- Quarterly Report (10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10−Q

(Mark One)

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

For the quarterly period ended: June 30, 2010

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ____________ to _____________

Commission File Number: 333-83375

CHINA NEW ENERGY GROUP COMPANY

(Exact Name of Registrant as Specified in Its Charter)

Delaware		65-0972647
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

Block B1, 18/F,No. 85,Nanjing Road,

Tianjin Emperor Place,Heping District,Tianjin, 300040

People's Republic of China

(Address of principal executive offices, Zip Code)

(86 22) 2321 0508

(Registrant’s telephone number, including area code)

20/F, Center Plaza, No.188 Jie Fang Road

He Ping District, Tianjin, China 300042

________________________________________________

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 x No ¨

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

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.

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

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

The number of shares outstanding of each of the issuer’s classes of stock, as of August 10, 2010 is as follows:

Class of Securities		Shares Outstanding
Common Stock, $0.001 par value		107,070,281

Quarterly Report on FORM 10-Q/A

Three and Six Months Ended June 30, 2010

TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION

ITEM 1.	FINANCIAL STATEMENTS	1
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	37
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	50
ITEM 4.	CONTROLS AND PROCEDURES	50

PART II
OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS	51
ITEM 6.	EXHIBITS	52

PART I

FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS.

CHINA NEW ENERGY GROUP COMPANY

UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

Index to unaudited condensed consolidated financial statements

	Page
Unaudited Condensed Consolidated Balance Sheets (Restated)	2
Unaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (Restated)	3
Unaudited Condensed Consolidated Statements of Cash Flows (Restated)	4
Notes to Unaudited Condensed Consolidated Financial Statements	5

CHINA NEW ENERGY GROUP COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS

	June 30,			December 31,
	2010			2009
ASSETS	（ Unaudited ）
CURRENT ASSETS
Cash and cash equivalents	$	262,728		$	2,672,884
Restricted cash		131,930			180,352
Accounts receivable, net of allowance for doubtful accounts of $231,550 and $-		4,555,133			4,619,232
Receivable from sale of a subsidiary		3,260,582			5,119,055
Inventories, net		286,595			271,104
Prepaid expenses		205,024			179,011
Deemed receivable from former shareholders of subsidiaries acquired for settlement of certain liabilities		1,384,073			1,983,782
Current assets held for sale		1,407,538			1,768,278
NET CURRENT ASSETS		11,493,603			16,793,698

Property, plant and equipment, net		10,039,454			8,000,069
Other receivables		1,940,197			2,091,092
Deposits for acquisitions of subsidiaries		1,222,946			197,696
Intangible assets, net		1,181,224			1,186,272
Deposits paid for acquisition of long term assets		2,960,522			1,972,162
Goodwill		225,430			224,488
Non-current assets held for sale		9,970,525			9,760,345

TOTAL ASSETS	$	39,033,901		$	40,225,822

LIABILITIES AND EQUITY
CURRENT LIABILITIES
Accounts payable	$	908,076		$	614,642
Deposits receipt for disposal		734,365			-
Accruals and other payable		683,732			187,904
Acquisition consideration payable		1,538,654			1,651,888
Tax payable		621,980			1,323,815
Registration rights penalties payable		2,160,000			2,160,000
Related party payables		98,305			97,893
Dividends payable on preferred stock		503,515			509,381
Derivative financial instruments – warrants		6,476,070			6,768,106
Liabilities to be settled by former shareholders of subsidiaries acquired		1,384,073			1,983,782
Current liabilities held for sale		430,656			548,832
TOTAL CURRENT LIABILITIES		15,539,426			15,846,243

Commitments and contingencies (Note 23)

Preferred Stock : 10,000,000 shares authorized, $0.001 par value Series A Convertible Preferred Stock : 2,098,918 and 2,098,918 shares issued and outstanding, liquidation preference of $10,137,774 and $10,137,774 as of June 30, 2010 and December 31, 2009		7,031,818			7,031,818

Series B Convertible Preferred Stock: 1,116,388 and 1,116,388 shares issued and outstanding, liquidation preference of $5,399,969 and $5,399,969 as of June 30, 2010 and December 31, 2009		2,153,307			2,153,307

CHINA NEW ENERGY'S STOCKHOLDERS' EQUITY
Common Stock: 500,000,000 shares authorized, $0.001 par value, 105,395,032 and 101,788,199 shares issued and outstanding, respectively		105,395			101,788
Additional paid in capital		10,629,380			10,152,971
(Accumulated deficit)/ Retained earnings		(98,061	)		1,423,523
Statutory surplus reserve fund		1,746,890			1,746,890
Accumulated other comprehensive income		1,754,684			1,600,941
TOTAL CHINA NEW ENERGY'S STOCKHOLDERS' EQUITY		14,138,288			15,026,113

Non-controlling interest		171,062			168,341
TOTAL EQUITY		14,309,350			15,194,454

TOTAL LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND EQUITY	$	39,033,901		$	40,225,822

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

CHINA NEW ENERGY GROUP COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) – (UNAUDITED)

	For the three months ended						For the six months ended
	June 30,						June 30,
	2010			2009			2010			2009

Revenues:
Connection services	$	663,179		$	505,106		$	2,354,541		$	651,858
Natural gas		28,452			29,610			46,902			42,243
		691,631			534,716			2,401,443			694,101
Cost of Sales:
Connection services		140,102			161,489			571,678			221,583
Natural gas		44,723			35,136			73,585			58,417
		184,825			196,625			645,263			280,000
Gross Profit		506,806			338,091			1,756,180			414,101

Operating Expenses:
General and administrative expenses		1,175,719			485,146			2,484,325			772,298
Selling expenses		81,969			48,541			151,636			86,602
Registration right liabilities		-			-			-			450,000
Total operating expenses		1,257,688			533,687			2,635,961			1,308,900

Operating (Loss)		(750,882	)		(195,596	)		(879,781	)		(894,799	)

Other Income (Expenses):
Change in fair value of derivative financial instruments - warrants		(107,680	)		13,688,558			292,036			1,976,044
Interest income		111			25			2,550			2,234
Interest expense		(2,192	)		(2,401	)		(4,365	)		(3,010	)
Other income		12,561			-			13,090			93
Total other income (expenses)		(97,200	)		13,686,182			303,311			1,975,361

(Loss) Income From continuing operations, Before Income Tax		(848,082	)		13,490,586			(576,470	)		1,080,562

Income Tax		92,674			5,111			382,597			6,108

(Loss) Income From continuing operations, net of Income Tax		(940,756	)		13,485,475			(959,067	)		1,074,454

Discontinued Operations:
(Loss) Income from discontinued operations, net of income tax		(16	)		1,165,559			(85,646	)		1,085,037

(Loss) Income from discontinued operations, net of Income Tax		(16	)		1,165,559			(85,646	)		1,085,037

Net (Loss) Income		(940,772	)		14,651,034			(1,044,713	)		2,159,491

Net Loss (Income) attributable to Non-controlling Interest		(996	)		(14,052	)		(2,721	)		6,903

Net (Loss) Income attributable to China New Energy Group		(941,768	)		14,636,982			(1,047,434	)		2,166,394

Dividend on Preferred Stock		(258,975	)		(2,342,807	)		(474,150	)		(2,477,807	)

Net (Loss) Income attributable to China New Energy Group Common Stockholders		(1,200,743	)		12,294,175			(1,521,584	)		(311,413	)

Other Comprehensive Income:
Net (Loss) Income		(940,772	)		14,651,034			(1,044,713	)		2,159,491
Foreign currency translation loss		(147,358	)		(10,679	)		(152,539	)		(10,679	)
Comprehensive Income attributable to Non-controlling interest		-			5,026			-			5,026
Comprehensive (loss) income	$	(1,088,130	)	$	14,645,381		$	(1,197,252	)	$	2,153,838

(Loss) Income per share – Basic
(Loss) Income from continuing operations	$	(0.01	)	$	0.10		$	(0.01	)	$	(0.03	)
(Loss) Income from discontinued operations	$	(0.00	)	$	0.01		$	(0.00	)	$	0.01
Total (loss) income per share	$	(0.01	)	$	0.11		$	(0.01	)	$	(0.02	)

(Loss) Income per share – Diluted
(Loss) Income from continuing operations	$	(0.01	)	$	0.10		$	(0.01	)	$	(0.03	)
(Loss) Income from discontinued operations	$	(0.00	)	$	0.01		$	(0.00	)	$	0.01
Total (loss) income per share	$	(0.01	)	$	0.11		$	(0.01	)	$	(0.02	)

Weighted average common shares outstanding
Basic		102,580,909			100,000,041			102,186,744			100,000,041
Diluted		227,672,021			144,433,653			227,340,954			142,264,680

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

CHINA NEW ENERGY GROUP COMPANY

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS – (UNAUDITED)

	For The Six Months Ended
	June 30,
	2010			2009

Cash flows from operating activities:
Net (loss) income	$	(1,044,713	)	$	2,159,491
Net (income) loss from discontinued operations		(85,646	)		1,085,037
Net (loss) income from continuing operations	$	(959,067	)	$	1,074,454

Adjustments to reconcile net (loss) income to net cash used in operating activities:
Change in fair value of derivative financial instruments – warrants		(292,036	)		(1,976,044	)
Registration rights penalties		-			450,000
Depreciation and amortization		169,590			88,702

Changes in operating assets and liabilities:
Accounts receivable		83,183			(1,502,292	)
Other receivables		160,267			385,321
Inventories		(14,297	)		21,316
Prepayment		(25,180	)		211,701
Other current assets		-			(72,372	)
Accounts payable		289,740			(446,848	)
Accruals and other payables		1,225,507			(21,764	)
Tax payable		(704,689	)		(241,029	)
Cash used in operating activities – continuing operations		(66,982	)		(2,028,855	)
Cash provided by operating activities – discontinued operations		171,811			(410,215	)

Net cash provided by (used in) operating activities		104,829			(2,439,070	)

Cash flows from investing activities
Acquisition of property, plant and equipment		(2,157,702	)		(664,429	)
Deposit paid for property, plant and equipment		(976,326	)		(395,017	)
Deposits paid for acquisitions of subsidiaries		(1,025,250	)		-
Payment made to acquire subsidiary – Chensheng		-			(1,838,946	)
Proceeds from sale of subsidiary		1,872,782			-
Acquisition consideration payable		(117,049	)		-
Distribution from discontinued operation		1,994			-
Cash used in investing activities-continuing operations		(2,401,551	)		(2,898,392	)
Cash used in investing activities-discontinued operations		(179,250	)		(1,849,891	)

Net cash used in investing activities		(2,580,801	)		(4,748,283	)

Cash flows from financing activities
Change from restricted cash		48,422			16,437
Issued preferred stock		-			4,752,140
Cash provided by financing activities-continuing operations		48,422			4,768,577
Cash provided by financing activities-discontinued operations		-			439,060

Net cash flows provided by financing activities		48,422			5,207,637

Effect of exchange rate changes in cash and cash equivalents		17,394			1,392

Net decrease in cash and cash equivalents		(2,410,156	)		(1,978,324	)

Cash and cash equivalents - beginning of period		2,672,884			5,612,356

Cash and cash equivalents - end of period	$	262,728		$	3,634,032

Supplemental disclosure of cash flow information:

Cash paid for interest	$	4,365		$	3,010
Cash paid for income tax	$	1,036,534		$	372,556

Supplemental disclosure of non-cash investing and financing activities:
Preferred stock dividends payable	$	474,150		$	324,000

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

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

1.	Basis of Presentation

The financial statements are prepared in accordance with the accounting principles generally accepted in the United States of America (“US GAAP”). This basis differs from that used in the statutory accounts of our subsidiaries in China, which were prepared in accordance with the accounting principles and relevant financial regulations applicable to enterprises in the PRC. All necessary adjustments have been made to present the financial statements in accordance with US GAAP.

The interim condensed consolidated financial statements included herein, presented in accordance with United States generally accepted accounting principles and stated in US dollars, have been prepared by the Group (which together with the company are collectively referred to as the “Group”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations, although the Group believes that the disclosures are adequate to make the information presented not misleading. These statements reflect all adjustments, consisting of normal recurring adjustments, which, in the opinion of management, are necessary for fair presentation of the information contained therein. It is suggested that these interim condensed consolidated financial statements be read in conjunction with the financial statements of the Group for the year ended December 31, 2009 and notes thereto included in the Form 10K of China New Energy Group Company filed on April 15, 2010. The Group follows the same accounting policies in the preparation of interim reports.

Results of operations for the interim periods are not indicative of annual results.

2. Organization and description of business

China New Energy Group Company (“CNER”, the “Company”, “we”, “us” or “our”) was incorporated on March 28, 2008 in the state of Delaware USA, under the name of Travel Hunt Holdings, Inc. (“Travel Hunt”). On May 27, 2008, Travel Hunt changed its name to China New Energy Group Company in connection with a share exchange transaction.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

2. Organization and description of business-continued

Principal activity

The principal activity of the Company is the operation of a natural gas distribution network through its Chinese subsidiary companies. The Company’s operating subsidiaries and branches at June 30, 2010 and their principal activities are as follows:

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

2. Organization and description of business-continued

Willsky Development Ltd. (“Willsky”)

Willsky was incorporated on May 31, 2005 under the laws of the British Virgin Islands.

