China Energy CORP - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - China Energy CORP	Financial_Report.xls
EX-32 - EXHIBIT 32 - China Energy CORP	v318608_ex32.htm
EX-31.2 - EXHIBIT 31.2 - China Energy CORP	v318608_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - China Energy CORP	v318608_ex31-1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

x Quarterly report under Section 13 or 15(d) of the Securities Exchange Act of 1934 for the fiscal quarter ended May 31, 2012

¨ Transition report under Section 13 or 15(d) of the Securities

Exchange Act of 1934 for the transition period from ____ to______.

Commission file number: 000-52409

CHINA ENERGY CORPORATION

(Exact name of Registrant as specified in its charter)

Nevada		98-0522950
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

No. 57 Xinhua East Street Hohhot, Inner Mongolia, People’s Republic of China		010010
(Address of principal executive offices)		(Zip Code)

+86-0471-466-8870
(Registrant’s telephone number including area code)

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

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

Large accelerated filer ¨	Accelerated filer ¨	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 x No

State the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date:

45,060,000 shares of Common Stock, $0.001 par value, outstanding as of July 16, 2012

TABLE OF CONTENTS
PART I.	FINANCIAL INFORMATION
ITEM 1.	Financial Statements
ITEM 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	3
ITEM 3.	Quantitative And Qualitative Disclosure About Market Risk	13
ITEM 4T	Controls and Procedures	13

PART II.	OTHER INFORMATION
ITEM 1.	Legal Proceedings	13
ITEM 1A	Risk Factors	13
ITEM 2.	Unregistered Sales of Equity Securities and Use of Proceeds	13
ITEM 3.	Defaults Upon Senior Securities.	13
ITEM 4.	Mine Safety Disclosures	13
ITEM 5.	Other Information.	13
ITEM 6.	Exhibits	14
	Signatures	15

SPECIAL NOTE REGARDING FORWARD LOOKING STATEMENTS

This report contains forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends affecting the financial condition of our business. These forward-looking statements are subject to a number of risks, uncertainties and assumptions, including, among other things:

general economic and business conditions, both nationally and in our markets,

our expectations and estimates concerning future financial performance, financing plans and the impact of competition,

our ability to implement our growth strategy, anticipated trends in our business,

advances in technologies, and

other risk factors set forth herein.

In addition, in this report, we use words such as “anticipates,” “believes,” “plans,” “expects,” “future,” “intends,” and similar expressions to identify forward-looking statements.

China Energy Corporation and its subsidiaries (the “Company”) undertake no obligation to update publicly or revise any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this prospectus. In light of these risks and uncertainties, the forward-looking events and circumstances discussed in this prospectus may not occur and actual results could differ materially from those anticipated or implied in the forward-looking statements.

ITEM 1. INTERIM FINANCIAL STATEMENTS.

CHINA ENERGY CORPORATION

AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED

MAY 31, 2012 AND 2011

CHINA ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	May 31,		November 30,
	2012		2011
	(Unaudited)		(Audited)
	US$		US$
ASSETS
Current assets:
Cash	$	34,285,849	$	31,007,269
Accounts receivable, net of allowance for doubtful accounts of $11,265 and $11,251, respectively		28,650,258		17,364,962
Other receivables		14,742,036		24,562,536
Inventories		20,542,245		10,096,645
Prepaid expenses		704,151		323,072
Advance to suppliers		42,422,506		27,566,516
Total current assets		141,347,045		110,921,000

Fixed assets, net		63,711,143		62,937,747

Other assets:
Investment property, net of accumulated depreciation of $563,185 and $475,649, respectively		5,646,832		5,730,169
Mining right, net of amortization of $1,906,131 and $1,635,072, respectively		2,826,518		3,091,565
Restricted cash		575,831		573,542
Other long term assets		5,963,098		3,889,144
Total other assets		15,012,279		13,284,420

TOTAL ASSETS	$	220,070,467	$	187,143,167

LIABILITIES AND STOCKHOLDERS’ EQUITY
Current liabilities:
Short term bank loans	$	29,803,404	$	29,138,242
Accounts payable		24,750,164		21,716,148
Advances from customers		16,900,241		10,321,920
Accrued liabilities		970,607		629,016
Other payables		8,397,741		13,111,017
Stockholder loans		9,614,022		9,452,712
Current portion of finance obligations		3,059,834		1,695,944
Current portion of deferred income		1,487,186		1,333,695
Total current liabilities		94,983,199		87,398,694

Non-current liabilities
Finance obligations, net of current portion		12,256,272		6,906,957
Deferred income, net of current portion		9,447,352		8,804,664
Total non-current liabilities		21,703,624		15,711,621

Total liabilities		116,686,823		103,110,315

Commitments and contingencies		-		-

Stockholders’ equity:
Preferred stock: no par value; 5,000,000 shares authorized; none issued and outstanding shares		-		-
Common stock: $0.001 par value; 195,000,000 shares authorized; 45,060,000 shares issued and outstanding at May 31, 2012 and November 30, 2011, respectively		45,060		45,060
Additional paid-in capital		10,625,225		10,620,368
Retained earnings		75,328,995		56,818,378
Statutory reserves		9,916,340		9,032,855
Accumulated other comprehensive income		7,468,024		7,516,191
Total stockholders’ equity		103,383,644		84,032,852

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	220,070,467	$	187,143,167

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

F-3

CHINA ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF Income And OTHER comprehensive income
(UNAUDITED)

	For the three months ended May 31,						For the six months ended May 31,
	2012			2011			2012			2011
	US$			US$			US$			US$

Revenues	$	86,540,087		$	32,191,523		$	125,227,238		$	54,544,252
Cost of revenues		(65,718,814	)		(21,572,903	)		(90,853,664	)		(35,926,889	)
Gross profit		20,821,273			10,618,620			34,373,574			18,617,363

Operating expenses:
Selling and marketing		(2,207,548	)		(1,351,996	)		(5,519,705	)		(2,595,802	)
General and administrative		(1,925,538	)		(2,366,181	)		(3,650,432	)		(3,483,311	)
Total operating expenses		(4,133,086	)		(3,718,177	)		(9,170,137	)		(6,079,113	)

Income from operations		16,688,187			6,900,443			25,203,437			12,538,250

Other income and expenses
Interest expense, net		(900,049	)		(628,762	)		(1,701,681	)		(949,704	)
Government subsidies		756,597			-			756,597			-
Non-operating income		428,854			329,845			606,753			763,049
Non-operating expenses		(50,070	)		(42,629	)		(150,343	)		(122,628	)
Income before provision for income taxes		16,923,519			6,558,897			24,714,763			12,228,967

Provision for income taxes		(3,831,632	)		(2,771,594	)		(5,320,661	)		(4,077,454	)

Net income		13,091,887			3,787,303			19,394,102			8,151,513

Other comprehensive income
Foreign currency translation adjustment		(1,184,162	)		832,589			(48,167	)		1,640,593
Total comprehensive income	$	11,907,725		$	4,619,892		$	19,345,935		$	9,792,106

Net income per common share, basic and diluted	$	0.26		$	0.08		$	0.43		$	0.18

Weighted average common shares outstanding, basic and diluted		45,060,000			45,060,000			45,060,000			45,060,000

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

F-4

CHINA ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For the SIX Months Ended MAY 31, 2012

(UNAUDITED)

												Accumulated
					Additional							Other			Total
	Common Stock				Paid-in		Retained			Statutory		Comprehensive			Stockholders’
	Shares		Amount		Capital		Earnings			Reserves		Income (loss)			Equity
			US$		US$		US$			US$		US$			US$
Balance as of November 30, 2011		45,060,000	$	45,060	$	10,620,368	$	56,818,378		$	9,032,855	$	7,516,191		$	84,032,852
Net income		-		-		-		19,394,102			-		-			19,394,102
Other comprehensive (loss)		-		-		-		-			-		(48,167	)		(48,167	)
Stock-based compensation		-		-		4,857		-			-		-			4,857
Appropriation of statutory reserves		-		-		-		(883,485	)		883,485		-			-
Balance as of May 31, 2012 (unaudited)		45,060,000	$	45,060	$	10,625,225	$	75,328,995		$	9,916,340	$	7,468,024		$	103,383,644

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

F-5

CHINA ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	For the six months ended May 31,
	2012			2011
	US$			US$
Cash flows from operating activities:
Net income	$	19,394,102		$	8,151,513
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Decrease in allowance for doubtful accounts		-			(44,641	)
Depreciation and amortization		4,354,907			3,007,127
Stock-based compensation		4,857			1,533,906
Interest accrued on shareholder loans		197,976			180,620
Loss on disposal of property, plant and equipment		12,906			-
Changes in operating assets and liabilities:
(Increase) in restricted cash		(2,289	)		(15,879	)
(Increase) in accounts receivable		(11,285,310	)		(7,743,155	)
Decrease in other receivables		9,820,500			2,091,373
(Increase) in prepaid expense		(381,079	)		-
(Increase) in advances to suppliers		(13,761,483	)		(15,461,740	)
(Increase) in inventories		(10,445,600	)		(8,923,265	)
(Increase) in other long term assets		-			(3,593,056	)
Increase in deferred income		796,179			100,248
Increase in accounts payable		1,197,528			1,646,061
Increase in advances from customers		6,578,320			1,806,317
(Decrease) in accrual liabilities and other payables		(4,371,685	)		(319,752	)
Net cash provided by (used in) operating activities		2,109,829			(17,584,323	)

Cash flows from investing activities:
Purchase of property, plant and equipment		(3,520,042	)		(4,283,784	)
Increase in construction in progress		(109,429	)		(117,547	)
Payments made on other long term assets		(528,170	)		-
Payments received on notes receivable		-			14,679,099
Net cash (used in) provided by investing activities		(4,157,641	)		10,277,768

Cash flows from financing activities:
Proceeds from short term bank loans		22,160,665			20,702,358
Repayment of short term bank loans		(21,527,503	)		(4,566,697	)
Proceeds from finance obligations		5,710,602			9,261,260
Repayments of lease finance obligations		(841,679	)		-
Repayments of stockholders loans		(47,487	)		(162,518	)
Net cash provided by financing activities		5,454,598			25,234,403

Effect of exchange rate changes on cash		(128,206	)		502,886

Net change in cash and cash equivalents		3,278,580			18,430,734
Cash and cash equivalents, beginning of period		31,007,269			4,580,540

Cash and cash equivalents, end of period	$	34,285,849		$	23,011,274

F-6

CHINA ENERGY CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

	For the six months ended May 31,
	2012		2011
	US $		US $
Supplemental disclosure of cash flow information

Cash paid for interest	$	1,123,830	$	837,541
Cash paid for income taxes	$	6,480,489	$	5,010,268

Supplemental disclosure of non-cash financing activities

Service fee and refundable deposit included with financing leases	$	1,887,340	$	-

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

F-7

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Organization and Business

Organization of the Company

China Energy Corporation (the “Company”) is a Nevada corporation, formed on October 11, 2002 under the name Omega Project Consultations, Inc. The name was changed to China Energy Corporation on November 3, 2004. On November 30, 2004, the Company entered into a share exchange agreement with Inner Mongolia Tehong Coal Group Co., Ltd. (“Coal Group”), and Inner Mongolia Zhunger Heat Power Co. Ltd. (“Heat Power”) and their respective shareholders. The transaction was accounted for as a reverse merger, a procedure that treats the transaction as though Coal Group had acquired the Company. Under the accounting for a reverse merger, the assets and liabilities of the Company, which were nil at the time, were recorded on the books of Coal Group, the continuing company, and the stockholders’ equity accounts of Coal Group were reorganized to reflect the shares issued in this transaction.

