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 December 31, 2009


[ ]	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. 27,627,878 shares of common stock were issued and outstanding as of February 9, 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.	29
	Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	45
	Item 4T.	Controls and Procedures.	45
PART II - OTHER INFORMATION
	Item 1.	Legal Proceedings.	46
	Item 1A.	Risk Factors.	46
	Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	46
	Item 3.	Defaults Upon Senior Securities.	46
	Item 4.	Submission of Matters to a Vote of Security Holders.	46
	Item 5.	Other Information.	46
	Item 6.	Exhibits.	46
	Signatures		49

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

	December 31, 2009			September 30, 2009
ASSETS	Unaudited
Current Assets:
Cash and cash equivalents	$	9,102,894		$	12,851,310
Investment in marketable securities available for sale		4,039,703			4,984,351
Investment in marketable securities available for sale - related party		585,034			604,686
Investment in subsidiaries -- cost method		290,864			290,864
Accounts receivable, net of allowance of $ 516,610 and $745,786 at December 31, 2009 and September 30, 2009, respectively		8,761,238			8,195,916
Accounts receivable - related parties		2,611,884			2,355,059
Inventories, net		5,605,654			5,806,722
Prepaid expenses and other current assets		8,878,990			5,092,205
Prepaid expenses - related parties		3,666,143			5,823,039
Loans receivable - related parties		1,309,069			1,094,142
Current Assets in discontinued operations (see Note 14)		51,345			51,345
Total current assets		44,902,818			47,149,639
Restricted cash		716,668			722,324
Property, plant and equipment, net		30,799,602			31,331,992
Prepaid expenses and other assets		2,494			1,836
Property use rights, net		1,101,779			1,113,902
Long-lived assets in discontinued operations (see Note 14)		196,078			196,077
Total assets	$	77,719,439		$	80,515,770

LIABILITIES AND EQUITY
Current Liabilities:
Loans payable-short term	$	1,806,295		$	1,521,002
Accounts payable and accrued expenses		8,871,035			7,708,730
Accounts payable-related parties		63,673			51,716
Advances from customers and deferred revenue		562,614			2,007,137
Other payables		2,014,973			3,072,238
Taxes payable		547,210			1,130,907
Loans payable - related parties		53,677			399,629
Current Liabilities of discontinued operations (see Note 14)		300,000			300,000
Total current liabilities		14,219,477			16,191,359
Loans payable-long term		-			-
Total liabilities		14,219,477			16,191,359

China Direct Industries, Inc. Stockholders' Equity
Preferred Stock: $.0001 par value, stated value $1,000 per share; 1,006 shares outstanding at December 31, 2009 and September 30, 2009, respectively.		1,006,250			1,006,250
Common Stock: $.0001 par value; 27,420,873 and 27,189,719 outstanding at December 31, 2009 and September 30, 2009, respectively.		2,742			2,719
Additional paid-in capital		57,923,743			57,492,755
Accumulated other comprehensive income		1,589,967			1,902,221
Accumulated deficit		(15,353,430	)		(14,328,732	)
Total China Direct Industries, Inc. stockholders' equity		45,169,272			46,075,213
Noncontrolling interests		18,330,690			18,249,198
Total Equity		63,499,962			64,324,411
Total liabilities and equity	$	77,719,439		$	80,515,770

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

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three Months ended December 31, 2009			Three months ended December 31, 2008
				Restated
Revenues	$	19,810,732		$	25,350,809
Revenues-related parties		2,441,797			13,605,642
Total revenues		22,252,529			38,956,451
Cost of revenues		20,428,311			40,022,618
Gross profit		1,824,218			(1,066,167	)

Operating expense:
Selling, general, and administrative		2,793,503			3,669,840
Operating loss		(969,285	)		(4,736,007	)

Other (expense) income:
Other (expense) income		(47,686	)		10,659
Interest expense		(1,001	)		(57,472	)
Realized gain (loss) on sale of marketable securities		34,691			(98,818	)
Realized loss on other than temporary impairment		-			(7,521,088	)
Realized gain on sale of subsidiaries		-			238,671
Total other expenses		(13,996	)		(7,428,048	)
Net loss from continuing operations before income taxes		(983,281	)		(12,164,055	)

Income tax benefits		110,373			107,891
Net loss from continuing operations, net of income taxed		(872,908	)		(12,056,164	)
Loss from discontinued operations		-			(916,244	)
Net loss	$	(872,908	)	$	(12,972,408	)
Net (income) loss attributable to noncontrolling interests -continuing operations		(111,608	)		2,375,357
Net loss attributable to noncontrolling interests -discontinued operations		-			448,961
Net loss attributable to China Direct Industries, Inc.	$	(984,516	)	$	(10,148,090	)