Tianjin Sing Ocean Public Utility Development Co., Ltd. (“SingOcean”)

In 2005, Willsky acquired a 99% shareholding in SingOcean, which was formed in the PRC as an equity joint venture to be operated for a period of 50 years until January 18, 2054, with registered capital of $4,500,000 (RMB31,897,000). SingOcean set up a branch division in Acheng, Tianjin, called Tianjin Sing Ocean Public Utility Development Co., Ltd. - Acheng Division (“SingOcean - Acheng Division”) which is to be operated for a period of five years until December 28, 2010, but the Acheng Division was sold in 2009.

Qinhuangdao Chensheng Gas Company Limited (“Chensheng”)

On September 16, 2008, our SingOcean subsidiary entered into an Equity Swap Agreement with Mr. Xiu Hai Tian, whereby we acquired from Mr. Xiu a 49% ownership interest in Chensheng, in exchange for our 99% ownership in Hunchun Sing Ocean. The parties to the Equity Swap Agreement determined that the value of the 49% interest in Chensheng and the 99% interest in Hunchun Sing Ocean were approximately equal and therefore there was no cash or other consideration exchanged.

On December 10, 2008, we entered into an Agreement for Equity Transfer with the holders of the remaining 51% ownership interest in Chensheng. The Agreement was consummated on December 30, 2008 and CNER purchased the remaining 51% of Chensheng from 17 individuals, for an aggregate purchase price of approximately $1,840,000 (RMB12,560,000). As a result, the Company owns 51% of Chensheng and our 99%-owned subsidiary SingOcean owns 49% of Chensheng and thus the Group ultimately owns 99.5% of Chensheng.

China New Energy (Tianjin) Investment & Consulting Co., Ltd. (“Tianjin Investment”)

On January 12, 2009, Tianjin Investment was established in the PRC and is engaged in the business of investment holding and CNER owns 100% of Tianjin Investment.

Yingkou Zhongneng Gas Development Co., Ltd. (“Yingkou Zhongneng”)

On January 23, 2009, Yingkou Zhongneng was established in the PRC through our 99% owned subsidiary, SingOcean and operates a natural gas distribution network in the city of Dashiqiao. As described in Note 4, on March 17, 2010, we entered into an agreement to sell our interest in Yingkou Zhongneng.

Tianjin Binhai Zhongneng Gas Co., Ltd. (“Binhai Zhongneng”)

On June 26, 2009, Binhai Zhongneng was established in the PRC by SingOcean and Chengsheng. Through our 99.5%-owned subsidiary, Chensheng, SingOcean invested $1,462,501 (RMB10,000,000) in cash for a 60.6% interest in Binhai Zhongneng, and through our wholly-owned subsidiary, SingOcean, transferred $950,626 (RMB6,500,000) in assets for a 39.4% interest in Binhai Zhongneng. As a result, the Group holds a 100% interest in Binhai Zhongneng.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

2. Organization and description of business-continued

Zhanhua Jiutai Gas Co.Ltd. (“Zhanhua Jiutai”)

On December 12, 2009, Chensheng entered into an Equity Interest Purchase Agreement to acquire all of the equity interests in Zhanhua Jiutai, a PRC company, from the five shareholders of Zhanhua Jiutai, for a total purchase price of $2,413,259 (RMB16,500,000).

Wuyuan County Zhongran Gas Ltd. (“Wuyuan”)

On December 16, 2009, Willsky entered into an Equity Interest Purchase Agreement to acquire all of the equity interests in Wuyuan, a PRC company, from Flying Dragon Investment Management Limited, for a total purchase price of $877,552 (RMB6,000,000), based on an appraised value of Wuyuan as of September 30, 2009.

Operational Rights and Right to Supply and Operate Gas Pipeline

The Group, through SingOcean, has signed an “ Investment Agreement of Piped Gas Project Construction in Dashiqiao City ” which states that the Group is in charge of operations and management of the piped gas project in Dashiqiao. On June 16, 2005, the Dashiqiao City Construction Bureau gave the Group a certificate which confirmed that SingOcean has exclusive operational rights for thirty years in Dashiqiao City. The Group receives a connection fee of $380 (RMB2,600) per user. On March 17, 2010, SingOcean entered into an agreement to sell our interest in Yingkou Zhongneng which was established in Dashiqiao City at approximately $3,200,000 (RMB21,900,000).

On June 10, 2005, the Group, through SingOcean, signed an “ Investment Agreement of Piped Gas Project Construction in Acheng City ” which states that the Group has the exclusive right to invest in and operate the gas pipeline system in Acheng City for thirty years. The Group receives a connection fee of $293 (RMB2,000) per user. This SingOcean - Acheng division was sold in the third quarter of 2009.

On October 8, 2005, Chengsheng signed an “ Investment Agreement of Piped Gas Project Construction in Qinhuangdao ” which states that Chengsheng has the exclusive right to invest in and operate the gas pipeline system in Qinhuangdao for twenty-five years. The Group acquired Chengsheng in the fourth quarter of 2008 to have the above operation rights. The Group receives a connection fee of $351 (RMB2,400) per user.

2010 Acquisitions

In 2010, we have entered into various agreements to acquire additional subsidiaries, as described in Note 15 and 16.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

3. Summary of Significant Accounting Policies

(a) Basis of Presentation

The financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“US GAAP”). This basis differs from that used in the statutory accounts of our subsidiaries in China, which were prepared in accordance with the accounting principles and relevant financial regulations applicable to enterprises in the PRC. All necessary adjustments have been made to present the financial statements in accordance with US GAAP.

(b) Use of Estimates

In preparing consolidated financial statements in conformity with US GAAP, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and revenues and expenses during the reported periods. Actual results could differ from those estimates.

Significant Estimates

These consolidated financial statements include some amounts that are based on management's best estimates and judgments. The most significant estimates relate to revenue recognition of gas connection contracts, depreciation of property, plant and equipment, the valuation allowance for deferred taxes, impairment testing of intangible assets, the fair value of derivative instrument liabilities and various contingent liabilities. It is reasonably possible that the above-mentioned estimates and others may be adjusted as more current information becomes available, and any adjustment could be significant in future reporting periods.

The consolidated financial statements include the accounts of the Company and all of its subsidiaries. All significant intercompany transactions and accounts have been eliminated in consolidation.

(d) Reclassification

Certain amounts in the prior year have been reclassified to conform to the current period’s presentation.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

3. Summary of Significant Accounting Policies-continued

( e) Revenue Recognition

Among the accounting policies adopted by the Group, the most critical one is the policy regarding revenue recognition of the Group’s major sources of income from gas connection services and sales of gases. In accordance with FASB ASC 650-10-S99 Revenue Recognition , all of the following criteria must be met in order for us to recognize revenue:

Persuasive evidence of an arrangement exists;

Delivery has occurred or services have been rendered;

The seller's price to the buyer is fixed or determinable; and

Collectibility is reasonably assured.

Gas connection revenue

Gas connection revenue is recognized when the outcome of a contract can be estimated reliably and the stage of completion at the balance sheet date can be measured reliably.

Revenue from gas connection contracts is recognized on the percentage of completion method, measured by reference to the value of work carried out during the year. When the outcome of a gas connection contract cannot be estimated reliably, revenue is recognized only to the extent of contract costs incurred that it is probable will be recoverable.

When the outcome of a gas connection contract can be estimated reliably and the stage of contract completion at the balance sheet date can be measured reliably, contract costs are charged to the income statement by reference to the stage of completion of the contract activity at the balance sheet date on the same basis as revenue from the gas connection contract is recognized.

When the outcome of a gas connection contract cannot be estimated reliably, contract costs are recognized as expenses in the period in which they are incurred. When it is probable that total contract costs will exceed contract revenue, the expected loss is recognized as an expense immediately.

Where contract costs incurred to date plus recognized profits less recognized losses exceed progress billings, the surplus is shown as an amount due from customers for contract work. For contracts where progress billings exceed contract costs incurred to date plus recognized profits less recognized losses, the surplus is shown as an amount due to customers for contract work. Amounts received before the related work is performed are included in the consolidated balance sheet, as a liability, as advances received. Amounts billed for work performed but not yet paid by the customer are included in the consolidated balance sheet under trade and other receivables.

During the six months ended June 30, 2010 and 2009, all the contracts for connection services were started and completed in the same period.

Revenue from sale of gas

Sales revenue from the sale of gas represents the invoiced value of goods sold, net of value-added tax (“VAT”). Revenue from the sale of gas is recognized when the goods are delivered and title has passed.

All of the Company’s products that are sold in the PRC are subject to Chinese value-added tax of 3% of the gross sales price. This VAT may be offset by VAT paid by the Company on raw materials and other materials included in the cost of producing their finished product. The Company recorded VAT payable and VAT receivable net of payments in the financial statements.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

3. Summary of Significant Accounting Policies-continued

(f) Fair Value of Financial Instruments

The Group records and discloses certain financial and non-financial assets and liabilities at their fair value. The fair value of an asset is the price at which the asset could be sold in an orderly transaction between unrelated, knowledgeable and willing parties able to engage in the transaction. A liability’s fair value is defined as the amount that would be paid to transfer the liability to a new obligor in a transaction between such parties, not the amount that would be paid to settle the liability with the creditor.

Assets and liabilities recorded at fair value are measured using a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value. These tiers include:

Level 1, defined as observable inputs such as quoted prices in active markets;

Level 2, defined as inputs other than quoted prices in active markets that are either directly or indirectly observable; and

Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring the Group to develop its own assumptions.

Our derivative instrument liabilities are recorded at fair value. Our financial instruments that are recorded at cost include cash and cash equivalents, restricted cash, accounts receivable, receivables related to subsidiaries sold, deposits for acquisitions, accounts payable, accrued expenses, dividends payable, and other current liabilities. We believe the carrying values of these financial instruments approximate their fair values due to their short-term nature.

(g) New accounting pronouncements

Fair Value Measurements

In January 2010, the FASB issued guidance to amend the disclosure requirements related to recurring and nonrecurring fair value measurements. The guidance requires disclosure of transfers of assets and liabilities between Level 1 and Level 2 of the fair value measurement hierarchy, including the reasons and the timing of the transfers and information on purchases, sales, issuance, and settlements on a gross basis in the reconciliation of the assets and liabilities measured under Level 3 of the fair value measurement hierarchy. The guidance is effective for annual and interim reporting periods beginning after December 15, 2009, except for Level 3 reconciliation disclosures which are effective for annual and interim periods beginning after December 15, 2010. The Company adopted this guidance at January 1, 2010, except for the Level 3 reconciliation disclosures on the rollforward activities, which it will adopt at the beginning of January 1, 2011. Adoption did not have a material impact on our consolidated financial statements.

Receivables

In April 2010, the FASB issued ASU 2010-18, Receivables (Topic 310), Effect of a Loan Modification When the Loan is Part of A Pool That Is Accounted for as a Single Asset . ASU 2010-18 provides that modifications of loans that are accounted for within a pool under Subtopic 310-30 do not result in the removal of those loans from the pool even if the modification of those loans would otherwise be considered a trouble debt restructuring. An entity will continue to be required to consider whether the pool of assets in which the loans are included is impaired if expected cash flows for the pool change. This guidance is effective prospectively for the first interim and annual period ending on or after July 15, 2010. Early adoption is permitted. The Company adopted this guidance without a material impact on its consolidated financial statements.

For a description of further accounting policies, please see the December 31, 2009 10K.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

4. Discontinued Operations

Disposal of Yingkou Zhongneng Gas Development Co.,Ltd in 2010 – completed in 2010

On March 17, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity Transfer Agreement with Hunan Zhongyouzhiyuan Gas Co., Ltd. (the “Purchaser”). Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100% equity interest in Yingkou Zhongneng for a cash purchase price of approximately $3,200,000 (RMB21,900,000). On March 31, 2010, the agreement was terminated.

On April 2, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity Transfer Agreement with Changsha Yuedu Steel Co., Ltd. (the “Purchaser”). Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100% equity interest in Yingkou Zhongneng for a cash purchase price of approximately $3,200,000 (RMB21,900,000). As of June 30, 2010, the Group received part of the downpayment of $731,000 (RMB5,000,000). And the Group received a further part of the downpayment of $297,000 (RMB2,000,000) on July 7, 2010.

As of June 30, 2010, the control of Yingkou still remains in the Group, and therefore, the Group recorded all the assets and liabilities of Yingkou under the caption of “Current Assets Held for Sale”, “Non-current Assets Held for Sale” and “Liabilities Held for Sale”. The operating activity of Yingkou was recorded under the discontinued operations for the six months ended June 30, 2010 and 2009.

The following table displays summarized operating activity for the discontinued operations of Yingkou for the six and three months ended June 30, 2010, and Yingkou and Acheng for the six and three months ended June 30, 2009.

	For the three months ended					For the six months ended
	June 30,					June, 30
	2010			2009		2010			2009

Revenue	$	-		$	2,275,875	$	201,159		$	2,441,507
Operating (loss) profit	$	(16	)	$	1,526,133	$	(108,698	)	$	1,439,525
(Loss) Profit before income taxes	$	(16	)	$	1,527,238	$	(85,646	)	$	1,446,716
Income tax expense	$	-		$	361,679	$	-		$	361,679
(Loss) Profit from discontinued operations, net of tax	$	(16	)	$	1,165,559	$	(85,646	)	$	1,085,037

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

5. Restricted cash

At June 30, 2010 and December 31, 2009, restricted cash of $131,930 and $180,352 represented the cash held by an escrow agent for expenses relating to investor and public relations.

