UNITED
      STATESSECURITIES
      AND EXCHANGE COMMISSIONWashington,
      D.C. 20549(Mark
      One)Form
      10-Q





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





For the
quarterly period ended September 30, 2008





or


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





For the
transition period from __________________ to __________________





Commission
file number: 001-33694


CHINA
      DIRECT, INC.(Exact
      name of registrant as specified in its
charter)





Florida
            13-3876100(State
      or other jurisdiction of incorporation or organization)
            (I.R.S.
      Employer Identification No.)431
      Fairway Drive, Suite 200, Deerfield Beach, Florida
            33441(Address
      of principal executive offices)
            (Zip
      Code)954-363-7333(Registrant’s
      telephone number, including area code)Not
      Applicable(Former
      name, former address and former fiscal year, if changed since last
      report)





Indicate
by check mark whether the registrant (1) has filed all reports required to be
filed by Section 13 or 15(d) of the 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 [√]
No [  ]





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





Large
      accelerated filer
            [  ]
            Accelerated
      filer
            [  ]Non-accelerated
      filer
            [  ]
            Smaller
      reporting company
            [√](Do
      not check if smaller reporting company)





Indicate
by check mark whether the registrant is a shell company (as defined in Rule
12b-2 of the Exchange Act)


Yes
[  ] No [√]





Indicate
the number of shares outstanding of each of the issuer’s classes of common
stock, as of the latest practicable date. 23,477,142 shares of common stock
are issued and outstanding as of November 13, 2008.





Index








TABLE OF CONTENTS





Page
      No.PART I. -
      FINANCIAL INFORMATIONItem
      1.
              Financial
      Statements.
              
              2Item
      2.
              Management’s Discussion and
      Analysis of Financial Condition and Results of
      Operations.
              
              33Item
      3.
              Quantitative and Qualitative
      Disclosures About Market Risk.
              
              51Item
      4T
              Controls and
      Procedures.
              
              51PART II -
      OTHER INFORMATIONItem
      1.
              Legal
      Proceedings.
              
              52Item
      1A.
              Risk
      Factors.
              
              52Item
      2.
              Unregistered Sales of Equity
      Securities and Use of Proceeds.
              
              52Item
      3.
              Defaults
      Upon Senior Securities.
              
              54Item
      4.
              Submission of Matters to a Vote
      of Security Holders.
              
              54Item
      5.
              Other
      Information.
              
              54Item
      6.
              Exhibits.
              
              56








Index








INDEX
OF CERTAIN DEFINED TERMS USED IN THIS REPORT





We
operate our company in two primary divisions. Our Management Services division
acquires controlling interests of Chinese business entities which we consolidate
as either our wholly or majority owned subsidiaries. Our Advisory Services
division provides consulting services to Chinese entities seeking access to the
U.S. capital markets. The following list reflects our primary business
entities.





When used
in this report the terms:




·
                            "China
      Direct", "we", "us" or "our" refers to China Direct, Inc., a Florida
      corporation, and our subsidiaries,Management Services
  Division·
                            “CDI
      China”, refers to CDI China, Inc., a Florida corporation and a wholly
      owned subsidiary of China Direct,Magnesium
      Segment·
                            “Chang
      Magnesium”, refers to Taiyuan Changxin Magnesium Co., Ltd., a Chinese
      limited liability company and a 51% majority owned subsidiary of CDI
      China,·
                            “Chang
      Trading”, refers to Taiyuan Changxin YiWei Trading Co., Ltd., a Chinese
      limited liability company 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%
      majority owned subsidiary of Capital One Resource,·
                            “Asia
      Magnesium”, refers to Asia Magnesium Corporation Ltd., a Hong Kong limited
      liability company and a wholly owned subsidiary of Capital One
      Resource·
                            “Golden
      Magnesium”, refers to Shanxi Gu County Golden Magnesium Co., Ltd., a
      Chinese limited liability company, formerly referred to by us in filings
      and press releases as “Jinwei Magnesium”, and a 52% majority owned
      subsidiary of Asia Magnesium,·
                            “Pan
      Asia Magnesium”, refers to Pan Asia Magnesium Co., Ltd., a Chinese limited
      liability company and a 51% majority owned subsidiary of CDI
      China,·
                            “Baotou
      Changxin Magnesium”, refers to Baotou Changxin Magnesium Co., Ltd., a
      Chinese limited liability company and a 51% majority owned subsidiary of
      CDI China,Basic Materials
      Segment·
                            “Lang
      Chemical”, refers to Shanghai Lang Chemical Co., Ltd. a Chinese limited
      liability company and a 51% majority owned subsidiary of CDI
      China,·
                            “CDI
      Jingkun Zinc”, refers to CDI Jingkun Zinc Industry Co., Ltd., a Chinese
      limited liability company and a 95% majority owned subsidiary of CDI
      Shanghai Management,·
                            “CDI
      Jixiang Metal”, refers to CDI Jixiang Metal Co., Ltd., a Chinese limited
      liability company and a wholly owned subsidiary of CDI
    China,·
                            “CDI
      Beijing” refers to CDI (Beijing) International Trading Co., Ltd., a
      Chinese limited liability company and a 51% majority owned subsidiary of
      CDI Shanghai Management,·
                            “CDI
      Metal Recycling”, refers to Shanghai CDI Metal Recycling Co., Ltd., a
      Chinese limited liability company and an 83% majority owned subsidiary of
      CDI Shanghai Management.Advisory Services
  DivisionConsulting 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
      Chinese limited liability company and a wholly owned subsidiary of CDI
      China,·
                            “Capital
      One Resource”, refers to Capital One Resource Co., Ltd., a Brunei company
      and a wholly owned subsidiary of CDI Shanghai
  Management,








- 1
-
 Index





PART 1 - FINANCIAL INFORMATION


Item 1.
            Financial
      Statements.


CHINA
DIRECT, INC. AND SUBSIDIARIES


CONSOLIDATED
BALANCE SHEETS


September
      30,
                                                          
                                                          
                                                          December
      31,2008
                                                          
                                                          
                                                          2007ASSETS
                                                          
                                                          (Unaudited)Current
      Assets:Cash
      and cash equivalents
                                                          
                                                          $
                                                          19,636,862
                                                          
                                                          
                                                          $
                                                          19,024,604Investment
      in marketable securities available for sale
                                                          
                                                          
                                                          8,559,219
                                                          
                                                          
                                                          
                                                          7,820,500Investment
      in marketable securities available for sale-related party
                                                          
                                                          
                                                          209,351
                                                          
                                                          
                                                          
                                                          1,315,488Accounts
      receivable, net of allowance
                                                          
                                                          
                                                          17,535,988
                                                          
                                                          
                                                          
                                                          10,529,316Accounts
      receivable-related parties
                                                          
                                                          
                                                          750,419
                                                          
                                                          
                                                          
                                                          2,283,600Inventories
                                                          
                                                          
                                                          15,416,872
                                                          
                                                          
                                                          
                                                          5,270,388Prepaid
      expenses and other current assets
                                                          
                                                          
                                                          21,301,463
                                                          
                                                          
                                                          
                                                          13,951,918Prepaid
      expenses-related parties
                                                          
                                                          
                                                          9,420,705
                                                          
                                                          
                                                          
                                                          4,150,943Loans
      receivable-related parties
                                                          
                                                          
                                                          1,525,114
                                                          
                                                          
                                                          
                                                          -Due
      from related parties
                                                          
                                                          
                                                          14,588
                                                          
                                                          
                                                          
                                                          1,287,877Subsidiaries
      held for sale
                                                          
                                                          
                                                          7,180,439
                                                          
                                                          
                                                          
                                                          3,604,849Total
      current assets
                                                          
                                                          
                                                          101,551,020
                                                          
                                                          
                                                          
                                                          69,239,483Restricted
      cash
                                                          
                                                          
                                                          1,420
                                                          
                                                          
                                                          
                                                          646,970Property,
      plant and equipment, net of accumulated depreciation of$1,792,566
      and $509,247 at September 30, 2008 and December 31, 2007,
      respectively
                                                          
                                                          
                                                          28,618,127
                                                          
                                                          
                                                          
                                                          17,413,489Prepaid
      expenses and other assets
                                                          
                                                          
                                                          229,058
                                                          
                                                          
                                                          
                                                          433,075Property
      use rights, net
                                                          
                                                          
                                                          583,918
                                                          
                                                          
                                                          
                                                          553,304Total
      assets
                                                          
                                                          $
                                                          130,983,543
                                                          
                                                          
                                                          $
                                                          88,286,321LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      Liabilities:Loans
      payable-short term
                                                          
                                                          $
                                                          1,159,721
                                                          
                                                          
                                                          $
                                                          1,909,781Accounts
      payable and accrued expenses
                                                          
                                                          
                                                          9,986,741
                                                          
                                                          
                                                          
                                                          9,524,411Accounts
      payable-related parties
                                                          
                                                          
                                                          3,285,754
                                                          
                                                          
                                                          
                                                          964,114Notes
      payable-related party
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          410,167Accrued
      dividends payable
                                                          
                                                          
                                                          20,235
                                                          
                                                          
                                                          
                                                          -Advances
      from customers
                                                          
                                                          
                                                          6,848,069
                                                          
                                                          
                                                          
                                                          6,891,788Other
      payables
                                                          
                                                          
                                                          3,945,819
                                                          
                                                          
                                                          
                                                          3,090,790Income
      taxes payable
                                                          
                                                          
                                                          757,125
                                                          
                                                          
                                                          
                                                          304,977Due
      to related parties
                                                          
                                                          
                                                          734,996
                                                          
                                                          
                                                          
                                                          3,137,233Subsidiaries
      held for sale
                                                          
                                                          
                                                          6,668,981
                                                          
                                                          
                                                          
                                                          2,303,405Total
      current liabilities
                                                          
                                                          
                                                          33,407,441
                                                          
                                                          
                                                          
                                                          28,536,666Loans
      payable-long term
                                                          
                                                          
                                                          198,392
                                                          
                                                          
                                                          
                                                          166,573Minority
      interest
                                                          
                                                          
                                                          27,977,974
                                                          
                                                          
                                                          
                                                          16,957,503Stockholders'
      Equity:Preferred
      Stock: $.0001 par value, stated value $1,000 per share;
                                                            10,000,000
      authorized, 1,006 shares and 0 shares issued and outstanding
                                                            at
      September 30, 2008 and December 31, 2007, respectively
                                                          
                                                          
                                                          1,006,250
                                                          
                                                          
                                                          
                                                          -Common
      Stock: $.0001 par value, 1,000,000,000 authorized,
                                                            23,545,236
      and 20,982,010 issued and outstanding
                                                            at
      September 30, 2008 and December 31, 2007, respectively
                                                          
                                                          
                                                          2,355
                                                          
                                                          
                                                          
                                                          2,098Additional
      paid-in capital
                                                          
                                                          
                                                          51,542,323
                                                          
                                                          
                                                          
                                                          30,257,644Deferred
      compensation
                                                          
                                                          
                                                          (22,000
                                                          )
                                                          
                                                          
                                                          (55,000
                                                          )Accumulated
      comprehensive income (loss)
                                                          
                                                          
                                                          (7,166,802
                                                          )
                                                          
                                                          
                                                          54,688Retained
      earnings
                                                          
                                                          
                                                          24,037,610
                                                          
                                                          
                                                          
                                                          12,366,149Total
      stockholders’ equity
                                                          
                                                          
                                                          69,399,736
                                                          
                                                          
                                                          
                                                          42,625,579Total
      liabilities and stockholders’ equity
                                                          
                                                          $
                                                          130,983,543
                                                          
                                                          
                                                          $
                                                          88,286,321





See notes
to unaudited consolidated financial statements





- 2
-
 Index




CHINA
DIRECT, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF OPERATIONS


(Unaudited)





For
      the Three Months
                                                                                  
                                                                                  
                                                                                  For
      the Nine MonthsEnded
      September 30,
                                                                                  
                                                                                  
                                                                                  Ended
      September 30,2008
                                                                                  
                                                                                  
                                                                                  2007
                                                                                  
                                                                                  
                                                                                  2008
                                                                                  
                                                                                  
                                                                                  2007Revenues
                                                                                  
                                                                                  $
                                                                                  62,297,299
                                                                                  
                                                                                  
                                                                                  $
                                                                                  43,013,630
                                                                                  
                                                                                  
                                                                                  $
                                                                                  196,956,852
                                                                                  
                                                                                  
                                                                                  $
                                                                                  111,298,794Revenues-related
      parties
                                                                                  
                                                                                  
                                                                                  1,065,720
                                                                                  
                                                                                  
                                                                                  
                                                                                  580,777
                                                                                  
                                                                                  
                                                                                  
                                                                                  3,144,366
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,460,777Total
      revenues
                                                                                  
                                                                                  
                                                                                  63,363,019
                                                                                  
                                                                                  
                                                                                  
                                                                                  43,594,407
                                                                                  
                                                                                  
                                                                                  
                                                                                  200,101,218
                                                                                  
                                                                                  
                                                                                  
                                                                                  112,759,571Cost
      of revenues
                                                                                  
                                                                                  
                                                                                  52,772,513
                                                                                  
                                                                                  
                                                                                  
                                                                                  39,009,589
                                                                                  
                                                                                  
                                                                                  
                                                                                  166,080,439
                                                                                  
                                                                                  
                                                                                  
                                                                                  101,426,722Gross
      profit
                                                                                  
                                                                                  
                                                                                  10,590,506
                                                                                  
                                                                                  
                                                                                  
                                                                                  4,584,818
                                                                                  
                                                                                  
                                                                                  
                                                                                  34,020,779
                                                                                  
                                                                                  
                                                                                  
                                                                                  11,332,849Operating
      expenses:Selling,
      general, and administrative
                                                                                  
                                                                                  
                                                                                  3,168,049
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,031,238
                                                                                  
                                                                                  
                                                                                  
                                                                                  7,265,630
                                                                                  
                                                                                  
                                                                                  
                                                                                  2,351,485Operating income
                                                                                  
                                                                                  
                                                                                  7,422,457
                                                                                  
                                                                                  
                                                                                  
                                                                                  3,553,580
                                                                                  
                                                                                  
                                                                                  
                                                                                  26,755,149
                                                                                  
                                                                                  
                                                                                  
                                                                                  8,981,364Other
      income (expense):Other
      income
                                                                                  
                                                                                  
                                                                                  126,635
                                                                                  
                                                                                  
                                                                                  
                                                                                  9,723
                                                                                  
                                                                                  
                                                                                  
                                                                                  423,127
                                                                                  
                                                                                  
                                                                                  
                                                                                  382,981Interest
      income
                                                                                  
                                                                                  
                                                                                  93,782
                                                                                  
                                                                                  
                                                                                  
                                                                                  44,847
                                                                                  
                                                                                  
                                                                                  
                                                                                  333,659
                                                                                  
                                                                                  
                                                                                  
                                                                                  118,086Realized
      gain (loss) on sale of marketable securities
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  494,605
                                                                                  
                                                                                  
                                                                                  
                                                                                  (35,705
                                                                                  )
                                                                                  
                                                                                  
                                                                                  700,841Realized
      loss on sale of marketable securities-related party
                                                                                  
                                                                                  
                                                                                  (2,400
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (9,871
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (2,400
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (41,885
                                                                                  )Total
      other income
                                                                                  
                                                                                  
                                                                                  218,017
                                                                                  
                                                                                  
                                                                                  
                                                                                  539,304
                                                                                  
                                                                                  
                                                                                  
                                                                                  718,681
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,160,023Income
      from continuing operations before income taxes
                                                                                  
                                                                                  
                                                                                  7,640,474
                                                                                  
                                                                                  
                                                                                  
                                                                                  4,092,884
                                                                                  
                                                                                  
                                                                                  
                                                                                  27,473,830
                                                                                  
                                                                                  
                                                                                  
                                                                                  10,141,387Income
      tax benefit (expense)
                                                                                  
                                                                                  
                                                                                  567,272
                                                                                  
                                                                                  
                                                                                  
                                                                                  (173,737
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (473,152
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (903,488
                                                                                  )Income
      from continuing operations before minority interest
                                                                                  
                                                                                  
                                                                                  8,207,746
                                                                                  
                                                                                  
                                                                                  
                                                                                  3,919,147
                                                                                  
                                                                                  
                                                                                  
                                                                                  27,000,678
                                                                                  
                                                                                  
                                                                                  
                                                                                  9,237,899Minority
      interest
                                                                                  
                                                                                  
                                                                                  (2,303,585
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (1,030,591
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (8,902,123
                                                                                  )
                                                                                  
                                                                                  
                                                                                  (2,236,598
                                                                                  )Income
      from continuing operations
                                                                                  
                                                                                  
                                                                                  5,904,161
                                                                                  
                                                                                  
                                                                                  
                                                                                  2,888,556
                                                                                  
                                                                                  
                                                                                  
                                                                                  18,098,555
                                                                                  
                                                                                  
                                                                                  
                                                                                  7,001,301Income
      (loss) from discontinued operation, net of tax
                                                                                  
                                                                                  
                                                                                  (18,738
                                                                                  )
                                                                                  
                                                                                  
                                                                                  92,021
                                                                                  
                                                                                  
                                                                                  
                                                                                  54,619
                                                                                  
                                                                                  
                                                                                  
                                                                                  117,887Net
      income
                                                                                  
                                                                                  
                                                                                  5,885,423
                                                                                  
                                                                                  
                                                                                  
                                                                                  2,980,577
                                                                                  
                                                                                  
                                                                                  
                                                                                  18,153,174
                                                                                  
                                                                                  
                                                                                  
                                                                                  7,119,188Deduct
      dividends on Series A Preferred Stock:Preferred
      stock dividend
                                                                                  
                                                                                  
                                                                                  (20,235
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  (1,209,702
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -Relative
      fair value of detachable warrants issued
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  (2,765,946
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -Preferred
      stock beneficial conversion feature
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  (2,451,446
                                                                                  )
                                                                                  
                                                                                  
                                                                                  -Income
      applicable to common stockholders
                                                                                  
                                                                                  $
                                                                                  5,865,188
                                                                                  
                                                                                  
                                                                                  $
                                                                                  2,980,577
                                                                                  
                                                                                  
                                                                                  $
                                                                                  11,726,080
                                                                                  
                                                                                  
                                                                                  $
                                                                                  7,119,188Basic
      and diluted income per common share afterdeduction
                                                                                    in
      the first quarter of 2008, of noncash deemed dividends
                                                                                    attributable
      to Series A Preferred Stock as described in
                                                                                    Notes
      3 & 11 of the Notes to the unaudited consolidated financial
      statements:Basic
                                                                                  
                                                                                  $
                                                                                  0.25
                                                                                  
                                                                                  
                                                                                  $
                                                                                  0.18
                                                                                  
                                                                                  
                                                                                  $
                                                                                  0.52
                                                                                  
                                                                                  
                                                                                  $
                                                                                  0.49Diluted
                                                                                  
                                                                                  $
                                                                                  0.23
                                                                                  
                                                                                  
                                                                                  $
                                                                                  0.16
                                                                                  
                                                                                  
                                                                                  $
                                                                                  0.48
                                                                                  
                                                                                  
                                                                                  $
                                                                                  0.44Basic
      weighted average common shares outstanding
                                                                                  
                                                                                  
                                                                                  23,522,179
                                                                                  
                                                                                  
                                                                                  
                                                                                  16,339,868
                                                                                  
                                                                                  
                                                                                  
                                                                                  22,403,054
                                                                                  
                                                                                  
                                                                                  
                                                                                  14,431,869Diluted
      weighted average common shares outstanding
                                                                                  
                                                                                  
                                                                                  25,661,353
                                                                                  
                                                                                  
                                                                                  
                                                                                  18,241,143
                                                                                  
                                                                                  
                                                                                  
                                                                                  24,687,015
                                                                                  
                                                                                  
                                                                                  
                                                                                  16,106,921





See notes
to unaudited consolidated financial statements





- 3
-
 Index





CHINA
DIRECT, INC. AND SUBSIDIARIES


CONSOLIDATED
STATEMENTS OF CASH FLOWS


(Unaudited)







For
      the Nine MonthsEnded
      September 30,2008
                                                                  
                                                                  
                                                                  2007Cash
      flows from operating activities:Net
      income
                                                                  
                                                                  $
                                                                  18,153,174
                                                                  
                                                                  
                                                                  $
                                                                  7,119,188Adjustments
      to reconcile net income to net cash (used in) provided by operating
      activities:Depreciation
                                                                  
                                                                  
                                                                  1,283,319
                                                                  
                                                                  
                                                                  
                                                                  112,216Bad
      debt recovery
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  (102,005
                                                                  )Stock
      based compensation
                                                                  
                                                                  
                                                                  1,672,263
                                                                  
                                                                  
                                                                  
                                                                  576,557Realized
      loss (gain) on investment in marketable securities
                                                                  
                                                                  
                                                                  35,705
                                                                  
                                                                  
                                                                  
                                                                  (700,841
                                                                  )Realized
      loss on investment in marketable securities-related party
                                                                  
                                                                  
                                                                  2,400
                                                                  
                                                                  
                                                                  
                                                                  41,885Fair
      value of securities received for services
                                                                  
                                                                  
                                                                  (10,300,138
                                                                  )
                                                                  
                                                                  
                                                                  (4,362,275
                                                                  )Minority
      interest
                                                                  
                                                                  
                                                                  11,020,471
                                                                  
                                                                  
                                                                  
                                                                  1,745,197Changes
      in operating assets and liabilities:Prepaid
      expenses and other current assets
                                                                  
                                                                  
                                                                  (5,609,520
                                                                  )
                                                                  
                                                                  
                                                                  (9,082,939
                                                                  )Prepaid
      expenses-related parties
                                                                  
                                                                  
                                                                  (5,269,762
                                                                  )
                                                                  
                                                                  
                                                                  (1,423,766
                                                                  )Inventories
                                                                  
