Item 1.

Financial Statements.

CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

 

		June 30,				December 31,
		2009				2008
ASSETS		Unaudited
Current Assets:
Cash and cash equivalents		$	13,792,725				14,205,229
Investment in marketable securities available for sale			4,928,754				7,569,333
Investment in marketable securities available for sale - related party			385,101				160,459
Investment in subsidiaries -- cost method			290,864				290,864
Accounts receivable, net of allowance			5,874,166				9,457,306
Accounts receivable - related parties			4,349,383				1,676,191
Inventories, net			9,992,885				8,559,593
Prepaid expenses and other current assets			6,508,666				8,127,300
Prepaid expenses - related parties			4,142,066				8,007,111
Loans receivable - related parties			1,120,432				1,652,728
Due from related parties			42,002				35,710
Total current assets			51,427,044				59,741,824
Restricted cash			1,663,343				846,197
Property, plant and equipment, net			44,641,972				43,455,683
Prepaid expenses and other assets			1,800,431				2,744,427
Property use rights, net			1,281,046				591,277
Total assets		$	100,813,836			$	107,379,408
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Loans payable-short term		$	2,768,503			$	933,735
Accounts payable and accrued expenses			9,736,879				8,590,010
Accounts payable-related parties			1,552,780				7,516,728
Advances from customers			1,503,580				1,545,273
Other payables			1,405,597				1,624,370
Taxes payable			843,731				1,039,112
Due to related parties			71,963				978,739
Total current liabilities			17,883,033				22,227,967
Loans payable-long term			8,035				186,018
Stockholders' equity:
China Direct Industries, Inc. stockholders' equity
Series A Convertible Preferred Stock: $.0001 par value, stated value $1,000 per share; 10,000,000 authorized, 1,006 shares issued and outstanding at June 30, 2009 and December 31, 2008.			1,006,250				1,006,250
Common Stock: $.0001 par value, 1,000,000,000 authorized, 26,519,623 and 23,530,642 issued and outstanding at June 30, 2009 and December 31, 2008, respectively			2,652				2,353
Additional paid-in capital			56,239,467				51,701,293
Deferred compensation							(11,000	)
Accumulated comprehensive income			(13,554,759	)			(11,711,021	)
Retained earnings			12,629,575				17,037,407
Total China Direct Industries, Inc. stockholders’ equity			56,323,185				58,025,282
Non-controlling interests			26,599,583				26,940,141
Total Equity			82,922,768				84,965,423
Total liabilities and stockholders’ equity		$	100,813,836			$	107,379,408

See notes to unaudited consolidated financial statements

 

 

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

 

		For the Three Months								For the Six Months
		Ended June 30,								Ended June 30,
		2009				2008				2009				2008
Revenues		$	18,417,789			$	75,999,328			$	34,474,466			$	134,659,553
Revenues-related parties			2,007,621				1,344,725				6,637,053				2,078,646
Total revenues			20,425,410				77,344,053				41,111,519				136,738,199
Cost of revenues			21,136,660				63,893,924				40,453,953				113,307,926
Gross profit			(711,250	)			13,450,129				657,566				23,430,273
Operating expenses:
Selling, general, and administrative			2,419,684				2,486,588				5,518,814				4,097,581
Operating (loss) income			(3,130,934	)			10,963,541				(4,861,248	)			19,332,692
Other income (expense):
Other income (expense)			(403,548	)			102,874				(331,963	)			296,492
Interest (expense) income			(86,911	)			143,018				(40,797	)			239,877
Realized (loss) gain on sale of marketable securities			(79,221	)			3,756				(311,932	)			(35,705	)
Total other (expense) income			(569,680	)			249,648				(684,692	)			500,664
(Loss) income from continuing operations, before tax			(3,700,614	)			11,213,189				(5,545,940	)			19,833,356
Income tax (expense) benefit			(13,492	)			(716,791	)			58,087				(1,040,424	)
(Loss) income from continuing operations, net of tax			(3,714,106	)			10,496,398				(5,487,853	)			18,792,932
Income from discontinued operations			-				(70,151	)			-				73,357
Net (loss) income			(3,714,106	)			10,426,247				(5,487,853	)			18,866,289
Net (loss) income attributable to noncontrolling interests			826,450				(2,911,372	)			1,144,666				(6,598,538	)
Net (loss) income attributable to China Direct Industries, Inc.			(2,887,656	)			7,514,875				(4,343,187	)			12,267,751
Deduct dividends on Series A Preferred Stock:
Preferred stock dividend			(20,271	)			(1,047,937	)			(53,926	)			(1,189,467	)
Relative fair value of detachable warrants issued			-				-				-				(2,765,946	)
Preferred stock beneficial conversion feature			-				-				-				(2,451,446	)
(Loss) income attributable to China Direct Indstries, Inc. common stockholders		$	(2,907,927	)		$	6,466,938			$	(4,397,113	)		$	5,860,892
Basic and diluted income (loss) per common share after deduction in the first quarter of 2008, of noncash deemed dividends attributable to Series Convertible A Preferred Stock as described in Note 11
Basic		$	(0.12	)		$	0.29			$	(0.18	)		$	0.27
Diluted		$	(0.12	)		$	0.26			$	(0.18	)		$	0.24
Basic weighted average common shares outstanding			24,168,640				22,663,337				24,082,025				21,833,388
Diluted weighted average common shares outstanding			24,168,640				25,427,385				24,082,025				24,160,683

See notes to unaudited consolidated financial statements

 

 

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

		For the Six Months Ended
		June 30,
		2009				2008
Cash flows from operating activities:
Net income attributable to China Direct Industries, Inc.		$	(4,343,187	)		$	12,267,751
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation & Amortization			1,451,354				962,281
Allowance for bad debt			(127,424	)			45,395
Stock based compensation for employees and board of directors			1,122,803				848,364
Realized loss on sale of investment in marketable securities			295,707				35,705
Fair value of securities received for services and interest			(584,371	)			(392,942	)
Fair value of securities paid for services			205,165				-
Deferred compensation expense			11,000				-
Income (loss) attributable to noncontrolling interest			(1,144,666	)			6,598,538
Changes in operating assets and liabilities:
Prepaid expenses and other assets			2,115,450				(4,857,996	)
Prepaid expenses - related parties			3,865,045				(670,220	)
Inventories			(1,433,292	)			(6,881,077	)
Accounts receivable			3,710,564				(14,733,064	)
Accounts receivable - related parties			(2,673,192	)			1,726,913
Accounts payable and accrued expenses			1,153,722				2,526,304
Accounts payable - related party			(5,963,948	)			(228,930	)
Advances from customers			(41,693	)			(1,177,456	)
Other payables			(218,773	)			1,006,401
Income taxes payable			(195,381	)			582,015
Net cash (used in) provided by continuing activities			(2,795,117	)			(2,342,018	)
Net cash provided by discontinued operations			-				(421,642	)
Net cash (used in) provided by operating activities			(2,795,117	)			(2,763,660	)
Cash flows from investing activities:
Decrease (increase) in notes receivable			-				946,897
Increase in loans receivable			-				(1,060,156	)
Repayment of loans and advances to related parties			546,881				(1,597,305	)
Proceeds from the sale of marketable securities available for sale			483,723				428,395
Purchases of property, plant and equipment			(2,880,232	)			(7,364,599	)
Net cash used in investing activities			(1,849,628	)			(8,646,768	)
Cash flows from financing activities:
Decrease (increase) in restricted cash			(817,146	)			644,096
Proceeds from loans payable			926,325				1,161,303
Payment of loans payable			-				(1,866,075	)
Payment of notes payable			-				(592,007	)
Payment of notes payable-related party			-				(410,167	)
Proceeds from repayment of advances to related parties			-				1,273,325
Due to related parties			(176,316	)			(2,560,343	)
Gross proceeds from sale of preferred stock			-				12,950,000
Gross proceeds from sale of common stock			5,000,000				-
Proceeds from exercise of warrants/options			10,000				2,782,376
Cash payment for stock split/forward and stock repurchase			(1,650,000	)			-
Cash dividend payment to preferred stock holders			-				(141,530	)
Capital contribution from minority interest owners			715,788				2,217,296
Offering expenses			(190,000	)			(1,504,345	)
Net cash provided by financing activities			3,818,652				13,953,929
EFFECT OF EXCHANGE RATE ON CASH			413,591				1,872,188
Net (decrease) increase in cash			(412,504	)			4,415,689
Cash, beginning of year			14,205,229				19,024,604
Cash, end of period		$	13,792,725			$	23,440,293

