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

Form 10-Q

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

For the Quarterly Period Ended November 30, 2017
or

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

For the Transition Period from ___________ to _____________

Commission File Number: 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.)
 
 
229 Tongda Avenue
Economic and Technological Development Zone,
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  No 

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

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

Large accelerated filer
 
Accelerated filer
 
 
 
 
 
Non-accelerated filer
(Do not check if a smaller reporting company)
Smaller reporting company
 
 
 
 
 
 
 
 
Emerging growth company

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  No 
 
As of January 9, 2018, there were 63,020,871 outstanding shares of common stock of the registrant, par value $0.001 per share.
 

 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC.

FORM 10-Q

TABLE OF CONTENTS
 

PART I – FINANCIAL INFORMATION
 
Page
 
 
Item 1. Financial Statements.
 1
 
 
Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.
31
 
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk.
39
 
 
Item 4. Controls and Procedures.
39
 
 
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.
42
 
 
Signatures
43
 
 

 
PART I – FINANCIAL INFORMATION


ITEM 1. FINANCIAL STATEMENTS.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 (IN U.S. $)
 
   
November 30,
   
May 31,
 
ASSETS
 
2017
   
2017
 
   
(Unaudited)
       
             
Current assets:
           
  Cash
 
$
19,445,636
   
$
10,343,963
 
  Accounts receivable
   
3,734,855
     
4,365,854
 
  Inventory
   
29,032
     
-
 
  Prepaid Expenses
   
333,040
     
7,009,322
 
  Prepaid VAT
   
5,105,938
     
4,649,599
 
  Deferred registration cost
   
141,975
     
-
 
                 
    Total current assets
   
28,790,476
     
26,368,738
 
                 
Noncurrent assets:
               
Fixed assets, net
   
33,747,056
     
23,860,312
 
Lease equipment, net
   
27,335,112
     
23,774,359
 
Prepaid lease
   
5,700,277
     
5,592,757
 
Accounts receivable-non-current
   
-
     
1,463,078
 
Deferred income tax assets
   
500,276
     
211,653
 
                 
Total noncurrent assets
   
67,282,721
     
54,902,159
 
                 
TOTAL ASSETS
 
$
96,073,197
   
$
81,270,897
 

See accompanying notes to the consolidated financial statements.
1

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
 (IN U.S. $)
 
   
November 30,
   
May 31,
 
LIABILITIES AND STOCKHOLDERS' EQUITY
 
2017
   
2017
 
   
(Unaudited)
       
             
Current liabilities:
           
  Accounts payable
 
$
1,227,041
   
$
498,959
 
  Deferred revenues
   
4,463,186
     
3,695,730
 
  Taxes payable
   
572,082
     
596,765
 
  Loan from stockholder
   
18,009,106
     
17,468,486
 
  Accrued liabilities
   
223,421
     
99,299
 
                 
    Total current liabilities
   
24,494,836
     
22,359,239
 
                 
Security deposits payable
   
4,838,688
     
3,404,670
 
                 
TOTAL LIABILITIES
   
29,333,524
     
25,763,909
 
                 
Stockholders' equity:
               
  Common stock, $0.001 par value per share, 75,000,000 shares authorized; 66,520,871 and 63,020,871 shares issued and outstanding as of November 30, 2017 and May 31, 2017
   
66,521
     
63,021
 
  Additional paid-in capital
   
41,581,497
     
34,584,997
 
  Statutory reserve fund
   
2,592,153
     
2,437,684
 
  Retained earnings
   
24,352,345
     
22,022,689
 
  Other comprehensive income (loss)
   
(1,852,843
)
   
(3,601,403
)
                 
    Total stockholders' equity
   
66,739,673
     
55,506,988
 
                 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
96,073,197
   
$
81,270,897
 
 

See accompanying notes to the consolidated financial statements.
2

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (CONTINUED) (IN U.S. $)

   
Three Months Ended,
November 30,
   
Six Months Ended,
November 30,
 
 
 
  2017
   
2016
   
2017
   
2016
 
                         
Revenue:
                       
    Sales
 
$
1,811,796
   
$
1,952,580
   
$
3,144,732
   
$
3,488,689
 
    Lease income
   
948,442
     
582,737
     
1,834,534
     
1,174,836
 
                                 
Total revenue
   
2,760,238
     
2,535,317
     
4,979,266
     
4,663,525
 
                                 
Cost of goods sold:
                               
    Cost of sales
   
126,987
     
116,543
     
267,435
     
256,329
 
Depreciation expense - leased equipment
   
458,868
     
286,878
     
887,659
     
573,201
 
                                 
Total cost of goods sold
   
585,855
     
403,421
     
1,155,094
     
829,530
 
                                 
  Gross profit
 
 2,174,383
   
 2,131,896
     
3,824,172
     
3,833,995
 
                                 
Operating expenses:
                               
    Selling and marketing
   
252,662
     
177,205
     
429,568
     
328,643
 
    General and administrative
 
  281,625
   
  281,459
     
522,286
     
543,313
 
    R&D Expense
 
 374,841
   
  -
     
374,841
     
-
 
                                 
      Total operating expenses
 
 909,128
   
 458,664
     
1,326,695
     
871,956
 
 
See accompanying notes to the consolidated financial statements.
3

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (CONTINUED) (IN U.S. $)
 
   
Three Months Ended,
November 30,
   
Six Months Ended,
November 30,
 
 
 
   2017
   
2016
   
2017
   
2016
 
                         
Income from operations
 
 1,265,255
   
 1,673,232
     
2,497,477
     
2,962,039
 
    Interest income
   
69,560
     
122,129
     
152,247
     
257,294
 
    Government subsidy
   
227,093
     
222,327
     
449,248
     
448,226
 
                                 
Income before provision for income taxes
   
1,561,908
     
2,017,688
     
3,098,972
     
3,667,559
 
Provision for income taxes
 
  296,280
     
454,637
     
614,847
     
816,880
 
                                 
Net income
   
1,265,628
     
1,563,051
     
2,484,125
     
2,850,679
 
                                 
Earnings per common share, basic and diluted
 
$
0.02
   
$
0.02
   
$
0.04
   
$
0.05
 
                                 
Weighted average shares outstanding, basic and diluted
   
64,187,538
     
63,020,871
     
63,604,204
     
63,020,871
 
                                 
Comprehensive Income:
                               
Net Income
 
$
1,265,628
   
$
1,563,051
   
$
2,484,125
   
$
2,850,679
 
Foreign currency translation adjustment
   
(162,023
)
   
(1,568,218
)
   
1,748,560
     
(2,319,003
)
                                 
Comprehensive income
 
$
1,103,605
   
$
(5,167
)
 
$
4,232,685
   
$
531,676
 

See accompanying notes to the consolidated financial statements.
4

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
FOR THE SIX MONTHS ENDED NOVEMBER 30, 2017
 (IN U.S. $)

   
Common
Stock
   
Additional
 Paid-in
Capital
   
Retained
Earnings
   
Statutory
Reserve Fund
   
Other
Comprehensive
 Income
   
Total
 
                                                 
Balance, May 31, 2017
 
$
63,021
   
$
34,584,997
   
$
22,022,689
   
$
2,437,684
   
$
(3,601,403
)
 
$
55,506,988
 
   Ordinary shares issue
   
3,500
     
6,996,500
     
-
     
-
     
-
     
7,000,000
 
   Net income
   
-
     
-
     
2, 484,125
     
-
     
-
     
2, 484,125
 
   Appropriation to statutory reserve
   
-
     
-
     
(154,469
)
   
154,469
     
-
     
-
 
   Foreign currency  translation adjustment
   
-
     
-
     
-
     
-
     
1,748,560
     
1,748,560
 
                                                 
Balance,  November 30, 2017 (Unaudited)
 
$
66,521
   
$
41,581,497
   
$
24,352,345
   
$
2,592,153
   
$
(1,852,843
)
 
$
66,739,673
 
 

See accompanying notes to the consolidated financial statements.
5

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)
 
     
For Six Months Ended
November 30,
 
   
2017
   
2016
 
   
(Unaudited)
   
(Unaudited)
 
