China Xuefeng Environmental Engineering Inc. - FORM 10-Q

Attached files

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EXCEL - IDEA: XBRL DOCUMENT - China Xuefeng Environmental Engineering Inc.	Financial_Report.xls
EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 - China Xuefeng Environmental Engineering Inc.	chinaexh311.htm
EX-31.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 - China Xuefeng Environmental Engineering Inc.	chinaexh312.htm
EX-32.2 - CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER OF THE COMPANY, PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 - China Xuefeng Environmental Engineering Inc.	chinaexh322.htm
EX-32.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER OF THE COMPANY, PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 - China Xuefeng Environmental Engineering Inc.	chinaexh321.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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

For the Quarterly Period Ended February 28, 2015

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

For the Transition Period from ___________ to _____________

Commission File Number: 333-175483

China Xuefeng Environmental Engineering Inc.

(Exact name of registrant as specified in its charter)

Nevada	99-0364975
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

The Beijing-Hangzhou Grand Canal Service Center Building C, Suite 214 Sucheng District, Suqian, Jiangsu Province, P.R. China	223800
(Address of principal executive offices)	(Zip Code)

+86 (527) 8437-0508

(Registrant’s telephone number, including area code)

Not Applicable

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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

Large accelerated filer	o		Accelerated filer	o

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

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

As of April 10, 2015, there were 55,200,000 outstanding shares of common stock of the registrant, par value $.001 per share.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC.

QUARTERLY REPORT ON FORM 10-Q

February 28, 2015

TABLE OF CONTENTS

	PART I—FINANCIAL INFORMATION	Page

Item 1.	Financial Statements.	3

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	33

Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	40

Item 4.	Controls and Procedures.	40

	PART II—OTHER INFORMATION

Item 1.	Legal Proceedings.	41

Item 1A.	Risk Factors.	41

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	41

Item 3.	Defaults Upon Senior Securities.	41

Item 4.	Mine Safety Disclosures.	41

Item 5.	Other Information.	41

Item 6.	Exhibits.	41

Signatures		42

CERTAIN USAGE OF TERMS

Except as otherwise indicated by the context, references in this report to “we,” “us,” “our,” “our Company,” or “the Company” are to the combined business of China Xuefeng Environmental Engineering Inc. (formerly known as NYC Moda Inc.).

CAUTIONARY STATEMENT ON FORWARD-LOOKING INFORMATION

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements discuss matters that are not historical facts. Because they discuss future events or conditions, forward-looking statements may include words such as “anticipate,” “believe,” “estimate,” “intend,” “could,” “should,” “would,” “may,” “seek,” “plan,” “might,” “will,” “expect,” “anticipate,” “predict,” “project,” “forecast,” “potential,” “continue” negatives thereof or similar expressions. Forward-looking statements speak only as of the date they are made, are based on various underlying assumptions and current expectations about the future and are not guarantees. Such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, level of activity, performance or achievement to be materially different from the results of operations or plans expressed or implied by such forward-looking statements.

We cannot predict all of the risks and uncertainties. Accordingly, such information should not be regarded as representations that the results or conditions described in such statements or that our objectives and plans will be achieved and we do not assume any responsibility for the accuracy or completeness of any of these forward-looking statements. These forward-looking statements are found at various places throughout this Quarterly Report on Form 10-Q and include information concerning possible or assumed future results of our operations, including statements about potential acquisition or merger targets; business strategies; future cash flows; financing plans; plans and objectives of management; any other statements regarding future acquisitions, future cash needs, future operations, business plans and future financial results, and any other statements that are not historical facts.

These forward-looking statements represent our intentions, plans, expectations, assumptions and beliefs about future events and are subject to risks, uncertainties and other factors. Many of those factors are outside of our control and could cause actual results to differ materially from the results expressed or implied by those forward-looking statements. In light of these risks, uncertainties and assumptions, the events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than we have described. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of the Quarterly Report on Form 10-Q. All subsequent written and oral forward-looking statements concerning other matters addressed in this Quarterly Report on Form 10-Q and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this Quarterly Report on Form 10-Q.

Except to the extent required by law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, a change in events, conditions, circumstances or assumptions underlying such statements, or otherwise.

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

Consolidated Financial Statements for the Three and

Nine Months Ended February 28, 2015 and 2014

CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

CONTENTS	PAGE

CONSOLIDATED FINANCIAL STATEMENTS:

Consolidated Balance Sheets	5

Consolidated Statements of Income and Comprehensive Income	7

Consolidated Statements of Changes in Stockholders’ Equity	9

Consolidated Statements of Cash Flows	10

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS	11

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (IN U.S. $)

	February 28,		May 31,
ASSETS	2015		2014
	(Unaudited)
Current assets:
Cash	$	23,528,314	$	20,629,604
Prepaid expenses		131,268		97,735

Total current assets		23,659,582		20,727,339

Fixed assets, net		18,447		23,587

TOTAL ASSETS	$	23,678,029	$	20,750,926

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (IN U.S. $)

	February 28,		May 31,
LIABILITIES AND STOCKHOLDERS’ EQUITY	2015		2014
	(Unaudited)

Current liabilities:
Deferred revenues	$	2,188,350	$	1,895,400
Taxes payable		290,603		97,248
Loan from stockholder		375,385		255,468
Accrued liabilities		33,162		82,991
Total current liabilities		2,887,500		2,331,107

Commitments and contingencies		-		-

Stockholders’ equity:
Common stock, $0.001 par value per share,
75,000,000 shares authorized; 55,200,000 shares issued and outstanding as of February 28, 2015 and May 31, 2014		55,200		55,200
Additional paid-in capital		11,389,049		11,389,049
Statutory reserve fund		840,850		604,333
Retained earnings		7,407,471		5,392,092
Other comprehensive income		427,343		421,823

Stockholders’ equity before noncontrolling interests		20,119,913		17,862,497
Noncontrolling interests		670,616		557,322

Total stockholders’ equity		20,790,529		18,419,819

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	23,678,029	$	20,750,926

See accompanying notes to the consolidated financial statements

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

	Three Months Ended February 28,						Nine Months Ended February 28,
	2015			2014			2015			2014

Revenue	$	1,950,000		$	886,380		$	3,705,000		$	3,833,940
Cost of revenue		(95,119	)		(75,991	)		(249,936	)		(279,456	)

Gross profit		1,854,881			810,389			3,455,064			3,554,484

Operating expenses
Selling and marketing		25,795			20,281			76,407			73,176
General and administrative		98,755			96,960			280,432			244,352

Total operating expenses		124,550			117,241			356,839			317,528

Income from operations		1,730,331			693,148			3,098,225			3,236,956
Interest income		18,816			16,039			55,284			45,400

Income before provision for income taxes		1,749,147			709,187			3,153,509			3,282,356
Provision for income taxes		437,287			177,121			788,384			820,414

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

	Three Months Ended February 28,						Nine Months Ended February 28,
	2015			2014			2015			2014

Net income		1,311,860			532,066			2,365,125			2,461,942
Noncontrolling interests		(63,916	)		(24,921	)		(113,229	)		(118,607	)

Net income attributable to common stockholders	$	1,247,944		$	507,145		$	2,251,896		$	2,343,335

Earnings per common share, basic and diluted	$	0.02		$	0.01		$	0.04		$	0.04

Weighted average shares outstanding, basic and diluted		55,200,000			55,200,000			55,200,000			55,200,000

Comprehensive Income:
Net Income	$	1,311,860		$	532,066		$	2,365,125		$	2,461,942
Foreign currency translation adjustment		(99,691	)		2,798			5,585			155,089

Comprehensive income		1,212,169			534,864			2,370,710			2,617,031
Comprehensive income attributable to noncontrolling interests		(60,762	)		(25,058	)		(113,294	)		(122,501	)

Net Comprehensive income attributable to common stockholders	$	1,151,407		$	509,806		$	2,257,416		$	2,494,530

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE NINE MONTHS ENDED FEBRUARY 28, 2015 (UNAUDITED) (IN U.S. $)

	Common Stock		Additional Paid-in Capital		Retained Earnings			Noncontrolling Interests		Statutory Reserve Fund		Other Comprehensive Income		Total

Balance, May 31, 2014	$	55,200	$	11,389,049	$	5,392,092		$	557,322	$	604,333	$	421,823	$	18,419,819

Net income		-		-		2,251,896			113,229		-		-		2,365,125

Appropriation to statutory reserve		-		-		(236,517	)		-		236,517		-		-

Foreign currency translation adjustment		-		-		-			65		-		5,520		5,585

Balance, February 28, 2015- Unaudited	$	55,200	$	11,389,049	$	7,407,471		$	670,616	$	840,850	$	427,343	$	20,790,529

