China Xuefeng Environmental Engineering Inc. - FORM 10-Q

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EX-32.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL ACCOUNTING OFFICER, P - China Xuefeng Environmental Engineering Inc.	exh32_1.htm
EX-31.1 - CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER AND PRINCIPAL ACCOUNTING OFFICER, P - China Xuefeng Environmental Engineering Inc.	exh31_1.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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

For the Quarterly Period Ended August 31, 2018

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

For the Transition Period from ___________ to _____________

Commission File Number: 333-175483

China Xuefeng Environmental Engineering Inc.

(Exact name of registrant as specified in its charter)

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

229 Tongda Avenue Economic and Technological Development Zone, Suqian, Jiangsu Province, P.R. China	223800
(Address of principal executive offices)	(Zip Code)

+86 (527) 8437-0508

(Registrant's telephone number, including area code)

Not Applicable

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

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

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

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

Large accelerated filer	☐		Accelerated filer	☐

Non-accelerated filer	☐	(Do not check if a smaller reporting company)	Smaller reporting company	☒

			Emerging growth company	☐

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

As of October 10, 2018, there were 66,520,871 outstanding shares of common stock of the registrant, par value $0.001 per share.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC.

FORM 10-Q

TABLE OF CONTENTS

PART I – FINANCIAL INFORMATION
	Page

Item 1. Financial Statements.	1

Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.	27

Item 3. Quantitative and Qualitative Disclosures About Market Risk.	31

Item 4. Controls and Procedures.	31

PART II – OTHER INFORMATION

Item 1. Legal Proceedings.	33

Item 1A. Risk Factors.	33

Item 2 Unregistered Sales of Equity Securities and Use of Proceeds.	33

Item 3 Defaults Upon Senior Securities.	33

Item 4. Mine Safety Disclosures.	33

Item 5. Other Information.	33

Item 6. Exhibits.	33

Signatures	34

PART I – FINANCIAL INFORMATION

Item 1. Financial Statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(IN U.S. $)

	August 31,		May 31,
ASSETS	2018		2018
	(Unaudited)
Current assets:
Cash	$	19,977,874	$	17,559,007
Accounts receivable		1,420,125		2,607,798
Inventory		20,422		37,669
Prepaid Expenses		489,484		137,632
Prepaid VAT		3,958,335		4,615,812

Total current assets		25,866,240		24,957,918

Noncurrent assets:
Fixed assets, net		31,047,189		33,729,725
Lease equipment, net		25,009,946		27,167,719
Prepaid lease		5,427,770		5,816,243
Deferred income tax assets		815,907		823,949

Total noncurrent assets		62,300,812		67,537,636

TOTAL ASSETS	$	88,167,052	$	92,495,554

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(CONTINUED)

(IN U.S. $)

	August 31,			May 31,
LIABILITIES AND STOCKHOLDERS' EQUITY	2018			2018
	(Unaudited)
Current liabilities:
Accounts payable	$	84,188		$	1,049,776
Deferred revenues		4,606,091			3,995,944
Taxes payable		462,210			489,349
Loan from stockholder		10,286,018			10,892,539
Accrued liabilities		108,054			118,375

Total current liabilities		15,546,561			16,545,983

Security deposits payable		4,684,160			4,991,680

TOTAL LIABILITIES		20,230,721			21,537,663

Stockholders' equity:
Common stock, $0.001 par value per share, 75,000,000 shares authorized; 66,520,871 shares issued and outstanding as of August 31 and May 31, 2018		66,521			66,521
Additional paid-in capital		41,581,497			41,581,497
Statutory reserve fund		2,595,662			2,595,662
Retained earnings		27,880,157			26,462,203
Other comprehensive (loss) income		(4,187,506	)		252,008

Total stockholders' equity		67,936,331			70,957,891

TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY	$	88,167,052		$	92,495,554

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $)

	Three Months Ended August 31,
	2018		2017
	(Unaudited)		(Unaudited)
Revenue:
Sales	$	2,772,585	$	1,332,936
Lease income		1,034,464		886,092

Total revenue		3,807,049		2,219,028

Cost of goods sold:
Cost of sales		1,170,680		140,448
Depreciation expense - leased equipment		496,027		428,791

Total cost of goods sold		1,666,707		569,239

Gross profit		2,140,342		1,649,789

Operating expenses:
Selling and marketing		295,607		176,906
General and administrative		289,775		240,661

Total operating expenses		585,382		417,567

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $)

	Three Months Ended August 31,
	2018			2017
	(Unaudited)			(Unaudited)

Income from operations	$	1,554,960		$	1,232,222
Interest income		25,943			82,687
Government subsidy		224,996			222,156

Income before provision for income taxes		1,805,899			1,537,065
Provision for income taxes	387,945				318,567

Net income		1,417,954			1,218,498

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

Weighted average shares outstanding, basic and diluted		66,520,871			63,020,871

Comprehensive Income:
Net Income	$	1,417,954		$	1,218,498
Foreign currency translation adjustment		(4,439,514	)		1,910,583

Comprehensive (loss) income	$	(3,021,560	)	$	3,129,081

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

FOR THE THREE MONTHS ENDED AUGUST 31, 2018

(IN U.S. $) (UNAUDITED)

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

Balance, May 31, 2018	$	66,521	$	41,581,497	$	26,462,203	$	2,595,662	$	252,008		$	70,957,891

Net income		-		-		1,417,954		-		-			1,417,954

Foreign currency translation adjustment		-		-		-		-		(4,439,514	)		(4,439,514	)

Balance, August 31, 2018	$	66,521	$	41,581,497	$	27,880,157	$	2,595,662	$	(4,187,506	)	$	67,936,331