             
 Cash flows from operating activities:                
Net income
 
$
2,484,125
   
$
2,850,679
 
Adjustments to reconcile net income to net cash provided by operating activities:
               
  Depreciation
   
941,370
     
618,489
 
  Amortization for the land
   
61,697
     
61,556
 
 (Increase) in deferred income tax assets
   
(272,103
)
   
(48,471
)
         Changes in operating assets and liabilities:
               
       Decrease  in accounts receivable
   
2,137,244
     
2,024,011
 
       (Increase) in inventory
   
(28,752
)
   
-
 
       (Increase) in prepaid VAT
   
(312,117
)
   
(552,883
)
       (Increase) in prepaid expenses
   
(4,214,041
)
   
(245,628
)
       Increase (decrease) in accounts payable andaccrued liabilities
   
4,060,305
     
(654,862
)
       Increase in deferred revenue
   
648,913
     
67,234
 
       Decrease in taxes payable
   
(49,759
)
   
(85,124
)
                 
              Net cash provided by operating activities
   
5,456,882
     
4,035,001
 
                 
Cash flows from investing activities:
               
Purchase of fixed assets
   
(5,930
)
   
(4,501,517
)
Cash paid for stock issuance costs
   
(141,975
)
   
-
 
Purchase of items of leasing equipment
   
(3,699,121
)
   
-
 
                 
          Net cash (used in) investing activities
   
(3,847,026
)
   
(4,501,517
)
                 
Cash flows from financing activities:
               
     Cash received from stock issuance
   
7,000,000
     
-
 
     Increase in security deposit payable
   
718,796
     
-
 
                 
               Net cash provided by financing activities
   
7,718,796
     
-
 
                 
Effect of exchange rate changes on cash
   
(226,980
)
   
(204,853
)
                 
Net increase (decrease) in cash
   
9,101,672
     
(671,369
)
Cash, beginning
   
10,343,963
     
5,912,106
 
                 
Cash, end
 
$
19,445,635
   
$
5,240,737
 
 
See accompanying notes to the consolidated financial statements.

 
6

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

 
Supplemental disclosure of cash flow information
       
     Income taxes paid
 
$
935,701
   
$
950,476
 
                 
     Land appreciation tax paid
 
$
2,995
   
$
2,988
 
                 
Supplemental disclosure of non-cash activities
         
     Property, equipment, equipment construction in process
 
$
9,120,991
   
$
-
 
                 
     Payment of accrued liabilities by shareholder
 
$
29,826
   
$
89,000
 

See accompanying notes to the consolidated financial statements.


7

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (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.

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 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.

In November, 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 Name Change and the Forward Split were effective in December, 2012. 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. In March, 2013, the Company sold 14,000,000 shares of common stock to 12 unrelated individuals in a private offering, generating $7,000,000 in net proceeds.

As a result of the transaction with Inclusion, the Company owns all of the issued and outstanding common 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") in December, 2007, is primarily engaged in the sale, lease and installation of garbage recycling equipment and provides improvement and upgrading services of garbage recycling processing technology and equipment. 

In October 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.
8
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (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 and an additional payment of approximately US$15,910 (RMB100,000) 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.

On January 19, 2016, the VIE structure was terminated upon Baichuang Consulting exercising its option to purchase all of the registered equity of Jiangsu Xuefeng.  Baichuang Consulting became the sole owner of Jiangsu Xuefeng.

On August 4, 2016, Baichuang Information Consulting Co., Ltd ("Baichuang Information") entered into an agreement with Mr. Li Yuan, the sole shareholder of Linyi County Xuefeng Renewable Resources Utilization Technology Co., Ltd ("Linyi Xuefeng"), to purchase his 100% ownership of Linyi Xuefeng. Mr. Li Yuan is the Chief Executive Officer and main shareholder of the Company. The purchase price was determined by the audited net assets of the Company as of May 31, 2016, initially with a payment of RMB10,000,000 ($1,500,000 US) in cash and the balance to be paid in common shares of China Xuefeng at 75% of the closing price on August 4, 2016. On October 7, 2016, a supplementary agreement was entered between both parties to finalize the purchase based upon the audited net asset value of $ 23,462,612 on May 31, 2016. The supplementary agreement eliminated the cash payment making the entire purchase with stock of the Company. The price utilized was $3 per share and 7,820,871 shares were issued to Mr. Li Yuan.

9

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)
 
 
 
NOTE 1.   ORGANIZATION (CONTINUED)

Linyi Xuefeng also signed a series of agreements with Jiangsu Liding Machinery Manufacturing Co., Ltd ("Jiangsu Liding") for the construction of the garbage recycling processing plant and production facilities purchase. The shareholder of the Company, Mr. Li Yuan, is also the shareholder of Jiangsu Liding (see note 6). In 2016, the total purchase amount $7,714,280 from Jiangsu Liding was fully delivered in December 2015 and included in the fixed assets of the accompanying consolidated balance sheet as of November 30, 2017 and May 31, 2016. In 2017, and the total purchase amount $8,599,726 from Jiangsu Liding, and paid in advanced with $6,879,781 was included in prepaid expenses with of the accompanying consolidated balance sheet as of  May 31, 2017. The total purchase in 2017 was fully delivered in July, 2017 and included in the fixed assets of the accompanying consolidated balance sheet as of November 30, 2017.

"Linyi Xuefeng was officially approved and incorporated under the laws of the People's Republic of China ("PRC") in June 2013. Mr. Yuan Li was the sole owner since inception. Linyi Xuefeng is constructing a garbage processing plant which is planned to commerce operations in 2018. The only non-operating revenue was a subsidy received from the government for the city pollution garbage processing plant construction."

On October 30, 2017, China Xuefeng Environmental Engineering, Inc. (the "Company") completed a closing of private placement offering (the "Offering") of shares of the Company's common stock, par value $0.001 per share (the "Shares"), at a purchase price of RMB 13.275, or US$2.00 per share, based on the currency exchange rate of 6.6375 on October 27, 2017, for an aggregate purchase price of RMB 46,462,500, or approximately $7,000,000. Upon the closing, the Company issued a total of 3,500,000 shares of its common stock to the subscribers in the Offering.

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


10

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)
 
NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF ACCOUNTING AND PRESENTATION

The unaudited interim consolidated financial statements of the Company as of November 30, 2017 and for the three and six months ended November 30, 2017 and 2016, 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 six months ended November 30, 2017 are not necessarily indicative of the results to be expected for future three months or for the year ending May 31, 2018.

The acquisition of Linyi Xuefeng was treated as a combination of entities under common control as Mr. Li Yuan was the chief executive officer, a major shareholder and had voting control of both companies. An acquisition of an entity under common control is treated similar to a "pooling of interest." Accordingly, the financial statements of the Company has been restated and include the historical balances of Linyi Xuefeng as if the acquisition occurred on the first day of the earliest period presented.

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

Until January 19, 2016, the consolidated financial statements include the accounts of the Company, its wholly owned subsidiaries and its VIE for which it is deemed the primary beneficiary.  On January 19, 2016, the VIE structure was terminated upon Baichuang Consulting exercising its option to purchase all of the registered equity of Jiangsu Xuefeng.  Baichuang Consulting became the sole owner of Jiangsu Xuefeng.  All significant inter-company accounts and transactions have been eliminated in consolidation.
11

 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

ACQUISITION OF LINYI XUEFENG

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

   
November 30,
   
May 31,
 
   
2017
   
2017
 
             
TOTAL ASSETS
 
$
42,876,706
   
$
40,133,685
 
                 
TOTAL LIABILITIES
 
$
18,978,349
   
$
16,877,408
 

   
For Three Months Ended
November 30,
   
For Six Months Ended
November 30,
 
   
2017
   
2016
   
2017
   
2016
 
                         
TOTAL OPERATING EXPENSES
 
$
571,105
   
$
96,012
   
$
687,008
   
$
193,047
 
                                 
TOTAL OTHER INCOME
 
$
228,546
   
$
223,004
   
$
452,659
   
$
449,062
 
                                 
NET (LOSS) INCOME
 
$
(200,146
)
 
$
151,244
   
$
(63,450
)
 
$
304,486
 

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.
12

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

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).

