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


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-K
 
(Mark One)
x    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended May 31, 2014

or
 
o    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from _____________ to _____________

Commission File No. 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.
   
C214. Fitting Integration Building,
Fazhan Road to Sugian Gate Section
Jiangsu Province, 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)
 
Securities registered under Section 12(b) of the Exchange Act:
   
Title of each class:
Name of each exchange on which registered:
None
None
 
Securities registered under Section 12(g) of the Exchange Act:
None
 
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes  o  No  x
 
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes  o  No  x
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes  x  No o
 
 
 

 
 
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).Yes  x  No  o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference Part III of this Form 10-K or any amendment to this Form
10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
 
Large accelerated filer
o
Accelerated filer
o
       
Non-accelerated filer
o
Smaller reporting company
x
(Do not check if a smaller reporting company)
     
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
 
State the aggregate market value of the voting and non-voting common equity held by non-affiliates computed by reference to the price at which the common equity was last sold, or the average bid and asked price of such common equity, as of the last business day of the registrant’s most recently completed second fiscal quarter: $184,012,032.
 
As of August 26, 2014, the registrant had 55,200,000 shares of common stock, par value $0.001 per share, issued and outstanding.
 
Documents Incorporated by Reference: None.
 
 
 

 
 
TABLE OF CONTENTS
 
PART I
  Page
     
ITEM 1.
BUSINESS
1
     
ITEM 1A.
RISK FACTORS
12
     
ITEM 1B.
UNRESOLVED STAFF COMMENTS
22
     
ITEM 2.
PROPERTIES
22
     
ITEM 3.
LEGAL PROCEEDINGS
22
     
ITEM 4.
MINE SAFETY DISCLOSURES
22
     
PART II
 
     
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
23
     
ITEM 6.
SELECTED FINANCIAL DATA
24
     
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
24
     
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
31
     
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
32
     
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
60
     
ITEM 9A.
CONTROLS AND PROCEDURES
60
     
ITEM 9B.
OTHER INFORMATION
61
     
PART III
 
     
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
61
     
ITEM 11.
EXECUTIVE COMPENSATION
63
     
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
65
     
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
65
     
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
66
     
PART IV
 
     
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
68
     
SIGNATURES
70
 
 
 

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

This Annual Report on Form 10-K (this “Report”) contains “forward-looking statements” within the meaning of the Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Exchange Act of 1934, as amended (the “Exchange Act”). Forward-looking statements discuss matters that are not historical facts. Because they discuss future events or conditions, forward-looking statements may include words such as “anticipate,” “believe,” “estimate,” “intend,” “could,” “should,” “would,” “may,” “seek,” “plan,” “might,” “will,” “expect,” “predict,” “project,” “forecast,” “potential,” “continue” negatives thereof or similar expressions. These forward-looking statements are found at various places throughout this Report and include information concerning possible or assumed future results of our operations; business strategies; future cash flows; financing plans; plans and objectives of management; any other statements regarding future operations, future cash needs, business plans and future financial results, and any other statements that are not historical facts.

From time to time, forward-looking statements also are included in our other periodic reports on Forms 10-Q and 8-K, in our press releases, in our presentations, on our website and in other materials released to the public.  Any or all of the forward-looking statements included in this Report and in any other reports or public statements made by us are not guarantees of future performance and may turn out to be inaccurate. These forward-looking statements represent our intentions, plans, expectations, assumptions and beliefs about future events and are subject to risks, uncertainties and other factors.  Many of those factors are outside of our control and could cause actual results to differ materially from the results expressed or implied by those forward-looking statements. In light of these risks, uncertainties and assumptions, the events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than we have described. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Report. All subsequent written and oral forward-looking statements concerning other matters addressed in this Report and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this Report.

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

For discussion of factors that we believe could cause our actual results to differ materially from expected and historical results see “Item 1A — Risk Factors” below.

PART I
 
ITEM 1.  BUSINESS
 
OVERVIEW
 
We are in the business of providing services to optimize garbage-recycling processes. We utilize our patented technology of “comprehensive and harmless garbage-processing equipment,” to upgrade software systems and reconstruct hardware for our clients, and therefore expand the sorting scope and capacity of our clients’ garbage recycling equipment. We conduct our operations through our controlled consolidated affiliate Jiangsu Xuefeng Environmental Protection Science and Technology Co., Ltd. (“Jiangsu Xuefeng”). Jiangsu Xuefeng was incorporated under the laws of the People’s Republic of China (“PRC”) on December 14, 2007.

OUR CORPORATE HISTORY AND BACKGROUND
 
The Company was incorporated in the state of Nevada on March 30, 2011. The Company was initially formed to engage in the business of clothing distribution.  Since its inception and until the acquisition of Inclusion, the Company was a development stage company without significant assets or any revenue.
 
 
1

 
 
Acquisition of Inclusion

On November 27, 2012, we completed a reverse acquisition transaction through a share exchange with Inclusion Business Limited (BVI) (“Inclusion”) and its stockholders (the “Inclusion Stockholders”), whereby we acquired 100% of the issued and outstanding capital stock of Inclusion and in exchange we issued 7,895,000 shares of our common stock (pre-Forward Split), or 76.65% of our issued and outstanding capital stock as of and immediately after the consummation of the reverse acquisition, to the Inclusion Stockholders. As a result of the reverse acquisition, Inclusion became our wholly-owned subsidiary and the former Inclusion Stockholders became our controlling stockholders. The share exchange transaction has been treated as a reverse acquisition, with Inclusion as the acquirer and the Company as the acquired party for accounting purposes.

Prior to the closing of the reverse acquisition, the Company’s prior shareholder, Mr. Zhenxing Liu, surrendered 7,895,000 shares of the common stock of the Company. Mr. Zhenxing Liu did not receive any consideration from the Company for accounting purposes. However, Mr. Zhenxing Liu may be deemed to have received consideration from the increase in the value of 250,000 shares held by Mr. Zhenxing Liu as a result of the reverse acquisition. Mr. Zhenxing Liu purchased 8,145,000 shares at approximately $0.007 per share at the time when the Company was considered a shell and kept 250,000 shares after the surrender. On November 30, 2012, at the closing of the reverse acquisition, the stockholder’s equity increased to $5,194,728. Accordingly, the value of the 250,000 shares held by Mr. Zhenxing Liu appreciated to approximately $124,673. Other than such appreciation in the value of his shares, Mr. Zhenxing Liu did not receive any other consideration in connection with the reverse acquisition.

As a result of our acquisition of Inclusion, we now own all of the issued and outstanding capital stock of Lotus International Holdings Limited (“Lotus”), which in turn owns all of the issued and outstanding capital stock of Baichuang Information Consulting (Shenzhen) Co. Ltd (“Baichuang Consulting”). In addition, we effectively and substantially control Jiangsu Xuefeng through a series of captive agreements with Baichuang Consulting.

Subsequent to the closing of the Exchange Agreement, we conduct our operations through our controlled consolidated affiliate Jiangsu Xuefeng. Jiangsu Xuefeng is primarily engaged in providing improvement and upgrading services of garbage recycling processing technology and equipment.

Name Change and Forward Split

On November 27, 2012, the Company filed a certificate of amendment to its articles of incorporation to change its name from “NYC Moda Inc” to “China Xuefeng Environmental Engineering Inc” and to effect a 4-for-1 forward stock split of its outstanding shares of common stock.  The name change went effective on December 14, 2012 and the forward split went effective on December 17, 2012, upon the approval of Financial Industry Regulatory Authority, Inc. (FINRA). 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, and the number of authorized shares of common stock remained 75,000,000 shares. The effect of the forward split applies retroactively to the Company’s consolidated financial statements for the periods presented.
 
Contractual Arrangements with our Controlled Consolidated Affiliate and its Shareholders
 
On October 17, 2012, prior to the reverse acquisition transaction, Baichuang Consulting and Jiangsu Xuefeng and its shareholders Li Yuan and Yi Yuan entered into a series of agreements known as variable interest agreements (the “VIE Agreements”) pursuant to which Jiangsu Xuefeng became Baichuang Consulting’s contractually controlled affiliate. The VIE Agreements included:
 
(1)
an Exclusive Technical Service and Business Consulting Agreement between Baichuang Consulting and Jiangsu Xuefeng pursuant to which Baichuang Consulting is to provide technical support and consulting services to Jiangsu Xuefeng in exchange for (i) 95% of the total annual net profit of Jiangsu Xuefeng plus (ii) RMB100,000 per month (U.S.$15,873).
   
(2)
a Call Option Agreement among Li YUAN and Yi YUAN (together referred to as “Jiangsu Xuefeng Shareholders”), and Baichuang Consulting under which the  Jiangsu Xuefeng Shareholders have granted to Baichuang Consulting the irrevocable right and option to acquire all of the equity interests in Jiangsu Xuefeng to the extent permitted by PRC law. If PRC law limits the percentage of Jiangsu Xuefeng that Baichuang Consulting may purchase at any time, then Baichuang Consulting may repeatedly exercise its option in such increments as may be allowed by PRC law. The exercise price of the option is RMB1.00 ($0.16) or any lower price permitted by PRC law. The Jiangsu Xuefeng Shareholders agreed to refrain from taking certain actions which might harm the value of Jiangsu Xuefeng or Baichuang Consulting’s option;
   
(3)
a Proxy Agreement by Li YUAN and Yi YUAN pursuant to which they each authorize Baichuang Consulting to designate someone to exercise all of their shareholder decision rights with respect to Jiangsu Xuefeng; and
   
(4)
a Share Pledge Agreement among Li YUAN and Yi YUAN, Jiangsu Xuefeng, and Baichuang Consulting under which the Jiangsu Xuefeng Shareholders agree to pledge all of their equity in Jiangsu Xuefeng to Baichuang Consulting to guarantee Jiangsu Xuefeng’s and its shareholders’ performance of their obligations under the Exclusive Technical Service and Business Consulting Agreement, the Call Option Agreement and the Proxy Agreement.
 
 
2

 
 
The VIE Agreements with our Chinese affiliate and its shareholders, which relate to critical aspects of our operations, may not be as effective in providing operational control as direct ownership. In addition, these arrangements may be difficult and costly to enforce under PRC law. See “Risk Factors - Risks Relating to the VIE Agreements.”
 
The foregoing description of the terms of the Exclusive Technical Service and Business Consulting Agreement, the Call Option Agreement, the Proxy Agreement and the Share Pledge Agreement is qualified in its entirety by reference to the provisions of the agreements filed as Exhibits 10.1, 10.2, 10.3 and 10.4 to this report, respectively, which are incorporated by reference herein.
 
See “Related Party Transactions” for further information on our contractual arrangements with these parties.

After the exchange, our current organizational structure after giving effect to the name change is as follows:
 
 
 
 
3

 
 
Inclusion was established in the British Virgin Islands on August 9, 2012.  Lotus was established in Hong Kong on May 2, 2012 to serve as an intermediate holding company with authorized shares of 10,000 at HK$1.00 per share. Baichuang Consulting was established by Lotus as a wholly foreign owned enterprise (the “WFOE”) in the PRC on September 5, 2012.  Jiangsu Xuefeng, our operating consolidated affiliate, was established in the PRC on December 14, 2007. The local government of the PRC issued a certificate of approval of the foreign ownership of Baichuang Consulting by Lotus, a Hong Kong entity on September 5, 2012.
 
OUR BUSINESS
 
We are in the business of providing services to optimize garbage-recycling processes. We utilize our patented technology of “comprehensive and harmless garbage-processing equipment”, to upgrade software systems and reconstruct hardware for our clients, and therefore expand the sorting scope and capacity of our clients’ garbage recycling equipment. We conduct our operations through our controlled consolidated affiliate Jiangsu Xuefeng. Jiangsu Xuefeng was incorporated under the laws of the People’s Republic of China (“PRC”) on December 14, 2007.

OUR SERVICES

As the urbanization in China progresses, the amount of household garbage increases. The processing capability of current garbage processing equipment in China cannot typically satisfy the increasing demands. We expand the garbage sorting scope and capacity of our clients’ garbage processing equipment, by installing the various systems that embody the patented technology “comprehensive and harmless garbage-processing equipment” into clients’ garbage processing equipment and reconstructing their hardware, to provide upgrades and improvement to their equipment.

The patented technology “harmless and comprehensive garbage processing equipment” helps to achieve high and stable garbage processing capacity, which uses Distributed Control System (DCS) to realize mechanical automation for the comprehensive garbage treatment. The 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 its resource utilization and harmless utilization rate approximate 100%. The resource recovery products, biogas, can not only be used for meeting the needs of the plant itself, but also for outer supply, which greatly improves the efficiency of garbage processing of customer’s equipment, decreases production cost, and increases the recovery return of garbage processing.

The comprehensive and harmless garbage processing equipment is comprised of 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 and 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 could run whole day. The stand-alone equipment can process 500 tons to 1000 tons of garbage per day. It can sort and process complicated municipal solid waste, leaving no pollution and no residue, reaching the"3 without" standard of no waste gas, no waste water and no waste residue.

After we complete the internal system upgrade and hardware equipment improvement of the garbage equipment, we deliver the upgraded equipment to the customers. The customers will conduct inspection and performance testing to the upgraded equipment no more than one month pursuant to the contract to inspect whether the internal control system and the hardware structure can operate steadily and reach the garbage process features. The inspecting items including the following: whether the quality of the equipment and accessories after improvement can match the patented technology and process various kinds of garbage, whether the various garbage systems can process automatically, and whether the daily garbage processing capacity reaches the standard of the contract. If during the performance testing period, all the performance index can fulfill the requirements of the contract, it would be deemed that we have fully executed the agreements.

 
4

 
 
Prior to the first service agreement in April 2012, we did not conduct any business activities except for the preparation of the business and the development of the clients, etc. When we complete the upgrading service for the client, we go through the acceptance check and commissioning of the company in accordance with the contract, to make sure that the service provided met the demand of the clients. After that, we are not subject to any additional service. 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 are the responsibility of the clients.

Until August 31, 2012 the main revenue of Jiangsu Xuefeng was generated from providing improvement and upgrading services to garbage recycling processing plants. On August 5, 2012, Jiangsu Xuefeng entered into a lease agreement with Li Yuan, one of its stockholders for the use of a patent on garbage recycling processing technology, a Utility Model Patent of Comprehensive and Harmless Garbage Processing Equipment, issued by the State Intellectual Property Office (SIPO) on July 7, 2010 and valid for ten years (Patent Number: ZL 2009 2 0232893.7).  The patent is owned by our Chief Executive Officer, Mr. Li Yuan.  The lease commenced on September 1, 2012 and expires in August 2017.  Jiangsu Xuefeng expanded its business model from the sole service of providing upgrading to waste processing plants to also providing patent licensing based on its newly acquired use right of the patent technology.  We use the patent technology to help the clients to upgrade their internal system or reconstruct the hardware equipment of the garbage processing equipment so that the equipment performance could reach the standard of our patent technology. After the upgrade and reconstruction, our patent technology will continue to be used in their equipment and we allow the clients to continue using our patent technology in their equipment for patent licensing revenue. License agreements will be offered to clients for a limited period of three to five years, within which period, the client shall pay patent royalties yearly to Jiangsu Xuefeng for their use of the equipment containing the patent technology.
 
Therefore, under the new business model, Jiangsu Xuefeng generates its revenues from two sources: improvement and upgrading services of garbage processing equipment and patent licensing for the use of the upgraded technology.
 
For the year ended May 31, 2014, sales from improvement and upgrading services and patent licensing were $1,464,300 and $3,245,865, respectively.  
 
PRODUCTS AND FACILITIES
 
We provide equipment improvement and upgrading service and lease the patented technology to our customers.
 
We mainly incorporate and install the patented technology into garbage processing equipment’s internal control and operation system to achieve the requested processing capacity. During the internal system upgrading process, if any hardware equipment, such as the machine parts, is required to be reconstructed, the customers are responsible for the hardware purchase while we provide guided and assisted installation.

In addition, as our customers continue to use the equipment embodying the patented technology, they pay us a fee for the use of the patented technology.
 
