UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10−Q
(Mark One)
 
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended: June 30, 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 17, 2009 is as follows:
 
Class of Securities
 
Shares Outstanding
Common Stock, $0.001 par value
 
100,000,041
Series A Convertible Preferred Stock, $0.001 par value
 
1,857,373
Series B Convertible Preferred Stock, $0.001 par value
 
1,116,388
 
 
 

 


Quarterly Report on FORM 10-Q
  Three and Six Months Ended June 30, 2009

 
TABLE OF CONTENTS

PART I
FINANCIAL INFORMATION
     
ITEM 1.
FINANCIAL STATEMENTS
2
ITEM 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
20
ITEM 3.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
28
ITEM 4T.
CONTROLS AND PROCEDURES
28
     
PART II
OTHER INFORMATION
     
ITEM 1.
LEGAL PROCEEDINGS
28
ITEM 1A.
RISK FACTORS
28
ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
29
ITEM 3.
DEFAULTS UPON SENIOR SECURITIES
29
ITEM 4.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
29
ITEM 5.
OTHER INFORMATION
29
ITEM 6.
EXHIBITS
29
 
 
 

 

PART I
FINANCIAL INFORMATION
 
ITEM 1.
FINANCIAL STATEMENTS.
 
China New Energy Group Company
Condensed Consolidated Financial Statements
For the three and six months ended
June 30, 2009
(Stated in US dollars)

 
Page
Condensed Consolidated Balance Sheets (Unaudited)
3
   
Condensed Consolidated Statements of Operations and Comprehensive Loss (Unaudited)
4
   
Condensed Consolidated Statements of Cash Flows (Unaudited)
5
   
Notes to Consolidated Financial Statements (Unaudited)
6
 
 
2

 
 
China New Energy Group Company
Condensed Consolidated Balance Sheets
(Stated in US Dollars)

   
June 30
   
December 31
 
   
2009
   
2008
 
   
(Unaudited)
       
ASSETS
           
CURRENT ASSETS
           
Cash and equivalents
  $ 6,128,037     $ 5,833,508  
Accounts receivable
    2,887,687       2,183,087  
Other receivables
    2,013,839       2,254,997  
Inventories, net
    245,724       254,585  
Prepayment
    -       1,558,361  
Other current assets
    77,728       3,340  
Total current assets
    11,353,015       12,087,878  
                 
                 
Property, plant and equipment, net
    6,819,008       6,844,262  
Construction in progress
    9,777,981       5,589,551  
Related party receivable
    -       84,120  
Intangible assets
    1,834,265       1,814,316  
TOTAL ASSETS
  $ 29,784,269     $ 26,420,127  
                 
LIABILITIES AND  EQUITY
               
CURRENT LIABILITIES
               
Accounts payable
  $ 44,558     $ 111,660  
Accrued expenses
    331,008       256,071  
Accruals and other payable-Third Party
    544,120       3,144,043  
Tax payable
    688,629       693,116  
Related party payable
    97,969       -  
Dividend payable
    518,000       194,000  
TOTAL CURRENT LIABILITIES
    2,224,284       4,398,890  
                 
Commitments and contingencies (Note 11)
               
                 
China New Energy's Stockholders' equity:
               
Preferred shares: 10,000,000 shares authorized, $0.001 par value, 2,973,761 and 1,857,373 shares issued and outstanding as of June 30,2009 and December 31, 2008, respectively
    2,973       1,857  
Common Stock: 500,000,000 shares authorized, $0.001 par value, 100,000,041 shares issued and outstanding as of June 30,2009 and December 31, 2008, respectively
    100,000       100,000  
Additional paid in capital
    27,269,162       19,725,482  
Retained deficit
    (2,646,872 )     (619,357 )
Statutory surplus reserve fund
    1,903,034       1,903,034  
Accumulated other comprehensive income
    735,847       730,168  
Total China New Energy's Stockholders' equity
    27,364,144       21,841,184  
                 
Non-controlling interest
    195,841       180,053  
TOTAL EQUITY
    27,559,985       22,021,237  
                 
TOTAL LIABILITIES AND EQUITY
  $ 29,784,269     $ 26,420,127  

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

 
3

 

China New Energy Group Company
Condensed Consolidated Statement of Operations and Comprehensive Income (Loss) - (Unaudited)
(Stated in US Dollars)

   
For the Three months ended
   
For the Six months ended
 
   
June 30,
   
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Revenues:
                       
Connection services
  $ 2,627,230     $ 1,780,417     $ 2,773,982     $ 1,780,417  
Natural gas
    183,361       125,662       361,625       227,417  
      2,810,591       1,906,079       3,135,608       2,007,834  
Cost of Sales
                               
Connection services
    656,874       387,237       693,562       387,237  
Natural gas
    56,398       96,698       282,210       172,635  
      713,272       483,935       975,773       559,872  
Gross Profit
    2,097,319       1,422,145       2,159,835       1,447,963  
                                 
Operating Expenses:
                               
Selling, general and administrative expenses
    752,489       224,714       1,160,687       471,133  
                                 
Total operating expenses
    752,489       224,714       1,160,687       471,133  
                                 
Operating income
    1,344,830       1,197,430       999,148       976,829  
                                 
Other Income (Expenses):
                               
Change in derivative liability
    -       - 910,000       -       - 910,000  
Interest Income
    1,270       6,539       9,627       6,415  
Interest (expense)
    -       -       - 671       -  
Other Income (expenses)
    -       -       93       -  
Total other income (expenses)
    1,270       (903,461 )     9,049       (903,585 )
                                 
Income from continuing operations, before tax
    1,346,100       293,970       1,008,198       73,245  
                                 
Income Taxes
    366,790       318,047       367,787       318,047  
                                 
Income (Loss) from continuing operations, net of tax
    979,310       (24,077 )     640,411       (244,802 )
                                 
Income from discontinued operations, net of tax
    -       235,329       -       217,491  
Net Income (Loss)
    979,310       211,252       640,411       (27,311 )
                                 
