- Amended Quarterly Report (10-Q/A)

Share Name	Share Symbol	Market	Type
China New Energy Group Company (PK)	USOTC:CNER	OTCMarkets	Common Stock

	Price Change	% Change	Share Price	Bid Price	Offer Price	High Price	Low Price	Open Price	Shares Traded	Last Trade
	0.00	0.00%	0.0085	0.0021	0.009				0.00	13:07:39

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10−Q/A

(Mark One)

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

For the quarterly period ended: September 30, 2009

¨	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.)

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

He Ping District, Tianjin, 300042

People's Republic of China

(Address of principal executive offices, Zip Code)

(86 22) 5829 9778

(Registrant’s telephone number, including area code)

(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 Nine Months Ended September 30, 2009

TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION

ITEM 1.	FINANCIAL STATEMENTS	4
ITEM 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	49
ITEM 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	63
ITEM 4.	CONTROLS AND PROCEDURES	64

PART II
OTHER INFORMATION

ITEM 1.	LEGAL PROCEEDINGS	65
ITEM 6.	EXHIBITS	65

EXPLANATORY NOTE REGARDING RESTATEMENT

This Amendment No. 1 ("Form 10-Q/A") to our Quarterly Report on Form 10-Q for the three month period ended September 30, 2009 ("Form 10-Q"), which was filed with the SEC on November 16, 2009, amends the Form 10-Q to reflect restated amounts and revised disclosures of the Company's consolidated financial statements for the three and nine month periods ended September 30, 2009.

A detailed discussion of the restatement of the consolidated financial statements for the nine months ended September 30, 2009 is included in note 20.

PART I

FINANCIAL INFORMATION

ITEM 1.

FINANCIAL STATEMENTS.

CHINA NEW ENERGY GROUP COMPANY

UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

FOR THE NINE MONTHS ENDED JUNE 30, 2009 AND 2008

Index to unaudited condensed consolidated financial statements

	Page
Unaudited Condensed Consolidated Balance Sheets (Restated)	5
Uaudited Condensed Consolidated Statements of Operations and Comprehensive Income (Loss) (Restated)	7
Unaudited Condensed Consolidated Statements of Cash Flows (Restated)	8
Notes to Unaudited Condensed Consolidated Financial Statements	9

CHINA NEW ENERGY GROUP COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS

	September 30		December 31
	2009		2008
	Restated
	(Unaudited)
ASSETS
CURRENT ASSETS
Cash and cash equivalents	$	4,878,751	$	5,612,356
Restricted cash		196,873		221,152
Accounts receivable, net of allowance for doubtful accounts of $- and $-		3,925,491		2,183,087
Inventories, net		288,799		257,597
Prepaid expenses		135,740		133,614
Other current assets		94,017		3,340
TOTAL CURRENT ASSETS		9,519,671		8,411,146

Property, plant and equipment, net		17,121,635		13,470,468
Intangible assets, net		1,286,758		1,308,375
Other receivables		2,075,390		2,254,997
Deposit paid for acquisition of long term assets		649,213		1,424,747
Goodwill		63,002		63,014
TOTAL ASSETS		30,715,669		26,932,747

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

CHINA NEW ENERGY GROUP COMPANY

CONDENSED CONSOLIDATED BALANCE SHEETS

	September 30		December 31
	2009		2008
	Restated
	(Unaudited)
LIABILITIES AND EQUITY

CURRENT LIABILITIES
Accounts payable	$	351,750	$	874,542
Accruals and other payables		243,648		242,309
Acquisition consideration payable		-		1,838,946
Registration rights penalties payable		1,728,000		900,000
Tax payable		523,770		693,116
Related party payables		498,491		498,703
Dividends payable on preferred stock		744,946		194,000
Derivative financial instruments - warrants		2,358,908		5,506,143
TOTAL CURRENT LIABILITIES		6,449,51 3		10,747,759

Commitment and contingencies (Note 18)

Preferred Stock : 10,000,000 shares authorized, $0.001 par value Series A Convertible Preferred Stock:		7,031,818		7,031,818
2,098,918 and 1,857,373 shares issued and outstanding, liquidation preference of $10,137,774 and $8,971,112, respectively
Series B Convertible Preferred Stock:		2,153,307		-
1,116,388 and 0 shares issued and outstanding, liquidation preference of $5,399,969 and $0

CHINA NEW ENERGY'S STOCKHOLDERS' EQUITY

Common Stock: 500,000,000 shares authorized, $1 par value, 100,000,041 shares issued and outstanding		100,000		100,000
Additional paid in capital		9,720,473		9,396,046
Retained earnings/ (Accumulated deficit)		1,790,113		(3,809,149	)
Statutory surplus reserve fund		1,746,890		1,746,890
Accumulated other comprehensive income		1,580,509		1,616,977
TOTAL CHINA NEW ENERGY'S STOCKHOLDERS' EQUITY		14,937,985		9,050,764

Non-controlling interest		143,046		102,406
TOTAL EQUITY		15,081,031		9,153,170

TOTAL LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND EQUITY	$	30,715,669	$	26,932,747

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

CHINA NEW ENERGY GROUP COMPANY

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME

	(Unaudited)						(Unaudited)
	For the Three months ended						For the nine months ended
	September 30,						September 30,
	2009			2008			2009			2008
	Restated						Restated

Revenues:
Connection services	$	2,659,930		$	2,092,445		$	5,433,912		$	3,846,773
Natural gas		157,34 4			161,413			518,9 70			390,214
		2,817,274			2,253,858			5,952,882			4,236,987
Cost of Sales:
Connection services		742,925			454,061			1,548,040			833,644
Natural gas		157,863			121,565			517,745			295,257
		900,788			575,626			2,065,785			1,128,901
Gross Profit		1,916,486			1,678,232			3,887,097			3,108,086

Operating Expenses:
General and administrative expenses		909,061			284,205			1,772,908			660,927
Selling expenses		59,458			61,889			174,036			153,047
Registration rights penalties		378,000			-			828,000			-

Total operating expenses		1,346,519			346,094			2,774,944			813,974

Income from Operations		569,967			1,332,138			1,112,153			2,294,112

Other Income:
Change in fair value of warrant liability		6,041,231			-			8,017,275			-
Interest income		10,680			-			20,307			-
Interest expense		(3,699	)		-			(4,370	)		-
Other Income		5,558			3,702			5,651			9,974
Total other income		6,053,770			3,702			8,038,863			9,974

Income From Continuing Operations, Before Income Tax		6,623,737			1,335,840			9,151,016			2,304,086

Income Tax		(461,013	)		(391,358	)		(828,800	)		(705,244	)

Income From Continuing Operations, net of Income Tax		6,162,724			944,482			8,322,216			1,598,842

Income (Loss) From Discontinued Operations, net of Income Tax		-			(7,116	)		-			223,410
Net Income		6,162,724			937,366			8,322,216			1,822,252

Net Income Attributable to Non-controlling Interest		(25,104	)		(37,009	)		(18,200	)		(46,277	)

Net Income attributable to China New Energy Group		6,137,620			900,357			8,304,016			1,775,975

Dividend and Deemed Dividend on Preferred Stock		(204,000	)		-			(2,074,753	)		-

Net Income Attributable to Common Stockholders		5,933,620			900,357			6,229,263			1,775,975

Other Comprehensive Income
Net Income		6,162,724			937,366			8,322,216			1,822,252
Foreign currency translation gain (loss)		(5,458	)		-			(24,442	)		377,403
Comprehensive income (loss) attributable to the Non-controlling interest		251			-			(12,026	)		-
Comprehensive income attributable to the Company	$	6,157,517		$	937,366		$	8,285,748		$	2,199,655

Income (Loss) per share - Basic
Income (Loss) from continuing operations	$	0.06		$	(0.06	)	$	0.05		$	(0.05	)
Loss from discontinued operations	$	-		$	-		$	-		$	-
Total income (loss) per share	$	0.06		$	(0.06	)	$	0.05		$	(0.05	)

Income (Loss) per share - Diluted
Income from continuing operations	$	0.03		$	(0.06	)	$	0.04		$	(0.05	)
Income (Loss) from discontinued operations	$	-		$	-		$	-		$	-
Total income(loss) per share	$	0.03		$	(0.06	)	$	0.04		$	(0.05	)

Weighted average common shares outstanding
Basic		100,000,041			100,000,041			100,000,041			98,3 21 , 5 60
Diluted		217,949,744			150,677,768			1 99 , 844 , 225			116 , 245 , 214

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

CHINA NEW ENERGY GROUP COMPANY

UNAUDITED CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

	For The Nine Months Ended
	September 30
	2009			2008
	As Restated
Cash flows from operating activities:
Net Income	$	8,322,216		$	1,822,252
Net Income From Discontinued Operations		-			223,410
Net Income From Continuing Operations		8,322,216			1,598,842

Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		337,500			129,982
Change in fair value of warrant liability		(8,017,275	)		-
Registration right payable		828,000			-
Changes in operating assets and liabilities:
Accounts receivable		(1,741,568	)		(446,814	)
Other receivables		205,909			(646,372	)
Inventories		(31,228	)		128,215
Prepayment		(2,150	)		-
Other current assets		(90,613	)		-
Accounts payable		(598,522	)		(59,384	)
Accruals and other payable-Third Party		41,716			(789,882	)
Taxes payable		(169,093	)		(276,093	)
Cash used in operating activities-continuing operations		(915,108	)		(361,506	)
Cash used in operating activities-discontinued operations		-			(140,143	)

Net cash used in operating activities		(915,108	)		(501,649	)

Cash flows from investing activities
Additions to property, plant and equipments		(3,192,542	)		(933,657	)
Payments made to acquire Chensheng		(1,838,946	)		-
Proceeds from an associated company		-			483,512
Cash used in investing activities-continuing operations		(5,031,488	)		(450,145	)
Cash used in investing activities-discontinued operations		-			(124,410	)

Net cash used in investing activities		(5,031,488	)		(574,555	)

Cash flows from financing activities
Repayment of cash advanced from director		-			(210,711	)
Proceeds from issuance of preferred stock		5,400,000			9,000,000
Payment of offering costs associated with preferred stock		(647,860	)		(1,507,144	)
Contribution from former non-controlling interest		439,060			-
Change from restricted cash		24,279			-
Cash used in financing activities-continuing operations		5,215,479			7,282,145
Cash used in financing activities-discontinued operations		-			-

Net cash flows provided by financing activities		5,215,479			7,282,145

Effect of exchange rate changes in cash and cash equivalents		(2,488	)		(1,308,366	)

Net (decrease) increase in cash and cash equivalents		(733,605	)		4,897,575

Cash and cash equivalents - beginning of period		5,612,356			2,311,028

Cash and cash equivalents - end of period	$	4,878,751		$	7,208,603

Supplemental disclosure of cash flow information:

Cash paid for interest		-			-
Cash paid for income tax		937,110			-

Supplemental disclosure of non cash investing and financing activities:

Dividend and deemed dividend on preferred stock		2,704,753			-

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

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

Restatement of previously issued September 30, 2009 consolidated Financial Statements

The Group has restated its property, plant and equipment, intangible assets, registration rights penalties payable and certain expenses for the nine months ended September 30, 2009 and expanded the related footnote disclosures. These adjustments resulted in an increase in the Group’s net income for the nine months ended September 30, 2009 by $7,165,496 from the net income of $1,156,720 to $8,322,216 with a corresponding increase in accumulated deficit and equity at September 30, 2009. A detailed discussion of the restatement of the consolidated financial statements for the nine months ended September 30, 2009 originally filed November 16, 2009 is included in note 20.