6. Other Receivables

Other receivables consist of the following:

	June 30, 2010		December 31, 2009

Due from Tianjin East Ocean Gas Company Limited	$	1,460,832	$	1,454,721
Other receivables		479,365		636,371
Total	$	1,940,197	$	2,091,092

The balance due from Tianjin East Ocean Gas Company Limited (“East Ocean”) represents the amount due from Hunchun to the Group which was assigned to East Ocean when East Ocean obtained 99% ownership of Hunchun by the exchange of a 49% ownership interest in Chensheng in 2008.

Other receivables, which are unsecured, interest free, and have no fixed repayment date, are mainly comprised of an amount due from the Dashiqiao City Construction Bureau relating to various construction projects. These deposits will be refunded to us once certain construction milestones are completed.

7. Inventories

Inventories at June 30, 2010 and December 31, 2009 of $286,595 and $271,104, respectively, consist of raw materials and do not include any work in progress or finished goods.

8. Property, Plant and Equipment, net

Property, plant and equipment consist of the following:

	June 30, 2010			December 31, 2009
Cost:
Leasehold improvements	$	75,991		$	75,673
Building		79,936			79,603
Office Equipment		135,210			112,987
Motor Vehicles		324,258			304,359
Gas Transportation Vehicles		190,984			190,099
Gas Station		182,396			181,511
Machinery		137,412			134,484
Underground Gas Pipelines		3,719,386			2,388,733
	$	4,845,573		$	3,467,449

Less: Accumulated depreciation		(486,280	)		(324,706	)
	$	4,359,293		$	3,142,743

Construction-in-progress		5,680,161			4,857,326
	$	10,039,454		$	8,000,069

Construction-in-progress represents labor costs, materials, and capitalized interest incurred in connection with the construction of pipelines and networks. No depreciation is provided for construction-in-progress until it is completed and placed into service. Most construction-in-progress we purchased with cash and in general the assembling process can be done in less than 12 weeks. Therefore, no interest expense was capitalized as the capitalized interest was not significant.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

The gas pipelines, gas station, and other constructed assets belong to the Group, not to the municipalities or other units that contract with the Group to provide the hookups and the gas distribution to the households. Depreciation is provided for these assets as they are used in operations.

During the three months ended June 30, 2010, depreciation expense amounted to $85,468, of which $51,387 and $34,081 was recorded as cost of sales and as general and administrative expenses, respectively.

During the six months ended June 30, 2010, depreciation expense amounted to $159,597, of which $92,341 and $67,256 was recorded as cost of sales and as general and administrative expenses, respectively.

During the three months ended June 30, 2009, depreciation expense amounted to $38,520, of which $31,555 and $6,965 was recorded as cost of sales and as general and administrative expenses, respectively.

During the six months ended June 30, 2009, depreciation expense amounted to $78,705, of which $63,080 and $15,625 was recorded as cost of sales and as general and administrative expenses, respectively.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

9. Intangibles Assets, net

Intangible assets consist of the following:

	June 30, 2010			December 31, 2009

Land use rights	$	1,216,338		$	1,211,250
Less: accumulated amortization		(35,114	)		(24,978	)

	$	1,181,224		$	1,186,272

Amortization expense for the three months ended June 30, 2010 and 2009 was $4,997 and $5,000, respectively.

Amortization expense for the six months ended June 30, 2010 and 2009 was $9,993 and $9,997, respectively.

Estimated amortization for the next five years and thereafter is as follows:

Remainder of 2010	$	14,183
2011		28,367
2012		28,367
2013		28,367
2014		28,367
Thereafter		1,053,573

Total	$	1,181,224

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

10. Acquisition Consideration Payable

	June 30, 2010		December 31, 2009

Acquisition consideration payable relating to the purchase of Zhanhua Jiutai	$	901,804	$	1,015,038

Acquisition consideration payable relating to the purchase of Wuyuan		636,850		636,850

Total	$	1,538,654	$	1,651,888

The acquisition consideration payable as of June 30, 2010 represents the remaining amounts due as of that date in connection with the December 2009 acquisitions of Zhanhua Jiutai and Wuyuan (see Note 2 & 15). This amount will be due according to the payment terms under Equity Interest Purchase Agreement.

11. Related Party Payables

Related party payables consist of the following:

	June 30, 2010		December 31, 2009

Tianjin Huan Long Trading Ltd. (non-controlling shareholder of a subsidiary)	$	98,305	$	97,893

The balances have no stated terms for repayment and are not interest bearing.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

12. Capital Stock

Common Stock

We are authorized to issue 500,000,000 shares of Common Stock, $0.001 par value. Holders of Common Stock are entitled to one vote for each share held of record on each matter submitted to a vote of shareholders. Subject to the prior rights of any class or series of preferred stock which may from time to time be outstanding, if any, holders of Common Stock are entitled to receive ratably, dividends when, as, and if declared by our Board of Directors out of funds legally available for that purpose and, upon our liquidation, dissolution, or winding up, are entitled to share ratably in all assets remaining after payment of liabilities and payment of accrued dividends and liquidation preferences on the preferred stock, if any. As long as any shares of our Series A and Series B Preferred Stock are outstanding, the terms of those instruments prohibit us from paying dividends on the Common Stock. Holders of Common Stock have no preemptive rights and have no rights to convert their Common Stock into any other securities. The outstanding Common Stock is duly authorized and validly issued, fully-paid, and non-assessable.

Except as otherwise required by Delaware law, and subject to the rights of the holders of preferred stock, all stockholder action is taken by the vote of a majority of the outstanding shares of Common Stock present at a meeting of stockholders at which a quorum consisting of a majority of the outstanding shares of Common Stock is present in person or by proxy. However, for so long as the number of outstanding shares of Series B Preferred Stock is at least 30% of the total number of shares of Series B Preferred Stock originally issued, the holders of Series B Preferred Stock vote together as a single class with the holders of the Company’s Common Stock, and the holders of any other class or series of shares entitled to vote with the Common Stock, with the holders of Series B Preferred Stock being entitled to 70% of the total votes on all such matters regardless of the actual number of shares of Series B Preferred Stock then outstanding, and the holders of Series A Preferred Stock and Common Stock being entitled to their proportional share of the remaining 30% of the total votes based on their respective voting power.

At June 30, 2010 and December 31, 2009, 105,395,032 and 101,788,199 shares of Common Stock were issued and outstanding, respectively.

Series A Convertible Preferred Stock

In connection with the August 20, 2008 private placement described in Note 13, the Company filed a Certificate of Designations of Preferences, Rights and Limitations of Series A Convertible Preferred Stock with the Secretary of State of the State of Delaware (the "Certificate"). The Company’s Certificate of Incorporation authorizes it to issue 10,000,000 shares of Preferred Stock and by the filing, 5,500,000 shares were designated as Series A Convertible Preferred Stock ("Series A Preferred Stock"). On August 20, 2008, the Company issued 1,857,373 shares of Series A Preferred Stock to China Hand Fund I, LLC (“China Hand”),.

On May 1, 2009, the Company issued an additional 241,545 shares of Series A Preferred Stock to China Hand in connection with a make-good provision. At June 30, 2010 and December 31, 2009, 2,098,918 shares of Series A Preferred Stock were issued and outstanding.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

12. Capital Stock-continued

Dividends

The holders of the Series A Preferred Stock are entitled to cumulative dividends at a rate of 6% per annum of the stated price paid per share of $4.83, compounded daily and payable semi-annually on June 1 and December 1. Dividends are payable in shares of Common Stock or, at the option of the Company, in cash. If paid in shares of Common Stock, the number of shares to be issued is determined by dividing the dividend payable by 90% of the volume-weighted average price for the 20 days preceding the dividend payment date of June 1 or December 1. As long as any shares of Series A Preferred Stock are outstanding, the Company may not declare or pay dividends with respect to the Common Stock.

Voting Rights

In addition to the right to vote as a separate class of securities, the holders of the Preferred Stock are entitled to vote together with the holders of the Company’s Common Stock, with each such holder of Series A Preferred Stock entitled to the number of votes equal to the number of shares of the Company’s Common Stock in to which such Series A Preferred Stock would be converted if converted on the record date for the taking of a vote. However, for so long as the number of outstanding shares of Series B Preferred Stock is at least 30% of the total number of shares of Series B Preferred Stock originally issued, the holders of Series B Preferred Stock vote together as a single class with the holders of the Company’s Common Stock and the holders of any other class or series of shares entitled to vote with the Common Stock, including the Series A Preferred Stock, with the holders of Series B Preferred Stock being entitled to 70% of the total votes on all such matters regardless of the actual number of shares of Series B Preferred Stock then outstanding, and the holders of Series A Preferred Stock and Common Stock being entitled to their proportional share of the remaining 30% of the total votes based on their respective voting power.

Liquidation

Upon any liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary (each, a “Liquidation Event”), the holders of the Series A Preferred Stock are entitled to receive out of the assets of the Company, whether such assets are capital or surplus, for each share of Series A Preferred Stock an amount equal to $4.83, plus any accumulated but unpaid dividends thereon (the “Liquidation Value”), before any distribution or payment is made to the holders of any securities which are junior to the Series A Preferred Stock upon the occurrence of a Liquidation Event and after any distributions or payments made to holders of any class or series of securities which are senior to the Series A Preferred Stock upon the occurrence of a Liquidation Event. If the assets of the Company are insufficient to pay in full such amounts, then the entire assets to be distributed to the Series A Holders will be distributed among the Series A Holders ratably in accordance with the respective amounts that would be payable on such shares if all amounts payable thereon were paid in full. In the event the assets of the Company available for distribution to the holders of shares of Series A Preferred Stock upon the occurrence of a Liquidation Event are insufficient to pay in full all amounts to which such holders are entitled, no such distribution shall be made on account of any shares of any other class or series of capital stock of the Company ranking on a parity with the shares of Series A Preferred Stock upon the occurrence of such Liquidation Event unless proportionate distributive amounts are paid on account of the shares of Series A Preferred Stock, ratably, in proportion to the full distributable amounts for which holders of all such parity shares are respectively entitled upon the occurrence of such Liquidation Event.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

12. Capital Stock-continued

Conversion

Each share of Series A Preferred Stock is initially convertible, at any time at the option of the holder, into 35 shares of the Company’s Common Stock, subject to future adjustments as provided for in the Certificate. The Series A Preferred Stock will automatically convert into shares of the Company’s Common Stock immediately prior to any transaction resulting in a Change in Control of the Company. Further, provided there is an effective registration statement covering the shares to be received on conversion, the Company may require conversion of the Series A Preferred Stock if the volume-weighted average price for at least 20 trading days in any consecutive 30 day period equals or exceeds twice the conversion price and the trading volume on each day in the 30 day period has equaled or exceeded 100,000 shares.

The conversion price of the Series A Preferred Stock will be adjusted for standard anti-dilution events, including stock dividends or stock splits or reclassification of shares of the Common Stock. For as long as any shares of Series A Preferred Stock remain outstanding, the Company may not enter into any Variable Rate Transactions or Most Favored Nation transactions. If the Company does enter into a Variable Rate Transaction, in which it issues debt or equity securities that are convertible into shares of Common Stock at a conversion or exercise price that is based upon or varies with the trading price for shares of the Common Stock or enters into a Most Favored Nation transaction in which the Company issues any securities in a capital raising transaction or series of transactions on terms more favorable than those granted to the holders of the Series A Preferred Stock, the holders of the Series A Preferred Stock are entitled to adjustment of the conversion price and to receive additional shares or other rights. Furthermore, if the Company issues (except in an underwritten public offering approved by holders of the Series A Preferred Stock in which the gross proceeds to the Company are not less than $20 million) any shares of Common Stock or securities convertible into shares of Common Stock at a price which is less than the conversion price then in effect, the conversion price will be reduced to that lower price.

As long as 20% of the shares of Series A Preferred Stock remain outstanding, the Company may not issue any other preferred stock (except for the issuance of Series A Preferred Stock and Series B Preferred Stock issued pursuant to the agreements under which those Series were originally issued) or any convertible debt convertible into Common Stock, without the consent of the holders of outstanding shares of Series A Preferred Stock.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

12. Capital Stock-continued

Series B Convertible Preferred Stock

On April 30, 2009, the Company entered into a Series B Convertible Preferred Stock Securities Purchase Agreement with China Hand, as described in Note 13. In connection with this private placement, the Company filed a Certificate of Designations of Preferences, Rights and Limitations of Series B Convertible Preferred Stock with the Secretary of State of the State of Delaware, designating 2,000,000 shares as Series B Preferred Stock. At June 30, 2010 and December 31, 2009, there were 1,116,388 shares of Series B Preferred Stock issued and outstanding.

Dividends

The holders of the Series B Preferred Stock are entitled to cumulative dividends at a rate of 6% per annum of the stated price paid per share of $4.837, compounded daily and payable semi-annually in arrears on June 1 and December 1 of each year. Dividends are payable in shares of Common Stock or, at the option of the Company, in cash. If paid in shares of Common Stock, the number of shares to be issued is determined by dividing the dividend payable by 90% of the volume-weighted average price for the 20 days preceding the dividend payment date of June 1 or December 1. As long as any shares of Series B Preferred Stock are outstanding, the Company may not declare or pay dividends with respect to the Common Stock.