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

	Nine Months Ended February 28,
	2015			2014

Cash flows from operating activities:
Net income	$	2,365,125		$	2,461,942
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation		9,162			11,054
Deferred income taxes		-			323,565
Changes in operating assets and liabilities:
Decrease in prepaid expenses		(33,533	)		(34,656	)
Increase in deferred revenue		292,950			870,000
Increase (decrease) in taxes payable		193,355			(495,486	)
(Decrease) increase in accrued liabilities		(49,830	)		12,596

Net cash provided by operating activities		2,777,229			3,149,015

Cash flows from investing activities:
Purchase of equipment		-			(16,622	)

Cash flows from financing activities:
Proceeds from stockholder loans		120,000			31,000
Effect of exchange rate changes on cash		1,481			145,972

Net increase in cash		2,898,710		3,309,365
Cash, beginning		20,629,604		16,341,986

Cash, end	$	23,528,314	$	19,651,351

Supplemental disclosure of cash flow information
Cash paid during the period for:
Interest	$	-	$	-
Income taxes	$	599,383	$	291,480

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 1. ORGANIZATION

China Xuefeng Environmental Engineering Inc. (the “Company”), formerly known as NYC Moda Inc., was incorporated under the laws of the State of Nevada on March 30, 2011. Since its inception until the closing of the Exchange Agreement, the Company was a development-stage company in the business of distributing designer clothing and footwear from established brands to customers around the world.

On November 27, 2012, the Company completed a reverse acquisition transaction through a share exchange with the stockholders of Inclusion Business Limited (“Inclusion”), whereby the Company acquired 100% of the outstanding shares of Inclusion in exchange for a total of 7,895,000 shares of its common stock, representing 76.65% of the issued and outstanding shares of common stock. As a result of the reverse acquisition, Inclusion became the Company’s wholly-owned subsidiary and the former Inclusion Stockholders became our controlling stockholders. The share exchange transaction was treated as a reverse acquisition, with Inclusion as the acquirer and the Company as the acquired party for accounting purposes.

On November 27, 2012, the Company filed a certificate of amendment to its articles of incorporation to change its name from “NYC Moda, Inc.” to “China Xuefeng Environmental Engineering Inc.” (the “Name Change”) and to initiate a 4-for-1 forward stock split (the “Forward Split”) of its outstanding shares of common stock. The effective dates of the Name Change and the Forward Split were December 14, 2012 and December 17, 2012, respectively. Upon the effectiveness of the Forward Split, the number of outstanding shares of the Company’s common stock increased from 10,300,000 to 41,200,000 shares. On March 19, 2013, the Company issued 14,000,000 shares of common stock to 12 unrelated individuals in a private offering, generating approximately $7,000,000 in net proceeds.

As a result of the transaction with Inclusion, the Company owns all of the issued and outstanding capital stock of Lotus International Holdings Limited (“Lotus”), a wholly-owned subsidiary of Inclusion, which in turn owns all of the issued and outstanding capital stock of Baichuang Information Consulting (Shenzhen) Co. Ltd (“Baichuang Consulting”). In addition, the Company effectively and substantially controls Jiangsu Xuefeng Environmental Protection Science and Technology Co., Ltd. (“Jiangsu Xuefeng”) through a series of captive agreements with Baichuang Consulting.

The Company conducts its operations through its controlled consolidated variable interest entity (“VIE”), Jiangsu Xuefeng. Jiangsu Xuefeng, incorporated under the laws of the People’s Republic of China (“PRC”) on December 14, 2007, is primarily engaged in providing improvement and upgrading services of garbage recycling processing technology and equipment.

On October 17, 2012, Baichuang Consulting (the “WFOE”), a wholly-owned subsidiary of Lotus, entered into a series of contractual arrangements (the “VIE agreements”). The VIE agreements include (i) an Exclusive Technical Service and Business Consulting Agreement; (ii) a Proxy Agreement, (iii) Share Pledge Agreement and, (iv) Call Option Agreement with the stockholders of Jiangsu Xuefeng.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 1. ORGANIZATION (CONTINUED)

Exclusive Technical Service and Business Consulting Agreement: Pursuant to the Exclusive Technical Service and Business Consulting Agreement, the WFOE provides technical support, consulting, training, marketing and operational consulting services to Jiangsu Xuefeng. In consideration for such services, Jiangsu Xuefeng has agreed to pay an annual service fee to the WFOE of 95% of Jiangsu Xuefeng’s annual net income with an additional payment of approximately US$16,250 (RMB 100,000) each month. The Agreement has an unlimited term and only can be terminated upon written notice agreed to by both parties.

Proxy Agreement: Pursuant to the Proxy Agreement, the stockholders of Jiangsu Xuefeng agreed to irrevocably entrust the WFOE to designate a qualified person acceptable under PRC law and foreign investment policies, all of the equity interests in Jiangsu Xuefeng held by the stockholders of Jiangsu Xuefeng. The Agreement has an unlimited term and only can be terminated upon written notice agreed to by both parties.

Call Option Agreement: Pursuant to the Call Option agreement, the WFOE has an exclusive option to purchase, or to designate a purchaser, to the extent permitted by PRC law and foreign investment policies, part or all of the equity interests in Jiangsu Xuefeng held by each of the stockholders. To the extent permitted by PRC laws, the purchase price for the entire equity interest is approximately US$0.16 (RMB1.00) or the minimum amount required by PRC law or government practice. This Agreement remains effective until all the call options under the Agreement have been exercised by Baichuang Consulting or its designated entities or natural persons.

Share Pledge Agreement: Pursuant to the Share Pledge agreement, each of the stockholders pledged their shares in Jiangsu Xuefeng to the WFOE, to secure their obligations under the Exclusive Technical Service and Business Consulting Agreement. In addition, the stockholders of Jiangsu Xuefeng agreed not to transfer, sell, pledge, dispose of or create any encumbrance on their interests in Jiangsu Xuefeng that would affect the WFOE’s interests. This Agreement remains effective until the obligations under the Exclusive Technical Service and Business Consulting Agreement, Call Option Agreement and Proxy Agreement have been fulfilled or terminated.

As a result of the entry into the foregoing agreements, the Company has a corporate structure which is set forth as follows:

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 1. ORGANIZATION (CONTINUED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF ACCOUNTING AND PRESENTATION

The accompanying consolidated financial statements have been prepared on the accrual basis of accounting. The consolidated financial statements for the three and nine months ended February 28, 2015 and 2014 include China Xuefeng Environmental Engineering Inc., and its wholly owned subsidiaries, Inclusion, Lotus and Baichuang Consulting and its VIE, Jiangsu Xuefeng. All significant intercompany accounts and transactions have been eliminated in consolidation when applicable.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

BASIS OF ACCOUNTING AND PRESENTATION (CONTINUED)

The unaudited interim consolidated financial statements of the Company as of February 28, 2015 and for the three and nine months ended February 28, 2015 and 2014, have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the SEC which apply to interim financial statements. Accordingly, they do not include all of the information and footnotes normally required by accounting principles generally accepted in the United States of America for annual 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 interim consolidated financial information should be read in conjunction with the consolidated financial statements and the notes thereto, included in the Company’s Form 10-K filed with the SEC. The results of operations for the three and nine months ended February 28, 2015 are not necessarily indicative of the results to be expected for future quarters or for the year ending May 31, 2015.

All consolidated financial statements and notes to the consolidated financial statements are presented in United States dollars (“US Dollar” or “US$” or “$”).

VARIABLE INTEREST ENTITY

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

Under ASC 810, a reporting entity has a controlling financial interest in a VIE, and must consolidate that VIE, if the reporting entity has both of the following characteristics: (a) the power to direct the activities of the VIE that most significantly affect the VIE’s economic performance; and (b) the obligation to absorb losses, or the right to receive benefits, that could potentially be significant to the VIE. The reporting entity’s determination of whether it has this power is not affected by the existence of kick-out rights or participating rights, unless a single enterprise, including its related parties and de facto agents, have the unilateral ability to exercise those rights. Jiangsu Xuefeng’s actual stockholders do not hold any kick-out rights that affect the consolidation determination.

