Edgar Filing: China Direct Industries, Inc.

cdii10-q.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 June 30, 2011


[ ]	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 [ X ] 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. 40,334,892 shares of common stock were issued and outstanding as of August 12, 2011.

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.	23
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	39
	Item 4.	Controls and Procedures.	39
PART II - OTHER INFORMATION
	Item 1.	Legal Proceedings.	41
	Item 1A.	Risk Factors.	41
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	41
	Item 3.	Defaults Upon Senior Securities.	41
	Item 4.	(Removed and Reserved).	41
	Item 5.	Other Information.	41
	Item 6.	Exhibits.	41
	Signatures		46

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 100% owned subsidiary of Asia Magnesium;
	•		“Pan Asia Magnesium”, refers to Pan Asia Magnesium Co., Ltd., a company organized under the laws of the PRC and a 51% owned subsidiary of CDI China;
	•		“Baotou Changxin Magnesium”, refers to Baotou Changxin Magnesium Co., Ltd., a company organized under the laws of the PRC, a 51% owned subsidiary of CDI China, and a 39% owned subsidiary of Excel Rise. Effectively China Direct holds a 70.9% interest;
	•		“IMG” or “International Magnesium Group”, refers to International Magnesium Group, Inc., a Florida corporation and a 100% owned subsidiary of China Direct Industries;
	•		“IMTC” or “International Magnesium Trading”, refers to International Magnesium Trading Corp., a company organized under the laws of Brunei and a 100% owned subsidiary of IMG;
	•		“Ruiming Magnesium”, refers to Taiyuan Ruiming Yiwei Magnesium Co., Ltd., a company organized under the laws of the PRC and an 80% majority owned subsidiary of CDI China; and
	•		“Beauty East”， refers to Beauty East International, Ltd., a Hong Kong company and a 100% 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.

PART 1 - FINANCIAL INFORMATION

Item 1.

Financial Statements.

CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

	June 30, 2011			September 30, 2010
ASSETS	(unaudited)
Current Assets:
Cash and cash equivalents	$	10,263,787		$	10,110,818
Marketable securities available for sale		19,693,322			2,221,290
Marketable securities available for sale-related parties		436,267			672,735
Accounts and notes receivables, net of allowance of $303,165 and $214,701, respectively		25,887,544			15,235,983
Accounts, loans and other receivables, and prepaid expenses - related parties		9,049,536			7,680,222
Inventories, net		12,137,739			6,372,925
Prepaid expenses and other current assets, net		12,490,941			8,552,369
Current assets of discontinued operations		51,345			51,345
Restricted cash, current		1,129,583			5,091,023
Total current assets		91,140,064			55,988,710
Property, plant and equipment, net		36,819,805			37,512,261
Intangible assets		171,576			194,541
Property use rights, net		2,229,511			1,970,585
Other long-term assets		62,914			-
Long-lived assets of discontinued operations		196,078			196,078
Total assets	$	130,619,948		$	95,862,175

LIABILITIES AND EQUITY
Current Liabilities:
Loans payable-short term	$	2,681,649		$	5,613,532
Accounts payable and accrued expenses		20,515,470			11,250,879
Accounts and other payables-related parties		5,082,646			3,973,704
Advances from customers and deferred revenue		3,217,304			2,797,315
Other liabilities		2,398,111			1,073,926
Taxes payable		606,583			877,840
Current liabilities of discontinued operations		49,538			80,000
Total liabilities		34,551,301			25,667,196

CHINA DIRECT INDUSTRIES INC. EQUITY
Series A Convertible Preferred Stock: $.0001 par value, stated value $1,000 per share; 10,000,000 authorized, 1,006 shares outstanding at September 30, 2010 and June 30, 2011.		1,006,250			1,006,250
Common Stock: $.0001 par value; 40,248,583 and 31,657,244 authorized and outstanding, respectively		4,025			3,166
Additional paid-in capital		75,983,627			65,032,845
Accumulated other comprehensive income		13,915,150			1,795,387
Accumulated deficit		(10,595,627	)		(17,643,217	)
Total China Direct Industries, Inc. stockholders' equity		80,313,425			50,194,431
Noncontrolling interests		15,755,222			20,000,548
Total equity		96,068,647			70,194,979
Total liabilities and equity	$	130,619,948		$	95,862,175

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

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(unaudited)

	For the three months ended June 30,						For the nine months ended June 30,
	2011			2010			2011			2010

Revenues	$	55,154,956		$	29,987,583		$	141,588,028		$	71,021,737
Revenues-related parties		1,860,644			1,956,931			3,465,187			6,545,831
Total revenues		57,015,600			31,944,514			145,053,215			77,567,568
Cost of revenues		49,457,823			29,984,123			127,739,204			71,788,808
Gross profit		7,557,777			1,960,391			17,314,011			5,778,760

Operating income (expenses):
Selling, general, and administrative		3,006,256			3,304,123			9,821,167			8,566,932
Other operating income-related party		(3,919	)		-			(106,791	)		-
Other operating expense (income)		1,180			-			(354,018	)		-
Operating income (expenses)		4,554,260			(1,343,732	)		7,953,653			(2,788,172	)
Other (expenses) income:
Other (expense) income:		(178,469	)		(43,961	)		86,892			4,524
Interest (expense) income		(119,025	)		37,332			(186,069	)		40,944
Realized income (loss) on investment securities available for sale		-			33,155			(379,969	)		2,134,344
Total other (expenses) income		(297,494	)		26,526			(479,146	)		2,179,812
Income (loss) from continuing operations before income taxes		4,256,766			(1,317,206	)		7,474,507			(608,360	)
Income tax expense		(53,078	)		(7,378	)		(120,719	)		(62,302	)
Net income (loss)		4,203,688			(1,324,584	)		7,353,788			(670,662	)
Net (income) loss attributable to noncontrolling interests-continuing operations		102,870			240,167			424,981			258,913
Net income (loss) attributable to China Direct Industries	$	4,306,558		$	(1,084,417	)	$	7,778,769		$	(411,749	)

Deduct dividends on Series A Preferred Stock:
Preferred stock dividend		(20,130	)		(20,125	)		(60,390	)		(80,433	)
Deemed dividend - beneficial conversion feature		-			-			(600,693	)		-
Dividend - warrant valuation		-			-			(76,705	)		-
Net income attributable to common stockholders	$	4,286,428		$	(1,104,542	)	$	7,040,981		$	(492,182	)

Basic and diluted income per common share
Basic	$	0.11		$	(0.04	)	$	0.20		$	(0.02	)
Diluted	$	0.11		$	(0.04	)	$	0.20		$	(0.02	)
Basic weighted average common shares outstanding		37,567,331			28,828,887			34,694,215			28,940,495
Diluted weighted average common shares outstanding		38,250,045			28,828,887			34,818,040			28,940,495

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

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CHINA DIRECT INDUSTRIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY

For the nine months ended June 30, 2011

(unaudited)

	Preferred Stock Issued		Common Stock Amount		Additional Paid-in Capital			Accumulated Deficit			Accumulated Other Comprehensive Income		Noncontrolling interests			Total Equity
Balance, September 30, 2010	$	1,006,250	$	3,166	$	65,032,845		$	(17,643,217	)	$	1,795,387	$	20,000,548		$	70,194,979