The share exchange agreement, which resulted in the Company’s acquisition of the Coal Group and Heat Power, was governed by and valid under Nevada law and was not perfected under the then People’s Republic of China (“PRC”) law. It was not until certain changes in PRC law, which became definitive in 2006, made clear that a series of procedures of governmental approvals and certain additional corporate actions would be conditions precedents to that perfection. The Company does not believe the lack of perfection impairs its ability to exercise control over the Coal Group and Heat Power as it continues to exercise control over them, consistent with the intent of the original shareholders.

On July 13, 2009, the Company entered into a framework agreement which detailed the actions contemplated for the restructuring of the Company, Coal Group and Heat Power under a "variable interest entity" (“VIE”) structure to meet the current requirements of applicable PRC law.

On November 30, 2010, the Company entered into a series of contractual arrangements pursuant to which the control and the economic benefits and costs of ownership of its two operating companies Coal Group and Heat Power (collectively, the “Operating Companies”) in the PRC would flow directly to Beijing Tehong Energy Technology Consulting Co., Ltd. (the “WFOE”), wholly owned through subsidiaries of the Company.

The Company first entered into a Termination And Restructuring Agreement with the Operating Companies, the WFOE, Pacific Projects Inc. (“PPI”) and the respective stockholders of the Operating Companies (collectively, the “PRC Shareholders”) dated November 30, 2010 pursuant to which the parties agreed (i) to terminate the Trust Agreement dated as of December 31, 2007 under which the PRC Shareholders agreed to hold their equity interests in the Operating Companies in trust for PPI, (ii) to the merger of PPI into the Company and (iii) to enter into Management and Control Agreements.

F-8

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

On November 30, 2010, the WFOE entered into (i) an Exclusive Business Cooperation Agreement with Coal Group, (ii) an Equity Interest Pledge Agreement and an Exclusive Option Agreement with Coal Group and the stockholders of Coal Group and (iii) a Power of Attorney, with each of the stockholders of the Coal Group. The WFOE also entered into (i) an Exclusive Business Cooperation Agreement with Heat Power, (ii) an Equity Interest Pledge Agreement and an Exclusive Option Agreement with Heat Power and the stockholders of Heat Power and (iii) a Power of Attorney with each of the stockholders of Heat Power. The foregoing agreements are herein collectively referred to as the “Management and Control Agreements.”

The Management and Control Agreements described below allow the WFOE to exercise control over, and derive all economic benefits from Coal Group and Heat Power. Previously, the operating businesses were controlled pursuant to a trust arrangement which has been terminated as part of the restructuring described below.

Exclusive Business Cooperation Agreements: Pursuant to the Exclusive Business Cooperation Agreements, the WFOE provides technical and consulting services related to the business operations of each of Coal Group and Heat Power. In consideration for such services, Coal Group and Heat Power has agreed to pay an annual service fee to the WFOE in an amount equal 100% of Coal Group’s and Heat Power’s annual net income, respectively. Each Exclusive Business Cooperation Agreement has a term of 10 years, which automatically renews unless terminated by the WFOE. The WFOE may terminate the agreements at any time upon 30 days’ prior written notice to Coal Group or Heat Power, as the case may be.

Exclusive Option Agreements: Pursuant to the Exclusive Option Agreements, the WFOE has an exclusive option to purchase, or to designate another qualified person to purchase, to the extent permitted by PRC law and foreign investment policies, part or all of the equity interests in each of the Coal Group and Heat Power held by the stockholders of Coal Group and the stockholders of Heat Power, respectively. To the extent permitted by the PRC laws, the purchase price for the entire equity interest is RMB1.00 or the minimum amount required by PRC law or government practice. Each of the exclusive option agreements has a term of 10 years, with renewal for an additional 10 years at the option of the WFOE.

Powers of Attorney: Each of the stockholders of the Coal Group and Heat Power, respectively, executed a Power of Attorney that provides the WFOE with the power to act as such stockholder’s exclusive agent with respect to all matters related to such stockholder’s ownership interest in each of Coal Group or Heat Power, including the right to attend stockholders’ meetings and the right to vote, dispose or pledge such shares.

Equity Interest Pledge Agreements: Pursuant to such agreements, each of the stockholders of Coal Group and Heat Power pledged their shares in Heat Power and Coal Group, respectively, to the WFOE, to secure their obligations under the Exclusive Business Cooperation Agreements. In addition, the stockholders of Coal Group and Heat Power agreed not to transfer, sell, pledge, dispose of or create any encumbrance on any equity interests in Coal Group or Heat Power that would affect the WFOE’s interests. The Equity Interest Pledge Agreement expires when Coal Group and Heat Power, respectively, fully perform their obligations under the Exclusive Business Cooperation Agreements.

F-9

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Termination of Trust Arrangements: Prior to entering into the Management and Control Agreements, the Company controlled Coal Group and Heat Power through a series of trust agreements which were terminated contemporaneously with the execution of the Management and Control Agreements. In connection with the termination of such trust arrangements, ownership of 68% of the shares of the Company previously held by Georgia Pacific Investments Inc. and Axim Holdings Ltd. was transferred to Fortune Place Holdings Ltd. (“Fortune Place”).

Entrustment Agreement and Share Option Agreement: Ninghua Xu, owner of 100% equity interests of Fortune Place, entered into an entrustment agreement with WenXiang Ding, the Chief Executive Officer, pursuant to which Mr. Ding was entrusted to manage the Operating Companies and related entities as provided in the agreement as the agent of Mr. Xu. The agreement also appoints Mr. Ding as the exclusive agent with respect to all matters concerning 100% of Mr. Xu’s equity interest in Fortune Place. In addition, Mr. Xu and Mr. Ding entered into a share option agreement pursuant to which Mr. Ding has the option to purchase all of the shares of Fortune Place from Mr. Xu upon the achievement of certain performance targets by the Operating Companies and related entities.

Revised Corporate Structure: As a result of the entry into the foregoing agreements, and the termination of the trust arrangements, the Company has a revised corporate structure which is set forth below:

F-10

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Business

The Company’s business is made up of two segments: Coal Group and Heat Power.

Coal Group: Coal Group was organized in China on August 8, 2000 as Inner Mongolia Zhunger Tehong Coal Co., Ltd. The name was changed in December 2003 to Inner Mongolia Tehong Coal Group Co. Ltd. Coal Group has mining rights to a coal mine in the Inner Mongolia District from which it mines coal. It also buys, sells, and transports coal, serving the Inner Mongolia District.

Heat Power: During 2003, Heat Power was granted a license, to supply heating to the entire XueJiaWan area. To provide for this requirement, construction began in 2004 on a thermoelectric plant, which was completed in September 2006. Heat Power supplies heating directly to users and supplies electricity within the XueJiaWan area through a government controlled intermediary, Inner Mongolia Electric Power Group Co., Ltd. (“Electric Power Group”).

The Coal Group does not sell any coal to Heat Power.

F-11

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Summary of Significant Accounting Policies

Basis of Accounting and Presentation

The unaudited interim financial statements of the Company as of May 31, 2012 and for three and six month periods ended May 31, 2012 and 2011, have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the Securities and Exchange Commission (the “SEC”) which apply to interim financial statements. In the opinion of management, such information contains all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the periods presented. The results of operations for the three and six months ended May 31, 2012 are not necessarily indicative of the results to be expected for future quarters or for the year ending November 30, 2012.

Certain information and disclosures normally included in the notes to the financial statements have been condensed or omitted as permitted by the rules and regulations of the SEC, although the Company believes the disclosure is adequate to make the information presented not misleading. The accompanying unaudited financial statements should be read in conjunction with the consolidated financial statements of the Company for the year ended November 30, 2011.

All financial statements and notes to the financial statements are presented in US dollars.

Basis of Consolidation

Pursuant to Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 810, the Company is required to include in its consolidated financial statements the financial statements of variable interest entities. ASC Topic 810 requires a variable interest entity to be consolidated by a company if that company is subject to a majority of the risk of loss for the variable interest entity or is entitled to receive a majority of the variable interest entity’s residual returns. Variable interest entities are those entities in which the Company, through contractual arrangements, bears the risk of, and enjoy the rewards normally associated with ownership of the entity, and therefore the Company is the primary beneficiary of the entity.

The consolidated financial statements include the accounts of the Company’s WFOE and Coal Group and Heat Power since they are deemed variable interest entities and the Company is the primary beneficiary. All significant intercompany accounts and transactions have been eliminated in consolidation.

F-12

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Recently Issued Accounting Standards

In December 2009, the FASB issued Accounting Standards Update (“ASU”) 2009-17, “Consolidations (Topic 810) – Improvements to Financial Reporting by Enterprises Involved with Variable Interest Entities” (“ASU 2009-17”). The Company adopted ASU 2009-17, which requires an enterprise to perform an analysis to determine whether the enterprise’s variable interest or interests give it a controlling financial interest in a VIE. This analysis identifies the primary beneficiary of a variable interest entity as the enterprise that has (1) the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses of the entity that could potentially be significant to the variable interest entity or the right to receive benefits from the entity that could potentially be significant to the variable interest entity. In addition, the required changes provide guidance on shared power and joint venture relationships, remove the scope exemption for qualified special purpose entities, revise the definition of a variable interest entity, and require additional disclosures. The Company has assessed the terms contained in the Management and Control Agreements between the Company and Coal Group and Heat Power and determined that Coal Group and Heat Power are VIEs, and accordingly, are consolidated in these financial statements.

In January 2010, the FASB issued Accounting Standards Update No. 2010-6, “Improving Disclosures about Fair Value Measurements” (“ASU No. 2010-06”). ASU No. 2010-06 amends ASC Topic 820, “Fair Value Measurements and Disclosures,” to require additional information to be disclosed principally regarding Level 3 measurements and transfers to and from Level 1 and 2. In additional, enhanced disclosure is required concerning inputs and valuation techniques used to determine Level 2 and Level 3 measurements. This guidance is generally effective for interim and annual reporting periods beginning after December 15, 2009; however, requirements to disclose separately purchases, sales, issuances, and settlements in the Level 3 reconciliation are effective for fiscal years beginning after December 15, 2010 (and for interim periods within such years). The update did not have a material impact on the Company’s consolidated results of operations or financial position.

In May 2011, the FASB issued ASU No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S.GAAP and IFRSs” (“ASU No. 2011-04”) that provides clarification about the application of existing fair value measurements and disclosure requirements and expands certain other disclosure requirements. ASU 2011-04 amends U.S. GAAP to provide common fair value measurements and disclosure requirements with International Financial Reporting Standards. The amendments in this ASU are effective prospectively for interim and annual periods beginning after December 15, 2011, with no early adoption permitted. The Company does not believe that the adoption of this standard will have any material impact on its consolidated financial statements.

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income” (“ASU No. 2011-05”) that improves the comparability, consistency, and transparency of financial reporting and increases the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. ASU No. 2011-05 requires that all nonowner changes in comprehensive income be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In both methods, the entity is required to present on the face of the financial statements reclassification adjustments for items that are reclassified from other comprehensive income to net income in the statement(s) where the component of net income and the components of other comprehensive income are presented. ASU No. 2011-05 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2011 and is to be applied retrospectively, with early adoption permitted. The Company does not believe that the adoption of this standard had a material impact on its consolidated financial statements.

F-13

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

In September 2011, the FASB issued ASU No. 2011-08, “Testing Goodwill for Impairment” (“ASU No. 2011-08”) that permits an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the required annual goodwill impairment test. ASU No. 2011-08 is effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011; however, early adoption is permitted. The Company does not believe that the adoption of this standard had a material impact on its consolidated financial statements.