Supplemental disclosures of cash flow information:
Cash paid for taxes		$	-			$	146,716
Cash paid for interest		$	-			$	169,385
Dividend payment in stock to preferred stock shareholders		$	53,926			$	1,027,922
Non-cash preferred stock deemed dividend		$	-			$	5,217,392
See notes to audited consolidated financial statements

 

 

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NOTE 1 - ORGANIZATION AND DESCRIPTION OF BUSINESS

Business and Organization

China Direct Industries, Inc., a Florida corporation and its subsidiaries are referred to in this report as the “Company”, “we”, “us”, “our”, or “China Direct”. We are on a calendar year, as such the three month period ending June 30, is our second quarter and the six month period ending June 30 is referred to as the “six months”. The year ended December 31, 2008 is referred to as “2008” and the coming year ending December 31, 2009 is referred to as “2009”.

We are a U.S. company that manages a portfolio of Chinese entities. We also provide consulting services to Chinese businesses. We operate in three identifiable segments, Magnesium, Basic Materials and Consulting, in accordance with SFAS No. 131, “Disclosure about segments of an Enterprise and Related Information”. In 2006 we established our Magnesium and Basic Materials segments which have grown through acquisitions of controlling interests of Chinese private companies. We consolidate these acquisitions as either our wholly or majority owned subsidiaries. Through this ownership control, we provide management advice as well as investment capital to expand their businesses. We hold a controlling interest in twelve subsidiaries operating in China, five of which comprise our Magnesium segment and five comprise our Basic Materials segment. As of the date of this report, we have a total of 1,297 full-time employees, the majority of which, 1,281, work in the Peoples Republic of China (the “PRC”).

In our largest segment, Magnesium, we operate five entities which produce, sell and distribute pure magnesium ingots, magnesium powders and magnesium scraps.

In our Basic Materials segment, we operate five entities which sell and distribute a variety of products including (i) industrial grade synthetic chemicals, (ii) steel products, (iii) non ferrous metals, and (iv) recycled materials. This segment also includes our zinc mining property which has not commenced operations.

In our Consulting segment, we provide a suite of consulting services to U.S. public companies that operate primarily in China. The consulting and transactional fees we charge vary based upon the scope of the services to be rendered.

In 2007 we launched a Clean Technology segment. We discontinued this segment in the third quarter of 2008 when we completed the sale in October 2008 of an 81% interest in CDI Clean Technology and its 51% interest in CDI Wanda and its 52% interest in Yantai CDI Wanda to PE Brothers Corp. for $1,240,000. We plan to maintain the 19% ownership interest in CDI Clean Technology we retained. We have received the first installment payment of $240,000.

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

Basis of Presentation

Our unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles for interim financial information and pursuant to the requirements for reporting on Form 10-Q. Accordingly, they do not include all the information and footnotes required by U.S. generally accepted accounting principles for annual financial statements. However, the information included in these interim financial statements reflects all adjustments (consisting solely of normal recurring adjustments) which are, in the opinion of management, necessary for the fair presentation of the consolidated financial position and the consolidated results of operations. Results shown for interim periods are not necessarily indicative of the results to be obtained for a full year. The consolidated balance sheet information as of December 31, 2008 was derived from the audited consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2008. These interim financial statements should be read in conjunction with our Form 10-K for the year ended December 31, 2008. Certain reclassifications have been made to prior year amounts to conform to the current year presentation and to disclose our reclassification of discontinued operations treatment reflecting the sale of an 81% interest in CDI Clean Technology.

Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States 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 periods presented.

Significant estimates for the periods reported include the fair value of share-based compensation, allowance for doubtful accounts, and useful life of fixed assets.

 

 

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We rely on assumptions such as volatility, forfeiture rate, and expected dividend yield when deriving the grant date fair value of share-based compensation. If an equity award is modified, and we expect the service conditions of the original award will be met, we will adjust our assumptions and estimates as of the modification date and compare the old equity award valued at the modification date with the new equity award valued at the modification date to calculate any incremental cost. We then continue to recognize the original grant date fair value plus any incremental cost over the modified service period

Our estimate for allowance for doubtful accounts is based on an evaluation of our outstanding accounts receivable including the age of amounts due, the financial condition of our specific customers, knowledge of our industry segment in Asia, and historical bad debt experience. This evaluation methodology has proven to provide a reasonable estimate of bad debt expense in the past and we intend to continue to employ this approach in our analysis of collectability. However, we are aware that given the current global economic situation, including that of China, meaningful time horizons may change. We intend to enhance our focus on the evaluation of our customers' sustainability and adjust our estimates as may be indicated.

We group property plant and equipment into similar groups of assets and estimate the useful life of each group of assets; see Note 7 – Property and Equipment for further information on asset groups and estimated useful lives.

Assumptions and estimates employed in these areas are material to our reported financial conditions and results of operations. These assumptions and estimates have been materially accurate in the past and are not expected to materially change in the future. Actual results could differ from these estimates.

Cash and Cash Equivalents

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

Concentration of Credit Risks

Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash and trade accounts receivable. We deposit our cash with high credit quality financial institutions in the United States and China. As of June 30, 2009, bank deposits in the United States exceeded federally insured limits by $4,773,504. This amount reflected substantially all of the net proceeds of our June 15, 2009 offering of our securities. On July 9, 2009, the $4,773,504 was deposited in a CDARS account. At June 30, 2009, we had deposits of $5,120,032 in banks in China. In China, there is no equivalent federal deposit insurance as in the United States, so the amounts held in banks in China are not insured. We have not experienced any losses in such bank accounts through June 30, 2009.

At June 30, 2009 and December 31, 2008, bank deposits by geographic area were as follows:

Country		June 30, 2009								December 31, 2008
United States		$	8,672,693				63	%		$	6,640,672				47	%
China			5,120,032				37	%			7,564,557				53	%
Total cash and cash equivalents		$	13,792,725				100	%		$	14,205,229				100	%

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

Accounts Receivable

Accounts receivable are reported at net realizable value. We have established an allowance for doubtful accounts based upon factors pertaining to the credit risks of specific customers, historical trends, age of the receivable and other information. Delinquent accounts are written off when it is determined that the amounts are uncollectible. At June 30, 2009 and December 31, 2008, allowances for doubtful accounts were approximately $300,000 and $500,000, respectively.