We plan to construct our own garbage processing plant to process various environmental wastes.

 
5

 
 
CUSTOMERS

The following table sets forth our major customers for the year of 2014:

Customers
 
Sales (US Dollar)
   
% of Total Revenue
 
             
Gaoyou Zhujia Household Garbage Process Co., Ltd
    732,150.00       15.54 %
Tianjin Yongtai Household Garbage Process Co., Ltd
    707,745.00       15.03 %
Linxiang Municipal Garbage Process Co., Ltd
    634,530.00       13.47 %
 
On July 8, 2013, Jiangsu Xufeng entered into another technical service agreement with Gaoyou Zhujia Household Garbage Process Co., Ltd (Zhujia), according to which, by July 31, 2013, Jiangsu Xuefeng would finish upgrading and improvement of Zhujia’s major garbage processing equipment. Jiangsu Xuefeng charged a fee of 3 million RMB ($488,100) for the service and it was paid in one lump sum within ten days upon signing of the contract. Jiangsu Xuefeng also licensed its technology to Zhujia upon completion of the upgrading for five years at a royalty fee of 1.8 million RMB ($292,860) per year.

On August 2, 2013, Jiangsu Xufeng entered into another technical service agreement with Tianjin Yongtai Household Garbage Process Co., Ltd (Yongtai), according to which, by August 31, 2013, Jiangsu Xuefeng would finish upgrading and improvement of Yongtai’s major garbage processing equipment. Jiangsu Xuefeng charged a fee of 3 million RMB ($488,100) for the service and it was paid in one lump sum within 30 days upon signing of the contract. Jiangsu Xuefeng also licensed its technology to Yongtai upon completion of the upgrading for five years at a royalty fee of 1.8 million RMB ($292,860) per year.

On October 20, 2013, Jiangsu Xufeng entered into another technical service agreement with Linxiang Municipal Garbage Process Co., Ltd (Linxiang), according to which, by November 8, 2013, Jiangsu Xuefeng would finish upgrading and improvement of Linxiang’s major garbage processing equipment. Jiangsu Xuefeng charged a fee of 3 million RMB ($488,100) for the service and it was paid in one lump sum within one month upon signing of the contract. Jiangsu Xuefeng also licensed its technology to Linxiang upon completion of the upgrading for five years at a royalty fee of 1.8 million RMB ($292,860) per year.
 
OUR INDUSTRY
 
In the description below we rely on certain information and statistics regarding our industry and the economy in China from the reports published by National Bureau of Statistics of China and the PRC Ministry of Environmental Protection.  We have no reason to believe that the information and statistics we cite are not accurate.

The Chinese industry of garbage processing is highly fragmented and in a very early-stage of development. Benefiting from a series of encouraging and supportive policies on garbage processing formulated by the Chinese government, the urban garbage processing industry has been in rapid development. The current market is primarily dominated by small regional companies, like Jiangsu Xuefeng, which account for approximately 90% of all environmental protection enterprises in China.
 
The volume of solid waste generated by industrial companies is directly correlates to the industrial rate of utilization of natural resources and is expected to grow by over 10% per year according to the National Bureau of Statistics of China. In addition, according to estimates from the PRC Ministry of Environmental Protection, the production of industrial waste was approximately 1.34 billion tons in 2010, excluding approximately 13 million tons of hazardous industrial waste.
 
According to the Opinions on Further the Municipal Solid Waste Processing Service issued by the Chinese government, the harmless garbage processing rate will reach over 80% by 2015.  This anticipated increase creates a strong incentive for companies to improve their garbage processing capability.  Thus the Chinese garbage processing industry has significant potential room for growth both in areas of equipment marketing and equipment upgrading and improvement.
 
Nationwide Innocuous Disposal Facilities MSW Facilities Construction Planning (2011-2015) (“Planning”), recently passed by the Chinese government, has gone into the implementation phase. In accordance with the Planning, the aggregate investment in the items of the Planning will reach RMB 260Billion Yuan ($41.08 billion).
 
 
6

 
 
According to the Environmental Protection Equipment “Twelfth Five-Year” Development Planning, the yearly growth rate of environmental protection industry gross output during the Twelfth Five-Year period is 20% and will reach 500 billion yuan ($79 billion)by 2015.
 
The “Twelfth Five-Year” Energy Saving and Environmental Protection Industry Development Program recently issued by the Chinese government will provide support for the energy saving and environmental protection industry in finance, tax and many other aspects and will also provide directional guidance to the industry’s development. Based on the “three years exemptions and three years reductions” tax preference that the energy saving and environmental protection enterprises have already acquired, and the tax applied to high and new tech enterprises enjoying special support from the government, the income tax rate that energy saving and environmental protection enterprises are subjected to is 15% lower than the customary tax of 25%.
 
Thus, recently issued policies reducing the cost of Jiangsu Xuefeng operations, and anticipated future industrial policies of the Chinese government show the Chinese government’s encouragement and support for the long term development of the environment waste processing industry, setting the stage for a larger market place for the environmental protection equipment upgrading and improvement business.
 
COMPETITION

Competitive Advantages
 
The industry for environmental protection equipment upgrading and improvement in China, being in its early stage, lends a great amount of business opportunities. We believe that, with our services and products that are supported by the patented technology and gradually gaining its market acceptance, we are well positioned to take advantage of the opportunities presented in this industry.
 
Competitive Disadvantages
 
While we saw gross profit margins of 92% and 90% for the years of 2014 and 2013, we are uncertain that our high gross profit margins are sustainable if we have to commit to substantive research and development activities when the Chinese government adopts higher standards for environmental protection technologies and when the cost of our services become substantially higher.
 
 
7

 
 
Our Growth Strategy
 
As industrial development continues its rapid increase in growth, the demand for the Company should also increase rapidly.  The Company hopes to seize the opportunity to use industrial growth of both large and medium-size enterprises, establishing cooperative relationships with high-quality customers by fully using its advantages in waste processing technology providing customers with improved environmental solutions and larger scale processing capability.
 
The Company will further develop the equipment upgrading business. Jiangsu Xuefeng will make the best use of patented technology of comprehensive and harmless garbage processing equipment to carry on the improvement and upgrading service for Chinese clients. In addition, patent license agreements will be offered to clients for a limited period of three to five years, within which period, the client shall pay patent royalties yearly to Jiangsu Xuefeng for their use of the equipment containing the patent technology thus providing the Company with an additional source of revenue.
 
The Company will establish an equipment manufacturing and sales center. While continuing to provide equipment upgrading services, Jiangsu Xuefeng intends to establish a garbage processing equipment manufacturing and sales center to meet the anticipated market needs for Chinese garbage processing equipment, gradually branching further into the Chinese garbage processing equipment market and improving the Company’s revenue.
 
The Company plans to also undertake technical cooperation with key domestic and foreign R&D institutions and industry partners. Keeping abreast of domestic and foreign technical developments, the Company plans to make use of international and domestic newly advanced technology in comprehensive garbage processing with high daily processing capacity. The Company plans to constantly expand marketing channels and increase its market shares.

MARKETS, SALES AND DISTRIBUTION
 
Currently, our marketing and sales efforts largely rely on word of mouths among our existing clients.
 
INTELLECTUAL PROPERTY
 
The Company acquired the use right of the  “patent technology of comprehensive and harmless garbage processing equipment”  that passed the ISO9001:2008 International Quality Management System Certification through the Patent Licensing Service Agreement signed with our Chairman, Chief Executive Officer and a shareholder, Li Yuan. The Licensing Agreement commenced on September 1, 2012 with a monthly payment from the Jiangsu Xuefeng to Li Yuan of approximately $12,600 (RMB 80,000).  The Licensing Agreement expires in July 2017.
 
Comprehensive and Harmless Garbage Processing Equipment is a Utility Model Patent issued by the State Intellectual Property Office (SIPO) on July 7, 2010 and valid for ten years (Patent Number: ZL 2009 2 0232893.7). It is owned by with our Chairman.  This patented technology is for the treatment of complex municipal solid waste including sorting and classification, leaving no pollution and no residue.
 
 
8

 
 
PROPERTIES

The Company leases office space under a one-year operating lease from an unrelated third party, which expired on March 31, 2013 and was extended to March 31, 2016.  The lease requires the Company to prepay the rental for one year of $7,267 (RMB 44,664). The related prepayments of $6,030 and $6,015 are included in the prepaid expenses on the consolidated balance sheets as of May 31, 2014 and 2013, respectively.  The lease provides for renewal options.  Rent expense charged to operations for the years ended May 31, 2014 and 2013 was $7,267 and $7,097, respectively.  The minimum future rentals under the lease as of May 31, 2014 are as follows:

Period Ending
     
May 31,
 
Amount
 
       
2015
   
1,212
 
2016
   
6,060
 
         
   
$
7,272
 
 
On March 23, 2012, Jiangsu Xuefeng entered into an agreement with an independent third party to acquire a 50-year land use right for construction of a factory facility for cash consideration of US$872,640, equivalent to RMB 5,400,000, of which US$808,000, equivalent to RMB 5,000,000 was paid before May 31, 2013.  As of May 31, 2013, no land use right certificate has been issued to the Company and thus the land used right has not been successfully acquired. In March 2014, the land use right acquisition agreement was terminated and the prior payment made by the Company under such agreement was returned to the Company.
 
REGULATION
 
Because our operating affiliate Jiangsu Xuefeng is located in the PRC, our business is regulated by the national and local laws of the PRC. We believe our conduct of business complies with existing PRC laws, rules and regulations.

Environmental Law
 
Jiangsu Xuefeng is subject to China’s national Environmental Protection Law, which was enacted on December 26, 1989, as well as a number of other national and local laws and regulations governing landfills, air, water, and noise pollution and establishing pollutant discharge standards for wastewater.
 
On July 1, 2004, the PRC central government adopted the Measures for the Administration of Permit for Operation of Dangerous Wastes (the “Measures”). The Measures are intended to strengthen supervision and administration of activities relating to the collection, storage and disposal of dangerous wastes, and preventing dangerous wastes from polluting the environment.
 
Both the PRC Ministry of Environment Protection and local bureaus of environmental protection, license and regulate companies engaged in waste disposal and treatment in China. The requirements for licensing have become more stringent, with applicants having to demonstrate a sufficient operating history and a number of professional technicians, as well as comply with national and local environmental standards. The licensing process is also very time consuming and requires lengthy lead times.

General Regulation of Businesses
 
We believe we are in material compliance with all applicable labor and safety laws and regulations in the PRC, including the PRC Labor Contract Law, the PRC Production Safety Law, the PRC Regulation for Insurance for Labor Injury, the PRC Unemployment Insurance Law, the PRC Provisional Insurance Measures for Maternity of Employees, PRC Interim Provisions on Registration of Social Insurance, PRC Interim Regulation on the Collection and Payment of Social Insurance Premiums and other related regulations, rules and provisions issued by the relevant governmental authorities from time to time, for our operations in the PRC.
 
According to the PRC Labor Contract Law, we are required to enter into labor contracts with our employees. We are required to pay no less than local minimum wages to our employees. We are also required to provide employees with labor safety and sanitation conditions meeting PRC government laws and regulations and carry out regular health examinations of our employees engaged in hazardous occupations.
 
 
9

 
 
Foreign Currency Exchange
 
The principal regulation governing foreign currency exchange in China is the Foreign Currency Administration Rules (1996), as amended (2008). Under these Rules, RMB is freely convertible for current account items, such as trade and service-related foreign exchange transactions, but not for capital account items, such as direct investment, loan or investment in securities outside China unless the prior approval of, and/or registration with, the State Administration of Foreign Exchange of the People’s Republic of China, or SAFE, or its local counterparts (as the case may be) is obtained.
 
Pursuant to the Foreign Currency Administration Rules, foreign invested enterprises, or FIEs, in China may purchase foreign currency without the approval of SAFE for trade and service-related foreign exchange transactions by providing commercial documents evidencing these transactions. They may also retain foreign exchange (subject to a cap approved by SAFE) to satisfy foreign exchange liabilities or to pay dividends. In addition, if a foreign company acquires a company in China, the acquired company will also become an FIE. However, the relevant PRC government authorities may limit or eliminate the ability of FIEs to purchase and retain foreign currencies in the future. In addition, foreign exchange transactions for direct investment, loan and investment in securities outside China are still subject to limitations and require approvals from, and/or registration with, SAFE.

Regulation of Income Taxes
 
On March 16, 2007, the National People’s Congress of China passed the Enterprise Income Tax Law, or the EIT Law, and its implementing rules, both of which became effective on January 1, 2008. The EIT Law and its implementing rules impose a unified EIT rate of 25.0% on all domestic-invested enterprises and FIEs, unless they qualify under certain limited exceptions.
  
Under the EIT Law, companies designated as High- and New-Technology Enterprises may enjoy a reduced national EIT rate of 15%. The Administrative Measures for Assessment of High-New Tech Enterprises and Catalogue of High/New Tech Domains Strongly Supported by the State (2008), jointly issued by the Ministry of Science and Technology and the Ministry of Finance and State Administration of Taxation set forth general guidelines regarding criteria as well as application procedures for qualification as a High- and New-Tech Enterprise under the EIT Law.
 
In addition to the changes to the current tax structure, under the EIT Law, an enterprise established outside of China with “de facto management bodies” within China is considered a resident enterprise and will normally be subject to an EIT of 25% on its global income. The implementing rules define the term “de facto management bodies” as “an establishment that exercises, in substance, overall management and control over the production, business, personnel, accounting, etc., of a Chinese enterprise.” If the PRC tax authorities subsequently determine that we should be classified as a resident enterprise, then our organization’s global income will be subject to PRC income tax of 25%. For detailed discussion of PRC tax issues related to resident enterprise status, see “Risk Factors – Risks Related to Our Business – Under the EIT Law, we may be classified as a ‘resident enterprise’ of China. Such classification will likely result in unfavorable tax consequences to us and our non-PRC stockholders.”
 
Our future effective income tax rate depends on various factors, such as tax legislation, the geographic composition of our pre-tax income and non-tax deductible expenses incurred. Our management carefully monitors these legal developments and will timely adjust our effective income tax rate when necessary.
 
 
10

 
 
Dividend Distribution
 
Under applicable PRC regulations, FIEs in China may pay dividends only out of their accumulated profits, if any, determined in accordance with PRC accounting standards and regulations. In addition, a FIE in China is required to set aside at least 10.0% of its after-tax profit based on PRC accounting standards each year to its general reserves until the cumulative amount of such reserves reach 50.0% of its registered capital. These reserves are not distributable as cash dividends. The board of directors of a FIE has the discretion to allocate a portion of its after-tax profits to staff welfare and bonus funds, which may not be distributed to equity owners except in the event of liquidation.
 
The EIT Law and its implementing rules generally provide that a 10% withholding tax applies to China-sourced income derived by non-resident enterprises for PRC enterprise income tax purposes unless the jurisdiction of incorporation of such enterprises’ shareholder has a tax treaty with China that provides for a different withholding arrangement. Baichuang Consulting is considered a FIE and is directly held by our subsidiary in Hong Kong, Lotus. According to a 2006 tax treaty between the Mainland and Hong Kong, dividends payable by an FIE in China to the company in Hong Kong who directly holds at least 25% of the equity interests in the FIE will be subject to a no more than 5% withholding tax. We expect that such 5% withholding tax will apply to dividends paid to Lotus by Baichuang Consulting, but this treatment will depend on our status as a non-resident enterprise.    