In December 2011, the FASB issued ASU No. 2011-11, “Balance Sheet (Topic 210): Disclosures about Offsetting Assets and Liabilities” (“ASU No. 2011-11”). The amendments in this ASU require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company does not expect that the adoption of ASU No. 2011-11 will have a significant, if any, impact on its consolidated financial statements.

Foreign Currency Translation

Substantially all Company assets are located in China. The functional currency for the majority of the Company’s operations is the Renminbi (“RMB”). The Company uses the United States dollar (“US Dollar” or “US$” or “$”) for financial reporting purposes. The financial statements of the Company’s foreign subsidiaries have been translated into US dollars in accordance with FASB ASC 830, “Foreign Currency Matters.” All asset and liability accounts have been translated using the exchange rate in effect at the balance sheet date. Equity accounts have been translated at their historical exchange rates when the capital transactions occurred. Statements of operations amounts have been translated using the average exchange rate for the periods presented. Adjustments resulting from the translation of the Company’s financial statements are recorded as other comprehensive income.

The exchange rates used to translate amounts in RMB into US dollars for the purposes of preparing the consolidated financial statements were as follows:

	May 31, 2012	November 30, 2011

Balance sheet items, except for common stock, preferred stock, additional paid-in capital, statutory reserves and retained earnings, as of period end	US$1=RMB 6.3684	US$1=RMB 6.3765

F-14

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

For the three months
ended May 31,

For the Six months
ended May 31,

2012

2011

2012

2011

Amounts included in the statements of income, statements of changes in stockholders’ equity and statements of cash flows

US$1=RMB
6.3139

US$1=RMB
6.5219

US$1=RMB
6.3175

US$1=RMB
6.5693

Foreign currency translation adjustments of approximately $(1,184,162) and $832,589 for the three months ended May 31, 2012 and 2011 respectively, and $(48,167) and $1,640,593 for the six months then ended, respectively, have been reported as other comprehensive (loss)income in the consolidated statements of income and comprehensive income.

Although government regulations now allow convertibility of RMB for current account transactions, significant restrictions still remain. Hence, such translations should not be construed as representations that RMB could be converted into US dollars at that rate or any other rate.

The value of RMB against the US dollar and other currencies may fluctuate and is affected by, among other things, changes in China’s political and economic conditions. Any significant revaluation of RMB could materially affect the Company’s financial condition in terms of US dollar reporting.

Cash and Cash equivalents

The Company considers all demand and time deposits and all highly liquid investments with an original maturity of three months or less as of the date of purchase to be cash equivalents.

Accounts Receivable

Accounts receivable is stated at cost, net of an allowance for doubtful accounts. The Company maintains an allowance for doubtful accounts for estimated losses resulting from the failure of customers to make required payments. The Company reviews the accounts receivable on a periodic basis and makes allowances where there is doubt as to the collectibility of individual balances. In evaluating the collectibility of individual receivable balances, the Company considers many factors, including the age of the balance, the customer’s payment history, its current credit-worthiness and current economic trends. As of May 31, 2012 and November 30, 2011, the balance of allowance for doubtful accounts was $11,265 and $11,251, respectively. For the periods presented, the Company did not write off any accounts receivable as bad debts.

F-15

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Accounts receivable included amounts due from an entity affiliated with the Company through a family member of the Company’s Chairman of $0 and $1,712,113 as of May 31, 2012 and November 30, 2011, respectively.

Inventories

Inventories consist of coal and operating supplies. Inventories are valued at the lower of cost or market, using the weighted average cost method. Provisions are made for excess, slow moving and obsolete inventory as well as inventory whose carrying value is in excess of market. The Company did not make any inventory provisions for the three and six month periods ended May 31, 2012 and 2011.

Fixed Assets

Fixed assets are recorded at cost, less accumulated depreciation. Cost includes the price paid to acquire or construct the asset, including capitalized interest during the construction period, and any expenditures that substantially increase the assets value or extend the useful life of an existing asset. Depreciation is computed using the straight line method over the estimated useful lives of property, plant and equipment, which are approximately five years for electrical and office equipment, ten years for transportation equipment and pipelines, and 20 to 45 years for buildings. Leasehold improvements are amortized over the lesser of their estimated useful lives or the term of the lease. Capitalized costs related to assets under construction are not depreciated until construction is complete and the asset is ready for its intended use. Major repairs and betterments that significantly extend original useful lives or improve productivity are capitalized and depreciated over the period benefited. Maintenance and repairs are generally expensed as incurred. When property, plant and equipment are retired or otherwise disposed of, the related cost and accumulated depreciation are removed from the respective accounts, and any gain or loss is included in operations.

Costs of mine development, expansion of the capacity of or extending the life of the mine (“Mining Structures”) are capitalized and amortized using the units-of-production (“UOP”) method over the estimated productive life of the mine based on proven and probable reserves. Mining Structures includes the main and auxiliary mine shafts, underground tunnels, ramps, and other integrant mining infrastructure.

Investment Property

Investment property represents rental real estate purchased or constructed by the Company for investment purposes. Depreciation is computed using the straight line method over the estimated useful life of 45 years. The related rental income is included in non-operating income in the accompanying consolidated statements of income and other comprehensive income.

F-16

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Mining Right

All land in China belongs to the government. To extract resources from the land, the Company was required to obtain a mining right. The Company’s Coal Group acquired its mining right from the Provincial Bureau of National Land and Resource in November of 2005. The price of the mining right, which represents the acquisition cost of the mine, was assessed in 2005 by the Bureau to be $3,656,731. The mine acquisition cost was payable in instalments over a six year period from the date the mining right was granted. The mine acquisition cost being amortized using the UOP method over the estimated productive life of the mine based on proven and probable reserves.

Restricted Cash

Long-term restricted cash represents the bank deposits held as a guarantee for the future payments of rehabilitation costs as required by the PRC government. The long-term deposits earn an interest rate of 0.50% per annum, which is determined by the PRC government.

Advances from Customers

Advances from customers primarily consist of payments received from customers by the Coal Group and Heat Power prior to the delivery of goods and services.

Deferred Income

Deferred income represents reimbursements received by Heat Power from various real estate development companies for the cost of constructing pipelines to connect to rural areas being developed. The income is recognized on a straight line basis over the estimated useful life of the pipelines of ten years.

Impairment of Long-lived Assets

The Company utilizes FASB ASC 360, “Property, Plant and Equipment” (“ASC 360”), which addresses the financial accounting and reporting for the recognition and measurement of impairment losses for long-lived assets. In accordance with ASC 360, long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company may recognize impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to these assets. If the total of the expected undiscounted future net cash flows is less than the carrying amount of the asset, a loss, if any, is recognized for the difference between the fair value of the asset and its carrying value. No impairment of long-lived assets was recognized for the three and six month periods ended May 31, 2012 and 2011.

F-17

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Revenue Recognition

Revenues from sales of products are recognized when the products are delivered and the title is transferred, the risks and rewards of ownership have been transferred to the customer, the price is fixed and determinable and collection of the related receivable is reasonably assured.

Revenue associated with sales of coal is recognized when the title to the goods has been passed to customers, which is the date when the goods are delivered to designated locations and accepted by the customers and the previously discussed requirements are met.

Heat Power supplies heat to users directly and supplies electricity through a government controlled intermediary. Revenue from sales of heat and electricity represents the amount of tariffs billed for heat and electricity generated and transmitted to the users and the government controlled intermediary, respectively.

Resource Compensation Fees

In accordance with the relevant regulations in the PRC, a company that is engaged in the coal production business is required to pay a fee to the Inner Mongolia National Land and Resources Administration Bureau as compensation for the depletion of coal resources. Coal Group was required to pay a resource compensation fee of $228,634 and $108,727 for the three months ended May 31, 2012 and 2011, respectively, and $331,998 and $197,390 for the six month then ended, respectively, which is included in cost of revenues in the consolidated statements of income and comprehensive income.

Environmental Costs

The PRC has adopted extensive environmental laws and regulations that affect the operations of the coal mining industry. The potential environmental liabilities under proposed or future environmental legislation cannot currently be reasonably estimated, and could be material. Under existing legislation, however, Company management believes that there are no probable liabilities that will have a material adverse effect on the Company.

Fair Value of Financial Instruments

FASB ASC 820, “Fair Value Measurements and Disclosures,” specifies a hierarchy of valuation techniques based upon whether the inputs to those valuation techniques reflect assumptions other market participants would use based upon market data obtained from independent sources (observable inputs). In accordance with ASC 820, the following summarizes the fair value hierarchy:

Level 1 Inputs – Unadjusted quoted market prices for identical assets and liabilities in an active market that the Company has the ability to access.

F-18

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Level 2 Inputs – Inputs other than the quoted prices in active markets that are observable either directly or indirectly.

Level 3 Inputs – Inputs based on prices or valuation techniques that are both unobservable and significant to the overall fair value measurements.

ASC 820 requires the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement.

The Company did not identify any assets or liabilities that are required to be presented at fair value at May 31, 2012 and November 30, 2011.

Income Taxes

Coal Group and Heat Power generate their income in China where a Value Added Tax, Income Tax, City Construction and Development Tax and Education Surcharge taxes are applicable. The Company, Coal Group and Heat Power do not conduct any operations in the U.S. and therefore, are not subject to U.S. taxes.

The Company accounts for income taxes in accordance with FASB ASC 740, “Income Taxes” (“ASC 740”), which requires the recognition of deferred income taxes for differences between the basis of assets and liabilities for financial statement and income tax purposes. Deferred tax assets and liabilities represent the future tax consequence for those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. Deferred taxes are also recognized for operating losses that are available to offset future taxable income. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

Use of Estimates

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

Net Income (Loss) Per Share

The Company computes net income (loss) per common share in accordance with FASB ASC 260, “Earnings Per Share” (“ASC 260”) and SEC Staff Accounting Bulletin No. 98 (“SAB 98”). Under the provisions of ASC 260 and SAB 98, basic net income (loss) per common share is computed by dividing the amount available to common shareholders by the weighted average number of shares of common stock outstanding during the period. Diluted income per common share is computed by dividing the amount available to common shareholders by the weighted average number of shares of common stock outstanding plus the effect of any dilutive shares or common stock equivalents outstanding during the period. Accordingly, the number of weighted average shares outstanding as well as the amount of net income per share are presented for basic and diluted per share calculations for all periods reflected in the accompanying consolidated financial statements.

F-19

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Statutory Reserves

Pursuant to corporate law of the PRC, the Company is required to maintain statutory reserves by appropriating from its after-tax profit before declaration or payment of dividends. The statutory reserves, representing restricted retained earnings, consist of the following funds:

Surplus Reserve Fund: The Company is required to transfer 10% of its net income, as determined under PRC accounting rules and regulations, to a statutory surplus reserve fund until such reserve balance reaches 50% of the Company’s registered capital. The surplus reserve fund is non-distributable other than during liquidation and can be used to fund previous years’ losses, if any, and may be utilized for business expansion or converted into share capital by issuing new shares to existing shareholders in proportion to their shareholding or by increasing the par value of the shares currently held by them, provided that the remaining reserve balance after such issuance is not less than 25% of the registered capital.

Common Welfare Fund: The common welfare fund is a voluntary fund that the Company can elect to transfer 5% to 10% of its net income, as determined under PRC accounting rules and regulations, to this fund. This fund can only be utilized on capital items for the collective benefit of the Company’s employees, such as construction of dormitories, cafeteria facilities, and other staff welfare facilities. This fund is non-distributable other than upon liquidation.

