UNITED
STATES
  SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
 (Mark
One)
 Form
10-K
 
  ̈ANNUAL REPORT PURSUANT TO SECTION 13
OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  or
  þ  TRANSITION REPORT UNDER SECTION 13 OR
15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
  For
the transition period from January 1, 2009 to September 30, 2009
  Commission
file number: 001-33694
  CHINA DIRECT INDUSTRIES,
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 whether the registrant has submitted electronically and posted on
its corporate Web site, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this
chapter) during the preceding 12 months (or for such shorter period that the
registrant was required to submit and post such files).  ̈ Yes  ̈ 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.
$27,677,561 on March 31, 2009.
 
 Indicate
the number of shares outstanding of each of the registrant's classes of common
stock, as of the latest practicable date. 27,420,873 shares of common stock are
issued and outstanding as of December 24, 2009.
 
 DOCUMENTS
INCORPORATED BY REFERENCE
 
 Portions
of the Registrant’s definitive proxy statement relating to its 2009 Annual
Meeting of Shareholders, to be filed no later than 120 days after the close of
the Registrant’s year ended September 30, 2009, are hereby incorporated by
reference in Part III of this Transition Report on Form 10-K.
  
  
 TABLE
OF CONTENTS
 Part
      IItem
      1.
                Business.
                1Item
      1A.
                Risk
      Factors.
                10Item
      1B.
                Unresolved
      Staff Comments.
                19Item
      2.
                Properties.
                19Item
      3.
                Legal
      Proceedings.
                20Item
      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.
                21Item
      6.
                Selected
      Financial Data.
                22Item
      7.
                Management’s
      Discussion and Analysis of Financial Condition and Results of
      Operations.
                22Item
      7A.
                Quantitative
      and Qualitative Disclosures About Market Risk.
                39Item
      8.
                Financial
      Statements and Supplementary Data.
                39Item
      9.
                Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure.
                39Item 9A
      (T).
                Controls
      and Procedures.
                39Item
      9B.
                Other
      Information.
                42Part
      IIIItem
      10.
                Directors,
      Executive Officers and Corporate Governance.
                42Item
      11.
                Executive
      Compensation.
                42Item
      12.
                Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters.
                42Item
      13.
                Certain
      Relationships and Related Transactions, and Director
      Independence.
                42Item
      14.
                Principal
      Accountant Fees and Services.
                42Part
      IVItem
      15.
                Exhibits,
      Financial Statement Schedules.
                42Signatures
                
                46
 
 - i
-
 
 INDEX
OF CERTAIN DEFINED TERMS USED IN THIS REPORT
 
 Change in Fiscal
Year
 
 Effective
August 13, 2009, we changed our fiscal year end from December 31 to
September 30. We have defined various periods that are covered in this report as
follows:
 
 •
              
              “2009
      transition period” — January 1, 2009 through September 30,
      2009.•
              
              “first
      nine months of 2008” — January 1, 2008 through September 30,
      2008.•
              
              “fiscal
      2010” — October 1, 2009 through September 30,
2010.•
              
              “fiscal
      2008” — January 1, 2008 through December 31, 2008.•
              
              “fiscal
      2007” — January 1, 2007 through December 31,
  2007.
 
 When used
in this report the terms:
 
 •
              
              "China
      Direct Industries”, "we”, "us” or “our” refers to China Direct Industries,
      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.•
              
              “IMG”
      or “International Magnesium Group”, refers to International Magnesium
      Group, Inc., a Florida corporation and a 100% owned subsidiary of China
      Direct Industries.•
              
              “IMTC”
      or “International Magnesium Trading”, refers to International Magnesium
      Trading Corp., a company organized under the laws of Brunei and a 100%
      owned subsidiary of CDI China.
 
 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.•
              
              “CDII
      Trading” refers to CDII Trading, Inc., a Florida corporation and a 100%
      owned subsidiary of China Direct
Industries.
 
  - ii
-
  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.
 
 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.
 
 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.
  - iii
-
  
 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 fiscal 2006, we established our Magnesium and Basic Materials
segments which have grown in fiscal 2007 and fiscal 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 our
Magnesium segment, our largest segment, we produce, sell and distribute pure
magnesium ingots, magnesium powders and magnesium scraps.
 
 In our
Basic Materials segment, we sell and distribute a variety of products including
industrial grade synthetic chemicals, steel products, non ferrous metals,
recycled materials, and industrial commodities. This segment also includes our
zinc ore mining property and zinc concentrate distribution businesses which have
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.
 
 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 and accounting staff
and our legal and other executive management. These professionals focus on due
diligence, business development, 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.
 
 Magnesium
Segment
 
 We
operate three magnesium facilities in China that produce and/or distribute
magnesium products such as pure magnesium ingots, magnesium powders, granules
and alloy. In the 2009 transition period revenues from this segment were $26.7
million, including revenues of $11.5 million from related parties, and
represented 38.9% of our total consolidated revenues. In the first nine months
of 2008 revenues from this segment were $129.6 million, including revenues of
$3.1 million from related parties, and represented 70.6% of our total
consolidated revenues.
 
 Magnesium
is the third most commonly used structural metal, following steel and aluminum,
and is used in themanufacturing
process of steel and titanium.Magnesium is the
lightest and strongest of the structural metals; it is one fourth the weight of
steel, two fifths the weight of titanium and two thirds the weight of aluminum.
Due to its light weight and high strength, magnesium and magnesium related
products have a variety of technological and consumer applications. Magnesium
alloys which are produced from the magnesium we make, are used in aircraft and
automobile parts.In addition,
magnesium in various forms is used in the manufacture of electronic equipment
such as computers, cameras and cell phones. Magnesium powder is used as
desulphurizer that removes sulfur in the production of steel.
 
 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 produce pure magnesium. In
addition, these areas have vast deposits of coal. Our magnesium facilities in
the Shanxi Province utilize waste gas to fuel their furnaces. The waste gas is a
by-product in the processing of coal into coke. This utilization of waste gas as
an energy source is less expensive than burning coal. 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.
 
  - 1
-
  Our
Magnesium segment utilizes a production method known as the silicothermic
manufacturing process, sometimes referred to as the ‘pigeon process’, as the
primary production method of its magnesium products. The pigeon 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.
 
 We
produced, sold and distributed approximately 11,775 metric tons of magnesium in
the 2009 transition period. As of September 30, 2009, we have total annual
magnesium production capacity of 42,000 metric tons. In the 2009 transition
period, we expanded Chang Magnesium from 8,000 metric ton capacity to 10,000
metric ton capacity. In addition, we expanded the capacity at Baotou Changxin
Magnesium from 12,000 to 20,000 tons as of the end of the 2009 transition
period. In the 2009 transition period our average selling price of magnesium was
approximately $2,270 per metric ton as compared to $3,390 per metric ton in the
first nine months of fiscal 2008.
 
 Magnesium
Segment Initiatives
 
 Since
late fiscal 2006 we have invested approximately $20.5 million in this segment to
acquire a controlling interest in our Magnesium segment. Additionally we
began to restructure our senior management in the 2009 transition period to add
personnel with magnesium operating experience in the PRC. As a result, 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 and has over 15 years of experience
in the production and sale of magnesium in the PRC.  He is the
principal owner of the minority shareholder in our magnesium production
subsidiaries and an owner of several other magnesium factories in
China.
 
 The
continuing effects of the global economic slowdown throughout the 2009
transition period substantially affected demand from key end markets such as
steel production, parts die casting for the automobile industry, and aluminum
alloying. As a result, management responded by reducing our Magnesium segment
workforce and idling facilities to reduce expenses. We have seen, however, an
improvement in quoting activity and a stabilization in prices late in the 2009
transition period and believe this improvement will carry into fiscal 2010.
Management plans to restart production at certain locations to further ramp up
production in fiscal 2010.
 
 Additionally,
with the worldwide, and more specifically, the Chinese economy showing signs of
rebounding, management has undertaken or is evaluating several key initiatives
to continue the expansion into magnesium begun in fiscal 2006. In an effort to
move into the next phase of growth for our Magnesium segment, management is
currently considering a plan to further consolidate our Magnesium segment
holdings as well as acquire additional operations owned or controlled by Yuwei
Huang. Toward that end we signed a non-binding letter of intent in October, 2009
outlining the proposed targets and are currently in the process of reviewing the
operations, performing necessary due diligence and evaluating financing options.
Additionally, as it is our intention to focus on our magnesium operations
associated with Mr. Huang, our board of directors committed to a plan to sell
our interest in Pan Asia Magnesium and present it as a discontinued operation
beginning with our financial statements for the fiscal year ended September 30,
2009. On December 29, 2009, our audit committee approved the establishment of a
$7.2 million reserve for a contingent loss from discontinued operations. Should
we be unable to negotiate an amicable resolution of our dispute, we will take
appropriate legal action in China which may include a court supervised
dissolution and audit of Pan Asia Magnesium in addition to appropriate legal
action against its noncontrolling Chinese shareholders and Mr. Zhao based upon
the findings in an audit. See Note 17 – Commitments and Contingencies to our
consolidated financial statements included in this report.
 
 We intend
to brand our current magnesium operations and planned acquisitions under our
International Magnesium Group (“IMG”) subsidiary. We intend to promote our IMG
brand as the premier global source for quality and reliability for magnesium
related products. We also intend to expand our domestic and international sales
capabilities under the IMG brand to create a cohesive and unified worldwide
marketing effort for our production and distribution operations. We
believe these actions will allow us to become more effective in our global
sales efforts and a strong, 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
the launch of the IMG brand will enable us to fully realize the value of our
magnesium holdings in the future.
 
  - 2
-
  Sources
and Availability of Raw Materials
 
 We obtain
dolomite and ferrosilicon, the primary raw materials used to produce 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. We have a fixed price supply agreement for a
specified quantity of waste gas for our Golden Magnesium facility which expires
in August 2027. In the 2009 transition period, we have two suppliers that
accounted for over 10% of the purchases of finished goods for resale and raw
materials used in magnesium production, Pine Capital Enterprises, Inc., a
related party, and China Shanxi Xinghua Cun International Trading Co. We
purchase dolomite and ferrosilicon on a purchase order basis from local
suppliers at market prices based on our production requirements.
 
 We
believe we will have access to sufficient dolomite, ferrosilicon and gas to
meet our needs for the foreseeable future.
 
 Basic
Materials Segment
 
 In our
Basic Materials segment, we sell and distribute a variety of products in Asia
including industrial grade synthetic chemicals, steel products, non ferrous
metals, recycled materials and industrial commodities. This segment also
includes our zinc mining property and zinc concentrate distribution businesses
which have not commenced operations. In the 2009 transition period our Basic
Materials segment generated revenues of $41.1 million, representing
approximately 60% of our total consolidated revenues. In the first nine months
of 2008 revenues from this segment were $39.5 million and represented 21.5% of
our total consolidated revenues.
 
 Distribution
of Synthetic Chemicals and Basic Resources. 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”). We also sell and distribute steel and non-ferrous metals such as
aluminum, zinc and lead in China.
 
 In July
2009, we launched CDII Trading. CDII Trading is engaged in the global purchase
and sale of industrial commodities which includes mineral ores, non-ferrous
metals, scrap metals, rare metals, petrochemicals, and other related
commodities. CDII Trading also markets products from our other business units as
well as some of our consulting clients by leveraging our relationships with
buyers in China and abroad with worldwide suppliers we source.
 
 Recycling.
In fiscal 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
fiscal 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, and the Company now owns a minority interest in these
operations.
 
 We are
evaluating the feasibility of continuing the development of a proposed facility
to create aluminum powder from recycled aluminum. While the market price of
aluminum did not support the economic viability of a recycling operation in the
2009 transition period, we believe aluminum wire recycling will become viable as
natural resources continue to be depleted. Additionally, this operation
possesses a license to import metal into China and management is evaluating the
potential use of this license for additional purposes within the organization.
This subsidiary was consolidated with our Basic Materials segment in the first
quarter of the 2009 transition period.
 
 Zinc Ore
Mining and Distribution Operations. We hold mining rights to
approximately 51 acres located in the Yongshun Kaxi Lake Mining area which is
known to hold zinc ore. 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 ore per year. As of the date of this report, we have not commenced
operations or established a reserve on this property. We also have a
distribution agreement to distribute zinc concentrate for a zinc processing
company that was suspended as a result of current weakness in the market price
of zinc and zinc-related products in fiscal 2008.
 
 Management
is currently re-negotiating its zinc concentrate distribution agreement and
evaluating strategic alternatives for these two operations including the partial
or full sale of its interest in these businesses, the launch of operations in
fiscal 2010 or potential joint venture partners to operate the mining and
distribution operations. Presently we do not have a timetable for when or if
these operations will commence, be operated or sold.
 
  - 3
-
  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
within 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.
 
 Our
Consulting segment was also affected by the global economic slowdown and during
the course of the 2009 transition period as our revenues in this segment were
$0.81 million compared to $14.5 million in the first nine months of fiscal 2008.
As markets have rebounded and the environment for small to medium sized
companies in China has improved we intend to pursue the addition of clients in
fiscal 2010, focusing on emerging companies with greater potential for growth
and profitability who are in need of business development and consulting
services and capital.
 
 EMPLOYEES
 
 As of
November 30, 2009 we have approximately 515 full time employees, including 16
employees in the United States and 499 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
September 30, 2009 and the positions they hold:
 
 Name
              
              Age
              
              Position
      with the CompanyYuejian
      (James) Wang, Ph.D
              
              
              47
              
              Chairman,
      President and Chief Executive OfficerAndrew
      X. Wang
              
              
              47
              
              Executive
      Vice President and Chief Financial OfficerYuwei
      Huang
              
              
              54
              
              Executive
      Vice President - MagnesiumLazarus
      Rothstein
              
              
              51
              
              Executive
      Vice President, General Counsel and
  Secretary
 
 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.
 
  - 4
-
  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 from
since June 2004 to 2007. From 2001 to 2004, he was President and Chairman
of the board of directors of Jiangbo Genesis Pharmaceuticals Enterprises, Inc.
(formerly Genesis Pharmaceuticals Enterprises, Inc.) (OTCBB: JGBO). 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 Ten Sleep
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 Ten
Sleep 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 He Fei, 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 X. Wang has served as
Executive Vice President and Chief Financial Officer of the Company since
December 2009 and from August of 2009 through early December 2009 as a
consultant to the Company.  As a consultant, Mr. Wang was responsible
for overseeing the financial management of the Company’s subsidiaries in China.
Prior to joining the Company, from 2006 to 2008, Mr. Wang served as
International Accounting and Project Manager for Healthways, Inc. (NASDAQ: HWAY)
a multinational company where he oversaw general ledger accounting, month-end
closing, foreign currency translations, consolidation, and financial reporting
over all subsidiaries and controlled entities outside the United States. From
2002 to 2006, Mr. Wang served as International Finance Manager for Adtran, Inc,
(NASDAQ: ADTN), a telecommunication and network equipment manufacturer, where
his responsibilities included overhauling and overseeing all global accounting
and financial reporting, taxation, trade finance, banking, foreign currency
transactions, and other treasury operations. Mr. Wang has held various financial
and business development positions from 1986 through 2002 including having
served as Vice President of International Operations at Oracle Communications
Corp. from 1996 to 2000, where he was responsible for providing strategic
advisory services on merger and acquisition activities for News Corp. (NASDAQ:
NWS) and its Satellite Television Asia Region (STAR) in Beijing, China. From
1988 to 1996 Mr. Wang served as Business Development Manager for WBA, Inc., a
multinational company with offices in China, where his responsibilities included
the management of OEM relationships with companies including General Electric
and Sylvania. During his tenure at WBA, Inc. Mr. Wang helped secure one of
China’s first large scale governmental contracts in North America. Mr. Wang is a
Certified Public Accountant and received a Masters Degree in Business
Administration from Pepperdine University in 2001. Mr. Wang also received a
Bachelor of Arts Degree from the University of Southern California in
1986.
 
 Lazarus Rothstein has
served as our Executive Vice President, General Counsel and Secretary since
February the 2009 transition period 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.
 
 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.
 
  - 5
-
  Huaqin (Kim) Chenhas served
as our Controller and Internal Audit Manager since April 2009 and as our
Principal Financial and Accounting Officer from May 2009 to December 2009. From
January 2001 to March 2009, Ms. Chen was the Assistant Controller at
International Paper Company where she was responsible for financial reporting,
analysis and budgeting, internal controls, domestic and international audits,
supervision of accounts receivable and payables, payroll and project managers
and the establishment of the financial controls over a Hong Kong based business.
From January 1992 to November 2000, Ms. Chen held various corporate accounting
positions. From August 1980 through December 1989, Ms. Chen was an Assistant
Professor of English at Shanghai International Studies University in China where
she received a Bachelors of Arts Degree in English and Literature in 1980.
Ms. Chen also received a Masters in Business Administration with a Concentration
in Accounting and Finance from Winthrop University, Rock Hill, South Carolina in
1992.
 
 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 38, 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 46, 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.
 
 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 the 2009 transition period produced an
estimated 80% 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
Note 12 – Related Party Transactions included in our notes to consolidated
financial statements 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. Effective January 2008, a 10%
export tariff on magnesium was imposed that equally impacted the profit margins
of all China based producers and has somewhat affected our competitive advantage
over non-China based magnesium 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 array of products and services than
we are able to provide. For these and other reasons, these competitors may
achieve greater acceptance in the marketplace than our company, limiting our
ability to gain market share and customer loyalty and increase our
revenues. We believe that we compete primarily on the basis of price and
availability of the products we sell.
  - 6
-
  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. We believe that we compete
primarily on the basis of our ability to offer a wider range of value-added
services than our competitors. 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”).
 
 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 the 2009 transition period 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.
  - 7
-
  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. In addition, the provincial government in Shanxi
Province seeks to control total magnesium production volume, speed up the
elimination of outmoded production capacity and, by 2011, eliminate magnesium
manufacturers that have annual production of less than 10,000 tons and by 2015,
eliminate magnesium producers that have annual production of less than 20,000
tons. These regulations are expected to reduce from the current more than 70
magnesium producers to about 30 in 2011 and to less than 10 by 2015. The
regulation are further intended to intensify technological innovations, improve
industrial competitiveness and research and development in magnesium alloying
directly from magnesium, continuous casting and rolling production technology,
as well as anti-oxidation of magnesium surface treatment process
technology.
 
 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 operations in the PRC comply with the current environmental
protection requirements and will continue to evaluate the proposed environmental
regulation. 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.
 
 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.
 
  - 8
-
  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, Inc.,
which became 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.
 
 On March
29, 2009 we changed our name to China Direct Industries, Inc. to more accurately reflect our business of producing magnesium
and distributing basic materials in China.
 
 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 and dispositions 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 our common stock valued at $100,000. The fair value of our common
stock was based on its value of $4.00 per share on February 6, 2007. Since its
inception, CDI Magnesium had no operations and on October 10, 2009 its board of
directors elected to dissolve the company and distribute its assets to its
shareholders or otherwise dispose of the assets upon agreement among its
shareholders. Beginning with our financial statements for the fiscal year ended
September 30, 2009, we will treat CDI Magnesium as a discontinued operation. See
Note 20 – Discontinued Operations included in our notes to consolidated
financial statements included in this report.
 CDI Wanda. In February 2007,
CDI China acquired a 51% interest in CDI Wanda in exchange for $511,458. During
the third quarter of fiscal 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.
 
  - 9
-
  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 an aggregate investment of $7.4 million. Additionally, as it is our
intention to focus on our magnesium operations associated with Mr. Huang, on
September 29, 2009 our board of directors committed to a plan to sell our
interest in Pan Asia Magnesium and present it as a discontinued operation
beginning with our financial statements for the fiscal year ended September 30,
2009. See Note 20 – Discontinued Operations included in our notes to
consolidated financial statements appearing later in this report.
 
 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. In connection with the discontinuance of our Clean Technology segment,
we sold substantially all of our interest in CDI Wanda when we completed the
sale of our 81% interest in its parent, CDI Clean Technology to PE Brothers
Corp. in the third quarter of fiscal 2008. We sold this interest for $1,240,000
and recorded a gain on the sale of $238,670. We plan to account for our 19%
ownership interest in CDI Clean Technology using the cost method of
accounting.
 
 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.
  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.  On December
30, 2009, the shareholders of CDI Beijing agreed to limit their capital
contributions to the $2.9 million they already contributed and waived their
requirement to contribute additional capital including CDI Shanghai Management’s
obligation to contribute $2,200,000 by September 30, 2009.
 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 Transition
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,” “are 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
 
 Risks
Related to Our Business
 
 The
metals industry is highly cyclical. Fluctuations in the pricing and 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.
  - 10
-
  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 and, magnesium-related products, zinc and
zinc-related products will have a significant impact on our operating results
and financial condition.
 
 We derive
a substantial portion 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.
 
 Declines
in the price of magnesium, and to a lesser extent a decrease in zinc prices,
have had a negative impact on our operations since 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. Furthermore, the decline in the price of zinc and zinc
related products resulted in us delaying completion of construction of our
planned zinc ore mining and production facility, our planned aluminum wire
recycling facility and our planned zinc concentrate distribution business.
Consequently, we are evaluating our strategic alternatives for these operations
including the partial or full sale of our interest in these businesses, the
launch of operations in fiscal 2010, seeking potential joint venture partners to
operate the businesses. Market prices for magnesium may decrease even further,
and therefore our operating results may be significantly harmed.
 
 If
we fail to implement our acquisition strategy, our financial condition and
results of operations could be materially and adversely affected.
 
 An
important part of our strategy is to grow our business by acquiring additional
production facilities for magnesium and magnesium related products by
consolidating our Magnesium segment holdings as well as acquire additional
operations owned or controlled by Mr. Huang. We will need additional financing
to implement our acquisition expansion strategy and we may not have access to
the funding required for the acquisitions on acceptable terms. Our planned
acquisitions may also suffer significant delays as a result of a variety of
factors, such as legal and regulatory requirements, either of which could
prevent us from completing our acquisition plans as currently expected. Our
acquisition 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.
  - 11
-
  Energy is
one of our most significant costs in our Magnesium segment. Most of our
magnesium production facilities utilize coke gas as energy, only Baotou Changxin
Magnesium facility utilizes coal. Energy prices, particularly for coal and coke
gas, have been volatile in recent years and currently exceed historical
averages. While we have a fixed price supply agreement for a specified quantity
of waste gas for our Golden Magnesium facility which expires in August 2027,
fluctuations in price impact our manufacturing costs and contribute to earnings
volatility. In the 2009 transition period we witnessed rising energy costs that
were not material to our results of operation which were partially offset by our
fixed price waste gas supply agreement at our Golden Magnesium facility. In the
event of an interruption in the supply of coke gas or coal to our magnesium
facilities, production at our manufacturing facilities would have to be shut
down. 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. While we have not experienced shortages of coke waste
gas in the 2009 transition period like we experienced in fiscal 2008, any future
shortages would 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 the
2009 transition period, our five largest customers (exclusive of related
parties) in our Magnesium segment were responsible for 45.8% of our
total revenues in this segment and approximately 17.8% of our total consolidated
revenues. These customers purchase products from us on a spot or short term
contract basis and may choose not to continue to purchase our products. A loss
of order volumes from any major customer, including a related party, or a
significant reduction in their purchase orders could negatively affect our
financial condition and results of operations by lowering sales volumes,
increasing costs and lowering profitability.
 
 We
have a dispute with the noncontrolling shareholders of Pan Asia Magnesium that
resulted in our establishment of a reserve for loss and the possibility of
litigation and adverse outcomes in such litigation could have a material adverse
effect on our financial condition.
 
 We have a
dispute with the noncontrolling shareholders of Pan Asia Magnesium and its
Chairman of the Board of Directors, Haixin Zhao that resulted in our
establishment of a $7.4 million reserve for loss which is described in Note 17 –
Commitments and Contingencies in our audited consolidated financial statements
included in this report. Any litigation ensuing from this dispute may be both
time consuming and expensive.
 
 We
evaluate this claim to assess the likelihood of an unfavorable outcome and to
estimate, if possible, the amount of potential loss. Based on this assessment
and estimate, we established a reserve of $7.4 million and disclosed the
relevant claim, as appropriate. This assessment and estimate is based on the
information available to management as of the date of this report and involves a
significant amount of management judgment. As a result, the actual outcome or
loss may differ materially from those envisioned by our current assessment and
estimate. Our failure to successfully prosecute or settle this claim could have
a material adverse effect on our financial condition, revenue and profitability
and could cause the market value of our common stock to decline.
 
 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 is shall be
written down to fair value as a new cost basis and the amount of the write-down
is charged to earnings. At September 31, 2009 we recognized an
“other-than-temporary” impairment of $9.5 million and realized loss on sale of
marketable securities of $1.9 million and at December 31, 2008 a realized loss
on other-than-temporary impairment of $7.5 million 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.
  - 12
-
  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 have
acquired. 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. Each of our acquisitions, including 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 our past or any future these proposed acquisitions
will be fully realized.
 
 We
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 need
to raise additional capital to carry out our plans to acquire additional
production facilities for magnesium and magnesium related products by
consolidating our Magnesium segment holdings as well as acquire additional
operations owned or controlled by Mr. Huang. Also, we may need to raise
additional working capital to fund our operations as a result of our operating
losses which were $10.4 million in the 2009 transition period. Our future
capital requirements depend 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. Also, 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 operate our business or fully implement our acquisition expansion
strategy.
 
 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.
 
  - 13
-
  We
have had 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 have had difficulty with compliance by our management at our subsidiaries and
in hiring and retaining a sufficient number of qualified employees to work in
the PRC. See “Part II — Item 9A (T) — Controls and Procedures.” As a result of
these factors, we have experienced difficulties with our subsidiaries 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. In addition, we may
experience these difficulties with any of our subsidiaries and our future
acquisitions. Therefore, we may, in turn, experience continued 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 and may result in
additional restatements of our financial statements in future
periods.
 
 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 September 30, 2009, 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, the lack of an integrated financial
accounting system, control deficiencies at one of our subsidiaries that
prevented us from auditing its financial statements prompting us to establish a
loss reserve equal to our investment in that subsidiary, failure to maintain a
sufficient complement of accounting personnel in our Magnesium segment
operations and accounting for other-than-temporary-impairment related to
available for sale securities that caused us to restate our consolidated
financial statements for the year ended December 31, 2008. 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 the PRC omit these customary clauses, notwithstanding the
differences in PRC 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. Although we
have a dispute with the minority shareholders of our Pan Asia Magnesium
subsidiary 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 additional disputes
which could have been avoided if the contracts included customary clauses in
conformity with U.S. standards. Contractual and other disputes which may arise
from this lack of legal protection and our dispute with the minority
shareholders of Pan Asia Magnesium 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
-
  Intercompany
loans may be subject to PRC regulations.
 