Deduct dividends on Series A Preferred Stock:
Preferred stock dividend		(40,183	)		(20,235	)
Net loss attributable to common stockholders	$	(1,024,699	)	$	(10,168,325	)

Basic and diluted loss per common share
Basic	$	(0.04	)	$	(0.43	)
Diluted	$	(0.04	)	$	(0.43	)
Basic weighted average common shares outstanding		27,381,946			23,494,180
Diluted weighted average common shares outstanding		27,381,946			23,494,180

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

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CHINA DIRECT INDUSTRIES INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF EQUITY

(Unaudited)

	Preferred Stock				Common Stock				Additional		Comprehensive			Retained			Non-controlling
	Shares		Amount		Shares		Amount		Paid-in Capital		Income			Earnings			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		-		-		12,204		1		40,183		-			(40,183	)		-		1
Stock sold		-		-		34,000		3		52,394		-			-			-		52,397
Restricted stock award - employees		-		-		22,200		2		125,201		-			-			-		125,203
Restricted stock award - consultants		-		-		-		-		16,668		-			-			-		16,668
Restricted stock award - Board of Directors		-		-		27,750		3		24,370		-			-			-		24,373
Stock option amortizated		-		-						18,288		-			-			-		18,288
Stock warrants exercised		-		-		135,000		14		153,883		-			-			-		153,897
Noncontrolling interests		-		-		-		-		-		-			-			81,492		81,492
Net loss for the quarter ended December 31, 2009		-		-		-		-		-		-			(984,516	)		-		(984,516	)
Foreign currency translation gain		-		-		-		-		-		(44,447	)		-			-		(44,447	)
Unrealized loss on marketable secutities AFS		-		-		-		-		-		(267,807	)		-			-		(267,807	)
Balance, December 31, 2009		1,006	$	1,006,250		27,420,873	$	2,742	$	57,923,743	$	1,589,967		$	(15,353,431	)	$	18,330,690	$	63,499,962

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

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	For the three months ended December 31,
	2009			2008
CASH FLOWS - OPERATING ACTIVITIES
Net loss	$	(872,908	)	$	(12,972,408	)
Loss from discontinued operations		-			916,244
Adjustments to reconcile net loss to net cash (used in) provided by operating activities:
Depreciation and amortization		520,458			287,058
Allowance for bad debt		(229,176	)		161,869
Stock based compensation		167,865			530,867
Realized (gain) loss on sale of investment in marketable securities		(34,379	)		98,818
Realized gain on sale of subsidiaries		-			(238,670	)
Realized loss on investment in marketable securities		-			7,521,088
Fair value of securities received for services and interest		-			(5,032,000	)
Fair value of securities paid for services		16,668			-
Changes in operating assets and liabilities:
Prepaid expenses and other assets		(3,942,998	)		8,914,613
Prepaid expenses - related parties		2,127,644			(254,108	)
Inventories		201,068			6,085,776
Accounts receivable		(336,146	)		8,399,078
Accounts receivable - related parties		(256,825	)		(925,772	)
Deferred compensation		155,556			-
Accounts payable and accrued expenses		1,162,305			(1,164,239	)
Accounts payable - related party		11,957			4,230,974
Advances from customers		(1,340,399	)		(5,007,483	)
Deferred revenue		(104,124	)
Other payables		(1,057,265	)		(2,167,703	)
Taxes payable		(583,697	)		(376,943	)
Net cash (used in) provided by continuing operations		(4,394,396	)		9,007,059
Net cash provided by discontinued operations - Wanda		-			511,448
Net cash provided by discontinued operations - Pan Asia		-			3,701,335
CASH (USED IN) PROVIDED BY OPERATING ACTIVITIES		(4,394,396	)		13,219,842

CASH FLOWS - INVESTING ACTIVITIES
Notes receivable		-			(942,713	)
Loans receivable		-			1,531,138
Loans receivable - related party		(214,927	)		1,731,808
Proceeds from the sale of marketable securities available for sale		705,420			79,064
Purchases of property, plant and equipment		-			(15,799,492	)
Net cash provided by (used in) investing activities - continuing operations		490,493			(13,400,195	)
Net cash used in investing activities - discontinued operations		-			(4,565,644	)
CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES		490,493			(17,965,839	)

CASH FLOWS - FINANCING ACTIVITIES
Restricted cash		5,656			(844,777	)
Loans payable		285,293			(3,168,317	)
Due from related parties		-			389,226
Due to related parties		(345,952	)		531,415
Gross proceeds from sale of common stock		52,397			-
Proceeds from exercise of warrants		153,897			-
Cash payment for reverse/forward stock split and stock repurchase		-			(395,043	)
Capital contribution from noncontrolling interest owners		-			1,485,544
Cash provided by (used in) financing activities - continuing operations		151,291			(2,001,952	)
Cash provided by financing activities - discontinued operations		-			1,182,536
CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES		151,291			(819,416	)