Non-Surplus Reserve Fund (Safety and Maintenance): According to ruling No. 119 (2004) issued on May 21, 2004, and amended ruling No. 168 (2005) on April 8, 2005 by the PRC Ministry of Finance regarding “Accrual and Utilization of Coal Production Safety Expense” and “Criterion on Coal Mine Maintenance and Improvement,” the Company is required to set aside a safety fund of 6 RMB per ton of raw coal mined, and 10.5 RMB per ton for a maintenance fund. As defined under US GAAP, a liability for safety and maintenance expenses does not exist at the balance sheet date because there is no present obligation to transfer assets or to provide services as a result of any past transactions. Therefore, for financial reporting purposes, this statutory reserve has been recorded as an appropriation of retained earnings.

The statutory reserves consist of the following:

	May 31, 2012		November 30, 2011

Surplus reserve and common welfare fund	$	2,447,598	$	2,447,598
Safety and maintenance reserve		7,468,742		6,585,257
Total statutory reserves	$	9,916,340	$	9,032,855

F-20

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Stock Based Compensation

The Company records stock based compensation in accordance with FASB ASC 718, “Compensation – Stock Based Compensation” which requires the measurement and recognition of compensation expense based on estimated fair values for all stock-based awards made to employees and directors, including stock options. FASB ASC 718 requires companies to estimate the fair value of stock-based awards on the date of grant using an option-pricing model. The Company uses the Black-Scholes option-pricing model as its method of determining fair value. This model is affected by the Company’s stock price as well as assumptions regarding a number of subjective variables. These subjective variables include, but are not limited to the Company’s expected stock price volatility over the term of the awards, and actual and projected stock option exercise behaviours. The value of the portion of the award that is ultimately expected to vest is recognized as an expense in the statements of income over the requisite service period.

Asset Retirement Cost and Obligation

The Company has adopted FASB ASC 410, “Asset Retirement and Environmental Obligations” (“ASC 410”). ASC 410 generally requires that the Company’s legal obligations associated with the retirement of long-lived assets are recognized at fair value at the time the obligations are incurred. Obligations are incurred at the time development of a mine commences for underground mines or construction begins for support facilities, refuse areas and slurry ponds. The obligation’s fair value is determined using discounted cash flow techniques and is accreted over time to its expected settlement value. Upon initial recognition of a liability, a corresponding amount is capitalized as part of the carrying amount of the related long-lived asset. The related asset is amortized using the UOP method over the productive life of the mine based on proven and probable reserves. The Company did not incur and does not anticipate incurring any material dismantlement, restoration and abandonment costs given the nature of its mining activities and the current PRC regulations surrounding such activities.

Vulnerability Due to Operations in PRC

The Company’s operations may be adversely affected by significant political, economic and social uncertainties in the PRC. Although the PRC government has been pursuing economic reform policies for more than twenty years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRCs political, economic and social conditions. There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent or effective.

All of the Company’s businesses are transacted in RMB, which is not freely convertible into other currencies. The People’s Bank of China and other banks are authorized to buy and sell foreign currencies at the exchange rates quoted by the People’s Bank of China. Approval of foreign currency payments by the People’s Bank of China or other institutions requires submitting a payment application form together with suppliers’ invoices, shipping documents and signed contracts.

F-21

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Since the Company has its primary operations in the PRC, its revenues will be settled in RMB, not US dollars. Due to certain restrictions on currency exchanges that exist in the PRC, the Company’s ability to use revenue generated in RMB to pay any dividend payments to its shareholders outside of China will be limited.

All of the Company’s bank accounts are in banks located in PRC and are not covered by protection similar to that provided by the FDIC on funds held in United States banks.

The Company's mining operations are subject to extensive national and local governmental regulations in China, which regulations may be revised or expanded at any time. Generally, compliance with these regulations requires the Company to obtain permits issued by government regulatory agencies. Certain permits require periodic renewal or review of their conditions. The Company cannot predict whether it will be able to obtain or renew such permits or whether material changes in permit conditions will be imposed. The inability to obtain or renew permits or the imposition of additional conditions could have a material adverse effect on the Company's ability to develop and operate its mines.

Segment Reporting

The Company is made up of two segments of business, Coal Group which derives its revenue from the mining and purchase and sale of coal, and Heat Power which derives its revenue by providing heating and electricity to residents and businesses of a local community. Each of these segments is conducted in a separate variable interest corporation and each functions independently of the other.

Except for the loans made to Heat Power by Coal Group in the principal amount of RMB 84 million (equivalent to U.S. $13.2 million) as of May 31, 2012, during the periods reported herein, there were no other transactions between the two segments. There also were no differences between the measurements used to report operations of the segments and those used to report the consolidated operations of the Company. In addition, there were no differences between the measurements of the assets of the reported segments and the assets reported on the consolidated balance sheets.

	Three Months Ended May 31,
	2012						2011
	Heat		Coal				Heat		Coal
	Power		Group		Total		Power		Group		Total
	US$		US$		US$		US$		US$		US$
Sales to external customers	$	5,450,053	$	80,178,867	$	85,628,920	$	5,558,737	$	26,241,752	$	31,800,489
Sales – government subsidies		911,167		-		911,167		391,034		-		391,034
Other income – government subsidies		-		756,597		756,597		-		-		-
Interest expense, net		385,048		515,001		900,049		234,505		394,257		628,762
Depreciation and amortization		1,304,963		785,318		2,090,281		1,044,027		576,749		1,620,776
Segment profit (loss)		750,661		12,967,917		13,718,578		77,266		4,950,527		5,027,793

F-22

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

	Six Months Ended May 31,
	2012						2011
	Heat		Coal				Heat		Coal
	Power		Group		Total		Power		Group		Total
	US$		US$		US$		US$		US$		US$
Sales to external customers	$	12,692,231	$	110,318,197	$	123,010,428	$	11,655,041	$	42,498,177	$	54,153,218
Sales - government subsidies		2,216,810				2,216,810		391,034		-		391,034
Other income – government subsidies		-		756,597		756,597		-		-		-
Interest expense, net		682,784		1,018,897		1,701,681		379,347		570,357		949,704
Depreciation and amortization		3,010,388		1,344,519		4,354,907		2,067,358		939,769		3,007,127
Segment profit		1,281,891		18,894,691		20,176,582		640,275		8,984,380		9,624,655

	May 31, 2012						November 30, 2011
	Heat		Coal				Heat		Coal
	Power		Group		Total		Power		Group		Total
	US$		US$		US$		US$		US$		US$
Segment assets	$	84,949,125	$	135,121,342	$	220,070,467	$	71,566,508	$	115,576,659	$	187,143,167
Construction in progress		2,916,210		18,058		2,934,268		2,801,159		18,035		2,819,194
Investment property, net		3,692,720		1,954,112		5,646,832		3,754,281		1,975,888		5,730,169

Reconciliation of the total segment income to net income included in the consolidated financial statements is as follows:

	Three Months Ended May 31, 2012			Six Months Ended May 31, 2012

Total segment profits	$	13,718,578		$	20,176,582
Unallocated corporate expenses		(626,691	)		(782,480	)
Net income	$	13,091,887		$	19,394,102

	Three Months Ended May 31, 2011			Six Months Ended May 31, 2011

Total segment profits	$	5,027,793		$	9,624,655
Unallocated corporate expenses		(1,240,490	)		(1,473,142	)
Net income	$	3,787,303		$	8,151,513

F-23

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Stockholder Loans

A substantial portion of the funds required for the construction of the thermoelectric plant and the costs of expansion projects at Heat Power and the coal mine were provided by stockholder loans. Balances are as follows:

	May 31, 2012		November 30, 2011

Ordos City YiYuan Investment Co., Ltd.	$	1,696,474	$	1,702,421
Hangzhou Dayuan Group, Ltd.		5,860,904		5,736,898
Inner Mongolia Duoyida Mining Co. Ltd.		2,056,644		2,013,393
Total	$	9,614,022	$	9,452,712

The stockholder loans are due on demand with interest as follows:

	May 31, 2012			November 30, 2011
		Balance	Interest rate		Balance	Interest rate

Stockholder loans – interest bearing	$	6,940,519	5.31% and 7.32%	$	6,931,702	5.31	%
Interest payable		2,673,503			2,521,010
Total	$	9,614,022		$	9,452,712

Lease obligation

The Company leases office space under an operating lease expiring December 31, 2015. The minimum future annual rent payments under the lease as of May 31, 2012 are as follows:

Year Ending	Annual
November 30,	Amount

2012	$	51,033
2013		102,066
2014		102,066
2015		102,066
2016		8,506

Total	$	365,737

Rent expense charged to operations for the three months ended May 31, 2012 and 2011 was $25,737 and $23,105, respectively and $51,444 and $45,667 for the six months then ended, respectively.

F-24

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Other payables

Included in other payables are advances from a family member of the Company’s Chairman totalling $4,710,759 and $4,704,775 as of May 31, 2012 and November 30, 2011, respectively. These advances are non-interest bearing and payable on demand. At May 31, 2012 and November 30, 2011, other payables amounted to $8,397,741 and $13,111,017, respectively.

Advances to Suppliers

As is customary in China, the Company has made advances to its suppliers for coal purchases, utility payments and other purchases. At May 31, 2012 and November 30, 2011, advances amounted to $42,422,506 and $27,566,516, respectively. There is no interest due on these advances and they are offset against billings as they are made by the suppliers.

Other Receivables

Other receivables consist of the following:

	May 31, 2012		November 30, 2011

Loans to suppliers and other associated firms	$	6,827,329	$	20,499,415
Employee expense advances		584,802		739,596
Government subsidies receivable		5,789,166		2,368,440
Heat network access fee receivable		1,508,707		955,085
Rental fee receivable		32,032		-
Total	$	14,742,036	$	24,562,536

Included in loans to suppliers and other associated firms are advances to an entity affiliated to the Company through a family member of the Company’s Chairman totalling $3,151,396 and $752,380 as of May 31, 2012 and November 30, 2011, respectively. In addition, included in loans to suppliers and other associated firms is also an advance to one of Heat Power’s stockholders for fixed assets purchases of $1,190,855 as of May 31, 2012. Also included in loans to suppliers and other associated firms are advances to Heat Power’s Vice President and family members of the Company’s Chairman of $541,115 and $39,923 as of May 31, 2012 and November 30, 2011, respectively. These advances are non-interest bearing and payable on demand.

On a periodic basis, management reviews the other receivable balances and establishes allowances where there is doubt as to the collectability of the individual balances. In evaluating collectability of the individual balances, the Company considers factors such as the age of the balance, payment history, and credit-worthiness of the creditor. The Company considers all other receivables at May 31, 2012 and November 30, 2011 to be fully collectible and, therefore, did not provide for an allowance for doubtful accounts.

F-25

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Fixed Assets

Fixed assets are summarized as follows:

	May 31, 2012			November 30, 2011

Buildings	$	10,773,691		$	10,777,208
Machinery & equipment		39,823,597			43,845,438
Transferred assets (a)		27,939,435			19,702,907
Automotive equipment		2,015,929			1,953,696
Office Equipment		1,419,612			1,379,812
Construction in progress		2,934,268			2,819,194
		84,906,532			80,478,255
Accumulated depreciation		(21,195,389	)		(17,540,508	)
Fixed assets, net	$	63,711,143		$	62,937,747

(a)

Real estate with equipment subject to the finance obligation as described in Note 11 under “Finance Obligation.”