PRC M&A Rule, Circular 75 and Circular 638

On August 8, 2006, six Chinese government agencies, namely, the Ministry of Commerce, or MOFCOM, the State Administration for Industry and Commerce, or SAIC, the China Securities Regulatory Commission, or CSRC, the State Administration of Foreign Exchange, or SAFE, the State Assets Supervision and Administration Commission, or SASAC, and the State Administration for Taxation, or SAT, jointly issued the Regulations on Mergers and Acquisitions of Domestic Enterprises by Foreign Investors, referred to as the “New M&A Rules”, which became effective on September 8, 2006. The New M&A Rules purport, among other things, to require offshore “special purpose vehicles,” that are (1) formed for the purpose of overseas listing of the equity interests of Chinese companies via acquisition and (2) are controlled directly or indirectly by Chinese companies and/or Chinese individuals, to obtain the approval of the CSRC prior to the listing and trading of their securities on overseas stock exchanges. Based on our understanding of current Chinese Laws and pursuant to a legal opinion issued by Jilin Changchun Law Firm dated October 17, 2012, (i) Baichuang Consulting was incorporated by a foreign investor and therefore has no Chinese shareholders; (ii) the share exchange between Inclusion and the Company,  is between two offshore companies and is not deemed as a transaction to acquire equity or assets of a “Chinese domestic company” as defined under the New M&A Rules and (ii) no provision in the New M&A Rules clearly classifies the contractual arrangements between Baichuang Consulting and Jiangsu Xuefeng as a type of transaction falling within the New M&A Rules.

The SAFE issued a public notice in October 2005, or the Circular 75, requiring Chinese residents to register with the local SAFE branch before establishing or controlling any company outside of China for the purpose of capital financing with assets or equities of Chinese companies, referred to in the Circular 75 as special purpose vehicles, or SPVs. Chinese residents who are shareholders of SPVs established before November 1, 2005 were required to register with the local SAFE branch before June 30, 2006. Further, Chinese residents are required to file amendments to their registrations with the local SAFE branch if their SPVs undergo a material event involving changes in capital, such as changes in share capital, mergers and acquisitions, share transfers or exchanges, spin-off transactions or long-term equity or debt investments.
 
Pursuant to the Circular 698, where a foreign investor transfers the equity interests of a Chinese resident enterprise indirectly via disposing of the equity interests of an overseas holding company, which we refer to as an Indirect Transfer, and such overseas holding company is located in a tax jurisdiction that: (i) has an effective tax rate less than 12.5% or (ii) does not tax foreign income of its residents, the foreign investor shall report such Indirect Transfer to the competent tax authority of the Chinese resident enterprise. The Chinese tax authority will examine the true nature of the Indirect Transfer, and if the tax authority considers that the foreign investor has adopted an abusive arrangement in order to avoid Chinese tax, they will disregard the existence of the overseas holding company and re-characterize the Indirect Transfer and as a result, gains derived from such Indirect Transfer may be subject to Chinese withholding tax at the rate of up to 10%. Circular 698 also provides that, where a non-Chinese resident enterprise transfers its equity interests in a Chinese resident enterprise to its related parties at a price lower than the fair market value, the competent tax authority has the power to make a reasonable adjustment to the taxable income of the transaction.

INSURANCE
 
Insurance companies in China offer limited business insurance products. While business interruption insurance is available to a limited extent in China, we have determined that the risks of interruption, cost of such insurance and the difficulties associated with acquiring such insurance on commercially reasonable terms make it impractical for us to have such insurance. As a result, we could face liability from the interruption of our business as summarized under “Risk Factors – Risks Related to Our Business – We do not carry business interruption insurance so we could incur unrecoverable losses if our business is interrupted.”
 
 
11

 
 
OUR EMPLOYEES
 
As of August 26, 2014, we had a total of 32 employees. The Company employs a highly qualified team of technically trained personnel. Among the Company’s employees, 11employees have environmental assessment engineer degrees and 10 employees have ecological and environmental protection planning qualifications.  This team provides support for clients when the Company upgrades waste management systems with our new patented technology. 

ITEM 1A.       RISK FACTORS
 
An investment in our common stock involves a high degree of risk. You should carefully consider the risks described below, together with all of the other information included in this report, before making an investment decision. If any of the following risks actually occurs, our business, financial condition or results of operations could suffer. In that case, the trading price of our common stock could decline, and you may lose all or part of your investment. You should read the section entitled "Special Notes Regarding Forward-Looking Statements" immediately following these risk factors for a discussion of what types of statements are forward-looking statements, as well as the significance of such statements in the context of this report.

Risks Related to Being an Emerging Growth Company

We are an emerging growth company and as such are not required to comply with certain reporting standards.

We will be required to disclose changes made in our internal controls and procedures on a quarterly basis and our management will be required to assess the effectiveness of these controls annually. However, for as long as we are an "emerging growth company" under the JOBS Act, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal controls over financial reporting pursuant to Section 404. We could be an emerging growth company for up to five years. An independent assessment of the effectiveness of our internal controls could detect problems that our management's assessment might not. Undetected material weaknesses in our internal controls could lead to financial statement restatements and require us to incur the expense of remediation.
 
If we take advantage of specified reduced disclosure requirements applicable to an "emerging growth company" under the JOBS Act, the information that we provide to stockholders may be different than they might receive from other public companies.

As a company with less than $1 billion in revenue during our last fiscal year, we qualify as an "emerging growth company" under the JOBS Act. As an emerging growth company, we may take advantage of specified reduced disclosure and other requirements that are otherwise applicable generally to public companies. These provisions include:
 
·
Only two years of audited financial statements in addition to any required unaudited interim financial statements with correspondingly reduced "Management's Discussion and Analysis of Financial Condition and Results of Operations" disclosure.
   
·
Reduced disclosure about our executive compensation arrangements.
 
·
No non-binding advisory votes on executive compensation or golden parachute arrangements.
   
·
Exemption from the auditor attestation requirement in the assessment of our internal control over financial reporting.

We may take advantage of these exemptions for up to five years or such earlier time that we are no longer an emerging growth company. We would cease to be an emerging growth company if we have more than $1 billion in annual revenues, we have more than $700 million in market value of our stock held by non-affiliates, or we issue more than $1 billion of non-convertible debt over a three-year period. We may choose to take advantage of some but not all of these reduced burdens. We have not taken advantage of any of these reduced reporting burdens in this report, although we may choose to do so in future filings. If we do, the information that we provide stockholders may be different than you might get from other public companies in which you hold stock.

 
12

 
 
We are an “emerging growth company” and we cannot be certain if the reduced disclosure requirements applicable to emerging growth companies will make our common stock less attractive to investors.
 
The JOBS Act permits "emerging growth companies" like us to rely on some of the reduced disclosure requirements that are already available to companies having a public float of less than $75 million, for as long as we qualify as an emerging growth company or smaller reporting company. As long as we are qualified as “emerging growth company” or “smaller reporting company”, we are permitted to omit the auditor's attestation on internal control over financial reporting that would otherwise be required by the Sarbanes-Oxley Act. Companies with a public float of $75 million or more must otherwise procure such an attestation beginning with their second annual report after their initial public offering. For as long as we qualify as an emerging growth company, we are also excluded from the requirement to submit "say-on-pay", "say-on-pay frequency" and "say-on-parachute" votes to our stockholders and may avail ourselves of reduced executive compensation disclosure compared to larger companies.
 
In addition, Section 107 of the JOBS Act also provides that, as an emerging growth company, we can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. We can therefore delay the adoption of certain accounting standards until those standards would otherwise apply to private companies.  We have elected to take advantage of the benefits of this extended transition period. Our financial statements may therefore not be comparable to those of companies that comply with such new or revised accounting standards. Please refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations — Critical Accounting Policies and Estimates" for further discussion of the extended transition period for complying with new or revised accounting standards.
 
Until we cease to be an emerging growth company, we cannot predict if investors will find our common stock less attractive because we may rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile.
 
Risks Related to our Business

Our failure to effectively compete in the waste processing market may have a material adverse effect on our growth prospects and our ability to generate revenue.

We currently compete primarily on the basis of our ability to secure contracts with waste processing companies, and local government entities in Jiangsu Province, China and surrounding areas for  the updating of waste processing equipment.  The Company is embarking on a new area of growth in licensing the use of our patented technology used in these updates and in beginning to establish our own waste processing centers.  There can be no absolute assurance that we will be able to complete such expansion without losses or that our competitors will not develop at a faster rate and offer more favorable arrangements to our current and future customers. We expect that we will be required to continue to invest in research and development and building waste treatment and disposal infrastructure.

Our competitors include both domestic companies and international companies operating in the waste processing industry in China. Some of these competitors have significantly greater financial and marketing resources and name recognition than that of our company at this point. As the Chinese government continues to support and encourage the development of the environmentally sound waste processing industry, more domestic and international competitors may enter the market. We believe that the Chinese market for our services is subject to intense regional competition, with a relatively limited number of large competitors. While the Company effectively competes in our current focus of updating waste processing equipment for centers in our primary regional market of Jiangsu Province and surrounding areas, our reach outside this primary market and beyond our current focus has yet to be tested and we will necessarily face new competitors in the other geographic markets into which we plan to expand. If the Chinese government continues to emphasize the spending on environmental protection and continues to allocate funds to our industry, the number of our competitors throughout China, both domestic and foreign companies, will likely increase, so we cannot assure you that we will be able to compete successfully against any new or existing competitors, or against any new technologies our competitors may develop or implement.  All of these competitive factors could have a material adverse effect on our revenues, profitability and growth prospects.
 
 
13

 
 
The waste processing industry is highly regulated and our business depends on governmental permits and certifications to operate our business, the loss of any of which would have a material adverse impact on our business.
 
Only those companies that have been granted operating licenses issued by the PRC central and local governments are permitted to engage in the industrial waste treatment and disposal business in China. Our company is currently fully licensed to carry out our core business of updating and improving waste processing equipment, however, expansion into our own waste processing center in the future will require new licenses for which we will apply. The central and local governments of the PRC impose strict requirements on companies regarding the technology which must be employed and the qualifications and training of management employees which must be maintained. While we possess the necessary permits and certifications to operate our business, our regulatory approvals authorizing our operations and activities are subject to periodic review, reassessment and renewal by Chinese authorities.  Standards of compliance necessary to pass such reviews change from time to time and differ from jurisdiction to jurisdiction, leading to a degree of uncertainty. If our licenses and permits are revoked, substantially modified or not renewed or if additional permits, business licenses or approvals that may become necessary in connection with our business are not granted or are delayed, we may suffer adverse consequences. As a result, the termination or suspension of our licenses to operate would have a material adverse impact on our revenue and business.
 
If we fail to introduce new products or services or our existing products and services do not meet the requirements of our customers, we may not gain or may lose market share.

Our continued growth is dependent upon our ability to generate increased revenue from our existing customers, obtain new customers and raise capital from outside sources. While our current technology is at the forefront of industry developments, in order to maintain that advantage we will need to continue to pursue innovative solutions to meet our customers’ needs. We believe that in order to continue to capture additional market share and generate additional revenue, we will have to raise more capital to fund the construction and installation of new facilities and to obtain additional equipment to collect, process and dispose of industrial waste and recycle waste for our existing and future customers. We anticipate that such funding will be provided through a variety of sources including bank loans, equity financing and net cash flow generated from operations.
 
In the future we may be unable to obtain the necessary financing for our capital requirements on a timely basis or on acceptable terms, which may prevent or delay the planned expansion of our service offerings. Our failure to provide new products or services may prevent us from retaining customers or gaining new customers, which may adversely affect our financial position, competitive position, growth and profitability. Our ability to obtain acceptable financing at any time may depend on a number of factors, including, our financial condition and results of operations; the condition of the PRC economy and the industrial waste treatment industry in the PRC, and conditions in relevant financial markets in the United States, PRC and elsewhere in the world.

The rapid expansion of our business could strain our resources and adversely affect our ability to effectively control and manage our growth.

If our business and markets grow and develop as planned, it will be necessary for us to finance and manage expansion in an efficient mannor. We may face challenges in managing our waste processing equipment updating business over an expanded geographical area as well as managing expanded service offerings, including, among other things, waste processing services and patent licensing. Such eventualities will increase demands on our existing management, workforce and facilities. Failure to satisfy such increased demands could interrupt or adversely affect our operations and cause administrative inefficiencies.

Waste processing operations can be hazardous and may subject us to civil liabilities as a result of hazards posed by such operations.

Waste processing operations are subject to potential hazards incident to the gathering, processing and storage of industrial hazardous waste such as explosions, product spills, leaks, emissions and fires. These hazards can cause personal injury and loss of life, severe damage to and destruction of property and equipment, and pollution or other environmental damage, and may result in the curtailment or suspension of operations at the affected facility. Consequently, we may face civil liabilities in the ordinary course of our business as we update the equipment which performs this process at clients’ waste processing plants and as we branch into our own waste processing business. As the environmental protection industry in China is in its developing stage, there is no comprehensive insurance available to cover environmental liabilities. Although we have not faced any civil liabilities in the ordinary course of our waste processing equipment updating operations, there is no assurance that we will not face such liabilities in the future. If such liabilities occur in the future, they may have a material adverse effect on our results of operations, financial condition and business prospects.

Our success depends on our management team and other key personnel, the loss of any of whom could disrupt our business operations and have a material adverse effect on our financial condition, operating results and growth prospects.

Our success to date has been largely due to the contributions of our current management team, especially Chairman Li Yuan. The continued success of our business is very much dependent on the experience of the members of our management team and the goodwill that they have developed in the industry to date. As a result, our continued success is dependent, to a large extent, on our ability to retain the services of our management team and key personnel. The loss of the services of any of our management team or key personnel due to resignation, retirement, illness or otherwise without suitable replacement or the inability to attract and retain qualified personnel would have a material adverse effect on our operations and may reduce our profitability and the return on your investment. We do not currently maintain key man insurance covering our key personnel.
 
 
14

 
 
If we fail to adequately protect or enforce our intellectual property rights, we may be exposed to intellectual property infringement and the value of our intellectual property rights could diminish.
 
If we need to initiate litigation or administrative proceedings to enforce or protect our intellectual property rights, such actions may be costly and may divert management attention as well as expend other resources which could otherwise have been devoted to our business. An adverse determination in any such litigation could impair our intellectual property rights and may harm our business, prospects and reputation. In addition, historically, implementation of PRC intellectual property-related laws has been lacking, primarily because of ambiguities in the PRC laws and difficulties in enforcement. Accordingly, intellectual property rights and confidentiality protections in China may not be as effective as in the United States or other countries, which increases the risk that we may not be able to adequately protect our intellectual property. Given the relative unpredictability of China’s legal system and potential difficulties enforcing a court judgment in China, there is no guarantee that we would be able to halt any unauthorized use of our intellectual property through litigation which may cause us to lose our competitive advantage and adversely affect our business and profitability.

We may face claims for infringement of third-party intellectual property rights.

We may face claims from third parties in respect of the infringement of any intellectual property rights owned by such third parties. There is no assurance that third parties will not assert claims to our processes, technologies and systems. In such an event, we may need to acquire licenses to, or to contest the validity of, issued or pending patents or claims of third parties. There can be no assurance that any license acquired under such patents would be made available to us on acceptable terms, if at all, or that we would prevail in any such contest. In addition, we would incur substantial costs and spend substantial amounts of time in defending ourselves in or contesting suits brought against us for alleged infringement of another party’s patent rights. As such, our operations and business may be adversely affected by such civil actions. We rely on trade secrets, technology and know-how. There can be no assurance that other parties may not obtain knowledge of our trade secrets and processes, technology and systems. Should these events occur, our business would be affected and our profitability reduced.

A significant portion of our revenue is dependent on our improvement and upgrading business.  As our improvement and upgrading business have become dependent on only a limited few customers, such dependency may have a material adverse effect on our business, operating results and financial condition.
  
Our improvement and upgrading business greatly relies on our ability to maintain and continue to develop our customer base. Our improvement and upgrading business generated revenue from three customers for the fiscal year of 2014. Should any of our current customers cease to require the use of our service, and if we are unable to grow our customer base on a timely basis, our operations, revenue and profitability could be materially and adversely affected.
 
BOT (Build-Operate-Transfer) projects that we may be awarded could be adversely affected by cost overruns, project delays and/or incorrect estimation of project costs.