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, 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, 2008 and notes thereto included in the Form 10KA 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.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

2.	Organization and Nature of Business

China New Energy Group Company (“CNER” and the “Group”) 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.

Reverse Acquisition

On March 28, 2008, the Company executed a share exchange agreement with Willsky Development Ltd. (“Willsky”) whereby the Company issued to the stockholders of Willsky 94,908,650 shares of the Company’s Common Stock in exchange for all of the issued and outstanding capital stock of Willsky (the “Share Exchange”). Prior to the Share Exchange, 7,091,391 shares of Common Stock were issued and outstanding. Willsky thereby became our wholly-owned subsidiary and the former shareholders of Willsky became our controlling stockholders.

Concurrently with the Share Exchange, the two 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.

Simultaneous with the consummation of the Share Exchange, the shareholder of Willsky, Eternal International Holding Group Ltd, a Hong Kong corporation, distributed 85,417,785 shares of the Company’s Common Stock to its shareholders as a dividend. Accordingly, following this distribution and the surrender of 2,000,000 shares held by the existing shareholders, Eternal International beneficially owned approximately 9.49% of the Company’s outstanding capital stock of 100,000,041 common 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.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

2. Organization and Nature of Business-continued

Principal activity

The principal activity of the Group is the operation of natural gas distribution network through its Chinese subsidiary companies. The Group’s operating subsidiaries and branches (which together with the Company are collectively referred to as the “Group”) and their principal activities as of September 30, 2009 are as follows:

Willsky Development Ltd. (“Willsky”)

Willsky Development Ltd. (“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.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

2. Organization and Nature of Business-continued

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 the Company purchased the remaining 51% of Chensheng from 17 individuals, for an aggregate purchase price of approximately $1,840,000 (RMB 12,560,000). 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.

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

On January 23, 2009, Yingkou Zhongneng was established in the PRC and operates a natural gas distribution network in the city of Dashiqiao.

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

On June 26, 2009, Tianjin Binhai Zhongneng Gas Co., Ltd. (“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 another wholly owened subsidiary, Singocean contributed $950,626 (RMB6,500,000) in assets representing 39.4% of the shareholding of Binhai Zhongneng. As a result, the group hold 99.3% of the Binhai Zhongneng.

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 the Group has exclusive operational rights for thirty years in Dashiqiao City. The Group receives a connection fee of $380 (RMB2,600) per user.

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.

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

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

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) Accounting Standards Codification

Effective July 1, 2009, the Financial Accounting Standards Board’s (“FASB”) Accounting Standards Codification TM (“ASC”) became the single official source of authoritative, non-governmental generally accepted accounting principles (“GAAP”) in the United States. The historical GAAP hierarchy was eliminated and the ASC became the only level of authoritative GAAP, other than guidance issued by the Securities and Exchange Commission. Our accounting policies were not affected by the introduction of the Codification but we have updated our references to US GAAP to reflect the Codification.

(e) Cash and Cash Equivalents

The Group considers all highly liquid investments with original maturities of three months or less at the time of purchase to be cash equivalents. As of September 30, 2009 and 2008, the Group did not have any cash equivalents.

Deposits in banks in the PRC are not insured by any government entity or agency, and are consequently exposed to risk of loss. Management believes the probability of a bank failure, causing loss to the Group, is remote.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

3. Summary of Significant Accounting Policies-continued

(f) Property, Plant and Equipment

Property, plant and equipment are stated at cost. Expenditures for maintenance and repairs, which do not improve or extend the expected useful life of the assets, are expensed to operations but major repairs are capitalized. Depreciation is provided principally by use of the straight-line method over the useful lives of the related assets, as follows:

Computer equipment		3 years
Furniture & fixtures		5 years
Office equipment		5 years
Motor vehicles		5 years
Gas transportation vehicles		5 -20 years
Gas station		20-25 years
Underground gas pipelines		20-30 years

The gain or loss on disposal of property, plant and equipment is the difference between the net sales proceeds and the carrying amount of the relevant assets, and, if any, is recognized in the statement of operations.

(g) Intangible Assets

Intangible assets are generally amortized on a straight line basis over their respective estimated useful lives. The Company has no intangible assets with indefinite useful lives. Intangible assets represent land use rights in the PRC. According to Chinese regulations, land belongs to the nation. Land use rights refer to the purchase from the government of the legal right to use the land for 50 years. The land use rights are amortized using the straight-line method over their estimated useful life of 50 years.

(h) Inventories

Inventories, including construction materials, integrated circuit cards, gas meters, polyethylene valves and natural gas are stated at the lower of cost and net realizable value. Cost is calculated using the weighted average method. Net realizable value is based on estimated selling prices in the ordinary course of business less estimated costs to completion and the estimated costs necessary to make the sale.

(i) Goodwill

Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in a business combination. In accordance with FASB ASC 350 Intangibles - Goodwill and Other , goodwill is no longer subject to amortization. Rather, goodwill is subject to at least an annual assessment for impairment, applying a fair-value based test. Fair value is generally determined using a discounted cash flow analysis.

(j) Impairment of Assets

In accordance with FASB ASC 360 Property, Plant and Equipment , the Company evaluates its long-lived assets to determine whether events and circumstances warrant revised estimates of useful lives or a reduction in carrying values due to impairment. If indicators of impairment exist and if the value of the assets is impaired, an impairment loss would be recognized. As of September 30, 2009 and 2008, no impairment loss has been recognized.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

3. Summary of Significant Accounting Policies-continued

(k) Income Taxes

The Group accounts for income taxes under FASB ASC 740 Accounting for Income Taxes . Under FASB ASC 740, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. Under FASB ASC 740, the effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. FASB ASC 740-10-05 Accounting for Uncertainty in Income Taxes prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement of tax positions taken or expected to be taken in a tax return. For those benefits to be recognized, a tax position must be more-likely-than-not to be sustained upon examination by taxing authorities. The amount recognized is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. See Note 14 for a discussion of our income tax provisions.

(l) 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:

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.

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.

For the three and nine months ended September 30, 2009 and 2008, all the contracts for connection services were started and completed in the same period.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

3. Summary of Significant Accounting Policies-continued

(l) Revenue Recognition-continued

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.

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.

(m) Foreign Currency Translation and Transactions

The Group’s functional currency is the Renminbi (“RMB”) and its reporting currency is the U.S. dollar. The Group’s consolidated balance sheet accounts are translated into U.S. dollars at the year-end exchange rates and all revenue and expenses are translated into U.S. dollars at the average exchange rates prevailing during the periods in which these items arise. Translation gains and losses are deferred and accumulated as a component of other comprehensive income in stockholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations from transactions denominated in a currency other than the functional currency are included in the statement of operations as incurred. The translation and transaction gains and losses were immaterial for the nine months ended September 30, 2009 and 2008.

The PRC government imposes significant exchange restrictions on fund transfers out of the PRC that are not related to business operations. These restrictions have not had a material impact on the Group because it has not engaged in any significant transactions that are subject to the restrictions.

(n) 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:

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

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

3)	Level 3, defined as unobservable inputs in which little or no market data exists, therefore requiring the Group to develop our 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, other current liabilities, and our convertible preferred stock. We believe the carrying values of these financial instruments approximate their fair values due to their short-term nature.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

3. Summary of Significant Accounting Policies-continued

(o) Derivative Financial Instruments

We do not use derivative financial instruments to hedge exposures to cash-flow, exchange-rate or market-risks that may affect the fair values of our financial instruments. However, certain financial instruments, such as warrants, which are indexed to our Common Stock, are classified as liabilities when either (a) the holder possesses rights to net-cash settlement or physical or net-share settlement is not within our control or (b) the instrument is not solely indexed to our Common Stock. Derivative financial instruments are initially recorded, and continuously carried, at fair value.

Determining the fair value of these complex derivative financial instruments involves judgment and the use of certain relevant assumptions including, but not limited to, interest rates and stock price volatility. The use of different assumptions could have a material effect on the estimated fair value amounts.

(p) Basic and Diluted Earnings Per Share

The Company reports basic earnings per share in accordance with FASB ASC 260 Earnings Per Share . Basic earnings per share is computed by dividing net income attributable to common shareholders of the Company by the weighted average number of shares outstanding during the periods presented.

Diluted earnings per share is based on the assumption that all dilutive convertible preferred stock, options and warrants were converted or exercised as of the beginning of the period or when issued, if later. Dilution is computed by applying the treasury stock method. Under this method, options are assumed to be exercised at the beginning of the period or the time of issuance, if later, and as if the funds obtained thereby were used to re-purchase Common Stock at the average market price during the period.

(q) Accumulated Other Comprehensive Income

We report comprehensive income in accordance with FASB ASC 220 Comprehensive Income. This statement requires the disclosure of accumulated other comprehensive income or loss (excluding net income or loss) as a separate component of shareholders’ equity. Accumulated other comprehensive income represents the change in equity of the Group during the periods presented from foreign currency translation adjustments.

(r) Profit Appropriation

In accordance with PRC regulations, the Group is required to make appropriations to the statutory surplus reserve, based on after-tax net income determined in accordance with PRC GAAP. Appropriation to the statutory surplus reserve should be at 10% of the after-tax net income determined in accordance with PRC GAAP until the reserve is equal to 50% of the entity’s registered capital. Statutory surplus reserve is non-distributable other than in liquidation.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

3. Summary of Significant Accounting Policies-continued

(s) Accounts Receivable

Gas connection fees are recognized on the percentage of completion method, measured by reference to the value of work carried out during the year. The portion that is not received in cash is recorded as accounts receivable.

Trade accounts receivable are stated at the amount management expects to collect from balances outstanding at the period end. Outstanding account balances are reviewed individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. Over the last two years, we have not experienced any bad debts from customers and, accordingly, did not have a provision for uncollectible accounts at September 30, 2009 and December 31, 2008.

Allowances for doubtful accounts receivable balances are recorded when circumstances indicate that collection is doubtful for particular accounts receivable or as a general reserve for all accounts receivable. Management estimates such allowances based on historical evidence such as amounts that are subject to risk. Accounts receivable are written off if reasonable collection efforts are not successful.

Based on management’s evaluation of historical experience, the following policy for allowance of doubtful accounts is established:

Trade and other receivables due:	% of Balance

Between 91 and 180 days:		5	%
Between 181 and 360 days:		20	%
Between 361 and 720 days:		50	%
Over 721 days:		100	%

(t) Non-controlling interests

As of September 30, 2009, Tianjin Huan Long Trading Ltd. directly held a 1% non-controlling interest in Tianjin Singocean and indirectly held a 0.5% non-controlling interest in Chengsheng, Binhai Zhongneng, and Yingkou Zhongneng.