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

	For Three Months Ended August 31,
	2018			2017

Cash flows from operating activities:
Net income	$	1,417,954		$	1,218,498
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation		1,115,533			455,497
Amortization for the land		30,899			30,509
(Increase) in deferred income tax assets		(43,775	)		(312,731	)
Changes in operating assets and liabilities:
Decrease in accounts receivable		1,157,182			1,049,991
Decrease in inventory		15,295			-
Decrease in prepaid VAT		382,332			150,636
(Increase) in prepaid expenses		(369,173	)		(4,164,190	)
(Decrease) increase in accounts payable and accrued liabilities		(926,286	)		345,580
Increase in deferred revenue		877,484			814,572
Increase (decrease) in taxes payable		3,076			(174,966	)

Net cash provided by (used in) operating activities		3,660,521			(586,604	)

Cash flows from financing activities:
Loan received from shareholder		30,400			20,000
Increase in security deposit payable		-			710,899

Net cash provided by financing activities		30,400			730,899

Effect of exchange rate changes on cash		(1,272,054	)		13,420

Net increase in cash		2,418,867			157,715
Cash, beginning of year		17,559,007			10,343,963

Cash, end of year	$	19,977,874		$	10,501,678

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

		For Three Months Ended
		August 31,
		2018		2017

Supplemental disclosure of cash flow information

Income taxes paid	$	428,644	$	535,904

Land appreciation tax paid	$	1,500	$	1,481
Supplemental disclosure of non-cash activities

Property, equipment, equipment and construction in progress accrued	$	-	$	9,020,787

Payment of accrued liabilities by shareholder	$	30,400	$	20,000

See accompanying notes to the consolidated financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 1. ORGANIZATION

China Xuefeng Environmental Engineering Inc. (the "Company"), formerly known as NYC Moda Inc., was incorporated under the laws of the State of Nevada on March 30, 2011. Since its inception until the closing of the Exchange Agreement, the Company was a development-stage company.

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

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

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

The Company conducts its operations through its controlled consolidated variable interest entity ("VIE"), Jiangsu Xuefeng. Jiangsu Xuefeng, incorporated under the laws of the People's Republic of China ("PRC") in December, 2007, is primarily engaged in the sale, lease and installation of garbage recycling equipment and provides improvement and upgrading services of garbage recycling processing technology and equipment.

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

Exclusive Technical Service and Business Consulting Agreement: Pursuant to the Exclusive Technical Service and Business Consulting Agreement, the WFOE provides technical support, consulting, training, marketing and operational consulting services to Jiangsu Xuefeng. In consideration for such services, Jiangsu Xuefeng has agreed to pay an annual service fee to the WFOE of 95% of Jiangsu Xuefeng's annual net income and an additional payment of approximately US$15,910 (RMB100,000) each month. The Agreement has an unlimited term and only can be terminated upon written notice agreed to by both parties.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 1. ORGANIZATION (CONTINUED)

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, to oversee all of the equity interests in Jiangsu Xuefeng held by the stockholders of Jiangsu Xuefeng. The Agreement has an unlimited term and only can be terminated upon written notice agreed to by both parties.

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

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

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

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

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

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 1. ORGANIZATION (CONTINUED)

Linyi Xuefeng was officially approved and incorporated under the laws of the People's Republic of China ("PRC") in June 2013. Mr. Yuan Li was the sole owner since inception. Linyi Xuefeng constructed a garbage processing plant which commenced operations in February 2018. Previously Linyi Xufeng received non-operating revenue, which was a subsidy received from the government for the city pollution garbage processing plant construction.

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

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

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

BASIS OF ACCOUNTING AND PRESENTATION

The unaudited interim consolidated financial statements of the Company as of August 31, 2018 and for the three months ended August 31, 2018 and 2017, have been prepared in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the SEC which apply to interim financial statements. Accordingly, they do not include all of the information and footnotes normally required by accounting principles generally accepted in the United States of America for annual financial statements. In the opinion of management, such information contains all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the results for the periods presented. The interim consolidated financial information should be read in conjunction with the consolidated financial statements and the notes thereto, included in the Company's Form 10-K filed with the SEC. The results of operations for the three months ended August 31, 2018 are not necessarily indicative of the results to be expected for future three months or for the year ending May 31, 2019.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

BASIS OF ACCOUNTING AND PRESENTATION (CONTINUED)

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

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

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 "U.S. $" or "$") for financial reporting purposes. The financial statements of the Company have been translated into US dollars in accordance with FASB ASC 830, "Foreign Currency Matters."

All asset and liability accounts have been translated using the exchange rate in effect at the balance sheet date. Equity accounts have been translated at their historical exchange rates when the capital transactions occurred. Statements of income amounts have been translated using the average exchange rate for the periods presented. Adjustments resulting from the translation of the Company's financial statements are recorded as other comprehensive income (loss).

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

	August 31, 2018		May 31, 2018		August 31, 2017

Balance sheet items, except for stockholders' equity, as of periods end		0.1464		0.1560		0.1517

Amounts included in the statements of income, statements of changes in stockholders' equity and statements of cash flows		0.1500		0.1532		0.1481

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

FOREIGN CURRENCY TRANSLATION (CONTINUED)

For the three months ended August 31, 2018 and 2017, foreign currency translation adjustments of $(4,439,514) and $1,910,583, respectively, have been reported as other comprehensive (loss) income. Other comprehensive (loss) 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 the operation of a garbage processing plant, selling and leasing garbage processing equipment, providing garbage recycling processing system technology support, renovation and upgrade services and patent licensing to customers. The Company's revenue recognition policies comply with FASB ASC 605 "Revenue Recognition." In general, the Company recognizes revenue when there is persuasive evidence of an arrangement, the fee is fixed or determinable, the products or services have been delivered or performed and collectability of the resulting receivable is reasonably assured.