                                                                  
                                                                  (10,146,484
                                                                  )
                                                                  
                                                                  
                                                                  2,079,260Accounts
      receivable
                                                                  
                                                                  
                                                                  (7,932,422
                                                                  )
                                                                  
                                                                  
                                                                  (7,018,584
                                                                  )Accounts
      receivable-related parties
                                                                  
                                                                  
                                                                  1,533,181
                                                                  
                                                                  
                                                                  
                                                                  (140,777
                                                                  )Accounts
      payable and accrued expenses
                                                                  
                                                                  
                                                                  1,054,337
                                                                  
                                                                  
                                                                  
                                                                  2,826,854Accounts
      payable-related party
                                                                  
                                                                  
                                                                  2,321,640
                                                                  
                                                                  
                                                                  
                                                                  2,232,636Advances
      from customers
                                                                  
                                                                  
                                                                  (43,719
                                                                  )
                                                                  
                                                                  
                                                                  1,275,847Other
      payables
                                                                  
                                                                  
                                                                  855,029
                                                                  
                                                                  
                                                                  
                                                                  (106,994
                                                                  )Deferred
      income taxes
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  (72,346
                                                                  )Income
      taxes payable
                                                                  
                                                                  
                                                                  452,148
                                                                  
                                                                  
                                                                  
                                                                  (448,164
                                                                  )Net
      cash used in continuing activities
                                                                  
                                                                  
                                                                  (918,378
                                                                  )
                                                                  
                                                                  
                                                                  (5,449,051
                                                                  )Net
      cash provided by (used in) discontinued operations
                                                                  
                                                                  
                                                                  735,367
                                                                  
                                                                  
                                                                  
                                                                  (765,495
                                                                  )Net
      cash used in operating activities
                                                                  
                                                                  
                                                                  (183,011
                                                                  )
                                                                  
                                                                  
                                                                  (6,214,546
                                                                  )Cash
      flows from investing activities:Cash
      acquired from acquisitions
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  2,229,742Decrease
      (increase) in notes receivable
                                                                  
                                                                  
                                                                  937,843
                                                                  
                                                                  
                                                                  
                                                                  (71,581
                                                                  )Increase
      in loans receivable
                                                                  
                                                                  
                                                                  (1,531,138
                                                                  )
                                                                  
                                                                  
                                                                  -Increase
      in loans receivable-related parties
                                                                  
                                                                  
                                                                  (1,525,114
                                                                  )
                                                                  
                                                                  
                                                                  -Proceeds
      from the sale of marketable securities available for sale
                                                                  
                                                                  
                                                                  432,395
                                                                  
                                                                  
                                                                  
                                                                  1,887,735Purchases
      of property, plant and equipment
                                                                  
                                                                  
                                                                  (11,243,330
                                                                  )
                                                                  
                                                                  
                                                                  (1,411,740
                                                                  )Net
      cash (used in) provided by investing activities
                                                                  
                                                                  
                                                                  (12,929,344
                                                                  )
                                                                  
                                                                  
                                                                  2,634,156Cash
      flows from financing activities:Decrease
      (increase) in restricted cash
                                                                  
                                                                  
                                                                  645,550
                                                                  
                                                                  
                                                                  
                                                                  (160,634
                                                                  )Proceeds
      from loans payable
                                                                  
                                                                  
                                                                  2,147,997
                                                                  
                                                                  
                                                                  
                                                                  1,558,528Payment
      of loans payable
                                                                  
                                                                  
                                                                  (2,866,238
                                                                  )
                                                                  
                                                                  
                                                                  (22,793
                                                                  )Payment
      of notes payable
                                                                  
                                                                  
                                                                  (592,007
                                                                  )
                                                                  
                                                                  
                                                                  -Payment
      of notes payable-related party
                                                                  
                                                                  
                                                                  (410,167
                                                                  )
                                                                  
                                                                  
                                                                  -Payment
      of advances from executive officers
                                                                  
                                                                  
                                                                  -
                                                                  
                                                                  
                                                                  
                                                                  (140,893
                                                                  )Due
      from related parties
                                                                  
                                                                  
                                                                  1,273,289
                                                                  
                                                                  
                                                                  
                                                                  369,900Due
      to related parties
                                                                  
                                                                  
                                                                  (2,402,237
                                                                  )Gross
      proceeds from sale of preferred stock
                                                                  
                                                                  
                                                                  12,950,000
                                                                  
                                                                  
                                                                  
                                                                  -Proceeds
      from exercise of warrants/options
                                                                  
                                                                  
                                                                  2,982,376
                                                                  
                                                                  
                                                                  
                                                                  14,908,028Cash
      payment for stock split/forward and stock buy-back
                                                                  
                                                                  
                                                                  (41,438
                                                                  )Cash
      dividend payment to preferred stock holders
                                                                  
                                                                  
                                                                  (141,530
                                                                  )Offering
      expenses
                                                                  
                                                                  
                                                                  (1,504,345
                                                                  )
                                                                  
                                                                  
                                                                  -Net
      cash provided by financing activities
                                                                  
                                                                  
                                                                  12,041,250
                                                                  
                                                                  
                                                                  
                                                                  16,512,136EFFECT
      OF EXCHANGE RATE ON CASH
                                                                  
                                                                  
                                                                  1,683,363
                                                                  
                                                                  
                                                                  
                                                                  235,355Net
      increase in cash
                                                                  
                                                                  
                                                                  612,258
                                                                  
                                                                  
                                                                  
                                                                  13,167,101Cash,
      beginning of year
                                                                  
                                                                  
                                                                  19,024,604
                                                                  
                                                                  
                                                                  
                                                                  3,030,345Cash,
      end of period
                                                                  
                                                                  $
                                                                  19,636,862
                                                                  
                                                                  
                                                                  $
                                                                  16,197,446Supplemental
      disclosures of cash flow information:Cash
      paid for taxes
                                                                  
                                                                  $
                                                                  250,059
                                                                  
                                                                  
                                                                  $
                                                                  626,995Cash
      paid for interest
                                                                  
                                                                  $
                                                                  187,188
                                                                  
                                                                  
                                                                  $
                                                                  5,936Dividend
      payment in stock to preferred stock shareholders
                                                                  
                                                                  $
                                                                  1,047,937
                                                                  
                                                                  
                                                                  $
                                                                  -Non-cash
      preferred stock deemed dividend
                                                                  
                                                                  $
                                                                  5,217,392
                                                                  
                                                                  
                                                                  $
                                                                  -See
      notes to unaudited consolidated financial statements




- 4
-
 Index
 CHINA
DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS
 SEPTEMBER
30, 2008








NOTE
1 - ORGANIZATION AND DESCRIPTION OF BUSINESS





Business
and Organization





China
Direct, Inc., a Florida corporation and its subsidiaries are referred to in this
report as the “Company”, “we”, “us”, “our”, or “China Direct”.





We are a
management and advisory services organization, which owns and consults with
business entities operating in the People’s Republic of China (“PRC”). China
Direct operates in two primary divisions: (i) Management Services and (ii)
Advisory Services. Our Management Services division acquires controlling
interests of Chinese business entities which we consolidate as either our wholly
or majority owned subsidiaries. Through this ownership control, we provide
management advice as well as investment capital. We refer to these subsidiaries
as our portfolio companies. Our Advisory Services division provides consulting
services to Chinese entities seeking access to the U.S. capital markets. We
currently have service contracts with various clients who conduct business
within China or seek to conduct business in China. We refer to these companies
as client companies.





Our
primary, but not exclusive, method of acquiring a portfolio company in the PRC
is to create a foreign invested entity (“FIE”), or a joint venture entity
(“JV”). Generally, to create a FIE or a JV, an application is made to the local
PRC government to increase the registered capital of a Chinese domestic company.
The Chinese domestic company will contribute assets and we will contribute
investment capital. When a new FIE or JV is created, our ownership is determined
by the value of our capital contribution as compared to the new total registered
capital amount, giving effect to the value of assets contributed. Our
investments in the PRC adhere to the rules and regulations governing foreign
investment in China and we obtain all relevant and necessary governmental
approvals and business licenses.





NOTE
2 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING
POLICIES





Basis
of Presentation





Our
unaudited consolidated financial statements have been prepared in accordance
with U.S. generally accepted accounting principles for interim financial
information and pursuant to the requirements for reporting on Form 10-Q.
Accordingly, they do not include all the information and footnotes required by
U.S. generally accepted accounting principles for annual financial statements.
However, the information included in these interim financial statements reflects
all adjustments (consisting solely of normal recurring adjustments) which are,
in the opinion of management, necessary for the fair presentation of the
consolidated financial position and the consolidated results of operations.
Results shown for interim periods are not necessarily indicative of the results
to be obtained for a full year. The consolidated balance sheet information as of
December 31, 2007 was derived from the audited consolidated financial
statements included in our Annual Report on Form 10-K for the year ended
December 31, 2007. These interim financial statements should be read in
conjunction with our Form 10-K for the year ended December 31, 2007. Certain
reclassifications have been made to prior year amounts to conform to the current
year presentation and to disclose our reclassification of discontinued
operations.





During
the third quarter of 2008, we elected to exit the alternative energy and
recycling business conducted by CDI Clean Technology Group, Inc. (“CDI Clean
Technology”). Included as part of the sale of CDI Clean Technology are: (i)
Shandong CDI Wanda New Energy Co., Ltd., a Chinese limited liability company, a
51% majority owned subsidiary of CDI Clean Technology (“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, accordingly no loss was
recognized during the nine months ended September 30, 2008.





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.





- 5
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




As
disclosed in earlier filings, on April 26, 2008 CDI China entered into an
Investment Framework Agreement to form Baotou Xinjin Magnesium Co., Ltd., a
Chinese limited liability company (“Xinjin Magnesium”) to jointly invest and
increase the registered capital thereby forming an FIE. During the quarter ended
September 2008, we elected not to pursue this venture. We did not
contribute any capital to Xinjin Magnesium.





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. CDI Metal Recycling will
recycle aluminum wire into aluminum powder. CDI Metal Recycling expects to
commence operations in 2009.





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 Chinese limited liability company as a FIE. Prior to September 30,
2008 CDI China contributed approximately $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. We own a
70.9% interest in Baotou Changxin Magnesium based on our 51% ownership interest
through our wholly owned subsidiary CDI China and a 19.9% ownership interest
through our 51% ownership interest in Excel Rise.





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. CDI Beijing is engaged in the sale and distribution of
steel, non ferrous metals and lumber products in China. Under the terms of the
agreement, the initial registered investment amount of CDI Beijing is $7.27
million; $3.57 million and $3.7 million to be contributed by Mr. Chen and
CDI Shanghai Management Mr. Chen and CDI Shanghai Management respectively, in
installments on or before September 2009.  On August 28, 2008, we
contributed $750,000 while Mr. Chen made his capital contribution of
$720,000.  As of the date of this report, CDI Shanghai Management has
a commitment to contribute an additional $2.95 million to CDI Beijing by March
31, 2009.





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 include the allowance for
doubtful accounts of accounts receivable, certain assumptions underlying the
calculation of stock-based compensation, investments in marketable securities
available for sale, assets and liabilities held for sale and the useful life of
property, plant and equipment.





Cash
and Cash Equivalents





For
purposes of the consolidated statements of cash flows, we consider all highly
liquid investments with original maturities of three months or less to be cash
equivalents. The carrying value 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, 2008, bank deposits in the United States exceeded federally
insured limits by $130,068. At September 30, 2008, we had deposits of
$12,131,796 in banks in China. Our deposits in China are not insured as there is
no equivalent of the FDIC as in the United States. We have not experienced any
losses in such bank accounts through September 30, 2008.





At
September 30, 2008 and December 31, 2007, bank deposits, (reclassified
to reflect discontinued operations), by geographic area were as
follows:





Country
                                                                                                                        
                                                                                                                        September
      30, 2008
                                                                                                                        
                                                                                                                        
                                                                                                                        December
      31, 2007United
      States
                                                                                                                        
                                                                                                                        $
                                                                                                                        7,505,066
                                                                                                                        
                                                                                                                        38
                                                                                                                        %
                                                                                                                        
                                                                                                                        $
                                                                                                                        9,942,948
                                                                                                                        
                                                                                                                        52
                                                                                                                        %China
                                                                                                                        
                                                                                                                        
                                                                                                                        12,131,796
                                                                                                                        
                                                                                                                        62
                                                                                                                        %
                                                                                                                        
                                                                                                                        
                                                                                                                        9,081,656
                                                                                                                        
                                                                                                                        48
                                                                                                                        %Total
      cash and cash equivalents
                                                                                                                        
                                                                                                                        $
                                                                                                                        19,636,862
                                                                                                                        
                                                                                                                        100
                                                                                                                        %
                                                                                                                        
                                                                                                                        $
                                                                                                                        19,024,604
                                                                                                                        
                                                                                                                        100
                                                                                                                        %





In
addition, at December 31, 2007, we held an additional $1,370,327 in China which
has been reclassified as “Subsidiaries held for sale” at September 30,
2008.





- 6
-
 Index
  CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




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.





Marketable
securities available for sale at September 30, 2008 and December 31, 2007
consist of the following:





Client
      Name
                                                                                      
                                                                                      September
      30, 2008
                                                                                      
                                                                                      
                                                                                      December
      31, 2007China
      America Holdings, Inc.
                                                                                      
                                                                                      $
                                                                                      589,810
                                                                                      
                                                                                      7
                                                                                      %
                                                                                      
                                                                                      $
                                                                                      1,828,481
                                                                                      
                                                                                      23
                                                                                      %China
      Logistics Group, Inc. (“China Logistics”)
                                                                                      
                                                                                      
                                                                                      4,085,215
                                                                                      
                                                                                      48
                                                                                      %
                                                                                      
                                                                                      
                                                                                      4,042,500
                                                                                      
                                                                                      52
                                                                                      %Dragon
      International Group Corp.
                                                                                      
                                                                                      
                                                                                      953,123
                                                                                      
                                                                                      11
                                                                                      %
                                                                                      
                                                                                      
                                                                                      1,171,844
                                                                                      
                                                                                      15
                                                                                      %China
      Armco Metals, Inc.
                                                                                      
                                                                                      
                                                                                      2,798,822
                                                                                      
                                                                                      33
                                                                                      %Other
                                                                                      
                                                                                      
                                                                                      132,249
                                                                                      
                                                                                      1
                                                                                      %
                                                                                      
                                                                                      
                                                                                      777,675
                                                                                      
                                                                                      10
                                                                                      %Total
      marketable securities available for sale
                                                                                      
                                                                                      $
                                                                                      8,559,219
                                                                                      
                                                                                      100
                                                                                      %
                                                                                      
                                                                                      $
                                                                                      7,820,500
                                                                                      
                                                                                      100
                                                                                      %





We
categorize securities as investment in marketable securities available for sale
and investment in marketable securities available for sale-related party. The
securities of China Logistics we own are restricted securities and cannot be
readily resold by us absent a registration of those securities under the
Securities Act of 1933 (the “Securities Act”) or the availability of an
exemption from the registration requirements under the Securities Act. The
exemption from registration under Rule 144 of the Securities Act is not
available because China Logistics is deemed not to be current in its filings
with the SEC as a result of its need to restate its financial statements for the
year ended December 31, 2007, the three months ended March 31, 2008 and the six
months ended June 30, 2008.





The
securities of one client, Dragon Capital Group Corp. (“Dragon Capital”),
accounted for all investment in marketable securities available for sale-related
party and totaled $209,351 and $1,315,488 at September 30, 2008 and December 31,
2007, respectively. Dragon Capital is a related party. Mr. Lisheng
(Lawrence) Wang, the CEO and Chairman of the Board of Dragon Capital, is the
brother of Dr. James Wang, CEO and Chairman of China Direct. These securities
were issued by Dragon Capital as compensation for consulting services. Dragon
Capital is a non-reporting company whose securities are quoted on the Pink
Sheets, and as such, under Federal securities laws, securities of Dragon Capital
cannot be readily resold by us, generally, absent a registration of those
securities under the Securities Act. Dragon Capital does not intend to register
the securities.





Accordingly,
while under generally accepted accounting principles we are required to reflect
the fair market value of our holdings in China Logistics and Dragon Capital,
they are not readily convertible into cash and we may never realize the carrying
value of these securities.





At
September 30, 2008 our consolidated balance sheet includes accounts
receivable-related party of $558,044 and $192,375 due from Taiyuan YiWei
Magnesium Industry Co., Ltd. to Chang Magnesium and Golden Magnesium,
respectively. The $558,044 resulted from sales generated during the nine
months ended September 30, 2008 of residual scrap products created during
the manufacturing process, which are outside the ordinary course of business for
our Magnesium segment. These amounts reflect payment, which had not yet been
collected as of September 30, 2008. Yuwei Huang, CEO and Chairman of Chang
Magnesium, Chairman of Baotou Changxin Magnesium, and CEO and Vice Chairman of
Golden Magnesium, is the Chairman of Taiyuan YiWei Magnesium Industry Co., Ltd.,
a Chinese limited liability company (“YiWei Magnesium”).





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, 2008 and December 31, 2007,
allowances for doubtful accounts were $278,363 and $290,456,
respectively.





- 7
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




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,
2008 and December 31, 2007 totaled $15,416,872 and $5,270,388, respectively. Due
to the nature of our business and the short duration of the manufacturing
process of our products, there was no work-in-process inventory at September 30,
2008 and December 31, 2007.





Accounts
Payable-Related Parties





At
September 30, 2008 our consolidated balance sheet reflects accounts
payable-related party of $3,285,754, which is comprised of $2,186,773, $34,823,
and $738,381 due YiWei Magnesium for the purchase of inventory by Chang
Magnesium, Baotou Changxin Magnesium and Golden Magnesium, respectively, and
$325,777 due to Shanxi Senrun Coal Chemistry Co., Ltd., from Golden
Magnesium. At December 31, 2007 our consolidated balance sheet reflects accounts
payable-related party of $964,114 comprised of $604,596 and $359,518 due YiWei
Magnesium for the purchase of inventory by Chang Magnesium and Golden Magnesium,
respectively.





Shanxi
Senrun Coal Chemistry Co., Ltd., a Chinese limited liability company, holds a
20% interest in Golden Magnesium, (“Senrun Coal”).





Fair
Value of Financial Instruments





As of
January 1, 2008, we adopted on a prospective basis certain required provisions
of Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value
Measurements, as amended by Financial Accounting Standards Board (FASB)
Financial Staff Position (FSP) No. 157-2, on the effective date of FASB
Statement No. 157. Those provisions relate to our financial assets and
liabilities carried at fair value and our fair value disclosures related to
financial assets and liabilities. SFAS 157 defines fair value, expands related
disclosure requirements and specifies a hierarchy of valuation techniques based
on the nature of the inputs used to develop the fair value measures. Fair value
is defined as the price that would be received to sell an asset or paid to
transfer a liability in an orderly transaction between market participants at
the measurement date. There are three levels of inputs to fair value
measurements - Level 1, meaning the use of quoted prices for identical
instruments in active markets; Level 2, meaning the use of quoted prices for
similar instruments in active markets or quoted prices for identical or similar
instruments in markets that are not active or are directly or indirectly
observable; and Level 3, meaning the use of unobservable inputs. Observable
market data should be used when available.





Most, but
not all, of our financial instruments are carried at fair value, including, all
of our cash equivalents, investments classified as available for sale securities
and assets held for sale and are carried at fair value, with unrealized gains
and losses, net of tax. Virtually all of our valuation measurements are Level 1
measurements. The adoption of SFAS 157 did not have a significant impact on our
consolidated financial statements.





Marketable
Securities





Through
our Advisory Services division, we receive securities which include common stock
and common stock purchase warrants from client companies as compensation for
consulting services. We classify these securities as investments in marketable
securities available for sale or investment in marketable securities available
for sale-related party. These securities are stated at their fair value in
accordance with SFAS No. 115 “Accounting for Certain Investments
in Debt and Equity Securities ”, and EITF 00-8 “Accounting by a Grantee for an
Equity Instrument to be Received in Conjunction with Providing Goods or
Services ”. Unrealized gains or losses in investments in marketable
securities available for sale are recognized as an element of other
comprehensive income on a monthly basis based on fluctuations in the fair value
of the security as quoted on an exchange or an inter-dealer quotation system.
Realized gains or losses are recognized in the consolidated statements of
operations when the securities are liquidated.





To date,
all securities (exclusive of preferred stock and warrants) received from our
client companies as compensation are quoted either on the Over the Counter
Bulletin Board or the Pink Sheets. The securities are typically restricted as to
resale. Our policy is to liquidate securities received as compensation when
market conditions are favorable for sale. As these securities are often
restricted, we are unable to liquidate these securities until the restriction is
removed. We recognize revenue for common stock based on the fair value at the
time common stock is granted and for common stock purchase warrants based on the
Black-Scholes valuation model. Unrealized gains or losses on marketable
securities available for sale and on marketable securities available for
sale-related party are recognized as an element of comprehensive income on a
monthly basis based on changes in the fair value of the security as quoted on an
exchange or an inter-dealer quotation system. Once liquidated, realized gains or
losses on the sale of marketable securities available for sale and marketable
securities available for sale-related party are reflected in our net income for
the period in which the security was liquidated.





- 8
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




Other-than-temporary
impairment of securities are evaluated periodically to determine whether a
decline in their value is other than temporary. Management utilizes criteria
such as the magnitude and duration of the decline, in addition to the reasons
underlying the decline, to determine whether the loss in value is other than
temporary. The term “other-than-temporary” is not intended to indicate that the
decline is permanent. It indicates that the prospects for a near term recovery
of value are not necessarily favorable, or that there is a lack of evidence to
support fair values equal to, or greater than, the carrying value of the
investment. Once a decline in value is determined to be other than temporary,
the value of the security is reduced and a corresponding impairment charge to
earnings is recognized.