Dividends paid to preferred stockholders		-		4		60,386			(60,390	)		-		-			-
Public offering		-		222		3,771,280			-			-		-			3,771,502
Acquisition of noncontrolling interests		-		565		6,049,137			-			-		(4,517,779	)		1,531,923
Additional paid-in capital - noncontrolling interests		-		0		-			-			-		302,489			302,489
Restricted Stock Award - Employees		-		50		358,604			-			-		-			358,654
Restricted Stock Award - Board of Directors		-		9		51,603			-			-		-			51,612
Restricted Stock Award - Consultants		-		1		38,647			-			-		-			38,648
Stock Option exercised		-		8		103,193						-		-			103,201
Net earnings (loss)		-		-		-			7,778,768			-		(424,980	)		7,353,788
Changes in cumulative foreign currency translation		-		-		-			-			1,349,002		394,944			1,743,946
Unrealized gain on marketable securities available for sale		-		-		-			-			10,770,761		-			10,770,761
Deemed dividends adjustment		-		-		(55,161	)		(677,398	)		-		-			(732,559	)
Dividends - warrants adjustment		-		-		573,093			-			-		-			573,093
Reclassification adjustment for welfare benefit included in other comprehensive income		-		-		-			6,609			-		-			6,609
Balance, June 30, 2011		1,006,250		4,025		75,983,627			(10,595,628	)		13,915,150		15,755,222			96,068,647

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

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	For nine months ended June 30,
	2011			2010
OPERATING ACTIVITIES:
Net income (loss)	$	7,353,788		$	(670,662	)
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization		2,934,788			1,741,893
Allowance for bad debt		25,868			(618,697	)
Stock based compensation		410,267			871,842
Realized loss (gain) on investments in marketable securities		379,969			(2,134,344	)
Gain on preferred stock revaluation		(159,467	)		-
Fair value of marketable securities received for services		(18,157,734	)		(2,053,560	)
Fair value of securities paid for services		6,370,148			225,063
Changes in operating assets and liabilities:
Prepaid expenses and other assets		(3,978,520	)		(1,640,322	)
Accounts receivable and other assets-related parties		(1,369,314	)		1,186,849
Inventories		(5,764,814	)		(1,428,633	)
Accounts receivable		897,777			(3,178,458	)
Accounts payable and accrued expenses		3,216,591			1,879,378
Accounts and other payable - related parties		1,108,942			218,036
Advances from customers		(120,011	)		(1,019,563	)
Other payables		1,022,466			(2,986,526	)
CASH USED IN OPERATING ACTIVITIES		(5,829,256	)		(9,607,704	)

INVESTING ACTIVITIES:
Proceeds from the sale of marketable securities available for sale		818,456			5,874,760
Purchases of property, plant and equipment		(2,242,333	)		(561,079	)
Increase in property use rights		(258,926	)		-
CASH (USED IN) PROVIDED BY INVESTING ACTIVITES		(1,682,803	)		5,313,681

FINANCING ACTIVITIES:
Decrease in restricted cash		3,961,441			120,144
(Payments of) proceeds from loans payable		(2,931,883	)		322,255
Proceeds from sale of stocks and exercise of warrants/options		3,874,702			4,955,818
Cash dividend payment to preferred stock holders		-			(20,124	)
Capital contribution from noncontrolling interest owners		1,710,909			-
CASH PROVIDED BY FINANCING ACTIVITIES		6,615,169			5,378,093

EFFECT OF EXCHANGE RATE ON CASH		1,049,859			462,322
Net increase in cash		152,969			1,546,392
Cash and equivalents, beginning of the period		10,110,818			12,851,310
Cash and equivalents of continuing operations, end of the period	$	10,263,787		$	14,397,702
Supplemental disclosures of cash flow information:
Preferred dividend paid in our common stock	$	60,390		$	80,433
Deemed dividend - beneficial conversion feature	$	600,693		$	-
Dividend - warrant valuation	$	76,705		$	-

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

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

NOTE 1 - BASIS OF PRESENTATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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. based company that sources, produces and distributes industrial products in China and the Americas. We also provide business and financial consulting services to public and private American and Chinese businesses. We operate in three identifiable segments, as defined by the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 280, “Segment Reporting:” Magnesium, Basic Materials and Consulting. Beginning in 2006 we established our Magnesium and Basic Materials segments which have grown through acquisitions of controlling interests in Chinese private companies. We consolidate these acquisitions as either wholly or majority owned subsidiaries. Through our U.S. based industrial commodities business, established in 2009, we source, finance, manage logistics, and sell industrial commodities from North and South America for ultimate distribution in China.

In our Magnesium segment, currently our largest segment by revenues and assets, we produce, sell and distribute pure magnesium ingots, magnesium powder 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 which has not commenced operations.

In our Consulting segment, we provide business and financial 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 we provide.

We have defined various periods that are covered in this report as follows:

	•		“fiscal 2011” – October 1, 2010 through September 30, 2011
	•		“fiscal 2010” — October 1, 2009 through September 30, 2010.

Basis of Presentation

Our interim consolidated financial statements are unaudited. We prepared the consolidated financial statements in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) and pursuant to the U.S. Securities and Exchange Commission (“SEC”) rules for interim reporting. In the opinion of management, we included all adjustments that are necessary for the fair presentation of our financial position, results of operations, and cash flows for the interim periods presented. Except as disclosed herein, such adjustments are of a normal and recurring nature. Results for the first nine months of the fiscal year may not necessarily be indicative of full year results. It is suggested that these consolidated financial statements be read in conjunction with the audited financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended September 30, 2010 and our Quarterly Reports on Form 10-Q for interim periods.

Summary of Significant Accounting Policies

Concentration of Credit Risks

Financial instruments which potentially subject us to concentrations of credit risk consist principally of cash, trade accounts receivable and notes receivables. We deposit our cash with high credit quality financial institutions in the United States and China. As of June 30, 2011, we had no bank deposits in the United States that exceeded federally insured limits. At June 30, 2011, we had bank deposits of $5,866,219 in China. In China, there is no equivalent federal deposit insurance as in the United States, so the amounts held in banks in China are not insured. We have not experienced any losses in such bank accounts through June 30, 2011.

At June 30, 2011 and September 30, 2010, bank deposits by geographic area were as follows:

Country	June 30, 2011				September 30, 2010
United States		4,397,568	43	%		4,851,329	48	%
China		5,866,219	57	%		5,259,489	52	%
Total cash and cash equivalents		10,263,787	100	%		10,110,818	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.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

A significant portion of our revenues during the three month period ended June 30, 2011 were comprised of a note receivable in the principal amount of $11,075,206 that is convertible into shares of common stock of the issuer and a receivable of $500,000 that we received from to a client as consulting fees whose ability to pay is dependent upon the success of its business and the industry in which it operates. Concentrations of credit risk with respect to trade accounts and notes receivables is, however, limited as the payment terms due to generally short payment terms. We also perform ongoing credit evaluations of our clients to help further reduce credit risk.

Foreign Currency Translation

Our reporting currency is the U.S. dollar. The functional currency of the parent company is the U.S. dollar and the functional currency of our Chinese subsidiaries is the Renminbi (“RMB”), the official currency of the People’s Republic of China. 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 dates. Income and expenditures are translated at the average exchange rates for the nine month period ended June 30, 2011 and the fiscal year ended September 30, 2010. A summary of the conversion rates for the periods presented is as follows:

	June 30, 2011		September 30, 2010
Period end RMB: U.S. dollar exchange rate		6.4630		6.6981
Average fiscal-year-to-date RMB: U.S. dollar exchange rate		6.5710		6.8214

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 RMB amounts could have been, or could be, converted into United States dollars at the rates applied in the translation.