 We
currently have several inter-company loans between our PRC subsidiaries and PRC
based client companies totaling $12.0 million and we may continue to enter into
inter-company and client based financing arrangements to meet our internal
capital needs and those of our client companies. 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. In
December 2009 we adopted a related person transaction policy which will require
the pre-approval of the board of directors pre-approval or ratification of
transactions between us or one or more of our subsidiaries and any related
person involving an amount in excess of $120,000. Notwithstanding this policy,
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 of our company and his daughter Lifei
Huang 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 and his daughter Lifei Huang who is the General Manager of International
Magnesium Trading are also the principal owners and executive officers 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. In addition, we have
recently signed a non-binding letter of intent to acquire certain facilities
owned by YiWei Magnesium. Due to Mr. Huang and Ms. Huang’s interest in our
competitors and  Mr. Huang’s management position as an officer and
director with of our company, there are 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.
 
 Our
business will suffer if we lose our land use rights.
 
 There is
no private ownership of land in China and all land ownership is held by the
government of China, its agencies, and collectives. In the case of land used for
business purposes, land use rights can be obtained from the government for a
period up to 50 years, and are typically renewable. Land use rights can be
granted upon approval by the land administrative authorities of China (State
Land Administration Bureau) upon payment of the required land granting fee, the
entry into a land use agreement with a competent governmental authority and
certain other ministerial procedures. We have entered into agreements to acquire
land use rights for some of our occupied properties and other agreements to use
the land and the buildings which house our magnesium operations from parties
that we reasonably believe have proper land use rights. We cannot give, however,
any assurance that our land use rights will be renewed or that the parties we
have entered into agreements with will maintain their land use rights. In
addition, we may not have followed all procedures required to obtain the land
use certificate for the land use rights we agreed to purchase or paid all
required fees. If the Chinese administrative authorities determine that we have
not fully complied with all procedures and requirements needed to hold a land
use certificate for this or any other property which we occupy, we may be forced
by the Chinese administrative authorities to retroactively comply with such
procedures and requirements, which may be burdensome and require us to make
payments, or such Chinese administrative authorities may invalidate or revoke
our land use certificate entirely. If the land use right certificates
needed for our operations are determined by the government of China to be
invalid or if they are not renewed, or if we are unable to renew the lease for
our facilities when they , we may lose production facilities or employee
accommodations that would be difficult or even impossible to replace. Should we
have to relocate, our workforce may be unable or unwilling to work in the new
location and our business operations will be disrupted during the relocation.
The relocation or loss of facilities could cause us to lose sales and/or
increase its costs of production, which would negatively impact financial
results.
 
 Failure
to comply with the United States Foreign Corrupt Practices Act could subject us
to penalties and other adverse consequences.
  - 15
-
  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.
 
 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 ore. 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. Furthermore, we are evaluating our
strategic alternatives related to this business including the partial or full
sale of our interest, the launch of operations in fiscal 2010 or seeking a
potential joint venture partner to operate this business.
 
 Risks
Related to Doing Business in China
 
 We
may be unable to enforce our rights due to policies regarding the regulation of
foreign investments in China.
 
  - 16
-
  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. There are substantial uncertainties regarding
the interpretation and application of Chinese laws and regulations, including
but not limited to the laws and regulations governing our business, or the
enforcement and performance of our investment agreements with the minority
shareholders and management of our subsidiaries, arrangements with customers in
the event of the imposition of statutory liens, death, bankruptcy and criminal
proceedings. The Chinese government has been developing a comprehensive system
of commercial laws, and considerable progress has been made in introducing laws
and regulations dealing with economic matters such as foreign investment,
corporate organization and governance, commerce, taxation and trade. However,
because these laws and regulations are relatively new, and because of the
limited volume of published cases and judicial interpretation and their lack of
force as precedents, interpretation and enforcement of these laws and
regulations involve significant uncertainties. New laws and regulations that
affect existing and proposed future businesses may also be applied
retroactively.  We are considered a foreign invested enterprise under
Chinese laws, and as a result, we must comply with Chinese laws and regulations.
We cannot predict what effect the interpretation of existing or new Chinese laws
or regulations may have on our business. If the relevant authorities find us to
be in violation of Chinese laws or regulations, they would have broad discretion
in dealing with such a violation, including, without limitation: levying fines;
revoking our business and other licenses; requiring that we restructure our
ownership or operations; and requiring that we discontinue any portion or
all of our business. 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. Also, if we are unable to enforce any legal rights we may
have under our agreements or otherwise with the shareholder of Pan Asia
Magnesium or the shareholders of our other subsidiaries, our ability to control
their operations could be limited. Any significant limitation on our ability to
control the operations of our subsidiaries could result in a loss of our
investment which could have a material adverse effect on our business, financial
condition and results of operations.
 
 We
are subject to environmental and safety regulations, which may increase our
compliance costs and reduce our overall profitability.
 
 We are
subject to the requirements of environmental and occupational safety and health
laws and regulations in China. In addition, there are governmental initiatives
under consideration in an effort to, among other things, moderate the
environmental impact of magnesium production industry. These initiatives
include, but are not limited to national standards for environmental quality and
discharge of pollutants in China. See “Item 1. Business – Government Regulation
– Environment”. We may incur substantial costs or liabilities in connection with
these requirements that could reduce our overall profitability. The capital
requirements and other expenditures that may be necessary to comply with
environmental requirements could increase and become a significant expense
linked to the conduct of our business.
 
 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
moderate the environmental impact of manufacturing businesses, 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.
  - 17
-
  Although
the majority of productive assets in the PRC 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.
 
 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, or SARS, 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 September 30, 2009 our PRC
subsidiaries had approximately $4.2 million on deposit in banks in China, which
represented approximately 32.9% 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.
 
  - 18
-
  Risks Related to Our Common Stock
 
 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 the past 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 shareholders;•
              
              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.
  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 capable of producing 10,000
metric tons of pure magnesium per year located on approximately 250,000 square
feet of land 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 capable of producing 12,000
metric tons of pure magnesium per year located on approximately 500,000 square
feet of land located in Yueyan, of Gu County, in the Shanxi
Province.
 
 Baotou
Changxin Magnesium owns and operates a magnesium facility capable of producing
20,000 metric tons of pure magnesium per year located on approximately 406,000
square feet of land located in the Shiguai district of Baotou city, in Inner
Mongolia. Baotou Changxin Magnesium occupies this land pursuant to an asset
acquisition agreement entered into with Baotou Sanhe Mangesium Co., Ltd. to
acquire the land use rights for this property, among other assets. The land use
rights expire in May 2045.
  - 19
-
  Lang
Chemical owns the rights to use 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 pursuant to a
land use agreement which expires on April 21, 2055. Lang Chemical purchased the
rights to use this land where this facility is located in April 2005 at a cost
of $308,900 and owns the warehouse and storage area located on this
land.
 
 Lang
Chemical owns the rights to use an approximately 4,360 square foot office space
located at 58 Jinqiao Rd, Suite 21A Shanghai, China pursuant to a land use
agreement which expires on November 29, 2043. Lang Chemical permits Ms. Zhu to
lease this office and retain the monthly rent of approximately $3,125 she
receives from that space in exchange for our right to use the 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.
 
 CDI
Jixiang Metal holds the zinc ore mining rights to approximately 51 acres of land
located in the Yongshun Kaxi Lake Mining area, obtained in 2004 from the
Ministry of Land and Resources. We are in the process of renewing the lease for
these mining rights as the current lease expired in October 2009. In addition,
we have a land lease agreement with a Yanjing County Government agency for
approximately 96,000 square feet of land on which expires on January 12, 2016.
We are obligated to pay $7,878 annual rent under this land lease agreement. 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 an 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 Beijing plans to relocate its offices upon
expiration of the term for its lease at this location.
 
 CDI
Shanghai Management leases approximately 2,800 square feet of office space in
Shanghai for an annual expense of approximately $93,825 per year. The lease
expires on December 31, 2009 and we plans to renew our lease at this
location.
 
 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.
 
 We are,
however, currently involved in a dispute with Shanxi Jinyang Coal and Coke Group
Co., Ltd. (“Shanxi Jinyang”) and Ms. Runlian Tian, the noncontrolling
shareholders of our subsidiary Pan Asia Magnesium and its Chairman of the Board
of Directors, Haixin Zhao, as discussed in Note 17 – Commitments and
Contingencies in our audited consolidated financial statements included in this
report. Should we be unable to negotiate an amicable resolution of our dispute,
we will take appropriate legal action in the PRC against the noncontrolling
shareholders of Pan Asia Magnesium and Mr. Zhao.
 
 ITEM
      4.
              SUBMISSION
      OF MATTERS TO A VOTE OF SECURITY
HOLDERS.
 
 None.
 
  - 20
-
  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 or, the American Stock Exchange, or the OTC Bulletin Board
as applicable, for the last two fiscal years. These prices do not include retail
mark-ups, markdowns or commissions, and may not necessarily represent actual
transactions.
 
 High
              
              
              LowJanuary
      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
              
              
              $
              1.21January
      1, 2009 to March 31, 2009
              
              $
              2.00
              
              
              $
              0.95April
      1, 2009 to June 30, 2009
              
              
              2.24
              
              
              
              1.12July
      1, 2009 to September 30, 2009
              
              $
              1.99
              
              
              $
              1.31
 
 As of
December 28, 2009 there were approximately 946 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.
 
 Recent
Sales of Unregistered Securities
 
 None.
 
 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.
 
  - 21
-
  
  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, Restructuring and Impairments, Third-Party Loan Impairments,
Realized and 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.
 
 Nine
      Months Ended September 30, 2009
              
              
              Nine
      Months Ended September 30, 2008UnauditedGAAP
      net income attributable to China Direct Industries
              
              $
              (27,858,996
              )
              
              $
              18,153,164Restricted
      Share-based compensation expenses - Employees (1)
              
              
              1,694,277
              
              
              
              1,672,263Provisional
      reserve for discontinued operations (2)
              
              
              7,362,039
              
              
              
              -Other
      impairment charges – Prepaid expenses and other current assets
      (3)
              
              
              1,753,744
              
              
              
              -Realized
      loss on sale of marketable securities (4)
              
              
              1,909,056
              
              
              
              38,105Realized
      loss on Other-Than-Temporary-Impairment on Marketable Securities
      (5)
              
              
              9,466,329
              
              
              
              -Non-GAAP
      net income
              
              $
              (5,673,550
              )
              
              $
              19,863,532GAAP
      Earnings applicable to common stockholders
              
              $
              (27,939,921
              )
              
              $
              11,726,070GAAP
      Basic EPS
              
              
              (1.13
              )
              
              
              0.52GAAP
      Diluted EPS
              
              
              (1.13
              )
              
              
              0.47Non-GAAP
      net income reconciliation total (1)+(2)+(3)+(4)+(5)
              
              
              22,185,446
              
              
              
              1,710,368Non-cash
      deducted related to Preferred Stock issuance:Relative
      Fair Value of warrants
              
              
              
              
              
              
              2,765,946Beneficial
      Conversion Feature
              
              
              
              
              
              
              2,451,446Non-GAAP
      Earnings applicable to common stockholders
              
              
              (5,754,474
              )
              
              
              18,653,830Non-GAAP
      Basic EPS
              
              
              (0.23
              )
              
              
              0.83Non-GAAP
      Diluted EPS
              
              $
              (0.23
              )
              
              $
              0.77Shares
      used in basic net income per-share calculation - GAAP
              
              
              24,802,730
              
              
              
              22,403,054Shares
      used in basic net income per-share calculation - Non-GAAP
              
              
              24,802,730
              
              
              
              22,403,054Shares
      used in diluted net income per-share calculation - GAAP
              
              
              24,802,730
              
              
              
              24,160,683Shares
      used in diluted net income per-share calculation -
Non-GAAP
              
              
              24,802,730
              
              
              
              24,160,683


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 September 30, 2009 and December 31
2008 should be read in conjunction with the consolidated financial statements,
including footnotes and list of related parities included in Note 12 of our
financial statements, and other information presented elsewhere in this
Transition Report on Form 10-K.
 
  - 22
-
  Restatement
 
 We
restated our consolidated financial statements for fiscal 2008 to correct an
error in the method of calculating the other-than-temporary impairment of
available for sale securities.  The impact of the restatement on our
consolidated financial statements for fiscal 2008 is discussed in Note 2 –
“Basis of Presentation and Summary of Significant Accounting Policies -
Restatement of Financial Statements” of the notes to the consolidated financial
statements included in this report.  All information included in this
Management’s Discussion and Analysis of Results of Operations and Financial
Condition has been correspondingly corrected to give effect to such
restatement.
 
 Change
in Fiscal Year End
 
 Effective
August 13, 2009, we changed our fiscal year end from December 31 to
September 30. We have defined various periods that are covered in this report as
follows:
 
 •
              
              “2009
      transition period” — January 1, 2009 through September 30,
      2009.•
              
              “first
      nine months of 2008” — January 1, 2008 through September 30,
      2008.•
              
              “fiscal
      2010” — October 1, 2009 through September 30,
2010.•
              
              “fiscal
      2008” — January 1, 2008 through December 31, 2008.•
              
              “fiscal
      2007” — January 1, 2007 through December 31, 2007.•
              
              “fiscal
      2006” — January 1, 2006 through December 31,
  2006.
 
 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 ASC
Codifications Topic 280 (SFAS 131), “Disclosure about segments of an
Enterprise and Related Information”. In the fourth quarter of fiscal 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.
 
 Our
Magnesium segment is currently our largest segment by assets and prior to the
2009 transition period was the largest segment by revenues. We manufacture and
sell pure magnesium and related by-products. We also purchase and resell
magnesium products manufactured by third parties. 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 and strongest of the
structural metals; it is one fourth the weight of steel, two fifth the weight of
titanium and two thirds the weight of aluminum.  Due to its light weight
and high strength, magnesium and magnesium related products have a variety of
technological and consumer applications. Magnesium alloys which are produced
from the magnesium we make, are used in aircraft and automobile parts.In addition,
magnesium in various forms is used in the manufacture of electronic equipment
such as computers, cameras and cell phones. Magnesium powder is used as
desulphurizer that removes sulfur in the production of steel .
 
 Our Basic
Materials segment engages in the sale and distribution of basic resources within
Asia. Our Basic Materials segment includes the sale and distribution of a
variety of products including (i) industrial grade synthetic chemicals, (ii)
steel products (iii) nonferrous metals, and (iv) recycled materials. As
well, within this segment we hold the rights to mining properties and are
evaluating the economic feasibility of commencing mining and production
operations at this site given the current weakness in the market price of zinc
and related products. Presently we do not have a timetable for when our
mining operations will commence. In July 2009, we launched CDII Trading. CDII
Trading is engaged in the global purchase and sale of industrial commodities
which includes mineral ores, non-ferrous metals, scrap metals, rare metals,
petrochemicals, and other related commodities. CDII Trading also markets
products from our other business units as well as some of our consulting clients
by leveraging our relationships in China and abroad.
 
 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.
 
  - 23
-
  Our
Performance
 
 During
the 2009 transition period we continued to experience a slowdown in revenue
growth that began in the last quarter of fiscal 2008. Revenues in the 2009
transition period totaled $68.6 million, a decrease of $115 million compared to
the first nine months in 2008, primarily attributable to a decrease in revenues
within our Magnesium and Consulting segments due to continued weakness in prices
and demand and our discontinuance of our Pan Asia Magnesium investment, which
were offset by a slight increase in revenues in our Basic Materials segment.
During the 2009 transition period our Magnesium segment produced, sold or
distributed approximately 11,775 metric tons of magnesium generating revenues of
$26.7 million compared to the production, sale and distribution of 42,651 metric
tons and revenues of $129.6 million in the first nine months of 2008. In the
2009 transition period our Basic Materials segment generated revenues of $41.1
million compared to $39.6 million in the first nine months of 2008. For our
Consulting segment, in the 2009 transition period this segment generated
revenues of $0.810 million compared to $14.5 million in the first nine months of
2008.
 
 Our gross
profit margins decreased to 3.3% in the 2009 transition period from 13.3% in the
first nine months of 2008 primarily as a result of price concessions to a major
customer, sales of inventory on hand with a higher historical cost relative to
current magnesium selling prices and fixed production costs within our Magnesium
segment. In particular, in late fiscal 2008, we purchased material and finished
product in anticipation of the fulfillment of a fixed price supply contract in
the 2009 transition period with a major customer. As magnesium prices declined
rapidly, we made concessions under this agreement to maintain our long term
relationship with this customer that contributed to our lower gross
profit.
 
 Selling,
general and administrative expenses increased $4.2 million in the 2009
transition period compared to first nine months of 2008 primarily as a result of
non-recurring charges related to higher non-cash stock based compensation
expenses, payroll expense and professional fees in our Consulting segment,
increases in senior management salaries and bonuses in our Magnesium segment of
$1.5 million and overall higher expenses in our Basic materials
segment.
 
 We
incurred a loss for the 2009 transition period of $9.5 million on other than
temporary impairment related to certain marketable securities available for sale
that had been previously reflected as unrealized losses in our accumulated other
comprehensive income on our balance sheet and a realized loss of $1.9 million on
the sale of marketable securities available for sale as we sold securities of
our clients we previously received as consulting fees.
 
 We
incurred a loss for the 2009 transition period from discontinued operations net
of tax of $8.6 million, consisting of $1.19 million from operations and $7.4
million from our provisionally reserved impairment charges against the
carry-value of our net investment and estimated costs on the disposal of our
investment in Pan Asia Magnesium as discontinued operations as of September 30,
2009.
 
 Historically
we realized significant growth in our Magnesium segment due to (i) investments
in our Magnesium segment in the latter half of fiscal 2007 which increased our
capacity and revenues, and (ii) increases in the market price of magnesium
during the first six months of 2008. However, in the 2009 transition period the
global economic slowdown has adversely affected our growth trajectory across all
of our business segments.
 
 Our
Outlook
 
 During
fiscal 2010 and beyond, we face a number of challenges in growing our business,
such as the continuing integration and streamlining of our PRC based
subsidiaries. At September 30, 2009 we had $31 million of working capital
including $12.9 million in cash and cash equivalents. While this amount is
believed sufficient to meet our current operating cash needs, we expect to seek
additional capital to finance the strategic expansion of our magnesium
production holdings.
 
 Magnesium segment. For the
2009 transition period, we believe that global magnesium production is estimated
to be approximately 411,875 metric tons, a decrease from the estimated 623,125
metric tons produced in the first nine months of 2008, with China representing
329,500 metric tons or approximately 80% of the world’s production. China’s
domestic magnesium production decreased an estimated 33.9% in the 2009
transition period as compared to the first nine months in 2008. During the 2009
transition period our Magnesium segment produced, sold or distributed
approximately 11,775 metric tons of magnesium generating revenues of $26.7
million compared to the production, sale and distribution of 42,651 metric tons
and revenues of $129.6 million in the first nine months of 2008. The weak global
economy has reduced demand for magnesium and as a result the price of magnesium,
(about $2,300.00 per metric ton, as of September 30, 2009) has declined 35%
since September 2008. We are unable to predict if and when demand or prices will
increase. We estimate that China exports for the nine months ended September 30,
2009 were 148,703 metric tons as compared to 338,629 metric tons in first nine
months of 2008. Management believes export demand was further impacted due to a
10% export tax on magnesium products which became effective in January
2008.
 
  - 24
-
  The
average magnesium ingot price during the period from September 2009 through
December 2009 was approximately $2,300 per metric ton (Ex Works) , up from
$2,200 per metric ton in the second quarter of the 2009 transition period. These
prices were significantly lower than $4,500 per metric ton average price during
the second quarter of fiscal 2008. Based on this trend, among other factors, we
believe that current magnesium prices are showing signs of stabilization and
recovery.
 
 Despite
these factors, we believe that now is the time to expand our magnesium
production holdings by acquiring additional interests in our current Magnesium
segment holdings as well as acquire additional operations owned or controlled by
Yuwei Huang. Additionally, on September 29, 2009, our board of directors
committed to a plan to sell our interest in Pan Asia Magnesium and present it as
a discontinued operation beginning with our financial statements for the fiscal
year ended September 30, 2009 as we elected to focus our magnesium production
efforts with our key Chinese partner, Yiwei Magnesium, a related party.
Furthermore, we believe that by expanding our ownership of magnesium operations,
we will be in a better position to comply with recently proposed environmental
regulation which seeks to speed up the elimination of outmoded magnesium
production capacity and, by 2011, eliminate magnesium manufacturers that have
annual production of less than 10,000 tons and by 2015, eliminate magnesium
producers that have annual production of less than 20,000 tons.
 
 Basic Materials Segment. The
worldwide economic slowdown continues to negatively impact the market price for
zinc. At current market prices for zinc, it is not economically feasible for us
to commence operations at our zinc ore property, complete construction of a
planned zinc mining facility launch our zinc concentrate distribution operations
that that have been suspended.
 
 Management
is currently re-negotiating its zinc concentrate distribution agreement and
evaluating strategic alternatives for these two operations including the partial
or full sale of its mining and distribution rights, the launch of operations in
fiscal 2010 or potential joint venture partners to operate the mining and
distribution operations. Presently we do not have a timetable for when or if
these operations will be operated or sold.
 
 Also, we
will continue to operate as a distributor of industrial chemicals, commodities,
steel and nonferrous metals and believe that demand for these materials will
increase as worldwide economic activity increases and domestic consumption
increases as the domestic Chinese market rebounds as a result of the November
2008 China domestic stimulus program and a rebound in the worldwide economy.
Despite our optimism in some of these businesses, we continue to work with the
management of these operations to identify strategies to maximize their
potential which may include a sale of their operations or assets.
 
 Consulting Segment.While we
have made efforts to improve the caliber of the clients within our Consulting
segment, the global economy and severe liquidity crisis in the capital markets
in the 2009 transition period have created a difficult environment for smaller
companies to attract interest in the financial community. Accordingly, in fiscal
2010 the growth within this segment will be largely dependent upon a recovery of
the capital market for smaller companies.
 
 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. These programs adopted by the PRC government are aimed towards
supporting growth in some of the sectors in which we operate and there have been
signs that the program, along with China’s significant foreign currency
reserves, has resulted in heavy accelerated spending on building infrastructures
and domestic spending on automobiles and appliances. In addition, with China’s
2009 third quarter gross domestic product of 8.9% per annum, up from 7.9% in the
second quarter, it appears as though China has been shielded from the worst
effects of the global economic recession.
 
 Presentation
of Financial Statements. The presentation of the statements of operations
included in Part II, Item 6 in this Transition Report on 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 Transition Report
on Form 10-K. In addition, a portion of our audited consolidated financial
statements have been reclassified to recognize discontinued operations treatment
of our 51% interest in Pan Asia Magnesium and CDI Magnesium if the 2009
transition period and reflecting our sale of an 81% interest in CDI Clean
Technology in fiscal 2008 and our restatement of our restated financial
statements for the period ended December 31, 2008 to properly account for
other-than-temporary impairment of available for sale securities and recognize
an impairment loss in earnings equal to the entire difference between the
impaired investment's cost and its fair value at the balance sheet date of the
reporting period for which the assessment was made applying FSP FAS 115-1 or
Accounting Standard Codification paragraph 320-10-35-34.
 
  - 25
-
  Results
of Operations
 
 The
results discussed below are for our Fiscal 2009 transition period covering the
nine 9 months ended September 30, 2009 compared to the first nine
months of 2008 (which is unaudited), as a result of our fiscal year end change.
For comparative purposes we believe that our variance explanations between these
periods related to data in consolidated statements of operations are more
meaningful to users, which address the significant impact of the weakness in
pricing and demand, decreases in our gross profit margin and increases in
selling, general and administrative expenses. For comparative purposes we
believe that our variance explanations related to data in consolidated balance
sheets and consolidated statements of cash flows would not be significantly
different than if we compared our Fiscal 2009 transition period (9 months) and
fiscal 2008 (12 months). Therefore, Fiscal 2008 results are shown in the tables
below for such comparative and reference purposes.
 
 The
following table shows the percentage change in our consolidated revenues for the
Fiscal 2009 transition period (9 months), the first nine months of 2008
(unaudited):
 
 Consolidated
Revenues
  Nine
      Months Ended September 30
                
                Twelve
      Months Ended December 312009
                
                
                2008
                
                
                
                
                2008(Unaudited)(Dollars
      in thousands)
                
                Revenues
                
                
                %
      of Revenues
                
                
                Revenues
                
                
                %
      of Revenues
                
                
                %
      increase (decrease)
                
                Revenues
                %
      of RevenuesMagnesium
      segment
                
                $
                26,708
                
                
                
                39
                %
                
                $
                129,575
                
                
                
                70
                %
                
                
                (79)
                %
                $
      152,426
                68%Basic
      Materials segment
                
                
                41,112
                
                
                
                60
                %
                
                
                39,572
                
                
                
                22
                %
                
                
                4
                %
                53,837
                24%Consulting
      segment
                
                
                810
                
                
                
                1
                %
                
                
                14,518
                
                
                
                8
                %
                
                
                (94)
                %
                16,358
                7%Total
      Consolidated
                
                $
                68,630
                
                
                
                100
                %
                
                $
                183,666
                
                
                
                100
                %
                
                
                (63)
                %
                $222,622
                100%
 Total
consolidated revenues for fiscal the 2009 transition period were $68.6 million,
a decrease of approximately 63% compared to first nine months of 2008. These
decreases were primarily a result of decreases in revenues within our Magnesium
and Consulting segments, which were offset by an increase in revenues in our
Basic Materials segment.
 