EFFECT OF EXCHANGE RATE ON CASH		4,196			133,780
Net decrease in cash		(3,748,416	)		(5,431,633	)
Cash and equivalents, beginning of period-continuing operations		12,851,310			19,097,265
Cash and equivalents, beginning of period-discontinued operations		-			539,597
Cash and equivalents, beginning of the period		12,851,310			19,636,862
Cash and equivalents, end of period		9,102,894			14,205,229
Less cash and equivalents of discontinued operations, end of period		-			205,044
Cash and equivalents of continuing operations, end of period	$	9,102,894		$	14,000,185
Supplemental disclosures of cash flow information:
Dividend payment in stock to preferred stockshareholders	$	40,183		$	80,925

The accompanying notes are an integral part of theses consolidated financial statements.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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”.

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 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 remaining 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) China Direct formed International Magnesium Group, as our 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 CDI Trading, as our wholly owned subsidiary to engage in the global purchases and sales of industrial commodities for us and our subsidiaries and client companies. CDI Trading focuses its efforts in North and South America, Russia, parts of Africa and the European Union. CDI Trading will seek to market products from China Direct and our various business units as well as market and procure products for its consulting clients. CDI Trading will also seek to leverage our 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 and our interest in CDI 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 as a wholly owned subsidiary of International Trading Group to engage in the trading of magnesium products.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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.

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

DECEMBER 31, 2009

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 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 reflect 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 2009 Transition Report on Form 10-K. These interim financial statements should be read in conjunction with our 2009 Transition Report on Form 10-K. 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 CDI Magnesium and the sale of an 81% interest in CDI Clean Technology.

Estimates

The preparation of financial statements in conformity with generally accepted accounting principles in the United States 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 for the periods reported include the investments held for sale, the allowance for doubtful accounts of accounts receivable, 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 the PRC, 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 the PRC, meaningful time horizons may change. We intend to enhance our focus on the evaluation of our customers' sustainability and adjust our estimates as may be indicated.

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

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

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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 December 31, 2009, bank deposits in the United States exceeded federally insured limits by $500,000. At December 31, 2009, we had deposits of $4,144,392 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 December 31, 2009.

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

Country	December 31, 2009				September 30, 2009
United States	$	4,958,502	54	%	$	8,625,782	67	%
China		4,144,392	46	%		4,225,528	33	%
Total Cash and cash equivalents	$	9,102,894	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 December 31, 2009 and September 30, 2009, allowances for doubtful accounts were $516,610 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 December 31, 2009 and September 30, 2009 were $5,605,654 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 December 31, 2009 and September 30, 2009.

Accounts Payable-Related Parties

At December 31, 2009 our consolidated balance sheet reflects accounts payable-related parties of $63,673. At September 30, 2009, our consolidated balance sheet reflects accounts payable-related parties 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.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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.

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 December 31, 2009 and September 30, 2009 consists of the following:

Company	December 31, 2009		% of total			September 30, 2009		% of total
China America Holdings, Inc.	$	540,201		12	%	$	540,200		10	%
China Logistics Group, Inc.		761,000		16	%		761,000		14	%
Dragon International Group Corp.		36,506		1	%		228,158		4	%
China Armco Metals, Inc.		2,515,835		54	%		3,116,993		55	%
Sunwin International Neutraceuticals, Inc.		186,161		4	%		338,000		6	%
Dragon Capital Group Corp.		585,034		13	%		604,686		11	%
Total Marketable securities held for sale	$	4,624,737		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 inter-dealer quotation (pink sheet) 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 $585,034 at December 31, 2009. 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.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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 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. Under the guidance we recognized the other-than-temporary impairment and charged the loss to the income in the three month period ended December 31, 2009.

The realized gain (loss) on investments in marketable securities available for sale in the three month periods ended December 31, 2009 and December 31, 2008 was $34,691and $(98,818), respectively. During the three months ended December 31, 2008 we also had an impairment loss of $7,521,088 related to our assessment of OTTI for securities available for sale under the guidance of ASC 325.

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 December 31, 2009 and September 30, 2009, our consolidated balance sheets include prepaid expenses and other current assets of $8,878,990 and $5,092,205, respectively.

Prepaid Expenses – Related Parties

Prepaid expenses-related parties were $3,666,143 and $5,823,039 at December 31, 2009 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 the prior periods presented, we determined that fair values were equivalent to the acquired historical carrying costs. We had no acquisitions during the three months ended December 31, 2009.