Through the VIE agreements disclosed in Note 1, the Company is deemed the primary beneficiary of Jiangsu Xuefeng. Accordingly, the results of Jiangsu Xuefeng have been included in the accompanying consolidated financial statements. Jiangsu Xuefeng has no assets that are collateral for or restricted solely to settle their obligations. The creditors of Jiangsu Xuefeng do not have recourse to the Company’s general credit.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

VARIABLE INTEREST ENTITY (CONTINUED)

The following financial statement amounts and balances of Jiangsu Xuefeng have been included in the accompanying consolidated financial statements.

ASSETS	February 28, 2015			May 31, 2014
	(UNAUDITED)
Current assets:
Cash	$	23,296,950		$	20,390,978
Prepaid expenses		130,283			96,750

Total current assets		23,427,233			20,487,728

Fixed assets		60,041			56,019
Less: accumulated depreciation		(41,594	)		(32,432	)

Fixed assets, net		18,447			23,587

TOTAL ASSETS	$	23,445,680		$	20,511,315

LIABILITIES

Current liabilities:
Due to China Xuefeng Environmental Engineering, Inc. (1)	$	7,053,068		$	7,048,717
Payable to WFOE(2)		8,187,683			5,890,442
Deferred revenue		2,188,350			1,895,400
Taxes payable		168,507			13,395
Loan from stockholder		347,120			227,172
Accrued liabilities		33,161			82,991

Total current liabilities		17,977,889			15,158,117

TOTAL LIABILITIES	$	17,977,889		$	15,158,117

(1)	Due to China Xuefeng Environmental Engineering, Inc. is for the proceeds from the sale of common stock which proceeds were received by Jiangsu Xuefeng for 14,000,000 common shares issued by China Xuefeng Environmental Engineering, Inc. on March 19, 2013 at $0.50 each (approximately US$7,000,000).

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

VARIABLE INTEREST ENTITY (CONTINUED)

(2)

Payable to WFOE represents outstanding amounts due to Baichuang Information Consulting (Shenzhen) Co. Ltd. under the Exclusive Technical Service and Business Consulting Agreement for consulting services provided to Jiangsu Xuefeng in exchange for 95% of Jiangsu Xuefeng’s net income and additional monthly payments of RMB 100,000 (approximately US$16,250). During this quarter Jiangsu Xuefeng did not make any payment to the WOFE.

	Three Months Ended February 28,
	2015		2014
	(UNAUDITED)		(UNAUDITED)

Revenue	$	1,950,000	$	886,380
Net income (3)	$	1,278,288	$	498,404

	Nine Months Ended February 28,
	2015		2014
	(UNAUDITED)		(UNAUDITED)

Revenue	$	3,705,000	$	3,833,940
Net income (3)	$	2,264,580	$	2,361,971

(3)	Under the Exclusive Technical Service and Business Consulting Agreement, 95% of the net income is to be remitted to the WFOE, which is not reflected above.

	Nine Months Ended February 28,
	2015		2014
	(UNAUDITED)		(UNAUDITED)

Net cash provided by operating activities	$	2,782,034	$	3,008,769
Net cash provided by (used in) investing activities		-		(16,581	)
Net cash provided by financing activities		120,000		31,000
Effect of exchange rate changes on cash		3,938		198,758

Net increase in cash	$	2,905,972	$	3,221,946

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

VARIABLE INTEREST ENTITY (CONTINUED)

The Company believes that Baichuang Consulting’s contractual agreements with Jiangsu Xuefeng are in compliance with PRC law and are legally enforceable. The stockholders of Jiangsu Xuefeng are also the senior management of the Company and therefore the Company believes that they have no current interest in seeking to act contrary to the contractual arrangements. However, Jiangsu Xuefeng and its stockholders may fail to take certain actions required for the Company’s business or to follow the Company’s instructions despite their contractual obligations to do so. Furthermore, if Jiangsu Xuefeng or its stockholders do not act in the best interests of the Company under the contractual arrangements and any dispute relating to these contractual arrangements remains unresolved, the Company will have to enforce its rights under these contractual arrangements through PRC law and courts and therefore will be subject to uncertainties in the PRC legal system. All of these contractual arrangements are governed by PRC law and provide for the resolution of disputes through arbitration in the PRC. Accordingly, these contracts would be interpreted in accordance with PRC law and any disputes would be resolved in accordance with PRC legal procedures. As a result, uncertainties in the PRC legal system could limit the Company’s ability to enforce these contractual arrangements, which may make it difficult to exert effective control over Jiangsu Xuefeng, and its ability to conduct the Company’s business may be adversely affected.

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 disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results could differ from those estimates.

FOREIGN CURRENCY TRANSLATION

Almost all Company assets are located in the PRC. 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 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 income 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 (loss).

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

FOREIGN CURRENCY TRANSLATION (CONTINUED)

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

	February 28, 2015		May 31, 2014

Balance sheet items, except for stockholders’ equity, as of period end		0.1621		0.1620

	For the three months ended February 28,				For the nine months ended February 28,
	2015		2014		2015		2014

Amounts included in the statements of income, statements of changes in stockholders’ equity and statements of cash flows		0.1627		0.1636		0.1625		0.1628

For the three months ended February 28, 2015 and 2014, foreign currency translation adjustments of $(99,691) and $2,798, respectively, and for the nine months ended February 28, 2015 and 2014, foreign currency translation adjustments of $5,585 and $155,089, respectively, have been reported as other comprehensive income. Other comprehensive income of the Company consists entirely of foreign currency translation adjustments. Pursuant to ASC 740-30-25-17, “Exceptions to Comprehensive Recognition of Deferred Income Taxes,” the Company does not recognize deferred U.S. taxes related to the undistributed earnings of its foreign subsidiaries and, accordingly, recognizes no income tax expense or benefit from foreign currency translation adjustments.

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

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

REVENUE RECOGNITION

Revenues are primarily derived from providing garbage recycling processing system technology support, renovation and upgrade services and patent licensing to customers. The Company’s revenue recognition policies comply with FASB ASC 605 “Revenue Recognition.” In general, the Company recognizes revenue when there is persuasive evidence of an arrangement, the fee is fixed or determinable, the products or services have been delivered or performed and collectability of the resulting receivable is reasonably assured.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

Multiple-Element Arrangements

In October 2009, the FASB issued Accounting Standards Update (“ASU”) No. 2009-13, “Multiple Deliverable Revenue Arrangements.” ASU No. 2009-13 amended the guidance on arrangements with multiple deliverables under ASC 605-25, “Revenue Recognition—Multiple-Element Arrangements.” To qualify as a separate unit of accounting under ASC 605-25, the delivered item must have value to the customer on a standalone basis. The significant deliverables under the Company’s multiple-element arrangements are improvement and upgrade services and patent licensing.

Improvement and Upgrade Service

The improvement and upgrade service is a one-time service. An inspection is conducted by the customer according to industry standards within three days of the completion of the improvement and upgrade. An acceptance form is provided by the customer if the inspection is satisfactory. Performance testing is conducted on the upgraded equipment within one month. Testing can be done in less than a month period. A final evaluation report is provided within five days of the completion of the performance testing. The fee for improvement and upgrade services is fixed and becomes due within 30 days, upon the signing of the contract. If the performance testing does not meet the specifications as agreed to in the contract, the customer is refunded 20% of the fee for the improvement and upgrade services. The Company has met the agreed upon specifications and has not been required to make any refunds for its services. No warranty is provided by the Company.

The customer is responsible for repair services when they are necessary. The out of pocket expenses for the repair services will be charged separately to the customer by the Company.

Patent Licensing

Patent licensing is limited to 5 years with payments due annually in advance. The patent technology of “harmless and comprehensive garbage processing equipment” provided by the Company to its customers has high garbage processing capacity and stable operation capacity. It is the first modern system equipment in China to use DCS (Distributed Control System) centralized control, by which mechanical automation will be realized for the comprehensive treatment of life garbage. Its core technology is to organically integrate the anaerobic digestion and aerobic fermentation garbage process, degrade and transform the organic matter of domestic waste, effectively sort out the garbage and recycle all kinds of materials, to eventually realize the true waste resource utilization and harmless utilization, with a utilization rate approaching 100%. The resource recovery products, biogas, not only can be used for meeting the needs of the plant itself, but also can be sold as a separate product, which greatly improves the efficiency of garbage processing of the customer’s equipment, decreases production cost, and increases the recovery return of garbage processing.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

Patent Licensing (Continued)

The Company’s customer who pays for an upgrade and improvement fee is not required to enter into a licensing agreement to continue to use the patented technology. If the customer does not require the garbage process equipment to reach the level of the patented technology which can process 500 tons to 1,000 tons of garbage per day, then the customer does not need to enter into the patent licensing agreement.