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

   
November 30,
2017
   
May 31,
2017
   
November 30,
2016
 
Balance sheet items, except for stockholders' equity, as of periods end
   
0.1512
     
0.1468
     
N/A
 
Amounts included in the statements of income, statements of changes in stockholders' equity and statements of cash flows for three months
   
0.1514
     
N/A
     
0.1481
 
Amounts included in the statements of income, statements of changes in stockholders' equity and statements of cash flows for six months
   
0.1497
     
N/A
     
0.1494
 

For the three months ended November 30, 2017 and 2016, foreign currency translation adjustments of $(163,117) and $(1,568,218) , respectively, for the six months ended November 30, 2017 and 2016, foreign currency translation adjustments of $1,747,466 and $(2,319,003), respectively, have been reported as other comprehensive income (loss).  Other comprehensive income (loss) 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.
13

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

 
NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION

Revenues are primarily derived from selling and leasing garbage processing equipment, 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.

Improvement and upgrading service is a one-time service provided to upgrade customer's existing equipment before they opt to license and use our patented technology. The fee for the service would be paid within thirty (30) days upon execution of the contract.

Inspection would be conducted by the customers according to industry standards within three days upon completion of the improvement and upgrading service. Performance testing would then be conducted on the upgraded equipment, which typically can be done within a month. A final inspection assessment report would be provided to the customers within five days upon completion of the testing and Customers would provide the Company with a signed acceptance form if they are satisfied. The Company will recognize the revenue for the improvement and upgrading service once the performance testing is passed and the final evaluation report is provided by the customer.

Patent licensing is limited to five (5) years with payments due annually in advance and recognized as revenue monthly. We are responsible to provide repairing service when necessary, but customers would bear any out of pocket expense relating to the repairing service.

We believe that lease receivables have four potential risks: operation risk, credit risk, accident risk and natural disasters risk.

First, there is no guarantee that the licensee of our patent will have sufficient capital resources to perform the licensing agreement and pay the licensing fee on time or at all. The length of the agreement is up to five (5) years and therefore the Company may not able to collect fees for the entire agreement. Second, there is a potential credit risk for which the licensee may unilaterally terminate the agreement and thus affect the payout of the licensing agreement. Third, an accident involving the equipment caused by employees of the licensee may have material adverse effect on the operation of the licensee. This unforeseeable risk could impact the licensee's ability to perform throughout the length of the agreement. Lastly, unforeseeable natural disasters could have a material adverse effect on the production and operation of the Company's licensees. If their operation is impacted by events such as fire, flood or earthquakes, they may need to cease their operation and therefore may be unable to perform their obligations under the agreement.

Linyi Xuefeng's income relates solely to government for city pollution garbage processing system constructions.  Government subsidies are recognized as earned when grant expenses are incurred up to the maximum amount allowed for each grant award.
14

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

Sales-Type Leases

The Company entered into three sales-type lease arrangements during the three months ended August 31, 2015, with two customers for financing of their purchase of garbage processing equipment.  The arrangements with the customers have a fixed term of three years.  Revenue from the sale of the equipment is recognized at the inception of the lease.  The payments have been present valued with an annual interest rate of 5.25%.  In connection with these arrangements, the Company recognized no revenue for the three and six months ended November 30, 2017 and 2016.  Future minimum collections for the year ending May 31 are as follows:
 
Year Ending
   
May 31,
Amount
 
     
2018
 
$
2,215,100
 
2019
   
1,507,503
 
         
   
$
3,722,603
 

 Operating Leases

The Company entered into seven operating lease arrangements with six customers for garbage processing equipment on October 20, 2017, March 31, 2017, December 28, 2016, April 25, 2016, December 28, 2015 and November 6, 2015, respectively. The arrangement with the customer has a fixed term of five years with quarterly payments of $149,749 (RMB1,000,000), $179,699 (RMB1,200,000), $179,699 (RMB1,200,000), $179,699 (RMB1,200,000), $359,398 (RMB2,400,000), and $149,749 (RMB1,000,000) respectively. Revenue from the leasing of the equipment is recognized monthly. In addition, the lease required a security deposit on $604,836    (RMB4,000,000), $725,803 (RMB4,800,000), $725,803 (RMB4,800,000), $725,803 (RMB4,800,000), $1,451,606 (RMB9,600,000) and $604,836 (RMB4,000,000), respectively. At the end of the five years lease term, it will be determined whether the lease will be extended, leased to a new customer or returned to the Company. Future minimum payments for the years ending May 31 are as follows:
 
Year Ending
     
May 31,
 
Amount
 
       
2018
 
$
2,395,987
 
2019
   
4,791,973
 
2020
   
4,791,973
 
2021
   
3,783,662
 
2022
   
1,617,291
 
Thereafter
   
249,582
 
         
   
$
17,630,468
 

15

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (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. By the end of improvement and upgrading services, there is persuasive evidence of an arrangement exists since company has a signed contract with a customer; delivery has occurred and a customer has completed inspection and accepted the improvement and upgrading services then delivered; the fee is fixed and become due within 30 days upon the signing of the contract; and collectability is probable. 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. 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.  The fees for the improvement and upgrading services are not subject to refund, forfeiture or any other concession if patent licensing is not completed.

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 necessary.  The out of pocket expenses for the repair services will be charged separately to the customer by the Company.
16

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

 
NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

Multiple-Element Arrangements (Continued)

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.

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 processing 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 services are 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 services.  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 licensed separately, the price established by the management has the relevant authority.  The Company establishes the price of upgrading and improvement service and the price of patent licensing is determined based on the following method:
17

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)


NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

Multiple-Element Arrangements (Continued)

Multiple Elements (Continued)

Since equipment improvement and upgrade service and patent leasing service are derived from the Company's patented technology, which the Company has the exclusive right to while others must obtain licensing rights to use the technology, the Company has a strong bargaining power in the market to undertake the promotion of its brand and corporate image. Furthermore, the Company uses a profit cost pricing method to determine the price of its product. The Company calculates the price by adding its target profit, or a 90% gross profit margin, to the base product cost to derive the final sale price of its services.

The Company allocates the arrangement consideration based on their relative selling prices.  Revenues for the improvement and upgrade services are recognized when completed, 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.

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.

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
.
18

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

 
NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

FAIR VALUE OF FINANCIAL INSTRUMENTS (CONTINUED)

ASC 820 requires the use of observable market data, when available, in making fair value measurements.  When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.  As of November 30, 2017 and May 31, 2017, 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, accounts receivable, prepaid VAT, accounts payable and accrued expenses, and deferred revenue 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.

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 AND LEASE EQUIPMENT

Fixed assets are recorded at cost, less accumulated depreciation.  Cost includes the price paid to acquire the asset, and any expenditures 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
Lease equipment
15 years
Machinery
10 years
Building and improvement
20 years

IMPAIRMENT OF LONG-LIVED ASSETS

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.
19

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

DEFERRED REVENUE

Deferred revenue is advance payments received for patent licensing fees and received from government for city pollution garbage processing system constructions. These payments received, but not yet earned, are recognized as deferred revenue in 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 of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.   As November 30, 2017 and May 31, 2017, the differences relate entirely to revenue deferred for financial statement purposes.  During the year ended May 31, 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 the financial statement recognition.  As a result, there are no differences between the basis of assets and liabilities for financial statements 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 November 30, 2017 and May 31, 2017, the Company does not have a liability for any unrecognized tax benefits.

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 34%.  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 six months ended November 30, 2017 and 2016.

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.


20

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

 
NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

INCOME TAXES (CONTINUED)

BVI

Inclusion is incorporated in the BVI and is governed by their income tax laws.  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 November 30, 2017 and 2016, advertising expense was $136,255 and $133,741 respectively. For the six months ended November 30, 2017 and 2016, advertising expense was $269,549  and $224,100, respectively .

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 six months ended November 30, 2017 and 2016, a statutory reserve of $154,469 and $252,411, respectively, was required to be allocated to the Company.