Advances from Customers and Deferred Revenue

Advances from customers and deferred revenue 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. At December 31, 2009 and September 30, 2009 advances from customers totaled $423,778 and $1,764,177, respectively, while deferred revenue totaled $138,836 and $242,960, respectively.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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 three months ended December 31, 2009 and 2008 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.

Foreign Currency Translation

The accompanying consolidated financial statements are presented in United States dollars. The functional currency of our Chinese subsidiaries is the Renminbi (“RMB”), the official currency of the PRC. 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 were translated at the average exchange rates for the three months ended December 31, 2009 and 2008. A summary of the conversion rates for the periods presented is as follows:

	December 31, 2009		September 30, 2009		December 31, 2008
Year end RMB: U.S. dollar exchange rate		6.8372		6.8376		6.8542
Average year-to-date RMB: U.S. dollar exchange rate		6.8360		6.8425		6.8532

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 three months ended December 31, 2009 and 2008.

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 have been initiated; the sale of the assets is probable and their transfer is expected to qualify for recognition as a completed sale within one year; the assets are being marketed at reasonable prices in relation to their fair value; and it is unlikely that significant changes will be made to the plan to sell the assets. We measure long-lived assets to be disposed of by sale at the lower of carrying amount or fair value, less cost to sell. 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.

Non-controlling 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.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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.

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.

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.

Stock-based Compensation

We account for the grant of stock options 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

EITF Issue No. 07-5 (ASC 815), "Determining Whether an Instrument (or embedded Feature) is Indexed to an Entity's Own Stock" (EITF 07-5) was issued in June 2008 to clarify how to determine whether certain instruments or features were indexed to an entity's own stock under EITF Issue No. 01-6 (ASC 815), "The Meaning of "Indexed to a Company's Own Stock" (EITF 01-6) (ASC 815),. EITF 07-5(ASC 815), applies to any freestanding financial instrument (or embedded feature) that has all of the characteristics of a derivative as defined in FAS 133, for purposes of determining whether that instrument (or embedded feature) qualifies for the first part of the paragraph 11(a) scope exception. It is also applicable to any freestanding financial instrument (e.g., gross physically settled warrants) that is potentially settled in an entity's own stock, regardless of whether it has all of the characteristics of a derivative as defined in FAS 133 (ASC 815), for purposes of determining whether to apply EITF 00-19 (ASC 815). EITF 07-5(ASC 815) does not apply to share-based payment awards within the scope of FAS 123(R), Share-Based Payment (FAS 123(R) (ASC 718). However, an equity-linked financial instrument issued to investors to establish a market-based measure of the fair value of employee stock options is not within the scope of FAS 123(R) and therefore is subject to EITF 07-5(ASC 815).

In January 2009, the FASB issued FSP EITF 99-20-1 (ASC 325), to amend the impairment guidance in EITF Issue No. 99-20 (ASC 325) in order to achieve more consistent determination of whether an other-than-temporary impairment (“OTTI”) has occurred. This FSP amended EITF 99-20 (ASC 325) to more closely align the OTTI guidance therein to the guidance in Statement No. 115 (ASC 320, 10-35-31). Retrospective application to a prior interim or annual period is prohibited. The guidance in this FSP was considered in the assessment of OTTI for various securities at December 31, 2008.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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 its annual report for the year ending September 30, 2010, we will be required to include a report of management on its 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, it is required to file the auditor’s attestation report separately on our internal control over financial reporting on whether it believes that we have maintained, in all material respects, effective internal control over financial reporting.

In June 2009, the FASB approved the “FASB Accounting Standards Codification” (the “Codification”) as the single source of authoritative nongovernmental U.S. GAAP to be launched on July 1, 2009. The Codification does not change current U.S. GAAP, but is intended to simplify user access to all authoritative U.S. GAAP by providing all the authoritative literature related to a particular topic in one place. All existing accounting standard documents will be superseded and all other accounting literature not included in the Codification will be considered non-authoritative. The Codification is effective for interim and annual periods ending after September 15, 2009.

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

DECEMBER 31, 2009

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.