As of December 31, 2008, Tianjin Huan Long Trading Ltd. directly held a 1% non-controlling interest in Tianjin Singocean and indirectly held a 0.5% non-controlling interest in Chengsheng.

(u) Advertising and promotion costs

Costs incurred in direct-response advertising are capitalized and amortized on a straight-line basis over the duration of the advertising campaign. As of September 30, 2009 and December 31, 2008, there was no capitalized direct-response advertising. All other advertising costs are expensed as incurred. During the three months and nine months ended September 30, 2009 and 2008, advertising and promotion costs were nil.

(v) Post-retirement and post-employment benefits

The Company’s subsidiaries contribute to a state pension plan in respect of their PRC employees. Other than the above, neither the Company nor its subsidiaries provide any other post-retirement or post-employment benefits.

(w) Shipping and handling costs

Shipping and handling costs related to delivery of finished goods are included in selling expenses. During the three months and nine months ended September 30, 2009 and 2008, shipping and handling costs were nil.

(x) Seasonality

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

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

3. Summary of Significant Accounting Policies-continued

(y) New accounting pronouncements

In December 2007, the FASB amended its guidance on accounting for business combinations. The new accounting guidance resulted in a change in our accounting policy effective January 1, 2009, and is being applied prospectively to all business combinations subsequent to the effective date. Among other things, the new guidance amends the principles and requirements for how an acquirer recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, any non-controlling interest in the acquiree and the goodwill acquired. It also establishes new disclosure requirements to enable the evaluation of the nature and financial effects of the business combination. The adoption of this new accounting policy, which has no effect in these consolidated financial statements.

In December 2007, the FASB issued new accounting and disclosure guidance related to non-controlling interests in subsidiaries (previously referred to as minority interests), which resulted in a change in our accounting policy effective January 1, 2009. Among other things, the new guidance requires that a non-controlling interest in a subsidiary be accounted for as a component of equity separate from the parent's equity, rather than as a liability. The new guidance is being applied prospectively, except for the presentation and disclosure requirements, which have been applied retrospectively. The adoption of this new accounting policy affects the presentation and disclosure of non-controlling interests in our consolidated financial statements.

The following Accounting Standards Codification Updates have been issued, or will become effective, after the end of the period covered by these financial statements:

Pronouncement	Issued	Title

ASU No. 2009-13	October 2009	Revenue Recognition (Topic 605): Multiple-Deliverable Revenue Arrangements – a consensus of the FASB Emerging Issues Task Force
ASU No. 2009-14	October 2009	Software (Topic 985): Certain Revenue Arrangements That Include Software Elements—a consensus of the FASB Emerging Issues Task Force
ASU No. 2009-15	October 2009	Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing
ASU No. 2009-16	December 2009	Transfers and Servicing (Topic 860): Accounting for Transfers and Financial Assets
ASU No. 2009-17	December 2009	Consolidations (Topic 810): Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities
ASU No. 2010-01	January 2010	Equity (Topic 505): Accounting for Distributions to Shareholders with Components of Stock and Cash – a consensus of the FASB Emerging Issues Task Force
ASU No. 2010-02	January 2010	Consolidations (Topic 810): Accounting and Reporting for Decreases in Ownership of a Subsidiary – a Scope Clarification
ASU No. 2010-03	January 2010	Extractive Activities – Oil and Gas (Topic 932): Oil and Gas Reserve Estimation and Disclosures
ASU No. 2010-04	January 2010	Accounting for Various Topics: Technical Corrections to SEC Paragraphs
ASU No. 2010-05	January 2010	Compensation - Stock Compensation (Topic718): Escrowed Share Arrangements and the Presumption of Compensation
ASU No. 2010-06	January 2010	Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements
ASU No. 2010-07	January 2010	Not-for-Profit Entities (Topic 958): Not-for-Profit Entities - Mergers and Acquisitions
ASU No. 2010-08	February 2010	Technical Corrections to Various Topics
ASU No. 2010-09	February 2010	Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements
ASU No. 2010-10	February 2010	Consolidation (Topic 810): Amendments for Certain Investment Funds
ASU No. 2010-11	March 2010	Derivatives and Hedging (Topic 815): Scope Exception Related to Embedded Credit Derivatives

To the extent appropriate, the guidance in the above Accounting Standards Codification Updates is already reflected in our consolidated financial statements and management does not anticipate that these accounting pronouncements will have any future effect on our consolidated financial statements.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

4. Restricted cash

At September 30, 2009 and December 31, 2008, restricted cash of $196,873 and $221,152 respectively represented the cash held by Escrow agent for the expenses relating to investor and public relations.

5. Other Receivables

Other receivables consist of the following:

	September 30 2009		December 31 2008

	Restated

Due from Tianjin East Ocean Gas Company Limited	$	1,454,636	$	1,416,707
Other receivables		620,754		838,290

Total	$	2,075,390	$	2,254,997

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 during September 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.

6. Inventories

Inventories at September 30, 2009 and December 31, 2008 of $288,799 and $257,597, respectively, consist of raw materials and do not include any work in progress or finished goods.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

7. Property, plant and Equipment, net

Property, plant and equipment consist of the following:

	September 30, 2009			December 31 2008

	Restated
At Cost
Office Equipment	$	101,126		$	33,660
Motor Vehicles		263,988			171,175
Gas Transportation Vehicles		721,670			652,910
Gas Station		891,121			891,291
Machinery		241,234			141,725
Underground Gas Pipelines		7,411,842			6,630,897
		9,630,981			8,521,658

Less: Accumulated depreciation		(956,991	)		(640,741	)
	$	8,673,990		$	7,880,917

Construction-in-progress		8,447,645			5,589,551
	$	17,121,635		$	13,470,468

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 September 30, 2009, depreciation expenses amounted to $109,069, of which $96,468 and $12,601 was recorded as cost of sales and other selling, general administrative expenses, respectively.

During the three months ended September 30, 2008, depreciation expenses amounted to $43,639, of which $37,811 and $5,828 was recorded as cost of sales and other selling, general administrative expenses, respectively.

During the nine months ended September 30, 2009, depreciation expenses amounted to $315,073, of which $285,692 and $29,381 was recorded as cost of sales and other selling, general administrative expenses, respectively.

During the nine months ended September 30, 2008, depreciation expenses amounted to $123,553, of which $111,637 and $11,916 was recorded as cost of sales and other selling, general administrative expenses, respectively.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

8. Intangible Asset, net

Intangible asset consist of the following:

	September 30, 2009			December 31 2008

	Restated
Land use rights	$	1,348,659		$	1,348,915
Less: accumulated amortization		(61,901	)		(40,540	)

	$	1,286,758		$	1,308,375

Amortization expense for the three months ended September 30, 2009 and 2008 was $8,171 and $2,172, respectively

Amortization expense for the nine months ended September 30, 2009 and 2008 was $22,427 and $6,429, respectively.

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

Remainder of 2009	$	6,345
2010		28,772
2011		28,772
2012		28,772
2013		28,772
Thereafter		1,165,325

Total	$	1,286,758

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

9. Acquisition Consideration Payable

	September 30 2009		December 31 2008
	Restated

Acquisition consideration payable relating to the purchase of Chensheng	$	-	$	1,838,946
Total	$	-	$	1,838,946

The acquisition consideration payable as of December 31, 2008 represents the amount due for acquiring the remaining 51% interest in Chensheng in December, 2008 (see Note 2). This amount was paid on January 20, 2009.

10. Related Party Payable

As of September 30, 2009 and December 31, 2008, the Group has the following balances payable to related parties:

	September 30, 2009		December 31 2008

	Restated
Eternal International Holding Group Ltd, shareholder of the Company	$	400,522	$	400,797

Tianjin Huanlong Commercial and Trading Company, non-controlling shareholder of the a subsidiary	$	97,969	$	97,906
	$	498,491	$	498,703

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

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

11. 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 September 30, 2009 and December 31, 2008, 100,000,041 shares of Common Stock were issued and outstanding.

Series A Convertible Preferred Stock

In connection with the August 20, 2008 private placement described in Note 12, 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”), as described in Note 12.

As described in Note 12, 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 September 30, 2009 and December 31, 2008, there were 2,098,918 shares and 1,857,373 shares, respectively, of Series A Preferred Stock issued and outstanding.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

11. 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 UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

11. 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 UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

11. 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 12. 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 September 30, 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 UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

11. 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 UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

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

August 20, 2008 Private Placement

On August 20, 2008, the Company entered into a Securities Purchase Agreement with China Hand Fund I, LLC (“China Hand”), an accredited investor. Pursuant to the Agreement, the Company issued to China Hand 1,857,373 shares of the Company’s Series A Convertible Preferred Stock and 13,001,608 warrants to purchase Common Stock, for aggregate gross proceeds of $9,000,000. 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 A Preferred Stock are described in Note 11 and the warrants are further described in Note 13.

Kuhns Brothers Securities Corporation (“Kuhns Brothers”) acted as placement agent in connection with the private placement. As compensation for its services, Kuhns Brothers received a cash fee of $900,000, representing 10% of the gross proceeds received from the private placement, as well as warrants to purchase 6,500,804 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 A Preferred Stock.

As discussed in Note 13, on August 20, 2008, the fair value of the 13,001,608 warrants issued to China Hand with the Series A Convertible Preferred Stock was $1,968,182 and the fair value of the 6,500,804 warrants issued to Kuhns Brothers was $984,091.

After deducting the placement agent cash fees and other costs of $1,023,698, the Company received net cash proceeds of $7,076,302.

Registration Rights Agreement

In connection with the private placement, the Company and China Hand entered into a Registration Rights Agreement dated August 20, 2008, in which the Company agreed to register all of the shares of Common Stock underlying the securities issued to China Hand, within a defined period. As discussed and described below, in connection with the May 1, 2009 private placement with China Hand, the Registration Rights Agreement was subsequently amended and restated.

Make Good Provision

The Agreement also provided for a make good provision that initially required the Company to issue to China Hand up to an aggregate of 1,114,442 additional shares of Series A Preferred Stock (557,221 shares for each of 2008 and 2009) if the Company did not achieve defined after-tax net income and earnings per share targets for 2008 and 2009. The 2008 after tax net income and earnings per share targets were $4,300,000 and $0.0261 per share on a fully-diluted basis, respectively. The 2009 after tax net income and earnings per share targets were $6,000,000 and $0.0294 per share on a fully diluted basis, respectively. These targets were subsequently amended in connection with the May 1, 2009 private placement with China Hand.

As amended, the Company agreed to issue to China Hand 241,545 shares of Series A Preferred Stock because the Company did not meet the 2008 earnings target. These additional shares were issued to China Hand on May 1, 2009. For 2009, the number of shares and the earnings target was amended so that China Hand would be entitled to receive up to an additional 241,545 shares if the Company’s 2009 after tax net income was less than $5,000,000. In the event that the 2009 earnings were equal to or greater than 85% of the $5,000,000 target, no shares would be issued to China Hand; in the event that 2009 earnings were less than 50% of the target, all 241,545 shares would be issued to China Hand; and in the event that the 2009 earnings were between 50% and 85% of the target, a pro-rata portion of the 241,545 additional shares would be issued to China Hand. The 2009 earnings target was not met but the target income is greater than 85% of the $5,000,000 target and, accordingly, no further shares were issued.