VALUE ADDED TAX ("VAT")

All China-based enterprises are subject to a VAT imposed by the PRC government on their domestic product sales.  The output VAT is charged to customers who purchase goods from the Company and the input VAT is paid when the Company purchases goods from its vendors. Input VAT rates are 17% for the purchasing activities conducted by the Company. Output VAT rate is 17% for all products.  The input VAT can be offset against the output VAT.  The VAT payable will be presented on the balance sheets when input VAT is less than the output VAT.  Recoverable balance will be presented on the balance sheets when input VAT is larger than the output VAT.
21

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

 
NOTE 3.   RECENTLY ISSUED ACCOUNTING STANDARDS

In November 2016, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") No. 2016-18, "Statement of Cash Flows: Restricted Cash". The amendments address diversity in practice that exists in the classification and presentation of changes in restricted cash on the statement of cash flows. The amendment is effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company does not anticipate that this adoption will have a significant impact on its financial position, results of operations, or cash flows.

In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. This ASU addresses the classification of certain specific cash flow issues including debt prepayment or extinguishment costs, settlement of certain debt instruments, contingent consideration payments made after a business combination, proceeds from the settlement of certain insurance claims and distributions received from equity method investees. This ASU is effective for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years, with early adoption permitted. An entity that elects early adoption must adopt all of the amendments in the same period. The Company is currently evaluating the effect this ASU will have on its consolidated statement of cash flows.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The new standard requires financial assets measured at amortized cost be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized cost basis. The standard will be effective for the Company beginning January 1, 2020, with early application permitted. The Company is evaluating the impact of adopting this new accounting guidance on its consolidated financial statements.

In May, 2016, the FASB issued ASU No. 2016-10, Revenue with Contracts with Customers: Narrow-scope Improvements and Practical Expedients, which is an amendment to ASU No. 2014-09 that clarifies the objective of the collectability criterion, to allow entities to exclude amounts collected from customers from all sales taxes from the transaction price, to specify the measurement date for noncash consideration is contract inception, variable consideration guidance applies only to variability resulting from reasons other than the form of the consideration, and clarification on contract modifications at transition. The implementation guidelines follow ASU No. 2014-09.

In April 2016, the FASB issued ASU No. 2016-12, Revenue from Contracts with Customers. In May 2014, the FASB issued ASU No. 2014-09, "Revenue from Contracts with Customers (Topic 606).'' This guidance supersedes current guidance on revenue recognition in Topic 605, "Revenue Recognition.'' In addition, there are disclosure requirements related to the nature, amount, timing, and uncertainty of revenue recognition. In August 2015, the FASB issued ASU No.2015-14 to defer the effective date of ASU No. 2014-09 for all entities by one year. For public business entities that follow U.S. GAAP, the deferral results in the new revenue standard are being effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017, with early adoption permitted for interim and annual periods beginning after December 15, 2016. The Company is currently evaluating the impact of adopting this standard on its consolidated financial statements.
22

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)


NOTE 4.   FIXED ASSETS

Fixed assets are summarized as follows:
 
   
November 30,
2017
   
May 31,
2017
 
             
Computers and equipment
 
$
88,006
   
$
79,601
 
Vehicles
   
87,587
     
85,007
 
Production facilities
   
17,770,883
     
8,308,691
 
Furniture and fixtures
   
116,556
     
112,548
 
Building and improvement
   
15,952,550
     
15,482,441
 
                 
     
34,015,582
     
24,068,288
 
Less: accumulated depreciation
   
(268,526
)
   
(207,976
)
                 
   
$
33,747,056
   
$
23,860,312
 
 

For the three months ended November 30, 2017 and 2016, depreciation expense was $27,005 and $25,361  respectively. For the six months ended November 30, 2017 and 2016, depreciation expense was $53,711 and $50,370 respectively.

Building and improvements and production facilities include approximately $34 million relating to construction of the garbage recycling processing plant and production facilities purchase.

NOTE 5.   LEASE EQUIPMENT
 
   
November 30,
2017
   
May 31,
2017
 
             
Leasing equipment
 
$
30,002,018
   
$
25,492,775
 
Less: accumulated depreciation
   
(2,666,906
)
   
(1,718,416
)
                 
   
$
27,335,112
   
$
23,774,359
 

For the three months ended November 30, 2017 and 2016, depreciation expense was $458,868 and $281,711 respectively. For the six months ended November 30, 2017 and 2016, depreciation expense was $887,659 and $568,119 respectively.

Before leasing the equipment to their client, the Company will upgrade the equipment to meet the client's requirement. The Company recorded the equipment as equipment construction in process before it finishes the upgrading process. As of November 30, 2017, no equipment construction in process was included in lease equipment.
23

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)


 
NOTE 6.   INCOME TAXES

The Company is required to file income tax returns in both the United States and the PRC.  Its operations in the United States have been insignificant and income taxes have not been accrued.  In the PRC, the Company files tax returns for Jiangsu Xuefeng.

The provision for (benefit from) income taxes consists of the following for the three and six months ended November 30, 2017 and 2016:

   
For the Three Months
Ended November 30
   
For the Six Months
Ended November 30
 
   
2017
   
2016
   
2017
   
2016
 
                         
Current
 
$
482,640
   
$
478,886
   
$
894,319
     
865,348
 
Deferred
   
(186,360
)
   
(24,249
)
   
(279,472
)
   
(48,468
)
                                 
Total
 
$
296,280
     
454,637
     
614,847
     
816,880
 

As of November 30, 2017, the Company had unused operating loss carry-forwards of approximately $1,971,340  expiring in various years through 2022.  

The expected tax rate for income in the PRC is 25%.  The following table reconciles the effective income tax rates with the statutory rates For the six months ended November 30:

   
2017
   
2016
 
             
Statutory rate
   
25
%
   
25
%
Permanent difference
   
1.5
%
   
-
 
Government subsidy
   
3.5
%
   
2
%
                 
Effective income tax rate
   
20
%
   
23
%

The recognized government subsidy by Linyi Xuefeng was tax exempt per notice form the PRC tax authorities and accordingly there is no tax provision to be recognized.

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, 2016 was examined by the PRC tax authorities in May 2017. PRC tax filings for the tax year ended December 31, 2015 were examined by PRC tax authorities in May 2016. The tax filings were accepted and no adjustments were proposed by the PRC tax authorities.
24

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)


NOTE 6.   INCOME TAXES (CONTINUED)

During the year ended May 31, 2017, the Company filed 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 years ended May 31, 2017, May 31, 2016, and May 31, 2015, which is a short year income tax return required to be filed as a result of the change in fiscal year. and the information reports for the years ended December 31, 2016, 2015 and 2014 concerning its interest in foreign bank accounts on form TDF 90-22.1, "Report of Foreign Bank and Financial Accounts" ("FBAR"). Currently, the 2014, 2015 and 2016 tax years are open and subject to examination by the taxing authorities.  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 May 31, 2017. 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, 2017, 2016 and 2015 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 patent rights on garbage recycling processing technology from Li Yuan, one of the Company's stockholders.  Under the current terms, the Company is required to pay a fee of $11,980 (RMB80,000) each month for five years from September 2012 to August 2017.  The Company has renewed the agreement to pay the same fee each month for five years from September 2017 to August 2022. The related prepaid patent leasing fees of $12,097 and $82,182 are included in prepaid expenses on the consolidated balance sheets as of November 30, 2017 and May 31, 2017, respectively.

The remaining payments for the patent rights are as follows:

Year Ending
     
May 31,
 
Amount
 
       
2018
   
72,580
 
2019
   
145,161
 
2020
   
145,161
 
2021
   
145,161
 
2022
   
145,161
 
Thereafter
   
36,290
 
         
Total
 
$
689,514
 

25


CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)




NOTE 7.   RELATED PARTY TRANSACTIONS (CONTINUED)

The Company obtained a demand loan from Li Yuan, a stockholder which is non-interest bearing.  The total loan of approximately $605,430 represents $526,430 of expenses paid by the stockholder and payments of approximately $79,000 representing the registered capital and operating expenses of Baichuang Information Consulting (Shenzhen) Co., Ltd. The balance is reflected as loan from stockholder As of November 30, 2017 and May 31, 2017.