The
unrealized loss on marketable securities available for sale, net of the effect
of taxes, for the three months ended September 30, 2008 and 2007 was $6,323,015
and $763,053, respectively. The unrealized loss on marketable securities
available for sale-related party, net of the effect of taxes, for the three
months ended September 30, 2008 and 2007 was $641,139 and $467,269
respectively.





The
unrealized loss on marketable securities available for sale, net of the effect
of taxes, for the nine months ended September 30, 2008 and 2007 was $9,097,319
and $1,322,277, respectively. The unrealized loss on marketable securities
available for sale-related party, net of the effect of taxes, for the nine
months ended September 30, 2008 and 2007 was $1,099,737 and $1,023,351
respectively.





The
realized (loss) gain on investments in marketable securities available for sale
for the three months ended September 30, 2008 and 2007 was $0 and $494,605,
respectively. The net realized loss on the sale of marketable securities
available for sale-related party for the three months ended September 30, 2008
and 2007 was $2,400 and $9,871, respectively.





The
realized (loss) gain on investments in marketable securities available for sale
for the nine months ended September 30, 2008 and 2007 was ($35,705) and
$700,841, respectively. Net realized loss on the sale of marketable securities
available for sale-related party for the nine months ended September 30, 2008
and 2007 was $2,400 and $41,885, respectively.





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,
2008 and December 31, 2007 our consolidated balance sheets include prepaid
expenses and other current assets of $21,301,463 and $13,951,918,
respectively.





Prepaid
expenses-related parties were $9,420,705 and $4,150,943, at September 30, 2008
and December 31, 2007, respectively. Chang Magnesium and Golden Magnesium
advanced $4,391,173 and $28,497, respectively to YiWei Magnesium for the future
delivery of inventory which has not yet been received. Golden Magnesium advanced
$1,568,221 to Senrun Coal for the future supply of gas, which had not yet
been provided. Pan Asia Magnesium advanced $1,682,292 to Shanxi Jinyang Coal and
Coke Group Co., Ltd., for the future supply of gas, which had not yet been
provided. The gas to be provided will be utilized in future periods as energy to
fuel our magnesium production facilities. Baotou Changxin Magnesium advanced
Youbing Yang, a member of its board of directors, $1,750,522 for its purchase of
a magnesium facility. This amount is classified as “other
receivable-related party” as the transaction is pending as of the report
date.  Upon completion of a final agreement, this amount will be
reclassified as a fixed asset.





Non-current
prepaid expenses and other assets consist of (i) the fair value of the
securities of our client companies assigned to executive officers and employees
as compensation for services to be rendered over the term of the respective
consulting agreement which will be amortized beyond the twelve month period, and
(ii) other assets acquired in connection with the acquisition of Pan Asia
Magnesium. Accordingly, non-current prepaid
expenses totaled $229,058 and $433,075 at September 30, 2008 and December 31,
2007, respectively.





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 Index
  CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




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 SFAS No. 141. In each of our acquisitions for the periods
presented, we determined that fair values were equivalent to the acquired
historical carrying costs.





Advances
from Customers and Deferred Revenues





Advances
from customers represent (i) prepayments to us for merchandise that had not yet
been shipped to customers of $5,155,244, and (ii) the fair value of securities
received as compensation which will be amortized over the term of the respective
consulting agreement totaled $1,692,825. 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 $6,848,069 and $6,891,788 at September 30, 2008 and December
31, 2007 (reclassified to reflect discontinued operation),
respectively.





Comprehensive
Income





We follow
Statement of Financial Accounting Standards No. 130 (SFAS 130) “Reporting Comprehensive
Income” to recognize the elements of comprehensive income. Comprehensive
income is comprised of net income and all changes to the statements of
stockholders’ equity, except those due to investments by stockholders, changes
in paid-in capital and distributions to stockholders. Comprehensive income for
the nine months ended September 30, 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.





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 three and nine month periods ended September
30, 2008 and September 30, 2007. A summary of the conversion rates for the
periods presented is as follows:





September
      30,2008
                                    
                                    2007Quarter
      end RMB : U.S. Dollar exchange rate
                                    
                                    
                                    6.8551
                                    
                                    7.5176Average
      year-to-date RMB : U.S. Dollar exchange rate
                                    
                                    
                                    6.9989
                                    
                                    7.6758





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.





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 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




Impairment
of Long-Lived Assets





In
accordance with SFAS No. 144, “Accounting for the Impairment or
Disposal of Long-Lived Assets”, we periodically review our long-lived
assets for impairment whenever events or changes in circumstances indicate that
the carrying amount of the assets may not be fully recoverable. We recognize an
impairment loss when the sum of expected undiscounted future cash flows is less
than the carrying amount of the asset. The amount of impairment is measured as
the difference between the estimated fair value and the book value of the
underlying asset. We did not record any impairment charges during the nine
months ended September 30, 2008 or 2007.





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. See Note 14, “Subsidiaries Held
for Sale,” for further information.





Minority
Interest





Under
generally accepted accounting principles when losses applicable to the minority
interest in a subsidiary exceed the minority interest in the equity capital of
the subsidiary, the excess is not charged to the majority interest since there
is no obligation of the minority interest to make good on such losses. We,
therefore, absorbed all losses applicable to a minority interest where
applicable. If future earnings do materialize, we shall be credited to the
extent of such losses previously absorbed.





Income
Taxes





We
accounted for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”.
SFAS No. 109 requires the recognition of deferred tax assets and
liabilities to reflect the future tax consequences of events that have been
recognized in our financial statements or tax returns. Measurement of the
deferred items is based on enacted tax laws. In the event the future
consequences of differences between the financial reporting and tax basis of our
assets and liabilities result in a deferred tax asset, SFAS No. 109
requires an evaluation of the probability of our being able to realize the
future benefits indicated by such assets. A valuation allowance related to a
deferred tax asset is recorded when it is more likely than not that some or the
entire deferred tax asset will not be realized.





Basic
and Diluted Earnings per Share





Basic
income per common share is computed by dividing income available to common
shareholders by the weighted average number of shares of common stock
outstanding for the periods presented. Diluted income per share reflects the
potential dilution that could occur if securities were exercised or converted
into common stock or other contracts to issue common stock resulted in the
issuance of common stock that would then share in our income, subject to
anti-dilution limitations.





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 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




Revenue
Recognition





We follow the guidance of the
Securities and Exchange Commission's Staff Accounting Bulletin (“SAB”) No. 104
and SAB Topic 13 for revenue recognition. In general, we record revenue when
persuasive evidence of an arrangement exists, services have been rendered or
product delivery has occurred, the sales price to the customer is fixed or
determinable, and collectability is reasonably assured.





Stock
Based Compensation





We
account for the grant of stock options and restricted stock awards in accordance
with SFAS 123R, “Share-Based
Payment, an Amendment of FASB Statement No. 123” (“SFAS 123R”). SFAS 123R
requires companies to recognize in the statement of operations the grant-date
fair value of stock options and other equity based compensation.





Recent
Pronouncements





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities-including an amendment of FAS 115 ”.
SFAS 159 allows entities to choose, at specified election dates, to measure
eligible financial assets and liabilities at fair value that are not otherwise
required to be measured at fair value. If a company elects the fair value option
for an eligible item, changes in that item’s fair value in subsequent reporting
periods must be recognized in current earnings. SFAS 159 is effective for fiscal
years beginning after November 15, 2007. SFAS 159 had no impact on our financial
statements as of September 30, 2008, and we will continue to evaluate the
impact, if any, of SFAS 159 on our financial statements.





In
December 2007, the FASB issued SFAS 141 (revised 2007), “Business Combinations”. SFAS
141R is a revision to SFAS 141 and includes substantial changes to the
acquisition method used to account for business combinations (formerly the
“purchase accounting” method), including broadening the definition of a
business, as well as revisions to accounting methods for contingent
consideration and other contingencies related to the acquired business,
accounting for transaction costs, and accounting for adjustments to provisional
amounts recorded in connection with acquisitions. SFAS 141R retains the
fundamental requirement of SFAS 141 that the acquisition method of accounting be
used for all business combinations and for an acquirer to be identified for each
business combination. SFAS 141R is effective for periods beginning on or after
December 15, 2008, and will apply to all business combinations occurring after
the effective date. We are currently evaluating the requirements of SFAS 141R
and the impact of adoption on our consolidated financial
statements.





In
December 2007, the FASB issued SFAS 160, “Non-controlling Interests in
Consolidated Financial Statements - an amendment of Accounting Research Bulletin
No. 51, Consolidated Financial Statements ” (“ARB 51”). This Statement
amends ARB 51 to establish new standards that will govern the (1) accounting for
and reporting of non-controlling interests in partially owned consolidated
subsidiaries and (2) the loss of control of subsidiaries. A non-controlling
interest will be reported as part of equity in the consolidated financial
statements. Losses will be allocated to the non-controlling interest, and, if
control is maintained, changes in ownership interests will be treated as equity
transactions. Upon a loss of control, any gain or loss on the interest sold will
be recognized in earnings. SFAS 160 is effective for periods beginning after
December 15, 2008. We are currently evaluating the requirements of SFAS 160 and
the impact of adoption on our consolidated financial statements.





In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 is intended to
improve financial reporting about derivative instruments and hedging activities
by requiring enhanced disclosures to enable investors to better understand their
effects on an entity’s financial position, financial performance, and cash
flows. It is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, with early application
encouraged. We are currently evaluating the requirements of SFAS 161 and the
impact of adoption on our consolidated financial statements.





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 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




In May
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (“FSP”) APB 14-1,Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement). FSP APB 14-1 clarifies
that convertible debt instruments that may be settled in cash upon either
mandatory or optional conversion (including partial cash settlement) are not
addressed by paragraph 12 of APB Opinion No. 14,Accounting for Convertible Debt and
Debt issued with Stock Purchase Warrants. Additionally, FSP APB 14-1
specifies that issuers of such instruments should separately account for the
liability and equity components in a manner that will reflect the entity’s
nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. FSP APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. We will adopt FSP APB 14-1 beginning in the first quarter of
fiscal 2009, and this standard must be applied on a retrospective basis. We are
evaluating the impact the adoption of FSP APB 14-1 will have on our consolidated
financial position and results of operations.





In May
2008, the FASB issued SFAS No. 162,The Hierarchy of Generally Accepted
Accounting Principles. This standard is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting
accounting principles to be used in preparing financial statements that are
presented in conformity with generally accepted accounting principles in the
United States for non-governmental entities. SFAS No. 162 is effective 60 days
following approval by the U.S. Securities and Exchange Commission (“SEC”) of the
Public Company Accounting Oversight Board’s amendments to AU Section 411,The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting Principles. We do not
expect SFAS No. 162 to have a material impact on the preparation of our
consolidated financial statements.





On
September 16, 2008, the FASB issued FSP No. EITF 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities”
to address the question of whether instruments granted in share-based payment
transactions are participating securities prior to vesting. The FSP determines
that unvested share-based payment awards that contain rights to dividend
payments should be included in earnings per share calculations. The guidance
will be effective for fiscal years beginning after December 15, 2008. We are
currently evaluating the requirements of FSP No. EITF 03-6-1.





On
October 10, 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active.This FASB
Staff Position (FSP) clarifies the application of FASB Statement No. 157, Fair Value Measurements(“Statement 157”), in a
market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset under those
circumstances. Statement 157 was issued in September 2006, and is effective for
financial assets and financial liabilities for financial statements issued for
fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. We have adopted FSP 157-3 and determined that it had no
impact as of September 30, 2008 on our financial statements, and we will
continue to evaluate the impact, if any, of FSP 157-3 on our financial
statements.





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 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




NOTE
3 - EARNINGS (LOSSES) PER SHARE





Under the
provisions of SFAS 128, “Earnings Per Share”, basic
income (loss) per common share is computed by dividing income (loss) available
to common shareholders by the weighted average number of shares of common stock
outstanding for the periods presented. Diluted income (loss) per share reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that would then share in the income of the company,
subject to anti-dilution limitations.





Three
      Months Ended September 30,2008
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            Per
      Share
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            2007
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            Per
      ShareNumerator:Income
      from continuing operations
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            5,904,161
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.25
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            2,888,556
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.18Income
      (loss) from discontinued operations, net of tax
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            (18,738)
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.00
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            92,021
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.00Series
      A preferred stock:Preferred
      stock dividend
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            (20,235
                                                                                                                                            )
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.00
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -Relative
      fair value of detachable warrants issued
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -Preferred
      stock beneficial conversion feature
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -Numerator
      for basic EPS, Income applicable to common stock holders
    (A)
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            5,865,188
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.25
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            2,980,577
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.18Plus:
      Income impact of assumed conversionsPreferred
      stock dividends - unconverted
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            20,235
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -Numerator
      for diluted EPS, Income applicable to common stock holders plus assumed
      conversions (*)(B)
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            5,885,423
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.23
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            2,980,577
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.16Denominator:Denominator
      for basic earnings per share - weighted average number of common shares
      outstanding (C)
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            23,522,179
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            16,339,868Stock
      Awards, Options, and Warrants
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            1,995,424
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            1,901,275Preferred
      stock dividends - unconverted
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            143,750
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -Denominator
      for diluted earnings per share - adjusted weighted average outstanding
      average number of common shares outstanding (D)
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            25,661,353
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            18,241,143Basic
      and Diluted Income Per Common Share:Earnings
      per share - basic (A)/(C)
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.25
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.18Earnings
      per share - diluted (B)/(D)
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.23
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.16Nine
      Months Ended September 30,2008
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            Per
      Share
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            2007
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            Per
      ShareNumerator:Income
      from continuing operations
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            18,098,555
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.81
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            7,001,301
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            0.49Income
      (loss) from discontinued operations, net of taxes
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            54,619
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.00
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            117,887
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.00Series
      A preferred stock:Preferred
      stock dividend
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            (1,209,702
                                                                                                                                            )
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            (0.05
                                                                                                                                            )
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -Relative
      fair value of detachable warrants issued
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            (2,765,946
                                                                                                                                            )
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            (0.12
                                                                                                                                            )
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -Preferred
      stock beneficial conversion feature
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            (2,451,446
                                                                                                                                            )
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            (0.11
                                                                                                                                            )
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -Numerator
      for basic EPS, Income applicable to common stock holders
    (A)
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            11,726,080
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.52
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            7,119,188
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            0.49Plus:
      Income impact of assumed conversionsPreferred
      stock dividends - unconverted
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            51,332
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -Numerator
      for diluted EPS, Income applicable to common stock holders plus assumed
      conversions (*)(B)
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            11,777,412
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.48
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            7,119,188
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            0.44Denominator:Denominator
      for basic earnings per share - weighted average number of common shares
      outstanding (C)
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            22,403,054
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            14,431,869Stock
      Awards, Options, and Warrants
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            2,161,721
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            1,675,052Preferred
      stock dividends - unconverted
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            122,240
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            -Denominator
      for diluted earnings per share - adjusted weighted average outstanding
      average number of common shares outstanding (D)
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            24,687,015
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            $
                                                                                                                                            16,106,921Basic
      and Diluted Income Per Common Share:Earnings
      per share - basic (A)/(C)
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.52
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.49Earnings per share - diluted (B) (D)
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.48
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            
                                                                                                                                            0.44





* The
denominator in diluted earnings per share for the three months period and nine
months period ended September 30, 2008 does not include assumed shares
outstanding prior to conversion under the “if converted” method of 518,764
shares and 728,134 shares, respectively, as such inclusion would be
anti-dilutive.





- 14
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




EITF
Issue No. 03-6, “Participating
Securities and the Two-Class Method under FASB Statement No. 128” (EITF
03-6) requires companies with participating securities to calculate earnings per
share using the two-class method. Our shares of Series A Convertible Preferred
Stock are considered to be participating securities as these securities are
entitled to dividends declared on our common stock; therefore, EITF 03-6
requires the allocation of a portion of undistributed earnings to the Series A
Convertible Preferred Stock in the calculation of basic earnings per
share.





NOTE
4 - COMPREHENSIVE INCOME





Comprehensive
income is comprised of net income and other comprehensive income or loss. Other
comprehensive income or loss refers to revenue, expenses, gains and losses that
under accounting principles generally accepted in the United States are included
in comprehensive income but excluded from net income as these amounts are
recorded directly as an adjustment to stockholders’ equity.





Our other
comprehensive income consists of currency translation adjustments, unrealized
loss on marketable securities available for sale, net of taxes and unrealized
loss on marketable securities available for sale-related party, net of taxes.
The following table sets forth the computation of comprehensive income for the
nine month periods ended September 30, 2008 and 2007, respectively.








Three
      Months Ended
                                    
                                    
                                    Nine
      Months EndedSeptember
      30,
                                    
                                    
                                    September
      30,2008
                                    
                                    
                                    2007
                                    
                                    
                                    2008
                                    
                                    
                                    2007Comprehensive
      IncomeNet
      Income
                                    
                                    $
                                    5,885,423
                                    
                                    
                                    
                                    2,980,577
                                    
                                    
                                    $
                                    18,153,174
                                    
                                    
                                    
                                    7,119,188Other
      Comprehensive Income (Loss)Foreign
      currency translation gain (loss)
                                    
                                    
                                    (131,367
                                    )
                                    
                                    
                                    145,109
                                    
                                    
                                    
                                    2,975,566
                                    
                                    
                                    
                                    393,158Unrealized
      loss on marketable securities held for sale, net of income
      taxes
                                    
                                    
                                    (6,323,015
                                    )
                                    
                                    
                                    (763,053
                                    )
                                    
                                    
                                    (9,097,319
                                    )
                                    
                                    
                                    (1,322,277
                                    )Unrealized
      gain (loss) on marketable securities held for sale-related parties, net of
      income taxes
                                    
                                    
                                    (641,139
                                    )
                                    
                                    
                                    (467,269
                                    )
                                    
                                    
                                    (1,099,737
                                    )
                                    
                                    
                                    (1,023,351
                                    )Total
      Other Comprehensive Income (Loss)
                                    
                                    
                                    (7,095,521
                                    )
                                    
                                    
                                    (1,085,213
                                    )
                                    
                                    
                                    (7,221,490
                                    )
                                    
                                    
                                    (1,952,470
                                    )Total
      Comprehensive Income (Loss)
                                    
                                    $
                                    (1,210,098
                                    )
                                    
                                    $
                                    1,895,364
                                    
                                    
                                    $
                                    10,931,684
                                    
                                    
                                    $
                                    5,166,718








- 15
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 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008






NOTE
5 - INVENTORIES





At
September 30, 2008 and December 31, 2007, inventories, (reclassified to
reflect discontinued operations), consisted of the following:





September
      30, 2008 (Unaudited)
                                                          
                                                          December
      31, 2007Raw
      materials
                                                          
                                                          $
                                                          5,618,782
                                                          
                                                          
                                                          $
                                                          4,194,190Finished
      goods
                                                          
                                                          
                                                          9,798,090
                                                          
                                                          
                                                          
                                                          1,076,198Total
                                                          
                                                          $
                                                          15,416,872
                                                          
                                                          
                                                          $
                                                          5,270,388





Due to
the nature of our business and the short duration of the manufacturing process
for our products; there was no work in process inventory at September 30, 2008
and December 31, 2007.





NOTE
6 - PREPAID EXPENSES AND OTHER CURRENT ASSETS





At
September 30, 2008 and December 31, 2007, prepaid expenses and other current
assets, (reclassified to reflect discontinued operations), consist of the
following:








September
      30, 2008
                                  
                                  
                                  December
      31, 2007(unaudited)Prepayments
      to vendors
                                  
                                  $
                                  10,876,298
                                  
                                  
                                  $
                                  10,069,687Other
      receivables
                                  
                                  
                                  7,739,153
                                  
                                  
                                  
                                  3,043,193Fair
      value of client securities received for payment of services assigned to
      executive officers and employees as compensation
                                  
                                  
                                  170,775
                                  
                                  
                                  
                                  638,961Loans
      receivable
                                  
                                  
                                  1,531,138
                                  
                                  
                                  
                                  -Other
      assets acquired in connection with acquisition of Pan Asia
      Magnesium
                                  
                                  
                                  142,959
                                  
                                  
                                  
                                  138,089Tax
      refund
                                  
                                  
                                  1,026,701
                                  
                                  
                                  
                                  143,784Security
      deposits
                                  
                                  
                                  43,497
                                  
                                  
                                  
                                  351,279Total
                                  
                                  
                                  21,530,521
                                  
                                  
                                  
                                  14,384,993Less:
      Current Portion
                                  
                                  
                                  (21,301,463
                                  )
                                  
                                  
                                  (13,951,918
                                  )Prepaid
      expenses and other assets, non-current
                                  
                                  $
                                  229,058
                                  
                                  
                                  $
                                  433,075





- 16
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 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008







NOTE
7 - PROPERTY, PLANT AND EQUIPMENT





At
September 30, 2008 and December 31, 2007, property, plant and
equipment, (reclassified to reflect discontinued operations), consisted of
the following:





Useful
      Life
                                            
                                            
                                            September
      30, 2008
                                              (unaudited)
                                            
                                            
                                            December
      31, 2007Buildings
                                            
                                            10-40
      years
                                            
                                            
                                            $
                                            5,337,539
                                            
                                            
                                            $
                                            4,904,304Manufacturing
      equipment
                                            
                                            10
      years
                                            
                                            
                                            
                                            10,173,427
                                            
                                            
                                            
                                            7,099,541Office
      equipment and furniture
                                            
                                            3-5
      years
                                            
                                            
                                            
                                            639,739
                                            
                                            
                                            
                                            380,846Autos
      and trucks
                                            
                                            5
      years
                                            
                                            
                                            
                                            1,078,095
                                            
                                            
                                            
                                            468,761Construction
      in progress
                                            
                                            
                                            N/A
                                            
                                            
                                            
                                            13,181,893
                                            
                                            
                                            
                                            5,069,284Total
                                            
                                            
                                            
                                            
                                            
                                            
                                            30,410,693
                                            
                                            
                                            
                                            17,922,736Less:
      Accumulated Depreciation
                                            
                                            
                                            
                                            
                                            
                                            
                                            (1,792,566
                                            )
                                            
                                            
                                            (509,247
                                            )$
                                            28,618,127
                                            
                                            
                                            $
                                            17,413,489





For the
three and nine months ended September 30, 2008 depreciation expense totaled
$362,032 and $1,283,319, respectively. For the three and nine months ended
September 30, 2007 depreciation expense totaled $63,327 and $112,216,
respectively.





