Edgar Filing: China Natural Gas, Inc.

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2013 or

¨ 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: 00134373

CHINA NATURAL GAS, INC.

(Exact name of registrant as specified in its charter)

Delaware		98-0231607
(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)

19th Floor, Building B, Van Metropolis

35 Tang Yan Road, Hi-Tech Zone

Xi’an, 710065, Shaanxi Province, China

+86-29-8832-7391

(Address, including zip code, and telephone number, including area code, of registrant’s
principal executive offices)

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 ¨ No x

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

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

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨	Smaller reporting company	x

(Do not check if a smaller reporting company)

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

The number of shares outstanding of the registrant’s common stock as of November 5, 2013 was 21,458,654.

CHINA NATURAL GAS, INC.
AND SUBSIDIARIES

Index

PART I.	FINANCIAL INFORMATION
Item 1.	Consolidated Balance Sheets as of September 30, 2013 and December 31, 2012	4
	Consolidated Statements of Income and Comprehensive Income for the Three and Nine Months Ended September 30, 2013 and 2012	5
	Consolidated Statements of Stockholders’ Equity as of September 30, 2013 and December 31, 2012	6
	Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2013 and 2012	7
	Notes to Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	41
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	66
Item 4.	Controls and Procedures	66
PART II. OTHER INFORMATION
Item 1.	Legal Proceedings	68
Item 1A.	Risk Factors	72
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	72
Item 3.	Defaults Upon Senior Securities	72
Item 4.	Mine Safety Disclosures	73
Item 5.	Other Information	73
Item 6.	Exhibits	73
Signatures		74

	2

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To:	The Board of Directors and Stockholders of
	China Natural Gas, Inc.

We have reviewed the accompanying interim consolidated balance sheets of China Natural Gas, Inc. (“the Company”) as of September 30, 2013 and December 31, 2012, and the related statements of income and comprehensive income, stockholders’ equity, and cash flows for the three and nine month periods ended September 30, 2013 and 2012. These interim consolidated financial statements are the responsibility of the Company's management.

We conducted our review in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board, the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.

Based on our review, we are not aware of any material modifications that should be made to the accompanying interim consolidated financial statements for them to be in conformity with U.S. generally accepted accounting principles.

The accompanying financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 2 to the financial statements, the Company has incurred substantial losses and has a working capital deficit, all of which raise substantial doubt about its ability to continue as a going concern. Management’s plans in regards to these matters are also described in Note 2. These financial statements do not include any adjustments that might result from the outcome of this uncertainty.

San Mateo, California	WWC, P.C.
November 8, 2013	Certified Public Accountants

	3

CHINA NATURAL GAS, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF SEPTEMBER 30, 2013 AND DECEMBER 31, 2012

(Stated in US Dollars)

	Note	September 30, 2013		(Audited) December 31, 2012
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	3(f)	$	10,334,452	$	10,857,456
Accounts receivable, net	3(g)		2,714,988		2,148,379
Other receivables, net			346,234		458,605
Employee advances	3(h)		336,286		399,031
Inventories	3(i)		3,011,956		2,473,933
Advances to suppliers			11,187,066		4,869,606
Prepaid expense and other current assets			4,558,512		3,541,431
Total current assets			32,489,494		24,748,441

Investment in unconsolidated joint ventures	3(j)		-		1,587,000
Property and equipment, net	3(k)		210,683,183		179,515,563
Construction in progress	3(l)		34,821,916		53,393,933
Goodwill	3(m), 4		862,561		839,806
Other intangible assets	4		21,176,688		21,400,924
Prepaid expenses and other assets	5		7,463,106		7,015,142
TOTAL ASSETS		$	307,496,948	$	288,500,809

LIABILITIES AND STOCKHOLDERS' EQUITY

CURRENT LIABILITIES:
Senior notes- current maturities	6	$	38,908,332	$	38,352,498
Current portion of bank loan payable	7		4,890,000		4,761,000
Redeemable liabilities - warrants			17,500,000		17,500,000
Accounts payable and accrued liabilities			9,281,250		6,756,278
Other payable - related party			845,226		1,616,429
Short-term borrowing - related party			2,679,945		2,679,945
Unearned revenue			5,481,579		3,663,570
Accrued interest			3,320,356		1,936,584
Taxes payable			1,233,722		2,232,546
Total current liabilities			84,140,410		79,498,850

LONG-TERM LIABILITIES:
Bank loan payable, net of current portion	7		3,260,000		4,761,000
Long-term payables			313,913		-
Total long-term liabilities	7		3,573,913		4,761,000

Total liabilities		$	87,714,323	$	84,259,850

STOCKHOLDERS' EQUITY:
Preferred stock, par value $0.0001 per share, 5,000,000 authorized, none issued and outstanding		$	-	$	-
Common stock, par value $0.0001 per share, 45,000,000 authorized, 21,458,654 issued and outstanding at September 30, 2013 and December 31, 2012, respectively			2,145		2,145
Additional paid-in capital			83,649,675		83,501,637
Accumulated other comprehensive income			28,103,067		21,276,931
Statutory reserves	10		12,955,189		11,818,087
Retained earnings			94,768,161		87,410,615
Noncontrolling interests			304,388		231,544
Total stockholders' equity			219,782,625		204,240,959
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY		$	307,496,948	$	288,500,809

See Accompanying Notes to the Financial Statements and Accountant’s Report.

	4

CHINA NATURAL GAS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

FOR THE THREE AND NINE MONTHS PERIODS ENDED SEPTEMBER 30, 2013 AND 2012

(Stated in US Dollars)

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2013		2012		2013		2012
Revenues
Natural gas	$	29,708,201	$	27,903,522	$	93,653,522	$	92,231,013
Gasoline		452,626		647,061		1,431,305		2,174,124
Installation and others		1,870,301		2,511,199		6,693,589		6,835,658
		32,031,128		31,061,782		101,778,416		101,240,795

Cost of revenues
Natural gas		21,240,267		18,950,048		63,890,663		60,687,423
Gasoline		390,100		616,290		1,264,125		2,060,048
Installation and others		835,162		1,013,647		2,881,267		2,821,175
		22,465,529		20,579,985		68,036,055		65,568,646

Gross profit		9,565,599		10,481,797		33,742,361		35,672,149

Operating expenses
Selling		6,059,053		6,503,728		17,646,944		17,074,392
General and administrative		2,124,371		1,255,336		4,833,830		5,603,011
		8,183,424		7,759,064		22,480,774		22,677,403