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

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

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

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

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

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

Linyi Xuefeng's revenues are primarily derived from selling organic manure, hollow brick, wood plastic tray and ferrous metal. It's income also relates to government for city pollution garbage processing system constructions. Government subsidies are recognized as earned when grant expenses are incurred up to the maximum amount allowed for each grant award.

Sales-Type Leases

The Company entered into three sales-type lease arrangements during the three months ended August 31, 2015, with two customers for financing of their purchase of garbage processing equipment. The arrangements with the customers have a fixed term of three years. Revenue from the sale of the equipment is recognized at the inception of the lease. The payments have been present valued with an annual interest rate of 5.25%. In connection with these arrangements, the Company recognized no revenue for the three months ended August 31, 2018 and 2017. Future minimum collections for the year ending May 31 are as follows:

Year Ending
May 31,	Amount

2019		$	366,025

		$	366,025

Operating Leases

The Company entered into multiplelease arrangements with customers for garbage processing equipment. The arrangements with a fixed term of five years with payments due quarterly with deposit payments equivalent to one year leasing fee. Revenue from the leasing of the equipment is recognized monthly. At the end of each of the five year lease terms, it will be determined whether the lease will be extended, leased to a new customer or returned to the Company. Future minimum payments for the years ending May 31 are as follows:

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

Operating Leases (Continued)

Year Ending
May 31,	Amount

2019	$	3,599,936
2020		4,799,915
2021		3,789,933
2022		1,619,971
2023		249,996

	$	14,059,751

Multiple-Element Arrangements

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

Improvement and Upgrade Service

The improvement and upgrade service is a one-time service. By the end of improvement and upgrading services, there is persuasive evidence that an arrangement exists since the Company has a signed contract with a customer; delivery has occurred and a customer has completed inspection and accepted the improvement and upgrading services then delivered; the fee is fixed and become due within 30 days upon the signing of the contract; and collectability is probable. An inspection is conducted by the customer according to industry standards within three days of the completion of the improvement and upgrade. An acceptance form is provided by the customer if the inspection is satisfactory. Performance testing is conducted on the upgraded equipment within one month. A final evaluation report is provided within five days of the completion of the performance testing. The fee for improvement and upgrade services is fixed and becomes due within 30 days, upon the signing of the contract. The fees for the improvement and upgrading services are not subject to refund, forfeiture or any other concession if patent licensing is not completed.

The Company has met the agreed upon specifications and has not been required to make any refunds for its services. No warranty is provided by the Company.

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

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

Multiple-Element Arrangements (Continued)

Patent Licensing

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

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

Multiple Elements

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

The Company also determined that the patent licensing has standalone value because the patent can be licensed separately. The Company uses the vendor-specific objective evidence to determine the price for patent licensing when sold in multiple-element arrangements. Although not yet being licensed separately, the price established by the management has the relevant authority. The Company establishes the price of upgrading and improvement service and the price of patent licensing is determined based on the following method:

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

REVENUE RECOGNITION (CONTINUED)

Multiple-Element Arrangements (Continued)

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

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

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

FAIR VALUE OF FINANCIAL INSTRUMENTS

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

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

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

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

ASC 820 requires the use of observable market data, when available, in making fair value measurements. When inputs used to measure fair value fall within different levels of the hierarchy, the level within which the fair value measurement is categorized is based on the lowest level input that is significant to the fair value measurement. Valuation techniques used need to maximize the use of observable inputs and minimize the use of unobservable inputs. As of August 31, 2018 and May 31, 2018, none of the Company's assets and liabilities were required to be reported at fair value on a recurring basis. Carrying values of non-derivative financial instruments, including cash, accounts receivable, prepaid VAT, accounts payable and accrued expenses, and deferred revenue approximate their fair values due to the short term nature of these financial instruments. There were no changes in methods or assumptions during the periods presented.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

CASH AND CASH EQUIVALENTS

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

FIXED ASSETS AND LEASE EQUIPMENT

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

Computers and equipment	3 years
Motor vehicles	4 years
Furniture and fixtures	5 years
Lease equipment	15 years
Machinery	10 years
Building and improvements	20 years

IMPAIRMENT OF LONG-LIVED ASSETS

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

DEFERRED REVENUE

Deferred revenue is advance payments received for patent licensing fees and received from the government for city pollution garbage processing system constructions. These payments received, but not yet earned, are recognized as deferred revenue in the consolidated balance sheets.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

INCOME TAXES

The Company accounts for income taxes in accordance with FASB ASC 740, "Income Taxes" ("ASC 740"), which requires the recognition of deferred income taxes for differences between the basis of assets and liabilities for financial statement and income tax purposes. Deferred tax assets and liabilities represent the future tax consequences of those differences, which will either be taxable or deductible when the assets and liabilities are recovered or settled. During the year ended May 31, 2015, as permitted by the PRC tax law, the Company began recognizing revenue from patent licensing fees for income tax purposes, based on when it is earned rather than when it is collected, consistent with the financial statement recognition. As a result, there are no differences between the basis of assets and liabilities for financial statements and income tax purposes for deferred revenue and, as a result, deferred income taxes are no longer required to be recognized. A valuation allowance is established when necessary to reduce deferred tax assets to the amount expected to be realized.