NOTE
8 - PROPERTY USE RIGHTS





Property
use rights, consisting of mining and property use rights amounted to $583,918
and $553,304 at September 30, 2008 and December 31, 2007,
respectively.





We
acquired property use rights valued at $96,078, in connection with the
acquisition of CDI Magnesium in February 2007. The property use rights provide
for the use of certain properties located in China until February 12, 2010.
We will begin to amortize the value of the property use rights when the
magnesium refinery commences operations.





In
connection with our acquisition of CDI Jixiang Metal in December 2007, we
acquired mining rights to approximately 51 acres located in the Yongshun Kaxi
Lake Mining area of China. Acquisition costs for the mining rights as of
September 30, 2008 are $487,840. 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.





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 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




Mineral
property acquisition costs, site restoration costs and development costs on
mineral properties with proven and probable reserves are capitalized and will be
depleted using the units-of-production method over the estimated life of the
reserves. If there are insufficient reserves to use as a basis for depleting
such costs, they will be written off as mineral property or mineral interest
impairment in the period in which the determination is made. Site restoration
costs are depleted over the term of their expected life. The development
potential of mining properties is established by the existence of proven and
probable reserves, reasonable assurance that the property can be permitted as an
operating mine and evidence that there are no metallurgical or other impediments
to the production of saleable metals.





Exploration
costs incurred on mineral interests, other than acquisition costs, prior to the
establishment of proven and probable reserves are charged to operations as
incurred. Development costs incurred on mineral interests with proven and
probable reserves will be capitalized as mineral properties. We regularly
evaluate our investments in mineral interests to assess the recoverability
and/or the residual value of the investments in these assets. All mineral
interests and mineral properties are reviewed for impairment whenever events or
circumstances change which indicate the carrying amount of an asset may not be
recoverable, utilizing established guidelines based upon undiscounted future net
cash flows from the asset or upon the determination that certain exploration
properties do not have sufficient potential for economic
mineralization.





The
estimates of mineral prices and operating, capital and reclamation costs, when
available, are subject to certain risks and uncertainties, which may affect the
recoverability of mineral property costs. Although we make our best estimates of
these factors, it is possible that changes could occur in the near term, which
could adversely affect the future net cash flows to be generated from our
mineral properties.





NOTE
9 - LOANS PAYABLE





Loans payable
at September 30, 2008 and December 31, 2007 consisted of the
following:




September
      30,2008
                                                                          
                                                                          
                                                                          December
      31,2007Description
                                                                          
                                                                          (Unaudited)Loan
      due to Shanxi Xinglong Foundry Co., Ltd. Due on demand. Non-interest
      bearing.
                                                                          
                                                                          $
                                                                          -
                                                                          
                                                                          
                                                                          $
                                                                          410,167Loan
      due to Taiyuan YanKang Industrial Co., Ltd. Due on demand. Non-interest
      bearing.
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          410,167Loan
      due to Xu XianJun. Due on demand. Non-interest bearing.
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          492,200Loan
      due to ShanXi Rural Credit Union from Golden Magnesium. Due on demand.
      17.18% annual interest rate.
                                                                          
                                                                          
                                                                          430,337
                                                                          
                                                                          
                                                                          
                                                                          -Loan
      due to China MinSheng Bank. Due July 24, 2008. 7.89% annual interest rate.
      Secured by Lang Chemical’s restricted cash. This loan was satisfied as of
      the date of this report.
                                                                          
                                                                          
                                                                          729,384
                                                                          
                                                                          
                                                                          
                                                                          -Loan
      due to China Commercial Bank, dated July 3, 2007, due in quarterly
      installments through July 3, 2012. 8.13% annual interest rate. Secured by
      Lang Chemical’s property.
                                                                          
                                                                          
                                                                          198,392
                                                                          
                                                                          
                                                                          
                                                                          216,931Loan
      due to ShanXi Rural Credit Union. Due on demand. 12.58% annual interest
      rate.
                                                                          
                                                                          
                                                                          -
                                                                          
                                                                          
                                                                          
                                                                          546,889Total
                                                                          
                                                                          
                                                                          1,358,113
                                                                          
                                                                          
                                                                          
                                                                          2,076,354Less:
      current portion
                                                                          
                                                                          
                                                                          (1,159,721
                                                                          )
                                                                          
                                                                          
                                                                          (1,909,781
                                                                          )Loans
      payable, long-term
                                                                          
                                                                          $
                                                                          198,392
                                                                          
                                                                          
                                                                          $
                                                                          166,573





- 18
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 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




NOTE
10 - RELATED PARTY TRANSACTIONS





Yuwei
Huang, CEO and Chairman of Chang Magnesium, Chairman of Baotou Changxin
Magnesium, and CEO and Vice Chairman of Golden Magnesium, is the Chairman of
YiWei Magnesium.





At
September 30, 2008 we reported accounts receivable-related party of $750,419
which is comprised of $558,044 due to Chang Magnesium from YiWei Magnesium and
$192,375 due to Golden Magnesium from YiWei Magnesium. The $558,044 resulted
from sales generated during the nine months ended September 30, 2008 of residual
scrap products created during the manufacturing process, which are outside the
ordinary course of business for our Magnesium segment. These amounts
reflect payments which had not yet been collected as of September 30,
2008.





At
September 30, 2008, we reported prepaid expenses-related parties of
$9,420,705 comprised of the following:





·
              $4,391,173
      prepaid by Chang Magnesium to YiWei Magnesium for the future delivery of
      inventory which has not yet been received,·
              $28,497
      prepaid by Golden Magnesium to YiWei Magnesium for the future delivery of
      inventory which has not yet been received,·
              $1,568,221
      prepaid by Golden Magnesium to Senrun Coal for the future supply of gas
      which has not yet been provided,·
              $1,682,292
      prepaid by Pan Asia Magnesium to Shanxi Jinyang Coal and Coke Group Co.,
      Ltd., a Chinese limited liability company (“Jinyang Group”) for the future
      supply of gas which has not yet been provided. Jinyang Group, holds a 49%
      interest in Pan Asia Magnesium,·
              $1,750,522
      due to Baotou Changxin Magnesium from Youbing Yang, a member of its board
      of directors.  Baotou Changxin Magnesium advanced the funds
      towards its  purchase of a magnesium facility. This amount is
      classified as “other receivable-related party” as the transaction is
      pending as of the report date.  Upon completion of a final
      agreement, this amount will be reclassified as a fixed
      asset.





At
September 30, 2008 we reported due from related party of $14,588 due CDI
Metal Recycling from Zhou Weiyi, the minority interest holder, for the
contribution of registered capital related to the formation of CDI Metal
Recycling.





At
September 30, 2008 we reported accounts payable-related parties of
$3,285,754 comprised of the following:





·
                $2,186,773
      due from Chang Magnesium to YiWei Magnesium for inventory
      purchases.·
                $738,381
      due from Golden Magnesium to YiWei Magnesium for inventory
      purchases,·
                $325,777
      due from Golden Magnesium to Senrun Coal for inventory
      purchases.·
                $34,823
      due from Baotou Changxin Magnesium to YiWei Magnesium for inventory
      purchases.





At
September 30, 2008, we reported due to related party of $734,996 comprised of
the following:





·
                $729,384
      due to Chi Chen from Capital One Resource, and·
                $5,612
      due to Chi Chen from CDI
Beijing.





Chi Chen,
minority owner of CDI Beijing, advanced these funds for working capital purposes
related to CDI Beijing.





- 19
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




At
September 30, 2008 we reported loans receivable-related parties of
$1,525,114 comprised of the following:





·
                $74,397
      due CDI Shanghai Management from Dragon Capital.  Lisheng
      (Lawrence) Wang, the CEO and Chairman of Dragon Capital is the brother of
      Dr. James Wang, our CEO and Chairman.  The funds were advanced
      for working capital purposes.·
                $1,450,717
      due Lang Chemical from NanTong Langyuan Chemical Co., Ltd., a Chinese
      limited liability company owned by Jingdong Chen and Qian Zhu, the two
      minority shareholders of Lang Chemical (“NanTong Chemical”). The funds
      were advanced for working capital
purposes.





NOTE
11 - 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, 2008, there were 1,006 shares of Series A Convertible Preferred
Stock issued and outstanding. There were no shares of Series A Convertible
Preferred Stock issued and outstanding as of December 31, 2007.





Series
A Preferred Stock and Related Dividends





On
February 11, 2008, we entered into a Securities Purchase Agreement with
accredited investors to sell, in a private placement transaction, 12,950 shares
of our Series A Convertible Preferred Stock (“Series A Preferred Stock”)
together with common stock purchase warrants to purchase an aggregate of
1,850,000 shares of our common stock. At closing, we received gross proceeds of
$12,950,000. The Series A Preferred Stock has a stated value per share of
$1,000, carries an 8% per annum dividend rate payable quarterly in arrears and
is convertible into common stock at $7.00 per share. The dividends are payable
in cash or shares of our common stock, at our option, subject to certain
provisions. If paid in shares of common stock, the stock shall be valued at the
lower of the conversion price or the average of the weighted average price of
the 10 consecutive trading days immediately preceding the dividend
date.





Upon
conversion of the Series A Preferred Stock, we are required to pay an amount
(the “Make-Whole Additional Amount”) equal to 8% of the stated value of the
shares converted or redeemed - essentially an extra year’s dividend. This amount
shall be paid in shares valued at the lower of the conversion price or 90% of
the weighted average price of our common stock for the 10 consecutive trading
days immediately preceding the date of notice.





A
registration statement covering the public resale of the shares of common stock
underlying the Series A Preferred Stock and the warrants was declared effective
by the Securities and Exchange Commission on April 23, 2008.





As of
September 30, 2008, holders of our Series A Preferred Stock have converted
11,944 shares of the 12,950 shares of the Series A Preferred Stock. Each share
of Series A Preferred stock was convertible into 142.8541 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, 10,346 shares of common stock in
payment of the accrued dividends, and 136,500 shares of common stock, the Make
Whole Additional Amount.





- 20
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




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 return
to the Preferred Stockholder (dividend) by debiting Retained Earnings and
crediting Additional Paid-In Capital.





In
addition, under the provisions of EITF 98-5‘Accounting for Convertible
Securities with Beneficial Conversion Features or Contingently Adjustable
Conversion Ratios’ (“EITF 98-5”),  and EITF 00-27‘Application of Issue
No. 98-5 to Certain Convertible Instruments’  (“EITF 00-27”),
the Series A Preferred Stock issuance carried an embedded beneficial conversion
feature at issuance. Accordingly, after first allocating the proceeds received
from the Series A Preferred Stock offering to the preferred shares and
detachable warrants on a relative fair value basis, we derived an intrinsic
value of the conversion feature of $2,451,446. As the Series A Preferred Stock
does not have a stated redemption date or finite life, the deemed dividend was
recognized immediately as a non-cash charge during the nine months ended
September 30, 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 three
months or nine months ended September 30, 2008. The estimated fair market
value of the Warrants of $2,765,946 has been recorded as additional paid-in
capital and a reduction to the recorded amount of the Series A Preferred
Stock.





We paid
Roth Capital a fee of $1,295,000 for serving as the placement agent in the
Series A Preferred Stock Offering. Roth Capital also received 300,000 common
stock purchase warrants, exercisable at $8.00 per share for five years as part
of their fee. At February 11, 2008, the warrants granted to Roth Capital had a
fair value of $2.07 per share, totaling $621,000. The warrants issued to Roth
Capital have the same terms, and were valued in the same manner as the warrants
issued to the purchasers of the Series A Preferred Stock.





In
addition, at closing of the Series A Preferred Stock Offering, Dr. James Wang
and Messrs. Marc Siegel, David Stein and Richard Galterio entered into “lock up”
agreements whereby they agreed not to sell any shares of common stock
beneficially owned by them for a sale price of less than $7.70 per
share.  These agreements expired November 11, 2008.





- 21
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




Common
Stock





China
Direct has 1,000,000,000 shares of common stock, par value $.0001, authorized.
At September 30, 2008 there were 23,545,236 shares of common stock issued and
outstanding and there were 20,982,010 shares of common stock issued and
outstanding at December 31, 2007.





For the
nine months ended September 30, 2008 and 2007, amortization of stock based
compensation amounted to $1.7 million and $576,557, respectively.





During
the nine months ended September 30, 2008, we issued 205,000 shares of common
stock in connection with the exercise of common stock purchase warrants. Of
these common stock purchase warrants 75,000 were exercised at $4.00 per share,
30,000 were exercised at $7.50 per share, and 100,000 were exercised at $8.00
per share.





During
the nine months ended September 30, 2008, we issued 510,950 shares of common
stock in connection with the exercise of common stock options with net proceeds
of $1,757,376. Of these options, 298,950 shares were exercised at $2.50 per
share, 25,000 shares were exercised at $3.00 per share and 187,000 shares were
exercised at $5.00 per share.





We issued
1,706,250 shares of our common stock upon conversion of the Series A Preferred
Stock, 13,206 shares of common stock in payment of the accrued dividends, and
136,500 shares of common stock pursuant to the Make Whole Additional Amount
feature of the Series A Preferred Stock.





A
registration statement on Form S-3 covering the public sale of shares of up to
$70 million of our common stock or other securities and the resale of shares of
our common stock by certain selling shareholders pursuant to Rule 415 under the
Securities Act of 1933 was declared effective by the Securities and Exchange
Commission on August 1, 2008.





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 the three months ended September 30, 2008
we purchased 4,919 shares at a price of $4.55 per share, which were redeemed in
September 2008.





Reverse
Split/Forward Split





On
September 10, 2008, our board of directors approved a 1-for-100 shares reverse
split of our common stock (the “Reverse Split”) to be immediately followed by a
100-for-1 forward split of our common stock (the “Forward Split”). The Reverse
Split/Forward Split was announced on September 19, 2008. Shareholders who held
in the aggregate less than one share of common stock following the Reverse Split
were not included in the Forward Split. Rather, such shares received a cash
payment of $5.07 per share, the closing price of our common stock as of
September 19, 2008. During the three months ended September 30, 2008, we
purchased 3,761 shares at a purchase price of $5.07 per share, which were
redeemed during September 2008.





- 22
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 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, 2008, and
December 31, 2007 there were options outstanding to purchase an aggregate of
365,000 and 390,000 shares, respectively of common stock outstanding under the
2006 Equity Plan at exercise prices ranging from $2.50 to $7.50 per
share.





On
October 19, 2006, our board of directors authorized the 2006 Stock Plan (the
“2006 Stock Plan”) covering 2,000,000 shares of our common stock. As the 2006
Stock Plan was not approved by our shareholders prior to October 19, 2007, we
may no longer award incentive stock options under the 2006 Stock Plan and any
incentive stock options previously awarded under the 2006 Stock Plan were
converted into non-qualified options upon terms and conditions determined by the
board of directors, as nearly as is reasonably practicable in their sole
determination, to the terms and conditions of the incentive stock options being
so converted. At September 30, 2008 and December 31, 2007, there were options
outstanding to purchase an aggregate of 1,993,750 and 1,615,000 shares,
respectively of common stock outstanding under the 2006 Stock Plan at exercise
prices ranging from $.01 to $5.00 per share.





During
the nine months ended September 30, 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, 90,000 options were canceled during the nine months
ended September 30, 2008. The options were valued on the date of grant using the
Black-Scholes option-pricing model, in accordance with SFAS No. 123R using
the following weighted-average assumptions: expected dividend yield 0%,
risk-free interest rate of 2.51%, volatility of 78% and expected term of 1.31
years.





On April
25, 2008, our board of directors adopted the 2008 Executive Stock Incentive Plan
covering 1,000,000 shares of our common stock, which was approved by a majority
vote of our shareholders on May 30, 2008. As of September 30, 2008 no awards had
been made 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, 2008 we
granted 53,648 shares of restricted stock with vesting dates ranging from August
2008 to September 2010 under this plan.





The
following table sets forth our stock option activity during the nine months
ended September 30, 2008:





Shares
      underlying options
                                                
                                                
                                                Weighted
      average exercise priceOutstanding
      at December 31, 2007
                                                
                                                
                                                6,940,620
                                                
                                                
                                                $
                                                8.14Granted
                                                
                                                
                                                240,000
                                                
                                                
                                                
                                                6.20Exercised
                                                
                                                
                                                (510,950
                                                )
                                                
                                                
                                                3.44Expired
      or cancelled
                                                
                                                
                                                (90,000
                                                )
                                                
                                                
                                                7.50Outstanding
      at September 30, 2008
                                                
                                                
                                                6,579,670
                                                
                                                
                                                $
                                                8.44Exercisable
      at September 30, 2008
                                                
                                                
                                                5,167,670
                                                
                                                
                                                $
                                                8.00Weighted-average
      exercise price of options granted during the period
                                                
                                                
                                                
                                                
                                                
                                                $
                                                6.20





- 23
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




The
weighted average remaining contractual life and weighted average exercise price
of options outstanding at September 30, 2008, for selected exercise price
ranges, are as follows:








Range
      of exercise prices
                            
                            
                            Number
      of options outstanding
                            
                            
                            Weighted
      average remaining contractual life (Years)
                            
                            
                            Weighted
      average exercise price
                            
                            
                            Options
      exercisable
                            
                            
                            Weighted
      average exercise price of options exercisable$
                            0.01
                            
                            
                            
                            1,050,000
                            
                            
                            
                            1.40
                            
                            
                            $
                            0.01
                            
                            
                            
                            1,050,000
                            
                            
                            $
                            0.012.25
                            
                            
                            
                            400
                            
                            
                            
                            6.06
                            
                            
                            
                            2.25
                            
                            
                            
                            400
                            
                            
                            
                            2.252.50
                            
                            
                            
                            579,690
                            
                            
                            
                            3
                            
                            
                            
                            2.50
                            
                            
                            
                            579,690
                            
                            
                            
                            2.503.00
                            
                            
                            
                            50,000
                            
                            
                            
                            2
                            
                            
                            
                            3.00
                            
                            
                            
                            50,000
                            
                            
                            
                            3.005.00
                            
                            
                            
                            1,352,000
                            
                            
                            
                            3
                            
                            
                            
                            5.00
                            
                            
                            
                            1,352,000
                            
                            
                            
                            5.007.50
                            
                            
                            
                            1,412,000
                            
                            
                            
                            4
                            
                            
                            
                            7.50
                            
                            
                            
                            1,375,000
                            
                            
                            
                            7.5010.00
                            
                            
                            
                            1,375,000
                            
                            
                            
                            5
                            
                            
                            
                            10.00
                            
                            
                            
                            -
                            
                            
                            
                            -15.00
                            
                            
                            
                            500
                            
                            
                            
                            1.68
                            
                            
                            
                            15.00
                            
                            
                            
                            500
                            
                            
                            
                            15.0030.00
                            
                            
                            
                            760,000
                            
                            
                            
                            4
                            
                            
                            
                            30.00
                            
                            
                            
                            760,000
                            
                            
                            
                            30.0056.25
                            
                            
                            
                            80
                            
                            
                            
                            6.17
                            
                            
                            
                            56.25
                            
                            
                            
                            80
                            
                            
                            
                            56.256,579,670
                            
                            
                            
                            3.56
                            
                            
                            $
                            8.44
                            
                            
                            
                            5,167,670
                            
                            
                            $
                            8.00








During
the nine months ended September 30, 2008, 510,950 options were exercised at an
average exercise price of $3.44 per share with an intrinsic value of $2,998,055.
At September 30, 2008, the aggregate intrinsic value of outstanding and
exercisable options was $5,478,566. As of September 30, 2008, the unrecognized
expense of options that have not vested is $240,184.





Common
Stock Purchase Warrants





During
the nine months ended September 30, 2008, we granted 25,000 common stock
purchase warrants to consultants. The warrants are exercisable immediately at an
exercise price of $11.00. These warrants were fair valued on the date of grant
at $103,707 using the Black-Scholes option-pricing model, in accordance with
SFAS No. 123R using the following weighted-average assumptions: expected
dividend yield of 0%, risk-free interest rate of 3.0%, volatility factor of 100%
and expected term of 3 years. The fair value of these grants was recognized as
selling, general and administrative expenses.





In
February 2008, in connection with the $12,950,000 Series A Preferred Stock
offering, we issued a total of 2,150,000 common stock purchase warrants,
including 1,850,000 warrants issued to investors and 300,000 warrants issued to
Roth Capital as the placement agent as part of their fee. The warrants are
exercisable at $8.00 per share for a period of five years and were fair valued
at $2.07 per warrant using the Black-Scholes Option-pricing model. Assumptions
used in the calculation included: expected dividend yield of 0%; risk-free
interest rate of 2.06%; volatility factor of 90% and expected term of 1
year.





- 24
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




A summary
of the status of our outstanding common stock purchase warrants granted as of
September 30, 2008 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 September 30, 2008
                                                  4,618,312
                                                  
                                                  $
                                                  8.49Exercisable
      at September 30, 2008
                                                  4,618,312
                                                  
                                                  $
                                                  8.49





The
following information applies to all warrants outstanding at September 30,
2008.