Depreciation expense charged to operations for the three months ended May 31, 2012 and 2011 was $1,673,277 and $1,380,039, and was $3,666,296 and $2,635,493 for the six months then ended, respectively.

Land use rights of $245,630 and $245,318 at May 31, 2012 and November 30, 2011, respectively, are included in buildings and are depreciated over the useful lives along with the related buildings.

10.

Short Term Bank Loans

The Company has bank loans collateralized by investment property and guaranteed by a related party. Relevant terms of these bank loans are as follows:

	May 31, 2012		November 30, 2011
Bank loan due 1/17/12, with interest at 6.94% (a)	$	-	$	12,546,068
Bank loan due 1/17/12, with interest at 6.94% (b)		-		8,782,247
Bank loan due 7/28/12, with interest at 7.22% (a)		7,819,860		7,809,927
Bank loan due 12/14/12, with interest at 7.22% (b)		12,562,025		-
Bank loan due 1/12/13, with interest at 7.22% (b)		9,421,519		-
Total	$	29,803,404	$	29,138,242

F-26

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

(a) Loan to Coal Group, collateralized by mining rights and the real estate properties of Coal Group.

(b) Loan to Coal Group, collateralized by mining rights of Coal Group.

At May 31, 2012, the Company had a letter of intent with a bank to provide the Company an additional line of credit of RMB 10.2 million (US$1,601,658).

11.

Finance Obligations

On March 31, 2011, Heat Power entered into a Finance Leasing Contract (“Contract 1”) with a leasing company covering its thermoelectric plants, heat transfer stations, and related machinery and equipment (“Transferred Assets 1”), having a gross value of RMB 125,635,589 (US$19,392,298). Pursuant to Contract 1, Heat Power sold to the leasing company its Transferred Assets 1 used for its operation in exchange for RMB 60,000,000 (US$9,261,260) in cash. Under Contract 1, Heat Power leased back the Transferred Assets 1 with a quarterly installment payment of RMB 3,555,163 (US$548,755) until April 2016, when Contract 1 expires. Contract 1 is guaranteed by Coal Group and an unrelated third party. Upon the repayment of all outstanding rental obligations, Heat Power may re-purchase the Transferred Assets 1 at a purchase price of RMB 900,000, or RMB 1 if Heat Power timely pays the quarterly installments. Upon the execution of Contract 1, Heat Power paid a servicing fee of RMB 3,300,000 (US$502,337) and a refundable deposit of RMB 9,000,000 (US$1,389,189) to the leasing company.

On March 28, 2012, Heat Power entered into another Finance Leasing Contract (“Contract 2”) with a leasing company related to its thermoelectric plants, heat transfer stations, and machinery and equipment (“Transferred Assets 2”), with a gross value of RMB 52,293,912 (US$8,211,468). Pursuant to Contract 2, Heat Power sold to the leasing company its Transferred Assets 2 used for its operation in exchange of RMB 48,000,000 (US$7,537,215) in cash. Under Contract 2, Heat Power leased back the Transferred Assets 2 with a quarterly installment payment of RMB 2,868,777 (US$450,471) until April 2017, when Contract 2 expires. Contract 2 is guaranteed by Coal Group and an unrelated third party. Upon the repayment of all outstanding rental obligations, Heat Power may re-purchase the Transferred Assets 2 at a purchase price of RMB 720,000, or RMB 1 if Heat Power timely pays the quarterly installments. Included in the amount borrowed is a servicing fee of RMB 2,400,000 (US$379,897) and a refundable deposit of RMB 9,600,000 (US$1,507,443).

Since Heat Power has the option to repurchase its Transferred Assets, Heat Power is considered to have “continuing involvement” pursuant to ASC 840-40, “Sales-Leaseback Transactions” (ASC 840-40). Accordingly, the lease did not qualify as a normal sale-leaseback transaction and is being accounted for under the financing method in which Heat Power reports the sales proceeds as a finance obligation, continues to report the Transferred Assets as its assets, and continues to depreciate the Transferred Assets. The lease payments are being recognized under the interest method. The effective interest rate of these transactions are 6.70% and 7.05% for Contract 1 and Contract 2, respectively.

F-27

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Future payments of these finance obligations as of May 31, 2012 are as follows:

Year Ending
November 30,	Amount

2012	$	2,012,487
2013		4,034,885
2014		4,034,885
2015		4,034,885
Thereafter		3,814,370

		17,931,512
Less: amount representing interest		2,615,406

Finance obligations		15,316,106
Less: current portion of finance obligations		3,059,834

Finance obligation, net of current portions	$	12,256,272

Interest expense for the finance obligations amounted to US$285,622 and US$106.821 for the three months ended May 31, 2012 and May 31, 2011, and $485,570 and $106,821 for the six months then ended, respectively. The refundable deposits are included in other long term assets in the consolidated balance sheets as of May 31, 2012. The costs related to these Contracts of RMB 7,200,000 (US$1,130,582) are being amortized by the interest method over the life of the leases.

12.

Rental Income

The Company entered into rental agreements with various unrelated parties to lease commercial space in its building under operating leases expiring through 2015.

Future minimum rental income as of May 31, 2012 is as follows:

Year Ending
November 30,	Amount

2012	$	137,186
2013		239,042
2014		227,265
2015		40,643

	$	644,136

F-28

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Rental income, under operating leases, included in non-operating income in the consolidated statements of income and other comprehensive income for the three months ended May 31, 2012 and 2011 was $70,190 and $130,072, respectively and was $140,798 and $218,440 for the six months then ended, respectively. The related rent receivable of $32,032 at May 31, 2012 is included in other receivables on the consolidated balance sheets.

13.

Government Subsidies

Government subsidies are primarily comprised of financial support provided by the local government to Heat Power to ensure supply of heat to the XueJiaWan area as the price for heat charged is regulated and approved by the government. The financial support includes revenue subsidies to compensate for lower government regulated prices charged for heat and cost subsidies for the purchase of coal used in providing heat. Government subsidies are intended to be an incentive for Heat Power to supply heat at the government regulated prices. Government subsidies amounted to $1,667,764 and $391,034 for the three months ended May 31, 2012 and 2011, respectively and were $2,973,407 and $391,034 for the six months then ended, respectively. During the period ended May 31, 2012, Coal Mine also received subsidies from the Government totalled of $756,597.

14.

Income Taxes

The Company is required to file income tax returns in both the United States and the PRC. Its operations in the United States have been insignificant and income taxes have not been provided or accrued. In the PRC, the Company files tax returns for Heat Power and Coal Group and, although it is part of Coal Group, a separate tax return is required for the operations of the coal mine. The laws of the PRC permit the carryforward of net operating losses for a period of five years. As of November 30, 2011, the PRC entities had no net operating losses available for future use which was confirmed by the local taxing authority.

Under ASC 740, recognition of deferred tax assets is permitted unless it is more likely than not that the assets will not be realized. There are no deferred tax assets or liabilities as of May 31, 2012 and November 30, 2011.

The following tables reconcile the effective income tax rate with the statutory rate for the periods presented:

Three months ended May 31, 2012	Tax Provision			Rate of Tax

As calculated at the statutory rate	$	4,230,880			25.0	%
Non deductible expenses		364			0	%
Tax effect of loss of subsidiaries		(156,294	)		(0.92	)%
Tax effect of eliminated intercompany profit		(243,319	)		(1.44	)%

Effective tax rate	$	3,831,631			22.64	%

F-29

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

Three months ended May 31, 2011	Tax Provision		Rate of Tax

As calculated at the statutory rate	$	1,639,724		25.0	%
Tax effect of loss of subsidiaries		86,978		1.3	%
Tax effect of eliminated intercompany profit (loss)		1,044,892		15.9	%

Effective tax rate	$	2,771,594		42.2	%

Six months ended May 31, 2012	Tax Provision			Rate of Tax

As calculated at the statutory rate	$	6,178,691			25.0	%
Non deductible expenses		1,214			0	%
Tax effect of loss of subsidiaries		(85,185	)		(0.34	)%
Tax effect of eliminated intercompany profit		(774,060	)		(3.13	)%

Tax at effective tax rate	$	5,320,660			21.53	%

Six months ended May 31, 2011	Tax Provision		Rate of Tax

As calculated with statutory rate	$	3,057,242		25.0	%
Tax effect of loss of subsidiaries		12,136		0.1	%
Tax effect of eliminated intercompany profit (loss)		1,008,076		8.2	%

Effective tax rate	$	4,077,454		33.3	%

The Company has adopted Financial Accounting Standards Board Interpretation No. 48, “Accounting for Uncertainty in Income Taxes — an interpretation of SFAS 109.” (“FIN 48”), as codified in ASC 740. ASC 740 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC 740, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position would be measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate settlement. ASC 740 also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, and accounting for interest and penalties associated with tax positions. The Company does not have any accruals for uncertain tax positions for the periods presented.

F-30

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

The Company did not file its U.S. federal income tax returns, including, without limitation, information returns on Internal Revenue Service (“IRS”) Form 5471, “Information Return of U.S. Persons With Respect to Certain Foreign Corporations” for the years ended November 30, 2002 through 2005. The Company was also late in filing for the years ended November 30, 2007 and 2008. Failure to furnish any information return with respect to any foreign business entity required, within the time prescribed by the IRS, subjects the Company to certain civil penalties. The Company is unable to determine the amount of any penalties that may be assessed at this time. Management is of the opinion that penalties, if any, that may be assessed would not be material to the consolidated financial statements.

In addition, because the Company did not generate any income in the United States or otherwise have any U.S. taxable income, the Company does not believe that it owes U.S. federal income taxes in respect to any transactions that the Company or any of its subsidiaries may have engaged in through May 31, 2012. However, there can be no assurance that the IRS will agree with the position, and therefore the Company ultimately could be held liable for U.S. federal income taxes, interest and penalties. The tax years ended November 30, 2002 to 2011 remain open to examination by tax authorities.

15.

Stock-Based Compensation

On May 31, 2010, the Company granted to each of its three independent directors an option to purchase 20,000 shares of common stock at an exercise price of US$2.02 per share. The options vested over one year in equal, quarterly installments on the last day of the Company’s fiscal quarter, beginning with the fiscal quarter ending August 31, 2010, subject to their continued service as a director.

On September 5, 2011, the Company granted additional options to two of its three independent directors to purchase 20,000 shares of common stock and options to purchase 15,000 shares to the other independent director all at an exercise price of US$0.39 per share. The options vest over one year in equal, quarterly instalments on the last day of the Company’s fiscal quarter, beginning with the fiscal quarter ending August 31, 2011, subject to their continued service as a director. The Compensation Committee of the Board of Directors has determined the performance conditions have been met.

The fair value of the options is estimated using the Black-Scholes option pricing model. Expected volatility is based on historical volatility data of the Company’s stock. The expected term of stock options granted is based on historical data and represents the period of time that stock options are expected to be outstanding. The risk-free interest rate is based on a zero-coupon United States Treasury bond whose maturity period equals the expected term of the options. The weighted average estimated grant date fair value for options granted to the independent directors was US$1.24 per share.

Weighted average assumptions used to estimate the fair value of stock options on the date of grant are as follows:

	September 5, 2011
Expected dividend yield		-
Expected stock price volatility		182.07	%
Risk free interest rate		2.00	%
Expected life (years)		10 years

F-31

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

	May 31, 2010

Expected dividend yield		-
Expected stock price volatility		210.57	%
Risk free interest rate		3.29	%
Expected life (years)		10 years

The stock-based compensation, included in general and administrative expenses in the accompanying consolidated statements of income and comprehensive income, was $1,457 and $7,832 for the three month periods ended May 31, 2012 and 2011, respectively and $4,857 and $26,106 for the six months then ended, respectively.