Multiple Elements

The Company determined that its improvement and upgrade service is individually a separate unit of accounting. In determining whether the improvement and upgrade services has standalone value, the Company considered factors including the availability of similar services from other vendors, its fee structure based on inclusion and exclusion of the service, and its marketing and delivery of the service. The Company uses the vendor-specific objective evidence to determine the selling price for its improvement and upgrade services when sold in multiple-element arrangements. Although not yet being sold separately, the price established by the management has the relevant authority.

The Company also determined that the patent licensing has standalone value because the patent can be licensed separately. The Company uses the vendor-specific objective evidence to determine the price for patent licensing when sold in multiple-element arrangements. Although not yet being leased separately, the price established by the management has the relevant authority.

The Company allocates the arrangement consideration based on their relative selling prices. Revenues for deliverables under improvement and upgrade services are recognized by the end of the improvement and upgrade period at the time the performance testing is passed and the final evaluation report is provided by the customer, which generally is within 30 days, assuming all other revenue recognition criteria are met. Revenues for patent licensing are recognized monthly over the licensing period.

The Company believes the effect of changes in the selling price for improvement and upgrade services and patent licensing will not have significant effect on the allocation of the arrangement.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

VULNERABILITY DUE TO OPERATIONS IN PRC

The Company’s operations may be adversely affected by significant political, economic and social uncertainties in the PRC. The different cultures, business preferences, corruption, diverse uncertain government regulations, tax systems and currency regulations are risks impacting the Company’s current operations. 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 PRC’s political, economic and social conditions. There is also no guarantee that the PRC government’s pursuit of economic reforms will be consistent, effective or continue.

FAIR VALUE OF FINANCIAL INSTRUMENTS

FASB ASC 820, “Fair Value Measurement,” defines fair value as the price that would be received upon sale of an asset or paid upon transfer of a liability in an orderly transaction between market participants at the measurement date and in the principal or most advantageous market for that asset or liability. The fair value should be calculated based on assumptions that market participants would use in pricing the asset or liability, not on assumptions specific to the entity.

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 to be cash equivalents.

FIXED ASSETS

Fixed assets are recorded at cost, less accumulated depreciation. Cost includes the price paid to acquire the asset, and any expenditure that substantially increase the asset’s value or extends the useful life of an existing asset. Depreciation is computed using the straight-line method over the estimated useful lives of the assets. Major repairs and betterments that significantly extend the original useful life or improve productivity are capitalized and depreciated over the periods benefited. Maintenance and repairs are generally expensed as incurred. The estimated useful lives for fixed asset categories are as follows:

Computers and equipment	3 years
Motor vehicles	4 years
Furniture and fixtures	5 years

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

IMPAIRMENT OF LONG-LIVED ASSESTS

The Company applies FASB ASC 360, “Property, Plant and Equipment,” 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 the impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to those assets. No impairment of long-lived assets was recognized for the periods presented.

DEFERRED REVENUE

Deferred revenue includes payments received for a) improvement and upgrade services and b) patent licensing fees. These payments received, but not yet earned, are recognized as deferred revenue on the consolidated balance sheets.

INCOME 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 consequences for those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. At February 28, 2015 and May 31, 2014, the differences relate entirely to revenue deferred for financial statement purposes. During the three and nine months ended February 28, 2015, as permitted by the PRC tax law, the Company began recognizing revenue from patent licensing fees for income tax purposes, based on when it is earned rather than when it is collected, consistent with financial statement recognition. As a result, there are no differences between the basis of assets and liabilities for financial statement and income tax purposes for deferred revenue and, as a result, deferred income taxes are no longer required to be recognized. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized.

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 50% 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. As of February 28, 2105 and May 31, 2014, the Company does not have a liability for any unrecognized tax benefits.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

INCOME TAXES (CONTINUED)

The income tax laws of various jurisdictions in which the Company and its subsidiaries operate are summarized as follows:

United States

The Company is subject to United States tax at graduated rates from 15% to 35%. No provision for income taxes in the United States has been made as the Company had no U.S. taxable income for the three and nine months ended February 28, 2015 and 2014.

PRC

Jiangsu Xuefeng and Baichuang Consulting are subject to an Enterprise Income Tax at 25% and file their own tax returns. Consolidated tax returns are not permitted in China.

BVI

Inclusion is incorporated in the BVI and is governed by the income tax laws of the BVI. According to current BVI income tax law, the applicable income tax rate for the Company is 0%.

Hong Kong

Lotus is incorporated in Hong Kong. Pursuant to the income tax laws of Hong Kong, the Company is not subject to tax on non-Hong Kong source income.

ADVERTISING COSTS

Advertising costs are charged to operations when incurred. For the three months ended February 28, 2015 and 2014, advertising expense was $12,513 and $8,992, respectively, and for the nine months ended February 28, 2015 and 2014, advertising expense was $36,888 and $24,420, respectively.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

STATUTORY RESERVE FUND

Pursuant to corporate law in the PRC, the Company is required to transfer 10% of its net income, as determined under PRC accounting rules and regulations, to a statutory reserve fund until such reserve balance reaches 50% of the Company’s registered capital. The statutory 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 used to increase registered capital, provided that the remaining reserve balance after such use is not less than 25% of the registered capital. For the nine months ended February 28, 2015 and 2014, a statutory reserve of $236,517 and $236,197, respectively, was required to be allocated by the Company.

NOTE 3. RECENTLY ISSUED ACCOUNTING STANDARDS

In August 2014, the FASB issued authoritative guidance that requires an entity’s management to evaluate whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the entity’s ability to continue as a going concern and requires additional disclosures if certain criteria are met. This guidance is effective for fiscal periods ending after December 15, 2016, with early adoption permitted. This accounting standard update is not expected to have any impact on the Company’s financial statements.

In June 2014, the FASB issued ASU No. 2014-12, “Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period”. ASU 2014-12 requires a reporting entity to treat a performance target that affects vesting and that could be achieved after the requisite service period as a performance condition. It is effective for annual periods, and interim periods within those annual periods, beginning after December 15, 2015. Early adoption is permitted. This accounting standard update is not expected to have a material impact on the Company’s consolidated financial statements.

In May 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers”, which supersedes the revenue recognition requirements in ASC 605, “Revenue Recognition”. The core principle of this updated guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The new rule also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This guidance is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Companies are permitted to adopt this new rule following either a full or modified retrospective approach. Early adoption is not permitted. The Company has not yet determined the potential impact of this updated authoritative guidance on its consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 3. RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED)

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360), Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity”, which amends the requirements for reporting discontinued operations. Under ASU 2014-08, a disposal of a component of an entity or a group of components of an entity is required to be reported as discontinued operations if the disposal represents a strategic shift that has (or will have) a major effect on an entity's operations and financial results when the component or group of components meets the criteria to be classified as held for sale or when the component or group of components is disposed of by sale or other than by sale. In addition, this ASU requires additional disclosures about both discontinued operations and the disposal of an individually significant component of an entity that does not qualify for discontinued operations presentation in the financial statements. The guidance is effective for annual and interim periods beginning after December 15, 2014, with early adoption permitted. This accounting standard update is not expected to have a material impact on the Company’s consolidated financial statements.

NOTE 4. FAIR VALUE MEASUREMENTS

FASB ASC 820, “Fair Value Measurement,” 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.

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 measurements. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. As of February 28, 2015 and May 31, 2014, none of the Company’s assets and liabilities were required to be reported at fair value on a recurring basis. Carrying values of non-derivative financial instruments, including cash, deferred revenues, payables and accrued liabilities, approximate their fair values due to the short term nature of these financial instruments. There were no changes in methods or assumptions during the periods presented.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 5. FIXED ASSETS

Fixed assets are summarized as follows:

	February 28, 2015			May 31, 2014
	(UNAUDITED)

Computers and equipment	$	31,736		$	27,732
Vehicle		15,189			15,179
Furniture and fixtures		13,116			13,108

		60,041			56,019
Less: Accumulated depreciation		(41,594	)		(32,432	)

	$	18,447		$	23,587

For the three months ended February 28, 2015 and 2014, depreciation expense was $2,454 and $3,952, respectively. For the nine months ended February 28, 2015 and 2014, depreciation expense was $9,162 and $11,054, respectively.

NOTE 6. INCOME TAXES

The provision for income taxes consisted of the following:

	Three Months Ended February 28,
	2015		2014
	(UNAUDITED)		(UNAUDITED)

Current	$	437,287	$	122,041
Deferred		-		55,080

	$	437,287	$	177,121

	Nine Months Ended February 28,
	2015		2014
	(UNAUDITED)		(UNAUDITED)

Current	$	788,384	$	496,849
Deferred		-		323,565

	$	788,384	$	820,414

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 6. INCOME TAXES (CONTINUED)

The expected tax rate for income in PRC is 25% which is the same as the effective tax rate for the periods presented.