Income from operations		1,382,175		2,722,733		11,261,587		12,994,746

Other income (expense):
Interest income		10,350		22,084		31,046		42,683
Interest expense		(173,293)		(277,347)		(534,664)		(985,027)
Loss on disposal of fixed assets		(251)		(4,017,726)		(57,654)		(4,017,726)
Loss on sales of long term investment		(350)		-		(80,500)		-
Other income (expense), net		(64,078)		133,625		(28,336)		119,295
Change in fair value of warrants		-		1,233		-		4
Foreign currency exchange loss		(1,546)		2,634		(6,815)		(501,812)
		(229,168)		(4,135,497)		(676,923)		(5,342,583)

Income before income tax		1,153,007		(1,412,764)		10,584,664		7,652,163

Provision for income tax		426,244		87,239		2,017,172		2,129,838

Net income		726,763		(1,500,003)		8,567,492		5,522,325
Less: Income (loss) attributable to noncontrolling interests		13,256		23,594		72,844		(175,589)
Net income attributable to China Natural Gas, Inc.		713,507		(1,523,597)		8,494,648		5,697,914

Other comprehensive income
Foreign currency translation gain		2,029,574		(844,824)		6,826,136		896,392
Comprehensive income	$	2,743,081	$	(2,368,421)	$	15,320,784	$	6,594,306

Weighted average shares outstanding
Basic		21,458,654		21,458,654		21,458,654		21,458,654
Diluted		21,458,654		21,458,654		21,458,654		21,458,654

Earnings per share

Basic	$	0.03	$	(0.07)	$	0.40	$	0.27
Diluted	$	0.03	$	(0.07)	$	0.40	$	0.27

See Accompanying Notes to the Financial Statements and Accountant’s Report.

	5

CHINA NATURAL GAS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

AS OF SEPTEMBER 30, 2013 AND DECEMBER 31, 2012

(Stated in US Dollars)

					Additional		Accumulative Other				Retained Earnings				Total
	Common Stock				Paid-in		Comprehensive		Non-controlling		Statutory				Stockholders'
	Shares		Amount		Capital		Income		Interest		Reserve		Unrestricted		Equity
Balance at 1/1/2012		21,458,654	$	2,145	$	82,909,485	$	19,817,493	$	-	$	10,124,710	$	77,903,478	$	190,757,311
Stock based compensation		-		-		592,152		-		-		-		-		592,152
Purchases of a Noncontrolling interest equity		-		-		-		-		394,789		-		-		394,789
Cumulative translation adjustment		-		-		-		1,459,438		-		-		-		1,459,438
Net income		-		-		-		-		(163,245)		-		11,200,514		11,037,269
Appropriation of retain earnings		-		-		-		-		-		1,693,377		(1,693,377)		-
Balance at 12/31/2012		21,458,654	$	2,145	$	83,501,637	$	21,276,931	$	231,544	$	11,818,087	$	87,410,615	$	204,240,959

Balance at 1/1/2013		21,458,654	$	2,145	$	83,501,637	$	21,276,931	$	231,544	$	11,818,087	$	87,410,615	$	204,240,959
Stock based compensation		-		-		148,038		-		-		-		-		148,038
Cumulative translation adjustment		-		-		-		6,826,136		-		-		-		6,826,136
Net income		-		-		-		-		72,844		-		8,494,648		8,567,492
Appropriation of retain earnings		-		-		-		-		-		1,137,102		(1,137,102)		-
Balance at 9/30/2013		21,458,654	$	2,145	$	83,649,675	$	28,103,067	$	304,388	$	12,955,189	$	94,768,161	$	219,782,625

See Accompanying Notes to the Financial Statements and Accountant’s Report.

	6

CHINA NATURAL GAS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2013 AND 2012

(Stated in US Dollars)

	2013		2012
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income attributable to China Natural Gas, Inc.		8,494,648		5,697,914
Add: income (loss) attributable to noncontrolling interests		72,844		(175,589)
Net income		8,567,492		5,522,325
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		10,757,202		10,443,635
Provision for doubtful accounts		50,970		200,984
Loss on disposal of equipment		57,654		4,017,726
Loss on sales of long term investment		80,500		-
Stock-based compensation		148,038		444,114
Change in fair value of warrants		-		(4)
Change in assets and liabilities:
Accounts receivable		(553,131)		1,067,790
Other receivables		(301,293)		170,241
Employee advances		72,453		(526,366)
Inventories		(465,213)		(1,365,120)
Advances to suppliers		(8,101,755)		(2,458,489)
Prepaid expense and other current assets		(890,060)		3,049,626
Accounts payable and accrued liabilities		3,158,456		325,648
Unearned revenue		1,697,655		1,176,182
Accrued interest		1,383,772		440,838
Taxes payable		(1,046,317)		(1,432,165)
Net cash provided by operating activities		14,616,423		21,076,965

CASH FLOWS FROM INVESTING ACTIVITIES:
Payment for acquisition of property and equipment		(1,649,846)		(4,129,677)
Proceeds from sales of property and equipment		7,209		2,850,914
Proceeds from sales of long term investment		724,500		(13,107,944)
Additions to construction in progress		(11,894,106)		(418,295)
Prepayment on long-term assets		(239,593)		(656,179)
Payment for acquisition of business		-		(1,768,049)
Payment for intangible assets		-		-
Net cash used in investing activities		(13,051,836)		(17,229,230)

CASH FLOWS FROM FINANCING ACTIVITIES:
Repayment of short-term borrowing and other payable, related parties		(805,000)		-
Repayment of long-term debt		(1,610,000)		(792,500)
Repayment of senior notes		-		(3,333,334)
Increase in restricted cash		-		(740,084)
Net cash (used in) provided by financing activities		(2,415,000)		(4,865,918)

Effect of exchange rate changes on cash and cash equivalents		327,409		206

NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS		(523,004)		(1,017,977)

CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD		10,857,456		9,622,883

CASH AND CASH EQUIVALENTS, END OF PERIOD	$	10,334,452	$	8,604,906

SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid, net of capitalized interest	$	417,884	$	718,541
Income taxes paid	$	2,009,997	$	3,330,382

Non-cash transactions for investing and financing activities:
Construction materials transferred to Construction in progress	$	-	$	67,058
Construction in progress transferred to property and equipment	$	33,786,303	$	19,380,905
Capitalized interest - amortization of discount of notes payable and issuance cost	$	-	$	6,107,601
Other assets transferred to construction in progress	$	126,957	$	2,577,107

See Accompanying Notes to the Financial Statements and Accountant’s Report.

