UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, 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 June 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. 23,503,916 shares of common stock are issued and outstanding as of August 7, 2008.


 

TABLE OF CONTENTS

 

 

 

 

 

 

 

Page No.

 

 

 

 

PART I. - FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements.

 

5

Item 2.

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

 

28

Item 3.

Quantitative and Qualitative Disclosures About Market Risk.

 

43

Item 4T

Controls and Procedures.

 

43

 

 

 

 

PART II - OTHER INFORMATION

 

 

Item 1.

Legal Proceedings.

 

44

Item 1A.

Risk Factors.

 

44

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds.

 

44

Item 3.

Defaults Upon Senior Securities.

 

44

Item 4.

Submission of Matters to a Vote of Security Holders.

 

44

Item 5.

Other Information.

 

45

Item 6.

Exhibits.

 

46

2


ORGANIZATIONAL CHART

          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 chart reflects our current organizational structure.

3


INDEX OF CERTAIN DEFINED TERMS USED IN THIS REPORT

 

 

 

When used in this report the terms:

 

 

“China Direct”, “we”, “us” or “our” refers to China Direct, Inc., a Florida corporation, and our subsidiaries,

 

 

“China Direct Investments”, refers to China Direct Investments, Inc., a Florida corporation and a wholly owned subsidiary of China Direct,

 

 

“CDI China”, refers to CDI China, 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,

 

 

“Lang Chemical”, refers to Shanghai Lang Chemical Co., Ltd. a Chinese limited liability company and a 51% majority owned subsidiary of CDI China,

 

 

“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,

 

 

“Xinjin Magnesium”, refers to Baotou Xinjin Magnesium Co., Ltd., a Chinese limited liability company. In April 2008 CDI China entered into an agreement to acquire a 51% majority owned subsidiary of Xinjin Magnesium,

 

 

“CDI Clean Technology”, refers to CDI Clean Technology Group, Inc., a Florida corporation formerly known as Jinan Alternative Energy Group Corp., and a wholly owned subsidiary of CDI China,

 

 

“CDI Wanda”, refers to Shandong CDI Wanda New Energy Co., Ltd., a Chinese limited liability company and a 51% majority owned subsidiary of CDI Clean Technology,

 

 

“Yantai CDI Wanda”, refers to Yantai CDI Wanda Renewable Resources Co., Ltd., a Chinese limited liability company and a 52% majority owned subsidiary of CDI Wanda,

 

 

“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 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

 

 

“CDI Beijing”, refers to CDI (Beijing) International Trading Co., Ltd, a Chinese limited liability company.

4


PART 1 - FINANCIAL INFORMATION

 

 

Item 1.

Financial Statements.

CHINA DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

 

 

 

 

 

 

 

 

 

 

June 30,
2008

 

December 31,
2007

 

 

 

 

 

 

 

 

 

Unaudited

 

 

 

 

ASSETS

 

 

 

 

 

 

 

Current Assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

26,424,935

 

$

20,394,931

 

Investment in marketable securities available for sale

 

 

4,732,593

 

 

7,820,500

 

Investment in marketable securities available for sale-related party

 

 

766,019

 

 

1,315,488

 

Accounts receivable, net of allowance for doubtful accounts of $335,851 and $290,456 at June 30, 2008 and December 31, 2007, respectively

 

 

24,415,061

 

 

10,655,661

 

Accounts receivable-related parties

 

 

556,687

 

 

2,283,600

 

Inventories

 

 

12,286,538

 

 

5,293,986

 

Prepaid expenses and other current assets

 

 

21,564,895

 

 

15,439,462

 

Prepaid expenses-related parties

 

 

4,821,163

 

 

4,150,943

 

Loans receivable-related parties

 

 

1,597,305

 

 

 

Due from related parties

 

 

14,552

 

 

1,287,877

 

 

 

 
 

 

 
 

 

Total current assets

 

 

97,179,748

 

 

68,642,448

 

 

 

 

 

 

 

 

 

Restricted cash

 

 

2,874

 

 

646,970

 

Property, plant and equipment, net of accumulated depreciation of $1,499,088 and $577,801 at June 30, 2008 and December 31, 2007, respectively

 

 

25,650,264

 

 

18,010,524

 

Prepaid expenses and other assets

 

 

234,683

 

 

433,075

 

Property use rights, net

 

 

582,733

 

 

553,304

 

 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

Total assets

 

$

123,650,302

 

$

88,286,321

 

 

 

 
 

 

 
 

 

LIABILITIES AND STOCKHOLDERS’ EQUITY

 

 

 

 

 

 

 

Current Liabilities:

 

 

 

 

 

 

 

Loans payable-short term

 

$

1,229,663

 

$

1,978,142

 

Accounts payable and accrued expenses

 

 

11,584,094

 

 

9,649,797

 

Accounts payable-related parties

 

 

735,184

 

 

964,114

 

Notes payable-related party

 

 

 

 

410,167

 

Accrued dividends payable

 

 

20,015

 

 

 

Advances from customers

 

 

5,785,605

 

 

6,963,061

 

Other payables

 

 

6,229,216

 

 

4,097,716

 

Taxes payable

 

 

943,779

 

 

560,116

 

Due to related parties

 

 

576,890

 

 

3,137,233

 

 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

Total current liabilities

 

 

27,104,446

 

 

27,760,346

 

 

 

 

 

 

 

 

 

Loans payable-long term

 

 

210,280

 

 

166,573

 

 

 

 

 

 

 

 

 

Minority interest

 

 

26,351,743

 

 

17,535,909

 

 

 

 

 

 

 

 

 

Stockholders’ 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 June 30, 2008 and December 31, 2007, respectively

 

 

1,006,250

 

 

 

Common Stock: $.0001 par value, 1,000,000,000 authorized, 23,501,056 and 20,982,010 issued and outstanding at June 30, 2008 and December 31, 2007, respectively

 

 

2,350

 

 

2,098

 

Additional paid-in capital

 

 

50,654,559

 

 

30,257,644

 

Deferred compensation

 

 

(33,000

)

 

(55,000

)

Accumulated comprehensive income

 

 

36,076

 

 

162,045

 

Retained earnings

 

 

18,317,598

 

 

12,456,706

 

 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

Total stockholders’ equity

 

 

69,983,833

 

 

42,823,493

 

 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

Total liabilities and stockholders’ equity

 

$

123,650,302

 

$

88,286,321

 

 

 

 
 

 

 
 

 

See notes to unaudited consolidated financial statements

5


CHINA DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

For the Three Months
Ended June 30,

 

For the Six Months
Ended June 30,

 

 

 

 

 

 

 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

76,215,437

 

$

40,012,970

 

$

135,456,235

 

$

70,511,910

 

Revenues-related parties

 

 

1,344,725

 

 

440,000

 

 

2,078,646

 

 

880,000

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

Total revenues

 

 

77,560,162

 

 

40,452,970

 

 

137,534,881

 

 

71,391,910

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cost of revenues

 

 

64,045,927

 

 

36,742,381

 

 

113,525,741

 

 

64,209,395

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Gross profit

 

 

13,514,235

 

 

3,710,589

 

 

24,009,140

 

 

7,182,515

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

Selling, general, and administrative

 

 

2,635,633

 

 

847,417

 

 

4,335,603

 

 

1,684,926

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Operating income

 

 

10,878,602

 

 

2,863,172

 

 

19,673,537

 

 

5,497,589

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

 

 

 

Other income

 

 

102,521

 

 

371,433

 

 

296,139

 

 

381,369

 

Interest income

 

 

129,470

 

 

41,855

 

 

220,172

 

 