 Consolidated
Operating Income and Expenses
 Nine
      Months Ended September 30, 2009
                
                
                Nine
      Months Ended September 30, 2008
                
                
                
                
                Twelve
      Months Ended Decmeber 31, 2008Unaudited(Dollars
      in thousands)
                
                Amount
                
                
                %
                
                
                Amount
                
                
                %
                
                
                %
      increase (decrease)
                
                Amount
                %Revenues
                
                $
                68,630
                
                
                
                100
                %
                
                $
                183,665
                
                
                
                100
                %
                
                
                (63)
                %
                222,622
                100%Cost
      of revenues
                
                
                66,350
                
                
                
                97
                %
                
                
                152,125
                
                
                
                83
                %
                
                
                (56)
                %
                192,074
                86%Gross
      profit
                
                
                2,281
                
                
                
                3
                %
                
                
                31,540
                
                
                
                17
                %
                
                
                (93)
                %
                30,547
                14%Selling,
      general and administrative expenses
                
                
                10,939
                
                
                
                16
                %
                
                
                6,708
                
                
                
                4
                %
                
                
                63
                %
                10,451
                5%Operating
      (loss) income
                
                $
                (
      8,658)
                
                
                
                (13)
                %
                
                $
                24,832
                
                
                
                13
                %
                
                
                (135)
                %
                20,096
                9%
 Revenues
for the 2009 transition period decreased by $115 million compared to the first
nine months of 2008 primarily as a result of the decrease in revenues in our
Magnesium Segment of $102.9 million and Consulting segments of $13.7 million
partially offset by an increase in revenues in our Basic Materials segment of
$1.5.
 
 In the
2009 transition period our cost of revenues decreased by $85.8 million compared
to the first nine months of 2008 as a result of the reduction in our revenues.
Our cost of revenues as a percentage of revenues over the same periods increased
13.9% primarily as a result of weakness in pricing relative to the cost of
revenues, higher historical costs of raw materials and inventory on hand and
fixed production costs within our Magnesium segment.
 
  - 26
-
  Our gross
profit for the 2009 transition period was $2.3 million, a decrease of $29.3
million compared to first nine months of 2008 as a result of lower revenues of
$115 million and higher costs of revenues as a percentage of revenues of 97% for
these periods.
 
 Selling,
general and administrative expenses increased $4.2 million in the 2009
transition period compared to first nine months of 2008 was primarily a result
of non-recurring charges related to higher non-cash stock based compensation
expenses, payroll expense and professional fees in our Consulting segment,
increases in senior management salaries and bonuses in our Magnesium segment of
$1.5 million and overall higher expenses in our Basic materials
segment.
 
 Total
consolidated operating loss for the 2009 transition period was $8.7 million
compared to operating income of $24.8 million in first nine months of 2008
primarily as a result of the decrease in revenues in our Magnesium segment of
$102.8 million and Consulting segment of $13.7 million partially offset by an
increase in revenues in our Basic Materials segment of $1.5
million.
 
 Segment
Information
 
 A summary
of our operating results, by segment, for the 2009 transition period, the first
nine months of 2008 and fiscal 2008 are as follows:
 MagnesiumNine
      Months Ended September 30,
                
                Twelve
      Months Ended December 31, 2008(Dollars
      in thousands)
                2009
                
                2008UnauditedRevenues
                
                $
                15,166
                
                
                $
                126,431
                
                
                $
                135,676Revenues
      - related party
                
                
                11,542
                
                
                
                3,144
                
                
                
                16,750Cost
      of revenues
                
                
                27,099
                
                
                
                112,386
                
                
                
                138,810Gross
      profit
                
                
                (391
                )
                
                
                17,189
                
                
                
                13,616Total
      operating expenses
                
                
                2,882
                
                
                
                1,319
                
                
                
                3,788Operating
      income (loss)
                
                $
                (3,273
                )
                
                $
                15,870
                
                
                $
                9,828
   Basic
      MaterialsNine
      Months Ended September 30,
                
                Twelve
      Months Ended December 31, 2008(Dollars
      in thousands)
                2009
                
                2008UnauditedRevenues
                
                $
                41,112
                
                
                $
                39,572
                
                
                $
                53,838Revenues
      - related party
                
                
                -
                
                
                
                -Cost
      of revenues
                
                
                38,853
                
                
                
                38,224
                
                
                
                51,764Gross
      profit
                
                
                2,259
                
                
                
                1,348
                
                
                
                2,074Total
      operating expenses
                
                
                2,684
                
                
                
                1,111
                
                
                
                1,521Operating
      income (loss)
                
                $
                (425
                )
                
                $
                237
                
                
                $
                553
  ConsultingNine
      Months Ended September 30,
                
                Twelve
      Months Ended December 31, 2008(Dollars
      in thousands)
                2009
                
                2008UnauditedRevenues
                
                $
                810
                
                
                $
                14,518
                
                
                $
                16,358Revenues
      - related party
                
                
                -Cost
      of revenues
                
                
                397
                
                
                
                1,515
                
                
                
                1,500Gross
      profit
                
                
                413
                
                
                
                13,003
                
                
                
                14,858Total
      operating expenses
                
                
                5,372
                
                
                
                4,278
                
                
                
                5,143Operating
      income (loss)
                
                $
                (4,959
                )
                
                $
                8,725
                
                
                $
                9,715
  - 27
-
 Magnesium
Segment Operating Results
 
 Revenues.
Magnesium segment revenues for the 2009 transition period were $26.7 million,
(inclusive of related party revenues of $11.5 million) a decrease of 79%
compared to first nine months of 2008, due primarily to weakness in pricing as a
result of a slowdown in magnesium demand and oversupply in the market and
pricing concessions.
 
 Revenues
– Related Party in the 2009 transition period were $11.5 million, an increase of
8.4 million compared to the first nine months of 2008 primarily as a result of
sales at market prices of our excess inventory to a minority shareholder of our
Magnesium segment subsidiaries.
 
 In the
2009 transition period our Magnesium segment produced, sold and distributed
approximately 11,775 metric tons with an average price of $2,268 per metric ton.
In the first nine months of 2008 we produced, sold and distributed approximately
50,000 metric tons with an average price of $3,315 per metric ton.
 
 Gross
Profit. In the 2009 transition period the gross profit for the segment decreased
$17.6 million compared to first nine months of 2008. The gross profit margin for
this segment in the 2009 transition period was (1.5)% compared to 13% for the
first nine months of 2008. The decrease is primarily a result of price
concessions to a major customer, sales of inventory on hand with a higher
historical cost relative to current magnesium selling prices and fixed
production costs within our Magnesium segment. In particular, in late 2009, we
purchased material and finished product in anticipation of the fulfillment of a
fixed price supply contract with a major customer. As magnesium prices declined
rapidly, we made concessions under this agreement to maintain our long term
relationship with this customer that contributed to our lower gross
profit.
 
 Operating
Expenses. In the 2009 transition period operating expenses were $2.9 million, an
increase of $1.6 million compared to first nine months of 2008 primarily as a
result of increases in senior management salaries and bonuses in our Magnesium
segment of $1.5 million, higher depreciation expenses at our newly operational
Baotou Changxin Magnesium facility, and partially offset by the collection of a
bad debt previously written off, a reduction in labor costs as we stopped
production at some of our facilities and other adjustments.
 
 Basic
Materials segment
 
 Revenues.
In the 2009 transition period revenues in the Basic Materials segment were $41.1
million, an increase of 4% compared to first nine months of 2008. This increase
is a result of an increase in revenues from CDI Beijing which we formed in June
2008 in the amount of $10.6 million partially offset by a decrease in revenues
of $9.0 million at Lang Chemical.
 
 Gross
Profit. In the 2009 transition period the gross income for this segment
increased $0.91 million, a 67.6% increase compared to first nine months of 2008.
This margin improvement is due to the contribution of CDI Beijing which
generated gross margins of 8.4% in first nine months of the 2009 transition
period and an increase in gross margins at Lang Chemical from 3.2% in the first
nine months of 2008 to 4.2% in the 2009 transition period.
 
 Operating
Expenses. In the 2009 transition period for this segment operating expenses were
$2.7 million, an increase of $1.6 million compared to first nine months of 2008.
These increases are primarily a result of increases of $0.172 million in selling
expenses and of $0.207 million in general and administrative expenses at Lang
Chemical, increases of $0.707 million in selling expenses and $0.425 million in
general administrative expenses at CDI Beijing.
 
 Consulting
segment
 
 Revenues.
In the 2009 transition period the Consulting segment revenues were $0.810
million, a decrease of 13.7 million or 94% compared to first nine months of
2008. The decrease was due primarily to the absence of $5.39 million in one-time
transaction fees that we recognized in the first nine months of 2008, a
reduction in recurring consulting fees as a result of the reduction in the
market price of the fixed number of securities we received from our client
companies as fees and the lack of new clients engaged in the 2009 transition
period.
 
 Gross
Profit. In the 2009 transition period the gross profit for this segment was
$0.412 million compared to $13.0 million in first nine months of 2008, this
represents a decrease of 97%. This decrease was due primarily to the reduction
in revenues of $12.6 million partially offset by a reduction in cost of revenues
of $1.1 million primarily reflecting a reduction of professional fees associated
with services we provided internally.
 
 Operating
Expenses. In the 2009 transition period operating expenses in this segment,
which include selling, general and administrative expenses for our U.S.
headquarters and executive management, were $5.4 million, an increase of $1.1
million or 25.6% compared to the first nine months of 2008. These increases were
due primarily to non-cash stock based compensation expenses, payroll expense,
professional fees and approximately $94,000 in severance costs related to the
elimination of four employees that is expected to result in future savings of
approximately $250,000 per year.
  - 28
-
  Total
Other (Expense) Income
 
 Total
other expense in the 2009 transition period was $(13) million compared to total
other income of $0.651 million in first nine months of 2008. The decrease of
$13.6 million was due primarily to realized losses of $(9.5) million on other
than temporary impairment related to certain marketable securities available for
sale that had been previously reflected as unrealized losses in our accumulated
other comprehensive income on our balance sheet and $(1.9) million on the sale
of marketable securities available for sale pursuant to the guidance of ASC 320,
“Investments - Debt & Equity Securities,” and other impairment charges
related to $(1) million loan to a consulting client, and $(0.731) million loan
at CDI Jingkun Zinc as we are in the process of renegotiating a zinc concentrate
distribution agreement with our vendor.
 
 Income
Tax Benefit (Expense)
 
 Income
tax benefit for the 2009 transition period was $0.021 million compared to $0.01
million in first nine months of 2008. The increase was due primarily to a tax
credit/refund of $0.195 million attributable to our Consulting segment,
partially offset by accrued tax liabilities of $0.174 million in our Magnesium
and Basic Material segments, respectively in the 2009 transition
period.
 
 Discontinued
Operations
 
 Loss from
discontinued operations for the 2009 transition period from discontinued
operations net of tax was $(8.6) million, as compared to a gain of $1.6 million
in first nine months of 2008.  This loss was primarily due to our
provisional reserve of $7.4 million on the disposal of Pan Asia Magnesium as
discontinued operations, and losses from above identified discontinued
operations of $1.2 million during the first and second quarters of 2009. As a
result of an ongoing dispute with Shanxi Jinyang and Ms. Runlian Tian, the
non-controlling shareholders of our subsidiary Pan Asia Magnesium and its
Chairman of the Board of Directors, Haixin Zhao, which prevented us from
completing the audit of Pan Asia Magnesium, including its operating results for
the third quarter of the 2009 transition period and for the entire 2009
transition period, we recognized a provisional impairment charge against the net
book value of our investment in Pan Asia Magnesium and estimated legal fees. See
Note 17 – Commitments and Contingencies in our audited consolidated financial
statements included in this report.
 
 Net
(Loss) Income Before Noncontrolling Interests
 
 Net loss
for the 2009 transition period was $(30.2) million, as compared to a gain of
$27.1 million in first nine months of 2008. The decrease of $55.8, or 211% was
primarily due to our operating loss of $(8.7) million, other than temporary
impairment losses of $(9.5) million, a realized loss on the sale of marketable
securities of $(1.9), $(1.7) million other impairment charges, and a provisional
impairment charge related to our investment in Pan Asia Magnesium of $(7.4)
millions.
 
 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 $0.145 million
in the 2009 transition period as compared to $2.1 million in first nine months
of 2008. 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
report.
 
 Unrealized
Gain/(Loss) on Marketable Securities Available for Sale, Net of Income
Tax
 
 The
unrealized gain on marketable securities available for sale, net of income taxes
in the 2009 transition period totaled $0.175 million, compared to an
unrealized loss of approximately $(10.2) million in first nine months of 2008.
This increase in unrealized gain is representative of our fair market value
adjustment to the carrying value of our equity securities and warrants held as
marketable securities available for sale. We also recognized and reclassified
$(9.9) million of unrealized (loss) in accumulative comprehensive income (AOCI)
from the prior 2008 period as other than temporary impairment, a reduction in
the fair value of securities received from our clients in the Consulting
Segment.
 
  - 29
-
  We make
valuations of the carrying amount of our marketable securities available for
sale on a quarterly basis pursuant to ASC 320 (SFAS 115) “Investments – Debt and
Equity Securities.” We record an unrealized gain/(loss) for the fair market
valuation (FMV) of such securities in the equity section of our balance sheet as
Other comprehensive income (OCI). We make an analysis on an annual basis to
determine if and when such unrealized (loss) has become other than temporarily
impaired, and reclassify it as a realized (loss) into our current period’s net
income/(loss). This determination is based on a number of factors, including but
not limited to (i) the percentage of the decline, (ii) the severity of the
decline in relation to the enterprise/market conditions, and (iii) the duration
of the decline. See the Critical Accounting Polices of this Item 7 and Note 2 of
our audited consolidated financial statements included in this
report.
 
 Comprehensive
(Loss) Income
 
 Comprehensive
(loss) income for the 2009 transition period was $(20.0) million, compared to
$10 million in first nine months of 2008. This is a result of our net loss of
$30.2 million offset by $0.145 million foreign currency translation, $0.175
million unrealized gains on marketable securities available for sale (including
marketable securities available for sale-related party), and $9.9 million from
reclassification of unrealized losses in accumulative other comprehensive income
in the first nine months of 2008.  In first nine months of 2008 we
reflected a comprehensive income of $10.0 million derived from our net income of
$18.1 million, plus foreign currency translation gains of $2.1 million, and
offset by an unrealized (loss) on marketable securities held for sale (including
marketable securities held for sale-related party), net of income tax of $(10.2)
million.
 
 Liquidity
and Capital Resources
 
 Liquidity
is the ability of a company to generate funds to support its current and future
operations, satisfy its obligations and otherwise operate on an ongoing basis.
At September 30, 2009 our working capital was $31 million as compared to $37.5
million at December 31, 2008.
 
 Our cash
balance at September 30, 2009 totaled $12.9 million, a decrease of $1.15
over our balance at December 31 2008. During the 2009 transition period we
received net proceeds of $4.8 million from a June 2009 offering of its
common stock and warrants, offset by investments in capital expenditures of
$2.1 million in property, plant and equipment made during the 2009 transition
period.
 
 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 fiscal 2010, we plan to use our magnesium holdings as
a basis for raising capital and expansion of our magnesium holdings by acquiring
additional interests in our Magnesium segment holdings as well as acquire
additional operations owned or controlled by Yuwei Huang as contemplated in a
non-binding letter of intent we have entered into with Mr. Huang. Additionally,
we plan to use the proceeds, if any, from the disposition of our ownership
interest in Pan Asia Magnesium which we discontinued as of September 30,
2009.
 
 On June
15, 2009 we sold 2,702,702 shares of our common stock, at a price of $1.85 per
share and warrants to purchase up to an additional 1,351,352 shares of common
stock in a registered direct offering. We received net proceeds of approximately
$4.8 million. In addition, we have formed International Magnesium Group, Inc. as
the vehicle to consolidate our strategic magnesium operations and to create an
identifiable brand name to unify our marketing efforts for these
operations.
 
 We have
an effective registration statement on Form S-3 which permits us to sell on a
delayed or continuous basis, shares 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 and subtracting
the $5,000,000 raised in our June 15, 2008 offering, as of June 30, 2009, we and
the selling shareholders would be limited to selling no more than approximately
$5.2 million (or 3,191,000 shares) of our common stock assuming there were no
other sales within a 12 month period and a market price for our common stock of
$1.63, the closing price of our common stock on NASDAQ on October 14, 2009. We
are evaluating our ability to continue to use the Form S-3 registration
statement in fiscal 2010 as we inadvertently filed our Quarterly Report on
Form 10-Q for the quarter ended June 30, 2009 late and are not eligible to
use Form S-3 to register our securities with the SEC until all reports required
under the Exchange Act have been timely filed for at least 12 months and other
conditions are met.  We believe we have a good faith basis for
obtaining a waiver of the 12-month timely filing requirement and will submit a
request with the SEC after we file this report.
 
  - 30
-
  On
October 14, 2009, we entered into a Continuous Offering Program Agreement (the
“Agreement”), with Rodman & Renshaw, LLC (“Rodman & Renshaw”), under
which we may sell an aggregate of up to $5,201,330 in gross proceeds of our
common stock from time to time through Rodman & Renshaw, as the agent for
the offer and sale of the common stock. Rodman & Renshaw may sell the common
stock by any method permitted by law, including sales deemed to be an “at the
market” offering as defined in Rule 415 of the Securities Act of 1933,
including without limitation sales made directly on NASDAQ Global Market, on any
other existing trading market for the common stock or to or through a market
maker. Rodman & Renshaw may also sell the common stock in privately
negotiated transactions, subject to our prior approval. We will pay Rodman &
Renshaw a commission equal to 4% of the gross proceeds of the sales price of all
common stock sold through it as sales agent under the Agreement.  The
Agreement may be terminated by either party at any time except with respect to
any pending sale by Rodman & Renshaw for us.  As of December 29,
2009, we sold 22,300 shares and received net proceeds in the amount of $34,253
under the Agreement.
 
 The
following table provides certain selected balance sheets comparisons between the
transition period ended September 30, 2009 and that ended December 31,
2008:
 
 Increase
      /(Dollars
      in Thousands)
              
              September
      30, 2009
              
              
              December
      31, 2008
              
              
              (Decrease)Cash
              
              $
              12,851
              
              
              $
              14,000
              
              
              $
              (1,149)Marketable
      securities
              
              
              4,984
              
              
              
              7,569
              
              
              
              (2,585)Accounts
      receivable, net
              
              
              8,196
              
              
              
              9,448
              
              
              
              (1,252)Inventories,
      net
              
              
              5,807
              
              
              
              6,288
              
              
              
              (481)Prepaid
      expenses and other assets
              
              
              5,092
              
              
              
              7,985
              
              
              
              (2,893)Total
      current assets
              
              
              47,150
              
              
              
              59,742
              
              
              
              (12592)Property
      and equipment, net
              
              
              31,332
              
              
              
              31,224
              
              
              
              108Total
      assets
              
              
              80,515
              
              
              
              107,379
              
              
              
              (26,864)Accounts
      payable and accrued expenses (including related
    party)
              
              
              7,760
              
              
              
              15,199
              
              
              
              (7,439)Advances
      from customers
              
              
              2,007
              
              
              
              1,545
              
              
              
              462Other
      payables
              
              
              3,072
              
              
              
              1,607
              
              
              
              1,465Due
      to related parties
              
              
              400
              
              
              
              979
              
              
              
              (579)Total
      current liabilities
              
              $
              16,191
              
              
              $
              22,228
              
              
              $
              (6,037)
 
 We
maintain cash and cash equivalents in the United States and China. At September
30, 2009 and December 31, 2008, bank deposits by geographic area (reclassified
to reflect discontinued operations), was as follows:
 
 Country
              
              September
      30, 2009
              
              
              December
      31, 2008United
      States
              
              $
              8,625,782
              
              
              
              67
              %
              
              $
              6,640,672
              
              
              
              47
              %China
              
              
              4,225,528
              
              
              
              33
              %
              
              
              7,359,513
              
              
              
              53
              %Total
      cash and cash equivalents
              
              $
              12,851,310
              
              
              
              100
              %
              
              $
              14,000,185
              
              
              
              100
              %
 
 A
substantial portion of our cash balance, 33% at September 30, 2009, 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 $4.2 million at September 30, 2009 has been converted based on the
exchange rate as of September 30, 2009. 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 September 30, 2009 totaled $47.1 million, a decrease of 21%
compared to December 31, 2008. Current liabilities as of September 30, 2009
totaled $15.9 million, reflecting a decrease of 29% from our December 31, 2008
balance.
 
  - 31
-
  A summary
of total assets by segment and discontinued operations at September 30, 2009 and
at December 31, 2008 is as follows:
 
 (Dollars
      in thousands)
              
              September
      30, 2009
              
              
              December
      31, 2008Magnesium
      segment
              
              $
              44,858
              
              
              $
              59,098Basic
      Materials segment
              
              
              17,095
              
              
              
              9,158Consulting
      segment
              
              
              18,315
              
              
              
              24,551Discontinued
      Operations
              
              
              247
              
              
              
              14,572Total
              
              $
              80,515
              
              
              $
              107,379
 
 The
following table provides detail of selected balance sheet items by segment as of
September 30, 2009:
 
 (Dollars
      in thousands)
              
              Magnesium
              
              
              Basic
      Materials
              
              
              Consulting
              
              
              ConsolidatedAccounts
      receivable, net (including related-party)
              
              $
              3,282
              
              
              $
              7,133
              
              
              $
              
              
              
              $
              10,550Inventories,
      net
              
              
              3,528
              
              
              
              2,278
              
              
              
              -
              
              
              
              5,806Prepaid
      expenses and other current assets (including related
      party)
              
              
              8,695
              
              
              
              182
              
              
              
              2,038
              
              
              
              10,915Total
      current assets
              
              
              16,129
              
              
              
              13,054
              
              
              
              17,966
              
              
              
              47,149Accounts
      payable and accrued expenses
              
              
              5,797
              
              
              
              1,724
              
              
              
              187
              
              
              
              7,708Advances
      from customers
              
              
              772
              
              
              
              992
              
              
              
              243
              
              
              
              2,007Other
      payables
              
              
              1,001
              
              
              
              2,071
              
              
              
              -
              
              
              
              3,072Total
      current liabilities
              
              $
              8,103
              
              
              $
              7,657
              
              
              $
              431
              
              
              $
              16,191
 
 Our
accounts receivables (including related party), net of allowances for doubtful
accounts, as of September 30, 2009, were $10.5 million, a decrease of
$0.6 million compared to December 31, 2008. This decrease is attributed to
the overall increase in collections efforts primarily in our Magnesium segment
partially offset by an increase in accounts receivables in our CDI Beijing
subsidiary of $3.5 million, and an increase of revenues to $12.7 million in the
transition period ended September 30, 2009 as compared to $2.1 million in the
first nine months of 2008. We extended credit terms to our credit worthy
customers in order to stay competitive in the marketplace. 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.
 
 Inventories
as of September 30, 2009 were $5.8 million, a decrease of $0.5 million
compared to December 31, 2008. This decrease is due primarily to a decrease in
magnesium inventories due to a lower demand in the marketplace, and offset by an
increase in inventories at Lang Chemical at our Basic Material
Segment.
 
 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, VAT tax refunds, and security deposits. Prepaid expenses and other
current assets as of September 30, 2009 were $5.1 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
$2 million in advances from customers reflected at September 30, 2009,
$0.992 million and $0.772 million were attributable to our Basic Material
and Magnesium segments respectively, for orders placed in the ordinary course of
business but not yet shipped.
 
 Consolidated
Statement of Cash Flows
 
 In the
2009 transition period, our net decrease in cash from continuing operations
totaled $1.15 million and was comprised of $6.851 million used by
operating activities, $0.08 million provided by investing activities,
$4.019 million provided by financing activities, and the effect of
prevailing exchange rates provided on our cash position of $1.448 million,
offset by $0.05 million in cash from discontinued operations held by the
noncontrolling interest.
 
 In fiscal
2008, our net decrease in cash from continuing operations totaled
$5 million and consisted of $10.9 million provided in operating
activities, $34.6 million used in investing activities, $17 million
provided by financing activities, and the effect of prevailing exchange rates on
our cash position of $1.8 million, offset by $0.2 million from discontinued
operations.
 
  - 32
-
  Cash
Used in Operating Activities
 
 Net cash
used by operating activities in the 2009 transition period totaled $(6.9)
millions.  The continuing activities were mainly comprised of our net
(loss) of $(30.2) million, a decrease in our prepaid expenses (including related
party) and other assets of $5.3 million, a decrease in accounts payable related
party of $(7.5) million, and reconciling non cash transactions comprised of
the followings: (i) $8.6 millions in our provisional impairment reserve,
estimated disposal costs, and operating loss from discontinued operations,
(iii) $1.4 million in depreciation expense, (iii) stock based compensation
expenses of $1.7 million, and (iv) $11.4 million in realized losses from
sales and of other than temporary impairment on our marketable securities
available for sale.
 
 In fiscal
2008 cash provided by operations of $10.9 million (including $3.5 million
provided by discontinuing operations).  The continuing activities
comprised of an increase in net prepaid expense - related party of $(3.8)
million, an increase in inventory of $(2.5) million, an increase in accounts
payable –related party of $6.6 million. These increases were partially offset by
a decrease in prepaid expenses and other assets of $3.7 million, a decrease in
advance from customers of $(5.3) million, a decrease in accounts payable and
other accrued expenses of $(0.6) million, and a decrease of other payables of
$(1.1) million. Non cash transactions comprised of (i) fair values of securities
received for services of $(15.3) million, (ii) realized losses on other than
temporary impairment of $7.5 million, (iii) depreciation expenses of $1 million,
and (iv) stock based compensation expenses of $2.2 million.
 
 Cash
(Used in) Provided by Investing Activities
 
 Net cash
provided by investing activities for the 2009 transition period totaled
$80,176.  The continuing activities were primarily comprised of
$(2.1) million of capital expenditures in property, plant and equipment,
offset by cash provided from the sale of marketable securities available for
sale of $1.6 million and a repayment of loan – related party of $0.594
million.
 
 In fiscal
2008, our cash used in investing activities totaled $(35) million (including
$(8.5) million used by discontinued operations).  The continuing
activities were mainly comprised of purchases of $(23) million in property,
plant and equipment, investment of $(3.75) million in subsidiaries, offset by a
sale of marketable securities available for sale of $0.5 million and a loan
repayment of $0.2 million.
 
 Cash
Provided by Financing Activities
 
 For the
2009 transition period net cash provided by financing activities was
$4 million including $(0.154) million used by discontinued operations. The
continuing activities were mainly comprised of gross proceeds of $5 million
from the sale of Common Stock, capital contribution from minority interest
owners of $0.99 million, proceeds from exercise of stock options and warrants of
$0.08 million, and proceeds from loans payable of $0.587 million. These
were partially offset by cash payments for stock split/forward and stock
repurchase of $(1.7) million, payment of loans payable of $(0.186) million, and
$(0.190) million in offering expenses related to share
placements.
 