	7

CHINA NATURAL GAS, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

AS OF SEPTEMBER 30, 2013 AND DECEMBER 31, 2012

(Stated in US Dollars)

Note 1 - Organization

Organization and Line of Business

China Natural Gas, Inc. (the “Company,” “our,” “us” or “we”) was incorporated in the State of Delaware on March 31, 1999. The Company through its wholly owned subsidiaries and variable interest entity (“VIE”), Xi’an Xilan Natural Gas Co., Ltd. (“XXNGC”) and subsidiaries of its VIE, which are located in Hong Kong, Shaanxi Province, Henan Province and Hubei Province in the People’s Republic of China (“PRC”), engages in sales and distribution of natural gas and gasoline to commercial, industrial and residential customers through fueling stations and pipelines, construction of pipeline networks, installation of natural gas fittings and parts for end-users, and conversions of gasoline-fueled vehicles to hybrid (natural gas/gasoline) powered vehicles at automobile conversion sites. The consolidated balance sheets as of September 30, 2013 and December 31, 2012 and the consolidated statements of income and comprehensive income for the three and nine months ended September 30, 2013 and 2012, and cash flows for the nine months ended September 30, 2013 and 2012 include the accounts of China Natural Gas, Inc. and subsidiaries and VIE. Our subsidiaries are: Xilan Energy Co. Ltd. (“XEC”), Shaanxi Xilan Natural Gas Equipment Co. Ltd (“SXNGE”), Hubei Xian Natural Gas Co., Ltd (“HBXNG”), Lingbao Yuxi Natural Gas Co. Ltd. (“LYNG”), Shaanxi Jingbian Liquefied Natural Gas Co. Ltd (“JBLNG”), Henan Xilan Natural Gas Co. Ltd (“HXNGC”), Xi’an Xilan Auto Body Shop Co, Ltd. (“XXABC”) , Hanchuan Makou Yuntong Compressed Natural Gas Co., Ltd (“Makou”) and Xiantao City Jinhua Gas And Oil Co., Ltd. (“XTJH”).

Note 2 – Going Concern Uncertainties

These financial statements have been prepared assuming that Company will continue as a going concern, which contemplates the realization of assets and the discharge of liabilities in the normal course of business for the foreseeable future.

As of September 30, 2013, the Company had working capital deficit of current liabilities exceeding current assets by $51,650,916 due to the default of its senior notes payable. Management has taken certain action and continues to implement changes designed to improve the Company's financial results and operating cash flows. The actions involve certain cost-saving initiatives and growing strategies, including (a) reductions in headcount and corporate overhead expenses; and (b) obtainment of new short-term bank loans to finance our working capital, and long-term loans to fund our capital expenditure projects. Management believes that these actions will enable the Company to improve future profitability and cash flow in its continuing operations through December 31, 2013. As a result, the financial statements do not include any adjustments to reflect the possible future effects on the recoverability and classification of assets or the amounts and classification of liabilities that may result from the outcome of the Company's ability to continue as a going concern.

	8

Note 3 – Summary of Significant Accounting Policies

(a.)

Basis of Presentation

The accompanying consolidated financial statements have been prepared in conformity with the accounting principles generally accepted in the United States of America (“U.S. GAAP”).

The consolidated financial statements include all adjustments necessary to present fairly the consolidated financial position, results of operations and cash flows of the Company for the periods presented.

(b.)

Use of Estimates

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant accounting estimates reflected in the Company’s consolidated financial statements include revenue recognition, allowance for doubtful accounts, inventory obsolescence, construction in progress, warrants liability and useful lives of property and equipment. Actual results could differ from those estimates.

(c.)

Principles of Consolidation

The accompanying consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries and its 100% VIE, XXNGC, and XXNGC’s subsidiaries. All inter-company accounts and transactions have been eliminated in consolidation.

(d.)

Consolidation of Variable Interest Entity

VIEs are entities that lack sufficient equity to finance their activities without additional financial support from other parties or whose equity holders lack adequate decision-making ability. Any VIE with which the Company is involved must be evaluated to determine the primary beneficiary of the risks and rewards of the VIE. Management makes ongoing reassessments of whether the Company is the primary beneficiary of XXNGC.

On February 21, 2006, the Company formed SXNGE as a wholly foreign owned enterprise (“WFOE”) under the laws of the PRC. Through SXNGE, the Company entered into exclusive arrangements with XXNGC and its shareholders that give the Company the ability to substantially influence XXNGC’s daily operations and financial affairs and appoint its senior executives. The Company is considered the primary beneficiary of XXNGC and it consolidates its accounts as a VIE. The Company’s arrangements with XXNGC consist of the following agreements:

	9

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

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

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

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

	10

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

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

(e.)

Foreign Currency Translation

Our reporting currency is the U.S. dollar. The functional currency of XXNGC and the Company’s and XXNGC’s PRC subsidiaries is the Chinese Renminbi (“RMB”). The results of operations and financial position of XXNGC and the Company’s and XXNGC’s PRC subsidiaries are translated to U.S. dollars using the period end exchange rates as to assets and liabilities and weighted average exchange rates as to revenues, expenses and cash flows. Capital accounts are translated at their historical exchange rates when the capital transaction occurred. The resulting currency translation adjustments are recorded as a component of accumulated other comprehensive income (loss) within stockholders’ equity.

The balance sheet amounts, with the exception of equity, were translated at the September 30, 2013 exchange rate of RMB 6.14 to $1.00 as compared to RMB 6.30 to $1.00 at December 31, 2012. The equity accounts were stated at their historical rate. The average translation rates applied to income and cash flow statement amounts for the nine months ended September 30, 2013 and 2012 were RMB 6.21 and RMB 6.31 to $1.00, respectively.

(f.)

Cash and Cash Equivalents

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

The Company maintains balances at financial institutions which, from time to time, may exceed Hong Kong Deposit Protection Board (“HKDPB”) insured limits for the banks located in Hong Kong or may exceed Federal Deposit Insurance Corporation (“FDIC”) insured limits for the banks located in the United States. Balances at financial institutions or state-owned banks within the PRC are not covered by insurance. As of September 30, 2013 and December 31, 2012, the Company had total deposits of $9,522,078 and $10,481,343, respectively, without insurance coverage or in excess of HKDPB or FDIC insured limits. The Company has not experienced any losses to date as a result of this policy.

	11

(g.)

Accounts Receivable

Accounts receivable are presented net of an allowance for doubtful accounts. Management periodically reviews the composition of accounts receivable and analyzes historical bad debts, customer concentrations, customer credit-worthiness, current economic trends and changes in customer payment patterns to evaluate the adequacy of the allowance.

Management considers accounts past due after three months. Delinquent account balances are allowed for when management has determined that the likelihood of collection is not probable. Uncollectible receivables are written off against the allowance for doubtful accounts when identified. The Company recorded allowances for doubtful accounts in the amount of $61,196 and $9,340 as of September 30, 2013 and December 31, 2012, respectively.

(h.)

Employee Advances

From time to time, the Company advances predetermined amounts based upon internal Company policy to certain employees and internal units. As of September 30, 2013 and December 31, 2012, the Company had employee advances in the amount of $336,286 and $399,031, respectively.

(i.)