71,021

 

Realized gain (loss) on sale of marketable securities

 

 

3,756

 

 

206,236

 

 

(35,705

)

 

206,236

 

Realized loss on sale of marketable
securities-related party

 

 

 

 

(16,041

)

 

 

 

(32,014

)

 

 

 
 

 

 
 

 

 
 

 

 
 

 

Total other income

 

 

235,747

 

 

603,483

 

 

480,606

 

 

626,612

 

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

Income before income taxes and minority interest

 

 

11,114,349

 

 

3,466,655

 

 

20,154,143

 

 

6,124,201

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

 

(705,176

)

 

(522,159

)

 

(1,157,656

)

 

(754,731

)

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income before minority interest

 

 

10,409,173

 

 

2,944,496

 

 

18,996,487

 

 

5,369,470

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Minority interest

 

 

(2,894,298

)

 

(676,754

)

 

(6,728,736

)

 

(1,230,859

)

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

 

7,514,875

 

 

2,267,742

 

 

12,267,751

 

 

4,138,611

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Deduct dividends on Series A Preferred Stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock dividend

 

 

(1,047,937

)

 

 

 

(1,189,467

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Relative fair value of detachable warrants issued

 

 

 

 

 

 

(2,765,946

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock beneficial conversion feature

 

 

 

 

 

 

(2,451,446

)

 

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income applicable to common stockholders

 

$

6,466,938

 

$

2,267,742

 

$

5,860,892

 

$

4,138,611

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic and diluted income per common share after deduction in the first quarter of 2008, of noncash deemed dividends attributable to Series A Preferred Stock as described in Notes 3 & 11 of the Notes to the Unaudited Consolidated Financial Statements:

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.29

 

$

0.16

 

$

0.27

 

$

0.31

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted

 

$

0.26

 

$

0.15

 

$

0.24

 

$

0.27

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic weighted average common shares outstanding

 

 

22,663,337

 

 

13,882,955

 

 

21,833,388

 

 

13,464,666

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Diluted weighted average common shares outstanding

 

 

25,427,385

 

 

15,380,420

 

 

24,160,683

 

 

15,174,110

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

See notes to unaudited consolidated financial statements

6


CHINA DIRECT, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 

 

 

 

 

 

 

 

 

 

For the Six Months
Ended June 30,

 

 

 

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

Net income

 

$

12,267,751

 

$

4,138,611

 

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

 

 

 

 

 

 

 

Depreciation

 

 

921,287

 

 

122,810

 

Bad debt recovery

 

 

 

 

(102,126

)

Allowance for doubtful accounts

 

 

45,395

 

 

 

Stock based compensation

 

 

848,364

 

 

196,010

 

Realized gain on investment in marketable securities

 

 

35,705

 

 

(206,236

)

Realized loss on investment in marketable securities-related party

 

 

 

 

32,014

 

Fair value of securities received for services

 

 

(392,942

)

 

(3,275,450

)

Minority interest

 

 

8,815,834

 

 

1,230,859

 

Changes in operating assets and liabilities:

 

 

 

 

 

 

 

Prepaid expenses and other current assets

 

 

(4,857,996

)

 

(4,189,986

)

Prepaid expenses-related parties

 

 

(670,220

)

 

(418,875

)

Inventories

 

 

(6,992,552

)

 

4,523,227

 

Accounts receivable

 

 

(14,751,692

)

 

(7,455,735

)

Accounts receivable-related parties

 

 

1,726,913

 

 

 

Accounts payable and accrued expenses

 

 

2,526,304

 

 

697,606

 

Accounts payable-related party

 

 

(228,930

)

 

3,145,428

 

Advances from customers

 

 

(1,177,456

)

 

825,145

 

Other payables

 

 

2,131,500

 

 

2,940,552

 

Deferred income taxes

 

 

 

 

12,929

 

Income taxes payable

 

 

820,686

 

 

(71,600

)

 

 

 
 

 

 
 

 

Net cash provided by operating activities

 

 

1,067,951

 

 

2,145,183

 

 

 

 
 

 

 
 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

Cash acquired from acquisitions

 

 

 

 

55,777

 

Decrease in notes receivable

 

 

946,897

 

 

750,086

 

Increase in loans receivable

 

 

(1,060,156

)

 

 

Increase in loans receivable-related parties

 

 

(1,597,305

)

 

 

Proceeds from the sale of marketable securities available for sale

 

 

428,395

 

 

1,192,487

 

Purchases of property, plant and equipment

 

 

(7,364,599

)

 

(152,273

)

 

 

 
 

 

 
 

 

Net cash (used in) provided by investing activities

 

 

(8,646,768

)

 

1,846,077

 

 

 

 
 

 

 
 

 

Cash flows from financing activities:

 

 

 

 

 

 

 

Decrease in restricted cash

 

 

644,096

 

 

447,713

 

Proceeds from loans payable

 

 

1,161,303

 

 

 

Payment of loans payable

 

 

(1,866,075

)

 

(1,455,746

)

Payments of notes payable

 

 

(592,007

)

 

 

Payments of notes payable-related party

 

 

(410,167

)

 

 

Payment of advances from executive officers

 

 

 

 

(140,893

)

Due from related parties

 

 

1,273,325

 

 

(996,525

)

Due to related parties

 

 

(2,560,343

)

 

17,336

 

Gross proceeds from sale of preferred stock

 

 

12,950,000

 

 

 

Proceeds from exercise of warrants/options

 

 

2,782,376

 

 

3,062,500

 

Cash dividend payment to preferred stock holders

 

 

(141,530

)

 

 

 

Offering expenses

 

 

(1,504,345

)

 

 

 

 

 
 

 

 
 

 

Net cash provided by financing activities

 

 

11,736,633

 

 

934,385

 

 

 

 
 

 

 
 

 

EFFECT OF EXCHANGE RATE ON CASH

 

 

1,872,188

 

 

176,805

 

 

 

 

 

 

 

 

 

Net increase in cash

 

 

6,030,004

 

 

5,102,450

 

 

 

 

 

 

 

 

 

Cash, beginning of year

 

 

20,394,931

 

 

3,030,345

 

 

 

 
 

 

 
 

 

Cash, end of period

 

$

26,424,935

 

$

8,132,795

 

 

 

 
 

 

 
 

 

Supplemental disclosures of cash flow information:

 

 

 

 

 

 

 

Cash paid for taxes

 

$

146,716

 

$

476,995

 

 

 

 
 

 

 
 

 

Cash paid for interest

 

$

169,385

 

$

5,036

 

 

 

 
 

 

 
 

 

Dividend payment in stock to preferred stock shareholders

 

$

1,027,922

 

$

 

 

 

 
 

 

 
 

 

Non-cash preferred stock deemed dividend

 

$

5,217,392

 

$

 

 

 

 
 

 

 
 

 

See notes to unaudited consolidated financial statements

7


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

NOTE 1 – ORGANIZATION AND DESCRIPTION OF BUSINESS

Business and Organization

China Direct, Inc., a Florida corporation formerly known as Evolve One, Inc., and its subsidiaries are referred to in this report as the “Company”, “we”, “us”, “our”, or “China Direct”. China Direct Investments, Inc., a Florida corporation and a wholly owned subsidiary of China Direct is referred to in this report as “China Direct Investments”. CDI China, Inc., a Florida corporation and a wholly owned subsidiary of China Direct is referred to in this report as “CDI China”.

China Direct is 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. 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 accounting principles generally accepted in the United States of America 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.