Net (Income) Loss attributable to non controlling interest
    (14,051 )     (8,237 )     6,903       (7,071 )
                                 
Net Income (Loss) attributable to China New Energy Group
    965,259       203,015       647,314       (34,382 )
                                 
Other Comprehensive income
                               
Net Incom (Loss)     979,310       211,252       640,411       (27,311 )
Foreign currency translation
    11,094       (127,843 )     305       -  
Comprehensive income attributable to the Non-controlling interest
    (8,678 )     (1,291 )     (12,277 )     -  
Comprehensive income (loss) attributable to China New Energy Group
  $ 981,726     $ 82,118     $ 628,439     $ (27,311 )
                                 
Income (Loss) per share - Basic & Diluted
                               
Loss from continuing operations attributable to the Company's common stockholders
  $ (0.02 )   $ 0.00     $ (0.02 )   $ (0.00 )
Discontinued operations attributable to the Company's common stockholders
  $ 0.00     $ 0.00     $ 0.00     $ 0.00  
Net (Loss) income attributable to the Company's common stockholders
  $ (0.02 )   $ 0.00     $ (0.02 )   $ 0.00  
                                 
Weighted average common shares outstanding
                               
Basic & Diluted
    100,000,041       100,000,041       100,000,041       97,566,244  

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

 
4

 

China New Energy Group Company
Condensed Consolidated Statements of Cash Flows - (Unaudited)
(Stated in US Dollars)

   
For The Six Months Ended
 
   
June 30
 
   
2009
   
2008
 
   
(Unaudited)
   
(Unaudited)
 
Cash flows from operating activities:
           
Net income attributable to China New Energy Group Company
  $ 647,314     $ (34,382 )
(Loss) Income attributable to non-controlling interest
    (6,903 )     15,957  
Change in derivative liability
            910,000  
Adjustments to reconcile net income to net cash used in operating activities:
               
Depreciation
    180,187       83,066  
Amortization
    6,392       4,257  
                 
Changes in operating assets and liabilities:
               
Accounts receivable
    (703,104 )     (393,348 )
Other receivables
    353,535       3,141  
Inventories
    9,024       186,918  
Prepayment
    1,559,165       -  
Other current assets
    (74,377 )     -  
Accounts payable
    (67,166 )     349,426  
Accrued expenses
    74,772       -  
Accruals and other payable-Third Party
    (693,240 )     (801,863 )
Taxes payable
    (4,933 )     (781,975 )
                 
Net cash provided by (used in) operating activities
    1,280,666       (458,803 )
                 
Cash flows from investing activities
               
Addition of construction in progress
    (4,184,295 )     (1,467,327 )
Addition of fixed assets
    (150,529 )     -  
Increase in short-term loan
            660,000  
Payments made to acquire Chensheng
    (1,838,946 )     -  
                 
Net cash used in investing activities
    (6,173,770 )     (807,327 )
                 
Cash flows from financing activities
               
Issued preferred stock
    4,752,140       -  
Contribution from former non-controlling interest
    439,060       -  
Loan from related parties
    -       252,064  
                 
Net cash flows provided by financing activities
    5,191,201       252,064  
                 
Effect of exchange rate changes in cash
    (3,567 )     (11,869 )
                 
Net increase (decrease) in cash
    294,529       (1,025,935 )
                 
Cash- beginning of year
    5,833,508       2,311,028  
                 
Cash- end of year
  $ 6,128,037     $ 1,285,093  
                 
Supplemental disclosure of cash flow information:
               
Interest paid in cash
    671       -  
Income taxes paid in cash
    372,605       -  
                 
Supplemental disclosure of non cash investing and financing activities:
               
                 
Accrued dividend of preferred stock
    324,000          

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

 
5

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
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 Company, 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 Company 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 Company for the year ended December 31, 2008 and notes thereto included in the Form 10K of China New Energy Group Company filed on April 15, 2009. The Company follows the same accounting policies in the preparation of interim reports.

Reclassifications
Certain prior year amounts on the financial statements have been reclassified to conform to current classifications. Such reclassifications had no effect on net income (loss).

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

2. 
Discontinued Operations

Effective September 26, 2008, the Company entered into an asset swap in which it disposed of the subsidiary Hunchun SingOcean including substantially all of the assets. 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 2009 and 2008.

 
6

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
3. 
New Accounting Pronouncements

In June 2009, the FASB issued Statement of Financial Accounting Standards No. 168, “The FASB Accounting Standards CodificationTM and the Hierarchy of Generally Accepted Accounting Principles a replacement of FASB Statement No. 162. This Statement identifies the sources of accounting principles and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles in the United States. SFAS 168 shall be effective for financial statements issued for interim and annual periods ending after September 15, 2009. The adoption of this pronouncement did not have a material impact on the company’s financial statements

On June 12, 2009 the FASB issue two statements that amended the guidance for off-balance sheet accounting of financial instruments: SFAS No. 177, Accounting for transfers of Financial assets, and SFAS No. 167, Amendments to FASB Interpretation No. 46 (R).

SFAS No. 166 revises SFAS No. 140 , Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and will require entities to provide more information about sale of securitized financial assts and similar transactions, particularly if the seller retains some risk to the assets, the FASB said.  The statement eliminates the concept of a qualifying special-purpose entity, changes the requirements for the derecognition of financial assets and call upon sellers of the assets to make additional disclosures about them.

SFAS no. 167 amends FASB Interpretation (FIN) No 46(R), Consolidation of Variable Interest Entities, by altering how a company determines when an entity that is sufficiently capitalized or not controlled through voting should be consolidated, the FASB said.  A company has to determine whether it should provide consolidated reporting of an entity based upon the entity’s purpose and design and the parent company’s ability to direct the entity’s actions.

The standards will be effective at the start of the first fiscal year beginning after November 15, 2009, which will mean January 2010 for companies that are on calendar years.  The Company is currently evaluating the impact that SFAS No. 166 and No. 167 will have on its financial statements.