The Company is required to file income tax returns in both the PRC and the United States. PRC tax filings for the tax year ended December 31, 2013 were examined by the PRC tax authorities in May 2014. The tax filings were accepted and no adjustments were proposed by the PRC tax authorities.

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 fiscal year ended May 31, 2014, April 30, 2013 and for the one month period ended May 31, 2013, a short year income tax return required to be filed as a result of the change in fiscal year. Failure to furnish any income tax returns and information returns with respect to any foreign business entity required, within the time prescribed by the IRS, subjects the Company to certain civil penalties. 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 has any U.S. Federal income tax liabilities with respect to any transactions that the Company or any of its subsidiaries may have engaged in through February 28, 2015. However, there can be no assurance that the IRS will agree with this position, and therefore the Company ultimately could be liable for U.S. Federal income taxes, interest and penalties. The tax years ended May 31, 2014 and 2013 and April 30, 2013, 2012 and 2011 remain open to examination by the IRS.

NOTE 7. RELATED PARTY TRANSACTIONS

On August 5, 2012, the Company entered into an agreement to lease the rights of a patent on garbage recycling processing technology from Li Yuan, one of the Company’s officers/stockholders. Under the current terms, the Company is required to pay a fee of $12,968 (RMB 80,000) each month for five years from September 2012 to August 2017. The related prepaid patent leasing fees of $129,680 and $90,720 are included in prepaid expenses on the consolidated balance sheets as of February 28, 2015 and May 31, 2014, respectively.

The remaining payments for the patent rights are as follows:

Year Ending
May 31,	Amount

2015	$	-
2016		155,616
2017		103,744

	$	259,360

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 7. RELATED PARTY TRANSACTIONS (CONTINUED)

The Company obtained a demand loan from Li Yuan, an officer/stockholder which is non-interest bearing. The loan of approximately $375,385 represents expenses paid by the officer/stockholder and approximately $79,000 representing the registered capital and operating expenses of Baichuang Information Consulting (Shenzhen) Co., Ltd. (“Baichuang Consulting”) for year ended May 31, 2014. The net balance is reflected as loan from stockholder as of February 28, 2015.

NOTE 8. LEASES

The Company leases office space under a one-year operating lease from an unrelated third party, which expires on March 31, 2016. The lease requires the Company to prepay the rental for one year of $7,240 (RMB 44,664). The related prepayments of $603 and $6,030 are included in prepaid expenses on the consolidated balance sheets as of February 28, 2015 and May 31, 2014, respectively. The lease provides for renewal options. Rent expense for the three months ended February 28, 2015 and 2014 was $1,814 and $1,826, respectively, and rent expense for the nine months ended February 28, 2015 and 2014 was $5,443 and $5,453 respectively.

The minimum future rental commitment under the lease is as follows:

Year Ending
May 31,	Amount

2015	$	7,236

NOTE 9. CONTINGENCIES

As disclosed in Note 6, the Company is delinquent in filing certain tax returns with the U.S. Internal Revenue Service. The Company is unable to determine the amount of penalties, if any, 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 did not file the information reports for the years ended December 31, 2014, 2013 and 2012 concerning its interest in foreign bank accounts on form TDF 90-22.1, “Report of Foreign Bank and Financial Accounts” (“FBAR”). Not complying with the FBAR reporting and recordkeeping requirements will subject the Company to civil penalties up to $10,000 for each year it has foreign bank accounts. The Company has not determined 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.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 10. CONCENTRATION OF CREDIT AND BUSINESS RISK

Cash and cash equivalents

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

Major customers

The following table represents certain information about the Company’s customers which individually accounted for more than 10% of the Company’s revenue during the three and nine months ended February 28, 2015:

	Three months ended					Nine months ended
	February 28, 2015					February 28, 2015
	Amount		%			Amount		%
CUSTOMER 1		430,890		22	%		576,875		16	%
CUSTOMER 2		430,890		22	%		576,875		16	%
CUSTOMER 3		430,890		22	%		576,875		16	%

	February 28, 2014					February 28, 2014
	Amount		%			Amount		%
CUSTOMER 4		*		*			659,340		17.20	%
CUSTOMER 5		*		*			634,920		16.56	%
CUSTOMER 6		*		*			561,660		14.65	%

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 11. CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY

The following condensed financial information of the Company’s US parent only balance sheets as of February 28, 2015 and May 31, 2014, and the US parent company only statements of income, and cash flows for the nine months ended February 28, 2015 and 2014:

Condensed Balance Sheets

ASSETS	February 28, 2015		May 31, 2014
	(UNAUDITED)

Investment in subsidiaries and VIE	$	20,119,913	$	17,862,497

TOTAL ASSETS	$	20,119,913	$	17,862,497

LIABILITIES AND STOCKHOLDERS’ EQUITY

Accrued expenses and other payables	$	-	$	-

Stockholders’ equity

Common stock, $0.001 par value; 75,000,000 shares authorized; 55,200,000 shares issued and outstanding at February 28, 2015 and May 31, 2014		55,200		55,200
Additional paid-in capital		11,389,049		11,389,049
Retained earnings		8,675,664		6,418,248

Total stockholders’ equity		20,119,913		17,862,497

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	20,119,913	$	17,862,497

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

Condensed Statements of Income

	Three Months Ended February 28,
	2015		2014
	(UNAUDITED)		(UNAUDITED)
Revenues
Share of earnings from investment in subsidiaries and VIE	$	1,151,407	$	509,806

Net income	$	1,151,407	$	509,806

	Nine Months Ended February 28,
	2015		2014
	(UNAUDITED)		(UNAUDITED)
Revenues
Share of earnings from investment in subsidiaries and VIE	$	2,257,416	$	2,494,530

Net income	$	2,257,416	$	2,494,530

Condensed Statements of Cash Flows

	Six Months Ended November 30,
	2015			2014
	(UNAUDITED)			(UNAUDITED)
Cash flows from operating activities
Net income	$	1,151,407		$	509,806
Adjustments to reconcile net income to net cash provided by (used in) operating activities
Share of earnings from investment in subsidiaries and VIE		(1,151,407	)		(509,806	)

Net cash (used in) operating activities		-			-

Net increase in cash		-			-
Cash, beginning of year		-			-

Cash, end of year	$	-		$	-

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE AND NINE MONTHS ENDED FEBRUARY 28, 2015 AND 2014

(UNAUDITED) (IN U.S. $)

NOTE 11. CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY (CONTINUED)

Basis of Presentation

The Company records its investment in its subsidiaries and VIE under the equity method of accounting. Such investment is presented as “Investment in subsidiaries and VIE in the condensed balance sheets and the U.S. parent’s share of the subsidiaries and VIE’s profits are presented as “Share of earnings from investment in subsidiaries and VIE” in the condensed statements of income.

Certain information and footnote disclosures normally included in financial statements prepared in conformity with accounting principles generally accepted in the United States of America have been condensed or omitted. The parent only financial information has been derived from the Company’s consolidated financial statements and should be read in conjunction with the Company’s consolidated financial statements.

Restricted Net Assets

Under PRC laws and regulations, the Company’s PRC subsidiary and VIE are restricted in their ability to transfer certain of their net assets to the parent company in the form of dividend payments, loans or advances. The restricted net assets of the Company’s PRC subsidiary and VIE amounted to $20,119,914 and $17,862,497 as of February 28, 2015 and May 31, 2014, respectively.

In addition, the Company’s operations and revenues are conducted and generated in the PRC; all of the Company’s revenues being earned and currency received are denominated in RMB. RMB is subject to the foreign exchange control regulations in China, and, as a result, the Company may be unable to distribute any dividends outside of China due to PRC foreign exchange control regulations that restrict the Company’s ability to convert RMB into US Dollars.