Inventories

Inventories, consisting of raw materials and finished goods, are stated at the lower of cost or market utilizing the weighted average method. Inventories as of June 30, 2009 and December 31, 2008 were $9,992,885 and $8,559,593, respectively. Due to the nature of our business and the short duration of the manufacturing process of our products, there was no work-in-process inventory at June 30, 2009 and December 31, 2008.

 

 

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Accounts Payable-Related Parties

At June 30, 2009 our consolidated balance sheet reflects accounts payable-related party of $1,552,780, an amount due from Chang Magnesium to Pine Capital in repayment of an advance from customer for the expected delivery of inventory. At December 31, 2008, our consolidated balance sheet reflects accounts payable-related party of $7,516,728, comprised of $4,497,180 and $3,019,548 due Chang Magnesium in repayment of customer advances by Pine Capital and Wheaton Group, 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 liabilities. SFAS 157 defines fair value, expands related disclosure requirements and specifies a hierarchy of valuation techniques based on the nature of the inputs used to develop the fair value measures. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There are three levels of inputs to fair value measurements - Level 1, meaning the use of quoted prices for identical instruments in active markets; Level 2, meaning the use of quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active or are directly or indirectly observable; and Level 3, meaning the use of unobservable inputs. Observable market data should be used when available.

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

Marketable Securities

Marketable securities held for sale and marketable securities held for sale-related party at June 30, 2009 and December 31, 2008 consists of the following:

Company			June 30, 2009								December 31, 2008
							%								%
China America Holdings, Inc.		$	357,557				7	%		$	272,200				5	%
China Logistics Group, Inc.			694,745				13	%			1,807,357				23	%
Dragon International Group Corp.			807,289				15	%			704,656				9	%
China Armco Metals, Inc.			2,773,945				52	%			4,045,002				52	%
Sunwin International Neutraceuticals, Inc.			295,218				6	%			649,337				8	%
Other			385,101				7	%			251,240				3	%
Marketable securities held for sale		$	5,313,855				100	%		$	7,729,792				100	%

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

Our consulting fees vary based upon the scope of the services to be rendered. Historically, a significant portion of the fees we earned have been paid in the form of our clients’ securities which include preferred stock, common stock and common stock purchase warrants. Some of the securities of China Logistics we own are restricted securities and cannot be readily resold by us absent a registration of those securities under the Securities Act of 1933 (the “Securities Act”) or the availability of an exemption from the registration requirements under the Securities Act.

 

 

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The securities of one client, Dragon Capital Group Corp. (“Dragon Capital”), accounted for all of the investment in marketable securities available for sale-related party and totaled $385,101 and $160,459 at June 30, 2009 and December 31, 2008, respectively. The per share price of these securities went up from $0.003 to $0.006, which accounted for the increase in the value of the securities. Dragon Capital is a related party. Mr. Lisheng (Lawrence) Wang, the CEO and Chairman of the Board of Dragon Capital, is the brother of Dr. James Wang, CEO and Chairman of China Direct. These securities were issued by Dragon Capital as compensation for consulting services. Dragon Capital is a non-reporting company whose securities are quoted on the Pink Sheets, and as such, under Federal securities laws, securities of Dragon Capital cannot be readily resold by us, generally, absent a registration of those securities under the Securities Act. Dragon Capital does not intend to register the securities.

 

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

In January 2009, the FASB issued FSP EITF 99-20-1 to amend the impairment guidance in EITF Issue No. 99-20 in order to achieve more consistent determination of whether other-than-temporary impairment (“OTTI”) has occurred. This FSP amended EITF 99-20 to more closely align the OTTI guidance to the guidance in Statement No. 115. Retrospective application to a prior interim or annual period is prohibited. The guidance in this FSP will be considered at the end of our fiscal year when we conduct an assessment of OTTI for our investment in securities available for sale.

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

The unrealized loss on marketable securities available for sale, net of the effect of taxes, for the second quarter of 2009 and 2008 was $207,262 and $1,590,347, respectively. The realized gain (loss) on investments in marketable securities available for sale for the second quarter of 2009 and 2008 was a loss of $79,221 and a gain of $3,756, 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, 2009 and December 31, 2008, our consolidated balance sheets include prepaid expenses and other current assets of $6,508,666 and $8,127,300, respectively.

Prepaid expenses-related parties were $4,142,066 and $8,007,111 at June 30, 2009 and December 31, 2008, respectively. This item is discussed in further detail in Note 10 - Related Party Transactions.

Non-current prepaid expenses and other assets consist of (i) the fair value of the securities of our client companies assigned to executive officers and employees as compensation for services to be rendered over the term of the respective consulting agreement which will be amortized beyond the twelve month period, and (ii) other assets acquired in connection with the acquisition of Pan Asia Magnesium. This item is discussed in further detail in Note 6- Prepaid Expenses and other current assets. Accordingly, non-current prepaid expenses totaled $1,800,431 and $2,744,427 at June 30, 2009 and December 31, 2008, respectively.

 

 

 

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Property, Plant and Equipment

Property, plant and equipment are recorded at cost and depreciated on a straight line basis over their estimated useful lives of three to forty years. Maintenance and repairs are charged to expense as incurred. Significant renewals and improvements are capitalized.

Acquisitions

We account for acquisitions using the purchase method of accounting in accordance with the provisions of SFAS No. 141. In each of our acquisitions for the periods presented, we determined that fair values were equivalent to the acquired historical carrying costs. Acquisitions to be made after December 15, 2008 will be accounted for under the provisions of SFAS 141R.

Advances from Customers and Deferred Revenues

Advances from customers represent (i) prepayments to us for merchandise that had not yet been shipped to customers, and (ii) the fair value of securities received as compensation which will be amortized over the term of the respective consulting agreement. We will recognize these advances as revenues as customers take delivery of the goods or when the services have been rendered, in compliance with our revenue recognition policy. Advances from customers totaled $1,503,580 and $1,545,273 at June 30, 2009 and December 31, 2008, 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 second quarter of 2009 and 2008 included net income, foreign currency translation adjustments, unrealized gains or losses on marketable securities available for sale, net of income taxes, and unrealized gains or losses on marketable securities available for sale-related party, net of income taxes.

Foreign Currency Translation

The accompanying consolidated financial statements are presented in United States dollars. The functional currency of our Chinese subsidiaries is the Renminbi, the official currency of the People’s Republic of China, (“RMB”). Capital accounts of the consolidated financial statements are translated into United States dollars from RMB at their historical exchange rates when the capital transactions occurred. Assets and liabilities are translated at the exchange rates as of the balance sheet date. Income and expenditures are translated at the average exchange rates for the second quarter of 2009 and 2008. A summary of the conversion rates for the periods presented is as follows:

	June 30,
	2009					2008
Quarter end RMB : U.S. Dollar exchange rate			6.8448				6.8718
Average year-to-date RMB : U.S. Dollar exchange rate			6.8432				7.0726

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 first and second quarters of 2009 and 2008.

 

 

 

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Subsidiaries Held for Sale

Long-lived assets are classified as held for sale when certain criteria are met. These criteria include management’s commitment to a plan to sell the assets; the availability of the assets for immediate sale in their present condition; an active program to locate buyers and other actions to sell the assets has been initiated; the sale of the assets is probable and their transfer is expected to qualify for recognition as a completed sale within one year; the assets are being marketed at reasonable prices in relation to their fair value; and it is unlikely that significant changes will be made to the plan to sell the assets. We measure long-lived assets to be disposed of by sale at the lower of carrying amount or fair value, less cost to sell.