We have considered all other recently issued accounting pronouncements and do not believe the adoption of such pronouncements will have a material impact on our consolidated financial statements.

 
7

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
4. 
Net (Loss) Income Per Share

Earnings (loss) per share are computed pursuant to Statement of Financial Accounting Standards No. 128 “Earnings Per Share” (“SFAS No. 128). Basic net (loss) income per share is computed by dividing net (loss) income available to common shareholders by the weighted-average number of common shares outstanding during the period. Diluted net loss per common share is computed by dividing net (loss) income by the weighted average number of shares of common stock and potentially outstanding shares of common stock during each period to reflect potential dilution that could occur from common shares issuable through common stock equivalents.

Warrants and contingently issuable shares are included in the diluted EPS denominator through the treasury stock method. In applying the treasury stock method, all dilutive potential common shares, regardless of whether they are exercisable, are treated as if they had been exercised. The treasury stock method assumes that the proceeds upon exercise are used to repurchase the entity’s common stock at the average market price during the period. If the exercise price is lower than the market price of the stock then the proceeds are not sufficient to buy back all the shares. The incremental shares remaining are added to the weighted average number of shares outstanding for the period.

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

   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
   
June 30,
   
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
(Loss) income per share – Basic
                       
Numerator for basic EPS:
                       
Net income (loss) attributable to China New Energy Group
  $ 965,259     $ 203,015     $ 647,314     $ (34,382 )
Dividend accrued on Preferred Stock
    (130,000 )     -       (324,000 )     -  
Deemed dividend due to Beneficial Conversion Feature
    (2,350,829 )     -       (2,350,829 )     -  
(Loss) income attributable to common stockholders
    (1,515,570 )     203,015       (2,027,515 )     (34,382 )
                                 
Denominator for basic and diluted EPS
                               
Weighted average shares of common stock outstanding
    100,000,041       100,000,041       100,000,041       97,566,244  
                                 
(Loss) income per share – Basic
  $ (0.02 )   $ 0.00     $ (0.02 )   $ (0.00 )
                                         - Diluted
  $ (0.02 )   $ 0.00     $ (0.02 )   $ (0.00 )

The following table shows the weighted average number of potentially dilutive shares excluded from the diluted net (loss) income per share calculation for the three months and six months ended June 30, 2009 and 2008, respectively.

 
8

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
 
   
Three months ended
   
Six months ended
 
   
June 30,
   
June 30,
   
June 30,
   
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
Potentially Dilutive Shares:
                       
Convertible preferred stock
    91,200,235       -       78,176,499       -  
Warrants, and contingently issuable shares
    20,980,665       -       18,811,693       -  
Total
    112,180,900       -       96,988,192       -  

These potentially dilutive securities were excluded because the effect would have been anti-dilutive.

5. 
Inventories

Inventories consist of the following:

   
June 30
   
December 31
 
   
2009
   
2008
 
                 
Raw materials
  $ 245,724     $ 254,585  
 
9

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

6.
Plant and Equipment, net

   
June 30
   
December 31,
 
   
2009
   
2008
 
   
 
       
At cost
           
Office equipment
  $ 91,540     $ 33,893  
Motor vehicles
    280,181       187,137  
Gas transportation vehicles
    425,211       424,937  
Gas station
    2,103,966       2,102,612  
Underground gas pipelines
    4,726,562       4,723,520  
      7,627,460       7,472,099  
                 
Less: accumulated depreciation
    (808,452 )     (627,837 )
                 
    $ 6,819,008     $ 6,844,262  

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

Depreciation expense for the six months ended June 30, 2009 and 2008 was $180,187 and $83,066 respectively.

 
10

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

7.
Intangible Assets, net

   
June 30
   
December 31,
 
   
2009
   
2008
 
   
 
       
At cost
           
Land use rights
  $ 587,808     $ 587,430  
Goodwill
    1,289,478       1,263,492  
      1,877,286       1,850,922  
                 
Less: accumulated amortization
    (43,021 )     (36,606 )
                 
    $ 1,834,265     $ 1,814,316  

Amortization expense for the six months ended June 30, 2009 and 2008 was $ 6,392 and $ 4,257, respectively.

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

Remainder of 2009
  $ 6,703  
2010
    12,768  
2011
    12,768  
2012
    12,768  
2013
    12,768  
Thereafter
    487,012  
         
Total
  $ 544,787  
 
 
11

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

8.
Income Taxes

The Company, 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 operated. 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 June 30, 2009 other than minimum tax liability. A subsidiary of the Company was incorporated under the international Business Companies Act of British Virgin Islands and, accordingly is exempted from payment of British Virgin Islands income taxes. Pursuant to the PRC Income Tax Laws, the prevailing statutory rate of enterprise income tax is 25% for Tianjin Sing Ocean, Yingkou Zhongneng Gas, and China New Energy (Tianjin), and Tianjin Binhai ZhongNeng Gas whereas QinHuangDao ChenSheng Gas is being taxed on 0.8% of its annual sales.

The Company had no material adjustments to its liabilities for unrecognized income tax benefits according to the provisions of FIN 48.  The income tax expenses was $367,787 and $318,047 for the six months ended June 30, 2009 and 2008, respectively.  The Company has recorded no deferred tax assets or liabilities as of June 30, 2009 and 2008, since nearly all differences in tax basis and financial statement carrying values are permanent differences.

