UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 (Mark
One)
 Form
10-K
  þ           ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For the
year ended December 31, 2008
  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: 001-33694
    CHINA DIRECT,
INC.
 (Exact
name of registrant as specified in its charter)
  Florida
              
              13-3876100(State
      or other jurisdiction of incorporation or organization)
              
              (I.R.S.
      Employer Identification No.)
  431
Fairway Drive, Suite 200, Deerfield Beach, Florida 33441
 (Address
of principal executive offices) (Zip Code)
  Registrant's
telephone number, including area code: (954) 363-7333
  Securities
registered under Section 12(b) of the Act:
 
 Title
      of each class
              
              Name
      of each exchange on which registeredCommon
      stock, par value $0.0001
              
              Nasdaq
      Global Market
 
 Securities
registered under Section 12(g) of the Act:
 None
 (Title of
class)
  Indicate
by check mark if the registrant is a well-known seasoned issuer, as defined in
Rule 405 of the Securities Act.  ̈ Yes þ No
  Indicate
by check mark if the registrant is not required to file reports pursuant to
Section 13 or Section 15(d) of the Act.  ̈ Yes þ No
  Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the
preceding 12 months (or for such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days. Yes þ No  ̈
  Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the best
of the registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. þ
  Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting
company:
 
 Large
      accelerated filer
               ̈
              Accelerated
      filer
               ̈Non-accelerated
      filer
                (Do
      not check if a smaller reporting company)
               ̈
              Smaller
      reporting company
              þ
 
 
  
  Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act)
 Yes  ̈ No þ
 
 State the
aggregate market value of the voting and non-voting common equity held by
non-affiliates computed by reference to the price at which the common equity was
sold, or the average bid and asked prices of such common equity, as of the last
business day of the registrant's most recently completed second fiscal quarter.
$91,147,687 on June 30, 2008.
 
 Indicate
the number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date. 23,424,172 shares of common stock are
issued and outstanding as of March 30, 2009.
 
 DOCUMENTS
INCORPORATED BY REFERENCE
 
 Portions
of the Registrant’s definitive proxy statement relating to its 2008 Annual
Meeting of Shareholders, to be filed no later than 120 days after the close of
the Registrant’s year ended December 31, 2008, are hereby incorporated by
reference in Part III of this Annual Report on Form 10-K.
 
  
  TABLE OF CONTENTS
 
 Part
      IItem
      1.
                    Business.
                    1Item
      1A.
                    Risk
      Factors.
                    11Item
      1B.
                    Unresolved
      Staff Comments.
                    19Item
      2.
                    Properties.
                    19Item
      3.
                    Legal
      Proceedings.
                    19Item
      4.
                    Submission
      of Matters to a Vote of Security Holders.
                    20Part
      IIItem
      5.
                    Market
      For Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities.
                    20Item
      6.
                    Selected
      Financial Data.
                    23Item
      7.
                    Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                    24Item
      7A.
                    Quantitative
      and Qualitative Disclosures About Market Risk.
                    37Item
      8.
                    Financial
      Statements and Supplementary Data.
                    37Item
      9.
                    Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure.
                    37Item
      9A (T).
                    Controls
      and Procedures.
                    37Item
      9B.
                    Other
      Information.
                    39Part
      IIIItem
      10.
                    Directors,
      Executive Officers and Corporate Governance.
                    39Item
      11.
                    Executive
      Compensation.
                    39Item
      12.
                    Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters.
                    39Item
      13.
                    Certain
      Relationships and Related Transactions, and Director
      Independence.
                    39Item
      14.
                    Principal
      Accountant Fees and Services.
                    39Part
      IVItem
      15.
                    Exhibits,
      Financial Statement Schedules.
                    39Signatures
                    43
 
  - i
-
 Table of Contents
 
 INDEX
OF CERTAIN DEFINED TERMS USED IN THIS REPORT
 
 Our year
end is December 31. The year ended December 31, 2006 is referred to as “2006”;
the year ended December 31, 2007 is referred to as “2007”; the year ended
December 31, 2008 is referred to as “2008”; and the year ending December 31,
2009 is referred to as “2009”.
 
 All share
and per share information contained herein gives retroactive effect to the
1-for-100 shares reverse split of our common stock on September 19, 2008 which
was  immediately followed by a 100-for-1 forward split of our common
stock.
 
 When used
in this report the terms:
 
 •
                  "China
      Direct”, "we”, "us” or “our” refers to China Direct, Inc., a Florida
      corporation, and our subsidiaries;•
                  “CDI
      China”, refers to CDI China, Inc., a Florida corporation, and a wholly
      owned subsidiary of China Direct; and•
                  “PRC”
      refers to the People’s Republic of
China.
 
 Magnesium
Segment
 
 •
              “Chang
      Magnesium”, refers to Taiyuan Changxin Magnesium Co., Ltd., a company
      organized under the laws of the PRC and a 51% majority owned subsidiary of
      CDI China;•
              “Chang
      Trading”, refers to Taiyuan Changxin YiWei Trading Co., Ltd., a company
      organized under the laws of the PRC and a wholly owned subsidiary of Chang
      Magnesium;•
              “Excel
      Rise”, refers to Excel Rise Technology Co., Ltd., a Brunei company and a
      wholly owned subsidiary of Chang Magnesium;•
              “CDI
      Magnesium”, refers to CDI Magnesium Co., Ltd., a Brunei company and a 51%
      owned subsidiary of Capital One Resources;•
              “Asia
      Magnesium”, refers to Asia Magnesium Co. Ltd., a company organized under
      the laws of Hong Kong and a wholly owned subsidiary of Capital One
      Resource;•
              “Golden
      Magnesium”, refers to Shanxi Gu County Golden Magnesium Co., Ltd., a
      company organized under the laws of the PRC and a 52% owned subsidiary of
      Asia Magnesium;•
              “Pan
      Asia Magnesium”, refers to Pan Asia Magnesium Co., Ltd., a company
      organized under the laws of the PRC and a 51% owned subsidiary of CDI
      China;•
              “Baotou
      Changxin Magnesium”, refers to Baotou Changxin Magnesium Co., Ltd., a
      company organized under the laws of the PRC; a 51% owned subsidiary of CDI
      China, and a 39% owned subsidiary of Excel Rise, effectively China Direct
      holds a 70.9% interest.
 
 Basic Materials
Segment
 
 •
              “Lang
      Chemical”, refers to Shanghai Lang Chemical Co., Ltd. a company organized
      under the laws of the PRC and a 51% owned subsidiary of CDI
      China;•
              “CDI
      Jingkun Zinc”, refers to CDI Jingkun Zinc Industry Co., Ltd., a company
      organized under the laws of the PRC and a 95% owned subsidiary of CDI
      Shanghai Management;•
              “CDI
      Jixiang Metal”, refers to CDI Jixiang Metal Co., Ltd., a company organized
      under the laws of the PRC and a wholly owned subsidiary of CDI
      China;•
              “CDI
      Metal Recycling”, refers to Shanghai CDI Metal Recycling Co., Ltd., a
      company organized under the laws of the PRC and an 83% owned subsidiary of
      CDI Shanghai Management; and•
              “CDI
      Beijing” refers to CDI (Beijing) International Trading Co., Ltd., a
      company organized under the laws of the PRC and a 51% owned subsidiary of
      CDI Shanghai Management.
 
 Consulting
Segment
 
 •
              “China
      Direct Investments”, refers to China Direct Investments, Inc., a Florida
      corporation, and a wholly owned subsidiary of China
  Direct;•
              “CDI
      Shanghai Management”, refers to CDI Shanghai Management Co., Ltd., a
      company organized under the laws of the PRC and a wholly owned subsidiary
      of CDI China; and•
              “Capital
      One Resource”, refers to Capital One Resource Co., Ltd., a Brunei company,
      and a wholly owned subsidiary of CDI Shanghai
  Management.
 
  - ii
-
 Table of Contents
 
 Clean Technology
Segment: (All
operations related to the following entities were discontinued in September
2008)
 
 •
              “CDI
      Clean Technology”, refers to CDI Clean Technology Group, Inc., a Florida
      corporation formerly known as Jinan Alternative Energy Group Corp.,
      effective October 30, 2008, CDI China holds a 19%
  interest;•
              “CDI
      Wanda”, refers to Shandong CDI Wanda New Energy Co., Ltd., a company
      organized under the laws of the PRC and a 51% owned subsidiary of CDI
      Clean Technology; and•
              “Yantai
      CDI Wanda”, refers to Yantai CDI Wanda Renewable Resources Co., Ltd., a
      company organized under the laws of the PRC and a 52% owned subsidiary of
      CDI Wanda.
  
  - iii
-
 Table of Contents
  PART
I
 
 ITEM
      1.
              BUSINESS.
 
 Overview
 
 We are a
U.S. company that manages a portfolio of Chinese entities.  We also
provide consulting services to Chinese businesses. We operate in three
identifiable business segments: Magnesium, Basic Materials and Consulting. In
the fourth quarter of 2006, we established our Magnesium and Basic Materials
segments which have grown in 2007 and 2008 through acquisitions of controlling
interests of Chinese private companies. We consolidate these acquisitions as
either our wholly or majority owned subsidiaries. Through this ownership
control, we provide management advice, business development services, strategic
planning, macroeconomic industry analysis and financial management seeking to
improve the quality and performance of each portfolio company.  We
also provide our subsidiaries with investment capital to expand their
businesses. In an effort to augment the growth and expand the business
opportunities of our subsidiaries, we have invested $23.5 million to acquire a
contolling interest in our subsidiaries and provided them approximately $8.9
million in working capital since 2006.
 
 In our
Magnesium segment, our largest segment, we operate five entities which produce,
sell and distribute pure magnesium ingots, magnesium powders and magnesium
scraps.
 
 In our
Basic Materials segment, we operate five entities which sell and distribute a
variety of products including (i) industrial grade synthetic chemicals, (ii)
steel products (iii) non ferrous metals, and (iv) recycled materials. This
segment also includes our zinc mining property which has not commenced
operations.
 
 In our
Consulting segment, we provide a suite of consulting services to U.S. public
companies that operate primarily in China. The consulting fees we charge vary
based upon the scope of the services to be rendered.
 
 In 2007
we launched a Clean Technology segment.  We discontinued this segment
in the third quarter of 2008 when we completed the sale in October 2008 of an
81% interest in CDI Clean Technology and its subsidiaries, CDI Wanda and Yantai
CDI Wanda to PE Brothers Corp. for $1,240,000 and recorded a gain on the sale of
$238,670. We plan to maintain the 19% ownership interest in CDI Clean Technology
we retained using the cost method of accounting.
 
 Our
corporate headquarters are in Deerfield Beach, Florida which houses the U.S.
executive and administrative team that guides our overall operations. Our U.S.
office employs both English and Chinese speaking business, legal and accounting
staff. These professionals focus on due diligence, finance, accounting and
compliance with the reporting requirements of the Securities and Exchange
Commission (“SEC”) and other applicable laws in the U.S. and the
PRC.
 
 Our
Repositioning
 
 Beginning
in 2005, we began operating as a management and advisory services organization
to provide consulting services to private companies in the PRC. In 2008 our
Consulting segment continued to account for a small portion of our consolidated
revenues, accounting for $16.4 million or 6.8% of our total consolidated
revenues of $240.0 million.  As we have grown our Magnesium and Basic
Materials segments in 2007 and 2008, we have devoted a significant amount of our
capital and human resources to these aspects of our operations and will continue
to do so in the future.  We believe these changes strengthen our
ability to effectively grow our business in our Magnesium and Basic Materials
segments in a challenging worldwide economic environment as we seek to become
the global leader in the production and distribution of pure
magnesium.
 
 In order
to support our transition towards the development of our Magnesium and Basic
Materials segments, we have begun to restructure our senior management to add
personnel with operating experience in the PRC which included the following
management changes.
 
 Yuwei
Huang was appointed executive vice president for the Magnesium segment and as a
member of our board of directors. Mr. Huang has served as chief executive
officer of Chang Magnesium since June 2006. Mr. Huang holds an interest in
several magnesium entities operating in China including Taiyuan YiWei Magnesium
Industry Co., Ltd., a company organized under the laws of the PRC (“YiWei
Magnesium”), which he created in 1999. YiWei Magnesium is a minority owner of
Chang Magnesium, which holds interests in several entities operating in the
magnesium industry in China. Mr. Huang is responsible for the operations of our
Magnesium segment.
  - 1
-
 Table of Contents
 
 Jingdong
Chen was appointed as a vice president for the Basic Materials segment. Mr.
Chen, a minority owner of Lang Chemical, has served as its chief executive
officer since co-founding the company in 1998. Since our acquisition of Lang
Chemical in November 2006, Mr. Chen has served as its General Manager,
responsible for its daily operations. Mr. Chen has in excess of 10 years of
experience operating businesses in the chemical industry in China.
 
 We
accepted the resignation of Marc Siegel as President and as a member of our
board of directors. Mr. Siegel co-founded China Direct Investments in 2005 and
was responsible for its U.S. based consulting operations. Mr. Siegel will remain
with China Direct in 2009 as a consultant assisting its client companies in
matters relating to financing, mergers and acquisitions and business
development.
 
 In
addition to our management changes, our board of directors authorized the change
of our corporate name to China Direct Industries, Inc., subject to shareholder
approval.
 
 Magnesium
Segment
 
 Our
Magnesium segment is currently our largest segment by revenue. Since the fourth
quarter of 2006, we have entered into agreements to acquire a controlling
interest in five magnesium entities and their subsidiaries operating in China
that produce and/or distribute magnesium products such as pure magnesium ingots,
magnesium powders and magnesium scraps. In 2008 revenues from this segment were
$169.8 million, including revenues of $16.8 million from related parties, and
represented 71% of our total consolidated revenues.
 
 Magnesium
and magnesium related products have a variety of technological and consumer
applications. Magnesium is the third most commonly used structural metal,
following steel and aluminum, and is used in the production of alloys used in
aircraft and automobile parts. Magnesium is the lightest of the structural
metals; it is one fourth the weight of steel and two thirds the weight of
aluminum. Various forms of magnesium are also used in the manufacture of
electronic equipment such as computers, cameras and cell phones. Magnesium
powder is also used in flares, flashes and pyrotechnics.
 
 Our
magnesium production facilities are located in the Shanxi Province and Inner
Mongolia, China. These regions are rich in natural resources such as dolomite
and ferrosilicon, the primary raw materials used to create pure magnesium. In
addition, these areas have vast deposits of coal which enable our magnesium
subsidiaries in the Shanxi Province to utilize waste gas of neighboring coke
refineries to fuel their magnesium producing furnaces. This utilization of waste
gas as an energy source is less expensive than burning coal.  Each of
our subsidiaries in the Shanxi Province has entered into multi-year agreements
with certain coke refineries to access their waste gas and thus lock in energy
cost savings. Additionally, the use of waste gas is a more environmentally
friendly source of energy compared to magnesium producers who burn coal to fuel
their furnaces.  Our magnesium facility in Inner Mongolia burns coal
in order to generate coke gas to fuel its furnaces.
 
 This
exploitation of waste gas as energy is an important element to our Magnesium
segment in light of recent regulations implemented by the PRC to control
industrial pollution. In April 2008, the PRC amended the Energy Conservation
Law, previously adopted in 1997 which regulates national standards on energy
conservation. The amendment establishes per unit energy consumption quotas for
magnesium smelting, effective as of June 2008. Companies failing to meet the new
environmental protection standards may be subject to penalties, in the form of
fines and/or suspension. Our facilities have obtained a license from the
appropriate provincial environmental protection administrations permitting them
to produce magnesium.
 
 Our
Magnesium segment utilizes a production method known as the silicothermic
manufacturing process, sometimes referred to as the ‘pidgeon process’, as the
primary production method of its magnesium products. The pidgeon process, a
common method employed in China, offers several advantages including reduced
costs and production cycles. From an environmental perspective the process is
beneficial when compared with alternative production methods. In addition, all
of our facilities utilize high temperature air combustion technology, also known
as flameless combustion in an attempt to further reduce production
costs.
  - 2
-
 Table of Contents
 
 We
produced, sold and distributed approximately 50,000 metric tons of magnesium in
2008. This included the sale of approximately 700 metric tons of magnesium
produced at Baotou Changxin Magnesium which began operations in December, 2008.
As of December 31, 2008, we have total annual magnesium production capacity of
50,000 metric tons with capacity for an additional 8,000 metric tons under
construction. We will continue to upgrade and expand our current facilities as
we grow this segment. In 2008 our average selling price of magnesium was
approximately $3,300 per metric ton as compared to $2,200 per metric ton in
2007. Typically approximately 65% of our sales in the segment are made through
long term sales agreements, while the remaining portion are made at prevailing
market prices.
 
 Magnesium
Segment Initiatives
 
 Since
late 2006 we have invested approximately $20.5 million in this segment to
acquire a controlling interest in five entities that produced, sold and
distributed a combined 50,000 metric tons of magnesium in 2008. As a result
of the growth of our magnesium operations, we plan to raise capital and expand
our magnesium holdings within a single entity in 2009. We believe we will be in
a position to acquire additional magnesium properties or increase our
ownership interest in our existing subsidiaries with our magnesium business
under a single entity.  We believe these actions will allow us to
become more effective in developing a global sales organization and a stronger
and reliable source of greater quantities of magnesium needed to meet the needs
of customers in the automotive, aerospace, transportation and consumer
electronics industries. In addition, we believe a consolidated holding structure
will enable us to fully realize the value of our magnesium holdings in the
future.
 
 Sources
and Availability of Raw Materials
 
 We obtain
dolomite and ferrosilicon, the primary raw materials used to create pure
magnesium and waste gas used to fuel our magnesium producing furnaces from a
variety of sources including mining companies, coke refineries who produce waste
gas as a by-product in the production of coke, washing coal, coal tar, sulfur,
ammonium sulfate and benzene. In 2008, no suppliers accounted for over 10% of
the purchases of raw materials used in our Magnesium segment. We
purchase dolomite and ferrosilicon on a purchase order basis from local
suppliers at market prices based on our production requirements. We have long
term supply contracts for waste gas with suppliers primarily at a fixed
price.
 
 We
believe we will have access to sufficient dolomite and ferrosilicon to meet
our needs for the foreseeable future. We have, however, experienced shortages of
coke waste gas in the fourth quarter of 2008 as the coal coke plants that
produce this gas slowed production due to reduced demand for products they
supply to steel smelters. In the first six months of 2008, we experienced rising
raw material costs, primarily in the price of ferrosilicon, dolomite and coal;
directly a result of the rising price of magnesium during the same period. These
increases were further impacted due to stockpiling of inventory levels in
advance of the 2008 Beijing Olympics. In the latter half of 2008 we witnessed
decreased raw material costs in tandem with the decreasing market price of
magnesium.
 
 Basic
Materials Segment
 
 In our
Basic Materials segment, we sell and distribute a variety of products in Asia
including (i) industrial grade synthetic chemicals, (ii) steel products (iii)
non ferrous metals, and (iv) recycled materials. This segment also includes our
zinc mining property. In 2008 our Basic Materials segment generated revenues of
$53.8 million, representing approximately 22% of our total consolidated
revenues.
 
 Synthetic
Chemicals.  We act as a third party agent in the sale and
distribution of industrial chemicals which are employed as raw materials in the
production of a variety of finished products such as paint, glue, plastics,
textiles, leather goods as well as various medical products.  We sell and
distribute four primary product categories of industrial grade synthetic
chemicals, glacial acetic acid and acetic acid derivatives, acrylic acid and
acrylic ester, vinyl acetate-ethylene (“VAE”) and polyvinyl alcohol (“PVA”).
  Distribution
of Basic Resources.  We sell and distribute steel and
non-ferrous metals such as aluminum, zinc, and lead in China. We are also
planning on distributing zinc concentrate once our supplier commences
production. In October 2007, we entered into a distribution agreement with
a zinc processing company that has suspended its production as a result of
current weakness in the market price of zinc and zinc-related
products.  Once our supplier commences production, we will begin to
distribute its products.  Presently we do not have a timetable for
when our zinc concentrate distribution operations will
commence.
  - 3
-
 Table of Contents
 
 Recycling.  In
2007 we operated a Clean Technology segment which primarily focused on a process
to recycle waste tires into tire derived fuel. While management believes in the
long term viability of this technology, falling fuel prices have reduced the
demand for alternative energy sources. In the third quarter of 2008, we elected
to exit the alternative energy and recycling business conducted by CDI Clean
Technology and its subsidiaries, CDI Wanda and Yantai CDI Wanda.
 
 We are
evaluating the feasibility of continuing the development of a proposed facility
to create aluminum powder from recycled aluminum. While the current market price
of aluminum does not support the economic viability of a recycling operation, we
believe aluminum wire recycling will become viable as natural resources continue
to be depleted. This proposed recycling operation was consolidated with our
Basic Materials segment in the fourth quarter of 2008.
 
 Mining
Operations.  We hold mining rights to approximately 51 acres
located in the Yongshun Kaxi Lake Mining area which is known to hold both zinc
and lead ores. The mining rights we obtained from the Ministry of Land and
Resources in 2004 allow for the mining of an aggregate of 10,000 metric tons of
zinc per year. As of the date of this report, we have not established a reserve
on this property. Also, as a result of current weakness in the market price of
zinc and related products, we are evaluating the economic feasibility of
commencing mining and productions operations at this site. Once we complete our
assessment, we will obtain an independent valuation of the ore deposits and, if
warranted, complete construction of the mining processing facilities we
planned to build on this site. Presently we do not have a timetable for when we
will complete our assessment or when our operations will commence.
 
 Consulting
Segment
 
 In our
Consulting segment, we provide a suite of consulting services to U.S. public
companies that operate primarily in China. We currently have service contracts
with various clients who conduct business in China or seek to conduct business
with China. We generate revenues by providing consulting services in the areas
of financing structures and arrangements, mergers, acquisitions
and  other business transactions, identifying potential areas of
growth, translation services, managing and coordinating all necessary government
approvals and licenses in the PRC, marketing services, investor relations
services, and coordination of the preparation of required SEC
filings.
  Our
consulting fees vary based upon the scope of the services to be rendered.
Historically, a significant portion of the fees we earned have been paid in the
form of our clients’ securities which include preferred stock, common stock and
common stock purchase warrants from clients. We classify these securities as
investments in marketable securities available for sale or investment in
marketable securities available for sale-related party. We value these
securities at fair market value at the time of receipt for the purposes of our
revenue recognition. Primarily all of the securities we receive as compensation
pursuant to agreements in our Consulting segment are from small public companies
and are typically restricted under Federal securities laws as to resale.
Generally we recognize revenue from such securities based on the fair value at
the time preferred stock or common stock is granted and for common stock
purchase warrants based on the Black-Scholes valuation model.
 
 EMPLOYEES
 
 As of
March 31, 2009 we have a total of 1,287 full time employees, including 18
employees in the United States and 1,269 employees in the PRC. We believe we
have good working relationships with our employees. We are currently not a party
to any collective bargaining agreements.
 
 For our
employees in the PRC, we are required to contribute a portion of their total
salaries to the Chinese government’s social insurance funds, including medical
insurance, unemployment insurance and job injuries insurance, as well as a
housing assistance fund, in accordance with relevant regulations. We expect the
amount of our contribution to the government’s social insurance funds to
increase in the future as we expand our workforce and operations.
 
 Executive
Officers of the Company
 
 The
following sets forth the names and ages of each of our executive officers as of
March 31, 2009 and the positions they hold:
 
 Name
                  
                  Age
                  
                  Position
      with the CompanyYuejian
      (James) Wang, Ph.D
                  
                  
                  47
                  
                  Chairman,
      President and Chief Executive OfficerI.
      Andrew Weeraratne
                  
                  
                  58
                  
                  Chief
      Financial OfficerYuwei
      Huang
                  
                  
                  54
                  
                  Executive
      Vice President - MagnesiumLazarus
      Rothstein
                  
                  
                  51
                  
                  Executive
      Vice President, General Counsel and
Secretary
 
  - 4
-
 Table of Contents
 
 Each of
our executive officers holds office for such term as may be determined by our
board of directors. Set forth below is a brief description of the business
experience of each of our executive officers.
 
 Yuejian (James) Wang, Ph.D.
has served as our CEO and Chairman of the board of directors since
August 2006. Dr. Wang, a co-founder of China Direct Investments, has served
as its CEO and Chairman of its board of directors since its inception in
January 2005. Dr. Wang has also been a member of the board of
directors of CIIC Investment Banking Services (Shanghai) Company Limited since
June 2004. From 2001 to 2004, he was President and Chairman of the board of
directors of Genesis Pharmaceuticals Enterprises, Inc. (OTCBB: GNPH). From 2000
until 2001, Dr. Wang was President, Chief Operating Officer and director of
China Net & Technologies, Inc., a technology firm. From 2000 until 2001, Dr.
Wang was Vice President, Chief Operating Officer and director of Tensleep
Corporation, a California-based integrated Internet company that acquired and
licensed technology, identified, acquired and developed development-stage
technology and service entities and focused on the internet infrastructure
market-PC, application-ready devices. From January 2000 until
November 2000, Dr. Wang was President of Master Financial Group, Inc., a
St. Paul, Minnesota-based company which was a wholly-owned subsidiary of
Tensleep Corporation that provided consulting services for small private and
public entities in the area of corporate finance, investor relations and
business management. Between 1997 and 2000, Dr. Wang was a research scientist
and Assistant Professor, Lab Director at the University of Minnesota, School of
Medicine. Dr. Wang received a Bachelor of Science degree from the University of
Science and Technology of China in Hefei, China in 1985, a Master of Science
Degree from the Shanghai Second Medical University, Shanghai, China in 1988, and
his Ph.D. degree from the University of Arizona in 1994.
  Yuwei Huang has served as our Executive Vice President – Magnesium since
February 2009 and as Chief Executive Officer of our subsidiary, Chang Magnesium,
since June 2006. Mr. Huang is responsible for the operations of Chang
Magnesium. Mr. Huang also serves as General Manager of Taiyuan YiWei
Magnesium Industry Co., Ltd. (“YiWei Magnesium”) since founding the company
in 1999 and serves in various positions with its affiliated entities including
Vice Chairman of Shanxi Golden Trust YiWei Magnesium Industry Co., Ltd. since
2002, Vice Chairman of Taiyuan Qingcheng YiWei Magnesium Industry Co., Ltd.
since 2001, Vice Chairman and General Manager of Taiyuan Minwei Magnesium
Industry Co., Ltd. since 2000, General Manager of Taiyuan YiWei Magnesium
Factory since 1998 and Chairman of Shangxi NiChiMen YiWei Magnesium Co., Ltd.
since 1994. YiWei Magnesium, a minority owner of Chang Magnesium, owns interests
in seven subsidiary magnesium factories, a magnesium alloy factory and a
magnesium powder desulphurization reagent factory, all located in
China.
 
 Andrew Weeraratne has served
as our Chief Financial Officer since February 2009. From February 2000 to
January 2009, Mr. Weeraratne was the investment officer for Passerelle Corp., a
private investment company. From August 2004 to December 2008, Mr.
Weeraratne acted as a financial consultant working in a variety of industries
including work with the Embassy of the United States of America in Iraq as a
financial advisor to form an Iraqi Accounting Association to introduce
International Accounting Standards to Iraq as part of a plan to privatize State
owned enterprises after the Iraq war. From December 1998 to February 2000,
Mr. Weeraratne was the Chief Financial Officer of National Lampoon, Inc.
(formerly known as J2 Communications), a provider of branded comedic
content. From November 1996 to December 1998, Mr. Weeraratne was the
Controller for Beachport Entertainment Corp., a provider of family entertainment
and sporting events and television programming. From 1990 to 1996 Mr.
Weeraratne was the Chief Financial Officer of Business Resource Exchange, a
business consulting company that identified and resold undervalued companies.
From 1982 to 1989, Mr. Weeraratne managed his own CPA firm in Washington D.C.
representing foreign clients with investments in the U.S. and in International
taxation matters. Mr. Weeraratne has been a Florida licensed Certified Public
Accountant since 1981.
 
 Lazarus Rothstein has
served as our Executive Vice President, General Counsel and Secretary since
February 2009 and as our Vice President, General Counsel and Secretary since
April 2008.  From 2003 to 2006, Mr. Rothstein was an Assistant General
Counsel at Elizabeth Arden, Inc. a global prestige fragrance and beauty products
company. From 2001 to 2003, Mr. Rothstein was a Senior Corporate Counsel at The
Sports Authority, Inc., a national full line sporting goods
retailer.  From 2000 to 2001, Mr. Rothstein was Vice President and
General Counsel at Daleen Technologies, Inc., a billing and customer care
software provider. From 1996 to January 2000, Mr. Rothstein was General
Counsel at Let’s Talk Cellular and Wireless, Inc., a wireless communications
retailer. In 2007 and 2008 prior to joining China Direct and prior to 1996, Mr.
Rothstein was engaged in the private practice of law. Mr. Rothstein received a
Bachelors of Science degree in Accounting from Florida State University in 1980
and a Juris Doctor Degree from Nova Southeastern University Law School in
1983.
  - 5
-
 Table of Contents
 
 Key
Employees
 
 We employ
certain individuals who, while not executive officers, make significant
contributions to our business and operations and hold various positions within
our subsidiaries.
 
 Xiaowen (Robert) Zhuang, age
52, has served as General Manager of CDI Shanghai Management since
December 2006. Mr. Zhuang supervises our operations in China.
Mr. Zhuang has been working as a business consultant in various capacities
for private Chinese entities since 1992. From June 2004 until
December 2006 he served as Vice General Manager of CIIC Investment Banking
Services (Shanghai) Co., Ltd. and from March 2000 until June 2004 he
was General Manager of Shanghai Yazheng Investment Advisory Co., Ltd.
Mr. Zhuang served as Vice President and a director of Dragon Capital Group
Corp. (Pink Sheets: DRVG) from December 2005 through December 2006. He
was a member of the board of directors of Genesis Technology Group, Inc. from
May 2003 until May 2005. From April 2001 to July 2006 he was
President and the founder of Yastock Investment Consulting Co., Ltd., a
consulting firm located in China which was acquired by Genesis Technology Group,
Inc. From May 2001 through December 2004, Mr. Zhuang served as Vice General
Manager of Shanghai Yazheng Information Technology Co., Ltd. From 2000 to 2002
he was the assistant to the President of Shanghai Pudong Haike Group from 1995
to 2000. Mr. Zhuang holds a Bachelor of Law from East China University of
Politics and Law and studied at the College of Electronics Engineering of East
China Normal University in 1987. Mr. Zhuang is a registered property broker
in Shanghai, China and registered Corporate Law consultant. Mr. Zhuang is
the brother of Dr. Wang, our CEO and Chairman.
 
 Jingdong Chen, age 41, has
served as chief executive officer of Lang Chemical since co-founding the company
in 1998. Mr. Chen is also a minority owner of Lang Chemical. Since our
acquisition of Lang Chemical in November 2006, Mr. Chen has served as
the General Manager, responsible for the daily operations. Mr. Chen has in
excess of 10 years of experience operating in the chemical industry in China.
From 1990 to July 1996, Mr. Chen was sales manager for Shanghai
Chemical Industry Sales Corporation and from August 1996 to
September 1998 he was Vice General Manager for Vinda Group in the Shanghai
Branch, a paper manufacture in China. Mr. Chen received a master’s degree
from East China Normal University in 1990. Mr. Chen is the spouse of
Ms. Qian Zhu.
 
 Chi Chen, age 37, has served
as a vice president of our Basic Materials segment as well as general manager
and chairman of CDI Beijing since September 2008. From 2004 to 2008 Mr.
Chen served as general manager and chairman of Beijing Kaiyuan Tongbao Trading
Co., Ltd., a steel and lumber distribution company.  From 2002 to
2004, Mr. Chen served as chairman of Beijing Putaoyuan Investment Consulting
Co., Ltd., a real estate company. From 2000 to 2002 Mr. Chen served as the
general manager of Beijing Guohuan Exhibition Center, a property management
company. From 1997 to 2000 Mr. Chen served as China’s Chief Representative for
the Western Caroline Trading Co., Ltd., a food distribution
company.  From 1993 to 1997 Mr. Chen served as chairman of Baotou
Dongfu Industry Co., Ltd. a lumber distribution company.  Mr. Chen
holds a Bachelor degree from Fuzhou University.
 
 Richard Galterio, age 45, has
served as Vice President – Investor Relations of China Direct since February
2009 and from February 2007 to January 2009 Executive Vice President. His
responsibilities include corporate development and communications as well as the
management of all public and investor relations for China Direct, subsidiaries
and client companies. Mr. Galterio has over 16 years of experience in
investment banking with a focus on early stage companies. Mr. Galterio
served as COO of Skyebanc, Inc., a FINRA member broker/dealer from 2005 to 2007.
Prior to that position, he served as Director of Private Equity for vFinance
Investments, Inc., a FINRA member broker/dealer from 2001 to 2005. Mr. Galterio
had been engaged by vFinance Investments, Inc. since the acquisition of First
Level Capital in 2000, a company co-founded by Mr. Galterio in
September of 1998. Mr. Galterio served as Compliance and Operations
Director for First Level Capital from 1998 to 2000. Prior to First Level Capital
Mr. Galterio was Managing Director of Commonwealth Associates from 1994 to
1998 where his responsibilities included branch management and compliance.
Mr. Galterio was a member of the board of directors of Spare Backup, Inc.
(OTCBB: SPBU) from June of 2003 to September of 2008. Mr. Galterio has a
Bachelor of Science degree in Business Administration and Psychology from
Villanova University.
  - 6
-
 Table of Contents
 
 COMPETITION
 
 Our
subsidiaries and the business segments they operate in face unique challenges
and extensive competition.
 
 Magnesium
segment. The
magnesium market in China, which in 2008 produced approximately 78% of global
magnesium production, is dominated by several large manufacturers. Our main
competitors in the industry are Tongxiang Magnesium Co., Ltd., Yingguang
Magnesium Co., Ltd. and YiWei Magnesium, a related party. See Item 13. Certain
Relationships and Related Transactions, and Director Independence appearing
later in this report. Production costs associated with the energy needed to fuel
the magnesium refinery are a significant challenge facing all producers. We
believe we are competitive with other local magnesium producers because several
of our production facilities are located in the Shanxi Province, in close
geographic proximity to coke refineries who supply waste gas that fuels our
magnesium refineries. Additionally, we have entered into long term contracts
providing for the necessary energy to keep our facilities running in an effort
to compete effectively with other companies in this market. A recent 10% export
tariff on magnesium has equally impacted the profit margins of all China based
producers.
 
 Basic
Materials segment. While we believe our subsidiaries in this segment have
viable business models, we also recognize that many rival entities possess
greater financial and technical resources to compete in these businesses. We
compete with a variety of companies which include global and domestic
distribution agents as well as manufacturers. These companies have more capital,
longer operating histories, greater brand recognition, larger customer bases and
significantly greater financial and marketing resources than us. These
competitors may offer a more comprehensive package of services than we are able
to provide. For these and other reasons, these competitors' services may achieve
greater acceptance in the marketplace than our company, limiting our ability to
gain market share and customer loyalty and increase our
revenues.
 
