10QSB 1 form10qsb063006.txt UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-QSB (Mark One) [X] QUARTERLY REPORT UNDER SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended: June 30, 2006 ------------------------------------------- [ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE EXCHANGE ACT For the transition period from ______ to ______ Commission file number 000-28831 -------------------------------------------------------------- China Direct Trading Corporation -------------------------------- --------------------------------- (Exact name of small business issuer as specified in its charter) Florida 84-1047159 -------------------------------------------------------------------------------- (State or other jurisdiction (IRS Employer of incorporation or organization) Identification No.) 10400 Griffin Road, Suite 109, Cooper City, Florida 33328 (Address of principal executive offices) (954) 252-3440 Issuer's telephone number (Former name, former address and former fiscal year, if changed since last report.) APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDING DURING THE PRECEDING FIVE YEARS Check whether the registrant filed all documents and reports required to be filed by Section 12, 13 or 15(d) of the Exchange Act after the distribution of securities under a plan confirmed by a court. Yes ----- No ----- Indicate by check mark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act). Yes [ ] No [X ] APPLICABLE ONLY TO CORPORATE ISSUERS State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date: June 30, 2006 Approximately 543,122,028 shares Transitional Small Business Disclosure Format (check one). Yes ; No X ---- ----- PART I ITEM 1. FINANCIAL STATEMENTS CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS
(Unaudited) June 30, December 31, 2006 2005 ------------------ ------------------ Assets: Current assets: Cash $ 873,211 $ 9,090 Accounts receivable - net 3,856,521 4,000 Advances 1,200 - Inventory 659,325 11,760 Prepaid expense 49,134 - ------------------ ------------------ Total Current Assets 5,439,391 24,850 ------------------ ------------------ Fixed assets: Communications equipment 12,941 - Computer equipment 29,898 4,965 Computer software 6,724 - Transportation equipment 365,303 - Machinery and equipment 103,296 - Furniture and fixtures 43,945 - Leasehold improvements 19,413 - Less: Accumulated Depreciation (93,506) (2,132) ------------------ ------------------ Total Fixed Assets 488,014 2,833 ------------------ ------------------ Other non-current assets: Deposits 89,610 1,775 Goodwill 1,567,214 - ------------------ ------------------ Total other non-current assets 1,656,824 1,775 ------------------ ------------------ Total assets $ 7,584,229 $ 29,458 ================== ==================
CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (Continued)
(Unaudited) June 30, December 31, 2006 2005 ------------------ ------------------ Liabilities and Stockholders' Deficit: Current Liabilities: Accounts payable, trade $ 763,584 $ 35,666 Accrued expenses 549,161 496,783 Customer deposits 1,970,544 24,891 Notes payable - current maturities 80,535 - Related party payables 26,011 16,011 ------------------ ------------------ Total Current Liabilities 3,389,835 573,351 ------------------ ------------------ Long-Term Liabilities: Notes payable - less current maturities 284,296 - Stockholder loans payable 747,500 - Investor loans payable 710,100 - ------------------ ------------------ Total Long-Term Liabilities 1,741,896 - ------------------ ------------------ Total Liabilities 5,131,731 573,351 ------------------ ------------------ Minority Interest 741,788 - ------------------ ------------------ Stockholders' Deficit: Preferred Stock, par value $.001 per share Authorized 100,000,000 shares, Issued 1,265,000 shares at June 30, 2006 and 8,000 shares at December 31, 2005 1,265 8 Common Stock, par value $.0001 per share Authorized 600,000,000 shares, Issued 543,122,028 Shares at June 30, 2006 and December 31, 2005 54,313 54,313 Additional paid-in capital 2,668,408 832,665 Accumulated deficit (1,013,276) (1,430,879) ------------------ ------------------ Total Stockholders' Deficit 1,710,710 (543,893) ------------------ ------------------ Total Liabilities and Stockholders' Deficit $ 7,584,229 $ 29,458 ================== ==================
