Edgar Filing: China Direct Industries, Inc.

cdii10q.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

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

For the quarterly period ended March 31, 2010


[ ]	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 INDUSTRIES, INC.

(Exact name of registrant as specified in its charter)


Florida	13-3876100
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

431 Fairway Drive, Suite 200, Deerfield Beach, Florida	33441
(Address of principal executive offices)	(Zip Code)

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [ ] No [ ]

Indicate by check mark 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. 30,798,093 shares of common stock were issued and outstanding as of May 10, 2010.

TABLE OF CONTENTS

PART I. - FINANCIAL INFORMATION			Page No.
	Item 1.	Financial Statements.	1
	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations.	32
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	49
	Item 4T.	Controls and Procedures.	50
PART II - OTHER INFORMATION
	Item 1.	Legal Proceedings.	51
	Item 1A.	Risk Factors.	51
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	51
	Item 3.	Defaults Upon Senior Securities.	51
	Item 4.	(Removed and Reserved).	51
	Item 5.	Other Information.	51
	Item 6.	Exhibits.	51
	Signatures		54

INDEX OF CERTAIN DEFINED TERMS USED IN THIS REPORT

When used in this report the terms:

	•		“China Direct Industries”, “we”, “us” or "our” refers to China Direct Industries, Inc., a Florida corporation, and our subsidiaries;
	•		“CDI China”, refers to CDI China, Inc., a Florida corporation, and a wholly owned subsidiary of China Direct Industries; and
	•		“PRC” refers to the People’s Republic of China.

Magnesium Segment

	•		“Chang Magnesium”, refers to Taiyuan Changxin Magnesium Co., Ltd., a company organized under the laws of the PRC and a 51% owned subsidiary of CDI China;
	•		“Chang Trading”, refers to Taiyuan Changxin YiWei Trading Co., Ltd., a company organized under the laws of the PRC and a wholly owned subsidiary of Chang Magnesium;
	•		“Excel Rise”, refers to Excel Rise Technology Co., Ltd., a Brunei company and a wholly owned subsidiary of Chang Magnesium;
	•		“CDI Magnesium”, refers to CDI Magnesium Co., Ltd., a Brunei company and a 51% owned subsidiary of Capital One Resources;
	•		“Asia Magnesium”, refers to Asia Magnesium Corporation Limited, a company organized under the laws of Hong Kong and a wholly owned subsidiary of Capital One Resource;
	•		“Golden Magnesium" refers to Shanxi Gu County Golden Magnesium Co., Ltd., a company organized under the laws of the PRC and a 52% owned subsidiary of Asia Magnesium;
	•		“Pan Asia Magnesium”, refers to Pan Asia Magnesium Co., Ltd., a company organized under the laws of the PRC and a 51% owned subsidiary of CDI China;
	•		“Baotou Changxin Magnesium”, refers to Baotou Changxin Magnesium Co., Ltd., a company organized under the laws of the PRC, a 51% owned subsidiary of CDI China, and a 39% owned subsidiary of Excel Rise. Effectively China Direct holds a 70.9% interest;
	•		“IMG” or “International Magnesium Group”, refers to International Magnesium Group, Inc., a Florida corporation and a 100% owned subsidiary of China Direct Industries; and
	•		“IMTC” or “International Magnesium Trading”, refers to International Magnesium Trading Corp., a company organized under the laws of Brunei and a 100% owned subsidiary of CDI China.

Basic Materials Segment

	•		“Lang Chemical”, refers to Shanghai Lang Chemical Co., Ltd., a company organized under the laws of the PRC and a 51% owned subsidiary of CDI China;
	•		“CDI Jingkun Zinc”, refers to CDI Jingkun Zinc Industry Co., Ltd., a company organized under the laws of the PRC and a 95% owned subsidiary of CDI Shanghai Management;
	•		“CDI Jixiang Metal”, refers to CDI Jixiang Metal Co., Ltd., a company organized under the laws of the PRC and a wholly owned subsidiary of CDI China;
	•		“CDI Metal Recycling”, refers to Shanghai CDI Metal Recycling Co., Ltd., a company organized under the laws of the PRC and an 83% owned subsidiary of CDI Shanghai Management;
	•		“CDI Beijing”, refers to CDI (Beijing) International Trading Co., Ltd., a company organized under the laws of the PRC and a 51% owned subsidiary of CDI Shanghai Management; and
	•		“CDII Trading”, refers to CDII Trading, Inc., a Florida corporation and a 100% owned subsidiary of China Direct Industries.

Consulting Segment

	•		“China Direct Investments”, refers to China Direct Investments, Inc., a Florida corporation, and a wholly owned subsidiary of China Direct;
	•		“CDI Shanghai Management”, refers to CDI Shanghai Management Co., Ltd., a company organized under the laws of the PRC and a wholly owned subsidiary of CDI China; and
	•		“Capital One Resource”, refers to Capital One Resource Co., Ltd., a Brunei company, and a wholly owned subsidiary of CDI Shanghai Management.

Clean Technology Segment: (All operations related to the following entities were discontinued in September 2008)

	•		“CDI Clean Technology”, refers to CDI Clean Technology Group, Inc., a Florida corporation formerly known as Jinan Alternative Energy Group Corp.. Effective October 30, 2008, CDI China holds a 19% interest;
	•		“CDI Wanda”, refers to Shandong CDI Wanda New Energy Co., Ltd., a company organized under the laws of the PRC and a 51% owned subsidiary of CDI Clean Technology; and
	•		“Yantai CDI Wanda”, refers to Yantai CDI Wanda Renewable Resources Co., Ltd., a company organized under the laws of the PRC and a 52% owned subsidiary of CDI Wanda.

The information which appears on our websites is not part of this report.

All share and per share information contained herein gives retroactive effect to the 1-for-100 shares reverse split of our common stock on September 19, 2008 which was immediately followed by a 100-for-1 forward split of our common stock.

PART 1 - FINANCIAL INFORMATION

Item 1.

Financial Statements.

CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	March 31, 2010			September 30, 2009
	Unaudited
ASSETS
Current Assets:
Cash and cash equivalents	$	15,072,206		$	12,851,310
Investment in marketable securities available for sale		2,274,299			4,984,351
Investment in marketable securities available for sale - related party		596,680			604,686
Investment in subsidiaries -- cost method		290,864			290,864
Accounts receivable, net of allowance of $216,875 and $745,786 at March 31, 2010 and September 30, 2009, respectively		10,355,073			8,195,916
Accounts receivable - related parties		2,065,328			2,355,059
Inventories, net		7,664,580			5,806,722
Prepaid expenses and other current assets		6,599,312			5,092,205
Prepaid expenses - related parties		4,465,723			5,823,039
Loans receivable - related parties		1,370,747			1,094,142
Current assets of discontinued operations		51,345			51,345
Total current assets		50,806,157			47,149,639
Restricted cash		716,783			722,324
Property, plant and equipment, net		30,323,027			31,331,992
Prepaid expenses and other assets		2,443			1,836
Property use rights, net		1,089,766			1,113,902
Long-lived assets of discontinued operations		196,078			196,077
Total assets	$	83,134,254		$	80,515,770

LIABILITIES AND EQUITY
Current Liabilities:
Loans payable-short term	$	1,952,868		$	1,521,002
Accounts payable and accrued expenses		7,139,870			7,708,730
Accounts payable-related parties		51,736			51,716
Advances from customers and deferred revenue		1,388,865			2,007,137
Other payables		1,276,348			3,072,238
Other payables - related parties		374,483			399,629
Taxes payable		443,057			1,130,907
Current liabilities of discontinued operations		300,000			300,000
Total current liabilities		12,927,227			16,191,359
Total liabilities		12,927,227			16,191,359

CHINA DIRECT INDUSTRIES INC. EQUITY
Preferred Stock: $.0001 par value, stated value $1,000 per share; 1,006 shares outstanding at March 31, 2010 and September 30, 2009, respectively.		1,006,250			1,006,250
Common Stock: $.0001 par value; 30,635,475 and 27,189,719 outstanding at March 31, 2010 and September 30, 2009, respectively.		3,064			2,719
Additional paid-in capital		63,044,813			57,492,755
Accumulated other comprehensive income		1,543,404			1,902,221
Accumulated deficit		(13,716,371	)		(14,328,732	)
Total China Direct Industries, Inc. stockholders' equity		51,881,160			46,075,213
Noncontrolling interests		18,325,867			18,249,198
Total Equity		70,207,027			64,324,411
Total liabilities and equity	$	83,134,254		$	80,515,770

