Form 10-KSB Amendment No.1

Name of associate

Percentage

of equity

attributable to

The Group

EGAG

Xin Le Sheng Mei Water Purifying Company Limited (“XL”)

10KSB/A 1 d10ksba.htm FORM 10-KSB AMENDMENT NO.1 Form 10-KSB Amendment No.1

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-KSB/A

Amendment No. 1

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

For the year ended December 31, 2005

-OR-

¨	TRANSITION REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number 000-26175

CHINA EVERGREEN ENVIRONMENTAL CORPORATION

(Name of Small Business Issuer as Specified in its Charter)

NEVADA

88-0409151

(State or Other Jurisdiction of

Incorporation or Organization)

(IRS Employer

Identification No.)

SUITE 7A01, BAICHENG BUILDING

584 YINGBIN ROAD

DASHI, PANYU DISTRICT

GUANGZHOU, GUANGDONG, CHINA

(Address of Principal Executive Offices)

(86-20) 3479 9768

(Issuer’s Telephone Number, Including Area Code)

Securities registered pursuant to section 12 (b) of the Act:

None

Securities registered pursuant to section 12(g) of the Act:

Common Stock, par value $0.001 per share

(Title of Class)

Check whether the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. ¨

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

Check if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-KSB or any amendment to this Form 10-KSB. x

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act): Yes ¨ No x

The registrant’s revenues for its most recent fiscal year were $6,983,969.

The aggregate market value of the voting and non-voting stock held by non-affiliates of the registrant as of March 28, 2006 was approximately $29,325,179.

The number of shares of the common outstanding as of April 13, 2006 was 135,903,698.

Documents incorporated by reference: None.

EXPLANATORY NOTE

We, China Evergreen Environmental Corporation, are filing this Amendment No. 1 to our Annual Report on Form 10-KSB for the year ended December 31, 2005 in conjunction with our decision to restate the audited financial statements contained in our report on Form 10-KSB for the fiscal year ended December 31, 2005 (the “2005 10-KSB”), filed with the Securities and Exchange Commission (the “SEC”) on April 17, 2006. Our board of directors determined, on or about August 11, 2006, that the original financial statements for the periods in question should no longer be relied upon. We have filed a Form 8-K on Item 4.02 Non-Reliance on Previously Issued Financial Statements or a Related Audit Report or Completed Interim Review on September 25, 2006 for the restatement.

In our previous 2005 10-KSB, we recorded as equity the warrants issued as part of the units sold in our April 2005 convertible debt issuance. Under EITF No. 00-19, the fair value of these warrants should be reported as a liability. Pursuant to the Warrant Agreement, because there is currently no effective registration statement covering the shares of common stock underlying these warrants, these warrants are currently subject to a cashless exercise whereby the warrant holders may surrender their warrants to the company in exchange for shares of common stock. The number of shares of common stock into which a warrant would be exchangeable in such a cashless exercise depends on both the exercise price of the warrants and the market price of the common stock, each at or near the time of exercise. Because both of these factors are variable, it is possible that the company could have insufficient authorized shares to satisfy a cashless exercise. In this scenario, if the company were unable to obtain shareholder approval to increase the number of authorized shares, the company could be obligated to settle such a cashless exercise with cash rather than by issuing shares of common stock. Further, EITF No. 00-19 requires that we record the potential settlement obligation at each reporting date using the current estimated fair value of the warrants, with any changes being recorded through our statement of operations. We will continue to report the potential settlement obligation as a liability until such time as the warrants are exercised or expire or we are otherwise able to modify the warrant agreement to remove the provisions which require this treatment.

In Note 2(ii) and 2(iii) to the consolidated financial statements contained in our previous 2005 10-KSB, we disclosed the group reorganization transactions. Pursuant to rules promulgated by the SEC, the merger or acquisition of a private operating company into a non-operating public shell corporation with nominal net assets is considered a capital transaction, rather than a business combination. As such, no disclosures are required under FAS 141 because the transactions described were not business combinations. For accounting purposes, the transaction has been treated as a reverse acquisition and a recapitalization, and pro-forma information is not presented. Accordingly, this Amendment No. 1 to the 2005 10-KSB will not include references to the group reorganization transactions throughout the financial statements.

Unless otherwise indicated, all references to our company include our wholly and majority owned subsidiaries.

All of our sales and nearly all our expenses are denominated in renminbi (“RMB”), the national currency of the People’s Republic of China (the “PRC”). Solely for the convenience of the reader, certain financial information as of and for the years ended December 31, 2004 and 2005 have been converted into United States dollars. Assets and liabilities are translated at the exchange rate in effect at period end. Income statement accounts are translated at the average rate of exchange prevailing during the period. No representation is made that the RMB amounts could have been, or could be, converted into United States dollars at that rate or at any other certain rate as of the respective dates or at any other date.

The statements contained in this report that are not historical are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), including statements, without limitation, regarding our expectations, beliefs, intentions or strategies regarding the future. We intend that such forward-looking statements be subject to the safe-harbor provided by the Private Securities Litigation Reform Act of 1995. Such forward-looking statements relate to, among other things: (1) expected revenue and earnings growth; (2) estimates regarding the size of target markets; and (3) regulation of our industries and markets by the Chinese government. These statements are qualified by important factors that could cause our actual results to differ materially from those reflected by the forward-looking statements. Such factors include, but are not limited to, those risk factors described elsewhere in this annual report.

Part I

Item 1. Description of Business.

We are a waste water engineering company based in the PRC. Through our majority-owned subsidiaries, we are engaged in the design, construction, implementation and management of industrial and municipal waste water treatment facilities throughout the PRC.

We provide turn-key waste water treatment engineering design and contracting. From 2000 to 2004, we completed the following turn-key projects: Yongji Development Zone Wastewater Treatment Plant (Phase 1), Guangdong Nanhai City Jinsha Town Wastewater Treatment Plant, Guangdong Sanshui Baini Wastewater Treatment Plant and Guangzhou Yantang Wastewater Treatment Plant. The following turn-key projects are still in process: Tianjin City Meichang Town Wastewater Treatment Plant, Dayawan Wastewater Treatment Plant, Yongji Development Zone Wastewater Treatment Plant (Phase 2), China Environment Industrial Park Wastewater Treatment Plant and Huangzhuang Industrial Park Wastewater Treatment Plant.

We hold 90% and 35%, respectively, of the equity interest in the following two water treatment facilities operated through build, operate and transfer (“BOT”) arrangements with the PRC government: (i) Tian Jin Shi Sheng Water Treatment Company Limited (“TJ”), which commissioned water treatment in November 2003 and has a daily treatment capacity of approximately 10,000 tons; and (ii) Xin Le Sheng Mei Water Purifying Company Limited (“XL”), which also commissioned water treatment in November 2003 and has a daily treatment capacity of 40,000 tons. We have been retained as the manager to manage both TJ and XL. The fees from XL and TJ did not represent a significant portion of our revenue during 2004.

We also developed a BOT water treatment facility project in Hai Yang City under our subsidiary Hai Yang City Sheng Shi Environment Protection Company Limited (“HY”) with capacity of 20,000 tons per day. We began construction of this project in April 2004 and completed the project and commenced water treatment in June 2005. We are also developing another BOT water treatment facility project in Beijing under our subsidiary Bei Jing Hao Tai Shi Yuan Water Purifying Company Limited (“BJHTSY”) with planned capacity of 20,000 tons per day. We began construction of this project in July 2004 and was in the final stage of commissioning and testing as of March 31, 2006. In July 2005, we started construction of a BOT water treatment facility project for the Handan Fengfeng Mining Area in the Hebei Province under our subsidiary Han Dan Cheng Sheng Water Affairs Company Limited (“HDFF”) with capacity of 33,000 tons per day. We expect the completion of the project in the second quarter of 2006. The fees from these projects are expected to strengthen our net sales in the future.

In addition to the above, we provide sales of environment protection-related products. The product we are currently selling is GM Bio-carriers, a natural, chemical-free, mineral- and enzyme-based catalyst material that facilitates the rapid growth of bacteria which improves efficiency of degrading micro-organism materials in waste water, reduces land use and construction time, enables more efficient operation and reduces energy consumption for the waste water treatment process.

Corporate History

Our predecessor in interest, Discovery Investments, Inc. (“Discovery”) was incorporated on September 10, 1996, under the laws of the State of Nevada to engage in any lawful corporate activity. Discovery had been in the development stage and was not active until October 26, 1999.

On December 10, 1999, Discovery entered into a Plan and Agreement of Reorganization (the “Plan”) with LLO-Gas, Inc. and John Castellucci. On October 26, 1999, LLO-Gas had acquired certain ARCO facilities and a so-called card lock facility and commenced operations. LLO-Gas was incorporated in July 1998 under the laws of the State of Delaware. On December 20, 1999, there was a closing under the Plan and LLO-Gas, Inc. became a wholly-owned subsidiary of Discovery and there was a change of control of Discovery. Between December 20, 1999 and August 10, 2000, differences of opinion as to matters of fact and as to matters of law had arisen by and between certain of the shareholders of Discovery, who were shareholders prior to the closing, and between Discovery, John Castellucci and LLO-Gas, Inc.

On June 7, 2000, LLO-Gas, Inc. filed a Voluntary Petition under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court, Central District of California, San Fernando Valley Division, case number SV 00-15398-AG. On December 1, 2000, the United States Bankruptcy Court converted the pending matter into a Chapter 7 liquidation. Said Chapter 7 effected LLO-Gas, Inc. and not Discovery.

On August 10, 2000, Discovery entered into a Mutual Rescission Agreement and Mutual Release with John Castellucci which provided, inter alia, that Discovery consented and agreed to rescind said Plan with John Castellucci consenting and agreeing to the rescission. The parties mutually agreed to forego all rights and benefits provided to each other thereunder.

On August 9, 2001, Discovery filed a voluntary petition under Chapter 11 of the Bankruptcy Code in the United States Bankruptcy Court, District of Nevada, Case Number BK-S-01-18156-RCJ. On September 24, 2001, the Bankruptcy Court confirmed the Disclosure Statement and Plan of Reorganization submitted by Discovery and Discovery was thereafter released from Bankruptcy.

On April 29, 2002, Discovery entered into a Plan and Agreement of Reorganization with Bycom Media Inc., an Ontario, Canada corporation (“Bycom”). Pursuant to this agreement, Discovery acquired all the outstanding shares of Bycom for 4,800,000 shares of Common Stock. On October 5, 2002, Bycom became a wholly-owned subsidiary of Discovery and there was a change of control.

Bycom was engaged in multimedia applications for internet-based business. Utilizing business search tools and databases, Bycom intended to be able to locate and access global business information for a fee, or was to act as an “out-source provider” of information. Bycom currently is an inactive, wholly owned subsidiary of the Company.

On September 4, 2002, Discovery completed a transaction set out in a Plan and Agreement of Reorganization dated June 13, 2002, pursuant to which Discovery acquired all of the outstanding shares of Cavio Corporation, a Washington corporation, (“Cavio”) in exchange for 14 million share of Discovery common stock. Due to poor market conditions and Discovery’s inability to seek adequate financing from third parties to properly finance the operations of Cavio, on December 2, 2002 Discovery’s board of directors approved, subject to receiving the approval of a majority of the shareholders, to unwind the acquisition of Cavio in cancellation of the shares of common stock issued.

On December 2, 2002, Discovery unanimously approved the disposition of its interest in Cavio and thereafter received the consent of a majority of the outstanding shares of the company’s common stock. Discovery determined the effective date for the divestiture to be June 30, 2003.

For the two years prior to a reverse acquisition in September 2004, we had not generated significant revenues and were considered a development stage company as defined in Statement of Financial Accounting Standards No. 7. We were seeking business opportunities or potential business acquisitions. Pursuant to a securities purchase agreement and plan of reorganization dated September 9, 2004, as amended, between our company, Evergreen Asset Group Limited, an International Business Company organized under the laws of the British Virgin Islands (“Evergreen” or “EGAG”), and the stockholders of Evergreen, we acquired 100% of the issued and outstanding shares of Evergreen’s capital stock. We issued 83,500,000 shares of our common stock in exchange for all the 300 issued and outstanding shares of Evergreen capital stock which had an estimated value of $4.24 million at the time of such issuance, valued based on the fair market value of the net assets of Evergreen. Since the stockholders of Evergreen acquired approximately 83.5% of our outstanding shares and the Evergreen management team and board of directors became the management team and board of directors of our company, according to FASB Statement No. 141 – “Business Combinations”, this acquisition has been treated as a recapitalization for accounting purposes, in a manner similar to reverse acquisition accounting. In accounting for this transaction:

•

Evergreen is deemed to be the purchaser and surviving company for accounting purposes. Accordingly, its net assets are included in the balance sheet at their historical book values and the results of operations of Evergreen have been presented for the comparative prior period;

•

Control of the net assets and business of our company was acquired effective October 15, 2004. This transaction has been accounted for as a purchase of the assets and liabilities of our company by Evergreen. The historical cost of the net liabilities assumed was $0.00.

As a result of the transaction described above we changed our name from Discovery Investments, Inc. to China Evergreen Environmental Corporation.

Due to the reverse acquisition mentioned above, EGAG, pursuant to a group reorganization which was completed in July 2004, acquired 90% equity interests in each of XXM, XY, HY and BJHTSY for cash consideration of RMB12,601,000 (approximately $1,521,860), RMB18,000,000 (approximately $2,173,913), RMB2,700,000 (approximately $326,087) and RMB1,800,000 (approximately $217,391) respectively, all of which are domestic incorporated companies established in the PRC with limited liability.

In March 2003, GDXS entered into a BOT agreement with Xian Yang City Environment Protection Bureau. The BOT agreement was later transferred to Xian Yang Bai Sheng Water Purifying Company Limited (“XY”), after XY was incorporated. The construction of the wastewater plant of XY started in the beginning of 2004. Due to the group reorganization in July 2004, 90% of GDXS’s interest in XY was transferred to EGAG. In October 2004, EGAG entered into a tri-party framework agreement with True Global Limited (“TGL”), an independent party and Guang Dong Xin Sheng Environmental Protection Company Limited (“GDXS”) for the disposal of its 90% interest in XY to TGL at a total consideration of $13,246,377. A gain on disposal of $5,220,299 was recorded in 2004 for the disposal of our entire 90% attributable interest in XY to TGL.The gain represents the difference between the disposal proceeds and our attributable share of net assets of XY at the date of disposal.

In April 2005, we conducted a private placement of 20 investment units, at $25,000 per unit, for gross proceeds of $500,000. Each unit consisted of (a) one 12% convertible debenture in the original principal amount of $25,000, convertible into shares of our common stock at the rate of the lesser of (i) $0.20 per share or (ii) a 10% discount to the price per share of common stock (or conversion price per share of common stock) of the next private placement conducted by us prior to any conversion of the debenture, and (b) 125,000 detachable warrants to purchase one share each of our common stock at an exercise price of $0.20 per share, expiring ten years from their date of issuance. The debentures were due and payable August 1, 2005. The debenture holders, however, extended the payment period to September 30, 2005. We granted the investors limited registration rights for the common shares underlying their debentures and warrants. Westminster Securities Corporation acted as placement agent for this offering on our behalf. All the debenture holders have converted the debentures into 3,703,701 shares of our common stock on October 1, 2005.

Our executive offices are located at Suite 7A01, Baicheng Building, 584 Yingbin Road, Dashi, Panyu District, Guangzhou, Guangdong, China; telephone number (86-20) 3479 9768.

Our Business

General

Our business was originally established in 1999 by our Chairman, Mr. Chong Liang Pu, with a focus on developing innovative biochemical technologies and processes for waste water treatment. We have the exclusive rights to MHA biological treatment processes technologies (“MHA”) and GM Bio-carriers. Both are the subject of patents owned by our Chairman, Mr. Pu, and we have acquired the exclusive rights pursuant to a license agreement with Mr. Pu. Both technologies were developed to improve the efficiency and effectiveness of waste water treatment processes and reduce the initial investment and on-going operating cost of waste water treatment facilities.

We have applied biotechnological processes to waste water treatment and have developed relationships with the PRC environmental authorities at both national and provincial levels throughout the PRC. Since 2000, we have successfully completed the design and construction of over 14 waste water facilities across China with total daily capacity of over 120,000 tons (inclusive of three BOT waste water treatment facilities with daily capacity of 70,000 tons). Our customers include municipal governments, food processing and beverage companies and industrial companies.

Because of these achievements, we have been recognized as a “Key Enterprise in Environmental Industry in the PRC” by the General Bureau of Environmental Protection of China and are viewed as a “High-Tech Enterprise” by the Bureau of Science and Technology of Guangzhou, PRC.

Industry Background

Waste Water Treatment Markets in the PRC. The waste water treatment business is in a developmental stage in China. Following decades of rapid industrialization and urbanization resulting from PRC’s breakneck economic expansion, demands for urban and industrial waste water treatment are immense. In 2002, total volume of municipal and industrial waste water produced reached 23 billion and 26 billion tons, respectively, of which only approximately 25% was treated in some form. The PRC government, which views environmental issues as a policy priority, has targeted a 90% treatment ratio by 2030. This targeted growth, combined with a policy of privatizing all existing government facilities, is resulting in extraordinarily high levels of expansion in an industry that did not effectively exist until the 1980s.

In order to promote investment in the waste water treatment industry, the central government has created incentives such as tax relief and higher throughput fees which can improve the profitability of certain municipal projects.

Under the tax regulations in the PRC, companies providing water purification are exempted from business tax on the collection of waste water treatment fees. The PRC government also gives tax relief in the form of reduction in or exemption from value-added tax and income tax to encourage treated water to be reused in residential, agricultural, commercial or industrial sectors.

The PRC government introduced a new policy in relation to the water supply tariff management methods for the water-resource system which became effective in January 2004. The new policy prescribes a water tariff approach, comprising of water production costs, expenses, profit, and tax. Pertinent pricing is expected to be in accord with local market demand.

Before the 1990s, water tariffs were extremely low, and there were no wastewater discharge fees. People were more concerned with water quality than with the price and quantity they used. As citizens now pay closer attention to water quality, they expect higher prices to accompany water quality improvements. Therefore, water tariff and wastewater treatment throughput fees, especially in the cities, are rising to rational levels.

Fresh Water Markets. Before 2003, the facilities for fresh water supply in the PRC were owned and operated by the agencies of local governments. As industrial, economic and population growth and chronic pollution have placed intense demands on the water supply in China, the fresh water supply has had a serious shortage. Similar to the waste water treatment industry, the PRC government has opened up the fresh water supply business to private sector and international operators.

Our Business Activities

There are different types and quantities of pollutants in water due to the environment, conditions and purpose for which the water is used. Municipal water has organic matters including nitrogen and phosphorus. The composition of such municipal wastewater is relatively stable. In contrast, pollutants in water discharged from industries include organic pollutants, inorganic matters, metal ions and salt ion. We adopt varying treatment processes for different industrial wastewater.

We provide turn-key engineering, equipment and chemical sales for industrial and municipal waste water treatment facilities in the PRC. We also invest in, manage and operate our own water treatment facilities through BOT arrangements in the PRC.

The following chart describes the waste water treatment process that we service:

LOGO

Turn-Key Waste Water Engineering. We provide turn-key waste water treatment engineering services to both public and private sectors. Our public sector clients include municipal governments at the city, district and town levels. Our private sector clients include heavy industries, such as steel, car manufacturing, electronic; light industries, such as chemical, food and beverage, paper, printing and breweries; and others, including hospitals and the pharmaceutical industry. The industrial wastewater qualities differ due to the different industrial products and manufacturing processes.

These contracts are awarded either by public tender or by direct contract. A typical turn-key waste water treatment project can be classified into three phases; (1) survey and design, (2) construction and equipment installation, and (3) operation and management services.