Fair Value of Financial Instruments

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

Most of our financial instruments are carried at fair value, including, all of our cash and cash equivalents, accounts and notes receivable, prepayments and other current assets, accounts payable, taxes payable, accrued expenses and other current liabilities, investments classified as available for sale securities and assets held for sale, with unrealized gains or losses recognized as Other Comprehensive Income (OCI), net of tax. Virtually all of our valuation measurements are Level 1 measurements.

Marketable Securities

Marketable Securities that we receive from our clients as compensation are generally restricted for sale under Federal securities laws. Our policy is to liquidate securities received as compensation when market conditions are favorable for sale. Since these securities are often restricted, we are unable to liquidate them until the restriction is removed. We recognize revenue for the common stock we receive as compensation based on the fair value at the time the common stock is granted or at the time service has been rendered and for common stock purchase warrants based on the Black-Scholes valuation model. Pursuant to ASC Topic 320, “Investments –Debt and Equity Securities” our marketable securities have a readily determinable and active quoted price, such as from NASDAQ, NYSE Euronext, the Over the Counter Bulletin Board, and the OTC Markets Group (formerly known as the Pink Sheets) and any unrealized gain or loss is recognized as an element of comprehensive income based on changes in the fair value of the security as quoted on an exchange or an inter-dealer quotation system. Once liquidated, any realized gain or loss on the sale of marketable securities is reflected in our net income for the period in which the security was liquidated.

We perform an analysis of our marketable securities at least on an annual basis to determine if any of these securities have become other than temporarily impaired. If we determine that the decline in fair value is other than temporary we recognize the amount of the impairment as a realized loss into our current period net income (loss). This determination is based on a number of factors, including but not limited to (i) the percentage of the decline, (ii) the severity of the decline in relation to the enterprise/market conditions, and (iii) the duration of the decline.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

Derivative Warrant Liabilities

ASC Subtopic 815-40 (formerly EITF 07-5), “Contracts in Entity’s Own Equity,” requires that entities recognize as derivative liabilities the derivative instruments, including certain derivative instruments embedded in other contracts that are not indexed to an entity’s’ own stock. Pursuant to the provisions of ASC Section 815-40-15, an entity should use a two-step approach to evaluate whether an equity-linked financial instrument (or embedded feature) is indexed to its own stock, including evaluating the instrument’s contingent exercise and settlement provisions. The adoption of ASC Subtopic 815-40 has affected the accounting for (i) certain freestanding warrants that contain exercise price adjustment features and (ii) convertible bonds issued by foreign subsidiaries with a strike price denominated in a foreign currency. In the case of any such warrants and convertible bonds, ASC Subtopic 815-40 provides that such warrants and bonds are to be treated as a liability at fair value with changes in fair value recognized in earnings.

We adopted ASC Subtopic 815-40 on December 31, 2010 and reclassified certain warrants we issued in connection with our February 2008 series A convertible preferred stock offering as a liability rather than as stockholders’ equity and recognized the changes in fair value in earnings. The balance of the derivative liabilities as of June 30, 2011 was zero as the warrants expected time to exercise expired on June 30, 2011. The cumulative unrealized gain on the change in fair value was $159,467. See Note 11 – Capital Stock – Reclassification of Derivative Liabilities for more details.

Accrual of Environmental Obligations

ASC Section 410-30-25 “Recognition” of environmental obligations requires the accrual of a liability if both of the following conditions are met:

a.	Information available before the financial statements are issued or are available to be issued indicates that it is probable that an asset has been impaired or a liability has been incurred at the date of the financial statements.

b.	The amount of the loss can be reasonably estimated.

As of June 30, 2011, we do not have any environmental remediation obligations, nor do we have any asset retirement obligations under ASC 410. Furthermore, we do not have any environmental remediation loss contingencies requiring recognition or disclosure in our financial statements.

Recent Pronouncements

Comprehensive Income

Accounting Standards Update (“ASU”) No. 2011-05 amends FASB Codification Topic 220 on comprehensive income (1) to eliminate the current option to present the components of other comprehensive income in the statement of changes in equity, and (2) to require presentation of net income and other comprehensive income (and their respective components) either in a single continuous statement or in two separate but consecutive statements. These amendments do not alter any current recognition or measurement requirements in respect of items of other comprehensive income.

The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. Earlier adoption is permitted, because compliance with the amendments is already permitted. We will start to adopt this guidance in our 2012 fiscal year.

Business Combinations

In January 2011, ASU No. 2010-29 clarified that pro forma revenue and earnings for a business combination occurring in the current year should be presented as though the business combination occurred as of the beginning of the year or, if comparative statements are presented, as though the business combination took place as of the beginning of the comparative year.

The disclosures required of public entities in respect of a business combination occurring during the current reporting period called for in ASC Section 805-10-50 have been amended as follows:



If comparative financial statements are not presented, pro forma revenue and earnings of the combined entity should be based on the assumption that the business combination took place as of the beginning of the current year.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011



If comparative financial statements are presented (1) pro forma revenue and earnings of the combined entity should be based on the assumption that the business combination occurred as of the beginning of the comparative year, and (2) in the year following the business combination, pro forma information should not be revised if comparative statements for the year in which the acquisition occurred are presented (even if such year is the earliest period presented).



To require disclosure of the nature and amounts of any material nonrecurring adjustments directly attributable to the business combination included in the pro forma revenue and earnings (i.e., supplemental pro forma information).

The new and amended disclosures should be applied prospectively to business combinations consummated on or after the start of the first annual reporting period beginning on or after December 15, 2010, with earlier application permitted. We have adopted this guidance.

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

NOTE 2 – EARNINGS PER SHARE

Under the provisions of ASC Topic 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. For the three and nine months ended June 30, 2010, the effect of stock options, warrants and restricted stock awards is anti-dilutive. Accordingly, basic and diluted income (loss) per share is the same for both periods presented.

The following table sets forth the computation of basic and diluted income (loss) per share for the three and nine months ended June 30, 2011 and 2010 (unaudited):

See comment about defined term

	For three months ended June 30,					For nine months ended June 30，
	2011		2010			2011		2010
Earnings attributable to Shareholders' equity	$	4,286,428	$	(1,104,542	)	$	7,040,981	$	(492,182	)
Effect of series A preferred stock dividends		20,130		-			-		-
Earnings attributable to Shareholders' equity-assuming dilution	$	4,306,558	$	(1,104,542	)	$	7,040,981	$	(492,182	)

Average common shares outstanding		37,567,331		28,828,887			34,694,215		28,940,495
Effect of dilutive securities （1）
Unvested stock-based compensation（2）		123,825		-			123,825		-
Series A preferred stock （2）		558,889		-			-		-
Average common shares outstanding-assuming dilution		38,250,045		28,828,887			34,818,040		28,940,495

Basic earning per common share	$	0.11	$	(0.04	)	$	0.20	$	(0.02	)
Diluted earings per common share	$	0.11	$	(0.04	)	$	0.20	$	(0.02	)

Comments for table above

(1)	Securities are not included in the denominator in periods when anti-dilutive. We excluded 2,142,980 shares of our common stock issuable upon exercise of options and 6,264,942 shares of our common stock issuable upon exercise of warrants as of June 30, 2011 as their effect was anti-dilutive.

(2)	We excluded 558,889 shares of our common stock that are issuable upon conversion of our series A preferred stock as its effect was anti-dilutive.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

NOTE 3 – 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 U.S. GAAP are included in comprehensive income but excluded from net income as these amounts are recorded directly as an adjustment to stockholders’ equity. 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 parties, net of taxes.

CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)

	For three months ended June 30,						For nine months ended June 30,
	2011			2010			2011		2010

Net income (loss)	$	4,203,688			(1,324,584	)		7,353,788		(670,662	)
Other comprehensive income:
Foreign currency translation adjustments
Foreign currency translation during period		(187,504	)		171,878			1,349,002		277,861
Foreign currency translation adjustments		(187,504	)		171,878			1,349,002		277,861

Unrealized gains on securities
Unrealized holding gains/(loss) arising during period		6,444,495			(377,382	)		10,770,761		(833,018	)
Unrealized gains (loss) on Securities		6,444,495			(377,382	)		10,770,761		(833,018	)
Other comprehensive income		6,256,991			(205,504	)		12,119,763		(555,157	)
Comprehensive income		10,460,679			(1,530,088	)		19,473,551		(1,225,819	)
Comprehensive income attributable to the noncontrolling interest		102,870			240,167			424,981		258,913
Comprehensive income (loss) attributable to common stockholders	$	10,563,549			(1,289,921	)		19,898,532		(966,906	)

The following table shows the accumulated other comprehensive income balances as of June 30, 2011.

	Foreign Currency Items		Unrealized Gains on Securities			Sales of a subsidiary			Accumulated Other Comprehensive Income
Beginning balance	$	3,062,779		(1,160,035	)		(107,357	)	$	1,795,387
Current-period change	$	1,349,002	$	10,770,761		$	-		$	12,119,763
Ending balance	$	4,411,781	$	9,610,726		$	-107,357		$	13,915,150

NOTE 4 – ACCOUNTS AND NOTES RECEIVABLE

Accounts and notes receivables includes a convertible promissory note in the principal amount of $11,075,206 (the “Convertible Note”) due from China America Holdings, Inc. (“CAAH”) that we received as payment for certain consulting services we provided to CAAH related to its acquisition of a Chinese tile manufacturer that was completed on June 30, 2011. The Convertible Note bears interest at the rate of 3% per annum and will automatically convert into 1,538,223 shares of CAAH’s common stock upon the completion of, and after giving effect to, a 400 for 1 reverse stock split (the “Reverse Stock Split”) CAAH is in the process of completing in connection with its June 30, 2011 acquisition. We own approximately 15.5% of CAAH’s common stock without regard to the 1,538,223 shares of common stock we expect to receive after CAAH’s proposed Reverse Stock Split. CAAH issued the Convertible Note to us because the number of shares they agreed to pay us for these services exceeded its authorized shares of common stock at June 30, 2011. Accounts and notes receivables also reflects $500,000 of cash that CAAH agreed to pay us, in addition to the Convertible Note, for our services related to its June 30, 2011 acquisition. The $500,000 of cash is payable to us when CAAH receives the proceeds under a note receivable that is due to CAAH on December 31, 2011. We determined the fair value of the Convertible Note by multiplying the number of shares issuable upon conversion of the Convertible Note prior to giving effect to the Reverse Stock Split by the closing price of CAAH’s common stock on June 30, 2011. We recognized revenue of $11,575,206 at June 30, 2011 in connection with these services.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

We determined the fair value of the Convertible Note by multiplying the number of shares issuable upon conversion of the Convertible Note prior to giving effect to a 400 for 1 reverse stock split times the closing price of CAAH’s common stock on the closing of the acquisition target. We recognized revenue of $11,575,206 at June 30, 2011 in connection with these services.

NOTE 5 – MARKETABLE SECURITIES

Marketable securities available for sale and marketable securities available for sale-related party at June 30, 2011 and September 30, 2010 consist of the following:

Company	June 30, 2011		% of Total			September 30, 2010		% of Total
	(unaudited)
China America Holdings, Inc.	$	1,293,947		6	%	$	950,250		33	%
China Logistics Group, Inc.		590,106		3	%		515,625		18	%
Dragon International Group Corp.		22,815		1	%		22,815		1	%
China Armco Metals, Inc.		-		0	%		277,600		10	%
Sunwin International Neutraceuticals, Inc.		300,000		1	%		455,000		15	%
Dragon Capital Group Corp.		436,267		2	%		672,735		23	%
China Education International, Inc.		17,486,454		87	%		-		0	%
Marketable securities availabe for sale	$	20,129,589		100	%	$	2,894,025		100	%

On December 31, 2010, we received a total of 4,740,694 shares of China Education International, Inc. (“CEII”), formerly known as USChina Channel, Inc. common stock as the stock-based payment for consulting services we provided to CEII in connection with CEII’s acquisition of China Education Schools, Ltd. In connection with this transaction, we also paid $170,000 to acquire 758,124 shares of CEII’s common stock in a private sale. We accounted for this class of securities as marketable securities available for sale. Pursuant to ASC Topic 820, “Fair Value Measurement”, we used the quoted price for the CEII’s securities to value the shares of CEII’s common stock and recognized $4,977,728 or $1.05 per share as our consulting service revenue for the nine months ended June 30, 2011.

Invictus Advisory Services, Inc. (“Invictus”), CEII and our company entered into a Consulting and Management Agreement as of December 31, 2010 whereby we agreed to perform certain consulting and business advisory services for CEII, including advising CEII on financing matters, assistance with acquisitions, and coordination of SEC filings. The term of the agreement is for one year, beginning January 1, 2011. On February 15, 2011, Invictus transferred to us on behalf of CEII a total of 600,000 shares of CEII’s common stock previously issued to Invictus as payment for our services. The 600,000 shares of CEII’s common stock we received were fully vested and non-forfeitable at the time of transfer and were valued at $1,800,000. We recognized revenue of $1,500,000 for the nine months ended June 30, 2011. The balance of deferred revenue was $300,000 as of June 30, 2011.

For the nine months ended June 30, 2011, the total fair value of CEII’s common stock we received for services was $6,477,729. We transferred shares of CEII’s common stock with a value of $283,500 to Animus Advisory Group, Inc. as a fee for its work for us in connection with work we performed for CEII. As of June 30, 2011, the aggregated carrying value of the CEII common stock was $17,486,454. The CEII common stock is quoted in the over the counter market system, but is restricted and cannot be readily sold by us absent a registration of those securities under the Securities Act of 1933 (the “Securities Act”) or the availability of an exemption from the registration requirements under the Securities Act. Our policy is to liquidate the securities we receive as compensation on a regular basis. As these securities are often restricted, we are unable to liquidate them until the restriction is removed. Unrealized gains or losses on marketable securities available for sale are recognized on a periodic 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.

The investments in marketable securities available for sale-related party totaled $436,267 and $672,735 at June 30, 2011 and September 30, 2010, respectively and are comprised solely of the securities of Dragon Capital Group Corp. (“Dragon Capital”). 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. 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 OTC Pink Tier of the OTC Markets Group. As such, under Federal securities laws, securities of Dragon Capital generally cannot be resold by us absent a registration of those securities under the Securities Act.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

NOTE 6 - INVENTORIES

Inventories at June 30, 2011 and September 30, 2010 consisted of the following:

	June 30, 2011		September 30, 2010
	(Unaudited)
Raw materials	$	3,628,399	$	3,478,947
Finished goods		8,509,340		2,893,978
Total Inventory	$	12,137,739	$	6,372,925

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 June 30, 2011 and September 30, 2010.