The company plans to establish its own waste processing centers as an extension of its current business.  However, any future BOT projects we may be awarded will require us to incur high up-front expenditures.  Therefore, it is important that we manage such projects efficiently in terms of time, procurement of materials and allocation of resources. If our initial cost estimates are incorrect or delays occur in a project resulting in cost overruns, the profitability of that project could be adversely affected. Cost overruns due to additional rectification work and delays in completion of projects or delivery of waste to our new processing center would adversely affect our profitability. We may also face potential liability from legal suits brought against us by our government customers for causing loss due to any delay in completing a project. In addition, we may also face potential liability from legal suits brought against us by our customers who have suffered loss due to such mismanagement or mistakes. This would also adversely affect our profitability and financial position.

Substantially all of our business operations are concentrated in Jiangsu and surrounding areas, and expose us to regional economic or market declines.
 
Substantially all of our revenues are generated from Jiangsu, China. Our current customer base is comprised of companies located in Jiangsu and surrounding areas. As a result, any adverse economic developments in Jiangsu could affect regional waste generation rates and demand for waste processing services which we intend to provide in the future or waste processing equipment upgrades which we currently provide to waste processing centers in Jiangsu. In addition, adverse market developments caused by increased waste disposal capacity from our competitors in this region could adversely affect waste disposal pricing. While one of our main growth strategies is to expand into other geographic markets in China, the occurrence of any adverse economic developments in Jiangsu and surrounding areas could have a material adverse effect on our business, financial condition and growth prospects.

 
15

 
 
We are subject to risks relating to expanding into other geographic markets in China outside of our principal market of Jiangsu.
 
To take advantage of industrialization outside of Jiangsu and to expand our service offerings to other geographic markets, we plan to establish centers for waste processing both within Jiangsu and expanding into other areas of the country. We intend to build and operate waste treatment facilities gradually as the company develops as a commercial zone.

Expansion into new geographic markets will require us to comply with rules and regulations of the applicable local government, and to address certain business issues particular to each market depending on the development and demand of customers within that market. As a result, there may be a significant period of time before any facility that we construct develops a consistent revenue stream. Accordingly, any delays or interruptions in implementing our expansion strategy or our business operations outside of Jiangsu may have a material adverse effect on our growth prospects, profitability and financial condition.

Relaxed enforcement of PRC environmental laws and governmental approvals and non-compliance by new and existing customers could have an adverse effect on our business, financial condition and growth prospects.

Companies operating in the waste treatment and disposal industry are subject to China’s national Environmental Protection Law as well as a number of other national and local laws and regulations governing air, water, noise pollution and establishing pollutant discharge standards. In addition, such companies are subject to stringent licensing and certification requirements imposed by the PRC Ministry of Environmental Protection and the provincial environmental bureaus, which has created high barriers to entry for potential market participants.  However, the urbanization and industrialization from China’s rapid economic growth has created an increased need for waste treatment services from solid waste disposal to sewage and sludge treatment. In order to help meet the demand for such services, the central government may not strictly enforce the compliance with environmental laws and relax certain conditions to gaining governmental licensing and approvals.  If such an event were to occur, there would be more competitors to our business operations and customers may turn to less expensive competitors for their waste disposal needs, which in turn, would have an adverse effect on our business, financial condition and grow prospects.

Fluctuations in exchange rates could adversely affect our business and the value of our securities

The value of our common stock will be indirectly affected by the foreign exchange rate between U.S. dollars and RMB and between those currencies and other currencies in which our sales may be denominated. Appreciation or depreciation in the value of the RMB relative to the U.S. dollar would affect our financial results reported in U.S. dollar terms without giving effect to any underlying change in our business or results of operations. Fluctuations in the exchange rate will also affect the relative value of any dividend we issue that will be exchanged into U.S. dollars as well as earnings from, and the value of, any U.S. dollar-denominated investments we make in the future.
 
Since July 2005, the RMB is no longer pegged to the U.S. dollar. Although the People’s Bank of China regularly intervenes in the foreign exchange market to prevent significant short-term fluctuations in the exchange rate, the RMB may appreciate or depreciate significantly in value against the U.S. dollar in the medium to long term. Moreover, it is possible that in the future PRC authorities may lift restrictions on fluctuations in the RMB exchange rate and lessen intervention in the foreign exchange market.
 
Very limited hedging transactions are available in China to reduce our exposure to exchange rate fluctuations. To date, we have not entered into any hedging transactions. While we may enter into hedging transactions in the future, the availability and effectiveness of these transactions may be limited, and we may not be able to successfully hedge our exposure at all. In addition, our foreign currency exchange losses may be magnified by PRC exchange control regulations that restrict our ability to convert RMB into foreign currencies.

 
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Under the EIT Law, we may be classified as a ‘resident enterprise’ of China

Under the New Income Tax Law, enterprises established outside the PRC whose "de facto management bodies" are located in the PRC are considered "resident enterprises" and their global income will generally be subject to the uniform 25.0% enterprise income tax rate. On December 6, 2007, the PRC State Council promulgated the Implementation Regulations on the New Income Tax Law (the "Implementation Regulations"), which define "de facto management bodies" as bodies that have material and overall management control over the business, personnel, accounts and properties of an enterprise. In addition, a recent circular issued by the State Administration of Taxation on April 22, 2009 provides that a foreign enterprise controlled by a PRC company or a PRC company group will be classified as a "resident enterprise" with its "de facto management bodies" located within the PRC if the following requirements are satisfied:
 
(i)    
the senior management and core management departments in charge of its daily operations function mainly in the PRC;
   
(ii)     
its financial and human resources decisions are subject to determination or approval by persons or bodies in the PRC;
   
(iii)      
its major assets, accounting books, company seals, and minutes and files of its board and shareholders' meetings are located or kept in the PRC; and
   
(iv)       
more than half of the enterprise's directors or senior management with voting rights reside in the PRC.
 
Because the EIT Law, its implementing rules and the recent circular are relatively new, no official interpretation or application of this new "resident enterprise" classification is available. Therefore, it is unclear how tax authorities will determine tax residency based on the facts of each case.

If the PRC tax authorities determine that we are a "resident enterprise" for PRC enterprise income tax purposes, a number of unfavorable PRC tax consequences could follow. First, we may be subject to the enterprise income tax at a rate of 25% on our worldwide taxable income as well as PRC enterprise income tax reporting obligations. In our case, this would mean that non-China source income would be subject to PRC enterprise income tax at a rate of 25%. Second, although under the EIT Law and its implementing rules dividends paid to us from our PRC subsidiary would qualify as "tax-exempt income," we cannot guarantee that such dividends will not be subject to a 10% withholding tax, as the PRC foreign exchange control authorities, which enforce the withholding tax, have not yet issued guidance with respect to the processing of outbound remittances to entities that are treated as resident enterprises for PRC enterprise income tax purposes. Finally, it is possible that future guidance issued with respect to the new "resident enterprise" classification could result in a situation in which a 10% withholding tax is imposed on dividends we pay to our non-PRC stockholders and with respect to gains derived by our non-PRC stockholders from transferring our shares.
 
If we were treated as a "resident enterprise" by PRC tax authorities, we would be subject to taxation in both the U.S. and China, and our PRC tax may not be creditable against our U.S. tax.

We do not carry business interruption insurance so we could incur unrecoverable losses if our business is interrupted

We are subject to risk inherent to our business, including equipment failure, theft, natural disasters, industrial accidents, labor disturbances, business interruptions, property damage, product liability, personal injury and death. We do not carry any business interruption insurance or third-party liability insurance or other insurance to cover risks associated with our business. As a result, if we suffer losses, damages or liabilities, including those caused by natural disasters or other events beyond our control and we are unable to make a claim against a third party, we will be required to bear all such losses from our own funds, which could have a material adverse effect on our business, financial condition and results of operations.

We will incur increased costs as a result of operating as a public company, and our management will be required to devote substantial time to new compliance initiatives.

As a public company, we will incur significant legal, accounting and other expenses that we did not incur as a private company. We will be subject to the reporting and other requirements of the Securities Exchange Act of 1934, as amended, or the Exchange Act, the Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, and the Dodd-Frank Wall Street Reform and Protection Act. These rules and regulations will require, among other things, that we file annual, quarterly and current reports with respect to our business and financial condition and establish and maintain effective disclosure and financial controls and corporate governance practices. We expect these rules and regulations to substantially increase our legal and financial compliance costs and to make some activities more time-consuming and costly, particularly after we are no longer an "emerging growth company" as defined in the recently enacted Jumpstart Our Business Startups Act of 2012, or the JOBS Act. Our management and other personnel will need to devote a substantial amount of time to these compliance initiatives.

 
17

 
 
Risks Related to Doing Business in the PRC

We face the risk that changes in the policies of the PRC government could have a significant impact upon the business we may be able to conduct in the PRC and the profitability of such business.

The PRC’s economy is in a transition from a planned economy to a market oriented economy subject to five-year and annual plans adopted by the central government that set national economic development goals. Policies of the PRC government can have significant effects on the economic conditions of the PRC. The PRC government has confirmed that economic development will follow the model of a market economy. Under this direction, we believe that the PRC will continue to strengthen its economic and trading relationships with foreign countries and business development in the PRC will follow market forces. While we believe that this trend will continue, we cannot assure you that this will be the case. A change in policies by the PRC government could adversely affect our interests by, among other factors: changes in laws, regulations or the interpretation thereof, confiscatory taxation, restrictions on currency conversion, imports or sources of supplies, or the expropriation or nationalization of private enterprises. Although the PRC government has been pursuing economic reform policies for more than two decades, we cannot assure you that the 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 other circumstances affecting the PRC's political, economic and social environment.
 
Introduction of new laws or changes to existing laws by the PRC government may adversely affect our business.

The PRC legal system is a codified legal system made up of written laws, regulations, circulars, administrative directives and internal guidelines. Unlike common law jurisdictions like the U.S., decided cases (which may be taken as reference) do not form part of the legal structure of the PRC and thus have no binding effect on subsequent cases with similar issues and fact patterns. Furthermore, in line with its transformation from a centrally-planned economy to a more free market-oriented economy, the PRC government is still in the process of developing a comprehensive set of laws and regulations. As the legal system in the PRC is still evolving, laws and regulations or the interpretation of the same may be subject to further changes. For example, the PRC government may impose restrictions on the amount of service fees that may be payable by municipal governments to wastewater and sludge treatment service providers. Also, the PRC central and municipal governments may impose more stringent environmental regulations which would affect our ability to comply with, or our costs to comply with, such regulations. Such changes, if implemented, may adversely affect our business operations and may reduce our profitability.

The PRC laws and regulations governing our current business operations are sometimes vague and uncertain. Any changes in such PRC laws and regulations may have a material adverse effect on our business.
 
There are substantial uncertainties regarding the interpretation and application of PRC laws and regulations, including, but not limited to, the laws and regulations governing our business, or the enforcement and performance of our arrangements with customers in the event of the imposition of statutory liens, death, bankruptcy and criminal proceedings. We are required to comply with PRC laws and regulations. These laws and regulations are sometimes vague and may be subject to future changes, and their official interpretation and enforcement may involve substantial uncertainty. The effectiveness of newly enacted laws, regulations or amendments may be delayed, resulting in detrimental reliance by foreign investors. New laws and regulations that affect existing and proposed future businesses may also be applied retroactively. We cannot predict what effect the interpretation of existing or new PRC laws or regulations may have on our operations, financial condition, and business prospects.

A slowdown or other adverse developments in the PRC economy or other major economies all over the world may have a material adverse effect on our customers’ demand for our services and our business.
 
All of our revenues are currently generated in the PRC where all of our business operations are conducted. Although the PRC economy has grown significantly in recent years, we cannot assure you that such growth will continue. Moreover, China enjoys an export-oriented economy and it relies on external demand. The industrial waste treatment industry in the PRC is relatively new and growing, but we do not know how sensitive we are to a slowdown in economic growth or other adverse changes in the PRC economy which may affect demand for our products and services. A slowdown in overall economic growth, an economic downturn or recession or other adverse economic developments in the PRC or other major economies all over the world may materially reduce the demand for our products and services, which could have a material adverse effect on our business. 

Inflation in the PRC could negatively affect our profitability and growth.
 
While the PRC economy has experienced rapid growth, such growth has been uneven among various sectors of the economy and in different geographical areas of the country. Rapid economic growth can lead to growth in the money supply and rising inflation. In order to control inflation in the past, the PRC government has imposed controls on bank credits, limits on loans for fixed assets and restrictions on state bank lending. Such an austere policy can lead to a slowing of economic growth, which may have an adverse effect on our business operations and financial condition.

Governmental control of currency conversion may affect the value of your investment.

The PRC government imposes controls on the convertibility of Renminbi, or RMB, into foreign currencies and, in certain cases, the remittance of currency out of the PRC. We receive all of our revenues in RMB, which is currently not a freely convertible currency. Shortages in the availability of foreign currency may restrict our ability to remit sufficient foreign currency to pay expenses and dividends, or otherwise satisfy foreign currency dominated obligations. Under existing PRC foreign exchange regulations, payments of current account items, including profit distributions, interest payments and expenditures from the transaction, can be made in foreign currencies without prior approval from the PRC State Administration of Foreign Exchange, or SAFE, by complying with certain procedural requirements. However, approval from appropriate governmental authorities is required where RMB is to be converted into foreign currency and remitted out of PRC to pay capital expenses such as the repayment of bank loans denominated in foreign currencies.
 
The PRC government also may at its discretion restrict access in the future to foreign currencies for current account transactions. If the foreign exchange control system prevents us from obtaining sufficient foreign currency to satisfy our currency demands, we may not be able to pay certain of our expenses as they come due.

 
18

 
 
The fluctuation of RMB may materially and adversely affect your investment.

The value of the RMB against the U.S. dollar and other currencies may fluctuate and is affected by, among other things, changes in the PRC's political and economic conditions. As we rely entirely on revenues earned in the PRC, any significant revaluation of RMB may materially and adversely affect our cash flows, revenues and financial condition. For example, to the extent that we need to convert U.S. dollars we receive from an offering of our securities into RMB for our operations, appreciation of the RMB against the U.S. dollar could cause the RMB equivalent of U.S. dollars to be reduced and therefore could have a material adverse effect on our business, financial condition and results of operations. Conversely, if we decide to convert our RMB into U.S. dollars for the purpose of making dividend payments on our common stock or for other business purposes and the U.S. dollar appreciates against the RMB, the U.S. dollar equivalent of the RMB we convert would be reduced. In addition, the depreciation of significant U.S. dollar denominated assets could result in a change to our operations and a reduction in the value of these assets.
  
Because our principal assets are located outside of the United States and all of our directors and all our officers reside outside of the United States, it may be difficult for you to enforce your rights based on U.S. Federal Securities Laws against us and our officers and directors or to enforce a judgment of a United States court against us or our officers and directors in the PRC.

All of our directors and officers reside outside of the United States. In addition, substantially all of our assets are located outside of the United States. It may therefore be difficult for investors in the United States to enforce their legal rights based on the civil liability provisions of the U.S. Federal securities laws against us in the courts of either the U.S. or the PRC and, even if civil judgments are obtained in U.S. courts, to enforce such judgments in PRC courts. Further, it is unclear if extradition treaties now in effect between the United States and the PRC would permit effective enforcement against us or our officers and directors of criminal penalties, under the U.S. Federal securities laws or otherwise.

Adverse changes in economic and political policies of the PRC government could have a material adverse effect on the overall economic growth of China, which could adversely affect our business.

Substantially all of our business operations are conducted in China. Accordingly, our results of operations, financial condition and prospects are subject to a significant degree to economic, political and legal developments in China. China’s economy differs from the economies of most developed countries in many respects, including with respect to the amount of government involvement, level of development, growth rate, and control of foreign exchange and allocation of resources.

Since the adoption of the “open door policy” in 1978 and the “socialist market economy” in 1993, the PRC government has been reforming and is expected to continue to reform its economic and political systems. Any changes in the political or economic policy of the PRC government may lead to changes in the laws and regulations or the interpretation of the same, as well as changes in the foreign exchange regulations, taxation and import and export restrictions, which may in turn adversely affect our financial performance. While the current policy of the PRC government seems to be one of imposing economic reform policies to encourage foreign investments and greater economic decentralization, there is no assurance that such a policy will continue to prevail in the future.