NOTE 3 – EARNINGS PER SHARE

The following table sets forth the computation of basic and diluted earnings per share for the three months ended December 31, 2009 and 2008:

	Three Months Ended December 31,
	2009			Per Share			2008			Per Share
NUMERATOR:	Unaudited						Unaudited
Loss from continuing operations	$	(984,516	)	$	(0.04	)	$	(9,231,846	)	$	(0.39	)
Loss from discontinuing operations		-			-			(916,244	)		(0.04	)
Series A preferred stock:
Preferred stock dividend		(40,183	)		(0.00	)		(20,235	)		(0.00	)
Numerator for basic EPS, income applicable to common stockholders (A)	$	(1,024,699	)	$	(0.04	)	$	(10,168,325	)	$	(0.43	)
Plus: Income impact of assumed conversions
Preferred stock dividends-unconverted		-						-
Numerator for diluted EPS, income applicable to common stockholders plus assumed conversions (B)	$	(1,024,699	)	$	(0.04	)	$	(10,168,325	)	$	(0.43	)
DENOMINATOR(1):
Denominator for basic earnings per share-weighted average number of common shares outstanding ( C)		27,381,946						23,494,180
Stock awards, options, and warrants		-						-
Denominator for diluted earnings per share-adjusted weighted average outstanding average number of common shares outstanding (D)		27,381,946						23,494,180

Basic and Diluted Income per Common Share:
Earnings per share-basic (A)/( C)	$	(0.04	)				$	(0.43	)
Earnings per share-diluted (B)/(D)	$	(0.04	)				$	(0.43	)

(1)	The denominator in diluted earnings per share during the three months ended December 31, 2009 and 2008 does not include unvested restricted stock awards, stock options and warrants to purchase common stock, as such inclusion would be anti-dilutive.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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 months ended December 31, 2009 and 2008, respectively:

Description	Three months ended December, 31 2009			Three months ended December, 31 2008 (Restated)
	(unaudited)			(unaudited)
Net loss	$	(872,908	)	$	(12,972,408	)
Other comprehensive (loss) income
Unrealized (loss) gain on marketable securities held for sale		(267,807	)		1,277,458
Unrealized loss on marketable securities available for sale-related party		-			(55,292	)
Foreign currency translation loss		(44,447	)		(2,372,852	)
Total other comprehensive loss	$	(312,254	)	$	(1,150,686	)
Comprehensive loss	$	(1,185,162	)	$	(14,123,094	)
Comprehensive (loss) income attributable to the noncontrolling interests		(111,608	)		2,824,318
Comprehensive loss attributable to China Direct Industries, Inc.	$	(1,296,770	)	$	(11,298,776	)

NOTE 5 - INVENTORIES

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

	December 31, 2009		September 30, 2009
	(unaudited)
Raw materials	$	2,915,450	$	2,454,443
Finished goods		2,690,204		3,695,184
Inventory reserve		-		(342,905	)
Total Inventory	$	5,605,654	$	5,806,722

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

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

NOTE 6 - PREPAID EXPENSES AND OTHER CURRENT ASSETS

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

Description	December 31, 2009			September 30, 2009
	Unaudited
Prepayments to vendors for merchandise that had not yet been shipped or services that had not been performed	$	6,405,632		$	2,853,504
Other receivables		588,794			642,370
Loans receivable		1,767,000			1,435,000
Other		59,698			142,692
Security deposits		60,360			20,475
Total		8,881,484			5,094,041
Less: Current Portion		(8,878,990	)		(5,092,205	)
Prepaid expenses and other assets, non-current	$	2,494		$	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 magnesium alloy products per year, Golden Magnesium built its magnesium production plant on this land. The land use rights expire in 2057.

NOTE 7 - PROPERTY, PLANT AND EQUIPMENT

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

Property, Plant and Equipment
Description	Useful Life	December 31, 2009			September 30, 2009
		Unaudited
Building	10-40 years	$	10,935,713		$	10,727,622
Manufacturing equipment	10 year		14,796,749			14,849,040
Office equipment and furniture	3-5 year		420,944			403,570
Autos and trucks	5 year		984,817			911,964
Construction in progress	N/A		6,887,113			7,145,072
Total			34,025,336			34,037,268
Less: Accumulated Depreciation			(3,225,734	)		(2,705,276	)
Property, Plant and Equipment, Net		$	30,799,602		$	31,331,992

For the three months ended December 31, 2009 and 2008, depreciation expense totaled $520,458 and $287,058, respectively.

NOTE 8 - PROPERTY USE RIGHTS

Property use rights, consisting of mining and property use rights amounted to $1,101,779 and $1,113,902 at December 31, 2009 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 magnesium alloy 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 three months ended December 31, 2009 was $12,189.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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 December 31, 2009 are $496,401. 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.