   
For The Three Months Ended
   
For The Six Months Ended
 
   
June 30,
   
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
                         
Current tax
  $ 366,790     $ 318,047     $ 367,787     $ 318,047  
Deferred tax
    -       -       -       -  
Total
  $ 366,790     $ 318,047     $ 367,787     $ 318,047  
 
 
12

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

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 fiscal year of 2009 and 2008 respectively to income (loss) before income taxes for the six months and three months ended June 30, 2009 and 2008 for the following reasons:

   
For The three Months Ended
   
For The six Months Ended
 
   
June 30,
   
June 30,
 
   
2009
   
2008
   
2009
   
2008
 
Profit before income taxes
    1,346,100       293,970       1,008,198       73,245  
                                 
Computed “expected” income tax expense at 25%
  $ 336,525     $ 73,492     $ 252,049     $ 18,311  
Tax effect on net taxable temporary differences
    76,751       -       20,810       -  
Effect of cumulative tax losses
    (46,486 )     244,555       94,928       299,736  
                                 
    $ 366,790     $ 318,047     $ 367,787     $ 318,047  
 
 
13

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

9.
Related Party Transactions

As of June 30, 2009 and December 31, 2008, the Company has the following receivable (payable) balances with related parties:-

 
(a)
Huan Long is a shareholder of the Company's subsidiary Tianjin Sing Ocean since January 14, 2009

   
June 30,
   
December 31
 
   
2009
   
2008
 
             
Huan Long
  $ (97,969 )   $ -  
Qu Qiangxi
    -       84,120  
    $ (97,969 )   $ 84,120  

The balances have no stated terms for repayment and are not interest bearing and therefore are presented as long-term assets and liabilities.

 
14

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

10.
Concentrations and Credit Risk

The Company operates principally in the PRC and grants credit to its customers in this geographic region. Although the PRC is economically stable, it is always possible that unanticipated events in foreign countries could disrupt the Company's operations.  Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and accounts receivable.  The Company does not have concentrations of business with any customer constituting greater than 10% of the Company’s gross sales.

For the six months ended June 30 2009, revenue attributed to connection fees was 88% of total revenue whereas gas revenue contributed to the remaining 12%. For the six months ended June 30 2008, revenue attributed to connection fees was 91% of total revenue whereas gas revenue contributed to the remaining 9 %.

For the six months ended June 30 2009, costs of connection fee contributed to 71% of costs of good sold whereas cost of gas to remaining 29%. For the six months ended June 30 2008, costs of connection fee contributed to 69% of costs of good sold whereas cost of gas contributed to remaining 31%.

At June 30, 2009, one major customer accounted for 49%, of net accounts receivable. At December 31, 2008, two major customers accounted for 19% and 11% of net accounts receivable, respectively

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

 
15

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

11.
Commitments and Contingencies

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

As of June 30, 2009
     
       
Remainder of 2009
  $ 64,624  
2010
    114,743  
2011
    -  
2012
    -  
2013
    -  
Thereafter
    -  
Total minimum lease payments
    179,367  

During the six months ended June 30, 2009 and 2008, rental expenses included in general and administrative expenses were $62,593 and $8,748 respectively.

As of June 30, 2009, the company did not have any contingent liabilities.

The Company is obligated to provide uninterrupted piped gas to connected users and to ensure the safety in the process of piped gas operations. The volume of gas to be supplied by the Company will grow with the increase of gas users. The Company has selected three qualified gas resource suppliers to ensure the stable operation to meet its obligation.

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 Company, is remote.

 
16

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

12.
Environmental Matters

The Company does not anticipate any material future cash requirements to environmental issues. If circumstances change, the Company will record the estimated charges to return the sites to their original condition.

13.
Business and Geographical Segments

Reportable Segments

   
For the six months ended June 30, 2009
   
For the six months ended June 30, 2008
   
For the six months ended June 30
 
                                           
   
Connection
services
   
Natural gas
   
Corporate
   
Connection
services
   
Natural gas
   
Corporate
   
Total
 
               
2009
   
2008
 
External revenue
  $ 2,773,982     $ 361,625     $       $ 1,780,417     $ 227,417     $ -     $ 3,135,608     $ 2,007,834  
Interest income
    9,627                       6,415                       9,627       6,415  
Interest expense
 
671)
                                              (671 )        
Depreciation and amortization
            186,579                       87,323               186,579       87,323  
Net profit/(loss) after tax
    1,920,122       (194,104 )     (1,085,607 )     1,134,931       79,753       (1,241,995 )     640,411       (27,311 )
                                                                 
Expenditures for long-lived assets
    4,334,824                       1,467,327                       4,334,824       1,467,327  
 
   
As at June 30, 2009
   
As at June 30, 2008
   
As at June 30, 2009
   
As at June 30, 2008
 
Assets
    15,002,960       7,363,794       7,417,515       5,942,797       9,538,468       3,071,611       29,784,269       18,552,876  

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

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

14.
Issuance of Series B Convertible Preferred Stock Securities Purchase Agreement

On April 30, 2009, the Company entered into a Series B Convertible Preferred Stock Securities Purchase Agreement (the “SPA”) with China Hand Fund I L.P. (“China Hand”). Pursuant to the SPA, on May 1, 2009, the Company issued and sold to China Hand, and China Hand purchased from the Company, 1,116,388 shares of the Company’s Series B Convertible Preferred Stock (“Series B Preferred Stock”) and warrants (the “Warrants”) to purchase 7,814,719 shares of its Common Stock at an initial exercise price of $0.187 per share (subject to adjustments) for a period of five (5) years following the date of issuance for an aggregate purchase price of $5,400,000 (the “Private Placement”).

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 equal to $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 (the “Agent Warrants”), representing 10% of the aggregate number of shares of common stock issuable to China Hand in the Private Placement upon conversion of the Preferred Stock. In connection with the signing of the SPA, on April 30, 2009, the Company also entered into a Closing Escrow Agreement by and among the Company, China Hand and Escrow LLC (the “Escrow Agent”), pursuant to which China Hand agreed to deposit all funds due to the Company under the SPA in escrow until such time as all closing conditions of the SPA have been satisfied and the Escrow Agent shall have received notice, executed by both the Company and China Hand, instructing the Escrow Agent to release such funds to the Company. The Closing Escrow Agreement terminates upon the release of all funds from escrow as described above, or upon the 90 the day following the date of the Closing Escrow Agreement if no such instructions to disburse funds are received by the Escrow Agent, on which date all such funds will be returned to China Hand.