Inventories

Inventories are stated at the lower of cost or market, as determined on a first-in, first-out basis. Management compares the cost of inventories with the market value, and writes down the inventories to their market value, if lower than cost. Inventories consist of material used in the construction of pipelines, material used in repairing and modifying vehicles and material used in processing LNG. Inventory also consists of LNG and gasoline.

The following are the details of the inventories:

	September 30, 2013		December 31, 2012
Materials and supplies	$	2,525,021	$	2,108,837
Liquefied natural gas		328,065		113,203
Gasoline		158,870		251,893
	$	3,011,956	$	2,473,933

	12

(j.)

Investments in Unconsolidated Joint Ventures

Investee companies that are not required to be consolidated, but over which the Company exercises significant influence, are accounted for under the equity method of accounting. Whether or not the Company exercises significant influence with respect to an investee depends on an evaluation of several factors including, among others, representation on the investee company’s board of directors and ownership level, which is generally a 20% to 50% interest in the voting securities of the investee company. Under the equity method of accounting, the Company’s share of the earnings or losses of the investee company is reflected in the caption “other income (expense), net” in the consolidated statements of income and comprehensive income.

The Company’s investment in unconsolidated joint ventures that are accounted for on the equity method of accounting represents the Company’s 49% interest in the JV. The investment in the JV amounted to $1,587,000 at December 31, 2012. On February 19, 2013, the JV held a shareholder meeting, decided that we transferred our investment in JV to Shaanxi Jinyuan Investment Co., Ltd for a sale price of $1,522,850 (RMB 9.5 million). The transfer was completed on February 27, 2013, which incurred a loss of $80,150 (RMB 0.5 million).

The financial position of the JV is summarized below:

	December 31, 2012
Current assets	$	3,238,776
Noncurrent assets		-
Total assets		3,238,776
Current liabilities		-
Noncurrent liabilities		-
Equity		3,238,776
Total liabilities and equity	$	3,238,776

(k.)

Property and Equipment

Property and equipment are stated at cost. Expenditures for maintenance and repairs are charged to earnings as incurred while additions, renewals and betterments are capitalized. Depreciation of property and equipment is provided using the straight-line method for all assets with estimated lives as follows:

Office equipment		5 years
Operating equipment		5-20 years
Vehicles		5 years
Buildings and improvements		5-30 years

	13

The following are the details of the property and equipment:

	September 30, 2013		December 31, 2012
Office equipment	$	1,119,358	$	936,749
Operating equipment		211,189,990		176,463,908
Vehicles		4,342,820		4,228,255
Buildings and improvements		45,858,871		38,557,910
Total property and equipment		262,511,039		220,186,822
Less accumulated depreciation		(51,827,856)		(40,671,259)
Property and equipment, net	$	210,683,183	$	179,515,563

Depreciation expense for the three months ended September 30, 2013 and 2012 was $3,655,239 and $3,375,601, respectively. Depreciation expense for the nine months ended September 30, 2013 and 2012 was $10,259,814 and $9,915,078, respectively.

(l.)

Construction in Progress

Construction in progress consists of (1) the costs for constructing compressed natural gas (“CNG”) fueling stations, the liquefied natural gas (“LNG”) project in Jingbian County, and the natural gas infrastructure project in Xi’an Fangzhi District and International Port District, and (2) other costs related to construction in progress projects, including technology licensing fees, equipment purchases, land use rights acquisition costs, capitalized interests and other construction fees. No depreciation is provided for construction in progress until such time as the assets are completed and placed into service. To the extent that the borrowings could have been avoided, should the construction in progress projects not be implemented, interest incurred on such borrowings during construction period is capitalized into construction in progress. All other interest is expensed as incurred.

As of September 30, 2013 and December 31, 2012, the Company had construction in progress in the amount of $34,821,916 and $53,393,933, respectively. Interest cost capitalized into construction in progress for the three months ended September 30, 2013 and 2012 amounted to $425,926 and $4,493,138, respectively. Interest cost capitalized into construction in progress for the nine months ended September 30, 2013 and 2012 amounted to $1,263,889, and $7,389,545, respectively.

Construction in progress at September 30, 2013 and December 31, 2012 is set forth in the table below. The column of “estimated additional cost to complete” reflects the amounts currently estimated by management to be necessary to complete the relevant project. As of September 30, 2013, the Company was not contractually or legally obligated to expend the estimated additional cost to complete these projects, except to the extent reflected in Note 14 – Commitments and Contingencies to the consolidated financial statements.

	14

Project Description

Location

September
30, 2013

Commencement
date

Expected
completion
date

Estimated
additional cost
to
complete

Fangzhi District

Fangzhi District, Xi’an, PRC

11,555,351

October 2010

December 2014

6,000,000

Phases II and III of LNG Project

Jingbian County, Shaanxi Province, PRC

8,171,249

(1)

December 2006

December 2015

190,500,000

(2)

Men Street Project

Lantian County, Shaanxi Province, PRC

2,291,977

December 2011

December 2013

200,000

Three-in-One LNG Fueling Stations

Hubei Province, PRC

2,180,091

January 2013

February 2014

1,300,000

LNG Fueling Stations

Shaanxi & Henan Province, PRC

1,942,802

Various

10,750,000

Sa Pu Mother Station

Henan Province, PRC

1,507,577

July 2008

June 2015

5,800,000

Other Construction in Progress Costs

PRC

7,172,869

Various

800,000

34,821,916

215,350,000

Project Description

Location

December 31,
2012

Commencement
date

Expected
completion
date

Estimated
additional cost
to
complete

Phase I of LNG Project

Jingbian County, Shaanxi Province, PRC

8,424,350

December 2006

March 2014

94,000

Phases II and III of LNG Project

Jingbian County, Shaanxi Province, PRC

14,660,048

December 2006

December 2015

192,800,000

Fangzhi District

Fangzhi District, Xi’an, PRC

8,904,054

October 2010

December 2013

4,120,000

Sa Pu Mother Station

Henan Province, PRC

1,376,421

July 2008

June 2013

6,100,000

International Port(6)

International Port District, Xi’an, PRC

9,835,400

May 2009

December 2020

295,300,000

LNG fueling stations

Shaanxi & Henan Province, PRC

1,646,358

Various

11,050,000

Other Construction in Progress Costs

PRC

8,547,302

Various

1,200,000

53,393,933

510,664,000

(1)

Includes $3,158,697 of construction cost and $5,012,552 of capitalized interest for Phases II and III of the LNG project

	15

(2)

This amount reflects the estimated costs of Phases II and III of the LNG project from September 30, 2013 to December 31, 2015, including an estimated $177 million of construction costs and $14 million of capitalized interest. Such costs should be able to finance the construction of a facility capable of processing 3 million cubic meters of LNG per day, or approximately 900 million cubic meters of LNG per year.

(m.)