The Company will issue new shares of common stock upon exercise of stock options. The following is a summary of option activity for the Company’s stock options:

	Options		Weighted Average Exercise Price		Weighted- Average Remaining Contractual Life		Aggregate Intrinsic Value

Outstanding at November 30, 2010		60,000	$	2.02		8 years		-
Granted		55,000		0.39		10 years		-
Exercised		-		-		-		-
Cancelled and expired		-		-		-		-
Forfeited		-		-		-		-

Outstanding at November 30, 2011		115,000	$	1.24		9 years		-

Vested and expected to vest at May 31, 2012		100,000	$	1.37		9 years		-

Exercisable at May 31, 2012		100,000	$	1.37		9 years		-

The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying awards and the quoted price of the Company’s common stock. There were no options that were exercised during the three and six month periods ended May 31, 2012 and 2011.

F-32

CHINA ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND SIX MONTH PERIODS ENDED MAY 31, 2012 AND 2011

(UNAUDITED)

There is no unrecognized compensation costs related to these options as of May 31, 2012.

The Company entered into a Terms of Services and Release Agreement with the Company’s CEO, a consulting firm, and Fortune Place Holdings Limited (“Fortune Place”), a British Virgin Islands corporation. The Company’s CEO is the sole director of Fortune Place. Pursuant to the terms of the agreement, the consulting firm would be entitled to receive equity consideration of 1,800,000 restricted shares of the Company held by Fortune Place for consulting services rendered to the Company, contingent upon the completion of all of the consulting services enumerated in the agreement. The filing of the Company’s Form 10-Q for the quarter ended February 28, 2011 represented the final item of the consulting services that the consulting firm was required to complete (“Completion Date”). As of the Completion Date, the fair value of shares transferred for the services rendered to the Company was valued at $1,386,000.

The Company issued 60,000 share of common stock to an investor relations firm in consideration for consulting services rendered through the period ended on March 14, 2011. The fair value of the stock was $121,800.

16.

Contingencies

As is customary in the PRC, except for auto coverage, Coal Group and Heat Power do not carry sufficient insurance. As a result, the Company is effectively self-insuring the risk of potential accidents or loss that could occur in the workplace. Given the nature of the industry, the Company may be exposed to risks that could have a material adverse impact on its consolidated financial statements.

The PRC has enacted legislation which appears to restrict the ability of entities considered foreign, like the Company, to have ownership interests in operating companies located in the PRC. The Company has taken steps to avoid any potential adverse impact of this legislation. (See Note 1)

As disclosed in note 14, the Company was delinquent in filing certain tax returns with the U.S. Internal Revenue Service. The Company filed the delinquent returns and sought waivers of any penalties under the IRS 2011 Offshore Voluntary Disclosure Initiative. Under the program, the IRS has indicated that it will not impose a penalty for the failure to file delinquent information returns (Form 5471) if there are no underreported tax liabilities and the information returns are filed by August 31, 2011. The Company is unable to determine the amount of any penalties that may be assessed at this time. Management is of the opinion that penalties, if any, that may be assessed would not be material to the consolidated financial statements.

The Company was late in filing the information reports for the years ended November 30, 2004 through 2008 concerning its interest in foreign bank accounts on form TDF 90-22.1, “Report of Foreign Bank and Financial Accounts” (“FBARs”). For not complying with the FBAR reporting and recordkeeping requirements, the Company is subject to civil penalties up to $10,000 for each of its foreign bank accounts. The Company is unable to determine the amount of any penalties that may be assessed at this time and believes that penalties, if any, that may be assessed would not be material to the consolidated financial statements.

F-33

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

Overview

We are structured as a holding company that controls our two PRC Operating Companies: Coal Group, which operates our coal segment, and Heat Power, which operates our heating and electricity service segment. Through Coal Group, we produce coal using the longwall method of mining at the Laiyegou coal mine located in the Dongsheng coal field in the Dongsheng district of Ordos City, Inner Mongolia.

Coal Group is the major revenue and profit driver of the Company. For the six month periods ended May 31, 2012 and 2011, Coal Group contributed 88% and 78% to our total revenue, respectively, with the balance attributable to Heat Power. For the three month periods ended May 31, 2012 and 2011, Coal Group contributed 93% and 81% to our total revenue, respectively, with the balance attributable to Heat Power. While the sales prices of heat and electricity units generated by Heat Power are regulated by the government, sales prices of coal are market driven to a significant extent. Therefore, Coal Group enjoys a higher gross margin.

In addition to directly selling coal from our mine location, Coal Group also buys, sells and transports coal as part of its expanding proprietary coal trading business. Each year the PRC government regulates the amount of coal we and other coal producers are able to sell in the open market at the port in Qinhuangdao by allocating rail space to coal mines in Inner Mongolia to ship their coal to the port. In order to capitalize on excess quota for rail space that we may have from time to time, commencing in 2009, we began to buy excess coal from other coal producers in Inner Mongolia and then paid to have that coal delivered by rail from the other producer’s mine to the Qinhuangdao port. The source of the coal sold by our trading business is either from the Laiyegou coal mine or from other local coal producers. Our business of buying and re-selling coal expanded in 2010 as a result of our receipt of additional quota from the local railway bureau. Due to the increased quota, we were able to trade more coal. Parties are awarded additional quotas based on their successful use of the quota in the previous year. Our official confirmed quota increased 760,000 metric tons in 2011 from 660,000 metric tons in 2010, and maintained at the same level in 2012. In addition, occasionally the government grants a discretionary increase in the quota depending upon business conditions. We believe that, given the demand for coal and our past track record of successfully filling our extra quota, we will be able to grow our coal trading business through increased quotas granted to us by the local railway bureau; however, our ability to use any or all of our quota in 2012 will vary with market conditions and depends on our ability to source commercially acceptable coal purchases and subsequent trades. Coal that we produce and sell directly to our customers is customarily transported at the buyer’s expense and therefore does not count against our quota.

Through Coal Group, we produced and sold 428,269 and 644,774 metric tons of coal in the three month and six periods ended May 31, 2012 at our Laiyegou coal mine, representing a 33% and 42% increase, respectively, over the same periods in 2011.We increased our coal trading volume by selling 903,087 and 1,187,627 tons of coal in the three and six month periods ended May 31, 2012, representing a 376% and 211% increase, respectively, over the same periods in 2011. Going forward, we plan to leverage on the rich coal reserve in Inner Mongolia and acquire coal mine(s) if we can locate acceptable targets at reasonable prices, while continuing to increase our trading volume. We expect Coal Group to continue to be the key growth factor of the Company.

Through Heat Power, we use our thermoelectric plant to generate and provide heating and electricity to residential and commercial customers throughout Xuejiawan, the administrative center of Zhunger, one of the seven counties of Ordos.

During 2011, Heat Power increased its coverage area from approximately 3,300,000 square meters to approximately 4,000,000 square meters due to the development of the Xuejiawan area. For the three month period ended May 31, 2012, we decreased electricity sales to approximately 25.5 million kWh, representing a 31% decrease as compared to the same period of 2011.

Seasonality

Coal Group experiences lower sales volume in the first fiscal quarter of each year due to the Chinese New Year holidays, when most businesses are closed. Heat Power provides heating from October 15th each year to April 15th of the next calendar year, resulting in higher sales and profit in the first fiscal quarter, lower sales in the second and fourth fiscal quarter, and no sales from heating in the third fiscal quarter of each year.

Results of Operations

Results of Operations – Three Months Ended May 31, 2012

Revenues

The following is an analysis of our revenues and gross profit, details and analysis of components of expenses, and variance; for the three months ended May 31, 2012 compared to the same period in 2011:

Coal Group	Three Months Ended May 31,
			% of total				% of total
	2012		revenue		2011		revenue
Revenues	$	80,178,867		93	$	26,241,752		81
Cost of revenues		60,729,053		70		15,694,770		49
Gross Profit	$	19,449,814		23	$	10,546,982		32

Heat Power	Three Months Ended May 31,
			% of total				% of total
	2012		revenue		2011		revenue
Revenues	$	6,361,220		7	$	5,949,771		19
Cost of revenues		4,989,761		6		5,878,133		18
Gross Profit	$	1,371,459		1	$	71,638		1

Coal Group

For the three months ended May 31, 2012, revenues for Coal Group were $80,178,867 compared to $26,241,752 in the comparable three months in 2011. The $53,937,115 increase was mainly due to the increase of in the volume of coal produced and sold at our Laiyegou coal mine and the increase in our proprietary trading business by 33% and 376%, respectively from the corresponding period in 2011.

Coal Trading	Three Months Ended May 31,
			% of total				% of total
	2012		revenue		2011		revenue
Revenues	$	55,024,850		64	$	12,777,727		39
Cost of revenues		52,762,935		61		10,334,633		32
Gross Profit	$	2,261,915		3	$	2,443,094		7

Coal Production	Three Months Ended May 31,
			% of total				% of total
	2012		revenue		2011		revenue
Revenues	$	25,154,017		29	$	13,464,025		42
Cost of revenues		7,966,118		9		5,360,137		17
Gross Profit	$	17,187,899		20	$	8,103,888		25

Coal Group produced approximately 428,269 metric tons of coal during the three months ended May 31, 2012, compared to 321,826 metric tons in the comparable three months in 2011. Volume of coal sold by our proprietary trading business was approximately 903,087 metric tons during the three months ended May 31, 2012 as compared to 189,577 metric tons during the three months ended May 31, 2011. The increase in coal production volume in the second quarter was mainly due to permission granted by local government to increase the coal volume which is allowed to be produced and sold by the Company since the third quarter of 2011. Coal Group was selected by the Inner Mongolia Autonomous Region Coal Industry Bureau as one of the 44 major coal enterprises in the Inner Mongolia region to be promoted by the Inner Mongolia Government. The Company believes that this governmental decision to promote the Company is the reason behind the Company being permitted to produce and sell more coal than previously allowed.

Heat Power

For the three months ended May 31, 2012, revenues for Heat Power were $6,361,220 as compared to $5,949,771 in the comparable three months in 2011.

For the three months ended May 31, 2012, revenues generated by Heat Power from its electricity operations were $1,039,778 compared to $1,263,767in the comparable three month period in 2011. Our revenue during the second quarter from our electricity operations was as follows:

Electricity Revenue for the Quarter Ended May 31,

					Units of
					power
					supplied				Revenue
	Unit Price* ($/kWh)				(1000kWh)				($)
Period	2012		2011		2012		2011		2012		2011		Variance
March		0.04		0.03		8,924		12,298		363,495		420,462		(56,967	)
April		0.04		0.03		7,177		13,029		292,359		445,472		(153,113	)
May		0.04		0.03		9,425		11,636		383,924		397,833		(13,909	)

Total						25,526		36,963		1,039,778		1,263,767		(223,989	)

For the three months ended May 31, 2012, revenues generated by Heat Power from its heating supply operations were $5,321,442 compared to $4,686,004 in the comparable three month period in 2011. The $635,438 increase was due to the expansion of heating supply area from approximately 3.3 million square meters to approximately 4.0 million square meters. Our revenue during the second quarter in 2012 from our heating supply operations were as follows:

Heating Revenue for the Quarter Ended May 31,

	Unit Price				Area (‘000)
	($/sq meters				sq meters					Revenue
	/month)				range)					($)
User	2012		2011		2012		2011			2012		2011			Variance
Residential	0.41		0.39		2,690		2,133		*	2,525,957		1,526,501			999,456
Non-residential		0.69		0.65		1,326		1,178	*		1,884,318		2,768,469			(884,151	)

Total						4,016		3,311			4,410,275		4,294,970	**		115,305

* Adjustment to revenue was made in the second quarter of 2011 to reflect the actual heating supply area verified by the local authority after the end of the 2010-2011 heating season.