In January 2008, our majority owned subsidiary, CDI Wanda, formed Yantai CDI Wanda Renewable Resources Co., Ltd., a Chinese limited liability company (“Yantai CDI Wanda”) as a joint venture entity. CDI Wanda contributed $712,329 as registered capital to acquire its 52% interest. Yantai CDI Wanda is constructing and will operate a scrap tire recycling center utilizing a recycling process developed by CDI Wanda.

In February 2008, our subsidiary, CDI Shanghai Management formed Shanghai CDI Metal Recycling Co., Ltd., a Chinese limited liability company (“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 October 2008.

In February 2008, our subsidiary, CDI China, entered into an agreement with Excel Rise and Three Harmony (Australia) Party, Ltd. (“Three Harmony”) to form Baotou Changxin Magnesium Co., Ltd., a Chinese limited liability company (“Baotou Changxin Magnesium”) as a FIE. CDI China contributed approximately $7,084,000 to the registered capital of this entity, Excel Rise $5,417,000 and Three Harmony $1,389,000, representing a 51%, 39% and 10% interest, respectively. Baotou Changxin Magnesium is a 51% owned subsidiary of CDI China and a 39% owned subsidiary of Excel Rise. Accordingly, China Direct holds a 70.9% interest in Baotou Changxin Magnesium. As of the date of this report, CDI China has contributed $7,084,000 to the registered capital of this entity.

8


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

On April 26, 2008 CDI China entered into an Investment Framework Agreement with Baotou Xinjin Magnesium Co., Ltd., a Chinese limited liability company (“Xinjin Magnesium”) to jointly invest and increase the registered capital of Xinjin Magnesium thereby forming a foreign invested enterprise (“FIE”). Under the terms of the agreement, prior to forming the FIE, Xinjin Magnesium will increase its registered capital from approximately $285,714 to approximately $4.7 million. Upon forming the FIE, CDI China will invest a total of approximately $7.3 million to obtain a 51% interest in the new entity and the current owners of Xinjin Magnesium will invest approximately $2.3 million in the form of cash and fixed assets representing the remaining 49% interest. CDI China's investment will be made over the course of two years, once the business license has been approved, in accordance with PRC law. On August 1, 2008, CDI China and Xinjin Magnesium agreed to amend the April 26, 2008 Investment Framework Agreement to extend the date on which CDI China’s initial investment is due until December 31, 2008.

On June 20, 2008, CDI Shanghai Management entered into a Joint Venture Agreement (the “Agreement”) with Chen Chi, an individual, to form CDI (Beijing) International Trade Co., Ltd., a Chinese limited liability company (“CDI Beijing”). Under the terms of the Agreement, CDI Shanghai Management will acquire a 51% interest in CDI Beijing upon approval of a business license from the Chinese government. CDI Beijing plans to engage 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 to be contributed by Mr. Chi and CDI Shanghai Management is an aggregate of $7.27 million. Mr. Chi and CDI Shanghai Management have subscribed to invest $3.57 million and $3.7 million, respectively, in installments over a 12 month period after approval of CDI Beijing’s business license. Chen Chi is a minority interest owner in Yantai CDI Wanda.

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, and the useful life of property, plant and equipment.

Cash and Cash Equivalents

For purposes of the consolidated statements of cash flows, we consider all highly liquid investments with original maturities of three months or less to be cash equivalents. The carrying values of these investments approximate their fair value.

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 June 30, 2008, bank deposits in the United States exceeded federally insured limits by $1,520,009. At June 30, 2008, we had deposits of $14,536,425 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 June 30, 2008.

At June 30, 2008 and December 31, 2007, our bank deposits by geographic area were as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Country

 

June 30, 2008

 

December 31, 2007

 

 
 
 
 
 
 

United States

 

$

11,888,510

 

 

45

%

$

9,942,948

 

 

49

%

China

 

 

14,536,425

 

 

55

%

 

10,451,983

 

 

51

%

 

 

 
 
 
 
 
 
 
 
 
 
 
 

Total cash and cash equivalents

 

$

26,424,935

 

 

100

%

$

20,394,931

 

 

100 

%

 

 

 
 
 
 
 
 
 
 
 
 
 
 

In an effort to mitigate any potential risk, we periodically evaluate the credit quality of the financial institutions at which it holds deposits, both in the United States and China.

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Client Name

 

June 30, 2008

 

December 31, 2007

 

 
 
 
 
 
 

China America Holdings, Inc.

 

$

860,840

 

 

18

%

$

1,828,481

 

 

23

%

China Logistics Group, Inc.

 

 

2,488,250

 

 

53

%

 

4,042,500

 

 

52

%

Dragon International Group Corp.

 

 

1,012,403

 

 

21

%

 

1,171,844

 

 

15

%

Other

 

 

371,100

 

 

8

%

 

777,675

 

 

10

%

 

 

 
 
 
 
 
 
 
 
 
 
 
 

Total Marketable securities available for sale

 

$

4,732,593

 

 

100

%

$

7,820,500

 

 

100

%

 

 

 
 
 
 
 
 
 
 
 
 
 
 

9


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

We categorize securities as investment in marketable securities available for sale and investment in marketable securities available for sale-related party. The securities of one client, Dragon Capital Group Corp., accounted for all investment in marketable securities available for sale–related party and totaled $766,019 and $1,315,488 at June 30, 2008 and December 31, 2007, respectively.

Dragon Capital Group Corp. (“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 of 1933. 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 these securities on our consolidated balance sheet, they are not readily convertible into cash and we may never realize the carrying value of these securities.

At June 30, 2008 our consolidated balance sheet includes accounts receivable–related party of $556,687. The total amount is due from Taiyuan YiWei Magnesium Industry Co., Ltd. to our majority owned subsidiary Chang Magnesium and resulted from other income generated in the six month period ended June 30, 2008, for which payment had not yet been collected.

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 June 30, 2008 and December 31, 2007, allowances for doubtful accounts were $335,851 and $290,456, respectively.

Inventories

Inventories, consisting of raw materials and finished goods related to our products, are stated at the lower of cost or market utilizing the weighted average method.

Accounts payable-related parties

At June 30, 2008 our consolidated balance sheet reflects accounts payable–related party of $735,184, which is comprised of $640,113 and $95,071 due YiWei Magnesium for the purchase of inventory by our majority owned subsidiaries, Chang Magnesium and Golden Magnesium, respectively. 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.

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

10


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

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 are classified as available for sale securities 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. We did not elect to adopt SFAS 157 for acquired non-financial assets and assumed non-financial liabilities.

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 #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 statement of operations when the securities are liquidated.

To date, all securities received from our client companies 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 recognizes 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.

Other-than-temporary impairment of securities, 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) gain on marketable securities available for sale, net of the effect of taxes, for the three months ended June 30, 2008 and 2007 was ($1,646,180) and $ 48,315, respectively. The unrealized gain (loss) on marketable securities available for sale-related party, net of the effect of taxes, for the three months ended June 30, 2008 and 2007 was $3,625 and ($214,624) respectively.

The unrealized loss on marketable securities available for sale, net of the effect of taxes, for the six months ended June 30, 2008 and 2007 was $2,774,304 and $ 559,224, respectively. The unrealized loss on marketable securities available for sale-related party, net of the effect of taxes, for the six months ended June 30, 2008 and 2007 was $458,598 and $556,082 respectively.

11


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

The realized gain related to investments in marketable securities available for sale for the three months ended June 30, 2008 and 2007 was $3,756 and $206,236, respectively. Net realized loss on the sale of marketable securities available for sale-related party for the three months ended June 30, 2008 and 2007 was $0 and $16,041, respectively.