Goodwill

The excess of the cost of an acquired entity over the net of the amounts assigned to assets acquired and liabilities assumed is recognized as goodwill. Goodwill is tested for impairment at the reporting unit level (operating segment or one level below an operating segment) on an annual basis in the fourth quarter or more frequently if indicators of impairment exist. The Company uses a two-step goodwill impairment test to identify the potential impairment and to measure the amount of goodwill impairment, if any. The first step is to compare the fair value of the reporting unit with its carrying amount, including goodwill. If the fair value of the reporting unit exceeds its carrying amount, goodwill is considered not impaired. If the carrying amount of a reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. Under step two, the impairment loss is measured by comparing the implied fair value of the reporting unit goodwill with the carrying amount of that goodwill. If the carrying amount of the reporting unit goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess.

(n.)

Long-Lived Assets

We evaluate the carrying value of long-lived assets to be held and used whenever events or changes in circumstances indicate that the assets might be impaired. Impairment losses are recorded on long-lived assets used in operations when indicators of impairment are present and the undiscounted cash flows estimated to be generated by those assets are less than the assets' carrying amounts. In that event, a loss is recognized based on the amount by which the carrying amount exceeds the fair market value of the long-lived assets. Loss on long-lived assets to be disposed of is determined in a similar manner, except that fair market values are reduced for the cost of disposal. Based on our review, no impairment indicators were noted at September 30, 2013.

(o.)

Fair Value of Financial Instruments

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

	16

⋅

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

⋅

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

⋅

Level 3 inputs to the valuation methodology are unobservable.

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

The following tables set forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2013 and December 31, 2012.

	Carrying Value at		Fair Value Measurement at
	September 30,		September 30, 2013
	2013		Level 1		Level 2		Level 3
Redeemable liability – warrants	$	17,500,000	$	-	$	17,500,000	$	-
Total liability measured at fair value	$	17,500,000	$	-	$	17,500,000	$	-

	Carrying Value at		Fair Value Measurement at
	December 31,		December 31, 2012
	2012		Level 1		Level 2		Level 3
Redeemable liability – warrants	$	17,500,000	$	-	$	17,500,000	$	-
Total liability measured at fair value	$	17,500,000	$	-	$	17,500,000	$	-

Other than the assets and liabilities set forth in the table above, the Company did not identify any other assets or liabilities that are required to be accounted for at fair value on the balance sheet. The carrying value of long-term debt with variable interest rate approximates its fair value based on market rates available to the Company with similar terms (See Notes 6 and 7).

	17

The following is a reconciliation of the beginning and ending balance of warrants liability measured at fair value on a recurring basis as of December 31, 2012:

	Fair Value Measurement at
	December 31, 2012
Beginning balance	$	4
Change in fair value		(4)
Ending balance	$	-

The warrants expired at October 26, 2012. The Company recognized a loss of $0 and $4 for the three and nine months ended September 30, 2013, to reflect the change in fair value of the warrants.

(p.)

Revenue Recognition

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

(q.)

Stock-Based Compensations

The Company records and reports stock-based compensation based on a fair-value-based method of accounting for stock-based employee compensation and transactions in which an entity issues its equity instruments to acquire goods and services from non-employees. Compensation for stock granted to non-employees is determined as the fair value of the consideration received or the fair value of equity instruments issued, whichever is more reliably measured.

	18

(r.)

Income Taxes

FASB’s accounting standard regarding income taxes requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or tax returns. Under this method, deferred income taxes are recognized for the tax consequences in future years of temporary differences between the tax bases of assets and liabilities and their financial reporting amounts at each period end based on enacted tax laws and statutory tax rates applicable to the periods in which the differences are expected to affect taxable income. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. As at September 30, 2013 and December 31, 2012, there were no significant book to tax differences except for warrants liability and stock based compensation. An uncertain tax position is recognized as a benefit only if it is “more likely than not” that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. Penalties and interest incurred related to underpayment of income tax are classified as income tax expense in the year incurred. No significant penalties or interest relating to income taxes have been incurred during the three and nine months ended September 30, 2013 and 2012.

XXNGC, the Company’s PRC VIE, and XXNGC’s subsidiaries operate in the PRC. Pursuant to the tax laws of PRC, general enterprises are subject to income tax at an effective rate of 25%. However, under PRC income tax regulation, any company deemed to be engaged in the natural gas industry in the West Regions of the PRC under such regulation enjoys a favorable income tax rate. Thus, XXNGC’s income is subject to a reduced tax rate of 15%. And one of XXNGC’s subsidiaries, JBLNG is subject to a reduced income tax rate of 15% beginning on January 1, 2013. Other XXNGC’s subsidiaries are not deemed to be engaged in the natural gas industry in the West Regions under PRC income tax regulation and, accordingly, are subject to a 25% income tax rate.

The estimated tax savings as a result of the reduced tax rate enjoyed by XXNGC and JBLNG for the three months ended September 30, 2013 and 2012 amounted to approximately $224,524 and $0, respectively. The net effect on earnings per share, had the income tax been applied, would decrease basic and diluted earnings per share for the three months ended September 30, 2013 and 2012, from $0.03 to $0.02 and $(0.07) to $(0.07), respectively.

The estimated tax savings as a result of the reduced tax rate enjoyed by XXNGC and JBLNG for the nine months ended September 30, 2013 and 2012 amounted to approximately $1,213,066 and $851,491 respectively. The net effect on earnings per share, had the income tax been applied, would decrease basic and diluted earnings per share for the nine months ended September 30, 2013 and 2012, from $0.40 to $0.34 and $0.27 to $0.23, respectively.

China Natural Gas, Inc. was incorporated in the United States and has incurred net operating loss for income tax purpose for the period ended September 30, 2013. The estimated net operating loss carry-forwards for United States income tax purposes amounted to $14,660,942 as of September 30, 2013, which may be available to reduce future years' taxable income. These carry-forwards will expire, if not utilized through 2033. Management believes that the realization of the benefits arising from this loss appear to be uncertain due to Company's limited operating history and continuing losses for U.S. income tax purposes. Accordingly, the Company has provided a 100% valuation allowance at September 30, 2013 and December 31, 2012 for net deferred tax assets resulting from net operating loss carry forwards, stock based compensation and warrants liability. Management reviews this valuation allowance periodically and makes adjustments as warranted. The valuation allowances were as follows:

	19

Valuation allowance	For the nine months ended September 30, 2013		For the years ended December 31, 2012
Balance, beginning of period	$	5,286,456	$	4,222,489
Increase		735,445		1,063,967
Balance, end of period	$	6,021,901	$	5,286,456

Provision for income tax is as follow:

	For the three months ended				For the nine months ended
	September 30,				September 30,
	2013		2012		2013		2012
Current	$	426,244	$	87,239	$	2,017,172	$	2,129,838
Deferred		-		-		-		-
	$	426,244	$	87,239	$	2,017,172	$	2,129,838