NOTE 7 - PREPAID EXPENSES AND OTHER CURRENT ASSETS

Description	June 30, 2011		September 30, 2010
	(Unaudited)
Prepayments to vendors for merchandise that had not yet been shipped or services that had not been performed	$	5,572,930	$	4,469,249
Prepaid expenses		2,722,397	$	2,546,278
Other receivables		2,728,195		911,217
Loans receivable		1,467,419		608,904
Security deposits		-		16,721
Total		12,490,941		8,552,369

For the fiscal year ended September 30, 2010, prepayments to vendors for merchandise that had not yet been shipped or services that had not been performed included $2,546,278 non-trade related prepaid expenses. We reclassified the amount to prepaid expenses to better reflect the nature of the item. Prepaid expenses as of June 30, 2011 also include a prepayment for Baotou Changxin Magnesium land use rights. Baotou Changxin Magnesium owns and operates a magnesium facility capable of producing 20,000 metric tons of pure magnesium per year located on approximately 406,000 square feet of land located in the Shiguai district of Baotou city, in Inner Mongolia. Baotou Changxin Magnesium occupies this land pursuant to an asset acquisition agreement entered into with Baotou Sanhe Magnesium Co., Ltd. to acquire the land use rights for this property, among other assets. Since the land use right has yet to be transferred from Baotou Sanhe Magnesium Co. to Baotou Changxin Magnesium, the land use right balance of $1,126,870 is included in prepaid expenses. The land use right expires in May 2045.

NOTE 8 - PROPERTY, PLANT AND EQUIPMENT

At June 30, 2011 and September 30, 2010, property, plant and equipment, consisted of the following:

Property, Plant and Equipment
Description	Useful Life		June 30, 2011			September 30, 2010
			(unaudited)
Building	10-40 years		$	16,111,379		$	14,978,242
Manufacturing equipment	5-10 year			19,329,738			18,650,462
Office equipment and furniture	3-5 year			494,935			470,238
Autos and trucks	5 year			1,041,872			995,963
Construction in progress		N/A		7,991,559			7,716,777
Total				44,969,483			42,811,682
Less: accumulated depreciation				(8,149,678	)		(5,299,421	)
Property, Plant and Equipment, Net			$	36,819,805		$	37,512,261

For the nine months ended June 30, 2011 and 2010, depreciation expense totaled $2,850,257 and $1,709,919, respectively.

Included in property and equipment is construction-in-progress which consisted of factory improvements and machinery pending installation and includes the costs of construction, machinery and equipment. No provision for depreciation is made on construction-in-progress until such time as the relevant assets are completed and ready for their intended use.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

NOTE 9 - PROPERTY USE RIGHTS

For the nine months ended June 30, 2011 and 2010, amortization expense of the property use rights totaled $54,659 and $31,974, respectively. Property use rights, net of accumulated amortization, consisting of mining and property use rights, amounted to $2,229,511 and $1,970,585 at June 30, 2011 and September 30, 2010, respectively. During the nine months ended June 30, 2011, our subsidiary Shanxi Gu County Golden Magnesium Industry Co., Ltd. (“Golden Magnesium”) paid an additional $270,827 for governmental fees required to complete the transfer of the land use right to Golden Magnesium.

In connection with our acquisition of CDI Jixiang Metal Co., Ltd. (“CDI Jixiang”) in December 2007, we acquired mining rights to 51 acres of land located in the Yong shun Kaxi Lake Mining area of China. In July 2009, CDI Jixiang Metal submitted an application to the Ministry of Land Resources of Yongshun County to begin the process of obtaining a 5-year renewal for these mining rights as the current lease expired in October 2009. This application was approved by the Ministry of Land Resources of Yongshun County and was forward to the Ministry of Land Resources of Hunan Province with a recommendation that the application be approved. During the review of the application by the Ministry of Land Resources of Hunan Province a discrepancy in the requested depth of the mine was noted as the depth requested by CDI Jixiang Metal depth was greater than the depth specified in the original permit. In December 2010, CDI Jixiang Metal acknowledged the discrepancy and requested that the application be considered using the previously approved mining depth. In addition, during the Ministry of Land Resources of Hunan Province review, it was determined that CDI Jixiang’s application required submission of reports on mining reserves, mining development and utilization program, environmental geological assessment, and land reclamation plan. These reports were then submitted to the Ministry of Land Resources of Hunan Province and are awaiting approval by government appointed experts. Ministry of Land Resources of Hunan Province has advised CDI Jixiang Metal that a new mining permit will be issued once the reports are approved which are expected to approved in the next several months. Based on these circumstances, we believe that the mining rights will ultimately be renewed. Based on our periodic evaluation of our long-lived assets, we have concluded that none of the assets related to CDI Jixiang are impaired.

NOTE 10 - LOANS PAYABLE

Our loans payable reflect borrowings for general working capital purposes. Loans payable at June 30, 2011 and September 30, 2010 consisted of the following:

Description	June 30, 2011			September 30, 2010
	(Unaudited)
Lang Chemical loan from Bank of Shanghai. Due on February 20, 2011. 5.31% annual interest rate. Guaranteed by China Investment Guarantor Co. Ltd.	$	-		$	447,888

Lang Chemical loan from China Mingsheng Bank. Due on May 26, 2011. 6.638% annual interest rate. Guaranteed by Chen Jingdong.		-			686,762

CDI Beijing non-interest bearing loan from Beijing Mingshang Intestment Guarantee Co. Ltd. Due on August 31, 2011. Guaranteed by Chi Chen.		-			4,478,882

CDI China loan from Sunwin Tech Group, Inc. Due on December 31, 2011. 3% annual interest rate. Secured by pledge of CDI China assets.		500,000			-

Lang Chemical loan from China Mingsheng Bank. Due on May 16, 2012. 6.941% annual interest rate. Guaranteed by Zhu Qian and Chen Jingdong.		711,744			-

Lang Chemical loan from Bank of Shanghai. Due on March 22, 2012. 6.666% annual interest rate. Guaranteed by China Investment Guarantor Co. Ltd. and Zhu Qian.		541,544			-

CDI Beijing loan from Bank of Hongzhou. Due on October 21, 2011. 6.672% annual interest rate. Guranteed by Chi Chen.		928,361			-

Total		2,681,649			5,613,532
Less: Current Portion		(2,681,649	)		(5,613,532	)

Loans payable, long-term	$	-		$	-

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

NOTE 11 - RELATED PARTY TRANSACTIONS

List of Related Parties

We have specified the following persons and entities as related parties with ending balances as of June 30, 2011and September 30, 2010:

	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; Suihuan Huang is the sister of Yuwei Huang;
	Lifei Huang, is a registered representative of Pine Capital Enterprises Inc., a company organized under the laws of the Cayman Islands (“Pine Capital”);
	Lifei Huang, is a registered representative of Wheaton Group Corp., a company organized under the laws of Brunei Darussalam (“Wheaton”);
	LuCheng Haixu Magnesium Co., Ltd., a company organized under the laws of the PRC (“Haixu Magnesium”), is legally represented by an officer of Chang Magnesium;
	Lingshi Xinghai Magnesium Co., Ltd., a company organized under the laws of the PRC (“Xinghai Magnesium”), is legally represented by an officer of Chang 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;
	Chen Chi is vice president of our Basic Materials Segment and minority interest owner of CDI Beijing; 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.