From 2000 to 2004, we completed the following turn-key projects: Yongji Development Zone Wastewater Treatment Plant (Phase 1), Guangdong Nanhai City Jinsha Town Wastewater Treatment Plant, Guangdong Sanshui Baini Wastewater Treatment Plant and Guangzhou Yantang Wastewater Treatment Plant. The following table sets forth the company’s turn-key projects which are still in process:


Name of New Turn-key Project	Project value		Capacity/Per Day	Date of commencement of construction
Tianjin City Meichang Town Wastewater Treatment Plant	US$	0.22 million	2,000 tons	Commenced in July 2005
Dayawan Wastewater Treatment Plant	US$	3.38 million	30,000 tons	Expected to Commence in the second quarter of 2006
Yongji Development Zone Wastewater Treatment Plant (Phase 2)	US$	1.45 million	11,000 tons	Commenced in August 2005
China Environment Industrial Park Wastewater Treatment Plant	US$	0.72 million	5,000 tons	Commenced in July 2005
Huangzhuang Industrial Park Wastewater Treatment Plant	US$	0.12 million	1,000 tons	Commenced in July 2005

As of December 31, 2005, we had completed approximately 80%, 32%, 44% and 80% for each of Tianjin City Meichang Town Wastewater Treatment Plant, Yongji Development Zone Wastewater Treatment Plant (Phase 2), China Environment Industrial Park Wastewater Treatment Plant and Huangzhuang Industrial Park Wastewater Treatment Plant, respectively.

We financed our turn-key projects through progressive payments from our customers as stipulated in the agreements for these projects.

Investment in BOT Waste Water Treatment Facilities. We also invest in waste water treatment facilities through BOT arrangements. BOT projects provide us with a stable income source under a long-term (usually 20-30 year) contract granted by municipal governments to build and operate waste water plants. BOT project land is typically contributed by the municipal government with the operator providing investment and daily management. After the contract period, the project is transferred to the local government. After we secure a contract for a BOT project from a municipal government and the financing for such project is in place, we will proceed to construct the facility. After the completion of construction and testing and commissioning, we will operate the waste water treatment facility for a period of 20-25 years as stipulated in the BOT contract.

The following table sets forth the BOT projects which we have completed or are in process of completing:


BOT Projects	Cost of investment		Capacity/ Per Day	Operation Period	Date of commencement of operation
Waste water treatment plant of TJ	US$	1.09 million	10,000 tons	20 years	November 2003
Waste water treatment plant of XL	US$	4.11 million	40,000 tons	22 years	October 2003
Waste water treatment plant of HY	US$	3.62 million	20,000 tons	22 years	June 2005
Waste water treatment plant of BJHTSY	US$	2.42 million	20,000 tons	25 years	Operation expected to commence in second quarter of 2006
Waste water treatment plant of HDFF	US$	3.53 million	33,000 tons	22 years	Operation expected to commence in third quarter of 2006

As of December 31, 2005, the waste water treatment plants of TJ, XL and HY were operational and have been providing waste water treatment services. The waste water treatment plant of BJHTSY is in the stage of testing and commissioning whereas approximately 45% of the construction of the waste water treatment plant of HDFF has been completed.

We have been financing the BOT projects of TJ, XL, HY and BJHTSY through capital injections and funds generated from our operations. We will finance the remaining capital expenditure of HDFF of approximately $2 million through funds generated from our operations.

Our Production Process

Though the chemicals used for treating municipal and industrial wastewater qualities are different due to the different sources of wastewater for municipal wastewater treatment and different industrial product and manufacturing process for industrial wastewater treatment, the treatment processes are largely similar.

During the wastewater treatment process, the wastewater is first collected by a pipeline network system and then transported to a sand sedimentation pool. The wastewater will then go through the MHA waste water treatment process, which is a natural, chemical-free, biological and mineral-based process that facilitates the rapid growth of bacteria in order to improve the efficiency of degrading the micro-organism materials in the wastewater and for more efficient operation and reduced energy consumption. After the MHA waste water treatment process, the wastewater is then transported to the sedimentation pool to remove the fine particles in the wastewater. The wastewater will then be sterilized in the sterilization pool and be transported to the water outlet.

Our Project Management Process

The following is the flow chart of our project management process for both turn-key wastewater engineering projects and BOT projects:

LOGO

Market Intelligence. The starting point for all our projects is market intelligence so that our management is able to decide which projects they wish to secure for the benefit of the company. Our marketing personnel are in charge of market information on potential projects on a regular and ad-hoc basis. Our management is able to identify and decide on projects which we may potentially bid for.

Project Tracking. Based on the information gathered through market intelligence and the subsequent comprehensive analysis conducted on such information, our management will decide on which projects to pursue. We carry out internal evaluations which consist of three steps: initial evaluation, revaluation and valuation by professionals. We also engage external advisors to carry out external evaluation. We will then embark on determining what the tender rules and conditions are and the capital requirements and technologies used for the project. Project tracking allows us to plan ahead and make the necessary cost planning.

Tender Process. Once we decide to proceed to tender for a particular project, we will form a tender committee comprising marketing personnel and technical personnel, who will be responsible for compiling the tender documents to be submitted for tender within the stipulated deadline. The tender committee will compile internal costing and budgetary estimates of labor and material costs based on quotations from the relevant suppliers and factor in a suitable profit margin in determining our tender pricing.

Design and Development. After signing of the contract, we will appoint a project team to be responsible for the execution of the project, including an ad-hoc research and development team to handle the design and development of that particular project. The research and development team will follow our overall guidelines to analyze, assess and determine the design and specifications of a system which will ensure that all of our customers’ requirements are met. The design and development process includes collection of information, site survey, key design concept, design specification, individual design, evaluation, revaluation and issue for construction. In addition to our own design and development capabilities, we have also entered into collaboration arrangements with other parties to test our equipment to ensure its suitability and effectiveness.

Procurement. After the necessary design and analysis, the specifications of the system are confirmed, and our procurement department will proceed to purchase all the materials and equipment required or appoint appropriate sub-contractors to carry out certain parts of the project.

Construction. The construction process includes sub-contracting and site supervision. During construction, we will send site representatives to control and supervise the construction.

Assembly and Installation. We will carry out assembly and installation of equipment and/or system and coordinate the assembly and installation fully with the construction process to ensure all equipment and/or system are properly assembled and installed. We will send technical staff to assist and guide the assembly and installation.

Testing. After the equipment and/or system has been assembled and installed, we will test the system in accordance with industrial and national rules and regulations formulated by the relevant PRC authorities.

Commissioning and Fine-Tuning. For turn-key projects, should the system pass all tests, we will proceed to hand over the system to our customers. 5%-10% of the total contract value will be will be treated as retention monies during the warranty period of up to 12 months requirement. Our technical personnel will carry out fine-tuning and on-site services. After successful commissioning of the entire system, the retention monies will be paid by our customers to us after the warranty period of up to 12 months. For BOT projects, the plant will start operation after passing all tests. The technical team will carry out fine-tuning and on-site services. The operation team will follow the operational guidelines and monitor the quality of treated water.

Competition

We believe our main competitor is Beijing Capital Co., Ltd. (“Beijing Capital”), a subsidiary of Capital Group, which has identified investment, development, operation and management in the PRC water industry as its core business. Beijing Capital provides environment management services. We also compete with several other environmental and water treatment companies. We believe that we compete primarily on the basis of contract pricing. Though many of our competitors offer similar but less cost-effective services, they may have greater financial resources and hence be able to secure contracts with reduced operating margins but more competitive pricing. However, we believe that as a result of our cost efficiency through our patented technologies, we are able to offer even more competitive pricing. In addition, having access to the capital markets in the United States through our public listing will help to differentiate us from our competition. Another area of competition comes from local protectionism where local governments wish to protect local environmental businesses. In order for us to overcome this kind of competition, we rely on our financial and technical resources.

Our Competitive Strengths

Key elements of our competitive strengths include:

Sufficient Capital Resources. The threshold of capital requirements for entering the waste water treatment segment and the initial capital investment of waste water treatment facilities and projects, especially BOT projects, is relatively high. Based on our good track record and relationships with local governments in the PRC, we believe we are capable of obtaining sufficient capital resources to fund our operation of projects and expansion plan.

Experienced Management Team and Strong Research and Development Capability. We have a qualified and experienced management team and staff who possess strong technical capabilities and who specialize in project management, project design and research and development in relation to the water purification and wastewater treatment industry. Among our senior management, most possess degrees or senior technical qualifications. Members of our senior management team also have prior experience in managing large corporations and are familiar with all levels of management. Most of our management and staff have strong technical expertise and are professionally trained.

We place great emphasis on technical research and development, and typically set up research and development teams for specific projects to handle the design, development and improvement of such projects.

We also keep track of the latest developments in water treatment technology through our advisors and consultants who are experts in the water purification and waste water treatment industry. We have established a long-term cooperation with the Chinese Academy of Science at Guangdong and a number of universities to maintain its superiority in developing innovative wastewater treatment technology.

We believe that our management experience and our strong technical capabilities provide us with a competitive edge over our competitors.

Good Track Record and Professional Quality. We believe that our good track record and goodwill that we have built up in the provision of water treatment systems for the municipal government and industrial waste water treatment give us an edge over our competitors. Due to our strong track record, we have been awarded various certifications by different environmental institutions, including certifications of Quality Facility for Environmental Protection, Gold Price of 2^nd Chinese Patent Technology Fair, World Chinese Scientific and Technology Invention Prize, certificates of “Quality Branded Environmental Protection” and “Asia International Scientific and Technology Improvement Prize”. These certificates typically strengthen our ability to tender for BOT projects with the municipal government and also turn-key projects for industrial waste water treatment.

Effective Market Network. We emphasize the importance of marketing and have people specialized in promotion of our company and securing projects. We have marketing networks in Shangdong, Tianjin, Neijing, Handan Hebei, Xianyang Shangxi and Guangdong, where we have BOT projects. Such offices provide feedback on market intelligence and deal with existing and potential customers. Project selection is partially based on intelligence feedback from these networks. We retain a team of 15 to 20 former senior government officials with considerable influence on local and central governments in the PRC. We identify this team through introduction and conferences/conventions that we attend. This team identifies and helps to secure major environmental projects for the group. The team also provides timely feedback of market conditions and deals with our existing and potential customers regularly. Though we do not have any contract with this team, we give incentives/commissions for each successful project secured.

Long-Term Relationships with Academic Institutions. We have good long-term relationships with Guangdong Province Environmental Protection Design Institute and North-Eastern Environmental Protection Design Institute, who provide important technical support in design and project execution. North-Eastern Environmental Protection Design Institute will provide technical support in the design of waste water treatment facilities and preparation for the tendering of projects while Guangdong Province Environmental Protection Design Institute will evaluate the feasibility and acceptability of the blue prints of the facilities. Compensation for both institutions are based on amount of work done.

Customers, Sales and Marketing

Many of our principal customers are local governments, food and beverage processing companies and industrial companies that use our technologies to treat their waste water.

Our major customers in 2005 are China Environment Industrial Park and Shenzhen Jukeyuan Industrial Development Company, both independent third parties, which, together, accounted for approximately 49.3% of our total revenue of 2005 in relation to the turn-key engineering project of China Environment Industrial Park Wastewater Treatment Plant and the sale of environment protection-related products, respectively.

We market and sell our products through our direct sales force and independent sales representatives throughout the PRC. Our sales and marketing team is responsible for evaluating the marketplace, generating leads and creating sales programs. We use a “Project-Company” strategy for each BOT project, establishing a company in the location of the project, responsible for construction and operation of the project. Through establishing a good relationship with the local government, the Project-Company markets its business in the location. Our on-site direct service organization provides ongoing services to customers using our products.

In order to compete effectively, we focus on projects of a scale between 10,000 tons and 50,000 tons of waste water per day, where we can achieve a balance between economies of scale arising from our technology and our available capital base.

Research and Development

Our research and development efforts are directed toward enhancing our existing technology and products and developing our next generation of technology.

We have the exclusive rights to MHA biological treatment processes technologies (“MHA”) and GM Bio-carriers. Both are the subject of patents owned by our Chairman, Mr. Pu, and we have acquired the exclusive rights pursuant to a license agreement with Mr. Pu. We have applied both technologies to improve the efficiency and effectiveness of waste water treatment processes as well as to reduce the initial investment and on-going operating cost of waste water treatment facilities. The advantages of MHA are:

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Proprietary design of water flow control mixer to ensure even distribution of waste treatment bacteria in the treatment facility.

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Proprietary design of no-oxygen, low-oxygen and oxygen tanks to reduce energy consumption and ensure low sludge build up in the treatment process.

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Proprietary blend of waste water treatment bacteria (i.e., photosynthetic, lactobacillus, yeast, streptonyces, etc.) of over 50 types of different degradation and effectiveness to achieve toxic, aromatic and micro-organism-free water of release.

We have spent approximately $7750 and $8,200 on research and development activities during the fiscal years ending December 31, 2005 and 2004, respectively.

GM Bio-carrier is a natural, chemical-free, biological and mineral-based process that facilitates the rapid growth of bacteria in order to improve the efficiency of degrading the micro-organism materials in the waste water. Installation of such carriers into the waste treatment process facilitates bacterial growth for more efficient operation and reduced energy consumption.

Currently we are developing technology with universities and research institutions in Guangdong Province and have on staff a chief scientist, who is a researcher in the field of environmental protection, and two research fellows. We are planning to invite additional experts in the waste water treatment field to join our company. The technology that we are developing with these universities and research institutions is for the improvement of quality of treated water, increase in efficiency, reduction in costs in the waste water treatment process and to further enhance the current technologies that we have.

Quality Control

Our quality control department is headed by Ying Mo Zhang, who has more than 30 years of relevant experience. Mr. Zhang has been an engineer and a general manager at several companies, and Vice Chairman of our company, and he is familiar with resource allocation, quality control and environmental facility management control.

To ensure the quality of our products and services, we carry out stringent quality control checks at every stage of project execution.

Quality Control During Design, Research and Development. The design of every project is carried out by our experienced staff following strict guidelines. We have also established a three-tier examination and verification system. A strict examination and approval system is also adopted in respect of any design changes.

Quality Control During Procurement. To ensure the quality of equipment and materials procured, we maintain a list of suppliers and sub-contractors whose goods and services meet our quality control standards. We purchase our materials and equipment only from these suppliers, and such materials and equipment are subject to further inspection and checks by our quality control staff upon arrival at our production facilities. Goods which do not meet our quality control standards are rejected.

Quality Control During Assembly and Integration. As a general policy, our sub-contractors selected and appointed by us to carry out engineering, assembly and integration works should be long established and have good track records.

Quality Control During Delivery and Installation. To ensure that our qualified sub-contractors comply with our quality control standards during delivery and installation, we also task our engineers with formulating a quality control and progress plan, and to identify the key quality control points of the delivery and installation procedure. Such engineers will supervise our sub-contractors during delivery and installation.

Quality Control During Operation for BOT Projects. Our operation team starts their training prior to the commencement of operation. After test run and commissioning, the operation team will take over the operation. We have very strict guidelines for the operating team to ensure quality of clean water. A production report is to be faxed to the head office everyday and we will perform regular tests to ensure the treated water meet high quality standard. We also conduct regular training to ensure that our operation teams are equipped with the latest know-how.

Cooperative Partners and Suppliers

We outsource the design and construction of our subsystems to a number of cooperative partners and key suppliers and maintain close relationships with them. Our cooperative partners include North-Eastern Environmental Protection Design Institute, Guangdong Province Environmental Protection Design Institute, and the 20^th Group of China Railway Company. We have signed cooperative agreements with these cooperative partners. North-Eastern Environmental Protection Design Institute provides technical support in the design of waste water treatment facilities and preparation for the tendering of projects, 20^th Group of China Railway Company evaluates all documents and information required for tendering while Guangdong Province Environmental Protection Design Institute evaluates feasibility and acceptability of the blue prints of the facilities. Compensation for our cooperative partners are based on amount of work done.

North-Eastern Environmental Protection Design Institute was established in 1961 in the city of Changchun. The institute focuses on design of, research in and provision of consultancy services for municipal infrastructure construction works including water supply, waste water treatment, waste treatment, energy supply, construction of road and bridges, public transport and afforestation of city etc. The institute also provides other services in relation to civil construction works for municipal projects like feasibility studies for projects, evaluation of projects, project management and project supervision.

The Guangdong Province Environmental Protection Design Institute was established in 1990. Over the years, the institute has gained experiences in the design, management, treatment and turn-key engineering of waste water, air pollution, noise pollution and waste residue. The institute has achieved remarkable results especially in waste water treatment for the printing and dyeing, electroplating, brewing, pharmaceutical, chemical and food & beverages industries.

The 20^th Group of China Railway is a large-scale construction company in the PRC. The history of the 20^th Group of China Railway dated back to the year 1949. The company has enormous experience in the construction of railway systems in the PRC and related infrastructure including road construction, water supply, energy supply, waste water treatment, urban and rural planning, municipal projects etc. The company is also involved in many large scale construction projects overseas.

There are three main types of equipment for our waste water treatment and potable water projects: (i) electrical equipment which includes various types of sewage pumps, slush pumps and other water pumps, separators, sludge scrapers, mixers, air compressors, filters, dehydrators, blow fans, etc; (ii) automated control systems and electrical parts; and (iii) various test, analysis, detection and monitoring instruments. All purchases from foreign companies are made through their authorized dealers/agents in the PRC. We adhere closely to the principles of total quality management. Our customers, suppliers and employees are encouraged to provide feedback and suggestions for improvements in products and services.

The following table sets forth our major suppliers of equipment and materials:


Component, Raw Materials and Equipments		Our Major Suppliers
Waste water treatment analytical instruments		Hach Company

Blow fan systems		HV-Turbo A/S

Sewage pumps, slush pumps, other water pumps and mixers		German Pump Industry Company

PLC automated control systems		Mitsubishi Electric

Electrical parts		Schneider Electric Low Voltage (Tianjin) Co.

Automated systems		Xian Huiyou Automated Engineering Company

Intellectual Property

We seek to protect our intellectual property by way of our license rights to patents on proprietary features of our advanced bio-chemical treatment technology and processing systems for waste water treatment and by challenging third parties that we believe infringe on our licensed patents. We have obtained the exclusive right to use two patents owned by our Chairman, Mr. Pu, for our MHA and GM Bio-carriers technologies. We also protect our intellectual property rights with nondisclosure and confidentiality agreements with employees, consultants and key customers.

Specifically, we have registered the following patents with the State Intellectual Property Office of the PRC:

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MHA biological treatment process technology (PRC Patent No. ZL 01 1 07637.2) applied on March 14, 2001, declared effective on March 3, 2004 with a duration of 20 years from the date of application; and

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GM Bio carriers (PRC Patent No. ZL 01 1 07624.0) applied on March 8, 2001, declared effective on September 10, 2003 with a duration of 20 years from the date of application.

Employees

As of March 29, 2006, we had 54 employees, of whom 8 were engaged in sales, marketing and service, 12 in research, development and engineering, 25 in finance and administration and 9 in operations. None of our employees is represented by a collective bargaining agreement, and we believe that we have satisfactory relations with our employees.

Environmental

One of our core values is protecting the environment in which we operate and the environment in which our equipment operates. Compliance with laws and regulations regarding the discharge of materials into the environment, or otherwise relating to the protection of the environment, has not had any material effect on our capital expenditures, earnings or competitive position. We do not anticipate any material capital expenditures for environmental control facilities in 2006.

Regulation

The PRC’s numerous ongoing water reforms are moving toward a user-pay, market-driven sector. Legislation serves as the basis to regulate and enforce these reforms. The Water Resource Law, amended and put into effect on October 1, 2002, significantly changes water resource management systems, water resource protection, water conservation, and legal responsibilities.

Environmental Laws and Regulations

In the PRC, environmental laws and regulations are stipulated and implemented through legislation and through administrative authorities at various levels of government. Current environmental laws and regulations can be classified into two categories: environmental management and environmental pollution prevention and control. All environmental laws and regulations are stipulated on the basis of the Environmental Protection Law (EPL). EPL, effective in December 1989, sets the framework for environmental management and pollution control legislation in the PRC.

Environmental Management Law and Regulation. The PRC’s environmental management measures include environmental impact assessment (EIA), the Three Synchronies Policy, permitting requirements, and reporting requirements. Each of these is described below:

Environmental impact assessment. The 1989 Environmental Impact Assessment Law was revised in October 2002. These revisions became effective in September 2003 and apply to all construction projects that may negatively impact the environment. An EIA must be prepared during the project feasibility stage to assess the project’s environmental impact. EIA approval is necessary to secure a construction and operating permit.

Three Synchronies Policy. Article 26 of the EPL defines the Three Synchronies Policy as the installation of pollution prevention and control facilities in a construction project to be undertaken concurrently with the main construction phase. The pollution prevention and control facilities are to be installed and commissioned only after they are inspected and approved by the Environmental Protection Bureau (EPB).