Warrants
      Outstanding
                                
                                
                                WarrantsExercisableWeightedAverage
                                
                                
                                Weighted
                                
                                
                                
                                
                                
                                WeightedRemaining
                                
                                
                                Average
                                
                                
                                
                                
                                
                                AverageRang
      of
                                
                                
                                
                                
                                
                                Contractual
                                
                                
                                Exercise
                                
                                
                                
                                
                                
                                ExerciseExercise
      prices
                                
                                
                                Shares
                                
                                
                                Life
      (Years)
                                
                                
                                Price
                                
                                
                                Shares
                                
                                
                                Price$
                                2.50
                                
                                
                                
                                50,000
                                
                                
                                
                                3.17
                                
                                
                                $
                                2.50
                                
                                
                                
                                50,000
                                
                                
                                $
                                2.504.00
                                
                                
                                
                                473,750
                                
                                
                                
                                3.04
                                
                                
                                
                                4.00
                                
                                
                                
                                473,750
                                
                                
                                
                                4.007.50
                                
                                
                                
                                60,000
                                
                                
                                
                                1.64
                                
                                
                                
                                7.50
                                
                                
                                
                                60,000
                                
                                
                                
                                7.508.00
                                
                                
                                
                                2,050,000
                                
                                
                                
                                4.37
                                
                                
                                
                                8.00
                                
                                
                                
                                2,050,000
                                
                                
                                
                                8.0010.00
                                
                                
                                
                                1,869,562
                                
                                
                                
                                2.99
                                
                                
                                
                                10.00
                                
                                
                                
                                1,869,562
                                
                                
                                
                                10.0011.00
                                
                                
                                
                                25,000
                                
                                
                                
                                2.52
                                
                                
                                
                                11.00
                                
                                
                                
                                25,000
                                
                                
                                
                                11.0015.00
                                
                                
                                
                                90,000
                                
                                
                                
                                1.64
                                
                                
                                
                                15.00
                                
                                
                                
                                90,000
                                
                                
                                
                                15.004,618,312
                                
                                
                                
                                3.56
                                
                                
                                $
                                8.49
                                
                                
                                
                                4,618,312
                                
                                
                                $
                                8.49








- 25
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




NOTE
12 - SEGMENT INFORMATION





The
following information is presented in accordance with SFAS No. 131, “Disclosure about segments of an
Enterprise and Related Information”. For the nine month period ended
September 30, 2008, we operated in three reportable business segments after
giving effect to our decision to exit the clean technology segment during this
period as follows:





Magnesium
segment:





·
              Chang
      Magnesium, a 51% majority owned subsidiary of CDI
China,·
              Chang
      Trading, a wholly owned subsidiary of Chang Magnesium,·
              Excel
      Rise, a wholly owned subsidiary of Chang Magnesium,·
              CDI
      Magnesium, a 51% majority owned subsidiary of Capital One
      Resource,·
              Asia
      Magnesium, a wholly owned subsidiary of Capital One
    Resource,·
              Golden
      Magnesium, a 52% majority owned subsidiary of Asia
    Magnesium,·
              Pan
      Asia Magnesium, a 51% majority owned subsidiary of CDI
    China,·
              Baotou
      Changxin Magnesium, a 51% majority owned subsidiary of CDI China,
      and·
              Capital
      One Resource, a wholly owned subsidiary of CDI Shanghai Management. 1





Basic
Materials segment:





·
              Lang
      Chemical, a 51% majority owned subsidiary of CDI China,·
              CDI
      Jingkun Zinc, a 95% majority owned subsidiary of CDI Shanghai
      Management,·
              CDI
      Jixiang Metal, a wholly owned subsidiary of CDI China,
  and·
              CDI
      Metal Recycling, an 83% majority owned subsidiary of CDI Shanghai
      Management.





Consulting
segment:





·
                China
      Direct Investments, a wholly owned subsidiary of China
    Direct,·
                CDI
      Shanghai Management, a wholly owned subsidiary of CDI China,
      and·
                Capital
      One Resource, a wholly owned subsidiary of CDI Shanghai
      Management.





1Capital
One Resource generated revenues in two reporting segments; Magnesium and
Consulting.





- 26
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




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 as of September 30, 2008. CDI
Metal Recycling is in its start up phase and has no significant operations.
Condensed consolidated information with respect to these reportable segments
(after giving effect to our decision to exit the clean technology segment during
the three month period ended September 30, 2008 for the three and nine months
ended September 30, 2008 and 2007 are as follows:





For the
three months ended September 30, 2008:





(Amounts
      in thousands)
                            
                            Magnesium
                            
                            
                            Basic
      Materials
                            
                            
                            Consulting
                            
                            
                            ConsolidatedRevenues
                            
                            $
                            44,603
                            
                            
                            $
                            12,192
                            
                            
                            $
                            5,502
                            
                            
                            $
                            62,297Revenues
      – related party
                            
                            
                            1,065
                            
                            
                            
                            -
                            
                            
                            
                            -
                            
                            
                            
                            1,06545,668
                            
                            
                            
                            12,192
                            
                            
                            
                            5,502
                            
                            
                            
                            63,362Interest
      income (expense)
                            
                            
                            (26
                            )
                            
                            
                            (18
                            )
                            
                            
                            138
                            
                            
                            
                            94Net
      income
                            
                            
                            1,852
                            
                            
                            
                            (65
                            )
                            
                            
                            4,098
                            
                            
                            
                            5,885Segment
      assets
                            
                            $
                            83,858
                            
                            
                            $
                            14,348
                            
                            
                            $
                            25,598
                            
                            
                            $
                            130,984





For the
three months ended September 30, 2007:





(Amounts
      in thousands)
                  
                  Magnesium
                  
                  
                  Basic
      Materials
                  
                  
                  Consulting
                  
                  
                  ConsolidatedRevenues
                  
                  $
                  25,936
                  
                  
                  $
                  15,681
                  
                  
                  $
                  1,396
                  
                  
                  $
                  43,013Revenues
      – related party
                  
                  
                  141
                  
                  
                  
                  -
                  
                  
                  
                  440
                  
                  
                  
                  58126,077
                  
                  
                  
                  15,681
                  
                  
                  
                  1,836
                  
                  
                  
                  43,594Interest
      income (expense)
                  
                  
                  1
                  
                  
                  
                  (5
                  )
                  
                  
                  51
                  
                  
                  
                  44Net
      income
                  
                  
                  1,026
                  
                  
                  
                  39
                  
                  
                  
                  1,823
                  
                  
                  
                  2,980Segment
      assets
                  
                  $
                  22,860
                  
                  
                  $
                  8,578
                  
                  
                  $
                  25,086
                  
                  
                  $
                  57,919





For the
nine months ended September 30, 2008:





(Amounts
      in thousands)
                    
                    Magnesium
                    
                    
                    Basic
      Materials
                    
                    
                    Consulting
                    
                    
                    ConsolidatedRevenues
                    
                    $
                    142,867
                    
                    
                    $
                    39,572
                    
                    
                    $
                    14,518
                    
                    
                    $
                    196,957Revenues
      – related party
                    
                    
                    3,144
                    
                    
                    
                    -
                    
                    
                    
                    -
                    
                    
                    
                    3,144146,011
                    
                    
                    
                    39,572
                    
                    
                    
                    14,518
                    
                    
                    
                    200,101Interest
      income (expense)
                    
                    
                    (90
                    )
                    
                    
                    (40
                    )
                    
                    
                    464
                    
                    
                    
                    334Net
      income
                    
                    
                    8,609
                    
                    
                    
                    88
                    
                    
                    
                    9,401
                    
                    
                    
                    18,153Segment
      assets
                    
                    $
                    83,858
                    
                    
                    $
                    14,348
                    
                    
                    $
                    25,598
                    
                    
                    $
                    130,984








- 27
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




For the
nine months ended September 30, 2007:





(Amounts
      in thousands)
                  
                  Magnesium
                  
                  
                  Basic
      Materials
                  
                  
                  Consulting
                  
                  
                  ConsolidatedRevenues
                  
                  $
                  63,797
                  
                  
                  $
                  42,401
                  
                  
                  $
                  5,101
                  
                  
                  $
                  111,299Revenues
      – related party
                  
                  
                  141
                  
                  
                  
                  -
                  
                  
                  
                  1,320
                  
                  
                  
                  1,46163,938
                  
                  
                  
                  42,401
                  
                  
                  
                  6,421
                  
                  
                  
                  112,760Interest
      income (expense)
                  
                  
                  26
                  
                  
                  
                  (2
                  )
                  
                  
                  94
                  
                  
                  
                  118Net
      income
                  
                  
                  2,176
                  
                  
                  
                  241
                  
                  
                  
                  4,584
                  
                  
                  
                  7,119Segment
      Assets
                  
                  $
                  22,860
                  
                  
                  $
                  8,578
                  
                  
                  $
                  25,086
                  
                  
                  $
                  57,919








NOTE
13 - FOREIGN OPERATIONS





As of
September 30, 2008 the majority of our revenues and assets are associated with
subsidiaries located in the People’s Republic of China.





Assets at
September 30, 2008 and September 30, 2007, reclassified to reflect discontinued
operations, as well as revenues for the three months ended September 30, 2008
and 2007 were as follows:





September
      30, 2008(Amounts
      in thousands)
                                                                              United
      States
                                                                              
                                                                              People’s
      Republic of China
                                                                              
                                                                              TotalRevenues
                                                                              
                                                                              $
                                                                              5,502
                                                                              
                                                                              
                                                                              
                                                                              $
                                                                              56,795
                                                                              
                                                                              
                                                                              $
                                                                              62,297Revenues
      - related party
                                                                              
                                                                              
                                                                              -
                                                                              
                                                                              
                                                                              
                                                                              
                                                                              1,065
                                                                              
                                                                              
                                                                              
                                                                              1,065Total
      Revenues
                                                                              
                                                                              
                                                                              5,502
                                                                              
                                                                              
                                                                              
                                                                              
                                                                              57,860
                                                                              
                                                                              
                                                                              
                                                                              63,362Identifiable
      assets at September 30, 2008
                                                                              
                                                                              $
                                                                              22,792
                                                                              
                                                                              
                                                                              
                                                                              $
                                                                              108,192
                                                                              
                                                                              
                                                                              $
                                                                              130,984





- 28
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008


September
      30, 2007(Amounts
      in thousands)
                                                                      United
      States
                                                                      
                                                                      People’s
      Republic of China
                                                                      
                                                                      TotalRevenues
                                                                      
                                                                      $
                                                                      1,376
                                                                      
                                                                      
                                                                      $
                                                                      41,637
                                                                      
                                                                      
                                                                      $
                                                                      43,013Revenues
      - related party
                                                                      
                                                                      
                                                                      440
                                                                      
                                                                      
                                                                      
                                                                      141
                                                                      
                                                                      
                                                                      
                                                                      581Total
      Revenues
                                                                      
                                                                      
                                                                      1,816
                                                                      
                                                                      
                                                                      
                                                                      41,778
                                                                      
                                                                      
                                                                      
                                                                      43,594Identifiable
      assets at September 30, 2007
                                                                      
                                                                      $
                                                                      16,974
                                                                      
                                                                      
                                                                      $
                                                                      40,945
                                                                      
                                                                      
                                                                      $
                                                                      57,919





Assets at
September 30, 2008, and September 30, 2007, reclassified to reflect
discontinued operations, as well as revenues for the nine months ended September
30, 2008 and 2007 are as follows:





September
      30, 2008(Amounts
      in thousands)
                                                          
                                                          United
      States
                                                          
                                                          
                                                          People’s
      Republic of China
                                                          
                                                          
                                                          TotalRevenues
                                                          
                                                          $
                                                          14,435
                                                          
                                                          
                                                          $
                                                          182,522
                                                          
                                                          
                                                          $
                                                          196,957Revenues
      - related party
                                                          
                                                          
                                                          -
                                                          
                                                          
                                                          
                                                          3,144
                                                          
                                                          
                                                          
                                                          3,144Total
      Revenues
                                                          
                                                          
                                                          14,435
                                                          
                                                          
                                                          
                                                          185,666
                                                          
                                                          
                                                          
                                                          200,101Identifiable
      assets at September 30, 2008
                                                          
                                                          $
                                                          22,792
                                                          
                                                          
                                                          $
                                                          108,192
                                                          
                                                          
                                                          $
                                                          130,984






- 29
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008





September
      30, 2007(Amounts
      in thousands)
                    United
      States
                    
                    People’s
      Republic of China
                    
                    TotalRevenues
                    
                    $
                    5,081
                    
                    
                    $
                    106,218
                    
                    
                    $
                    111,299Revenues
      - related party
                    
                    
                    1,320
                    
                    
                    
                    141
                    
                    
                    
                    1,461Total
      Revenues
                    
                    
                    6,401
                    
                    
                    
                    106,359
                    
                    
                    
                    112,760Identifiable
      assets at September 30, 2007
                    
                    $
                    16,974
                    
                    
                    $
                    40,945
                    
                    
                    $
                    57,919





NOTE
14 – DISCONTINUED OPERATIONS





During
the third quarter of 2008, we elected to exit the alternative energy and
recycling business conducted by CDI Clean Technology Group, Inc. (“CDI Clean
Technology”). We devised a formal plan of disposal of  a majority
ownership in these subsidiaries. The business of CDI Clean Technology and its
subsidiaries comprised substantially all of the business of our Clean Technology
segment. We classified the assets and liabilities of CDI Clean Technology and
its subsidiaries as “Subsidiaries held for sale” in accordance with the
provisions of FASB No. 144.





On
September 30, 2008, we ceased depreciating the assets of CDI Clean Technology
and its subsidiaries and as a result of the held for sale classification, we
assessed the estimated fair value of the subsidiary and no impairment charge was
recognized. The results of operations from CDI Clean Technology and its
subsidiaries are classified as discontinued operations in 2008 and previously
reported results of operations of CDI Clean Technology have been reclassified to
reflect this subsidiary as “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, accordingly no loss was
recognized during the nine months ended September 30, 2008. We plan to
maintain our 19% ownership interest in CDI Clean Technology.





- 30
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




The
following table sets forth the components of discontinued operations for the
three and nine months ended September 30, 2008 and 2007.





Subsidiaries
Held for Sale








For
      the Three Months
                      
                      
                      For
      the Nine MonthsEnded
      September 30,
                      
                      
                      Ended
      September 30,2008
                      
                      
                      2007
                      
                      
                      2008
                      
                      
                      2007Revenues
                      
                      $
                      121,689
                      
                      
                      $
                      982,618
                      
                      
                      $
                      918,371
                      
                      
                      $
                      3,209,364Cost
      of revenues
                      
                      
                      127,459
                      
                      
                      
                      777,154
                      
                      
                      
                      345,274
                      
                      
                      
                      2,569,416Gross
      profit
                      
                      
                      (5,770
                      )
                      
                      
                      205,464
                      
                      
                      
                      573,097
                      
                      
                      
                      639,948Selling,
      general, and administrative
                      
                      
                      100,620
                      
                      
                      
                      84,275
                      
                      
                      
                      338,642
                      
                      
                      
                      448,954Operating
      income
                      
                      
                      (106,390
                      )
                      
                      
                      121,189
                      
                      
                      
                      234,455
                      
                      
                      
                      190,994Other
      income (expenses)
                      
                      
                      19,932
                      
                      
                      
                      147,874
                      
                      
                      
                      (126
                      )
                      
                      
                      153,767Net
      (loss) income before income tax and minority interest
                      
                      
                      (86,458
                      )
                      
                      
                      269,063
                      
                      
                      
                      234,329
                      
                      
                      
                      344,761Income
      tax expense
                      
                      
                      10,000
                      
                      
                      
                      88,630
                      
                      
                      
                      127,232
                      
                      
                      
                      113,610Net
      income (loss) before minority interest
                      
                      
                      (96,458
                      )
                      
                      
                      180,433
                      
                      
                      
                      107,097
                      
                      
                      
                      231,151Minority
      Interest in income of subsidiary
                      
                      
                      (77,720
                      )
                      
                      
                      88,412
                      
                      
                      
                      52,478
                      
                      
                      
                      113,264Discontinued
      operation's net (loss) income
                      
                      $
                      (18,738
                      )
                      
                      $
                      92,021
                      
                      
                      $
                      54,619
                      
                      
                      $
                      117,887








- 31
-
 Index
 CHINA DIRECT, INC. AND SUBSIDIARIES
 NOTES
TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS (Continued)
 SEPTEMBER
30, 2008




NOTE
15 - SUBSEQUENT EVENTS





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, which was
paid in the form of the buyer’s promissory note. The promissory note provides
for principal payments of $240,000 on December 31, 2008, $500,000 on December
31, 2009 and $500,000 on June 30, 2010 and interest at the rate of 1% per annum.
The promissory note is secured by all of the assets of CDI Clean Technology, the
CDI Clean Technology stock purchased by PE Brothers Corp., all of the assets of
CDI Wanda, the 51% owned subsidiary of CDI Clean Technology and additional
assets pledged by Yang Li, the principal shareholder of PE Brothers Corp. and a
minority owner of Yantai CDI Wanda. CDI Clean Technology and its subsidiaries
was included within “Subsidiaries held for sale” on our September 30, 2008
Consolidated Balance Sheet. Accordingly no loss was recognized during the nine
months ended September 30, 2008.





On
November 13, 2008, Yuejian (James) Wang, Ph.D, our Chief Executive Officer, Marc
Siegel, our President and David Stein, entered into an amendment to their
respective August 7, 2008 employment agreements. The November 13, 2008
amendments waive the annual base salary included in the employment agreements
from August 1, 2008 through October 1, 2008. All other terms and conditions of
the employment agreements remain in full force and effect.








- 32
-
 Index








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





The
following discussion should be read in conjunction with the information
contained in our unaudited consolidated financial statements and the notes
thereto appearing elsewhere herein and in conjunction with the Management’s
Discussion and Analysis set forth in our Annual Report on Form 10-K for the year
ended December 31, 2007.





We are on
a calendar year, as such the nine month period ending September 30, is our third
quarter. The year ended December 31, 2007 is referred to as “2007” and the
coming year ending December 31, 2008 is referred to as “2008”.





OVERVIEW
OF OUR PERFORMANCE AND OPERATIONS





Our
Business





We are a
management and advisory services organization which owns and consults with
business entities operating in the People’s Republic of China (“PRC”). We
operate in two primary divisions: (i) Management Services and (ii) Advisory
Services. Our Management Services division acquires controlling interest in
Chinese business entities which we consolidate as either our wholly or majority
owned subsidiaries. Through this ownership control, we provide management advice
as well as investment capital, enabling these subsidiaries to successfully
expand their businesses. Our Advisory Services division provides consulting
services to Chinese entities seeking access to the U.S. capital markets. As of
the date of this report, our Management Services division oversees 14
subsidiaries in various industries with over 2,100 employees in the PRC. Our
Advisory Services division currently has five clients which trade publicly in
the U.S. markets.





Within
our two divisions, we maintain and report three business segments as defined in
SFAS No. 131 after giving effect to our decision to exit the clean technology
segment during this period:





·
              Magnesium
      segment,·
              Basic
      Materials segment, and·
              Consulting
      segment.





Our
Magnesium segment is currently our largest segment by revenue, assets and number
of portfolio companies. Magnesium is used in a variety of markets and
applications due to the physical and mechanical properties of the element and
its alloys. Global production of magnesium was estimated to be approximately
755,000 metric tons in 2007. China represents approximately 80% of the global
production of magnesium. As of November 1, 2008 the price of magnesium on the
spot market was approximately $2,800 per metric ton, which has decreased from
approximately $3,900 per metric ton at December 31, 2007. We believe this
decrease is attributable to a decline in demand due to the current global
economic slowdown. Despite the current market declines, we believe the magnesium
industry represents a significant opportunity and, accordingly, we have made
significant investments to expand our operations in this segment. We currently
have eight portfolio companies in our Magnesium segment.





- 33
-
 Index


Our Basic
Materials segment includes the sale and distribution of industrial grade
synthetic chemicals consisting primarily of: glacial acetic acid and acetic acid
derivatives, acrylic acid and acrylic ester, vinyl acetate-ethylene (“VAE”) and
polyvinyl alcohol (“PVA”). In the three months ended September 2008, we
commenced operations at CDI Beijing.  CDI Beijing is involved in the
distribution of wood and steel products primarily to companies engaged in
industrial and civil construction projects. We are evaluating a possible
investment to acquire a producer of pharmaceutical intermediates used in the
manufacture of consumer and pharmaceutical products. We started construction at
CDI Jixing Metal which we expect to complete in the first quarter of 2009 and
are awaiting an independent valuation of the ore deposits at CDI Jixiang
Metal.





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.





Our
Performance





Revenues
during the nine months ended September 30, 2008 totaled $200.1 million, a 77.5%
increase as compared to the nine months ended September 30, 2007. During the
nine months ended September 30, 2008 we continued to experience a dramatic
growth in revenues, income and total assets as compared to prior years. This
growth was primarily attributable to (i) investments in our Magnesium segment in
the latter half of 2007 to obtain a controlling interest in several joint
venture entities operating within the PRC, (ii) an increase in the market
price of magnesium during the nine months ended September 30, 2008, and
(iii) the expansion into the steel and wood distribution business in our basic
materials segment. The global economic slowdown has adversely affect the rate of
our year-over-year growth across all of our business segments. In spite of the
weakness in the global economy, the disruption caused by the 2008 Beijing
Olympics and the strength of the RMB relative to the U.S. dollar, our revenues
remain strong but are increasing at a lower rate of growth.





Our
annual growth rate of over 77.5% is not sustainable, but rather reflects the
continued implementation of the acquisition component of our business model, the
completion of recent consulting transactions that may not occur in the future
and the launch of our wood and steel distribution business. Accordingly, we
believe comparisons between the third quarter and nine months ending September
30, 2008 and 2007 are of limited value and should not be viewed as an indication
of our period-over-period sustainable growth rate potential.





Our
Outlook





During
the remainder of 2008 and beyond, we face a number of challenges in growing our
business, such as the continuing integration of our PRC based subsidiaries. At
September 30, 2008 we had $68.0 million of working capital including $19.6
million in cash and cash equivalents. While this amount is believed sufficient
to meet our current obligations, we may seek additional capital to provide funds
to enable each of our subsidiaries to grow their businesses and operations and
to take advantage of strategic opportunities. We continue to work with the
management of our portfolio companies to identify strategies to maximize their
potential within their segment and to the consolidated group.