 Consulting
segment. The
services we offer in our Consulting segment competes with the services offered
by many entities and individuals seeking to take advantage of the growing need
of Chinese entities seeking management advice in order to obtain access the U.S.
capital markets for their expansion. This competition ranges from large
management consulting firms and investment banks that offer a broad range of
consulting and financial services, to small companies and independent
contractors that provide specialized services. Many of the firms prospecting
these clients are well established and have extensive experience identifying and
effecting business combinations directly or through affiliates. Furthermore, we
acknowledge we are competing with firms that may possess greater financial,
marketing, technical, human and other resources. In light of the current global
economic environment and a severe liquidity crisis in the global capital
markets, we believe it has become more difficult for smaller companies to
attract interest in the financial community, make acquisitions and increase
revenues and profitability. These factors impact our clients’ ability to pay the
management fees needed to meet the costs of providing the services needed to
comply with U.S. securities laws which our competitors may be able to provide at
lower rates.
 
 TRADEMARKS,
LICENSES AND PATENTS
 
 We own
the trademark for “China Direct” and “Your Direct Link to China”. These
trademarks are registered in the United States. We do not consider the
protection of our trademarks to be important to our business.
 
 GOVERNMENT
REGULATION
 
 Despite
efforts to develop the legal system over the past several decades, including but
not limited to legislation dealing with economic matters such as foreign
investment, corporate organization and governance, commerce, taxation and trade,
the PRC continues to lack a comprehensive system of laws. Further, the laws that
do exist in the PRC are often vague, ambiguous and difficult to enforce, which
could negatively affect our ability to do business in China and compete with
other companies in our segments.
 
 In
September 2006, the Ministry of Commerce (“MOFCOM”) promulgated the Regulations
on Foreign Investors' Mergers and Acquisitions of Domestic Enterprises (M&A
Regulations) in an effort to better regulate foreign investment in China. The
M&A Regulations were adopted in part as a needed codification of certain
joint venture formation and operating practices, and also in response to the
government's increasing concern about protecting domestic companies in perceived
key industries and those associated with national security, as well as the
outflow of well-known trademarks, including traditional Chinese
brands.
 
 As a U.S.
based company doing business in China, we seek to comply with all PRC laws,
rules and regulations and pronouncements, and endeavor to obtain all necessary
approvals from applicable PRC regulatory agencies such as the MOFCOM, the State
Assets Supervision and Administration Commission (“SASAC”), the State
Administration for Taxation, the State Administration for Industry and Commerce,
the China Securities Regulatory Commission (“CSRC”), and the State
Administration of Foreign Exchange (“SAFE”).
  - 7
-
 Table of Contents
 
 Economic Reform Issues. Since
1979, the Chinese government has reformed its economic systems. Many reforms are
unprecedented or experimental; therefore they are expected to be refined and
improved. Other political, economic and social factors, such as political
changes, changes in the rates of economic growth, unemployment, inflation, or
the disparities in per capita wealth between regions in China, could lead to
further readjustment of the reform measures. We cannot predict if this refining
and readjustment process may negatively affect our operations in future periods,
particularly in relation to future policies including but not limited to foreign
investment, taxation, inflation and trade.
 
 Currency.The value of the
Renminbi (“RMB”), the main currency used in China, fluctuates and is affected
by, among other things, changes in China’s political and economic conditions.
The conversion of RMB into foreign currencies such as the U.S. dollar have been
generally based on rates set by the People’s Bank of China, which are set daily
based on the previous day’s interbank foreign exchange market rates and current
exchange rates on the world financial markets.
 
 Environment.We are currently
subject to numerous Chinese provincial and local laws and regulations relating
to the protection of the environment which are highly relevant to our Magnesium,
and Basic Materials segments. These laws continue to evolve and are becoming
increasingly stringent. The ultimate impact of complying with such laws and
regulations is not always clearly known or determinable because regulations
under some of these laws have not yet been promulgated or are undergoing
revision. In 2008 we did not spend any funds related to compliance with
environmental regulations.
 
 The
Environmental Protection Law requires production facilities that may cause
pollution or produce other toxic materials to take steps to protect the
environment and establish an environmental protection and management system.
Penalties for breaching the Environmental Protection Law include a warning,
payment of a penalty calculated on the damage incurred, or payment of a fine.
When an entity has failed to adopt preventive measures or control facilities
that meet the requirements of environmental protection standards, it may be
required to suspend its production or operations and pay a fine.
 
 The State
Environmental Protection Administration Bureau is responsible for the
supervision of environmental protection, the implementation of national
standards for environmental quality and discharge of pollutants, and supervision
of the environmental management system in China. Environmental protection
bureaus at the county level or above are responsible for environmental
protection in their jurisdictions. The laws and regulations on environmental
protection require each company to prepare environmental impact statements for a
construction project to the environmental protection bureaus at the county
level. These must be prepared prior to when the construction, expansion or
modification commences.
 
 We
recognize this tighter scrutiny surrounding environmental protection in the PRC
and this consideration is a material factor in our due diligence process when
selecting and acquiring companies in China. In our Magnesium segment, for
example, the manufacturing companies we have acquired since December 2006
utilize waste gas to fuel their plants. We believe this mitigates the risk of
our magnesium production being limited in the future due to environmental
protection actions initiated by the PRC.
 
 We
believe our current operations in the PRC comply with the environmental
protection requirements. We are not subject to any admonition, penalty,
investigations or inquiries imposed by the environmental regulators, nor are we
subject to any claims or legal proceedings to which we are named as a defendant
for violation of any environmental laws and regulations.
 
 Other
regulations particularly applicable to Basic Materials segment
 
 Regulation
of the chemical industry in China is monitored by The Ministry of China Chemical
Industry. Industry participants are governed by the Industrial Chemical Control
Law (“ICCL”) issued by the Ministry of China Chemical Industry. The Shanghai
provincial government issues licenses for the distribution of chemical products
in China. Lang Chemical received its license to operate in the chemical industry
in January 1998, and presently believes it is in substantial compliance with all
provisions of those PRC registrations, inspections and licenses and has no
reason to believe it will not be renewed as required by the applicable
rules of the Central Government and Shanghai City.
  - 8
-
 Table of Contents
 
 Other
regulations particularly applicable to Magnesium and Basic Resource
segments
 
 China's
Mining Ministry, and other provincial, county and local authorities in
jurisdictions in which our products are processed or sold, monitors the
processing, storage, and distribution of our magnesium products. Our processing
facilities are subject to periodic inspection by national, provincial, county
and local authorities. We may not be able to comply with current laws and
regulations, or any future laws and regulations. To the extent that new
regulations are adopted, we will be required to conform our activities in order
to comply with such regulations. We may be required to incur substantial costs
in order to comply. Our failure to comply with applicable laws and regulations
could subject us to civil remedies, including fines, injunctions, recalls or
seizures, as well as potential criminal sanctions, which could have a material
and adverse effect on our business, operations and finances. Changes in
applicable laws and regulations may also have a negative impact on our
sales.
 
 China’s
domestic economic stimulus program
 
 In
November 2008, the Chinese government announced a $586 billion domestic economic
stimulus program aimed at bolstering domestic economic activity. The
two year program includes tax rebates, spending in housing,
infrastructure, agriculture, health care and social welfare, and a tax deduction
for capital spending by companies.
 
 In
February 2009 China's State Council announced support plans for the country's
nonferrous metals and logistics sectors. The support plans included; subsidized
loans to support technical innovations in the nonferrous metals sector,
adjustments to export rebate rates of nonferrous products, and the establishment
of a national reserve system for the industry.
 
 While
these programs adopted by the PRC government are aimed towards supporting growth
in some of the sectors in which we operate its difficult to predict if any of
our businesses will benefit. It remains to be seen if domestic consumption can
compensate for slower export growth, and the impact this will have on our future
revenues.
 
 Our
Corporate History
 
 We were
incorporated on June 7, 1999 in Delaware initially under the name Caprock
Corporation to engage in any lawful corporate undertaking, including, but not
limited to, selected mergers and acquisitions.On November 26, 1999,
International Internet, Inc., a Delaware corporation, acquired 100% of our
issued and outstanding stock from TPG Capital Corporation, our sole stockholder,
pursuant to a stock purchase agreement in exchange for 50,000 shares of common
stock of International Internet, Inc.
 
 In
December 1999 Caprock Corporation was merged into International Internet with
International Internet, Inc. being the surviving company. Effective November 21,
2000, International Internet, Inc. changed its name to Evolve One,
Inc.
 
 Between
1999 and 2005 we operated a number of small, start up or development stage
businesses. During 2005 our operations consisted of two internet based
businesses, StogiesOnline.com and AuctionStore.com. StogiesOnline.com was an
online distributor and retailer of brand name premium cigars. AuctionStore.com
was an eBay(R) Trading Assistant and internet based seller of consigned
merchandise whose primary medium of sales is eBay(R). While we reported sales
from these operations of $114,904 for the nine months ended September 30, 2005,
as a result of competition in the marketplace and a lack of sufficient working
capital, during October 2005 we determined that our business model was
unprofitable and decided to discontinue the balance of our operations. We became
a shell company and began a search for a business combination
candidate.
 
 On August
16, 2006 we acquired 100% of the issued and outstanding stock of China Direct
Investments in exchange for 10,000,000 shares of our common stock, which at
closing, represented approximately 95% of our issued and outstanding shares of
common stock. China Direct Investments was incorporated under the laws of the
State of Florida on January 18, 2005 and its operations constitute our
Consulting segment. As a result of the reverse merger transaction, China Direct
Investments became a wholly owned subsidiary and the transaction resulted in a
change of control of our company. For financial accounting purposes, the
transaction in which we acquired China Direct Investments was treated as a
recapitalization of our company with our former stockholders retaining
approximately 5.0% of our outstanding common stock.
 
 In
September 2006, we changed our name to China Direct, Inc. and in June 2007 we
redomiciled our company from Delaware to Florida. Subsequent to the transaction
with China Direct Investments in September 2006, we have substantially grown our
business by acquiring growth oriented companies in the PRC.
  - 9
-
 Table of Contents
 
 When we
acquire a company in the PRC, we generally do so by creating a foreign invested
entity (“FIE”) with a local person or company experienced in the business we
seek to acquire. An FIE is created by submitting an application to the local PRC
government to increase the “registered capital” of a Chinese domestic company.
The local Chinese person or company will contribute assets to the FIE and we
will contribute investment funds over time to satisfy the registered capital
amount. Upon receipt of the requisite government approvals, a new FIE is created
with our ownership percentage represented by the value of our registered capital
contribution as compared to the new total registered capital amount. We endeavor
to adhere to all rules and regulations governing foreign investment in China and
to obtain all necessary governmental approvals and business licenses for our
subsidiaries.
 
 Our
material acquisitions acquired by formation of an FIE are as
follows:
 
 Lang Chemical. In September
2006, CDI China acquired a 51% interest in Lang Chemical in exchange for
$701,250.
 
 Chang Magnesium. In October
2006, CDI China acquired a 51% interest in Chang Magnesium in exchange for
$2,550,000.
 
 CDI Magnesium. In February
2007, CDI China acquired a 51% interest in CDI Magnesium in exchange for 25,000
shares of China Direct common stock valued at $100,000. The fair value of the
China Direct common stock was based on the value of the common stock of $4.00
per share on February 6, 2007.
 
 CDI Wanda. In February 2007,
CDI China acquired a 51% interest in CDI Wanda in exchange for $511,458. During
the third quarter of 2008, we elected to exit the alternative energy and
recycling business conducted by CDI Clean Technology. In October 2008, we
completed the sale of an 81% interest in CDI Clean Technology and its
subsidiaries, CDI Wanda and Yantai CDI Wanda to PE Brothers Corp. for
$1,240,000.
 
 Asia Magnesium. In July 2007,
Capital One Resource acquired Asia Magnesium.
 
 Golden Magnesium. In July
2007, Asia Magnesium acquired a 52% interest in Golden Magnesium in exchange for
$3,380,000.
 
 Pan Asia Magnesium. In
September 2007, CDI China acquired a 51% interest in Pan Asia Magnesium in
exchange for $6,750,000.
 
 CDI Jingkun Zinc.In October
2007, CDI China formed CDI Jingkun Zinc as a FIE with a capital contribution of
$260,273 as registered capital, representing a 95% interest.
 
 CDI Jixiang Metal. In
November 2007, CDI China entered into an agreement with the shareholders of
Xiangxi Autonomous Prefecture Jixiang Mining Industry Co., Ltd., a company
organized under the laws of the PRC, to acquire it for $675,676. The transaction
closed in December 2007 and the entity was renamed CDI Jixiang
Metal.
 
 Yantai CDI Wanda. In January
2008, CDI Wanda acquired a 52% interest in Yantai CDI Wanda in exchange for
$712,329.
 
 Baotou Changxin Magnesium. In
February 2008, CDI China acquired a 51% interest in Baotou Changxin Magnesium in
exchange for $7,084,000. Excel Rise, a wholly owned subsidiary of Chang
Magnesium, acquired a 39% interest in Baotou Changxin Magnesium in exchange for
$5,417,000. Accordingly, China Direct holds a 70.9% interest in Baotou Changxin
Magnesium.
 
 CDI Metal Recycling. In
February 2008, CDI Shanghai Management invested $347,222 to acquire an 83%
interest in CDI Metal Recycling.
 
 Baotou Xinjin Magnesium Co.,
Ltd. In April 2008 CDI China entered into an Investment Framework
Agreement to form Baotou Xinjin Magnesium Co., Ltd., as a foreign invested
enterprise (“Xinjin Magnesium”). Under the terms of the agreement, CDI China
intended to invest a total of approximately $7.3 million to obtain a 51%
interest. CDI China's investment would have been made over the course of two
years, once the business license has been approved, in accordance with PRC law.
During the third quarter of 2008, we elected not to pursue this venture, and we
have not submitted the business license applications. We did not contribute any
capital to Xinjin Magnesium.
 
 CDI Beijing. In June 2008,
CDI Shanghai Management entered into an agreement to form CDI Beijing. Under the
terms of the Agreement, CDI Shanghai Management acquired a 51% interest in CDI
Beijing, in exchange for $3.7 million. As of the date of this report, we have
contributed $1.5 million; the remainder of $2.2 million is due on or before
September 30, 2009.
  - 10
-
 Table of Contents
 
 ITEM
      1A.
              RISK FACTORS
 
 The risk
factors in this section describe the major risks to our business, prospects,
results of operations, financial condition or cash flows, and should be
considered carefully. In addition, these factors constitute our cautionary
statements under the Private Securities Litigation Reform Act of 1995 and could
cause our actual results to differ materially from those projected in any
forward-looking statements (as defined in such act) made in this Annual Report
on Form 10-K. Investors should not place undue reliance on any such
forward-looking statements. Any statements that are not historical facts and
that express, or involve discussions as to, expectations, beliefs, plans,
objectives, assumptions or future events or performance (often, but not always,
through the use of words or phrases such as “will likely result,” ?癮re expected
to,” “will continue,” “is anticipated,” “estimated,” “intends,” “plans,”
“believes” and “projects”) may be forward-looking and may involve estimates and
uncertainties which could cause actual results to differ materially from those
expressed in the forward-looking statements.
  Further,
any forward-looking statement speaks only as of the date on which such statement
is made, and we undertake no obligation to update any forward-looking statement
to reflect events or circumstances after the date on which such statement is
made or to reflect the occurrence of anticipated or unanticipated events or
circumstances. New factors emerge from time to time, and it is not possible for
us to predict all of such factors. Further, we cannot assess the impact of each
such factor on our results of operations or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statements.
 
 Risks
Related To Our Business
 
 The
metals industry is highly cyclical. Fluctuations in the availability of
magnesium and in levels of customer demand have historically been severe, and
future changes and/or fluctuations could cause us to experience lower sales
volumes and revenues, which would negatively impact our profit
margins.
 
 The
metals industry is highly cyclical. The length and magnitude of industry cycles
have varied over time and by product, but generally reflect changes in
macroeconomic conditions, levels of industry capacity and availability of usable
raw materials. The overall levels of demand for our magnesium and
magnesium-based products reflect fluctuations in levels of end-user demand,
which depend in large part on general macroeconomic conditions worldwide which
then impact the level of production in China. For example, many of the
principal uses of magnesium and magnesium-related products are for the
production of structural metal, steel and aluminum manufacturing, production of
alloys used in aircraft and automobile parts, the manufacture of electronic
equipment such as computers, cameras, and cell phones and the use of magnesium
powder in flares, flashes and pyrotechnics. The market for these products are
heavily dependent on general economic conditions, including the availability of
affordable energy sources, employment levels, interest rates, consumer
confidence and construction demand. These cyclical shifts in our customers’
industries tend to result in significant fluctuations in demand and pricing for
our products. As a result, in periods of recession, such as the one we are
currently experiencing, or low economic growth, metals companies, including
ours, have generally tended to under-perform compared to other industries. We
generally have high fixed costs, so changes in industry demand that impact our
production volume also can significantly impact our profit margins and our
overall financial condition. Economic downturns in the worldwide economy or a
prolonged decline in demand in our Magnesium segment has had a negative impact
on our operations and a continuation or further deterioration of current
economic conditions could have a negative impact on our future financial
condition or results of operations.
 
 Changes
in the prices of magnesium, magnesium-related products, zinc and zinc-related
products will have a significant impact on our operating results and financial
condition.
 
 We derive
most of our revenue from the sale of magnesium and magnesium-based products.
Changes in the market price of magnesium and zinc impact the selling prices
of our products, and therefore our profitability is significantly affected by
decreased magnesium prices and to a lesser extent by decreased zinc prices.
Market prices of magnesium and zinc are dependent upon supply and demand
and a variety of factors over which we have little or no control,
including:
 
 •
              world
      economic conditions;•
              availability
      and relative pricing of metal substitutes;•
              labor
      costs;•
              energy
      prices;•
              environmental
      laws and regulations;•
              weather; and•
              import
      and export restrictions.
 
  - 11
-
 Table of Contents
 
 Declines
in the price of magnesium, and to a lesser extent a decrease in zinc prices,
have had a negative impact on our operations commencing in September 2008, and
further or future declines could have a negative impact on our future financial
condition or results of operations. Market conditions beyond our control
determine the prices for our products, and the price for any one or more of our
products may fall below our production costs, requiring us to either incur
short-term losses, delay completion of construction of our planned zinc mining
and production facility and recycling of aluminum wire facility and/or idle
or permanently shut down production capacity. Market prices for magnesium may
decrease even further, and therefore our operating results may be significantly
harmed.
 
 If
we fail to implement our business strategy, our financial condition and results
of operations could be materially and adversely affected.
 
 Our
ability to achieve our business and financial objectives is subject to a variety
of factors, many of which are beyond our control. For example, factors such as
increased competition, legal and regulatory developments, general economic
conditions or increased operating costs could prevent us from increasing our
capacity, implementing further productivity improvements or continuing to
enhance our business and product mix.
 
 An
important part of our strategy is to grow our business by expanding our capacity
to produce magnesium and acquire additional magnesium production facilities and
producers. In 2008, we produced, sold and distributed approximately 50,000
metric tons as compared to 45,000 metric tons in 2007. We may need additional
financing to implement our acquisition expansion strategy and we may not have
access to the funding required for the expansion on acceptable terms. Our
construction costs may also increase to levels that would make our facilities
unprofitable to operate. Our planned capacity expansions may also suffer
significant delays or cost overruns as a result of a variety of factors, such as
shortages of workers or materials, transportation constraints, adverse weather,
unforeseen difficulties or labor issues, any of which could prevent us from
completing our expansion plans as currently expected. Our expansion plans may
also result in other unanticipated adverse consequences, such as the diversion
of management’s attention from our existing operations. In addition, even if we
can implement our strategy, expansion in the magnesium market, increased sales
to various industries, including the automobile industry may not materialize to
the extent we expect, or at all, resulting in unutilized capacity. Any failure
to successfully implement our business strategy, including for any of the above
reasons, could materially and adversely affect our financial condition and
results of operations. We may, in addition, decide to alter or discontinue
certain aspects of our business strategy at any time.
 
 Fluctuations
in the cost or availability of electricity, coke, coal and/or natural gas would
lead to higher manufacturing costs, thereby reducing our margins and limiting
our cash flows from operations.
 
 Energy is
one of our most significant costs. Most of our entities within the
Magnesium segment utilize coke gas as energy, only Baotou Changxin Magnesium
utilizes coal. Energy prices, particularly for coal and coke gas, have been
volatile in recent years and currently exceed historical averages. These
fluctuations impact our manufacturing costs and contribute to earnings
volatility. In 2008 we witnessed rising energy costs. In expectation of the
Olympics, electricity was routed to Beijing from nearby Hebei, Shanxi, and Inner
Mongolia to ensure adequate power supply for the Olympics. In the event of an
interruption in the supply of coke gas or coal to our magnesium facilities would
require the facility to shut down production. In addition, we do not maintain
sources of secondary power at our facilities that only use coke gas, and
therefore any prolonged interruptions in the supply of energy to our facilities
could result in lengthy production shutdowns, increased costs associated with
restarting production and waste of production in progress. We have experienced
shortages of coke waste gas in the fourth quarter of 2008 as the plants that
produce this gas slowed production due to reduced demand for products they
supply to steel smelters. These shortages and any future shortages reduce our
production capacity, reducing our net sales and potentially impacting our
ability to deliver products to our customers.
 
 If
we were to lose order volumes from any of our major customers, our sales could
decline significantly and our cash flows may be reduced.
 
 In 2008,
our five largest customers in our Magnesium segment were responsible for
19.2% of our total revenues in this segment. A loss of order volumes from
any major customer could negatively affect our financial condition and results
of operations by lowering sales volumes, increasing costs and lowering
profitability.
 
 In
addition, approximately 35% by volume of our magnesium product shipments in 2008
were to customers who do not have long-term contractual arrangements with us.
These customers purchase products from us on a spot basis and may choose not to
continue to purchase our products. The loss of these customers or a significant
reduction in their purchase orders could have a negative impact on our
operations.
  - 12
-
 Table of Contents
 
 The
value of the equity securities we accept as compensation is subject to
adjustment which could result in losses to us in future periods.
 
 In our
Consulting segment, historically we have accepted equity securities of our
clients as compensation for services. These securities are reflected on our
balance sheet as “investment in marketable securities held for sale” and
“investment in marketable securities held for sale - related party”. At the end
of each period, we evaluate the carrying value of the marketable securities for
a decrease in value.  We evaluate the company underlying these
marketable securities to determine whether a decline in fair value below the
amortized cost basis is other than temporary. If the decline in fair value is
judged to be other than temporary, the cost basis of the individual security
shall be written down to fair value as a new cost basis and the amount of the
write-down is charged to earnings. At December 31, 2008 we recognized
an impairment of $4,127,555 related to these marketable securities. In the
future, should we identify additional impairments, this would adversely affect
our operating results for the corresponding periods in that we might be required
to reduce the carrying value of these investments. In addition, if we are unable
to liquidate these securities, we will be required to write off the investments
which would adversely affect our financial position.
 
 Our
management may be unable to effectively integrate our acquisitions and to manage
our growth and we may be unable to fully realize any anticipated benefits of
these acquisitions.
 
 We are
subject to various risks associated with our growth strategy, including the risk
that we will be unable to identify and recruit suitable acquisition candidates
in the future or to integrate and manage the acquired companies. We face
particular challenges in that our acquisition strategy is based on companies
located in and operating within China. Acquired companies’ histories, the
geographical location, business models and business cultures will be different
from ours in many respects. Even if we are successful in identifying and closing
acquisitions of companies, our directors and executive management will face
significant challenges in their efforts to integrate the business of the
acquired companies or assets and to effectively manage our continued growth. Any
future acquisitions will be subject to a number of challenges,
including:
 
 •
              the
      diversion of management time and resources and the potential disruption of
      our ongoing business;•
              difficulties
      in maintaining uniform standards, controls, procedures and
      policies;•
              unexpected
      costs and time associated with upgrading both the internal accounting
      systems as well as educating each of their staff as to the proper methods
      of collecting and recording financial data;•
              potential
      unknown liabilities associated with acquired
businesses;•
              the
      difficulty of retaining key alliances on attractive terms with partners
      and suppliers; and•
              the
      difficulty of retaining and recruiting key personnel and maintaining
      employee morale.
 
 There can
be no assurance that our efforts to integrate the operations of any acquired
assets or companies will be successful, that we can manage our growth or that
the anticipated benefits of these proposed acquisitions will be fully
realized.
 
 We
may need additional financing to fund acquisitions and our operations which we
may not be able to obtain on acceptable terms. Additional capital raising
efforts in future periods may be dilutive to our then current shareholders or
result in increased interest expense in future periods.
 
 We may
need to raise additional working capital to continue to make acquisitions and
fund our operations. In an effort to augment growth and expand business
opportunities, since 2006 we have provided approximately $8.9 million in working
capital to our subsidiaries. Our future capital requirements depend, however, on
a number of factors, including our operations, the financial condition of an
acquisition target and its need for capital, our ability to grow revenues from
other sources, our ability to manage the growth of our business and our ability
to control our expenses. During 2009, we plan to use our magnesium holdings as a
basis for raising capital and expansion of our magnesium holdings. If we raise
additional capital through the issuance of debt, this will result in increased
interest expense. If we raise additional capital through the issuance of equity
or convertible debt securities, the percentage ownership of our company held by
existing shareholders will be reduced and those shareholders may experience
significant dilution. As we will generally not be required to obtain the consent
of our shareholders before entering into acquisition transactions, shareholders
are dependent upon the judgment of our management in determining the number of,
and characteristics of, stock issued as consideration in an acquisition. In
addition, new securities may contain certain rights, preferences or
privileges that are senior to those of our common stock. We cannot assure you
that we will be able to raise the working capital as needed in the future on
terms acceptable to us, if at all, as the current capital markets have been
adversely affected by the severe liquidity crisis. If we do not raise capital as
needed, we will be unable to fully implement our acquisition expansion
strategy.
  - 13
-
 Table of Contents
 
 We
are dependent on certain key personnel and the loss of these key personnel could
have a material adverse effect on our business, financial condition and results
of operations.
 
 Our
success is, to a certain extent, attributable to the management, sales and
marketing, and operational expertise of key personnel of our subsidiaries in
China who perform key functions in the operation of our business as well as our
U.S. based management team. We do not exercise any substantive day to day
supervision over the activities of key members of our China based management
team which includes Messrs. Jingdong Chen, Chen Chi, and Xiaowen
Zhuang. The loss of one or more of these key employees or our senior
management, including Dr. Wang, our Chief Executive Officer or Yuwei Huang,
our Executive Vice President - Magnesium, could have a material adverse effect
upon our business, financial condition and results of operations.
 
 We
may have difficulty establishing adequate management, legal and financial
controls in the PRC.
 
 PRC
companies have in some cases, been resistant to the adoption of Western styles
of management and financial reporting concepts and practices, which include
sufficient corporate governance, cash management and other internal
controls and, computer, financial and other control systems. In addition,
we may have difficulty in hiring and retaining a sufficient number of qualified
employees to work in the PRC. As a result of these factors, we may experience
difficulties in establishing management, legal and financial controls,
collecting financial data and preparing financial statements, books of account
and corporate records and instituting business practices that meet western
standards with our subsidiaries and our future acquisitions. Therefore, we may,
in turn, experience difficulties in implementing and maintaining adequate
internal controls. Any such deficiencies, weaknesses or lack of compliance could
have a material adverse effect on our business, financial condition and results
of operations.
 
 If
we fail to maintain an effective system of internal control over financial
reporting, we may not be able to accurately report our financial results. As a
result, current and potential shareholders could lose confidence in our
financial reporting, which would harm our business and the trading price
of our stock.
 
 Our
management has determined that as of December 31, 2008, we did not maintain
effective internal controls over financial reporting based on criteria set forth
by the Committee of Sponsoring Organizations of the Treadway Commission (“COSO”)
in Internal Control-Integrated Framework as a result of identified material
weaknesses in our internal control over financial reporting related to cash
management and related party transactions.  A material weakness is a
deficiency, or a combination of deficiencies, in internal control over financial
reporting, such that there is a reasonable possibility that a material
misstatement of the company's annual or interim financial statements will not be
prevented or detected on a timely basis.  For a detailed description
of these material weaknesses and our remediation efforts and plans, see “Part II
— Item 9A (T) — Controls and Procedures.”  If the result of our
remediation of the identified material weaknesses is not successful, or if
additional material weaknesses are identified in our internal control over
financial reporting, our management will be unable to report favorably as to the
effectiveness of our internal control over financial reporting and/or our
disclosure controls and procedures, and we could be required to further
implement expensive and time-consuming remedial measures and potentially lose
investor confidence in the accuracy and completeness of our financial reports
which could have an adverse effect on our stock price and potentially subject us
to litigation.
 
 Certain
agreements to which we are a party and which are material to our operations lack
various legal protections which are customarily contained in similar contracts
prepared in the United States.
 
 Our
subsidiaries include companies organized under the laws of the PRC and all of
their business and operations are conducted in China. We are a party to certain
contracts related to our operations in China. While these contracts
contain the basic business terms of the agreements between the parties, these
contracts do not contain certain clauses which are customarily contained in
similar contracts prepared in the U.S., such as representations and warranties
of the parties, confidentiality and non-compete clauses, provisions outlining
events of defaults, and termination and jurisdictional clauses. Because our
contracts in China omit these customary clauses, notwithstanding the differences
in Chinese and U.S. laws, we may not have the same legal protections as we would
if the contracts contained these additional clauses. We anticipate that our
Chinese subsidiaries will likely enter into contracts in the future which will
likewise omit these customary legal protections. While we have not been subject
to any adverse consequences as a result of the omission of these customary
clauses, and we consider the contracts to which we are a party to contain all
the material terms of our business arrangements with the other party, future
events may occur which lead to a dispute which could have been avoided if the
contracts included customary clauses in conformity with U.S. standards.
Contractual disputes which may arise from this lack of legal protection could
divert management’s time from the operation of our business, require us to
expend funds attempting to settle a possible dispute, limit the time our
management would otherwise devote to the operation of our business, and have a
material adverse effect on our business, financial condition and results of
operations.
  - 14
-
 Table of Contents
 
 Intercompany
loans may be subject to PRC regulations.
 
 We
currently have several inter-company loans between our PRC subsidiaries and we
may continue to enter into inter-company financing arrangements to meet our
internal capital needs. PRC laws generally do not permit companies that do not
possess a financial service business license to extend loans directly to other
companies, including affiliates, without proceeding through a financial agency.
The enforcement of these restrictions remains unpredictable, and government
authorities may declare these loans void, require the forfeiture of any interest
paid and levy fines or other penalties upon the parties involved, among
other remedies.
 
 From
time to time we engage in related party transactions. There are no assurances
that these transactions are fair to our company.
 
 From time
to time our subsidiaries enter into transactions with related parties which
include purchases from or sales to a related party, advancing related parties
significant sums as prepayments for future goods or services and working capital
and the payment of fees for consulting services, among other transactions. We
are in the process of adopting policies and procedures which will require the
pre-approval of loans between related parties and have adopted a related person
transaction policy that requires the pre-approval or ratification transactions
between the company or one or more of our subsidiaries and any related person in
amounts and under terms to be established by the board of directors upon
completion of a study to determine amounts that are appropriate given the
relationship we have with the related party. Notwithstanding these policies, we
cannot assure you that in every instance the terms of the transactions with
related parties are on terms as fair as we might receive from or extend to third
parties.
 
 Yuwei
Huang, our Executive Vice President – Magnesium, an officer of several of our
magnesium subsidiaries and a director is also an owner and executive officer of
several companies which directly compete with our magnesium
business
 
 Mr. Yuwei
Huang who serves as our Executive Vice President – Magnesium, an executive
officer of several of our Magnesium segment subsidiaries and a director of our
company is also an owner and the Chairman of a competitor of ours, YiWei
Magnesium. YiWei Magnesium, a minority owner of two of our Magnesium segment
subsidiaries, owns interests in several other magnesium factories, a magnesium
alloy factory and a magnesium powder desulphurization reagent factory, all
located in China. Due to Mr. Huang’s interest in our competitors and his
position as an officer and director of our company, he is subject to certain
inherent conflicts of interest and there can be no assurances that our business
and operations will not be adversely impacted as a result of these
conflicts.
 
 Failure
to comply with the United States Foreign Corrupt Practices Act could subject us
to penalties and other adverse consequences.
 
 We are
subject to the United States Foreign Corrupt Practices Act, which generally
prohibits United States companies from engaging in bribery or other prohibited
payments to foreign officials for the purpose of obtaining or retaining
business. Corruption, extortion, bribery, pay-offs, theft and other fraudulent
practices occur from time-to-time in the PRC. We can make no assurance, however,
that our employees or other agents will not engage in such conduct for
which we might be held responsible. If our employees or other agents are found
to have engaged in such practices, we could suffer severe penalties and other
consequences that may have a material adverse effect on our business, financial
condition and results of operations.
 
 The Investment
Company Act of 1940 will limit the value of securities we can accept as payment
for our business consulting services which may limit our future
revenues.
 
 We have
historically accepted securities as payment for our services and will likely
continue to do so in the future, but only to the extent that it does not cause
us to become classified as an investment company under the Investment Company
Act 1940. To the extent that we are required to reduce the amount of
securities we accept as payment for our consulting services to avoid becoming an
investment company, our future revenues from our business consulting services
may substantially decline if our clients cannot pay our fees in cash. A
reduction in the amount of our consulting fees will materially adversely affect
our financial condition and results of operations in future periods. Any future
change in our fee structure for our consulting services could also severely
limit our ability to attract business consulting clients in the
future.
  - 15
-
 Table of Contents
 
 The
acquisition of new businesses is costly and such acquisitions may not enhance
our financial condition.
 
 A
significant element of our growth strategy is to acquire controlling interests
in companies that operate in China and that offer services, products,
technologies, industry specializations or geographic coverage that extend or
complement our existing business. The process to undertake a potential
acquisition is time-consuming and costly. We expect to expend significant
resources to undertake business, financial and legal due diligence on our
potential acquisition targets and there is no guarantee that we will acquire the
company after completing due diligence. The process of identifying and
consummating an acquisition could result in the use of substantial amounts of
cash and exposure to undisclosed or potential liabilities of acquired companies.
In addition, even if we are successful in acquiring additional companies, there
are no assurances that the operations of these businesses will enhance our
future financial condition. To the extent that a business we acquire does not
meet the performance criteria used to establish a purchase price, some or all of
the goodwill related to that acquisition could be charged against our future
earnings, if any.
 
 The
operations of our basic materials segment will be subject to risks and hazards
inherent in the mining industry.
 
 Our Basic
Materials segment, if and when mining operations commence, will be engaged
in the mining and processing of zinc. These operations will be subject to risks
and hazards inherent in the mining industry, including, but not limited to,
ground fall, flooding, environmental hazards and the discharge of toxic
chemicals, explosions and other accidents, unanticipated variations in grade and
other geological problems, water conditions, surface or underground conditions,
metallurgical and other processing problems, mechanical equipment performance
problems, the lack of availability of materials and equipment, the occurrence of
accidents, labor force disruptions, force majeure factors, unanticipated
transportation costs, and weather conditions. Any of these risks could result in
work stoppages, delays in production, the development of properties, production
commencement dates and production quantities, increased production costs and
rates, damage to or destruction of mines and other production facilities, injury
or loss of life, damage to property, environmental damage, and possible legal
liability for such damages. As of the date of this report, we have not
established a reserve on this property. Presently we do not have a timetable for
when our operations will commence.
 
 Substantially
all of our assets and operations are located in the PRC and are subject to
changes resulting from the political and economic policies of the Chinese
government.
 