As of June 30, 2011, accounts, loans, and other receivables and prepaid expenses- related parties were $9,049,536 and were comprised of accounts receivable – related party of $1,182,257, Prepaid expenses – related parties of $4,601,160, Loans receivable – related parties of $1,505,820, and Due from related parties of $1,760,299 as set forth below:

Accounts Receivable – related parties

At June 30, 2011, accounts receivable – related parties of $1,182,257 was comprised of the following:

	$645,412 due Baotou Changxin Magnesium from YiWei Magnesium for inventory provided;
	$4,803 due Chang Magnesium from Wheaton for inventory provided;
	$58,716 due Chang Magnesium from Pine Capital for inventory provide;
	$355,998 due Chang Magnesium from YiWei Magnesium for inventory provided; and
	$117,328 due Golden Magnesium from YiWei Magnesium for inventory provided.

At September 30, 2010, accounts receivable – related parties of $2,119,582 was comprised of the following:

	$834,758 due Baotou Changxin Magnesium from YiWei Magnesium for inventory provided;
	$4,635 due Chang Magnesium from Wheaton for inventory provided; and
	$1,280,189 due Golden Magnesium from YiWei Magnesium for inventory provided.

Prepaid Expenses – related parties

At June 30, 2011, prepaid expenses – related parties of $4,601,160 was comprised of the following:

	$77,372 prepaid by Chang Magnesium to Haixu Magnesium for future delivery of inventory;
	$2,854,698 prepaid by Chang Magnesium to YiWei Magnesium for future delivery of inventory;
	$1,149,090 prepaid by IMTC to Pine Capital for future delivery of inventory; and
	$520,000 prepaid by IMTC to Wheaton for future delivery of inventory.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

At September 30, 2010, prepaid expenses – related parties of $3,982,163 was comprised of the following:

	$204,536 prepaid by Baotou Changxi Magnesium to YiWei Magnesium for future delivery of inventory;
	$74,656 prepaid by Chang Magnesium to Haixu Magnesium for future delivery of inventory;
	$120,838 prepaid by Chang Magnesium to Xinghai Magnesium for future delivery of inventory;
	$3,217,076 prepaid by Chang Magnesium to YiWei Magnesium for future delivery of inventory,
	$4,544 prepaid by Golden Magnesium to Senrun Coal for future delivery of coke gas for fuel;
	$120 prepaid by Golden Magnesium to YiWei Magnesium for future delivery of inventory; and
	$360,393 prepaid by IMTC to YiWei Magnesium for future delivery of inventory.

Loans Receivable – related parties

At June 30, 2011, loan receivables – related parties of $1,505,820 was comprised of the following:

	$1,488,800 due Lang Chemical from NanTong Chemical for funds advanced for working capital purposes; and
	$17,020 due Chen Chi from CDI Beijing for funds advanced for working capital purposes.

At September 30, 2010, loan receivables – related parties of $1,528,911 was comprised of the following:

	$1,324,309 due Lang Chemical from NanTong Chemical for funds advanced for working capital purposes;
	$74,648 due Chen Chi from CDI Beijing for funds advanced for working capital purposes;
	$119,437 due Baotou Changxi Magnesium from Haixu Magnesium for funds advanced for working capital purposes; and
	$10,517 due Ruiming Magnesium from YiWei Magnesium for funds advanced for working capital purposes.

Due from related parties

At June 30, 2011, due from related parties of $1,760,299 was comprised of the following:

	$154,727 due Baotou Changxi Magnesium from YiWei Magnesium for working capital purposes;
	$502,862 due Chang Magnesium from Xinghai Magnesium for working capital purposes;
	$600,938 due Chang Magnesium from Yiwei Magnesium for working capital purposes;
	$451,950 due Ruiming Magnesium from Xinghai Magnesium for working capital purposes; and
	$49,822 due CDI Beijing from Zhongmen International for working capital purposes.

At September 30, 2010, due from related parties of $49,566 was comprised of the following:

$49,566 due CDI Beijing from Zhongmen International for working capital purposes.

As of June 30, 2011, accounts and other payables – related parties were $5,082,646 consisting of Accounts payable – related parties of $858,907, Loans payable – related parties of $637,475, and Due to related parties of $3,586,264 as set forth below:

Accounts Payable – related parties

At June 30, 2011, accounts payable – related party of $858,907 was comprised of the following:

	$15,687 due from Baotou Changxi Magnesium to Haixu Magnesium for purchases of goods;
	$841,327 due from Chang Magnesium to Xinghai Magnesium for purchases of goods;
	$346 due from Golden Magnesium to Xinghai Magnesium for purchases of goods; and
	$1,547 due from Golden Magnesium to Haixu Magnesium for purchases of goods.

At September 30, 2010, accounts payable – related party of $40,558 was comprised of the following:

	$12,200 due from Chang Magnesium to Pine Capital for purchases of goods;
	$15,135 due from Baotou Changxi Magnesium to Haixu Magnesium for purchases of goods;
	$11,396 due from Golden Magnesium to YiWei Magnesium for purchases of goods;
	$1,493 due from Golden Magnesium to Haixu Magnesium for purchases of goods; and
	$334 due from Golden Magnesium to Xinghai Magnesium for purchases of goods.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

Loan Payable – related parties

At June 30, 2011, the loan payable – related parties of $637,475 reflected the balance due to Zhu Qian for funds advance to Lang Chemical for working capital.

At September 30, 2010, the loan payable – related parties of $60,990 reflected the balance due to Pine Capital for funds advanced to Golden Magnesium for working capital.

Due to related parties

At June 30, 2011, due to related parties balance of $3,586,264 was comprised of the following:



$3,176,659 due to YiWei Magnesium for the balance of the purchase price for Ruiming Magnesium;

$387,881 due YiWei Magnesium for working capital of Ruiming Magnesium;

$9,953 due to Yuwei Huang for working capital of Chang Magnesium; and

$11,771 due to Kong Tung for working capital of Golden Magnesium.

At September 30, 2010, due to related parties balance of $3,872,157 was comprised of the balance due to Yiwei Magnesium for the purchase price of Ruiming Magnesium.

Restricted cash, current

At September 30, 2010 our current restricted cash was $5,091,023. Restricted cash was principally comprised of the cash proceeds of a $4,478,882 loan to CDI Beijing from Beijing Mingshang Investment Guarantee Co., Ltd. (the “Beijing Mingshang Loan”). The proceeds from this loan were pledged as collateral for a loan from Fushun Bank of Northern China (the “Fushun Bank Loan”) to an unrelated third-party trading partner of CDI Beijing, who is also a strategic business associate of Chi Chen, the General Manager of CDI Beijing and an owner of a 49% noncontrolling interest in that company. The Fushun Bank Loan was used for the borrower's working capital. Subsequently, Mr. Chen pledged his own personal assets as collateral for the Beijing Mingshang Loan. As a result, the removal of the restrictions on this cash and the repayment of this loan were completed within the second quarter of fiscal 2011.

NOTE 12 – CAPITAL STOCK

Preferred Stock and Related Dividends

We have 10,000,000 shares of preferred stock, par value $.0001, authorized, of which we designated 12,950 as our Series A Convertible Preferred Stock in February 2008. At June 30, 2011 and September 30, 2010 there were 1,006 shares of Series A Convertible Preferred Stock outstanding. The Series A Convertible 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 $1.80 per share after giving effect to a price reduction in connection with a December 30, 2010 offering of our securities. During the nine months ended June 30, 2011, we paid $60,390 of ordinary dividends in the form of 43,533 shares of our common stock. During the nine months ended June 30, 2010, we paid dividends of $60,304 in the form of 45,876 shares of our common stock and cash of $20,125.