The realized (loss) gain related to investments in marketable securities available for sale for the six months ended June 30, 2008 and 2007 was ($35,705) and $206,236, respectively. Net realized loss on the sale of marketable securities available for sale-related party for the six months ended June 30, 2008 and 2007 was $0 and $32,014, 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 June 30, 2008 and December 31, 2007 our consolidated balance sheets include prepaid expenses and other current assets of $21,564,895 and $15,439,462, respectively.

Prepaid expenses–related parties were $4,821,163 and $4,150,943, at June 30, 2008 and December 31, 2007, respectively. Chang Magnesium and Golden Magnesium advanced $1,917,468 and $28,544, respectively to YiWei Magnesium for the future delivery of inventory which has not yet been received. Golden Magnesium advanced $1,658,143 to Shanxi Senrun Coal Chemistry Co., Ltd., for the future supply of gas which had not yet been provided. Pan Asia Magnesium advanced $1,217,008 to Shanxi Jinyang Coal and Coke Group Co., Ltd., for the future supply of gas which had not yet been provided.

Non-current prepaid expenses and other assets consist of (i) the fair value of client company securities 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 $234,683 and $433,075 at June 30, 2008 and December 31, 2007, respectively.

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 SFAS No. 141. In each of our acquisitions we determined that fair values were equivalent to the acquired historical carrying costs. The estimated purchase price and the preliminary adjustments to historical book value of business entities acquired were recorded by us at the pre-acquisition carrying amount.

Advances from customers

Advances from customers represent (i) prepayments to us for merchandise that had not yet been shipped to customers of approximately $5.5 million, and (ii) the fair value of securities received as compensation which will be amortized over the term of the respective consulting agreement totaled approximately $248,900. We will recognize these advances as revenues as customers take delivery of the goods, in compliance with our revenue recognition policy. Advances from customers totaled $5,785,605 and $6,963,061 at June 30, 2008 and December 31, 2007, 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 six months ended June 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.

12


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

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 rate during the six months ended June 30, 2008.

 

 

 

 

 

 

 

 

 

 

June 30,

 

 

 

 

 

 

 

2008

 

2007

 

 

 

 

 

 

 

Quarter end RMB : U.S. Dollar exchange rate

 

 

6.8718

 

 

7.6248

 

Average year-to-date RMB : U.S. Dollar exchange rate

 

 

7.0726

 

 

7.7299

 

The RMB is not freely convertible into foreign currency and all foreign exchange transactions must take place through PRC authorized institutions. No representation is made that the RMB amounts could have been, or could be, converted into United States dollars at the rates applied in the translation.

Impairment of long-lived assets

In accordance with 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 six months ended June 30, 2008 or 2007.

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.

13


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

Revenue Recognition

We follow the guidance of the Securities and Exchange Commission’s Staff Accounting Bulletin 104 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. We have adopted SFAS 159 and determined that it had no impact as of June 30, 2008, and we will continue to evaluate the impact, if any, of SFAS 159 on its 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

14


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

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 2010, and this standard must be applied on a retrospective basis. We are evaluating the impact the adoption of FSP APB 14-1 will have on our consolidated financial position and results of operations.

In May 2008, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 162, The Hierarchy of Generally Accepted 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 June 16, 2008, the FASB issued final Staff Position (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, as well as the impact of the adoption on our consolidated financial statements.

NOTE 3 – EARNINGS (LOSS) 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
June 30,

 

 

 

 
 

 

 

2008

 

Per
Share

 

2007

 

Per
Share

 

 
 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

7,514,875

 

 

0.33

 

$

2,267,742

 

 

0.16

 

Series A preferred stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock dividend

 

 

(1,047,937

)

 

(0.05

)

 

 

 

 

 

Relative fair value of detachable warrants issued

 

 

 

 

 

 

 

 

 

 

 

Preferred stock beneficial conversion feature

 

 

 

 

 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Numerator for basic EPS, Income applicable to common stock
holders (A)

 

 

6,466,938

 

 

0.29

 

 

2,267,742

 

 

0.16

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Plus: Income impact of assumed conversions

 

 

 

 

 

 

 

 

 

 

 

 

 

  Preferred stock dividends – unconverted

 

 

20,015

 

 

 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Numerator for diluted EPS, Income applicable to common stock holders plus assumed conversions (*)(B)

 

$

6,486,953

 

 

0.26

 

$

2,267,742

 

 

0.15

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

Denominator for basic earnings per share - weighted average number of common shares outstanding (C)

 

 

22,663,337

 

 

 

 

 

13,882,955

 

 

 

 

Stock Awards, Options, and Warrants

 

 

2,620,298

 

 

 

 

 

1,497,465

 

 

 

 

Preferred stock dividends – unconverted

 

 

143,750

 

 

 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Denominator for diluted earnings per share – adjusted weighted average outstanding average number of common shares outstanding (D)

 

 

25,427,385

 

 

 

 

 

15,380,420

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Basic and Diluted Income Per Common Share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share - basic (A)/(C)

 

$

0.29

 

 

 

 

$

0.16

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Earnings per share - diluted (B)/(D)

 

$

0.26

 

 

 

 

$

0.15

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

15


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Six Months Ended
June 30,

 

 

 

 
 

 

 

2008

 

Per
Share

 

2007

 

Per
Share

 

 
 

Numerator:

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

12,267,751

 

 

0.56

 

$

4,138,611

 

 

0.31

 

Series A preferred stock:

 

 

 

 

 

 

 

 

 

 

 

 

 

Preferred stock dividend

 

 

(1,189,467

)

 

(0.05

)

 

 

 

 

 

Relative fair value of detachable warrants issued

 

 

(2,765,946

)

 

(0.13

)

 

 

 

 

 

Preferred stock beneficial conversion feature

 

 

(2,451,446

)

 

(0.11

)

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Numerator for basic EPS, Income applicable to common stock
holders (A)

 

 

5,860,892

 

 

0.27

 

 

4,138,611

 

 

0.31

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Plus: Income impact of assumed conversions

 

 

 

 

 

 

 

 

 

 

 

 

 

  Preferred stock dividends – unconverted

 

 

31,097

 

 

 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Numerator for diluted EPS, Income applicable to common stock holders plus assumed conversions (*)(B)

 

$

5,891,989

 

 

0.24

 

$

4,138,611

 

 

0.27

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Denominator:

 

 

 

 

 

 

 

 

 

 

 

 

 

Denominator for basic earnings per share - weighted average number of common shares outstanding (C)

 

 

21,833,388

 

 

 

 

 

13,464,666

 

 

 

 

Stock Awards, Options, and Warrants

 

 

2,215,928

 

 

 

 

 

1,709,444

 

 

 

 

Preferred stock dividends – unconverted

 

 

111,367

 

 

 

 

 

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Denominator for diluted earnings per share – adjusted weighted average outstanding average number of common shares outstanding (D)

 

 

24,160,683

 

 

 

 

 

15,174,110

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Basic and Diluted Income Per Common Share:

 

 

 

 

 

 

 

 

 

 

 

 

 

Earnings per share - basic (A)/(C)

 

$

0.27

 

 

 

 

$

0.31

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Earnings per share - diluted (B)/(D)

 

$

0.24

 

 

 

 

$

0.27

 

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

* The denominator in diluted earnings per share for the three months period and six month period ended June 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.

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 are 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 six month periods ended June 30, 2008 and 2007, respectively.