Make Good Provision

Additionally, the Company agreed to make good provisions that will require the Company to issue to China Hand up to 334,916 additional shares (the “Make Good Shares”) of its Series B Preferred Stock if it does not achieve an audited after-tax net income of $5.0 million for the year ending December 31, 2009 (the “2009 Income Target”); if the Company is successful in achieving the 2009 Income Target, China Hand will transfer 22,327 shares of its Series B Preferred Stock to certain members of the Company’s management, which shares have been deposited into an escrow account. The Company also agreed to issue to China Hand 27,910 shares of Series B Preferred Stock if the Company’s Common Stock is not listed for trading on a national securities exchange on or before January 31, 2010 (the “Listing Shares”).

 
18

 

CHINA NEW ENERGY GROUP COMPANY
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

14.
Issuance of Series B Convertible Preferred Stock Securities Purchase Agreement  (continued)

Amendment and Restatement of Certain Registration Rights

In connection with the closing of the Private Placement, the Company and China Hand amended and restated that certain registration rights agreement between the Company and China Hand dated August 20, 2008. Pursuant to the Amended and Restated Registration Rights Agreement (the “Amended and Restated Registration Rights Agreement”), among other things, the Company agreed to register all of the shares of common stock underlying the securities issued to China Hand in the Private Placement, as well as the private placement that was consummated on August 20, 2008 (collectively, the “Shares”) within a pre-defined period. Under the terms of the Amended and Restated Registration Rights Agreement, the Company is obligated to file a registration statement (the “Registration Statement”) under the Securities Act of 1933 covering the resale of the Shares by May 30, 2009.

The Company is subject to registration delay payments in amounts prescribed by the Amended and Restated Registration Rights Agreement 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 will accrue at a rate of $54,000 per month or one percent (1%) of the gross proceeds of the Private Placement; provided that the maximum aggregate amount of the registration delay payments pursuant to the Amended and Restated Registration Rights Agreements $810,000, or fifteen percent (15%) of the gross proceeds of the Private Placement.

15.
Subsequent Events
The company has evaluated subsequent events from the balance sheet date through August 19, 2009 with the date being the date that the financial statements are issued or are available to be issued. There are no subsequent events.
 
 
19

 

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

Special Note Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q, including the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains forward-looking statements that are based on the beliefs of our management, and involve risks and uncertainties, as well as assumptions, that, if they ever materialize or prove incorrect, could cause actual results to differ materially from those expressed or implied by such forward-looking statements. The words “believe,” “expect,” “anticipate,” “project,” “targets,” “optimistic,” “intend,” “aim,” “will” or similar expressions are intended to identify forward-looking statements. All statements, other than statements of historical fact, are statements that could be deemed forward-looking statements, including statements regarding new and existing products, technologies and opportunities; statements regarding market and industry segment growth and demand and acceptance of new and existing products; any projections of sales, earnings, revenue, margins or other financial items; any statements of the plans, strategies and objectives of management for future operations; any statements regarding future economic conditions or performance; uncertainties related to conducting business in China; any statements of belief or intention; any of the factors and risks mentioned in the “Risk Factors” sections of our Annual Report on Form 10-K filed with the Securities and Exchange Commission on April 15, 2009, 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.

Use of Terms

Except as otherwise indicated by the context, all references in this Quarterly Report to (i) “China New Energy,” the “Company,” “we,” “us” or “our” are references to China New Energy Group Company and its wholly-owned subsidiaries, Willsky Development, Ltd., or Willsky Development, Tianjin SingOcean Public Utility Development Co., Ltd., or SingOcean, Qinhuangdao Chensheng Gas Co. Ltd., or Chensheng Gas, Tianjin SingOcean Public Utility Development Co., Ltd. - Acheng Division, or Acheng SingOcean, Yingkou Zhongneng Gas Development Co., Ltd., or Yingkou Zhongneng (formerly Tianjin SingOcean Public Utility Development Co., Ltd. - Dashiqiao Division, or Dashiqiao SingOcean), and China New Energy (Tianjin) Investment and Consulting Co., Ltd, or Tianjin CNE, and Tianjin Binhai Zhongneng Gas Company, or Binhai Zhongneng, but do not include the stockholders of China New Energy; (ii) “SEC” are to the Securities and Exchange Commission; (iii) “Securities Act” are to the Securities Act of 1933, as amended; (iv) “Exchange Act” are to the Securities Exchange Act of 1934, as amended; (v) “RMB” are to Renminbi, the legal currency of China; (vi) “U.S. dollar,” “$” and “US$” are to the legal currency of the United States; (vii) “BVI” are to the British Virgin Islands; and (viii) “China” and “PRC” are to the People’s Republic of China.

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, Acheng and Nandaihe. Currently, these distribution networks provide natural gas to an aggregate of approximately 61,000 consumers in these cities, and we anticipate that we will be able to extend these distribution networks to connect in excess of 115,000 consumers in these cities by 2010.

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.
 
20

 


Our Current Organizational Structure
 
We own all of the issued and outstanding capital stock of Willsky Development, which in turn owns 99% of the outstanding capital stock of SingOcean. The remaining 1% of SingOcean is owned by Tianjin Huanlong Commercial and Trading Company.
 
SingOcean continues to hold  49% of the equity of Chensheng Gas, with the remaining 51% owned by China New Energy Group Company, and  Acheng SingOcean continues to be a wholly-controlled division of SingOcean.

Acheng SingOcean and Yingkou Zhongneng are principally responsible for the construction and operation of the natural gas distribution networks in the cities of Acheng and Dashiqiao in Northeast China. Chensheng Gas is a natural gas distribution company operating in the Nandaihe area in Northern China, which could potentially provide natural gas to an aggregate of 23,000 individuals in the Nandaihe area by 2012, and we anticipate that it will connect to an excess of 5,000 customers every year over the next three to five years.

We have established our wholly-owned subsidiary Tianjin CNE on January 12, 2009, in Tianjin, China, for investment holding purposes.