Permitting requirements. Pollution discharges in the PRC are subject to registration and permitting requirements. The EPL defines requirements for pollution discharge registration and permits. Pollution discharges must be registered with the relevant environmental authority. A pollution discharge permit is issued after registration. The Management Regulation on the Registration of Discharged Pollutants, issued by the State Environmental Protection Administration (SEPA), effective Oct. 1, 1992, details requirements for pollution discharge registration. At the state level, the Department of Pollution Control under SEPA implements pollution discharge registration and permitting policies. Pollution control departments under local EPBs are in charge of the registration procedures and issue a pollution discharge permit.

Reporting requirements. According to Article 31 of the EPL, any organization that causes or has a potential to cause an accident resulting in environmental pollution must promptly take measures to prevent and control the pollution hazard and notify the relevant authorities. In addition, enterprises and institutions that have a greater likelihood to cause severe pollution accidents must adopt effective pollution prevention measures.

Environmental Pollution Law and Regulation. Environmental pollution prevention and control measures in the PRC apply to various environmental media, including water, water supply, wastewater discharge, air emissions, hazardous waste management, noise, and soil and groundwater. In November 2004, the management rules regarding environmental pollution prevention facilities operation permit was enacted and it set forth the requirements for getting a permit and how the facilities must be operated.

The following is a summary of environmental pollution laws and regulations regarding water, water supply and waste water discharge in the PRC:

Water. Three laws apply to the water sector:

The Water Resources Law emphasizes the uniform management of river basins and the macro-management of water distribution and consumption. In addition, the law identifies a water quality management system.

The 1984 Water Pollution Prevention and Control Law (WPL) applies to discharges to rivers, lakes, canals, reservoirs, and groundwater. The WPL contains sections pertaining to water quality and discharge standards, pollution prevention, surface water, and groundwater. Amendments in 1996 introduced further controls on river basins, including requirements for cities and towns to establish central sewage treatment plants and to set treatment fees, mass-loading controls, provisions for strengthening the supervision and management of water pollution, and non-point-source pollution controls.

The Implementation Regulation of Water Pollution Prevention and Control Law was enacted on March 20, 2000. This law regulates the supervision and management of surface and ground water pollution, prevention, and control measures.

Water supply. In urban areas, water is usually supplied by the municipal water utility companies, which are responsible for ensuring that water quality complies with the National Drinking Water Standard (GB5749-85). A groundwater abstraction permit is required if any company intends to use groundwater directly. In the northern part of the PRC, however, the use of groundwater is strictly controlled because of significant water shortages and ground settlement issues. Users must apply to provincial or higher level administrative committees for a groundwater abstraction permit.

Wastewater discharge. Two types of wastewater discharge systems are defined in the PRC: (1) polluted wastewater discharges (typically industrial and domestic wastewater) and (2) non-polluted wastewater discharges (for example, storm water). Separate drainage systems for polluted and non-polluted discharges are required for a facility in which a municipal sewer system is available.

Environmental Enforcement

In the PRC, methods of enforcing environmental legislation include discharge fees, surcharge fees, fines, and administrative sanctions. Pollutant discharge activity is subject to a discharge permit, which must be registered and obtained before the pollutants are generated.

In major pollution control areas, such as Shanghai and Beijing, mass-loading targets are established and allocated to major emission facilities by the local EPB. In some pilot locations, emission quotas can be traded among facilities.

In areas with significant pollution problems, such as those impacted by sulfur dioxide emissions, acid rain, and water quality deterioration, specific discharge limitations are adopted to prevent further degradation.

There are specific items within the Constitution of the People’s Republic of China and the PRC Criminal Law to strengthen the enforcement of environmental legislation by disciplinary sanction, civil liability, and even criminal liability. Disciplinary sanctions may come in the form of a warning, a fine, a requirement to install environmental protection equipment, or a requirement to cease operations. Criminal liability can also be passed on to the legal representative of an enterprise if the polluting activity caused severe damage to property, health, or interests of the state or its citizens. In these cases, the individual deemed responsible may be prosecuted. Civil liability also exists and is aimed at activities that may result in civil disputes. Generally, the dispute may be settled through financial compensation by the facility that caused the damage.

Risk Factors

We make written and oral statements from time to time regarding our business and prospects, such as projections of future performance, statements of management’s plans and objectives, forecasts of market trends, and other matters that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Statements containing the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimates,” “projects,” “believes,” “expects,” “anticipates,” “intends,” “target,” “goal,” “plans,” “objective,” “should” or similar expressions identify forward-looking statements, which may appear in documents, reports, filings with the Securities and Exchange Commission, news releases, written or oral presentations made by officers or other representatives made by us to analysts, stockholders, investors, news organizations and others, and discussions with management and other representatives of us. For such statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Our future results, including results related to forward-looking statements, involve a number of risks and uncertainties. No assurance can be given that the results reflected in any forward-looking statements will be achieved. Any forward-looking statement made by or on behalf of us speaks only as of the date on which such statement is made. Our forward-looking statements are based upon assumptions that are sometimes based upon estimates, data, communications and other information from suppliers, government agencies and other sources that may be subject to revision. Except as required by law, we do not undertake any obligation to update or keep current either (i) any forward-looking statement to reflect events or circumstances arising after the date of such statement, or (ii) the important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or which are reflected from time to time in any forward-looking statement which may be made by or on behalf of us.

In addition to other matters identified or described by us from time to time in filings with the SEC, there are several important factors that could cause our future results to differ materially from historical results or trends, results anticipated or planned by us, or results that are reflected from time to time in any forward-looking statement that may be made by or on behalf of us. Some of these important risk factors, but not necessarily all important factors, include the following:

We are dependent on the state of the PRC’s economy as all of our business is conducted in the PRC. All of our business operations are conducted in the PRC and all of our customers are also located in the PRC. Accordingly, any significant slowdown in the PRC economy may cause the waste water treatment industry to reduce expenditure or delay the building of new facilities or projects for waste water treatment. This may in turn lead to a decline in the demand for our products and services, and may reduce our profitability and the return on your investment.

We may not be able to secure new customers. Our business is project-based, though our BOT projects customers are bound to us for the contractual periods of twenty to twenty five years, our other customers are non-recurring customers and we do not expect them to continue to be our customers because of the nature of the industry. If we fail to secure projects from new customers, our revenues and profitability may decline and the return on your investment may be reduced.

Our business could be affected by cost overruns, project delays and/or incorrect estimation of project costs. As our business is project-based, it is important that we manage our projects efficiently in terms of time, procurement of materials and allocation of resources. If our initial cost estimates are incorrect or delays occur in a project resulting in cost overruns, the profitability of that project will be adversely affected. Currently, we offer some of our customers a warranty period of up to 12 months after the commissioning of the water treatment projects, during which we are obliged to provide free rectification work against any manufacturing defects. Cost overruns due to additional rectification work and delays in completion of projects would adversely affect our profitability. We may also face potential liability from legal suits brought against us by our customers for causing loss due to any delay in completing a project. Mismanagement of or mistakes made during our projects will adversely affect our profitability as well as our reputation among our customers. We may also face potential liability from legal suits brought against us by our customers who have suffered loss due to such mismanagement or mistakes. This would also reduce our profitability and the return on your investment.

Failure to retain services of key personnel will affect our operations and results. Our success to date has been largely due to the contributions of our executive officers. The continued success of our business is very much dependent on the goodwill that they have developed in the industry over the past several years.

Our continued success is dependent, to a large extent, on our ability to retain the services of our executive officers. The loss of any of our executive officers’ services due to resignation, retirement, illness or otherwise without suitable replacement or the inability to attract and retain qualified personnel would affect our operations and may reduce our profitability and the return on your investment.

We may not be able to protect our processes, technologies and systems against claims by other parties. Although we have two registered patents in respect of the processes, technologies and systems we use frequently in our systems, we have not purchased or applied for any patents other than these as we are of the view that it may not be cost-effective to do so. For such other processes, technologies and systems for which we have not applied for or purchased or been licensed to use patents, we may have no legal recourse to protect our rights in the event that they are replicated by other parties. If our competitors are able to replicate our processes, technologies and systems at lower costs, we may lose our competitive edge and our profitability may be reduced.

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

We rely on trade secrets, technology and know-how, which we seek to protect, in part, by confidentiality provisions in contracts with our customers and our employees. There can be no assurance that these agreements will not be breached, or that we will have adequate remedies for any breach, or that other parties may not obtain knowledge of our trade secrets and processes, technology and systems. Should these events occur, our business would be affected and hence, our profitability, may be reduced.

We may require additional funding for our future growth. Our future growth will depend, to a large extent, on our ability to secure and invest in BOT projects which require a higher amount of capital investment. In order to obtain additional capital to develop these growth opportunities, we may issue additional shares of our equity securities. If new shares placed to new and/or existing shareholders are issued, they may be priced at a discount to the then prevailing market price of our shares, in which case, existing shareholders’ equity interests may be diluted. If we fail to utilize the new equity to generate a commensurate increase in earnings, our earnings per share will be diluted, and this could lead to a decline in our share price. Any additional debt financing may, apart from increasing interest expense, contain restrictive covenants with respect to dividends, future fund-raising exercises and other financial and operational matters.

Our customers may make claims against us and/or terminate our services, in whole or in part, prematurely should we fail to implement projects that fully satisfy their requirements and expectations. Failure to implement projects that fully satisfy the requirements and expectations of our customers or defective system structure or products as a result of design or workmanship or due to acts of nature may lead to claims against us and/or termination of our services, in whole or in part, prematurely. This may arise from a variety of factors including unsatisfactory design or implementation, staff turnover, human errors or misinterpretation of and failure to adhere to regulations and procedures. This may adversely affect our reputation and may reduce our profitability.

We are exposed to credit risks of our customers. Defaults in payment by our customers will affect our financial position and our profitability. As of December 31, 2005, accounts receivables of $5.22 million accounted for approximately 37% of our current assets. Therefore, our financial position and profitability are dependent on the credit worthiness of our customers. Generally, our credit terms vary from 90 days to 180 days. Defaults in payment by our customers would adversely affect our profitability and cash flow. There was no allowance for doubtful amounts for the years ended December 31, 2004 and 2005. We are unable to provide assurance that risks of default by our customers would not increase in the future, or that we will not experience cash flow problems as a result of such defaults. Should these develop into actual events, our operations will be adversely affected and our profitability may be reduced.

We are reliant on a few major suppliers. We are dependent on our major suppliers for the timely delivery of materials and equipment that we require for the equipment and systems we install. Should our major suppliers fail to deliver the materials and equipment on time, and if we are unable to source these materials and equipment from alternative suppliers on a timely basis, our project timeline will be delayed, thereby affecting delivery to our customers. This, in turn, would adversely affect our reputation if our customers lose confidence in our services and as a result, reduce our revenue and profitability.

We are subject to risks relating to BOT projects in which we have started to invest. We have begun to invest capital in BOT projects which require high up-front capital expenditures. Our returns from BOT projects are derived from fees paid by the PRC government and such BOT projects are able to generate a steady and recurring source of income for us over a sustained period of time between 20 and 25 years. However, our BOT projects are exposed to risks such as the occurrence of natural disasters or the imposition of more stringent government regulations, which may result in the disruption of our BOT projects. Our investment returns from these BOT projects may thus be reduced should any of such risks materialize.

We rely on subcontractors for our projects. As we may, from time to time, subcontract some parts of our projects to subcontractors, such as engineering, assembly and integration works, we face the risk of unreliability of work performed by our subcontractors. Should our subcontractors default on their contractual obligations and work specifications, our ability to deliver the end product or service to our customers in accordance with quality and/or timing specifications may, in turn, be compromised. Furthermore, if we are unable to secure competitive rates from our subcontractors, our profitability may be reduced.

The registered capital of our PRC subsidiaries may, in some cases, limit the size of the projects we bid for. We tender for projects in the normal course of business. There are instances where the projects that we intend to tender for require tendering companies to have a minimum registered share capital which is more than the registered share capital of our PRC subsidiaries. Under applicable PRC law, registered capital is defined as the total amount of capital contributions subscribed to by the parties and registered with the PRC authorities. Therefore, the quantum of our capital contributions to the PRC subsidiaries may limit the size of the projects that we are able to successfully tender for, even if we could show that we have other sources of fund. Although some customers may take into account other factors like our trading status and our track record, we are unable to assure you that we would be able to secure projects which are valued at more than our registered capital. Consequently, our revenue, business and financial results may decline.

We are subject to foreign exchange risks. Our dominant transactional currency is the Chinese RMB, including the cost of materials which are imported by our suppliers. With costs mainly denominated in RMB, our transactional foreign exchange exposure for the past few years has been insignificant. However, as our suppliers take into account the fluctuations in foreign exchange rates when they price the imported materials which we procure from them, such fluctuations in foreign exchange rates may result in changes in the purchase price of imported materials. Any future significant fluctuations in foreign exchange rates may have a material impact on our financial performance in the event that we are unable to transfer the increased costs to our customers.

We may be adversely affected by slow downs in the PRC economy owing to unforeseen circumstances, such as an outbreak of infectious diseases. Our business is dependent on the number of contracts we are able to secure from our customers. Unforeseen circumstances such as an outbreak of infectious diseases may lead to a decline in global and regional business, which may, in turn, lead to a decline in demand for our services.

Furthermore, should such unforeseen circumstances cause disruptions to our customers’ operations, they may undertake cost-cutting measures such as cutting capital expenditure and deferring projects such as installation of water treatment systems. The demand for our business may decline as a result of such cost-cutting measures.

Since our subsidiaries, operations and significant assets are located in the PRC, shareholders may find it difficult to enforce a U.S. judgment against the assets of our company, our directors and executive officers. Our subsidiaries’ operations and significant assets are located in the PRC. In addition, all of our executive officers and our directors are non-residents of the U.S., and substantially all the assets of these persons are located outside the U.S. As a result, it could be difficult for investors to effect service of process in the U.S., or to enforce a judgment obtained in the U.S. against us or any of these persons.

Our operations could be adversely affected by changes in the political and economic conditions in the PRC. The PRC is our main market and accounted for all of our revenue in 2004. Therefore, we face risks related to conducting business in the PRC. Changes in the social, economic and political conditions of the PRC may adversely affect our business. Unfavorable changes in government policies, political unrest and economic developments may also have a negative impact on our operations.

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

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

We may be subject to foreign exchange controls in the PRC. Our PRC subsidiaries are subject to PRC rules and regulations on currency conversion. In the PRC, the State Administration for Foreign Exchange (“SAFE”) regulates the conversion of the RMB into foreign currencies. Currently, foreign investment enterprises (“FIEs”) are required to apply to SAFE for “Foreign Exchange Registration Certificate for FlEs”. All of our subsidiaries are FIEs. With such registration certifications (which need to be renewed annually), FlEs are allowed to open foreign currency accounts including the “recurrent account” and the “capital account”. Currently, conversion within the scope of the “recurrent account” can be effected without requiring the approval of SAFE. However, conversion of currency in the “capital account” (e.g. for capital items such as direct investments, loans, securities, etc.) still requires the approval of SAFE. Our operations and business may be adversely affected if conversion of currency in the “capital account” is not approved by the SAFE.

Item 2. Description of Property

Our principal executive office consists of approximately 400 square meters of office space that we lease and which are located at Suite 7A01, Baicheng Building, 584 Yingbin Road, Dashi, Panyu District, Guangzhou, Guangdong, China. We lease this space pursuant to a three year lease at a rate of approximately $19,000 per year commencing April 1, 2006.

Our BOT facilities are located at the following locations:


BOT Facilities		Location
Waste water treatment plant of TJ		Dinan Road, Wuqing Development Zone, Tianjin, PRC.

Waste water treatment plant of XL		South west of Matoupu Village, Xinle City, Hebei, PRC.

Waste water treatment plant of HY		Hexi, Zangjia Village, Yaiyang Touring and Vacationing Area, Haiyang City, Shandong, PRC.

Waste water treatment plant of BJHTSY		Tianzhu Real Estate Development Area of Shunyi District, Beijing, PRC.

Waste water treatment plant of HDFF		West of Qianpuzi Village, Mafeng Road, Fengfeng Mining Area, Handan, Hebei, PRC.

Each of the above BOT facilities consists of waste water treatment plants, office buildings and staff facilities. Apart from the waste water treatment plant of HDFF which is still under construction, constructions of the waste water treatment plants of TJ, XL, HY and BJHTSY are completed.

Item 3. Legal Proceedings.

Neither our company nor any of our properties are currently subject to any pending legal proceedings.

Item 4. Submission of Matters to a Vote of Security Holders.

No matters were submitted to a vote of shareholders during the fourth quarter of the year ending December 31, 2005.

Part II

Item 5. Market for Common Equity and Related Shareholder Matters.

Market Information

Our common stock is traded on the OTC Bulletin Board (“OTCBB”) under the symbol “CEEC”. The following table sets forth, for the periods indicated, the high and low sale prices of our common stock as reported on the OTCBB. We consider our common stock to be thinly traded and that any reported bid or sale prices may not be a true market-based valuation of the common stock.


Quarter Ended	High		Low
March 31, 2004	$	0.54	$	0.10
June 30, 2004	$	0.58	$	0.365
September 30, 2004	$	0.65	$	0.38
December 31, 2004	$	0.55	$	0.35

March 31, 2005	$	0.48	$	0.30
June 30, 2005	$	0.37	$	0.15
September 30, 2005	$	0.43	$	0.14
December 31, 2005	$	0.32	$	0.20

March 31, 2006	$	0.43	$	0.20
Second quarter (through April 13, 2006)	$	0.40	$	0.35

Holders

As of March 28, 2006, there were 141 record holders of our common stock.

Dividends

Our policy is to retain earnings to provide funds for the operation and expansion of our business. We have not paid cash dividends on our common stock and do not anticipate that we will do so in the foreseeable future. The payment of dividends in the future will depend on our growth, profitability, financial condition and other factors that our board of directors may deem relevant.

Securities Authorized for Issuance Under Equity Compensation Plans

We did not have any securities underlying outstanding options and securities remaining available for issuance under any equity compensation plans as of December 31, 2005.

Sales of Unregistered Securities

In April 2005, we conducted a private placement of 20 investment units, at $25,000 per unit, for gross proceeds of $500,000. Each unit consisted of (a) a 12% convertible debenture in the original principal amount of $25,000, convertible into shares of our common stock at the rate of the lesser of (i) $0.20 per share or (ii) a 10% discount to the price per share of common stock (or conversion price per share of common stock) of the next private placement conducted by us prior to any conversion of the debenture, and (b) 125,000 detachable warrants to purchase one share each of our common stock at an exercise price of $0.20 per share, expiring ten years from their date of issuance. The debentures were due and payable August 1, 2005 and later extended to September 30, 2005. We granted the investors limited registration rights for the common shares underlying their debentures and warrants. Westminster Securities Corporation acted as placement agent for this offering on our behalf. On October 1, 2005, all debenture holders converted the debentures into 3,703,701 shares of our common stock. As of January 9, 2006, none of the detachable warrants issued with the convertible debenture had been exercised. The issuances were made in reliance on Section 4(2) of the Securities Act of 1933 and Rule 506 of thereunder, and were made without general solicitation or advertising. The recipient was a sophisticated investor with access to all relevant information necessary to evaluate the investment, and who represented to us that the warrants and the underlying shares were being acquired for investment purposes.

On September 14, 2005, we closed the private placement sale to accredited investors of units consisting of shares of our common stock and warrants to purchase shares of our common stock for aggregate gross proceeds of $4.83 million. Pursuant to the subscription agreements entered into with the investors, we issued to the investors 161 units at a price of $30,000 per unit. Each unit consisted of 200,000 shares of our common stock, priced at $0.15 per share, and warrants to purchase 200,000 shares of our common stock over a five-year period at an exercise price of $0.20 per share. Pursuant to the terms of the subscription agreements, we granted the investors limited registration rights for all common shares comprising the units, including the common shares issuable on exercise of the warrants. Westminster Securities Corporation acted as placement agent for this offering on our behalf. As of December 8, 2005, none of the detachable warrants issued with the issuance of shares of our common stock had been exercised. The issuances were made in reliance on Section 4(2) of the Securities Act of 1933 and Rule 506 of thereunder, and were made without general solicitation or advertising. The recipients were sophisticated investors with access to all relevant information necessary to evaluate the investments, and who represented to us that the shares were being acquired for investment purposes.