Management Incentive

China Hand agreed to place in escrow 46,434 shares of Series A Preferred Stock, to be issued to certain members of the Company’s management as a performance incentive if the 2008 and 2009 earnings targets were met. The 2008 earnings target was not met and the shares were returned to China Hand. In connection with the May 1, 2009 private placement with China Hand, the number of shares to be provided as an incentive for 2009 was revised to 22,328 shares of Series B Preferred Stock, as discussed below.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

12. Private Placement of Series A and B Convertible Preferred Stock and Warrants-continued

Accounting

In accordance with the guidance in ASC 815-15-25 Derivatives and Hedging – Recognition , the Series A Preferred Stock is considered to be an equity instrument and, accordingly, the embedded conversion option has not been separated and accounted for as a derivative financial instrument. After allocating $1,968,182 to the initial fair value of the warrants issued to China Hand, the remaining proceeds received from China Hand of $7,031,818 were allocated to the carrying value of the Series A Preferred Stock. As required by ASC 470-20-30 Beneficial Conversion Features , the Company recognized a beneficial conversion feature as of the date of issuance of the Series A Preferred Stock. The amount of the beneficial conversion feature exceeded the proceeds allocated to the carrying value of the Series A Preferred Stock and, accordingly, the beneficial conversion feature recorded was limited to the allocated proceeds. Because the holders of the Series A Preferred Stock may convert their shares at any time, the beneficial conversion feature recorded of $7,031,818 was immediately recognized as a deemed dividend to those holders.

As discussed above, the Company was obligated to issue additional shares of Series A Preferred Stock to China Hand if the Company did not meet prescribed earnings targets for 2008 and 2009. This obligation represents a contingent beneficial conversion feature, which would be accounted for at the date the contingency is resolved. Because all of the proceeds allocated to the Series A Preferred Stock were recognized at inception as a beneficial conversion feature, no further recognition of any beneficial conversion feature is permitted and the 241,545 additional shares issued to China Hand because the 2008 earnings target was not met have been recorded at their value.

Because the Series A Preferred Stock has conditions for its redemption that may be outside our control, including the right of the holders to request redemption at the liquidation value in the event of a Fundamental Transaction or a Change in Control, in accordance with FASB ASC 480-10-S99 Distinguishing Liabilities from Equity , the Series A Preferred Stock has been classified outside of Stockholders’ Equity in our consolidated balance sheet. Because the Company believes that it is not probable that the Series A Preferred Stock will become redeemable, the carrying value of the Series A Preferred Stock is not being adjusted to its redemption value.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

12. Private Placement of Series A and B Convertible Preferred Stock and Warrants-continued

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 11 and the warrants are further described in Note 13.

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 13, 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 September 30,, 2009, 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 May, 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 May 31, 2010. As of September 30, 2009 and December 31, 2008, the Company has accrued $1,728,000 and $900,000 for these registration delay payments, respectively.

Waiver Agreement

On April 30, 2009, in connection with the second private placement, the Company signed a waiver agreement with China Hand. As described above, China Hand agreed to (a) waive any registration delay payments that may have accrued as of the date of the waiver, (b) accept 241,545 additional shares of Series A Preferred Stock in satisfaction of the Company’s obligation for failure to meet the required 2008 earnings target and (c) modify the 2009 earnings target.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

12. Private Placement of Series A and B Convertible Preferred Stock and Warrants-continued

Exchange Listing

In the second Securities Purchase Agreement, the Company agreed to list and trade its shares of Common Stock on the Nasdaq Capital Market or the Nasdaq Global Market or the American Stock Exchange and to include in the listing the shares underlying the Series B Preferred Stock and the Warrants issued to China Hand. In the event the required listing was not completed by January 31, 2010, the Company was obligated to issue to China Hand an additional 27,910 shares of Series B Preferred Stock. The Company’s Common Stock is traded on the Over-The-Counter Bulletin Board but has not yet been listed on a national securities exchange, as required by the agreement with China Hand. Accordingly, the Company expects to issue an additional 27,910 shares of Series B Preferred Stock to China Hand.

Management Incentive

China Hand agreed to place in escrow 22,328 shares of Series B Preferred Stock, to be issued to certain members of the Company’s management as a performance incentive if the 2009 earnings target was met. The earnings target was not met and the Company did not distribute any shares to members of the Company’s management.

Accounting

In accordance with the guidance in ASC 815-15-25 Derivatives and Hedging – Recognition , the Series B Preferred Stock is considered to be an equity instrument and, accordingly, the embedded conversion option has not been separated and accounted for as a derivative financial instrument. After allocating $3,246,693 to the initial fair value of the warrants issued to China Hand, the remaining proceeds received from China Hand of $2,153,807 were allocated to the carrying value of the Series B Preferred Stock. As required by ASC 470-20-30 Beneficial Conversion Features , the Company recognized a beneficial conversion feature as of the date of issuance of the Series B Preferred Stock. The amount of the beneficial conversion feature exceeded the proceeds allocated to the carrying value of the Series B Preferred Stock and, accordingly, the beneficial conversion feature recorded was limited to the allocated proceeds. Because the holders of the Series B Preferred Stock may convert their shares at any time, the beneficial conversion feature recorded of $2,153,807 was immediately recognized as a deemed dividend to those holders.

As discussed above, the Company is obligated to issue additional shares of Series B Preferred Stock to China Hand because the Company did not meet its obligation to list its Common Stock on a national stock exchange no later than January 31, 2010. This obligation represents a contingent beneficial conversion feature, which would be accounted for at the date the contingency is resolved. Because all of the proceeds allocated to the Series B Preferred Stock were recognized at inception as a beneficial conversion feature, no further recognition of any beneficial conversion feature is permitted and the 27,910 additional shares to be issued to China Hand, because the required listing has not yet been obtained, will be recorded at their value.

Because the Series B Preferred Stock has conditions for its redemption that may be outside our control, including the right of the holders to request redemption at the liquidation value in the event of a Fundamental Transaction or a Change in Control, in accordance with FASB ASC 480-10-S99 Distinguishing Liabilities from Equity , the Series B Preferred Stock has been classified outside of Stockholders’ Equity in our consolidated balance sheet. Because the Company believes that it is not probable that the Series B Preferred Stock will become redeemable, the carrying value of the Series B Preferred Stock is not being adjusted to its redemption value.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

13. Derivative financial instruments - warrants

As discussed in Note 12, 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. Accordingly, the Company has restated its 2008 financial statements to account for those warrants as derivative instruments from the time they were 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 $3,246,694 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 September 30, 2009 and 2008, the fair value of the warrants was $2,358,908 and $5,506,143, respectively, based on the following assumptions:

	September 30, 2009	December 31, 2008

Warrants outstanding	31,224,489	19,502,412
Exercise price	$0.187	$0.187
Annual dividend yield	0%	0%
Expected life (years)	3.91 – 4.58	4.64
Risk-free interest rate	1.51% - 2.47%	1.45%
Expected volatility	90%	66%

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 gain of $6,041,231 and $8,017,275 from the change in fair value of these warrants during the three months and nine months ended September 30, 2009.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

14. 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 Company 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 September 30, 2009.

BVI

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

PRC

Pursuant to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for Singocean, Acheng, and Daishiquiao for fiscal year 2009 and 2008, whereas Chensheng is being taxed on 1% of sales figure from January to June 2009 and 25% on net income from July to December 2009 and 0.8% of its annual sales for fiscal year of 2008.

The Company had no material adjustments to its liabilities for unrecognized income tax benefits according to the provisions of FASB ASC 740. The income tax expenses were $828,800 and $461,013 for the nine months ended September 30, 2009 and 2008, respectively. The Company has recorded no deferred tax assets or liabilities as of September 30, 2009 and 2008, since nearly all differences in tax basis and financial statement carrying values are permanent differences.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

14. Income Taxes -continued

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

	For The Three Months Ended						For The Nine Months Ended
	September 30,						September 30,
	2009			2008			2009			2008

	Restated						Restated
Income Tax Expenses
Current tax	$	461,013		$	391,358		$	828,800		$	705,244
Change in deferred tax assets – NOL		1,437,684			57,398			1,681,432			129,223
Change in valuation allowance		(1,437,684	)		(57,398	)		(1,681,432	)		(129,223	)

Total	$	461,013		$	391,358		$	828,800		$	705,244

All of the Company’s income (loss) before income taxes is from PRC sources. Actual income tax expenses reported in the consolidated statements of income and comprehensive income differ from the amounts computed by applying the PRC statutory income tax rate of 25% for the three and nine months ended September 30, 2009 and 2008 respectively to income (loss) before income taxes for the three and nine months ended September 30, 2009 and 2008 for the following reasons:

	For The Three Months Ended						For The Nine Months Ended
	September 30						September 30
	2009			2008			2009			2008

	Restated						Restated

Profit before income taxes	$	6,623,737		$	1,335,840		$	9,151,016		$	2,304,086

Computed “expected” income tax expense at 25% in 2009 and 2008, except on the net income of Chensheng Gas of $70,627 in 2009 and $- in 2008		1,655,934			557,710			2,270,097			576,021
Income tax expense of “Chensheng Gas” - charged at 0.8% of gross sales of $64,519 and $- in 2008		71,460			-			6,941			-
Tax effect of net taxable permanent differences		171,303			33,048			233,194			28,889
Effect of cumulative tax losses		(1,437,684	)		(199,400	)		(1,681,432	)		100,334

	$	461,013		$	391,358		$	828,800		$	705,244

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 three and six months ended June 30, 2009 and 2008.