16


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three Months Ended
June 30,

 

Six Months Ended
June 30,

 

 

 

 
 
 
 

 

 

2008

 

2007

 

2008

 

2007

 

 

 

 

 

 
 
 

 

 
 

Comprehensive Income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income

 

$

7,514,875

 

$

2,267,742

 

$

12,267,751

 

$

4,138,611

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other Comprehensive Income (Loss)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation gains

 

 

1,309,234

 

 

167,891

 

 

3,106,933

 

 

248,049

 

Unrealized loss on marketable securities held for sale, net of income taxes

 

 

(1,646,180

)

 

48,315

 

 

(2,774,304

)

 

(559,224

)

Unrealized gain (loss) on marketable securities held for sale-related parties, net of income taxes

 

 

3,625

 

 

(214,624

)

 

(458,598

)

 

(556,082

)

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Total Other Comprehensive Income (Loss)

 

 

(333,321

)

 

1,582

 

 

(125,969

)

 

(867,257

)

 
 
 
 
 
 
 
 
 
 
 
 
 
 

Total Comprehensive Income

 

$

7,181,554

 

$

2,269,324

 

$

12,141,782

 

$

3,271,354

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 

NOTE 5 – INVENTORIES

At June 30, 2008 and December 31, 2007, inventories consisted of the following:

 

 

 

 

 

 

 

 

 

 

June 30, 2008

 

December 31, 2007

 

 

 

 
 
 
 

 

 

 

 

 

 

 

 

Raw materials

 

$

9,969,438

 

$

4,217,788

 

Finished goods

 

 

2,317,100

 

 

1,076,198

 

 

 

 
 
 
 
 
 

 

 

$

12,286,538

 

$

5,293,986

 

 

 

 
 
 
 
 
 

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

NOTE 6 – PREPAID EXPENSES AND OTHER ASSETS

At June 30, 2008 and December 31, 2007, prepaid expenses and other assets consist of the following:

 

 

 

 

 

 

 

 

 

 

June 30, 2008

 

December 31, 2007

 

 

 

 
 
 
 

 

 

 

 

 

 

 

 

Prepayments to vendors for merchandise that had not yet been shipped

 

$

14,795,191

 

$

11,557,231

 

Other receivables

 

 

4,348,620

 

 

3,043,193

 

Fair value of client securities received for payment of services assigned to executive officers and employees as compensation

 

 

295,775

 

 

638,961

 

Loans receivable

 

 

1,060,156

 

 

 

Other assets acquired in connection with acquisition of CDI Pan Asia

 

 

146,978

 

 

138,089

 

VAT Tax refund available from Chinese government

 

 

1,109,361

 

 

143,784

 

Security deposits

 

 

43,497

 

 

351,279

 

 

 

 
 
 
 
 
 

 

 

 

 

 

 

 

 

Total

 

 

21,799,578

 

 

15,872,537

 

 

 

 

 

 

 

 

 

Less: Current Portion

 

 

(21,564,895

)

 

(15,439,462

)

 

 

 
 
 
 
 
 

 

 

 

 

 

 

 

 

Prepaid expenses and other assets, non-current

 

$

234,683

 

$

433,075

 

 

 

 
 
 
 
 
 

17


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

NOTE 7 – PROPERTY, PLANT AND EQUIPMENT

At June 30, 2008 and December 31, 2007, property, plant and equipment consisted of the following:

 

 

 

 

 

 

 

 

 

 

 

 

 

Useful Life

 

June 30, 2008

 

December 31, 2007

 

 

 

 
 
 
 
 
 

 

 

 

 

 

 

 

 

 

 

 

Building

 

 

10-40 years

 

$

5,335,130

 

$

4,904,304

 

Manufacturing equipment

 

 

10 years

 

 

12,070,906

 

 

7,765,130

 

Office equipment and furniture

 

 

3-5 years

 

 

570,812

 

 

380,846

 

Autos and trucks

 

 

5 years

 

 

766,328

 

 

468,761

 

Construction in progress

 

 

N/A

 

 

8,406,176

 

 

5,069,284

 

 

 

 

 

 

 
 
 
 
 
 

 

 

 

 

 

 

 

 

 

 

 

Total

 

 

 

 

 

27,149,352

 

 

18,588,325

 

 

 

 

 

 

 

 

 

 

 

 

Less: Accumulated Depreciation

 

 

 

 

 

(1,499,088

)

 

(577,801

)

 

 

 

 

 

 
 
 
 
 
 

 

 

 

 

 

$

25,650,264

 

$

18,010,524

 

 

 

 

 

 

 
 
 
 
 
 

For the three and six months ended June 30, 2008 depreciation expense totaled $494,967 and $921,287, respectively. For the three and six months ended June 30, 2007 depreciation expense totaled $65,989 and $122,810, respectively.

NOTE 8 – PROPERTY USE RIGHTS

Property use rights, consisting of mining and property use rights amounted to $582,733 and $553,304 at June 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 June 30, 2008 are $486,655 (RMB 3,344,193). CDI Jixiang Metal is presently in the exploration stage of its business operations and is engaged in the search of mineral deposits or reserves. We intend to conduct exploration activities on this property and have not established a reserve. There is no assurance that commercially viable mineral deposits exist on this property and further exploration will be required before a final evaluation as to the economic feasibility is determined.

Mineral property acquisition costs, site restoration costs and development costs on mineral properties with proven and probable reserves are capitalized and will be depleted using the units-of-production method over the estimated life of the reserves. If there are insufficient reserves to use as a basis for depleting such costs, they will be written off as mineral property or mineral interest impairment in the period in which the determination is made. Site restoration costs are depleted over the term of their expected life. Interest costs are capitalized on mineral properties and mineral interests in development. 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.

18


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

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 June 30, 2008 and December 31, 2007 consisted of the following:

 

 

 

 

 

 

 

 

Description

 

June 30,
2008

 

December 31,
2007

 

 
 
 
 
 
 

 

 

 

 

 

 

Loan due to Shanxi Xinglong Foundry Co., Ltd. Due on demand. Non-interest bearing.

 

$

 

$

410,167

 

 

 

 

 

 

 

 

 

Loan due to Taiyuan YanKang Industrial Co., Ltd. Due on demand. Non-interest bearing.

 

 

 

 

410,167

 

 

 

 

 

 

 

 

 

Loan due to Xu XianJun. Due on demand. Non-interest bearing.

 

 

 

 

492,200

 

 

 

 

 

 

 

 

 

Loan due to ShanXi Rural Credit Union. Due on demand. 17.18% annual interest rate.

 

 

429,291

 

 

 

 

 

 

 

 

 

 

 

Loan due to China MinSheng Bank. Due July 24, 2008. 7.89% annual interest rate. Secured by Lang Chemical’s restricted cash.

 

 

727,611

 

 

 

 

 

 

 

 

 

 

 

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.

 

 

210,280

 

 

216,932

 

 

 

 

 

 

 

 

 

Loan due to JiNan Commercial Bank due October 15, 2008. 9.72% annual interest rate. Guaranteed by JiNan WuFa Boiler Co., Ltd.

 

 

72,761

 

 

68,360

 

 

 

 

 

 

 

 

 

Loan due to ShanXi Rural Credit Union. Due on demand. 12.58% annual interest rate.

 

 

 

 

546,889

 

 

 

 
 
 
 
 
 

 

 

 

 

 

 

 

 

Total

 

 

1,439,943

 

 

2,144,715

 

Less: Current Portion

 

 

(1,229,663

)

 

(1,978,142

)

 

 

 
 
 
 
 
 

 

 

 

 

 

 

 

 

Loans payable, long-term

 

$

210,280

 

$

166,573

 

 

 

 
 
 
 
 
 

NOTE 10 – RELATED PARTY TRANSACTIONS

At June 30, 2008 we reported accounts receivable–related party of $556,687 due Chang Magnesium from YiWei Magnesium for services provided during the six months ended June 30, 2008. Income generated from these services is reflected in other income for the six months ended June 30, 2008.