On June 25, 2013, Linyi Xuefeng and the shareholder, Mr. Li Yuan, entered into a loan agreement pursuant to which Mr. Li Yuan provides a loan facility to the Linyi Xuefeng, which are non-interest bearing and expiring on June 30, 2017. The maximum amount of the loan is RMB200,000,000 ($29,350,600). Any borrowings in excess of this amount may be negotiated between the parties. As of November 30, 2017, the loans outstanding was RMB115,096,000 (approximately $17,403,000). On December 17, 2015, a resolution of the board was signed by Mr. Li Yuan, who is the sole shareholder of Linyi Xuefeng, surrendered another loan to the Linyi Xuefeng of RMB140,000,000 (approximately $20,545,00) and treated as a capital contribution to the Linyi Xuefeng.

Linyi Xuefeng also signed a series of agreements with Jiangsu Liding Machinery Manufacturing Co., Ltd ("Jiangsu Liding") for the construction of the garbage recycling processing plant and production facilities purchase. The shareholder of the Company, Mr. Li Yuan, is also the shareholder of Jiangsu Liding. Total purchase amount $7,714,280 from Jiangsu Liding was fully delivered in December 2015, and included in the fixed assets of the accompanying consolidated balance sheet as of May 31, 2017 and 2016. In 2017, and the total purchase amount $8,599,726 from Jiangsu Liding, and advanced payment of $6,879,781 was included in prepaid expenses with of the accompanying consolidated balance sheet as of  May 31, 2017. In 2018, and the total purchase in 2017 was fully delivered in July, 2017 and included in the fixed assets of the accompanying consolidated balance sheet as of November 30, 2017.

NOTE 8.   LAND USE RIGHT

On September 6, 2013, the Company signed with Linyi Yanjiazhuang Beizhi Village government to obtain a land use right 66,667 square meters of land at total $5,870,120 (RMB40,000,000). In addition, the Company was required to subject a deed tax of $176,104 (RMB1,200,000 ). The purchase of the land was approved by local government on September 9, 2013. The Company fully paid the deed tax of $176,104 when the purchase agreement was signed. The Company paid $3,668,825 (RMB25,000,000) on September 25, 2013 and $2,201,295 (RMB15,000,000) on November 12, 2013 to local government for the land purchase. The land use right started on September 9, 2013 and ends on September 8, 2063.

The amortization for the land use right for the three months ended November 30, 2017 and 2016 was $31,188 and $30,532 respectively. The amortization for the land use right for the six months ended November 30, 2017 and 2016 was $61,697 and $61,556 respectively.

NOTE 9.   SECURITY DEPOSIT PAYABLE

The company leased out highly efficient waste disposal equipment to customers and received one year leasing fee as deposit. The security deposit payable was $4,838,688 and $3,404,670,  as of November 30, 2017 and May 31, 2017, respectively.
 
26

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)



NOTE 10.   LEASES

The Company entered into a new lease agreement with an unrelated third party for new office space, which commenced on April 1, 2016 and expires on March 31, 2019.  The lease requires the Company to prepay the semi-annual rental of $3,594 (RMB24,000). The lease provides for renewal options.

The Company leases another office space for Linyi Xuefeng under a three-year operating lease from an unrelated third party, which expired on May 31, 2016. The lease required the Company to prepay the semi-annual rental. On May 26, 2016, the Company renewed the lease for another three years which ends on May 31, 2019.

Rent expense For the three months ended November 30, 2017 and 2016 was $3,724 and $1,779  respectively. Rent expense For the six months ended November 30, 2017 and 2016 was $7,368 and $3,586  respectively.

Future minimum payments for the years ending May 31 are as follows:
 
Year Ending
   
May 31,
Amount
 
     
2018
 
$
7,368
 
2019
   
13,897
 
         
   
$
21,265
 


NOTE 11.   CONTINGENCIES

As disclosed in Note 6, the 2014, 2015 and 2016 tax years are open and subject to examination by the taxing authorities. On July 17, 2017, the Company received a notice from the IRS with the amount due totaled of $30,208 in relates to the late filing of the Company's tax returns.  The Company is currently in the progress of communicating with the IRS to appeal to the amount.  As of the date of the report, the result is pending and the management is unable to assess the outcome of the communication.

NOTE 12.   VULNERABILITY DUE TO OPERATIONS IN THE 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.

27

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)


NOTE 13.   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

For the three months ended November 30, 2017 and 2016, two customers of the Company accounted for 30% of revenue, and five customers of the Company accounted for 53% of revenue for operating lease, respectively. For the six months ended November 30, 2017 and 2016, one customers of the Company accounted for 15% of revenue, and five customers of the Company accounted for 43% of revenue for operating lease, respectively.

Two customers accounted for 100% accounts receivable  as November 30, 2017 and May 31, 2017.
 
NOTE 14.   CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY

The condensed financial information of the Company's US parent only balance sheets as of May 31, 2017, and the US parent company only statements of income, and cash flows for the year ended May 31, 2017 are as follows:

Condensed Balance Sheets

ASSETS
May 31,
2017
 
     
Investment in subsidiaries and VIE
 
$
56,110,357
 
         
TOTAL ASSETS
 
$
56,110,357
 
 
LIABILITIES AND STOCKHOLDERS' EQUITY
     
       
Current liabilities:
     
       
   Loan from stockholder
 
$
564,401
 
Accrued liabilities
   
38,968
 
         
Total current liabilities
   
603,369
 
 
Stockholders' equity:        
         
Common stock, $0.001 par value; 75,000,000 shares authorized; 63,020,871 shares issued and outstanding
   
63,021
 
 Additional paid-in capital
   
34,584,997
 
 Statutory reserve fund
   
2,437,684
 
 Retained earnings
   
22,022,689
 
 Other comprehensive income
   
(3,601,403
)
         
Total stockholders' equity
   
55,506,988
 
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY
 
$
56,110,357
 


28

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)

NOTE 14.   CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY (CONTINUED)

Condensed Statements of Income

   
For The
Year Ended
 May 31,
 
   
2017
 
       
Revenues:
     
 Share of earnings from investment in subsidiaries and
 
$
4,659,228
 
         
Operating expenses:
       
 General and administrative
   
148,316
 
         
Net income
 
$
4,510,912
 

Condensed Statements of Cash Flows

   
For The
Year Ended
 May 31,
 
   
2017
 
       
Cash flows from operating activities:
     
 Net income
 
$
4,510,912
 
 Adjustments to reconcile net income to net cash provided by (used in) operating activities
       
 Share of earnings from investment in subsidiaries
   
(4,659,228
)
     Increase in accrued liabilities
   
148,316
 
         
    Net cash from operating activities
   
-
 
         
Net increase in cash
   
-
 
Cash, beginning of year
   
-
 
         
Cash, end of year
 
$
-
 
         
Noncash financing activities:
       
    Payment of accrued liabilities by shareholder
 
$
152,348
 


29

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE THREE AND SIX MONTHS ENDED NOVEMBER 30, 2017 AND 2016
 (IN U.S. $)




NOTE 14.   CONDENSED FINANCIAL INFORMATION OF THE PARENT COMPANY (CONTINUED)

Basis of Presentation

The Company records its investment in its subsidiaries under the equity method of accounting.  Such investments are presented as "Investment in subsidiaries" on the condensed balance sheet and the subsidiaries' profits are presented as "Share of earnings from investment in subsidiaries" in the condensed statement of operations.

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.

There were no cash transactions in the US parent company during the three months ended May 31, 2017.

Restricted Net Assets

Under PRC laws and regulations, the Company's PRC subsidiaries are restricted in their ability to transfer certain of their net assets to the Company in the form of dividend payments, loans or advances. The restricted net assets of the Company's PRC subsidiaries amounted to approximately $56,110,357, as of  May 31, 2017.

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's foreign exchange control regulations that restrict the Company's ability to convert RMB into US Dollars.
30

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 equipment and upgrade services to optimize garbage-recycling processes. We sell and lease comprehensive and environmental-friendly garbage recycling equipment. We also utilize our licensed 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 also have manufactured, sold and leased garbage-processing equipment commencing since fiscal year ended May 31, 2016. We conduct our operations through our wholly-owned subsidiaries Jiangsu Xuefeng Environmental Protection Science and Technology Co., Ltd. ("Jiangsu Xuefeng") and Linyi County Renewable Resources Utilization Co., Ltd. ("Linyi 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 increasing amount of garbage. 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 our licensed patented technology "comprehensive and harmless garbage-processing equipment" into customers' equipment, and reconstruct the hardware to expand the garbage sorting scope and capacity of their equipment.