ASC 740 addresses the determination of whether tax benefits claimed or expected to be claimed on a tax return should be recorded in the financial statements. Under ASC 740, the Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position would be measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. ASC 740 also provides guidance on de-recognition of income tax assets and liabilities, classification of current and deferred income tax assets and liabilities, and accounting for interest and penalties associated with tax positions. As of August 31, 2018 and May 31, 2018, 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

On December 22, 2017, the Tax Cuts and Jobs Act of 2017 (the "Act") was signed into law making significant changes to the Internal Revenue Code. Changes include, but are not limited to, a U.S. corporate tax rate decrease from 35% to 21% effective for tax years beginning after December 31, 2017, the transition of U.S international taxation from a worldwide tax system to a territorial system, and a one-time transition tax on the mandatory deemed repatriation of cumulative foreign earnings as of December 31, 2017. On December 22, 2017, Staff Accounting Bulletin No. 118 ("SAB 118") was issued to address the application of US GAAP in situations when a registrant does not have the necessary information available, prepared, or analyzed (including computations) in reasonable detail to complete the accounting for certain income tax effects of the Act. The Company hasn't determined the reasonable estimate in connection with the transition tax on the mandatory deemed repatriation of foreign earnings at December 31, 2017. Additional work is necessary to do a more detailed analysis of the Act as well as potential correlative adjustments. Any subsequent adjustment to these amounts will be recorded to current tax expense in fiscal 2019 when the analysis is complete.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)

INCOME TAXES (CONTINUED)

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 their income tax laws. According to current BVI income tax law, the applicable income tax rate for the Company is 0%.

Hong Kong

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

ADVERTISING COSTS

Advertising costs are charged to operations when incurred. For the three months ended August 31, 2018 and 2017, advertising expense was $134,998 and $133,294 respectively.

STATUTORY RESERVE FUND

Pursuant to corporate law in the PRC, the Company is required to transfer 10% of its net income, as determined under PRC accounting rules and regulations, to a statutory reserve fund until such reserve balance reaches 50% of the Company's registered capital. The statutory reserve fund is non-distributable other than during liquidation and can be used to fund previous years' losses, if any, and may be utilized for business expansion or used to increase registered capital, provided that the remaining reserve balance after such use is not less than 25% of the registered capital. For the three months ended August 31, 2018 and 2017, a statutory reserve of $0 and $109,670, respectively, was required to be allocated by the Company.

VALUE ADDED TAX ("VAT")

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

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 3. RECENTLY ISSUED ACCOUNTING STANDARDS

In July 2017, the FASB issued ASU 2017-11, Earnings Per Share (Topic 260), Distinguishing Liabilities from Equity (Topic 480), Derivatives and Hedging (Topic 815). The amendments in Part I of this Update change the classification analysis of certain equity-linked financial instruments (or embedded features) with down round features. When determining whether certain financial instruments should be classified as liabilities or equity instruments, a down round feature no longer precludes equity classification when assessing whether the instrument is indexed to an entity's own stock. The amendments also clarify existing disclosure requirements for equity-classified instruments. The amendments in Part II of this Update recharacterize the indefinite deferral of certain provisions of Topic 480 that now are presented as pending content in the Codification, to a scope exception. Those amendments do not have an accounting effect. For public business entities, the amendments in Part I of this Update are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Early adoption is permitted for all entities, including adoption in an interim period. If an entity early adopts the amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The Company believes that the adoption of this ASU will not have a material impact on its financial statements.

In September 2017, the FASB issued ASU 2017-13, Revenue from Contracts with Customers (Topic 606) and Leases (Topic 842). The main objective of this pronouncement is to clarify the effective date of the adoption of ASC Topic 606 and ASC Topic 842 and the definition of public business entity as stipulated in ASU 2014-09 and ASU 2016-02. ASU 2014-09 provides that a public business entity and certain other specified entities adopt ASC Topic 606 for annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. All other entities are required to adopt ASC Topic 606 for annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019. ASU 2016-12 requires that "a public business entity and certain other specified entities adopt ASC Topic 842 for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. All other entities are required to adopt ASC Topic 842 for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020". ASU 2017-13 clarifies that the SEC would not object to certain public business entities electing to use the non-public business entities effective dates for applying ASC 606 and ASC 842. ASU 2017-13, however, limits such election to certain public business entities that "otherwise would not meet the definition of a public business entity except for a requirement to include or inclusion of its financial statements or financial information in another entity's filings with the SEC". The Company expects that the adoption of this ASU will not have a material impact on its financial statements.

In February 2018, the FASB issued ASU 2018-02, Income Statement—Reporting Comprehensive Income (Topic 220). The amendments in this update allow a reclassification from accumulated other comprehensive income to retained earnings for stranded tax effects resulting from the Tax Cuts and Jobs Act. Consequently, the amendments eliminate the stranded tax effects resulting from the Tax Cuts and Jobs Act and will improve the usefulness of information reported to financial statement users. However, because the amendments only relate to the reclassification of the income tax effects of the Tax Cuts and Jobs Act, the underlying guidance that requires that the effect of a change in tax laws or rates be included in income from continuing operations is not affected. The amendments in this update also require certain disclosures about stranded tax effects. The guidance is effective for fiscal years beginning after December 15, 2018 with early adoption permitted, including interim periods within those years. The Company expects that the adoption of this ASU will not have a material impact on its financial statements.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 3. RECENTLY ISSUED ACCOUNTING STANDARDS (CONTINUED)

In June 2018, the FASB issued ASU No. 2018-07, Compensation – Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, or ASU 2018-07. ASU 2018-07 simplifies the accounting for share-based payments made to nonemployees so the accounting for such payments is substantially the same as those made to employees. Under this ASU, share based awards to nonemployees will be measured at fair value on the grant date of the awards, entities will need to assess the probability of satisfying performance conditions if any are present, and awards will continue to be classified according to Accounting Standards Codification ("ASC") 718 upon vesting which eliminates the need to reassess classification upon vesting, consistent with awards granted to employees. This ASU is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. The Company expects that the adoption of this ASU will not have a material impact on its financial statements.