 Our
business operations could be restricted by the political environment in the PRC.
The PRC has operated as a socialist state since 1949 and is controlled by the
Communist Party of China. In recent years, however, the government has
introduced reforms aimed at creating a socialist market economy and policies
have been implemented to allow business enterprises greater autonomy in their
operations. Changes in the political leadership of the PRC may have a
significant effect on laws and policies related to the current economic reform
programs, other policies affecting business and the general political, economic
and social environment in the PRC, including the introduction of measures to
control inflation, changes in the rate or method of taxation, the imposition of
additional restrictions on currency conversion and remittances abroad, and
foreign investment. Moreover, economic reforms and growth in the PRC have been
more successful in certain provinces than in others, and the continuation or
increases of such disparities could affect the political or social stability of
the PRC.
 
 Although
we believe that the economic reform and the macroeconomic measures adopted by
the Chinese government have had a positive effect on the economic development of
China, the future direction of these economic reforms is uncertain and the
uncertainty may decrease the attractiveness of our company as an investment,
which may in turn result in a decline in the trading price of our common
stock.
 
 We
cannot assure you that the current Chinese policies of economic reform will
continue. Because of this uncertainty, there are significant economic risks
associated with doing business in China.
 
 Although
the majority of productive assets in China are owned by the Chinese government,
in the past several years the government has implemented economic reform
measures that emphasize decentralization and encourages private economic
activity. In keeping with these economic reform policies, the PRC has been
openly promoting business development in order to bring more business into the
PRC. Because these economic reform measures may be inconsistent or ineffective,
there are no assurances that:
 
 •
              the
      Chinese government will continue its pursuit of economic reform
      policies;•
              the
      economic policies, even if pursued, will be successful;•
              economic
      policies will not be significantly altered from time to time;
      or•
              business
      operations in China will not become subject to the risk of
      nationalization.
 
  - 16
-
 Table of Contents
 
 We cannot
assure you that we will be able to capitalize on these economic reforms,
assuming the reforms continue. Because our business model is dependent upon the
continued economic reform and growth in China, any change in Chinese government
policy could materially adversely affect our ability to continue to implement
our business model. China’s economy has experienced significant growth in the
past decade, but such growth has been uneven across geographic and economic
sectors and has recently been slowing. Even if the Chinese government continues
its policies of economic reform, there are no assurances that economic growth in
that country will continue or that we will be able to take advantage of these
opportunities in a fashion that will provide financial benefit to
us.
 
 The
Chinese government exerts substantial influence over the manner in which our
Chinese subsidiaries must conduct our business activities.
 
 The PRC
only recently has permitted provincial and local economic autonomy and private
economic activities. The government of the PRC has exercised and continues to
exercise substantial control over virtually every sector of the Chinese economy
through regulation and state ownership. Accordingly, government actions in the
future, including any decision not to continue to support recent economic
reforms and to return to a more centrally planned economy or regional or local
variations in the implementation of economic policies, could have a significant
effect on economic conditions in the PRC or particular regions of the PRC, and
could require us to divest ourselves of any interest we then hold in our Chinese
subsidiaries.
 
 Any recurrence of
severe acute respiratory syndrome, orSARS, or another
widespread public health
problem, could interrupt our operations
 
 A renewed
outbreak of SARS or another widespread public health problem in China could have
a negative effect on our operations. Our operations may be impacted by a number
of health-related factors, including the following:
 
 •
              quarantines
      or closures of some of our offices which would severely disrupt our
      operations;•
              the
      sickness or death of our key management and employees;
  or•
              a
      general slowdown in the Chinese
economy.
 
 An
occurrence of any of the foregoing events or other unforeseen consequences of
public health problems could result in a loss of revenues in future periods and
could impact our ability to conduct the operations of our Chinese subsidiaries
as they are presently conducted. If we were unable to continue the
operations of our Chinese subsidiaries as they are now conducted, our revenues
in future periods would decline and our ability to continue as a going concern
could be in jeopardy. If we were unable to continue as a going concern, you
could lose your entire investment in our company.
 
 Restrictions
on currency exchange may limit our ability to receive and use our revenues
effectively. We may not have ready access to cash on deposit in banks in the
PRC.
 
 Because a
substantial portion of our revenues are in the form of Renminbi (RMB), the main
currency used in China, any future restrictions on currency exchanges may limit
our ability to use revenue generated in RMB to fund any future business
activities outside China or to make dividend or other payments in U.S.
Dollars. Although the Chinese government introduced regulations in 1996 to allow
greater convertibility of the RMB for current account transactions, significant
restrictions still remain, including primarily the restriction that
foreign-invested enterprises may only buy, sell or remit foreign currencies,
after providing valid commercial documents, at those banks authorized to conduct
foreign exchange business. In addition, conversion of RMB for capital account
items, including direct investment and loans, is subject to government approval
in China, and companies are required to open and maintain separate foreign
exchange accounts for capital account items. At December 31, 2008 our PRC
subsidiaries had approximately $7.6 million on deposit in banks in China, which
represented approximately 53% of our cash. We cannot be certain that we could
have ready access to that cash should we wish to transfer it to bank accounts
outside the PRC nor can we be certain that the Chinese regulatory authorities
will not impose more stringent restrictions on the convertibility of the RMB,
especially with respect to foreign exchange transactions.
  - 17
-
 Table of Contents
 
 We
may be unable to enforce our rights due to policies regarding the regulation of
foreign investments in China.
 
 The PRC’s
legal system is a civil law system based on written statutes in which decided
legal cases have little value as precedent, unlike the common law system
prevalent in the United States. The PRC does not have a well-developed,
consolidated body of laws governing foreign investment enterprises. As a result,
the administration of laws and regulations by government agencies may be subject
to considerable discretion and variation, and may be subject to influence by
external forces unrelated to the legal merits of a particular matter. China’s
regulations and policies with respect to foreign investments are evolving.
Definitive regulations and policies with respect to such matters as the
permissible percentage of foreign investment and permissible rates of equity
returns have not yet been published. Statements regarding these evolving
policies have been conflicting and any such policies, as administered, are
likely to be subject to broad interpretation and discretion and to be modified,
perhaps on a case-by-case basis. The uncertainties regarding such regulations
and policies present risks which may affect our ability to achieve our stated
business objectives. If we are unable to enforce any legal rights we may have
under our contracts or otherwise, our ability to compete with other companies in
our industry could be limited which could result in a loss of revenue in future
periods which could have a material adverse effect on our business, financial
condition and results of operations.
 
 The
market price for shares of our common stock has declined substantially in recent
months and may continue to be highly volatile and subject to wide
fluctuations.
 
 The
market for common stock has recently been subject to significant disruptions
that have caused substantial volatility in the prices of these securities, which
may or may not have corresponded to the business or financial success of the
particular company. The market price for shares of our common stock has declined
substantially in recent months and could decline further if our future operating
results fail to meet or exceed the expectations of market analysts and investors
and/or current economic or market conditions persist or worsen.
 
 Some
specific factors that may have a significant effect on the future market price
of our shares of common stock include:
 
 •
              actual
      or expected fluctuations in our operating results;•
              variance
      in our financial performance from the expectations of market
      analysts;•
              changes
      in general economic conditions or conditions in our industry
      generally;•
              changes
      in conditions in the financial markets;•
              announcements
      of significant acquisitions or contracts by us or our
      competitors;•
              our
      inability to raise additional capital;•
              changes
      in applicable laws or regulations, court rulings and enforcement and legal
      actions;•
              additions
      or departures of key management personnel;•
              actions
      by our stockholders;•
              changes
      in market prices for our products or for our raw
      materials; and•
              changes
      in stock market analyst research and recommendations regarding the shares
      of our common stock, other comparable companies or our industry
      generally.
 
 In
addition, the stock market in general, and the Nasdaq and the market for
companies with China based operations in particular, have experienced extreme
price and volume fluctuations that have often been unrelated or disproportionate
to the operating performance of the affected companies. These broad market and
industry factors may materially harm the market price of our common stock,
regardless of our operating performance. In the past, following periods of
volatility in the market price of a company’s securities, securities
class-action litigation has often been instituted against that company. Such
litigation, if instituted against us, could result in substantial costs and a
diversion of management’s attention and resources, which could have a material
adverse effect on our business, financial condition and results of
operations.
 
 As a
result of these and other factors, you may be unable to resell your shares of
our common stock at or above the price you paid for such shares.
 
 Future
sales of common stock by some of our existing stockholders and stock options
could cause our stock price to decline.
 
 As of the
date of this report, our Chief Executive Officer, former President and former
Chief Operating Officer in the aggregate beneficially own approximately 39.1% of
our outstanding common stock. Sales of such shares in the open market,
as well as shares we may issue upon the exercise of outstanding options, could
cause the market price of our common stock to decline significantly. The
perception among investors that these sales may occur could produce the same
effect.
  - 18
-
 Table of Contents
 
 ITEM
      1B.
              UNRESOLVED STAFF
  COMMENTS.
 
 Not
applicable to a smaller reporting company.
 
 ITEM
      2.
              PROPERTIES.
 
 Our
principal executive offices are located in Deerfield Beach, Florida. We lease
approximately 6,508 square feet of office space for an annual expense of
approximately $223,000 under lease agreements which expire on February 28,
2013.
 
 Chang
Magnesium owns and operates a magnesium facility which is approximately 250,000
square feet and located in the Aluminum & Magnesium Industrial Park in
Yangqu County, of the Shangxi Province, China. The land use rights are owned by
Taiyuan Sanding Coal Gasification Co., Ltd. and Chang Magnesium has been granted
the land use rights through 2020 at no cost.
 
 Chang
Trading's offices are located in approximately 2,000 square feet of office space
at the Chang Magnesium plant. Chang Trading does not pay rent to Chang
Magnesium.
 
 Golden
Magnesium owns and operates a magnesium facility, encompassing 500,000 square
feet located in Yueyan, of Gu County, in the Shanxi Province.
 
 Pan Asia
Magnesium operates a magnesium facility encompassing 500,000 square feet. We
lease this facility from the Jinyang Group, a 27% minority owner of Pan Asia
Magnesium, pursuant to a lease which expires in March 2030. We pay Jinyang Group
approximately $14,550 annually to occupy this facility. Included in the lease is
a 33,000 square foot warehouse, a 28,000 square foot dormitory, 4,300 square
feet of office space, and a 3,300 square foot quality control lab.
 
 Baotou
Changxin Magnesium owns and operates a magnesium facility encompassing 170,000
square feet located in the Shiguai district of Baotou city, in Inner
Mongolia.
 
 Lang
Chemical owns a storage facility consisting of a 105,000 cubic foot storage tank
area and a 21,800 square foot warehouse located in the Beixin Fine Chemical
Industrial Park, Qidong, Jiangsu Province of China. Lang Chemical purchased the
land where this facility is located in April 2005 at a cost of $308,900 and owns
the warehouse, storage area and the land use rights. In addition, Lang Chemical
has a minimum commitment of $732 to reserve a storage facility in the Jiangsu
province.
 
 Lang
Chemical owns an approximate 4,360 square foot office space located at 58
Jinqiao Rd, Suite 21A Shanghai, China which it does not occupy. Lang Chemical's
principal offices are located in a 3,270 square foot office space located at No.
970, Da Liang Road., Suite 901, Shanghai, China. The Da Liang Road office is
owned by Ms. Qian Zhu, a minority shareholder and CFO of Lang Chemical as well
as an employee of CDI Shanghai Management. In lieu of paying rent for the use of
the Da Liang Road office, Lang Chemical permits Ms. Zhu to lease our premises
located at 58 Jinqiao Road, Shanghai China and retain the monthly rent of
approximately $3,125 in rent she receives from that space.
 
 CDI
Jixiang Metal holds the mining rights to approximately 51 acres located in the
Yongshun Kaxi Lake Mining area, obtained in 2004 from the Ministry of Land and
Resources. As of the date of this report, we have not established a reserve on
this property and we do not have a timetable for when our operations will
commence.
 
 CDI Metal
Recycling operates from a 14,000 square foot manufacturing and office space
located at 1258 Nangang Road, Nanhui District, Shanghai, China. The term of the
lease is from January 1, 2008 to December 31, 2017 for a commitment of
approximately $17,000 annually.
 
 CDI
Beijing leases approximately 1,654 square foot office space located in Beijing,
China for an annual expense of approximately $20,500 pursuant to a lease that
expires in March 2010.
 
 CDI
Shanghai Management leases approximately 2,200 square feet of office space in
Shanghai for an annual expense of approximately $48,529 per year. The lease
expires on December 31, 2009.
 
 ITEM
      3.
              LEGAL
      PROCEEDINGS.
 
 We are
not a party to any pending legal proceedings and, to our knowledge, none of our
officers, directors or principal shareholders are party to any legal proceeding
in which they have an interest adverse to us .
  - 19
-
 Table of Contents
 
 ITEM
      4.
              SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS.
 
 None.
 
 PART
II
 
 ITEM
      5.
              MARKET
      FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER
      PURCHASES OF EQUITY SECURITIES.
 
 As of May
1, 2008 our common stock has been traded on the Nasdaq Global Market. From May
1, 2008 until January 25, 2009 our stock was traded under the symbol “CDS”. On
January 26, 2009 we changed our symbol to “CDII”. From September 24, 2007 until
May 1, 2008 our common stock traded on the American Stock Exchange under the
symbol “CDS”. Prior to September 24, 2007, our common stock was quoted on the
OTC Bulletin Board under the symbol “CHND”. The following table sets forth the
reported high and low closing prices for our common stock as reported on the
Nasdaq Global Market, the American Stock Exchange, or the OTC Bulletin Board as
applicable, for the last two years. These prices do not include retail mark-ups,
markdowns or commissions, and may not necessarily represent actual
transactions.
 
 High
                          
                          
                          LowJanuary
      1, 2007 to March 31, 2007
                          
                          $
                          9.25
                          
                          
                          $
                          2.68April
      1, 2007 to June 30, 2007
                          
                          
                          3.94
                          
                          
                          
                          2.55July
      1, 2007 to September 30, 2007
                          
                          
                          9.45
                          
                          
                          
                          3.10October
      1, 2007 to December 31, 2007
                          
                          
                          12.95
                          
                          
                          
                          7.01January
      1, 2008 to March 31, 2008
                          
                          
                          8.97
                          
                          
                          
                          5.10April
      1, 2008 to June 30, 2008
                          
                          
                          10.24
                          
                          
                          
                          7.10July
      1, 2008 to September 30, 2008
                          
                          
                          7.90
                          
                          
                          
                          1.90October
      1, 2008 to December 31, 2008
                          
                          $
                          4.41
                          
                          
                          $
                          1.21
 
 As of
March 30, 2009 there were approximately 992 shareholders of record of our common
stock. The number of record holders does not include beneficial owners of common
stock whose shares are held in the names of banks, brokers, nominees or other
fiduciaries.
 
 Transfer
Agent
 
 Our
transfer agent is Computershare Trust Company, Inc. which is located at 350
Indiana Street Suite 800, Golden, CO 80401. The phone number is (303) 262-0600
and its website is www.computershare.com.
 
 Dividends
 
 We have
never paid cash dividends on our common stock. Payment of dividends will be
within the sole discretion of our Board of Directors and will depend, among
other factors, upon our earnings, capital requirements and our operating and
financial condition. In addition, under Florida law, we may declare and pay
dividends on our capital stock either out of our surplus, as defined in the
relevant Florida statutes, or if there is no such surplus, out of our net
profits for the year in which the dividend is declared and/or the preceding
year. If, however, the capital of our company computed in accordance with the
relevant Florida statutes, has been diminished by depreciation in the value of
our property, or by losses, or otherwise, to an amount less than the aggregate
amount of the capital represented by the issued and outstanding stock of all
classes having a preference upon the distribution of assets, we are prohibited
from declaring and paying out of such net profits and dividends upon any shares
of our capital stock until the deficiency in the amount of capital represented
by the issued and outstanding stock of all classes having a preference upon the
distribution of assets shall have been repaired. The Company intends to utilize
profits earned by our Chinese based subsidiaries to expand our PRC based
operations.
  - 20
-
 Table of Contents
  Securities
Authorized for Issuance under Equity Compensation Plans
 
 The
following table sets forth securities authorized for issuance under any equity
compensation plans approved by our shareholders as well as any equity
compensation plans not approved by our shareholders as of December 31,
2008.
 
 Number
      of securities to be issued upon exercise of outstanding options, warrants
      and rights (a)
                                
                                
                                Weighted
      average exercise price of outstanding options, warrants and rights
      (b)
                                
                                
                                Number
      of securities remaining available for future issuance under equity
      compensation plans (excluding securities reflected in column (a))
      (c)Plans
      approved by our shareholders:Evolve
      One, Inc. Stock Option Plan
                                
                                
                                480
                                
                                
                                $
                                11.25
                                
                                
                                
                                7,999,5202006
      Equity Plan
                                
                                
                                375,250
                                
                                
                                $
                                2.85
                                
                                
                                
                                9,612,7502008
      Executive Stock Incentive Plan
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                1,000,0002008
      Non-Executive Stock Incentive Plan
                                
                                
                                -
                                
                                
                                
                                -
                                
                                
                                
                                2,731,352Plans
      not approved by shareholders:2005
      Equity Compensation Plan
                                
                                
                                260,500
                                
                                
                                $
                                29.97
                                
                                
                                
                                99,739,5002006
      Stock Plan
                                
                                
                                414,590
                                
                                
                                $
                                2.97
                                
                                
                                
                                119,250
 
 A
description of each of these plans is contained later in the notes to the
audited consolidated financial statements which appear elsewhere in this Form
10-K.
 
 Recent
Sales of Unregistered Securities
 
 None.
 
 Issuer
Purchases of Equity Securities
 
 This
table provides information with respect to our purchases of shares of our common
stock during the three months ended December 31, 2008.
 
 Period
                        
                        Total
      Number of Shares Purchased (1)
                        
                        Average
      Price Paid Per Share
                        
                        Total
      Number Of Shares Purchased as Part of Publicly Announced Plans or
      Programs
                        
                        Maximum
      Approximate Dollar Value of Shares that May Yet Be Purchased Under the
      Plans or Programs (2)October
      1, 2008 through October 31, 2008
                        
                        15,000
                        
                        $
                        3.80
                        
                        89,502
                        
                        $
                        2,420,613November
      1, 2008 through November 30, 2008
                        
                        -
                        
                        
                        -
                        
                        -
                        
                        
                        2,420,613December
      1, 2008 through December 31, 2008
                        
                        -
                        
                        
                        
                        
                        -
                        
                        
                        2,420,613Total
                        
                        15,000
                        
                        $
                        3.80
                        
                        89,502
                        
                        $
                        2,420,613
 
 (1) The
table includes 15,000 shares purchased at $3.80 per share which were redeemed in
October 2008.
 (2)Amounts
reflect the remaining dollar value at December 31, 2008 of shares that may be
purchased under the stock repurchase program.
  - 21
-
 Table of Contents
  Stock
Repurchase Program
 
 On
September 10, 2008, our board of directors authorized a stock repurchase program
to repurchase up to $2.5 million worth of our common stock through March 31,
2009. The stock repurchase program was announced on September 12, 2008. The
amount and timing of specific repurchases are subject to market conditions,
applicable legal requirements and other factors deemed appropriate by our CEO
and President. Repurchases may be in open-market transactions or through
privately negotiated transactions, and our board of directors may
discontinue the repurchase program at any time. During 2008 we purchased 19,919
shares at an average price of $3.99 per share, which were
redeemed.
 
 In
January 2009 our board of directors authorized the purchase of 1,500,000 shares
of our common stock from Marc Siegel, our former President and director, for an
aggregate purchase price of $1,650,000. The purchase was made under our stock
repurchase program. This transaction is not included in the table as the
transaction occurred in 2009. Following this purchase the Stock Repurchase
Program was terminated.
  Reverse
Split/Forward Split
 
 On
September 10, 2008, our board of directors approved a 1 for 100 shares reverse
split of our common stock (the “Reverse Split”) to be immediately followed by a
100 for 1 forward split of our common stock (the “Forward Split”). The Reverse
Split/Forward Split was announced on September 19, 2008. Shareholders who held
in the aggregate less than one share of common stock following the Reverse Split
were not included in the Forward Split. Rather, such shares received a cash
payment of $5.07 per share, the closing price of our common stock as of
September 19, 2008. Accordingly in 2008, we purchased 69,583 shares at a
purchase price of $5.07 per share, which were redeemed. These stock
purchases were not part of the stock repurchase program.
  - 22
-
 Table of Contents
 
 ITEM
      6.
              SELECTED
      FINANCIAL DATA.
 
 RECONCILIATION
OF GAAP TO NON-GAAP NET INCOME
  The
following table reconciles the calculation of net income per share on a basic
and fully diluted basis from the amounts reported in accordance with generally
accepted accounting principles ("GAAP") to such amounts before giving effect to
employee share-based compensation expense and the fair value of warrants granted
for services, Other-Than-Temporary-Impairment on marketable securities available
for sale received for services and Non-cash deductions related to Preferred
Stock issuance. This disclosure is being provided as we believe it is meaningful
to our investors and other interested parties to understand our operating
performance on a consistent basis without regard to the anti-dilutive effects of
the timing of the employee share-based compensation and the fair value of
warrants granted for services. The presentation of the non-GAAP information
titled "Non-GAAP net income”, “Non-GAAP Earnings applicable to common
stockholders”, “Non-GAAP Basic EPS” and “Non-GAAP Diluted EPS” is not meant to
be considered in isolation or as a substitute for net income or diluted income
per share prepared in accordance with GAAP.
 
 The
      Year Ended December 31,2008
                      
                      
                      2007GAAP
      net income
                      
                      $
                      11,398,606
                      
                      
                      $
                      11,826,551Employee
      share-based compensation expense and fair value of warrants granted
      (1)
                      
                      
                      2,203,130
                      
                      
                      
                      709,352Other-Than-Temporary-Impairment
      on marketable securities available for sale received for services
      (2)
                      
                      
                      4,127,555
                      
                      
                      
                      -Non-GAAP
      net income
                      
                      $
                      17,729,291
                      
                      
                      $
                      12,535,903GAAP
      Earnings applicable to common stockholders
                      
                      $
                      4,951,277
                      
                      
                      $
                      11,826,551GAAP
      Basic EPS
                      
                      
                      0.22
                      
                      
                      
                      0.75GAAP
      Diluted EPS
                      
                      
                      0.20
                      
                      
                      
                      0.67Non-GAAP
      net income reconciliation total (1)+(2)
                      
                      
                      6,330,685
                      
                      
                      
                      709,352Non-cash
      deducted related to Preferred Stock issuance:Relative
      Fair Value of warrants
                      
                      
                      2,765,946
                      
                      
                      
                      -Beneficial
      Conversion Feature
                      
                      
                      2,451,446
                      
                      
                      
                      -Non-GAAP
      Earnings applicable to common stockholders
                      
                      
                      16,499,354
                      
                      
                      
                      12,535,903Non-GAAP
      Basic EPS
                      
                      
                      0.73
                      
                      
                      
                      0.79Non-GAAP
      Diluted EPS
                      
                      $
                      0.67
                      
                      
                      $
                      0.71Shares
      used in basic net income per-share calculation - GAAP
                      
                      
                      22,671,998
                      
                      
                      
                      15,841,560Shares
      used in basic net income per-share calculation - Non-GAAP
                      
                      
                      22,671,998
                      
                      
                      
                      15,841,560Shares
      used in diluted net income per-share calculation - GAAP
                      
                      
                      24,565,869
                      
                      
                      
                      17,605,664Shares
      used in diluted net income per-share calculation -
Non-GAAP
                      
                      
                      24,565,869
                      
                      
                      
                      17,605,664
 
  - 23
-
 Table of Contents
 
 ITEM
      7.
              MANAGEMENT'S
      DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
      OPERATION.
 
 The
following discussion and analysis of our consolidated financial condition and
results of operations for the years ended December 31, 2008 and 2007 should be
read in conjunction with the consolidated financial statements, including
footnotes and  a list of related parities included in Note 12 of our
financial statements, and other information presented elsewhere in this Form
10-K. The year ended December 31, 2008 is referred to as “2008”, the year ended
December 31, 2007 is referred to as “2007”, and the coming year which will end
December 31, 2009 is referred to as “2009”.
 
 OVERVIEW
OF OUR PERFORMANCE AND OPERATIONS
 
 Our
Business
 
 We are a
U.S. company that manages a portfolio of Chinese entities.  We also
provide consulting services to Chinese businesses. We operate in three
identifiable segments, Magnesium, Basic Materials, and Consulting, in accordance
with SFAS No. 131, “Disclosure
about segments of an Enterprise and Related Information”. In the fourth
quarter of 2006 we established our Magnesium and Basic Materials segments which
have grown through acquisitions of controlling interests of Chinese private
companies. We consolidate these acquisitions as either our wholly or majority
owned subsidiaries. Through this ownership control, we provide management advice
as well as investment capital to expand their businesses. We hold a controlling
interest in twelve subsidiaries operating in China, five of which comprise our
Magnesium segment and five comprise our Basic Materials segment. We have a total
of 1,287 full-time employees, of which 1,269 work in the PRC.
 
 Our
Magnesium segment is currently our largest segment by revenues and assets. We
manufacture and sell pure magnesium and related by-products; we also purchase
and resell magnesium products manufactured by third parties. In 2008 our
Magnesium segment produced sold or distributed approximately 50,000 metric tons
of magnesium generating revenues of $169.8 million. According to the China
Non-ferrous Industry Association, China produced 630,000 metric tons of
magnesium in 2008. Magnesium is used in a variety of markets and applications
due to the physical and mechanical properties of the element and its alloys.
Magnesium is the lightest of the structural metals; it is one fourth the weight
of steel and two thirds the weight of aluminum. Various forms of magnesium are
also used in the manufacture of electronic equipment such as computers, cameras,
and cell phones. Magnesium powder is also used in flares, flashes and
pyrotechnics. Global production of magnesium was estimated to be approximately
805,000 metric tons in 2008 as compared to 755,000 metric tons in 2007. China
produced an estimated 630,000 metric tons in 2008, of which 160,000 metric tons
were consumed domestically.
 
 Our Basic
Materials segment engages in the sale and distribution of basic resources within
Asia. In 2008 this segment generated revenues of $53.8 million. Our Basic
Materials segment includes sale and distribution of a variety of products
including (i) industrial grade synthetic chemicals, (ii) steel products (iii)
non ferrous metals, and (iv) recycled materials. As well, within this
segment we hold the rights to mining properties and are awaiting an independent
valuation of the ore deposits prior to completion of construction. Presently we
do not have a timetable for when our operations will commence.
 
 Our
Consulting segment provides services to Chinese entities seeking access to the
U.S. capital markets. These services include general business consulting,
Chinese regulatory advice, translation services; formation of entities in the
PRC, coordination of professional resources, strategic alliances and
partnerships, advice on effective means of accessing U.S. capital markets,
mergers and acquisitions, coordination of Sarbanes-Oxley compliance, and
corporate asset evaluations.
 
 In 2007
we launched a Clean Technology segment.  We discontinued this segment
in the third quarter of 2008 when we completed the sale in October 2008 of an
81% interest in CDI Clean Technology and its subsidiaries, CDI Wanda and Yantai
CDI Wanda to PE Brothers Corp. for $1,240,000 and recorded a gain on the sale of
$238,670. We plan to maintain the 19% ownership interest in CDI Clean Technology
we retained using the cost method of accounting.
 
 Our
Performance
 
 During
2008 we experienced growth in revenues, and total assets as compared to 2007.
Revenues in 2008 totaled $240.0 million, an increase of $72.4 million compared
to 2007, primarily attributable to increases in revenues within our Magnesium
and Consulting segments, which were offset by a decrease in revenues in our
Basic Materials segment. We realized significant growth in our Magnesium segment
due to (i) investments in our Magnesium segment in the latter half of 2007 which
increased our capacity, and (ii) increases in the market price of magnesium
during the first six months of 2008. The global economic slowdown has adversely
affected the rate of our year-over-year growth across all of our business
segments.
  - 24
-
 Table of Contents
 
 Our
annual growth rate of 43% for 2008 over 2007 is not sustainable, but rather
reflects the continued implementation of the acquisition component of our
business model, the completion of consulting transactions that may not occur in
the future and the launch of our steel and nonferrous metals distribution
operations late in the third quarter of 2008. Accordingly, we believe
comparisons between 2008 and 2007 are of limited value and should not be viewed
as an indication of our year-over-year sustainable growth rate
potential.
 
 Our
Outlook
 
 During
2009 and beyond, we face a number of challenges in growing our business, such as
the continuing integration of our PRC based subsidiaries. At December 31, 2008
we had $37.5 million of working capital including $14.2 million in cash and cash
equivalents. While this amount is believed sufficient to meet our current
obligations, we may seek additional capital to provide funds to enable each of
our subsidiaries to grow their businesses and operations and to take advantage
of strategic opportunities. We continue to work with the management of our
subsidiaries to identify strategies to maximize their potential within their
segment and to the consolidated group.
 
 In the
first six months of 2008 our operations in China, primarily our Magnesium
segment experienced growth as compared to the first six months of 2007. However
in the latter half of 2008 our operations in China were negatively impacted by a
variety of events including (i) disruption caused by the 2008 Beijing Olympics
and (ii) the global economic crisis. We cannot predict when global economic
conditions will improve and accordingly we forecast weak demand within each of
segments until global economic conditions improve.
 
 Global
production of magnesium was estimated to be approximately 805,000 metric tons in
2008, an increase from the estimated 755,000 metric tons produced in 2007 and
725,000 metric tons in 2006, with China representing 630,000 metric tons or
approximately 78% of the world’s production. China’s domestic production figures
remained constant in 2008 as compared to 2007. During 2008 our Magnesium segment
produced, sold and/or distributed approximately 50,000 metric tons of magnesium
and with capacity for an additional 8,000 metric tons under construction. The
weak global economy has reduced demand for magnesium and as a result the price
of magnesium, ($2,670 per metric ton, as of March 25, 2009) has declined 25%
since August 2008. We are unable to predict if and when demand or prices will
increase. As a result we expect Magnesium segment revenues will decline in
future periods. We will seek to continue to purchase and resell magnesium from
third parties if demand permits. China exports for 2008 were 384,000 metric tons
as compared to 395,000 metric tons in 2007. Management believes export demand
was further impacted due to a 10% export tax on magnesium products which became
effective in January 2008. Furthermore, in 2008 domestic magnesium consumption
decreased to 160,000 metric tons; the first domestic decline since 2003.
Management estimates domestic consumption decreased as a result of reduced
construction related to the Beijing Olympics in 2008 as compared to 2007. In
2008 we witnessed rising energy costs. Coal prices increased during the first
nine months of 2008. Furthermore electricity was routed to Beijing from nearby
Hebei, Shanxi, and Inner Mongolia to ensure adequate power supply for the
Beijing Olympics. This led to higher energy costs in the segment. Recently in
2009 we have witnessed growing demand from well established buyers seeking to
engage us directly in long term supply contracts. We believe these buyers were
negatively impacted by the surge in market prices in late 2007 and early 2008
and seek to establish long term supply at current market prices. While these
discussions are preliminary, management is enthused by these overtures, as they
may indicate a market bottom.
 
 In the
first six months of 2008, we witnessed price increases in our Basic Materials
segment due to production interruptions caused by severe snowstorms in February
and the Sichuan earthquake in May. These price increases were, however, short
lived as the global economic crisis caused a reduction in demand for zinc which
in turn resulted in below market price cuts by mining companies seeking to
generate cash. As a result our revenues decreased in the segment as compared to
2007. At current market prices for zinc, it is not economically feasible to
commence operations at our zinc property. We believe that prices for lead and
lead concentrate will remain stable in 2009 because the uses for lead are more
widespread than zinc. At current market prices for lead and zinc, it is not
economically feasible to complete construction of a planned zinc mining
facility. We will continue to operate as a distributor of steel and non ferrous
metals. Following the discontinuation of our Clean Technology segment in
September 2008, CDI Metal Recycling was realigned under this
segment.
 
 Recycling.  In
2007 we operated a Clean Technology segment which primarily focused on a process
to recycle waste tires into tire derived fuel. While management believes in the
long term viability of this technology, falling fuel prices have reduced the
demand for alternative energy sources. In the third quarter of 2008, we elected
to exit the alternative energy and recycling business conducted by CDI Clean
Technology and its subsidiaries, CDI Wanda and Yantai CDI Wanda.
  - 25
-
 Table of Contents
 
 We are
evaluating the feasibility of continuing the development of a proposed facility
to create aluminum powder from recycled aluminum. While the current market price
of aluminum does not support the economic viability of a recycling operation, we
believe aluminum wire recycling will become viable as natural resources continue
to be depleted. This proposed recycling operation was consolidated with our
Basic Materials segment in the fourth quarter of 2008.
 
 During
2008 we experienced growth in our Consulting segment attributable to new clients
engaged during 2008. While we have made efforts to improve the caliber of the
clients within this segment the global economy and severe liquidity crisis in
the capital markets, have created a difficult environment for smaller companies
to attract interest in the financial community. Accordingly, we do not
anticipate this segment will grow in 2009.
 
 From
inception through 2007 a significant majority of our resources were devoted to
our Consulting segment. In 2008 approximately $223.6 million or roughly 93.2% of
our total consolidated revenues are generated from our Magnesium and Basic
Materials segments. An overwhelming majority of our resources are expended in
support of these operations. In 2009 we expect this trend to continue as we
continue our transition from solely a consulting practice to a Company with
significant operations in China. Accordingly we have made efforts to reposition
our Company in an effort to support this transition. In January 2009 we changed
the name of our Company to China Direct Industries, Inc. Furthermore we have
restructured our senior management to add personnel with operating experience
within the PRC. In January 2009 we announced a management restructuring
including several changes to our senior management and board of directors in an
effort to supplement our operations in China.
 
 Yuwei
Huang was appointed executive vice president for the Magnesium segment and as a
member of our board of directors. Jingdong Chen was appointed executive vice
president for the Basic Materials segment. Philip Shen, Ph.D. was appointed as a
member of the board of directors. As well we accepted the resignation of Marc
Siegel as President and as a member of its board of directors. Mr. Siegel
offered his resignation paving the way for the members of our organization with
experience operating within China to assume a managerial position with
additional responsibilities. This we believe provides our Company with a
management team capable of expanding our Magnesium and Basic Materials
segments.
 
 PRC Government Programs.In
November 2008, the Chinese government announced a $586 billion domestic economic
stimulus program aimed at bolstering economic activity in China. The two year
program includes tax rebates, spending in housing, infrastructure, agriculture,
health care and social welfare, and a tax deduction for capital spending by
companies. In February 2009, China's State Council announced support plans for
the country's nonferrous metals and logistics sectors. The support plans include
subsidized loans to support technical innovations within the nonferrous metals
sector, adjustments to export rebate rates of nonferrous products, and the
establishment of a national reserve system for the industry. While these
programs adopted by the PRC government are aimed towards supporting growth in
some of the sectors in which we operate, it is difficult to predict if any of
our businesses will benefit. It remains to be seen if domestic consumption can
compensate for slower worldwide demand, and the impact this will have on our
future revenues.
 
 Presentation of Financial
Statements. The presentation of the statements of operations included in
Part II, Item 6 in this Form 10-K have been modified to allow for the
reporting of deductions from net income to arrive at income (loss) applicable to
common stockholders. Items reflected in our comprehensive income for the periods
reported are now included in our notes to the audited consolidated financial
statements included in this Form 10-K. In addition, portion of our audited
consolidated financial statements have been reclassified to recognize
discontinued operations treatment reflecting the sale of an 81% interest in CDI
Clean Technology.
 