Item 6. Management’s Discussion and Analysis or Plan of Operation.

General

We design, construct, and invest in waste water treatment projects in the PRC. We sell materials and products related to environmental protection. We also operate waste water treatment facilities and tap water facilities under our BOT model.

We invest in waste water treatment facilities through BOT arrangements. BOT projects provide us with a stable and guaranteed income source under a long-term (usually 20-25 year) contract granted by municipal governments to build and operate waste water plants. BOT project land is typically contributed by the municipal government with the operator providing investment and daily management. After the contract period, the project is transferred to the local government. After we secure a contract for a BOT project from a municipal government and the financing for such project is in place, we will proceed to construct the facility. After the completion of construction and testing and commissioning, we will operate the waste water treatment facility for a period of 20-25 years as stipulated in the BOT contract.

We also provide turn-key waste water treatment engineering services to both public and private sectors. Our public sector clients include municipal governments at the city, district and town levels. Our private sector clients include heavy industries, such as steel, car manufacturing, electronic; light industries, such as chemical, food and beverage, paper, printing and breweries; and others, including hospitals and the pharmaceutical industry. The industrial wastewater qualities differ due to the different industrial products and manufacturing processes. These turn-key waste water treatment contracts are awarded either by public tender or by direct contract. A typical turn-key waste water treatment project can be classified into three phases; (1) survey and design, (2) construction and equipment installation, and (3) operation and management services.

Many of our principal customers are local governments, food and beverage processing companies and industrial companies that use our technologies to treat their waste water. In 2005, the Group’s major customers are Beijing Jinqiao Luyuan Environment Protection Investment Development Company Limited and Shenzhen Jukeyuan Industrial Development Company Limited, both independent third parties, which, accounted for approximately 25.2% and 23.4%, respectively, of the Group’s total revenue of 2005. Revenue from Beijing Jinqiao Luyuan Environment Protection Investment Development Company Limited was in relation to the turnkey engineering project of China Environment Industrial Park Wastewater Treatment Plant while revenue from Shenzhen Jukeyuan Industrial Development Company was for the turnkey engineering project of Lechang City Lecheng Wastewater Treatment Plant and the sale of environment protection related products. In 2004, our major customer is the People’s Government of Wuqing District, Tianjin City, which accounted for 100% of our total revenue in relation to the provision of BOT wastewater treatment services.

For more information on our business, see “Our Business” section.

•

As a result of the transaction described above we changed our name from Discovery Investments, Inc. to China Evergreen Environmental Corporation.

Critical Accounting Policies

The following is a discussion of those accounting policies that we deem to be “critical” — that is, they are important to the portrayal of our financial condition and results, and they reflect management’s reliance on estimates regarding matters that are inherently uncertain.

Revenue recognition. We recognize revenue using various revenue recognition policies based on the nature of the sale and the terms of the contract.

Revenues from turn-key engineering projects are recognized on the percentage of completion method for individual contracts. We follow the guidance of American Institute of Certified Public Accountants (AICPA) Statement of Position (SOP) 81-1, Accounting for Performance of Construction-Type and Certain Production-Type Contracts, for our accounting policy relating to the use of the percentage-of-completion method, estimated costs and claim recognition for construction contracts. Revenues are recognized in the ratio that costs incurred bear to total estimated contract costs to the extent we believe related collection is probable. The use of the percentage of completion method of revenue recognition requires estimates of percentage of project completion. Changes in job performance, estimated profitability and final contract settlements may result in revisions to costs and income in the period in which the revisions are determined. Provisions for any estimated losses on uncompleted contracts are made in the period in which such losses are determinable. In instances when the work performed on fixed price agreements is of relatively short duration, we use the completed contract method of accounting whereby revenue is recognized when the work is completed. 5% to 10% of the total contract value will be treated as retention monies withheld to ensure performance of contract during the warranty period of up to 12 months as stipulated in the fixed price contracts, both long term and short term.

Revenues arising from waste water treatment are recognized based on waste water treated as recorded daily by meters read at rates, in RMB/ton, as prescribed under the BOT agreements in accordance with SEC Staff Accounting Bulletin, (“SAB”) Topic 13 “Revenue Recognition”. We meet the following four criteria for revenue recognition outlined in SAB Topic 13:

There is sufficient evidence to support that sales arrangements exist;

The price to the buyer is fixed through signed contracts;

Meter readings illustrate that delivery of treated waste water has occurred; and

Collectibility is reasonably assured through one or more of the following: due diligence prior to contract signing; historical payment practices; or required upfront payments.

Revenues from sale of environment protection related products and provision of technical services are recognized when goods are delivered or as services are performed. The contractual terms of the purchase agreements or consultancy agreements dictate the recognition of revenues by us. We recognize revenue in accordance with Staff Accounting Bulletin No. 104. Accordingly, four basic criteria must be met before revenue can be recognized: (1) persuasive evidence of an arrangement exists; (2) delivery has occurred; (3) the selling price is fixed and determinable; and (4) collectibility is reasonably assured. Determination of criteria (3) and (4) are based on management’s judgments regarding the fixed nature of the selling prices of the products or services delivered and the collectibility of those amounts. Provisions for discounts and rebates to customers, estimated returns and allowances, and other adjustments are provided for in the same period the related sales are recorded. We defer any revenue for which the product has not been delivered or is subject to refund until such time that we and our customer jointly determine that the product has been delivered or no refund will be required.

Impairment of assets. Our policy is to periodically review and evaluate whether there has been a permanent impairment in the value of long-lived assets. Factors considered in the evaluation include current operating results, trends and whether the anticipated undiscounted estimated future cash flows are less than the carrying value.

Allowances for accounts receivables. Our provisioning policy for bad and doubtful debt is based on the evaluation of collectibility and aging analysis of accounts receivables and on management’s judgment. We do not require collateral or other security to support clients’ receivables. We conduct periodic review of our clients’ financial condition and customer payment practice to minimize collection risk on accounts receivables. This review is based on considerable amount of judgment which is required in assessing the ultimate realization of these receivables, including the current creditworthiness and the past collection history of each customer. During the 2004 financial period, we had not made any allowance for doubtful debts.

Credit Policy. As of December 31, 2005 and 2004, our accounts receivables were US$5.22 million and US$0.05 million, respectively. The increase in accounts receivables in 2005 was due to increase in receivable from turnkey engineering projects. There is no allowance for doubtful amounts for both 2005 and 2004.

For turn-key projects, we bill our customers based on the percentage of completion as set forth in the contract signed with our customers whereas for BOT projects, we start billing our customers monthly once the wastewater treatment facilities start operation for the operating period as stipulated in the BOT agreements.

Financial Instruments. The Company conducted a private placement in April 2005 (“April Private Placement”) of 20 investment units, at $25,000 per unit, for gross proceeds of $500,000. Each unit consisted of (a) a 12% convertible debenture in the original principal amount of $25,000, convertible into shares of our common stock at the rate of the lesser of (i) $0.20 per share or (ii) a 10% discount to the price per share of common stock (or conversion price per share of common stock) of the next private placement conducted by us prior to any conversion of the debenture, and (b) 125,000 detachable warrants to purchase one share each of our common stock at an exercise price of $0.20 per share, expiring ten years from their date of issuance (“April Warrants”). As a result of the September 2005 private placement, pursuant to Section 5(d) of the warrant agreement, the exercise price has been adjusted to $0.15 per share on September 14, 2005. The debentures were due and payable August 1, 2005. The debenture holders, however, extended the payment period to September 30, 2005. The debentures were converted into 3,703,701 shares of common stock on October 1, 2005.

The Company used the Black-Scholes model in calculating the fair market value of the April Warrants and allocated $148,531, $74,266 and $185,664 of the $408,461 net proceeds to the Convertible Debenture, the Bifurcated Conversion Feature of the Debenture and the April Warrants, respectively. The differences between the fair value of each of the Convertible Debenture, the Bifurcated Conversion Feature of the Debenture and the April Warrants and the respective allocated amounts are recorded as non-cash financing charges and expensed of at the date of issuance. The principal assumptions used in the computation of the April Warrants are: expected term of 10 years; a risk-free rate of return of 4.24%; dividend yield of zero percent; and a volatility of 70%.

The Company granted to the holders of the April Warrants certain piggy-back and demand registration rights. Pursuant to the agreements surrounding the April Private Placement, in the event that the Company determined to undertake a registration of securities, the Company would include, at the request of the holder of “Registrable Securities”, the Registrable Securities in the registration statement. If the Company did not file a registration statement by the 120th day from the closing of such financing, and the Company shall have received a written request signed by the holders holding the majority of the Registrable Securities, then the Company was obligated to file, at its expense, a registration statement covering the Registrable Securities. Once such registration statement has been filed and declared effective, the Company is obligated to keep such registration statement effective until the earlier of (i) the date that all of the Registrable Securities have been sold pursuant to such registration statement, (ii) all Registrable Securities have been otherwise transferred to persons who may trade such shares without restriction under the Securities Act, and the Company has delivered a new certificate or other evidence of ownership for such securities not bearing a restrictive legend, or (iii) all Registrable Securities may be sold at any time, without volume or manner of sale limitations pursuant to Rule 144(k) or any similar provision then in effect under the Securities Act. As of December 31, 2005, the Company has not received any written request signed by the holders holding the majority of the Registrable Securities.

The conversion feature of the convertible debenture issued in April did not qualify for the scope of exception from the provisions of SFAS 133 because the convertible debentures are convertible into a variable number of shares. As such, the conversion feature was bifurcated from the convertible debenture and accounted for as a derivative at fair value with changes in fair value recorded in earnings. Upon the conversion of the convertible debentures in October 2005, the convertible debenture was recorded in equity as additional capital.

On September 14, 2005, the Company closed the private placement sale to accredited investors of units consisting of shares of our common stock and warrants to purchase shares of our common stock for aggregate gross proceeds of $4.83 million (“September Private Placement”). Pursuant to the subscription agreements entered into with the investors, we issued to the investors 161 units at a price of $30,000 per unit. Each unit consisted of 200,000 shares of our common stock, priced at $0.15 per share, and warrants to purchase 200,000 shares of our common stock over a five year period at an exercise price of $0.20 per share. Pursuant to the terms of the subscription agreements, we granted the investors limited registration rights for all common shares comprising the units, including the common shares issuable on exercise of the warrants. The Company also issued to Westminster Securities Corporation, as partial compensation for their placement agent services, 7,728,000 placement agent warrants to purchase one share each of our common shares, a portion of which has been assigned by Westminster Securities Corporation to certain of its officers and employees (the warrants issued in the September Private Placement together with the placement agent warrants are hereinafter referred to as “September Warrants”).

The Company used the Black-Scholes model in calculating the fair market value of the September Warrants and allocated $4,140,535 of the $4,172,735 net proceeds to the September Warrants. The difference between the fair value of the September Warrants and the allocated amount is recorded as non-cash financing charges and expensed of at the date of issuance. The principal assumptions used in the computation of the September Warrants are: expected term of 5 years; a risk-free rate of return of 4.24%; dividend yield of zero percent; and a volatility of 70%.

The September Warrants were issued pursuant to the agreements surrounding the September Private Placement. The subscription agreement contains a liquidated damages clause which requires cash penalties equal to two percent (2.0%) of the purchase price of the registrable securities purchased from the Group and held by the investors each month (or portion thereof) if the Group’s registration statement is not filed with the SEC within thirty (30) days of the final closing, (ii) such registration statement is not declared effective by the SEC within the earlier of one hundred and twenty (120) days from the final closing or three (3) business days of clearance by the SEC to request effectiveness, (iii) such registration statement is not maintained as effective by the Group for the effectiveness period or as allowed by 5(k)(ii) below or (iii) the additional registration statement referred to in Section 5(b) is not filed within thirty (30) days or declared effective within ninety (90) days as set forth therein. As of December 31, 2005, the Group has estimated a registration right liability of $94,981.

Since the liquidated damages are payable in cash, under paragraphs 12-32 of EITF 00-19 “Accounting for Derivative Financial Instruments Indexed to and Potentially Settled in a Company’s Own Stock”, contracts that include any provision that could require net-cash settlement cannot be accounted for as equity. Accordingly, the proceeds of the private placement in September allocated for par value of the common stock and the September Warrants have been recorded as a liability on the balance sheet. Upon the effectiveness of the registration statement, the amount will be recorded as equity.

Results of Operations

For the fiscal year ended December 31, 2005 compared to December 31, 2004

The following table sets forth the items in our consolidated statements of operations for the periods indicated.


	*Year ended December 31,*
	*2005* *USD*		*2004* *USD*
Revenue from turn-key engineering projects	4,830,613		—
Revenue from BOT wastewater treatment services	302,011		250,571
Revenue from provision of technical services	600,734		—
Revenue from sales of environment protection related products	1,250,611		—

Total revenue	6,983,969		250,571
Cost of revenue for turn-key engineering projects	(2,784,341	)
Cost of revenue for BOT wastewater treatment services	(175,077	)	(100,072	)
Cost of revenue for provision of technical services	(2,406	)	—
Cost of revenue for sales of environment protection related products	(310,379	)	—

Total cost of revenue exclusive of depreciation and amortization and sales taxes shown separately below	(3,272,203	)	(100,072	)
Depreciation and amortization	(115,737	)	(66,413	)
Sales taxes	(369,052	)	—

Gross profit	3,226,977		84,086
General and administrative expenses	(820,170	)	(1,328,756	)

Income/(loss) from operations	2,406,807		(1,244,670	)
Other income	54,622		19,295
Interest expense	(42,991	)	(2,420	)
Non-cash financing charges	(8,001,211	)	—
Unrealized gain on financial instruments	5,440,454		—
Share of results in an associate – XL	416,218		130,113
Gain on disposal of interest in a subsidiary – XY	—		5,220,299
Gain on disposal of construction project	635,941		—
Loss on disposal of investment	(472,643	)	—

Income before income tax and minority interest	437,197		4,122,617
Income tax expense	(920,001	)	(467,911	)

(Loss)/income before minority interest	(482,804	)	3,654,706
Minority interests	(277,700	)	42,243

Net (loss)/income	(760,504	)	3,696,949

Basic net (loss)/income per share	(0.01	)	0.03

Diluted net (loss)/ income per share	(0.01	)	0.03

Revenue. The Company reported total revenue of $6,983,969 for the year ended December 31, 2005 as compared to $250,571 for the year ended December 31, 2004. The total revenue for the year ended December 31, 2005 is comprised of revenue from turn-key engineering projects of $4,830,613, revenue from BOT wastewater treatment services of $302,011, revenue from provision of technical services of $600,734 and revenue from sale of environment protection related products of $1,250,611 while the total revenue of $250,571 for the year ended December 31, 2004 is comprised of revenue from the provision of BOT wastewater treatment services for the Tianjin BOT plant. The revenue from turn-key engineering projects in 2005 as below:


*Turn-key engineering projects in 2005*	*Capacity* *(tons/day)*	*Percentage of* completion at December 31, *2005*
Tianjin City Meichang Town Wastewater Treatment Plant	2,000	80	%
Lechang City Lecheng Wastewater Treatment Plant	25,000	100	%
Yongji Development Zone Wastewater Treatment Plant (Phase 1)	3,000	100	%
Yongji Development Zone Wastewater Treatment Plant (Phase 2)	14,000	32	%
China Environment Industrial Park Wastewater Treatment Plant	30,000	44	%
Huangzhuang Industrial Park Wastewater Treatment Plant	500	80	%

Revenue from BOT projects in 2005 increased to $302,011 from that of $250,571 in 2004. This is mainly due to the commencement of operation of the HY BOT project in the forth quarter of 2005.

Revenue from provision of technical services in 2005 is $600,734. There was no such revenue in 2004.

Revenue from sale of environment protection related products in 2005 is $1,250,611. There was no such revenue in 2004.

Cost of revenue. Our total cost of revenue, exclusive of depreciation and amortization and sales taxes, increased from $100,072 for the year ended December 31, 2004 to $3,272,203 for the year ended December 31, 2005. This is in line with the increase in total revenue for the year ended December 31, 2005 as compared to the total revenue for the year ended December 31, 2004. Cost of revenue for the year ended December 31, 2005 comprised of cost of revenue for turn-key engineering projects of $2,784,341, cost of revenue for BOT wastewater treatment services of $175,077, cost of revenue for provision of technical services of $2,406 and cost of revenue for the sale of environment protection related products of $310,379 whereas cost of revenue for the year ended December 31, 2004 comprised of only cost of revenue for BOT wastewater treatment services of $100,072.

Gross profit. Gross profit as a percentage of total revenue for the years ended December 31, 2005 and 2004 were approximately 46% or $3,226,977 and approximately 34% or $84,086, respectively. The increase is mainly due to the higher gross margin for turnkey projects, provision of technical services and sale of environment protection related products which the company did not engaged in 2004. Gross margin, exclusive of depreciation and amortization and sales taxes, for turn-key engineering projects for the years ended December 31, 2005 was approximately 42% or $2,046,272. There was no revenue from turnkey projects in 2004. Gross margin, exclusive of depreciation and amortization and sales taxes, for BOT wastewater treatment services for the years ended December 31, 2005 and 2004 were approximately 42% or $126,934 and approximately 60% or $150,499. The decrease in gross margin, exclusive of depreciation and amortization and sales taxes, for BOT wastewater treatment services for the year ended December 31, 2005 is mainly due to repair and maintenance cost in 2005. Gross margin, exclusive of depreciation and amortization and sales taxes, for sale of environment protection related products for the year ended December 31, 2005 was approximately 75% or $940,232. Gross margin, exclusive of depreciation and amortization and sales taxes, for provision of technical services for the year ended December 31, 2005 was approximately 99.6% or $598,328. The high gross margin for provision of technical services is mainly because of the low cost of salary for the engineers designated for the provision of such technical services which is a transfer of experience and technical know-how of the company.

General and administrative expenses. Our total general and administrative expenses for the years ended December 31, 2005 and 2004 were $820,170 and $1,328,756 respectively. The principal components of general and administrative expenses are administrative salaries and benefits, traveling expenses, rental and other general administration costs. However, general and administrative expenses for the year ended December 31, 2004 include cost of reverse acquisition. The decrease in general and administrative expenses for the year ended December 31, 2005 as compared to that for the year ended December 31, 2004 is mainly due to the cost of reverse acquisition amounted to $0.53 million.

Non-cash financing charges. Non-cash financing charge represents the amount of fair value of derivative liabilities issued exceeds the amount of proceeds received, which is recorded as an expense at the date of issuance. The Non-cash financing charges recorded for the convertible debenture issuance in April was approximately $0.9 million while the Non-cash financing charges recorded for the September private placement was approximately $7.1 million. No Non-cash financing charges was recorded in 2004.

Unrealized gain in financial instruments. Unrealized gains or losses in financial instruments represent the change in fair market value of the financial instruments at each reporting date. The unrealized gain in financial instruments of approximately $5.44 million for the year ended December 31, 2005 comprised of unrealized gain for the changes in fair values of the September issued warrant and the placement agent warrants amounted to approximately $5.66 million offset by the unrealized loss for the changes in fair values of the April warrants and the bifurcated conversion feature amounted to approximately $0.22 million. There were no unrealized gains or losses in financial instruments recorded in 2004.

Loss on disposal of investment. In March 2005, the Group converted the convertible note receivable from China Water Affairs Group Limited (previously know as China Silver Dragon Group Limited) of face value $1,366,997 into 13,260,000 common shares of China Water Affairs Group Limited and an amount receivable of $135,019, after off-setting the deposit received for disposal of a subsidiary. All the shares were subsequently disposed of to Hampton Limited at a consideration of $759,335 and a loss on disposal of investment of $472,643 was recorded.

Lost on disposal of investment. In March 2005, the Group converted the convertible note receivable from China Water Affairs Group Limited (previously know as China Silver Dragon Group Limited) of face value $1,366,997 into 13,260,000 common shares of China Water Affairs Group Limited and an amount receivable of $135,019. All the shares were subsequently disposed of at a consideration of $759,335 and a loss on disposal of investment of $472,643 was recorded.