 In fiscal
2008, cash provided by financing activities was $17 million (including $4.4
million from discontinued operations).  The continuing activities were
comprised of approximately $3.6 from capital contribution from noncontrolling
shareholder of our subsidiaries of owners, $3.0 million from the exercise
of options and warrants, $12.9 million from proceeds of the Series A
Preferred Stocks, and $1.1 million in proceeds from loans payable. These
increases in our cash balance were offset somewhat by the repayment of loans and
notes payable (including related party) of $(4.15) million, and costs
associated with share offerings of $(1.5) million and $(1.9) million in
repayment of due to the related party.
 
 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.
 
 In 2008,
holders of our Series A Preferred Stock converted 11,944 shares out of the
12,950 shares of the Series A Preferred Stock. As of September 30 2009 only
1,006.25 shares of Series A Preferred remained outstanding. In the 2009
transition period we paid dividends of $60,656 in the form of our common shares,
at an average of $1.38 per share. This item is discussed in further detail in
the notes to the audited consolidated financial statements appearing elsewhere
in this Form 10-K.
 
  - 33
-
  Noncontrolling
Interest
 
 At
September 30, 2009, our consolidated balance sheet reflects a total
noncontrolling interest of approximately $18.3 million, of which $18.2 million
and $96,000.00 represent noncontrolling interest in continuing operations and
discontinued operations, respectively. The following table provides information
regarding the minority interest by segment:
 
 Segment
              
              September
      30, 2009
              
              
              December
      31, 2008Magnesium
      segment
              
              $
              15,175,179
              
              
              $
              16,719,572Basic
      Materials segment
              
              
              3,074,019
              
              
              
              2,197,934Consulting
      segment
              
              
              -
              
              
              
              -Total
              
              $
              18,249,198
              
              
              $
              18,917,506
 
 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 are 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.
 
 Revenue
Recognition
 
 We follow
the guidance of ASC 605, ‘Revenue Recognition,” and 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.
 
  - 34
-
  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 the 2009 transition period
and 2008 include the allowance for doubtful accounts of accounts receivable,
stock-based compensation, and the useful life of property, plant and
equipment.
 
 Fair
Value of Financial Instruments
 
 We follow
ASC 820, “Fair Value Measurements and Disclosures,” (SFAS 157), 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. ASC 820 (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.
 
 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.
 
 Marketable
Securities
 
 We make
valuations of the carrying amount of our Marketable Securities Available for
Sale quarterly pursuant to ASC 320 (SFAS 115), “Investments – Debt and Equity
Securities”. We record an unrealized gain/(loss) for the fair market valuation
(FMV) of such securities in the equity section of our balance sheet as Other
Comprehensive income (OCI). We make an analysis at the least on an annual basis
to determine if and when such unrealized (loss) has become other than
temporarily impaired, and reclassify it as a realized (loss) into our current
period’s net income/(loss). This determination is based on a number of factors,
including but not limited to (i) the percentage of the decline, (ii) the
severity of the decline in relation to the enterprise/market conditions, and
(iii) the duration of the decline. It’s further discussed in Note 2 of our
Financial Statements.
 
 In
January 2009, the FASB issued FSP EITF 99-20-1 (ASC 325-40) 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 has
occurred. This FSP amended EITF 99-20 to more closely align the
other-than-temporary impairment guidance therein to the guidance in ASC 320,
10-35-31 (SFAS 115). Retrospective application to a prior interim or annual
period is prohibited.
 
 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
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.
 
 Comprehensive
income
 
 We follow
ASC 205, “Presentation of
Financial Statements,” and ASC 220 (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.
 
  - 35
-
  Impairment
of long-lived assets
 
 In
accordance with ASC 360-10 (SFAS 144), “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
 
 We follow
ASC 360-10-45, “Long-Lived
Assets Classified as Held for Sale,” and ASC 360-10-15, “Impairment or Disposal of Long-Lived
Assets.” 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.
  Acquisitions
 
 We
account for acquisitions using the purchase method of accounting in accordance
with ASC 8005 (SFAS 141), Business Combinations. 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
 
 EITF
Issue No. 07-5 (ASC 815) "Determining Whether an Instrument (or embedded
Feature) is Indexed to an Entity's Own Stock" (EITF 07-5) was issued in June
2008 to clarify how to determine whether certain instruments or features were
indexed to an entity's own stock under EITF Issue No. 01-6 (ASC 815), "The
Meaning of "Indexed to a Company's Own Stock" (EITF 01-6) (ASC 815),. EITF
07-5(ASC 815), applies to any freestanding financial instrument (or embedded
feature) that has all of the characteristics of a derivative as defined in FAS
133 (ASC 815), for purposes of determining whether that instrument (or embedded
feature) qualifies for the first part of the paragraph 11(a) scope exception. It
is also applicable to any freestanding financial instrument (e.g., gross
physically settled warrants) that is potentially settled in an entity's own
stock, regardless of whether it has all of the characteristics of a derivative
as defined in FAS 133 (ASC 815), for purposes of determining whether to apply
EITF 00-19 (ASC 815). EITF 07-5(ASC 815) does not apply to share-based payment
awards within the scope of FAS 123(R), Share-Based Payment (FAS 123(R) (ASC
718)). However, an equity-linked financial instrument issued to investors to
establish a market-based measure of the fair value of employee stock options is
not within the scope of FAS 123(R) (ASC 718) and therefore is subject to EITF
07-5(ASC 815).
 
 In
January 2009, the FASB issued FSP EITF 99-20-1 (ASC 325), to amend the
impairment guidance in EITF Issue No. 99-20 (ASC 325) in order to achieve
more consistent determination of whether an other-than-temporary impairment has
occurred. This FSP amended EITF 99-20 (ASC 325) to more closely align the
other-than-temporary impairment guidance therein to the guidance in Statement
No. 115 (ASC 320, 10-35-31). Retrospective application to a prior interim
or annual period is prohibited.
  On June
5, 2003, the United States Securities and Exchange Commission (“SEC”) adopted
final rules under Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”),
as amended by SEC Release No. 33-9072 on October 13, 2009. Commencing with its
annual report for the year ending December 31, 2010, the Company will be
required to include a report of management on its internal control over
financial reporting. The internal control report must include a
statement
  •
              
              Of
      management’s responsibility for establishing and maintaining adequate
      internal control over its financial reporting;•
              
              Of
      management’s assessment of the effectiveness of its internal control over
      financial reporting as of year end;
and
  - 36
-
  
  •
              
              Of
      the framework used by management to evaluate the effectiveness of the
      Company’s internal control over financial
  reporting.
 
  Furthermore,
it is required to file the auditor’s attestation report separately on the
Company’s internal control over financial reporting on whether it believes that
the Company has maintained, in all material respects, effective internal control
over financial reporting.
  In
June 2009, the FASB approved the “FASB Accounting Standards Codification”
(“ASC”) as the single source of authoritative nongovernmental U.S. GAAP to be
launched on July 1, 2009. ASC does not change current U.S. GAAP, but is
intended to simplify user access to all authoritative U.S. GAAP by providing all
the authoritative literature related to a particular topic in one place. All
existing accounting standard documents will be superseded and all other
accounting literature not included in the Codification will be considered
non-authoritative. ASC also includes all relevant Securities and Exchange
Commission guidance organized using the same topical structure in separate
sections within the Codification. The FASB will not issue new standards in the
form of Statements, FASB Staff Positions or Emerging Issue Task Force Abstracts,
but instead will issue Accounting Standard Updates (“ASUs”). ASUs will not be
considered “authoritative” in their own right as they serve only to update the
Codification by providing the basis for conclusions on the change(s) in the
Codification. ASC is effective for interim and annual periods ending after
September 15, 2009, and the principle impact on our financial statements is
limited to disclosures, as all references to authoritative accounting literature
will now be referenced in accordance with the ASC Codification.
  In
August 2009, the FASB issued the FASB Accounting Standards Update (ASU) No.
2009-04 “Accounting for
Redeemable Equity Instruments - Amendment to ASC 480-10-S99,” which
represents an update to ASC Section 480-10-S99, distinguishing liabilities from
equity, per EITF Topic D-98, Classification and Measurement of
Redeemable Securities. The Company does not expect the adoption of this
update to have a material impact on its consolidated financial position, results
of operations or cash flows.
  In
August 2009, the FASB issued the FASB Accounting Standards Update (ASU) No.
2009-05 “Fair Value
Measurement and Disclosures(ASC Topic 820) – Measuring Liabilities at Fair
Value”, which provides amendments to ASC Subtopic 820-10, Fair Value
Measurements and Disclosures – Overall, for the fair value measurement of
liabilities. This update provides clarification that in circumstances in which a
quoted price in an active market for the identical liability is not available, a
reporting entity is required to measure fair value using one or more of the
following techniques: 1. A valuation technique that uses: a. The quoted price of
the identical liability when traded as an asset b. Quoted prices for similar
liabilities or similar liabilities when traded as assets. 2. Another valuation
technique that is consistent with the principles of ASC 820; two examples would
be an income approach, such as a present value technique, or a market approach,
such as a technique that is based on the amount at the measurement date that the
reporting entity would pay to transfer the identical liability or would receive
to enter into the identical liability. The amendments in this update also
clarify that when estimating the fair value of a liability, a reporting entity
is not required to include a separate input or adjustment to other inputs
relating to the existence of a restriction that prevents the transfer of the
liability. The amendments in this update also clarify that both a quoted price
in an active market for the identical liability when traded as an asset in an
active market when no adjustments to the quoted price of the asset are required
are Level 1 fair value measurements. The Company does not expect the adoption of
this update to have a material impact on its consolidated financial position,
results of operations or cash flows.
  In
September 2009, the FASB issued the FASB Accounting Standards Update (ASU)
No. 2009-08 “Earnings Per
Share – Amendments to Section 260-10-S99,”which represents technical
corrections to ASC 260-10-S99, Earnings per share, based on EITF Topic D-53,
Computation of Earnings Per
Share for a Period that includes a Redemption or an Induced Conversion of a
Portion of a Class of Preferred Stock and EITF Topic D-42, The Effect of the Calculation of
Earnings per Share for the Redemption or Induced Conversion of Preferred
Stock. The Company does not expect the adoption of this update to have a
material impact on its consolidated financial position, results of operations or
cash flows.
  In
September 2009, the FASB issued the FASB Accounting Standards Update (ASU)
No. 2009-09 “Accounting for
Investments-Equity Method and Joint Ventures and Accounting for Equity-Based
Payments to Non-Employees”. This update represents a correction to
Section 323-10-S99-4, Accounting by an Investor for
Stock-Based Compensation Granted to Employees of an Equity Method
Investee. Additionally, it adds observer commentAccounting Recognition for Certain
Transactions Involving Equity Instruments Granted to Other Than Employees
to the Codification. The Company does not expect the adoption to have a material
impact on its consolidated financial position, results of operations or cash
flows.
   - 37
-
   In
September 2009, the FASB issued the FASB Accounting Standards Update (ASU)
No. 2009-12 “Fair Value
Measurements and Disclosures Topic 820 – Investment in Certain Entities That
Calculate Net Assets Value Per Share (or Its Equivalent)”, which provides
amendments to ASC Subtopic 820-10, Fair Value Measurements and
Disclosures-Overall, for the fair value measurement of investments in certain
entities that calculate net asset value per share (or its equivalent). The
amendments in this update permit, as a practical expedient, a reporting entity
to measure the fair value of an investment that is within the scope of the
amendments in this update on the basis of the net asset value per share of the
investment (or its equivalent) if the net asset value of the investment (or its
equivalent) is calculated in a manner consistent with the measurement principles
of ASC Topic 946 as of the reporting entity’s measurement date, including
measurement of all or substantially all of the underlying investments of the
investee in accordance with ASC Topic 820. The amendments in this update also
require disclosures by major category of investment about the attributes of
investments within the scope of the amendments in this update, such as the
nature of any restrictions on the investor’s ability to redeem its investments
at the measurement date, any unfunded commitments (for example, a contractual
commitment by the investor to invest a specified amount of additional capital at
a future date to fund investments that will be make by the investee), and the
investment strategies of the investees. The major category of investment is
required to be determined on the basis of the nature and risks of the investment
in a manner consistent with the guidance for major security types in U.S. GAAP
on investments in debt and equity securities in paragraph ASC 320-10-50-1B. The
disclosures are required for all investments within the scope of the amendments
in this update regardless of whether the fair value of the investment is
measured using the practical expedient. The Company does not expect the adoption
to have a material impact on its consolidated financial position, results of
operations or cash flows.
  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 Transition 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 Transition Report on Form 10-K for the year ended September 30,
2009:
 
 •
              
              Continued
      global economic weakness is expected to reduce demand for our products in
      each of our segments.•
              
              Fluctuations
      in the pricing and availability of magnesium and in levels of customer
      demand.•
              
              Changes
      in the prices of magnesium and magnesium-related
  products.•
              
              Our
      ability to implement our acquisition 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.•
              
              Difficulties
      we have in establishing adequate management, cash, legal and financial
      controls in the PRC.•
              
              Our
      ability to maintain an effective system of internal control over financial
      reporting.•
              
              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.
  - 38
-
  
  •
              
              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 and his daughter Lifei Huang is
      also an owner and executive officer of several companies which directly
      compete with our magnesium business.•
              
              The
      impact of a loss of our land use rights.•
              
              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.•
              
              Our
      inability to enforce our rights due to policies regarding the regulation
      of foreign investments in China.•
              
              The
      impact of environmental and safety regulations, which may increase our
      compliance costs and reduce our overall profitability.•
              
              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.•
              
              Delisting
      of our securities by NASDAQ from quotation on its exchange could limit
      investors’ ability to make transactions in our securities and subject us
      to additional trading restrictions.•
              
              Recent
      substantial declines in the market price for shares of our common stock
      and continued highly volatile and wide market price
      fluctuations.
 
 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.
 
 ITEM
      7A.
              QUANTITATIVE
      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-36, which appear at
the end of this report.
 
 ITEM
      9.
              CHANGES
      IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
      DISCLOSURE.
 
 None.
 
 ITEM
      9A (T).
              CONTROLS
      AND PROCEDURES.
 
  - 39
-
  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,
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 September 30,
2009. Based on that evaluation and as described below under “Management’s Report
on Internal Control Over Financial Reporting,” we have identified material
weaknesses in our internal control over financial reporting (as defined in
Exchange Act Rules 13a-15(f)). These weaknesses involve our lack of
internal control over financial reporting related to cash management and related
party transactions, lack of an integrated financial accounting system, control
deficiencies at one of our subsidiaries that prevented us from auditing its
financial statements prompting us to establish a loss reserve equal to our
investment in that subsidiary, failure to maintain a sufficient complement of
accounting personnel in our Magnesium segment operations and accounting for
other-than-temporary-impairment related to available for sale securities that
caused us to restate our consolidated financial statements for the year ended
December 31, 2008. 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 September 30, 2009.
 
 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 September
30, 2009.
 
 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.
 
 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 fiscal 2008.•
              
              The
      lack of an integrated financial accounting system to collect and record
      data across all of our subsidiaries; and•
              
              A
      lack of controls over the management, operations and accounting at Pan
      Asia Magnesium subsidiary as a result of a dispute with Haixin Zhao, its
      minority shareholders Shanxi Jinyang Coal and Coke Group Co., Ltd.
      (“Shanxi Jinyang”) and Ms. Runlian Tian and a principal shareholder of
      Shanxi Jinyang’s and Pan Asia Magnesium’s Chairman of the Board of
      Directors, Haixin Zhao. As a result of this dispute, Mr. Zhao prevented us
      from gaining access to Pan Asia Magnesium’s books and records necessary to
      complete our audit for the fiscal year ended September 30,
      2009.•
              
              We
      did not maintain a sufficient complement of personnel at Chang Magnesium,
      Golden Magnesium and Baotou Changxin Magnesium, with an appropriate level
      of accounting knowledge, experience, and training in the application of
      generally accepted accounting principles commensurate with financial
      reporting requirements and did not implement adequate supervisory review
      to ensure the financial statements at the subsidiary level were prepared
      in conformity with generally accepted accounting principles in the United
      States of America. This lack of sufficient accounting personnel and
      management oversight resulted in audit adjustment to correct the
      accounting for certain commissions, inventory balances, construction in
      progress, shipping details related to certain sales, and related party
      transactions. We discovered that some of these transactions took place
      without sufficient
documentation.
  - 40
-
  
  •
              
              The
      lack of controls over the accounting for other-than-temporary-impairment
      related to available for sale securities that caused us to restate our
      consolidated financial statements for the year ended December 31,
      2008.
 
 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:
 
 •
              
              We
      are evaluating a restructure plan to overhaul both our management and
      operational controls and protocols in China;•
              
              On
      December 22, 2009 Andrew X. Wang, who is bi-lingual, was appointed as our
      Chief Financial Officer. Mr. Wang is knowledgeable and experienced in the
      application of generally accepted accounting principles and will oversee
      and assist in the implementation of our remediation
  plan;•
              
              We
      are evaluating the roles of our existing accounting personnel in an effort
      to realign the reporting structure of our internal auditing staff in China
      that will test and monitor the implementation of our accounting and
      internal control procedures;•
              
              We
      have completed a review and revision of our existing documentation of our
      accounting and internal control procedures and policies which will
      included appropriate controls and procedures for cash management in China
      and related party transactions;•
              
              We
      have begun implementation an initiative and training in China to ensure
      the importance of internal controls and compliance with established
      policies and procedures are fully understood throughout the
      organization.;•
              
              Our
      board of directors adopted a Related Person Transaction Policy to govern
      our accounting and internal control procedures and
    policies;•
              
              We
      have begun implementing a financial software system both in our U.S.
      office and in our Chinese subsidiaries to standardize the process and
      access to financial reports on a timely manner;•
              
              We
      continue to provide training to our employees to ensure these procedures
      are properly performed;•
              
              We
      committed to a plan to sell our interest in Pan Asia Magnesium on
      September 29, 2009 and are evaluating our legal alternatives in the event
      we are unable to resolve our dispute with its noncontrolling
      shareholders;•
              
              We
      plan to hire additional accounting staff with experience in public
      accounting to oversee financial systems on
subsidiaries;•
              
              We
      plan to provide training in various areas of US generally accepted
      accounting principles. In this regard, accountant of head office and
      subsidiaries are both included in this training program;
    and•
              
              We
      will make efforts to review internal control over financial reporting with
      the intent to automate previously manual processes especially in the area
      of related party transaction
identification.
 
 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 by December 31, 2010. As we
work towards improvement of our internal control over financial reporting and
implement remediation measures identified above, we may supplement or modify
these 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
 
 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 September 30, 2009 that have materially affected, or are reasonably likely
to materially affect, our internal control over financial
reporting.
 
  - 41
-
  
  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 2009 Annual Meeting of Shareholders to held on March 15, 2010,
2010 (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 Exhibit3.1
              
              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)).4.2
              
              Form
      of common stock purchase warrant (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 June 17, 2009 (Commission File No.
      001-33694)).
  - 42
-
  
  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)).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)).
  - 43
-
  
  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)).10.37
              
              Lease
      Agreement dated August 21, 2007 between 431 Fairway Associates, LLC and
      China Direct, Inc. (incorporated herein by reference to Exhibit 10.37
      filed as a part of the Company’s Form 10-K filed with the Commission on
      March 31, 2009 (Commission File No.
001-33694)).
  - 44
-
  
  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)).10.46
              +
              Severance
      Agreement dated May 23, 2008 between China Direct, Inc. and Lazarus
      Rothstein (incorporated herein by reference to Exhibit 10.46 as part of
      the Company’s Quarterly Report on Form 10-Q filed with the Commission on
      August 14, 2009 (Commission File No. 001-33694)).10.47
              
              Form of
      Securities Purchase Agreement dated as of March 23, 2009 between the
      Company and the Purchasers (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 June 17, 2009 (Commission File No.
    001-33694)).10.48
              
              Continuous
      Offering Program Agreement dated October 14, 2009 between China Direct
      Industries, Inc. and Rodman & Renshaw, LLC (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 October 15, 2009 (Commission File No.
      001-33694)).10.49
              +
              Letter
      Agreement between China Direct Industries, Inc. and Andrew Wang dated as
      of December 23, 2009 (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 December 23, 2009 (Commission File No. 001-33694)).10.50
              +
              Separation
      Agreement between China Direct Industries, Inc. and Andrew Wang dated as
      of December 23, 2009 (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 December 23, 2009 (Commission File No. 001-33694)).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 Principal Financial and Accounting
  Officer.*32.1
              
              Section 906
      Certificate of Chief Executive Officer and Principal Financial and
      Accounting Officer.*
 
 +
              
              Management
      contract or compensatory plan or arrangement.*
              
              Filed
      herewith.
 
  - 45
-
  
 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 INDUSTRIES, INC.Date:
      December 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 Industries, Inc., hereby
severally constitute Yuejian (James) Wang and Andrew X. Wang, 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 Transition 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)
              
              December
      31, 2009Yuejian
      (James) Wang/S/
      Andrew X. Wang
              
              Executive
      Vice President and Chief Financial Officer (Principal Financial and
      Accounting Officer)
              
              December
      31, 2009Andrew
      X. Wang/S/
      Yuwei Huang
              
              Executive
      Vice President - Magnesium, Director
              
              December
      31, 2009Yuwei
      Huang/S/
      David Barnes
              
              Director
              
              December
      31, 2009David
      Barnes/S/
      Sheldon Steiner
              
              Director
              
              December
      31, 2009Sheldon
      Steiner/S/
      Philip Y. ShenPhilip
      Y. Shen, Ph.D
              
              Director
              
              December
      31, 2009
 
 - 46
-
  CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 FINANCIAL
STATEMENTS
 FOR
THE YEARS ENDED SEPTEMBER 30, 2009 AND DECEMBER 31, 2008
 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-7
      to F-36
 
  F-1
  
 REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
  To
the Stockholders and Board of Directors
 China
Direct Industries, Inc.
  We
have audited the accompanying consolidated balance sheets of China Direct
Industries, Inc (the “Company”) as of September 30, 2009 and December 31, 2008
and the related consolidated statement of operations and comprehensive income,
stockholders' equity and cash flows for the period ended September 30, 2009 and
for the year ended December 31, 2008. These consolidated financial statements
are the responsibility of the Company's management. Our responsibility is to
express an opinion on these financial statements based on our
audit.
  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 as a basis for designing audit procedures that are
appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Company's internal control over financial
reporting. Accordingly we express no such opinion. An audit 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 audit provides 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 the Company as of
September 30, 2009 and December 31, 2008 and the results of their operations and
their cash flows for the period ended September 30, 2009 and the year ended
December 31, 2008, in conformity with accounting principles generally accepted
in the United States of America.
  We
also audited the adjustments described in Note 2 that were applied to restate
the year ended December 31, 2008 financial statements. In our opinion, such
adjustments are appropriate and have been properly applied.
   /s/Sherb
& Co., LLP
 Certified
Public Accountants
  Boca
Raton, Florida
 December
29, 2009
 F-2
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 CONSOLIDATED
BALANCE SHEET
 
 September
      30,2009
                  
                  
                  December
      31, 2008ASSETS
                  
                  
                  
                  
                  RestatedCurrent
      Assets:Cash
      and cash equivalents
                  
                  $
                  12,851,310
                  
                  
                  
                  14,000,185Investment
      in marketable securities available for sale
                  
                  
                  4,984,351
                  
                  
                  
                  7,569,333Investment
      in marketable securities available for sale - related
party
                  
                  
                  604,686
                  
                  
                  
                  160,459Investment
      in subsidiaries -- cost method
                  
                  
                  290,864
                  
                  
                  
                  290,864Accounts
      receivable, net of allowance of $745,786 and $500,000 at September 30,
      2009 and December 31, 2008, respectively
                  
                  
                  8,195,916
                  
                  
                  
                  9,448,463Accounts
      receivable - related parties
                  
                  
                  2,355,059
                  
                  
                  
                  1,676,191Inventories,
      net
                  
                  
                  5,806,722
                  
                  
                  
                  6,288,378Prepaid
      expenses and other current assets
                  
                  
                  5,092,205
                  
                  
                  
                  7,985,134Prepaid
      expenses - related parties
                  
                  
                  5,823,039
                  
                  
                  
                  7,617,887Loans
      receivable - related parties
                  
                  
                  1,094,142
                  
                  
                  
                  1,652,728Other
      receivable - related parties
                  
                  
                  -
                  
                  
                  
                  35,710Current
      assets of discontinued operations (see Note 20)
                  
                  
                  51,345
                  
                  
                  
                  3,016,492Total
      current assets
                  
                  
                  47,149,639
                  
                  
                  
                  59,741,824Restricted
      cash
                  
                  
                  722,324
                  
                  
                  
                  846,197Property,
      plant and equipment, net
                  
                  
                  31,331,992
                  
                  
                  
                  31,223,840Prepaid
      expenses and other assets
                  
                  
                  1,836
                  
                  
                  
                  500,000Property
      use rights, net
                  
                  
                  1,113,902
                  
                  
                  
                  495,199Long-lived
      assets of discontinued operations (see Note 20)
                  
                  
                  196,077
                  
                  
                  
                  14,572,348Total
      assets
                  
                  $
                  80,515,770
                  
                  
                  $
                  107,379,408LIABILITIES
      AND EQUITYCurrent
      Liabilities:Loans
      payable-short term
                  
                  $
                  1,521,002
                  
                  
                  
                  933,735Accounts
      payable and accrued expenses
                  
                  
                  7,708,730
                  
                  
                  
                  7,681,884Accounts
      payable-related parties
                  
                  
                  51,716
                  
                  
                  
                  7,516,728Advances
      from customers
                  
                  
                  2,007,137
                  
                  
                  
                  1,545,273Other
      payables
                  
                  
                  3,072,238
                  
                  
                  
                  1,607,254Taxes
      payable
                  
                  
                  1,130,907
                  
                  
                  
                  354,875Due
      to related parties
                  
                  
                  399,629
                  
                  
                  
                  978,739Current
      liabilities of discontinued operations (see Note 20)
                  
                  
                  300,000
                  
                  
                  
                  1,609,479Total
      current liabilities
                  
                  
                  16,191,359
                  
                  
                  
                  22,227,967Loans
      payable-long term
                  
                  
                  -
                  
                  
                  
                  186,018Total Liabilities
                  
                  
                  16,191,359
                  
                  
                  
                  22,413,985China
      Direct Industries, Inc. stockholders' equityPreferred
      Stock: $.0001 par value, stated value $1,000 per share; 1,006 shares
      outstanding at September 30, 2009 and December 31, 2008,
      respectively.
                  