** Government subsidies amounting to $911,167 and $391,034 in three months ended May 31, 2012 and 2011, respectively, to compensate for lower regulated residential heat price and non-residential heat prices was not included in this table.

Cost of Sales

For the three months ended May 31, 2012, cost of sales increased to $65,718,814, as compared to $21,572,903 in the comparable three months in 2011, as a result of changes in the following expenses:

	Three Months Ended May 31,
	2012		2011		Variance
Coal & freight	$	61,713,048	$	16,362,752	$	45,350,296
Depreciation & amortization		1,781,408		1,456,901		324,507
Heat resource rental		1,045,951		2,760,995		(1,715,044	)
Utilities		617,064		380,389		236,675
Operating supplies		222,492		135,040		87,452
Salaries and welfares		204,472		398,546		(194,074	)
Repairs		38,558		63,839		(25,281	)
Other		95,821		14,441		81,380

Total	$	65,718,814	$	21,572,903	$	44,145,911

For the three months ended May 31, 2012 our overall gross margin was 24% compared to 33% in the comparable three month period in 2011. The decrease in our overall gross profit margin was primarily attributable to the fact that Coal Group purchased more coal from third parties for its coal trading business during the first half year of 2012, which was less profitable than coal purchased from our Laiyegou coal mine in terms of gross margin.

Coal & freight: Coal & freight costs are comprised of (i) the production costs of the Laiyegou coal mine; (ii) the cost of coal purchased in the coal trading business and (iii) cost of coal consumed by Heat Power. The increase of these costs was mainly due to (i) increased production cost which rose in line with the production volume, and (ii) increased coal purchases in connection with our coal trading business.

Depreciation and amortization: The increase in depreciation and amortization was mainly due to the expanded heating supply area. We constructed more pipelines to supply heat to these areas. The increase in depreciation & amortization was also attributable to the increase of production volume in our Laiyegou coal mine.

Heat resource rental: The decrease in heat resource rental costs was mainly due to extremely higher costs accrued during the three months period ended May 31, 2011. However, we adjusted the heat resource rental fee in the third quarter of 2011 to reflect the actual cost confirmed by the supplier after the end of 2010-2011 heating season.

Utilities: Utilities mainly represented the cost of electricity consumed by heat transfer stations of Heat Power. Increase in utility costs was in line with the expanded heating supply area.

Salaries and welfares. Decrease in salaries and welfares was mainly due to the reversal of over accrued employee benefits, union fees and employee education expenses amounting to approximately $265,000. However, this decrease is mitigated by the 20% increase in pay to employees and additions to the Heat Power employee headcount.

Selling Expenses

For the three months ended May 31, 2012, selling expenses increased by $855,552 compared to the same period in 2011.

	Three Months Ended May 31,
	2012		2011		Variance
Transportation & Storage	$	1,191,736	$	748,700	$	443,036
Sales tax and other expenses		696,791		484,387		212,404
Office		178,800		55,684		123,116
Salaries and welfares		131,270		56,825		74,445
Depreciation		8,951		6,400		2,551

Total	$	2,207,548	$	1,351,996	$	855,552

Transportation & storage: Transportation & storage expenses increased as we expanded our proprietary coal trading business. Such expenses are expected to increase in line with coal trading volume.

Sales tax and other expenses. Increase in sales tax and other expenses was mainly due to the increase in volume of coal produced and sold by our Laiyegou coal mine and sold by the proprietary trading business by 33% and 376%, respectively from the corresponding period in 2011.

General and Administrative Expenses

For the three months ended May 31, 2012, general and administrative expenses decreased by $440,643 as a result of changes in the following expenses:

	Three Months Ended May 31,
	2012		2011		Variance
Professional and other fees	$	892,751	$	254,600	$	638,151
Office		306,255		104,703		201,552
Salaries and welfares		245,718		277,589		(31,871	)
Travel		164,433		51,965		112,468
Depreciation		127,143		115,297		11,846
Repairs		40,087		21,403		18,684
Tax		10,376		16,501		(6,125	)
Stock options		1,457		1,509,815		(1,508,358	)
Other		137,318		14,308		123,010

Total	$	$1,925,538	$	2,366,181	$	(440,643	)

Professional and other fees. Increase in professional and other fees was mainly due to the accrual of environmental protection fees for the Laiyegou coal mine and Heat Power amounting to $0.7 million in the second fiscal quarter of 2012.

Office. The increase in office expenses was mainly attributable to (i) conference and accommodation fees for 2011 annual meeting incurred in this quarter amounting to approximately $40,000; (ii) increased fuel cost in line with the climbing gasoline and diesel prices amounting to approximately $60,000; (iii) property insurance premiums amounting to approximately $40,000; and (iv) miscellaneous office charge increases in line with the business volume amounting to approximately $60,000.

Stock options. Stock-based compensation incurred in 2011 was mainly due to the transfer of 1,800,000 shares beneficially owned by Mr. Ding, Chairman of the Company, to Jessie International Inc. (“Jessie”), and issuance of 60,000 new shares to Hayden Communication International (“HCI”), for consulting service and IR services provided by them for the Company. Shares transferred/issued to Jessie and HCI were valued at approximately $1.4 million and $0.1 million, respectively. Such expenses were non-cash, one time, share-based payments.

Interest Expense

For the second quarter in 2012 and 2011, interest expenses amounted to $900,049 and $628,762, respectively. Interest expense increased mainly because of the rise of interest rates per annum from 6.6% to 7.2%, and (ii) the Finance Leasing Contract entered into by Heat Power with a leasing company in this quarter. Interest expense related to the finance obligation amounted to approximately US$0.3 million and US$0.1 million for the three months ended May 31, 2012 and May 31, 2011, respectively.

Results of Operations – Six Months Ended May 31, 2012

Revenues

The following is an analysis of our revenues and gross profit, details and analysis of components of expenses, and variances; for the six months ended May 31, 2012 compared to May 31, 2011:

Coal Group	Six Months Ended May 31,
			% of total				% of total
	2012		Revenue		2011		revenue
Revenues	$	110,318,197		88	$	42,498,177		78
Cost of revenues		78,099,193		62		24,531,600		45
Gross Profit	$	32,219,004		26	$	17,966,577		33

Heat Power	Six Months Ended May 31,
			% of total				% of total
	2012		Revenue		2011		revenue
Revenues	$	14,909,041		12	$	12,046,075		22
Cost of revenues		12,754,471		10		11,395,289		21
Gross Profit	$	2,154,570		2	$	650,786		1

Coal Group

For the six months ended May 31, 2012, revenues for the Coal Group were $110,318,197 compared to $42,498,177 in the comparable six months in 2011. The $67,820,020 increase was mainly due to the increase of in the volume of coal produced and sold at our Laiyegou coal mine and the increase in our proprietary trading business by 42% and 211%, respectively compared to the corresponding period in 2011.

Coal Trading	Six Months Ended May 31,
			% of total				% of total
	2012		revenue		2011		revenue
Revenues	$	70,488,672		56	$	22,403,326		41
Cost of revenues		66,279,541		53		16,864,919		31
Gross Profit	$	4,209,131		3	$	5,538,407		10

Coal Production	Six Months Ended May 31,
			% of total				% of total
	2012		revenue		2011		revenue
Revenues	$	39,829,525		32	$	20,094,851		37
Cost of revenues		11,819,652		9		7,666,681		14
Gross Profit	$	28,009,873		23	$	12,428,170		23

Coal Group produced approximately 644,774 metric tons of coal during the six months ended May 31, 2012, compared to 454,209 metric tons for the comparable six months in 2011. Volume of coal sold by our proprietary trading business was approximately 1,187,627 metric tons during the six months ended May 31, 2012, compared to 381,843 metric tons for the comparable six months in 2011.

Heat Power

For the six months ended May 31, 2012, revenues for Heat Power were $14,909,041 compared to $12,046,075 in the comparable six months in 2011.

For the six months ended May 31, 2012, revenues generated by Heat Power from its electricity operations were $2,326,862 compared to $2,437,896 in the comparable six month period in 2011.

For the six months ended May 31, 2012, revenues generated by Heat Power from its heating supply operations were $12,582,179 compared to $9,608,179 in the comparable six month period in 2011. The $2,974,000 increase was mainly due to the expansion of the heating supply area from approximately 3.3 million square meters to approximately 4.0 million square meters.

Cost of Sales

For the six months ended May 31, 2012, cost of sales increased by $54,926,775 from the comparable six months in 2011, as a result of changes in the following expenses:

	Six Months Ended May 31,
	2012		2011		Variance
Coal & freight	$	80,399,064	$	26,594,558	$	53,804,506
Heat resource rental		3,916,369		4,371,783		(455,414	)
Depreciation & amortization		3,768,115		2,712,716		1,055,399
Utilities		1,072,485		821,130		251,355
Salaries		678,161		732,094		(53,933	)
Operating supplies		590,585		301,220		289,365
Repairs		246,598		85,476		161,122
Other		182,287		307,912		(125,625	)

Total	$	90,853,664	$	35,926,889	$	54,926,775

For the six months ended May 31, 2012 our overall gross margin was 26% compared with 33% in the 2011 comparable six month period. The decrease in our overall gross profit margin was primarily attributable to the fact that Coal Group purchased more coal from third parties for its coal trading business during the first half year of 2012, which was less profitable than coal purchased from our Laiyegou coal mine in terms of gross margin.

Coal and freight. Coal and freight costs are comprised of (i) the production costs of the Laiyegou coal mine; (ii) the cost of coal purchased in the coal trading business; and, (iii) cost of coal consumed by Heat Power. The increase of these costs was mainly due to (i)increased production cost which rose in line with the production volume, and (ii) increased coal purchases in connection with our coal trading business.

Heat resource rental. The decrease in heat resource rental costs was mainly due to extremely higher costs accrued during the six months period ended May 31, 2011. However, we adjusted the heat resource rental fee in the third quarter of 2011 to reflect the actual cost confirmed by the supplier after the end of 2010-2011 heating season.

Depreciation and amortization. Increase in depreciation and amortization was mainly due to expanded heating supply area. We constructed more pipelines to supply heat to these areas. The increase in depreciation & amortization was also attributable to the increase of production volume in our Laiyegou coal mine.

Utilities. Utilities mainly represented the cost of electricity consumed by heat transfer stations of Heat Power. Increase in utility costs was in line with the expanded heating supply area.

Operating supplies. The increase in operating supplies was from the increase of the volume of limestone used in our heating supply business. We needed to mix raw coal with limestone to reduce sulfur emission. The volume of limestone used in the heating supply business increased in line with our growing heating service coverage area.

Selling Expenses

For the six months ended May 31, 2012, selling expenses increased by $2,923,903 as compared to the same period in 2011. Selling expenses are expected to increase in line with the expanding proprietary coal trading business and production volume of our Laiyegou coal mine in 2012.