 RESULTS
OF OPERATIONS
 
 Consolidated
revenues and operating expenses by segment for 2008 and 2007 are as
follows:
 
 Consolidated
Revenues
 
 2008
                    
                    
                    2007(Dollars
      in thousands)
                    
                    Revenues
                    
                    
                    %
      of Revenues
                    
                    
                    Revenues
                    
                    
                    %
      of Revenues
                    
                    
                    %
      increase (decrease)Magnesium
      segment
                    
                    $
                    169,771
                    
                    
                    
                    71
                    %
                    
                    $
                    100,920
                    
                    
                    
                    60
                    %
                    
                    
                    68
                    %Basic
      Materials segment
                    
                    
                    53,838
                    
                    
                    
                    22
                    %
                    
                    
                    55,309
                    
                    
                    
                    33
                    %
                    
                    
                    -3
                    %Consulting
      segment
                    
                    
                    16,358
                    
                    
                    
                    7
                    %
                    
                    
                    11,333
                    
                    
                    
                    7
                    %
                    
                    
                    44
                    %Total
      Consolidated
                    
                    $
                    239,967
                    
                    
                    
                    100
                    %
                    
                    $
                    167,562
                    
                    
                    
                    100
                    %
                    
                    
                    43
                    %
 
  - 26
-
 Table of Contents
  
 Total
consolidated revenues for 2008 were $240.0 million, an increase of approximately
43% compared to 2007. These increases were primarily a result of increases in
revenues within our Magnesium and Consulting segments, which were offset by a
decrease in revenues in our Basic Materials segment.
 
 Consolidated
Operating Income and Expenses
  2008
                        
                        
                        2007(Dollars
      in thousands)
                        
                        Amount
                        
                        
                        %
                        
                        
                        Amount
                        
                        
                        %
                        
                        
                        %
      increase (decrease)Revenues
                        
                        $
                        239,967
                        
                        
                        
                        100
                        %
                        
                        $
                        167,562
                        
                        
                        
                        100
                        %
                        
                        
                        43
                        %Cost
      of revenues
                        
                        
                        206,948
                        
                        
                        
                        86
                        %
                        
                        
                        149,333
                        
                        
                        
                        89
                        %
                        
                        
                        39
                        %Gross
      profit
                        
                        
                        33,019
                        
                        
                        
                        14
                        %
                        
                        
                        18,229
                        
                        
                        
                        11
                        %
                        
                        
                        81
                        %Total
      operating expenses
                        
                        
                        12,050
                        
                        
                        
                        5
                        %
                        
                        
                        4,159
                        
                        
                        
                        2
                        %
                        
                        
                        190
                        %Operating
      income
                        
                        $
                        20,969
                        
                        
                        
                        9
                        %
                        
                        $
                        14,070
                        
                        
                        
                        8
                        %
                        
                        
                        49
                        %
  Total
consolidated operating income for 2008 was $21.0 million, an increase of 49%
compared to 2007. This increase over the prior year was due primarily to the 43%
increase in revenues, which caused our consolidated gross profit to increase
81%. Our year over year growth in revenues was mainly due to our Magnesium and
Consulting segments which increased 68% and 44%, respectively, partially offset
by a 3% decrease in revenues in our Basic Materials segment.
 
 In 2008
our cost of revenues was $206.9 million, a 39% increase compared to 2007. This
increase is a direct result of increased sales volume. Our cost of revenues for
2008 as a percentage of revenues decreased 3% from the prior year primarily as a
result of favorable purchases of raw materials in late 2007 and the first
quarter of 2008 and cost savings derived from economies of scale within our
Magnesium segment.
 
 Our gross
profit for 2008 was $33.0 million, an increase of 81% compared to 2007. This
increase is attributable to higher income generated by our Magnesium and
Consulting segments.
 
 Operating
expenses increased $7.9 million in 2008 compared to 2007. Included in our
operating expenses in 2008 included are non-cash impairment charges related to
certain inventory and other assets of $1.3 million.
 
 Segment
Information
 
 A summary
of our operating results, by segment, for 2008 and 2007 are as
follows:
 
 Magnesium
                  
                  
                  Basic
      Materials
                  
                  
                  Consulting
                  
                  
                  Consolidated(Dollars
      in thousands)
                  
                  2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Revenues
                  
                  $
                  153,022
                  
                  
                  $
                  98,141
                  
                  
                  $
                  53,838
                  
                  
                  $
                  55,310
                  
                  
                  $
                  16,358
                  
                  
                  $
                  9,573
                  
                  
                  $
                  223,218
                  
                  
                  $
                  163,024Revenues
      - related party
                  
                  
                  16,750
                  
                  
                  
                  2,778
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,760
                  
                  
                  
                  16,750
                  
                  
                  
                  4,538169,772
                  
                  
                  
                  100,919
                  
                  
                  
                  53,838
                  
                  
                  
                  55,310
                  
                  
                  
                  16,358
                  
                  
                  
                  11,333
                  
                  
                  
                  239,968
                  
                  
                  
                  167,563Cost
      of revenues
                  
                  
                  153,684
                  
                  
                  
                  93,516
                  
                  
                  
                  51,764
                  
                  
                  
                  54,046
                  
                  
                  
                  1,500
                  
                  
                  
                  1,772
                  
                  
                  
                  206,948
                  
                  
                  
                  149,334Gross
      profit
                  
                  
                  16,087
                  
                  
                  
                  7,403
                  
                  
                  
                  2,074
                  
                  
                  
                  1,264
                  
                  
                  
                  14,858
                  
                  
                  
                  9,561
                  
                  
                  
                  33,019
                  
                  
                  
                  18,229Total
      operating expenses
                  
                  
                  5,387
                  
                  
                  
                  1,122
                  
                  
                  
                  1,522
                  
                  
                  
                  734
                  
                  
                  
                  5,142
                  
                  
                  
                  2,302
                  
                  
                  
                  12,051
                  
                  
                  
                  4,158Operating
      income (loss)
                  
                  $
                  10,701
                  
                  
                  $
                  6,281
                  
                  
                  $
                  552
                  
                  
                  $
                  530
                  
                  
                  $
                  9,716
                  
                  
                  $
                  7,259
                  
                  
                  $
                  20,969
                  
                  
                  $
                  14,071
  - 27
-
 Table of Contents
 
 Magnesium
Segment Operating Results
 
 Revenues.
Magnesium segment revenues for 2008 were $169.8 million, (inclusive of related
party revenues of $16.8 million) an increase of 68% compared to 2007, due
primarily to (i) acquisitions of Golden Magnesium and Pan Asia Magnesium in July
and September 2007, respectively, (ii) increased magnesium production, (iii) the
increase in the market price of magnesium during the first six months of 2008,
which were partially offset by (iv) reduced sales volume and falling market
prices in the fourth quarter due to weak demand. During the first six months of
2008 we witnessed increasing demand, which coupled with stockpiling of inventory
in expectation of production shortages and/or transportation interruptions
associated with the 2008 Beijing Olympics drove market prices higher, which was
offset by the significant decline in market prices during the second half of the
year.
 
 In 2008
our Magnesium segment produced, sold and distributed approximately 50,000 metric
tons with an average price of $3,315 per metric ton. In comparison, for 2007 we
produced, sold and distributed approximately 45,000 metric tons with an average
price of $2,218 per metric ton. As of March 25, 2009 the spot market price of
magnesium was $2,670 per metric ton, a significant decrease from $3,900 per
metric ton at December 31, 2007.
 
 Gross
Profit. In 2008 gross profit for the segment increased $8.7 million, this
represents a 2% increase in the gross profit margin compared to 2007. This
margin improvement is due to the rapidly increasing sales price of magnesium in
the first six months of 2008.
 
 Operating
Expenses. In 2008 Magnesium segment operating expenses were $5.4 million,
an increase of $4.3 million compared to 2007. These increases were primarily
attributable to (i) expanded sales and support staff to support the growth in
our operations, and (ii) additional operational expenses associated with
acquisitions of Golden Magnesium and Baotou Changxin Magnesium, July 2007 and
February 2008, respectively. (iii) bad debt expense, (iv) inventory impairment
and amortization of intangible asset non-cash charges due of $1.3 million,
and (v) increased energy costs.
 
 Basic
Materials segment
 
 Revenues.
In 2008 Basic Materials segment revenues were $53.8 million, a decrease of 3%
compared to 2007. This decrease is a result of a decrease in revenues of $9.2
million at Lang Chemical which was partially offset by revenues of $7.7 million
at CDI Beijing, a subsidiary we formed in 2008. In the first six months of 2008,
Lang Chemical benefitted from price increases due to production interruptions
caused by snowstorms in February and the Sichuan earthquake in May, however
these price increases were short lived as the looming economic crisis spread
globally. In the latter half of 2008 Lang Chemical was negatively impacted by
the disruptions caused by the 2008 Beijing Olympics and the depressed global
economy.
 
 Gross
Profit. In 2008 gross profit for the segment increased $810,000, this
represents a 1.6% increase in the gross profit margin compared to 2007. This
margin improvement is due to the contribution of CDI Beijing which generated
gross margins of 9.8% in 2008.
 
 Operating
Expenses. In 2008 Basic Materials segment operating expenses were $1.5
million, an increase of approximately $800,000 compared to 2007. In 2008 we
experienced increased operating expenses of (i) $400,000 at Lang Chemical due
primarily to increased shipping expenses, (ii) $363,000 at CDI Beijing, a new
subsidiary formed in 2008, and (iii) an aggregate of $446,000 in development
costs related to CDI Jixiang Metal, CDI Metal Recycling and CDI Jingkun
Zinc.
 
 Consulting
segment
 
 Revenues.
In 2008 Consulting segment revenues were $16.4 million, an increase of 44%
compared to 2007. The increase was due primarily to new clients engaged in
2008.
 
 Gross
Profit. In 2008 gross profit for the segment increased $5.3 million
compared to 2007, this represents a 7% increase in gross profit margin compared
to 2007. The increase was due primarily to a decrease in professional fees
associated with the segment as we provided these services
internally.
 
 Operating
Expenses. In 2008 Consulting segment operating expenses, which include
general and administrative expenses, were $5.1 million, an increase of $2.8
million. These increases were due primarily to $2.2 million of stock based
compensation expenses as we expanded our staff to meet the needs of our growing
operations.
  - 28
-
 Table of Contents
 
 Total
Other (Expense) Income
 
 Total
other expense in 2008 was $3.3 million compared to total other income of $1.7
million in 2007. In 2008 we generated $877,485 of interest income from
short-term loans, and realized a gain $238,670 on the sale of subsidiaries
discontinued and held for sale, related to our sale of CDI Wanda in October
2008. These gains were offset by a net realized loss of $4.1 million associated
with an impairment of marketable securities available for sale pursuant to the
guidance of FSP EITF 99-20-1 and Statement No. 115. and a realized loss of
$136,923 on the sale of marketable securities.
 
 In 2007
total other income was $1.7 million, mainly comprised of (i) a gain of $400,000
representing the waiver of accrued income taxes related to Chang Magnesium in
our Magnesium segment, (ii) $284,000 of income generated from the sale of waste
reduction bottles by Pan Asia Magnesium in our Magnesium segment, and (iii) a
realized gain of $574,000 from the sale of marketable securities within our
Consulting segment.
 
 Income
Tax Expense
 
 Income
tax expense for 2008 was $267,245 compared to $727,479 in 2007. In 2008 our tax
expense was offset by a $300,000 tax refund associated with our U.S operations
for the 2007 calendar year.
 
 Net
Income
 
 Net
income for 2008 was $11.4 million, compared to $11.8 million in 2007. The
decrease of 4% was due to the items mentioned herein, most notably a net
realized loss of $4.1 million associated with an impairment of marketable
securities available for sale pursuant to the guidance of FSP EITF 99-20-1 and
Statement No. 115.
 
 Foreign
Currency Translation Gain
 
 The
functional currency of our subsidiaries operating in the PRC is the Chinese
dollar or Renminbi (“RMB”). The financial statements of our subsidiaries are
translated to U.S. dollars using period end rates of exchange for assets and
liabilities, and average rates of exchange (for the period) for revenues, costs,
and expenses. Net gains and losses resulting from foreign exchange transactions
are included in the consolidated statements of operations. As a result of these
translations, we reported a foreign currency translation gain of $602,714 in
2008 as compared to $1,314,343 in 2007. This non-cash gain had the effect
of increasing our reported comprehensive income. This item is discussed in
further detail in the notes to the audited consolidated financial statements
appearing elsewhere in this Form 10-K.
 
 Unrealized
Loss on Marketable Securities Available for Sale, Net of Income Tax
 
 The
unrealized loss on marketable securities available for sale, net of income taxes
in 2008 totaled $12.4 million, compared to an unrealized loss of $1.7
million in 2007. The significant increase in the unrealized loss is
representative of the declining value of marketable securities available for
sale as a result of the global economic crisis. The decline reflects a reduction
in the fair value of securities received from our clients in the Consulting
segment. As mentioned earlier we recognized a realized loss of $4.1 million
associated with an impairment of marketable securities available for sale
pursuant to the guidance of FSP EITF 99-20-1 and Statement
No. 115.
 
 Comprehensive
Income
 
 Comprehensive
income for 2008 was $11.7 million, an increase of $0.2 million from 2007, is a
result of our net income of $11.4 million plus foreign currency translation
gains of $602,716, less unrealized losses on marketable securities available for
sale (including marketable securities available for sale-related party), net of
income tax of $12.4 million. In 2007 we reflected Comprehensive income of
$11.5 million derived from our net income of $11.8 million, plus foreign
currency translation gains of $1.3 million, plus unrealized gains on marketable
securities held for sale (including marketable securities held for sale-related
party), net of income tax of $1.7 million.
  - 29
-
 Table of Contents
 
 LIQUIDITY
AND CAPITAL RESOURCES
 
 Liquidity
is the ability of a company to generate funds adequate amounts of cash to meet
its needs for cash. At December 31, 2008 our working capital was $37.5 million
as compared to $41.0 million at December 31, 2007.
 
 Our cash
balance at December 31, 2008 totaled $14.2 million, a decrease of
$4.8 over our balance at December 31, 2007. During 2008 we received net
proceeds of $11.5 million from a preferred stock offering, which was offset
by investments in capital expenditures of 26.0 million in property, plant
and equipment made during 2008.
 
 In 2008
we expended $26.0 million in property, plant, and equipment; the primary
expenditures were $17.3 million at Baotou Changxin Magnesium to construct a
magnesium facility, $4.0 million at Pan Asia Magnesium to expand capacity, and
$1.2 million at CDI Jixiang Metal.
 
 We have
commitments, which will be satisfied from working capital, including $2.2
million to increase the registered capital of CDI Beijing.
 
 The
continued implementation of our business model, which includes providing
investment capital to augment the growth of our portfolio companies and expand
our business through new accretive acquisitions, will in all likelihood require
additional capital. During 2009, we plan to use our magnesium holdings as a
basis for raising capital and expansion of our magnesium holdings. Accordingly,
we may raise additional capital through private or public financing. We have an
effective registration statement on Form S-3 which permits us  to sell
on a delayed or continuous basis up to $70,000,000 worth of our common stock or
other securities along with certain selling shareholders at any time pursuant to
a registration statement that we filed pursuant to Rule 415 under the Securities
Act of 1933,    The amount of our common stock which we or the
selling shareholders are permitted to sell pursuant to our prospectus dated
August 1, 2008  is limited to no more than one-third of the aggregate
market value during the period of 12 calendar months prior to the sale of the
voting and non-voting common equity held by non-affiliates of our
company.  Based on this limitation, as of March 30, 2009, we and the
selling shareholders would be limited to selling no more than approximately
$27,000,000 of our common stock assuming there were no other sales within a 12
month period.
 
 The
following table provides certain selected balance sheets comparisons between
December 31, 2008 and December 31, 2007.
 
 (Dollars
      in Thousands)
                  
                  December
      31,
                  
                  
                  Increase
      /2008
                  
                  
                  2007
                  
                  
                  (decrease)Cash
                  
                  $
                  14,205
                  
                  
                  $
                  19,025
                  
                  
                  $
                  (4,820
                  )Marketable
      securities
                  
                  
                  7,730
                  
                  
                  
                  9,136
                  
                  
                  
                  (1,406
                  )Accounts
      receivable, net
                  
                  
                  9,457
                  
                  
                  
                  10,529
                  
                  
                  
                  (1,072
                  )Inventories,
      net
                  
                  
                  8,560
                  
                  
                  
                  5,270
                  
                  
                  
                  3,290Prepaid
      expenses and other assets
                  
                  
                  8,127
                  
                  
                  
                  13,952
                  
                  
                  
                  (5,825
                  )Total
      current assets
                  
                  
                  59,742
                  
                  
                  
                  69,239
                  
                  
                  
                  (9,497
                  )Property
      and equipment, net
                  
                  
                  43,456
                  
                  
                  
                  17,413
                  
                  
                  
                  26,043Total
      assets
                  
                  
                  107,379
                  
                  
                  
                  88,286
                  
                  
                  
                  19,093Accounts
      payable and accrued expenses
                  
                  
                  8,590
                  
                  
                  
                  9,524
                  
                  
                  
                  (934
                  )Advances
      from customers
                  
                  
                  1,545
                  
                  
                  
                  6,892
                  
                  
                  
                  (5,347
                  )Other
      payables
                  
                  
                  1,624
                  
                  
                  
                  3,091
                  
                  
                  
                  (1,467
                  )Due
      to related parties
                  
                  
                  979
                  
                  
                  
                  3,137
                  
                  
                  
                  (2,158
                  )Total
      current liabilities
                  
                  $
                  22,228
                  
                  
                  $
                  28,537
                  
                  
                  $
                  (6,309
                  )
  - 30
-
 Table of Contents
 
 We
maintain cash balances in the United States and China. At December 31, 2008 and
December 31, 2007, bank deposits by geographic area (reclassified to reflect
discontinued operations), was as follows:
 
 Country
                  
                  2008
                  
                  
                  2007United
      States
                  
                  $
                  6,640,672
                  
                  
                  
                  47
                  %
                  
                  $
                  9,942,948
                  
                  
                  
                  52
                  %China
                  
                  
                  7,564,557
                  
                  
                  
                  53
                  %
                  
                  
                  9,081,656
                  
                  
                  
                  48
                  %Total
      cash and cash equivalents
                  
                  $
                  14,205,229
                  
                  
                  
                  100
                  %
                  
                  $
                  19,024,604
                  
                  
                  
                  100
                  %
 
 
 A
substantial portion of our cash balance, 53% at December 31, 2008, is in the
form of RMB held in bank accounts at financial institutions located in the PRC.
Cash held in banks in the PRC is not insured. The value of cash on deposit in
China of $7.6 million at December 31, 2008 has been converted based on the
exchange rate as of December 31, 2008. In 1996, the Chinese government
introduced regulations, which relaxed restrictions on the conversion of the RMB;
however restrictions still remain, including but not limited to restrictions on
foreign invested entities. Foreign invested entities may only buy, sell or remit
foreign currencies after providing valid commercial documents at only those
banks authorized to conduct foreign exchanges. Furthermore, the conversion of
RMB for capital account items, including direct investments and loans, is
subject to PRC government approval. Chinese entities are required to establish
and maintain separate foreign exchange accounts for capital account items. We
cannot be certain Chinese regulatory authorities will not impose more stringent
restrictions on the convertibility of the RMB, especially with respect to
foreign exchange transactions. Accordingly, cash on deposit in banks in the PRC
is not readily deployable by us for purposes outside of China.
 
 Current
assets as of December 31, 2008 totaled $59.7 million, a decrease of 14 %
compared to December 31, 2007. Current liabilities as of December 31, 2008
totaled $22.2 million, reflecting a 22% decrease from our December 31, 2007
balance.
 
 A summary
of total assets by segment at December 31, 2008 and at December 31, 2007 is as
follows:
  2008
                    
                    
                    2007(Dollars
      in thousands)Magnesium
      segment
                    
                    $
                    73,670
                    
                    
                    $
                    53,010Basic
      Materials segment
                    
                    
                    9,158
                    
                    
                    
                    11,802Consulting
      segment
                    
                    
                    24,551
                    
                    
                    
                    23,474Total
                    
                    $
                    107,379
                    
                    
                    $
                    88,286
 
 The
following table provides detail of selected balance sheet items by segment as of
December 31, 2008.
 
 Magnesium
                  
                  
                  Basic
      Materials
                  
                  
                  Consulting
                  
                  
                  Consolidated(Dollars
      in thousands)Accounts
      receivable, net (including related-party)
                  
                  $
                  6,579
                  
                  
                  $
                  4,484
                  
                  
                  $
                  71
                  
                  
                  $
                  11,134Inventories,
      net
                  
                  
                  7,828
                  
                  
                  
                  732
                  
                  
                  
                  -
                  
                  
                  
                  8,560Prepaid
      expenses and other current assets
                  
                  
                  6,499
                  
                  
                  
                  1,052
                  
                  
                  
                  576
                  
                  
                  
                  8,127Total
      current assets
                  
                  
                  34,399
                  
                  
                  
                  5,385
                  
                  
                  
                  19,958
                  
                  
                  
                  59,742Accounts
      payable and accrued expenses
                  
                  
                  7,522
                  
                  
                  
                  760
                  
                  
                  
                  308
                  
                  
                  
                  8,590Advances
      from customers
                  
                  
                  1,228
                  
                  
                  
                  317
                  
                  
                  
                  -
                  
                  
                  
                  1,545Other
      payables
                  
                  
                  149
                  
                  
                  
                  1,475
                  
                  
                  
                  -
                  
                  
                  
                  1,624Total
      current liabilities
                  
                  $
                  14,966
                  
                  
                  $
                  5,887
                  
                  
                  $
                  1,375
                  
                  
                  $
                  22,228
 
 Our
accounts receivables, net of allowances for doubtful accounts, as of December
31, 2008 was $9.5 million, a decrease of $1.1 million compared to December
31, 2007. This slight decrease is attributed to the overall increase in
collections efforts due to higher sales levels from the prior year primarily in
our Magnesium segment. Our Magnesium and Basic Materials segments generally
offer payment terms to its customers of 90 days. Our Consulting segment
generally receives full payment in advance for consulting services to be
provided, upon entering into a consulting agreement.
  - 31
-
 Table of Contents
 
 Inventories
as of December 31, 2008 were $8.6 million, an increase of $3.3 million
compared to December 31, 2007. This increase is due primarily to higher
magnesium inventories which accounted for 70% and 60% of consolidated inventory
levels at December 31, 2008 and December 31, 2007, respectively. These levels
increased sharply as a result of the 68% increase year-over-year in the level of
magnesium related revenues and inventory on-hand required for our magnesium
related acquisitions made in the second half of 2007 and first quarter
2008.
 
 Prepaid
expenses and other current assets consist of prepayments to vendors for
inventory, other receivables, the fair value of client securities which were
assigned to our executive officers and employees as compensation, loans
receivable, assets acquired in the acquisition of Pan Asia Magnesium, VAT tax
refunds, and security deposits. Prepaid expenses and other current assets as of
December 31, 2008 were $8.1 million.
  Accounts
payable and accrued expenses represent payables associated with the general
operation of each segment, including accrued payrolls. Advances from customers
represent prepayments for products, which have not yet been shipped. Of the
$1.5 million in advances from customers reflected at December 31, 2008,
$1.2 million is attributable to our Magnesium segment for orders placed in
the ordinary course of business but not yet shipped.
 
 Consolidated
Statement of Cash Flows
 
 In 2008,
our net decrease in cash totaled $4.8 and was comprised of
$10.9 provided by operating activities, $30.9 million used in
investing activities, $13.3 million provided by financing activities, and
the effect of prevailing exchange rates on our cash position of
$1.8 million.
 
 In 2007,
our net increase in cash totaled $16.0 million and consisted of
$11.7 million used in operating activities, $1.1 million used in
investing activities, $26.4 million provided by financing activities, and
the effect of prevailing exchange rates on our cash position of
$2.4 million.
 
 Cash
Used in Operating Activities
 
 Net cash
provided by operating activities in 2008 totaled $10.9 million and was
mainly comprised of our net income of $11.4 million, a decrease in our prepaid
expenses and other assets of $3.5 million, an increase in accounts payable
related party of $6.6 million, and reconciling non cash transactions
comprised of the followings: (i) $3.7 in depreciation expense, (ii) stock
based compensation expense of $2.2 million, and (iii) $4.1 million in
realized loss of OTTI on our marketable securities. These increases were
partially offset by the decrease in our fair value of securities received for
services of $15.3 million, purchases of inventory of $3.3 million, and a
decrease in advances from customers of $5.3 million.
 
 In 2007
cash used in operations included an increase in accounts receivable and accounts
receivable related parities of $12.3 million, an increase in prepaid
expenses and other current assets of $10.0 million, and a decrease in our fair
value of securities received for services of $8.2 million. These decreases were
partially offset by our net income of $11.8 million, increase in accounts
payable and accrued expenses of $3.6 million, and advances from customers of
$4.2 million.
 
 Cash
(Used in) Provided by Investing Activities
 
 Net cash
used in investing activities for 2008 totaled $30.9 million and was mainly
comprised of $29.8 million of capital expenditures in property, plant and
equipment, and increase in loans receivable related party of $1.7 million. Cash
used in investing was offset by proceeds from the sale of marketable securities
available for sale of $511,459.
 
 In 2007,
our cash used in investing activities totaled $1.1 million and was mainly
comprised of purchases of $5.8 million in property, plant and equipment;
offset by a realized loss of $2.1 million from the sale of marketable
securities held for sale and received cash of $2.7 million in conjunction
with acquisitions made during 2007.
  - 32
-
 Table of Contents
 
 Cash
Provided by Financing Activities
 
 For 2008
net cash provided by financing activities was $13.3 million and was mainly
comprised of gross proceeds of $12.95 million from the sale of Series A
Preferred Stock, proceeds from exercise of stock options and warrants of
$3.0 million, capital contribution from minority interest owners of $3.6
million, and proceeds from loans payable of $1.1 million. These were partially
offset by payment of loans payable of $3.1 million, and $1.5 million in
offering expenses related to our sale of Series A Preferred Stock.
 
 In 2007,
cash provided by financing activities was $26.4 comprised of
$24.0 million from the exercise of options and warrants, $3.3 million
from related parties and $1.9 million in proceeds from loans payable. These
increases in our cash balance were offset somewhat by the repayment of loans
payable of $2.4 million, an increase in restricted cash of $199,000 and
$141,000 in the repayment of advances to customers.
 
 Series
A Preferred Stock and Related Dividends
 
 In
February 2008, we completed a private placement (“Series A Preferred Stock
Offer”) whereby we sold to accredited investors 12,950 shares of our Series A
Convertible Preferred Stock (“Series A Preferred Stock”) together with common
stock purchase warrants to purchase an aggregate of 1,850,000 shares of our
common stock. At closing, we received gross proceeds of $12,950,000 with net
proceeds of $11.5 million. The Series A Preferred Stock has a stated value per
share of $1,000, carries an 8% per annum dividend rate payable quarterly in
arrears and is convertible into our common stock at $7.00 per share. The
dividends are payable in cash or shares of our common stock, at our option,
subject to certain provisions.
 
 As of
December 31, 2008, holders of our Series A Preferred Stock have converted 11,944
shares of the 12,950 shares of the Series A Preferred Stock, and only 1,006.25
shares of Series A Preferred remain outstanding. As a result of the conversion
of the Series A Preferred Stock, we have issued 1,706,250 shares of our common
stock, 14,624 shares of common stock in payment of the accrued dividends and
136,500 shares of common stock pursuant to the make whole additional amount
feature of the Series A Preferred Stock. Since then we have issued 7,138 shares
of common stock as dividends on the remaining Series A Preferred Stock
outstanding. In connection with this offering, we recorded the relative fair
value of the warrants of $2,765,946 and an additional $2,451,446 attributable to
the beneficial conversion feature as a non-cash one-time preferred stock deemed
dividend in the first quarter of 2008. This item is discussed in further detail
in the notes to the audited consolidated financial statements appearing
elsewhere in this Form 10-K.
 
 Minority
Interest
 
 At
December 31, 2008, our consolidated balance sheet reflects a total minority
interest of $26,940,141 which represents the equity portion of our subsidiaries
held by minority shareholders. The following table provides information
regarding the minority interest by segment:
  Segment
                    
                    2008
                    
                    
                    2007Magnesium
      segment
                    
                    $
                    24,742,209
                    
                    
                    $
                    15,945,184Basic
      Materials segment
                    
                    
                    2,197,932
                    
                    
                    
                    1,590,725Consulting
      segment
                    
                    
                    -
                    
                    
                    
                    -Total
                    
                    $
                    26,940,141
                    
                    
                    $
                    17,535,909
  - 33
-
 Table of Contents
 
 Off
Balance Sheet Items
 
 Under SEC
regulations, we are required to disclose our off-balance sheet arrangements that
have or are reasonably likely to have a current or future effect on our
financial condition, such as changes in financial condition, revenues or
expenses, results of operations, liquidity, capital expenditures or capital
resources that are material to investors. An off-balance sheet arrangement means
a transaction, agreement or contractual arrangement to which any entity that is
not consolidated with us is a party, under which we have:
 
 •
              Any
      obligation under certain guarantee contracts,•
              Any
      retained or contingent interest in assets transferred to an unconsolidated
      entity or similar arrangement that serves as credit, liquidity or market
      risk support to that entity for such assets,•
              Any
      obligation under a contract that would be accounted for as a derivative
      instrument, except that it is both indexed to our stock and classified in
      stockholder’s equity in our statement of financial position,
      and•
              Any
      obligation arising out of a material variable interest held by us in an
      unconsolidated entity that provides financing, liquidity, market risk or
      credit risk support to us, or engages in leasing, hedging or research and
      development services with us.
 
 We do not
have any off-balance sheet arrangements that we are required to disclose
pursuant to these regulations. In the ordinary course of business, we enter into
operating lease commitments, purchase commitments and other contractual
obligations. These transactions are recognized in our financial statements in
accordance with generally accepted accounting principles in the United
States.
 
 Critical
Accounting Policies
 
 The
discussion and analysis of our financial condition and results of operations are
based upon our audited consolidated financial statements, which have been
prepared in accordance with accounting principles generally accepted in the
United States. The preparation of these unaudited consolidated financial
statements requires us to make estimates and judgments that affect the reported
amounts of assets, liabilities, revenues and expenses, and related
disclosure of contingent assets and liabilities. On an on-going basis, we
evaluate our estimates based on historical experience and on various other
assumptions that are believed to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.
 
 A summary
of significant accounting policies is included in This item is discussed in
further detail in the notes to the audited consolidated financial statements
appearing elsewhere in this Form 10-K. Management believes that the application
of these policies on a consistent basis enables us to provide useful and
reliable financial information about our operating results and financial
condition.
 
 Acquisitions
 
 We
account for acquisitions using the purchase method of accounting in accordance
with SFAS No. 141. In each of our acquisitions for the periods presented, we
determined that fair values were equivalent to the acquired historical carrying
costs.
 
 Recent
Accounting Pronouncements
 
 In
January 2009, the FASB issued FSP EITF 99-20-1 to amend the impairment
guidance in EITF Issue No. 99-20in order to achieve more consistent
determination of whether an other-than-temporary impairment (“OTTI”) has
occurred. This FSP amended EITF 99-20 to more closely align the OTTI guidance
therein to the guidance in Statement No. 115. Retrospective application to
a prior interim or annual period is prohibited. The guidance in this FSP was
considered in the assessment of OTTI for various securities at December 31,
2008.
 
 In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging
Activities ” (“SFAS 161”). SFAS 161 is intended
to improve financial reporting about derivative instruments and hedging
activities by requiring enhanced disclosures to enable investors to better
understand their effects on an entity’s financial position, financial
performance, and cash flows. It is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged. We are currently evaluating the requirements of
SFAS 161 and the impact of adoption on our consolidated financial
statements.
  - 34
-
 Table of Contents
 
 In May
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (“FSP”) APB 14-1,Accounting for Convertible Debt Instruments That May Be Settled in Cash
upon Conversion
(Including Partial Cash Settlement . FSP APB 14-1 clarifies that
convertible debt instruments that may be settled in cash upon either mandatory
or optional conversion (including partial cash settlement) are not addressed by
paragraph 12 of APB Opinion No. 14,Accounting for Convertible Debt and
Debt issued with Stock PurchaseWarrants. Additionally, FSP
APB 14-1 specifies that issuers of such instruments should separately account
for the liability and equity components in a manner that will reflect the
entity’s nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. FSP APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. We will adopt FSP APB 14-1 beginning in the first
quarter of fiscal 2009,
and this standard must be applied on a retrospective basis. We are evaluating
the impact the adoption of FSP APB 14-1 will have on our consolidated financial
position and results of operations.
 
 In May
2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No.
162,The Hierarchy of
Generally Accepted AccountingPrinciples. This standard is
intended to improve financial reporting by identifying a consistent framework,
or hierarchy, for selecting accounting principles to be used in preparing
financial statements that are presented in conformity with generally accepted
accounting principles in the United States for non-governmental entities. SFAS
No. 162 is effective 60 days following approval by the U.S. Securities and
Exchange Commission (“SEC”) of the Public Company Accounting Oversight Board’s
amendments to AU Section 411,The Meaning of Present Fairly in Conformity with Generally Accepted AccountingPrinciples. We do not expect
SFAS No. 162 to have a material impact on the preparation of our consolidated
financial statements.
 
 On
September 16, 2008, the FASB issued final Staff Position (FSP) No. EITF
03-6-1, “Determining Whether
Instruments Granted in Share-Based Payment Transactions Are
ParticipatingSecurities,” to address the
question of whether instruments granted in share-based payment transactions are
participating securities prior to vesting. The FSP determines that unvested
share-based payment awards that contain rights to dividend payments should be
included in earnings per share calculations. The guidance will be effective for
fiscal years beginning after December 15, 2008. We are currently evaluating the
requirements of (FSP) No. EITF 03-6-1, as well as the impact of the adoption on
our consolidated financial statements.
 
 On
October 10, 2008, the FASB issued Statement of Financial Accounting
Standards (“SFAS”) No. 157-3,Determining the Fair Value of a Financial Asset When the Market for That
Asset Is Not
Active.  This FASB Staff Position (FSP) clarifies the
application of FASB Statement No. 157,Fair Value Measurements, in
a market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset when the
market for that financial asset is not active. Statement 157 was issued in
September 2006, and is effective for financial assets and financial liabilities
for financial statements issued for fiscal years beginning after November
15, 2007, and interim periods within those fiscal years. We have adopted
SFAS 157-3 and determined that it had no impact as of December 31, 2008, and we
will continue to evaluate the impact, if any, of SFAS 157-3 on our financial
statements.
 
 A variety
of proposed or otherwise potential accounting standards are currently under
study by standard setting organizations and various regulatory agencies. Due to
the tentative and preliminary nature of those proposed standards, management has
not determined whether implementation of such proposed standards would be
material to our consolidated financial statements.
 