The Company believes that other recent accounting pronouncement updates will not have a material effect on the Company's consolidated financial statements.

NOTE 4. FIXED ASSETS

Fixed assets are summarized as follows:

	August 31, 2018			May 31, 2018
	(Unaudited)

Computers and equipment	$	85,195		$	90,789
Vehicles		84,790			90,356
Production facilities		17,203,354			18,332,771
Furniture and fixtures		112,834			120,242
Building and improvement		15,443,090			16,456,945

		32,929,263			35,091,103
Less: accumulated depreciation		(1,882,074	)		(1,361,378	)

	$	31,047,189		$	33,729,725

For the three months ended August 31, 2018 and 2017, depreciation expense was $619,506 and $26,706 respectively.

Building and improvements and production facilities include approximately $33 million relating to construction of the garbage recycling processing plant and production facilities purchase (see note 1).

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 5. LEASE EQUIPMENT

Lease equipment is summarized as follows:

	August 31, 2018			May 31, 2018
	(Unaudited)

Leasing equipment	$	29,043,876		$	30,950,637
Less: accumulated depreciation		(4,033,930	)		(3,782,918	)

	$	25,009,946		$	27,167,719

For the three months ended August 31, 2018 and 2017, depreciation expense was $496,027 and $428,791 respectively.

Before leasing the equipment to their client, the Company will upgrade the equipment to meet the client's requirement. The Company records the equipment as equipment construction in process before it finishes the upgrading process. As of August 31, 2018, no equipment construction in process was included in lease equipment.

NOTE 6. INCOME TAXES

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

The provision for income taxes consists of the following for the three months ended August 31, 2018 and 2017:

	For the Three Months Ended August 31,
	2018		2017
	(Unaudited)		(Unaudited)

Current	$	374,836	$	411,679
Deferred		13,109		(93,112	)

Total	$	387,945	$	318,567

As of August 31, 2018, the Company had unused operating loss carry-forwards of approximately $3,263,628 expiring in various years through 2023.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 6. INCOME TAXES (CONTINUED)

The expected tax rate for income in the PRC is 25%. The following table reconciles the effective income tax rates with the statutory rates for the three months ended August 31:

	2018			2017

Statutory rate		25	%		25	%
Government subsidy		4	%		4	%

Effective income tax rate		21	%		21	%

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

The Company is required to file income tax returns in both the PRC and the United States. PRC tax filings for the tax year ended December 31, 2017 was examined by the PRC tax authorities in May 2018. The tax filings were accepted and no adjustments were proposed by the PRC tax authorities.

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, 2018. However, there can be no assurance that the IRS will agree with this position, and therefore the Company ultimately could be liable for U.S. Federal income taxes, interest and penalties. The tax years ended May 31, 2017, 2016 and 2015 remain open to examination by the IRS.

NOTE 7. RELATED PARTY TRANSACTIONS

The Company is currently leasing the patent rights on garbage recycling processing technology from Li Yuan, one of the Company's stockholders under an agreement expiring Aug 2022. The Company is required to pay a fee of $12,000 (RMB80,000) each month during the agreement term. The related prepaid patent leasing fees of $46,842 and $87,354 are included in prepaid expenses on the consolidated balance sheets as of August 31, 2018 and May 31, 2018, respectively.

The remaining payments for the patent rights are as follows:

Year Ending
May 31,	Amount

2019	$	105,394
2020		140,525
2021		140,525
2022		140,525
2023		35,131

Total	$	562,100

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 7. RELATED PARTY TRANSACTIONS (CONTINUED)

The Company obtained a demand loan from Li Yuan, a stockholder which is non-interest bearing. The total loan of approximately $757,145 represents $678,145 of expenses paid by the stockholder and payments of approximately $79,000 representing the registered capital and operating expenses of Baichuang Information Consulting (Shenzhen) Co., Ltd. The balance is reflected as loan from stockholder as of August 31, 2018.

On June 25, 2013, Linyi Xuefeng and the shareholder, Mr. Li Yuan, entered into a loan agreement pursuant to which Mr. Li Yuan provides a loan facility to the Linyi Xuefeng, which are non-interest bearing with the maximum amount of the loan is RMB200,000,000 ($29,350,600). Any borrowings in excess of this amount may be negotiated between the parties. On December 17, 2015, a resolution of the board was signed by Mr. Li Yuan, who is the sole shareholder of Linyi Xuefeng, surrendered another loan to the Linyi Xuefeng of RMB140,000,000 (approximately $20,545,00) and treated as a capital contribution to the Linyi Xuefeng. The loans outstanding were $9,528,873 and $10,154,453 as of August 31, 2018 and May 31, 2018, respectively.

NOTE 8. LAND USE RIGHT

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

The amortization for the land use right for the three months ended August 31, 2018 and 2017 was $30,899 and $30,509 respectively.

NOTE 9. SECURITY DEPOSIT PAYABLE

The company leased out highly efficient waste disposal equipment to customers and received a one year leasing fee as a deposit. The security deposit payable was $4,684,160 and $4,991,680 as of August 31, 2018 and May 31, 2018, respectively.

NOTE 10. LEASES

The Company leases office space from an unrelated third party, which commenced on April 1, 2016 and expires on March 31, 2019. The lease requires the Company to prepay the semi-annual rental of $3,600 (RMB24,000). The lease provides for renewal options.

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

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 10. LEASES (CONTINUED)

Rent expense for the three months ended August 31, 2018 and 2017 was $3,690, and $3,643, respectively.