In the
third quarter of 2008, we experienced reduced demand in our Magnesium and Basic
Materials segments as a result of the weak global economy. We cannot predict
when global economic conditions will improve. We forecast continued weak demand
within our Magnesium and Basic Materials segments until global economic
conditions improve. In spite of the weakness in the global economy and the
disruption caused by the 2008 Beijing Olympics, we expect our revenues to remain
consistent with the level of revenues in the third quarter of 2008.





- 34
-
 Index


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. We expect to see a benefit to the Chinese economy from
this stimulus program. However in the short-term, it remains to be seen whether
domestic consumption can compensate for slower export growth, and the impact
this will have on our revenues through the balance of this year.





Our
performance for the nine months ended September 2008 as compared to the nine
months ended September 30, 2007 reflects a marked year-to-date increase in our
operations within China. As of the date of this report, the majority of our
operations, personnel and assets are located in China. A significant majority of
our resources are dedicated to our Management Services division relative to our
Advisory Services division.  We intend to devote additional resources,
which will support the continuing growth of our operations in
China.





While
consulting was the genesis of our company, our Advisory Services division
continues to diminish as a percentage of our overall combined operations as we
continue to expand our operations in China. In 2008, made efforts to attract
clients with larger operations and revenues and in 2009, we intend to continue
these efforts. However, given the size and growth of our Management Services
division, our Advisory Services division will continue to represent a
diminishing portion of our overall operations. As such, we will devote fewer
resources to this division and focus more of our resources on our Management
Services division and its operations within China.





We have
begun discussions with the owners of the minority interests in three of our
magnesium companies, Chang Magnesium, Golden Magnesium, and Baotou Changxin
Magnesium, to consolidate them to form the nucleus of a business that will focus
on the production of pure magnesium. Once combined, we anticipate these three
companies will produce, sell and distribute a combined 72,000 metric tons of
magnesium in 2009.





The
remaining portfolio companies within our Magnesium segment, Pan Asia Magnesium
and CDI Magnesium, will focus on the magnesium alloy sector of the market. We
believe the stabilization of magnesium pricing will afford us an opportunity to
position ourselves to capitalize on this sector of the market. Commencing with
the fourth quarter of 2008 we expect these companies will form our magnesium
alloy division.





We will
continue to strengthen our Basic Materials segment. In the third quarter of
2008, we formed CDI Beijing. CDI Beijing is engaged in the distribution in China
of basic resources such as steel and lumber. CDI Beijing is expected to increase
our market presence in the Beijing region. CDI Metal Recycling will be realigned
under this segment.





During
September 2008, we decided to discontinue the Clean Technology segment. In the
third quarter of 2008, we completed a formal plan of disposal and entered into
an agreement to sell our majority interest in CDI Clean Technology and its
subsidiaries, CDI Wanda and Yantai CDI Wanda. Our current recycling operations
conducted through CDI Metal Recycling will be realigned into our Basic Materials
segment. As the global markets improve, we may reevaluate the Clean Technology
segment.





Risk Factors. We encounter a
variety of challenges that may affect our business and should be considered as
described in Item 1A “Risk Factors” of our Annual Report on Form 10-K for the
year ended December 31, 2007 and in the section of this quarterly report
captioned Management’s Discussion and Analysis of Financial Condition and
Results of Operations “Cautionary Note Regarding Forward-Looking Information and
Factors That May Affect Future Results”.





Presentation of Financial
Statements. The presentation of the statements of operations included in
Part 1, Item 1 in this Form 10-Q 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 consolidated notes to the unaudited
consolidated financial statements included in this Form 10-Q. In addition,
portion of our audited financial statements have been reclassified to recognize
discontinued operations treatment reflecting the planned disposal of a majority
interest in our Clean Technology Segment.





- 35
-
 Index


RESULTS
OF OPERATIONS





Consolidated
revenues and operating expenses by segment for the third quarter and nine months
of 2008 and 2007 are as follows:





Consolidated
Revenues





Three
      months ended September 30,(Dollars
      in thousands)
                                                                                
                                                                                2008
                                                                                
                                                                                
                                                                                2007
                                                                                
                                                                                
                                                                                %Revenues
                                                                                
                                                                                %
      ofRevenues
                                                                                
                                                                                
                                                                                Revenues
                                                                                  (in
      thousands)
                                                                                
                                                                                %
      ofRevenues
                                                                                
                                                                                
                                                                                increase/(decrease)Magnesium
      segment
                                                                                
                                                                                $
                                                                                45,668
                                                                                
                                                                                72.1
                                                                                %
                                                                                
                                                                                $
                                                                                26,077
                                                                                
                                                                                59.8
                                                                                %
                                                                                
                                                                                75.1
                                                                                %Basic
      Materials segment
                                                                                
                                                                                
                                                                                12,192
                                                                                
                                                                                19.2
                                                                                %
                                                                                
                                                                                
                                                                                15,681
                                                                                
                                                                                36.0
                                                                                %
                                                                                
                                                                                (22.2)
                                                                                %Consulting
      segment
                                                                                
                                                                                
                                                                                5,502
                                                                                
                                                                                8.7
                                                                                %
                                                                                
                                                                                
                                                                                1,836
                                                                                
                                                                                4.2
                                                                                %
                                                                                
                                                                                199.7
                                                                                %Total
      Consolidated
                                                                                
                                                                                $
                                                                                63,362
                                                                                
                                                                                100.0
                                                                                %
                                                                                
                                                                                $
                                                                                43,594
                                                                                
                                                                                100.0
                                                                                %
                                                                                
                                                                                45.3
                                                                                %





Nine
      months ended September 30,(Dollars
      in thousands)
                                                                                                      
                                                                                                      2008
                                                                                                      2007
                                                                                                      
                                                                                                      
                                                                                                      %Segment
                                                                                                      
                                                                                                      Revenues
                                                                                                      
                                                                                                      %
      of
                                                                                                        Revenues
                                                                                                      
                                                                                                      
                                                                                                      Revenues
                                                                                                        (in
      thousands)
                                                                                                      
                                                                                                      %
      ofRevenues
                                                                                                      
                                                                                                      
                                                                                                      increase/(decrease)Magnesium
      segment
                                                                                                      
                                                                                                      $
                                                                                                      146,011
                                                                                                      
                                                                                                      73.0
                                                                                                      %
                                                                                                      
                                                                                                      $
                                                                                                      63,938
                                                                                                      
                                                                                                      56.7
                                                                                                      %
                                                                                                      
                                                                                                      128.4
                                                                                                      %Basic
      Materials segment
                                                                                                      
                                                                                                      
                                                                                                      39,572
                                                                                                      
                                                                                                      19.8
                                                                                                      %
                                                                                                      
                                                                                                      
                                                                                                      42,401
                                                                                                      
                                                                                                      37.6
                                                                                                      %
                                                                                                      
                                                                                                      (6.7)
                                                                                                      %Consulting
      segment
                                                                                                      
                                                                                                      
                                                                                                      14,518
                                                                                                      
                                                                                                      7.3
                                                                                                      %
                                                                                                      
                                                                                                      
                                                                                                      6,421
                                                                                                      
                                                                                                      5.7
                                                                                                      %
                                                                                                      
                                                                                                      126.1
                                                                                                      %Total
      Consolidated
                                                                                                      
                                                                                                      $
                                                                                                      200,101
                                                                                                      
                                                                                                      100.0
                                                                                                      %
                                                                                                      
                                                                                                      $
                                                                                                      112,760
                                                                                                      
                                                                                                      100.0
                                                                                                      %
                                                                                                      
                                                                                                      77.5
                                                                                                      %





Total
consolidated revenues for the third quarter of 2008 were $63.4 million, an
increase of 45.3% compared to the third quarter of 2007, and for the nine months
of 2008 totaled $200.1 million, an increase of 77.5% compared to the nine months
of 2007. These increases were due primarily to:





·Our
      acquisitions of Golden Magnesium in July 2007 and Pan Asia Magnesium in
      September 2007,·
      An increase in the market price
      of magnesium during the nine months ended September 30,
      2008,·Production
      increases within our existing magnesium operations,·An
      increase in revenues in the third quarter of $5.5 million from our
      Consulting segment, and·These
      increases were partially offset by a reduction in revenues in Lang
      Chemical within our Basic Materials
segment.








- 36
-
 Index


Consolidated
Operating Income and Expenses





Three
      months ended September 30,(Dollars
      in thousands)
                                                                    
                                                                    2008
                                                                    
                                                                    
                                                                    2007
                                                                    
                                                                    
                                                                    %Amount
                                                                    
                                                                    %
      of
                                                                      Revenue
                                                                    
                                                                    
                                                                    Amount
                                                                    
                                                                    %
      of
                                                                      Revenue
                                                                    
                                                                    
                                                                    Increase/
                                                                      (decrease)Revenues
                                                                    
                                                                    $
                                                                    63,363
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    $
                                                                    43,594
                                                                    
                                                                    -
                                                                    
                                                                    
                                                                    45.3
                                                                    %Cost
      of revenues
                                                                    
                                                                    
                                                                    52,773
                                                                    
                                                                    83.3
                                                                    %
                                                                    
                                                                    
                                                                    39,009
                                                                    
                                                                    89.5
                                                                    %
                                                                    
                                                                    35.3
                                                                    %Gross
      profit
                                                                    
                                                                    
                                                                    10,590
                                                                    
                                                                    16.7
                                                                    %
                                                                    
                                                                    
                                                                    4,585
                                                                    
                                                                    10.5
                                                                    %
                                                                    
                                                                    131.0
                                                                    %Total
      operating expenses
                                                                    
                                                                    
                                                                    3,168
                                                                    
                                                                    5.0
                                                                    %
                                                                    
                                                                    
                                                                    1,031
                                                                    
                                                                    2.4
                                                                    %
                                                                    
                                                                    207.3
                                                                    %Operating
      income
                                                                    
                                                                    $
                                                                    7,422
                                                                    
                                                                    11.7
                                                                    %
                                                                    
                                                                    $
                                                                    3,554
                                                                    
                                                                    8.2
                                                                    %
                                                                    
                                                                    108.8
                                                                    %





(Dollars
      in thousands)
                                                                                                                          
                                                                                                                          Nine
      months ended September 30,2008
                                                                                                                          
                                                                                                                          
                                                                                                                          2007
                                                                                                                          
                                                                                                                          
                                                                                                                          %Amount
                                                                                                                          
                                                                                                                          %
      of
                                                                                                                            Revenue
                                                                                                                          
                                                                                                                          
                                                                                                                          Amount
                                                                                                                          
                                                                                                                          %
      of
                                                                                                                            Revenue
                                                                                                                          
                                                                                                                          
                                                                                                                          Increase/
                                                                                                                            (decrease)Revenues
                                                                                                                          
                                                                                                                          $
                                                                                                                          200,101
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          $
                                                                                                                          112,760
                                                                                                                          
                                                                                                                          -
                                                                                                                          
                                                                                                                          
                                                                                                                          77.5
                                                                                                                          %Cost
      of revenues
                                                                                                                          
                                                                                                                          
                                                                                                                          166,080
                                                                                                                          
                                                                                                                          83.0
                                                                                                                          %
                                                                                                                          
                                                                                                                          
                                                                                                                          101,427
                                                                                                                          
                                                                                                                          89.9
                                                                                                                          %
                                                                                                                          
                                                                                                                          63.7
                                                                                                                          %Gross
      profit
                                                                                                                          
                                                                                                                          
                                                                                                                          34,021
                                                                                                                          
                                                                                                                          17.0
                                                                                                                          %
                                                                                                                          
                                                                                                                          
                                                                                                                          11,333
                                                                                                                          
                                                                                                                          10.1
                                                                                                                          %
                                                                                                                          
                                                                                                                          200.2
                                                                                                                          %Total
      operating expenses
                                                                                                                          
                                                                                                                          
                                                                                                                          7,266
                                                                                                                          
                                                                                                                          3.6
                                                                                                                          %
                                                                                                                          
                                                                                                                          
                                                                                                                          2,352
                                                                                                                          
                                                                                                                          2.1
                                                                                                                          %
                                                                                                                          
                                                                                                                          208.9
                                                                                                                          %Operating
      income
                                                                                                                          
                                                                                                                          $
                                                                                                                          26,755
                                                                                                                          
                                                                                                                          13.4
                                                                                                                          %
                                                                                                                          
                                                                                                                          $
                                                                                                                          8,981
                                                                                                                          
                                                                                                                          8.0
                                                                                                                          %
                                                                                                                          
                                                                                                                          197.9
                                                                                                                          %





- 37
-
 Index


Total consolidated operating income for the third quarter of
2008 was $7.4 million, an increase of 108.8% compared to the third quarter of
2007, and for the nine months of 2008 was $26.8 million, an increase of 197.9%
over the nine months of 2007. These increases were due primarily to the $4.2
million and $17.8 million of operating income generated by our Magnesium segment
for the third quarter and nine months of 2008, respectively and $3.2 million and
$8.7 million of operating income from our Consulting segment for the third
quarter and nine months of 2008, respectively. The increases in operating income
from our Magnesium segment were generated by Chang Magnesium, Golden Magnesium
and Pan Asia Magnesium. Our operations in this segment in 2008 reflect
consolidation for the entire nine month period of Golden Magnesium, acquired in
July 2007, and Pan Asia Magnesium, acquired in September 2007.





Our cost
of revenues for the third quarter of 2008 was $52.8 million, an increase of
35.3% compared to the third quarter of 2007, and for the nine months of 2008
were $166.1 million, an increase of 63.7% compared to the nine months of 2007.
These increases for the three and nine month period were primarily due to
the significantly higher sales in our Magnesium segment. Our cost of revenues
for the third quarter of 2008 as a percentage of revenues decreased, however, by
6.2% and 6.9% compared to the third quarter of 2007 primarily as a result of
favorable purchases of raw materials and cost savings derived from economies of
scale within our Magnesium segment.





Our gross
profit for the third quarter of 2008 was $10.6 million, an increase of 131.0%
compared to the third quarter of 2007, and for the nine months of 2008 was $34
million, an increase of 200.2% compared to the nine months of 2007. These
increases are attributable to the higher income generated by our Magnesium
segment and consulting segment and the reduction in the cost of revenues as a
percentage of revenues in our Magnesium segment.





Segment
Information





A summary
of our operating results, by segment, for the third quarter and nine months
periods of 2008 and 2007 are as follows:




Three
      months ended September 30, 2008 and 2007:Magnesium
                                                                                  
                                                                                  Basic
      Materials
                                                                                  
                                                                                  Consulting
                                                                                  
                                                                                  Consolidated(Amounts
      in thousands)
                                                                                  2008
                                                                                  
                                                                                  2007
                                                                                  
                                                                                  2008
                                                                                  
                                                                                  2007
                                                                                  
                                                                                  2008
                                                                                  
                                                                                  2007
                                                                                  
                                                                                  2008
                                                                                  
                                                                                  2007Revenues
                                                                                  
                                                                                  $
                                                                                  44,603
                                                                                  
                                                                                  
                                                                                  $
                                                                                  25,937
                                                                                  
                                                                                  
                                                                                  $
                                                                                  12,192
                                                                                  
                                                                                  
                                                                                  $
                                                                                  15,681
                                                                                  
                                                                                  
                                                                                  $
                                                                                  5,502
                                                                                  
                                                                                  
                                                                                  $
                                                                                  1,396
                                                                                  
                                                                                  
                                                                                  $
                                                                                  62,297
                                                                                  
                                                                                  
                                                                                  $
                                                                                  43,014Revenues
      - related party
                                                                                  
                                                                                  
                                                                                  1,065
                                                                                  
                                                                                  
                                                                                  
                                                                                  140
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  -
                                                                                  
                                                                                  
                                                                                  
                                                                                  440
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,065
                                                                                  
                                                                                  
                                                                                  
                                                                                  58045,668
                                                                                  
                                                                                  
                                                                                  
                                                                                  26,077
                                                                                  
                                                                                  
                                                                                  
                                                                                  12,192
                                                                                  
                                                                                  
                                                                                  
                                                                                  15,681
                                                                                  
                                                                                  
                                                                                  
                                                                                  5,502
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,836
                                                                                  
                                                                                  
                                                                                  
                                                                                  63,362
                                                                                  
                                                                                  
                                                                                  
                                                                                  43,594Cost
      of revenues
                                                                                  
                                                                                  
                                                                                  40,403
                                                                                  
                                                                                  
                                                                                  
                                                                                  23,403
                                                                                  
                                                                                  
                                                                                  
                                                                                  11,707
                                                                                  
                                                                                  
                                                                                  
                                                                                  15,418
                                                                                  
                                                                                  
                                                                                  
                                                                                  662
                                                                                  
                                                                                  
                                                                                  
                                                                                  189
                                                                                  
                                                                                  
                                                                                  
                                                                                  52,772
                                                                                  
                                                                                  
                                                                                  
                                                                                  39,010Gross
      profit
                                                                                  
                                                                                  
                                                                                  5,265
                                                                                  
                                                                                  
                                                                                  
                                                                                  2,674
                                                                                  
                                                                                  
                                                                                  
                                                                                  485
                                                                                  
                                                                                  
                                                                                  
                                                                                  263
                                                                                  
                                                                                  
                                                                                  
                                                                                  4,840
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,647
                                                                                  
                                                                                  
                                                                                  
                                                                                  10,590
                                                                                  
                                                                                  
                                                                                  
                                                                                  4,584Total
      operating expenses
                                                                                  
                                                                                  
                                                                                  1,064
                                                                                  
                                                                                  
                                                                                  
                                                                                  370
                                                                                  
                                                                                  
                                                                                  
                                                                                  462
                                                                                  
                                                                                  
                                                                                  
                                                                                  176
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,642
                                                                                  
                                                                                  
                                                                                  
                                                                                  485
                                                                                  
                                                                                  
                                                                                  
                                                                                  3,168
                                                                                  
                                                                                  
                                                                                  
                                                                                  1,031Operating
      income (loss)
                                                                                  
                                                                                  $
                                                                                  4,201
                                                                                  
                                                                                  
                                                                                  $
                                                                                  2,304
                                                                                  
                                                                                  
                                                                                  $
                                                                                  23
                                                                                  
                                                                                  
                                                                                  $
                                                                                  87
                                                                                  
                                                                                  
                                                                                  $
                                                                                  3,198
                                                                                  
                                                                                  
                                                                                  $
                                                                                  1,162
                                                                                  
                                                                                  
                                                                                  $
                                                                                  7,422
                                                                                  
                                                                                  
                                                                                  $
                                                                                  3,553
   - 38
-
 Index
 Nine
      months ended September 30, 2008 and 2007:Magnesium
                                                            
                                                            Basic
      Materials
                                                            
                                                            Consulting
                                                            
                                                            Consolidated(Amounts
      in thousands)
                                                            2008
                                                            
                                                            2007
                                                            
                                                            2008
                                                            
                                                            2007
                                                            
                                                            2008
                                                            
                                                            2007
                                                            
                                                            2008
                                                            
                                                            2007Revenues
                                                            
                                                            $
                                                            142,867
                                                            
                                                            
                                                            $
                                                            63,798
                                                            
                                                            
                                                            $
                                                            39,572
                                                            
                                                            
                                                            $
                                                            42,401
                                                            
                                                            
                                                            $
                                                            14,518
                                                            
                                                            
                                                            $
                                                            5,101
                                                            
                                                            
                                                            $
                                                            196,957
                                                            
                                                            
                                                            $
                                                            111,300Revenues
      - related party
                                                            
                                                            
                                                            3,144
                                                            
                                                            
                                                            
                                                            140
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            -
                                                            
                                                            
                                                            
                                                            1,320
                                                            
                                                            
                                                            
                                                            3,144
                                                            
                                                            
                                                            
                                                            1,460146,011
                                                            
                                                            
                                                            
                                                            63,938
                                                            
                                                            
                                                            
                                                            39,572
                                                            
                                                            
                                                            
                                                            42,401
                                                            
                                                            
                                                            
                                                            14,518
                                                            
                                                            
                                                            
                                                            6,421
                                                            
                                                            
                                                            
                                                            200,101
                                                            
                                                            
                                                            
                                                            112,760Cost
      of revenues
                                                            
                                                            
                                                            126,342
                                                            
                                                            
                                                            
                                                            58,909
                                                            
                                                            
                                                            
                                                            38,223
                                                            
                                                            
                                                            
                                                            41,530
                                                            
                                                            
                                                            
                                                            1,515
                                                            
                                                            
                                                            
                                                            988
                                                            
                                                            
                                                            
                                                            166,080
                                                            
                                                            
                                                            
                                                            101,427Gross
      profit
                                                            
                                                            
                                                            19,669
                                                            
                                                            
                                                            
                                                            5,029
                                                            
                                                            
                                                            
                                                            1,349
                                                            
                                                            
                                                            
                                                            871
                                                            
                                                            
                                                            
                                                            13,003
                                                            
                                                            
                                                            
                                                            5,433
                                                            
                                                            
                                                            
                                                            34,021
                                                            
                                                            
                                                            
                                                            11,333Total
      operating expenses
                                                            
                                                            
                                                            1,876
                                                            
                                                            
                                                            
                                                            555
                                                            
                                                            
                                                            
                                                            1,112
                                                            
                                                            
                                                            
                                                            384
                                                            
                                                            
                                                            
                                                            4,278
                                                            
                                                            
                                                            
                                                            1,412
                                                            
                                                            
                                                            
                                                            7,266
                                                            
                                                            
                                                            
                                                            2,351Operating
      income (loss)
                                                            
                                                            $
                                                            17,793
                                                            
                                                            
                                                            $
                                                            4,474
                                                            
                                                            
                                                            $
                                                            237
                                                            
                                                            
                                                            $
                                                            487
                                                            
                                                            
                                                            $
                                                            8,725
                                                            
                                                            
                                                            $
                                                            4,021
                                                            
                                                            
                                                            $
                                                            26,755
                                                            
                                                            
                                                            $
                                                            8,982








Magnesium Segment Operating
Results





Revenues.
Magnesium segment revenues for the third quarter of 2008 were $45.7 million, an
increase of 75.1% compared to the third quarter of 2007, and for the nine months
of 2008 were $146.0 million, an increase of 128.4% compared to the nine months
of 2007, due primarily to (i) our acquisitions of Golden Magnesium in July
2007 and Pan Asia Magnesium in September 2007 and (ii) the increase in the
market price of magnesium during the nine months ended September 30,
2008.