                  
                  1,006,250
                  
                  
                  
                  1,006,250Common
      Stock: $.0001 par value; 27,189,719 and 23,530,642 outstanding at
      September 30, 2009 and December 31, 2008, respectively.
                  
                  
                  2,719
                  
                  
                  
                  2,353Additional
      paid-in capital
                  
                  
                  57,492,755
                  
                  
                  
                  51,701,293Deferred
      compensation
                  
                  
                  -
                  
                  
                  
                  (11,000
                  )Accumulated
      other comprehensive income (loss)
                  
                  
                  1,902,221
                  
                  
                  
                  (8,317,488
                  )(Accumulated
      deficit) retained earnings
                  
                  
                  (14,328,732
                  )
                  
                  
                  13,643,874Total
      China Direct Industries, Inc. stockholders' equity
                  
                  
                  46,075,213
                  
                  
                  
                  58,025,282Noncontrolling
      interests
                  
                  
                  18,249,198
                  
                  
                  
                  26,940,141Total
      Equity
                  
                  
                  64,324,411
                  
                  
                  
                  84,965,423Total
      liabilities and equity
                  
                  $
                  80,515,770
                  
                  
                  $
                  107,379,408The
      accompanying notes are an intergral part of the financial
      statements.
 
  F-3
  CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 CONSOLIDATED
STATEMENTS OF OPERATIONS
 
 Nine
      months ended September 30, 2009
                  
                  
                  Nine
      months ended September 30, 2008
                  
                  
                  Twelve
      months ended December 31, 2008Unaudited
                  
                  
                  RestatedRevenues
                  
                  $
                  57,088,400
                  
                  
                  $
                  180,521,387
                  
                  
                  $
                  205,872,196Revenues-related
      parties
                  
                  
                  11,541,914
                  
                  
                  
                  3,144,366
                  
                  
                  
                  16,750,008Total
      revenues
                  
                  
                  68,630,313
                  
                  
                  
                  183,665,753
                  
                  
                  
                  222,622,204Cost
      of revenues
                  
                  
                  66,349,604
                  
                  
                  
                  152,125,418
                  
                  
                  
                  192,074,240Gross
      profit
                  
                  
                  2,280,710
                  
                  
                  
                  31,540,335
                  
                  
                  
                  30,547,964Operating
      expenses:Selling,
      general, and administrative
                  
                  
                  10,938,867
                  
                  
                  
                  6,708,219
                  
                  
                  
                  10,451,865Operating
      (loss) income
                  
                  
                  (8,658,157
                  )
                  
                  
                  24,832,106
                  
                  
                  
                  20,096,099Other
      income (expense):Other
      (expenses) income
                  
                  
                  (119,313
                  )
                  
                  
                  339,376
                  
                  
                  
                  350,035Other
      impairment charges
                  
                  
                  (1,753,744
                  )
                  
                  
                  -
                  
                  
                  
                  -Interest
      income
                  
                  
                  283,288
                  
                  
                  
                  349,731
                  
                  
                  
                  292,259Realized
      loss on sale of marketable securities
                  
                  
                  (1,909,056
                  )
                  
                  
                  (38,105
                  )
                  
                  
                  (136,923
                  )Realized
      loss
                  
                  
                  (9,466,329
                  )
                  
                  
                  
                  
                  
                  
                  (7,521,088
                  )Realized
      gain on sale subsidiaries
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  238,671Total
      other (expense) income
                  
                  
                  (12,965,155
                  )
                  
                  
                  651,002
                  
                  
                  
                  (6,777,046
                  )Net
      (loss) income from continuing operations before income
    taxes
                  
                  
                  (21,623,311
                  )
                  
                  
                  25,483,108
                  
                  
                  
                  13,319,053Income
      tax benefit
                  
                  
                  21,165
                  
                  
                  
                  10,460
                  
                  
                  
                  118,351Net
      (loss) income from continuing operations, net of income
    taxed
                  
                  
                  (21,602,146
                  )
                  
                  
                  25,493,568
                  
                  
                  
                  13,437,404(Loss)
      income from discontinued operations (See Note 20)
                  
                  
                  (1,194,767
                  )
                  
                  
                  1,561,719
                  
                  
                  
                  645,475Provisional
      reserve of discontinued operations (See Note 20)
                  
                  
                  (7,362,039
                  )
                  
                  
                  -
                  
                  
                  
                  -Net
      (loss) income
                  
                  
                  (30,158,952
                  )
                  
                  
                  27,055,287
                  
                  
                  
                  14,082,879Net
      loss (income) attributable to noncontrolling interests-discontinued
      operations
                  
                  
                  585,436
                  
                  
                  
                  (738,478
                  )
                  
                  
                  (289,517
                  )Net
      loss (income) attributable to noncontrolling interests
                  
                  
                  1,714,521
                  
                  
                  
                  (8,163,645
                  )
                  
                  
                  (5,788,288
                  )Net
      (loss) income attributable to China Direct Industries,
Inc.
                  
                  
                  (27,858,995
                  )
                  
                  
                  18,153,174
                  
                  
                  
                  8,005,074Deduct
      dividends on Series A Preferred Stock:Preferred
      stock dividend
                  
                  
                  (80,925
                  )
                  
                  
                  (1,209,702
                  )
                  
                  
                  (1,229,937
                  )Relative
      fair value of detachable warrants issued
                  
                  
                  -
                  
                  
                  
                  (2,765,946
                  )
                  
                  
                  (2,765,946
                  )Preferred
      stock beneficial conversion feature
                  
                  
                  -
                  
                  
                  
                  (2,451,446
                  )
                  
                  
                  (2,451,446
                  )Net
      (loss) income attributable to common stockholders
                  
                  $
                  (27,939,920
                  )
                  
                  $
                  11,726,070
                  
                  
                  $
                  1,557,745Basic
      and diluted (loss) income per common shareBasic
                  
                  $
                  (1.13
                  )
                  
                  $
                  0.52
                  
                  
                  $
                  0.07Diluted
                  
                  $
                  (1.13
                  )
                  
                  $
                  0.47
                  
                  
                  $
                  0.06Basic
      weighted average common shares outstanding
                  
                  
                  24,802,730
                  
                  
                  
                  22,403,054
                  
                  
                  
                  22,403,054Diluted
      weighted average common shares outstanding
                  
                  
                  24,802,730
                  
                  
                  
                  24,687,015
                  
                  
                  
                  24,687,015
 
 The
accompanying notes are an intergral part of the financial
statements.
  F-4
  CHINA
      DIRECT INDUSTRIES, INC. AND SUBSIDIARIESSTATEMENT
      OF STOCKHOLDERS' EQUITYAccumulatedPreferred
      Stock
                  
                  
                  Common
      Stock
                  
                  
                  Additional
                  
                  
                  Deferred
                  
                  
                  Comprehensive
                  
                  
                  Retained
                  
                  
                  Non-controllingShares
                  
                  
                  Amount
                  
                  
                  Shares
                  
                  
                  Amount
                  
                  
                  Paid-in
      Capital
                  
                  
                  Compensation
                  
                  
                  Income
                  
                  
                  Earnings
                  
                  
                  interests
                  
                  
                  TotalBalance,
      December 31, 2007
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  20,982,010
                  
                  
                  
                  2,098
                  
                  
                  
                  30,257,644
                  
                  
                  
                  (55,000
                  )
                  
                  
                  54,688
                  
                  
                  
                  12,366,149
                  
                  
                  
                  16,957,503
                  
                  
                  
                  59,583,082Sale
      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 February Offering
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,765,946
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (2,765,946
                  )
                  
                  
                  -
                  
                  
                  
                  -Intrinsic
      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
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (85,741
                  )
                  
                  
                  (8
                  )
                  
                  
                  (417,387
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (417,395
                  )Reverse/Forward
      Split
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (3,761
                  )
                  
                  
                  (1
                  )
                  
                  
                  (19,070
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (19,071
                  )Reclassification
      to Minority Interest
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (300,667
                  )
                  
                  
                  300,667
                  
                  
                  
                  -Noncontrolling
      interest capital contribution
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  3,603,892
                  
                  
                  
                  3,603,892Comprehensive
      income:Net
      income for the year ended December 31, 2008
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  8,005,074
                  
                  
                  
                  6,077,805
                  
                  
                  
                  14,082,879Other
      comprehensive income, net of taxUnrealized
      (loss) on marketable securities available for sale
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (7,819,861
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (7,819,861
                  )Unrealized
      (loss) on marketable securities available for sale-related
      party
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,155,029
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,155,029
                  )Foreign
      currency translation loss
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  602,714
                  
                  
                  
                  -
                  
                  
                  
                  269
                  
                  
                  
                  602,983Balance,
      December 31, 2008
                  
                  
                  1,006
                  
                  
                  $
                  1,006,250
                  
                  
                  
                  23,530,642
                  
                  
                  $
                  2,353
                  
                  
                  $
                  51,701,293
                  
                  
                  $
                  (11,000
                  )
                  
                  $
                  (8,317,488
                  )
                  
                  $
                  13,643,874
                  
                  
                  $
                  26,940,141
                  
                  
                  
                  84,965,4232009
      Dividends paid to Liberty Harbor and Alpha
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  44,018
                  
                  
                  
                  4
                  
                  
                  
                  80,925
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (80,925
                  )
                  
                  
                  -
                  
                  
                  
                  4Dividends
      payable
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Public
      offering
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,702,702
                  
                  
                  
                  270
                  
                  
                  
                  4,809,729
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  4,809,999Stock
      option amortization
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (159,508
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (159,508
                  )Restricted
      Stock Award - Employees
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  578,829
                  
                  
                  
                  34
                  
                  
                  
                  1,518,063
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,518,097Restricted
      Stock Award - Consultants
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  169,371
                  
                  
                  
                  41
                  
                  
                  
                  204,758
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  204,799Restricted
      Stock Award - Board of Directors
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  76,250
                  
                  
                  
                  8
                  
                  
                  
                  176,172
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  176,180Stock
      Option Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  1,068,348
                  
                  
                  
                  107
                  
                  
                  
                  9,895
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  10,002Stock
      Warrants Exercised
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  60,000
                  
                  
                  
                  6
                  
                  
                  
                  68,394
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  68,400Individual
      loan exchanged to stocks
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  459,559
                  
                  
                  
                  46
                  
                  
                  
                  732,885
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  732,931Sale
      (buyback) of stock shares
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,500,000
                  )
                  
                  
                  (150
                  )
                  
                  
                  (1,649,850
                  )
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (1,650,000
                  )Deferred
      compensation
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  11,000
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  11,000Noncontrolling
      interest capital contribution
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  802,070
                  
                  
                  
                  802,070Discontinued
      operations
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (7,154,046
                  )
                  
                  
                  (7,154,046
                  )Comprehensive
      income:Net
      loss for the year ended September 30, 2009
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (27,858,996
                  )
                  
                  
                  (2,299,956
                  )
                  
                  
                  (30,158,953
                  )Other
      comprehensive income, net of tax
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (32,685
                  )
                  
                  
                  -
                  
                  
                  
                  (32,685
                  )Unrealized
      gain on marketable securities available for sale
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  175,436
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  175,436Reclassification
      of unrealized loss from marketable securities available for
      sale
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  9,860,445
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  9,860,445Foreign
      currency translation gain
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  183,828
                  
                  
                  
                  -
                  
                  
                  
                  (39,006
                  )
                  
                  
                  144,822Balance,
      September 30, 2009
                  
                  
                  1,006
                  
                  
                  $
                  1,006,250
                  
                  
                  
                  27,189,719
                  
                  
                  $
                  2,719
                  
                  
                  $
                  57,492,755
                  
                  
                  
                  -
                  
                  
                  $
                  1,902,221
                  
                  
                  $
                  (14,328,732
                  )
                  
                  $
                  18,249,198
                  
                  
                  $
                  64,324,411
  The
accompanying notes are an intergral part of the financial
statements.
  F-5
  
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 STATEMENT
OF CASH FLOWS
 
 September
      30,
                  
                  
                  September
      30,
                  
                  
                  December
      31,2009
                  
                  
                  2008
                  
                  
                  2008CASH
      FLOWS - OPERATING ACTIVITIES
                  
                  
                  
                  
                  Unaudited
                  
                  
                  RestatedNet
      (loss) income
                  
                  $
                  (30,158,952
                  )
                  
                  $
                  27,055,287
                  
                  
                  
                  14,082,879Less:
      (Loss) income from discontinued operations
                  
                  
                  8,556,806
                  
                  
                  
                  (1,561,719
                  )
                  
                  
                  (645,475
                  )Adjustments
      to reconcile net income to net cash (used in) provided by operating
      activities:Depreciation and
      Amortization
                  
                  
                  1,361,824
                  
                  
                  
                  747,947
                  
                  
                  
                  1,035,005Allowance
      for bad debt
                  
                  
                  245,786
                  
                  
                  
                  -
                  
                  
                  
                  161,869Stock
      based compensation
                  
                  
                  1,694,277
                  
                  
                  
                  1,672,263
                  
                  
                  
                  2,203,130Realized
      loss on sale of investment in marketable securities
                  
                  
                  1,909,056
                  
                  
                  
                  35,705
                  
                  
                  
                  134,523Realized
      loss on investment in marketable securities-related party
                  
                  
                  -
                  
                  
                  
                  2,400
                  
                  
                  
                  2,400Realized
      gain on sale of subsidiaries
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  (238,670
                  )Realized
      loss on investment in marketable securities
                  
                  
                  9,466,329
                  
                  
                  
                  -
                  
                  
                  
                  7,521,088Fair
      value of securities received for services and interest
                  
                  
                  (784,371
                  )
                  
                  
                  (10,300,138
                  )
                  
                  
                  (15,332,138
                  )Fair
      value of securities paid for services
                  
                  
                  204,799
                  
                  
                  
                  -
                  
                  
                  
                  -Changes
      in operating assets and liabilities:Prepaid
      expenses and other assets
                  
                  
                  3,476,953
                  
                  
                  
                  (5,172,000
                  )
                  
                  
                  3,742,613Prepaid
      expenses - related parties
                  
                  
                  1,794,848
                  
                  
                  
                  (3,587,470
                  )
                  
                  
                  (3,841,578
                  )Inventories
                  
                  
                  481,656
                  
                  
                  
                  (8,561,114
                  )
                  
                  
                  (2,475,338
                  )Accounts
      receivable
                  
                  
                  776,261
                  
                  
                  
                  (7,536,371
                  )
                  
                  
                  862,707Accounts
      receivable - related parties
                  
                  
                  (678,868
                  )
                  
                  
                  1,533,181
                  
                  
                  
                  607,409Accounts
      payable and accrued expenses
                  
                  
                  26,846
                  
                  
                  
                  556,354
                  
                  
                  
                  (607,885
                  )Accounts
      payable - related party
                  
                  
                  (7,465,012
                  )
                  
                  
                  2,321,640
                  
                  
                  
                  6,552,614Advances
      from customers
                  
                  
                  -
                  
                  
                  
                  (289,626
                  )
                  
                  
                  (5,297,109
                  )Other
      payables
                  
                  
                  1,464,984
                  
                  
                  
                  1,080,586
                  
                  
                  
                  (1,087,117
                  )Taxes
      payable
                  
                  
                  776,032
                  
                  
                  
                  426,841
                  
                  
                  
                  49,898Net
      cash (used for) provided by continuing activities
                  
                  
                  (6,850,747
                  )
                  
                  
                  (1,576,232
                  )
                  
                  
                  7,430,825Net
      cash provided by discontinued operations - Wanda
                  
                  
                  
                  
                  
                  
                  789,996
                  
                  
                  
                  1,301,444Net
      cash (used for) provided by  discontinued operations - Pan
      Asia
                  
                  
                  
                  
                  
                  
                  (1,515,123
                  )
                  
                  
                  2,186,212CASH
      (USED FOR) PROVIDED BY OPERATING ACTIVITIES
                  
                  
                  (6,850,747
                  )
                  
                  
                  (2,301,359
                  )
                  
                  
                  10,918,481CASH
      FLOWS - INVESTING ACTIVITIESDecrease in
      notes receivable
                  
                  
                  -
                  
                  
                  
                  942,713Increase
      in loans receivable
                  
                  
                  -
                  
                  
                  
                  (1,531,138
                  )Increase
      in loans receivable - related party
                  
                  
                  
                  
                  
                  
                  (1,525,114
                  )Repayment
      of loans and advances to related parties
                  
                  
                  594,296
                  
                  
                  
                  
                  
                  
                  
                  206,694Proceeds
      from the sale of marketable securities available for sale
                  
                  
                  1,574,559
                  
                  
                  
                  432,395
                  
                  
                  
                  511,459China
      Direct Industries Inc. investment in subsidaries
                  
                  
                  
                  
                  
                  
                  (3,746,065
                  )
                  
                  
                  (3,746,065
                  )Purchases
      of property, plant and equipment
                  
                  
                  (2,088,679
                  )
                  
                  
                  (7,266,534
                  )
                  
                  
                  (23,066,026
                  )Net
      cash (used for) provided by investing activities - continuing
      operations
                  
                  
                  80,176
                  
                  
                  
                  (12,693,743
                  )
                  
                  
                  (26,093,938
                  )Net
      cash (used for) provided by investing activities - discontinued
      operations
                  
                  
                  
                  (3,981,666
                  )
                  
                  
                  (8,547,310
                  )CASH
      PROVIDED BY (USED FOR) FROM INVESTING ACTIVITES
                  
                  
                  80,176
                  
                  
                  
                  (16,675,409
                  )
                  
                  
                  (34,641,248
                  )CASH
      FLOWS - FINANCING ACTIVITIESDecrease
      (increase) in restricted cash
                  
                  
                  123,873
                  
                  
                  
                  645,550
                  
                  
                  
                  (199,227
                  )Proceeds
      from loans payable
                  
                  
                  587,267
                  
                  
                  
                  2,147,997
                  
                  
                  
                  1,119,753Payment
      of loans payable
                  
                  
                  (186,018
                  )
                  
                  
                  (1,006,816
                  )
                  
                  
                  (3,146,889
                  )Payment
      of notes payable
                  
                  
                  -
                  
                  
                  
                  (592,007
                  )
                  
                  
                  (592,007
                  )Payment
      of notes payable-related party
                  
                  
                  -
                  
                  
                  
                  (410,167
                  )
                  
                  
                  (410,167
                  )Proceeds
      from repayment of advances to related parties
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  -Due
      from related parties
                  
                  
                  
                  
                  
                  
                  (14,588
                  )
                  
                  
                  374,638Due
      to related parties
                  
                  
                  (579,110
                  )
                  
                  
                  (2,402,237
                  )
                  
                  
                  (1,870,822
                  )Gross
      proceeds from sale of preferred stock
                  
                  
                  -
                  
                  
                  
                  12,950,000Gross
      proceeds from sale of common stock
                  
                  
                  5,000,000
                  
                  
                  
                  -
                  
                  
                  
                  12,950,000Proceeds
      from exercise of warrants/options
                  
                  
                  78,402
                  
                  
                  
                  2,982,376
                  
                  
                  
                  2,982,376Cash
      payment for stock split/forward and stock repurchase
                  
                  
                  (1,650,000
                  )
                  
                  
                  (41,438
                  )
                  
                  
                  (436,481
                  )Cash
      dividend payment to preferred stockholders
                  
                  
                  -
                  
                  
                  
                  (141,530
                  )
                  
                  
                  (141,530
                  )Capital
      contribution from minority interest owners
                  
                  
                  988,465
                  
                  
                  
                  2,118,348
                  
                  
                  
                  3,603,892Offering
      expenses
                  
                  
                  (190,000
                  )
                  
                  
                  (1,504,345
                  )
                  
                  
                  (1,504,345
                  )Cash
      from financing activities - continuing operations
                  
                  
                  4,172,879
                  
                  
                  
                  14,731,143
                  
                  
                  
                  12,729,191Cash (used
      for) from financing activities - discontinued operations
                  
                  
                  (153,704
                  )
                  
                  
                  3,174,520
                  
                  
                  
                  4,357,056CASH
      FROM (USED FOR) FINANCING ACTIVITIES
                  
                  
                  4,019,175
                  
                  
                  
                  17,905,663
                  
                  
                  
                  17,086,247EFFECT
      OF EXCHANGE RATE ON CASH
                  
                  
                  1,448,817
                  
                  
                  
                  1,683,363
                  
                  
                  
                  1,817,150Net
      (decrease) increase in cash
                  
                  
                  (1,302,579
                  )
                  
                  
                  612,258
                  
                  
                  
                  (4,819,370
                  )Cash
      and equivalents, beginning of year-continuing operations
                  
                  
                  14,000,185
                  
                  
                  
                  17,082,808
                  
                  
                  
                  17,082,808Cash
      and equivalents, beginning of year-discontinued operations
                  
                  
                  205,049
                  
                  
                  
                  1,941,796
                  
                  
                  
                  1,941,796Cash
      and equivalents, beginning of the year
                  
                  $
                  14,205,234
                  
                  
                  $
                  19,024,604
                  
                  
                  $
                  19,024,604Cash
      and equivalents, end of period
                  
                  $
                  12,902,657
                  
                  
                  $
                  19,636,862
                  
                  
                  $
                  14,205,234Less
      cash and equivalents of discontinued operations, end of
    year
                  
                  
                  51,347
                  
                  
                  
                  539,597
                  
                  
                  
                  205,049Cash
      and equivalens of continuing operations, end of year
                  
                  $
                  12,851,310
                  
                  
                  $
                  19,097,265
                  
                  
                  $
                  14,000,185Supplemental
      disclosures of cash flow information:Cash
      paid for taxes
                  
                  $
                  -
                  
                  
                  $
                  146,716
                  
                  
                  $
                  250,059Cash
      paid for interest
                  
                  $
                  -
                  
                  
                  $
                  169,385
                  
                  
                  $
                  187,188Dividend
      payment in stock to preferred stock shareholders
                  
                  $
                  80,925
                  
                  
                  $
                  1,027,922
                  
                  
                  $
                  1,047,937Non-cash
      preferred stock deemed dividend
                  
                  $
                  -
                  
                  
                  $
                  5,217,392
                  
                  
                  $
                  5,217,392The
      accompanying notes are an intergral part of the financial
      statement.
  F-6
  CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008
 
 NOTE
1 – ORGANIZATION AND DESCRIPTION OF BUSINESS
 
 Business
and Organization
 
 China
Direct Industries, 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 the Financial Standard Board Accounting Standard Codifications
(ASC) 280, “Segment Reporting”.   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 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 our
Magnesium segment, our largest segment, we produce, sell and distribute pure
magnesium ingots, magnesium powders and magnesium scraps.
 
 In our
Basic Materials segment, we sell and distribute a variety of products including
industrial grade synthetic chemicals, steel products, non ferrous metals,
recycled materials, and industrial commodities. This segment also includes our
zinc ore mining property and zinc concentrate distribution businesses which have
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 the
second quarter of the 2009 Transition Period China Direct formed International
Magnesium Group, Inc. ("IMG"), a Florida Corporation, as a wholly owned
subsidiary of China Direct Industries to be used to consolidate its magnesium
holdings under one corporate entity and to create an identifiable brand name to
unify marketing efforts for these operations.
  In July
2009 we formed CDI Trading, Inc., a wholly owned subsidiary to engage in the
global purchases and sales of industrial commodities for China Direct Industries
and its subsidiaries and client companies. CDI Trading focuses  its
sourcing efforts in North and South America, Russia, parts of Africa and the
European Union. CDI Trading will seek to market products from China Direct
Industries and its various business units as well as market and procure products
for its consulting clients. CDI Trading will also seek to leverage China Direct
Industries relationships in China and other countries to opportunistically trade
additional complementary products for its end customers.
   NOTE
2 – BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES
 
 Restatement
of Financial Statements
 
 The
December 31, 2008 financial statements included in our Form 10-K filed on March
31, 2009 with the SEC, contained an error related to the method of calculating
the other-than-temporary impairment of available for sale
securities.  Accordingly, the consolidated balance sheets,
consolidated statements of operations, consolidated statement of stockholders’
equity, and consolidated statement of cash flows for fiscal 2008 have been
restated to correct the accounting treatment previously accorded the
other-than-temporary impairment treatment.  Furthermore, we
discontinued a component of our business which also affected our financial
statements for the year ended December 31, 2008.
  F-7
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 The
effect of correcting this error and the discontinued operations on our
consolidated balance sheet at December 31, 2008, and consolidated statement of
operations and statement of cash flows for fiscal 2008 is shown in the table
below.  There was no net effect on comprehensive income from this
error and all other changes to our consolidated statement of equity will be
shown in the tables provided for in the consolidated balance sheet and
consolidated statement of operations.  Additionally, for accounts
effected by the restatement error and adjustments related to the retrospective
presentation of discontinued operations are also shown.
 
 Consolidate
      Balance Sheet Data
                  
                  December
      31, 2008As
      filed
                  
                  
                  Adjustment
      to Restate
                  
                  
                  Adjustment
      for discontinued operations
                  
                  
                  RestatedShareholders'
      equityAccumulated
      other comprehensive (loss) income
                  
                  $
                  (11,711,021
                  )
                  
                  $
                  3,393,533
                  
                  
                  
                  -
                  
                  
                  $
                  (8,317,488
                  )Retained
      Earnings
                  
                  $
                  17,037,407
                  
                  
                  $
                  (3,393,533
                  )
                  
                  
                  -
                  
                  
                  $
                  13,643,874Consolidated
      Statement of Operations Data
                  
                  For
      the year ended December 31, 2008As
      filed
                  
                  
                  Adjustment
      to
                    Restate
                  
                  
                  Adjustment
      for discontinued operations
                  
                  
                  RestatedRealized
      loss on Other Than Temporary Impairment
                  
                  $
                  (4,127,555
                  )
                  
                  $
                  (3,393,533
                  )
                  
                  $
                  -
                  
                  
                  $
                  (7,521,088
                  )Total
      other expense
                  
                  $
                  (3,279,746
                  )
                  
                  $
                  (3,393,533
                  )
                  
                  $
                  (103,767
                  )
                  
                  $
                  (6,777,046
                  )Net
      income from continuing operations before income taxes
                  
                  $
                  17,689,043
                  
                  
                  $
                  (3,393,533
                  )
                  
                  $
                  (976,457
                  )
                  
                  $
                  13,319,053Net income
      from continuing operations net of income taxes
                  
                  $
                  17,421,798
                  
                  
                  $
                  (3,393,533
                  )
                  
                  $
                  (590,861
                  )
                  
                  $
                  13,437,404Net
      Income
                  
                  $
                  17,476,417
                  
                  
                  $
                  (3,393,533
                  )
                  
                  $
                  (289,522
                  )
                  
                  $
                  13,793,362Net
      income attributable to China Direct Industries, Inc.
                  