Non-controlling Interest

 

Noncontrolling interests in our subsidiaries are recorded in accordance with the provisions of SFAS 160 Noncontrolling Interests in Consolidated Financial Statements, an amendment to ARB No. 51 and are reported as a component of our equity, separate from the parent’s equity.  Purchase or sale of equity interests that do not result in a change of control are accounted for as equity transactions.  Results of operations attributable to the noncontrolling interest are included in our consolidated results of operations and, upon loss of control, the interest sold, as well as interest retained, If any, will be reported at fair value with any gain or loss recognized in earnings.

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.

Revenue Recognition

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

Stock-based Compensation

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

Recent Pronouncements

In June 2009 the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting , or SFAS 168. SFAS 168 represents the last numbered standard to be issued by FASB under the old (pre-Codification) numbering system, and amends the GAAP hierarchy established under SFAS 162. On July 1, 2009 the FASB launched FASB’s new Codification entitled The FASB Accounting Standards Codification, or FASB ASC. The Codification will supersede all existing non-SEC accounting and reporting standards. SFAS 168 is effective in the first interim and annual periods ending after September 15, 2009. This pronouncement will have no effect on our consolidated financial statements upon adoption other than current references to GAAP which will be replaced with references to the applicable codification paragraphs.

 

 

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In June 2009 the FASB issued SFAS No. 167, Amendments to FASB Interpretation No. 46(R), or SFAS 167, that will change how we determine when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. Under SFAS No. 167, determining whether a company is required to consolidate an entity will be based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance. SFAS 167 is effective for financial statements after January 1, 2010. We are currently evaluating the requirements of SFAS 167 and the impact of adoption on our consolidated financial statements.

In May 2009 the FASB issued SFAS No. 165, Subsequent Events, or SFAS 165. SFAS 165 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. SFAS 165 requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date, that is, whether the date represents the date the financial statements were issued or were available to be issued. SFAS 165 is effective in the first interim period ending after June 15, 2009. We expect SFAS 165 will have an impact on disclosures in our consolidated financial statements, but the nature and magnitude of the specific effects will depend upon the nature, terms and value of the any subsequent events occurring after adoption.

In April 2009, the FASB issued three final Staff Positions “FSPs” intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities. FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, provides guidelines for making fair value measurements more consistent with the principles presented in FASB Statement No. 157, Fair Value Measurements. FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments, enhances consistency in financial reporting by increasing the frequency of fair value disclosures. FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments, provides additional guidance designed to create greater clarity and consistency in accounting for and presenting impairment losses on securities. We are currently evaluating the requirements of these FSPs, as well as the impact of the adoption on our consolidated financial statements, if any.

In January 2009, the FASB issued FSP EITF 99-20-1 to amend the impairment guidance in EITF Issue No. 99-20 in order to achieve more consistent determination of whether an other-than-temporary impairment (“OTTI”) has occurred. This FSP amended EITF 99-20 to more closely align the OTTI guidance therein to the guidance in Statement No. 115. Retrospective application to a prior interim or annual period is prohibited. We considered the guidance in this FSP in the assessment of OTTI for our investment in marketable securities at March 31, 2009.

On September 16, 2008, the FASB issued final 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 have evaluated the requirements of EITF 03-6-1 and it had no impact on the preparation of our consolidated financial statements as of June 30, 2009.

On October 10, 2008, the FASB issued SFP No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. This FSP clarifies the application of FASB Statement No. 157, Fair Value Measurements, in a market that is not active and provides an example to illustrate key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FASB Statement No. 157 was issued in September 2006, and is effective for financial assets and financial liabilities for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. We have adopted SFAS 157-3 and determined that it had no impact as of June 30, 2009, and we will continue to evaluate the impact, if any, of SFAS 157-3 on our financial statements.

In May 2008, the FASB issued 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) . FSP APB 14-1 clarifies that convertible debt instruments that may be settled in cash upon either mandatory or optiona1l conversion (including partial cash settlement) are not addressed by paragraph 12 of APB Opinion No. 14, Accounting for Convertible Debt and Debt issued with Stock Purchase Warrants. Additionally, FSP APB 14-1 specifies that issuers of such instruments should separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. FSP APB 14-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008, and interim periods within those fiscal years. We will adopt FSP APB 14-1 beginning in the first quarter of fiscal 2009, and this standard must be applied on a retrospective basis. We have evaluated the requirements of APB 14-1 and it had no impact on the preparation of our consolidated financial statements as of June 30, 2009.

 

 

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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 have evaluated the requirements of SFAS 161 and it had no impact on the preparation of our consolidated financial statements as of June 30, 2009.

A variety of proposed or otherwise potential accounting standards are currently under study by standard setting organizations and various regulatory agencies. Due to the tentative and preliminary nature of those proposed standards, management has not determined whether implementation of such proposed standards would be material to our consolidated financial statements.

 

NOTE 3 - EARNINGS PER SHARE

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

		For three months ended								For six months ended
		June 30,								June 30,
		2009				2008				2009				2008
Numerator:
Net (loss) income		$	(2,887,656	)		$	7,514,875			$	(4,343,187	)		$	12,267,751
Series A preferred stock:
Preferred stock dividend			(20,271	)			(1,047,937	)			(53,926	)			(1,189,467	)
Relative fair value of detachable warrants issued			-								-				(2,765,946	)
Preferred stock beneficial conversion feature			-								-				(2,451,446	)
Numerator for basic EPS, loss applicable to common stock holders (A)		$	(2,907,927	)		$	6,466,938			$	(4,397,113	)		$	5,860,892
Plus: Income impact of assumed conversion
Preferred stock dividends - unconverted						$	20,015							$	31,097
Numerator for diluted EPS, Income applicable to common stock holders   assumed conversions (*)(B)		$	(2,907,927	)		$	6,486,953			$	(4,397,113	)		$	5,891,989
Denominator:
Denominator for basic earnings per share - weighted average number of common shares outstanding (C)			24,168,640				22,663,337				24,082,025				21,833,388
Stock Awards, Options, and Warrants			-				2,620,298				-				2,215,928
Preferred stock dividends - unconverted							143,750								111,367
Denominator for diluted earnings per share - adjusted weighted average outstanding average number of common shares outstanding (D)			24,168,640				25,427,385				24,082,025				24,160,683
Basic and Diluted loss Per Common Share:
Earnings per share - basic (A)/ (C )		$	(0.12	)		$	0.29			$	(0.18	)		$	0.27
Earnings per share - diluted (B)/(D)		$	(0.12	)		$	0.26			$	(0.18	)		$	0.24

* The denominator in diluted earnings per share in 2009 and 2008 does not include shares that were assumed to be outstanding prior to conversion under the “if converted” method, 122,240 shares issuable under the unconverted preferred stock as dividends, and 217,148 of non-vested restricted shares and stock options, as such inclusion would be anti-dilutive.