At June 30, 2008, we reported prepaid expenses-related parties of $4,821,163 comprised of:

 

 

 

 

$1,917,468 prepaid by Chang Magnesium to YiWei Magnesium, the minority interest holder in Chang Magnesium and Golden Magnesium, for future delivery of inventory which has not yet been received,

 

 

 

 

$28,544 prepaid by Golden Magnesium to YiWei Magnesium for future delivery of inventory which has not yet been received,

19


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

 

 

$1,658,143 prepaid by Golden Magnesium to Shanxi Senrun Coal Chemistry Co., Ltd., for the future supply of gas which has not yet been provided, Shanxi Senrun Coal Chemistry Co., ltd., a Chinese limited liability company, holds a 20% interest in Golden Magnesium (“Senrun Coal”), and

 

 

$1,217,008 prepaid by Pan Asia Magnesium to Shanxi Jinyang Coal and Coke Group Co., Ltd. for the future supply of gas supplies which has not yet been provided. Shanxi Jinyang Coal and Coke Group Co., Ltd., a Chinese limited liability company, holds a 49% interest in Pan Asia Magnesium (“Jinyang Group”).

At June 30, 2008 we reported due from related party of $14,552 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 June 30, 2008 we reported accounts payable–related parties of $735,184 comprised of:

 

 

$640,113 due from Chang Magnesium to YiWei Magnesium, and

 

 

$95,071 due from Golden Magnesium to YiWei Magnesium.

At June 30, 2008, we reported due to related party of $576,890 due YiWei Magnesium from Golden Magnesium. YiWei Magnesium advanced funds to Golden Magnesium for working capital purposes in 2007 prior to our contribution of investment.

At June 30, 2008 we reported Loans receivable–related parties of $1,597,305 comprised of:

 

 

$74,216 loan receivable from Dragon Capital; and

 

 

$1,523,089 loan receivable from NanTong Chemical.

NanTong Chemical Co., Ltd. is a Chinese limited liability company, (“NanTong Chemical”) owned by Jingdong Chen and Qian Zhu, the two minority shareholders of Lang Chemical.

At June 30, 2008 our consolidated balance sheet includes accounts receivable–related party of $556,687. The total amount is due from Taiyuan YiWei Magnesium Industry Co., Ltd. to our majority owned subsidiary Chang Magnesium and resulted from other income generated in the six month period ended June 30, 2008, for which payment had not yet been collected.

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”).

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 June 30, 2008, there were 1,006 shares of Series A Convertible Preferred Stock issued and outstanding and 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.

20


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

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 June 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.

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

 

 

risk free rate of 2.06%

The relative fair value of the warrants of $2,765,946 was 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 six months ended June 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 and six months ended June 30, 2008 or have an impact on total stockholders’ equity as of that date. 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.

21


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

Common Stock

China Direct has 1,000,000,000 shares of common stock, par value $.0001, authorized. At June 30, 2008 there were 23,501,056 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 six months ended June 30, 2008 and 2007, amortization of stock based compensation amounted to $848,364 and $196,010, respectively.

During the six months ended June 30, 2008, we issued 155,000 shares of common stock in connection with the exercise of common stock warrants. Of these warrants, 25,000 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 six months ended June 30, 2008, we issued 510,950 shares of common stock in connection with the exercise of common stock options for net proceeds of $1,757,376. Of these options, 298,950 were exercised at $2.50 per share; 25,000 were exercised at $3.00 per share and 187,000 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, 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.

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 Option Plans

On August 16, 2006, our board of directors authorized 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 June 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 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 its sole determination, to the terms and conditions of the incentive stock options being so converted. At June 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 six months ended June 30, 2008, we granted 115,000 options under the 2006 equity plan to employees with an exercise price of $7.50 per share, of these option, 90,000 options were canceled during the quarter ended June 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 3.28%, volatility of 90% and expected term of 3 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 June 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 June 30, 2008 we granted 32,900 shares of restricted stock with vesting dates ranging from August 2008 to June 2010 under this plan.

22


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

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

 

 

 

 

 

 

 

 

 

 

Shares underlying options

 

Weighted average exercise price

 

 

 

 
 
 

 

Outstanding at December 31, 2007

 

 

6,940,620

 

$

8.14

 

Granted

 

 

115,000

 

 

7.50

 

Exercised

 

 

(510,950

)

 

3.44

 

Expired or cancelled

 

 

(90,000

)

 

7.50

 

 

 

 
 
 
 
 

 

Outstanding at June 30, 2008

 

 

6,454,670

 

$

8.51

 

 

 

 
 
 
 
 

 

Exercisable at June 30, 2008

 

 

5,042,670

 

$

8.08

 

 

 

 
 
 
 
 

 

 

 

 

 

 

 

 

 

Weighted-average exercise price of options granted during the period

 

 

 

 

$

7.50

 

 

 

 

 

 

 

 

 

The weighted average remaining contractual life and weighted average exercise price of options outstanding at June 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

 

 

1.65

 

$

0.01

 

 

1,050,000

 

$

0.01

 

 

2.25

 

 

400

 

 

6.31

 

 

2.25

 

 

400

 

 

2.25

 

 

2.50

 

 

579,690

 

 

3

 

 

2.50

 

 

579,690

 

 

2.50

 

 

3.00

 

 

50,000

 

 

3

 

 

3.00

 

 

50,000

 

 

3.00

 

 

5.00

 

 

1,227,000

 

 

3

 

 

5.00

 

 

1,227,000

 

 

5.00

 

 

7.50

 

 

1,412,000

 

 

4

 

 

7.50

 

 

1,375,000

 

 

7.50

 

 

10.00

 

 

1,375,000

 

 

6

 

 

10.00

 

 

 

 

 

 

15.00

 

 

500

 

 

1.94

 

 

15.00

 

 

500

 

 

15.00

 

 

30.00

 

 

760,000

 

 

4

 

 

30.00

 

 

760,000

 

 

30.00

 

 

56.25

 

 

80

 

 

6.42

 

 

56.25

 

 

80

 

 

56.25

 

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 
 

 

 

 

 

 

6,454,670

 

 

3.83

 

$

8.51

 

 

5,042,670

 

$

8.08

 

 

 

 

 
 

 

 
 

 

 
 

 

 
 

 

 
 

 

          During the six months ended June 30, 2008, 510,950 options were exercised at an average excercise price of $3.44 per share with an intrinsic value of $2,998,055. At June 30, 2008, the aggregate intrinsic value of outstanding and exercisable options was $13,592,416.

Common Stock Purchase Warrants

During the six months ended June 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.