Schedule I of Article 5-04 of Regulation S-X requires the condensed financial information of the parent company to be filed when the restricted net assets of consolidated subsidiaries and VIE’s exceed 25 percent of consolidated net assets as of the end of the most recently completed fiscal year. For purposes of this test, restricted net assets of consolidated subsidiaries and VIEs shall mean that amount of the registrant’s proportionate share of net assets of its consolidated subsidiaries and VIEs (after intercompany eliminations) which as of the end of the most recent fiscal year may not be transferred to the parent company in the form of loans, advances or cash dividends without the consent of a third party. The condensed parent company financial statements have been prepared in accordance with Rule 12-04, Schedule I of Regulation S-X as the restricted net assets of the Company’s PRC subsidiary and VIE exceed 25% of the consolidated net assets of the Company.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion of our financial condition and results of operations should also be read in conjunction with our unaudited consolidated financial statements and the notes to those financial statements appearing elsewhere in this Form 10-Q. The following discussion contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 relating to future events or our future performance. Actual results may materially differ from those projected in the forward-looking statements as a result of certain risks and uncertainties set forth in this Form 10-Q. Although management believes that the assumptions made and expectations reflected in the forward-looking statements are reasonable, there is no assurance that the underlying assumptions will, in fact, prove to be correct or that actual results will not be different from expectations expressed in this report.

Overview

We are in the business of providing services to optimize garbage-recycling processes. We utilize our patented technology of “comprehensive and harmless garbage-processing equipment” to upgrade software systems and reconstruct hardware for our clients and therefore expand the sorting scope and capacity of our clients’ garbage recycling equipment. We conduct our operations through our controlled consolidated affiliate Jiangsu Xuefeng Environmental Protection Science and Technology Co., Ltd. (“Jiangsu Xuefeng”).

Our Services

With the development of the urbanization in China, the amount of household garbage is growing, whereas the processing capability of garbage processing equipment cannot satisfy the demand. In order to improve the processing equipment of garbage processing plants, we provide upgrades and improvements to the software systems and hardware equipment by installing various systems of patented technology “comprehensive and harmless garbage-processing equipment” into customers’ equipment, and reconstructing the hardware to expand the garbage sorting scope and capacity of their equipment.

The Patent technology of “harmless and comprehensive garbage processing equipment” provided by Jiangsu Xuefeng to its customers has a high garbage processing capacity and stable operation capacity. It is the first modern system equipment in China to use DCS (Distributed Control System) centralized control, by which mechanical automation will be realized for the comprehensive treatment of life garbage. Its core technology is to organically integrate the anaerobic digestion and aerobic fermentation garbage process, degrade and transform the organic matter of domestic waste, effectively sort out the garbage and recycle all kinds of materials, to eventually realize the true waste resource utilization and harmless utilization rate, approaching 100%. The resource recovery products, biogas, can not only be used for meeting the needs of the plant itself, but also for sale outside the company, which greatly improves the efficiency of the garbage processing equipment, decreases production costs, and increases the recovery return of garbage processing.

The comprehensive and harmless garbage processing equipment is comprised of a waste digestion pretreatment system, methane gas power generation system, sorting processing system, bricklaying building system, leachate treatment system, DCS (distribution control system), XFET-5 ecological and water-saving toilets and excrement comprehensive processing system and various material collection systems. The equipment technology is designed and manufactured based on the complicated situation of the household garbage in China. According to the features of various garbage, the equipment utilizes the wind-force, gravity, magnetic, shape, etc. to process the garbage by the combined way of machine selecting, winnowing, magnetic separation, automatic cutting, smashing and other technological processes. The equipment has large processing capacity and can run the whole day. The stand-alone equipment can process 500 to 1000 tons of garbage per day. It can sort and process complicated municipal solid waste, leaving no pollution and no residue, reaching the "3 without" standard of no waste gas, no waste water and no waste residue.

After we complete the internal system upgrade and hardware equipment improvements of the garbage equipment, we deliver the upgraded equipment to the customers. The customers will conduct an inspection and performance testing of the upgraded equipment within one month pursuant to the contract to inspect whether the internal control system and the hardware structure can operate steadily and reach the expected results. The inspection includes the following: whether the quality of the equipment and accessories after improvement can match the patented technology and process various kinds of garbage, whether the various garbage systems can process automatically, and whether the daily garbage processing capacity reaches the expected results per the contract. If during the performance testing period, the performance meets the requirements of the contract, it would be deemed that we have fully executed the contract.

When we complete the upgrading service for a client, we go through the acceptance check and commissioning of the company in accordance with the contract, to make sure that the services provided met the expectations of the clients. After that, we are not subject to any additional services. The revenue we generated belongs to the service class income, with the main cost being the salaries of the staff and the leasing fees for the patent, whereas the hardware and software equipment, as well as the material used in the upgrading process are the responsibility of the client.

Emerging Growth Company Status

We are an “emerging growth company”, or “EGC” as defined in the Jumpstart Our Business Startups Act, or the JOBS Act, and we are eligible to take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not “emerging growth companies” including, but not limited to, not being required to comply with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act, reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding a nonbinding advisory vote on executive compensation, from which we are currently exempt as a smaller reporting company, and stockholder approval of any golden parachute payments not previously approved in connection with a transaction resulting in a change of control. We expect to take advantage of these exemptions. If we do take advantage of any of these exemptions, we do not know if some investors will find our common stock less attractive as a result. The result may be a less active trading market for our common stock and the stock price may be more volatile.

While we have not yet done so, Section 107 of the JOBS Act also provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act of 1933, as amended, for complying with new or revised accounting standards. In other words, an “emerging growth company” can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies.

We could remain an “emerging growth company” for up to five years, or until the earliest of (i) the last day of the first fiscal year in which our annual gross revenues exceed $1 billion, (ii) the date that we become a “large accelerated filer” as defined in Rule 12b-2 under the Securities Exchange Act of 1934, as amended, which would occur if the market value of our common stock that is held by non-affiliates exceeds $700 million as of the last business day of our most recently completed second fiscal quarter, or (iii) the date on which we have issued more than $1 billion in non-convertible debt during the preceding three year period.

Results of Operations

Three Months Ended February 28, 2015 compared to the Three Months Ended February 28, 2014

The following table sets forth in U.S. dollars, key components of our unaudited results of operations for the three months ended February 28, 2015 and 2014, and the percentage change between 2015 and 2014.

	Three Months Ended February 28,
	2015			2014			Percentage
	(U.S. $)			(U.S. $)			Change

Revenue	$	1,950,000		$	886,380		120	%
Cost of revenue		(95,119	)		(75,991	)	25	%
Gross profit		1,854,881			810,389		129	%
Selling expenses		25,795			20,281		27	%
General and administrative expenses		98,755			96,960		2	%
Total operating expenses		124,550			117,241		6	%
Operating income		1,730,331			693,148		150	%
Interest income		18,816			16,039		17	%
Income before provision for income taxes		1,749,147			709,187		147	%
Provision for income taxes		437,287			177,121		147	%
Net income		1,311,860			532,066		147	%
Noncontrolling interests		(63,916	)		(24,921	)	156	%
Net income attributable to common stockholders	$	1,247,944		$	507,145		146	%

Revenue

We provide improvement and upgrading services for garbage processing equipment to our customers. This is a one-time service. We also lease the licensed patent to our customers. The patent licensing is limited to five years with payments due annually in advance.

Our sales for the three months ended February 28, 2015 increased by $1,063,620 or 120% compared to the sales for the three months ended February 28, 2014. The primary reason for the significant increase in revenue was a result of not signing any new contracts for technical upgrade services in the quarter ended February 28, 2014, and the new contracts for the quarter ended February 28, 2015, but patent leasing revenue remained constant for the quarter ended February 28, 2015 and 2014. The following table sets forth our revenue for the three months ended February 28, 2015 and 2014:

	Three Months Ended February 28,
	2015		2014		Percentage
	(U.S. $)		(U.S. $)		Change

Improvements and Upgrading Services	$	1,073,050	$	-	100	%
Patent Leasing		877,950		886,380	(1	%)
Total	$	1,951,000	$	886,380	120	%

Improvement and Upgrading Services. For the three months ended February 28, 2015, revenue from improvement and upgrading services provided to three unrelated customers was $1,073,050; For the three months ended February 28, 2014, there was no revenue from improvement and upgrading services. The services were completed and accepted by the customers and the payments were received in full as of February 28, 2015.

Patent Licensing. For the three months ended February 28, 2015, revenue from patent licensing was from 12 unrelated customers totaling $877,950. For the three months ended February 28, 2014, revenue from patent licensing was from 12 unrelated customers totaling $886,380.

Cost of Revenues

Our cost of revenues increased to $95,119 for the three months ended February 28, 2015 from $75,991 for three months ended February 28, 2014. The increase in cost of revenues was principally due to the increase in training expenses and other expenses associated with our technical department, including entertainment expenses, as the Company entered into the new contracts for upgrading services in the quarter ended February 28, 2015. Our cost of revenues primarily consists of fees paid to the related party for licensing the patent, employees’ salaries, entertainment expenses, training expenses and other daily operating expenses.