 

 

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

NOTE 4 - COMPREHENSIVE INCOME

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

Our other comprehensive income consists of currency translation adjustments, unrealized loss on marketable securities available for sale, net of taxes and unrealized loss on marketable securities available for sale-related party, net of taxes. The following table sets forth the computation of comprehensive income for the second quarter and six months of 2009 and 2008, respectively:

		For the Three Months Ended June 30,								For the Six Months Ended June 30,
		2009				2008				2009				2008
		unaudited				unaudited				unaudited				unaudited
Net (loss) income		$	(3,714,106	)		$	10,426,247			$	(5,487,853	)		$	18,866,289
Other comprehensive (loss) income, net of tax
Foreign currency translation gain, net of tax			64,083				1,309,234				380,875				3,106,933
Unrealized loss on marketable securities held for sale, net of tax			(399,812	)			(1,646,180	)			(2,465,397	)			(2,774,304	)
Unrealized gain (loss) on marketable securities held for sale, net taxes - related parties			192,551				3,625				240,783				(458,598	)
Total other comprehensive (loss) income, net of tax			(143,178	)			(333,321	)			(1,843,739	)			(125,969	)
Comprehensive Income			(3,857,284	)			10,092,926				(7,331,592	)			18,740,320
Comprehensive Income attributable to the noncontrolling interests			826,450				(2,911,372	)			1,144,666				(6,598,538	)
Comprehensive (loss) Income attributable to China Direct Industries Inc.		$	(3,030,834	)		$	7,181,554			$	(6,186,926	)		$	12,141,782

NOTE 5 - INVENTORIES

Inventories at June 30, 2009 and December 31, 2008 consisted of the following:

		June 30, 2009				December 31, 2008
		unaudited
Raw materials		$	5,097,978			$	6,081,259
Finished goods			4,894,907				3,038,956
Inventory Reserve			-				(560,622	)
		$	9,992,885			$	8,559,593

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, 2009 and December 31, 2008.

 

 

 

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NOTE 6 - PREPAID EXPENSES AND OTHER CURRENT ASSETS

At June 30, 2009 and December 31, 2008, prepaid expenses and other current assets, consist of the following:

Description		June 30, 2009				December 31, 2008
		unaudited
Prepayments to vendors for merchandise that had not yet been shipped or services that had not been performed		$	2,865,690			$	2,173,989
Other recievables			446,696				2,434,578
Fair value of securities received from client companies associated with our Consulting segment assigned to employees as compensation			-				524,907
Loans receivable			3,198,156				2,987,615
Other assets acquired in connection with acquisition			1,798,555				2,750,638
Total			8,309,097				10,871,726
Less: Current Portion			(6,508,666	)			(8,127,300	)
Prepaid expenses and other assets, non-current		$	1,800,431			$	2,744,426

In the fourth quarter of 2008 we reallocated a portion of the purchase price to our September 29, 2007 acquisition of a 51% interest in Pan Asia Magnesium in accordance with FAS 144. At December 31, 2008, we reallocated $2,229,837, net of accumulated amortization of $445,967, from “fixed assets” to “other assets acquired in connection with acquisition”. This reallocation reflects the intangible value of a three-year fixed price coke supply agreement between Pan Asia Magnesium and Shanxi Jinyang Coal and Coke Group Co., Ltd., (“Jinyang Group”) a minority shareholder of Pan Asia Magnesium. In September 2007 Jinyang Group and CDI China entered into Joint Venture Investment Supplementary Agreement (“Pan Asia JV Agreement”) establishing Pan Asia Magnesium as a foreign invested entity. Under the terms of the Pan Asia JV Agreement, Jinyang Group has a commitment to provide coke gas to Pan Asia Magnesium at a fixed price until July, 2011; thereafter the price of the coke gas will be at a discount to prevailing market prices. Pan Asia Magnesium utilizes coke gas as fuel to operate its magnesium production facility. The relationship with Jinyang Group is, among other things, intended to ensure a stable supply of energy to Pan Asia Magnesium at advantageous prices, given the rising cost of fuel.

 

In the second quarter of 2009, we reclassified $689,087, net of accumulated amortization of $41,394,  from “Prepaid expenses and other assets” to “Property use rights, net” to reflect Senrun Coal’s contribution of land use rights to Golden Magnesium pursuant to the November 11, 2006 joint venture agreement entered into among the parties. Pursuant to these land use rights which permit construction of a magnesium production plant capable of producing up to 20,000 tons of magnesium alloy products per year, Golden Magnesium built its magnesium production plant on this land. The land use rights expire in 2057.

         For the second quarter and six months of 2009 amortization expense totaled $249,052 and $498,104, respectively. For the second quarter and six months of 2008 amortization expense totaled $222,984 and $445,967, respectively.

NOTE 7 - PROPERTY, PLANT AND EQUIPMENT

 

At June 30, 2009 and December 31, 2008, property, plant and equipment, consisted of the following:

Description		Useful Life				June 30, 2009				December 31, 2008
						Unaudited
Building		10-40 years				$	12,013,505			$	7,792,403
Manufacturing equipment		10 years					18,989,327				12,635,161
Office equipment and furniture		3-5 years					707,028				636,621
Autos and trucks		5 years					1,267,261				334,630
Construction in progress		N/A					16,839,070				26,277,835
Total							49,816,191				47,676,650
Less:  Accumulated Depreciation							(5,174,219	)			(4,220,967	)
Property, Plant and Equipment, Net						$	44,641,972			$	43,455,683

For the second quarter and six months of 2009 depreciation expense totaled $451,163 and $953,250, respectively. For the second quarter and six months of 2008 depreciation expense totaled $494,967 and $921,287 , respectively.

  Golden Magnesium holds land use rights to use approximately 24.5 acres of land located in Yueyan, Gu County, Shanxi Province, China.  Pursuant to these land use rights which permit construction of a magnesium production plant capable of producing up to 20,000 tons of magnesium alloy products per year, Golden Magnesium built its magnesium production plant on this land. The land use rights expire in 2057.

 

 

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NOTE 8 - PROPERTY USE RIGHTS

 

        Property use rights, consisting of mining and property use rights amounted to $1,281,046 and $591,277 at June 30, 2009 and December 31, 2008, respectively.

 

       CDI Magnesium holds property use rights valued at $96,078 for the use of magnesium alloy manufacturing equipment located in a magnesium alloy facility in China which is owned by Jinyang Group. We will begin to amortize the value of the property use rights over the useful life of equipment when the magnesium refinery commences operations.

In connection with our acquisition of CDI Jixiang Metal in December 2007, we acquired mining rights to 51 acres located in the Yongshun Kaxi Lake Mining area of China. CDI Jixiang Metal is presently in the exploration stage of its business operations and is engaged in the evaluation of mineral deposits or reserves. We have not established a reserve. There is no assurance that commercially viable mineral deposits exist on this property and further exploration will be required before a final evaluation as to the economic feasibility is determined.

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

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

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

NOTE 9 - LOANS PAYABLE

Loans payable at June 30, 2009 and December 31, 2008 consisted of the following:

Description		June 30, 2009				December 31, 2008
Loan due to China Industry Bank., an unrelated party.  Due July 2012.  6.06375% annual interest rate		$	8,035			$	186,018
Commerical Bank due November 2009, related to Lang Chemical, (Lang Chemical deposited Principal amount to guarantee this note)			1,249,123				262,613
Loan due to Chen Jian Fei, unsecured, payable on demand, no interest*			730,460				-
Mingsheng Bank Due May 2010, interest is LIBOR plus 20%			496,727				671,122
Shanghai Bank Due January 2010, interest is 5.84%			292,193				-
Total			2,776,538				1,119,753
Less: Current Portion			(2,768,503	)			(933,735	)
Loans payable, long-term		$	8,035			$	186,018

 

* This loan was inadvertently classified in prior periods as an amount due to Chen Chi, a related party, and was reclassified in the current period to loans payable – short term to reflect amounts due to Chen Jian Fei, a non-related party.