Voting Rights

In addition to the right to vote as a separate class of securities, the holders of the Preferred Stock are entitled to vote together with the holders of the Company’s Common Stock, with each such holder of Preferred Stock entitled to the number of votes equal to the number of shares of the Company’s Common Stock in to which such Preferred Stock would be converted if converted on the record date for the taking of a vote. For so long as the number of outstanding shares of Series B Preferred Stock is at least 30% of the total number of shares of Series B Preferred Stock issued under the Securities Purchase Agreement, the holders of Series B Preferred Stock shall vote together as a single class with the holders of the Company’s Common Stock, and the holders of any other class or series of shares entitled to vote with the Common Stock, with the holders of Series B Preferred Stock issued under the Securities Purchase Agreement being entitled to 70% of the total votes on all such matters regardless of the actual number of shares of Series B Preferred Stock then outstanding, and the holders of Series A Preferred Stock and Common Stock being entitled to their proportional share of the remaining 30% of the total votes based on their respective voting power.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

12. Capital Stock-continued

Liquidation

Upon any liquidation, dissolution or winding-up of the Company, whether voluntary or involuntary (each, a “Liquidation Event”), the Series B Holders shall be entitled to receive out of the assets of the Company, whether such assets are capital or surplus, for each share of Series B Preferred Stock an amount equal to the Original Purchase Price, which is $4.837 per share, plus any accumulated but unpaid dividends thereon (the “Series B Liquidation Value”), before any distribution or payment shall be made to the holders of any securities which are junior to the Series B Preferred Stock upon the occurrence of a Liquidation Event and after any distributions or payments made to holders of any class or series of securities which are senior to the Series B Preferred Stock upon the occurrence of a Liquidation Event. Upon the occurrence of a Liquidation Event, the right of the Series B Holders to receive Liquidation Value hereunder shall rank pari passu with that of the holders of Series A Preferred Stock (the “Series A Holders”). If the assets of the Company shall be insufficient to pay in full such amounts, then the entire assets to be distributed to the Series B Holders shall be distributed among the Series B Holders and the Series A Holders ratably in accordance with the respective amounts that would be payable on such shares if all amounts payable thereon were paid in full. In the event the assets of the Company available for distribution to the holders of shares of Series B Preferred Stock upon the occurrence of a Liquidation Event shall be insufficient to pay in full all amounts to which such holders are entitled, no distribution shall be made on account of any shares of any other class or series of capital stock of the Company ranking on a parity with the shares of Series B Preferred Stock upon the occurrence of such Liquidation Event unless proportionate distributive amounts shall be paid on account of the shares of Series B Preferred Stock, ratably, in proportion to the full distributable amounts for which holders of all such parity shares are respectively entitled upon the occurrence of such Liquidation Event.

Conversion

Each share of Series B Preferred Stock is initially convertible, at any time at the sole option of the holder of such Preferred Stock, at a conversion price of $0.1382 per share, into 35 shares of the Company’s Common Stock, subject to future adjustments as provided for in the Certificate. The Series B Preferred Stock will automatically convert into shares of the Company’s Common Stock immediately prior to any transaction resulting in a change in control of the Company.

The conversion price of the Series B Preferred Stock will be adjusted for standard anti-dilution events, including stock dividends or stock splits or reclassification of shares of the Common Stock. For as long as any shares of Series B Preferred Stock remain outstanding, the Company may not enter into any Variable Rate Transactions or Most Favored Nation transactions. If the Company does enter into a Variable Rate Transaction, in which it issues debt or equity securities that are convertible into shares of Common Stock at a conversion or exercise price that is based upon or varies with the trading price for shares of the Common Stock or enters into a Most Favored Nation transaction in which the Company issues any securities in a capital raising transaction or series of transactions on terms more favorable than those granted to the holders of the Series B Preferred Stock, the holders of the Series B Preferred Stock are entitled to adjustment of the conversion price and to receive additional shares or other rights. Furthermore, if the Company issues (except in an underwritten public offering approved by holders of the Series A Preferred Stock in which the gross proceeds to the Company are not less than $20 million) any shares of Common Stock or securities convertible into shares of Common Stock at a price which is less than the conversion price then in effect, the conversion price will be reduced to that lower price.

As long as 20% of the shares of Series B Preferred Stock remain outstanding, the Company may not issue any other preferred stock (except for the issuance of Series A Preferred Stock and Series B Preferred Stock issued pursuant to the agreements under which those Series were originally issued) or any convertible debt convertible into Common Stock, without the consent of 75% of the holders of outstanding shares of Series B Preferred Stock.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

13. Private Placement of Series A and B Convertible Preferred Stock and Warrants

May 1, 2009 Private Placement

On April 30, 2009, the Company entered into a second Securities Purchase Agreement with China Hand and on May 1, 2009, the Company issued to China Hand 1,116,388 shares of the Company’s Series B Convertible Preferred Stock and 7,814,719 warrants to purchase Common Stock, for aggregate gross proceeds of $5,400,000. The warrants are exercisable at any time at an initial exercise price of $0.187 per share (subject to adjustment) for a period of five years following the date of issuance The terms of the Series B Preferred Stock are described in Note 12 and the warrants are further described in Note 14.

Kuhns Brothers acted as placement agent in connection with the second private placement. As compensation for its services, Kuhns Brothers received a cash fee of $540,000, representing 10% of the gross proceeds received from the private placement, as well as warrants to purchase 3,907,358 shares of the Company’s Common Stock, representing 10% of the aggregate number of shares of Common Stock issuable to China Hand on conversion of the Series B Preferred Stock.

As discussed in Note 14, on May 1, 2009, the fair value of the 7,814,719 warrants issued to China Hand with the Series B Convertible Preferred Stock was $3,246,693 and the fair value of the 3,907,358 warrants issued to Kuhns Brothers was $1,623,346.

After deducting the placement agent cash fees and other costs of $130,528, the Company received net cash proceeds of $4,729,472.

Amendment and Restatement of Certain Registration Rights

In connection with the second private placement, the Company and China Hand amended and restated the Registration Rights Agreement dated August 20, 2008 and China Hand waived any registration delay payments that may have accrued under that Registration Rights Agreement up to the date of the Amended Agreement. Pursuant to the Amended and Restated Registration Rights Agreement, the Company agreed to register all of the shares of Common Stock underlying the securities issued to China Hand in the August 20, 2008 and May 1, 2009 private placements and to file a Registration Statement covering the resale of the shares by May 31, 2009. The Company is subject to registration delay payments if it is unable to file the Registration Statement, cause it to become effective or maintain its effectiveness as required by the Amended and Restated Registration Rights Agreement. Registration delay payments accrue at a rate of 1% per month of the aggregate investment amount paid by the holder applicable to each securities purchase agreement or $144,000 per month, provided that the maximum aggregate amount of the registration delay payments will be $2,160,000, or 15% of the gross proceeds of the private placements. As of June 30, 2010, the Company has not filed the required Registration Statement.

Management expects to file the required Registration Statement and use its best efforts to have it effective by August, 2010. In accordance with the guidance in FASB ASC 815-40-05 Accounting for Registration Payment Arrangements (formerly FSP EITF 00-19-2), the Company has accrued the $144,000 per month registration delay payments for the period from June 1, 2009 to August 31, 2010. As of June 30, 2010 and December 31, 2009, the Company has accrued $2,160,000 (which is the maximum amount of the registration delay payments) for these registration delay payments.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

14. Derivative financial instruments - warrants

In connection with the sale of its Series A and Series B Convertible Preferred Stock to China Hand, an accredited investor, the Company issued Common Stock warrants to China Hand and to the Company’s placement agent.

Effective January 1, 2009, the Company adopted the provisions of FASB ASC 815-40-15-5 Derivatives and Hedging (formerly EITF Issue 07-5). Because the warrants are denominated in U.S. dollars whereas the Company’s functional currency is the Renminbi, the warrants are not considered to be indexed only to the Company’s Common Stock. Furthermore, the warrants contain full ratchet anti-dilution protection requiring the exercise price of the warrants to be reduced in the event that the Company issues securities in the future at a lower price. Accordingly, the warrants do not qualify for the exemption from being accounted for as derivative financial instruments provided by FASB ASC 815-10-15-74. In addition, because the warrants contain a provision requiring the Company to re-purchase the warrants from the investor in certain circumstances, the Company has concluded that the warrants issued in 2008 should be accounted for as derivative financial instruments from the time they were originally issued.

Derivative instruments are recorded at fair value and marked-to-market each period until they are exercised or expire, with any change in the fair value charged or credited to income each period. Because these warrants do not trade in an active securities market, we estimate their fair value using the Cox-Ross-Rubinstein (“CRR”) binomial model.

On August 20, 2008, the fair value of the 13,001,608 warrants issued to China Hand in connection with the Series A Convertible Preferred Stock was $1,968,182 and the fair value of the 6,500,804 warrants issued to the placement agent was $984,091. The fair values were based on the five year life of the warrants, the exercise price of $0.187, estimated volatility of 66%, a risk free interest rate of 3% and an assumed dividend rate of 0%.

On May 1, 2009, the fair value of the 7,814,719 warrants issued to China Hand in connection with the Series B Convertible Preferred Stock was $3,246,693 and the fair value of the 3,907,358 warrants issued to the placement agent was $1,623,346. The fair values were computed using the CRR model, based on the five year life of the warrants, the exercise price of $0.187, estimated volatility of 90%, a risk free interest rate of 2.03% and an assumed dividend rate of 0%.

At June 30, 2010 and December 31, 2009, the fair value of the warrants was $6,476,070 and $6,768,106, respectively, based on the following assumptions:

	June 30, 2010			December 31, 2009

Warrants outstanding		31,224,489			31,224,489
Exercise price	$	0.187		$	0.187
Annual dividend yield		0	%		0	%
Expected life (years)		3.14-3.83			3.64-4.33
Risk-free interest rate		1.06%-3	%		2.02% - 2.36	%
Expected volatility		90	%		90	%

Because of the limited trading history of the Company’s Common Stock, expected volatility is based on the historical volatility of a similar U.S. public company with a longer trading history. The Company has no reason to believe that the future volatility of its Common Stock over the remaining life of these warrants will differ materially from this estimate. The expected life of the warrants is based on their remaining term. Risk-free interest rates are based on published rates for U.S. Treasury securities for the remaining term of the warrants. The expected dividend yield is based on the Company’s current and expected dividend policy.

The Company recognized a loss of $107,680 from the change in fair value of these warrants for the three months ended June 30, 2010 and a gain of $13,688,558 from the change in fair value for the three months ended June 30, 2009. The Company recognized a gain of $292,036 from the change in fair value of these warrants for the six months ended June 30, 2010 and a gain of $1,976,044 from the change in fair value for the six months ended June 30, 2009.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

15. Acquisitions of Subsidiaries

Zhanhua Jiutai Gas Co.Ltd. (“Zhanhua Jiutai”)

On December 12, 2009, Chensheng, our indirect wholly-owned subsidiary, entered into an Equity Interest Purchase Agreement to acquire 100% of the outstanding equity interests of Zhanhua Jiutai, a PRC company, from the five shareholders of Zhanhua Jiutai, for a total purchase price of $2,413,269 (RMB16,500,000).

Below set forth the payment terms of the acquisition consideration payable under the Equity Interest Purchase Agreements.

1 ） The amount of the first installment is 58% of the total transfer price, Renminbi 9,500,000 Yuan (approximately $1.40 million). The Transferee (CNER) shall make the first installment payment to the Transferors (former shareholders) within 13 working days as of the effective day of the Equity Transfer Agreement.

2 ） The amount of the second installment payment is 36% of the total transferred price, that is, Renminbi 6,000,000 Yuan (approximately $0.87 million). And the second installment payment is completed within the sixth month as of the date of the first installment payment. The Parties agree that, all the debts owed by Zhanhua Jiutai, including but not limited to the amount owed to the original shareholders, the amount payable to suppliers and construction teams, salaries and benefits payable to employees, taxes payable to tax bureau and so on should have been paid up by the Transferors at its own cost. Otherwise, the Transferee shall have the right to refuse to make the second installment payment.

3 ） The amount of the third installment payments is 6% of the total transfer price, that is, Renminbi 1,000,000 Yuan (approximately $0.14 million) will be paid to the Transferors on December 31, 2010 on the condition that the Transferor are free of any liabilities.

As of June 30, 2010, the total outstanding on the acquisition of Zhanhua Jiutai is $901,804 which is recorded under the Acquisition consideration payable (see Note 10).

The acquisition of Zhanhua Jiutai was accounted for as a business combination, in accordance with FASB ASC 805 Business Combinations . The results of Zhanhua Jiutai and the estimated fair market values of the assets and liabilities have been included in the Group’s consolidated financial statements from the date of acquisition. The assets acquired and liabilities assumed of Zhanhua Jiutai were recorded based on their fair values, as follows:

Other receivables	$	2,925
Inventories		82,939
Property, plant and equipment		139,014
Construction in progress		2,218,043
Advance accounts		(254,140	)
Goodwill		224,488
Purchase price	$	2,413,269

Zhanhua Jiutai did not commence business up to the acquisition date, and therefore, the pro forma financial information for the six months ended June 30, 2009 is the same as the actual figure shown in the statement of Condensed Consolidated Statements of Operations and Comprehensive Income.

In accordance with FASB 810-10-5, the condensed consolidated balance sheet at June 30, 2010 includes certain liabilities of Zhanhua Jiutai assumed by the five former shareholders of Zhanhua Jiutai in 2009, as the Group consolidates Zhanhua Jiutai.

The following table summarizes the liabilities to be settled by the former shareholders, but which are included in our balance sheet as of June 30, 2010. In accordance with the Agreement, these liabilities were not assumed by Chensheng and will be settled by the five former shareholders of Zhanhua Jiutai in 2010.