 Cautionary
Note Regarding Forward-Looking Information and Factors That May Affect Future
Results
 
 This
report contains forward-looking statements within the meaning of Section 27A of
the Securities Act of 1933, as amended and Section 21E of the Securities
Exchange Act of 1934, as amended. The Securities and Exchange Commission
encourages companies to disclose forward-looking information so that investors
can better understand a company’s future prospects and make informed investment
decisions. This Annual Report on Form 10-K and other written and oral statements
that we make from time to time contain such forward-looking statements that set
out anticipated results based on management’s plans and assumptions regarding
future events or performance. We have tried, wherever possible, to identify such
statements by using words such as “anticipate,” “estimate,” “expect,” “project,”
“intend,” “plan,” “believe,” “will” and similar expressions in connection with
any discussion of future operating or financial performance. In particular,
these include statements relating to future actions, future performance or
results of current and anticipated sales efforts, expenses, the outcome of
contingencies, such as legal proceedings, and financial results. A list of
factors that could cause our actual results of operations and financial
condition to differ materially is set forth below, and these factors are
discussed in greater detail under Item 1A – “Risk Factors” of our Annual Report
on Form 10-K for the year ended December 31, 2008:
  - 35
-
 Table of Contents
 
 •
              Continued
      global economic weakness is expected to reduce demand for our products in
      each of our segments.•
              Fluctuations
      in the availability of magnesium and in levels of customer
      demand.•
              Changes
      in the prices of magnesium and magnesium-related
  products.•
              Our
      ability to implement our business strategy of growing our business through
      increased magnesium production capacity and
  acquisitions.•
              Fluctuations
      in the cost or availability of coke gas and coal.•
              Loss
      of orders from any of our major customers.•
              The
      value of the equity securities we accept as compensation is subject to
      adjustment which could result in losses to us in future
      periods.•
              Our
      ability to effectively integrate our acquisitions and to manage our growth
      and our inability to fully realize any anticipated benefits of acquired
      business.•
              Our
      need for additional financing which we may not be able to obtain on
      acceptable terms, the dilutive effect additional capital raising efforts
      in future periods may have on our current shareholders and the increased
      interest expense in future periods related to additional debt
      financing.•
              Our
      dependence on certain key personnel.•
              Our
      ability to establish adequate management, cash, legal and financial
      controls in the PRC.•
              The
      lack various legal protections in certain agreements to which we are a
      party and which are material to our operations which are customarily
      contained in similar contracts prepared in the United
    States.•
              Potential
      impact of PRC regulations on our intercompany loans.•
              Our
      ability to assure that related party transactions are fair to our
      company.•
              Yuwei
      Huang, our executive vice president – magnesium, director and an officer
      of several of our magnesium subsidiaries is also an owner and executive
      officer of several companies which directly compete with our magnesium
      business.•
              Our
      ability to comply with the United States Foreign Corrupt Practices Act
      which could subject us to penalties and other adverse
      consequences.•
              Limits
      under the Investment Company Act of 1940 on the value of securities we can
      accept as payment for our business consulting services.•
              Our
      acquisition efforts in future periods may be dilutive to our then current
      shareholders.•
              The
      risks and hazards inherent in the mining industry on the operations of our
      basic materials segment.•
              The
      effect of changes resulting from the political and economic policies of
      the Chinese government on our assets and operations located in the
      PRC.•
              The
      impact of Chinese economic reform policies.•
              The
      influence of the Chinese government over the manner in which our Chinese
      subsidiaries must conduct our business activities.•
              The
      impact on future inflation in China on economic activity in
      China.•
              The
      impact of any recurrence of severe acute respiratory syndrome, or SAR’s,
      or another widespread public health problem.•
              The
      limitation on our ability to receive and use our revenues effectively as a
      result of restrictions on currency exchange in China.•
              Our
      ability to enforce our rights due to policies regarding the regulation of
      foreign investments in China.•
              Recent
      substantial declines in the market price for shares of our common stock
      and continued highly volatile and wide market price
      fluctuations.•
              The
      impact on our stock price due to sales of our stock by existing
      shareholders and stock option exercises and sales of those shares of
      stock.
 
 We
caution that the factors described herein and other factors could cause our
actual results of operations and financial condition to differ materially from
those expressed in any forward-looking statements we make and that investors
should not place undue reliance on any such forward-looking statements. Further,
any forward-looking statement speaks only as of the date on which such statement
is made, and we undertake no obligation to update any forward-looking statement
to reflect events or circumstances after the date on which such statement is
made or to reflect the occurrence of anticipated or unanticipated events or
circumstances. New factors emerge from time to time, and it is not possible for
us to predict all of such factors. Further, we cannot assess the impact of each
such factor on our results of operations or the extent to which any factor, or
combination of factors, may cause actual results to differ materially from those
contained in any forward-looking statements.
  - 36
-
 Table of Contents
 
 ITEM
      7A.
              QUANTITIATIVE
      AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK.
 
 Not
applicable to a smaller reporting company.
 
 ITEM
      8.
              FINANCIAL
      STATEMENTS AND SUPPLEMENTARY DATA.
 
 Our
financial statements are contained in pages F-1 through F-49, which appear at
the end of this annual report.
 
 ITEM
      9.
              CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE.
 
 None.
 
 ITEM
      9A (T).
              CONTROLS
      AND PROCEDURES.
 
 Evaluation of Disclosure Controls and
Procedures
  We
maintain disclosure controls and procedures (as defined in Rule 13a-15(e)
under the Exchange Act) that are designed to ensure that information required to
be disclosed by us in reports that we file under the Exchange Act is recorded,
processed, summarized and reported as specified in the SEC’s rules and forms and
that such information required to be disclosed by us in reports that we file
under the Exchange Act is accumulated and communicated to our management,
including our Chief Executive Officer, or CEO, and our Chief Financial Officer,
or CFO, to allow timely decisions regarding required disclosure. Management,
with the participation of our CEO and CFO, performed an evaluation of the
effectiveness of our disclosure controls and procedures as of December 31,
2008. Based on that evaluation and as described below under “Management’s Report
on Internal Control Over Financial Reporting,” we have identified two material
weaknesses in our internal control over financial reporting (as defined in
Exchange Act Rules 13a-15(f)). These weaknesses involve the lack of
controls over the accounting for cash receipts and disbursement and accounting
for related party transactions, some of which are customarily found in China.
These weaknesses are described in more detail in the next section. Solely as a
result of these material weaknesses, our management, including our CEO and CFO,
concluded that our disclosure controls and procedures were not effective as of
December 31, 2008.
 
 Our
evaluation included business activities which were part of our Company for the
entire 2008 period and excluded Baotou Changxin Magnesium and CDI Beijing which
were acquired during 2008. In 2008, Baotou Changxin Magnesium and CDI Beijing
and represent approximately 5% of our total consolidated revenues and
10% of our total consolidated assets. Baotou Changxin Magnesium incurred a net
loss of $1.9 million and CDI Beijing earned net income of $.15 million at
December 31, 2008.
 
 Management’s Report on Internal
Control Over Financial Reporting
  Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting (as defined in Rule 13a-15(f) under the
Exchange Act). Under the supervision and with the participation of our
management, including our CEO and CFO, we conducted an evaluation of the
effectiveness of our internal control over financial reporting based on the
framework in Internal Control Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission. Based on that evaluation,
our management concluded that, due to the material weaknesses described below,
our internal control over financial reporting was not effective as of
December 31, 2008.
 
 A
material weakness is a deficiency, or combination of deficiencies, in internal
control over financial reporting such that there is a reasonable possibility
that a material misstatement of the company’s annual or interim financial
statements would not be prevented or detected on a timely
basis.
  - 37
-
 Table of Contents
  The
specific material weaknesses identified by our management were as
follows:
 
 •
              The
      lack of controls over the accounting for cash receipts and disbursements.
      Specifically the lack of these controls permitted employees and vendors to
      be paid in cash. We discovered that some of these transactions took place
      without sufficient externally prepared documentation or
      approvals.•
              The
      lack of controls over the accounting for related party
      transactions.  Specifically the lack of these controls caused
      related party sales to be classified as regular sales. These sales totaled
      $16.8 million in 2008.
 
 Although
these material weaknesses did not result in a material misstatement for the
period ended December 31, 2008 or any prior periods, they did result in
accounting adjustments and a reasonable probability that a material misstatement
of income or expenses in our annual or interim financial statements would not
have been prevented or timely detected.
  Remediation of Material Weakness in
Internal Control
  We
believe the following actions we have taken and are taking will be sufficient to
remediate the material weaknesses described above:
 
 •
              Internal
      audit activities and resources have been expanded. We added a position for
      an internal auditor who will manage an internal audit team that will test
      and monitor the implementation of our accounting and internal control
      procedures;•
              We
      are in the process of completing a review and revision of our existing
      documentation of our accounting and internal control procedures and
      policies which will include appropriate controls and procedures for cash
      management in China and related party transactions;•
              We
      are in the process of implementing an initiative to ensure the importance
      of internal controls and compliance with established policies and
      procedures are fully understood throughout the organization. These
      initiatives will be managed by our Chief Financial
  Officer;•
              Our
      board of directors will adopt a Related Person Transaction Policy to
      govern our accounting and internal control procedures and
      policies;•
              We
      are in the process of evaluating an appropriate financial software system
      to be implemented both in our U.S. office and in our subsidiaries to
      standardize the process and access to financial reports on a timely
      manner; and•
              Provide
      training to our employees to ensure these procedures are properly
      performed.
 
 Management
believes the actions described above will remediate the material weaknesses we
have identified and strengthen our internal control over financial reporting. We
expect the material weakness will be remediated prior to December 31, 2009.
As we improve our internal control over financial reporting and implement
remediation measures, we may supplement or modify the remediation measures
described above.
 
 Our
management, including our Chief Executive Officer and our Chief Financial
Officer, does not expect that our disclosure controls and procedures or our
internal controls will prevent all error and all fraud. A control system, no
matter how well conceived and operated, can provide only reasonable, not
absolute, assurance that the objectives of the control system are met. Further,
the design of a control system must reflect the fact that there are resource
constraints and the benefits of controls must be considered relative to their
costs. Due to the inherent limitations in all control systems, no evaluation of
controls can provide absolute assurance that all control issues and instances of
fraud, if any, within our Company have been detected.
 
 Changes in Internal
Control
  Other
than as expressly noted above in this Item 9A, there were no changes in our
internal control over financial reporting identified in connection with the
evaluation of our controls performed during the quarter ended December 31,
2008 that have materially affected, or are reasonably likely to materially
affect, our internal control over financial reporting.
  - 38
-
 Table of Contents
 
 ITEM
      9B.
              OTHER
      INFORMATION.
 
 None.
 
 PART
III
 
 ITEM
      10.
              DIRECTORS,
      EXECUTIVE OFFICERS AND CORPORATE
GOVERNANCE.
 
 The
information required by this item will be contained in our Proxy Statement
relation to the 2008 Annual Meeting of Shareholders to held on May 29, 2009 (the
“Proxy Statement”) and is incorporated herein by this reference or in included
in Part I under “Executive Officers of the Company.”
 
 ITEM
      11.
              EXECUTIVE
      COMPENSATION.
 
 The
information required by this item will be contained in our Proxy Statement and
is incorporated herein by this reference.
 
 ITEM
      12.
              SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS.
 
 The
information required by this item will be contained in our Proxy Statement and
is incorporated herein by this reference.
 
 ITEM
      13.
              CERTAIN
      RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR
      INDEPENDENCE.
 
 The
information required by this item will be contained in our Proxy Statement and
is incorporated herein by this reference.
 
 ITEM
      14.
              PRINCIPAL
      ACCOUNTANT FEES AND SERVICES.
 
 The
information required by this item will be contained in our Proxy Statement and
is incorporated herein by this reference.
 
 PART
IV
 
 
 ITEM
      15.
              EXHIBITS,
      FINANCIAL STATEMENT SCHEDULES.
 
 Exhibit No.
                  
                  Description
      of Exhibit2.2
                  
                  Certificate
      of Ownership and Merger (incorporated herein by reference to Exhibit
      99.1.1 as part of the Company’s Current Report on Form 8-K filed with the
      Commission on December 83, 1999 (Commission File No.
      000-26415)).3.1
                  
                  Certificate
      of Incorporation Incorporated by reference to the Form 10-SB as filed
      on June 17, 1999 (incorporated herein by reference to Exhibit 3.1 as
      part of the Company’s Form 10-SB as filed with the Commission on
      June 17, 1999 (Commission File No. 000-26415)).3.2
                  
                  Bylaws
      (incorporated herein by reference to Exhibit 3.2 filed as a part of the
      Company’s Form 10-Q filed with the Commission on August 8, 2008
      (Commission File No. 001-33694)).3.3
                  
                  Certificate
      of Amendment to the Certificate of Incorporation (incorporated herein by
      reference to Exhibit 3.3 as part of the Company’s Current Report on Form
      8-K filed with the Commission on August 17, 2006 (Commission File No.
      000-26415)).3.4
                  
                  Certificate
      of Domestication of China Direct, Inc. (incorporated herein by reference
      to Exhibit 3.4 as part of the Company’s Current Report on Form 8-K filed
      with the Commission on June 27, 2007 (Commission File No.
      000-26415)).3.5
                  
                  Form
      of Certificate of Designations, Preferences and Rights of Series A
      Convertible Preferred Stock (incorporated herein by reference to Exhibit
      3.5 as part of the Company’s Current Report on Form 8-K filed with the
      Commission on February 12, 2008 (Commission File No.
      001-33694)).4.1
                  
                  Form
      of common stock purchase warrant (incorporated herein by reference to
      Exhibit 4.1 as part of the Company’s Current Report on Form 8-K filed with
      the Commission on February 12, 2008 (Commission File No.
      001-33694)).
 
  - 39
-
 Table of Contents
  
 10.1
                  +
                  Employment
      Agreement dated August 16, 2006 with Dr. Yuejian (James) Wang
      (incorporated herein by reference to Exhibit 10.9 as part of the Company’s
      Current Report on Form 8-K filed with the Commission on August 17,
      2006 (Commission File No. 000-26415)).10.2
                  +
                  Employment
      Agreement dated August 16, 2006 with Mr. Marc Siegel
      (incorporated herein by reference to Exhibit 10.10 as part of the
      Company’s Current Report on Form 8-K filed with the Commission on August
      17, 2006 (Commission File No. 000-26415)).10.3
                  +
                  Employment
      Agreement dated August 16, 2006 with Mr. David Stein
      (incorporated herein by reference to Exhibit 10.11 as part of the
      Company’s Current Report on Form 8-K filed with the Commission on August
      17, 2006 (Commission File No. 000-26415)).10.4
                  +
                  Employment
      Agreement dated August 16, 2006 with Yi (Jenny) Liu (incorporated
      herein by reference to Exhibit 10.12 as part of the Company’s Current
      Report on Form 8-K filed with the Commission on August 17, 2006
      (Commission File No. 000-26415)).10.5
                  +
                  Evolve
      One, Inc. Stock Option Plan, as amended (incorporated herein by reference
      to Exhibit 10.1 as part of the Company’s Form S-8 filed with the
      Commission on January 11, 2005 (Commission File No.
      333-121963)).10.6
                  +
                  2005
      Equity Compensation Plan (incorporated herein by reference to Exhibit 99.1
      as part of the Company’s Registration Statement on Form S-8 filed with the
      Commission on June 16, 2005 (Commission File No.
    333-125871)).10.7
                  +
                  2006
      Equity Compensation Plan (incorporated herein by reference to Exhibit
      10.14 as part of the Company’s Current Report on Form 8-K filed with the
      Commission on August 17, 2006 (Commission File No.
      000-26415)).10.8
                  +
                  2006
      Stock Compensation Plan (incorporated herein by reference to Exhibit 10.1
      as part of the Company’s Registration Statement on Form S-8 filed with the
      Commission on October 30, 2006 (Commission File No.
      333-138297)).10.12
                  
                  CDI
      China, Inc., Jinan Alternative Energy Group Corp. and CDI Wanda New Energy
      Co., Ltd. Amended Agreement dated as of May 8, 2007 (incorporated herein
      by reference to Exhibit 10.1 as part of the Company’s Quarterly Report on
      Form 10-QSB for the period ended March 31, 2007 filed with the
      Commission on May 9, 2007 (Commission File No.
  000-26415)).10.13
                  
                  Contract
      for Sino-Foreign Equity Joint Venture between Asia Magnesium Co., Ltd.,
      Shanxi Senrun Coal Chemistry Co., Ltd. and Taiyuan YiWei Magnesium
      Industry Co., Ltd. dated December 12, 2006 (incorporated herein by
      reference to Exhibit 10.1 as part of the Company’s Quarterly Report on
      Form 10-QSB for the period ended June 30, 2007 filed with the Commission
      on August 8, 2007 (Commission File No. 000-26415)).10.14
                  
                  Asia
      Magnesium Ownership Transfer Agreement dated July 1, 2007 between Jiang
      Dong and Capital One Resource Co., Ltd. (incorporated herein by reference
      to Exhibit 10.2 as part of the Company’s Quarterly Report on Form
      10-QSB for the period ended June 30, 2007 filed with the Commission on
      August 8, 2007 (Commission File No. 000-26415)).10.15
                  
                  Shangxi
      Gu County Golden Magnesium Co., Ltd. Investment Agreement Supplement dated
      May 30, 2007 among Taiyuan YiWei Magnesium Co., Ltd., Asia Magnesium
      Co., Ltd. and Shanxi Senrun Coal Chemistry Co. Ltd. (incorporated herein
      by reference to Exhibit 10.3 as part of the Company’s Quarterly Report on
      Form 10-QSB for the period ended June 30, 2007 filed with the Commission
      on August 8, 2007 (Commission File No. 000-26415)).10.16
                  
                  Consulting
      and Management Agreement dated June 27, 2007 between Mr. Aihua Hu and
      Capital One Resource Co., Ltd. (incorporated herein by reference to
      Exhibit 10.4 as part of the Company’s Quarterly Report on Form 10-QSB for
      the period ended June 30, 2007 filed with the Commission on August 8, 2007
      (Commission File No. 000-26415)).10.17
                  
                  Stock
      Purchase Agreement dated August 24, 2007 between CDI China, Inc., China
      Direct, Inc. and Sense Holdings, Inc. (incorporated herein by reference to
      Exhibit 10.1 as part of the Company’s Current Report on Form 8-K filed
      with the Commission on August 28, 2007 (Commission File No.
      000-26415)).10.18
                  
                  Joint
      Venture Agreement dated September 28, 2007 among Shanxi Jinyang Coal And
      Coke Group Co., Ltd., Runlian Tian and CDI China, Inc. (incorporated
      herein by reference to Exhibit 10.1 as part of the Company’s Quarterly
      Report on Form 10-QSB for the period ended September 30, 2007 filed with
      the Commission on November 14, 2007 (Commission File No.
      000-26415)).10.19
                  
                  Securities
      Purchase Agreement dated February 11, 2008 (incorporated herein by
      reference to Exhibit 10.19 as part of the Company’s Current Report on Form
      8-K filed with the Commission on February 12, 2008 (Commission File No.
      001-33694)).
 
  - 40
-
 Table of Contents
  
 10.20
                  
                  Registration
      Rights Agreement dated February 11, 2008 (incorporated herein by reference
      to Exhibit 10.20 as part of the Company’s Current Report on Form 8-K filed
      with the Commission on February 12, 2008 (Commission File No.
      001-33694)).10.21
                  +
                  Option
      Agreement dated August 16, 2006 between China Direct, Inc. and David Stein
      (incorporated herein by reference to Exhibit 10.3 filed as a part of the
      Company’s Form S-8 filed with the Commission on November 11, 2007
      (Commission File No. 333-147603)).10.22
                  +
                  Employment
      Agreement dated August 7, 2008 between China Direct, Inc. and Dr. Yuejian
      (James) Wang (incorporated herein by reference to Exhibit 10.22 filed as a
      part of the Company’s Form 10-Q filed with the Commission on August 8,
      2008 (Commission File No. 001-33694)).10.23
                  +
                  Employment
      Agreement dated August 7, 2008 between China Direct, Inc. and Marc Siegel
      (incorporated herein by reference to Exhibit 10.23 filed as a part of the
      Company’s Form 10-Q filed with the Commission on August 8, 2008
      (Commission File No. 001-33694)).10.24
                  +
                  Employment
      Agreement dated August 7, 2008 between China Direct, Inc. and David Stein
      (incorporated herein by reference to Exhibit 10.24 filed as a part of the
      Company’s Form 10-Q filed with the Commission on August 8, 2008
      (Commission File No. 001-33694)).10.25
                  +
                  Form
      of Restricted Stock Agreement for Executive Officer awards under the
      Company’s 2008 Executive Stock Incentive Plan (incorporated herein by
      reference to Exhibit 10.25 filed as a part of the Company’s Form 10-Q
      filed with the Commission on August 8, 2008 (Commission File No.
      001-33694)).10.26
                  +
                  Form
      of Restricted Stock Agreement for Non-Executive Officer awards under the
      Company’s 2008 Non-Executive Stock Incentive Plan (incorporated herein by
      reference to Exhibit 10.26 filed as a part of the Company’s Form 10-Q
      filed with the Commission on August 8, 2008 (Commission File No.
      001-33694)).10.27
                  +
                  Form
      of Restricted Stock Agreement for awards to Directors under the Company’s
      2008 Non-Executive Stock Incentive Plan (incorporated herein by reference
      to Exhibit10.27 filed as a part of the Company’s Form 10-Q filed with the
      Commission on August 8, 2008 (Commission File No.
    001-33694)).10.28
                  
                  Joint
      Venture Agreement entered into between CDI Shanghai Management Co., Ltd.
      and Chi Chen dated September 20, 2008 (incorporated herein by reference to
      Exhibit 10.28 filed as a part of the Company’s Form 10-Q filed with the
      Commission on August 8, 2008 (Commission File No.
    001-33694)).10.29
                  +
                  Form
      of November 13, 2008 Amendment to Employment Agreements dated August 7,
      2008 between China Direct, Inc. and Dr. Yuejian (James) Wang, Marc Siegel
      and David Stein (incorporated herein by reference to Exhibit 10.29 filed
      as a part of the Company’s Current Report on Form 10-Q for the period
      ended September 30, 2008 filed with the Commission on November 13,
      2008 (Commission File No. 001-33694)).10.30
                  +
                  Option
      Agreement dated August 16, 2006 between China Direct, Inc. and Dr. Yuejian
      (James) Wang (incorporated herein by reference to Exhibit 10.1 filed as a
      part of the Company’s Form S-8 filed with the Commission on November 11,
      2007 (Commission File No. 333-147603)).10.31
                  +
                  Option
      Agreement dated August 16, 2006 between China Direct, Inc. and Marc Siegel
      (incorporated herein by reference to Exhibit 10.2 filed as a part of the
      Company’s Form S-8 filed with the Commission on November 11, 2007
      (Commission File No. 333-147603)).10.32
                  
                  Baotou
      Changxin Magnesium Co., Ltd. Investment Agreement dated February 20, 2008
      among CDI China, Inc., Excel Rise Technology Co., Ltd. and Three Harmony
      (Australia) Pty, Ltd. (incorporated herein by reference to Exhibit 10.1 as
      part of the Company’s Current Report on Form 8-K filed with the Commission
      on February 26, 2008 (Commission File No. 001-33694)).10.33
                  
                  Baotou
      Changxin Magnesium Co., Ltd. Articles of Association dated January 31,
      2008 (incorporated herein by reference to Exhibit 3.1 as part of the
      Company’s Current Report on Form 8-K filed with the Commission on February
      26, 2008 (Commission File No. 001-33694)).10.34
                  
                  Investment
      Framework Agreement dated as of April 26, 2008 by and between Baotou
      Xinjin Magnesium Co., Ltd. and CDI China, Inc. (incorporated herein by
      reference to Exhibit 10.18 as part of the Company’s Current Report on Form
      8-K filed with the Commission on May 1, 2008 (Commission File No.
      001-33694)).10.35
                  +
                  Independent
      Board of Directors Compensation Plan (incorporated herein by reference to
      the Company’s Current Report on Form 8-K filed with the Commission on June
      3, 2008 (Commission File No. 001-33694)).10.36
                  +
                  Compensation
      Award to Yi (Jenny) Liu on December 3, 2008 (incorporated herein by
      reference to the Company’s Current Report on Form 8-K filed with the
      Commission on December 5, 2008 (Commission File No.
      001-33694)).
 
  - 41
-
 Table of Contents
  
 10.37
                  
                  Lease Agreement dated August 21, 2007 between 431
      Fairway Associates, LLC and China Direct, Inc. *10.38
                  +
                  Consulting
      Agreement dated January 23, 2006 between China Direct, Inc. and Marc
      Siegel (incorporated herein by reference to Exhibit 10.1 as part of the
      Company’s Current Report on Form 8-K filed with the Commission on January
      26, 2009 (Commission File No. 001-33694)).10.39
                  +
                  Separation
      and Severance Agreement dated January 23, 2006 between China Direct, Inc.
      and Marc Siegel (incorporated herein by reference to Exhibit 10.2 as part
      of the Company’s Current Report on Form 8-K filed with the Commission on
      January 26, 2009 (Commission File No. 001-33694)).10.40
                  
                  Stock
      Purchase Agreement dated January 23, 2006 between China Direct, Inc. and
      Marc Siegel (incorporated herein by reference to Exhibit 10.3 as part of
      the Company’s Current Report on Form 8-K filed with the Commission on
      January 26, 2009 (Commission File No. 001-33694)).10.41
                  
                  Lock-Up
      Agreement dated January 23, 2006 between China Direct, Inc. and Marc
      Siegel (incorporated herein by reference to Exhibit 10.4 as part of the
      Company’s Current Report on Form 8-K filed with the Commission on January
      26, 2009 (Commission File No. 001-33694)).10.42
                  +
                  Compensation
      Arrangements with I. Andrew Weeraratne (incorporated herein by reference
      to the Company’s Current Report on Form 8-K filed with the Commission on
      January 26, 2009 (Commission File No. 001-33694)).10.43
                  +
                  Compensation
      Arrangements with Philip Y. Shen, Ph.D. effective January 26, 2009
      (incorporated herein by reference to the Company’s Current Report on Form
      8-K filed with the Commission on January 26, 2009 (Commission File No.
      001-33694)).10.44
                  +
                  Amendment
      dated January 23, 2009 to Yuejian (James) Wang, Ph.D.’s Employment
      Agreement (incorporated herein by reference to the Company’s Current
      Report on Form 8-K filed with the Commission on January 26, 2009
      (Commission File No. 001-33694)).10.45
                  
                  Stock
      Purchase Agreement dated August 24, 2007 between Sense Holdings, Inc., CDI
      China, Inc. and China Direct, Inc. (incorporated herein by reference to
      Exhibit 10.1 as part of the Company’s Current Report on Form 8-K filed
      with the Commission on August 28, 2007 (Commission File No.
      000-26415)).14.1
                  
                  Code
      of Business Conduct and Ethics (incorporated herein by reference to
      Exhibit 14.1 as part of the Company’s Annual Report on Form 10-K for year
      ended December 31, 2007 filed with the Commission on March 31, 2008
      (Commission File No. 001-33694)).21.1
                  
                  Subsidiaries of the
  registrant.*23.1
                  
                  Consent of Sherb & Co.,
  LLP.*31.1
                  
                  Section 302 Certificate of Chief Executive
      Officer. *31.2
                  
                  Section 302 Certificate of Chief Financial
      Officer.*32.1
                  
                  Section 906 Certificate of Chief Executive
      Officer and Chief Financial Officer.*
 
 +
              
              Management
      contract or compensatory plan or arrangement.*
              
              Filed
      herewith.
 
  - 42
-
 Table of Contents
 
 SIGNATURES
 
 Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
 
 CHINA
      DIRECT, INC.Date:
      March 31, 2009
              By:
              /s/
      Yuejian (James) WangYuejian
      (James) Wang, Chief Executive Officer, President and Chairman (Principal
      Executive Officer)
 
 We, the
undersigned directors and officers of China Direct, Inc., hereby severally
constitute Yuejian (James) Wang and I. Andrew Weeraratne, and each of them
singly, our true and lawful attorneys with full power to them and each of them
to sign for us, in our names in the capacities indicated below, any and all
amendments to this Annual Report on Form 10-K filed with the Securities and
Exchange Commission.
 
 Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated.
 
 Signature
              
              Title
              
              Date/s/
      YUEJIAN (JAMES) WANG
              
              Chief
      Executive Officer, President and Chairman (Principal Executive
      Officer)
              
              March 31,
      2009Yuejian
      (James) Wang/s/
      INDRAJITH ANDREW WEERARATNE
              
              Chief
      Financial Officer (Principal Financial and Accounting
    Officer)
              
              March 31,
      2009INDRAJITH ANDREW
      WEERARATNE/s/
      YUWEI HUANG
              
              Executive
      Vice President - Magnesium, Director
              
              March 31,
      2009Yuwei
      Huang/s/
      DAVID BARNES
              
              Director
              
              March 31,
      2009David
      Barnes/s/
      GEORGE LEIBOWTIZ
              
              Director
              
              March 31,
      2009George
      Leibowitz/s/
      SHELDON STEINER
              
              Director
              
              March 31,
      2009Sheldon
      Steiner/s/
      PHILIP Y. SHENPhilip
      Y. Shen, Ph.D
              
              Director
              
              March 31,
      2009
 
 
  - 43
-
 Table of Contents
  CHINA
DIRECT, INC. AND SUBSIDIARIES
 FINANCIAL
STATEMENTS
 FOR
THE YEARS ENDED DECEMBER 31, 2008 AND 2007
 INDEX
TO AUDITED CONSOLIDATED FINANCIAL STATEMENTS
 
 CONTENTS
 
 Report
      of Independent Registered Public Accounting Firm
              
              F-2Consolidated
      Financial Statements:Consolidated
      Balance Sheets
              
              F-3Consolidated
      Statements of Operations
              
              F-4Consolidated
      Statement of Stockholders’ Equity
              
              F-5Consolidated
      Statements of Cash Flows
              
              F-6Notes
      to Audited Consolidated Financial Statements
              
              F-8
      to 36
  F -
1
 Table of Contents
  REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 
 Shareholders
and Directors
 China
Direct, Inc.
 
 We have
audited the accompanying consolidated balance sheets of China Direct, Inc. and
its Subsidiaries as of December 31, 2008 and 2007, and the related
consolidated statements of operations, stockholders’ equity and cash flows for
the years ended December 31, 2008 and 2007. 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. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. Our audit included consideration of internal
controls over financial reporting as a basis for designing audit procedures
that are appropriate in the circumstances, but not for the purposes of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. 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 financial position of China Direct, Inc. and its
subsidiaries as of December 31, 2008 and 2007, and the results of its
operations and its cash flows for the years ended December 31, 2008 and
2007 in conformity with accounting principles generally accepted in the
United States.
 
