    24,326,313Total
                    
                    $
                    32,303,139





For the
years ended December 31, 2009, 2008 and 2007, the land use right and office
lease expenses were $1,623,127, $1,127,558 and $ 433,755,
respectively.





(b)
Property and Equipment Purchase Commitments





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





Year
      ending December 31, 2010
                    
                    $
                    11,535,240Year
      ending December 31, 2011
                    
                    
                    2,143,287Thereafter
                    
                    
                    -Total
                    
                    $
                    13,678,527





(c)
Natural Gas Purchase Commitments





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




See
report of independent registered public accounting firm.
 F-34




(d) Legal
Proceedings





A former
member of the board of directors filed a lawsuit against the Company in the New
York State Supreme Court, Nassau County, in which he has sought, among other
things to recover a portion of his monthly compensation plus 20,000 options that
he alleges are due to him pursuant to a written agreement.  After the
plaintiff rejected an offer by the Company that included the options that the
plaintiff alleged were due to him, the Company moved to dismiss the
complaint.  The judge ordered the Company to issue the 20,000 options to
the plaintiff subject to any restrictions required by applicable securities
laws, which was essentially what the Company had previously offered, and
dismissed all of the plaintiff's remaining claims against the Company.  The
current board of directors has complied with the court's decision by tendering
an options agreement to the plaintiff consistent with the court's decision, but
the plaintiff has refused to execute the agreement, and instead has filed an
appeal.  Regardless of the outcome of the appeal, the Company believes that
any liability it would incur will not have a materially adverse effect on its
financial condition or its results of operations, and, accordingly, this matter
has not been reflected on the Company's consolidated financial
statements.





(e)
Registered capital commitments





On
September 8, 2009, SXNGE increased its registered capital from $53,929,260 to
$79,929,260.  CHNG contributed $10,000,000 registered capital of the
total $26,000,000 to SXNGE on September 29, 2009.  The remaining
registered capital of $16,000,000 is required to be contributed by CHNG by
October 10, 2011, two years after the new business license was obtained on
October 10, 2009





Note
14 – Quarterly Financial Information (Unaudited)





For the fiscal year
ended December 31, 2009, the Company has unaudited quarterly financialdata
informationas
following:





YearEndedDecember31,2009
                
                First
                  Quarter
                
                
                Second
                  Quarter
                
                
                Third
                  Quarter
                
                
                Fourth
                  Quarter
                
                
                FullYearRevenues
                
                $
                18,527,666
                
                
                $
                20,742,520
                
                
                $
                20,125,184
                
                
                $
                21,670,748
                
                
                $
                81,066,118Gross
profit
                
                
                9,633,652
                
                
                
                10,278,190
                
                
                
                9,717,692
                
                
                
                10,531,545
                
                
                
                40,161,079Net income
                
                
                4,201,623
                
                
                
                3,862,756
                
                
                
                4,647,519
                
                
                
                6,118,889
                
                
                
                18,830,787Basic EPS
                
                
                0.29
                
                
                
                0.26
                
                
                
                0.29
                
                
                
                0.29
                
                
                
                1.13Diluted EPS
                
                
                0.29
                
                
                
                0.26
                
                
                
                0.29
                
                
                
                0.28
                
                
                
                1.12





Note
15 – Subsequent Event (Restated)
 
 In
connection with the preparation of the Company’s consolidated financial
statements for the quarterly ended June 30, 2010, the below omission disclosure
were identified by the Company.
 
 On
February 26, 2010, the Company through its subsidiary, JBLNG entered into a
fixed assets loan contract with Shanghai Pudong Development Bank Xi’an Branch
(“SPDB”), pursuant to which SPDB agreed to lend the Company up to $17,676,000 at
the annual interest rate of 5.76% (the “Loan”). The Company was entitled to
borrow amounts under the loan between March 1, 2010 and June 30,
2010.
 
 In
addition, in connection with the Loan, XXNGC, the variable interest entity of
the Company, entered into a pledge agreement with SPDB, pursuant to which
XXNGC’s equipment and vehicles located within the PRC were pledged to secure the
repayment of the Loan. XXNGC also entered into a guaranty with SPDB to guaranty
the repayment of the Loan.
 
 Under the
terms of the Indenture for the 5.00% Guaranteed Senior Notes issued to Abax
Lotus Ltd. dated January 20, 2008 (the “Senior Notes”), the Company and its
subsidiaries including XXNGC, are prohibited from entering into such pledge and
guaranty agreements. As a result, Abax Lotus Ltd. has the right to declare a
default under the Indenture after written notice and the Company’s 30 days right
to cure. Upon an event of default, Abax may accelerate the outstanding
indebtedness together with all accrued interest thereon and demand immediate
repayment.
 
 In
addition, in connection with the Senior Notes, the Company also issued certain
warrants to purchase the Company’s common stock pursuant to a Warrant Agreement
and Warrant Certificates. Under the terms of the Warrant Agreement, in the event
of a default under the Indenture for the Senior Notes, the warrants holders are
entitled to require the Company to redeem the warrants for a price equal to the
pro rata portion of the aggregate redemption price of $17,500,000 applicable to
the warrants tendered by such holder.
 
 With the
exception of the subsequent events noted above, as of the date of this report,
the Company has not received a notice of default from Abax Lotus
Ltd.
 
 The
Company has performed an evaluation of subsequent events through March 10, 2010,
which is the date the financial statements were issued, and did not identify
major events that have a material impact on the Company’s financial
statements.


See
report of independent registered public accounting firm.
 F-35