On February 11, 2008, we entered into a Securities Purchase Agreement with accredited investors to sell 12,950 shares of our Series A Preferred Stock which was convertible into common stock at $7.00 per share. This class of preferred stock carries an embedded contingent beneficial conversion option that allows the conversion price to reset, contingent upon certain future transactional events. As of May 31, 2009, 1,006 shares of our Series A Preferred Stock were issued and outstanding. On June 15, 2009, we registered a direct offer of our common stock at $1.85 per share, and therefore as provided under the original Securities Purchase Agreement, we should have accounted for this conversion price reduction from $7.00 per share to $1.85 per share as additional intrinsic value beneficially extended to this class of stockholders during the 2009 transition when the first conversion price reset occurred. We made a determination that even if we retrospectively applied the adjustments to reflect such accounting changes to the prior periods, the net effect would be immaterial from both a quantitative and qualitative standpoint.

ASC 470-20 provides that upon the resolution of the contingency, a corresponding adjustment is required to account for and recognize the excess number of shares to be received multiplied by the stock price on the original commitment date as additional intrinsic economic benefits extended to this class of shareholders. Based on the facts and circumstances in our case, the re-measurement for this contingent beneficial conversion option amounted to $600,693, representing the remaining undiscounted portion of the net proceeds allocated to the outstanding 1,006 shares of Series A Preferred Stock in the original offer. As of December 31, 2010, we recorded a total discount of $600,693 to account for the additional intrinsic values for the outstanding 1,006 shares of Series A Preferred Stock, accreted the full amount immediately as this class of preferred stock does not have a stated redemption date or finite life, and recognized it as a one-time deemed dividend and a reduction to our retained earnings with a corresponding increase to additional paid-in capital.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

Reclassification of Derivative Liabilities

As of June 30, 2011 the Series A Preferred stockholders held an aggregate of 143,750 common stock purchase warrants, which contained a downside ratchet provision, that would allow the exercise price of these warrants to reset, contingent upon certain future transactional events. The terms of these warrants provide that if we sell common stock at a price per share less than the then exercise price of the warrants then we are required to reduce the exercise price of those warrants to the lower price of the subsequent sale. On June 15, 2009, we registered a direct offering of our common stock, which reduced the exercise price of the 143,750 warrants to purchase our common stock from $8.00 to $1.85 per share. On December 30, 2010, we entered into an engagement letter with Rodman & Renshaw for the sale of our common stock at $1.80 per share, which again reset the exercise price of the aforementioned warrants from $1.85 to $1.80 per share.

ASC Topic 815 “Derivatives and Hedging” requires any warrant (or embedded feature) that is not indexed to an entity’s own stock to be classified as a derivative liability instead of part of the permanent equity, with changes in fair value to be recognized into the then current earnings. Even though we should have adopted EITF 07-05 (currently ASC 815-40), beginning on January 1, 2009, applicable to our financial statements, we made a determination that even if we retrospectively applied the adjustments to reflect such accounting changes to the prior periods, the net effect would be immaterial from both a quantitative and qualitative standpoint.

As of December 31, 2010, we reclassified the 143,750 common stock purchase warrants with the downside ratchet provision from additional paid-in capital of the permanent equity into derivative liabilities to reflect the cumulative accounting effects on our balance sheet, with the cumulative effects on changes in fair values of derivative liabilities recognized in the current period of our statement of operations. In conjunction with the re-measurements and reclassifications, we recognized $76,705 as a one-time deemed dividend and a reduction to retained earnings, and recorded a corresponding increase in additional paid-in capital, to reflect the increase in fair value of the 143,750 warrants for the reduction of their exercise price. We reclassified $171,278 to derivative liabilities from additional paid-in capital on our balance sheet, and recorded a net amount of $104,305 as an unrealized gain into our current earnings to reflect the cumulative effects on changes in fair value of derivative liabilities.

As of December 31, 2010, the carrying amount of $66,973 reflected the then current fair value of the derivative liabilities. The fair value of the derivative liabilities of $11,811 was reclassified to additional paid-in capital on June 30, 2011 as the expected term of the warrants expired.

Inputs used in making the above determinations included:

	2009
	June 30			September 30			December 31
Value of per common share	$	1.72		$	1.57		$	1.18
Expected time to exercise (year)		2			1.75			1.5
Expected volatility		130	%		127	%		102	%
Risk-free interest rate		1.11	%		0.81	%		1.14	%
Dividend yield		0	%		0	%		0	%

	2010											2011
	March 31			June 30			September 30			December 31		March 31
Value of per common share	$	1.54		$	1.14		$	1.21		$	1.51	$ 1.38
Expected time to exercise (year)		1.25			1			0.75			0.5	0.25
Expected volatility		103	%		78	%		75	%		90	75%
Risk-free interest rate		1.14	%		0.32	%		0.27	%		0.19	0.09%
Dividend yield		0	%		0	%		0	%		0	0%

Common Stock

We have 1,000,000,000 shares of common stock, par value $.0001, authorized. At June 30, 2011 and September 30, 2010 there were 37,808,943 and 31,657,244 shares of common stock issued and outstanding, respectively.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

On December 30, 2010 we entered agreements with accredited investors to sell 2,222,224 shares of our common stock at $1.80 per share and warrants to purchase up to 777,778 of common stock. The registered offering was carried out under the terms of the December 30, 2010 engagement letter we entered into with Rodman & Renshaw, LLC (“Rodman & Renshaw”). The gross proceeds of this offering were $4,000,003 with offering expense of $228,501. We received the net proceeds of $3,771,502 on January 4, 2011. The warrants that are deemed as indexed to our own stock pursuant to ASC 815 have an exercise price of $2.00 per share and become exercisable beginning 183 days following the date they were issued for a period ending on the fifth anniversary of the initial exercise date. We are using the proceeds from this offering for general working capital purposes.

On May 6, 2011 CDI China, Inc., our wholly owned subsidiary, entered into a Stock Transfer Contract with Mr. Kong Tung, a member of our board of directors, and Mr. Hui Dong, his son, both of whom are the sole shareholders of Beauty East International, Ltd. (“Beauty East”), a Hong Kong company. Beauty East owns a 48% interest in our Golden Magnesium subsidiary. CDI China acquired 100% of Beauty East in exchange for 4,879,280 shares of our unregistered common stock, an equivalent of RMB 39,659,401 (approximately $6,099,107).The number of shares we agreed to issue was determined using the exchange rate announced by Bank of China on the date the agreement was signed by all of the parties. At the closing date the total value of the stock shares transferred was $6,147,893 or $1.26 per share.

During the nine months ended June 30, 2011, we issued a total of 6,151,699 shares of our common stock comprised of: 2,222,224 shares to accredited investors in connection with the December 30, 2010 agreement discussed above, 1,219,820 shares to Mr. Kong Tung and 1,219,820 shares to Mr. Hui Dong as part of the purchase price for the Stock Transfer Contract, 769,231 shares to Pine Capital as part of the purchase price for our acquisition of an 80% interest in Ruiming Magnesium, 43,533 shares to pay dividends on 1,006 shares of our series A preferred stock, 80,000 shares in connection with the exercise of stock options; 87,750 shares to members of our board of directors as compensation, 6,000 shares issued for consulting services, and 503,321 were issued to employees as compensation.