NOTE 9 - LOANS PAYABLE

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


Description	December 31, 2009			September 30, 2009
	Unaudited
Loan from Mingsheng Bank, due May 26, 2010. 6.37% annual interest rate. Secured by pledge of Lang Chemical's assets.	$	497,280		$	497,252

Loan from Industrial & Commercial Bank, due July 21, 2010. 5.58% annual interest rate. Guaranteed by the personal real estate of Zhu Qian and Chen JingDong.		329,082			336,375

Loan from Industrial & Commercial Bank, due March 21, 2010. 5.31% annual interest rate. Guaranteed by the personal real estate of ZhuQian and Chen Jingdong.		394,899			394,875

Loan from Bank of Shanghai, due January 14, 2010. 5.84% annual interest rate. Guaranteed by China Investment Guarantor Co. Ltd.		292,517			292,500

Note from Mingsheng Bank due May 24, 2010. 0.1% annual interest rate. Secured by restricted cash of Lang Chemical equal to 40% of the principal amount of the note.		219,388			-

Note from Mingsheng Bank due May 24, 2010. 0.1% annual interest rate. Secured by restricted cash of Lang Chemical equal to 40% of the principal amount of the note.		73,129			-

Total		1,806,295			1,521,002
Less: Current Portion		(1,806,295	)		(1,521,002	)

Loans payable, long-term	$	-		$	-

The $292,517 loan from Bank of Shanghai was repaid in January 19, 2010.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

NOTE 10 - RELATED PARTY TRANSACTIONS

We have specified the following persons and entities as related parties with ending balances as of December 31, 2009 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;
	•		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;
	•		Beijing Jiaozhuang Hotel, a company organized under the laws of the PRC (“Jiaozhuang Hotel”), is legally represented by an officer of CDI Beijing.

Accounts Receivable – related parties

At December 31, 2009 we reported accounts receivable – related parties of $2,611,884 comprised of the following:

	•		$1,218,752 due Baotou Changxin Magnesium from YiWei Magnesium, for inventory provided;
	•		$1,337,716 due Golden Magnesium from YiWei Magnesium for inventory provided;
	•		$52,424 due Chang Magnesium from Pine Capital for inventory provided; and
	•		$2,992 due Chang Magnesium from Wheaton for inventory provided

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.

Prepaid Expenses – related parties

At December 31, 2009 we reported prepaid expenses – related parties of $3,666,143 comprised of the following:

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

	•		$2,177,840 prepaid by Chang Magnesium to YiWei Magnesium for future delivery of inventory;
	•		$10,013 prepaid by Baotou Changxin Magnesium to YiWei Magnesium for future delivery of inventory;
	•		$686,307 prepaid by Chang Magnesium to Yihong Magnesium for future delivery of inventory;
	•		$7,445 prepaid by Chang Magnesium to Xinghai Magnesium for future delivery of inventory;
	•		$73,138 prepaid by Chang Magnesium to Haixu Magnesium for future delivery of inventory; and
	•		$711,400 prepaid by IMTC to YiWei Magnesium for future delivery of inventory.

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 December 31, 2009 we reported loan receivables – related parties of $1,309,069 comprised of the following:

	•		$1,162,810 due Lang Chemical from NanTong Chemical for funds advanced for working capital purposes; and
	•		$146,259 due Baotou Changxi 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 December 31, 2009 we reported accounts payable – related party of $63,673 comprised of the following:

	•		$14,827 due from Baotou Changxin Magnesium to Haixu Magnesium in repayment of an advance from customer for the future delivery of inventory;
	•		$35,112 due from Baotou Changxin Magnesium to Yihong Magnesium in repayment of an advance from customer for the future delivery of inventory;
	•		$1,463 due from Golden Magnesium to Haixu Magnesium in repayment of an advance from customer for the future delivery of inventory; and
	•		$12,271 due from Golden Magnesium to Senrun Coal in repayment of an advance from customer for the future delivery of inventory.

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 in repayment of an advance from customer for the future delivery of inventory;
	•		$14,826 due from Baotou Changxin Magnesium to Haixu Magnesium in repayment of an advance from customer for the future delivery of inventory; and
	•		$1,463 due from Golden Magnesium to Haixu Magnesium in repayment of an advance from customer for the future delivery of inventory.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

Due to related parties

At December 31, 2009 we reported due to related parties balance of $53,677 comprised of the following:

•

$53,677 advanced by Jiaozhuang Hotel to CDI Beijing for working capital purposes.

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 Jiaozhuang Hotel to CDI Beijing for working capital purposes.

NOTE 11 - STOCKHOLDERS’ EQUITY

Preferred Stock

We have 10,000,000 shares of preferred stock, par value $.0001, authorized, of which we designated 12,950 as our Series A Convertible Preferred Stock in February 2008. At December 31, 2009 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.

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 December 31, 2009, holders of our Series A Preferred Stock have converted 11,944 shares of the 12,950 shares of the Series A Preferred Stock. Each share of Series A Preferred stock was convertible into 142.8541 shares of common stock. As a result of the conversion of the Series A Preferred Stock, we have issued 1,706,250 shares of our common stock, 70,846 shares of common stock in payment of the accrued dividends, and 136,503 shares of common stock, the Make Whole Additional Amount.