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

15. Earnings Per Share

Basic earnings per share (EPS) is computed by dividing the earnings for the periods by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution of securities by including other potential common stock, including 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 EPS are presented in the following table:

Components of basic and diluted earnings per share were as follows:

	For The Three Months Ended						For The Nine Months Ended
	September 30						September 30
	2009			2008			2009			2008

	Restated						Restated
BASIC
Numerator for basic and diluted EPS:
Net income from continuing operations attributable to China New Energy Group’s Common Stockholders	$	6,137,620		$	900,357			8,304,016		$	1,775,975
Deemed dividend on preferred stock issued		-			(7,031,818	)		(2,350,829	)		(7,031,818	)
Dividend on preferred stock		(226,946	)		(59,000	)		(550,946	)		(59,000	)
Income (loss) from continuing operations used in computing basic EPS		5,910,674			(6,190,461	)		5,402,241			(5,314,843	)

Basic EPS per share from continuing operations		0.06			(0.06	)		0.05			(0.05	)

Numerator for basic and diluted EPS:
Net income (loss) from discontinued operations	$	-		$	(7,116	)	$	-		$	223,410
Deemed dividend on preferred stock issued		-			-			-			-
Dividend on preferred stock		-			-			-			-
Income (loss) from discontinued operations used in computing basis EPS		-			(7,116	)		-			223,410

Basic EPS per share from discontinued operations		-			(0.00	)		-			0.00

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

15. Earnings Per Share – Continued

DILUTED
Net income (loss) from continuing operations attributable to China New Energy Group’s Common stockholders	$	5,910,674	$	(6,190,461	)		5,402,241	$	(5,314,843	)
Deemed dividend on preferred stock issued		-		7,031,818			2,350,829		7,031,818
Dividend on preferred stock		226,946		59,000			550,946		59,000
Income (loss) from continuing operations used in computing diluted EPS		6,137,620		900,357			8,304,016		1,775,975

Diluted EPS per share from continuing operations		0.03		(0.06	)		0.04		(0.05	)

Net income (loss) from discontinued operations	$	-	$	(7,116	)	$	-	$	(223,410	)
Deemed dividend on preferred stock issued		-		-			-		-
Dividend on preferred stock		-		-			-		-
Income (loss) from discontinued operations used in computing diluted EPS		-		(7,116	)		-		(223,410	)

Diluted EPS per share from discontinued operations		-		(0.00	)		-		(0.00	)

Weighted average outstanding shares of common stock		100,000,041		100,000,041			100,000,041		98,321,560
Weighted average shares of convertible preferred stock outstanding		112,535,710		47,515,529			91,644,433		15,954,119
Warrants and contingently issuable shares		5,413,993		3,162,198			8,199,751		1,969,535
Shares used in computing diluted net income (loss) per share		217,949,744		150,677,768			199,844,225		116,245,214

Total Earnings (Loss) per share:
Basic	$	0.06	$	(0.06	)	$	0.05	$	(0.05	)
Diluted	$	0.03	$	(0.06	)	$	0.04	$	(0.05	)

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

16. Business and geographical segments

The Company’s operations are classified into two principal reportable segments which are provision of gas pipe connection services and 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 September 30, 2009								For the three months ended September 30, 2008							For the three months ended September 30
	Connection								Connection							2009			2008
	services			Natural gas			Corporate		services		Natural gas			Corporate		Total			Total

External revenue	$	2,659,930			157,344			-		2,,092.445		161,413			-		2,817,274			2,253,858
Interest income		10,680			-			-		-		-			-		10,680			-
Interest expense		(3,699	)		-			-		-		-			-		(3,699	)		-
Depreciation and amortization		59,858			36,610			20,772		24,708		13,103			8,000		117,240			45,811
Income tax		461,013			-			-		391,358		-			-		461,013			391,358
Net income/(loss) after income tax		1,923,987			(521	)		4,239,258		1,012,278		(116,817	)		41,905		6,162,724			937,366

Expenditures for long-lived assets		121,197			152,338			9,670				-			-		283,205

CHINA NEW ENERGY GROUP COMPANY

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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

16. Business and geographical segments

Reportable Segments

	For the nine months ended September 30, 2009							For the nine months ended September 30, 2008								For the nine months ended September 30
	Connection							Connection								2009			2008
	services			Natural gas		Corporate		services		Natural gas			Corporate			Total			Total

External revenue	$	5,433,912			518,970		-		3,846,773		390,214			-			5,952,882			4,236,987
Interest income		20,307			-		-		-		-			-			20,307			-
Interest expense		(4,370	)		-		-		-		-			-			(4,370	)		-
Depreciation and amortization		171,410			114,282		51,808		74,729		36,908			18,345			337,500			129,982
Income tax		828,494			306		-		705,244		-			-			828,800			705,244
Net income/(loss) after income tax		3,901,810			1,223		4,419,183		3,059,407		(37,064	)		(1,200,091	)		8,322,216			1,822,252

Expenditures for long-lived assets		2,860,140			172,203		160,199		933,657		-			-			3,192,542			933,657

	As at September 30, 2009							As at December 31, 2008								As at September 30,			As at December 31,
	Connection							Connection								2009			2008
	services			Natural gas		Corporate		services		Natural gas			Corporate			Total			Total

Assets		16,725,017			8,975,356		5,015,296		16,542,520		2,520,108			7,870,119			30,715,669			26,932,747

The Company’s operations are located in the PRC. All revenue is from customers in the PRC. All of the company’s assets are located in the PRC. Accordingly, no analysis of the Company’s sales and assets by geographical market is presented.

17. Concentrations and Credit Risk

Cash - Cash includes cash on hand and demand deposits in accounts maintained with state owned banks within the PRC. The Company 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 September 30, 2009 and December 31, 2008 amounted to $4,878,751 and $5,612,356, respectively, of which no deposits were covered by insurance. Also, as of September 30, 2009 and December 31, 2008, the Company held $196,873 and $221,152, respectively in restricted cash in a corporate legal counsel’s trust account, in accordance with an agreement with investors for the restricted use of preferred stock dividend and investor relation related expenses. Nonperformance by these institutions could expose the Company to losses not covered by insurance. Management reviews the financial condition of these institutions on a periodic basis. The Company has not incurred any losses on these accounts from nonperformance by the aforementioned institutions.

Major customers – For the three months ended September 30, 2009, four customers accounted for approximately 62% of the Company’s sales. For the nine months ended September 30, 2009, one customer accounted for approximately 12% of the Company’s sales and three customers accounted for approximately 40% of the Company’s accounts receivable as of September 30, 2009.

For the three months ended September 30, 2008, three customers accounted for approximately 93% of the Company’s sales. For the nine months ended September 30, 2008, three customers accounted for approximately 84% of the Company’s sales and three customers accounted for approximately 100% of the Company’s accounts receivable as of September 30, 2008.

Major suppliers – For the three months ended September 30, 2009, two suppliers accounted for approximately 47% of the Company’s purchases. For the nine months ended September 30, 2009, one supplier accounted for approximately 11% of the Company’s purchases and four suppliers accounted for approximately 71% of the Company’s accounts payable as of September 30, 2009.

For the three months ended September 30, 2008, two suppliers accounted for approximately 67% of the Company’s purchases. For the nine months ended September 30, 2008, two suppliers accounted for approximately 45% of the Company’s purchases and two suppliers accounted for approximately 61% of the Company’s accounts payable as of September 30, 2008.

Political and economic risks - The Company's operations are carried out in the PRC. Accordingly, the Company'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 Company'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 Company'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.

18. Commitments and Contingencies

Operating Leases - In the normal course of business, the Company leases the land for hen house under operating lease agreements. The Company rents land, primarily for the office rental. The operating lease agreements generally contain renewal options that may be exercised at the Company’s discretion after the completion of the base rental terms. The Company was obligated under operating leases requiring minimum rentals as follows:

As of December 31,

Remainder of 2009	$	43,329
2010		141,678
2011		-
2012		-
2013		-
Thereafter		-

Total minimum lease payments	$	185,007

During the nine months ended September 30, 2009 and 2008, rental expenses included in general and administrative expenses were $102,409 and $8,214, respectively.

During the three months ended September 30, 2009 and 2008, rental expenses included in general and administrative expenses were $39,816 and $0, respectively.

As of September 30, 2009, the Company 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 will grow with the increase of gas users. The Group has selected three qualified gas resource suppliers to ensure stable operations in meeting its obligations.

19. Subsequent Events

The Company evaluated subsequent events through the time of filing this Quarterly Report on Form 10-Q on November 16, 2009. 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.

20. Restatement and reclassification of financial statements

The Restatement results from our management’s determination subsequent to the issuance of our financial statements for the nine months ended September 30, 2009 that was originally filed on November 16, 2009. The Group has also reflected the corrections of the following errors and reclassifications in its consolidated financial statements as of and for the nine months ended September 30, 2009. For Note 1 to Note 3 are the errors reflected in the restated financial statements for the year ended December 31, 2008 which brings the same effects to the financial statements for the period ended September 30, 2009.

No. 1 to No.3 are the same restatement adjustments included in the Form 10KA of China New Energy Group Company filed on April 15, 2010, which brought forward to these financial statements for the nine months ended September 30, 2009.

There were errors in the recording of the fair value of the assets acquired during the acquisition of Chensheng. Therefore, the Group has recorded the increase to the fair value from the book value of several assets, including $1,036,655 of Property, plant and equipment, $757,550 of Intangible assets (ie Land use right) and $3,012 of Inventories, and the decrease in $1,200,477 of Goodwill. Consequently, we recalculated the $96,489 of the depreciation for such increment of those assets and minority interest in Chensheng, which caused a decrease to the minority interest by $77,647 in the consolidated balance sheet and a decrease to the minority interest’s share of net income by $414,763 in the consolidated statement of operations and comprehensive income.

There was an error in the elimination of its intercompany accounts. Therefore, the Group has recorded a decrease in the Related party receivable balances by $84,120 and an increase in the General and administrative expenses by $54,196 and the comprehensive income of $29,924.

The Group reassessed the nature of the Preferred stock together with warrants and the Group reclassified $1,857 and $7,029,961 (total amounting to $7,031,818) from Preferred stock and Additional paid in capital of Stockholders’ Equity to the mezzanine section as of December 31, 2008. Also, the Group reclassified warrant liabilities of $2,952,273 from additional paid in capital and recognized a $2,553,870 loss from the change in fair value of the warrant liabilities in the income statement and the total amount of the warrant liabilities was $5,506,143 as of December 31, 2008. Besides, the Group has accrued $900,000 registration right liabilities as of December 31, 2008.

The adjustments further made for this quarter owing to the effect on the above 3 brought forward restatement adjustments from the 2008K/A are:

The Group further provided the depreciation and amortization of $50,485 in the income statement which brought a decrease of $341 in exchange effects to accumulated other comprehensive income for the increment of the fair value of the assets which decreased $38,894 and $11,932 of the property, plant and equipment and intangible assets respectively for the nine months ended September 30, 2009. The Group decreased the goodwill of $39 by the exchange rate effects.

The Group further provided the depreciation and amortization of $16,817 in the income statement for the increment of the fair value of the assets for the three months ended September 30, 2009.

The Group corrected the Related party receivable by $84,120 and decrease in the General and administrative expenses by $26,706 and the comprehensive income of $57,414.

The Group has further accrued $378,000 and $828,000 registration right liabilities for the three and nine ended September 30, 2009 and it resulted in a total of $1,728,000 as of September 30, 2009.

The Group decreased the deemed dividend of $197,020 from $2,350,327 to $2,153,307 as the beneficial conversion feature further for the nine months ended September 30, 2009.

The Group has recorded an increase in the derivative financial instruments – warrants and the expense for change in fair value of warrant liabilities by $8,017,275 and $6,041,231 for the nine and three months ended September 30, 2009, respectively.

20. Restatement and reclassification of financial statements - continued

The Group has reflected the following reclassifications.

The Group reclassified $2,075,390 of other receivable from current assets to long term assets.

The Group reclassified $649,213 from prepayment to deposits paid for acquisition of long term assets.

The Group reclassified accrued expenses of $277,271 to related party payable.

The group reclassified $207,556 and $75,633 from other payable to accounts payable and related party payable respectively.

The Group reclassified $84,224 from related payable to other receivable.