While the PRC economy has experienced significant growth in the past 30 years, growth has been uneven across different regions and among various economic sectors of China. The PRC government has implemented various measures to encourage economic development and guide the allocation of resources. Some of these measures benefit the overall PRC economy, but may also have a negative effect on us. For example, our financial condition and results of operations may be adversely affected by government control over capital investments or changes in tax regulations that are applicable to us. Since early 2004, the PRC government has implemented certain measures to control the pace of economic growth. Such measures may cause a decrease in the level of economic activity in China, including the manufacturing output of our customers, which, in turn, could adversely affect our results of operations, financial condition and business prospects. 

Failure to comply with the U.S. Foreign Corrupt Practices Act and Chinese anti-corruption laws could subject us to penalties and other adverse consequences.

We are required to comply the China’s anti-corruption laws and the United States Foreign Corrupt Practices Act, which generally prohibits U.S. companies from engaging in bribery or other prohibited payments to foreign officials for the purpose of obtaining or retaining business. In addition, we are required to maintain records that accurately and fairly represent our transactions and have an adequate system of internal accounting controls. Foreign companies, including some of our competitors, are not subject to these prohibitions. Corruption, extortion, bribery, pay-offs, theft and other fraudulent practices occur from time-to-time in mainland China. If our competitors engage in these practices, they may receive preferential treatment from personnel of some companies, giving our competitors an advantage in securing business or from government officials who might give them priority in obtaining new licenses, which would put us at a disadvantage. Although we inform our personnel that such practices are illegal, we cannot assure you that our employees or other agents will not engage in such conduct for which we might be held responsible. If our employees or other agents are found to have engaged in such practices, we could suffer severe penalties and other consequences that may have a material adverse effect on our business, financial condition and results of operations. In addition, our brand and reputation, our sales activities or the price of our ordinary shares could be adversely affected if we become the target of any negative publicity as a result of actions taken by our employees or other agents.

 
19

 
 
We do not have liability business interruption, litigation or natural disaster insurance.

The insurance industry in China is still at an early stage of development. In particular PRC insurance companies offer limited business products. As a result, we do not have any business liability, disruption insurance or any other forms of insurance coverage for our operations in China. Any potential liability, business interruption, litigation or natural disaster may result in our business incurring substantial costs and the diversion of resources.

Restrictions under PRC law on our PRC subsidiary’s ability to make dividends and other distributions could materially and adversely affect our ability to grow, make investments or complete acquisitions that could benefit our business, pay dividends to you, and otherwise fund and conduct our businesses.

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

Failure to comply with PRC regulations relating to the Foreign Exchange Registration for Oversea Investment and Return Investment by PRC resident.

In October 2005, SAFE issued the Notice on Relevant Issues in the Foreign Exchange Control over Financing and Return Investment Through Special Purpose Companies by Residents Inside China, generally referred to as Circular 75, which required PRC residents to register with the competent local SAFE branch before establishing or acquiring control over an offshore special purpose company, or SPV, for the purpose of engaging in an equity financing outside of China on the strength of domestic PRC assets originally held by those residents. Internal implementing guidelines issued by SAFE, which became public in June 2007 (known as Notice 106), expanded the reach of Circular 75 by (1) purporting to cover the establishment or acquisition of control by PRC residents of offshore entities which merely acquire “control” over domestic companies or assets, even in the absence of legal ownership; (2) adding requirements relating to the source of the PRC resident’s funds used to establish or acquire the offshore entity; covering the use of existing offshore entities for offshore financings; (3) purporting to cover situations in which an offshore SPV establishes a new subsidiary in China or acquires an unrelated company or unrelated assets in China; and (4) making the domestic affiliate of the SPV responsible for the accuracy of certain documents which must be filed in connection with any such registration, notably, the business plan which describes the overseas financing and the use of proceeds.  Amendments to registrations made under Circular 75 are required in connection with any increase or decrease of capital, transfer of shares, mergers and acquisitions, equity investment or creation of any security interest in any assets located in China to guarantee offshore obligations, and Notice 106 makes the offshore SPV jointly responsible for these filings. In the case of an SPV which was established, and which acquired a related domestic company or assets, before the implementation date of Circular 75, a retroactive SAFE registration was required to have been completed before March 31, 2006; this date was subsequently extended indefinitely by Notice 106, which also required that the registrant establish that all foreign exchange transactions undertaken by the SPV and its affiliates were in compliance with applicable laws and regulations.  Failure to comply with the requirements of Circular 75, as applied by SAFE in accordance with Notice 106, may result in fines and other penalties under PRC laws for evasion of applicable foreign exchange restrictions. Any such failure could also result in the SPV’s affiliates being impeded or prevented from distributing their profits and the proceeds from any reduction in capital, share transfer or liquidation to the SPV, or from engaging in other transfers of funds into or out of China.
 
We have advised our shareholders who are PRC residents, as defined in Circular 75, to register with the relevant branch of SAFE, as currently required, in connection with their equity interests in us and our acquisitions of equity interests in our PRC subsidiary and affiliate. However, we cannot provide any assurances that their existing registrations have fully complied with, and they have made all necessary amendments to their registration to fully comply with, all applicable registrations or approvals required by Circular 75. Moreover, because of uncertainty over how Circular 75 will be interpreted and implemented, and how or whether SAFE will apply it to us, we cannot predict how it will affect our business operations or future strategies. For example, our present and prospective PRC subsidiary’s and affiliate’s ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our PRC resident beneficial holders. In addition, such PRC residents may not always be able to complete the necessary registration procedures required by Circular 75. We also have little control over either our present or prospective direct or indirect shareholders or the outcome of such registration procedures. A failure by our PRC resident beneficial holders or future PRC resident shareholders to comply with Circular 75, if SAFE requires it, could subject these PRC resident beneficial holders to fines or legal sanctions, restrict our overseas or cross-border investment activities, limit our subsidiary’s and affiliate’s ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects.
 
 
20

 
 
RISKS RELATING TO OUR VIE AGREEMENTS
 
The PRC government may determine that the VIE Agreements are not in compliance with applicable PRC laws, rules and regulations.
 
Baichuang Consulting provides support and consulting services to Jiangsu Xuefeng pursuant to the VIE Contractual Agreements.  Almost all economic benefits and risks arising from Jiangsu Xuefeng’s operations are transferred to Baichuang Consulting under these agreements.  Details of the VIE Agreements are set out in “DESCRIPTION OF BUSINESS – Contractual Arrangements with our Controlled Affiliate and its Shareholders” above.
 
There are risks involved with the operation of our business in reliance on the VIE Agreements, including the risk that the VIE Agreements may be determined by PRC regulators or courts to be unenforceable.  Our PRC counsel has provided a legal opinion that the VIE Agreements are binding and enforceable under PRC law, but has further advised that if the VIE Agreements were for any reason determined to be in breach of any existing or future PRC laws or regulations, the relevant regulatory authorities would have broad discretion in dealing with such breach, including:
 
      ●
imposing economic penalties;
 
      ●
discontinuing or restricting the operations of Baichuang Consulting or Jiangsu Xuefeng;
 
      ●
imposing conditions or requirements in respect of the VIE Agreements with which Baichuang Consulting or Jiangsu Xuefeng may not be able to comply;
 
      ●
requiring our company to restructure the relevant ownership structure or operations;
 
      ●
taking other regulatory or enforcement actions that could adversely affect our company’s business; and
 
      ●
revoking the business licenses and/or the licenses or certificates of Jiangsu Xuefeng, and/or voiding the VIE Agreements.
 
Any of these actions could adversely affect our ability to manage, operate and gain the financial benefits of Jiangsu Xuefeng, which would have a material adverse impact on our business, financial condition and results of operations.
 
Our ability to control Jiangsu Xuefeng under the VIE Agreements may not be as effective as direct ownership.
 
We conduct our business in the PRC and currently generate virtually all of our revenues through the VIE Agreements. Our plans for future growth are based substantially on growing the operations of Jiangsu Xuefeng.  However, the VIE Agreements may not be as effective in providing us with control over Jiangsu Xuefeng as direct ownership.  The VIE Agreements do not provide us with day-to-day control over the operations of Jiangsu Xuefeng.  Under the current VIE arrangements, as a legal matter, if Jiangsu Xuefeng fails to perform its obligations under these contractual arrangements, we may have to (i) incur substantial costs and resources to enforce such arrangements, and (ii) rely on legal remedies under PRC law, which we cannot be sure would be effective. Therefore, if we are unable to effectively control Jiangsu Xuefeng, it may have an adverse effect on our ability to achieve our business objectives and grow our revenues.
 
As the VIE Agreements are governed by PRC law, we would be required to rely on PRC law to enforce our rights and remedies under them; PRC law may not provide us with the same rights and remedies as are available in contractual disputes governed by the law of other jurisdictions.
 
The VIE Agreements are governed by PRC law and provide for the resolution of disputes through the jurisdiction of the courts in the PRC.  If Jiangsu Xuefeng or its shareholders fail to perform the obligations under the VIE Agreements, we would be required to resort to legal remedies available under PRC law, including seeking specific performance or injunctive relief, or claiming damages. We cannot be sure that such remedies would provide us with effective means of causing Jiangsu Xuefeng or its shareholders to meet their obligations, or recovering any losses or damages as a result of non-performance. Further, the legal environment in China is not as developed as in other jurisdictions. Uncertainties in the application of various laws, rules, regulations or policies in PRC legal system could limit our liability to enforce the VIE Agreements and protect our interests.
 
The payment arrangement under the VIE Agreements may be challenged by the PRC tax authorities.
 
We generate our revenues through the payments we receive pursuant to the VIE Agreements. Currently, all of our operations reside in the VIE which is required to pay our wholly owned subsidiary, Baichuang Consulting 95% of their earnings, as defined, plus a monthly consulting fee of RMB 100,000(U.S.$15,873).  We could face adverse tax consequences if the PRC tax authorities determine that the VIE Agreements were not entered into based on arm’s length negotiations. For example, PRC tax authorities may adjust our income and expenses for PRC tax purposes which could result in our being subject to higher taxes liability, or cause other adverse financial consequences.
 
 
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ITEM 1B.   UNRESOLVED STAFF COMMENTS

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

ITEM 2.  PROPERTIES

The Company leases office space under a one-year operating lease from an unrelated third party, which expired on March 31, 2013 and was extended to March 31, 2016.  The lease requires the Company to prepay the rental for one year of $7,267 (RMB 44,664). The related prepayments of $6,030 and $6,015 are included in the prepaid expenses on the consolidated balance sheets as of May 31, 2014 and 2013, respectively.  The lease provides for renewal options.  Rent expense charged to operations for the years ended May 31, 2014 and 2013 was $7,267 and $7,097, respectively.  The minimum future rentals under the lease as of May 31, 2014 are as follows:

Period Ending
     
May 31,
 
Amount
 
       
2015
   
1,212
 
2016
   
6,060
 
         
   
$
7,272
 
 
On March 23, 2012, Jiangsu Xuefeng entered into an agreement with an independent third party to acquire a 50-year land use right for construction of a factory facility for cash consideration of US$872,640, equivalent to RMB 5,400,000, of which US$808,000, equivalent to RMB 5,000,000 was paid before May 31, 2013.  As of May 31, 2013, no land use right certificate has been issued to the Company and thus the land used right has not been successfully acquired. In March 2014, the land use right acquisition agreement was terminated and the prior payment made by the Company under such agreement was returned to the Company.
  
ITEM 3.   LEGAL PROCEEDINGS
 
From time to time, we may become involved in various lawsuits and legal proceedings which arise in the ordinary course of business. However, litigation is subject to inherent uncertainties and an adverse result in these or other matters may arise from time to time that may harm our business. We are currently not aware of any such legal proceedings or claims that we believe will have a material adverse effect on our business, financial condition or operating results.
 
ITEM 4.  MINE SAFETY DISCLOSURES

Not applicable 

 
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PART II
 
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
 
Market Information

Our common stock has been quoted on the OTC Bulletin Board since May 9, 2012. Our initial symbol was “NYCM”. In January 2013, our symbol was changed to “CXEE”. The following table sets forth the range of the quarterly high and low bid price information from the first quote on February 27, 2013 to May 31, 2014 as reported by the OTC Bulletin Board.

   
High Bid* ($)
   
Low Bid* ($)
 
2014
           
                 
Fourth Quarter
   
3.90
     
3.68
 
Third Quarter
   
3.73
     
3.70
 
Second Quarter
   
3.72
     
3.62
 
First Quarter
   
3.70
     
3.20
 
2013
           
Fourth Quarter
   
3.50
     
2.66
 
From February 27, 2013 to February 28, 2013
   
2.60
     
2.60
 
 
* The quotations of the closing prices reflect inter-dealer prices, without retail mark-up, markdown or commission, and may not necessarily represent actual transactions.

The market price of our common stock is subject to significant fluctuations in response to variations in our quarterly operating results, general trends in the market, and other factors, over many of which we have little or no control. In addition, broad market fluctuations, as well as general economic, business and political conditions, may adversely affect the market for our common stock, regardless of our actual or projected performance.
 
Holders
 
As of August 26, 2014, there were approximately 1,077 stockholders of record of our common stock. This does not reflect the number of persons or entities who held stock in nominee or street name through various brokerage firms.
 
Dividends
 
Any future decisions regarding dividends will be made by our board of directors. We currently intend to retain and use any future earnings for the development and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. Our board of directors has complete discretion on whether to pay dividends, subject to the approval of our stockholders. Even if our board of directors decides to pay dividends, the form, frequency and amount will depend upon our future operations and earnings, capital requirements and surplus, general financial condition, contractual restrictions and other factors that the board of directors may deem relevant.
 
PRC regulations restrict the ability of our PRC subsidiary to make dividends and other payments to its offshore parent company. PRC legal restrictions permit payments of dividends by our PRC subsidiary only out of its accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC subsidiary is also required under PRC laws and regulations to allocate at least 10% of our annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amounts in said fund reaches 50% of our registered capital. Allocations to these statutory reserve funds can only be used for specific purposes and are not transferable to us in the form of loans, advances or cash dividends. Please refer to the section "Risk Factors — Risks Related to Doing Business In China.
 
Furthermore, our present PRC subsidiaries' ability to conduct foreign exchange activities, such as the remittance of dividends and foreign currency-denominated borrowings, may be subject to compliance with Circular 75 by our PRC resident beneficial holders. A failure by our PRC resident beneficial holders or future PRC resident stockholders to comply with Circular 75, if SAFE requires it, could limit our subsidiaries' ability to make distributions or pay dividends or affect our ownership structure, which could adversely affect our business and prospects. "Risk Factors — Risks Related to Doing Business In China.
 
 
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Recent Sales of Unregistered Securities

None.

ITEM 6.   SELECTED FINANCIAL DATA
 
Smaller reporting companies are not required to provide the information required by this item.

ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
This Management’s Discussion and Analysis of Financial Condition and Results of Operations is intended to provide a reader of our financial statements with a narrative from the perspective of our management on our financial condition, results of operations, liquidity, and certain other factors that may affect our future results.  The following discussion and analysis should be read in conjunction with our audited consolidated financial statements and the accompanying notes thereto included in “Item 8. Financial Statements and Supplementary Data.”

Overview

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

Our Services

As the urbanization in China progresses, the amount of household garbage increases. The processing capability of current garbage processing equipment in China cannot typically satisfy the increasing demands. We expand the garbage sorting scope and capacity of our clients’ garbage processing equipment, by installing the various systems that embody the patented technology “comprehensive and harmless garbage-processing equipment” into clients’ garbage processing equipment and reconstructing their hardware, to provide upgrades and improvement to their equipment.