Gross Profit.Our business stream has resulted in a high gross margin because we have no cost of products sold. Our cost of revenue is almost entirely direct labor and patent licensing fees, and other operating expenses. As a result of the increase in technical and upgrading service revenue, our gross profit increased to $1,854,881 for three months ended February 28, 2015 from $810,389 for three months ended February 28, 2014 which represented a gross profit ratio of 91% and 95% for the three months ended February 28, 2015 and 2014, respectively.

Selling and Marketing Expenses. Our selling and marketing expenses increased to $25,795 for three months ended February 28, 2015 from $20,281 for the three months ended February 28, 2014 which represented an increase of 27%. Our selling and marketing expenses were primarily comprised of sales employees’ salary, advertising expenses, training expenses and travelling expenses. The increase mainly caused by the increase in marketing activities.

General and Administrative Expenses. Our general and administrative expenses increased to $98,755 for the three months ended February 28, 2015 from $96,960 for the three months ended February 28, 2014, representing a 2% increase. Our general and administrative expenses were primarily comprised of employees’ salaries, travelling expenses, entertainment expenses and professional fees.

Provision for Income Taxes

Our provision for income taxes increased to $437,287 for the three months ended February 28, 2015 from $177,121 for the three months ended February 28, 2014. Our effective tax rate for the three months ended February 28, 2015 and 2014 was the statutory rate of 25%. Our tax filings for the year ended December 31, 2014 will be examined by the PRC tax authorities before May 31, 2015. Our prior filings were accepted and no adjustments were proposed. The increase in the provision for income taxes was primarily due to the increase in our income.

Net Income

For the three months ended February 28, 2015 and 2014, we generated net income of $1,311,860 and $532,066, respectively. This represented a increase in net income of $779,794 or 147%. The entrusted management agreements assign to Baichuang Consulting only 95% of the income generated from Jiangsu Xuefeng. For that reason, we reflected a “non-controlling interest” of $63,916 and $24,921 for the three months ended February 28, 2015 and 2014, respectively, before recognizing net income attributable to the common stockholders of the Company. After the discussed “non-controlling interest” deduction, and taking into account the income and expenses incurred by the parent corporation, our net income attributable to the common stockholders' of the Company for the three months ended February 28, 2015 and 2014 was $1,247,944 and $507,145, representing $0.02 and $0.01 per share, respectively.

Foreign Currency Translation Adjustment

Our reporting currency is the U.S. dollar. Our local currency, Renminbi (RMB), is our functional currency. Results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of stockholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. For the three months ended February 28, 2015 and 2014, a foreign currency (loss)gain of $(99,691) and $2,798, respectively, have been reported as other comprehensive (loss)income in the consolidated statements of income and other comprehensive income.

Nine Months Ended February 28, 2015 compared to the Nine Months February 28, 2014

The following table sets forth in U.S. dollars key components of our unaudited results of operations during the nine months ended February 28, 2015 and 2014, and the percentage change between 2015 and 2014.

	Nine Months Ended February 28,
	2015			2014			Percentage
	(U.S. $)			(U.S. $)			Change

Revenue	$	3,705,000		$	3,833,940		(3	%)
Cost of revenue		(249,936	)		(279,456	)	(0.1	%)
Gross profit		3,455,064			3,554,484		(3	%)
Selling expenses		76,407			73,176		4	%
General and administrative expenses		280,432			244,352		15	%
Total operating expenses		356,839			317,528		12	%
Operating income		3,098,225			3,236,956		(4	%)
Interest income		55,284			45,400		22	%
Income before provision for income taxes		3,153,509			3,282,356		(4	%)
Provision for income taxes		788,384			820,414		(4	%)
Net income		2,365,125			2,461,942		(4	%)
Noncontrolling interests		(113,229	)		(118,607	)	(5	%)
Net income attributable to common stockholders	$	2,251,896		$	2,343,335		(4	%)

Revenue

As we discussed above, we provide improvement and upgrading services for garbage processing equipment to our customers. This is a one-time service. We also lease the licensed patent to our customers. The patent licensing is limited to five years with payments due annually in advance.

Our sales for the nine months ended February 28, 2015 decreased slightly by $128,940 or 3% compared the sales for the nine months ended February 28, 2014. The company generated less revenue from upgrading services but generated higher patent leasing revenue in the nine months ended February 28, 2015 comparing with the nine months ended February 28, 2014. The following table sets forth our revenue for the nine months ended February 28, 2015 and 2014:

	Nine Months Ended February 28,
	2015		2014		Percentage
	(U.S. $)		(U.S. $)		Change

Improvements and Upgrading Services	$	1,072,500	$	1,465,200	(27	%)
Patent Leasing		2,632,500		2,368,740	11	%
Total	$	3,705,000	$	3,833,940	(3	%)

Improvement and Upgrading Services. For the nine months ended February 28, 2015, the Company generated $1,072,500 revenue of upgrading service which were all derived from 3 new contracts signed in the quarter ended February 28, 2015. The services were completed and accepted by the customer and the payment was received in full as of February 28, 2015. For the nine months ended February 28, 2014, revenue from improvement and upgrading services provided to three unrelated customers was $1,465,200.

Patent Licensing. For the nine months ended February 28, 2015, revenue from patent licensing was from 12 unrelated customers totaling $2,632,500. For the nine months ended February 28, 2014, revenue from patent licensing was from 10 unrelated customers for the first three months, 9 unrelated customers for the second three months and 12 unrelated customers for the third three months ended February 28, 2014, totaling $2,368,740.

Cost of Revenues

Our cost of revenues decreased to $249,936 for the nine months ended February 28, 2015 from $279,456 for the nine months ended February 28, 2014. The decrease in cost of revenues was principally due to the decrease in training expenses and other relevant expenses associated with our technical department, including travelling expenses, as there were no system upgrades in the first six months till the Company signed 3 new contracts in the quarter ended February 28, 2015. Our costs of revenues primarily consist of fees paid to the related party for licensing the patent, employees’ salaries, insurance, training expenses and other daily operating expenses.

Gross Profit.Our business stream has resulted in a high gross margin because we have no cost of products sold. Our cost of revenue is almost entirely direct labor and patent licensing fees, and other operating expenses. As the result of decrease in technical and upgrading service revenue, our gross profit decreased to $3,455,064 for nine months ended November 30, 2014 from $3,554,484 for nine months ended February 28, 2014 which represented a consistent gross profit ratio of 93% and 93% for the nine months ended February 28, 2015 and 2014.

Selling and Marketing Expenses. Our selling and marketing expenses increased to $76,407 for the nine months ended February 28, 2015 from $73,176 for the nine months ended February 28, 2014 which represented an increase of 4%. Our selling and marketing expenses were primarily comprised of sales employees’ salary, advertising expenses, training expenses and travelling expenses. Our selling and marketing expenses remain stable.

General and Administrative Expenses. Our general and administrative expenses increased to $280,432 for the nine months ended February 28, 2015 from $244,352 for the nine months ended February 28, 2014, representing a 15% increase. Our general and administrative expenses were primarily comprised of employees’ salaries, travelling expenses, entertainment expenses and professional fees.

Provision for Income Taxes

Our provision for income taxes decreased to $788,384 for the nine months ended February 28, 2015 from $820,414 for the nine months ended February 28, 2014. Our effective tax rate for the nine months ended February 28, 2015 and 2014 was the statutory rate of 25%. Our tax filings for the year ended December 31, 2014 will be examined by the PRC tax authorities before May 31, 2015. Our prior filings were accepted and no adjustments were proposed. The decrease in the provision for income taxes was primarily due to the decrease in our income.

Net Income

For the nine months ended February 28, 2015 and 2014, we generated net income of $2,365,125 and $2,461,942, respectively. This represented a decrease in net income of $96,817 or 4%. The entrusted management agreements assign to Baichuang Consulting only 95% of the income generated from Jiangsu Xuefeng. For that reason, we reflected a “non-controlling interest” of $113,229 and $118,607 for the nine months ended February 28, 2015 and 2014, respectively, before recognizing net income attributable to the common stockholders of the Company. After the “non-controlling interest” deduction, and taking into account the income and expenses incurred by the parent corporation. our net income attributable to the common stockholders’ of the Company for the nine months ended February 28, 2015 and 2014 was $2,251,896 and $2,343,335, representing $0.04 for both periods.