 SHERB
& CO., LLP
 
 /s/ Sherb & Co.,
LLP
 
 Boca
Raton, Florida
 March 27,
2009
 
 
  F -
2
 Table of Contents
 CHINA DIRECT, INC. AND SUBSIDIARIES
 CONSOLIDATED
BALANCE SHEETS
 December
      31,2008
                                  
                                  
                                  2007ASSETSCurrent
      Assets:Cash
      and cash equivalents
                                  
                                  $
                                  14,205,229
                                  
                                  
                                  $
                                  19,024,604Investment
      in marketable securities available for sale
                                  
                                  
                                  7,569,333
                                  
                                  
                                  
                                  7,820,500Investment
      in marketable securities available for sale - related
party
                                  
                                  
                                  160,459
                                  
                                  
                                  
                                  1,315,488Investment
      in subsidiaries -- cost method
                                  
                                  
                                  290,864
                                  
                                  
                                  
                                  -Accounts
      receivable, net of allowance
                                  
                                  
                                  9,457,306
                                  
                                  
                                  
                                  10,529,316Accounts
      receivable - related parties
                                  
                                  
                                  1,676,191
                                  
                                  
                                  
                                  2,283,600Inventories,
      net
                                  
                                  
                                  8,559,593
                                  
                                  
                                  
                                  5,270,388Prepaid
      expenses and other current assets
                                  
                                  
                                  8,127,300
                                  
                                  
                                  
                                  13,951,918Prepaid
      expenses - related parties
                                  
                                  
                                  8,007,111
                                  
                                  
                                  
                                  4,150,943Loans
      receivable - related parties
                                  
                                  
                                  1,652,728
                                  
                                  
                                  
                                  -Due
      from related parties
                                  
                                  
                                  35,710
                                  
                                  
                                  
                                  1,287,877Subsidiaries
      held for sale
                                  
                                  
                                  -
                                  
                                  
                                  
                                  3,604,849Total
      current assets
                                  
                                  
                                  59,741,824
                                  
                                  
                                  
                                  69,239,483Restricted
      cash
                                  
                                  
                                  846,197
                                  
                                  
                                  
                                  646,970Property,
      plant and equipment, net
                                  
                                  
                                  43,455,683
                                  
                                  
                                  
                                  17,413,489Prepaid
      expenses and other assets
                                  
                                  
                                  2,744,427
                                  
                                  
                                  
                                  433,075Property
      use rights, net
                                  
                                  
                                  591,277
                                  
                                  
                                  
                                  553,304Total
      assets
                                  
                                  $
                                  107,379,408
                                  
                                  
                                  $
                                  88,286,321LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      Liabilities:Loans
      payable-short term
                                  
                                  $
                                  933,735
                                  
                                  
                                  $
                                  1,909,781Accounts
      payable and accrued expenses
                                  
                                  
                                  8,590,010
                                  
                                  
                                  
                                  9,524,411Accounts
      payable-related parties
                                  
                                  
                                  7,516,728
                                  
                                  
                                  
                                  964,114Notes
      payable-related party
                                  
                                  
                                  -
                                  
                                  
                                  
                                  410,167Advances
      from customers
                                  
                                  
                                  1,545,273
                                  
                                  
                                  
                                  6,891,788Other
      payables
                                  
                                  
                                  1,624,370
                                  
                                  
                                  
                                  3,090,790Income
      taxes payable
                                  
                                  
                                  1,039,112
                                  
                                  
                                  
                                  304,977Due
      to related parties
                                  
                                  
                                  978,739
                                  
                                  
                                  
                                  3,137,233Subsidiaries
      held for sale
                                  
                                  
                                  -
                                  
                                  
                                  
                                  2,303,405Total
      current liabilities
                                  
                                  
                                  22,227,967
                                  
                                  
                                  
                                  28,536,666Loans
      payable-long term
                                  
                                  
                                  186,018
                                  
                                  
                                  
                                  166,573Minority
      interest
                                  
                                  
                                  26,940,141
                                  
                                  
                                  
                                  16,957,503Stockholders'
      Equity:Preferred
      Stock: $.0001 par value, stated value $1,000 per share; 10,000,000
      authorized, 1,006 sharesand
      0 shares issued and outstanding at December 31, 2008 and 2007,
      respectively
                                  
                                  
                                  1,006,250
                                  
                                  
                                  
                                  -Common
      Stock: $.0001 par value, 1,000,000,000 authorized, 23,530,642 and
      20,982,010issued
      and outstanding at December 31, 2008 and 2007,
respectively
                                  
                                  
                                  2,353
                                  
                                  
                                  
                                  2,098Additional
      paid-in capital
                                  
                                  
                                  51,701,293
                                  
                                  
                                  
                                  30,257,644Deferred
      compensation
                                  
                                  
                                  (11,000
                                  )
                                  
                                  
                                  (55,000
                                  )Accumulated
      comprehensive (loss) income
                                  
                                  
                                  (11,711,021
                                  )
                                  
                                  
                                  54,688Retained
      earnings
                                  
                                  
                                  17,037,407
                                  
                                  
                                  
                                  12,366,149Total
      stockholders’ equity
                                  
                                  
                                  58,025,282
                                  
                                  
                                  
                                  42,625,579Total
      liabilities and stockholders’ equity
                                  
                                  $
                                  107,379,408
                                  
                                  
                                  $
                                  88,286,321
 See notes
to audited consolidated financial statements
 F -
3
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 For
      the Year EndedDecember
      31,2008
                        
                        
                        2007Revenues
                        
                        $
                        223,217,359
                        
                        
                        $
                        163,023,330Revenues-related
      parties
                        
                        
                        16,750,008
                        
                        
                        
                        4,539,059Total
      revenues
                        
                        
                        239,967,367
                        
                        
                        
                        167,562,389Cost
      of revenues
                        
                        
                        206,947,930
                        
                        
                        
                        149,333,739Gross
      profit
                        
                        
                        33,019,437
                        
                        
                        
                        18,228,650Operating
      expenses:Selling,
      general, and administrative
                        
                        
                        12,050,648
                        
                        
                        
                        4,158,438Operating income
                        
                        
                        20,968,789
                        
                        
                        
                        14,070,212Other
      (expense) income:Other
      income
                        
                        
                        468,684
                        
                        
                        
                        877,485Interest
      income
                        
                        
                        277,378
                        
                        
                        
                        283,244Realized
      (loss) gain on sale of marketable securities
                        
                        
                        (136,923
                        )
                        
                        
                        616,045Realized
      (loss) on Other Than Temporary Impairment
                        
                        
                        (4,127,555
                        )
                        
                        
                        -Realized
      gain (loss) on sale subsidiaries
                        
                        
                        238,670
                        
                        
                        
                        (41,885
                        )Total
      other (expense) income
                        
                        
                        (3,279,746
                        )
                        
                        
                        1,734,889Net
      Income before income taxes
                        
                        
                        17,689,043
                        
                        
                        
                        15,805,101Income
      tax (expense)
                        
                        
                        (267,245
                        )
                        
                        
                        (727,479
                        )Income
      from continuing operations before minority interest
                        
                        
                        17,421,798
                        
                        
                        
                        15,077,622Minority
      interest
                        
                        
                        (6,077,810
                        )
                        
                        
                        (3,698,785
                        )Discontinued
      operation, net of tax
                        
                        
                        54,619
                        
                        
                        
                        447,714Net
      income
                        
                        $
                        11,398,607
                        
                        
                        $
                        11,826,551Deduct
      dividends on Series A Preferred Stock:Preferred
      stock dividend
                        
                        
                        (1,229,937
                        )
                        
                        
                        -Relative
      fair value of detachable warrants issued
                        
                        
                        (2,765,946
                        )
                        
                        
                        -Preferred
      stock beneficial conversion feature
                        
                        
                        (2,451,446
                        )
                        
                        
                        -Income
      applicable to common stockholders
                        
                        $
                        4,951,278
                        
                        
                        $
                        11,826,551Basic
      and diluted income per common share after deduction in the first quarter
      of 2008,of
      noncash deemed dividends attributable
      to Series A Preferred Stock as described in Note 13Basic
                        
                        $
                        0.22
                        
                        
                        $
                        0.75Diluted
                        
                        $
                        0.20
                        
                        
                        $
                        0.67Basic
      weighted average common shares outstanding
                        
                        
                        22,671,998
                        
                        
                        
                        15,841,560Diluted
      weighted average common shares outstanding
                        
                        
                        24,565,869
                        
                        
                        
                        17,605,664
 See notes
to audited consolidated financial statements
 F -
4
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENT OF STOCKHOLDERS' EQUITY
 Preferred
      Stock
                                        
                                        
                                        Common
      StockShares
                                        
                                        
                                        Amount
                                        
                                        
                                        Shares
                                        
                                        
                                        Amount
                                        
                                        
                                        Additional
      Paid-in Capital
                                        
                                        
                                        Deffered
      Compensation
                                        
                                        
                                        Accumulated
      Other Comprehensive Income (Loss)
                                        
                                        
                                        Retained
      Earnings
                                        
                                        
                                        TotalBalance,
      December 31, 2006
                                        
                                        
                                        -
                                        
                                        
                                        $
                                        -
                                        
                                        
                                        
                                        12,868,433
                                        
                                        
                                        $
                                        1,287
                                        
                                        
                                        $
                                        4,927,343
                                        
                                        
                                        $
                                        (226,840
                                        )
                                        
                                        $
                                        532,379
                                        
                                        
                                        $
                                        630,155
                                        
                                        
                                        $
                                        5,864,324Exercise
      of options
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        3,014,360
                                        
                                        
                                        
                                        302
                                        
                                        
                                        
                                        5,523,598
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        5,523,900Exercise
      of warrants
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        4,893,563
                                        
                                        
                                        
                                        489
                                        
                                        
                                        
                                        18,446,769
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        18,447,258Fair
      value of options granted to employees
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        257,804
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        257,804Fair
      value of options received by employees
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        234,550
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        234,550Issuance
      of common stock to key employees
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        52,000
                                        
                                        
                                        
                                        5
                                        
                                        
                                        
                                        135,195
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        135,200Issuance
      of common stock in connection with acquisitions
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        78,654
                                        
                                        
                                        
                                        7
                                        
                                        
                                        
                                        368,265
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        368,272Issuance
      of common stock for services
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        75,000
                                        
                                        
                                        
                                        8
                                        
                                        
                                        
                                        262,492
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        262,500Sale
      of Big Tree subsidiary
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        101,628
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        101,628Sale
      of Wanda subsidiary
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (107,357
                                        )
                                        
                                        
                                        (90,557
                                        )
                                        
                                        
                                        (197,914
                                        )Amortization
      of deferred compensation
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        171,840
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        171,840Comprehensive
      income:Net
      income for the year ended December 31, 2007
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        11,826,551
                                        
                                        
                                        
                                        11,826,551Unrealized
      (loss) on marketable securities held for sale
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (174,212
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (174,212
                                        )Unrealized
      (loss) on marketable securities held for sale related
party
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (1,510,465
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (1,510,465
                                        )Foreign
      currency translation gain
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,314,343
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,314,343Total
      Comprehensive Income
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        11,456,217Balance,
      December 31, 2007
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        20,982,010
                                        
                                        
                                        
                                        2,098
                                        
                                        
                                        
                                        30,257,644
                                        
                                        
                                        
                                        (55,000
                                        )
                                        
                                        
                                        54,688
                                        
                                        
                                        
                                        12,366,149
                                        
                                        
                                        
                                        42,625,579Sale
      of Series A Preferred Stock
                                        
                                        
                                        1,006
                                        
                                        
                                        
                                        1,006,250
                                        
                                        
                                        
                                        1,706,250
                                        
                                        
                                        
                                        170
                                        
                                        
                                        
                                        10,539,235
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        11,545,655Series
      A Preferred Stock conversion-make whole dividend
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        146,846
                                        
                                        
                                        
                                        15
                                        
                                        
                                        
                                        1,027,907
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (1,027,922
                                        )
                                        
                                        
                                        -Fair
      value of detachable warrants related to Februay Offering
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        2,765,946
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (2,765,946
                                        )
                                        
                                        
                                        -Instrinsic
      value of beneficial conversion feature related to February
      Offering
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        2,451,446
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (2,451,446
                                        )
                                        
                                        
                                        -Dividend
      declared for the first quarter-related to February
Offering
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (161,545
                                        )
                                        
                                        
                                        (161,545
                                        )Exercise
      of warrants
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        205,000
                                        
                                        
                                        
                                        20
                                        
                                        
                                        
                                        1,324,979
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,324,999Exercise
      of options
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        510,950
                                        
                                        
                                        
                                        51
                                        
                                        
                                        
                                        1,778,449
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,778,500Dividends
      Issued
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        2,860
                                        
                                        
                                        
                                        1
                                        
                                        
                                        
                                        20,015
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        20,016Dividends
      Payable
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        4,278
                                        
                                        
                                        
                                        1
                                        
                                        
                                        
                                        13,005
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (19,823
                                        )
                                        
                                        
                                        (6,818
                                        )Offering
      expenses related to warrants
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (200,000
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (200,000
                                        )Fair
      value of options granted to employees
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,459,745
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        1,459,745Fair
      value of warrants granted
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        103,708
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        103,708Stock
      award to Employees and Board of Director Member
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        61,950
                                        
                                        
                                        
                                        6
                                        
                                        
                                        
                                        595,671
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        595,677Amortization
      of deferred compensation
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        44,000
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        44,000Stock
      Repurchase
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (19,919
                                        )
                                        
                                        
                                        (8
                                        )
                                        
                                        
                                        (417,387
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (417,395
                                        )Reverse/Forward
      Split
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (69,583
                                        )
                                        
                                        
                                        (1
                                        )
                                        
                                        
                                        (19,070
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (19,071
                                        )Reclassification
      to Minority Interest
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (300,667
                                        )
                                        
                                        
                                        (300,667
                                        )Comprehensive
      income:Net
      income for the year ended December 31, 2008
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        11,398,607
                                        
                                        
                                        
                                        11,398,607Unrealized
      (loss) on marketable securities available for sale
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (11,213,394
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (11,213,394
                                        )Unrealized
      (loss) on marketable securities available for sale-related
      party
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (1,155,029
                                        )
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (1,155,029
                                        )Foreign
      currency translation loss
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        602,714
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        602,714Total
      Comprehensive Income
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        -
                                        
                                        
                                        
                                        (367,102
                                        )Balance,
      December 31, 2008
                                        
                                        
                                        1,006
                                        
                                        
                                        $
                                        1,006,250
                                        
                                        
                                        
                                        23,530,642
                                        
                                        
                                        $
                                        2,353
                                        
                                        
                                        $
                                        51,701,293
                                        
                                        
                                        $
                                        (11,000
                                        )
                                        
                                        $
                                        (11,711,021
                                        )
                                        
                                        $
                                        17,037,407
                                        
                                        
                                        $
                                        58,025,282
 See notes
to audited consolidated financial statements
 F -
5
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF CASH FLOWS
 For
      the Year EndedDecember
      31,2008
                                              
                                              
                                              2007Cash
      flows from operating activities:Net
      income
                                              
                                              $
                                              11,398,607
                                              
                                              
                                              $
                                              11,826,551Adjustments
      to reconcile net income to net cash (used in) provided by operating
      activities:Depreciation
                                              
                                              
                                              3,711,720
                                              
                                              
                                              
                                              314,097Allowance
      for bad debt
                                              
                                              
                                              161,869
                                              
                                              
                                              
                                              179,845Stock
      based compensation
                                              
                                              
                                              2,203,130
                                              
                                              
                                              
                                              429,644Realized
      loss (gain) on investment in marketable securities
                                              
                                              
                                              134,523
                                              
                                              
                                              
                                              (616,045
                                              )Realized
      loss on investment in marketable securities-related party
                                              
                                              
                                              2,400
                                              
                                              
                                              
                                              41,885Realized
      gain (loss) on sale subsidiaries
                                              
                                              
                                              (238,670
                                              )
                                              
                                              
                                              -Realized
      loss on investment in marketable securities - Other Than Temporary
      Impairment
                                              
                                              
                                              4,127,555
                                              
                                              
                                              
                                              -Fair
      value of securities received for services
                                              
                                              
                                              (15,332,138
                                              )
                                              
                                              
                                              (8,154,079
                                              )Minority
      interest
                                              
                                              
                                              6,077,810
                                              
                                              
                                              
                                              3,698,785Changes
      in operating assets and liabilities:Prepaid
      expenses and other current assets
                                              
                                              
                                              3,513,266
                                              
                                              
                                              
                                              (10,023,887
                                              )Prepaid
      expenses - related parties
                                              
                                              
                                              (3,856,168
                                              )
                                              
                                              
                                              (4,150,943
                                              )Inventories
                                              
                                              
                                              (3,289,205
                                              )
                                              
                                              
                                              1,455,461Accounts
      receivable
                                              
                                              
                                              910,140
                                              
                                              
                                              
                                              (10,922,512
                                              )Accounts
      receivable - related parties
                                              
                                              
                                              607,409
                                              
                                              
                                              
                                              (2,283,600
                                              )Accounts
      payable and accrued expenses
                                              
                                              
                                              (934,401
                                              )
                                              
                                              
                                              3,603,551Accounts
      payable - related party
                                              
                                              
                                              6,552,614
                                              
                                              
                                              
                                              (582,766
                                              )Advances
      from customers
                                              
                                              
                                              (5,346,515
                                              )
                                              
                                              
                                              4,238,626Other
      payables
                                              
                                              
                                              (1,466,420
                                              )
                                              
                                              
                                              434,009Deferred
      income taxes
                                              
                                              
                                              -
                                              
                                              
                                              
                                              (132,459
                                              )Income
      taxes payable
                                              
                                              
                                              734,135
                                              
                                              
                                              
                                              (249,535
                                              )Net
      cash provided by (used in) continuing activities
                                              
                                              
                                              9,671,661
                                              
                                              
                                              
                                              (10,893,372
                                              )Net
      cash provided by (used in) discontinued operations
                                              
                                              
                                              1,246,825
                                              
                                              
                                              
                                              (807,064
                                              )Net
      cash provided by (used in) operating activities
                                              
                                              
                                              10,918,486
                                              
                                              
                                              
                                              (11,700,436
                                              )Cash
      flows from investing activities:Cash
      acquired from acquisitions
                                              
                                              
                                              -
                                              
                                              
                                              
                                              2,700,963Decrease
      (increase) in notes receivable
                                              
                                              
                                              -
                                              
                                              
                                              
                                              (62,013
                                              )Increase
      in loans receivable-related parties
                                              
                                              
                                              (1,652,728
                                              )
                                              
                                              
                                              -Proceeds
      from the sale of marketable securities available for sale
                                              
                                              
                                              511,459
                                              
                                              
                                              
                                              2,094,344Purchases
      of property, plant and equipment
                                              
                                              
                                              (29,753,914
                                              )
                                              
                                              
                                              (5,813,138
                                              )Net
      cash (used in) provided by investing activities
                                              
                                              
                                              (30,895,183
                                              )
                                              
                                              
                                              (1,079,844
                                              )Cash
      flows from financing activities:Decrease
      (increase) in restricted cash
                                              
                                              
                                              (199,227
                                              )
                                              
                                              
                                              (199,257
                                              )Proceeds
      from loans payable
                                              
                                              
                                              1,119,753
                                              
                                              
                                              
                                              1,857,891Payment
      of loans payable
                                              
                                              
                                              (3,146,889
                                              )
                                              
                                              
                                              (2,409,419
                                              )Payment
      of notes payable
                                              
                                              
                                              (592,007
                                              )
                                              
                                              
                                              -Payment
      of notes payable-related party
                                              
                                              
                                              (410,167
                                              )
                                              
                                              
                                              -Payment
      of advances from executive officers
                                              
                                              
                                              -
                                              
                                              
                                              
                                              (140,893
                                              )Due
      from related parties
                                              
                                              
                                              1,273,291
                                              
                                              
                                              
                                              3,301,289Due
      to related parties
                                              
                                              
                                              (2,158,494
                                              )
                                              
                                              
                                              -Gross
      proceeds from sale of preferred stock
                                              
                                              
                                              12,950,000
                                              
                                              
                                              
                                              -Proceeds
      from exercise of warrants/options
                                              
                                              
                                              2,982,376
                                              
                                              
                                              
                                              23,971,158Cash
      payment for stock split/forward and stock repurchase
                                              
                                              
                                              (436,481
                                              )
                                              
                                              
                                              -Cash
      dividend payment to preferred stock holders
                                              
                                              
                                              (141,530
                                              )
                                              
                                              
                                              -Capital
      contribution from minority interest owners
                                              
                                              
                                              3,603,892
                                              
                                              
                                              
                                              -Offering
      expenses
                                              
                                              
                                              (1,504,345
                                              )
                                              
                                              
                                              -Net
      cash provided by financing activities
                                              
                                              
                                              13,340,172
                                              
                                              
                                              
                                              26,380,769Effects
      of exchange rate changes on cash
                                              
                                              
                                              1,817,150
                                              
                                              
                                              
                                              2,393,770Net
      (decrease) increase in cash
                                              
                                              
                                              (4,819,375
                                              )
                                              
                                              
                                              15,994,259Cash,
      beginning of year
                                              
                                              
                                              19,024,604
                                              
                                              
                                              
                                              3,030,345Cash,
      end of year
                                              
                                              $
                                              14,205,229
                                              
                                              
                                              $
                                              19,024,604Supplemental
      disclosures of cash flow information:Cash
      paid for taxes
                                              
                                              $
                                              250,059
                                              
                                              
                                              $
                                              929,865Cash
      paid for interest
                                              
                                              $
                                              187,188
                                              
                                              
                                              $
                                              34,751Dividend
      payment in stock to preferred stock shareholders
                                              
                                              $
                                              1,047,937
                                              
                                              
                                              $
                                              -Non-cash
      preferred stock deemed dividend
                                              
                                              $
                                              5,217,392
                                              
                                              
                                              $
                                              -
 See notes
to audited consolidated financial statements
 F -
6
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDI ARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007
  NOTE
1 – ORGANIZATION AND DESCRIPTION OF BUSINESS
 
 Business
and Organization
 
 China
Direct, Inc., a Florida corporation and its subsidiaries are referred to in this
report as the “Company”, “we”, “us”, “our”, or “China Direct”.
 
 We are a
U.S. company that manages a portfolio of Chinese entities.  We also
provide consulting services to Chinese businesses. We operate in three
identifiable segments, Magnesium, Basic Materials and Consulting, in accordance
with SFAS No. 131, “Disclosure
about segments of an Enterprise and Related Information”. In 2006 we
established our Magnesium and Basic Materials segments which have grown through
acquisitions of controlling interests of Chinese private companies. We
consolidate these acquisitions as either our wholly or majority owned
subsidiaries. Through this ownership control, we provide management advice as
well as investment capital to expand their businesses. We hold a controlling
interest in twelve subsidiaries operating in China, five of which comprise our
Magnesium segment and five comprise our Basic Materials segment. As of the date
of this report, we have a total of 1,287 full-time employees, the majority of
which, 1,269, work in the PRC.
 
 In our
largest segment, Magnesium, we operate eight entities which produce, sell and
distribute pure magnesium ingots, magnesium powders and magnesium
scraps.
 
 In our
Basic Materials segment, we operate five entities which sell and distribute a
variety of products including (i) industrial grade synthetic chemicals, (ii)
steel products (iii) non ferrous metals, and (iv) recycled materials. This
segment also includes our zinc mining property which has not commenced
operations.
 
 In our
Consulting segment, we provide a suite of consulting services to U.S. public
companies that operate primarily in China. The consulting fees we charge vary
based upon the scope of the services to be rendered.
 
 In 2007
we launched a Clean Technology segment. We discontinued this segment in the
third quarter of 2008 when we completed the sale in October 2008 of an 81%
interest in CDI Clean Technology and its 51% interest in CDI Wanda and its 52%
interest in Yantai CDI Wanda to PE Brothers Corp. for $1,240,000. We plan to
maintain the 19% ownership interest in CDI Clean Technology we
retained.
 
 NOTE
2 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
 
 Basis
of Presentation
 
 The
audited consolidated financial statements include China Direct, Inc. and all its
subsidiaries, including those operating outside the United States of America.
The audited consolidated financial statements have been prepared in accordance
with U.S. generally accepted accounting principles for annual financial
information and pursuant to the requirements for reporting on Form
10-K. Our year end is December 31. The year ended December 31,
2008 is referred to as “2008”, the year ended December 31, 2007 is referred to
as “2007”. Our consolidated statements include the accounts of the Company and
its controlled entities, including wholly owned and majority owned subsidiaries.
All significant inter-company account balances and transactions have been
eliminated.
 
 The
information included in these audited consolidated financial statements reflects
all adjustments (consisting solely of normal recurring adjustments) which are,
in the opinion of management, necessary for the fair presentation of the
consolidated financial position and the consolidated results of operations. The
consolidated balance sheet information as of December 31, 2007 was derived
from the audited consolidated financial statements included in our Annual Report
on Form 10-K for 2007. Certain reclassifications have been made to prior year
amounts to conform to the current year presentation and to disclose our
reclassification of discontinued operations.
 
 In
January 2008, CDI Wanda acquired a 52% interest in Yantai CDI Wanda in exchange
for $712,329.
  F -
7
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED F INANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
  In
February 2008, CDI China acquired a 51% interest in Baotou Changxin Magnesium in
exchange for $7,084,000, and Excel Rise, a wholly owned subsidiary of Chang
Magnesium, acquired a 39% interest in Baotou Changxin Magnesium in exchange for
$5,417,000. Accordingly, China Direct holds a 70.9% interest in Baotou Changxin
Magnesium.
 
 In
February 2008, CDI Shanghai Management invested $347,222 to acquire an 83%
interest in CDI Metal Recycling.
 
 In April
2008 CDI China entered into an Investment Framework Agreement to form Baotou
Xinjin Magnesium Co., Ltd., as a foreign invested enterprise. Under the terms of
the agreement, CDI China invested a total of approximately $7.3 million to
obtain a 51% interest. CDI China planned to make this investment over the
course of two years, once the business license had been approved, in accordance
with PRC law. During the third quarter of 2008, we elected not to pursue this
venture, and we have not submitted the business license applications. We did not
contribute any capital to Xinjin Magnesium.
 
 In June
2008, CDI Shanghai Management entered into an agreement to form CDI Beijing, a
company organized under the laws of the PRC. Under the terms of the Agreement,
CDI Shanghai Management acquired a 51% interest in CDI Beijing, in exchange for
$3.7 million. As of the date of this report, we have contributed $1.5 million;
the remainder of $2.2 million is due on or before September 30,
2009.
 
 During
the quarter ended September 30, 2008, we elected to exit the alternative energy
and recycling business conducted by CDI Clean Technology Group, Inc. (“CDI Clean
Technology”). Included as part of the sale of CDI Clean Technology are: (i)
Shandong CDI Wanda New Energy Co., Ltd., a Chinese limited liability company, a
51% majority owned subsidiary of CDI Clean Technology (?癈DI Wanda”) and (ii)
Yantai CDI Wanda Renewable Resources Co., Ltd., a Chinese limited liability
company, a 52% majority owned subsidiary of CDI Wanda (“Yantai CDI Wanda”). We
formed CDI Clean Technology in January 2007. We classified CDI Clean Technology
as “Subsidiaries held for sale” in accordance with the provisions of Statement
of Financial Accounting Standards (“SFAS”) No. 144. On October 30, 2008, we
completed the sale of an 81% interest in our wholly owned subsidiary CDI Clean
Technology to PE Brothers Corp. for $1,240,000.
 
 Accordingly,
during the quarter ended September 30, 2008, we ceased depreciation of CDI Clean
Technology and its subsidiaries and as a result of the held for sale
classification, we assessed the estimated fair value of the subsidiary and no
impairment charge was recognized. The results of operations from CDI Clean
Technology and its subsidiaries are classified as discontinued operations in
2008. Prior period reported results of operations of CDI Clean Technology and
its subsidiaries have been reclassified to reflect the assets and
liabilities of these subsidiaries as held for sale. As a result of this
transaction, we will account for our 19% ownership interest in CDI Clean
Technology as an investment using the equity method of accounting.
 
 Estimates
 
 The
preparation of financial statements in conformity with accounting principles
generally accepted in the United States of America requires management to make
estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements, and the reported amounts of revenue and expenses
during the reporting period. Actual results when ultimately realized could
differ from those estimates. Significant estimates in 2008 and 2007 include the
allowance for doubtful accounts of accounts receivable, stock-based
compensation, and the useful life of property, plant and equipment.
 
 Cash
and Cash Equivalents
 
 For
purposes of the consolidated statements of cash flows, we consider all highly
liquid investments with original maturities of three months or less to be cash
equivalents. The carrying values of these investments approximate their fair
value.
  F -
8
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 Concentration
of Credit Risks
 
 Financial
instruments which potentially subject us to concentrations of credit risk
consist principally of cash and trade accounts receivable. We deposit our cash
with high credit quality financial institutions in the United States and China.
As of December 31, 2008, bank deposits in the United States exceeded
federally insured limits by $130,068. At December 31, 2008, the Company had
deposits of $7,564,557 in banks in China. In China, there is no equivalent
federal deposit insurance as in United States; as such these amounts held in
banks in China are not insured. The Company has not experienced any losses in
such bank accounts through December 31, 2008.
 
 At
December 31, 2008 and 2007, our bank deposits by geographic area were as
follows:
 
 
 Country
                  
                  2008
                  
                  
                  2007United
      States
                  
                  $
                  6,640,672
                  
                  
                  
                  47
                  %
                  
                  $
                  9,942,948
                  
                  
                  
                  52
                  %China
                  
                  
                  7,564,557
                  
                  
                  
                  53
                  %
                  
                  
                  9,081,656
                  
                  
                  
                  48
                  %Total
      cash and cash equivalents
                  
                  $
                  14,205,229
                  
                  
                  
                  100
                  %
                  
                  $
                  19,024,604
                  
                  
                  
                  100
                  %
 
 In an
effort to mitigate any potential risk, we periodically evaluate the credit
quality of the financial institutions at which it holds deposits, both in the
United States and China.
 
 Accounts
receivable
 
 Accounts
receivable are reported at net realizable value. We have established an
allowance for doubtful accounts based upon factors pertaining to the credit
risks of specific customers, historical trends, age of the receivable and other
information. Delinquent accounts are written off when it is determined that the
amounts are uncollectible. At December 31, 2008 and December 31, 2007,
allowances for doubtful accounts were approximately $500,000 and $300,000,
respectively.
 
 Inventories
 
 Inventories,
consisting of raw materials and finished goods are stated at the lower of cost
or market utilizing the weighted average method. Inventories as of December 31,
2008 and December 31, 2007 totaled $8,559,593 and $5,270,388, respectively. Due
to the nature of our business and the short duration of the manufacturing
process of our products, there was no work-in-process inventory at December 31,
2008 and December 31, 2007.
 
 Accounts
payable-related parties
 
 At
December 31, 2008 our consolidated balance sheet reflects accounts
payable-related party of $7,516,728 compared to $964,114 in 2007. This item is
discussed in further detail in Note-12 Related Party Transactions.
 
 Fair
Value of Financial Instruments
 
 As of
January 1, 2008, we adopted on a prospective basis certain required provisions
of Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value
Measurements, as amended by Financial Accounting Standards Board (FASB)
Financial Staff Position (FSP) No. 157-2, on the effective date of FASB
Statement No. 157. Those provisions relate to our financial assets and
liabilities carried at fair value and our fair value disclosures related to
financial assets and liabilities. SFAS 157 defines fair value, expands related
disclosure requirements and specifies a hierarchy of valuation techniques based
on the nature of the inputs used to develop the fair value measures. Fair value
is defined as the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date. There are three levels of inputs to fair value
measurements - Level 1, meaning the use of quoted prices for identical
instruments in active markets; Level 2, meaning the use of quoted prices for
similar instruments in active markets or quoted prices for identical or similar
instruments in markets that are not active or are directly or indirectly
observable; and Level 3, meaning the use of unobservable inputs. Observable
market data should be used when available.
  F -
9
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 Most, but
not all, of our financial instruments are carried at fair value, including, all
of our cash equivalents, investments classified as available for sale securities
and assets held for sale and are carried at fair value, with unrealized gains
and losses, net of tax. Virtually all of our valuation measurements are Level 1
measurements. The adoption of SFAS 157 did not have a significant impact on our
consolidated financial statements.
 
 Marketable
Securities
 
 Marketable
securities held for sale and marketable securities held for sale-related party
at December 31, 2008 and December 31, 2007 consists of the
following:
 
 Company
                      
                      2008
                      
                      %
                      
                      
                      2007
                      
                      %China
      America Holdings, Inc.
                      
                      $
                      272,200
                      
                      
                      4
                      %
                      
                      $
                      1,828,481
                      
                      
                      20
                      %China
      Logistics Group, Inc.
                      
                      
                      1,807,357
                      
                      
                      24
                      %
                      
                      
                      4,042,500
                      
                      
                      44
                      %Dragon
      International Group Corp.
                      
                      
                      704,656
                      
                      
                      9
                      %
                      
                      
                      1,171,844
                      
                      
                      13
                      %China
      Armco Metals, Inc.
                      
                      
                      4,045,002
                      
                      
                      52
                      %
                      
                      
                      -
                      
                      
                      0
                      %Sunwin
      International Neutraceuticals, Inc.
                      
                      
                      649,337
                      
                      
                      8
                      %
                      
                      
                      -
                      
                      
                      0
                      %Other
                      
                      
                      251,240
                      
                      
                      3
                      %
                      
                      
                      2,093,163
                      
                      
                      23
                      %Marketable
      securities held for sale
                      
                      $
                      7,729,792
                      
                      
                      100
                      %
                      
                      $
                      9,135,988
                      
                      
                      100
                      %
  Through
our Consulting segment, we receive securities which include preferred stock,
common stock and common stock purchase warrants from clients. We classify these
securities as investments in marketable securities available for sale or
investment in marketable securities available for sale-related party. These
securities are stated at their fair value in accordance with SFAS No. 115“Accounting for Certain Investments
in Debt and Equity Securities ”, and EITF 00-8“Accounting by a Grantee for an
Equity Instrument to be Received in Conjunction with Providing Goods or
Services ”. Unrealized gains or losses in investments in marketable
securities available for sale are recognized as an element of other
comprehensive income on a monthly basis based on fluctuations in the fair value
of the security as quoted on an exchange or an inter-dealer quotation system.
Realized gains or losses are recognized in the consolidated statements of
operations when the securities are liquidated.
 Our
consulting fees vary based upon the scope of the services to be rendered.
Historically, a significant portion of the fees we earned have been paid in the
form of our clients’ securities which include preferred stock, common stock and
common stock purchase warrants from clients. We categorize securities as
investment in marketable securities available for sale and investment in
marketable securities available for sale-related party. Some of the securities
of China Logistics we own are restricted securities and cannot be readily resold
by us absent a registration of those securities under the Securities Act of 1933
(the “Securities Act”) or the availability of an exemption from the registration
requirements under the Securities Act.
 The
securities of one client, Dragon Capital Group Corp. (“Dragon Capital”),
accounted for all investment in marketable securities available for sale-related
party and totaled $160,459 at December 31, 2008. Dragon Capital is a
related party. Mr. Lisheng (Lawrence) Wang, the CEO and Chairman of the Board of
Dragon Capital, is the brother of Dr. James Wang, CEO and Chairman of China
Direct. These securities were issued by Dragon Capital as compensation for
consulting services. Dragon Capital is a non-reporting company whose securities
are quoted on the Pink Sheets, and as such, under Federal securities laws,
securities of Dragon Capital cannot be readily resold by us, generally, absent a
registration of those securities under the Securities Act. Dragon Capital does
not intend to register the securities.
  Other-than-temporary
impairment of securities is evaluated periodically to determine whether a
decline in their value is other than temporary. Management utilizes criteria
such as the magnitude and duration of the decline, in addition to the reasons
underlying the decline, to determine whether the loss in value is other than
temporary. The term “other-than-temporary” is not intended to indicate that the
decline is permanent. It indicates that the prospects for a near term recovery
of value are not necessarily favorable, or that there is a lack of evidence to
support fair values equal to, or greater than, the carrying value of the
investment. Once a decline in value is determined to be other than temporary,
the value of the security is reduced and a corresponding impairment charge to
earnings is recognized.
  F -
10
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 In
January 2009, the FASB issued FSP EITF 99-20-1 to amend the impairment
guidance in EITF Issue No. 99-20 in order to achieve more consistent
determination of whether an other-than-temporary impairment
(“OTTI”) has occurred. This FSP amended EITF 99-20 to more closely align
the OTTI guidance therein to the guidance in Statement No. 115.
Retrospective application to a prior interim or annual period is prohibited. The
guidance in this FSP was considered in the assessment of OTTI for various
securities at December 31, 2008.
 
 All
securities (exclusive of preferred stock and common stock purchase warrants)
received from our clients as compensation are quoted either on the Over the
Counter Bulletin Board or the Pink Sheets. The securities are typically
restricted as to resale. Our policy is to liquidate securities received as
compensation when market conditions are favorable for sale. As these securities
are often restricted, we are unable to liquidate these securities until the
restriction is removed. We recognize revenue for common stock based on the fair
value at the time common stock is granted and for common stock purchase warrants
based on the Black-Scholes valuation model. Unrealized gains or losses on
marketable securities available for sale and on marketable securities available
for sale-related party are recognized as an element of comprehensive income on a
monthly basis based on changes in the fair value of the security as quoted on an
exchange or an inter-dealer quotation system. Once liquidated, realized gains or
losses on the sale of marketable securities available for sale and
marketable securities available for sale-related party are reflected in our
net income for the period in which the security was liquidated.
 
 The
unrealized loss on marketable securities available for sale, net of the effect
of taxes, for the year ended December 31, 2008 and 2007 was $12,365,502 and
$1,684,677, respectively. Included in total unrealized loss is our unrealized
loss on marketable securities available for sale-related party, net of the
effect of taxes, for 2008 and 2007 of $1,291,474 and $1,510,465,
respectively.
 
 The
realized (loss) gain on investments in marketable securities available for sale
for the year ended December 31, 2008 and 2007 was $(4,242,059) and $574,160,
respectively. In 2008, our realized loss was mainly comprised of a $4,127,555
impairment loss related to our assessment of OTTI for securities available for
sale at December 31, 2008 under the guidance of FSP EITF 99-20-1 and
Statement No. 115.
 
 Prepaid
Expenses and Other Current Assets
 
 Prepaid
expenses and other current assets consist of (i) prepayments to vendors for
merchandise that had not yet been shipped, (ii) the fair value of securities
received from client companies associated with our Consulting segment assigned
to our executive officers and employees as compensation, (iii) value added tax
refunds available from the Chinese government, (iv) loans receivable and (v)
other receivables.
 At December 31, 2008 and 2007 our consolidated balance sheets include
prepaid expenses and other current assets of $8,127,300 and $13,951,918,
respectively.
 
 Non-current
prepaid expenses and other assets consist of (i) the fair value of the
securities of our client companies assigned to executive officers and employees
as compensation for services to be rendered over the term of the respective
consulting agreement which will be amortized beyond the twelve month period, and
(ii) other assets acquired in connection with the acquisition of Pan Asia
Magnesium. Accordingly, non-current prepaid expenses totaled $2,744,427 and
$433,075 at December 31, 2008 and 2007, respectively.
 
 Prepaid
Expenses – Related Parties
 
 Prepaid
expenses-related parties were $8,007,111 and $4,150,943, at December 31, 2008
and 2007, respectively. This item is discussed in further detail in Note-12
Related Party Transactions.
 
 Property,
Plant and Equipment
 
 Property,
plant and equipment are recorded at cost and depreciated on a straight line
basis over their estimated useful lives of three to forty years. Maintenance and
repairs are charged to expense as incurred. Significant renewals and
improvements are capitalized.
  F -
11
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 Acquisitions
 
 We
account for acquisitions using the purchase method of accounting in accordance
with the provisions of SFAS No. 141. In each of our acquisitions for the periods
presented, we determined that fair values were equivalent to the acquired
historical carrying costs.  Acquisitions to be made after December 15, 2008
will be accounted for under the provisions of SFAS 141R.
 
 Advances
from customers and deferred revenues
 
 Advances
from customers and deferred revenues represent prepayments to us for merchandise
that had not yet been shipped to customers, and the fair value of securities
received as compensation which will be amortized over the term of the
respective agreements. We will recognize these advances as revenues as
customers take delivery of the goods or when the services have been rendered, in
compliance with our revenue recognition policy. Advances from customers totaled
$1,545,273 and $6,891,788 at December 31, 2008 and 2007 (reclassified to
reflect discontinued operation), respectively.
 