                  $
                  11,398,607
                  
                  
                  $
                  (3,393,533
                  )
                  
                  $
                  -
                  
                  
                  $
                  8,005,074Income
      applicable to common stockholders
                  
                  $
                  4,951,278
                  
                  
                  $
                  (3,393,533
                  )
                  
                  $
                  -
                  
                  
                  $
                  1,557,745Basic
      and diluted income (loss) per common share:Basic
                  
                  $
                  0.22
                  
                  
                  $
                  (0.15
                  )
                  
                  $
                  (0.15
                  )
                  
                  $
                  0.07Diluted
                  
                  $
                  0.20
                  
                  
                  $
                  (0.14
                  )
                  
                  $
                  (0.14
                  )
                  
                  $
                  0.06Consolidated
      Statements of Cash Flows Data
                  
                  For
      the year ended December 31, 2008As
      filed
                  
                  
                  Adjustment
      to Restate
                  
                  
                  Adjustment
      for discontinued operations
                  
                  
                  RestatedNet
      income
                  
                  $
                  17,476,417
                  
                  
                  $
                  (3,393,533
                  )
                  
                  $
                  (289,522
                  )
                  
                  $
                  13,793,362Realized
      loss on investment in marketable securities - Other Than Temporary
      Impairment
                  
                  $
                  4,127,555
                  
                  
                  $
                  3,393,533
                  
                  
                  $
                  -
                  
                  
                  $
                  7,521,088For
      the year ended December 31, 2008Consolidated
      Statement of Changes in Equity
                  
                  As
      filed
                  
                  
                  Adjustment
      to
                    Restate
                  
                  
                  Adjustment
      to
                    Restate
                  
                  
                  RestatedNet
      income for the year ended December 31, 2008
                  
                  $
                  11,398,607
                  
                  
                  $
                  (3,393,533
                  )
                  
                  $
                  -
                  
                  
                  $
                  8,005,074Unrealized
      loss on marketable securities available for sale
                  
                  $
                  (11,213,394
                  )
                  
                  $
                  3,393,533
                  
                  
                  $
                  -
                  
                  
                  $
                  (7,819,861
                  )
 
  F-8
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 Basis
of Presentation
 
 Change in Fiscal
Year
 
 Effective
August 13, 2009, we changed our fiscal year end from December 31 to
September 30. We have defined various periods that are covered in this report as
follows:
 
 •
                  
                  “2009
      transition period” — January 1, 2009 through September 30,
      2009.•
                  
                  “first
      nine months of 2008” — January 1, 2008 through September 30,
      2008.•
                  
                  “fiscal
      2010” — October 1, 2009 through September 30,
2010.•
                  
                  “fiscal
      2008” — January 1, 2008 through December 31, 2008.•
                  
                  “fiscal
      2007” ??January 1, 2007 through December 31,
  2007.
 
 The
audited consolidated financial statements include China Direct Industries, Inc.
and all our controlled 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 this Transition Report on Form 10-K.  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  which are, in the opinion of management, necessary
for the fair presentation of the consolidated financial position and the
consolidated results of operations.  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.
 
 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. (?癈DI 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 (“CDI 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.
  F-9
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 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.
 
 On
September 29, 2009 our board of directors committed to a plan to sell our
51% interest in Pan Asia Magnesium, Ltd. (“Pan Asia Magnesium”) which is
presented in these consolidated financial statements as a discontinued
operation.  See Note 20 – Discontinued Operations.
  On
October 10, 2009, CDI Magnesium's board of directors elected to dissolve
the company and distribute its assets to its shareholders or otherwise dispose
of the assets upon agreement among its shareholders. Beginning with our
financial statements for the fiscal year ended September 30, 2009, we will treat
CDI Magnesium as a discontinued operation. See Note 20 – Discontinued Operations
included in our notes to consolidated financial statements included in this
report.
 
 Summary
of Significant Accounting Policies
 
 Estimates
 
 The
preparation of financial statements in conformity with generally accepted
accounting principles 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.  Significant estimates in the 2009 Transition
Period and fiscal 2008 include the investments held for sale, the allowance for
doubtful accounts of accounts receivable, the fair value of stock-based
compensation, and the useful life of property, plant and equipment.
 
 We rely
on assumptions such as volatility, forfeiture rate, and expected dividend yield
when deriving the grant date fair value of share-based
compensation.  If an equity award is modified, and we expect the
service conditions of the original award will be met, we will adjust our
assumptions and estimates as of the modification date and compare the old equity
award valued at the modification date with the new equity award valued at the
modification date to calculate any incremental cost.  We then continue
to recognize the original grant date fair value plus any incremental cost over
the modified service period.
 
 Our
estimate for allowance for doubtful accounts is based on an evaluation of our
outstanding accounts receivable including the age of amounts due, the financial
condition of our specific customers, knowledge of our industry segment in Asia,
and historical bad debt experience. This evaluation methodology has proven
to provide a reasonable estimate of bad debt expense in the past and we intend
to continue to employ this approach in our analysis of
collectability. However, we are aware that given the current global
economic situation, including that of China, meaningful time horizons may
change. We intend to enhance our focus on the evaluation of our customers'
sustainability and adjust our estimates as may be indicated.
 
 We group
property plant and equipment into similar groups of assets and estimate the
useful life of each group of assets; see Note 7 – Property, Plant and Equipment
for further information on asset groups and estimated useful lives.
 
 Assumptions
and estimates employed in these areas are material to our reported financial
conditions and results of operations. These assumptions and estimates have
been materially accurate in the past and are not expected to materially change
in the future. Actual results could differ from these
estimates.
 
 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.
 
 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 September 30, 2009, no bank deposits in the United States exceeded
federally insured limits. At September 30, 2009, we had deposits of $4,225,528
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.
We have not experienced any losses in such bank accounts through September 30,
2009.
  F-10
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 At
September 30, 2009 and December 31, 2008, our bank deposits by geographic area
were as follows:
 
 Country
                  
                  September
      30, 2009
                  
                  
                  December
      31, 2008United
      States
                  
                  $
                  8,625,782
                  
                  
                  
                  67
                  %
                  
                  $
                  6,640,672
                  
                  
                  
                  47
                  %China
                  
                  
                  4,225,528
                  
                  
                  
                  33
                  %
                  
                  
                  7,359,513
                  
                  
                  
                  53
                  %Total
      cash and cash equivalents
                  
                  $
                  12,851,310
                  
                  
                  
                  100
                  %
                  
                  $
                  14,000,185
                  
                  
                  
                  100
                  %
 
 In an
effort to mitigate any potential risk, we periodically evaluate the credit
quality of the financial institutions at which we hold 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 September 30, 2009 and December 31, 2008
allowances for doubtful accounts were $745,786 and $500,000
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 September 30,
2009 and December 31, 2008 totaled $5,806,722 and $6,288,378 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 September 30,
2009 and December 31, 2008.
 
 Accounts
payable-related parties
 
 Our
consolidated balance sheet reflects accounts payable-related party of $51,716
and $7,516,728 at September 30, 2009 and  December 31, 2008,
respectively. 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 Topic 820, “Fair Value Measurements”. Those provisions relate to our
financial assets and liabilities carried at fair value and our fair value
disclosures related to financial assets and liabilities. Topic 820 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.
 
 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, with unrealized gains or losses, net of tax. Virtually all of our
valuation measurements are Level 1 measurements. The adoption of Topic 820 did
not have a significant impact on our consolidated financial
statements.
  F-11
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 Marketable
Securities
 
 Marketable
securities held for sale at September 30, 2009 and December 31, 2008 consists of
the followings;
 
 
 Company
                  
                  September
      30,2009
                  
                  
                  %
                  
                  
                  December
      31,2008
                  
                  
                  %China
      America Holdings, Inc.
                  
                  $
                  540,200
                  
                  
                  
                  10
                  %
                  
                  $
                  272,200
                  
                  
                  
                  4
                  %China
      Logistics Group, Inc.
                  
                  
                  761,000
                  
                  
                  
                  14
                  %
                  
                  
                  1,807,357
                  
                  
                  
                  24
                  %Dragon
      International Group Corp.
                  
                  
                  228,158
                  
                  
                  
                  4
                  %
                  
                  
                  704,656
                  
                  
                  
                  9
                  %China
      Armco Metals, Inc.
                  
                  
                  3,116,993
                  
                  
                  
                  56
                  %
                  
                  
                  4,045,002
                  
                  
                  
                  52
                  %Sunwin
      International Neutraceuticals, Inc.
                  
                  
                  338,000
                  
                  
                  
                  6
                  %
                  
                  
                  649,337
                  
                  
                  
                  8
                  %Dragon
      Capital Group Corp.
                  
                  
                  604,686
                  
                  
                  
                  11
                  %
                  
                  
                  251,240
                  
                  
                  
                  3
                  %Marketable
      securities held for sale
                  
                  $
                  5,589,037
                  
                  
                  
                  100
                  %
                  
                  $
                  7,729,792
                  
                  
                  
                  100
                  %
 
 All the
securities, including preferred stock, common stock, and common stock purchase
warrants, were received from our clients as consulting fees.  We
categorize the securities as investments in marketable securities available for
sale or investments in marketable securities available for sale-related
parties.  These securities (exclusive of preferred stock and common
stock purchase warrants) are quoted either on an exchange or inter-dealer
quotation (pink sheet) system. Some of the securities are restricted and cannot
be readily resold by us absent a registration of those securities under the
Securities Act of 1933 (the “Securities Act”) or the availabilities of an
exemption from the registration requirements under the Securities Act. Our
policy is to liquidate the securities on a regular basis.  As these
securities are often restricted, we are unable to liquidate them 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 on a quarterly
basis  as an element of comprehensive income based on changes in the
fair value of the security. 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.
 
 In
accordance with ASC 850, “Related Party Disclosures”, we recognized Dragon
Capital Group (“Dragon Capital”) as a related party.   Mr.
Lisheng (Lawrence) Wang, the CEO and Chairman of the Board of Dragon Capital, is
the brother of Dr. James Wang, our CEO and Chairman of the Board of
Directors.  The securities of Dragon Capital, accounted for all the
investments in marketable securities available for sale-related party and
totaled $604,742 at September 30, 2009.  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.
 
 Under the
guidance of ASC 320, “Investments”, we periodically evaluate
other-than-temporary impairment (OTTI) of securities 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.  In the assessment of OTTI for
various securities at September 30, 2009 the guidance in ASC 320, “the
Investment-Debt and Equity Securities,” is carefully
followed.  Management determined that some of our investments in
marketable securities are impaired because their fair value as quoted on an
exchange or an inter-dealer quotation system is less than their cost basis and
also determined that the impairment is other –than-temporary impairment after
applying the guidance in Section 325-40-35 to the evaluation of the
securities.  In accordance with Section 325-35-33, when an entity has
decided to sell an impaired available-for-sale security and the entity does not
expect the fair value of the security to fully recover before the expected time
of sale, the security shall be deemed other-than-temporarily impaired in the
period in which the
  F-12
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  decision
to sell is made.  However, an entity shall recognize an impairment
loss when the impairment is deemed other than temporary impairment even if a
decision to sell has not been made.  Under the guidance we recognized
the other-than-temporary impairment and charged the loss to the income in the
2009 Transition Period.
 
 The
realized loss on investments in marketable securities available for sale in the
2009 transition period and fiscal 2008 was $11,375,386 and $7,658,011,
respectively.  In the 2009 transition period and fiscal 2008, our
realized loss includes $1,909,056 and $136,923 loss from the sale of marketable
securities available for sale, and $9,466,329 and $7,521,088 in impairment
losses related to our assessment of other than temporary impairment for
securities available for sale at September 30, 2009 and December 31, 2008 under
the guidance of ASC 325.  See Note 15 – Marketable
Securities.
 
 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 September 30, 2009 and December 31, 2008, our consolidated balance
sheets include prepaid expenses and other current assets of $5,092,205 and
$7,985,134, respectively.
 
 Prepaid
Expenses – Related Parties
 
 Prepaid
expenses-related parties were $5,823,039 and $7,617,887 at September 30, 2009
and December 31, 2008, 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.
 
 Acquisitions
 
 We
account for acquisitions using the purchase method of accounting in accordance
with the provisions of Topic 805, “Business Combinations”.  In each of
our acquisitions for fiscal 2008, we determined that fair values were equivalent
to the acquired historical carrying costs.  We had no acquisitions in
the 2009 Transition Period.
 
 Advances
from customers and deferred revenues
 
 Advances
from customers (i) represent prepayments to us for merchandise that had not yet
been shipped to customers, and (ii) the fair value of securities received as
compensation which will be amortized over the term of the respective consulting
agreement. 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
$2,007,137and $1,545,273 at September 30, 2009 and December 31, 2008
respectively.
 
 Comprehensive
income
 
 We follow
ASC 220, “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.  In accordance with ASC 220, we included in our
comprehensive income for the 2009 transition period and fiscal 2008 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.  See Note 3 for details.
 
 Shipping
Costs
 
 Shipping
costs are included in selling and general and administrative expenses and
totaled $1,342,386, and $973,911 for the 2009 Transition Period and fiscal 2008,
respectively.
  F-13
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 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 2009 Transition Period and fiscal
2008.  A summary of the conversion rates for the periods presented is
as follows:
 
 September
      30, 2009
                  
                  
                  December
      31, 2008Year
      end RMB: U.S. dollar exchange rate
                  
                  
                  6.8376
                  
                  
                  
                  6.8540Average
      year-to-date RMB: U.S. dollar exchange rate
                  
                  
                  6.8425
                  
                  
                  
                  6.9620
 
 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.
 
 Impairment
of long-lived assets
 
 In
accordance with ASC 360, “Property, Plant, and Equipment”, 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 2009 Transition Period and fiscal 2008
..
 
 Provisional
Reserve on discontinued operations
 
 We are
currently involved in a dispute with Shanxi Jinyang Coal and Coke Group Co.,
Ltd. (“Shanxi Jinyang”) and Ms. Runlian Tian, the noncontrolling shareholders of
our subsidiary Pan Asia Magnesium and its Chairman of the Board of Directors,
Haixin Zhao, as discussed in the notes to our audited consolidated financial
statements and under Item 3 entitled “Legal Proceedings.” We established a
$7,362,039 reserve for a loss from discontinued operations related to Pan Asia
Magnesium and this dispute. Because of the uncertainties related to both the
amount and range of loss related to our investment in Pan Asia Magnesium, our
current loss estimate could be wrong. As additional information becomes
available, we will assess the potential loss related our investment in Pan Asia
Magnesium and make or, if necessary, revise our estimate. Such revision in our
estimate of the potential loss could materially impact our results of operations
and financial position.  See Note 17 – Commitments and
Contingencies.
 
 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.  On September 29, 2009
our board of directors committed to a plan to sell our 51% interest in Pan Asia
Magnesium which is presented in these consolidated financial statements as a
discontinued operation.  See Note 20 – Discontinued
Operations.
 
 Noncontrolling
interests
 
 Noncontrolling
interests in our subsidiaries are recorded in accordance with the provisions of
ASC 810, “Consolidation”,   and are reported as a component of
our equity, separate from the parent’s equity.  Purchase or sale of equity
interests that do not result in a change of control are accounted for as equity
transactions.  Results of operations attributable to the noncontrolling
interests are included in our consolidated results of operations and, upon loss
of control, the interest sold, as well as interest retained, If any, will be
reported at fair value with any gain or loss recognized in
earnings.
  F-14
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 Under
generally accepted accounting principles when losses applicable to the
noncontrolling interest in a subsidiary exceed the noncontrolling interest in
the equity capital of the subsidiary, the excess is not charged to the majority
interest since there is no obligation of the noncontrolling interest to make
good on such losses. We, therefore, absorbed all losses applicable to a
noncontrolling 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 ASC 740, “Income
Taxes”.  ASC 740 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, ASC 740 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 ASC 260, “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.
 
 The
following table sets forth the computation of basic and diluted earnings per
share for the 2009 transition period and  fiscal 2008:
 
 Nine
      months ended September 30, 2009
                  
                  
                  Per
      Share
                  
                  
                  Twelve
      months ended December 31, 2008
                  
                  
                  
                  Per
      ShareNUMERATOR:Net
      (loss) income attributable to common shareholders
                  
                  $
                  (27,858,996
                  )
                  
                  
                  (1.12
                  )
                  
                  $
                  8,005,074
                  
                  
                  
                  $
                  0.36Series
      A preferred stock:Preferred
      stock dividend
                  
                  
                  (80,925
                  )
                  
                  
                  -
                  
                  
                  
                  (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 stockholders
(A)
                  
                  
                  (27,939,921
                  )
                  
                  
                  (1.13
                  )
                  
                  
                  1,557,745
                  
                  
                  
                  
                  0.06Plus:
      Income impact of assumed conversionsPreferred
      stock dividends-unconverted
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  51,332
                  
                  
                  
                  
                  -Numerator
      for diluted EPS, income applicable to common stockholders plus assumed
      conversions (B)
                  
                  
                  (27,939,921
                  )
                  
                  
                  -
                  
                  
                  
                  1,609,077
                  
                  
                  
                  
                  -DENOMINATOR:Denominator
      for basic earnings per share-weighted
                    average
      number of common shares outstanding ( C)
                  
                  
                  24,802,730
                  
                  
                  
                  -
                  
                  
                  
                  22,403,054
                  
                  
                  
                  
                  -Stock
      awards, options, and warrants
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  2,161,721
                  
                  
                  
                  
                  -Denominator
      for diluted earnings per share-adjusted weighted average outstanding
      average number of common shares outstanding (D)
                  
                  
                  24,802,730
                  (1
                  )
                  
                  -
                  
                  
                  
                  24,687,015
                  
                  
                  
                  
                  -Basic
      and Diluted Income per Common Share:(Loss)
      earnings per share-basic (A)/( C)
                  
                  $
                  (1.13
                  )
                  
                  
                  -
                  
                  
                  $
                  0.07
                  
                  
                  
                  
                  -(Loss)
      earnings per share-diluted (B)/(D)
                  
                  $
                  (1.13
                  )
                  
                  
                  -
                  
                  
                  $
                  0.06
                  
                  
                  
                  
                  -
 
 (1)
                  The
      denominator in diluted earnings per share in the 2009 transition
      period does not include assumed shares outstanding prior to
      conversion under the “if converted” method and unconverted preferred stock
      dividends, as such inclusion would be
  anti-dilutive.
  F-15
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 Revenue
Recognition
 
 We follow
the guidance of ASC 605, “Revenue Recognition,” 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 ASC 718, “Compensation-Stock Compensation.”   ASC 718
requires companies to recognize in the statement of operations the grant-date
fair value of stock options and other equity based compensation.
 
 Recent
Accounting Pronouncements
 
 EITF
Issue No. 07-5 (ASC 815), "Determining Whether an Instrument (or embedded
Feature) is Indexed to an Entity's Own Stock" (EITF 07-5) was issued in June
2008 to clarify how to determine whether certain instruments or features were
indexed to an entity's own stock under EITF Issue No. 01-6 (ASC 815), "The
Meaning of "Indexed to a Company's Own Stock" (EITF 01-6) (ASC 815),. EITF
07-5(ASC 815), applies to any freestanding financial instrument (or embedded
feature) that has all of the characteristics of a derivative as defined in FAS
133, for purposes of determining whether that instrument (or embedded feature)
qualifies for the first part of the paragraph 11(a) scope exception. It is also
applicable to any freestanding financial instrument (e.g., gross physically
settled warrants) that is potentially settled in an entity's own stock,
regardless of whether it has all of the characteristics of a derivative as
defined in FAS 133 (ASC 815), for purposes of determining whether to apply EITF
00-19 (ASC 815). EITF 07-5(ASC 815) does not apply to share-based payment awards
within the scope of FAS 123(R), Share-Based Payment (FAS 123(R) (ASC 718)).
However, an equity-linked financial instrument issued to investors to establish
a market-based measure of the fair value of employee stock options is not within
the scope of FAS 123(R) and therefore is subject to EITF 07-5(ASC
815).
 
 In
January 2009, the FASB issued FSP EITF 99-20-1 (ASC 325), to amend the
impairment guidance in EITF Issue No. 99-20 (ASC 325) in order to achieve
more consistent determination of whether an other-than-temporary impairment
(“OTTI”) has occurred. This FSP amended EITF 99-20 (ASC 325) to more
closely align the OTTI guidance therein to the guidance in Statement
No. 115 (ASC 320, 10-35-31). 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.
  On June
5, 2003, the United States Securities and Exchange Commission (“SEC”) adopted
final rules under Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”),
as amended by SEC Release No. 33-9072 on October 13, 2009.  Commencing with
its annual report for the year ending December 31, 2010, the Company will be
required to include a report of management on its internal control over
financial reporting. The internal control report must include a statement
of:
  management’s
      responsibility for establishing and maintaining adequate internal control
      over its financial reporting;management’s
      assessment of the effectiveness of its internal control over financial
      reporting as of year end; andthe
      framework used by management to evaluate the effectiveness of the
      Company’s internal control over financial
  reporting.
  Furthermore,
it is required to file the auditor’s attestation report separately on the
Company’s internal control over financial reporting on whether it believes that
the Company has maintained, in all material respects, effective internal control
over financial reporting.
   In
June 2009, the FASB approved the “FASB Accounting Standards Codification”
(the “Codification”) as the single source of authoritative nongovernmental U.S.
GAAP to be launched on July 1, 2009.  The Codification does not change
current U.S. GAAP, but is intended to simplify user access to all authoritative
U.S. GAAP by providing all the authoritative literature related to a particular
topic in one place.  All existing accounting standard documents will be
superseded and all other accounting literature not included in the Codification
will be considered non-authoritative. The Codification is effective for interim
and annual periods ending after September 15, 2009.
   F-16
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 In
August 2009, the FASB issued the FASB Accounting Standards Update No.
2009-04 “Accounting for
Redeemable Equity Instruments - Amendment to Section 480-10-S99” which
represents an update to section 480-10-S99, distinguishing liabilities from
equity, per EITF Topic D-98, Classification and Measurement of
Redeemable Securities.  The Company does not expect the adoption of
this update to have a material impact on its consolidated financial position,
results of operations or cash flows.
  In
August 2009, the FASB issued the FASB Accounting Standards Update No.
2009-05 “Fair Value
Measurement and Disclosures Topic 820 – Measuring Liabilities at Fair
Value”, which provides amendments to subtopic 820-10, Fair Value
Measurements and Disclosures – Overall, for the fair value measurement of
liabilities.  This update provides clarification that in circumstances in
which a quoted price in an active market for the identical liability is not
available, a reporting entity is required to measure fair value using one or
more of the following techniques: 1. A valuation technique that uses: a. The
quoted price of the identical liability when traded as an asset b. Quoted prices
for similar liabilities or similar liabilities when traded as assets. 2. Another
valuation technique that is consistent with the principles of topic 820; two
examples would be an income approach, such as a present value technique, or a
market approach, such as a technique that is based on the amount at the
measurement date that the reporting entity would pay to transfer the identical
liability or would receive to enter into the identical liability. The amendments
in this update also clarify that when estimating the fair value of a liability,
a reporting entity is not required to include a separate input or adjustment to
other inputs relating to the existence of a restriction that prevents the
transfer of the liability. The amendments in this update also clarify that both
a quoted price in an active market for the identical liability when traded as an
asset in an active market when no adjustments to the quoted price of the asset
are required are Level 1 fair value measurements.  The Company does not
expect the adoption of this update to have a material impact on its consolidated
financial position, results of operations or cash flows.
  In
September 2009, the FASB issued the FASB Accounting Standards Update No.
2009-08 “Earnings Per Share –
Amendments to Section 260-10-S99”,which represents technical corrections
to topic 260-10-S99, Earnings per share, based on EITF Topic D-53, Computation of Earnings Per Share
for a Period that includes a Redemption or an Induced Conversion of a Portion of
a Class of Preferred Stock and EITF Topic D-42, The Effect of the Calculation of
Earnings per Share for the Redemption or Induced Conversion of Preferred
Stock. The Company does not expect the adoption of this update to have a
material impact on its consolidated financial position, results of operations or
cash flows.
  In
September 2009, the FASB issued the FASB Accounting Standards Update No.
2009-09 “Accounting for
Investments-Equity Method and Joint Ventures and Accounting for Equity-Based
Payments to Non-Employees”.  This update represents a correction to
Section 323-10-S99-4, Accounting by an Investor for
Stock-Based Compensation Granted to Employees of an Equity Method
Investee. Additionally, it adds observer commentAccounting Recognition for Certain
Transactions Involving Equity Instruments Granted to Other Than Employees
to the Codification. The Company does not expect the adoption to have a material
impact on its consolidated financial position, results of operations or cash
flows.
  In
September 2009, the FASB issued the FASB Accounting Standards Update No.
2009-12 “Fair Value
Measurements and Disclosures Topic 820 – Investment in Certain Entities That
Calculate Net Assets Value Per Share (or Its Equivalent)”, which provides
amendments to Subtopic 820-10, Fair Value Measurements and Disclosures-Overall,
for the fair value measurement of investments in certain entities that calculate
net asset value per share (or its equivalent). The amendments in this update
permit, as a practical expedient, a reporting entity to measure the fair value
of an investment that is within the scope of the amendments in this update on
the basis of the net asset value per share of the investment (or its equivalent)
if the net asset value of the investment (or its equivalent) is calculated in a
manner consistent with the measurement principles of Topic 946 as of the
reporting entity’s measurement date, including measurement of all or
substantially all of the underlying investments of the investee in accordance
with Topic 820. The amendments in this update also require disclosures by major
category of investment about the attributes of investments within the scope of
the amendments in this update, such as the nature of any restrictions on the
investor’s ability to redeem its investments at the measurement date, any
unfunded commitments (for example, a contractual commitment by the investor to
invest a specified amount of additional capital at a future date to fund
investments that will be make by the investee), and the investment strategies of
the investees. The major category of investment is required to be determined on
the basis of the nature and risks of the investment in a manner consistent with
the guidance for major security types in U.S. GAAP on investments in debt and
equity securities in paragraph 320-10-50-1B. The disclosures are required for
all investments within the scope of the amendments in this update regardless of
whether the fair value of the investment is measured using the practical
expedient. The Company does not expect the adoption to have a material impact on
its consolidated financial position, results of operations or cash
flows.
   F-17
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  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.
 