Future minimum payments for the years ending May 31 are as follows:

Year Ending
May 31,	Amount

2019		$	10,140

		$	10,140

NOTE 11. CONTINGENCIES

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

The Company hasn't determined the reasonable estimate in connection with the transition tax on the mandatory deemed repatriation of foreign earnings at December 31, 2017. Additional work is necessary to do a more detailed analysis of the Act as well as potential correlative adjustments. Any subsequent adjustment to these amounts will be recorded to current tax expense in fiscal 2018 when the analysis is complete.

Yuan Li, the Chief Executive Officer of the Company, has been named in a lawsuit by an unrelated third party (the "Plaintiff") regarding a disputed loan plus interest due to the Plaintiff. The filing also alleges that the Company's two operating entities, Jiangsu Xuefeng and Linyi Xuefeng, are guarantors of the loan. The district court in China originally decided in favor of the plaintiff but the decision was subsequently overturned by the High Court of Jiangsu Province. The court's decision is currently under appeal. The Company has denied that it is a guarantor of the loan and believes that it does not have any liability to the Plaintiff.

NOTE 12. VULNERABILITY DUE TO OPERATIONS IN THE PRC

The Company's operations may be adversely affected by significant political, economic and social uncertainties in the PRC. The different cultures, business preferences, corruption, diverse uncertain government regulations, tax systems and currency regulations are risks impacting the Company's current operations. Although the PRC government has been pursuing economic reform policies for more than twenty years, no assurance can be given that the PRC government will continue to pursue such policies or that such policies may not be significantly altered, especially in the event of a change in leadership, social or political disruption or unforeseen circumstances affecting the PRC's political, economic and social conditions. There is also no guarantee that the PRC government's pursuit of economic reforms will be consistent, effective or continue.

CHINA XUEFENG ENVIRONMENTAL ENGINEERING INC. AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

FOR THE THREE MONTHS ENDED AUGUST 31, 2018 AND 2017

(IN U.S. $) (UNAUDITED)

NOTE 13. CONCENTRATION OF CREDIT AND BUSINESS RISK

Cash and cash equivalents

Substantially all of the Company's bank accounts are in banks located in the PRC and are covered by protection similar to that provided by the Federal Deposit Insurance Corporation ("FDIC") on funds held in United States banks. The Insurance covers amount upto RMB500,000 (approximately U.S. $73,200 for all depository accounts at each bank. The amount in excess of insured limits at August 31, 2018 was approximately $19,539,000.

Major customers

For the three months ended August 31, 2018 and 2017, three customers of the Company accounted for 45% of revenue and one customer of the Company accounted for 17% of revenue, respectively. Four customers accounted for 99% of accounts receivable as of August 31, 2018 and May 31, 2018.

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

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

Overview

We are in the business of providing equipment and upgrade services to optimize garbage-recycling processes. We sell and lease comprehensive and environmental-friendly garbage recycling equipment. We also utilize our licensed patented technology of "comprehensive and harmless garbage-processing equipment" to upgrade software systems and reconstruct hardware for our clients and therefore expand the sorting scope and capacity of our clients' garbage recycling equipment. We also have manufactured, sold and leased garbage-processing equipment commencing since fiscal year ended May 31, 2016. We operate one cycling facilities that processes garbage and generates manufactured products for sale since the fiscal year ended May 31, 2018. We conduct our operations through our wholly-owned subsidiaries Jiangsu Xuefeng Environmental Protection Science and Technology Co., Ltd. ("Jiangsu Xuefeng") and Linyi County Renewable Resources Utilization Co., Ltd. ("Linyi Xuefeng").

Our Services

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

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

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

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

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

Acquisition of Linyi Xuefeng

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

Results of Operations

Results of Operations for the Three Months Ended August 31, 2018 and 2017

The following table sets forth in U.S. dollars, key components of our unaudited results of operations for the three months ended August 31, 2018 and 2017 and the percentage change between these comparable periods.

	For the Three Months Ended August 31,
	2018			2017			Percentage
	(U.S. $)			(U.S. $)			Change

Revenue	$	3,807,049		$	2,219,028			72	%
Cost of revenue		(1,666,707	)		(569,239	)		193	%
Gross profit		2,140,342			1,649,789			30	%
Selling expenses		295,607			176,906			67	%
General and administrative expenses		289,775			240,661			20	%
Total operating expenses		585,382			417,567			40	%
Operating income		1,554,960			1,232,222			26	%
Non-operating income		250,939			304,843			(18	%)
Income before provision for income taxes		1,805,899			1,537,065			17	%
Provision for income taxes		387,945			318,567			22	%
Net income		1,417,954			1,218,498			16	%
Noncontrolling interests		-			-			0	%
Net income attributable to common stockholders	$	1,417,954		$	1,218,498			16	%

Revenue

We generated $3,807,049 in revenue for the three months ended August 31, 2018, as compared to $2,219,028 for the three months ended August 31, 2017. Our revenue for the three months ended August 31, 2018 increased by $1,588,021 or 72% compared to the revenue for the three months ended August 31, 2017, primarily resulting from the operations of Linyi Xuefeng recycling plant. The following table shows the details of our revenue in the three months ended August 31, 2018 and 2017.

	Three Months Ended August 31,
	2018			2017			Percentage
	(U.S. $)			(U.S. $)			Change

Patent Leasing		1,417,475			1,332,936		6		%
Operating lease		1,034,464			886,092		17		%
Sales of garbage related products			1,355,110			-		100	%
Total		$	3,807,049		$	2,219,028		72	%

Patent Licensing

During the three months ended August 31, 2018, we generated revenue of $1,417,475 from licensing our patent to 21 unrelated customers. During the three months ended August 31, 2017, we generated revenue of $1,332,936 from licensing our patent to 20 unrelated customers. As all these customers became licensees before June 1, 2017 and 2016, respectively, patent licensing revenue was recognized for the entire three months for these customers during the related periods.