Accounts payable	$	611,574
Other payables		4,307
Salary payables		459,824
Liabilities to be settled by former shareholders	$	1,075,705

Deemed receivable from former shareholders for settlement of certain liabilities	$	1,075,705

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

15. Acquisitions of Subsidiaries - continued

Wuyuan County Zhongran Gas Ltd. (“Wuyuan”)

On December 16, 2009, Willsky entered into an Equity Interest Purchase Agreement to acquire 100% of the outstanding equity interests in Wuyuan, a PRC company, from Flying Dragon Investment Management Limited, for a total purchase price of $877,552 (RMB6,000,000), which purchase price was based on an appraised value of Wuyaun as of September 30, 2009.

Below set forth the payment terms of the acquisition consideration payable under the Equity Interest Purchase Agreements.

1 ） The amount of the first installment is 27.5% of the Consideration, namely Renminbi 1,650,000 Yuan (approximately $0.24 million). The Transferee shall make the first installment payment to the Transferor before December 20, 2009.

2 ） The amount of the second installment is 52.5% of the Consideration, namely Renminbi 3,150,000 Yuan (approximately $0.46 million) shall be paid on April 30, 2010. The Parties agree that, all the debts owed by Wuyuan, including but not limited to the amount owed to the original shareholders, the amount payable to suppliers and construction teams, salaries and benefits payable to employees, taxes payable to tax bureau and so on should have been paid up by the Transferors at its own cost. Otherwise, the Transferee shall have the right to refuse to make the second installment payment

3 ） The amount of the third installment is 20% of the Consideration, namely Renminbi 1,200,000 Yuan (approximately $0.18 million) shall be considered as deposit of this transaction and will be paid to the Transferor on August 31, 2010 on the condition that the Transferor are free of any liabilities.

As of June 30, 2010, the total outstanding on the acquisition of Wuyuan is $636,850 which is recorded under the Acquisition consideration payable (see Note 10).

The acquisition of Wuyuan was accounted for as a business combination, in accordance with FASB ASC 805 Business Combinations . The results of Wuyuan and the estimated fair market values of the assets and liabilities have been included in the Group’s consolidated financial statements from the date of acquisition. The purchase price of $877,552 was less than the fair value of the assets acquired and liabilities assumed of Wuyuan on the date of the acquisition December 16, 2009 and, accordingly, we recognized a gain related to the acquisition, as follows:

Prepaid expenses	$	650,120
Other receivables		89,598
Inventories		67
Construction in progress		203,742
Intangible assets		244,000
Assets acquired	$	1,187,527
Less: Purchase consideration (net of $3,081 cash received)		(874,471	)
Gain on acquisition of Wuyuan	$	313,056

Wuyuan did not commence business up to the acquisition date, and therefore, the pro forma financial information for the six months ended June 30, 2009 is the same as the actual figure shown in the statement of Condensed Consolidated Statements of Operations and Comprehensive Income.

In accordance with FASB 810-10-5, the condensed consolidated balance sheet at June 30, 2010 includes certain liabilities of Wuyuan assumed by the former shareholder of Wuyuan in 2009, as the Group consolidates Wuyuan.

The following table summarizes the liabilities to be settled by the former shareholder but which are included in our balance sheet as of June 30, 2010. In accordance with the Agreement, these liabilities were not assumed by the Company and will be settled by the former shareholder of Wuyuan in 2010.


Accounts payable	$	105,769
Other current liabilities		202,563
Liabilities to be settled by former shareholder	$	308,332

Deemed receivable from former shareholder for settlement of certain liabilities	$	308,332

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

16. Deposits for Acquisitions of Subsidiaries

Fuzhou City Lean Zhongran Gas Inc., a PRC company (“Lean Zhongran”)

On December 16, 2009, Willsky entered into an Equity Interest Purchase Agreement to acquire all of the outstanding equity interests in Lean Zhongran, a PRC company, from Flying Dragon Resource Development Limited, for a total purchase price of approximately $702,782 (RMB4,800,000). The purchase price is based on an appraised value of Lean Zhongran as of September 30, 2009 and will be adjusted to reflect the appraised value of the assets as of the closing date. The closing of the transaction is subject to approval by our Board of Directors.

Fuzhou Flying Dragon Zhongran Gas Inc. (“Fuzhou Zhongran”)

On January 5, 2010, Willsky entered into an Equity Interest Purchase Agreement, to acquire all of the outstanding equity interests in Fuzhou Flying Dragon Gas Inc., a PRC company (“Fuzhou Zhongran”) from Flying Dragon Resource Development Limited and Flying Dragon Investment Management Limited. The effectiveness of the Agreement was subject to the approval of our Board of Directors, which approval was granted on December 2, 2009.

Under the Agreement, Willsky will purchase 100% of the outstanding equity interests in Fuzhou Zhongran for a total purchase price of approximately $3,800,000 (RMB26,000,000). The purchase price is based on an appraised value of Fuzhou Zhongran as of September 30, 2009 and will be adjusted to reflect the appraised value of the assets as of the closing date. The closing of the transaction is subject to Board approval.

As of June 30, 2010, the transfers of the ownership of Lean Zhonran and Fuzhou Zhongran were not completed and the Group paid $1,222,946 as deposits and recorded it under the caption of Deposits for acquisition.

The stockholder of Lean Zhongran, Flying Dragon Resources Investment Management Limited and Flying Dragon Resource Development Limited are two different companies but controlled by same person.

Deposits for acquisition of Lena Zhongran and Fuzhou Zhongran

	June 30, 2010		December 31, 2009

Deposit relating to the purchase of Lean Zhongran	$	197,696		197,696

Deposit relating to the purchase of Fuzhou Zhongran		1,025,250		-

Total	$	1,222,946		197,696

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

17. Deemed Receivable From Former Shareholders Of Subsidiaries Acquired For Settlement Of Certain Liabilities

Deemed receivable from former shareholders of subsidiaries acquired for settlement of certain liabilities of $1,384,073 and $1,983,782 as of June 30, 2010 and December 31, 2009, represents the liabilities of Zhanhua Jiutai and Wuyuan which are to be settled by the former shareholders of Zhanhua Jiutai and Wuyuan, as disclosed in Note 14. These amounts will be due in future financial reporting periods.

18. Non-controlling Interests in Subsidiaries

As of June 30, 2010, Tianjin Huan Long Trading directly held a 1% non-controlling interest in our subsidiary SingOcean and indirectly held a 0.5% non-controlling interest in Chengsheng and Zhanhua Jiutai and a 0.3% non-controlling interest in Binhai Zhongneng. The total of these non-controlling interests at June 30, 2010 was $171,062 and their share of net income for the six months ended June 30, 2010 was $2,721.

As of December 31, 2009, Tianjin Huan Long Trading directly held a 1% non-controlling interest in our subsidiary SingOcean and indirectly held a 0.5% non-controlling interest in Chengsheng and Zhanhua Jiutai and a 0.3% non-controlling interest in Binhai Zhongneng. The total of these non-controlling interests at December 31, 2009 was $168,341 and their share of net loss for the six months ended June 30, 2009 was $6,903.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

19. Income Taxes

USA

The Company and its subsidiary and branch divisions are subject to income taxes on an entity basis on income arising in, or derived, from the tax jurisdiction in which they operate. As the Group had no income generated in the United States, there was no tax expense or tax liability due to the Internal Revenue Service of the United States as of June 30, 2010 and December 31, 2009.

BVI

Willsky is incorporated under the International Business Companies Act of the British Virgin Islands and accordingly, is exempted from payment of British Virgin Island’s income taxes.

PRC

Pursuant to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for SingOcean, Chensheng and Yingkou for fiscal years 2010 and 2009. Chensheng was taxed at 1% of revenues from January to June 2009. From July 2009 onwards, Chensheng is taxed at 25% of net income.

The current year tax provision was $382,597 and $6,108 for the six months ended June 30, 2010 and 2009, respectively. The Group has recorded no deferred tax assets or liabilities as of June 30, 2010 and December 31, 2009, because all significant differences in tax basis and financial statement amounts are permanent differences.

	For the three months ended June 30,						For the six months ended June 30,
	2010			2009			2010			2009
Income Tax Expense:
Current tax	$	92,674		$	5,111		$	382,597		$	6,108
Change in deferred tax assets – Net operating loss		294,849			3,304,353			476,885			199,513
Change in valuation allowance		(294,849	)		(3,304,353	)		(476,885	)		(199,513	)
Total	$	92,674		$	5,111		$	382,597		$	6,108

We follow the guidance in FASB ASC 740 Accounting for Uncertainty in Income Taxes . We have not taken any uncertain tax positions on any of our open income tax returns filed through the period ended June 30, 2010. Our methods of accounting are based on established income tax principles and are properly calculated and reflected within our income tax returns. In addition, we have timely filed extension of income tax returns in all applicable jurisdictions in which we believe we are required to make an income tax return filing.

We re-assess the validity of our conclusions regarding uncertain tax positions on a quarterly basis to determine if facts or circumstances have arisen that might cause us to change our judgment regarding the likelihood of a tax position’s sustainability under audit. We have determined that there were no uncertain tax positions for the six months June 30, 2010 and 2009.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

19. Income Taxes - continued

All of the Group’s income before income taxes is from PRC sources. Actual income tax expense reported in the consolidated statements of operations and comprehensive income differ from the amounts computed by applying the PRC statutory income tax rate of 25% to income before income taxes for the three and six months ended June 30, 2010 and 2009 for the followings reasons:

	For the three months ended June 30,						For the six months ended June 30,
	2010			2009			2010			2009

(Loss) Income from continuing operations before income taxes	$	(848,082	)	$	13,490,586		$	(576,470	)	$	1,080,562

Computed “expected” income tax expense at 25% in 2010 and 2009, except on the net income of Chensheng of $2,931 in 2009	$	(212,021	)	$	3,375,577		$	(144,117	)	$	270,140

Income tax expense of Chensheng - charged at 0.8% of gross sales of $694,109 in 2009		-			(66,113	)		-			(64,519	)

Tax effect of net taxable permanent differences		39,164			-			49,829			-

Effect of cumulative tax losses		265,531			(3,304,353	)		476,885			(199,513	)

	$	92,674		$	5,111		$	382,597		$	6,108

Our policy for recording interest and penalties associated with audits is to record such items as a component of income tax expense. There were no interest and penalties recorded for the six months ended June 30, 2010 and 2009.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

20. Earnings Per Share

Basic earnings per share is computed by dividing net income attributable to common shareholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share reflects the potential dilution of securities by including other potential common stock, including convertible preferred stock, stock options and warrants, in the weighted average number of common shares outstanding for a period, if dilutive. The numerators and denominators used in the computations of basic and dilutive earnings per share are presented in the following table:

	For The Three months Ended						For The Six months Ended
	June 30,						June 30,
	2010			2009			2010			2009

BASIC
Numerator for basic (loss) earnings per share from continuing operations attributable to China New Energy Group’s common stockholders:
Net (loss) Income From Continuing Operations	$	(941,768	)	$	14,636,982		$	(1,047,434	)	$	2,166,394
Deemed dividend on preferred stock issued		-			(2,350,829	)		-			(2,350,829	)
Dividend on preferred stock		(258,975	)		(2,342,807	)		(474,150	)		(2,477,807	)
(Loss) Income From Continuing Operations used in computing basic (loss) earnings per share		(1,200,743	)		9,943,346			(1,521,584	)		(2,662,242	)

Basic (loss) earnings per share from continuing operations		(0.01	)		0.10			(0.01	)		(0.03	)

Numerator for basic (loss) earnings per share from discontinued operations
Net (loss) Income from Discontinued Operations		(16	)		1,165,559			(85,646	)		1,085,037
(Loss) Income from Discontinued Operations used in computing basis (loss) earnings per share		(16	)		1,165,559			(85,646	)		1,085,037

Basic (loss) earnings per share from discontinued operations		(0.00	)		0.01			(0.00	)		0.01

Weighted average outstanding shares of common stock		102,580,909			100,000,041			102,186,744			100,000,041

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

20. Earnings Per Share – continued

	For The Three months Ended					For The Six months Ended
	June 30,					June 30,
	2010			2009		2010			2009

DILUTED
Numerator for diluted (loss) earnings per share from continuing operations attributable to China New Energy Group’s common stockholders:
Net (loss) Income From Continuing Operations	$	(1,200,743	)	$	9,943,346	$	(1,521,584	)	$	(2,662,242	)
Deemed dividend on preferred stock issued		-			2,350,829		-			2,350,829
Dividend on preferred stock		258,975			2,342,807		474,150			2,477,807
(Loss) Income From Continuing Operations used in computing diluted (loss) earnings per share		(941,768	)		14,636,982		(1,047,434	)		2,166,394

Diluted (loss) earnings per share from continuing operations		(0.01	)		0.10		(0.01	)		(0.03	)

Numerator for diluted (loss) earnings per share from discontinued operations
Net (loss) Income From Discontinued Operations		(16	)		1,165,559		(85,646	)		1,085,037
(Loss) Income From Discontinued Operations used in computing diluted (loss) earnings per share		(16	)		1,165,559		(85,646	)		1,085,037

Diluted (loss) earnings per share from discontinued operations		(0.00	)		0.01		(0.00	)		0.01

Weighted average outstanding shares of common stock		102,580,909			100,000,041		102,186,744			100,000,041
Weighted average shares of convertible preferred stock outstanding		112,535,710			20,980,665		112,535,710			18,811,693
Warrants and contingently issuable shares		12,555,402			23,452,947		12,618,500			23,452,946
Common stock and common stock equivalents		227,672,021			144,433,653		227,340,954			142,264,680

(Loss) earnings per share:
Basic	$	(0.01	)	$	0.11	$	(0.01	)	$	(0.02	)
Diluted	$	(0.01	)	$	0.11	$	(0.01	)	$	(0.02	)

Potential common shares outstanding as of June 30,:
Series A Convertible Preferred Stock		7,031,818			-		7,031,818			7,031,818
Series B Convertible Preferred Stock		2,153,307			-		2,153,307			-
Warrant outstanding		31,224,489			-		31,224,489			19,502,412
		40,409,614			-		40,409,614			26,534,230

For the three months ended June 30, 2010, six months ended June 30, 2010 and 2009, the number of securities totaled was 40,409,614, 40,409,614 and 26,534,230 respectively not included in the diluted EPS because the effect would have been anti-dilutive.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

21. Business and Geographical Segments

The Group’s operations are classified into two principal reportable segments which are the provision of gas pipe connection services and the provision of natural gas. Separate management of each segment is required because each business unit is subject to different production and technology strategies.