The accompanying notes are an integral part of these financial statements.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	For the Three Months Ended March 31						For the Six Months Ended March 31
	2010			2009			2010			2009

Revenues	$	21,223,422		$	16,056,677		$	41,034,154		$	41,407,486
Revenues-related parties		2,147,104			4,629,432			4,588,900			18,235,074
Total revenues		23,370,526			20,686,109			45,623,054			59,642,560
Cost of revenues		21,376,375			19,317,293			41,804,685			59,339,911
Gross profit		1,994,151			1,368,816			3,818,369			302,649

Operating expenses:
Selling, general, and administrative		2,469,306			2,463,109			5,262,809			6,132,949
Operating loss		(475,155	)		(1,094,293	)		(1,444,440	)		(5,830,300	)
Other (expense) income:
Other (expense) income		(53,920	)		56,169			48,485			66,828
Interest income (expense)		4,614			46,088			3,614			(11,384	)
Realized gain (loss) on sale of marketable securities		2,066,497			(232,711	)		2,101,188			(331,529	)
Realized loss on Other Than Temporary Impairment		-			-			-			(7,521,088	)
Realized gain on sale subsidiaries		-			-			-			238,671
Total other income (expense)		2,017,191			(130,454	)		2,153,287			(7,558,502	)
Income (loss) from continuing operations before income taxes		1,542,036			(1,224,747	)		708,847			(13,388,802	)

Income tax (expense) benefit		(15,206	)		71,579			(54,924	)		179,470
Income (loss) from continuing operations, net of income taxes		1,526,830			(1,153,168	)		653,923			(13,209,332	)
Loss from discontinued operations		-			(620,579	)		-			(1,536,823	)
Net income (loss)	$	1,526,830		$	(1,773,747	)	$	653,924		$	(14,746,155	)
Net income attributable to noncontrolling interests-continuing operations		130,354			14,132			18,746			2,389,489
Net income attributable to noncontrolling interests-discontinued operations		-			304,084			-			753,045
Net income (loss) attributable to China Direct Industries, Inc.	$	1,657,184		$	(1,455,531	)	$	672,669		$	(11,603,621	)

Deduct dividends on Series A Preferred Stock:
Preferred stock dividend		(20,125	)		(20,235	)		(60,308	)		(40,470	)

Net income (loss) attributable to common stockholders	$	1,637,059		$	(1,475,766	)	$	612,361		$	(11,644,091	)

Basic and diluted income (loss) per common share:
Basic	$	0.06		$	(0.06	)	$	0.02		$	(0.49	)
Diluted	$	0.06		$	(0.06	)	$	0.02		$	(0.49	)
Basic weighted average common shares outstanding		28,594,256			23,414,500			27,981,440			23,555,518
Diluted weighted average common shares outstanding		29,057,018			23,414,500			28,444,202			23,555,518

The accompanying notes are an integral part of these financial statements.

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CHINA DIRECT INDUSTRIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY

(Unaudited)

	Preferred Stock				Common Stock
	Shares		Amount		Shares		Amount		Additional Paid-in Capital		Accumulated Comprehensive Income			Retained Earnings			Non-controlling Interests		Total

Balance, September 30, 2009		1,006	$	1,006,250		27,189,719	$	2,719	$	57,492,756	$	1,902,221		$	(14,328,732	)	$	18,249,198	$	64,324,411

Dividends paid to preferred stockholders		-		-		29,255		3		40,183		-			(60,308	)		-		(20,122	)
Common stock sold		-		-		2,760,975		276		4,520,209		-			-			-		4,520,485
Restricted stock award - employees		-		-		207,767		21		441,819		-			-			-		441,840
Restricted stock award - consultants		-		-		127,454		13		177,817		-			-			-		177,830
Restricted stock award - board of directors		-		-		60,305		6		57,336		-			-			-		57,342
Stock option amortization		-		-		-		-		18,292		-			-			-		18,292
Common stock purchase warrants exercised		-		-		260,000		26		296,401		-			-			-		296,427
Noncontrolling interests		-		-		-		-		-		-			-			76,669		76,669
Comprehensive income:
Net income for the period ended March 31, 2010		-		-		-		-		-		-			672,669			-		672,669
Other comprehensive income, net of tax:
Foreign currency translation gain		-		-		-		-		-		96,819			-			-		96,819
Unrealized loss on marketable securities AFS		-		-		-		-		-		(455,635	)		-			-		(455,635	)
Unrealized loss on marketable securities AFS-related parties
Balance, March 31, 2010		1,006	$	1,006,250		30,635,475	$	3,064	$	63,044,813	$	1,543,405		$	(13,716,371	)	$	18,325,867	$	70,207,027

The accompanying notes are an integral part of these financial statements.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the Six Months Ended March 31,
	2010			2009
CASH FLOWS - OPERATING ACTIVITIES
Net income (loss)	$	653,924		$	(14,746,155	)
Loss from discontinued operations		-			1,536,823
Adjustments to reconcile net income (loss) to net cash (used in) provided by operating activities:
Depreciation and amortization		1,128,648			841,506
Allowance for bad debt		(528,911	)		(128,774	)
Stock based compensation		517,472			1,053,538
Realized (gain) loss on sale of investment in marketable securities		(2,100,422	)		331,529
Realized gain on investment in marketable securities-related party		(786	)		-
Realized gain on sale subsidiaries		-			(238,670	)
Realized loss on investment in marketable securities		-			7,521,088
Fair value of securities received for services and interest		(1,737,248	)		(5,177,108	)
Fair value of securities paid for services		177,830			-
Changes in operating assets and liabilities:
Prepaid expenses and other assets		(1,507,712	)		11,598,685
Prepaid expenses - related parties		1,357,315			3,133,194
Inventories		(1,857,858	)		4,988,034
Accounts receivable		(1,630,245	)		14,187,919
Accounts receivable - related parties		289,731			(3,593,044	)
Deferred compensation		163,600			-
Accounts payable and accrued expenses		(568,861	)		(4,643,636	)
Accounts payable - related party		374,503			(548,374	)
Advances from customers		(20,160	)		(6,148,179	)
Other payables		(1,795,890	)		(1,779,364	)
Taxes payable		(687,850	)		(357,988	)
Net cash (used in) provided by continuing operations		(7,772,920	)		7,831,024
Net cash provided by discontinued operations - Wanda		-			511,448
Net cash provided by discontinued operations - Pan Asia		-			3,336,785
CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES		(7,772,920	)		11,679,257

CASH FLOWS - INVESTING ACTIVITIES
Increase in notes receivable		-			(942,713	)
Decrease in loans receivable		-			1,531,138
Repayment of loans		(276,605	)		-
Increase in loans payable-related party		-			2,037,454
Proceeds from the sale of marketable securities available for sale		5,758,313			372,038
Purchases of property, plant and equipment		(95,547	)		(15,873,468	)
Net cash provided by (used in) investing activities - continuing operations		5,386,161			(12,875,551	)
Net cash used for investing activities - discontinued operations		-			(4,538,229	)
CASH PROVIDED BY(USED IN) INVESTING ACTIVITIES		5,386,161			(17,413,780	)

CASH FLOWS - FINANCING ACTIVITIES
Decrease (increase) in restricted cash		5,541			(1,807,266	)
Proceeds from loans payable		431,866			221,906
Payment of loans payable		-			(2,152,257	)
Due from related parties		-			(158,041	)
Due to related parties		(399,629	)		(445,115	)
Net proceeds from sale of common stock		4,520,485			-
Proceeds from exercise of warrants/options		296,427			7,791
Cash payment for stock split/forward and stock repurchase		-			(2,045,043	)
Cash dividend payment to preferred stock holders		(20,125	)		-
Capital contribution from minority interest owners		-			2,201,332
Offering expenses		138,933			-
Cash provided by financing activities - continuing operations		4,973,498			(4,176,693	)
Cash (used in) provided by financing activities - discontinued operations		-			1,356,183
CASH PROVIDED BY(USED IN) FINANCING ACTIVITIES		4,973,498			(2,820,510	)

Effect of Exchange Rate on Cash		(365,843	)		517,655
Net (decrease) increase in cash		2,220,896			(8,037,378	)
Cash and equivalents, beginning of year-continuing operations		12,851,310			19,097,265
Cash and equivalents, beginning of year-discontinued operations		-			539,597
Cash and equivalents, beginning of the year		12,851,310			19,636,862
Cash and equivalents, end of period		15,072,206			11,599,484
Less cash and equivalents of discontinued operations, end of year		-			10,112
Cash and equivalents of continuing operations, end of year	$	15,072,206		$	11,589,372
Supplemental disclosures of cash flow information:
Dividend payment in stock to preferred shareholders	$	60,308		$	80,925

The accompanying notes are an integral part of these financial statements.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

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 “we”, “us”, “our”, or “China Direct Industries”.