 

 

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NOTE 10 - RELATED PARTY TRANSACTIONS

We have specified the following persons and entities as related parties with ending balances as of June 30, 2009 and December 31, 2008:

List of Related Parties

	•		Yuwei Huang is executive vice president of our Magnesium segment, a member of our board of directors, chief executive officer and chairman of Chang Magnesium, chairman of Baotou Changxin Magnesium, chairman of YiWei Magnesium, and chief executive officer and vice chairman of Golden Magnesium;
	•		Taiyuan YiWei Magnesium Industry Co., Ltd., a company organized under the laws of the PRC (“YiWei Magnesium”), is a non-controlling interest owner in Chang Magnesium;
	•		Lifei Huang is the daughter of Yuwei Huang;
	•		Huihuan Huang is the sister of Yuwei Huang;
	•		Lifei Huang is a registered representative of Pine Capital Enterprises Inc., a company organized under the laws of the Caymen Islands (“Pine Capital”);
	•		Lifei Huang is a registered representative of Wheaton Group Corp., a company organized under the laws of Brunei Darussalam (“Wheaton”);
	•		Nippon Magnetic Dressing Co., Ltd., a company organized under the laws of the Japan (“Nippon Magnetic”), is a non-controlling interest owner of YiWei Magnesium;
	•		LuCheng Haixu Magnesium Co., Ltd., a company organized under the laws of the PRC (“Haixu Magnesium”), is legally represented by an officer of Chang Magnesium;
	•		LingShi County Yihong Magnesium Co., Ltd., a company organized under the laws of the PRC (“Yihong Magnesium”), is legally represented by an officer of Chang Magnesium;
	•		Shanxi Senrun Coal Chemistry Co., Ltd., a company organized under the laws of the PRC (“Senrun Coal”), is a non-controlling interest owner in Golden Magnesium;
	•		Shanxi Jinyang Coal and Coke Group Co., Ltd., a company organized under the laws of the PRC (“Jinyang Group”), is a non-controlling interest owner of Pan Asia Magnesium;
	•		Japan Material Industry Co., Ltd. a company organized under the laws of the PRC, (“Japan Material”), is a non-controlling interest owner of YiWei Magnesium;
	•		Australia Three Harmony Co., Ltd., a company organized under the laws of Australia, is a non-controlling interest owner of Baotou Changxin Magnesium;
	•		Runlian Tian is a director of Pan Asia Magnesium;
	•		NanTong Langyuan Chemical Co., Ltd., a company organized under the laws of the PRC (“NanTong Chemical”), is owned by Jingdong Chen and Qian Zhu, the non-controlling interest owners of Lang Chemical;
	•		Jingdong Chen, is vice president of our Basic Materials segment and chief executive officer of Lang Chemical;
	•		Qian Zhu is chief financial officer of Lang Chemical. Jingdong Chen and Qian Zhu are husband and wife; and
	•		Lisheng (Lawrence) Wang is the chief executive officer and chairman of Dragon Capital Group Corp. a Nevada corporation, (“Dragon Capital”) and is the brother of Dr. Wang, our CEO and Chairman and Xiaowen Zhuang, a key employee of ours.

Accounts Receivable – related parties

At June 30, 2009 we reflected accounts receivable – related parties of $4,349,383 comprised of the following:

	•		$1,772,638 due Chang Magnesium from YiWei Magnesium for inventory provided; and,
	•		$1,710,945 due Baotou Changxin Magnesium from YiWei Magnesium, for inventory provided; and
	•		$865,800 due Golden Magnesium from YiWei Magnesium for inventory provided.

At December 31, 2008 we reflected accounts receivable – related parties of $1,676,191 comprised of the following:

	•		$1,628,896 due Baotou Changxin Magnesium from YiWei Magnesium, for inventory provided; and
	•		$47,295 due Golden Magnesium from YiWei Magnesium for inventory provided.

 

 

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Prepaid Expenses – related parties

At June 30, 2009 we reflected prepaid expenses – related parties of $4,142,066 comprised of the following:

	•		$2,953,028 prepaid by Chang Magnesium to YiWei Magnesium for future delivery of inventory;
	•		$661,586 prepaid by Chang Magnesium to Yihong Magnesium to for future delivery of inventory;
	•		$215,577 prepaid by Pan Asia Magnesium to Jinyang Group for the future delivery of coke gas;
	•		$156,252 prepaid by Golden Magnesium to Senrun Coal for future delivery of coke gas for fuel;
	•		$98,637 prepaid by Chang Magnesium to Wheaton Group for the future delivery of inventory; and
	•		$56,986 prepaid by Chang Magnesium to Haixu Magnesium for future delivery of inventory.

At December 31, 2008 we reflected prepaid expenses – related parties of $8,007,111 comprised of the following:

	•		$5,830,717 prepaid by Chang Magnesium to YiWei Magnesium for future delivery of inventory;
	•		$940,699 prepaid by Golden Magnesium to Senrun Coal for future delivery of coke gas for fuel;
	•		$520,397 prepaid by Chang Magnesium to Nippon Magnetic to for future delivery of inventory;
	•		$389,225 prepaid by Pan Asia Magnesium to Jinyang Group for the future delivery of coke gas; and
	•		$326,073 prepaid by Golden Magnesium to YiWei Magnesium for future delivery of inventory.

Loan Receivable – related parties

At June 30, 2009 we reflect loan receivables – related parties of $1,120,432 comprised of the following:

•

$1,120,432 due Lang Chemical from NanTong Chemical for funds advanced for working capital purposes, this loan is due on September 9, 2010 and carries an annual interest rate of 6%.

At December 31, 2008 we reflected loan receivables – related parties of $1,652,728 comprised of the following:

	•		$1,608,959 due Lang Chemical from NanTong Chemical for funds advanced for working capital purposes; and
	•		$43,769 due CDI Shanghai Management from Dragon Capital for funds advanced for working capital purposes.

Due from related parties

At June 30, 2009 we reflect due from related parties of $42,002 comprised of the following:

•

$42,002 due China Direct from a China Direct employee for the exercise price of exercised stock options and related taxes.

At December 31, 2008 we reflected due from related parties of $35,710 comprised of the following:

	•		$21,125 due China Direct from a China Direct employee for the exercise price of exercised options; and
	•		$14,585 due CDI Metal Recycling from Zhou Weiyi, for the contribution of registered capital related to the formation of CDI Metal Recycling.

Accounts Payable – related parties

At June 30, 2009 we reflect accounts payable – related party of $1,552,780 comprised of the following:

•

$1,552,780 due from Chang Magnesium to Pine Capital in repayment of an advance from customer for the expected delivery of inventory.

At December 31, 2008 we reflected accounts payable – related party of $7,516,728 comprised of the following:

	•		$4,497,180 due from Chang Magnesium to Pine Capital in repayment of an advance from customer for the expected delivery of inventory; and
	•		$3,019,548 due from Chang Magnesium to Wheaton Group in repayment of an advance form customer for the expected delivery of inventory.

 

 

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Due to related parties

At June 30, 2009 we reflect due to related parties balance of $71,963 comprised of the following:

•

$71,963 due to Australia Three Harmony from Golden Magnesium for fund advances for working capital purposes.