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

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

In addition, under the provisions of ASC 470, “Debt”, the Series A Preferred Stock issuance carried an embedded beneficial conversion feature at issuance. Accordingly, after first allocating the proceeds received from the Series A Preferred Stock offering to the preferred shares and detachable warrants on a relative fair value basis, we derived an intrinsic value of the conversion feature of $2,451,446.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

As the Series A Preferred Stock does not have a stated redemption date or finite life, the deemed dividend was recognized immediately as a non-cash charge during fiscal 2008. This non-cash one-time preferred stock deemed dividend was calculated as the difference between the average of our common stock price of $6.83 per share and the calculated effective conversion price of the Series A Preferred Stock. The effective conversion price of the Series A Preferred Stock was determined with reference to the relative fair value allocation of proceeds between the Series A Preferred Stock and Warrants issued. The non-cash deemed dividend did not have an effect on net earnings, or cash flows for the three months ended December 31, 2009. The estimated fair market value of the Warrants of $2,765,946 has been recorded as additional paid-in capital and a reduction to the recorded amount of the Series A Preferred Stock.

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

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

Common Stock

We have 1,000,000,000 shares of common stock, par value $.0001, authorized. At December 31, 2009 there were 27,420,873 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 three months ended December 31, 2009 and 2008, amortization of stock-based compensation amounted to $167,865 and $530,867, respectively.

During the three months ended December 31, 2009, we did not issue any shares of common stock in connection with the exercise of common stock options.

During the three months ended December 31, 2009 we issued 135,000 shares of common stock in connection with the exercise of common stock purchase warrants at a price of $1.14 per share for a total consideration of $153,897.

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

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 will pay 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.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

The Agreement may be terminated by either party at any time except with respect to any pending sale by Rodman & Renshaw for us. As of December 31, 2009, we sold 34,000 shares and received net proceeds in the amount of $52,397 under the Agreement.

Stock Repurchase Program

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

Reverse Split/Forward Split

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

Stock Incentive Plans

On August 16, 2006, our board of directors authorized the 2006 Equity Plan (the “2006 Equity Plan”) covering 10,000,000 shares of our common stock, which was approved by a majority of our shareholders on August 16, 2006. At December 31, 2009 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 December 31, 2009 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.

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 December 31, 2009 no awards had been granted under this plan.

On April 25, 2008, our board of directors adopted the 2008 Non-Executive Stock Incentive Plan covering 3,000,000 shares of our common stock, which was approved by a majority vote of our shareholders on May 30, 2008. As of December 31, 2009 we granted 1,100,771 shares of restricted stock with vesting dates ranging from May 2008 to August 2011.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

Stock Option Plans

The following table sets forth our stock option activity during the three months ended December 31, 2009:

Description	Shares underlying options			Weighted average exercise price
		Unaudited			Unaudited
Outstanding at September 30, 2009		3,655,670		$	10.83
Granted		-			-
Cancelled		(40,000	)		3.75
Adjusted(1)		(288,750	)		1.14
Outstanding at December 31, 2009		3,326,920		$	11.76
Exercisable at December 31, 2009		3,326,920		$	11.76

(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.

The weighted average remaining contractual life and weighted average exercise price of options outstanding at December 31, 2009, for selected exercise price ranges, are as follows:

Exercise price		Number of options outstanding		Weighted average remaining contractual life (Years)		Weighted average exercise price		Options Exercisable		Weighted average exercise price of options exercisable
$	2.25		400		4.81	$	2.25		400	$	2.25
$	2.50		472,940		1.14	$	2.50		472,940	$	2.50
$	3.00		25,000		1.04	$	3.00		25,000	$	3.00
$	5.00		806,000		2.15	$	5.00		806,000	$	5.00
$	7.50		637,000		3.00	$	7.50		637,000	$	7.50
$	10.00		625,000		4.01	$	10.00		625,000	$	10.00
$	15.00		500		3.44	$	15.00		500	$	15.00
$	30.00		760,000		3.07	$	30.00		760,000	$	30.00
$	56.25		80		4.92	$	56.25		80	$	56.25
			3,326,920		2.76	$	11.76		3,326,920	$	11.76

During the three months ended December 31, 2009, no options were exercised. The aggregate intrinsic value of our outstanding and exercisable options at December 31, 2009 and September 30, 2009 was $3,326,920 and $3,366,920, respectively.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

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.