	Six Months Ended May 31,
	2012		2011		Variance
Transportation & Storage	$	2,153,099	$	1,547,651	$	605,448
Sales tax and other expenses		2,572,227		808,879		1,763,348
Office		357,881		118,532		239,349
Salaries and welfares		419,012		108,090		310,922
Depreciation		17,486		12,650		4,836

Total	$	5,519,705	$	2,595,802	$	2,923,903

General and Administrative Expenses

For the six months ended May 31, 2012, general and administrative expenses increased by $167,122 as a result of changes in the following expenses:

	Six Months Ended May 31,
	2012		2011			Variance
Professional and other fees	$	1,214,221	$	582,864		$	631,357
Office		709,437		369,948			339,489
Salaries and welfares		620,538		528,636			91,902
Travel		309,537		147,725			161,812
Depreciation		294,647		205,502			89,145
Tax		269,837		96,282			173,555
Repairs		86,103		45,849			40,254
Stock options		4,857		1,528,089			(1,523,232	)
Other		141,255		(21,584	)		162,839

Total	$	3,650,432	$	3,483,311		$	167,121

Professional and other fees. Increase in professional and other fees was mainly due to accrual of environmental protection fee for the Laiyegou coal mine and Heat Power amounting to $0.7 million in the second fiscal quarter of 2012.

Office. The increase in office expenses was mainly attributable to (i) purchase of stationery which could be used for a long period; (ii) purchase of personal care items for all labors; and (iii) increased fuel cost amounting to $0.1 million in line with the climbing gasoline and diesel prices.

Tax. Tax expenses increased mainly attributable to the payment of urban land taxes on the goaf area of our Laiyegou coal mine for the past three years.

Stock-based compensation incurred in 2011 was mainly due to the transfer of 1,800,000 shares beneficially owned by Mr. Ding, Chairman of the Company, to Jessie International Inc. (“Jessie”), and issuance of 60,000 new shares to Hayden Communication International (“HCI”), for consulting and IR services provided by them for the Company. Shares transferred/issued to Jessie and HCI were valued at approximately $1.4 million and $0.1 million, respectively. Such expenses were non-cash, share-based payments.

Interest Expense

For the six months ended May 31, 2012 and May 31, 2011, interest expenses amounted to $1,701,681 and $949,704, respectively. Interest expense increased mainly because of (i) the rise of interest rates per annum from 6.6% to 7.2%, and (ii) the Finance Leasing Contract entered into by Heat Power with a leasing company in this quarter. Interest expense related to the finance obligation amounted to approximately US$0.5 million and US$0.1 million the six months ended May 31, 2012 and May 31, 2011, respectively.

Liquidity and Capital Resources

As of May 31, 2012 we had a working capital of $46,363,846. We anticipate that the combination of our sales and collection of accounts receivables with our longer accounts payable cycle, customer deposits and proceeds from bank and shareholder loans will generate sufficient cash flow to sustain our working capital needs. It is our view that, many of our current liabilities, which are included in the definition of working capital, do not impose strict and time sensitive cash repayment terms on us. For example, advances from customers to be repaid in coal (which we believe will be readily available), current portion of deferred income (which is the portion of pipeline construction reimbursement, already received by us) and shareholder loans (which we believe will not be called by a shareholder at a time adverse to the Company) amount to an aggregate of $28,001,449 of our current liabilities.

We do not know of any trends, events or uncertainties that are likely to have a material impact on our short-term or long-term liquidity other than those factors discussed below.

Sources of Capital

If additional capital is needed in excess of our current capital resources, we will explore financing options such as shareholder loans and bank loans. Shareholders loans have been granted from time to time as required to meet current working capital needs. We have no agreement that ensures that we will receive such loans and we cannot be certain that loans will be made available to us if or when required. We may exhaust this source of funding at any time. Existing shareholder loans are payable on demand and accrue interest at 5.31% and 7.32% per annum. The outstanding balance of our shareholder loans as of May 31, 2012 was $9,614,022.

The outstanding balances and interest rate of short-term bank loans obtained by the Company at May 31, 2012, were as follows:

Bank name

From

Principal

Interest rate

Security

Agricultural Bank of China

Jul.29, 2011

Jul.28, 2012

5,338,860

7.216

Secured

Agricultural Bank of China

Sep.20, 2011

Jul.28, 2012

1,570,253

7.216

Secured

Agricultural Bank of China

Sep.27, 2011

Jul.28, 2012

910,747

7.216

Secured

Agricultural Bank of China

Dec.15, 2011

Dec.14, 2012

12,562,025

7.216

Secured

Agricultural Bank of China

Jan.13, 2012

Jan.12, 2013

9,421,519

7.216

Secured

Cash Flows

Operating Activities:

Our cash flows provided by operating activities was $2,109,829 as compared to cash flows used in operating activities of $17,584,723 for the six months ended May 31, 2011. The following summarizes the inflow and outflow of cash for these periods:

	Six Months Ended May 31,
	2012			2011
Net income	$	19,394,102		$	8,151,513
Depreciation and amortization		4,354,907			3,007,127
(Increase) in restricted cash		(2,289	)		(15,879	)
(Increase) in accounts receivable		(11,285,310	)		(7,743,155	)
Decrease in other receivables		9,820,500			2,091,373
(Increase) in prepaid expenses		(381,079	)		-
(Increase) in advances to suppliers		(13,761,483	)		(15,461,740	)
(Increase) in inventories		(10,445,600	)		(8,923,265	)
(Increase) in other long term assets		-			(3,593,056	)
Increase in deferred income		796,179			100,248
Increase in accounts payable		1,197,528			1,646,061
Increase in advances from customers		6,578,320			1,806,317
(Decrease) in accrued liabilities and other payables		(4,371,685	)		(319,752	)
Others		215,739			1,669,885

Net cash provided by (used in) operating activities	$	2,109,829		$	(17,584,323	)

Accounts receivable. The increase in accounts receivable is mainly attributable to Coal Group’s receivables amounting to $7.2 million. This increase is in line with the expanded proprietary coal trading volume of 211% in the first half of 2012 as compared to the same period in 2011. The increase in accounts receivable was also due to the increase in Heat Power’s user fees made on account amounting to approximately $4.0 million, which increased in line with the heating supply area. The heating season is from October 15, 2010 to April 15, 2011. However, user fees will usually be collected after the end of current heating season.

Other receivables. The decrease in other receivables was mainly due to the repayment of loans made to suppliers in the first half of 2012.

Advance to suppliers. Advances increased for the purchase of coal and freight from third party suppliers, along with the increase of sales volume. The significant increase in volume of coal produced and sold by Coal Group was mainly due to the permitted increase in coal which was allowed to be produced and sold by the Company. Coal Group was selected by the Inner Mongolia Autonomous Region Coal Industry Bureau as one of the 44 major coal enterprises in the Inner Mongolia region to be promoted by the Inner Mongolia government. The Company believes that this decision to promote the Company is the reason behind the Company being permitted to produce and sell more coal than previously allowed. Our operating assets, especially advances to suppliers, increased in line with the increase in our coal trading business since 2011.

Inventory. Inventory mainly consists of coal for trading purposes. We have received more railway transportation quota this year. Our coal trading business volume was increased from 381,843 metric tons in the first half year of 2011 to 1,187,627 metric tons in the first half year of 2012. In order to assure the stability of the coal trading business, we maintained a higher level of inventory balance as compared to the prior year.

Accounts payable. As discussed above, our operating assets and liabilities, including accounts payable, rose in line with the expanding coal production and trading business.

Advances from customers. Advances on sales of coal represent the majority of customer advances received and it is a normal business practice that ensures that the customer obtains Coal Group’s products at the market price determined on the date of purchase. Coal Group’s advances increased during the first half year of 2012 as a result of more orders as of the last several days of the period. The level of advances fluctuates depending upon how quickly Coal Group delivers coal to customers.

Accrued liabilities and other payables. These amounts consist of accruals made for loan interest, repairs and maintenance of heating plants, labor costs, union fees, social insurance, technical training for our employees, etc. Decrease in accrued liabilities and other payables was mainly due to (i) payment of tax of $1.1 million and (ii) repayment of loans from customers of $3.1 million.

Investing Activities:

Cash flows used in investing activities were $4,157,641 for the six months ended May 31, 2012 as compared to cash flows provided by investing activities of $10,277,768 for the six months ended May 31, 2011 as the collection of notes receivable, represented amounts lent for strategic purposes to related parties affiliated to the Company through family members of the Chairman, of $14.7 million, in the first half year of 2011. Notes receivable were fully repaid in cash during 2011. Cash flow used in investing activities were mainly for purchase of property, plants, and equipments.

Financing Activities:

Our cash flows provided by financing activities were $5,454,598 for the six months ended May 31, 2012 as compared to $25,234,403 for the six months ended May 31, 2011. Cash flow provided by financing activities were mainly proceeds from finance obligations. On March 28, 2012, Heat Power entered into a Finance Leasing Contract with a leasing company to pledge its assets in exchange of RMB 48,000,000 (US$7,537,215) in cash. Included in the amount borrowed is a servicing fee of RMB 2,400,000 (US$379,897) and a refundable deposit of RMB 9,600,000 (US$1,507,443). Net proceeds from finance obligation were $5,710,602.

The outstanding balances and interest rate of shareholder loans at May 31, 2012, were as follows:

	Balance		Interest Rate
Ordos City YiYuan Investment Co., Ltd.	$	1,696,474		5.31	%
Hangzhou Dayuan Group, Ltd.		5,860,904		5.31% and 7.32	%
Inner Mongolia Duoyida Mining Co. Ltd.		2,056,644		5.31	%

Total	$	9,614,022

Material Commitments

We have commitments to payment for the bank loans and shareholder loans as mentioned above. We have title to all our capital assets consisting of production equipment, automobiles, and office equipment. The total amount of such commitments is $39,417,426.

Seasonal Aspects

Coal Group’s business is seasonal as sales are particularly low in the first quarter of the year, due to the Chinese New Year holiday. During this time our business is closed for about two weeks.

Heat Power heating sales decrease from April through October as the climate in the region is warm, reducing heating requirements.

Off Balance Sheet Arrangements

We have no off balance sheet arrangements.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Not applicable to smaller reporting companies.

ITEM 4. CONTROLS AND PROCEDURES

A. Evaluation of Disclosure Controls and Procedures

As of the end of the fiscal quarter covered by this report, our management carried out an evaluation, under the supervision and with the participation of the Company’s principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures, as such term is defined in Exchange Act Rule 13a-15(e). The Company’s disclosure controls and procedures are designed to provide a reasonable level of assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission's rules and forms. As a result of outstanding significant weaknesses in internal controls over financial reporting, the Company’s principal executive officer and principal financial officer have concluded that the Company’s disclosure controls and procedures were ineffective.

B. Changes in Internal Controls Over Financial Reporting

In connection with the evaluation of the Company’s internal controls during the quarter ended May 31, 2012, the Company’s principal executive officer and principal financial officer have determined that there are no changes to the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the Company’s internal controls over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

None.

ITEM 1A. RISK FACTORS

Not applicable to smaller reporting companies.

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

None.

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

None.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

ITEM 5. OTHER INFORMATION

None.

ITEM 6 EXHIBITS

(a) Exhibits

Exhibit No.		Document Description
31.1		Certification of Chief Executive Officer (Principal Executive Officer) pursuant to Rule 13A-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2		Certification of the Chief Financial Officer (Principal Financial Officer) pursuant to Rule 13a-14(a)/15d-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32		Certification of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. 1350 (Section 906 of the Sarbanes-Oxley Act of 2002).

SIGNATURES

In accordance with the Securities Exchange Act of 1934, this Quarterly Report on Form 10-Q has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

		CHINA ENERGY CORPORATION
Date: July 19, 2012

	By:	/s/ WenXiang Ding
		WenXiang Ding
		President, Chief Executive Officer, Director &
		Secretary

	By:	/s/ Fu Xu
		Fu Xu
		Acting Chief Financial Officer

Attached files

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