Cost of
Revenues. Magnesium segment cost of revenues as a percentage of revenues
for the third quarter of 2008 was 88.4%, a decrease of 1.3% compared to the
third quarter of 2007. For the nine months of 2008 cost of revenues was 86.5%, a
decrease of 5.6%. These decreases were due primarily to favorable purchases of
raw materials, increased sales of magnesium we manufactured which carries a
higher margin than magnesium we purchased and resold to our customers and cost
savings derived from economies of scale in our manufacturing process as a result
of increased production. In the third quarter, however, we witnessed falling
market prices of magnesium with higher cost of goods sold for inventory we had
stockpiled in advance of the 2008 Beijing Olympic Games. We expect the recent
decline in the price of raw materials within the segment to continue in future
periods as a result of reduced demand for magnesium.





Operating
Expenses. Magnesium segment operating expenses for the third quarter of
2008 were $1.1 million, an increase of $694,000 compared to the third quarter of
2007, and for the nine months of 2008 were $1.9 million, an increase of $1.3
million compared to the nine months of 2007. These increases were primarily
attributable to increases in production and sales and support staff and
facilities of the magnesium business we acquired in the second half of 2007 and
the first half of 2008. In particular, operating expenses for the nine months of
2008 included start up costs related to Baotou Changxin Magnesium, which we
acquired in February 2008, and Golden Magnesium which we acquired in July 2007.
While we expect operating expenses will continue to increase as we expand our
magnesium operations, we anticipate these costs will stabilize as a percentage
of revenues as these newly constructed facilities ramp up
production.





- 39
-
 Index


Outlook.
During the nine months of, 2008 our Magnesium segment produced, sold and/or
distributed approximately 43,000 metric tons of magnesium. The weak global
economy has reduced demand for magnesium and the price of magnesium has declined
approximately 25% since August 2008. We are unable to predict if and when demand
or prices will increase. As a result we expect revenues generated from the sale
of magnesium will decrease in future periods. We will seek to continue to
purchase and resell magnesium from third parties if demand permits.





Basic
Materials segment (formerly Chemical segment)





Revenues.
Basic Materials segment revenues for the third quarter of 2008 were $12.2
million, a decrease of $3.5 million compared to the third quarter of 2007, and
for the nine months of 2008 were $39.6 million, a decrease of $2.8 million
compared to the nine months of 2007. This decrease is due to a generally weaker
global economy. In spite of the weakness in the global economy, the disruption
caused by the 2008 Beijing Olympics and the strength of the RMB relative to the
U.S. dollar, our revenues in our recently launched steel and wood distribution
business in the third quarter of 2008 positively affected our Basic Materials
segment.





Cost of
Revenues. Basic Materials segment cost of revenues as a percentage of
revenues for the third quarter of 2008 decreased for third quarter of 2008
compared to the third quarter of 2007, and for the nine months of 2008 compared
to the nine months of 2007 as a result of favorable purchasing in light of
weakening demand for supplies.





Operating
Expenses. Operating expenses in the Basic Materials segment for the third
quarter of 2008 were $462,000, an increase of $286,000 compared to the third
quarter of 2007.  Operating expenses for the nine months of 2008 were
$1.1 million, an increase of approximately $728,000 compared to the nine months
of 2007.  The increases are due primarily to increased shipping
expenses at Lang Chemical due to higher fuel costs, operating and development
costs related to CDI Jingkun Zinc and CDI Jixiang Metal which we acquired in the
fourth quarter of 2007 but have not commenced operations.





Outlook.
We expect continued short term weakness in our Basic Materials segment due to
the global economic slowdown and the disruption caused by the 2008 Beijing
Olympics. In spite of these factors, we are hopeful the recently announced $586
billion domestic stimulus program can stimulate growth in the Chinese economy at
a higher rate of growth over the next two years.





As of the
date of this report, we have commenced construction at CDI Jixing Metal, which
we expect to complete in the first quarter of 2009. We have not commenced
operations at CDI Jixiang Metal or CDI Jingkun Zinc. We are presently awaiting
an independent valuation of the ore deposits at CDI Jixiang Metal. Once
completed, our previously announced plans to distribute zinc concentrate, to
mine zinc and to manufacture lead and zinc oxide will be evaluated due to the
current weakness in the price of zinc. Also, we are evaluating a possible
investment to acquire a facility capable of manufacturing pharmaceutical
intermediates used in the manufacture of consumer and pharmaceutical products.





- 40
-
 Index


Consulting
segment





Revenues.
Consulting segment revenues for the third quarter of 2008 were $5.5 million, an
increase of 199.7% compared to the third quarter of 2007, and for the nine
months of 2008 totaled $14.5 million, an increase of 126.1% compared to the nine
months of 2007. The increase was due primarily to completion of various
transactions from our client companies and the gain of one additional client
company during the second quarter of this year.





Cost of
Revenues. Consulting segment cost of revenues for the third quarter of
2008 were $662,000, an increase of 250.3% compared to the third quarter of 2007,
and for the nine months of 2008 were $1.5 million, an increase of 53.3% compared
to the nine months of 2007. The increase in the third quarter was due primarily
to professional fees related to our client companies. The cost of revenues as a
percentage of revenues was approximately 10.4% for the nine months ended
September 30, 2008 as compared to approximately 15.4% in 2007.





Operating
Expenses. Operating expenses, which include general and administrative
expenses, for the third quarter of 2008 totaled $1.6 million, an increase of
238.6% compared to the third quarter of 2007, and for the nine months of 2008
were $4.3 million, an increase of 203.0% compared to the nine months of 2007,
these increases were due primarily to additional stock based compensation
expenses incurred during the third quarter of 2008 and increases in our
infrastructure costs as we have expanded our staff and administrative support
facilities to support our expanded operations. We anticipate total operating
expenses for this segment will remain consistent with current
levels.





Outlook.
During the nine months of 2008 we experienced growth in our Consulting segment
attributable to new clients. In 2008 we have made efforts to improve the caliber
of the clients within this segment and in 2009 we will continue these efforts.
In light of the current economic environment and a severe liquidity crisis in
the capital markets, we believe it will be difficult for smaller companies to
attract interest in the financial community. As such we do not anticipate this
segment will grow for the remainder of 2008. Furthermore, given the size and
growth of our Management Services division, our Consulting segment will continue
to represent a dwindling portion of our operations. As such, we will devote
fewer resources to the consulting segment and focus more on our operations
within China.





Total
Other Income





Total
other income for the third quarter of 2008 was $218,000, a decrease of 59.6%
compared to the third quarter of 2007, and for the nine months of 2008 was
$719,000, a decrease of 38% as compared to the nine months of 2007. This
decrease was primarily comprised of:





-
            $137,307
      and $463,315 for the three and nine months ended September 30, 2008,
      respectively, within our Consulting segment representing interest income
      generated from short-term loans to YiWei Magnesium and Dragon
      Capital,


-
            $100,644
      and $295,762 for the three and nine months ended September 30, 2008,
      respectively, representing interest income generated from short-term loans
      due to CDI Jingkun Zinc from a supplier,
and


-
            a
      realized loss of $35,705 for the nine months ended September 30, 2008 on
      the sale of marketable securities within our Consulting segment during
      2008.





- 41
-
 Index


Income
Tax Expense





Income
tax benefit for the third quarter of 2008 totaled $567,000, which included a
$300,000 tax refund that was due from our 2007 tax year. For the nine months of
2008 tax expense was $473,000 due primarily to increased net income from our
consolidated operations.





Net
Income





Net
Income for the third quarter of 2008 was $5.9 million, an increase of 97.5%
compared to the third quarter of 2007, and for the nine months of 2008 was $18.2
million, an increase of 155.0% compared to the nine months of 2007 due primarily
to our Magnesium segment which significantly expanded profitable operations and
revenues, despite higher taxes within the segment. This growth resulted
primarily from additional capacity and acquisitions made in the second half of
2007 and first quarter of 2008.





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 $2.9 million
for the nine months ended September 30, 2008 and a loss of approximately
$131,000 for the third quarter of 2008. Gains on currency translation for the
three and nine months ended September 30 2007 were $225,000 and $393,000,
respectively. This non-cash gain had the effect of increasing our reported
comprehensive income.  Please see Note 4 - Comprehensive Income
included in the Notes to our unaudited consolidated financial statements
appearing elsewhere in this report.





Unrealized
Loss on Marketable Securities Available for Sale, Net of Income Tax





The
unrealized loss on marketable securities available for sale, net of income taxes
for the nine months of 2008 totaled $9.1 million, compared to an unrealized loss
of $1.3 million for the nine months of 2007. The unrealized loss on marketable
securities available for sale-related party net of income taxes for the nine
months of 2008 was approximately $1.1 million, compared to $1.0 million for the
nine months of 2007. These declines reflect a reduction in the fair value of
securities received from our client companies for consulting services provided
in the segment. We believe the declines are due in large part to the overall
decline in global market conditions during the period.





Comprehensive
Income





Comprehensive
income for the nine months of 2008 was $10.9 million, an increase of 111.5%
compared to the nine months of 2007, is a result of our net income of $18.2
million plus foreign currency translation gains of approximately $3.0 million,
less unrealized losses on marketable securities available for sale (including
marketable securities available for sale-related party), net of income tax of
$10.2 million.





- 42
-
 Index


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, 2008 our working capital was approximately $68.1 million as
compared to approximately $41.0 million at December 31, 2007.





Our cash
balance at September 30, 2008 totaled approximately $19.6 million, an increase
of approximately $600,000 over our year-end balance. During 2008 we have
received net proceeds of $11.5 million from a preferred stock offering which was
offset by investing and operational expenditures including $11.2 million in
property, and equipment made during the nine months ended September 30,
2008.





We have
commitments, which will be satisfied from working capital, including $3.0
million to increase the registered capital of CDI Beijing.





We are
also evaluating a possible investment to acquire a manufacturer of
pharmaceutical intermediates used in the manufacture of consumer and
pharmaceutical products in order to expand the product offerings within our
Basic Materials segment.





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. Accordingly, we may need to raise additional working capital
through private or public financing. We are permitted to sell on a delayed or
continuous basis up to $70,000,000 worth of our common stock or other securities
along with certain selling shareholders at any time pursuant to a registration
statement that we filed pursuant to Rule 415 under the Securities Act of 1933
and declared effective by the SEC on August 1, 2008.





The
following table provides certain selected balance sheets comparisons between
September 30, 2008 and December 31, 2007.








(Amounts
      in thousands)September
      30, 2008
                                                                                          December
      31, 2007
                                                                                          Increase/(Decrease)
                                                                                          
                                                                                          %Cash
                                                                                          $
                                                                                          19,637
                                                                                          
                                                                                          $
                                                                                          19,025
                                                                                          
                                                                                          $
                                                                                          612
                                                                                          
                                                                                          3.2%Marketable
      securities available for sale
                                                                                          
                                                                                          8,768
                                                                                          
                                                                                          
                                                                                          9,136
                                                                                          
                                                                                          
                                                                                          (368)
                                                                                          
                                                                                          -4.0%Accounts
      receivable, net
                                                                                          
                                                                                          18,286
                                                                                          
                                                                                          
                                                                                          12,813
                                                                                          
                                                                                          
                                                                                          5,473
                                                                                          
                                                                                          42.7%Inventories,
      net
                                                                                          
                                                                                          15,417
                                                                                          
                                                                                          
                                                                                          5,270
                                                                                          
                                                                                          
                                                                                          10,147
                                                                                          
                                                                                          192.5%Prepaid
      expenses and other assets
                                                                                          
                                                                                          30,951
                                                                                          
                                                                                          
                                                                                          18,536
                                                                                          
                                                                                          
                                                                                          12,415
                                                                                          
                                                                                          67.0%Total
      current assets
                                                                                          
                                                                                          101,551
                                                                                          
                                                                                          
                                                                                          69,239
                                                                                          
                                                                                          
                                                                                          32,312
                                                                                          
                                                                                          46.7%Property,
      plant and equipment, net
                                                                                          
                                                                                          28,618
                                                                                          
                                                                                          
                                                                                          17,413
                                                                                          
                                                                                          
                                                                                          11,205
                                                                                          
                                                                                          64.3%Total
      assets
                                                                                          $
                                                                                          130,984
                                                                                          
                                                                                          $
                                                                                          88,286
                                                                                          
                                                                                          $
                                                                                          42,698
                                                                                          
                                                                                          48.4%Loans
      payable - short-term
                                                                                          $
                                                                                          1,160
                                                                                          
                                                                                          $
                                                                                          1,910
                                                                                          
                                                                                          $
                                                                                          (750)
                                                                                          
                                                                                          -39.3%Accounts
      payable and accrued expenses
                                                                                          
                                                                                          9,987
                                                                                          
                                                                                          
                                                                                          9,524
                                                                                          
                                                                                          
                                                                                          463
                                                                                          
                                                                                          4.9%Advances
      from customers
                                                                                          
                                                                                          6,848
                                                                                          
                                                                                          
                                                                                          6,892
                                                                                          
                                                                                          
                                                                                          (44)
                                                                                          
                                                                                          -0.6%Other
      payables
                                                                                          
                                                                                          3,946
                                                                                          
                                                                                          
                                                                                          3,091
                                                                                          
                                                                                          
                                                                                          855
                                                                                          
                                                                                          27.7%Due
      to related parties
                                                                                          
                                                                                          735
                                                                                          
                                                                                          
                                                                                          3,137
                                                                                          
                                                                                          
                                                                                          (2,402)
                                                                                          
                                                                                          -76.6%Total
      current liabilities
                                                                                          
                                                                                          33,407
                                                                                          
                                                                                          
                                                                                          28,537
                                                                                          
                                                                                          
                                                                                          4,870
                                                                                          
                                                                                          17.1%Loan
      payable-long term
                                                                                          
                                                                                          198
                                                                                          
                                                                                          
                                                                                          167
                                                                                          
                                                                                          
                                                                                          31
                                                                                          
                                                                                          18.6%Total
      liabilities
                                                                                          $
                                                                                          33,605
                                                                                          
                                                                                          $
                                                                                          28,704
                                                                                          
                                                                                          $
                                                                                          4,901
                                                                                          
                                                                                          17.1%








- 43
-
 Index


We
maintain cash balances in the United States and China. At September 30, 2008 and
December 31, 2007, bank deposits by geographic area (reclassified to reflect
discontinued operations), was as follows:




Country
              
              September
      30, 2008
              
              
              December
      31, 2007United
      States
              
              $
              7,505,066
              
              38
              %
              
              $
              9,942,948
              
              52
              %China
              
              
              12,131,796
              
              62
              %
              
              
              9,081,656
              
              48
              %Total
      cash and cash equivalents
              
              $
              19,636,862
              
              100
              %
              
              $
              19,024,604
              
              100
              %





In addition, at December
31, 2007, we held an additional $1,370,327 in China which has been reclassified
as “Subsidiaries held for sale” at September 30,
2008.





A
substantial portion of our cash balance, approximately 61.8% at September 30,
2008, is in the form of RMB held in bank accounts at financial institutions
located in the PRC. Cash held in banks in the PRC is not insured. The value of
cash on deposit in China of approximately $12.1 million at September 30, 2008
has been converted based on the exchange rate as of September 30, 2008. In 1996,
the Chinese government introduced regulations, which relaxed restrictions on the
conversion of the RMB; however restrictions still remain, including but not
limited to restrictions on foreign invested entities. Foreign invested entities
may only buy, sell or remit foreign currencies after providing valid commercial
documents at only those banks authorized to conduct foreign exchanges.
Furthermore, the conversion of RMB for capital account items, including direct
investments and loans, is subject to PRC government approval. Chinese entities
are required to establish and maintain separate foreign exchange accounts for
capital account items. We cannot be certain Chinese regulatory authorities will
not impose more stringent restrictions on the convertibility of the RMB,
especially with respect to foreign exchange transactions. Accordingly, cash on
deposit in banks in the PRC is not readily deployable by us for purposes outside
of China.





Current
assets as of September 30, 2008 totaled $101.6 million, an increase of 46.7%
compared to December 31, 2007 and reflects an increase in most current asset
items including cash and cash equivalents, accounts receivables, inventories,
and prepaid expenses and other assets. These increases were due mainly to an
increase in our overall level of operations funded in part by our preferred
stock offering completed in February 2008. Current liabilities as of September
30, 2008 totaled $33.4 million, reflecting a 17.1% increase from our December
31, 2007 balance.





A summary
of total assets by segment at September 30, 2008 and at December 31, 2007 is as
follows:





(Amounts
      in thousands)
                                  
                                  September
      30, 2008
                                  
                                  
                                  December
      31, 2007Magnesium
      segment
                                  
                                  $
                                  83,858
                                  
                                  
                                  $
                                  53,010Basic
      Materials segment
                                  
                                  
                                  14,348
                                  
                                  
                                  
                                  11,802Consulting
      segment
                                  
                                  
                                  25,598
                                  
                                  
                                  
                                  23,474Total
                                  
                                  $
                                  130,984
                                  
                                  
                                  $
                                  88,286





- 44
-
 Index


The
following table provides detail of selected balance sheet items by segment as of
September 30, 2008.





(Amounts
      in thousands)
                            
                            Magnesium
                            
                            
                            Basic
      Materials
                            
                            
                            Consulting
                            
                            
                            ConsolidatedAccounts
      receivable, net (including related-party)
                            
                            $
                            9,037
                            
                            
                            $
                            4,273
                            
                            
                            $
                            4,976
                            
                            
                            $
                            18,286Inventories,
      net
                            
                            
                            13,483
                            
                            
                            
                            1,934
                            
                            
                            
                            0
                            
                            
                            
                            15,417Prepaid
      expenses and other current assets
                            
                            
                            15,877
                            
                            
                            
                            2,492
                            
                            
                            
                            194
                            
                            
                            
                            18,563Total
      current assets
                            
                            
                            36,989
                            
                            
                            
                            11,628
                            
                            
                            
                            52,934
                            
                            
                            
                            101,551Accounts
      payable and accrued expenses
                            
                            
                            9,698
                            
                            
                            
                            3,285
                            
                            
                            
                            290
                            
                            
                            
                            13,273Advances
      from customers and deferred revenue
                            
                            
                            4,514
                            
                            
                            
                            642
                            
                            
                            
                            1,692
                            
                            
                            
                            6,848Other
      payables
                            
                            
                            3,186
                            
                            
                            
                            758
                            
                            
                            
                            2
                            
                            
                            
                            3,946Total
      current liabilities
                            
                            
                            17,945
                            
                            
                            
                            7,101
                            
                            
                            
                            8,361
                            
                            
                            
                            33,407





Our
accounts receivables, net of allowances for doubtful accounts, as of September
30, 2008 was $18.3 million, an increase of $5.5 million compared to December 31,
2007. This increase is attributed to the overall increase in sales levels
primarily in our Magnesium segment. Our Magnesium and Basic Materials segments
generally offer payment terms to its customers of 90 days. Our Consulting
segment generally receives full payment in advance for consulting services to be
provided, upon entering into a consulting agreement.





Inventories
as of September 30, 2008 were $15.4 million, an increase of approximately $10.1
million compared to December 31, 2007. This increase is due primarily to higher
magnesium inventories which accounted for 87.5% and 84.6% of consolidated
inventory levels at September 30, 2008 and December 31, 2007, respectively.
These levels increased sharply as a result of the 128% increase year-over-year
in the level of magnesium related revenues and inventory on-hand required for
our magnesium related acquisitions made in the second half of 2007 and first
quarter 2008.





Prepaid
expenses and other current assets consist of prepayments to vendors for
inventory, other receivables, the fair value of client securities which were
assigned to our executive officers and employees as compensation, loans
receivable, assets acquired in the acquisition of Pan Asia Magnesium, VAT tax
refunds, and security deposits. Prepaid expenses and other current assets as of
September 30, 2008 were $21.3 million. Other current assets include $1,750,522
due to Baotou Changxin Magnesium from Youbing Yang, a member of its board of
directors. Baotou Changxin Magnesium advanced the funds towards its purchase of
a magnesium facility. This amount is classified as “other receivable-related
party” as the transaction is pending as of the report date.  Upon
completion of a final agreement, this amount will be reclassified as
a fixed asset.





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 $6.8
million in advances from customers reflected at September 30, 2008, $4.5 million
is attributable to our Magnesium segment for orders placed in the ordinary
course of business but not yet shipped.





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Consolidated
Statement of Cash Flows





For the
nine months ended September 30, 2008, our net increase in cash totaled $612,000
and was comprised of $183,011 used in operating activities, $12.9 million used
in investing activities, $12.0 million provided by financing activities, and the
effect of prevailing exchange rates on our cash position of a positive $1.7
million.





Cash
Used in Operating Activities





Net cash
used in operating activities for the nine months ended September 30, 2008
totaled $183,011 compared to $6.2 million for the same period of the preceding
year. This decrease in net cash used in operating activities was primarily due
to the $11.0 million increase in our net income between the periods, an increase
in our account payables and accounts payables-related party of $3.4 million, and
our non cash charges in depreciation and stock based compensation of $1.3
million and $1.7 million, respectively. These amounts were mainly offset by an
increase in inventories of $10.1 million, an increase in accounts receivable of
$7.9 million, and an increase in prepaid expenses and prepaid expenses-related
party of $10.9 million.