At December 31, 2008 we reflected due to related parties balance of $978,739 comprised of the following:

	•		$832,843 due to Chen Chi, this amount is made of up $729,257 due from Capital One Resource, and $103,586 from CDI Beijing for fund advances for working capital purposes; and
	•		$145,896 advanced by Huihuan Huang to Chang Magnesium for working capital purposes.

NOTE 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, 2009 and December 31, 2008 there were 1,006 shares of Series A Convertible Preferred Stock issued and outstanding.

Series A Preferred Stock and Related Dividends

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

Upon conversion of the Series A Preferred Stock, we are required to pay an amount (the “Make-Whole Additional Amount”) equal to 8% of the stated value of the shares converted or redeemed - essentially an extra year’s dividend. This amount 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, 2009, holders of our Series A Preferred Stock have converted 11,944 shares of the 12,950 shares of the Series A Preferred Stock. Each share of Series A Preferred stock was convertible into 142.8541 shares of common stock. As a result of the conversion of the Series A Preferred Stock, we have issued 1,706,250 shares of our common stock, 41,967 shares of common stock in payment of the accrued dividends, and 144,206 shares of common stock, the Make-Whole Additional Amount.

The 1,850,000 warrants issued to purchasers of the Series A Preferred Stock, exclusive of the 300,000 warrants issued to Roth Capital Partners, LLC (“Roth Capital”) as a fee, were determined to have a fair value of $2.07 per warrant with a total valuation of $3,829,500. Inputs used in making this determination included:

	·	Value of $6.83 per share of common stock;
	·	Expected volatility factor of 90%;
	·	$0 dividend rate on the common stock;
	·	Warrant exercise price of $8.00;
	·	Estimated time to exercise of 1 year; and
	·	Risk free rate of 2.06%.

The relative fair value of the warrants of $2,765,946 has been recorded as a dividend in the year ended December 31, 2008

 

 

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In addition, under the provisions of EITF 98-5 ‘Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios’ (“EITF 98-5”),and EITF 00-27 "Application of Issue No. 98-5 to Certain Convertible Instruments’" ("EITF 00-27”), the Series A Preferred Stock issuance carried an embedded beneficial conversion feature at issuance. Accordingly, after first allocating the proceeds received from the Series A Preferred Stock offering to the preferred shares and detachable warrants on a relative fair value basis, we derived an intrinsic value of the conversion feature of $2,451,446. As the Series A Preferred Stock does not have a stated redemption date or finite life, the deemed dividend was recognized immediately as a non-cash charge during 2008. This non-cash one-time preferred stock deemed dividend was calculated as the difference between the average of our common stock price of $6.83 per share and the calculated effective conversion price of the Series A Preferred Stock. The effective conversion price of the Series A Preferred Stock was determined with reference to the relative fair value allocation of proceeds between the Series A Preferred Stock and Warrants issued. The non-cash deemed dividend did not have an effect on net earnings, or cash flows for the six months ended June 30, 2009. The estimated fair market value of the Warrants of $2,765,946 has been recorded as additional paid-in capital and a reduction to the recorded amount of the Series A Preferred Stock.

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

As a result of our June 15, 2009 registered direct offering of our common stock discussed below, we reduced to $1.85 per share the exercise price of warrants to purchase 143,750 shares of our common stock with an exercise price of $8.00 per share and the conversion price of 1,006 shares of our series A convertible preferred stock outstanding that are convertible into 143,750 shares of our common stock at a conversion price of $7.00 per share. The terms of these warrants and preferred stock provide that if we sell common stock at a price per share less than the then exercise price of the warrants or the conversion price of the preferred stock, then we are required to reduce the exercise price of those warrants and the conversion price of the series A convertible preferred stock to the lower price of the subsequent sale. Because the market price of our common stock in our June 15, 2009 offering was $1.85 per share, an amount that is less than the exercise price of the $8.00 per share warrants and the $7.00 per share conversion price, we reduced the exercise price of those outstanding securities.

Common Stock

We have 1,000,000,000 shares of common stock, par value $.0001, authorized. At June 30, 2009 there were 26,519,623 shares of common stock issued and outstanding and there were 23,530,642 shares of common stock issued and outstanding at December 31, 2008.

For the six months ended June 30, 2009 and 2008, amortization of stock-based compensation amounted to $1,122,803 and $848,364, respectively.

During the six months ended June 30, 2009, we issued 1,050,000 shares of common stock in connection with the exercise of common stock options at an exercise price of $.01 with net proceeds of $10,000.

During the second quarter of 2009 we issued 21,000 shares of our common stock to Bazelon Less & Feldman, P.C. as compensation for legal services it provided to us.  These shares were issued at $1.71 per share for a total consideration of $36,000.

On June 16, 2009 we sold 2,702,704 shares of our common stock and warrants to purchase up to 1,351,352 of common stock to accredited investors. The purchase price per share of the common stock was $1.85. The warrants have an exercise price of $2.31 per share and will be exercisable beginning 183 days following the closing date for a period ending on the fifth anniversary of the initial exercise date. The gross proceeds of this offering were $5,000,000 with offering expenses of $190,000.  Management intends to use the proceeds from this offering for general working capital purposes which may include acquisitions of additional operations in China.

Stock Repurchase Program

On September 10, 2008, our board of directors authorized a stock repurchase program to repurchase up to $2.5 million of our common stock through June 30, 2009. The stock repurchase program was announced on September 12, 2008. The amount and timing of specific repurchases are subject to market conditions, applicable legal requirements and other factors deemed appropriate by our CEO and President. Repurchases may be in open-market transactions or through privately negotiated transactions, and our board of directors may discontinue the repurchase program at any time. In January 2009, we purchased 1,500,000 shares of our common stock at a price of $1.10 per share under this program from Marc Siegel, our former president and director. This stock repurchase program expired on June 30, 2009.

 

 

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Reverse Split/Forward Split

On September 10, 2008, our board of directors approved a 1 for 100 shares reverse split of our common stock (the “Reverse Split”) to be immediately followed by a 100 for 1 forward split of our common stock (the “Forward Split”). The Reverse Split/Forward Split was announced on September 19, 2008. Shareholders who held in the aggregate less than one share of common stock following the Reverse Split were not included in the Forward Split. Rather, such shares received a cash payment of $5.07 per share, the closing price of our common stock as of September 19, 2008. Accordingly in 2008, we purchased 69,583 shares at a purchase price of $5.07 per share, which were redeemed. These stock purchases were not part of the stock repurchase program.

Stock Incentive Plans

On August 16, 2006, our board of directors authorized the 2006 Equity Plan (the “2006 Equity Plan”) covering 10,000,000 shares of our common stock, which was approved by a majority of our shareholders on August 16, 2006. At June 30, 2009 and December 31, 2008 there were options outstanding to purchase an aggregate of 276,250 and 365,000 shares, respectively, of common stock outstanding under the 2006 Equity Plan at exercise prices ranging from $2.50 to $7.50 per share.

On October 19, 2006, our board of directors authorized the 2006 Stock Compensation Plan (the “2006 Stock Compensation Plan”) covering 2,000,000 shares of our common stock. As the 2006 Stock Compensation Plan was not approved by our shareholders prior to October 19, 2007, we may no longer award incentive stock options under this plan and any incentive stock options previously awarded under the 2006 Stock Plan were converted into non-qualified options upon terms and conditions determined by the board of directors, as nearly as is reasonably practicable in their sole determination, to the terms and conditions of the incentive stock options being so converted. At June 30, 2009 and December 31, 2008, there were options outstanding to purchase an aggregate of 556,740 and 414,590 shares, respectively of common stock outstanding under the 2006 Stock Plan at exercise prices ranging from $.01 to $5.00 per share.