The comprehensive and harmless garbage processing equipment that we sell or lease 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 all 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 almost no pollution and no residue, reaching the "3 without" standard of no waste gas, no waste water and no waste residue.

The licensed patented 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.

After we sell or lease the equipment or complete the internal system upgrade and hardware equipment improvements of the clients' 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 achieve the expected results. The inspection includes the following: whether the quality of the equipment and accessories or after improvement can match the licensed 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 fulfilled our obligations under 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.
31


Acquisition of Linyi Xuefeng

On August 4, 2016, we entered into an agreement with Mr. Li Yuan, the sole shareholder of Linyi County Xuefeng Renewable Resources Utilization Technology Co., Ltd ("Linyi Xuefeng"), to purchase his 100% ownership of Linyi Xuefeng. Mr. Li Yuan is the Chief Executive Officer and main shareholder of the Company. The purchase price is determined by the audited net assets of Linyi Xuefeng as of May 31, 2016, with payment of RMB10, 000,000 in cash and the rest to be paid in common shares of China Xuefeng depending on the 75% closing price of the last trading day. On October 7, 2016, a supplementary agreement was entered between both parties to finalize the purchase and cost based upon the audited net asset value $23,462,612 on May 31, 2016. The transfer price is $3 per share and 7,820,871 shares in total to Mr. Li Yuan without cash consideration. Linyi Xuefeng is primarily engaged in garbage recycling processing and currently still in development stage without any production.
   
Upon acquisition, Linyi Xuefeng became a wholly-owned subsidiary. The acquisition was accounted for as a business combination.

Results of Operations

Results of Operations for the Three Months Ended November 30, 2017 and 2016

The following table sets forth in U.S. dollars, key components of our audited results of operations for the three months ended November 30, 2017 and 2016 and the percentage change between these comparable periods.
 
 
 
 
2017
   
2016
   
Percentage
 
 
 
(U.S. $)
   
(U.S. $)
   
Change
 
 
                 
Revenue
 
$
2,760,238
   
$
2,535,317
      9 %
Cost of revenue
   
(585,855
)
   
(403,421
)    
45
%
      Gross profit
   
2,174,383
     
2,131,896
     
2
%
    Selling expenses
   
252,662
     
177,205
     
43
%
    General and administrative expenses
   
281,625
     
281,459
     
0
%
  R&D expenses
   
374,841
      -       N/A  
      Total operating expenses
   
909,128
     
458,664
     
98
%
Operating income
   
1,265,255
     
1,673,232
     
(24
%)
    Non-operating income
   
296,653
     
344,456
     
(14
%)
Income before provision for income taxes
   
1,561,908
     
2,017,688
     
(23
%)
Provision for income taxes
   
296,280
     
454,637
     
(35
%)
Net income
   
1,265,628
     
1,563,051
     
(19
%)
    Noncontrolling interests
   
-
 
   
-
     
0
%
Net income attributable to common stockholders
 
$
1,265,628
   
$
1,563,051
     
(19
%)
Revenue
 
We provide improvement and upgrading services for garbage processing equipment to our customers. This is a one-time service. We also license a patent to our customers. The patent licensing is limited to five years with payments due annually in advance. During the fiscal year ended May 31, 2016, we began to sell or lease the garbage processing equipment to our customers.

We generated $2,760,238 in revenue for the three months ended November 30, 2017, as compared to $2,535,317 for the three months ended November 30, 2016. Our revenue for the three months ended November 30, 2017 increased by $224,921 or 9% compared to the revenue for the three months ended November 30, 2016. Revenue remained stable by comparing with the three months ended November 30, 2017 and 2016.
32


 
Three Months Ended November 30,
 
2017
 
2016
 
Percentage
 
(U.S. $)
 
(U.S. $)
 
Change
                        
Improvements and Upgrading Services
 
$
449,248
   
$
773,353
 
 (42%)
Patent Leasing
  1,362,549
 
  1,179,227
 
 16%
Operating lease
  948,441
 
   582,737
 
 63%
 Total
 
$
2,760,238
   
$
2,535,317
 
 9%

Improvement and Upgrading Services
During the three months ended November 30, 2017, we provided improvement and upgrading services to one customer and generated improvement and upgrading service revenue of $449,248. During the three months ended November 30, 2016, we provided improvement and upgrading services to one customer and generated such revenue of $773,353.  During the three months ended November 30, 2015, we also provided such services to one customer and generated such revenue of $477,300. The services were completed and accepted by the customer and the payment was received in full as of November 30, 2017 and 2016, respectively. While our core business still focuses on providing improvement and upgrading services for customers' garbage processing equipment, we had also begun selling or leasing our garbage processing equipment.
 
Patent Licensing
During the three months ended November 30, 2017, we generated revenue of $1,362,549 from licensing our patent to 20 unrelated customers. During the three months ended November 30, 2016, we generated revenue of $1,179,227 from licensing our patent to 18 unrelated customers. As all these customers became licensees before June 1, 2017 and 2016, patent licensing revenue was recognized for the entire three months for these customers during prior periods.
 
Operating lease
During the three months ended November 30, 2016, we had four operating leases for a 300-ton and three 500-ton garbage processing system. The lease period is 5 years with annual lease payments of $598,997 and $2,156,388 (for the total three 500-ton garbage processing system), respectively, before VAT. The 300-ton garbage processing system was delivered and tested in the beginning of November 2015. The two 500-ton garbage processing systems were delivered and tested in the beginning of January 2016. Another 500-ton garbage processing system was delivered and tested in the end of April 2016. These leases are being accounted for as operating leases because they have no renewal or purchase option. At the end of the five years, either a new lease will be negotiated or the equipment will be returned. For the three months ended November 30, 2016, we generated operating lease revenue of $1,179,227 from the four equipment. During the three months ended November 30, 2017, we have three new operating leases for three 500-ton garbage processing system. The lease period is still 5 years with annual lease payments of $2,036,589, before VAT. These three 500-ton garbage processing systems were delivered and tested on December 28, 2016, March 31, 2017 and October 17, 2017, respectively. During the three months ended November 30, 2017, we generated operating lease revenue of $948,441 from the seven equipment.

Cost of Goods Sold 

Our cost of goods sold increased to $585,855 for the three months ended November 30, 2017 from $403,421 for the three months ended November 30, 2016, which represented an increase of 45%. It is primarily because the cost of leasing equipment increased. Our improvement and upgrading service and patent licensing revenue, the cost primarily consists of fees paid to the related party for licensing the patent, employees' salaries and training expenses. For the operating lease revenue, the depreciation of the garbage processing equipment is the main cost which also included in the cost of revenue.
 
Gross Profit

Our gross profit increased to $2,174,383 for the three months ended November 30, 2017 from $2,131,896 for the three months ended November 30, 2016. Our gross profit ratio for the three months ended November 30, 2017 and 2016 was 79% and 84%, respectively. Our business stream has resulted in a high gross margin because we have no cost of products sold if we don't sell garbage processing equipment. Our cost of goods sold is almost entirely direct labor and patent licensing fees, depreciation of leased equipment and other operating expenses. 
 
Selling and Marketing Expenses 

Our selling and marketing expenses increased to $252,662 for the three months ended November 30, 2017 from $177,205 for the three months ended November 30, 2016 which represented an increase of 43%. Our selling and marketing expenses were primarily comprised of sales employees' salaries, advertising expenses, training expenses and travelling expenses.
 
33


General and Administrative Expenses

Our general and administrative expenses remained stable for the three months ended November 30, 2017 and 2016 which is $281,625 and $281,459, respectively. Our general and administrative expenses were primarily comprised of employees' salaries, travelling expenses, entertainment expenses and professional fees such as legal and audit fees. The decrease is primarily caused by the decrease in professional fees incurred in the U.S.

R&D Expenses

We incurred R&D expense of $374,841 for the three months ended November 30, 2017. No such expense incurred in the three months ended November 30, 2016. Our R&D expenses primarily included the cost of the feasibility testing of the garbage processing machine in Liyi factory.