Stock Incentive Plans

The following table sets forth our stock incentive plan activities during the nine months ended June 30, 2011 and changes during the period is as follows:

Description	Shares underlying options			Weighted average exercise price
Outstanding at September 30, 2010		2,372,980		$	14.83
Exercised		(80,000	)		1.29
Expired		(44,000	)		2.50
Expired		(106,000	)		5.00
Outstanding at June 30, 2011		2,142,980		$	15.90
Exercisable at June 30, 2011		2,142,980		$	15.90

As of June 30, 2011, we had 2,142,980 shares underlying options outstanding and exercisable. The aggregate intrinsic value of these options at June 30, 2011 and September 30, 2010 was zero.

On June 2, 2010 we modified the exercise price of options to purchase 80,000 shares of our common stock previously awarded to David Stein, our former chief operating officer, from $5.00 per share to $1.29 per share as compensation for consulting and advisory services provided by Mr. Stein. The total additional stock-based compensation expense as a result of the modification was $32,604. On December 30, 2010, Mr. Stein exercised his option to purchase the 80,000 shares and we received proceeds of $103,201.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

The weighted average remaining contractual life and weighted average exercise price of options outstanding at June 30, 2011, 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)		Weighted average exercise price
	2.00		120,000		0.92		2.00		120,000		0.92		2.00
	2.25		400		3.31		2.25		400		3.31		2.25
	7.50		637,000		1.51		7.50		637,000		1.51		7.50
	10.00		625,000		2.51		10.00		625,000		2.51		10.00
	15.00		500		1.94		15.00		500		1.94		15.00
	30.00		760,000		1.58		30.00		760,000		1.58		30.00
	56.25		80		3.42		56.25		80		3.42		56.25
			2,142,980		1.79	$	15.90		2,142,980		1.79	$	15.90

Common Stock Purchase Warrants

In connection with our December 30, 2010 offering of our securities, we issued common stock purchase warrants (the “Warrants”) to purchase up to 777,778 shares of our common stock upon closing of the offering which occurred on January 4, 2011.

The Warrants are exercisable beginning six months after the issuance date at an exercise price of $2.00 per share until July 4, 2016. The Warrants may become exercisable on a cashless basis if we fail to maintain the effectiveness of our registration statement. The exercise price and number of shares issuable upon exercise are subject to adjustment in the event of stock splits or dividends, business combinations, rights offerings, sale of assets or other similar transactions. The Warrants are not exercisable to the extent that (a) the number of shares of our common stock beneficially owned by the holder, and (b) the number of shares of our common stock issuable upon the exercise of the Warrants would result in the beneficial ownership by the holder of more than 4.99% of our then outstanding common stock. This ownership limitation can be increased to 9.99% by the holder upon 61 days notice to us.

A summary of the status of our outstanding common stock purchase warrants granted as of June 30, 2011 and changes during the period is as follows:

	Shares underlying warrants			Weighted average exercise price
Outstanding at September 30, 2010		5,499,664			6.92
Additions		777,778			2.00
Expired		(12,500	)		11.00
Outstanding at June 30, 2011		6,264,942			6.30
Exercisable at June 30, 2011		5,487,164		$	6.91

Exercise Price		Number of Warrants outstanding		Weighted average remaining contractual life (Years)		Weighted average exercise price		Warrants Exercisable		Weighted average exercise price		Weighted average remaining contractual life (Years)
$	1.88		1,025,278		4.05	$	1.88		247,500	$	1.03		1.52
	2.31		1,351,352		3.47		2.31		1,351,352		3.47		2.31
	2.50		50,000		0.42		2.50		50,000		0.42		2.50
	4.00		50,000		0.17		4.00		50,000		0.17		4.00
	8.00		1,906,250		1.62		8.00		1,906,250		1.62		8.00
	10.00		1,882,062		0.20		10.00		1,882,062		0.20		10.01
$			6,264,942		1.97	$	6.30		5,487,164	$	1.54		6.91

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

NOTE 13 - SEGMENT INFORMATION

Our reportable segments are strategic business units that offer different products and services. Each segment is managed and reported separately based on the fundamental differences in their operations. Condensed consolidated information with respect to these reportable segments after giving effect to the discontinuance of the operations of Pan Asia Magnesium for the three and nine months ended June 30, 2011 and 2010 are as follows:

For the three months ended June 30, 2011 (unaudited):

(in thousands)	Magnesium			Basic Materials			Consulting		Discontinued Operations		Consolidated
Revenues	$	23,162		$	20,188		$	11,805	$	-	$	55,155
Revenues - related party		1,861			-			-		-		1,861
Total revenues	$	25,023		$	20,188		$	11,805	$	-	$	57,016
Interest (expense) income	$	(11	)	$	(112	)	$	4	$	-	$	(119	)
Net (loss) income	$	(334	)	$	81		$	4,457	$	-	$	4,204
Segment assets	$	67,834		$	25,059		$	37,480	$	247	$	130,620

For the nine months ended June 30, 2011 (unaudited):

(in thousands)	Magnesium			Basic Materials			Consulting		Discontinued Operations		Consolidated
Revenues	$	67,109		$	55,781		$	18,698	$	-	$	141,588
Revenues - related party		3,465			-			-		-		3,465
Total revenues	$	70,574		$	55,781		$	18,698	$	-	$	145,053
Interest (expense) income	$	(10	)	$	(206	)	$	30	$	-	$	(186	)
Net (loss) income	$	(1,227	)	$	501		$	8,080	$	-	$	7,354
Segment assets	$	67,834		$	25,059		$	37,480	$	247	$	130,620

For the three months ended June 30, 2010 (unaudited):

(in thousands)	Magnesium			Basic Materials			Consulting			Discontinued Operations		Consolidated
Revenues	$	12,364		$	16,942		$	682		$	-	$	29,988
Revenues - related party		1,957			-			-			-		1,957
Total revenues	$	14,321		$	16,942		$	682		$	-	$	31,945
Interest (expense) income	$	(2	)	$	(9	)	$	48		$	-	$	37
Net (loss) income	$	(389	)	$	(294	)	$	(401	)	$	-	$	(1,084	)
Segment assets	$	51,093		$	17,247		$	15,138		$	247	$	83,725

For the nine months ended June 30, 2010 (unaudited):

(in thousands)	Magnesium			Basic Materials			Consulting		Discontinued Operations		Consolidated
Revenues	$	25,854		$	42,693		$	2,475	$	-	$	71,022
Revenues - related party		6,546			-			-				6,546
Total revenues	$	32,400		$	42,693		$	2,475			$	77,568
Interest income (expense)	$	1		$	(91	)	$	131			$	41
Net (loss) income	$	(618	)	$	(322	)	$	528			$	(412	)
Segment assets	$	51,093		$	17,247		$	15,138	$	247	$	83,725

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

June 30, 2011

NOTE 14 - FOREIGN OPERATIONS

As of June 30, 2011 and 2010 the majority of our revenues and assets are associated with subsidiaries located in the PRC. Assets at June 30, 2011 and revenues for the three and nine months ended June 30, 2011 and 2010 were as follows (Unaudited):

For three months ended June 30, 2011(unaudited):

	For three months ended June 30, 2011
(in thousands)	United States		People’s Republic of China		Total
Revenues	$	14,098	$	41,057	$	55,155
Revenues – related party		-		1,861		1,861
Total revenues	$	14,098	$	42,918	$	57,016
Identifiable assets at June 30, 2011	$	47,898	$	82,722	$	130,620

For the nine months ended June 30, 2011(unaudited):

	For the nine months ended June 30, 2011
(in thousands)	United States		People’s Republic of China		Total
Revenues	$	23,052	$	118,536	$	141,588
Revenues – related party		-		3,465		3,465
Total revenues	$	23,052