We are a U.S. company that manages a portfolio of Chinese entities. We also provide consulting services to Chinese businesses. We operate in three identifiable segments, Magnesium, Basic Materials and Consulting in accordance with the Financial Standard Board Accounting Standard Codifications (ASC) 280, “Segment Reporting”. In 2006 we established our Magnesium and Basic Materials segments which have grown through acquisitions of controlling interests of Chinese private companies. We consolidate these acquisitions as either wholly or majority owned subsidiaries. Through this ownership control, we provide management advice, business development services, strategic planning, macroeconomic industry analysis and financial management seeking to improve the quality and performance of each portfolio company. We also provide our subsidiaries with investment capital to expand their businesses.

In our Magnesium segment, currently our largest segment by assets and prior to the 2009 transition period was the largest segment by revenues, we produce, sell and distribute pure magnesium ingots, magnesium powders and magnesium scraps.

In our Basic Materials segment, we sell and distribute a variety of products including industrial grade synthetic chemicals, steel products, non ferrous metals, recycled materials, and industrial commodities. This segment also includes our zinc ore mining property and zinc concentrate distribution businesses which have not commenced operations.

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

We discontinued our Clean Technology segment which we launched in fiscal 2007 when we completed the sale of our 81% interest in CDI Clean Technology and its subsidiaries, CDI Wanda and Yantai CDI Wanda to PE Brothers Corp. In the third quarter of fiscal 2008 for $1,240,000 and recorded a gain on the sale of $238,670. The sale was finalized in October 2008. We account for our 19% ownership interest in CDI Clean Technology using the cost method of accounting.

In the second quarter of the 2009 Transition Period (as defined later in this report) we formed International Magnesium Group as a wholly owned subsidiary to consolidate our magnesium holdings under one corporate entity and to create an identifiable brand name to unify marketing efforts for these operations.

In July 2009 we formed CDII Trading, Inc., a wholly owned subsidiary to engage in the global purchases and sales of industrial commodities for China Direct Industries and its subsidiaries and client companies. CDII Trading focuses its efforts in North and South America, Russia, parts of Africa and the European Union. CDII Trading seeks to market products from China Direct Industries and its various business units as well as to market and procure products for its consulting clients. CDII Trading also seeks to leverage China Direct Industries relationships in China and other countries to opportunistically trade additional complementary products for its end customers.

On September 29, 2009 our board of directors committed to a plan to sell our 51% interest in Pan Asia Magnesium, Ltd. (“Pan Asia Magnesium”) which is presented in these consolidated financial statements as a discontinued operation. See Note 14 - Discontinued Operations.

In October 2009 we formed International Magnesium Trading Corp as a wholly owned subsidiary of International Magnesium Group to engage in the trading of magnesium products.

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

Restatement of financial statements disclosure

The December 31, 2008 financial statements included in our Form 10-K filed on March 31, 2009, contained an error related to the method of calculating the other-than-temporary impairment of available for sale securities. Accordingly, the consolidated balance sheets, consolidated statements of operations, consolidated statement of stockholders’ equity, and consolidated statement of cash flows for fiscal 2008 have been restated in our Transition Report on Form 10-K for the nine month period ended September 30, 2009 (the “2009 Transition Report on Form 10-K”) to correct the accounting treatment previously accorded the other-than-temporary impairment transaction. Furthermore, we discontinued a component of our business which also affected our financial statements for the year ended December 31, 2008 included in the 2009 Transition Report on Form 10-K.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

The effect of correcting this error and the discontinued operations on our consolidated balance sheet at December 31, 2008, and consolidated statement of operations and statement of cash flows for the three months ended December 31, 2008 is shown in the table below. There was no net effect on comprehensive income from this error and all other changes to our consolidated statement of equity will be shown in the tables provided for in the consolidated balance sheet and consolidated statement of operations. Additionally, for accounts effected by the restatement error, adjustments related to the retrospective presentation of discontinued operations are also shown.

Consolidated Balance Sheet Data	December 31, 2008
	Unadjusted(1)			Adjustment to Restate			Restated
Shareholders' equity
Accumulated other comprehensive (loss) income	$	(11,711,021	)	$	3,393,533			(8,317,488	)
Retained Earnings	$	17,037,407		$	(3,393,533	)		13,643,874

Consolidated Statements of Operations Data	For the three months ended December 31, 2008
	Unadjusted(1)			Adjustment to Restate			Restated
Realized loss on Other Than Temporary Impairment	$	(4,127,555	)	$	(3,393,533	)	$	(7,521,088	)
Total other expense	$	(4,034,515	)	$	(3,393,533	)	$	(7,428,048	)
Net loss from continuing operations before income taxes	$	(8,770,522	)	$	(3,393,533	)	$	(12,164,055	)
Net loss from continuing operations net of income taxes	$	(8,662,631	)	$	(3,393,533	)	$	(12,056,164	)
Net loss	$	(9,578,875	)	$	(3,393,533	)	$	(12,972,408	)
Net loss attributable to China Direct Industries, Inc.	$	(6,754,557	)	$	(3,393,533	)	$	(10,148,090	)
Net loss applicable to common stockholders	$	(6,774,792	)	$	(3,393,533	)	$	(10,168,325	)

Basic and diluted loss per common share:
Basic	$	(0.29	)	$	(0.14	)	$	(0.43	)
Diluted	$	(0.29	)	$	(0.14	)	$	(0.43	)

Consolidated Statements of Cash Flows Data	For the three months ended December 31, 2008
	Unadjusted			Adjustment to Restate			Restated
Net loss	$	(9,578,875	)	$	(3,393,533	)	$	(12,972,408	)
Realized loss on investment in marketable securities - Other Than Temporary Impairment	$	4,127,555		$	3,393,533		$	7,521,088

	For the three months ended December 31, 2008
Consolidated Statement of Changes in Equity	Unadjusted			Adjustment to Restate			Restated
Net loss	$	(6,754,557	)	$	(3,393,533	)	$	(10,148,090	)
Unrealized (loss) gain on marketable securities available for sale	$	(2,116,075	)	$	3,393,533		$	1,277,458

(1) The unadjusted amounts were included in the consolidated statement of operations for the fiscal year ended December 31, 2008 included in our Form 10-K filed on March 31, 2009. These amounts were not, however, reflected on a standalone basis for the three month period ended December 31, 2008.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

Basis of Presentation

Change in Fiscal Year

Effective August 13, 2009, we changed our fiscal year end from December 31 to September 30. We have defined various periods that are covered in this report as follows:

	•		“fiscal 2010” — October 1, 2009 through September 30, 2010.
	•		“2009 transition period” — January 1, 2009 through September 30, 2009.
	•		“fiscal 2008” — January 1, 2008 through December 31, 2008.
	•		“fiscal 2007” — January 1, 2007 through December 31, 2007.

Our audited and 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, the unaudited consolidated financial statements 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 September 30, 2009 was derived from the audited consolidated financial statements included in our Transition Report on Form 10-K for the nine month period ended September 30, 2009. The interim financial statements should be read in conjunction with our Form 10-K for the nine month period ended September 30, 2009. 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 of Pan Asia Magnesium and a reclassification of revenues for intercompany interest income which should have been booked as Other Payable – Related Parties. See Note 4 – Comprehensive Income.

Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Significant estimates in the 2009 Transition Period and fiscal 2010 include the valuation of investments held for sale, the allowance for doubtful accounts on accounts receivable, the allowance for obsolete inventory, the fair value of stock-based compensation, and the useful life of property, plant and equipment.

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

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

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

Assumptions and estimates employed in these areas are material to our reported financial condition 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.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

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 March 31, 2010, bank deposits in the United States exceeded federally insured limits by $252,154. At March 31, 2010, we had deposits of $3,961,384 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 March 31, 2010.