The following is a reconciliation of the provision for income tax at the PRC tax rate, to the income tax reflected in the Consolidated Statement of Income and Comprehensive Income:

	For the three months ended						For the nine months ended
	September 30,						September 30,
	2013			2012			2013			2012
Tax expense at statutory rate-US		35.0	%		35.0	%		35.0	%		35.0	%
Changes in valuation allowance-US		(35.0)	%		(35.0)	%		(35.0)	%		(35.0)	%
Foreign income tax rate-PRC		25.0	%		25.0	%		25.0	%		25.0	%
Effect of favorable tax rate		(8.6)	%		-			(9.2)	%		(7.5)	%
Other item (1)		20.6	%		(31.2)	%		3.3	%		10.3	%
Total provision for income taxes		37.0	%		(6.2)	%		19.1	%		27.8	%

(1)

The 20.6% mainly represents $1,225,024 in expenses incurred by the Company that are not deductible in the PRC for the three months ended September 30, 2013. The (31.2)% represents loss of $261,626 incurred by XXNGC for the three months ended September 30, 2012. The 3.3% mainly represents $2,101,272 in expenses incurred by the Company that are not deductible in the PRC for the nine months ended September 30, 2013. The 10.3% represents $2,767,311 in expenses incurred by the Company that are not deductible in the PRC for the nine months ended September 30, 2012.

The Company has cumulative undistributed earnings of foreign subsidiaries of approximately $82,358,306 as of September 30, 2013, which is included in consolidated retained earnings and will continue to be indefinitely reinvested in international operations. Accordingly, no provision has been made for U.S. deferred taxes related to future repatriation of these earnings, nor is it practicable to estimate the amount of income taxes that would have to be provided if the Company concluded that such earnings will be remitted in the future.

	20

(s.)

Franchise Tax

According to the laws of the State of Delaware, we are required to pay annual franchise tax to the state government based on the number of the authorized shares.

(t.)

Basic and Diluted Earnings Per Share

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

(u.)

Reclassification

Certain reclassifications have been made to the prior year financial statements to confirm with the current year presentation.

(v.)

Recent Accounting Pronouncements

In January 2013, the FASB issued ASU No. 2013-01, “Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities” (“ASU 2013-01”). The Update clarifies that ordinary trade receivables and receivables are not in the scope of Accounting Standards Update No. 2011-11, Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities. Specifically, Update 2011-11 applies only to derivatives, repurchase agreements and reverse purchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with specific criteria contained in FASB Accounting Standards Codification® or subject to a master netting arrangement or similar agreement. The amendments in this Update are effective for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. Management does not expect the adoption of this standard has a significant effect on the Company’s consolidated financial position or results of operations.

In February 2013, the FASB issued ASU No. 2013-02, “Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income” (“ASU 2013-02”). The amendments require an organization to:

	21

Present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income–but only if the item reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period.

Cross-reference to other disclosures currently required under U.S. GAAP for other reclassification items (that are not required under U.S. GAAP) to be reclassified directly to net income in their entirety in the same reporting period. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is initially transferred to a balance sheet account (e.g., inventory for pension-related amounts) instead of directly to income or expense.

The amendments are effective for reporting periods beginning after December 15, 2012, for public companies. Management does not expect the adoption of this standard has a significant effect on the Company’s consolidated financial position or results of operations.

In February 2013, the FASB issued ASU No. 2013-03, “Clarifying the Scope and Applicability of a Particular Disclosure to Nonpublic Entities” (“ASU 2013-03”). The amendment clarifies that the requirement to disclose the level of the fair value hierarchy within which the fair value measurements are categorized in their entirety (as Level 1, Level 2, or Level 3) does not apply to private companies and nonpublic not-for-profits for items that are not measured at fair value in the statement of financial position, but for which fair value is disclosed. The amendments are effective upon issuance. Management does not expect the adoption of this standard has a significant effect on the Company’s consolidated financial position or results of operations.

In March 2013, the FASB issued ASU No. 2013-04, “Obligations Resulting from Joint and Several Liability Arrangements for Which the Total Amount of the Obligation Is Fixed at the Reporting Date” (“ASU 2013-04”). The update provides guidance for the recognition, measurement, and disclosure of obligations resulting from joint and several liability arrangements for which the total amount of the obligation within the scope of this ASU is fixed at the reporting date, except for obligations addressed within existing guidance in US GAAP. The guidance requires an entity to measure those obligations as the sum of the amount the reporting entity agreed to pay on the basis of its arrangement among its co-obligors and any additional amount the reporting entity expects to pay on behalf of its co-obligors. The guidance in this ASU also requires an entity to disclose the nature and amount of the obligation as well as other information about those obligations. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Management does not expect the adoption of this standard will have a significant effect on the Company’s consolidated financial position or results of operations.

	22

In March 2013, the FASB issued ASU No. 2013-05, “Parent’s Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity” (“ASU 2013-05”). The ASU clarifies that when a parent entity ceases to have a controlling financial interest in a subsidiary or group of assets that is a nonprofit activity or a business (other than a sale of in substance real estate or conveyance of oil and gas mineral rights) within a foreign entity, the parent is required to apply the guidance in Accounting Standards Codification 830-30 to release any related cumulative translation adjustment into net income. The ASU provides that the cumulative translation adjustment should be released into net income only if the sale or transfer results in the complete or substantially complete liquidation of the foreign entity in which the subsidiary or group of assets had resided. The amendments take effect prospectively for public companies for fiscal years beginning after December 15, 2013, and interim reporting periods within those years. Management does not expect the adoption of this standard will have a significant effect on the Company’s consolidated financial position or results of operations.

In March 2013, the FASB issued ASU No. 2013-07, “Liquidation Basis of Accounting” (“ASU 2013-07”). The ASU requires an entity to prepare its financial statements using the liquidation basis of accounting when liquidation is imminent. Liquidation would be considered imminent when the likelihood is remote that the reporting entity would return from liquidation and either: (a) a plan for liquidation has been approved by the person or persons with the authority to make such a plan effective and the likelihood is remote that the execution of the plan will be blocked by other parties or the entity will return from liquidation, or (b) a plan for liquidation is imposed by other forces, and the likelihood is remote that the entity will return from liquidation. If a plan for liquidation was specified in an entity's governing documents at its inception (for example, limited-life entities), then liquidation would be imminent only if the approved plan for liquidation differs from the plan specified at the entity’s inception. The amendments take effect for all entities reporting under U.S. GAAP, except investment companies that are regulated under the Investment Company Act of 1940. The standard is effective for annual reporting periods beginning after December 31, 2013, and interim reporting periods therein. Early adoption is permitted. Management does not expect the adoption of this standard will have a significant effect on the Company’s consolidated financial position or results of operations.