Reportable Segments

	For the three months ended June 30, 2010												For the three months ended June 30, 2009
	Connection												Connection
	services			Natural gas			Corporate			Total			services		Natural gas			Corporate			Total

External revenue For the three months ended June 30, 2009	$	663,179			28,452			-			691,631		$	505,106		29,610			-			534,716
Interest income		111			-			-			111			25		-			-			25
Interest expense		(2,192	)		-			-			(2,192	)		-		-			(2,401	)		(2,401	)
Depreciation and amortization		39,580			11,807			39,078			90,465			19,711		11,844			11,965			43,520
Income tax		92,674			-			-			92,674			5,111		-			-			5,111

Net income (loss)		682,005			(16,271	)		(1,606,506	)		(940,772	)		271,645		(59,536	)		14,438,925			14,651,034

Expenditures for long-lived assets		478,542			-			60,356			538,898			453,321		42,019			-			495,340
		As of June 30, 2010												As of December 31, 2009
Total Assets	$	13,409,165			2,418,303			23,206,433			39,033,901		$	23,608,532		2,820,280			13,797,010			40,225,822

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

21. Business and Geographical Segments – continued

Reportable Segments

	For the six months ended June 30, 2010												For the six months ended June 30, 2009
	Connection												Connection
	services			Natural gas			Corporate			Total			services			Natural gas			Corporate			Total

External revenue	$	2,354,541			46,902			-			2,401,443		$	651,858			42,243			-			694,101
Interest income		2,550			-			-			2,550			2,234			-			-			2,234
Interest expense		(4,365	)		-			-			(4,365	)		(259	)		-			(2,751	)		(3,010	)
Depreciation and amortization		68,733			23,609			77,248			169,590			39,416			23,664			25,622			88,702
Income tax		382,597			-			-			382,597			6,108			-			-			6,108

Net income (loss)		1,781,049			(26,683	)		(2,799,079	)		(1,044,713	)		360,113			(70,183	)		1,869,561			2,159,491

Expenditures for long-lived assets		2,097,346			-			60,356			2,157,702			514,142			150,287			-			664,429

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

22. Concentrations and Credit Risk

Cash - Cash includes cash on hand and demand deposits in accounts maintained with state owned banks within the PRC. The Group considers all highly liquid instruments purchased with original maturities of three months or less, and money market accounts, to be cash equivalents. Total cash in these banks at June 30, 2010 and December 31, 2009 amounted to $262,728 and $2,672,884, respectively, of which no deposits were covered by insurance. Also, as of both June 30, 2010 and December 31, 2009, the Group held $131,930 in restricted cash in a corporate legal counsel’s trust account, in accordance with an agreement with investors to restrict use of the funds to pay preferred stock dividends and investor relation expenses. Nonperformance by these institutions could expose the Group to losses not covered by insurance. Management reviews the financial condition of these institutions on a periodic basis. The Group has not incurred any losses on these accounts from nonperformance by the aforementioned institutions.

Major customers – For the three months ended June 30, 2010, four customers accounted for approximately 99% of the Company’s sales. For the six months ended June 30, 2010, four customers accounted for approximately 62% of the Company’s sales and two customers accounted for approximately 27% of the Company’s accounts receivable as of June 30, 2010.

For the three months ended June 30, 2009, two customers accounted for approximately 24% of the Company’s sales. For the six months ended June 30, 2009, one customer accounted for approximately 12% of the Company’s sales and two customers accounted for approximately 30% of the Company’s accounts receivable as of June 30, 2009.

Major suppliers – For the three months ended June 30, 2010, three suppliers accounted for approximately 95% of the Company’s purchase’s. For the six months ended June 30, 2010, five suppliers accounted for approximately 87% of the Company’s purchase’s and two suppliers accounted for approximately 67% of the Company’s accounts payable as of June 30, 2010.

For the three months ended June 30, 2009, four suppliers accounted for approximately 53% of the Company’s purchase’s. For the six months ended June 30, 2009, three suppliers accounted for approximately 34% of the Company’s purchase’s and three suppliers accounted for approximately 52% of the Company’s accounts payable as of June 30, 2009.

Political and economic risks - The Group's operations are carried out in the PRC. Accordingly, the Group's business, financial condition, and results of operations may be influenced by the political, economic, and legal environments in the PRC, and by the general state of the PRC's economy. The Group's operations in the PRC are subject to specific considerations and significant risks not typically associated with companies in North America and Western Europe. These include risks associated with, among others, the political, economic, and legal environments, and foreign currency exchange. The Group's results may be adversely affected 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 others.

The Group does not require collateral to support financial instruments that are subject to credit risk.

Environmental Matters - The Group does not anticipate any material future cash requirements related to environmental issues. If circumstances change, the Group will record the estimated charges necessary to return sites to their original condition.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

23. Commitments and Contingencies

Operating Leases - In the normal course of business, the Group leases office space under operating lease agreements. The operating lease agreements generally contain renewal options that may be exercised at the Company’s discretion after the completion of the base rental term. The Company is obligated under operating leases requiring minimum rentals as follows:

Remainder of 2010	$	166,698
2011		136,140
2012		45,380
Thereafter		-

Total minimum lease payments	$	348,218

During the three months ended June 30, 2010 and 2009, rental expenses included in general and administrative expenses were $71,440 and $25,818, respectively.

During the six months ended June 30, 2010 and 2009, rental expenses included in general and administrative expenses were $159,838 and $59,947, respectively.

As of June 30, 2010 and 2009, the Group did not have any contingent liabilities.

The Group is obligated to provide uninterrupted piped gas to connected users and to ensure safety in the process of piped gas operations. The volume of gas to be supplied by the Group is expected to grow with any increase in gas users. The Group has selected three qualified gas resource suppliers to ensure stable operations in meeting its obligations.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

24. Subsequent events

The Company evaluated subsequent events through the time of filing this Quarterly Report on Form 10-Q. No significant events occurred subsequent to the balance sheet date but prior to the filing of this report that would have a material impact on our Condensed Consolidated Financial Statements.

ITEM 2.

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

Special Note Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q, including the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements that are based on the beliefs of our management, and involve risks and uncertainties, as well as assumptions, that, if they ever materialize or prove incorrect, could cause actual results to differ materially from those expressed or implied by such forward-looking statements. The words “believe,” “expect,” “anticipate,” “project,” “targets,” “optimistic,” “intend,” “aim,” “will” or similar expressions are intended to identify forward-looking statements. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements, including statements regarding new and existing products, technologies and opportunities; statements regarding market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; uncertainties related to conducting business in China; any statements of belief or intention; and any statements of assumptions underlying any of the foregoing. All forward-looking statements included in this report are based on information available to us on the date of this report. We assume no obligation and do not intend to update these forward-looking statements, except as required by law.

In this report, unless indicated otherwise, references to:

“China New Energy,” “the company,” “we,” “us,” or “our,” are references to the combined business of China New Energy Group Company and its wholly-owned subsidiaries, Willsky, Wuyuan,Tianjin Investment, SingOcean, Chensheng and Yingkou Zhongneng, Zhanhua Jiutai, Binhai Zhongneng, but do not include the stockholders of China New Energy;

“Willsky” are references to Willsky Development, Ltd.

“Wuyuan” are references to Wuyuan County Zhongran Gas Limited.

“Tianjin Investment” are references to China New Energy(Tianjin) Investment & Consulting Co.,Ltd.

“SingOcean” are references to Tianjin SingOcean Public Utility Development Co., Ltd.

“Chensheng” are references to Qinhuangdao Chensheng Gas Co. Ltd.

“Yingkou Zhongneng” are reference to Yingkou Zhongneng Gas Development Company Limited.

“Zhanhua Jiutai” are reference to Zhanhua Jiutai Gas Co. Limited.

“Binhai Zhongneng” are reference to Tianjin Binhai Zhongneng Gas Company Limited.

“China,” “Chinese” and “PRC,” are references to the People’s Republic of China;

“BVI” are references to the British Virgin Islands;

“RMB” refer to Renminbi, the legal currency of China;

“U.S. dollar,” “$” and “US$” are to the legal currency of the United States;

“SEC” means the Securities and Exchange Commission; and

“Securities Act” means the Securities Act of 1933, as amended, and “Exchange Act” mean the Securities Exchange Act of 1934, as amended.

Overview of Our Business

We are a natural gas company engaged in the development of natural gas distribution networks, and the distribution of natural gas to residential, industrial and commercial customers in small and medium sized cities in China.

We currently own the exclusive rights to develop distribution networks to provide natural gas to industrial, commercial and residential consumers in the cities of Nandaihe ， Zhanhua, and Shangrao. Currently, these distribution networks provide natural gas to an aggregate of approximately 26,000 consumers in these cities.

We procure our natural gas by purchasing natural gas from third-party suppliers. Once natural gas is extracted by the supplier, all water content and impurities are removed. Natural gas is then delivered by truck to either (1) our natural gas supply stations, where the gas is either depressurized and then delivered to households through pipelines or delivered directly to customers in pressurized tanks, or (2) to gas stations where the gas is sold for use in motor vehicles.

Our major business activities include development and construction of local gas distribution networks, transportation of natural gas from suppliers to our storage facilities in a given operational location, and operating and maintaining the gas distribution networks.

Our Current Organizational Structure

China New Energy Group Company was incorporated on March 28, 2008 in the state of Delaware USA, under the name of Travel Hunt Holdings, Inc. On May 27, 2008, Travel Hunt changed its name to China New Energy Group Company in connection with a share exchange transaction as described below.

Willsky (Willsky Development Ltd) was incorporated on May 31, 2005 in the British Virgin Islands. On March 28, 2008, Travel Hunt Holdings, Inc. completed a reverse acquisition transaction with Willsky whereby Travel Hunt Holdings, Inc. issued to the shareholder of Willsky 94,908,650 shares of its common stock in exchange for all of the issued and outstanding capital stock of Willsky. Simultaneous with the consummation of the share exchange, the shareholder of Willsky, Eternal International Holding Group Ltd, a Hong Kong corporation, or Eternal International, distributed 85,417,785 shares of Travel Hunt Holdings, Inc. common stock as a dividend. Accordingly, following this distribution, Eternal International beneficially owns approximately 9.49% of Travel Hunt Holdings, Inc. outstanding capital stock. Willsky thereby became Travel Hunt Holdings, Inc.’s wholly-owned subsidiary and the former shareholders of Willsky became Travel Hunt Holdings, Inc. controlling stockholders.

Concurrently with the reverse merger, Fountainhead (Fountainhead Capital Management Limited) and La Pergola (La Pergola Investments Limited), the previously existing shareholders of Travel Hunt, surrendered to the Company a total of 2,000,000 shares of the common stock of the Company for cancellation in exchange for $660,000 payable through the delivery of a six month Convertible Promissory Note. After surrender, the existing shareholders retained 5,091,391 shares of our common stock.

After the reverse acquisition, the total common stock issued and outstanding of the Company as of December 31, 2008 was 100,000,041 shares.

This transaction has been accounted for as a reverse acquisition and recapitalization of the Company whereby Willsky is deemed to be the accounting acquirer (legal acquiree) and the Company the accounting acquiree (legal acquirer). The historical financial statements for periods prior to March 28, 2008 are those of Willsky, except that the equity section and earnings per share have been retroactively restated to reflect the reverse acquisition.

In 2005, Willsky acquired 99% of the equity of SingOcean which was formed in the PRC as an equity joint venture to be operated for a period of 50 years until January 18, 2054 with registered capital of $4.5 million (RMB31,897,000).

On September 16, 2008, we, through our 99%-owned subsidiary SingOcean, entered into an Equity Swap Agreement with Mr. Xiu Hai Tian, whereby we acquired from Mr. Xiu a 49% ownership interest in Chensheng, in exchange for our 99% ownership in Hunchun SingOcean. The parties to the Equity Swap Agreement determined that the value of the 49% interest in Chensheng and the 99% interest in Hunchun Sing Ocean were approximately equal and therefore there was no cash or other consideration involved in the transaction from either party.