Net (loss) / income. We had a net loss, after income tax and minority interests, of $760,504 for the year ended December 31, 2005 and a net income, after income tax and minority interests, of $3,696,949 for the year ended December 31, 2004. The net loss in 2005 is mainly due to the non-cash financing charge which represents the amount of fair value of derivative liabilities issued exceeds the amount of proceeds received, and is recorded as an expense at the date of issuance of the financial instruments though the amount was offset by the unrealized gain in financial instruments. In addition, the under provision of PRC tax for 2004 and the increase in taxable income also contributes to the net loss in 2005.

For the fiscal year ended December 31, 2004 compared to December 31, 2003

The following table sets forth the items in our consolidated statements of operations for the periods indicated.


	Fiscal year ended December 31,
	2004			2003
Revenue from construction of waste water treatment plants	$	—		$	2,889,094
Revenue from water treatment services per BOT agreements		250,571			—

Total revenue		250,571			2,889,094
Cost of revenue for construction of waste water treatment plants		—			(1,828,801	)
Cost of revenue for water treatment services per BOT agreements		(100,072	)		—

Total cost of revenue exclusive of depreciation and amortization Shown separately below		(100,072	)		(1,828,801	)
Depreciation and amortization		(66,413	)		(17,941	)

Gross profit		84,086			1,042,352
General and administrative expenses		(1,328,756	)		(337,472	)

(Loss)/ income from operations		(1,244,670	)		704,880
Other income		19,295			9,240
Interest expense		(2,420	)		(28,590	)
Share of results in XL		130,113			—
Gain on disposal of interest in XY		5,220,299			—
Impairment loss on other investment		—			(370,097	)

Income before income tax		4,122,617			315,433
Income tax expense		(467,911	)		(104,093	)
Minority interests		42,243			(42,993	)

Net income		3,696,949			168,347

Total revenue. Total revenue decreased from $2.89 million in 2003 to $0.25 million in 2004. The 2004 decrease in revenue was primarily due to no turnkey construction revenue was recognized in 2004. Revenue from wastewater treatment services per BOT agreements for 2004 was contributed by the waste water treatment plant of TJ while no such revenue was recorded in 2003. Although total revenue attributable to the operation of wastewater treatment plants under the BOT agreements was only $0.25 million in 2004, we expect such fees to increase in 2005.

Gross Profit. Gross profit decreased from $1.04 million in 2003 to $0.08 million in 2004 and, as a percentage of total revenue, decreased from 36.08% in 2003 to 33.56% in 2004. The decrease in gross profit for 2004 was primarily due to no turnkey construction revenue was recognized in 2004 while the lower gross profit margin as a percentage of total revenue was due to the lower gross profit margin for BOT projects as compare to that for turnkey engineering projects.

Selling, General and Administrative. Selling, general and administrative costs increased 292.5% from $0.36 million in 2003 to $1.4 million in 2004, and as a percentage of net sales, increased from 12.30% to 14.89%. The increase in costs in 2004 was primarily the result of consultant fees and legal fees paid for the reverse acquisition and the reorganization, whereby EGAG acquired equity interests in the PRC subsidiaries, which amounted to approximately $0.97 million.

Operating income. In 2003, the operating income was $0.70 million while in 2004, the operating loss was $1.24 million. The operating loss was due to low gross profit which is not sufficient to cover the high selling, general and administrative expenses.

Share of results in an associate –XL. This represents the share of net profits in Xin Le Sheng Mei Water Purifying Company Limited in which the Group has 35% equity interest. Share of results in XL for the year ended December 31, 2004 was $130,113. There was no share of results in an associate – XL in 2003 as the 55% equity interest in XL was disposed of in 2004.

Gain on disposal of interest in subsidiary XY. We recorded a $5.22 million gain in 2004 on the disposal of our entire 90% attributable interest in “XY” at a consideration of $13,246,377. The transaction was consummated on October 26, 2004. No revenue was generated from XY prior to the date of disposition as the waste water treatment plant was still under construction.The gain represents the difference between the disposal proceeds and our attributable share of net assets of XY at the date of disposal.

Liquidity and Capital Resources

As of December 31, 2005, we had $175,224 in cash and cash equivalents. During 2005, we created net cash resources of approximately $3.64 million by operating activities. We used net cash of $6.88 million for investing activities in 2005. This use of cash was primarily the result of acquisition of infrastructure assets for BJHTSY, HY and HDFF amounted to $4.39 million and deposit paid for acquisition of a subsidiary of $2.02 million. The net cash provided by financing activities was about $3.08 million, and the increase primarily resulted from convertible debenture issuance in April 2005 of $0.41 million, share issuance in September 2005 of $4.2 million and net proceeds from disposal of investment of $0.91 million offset by decrease in amounts due to a related company amounted to $2.6 million.

We have an unsecured loan of about $86,741 with a Chinese bank which is interest bearing at 9.486% per annum. Under the BOT agreements, we have capital commitments of $3.53 million for the BJHTSY and HDFF BOT projects. We also have capital commitments of $2.40 million for turn-key engineering projects. The total contracts due in 2005 within two years is about $5.93 million.

In April 2005, we conducted a private placement of 20 investment units, at $25,000 per unit, for gross proceeds of $500,000. Each unit consisted of (a) one 12% convertible debenture in the original principal amount of $25,000, convertible into shares of our common stock at the rate of the lesser of (i) $0.20 per share or (ii) a 10% discount to the price per share of common stock (or conversion price per share of common stock) of the next private placement conducted by us prior to any conversion of the debenture, and (b) 125,000 detachable warrants to purchase one share each of our common stock at an exercise price of $0.20 per share, expiring ten years from their date of issuance. As a result of the September 2005 private placement, pursuant to Section 5(d) of the warrant agreement, the exercise price has been adjusted to $0.15 per share on September 14, 2005. The debentures are due and payable August 1, 2005 and later extended to September 30, 2005. On October 1, 2005, all debenture holders converted the debentures into 3,703,701 shares of our common stock.

On September 14, 2005, we closed a private placement to accredited investors of units consisting of shares of our common stock and warrants to purchase shares of our common stock for aggregate gross proceeds of $4.83 million. Pursuant to the subscription agreements entered into with these investors, we issued to the investors 161 units at a price of $30,000 per unit. Each unit consisted of 200,000 shares of our common stock, priced at $0.15 per share, and warrants to purchase 200,000 shares of our common stock over a five year period at an exercise price of $0.20 per share. Pursuant to the terms of the subscription agreements, we granted the investors limited registration rights for all common shares comprising the units, including the common shares issuable on exercise of the warrants.

Our business forecasts project that our cash position, cash flow and our working capital line of credit will be sufficient to meet our corporate, operating and capital requirements throughout 2005. However, we may need additional access to long-term capital for acquisitions or other expansion projects.

Other Matters

The impact of inflation and the effect of foreign exchange rate changes during 2004 have not had a material impact on our business and financial results.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet financing arrangements.

Item 7. Financial Statements

INDEX TO FINANCIAL STATEMENTS


Report of Independent Registered Public Accounting Firm		F-1

Consolidated Balance Sheets at December 31, 2005 and 2004		F-2

Consolidated Statements of Operations for the years ended December 31, 2005 and 2004		F-3

Consolidated Statements of Stockholders’ Equity		F-4

Consolidated Statements of Cash Flows for the years ended December 31, 2005 and 2004		F-5

Notes to Consolidated Financial Statements		F-6

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Stockholders of

China Evergreen Environmental Corp.

We have audited the accompanying consolidated balance sheets of China Evergreen Environmental Corp. (the “Company”) and its subsidiaries as of December 31, 2005 and 2004 and the related consolidated statements of operations, stockholders’ equity and cash flows for each of the two years in the period ended December 31, 2005. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company and its subsidiaries as of December 31, 2005 and 2004 and the consolidated results of their operations and their cash flows for each of the two years in the period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America.

/s/ PKF

Certified Public Accountants

Hong Kong SAR

March 31, 2006

F-1

CHINA EVERGREEN ENVIRONMENTAL CORP.

CONSOLIDATED BALANCE SHEETS


	*December 31,*
	*2005* *USD*	*2004* *USD*
ASSETS

Current assets
Cash and cash equivalents	175,224	336,079
Accounts receivable (Note 9)	5,220,940	46,960
Prepayment, deposits and other receivables (Note 10)	5,942,751	10,193,404
Amounts due from related companies (Note 11)	887,277	3,158,328
Amounts due from directors (Note 12)	—	26,794
Amount due from an associate (Note 13)	1,772,052	1,744,775
Deferred tax assets (Note 24(b))	187,267	199,981

Total current assets	14,185,511	15,706,321

Infrastructure assets, net (Note 5)	7,773,485	3,305,089
Property, plant and equipment, net (Note 6)	343,709	330,865
Convertible note receivable (Note 7)	—	1,366,997
Deposits paid for acquisition of property, plant and equipment	635,500	543,478
Deposit paid for acquisition of a subsidiary (Note 30)	2,047,527	—
Interests in an associate (Note 8)	815,613	383,736

Total assets	25,801,345	21,636,486

LIABILITIES AND STOCKHOLDERS’ EQUITY

Current liabilities
Financial instruments (Note 18)	6,244,381	—
Unsecured loan (Note 14)	86,741	229,468
Other borrowing (Note 15)	24,783	24,155
Accounts payable	6,804,711	8,755,148
Accruals and other liabilities (Note 16)	1,398,054	526,068
Amounts due to directors (Note 12)	716,598	606,645
Amounts due to related companies (Note 17)	230,836	2,864,506
Deposit received for disposal of a subsidiary (Note 31)	—	350,514
Income tax payable	1,557,167	626,249

Total current liabilities	17,063,271	13,982,753

Minority interests (Note 19)	821,704	198,015

Stockholders’ equity
Common stock, USD0.001 par value, 200,000,000 shares authorized; 135,903,698 shares issued and outstanding at December 31, 2005 and 99,999,997 shares issued and outstanding at 2004 (Note 21)	103,704	100,000
Additional paid-in capital	4,837,392	3,841,096
Retained earnings	2,754,118	3,514,622
Accumulated other comprehensive income	221,156	—

Total stockholders’ equity	7,916,370	7,455,718

Total liabilities and stockholders’ equity	25,801,345	21,636,486

see accompanying notes to consolidated financial statements

F-2

CHINA EVERGREEN ENVIRONMENTAL CORP.

CONSOLIDATED STATEMENT OF OPERATIONS


	*Year ended December 31,*
	*2005* *USD*		*2004* *USD*
Revenue from turn-key engineering projects	4,830,613		—
Revenue from BOT wastewater treatment services	302,011		250,571
Revenue from provision of technical services	600,734		—
Revenue from sales of environment protection related products	1,250,611		—

Total revenue (Note 26)	6,983,969		250,571

Cost of revenue for turn-key engineering projects	(2,784,341	)	—
Cost of revenue for BOT wastewater treatment services	(175,077	)	(100,072	)
Cost of revenue for provision of technical services	(2,406	)	—
Cost of revenue for sales of environment protection related products	(310,379	)	—

Total cost of revenue exclusive of depreciation and amortization and sales taxes shown separately below	(3,272,203	)	(100,072	)

Depreciation and amortization	(115,737	)	(66,413	)
Sales taxes	(369,052	)	—

Gross profit	3,226,977		84,086

General and administrative expenses	(820,170	)	(1,328,756	)

Income/(loss) from operations	2,406,807		(1,244,670	)

Other income (Note 22)	54,622		19,295

Interest expense (Note 23)	(42,991	)	(2,420	)

Non-cash financing charges (Note 18)	(8,001,211	)	—

Unrealized gain on financial instruments (Note 18)	5,440,454		—

Share of results in an associate – XL (Note 8)	416,218		130,113

Gain on disposal of interest in a subsidiary - XY	—		5,220,299

Gain on disposal of construction project	635,941		—

Loss on disposal of investment (Note 7)	(472,643	)	—

Income before income tax and minority interest	437,197		4,122,617

Income tax expense (Note 24(a))	(920,001	)	(467,911	)

(Loss)/income before minority interests	(482,804	)	3,654,706

Minority interests (Note 19)	(277,700	)	42,243

Net (loss)/income	(760,504	)	3,696,949

Basic net (loss)/income per share (Note 20)	(0.01	)	0.03

Diluted net (loss)/ income per share (Note 20)	(0.01	)	0.03

see accompanying notes to consolidated financial statements

F-3

CHINA EVERGREEN ENVIRONMENTAL CORP.

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY


	*Common stock*			Additional paid-in capital USD	Retained earnings/ (accumulated *deficit)* *USD*		Accumulated other comprehensive *income* *USD*	Total stockholders’ *equity* *USD*
	*No. of* *shares*	Amount USD		Additional paid-in capital USD	Retained earnings/ (accumulated *deficit)* *USD*		Accumulated other comprehensive *income* *USD*	Total stockholders’ *equity* *USD*
At January 1, 2004	83,500,000	83,500		3,708,891	(182,327	)	—	3,610,064
Recapitalization	16,499,997	16,500		132,205	—		—	148,705
Net income	—	—		—	3,696,949		—	3,696,949

	99,999,997	100,000		3,841,096	3,514,622		—	7,455,718

At January 1, 2005	99,999,997	100,000		3,841,096	3,514,622		—	7,455,718
Issue of shares in September (Notes 18 and 21)	32,200,000	32,200		—	—		—	32,200
Share issued in October for conversion of convertible debenture	3,703,701	3,704		996,296	—		—	1,000,000
Shares issued accounted for as liability (Notes 18 and 21)	—	(32,200	)	—	—		—	(32,200	)
Foreign currency translation adjustments	—	—		—	—		221,156	221,156
Net loss	—	—		—	(760,504	)	—	(760,504	)

At December 31, 2005	135,903,698	103,704		4,837,392	2,754,118		221,156	7,916,370

see accompanying notes to consolidated financial statements

F-4

CHINA EVERGREEN ENVIRONMENTAL CORP.

CONSOLIDATED STATEMENTS OF CASH FLOWS


	*Year ended December 31,*
	*2005* *USD*		*2004* *USD*
Cash flows from operating activities :

Net (loss)/income	(760,504	)	3,696,949
Adjustments to reconcile net income to net cash provided by operating activities :
Depreciation and amortization	115,737		66,413
Non-cash financing charges	8,001,211		—
Unrealized gain in financial instruments	(5,440,454	)	—
Provision of inventories	—		12,559
Decrease/(increase) in deferred tax assets	17,677		(42,644	)
Minority interests	277,700		(18,089	)
Gain on disposal of interest in a subsidiary – XY	—		(5,220,299	)
Loss on disposal of investment	472,643		—
Share of results in an associate – XL	(416,218	)	(130,113	)

Changes in operating assets and liabilities :
Decrease in accounts receivable	4,427,952		37,399
Increase in prepayment, deposits and other receivables	(5,102,193	)	(7,160,941	)
Decrease in amounts due from related companies	2,321,593		1,012,593
Decrease/(increase) in amounts due from directors	27,122		(722,263	)
(Decrease)/increase in accounts payable	(2,148,974	)	6,944,138
Increase/(decrease) in accruals and other liabilities	846,754		(533,723	)
Increase in amounts due to directors	92,900		561,655
Increase in income tax payable	902,322		507,433

Net cash provided by/(used in) operating activities	3,635,268		(988,933	)

Cash flows used in investing activities :
Deposit paid for acquisition of a subsidiary	(2,019,993	)	—
Deposit paid for acquisition of property, plant and equipment	—		(543,478	)
Cash inflow arising from disposal of interest in a subsidiary – XY	(76,832	)	5,359,385
Acquisition of property, plant and equipment	(54,474	)	(4,691	)
Acquisition of infrastructure assets	(4,389,509	)	(2,405,113	)
Decrease/(increase) in amount due from an associate	17,882		(55,682	)
Decrease in deposit received for disposal of a subsidiary	(354,799	)	—
Recapitalization	—		77,282

Net cash (used in)/provided by investing activities	(6,877,725	)	2,427,703

Cash flows from financing activities :
Net proceeds from disposal of investment	911,065		—
Net proceeds from issuance of financial instruments	4,623,207		—
Repayment of unsecured loans	(146,699	)	(1,157,247	)
Initial capital injection of HDFF	260,223		—
Additional capital injection of BJHTSY	99,133		—
Decrease in amount due to a related company	(2,671,793	)	—

Net cash provided by/(used in) financing activities	3,075,136		(1,157,247	)

Effect of foreign currency translation on cash and cash equivalents	6,466		—

Net (decrease)/increase in cash and cash equivalents	(160,855	)	281,523

Cash and cash equivalents, beginning of year	336,079		54,556

Cash and cash equivalents, end of year	175,224		336,079

see accompanying notes to consolidated financial statements

F-5

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

1.	CHANGE OF COMPANY NAME

The Company was incorporated in the State of Nevada on September 10, 1996.

Following a reverse takeover transaction as detailed in note 2(ii), the Company has ended its development stage and is now engaging in the provision of the business as set out in note 3.

On November 12, 2004, the name of the Company was changed from Discovery Investment Inc. to China Evergreen Environmental Corp. (“CEEC”), with all the required filings submitted to the United States Securities and Exchange Commission.

2.	BASIS OF PRESENTATION

(i)

The accompanying consolidated financial statements of CEEC and its subsidiaries - Evergreen Asset Group Limited (“EGAG”), Evermaster Group Limited (“Evermaster”), Everbury Holdings Limited (“Everbury”), Guang Dong Xin Xing Mei Biology Company Limited (“XXM”), Tian Jin Shi Sheng Water Treatment Company Limited (“TJ”), Hai Yang City Sheng Shi Environment Protection Company Limited (“HY”), Bei Jing Hao Tai Shi Yuan Water Purifying Company Limited (“BJHTSY”) and Han Dan Cheng Sheng Water Affairs Company Limited (“HDFF”) (the “Group”) have been prepared in accordance with generally accepted accounting principles in the United States of America. All significant intercompany transactions and balances have been eliminated in consolidation.

(ii)

On October 15, 2004, CEEC completed a share exchange with the stockholders of EGAG which was incorporated in the British Virgin Islands on April 20, 2004 under the International Business Companies Act, British Virgin Islands (the “Exchange”) . In the Exchange, CEEC acquired 300 shares representing all the issued and outstanding common stock of EGAG from the stockholders of EGAG (the “Shareholders”) in exchange for the issuance of 83,500,000 shares of common stock of CEEC to the Shareholders.

The Exchange has been accounted for as a recapitalization of EGAG whereby the assets and liabilities and operations of EGAG become the assets and liabilities and operations of CEEC with no adjustments to the historical basis of assets and liabilities of EGAG and the operations consolidated. The 16,499,997 shares of CEEC outstanding prior to the Exchange are accounted for at the net book value at the time of the transaction, approximately $148,705. The accompanying financial statements reflect the recapitalization of the shareholders equity as if the transaction occurred as of the beginning of the first period presented.

3.	DESCRIPTION OF BUSINESS

The principal activities of the Group are the research and development of waste water, garbage treatment and aqueous purifying techniques, investment and construction of waste water treatment plant and sales of environment protection related products.

F-6

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Use of estimates

The preparation of the consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting years. Although management believes that the estimates and assumptions used in preparing the accompanying consolidated financial statements and related notes are reasonable in light of known facts and circumstances, actual results could differ from those estimates.

Significant estimates include the useful lives of property and equipment, revenue recognition based on percentage of completion and Black Scholes assumptions to measure the value of warrants and options. We believe that the estimates, judgments and assumptions upon which we rely are reasonable based upon information available to us at the time that these estimates, judgments and assumptions are made. Actual results could differ from those estimates. Future estimates and assumptions will be based upon information available to us at the time of the estimate.

Cash and cash equivalents

Cash equivalents are highly liquid investments and have maturities of three months or less at the date of purchase.