At March 31, 2010 and September 30, 2009, bank deposits by geographic area were as follows:

Country	March 31, 2010				September 30, 2009
United States	$	11,110,822	74	%	$	8,625,782	67	%
China		3,961,384	26	%		4,225,528	33	%
Total cash and cash equivalents	$	15,072,206	100	%	$	12,851,310	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 March 31, 2010 and September 30, 2009, allowances for doubtful accounts were $216,875 and $745,786, 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 March 31, 2010 and September 30, 2009 were $7,664,580 and $5,806,722, 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 March 31, 2010 and September 30, 2009.

Accounts Payable-Related Parties

At March 31, 2010 our consolidated balance sheet reflects accounts payable-related party of $51,736. At September 30, 2009, our consolidated balance sheet reflects accounts payable-related party of $51,716. Accounts payable-related parties are discussed in further detail in Note 10 - Related Party Transactions.

Fair Value of Financial Instruments

As of January 1, 2008, we adopted on a prospective basis certain required provisions of Topic 820, “Fair Value Measurements”. Those provisions relate to our financial assets and liabilities carried at fair value and our fair value disclosures related to financial assets and liabilities. Topic 820 defines fair value, expands related disclosure requirements and specifies a hierarchy of valuation techniques based on the nature of the inputs used to develop the fair value measures. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. There are three levels of inputs to fair value measurements - Level 1, meaning the use of quoted prices for identical instruments in active markets; Level 2, meaning the use of quoted prices for similar instruments in active markets or quoted prices for identical or similar instruments in markets that are not active or are directly or indirectly observable; and Level 3, meaning the use of unobservable inputs. Observable market data should be used when available.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

All of our financial instruments are carried at fair value, including, all of our cash equivalents, investments classified as available for sale securities and assets held for sale, with unrealized gains or losses, net of tax. Virtually all of our valuation measurements are Level 1 measurements. The adoption of Topic 820 did not have a significant impact on our consolidated financial statements.

Marketable Securities

Marketable securities held for sale and marketable securities held for sale-related party at March 31, 2010 and September 30, 2009 consists of the following:


Company	March 31, 2010		% of Total			September 30, 2009		% of Total
China America Holdings, Inc.	$	625,384		22	%	$	540,200		10	%
China Logistics Group, Inc.		761,000		26	%		761,000		13	%
Dragon International Group Corp.		45,632		2	%		228,158		4	%
China Armco Metals, Inc.		842,283		29	%		3,116,993		56	%
Sunwin International Neutraceuticals, Inc.		-		0	%		338,000		6	%
Dragon Capital Group Corp.		596,680		21	%		604,686		11	%
Marketable securities held for sale	$	2,870,979		100	%	$	5,589,037		100	%

All the securities, including preferred stock, common stock, and common stock purchase warrants, were received from our clients as consulting fees. We categorize the securities as investments in marketable securities available for sale or investments in marketable securities available for sale-related parties. These securities (exclusive of preferred stock and common stock purchase warrants) are quoted either on an exchange or over the counter market system. Some of the securities are restricted and cannot be readily resold by us absent a registration of those securities under the Securities Act of 1933 (the “Securities Act”) or the availabilities of an exemption from the registration requirements under the Securities Act. Our policy is to liquidate the securities on a regular basis. As these securities are often restricted, we are unable to liquidate them until the restriction is removed. We recognize revenue for common stock based on the fair value at the time common stock is granted and for common stock purchase warrants based on the Black-Scholes valuation model. Unrealized gains or losses on marketable securities available for sale and on marketable securities available for sale-related party are recognized on a quarterly basis as an element of comprehensive income based on changes in the fair value of the security. Once liquidated, realized gains or losses on the sale of marketable securities available for sale and marketable securities available for sale-related party are reflected in our net income for the period in which the security was liquidated.

In accordance with ASC 850, “Related Party Disclosures”, we recognized Dragon Capital Group Corp. (“Dragon Capital”) as a related party. Mr. Lisheng (Lawrence) Wang, the CEO and Chairman of the Board of Dragon Capital, is the brother of Dr. James Wang, our CEO and Chairman of the Board of Directors. The securities of Dragon Capital accounted for all the investments in marketable securities available for sale-related party and totaled $596,680 and $604,686 at March 31, 2010 and September, 2009, respectively. These securities were issued by Dragon Capital as compensation for consulting services. Dragon Capital is a non-reporting company whose securities are quoted on the Pink Sheets, and as such, under Federal securities laws, securities of Dragon Capital cannot be readily resold by us, generally, absent a registration of those securities under the Securities Act. Dragon Capital does not intend to register the securities.

Under the guidance of ASC320, “Investments”, we periodically evaluate other-than-temporary impairment (OTTI) of securities to determine whether a decline in their value is other than temporary. Management utilizes criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other-than-temporary” is not intended to indicate that the decline is permanent. It indicates that the prospects for a near term recovery of value are not necessarily favorable, or that there is a lack of evidence to support fair values equal to, or greater than, the carrying value of the investment. Once a decline in value is determined to be other than temporary, the value of the security is reduced and a corresponding impairment charge to earnings is recognized. In the assessment of OTTI for various securities at March 31, 2010 and September 30, 2009 the guidance in ASC 320, “the Investment-Debt and Equity Securities,” is carefully followed. Management determined that some of our investments in marketable securities are impaired because their fair value as quoted on an exchange or an inter-dealer quotation system is less than their cost basis and also determined that the impairment is other–than-temporary impairment after applying the guidance in Section 325-40-35 to the evaluation of the securities. In accordance with Section 325-35-33, when an entity has decided to sell an impaired available-for-sale security and the entity does not expect the fair value of the security to fully recover before the expected time of sale, the security shall be deemed other-than-temporarily impaired in the period in which the decision to sell is made. However, an entity shall recognize an impairment loss when the impairment is deemed other than temporary impairment even if a decision to sell has not been made. For the six month period ended March 31, 2010 and 2009 we had a loss related to other than temporary impairment of $0 and $7,521,088, respectively.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

The realized gain (loss) on sale of marketable securities available for sale in the three month periods ended March 31, 2010 and 2009 was $2,066,497 and ($232,711), respectively.

The realized gain (loss) on sale of marketable securities available for sale in the six month periods ended March 31, 2010 and 2009 was $2,101,188 and ($331,529), 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) value added tax refunds available from the Chinese government, (iii) loans receivable and (iv) other receivables. At March 31, 2010 and September 30, 2009, our consolidated balance sheets include prepaid expenses and other current assets of $6,599,312 and $5,092,205, respectively.

Prepaid Expenses – Related Parties

Prepaid expenses-related parties were $4,465,723 and $5,823,039 at March 31, 2010 and September 30, 2009, respectively. This item is discussed in further detail in Note 10 - Related Party Transactions.

Property, Plant and Equipment

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

Acquisitions

We account for acquisitions using the purchase method of accounting in accordance with the provisions of Topic 805, “Business Combinations”. In each of our acquisitions for prior periods presented, we determined that fair values were equivalent to the acquired historical carrying costs. We had no acquisitions during the six months ended March 31, 2010.

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 $790,753 and $1,764,177 at March 31, 2010 and September 30, 2009, respectively while deferred revenue totaled $598,112 and $242,960, respectively

Comprehensive Income

We follow ASC 220, “Comprehensive Income” to recognize the elements of comprehensive income. Comprehensive income is comprised of net income and all changes to the statements of stockholders’ equity, except those due to investments by stockholders, changes in paid-in capital and distributions to stockholders. Comprehensive income for the six months ended March 31, 2010 and 2009 included net income, foreign currency translation adjustments, unrealized gain/losses on marketable securities available for sale, net of income taxes, and unrealized losses on marketable securities available for sale-related party, net of income taxes. See Note 4 – Comprehensive Income for details.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

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 six months ended March 31, 2010 and September 30, 2009. A summary of the conversion rates for the periods presented is as follows:

	March 31,			September 30,
		2010			2009
Quarter end RMB: U.S. dollar exchange rate			6.8361			6.8376
Average year-to-date RMB: U.S. dollar exchange rate			6.8360			6.8425

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

Impairment of Long-Lived Assets

In accordance with ASC 360, “Property, Plant, and Equipment”, we periodically review our long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of the assets may not be fully recoverable. We recognize an impairment loss when the sum of expected undiscounted future cash flows is less than the carrying amount of the asset. The amount of impairment is measured as the difference between the estimated fair value and the book value of the underlying asset. We did not record any impairment charges during the six month periods ended March 31, 2010 and 2009.

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 associated costs. On September 29, 2009 our board of directors committed to a plan to sell our 51% interest in Pan Asia Magnesium which is presented in these consolidated financial statements as a discontinued operation. See Note 14 - Discontinued Operations.