On December 10, 2008, the Company entered into an Agreement for Equity Transfer with the holders of the remaining 51% outstanding equity in Chensheng. Pursuant to the Agreement for Equity Transfer, the Company agreed to purchase the remaining 51% of the outstanding equity of Chensheng from 17 individuals for an aggregate purchase price of RMB 12.56 million (approximately $1.84 million). The transaction was consummated on December 30, 2008, following which the Company now owns 51% of the equity of Chensheng, and Tianjin Sing Ocean now owns 49% of the equity of Chensheng.

On January 12, 2009, Tianjin Investment was established in the PRC and engaged in the business of investment holding.

On January 23, 2009, Yingkou Zhongneng was established in the PRC and operates a natural gas distribution network in the city of Dashiqiao. On March 17, 2010, we entered into an agreement to sell our interest in Yingkou Zhongneng.

On June 26, 2009, Binhai Zhongneng was established. Through our 99.5%-owned subsidiary, Chensheng contributed $1,462,501 (RMB10,000,000) in cash representing 60.6% of the shareholding of Binhai Zhongneng and, through our wholly-owned subsidiary, SingOcean contributed $950,626 (RMB6,500,000) in assets representing 39.4% of the shareholding of Binhai Zhongneng. As a result, the group holds 100% of Binhai Zhongneng.

On December 12, 2009, Chensheng, our indirect wholly-owned subsidiary, entered into an Equity Interest Purchase Agreement to acquire all of the outstanding equity interest of Zhanhua Jiutai from the 5 shareholders of Zhanhua Jiutai. Under this Agreement, Chensheng agreed to purchase 100% of the outstanding equity interest of Zhanhua Jiutai from the Zhanhua Jiutai Shareholders for a total purchase price of $2,413,259 (RMB 16,500,000).

On December 16, 2009, the Company entered into an Equity Interest Purchase Agreement to acquire all of the outstanding equity interest of Wuyuan from Flying Dragon Investment Management Limited. Under this Agreement, the Company agreed to purchase 100% of the outstanding equity interest of Wuyuan for a total purchase price of $877,552 (RMB 6,000,000), which purchase price is based on an appraised value of Wuyuan as of September 30, 2009.

Critical Accounting Policies

Accounting policies discussed in this section are those that we consider to be most critical to an understanding of our financial statements because they inherently involve significant judgment and uncertainties. For all of these estimates, we caution that future events rarely develop exactly as forecast, and the best estimates routinely require adjustment.

Revenue Recognition

Among the accounting policies adopted by the Group, the most critical one is the policy regarding revenue recognition of the Group’s major sources of income, namely, gas connection services and sales of gases. In accordance with the SEC's Staff Accounting Bulletin ("SAB") No. 104, under this policy, all of the following criteria must be met in order for us to recognize revenue:

1. Persuasive evidence of an arrangement exists;

2. Delivery has occurred or services have been rendered;

3. The seller's price to the buyer is fixed or determinable; and

4. Collectibility is reasonably assured.

Gas connection revenue

Gas connection revenue is recognized when the outcome of a contract can be estimated reliably and the stage of completion at the balance sheet date can be measured reliably.

During the three and six months ended June 30, 2010 and 2009, all the contracts for connection services were started and completed.

Revenue from sale of gas

Sales revenue from sale of gas represents the invoiced value of goods sold, net of value-added tax (“VAT”). Revenue from sale of gas is recognized when the goods are delivered and title has passed.

Use of Estimates

Significant Estimates

These consolidated financial statements include some amounts that are based on management's best estimates and judgments. The most significant estimates relate to revenue recognition of gas connection contracts, depreciation of property, plant and equipment, the valuation allowance for deferred taxes, impairment testing of intangible assets and various contingent liabilities. It is reasonably possible that the above-mentioned estimates and others may be adjusted as more current information becomes available, and any adjustment could be significant in future reporting periods.

Reportable Operating Segments

For the six months ended June 30, 2010, we had sales revenue of $2.40 million of which $2.35 million, or 98%, was from connection services while $0.05 million, or 2%, was from gas sales.

Our revenue for the six months ended June 30, 2010 was mainly contributed by the connection services segment as we concentrate our efforts to provide our services to property developers. Thus, the gas consumption will begin when the properties are sold in the market. Currently, the volume of gas sales to connected households is not high.This phenomenon does affect our revenue structure.

Second Quarter Financial Performance Highlights

The following are some financial highlights for the second quarter of 2010 (MM represents million):

Reve nues : Our revenues were $0.69 MM for the second quarter of 2010, an increase of 29% from the same period of 2009.

Gross Margin : Gross margin was 73% for the second quarter of 2010 compared to gross margin of 63% for the second quarter of 2009, representing a percentage increase of 10%.

Operating Expenses : Operating expenses (including selling, general and administrative expenses) were $1.26 MM for the second quarter of 2010, an increase of 136% from the same period of 2009.

Net Income / (Loss) : A net loss of $0.94 MM resulted for the second quarter of 2010, while the net income for the same period of 2009 was $14.64 MM. The decrease of net income was mainly due to: (1) an increase of operating expenses by $0.72 MM; (2) a change in fair value of warrant liabilities which resulted in other expenses of $0.11 MM while it resulted in other income of $13.69 MM for the same period of 2009; and (3) a decrease in income from discontinued operations by 1.17 MM.

Fully diluted net income per share : Fully diluted net loss per share was $0.01 for the second quarter of 2010, as compared to net income per share of $0.09 for the same period of 2009.

Taxation

As a Delaware company, the Company is subject to United States taxation, but no provision for income taxes was made for the six months ended June 30, 2010 and 2009 as the Company did not have reportable taxable income for the period.

Willsky, a wholly-owned subsidiary of the Company, is subject to BVI taxation, but no provision for income taxes was made for the six months ended June 30, 2010 and 2009 as Willsky did not have reportable taxable income for the period.

SingOcean is subject to the tax laws of the PRC at the prevailing statutory rate of enterprise income tax of 25%.

Prior to 2009 Chensheng was subject to the tax laws of the PRC being taxed on 0.8% of annual sales. Starting from January 1, 2009, the tax rate was changed to 1% on sales. On July 1, 2009, the tax rate was changed to 25% on net income.

Binhai Zhongneng is subject to the tax laws of the PRC at the prevailing statutory rate of enterprise income tax of 25%.

Zhanhua is subject to the tax laws of the PRC at the prevailing statutory rate of enterprise income tax of 25%.

Wuyuan is subject to the tax laws of the PRC at the prevailing statutory rate of enterprise income tax of 25%.

On April 22, 2009, the State Administration of Taxation issued the Notice Concerning Relevant Issues Regarding Cognizance of Chinese Investment Controlled Enterprises Incorporated Offshore as Resident Enterprises pursuant to Criteria of de facto Management Bodies, or the Notice, further interpreting the application of the New EIT Law and its implementation with respect to non-Chinese enterprises or group controlled offshore entities. Pursuant to the Notice, an enterprise incorporated in an offshore jurisdiction and controlled by a Chinese enterprise or group will be classified as a “non-domestically incorporated resident enterprise” if (i) its senior management in charge of daily operations reside or perform their duties mainly in China; (ii) its financial or personnel decisions are made or approved by bodies or persons in China; (iii) its main properties, accounting books, corporate seal, board and shareholder minutes are kept in China; and (iv) directors with voting rights or senior management often reside in China. Such resident enterprise would be subject to an EIT rate of 25% on its worldwide income and must pay a withholding tax at a rate of 10% when paying dividends to its non-PRC shareholders. However, it remains unclear as to whether the Notice is applicable to an offshore enterprise incorporated by a Chinese natural person. Nor are detailed measures available on the imposition of tax on non-domestically incorporated resident enterprises. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.

However, as our case substantially meets the foregoing criteria, there is a likelihood that we are deemed to be a resident enterprise by Chinese tax authorities. If the PRC tax authorities determine that we are a “resident enterprise” for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as subject to PRC enterprise income tax reporting obligations. In our case, this would mean that income such as interest on financing proceeds and non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the New EIT Law and its Implementing Rules dividends paid to us from our PRC subsidiaries would qualify as “tax-exempt income,” we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new “resident enterprise” classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our shares. We are actively monitoring the possibility of “resident enterprise” treatment and are evaluating appropriate organizational changes to avoid this treatment, to the extent possible.

Results of Operations

Comparison of Three Months Ended June 30, 2010 and 2009

The following table summarizes the results of our operations during the three-month periods ended June 30, 2010 and 2009:

(All amounts, other than percentages, are in thousands of U.S. dollars)

	For the three months ended
	June 30
	2010			2009			Change			Change%

Revenues:	$	692		$	535			157			29	%

Cost of Sales:		185			197			(12	)		-6	%

Gross Profit		507			338			169			50	%

Total operating expenses		1,258			534			724			136	%

Loss from operations		(751	)		(196	)		(555	)		283	%

Other Income (Expenses):
Change in fair value of derivative financial instruments - warrants		(108	)		13,689			(13,797	)		-101	%
Interest income(expense)		(2	)		(2	)		0
Other income		13			0			13

(Loss) Income from Continuing Operations, Before IncomeTax		(848	)		13,491			(14,339	)		-106	%

Income Tax		93			5			88			1760	%

(Loss) Income from Discontinued Operations, net of Income Tax		0			1,166			(1,166	)		-100	%

Non-controlling Interest		(1	)		(14	)		13			-93	%

Net (Loss) Income		(942	)		14,637			(15,579	)		-106	%

Revenues . Revenues are derived primarily from connection fees and sales of natural gas. Revenues increased $0.15 MM, or 29%, to $0.69 MM for the three months ended June 30, 2010 from $0.54 MM for the same period in 2009. This increase was mainly attributable to an increase in connection services for an industry customer.

Cost of Sales . Cost of sales consists primarily of connection costs and purchase of natural gas from our suppliers and depreciation.

Our cost of sales decreased by $0.01 MM, or 6%, to $0.19 MM for the three months ended June 30, 2010 from $0.20 MM during the same period in 2009. Such decrease in cost while increase in revenues was mainly attributable to increase in an industry customer which the gross margin is 99%. .

Gross Profit . Our gross profit increased by $0.17 MM, or 50%, to $0.51 MM for the three months ended June 30, 2010 from $0.34 MM during the same period in 2009. Gross profit as a percentage of revenues or gross profit margin, was 73% for the three months ended June 30, 2010. The gross profit margin during the same period in 2009 was 63%. Such increase in gross profit margin was mainly due to an increase of the industry connection services.

Total Operating Expenses The total operating expenses consist of two components, the first one is registration right penalties and the other is general and administrative expenses (“SG&A”). For the three months ended June 30, 2010, the total operating expenses were $1.26 MM while the amount was $0.53 MM for the same period of 2009, or increased by 136%. This increase was mainly due to the fact that we are expanding our company. Management believes that the relatively high SG&A expenses will continue as we endeavor to expand our business.

Loss from opera tions Our loss from operations increased by $0.56 MM, or 283%, to $0.75 MM for the three months ended June 30, 2010 from $0.19 MM during the same period in 2009. This increase was mainly due to an increase in operating expenses.

Other Income (Expenses)

Change In Fair Value of Warrant Liability: For the three months ended June 30, 2010, the change in fair value of warrant liability was recorded as other expenses of $0.11 MM while the one incurred in the same period of 2009 was recorded as other income of $13.69 MM.

The Company adopted a FASB accounting standard, which defines determining whether an instrument (or embedded feature) is indexed to an entity’s own stock. This accounting standard 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 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 scope exception.

As a result of adopting this FASB accounting standard, warrants previously treated as equity pursuant to the derivative treatment exemption are no longer afforded equity treatment because the warrants have a downward ratchet provision on the exercise price. 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 expired.

On August 20, 2008, the fair value of the 13,001,608 warrants issued with the Series A Convertible Preferred Stock to China Hand was $1.97 MM and the fair value of 6,500,804 warrants issued to Kuhns Brothers was $0.98 MM. The fair value was computed using the Cox-Ross-Rubinstein (“CRR”) Binomial Model under the following assumptions: (1) expected life of 5 years, (2) volatility of 90%, (3) risk free interest rate of 3% and dividend rate of 0%.

On May 1, 2009, the fair value of the 7,814,719 warrants issued with the Series B Convertible Preferred Stock to China Hand was $3.25 MM and the fair value of 3,907,358 warrants issued to Kuhns Brothers was $1.62 MM. The fair value was computed using the Cox-Ross-Rubinstein (“CRR”) Binomial Model under the following assumptions: (1) expected life of 5 years, (2) volatility of 90%, (3) risk free interest rate of 2.03% and dividend rate of 0%.

As of June 30, 2010, the fair value of the Series A and B Convertible Preferred Stock was $6.48 MM. Therefore, the Company recognized a $0.11 MM loss from the change in fair value for the three months ended June 30, 2010 and a $13.69 MM gain from the change in fair value during the same period in 2009.

Income (loss) From Continuing Operations, Before Income Tax . Our loss from continuing operations before income tax increased by $14.34 MM, to $0.85 MM for the three months ended June 30, 2010 from an income of $13.49 MM during the same period in 2009. Such increase was mainly due to the fact that the company recorded a $13.69 MM income from the change in fair value of the warrants during the period in 2009 according to EITF 07-05.

Income (Loss) From Discontinued Operation

Disposal of Yingkou Zhongneng Gas Development Co.,Ltd in 2010 – completed in 2010

On March 17, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity Transfer Agreement, with Hunan Zhongyouzhiyuan Gas Co., Ltd. (the “Purchaser”). Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100% equity interest in Yingkou Zhongneng for a cash purchase price of approximately $3,200,000 (RMB21,900,000). On March 31, 2010, the agreement was terminated.