The patent technology “harmless and comprehensive garbage processing equipment” helps to achieve high and stable garbage processing capacity, which uses Distributed Control System (DCS) to realize mechanical automation for the comprehensive garbage treatment. The 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 its resource utilization and harmless utilization rate approching 100%. The resource recovery products, biogas, can not only be used for meeting the needs of the plant itself, but also for outer supply, which greatly improves the efficiency of garbage processing of customer’s equipment, decreases production cost, and increases the recovery return of garbage processing.

The comprehensive and harmless garbage processing equipment is comprised of a waste digestion pretreatment system, methane gas power generation system, sorting processing system, bricklaying building system, leachate treatment system, DCS (distribution control system), XFET-5 ecological and water-saving toilets and excrement comprehensive processing system and various material collection systems. The equipment technology is designed and manufactured based on the complicated situation of the household garbage in China. To accommodate 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 a high processing capacity and can run the whole day. The stand-alone equipment can process 500 tons to 1000 tons of garbage per day. It can sort and process complicated municipal solid waste, leaving no pollution and no residue, reaching the "3 without" standard of no waste gas, no waste water and no waste residue.

 
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After we complete the internal system upgrade and hardware equipment improvement of the garbage equipment, we deliver the upgraded equipment to the customers. The customers will conduct inspection and performance testing of the upgraded equipment no more than one month pursuant to the contract. This inspection is to determine whether the internal control system and the hardware structure can operate steadily and reach the optimum garbage process features. The inspection is to determine the following: whether the quality of the equipment and accessories after improvement can match the patented technology and process various kinds of garbage, whether the various garbage systems can process automatically, and whether the daily garbage processing capacity reaches the standard of the contract. If during the performance testing period, we meet or exceed the requirements of the contract, it would be deemed that we have fully executed the agreements.

Prior to the first service agreement in April 2012, we did not conduct any business activities except for the preparation of the business and the development of the clients, etc. When we complete the upgrading service for the client, we go through the acceptance check and commissioning of the company in accordance with the contract, to make sure that the service provided met the demand of the clients. After that, we do not provide 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 are the responsibility of the clients.

Until August 31, 2012 the main revenue of Jiangsu Xuefeng was generated from providing improvement and upgrading services to garbage recycling processing plants. On August 5, 2012, Jiangsu Xuefeng entered into a lease agreement with Li Yuan, one of its stockholders for the use of a patent on garbage recycling processing technology, a Utility Model Patent of Comprehensive and Harmless Garbage Processing Equipment, issued by the State Intellectual Property Office (SIPO) on July 7, 2010 and valid for ten years (Patent Number: ZL 2009 2 0232893.7).  The patent is owned by our Chief Executive Officer, Mr. Li Yuan.  The lease commenced on September 1, 2012 and expires in August 2017.  Jiangsu Xuefeng expanded its business model from the sole service of providing upgrading to waste processing plants to also providing patent licensing based on its newly acquired use right of the patent technology.  We use the patent technology to help the clients to upgrade their internal system or reconstruct the hardware equipment of the garbage processing equipment so that the equipment performance could reach the standard of our patent technology. After the upgrade and reconstruction, our patent technology will continue to be used in their equipment and we allow the clients to continue using our patent technology in their equipment for patent licensing revenue. License agreements will be offered to clients for a limited period of three to five years, within which period, the client shall pay patent royalties yearly to Jiangsu Xuefeng for their use of the equipment containing the patent technology.
 
Therefore, under the new business model, Jiangsu Xuefeng generates its revenues from two sources: improvement and upgrading services of garbage processing equipment and patent licensing for the use of the upgraded technology.
 
For the year ended May 31, 2014, sales from improvement and upgrading services and patent licensing were $1,464,300 and $3,245,865, respectively.  

Recent Developments

Acquisition of Inclusion

The Company was organized in the state of Nevada on March 30, 2011. The Company was initially created to engage in the business of clothing distribution. Since its inception, the Company was in the development stage company and has not earned any revenue.

On November 27, 2012, we completed a reverse acquisition transaction through a share exchange with Inclusion and its stockholders, or the “Inclusion Stockholders”, whereby we acquired 100% of the issued and outstanding capital stock of Inclusion in exchange for our issuance of 7,895,000 shares of our common stock (pre-Forward Split), which constituted 76.65% of our issued and outstanding capital stock as of and immediately after the consummation of the reverse acquisition. As a result of the reverse acquisition, Inclusion became our wholly-owned subsidiary and the former Inclusion Stockholders became our controlling stockholders. The share exchange transaction has been treated as a reverse acquisition, with Inclusion as the acquirer and the Company as the acquired party for accounting purposes.

Prior to the closing of the reverse acquisition, the Company’s prior shareholder, Mr. Zhenxing Liu, surrendered 7,895,000 shares of the common stock of the Company. Mr. Zhenxing Liu did not receive any consideration from the Company for accounting purposes. However, Mr. Zhenxing Liu may be deemed to have received consideration from the increase in the value of 250,000 shares held by Mr. Zhenxing Liu as a result of the reverse acquisition. Mr. Zhenxing Liu purchased 8,145,000 shares at approximately $0.007 per share at the time when the Company was considered a shell and kept 250,000 shares after the surrender. On November 30, 2012, at the closing of the reverse acquisition, the stockholder’s equity increased to $5,194,728. Accordingly, the value of the 250,000 shares held by Mr. Zhenxing Liu appreciated to approximately $124,673. Other than such appreciation in the value of his shares, Mr. Zhenxing Liu did not receive any other consideration in connection with the reverse acquisition.

 
25

 
 
As a result of our acquisition of Inclusion, we now own all of the issued and outstanding capital stock of Lotus International Holdings Limited (“Lotus”), which in turn owns all of the issued and outstanding capital stock of Baichuang Information Consulting (Shenzhen) Co. Ltd (“Baichuang Consulting”). In addition, we effectively and substantially control Jiangsu Xuefeng through a series of captive agreements with Baichuang Consulting.

Subsequent to the closing of the Exchange Agreement, we conduct our operations through our controlled consolidated affiliate Jiangsu Xuefeng. Jiangsu Xuefeng is primarily engaged in providing improvement and upgrading services of garbage recycling processing technology and equipment. Jiangsu Xuefeng was incorporated under the laws of the People’s Republic of China (“PRC”) on December 14, 2007.

Name Change and Forward Stock Split

In connection with the acquisition of Inclusion, on November 27, 2012, the Company filed a certificate of amendment to its articles of incorporation to change its name from “NYC Moda, Inc.” to “China Xuefeng Environmental Engineering Inc.” (the “Name Change”) and effectuate a 4-for-1 forward stock split (the “Forward Split”) of its outstanding shares of common stock. The effective dates of the Name Change and the Forward Split were December 14, 2012 and December 17, 2012, respectively. Upon the effectiveness of the Forward Split, the number of outstanding shares of the Company’s common stock increased from 10,300,000 to 41,200,000 shares. The effect of the stock split was applied retroactively to all the periods’ consolidated financial statements as if the current structure existed since inception of the periods presented. The number of authorized shares of common stock remains at 75,000,000 shares.

Private Offering

On March 19, 2013, we completed a private offering (the “Offering”) of shares of the Company’s common stock, par value $0.001 per share (the “Shares”), at a price of $0.50 per share, for an aggregate purchase price of $7,000,000 (the “Purchase Price”). Upon the closing, the Company issued 14,000,000 shares of its common stock pursuant to the Offering.

Emerging Growth Company Status

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

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

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

 
26

 
 
Results of Operations
 
Year Ended May 31, 2014 compared to Year ended May 31, 2013
 
The following table sets forth in U.S. dollars key components of our audited results of operations during the year ended May 31, 2014 and 2013, and the percentage change between 2014 and 2013

   
Year Ended May 31,
 
 
2014
 
 
2013
   
Percentage
 
   
(U.S. $)
   
(U.S. $)
   
Change
 
                   
Revenue
 
$
4,710,165
   
$
5,426,435
     
(13
%)
Cost of revenue
   
(354,085
)
   
(524,734)
     
(33
%)
      Gross profit
   
4,356,080
     
4,901,701
     
(11
%)
    Selling expenses
   
97,520
     
66,166
     
47
%
    General and administrative expenses
   
391,546
     
350,174
        12
%
      Total operating expenses
   
489,066
     
416,340
        17
%
Operating income
   
3,867,014
     
4,485,361
     
(14
%)
    Interest income
   
62,041
     
11,630
     
433
%
Income before provision for income taxes
   
3,929,055
     
4,496,991
     
(13
%)
Provision for income taxes
   
982,264
     
1,124,273
     
(13
%)
Net income
   
2,946,791
     
3,372,718
     
(13
%)
    Noncontrolling interests
   
(140,671
)
   
(164,236)
     
(14
%)
Net income attributable to common stockholders
 
2,806,120
   
3,208,482
     
(13
%)

Revenue

We provide improvement and upgrading services for garbage processing equipment to our customers. This is a one-time service. We also lease the licensed patent to our customers. The patent licensing is limited to five years with payments due annually in advance.
 
 
27

 
 
Our sales for the year ended May 31, 2014 decreased by $716,270 or 13% compared the sales for the year ended May 31, 2013. The primary reason for the decrease in sales was a result that we did not sign new contracts for technical services in the last two quarters of 2014, but patent leasing revenue was increased by four new contracts comparing with the year ended May 31, 2013. The following table sets forth our revenue for the year ended May 31, 2014 and 2013:

   
Year Ended May 31
   
2014
   
2013
   
Percentage
 
   
(U.S. $)
   
(U.S. $)
   
Change
 
                   
Improvement and Upgrading Services
 
$
1,464,300
   
$
4,449,200
     
(67
%)
Patent Leasing
   
3,245,865
     
977,235
     
232
%
 Total
 
 $
4,710,165
   
5,426,435
     
(13
%)

Improvement and Upgrading Services

For the year ended May 31, 2014, revenue from improvement and upgrading services provided to three unrelated customers was $1,464,300. For the year ended May 31, 2013, revenue from improvement and upgrading services provided to ten unrelated customers was $4,449,200. The services were completed and accepted by the customers and the payments were received in full as of May 31, 2014 and 2013.

Patent Licensing

For the year ended May 31, 2014, revenue from patent leasing was generated from 12 unrelated customers of $3,245,865. For the year ended May 31, 2013, revenue from patent leasing was generated from eight unrelated customers of $977,235.

Cost of Revenues
 
Our cost of revenues decreased to $354,085 for the year ended May 31, 2014 from $524,734 for year ended May 31, 2013. The decrease in cost of revenues was mainly due to decreases including technical relevant training expenses and other relevant expenses directly associated with our technical department, e.g. entertainment, traveling expenses etc, as the decrease of system upgrade revenue in the year ended May 31, 2014. In addition, we were no longer subject to sales taxes effective December 1, 2012, which further contributed to the decrease in cost of revenues.

Our costs of revenues primarily consist of fees paid to the related party for licensing the patent, employees’ salaries, insurance, training expenses and other daily operating expenses. In addition, business taxes were classified as cost of revenues before December 1, 2012. Under China tax law, our business tax was changed to a value added tax after December 1, 2012, but we are exempt from the value added tax by the authority of the local tax bureau.

Gross Profit

Our business stream has resulted in a high gross margin because we have no cost of products to be sold. Our cost of revenue is almost entirely direct labor and patent licensing fees, and other operating expenses. As the result of decrease in technical and upgrading service revenue, our gross profit decreased to $4,356,080 for year ended May 31, 2014 from $4,901,701 for year ended May 31, 2013 which represented a gross profit ratio of 92% and 90%, respectively.
 
Selling and Marketing Expenses

Our selling and marketing expenses increased to $97,520 for year ended May 31, 2014 from $66,166 for year ended May 31, 2013 which represented an increase by 47%. Our selling and marketing expenses were primarily comprised of sales employees’ salaries, insurance, and advertising expenses. The total increase represented an increase in salaries, travelling, training, and entertainment expenses. The large increase was to try to expand over market by increasing the investment in market promotion.
 
 
28

 
 
General and Administrative Expenses

Our general and administrative expenses increased to $391,546 for year ended May 31, 2014 from $350,174 for year ended May 31, 2013, representing an 12% increase. Our general and administrative expenses were primarily comprised of employees’ salaries, insurance, rent, and professional fees

Provision for Income Taxes

Our provision for income taxes decreased to $982,264 for year ended May 31, 2014 from $1,124,273 for year ended May 31, 2013. Our effective tax rate for the years ended May 31, 2014 and 2013 was the statutory rate of 25%. Our tax filings for the year ended December 31, 2012 were examined by the tax authorities in April 2013. The tax filings were accepted and no adjustments were proposed by the tax authorities. The decrease in the provision for income taxes was primarily due to the decrease in our income.
 
Net Income

For the year ended May 31, 2014 and 2013, we generated net income of $2,946,791 and $3,372,718, respectively.  This represented a decrease in net income of $425,927 or 13%. The entrusted management agreements assign to Baichuang Consulting only 95% of the income generated from Jiangsu Xuefeng.  For that reason, we reflected a “non-controlling interest” of $140,671 and $164,236 for the years ended May 31, 2014 and 2013, respectively, before recognizing net income attributable to the common stockholders of the Company on our Consolidated Statements of Income and Comprehensive Income.  After the “non-controlling interest” deduction, our net income attributable to the common stockholders of the Company for the year ended May 31, 2014 and 2013 was $2,806,120 and $3,208,482, representing $0.05 and $0.07 per share, respectively.
 
Foreign Currency Translation Adjustment

 Our reporting currency is the U.S. dollar. Our local currency, Renminbi (RMB), is our functional currency. Results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People’s Bank of China at the end of the period. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of stockholders’ equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency are included in the results of operations as incurred. For the year ended May 31, 2014 and 2013, a foreign currency gain of $25,715 and $209,744, respectively, have been reported as other comprehensive income in the consolidated statements of income and other comprehensive income.

Liquidity and Capital Resources

As of May 31, 2014, we had cash and cash equivalents of $20,629,604, primarily consisting of cash on hand and demand deposits. The cash balance was principally derived from net proceeds of the private placement completed in March 2013 and cash provided from the operations. Despite our large cash balances, the interest income generated for the year ended May 31, 2014 was nominal for principally two reasons: the bank’s current deposit interest rate is very low, and the annual interest rates float up or down within 0.35% range; The interest income reported in our financial statements is the net interest after deducting bank service charges.
 
To date, we have financed our operations primarily through equity contributions by our stockholders, a private placement and cash flows from operations. We believe that our cash on hand and cash flows from operations will meet our present cash needs for the next 12 months.

Operating activities
 
Net cash provided by operating activities was $3,399,888 for the year ended May 31, 2014. Comparing with $4,859,227 for the year ended May 31, 2013, the difference was mainly due to the decrease in net income and income taxes payable only partially offset by an increase in deferred revenue.
 
Investing activities
 
Net cash used for investing activities represented a refund of the deposit related to a land use right of $813,500. For the year ended May 31, 2014 and 2013, $16,612 and $4,669 were used for purchase of equipment, respectively.
 
 
29

 
 
Financing activities
 
For the year ended May 31, 2014, the net cash provided by financing activities consists of net proceeds of the stockholder loan of $73,000. For the year ended May 31 2013 the net cash provided by financing activities consists of the net proceeds of the stockholder loan of $181,916, proceeds from the stockholder loan of $230,031 and the private placement proceeds of $7,000,000 from the sale of 14,000,000 common shares at $0.50 each in March 2013 only. The proceeds from the stockholder loan were utilized for the payment of professional services in the United States and the registration of Baichuang Consulting due to Chinese banks’ restriction of cash transfers.
 
We believe that our cash on hand and cash flows from operations will meet our present cash needs for the next 12 months.
 
Off-Balance Sheet Arrangements
 
We do not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition or results of operations.