Noncontrolling Interest

Noncontrolling interests in our subsidiaries are recorded in accordance with the provisions of ASC 810, “Consolidation”, and are reported as a component of our equity, separate from the parent’s equity. Purchase or sale of equity interests that do not result in a change of control are accounted for as equity transactions. Results of operations attributable to the noncontrolling interests are included in our consolidated results of operations and, upon loss of control, the interest sold, as well as interest retained, If any, will be reported at fair value with any gain or loss recognized in earnings.

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

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

Income Taxes

We accounted for income taxes in accordance with ASC 740, “Income Taxes”. ASC 740 requires the recognition of deferred tax assets and liabilities to reflect the future tax consequences of events that have been recognized in our financial statements or tax returns. Measurement of the deferred items is based on enacted tax laws. In the event the future consequences of differences between the financial reporting and tax basis of our assets and liabilities result in a deferred tax asset, ASC 740 requires an evaluation of the probability of our being able to realize the future benefits indicated by such assets. A valuation allowance related to a deferred tax asset is recorded when it is more likely than not that some or the entire deferred tax asset will not be realized. For the six month period ended March 31, 2010, we generated income of total $1,088,386 in the United States. Income tax expense was not recorded on these earnings as net operating loss carry-forwards are available to offset the income. We continue to evaluate whether the remaining deferred tax asset will be realized and will record an income tax benefit in the period the valuation allowance is removed.

Basic and Diluted Earnings per Share

Under the provisions of ASC 260, “Earnings Per Share,” basic income (loss) per common share is computed by dividing income (loss) available to common shareholders by the weighted average number of shares of common stock outstanding for the periods presented. Diluted income (loss) per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that would then share in the income of the company, subject to anti-dilution limitations.

Revenue Recognition

We follow the guidance of ASC 605, “Revenue Recognition,” for revenue recognition. In general, we record revenue when persuasive evidence of an arrangement exists, services have been rendered or product delivery has occurred, the sales price to the customer is fixed or determinable, and collectability is reasonably assured. When our clients securities are received for our services, we follow the guidance of ASC 505, “Equity-Based Payments to Non-Employees” to measure and recognize our revenue. Topic 505-30-18 instructs that an entity (grantee or provider) may enter into transactions to provide goods or services in exchange for equity instruments. The grantee shall measure the fair value of the equity instruments in these transactions using the stock price and other measurement assumptions as of the earlier of either of the following dates referred to as the measurement date.

a.	The date the parties come to a mutual understanding of the terms of the equity-based compensation arrangement and a commitment for performance by the grantee to earn the equity instruments (a performance commitment) is reached

b.	The date at which the grantee’s performance necessary to earn the equity instruments is complete (that is, the vesting date).

Currently we measure and recognize the revenue from the equity securities of China Armco Metals, Inc., upon completion of the services performed based on the terms provided for in our consulting agreements with our clients, while the equity securities of all other clients are measured, using the grant date in accordance with ASC 605.

Stock-based Compensation

We account for the grant of stock options, warrants and restricted stock awards in accordance with ASC 718, “Compensation-Stock Compensation.” ASC 718 requires companies to recognize in the statement of operations the grant-date fair value of stock options and other equity based compensation.

Recent Pronouncements

Accounting for decreases in ownership of a subsidiary - In January 2010, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2010-02, “Accounting and Reporting for Decreases in Ownership of a Subsidiary,” which clarifies the scope of the guidance for the decrease in ownership of a subsidiary in ASC 810, “Consolidations,” and expands the disclosures required for the deconsolidation of a subsidiary or de-recognition of a group of assets. This guidance was effective on January 1, 2009.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

Accounting for distributions to shareholders - In January 2010, the FASB issued ASU 2010-01, “Accounting for Distributions to Shareholders with Components of Stock and Cash,” which clarifies that the stock portion of a distribution to shareholders that allows them to elect to receive cash or stock with a potential limitation on the total amount of cash that all shareholders can elect to receive in the aggregate is considered a share issuance that is reflected in earnings per share prospectively and is not a stock dividend for purposes of applying ASC 505, “Equity,” and ASC 260, “Earnings Per Share.” This guidance is effective for interim and annual periods ending on or after December 15, 2009, and should be applied on a retrospective basis. The application of the requirements of this guidance had no effect on the accompanying consolidated financial statements.

On June 5, 2003, the United States Securities and Exchange Commission (“SEC”) adopted final rules under Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), as amended by SEC Release No. 33-9072 on October 13, 2009. Commencing with our annual report for the year ending September 30, 2010, we will be required to include a report of management on our internal control over financial reporting. The internal control report must include a statement

	·		Of management’s responsibility for establishing and maintaining adequate internal control over its financial reporting;
	·		Of management’s assessment of the effectiveness of its internal control over financial reporting as of year end; and
	·		Of the framework used by management to evaluate the effectiveness of our internal control over financial reporting.

Furthermore, we are required to file the auditor’s attestation report separately on our internal control over financial reporting on whether we believe that we have maintained, in all material respects, effective internal control over financial reporting.

In August 2009, the FASB issued the FASB Accounting Standards Update No. 2009-04 “Accounting for Redeemable Equity Instruments - Amendment to Section 480-10-S99” which represents an update to section 480-10-S99, distinguishing liabilities from equity, per EITF Topic D-98, Classification and Measurement of Redeemable Securities. We do not expect the adoption of this update to have a material impact on our consolidated financial position, results of operations or cash flows.

In August 2009, the FASB issued the FASB Accounting Standards Update No. 2009-05 “Fair Value Measurement and Disclosures Topic 820 – Measuring Liabilities at Fair Value”, which provides amendments to subtopic 820-10, Fair Value Measurements and Disclosures – Overall, for the fair value measurement of liabilities. This update provides clarification that in circumstances in which a quoted price in an active market for the identical liability is not available, a reporting entity is required to measure fair value using one or more of the following techniques: 1. A valuation technique that uses: a. The quoted price of the identical liability when traded as an asset b. Quoted prices for similar liabilities or similar liabilities when traded as assets. 2. Another valuation technique that is consistent with the principles of topic 820; two examples would be an income approach, such as a present value technique, or a market approach, such as a technique that is based on the amount at the measurement date that the reporting entity would pay to transfer the identical liability or would receive to enter into the identical liability. The amendments in this update also clarify that when estimating the fair value of a liability, a reporting entity is not required to include a separate input or adjustment to other inputs relating to the existence of a restriction that prevents the transfer of the liability. The amendments in this update also clarify that both a quoted price in an active market for the identical liability when traded as an asset in an active market when no adjustments to the quoted price of the asset are required are Level 1 fair value measurements. We do not expect the adoption of this update to have a material impact on our consolidated financial position, results of operations or cash flows.

In September 2009, the FASB issued the FASB Accounting Standards Update No. 2009-08 “Earnings Per Share – Amendments to Section 260-10-S99”, which represents technical corrections to topic 260-10-S99, Earnings per share, based on EITF Topic D-53, Computation of Earnings Per Share for a Period that includes a Redemption or an Induced Conversion of a Portion of a Class of Preferred Stock and EITF Topic D-42, The Effect of the Calculation of Earnings per Share for the Redemption or Induced Conversion of Preferred Stock. We do not expect the adoption of this update to have a material impact on our consolidated financial position, results of operations or cash flows.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

In September 2009, the FASB issued the FASB Accounting Standards Update No. 2009-09 “Accounting for Investments-Equity Method and Joint Ventures and Accounting for Equity-Based Payments to Non-Employees”. This update represents a correction to Section 323-10-S99-4, Accounting by an Investor for Stock-Based Compensation Granted to Employees of an Equity Method Investee. Additionally, it adds observer comment Accounting Recognition for Certain Transactions Involving Equity Instruments Granted to Other Than Employees to the Codification. We do not expect the adoption to have a material impact on our consolidated financial position, results of operations or cash flows.