On April 2, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity Transfer Agreement, with Changsha Yuedu Steel Co., Ltd (the “Purchaser”). Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100% equity interest in Yingkou Zhongneng for a cash purchase price of approximately $3,200,000 (RMB21,900,000). As of June 30, 2010, the Group received part of the downpayment of $731,000 (RMB5,000,000). And the Group received a further part of the downpayment of $297,000 (RMB2,000,000) on July 7, 2010.

The following table displays summarized operating activity for the discontinued operations of Yingkou for the three months ended June 30, 2010, and Yingkou and Acheng for the three months ended June 30, 2009.

	For the three months ended
	2010			2009

Revenue	$			$	2,275,875
Operating loss	$	(16	)	$	1,526,133
Loss before income taxes	$	(16	)	$	1,527,238
Income tax expense	$	-		$	361,679
Loss from discontinued operations, net of tax	$	(16	)	$	1,165,559

Net Income(loss) . Net loss increased by $15.58 MM, to a net loss of $0.94 MM for the three months ended June 30, 2010, from net income of $14.64 MM for the same period of 2009, which is mainly due to: (1) an increase in operating expenses by $0.72 MM; and (2) an increase in the loss from the change in fair value of the warrants $13.80 MM.

Comparison of Six Months Ended June 30, 2010 and 2009

The following table summarizes the results of our operations during the six-months ended June 30, 2010 and 2009:

(All amounts, other than percentages, are in thousands of U.S. dollars)

	June 30,
	2010			2009			Change			Change%


Revenues:		2,401			694			1,707			246	%

Cost of Sales:		645			280			365			130	%

Gross Profit		1,756			414			1,342			324	%

Total operating expenses		2,636			1,309			1,327			101	%

Loss from operations		(880	)		(895	)		15			-2	%

Other Income (Expenses):
Change in fair value of derivative financial instruments - warrants		292			1,976			(1,684	)		-85	%
Interest income(expense)		(2	)		(1	)		(1	)		100	%
Other income		13			0			13

(Loss) Income from Continuing Operations, Before IncomeTax		(576	)		1,081			(1,657	)		-153	%

Income Tax		383			6			377			6283	%

(Loss) Income from Discontinued Operations, net of Income Tax		(86	)		1,085			(1,171	)		-108	%

Non-controlling Interest		(3	)		7			(10	)		-143	%

Net (Loss) Income		(1,047	)		2,166			(3,213	)		-148	%

Revenues . Revenues are derived primarily from connection fees and sales of natural gas. Revenues increased $1.71 MM, or 246%, to $2.40 MM for the six months ended June 30, 2010 from $0.69 MM for the same period in 2009. This increase was mainly attributable to an increase in number of connection households for an industry customer.

Cost of Sales . Cost of sales consists primarily of connection costs and purchase of natural gas from our suppliers and depreciation.

Our cost of sales increased by $0.37 MM, or 130%, to $0.65 MM for the six months ended June 30, 2010 from $0.28 MM during the same period in 2009. Such increase was mainly attributable to an increase in the number of households connected to our distribution network.

Gross P rofit . Our gross profit increased by $1.35 MM, or 324%, to $1.76 MM for the six months ended June 30, 2010 from $0.41 MM during the same period in 2009. Gross profit as a percentage of revenues or gross profit margin, was 73% for the six months ended June 30, 2010. The gross profit margin during the same period in 2009 was 60%. Such increase in gross margin was mainly due to 98% of sales revenue was derived from connection services while 94% of sales revenue was derived from connection services during the same period in 2009, the gross margin of connection services was higher than that of gas sales..

Total Operating Expenses The total operating expenses consist of two components, the first one is registration right penalties and the other is general and administrative expenses (“SG&A”). For the six months ended June 30, 2010, the total operating expenses were $2.64 MM while the amount was $1.31 MM for the same period of 2009, or increased by 101%. This increase was mainly due to the fact that we are expanding our company. Management believes that the relatively high SG&A expenses will continue as we endeavor to expand our business.

Loss from operations Our loss from operations decreased by $0.02 MM, or 2%, to $0.88 MM for the six months ended June 30, 2010 from $0.90 MM during the same period in 2009. This decrease in loss from operations was mainly due to an increase in gross profit which was offset by the increase in operating expenses of $1.33 MM.

Total Other Income (Expenses)

Change In Fair Val ue of Warrant Liability: For the six months ended June 30, 2010, the change in fair value of warrant liability was recorded as other income of $0.29 MM while the one incurred in the same period of 2009 was $1.98 MM.

As of June 30, 2010, the fair value of the Series A and B Convertible Preferred Stock was $6.48 MM. Therefore, the Company recognized a $0.29 MM gain from the change in fair value for the six months ended June 30, 2010 and a $1.98 MM gain from the change in fair value during the same period in 2009.

Income (loss) From Continuing Operations, Before Income Tax. Our loss from continuing operations before income tax increased by $1.66 MM to $0.58MM for the six months ended June 30, 2010 from a gain of $1.08 MM during the same period in 2009. Such increase was mainly due to an increase by $1.33 in operating expenses and a decrease by $1.68 MM in income from the change in fair value of the warrants according to EITF 07-05.

Income (Loss) From Discontinued Operations

Disposal of Yingkou Zhongneng Gas Development Co.,Ltd in 2010 – completed in 2010

On March 17, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity Transfer Agreement with Hunan Zhongyouzhiyuan Gas Co., Ltd. (the“Purchaser”). Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100% equity interest in Yingkou Zhongneng for a cash purchase price of approximately $3,200,000 (RMB21,900,000). On March 31, 2010, the agreement was terminated.

As of June 30, 2010, the control of Yingkou still remains in the Group and, therefore, the Group recorded all the assets and liabilities of Yingkou under the caption of “Current Assets Held for Sale”, “Non-current Assets Held for Sale” and “Liabilities Held for Sale”. The operating activity of Yingkou was recorded under the discontinued operations for the six months ended June 30, 2010 and 2009.

The following table displays summarized operating activity for the discontinued operations of Yingkou for the six ended June 30, 2010, and Yingkou and Acheng for the six ended June 30, 2009.

	For the six months ended
	2010			2009

Revenue	$	201,159		$	2,441,507
Operating loss	$	(108,698	)	$	1,439,525
Loss before income taxes	$	(85,646	)	$	1,446,716
Income tax expense	$	-		$	361,679
Loss from discontinued operations, net of tax	$	(85,646	)	$	1,085,037

Net Income (Loss) . Net loss increased by $3.22 MM to a net loss of $1.05 MM for the six months ended June 30, 2010, from net income of $2.17 MM for the same period of 2009, which is mainly due to: (1) a decrease in the gain from the change in fair value of the warrants by $1.68 MM; and (2) an increase of operating expenses by $1.33 MM.

Liquidity and Capital Resources

As of June 30, 2010, we had cash and cash equivalents of approximately $0.26 million. The following table provides detailed information about our net cash flow for all financial statement periods presented in this report.

Cash Flow

(All amounts in thousands of U.S. dollars)

	For The Six Months Ended
	June 30
	2010			2009
Net cash provided by (used in) operating activities	$	105		$	(2,439	)

Net cash used in investing activities		(2,581	)		(4,748	)

Net cash provided by financing activities:		48			5,208

Effect of exchange rate changes in cash and cash equivalents		17			1

Net decrease in cash and cash equivalents	$	(2,410	)	$	(1,978	)

Operating Activities

Net cash provided by operating activities was $0.11 MM for the six months ended June 30, 2010, compared to net cash used in operating activities of $2.44 MM during the same period of 2009. This increase in funds provided by our operating activities was primarily due to a decrease in accounts receivable and an increase in accruals and other payables.

Investing Activities

Our main use of cash in investing activities was mainly for the construction of gas pipelines and acquisition of assets.

Net cash used in investing activities for the six months ended June 30, 2010 was $2.58 MM which was a decrease of $2.17 MM from $4.75 MM for the same period of 2009. This decrease was mainly due to the decrease in the investing activities-discontinued operations..

Financing Activities

Our debt (included warrant liabilities) to equity ratio (total debt/total equity) was 109% as of June 30, 2010. Net cash provided by financing activities for the six months ended June 30, 2010 was $0.05 MM, which is a decrease of $5.16 MM from $5.21 MM during the same period of 2009. This decrease was mainly due to the contribution from the private placement consummated on May 1, 2009.

On May 1, 2009, we issued and sold to China Hand 1,116,388 shares of our Series B Convertible Preferred Stock and warrants to purchase 7,814,719 shares of our common stock at an initial exercise price of $0.187 per share (subject to adjustments) exercisable for a period of five (5) years following the date of issuance for a purchase price of $5,400,000.

Capital Expenditures, Contractual Obligations, Commitments and Contingences

For the six months ended June 30, 2010, the company spent about $3.13 MM in capital expenditures which was mainly for the construction of gas pipelines, gas station and acquisition. The company settled the payments according to the terms of the contract and fulfilled its contractual obligations. Other than the operating leases stated in Note 23 to Unaudited Condensed Consolidated Financial Statements, we have no other commitments and contingencies. As disclosed in Note 3, the Company is obligated under operating leases to pay minimum lease payments of approximately $0.35 MM.

Seasonality

Our pipeline distribution networks are primarily located in northeastern China, which is extremely cold during the winter months. Additionally, gas consumption by residential customers is higher in the winter months for heating purposes, and there is a corresponding increase in usage during winter. However, due to the cold weather we are unable to construct primary gas pipelines. If a primary pipeline is already in place, we are able to connect new customers to our distribution network during this time.

Effects of Inflation

Our business, revenues and operating results have not been affected in any material way by inflation.

Off Balance Sheet Arrangements

On March 17, 2010, SingOcean, our PRC 99%-owned subsidiary, entered into an Equity Transfer Agreement with Hunan Zhongyouzhiyuan Gas Co., Ltd. (the “Purchaser”). Pursuant to the Agreement, SingOcean agreed to sell to the Purchaser its 100% equity interest in Yingkou Zhongneng for a cash purchase price of approximately $3,200,000 (RMB 21,900,000). The agreement was completed in April 9, 2010 and the Group received part of the installment of $731,000 (RBM5,000,000).

On March 8, 2010, the Company entered into an Equity Transfer Agreement with Mr. Tang Zhixiang to acquire from Mr. Tang a 70% equity interest in Century Dadi, a PRC company, and a 70% equity interest in its affiliated companies including Dadi Gas.

Century Dadi, Dadi Gas and their respective affiliated companies are primarily engaged in the business of the supply of natural gas and construction and development of a gas pipeline network in urban areas. The total purchase price has not yet been determined but will be based on a multiple of the net profits of Century Dadi and its consolidated subsidiaries for the year ended December 31, 2009, as determined in accordance with US GAAP consistently applied, capped at approximately $57,500,000 (RMB392,150,000). The purchase price is payable in three installments. Each payment is subject to satisfaction of certain preconditions.

Under the terms of the Agreement, the parties will open a mutually managed account and we will deposit approximately $1,466,000 (RMB10,000,000) into that account, to be applied towards the purchase price.

The Company paid part of the installment of $731,000 (RBM5,000,000) on April 9, 2010 on the acquisition of Dadi Gas.

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not Applicable.

ITEM 4.

CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures.

We maintain “disclosure controls and procedures” (as defined in Rule 13a-15(e) under the Exchange Act) that are designed to ensure that information that would be required to be disclosed in Exchange Act reports is recorded, processed, summarized and reported within the time period specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including to our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

As required by Rule 13a-15 under the Exchange Act, our management, including Mr. Yangkan Chong, our Chief Executive Officer and Mr. Eric Yu, our Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2010. Based on that evaluation, Mr. Chong and Mr. Yu concluded that as of June 30, 2010, and as of the date that the evaluation of the effectiveness of our disclosure controls and procedures was completed, our disclosure controls and procedures were effective and the following measurements have been deployed.

We continue to arrange necessary training for our accounting department staff;

We continue to engage external professional accounting or consultancy firms to assist us in the preparation of the US GAAP accounts;

We have established an effective internal audit function; through allocating financial and human resources to strengthen the internal control structure and we have been actively working with external consultants to assess our data collection, financial reporting, and control procedures and to strengthen our internal controls over financial reporting.

We believe that the foregoing steps will strengthen our disclosure controls and procedures, and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate.

Changes in Internal Controls.

Except as described above t here were no changes in our internal control over financial reporting that occurred during the fiscal quarter covered by this report that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting

PART II

OTHER INFORMATION

ITEM 1.

LEGAL PROCEEDINGS.

From time to time, we may become involved in various lawsuits and legal proceedings, which arise, in the ordinary course of business. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse affect on our business, financial condition or operating results. However, litigation is subject to inherent uncertainties, and an adverse result in these, or other matters, may arise from time to time that may harm our business.

ITEM 6.

EXHIBITS.

The following exhibits are filed as part of this report or incorporated by reference:

Exhibit No.		Description
31.1		Certifications of Principal Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

31.2		Certifications of Principal Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

32.1		Certifications of Principal Executive Officer and Principal Financial Officer furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

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

Date: August 16, 2010	CHINA NEW ENERGY GROUP COMPANY

	By:	/s/ Yangkan Chong
		Yangkan Chong, Chief Executive Officer
		(Principal Executive Officer)

	By:	/s/ Eric Yu
		Eric Yu, Chief Financial Officer
		(Principal Financial Officer and Principal Accounting Officer)

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