The Group reclassified $347,202 from additional paid-in capital and $156,144 from statutory surplus reserve fund to accumulated other comprehensive income of $503,347.

The Group reclassified $131,877 and $39,533 of depreciation from general and administrative expenses and cost of sales of natural gas, respectively, to cost of sales of connection services for the nine months ended September 30, 2009.

The Group reclassified $174,036 of depreciation from general and administrative expenses to connection services for the nine months ended September 30, 2009.

The Group reclassified $209,548 of depreciation from cost of sales of natural gas to cost of sales to connection services, general and administrative expenses and selling expenses of $59,857, $90,233 and $59,458 ,respectively, for the three months ended September 30, 2009.

The Group has the above reclassifications which brought the same reclassification effect into the cashflow statements for the nine months ended September 30, 2009.

The net effect of the correction of errors was to:

Increase the Group’s reported total assets as of September 30, 2009 by $461,651 from $30,254,018 to $30,715,669.

Decrease the Group’s reported non-controlling interest as of September 30, 2009 by $77,647 from $220,693 to $143,046.

Decrease the Group’s reported accumulated deficit as of September 30, 2009 by $4,172,726 from accumulated deficit of $(2,382,613) to retained earnings of $1,790,113.

Increase the Group’s reported accumulated other comprehensive income as of September 30, 2009 by $886,570 from $693,939 to $1,580,509.

Increase the Group’s reported net income by $5,646,414 and $7,165,496 for the three and nine months ended September 30, 2009 from $516,310 to $6,162,724 and $1,156,720 to $8,322,216, respectively.

Increase the Group’s reported net income attributable to China New Energy Group by $7,165,496 for the nine months ended September 30, 2009 from $1,156,720 to $8,322,216.

Increase the Group’s reported comprehensive income attributable to China New Energy Group by $5,683,115 and $7,182,908 for the three months and nine months ended September 30, 2009, from $474,402 to $6,157,517 and from $1,102,840 to 8,285,748 respectively.

Decrease the basic net income(loss) per share from continuing operations by $0.06 from $0.00 to $0.06 and $0.07 from $(0.02) to $0.05 for the three and nine months ended September 30, 2009.

Decrease the dilutive net income(loss) per share from continuing operations by $0.03 from $0.00 to $0.03 and $0.06from $(0.02) to $0.04for the three and nine months ended September 30, 2009

20. Restatement and reclassification of financial statements - continued

Condensed Consolidated Balance Sheet as at September 30, 2009

	September 30																September 30
	2009																2009
	(Reported)		Note 1			Note 2			Note 3		Note 4			Note 5			Restated
ASSETS

CURRENT ASSETS
Cash and cash equivalents	$	4,878,751																4,878,751
Restricted cash		196,873																196,873
Accounts receivable		3,925,491																3,925,491

															(84,224	)
Other receivables		2,159,614													(2,075,390	)		-
Related party receivable		-					(84,120	)				84,120						-
Inventories, net		285,787		3,012														288,799
Prepaid expenses		784,953													(649,213	)		135,740
Other current assets		94,017																94,017
TOTAL CURRENT ASSETS		12,325,486		3,012			(84,120	)		-		84,120			(2,808,827	)		9,519,671

Property, plant and equipment, net		16,123,874		1,036,655								(38,894	)					17,121,635
Intangible assets, net		541,140		757,550								(11,932	)					1,286,758
Other receivables		-													2,075,390			2,075,390
Deposits paid for acquisition of long term assets		-													649,213			649,213
Goodwill		1,263,518		(1,200,477	)							(39	)					63,002

TOTAL ASSETS	$	30,254,018		596,740			(84,120	)		-		33,255			(84,224	)		30,715,669

LIABILITIES AND STOCKHOLDERS’ EQUITY

CURRENT LIABILITIES
Accounts payable	$	276,117													75,633			351,750
Accrued expenses		277,271													(277,271	)		-

															(207,556	)
Accrual and other payables		526,837													(75,633	)		243,648
Registration right penalties payable										900,000		828,000						1,728,000
Tax payable		523,770																523,770

															277,271
															207,556
Related party payable		97,888													(84,224	)		498,491
Dividend payable on preferred stock		744,946																744,946
Derivative financial instruments - warrants		-								5,506,143		(3,147,235	)					2,358,908
TOTAL CURRENT LIABILITIES		2,446,829		-			-			6,406,143		(2,319,235	)		(84,224	)		6,449,513

Commitment and contingencies (Note 12)

20. Restatement and reclassification of financial statements - continued

Preferred Stock : 10,000,000 shares authorized, $0.001 par value Series A Convertible Preferred Stock: 2,098,918 and 1,857,373 shares issued and outstanding, liquidation preference of $10,137,774 and $8,971,112, respectively								7,031,818						7,031,818

Series B Convertible Preferred Stock: 1,116,388 and 0 shares issued and outstanding, liquidation preference of $5,399,969 and $0										2,153,307				2,153,307

CHINA NEW ENERGY'S STOCKHOLDERS' EQUITY

Common stock: (500,000,000 shares authorized, $0.001 par value, 100,000,041 shares issued and outstanding) as of September 30, 2009		100,000												100,000
Preferred shares: (10,000,000 shares authorized, 1,857,373 shares issued and outstanding)		2,973						(1,857	)	(1,116	)			-

								(7,029,961	)	(197,022	)
Additional paid in capital		27,269,163						(2,952,273	)	(7,022,231	)	(347,203	)	9,720,473

										8,017,275
										(828,000	)
				414,763				(900,000	)	(23,779	)
Retained earnings/ (Accumulated deficit)		(2,382,613	)	(96,489	)	(54,196	)	(2,553,870	)	197,022				1,790,113

Statutory surplus reserve fund		1,903,034										(156,144	)	1,746,890

										6,169
Accumulated other comprehensive income		693,939		356,113		(29,924	)			50,865		503,347		1,580,509
TOTAL CHINA NEW ENERGY'S STOCKHOLDERS EQUITY		27,586,496		674,387		(84,120	)	(13,437,961	)	199,183		-		14,937,985

Non-controlling interest		220,693		(77,647	)									143,046
TOTAL EQUITY		27,807,189		596,740		(84,120	)	(13,437,961	)	199,183		-		15,081,031

TOTAL LIABILITIES, REDEEMABLE CONVERTIBLE PREFERRED STOCK AND STOCKHOLDERS’ EQUITY	$	30,254,018		596,740		(84,120	)	-		33,255		(84,22 4	)	30,715,669

20. Restatement and reclassification of financial statements - continued

Condensed Consolidated Statements of Operations And Comprehensive Loss for the Nine Months Ended September 30, 2009

	Nine months ended															Nine months ended
	September 30															September 30
	2009															2009
	As reported			Note 1		Note 2		Note 3		Note 4			Note 5			Restated
Revenue:
Connection services		5,433,912															5,433,912
Natural gas		518,970															518,970
		5,952,882			-		-		-		-			-			5,952,882
Cost of Sales:
														39,533
Connection services		1,376,630												131,877			1,548,040
Natural gas		649,622												(131,877	)		517,745
		2,026,252			-		-		-		-			39,533			2,065,785

Gross Profit(Loss)		3,926,630			-		-		-		-			(39,533	)		3,887,097

Operating Expenses:
											(26,706	)		(174,036	)
General and administrative expenses		1,962,698									50,485			(39,533	)		1,772,908
Selling expenses											-			174,036			174,036
Registration rights penalties											828,000			-			828, 000
Total operating expenses		1,962,698			-		-		-		851,779			(39,533	)		2,774,944

Income (Loss) from Operations		1,963,932			-		-		-		(851,779	)		-			1,112,153

Other Income (Expenses):
Change in fair value of warrant liabilities		-									8,017,275						8,017,275
Interest income		20,307															20,307
Interest expense		(4,370	)														(4,370	)
Other Income		5,651															5,651
Total other income (expense)		21,588			-		-		-		8,017,275			-			8,038,863

Income From Continuing Operations, Before Income Tax		1,985,520			-		-		-		7,165,496			-			9,151,016

Income Tax		(828,800	)														(828,800	)

Income From Continuing Operations, net of Income Tax		1,156,720			-		-		-		7,165,496			-			8,322,216

Income From Discontinued Operations, net of Income Tax		-															-
Net Income		1,156,720			-		-		-		7,165,496			-			8,322,216

Less: Net Income Attributable to Non-controlling Interest		(18,200	)														(18,200	)

Net Income Attributable to China New Energy Group		1,138,520			-		-		-		7,165,496			-			8,304,016

Dividend and Deemed Dividend on Preferred Stock		-									(2,074,753	)					(2,074,753	)

Net Income Attributable to Common Stockholders		1,138,520			-		-		-		5,090,743			-			6,22 9,263

Other Comprehensive Income
Net Income		1,156,720									7,165,496						8,322,216
Foreign currency translation gain(loss)		(41,854	)								17,412						(24,442	)
Comprehensive Income Attributable to Non-controlling Interest		(12,026	)								-						(12,026	)

Comprehensive income attributable to the Company		1,102,840			-		-		-		7,182,908			-			8, 28 5,748

Income (Loss) per share - Basic
Income (Loss) from continuing operations		(0.02	)								0.07						0.05
Income (Loss) from discontinued operations		0.00															0.00
Total Income (Loss) per share		(0. 0 2	)		-		-		-		0.07			-			0.05

Income (Loss) per share - Diluted
Income (Loss) from continuing operations		(0.02	)								0.06						0.04
Income (Loss) from discontinued operations		-															0.00
Total Income (Loss) per share		( 0.02	)		-		-		-		0.06			-			0.0 4

Weighted average common shares outstanding
Basic		100,000,041															100,000,041
Diluted		199,84 4,225															199,844,225

20. Restatement and reclassification of financial statements - continued

Condensed Consolidated Statements of Operations And Comprehensive Loss for the Three Months Ended September 30, 2009

	Three months ended															Three months ended
	September 30,															September 30,
	2009															2009
	As reported			Note 1		Note 2		Note 3		Note 4			Note 5			Restated
Revenue:
Connection services		2,659,930															2,659,930
Natural gas		157,344															157,34 4
		2,817,274			-		-		-		-			-			2,817,274
Cost of Sales:
Connection services		683,068												59,857			742,925
Natural gas		367,411												( 209 , 548	)		157,863
		1,050,479			-		-		-		-			(149,691	)		900,788

Gross Profit		1,766,795			-		-		-		-			149,691			1,916,486

Operating Expenses:
General and administrative expenses		802,011									16,817			90,233			909,061
Selling expenses		-												59,458			59,458
Registration rights penalties		-									378,000						378,000
Total operating expenses		802,011			-		-		-		394,817			149,691			1,346,519

Income (Loss) from Operations		964,784			-		-		-		(394,817	)		-			569,967

Other Income (Expenses):
Change in fair value of warrant liabilities		-									6,041,231						6,041,231
Interest income		10,680															10,680
Interest expense		(3,699	)														(3,699	)
Other Income		5,558															5,558
Total other income (expense)		12,539			-		-		-		6,041,231			-			6,053,770