Non-Operating Income

Despite our large cash balances, the interest income generated for the three months ended November 30, 2017, 2016 was nominal for principally two reasons: 1) extremely low bank's current deposit interest rate and 2) minimal fluctuation of the annual interest rates within a 0.30% range; The interest income reported is net after deducting bank service charges.  For the three months ended November 30, 2017 and 2016, our interest income also includes interest of $63,439 and $111,833, respectively, earned on the sales type leases. Our non-operating income also included government subsidy. Our wholly owned subsidiary, Linyi Xuefeng, received government subsidy of approximate $898,495 (RMB 6,000,000) annually. For the three months ended November 30, 2017 and 2016, the income of government subsidy was $227,093 and $222,327 under accrue basis, respectively.

Provision for Income Taxes

Our provision for income taxes decreased to $296,280 for the three months ended November 30, 2017 from $454,637 for the three months ended November 30, 2016.  Our effective tax rate for the three months ended November 30, 2017 and 2016 was approximately 19% and 23%, respectively. The enterprise income tax rate is 25% in China. Our tax filing for the calendar year ended December 31, 2016 was examined by the PRC tax authorities in May 2017. 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 pre-tax income.

Net Income

For the three months ended November 30, 2017 and 2016, we generated net income of $1,265,628 and $1,563,051, respectively.  We terminated the variable interest entity agreement on January 11, 2016.  For that reason, we didn't have "non-controlling interest" for the three months ended November 30, 2017 and 2016, respectively.  As a result, our net income attributable to the common stockholders of the Company for the three months ended November 30, 2017 and 2016 was $1,265,628 and $1,563,051, respectively, representing $0.02 per share and $0.02 per share, respectively.

Results of Operations for the Six Months Ended November 30, 2017 and 2016

The following table sets forth in U.S. dollars, key components of our audited results of operations for the six months ended November 30, 2017 and 2016 and the percentage change between these comparable periods.
 
 
 
Six Months Ended November 30,
 
 
 
2017
   
2016
   
Percentage
 
 
 
(U.S. $)
   
(U.S. $)
   
Change
 
 
                 
Revenue
 
$
4,979,266
   
$
4,663,525
     
7
%
Cost of revenue
   
(1,155,094
)
   
(829,530
)    
39
%
      Gross profit
   
3,824,172
     
3,833,995
     
(0
%)
    Selling expenses
   
429,568
     
328,643
     
31
%
    General and administrative expenses
   
522,286
     
543,313
     
(4
%)
  R&D expenses
   
374,841
      -       N/A  
      Total operating expenses
   
1,326,695
     
871,956
     
52
%
Operating income
   
2,497,477
     
2,962,039
     
(16
%)
    Non-operating income
   
601,495
     
705,520
     
(15
%)
Income before provision for income taxes
   
3,098,972
     
3,667,559
     
(16
%)
Provision for income taxes
   
614,847
     
816,880
     
(15
%)
Net income
   
2,484,125
     
2,850,679
     
(13
%)
    Noncontrolling interests
   
-
 
   
-
     
0
%
Net income attributable to common  stockholders
 
$
2,484,125
   
$
2,850,679
     
(13
%)

34

Revenue

We generated $4,979,266 in revenue for the six months ended November 30, 2017, as compared to $4,663,525 for the six months ended November 30, 2016. Our revenue for the six months ended November 30, 2017 increased by $315,741 or 7% compared to the revenue for the six months ended November 30, 2016. Revenue remained stable by comparing with the six months ended November 30, 2017 and 2016.

 
Six Months Ended November 30,
 
2017
 
2016
 
Percentage
 
(U.S. $)
 
(U.S. $)
 
Change
                        
Improvements and Upgrading Services
 
$
449,248
   
$
1,225,150
 
 (63%)
Patent Leasing
  2,695,485
 
  2,263,539
 
 19%
Operating lease
  1,834,533
 
   1,174,836
 
 56%
 Total
 
$
4,979,266
   
$
4,663,525
 
 7%

Improvement and Upgrading Services
 
 
During the six months ended November 30, 2017, we provided improvement and upgrading services to one customer and generated improvement and upgrading service revenue of $449,248. During the six months ended November 30, 2016, we provided improvement and upgrading services to three customers and generated revenue of $1,225,150.  

The services were completed and accepted by the customer and the payment was received in full as of November 30, 2017 and 2016, respectively. While our core business still focuses on providing improvement and upgrading services for customers' garbage processing equipment, we had also begun selling or leasing our garbage processing equipment.
 
Patent Licensing
 
During the six months ended November 30, 2017, we generated revenue of $2,695,485 from licensing our patent to 20 unrelated customers. During the six months ended November 30, 2016, revenue from patent licensing was from 18 unrelated customers totaling $2,263,539. As 16 customers were licensed in the prior year and two customers commenced on September 1, 2016 and October 1, 2016, the patent licensing revenue was recognized for the whole six months for these 14 customers, for three months for the customer commenced on September 1, 2016 and for two months for the customer commenced on October 1, 2016. 
 
Operating lease
During the six months ended November 30, 2016, we had four operating leases for a 300-ton and three 500-ton garbage processing system. The lease period is 5 years with annual lease payments of $598,997 and $2,156,388 (for the total three 500-ton garbage processing system), respectively, before VAT. The 300-ton garbage processing system was delivered and tested in the beginning of November 2015. The two 500-ton garbage processing systems were delivered and tested in the beginning of January 2016. Another 500-ton garbage processing system was delivered and tested in the end of April 2016. These leases are being accounted for as operating leases because they have no renewal or purchase option. At the end of the five years, either a new lease will be negotiated or the equipment will be returned. For the six months ended November 30, 2016, we generated operating lease revenue of $1,174,836 from the four equipment. During the six months ended November 30, 2017, we have three new operating leases for three 500-ton garbage processing system. The lease period is still 5 years with annual lease payments of $2,036,589, before VAT. These three 500-ton garbage processing systems were delivered and tested on December 28, 2016, March 31, 2017 and October 17, 2017, respectively. During the six months ended November 30, 2017, we generated operating lease revenue of $1,834,533 from the seven equipment.
35


Cost of Goods Sold 

Our cost of goods sold increased to $1,155,094 for the six months ended November 30, 2017 from $829,530 for the six months ended November 30, 2016, which represented an increase of 39%. It is primarily because the cost of leasing equipment increased. Our improvement and upgrading service and patent licensing revenue, the cost primarily consists of fees paid to the related party for licensing the patent, employees' salaries and training expenses. For the operating lease revenue, the depreciation of the garbage processing equipment is the main cost which also included in the cost of revenue.

Gross Profit

Our gross profit remained stable by comparing for the six months ended November 30, 2017 and 2016 which is $3,824,172 and $3,833,995, respectively. Our gross profit ratio for the six months ended November 30, 2017 and 2016 was 77% and 82%, respectively. Our cost of goods sold is almost entirely direct labor and patent licensing fees, and other operating expenses. Our business stream has resulted in a high gross margin because we have no cost of products sold if we don't sell garbage processing equipment.

Selling and Marketing Expenses 

Our selling and marketing expenses increased to $429,568 for the six months ended November 30, 2017 from $328,643 for the six months ended November 30, 2016 which represented an increase of 31%. Our selling and marketing expenses were primarily comprised of sales employees' salaries, advertising expenses, training expenses and travelling expenses.

General and Administrative Expenses

Our general and administrative expenses remained stable for the six months ended November 30, 2017 and 2016 which is $522,286 and $543,313, respectively. Our general and administrative expenses were primarily comprised of employees' salaries, travelling expenses, entertainment expenses and professional fees such as legal and audit fees. The decrease is primarily caused by the decrease in professional fees incurred in the U.S.

R&D Expenses

We incurred R&D expense of $374,841 for the six months ended November 30, 2017. No such expense incurred in the six months ended November 30, 2016. Our R&D expenses primarily included the cost of the feasibility testing of the garbage processing machine in Liyi factory.