On July 18, the FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force)” (“ASU 2013-11”). The ASU presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists (a consensus of the FASB Emerging Issues Task Force), which requires an entity to present an unrecognized tax benefit as a reduction of a deferred tax asset for an net operating loss (NOL) carryforward, or similar tax loss or tax credit carryforward, rather than as a liability when (1) the uncertain tax position would reduce the NOL or other carryforward under the tax law of the applicable jurisdiction and (2) the entity intends to use the deferred tax asset for that purpose. The ASU does not require new recurring disclosures. It is effective prospectively for fiscal years, and interim periods within those years, beginning after December 15, 2013 and December 15, 2014, for public and nonpublic entities, respectively. Early adoption and retrospective application are permitted. Management does not expect the adoption of this standard will have a significant effect on the Company’s consolidated financial position or results of operations.

	23

Note 4 –Goodwill and Other Intangible Assets

Goodwill is the amount the Company paid to acquire 100% of the equity interests of Makou and 58.5284% of the equity interests of XTJH in excess of the fair value of Makou and XTJH’s identifiable assets and liabilities, respectively. Annual impairment testing is performed during the fourth quarter of each year unless events or circumstances indicate earlier impairment testing is required. No impairment loss was recognized during the period ended September 30, 2013 and 2012.

Other intangible assets include primarily the technical license related to liquefied natural gas business, which consisted of the following:

	September 30, 2013		December 31, 2012
Operating rights	$	5,476,303	$	5,339,474
Technical license (LNG)		9,927,563		10,072,170
Land use rights		5,757,667		5,971,006
Other		15,155		18,274
Total	$	21,176,688	$	21,400,924

The operating rights are deemed to have an indefinite useful life as cash flows are expected to continue indefinitely. The operating rights will not be amortized until their useful life is deemed to be no longer indefinite.

The technical license (LNG) is being amortized over its estimated useful life of 20 years. Amortization expense for the three months ended September 30, 2013 and 2012 was $138,659 and $134,988, respectively. Amortization expense for the nine months ended September 30, 2013 and 2012 was $412,391 and $405,988, respectively. Accumulated amortization at September 30, 2013 was $1,206,152.

The land use rights are being amortized over their estimated useful life of 30 years. For the three months ended September 30, 2013 and 2012, amortization expense amounted to $41,564 and $40,567, respectively. For the nine months ended September 30, 2013 and 2012, amortization expense amounted to $123,619 and $121,700, respectively. As of September 30, 2013, accumulated amortization was approximately $470,023.

	24

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

2013	$	178,670
2014		714,681
2015		714,681
2016		703,800
2017		703,800
thereafter		9,709,881
	$	12,725,513

Note 5 – Prepaid Expenses and Other Assets

Prepaid expenses and other assets consisted of the following:

	September 30, 2013		December 31, 2012
Prepaid rent – natural gas stations	$	495,180	$	501,599
Prepayment for acquiring land use right		1,304,000		1,269,600
Advances on purchasing equipment and construction in progress		4,251,327		4,286,898
Refundable security deposits		1,412,599		957,045
Total	$	7,463,106	$	7,015,142

Prepaid rent represents prepayments for leasing the land of our fueling stations. In China, land rental usually requires an advancement and then amortized into expense on a straight-line basis over the term of the land lease.

All land in the PRC is government owned. However, the government grants users land use rights. The Company is in the process of negotiating the final purchase price with relevant local government and the land use rights have not yet been granted to the Company. Therefore, the Company did not amortize these amounts for land use rights.

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

Refundable security deposits are monies deposited with one of the Company’s major vendors and a gas station landlord. These amounts will be returned to the Company if the other party terminates the business relationship or upon the expiration of the lease.

Note 6 –Senior Notes

The Company’s securities purchase agreement with Abax Lotus Ltd. (“Abax”) was amended on January 29, 2008 (as amended, the “Purchase Agreement”). On January 29, 2008, under the Purchase Agreement, the Company sold to Abax $20,000,000 in principal amount of its 5.0% Guaranteed Senior Notes due January 30, 2014 (the “Senior Notes”) and warrants to purchase 1,450,000 shares of its common stock (the “Abax Warrants”) and, on March 3, 2008, the Company issued to Abax an additional $20,000,000 in principal amount of Senior Notes.

	25

On the dates set forth in the table below, the Company will be required to make repayments of the corresponding percentage of the principal amount (or such lesser principal amount as shall be outstanding then) in respect of the aggregate outstanding principal amount of the Senior Notes:

Date	Repayment Percentage
July 30, 2011 (paid on August 5, 2011)		8.3333	%
January 30, 2012 (paid on March 7, 2012)		8.3333	%
July 30, 2012		16.6667	%
January 30, 2013		16.6667	%
July 30, 2013		25.0000	%
January 30, 2014		25.0000	%

The second repayment for 8.3333% of the principal of the Senior Notes was due on January 30, 2012. After negotiation with Abax, the note-holders agreed that the Company could make the payment on or before March 9, 2012. On March 7, 2012, the Company paid the principal due on January 30, 2012 in full plus accrued interest for the period from July 30, 2011 to January 29, 2012, as well as a penalty interest of $28,416 for the period from February 6, 2012 to March 7, 2012. Abax issued a waiver to exempt the Company from any other consequences of the late payment.

The repayment of 16.6666% of the principal of the notes payable plus accrued interest of the period from January 29, 2012 to July 30, 2012 was due on July 30, 2012. And the repayment of 16.6666% of the principal of the notes payable plus accrued interest of the period from July 31, 2012 to January 30, 2013 was due on January 30, 2013. The company did not make these payments at the time they were due and the payments remain unpaid.

On September 5, 2012, the Company received another notice from the Holders that the Holders elected to exercise their right to accelerated payment of the Senior Notes as a result of the continued Default (the “Acceleration Notice”). The immediate acceleration of all amounts owing under the Senior Notes totals approximately RMB 249,450,516.

Further, on September 10, 2012, the Company received a demand notice from the Holders’ legal counsel on behalf of the Holder for the payment of all amounts owing under the Senior Notes (the “Demand Notice”) within 15 days from the date of the Demand Notice. The Demand Notice stated that if the Company failed to meet the demand, the Holders intend to pursue all of its legal rights under the transaction documents, including, without limitation:

⋅

Requiring the Trustee to initiate suit in the courts of New York with respect to the Company’s failure to pay the entire amount due to the Holders under the Senior Notes;

	26

⋅

Initiating involuntary bankruptcy proceedings with respect to the Company under the U.S. Federal Bankruptcy Code;

⋅

Initiating arbitration in Hong Kong against the Company for breaches of the Company’s obligations under the SPA;

⋅

Exercising its rights under the Warrant Agreement to require the redemption of all Warrants held by it at the Redemption Price (as defined therein); and

⋅

All other rights under the transaction documents relating to the Senior Notes in relation to the Default, which may include, foreclosing on the security interest in 65% of all outstanding equity interest of the Company’s wholly owned subsidiary, Shaanxi Xilan Natural Gas Equipment Co., Ltd., and all funds in the account where the proceeds from the Senior Notes were deposited.