On June 26, 2009, our subsidiary, Qinhuangdao Chensheng Gas Co., Ltd., established a wholly-owned subsidiary, Tianjin Binhai Zhongneng Gas Co., Ltd., in Da Gang District, Tianjin, China, for constructing and developing the gas projects of  Private Economic Park and Taiping County in Dagang District, Tianjin.

The following chart reflects our organizational structure as of the date of this report.


 
21

 

Our principal executive office in China is located at 20/F, Center Plaza, No.188 Jiefang Road, He Ping District, Tianjin, China, and our telephone number is +(86 22) 5829 9778.

Second Quarter Financial Performance Highlights
In spite of the current global economic downturn, we continued to experience strong demand for our products and services during the second quarter of 2009 and growth in our revenues and net income.

The following are some financial highlights for the second quarter of 2009:

 
·
Revenues : Our revenues were approximately $2,810,591 for the second quarter of 2009, an increase of 47% from the same quarter of last year.

 
·
Gross Margin : Gross margin was 75% for the second quarter of 2009, equivalent to 75% for the same period in 2008.

 
·
Operating Expense : Operating Expense (Selling, General & Administrative expense) was $752,489 for the second quarter of 2009, an increase of 234% from the same period of 2008.

 
·
Net Income : Net income was approximately $965,259 for the second quarter of 2009, an increase of 375% from the same period of last year.

 
·
Fully diluted net loss per share : Fully diluted net loss per share was $0.02 for the three months ended June 30, 2009, as compared to $0.00 for the same period last year.

Principal Factors Affecting our Financial Performance

We believe that the following factors will continue to affect our financial performance:

 
·
Growth of China’s natural gas industry .   Currently, natural gas consumption in the PRC accounts for less than 3% of its total energy consumption.  However, driven by environmental pressure from the demand side and improvements in social infrastructure with economic growth, in the west in particular, and stable energy supply, it is anticipated that the use of natural gas will grow very rapidly in the PRC.  According to the statistics of the China National Development and Reform Commission, the consumption of natural gas has increased from 24.5 billion cubic meters in 2000 to 55.6 billion cubic meters in 2006, which represented an average growth of 32.42% per year. From the 4th Annual Asia Natural Gas Congress 2008, experts anticipated that the demand for natural gas in China would grow rapidly to 150 billion cubic meters in 2010 and to 240 billion cubic meters in 2015.

 
·
PRC regulations promoting the use of clean energy .  The PRC’s heavy reliance on coal exceeds world-wide consumption rates (Source: Energy Information Administration, U.S. Department of Energy).  The use of coal, however, causes air pollution and other negative consequences to the environment.  In the PRC, the heavy use of unwashed coal has led to large emissions of sulfur dioxide and particulate matter.  An air pollution study conducted by the World Health Organization in 1998 showed that seven of the 10 most polluted cities in the world were located in the PRC.  As such, there have been serious environmental concerns in many countries around the world, resulting in a global trend to reduce coal usage.  In consideration of such trends, in 1996, the PRC presented a plan to raise the share of natural gas in the country’s energy mix (Source: Ninth Five-Year Plan (1996-2000)).  In many locations where natural gas supply is available, local governments often require all new residential buildings to install piped gas connections as a condition to the issuance of the construction or occupancy permits.  Before 2000, local municipal governments controlled gas distribution.  Since then, the industry has been opened to private companies, whose investments have fostered an increase in the use of natural gas in the PRC.  The PRC government has deemed the natural gas industry a suitable industry for public and private investments.

 
22

 
 
 
·
Expans ion of our production and distribution networks .  We plan to expand our operations to acquire exclusive rights for the development of natural gas distribution networks in cities and regions beyond those that we currently possess.  We anticipate that we will own six natural gas pipeline networks.

Taxation

United States and British Virgin Islands

We are subject to United States tax at a tax rate of 34%.  No provision for income taxes in the United States has been made as we have no income taxable in the United States.  Our subsidiary Willsky Development was incorporated in the BVI and under the current laws of the BVI, is not subject to income taxes.

China

Before the implementation of the New EIT Law described below, Foreign Invested Enterprises, or FIEs, established in the PRC were generally subject to an enterprise income tax, or EIT, rate of 33.0%, which includes a 30.0% state income tax and a 3.0% local income tax.

On March 16, 2007, the National People’s Congress of China passed a new Enterprise Income Tax Law, or the New EIT Law, and on December 6, 2007, the State Council of China passed the Implementing Rules for the New EIT Law, or the Implementing Rules, which took effect on January 1, 2008. The New EIT Law and Implementing Rules impose a unified EIT rate of 25.0% on all domestic-invested enterprises and FIEs, unless they qualify under certain limited exceptions.  Therefore, nearly all FIEs are subject to the new tax rate alongside other domestic businesses rather than benefiting from the old FIE tax laws, and its associated preferential tax treatments, beginning January 1, 2008.

Despite these pending changes, the New EIT Law gives the FIEs established before March 16, 2007, or Old FIEs, a five-year grandfather period during which they can continue to enjoy their existing preferential tax treatment.  During this five-year grandfather period, the Old FIEs which enjoyed tax rates lower than 25% under the original EIT law shall gradually increase their EIT rate by 2% per year until the tax rate reaches 25%.  In addition, the Old FIEs that are eligible for the “two-year exemption and three-year half reduction” or “five-year exemption and five-year half-reduction” under the original EIT law, are allowed to remain to enjoy their preference until these holidays expire. The discontinuation of any such special or preferential tax treatment or other incentives would have an adverse effect on any organization’s business, fiscal condition and current operations in China.
 
In addition to the changes to the current tax structure, under the New EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25.0% on its global income.  The Implementing Rules define the term “de facto management bodies” as “substantial and overall management and control over the production and operations, personnel, accounting, and properties” of the enterprise.

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 enterprise 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 operation 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 substantial properties, accounting books, corporate chops, board and shareholder minutes are kept in China; and (iv) ½ of 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 on imposition of tax from non-domestically incorporated resident enterprises available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.