Operating leases

During the year ended May 31, 2017, we had six operating leases for a 300-ton and five 500-ton garbage processing system. The lease period is 5 years with annual lease payments of $612,604 and $3,675,625 (for the total five 500-ton garbage processing system), respectively, before VAT. The 300-ton garbage processing system was delivered and tested in the beginning of November 2015. The two 500-ton garbage processing systems were delivered and tested in the beginning of January 2016. Another two 500-ton garbage processing system was delivered and tested in the end of April 2016 and December 2016, respectively. We also delivered and tested one 500-ton garbage processing system in the end of March 2017. These leases are being accounted for as operating leases because they have no renewal or purchase option. At the end of the five years, either a new lease will be negotiated or the equipment will be returned. For the year ended May 31, 2017, we generated operating lease revenue of $2,667,783 from the six leases. During the year ended May 31, 2018, we have one new operating lease for a 500-ton garbage processing system. The lease period is still 5 years with annual lease payments of $612,604, before VAT. The 500-ton garbage processing system was delivered and tested on October 17, 2017. During the year ended May 31, 2018, we generated operating lease revenue of $3,973,691 from the seven leases. During the three months ended August 31, 2018 and 2017, we generated operating lease revenue of $1,034,464 and $886,092, respectively.

Sales of garbage related products

During the year ended May 31, 2018, we started to process and sell garbage related products, such as organic manure, hollow brick, wood plastic tray and ferrous metal. During the three months ended August 31, 2018, we generated revenue of $1,355,110 from selling garbage related products. During the three months ended August 31, 2017, we did not have such type of revenue.

Cost of Goods Sold

Our cost of goods sold increased to $1,666,707 for the three months ended August 31, 2018 from $569,239 for the three months ended August 31, 2017, which represented an increase of 193%. It is primarily because the cost of leasing equipment increased and the new revenue stream was introduced which has a lower gross margin. For the improvement and upgrading service and patent licensing revenue, the cost primarily consists of fees paid to the related party for licensing the patent, employees' salaries and training expenses. For the operating lease revenue, the depreciation of the garbage processing equipment is the main cost which also included in the cost of revenue. For the sales of garbage related products, we purchased raw material for the manufacturing and so the costs were increased. For the three months ended August 31, 2018, the cost of garbage related products was $1,035,097. It is the primary cost included in cost of goods sold for the three months ended August 31, 2018.

Gross Profit

Our gross profit increased to $2,140,342 for the three months ended August 31, 2018 from $1,649,789 for the three months ended August 31, 2017. Our gross profit ratio for the three months ended August 31, 2018 and 2017 was 56% and 74%, respectively. For the three months ended August 31, 2017, our business stream has resulted in a high gross margin because we have no cost of products sold. Our cost of goods sold is almost entirely direct labor and patent licensing fees, depreciation of leased equipment and other operating expenses. Since we started to sell garbage related products during the year ended May 31, 2018, we incurred an increased amount of cost of goods sold. As a result, we expect that gross profit margin to continue to decrease in the following periods.

Selling and Marketing Expenses

Our selling and marketing expenses increased to $295,607 for the three months ended August 31, 2018 from $176,906 for the three months ended August 31, 2017 which represented an increase of 67%. Our selling and marketing expenses were primarily comprised of sales employees' salaries, advertising expenses, training expenses and travelling expenses. The primary reason why selling and marketing expenses increased significantly is because of the acquisition of Linyi Xuefeng and Linyi Xuefeng incurred a significant amount of selling and marketing expenses due to its start of operations.

General and Administrative Expenses

Our general and administrative expenses increased to $289,775 for the three months ended August 31, 2018 from $240,661 for the three months ended August 31, 2017 which represented an increase of 20%. Our general and administrative expenses were primarily comprised of employees' salaries, travelling expenses, entertainment expenses and professional fees such as legal and audit fees. The primary reason for such an increase in General and Administrative expenses is the acquisition of Linyi Xuefeng.

Non-Operating Income

Despite our large cash balances, the interest income generated for the three months ended August 31, 2018 and 2017 was nominal for principally two reasons: 1) extremely low bank's current deposit interest rate and 2) minimal fluctuation of the annual interest rates within a 0.30% range; The interest income reported is net after deducting bank service charges. For the three months ended August 31, 2018 and 2017, our interest income also includes interest of $19,627 and $75,504, respectively, earned on the sales type leases. Our non-operating income also included a government subsidy. Our wholly owned subsidiary, Linyi Xuefeng, received a government subsidy of approximate $900,000 (RMB 6,000,000) annually. For the three months ended August 31, 2018 and 2017, the income related to the government subsidy was $224,996 and $222,156, respectively.

Provision for Income Taxes

The Company's two operating entities, Jiangsu Xuefeng and Linyi Xuefeng, and its Chief Executive Officer and main shareholder, Yuan Li, (collectively the "Defendants"), have been named in a court filing by an unrelated third party (the "Plaintiff"). The filing alleges that the Defendants borrowed approximately RMB45,000,000 (estimated USD$6,588,000) from the Plaintiff and is demanding that the balance including interest be repaid immediately. The Defendants have denied owing any amount to the Plaintiff in its appeal to the court. The Company believes that the litigation is at an early stage and the ultimate liability, if any, cannot be presently determined.

Net Income

Our net income attributable to the common stockholders of the Company for the three months ended August 31, 2018 and 2017 was $1,417,954 and $1,218,498, respectively, representing $0.02 per share and $0.02 per share, respectively.