 Transfer of Cash
 
All of our revenues are earned by Jiangsu Xuefeng, our PRC controlled consolidated affiliate and subsidiary. PRC regulations restrict the ability to make dividend and other payments to its offshore parent company. PRC legal restrictions permit payments of dividends only out of accumulated after-tax profits, if any, determined in accordance with PRC accounting standards and regulations. Our PRC controlled consolidated affiliate and subsidiary are also required under PRC laws and regulations to allocate at least 10% of their annual after-tax profits determined in accordance with PRC GAAP to a statutory general reserve fund until the amount of said fund reaches 50% of its registered capital. Allocations to this statutory reserve fund can only be used for specific purposes and are not transferable to us in the form of loans, advances or cash dividends. Any limitations on the ability of our PRC affiliate and subsidiary to transfer funds could materially and adversely limit our ability to grow, make investments or acquisitions that could be beneficial to our business, pay dividends and otherwise fund and conduct our business.
 
Lotus International Holdings Limited, a Hong Kong corporation and Baichuang Information Consulting (Shenzhen) Co., Ltd, a WFOE, is a bridge to transfer funds inside and outside the PRC. There are three ways for foreign cash to be transferred into Chinese subsidiaries:
 
(1) Capital funds: At the establishment of the WFOE, (Baichuang Consulting), in accordance with the provisions of PRC Foreign-Owned Enterprise Law, funds were injected as capital by Lotus International into its wholly foreign owned subsidiary established in mainland China, Baichuang Consulting.
 
(2) Raised capital - acquisition: if the Company raised sufficient capital, it could transfer the capital to Jiangsu Xuefeng by causing Lotus International (HK company) to apply to the Chinese Ministry of Commerce (MOFCOM) for approval of an acquisition of Jiangsu Xuefeng by Lotus International. MOFCOM would approve such an acquisition only after a lengthy review process, and only if it determined that the price paid by Lotus International for Jiangsu Xuefeng represented a commercially fair price.
 
(3) Raised capital - joint venture: If the Company obtained capital that was less than the purchase price for Jiangsu Xuefeng deemed acceptable by MOFCOM, Lotus International could still inject the funds into Jiangsu Xuefeng by complying with the provisions of the PRC Sino-Foreign Equity Joint Venture Law. To accomplish this capital transfer, we would be required to apply to the Chinese government for approval to convert Jiangsu Xuefeng into an equity joint venture, in which Lotus International (HK company) would be its equity joint venture. If approved, Lotus International would then own a portion of the equity in Jiangsu Xuefeng, and the VIE agreements between Jiangsu Xuefeng and Baichuang Consulting (WFOE) would be modified accordingly to reduce the portion of net income payable by Jiangsu Xuefeng to Baichuang Consulting.
 
 
30

 
 
We have no current plans for the Company to fund Jiangsu Xuefeng, and expect the VIE structure to remain in place for the foreseeable future.
 
Pursuant to the Exclusive Technical Service and Business Consulting Agreement between Baichuang Consulting (WFOE) and Jiangsu Xuefeng, Baichuang Consulting is to provide technical support and consulting services to Jiangsu Xuefeng in exchange for (i) 95% of the total annual net income of Jiangsu Xuefeng and (ii) RMB100,000 per month (US$16,270). As a result, there are also two ways to transfer the funds from inside the PRC to outside the PRC:
 
(1) According to the provisions of the Service Fee in Article 3 of the Exclusive Technology Service and Business Consulting Agreement, 95% of the net income of Jiangsu Xuefeng will be paid to Baichuang Consulting as a service fee, and in turn Baichuang Consulting will in compliance with the provisions of PRC Foreign-Owned Enterprise Law, transfer this income to Lotus International (HK company) for the purpose of profit distribution.
 
(2) According to the provisions of the Service Fee in Article 3 of the Exclusive Technology Service and Business Consulting Agreement, a management fee of $16,270 will be paid to Baichuang Consulting each month, and in turn Baichuang Consulting will be in compliance with the provisions of the PRC Foreign-Owned Enterprise Law and transfer this income to Lotus International (HK company) for the purpose of profit distribution.
 
The earnings and cash transfer procedures are all designed to comply with PRC regulations. As a result, there will be no government regulations which will impact our transactions to transfer cash within our corporate structure. However, when the funds are transferred to outside the PRC, all transferred amounts will be reported to the national tax bureau to examine whether the local and national taxes have been fully paid by Jiangsu Xuefeng and Baichuang Consulting.

Recent Accounting Pronouncements

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

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

In July 2013, FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”.  This ASU requires an unrecognized tax benefit to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward.  An exception exists to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax of the applicable jurisdiction does not require the entity to use, and entity does not intend to use, the deferred tax asset for such a purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets.  ASU No. 2013-11 is effective for fiscal years and interim periods beginning after December 15, 2013 and did not have a material impact on the Company's consolidated financial statements.

ITEM 7A.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
 
Smaller reporting companies are not required to provide the information required by this item.
 
 
31

 
 
ITEM 8.   FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

Consolidated Financial Statements for the
Years Ended May 31, 2014 and 2013
And
Report of Independent Registered Public Accounting Firm
 
 
32

 

 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING, INC. AND SUBSIDIARIES

CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013
 
 

CONTENTS
PAGE
   
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
34
   
CONSOLIDATED FINANCIAL STATEMENTS:
 
   
  Consolidated Balance Sheets
35
   
  Consolidated Statements of Income and Comprehensive Income
36
   
  Consolidated Statements of Changes in Stockholders’ Equity
37
   
  Consolidated Statements of Cash Flows
38
   
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
40
 
 
33

 
 
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


To the Board of Directors and
Stockholders of China Xuefeng Environmental Engineering, Inc.

We have audited the accompanying consolidated balance sheets of China Xuefeng Environmental Engineering, Inc. and subsidiaries (the “Company”) as of May 31, 2014 and 2013, and the related consolidated statements of income and comprehensive income, changes in stockholders’ equity, and cash flows for the years ended May 31, 2014 and 2013.  These consolidated financial statements are the responsibility of the Company’s management.  Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement.  The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting.  Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting.  Accordingly, we express no such opinion.  An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of China Xuefeng Environmental Engineering, Inc. and subsidiaries as of May 31, 2014 and 2013, and the consolidated results of their operations and their cash flows for the years ended May 31, 2014 and 2013, in conformity with accounting principles generally accepted in the United States of America.



/s/ Wei, Wei & Co., LLP

New York, New York
August 19, 2014

 
34

 

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
 CONSOLIDATED BALANCE SHEETS
(IN U.S. $)

   
May 31,
   
May 31,
ASSETS
 
2014
   
2013
             
Current assets:
           
  Cash
  $ 20,629,604     $ 16,341,986  
  Prepaid expenses
    97,735       97,496  
  Deferred income taxes
    -       333,300  
                 
    Total current assets
    20,727,339       16,772,782  
                 
Fixed assets, net
    23,587       21,851  
                 
Other assets:
               
  Prepayment for acquisition of land use right
    -       808,000  
                 
TOTAL ASSETS
  $ 20,750,926     $ 17,602,633  

See accompanying notes to the consolidated financial statements.
 
 
35

 

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN U.S. $)

   
May 31,
   
May 31,
LIABILITIES AND STOCKHOLDERS’ EQUITY
 
2014
   
2013
           
Current liabilities:
         
  Deferred revenues
  $ 1,895,400     $ 1,333,200  
  Taxes payable
    97,248       606,777  
  Loan from stockholder
    255,468       182,526  
  Accrued liabilities
    82,991       32,817  
    Total current liabilities
    2,331,107       2,155,320  
                 
Commitments and contingencies
    -       -  
                 
Stockholders’ equity:
               
   Common stock, $0.001 par value per share, 75,000,000 shares authorized; 55,200,000 shares issued and outstanding as of May 31, 2014 and 2013, respectively
    55,200       55,200  
  Additional paid-in capital
    11,389,049       11,389,049  
  Statutory reserve fund
    604,333       309,655  
  Retained earnings
    5,392,092       2,880,650  
  Other comprehensive income
    421,823       396,533  
                 
    Stockholders’ equity before noncontrolling interests
    17,862,497       15,031,087  
  Noncontrolling interests
    557,322       416,226  
                 
    Total stockholders’ equity
    18,419,819       15,447,313  
                 
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY
  $ 20,750,926     $ 17,602,633  
 
See accompanying notes to the consolidated financial statements.
 
 
36

 

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
FOR THE YEARS ENDED MAY 31, 2014 AND 2013 (IN U.S. $)
 
   
For the Year Ended May 31,
 
 
 
2014
   
2013
 
             
Revenue
  $ 4,710,165     $ 5,426,435  
Cost of revenue
    (354,085 )     (524,734 )
                 
Gross profit
    4,356,080       4,901,701  
                 
Operating expenses
               
   Selling and marketing
    97,520       66,166  
   General and administrative
    391,546       350,174  
                 
     Total operating expenses
    489,066       416,340  
                 
Income from operations
    3,867,014       4,485,361  
   Interest income
    62,041       11,630  
                 
Income before provision for income taxes
    3,929,055       4,496,991  
   Provision for  income taxes
    982,264       1,124,273  
                 
Net income
    2,946,791       3,372,718  
   Less: noncontrolling interest
    (140,671 )     (164,236 )
                 
Net income attributable to common stockholders
  $ 2,806,120     $ 3,208,482  
Earnings  per common share, basic and diluted
  $ 0.05     $ 0.07  
                 
Weighted average shares outstanding, basic and diluted
    55,200,000       44,038,356  

Comprehensive income:
           
 Net income
  $ 2,946,791     $ 3,372,718  
     Foreign currency translation adjustment
    25,715       209,744  
 Comprehensive income
    2,972,506       3,582,462  
     Comprehensive income attributable to noncontrolling interests
    (141,096 )     (173,032 )
                 
 Net Comprehensive income attributable to common  aastockholders
  $ 2,831,410     $ 3,409,430  
 
See accompanying notes to the consolidated financial statements.
 
 
37

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE YEARS ENDED MAY 31, 2014 AND 2013 (IN U.S.$)

   
Common
Stock
   
Additional
Paid-in
Capital
   
Retained Earnings
   
Noncontrolling
 Interests
   
Statutory
Reserve Fund
   
Other
Comprehensive
 Income
   
 
Total
 
                                           
Balance, May 31, 2012
  $ 41,200     $ 4,421,426     $ (18,177 )   $ 243,194     $ -     $ 195,585     $ 4,883,228  
                                                         
Reverse merger adjustment
    -       (18,377 )     -       -       -       -       (18,377 )
                                                         
  Issuance of common stock
    14,000       6,986,000       -       -       -       -       7,000,000  
                                                         
  Net income
    -       -       3,208,482       164,236       -       -       3,372,718  
                                                         
  Appropriation to statutory reserve
    -       -       (309,655 )     -       309,655       -       -  
                                                         
  Foreign currency translation adjustment
    -       -       -       8,796       -       200,948       209,744  
                                                         
Balance, May 31, 2013
    55,200       11,389,049       2,880,650       416,226       309,655       396,533       15,447,313  
                                                         
   Net income
    -       -       2,806,120       140,671       -       -       2,946,791  
                                                         
  Appropriation to statutory reserve
    -       -       (294,678 )     -       294,678       -       -  
                                                         
   Foreign currency translation adjustment
    -       -       -       425       -       25,290       25,715  
                                                         
Balance, May 31, 2014
  $ 55,200     $ 11,389,049     $ 5,392,092     $ 557,322     $ 604,333     $ 421,823     $ 18,419,819  
 
See accompanying notes to the consolidated financial statements.
 
 
38

 

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013 (IN U.S. $)

   
For the Year Ended May 31,
 
   
2014
   
2013
 
Cash flows from operating activities:
           
Net income
  $ 2,946,791     $ 3,372,718  
Adjustments to reconcile net income to net cash provided by operating activities:
               
  Depreciation
    14,922       10,756  
  Deferred income taxes
    335,569       (325,079 )
  Changes in operating assets and liabilities:
               
  (Increase) in prepaid expenses
    (239 )     (90,641 )
  Increase in deferred revenue
    562,200       1,333,200  
  (Decrease) increase in taxes payable
    (509,529 )     606,777  
  Increase (decrease) in accrued liabilities
    50,174       (48,504 )
                 
Net cash provided by operating activities
    3,399,888       4,859,227  
                 
Cash flows from investing activities:
               
Refund of deposit for purchase of land use right
    813,500       -  
Purchase of equipment
    (16,612 )     (4,669 )
                 
 Net cash provided by (used in) investing activities
    796,888       (4,669 )
                 
Cash flows from financing activities:
               
    Proceeds from issuance of common stock
    -       7,000,000  
    Repayment of stockholder loan
    -       (48,115 )
Proceeds from stockholder loan
    73,000       230,031  
                 
 Net cash provided by financing activities
    73,000       7,181,916  
Effect of exchange rate changes on cash
    17,842       166,347  
 
Net increase in cash
    4,287,618       12,202,821  
Cash, beginning
    16,341,986       4,139,165  
                 
Cash, end
  $ 20,629,604     $ 16,341,986  
                 
Supplemental disclosure of cash flow information
               
Cash paid during the year for:
               
Interest
  $ -     $ -  
Income taxes
  $ 1,163,119     $ 859,348  
 
See accompanying notes to the consolidated financial statements.
 
 
39

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013


NOTE 1.   ORGANIZATION

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

On November 27, 2012, the Company completed a reverse acquisition transaction through a share exchange with the stockholders of Inclusion Business Limited (“Inclusion”), whereby the Company acquired 100% of the outstanding shares of Inclusion in exchange for a total of 7,895,000 shares of its common stock, representing 76.65% of the issued and outstanding shares of common stock.  As a result of the reverse acquisition, Inclusion became the Company’s wholly-owned subsidiary and the former Inclusion Stockholders became 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. Unless the context suggests otherwise, when being referred in this report to business and financial information for periods prior to the consummation of the reverse acquisition, the reference is to the business and financial information of Inclusion and its consolidated subsidiaries and variable interest entity. 

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

As a result of the transaction with Inclusion, the Company owns all of the issued and outstanding capital stock of Lotus International Holdings Limited (“Lotus”), a wholly-owned subsidiary of Inclusion, which in turn owns all of the issued and outstanding capital stock of Baichuang Information Consulting (Shenzhen) Co. Ltd (“Baichuang Consulting”). In addition, the Company effectively and substantially controls Jiangsu Xuefeng Environmental Protection Science and Technology Co., Ltd. (“Jiangsu Xuefeng”) through a series of captive agreements with Baichuang Consulting.
 
Subsequent to the closing of the Exchange Agreement, the Company conducts its operations through its controlled consolidated variable interest entity (“VIE”), Jiangsu Xuefeng.  Jiangsu Xuefeng, incorporated under the laws of the People’s Republic of China (“PRC”) on December 14, 2007, is primarily engaged in providing improvement and upgrading services of garbage recycling processing technology and equipment. 

On October 17, 2012, Baichuang Consulting (the “WFOE”), a wholly-owned subsidiary of Lotus, entered into a series of contractual arrangements (the “VIE agreements”). The VIE agreements include (i) an Exclusive Technical Service and Business Consulting Agreement; (ii) a Proxy Agreement, (iii) Share Pledge Agreement and, (iv) Call Option Agreement with the stockholders of Jiangsu Xuefeng.
 
 
40

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013


NOTE 1.   ORGANIZATION (CONTINUED)

Exclusive Technical Service and Business Consulting Agreement: Pursuant to the Exclusive Technical Service and Business Consulting Agreement, the WFOE provides technical support, consulting, training, marketing and operational consulting services to Jiangsu Xuefeng. In consideration for such services, Jiangsu Xuefeng has agreed to pay an annual service fee to the WFOE of 95% of Jiangsu Xuefeng’s annual net income with an additional payment of approximately US$16,270 (RMB 100,000) each month. The Agreement has an unlimited term and only can be terminated upon written notice agreed to by both parties.

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

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.

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.

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

 
41

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013



NOTE 1.   ORGANIZATION (CONTINUED)


NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF ACCOUNTING AND PRESENTATION

The accompanying consolidated financial statements have been prepared on the accrual basis of accounting.  The consolidated financial statements for the years ended May 31, 2014 and 2013 include China Xuefeng Environmental Engineering Inc., and its wholly owned subsidiaries, Inclusion, Lotus and Baichuang Consulting and its VIE, Jiangsu Xuefeng.  All significant intercompany accounts and transactions have been eliminated in consolidation when applicable.