Property, plant and equipment

Property, plant and equipment are stated at cost less accumulated depreciation and amortization and impairment loss. Maintenance, repairs and betterments, including replacement of minor items, are charged to expense; major additions to physical properties are capitalized. Depreciation and amortization are provided using the straight-line method over the following estimated useful lives :-


Office equipment		5 years
Furniture and fixtures		5 years
Tools and equipment		5 years
Motor vehicles		10 years
Waste water treatment plant		20 years

Infrastructure assets

Infrastructure assets represents the cost of construction of the waste water treatment plants under the Build-Operate-Transfer (“BOT”) agreements with the PRC government. The cost includes development and construction expenditure incurred and other direct costs attributable to the development. No depreciation and amortization is provided in respect of infrastructure assets until such time as the relevant assets are completed and ready for use. Depreciation and amortization are provided using the straight-line method over the following useful lives :-

- Waste water treatment plant 20 years

F-7

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

BOT agreements for the three waste water treatment plants in PRC include the following terms :-


*Subsidiaries*	Treatment capacity per day (tons)	Term (years)	*Total investment as per* *BOT agreement*
			*RMB*	*USD*
TJ*	10,000	20	9,000,000	1,086,957
HY*	20,000	22	30,000,000	3,623,188
BJHTSY	20,000	25	20,000,000	2,415,459
HDFF	33,000	22	29,250,000	3,532,609

At December 31, 2005, infrastructure assets of TJ and HY were in use and depreciation and amortization are provided using the straight-line method over 20 years commencing on the date the infrastructure assets were ready for use. Infrastructure assets of BTHTSY and HDFF were not ready for use at December 31, 2005.

Impairment of assets

The Group’s policy is to periodically review and evaluate whether there has been a permanent impairment in the value of long-lived assets. Factors considered in the evaluation include current operating results, trends and anticipated undiscounted future cash flows. An impairment loss is recognized to the extent that the sum of undiscounted estimated future cash flows that is expected to result from the use of the asset, or other measure of fair value, is less than the carrying value.

Associate

An associate is one, not being a subsidiary or a joint venture, in which the Company is in a position to exercise significant influence, including participation in financial and operating policy decisions. Details of the associate are set out in note 8 to the consolidated financial statements.

Interests on an associate is accounted for by the equity method of accounting and is initially recognized at cost. The Group’s investment in an associate includes goodwill (net of any accumulated impairment loss) identified on acquisition.

Goodwill on acquisition of an associate represents the excess of the cost of an acquisition over the fair value of the Group’s share of the net identifiable assets of the acquired associate at the date of acquisition is included in interests in an associate. Goodwill is tested annually for impairment and carried at cost less accumulated impairment losses. Gains and losses on the disposal of an entity include the carrying amount of goodwill relating to the entity sold.

F-8

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

The Group’s share of its associate’s post-acquisition profits or losses is recognized in the statement of operations, and its share of post-acquisition movements in reserves is recognized in reserves. The cumulative post-acquisition movements are adjusted against the carrying amount of the investment. When the Group’s share of losses in an associate equals or exceeds its interest in the associate, including any other unsecured receivables, the Group does not recognize further losses, unless it has incurred obligations or made payments on behalf of the associate.

Unrealized gains on transactions between the Group and its associate are eliminated to the extent of the Group’s interest in the associate. Unrealized losses are also eliminated unless the transaction provides evidence of an impairment of the asset transferred. Accounting policies of an associate have been changed where necessary to ensure consistency with the policies adopted by the Group.

Research and development costs

Research and development costs are recognized as an expense in the period in which they are incurred.

Concentration of credit risk

Concentration of credit risk is limited to accounts receivable and is subject to the financial conditions of a major customer which is stated in note 26 to the consolidated financial statements. The Group does not require collateral or other security to support client’s receivables. The Group conducts periodic reviews of its clients’ financial condition and customer payment practices to minimize collection risk on accounts receivable.

Financial instruments

The carrying amounts of all financial instruments approximate fair value. The carrying amounts of cash, accounts receivable, related parties receivable, unsecured loans, accounts payable and related parties payable approximate fair value due to the short-term nature of these items. The carrying amounts of borrowings approximate the fair value based on the Group’s expected borrowing rate for debt with similar remaining maturities and comparable risk.

F-9

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Revenue recognition

We recognize revenue using various revenue recognition policies based on the nature of the sale and the terms of the contract.

There is sufficient evidence to support that sales arrangements exist;

The price to the buyer is fixed through signed contracts;

Meter readings illustrate that delivery of treated waste water has occurred; and

Collectibility is reasonably assured through one or more of the following: due diligence prior to contract signing; historical payment practices; or required upfront payments.

F-10

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Cost of revenues

Cost of revenues comprises labor and other cost of personnel directly engaged in providing the services, subcontracting and attributable overhead costs. Cost of revenues does not include any allocation of depreciation or amortization expense.

Segment reporting

Management believes that it has only a single segment consisting of waste water treatment with related services and support. The information presented in the consolidated statement of operations reflects the revenues and costs associated with this segment that management uses to make operating decisions and assess performance.

Income taxes

The Group utilizes the asset and liability method of accounting for income taxes whereby deferred taxes are determined based on the temporary differences between the financial statements and tax bases of assets and liabilities using enacted tax rates in effect in the years in which the differences are expected to reverse. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized.

F-11

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

Foreign currency translation and transactions

The Group uses China Renminbi (“RMB”) as the functional currency, which is not freely convertible into foreign currencies. Transactions denominated in currencies other than RMB are translated into RMB at the applicable rates of exchange prevailing at the dates of the transactions, quoted by the People’s Bank of China (“the PBOC”). Monetary assets and liabilities denominated in other currencies are translated into RMB at rates of exchange quoted by the PBOC prevailing at the balance sheet date. Exchange gains or losses arising from changes in exchange rates subsequent to the transactions dates for monetary assets and liabilities denominated in other currencies are included in the determination of net income for the respective period.

For financial reporting purposes, RMB has been translated into USD as the reporting currency. Assets and liabilities are translated at the exchange rate in effect at period end. Income statement accounts are translated at the average rate of exchange prevailing during the period. Translation adjustments arising from the use of different exchange rates from period to period are included as a component of stockholders’ equity as “Accumulated other comprehensive income - foreign currency translation adjustments”. Gains and losses resulting from foreign currency transactions are included in other income/(loss).

Income per share

Basic income per share is computed by dividing the net income for the year by the weighted average number of common shares outstanding during the year. Diluted income per share is computed by dividing the net income for the year by the weighted average number of common and common equivalent shares outstanding during the year. Common equivalent shares, composed of incremental common shares issuable upon the exercise of stock options, unvested restricted common stock and contingently issuable shares that are probable of being issued, are included in diluted income per share to the extent such shares are dilutive. In accordance with SFAS 128, “Earnings Per Share”, the Company uses income from continuing operations, net of income taxes as the “control number” in determining whether common equivalent shares are dilutive or anti-dilutive in periods where discontinued operations are reported.

F-12

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

New accounting pronouncements

(i)

The Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS No. 150”) was issued in May 2003. This statement affects the classification, measurement and disclosure requirements of the following three types of freestanding financial instruments :-

mandatory redeemable shares, which the issuing company is obligated to buy back with cash or other assets;

instruments that do or may require the issuer to buy back some of its shares in exchange for cash or other assets, which include put options and forward purchase contracts; and

obligations that can be settled with shares, the monetary value of which is fixed, tied solely or predominantly to a variable such as a market index, or varies inversely with the value of the issuers’ shares.

In general, SFAS No. 150 is effective for all financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. The adoption of this statement had no impact on the Group’s results of operations or financial position.

(ii)

Financial Accounting Standards Board Interpretation No. 46, “Consolidation of Variable Interest Entities (“VIE”)” (“FIN 46”), was issued in January 2003. FIN 46 requires that if an entity is the primary beneficiary of a variable interest entity, the assets, liabilities and results of operations of the variable interest entity should be included in the consolidated financial statements of the entity. The provisions of FIN 46 are effective immediately for all arrangements entered into after January 31, 2003.

In December 2003, the Financial Accounting Standards Board (“FASB”) completed deliberations on proposed modifications to FIN 46 and re-issued FIN 46 (“Revised Interpretation”) resulting in multiple effective dates based on the nature as well as the creation date of the VIE. VIEs created after January 31, 2003 but prior to January 1, 2004 may be accounted for either based on the original interpretation or the Revised Interpretation. The adoption of these interpretations had no impact on the Group’s results of operation or financial position.

F-13

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

New accounting pronouncements (cont’d)

(iii)

SFAS No. 132 (revised 2003), “Employer’s Disclosure about Pensions and Other Post-Retirement Benefits” was issued in December 2003. SFAS No. 132 (revised) revised employer’s disclosure about pension plans and other post-retirement benefit plans. SFAS No. 132 (revised) requires additional disclosures in annual financial statements about the types of plan assets, investment strategy, measurement dates, plan obligations, cash flows, and components of net periodic benefit cost of defined benefit pension plans and other post-retirement benefit plans. The annual disclosure requirements are effective for fiscal years ended after December 15, 2003. SFAS No. 132 (revised) also requires interim disclosure of the elements of net periodic benefit cost and the total amount of contributions paid or expected to be paid during the current fiscal year if significantly different from amounts previously disclosed. The interim disclosure requirements of SFAS No. 132 (revised) are effective for interim periods beginning after December 15, 2003. The adoption of this statement had no impact on the Group’s results of operation or financial position.

The details of the Group’s pension plans are disclosed in note 26 to the consolidated financial statements.

(iv)

In November 2004, the FASB issued SFAS No. 151 “Inventory costs – an amendment of ARB No. 43, Chapter 4”. SFAS No. 151 amends ARB No. 43, Chapter 4, to clarify that abnormal amounts of idle facility expense, freight, handling costs and wasted materials (spoilage) should be recognized as current-period charges. SFAS No. 151 is effective for inventory costs incurred during fiscal year beginning after June 15, 2005. The adoption of this standard has no impact on the Group’s results of operations or financial position.

(v)

In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment.” This Standard addresses the accounting for transactions in which a company receives employee services in exchange for (a) equity instruments of the company or (b) liabilities that are based on the fair value of the company’s equity instruments or that may be settled by the issuance of such equity instruments. This Standard eliminates the ability to account for share-based compensation transactions using Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and requires that such transactions be accounted for using a fair-value-based method. The Standard is effective for periods beginning after June 15, 2005. The Group is currently assessing the impact of this Standard on its results of operations and financial position.

F-14

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

4.	SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONT’D)

New accounting pronouncements (cont’d)

(vi)

SFAS No. 153, Exchanges of Nonmonetary Assets, issued December 2004, requires nonmonetary exchanges be accounted for at fair value, recognizing any gains or losses, if their fair value is determinable within reasonable limits and the transaction has commercial substance. A nonmonetary exchange has commercial substance if future cash flows of the entity are expected to change significantly as a result of the exchange. SFAS No. 153 was effective for nonmonetary asset exchange transactions occurring after July 1, 2005, and did not have a significant impact on the Group’s financial statements.

(vii)

In May 2005, the FASB issued SFAS No. 154, Accounting Changes and Error Corrections, which replaces APB Opinion No. 20 Accounting Changes and SFAS No. 3 Reporting Accounting Changes in Interim Financial Statements. SFAS No. 154 changes the requirements for the accounting for and reporting of a change in an accounting principle. SFAS No. 154 requires retrospective application for voluntary changes in an accounting principle unless it is impracticable to do so. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The Group will adopt SFAS No. 154 on January 1, 2006 with no expected material effect on its consolidated financial statements.

5.	INFRASTRUCTURE ASSETS, NET

Infrastructure assets, net represented the construction costs of three waste water treatment plants in the PRC under the BOT agreements as follows :-


	*December 31,*
	*2005* *USD*		*2004* *USD*
Construction costs :-

Infrastructure assets of TJ	1,054,842		983,895
Infrastructure assets of HY	3,586,557		1,951,566
Infrastructure assets of BJHTSY	2,410,610		418,823
Infrastructure assets of HDFF	838,903		—

Total	7,890,912		3,354,284

Less : Accumulated amortization	(117,427	)	(49,195	)

Infrastructure assets, net	7,773,485		3,305,089

As of December 31, 2005, infrastructure assets of TJ and HY were in use while infrastructure assets of BJHTSY and HDFF were not ready for use.

Amortization expenses for 2005 and 2004 amounted to USD65,679 and USD49,195 respectively.

F-15

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

6.	PROPERTY, PLANT AND EQUIPMENT, NET

Property, plant and equipment, net consisted of the following :-


	*December 31,*
	*2005* *USD*		*2004* *USD*
Purchase cost :-

Office equipment	2,965		—
Furniture and fixtures	6,220		6,063
Tools and equipment	29,490		25,270
Motor vehicles	173,597		121,739
Waste water treatment plant	241,170		235,053

Total	453,442		388,125

Less : Accumulated depreciation and amortization	(109,733	)	(57,260	)

Property, plant and equipment, net	343,709		330,865

Depreciation and amortization expenses for 2005 and 2004 amounted to USD50,058 and USD17,218 respectively.

There was no impairment loss for 2005 and 2004.

7.	LOSS ON DISPOSAL OF INVESTMENT

In March 2005, the Group converted the convertible note receivable from China Water Affairs Group Limited (previously know as China Silver Dragon Group Limited) of face value USD1,366,997 into 13,260,000 common shares of China Water Affairs Group Limited and an amount receivable of USD135,019, after off-setting the deposit received for disposal of a subsidiary. All the shares were subsequently disposed of to Hampton Limited (Note 10) at a consideration of USD759,335 and a loss on disposal of investment of USD472,643 was recorded.

F-16

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

8.	INTERESTS IN AN ASSOCIATE


	*December 31,*
	2005 USD	2004 USD
Share of net assets	815,613	383,736

(a)

Details of the associate, which was incorporated in the PRC, as at December 31, 2005 are as follows :-

(b)

Information extracted from the unaudited financial statements of the associate for the year ended December 31, 2005 and the audited financial statements of the associate for the year ended December 31, 2004 is as follows :-


	*Year ended December 31,*
	*2005* *USD*		*2004* *USD*
	*(Unaudited)*
(i) Statements of operations

Revenue from water treatment services per BOT agreement	1,160,147		1,149,275

Net profit	1,189,195		371,751


	*December 31,*
	*2005* *USD*		*2004* *USD*
	*(Unaudited)*
(ii) Balance sheet

Infrastructure assets	3,934,652		4,412,073
Cash and cash equivalents	17,316		591
Inventories	40,086		37,418
Accounts receivable	921,812		—
Prepayment, deposits and other receivables	1,270,617		1,576,542
Deferred tax assets	—		32,211
Accounts payable	(272,811	)	(630,808	)
Amount due to XXM	(1,772,052	)	(3,586,400	)
Other current liabilities	(1,809,296	)	(745,238	)

Net assets	2,330,324		1,096,389

As of March 31, 2006, the audited financial statements of the associate for the year ended December 31, 2005 is not yet available. As such, the above information is extracted from the unaudited financial statements of the associate for the year ended December 31, 2005.

F-17

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

9.	ACCOUNTS RECEIVABLE


	*December 31,*
	*2005* *USD*	2004 USD
Accounts receivable	5,220,940	46,960

Accounts receivable as at December 31, 2005 represents mainly (i) amounts receivable from Shenzhen Jukeyuan Industrial Development Company Limited for the sale of environment protection related products amounting to USD449,814, and (ii) amounts receivable for turn-key engineering projects from the following waste water treatment plants :-


*Customer*	*Turn-key engineering project*	*USD*
Tianjin City Wuqing Zone Fuyuan Economic Development Company Limited	Tianjin City Meichang Town Wastewater Treatment Plant	147,212
The Management Committee of Yongji Economic Development Zone	Yongji Development Zone Wastewater Treatment Plant (Phase 1)	61,223
The Management Committee of Yongji Economic Development Zone	Yongji Development Zone Wastewater Treatment Plant (Phase 2)	515,362
China Environment Industrial Park, Beijing	China Environment Industrial Park Wastewater Treatment Plant	1,629,720
Tianjin City Wuqing Zone Huangzhuang Indusrial Park	Huangzhuang Industrial Park Wastewater Treatment Plant	99,132
Shenzhen Jukeyuan Industrial Development Company Limited	Lechang City Lecheng Wastewater Treatment Plant	1,813,635

		4,266,284

There was no allowance for doubtful amounts for the years ended December 31, 2005 and 2004.

10.

PREPAYMENT, DEPOSITS AND OTHER RECEIVABLES


	*December 31,*
	*2005* *USD*	*2004* *USD*
Prepayment	74,624	47,186
Deposits	42,939	18,116
Other receivables:
Amounts receivable from True Global Limited	2,627,014	9,416,039
Amounts receivable from Hampton Limited (Note 7)	395,583	—
Amounts receivable from Zeng Xiangfeng	2,429,988	—
Advances and miscellaneous receivables	372,603	712,063

	5,942,751	10,193,404

Amounts due from Zeng Xiangfeng, an independent party, were deposits for acquisition of wastewater treatment plants. Due to a deferment in the proposed acquisition, the company has given a notice to withdraw the amounts in February 2006.

Amounts due from True Global Limited represent the remaining amount receivable from True Global Limited for the disposition of 90% direct interest in XY in 2004.

The management believes that all other receivables are collectible.

F-18

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

11.

AMOUNTS DUE FROM RELATED COMPANIES

At December 31, 2005, the balance mainly represents advanced cash to Guang Dong Xin Sheng Environmental Protection Company Limited (“GDXS”), Bei Jing Zhao Cheng Chuang Zhan Investment Company Limited (“BJZC”), Xin Sheng Environment Protection and Technology Group Limited and Tian Jin Zhong Ke Company Limited in which Mr. Pu Chongliang (“Mr. Pu”), a director who is also a principal stockholder of the Group, is also a director and has equity interests. Payment of the amount due had been guaranteed by Mr. Pu.

All amounts are interest-free, unsecured and repayable on demand.

12.

AMOUNTS DUE FROM/TO DIRECTORS

The amounts are interest-free, unsecured and repayable on demand.

13.

AMOUNT DUE FROM AN ASSOCIATE

The amount is interest-free, unsecured and repayable on demand.

14.

UNSECURED LOAN

The amount represents a loan borrowed from a financial institution which is interest bearing at 9.486% per annum, unsecured and repayable within one year.

15.

OTHER BORROWING

The amount represents a loan borrowed from the government for research and development of the application of the waste water treatment system. The amount is interest-free, unsecured and repayable on demand.

16.

ACCRUALS AND OTHER LIABILITIES

At December 31, 2005 and 2004, accruals and other liabilities comprised of the following :-


	*December 31,*
	*2005* *USD*	*2004* *USD*
Payroll	—	1,859
PRC tax	615,415	153,340
Staff welfare	41,171	30,124
Other payable	645,834	336,566
Other accruals	95,634	4,179

Total	1,398,054	526,068

F-19

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

17.

AMOUNTS DUE TO RELATED COMPANIES

At December 31, 2005, the balance mainly represents borrowed cash from Guang Dong Ke Tai Company Limited and Long Men Ke Tai Company Limited in which Mr. Pu has equity interests.

All amounts are interest-free, unsecured and repayable on demand.

18.

FINANCIAL INSTRUMENTS

The fair values of the financial instruments as of December 31, 2005 are as below :-


		*USD*
Warrants issued in April, at fair value		450,000
Warrants issued in September, at fair value		5,667,200
Shares issued in September, accounted for as liability		32,200
Registration right liability		94,981

		6,244,381

The Group has non-cash financing charges of USD8,001,211 for the year ended December 31, 2005 of which USD947,684 relates to the discounts given for the April Private Placement as described below and USD7,053,527 relates to the discounts given for the September Private Placement.

The Group has unrealized gain on financial instruments of USD5,440,454 for the year ended December 31, 2005 of which relates to the revaluation of the financial instruments to their fair value at year end.

The Group conducted a private placement in April 2005 (“April Private Placement”) of 20 investment units, at USD25,000 per unit, for gross proceeds of USD500,000. Each unit consisted of (a) a 12% convertible debenture in the original principal amount of USD25,000, convertible into shares of our common stock at the rate of the lesser of (i) USD0.20 per share or (ii) a 10% discount to the price per share of common stock (or conversion price per share of common stock) of the next private placement conducted by us prior to any conversion of the debenture, and (b) 125,000 detachable warrants to purchase one share each of our common stock at an exercise price of USD0.20 per share, expiring ten years from their date of issuance (“April Warrants”). As a result of the September 2005 private placement, pursuant to Section 5(d) of the warrant agreement, the exercise price has been adjusted to $0.15 per share on September 14, 2005. The debentures were due and payable August 1, 2005. The debenture holders, however, extended the payment period to September 30, 2005. The debentures were converted into 3,703,701 shares of common stock on October 1, 2005.

F-20

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

18.