In September 2009, the FASB issued the FASB Accounting Standards Update No. 2009-12 “Fair Value Measurements and Disclosures Topic 820 – Investment in Certain Entities That Calculate Net Assets Value Per Share (or Its Equivalent)”, which provides amendments to Subtopic 820-10, Fair Value Measurements and Disclosures-Overall, for the fair value measurement of investments in certain entities that calculate net asset value per share (or its equivalent). The amendments in this update permit, as a practical expedient, a reporting entity to measure the fair value of an investment that is within the scope of the amendments in this update on the basis of the net asset value per share of the investment (or its equivalent) if the net asset value of the investment (or its equivalent) is calculated in a manner consistent with the measurement principles of Topic 946 as of the reporting entity’s measurement date, including measurement of all or substantially all of the underlying investments of the investee in accordance with Topic 820. The amendments in this update also require disclosures by major category of investment about the attributes of investments within the scope of the amendments in this update, such as the nature of any restrictions on the investor’s ability to redeem its investments at the measurement date, any unfunded commitments (for example, a contractual commitment by the investor to invest a specified amount of additional capital at a future date to fund investments that will be make by the investee), and the investment strategies of the investees. The major category of investment is required to be determined on the basis of the nature and risks of the investment in a manner consistent with the guidance for major security types in U.S. GAAP on investments in debt and equity securities in paragraph 320-10-50-1B. The disclosures are required for all investments within the scope of the amendments in this update regardless of whether the fair value of the investment is measured using the practical expedient. We do not expect the adoption to have a material impact on our consolidated financial position, results of operations or cash flows.

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

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

NOTE 3 – EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings (loss) per share for the three and six months ended March 31, 2010 and 2009:

	For Three Months Ended March 31,						For Six Months Ended March 31,
	2010			2009			2010			2009
NUMERATOR:
Income (loss) from continuing operations	$	1,657,184		$	(834,952	)	$	672,669			(10,066,798	)
Loss from discontinuing operations		-			(620,579	)		-			(1,536,823	)
Series A preferred stock:
Preferred stock dividend		(20,125	)		(20,235	)		(60,308	)		(40,470	)
Numerator for basic EPS, income (loss) attributable to common stockholders (A)	$	1,637,059		$	(1,475,766	)	$	612,361		$	(11,644,091	)
Plus: Income impact of assumed conversions
Preferred stock dividends-unconverted		-			-			-			-
Numerator for diluted EPS, income (loss) attributable to common stockholders plus assumed conversions (B)	$	1,637,059		$	(1,475,766	)	$	612,361		$	(11,644,091	)
DENOMINATOR (1):
Denominator for basic earnings per share-weighted average number of common shares outstanding (C)		28,594,256			23,414,500			27,981,440			23,555,518
Stock awards, options, and warrants (1) (2)		462,762			-			462,762			-
Denominator for diluted earnings per share-adjusted weighted average outstanding average number of common shares outstanding (D)		29,057,018			23,414,500			28,444,202			23,555,518

Basic and Diluted Income (loss) per Common Share:
Earnings (loss) per common share-basic (A)/( C)	$	0.06		$	(0.06	)	$	0.02		$	(0.49	)
Earnings (loss) per common share-diluted (B)/(D)	$	0.06		$	(0.06	)	$	0.02		$	(0.49	)

(1)	Securities are not included in the denominator in periods when antidilutive.

(2)	The number of outstanding shares of restricted stock awards and warrants included were 435,814 and 26,948, respectively for the three month and six month periods ended March 31, 2010.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

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 three and six month periods ended March 31, 2010 and 2009, respectively:

Description	For Three Months Ended March 31,						For Six Months Ended March 31,
	2010			2009			2010			2009
	Unaudited			Unaudited			Unaudited			Unaudited

Net income (loss)-continuing operations	$	1,526,830	(1)	$	(1,153,168	)	$	653,923		$	(13,209,332	)
Net loss-discontinued operations		-			(620,579	)		-			(1,536,823	)
Other comprehensive (loss) income, net of tax
Unrealized (loss) on marketable securities held for sale, net taxes		(118,843	)		(2,065,585	)		(386,650	)		(788,127	)
Unrealized loss on marketable securities available for sale-related party		(68,985	)		48,232			(68,985	)		(7,060	)
Foreign currency translation gain (loss)		141,265			316,792			96,818			(2,056,060	)
Total other comprehensive income (loss), net of tax		(46,563	)		(1,700,561	)		(358,817	)		(2,851,247	)
Comprehensive income (loss)		1,480,267			(3,474,308	)		295,106			(17,597,402	)
Comprehensive income attributable to the noncontrolling interests		130,354			14,132			18,746			2,838,450
Comprehensive income attributable to the noncontrolling interests-discontinued operations		-			304,084			-			753,045
Comprehensive income (loss) attributable to China Direct Industries, Inc.	$	1,610,621		$	(3,156,092	)	$	313,852		$	(14,005,907	)

(1)

Amount reflects a $240,000 adjustment to a transaction mistakenly booked into revenues that reduced our net (loss) in the three month period ended December 31, 2009 which should have been booked as Other Payable – Related Parties. Accordingly our net income for the three month period ended March 31, 2010 was reduced by $240,000. We discussed this matter with our auditor and deemed it to be immaterial with respect to the financial statements taken as a whole, and that it had no effect on our net income for the six month period ended March 31, 2010.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

NOTE 5 - INVENTORIES

Inventories at March 31, 2010 and September 30, 2009 consisted of the following:

	March 31, 2010		September 30, 2009
	Unaudited
Raw materials	$	3,504,753	$	2,454,443
Finished goods		4,159,827		3,695,184
Inventory reserve		-		(342,905	)
Total Inventory	$	7,664,580	$	5,806,722

Due to the nature of our business and the short duration of the manufacturing process for our products, there is no material work in progress inventory at March 31, 2010 and September 30, 2009.

NOTE 6 - PREPAID EXPENSES AND OTHER CURRENT ASSETS

At March 31, 2010 and September 30, 2009, prepaid expenses and other current assets, consisted of the following:

Description	March 31, 2010			September 30, 2009
	Unaudited
Prepayments to vendors for merchandise that had not yet been shipped or services that had not been performed	$	3,585,067		$	2,853,504
Other receivables		1,295,759			642,370
Loans receivable		1,702,000			1,435,000
Other-long-term		2,443			142,692
Securities deposits		16,486			20,475
Total		6,601,755			5,094,041
Less: Current Portion		(6,599,312	)		(5,092,205	)
Prepaid expenses and other assets, non-current	$	2,443		$	1,836

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 pure magnesium products per year, Golden Magnesium built its magnesium production plant on this land. The land use rights expire in 2057.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

NOTE 7 - PROPERTY, PLANT AND EQUIPMENT

At March 31, 2010 and September 30, 2009, property, plant and equipment, consisted of the following:

Property, Plant and Equipment

Description	Useful Life	March 31, 2010			September 30, 2009
		Unaudited
Building	10-40 years	$	10,845,282		$	10,727,622
Manufacturing equipment	5-10 years		14,912,999			14,849,040
Office equipment and furniture	3-5 years		482,057			403,570
Autos and trucks	5 years		916,691			911,964
Construction in progress	N/A		6,975,786			7,145,072
Total			34,132,815			34,037,268
Less: Accumulated Depreciation			(3,809,788	)		(2,705,276	)
Property, Plant and Equipment, Net		$	30,323,027		$	31,331,992

For the six months ended March 31, 2010 and March 31, 2009, depreciation expense totaled $1,104,512 and $618,522, respectively.

NOTE 8 - PROPERTY USE RIGHTS

Property use rights, net of accumulated amprtization, consisting of mining and property use rights amounted to $1,089,766 and $1,113,902 at March 31, 2010 and September 30, 2009 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 pure magnesium products per year, Golden Magnesium built its magnesium production plant on this land. The land use rights expire in 2057. The land use rights amortization expense during the six months ended March 31, 2010 was $24,135.

In connection with our acquisition of CDI Jixiang Metal in December 2007, we acquired mining rights to 51 acres located in the Yongshun Kaxi Lake Mining area of China. Acquisition costs for the mining rights as of March 31, 2010 are $496,510. CDI Jixiang Metal has not commenced operations and has not established a reserve. There is no assurance that commercially viable mineral deposits exist on this property and further exploration will be required before an evaluation as to the economic feasibility is determined.