Income From Continuing Operations, Before Income Tax		977,323			-		-		-		5,646,414			-			6,623,737

Income Tax		(461,013	)														(461,013	)

Income From Continuing Operations, net of Income Tax		516,310			-		-		-		5,646,414			-			6,162,724

Income From Discontinued Operations, net of Income Tax		-															-
Net Income		516,310			-		-		-		5,646,414			-			6,162,724

Less: Net Income Attributable to Non-controlling Interest		(25,104	)														(25,104	)

Net Income Attributable to China New Energy Group		491,206			-		-		-		5,646,414			-			6,137,620

Dividend and Deemed Dividend on Preferred Stock		-									(204,000	)					(204,000	)

Net Income Attributable to Common Stockholders		468,260			-		-		-		5,442,414			-			5,933,620

Other Comprehensive Income
Net Income		516,310									5,646,414						6,162,724
Foreign currency translation gain (loss)		(42,159	)								36,701						(5,458	)
Comprehensive Income Attributable to Non-controlling Interest		251															251

Comprehensive Income attributable to the Company		474,402			-		-		-		5,683,115			-			6,157,517

Income per share - Basic
Income from continuing operations		0.00									0.06						0.06
Income from discontinued operations		0. 00															0.00
Total Income per share		0.00			-		-		-		0.06			-			0.0 6

Income per share - Diluted
Income from continuing operations		0.00									0.03						0.03
Income from discontinued operations		0.00															0.00
Total Income per share		0.00			-		-		-		0.03			-			0.0 3

Weighted average common shares outstanding
Basic		100,000,041															100,000,041
Diluted		209,495,669															217,949,744

20. Restatement and reclassification of financial statements - continued

	2009															2009
	(Unaudited)															(Unaudited)
	As reported			Note 1		Note 2		Note 3		Note 4			Note 5			Restated
Cash flows from operating activities:
Net income Attributable to China New Energy Group Company	$	1,138,520									7,183,696						8,322,216
Income Attributable to Non-controlling Interest		18,200									(18,200	)					-
Adjustments to reconcile net income to net cash used in operating activities:											-						-
Depreciation and amortization		287,048									50,452						337,500
Change in fair value of warrant liabilities		-									(8,017,275	)					(8,017,275	)
Registration right liabilities											828,000						828,000
Changes in operating assets and liabilities:
Accounts receivable		(1,741,568	)														(1,741,568	)
Other receivables		205,909															205,909
Inventories		(31,228	)														(31,228	)
Prepayment		772,557												(774,707	)		(2,150	)
Other current assets		(90,613	)														(90,613	)
Accounts payable		164,360												(762,882	)		(598,522	)
Accrued expenses		21,251												(21,251	)		-
Other payables		(710,835	)											752,551			41,716
Tax payable		(169,093	)														(169,093	)

Net cash used in operating activities		(135,492	)		-		-		-		26,673			(806,289	)		(915,108	)

Cash flows from investing activities
Addition to property plant and equipment		(3,967,253	)											774,711			(3,192,542	)
Payments made to acquire Chensheng		(1,838,946	)														(1,838,946	)

Net cash used in investing activities		(5,806,199	)		-		-		-		-			774,711			(5,031,488	)

Cash flows from financing activities
Repayment of cash advanced from director		-
Proceeds from issuance of preferred stock		5,400,000															5,400,000
Payment of offering costs associated with preferred stock		(647,860	)														(647,860	)
Contribution from former non-controlling interest		439,060															439,060
Change from restricted cash		24,279															24,279

Net cash provided by financing activities		5,215,479			-		-		-		-			-			5,215,479

Effect of exchange rate changes in cash and cash equivalents		(7,393	)								36,483			(31,578	)		(2,488	)

Net (decrease) in cash and cash equivalents		(733,605	)		-		-		-		-			-			(733,605	)

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

Cash and cash equivalents - end of period	$	4,878,751			-		-		-		-			-			4,878,751

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/A, 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 Dashiqiao, Nandaihe and Zhanhua. Currently, these distribution networks provide natural gas to an aggregate of approximately 64,000 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 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- 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 Travel Hunt Holdings, Inc. common stock in exchange for all of the issued and outstanding capital stock of Willsky Development. Simultaneous with the consummation of the share exchange agreement, 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's 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.

For accounting purposes, the acquisition was accounted for as a recapitalization effected by a share exchange, and the transaction treated as a reverse acquisition with Willsky as the acquirer and Travel Hunt Holdings, Inc. as the acquired party. The assets and liabilities of the acquired entity (Willsky) were brought forward at their book value and no goodwill was recognized.

In 2005, Willsky acquired 99% shareholding of Tianjin Sing Ocean Public Utility Development Co., Ltd. (“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). Singocean has two branch divisions, namely Acheng SingOcean and Dashiqiao SingOcean, and established in the PRC to be operated for a period of 5 years until December 28, 2010 and 50 years until January 18, 2054, respectively.

ChenSheng - 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. Tian 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 Gas 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 Gas 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 engaged in the business of natural gas distribution network in the city of Dashiqiao.

On June 26, 2009, Binhai Zhongneng was established in the PRC. Through our 99.5%-owned subsidiary, Chensheng, we paid $1,462,501 (RMB10,000,000) in cash for a 60.6% interest in Binhai Zhongneng, and through our wholly-owned subsidiary, Sing Ocean, paid $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.

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 nine months ended September 30, 2009 and 2008, all the contracts for connection services were started and completed.

Revenue from sale of gas

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.

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 nine months ended September 30, 2009, we had sales revenue of $5.95 million of which $5.43 million, or 91%, was from connection services while $0.52 million, or 9%, was from gas sales.

Our revenue for the nine months ended September 30, 2009 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.

Third Quarter Financial Performance Highlights

The following are some financial highlights for the third quarter of 2009 (MM represents million):

Revenues : Our revenues were $2.82 MM for the third quarter of 2009, an increase of 25% from the same period of 2008.

Gross Margin : Gross margin was 68% for the third quarter of 2009 compared to gross margin of 74% for the third quarter of 2008, representing a percentage decrease of 6%.

Operating Expenses : Operating expenses (including selling, general and administrative expenses) were $1.35 MM for the third quarter of 2009, an increase of 289% from the same period of 2008.

Net Income / (Loss) : A net income of $6.14 MM resulted for the third quarter of 2009, while the net income for the same period of 2008 was $0.90 MM, The increment of net income was mainly due to changes in fair value of warrant liabilities of $6.04 MM for the third quarter of 2009.

Fully diluted net income per share : Fully diluted net income per share was $0.03 for the third quarter of 2009, as compared to net loss per share of ($0.06) for the same period of 2008.

Taxation

As a Delaware company, the Company is subject to United States taxation, but no provision for income taxes was made for the nine months ended September 30, 2009 and 2008 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 nine months ended September 30, 2009 and 2008 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%.

Acheng is a division of SingOcean ； thus, it is not subject to separate statutory income tax.

Yingkou Zhongneng was funded as an independent legal entity in January 2009 from a division of SingOcean which is subject to the tax laws of the PRC at the prevailing statutory rate of enterprise income tax of 25%.

Chensheng is 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%.

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 September 30, 2009 and 2008

The following table summarizes the results of our operations during the three-month periods ended September 30, 2009 and 2008:

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

	For the three months ended
	September 30,
	2009			2008			Change			Change%
	Restated

Revenues:	$	2,817		$	2,254		$	563			25	%

Cost of Sales:		901			576			325			56	%

Gross Profit		1,916			1,678			238			14	%

Total operating expenses		1,347			346			1,001			289	%

Income from Operations		570			1,332			(762	)		-57	%

Other Income:
Change in fair value of warrant liability		6,041			-			6,041			100	%
Interest income		11			-			11			100	%
Interest expenses		-4			-			-4			-100	%
Other Income		6			4			2			50	%

Income From Continuing Operations, Before Income Tax		6,624			1,336			5,288			396	%

Income Tax		(461	)		(391	)		-70			-18	%

Income from Discontinued Operations, net of Income Tax		-			(7	)		7			100	%

Non-controlling Interest		(25	)		(37	)		12			-32	%

Net Income attributable to China New Energy Group		6,138			900			5,238			582	%

Revenues . Revenues are derived primarily from connection fees and sales of natural gas. Revenues increased $0.57 MM, or 25%, to $2.82 MM for the three months ended September 30, 2009 from $2.25 MM for the same period in 2008. This increase was mainly attributable to an increase in number of connection households.

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 $0.32 MM, or 56%, to $0.90 MM for the three months ended September 30, 2009 from $0.58 MM during the same period in 2008. Such increase was mainly attributable to a increase in the number of households connected to our distribution network.

Gross Profit . Our gross profit increased by $0.24 MM, or 14%, to $1.92 MM for the three months ended September 30, 2009 from $1.68 MM during the same period in 2008. Gross profit as a percentage of revenues or gross profit margin, was 68% for the three months ended September 30, 2009. The gross profit margin during the same period in 2008 was 74%. Such decrease in gross profit margin was mainly due to an increase of operating assets and thus increased the cost allocation of depreciation.

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 September 30, 2009, the total operating expenses were $1.35 MM while the amount was $0.35 MM for the same period of 2008, or increased by 289%. This increase was mainly due to the fact that: (1) we are expanding our company; and (2) recognized $0.38 MM of registration rights penalties in the third quarter of 2009. Management believes that the relatively high SG&A expenses will continue as we endeavor to expand our business.

Income from Operations Our income from operation decreased by $0.76 MM, or 57%, to $0.57 MM for the three months ended September 30, 2009 from $1.33 MM during the same period in 2008. This decrease in income from operations was mainly due to increase in operating expenses.

Other Income (Expenses)

Change In Fair Value of Warrant Liability: For the three months ended September 30, 2009, the change in fair value of warrant liability was recorded as other income of $6.04 MM while the one incurred in the same period of 2008 was nil.

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 September 30, 2009, the fair value of the Series A and B Convertible Preferred Stock were $2.36 MM. Therefore, the Company recognized a $6.04 MM gain from the change in fair value for the three months ended September 30, 2009 during the same period of 2008 gain from the change in fair value was nil.

Income From Continuing Operations, Before Income Tax Our income from continuing operations, before income tax increased by $5.29 MM, to $6.62 MM for the three months ended September 30, 2009 from $1.33 MM during the same period in 2008. Such increase was mainly due to the fact that the company recorded a $6.04 MM income from the change in fair value of the warrants which put through according to EITF 07-05.

Income (Loss) From Discontinued Operations

The income (loss) from the discontinued operation was due to the fact that, on September 26, 2008, the Company entered into an asset swap in which it disposed of the subsidiary Hunchun, including substantially (99%) of the net assets, for a 49% ownership in Qinhuangdao Chensheng Gas Co. Ltd.

In accordance with SFAS No. 144, “Accounting for the Impairment of Long-Lived Assets”, Hunchun Singocean operation is being accounted for as discontinued operations and, accordingly, its operating results are segregated and reported as discontinued operations in the accompanying consolidated statement of operations in 2008. There were no assets or liabilities of Hunchun in the consolidated balance sheet as of September 30, 2008.