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 shares to purchase 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 December 31, 2009 and changes during the period is as follows:

	Shares underlying warrants (unaudited)			Weighted average exercise price (unaudited)
Outstanding at September 30, 2009		5,834,664		$	8.34
Adjustment (1)		75,000			5.00
Exercised		(135,000	)		1.14
Outstanding at December 31, 2009		5,774,664			6.93
Exercisable at December 31, 2009		5,774,664		$	6.93

(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 transition period ended September 30, 2009.

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

The following information applies to all warrants outstanding at December 31, 2009.

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
$	1.85		372,500		2.25	$	1.41		372,500	$	1.85
$	2.31		1,351,352		4.96	$	2.31		1,351,352	$	2.31
$	2.50		50,000		1.92	$	2.50		50,000	$	2.50
$	1.14		50,000		1.67	$	1.14		50,000	$	4.00
$	8.00		1,966,250		3.03	$	7.98		1,966,250	$	8.00
$	10.00		1,894,562		1.69	$	10.01		1,894,562	$	10.00
$	15.00		90,000		0.38	$	15.00		90,000	$	11.00
			5,774,664		2.93	$	6.93		5,774,664	$	6.93

NOTE 12 - SEGMENT INFORMATION

The following information is presented in accordance with ASC 280, “Segment Reporting, “Disclosure about segments of an Enterprise and Related Information”. For the three months ended December 31, 2009, we operated in three reportable business segments as follows:

Magnesium segment:

	•		Chang Magnesium;
	•		Chang Trading;
	•		Excel Rise;
	•		Asia Magnesium;
	•		Golden Magnesium;
	•		Baotou Changxin Magnesium;
	•		International Magnesium Trading Corp.; and
	•		International Magnesium Group, Inc.

Basic Materials segment:

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

Consulting segment:

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

Our reportable segments are strategic business units that offer different products and services. Each segment is managed and reported separately based on the fundamental differences in their operations. CDI Metal Recycling was formerly in our Clean Technology Segment, which we exited in fiscal 2008. Condensed unaudited consolidated information with respect to these reportable segments after giving effect to our decision to exit the clean technology segment and Pan Asia Magnesium for the three months ended December 31, 2009 and December 31, 2008 are as follows:

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009

For the three months ended December 31, 2009 (unaudited):

(in thousands)	Magnesium		Basic Materials			Consulting			Discontinued Operations	Consolidated
Revenues	$	5,852	$	13,391		$	568		-	$	19,811
Revenues - related party		2,442		-			-		-		2,442
Total revenue		8,294		13,391			568		-		22,253
Interest income (expense)		1		(42	)		40		-		(1	)
Net income (loss)		39		70			(982	)	-		(873	)
Segment assets	$	47,109	$	15,741		$	14,622		247	$	77,719

For the three months ended December 31, 2008 (unaudited):

(in thousands)	Magnesium			Basic Materials			Consulting			Discontinued Operations	Consolidated
Revenues	$	9,245		$	14,265		$	1,840		-	$	25,350
Revenues - related party		13,606			-			-		-		13,606
Total revenue		22,851			14,265			1,840		-		38,956
Interest income (expense)		115			(12	)		(160	)	-		(57	)
Net (loss) income		(5,394	)		227			(6,889	)	-		(12,056	)
Segment assets	$	55,888		$	13,040		$	20,863		17,588	$	107,379

The discontinued operations column in the tables above include our investment in Pan Asia Magnesium and CDI Magnesium which are displayed as a reconciliation item. See Note 14 – Discontinued Operations. We also reclassified our investments from our Consulting segment to the Magnesium and Basic Material segments and the amounts of inter-company receivables from the prior periods to conform to the current period presentation, with no net impact on our total consolidated assets.

NOTE 13 - FOREIGN OPERATIONS

As of December 31, 2009 the majority of our revenues and assets are associated with subsidiaries located in the PRC. Assets at December 31, 2009 and 2008, as well as revenues for the three months ended December 31, 2009 and 2008 were as follows:

	For the three months ended December 31, 2009 (Unaudited)
(in thousands)	United States		People’s Republic of China		Total
Revenues	$	328	$	19,483	$	19,811
Revenues – related party				2,442		2,442
Total Revenue		328		21,925		22,253
Identifiable assets at December 31, 2009	$	12,866	$	64,853	$	77,719

	For the three months ended December 31, 2008 (Unaudited)
(in thousands)	United States		People’s Republic of China		Total
Revenues	$	1,786	$	23,564	$	25,350
Revenues – related party				13,606		13,606
Total Revenue		1,786		37,170		38,956
Identifiable assets at December 31, 2008	$	17,715	$	89,664	$	107,379

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CHINA DIRECT INDUSTRIES, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

DECEMBER 31, 2009