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.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

NOTE 9 - LOANS PAYABLE

Loans payable at March 31, 2010 and September 30, 2009 consisted of the following:

Description	March 31, 2010			September 30, 2009

Loan due to Mingsheng Bank, on May 26, 2010. 6.37% annual interest rate. Secured by pledge with Lang Chemical's assets.	$	497,360		$	497,252

Loan due to Industrial & Commercial Bank, on July 21, 2010. 5.58% annual interest rate. Guaranteed by the personal real estate of ZhuQian and Chen JingDong.		329,135			336,375

Loan due to Industrial & Commercial Bank, on September 21, 2010. 5.31% annual interest rate. Guaranteed by the personal real estate of ZhuQian and Chen Jingdong.		394,962			394,875

Loan due to Bank of Shanghai, on January 14, 2010. 5.84% annual interest rate. Guaranteed by China Investment Guarantor Co. Ltd.		-			292,500

Loan due to Bank of Shanghai, on February 21, 2011. 5.31% annual interest rate. Guaranteed by China Investment Guarantor Co. Ltd.		438,847			-

Notes due to Zhenjiang Yonghe, on May 24, 2010		219,423			-

Notes due to Shanghai Dongyan, on May 25, 2010		73,141			-

Total		1,952,868			1,521,002
Less: Current Portion		(1,952,868	)		(1,521,002	)

Loans payable, long-term	$	-		$	-

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

NOTE 10 - RELATED PARTY TRANSACTIONS

We have specified the following persons and entities as related parties with ending balances as of March 31, 2010 and September 30, 2009:

	·		Yuwei Huang, is executive vice president of our Magnesium segment, a member of the board of directors, chief executive officer and chairman of Chang Magnesium, chairman of Baotou Changxin Magnesium, chairman of YiWei Magnesium, and chief executive officer and vice chairman of Golden Magnesium;
	·		Taiyuan YiWei Magnesium Industry Co., Ltd., a company organized under the laws of the PRC (“YiWei Magnesium”), is a minority interest owner in Chang Magnesium;
	·		Lifei Huang, is the daughter of Yuwei Huang;
	·		Lifei Huang, is a registered representative of Pine Capital Enterprises Inc., a company organized under the laws of the Cayman Islands (“Pine Capital”);
	·		Lifei Huang, is a registered representative of Wheaton Group Corp., a company organized under the laws of Brunei Darussalam (“Wheaton”);
	·		LingShi County Yihong Magnesium Co., Ltd., a company organized under the laws of the PRC (“Yihong Magnesium”), is legally represented by an officer of Chang Magnesium;
	·		LuCheng Haixu Magnesium Co., Ltd., a company organized under the laws of the PRC (“Haixu Magnesium”), is legally represented by an officer of Chang Magnesium;
	·		LuCheng Xinghai Magnesium Co., Ltd., a company organized under the laws of the PRC (“Xinghai Magnesium”), is legally represented by an officer of Chang Magnesium;
	·		Shanxi Senrun Coal Chemistry Co., Ltd., a company organized under the laws of the PRC (“Senrun Coal”), is a minority interest owner in Golden Magnesium;
	·		NanTong Langyuan Chemical Co., Ltd., a company organized under the laws of the PRC (“NanTong Chemical”), is owned by Jingdong Chen and Qian Zhu, the minority interest owners of Lang Chemical;
	·		Jingdong Chen, is vice president of our Basic Materials segment and chief executive officer of Lang Chemical;
	·		Qian Zhu, is chief financial officer of Lang Chemical. Jingdong Chen and Qian Zhu are husband and wife; and
	·		Zhongmen International Investments Co., Ltd., a company organized under the laws of the PRC (“Zhongmen International”), is legally represented by an officer of CDI Beijing.

Accounts Receivable – related parties

At March 31, 2010 we reported accounts receivable – related parties of $2,065,328 comprised of the following:

	·		$1,167,522 due BaoTou Changxin Magnesium from YiWei Magnesium, for inventory provided;
	·		$894,813 due Golden Magnesium from YiWei Magnesium for inventory provided; and,
	·		$2,993 due Chang Magnesium from Wheaton for inventory.

At September 30, 2009 we reported accounts receivable – related parties of $2,355,059 comprised of the following:

	·		$756,795 due Chang Magnesium from YiWei Magnesium, for inventory provided;
	·		$869,105 due Chang Magnesium from Pine Capital for inventory provided; and,
	·		$729,159 due Golden Magnesium from YiWei Magnesium for inventory provided.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

Prepaid Expenses – related parties

At March 31, 2010 we reported prepaid expenses – related parties of $4,465,723 comprised of the following:

	·		$3,032,364 prepaid by Chang Magnesium to YiWei Magnesium for future delivery of inventory;
	·		$54,124 prepaid by Baotou Changxin Magnesium to YiWei Magnesium for future delivery of inventory;
	·		$694,844 prepaid by Chang Magnesium to Yihong Magnesium for future delivery of inventory;
	·		$453,475 prepaid by Chang Magnesium to Xinghai Magnesium for future delivery of inventory;
	·		$73,149 prepaid by Chang Magnesium to Haixu Magnesium for future delivery of inventory;
	·		$140,082 prepaid by IMTC to YiWei Magnesium for future delivery of inventory; and,
	·		$17,685 prepaid by Golden Magnesium to Senrun Coal for future delivery of coke gas for fuel.

At September 30, 2009 we reported prepaid expenses – related parties of $5,823,039 comprised of the following:

	·		$2,440,794 prepaid by Chang Magnesium to YiWei Magnesium for future delivery of inventory;
	·		$73,133 prepaid by Chang Magnesium to Haixu Magnesium to for future delivery of inventory;
	·		$530,888 prepaid by Chang Magnesium to Xinghai Magnesium to for future delivery of inventory;
	·		$684,922 prepaid by Chang Magnesium to Yihong Magnesium to for future delivery of inventory;
	·		$1,376,394 prepaid by Baotou Changxi Magnesium to YiWei Magnesium to for future delivery of inventory;
	·		$51,470 prepaid by Golden Magnesium to Senrun Coal for future delivery of coke gas for fuel; and,
	·		$665,438 prepaid by Golden Magnesium to YiWei Magnesium for future delivery of inventory.

Loan Receivable – related parties

At March 31, 2010 we reported loan receivables – related parties of $1,370,747 comprised of the following:

	·		$1,224,465 due Lang Chemical from NanTong Chemical for funds advanced for working capital purposes; and,
	·		$146,282 due Baotou Changxin Magnesium from Xinghai Magnesium for funds advanced for working capital purposes.

At September 30, 2009 we reported loan receivables – related parties of $1,094,142 comprised of the following:

$1,094,142 due Lang Chemical from NanTong Chemical for funds advanced for working capital purposes.

Accounts Payable – related parties

At March 31, 2010 we reported accounts payable – related party of $51,736 comprised of the following:

	·		$14,830 due from Baotou Changxin Magnesium to Haixu for the purchase of material;
	·		$35,116 due from Baotou Changxin Magnesium to Yihong Magnesium for the purchase of material;
	·		$1,463 due from Golden Magnesium to Haixu Magnesium for the purchase of material; and,
	·		$327 due from Golden Magnesium to Xinghai Magnesium for the purchase of material.

At September 30, 2009 we reported accounts payable – related party of $51,716 comprised of the following:

	·		$35,427 due from Chang Magnesium to Wheaton Group for the purchase of material;
	·		$14,826 due from Baotou Changxin Magnesium to Haixu for the purchase of material; and,
	·		$1,463 due from Golden Magnesium to Haixu Magnesium for the purchase of material.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

Other Payable-related parties

At March 31, 2010 we reported due to related parties a balance of $374,483 comprised of the following:

	·		$345,227 due to Zhongmen International Investments for working capital of CDI Beijing; and
	·		$29,256 due to Lifei Huang for Baotou Changxin Magnesium working capital purposes.

At December 31, 2009, we reported Other Payable – Related Parties a balance of $53,677, which did not include $240,000 due to Lifei Huang who made a cash payment to Capital One on behalf of Golden Magnesium for the intercompany interest expense incurred. This amount was previously recorded as revenues in error in our first quarter of fiscal 2010, which was subsequently reclassified and paid in our second quarter of 2010.

At September 30, 2009 we reported due to related parties balance of $399,629 comprised of the following:

	·		$355,753 due to Zhongmen International Investments for working capital of CDI Beijing; and
	·		$43,876 advanced by Beijing Jiaozhuang Hotel to CDI Beijing for working capital purposes.

Beijing Jiaozhuang Hotel, a company organized under the laws of the PRC was incorrectly identified as a related party in our previous reports filed with the SEC. The amounts were for expenses related to CDI Beijing’s operations.

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 March 31, 2010 and September 30, 2009 there were 1,006 shares of Series A Convertible Preferred Stock issued and outstanding.