 Comprehensive
income
 
 We follow
Statement of Financial Accounting Standards No. 130 (SFAS 130) “Reporting Comprehensive
Income” to recognize the elements of comprehensive income. Comprehensive
income is comprised of net income and all changes to the statements of
stockholders’ equity, except those due to investments by stockholders, changes
in paid-in capital and distributions to stockholders. Comprehensive income for
2008 and 2007 included net income, foreign currency translation adjustments,
unrealized gains or losses on marketable securities available for sale, net
of income taxes, and unrealized gains or losses on marketable securities
available for sale-related party, net of income taxes.
 
 Shipping
Costs
 
 Shipping
costs are included in selling and general and administrative expenses and
totaled $973,911 and $701,290 for the year ended December 31, 2008 and
2007, respectively.
 
 Foreign
currency translation
 
 The
accompanying consolidated financial statements are presented in United States
dollars. The functional currency of our Chinese subsidiaries is the Renminbi,
the official currency of the People’s Republic of China, (“RMB”). Capital
accounts of the consolidated financial statements are translated into United
States dollars from RMB at their historical exchange rates when the capital
transactions occurred. Assets and liabilities are translated at the exchange
rates as of the balance sheet date. Income and expenditures are translated at
the average exchange rates for the year ended December 31 2008 and 2007. A
summary of the conversion rates for the periods presented is as
follows:
 
 December
      31,2008
                  
                  
                  2007Year
      end RMB : U.S. Dollar exchange rate
                  
                  
                  6.854
                  
                  
                  
                  7.314Average
      year-to-date RMB : U.S. Dollar exchange rate
                  
                  
                  6.962
                  
                  
                  
                  7.617
 
 The RMB
is not freely convertible into foreign currency and all foreign exchange
transactions must take place through PRC authorized institutions. No
representation is made that the RMB amounts could have been, or could be,
converted into United States dollars at the rates applied in the
translation.
  F -
12
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 Impairment
of long-lived assets
 
 In
accordance with SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets”, we periodically review our long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying amount of the assets may not be fully recoverable. We recognize an
impairment loss when the sum of expected undiscounted future cash flows is less
than the carrying amount of the asset. The amount of impairment is measured as
the difference between the estimated fair value and the book value of the
underlying asset. We did not record any impairment charges during the years
ended December 31, 2008 and 2007, respectively.
 
 Subsidiaries
Held for Sale
 
 Long-lived
assets are classified as held for sale when certain criteria are met. These
criteria include management’s commitment to a plan to sell the assets; the
availability of the assets for immediate sale in their present condition; an
active program to locate buyers and other actions to sell the assets has been
initiated; the sale of the assets is probable and their transfer is expected to
qualify for recognition as a completed sale within one year; the assets are
being marketed at reasonable prices in relation to their fair value; and it is
unlikely that significant changes will be made to the plan to sell the assets.
We measure long-lived assets to be disposed of by sale at the lower of carrying
amount or fair value, less cost to sell.
 
 Minority
interest
 
 Under
generally accepted accounting principles when losses applicable to the minority
interest in a subsidiary exceed the minority interest in the equity capital of
the subsidiary, the excess is not charged to the majority interest since there
is no obligation of the minority interest to make good on such losses. We,
therefore, absorbed all losses applicable to a minority interest where
applicable. If future earnings do materialize, we shall be credited to the
extent of such losses previously absorbed.
 
 Income
Taxes
 
 We
accounted for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”.
SFAS No. 109 requires the recognition of deferred tax assets and
liabilities to reflect the future tax consequences of events that have been
recognized in our financial statements or tax returns. Measurement of the
deferred items is based on enacted tax laws. In the event the future
consequences of differences between the financial reporting and tax basis of our
assets and liabilities result in a deferred tax asset, SFAS No. 109
requires an evaluation of the probability of our being able to realize the
future benefits indicated by such assets. A valuation allowance related to a
deferred tax asset is recorded when it is more likely than not that some or the
entire deferred tax asset will not be realized.
 
 Basic
and Diluted Earnings per Share
 
 Under the
provisions of SFAS 128, “Earnings Per Share”, basic
income (loss) per common share is computed by dividing income (loss) available
to common shareholders by the weighted average number of shares of common stock
outstanding for the periods presented. Diluted income (loss) per share reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that would then share in the income of the company,
subject to anti-dilution limitations.
  F -
13
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 The
following table sets forth the computation of basic and diluted earnings per
share for 2008 and 2007:
 
 2008
                  
                  
                  Per
      Share
                  
                  
                  2007
                  
                  
                  Per
      ShareNumerator:Net
      income
                  
                  $
                  11,398,606
                  
                  
                  
                  
                  
                  
                  $
                  11,826,551Series
      A preferred stock:Preferred
      stock dividend
                  
                  
                  (1,229,937
                  )
                  
                  
                  
                  
                  
                  
                  -Relative
      fair value of detachable warrants issued
                  
                  
                  (2,765,946
                  )
                  
                  
                  
                  
                  
                  
                  -Preferred
      stock beneficial conversion feature
                  
                  
                  (2,451,446
                  )
                  
                  
                  
                  
                  
                  
                  -Numerator
      for basic EPS, Income applicable to common stock holders
    (A)
                  
                  
                  4,951,277
                  
                  
                  $
                  0.22
                  
                  
                  
                  11,826,551
                  
                  
                  $
                  0.75Denominator:Denominator
      for basic earnings per share - weighted average number of common shares
      outstanding
                  
                  
                  22,671,998
                  
                  
                  
                  
                  
                  
                  
                  15,841,560Stock
      Awards, Options, and Warrants
                  
                  
                  1,893,871
                  
                  
                  
                  
                  
                  
                  
                  1,764,104Denominator
      for diluted earnings per share - adjusted weighted average outstanding
      average number of common shares outstanding
                  
                  
                  24,565,869
                  
                  
                  
                  
                  
                  
                  
                  17,605,664Basic
      and Diluted Income Per Common Share:Earnings
      per share - basic
                  
                  $
                  0.22
                  
                  
                  
                  
                  
                  
                  $
                  0.75Earnings
      per share - diluted
                  
                  $
                  0.20
                  
                  
                  
                  
                  
                  
                  $
                  0.67
 
 * The
denominator in diluted earnings per share in 2008 does not include 728,134
shares that were assumed to be outstanding prior to conversion under the “if
converted” method and 122,240 shares issuable under the unconverted preferred
stock as dividends, as such inclusion would be anti-dilutive.
 
 Revenue
Recognition
 
 We follow
the guidance of the Securities and Exchange Commission's Staff Accounting
Bulletin (“SAB”) No. 104 and SAB Topic 13 for revenue recognition. In general,
we record revenue when persuasive evidence of an arrangement exists, services
have been rendered or product delivery has occurred, the sales price to the
customer is fixed or determinable, and collectability is reasonably
assured.
 
 Stock
Based Compensation
 
 We
account for the grant of stock options and restricted stock awards in accordance
with SFAS 123R, “Share-Based
Payment, an Amendment of FASB Statement No. 123” (“SFAS
123R”). SFAS 123R requires companies to recognize in the statement of operations
the grant-date fair value of stock options and other equity based
compensation.
 
 Recent
Pronouncements
 
 In
January 2009, the FASB issued FSP EITF 99-20-1 to amend the impairment
guidance in EITF Issue No. 99-20 in order to achieve more consistent
determination of whether an other-than-temporary impairment (“OTTI”) has
occurred. This FSP amended EITF 99-20 to more closely align the OTTI guidance
therein to the guidance in Statement No. 115. Retrospective application to
a prior interim or annual period is prohibited. The guidance in this FSP was
considered in the assessment of OTTI for various securities at December 31,
2008.
  F -
14
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 is
intended to improve financial reporting about derivative instruments and hedging
activities by requiring enhanced disclosures to enable investors to better
understand their effects on an entity’s financial position, financial
performance, and cash flows. It is effective for financial statements issued for
fiscal years and interim periods beginning after November 15, 2008, with early
application encouraged. We are currently evaluating the requirements of
SFAS 161 and the impact of adoption on our consolidated financial
statements.
 
 In May
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (“FSP”) APB 14-1,Accounting for Convertible Debt Instruments That
May Be Settled in Cash upon Conversion (Including Partial CashSettlement). FSP APB 14-1
clarifies that convertible debt instruments that may be settled in cash upon
either mandatory or optional conversion (including partial cash settlement) are
not addressed by paragraph 12 of APB Opinion No. 14,Accounting for Convertible Debt and
Debt issued with Stock PurchaseWarrants. Additionally, FSP
APB 14-1 specifies that issuers of such instruments should separately account
for the liability and equity components in a manner that will reflect the
entity’s nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. FSP APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. We will adopt FSP APB 14-1 beginning in the first
quarter of fiscal 2009, and this standard must
be applied on a retrospective basis. We are evaluating the impact the adoption
of FSP APB 14-1 will have on our consolidated financial position and results of
operations.
 
 In May
2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No.
162,The Hierarchy of
Generally Accepted AccountingPrinciples. This standard is
intended to improve financial reporting by identifying a consistent framework,
or hierarchy, for selecting accounting principles to be used in preparing
financial statements that are presented in conformity with generally accepted
accounting principles in the United States for non-governmental entities. SFAS
No. 162 is effective 60 days following approval by the U.S. Securities and
Exchange Commission (“SEC”) of the Public Company Accounting Oversight Board’s
amendments to AU Section 411,The Meaning of PresentFairly in Conformity with Generally
Accepted AccountingPrinciples. We do not expect
SFAS No. 162 to have a material impact on the preparation of our consolidated
financial statements.
 
 On
September 16, 2008, the FASB issued final FSP No. EITF 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions Are ParticipatingSecurities,” to address the
question of whether instruments granted in share-based payment transactions are
participating securities prior to vesting. The FSP determines that unvested
share-based payment awards that contain rights to dividend payments should be
included in earnings per share calculations. The guidance will be effective for
fiscal years beginning after December 15, 2008. We are currently evaluating the
requirements of (FSP) No. EITF 03-6-1, as well as the impact of the adoption on
our consolidated financial statements.
 
 On
October 10, 2008, the FASB issued SFP No. 157-3,Determining the Fair Value of a Financial Asset When
the Market for That Asset Is Not Active.  This FASB Staff Position
(FSP) clarifies the application of FASB Statement No. 157, Fair Value
Measurements, in a market that is not active and provides an example to
illustrate key considerations in determining the fair value of a financial asset
when the market for that financial asset is not active. Statement 157 was issued
in September 2006, and is effective for financial assets and financial
liabilities for financial statements issued for fiscal years beginning
after November 15, 2007, and interim periods within those fiscal
years. We have adopted SFAS 157-3 and determined that it had no impact as
of December 31, 2008, and we will continue to evaluate the impact, if any, of
SFAS 157-3 on our financial statements.
 
 A variety
of proposed or otherwise potential accounting standards are currently under
study by standard setting organizations and various regulatory agencies. Due to
the tentative and preliminary nature of those proposed standards, management has
not determined whether implementation of such proposed standards would be
material to our consolidated financial statements.
  F -
15
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 NOTE
3 – NOTES RECEIVABLE
 
 At
December 31, 2008 and 2007, notes receivable, included in our accounts
receivables, consisted of the following:
  2008
                    
                    
                    2007Notes
      receivable from Shanghai Xinshijie Petrochemical Industrial Co.,
      Ltd.
                    
                    $
                    -
                    
                    
                    $
                    27,344Due
      on demand. Non-interest bearing.Notes
      receivable from Shanghai Weigang Fine Chemical Industrial Co.,
      Ltd.
                    
                    
                    -
                    
                    
                    
                    15,444Due
      on demand. Non-interest bearing.Notes
      receivable from Shanghai GaoDong Chemical Industrial Co.,
    Ltd.
                    
                    
                    -
                    
                    
                    
                    6,836Due
      on demand. Non-interest bearing.Notes
      receivable from Shanghai Xulian Industrial Co., Ltd.
                    
                    
                    -
                    
                    
                    
                    4,102Due
      on demand. Non-interest bearing.Notes
      receivable from Mudanjiang Northeast Chemical Co., Ltd.
                    
                    
                    -
                    
                    
                    
                    273,444Due
      on demand. Non-interest bearing.Notes
      receivable from Xiamen International Trading Co., Ltd.
                    
                    
                    196,084
                    
                    
                    
                    683,611Due
      on demand. Non-interest bearing.Bank
      Guaranteed Notes due from Lang Chemical
                    
                    
                    123,443
                    
                    
                    
                    -Total
                    
                    
                    319,527
                    
                    
                    
                    1,010,781Less:
      Current Portion
                    
                    $
                    (319,527
                    )
                    
                    $
                    (1,010,781
                    )Notes
      Receivable, long-term
                    
                    $
                    -
                    
                    
                    $
                    -
 
 NOTE
4 – INVENTORIES
 
 At
December 31, 2008 and 2007, inventories, consisted of the
following:
 
 2008
                    
                    
                    2007Raw
      materials
                    
                    $
                    6,081,259
                    
                    
                    $
                    4,194,190Finished
      goods
                    
                    
                    3,038,956
                    
                    
                    
                    1,076,198Inventory
      Reserve
                    
                    
                    (560,622
                    )
                    
                    
                    -$
                    8,559,593
                    
                    
                    $
                    5,270,388
 
 Due to
the nature of our business and the short duration of the manufacturing process
for our products; there was no work in process inventory at December 31, 2008
and December 31, 2007.
  F -
16
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
  NOTE
5 – PREPAID EXPENSES AND OTHER CURRENT ASSETS
 
 At
December 31, 2008 and 2007, prepaid expenses and other current assets, consist
of the following:
 
 2008
                  
                  
                  2007Prepayments
      to vendors for merchandise that had not yet been shipped or services that
      had not been performed
                  
                  $
                  2,173,989
                  
                  
                  $
                  10,069,687Other
      receivables
                  
                  
                  2,434,578
                  
                  
                  
                  3,043,193Fair
      value of securities received from client companies associated with our
      Consulting segment assigned to employees as compensation
                  
                  
                  524,907
                  
                  
                  
                  638,961Loans
      receivable
                  
                  
                  2,987,615
                  
                  
                  
                  -Other
      assets acquired in connection with acquisition
                  
                  
                  2,745,525
                  
                  
                  
                  138,089VAT
      Tax refund available from Chinese government
                  
                  
                  -
                  
                  
                  
                  143,784Other
                  
                  
                  5,113Securities
      deposits
                  
                  
                  -
                  
                  
                  
                  351,279Total
                  
                  
                  10,871,727
                  
                  
                  
                  14,384,993Less:
      Current Portion
                  
                  
                  (8,127,300
                  )
                  
                  
                  (13,951,918
                  )Prepaid
      expenses and other assets, non-current
                  
                  $
                  2,744,427
                  
                  
                  $
                  433,075
 
 NOTE 6 – OTHER RECEIVABLES
 
 At
December 31, 2008 and 2007 other receivables included in prepaid expenses
and other assets consisted of the following:
 
 2008
                      
                      
                      2007Advances
      to suppliers
                      
                      $
                      1,538,540
                      
                      
                      $
                      2,317,173Tax
      refund
                      
                      
                      386,073
                      
                      
                      
                      653,995Deposits
      for equipment purchases
                      
                      
                      411,203
                      
                      
                      
                      47,579Other
                      
                      
                      98,762
                      
                      
                      
                      24,446$
                      2,434,578
                      
                      
                      $
                      3,043,193
 
 
 NOTE
7 - PROPERTY, PLANT AND EQUIPMENT
 
 At
December 31, 2008 and 2007, property, plant and equipment, consisted of the
following:
 
 Description
                      
                      Useful
      Life
                      
                      
                      2008
                      
                      
                      2007Building
                      
                      10-40
      years
                      
                      
                      $
                      7,792,403
                      
                      
                      $
                      4,904,304Manufacturing
      equipment
                      
                      10
      years
                      
                      
                      
                      12,635,161
                      
                      
                      
                      7,099,541Office
      equipment and furniture
                      
                      3-5
      years
                      
                      
                      
                      636,621
                      
                      
                      
                      380,846Autos
      and trucks
                      
                      5
      years
                      
                      
                      
                      334,630
                      
                      
                      
                      468,761Construction
      in progress
                      
                      N/A
                      
                      
                      
                      26,277,835
                      
                      
                      
                      5,069,284Total
                      
                      
                      
                      
                      
                      
                      47,676,650
                      
                      
                      
                      17,922,736Less:  Accumulated
      Depreciation
                      
                      
                      
                      
                      
                      
                      (4,220,967
                      )
                      
                      
                      (509,247
                      )Property,
      Plant and Equipment, Net
                      
                      
                      
                      
                      
                      $
                      43,455,683
                      
                      
                      $
                      17,413,489
 
 For the
years ended December 31, 2008 and 2007, depreciation expense totaled
$3,711,720 and $314,097, respectively.
  F -
17
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 NOTE
8 – PROPERTY USE RIGHTS
 
 Property
use rights, consisting of mining and property use rights amounted to $591,277
and $553,304 at December 31, 2008 and 2007, respectively.
 
 We
acquired property use rights valued at $96,078, in connection with the
acquisition of CDI Magnesium in February 2007. The property use rights provide
for the use of certain properties located in China until February 12, 2010.
We will begin to amortize the value of the property use rights when the
magnesium refinery commences operations.
 
 In
connection with our acquisition of CDI Jixiang Metal in December 2007, we
acquired mining rights to 51 acres located in the Yongshun Kaxi Lake Mining area
of China. Acquisition costs for the mining rights as of December 31, 2008 are
$495,199. CDI Jixiang Metal is presently in the exploration stage of its
business operations and is engaged in the evaluation of mineral deposits or
reserves. We have not established a reserve. There is no assurance
that commercially viable mineral deposits exist on this property and
further exploration will be required before a final evaluation as to the
economic feasibility is determined.
 
 Mineral
property acquisition costs, site restoration costs and development costs on
mineral properties with proven and probable reserves are capitalized and will be
depleted using the units-of-production method over the estimated life of the
reserves. If there are insufficient reserves to use as a basis for depleting
such costs, they will be written off as mineral property or mineral interest
impairment in the period in which the determination is made. Site restoration
costs are depleted over the term of their expected life. The development
potential of mining properties is established by the existence of proven and
probable reserves, reasonable assurance that the property can be permitted as an
operating mine and evidence that there are no metallurgical or other impediments
to the production of saleable metals.
 
 Exploration
costs incurred on mineral interests, other than acquisition costs, prior to the
establishment of proven and probable reserves are charged to operations as
incurred. Development costs incurred on mineral interests with proven and
probable reserves will be capitalized as mineral properties. We regularly
evaluate our investments in mineral interests to assess the recoverability
and/or the residual value of the investments in these assets. All mineral
interests and mineral properties are reviewed for impairment whenever events or
circumstances change which indicate the carrying amount of an asset may not be
recoverable, utilizing established guidelines based upon undiscounted future net
cash flows from the asset or upon the determination that certain exploration
properties do not have sufficient potential for economic
mineralization.
 
 The
estimates of mineral prices and operating, capital and reclamation costs, when
available, are subject to certain risks and uncertainties, which may affect the
recoverability of mineral property costs. Although we make our best estimates of
these factors, it is possible that changes could occur in the near term, which
could adversely affect the future net cash flows to be generated from our
mineral properties.
 
 NOTE
9 – OTHER PAYABLES
 
 At
December 31, 2008 and 2007, other payables consisted of the
following:
  2008
                  
                  
                  2007Refund
      on advances on purchases
                  
                  $
                  -
                  
                  
                  $
                  1,698,765VAT
      taxes
      payable
                  
                  
                  -
                  
                  
                  
                  1,390,917Interest
      payable
                  
                  
                  60,000
                  
                  
                  
                  -Payable
      to individuals
                  
                  
                  565,694
                  
                  
                  
                  -Payable
      to former shareholder
                  
                  
                  647,508
                  
                  
                  
                  -Other
                  
                  
                  351,168
                  
                  
                  
                  1,108$
                  1,624,370
                  
                  
                  $
                  3,090,790
 
  F -
18
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
  NOTE
10 – ACQUISITIONS
 
 Acquisition of a 83% interest inCDI Metal
Recycling
 
 In March
2008, CDI Shanghai Management formed CDI Metal Recycling as a joint venture
entity. CDI Shanghai Management contributed $347,222 to the registered capital
of the joint venture, representing an 83% interest.
  Acquisition
of a 70.9% interest in Baotou Changxin Magnesium
 
 In
February 2008, CDI China, entered into an agreement with Excel Rise and
Three Harmony (Australia) Party, Ltd. (“Three Harmony”) to form Baotou Changxin
Magnesium, a company organized under the laws of the PRC, as a FIE. Prior to
September 30, 2008 CDI China contributed  $7,084,000 to the registered
capital of this entity, Excel Rise contributed $5,417,000 and Three Harmony
contributed $1,389,000, representing a 51%, 39% and 10% interest, respectively.
Accordingly, China Direct controls a 70.9% interest in Baotou Changxin
Magnesium.
 
 Acquisition
of a 51% interest in CDI Beijing
 
 In June
2008, CDI Shanghai Management entered into an agreement to form CDI Beijing, a
Chinese limited liability company. Under the terms of the agreement, CDI
Shanghai Management acquired a 51% interest in CDI Beijing, which became
effective in September 2008 when CDI Beijing received a business license from
the Chinese government. Under the terms of the agreement, the initial registered
investment amount of CDI Beijing is $7,270,000; $3,570,000 and
$3,700,000 to be contributed by Mr. Chen and CDI Shanghai Management,
respectively, in installments on or before September 2009. As of the date
of this report, we have contributed $1,500,000 with the remainder of
$2,200,000 is due on or before September 30, 2009.
  F -
19
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
  NOTE
11 – LOANS PAYABLE
 
 Loans
payable at December 31, 2008 and 2007 consisted of the
following:
 
 2008
                                                                  
                                                                  
                                                                  2007Loan
      due to NanTong Chemical, a related party, due on
      demand.  Non-interest bearing. This full amount was satisfied in
      January 2008
                                                                  
                                                                  $
                                                                  -
                                                                  
                                                                  
                                                                  $
                                                                  410,167Loan
      due to Zhejiang JuNeng Import and Export Co., Ltd.  Due on
      demand.  Non-interest bearing.
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  273,444Secured
      by Lang Chemical’s restricted cash; which was satisfied in January
      2008Loan
      due to JiangSu Suopu Group Shanghai Branch.  Due on
      demand.  Non-interest bearing. Secured by Lang Chemical’s
      restricted cash
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  136,722Loan
      due to Shanghai WuJin Chemical Co., Ltd.  Due on
      demand.  Non-interest bearing. Secured by Lang Chemical’s
      restricted cash
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  181,841Loan
      due to China Commercial Bank, dated July 3, 2007, due in quarterly
      installments through July 3, 2012.  8.13% annual interest rate.
      Secured by Lang Chemical’s property
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  216,932Loan
      due to Shanxi Xinglong Foundry Co., Ltd. Due on demand. Non-interest
      bearing.
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  428,624Loan
      due to Taiyuan YanKang Industrial Co., Ltd. Due on demand. Non-interest
      bearing.
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  428,624Loan
      due to China Industry Bank., an unrelated party.  Due July
      2012.  6.06375% annual interest rate
                                                                  
                                                                  
                                                                  186,018Commercial
      Bank due May 2009, related to Lang Chemical, (Lang Chemical deposited
      Principal amount to guarantee this note)
                                                                  
                                                                  
                                                                  262,613Minsheng
      Bank Due October 2009, interest is LIBOR plus 25%
                                                                  
                                                                  
                                                                  671,122Total
                                                                  
                                                                  
                                                                  1,119,753
                                                                  
                                                                  
                                                                  
                                                                  2,076,354Less:
      Current Portion
                                                                  
                                                                  
                                                                  (933,735
                                                                  )
                                                                  
                                                                  
                                                                  (1,909,781
                                                                  )Loans
      payable, long-term
                                                                  
                                                                  $
                                                                  186,018
                                                                  
                                                                  
                                                                  $
                                                                  166,573
 
 Future
minimum loan payments required under the loan agreements as discussed herein are
as follows:
  Period
                    
                    TotalPeriod
      Ending December 31, 2009
                    
                    $
                    53,148Period
      Ending December 31, 2010
                    
                    
                    53,148Period
      Ending December 31, 2011
                    
                    
                    53,148Period
      Ending December 31, 2012
                    
                    
                    26,574Thereafter
                    
                    
                    —$
                    186,018
 
  F -
20
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
  NOTE
12 – RELATED PARTY TRANSACTIONS
 
 List of Related
Parties
 
 We have
specified the following persons and entities as related parties with ending
balances as of December 31, 2008 and 2007:
 
 •
              Yuwei
      Huang is executive vice president of our Magnesium segment, a member of
      the board of directors, chief executive officer and chairman of Chang
      Magnesium, chairman of Baotou Changxin Magnesium, chairman of YiWei
      Magnesium, and chief executive officer and vice chairman of Golden
      Magnesium;•
              Taiyuan
      YiWei Magnesium Industry Co., Ltd., a company organized under the laws of
      the PRC (“YiWei Magnesium”), is a minority interest owner in Chang
      Magnesium;•
              Lifei
      Huang is the daughter of Yuwei Huang;•
              Huihuan
      Huang is the sister of Yuwei Huang;•
              Lifei
      Huang is a registered representative of Pine Capital Enterprises Inc., a
      company organized under the laws of the Caymen Islands (“Pine
      Capital”);•
              Lifei
      Huang is a registered representative of Wheaton Group Corp., a
      company organized under the laws of Brunei Darussalam
      (“Wheaton”);•
              Nippon
      Magnetic Dressing Co., Ltd., a company organized under the laws of the
      Japan (“Nippon Magnetic”), is a minority interest owner of YiWei
      Magnesium;•
              Shanxi
      Senrun Coal Chemistry Co., Ltd., a company organized under the laws
      of the PRC (“Senrun Coal”), is a minority interest owner in Golden
      Magnesium;•
              Shanxi
      Jinyang Coal and Coke Group Co., Ltd., a company organized under the laws
      of the PRC (“Jinyang Group”), is a minority interest owner of Pan
      Asia Magnesium;•
              Japan
      Material Industry Co., Ltd. a company organized under the laws of the PRC,
      (“Japan Material”), is a minority interest owner of YiWei
      Magnesium;•
              Runlian
      Tian is a director of Pan Asia Magnesium;•
              Hiubiao
      Zhao is the brother of an officer of Pan Asia
Magnesium;•
              NanTong
      Langyuan Chemical Co., Ltd., a company organized under the laws of the PRC
      (“NanTong Chemical”), is owned by Jingdong Chen and Qian Zhu, the minority
      interest owners of Lang Chemical;•
              Jingdong
      Chen, is vice president of our Basic Materials segment and chief executive
      officer of Lang Chemical;•
              Qian
      Zhu is chief financial officer of Lang Chemical. Jingdong Chen and Qian
      Zhu are husband and wife;•
              Zhou
      Weiyi is the minority interest owner in CDI Metal
    Recycling;•
              Chen
      Chi is vice president of our Basic Materials Segment and minority interest
      owner of CDI Beijing; and•
              Lisheng
      (Lawrence) Wang is the chief executive officer and chairman of Dragon
      Capital Group Corp. a Nevada corporation, (“Dragon Capital”) and is the
      brother of Dr. Wang, CEO and Chairman of China Direct and Xiaowen Zhuang,
      a key employee.
  F -
21
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 Accounts
Receivable – related parties
 
 At
December 31, 2008 we reported accounts receivable – related parties of
$1,676,191 comprised of the following:
 
 •
              $1,628,896
      due Baotou Changxin Magnesium from YiWei Magnesium, for inventory
      provided; and,•
              $47,295
      due Golden Magnesium from YiWei Magnesium for inventory
      provided.
 
 At
December 31, 2007 we reported accounts receivable – related parties of
$2,283,600 comprised of the following:
 
 •
              $1,287,317
      due Chang Magnesium from YiWei Magnesium, for product
      provided;•
              $996,283
      due Golden Magnesium from YiWei Magnesium for product
      provided.
 
 Prepaid
Expenses – related parties
 
 At
December 31, 2008 we reported prepaid expenses – related parties of
$8,007,111 comprised of the following:
 
 •
              $5,830,717
      prepaid by Chang Magnesium to YiWei Magnesium for future delivery of
      inventory;•
              $940,699
      prepaid by Golden Magnesium to Senrun Coal for future delivery of coke gas
      for fuel;•
              $520,397
      prepaid by Chang Magnesium to Nippon Magnetic to for future delivery of
      inventory;•
              $389,225
      prepaid by Pan Asia Magnesium to Jinyang Group for the future delivery of
      coke gas.•
              $326,073
      prepaid by Golden Magnesium to YiWei Magnesium for future delivery of
      inventory; and,
 
 At
December 31, 2007 we reported prepaid expenses-related parties of
$4,150,943 comprised of the following:
 
 •
              $1,805,351
      prepaid by Chang Magnesium to YiWei Magnesium for future delivery of
      inventory;•
              $1,382,312
      prepaid by Golden Magnesium to YiWei Magnesium for future delivery of
      inventory; and•
              $963,280
      prepaid by Lang Chemical to NanTong Chemical for future delivery of
      chemical inventory;
 
 Loan
Receivable – related parties
 
 At
December 31, 2008 we reported loan receivables – related parties of
$1,652,728 comprised of the following:
 
 •
              $1,608,959
      due Lang Chemical from NanTong Chemical for funds advanced for working
      capital purposes; and,•
              43,769
      due CDI Shanghai Management from Dragon Capital for funds advanced for
      working capital purposes.
 
 At
December 31, 2007 we reported loan receivables – related parties of
$0.
  F -
22
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 Due
from related parties
 
 At
December 31, 2008 we reported due from related parties of $35,710 comprised
of the following:
 
 •
              $21,125
      due China Direct from a China Direct employee for the exercise price of
      exercised options; and,•
              $14,585 due
      CDI Metal Recycling from Zhou Weiyi, for the contribution of registered
      capital related to the formation of CDI Metal
  Recycling.
 
 At
December 31, 2007 we reported due from related parties of $1,287,877
comprised of the following:
 
 •
              $1,287,877
      due Pan Asia Magnesium from a Jinyang Group for working capital
      purposes.
 
 Accounts
Payable – related parties
 
 At
December 31, 2008 we reported accounts payable – related party of
$7,516,728 comprised of the following:
 
 •
              $4,497,180
      due from Chang Magnesium to Pine Capital in repayment of an advance from
      customer for the expected delivery of inventory,•
              $3,019,548
      due from Chang Magnesium to Wheaton Group in repayment of an advance form
      customer for the expected delivery of
inventory,
 
 At
December 31, 2007 we reported accounts payable–related parties of $964,114
comprised of the following:
 
 •
              $604,596
      due from Chang Magnesium to YiWei Magnesium for delivered inventory;
      and•
              $359,518
      due from Golden Magnesium to YiWei Magnesium for delivered
      inventory.
 
 Notes
Payable – related parties
 
 At
December 31, 2008 we reported notes payable–related party of
$0.
 
 At
December 31, 2007 we reported notes payable–related party of $410,167
comprised of the following:
 
 •
              $410,167
      due Nantong Chemical from Lang Chemical for fund advances for working
      capital purposes.
 
 Due
to related parties
 
 At
December 31, 2008 we reported due to related parties balance of
$978,739 comprised of the following:
 
 •
              $832,843 due
      to Chen Chi, this amount is made of up $729,257 due from Capital One
      Resource, and $103,586 from CDI Beijing for fund advances for working
      capital purposes;•
              $145,896
      advanced by Huihuan Huang to Chang Magnesium for working capital
      purposes.
  F -
23
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 At
December 31, 2007, our financial statements reflect a due to related
parties balance of $3,137,233. This amount is comprised of:
 
 •
              $1,993,410
      advanced by Japan Material to Chang Magnesium for working capital
      purposes;•
              $652,921
      advanced by YiWei Magnesium to Chang Magnesium and Golden Magnesium for
      working capital purposes;•
              $287,662
      advanced by Ms. Runlian Tian and Mr. Hiubiao Zhao to Pan Asia
      Magnesium for working capital purposes.•
              $203,240
      advanced by CDI Wanda to Mr. Dai Feng, an officer of CDI Wanda.
      NanTong Chemical is a Chinese limited liability company owned by Jingdong
      Chen and Qian Zhu, the two minority shareholders of Lang
      Chemical.
 
 NOTE
13 – STOCKHOLDERS' EQUITY
 
 Preferred
Stock
 
 We have
10,000,000 shares of preferred stock, par value $.0001, authorized, of which we
designated 12,950 as our Series A Convertible Preferred Stock in February 2008.
At December 31, 2008, there were 1,006 shares of Series A Convertible Preferred
Stock issued and outstanding. There were no shares of Series A Convertible
Preferred Stock issued and outstanding as of December 31, 2007.
 
 Series
A Preferred Stock and Related Dividends
 
 On
February 11, 2008, we entered into a Securities Purchase Agreement with
accredited investors to sell, in a private placement transaction, 12,950 shares
of our Series A Convertible Preferred Stock (“Series A Preferred Stock”)
together with common stock purchase warrants to purchase an aggregate of
1,850,000 shares of our common stock. At closing, we received gross proceeds of
$12,950,000. The Series A Preferred Stock has a stated value per share of
$1,000, carries an 8% per annum dividend rate payable quarterly in arrears and
is convertible into common stock at $7.00 per share. The dividends are payable
in cash or shares of our common stock, at our option, subject to certain
provisions. If paid in shares of common stock, the stock shall be valued at the
lower of the conversion price or the average of the weighted average price of
the 10 consecutive trading days immediately preceding the dividend
date.
 
 Upon
conversion of the Series A Preferred Stock, we are required to pay an amount
(the “Make-Whole Additional Amount”) equal to 8% of the stated value of the
shares converted or redeemed - essentially an extra year’s dividend. This amount
shall be paid in shares valued at the lower of the conversion price or 90% of
the weighted average price of our common stock for the 10 consecutive trading
days immediately preceding the date of notice.
 
 A
registration statement covering the public resale of the shares of common stock
underlying the Series A Preferred Stock and the warrants was declared effective
by the Securities and Exchange Commission on April 23, 2008.
 
 As of
December, 2008, holders of our Series A Preferred Stock have converted 11,944
shares of the 12,950 shares of the Series A Preferred Stock. Each share of
Series A Preferred stock was convertible into 142.85 shares of common stock. As
a result of the conversion of the Series A Preferred Stock, we have issued
1,706,250 shares of our common stock, 14,624 shares of common stock in payment
of the accrued dividends, and 136,500 shares of common stock, the Make-Whole
Additional Amount. The 1,850,000 warrants issued to purchasers of the Series A
Preferred Stock, exclusive of the 300,000 warrants issued to Roth Capital
Partners, LLC (“Roth Capital”) as a fee, were determined to have a fair value of
$2.07 per warrant with a total valuation of $3,829,500. Inputs used in making
this determination included:
 
 •
              Value
      of $6.83 per share of common stock;•
              Expected
      volatility factor of 90%;•
              $0
      dividend rate on the common stock;•
              Warrant
      exercise price of $8.00;•
              Estimated
      time to exercise of 1 year; and•
              Risk
      free rate of 2.06%.
 
  F -
24
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 The
relative fair value of the warrants of $2,765,946 has been recorded as a
dividend.
 