FINANCIAL INSTRUMENTS (CONT’D)

The Group used the Black-Scholes model in calculating the fair market value of the April Warrants and allocated USD148,531, USD74,266 and USD185,664 of the USD408,461 net proceeds to the Convertible Debenture, the Bifurcated Conversion Feature of the Debenture and the April Warrants, respectively. The differences between the fair value of each of the Convertible Debenture, the Bifurcated Conversion Feature of the Debenture and the April Warrants and the respective allocated amounts are recorded as non-cash financing charges and expensed of at the date of issuance. The principal assumptions used in the computation of the April Warrants are: expected term of 10 years; a risk-free rate of return of 4.24%; dividend yield of zero percent; and a volatility of 70%.

The Group granted to the holders of the April Warrants certain piggy-back and demand registration rights. Pursuant to the agreements surrounding the April Private Placement, in the event that the Group determined to undertake a registration of securities, the Group would include, at the request of the holder of “Registrable Securities”, the Registrable Securities in the registration statement. If the Group did not file a registration statement by the 120th day from the closing of such financing, and the Group shall have received a written request signed by the holders holding the majority of the Registrable Securities, then the Group was obligated to file, at its expense, a registration statement covering the Registrable Securities. Once such registration statement has been filed and declared effective, the Group is obligated to keep such registration statement effective until the earlier of (i) the date that all of the Registrable Securities have been sold pursuant to such registration statement, (ii) all Registrable Securities have been otherwise transferred to persons who may trade such shares without restriction under the Securities Act, and the Group has delivered a new certificate or other evidence of ownership for such securities not bearing a restrictive legend, or (iii) all Registrable Securities may be sold at any time, without volume or manner of sale limitations pursuant to Rule 144(k) or any similar provision then in effect under the Securities Act. As of December 31, 2005, the Group has not received any written request signed by the holders holding the majority of the Registrable Securities.

F-21

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

18.

FINANCIAL INSTRUMENTS (CONT’D)

On September 14, 2005, the Group closed the private placement sale to accredited investors of units consisting of shares of our common stock and warrants to purchase shares of our common stock for aggregate gross proceeds of USD4.83 million (“September Private Placement”). Pursuant to the subscription agreements entered into with the investors, we issued to the investors 161 units at a price of USD30,000 per unit. Each unit consisted of 200,000 shares of our common stock, priced at USD0.15 per share, and warrants to purchase 200,000 shares of our common stock over a five year period at an exercise price of USD0.20 per share. Pursuant to the terms of the subscription agreements, we granted the investors limited registration rights for all common shares comprising the units, including the common shares issuable on exercise of the warrants. The Group also issued to Westminster Securities Corporation, as partial compensation for their placement agent services, 7,728,000 placement agent warrants to purchase one share each of our common shares, a portion of which has been assigned by Westminster Securities Corporation to certain of its officers and employees (the warrants issued in the September Private Placement together with the placement agent warrants are hereinafter referred to as “September Warrants”).

The Group used the Black-Scholes model in calculating the fair market value of the September Warrants and allocated USD4,140,535 of the USD4,172,735 net proceeds to the September Warrants. The difference between the fair value of the September Warrants and the allocated amount is recorded as non-cash financing charges and expensed of at the date of issuance. The principal assumptions used in the computation of the September Warrants are: expected term of 5 years; a risk-free rate of return of 4.24%; dividend yield of zero percent; and a volatility of 70%.

F-22

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

19.

MINORITY INTERESTS


	*December 31,*
	2005 USD		*2004* *USD*
At January 1	198,015		449,515
Minority interests in the consolidated statements of operations	277,700		(42,243	)
Initial capital injection of BJHTSY	—		24,154
Release on disposal of XY	—		(233,411	)
Additional capital injection of BJHTSY	99,133		—
Initial capital injection of HDFF	260,223		—
Translation difference	(13,367	)	—

At December 31	821,704		198,015

20.

BASIC NET (LOSS)/INCOME PER SHARE

(i)

The basic net (loss)/income per share is calculated using the net income and the weighted average number of shares outstanding during the year.


	*Year ended December 31,*
	*2005*		*2004*
Net (loss)/income (USD)	(599,649	)	3,696,949

Weighted average number of common shares outstanding	110,549,423		139,748,509

Basic net (loss)/income per share (USD)	(0.01	)	0.03

(ii)

The diluted net (loss)/income per share is calculated using the net income and the weighted average number of shares outstanding during the year together with shares issuable upon exercise of all warrants issued.


	*Year ended December 31,*
	*2005*		*2004*
Net (loss)/income (USD)	(599,649	)	3,696,949

Diluted weighted average number of common shares outstanding	110,549,423		139,748,509

Diluted net (loss)/income per share (USD)	(0,01	)	0.03

As the April warrants and the September Warrants as disclosed in Note 18 are anti-dilutive, they are being excluded from the calculation of diluted earnings per shares.

F-23

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

21.

COMMON STOCK


	*No. of shares*	*Amount USD*
Authorized :-

Common stock at USD0.001 par value
At December 31, 2005 and 2004	200,000,000	200,000,000

Preferred stock at USD0.001 par value
At December 31, 2005 and 2004	50,000,000	50,000,000

Issued and outstanding :-

Common stock at USD0.001 par value
At January 1, 2004	83,500,000	83,500
Recapitalization	16,499,997	16,500

At December 31, 2004 and January 1, 2005	99,999,997	100,000
Issue of shares	35,903,701	35,904
Shares issued accounted for as liability (Note 18)	—	(32,200	)

At December 31, 2005	135,903,698	103,704

22.

OTHER INCOME


	Year ended December 31,
	2005 USD	2004 USD
Exchange gain	40,981	—
Bank interest income	—	5,215
Other income	13,641	14,080

	54,622	19,295

F-24

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

23.

INTEREST EXPENSE


	*Year ended December 31,*
	2005 USD	2004 USD
Interest on unsecured loans wholly repayable within one year	12,625	2,420
Interest on debenture	30,366	—

	42,991	2,420

24.

INCOME TAXES

(a)

The income tax expense consisted of the following :-


	*Year ended December 31,*
	*2005* *USD*		*2004* *USD*
Current tax :
PRC	(902,324	)	(510,555	)
Deferred tax :
PRC	(17,677	)	42,644

Total income tax expense	(920,001	)	(467,911	)

The provision for income tax represents the provision for PRC enterprise income tax calculated at the standard income tax rate of 33% on the assessable profits of the PRC’s subsidiaries and the standard withholding income tax rate of 10% on the total revenue generated by EGAG, a company incorporated in the British Virgin Islands, in the PRC.

Income tax expense can be reconciled with the amount computed by applying the statutory income tax rate to income before income tax as follows :-


	*Year ended December 31,*
	*2005* *USD*		*2004* *USD*
Income before income tax	437,197		4,122,617

Expected income tax expense at PRC statutory income tax rate of 33%	(144,275	)	(1,360,464	)
Under provision in prior years	(436,804	)	—
Income not taxable for tax purposes	—		48,968
Tax rate differential - Note	3,832		1,104,152
Tax effect of unrecognized tax losses	(831,882	)	—
Utilization of tax loss	367,832		—
Others	121,296		—
Valuation allowances	—		(260,567	)

Income tax expense	(920,001	)	(467,911	)

F-25

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

24.

INCOME TAXES (CONT’D)

Note :-

The amount represents the difference of the provision for PRC enterprise income tax calculated at the standard income tax rate of 33% and the standard withholding income tax rate of 10% on the total revenue of EGAG.

(b)

Deferred taxes result from temporary differences relating to items that are expensed/recognised as revenue for financial reporting, but are not currently deductible/taxable for income tax purposes. Significant components of our deferred tax assets and deferred tax liabilities as at December 31, 2005 and 2004 are as follows :-


	*December 31,*
	*2005* *USD*		*2004* *USD*
Deferred tax assets :
Inventories	16,372		146,309
Accrued audit fee	409		20,517
Investment income	304,743		102,822
Cost of revenue	616,405		550,868
Depreciation	34,245		10,585
Deferred expenditure	181,020		275,423
Other administrative expenses	14,721		23,107
Other items	39,259		25,337

Total deferred tax assets	1,207,174		1,154,968

Deferred tax liabilities :-
Property, plant and equipment	(4,007	)	(3,906	)
Deferred expenditure	—		(14,535	)
Depreciation	(989	)	(964	)
Exchange differences	(11,250	)	(8,092	)
Revenue	(978,211	)	(900,964	)
Other administrative expenses	(8,833	)	(8,609	)
Other items	(16,617	)	(17,917	)

Total deferred tax liabilities	(1,019,907	)	(954,987	)

Net deferred tax assets	187,267		199,981

At December 31, 2005, XXM had unutilized tax losses amounting to USD Nil (2004: USD789,598) which can be carried forward five years from the year of loss with expiry in 2009. The net federal tax loss of CEEC will expire in 2020.

F-26

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

25.

PENSION PLANS

As stipulated by the PRC government regulations, the Group is required to contribute to PRC insurance companies organized by the PRC government which are responsible for the payments of pension benefits to retired staff. The monthly contribution was equal to 12% of the salaries of the existing staff. The Group has no obligation for the payment of pension benefits beyond the annual contributions described above.

Pension contributions for 2005 and 2004 amounted to USD8,409 and USD13,981 respectively.

26.

CONCENTRATION

In 2005, the Group’s major customers are Beijing Jinqiao Luyuan Environment Protection Investment Development Company Limited and Shenzhen Jukeyuan Industrial Development Company Limited, both independent third parties, which, accounted for approximately 25.2% and 23.4%, respectively, of the Group’s total revenue of 2005. Revenue from Beijing Jinqiao Luyuan Environment Protection Investment Development Company Limited was in relation to the turnkey engineering project of China Environment Industrial Park Wastewater Treatment Plant while revenue from Shenzhen Jukeyuan Industrial Development Company was for the turnkey engineering project of Lechang City Lecheng Wastewater Treatment Plant and the sale of environment protection related products.

In 2004, the Group’s major customer is the People’s Government of Wuqing District, Tianjin City, which accounted for 100% of the Group’s total revenue in relation to the provision of BOT wastewater treatment services.

27.

COMMITMENTS

Capital commitment

At December 31, 2005, capital expenditure contracted for but not recognized in these financial statements was as follows :-


	*December 31,*
	*2005* *USD*	*2004* *USD*
Capital expenditures	5,928,800	3,103,042

The amount represents the unpaid amount of the total contract sum for constructing the waste water treatment plants of BJHTSY and HDFF together with the unpaid amount of contract sum for the turn-key engineering projects. The amount is expected to be paid within two years.

F-27

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

28.

RELATED PARTY TRANSACTIONS

Apart from those as disclosed in notes 11 to 13 and 17, the Group had the following transactions with its related parties :-


		*Year ended December 31,*
*Related party*	*Nature of transaction*	*2005* *USD*	2004 USD
GDXS	Deposit paid for acquisition of subsidiary	2,047,527	—
BJZC	Purchase of materials for construction	1,094,186	—
BJZC	Deposit paid for acquisition of property,
	plant and equipment	—	543,478

29.

SUPPLEMENTAL CASH FLOW INFORMATION


	*Year ended December 31,*
	*2005* *USD*	*2004* *USD*
(i) Interest paid	42,991	2,420

(ii) Non-cash investing activities
Conversion of Convertible debenture	1,000,000	—
Infrastructure assets (Note 5)	—	632,232
Convertible note receivable (Note 7)	—	1,366,997

30.

DEPOSIT FOR ACQUISITION OF A SUBSIDIARY

On December 23, 2005, the Group entered into an agreement with GDXS for the acquisition of the equity interest in a company that owns a BOT facility in Tian Jin city for a consideration of approximately USD2,047,527 through setting off the amount due from GDXS. The amount is treated as deposit until approval from the local government of Tian Jin city is received.

31.

DEPOSIT RECEIVED FOR DISPOSAL OF A SUBSIDIARY

On December 17, 2003, XXM entered into two sale and purchase agreements with an independent third party, a wholly-owned subsidiary of China Water Affairs Group Limited, in relation to the disposal of 55% equity interests in TJ and XL and the stockholder’s loans at a consideration of USD350,514 and USD1,927,815 respectively. The total consideration of USD2,278,329 will be settled by cash of USD911,332 within one year and by issuing a convertible note of USD1,366,997.

F-28

CHINA EVERGREEN ENVIRONMENTAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

31.

DEPOSIT RECEIVED FOR DISPOSAL OF A SUBSIDIARY (CONT’D)

The convertible note bears interest at 6% per annum with maturity date of three years from the date of issuance and are repayable after three years from the date of issuance or convertible into shares of China Water Affairs Group Limited, at the option of the holder, at the conversion price of approximately USD 0.103 subject to adjustments as stipulated in the convertible note at any time after six months from the date of issuance. In March 2005, the convertible note was converted into 13,260,000 common shares of China Water Affairs Group Limited and an amount receivable of USD135,019 (Note 7), after off-setting the deposit received for disposal of a subsidiary as discuss below.

At December 31, 2004, the equity interest in XL were disposed to China Water Affairs Group Limited, while the procedure for disposal of stake in TJ could not be completed due to prohibition by the government of Tian Jin city. As such, the entire amount of the deposit received for disposal of a subsidiary represented the outstanding deposit received for the disposal of TJ. The amount was off-set against the amount receivable from the conversion of the convertible note in March 2005 (Note 7).

F-29

Item 8. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.

On December 22, 2004, our board of directors approved a change in auditors. Our board approved the dismissal of Wm. Andrew Campbell C.A. as our independent public accountant and the selection of PKF Hong Kong SAR, as their replacement.

Wm. Andrew Campbell C.A ‘s report on our financial statements for the fiscal year ended December 31, 2003 did not contain any adverse opinion or disclaimer of opinion, nor were they qualified or modified as to audit scope, procedure or accounting principles except that the reports were modified as to uncertainty and contained a disclosure stating that the financial statements were prepared based on the assumption that we would continue as a going concern.

During our fiscal year ended December 31, 2003 and the subsequent interim period through December 22, 2004, there were no disagreements between us and Wm. Andrew Campbell C.A on any matter of accounting principles or practices, financial statement disclosure, or auditing scope or procedure, which disagreements, if not resolved to Wm. Andrew Campbell C.A ‘s satisfaction, would have caused them to make reference to the subject matter of the disagreement in connection with their reports on our financial statement for such years; and there were no reportable events as described in Item 304(a)(1)(iv) of Regulation S-B. We provided Wm. Andrew Campbell C.A with a copy of the foregoing disclosures and Wm. Andrew Campbell C.A has stated in writing its agreement with the foregoing disclosures.

In addition, during our two most recent fiscal years ended December 31, 2003 and 2002 and the subsequent interim periods, we did not consult with PKF Hong Kong SAR with respect to the application of accounting principles to a specified transaction, either completed or proposed, or the type of audit opinion that might be rendered on our financial statements, or any other matters or reportable events as set forth in Items 304(a)(2)(i) and (ii) of Regulation S-B.

Item 8A. Controls and Procedures

Disclosure controls and procedures are controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act of 1934 is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by us in the reports that we file under the Exchange Act is accumulated and communicated to our management, including our principal executive and financial officers, as appropriate to allow timely decisions regarding required disclosure.

Our Chief Executive Officer and Chief Financial Officer have evaluated the effectiveness of our disclosure controls and procedures (as this term is defined under the rules of the SEC) as of August 10, 2006. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer and Executive Chairman concluded that, as of August 10, 2006, our disclosure controls and procedures were not effective in recording, processing, summarizing and reporting, on a timely basis, information required to be disclosed by the Company in the reports that it files or submits under the US Securities Exchange Act of 1934 as a result of material weaknesses in our internal control over financial reporting described below.

In the process of filing our registration statement, we identified certain accounting errors in our reported US GAAP annual results for fiscal 2004 and 2005 and certain quarterly results in 2005 and 2006. As a result, we have restated the amounts and disclosures in those annual financial statements.

The financial statements which should no longer be relied upon include:

(i)

the audited consolidated financial statements contained in our report on Form 10-KSB for the fiscal year ended December 31, 2004 (the “2004 10-KSB”), filed with the SEC on April 15, 2005, Amendment No. 1 to the 2004 10-KSB filed on July 15, 2005, and Amendment No. 2 to the 2004 10-KSB filed on January 13, 2006 ;

(ii)

the audited consolidated financial statements contained in our report on Form 10-KSB for the fiscal year ended December 31, 2005 (the “2005 10-KSB”), filed with the SEC on April 17, 2006;

(iii)

the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended March 31, 2005 (the “March 31, 2005 10-QSB”), filed with the SEC on May 24, 2005;

(iv)

the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended June 30, 2005 (the “June 30, 2005 10-QSB”), filed with the SEC on August 15, 2005;

(v)

the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended September 30, 2005 (the “ September 30, 2005 10-QSB”), filed with the SEC on November 15, 2005 and Amendment No. 1 to the September 30, 2005 10-QSB filed on January 13, 2006; and

(vi)

the unaudited consolidated financial statements contained in our quarterly report on Form 10-QSB for the quarterly period ended March 31, 2006 (the “March 31, 2006 10-QSB”), filed with the SEC on May 15, 2006.

Gain on disposal of the XY

As previously disclosed in our 2004 10-KSB, including amendments thereto, and comparative figures in our 2005 10-KSB, we recorded a gain on disposal of $2,029,720 in 2004 for the disposal of our 90% attributable interest in Xian Yang Bai Sheng Water Purifying Company Limited (“XY”) to True Global Limited (“TGL”), an independent party, at a consideration of $4,130,435 (RMB34.2 million). The disposal was made pursuant to a tri-party framework agreement between Evergreen Asset Group Limited (“EGAG”), TGL and Guang Dong Xin Sheng Environmental Protection Company Limited (“GDXS”) in which EGAG transferred 90% of its equity interest in XY to TGL while GDXS continued to own 10% of its equity interest in XY. The transaction was consummated on October 26, 2004 and the gain represents the difference between the disposal proceeds and our attributable share of net assets of XY at the date of disposal. In the same year, we also recognized an amount of $9,115,942 for the construction revenue of XY using the percentage-of-completion method, estimated costs and claim recognition for construction contracts. The amount accounted for 97% of our total revenue in 2004.

In the previously filed 2004 10-KSB, as amended to date, and comparative figures in our previously filed 2005 10-KSB, the accounting treatment for the construction revenue of XY does not comply with SOP 81-1 or EITF 00-21. As a result, we will file an amendment to the 2004 10-KSB and 2005 10-KSB with adjusted disclosure to record the transaction as part of the gain on the disposal of the XY subsidiary rather than as revenue from construction of wastewater treatment plant. As such our adjusted total revenue for the fiscal year ended December 31, 2004 was $250,571 and the adjusted gain on disposal of interest in a subsidiary - XY was $5,220,299. Due to the same reason, account receivable from TGL amounted to $9,416,039 as of December 31, 2004 will be reclassified to prepayment, deposits and other receivables in our upcoming amendment to the 2004 10-KSB, comparative figures in this amendment to the 2005 10-KSB and comparative figures in the upcoming or recently filed amendments to the June 30, 2005 10-QSB and September 30, 2005 10-QSB.

Group reorganization

In Note 2(ii) and 2(iii) to the consolidated financial statements contained in the previously filed 2004 10-KSB and 2005 10-KSB and Note 2 to the consolidated financial statements contained in the previously filed March 31, 2005 10-QSB, June 30, 2005 10-QSB, September 30, 2005 10-QSB and March 31, 2006 10-QSB, we disclosed group reorganization transactions. Pursuant to rules promulgated by the SEC, the merger or acquisition of a private operating company into a non-operating public shell corporation with nominal net assets is considered a capital transaction, rather than a business combination. As such, no disclosures are required under FAS 141 because the transactions described were not business combinations. For accounting purposes, the transaction has been treated as a reverse acquisition and a recapitalization, and pro-forma information is not presented. Accordingly, the upcoming amendments to the 2004 10-KSB, this amendment to the 2005 10-KSB, and the recent or upcoming amendments to the March 31, 2005 10-QSB, June 30, 2005 10-QSB, September 30, 2005 10-QSB and March 31, 2006 10-QSB will not include references to the group reorganization transactions throughout the financial statements. We will also restate the common stock immediately after the recapitalization to $100,000 in the upcoming amended March 31, 2005 10-QSB and have done so in the recent amended June 30, 2005 10-QSB.