Series A Preferred Stock and Related Dividends

On February 11, 2008, we entered into a Securities Purchase Agreement with accredited investors to sell, in a private placement transaction, 12,950 shares of our Series A Convertible Preferred Stock (“Series A Preferred Stock”) together with common stock purchase warrants to purchase an aggregate of 1,850,000 shares of our common stock. At closing, we received gross proceeds of $12,950,000. The Series A Preferred Stock has a stated value per share of $1,000, carries an 8% per annum dividend rate payable quarterly in arrears and is convertible into common stock at $7.00 per share. The dividends are payable in cash or shares of our common stock, at our option, subject to certain provisions. If paid in shares of common stock, the stock shall be valued at the lower of the conversion price or the average of the weighted average price of the 10 consecutive trading days immediately preceding the dividend date. During the three months ended March 31, 2010, we paid $20,125 dividends in cash. For the six month period ended March 31, 2010, the total dividends paid was $60,308. $40,183 was in common stock.

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 March 31, 2010, 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 issued 1,706,250 shares of our common stock, 87,897 shares of common stock in payment of the accrued dividends, and 136,500 shares of common stock, the Make Whole Additional Amount.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

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 March 31, 2010 there were 30,635,475 shares of common stock issued and outstanding and there were 27,189,719 shares of common stock issued and outstanding at September 30, 2009.

For the six months ended March 31, 2010 and 2009, amortization of stock-based compensation amounted to $517,472 and $1,053,538, respectively.

For the six months ended March 31, 2010 and 2009, fair value of securities paid for services were $177,830 and $0, respectively.

During the six months ended March 31, 2010 we issued 75,000 and 185,000 shares of common stocks in connection with the exercise of warrants at $1.14 per share for a total consideration of $296,427.

On June 16, 2009 we sold 2,702,704 shares of our common stock and warrants to purchase up to 1,351,352 shares 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 have used the proceeds from this offering for general working capital purposes and potential acquisitions of additional operations in China.

On October 14, 2009, we entered into a Continuous Offering Program Agreement (the “Agreement”), with Rodman & Renshaw, LLC (“Rodman & Renshaw”), under which we may sell an aggregate of up to $5,201,330 in gross proceeds of our common stock from time to time through Rodman & Renshaw, as the agent for the offer and sale of the common stock. Rodman & Renshaw may sell the common stock by any method permitted by law, including sales deemed to be an “at the market” offering as defined in Rule 415 of the Securities Act of 1933, including without limitation sales made directly on NASDAQ Global Market, on any other existing trading market for the common stock or to or through a market maker. Rodman & Renshaw may also sell the common stock in privately negotiated transactions, subject to our prior approval. We paid Rodman & Renshaw a commission equal to 4% of the gross proceeds of the sales price of all common stock sold through it as sales agent under the Agreement. During the six months ended March 31, 2010, we sold 2,760,975 shares as an “at the market” offering with a total gross proceeds of $4,659,418.

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 were subject to market conditions, applicable legal requirements and other factors deemed appropriate by our CEO and President. Repurchases were made in open-market transactions and 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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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

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 March 31, 2010 and September 30, 2009 there were options outstanding to purchase an aggregate of 312,000 shares of common stock outstanding under the 2006 Equity Plan at exercise prices ranging from $2.50 to $7.50 per share.

On October 19, 2006, our board of directors authorized the 2006 Stock Plan (the “2006 Stock Plan”) covering 2,000,000 shares of our common stock. As the 2006 Stock Plan was not approved by our shareholders prior to October 19, 2007, we may no longer award incentive stock options under the 2006 Stock Plan and any incentive stock options previously awarded under the 2006 Stock Plan were converted into non-qualified options upon terms and conditions determined by the board of directors, as nearly as is reasonably practicable in their sole determination, to the terms and conditions of the incentive stock options being so converted. At March 31, 2010 and September 30, 2009, there were options outstanding to purchase an aggregate of 276,540 shares, respectively of common stock outstanding under the 2006 Stock Plan at exercise prices ranging from $.01 to $5.00 per share. As of March 31, 2010 we granted 281,735 shares of restricted stock with vesting dates ranging from March 31, 2009 to October 1, 2010 under this plan.

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 March 31, 2010 we granted 213,700 shares of restricted stock under this plan with vesting dates ranging from February 17, 2010 to October 1, 2010.

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 March 31, 2010 we granted 1,261,827 shares of restricted stock with vesting dates ranging from May 2009 to August 2011 under this plan.

Stock Option Plans

The following table sets forth our stock option activity during the six months ended March 31, 2010:

Description	Shares Underlying Options			Weighted Average Exercise price
Outstanding at September 30, 2009		3,655,670		$	10.83
Converted to Restricted Stock Award		(953,940	)		4.49
Cancelled		(40,000	)		3.75
Adjusted (1)		(288,750	)		1.14
Outstanding at March 31, 2010		2,372,980		$	14.95
Exercisable at March 31, 2010		2,372,980		$	14.95

(1)Reflects an adjustment to the schedule of outstanding stock options included in Note 13 Stockholders’ Equity - Stock Option Plans to our September 30, 2009 consolidated financial statements footnotes included in our 2009 Transition Report on Form 10-K which incorrectly included options to purchase 288,750 shares of our common stock at $1.14 per share.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

The weighted average remaining contractual life and weighted average exercise price of options outstanding at March 31, 2010, for selected exercise price ranges, are as follows:

Exercise Price		Number of Options Outstanding		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Number of Options Exercisable		Weighted Average Remaining Contractual Life (Years)
$	2.25		400		4.56	$	2.25		400		4.56
$	2.50		44,000		2.09	$	2.50		44,000		2.09
$	5.00		306,000		2.14	$	5.00		306,000		2.14
$	7.50		637,000		2.76	$	7.50		637,000		2.76
$	10.00		625,000		3.76	$	10.00		625,000		3.76
$	15.00		500		3.19	$	15.00		500		3.19
$	30.00		760,000		2.83	$	30.00		760,000		2.83
$	56.25		80		4.67	$	56.25		80		4.67
			2,372,980		2.95	$	14.95		2,372,980		2.95

During the six months ended March 31, 2010, no options were exercised.

Options previously awarded to employees to purchase 953,740 shares of our common stock with exercise prices ranging from $2.50 to $5.00 were converted into 476,970 shares of restricted stock on February 17, 2010 with vesting dates ranging from immediate to October 1, 2010. The total additional stock-based compensation expense as a result of the conversion is $328,952. The aggregate intrinsic value of our outstanding and exercisable options at March 31, 2010 and September 30, 2009 was $2,372,980 and $3,326,920, respectively.

Common Stock Purchase Warrants

During 2008, we granted 25,000 common stock purchase warrants to consultants, exercisable immediately at an exercise price of $11.00. These warrants were fair valued on the date of grant at $103,707 using the Black-Scholes option-pricing model, in accordance with ASC 718, “Compensation-Stock Compensation, 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 and potential acquisitions of additional operations in China.

- 25 -

CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

MARCH 31, 2010

As a result of the June 15, 2009 registered direct offering of our common stock, we reduced the per share exercise price of warrants to purchase 143,750 shares of our common stock from $8.00 to $1.85. On September 20, 2009, we reduced the exercise price of 423,750 common stock purchase warrants we issued in connection with our November 2006 offering from $4.00 to $1.14 pursuant to the price reset provisions of those warrants. A summary of the status of our outstanding common stock purchase warrants granted as of March 31, 2010 and changes during the period is as follows:

	Shares Underlying Warrants			Weighted Average Exercise Price
Outstanding at September 30, 2009		5,834,664		$	8.34
Adjustment (1)		75,000			5.00
Exercised		(260,000	)		1.14
Granted		-			-
Outstanding at March 31, 2010		5,649,664			7.05
Exercisable at March 31, 2010		5,649,664		$	7.05

(1) Reflects an adjustment to reverse the cancellation of 75,000 warrants to purchase shares of our common stock at $5.00 per share entered in error in the nine month trisition period ended September 30, 2009.

The following information applies to all warrants outstanding at March 31, 2010.

Exercise Price		Number of Warrants Outstanding		Weighted Average Remaining Contractual Life (Years)		Weighted Average Exercise Price		Warrants Exercisable		Weighted Average Exercise Price of Warrants Exercisable
$	1.14		50,000		1.42	$	1.14		50,000	$	1.14
$	1.55		247,500		2.28	$	1.55		247,500	$	1.55
$	2.31		1,351,352		4.72	$	2.31		1,351,352	$	2.31
$	2.50		50,000		1.67	$	2.50		50,000	$	2.50
$	8.00		1,966,250		2.79	$	8.00		1,966,250	$	8.00
$	10.00		1,894,562		1.45	$	10.00		1,894,562	$	10.00
$	15.00