 In
addition, under the provisions of EITF 98-5‘Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios’(“EITF 98-5”),  and EITF 00-27"Application of Issue No. 98-5 to
Certain Convertible Instruments’" ("EITF 00-27”), the
Series A Preferred Stock issuance carried an embedded beneficial conversion
feature at issuance. Accordingly, after first allocating the proceeds received
from the Series A Preferred Stock offering to the preferred shares and
detachable warrants on a relative fair value basis, we derived an intrinsic
value of the conversion feature of $2,451,446. As the Series A Preferred Stock
does not have a stated redemption date or finite life, the deemed dividend was
recognized immediately as a non-cash charge during 2008. This non-cash one-time
preferred stock deemed dividend was calculated as the difference between the
average of our common stock price of $6.83 per share and the calculated
effective conversion price of the Series A Preferred Stock. The effective
conversion price of the Series A Preferred Stock was determined with reference
to the relative fair value allocation of proceeds between the Series A Preferred
Stock and Warrants issued. The non-cash deemed dividend did not have an effect
on net earnings, or cash flows for the year ended December 31, 2008. The
estimated fair market value of the Warrants of $2,765,946 has been recorded as
additional paid-in capital and a reduction to the recorded amount of the Series
A Preferred Stock.
 
 We paid
Roth Capital a fee of $1,295,000 for serving as the placement agent in the
Series A Preferred Stock Offering. Roth Capital also received 300,000 common
stock purchase warrants, exercisable at $8.00 per share for five years as part
of their fee. At February 11, 2008, the warrants granted to Roth Capital had a
fair value of $2.07 per share, totaling $621,000. The warrants issued to Roth
Capital have the same terms, and were valued in the same manner as the warrants
issued to the purchasers of the Series A Preferred Stock.
 
 Common
Stock
 
 China
Direct has 1,000,000,000 shares of common stock, par value $.0001, authorized.
At December 31, 2008 there were 23,530,642 shares of common stock issued and
outstanding and there were 20,982,010 shares of common stock issued and
outstanding at December 31, 2007.
 
 For the
year ended December 31, 2008 and 2007, amortization of stock based compensation
amounted to $2.2 million and $429,644, respectively.
  F -
25
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 During
the year ended December 31, 2008, we issued 205,000 shares of common stock in
connection with the exercise of common stock purchase warrants. Of
the common stock purchase warrants; 75,000 were exercised at $4.00 per
share, 30,000 were exercised at $7.50 per share, and 100,000 were exercised at
$8.00 per share.
 
 During
the year ended December 31, 2008, we issued 510,950 shares of common stock in
connection with the exercise of common stock options and warrants with net
proceeds of $1,778,500. Of these options, 298,950 shares were exercised at $2.50
per share, 25,000 shares were exercised at $3.00 per share and 187,000
shares were exercised at $5.00 per share.
 
 During
the year ended December 31, 2008, we issued 1,706,250 shares of our common stock
upon conversion of the Series A Preferred Stock, 7,138 shares of common stock in
payment of the accrued dividends, and 136,500 shares of common stock pursuant to
the Make-Whole Additional Amount feature of the Series A Preferred
Stock.
 
 Stock
Repurchase Program
 
 On
September 10, 2008, our board of directors authorized a stock repurchase program
to repurchase up to $2.5 million of our common stock through March 31, 2009. The
stock repurchase program was announced on September 12, 2008. The amount and
timing of specific repurchases are subject to market conditions, applicable
legal requirements and other factors deemed appropriate by our CEO and
President. Repurchases may be in open-market transactions or through privately
negotiated transactions, and our board of directors may discontinue the
repurchase program at any time. During 2008 we purchased 19,919 shares at
an average price of $3.98 per share, these shares were redeemed in
September and October 2008.
 
 Reverse
Split/Forward Split
 
 On
September 10, 2008, our board of directors approved a 1 for 100 shares
reverse split of our common stock (the “Reverse Split”) to be immediately
followed by a 100 for 1 forward split of our common stock (the
“Forward Split”). The Reverse Split/Forward Split was announced on September 19,
2008. Shareholders who held in the aggregate less than one share of common stock
following the Reverse Split were not included in the Forward Split. Rather, such
shares received a cash payment. During 2008, we purchased 69,583 shares at
an average purchase price of $5.13 per share; these shares were
redeemed during September 2008.
 
 Stock
Option Plans
 
 On August
16, 2006, our board of directors authorized the 2006 Equity Plan (the “2006
Equity Plan”) covering 10,000,000 shares of our common stock, which was approved
by a majority of our shareholders on August 16, 2006. At December 31, 2008 2007
there were options outstanding to purchase an aggregate of 365,000 and 390,000
shares, respectively, of common stock outstanding under the 2006 Equity Plan at
exercise prices ranging from $2.50 to $7.50 per share.
 
 On
October 19, 2006, our board of directors authorized the 2006 Stock Plan (the
“2006 Stock Plan”) covering 2,000,000 shares of our common stock. As the 2006
Stock Plan was not approved by our shareholders prior to October 19, 2007, we
may no longer award incentive stock options under the 2006 Stock Plan and any
incentive stock options previously awarded under the 2006 Stock Plan were
converted into non-qualified options upon terms and conditions determined
by the board of directors, as nearly as is reasonably practicable in their
sole determination, to the terms and conditions of the incentive stock options
being so converted. At December 31, 2008 and December 31, 2007, there were
options outstanding to purchase an aggregate of 414,590 and 1,615,000 shares,
respectively of common stock outstanding under the 2006 Stock Plan at exercise
prices ranging from $.01 to $5.00 per share.
  F -
26
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 During
2008, we granted 240,000 options under the 2006 Equity Plan to employees with an
exercise price of $5.00 to $7.50 per share, of these options, 221,000 options
were canceled during the year ended December 31, 2008. The options were valued
on the date of grant using the Black-Scholes option-pricing model, in accordance
with SFAS No. 123R using the following weighted-average assumptions:
expected dividend yield 0%, risk-free interest rate of 2.51%, volatility of 78%
and expected term of 1.31 years.
 
 On April
25, 2008, our board of directors adopted the 2008 Executive Stock Incentive Plan
covering 1,000,000 shares of our common stock, which was approved by a majority
vote of our shareholders on May 30, 2008. As of December 31, 2008 no awards had
been granted under this plan.
 
 On April
25, 2008, our board of directors adopted the 2008 Non-Executive Stock Incentive
Plan covering 3,000,000 shares of our common stock, which was approved by a
majority vote of our shareholders on May 30, 2008. As of December 31, 2008 we
granted 268,648 shares of restricted stock with vesting dates ranging from
August 2008 to September 2010 under this plan.
 
 The
following table sets forth our stock option activity during the years ended
December 31, 2008 and 2007:
 
 
 Shares
      underlying options
                              
                              
                              Weighted
      average exercise priceOutstanding
      at January 1, 2007
                              
                              
                              9,843,980
                              
                              
                              $
                              3.27Granted
                              
                              
                              111,000
                              
                              
                              
                              3.92Exercised
                              
                              
                              (3,014,360
                              )
                              
                              
                              1.83Outstanding
      at December 31, 2007
                              
                              
                              6,940,620
                              
                              
                              
                              8.14Granted
                              
                              
                              240,000
                              
                              
                              
                              6.20Exercised
                              
                              
                              (519,400
                              )
                              
                              
                              3.44Expired
      or cancelled
                              
                              
                              (221,000
                              )
                              
                              
                              7.50Exercisable
      at December 31, 2008
                              
                              
                              6,440,220
                              
                              
                              $
                              5.71Weighted-average
      exercise price of options granted during 2008
                              
                              
                              
                              
                              
                              $
                              6.20
  F -
27
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
  
 The
weighted average remaining contractual life and weighted average exercise price
of options outstanding at December 31, 2008, for selected exercise price
ranges, are as follows:
 
 Range
      of exercise prices
                    
                    
                    Number
      of options outstanding
                    
                    
                    Weighted
      average remaining contractual life (Years)
                    
                    
                    Weighted
      average exercise price
                    
                    
                    Options
      Exercisable
                    
                    
                    Weighted
      average exercise price of options exercisable$
                    0.01
                    
                    
                    
                    1,050,000
                    
                    
                    
                    1.4
                    
                    
                    $
                    0.01
                    
                    
                    
                    1,050,000
                    
                    
                    $
                    0.012.25
                    
                    
                    
                    400
                    
                    
                    
                    6.06
                    
                    
                    
                    2.25
                    
                    
                    
                    400
                    
                    
                    
                    2.252.5
                    
                    
                    
                    571,240
                    
                    
                    
                    3
                    
                    
                    
                    2.5
                    
                    
                    
                    579,690
                    
                    
                    
                    2.53
                    
                    
                    
                    50,000
                    
                    
                    
                    2
                    
                    
                    
                    3
                    
                    
                    
                    50,000
                    
                    
                    
                    35
                    
                    
                    
                    1,221,000
                    
                    
                    
                    3
                    
                    
                    
                    5
                    
                    
                    
                    1,352,000
                    
                    
                    
                    57.5
                    
                    
                    
                    1,412,000
                    
                    
                    
                    4
                    
                    
                    
                    7.5
                    
                    
                    
                    1,375,000
                    
                    
                    
                    7.510
                    
                    
                    
                    1,375,000
                    
                    
                    
                    5
                    
                    
                    
                    10
                    
                    
                    
                    -
                    
                    
                    
                    -15
                    
                    
                    
                    500
                    
                    
                    
                    1.68
                    
                    
                    
                    15
                    
                    
                    
                    500
                    
                    
                    
                    1530
                    
                    
                    
                    760,000
                    
                    
                    
                    4
                    
                    
                    
                    30
                    
                    
                    
                    760,000
                    
                    
                    
                    30$
                    56.25
                    
                    
                    
                    80
                    
                    
                    
                    6.17
                    
                    
                    
                    56.25
                    
                    
                    
                    80
                    
                    
                    
                    56.256,440,220
                    
                    
                    
                    3.56
                    
                    
                    $
                    8.44
                    
                    
                    
                    5,167,670
                    
                    
                    $
                    8.00
 
 The
weighted average grant date fair value of options granted during 2008 and 2007
was $6.20 per share and $3.92 per share, respectively. The total
intrinsic value of stock options exercised during 2008 and 2007 was $2,998,055
and $10,846,281, respectively. The aggregate intrinsic value of the
Company’s outstanding and exercisable options at December 31, 2008 and 2007 was
$1,512,000 and $20,050,000, respectively.
 
 Common
Stock Purchase Warrants
 
 During
2008, we granted 25,000 common stock purchase warrants to consultants,
exercisable immediately at an exercise price of $11.00. These warrants were fair
valued on the date of grant at $103,707 using the Black-Scholes option-pricing
model, in accordance with SFAS No. 123R using the following weighted-average
assumptions: expected dividend yield of 0%, risk-free interest rate of 3.0%,
volatility factor of 100% and expected term of 3 years. The fair value of these
grants was recognized as selling, general and administrative
expenses.
 
 In
February 2008, in connection with the $12,950,000 Series A Preferred Stock
offering, we issued a total of 2,150,000 common stock purchase warrants,
including 1,850,000 warrants issued to investors and 300,000 warrants issued to
Roth Capital as the placement agent as part of their fee. The warrants are
exercisable at $8.00 per share for a period of five years and were fair valued
at $2.07 per warrant using the Black-Scholes Option-pricing model. Assumptions
used in the calculation included: expected dividend yield of 0%; risk-free
interest rate of 2.06%; volatility factor of 90% and expected term of 1
year.
  F -
28
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 A summary
of the status of our outstanding common stock purchase warrants granted as of
December 31, 2008 and changes during the period is as follows:
 
 
 Shares
      underlying warrants
                      
                      
                      Weighted
      average exercise priceOutstanding
      at January 1, 2007
                      
                      
                      7,541,875
                      
                      
                      $
                      6.89Granted
                      
                      
                      -
                      
                      
                      
                      -Exercised
                      
                      
                      (4,893,563
                      )
                      
                      
                      3.87Expired
      or cancelled
                      
                      
                      -
                      
                      
                      
                      -Outstanding
      at December 31, 2007
                      
                      
                      2,648,312
                      
                      
                      
                      8.70Granted
                      
                      
                      2,175,000
                      
                      
                      
                      8.03Exercised
                      
                      
                      (205,000
                      )
                      
                      
                      6.46Outstanding
      at December 31, 2008
                      
                      
                      4,618,312
                      
                      
                      $
                      8.49Exercisable
      at December 31, 2008
                      
                      
                      4,618,312
                      
                      
                      $
                      8.49
 
 The
following information applies to all warrants outstanding at December 31,
2008.
 
 Warrants
                                      
                                      
                                      WarrantsOutstanding
                                      
                                      
                                      ExercisableWeightedAverage
                                      
                                      
                                      Weighted
                                      
                                      
                                      
                                      
                                      
                                      WeightedRemaining
                                      
                                      
                                      Average
                                      
                                      
                                      
                                      
                                      
                                      AverageRange
      of
                                      
                                      
                                      
                                      
                                      
                                      Contractual
                                      
                                      
                                      Exercise
                                      
                                      
                                      
                                      
                                      
                                      ExerciseExercise
      prices
                                      
                                      
                                      Shares
                                      
                                      
                                      Life
      (Years)
                                      
                                      
                                      Price
                                      
                                      
                                      Shares
                                      
                                      
                                      Price$
                                      2.5
                                      
                                      
                                      
                                      50,000
                                      
                                      
                                      
                                      3.17
                                      
                                      
                                      $
                                      2.5
                                      
                                      
                                      
                                      50,000
                                      
                                      
                                      $
                                      2.54
                                      
                                      
                                      
                                      473,750
                                      
                                      
                                      
                                      3.04
                                      
                                      
                                      
                                      4.0
                                      
                                      
                                      
                                      473,750
                                      
                                      
                                      
                                      4.07.5
                                      
                                      
                                      
                                      60,000
                                      
                                      
                                      
                                      1.64
                                      
                                      
                                      
                                      7.5
                                      
                                      
                                      
                                      60,000
                                      
                                      
                                      
                                      7.58
                                      
                                      
                                      
                                      2,050,000
                                      
                                      
                                      
                                      4.37
                                      
                                      
                                      
                                      8.0
                                      
                                      
                                      
                                      2,050,000
                                      
                                      
                                      
                                      8.010
                                      
                                      
                                      
                                      1,869,562
                                      
                                      
                                      
                                      2.99
                                      
                                      
                                      
                                      10.0
                                      
                                      
                                      
                                      1,869,562
                                      
                                      
                                      
                                      10.011
                                      
                                      
                                      
                                      25,000
                                      
                                      
                                      
                                      2.52
                                      
                                      
                                      
                                      11.0
                                      
                                      
                                      
                                      25,000
                                      
                                      
                                      
                                      11.0$
                                      15
                                      
                                      
                                      
                                      90,000
                                      
                                      
                                      
                                      1.64
                                      
                                      
                                      
                                      15.0
                                      
                                      
                                      
                                      90,000
                                      
                                      
                                      
                                      15.04,618,312
                                      
                                      
                                      
                                      3.56
                                      
                                      
                                      $
                                      8.49
                                      
                                      
                                      
                                      4,618,312
                                      
                                      
                                      $
                                      8.49
 
 NOTE
15 – MARKETABLE SECURITIES
 
 Marketable
securities held for sale and marketable securities held for sale-related party
are valued at the date received. The fair market values at December 31,
2008 and 2007 are as follows:
 
 For
      the Year Ended December 31, 2008January
      1, 2008
                        
                        
                        Amount
      Received/Sold
                        
                        
                        Cost
      Basis Adjustment for OTTI
                        
                        
                        Unrealized
      (Loss)
                        
                        
                        December
      31, 2008Investment
      in marketable securities held for sale
                        
                        $
                        7,820,500
                        
                        
                        $
                        15,089,777
                        
                        
                        $
                        (4,127,550
                        )
                        
                        $
                        (11,213,394
                        )
                        
                        $
                        7,569,333Investment
      in marketable securities held for sale-related party
                        
                        
                        1,315,488
                        
                        
                        
                        -
                        
                        
                        
                        -
                        
                        
                        
                        (1,155,029
                        )
                        
                        
                        160,459Total
      Investment in marketable securities held for sale
                        
                        $
                        9,135,988
                        
                        
                        $
                        15,089,777
                        
                        
                        $
                        (4,127,550
                        )
                        
                        $
                        (12,368,423
                        )
                        
                        $
                        7,729,792
 
  F -
29
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
  For
      the Year Ended December 31, 2007January
      1, 2007
                            
                            
                            Amount
      Received/Sold
                            
                            
                            Reclassifying
      from/to trading
                            
                            
                            Unrealized
      (Loss)
                            
                            
                            December
      31, 2007Investment
      in trading securities
                            
                            $
                            2,166,603
                            
                            
                            $
                            -
                            
                            
                            $
                            (2,166,603
                            )
                            
                            $
                            -
                            
                            
                            $
                            -Investment
      in trading securities-related party
                            
                            
                            311,611
                            
                            
                            
                            (47,611
                            )
                            
                            
                            (264,000
                            )
                            
                            
                            -
                            
                            
                            
                            -Total
      Investment in trading securities
                            
                            $
                            2,478,214
                            
                            
                            $
                            (47,611
                            )
                            
                            $
                            (2,430,603
                            )
                            
                            $
                            -
                            
                            
                            $
                            -Investment
      in marketable securities held for sale
                            
                            $
                            -
                            
                            
                            $
                            5,801,837
                            
                            
                            $
                            2,166,603
                            
                            
                            $
                            (147,940
                            )
                            
                            $
                            7,820,500Investment
      in marketable securities held for sale-related party
                            
                            
                            1,325,400
                            
                            
                            
                            1,571,228
                            
                            
                            
                            264,000
                            
                            
                            
                            (1,845,140
                            )
                            
                            
                            1,315,488Total
      Investment in marketable securities held for sale
                            
                            $
                            1,325,400
                            
                            
                            $
                            7,373,065
                            
                            
                            $
                            2,430,603
                            
                            
                            $
                            (1,993,080
                            )
                            
                            $
                            9,135,988
 
 NOTE
16 – INCOME TAXES
 
 The
Company’s parent and their U.S. subsidiaries are subject to applicable Federal,
State and Local tax statues. The Company’s subsidiaries in China are governed by
the Income Tax Law of the Peoples Republic of China concerning Foreign
Investment Enterprises and Foreign Enterprises and local income tax laws (the
“PRC Income Tax Law”). Pursuant to the PRC Income Tax Law, wholly foreign owned
enterprises are subject to tax at a statutory rate of 25%. The Company intends
to utilize profits earned by our Chinese based subsidiaries in China to expand
our PRC based operations.
 
 The
components of income (loss) before income tax consist of the
following:
 
 2008
                      
                      
                      2007U.S.
      Operations
                      
                      $
                      (3,808,000
                      )
                      
                      $
                      (1,665,000
                      )China
      Operations
                      
                      
                      20,995,671
                      
                      
                      
                      16,743,000Discontinued
      Operations
                      
                      
                      234,329
                      
                      
                      
                      -$
                      17,422,000
                      
                      
                      $
                      15,078,000
 
 The
provision (benefit) for income taxes is including the discontinued operations
component composed of the following:
 
 2008
                    
                    
                    2007Current:Federal
                    
                    $
                    (277,759
                    )
                    
                    $
                    (461,000
                    )State
                    
                    
                    -
                    
                    
                    
                    (60,000
                    )Chinese
      Operations
                    
                    
                    545,006
                    
                    
                    
                    618,000Discontinued
      operations
                    
                    
                    127,200
                    
                    
                    
                    -Deferred:Federal
                    
                    
                    -
                    
                    
                    
                    554,000State
                    
                    
                    -
                    
                    
                    
                    76,000$
                    394,447
                    
                    
                    $
                    727,000
 
  F -
30
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 The table
below summarizes the reconciliation of the Company’s income tax provision
including the discontinued operations components computed at the federal
statutory rate and the actual tax provision as follows:
 
 2008
                        
                        
                        2007Income
      tax (benefit) provision at Federal statutory rate
                        
                        $
                        5,614,000
                        
                        
                        $
                        5,172,000State
      income taxes, net of Federal benefit
                        
                        
                        577,000
                        
                        
                        
                        680,000Unrealized
      (gains) losses on marketable securities
                        
                        
                        -
                        
                        
                        
                        1,105,000Stock
      based compensation
                        
                        
                        -
                        
                        
                        
                        264,000US
      & state tax rate in excess of China tax rate
                        
                        
                        (898,000
                        )
                        
                        
                        (1,183,000
                        )China
      reduced tax rate zones
                        
                        
                        (5,706,000
                        )
                        
                        
                        (5,369,000
                        )Other
                        
                        
                        807,000
                        
                        
                        
                        58,000Tax
      provision
                        
                        $
                        394,000
                        
                        
                        $
                        727,000
 
 Deferred
income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and
the amounts used for income tax purposes. There were no effect to the deferred
tax assets and liabilities as of December 31, 2008 and 2007.
 
 NOTE
17 – COMMITMENTS
  Acquisition of a 51% interest in CDI Beijing
 
 In June
2008, CDI Shanghai Management entered into an agreement to form CDI Beijing, a
Chinese limited liability company. Under the terms of the agreement, CDI
Shanghai Management acquired a 51% interest in CDI Beijing, which became
effective in September 2008 when CDI Beijing received a business license from
the Chinese government. Under the terms of the agreement, the initial registered
investment amount of CDI Beijing is $7,270,000; $3,570,000 and
$3,700,000 to be contributed by Mr. Chen and CDI Shanghai Management,
respectively, in installments on or before September 2009. As of the date
of this report, we have contributed $1,500,000 with the remainder of
$2,200,000 is due on or before September 30,
2009.
 Leases
 
 China
Direct entered into an office lease agreement for its corporate offices in
Florida at an annual expense of $233,000. The term of the lease is from
March 1, 2008 through February 28, 2013.
 
 CDI
Shanghai Management entered into an office lease agreement with an annual lease
expense of $48,529. The term of the lease is from January 1, 2009 through
December 31, 2009.
 
 CDI
Metal Recycling operates from a 14,000 square foot manufacturing and office
space located at 1258 Nangang Road, Nanhui District, Shanghai, China. The term
of the lease is from January 2008 to December 2017 for a commitment of
approximately $17,000 annually.
 
 CDI
Beijing leases approximately 1,654 square foot office space located in Beijing,
China for an annual expense of approximately $20,500 pursuant to a lease that
expires in March 2010. Future minimum rental payments required under the leases
as discussed herein are as follows:
 
 Period
                    
                    TotalPeriod
      Ended December 31, 2009
                    
                    $
                    308,911Period
      Ended December 31, 2010
                    
                    
                    260,382Period
      Ended December 31, 2011
                    
                    
                    240,236Period
      Ended December 31, 2012
                    
                    
                    240,236Period
      Ended December 31, 2013
                    
                    
                    63,695Thereafter
                    
                    
                    68,946$
                    1,182,406
 
 NOTE
18 - SEGMENT INFORMATION
 
 The
following information is presented in accordance with SFAS No. 131, “Disclosure about segments of an
Enterprise and Related Information”. For the year ended December 31,
2008, we operated in three reportable business segments after giving effect to
our decision to exit the clean technology segment during this period as
follows:
  F -
31
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 Magnesium
segment:
 
 •
              Chang
      Magnesium;•
              Chang
      Trading;•
              Excel
      Rise;•
              CDI
      Magnesium;•
              Asia
      Magnesium;•
              Golden
      Magnesium;•
              Pan
      Asia Magnesium;•
              Baotou
      Changxin Magnesium; and•
              Capital OneResource.  (1)
 
 Basic
Materials segment:
 
 •
              Lang
      Chemical;•
              CDI
      Jingkun Zinc;•
              CDI
      Jixiang Metal; and•
              CDI
      Metal Recycling.
 
 Consulting
segment:
 
 •
              China
      Direct Investments;•
              CDI
      Shanghai Management; and•
              Capital
      One Resource. (1)
 
 (1) Capital One Resource
generated revenues in two reporting segments; Magnesium and
Consulting.
 
 Our
reportable segments are strategic business units that offer different products
and services. Each segment is managed and reported separately based on the
fundamental differences in their operations. CDI Metal Recycling was formerly in
our Clean Technology Segment, which we exited during the quarter in 2008. CDI
Metal Recycling is in its start up phase and has no significant operations.
Condensed consolidated information with respect to these reportable segments
after giving effect to our decision to exit the clean technology segment for the
year ended December 31, 2008 and 2007 are as follows:
 
 For
the year ended December 31, 2008 and 2007 (Unaudited):
 
 Magnesium
                  
                  
                  Basic
      Materials
                  
                  
                  Consulting
                  
                  
                  Consolidated(Dollars
      in thousands)
                  
                  2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007
                  
                  
                  2008
                  
                  
                  2007Revenues
                  
                  $
                  153,021
                  
                  
                  $
                  98,141
                  
                  
                  $
                  53,838
                  
                  
                  $
                  55,310
                  
                  
                  $
                  16,358
                  
                  
                  $
                  9,573
                  
                  
                  $
                  223,217
                  
                  
                  $
                  163,024Revenues
      - related party
                  
                  
                  16,750
                  
                  
                  
                  2,778
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,760
                  
                  
                  
                  16,750
                  
                  
                  
                  4,538169,771
                  
                  
                  
                  100,919
                  
                  
                  
                  53,838
                  
                  
                  
                  55,310
                  
                  
                  
                  16,358
                  
                  
                  
                  11,333
                  
                  
                  
                  239,967
                  
                  
                  
                  167,562Interest
      income (expense)
                  
                  
                  26
                  
                  
                  
                  19
                  
                  
                  
                  (52
                  )
                  
                  
                  (3
                  )
                  
                  
                  303
                  
                  
                  
                  267
                  
                  
                  
                  227
                  
                  
                  
                  283Net
      (loss) income
                  
                  
                  4,350
                  
                  
                  
                  3,891
                  
                  
                  
                  (145
                  )
                  
                  
                  89
                  
                  
                  
                  6,016
                  
                  
                  
                  7,847
                  
                  
                  
                  11,399
                  
                  
                  
                  11,827Segment
      assets
                  
                  $
                  73,670
                  
                  
                  $
                  53,010
                  
                  
                  $
                  9,158
                  
                  
                  $
                  11,802
                  
                  
                  $
                  24,551
                  
                  
                  $
                  23,474
                  
                  
                  $
                  107,379
                  
                  
                  $
                  88,286
  F -
32
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 NOTE
19 – FOREIGN OPERATIONS
 
 As of
December 31, 2008 the majority of our revenues and assets are associated with
subsidiaries located in the PRC.
 
 Assets at
December 31, 2008 and 2007, reclassified to reflect discontinued operations, as
well as revenues for the year ended December 31 2008 and 2007 were as
follows:
 
 For
      the year ended December 31, 2008United
      States
                        
                        
                        PRC
                        
                        
                        TotalRevenues
                        
                        $
                        16,221,561
                        
                        
                        $
                        206,995,798
                        
                        
                        $
                        223,217,359Revenues
      – related party
                        
                        
                        -
                        
                        
                        
                        16,750,008
                        
                        
                        
                        16,750,00816,221,561
                        
                        
                        
                        223,745,806
                        
                        
                        
                        239,967,367Identifiable
      assets at December 31, 2008
                        
                        $
                        47,452,419
                        
                        
                        $
                        59,962,989
                        
                        
                        $
                        107,379,408
 
 For
      the year ended December 31, 2007United
      States
                        
                        
                        PRC
                        
                        
                        TotalRevenues
                        
                        $
                        9,549,129
                        
                        
                        $
                        153,474,201
                        
                        
                        $
                        163,023,330Revenues
      – related party
                        
                        
                        1,760,000
                        
                        
                        
                        2,779,059
                        
                        
                        
                        4,539,05911,309,129
                        
                        
                        
                        156,253,260
                        
                        
                        
                        167,562,389Identifiable
      assets at December 31, 2007
                        
                        $
                        20,565,289
                        
                        
                        $
                        67,721,032
                        
                        
                        $
                        88,286,321
 
 NOTE
20 – DISCONTINUED OPERATIONS
 
 During
the third quarter of 2008, we elected to exit the alternative energy and
recycling business conducted by CDI Clean Technology. We devised a formal plan
of disposal of a majority ownership in these subsidiaries. The business of
CDI Clean Technology and its subsidiaries comprised substantially all of the
business of our Clean Technology segment. We classified the assets and
liabilities of CDI Clean Technology and its subsidiaries as “Subsidiaries held
for sale” in accordance with the provisions of FASB No. 144.
 
 On
September 30, 2008, we ceased depreciating the assets of CDI Clean Technology
and its subsidiaries and as a result of the held for sale classification, we
assessed the estimated fair value of the subsidiary and no impairment charge was
recognized. The results of operations from CDI Clean Technology and its
subsidiaries are classified as discontinued operations in 2008 and previously
reported results of operations of CDI Clean Technology have been reclassified to
reflect this subsidiary as "Discontinued operations, net of tax". On October 30,
2008, we completed the sale of an 81% interest in our wholly owned subsidiary
CDI Clean Technology to PE Brothers Corp. for $1,240,000, recorded a gain of
$238,670 on the sale during the fourth quarter.  We plan to maintain our
19% ownership interest in CDI Clean Technology and recognize our investment
using the cost method.
  F -
33
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 The
following table sets forth the components of discontinued operations for 2008
and 2007.
 
 Subsidiaries
Held for Sale
 
 For
      the year ended December 31,2008
                          
                          
                          2007Revenues
                          
                          $
                          918,371
                          
                          
                          $
                          3,209,364Cost
      of revenues
                          
                          
                          345,274
                          
                          
                          
                          2,569,416Gross
      profit
                          
                          
                          573,097
                          
                          
                          
                          639,948Selling,
      general, and administrative
                          
                          
                          338,642
                          
                          
                          
                          119,127Operating
      income
                          
                          
                          234,455
                          
                          
                          
                          520,821Other
      income (expenses)
                          
                          
                          (126
                          )
                          
                          
                          153,767Net
      (loss) income before income tax and minority interest
                          
                          
                          234,329
                          
                          
                          
                          674,588Income
      tax expense
                          
                          
                          127,232
                          
                          
                          
                          113,610Net
      income (loss) before minority interest
                          
                          
                          107,097
                          
                          
                          
                          560,978Minority
      Interest in income of subsidiary
                          
                          
                          52,478
                          
                          
                          
                          113,264Discontinued
      operation's net income
                          
                          $
                          54,619
                          
                          
                          $
                          447,714
 
 NOTE
21 – STATUTORY RESERVES
 
 The
Company is required to make appropriations to statutory surplus reserve, based
on after-tax net income determined in accordance with generally accepted
accounting principles of the People’s Republic of China (the “PRC GAAP”).
Appropriation to the statutory surplus reserve should be at least 10% of the
after tax net income determined in accordance with the PRC GAAP until the
reserve is equal to 50% of the entities’ registered capital or members’ equity.
For the year ended December 31, 2008 and 2007, statutory reserve activity is as
follows and is included in retained earnings:
 
 
 Chang
                              
                              
                              Golden
                              
                              
                              Pan
      Asia
                              
                              
                              Lang
                              
                              
                              CDI
                              
                              
                              CDI
                              
                              
                              CDI
      ShanghaiMagnesium
                              
                              
                              Magnesium
                              
                              
                              Magnesium
                              
                              
                              Chemical
                              
                              
                              Beijing
                              
                              
                              Jingkun
      Zinc
                              
                              
                              Management
                              
                              
                              TotalBalance
      -December 2006
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Addition
      to statutory reserves
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -Balance
      – December 2007
                              
                              
                              58,000
                              
                              
                              
                              555
                              
                              
                              
                              53,329
                              
                              
                              
                              29,508
                              
                              
                              
                              -
                              
                              
                              
                              3,250
                              
                              
                              
                              69,707
                              
                              
                              
                              214,349Addition
      to statutory reserves
                              
                              
                              1,082,211
                              
                              
                              
                              90,517
                              
                              
                              
                              59,085
                              
                              
                              
                              -
                              
                              
                              
                              29,727
                              
                              
                              
                              -
                              
                              
                              
                              61,495
                              
                              
                              
                              1,323,035Balance
      – December 2008
                              
                              
                              1,140,211
                              
                              
                              
                              91,072
                              
                              
                              
                              112,414
                              
                              
                              
                              29,508
                              
                              
                              
                              29,727
                              
                              
                              
                              3,250
                              
                              
                              
                              131,202
                              
                              
                              
                              1,537,384
  F -
34
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 NOTE
22 - OPERATING RISK
 
 (a)
Country risk
 
 The
majority of the Company's revenues will be derived from the sale of magnesium
and basic materials in the PRC. The Company hopes to expand its operations to
countries outside the PRC, however, such expansion has not been commenced and
there are no assurances that the Company will be able to achieve such an
expansion successfully. Therefore, a downturn or stagnation in the economic
environment of the PRC could have a material adverse effect on the Company’s
financial condition.
 
 (b)
Products risk
 
 In
addition to competing with other companies, the Company could have to compete
with larger US companies who have greater funds available for expansion,
marketing, research and development and the ability to attract more qualified
personnel if access is allowed into the PRC market. If U.S. companies do gain
access to the
 PRC
markets, they may be able to offer products at a lower price. There can be no
assurance that the Company will remain competitive should this
occur.
 
 (c)
Exchange risk
 
 The
Company cannot guarantee that the current exchange rate will remain steady,
therefore there is a possibility that the Company could post the same amount of
profit for two comparable periods and because of a fluctuating exchange rate
actually post higher or lower profit depending on exchange rate of Chinese
Renminbi converted to U.S. dollars on that date. The exchange rate could
fluctuate depending on changes in the political and economic environments
without notice.
 
 (d)
Political risk
 
 Currently,
PRC is in a period of growth and is openly promoting business development in
order to bring more business into PRC. Additionally, the PRC allows a Chinese
corporation to be owned by a United States corporation. If the laws or
regulations are changed by the PRC government, the Company's ability to operate
the PRC subsidiaries could be affected.
 
 (e)
Key personnel risk
 
 The
Company’s future success depends on the continued services of executive
management in China and the United States. The loss of any of their services
would be detrimental to the Company and could have an adverse effect on business
development. The Company maintains key-man insurance on the lives of Yuejian
(James) Wang our CEO and Chairman, and Marc Siegel, our President and director.
Future success is also dependent on the ability to identify, hire, train and
retain other qualified managerial and other employees. Competition for these
individuals is intense and increasing.
 
 (f)
Performance of subsidiaries risk
 
 The vast
majority of the Company’s revenues will be derived via the operations of the
Company’s wholly owned or majority owned Chinese subsidiaries. Economic,
governmental, political, industry and internal company factors outside of the
Company’s control affect each of the subsidiaries. If the subsidiaries do not
succeed, the value of the assets and the price of our common stock would
decline.
  F -
35
 Table of Contents
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 DECEMBER
31, 2008 AND 2007 – Continued
 
 NOTE
23 - SUBSEQUENT EVENTS
 
 In January 2009 we did the following;
 
 •
              our
      board of directors authorized the change of our corporate name to China
      Direct Industries, Inc., subject to shareholder
  approval;•
              We
      accepted the resignation of Marc Siegel as President and as a member of
      our board of directors. Our board of directors authorized the purchase of
      1,500,000 shares of our common stock from Marc Siegel, our former
      President and director, for an aggregate purchase price of $1,650,000. Mr.
      Siegel abstained from the vote. The purchase was made under our stock
      repurchase program;•
              Philip
      Shen, Ph.D. was named as an independent member of the board of
      directors;•
              Yuwei
      Huang was appointed executive vice president for the Magnesium segment and
      as a member of our board of directors; and,•
              Jingdong
      Chen was appointed vice president for the Basic
  Materials
 
  F -
36
 Table of
Contents