Reclassification of April warrants

In our previously filed 2005 10-KSB, June 30, 2005 10-QSB and March 31, 2006 10-QSB, we recorded as equity the warrants issued as part of the units sold in our April 2005 convertible debt issuance. Under EITF No. 00-19, the fair value of these warrants should be reported as a liability. Pursuant to the Warrant Agreement, because there is currently no effective registration statement covering the shares of common stock underlying these warrants, these warrants are currently subject to a cashless exercise whereby the warrant holders may surrender their warrants to the company in exchange for shares of common stock. The number of shares of common stock into which a warrant would be exchangeable in such a cashless exercise depends on both the exercise price of the warrants and the market price of the common stock, each at or near the time of exercise. Because both of these factors are variable, it is possible that the company could have insufficient authorized shares to satisfy a cashless exercise. In this scenario, if the company were unable to obtain shareholder approval to increase the number of authorized shares, the company could be obligated to settle such a cashless exercise with cash rather than by issuing shares of common stock. Further, EITF No. 00-19 requires that we record the potential settlement obligation at each reporting date using the current estimated fair value of the warrants, with any changes being recorded through our statement of operations. We will continue to report the potential settlement obligation as a liability until such time as the warrants are exercised or expire or we are otherwise able to modify the warrant agreement to remove the provisions which require this treatment. In addition to this restatement of our 2005 10-KSB, we will restate our June 30, 2005 10-QSB and our March 31, 2006 10-QSB to reclassify the April 2005 warrants as a liability.

April and September 2005 Private Placements—non-cash financing charges

In our June 30, 2005 10-QSB, we did not record any non-cash financing charges and in our September 30, 2005 10-QSB, as amended to date, we did not properly record the non-cash financing charges. Non-cash financing charges represent the amount by which the fair value of derivative liabilities issued exceeds the amount of proceeds received, as an expense at the date of issuance of the April convertible debenture and the September private placement. We will restate our June 30, 2005 10-QSB and our September 30, 2005 10-QSB to record the non-cash financing charges, which represent the amount by which the fair value of derivative liabilities issued exceeds the amount of proceeds received, as an expense at the date of issuance of the April convertible debenture and the September private placement. As a result of the recording of non-cash financing charges, certain expenses which were previously recorded under general and administrative expenses in our September 30, 2005 10-QSB will be reclassified under non-cash financing charges.

April 2005 Private Placements—unrealized gains or losses in financial instruments

In our June 30, 2005 10-QSB and our September 30, 2005 10-QSB, as amended to date, we did not record properly the unrealized gains or losses in financial instruments, which represent the change in fair market value of the financial instruments at each reporting date for the April warrants and the bifurcated conversion feature for the convertible debenture. The unrealized gains or losses in financial instruments should have been reported in those filings. We will restate the June 30, 2005 10-QSB and September 30, 2005 10-QSB, as amended to date, to record the unrealized gains or losses in financial instruments which represent the change in fair market value of the financial instruments at each reporting date for the April warrants and the bifurcated conversion feature for the convertible debenture.

Interest in associate

In our June 30, 2005 10-QSB and our September 30, 2005 10-QSB, as amended to date, the comparative figures for our interest in associate as of December 31, 2004 were recorded based on an effective percentage of equity attributable to the group of 31.5% instead of a direct interest of 35%. We will restate the comparative figures for our interest in associate as of December 31, 2004 in the June 30, 2005 10-QSB and September 30, 2005 10-QSB to include our interest in associate based on a direct interest of 35%.

Prior Restatements

On January 13, 2006, we amended our 2004 10-KSB. Prior to the January 13, 2006 amendment, in our 2004 10-KSB we recorded our interest in associate based on an effective percentage of equity attributable to the group of 31.5% instead of a direct interest of 35%. In the January 13, 2006 restatement of our 2004 10-KSB, we reported our interest in associate based on a direct interest of 35%. In addition, we have restated the common stock immediately after the recapitalization to $100,000.

On January 13, 2006, we amended our September 30, 2005 10-QSB. Prior to the January 13, 2006 amendment, the September 30, 2005 10-QSB classified as equity the proceeds of our April Debenture and September 2005 private placement allocated to the warrants issued in these transactions. For reasons both the April warrants and September warrants should have been classified as a liability. The restated financial statements in the January 13, 2006 amendment of the September 30, 2005 10-QSB reflect this reclassification. In addition, prior to the January 13, 2006 amendment, the September 30, 2005 10-QSB did not originally report the unrealized gains or losses in financial instruments, which represent the change in fair market value of the financial instruments at each reporting date. The unrealized gains or losses in financial instruments should have been reported in the original filing. Accordingly, the January 13, 2006 restatement of the September 30, 2006 10-QSB reported the unrealized gains or losses in financial instruments, which represent the change in fair market value of the financial instruments at each reporting date. The restatement to the unrealized gains or losses in financial instruments, however, required to be further restated (refer discussion above). In addition, we have restated the common stock immediately after the recapitalization to $100,000.

Material Weaknesses

In connection with the above matters, we have identified material weaknesses in our internal control over financial reporting, which weaknesses we have reported to our auditors. These material weaknesses comprise:

(a)

insufficient knowledge and experience among our internal accounting personnel regarding the application of US GAAP and SEC requirements;

(b)

insufficient written policies and procedures for accounting and financial reporting with respect to the requirements and application of US GAAP and SEC disclosure requirements; and

(c)

insufficient emphasis by management on compliance with US GAAP requirements.

We have communicated with our auditors, PKF Hong Kong and concluded that these deficiencies constituted material weaknesses, as defined by Auditing Standard No. 2, “An Audit of Internal Control Over Financial Reporting Performed in Conjunction with an Audit of Financial Statements,” established by the Public Company Accounting Oversight Board, or PCAOB.

In order to address these material weaknesses our senior management is in the process of conducting a thorough review of our US GAAP financial reporting processes and will prepare and implement a US GAAP action plan. This plan will be designed to generally improve our US GAAP reporting processes and to strengthen our control processes and procedures in order to prevent a recurrence of the circumstances that resulted in the need to restate our quarterly financial statements. Our senior management intends to complete its review and implement a US GAAP action plan as soon as practicable. The US GAAP action plan will incorporate, among other matters, the following initiatives:

arrange for our senior management and certain accounting and finance-related personnel to attend training sessions on US GAAP and financial reporting responsibilities and SEC disclosure requirements;

modify the mandate of our internal audit function to place greater emphasis on the adequacy of, and compliance with, procedures relating to internal controls over US GAAP financial reporting and engage an internationally recognized accounting firm, which is not affiliated with PKF Hong Kong, to assist our accounting department and internal audit function in the preparation of our US GAAP consolidated financial statements;

recruit an accounting staff member with US GAAP expertise and who is not affiliated with PKF Hong Kong; and

engage an internationally recognized accounting firm, which is not affiliated with PKF Hong Kong, to provide us with technical advice on US GAAP matters and SEC disclosure requirements on an ongoing basis.

Our board of directors discussed the matters disclosed in this filing with the registrant’s independent accountant. On September 25, 2006, we filed a current report on Form 8-K relating to these matters, including a response from our independent account relating to the statements contained therein.

Other than those disclosed above, there were no changes in our internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during the fiscal year ended December 31, 2005.

Item 8B. Other Information

Not applicable.

Part III

Item 9. Directors, Executive Officers, Promoters and Control Persons; Compliance with Section 16(a) of the Exchange Act.

Set forth below are our executive officers and directors.


Name	Age	Position
Chong Liang Pu	47	Chief Executive Officer, President and Director
Peh Chung Lim	38	Chief Financial Officer
Jia He Li	63	Chief Operating Officer
Shi Rong Jiang	31	Director
Lin Hong Ye	63	Director

Mr. Pu has served as our chief executive officer, president and a director since October 2004. Mr. Pu founded Evergreen and has acted as its chairman and president since April 2004. From May 1999 until April 2004, Mr. Pu was the chief executive officer and general manager of Guang Dong Xin Xing Mei Biology Company Limited, a majority-owned subsidiary of Evergreen.

Mr. Lim became our Chief Financial Officer effective December 29, 2005. Mr. Lim has more than 10 years of financial management experience with large multi-national corporations in Malaysia, Singapore, Indonesia, Taiwan and the PRC. Mr. Lim has served as our deputy chief financial officer since May 2005. Prior to joining us, Mr. Lim was the senior manager in internal audit, risk management and compliance in United Securities Investment Trust Corp. in Taiwan. Mr. Lim was the senior manager in project management and execution in Asia Pulp & Paper Ltd from 1997 to 2003. Mr. Lim is a member of CPA Australia and has a degree in Economics from Monash University in Melbourne, Australia.

Mr. Li has served as our chief operating officer since October 2004. Immediately prior to joining our company, Mr. Li was the assistant to the general manager of Evergreen and the deputy general manager of Guang Dong Xin Xing Mei Biology Company Limited, a majority-owned subsidiary of Evergreen. From March 2003 until April 2004, Mr. Li was the deputy general manager of Baijitan Hot Spring Co., Ltd., a hotel resort and spa operator in the PRC. From 1999 until March 2003, Mr. Li was a freelance project promoter, developer and designer for various development projects in the PRC.

Ms. Jiang has served as member of our board of directors since October 2004. Between June 2002 and October 2004, Ms. Jiang served as the assistant to the president of Guangdong Xinsheng Environmental Investment Group Limited. From May 1999 to June 2002, Ms. Jiang was assistant to the general manager of Guangdong Xinxingmei Environment Protection Company, a majority-owned subsidiary of Evergreen.

Mr. Ye has served as member of our board of directors since October 2004. Between May 2000 and October 2004, Mr. Ye served as the vice president of the Guangdong Branch of the Chinese Academy of Sciences.

Audit Committee Financial Expert

We do not have an audit committee nor do we have a financial expert associated with an audit committee. Our entire board of directors performs the functions of our audit committee.

Code of Ethics

We have adopted a code of ethics that applies to the principal executive officer and principal financial and accounting officers. A copy of our code of ethics is filed as an exhibit to this annual report. We will provide to any person without charge, upon request, a copy of our code of ethics. Requests may be directed to our principal executive offices at Suite 7A01, Baicheng Building, 584 Yingbin Road, Dashi, Panyu District, Guangzhou, Guangdong, China.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our officers, directors and persons who beneficially own more than 10% of a registered class of our equity securities to file reports of securities ownership and changes in such ownership with the Securities and Exchange Commission (the “SEC”). Officers, directors and greater than 10% beneficial owners are also required by rules promulgated by the SEC to furnish us with copies of all Section 16(a) forms they file.

All of our officers, directors or 10% shareholders have filed the reports required to be filed under Section 16(a), except for Mr. Peh Chung Lim and Mr. Jia H Li.

Item 10. Executive Compensation.

Cash Compensation of Executive Officers. The following table sets forth the cash compensation paid by the company to its chief executive officer for services rendered during the fiscal years ended December 31, 2005 and 2004.


	Annual Compensation					Long-Term Compensation
Name and Position	Year	Salary		Bonus	Other Annual Compensation	Restricted Stock Awards ($)	Common Shares Underlying Options Granted (# Shares)	All Other Compensation
Chong Liang Pu, Chief Executive Officer	2005 2004	$	-0- 24,000	-0- -0-	-0- -0-	-0- -0-	-0- -0-	-0- -0-

Compensation of Directors. Members of our board of directors do not receive cash compensation for their services as directors, although some Directors are reimbursed for reasonable expenses incurred in attending board or committee meetings. In the future, we may have to consider compensating any outside directors that become members of our board of directors.

Item 11. Security Ownership of Certain Beneficial Owners and Management.

The following table sets forth certain information regarding the beneficial ownership of the shares of our common stock as of April 13, 2006 by (i) each person who is known by us to be the beneficial owner of more than five percent (5%) of the issued and outstanding shares of our common stock, (ii) each of our directors and executive officers and (iii) all directors and executive officers as a group. The information is determined in accordance with Rule 13(d) 3 promulgated under the Exchange Act based upon information furnished by persons listed or contained in filings made by them with the Securities and Exchange Commission by information provided by such persons directly to us. Except as indicated, the stockholders listed below possess sole voting and investment power with respect to their shares.


Name ⁽¹⁾	Number of Shares of Common Stock Beneficially Owned ⁽²⁾	Percentage Owned
Chong Liang Pu	57,489,750	42.30	%
Shi Rong Jiang	5,101,000	3.75	%
Jia He Li	-0-	0	%
Lin Hong Ye	-0-	0	%
Peh Chung Lim	-0-	0	%
Gao Yongping	10,145,250	7.47	%
Vision Opportunity Fund ⁽³⁾	13,600,000	9.53	%
All directors and executive officers as a group		53.52	%

(1)	The addresses of Chong Liang Pu, Shi Rong Jiang, Jia He Li, Lin Hong Ye, Peh Chung Lim and Gao Yongping are Suite 7A01, Baicheng Building, 584 Yingbin Road, Dashi, Panyu District, Guangzhou, Guangdong, China.

(2)

Beneficial ownership is determined in accordance with the rules of the Securities and Exchange Commission and generally includes voting or investment power with respect to securities. Ordinary shares relating to options currently exercisable or exercisable within 60 days of the date of this table, are deemed outstanding for computing the percentage of the person holding such securities but are not deemed outstanding for computing the percentage of any other person. Except as indicated by footnote, and subject to community property laws where applicable, the persons named in the table above have sole voting and investment power with respect to all shares shown as beneficially owned by them.

(3)	Vision Opportunity Master Fund Ltd. is the beneficial owner of the shares held of record by Vision Opportunity Master Fund Ltd.

This table is based upon information derived from our stock records. Unless otherwise indicated in the footnotes to this table and subject to community property laws where applicable, we believe that each of the shareholders named in this table has sole or shared voting and investment power with respect to the shares indicated as beneficially owned. Applicable percentages are based upon 135,903,698 shares of common stock outstanding as of April 13, 2006.

The common shares beneficially owned by Vision Opportunity Fund Ltd. include (i) 6,800,000 common shares, and (ii) 6,800,000 common shares issuable upon exercise of outstanding warrants. The address for Vision Opportunity Fund Ltd. is 253 East 77^th St., PH-F, New York, NY 10021.

Equity Compensation Plans

The following table sets forth certain information as of December 31, 2005 concerning our equity compensation plans:

Plan Category

Number of Common

Shares to Be Issued Upon

Exercise of Outstanding

Options

Weighted- Average

Exercise Price of

Outstanding Options

Number of Common

Shares Remaining

Available for Issuance

None

Item 12. Certain Relationships and Related Transactions.

We have the following related party transactions for the years ended December 31, 2005 and 2004:


		*Year ended December 31,*
*Related party*	*Nature of transaction*	*2005* *USD*	2004 USD
GDXS	Deposit paid for acquisition of subsidiary	2,047,527	—
BJZC	Purchase of materials for construction	1,094,186	—
BJZC	Deposit paid for acquisition of property, plant and equipment	—	543,478

“BJZC” - Bei Jing Zhao Cheng Chuang Zhan Investment Company Limited

“GDXS” - Guang Dong Xin Sheng Environmental Protection Company Limited

We hold the exclusive rights to use MHA biological treatment processes technologies and GM Bio-carriers. Both are the subject of patents owned by our Chairman, Mr. Pu, and we have acquired the exclusive rights pursuant to a license agreement with Mr. Pu.

Item 13. Exhibits.

Index To Exhibits

2.1

Securities Purchase Agreement and Plan of Reorganization (1)

2.2

Amendment No. 1 to Securities Purchase Agreement and Plan of Reorganization (1)

3.3

Certificate of Amended and Restated Articles of Incorporation (3)

3.4

Bylaws (4)

3.5

Amendments to Bylaws (3)

10.1

BOT Investment and Operation Contract for Sewage Treatment Plant between Guangdong Xinsheng Environmental Protection Co., Ltd. and City Administration of Feng Feng Mining Area of Handon City, Hebei Province (5)

10.2

Investment Management Contract dated August 14, 2002 between Guangdong Xinxingmei Environmental Protection Science and Technology Investment Co., Ltd. and The People’s Government of Wuqing District, Tianjin City (5)

10.3

BOT Investment Contract dated July 4, 2003 between Guandong Xinsheng Environmental Co., Ltd. and People’s Government of Shunyi District, Beijing (5)

10.4

Contract for BOT Project Investment and Operation between Guandong Xinsheng Environmental Co., Ltd. and Shandong Haiyang Planning and Construction Administration (5)

10.5

Agreement with Shenzhen Jukeyuan Industry Development Co., Ltd. dated July 28, 2005(5)

10.6

Agreement with Tianjin Wuqing Huangzhuang Industrial Zone dated July 20, 2005(5)

10.7

Agreement with Tianjin Wuqing Fuyuan Economic Development Co., Ltd. dated May 28, 2005(5)

10.8

Agreement with Beijing Jinqiao Luyuan Environmental Protection Investment and Development Co., Ltd. dated August 4, 2005(5)

10.9

Agreement with Yongji Economic Development Zone Land Planning and Construction Bureau dated August 6, 2005(5)

10.10

License Agreement with Chong Liang Pu(6)

Letter re Change in Certified Registered Public Account (2)

21.1

List of Subsidiaries (7)

31.1

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

31.2

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

32.1

Certification of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. §1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

(1)	Previously filed as part of the Company’s current report on Form 8-K filed with the Securities and Exchange Commission on October 21, 2004.

(2)	Previously filed as part of the Company’s current report on Form 8-K/A filed with the Securities and Exchange Commission on December 30, 2004.

(3)	Previously filed as part of the Company’s annual report on Form 10-KSB filed with the Securities and Exchange Commission on April 15, 2005.

(4)	Previously filed as part of the Company’s Form 10-SB filed with the Securities and Exchange Commission on May 24, 1999.

(5)	Previously filed as part of Amendment Number 1 to Registration Statement on Form SB-2, filed January 12, 2006, 1933 Act Number : 333-129064.

(6)	Previously filed as Exhibit 10.5 to the Company’s annual report on Form 10-KSB/A filed with the Securities and Exchange Commission on July 15, 2005.

(7)	Previously filed as Exhibit 21.1 to the Company’s annual report on Form 10-KSB filed with the Securities and Exchange Commission on April 17, 2006.

Item 14. Principal Accountant Fees and Services

Our board of directors has selected PKF Hong Kong SAR as our independent accountants to audit our consolidated financial statements for the two fiscal years ended December 31, 2005 and 2004. Wm Andrew Campbell C.A. previously audited our consolidated financial statements for the two fiscal years ended December 31, 2003 and 2002.

Audit and Non-Audit Fees

Aggregate fees for professional services rendered to us by our accountants for the years ended December 31, 2005 and 2004 were as follows:


Services Provided	2005		2004
Audit Fees	$	50,438	$	56,410
Audit Related Fees		-0-		-0-
Tax Fees		-0-		-0-
All Other Fees		-0-		-0-

Total	$	50,438	$	56,410

Audit Fees. The aggregate fees billed by PKF Hong Kong SAR for the years ended December 31, 2005 and 2004, respectively, were for the audits of our financial statements and reviews of our interim financial statements included in our annual and quarterly reports.

Audit Related Fees. There were no fees billed for the years ended December 31, 2005 and 2004 for the audit or review of our financial statement that are not reported under Audit Fees.

Tax Fees. There were no fees billed for the years ended December 31, 2005 and 2004 for professional services for tax compliance, tax advice and tax planning.

All Other Fees. There were no billed for the years ended December 31, 2005 and 2004 for services other than the services described above.

Pre-Approval Policies and Procedures

We have implemented pre-approval policies and procedures related to the provision of audit and non-audit services. Under these procedures, our board of directors pre-approves all services to be provided by PKF Hong Kong SAR and the estimated fees related to these services.

Signatures

In accordance with Section 13 or 15(d) of the Exchange Act, the registrant has caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


	CHINA EVERGREEN ENVIRONMENTAL CORPORATION

Date: September 25, 2006	By:	/s/ Chong Liang Pu
		Chong Liang Pu, President and Chief Executive Officer

In accordance with the Exchange Act, this report has been signed by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


Signature	Title	Date
/s/ Chong Liang Pu CHONG LIANG PU	President, Chief Executive Officer, and Director	September 25, 2006

/s/ Peh Chung Lim PEH CHUNG LIM	Chief Financial Officer	September 25, 2006

/s/ Lin Hong Ye LIN HONG YE	Director	September 25, 2006

/s/ Shi Rong Jiang SHI RONG JIANG	Director	September 25, 2006