Foreign Currency Translation Adjustment

Our reporting currency is the U.S. dollar. Our local currency, Renminbi (RMB), is our functional currency. Results of operations and cash flows are translated at average exchange rates during the period, and assets and liabilities are translated at the unified exchange rate as quoted by the People's Bank of China at the end of the period. Equity transactions are recorded at their historical amounts. Translation adjustments resulting from this process are included in accumulated other comprehensive income in the statement of stockholders' equity. Transaction gains and losses that arise from exchange rate fluctuations on transactions denominated in a currency other than the functional currency is included in the results of operations as incurred. For the three months ended August 31, 2018 and 2017, a foreign currency gain (loss) of $(4,439,514) and $1,910,583, respectively, have been reported as other comprehensive income in the consolidated statements of income and other comprehensive income. The foreign currency gain was mainly due to the revaluation of the Chinese currency since May 2018.

Liquidity and Capital Resources

As of August 31, 2018, we had cash and cash equivalents of $19,977,874, primarily consisting of cash on hand and demand deposits. The cash balance was principally derived from accumulated operations and issuance of stock of $7,009,000.

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

Operating activities

Net cash provided in operating activities was $3,660,521 for the three months ended August 31, 2018, as compared with the net cash used by operating activities of $586,604 for the three months ended August 31, 2017. For the three months ended August 31, 2018, the decrease in the accounts receivable of $1,157,182, depreciation expenses of $1,115,533, decrease in prepaid VAT of $382,332, decrease in accounts payable and accrued liability of $926,286, increase in prepaid expenses of $369,173 primarily caused the difference between the net cash provided by operating activities and the net income. For the three months ended August 31, 2017, the decrease in the accounts receivable of $1,049,991, prepaid VAT of $150,636, depreciation expenses of $455,497, increase in deferred revenue of $814,572, increased in accrued liability of $345,580, increase in deferred income tax assets of $312,731 and increase in prepaid expenses of $4,164,190 mainly caused the difference between the net cash provided by operating activities and the net income.

Investing activities

There were no investing activities in the three months ended August 31, 2018 and 2017, respectively.

Financing activities

For the three months ended August 31, 2018, we received a loan of $30,400 from a shareholder for the U.S listing expenses payment. For the three months ended August 31, 2017, we received security deposit payable of $710,899 for the leased equipment and loan of $20,000 from our shareholder.

Effect of Exchange Rate on Cash

The positive (negative) effect of the exchange rate on cash of $(1,272,054) and $13,420 was principally due to the revaluation (devaluation) by the PRC government of their currency for the years ended May 31, 2018 and 2017, respectively. There could be further negative adjustments should the PRC government or the exchange markets further devalue the Chinese currency.

Off-Balance Sheet Arrangements

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

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

Changes in interest rates may affect the interest earned and therefore affect our cash flows and results of operations. However, we do not believe that this interest rate change risk is significant.

Currency Exchange Fluctuations

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

Country Risk

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

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures

Our management, including our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of August 31, 2018.

Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), disclosure controls and procedures refer to controls and other procedures designed to ensure that information required to be disclosed in the reports we file or submit is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the SEC and that such information is accumulated and communicated to our management, including our chief executive officer and chief financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating our disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management is required to apply its judgment in evaluating and implementing possible controls and procedures.

Management, including our CEO and CFO, is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Exchange Act Rule 13a – 15(f). Management conducted an assessment as of August 31, 2018 of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission ("COSO"). Based on that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, because of the material weakness in internal control over financial reporting, our disclosure controls and procedures were not effective as of August 31, 2018.

A material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the Company's annual or interim financial statements will not be prevented or detected on a timely basis. In its assessment of the effectiveness of internal control over financial reporting as of August 31, 2018, the Company determined that there were control deficiencies that constituted the following material weaknesses:

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

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

Changes in Internal Control over Financial Reporting

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

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

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

Yuan Li, the Chief Executive Officer of the Company, has been named in a lawsuit by an unrelated third party (the "Plaintiff") regarding a disputed loan plus interest due to the Plaintiff. The filing also alleges that the Company's two operating entities, Jiangsu Xuefeng and Linyi Xuefeng, are guarantors of the loan. The district court in China originally decided in favor of the plaintiff but the decision was subsequently overturned by the High Court of Jiangsu Province on September 5, 2018. The court's decision is currently under appeal. The Company has denied that it is a guarantor of the loan and believes that it does not have any liability to the Plaintiff.

Item 1A. Risk Factors.

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

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

There were no unregistered sales of the Company's equity securities during the three months ended August 31, 2018, that were not otherwise disclosed in a Current Report on Form 8-K.

Item 3. Defaults Upon Senior Securities.

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

Item 4. Mine Safety Disclosures.

Not Applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.

Exhibit No.		Description

31.1*		Certification of Principal Executive Officer and Principal Accounting Officer, pursuant to 18 U.S.C. 1350, as adopted pursuant to Section 302 of 2002

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

101.INS**		XBRL Instance Document

101.SCH**		XBRL Taxonomy Extension Schema Document

101.CAL**		XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF**		XBRL Taxonomy Extension Definition Linkbase Document

101.LAB**		XBRL Taxonomy Extension Label Linkbase Document

101.PRE**		XBRL Taxonomy Extension Presentation Linkbase Document

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

SIGNATURES

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

	China Xuefeng Environmental Engineering Inc.

Date: October 19, 2018	By:	/s/ Li Yuan
		Li Yuan
		Chief Executive Officer and Chief Financial Officer Principal Executive Officer and Principal Accounting Officer

China Xuefeng Environmental Engineering Inc. - FORM 10-Q - October 19, 2018

Attached files

China Xuefeng Environmental Engineering Inc. Reports