In addition to the demands disclosed above, the Holders have also asserted that by virtue of the Default the Company is obliged to redeem the Warrants and pay to the Holders $17.5 million.

The Company disputes the amount allegedly owed, and has been in negotiation with the Holders but has not able to come to a resolution with the Holders.

On September 11, 2012, the holders of a majority of the Senior Notes (the “Holders”) notified the Company on August 21, 2012 (the “Default Notice”) that the Company was in default of the Senior Notes for failure to make the interest payment due and a mandatory redemption of the Senior Notes on July 30, 2012 (the “Default”). In the notice, the Holders also demanded that the Company make all payments due as of July 30, 2012 under the Senior Notes to avoid acceleration of all payments under the Senior Notes and foreclosure of collaterals pledged to secure the Senior Notes.

On February 8, 2013, an Involuntary Petition for Bankruptcy, entitled In re China Natural Gas, Inc. (Case No. 13-10419), was filed against China Natural Gas, Inc. (the "Company") by three creditors of the Company, namely Abax Lotus Ltd., Abax Nai Xin A Ltd., and Lake Street Fund LP (the “Petitioners”). The petition was filed in the United States Bankruptcy Court, Southern District of New York (the “Bankruptcy Court”). The Petitioners have claimed in the Involuntary Petition that they have debts totaling $42,218,956.88 as a result of the Company’s failure to make payments on the 5% Guaranteed Senior Notes issued in 2008. On or about June 26, 2013, the Company filed a consent to the Involuntary Petition. On July 12, 2013, the Order for Relief was entered in the Bankruptcy Court.

Senior notes consist of the following:

	September 30, 2013		December 31, 2012
Notes payable	$	38,908,332	$	38,352,498
Less discount		-		-
		38,908,332		38,352,498
Less current portion		(38,908,332)		(38,352,498)
	$	-	$	-

	27

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

The indenture limits the Company’s ability to incur debt and liens, make dividend payments and stock repurchases, make investments, reinvest proceeds from asset sales and enter into transactions with affiliates, among other things. The indenture also requires the Company to maintain certain financial ratios.

In connection with the issuance of the Senior Notes, the Company paid $2,122,509 in debt issuance costs, which are being amortized over the life of the Senior Notes. The Company amortized all outstanding amounts of debt issuance costs during the third quarter of 2012. For the three and nine months ended September 30, 2012, the Company amortized $312,418 and $517,334 of the issuance costs, which was recorded as capitalized interest included in construction in progress.

The Abax Warrants are presently exercisable and have an exercise price of $7.37 per share, although Abax has not exercised any of the Abax Warrants. As a result of the default of the Senior Notes, the Holders elected to exercise their right to accelerated payment of the Senior Notes in September 2012. The Company had reclassified the derivative liability to current liabilities during the third quarter of 2012.

The Abax Warrants are considered derivative instruments required to be bifurcated from the original security because there is a redemption requirement if the holder does not exercise the Warrants. If Abax does not exercise the Abax Warrants prior to their expiration date of January 29, 2015, Abax can require the Company to repurchase the Abax Warrants for $17,500,000. This amount is shown as a debt discount and is being amortized over the term of the Senior Notes. The Company amortized all outstanding amounts of debt discount during the third quarter of 2012. For the three and nine months ended September 30, 2012, the Company amortized $3,754,794 and $5,590,267 of the discounts, which were capitalized into construction in progress. The Holders have asserted that by virtue of the Default the Company is obliged to redeem the Warrants and pay to the Holders $17.5 million. The Company disputes the amount allegedly owed, and has been in negotiation with the Holders but has not able to come to a resolution with the Holders.

Note 7 –Bank Loan Payable

The Company’s bank loan payable as of September 30, 2013 consists of:

	September 30, 2013		December 31, 2012
A loan from Pudong Development Bank Xi’an Branch, due various dates from 2013 to 2014	$	8,150,000	$	9,522,000
Less current portion		(4,890,000)		(4,761,000)
	$	3,260,000	$	4,761,000

	28

The loan is secured by XXNGC’s equipment and vehicles located within the PRC. The carrying net value of the assets pledged is $9,199,246 as of September 30, 2013. Interest expense for the three and nine months ended September 30, 2013 was $135,996 and $417,884, respectively (interest rate applied at September 30, 2013 was 6.40%). Interest expense for the three and nine months ended September 30, 2012 was $236,958 and $718,541, respectively (interest rate applied at September 30, 2012 was 6.90%). According to the loan agreement, the interest rate is fixed throughout each single year and will only be adjusted at the beginning of the next year, based on the base interest rate on the same category of loans for the same term published by the People’s Bank of China. XXNGC also entered into a guaranty with the lender to guarantee the repayment of the loans. According to an amendment to the loan agreement with the Bank, which was signed on October 2011, the Company is required to make repayments on the long term loan as follows:

Date	Repayment Percentage			Repayment Amount
October 5, 2011 (paid on October 10, 2011)		4.2	%	$	815,000
December 5, 2011 (paid on December 5, 2011)		20.8	%		4,075,000
March 5, 2012 (paid on March 5, 2012)		4.2	%		815,000
December 5, 2012 (paid on December 5, 2012)		20.8	%		4,075,000
March 5, 2013 (paid on March 5, 2013)		8.3	%		1,630,000
December 5, 2013		16.7	%		3,260,000
March 5, 2014		8.3	%		1,630,000
December 5, 2014		16.7	%		3,260,000
		100.0	%	$	19,560,000

If the default of the Senior Notes is not resolved, the Company may be deemed to be in default on its fixed asset loan from Shanghai Pudong Development Bank (“SPDB”) as the Holders initiate involuntary bankruptcy proceedings with respect to the Company and the Company does not obtain prior written approval from SPDB. The default of the loan with SPDB may result in full or partial acceleration of the repayment of the loan.

Note 8 – Warrants

No warrants were granted, forfeited or exercised during the nine months ended September 30, 2013 and 2012, respectively.

	29

The following is a summary of warrants outstanding and exercisable as of September 30, 2013 and 2012:

Warrants Outstanding and Exercisable as of September 30, 2013

Exercise Price		Number		Average Remaining Contractual Life
$	7.37		1,450,000		1.33
			1,450,000

Warrants Outstanding and Exercisable as of September 30, 2012

Exercise Price		Number		Average Remaining Contractual Life
$	14.86		383,654		0.07
$	7.37		1,450,000		2.33
			1,833,654

Note 9 – Defined Contribution Plan