23


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

A summary of the status of our outstanding common stock purchase warrants granted as of June 30, 2008 and changes during the period is as follows:

 

 

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

Shares

 

Average

 

 

 

Underlying

 

Exercise

 

 

 

Warrants

 

Price

 

 

 

 

 

 

 

Outstanding at December 31, 2007

 

 

2,648,312

 

$

8.70

 

Granted

 

 

2,175,000

 

 

8.03

 

Exercised

 

 

(155,000

)

 

7.26

 

Expired or cancelled

 

 

 

 

 

 

 

 
 

 

 
 

 

Outstanding at June 30, 2008

 

 

4,668,312

 

$

8.44

 

 

 

 
 

 

 
 

 

Exercisable at June 30, 2008

 

 

4,668,312

 

$

8.44

 

 

 

 
 

 

 
 

 

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

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Warrants Outstanding

 

Warrants Exercisable

 

 

 

 

 

 

 

 

 

 

 

 

Weighted

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Average

 

Weighted

 

 

 

 

Weighted

Range of

 

 

 

 

Remaining

 

Average

 

 

 

 

Average

Exercise

 

 

 

 

Contractual

 

Exercise

 

 

 

 

Exercise

Prices

 

Shares

 

Life (Years)

 

Price

 

Shares

 

Price

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

2.50

 

 

50,000

 

 

3.42

 

$

2.50

 

 

50,000

 

$

2.50

 

4.00

 

 

523,750

 

 

3.28

 

 

4.00

 

 

523,750

 

 

4.00

 

7.50

 

 

60,000

 

 

1.89

 

 

7.50

 

 

60,000

 

 

7.50

 

8.00

 

 

2,050,000

 

 

4.62

 

 

8.00

 

 

2,050,000

 

 

8.00

 

10.00

 

 

1,869,562

 

 

3.24

 

 

10.00

 

 

1,869,562

 

 

10.00

 

11.00

 

 

25,000

 

 

2.78

 

 

11.00

 

 

25,000

 

 

11.00

 

15.00

 

 

90,000

 

 

1.89

 

 

15.00

 

 

90,000

 

 

15.00

 

 

 

 
 

 

 
 

 

 

 

 

 
 

 

 

 

 

 

 

 

4,668,312

 

 

3.81

 

 

 

 

 

4,668,312

 

 

 

 

 

 

 
 

 

 
 

 

 

 

 

 
 

 

 

 

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 six month period ending June 30, 2008, we operated in four reportable business segments as follows;

 

 

 

 

 

1.

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

 

 

 

 

 

 

Capital One Resource, a wholly owned subsidiary of CDI Shanghai Management A

 

 

 

 

 

2.

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

 

 

 

 

 

 

CDI Wanda, a 51% majority owned subsidiary of CDI Clean Technology B

24


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

 

 

 

 

 

3.

Consulting segment

 

 

 

China Direct Investments, a wholly owned subsidiary of China Direct

 

 

 

CDI Shanghai Management, a wholly owned subsidiary of CDI China

 

 

 

Capital One Resource, a wholly owned subsidiary of CDI Shanghai Management

 

 

 

 

 

4.

Clean Technology segment

 

 

 

CDI Clean Technology, a wholly owned subsidiary of CDI China

 

 

 

CDI Wanda, a 51% majority owned subsidiary of CDI Clean Technology

 

 

 

Yantai CDI Wanda, a 52% majority owned subsidiary of CDI Wanda

 

 

 

CDI Metal Recycling, an 83% majority owned subsidiary of CDI Shanghai Management


 

 

 

 

A.

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

 

 

 

 

B.

CDI Wanda generated revenues in two reporting segments; Basic Materials and Clean Technology.

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. Condensed consolidated information with respect to these reportable segments for the three and six months ended June 30, 2008 and 2007 are as follows:

For the three months ended June 30, 2008:
(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Magnesium

 

Basic Materials

 

Consulting

 

Clean Technology

 

Consolidated

 

 

 

 
 
 
 
 
 
 
 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

54,320

 

$

14,982

 

$

6,698

 

$

216

 

$

76,216

 

Revenues – related party

 

 

1,345

 

 

 

 

 

 

 

 

1,345

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

55,665

 

 

14,982

 

 

6,698

 

 

216

 

 

77,561

 

 

Interest income (expense)

 

 

(44

)

 

(29

)

 

216

 

 

(13

)

 

130

 

Net income (loss)

 

 

3,000

 

 

51

 

 

4,559

 

 

(95

)

 

7,515

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Segment Assets

 

 

79,015

 

 

12,188

 

 

27,997

 

$

4,450

 

$

123,650

 

For the three months ended June 30, 2007:
(Amounts in thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Magnesium

 

Basic Materials

 

Consulting

 

Clean Technology

 

Consolidated

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

23,445

 

$

14,324

 

$

2,036

 

$

209

 

$

40,014

 

Revenues – related party

 

 

 

 

 

 

440

 

 

 

 

440

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

23,445

 

 

14,324

 

 

2,476

 

 

209

 

 

40,454

 

Interest income (expense)

 

 

12

 

 

6

 

 

23

 

 

1

 

 

42

 

Net income (loss)

 

 

717

 

 

31

 

 

1,564

 

 

(44

)

 

2,268

 

Segment Assets

 

$

19,865

 

$

5,668

 

$

10,028

 

$

1,703

 

$

37,264

 

For the six months ended June 30, 2008:
(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Magnesium

 

Basic Materials

 

Consulting

 

Clean Technology

 

Consolidated

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

98,264

 

$

27,843

 

$

9,016

 

$

333

 

$

135,456

 

Revenues – related party

 

 

2,079

 

 

 

 

 

 

 

 

2,079

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

100,343

 

 

27,843

 

 

9,016

 

 

333

 

 

137,535

 

 

Interest income (expense)

 

 

(64

)

 

(29

)

 

326

 

 

(13

)

 

220

 

Net income (loss)

 

 

6,757

 

 

299

 

 

5,303

 

 

(91

)

 

12,268

 

Segment Assets

 

$

79,015

 

$

12,188

 

$

27,997

 

$

4,450

 

$

123,650

 

25


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

For the six months ended June 30, 2007:
(In thousands)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Magnesium

 

Basic Materials

 

Consulting

 

Clean Technology

 

Consolidated

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

37,861

 

$

26,719

 

$

3,705

 

$

2,227

 

$

70,512

 

Revenues – related party

 

 

 

 

 

 

880

 

 

 

 

880

 

 

 

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

 

 

 

37,861

 

 

26,719

 

 

4,585

 

 

2,227

 

 

71,392

 

Interest income (expense)

 

 

25

 

 

3

 

 

43

 

 

 

 

71

 

Net income

 

 

1,150

 

 

202

 

 

2,761

 

 

26

 

 

4,139

 

Segment Assets

 

$

19,865

 

$

5,668

 

$

10,028

 

$

1,703

 

$

37,264

 

NOTE 13 – FOREIGN OPERATIONS

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

Assets at June 30, 2008 and June 30, 2007 as well as revenues for the three months ended June 30, 2008 and 2007 are as follows;

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2008 (In thousands)

 

 

 

 
 

 

 

United States

 

People’s Republic of China

 

Total

 

 

 

 
 
 
 
 
 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

6,632

 

$

69,584

 

$

76,216

 

 

 

 

 

 

 

 

 

 

 

 

Revenues – related party

 

 

 

 

1,345

 

 

1,345

 

 

 

 
 
 
 
 
 
 
 
 

Total Revenues

 

 

6,632

 

 

70,929

 

 

77,561

 

 

 

 

 

 

 

 

 

 

 

 

Identifiable assets at June 30, 2008

 

$

26,557

 

$

97,093

 

$

123,650

 

 

 

 
 
 
 
 
 
 
 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2007 (In thousands)

 

 

 

 
 

 

 

United States

 

People’s Republic of China

 

Total

 

 

 

 
 
 
 
 
 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

2,036

 

$

37,978

 

$

40,014

 

 

 

 

 

 

 

 

 

 

 

 

Revenues – related party

 

 

440

 

 

 

 

440

 

 

 

 
 
 
 
 
 
 
 
 

Total Revenues

 

 

2,476

 

 

37,978

 

 

40,454

 

 

 

 

 

 

 

 

 

 

 

 

Identifiable assets at June 30, 2007

 

$

9,805

 

$

27,459

 

$

37,264

 

 

 

 
 
 
 
 
 
 
 
 

Assets at June 30, 2008, and June 30, 2007 as well as revenues for the six months ended June 30, 2008 and 2007 are as follows;