 
23

 
 
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 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.

Under the current PRC tax laws and the related implementing rules, the prevailing statutory rate of enterprise income tax is 25% for SingOcean, Acheng SingOcean, and Dashiqiao SingOcean, whereas Chensheng Gas is being taxed on 0.8% of its annual sales. Sales tax is at a rate of 3% on connection revenue and a sales tax is also levied on gas sales revenue at a rate of 4%.  
 
Results of Operations

Comparison of Three Months Ended June 30, 2009 and June 30, 2008

The following table summarizes the results of our operations during the three-month periods ended June 30, 2009 and 2008, and provides information regarding the dollar and percentage increase or (decrease) from the three-month period ended June 30, 2008 to the three-month period ended June 30, 2009.

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

   
Three   Months
Ended
June   30,   2009
   
Three   Months
End ed  
June   30,   2008
   
Percentage
Change  
Increase  
(Decrease)
 
Revenues
  $ 2,811     $ 1,906       47 %
                         
Cost of Sales
    714       484       47 %
                         
Gross Profit
    2,097       1,422       47 %
                         
Selling, General &Administrative Expense
    752       225       234 %
                         
Operating Income
    1,345       1,197       12 %
                         
Other Income and (Expense)
                       
Interest Income (Expense)
    1       7       (86 )
Other Income (Expense)
            (910 )     (100 )%
                         
Income from Continuing Operations  Before Income Taxes
    1,346       294       358 %
                         
Income Taxes
    (367 )     (318 )     15 %
                         
Income From Discontinued Operations
    -       235       (100 )%
Non controlling interest
    (14 )     (8 )     75 %
Net Income (Loss)
  $ 965     $ 203       375 %

Revenues .  Revenues are derived primarily from connection fees and sales of natural gas. Revenues increased $904,512, or 47% to $2,810,591 for the three months ended June 30, 2009 from $1,906 079 for the same period in 2008. This increase was mainly attributable to an increase in number of connection households and increase in natural gas consumption.

 
24

 

Cost of Sales . Cost of sales consists primarily of connection costs and purchase of natural gas from our suppliers.  Our cost of sales increased $229,337, or 47%, to $713,272 for the three months ended June 30, 2009 from $483,935 during the same period in 2008. Such increase was mainly attributable to a corresponding increase in the number of households connected to our distribution network and increase in natural gas consumption by our customers.

Gross Profit .   Our gross profit increased $675,174, or 47%, to $2,097,319 for the three months ended June 30, 2009 from $1,422,145 during the same period in 2008. Gross profit as a percentage of revenues was 74.6% for the three months ended June 30, 2009,  The gross profit margin during the same period in 2008 was also 74.6%.

Selling, General & Administrative Expenses ( S & G&A) Expenses . SG&A   expenses, including sales representative commissions, promotion fees, salesperson salaries and expenses, depreciation charges and other fees, increased $527,775, or 235%, to $752,489 for the three months ended June 30, 2009 from $224,714 during the same period in 2008. As a percentage of revenues, SG&A expenses increased to 27% for the three months ended June 30, 2009 from 11.8% for the same period in 2008. Such increase in  S,G&A expenses resulted from an increase in sales and administrative personnel, while the increase in SG&A  expenses as a percentage of revenues resulted from the reasons identified above.

Net Income . Net income increased $762,244, or 375% to a net income of $965,259 for the three months ended June 30, 2009 from net income of $203,015 for the same period of 2008, due to the absence of  a derivative expense charged in the second quarter of 2008.

Comparison of Six Months Ended June 30, 2009 and June 30, 2008

The following table summarizes the results of our operations during the six-month periods ended June 30, 2009 and ended June 30, 2008, and provides information regarding the dollar and percentage increase or (decrease) from the six-month period ended June 30, 2008 to the six-month period ended June 30, 2009.   

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

   
Six  Months
Ended 
June  30,  2009
   
Six  Months
Ended 
June  30,  2008
   
Percentage
Change
Increase
(Decrease)
 
Revenues
  $ 3,136     $ 2,008       56 %
                         
Cost of Sales
    976       560       74 %
                         
Gross Profit
    2,160       1,448       49 %
                         
Selling, general and Administrative Expenses
    1,161       471       146 %
                         
Operating Income (Expenses)
    999       977       2 %
                         
Other Income and (Expenses)
                       
Interest Income (Expense)
    9       6       50 %
Other Income (Expense)
            (910 )     (100 )%
                         
Income (Loss) from Continuing Operations Before Income Taxes
    1,008       73       1,281 %
                         
Income Taxes
    (368 )     (318 )     16 %
Income From Discontinued Operation
            218       (100 )%
Non controlling interest
    7       (7 )     200 %
Net Income (Loss)
  $ 647     $ (34 )     2,003 %
 
 
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Revenues .  Revenues are derived primarily from connection fees and sales of natural gas. Revenues increased $1,127,774 or 56% to $3,135,608 for the six months ended June 30, 2009 from $2,007,834 for the same period in 2008. This increase was mainly attributable to an increase in number of connection households and increase in natural gas consumption.

Cost of Sales . Cost of sales consists primarily of the purchase of natural gas from our suppliers. Our cost of sales increased $415,901, or 74%, to $975,773 for the six months ended June 30, 2009 from $559,872 during the same period in 2008. Such increase was mainly attributable to a corresponding increase in the number of households connected to our network and increase in natural gas consumption by our customers. As a percentage of revenues, the cost of sales increased to 31% during the six months ended June 30, 2009, from 28% in the same period in 2008, which was mainly attributable to an increase in our connection households.

Gross Profit .   Our gross profit increased $711,872, or 49%, to $2,159,835 for the six months ended June 30, 2009 from $1,447,963 during the same period in 2008. Gross profit as a percentage of revenues was 69% for the six months ended June 30, 2009, a decrease of 3% from 72% during the same period in 2008. Such percentage decrease was mainly due to an increase in our connection costs.