 NOTE
3 – OTHER COMPREHENSIVE INCOME
 
 The
following schedule presents the elements of the comprehensive income for the
2009 transition period and fiscal 2008.
 
 Description
                  
                  Nine
      months ended September 30, 2009
                  
                  
                  Twelve
      months ended December 31, 2009Net
      (loss) income
                  
                  $
                  (30,158,953
                  )
                  
                  $
                  14,082,879Other
      comprehensive (loss) income, net of taxUnrealized
      gain (loss) on marketable securities held for sale, net
    taxes
                  
                  
                  175,436
                  
                  
                  
                  (7,819,861
                  )Unrealized
      loss on marketable secutities available for sale-related
    party
                  
                  
                  -
                  
                  
                  
                  (1,155,029
                  )Reclassification
      of unrealized loss from marketable securities available for
      sale
                  
                  
                  9,860,445
                  
                  
                  
                  -Foreign
      currency translation gain, net of tax
                  
                  
                  144,822
                  
                  
                  
                  602,983Total
      other comprehensive income
                  
                  $
                  10,180,703
                  
                  
                  $
                  (8,371,907
                  )Comprehensive
      (loss) income
                  
                  $
                  (19,978,249
                  )
                  
                  $
                  5,710,972
 
 NOTE
4 – NOTES RECEIVABLE
 
 At
September 30, 2009 and December 31, 2008, notes receivable consisted of the
following:
 
 Description
                  
                  September
      30,2009
                  
                  
                  December
      31,2008Notes
      receivable from Xiamen International Trading Co. Ltd   Due
      on demand, non-interest bearing
                  
                  $
                  -
                  
                  
                  $
                  196,084Bank
      guaranted notes
                  
                  
                  -
                  
                  
                  
                  123,443Notes
      receivable from JiangShu Suopu due on demand, non-interest
      bearing
                  
                  
                  7,313
                  
                  
                  
                  -Notes
      receivable from ShaGang due on demand, non-interest
bearing
                  
                  
                  73,125
                  
                  
                  
                  -Notes
      receivable from WeiDa due on demand, non-interest bearing
                  
                  
                  17,693
                  
                  
                  
                  -Notes
      receivable from LeXi due on demand, non-interest bearing
                  
                  
                  7,313
                  
                  
                  
                  -Notes
      receivable from WanWei due on demand, non-interest bearing
                  
                  
                  36,563
                  
                  
                  
                  -Notes
      receivable from YongGu due on demand, non-interest bearing
                  
                  
                  4,388
                  
                  
                  
                  -Total
      Notes Receivable
                  
                  
                  146,395
                  
                  
                  
                  319,527Less:
      current portion
                  
                  $
                  (146,395
                  )
                  
                  $
                  (319,527
                  )Notes
      Receivable, long-term
                  
                  $
                  -
                  
                  
                  $
                  -
 
  F-18
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 NOTE
5 – INVENTORIES
 
 At
September 30, 2009 and December 31, 2008, inventories consisted of the
following:
 
 Description
                  
                  September
      30,2009
                  
                  
                  December
      31,2008Raw
      materials
                  
                  $
                  2,454,443
                  
                  
                  $
                  4,124,959Finished
      goods
                  
                  
                  3,695,184
                  
                  
                  
                  2,724,041Inventory
      Reserve
                  
                  
                  (342,905
                  )
                  
                  
                  (560,622
                  )Total  Inventories
                  
                  $
                  5,806,722
                  
                  
                  $
                  6,288,378
 
 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 September 30, 2009
and December 31, 2008.
 
 NOTE
6 – PREPAID EXPENSES AND OTHER CURRENT ASSETS
 
 At
September 30, 2009 and December 31, 2008, prepaid expenses and other current
assets consisted of the following:
 
 Description
                  
                  September
      30,2009
                  
                  
                  December
      31,2008Prepayments
      to vendors for merchandise that had not yet been shipped or services that
      had not been performed
                  
                  $
                  2,853,504
                  
                  
                  $
                  2,093,827Other
      recievables
                  
                  
                  642,370
                  
                  
                  
                  2,372,574Fair
      value of securities received from client companies associated with our
      Consulting segment assigned to employees as compensation
                  
                  
                  -
                  
                  
                  
                  524,907Loans
      recievable
                  
                  
                  1,435,000
                  
                  
                  
                  2,987,615Other
                  
                  
                  142,692
                  
                  
                  
                  5,113Security
      deposits
                  
                  
                  20,475
                  
                  
                  
                  -Total
                  
                  
                  5,094,041
                  
                  
                  
                  7,984,036Less:
      Current Portion
                  
                  
                  (5,092,205
                  )
                  
                  
                  (7,984,036
                  )Prepaid
      expenses and other assets, non-current
                  
                  $
                  1,836
                  
                  
                  $
                  -
 
 In the
second quarter of the 2009 transition period, we reclassified $689,087, net of
accumulated amortization of $41,394, from “Prepaid expenses and other
assets” to “Property use rights, net” to reflect Senrun Coal’s contribution of
land use rights to Golden Magnesium pursuant to the November 11, 2006 joint
venture agreement entered into among the parties. Pursuant to these land use
rights which permit construction of a magnesium production plant capable of
producing up to 20,000 tons of magnesium alloy products per year, Golden
Magnesium built its magnesium production plant on this land. The land use rights
expire in 2057.
  In the
third quarter of the 2009 transition period we wrote off  a $1,023,018
loan receivable due from Dragon International Group Corp. and a $730.726 loan to
a supplier of CDI Jingkun Zinc which we deemed to be
uncollectable.
  F-19
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 NOTE
7 - PROPERTY, PLANT AND EQUIPMENT
 
 At
September 30, 2009 and December 31, 2008, property, plant and equipment
consisted of the following:
 
 Description
                  
                  Useful
      Life
                  
                  
                  September
      30,2009
                  
                  
                  December
      31,2008Building
                  
                  10-40
      years
                  
                  
                  $
                  10,727,622
                  
                  
                  $
                  5,305,830Manufacturing
      equipment
                  
                  10
      years
                  
                  
                  
                  14,849,040
                  
                  
                  
                  7,644,868Office
      equipment and furniture
                  
                  3-5
      years
                  
                  
                  
                  403,570
                  
                  
                  
                  597,934Autos
      and trucks
                  
                  5
      years
                  
                  
                  
                  911,964
                  
                  
                  
                  132,161Construction
      in progress
                  
                  
                  N/A
                  
                  
                  
                  7,145,072
                  
                  
                  
                  19,000,249Total
                  
                  
                  
                  
                  
                  
                  34,037,268
                  
                  
                  
                  32,681,042Less:  Accumulated
      Depreciation
                  
                  
                  
                  
                  
                  
                  (2,705,276
                  )
                  
                  
                  (1,457,202
                  )Property,
      Plant and Equipment, Net
                  
                  
                  
                  
                  
                  $
                  31,331,992
                  
                  
                  $
                  31,223,840
 
 For the
2009 transition period and fiscal 2008, depreciation expense totaled $1,248,074
and $879,401, respectively.
 
 NOTE
8 – PROPERTY USE RIGHTS
 
 Property
use rights, consisting of mining and property use rights amounted to $1,113,902
and $495,199 at September 30, 2009 and December 31, 2009,
respectively.
 
 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 September 30, 2009 are
$496,401. 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.
  F-20
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 NOTE
9 – OTHER PAYABLES and TAX PAYABLES
 
 At
September 30, 2009 and December 31, 2008, other payables are consisted of the
followings:
 
 Description
                  
                  September
      30,2009
                  
                  
                  December
      31,2008VAT
      taxes
      payable
                  
                  $
                  1,130,907
                  
                  
                  $
                  354,874Interest
      payable
                  
                  
                  -
                  
                  
                  
                  60,000Payable
      to individuals
                  
                  
                  2,033,362
                  
                  
                  
                  565,694Benefits
      payable
                  
                  
                  1,006,509
                  
                  
                  
                  56,061Other
                  
                  
                  32,367
                  
                  
                  
                  925,500Total
                  
                  $
                  4,203,145
                  
                  
                  $
                  1,962,129
 
 NOTE
10 – ACQUISITIONS
 
 Acquisition of a 83% interest in CDI
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 holds 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 $1,489,075 while Mr. Chen made capital
contributions of $1,430,680. On December 30, 2009, the shareholders of CDI
Beijing agreed to limit their capital contributions to the $2,919,754 they
already contributed and waived their requirement for contributions of additional
capital including CDI Shanghai Management’s obligation to contribute $2,200,000
by September 30, 2009.
 We did
not make any business acquisitions in the 2009 Transition
Period.
  F-21
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 NOTE
11 – LOANS PAYABLE
 
 Loans
payable at September 30, 2009 and December 31, 2008 consisted of the
following:
 
 Description
                  
                  September
      30,2009
                  
                  
                  December
      31,2008Loan
      due to China Industry Bank, dated July 2012. 6.06% annual interest
      rate.
                  
                  $
                  -
                  
                  
                  $
                  186,018Loan
      due to Commercial Bank, dated May 2009, from Lang
      Chemical.  Secured by Lang Chemical's restricted
      cash.
                  
                  
                  -
                  
                  
                  
                  262,613Loan
      due to Minsheng Bank, dated October 2009, LIBOR plus 25% annual interest
      rate.
                  
                  
                  -
                  
                  
                  
                  671,122Loan
      due to Mingsheng Bank, dated May 26, 2010.  6.37% annual
      interest rate.  Secured by the company's assets.
                  
                  
                  497,252
                  
                  
                  
                  -Loan
      due to Industrial & Commercial Bank, dated July 21,
      2010.  5.58% annual interest rate.  Guaranteed by the
      personal real estate of ZhuQian and Chen Jiangdong.
                  
                  
                  336,375
                  
                  
                  
                  -Loan
      due to Industrial & Commercial Bank, dated March 21,
      2010.  5.31% annual interest rate.  Guaranteed by the
      personal real estate of ZhuQian and Chen Jiangdong.
                  
                  
                  394,875
                  
                  
                  
                  -Loan
      due to Bank of Shanghai, dated January 15, 2009 through January 14,
      2010.  5.84% annual interest rate.  Guranteed by China
      Investment Guarantor Co. Ltd.
                  
                  
                  292,500
                  
                  
                  
                  -Total
                  
                  
                  1,521,002
                  
                  
                  
                  1,119,753Less:
      Current Portion
                  
                  
                  (1,521,002
                  )
                  
                  
                  (933,735
                  )Loans
      payable, long-term
                  
                  $
                  0
                  
                  
                  $
                  186,018
 
 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 September 30, 2009 and December 31, 2008:
 
 ·
                  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”);·
                  LingShi
      County Yihong Magnesium Co., Ltd., a company organized under the laws of
      the PRC (“Yihong Magnesium”), is legally represented by an officer of
      Chang Magnesium;·
                  LuCheng
      Haixu Magnesium Co., Ltd., a company organized under the laws of the PRC
      (“Haixu Magnesium”), is legally represented by an officer of Chang
      Magnesium;
 
  F-22
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 ·
                  LuCheng
      Xinghai Magnesium Co., Ltd., a company organized under the laws of the PRC
      (“Xinghai Magnesium”), is legally represented by an officer of Chang
      Magnesium;·
                  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;·
                  Youbing
      Yang is a director on the Baotou Chang Magnesium’s Board of
      Directors;·
                  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;·
                  Chen
      Chi is vice president of our Basic Materials Segment and minority interest
      owner of CDI Beijing;·
                  Zhongmen
      International Investments Co., Ltd., a company organized under the laws of
      the PRC (“Zhongmen International”), is legally represented by an officer
      of CDI Beijing;·
                  Beijing
      Jiaozhuang Hotel, a company organized and under the laws of the
      PRC
                    (“Jiaozhuang
      Hotel”), is legally represented by an officer of CDI
    Beijing.
 
 Accounts
Receivable – related parties
 
 At
September 30, 2009 we reported accounts receivable – related parties of
$2,355,059 comprised of the following:
 
 ·
                  $756,795
      due Chang Magnesium from YiWei Magnesium, for inventory
      provided;·
                  $869,105
      due Chang Magnesium from Pine Capital for inventory provided;
      and,·
                  $729,159
      due Golden Magnesium from YiWei Magnesium for inventory
      provided.
 
 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.
 
 Prepaid
Expenses – related parties
 
 At
September 30, 2009 we reported prepaid expenses – related parties of $5,823,039
comprised of the following:
 
 ·
                  $2,440,794  prepaid
      by Chang Magnesium to YiWei Magnesium for future delivery of
      inventory;·
                  $73,133
      prepaid by Chang Magnesium to Haixu Magnesium to for future delivery of
      inventory;·
                  $530,888
      prepaid by Chang Magnesium toXinghai Magnesium to for future delivery of
      inventory;·
                  $684,922
      prepaid by Chang Magnesium to Yihong Magnesium to for future delivery of
      inventory;·
                  $1,376,395
      prepaid by Baotou Changxi Magnesium to YiWei Magnesium to for future
      delivery of inventory;·
                  $51,470
      prepaid by Golden Magnesium to Senrun Coal for future delivery of coke gas
      for fuel; and,·
                  $665,438
      prepaid by Golden Magnesium to YiWei Magnesium for future delivery of
      inventory.
 
  F-23
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 At
December 31, 2008 we reported prepaid expenses – related parties of
$7,617,887 comprised of the following:
 
 ·
                  $5,830,718
      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; and·
                  $326,073
      prepaid by Golden Magnesium to YiWei Magnesium for future delivery of
      inventory.
 
 Loan
Receivable – related parties
 
 At
September 30, 2009 we reported loan receivables – related parties of $1,094,142
comprised of the following:
 
 ·
                  $1,094,142
      due Lang Chemical from NanTong Chemical for funds advanced for working
      capital purposes.
 
 
 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.
 
 Due
from related parties
 
 At
September 30, 2009 we reported due from related parties of $0.
 
 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.
 
 Accounts
Payable – related parties
 
 At
September 30, 2009 we reported accounts payable – related party of $51,716
comprised of the following:
 
 ·
                  $35,428
      due from Chang Magnesium to Wheaton Group in repayment of an advance form
      customer for the expected delivery of inventory;·
                  $14,826
      due from Baotou Changxi Magnesium to Haixu Magnesium in repayment of an
      advance form customer for the expected delivery of inventory;
      and·
                  $1,463
      due from Golden Magnesium to Haixu Magnesium in repayment of an advance
      form customer for the expected delivery of
  inventory.
 
 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; and·
                  $3,019,548
      due from Chang Magnesium to Wheaton Group in repayment of an advance form
      customer for the expected delivery of
inventory.
 
  F-24
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 Due
to related parties
 
 At
September 30, 2009 we reported due to related parties balance of $399,629
comprised of the following:
 
 ·
                  $355,753
      due to Zhongmen International Investments for working capital of CDI
      Beijing; and·
                  $43,876
      advanced by Jiaozhuang Hotel to CDI Beijing for working capital
      purposes.
 
 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; and·
                  $145,896
      advanced by Huihuan Huang to Chang Magnesium for working capital
      purposes.
 
 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 September 30, 2009, there were 1,006 shares of Series A Convertible Preferred
Stock issued and outstanding.
 
 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
is payable 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
September 30, 2009, 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 142.8541 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, 58,642 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%.
 
 The
relative fair value of the warrants of $2,765,946 has been recorded as a
dividend.
  F-25
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 In
addition, under the provisions of ASC 470, “Debt”, 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 fiscal 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 September 30, 2009. 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.
 
 As a result of the June 15, 2009 registered direct offering of our
common stock discussed below, we reduced to $1.85 per share the exercise price
of warrants to purchase 143,750 shares of our common stock with an exercise
price of $8.00 per share and the conversion price of 1,006 shares of our series
A convertible preferred stock outstanding that are convertible into 143,750
shares of our common stock at a conversion price of $7.00 per share. The terms
of these warrants and preferred stock provide that if we sell common stock at a
price per share less than the then exercise price of the warrants or the
conversion price of the preferred stock, then we are required to reduce the
exercise price of those warrants and the conversion price of the series A
convertible preferred stock to the lower price of the subsequent
sale. Because the market price of our common stock in our June 15, 2009
offering was $1.85 per share, an amount that is less than the exercise price of
the $8.00 per share warrants and the $7.00 per share conversion price, we
reduced the exercise price of those outstanding securities.
 
 Common
Stock
 
 We have
1,000,000,000 shares of common stock, par value $.0001,
authorized.  At September 30, 2009 there were 27,189,719 shares of
common stock issued and outstanding.  At December 31, 2008, there were
23,530,642 shares of common stock issued and outstanding.
 
 For the
2009 transition period and fiscal 2008 , amortization of stock based
compensation amounted to$1,739,480 and $2,200,000, respectively.
 
 During
the 2009 transition period, we issued 60,000 shares of common stock in
connection with the exercise of common stock purchase warrants at $1.14 per
share.
 
 During
the 2009 transition period, we issued 1,050,000 shares of common stock in
connection with the exercise of common stock options with net proceeds of
$10,500.  All of these options were exercised at $.01 per
share.
 
 During
the 2009 transition period, we issued 21,000 shares of our common stock to
Bazelon Less & Feldman , P.C. as compensation for legal services it provided
to us.  These shares were issued at $1.71 per share for a total of
$36,000.
 
 On June
16, 2009 we sold 2,702,704 shares of our common stock and warrant to purchase up
to 1,351,352 of common stock to accredited investors.  The purchase
price per share of the common stock was $1.85.  The warrants have an
exercise price of $2.31 per share and will be exercisable beginning 183 days
following the date they were issued for a period ending on the fifth anniversary
of the initial exercise date.  The gross proceeds of this offering
were $5,000,000 with offering expense of $190,000.  We intend to use
the proceeds from this offering for general working capital purposes which may
include acquisitions of additional operations in China.
  On
September 17, 3009 we issued 459,559 shares of our common stock to Lei Shen in
exchange for the cancellation of a February 4, 2008 loan by Jian Fei Chen to
Capital One Resources Co., Ltd. in the amount of RMB 5,000,000 (US $735,294)
(the “Loan”).  We used a conversion rate of $1.60 per share in
calculating the number of shares issued. Mr. Chen assigned his rights to the
Loan to Mr. Shen prior to the conversion and cancellation of the
Loan.
  F-26
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 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 fiscal 2008 we purchased 19,919 shares at
an average price of $3.98 per share, these shares were redeemed in September and
October 2008.  During the 2009 Transition Period, we purchased
1,500,000 shares of our common stock at a price of $1.10 per share under this
program form Marc Siegal, our former president and director.  This
stock purchase program expired on June 30, 2009.
 
 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. During fiscal 2008, we purchased 69,583 shares at an average
purchase price of $5.13 or $5.07 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 September 30, 2009 and
December 31, 2008 there were options outstanding to purchase an aggregate of
312,000 and 365,000 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 September 30, 2009 and December 31, 2008, there were options
outstanding to purchase an aggregate of 301,540 and 414,590 shares, respectively
of common stock outstanding under the 2006 Stock Plan at exercise prices ranging
from $.01 to $5.00 per share.
 
 During
fiscal 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, 231,000
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 ASC 718, “Compensation – Stock Compensation”, 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 September 30, 2009 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 September 30, 2009 we
granted 1,079,327 shares of restricted stock with vesting dates ranging from May
2008 to May 2011 under this plan.
  F-27
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 The
following table sets forth our stock option activity during the 2009 Transition
Period and fiscal 2008:
 
 Description
                  
                  Shares
      underlying options
                  
                  
                  Weighted
      average exercise priceOutstanding
      at January 1, 2007
                  
                  
                  9,843,980.00
                  
                  
                  $
                  3.27Granted
                  
                  
                  111,000.00
                  
                  
                  
                  3.92Exercised
                  
                  
                  (3,014,360.00
                  )
                  
                  
                  1.83Expired
      or cancelled
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at December 31, 2007
                  
                  
                  6,940,620.00
                  
                  
                  $
                  8.14Granted
                  
                  
                  240,000.00
                  
                  
                  
                  6.20Exercised
                  
                  
                  (519,400.00
                  )
                  
                  
                  3.44Expired
      or cancelled
                  
                  
                  (221,000.00
                  )
                  
                  
                  7.50Outstanding
      at December 31, 2008
                  
                  
                  6,440,220.00
                  
                  
                  
                  5.71GrantedExercised
                  
                  
                  (1,050,000
                  )
                  
                  
                  0.01Expired
      or cancelled
                  
                  
                  (1,734,550
                  )
                  
                  
                  5.00Exercisable
      at September 30, 2009
                  
                  
                  3,655,670
                  
                  
                  $
                  10.83
 
 The
weighted average remaining contractual life and weighted average exercise price
of options outstanding at September 30, 2009, for selected exercise price
ranges, are as follows:
 
 Range
      of exercise prices
                  
                  
                  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$
                  2.25
                  
                  
                  $
                  2.25
                  
                  
                  
                  400
                  
                  
                  
                  1.5
                  
                  
                  $
                  2.25
                  
                  
                  
                  400
                  
                  
                  $
                  2.25$
                  2.50
                  
                  
                  $
                  2.50
                  
                  
                  
                  472,940
                  
                  
                  
                  1.25
                  
                  
                  $
                  2.50
                  
                  
                  
                  472,940
                  
                  
                  $
                  2.50$
                  3.00
                  
                  
                  $
                  3.00
                  
                  
                  
                  50,000
                  
                  
                  
                  1.25
                  
                  
                  $
                  3.00
                  
                  
                  
                  50,000
                  
                  
                  $
                  3.00$
                  5.00
                  
                  
                  $
                  5.00
                  
                  
                  
                  821,000
                  
                  
                  
                  3.25
                  
                  
                  $
                  5.00
                  
                  
                  
                  821,000
                  
                  
                  $
                  5.00$
                  7.50
                  
                  
                  $
                  7.50
                  
                  
                  
                  637,000
                  
                  
                  
                  3.25
                  
                  
                  $
                  7.50
                  
                  
                  
                  637,000
                  
                  
                  $
                  7.50$
                  10.00
                  
                  
                  $
                  10.00
                  
                  
                  
                  625,000
                  
                  
                  
                  4.25
                  
                  
                  $
                  10.00
                  
                  
                  
                  625,000
                  
                  
                  $
                  10.00$
                  15.00
                  
                  
                  $
                  15.00
                  
                  
                  
                  500
                  
                  
                  
                  3.69
                  
                  
                  $
                  15.00
                  
                  
                  
                  500
                  
                  
                  $
                  15.00$
                  30.00
                  
                  
                  $
                  30.00
                  
                  
                  
                  760,000
                  
                  
                  
                  3.25
                  
                  
                  $
                  30.00
                  
                  
                  
                  760,000
                  
                  
                  $
                  30.00$
                  56.25
                  
                  
                  $
                  56.25
                  
                  
                  
                  80
                  
                  
                  
                  3.25
                  
                  
                  $
                  56.25
                  
                  
                  
                  80
                  
                  
                  $
                  56.25$
                  1.14
                  
                  
                  $
                  1.14
                  
                  
                  
                  288,750
                  
                  
                  
                  1.95
                  
                  
                  $
                  0.30
                  
                  
                  
                  288,750
                  
                  
                  $
                  1.143,655,670
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  
                  3,655,670
                  
                  
                  $
                  10.83
 
 The
weighted average grant date fair value of options granted during fiscal 2008 was
$6.20 per share. The total intrinsic value of stock options exercised during the
2009 transition period and fiscal 2008 were $1,050,000 and $2,998,055,
respectively. The aggregate intrinsic value of our outstanding and exercisable
options at September 30, 2009 and December 31, 2008 was $3,655,670 and
$6,440,220, respectively.
 
 Common
Stock Purchase Warrants
 
 During
fiscal 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.
  F-28
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 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.
 
 On June
16, 2009 we sold 2,702,704 shares of our common stock and warrants to purchase
up to 1,351,352 of common stock to accredited investors. The purchase price per
share of the common stock was $1.85. The warrants have an exercise price of
$2.31 per share and will be exercisable beginning 183 days following the date
they were issued for a period ending on the fifth anniversary of the initial
exercise date. The gross proceeds of this offering were $5,000,000 with offering
expenses of $190,000.  Management intends to use the proceeds from
this offering for general working capital purposes which may include
acquisitions of additional operations in China.
 
 As a
result of the June 15, 2009 registered direct offering of our common stock, we
reduced the per share exercise price of warrants to purchase 143,750 shares of
our common stock from $8.00 to $1.85.  On September 20, 2009, we reduced
the exercise price of 423,750 shares to purchase common stock purchase warrants
we issued in connection with our November 2006 offering from $4.00 to $1.14
pursuant to the price reset provisions of those warrants. A summary of the
status of our outstanding common stock purchase warrants granted as of September
30, 2009 and changes during the period is as follows:
 
 Shares
      underlying warrants
                  
                  
                  Weighted
      average exercise priceOutstanding
      at December 31, 2007
                  
                  
                  2,648,312
                  
                  
                  $
                  8.70Granted
                  
                  
                  2,175,000
                  
                  
                  
                  8.03Exercised
                  
                  
                  (205,000
                  )
                  
                  
                  6.46Expired
      or cancelled
                  
                  
                  -
                  
                  
                  
                  -Outstanding
      at December 31, 2008
                  
                  
                  4,618,312
                  
                  
                  
                  8.70Granted
                  
                  
                  1,351,352
                  
                  
                  
                  2.31Exercised
                  
                  
                  (60,000
                  )
                  
                  
                  1.14Expired
      or cancelled
                  
                  
                  (75,000
                  )
                  
                  
                  5.00Outstanding
      at September 30, 2009
                  
                  
                  5,834,664
                  
                  
                  $
                  6.95Exercisable
      at September 30, 2009
                  
                  
                  4,483,312
                  
                  
                  $
                  8.34
 
 The
following information applies to all warrants outstanding at September 30,
2009.
 