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2008 (In thousands)

 

 

 

 
 

 

 

United States

 

People’s Republic of China

 

Total

 

 

 

 
 
 
 
 
 
 
 
 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

8,934

 

$

126,522

 

$

135,456

 

 

 

 

 

 

 

 

 

 

 

 

Revenues – related party

 

 

 

 

2,079

 

 

2,079

 

 

 

 
 
 
 
 
 
 
 
 

 

Total Revenues

 

 

8,934

 

 

128,601

 

 

137,535

 

 

 

 

 

 

 

 

 

 

 

 

Identifiable assets at June 30, 2008

 

$

26,557

 

$

97,093

 

$

123,650

 

 

 

 
 
 
 
 
 
 
 
  

26


CHINA DIRECT, INC. AND SUBSIDIARIES
NOTES TO UNAUDITED CONSOLIDATED STATEMENTS
JUNE 30, 2008

 

 

 

 

 

 

 

 

 

 

 

 

 

June 30, 2007 (In thousands)

 

 

 

United States

 

People’s Republic of China

 

Total

 

 

 

 

 

 

 

 

 

 

 

 

Revenues

 

$

3,705

 

$

66,807

 

$

70,512

 

 

 

 

 

 

 

 

 

 

 

 

Revenues – related party

 

 

880

 

 

 

 

880

 

Total Revenues

 

 

4,585

 

 

66,807

 

 

71,392

 

 

 

 

 

 

 

 

 

 

 

 

Identifiable assets at June 30, 2007

 

$

9,805

 

$

27,459

 

$

37,264

 

NOTE 14 – SUBSEQUENT EVENTS

A registration statement on Form S-3 covering the public sale of up to $70 million of shares 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.

On August 1, 2008, CDI China and Xinjin Magnesium agreed to amend the April 26, 2008 Investment Framework Agreement entered into between CDI China and Xinjin Magnesium (the “Investment Framework Agreement”) to extend the date on which CDI China's initial investment is due until December 31, 2008.

On August 6, 2008, the Board of Directors approved an amendment to our Articles of Incorporation to effect a 1-for-26 reverse split of our common stock followed by a 26-for-1 forward split of our common stock. The proposed transaction will be carried out on a per shareholder basis. The proposed transaction is comprised of a 1 share for 26 shares reverse stock split (the “Reverse Split”), followed by a subsequent forward stock split (the “Forward Split”) pursuant to which each whole share of common stock outstanding following completion of the Reverse Split will be converted into 26 shares of common stock. Following the proposed transaction, there will be no change in our authorized common stock or the par value of our common stock. Shareholders who hold in the aggregate less than one share of common stock following the Reverse Split will not be included in the Forward Split. Rather, such shares will receive a cash payment at a price equal to the closing price of our common stock as of August 22, 2008.

27



 

 

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.

China Direct is on a calendar year; as such the three months period ending June 30, is our second quarter. The year ended December 31, 2007 is referred to as “2007”, the year ended December 31, 2006 is referred to as “2006”, 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 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, 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 15 subsidiaries in various industries with over 2,300 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 four business segments as defined in SFAS No. 131:

 

 

Magnesium segment;

 

 

Basic Materials segment;

 

 

Consulting segment; and

 

 

Clean Technology segment.

Our Magnesium segment is currently our largest segment by revenue, profit and number of portfolio companies. Magnesium can be utilized 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 August 1, the price of magnesium on the spot market was approximately $4,280 per metric ton, which has increased from approximately $3,900 per metric ton at December 31, 2007. 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.

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 addition, we intend to distribute zinc concentrate which is the material utilized in the processing of zinc metal and zinc alloy products pursuant to an exclusive distribution agreement once the zinc manufacturer resumes production which is expected to occur in fourth quarter of fiscal year 2008. We are constructing a zinc mining facility and upon completion, which is expected in August 2008, we plan to manufacture lead and zinc oxide products as well as distribute zinc and lead concentrate which is used in the production of zinc metal and zinc alloys. Lead concentrate is used in the production of lead metal and lead alloys.

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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 (i.e. legal, audit and investment banking), strategic alliances and partnerships, advice on effective means of accessing U.S. capital markets, mergers and acquisitions, coordination of Sarbanes-Oxley compliance, corporate asset evaluation and interim CFO support.

Our Clean Technology segment engages in the assembly and sale of scrap tire recycling equipment and is constructing a scrap tire recycling center. Our planned scrap tire recycling center is expected to commence production in December 2008. In addition, we are constructing an aluminum recycling facility. This facility will be capable of recycling aluminum wires that can be used to create aluminum powder used in the manufacture of a variety of applications such as a conductor or dissipater of heat and electricity, metallurgy for molds and mixtures as well as metal coatings, rust proofing, paints and coatings, chemical and metallurgical applications, propellants, explosives, and fireworks.

Our Performance

Revenues during the six months ended June 30, 2008 totaled $137.5 million, a 93% increase as compared to the six months ended June 30, 2007. During the six months ended June 30, 2008 we experienced dramatic growth in revenues, income and total assets between the periods. This growth was primarily attributable to investments we made in our magnesium segment in the latter half of 2007 to obtain a controlling interest in several joint venture entities operating within the PRC.

Our annual growth rate of over 90% is not sustainable, but rather reflects the continued implementation of the acquisition component of our business model and the completion of recent consulting transactions that may not occur in the future. Accordingly, we believe inter-period comparisons between the second quarter and six months ending June 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.

During 2008 and beyond, we face a number of challenges in growing our business, such as the continuing integration of our PRC based subsidiaries. At June 30, 2008 we had $26.4 million in cash and cash equivalents. While this amount is believed sufficient to meet our current obligations, we may need to secure 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 recent acquisitions to identify strategies to maximize their potential within their segment and to the consolidated group.

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”.

Impact of the 2008 Beijing Olympic. Even though we are a U.S. company, the vast majority of our subsidiaries and their operations are located in the PRC. We could be adversely impacted by various policies recently adopted by the PRC which seek to minimize pollution by limiting the operation of polluting agents in advance of the Beijing Olympics to be held during August 2008. While it is not clear if the recently adopted anti-pollution policies, some of which went into effect commencing on June 1, 2008, apply to our magnesium production operations, the policies could cause an interruption in the supply of the raw material and natural gas which are used in the production of magnesium. Presently our magnesium production facilities or its suppliers have not been notified of any potential interruption in its supplies as a result of these policies. As a result of the adoption of these anti-pollution policies, during the six months ended June 30, 2008, our magnesium subsidiaries have increased inventory of raw materials and prepaid for the future supply of gas that could be affected by these policies as a measure to mitigate the impact of any possible interruption in the supply of these items.

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.

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RESULTS OF OPERATIONS

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

Consolidated Revenues

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Three months ended June 30,

 

 

 

2008

 

2007

 

%

 

Segment

 

Revenues
(in 000’s)

 

% of
Revenues

 

Revenues
(in 000’s)

 

% of
Revenues

 

increase/
(decrease)

 

 

Magnesium segment

 

$

55,665

 

 

71.8

%

$

23,445

 

 

58.0

%

137.4

%

 

Basic Materials segment

 

 

14,982

 

 

19.3

%

 

14,324

 

 

35.4

%

4.6

%

 

Consulting segment

 

 

6,698

 

 

8.6

%

 

2,476

 

 

6.1

%

170.5

%

 

Clean Technology segment

 

 

216

 

 

0.3

%

 

209

 

 

0.5

%

3.3

%

 

Total Consolidated

 

$

77,561

 

 

100.0

%

$

40,454

 

 

100.0

%

91.7

%