Selling, General and Administrative Expenses . Selling, General and Administrative expenses, including sales representative commissions, promotion fees, salesperson salaries and expenses, depreciation charges and other fees, increased $689,554, or 146%, to $1,160,687 for the six months ended June 30, 2009 from $471,133 during the same period in 2008. As a percentage of revenues, general and administrative expenses increased to 37% for the six months ended June 30, 2009 from 23% for the same period in 2008. Such increase in selling, general and administrative expenses resulted from an increase in salaries, rental fees, and depreciation charges.

Net Income . Net income increased $681,696, to a net income of $647,314 for the six months ended  June 30, 2009 from a net loss of $34,382 for the same period of 2008, as a result of the factors described above.

Liquidity and Capital Resources

As of June 30, 2009, we had cash and cash equivalents of approximately $6.1 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)

   
Six Months Ended June 30,
 
   
2009
   
2008
 
Net cash provided by (used in) operating activities
  $ 1,281     $ (459 )
Net cash used in investing activities
    (6,174 )     (807 )
Net cash provided by financing activities
    5,191       252  
Effect of exchange rate changes in cash
    (4 )     (12 )
Net cash provided (used)
  $ 294     $ (1,026 )

Operating Activities

Net cash provided by operating activities was $1,280,666 for the six months ended June 30, 2009, compared to net cash used in operating activities of $458,803 during the same period of 2008. This increase in funds used in our operating activities was primarily due to an increase in net income and a decrease in prepayments .

Investing Activities

Our main uses of cash for investing activities are mainly for the construction of gas pipelines.

Net cash used in investing activities for the six months ended June 30, 2009 was $6,173,770, which is an increase of  $5,366,443 from $807,327 for the same period of 2008.  Such increase is primarily due to a purchase of  the Chensheng subsidiary and pipeline construction.

26

 
Financing Activities
 
Our debt to equity ratio (total debt /total assets) was 7% as of June 30, 2009.  Net cash provided by financing activities for the six months ended June 30, 2009 was $5,191,201, which is an increase of $4,939,137 from $252,064 during the same period of 2008.  Such increase is mainly due to contributions from the private placement consummated on May 01, 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) 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) 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 an audited after-tax net income of $5.0 million for the year ending December 31, 2009.  If we are successful in achieving such 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.

We believe that our cash on hand and cash flow from operations will meet part of our present cash needs and we will require additional cash resources, including loans, to meet our expected capital expenditure and working capital for the next 12 months.  In addition, we may, in the future, require additional cash resources due to changed business conditions, implementation of our strategy to expand our production capacity or other investments or acquisitions we may decide to pursue.  If our own financial resources are insufficient to satisfy our capital requirements, we may seek to sell additional equity or debt securities or obtain additional credit facilities.  The sale of additional equity securities could result in dilution to our stockholders.  The incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that would restrict our operations.  Financing may not be available in amounts or on terms acceptable to us, if at all.  Any failure by us to raise additional funds on terms favorable to us, or at all, could limit our ability to expand our business operations and could harm our overall business prospects.

Critical Accounting Policies
There were no material changes in the Company’s critical accounting policies from those described in the Company’s 2008 Form 10-K.
 
Recent Accounting Pronouncements

See Note 3 to the June 30, 2009, Unaudited  Condensed Consolidated Financial Statements, under the subheading “New Accounting Pronouncements” regarding the effect of certain new accounting standards on the Company

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 primary gas pipelines. However, if a primary pipeline is already in place, we are able to connect new customers to our distribution network during this time.

 
27

 

Additionally, gas consumption by residential customers is higher in the winter months for heating purposes, and we see a corresponding increase in usage fees during that 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 4T.
CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures.

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

As required by Rule 13a-15 under the Exchange Act, our management, including Mr. Mr. Yangkan Chong, our Chief Executive Officer and Mr. Peng Mun Foo, our Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of June 30, 2009.  Based on that evaluation, Mr. Chong and Mr. Foo concluded that as of June 30, 2009, and as of the date that the evaluation of the effectiveness of our disclosure controls and procedures was completed, our disclosure controls and procedures were effective to satisfy the objectives for which they are intended.

Changes in Internal Control Over Financial Reporting.

During the fiscal quarter ended June 30, 2009, there were no changes in our internal control over financial reporting that has 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 1A.
RISK FACTORS.

You should carefully consider he risk factors discussed in Part I, Item 1A of the Company’s 2008 Form 10-K which could have a material impact on the Company’s business, financial condition or results of operations.  The risks described in the Company’s Form 10-K are not the only risks facing the Company.  Additional risks and uncertainties not presently known to the Company or that the Company currently believes to be immaterial may also adversely affect the Company’s business, financial condition or results of operations.

 
28

 

ITEM 2.
UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None.

ITEM 3.
DEFAULTS UPON SENIOR SECURITIES.

None.

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

None.

ITEM 5.
OTHER INFORMATION.

Appointment of Chief Operating Officer

On June 5, 2009, Mr. Dunhong Shi, age 45, was appointed as the Company’s Chief Operating Officer. Mr. Shi has experience in operations and management in energy-related companies. He has also held senior level positions in large and middle state-owned corporations, including Tianjin Soda Plant, Cogeneration Plant of Nanshan Group. Prior to joining the Company, and for over five years, Mr. Shi served as the Chief Operating Officer and Executive Director of Wahsang Gas (China) Investment Co., Ltd (a Hong Kong listed company), and as General Manager of Wahsang Energy Company.

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 furnished pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
32.2
 
Certifications of 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.

 
29

 

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 19, 2009
CHINA NEW ENERGY GROUP COMPANY
     
 
By: 
/s/ Yangkan Chong
 
Yangkan Chong, Chief Executive Officer
 
(Principal Executive Officer)
 
 
By: 
/s/ Peng Mun Foo
 
Peng Mun Foo, Chief Financial Officer
 
(Principal Financial Officer and Principal
Accounting Officer)
 
 
 

 

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