Cash used
in operating activities for the nine months ended September 30, 2007 was $6.2
million For the nine months ended September 30, 2007, we used cash in operating
activities due to increases in prepaid expenses and prepaid expenses related
party of $10.5 million, and an increase in accounts receivable of $7.0 million.
These amounts were offset by an increase in account payables and accounts
payables related party of $5.1 million, and an increase in advances from
customers of $1.3 million,





Cash
(Used in) Provided by Investing Activities





Net cash
used in investing activities for the nine months ended September 30, 2008
totaled $12.9 million compared to net cash provided by investing activities of
$2.6 million for the nine months ended September 30, 2007. The net cash used in
investing activities for the nine months ended September 30, 2008 was primarily
a result of additional property plant and equipment fixed asset purchases of
$11.2 million mainly to expansion in our magnesium segment, and increases in
loans receivables of 3.1 million, partially offset by a decrease in notes
receivables of $938,000 and proceeds from the sale of marketable securities of
$432,000.





The net
cash provided by investing activities as of September 30, 2007 of $2.6 million
was primarily due to $1.9 million received from sale of marketable securities,
and $2.2 million received in conjunction with our acquisitions, offset by the
purchase of $1.4 million in property, plant and equipment.





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Cash
Provided by Financing Activities





For the
nine months ended September 30, 2008 net cash provided by financing activities
was $12.0 million. We received gross proceeds of $12.95 million from the sale of
Series A Preferred Stock, $2.98 million from the exercise of warrants and
options, and $2.1 million of proceeds from loans payables and collections of
approximately $1.3 on due from related parties. These amounts received were
offset by $2.9 million in loan payments and payment of $1.5 million in offering
expenses related to our sale of Series A Preferred Stock.





For the
nine months ended September 30, 2007 net cash provided by financing activities
was $16.5 million which was mainly due to proceeds from exercises of options of
$14.9 million, and proceeds from loans payable of $1.6 million. These increases
were offset by repayment of advances in the amount of $141,000 made by our
executive officers during the nine months ended September 30, 2007.





Series
A Preferred Stock and Related Dividends





In
February 2008, we completed a private placement 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 approximately $11.5 million. The
Series A Preferred Stock has a stated value per share of $1,000, carries an 8%
per annum dividend rate payable quarterly in arrears and is convertible into our
common stock at $7.00 per share. The dividends are payable in cash or shares of
our common stock, at our option, subject to certain provisions.





As of
September 30, 2008, holders of our Series A Preferred Stock have converted
11,944 shares of the 12,950 shares of the Series A Preferred Stock sole in the
February 2008 offering. As a result of the conversion of the Series A Preferred
Stock, we have issued 1,706,250 shares of our common stock, 10,346 shares of
common stock in payment of the accrued dividends and 136,500 shares of common
stock pursuant to the make whole additional amount feature of the Series A
Preferred Stock.  In connection with this offering, we recorded the
relative fair value of the warrants of $2,765,946 and an additional $2,451,446
attributable to the beneficial conversion feature as a non-cash one-time
preferred stock deemed dividend in the first quarter of 2008. See Note 11 of the
Notes to Unaudited Consolidated Financial Statements - Stockholders’
Equity.





Minority
Interest





At
September 30, 2008, our consolidated balance sheet reflects a total minority
interest of $27.9 million which represents the equity portion of our
subsidiaries held by minority shareholders. The following table provides
information regarding the minority interest by segment:





Segment
                                
                                Amount
                                  (in
      thousands)Magnesium
      segment
                                
                                $
                                26,028Basic
      Materials segment
                                
                                
                                1,950Consulting
      segment
                                
                                
                                -Total
                                
                                $
                                27,978





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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 unaudited 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 Note 2 to the unaudited
consolidated financial statements included in this quarterly report. Management
believes that the application of these policies on a consistent basis enables us
to provide useful and reliable financial information about our operating results
and financial condition.





Acquisitions





We
account for acquisitions using the purchase method of accounting in accordance
with SFAS No. 141. In each of our acquisitions for the periods presented, we
determined that fair values were equivalent to the acquired historical carrying
costs.





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Recent
Accounting Pronouncements





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial
Assets and Financial Liabilities-including an amendment of FAS 115 ”.
SFAS 159 allows entities to choose, at specified election dates, to measure
eligible financial assets and liabilities at fair value that are not otherwise
required to be measured at fair value. If a company elects the fair value option
for an eligible item, changes in that item’s fair value in subsequent reporting
periods must be recognized in current earnings. SFAS 159 is effective for fiscal
years beginning after November 15, 2007. SFAS 159 had no impact on our financial
statements as of September 30, 2008, and we will continue to evaluate the
impact, if any, of SFAS 159 on our financial statements.





In
December 2007, the FASB issued SFAS 141 (revised 2007), “Business Combinations”. SFAS
141R is a revision to SFAS 141 and includes substantial changes to the
acquisition method used to account for business combinations (formerly the
“purchase accounting” method), including broadening the definition of a
business, as well as revisions to accounting methods for contingent
consideration and other contingencies related to the acquired business,
accounting for transaction costs, and accounting for adjustments to provisional
amounts recorded in connection with acquisitions. SFAS 141R retains the
fundamental requirement of SFAS 141 that the acquisition method of accounting be
used for all business combinations and for an acquirer to be identified for each
business combination. SFAS 141R is effective for periods beginning on or after
December 15, 2008, and will apply to all business combinations occurring after
the effective date. We are currently evaluating the requirements of SFAS 141R
and the impact of adoption on our consolidated financial
statements.





In
December 2007, the FASB issued SFAS 160, “Non-controlling Interests in
Consolidated Financial Statements - an amendment of Accounting Research Bulletin
No. 51, Consolidated Financial Statements ” (“ARB 51”). This Statement
amends ARB 51 to establish new standards that will govern the (1) accounting for
and reporting of non-controlling interests in partially owned consolidated
subsidiaries and (2) the loss of control of subsidiaries. A non-controlling
interest will be reported as part of equity in the consolidated financial
statements. Losses will be allocated to the non-controlling interest, and, if
control is maintained, changes in ownership interests will be treated as equity
transactions. Upon a loss of control, any gain or loss on the interest sold will
be recognized in earnings. SFAS 160 is effective for periods beginning after
December 15, 2008. We are currently evaluating the requirements of SFAS 160 and
the impact of adoption on our consolidated financial statements.





In March
2008, the FASB issued SFAS 161, “Disclosures about Derivative
Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 is intended to
improve financial reporting about derivative instruments and hedging activities
by requiring enhanced disclosures to enable investors to better understand their
effects on an entity’s financial position, financial performance, and cash
flows. It is effective for financial statements issued for fiscal years and
interim periods beginning after November 15, 2008, with early application
encouraged. We are currently evaluating the requirements of SFAS 161 and the
impact of adoption on our consolidated financial statements.





In May
2008, the Financial Accounting Standards Board (“FASB”) issued FASB Staff
Position (“FSP”) APB 14-1,Accounting for Convertible Debt Instruments That May Be Settled in Cash upon
Conversion (Including Partial Cash Settlement). FSP APB 14-1 clarifies
that convertible debt instruments that may be settled in cash upon either
mandatory or optional conversion (including partial cash settlement) are not
addressed by paragraph 12 of APB Opinion No. 14,Accounting for Convertible Debt and
Debt issued with Stock Purchase Warrants. Additionally, FSP APB 14-1
specifies that issuers of such instruments should separately account for the
liability and equity components in a manner that will reflect the entity’s
nonconvertible debt borrowing rate when interest cost is recognized in
subsequent periods. FSP APB 14-1 is effective for financial statements issued
for fiscal years beginning after December 15, 2008, and interim periods within
those fiscal years. We will adopt FSP APB 14-1 beginning in the first quarter of
fiscal 2009, and this standard must be applied on a retrospective basis. We are
evaluating the impact the adoption of FSP APB 14-1 will have on our consolidated
financial position and results of operations.





In May
2008, the FASB issued SFAS No. 162,The Hierarchy of Generally Accepted
Accounting Principles. This standard is intended to improve financial
reporting by identifying a consistent framework, or hierarchy, for selecting
accounting principles to be used in preparing financial statements that are
presented in conformity with generally accepted accounting principles in the
United States for non-governmental entities. SFAS No. 162 is effective 60 days
following approval by the U.S. Securities and Exchange Commission (“SEC”) of the
Public Company Accounting Oversight Board’s amendments to AU Section 411,The Meaning of Present Fairly in
Conformity with Generally Accepted Accounting Principles . We do not
expect SFAS No. 162 to have a material impact on the preparation of our
consolidated financial statements.





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On
September 16, 2008, the FASB issued FSP No. EITF 03-6-1, “Determining Whether Instruments
Granted in Share-Based Payment Transactions Are Participating Securities”
to address the question of whether instruments granted in share-based payment
transactions are participating securities prior to vesting. The FSP determines
that unvested share-based payment awards that contain rights to dividend
payments should be included in earnings per share calculations. The guidance
will be effective for fiscal years beginning after December 15, 2008. We are
currently evaluating the requirements of FSP No. EITF 03-6-1.





On
October 10, 2008, the FASB issued FSP No. 157-3, Determining the Fair Value of a
Financial Asset When the Market for That Asset Is Not Active.This FASB
Staff Position (FSP) clarifies the application of FASB Statement No. 157, Fair Value Measurements(“Statement 157”), in a
market that is not active and provides an example to illustrate key
considerations in determining the fair value of a financial asset under those
circumstances. Statement 157 was issued in September 2006, and is effective for
financial assets and financial liabilities for financial statements issued for
fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. We have adopted FSP 157-3 and determined that it had no
impact as of September 30, 2008 on our financial statements, and we will
continue to evaluate the impact, if any, of FSP 157-3 on our 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 Quarterly Report on Form 10-Q and other written and oral
statements that we make from time to time contain such forward-looking
statements that set out anticipated results based on management’s plans and
assumptions regarding future events or performance. We have tried, wherever
possible, to identify such statements by using words such as “anticipate,”
“estimate,” “expect,” “project,” “intend,” “plan,” “believe,” “will” and similar
expressions in connection with any discussion of future operating or financial
performance. In particular, these include statements relating to future actions,
future performance or results of current and anticipated sales efforts,
expenses, the outcome of contingencies, such as legal proceedings, and financial
results. A list of factors that could cause our actual results of operations and
financial condition to differ materially is set forth below, and these factors
are discussed in greater detail under Item 1A – “Risk Factors” of our Annual
Report on Form 10-K for the fiscal year ended December 31, 2007 and registration
statement filed on Form S-3 (File No. 333-151648) filed on July 16,
2008:







·
            Continued
      global economic weakness is expected to reduce demand for our products in
      each of our segments.·
            Our
      ability to identify and close acquisitions of operating companies in China
      in a cost effective manner that enhance our financial
      condition.·
            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
      ability to effectively integrate our acquisitions and to manage our growth
      and our inability to fully realize any anticipated benefits of acquired
      business.·
            The
      value of the equity securities we accept as compensation is subject to
      adjustment which could result in losses to us in future
      periods.·
            The
      Investment Company Act of 1940 which limits the value of securities we can
      accept as payment for our business consulting services which may limit our
      future revenues.·
            Our
      acquisition efforts in future periods may be dilutive to our then current
      shareholders.·
            Our
      dependence on certain key personnel.·
            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.·
            Our
      ability to assure that related party transactions are fair to our
      company.·
            Chang
      Magnesium’s chief executive officer is also chief executive officer of a
      group of companies which directly compete with Chang
      Magnesium.·
            The
      risks and hazards inherent in the mining industry on the operations of our
      basic materials segment.·
            The
      effect of changes resulting from the political and economic policies of
      the Chinese government on our assets and operations located in the
      PRC.·
            The
      influence of the Chinese government over the manner in which our Chinese
      subsidiaries must conduct our business activities.·
            The
      impact on future inflation in China on economic activity in
      China.·
            The
      impact of any recurrence of severe acute respiratory syndrome, or SAR’s,
      or another widespread public health problem.·
            The
      limitation on our ability to receive and use our revenues effectively as a
      result of restrictions on currency exchange in China.·
            Our
      ability to enforce our rights due to policies regarding the regulation of
      foreign investments in China.·
            Our
      ability to comply with the United States Foreign Corrupt Practices Act
      which could subject us to penalties and other adverse
      consequences.·
            Our
      ability to establish adequate management, legal and financial controls in
      the PRC.·
            The
      provisions of our articles of incorporation and bylaws which may delay or
      prevent a takeover which may not be in the best interests of our
      shareholders.





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.





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Item
      3.
            Quantitative and Qualitative Disclosures About
      Market Risk.





Not
applicable for a smaller reporting company.





Item
      4T.
            Controls
      and Procedures.





Disclosure
Controls and Procedures





Under the
supervision and with the participation of our management, including our Chief
Executive Officer who serves as our principal executive officer and our Vice
President - Finance who serves as our principal financial officer, we conducted
an evaluation of the effectiveness of the design and operation of our disclosure
controls and procedures, as defined in Rules 13a-15(e) under the Securities
Exchange Act of 1934, as amended, as of the period ended September 30,
2008 (the “Evaluation Dates”). Based on this evaluation, our principal executive
officer and principal financial officer concluded as of the Evaluation Dates
that our disclosure controls and procedures were effective such that the
information relating to China Direct, including our consolidated subsidiaries,
required to be disclosed in our SEC reports (i) is recorded, processed,
summarized and reported within the time periods specified in SEC rules and forms
and (ii) is accumulated and communicated to our management, including our
principal executive officer and principal financial officer, as appropriate, to
allow timely decisions regarding required disclosure. Our evaluation included
all business entities, which were part of our company at the Evaluation
Dates.





Our
management, including our Chief Executive Officer and our Vice President -
Finance, 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 over Financial Reporting





There
have been no changes in our internal control over financial reporting during our
last fiscal quarter that has materially affected, or is reasonably likely to
materially affect, our internal control over financial reporting.





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PART
II - OTHER INFORMATION





Item
      1.
            Legal
      Proceedings.





None.





Item
      1A.
            Risk
      Factors





Risk
factors describing the major risks to our business can be found under Item 1A,
“Risk Factors”, in our Annual Report on Form 10-K for the year ended December
31, 2007. There has been no material change in our risk factors from those
previously discussed in the Annual Report on Form 10-K.





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





(a)
Recent Sales of Unregistered Securities





During
the three month period ended September 30, 2008, we granted 20,748 shares of
restricted common stock, $.0001 par value, which vest over the next twenty-four
months.





The
restricted stock was awarded to our employees under the 2008 Non-Executive Stock
Incentive Plan approved by our shareholders. The restricted stock awards are
subject to vesting periods ranging from 2008 to 2011. The shares were granted
pursuant to an exemption from registration under Section 4(2) of the Securities
Act of 1933 since the award by us did not involve a public offering. The award
was not a "public offering" as defined in Section 4(2) of the Securities Act of
1933 due to the insubstantial number of persons involved, size of the offering,
manner of the offering and number of shares awarded. In addition, the recipients
had the necessary investment intent as required by Section 4(2) of the
Securities Act since they agreed to allow us to include a legend on any shares
issued stating that such shares are restricted pursuant to Rule 144 of the 1933
Securities Act. Based on an analysis of the above factors, we have met the
requirements to qualify for exemption under Section 4(2) of the Securities Act
of 1933 for the above awards.





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(b) Issuer
Purchases of Equity Securities





This
table provides information with respect to our purchases of shares of our common
stock, $.0001 par value per share, during the three months ended September 30,
2008.





Period
                                      
                                      Total
      Number of Shares Purchased(1)
                                      
                                      Average
      Price Paid Per Share
                                      
                                      Total
      Number Of Shares Purchased as Part of Publicly Announced Plans or
      Programs
                                      
                                      Maximum
      Approximate Dollar Value of Shares that May Yet Be Purchased Under the
      Plans or Programs(2)July 1,
      2008 through July 31, 2008
                                      
                                      -
                                      
                                      $
                                      -
                                      
                                      -
                                      
                                      $
                                      -August 1,
      2008 through August 31, 2008
                                      
                                      -
                                      
                                      $
                                      -
                                      
                                      -
                                      
                                      $
                                      -September 1,
      2008 through September 30, 2008
                                      
                                      74,502
                                      
                                      $
                                      5.04
                                      
                                      74,502
                                      
                                      $
                                      2,477,630Total
                                      
                                      74,502
                                      
                                      $
                                      5.04
                                      
                                      74,502
                                      
                                      $
                                      2,477,630





(1)  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. The table includes
4,919 shares purchased at a price of $4.55 per share, which were redeemed in
September 2008. The table does not include 15,000 shares purchased at $3.80 per
share in October 2008 redeemed in October 2008.





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. The table includes 69,583 shares purchased at a price of
$5.07 per share, 3,761 shares were redeemed during September 2008 and 65,822
shares were redeemed in October 2008.





(2)  Amounts
reflect the remaining dollar value of shares that may be purchased under the
stock repurchase program described above.




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Item
      3.
            Defaults Upon Senior
  Securities.





None.





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





None.





Item 5.
            Other
      Information.





On
October 30, 2008, we completed the sale of an 81% interest in our wholly owned
subsidiary CDI Clean Technology Group, Inc. (“CDI Clean Technology”) to PE
Brothers Corp. for $1,240,000, which was paid in the form of the buyer’s
promissory note. The promissory note provides for principal payments of $240,000
on December 31, 2008, $500,000 on December 31, 2009 and $500,000 on June 30,
2010 and interest at the rate of 1% per annum. The promissory note is secured by
all of the assets of CDI Clean Technology, the CDI Clean Technology stock
purchased by PE Brothers Corp., all of the assets of CDI Wanda, and additional
assets pledged by Yang Li, the principal shareholder of PE Brothers Corp. and a
minority owner of Yantai Wanda. CDI Clean Technology was included within
“Subsidiaries held for sale” on our September 30, 2008 Unaudited Consolidated
Balance Sheet.





On
November 13, 2008, Yuejian (James) Wang, Ph.D, our Chief Executive Officer, Marc
Siegel, our President and David Stein, entered into an amendment to their
respective August 7, 2008 employment agreements with us. The November 13, 2008
amendments waive the annual base salary included in the employment agreements
from August 1, 2008 through October 1, 2008. All other terms and conditions of
the employment agreements remain in full force and effect.





On April
26, 2008 CDI China entered into an Investment Framework Agreement to form Baotou
Xinjin Magnesium Co., Ltd., a Chinese limited liability company (“Xinjin
Magnesium”) to jointly invest and increase the registered capital thereby
forming an FIE.  During the quarter ended September 2008, we elected
not to pursue this venture. We did not contribute any capital to Xinjin
Magnesium.





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Management
Update





As we
shift our focus to our management services division operations within China, we
will seek to augment our management team with professionals who possess greater
operating experience within China.  As of the date of this filing, we
will make the following changes to improve the effectiveness of our management
team.





Wuliang
(Frank) Zhang, Vice General Manager of Chang Magnesium will assume the title of
Executive Vice President of our Magnesium segment.  In this capacity,
Mr. Zhang, who is based in Shanghai, will be responsible for ensuring that our
magnesium operations meet our prescribed operational objectives for sales,
profitability, efficiency, facility construction, quality, maintenance and
safety.





Mr. Zhang
is a veteran of the magnesium industry within China for the past ten years. Mr.
Zhang will provide U.S. based management with direct visibility to the
operations of our magnesium segment and will allow us to seek additional
opportunities to expand this segment.





Jingdong
Chen, CEO of Lang Chemical, the principal component of our Basic Materials
segment, will assume the title of Executive Vice President of our Basic
Materials segment. Mr. Chen will be our direct liaison to the segment, providing
critical insights into the industry on a real time basis. Mr. Chen has in excess
of 10 years of experience operating within the chemical industry within China.
As such, Mr. Chen will be instrumental as we look to expand this
segment.





Ms. Jenny
Liu, our Vice President of finance will head up the expansion of our accounting
staff in China in addition to her role as our Principal Financial and Accounting
Officer. Ms. Liu will recruit and train additional accounting staff in China to
enhance our accounting for our expanding operations and as a means to further
centralize our financial management.





As both
Mr. Zhang and Mr. Chen assume responsibility for operations of our Magnesium and
Basic Materials segments respectively, David Stein will assume the title of
Executive Vice President – Advisory Services and will be responsible for
supervision of our professional resources.





These
actions provide a summary of the action plan we will implement over the coming
months which we have devised to support our shift from a financial services
entity to one with significant operations within China. These actions will also
add additional resources in China necessary to support our growing operations
and enable us to continue our long-term success.





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Item
      6.
            Exhibits





No.
            Description3.2
            By-Laws
      (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. 333-147603)).10.19
            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)).10.20
            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)).10.21
            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. 333-147603)).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. 333-147603)).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. 333-147603)).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.
      333-147603)).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.
      333-147603)).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.
      333-147603)).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.
      333-147603)).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*31.1
            Rule 13a-14(a)/ 15d-14(a) Certification of Chief
      Executive Officer *31.2
            Rule 13a-14(a)/ 15d-14(a) Certification of Principal
      Financial and Accounting Officer *32
            Section 1350 Certification of Chief Executive Officer and
      the Principal Financial and Accounting Officer
  *





* Filed
herewith








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SIGNATURES





Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has
duly caused this report to be signed on its behalf by the undersigned thereunto
duly authorized.





CHINA
      DIRECT, INC.By:
      /s/ Yuejian (James) WangYuejian
      (James) Wang,Chairman
      and Chief Executive Officer(Principal
      Executive Officer)Date:
      November 13, 2008By:
      /s/ Yi (Jenny) LiuYi
      (Jenny) Liu,Vice
      President - Finance(Principal
      Financial and Accounting Officer)Date:
      November 13, 2008














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