Non-operating income

For the six months ended November 30, 2017 and 2016, our interest income also includes interest of $138,943 and $246,984, respectively, earned on the sales type leases. Our non-operating income also included government subsidy. Our wholly owned subsidiary, Linyi Xuefeng, received government subsidy of approximate $898,495 (RMB 6,000,000) annually. For the six months ended November 30, 2017 and 2016, the income of government subsidy was $449,248 and $448,226 under accrue basis, respectively.

Provision for Income Taxes

Our provision for income taxes decreased to $614,847 for the six months ended November 30, 2017 from $816,880 for the six months ended November 30, 2016.  Our effective tax rate for the six months ended November 30, 2017 and 2016 was approximately 20% and 22%, respectively. The enterprise income tax rate is 25% in China. Our tax filing for the calendar year ended December 31, 2016 was examined by the PRC tax authorities in May 2017. 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 pre-tax income.

36

Net Income

For the six months ended November 30, 2017 and 2016, we generated net income of $2,484,125 and $2,850,679, respectively.  We terminated the variable interest entity agreement on January 11, 2016.  For that reason, we didn't have "non-controlling interest" for the six months ended November 30, 2017 and 2016, respectively.  As a result, our net income attributable to the common stockholders of the Company for the six months ended November 30, 2017 and 2016 was $2,484,125 and $2,850,679, respectively, representing $0.04 per share and $0.05 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. Equity transactions are recorded at their historical amounts. 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 and six months ended November 30, 2017 and 2016, a foreign currency gain (loss) of $(162,023), $(1,568,218) and $1,051,507, respectively, $1,748,560, $(2,319,003) and $(102,828), respectively, have been reported as other comprehensive income in the consolidated statements of income and other comprehensive income. The foreign currency loss was mainly due to the devaluation of the Chinese currency by approximately 6.5%.
 
Liquidity and Capital Resources
 
As of November 30, 2017, we had cash and cash equivalents of $19,445,636, primarily consisting of cash on hand and demand deposits. The cash balance was principally derived from cash from operations.

To date, we have financed our operations primarily through 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 in operating activities was $5,456,882 for the six months ended November 30, 2017, as compared with the net cash provided by operating activities of $4,035,001 for the six months ended November 30, 2016. For the six months ended November 30, 2017, the decrease in the accounts receivable of $2,137,244, depreciation expenses of $941,330, increase in deferred revenue of $648,913, increased in accounts payable and accrued liability of $4,060,305, increase in prepaid expenses of $4,214,041 mainly caused the difference between the net cash provided by operating activities and the net income.  For the six months ended November 30, 2016, the decrease in the accounts receivable of $2,024,011, depreciation expenses of $618,489, increase in prepaid VAT of 552,883, the increase in prepaid expenses of $245,628 and the decrease in accounts payable and other accrued liabilities of $654,862 mainly caused the difference between the net cash provided by operating activities and the net income. 

Investing activities

Net cash used in investing activities was $3,847,026 for the six months ended November 30, 2017 which included purchase of fixed assets of $5,930, stock issuance payment of $141,975 and purchase leasing equipment of $3,699,121.

Financing activities

For the six months ended November 30, 2017, we received $7,000,000 from issue of our common stock and $718,716 from the security deposit received. For the six months ended November 30, 2016, we did not have any cash provided or used by any financing activities.
37
 
Effect of Exchange Rate on Cash

The positive (negative) effect of the exchange rate on cash of $(226,980) and $(204,853) was principally due to the devaluation by the PRC government of their currency for the six months ended November 30, 2017 and 2016, respectively. There could be further negative adjustments should the PRC government or the exchange markets further devalue the Chinese currency.

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.
38

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
 
Interest Rate Risk
 
Changes in interest rates may affect the interest earned and therefore affect our cash flows and results of operations. However, we do not believe that this interest rate change risk is significant.

Currency Exchange Fluctuations

All of the Company's revenues are denominated in Chinese Renminbi, while its expenses are denominated primarily in Chinese Renminbi ("RMB"). The value of the RMB-to-U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in political and economic conditions. Since 1994, the conversion of Renminbi into foreign currencies, including U.S. dollars, has been based on rates set by the People's Bank of China ("PBOC"), which are set daily based on the previous day's inter-bank foreign exchange market rates and current exchange rates on the world financial markets. Since 1994, the official exchange rate for the conversion of Renminbi to U.S. dollars had generally been stable and the Renminbi had appreciated slightly against the U.S. dollar. However, on July 21, 2005, the Chinese government changed its policy of pegging the value of Chinese Renminbi to the U.S. dollar. Under the new policy, Chinese Renminbi may fluctuate within a narrow and managed band against a basket of certain foreign currencies. Recently there has been increased political pressure on the Chinese government to decouple the Renminbi from the United States dollar. At the recent quarterly regular meeting of PBOC, its Currency Policy Committee affirmed the effects of the reform on Chinese Renminbi exchange rate. Since February 2006, the new currency rate system has been operated; the currency rate of Renminbi has become more flexible while basically maintaining stable and the expectation for a larger appreciation range is shrinking. In August 2015, the PRC government devalued its currency by approximately 3.0%. The Company has never engaged in currency hedging operations and has no present intention to do so.
 
Country Risk

A substantial portion of our assets and operations are located and conducted in PRC. While the PRC economy has experienced significant growth in the past twenty years, growth has been uneven, both geographically and among various sectors of the economy. The Chinese government has implemented various measures to encourage economic growth and guide the allocation of resources. Some of these measures benefit the overall economy of China, but may also have a negative effect on us. For example, our operating results and financial condition may be adversely affected by government control over capital investments or changes in tax regulations applicable to us.  If there are any changes in any policies by the Chinese government and our business is negatively affected as a result, then our financial results, including our ability to generate revenue and profits, will also be negatively affected. Economic growth in the PRC has recently begun to slow.

ITEM 4. CONTROLS AND PROCEDURES.

Evaluation of Disclosure Controls and Procedures
 
Our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of November 30, 2017.

Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating and implementing possible controls and procedures.
 
Management, including our CEO and CFO, is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a – 15(f).  Management conducted an assessment as of November 30, 2017 of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO").  Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, because of the material weakness in internal control over financial reporting, our disclosure controls and procedures were not effective as of November 30, 2017.
39

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 November 30, 2017, 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.  
40


PART II - OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS.

We are currently not involved in any litigation that we believe could have a material adverse effect on our financial condition or results of operations. There is no action, suit, proceeding, inquiry or investigation before or by any court, public board, government agency, self-regulatory organization or body pending or, to the knowledge of the executive officers of our company or any of our subsidiaries, threatened against or affecting our company, our common stock, any of our subsidiaries or of our companies or our subsidiaries officers or directors in their capacities as such, in which an adverse decision could have a material adverse effect.

ITEM 1A. RISK FACTORS.
 
We believe there are no changes that constitute material changes from the risk factors previously disclosed in our Annual Report on Form 10-K filed with the SEC on August 29, 2017.

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

 
There were no unregistered sales of the Company's equity securities during the three months ended November 30, 2017, that were not otherwise disclosed in a Current Report on Form 8-K.
 

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.
 
There has been no default in the payment of principal, interest, sinking or purchase fund installment, or any other material default, with respect to any indebtedness of the Company.

ITEM 4.  MINE SAFETY DISCLOSURES.
 
Not Applicable.

ITEM 5.  OTHER INFORMATION.

None.
41

 
ITEM 6. EXHIBITS
 
Exhibit No.
 
Description
 
 
 
31.1*
 
Certification of Principal Executive Officer and Principal Accounting Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 302 of 2002
 
 
 
32.1+
 
Certification of Principal Executive Officer and Principal Accounting Officer, pursuant to 18 U.S.C. 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
 

*
 
Filed herewith
**
 
In accordance with Regulation S-T, the XBRL related information on Exhibit No. 101 to this Quarterly Report on Form 10-Q shall be deemed "furnished" herewith not "filed".
 
In accordance with SEC Release 33-8238, Exhibit 32.1 is being furnished and not filed".
 


42

SIGNATURES



In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 
China Xuefeng Environmental Engineering Inc.
 
 
 
Date: January 9, 2018
By:
/s/ Li Yuan
 
 
Li Yuan
 
 
Chief Executive Officer and Chief Financial Officer
Principal Executive Officer and Principal Accounting Officer
 
 
43