Foreign Currency Translation Adjustment

Our reporting currency is the U.S. dollar. Our local currency, Renminbi (RMB), is our functional currency. Results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of stockholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. For the nine months ended February 28, 2015 and 2014, a foreign currency gain of $5,585 and $155,089, respectively, have been reported as other comprehensive income in the consolidated statements of income and other comprehensive income.

Liquidity and Capital Resources

As of February 28, 2015, we had cash and cash equivalents of $23,528,314, primarily consisting of cash on hand and demand deposits. The cash balance was principally derived from the net proceeds of the private placement completed in March 2013 and cash provided from operations. Despite our large cash balances, the interest income generated for the nine months ended February 28, 2015 was nominal for principally two reasons: the bank’s current deposit interest rate is very low, and the annual interest rates float up or down within a 0.35% range; The interest income reported in our financial statements is the net interest after deducting bank service charges.

To date, we have financed our operations primarily through equity contributions by our stockholders, a private placement and cash flows from operations. We believe that our cash on hand and cash flows from operations will meet our present cash needs for the next 12 months.

Operating activities

Net cash provided by operating activities was $2,777,229 for the nine months ended February 28, 2015. Comparing with $3,149,015 for the nine months ended February 28, 2014, the difference by comparing with the net income, was principally due to the decrease in deferred revenue for both periods.

Investing activities

We spent $0 and $16,622 for the nine months ended February 28, 2015 and 2014, respectively, for equipment purchases.

Financing activities

For the nine months ended February 28, 2015 and 2014, the net cash provided by financing activities were entirely from stockholder loans of $120,000 and $31,000, respectively. The proceeds from the stockholder loans were utilized for professional services.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.

Transfer of Cash

All of our revenues are earned by Jiangsu Xuefeng, our PRC controlled consolidated affiliate. PRC regulations restrict the ability to make dividend and other payments to its offshore parent company. PRC legal restrictions permit payments of dividends only out of accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiary is also required under PRC laws and regulations to allocate at least 10% of its annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the allocation reaches 50% of its registered capital. The statutory reserve fund can only be used for specific purposes and is not transferable to us in the form of loans, advances or cash dividends. Any limitations on the ability of our PRC subsidiary to transfer funds could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.

Lotus International Holdings Limited, a Hong Kong corporation and Baichuang Information Consulting (Shenzhen) Co., Ltd, a WFOE, is a bridge to transfer funds inside and outside the PRC. There are three ways for foreign cash to be transferred into Chinese subsidiaries:

(1) Capital funds: At the establishment of the WFOE (Baichuang Consulting), in accordance with the provisions of PRC Foreign-Owned Enterprise Law, funds were injected as capital by Lotus International into its wholly foreign owned enterprise established in mainland China, Baichuang Consulting.

(2) Raised capital - acquisition: if the Company raised sufficient capital, it could transfer the capital to Jiangsu Xuefeng by causing Lotus International (HK company) to apply to the Chinese Ministry of Commerce (MOFCOM) for approval of an acquisition of Jiangsu Xuefeng by Lotus International. MOFCOM would approve such an acquisition only after a lengthy review process, and only if it determined that the price paid by Lotus International for Jiangsu Xuefeng represented a commercially fair price.

(3) Raised capital - joint venture: Lotus International could inject the funds into Jiangsu Xuefeng by complying with the provisions of the PRC Sino-Foreign Equity Joint Venture Law. To accomplish this capital transfer, we would be required to apply to the Chinese government for approval to convert Jiangsu Xuefeng into an equity joint venture, in which Lotus International (HK company) would be its equity joint venturer. If approved, Lotus International would then own a portion of the equity in Jiangsu Xuefeng, and the VIE agreements between Jiangsu Xuefeng and Baichuang Consulting (WFOE) would be modified accordingly to reduce the portion of net income payable by Jiangsu Xuefeng to Baichuang Consulting.

We have no current plans for the Company to fund Jiangsu Xuefeng and expect the VIE structure to remain in place for the foreseeable future.

Pursuant to the Exclusive Technical Service and Business Consulting Agreement between Baichuang Consulting (WFOE) and Jiangsu Xuefeng, Baichuang Consulting is to provide technical support and consulting services to Jiangsu Xuefeng in exchange for (i) 95% of the total annual net income of Jiangsu Xuefeng and (ii) RMB100,000 per month (US$16,260). As a result, there are also two ways to transfer the funds from inside the PRC to outside the PRC:

(1) According to the provisions of the Service Fee in Article 3 of the Exclusive Technology Service and Business Consulting Agreement, 95% of the net income of Jiangsu Xuefeng will be paid to Baichuang Consulting as a service fee, and in turn Baichuang Consulting will in compliance with the provisions of PRC Foreign-Owned Enterprise Law, transfer this income to Lotus International (HK company) for the purpose of profit distribution.

(2) According to the provisions of the Service Fee in Article 3 of the Exclusive Technology Service and Business Consulting Agreement, a management fee of $16,260 will be paid to Baichuang Consulting each month, and in turn Baichuang Consulting will be in compliance with the provisions of the PRC Foreign-Owned Enterprise Law and transfer this income to Lotus International (HK company) for the purpose of profit distribution.

The earnings and cash transfer procedures are all designed to comply with PRC regulations. As a result, there will be no government regulations which will impact our transactions to transfer cash within our corporate structure. However, when the funds are transferred outside the PRC, all transferred amounts will be reported to the national tax bureau to examine whether the local and national taxes have been fully paid by Jiangsu Xuefeng and Baichuang Consulting.

Recent Accounting Pronouncements

Critical Accounting Policies

The Company does not currently have any estimates that it believes could materially affect its financial position or results of operations in the future.

The critical accounting policy that could have a material effect on the Company’s financial statements is the determination that the Company is the primary beneficiary of Jiangsu Xuefeng, its VIE. Should this determination change or the VIE agreements are not in compliance or enforceable under PRC law, it could result in the deconsolidation of the VIE.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Smaller reporting companies are not required to provide the information required by this item.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Pursuant to Rule 13a-15(b) under the Exchange Act, the Company carried out an evaluation, with the participation of the Company’s management, including the Company’s Chief Executive Officer (“CEO”) and Chief Financial Officer (“CFO”) (the Company’s principal financial and accounting officer), of the effectiveness of the Company’s disclosure controls and procedures (as defined under Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based upon that evaluation, for the reasons set forth below, the Company’s CEO and CFO concluded that the Company’s disclosure controls and procedures were not effective as of February 28, 2015 to ensure that information required to be disclosed by the Company in the reports that the Company files or submits under the Exchange Act, is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the Company’s management, including the Company’s CEO and CFO, as appropriate, to allow timely decisions regarding required disclosure.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company’s annual or interim financial statements will not be prevented or detected on a timely basis. In its assessment of the effectiveness of internal control over financial reporting as of February 28, 2015, the Company determined that there were control deficiencies that constituted the following material weaknesses:

●	The Company does not have a sufficient number of accounting personnel, which would provide segregation of duties within our internal control procedures to support the accurate and timely reporting of our financial results.

●	The Company’s current accounting personnel lack experience and knowledge in identifying and resolving complex accounting issues under U.S. Generally Accepted Accounting Principles (GAAP).

Changes in Internal Control over Financial Reporting

No change in our system of internal control over financial reporting occurred during the period covered by this report that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

From time to time, we may become involved in litigation relating to claims arising out of its operations in the normal course of business. We are not involved in any pending legal proceeding or litigation and, to the best of our knowledge, no governmental authority is contemplating any proceeding to which we are a party or to which any of our properties is subject, which would reasonably be likely to have a material adverse effect on us.

Item 1A. Risk Factors.

Smaller reporting companies are not required to provide the information required by this item.

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.

Exhibit No.		Description

31.1		Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2		Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1*		Certification of Principal Executive Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2*		Certification of Principal Financial Officer of the Company, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS		XBRL Instance Document

101.SCH		XBRL Taxonomy Extension Schema Document

101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB		XBRL Taxonomy Extension Label Linkbase Document

101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

*		In accordance with SEC Release 33-8238, Exhibits 32.1 and 32.2 are furnished and not filed.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, there unto duly authorized.

	China Xuefeng Environmental Engineering Inc.


Date: April 14, 2015	By:	/s/ Li Yuan
		Li Yuan
		Chief Executive Officer
		(Duly Authorized Officer and Principal Executive Officer)


Date: April 14, 2015	By:	/s/ Kuanfu Fan
		Kuanfu Fan
		Chief Financial Officer (Duly Authorized Officer and Principal Financial Officer)

China Xuefeng Environmental Engineering Inc. - FORM 10-Q - April 14, 2015

Attached files

China Xuefeng Environmental Engineering Inc. Reports