Disposal of Hunchun in 2008

The following table displays summarized activity in the Company's consolidated statements of operations for discontinued operations of Hunchun during the three months ended September 30, 2008.

	2009 (MM)	2008 (MM)

Revenue	$	$
Operating income	$	$	(0.01	)
Income before income taxes	$	$	(0.01	)
Income tax expense	$	$
Income from discontinued operations, net of tax	$	$	(0.01	)

Net Income attributable to China New Energy Group Net income increased by $5.24 MM, to a net income of $6.14 MM for the three months ended September 30, 2009, from net income of $0.90 MM for the same period of 2008, which is mainly due to: (1) an increase in gross profit by $0.24 MM; and (2) income from the change in fair value of the warrants, $6.04MM.

Comparison of Nine Months Ended September 30, 2009 and 2008

The following table summarizes the results of our operations during the nine-months ended September 30, 2009 and 2008:

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

	(Unaudited)
	For the nine months ended
	September 30,
	2009			2008			Change			Change%
	Restated

Revenues:	$	5,953		$	4,237			1,716			40	%

Cost of Sales:		2,066			1,129			937			83	%

Gross Profit		3,887			3,108			779			25	%

Total operating expenses		2,775			814			1,961			241	%

Income from Operations		1,112			2,294			(1,182	)		-52	%

Other Income:
Change in fair value of warrant liability		8,017			-			8,017			100	%
Interest income		20			-			20			100	%
Interest expenses		-4			-			-4			-100	%
Other Income		6			10			(4	)		-40	%

Income From Continuing Operations, Before Income Tax		9,151			2,304			6,847			297	%

Income Tax		(829	)		(705	)		-124			-18	%

Income from Discontinued Operations, net of Income Tax		-			223			-223			-100	%

Non-controlling Interest		(18	)		(46	)		28			-61	%

Net Income attributalbe to China New Energy Group		8,304			1,776			6,528			368	%

Revenues . Revenues are derived primarily from connection fees and sales of natural gas. Revenues increased $1.71 MM, or 40%, to $5.95 MM for the nine months ended September 30, 2009 from $4.24 MM for the same period in 2008. This increase was mainly attributable to an increase in number of connection households.

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 $0.94 MM, or 83%, to $2.07 MM for the nine months ended September 30, 2009 from $1.13 MM during the same period in 2008. Such increase was mainly attributable to an increase in the number of households connected to our distribution network.

Gross Profit . Our gross profit increased by 0.78 MM, or 25%, to $3.89 MM for the nine months ended September 30, 2009 from $3.11 MM during the same period in 2008. Gross profit as a percentage of revenues or gross profit margin, was 65% for nine months ended September 30, 2009. The gross profit margin during the same period in 2008 was 73%. Such decrease in gross profit margin was mainly due to an increase of operating assets and thus increased the cost allocation of depreciation.

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 nine months ended September 30, 2009, the total operating expenses were $2.78 MM while the amount was $0.81 MM for the same period of 2008, or increased by 241%. This increase was mainly due to the fact that: (1) we are expanding our company; and (2) recognized $0.83 MM of registration rights penalties during the nine months ended September 30, 2009. Management believes that the relatively high SG&A expenses will continue as we endeavor to expand our business.

Income from Operations Our income from operations decreased by $1.18 MM, or 52%, to $1.11 MM for the nine months ended September 30, 2009 from $2.29 MM during the same period in 2008. This decrease in operating income was mainly due to an increase in registration rights penalties.

Total Other Income (Expenses)

Change In Fair Value of Warrant Liability: For the nine months ended September 30, 2009, the change in fair value of warrant liability was recorded as other income of $8.02 MM while the one incurred in the same period of 2008 was nil.

As of September 30, 2009, the fair value of the Series A and B Convertible Preferred Stock were $2.36MM. Therefore, the Company recognized an $8.02 MM gain from the change in fair value for the nine months ended September 30, 2009 during the same period of 2008 loss from the change in fair value was nil.

Income From Continuing Operations, Before Income Tax. Our income from continuing operations, before income tax increased by $6.85 MM, to $9.15 MM for the nine months ended September 30, 2009 from $2.30 MM during the same period in 2008. Such increase was mainly due to the fact that the company recorded a $8.02 MM income from the change in fair value of the warrants which put through according to EITF 07-05.

Income (Loss) From Discontinued Operations

Disposal of Hunchun in 2008

The following table displays summarized activity in the Company's consolidated statements of operations for discontinued operations of Hunchun during the nine months ended September 30, 2008.

	2009 (MM)	2008 (MM)

Revenue	$	$	0.46
Operating income	$	$	0.30
Income before income taxes	$	$	0.30
Income tax expense	$	$
Income from discontinued operations, net of tax	$	$	0.30

Net Income . attributable to China New Energy Group Net income increased by $6.52 MM, to a net income of $8.30 MM for the nine months ended September 30, 2009, from a net income of $1.78 MM for the same period of 2008, which is mainly due to: (1) an increase in gross profit by $0.78 MM; and (2) income from the change in fair value of the warrants, $8.02 MM.

Liquidity and Capital Resources

As of September 30, 2009, we had cash and cash equivalents of approximately $4.88 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 Nine Months Ended
	September 30
	2009			2008
	Restated

Net cash used in operating activities	$	(915	)	$	(502	)

Net cash used in investing activities		(5,031	)		(575	)

Net cash flows provided by financing activities		5,215			7,282

Effect of exchange rate changes in cash and cash equivalents		(2	)		(1,308	)

Net increase (decrease) in cash and cash equivalents	$	(734	)	$	4,898

Operating Activities

Net cash used in operating activities was $0.92 MM for the nine months ended September 30, 2009, compared to net cash used in operating activities of $0.50 MM during the same period of 2008. This increase in funds used in our operating activities was primarily due to an increase in accounts receivable.

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 nine months ended September 30, 2009 was $5.03 MM which was an increase of $4.45 MM from $0.58 MM for the same period of 2008. This increase was due to payments made for the increased construction in progress and fixed assets.

Financing Activities

Our debt (included warrant liabilities) to equity ratio (total debt/total equity) was 104% as of September 30, 2009. Net cash provided by financing activities for the nine months ended September 30, 2009 was $5.22 MM, which is a decrease of $2.06 MM from $7.28 MM during the same period of 2008. This decrease was mainly attributable to issue less preferred stock in 2009.

On August 20, 2008, we completed a private placement in which we sold to China Hand Fund I, LLC, or China Hand, and its designees 1,857,373 shares of our Series A Preferred Stock and warrants to purchase 13,001,608 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 $9,000,000.

Subsequently, 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.

Additionally, we agreed to certain make good provisions that will require us to issue to China Hand up to 334,916 additional shares of our Series B Preferred Stock if we do not achieve audited after-tax net income of $5.0 million for the year ending December 31, 2009. If we are successful in achieving this income target, China Hand will transfer 22,327 shares of its Series B Preferred Stock to certain members of our management. We also agreed to issue to China Hand 27,910 shares of our Series B Preferred Stock if our common stock is not listed for trading on a national securities exchange on or before January 31, 2010.

Kuhns Brothers Securities Corporation, or Kuhns Brothers, acted as placement agent in connection with the August 20, 2008 and May, 1, 2009 private placements. In each case, as compensation for its services, Kuhns Brothers received a cash fee equal to 10% of the gross proceeds received from each private placement, as well as warrants to purchase 10% of the aggregate number of shares of our common stock issuable to China Hand in each private placement upon conversion of the Series A and Series B Preferred Stock. Accordingly, Kuhns Brothers received cash fees of $900,000 and $540,000, and warrants to purchase 6,500,804 and 3,907,358 shares of our common stock, in connection with the August 20, 2008 and May 1, 2009 private placements, respectively.

Capital Expenditures, Contractual Obligations, Commitments and Contingences

For the nine months ended September 30, 2009, the company spent about $5.03 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 of its contractual obligations. Other than the operating leases stated in Note 18 to Unaudited Condensed Consolidated Financial Statements, we have no other commitments and contingencies. As disclosed in Note 18, the Company is obligated under operating leases to pay minimum lease payments of approximately $0.19 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

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

ITEM 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.

Not Applicable.

ITEM 4.

CONTROLS AND PROCEDURES.

Disclosure Controls and Procedures.

As required by Rule 13a-15 under the Exchange Act, we carried out an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as of September 30, 2009. This evaluation was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and our Chief Financial Officer. Based upon that evaluation, management concluded that our disclosure controls and procedures were not effective. Our conclusion that our disclosure controls and procedures were not effective was based on the fact that, as more fully disclosed in our Current Report on Form 8-K filed on April 15, 2010, as amended on Form 8K/A filed on April 26 2010, we identified a number of “significant deficiencies” in the process of preparing our financial statements for the fiscal year ended December 31, 2008, which deficiencies have not yet been completely remedied. On April 9, 2010, the Chief Executive Officer and Chief Financial Officer of China New Energy Group, Inc. (the “Company or “we”) concluded that the previously issued audited financial statements for the fiscal year ended December 31, 2008 included in the Company’s Annual Report on Form 10-K filed on April, 15, 2009 (the “2008 10-K”) and the unaudited financial statements for the three months ended March 31, 2009, June 30, 2009 and September 30, 2009 included in its Quarterly Reports on Form 10-Q filed on May 15, 2009, August 14, 2009 and November 16, 2009 (collectively, the “2009 10-Qs”) should no longer be relied upon and that disclosure should be made and action should be taken to prevent future reliance.

On April 26, 2010, the Company filed an amendment to the 2008 10-K, which filing contains restated financial statements for the fiscal year ended December 31, 2008. The Company is filing amendments to the 2009 10-Qs on August 17, 2010.

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed in our reports filed or submitted under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act is accumulated and communicated to management, including the Company’s Chief Executive and acting Chief Financial Officer as appropriate, to allow timely decisions regarding required disclosure.

Changes in Internal Control Over Financial Reporting.

Because our current accounting department is relatively new to U.S. GAAP and the related internal control procedures required of U.S. public companies, our management has determined that they require additional training and assistance in U.S. GAAP matters. Management has determined that our internal audit function is also significantly deficient due to insufficient qualified resources to perform internal audit functions.

In order to correct the foregoing significant deficiencies, we have taken or are taking the following remediation measures:



We have hired a new chief executive officer,



We established an audit committee



We are in the process of arranging necessary training for our accounting department staff;



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



We have committed to the establishment of effective internal audit functions; however, due to the scarcity of qualified candidates with extensive experience in U.S. GAAP reporting and accounting in the region, we were not able to hire sufficient internal audit resources before the end of our reporting period. However, we will increase our search for qualified candidates with assistance from recruiters and through referrals;



In addition, we have allocated significant financial and human resources to strengthen the internal control structure. As part of our efforts to comply with Section 404 of the Sarbanes-Oxley Act for fiscal year 2010, 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 remediate the significant deficiency identified above, and we will continue to monitor the effectiveness of these steps and make any changes that our management deems appropriate.

As described above we are taking certain remediation measures that have materially affected, or is 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 17, 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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CNER China New Energy Group Company (PK)