During 2008, we granted 240,000 options under the 2006 Equity Plan to employees with an exercise price of $5.00 to $7.50 per share, of these options, 231,000 options were canceled as of June 30, 2009. The options were valued on the date of grant using the Black-Scholes option-pricing model, in accordance with SFAS No. 123R using the following weighted-average assumptions: expected dividend yield 0%, risk-free interest rate of 2.51%, volatility of 78% and expected term of 1.31 years.

On April 25, 2008, our board of directors adopted the 2008 Executive Stock Incentive Plan covering 1,000,000 shares of our common stock, which was approved by a majority vote of our shareholders on May 30, 2008. As of June 30, 2009 no awards had been granted under this plan.

On April 25, 2008, our board of directors adopted the 2008 Non-Executive Stock Incentive Plan covering 3,000,000 shares of our common stock, which was approved by a majority vote of our shareholders on May 30, 2008. As of June 30, 2009 we granted 268,648 shares of restricted stock under this plan with vesting dates ranging from August 2008 to September 2010.

The following table sets forth our stock option activity during the six months ended June 30, 2009:

		Shares underlying options				Weighted average exercise price
Outstanding at December 31, 2008			6,440,220			$	5.71
Granted			-				-
Exercised			1,050,000				0.01
Expired or cancelled			103,750				5.30
Outstanding at June 30, 2009			5,286,470			$	10.30

 

 

 

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The weighted average remaining contractual life and weighted average exercise price of options outstanding at June 30, 2009, 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
$	2.25				400				5.81			$	2.25				400			$	2.25
	2.50				492,490				2.75				2.50				492,490				2.50
	3.00				50,000				1.75				3.00				50,000				3.00
	5.00				1,221,000				2.75				5.00				1,221,000				5.00
	7.50				1,387,000				3.75				7.50				1,387,000				7.50
	10.00				1,375,000				4.75				10.00				1,375,000.00				10.00
	15.00				500				1.43				15.00				500				15.00
	30.00				760,000				3.75				30.00				760,000				30.00
	56.25				80				5.92				56.25				80				56.25
					5,286,470							$	10.30				5,286,470			$	10.30

During the six months ended June 30, 2009, 1,050,000 options were exercised at an exercise price of $.01 per share with an intrinsic value of $1,462,130. At June 30, 2009, the aggregate intrinsic value of outstanding and exercisable options was $0. As of June 30, 2009, the unrecognized expense of options that have not vested is $36,583.

Common Stock Purchase Warrants

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

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

On June 16, 2009 we sold 2,702,704 shares of our common stock and warrants to purchase up to 1,351,352 of common stock to accredited investors. The purchase price per share of the common stock was $1.85. The warrants have an exercise price of $2.31 per share and will be exercisable beginning 183 days following the closing date for a period ending on the fifth anniversary of the initial exercise date. The gross proceeds of this offering were $5,000,000 with offering expenses of $190,000.  Management intends to use the proceeds from this offering for general working capital purposes which may include acquisitions of additional operations in China.

As a result of our June 15, 2009 registered direct offering of our common stock, we reduced the per share exercise price of warrants to purchase 143,750 shares of our common stock from $8.00 to $1.85.  A summary of the status of our outstanding common stock purchase warrants granted as of June 30, 2009 and changes during the period is as follows:

 

 

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		Shares underlying warrants				Weighted average exercise price
Outstanding at December 31, 2008			4,618,312			$	8.49
Granted			1,351,352				2.31
Exercised			-				-
Expired or cancelled			-				-
Outstanding at June 30, 2009			5,969,664			$	6.94
Exercisable at June 30, 2009			4,618,312			$	8.29

The following information applies to all warrants outstanding at June 30, 2009.

 

				Warrants Outstanding												Warrants
																Exercisable
								Weighted
								Average				Weighted								Weighted
								Remaining				Average								Average
Range of								Contractual				Exercise								Exercise
Exercise prices				Shares				Life (Years)				Price				Shares				Price
$	1.85				143,750				4.12			$	1.85				143,750			$	1.85
	2.31				1,351,352				4.95				2.31				-				2.31
	2.5				50,000				2.92				2.50				50,000				2.50
	4				473,750				2.79				4.00				473,750				4.00
	7.50				60,000				1.39				7.50				60,000				7.50
	8.00				1,906,250				4.12				8.00				2,050,000				8.00
	10.00				1,869,562				2.74				10.00				1,869,562				10.00
	11.00				25,000				2.27				11.00				25,000				11.00
	15.00				90,000				1.39				15.00				90,000				15.00
					5,969,664							$	6.94				4,618,312			$	8.29

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 second quarter of 2009, we operated in three reportable business segments as follows:

Magnesium segment:

	•		Chang Magnesium;
	•		Chang Trading;
	•		Excel Rise;
	•		CDI Magnesium;
	•		Asia Magnesium;
	•		Golden Magnesium;
	•		Pan Asia Magnesium;
	•		Baotou Changxin Magnesium

 

 

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Basic Materials segment:

	•		Lang Chemical;
	•		CDI Jingkun Zinc;
	•		CDI Jixiang Metal;
	•		CDI Metal Recycling; and
	•		CDI Beijing.

Consulting segment:

	•		China Direct Investments;
	•		CDI Shanghai Management; and
	•		Capital One Resource*.

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

Our reportable segments are strategic business units that offer different products and services. Each segment is managed and reported separately based on the fundamental differences in their operations. CDI Metal Recycling was formerly in our Clean Technology Segment, which we exited during the third quarter in 2008. CDI Metal Recycling is in its start up phase and has no significant operations. Condensed consolidated information with respect to these reportable segments after giving effect to our decision to exit the clean technology segment for the three and six months ended June 30, 2009 and 2008 are as follows:

For the three months ended June 30, 2009:

(In thousands)		Magnesium				Basic Materials				Consulting				Consolidated
Revenues		$	8,091			$	10,005			$	322			$	18,418
Revenues – related party			2,008				-				-			$	2,008
			10,099				10,005				322				20,426
Interest income (expense)			19				54				(160	)			(87	)
Net income (loss) attributable to China Direct Industries, Inc.			(1,126	)			56				(1,818	)			(2,888	)
Segment Assets at June 30, 2009		$	45,750			$	10,615			$	44,449			$	100,814

For the three months ended June 30, 2008:

(In thousands)		Magnesium				Basic Materials				Consulting				Consolidated
Revenues		$	54,319			$	14,982			$	6,698			$	75,999
Revenues – related party			1,345				-				-				1,345
			55,664				14,982				6,698				77,344
Interest income (expense)			(43	)			(29	)			215				143
Net income attributable to China Direct Industries, Inc.			3,001				25				4,559				7,515
Segment Assets		$	84,883			$	10,770			$	27,997			$	123,650

 

 

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For the six months ended June 30, 2009:

(In thousands)		Magnesium				Basic Materials				Consulting				Consolidated
Revenues		$	11,895			$	21,899			$	680			$	34,474
Revenues – related party			6,637												6,637
			18,532				21,899				680				41,111
Interest income (expense)			(83	)			(14	)			56				(41	)
Net income attributable to China Direct Industries, Inc.			(1,123	)			16