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

VARIABLE INTEREST ENTITY

Pursuant to Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 810, “Consolidation” (“ASC 810”), the Company is required to include in its consolidated financial statements, the financial statements of its variable interest entities (“VIEs”).  ASC 810 requires a VIE to be consolidated by a company if that company is subject to a majority of the risk of loss for the VIE or is entitled to receive a majority of the VIE’s residual returns.  VIEs are those entities in which a company, through contractual arrangements, bears the risk of, and enjoys the rewards normally associated with ownership of the entity, and therefore the company is the primary beneficiary of the entity.
 
 
42

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013
 


NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

VARIABLE INTEREST ENTITY (CONTINUED)

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

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

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

 
ASSETS
 
May 31,
 2014
   
May 31,
 2013
 
   
(In U.S. $)
   
(In U.S. $)
 
Current assets:
           
 Cash
  $ 20,390,978     $ 16,186,742  
 Prepaid expenses
    96,750       96,511  
 Deferred income taxes
    -       333,300  
                 
  Total current assets
    20,487,728       16,616,553  
                 
Fixed assets
    56,019       39,382  
  Less: accumulated depreciation
    (32,432 )     (17,531 )
                 
  Fixed assets, net
    23,587       21,851  
                 
Other assets:
               
 Prepayment for acquisition of land use right
    -       808,000  
                 
TOTAL ASSETS
  $ 20,511,315     $ 17,446,404  


 
43

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013
 


NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

VARIABLE INTEREST ENTITY (CONTINUED)

 
LIABILITIES
 
May 31,
 2014
   
May 31,
 2013
 
   
(In U.S. $)
   
(In U.S. $)
 
Current liabilities:
           
 Due to China Xuefeng Environmental Engineering, Inc. (1)
  $ 7,048,717     $ 7,031,313  
 Payable to WFOE(2)
    5,890,442       3,120,492  
 Deferred revenue
    1,895,400       1,333,200  
 Taxes payable
    13,395       570,451  
 Loan from stockholder
    227,172       154,105  
 Accrued liabilities
    82,991       32,817  
                 
  Total current liabilities
    15,158,117       12,242,378  
                 
TOTAL LIABILITIES
  $ 15,158,117     $ 12,242,378  

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

(2)  
Payable to WFOE represents outstanding amounts due to Baichuang Information Consulting (Shenzhen) Co. Ltd. under the Exclusive Technical Service and Business Consulting Agreement for consulting services provided to Jiangsu Xuefeng in exchange for 95% of Jiangsu Xuefeng’s net income and additional monthly payments of RMB 100,000 (approximately US$16,270).

   
For the Year Ended May 31,
 
   
2014
   
2013
 
 
           
Revenue
  $ 4,710,165     $ 5,426,435  
Net income (3)
  $ 2,813,421     $ 3,284,728  

(3)  
Under the Exclusive Technical Service and Business Consulting Agreement, 95% of the net income is to be remitted to the WFOE.

   
For the Year Ended May 31,
 
   
2014
   
2013
 
 
           
Net cash provided by operating activities
  $ 3,333,595     $ 11,766,224  
Net cash provided by (used in) investing activities
    796,888       (4,669 )
Net cash provided by financing activities
    73,000       151,000  
Effect of exchange rate changes on cash
    753       153,376  
                 
Net increase in cash
  $ 4,204,236     $ 12,065,931  
 
 
44

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013


NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

VARIABLE INTEREST ENTITY (CONTINUED)

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

CHANGE OF FISCAL YEAR END DATE

In November, 2012, in connection with the Share Exchange, the Company changed its fiscal year end date from April 30 to May 31.

USE OF ESTIMATES

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

FOREIGN CURRENCY TRANSLATION

Almost all Company assets are located in the PRC.  The functional currency for the majority of the Company’s operations is the Renminbi (“RMB”).  The Company uses the United States dollar (“US Dollar” or “US$” or “$”) for financial reporting purposes.  The financial statements of the Company have been translated into US dollars in accordance with FASB ASC 830, “Foreign Currency Matters.”

 
45

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013


NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

FOREIGN CURRENCY TRANSLATION (CONTINUED)

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:

   
May 31,
2014
   
May 31,
 2013
 
         
 
 
Balance sheet items, except for stockholders’ equity, as of year end
    0.1620       0.1616  
                 
Amounts included in the statements of income, statements of changes in stockholders’ equity and statements of cash flows
      0.1627         0.1589  

For the years ended May 31, 2014 and 2013, foreign currency translation adjustments of $25,715 and $209,744, respectively, have been reported as other comprehensive income. Other comprehensive income of the Company consists entirely of foreign currency translation adjustments.  Pursuant to ASC 740-30-25-17, “Exceptions to Comprehensive Recognition of Deferred Income Taxes,” the Company does not recognize deferred U.S. taxes related to the undistributed earnings of its foreign subsidiaries and, accordingly, recognizes no income tax expense or benefit from foreign currency translation adjustments.

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

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

REVENUE RECOGNITION

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

 
46

 

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013


NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

Multiple-Element Arrangements

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

Improvement and Upgrade Service

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

Patent Licensing

Patent licensing is limited to 5 years with payments due annually in advance.  The customer is responsible for the repair services when they are necessary.  The out of pocket expenses for the repair services will be charged separately to the customer by the Company.  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 its resource utilization and harmless 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.

 
 
47

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013


NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

Patent Licensing (Continued)

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

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

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

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

VULNERABILITY DUE TO OPERATIONS IN PRC

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

 
48

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013
 

NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

FAIR VALUE OF FINANCIAL INSTRUMENTS

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

CASH AND CASH EQUIVALENTS

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

FIXED ASSETS

Fixed assets are recorded at cost, less accumulated depreciation.  Cost includes the price paid to acquire the asset, and any expenditure that substantially increase the asset’s value or extends the useful life of an existing asset.  Depreciation is computed using the straight-line method over the estimated useful lives of the assets.  Major repairs and betterments that significantly extend original useful lives 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

IMPAIRMENT OF LONG-LIVED ASSESTS

The Company applies FASB ASC 360, “Property, Plant and Equipment,” which addresses the financial accounting and reporting for the recognition and measurement of impairment losses for long-lived assets.  In accordance with ASC 360, long-lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.  The Company may recognize the impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to those assets.  No impairment of long-lived assets was recognized for the periods presented.

DEFERRED REVENUE

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

INCOME TAXES

The Company accounts for income taxes in accordance with FASB ASC 740, “Income Taxes” (“ASC 740”), which requires the recognition of deferred income taxes for differences between the basis of assets and liabilities for financial statement and income tax purposes.  Deferred tax assets and liabilities

 
49

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013
 

NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

INCOME TAXES (CONTINUED)

represent the future tax consequences for those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled.  At May 31, 2013, the differences relate entirely to revenue deferred for financial statement purposes.  During the year ended May 31, 2014, as permitted by the PRC tax law, the Company began recognizing revenue from patent licensing fees for income tax purposes, based on when it is earned rather than when it is collected, consistent with financial statement recognition.  As a result, there are no differences between the basis of assets and liabilities for financial statement and income tax purposes for deferred revenue and, as a result, deferred income taxes are no longer required to be recognized.  A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized.

ASC 740 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements.  Under ASC 740, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position.  The tax benefits recognized in the financial statements from such a position would be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.  ASC 740 also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, and accounting for interest and penalties associated with tax positions.  As of May 31, 2014 and 2013, 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 35%.  No provision for income taxes in the United States has been made as the Company had no U.S. taxable income for the years ended May 31, 2014 and 2013.

PRC

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

BVI

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

Hong Kong

Lotus is incorporated in Hong Kong.  Pursuant to the income tax laws of Hong Kong, the Company is not subject to tax on non-Hong Kong source income.
 
 
50

 

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013
 

NOTE 2.   SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

ADVERTISING COSTS

Advertising costs are charged to operations when incurred.  For the years ended May 31, 2014 and 2013, advertising expense was $35,794 and $47,670, respectively.

STATUTORY RESERVE FUND

Pursuant to corporate law of 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 years ended May 31, 2014 and 2013, a statutory reserve of $294,678 and $309,655 was required to be funded by the Company.

NOTE 3.   RECENTLY ISSUED ACCOUNTING STANDARDS

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

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

 
51

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013

NOTE 3.   RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED)

In July 2013, FASB issued ASU No. 2013-11, “Presentation of an Unrecognized Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists”.  This ASU requires an unrecognized tax benefit to be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward.  An exception exists to the extent that a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax of the applicable jurisdiction does not require the entity to use, and entity does not intend to use, the deferred tax asset for such a purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets.  ASU No. 2013-11 is effective for fiscal years and interim periods beginning after December 15, 2013 and did not have a material impact on the Company's consolidated financial statements.

NOTE 4.   FAIR VALUE MEASUREMENTS

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

Level 1 Inputs –
Unadjusted quoted market prices for identical assets and liabilities in an active market that the Company has the ability to access.
   
Level 2 Inputs –
Inputs other than the quoted prices in active markets that are observable either directly or indirectly.
   
Level 3 Inputs –
Inputs based on prices or valuation techniques that are both unobservable and significant to the overall fair value measurements.
 
ASC 820 requires the use of observable market data, when available, in making fair value measurements.  When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurements.  Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs.  As of May 31, 2014 and 2013, 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, payables and accrued liabilities, approximate their fair values due to the short term nature of these financial instruments.  There were no changes in methods or assumptions during the periods presented.

 
52

 

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013


NOTE 5.   FIXED ASSETS

Fixed assets are summarized as follows:

   
May 31,
2014
   
May 31,
2013
 
   
(U.S. $)
   
(U.S. $)
 
             
Computers and equipment
  $ 27,732     $ 26,306  
Vehicle
    15,179       -  
Furniture and fixtures
    13,108       13,076  
                 
      56,019       39,382  
Less: Accumulated depreciation
    (32,432 )     (17,531 )
                 
    $ 23,587     $ 21,851  

For the years ended May 31, 2014 and 2013, depreciation expense was $14,922 and $10,756, respectively.

NOTE 6.   PREPAYMENT FOR ACQUISITION OF LAND USE RIGHT

On March 23, 2012, the Company entered into an agreement with a PRC owned third party to acquire a 50-year land use right for construction of a factory facility for cash consideration of US$872,640, equivalent to RMB 5,400,000, of which US$ 808,000, equivalent to RMB 5,000,000 was paid before May 31, 2013.

During the year ended May 31, 2014, the land use right had not been obtained.  The Company was refunded the prepayment in March 2014.

NOTE 7.   ACCRUED LIABILITIES

Accrued liabilities consisted of the following:

   
May 31,
2014
   
May 31,
2013
 
   
(U.S. $)
   
(U.S. $)
 
             
Payroll
  $ 14,702     $ 14,369  
Professional fees
    68,136       18,306  
Other
    153       142  
                 
    $ 82,991     $ 32,817  
 
 
53

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013
 


NOTE 8.   INCOME TAXES

The provision for (benefit from) income taxes consisted of the following:

   
For the Year Ended May 31,
 
   
2014
   
2013
 
   
(U.S. $)
   
(U.S. $)
 
             
Current
  $ 646,695     $ 1,449,352  
Deferred
    335,569       (325,079 )
                 
    $ 982,264     $ 1,124,273  

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

The Company did not file its U.S. federal income tax returns, including, without limitation, information returns on Internal Revenue Service (“IRS”) Form 5471, “Information Return of U.S. Persons with Respect to Certain Foreign Corporations” for the fiscal year ended April 30, 2013 and for the one month period ended May 31, 2013, a short year income tax return required to be filed as a result of the change in fiscal year.  Failure to furnish any income tax returns and information returns with respect to any foreign business entity required, within the time prescribed by the IRS, subjects the Company to certain civil penalties.  Management is of the opinion that penalties, if any, that may be assessed would not be material to the consolidated financial statements.

In addition, because the Company did not generate any income in the United States or otherwise have any U.S. taxable income, the Company does not believe that it has any U.S. Federal income tax liabilities with respect to any transactions that the Company or any of its subsidiaries may have engaged in through May 31, 2014.  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 April 30, 2013 and 2012 and one month tax period ended May 31, 2013 remain open to examination by the IRS.

NOTE 9.   RELATED PARTY TRANSACTIONS
 
On August 5, 2012, the Company entered into an agreement to lease the rights of a patent on garbage recycling processing technology from Li Yuan, one of the Company’s officers/stockholders.  Under the current terms, the Company is required to pay a fee of $13,016 (RMB 80,000) each month for five years from September 2012 to August 2017.  The related prepaid patent leasing fees of $90,720 and $90,496 are included in the prepaid expenses on the consolidated balance sheets as of May 31, 2014 and 2013, respectively.

 
54

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013



NOTE 9.   RELATED PARTY TRANSACTIONS (CONTINUED)

The remaining payments for the patent rights not paid as of May 31, 2014 are as follows:

Period Ending
     
May 31,
 
Amount
 
       
2015
  $ 65,080  
2016
    156,192  
2017
    156,192  
Thereafter
    39,048  
 
       
    $ 416,512  

The Company obtained a demand loan from the above officer/stockholder which is non-interest bearing.  The loan of approximately $229,000 representing expenses paid by the above officer/stockholder and approximately $79,000 representing the registered capital and operating expenses of Baichuang Information Consulting (Shenzhen) Co., Ltd. (“Baichuang Consulting”) for the year ended May 31, 2013. For the year ended May 31, 2013, Baichuang Consulting repaid approximate $48,000 to the above officer/stockholder.  For the year ended May 31, 2014, no repayment was made. The net balance is reflected as loan from stockholder as of May 31, 2014.

NOTE 10.   LEASES

The Company leases office space under a one-year operating lease from an unrelated third party, which expired on March 31, 2013 and was extended to March 31, 2016.  The lease requires the Company to prepay the rental for one year of $7,267 (RMB 44,664).  The related prepayments of $6,030 and $6,015 are included in the prepaid expenses on the consolidated balance sheets as of May 31, 2014 and 2013, respectively.  The lease provides for renewal options.  Rent expense for the years ended May 31, 2014 and 2013 was $7,267 and $7,097, respectively.

The minimum future rentals under the lease as of May 31, 2014 are as follows:

Period Ending
     
May 31,
 
Amount
 
       
2015
  $ 1,212  
2016
    6,060  
 
       
    $ 7,272  
 
NOTE 11. CONTINGENCIES

As disclosed in Note 8, the Company was delinquent in filing certain tax returns with the U.S. Internal Revenue Service. The Company is unable to determine the amount of penalties, if any, that may be assessed at this time. Management is of the opinion that penalties, if any, that may be assessed would not be material to the consolidated financial statements.
 
 
55

 
 
CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES
NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED MAY 31, 2014 AND 2013
 



NOTE 11.   CONTINGENCIES (CONTINUED)

The Company did not file the information reports for the year ended December 31, 2013 and 2012 concerning its interest in foreign bank accounts on form TDF 90-22.1, “Report of Foreign Bank and Financial Accounts” (“FBAR”).  Not complying with the FBAR reporting and recordkeeping requirements will subject the Company to civil penalties up to $10,000 for each year it has foreign bank accounts.  The Company has not determined the amount of any penalties that may be assessed at this time and believes that penalties, if any, that may be assessed would not be material to the consolidated financial statements.

NOTE 12.   CONCENTRATION OF CREDIT AND BUSINESS RISK

Cash and cash equivalents

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

Major customers

The following table represents certain information about the Company’s customers which individually accounted for more than 10% of the Company’s gross revenue during the periods indicated:

   
For the Year Ended
   
For the Year Ended
 
   
May 31, 2014
   
May 31, 2013
 
   
Amount
   
%
   
Amount
   
%
 
CUSTOMER 1
    *       *       691,215       12.74 %
CUSTOMER 2
    *       *       643,545       11.86 %
CUSTOMER 3
    *       *       619,710       11.42 %
CUSTOMER 4
    *       *