 Range
      of exercise prices
                  
                  
                  Number
      of Warrants outstanding
                  
                  
                  Weighted
      average remaining contractual life (Years)
                  
                  
                  Weighted
      average exercise price
                  
                  
                  Warrants
      Exercisable
                  
                  
                  Weighted
      average exercise price of Warrants exercisable
                  
                  
                  Range
      of exercise prices$
                  2.31
                  
                  
                  $
                  1,351,352
                  
                  
                  $
                  4.95
                  
                  
                  $
                  2.31
                  
                  
                  $
                  -
                  
                  
                  $
                  2.31$
                  2.50
                  
                  
                  $
                  50,000
                  
                  
                  $
                  2.92
                  
                  
                  $
                  2.50
                  
                  
                  $
                  50,000
                  
                  
                  $
                  2.50
                  
                  
                  $
                  1.85$
                  4.00
                  
                  
                  $
                  338,750
                  
                  
                  $
                  0.48
                  
                  
                  $
                  4.00
                  
                  
                  $
                  338,750
                  
                  
                  $
                  4.00
                  
                  
                  $
                  2.31$
                  8.00
                  
                  
                  $
                  1,966,250
                  
                  
                  $
                  3.29
                  
                  
                  $
                  8.00
                  
                  
                  $
                  1,966,250
                  
                  
                  $
                  8.00
                  
                  
                  $
                  2.50$
                  10.00
                  
                  
                  $
                  1,894,562
                  
                  
                  $
                  1.95
                  
                  
                  $
                  10.00
                  
                  
                  $
                  1,894,562
                  
                  
                  $
                  10.00
                  
                  
                  $
                  1.14$
                  15.00
                  
                  
                  $
                  90,000
                  
                  
                  $
                  0.64
                  
                  
                  $
                  15.00
                  
                  
                  $
                  90,000
                  
                  
                  $
                  11.00
                  
                  
                  $
                  4.00$
                  1.85
                  
                  
                  $
                  143,750
                  
                  
                  $
                  4.12
                  
                  
                  $
                  1.85
                  
                  
                  $
                  143,750
                  
                  
                  $
                  1.85
                  
                  
                  $
                  7.50$
                  5,834,664
                  
                  
                  
                  
                  
                  
                  $
                  8.34
                  
                  
                  $
                  4,483,312
                  
                  
                  $
                  6.95
                  
                  
                  $
                  8.00
 
  F-29
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 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 September 30, 2009
and December 31, 2008 are as follows:
 
 For
      the Year Ended September 30, 2009Description
                  
                  January
      1, 2009
                  
                  
                  Amount
      Received/Sold
                  
                  
                  Cost
      Basis Adjustment for OTTI
                  
                  
                  Unrealized
      Gain
                  
                  
                  September
      30, 2009Investment
      in marketable securities held for sale
                  
                  $
                  7,569,333
                  
                  
                  $
                  5,893,918
                  
                  
                  $
                  (8,654,337
                  )
                  
                  $
                  175,436
                  
                  
                  $
                  4,984,350Investment
      in marketable securities held for sale-related party
                  
                  $
                  160,459
                  
                  
                  $
                  1,256,219
                  
                  
                  $
                  (811,992
                  )
                  
                  $
                  -
                  
                  
                  $
                  604,686Total
      Investment in trading securities
                  
                  $
                  7,729,792
                  
                  
                  $
                  7,150,137
                  
                  
                  $
                  (9,466,329
                  )
                  
                  $
                  175,436
                  
                  
                  $
                  5,589,036
 
 For
      the Year Ended December 31, 2008Description
                  
                  January
      1, 2008
                  
                  
                  Amount
      Received/Sold
                  
                  
                  Cost
      Basis Adjustment for OTTI
                  
                  
                  Unrealized
      Gain
                  
                  
                  December
      31, 2008Investment
      in marketable securities held for sale
                  
                  $
                  7,820,500
                  
                  
                  $
                  15,089,777
                  
                  
                  $
                  (7,521,083
                  )
                  
                  $
                  (7,819,861
                  )
                  
                  $
                  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
                  
                  
                  $
                  (7,521,083
                  )
                  
                  $
                  (8,974,890
                  )
                  
                  $
                  7,729,792
 
 NOTE
16 – INCOME TAXES
 
 Our
parent and their U.S. subsidiaries are subject to applicable Federal, State and
Local tax statues. Our 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 33% (30% state income tax plus 3% local income
tax). We intend to utilize profits earned by our Chinese based subsidiaries in
China to expand our PRC based operations.
 
 The
components of (loss) income before income tax consisted of the
following:
 
 Decscriptons
                  
                  September
      30, 2009
                  
                  
                  December
      31, 2008U.S.
      Operations
                  
                  $
                  (15,769,618
                  )
                  
                  $
                  (7,201,533
                  )China
      Operations
                  
                  
                  (5,832,529
                  )
                  
                  
                  20,638,937Discontinued
      Operations
                  
                  
                  (8,556,806
                  )
                  
                  
                  645,475Total
      (loss) income
                  
                  $
                  (30,158,953
                  )
                  
                  $
                  14,082,879
 
  F-30
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 The
provision (benefit) for income taxes is composed of the following:
 
 Description
                  
                  September
      30, 2009
                  
                  
                  December
      31, 2008Current:Federal
                  
                  $
                  (195,219
                  )
                  
                  $
                  (277,759
                  )State
                  
                  
                  -
                  
                  
                  
                  -Chinese
      Operations
                  
                  
                  174,054
                  
                  
                  
                  545,006Discontinued
      operations
                  
                  
                  -
                  
                  
                  
                  127,200Deferred:Federal
                  
                  
                  -
                  
                  
                  
                  -State
                  
                  
                  -
                  
                  
                  
                  -$
                  (21,165
                  )
                  
                  $
                  394,447
 
 The table
below summarizes the reconciliation of our income tax provision computed at the
federal statutory rate and the actual tax provision as follows:
 
 Description
                  
                  Nine
      months ended September 30, 2009
                  
                  
                  Twelve
      months ended December 31, 2008Income
      tax (benefit) expense provision at Federal statutory rate
                  
                  $
                  (10,555,633
                  )
                  
                  $
                  5,614,000State
      income tax (benefit) expense, net of Federal benefit
                  
                  
                  (1,085,722
                  )
                  
                  
                  577,000US
      and state tax rate in excess of China tax rate
                  
                  
                  1,688,901
                  
                  
                  
                  (898,000
                  )China
      reduced tax rate zones
                  
                  
                  4,666,647
                  
                  
                  
                  (5,706,000
                  )Other
                  
                  
                  5,203,974
                  
                  
                  
                  807,000Tax
      provision
                  
                  $
                  (81,833
                  )
                  
                  $
                  394,000
 
 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 September 30, 2009 and December 31,
2008.
 
 NOTE
17 – COMMITMENTS AND CONTINGENCIES
 
 Leases
 
 We
entered into an office lease agreement for our corporate offices in Florida at
an annual expense of $234,936. 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 $93,825. 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.
  F-31
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 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, 2010
                  
                  
                  366,261Period
      Ended December 31, 2011
                  
                  
                  350,886Period
      Ended December 31, 2012
                  
                  
                  350,886Period
      Ended December 31, 2013
                  
                  
                  350,886Thereafter
                  
                  
                  350,886$
                  1,769,805
 
 Contingencies
 
 We are
not currently involved in any litigation. However, we, have a dispute with
Shanxi Jinyang Coal and Coke Group Co., Ltd. (“Shanxi Jinyang”) and Ms. Runlian
Tian, the noncontrolling shareholders of our subsidiary Pan Asia Magnesium and
its Chairman of the Board of Directors, Haixin Zhao. Our dispute stems from
their refusal to fully cooperate with us in completing our audit of Pan Asia
Magnesium’s books and records as part of our audit for the fiscal year ended
September 30, 2009. In addition, they have failed to act in Pan Asia Magnesium’s
best interests, among other matters related to its management and
operation.  Our dispute with the noncontrolling shareholders of Pan
Asia Magnesium and Mr. Zhao also involves their claim that in connection with
our October 2007 acquisition of Pan Asia Magnesium we should have used the
equity method of accounting rather than consolidation. They also claim we failed
to disclose certain assets owned by, and obligations of, Shanxi Jinyang that
were improperly included in our consolidated financial statements for fiscal
2007 and fiscal 2008. We believe the noncontrolling shareholders’ claims against
us are without merit and were made to justify their refusal to allow us to
conduct our audit for the 2009 transition period, among other improper
purposes.  In addition, we believe that the noncontrolling
shareholders and Mr. Zhao have become increasingly non responsive to us as a
result of the September 29, 2009 decision of our board of directors to commit to
a plan to focus our magnesium production efforts with our key Chinese partner,
Yiwei Magnesium, a related party, and sell our interest in Pan Asia Magnesium
and present it as a discontinued operation beginning with our financial
statements for the fiscal year ended September 30, 2009.  While we
attempted to resolve our dispute amicably, we have been unable to do so as of
the date of the filing of this report. On December 29, 2009 our audit committee
approved the establishment of a $7.4 million reserve for a contingent loss from
discontinued operations reflecting our entire investment in Pan Asia Magnesium
and an estimate for legal fees. We are continuing our efforts to reach an
amicable resolution of our dispute with the noncontrolling shareholders of Pan
Asia Magnesium and Mr. Zhao including efforts to monetize our investment in this
company.  Should we be unable resolve our dispute, we will take
appropriate legal action against the noncontrolling shareholders of Pan Asia
Magnesium and Mr. Zhao in China which may include a court supervised dissolution
and audit of Pan Asia Magnesium in addition to appropriate legal action against
its noncontolling shareholders and Mr. Zhao based upon the findings in an
audit.
 
 Management
presently believes that the ultimate outcome of the dispute with the
noncontrolling shareholders of Pan Asia Magnesium and Mr. Zhao will be favorable
to us. However, litigation is subject to inherent uncertainties and unfavorable
rulings could occur. An unfavorable ruling could include monetary damages. Were
an unfavorable ruling to occur, there exists the possibility of a material
adverse impact on the business or results of operations for the period in which
the ruling occurs or future periods.
 
 Other
than as described above, we believe there are currently no litigation or legal
or administrative proceedings pending against us that are likely to have,
individually or in the aggregate, a material adverse effect on our business or
our results of operations.
  F-32
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 NOTE
18 - SEGMENT INFORMATION
 
 The
following information is presented in accordance with ASC 280, “Segment
Reporting”. For the 2009 Transition Period, we operated in three reportable
business segments during this period as follows:
 
 Magnesium
segment:
 
 ·
                  Chang
      Magnesium;·
                  Chang
      Trading;·
                  Excel
      Rise;·
                  Asia
      Magnesium;·
                  Golden
      Magnesium;·
                  Baotou
      Changxin Magnesium; and·
                  Capital
      One Resource.  1
 
 Basic
Materials segment:
 
 ·
                  Lang
      Chemical;·
                  CDI
      Jingkun Zinc;·
                  CDI
      Jixiang Metal; and·
                  CDI
      Metal Recycling.·
                  CDI
      (Beijing) International Trade Co.
Ltd.
 
 Consulting
segment:
 
 ·
                  China
      Direct Investments;·
                  CDI
      Shanghai Management; and·
                  Capital
      One Resource.
 
 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 in fiscal 2008.  We are
evaluating the feasibility of continuing the development of a proposed facility
to create aluminum powder from recycled aluminum by CDI Metal Recycling which
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 and Pan Asia Magnesium for the year ended
September 30, 2009, September 30, 2008, and December 31, 2008 are as
follows:
 
 For
      the nine months ended September 30, 2009(in
      thousands)
                  
                  Magnesium
                  
                  
                  Basic
      Materials
                  
                  
                  Consulting
                  
                  
                  ConsolidatedRevenues
                  
                  $
                  15,166
                  
                  
                  $
                  41,112
                  
                  
                  $
                  810
                  
                  
                  $
                  57,088Revenues
      - related party
                  
                  
                  11,542
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  11,54226,708
                  
                  
                  
                  41,112
                  
                  
                  
                  810
                  
                  
                  
                  68,630Interest
      income (expense)
                  
                  
                  200
                  
                  
                  
                  (12
                  )
                  
                  
                  96
                  
                  
                  
                  284Net
      (loss) income
                  
                  
                  (3,411
                  )
                  
                  
                  (1,147
                  )
                  
                  
                  (17,045
                  )
                  
                  
                  (21,602
                  )Segment
      assets
                  
                  $
                  31,941
                  
                  
                  $
                  12,422
                  
                  
                  $
                  36,152
                  
                  
                  $
                  80,516
 
  F-33
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
 
 For
      the nine months ended September 30, 2008(in
      thousands)
                  
                  Magnesium
                  
                  
                  Basic
      Materials
                  
                  
                  Consulting
                  
                  
                  ConsolidatedRevenues
                  
                  $
                  126,431
                  
                  
                  $
                  39,572
                  
                  
                  $
                  14,518
                  
                  
                  $
                  180,521Revenues
      - related party
                  
                  
                  3,144
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  3,144129,575
                  
                  
                  
                  39,572
                  
                  
                  
                  14,518
                  
                  
                  
                  183,665Interest
      (expense) income
                  
                  
                  (74
                  )
                  
                  
                  (40
                  )
                  
                  
                  463
                  
                  
                  
                  349Net
      income
                  
                  
                  15,795
                  
                  
                  
                  297
                  
                  
                  
                  9,401
                  
                  
                  
                  25,493Segment
      assets
                  
                  $
                  58,723
                  
                  
                  $
                  7,484
                  
                  
                  $
                  55,973
                  
                  
                  $
                  122,180
 
 For
      the twelve months ended December 31, 2008(in
      thousands)
                  
                  Magnesium
                  
                  
                  Basic
      Materials
                  
                  
                  Consulting
                  
                  
                  ConsolidatedRevenues
                  
                  $
                  135,676
                  
                  
                  $
                  53,838
                  
                  
                  $
                  16,358
                  
                  
                  $
                  205,872Revenues
      - related party
                  
                  
                  16,750
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  16,750152,426
                  
                  
                  
                  53,838
                  
                  
                  
                  16,358
                  
                  
                  
                  222,622Interest
      income (expense)
                  
                  
                  41
                  
                  
                  
                  (52
                  )
                  
                  
                  303
                  
                  
                  
                  292Net
      income
                  
                  
                  10,401
                  
                  
                  
                  523
                  
                  
                  
                  2,513
                  
                  
                  
                  13,437Segment
      assets
                  
                  $
                  73,670
                  
                  
                  $
                  9,158
                  
                  
                  $
                  24,551
                  
                  
                  $
                  107,379
 
 NOTE
19 – FOREIGN OPERATIONS
 
 As of
September 30, 2009 the majority of our revenues and assets are associated with
subsidiaries located in the People’s Republic of China.  Assets at
September 30, 2009 reclassified to reflect discontinued operations, as well as
revenues for the 2009 transition period, the first nine months of 2008, and
fiscal 2008 were as follows:
 
 For
      the nine months ended September 30, 2009(in
      thousands)
                  
                  United
      States
                  
                  
                  People’s
      Republic of China
                  
                  
                  TotalRevenues
                  
                  $
                  805
                  
                  
                  $
                  56,283
                  
                  
                  $
                  57,088Revenues
      – related party
                  
                  
                  
                  
                  
                  
                  11,542
                  
                  
                  
                  11,542Total
      Revenue
                  
                  
                  805
                  
                  
                  
                  67,825
                  
                  
                  
                  68,630Identifiable
      assets at September 30, 2009
                  
                  $
                  42,157
                  
                  
                  $
                  38,359
                  
                  
                  $
                  80,516
 
 For
      the nine months ended September 30, 2008(in
      thousands)
                  
                  United
      States
                  
                  
                  People’s
      Republic of China
                  
                  
                  TotalRevenues
                  
                  $
                  14,435
                  
                  
                  $
                  166,086
                  
                  
                  $
                  180,521Revenues
      – related party
                  
                  
                  -
                  
                  
                  
                  3,144
                  
                  
                  $
                  3,14414,435
                  
                  
                  
                  169,230
                  
                  
                  
                  183,665Identifiable
      assets at September 30, 2008
                  
                  $
                  54,758
                  
                  
                  $
                  76,226
                  
                  
                  $
                  130,984
 
 For
      the twelve months ended December 31, 2008(
      in thousands)
                  
                  United
      States
                  
                  
                  People’s
      Republic of China
                  
                  
                  TotalRevenues
                  
                  $
                  16,222
                  
                  
                  $
                  189,651
                  
                  
                  $
                  205,873Revenues
      – related party
                  
                  
                  -
                  
                  
                  
                  16,750
                  
                  
                  $
                  16,75016,222
                  
                  
                  
                  206,401
                  
                  
                  
                  222,623Identifiable
      assets at December 31, 2008
                  
                  $
                  44,080
                  
                  
                  $
                  63,299
                  
                  
                  $
                  107,379
  F-34
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  
 NOTE
20 – DISCONTINUED OPERATIONS
 
 During
the third quarter of fiscal 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 ASC 360.
 
 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 fiscal 2008 and
previously reported results of operations of CDI Clean Technology have been
reclassified to reflect this subsidiary as “Subsidiaries held for sale”. 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.
 
 On
September 29, 2009 our board of directors committed to a plan to sell our
interest in Pan Asia Magnesium and present it as a discontinued operation
beginning with our financial statements for the fiscal year ended September 30,
2009.  On December 22, 2009 when it became apparent that we would be
unable to complete the audit of Pan Asia Magnesium in time to file our
Transition Report on Form 10-K for the year ended September 30, 2009 as a result
of a dispute with Shanxi Jinyang Coal and Coke Group Co., Ltd. (“Shanxi
Jinyang”) and Ms. Runlian Tian, the noncontrolling shareholders of our
subsidiary Pan Asia Magnesium and its Chairman of the Board of Directors, Haixin
Zhao, our audit committee approved the establishment of a $7.4 million reserve
for a loss from discontinued operations.  The reserve for loss
reflects our entire investment in Pan Asia Magnesium. See Note 17 – Commitments
and Contingencies.
  In
February 2007, CDI China acquired a 51% interest in CDI Magnesium in exchange
for 25,000 shares of our common stock valued at $100,000. The fair value of our
common stock was based on its value of $4.00 per share on February 6, 2007.
Since its inception, CDI Magnesium had no operations and on October 10, 2009 its
board of directors elected to dissolve the company and distribute its assets to
its shareholders or otherwise dispose of the assets upon agreement among its
shareholders.
 
 In the
third quarter of 2009 China Direct discontinued the operations of Pan Asia
Magnesium Co., Ltd. and CDI Magnesium Co. Ltd.  The assets and
liabilities of both of the discontinued subsidiaries were reclassified in fiscal
2008 as “Discontinued Operations” and in the 2009 Transition Period the assets
and liabilities of CDI Magnesium are classified as “Discontinued Operations”
while our investment in Pan Asia Magnesium is presented on our statement of
operations as a “Provisional Reserve”.
 
 The
following tables set forth the components of the discontinued operations for the
2009 transition period, the first nine months of 2008, and fiscal
2008.
 
 (in
      thousands)
                  
                  Six months
      ended June 30, 2009
                  
                  
                  Nine
      months ended September 30, 2008
                  
                  
                  Twelve
      months ended December 31, 2008Unaudited
                  
                  
                  UnauditedRevenues
                  
                  $
                  949
                  
                  
                  $
                  17,353
                  
                  
                  $
                  18,264Cost
      of revenues
                  
                  
                  1,353
                  
                  
                  
                  14,300
                  
                  
                  
                  15,219Gross
      (loss) profit
                  
                  
                  (404
                  )
                  
                  
                  3,053
                  
                  
                  
                  3,045Selling,
      general, and administrative
                  
                  
                  344
                  
                  
                  
                  896
                  
                  
                  
                  1,734Operating
      (loss) income
                  
                  
                  (748
                  )
                  
                  
                  2,157
                  
                  
                  
                  1,311Other
      (expenses) income
                  
                  
                  (447
                  )
                  
                  
                  68
                  
                  
                  
                  (100
                  )Net
      (loss) income before income tax and non-controlling
    interests
                  
                  
                  (1,195
                  )
                  
                  
                  2,225
                  
                  
                  
                  1,211Income
      tax expense
                  
                  
                  (0
                  )
                  
                  
                  611
                  
                  
                  
                  -513Net
      (loss) income before non-controlling  interests
                  
                  
                  (1,195
                  )
                  
                  
                  1,562
                  
                  
                  
                  645Non-controlling
      Interests in income of subsidiary
                  
                  
                  585
                  
                  
                  
                  (790
                  )
                  
                  
                  (342
                  )Discontinued
      operation's net (loss) income
                  
                  $
                  (610
                  )
                  
                  $
                  772
                  
                  
                  $
                  303
 
  F-35
 CHINA
DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
 NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2009, SEPTEMBER 30, 20008 AND DECEMBER 31, 2008 - Continued
  Summarized Balance Sheet of
Discontinued Operations
  Pan Asia
Magnesium
   Six months
      ended June 30, 2009(in
      thousands)
                  
                  UnauditedInvestment
                  
                  $
                  7,346,065Adjustments
                  
                  $
                  (284,026
                  )Provisional
      Reserve
                  
                  $
                  (7,062,039
                  )Accrual
      on costs of disposal
                  
                  $
                  (300,000
                  )Total
      reserve: discontinued operations
                  
                  $
                  (7,362,039
                  )
  CDI
Magnesium
   Six months
      ended June 30, 2009(in
      thousands)
                  
                  UnauditedCurrent
      assets
                  
                  $
                  51Long-lived
      assets
                  
                  $
                  196Equity
                  
                  $
                  150Non-controlling
      interest
                  
                  $
                  97
  
 NOTE
21 – STATUTORY RESERVES
 
 We are
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 2009 Transition
Period 2009 and fiscal 2008, statutory reserve activity is as follows and is
included in retained earnings:
 
 Chang
                  
                  
                  Golden
                  
                  
                  Baotou
                  
                  
                  Lang
                  
                  
                  CDI
                  
                  
                  CDI
                  
                  
                  CDI
      ShanghaiMagnesium
                  
                  
                  Magnesium
                  
                  
                  Magnesium
                  
                  
                  Chemical
                  
                  
                  Beijing
                  
                  
                  Jingkun
      Zinc
                  
                  
                  Management
                  
                  
                  TotalBalance
      -December 2007
                  
                  $
                  58,000
                  
                  
                  $
                  555
                  
                  
                  $
                  -
                  
                  
                  $
                  29,508
                  
                  
                  $
                  -
                  
                  
                  $
                  3,250
                  
                  
                  $
                  69,707
                  
                  
                  $
                  161,020Addition
      to statutory reserves
                  
                  
                  1,082,211
                  
                  
                  
                  90,517
                  
                  
                  
                  -
                  
                  
                  
                  -
                  
                  
                  
                  29,727
                  
                  
                  
                  -
                  
                  
                  
                  61,495
                  
                  
                  
                  1,263,950Balance
      – December 2008
                  
                  $
                  1,140,211
                  
                  
                  $
                  91,072
                  
                  
                  $
                  -
                  
                  
                  $
                  29,508
                  
                  
                  $
                  29,727
                  
                  
                  $
                  3,250
                  
                  
                  $
                  131,202
                  
                  
                  $
                  1,424,970(Reduction)
      Addition to statutory reserves
                  
                  
                  (398,755
                  )
                  
                  
                  45,067
                  
                  
                  
                  12,580
                  
                  
                  
                  5,545
                  
                  
                  
                  (6,907
                  )
                  
                  
                  (95,768
                  )
                  
                  
                  (119,201
                  )
                  
                  
                  (557,439
                  )Balance
      – September 30, 2009
                  
                  $
                  1,881,667
                  
                  
                  $
                  227,211
                  
                  
                  $
                  12,580
                  
                  
                  $
                  64,561
                  
                  
                  $
                  30,133
                  
                  
                  $
                  (89,268
                  )
                  
                  $
                  143,203
                  
                  
                  $
                  30,133
 
 NOTE
22 – SUBSEQUENT EVENTS
 
 On
October 14, 2009, we entered into a Continuous Offering Program Agreement (the
“Agreement”), with Rodman & Renshaw, LLC (“Rodman & Renshaw”), under
which we may sell an aggregate of up to $5,201,330 in gross proceeds of our
common stock from time to time through Rodman & Renshaw, as the agent for
the offer and sale of the common stock. Rodman & Renshaw may sell the common
stock by any method permitted by law, including sales deemed to be an “at the
market” offering as defined in Rule 415 of the Securities Act of 1933,
including without limitation sales made directly on NASDAQ Global Market, on any
other existing trading market for the common stock or to or through a market
maker. Rodman & Renshaw may also sell the common stock in privately
negotiated transactions, subject to our prior approval. We will pay Rodman &
Renshaw a commission equal to 4% of the gross proceeds of the sales price of all
common stock sold through it as sales agent under the Agreement.  The
Agreement may be terminated by either party at any time except with respect to
any pending sale by Rodman & Renshaw for us.  As of December 29,
2009, we sold 22,300 shares and received net proceeds in the amount of $34,253
under the Agreement.
 In
February 2007, CDI China acquired a 51% interest in CDI Magnesium in exchange
for 25,000 shares of our common stock valued at $100,000. The fair value of our
common stock was based on its value of $4.00 per share on February 6, 2007.
Since its inception, CDI Magnesium had no operations and on October 10, 2009 its
board of directors elected to dissolve the company and distribute its assets to
its shareholders or otherwise dispose of the assets upon agreement among its
shareholders. Beginning with our financial statements for the fiscal year ended
September 30, 2009, we will treat CDI Magnesium as a discontinued operation. See
Note 20 – Discontinued Operations.
  On
December 30, 2009, the shareholders of CDI Beijing agreed to limit their capital
contributions to the $2,919,754 they already contributed to CDI Beijing and
waived the requirement for their contributions of additional capital including
CDI Shanghai Management’s obligation to contribute $2,200,000 by September 30,
2009.  See Note 10 – Acquisitions - Acquisition of a 51% interest in CDI
Beijing.
 F-36