See accompanying notes. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited) (Unaudited) For the Three Months For the Six Months Ended June 30, Ended June 30, ------------------------------------- ------------------------------------- 2006 2005 2006 2005 ------------------ ----------------- ----------------- ------------------ Revenues $ 3,969,957 $ 261,016 $ 6,481,766 $ 465,370 Cost of Sales (2,160,684) (155,101) (4,043,229) (327,376) ------------------ ----------------- ----------------- ------------------ Gross Profit 1,809,273 105,915 2,438,537 137,994 ------------------ ----------------- ----------------- ------------------ Operating Expenses: Sales and marketing 81,773 4,353 173,559 6,126 Compensation 738,923 50,000 896,340 100,000 Professional fees 34,039 36,282 65,907 49,095 Other General and administrative 203,884 33,388 362,968 85,909 ------------------ ----------------- ----------------- ------------------ Total Operating Expenses 1,058,619 124,023 1,498,774 241,130 ------------------ ----------------- ----------------- ------------------ Net Operating Income (Loss) 750,654 (18,108) 939,763 (103,136) Other Income (Expense): Interest income 2,150 11 2,150 11 Interest expense (26,715) - (41,724) (740) ------------------ ----------------- ----------------- ------------------ Net Income (Loss) before minority interest 726,089 (18,097) 900,189 (103,865) Minority interest (351,204) - (482,586) - ------------------ ----------------- ----------------- ------------------ Net Income (Loss) $ 374,885 $ (18,097) $ 417,603 $ (103,865) ================== ================= ================= ================== Weighted Average Shares Outstanding 543,122,028 517,232,972 543,122,028 516,348,305 ================== ================= ================= ================== Income (Loss) per Common Share $ - $ - $ - $ - ================== ================= ================= ==================
See accompanying notes. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited) For the Six Months Ended June 30, ------------------------------------- 2006 2005 ----------------- ------------------ CASH FLOWS FROM OPERATING ACTIVITIES: Continuing operations: Net Income (Loss) $ 417,603 $ (103,865) Adjustments necessary to reconcile net loss to net cash used in operating activities: Stock issued for accrued compensation - 200,000 Stock issued for expenses - 9,000 Depreciation 62,454 448 Minority interest in income 482,586 - (Increase) decrease in advances (1,200) 3,061 (Increase) decrease in accounts receivable (3,142,771) - (Increase) decrease in inventory (440,317) - (Increase) decrease in prepaids (49,134) - (Increase) decrease in deposits (69,710) - Increase (decrease) in accounts payable 705,138 (1,171) Increase (decrease) in accrued expenses 36,367 (108,079) Increase (decrease) in deposits from customers 1,618,886 - ----------------- ------------------ Net Cash Used in continuing operations (380,098) (606) ----------------- ------------------ CASH FLOWS FROM INVESTING ACTIVITIES: Purchase of fixed assets (188,098) - ----------------- ------------------ Net cash provided by (used) investing activities (188,098) - ----------------- ------------------ CASH FLOWS FROM FINANCING ACTIVITIES: Cash acquired in acquisition 82,373 - Loan proceeds 66,011 - Note payments (21,151) - Stockholder loan proceeds 750,000 - Investor loan proceeds 720,100 - Shareholder loan repayments (165,016) - ----------------- ------------------ Net Cash Provided by Financing Activities 1,432,317 - ----------------- ------------------ Net (Decrease) Increase in Cash and Cash Equivalents 864,121 (606) Cash and Cash Equivalents at Beginning of Period 9,090 77,503 ----------------- ------------------ Cash and Cash Equivalents at End of Period $ 873,211 $ 76,897 ================= ==================
CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Unaudited) For the Six Months Ended June 30, --------------------------------------- 2006 2005 ------------------- ------------------- SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid during the period for: Interest $ 41,724 $ 740 Franchise and income taxes $ - $ -
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES: On January 27, 2006, the Company entered into a Purchase Agreement (the "Purchase Agreement") with Complete Power Solutions ("CPS") pursuant to which the Company acquired 51% of the member interests of CPS for a purchase price consisting of the payment of $637,000 in cash and the delivery of 600,000 shares of Company's Series A Convertible Preferred Stock (the "Series A Preferred Stock") having a stated value of $1,200,000. See accompanying notes. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES This summary of accounting policies for China Direct Trading Corporation and Subsidiaries is presented to assist in understanding the Company's financial statements. The accounting policies conform to generally accepted accounting principles and have been consistently applied in the preparation of the financial statements. Interim Reporting The unaudited financial statements as of June 30, 2006 and for the six month periods ended June 30, 2006 and 2005 reflect, in the opinion of management, all adjustments (which include only normal recurring adjustments) necessary to fairly state the financial position and results of operations for the six months. Operating results for interim periods are not necessarily indicative of the results which can be expected for full years. Organization and Basis of Presentation China Direct Trading Corporation (formerly "CBQ, Inc."), a Florida corporation, was initially incorporated September 18, 1986 under the laws of the State of Delaware under the name "Yorkshire Leveraged Group, Incorporated", and then changed its situs to Colorado in 1989 by merging into a Colorado corporation, named "Freedom Funding, Inc.". Freedom Funding, Inc. then changed its name to "CBQ, Inc." by amendment of its Articles of Incorporation on November 25, 1998. In May 2004, the Company changed its name to China Direct Trading Corporation and reincorporated from the State of Colorado to the State of Florida. Souvenir Direct, Inc. was incorporated on September 9, 2002 under the laws of the State of Florida. On December 1, 2003, China Direct Trading Corporation acquired 100% of the outstanding common stock of Souvenir Direct, Inc. in a reverse acquisition. At this time, a new reporting entity was created. Souvenir Direct, Inc. is considered the reporting entity for financial reporting purposes. On January 27, 2006, the Company entered into a Purchase Agreement with Complete Power Solutions ("CPS") to acquire 51% of the member interests of CPS. CPS was organized by William Dato on September 20, 2004, as a Florida limited liability company to distribute power generators in Florida and adjacent states. CPS currently distributes Guardian-brand commercial and residential power generators. CPS sells to Home Depot and Lowe's retail stores and local electrical contractors in Florida. Nature of Business The Company is engaged in the business of marketing and selling novelty, gift, and promotional items in North America. The items are typically manufactured in the People's Republic of China by third-party manufacturing companies. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) On January 27, 2006, the Company entered into a Purchase Agreement with Complete Power Solutions ("CPS") to acquire 51% of the member interests of CPS. CPS currently distributes Guardian-brand commercial and residential power generators. CPS sells to Home Depot and Lowe's retail stores and local electrical contractors in Florida. Cash and Cash Equivalents For purposes of the statement of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents to the extent the funds are not being held for investment purposes. Inventory The Company's inventory consists of its power generators, electrical transfer switches, propane tanks, concrete slabs and electrical, plumbing and gas hardware and supplies. Inventory is recorded at cost. Fixed Assets Fixed assets are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated economic useful lives of the related assets as follows: Communications equipment 3 - 7 years Computer equipment 3 - 7 years Computer software 3 - 7 years Transportation equipment 3 - 7 years Machinery and equipment 3 - 7 years Furniture and fixtures 3 - 7 years Leasehold improvements Term of lease Upon sale or other disposition of property and equipment, the cost and related accumulated depreciation or amortization are removed from the accounts and any gain or loss is included in the determination of income or loss. Expenditures for maintenance and repairs are charged to expense as incurred. Major overhauls and betterments are capitalized and depreciated over their estimated economic useful lives. Depreciation expense was $62,454 and $448 for the six months ended June 30, 2006 and 2005, respectively. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Pervasiveness of Estimates The preparation of financial statements in conformity with generally accepted accounting principles required 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 revenues and expenses during the reporting period. Actual results could differ from those estimates. Principles of Consolidation The consolidated financial statements for the six months ended June 30, 2006 and 2005 include the accounts of the parent entity and its wholly-owned subsidiaries Souvenir Direct, Inc. and Overseas Building Supplies, LLC (formerly China Pathfinder Fund, LLC), and its majority owned subsidiary Complete Power Solutions. The results of subsidiaries acquired or sold during the year are consolidated from their effective dates of acquisition through their effective dates of disposition. All significant intercompany balances and transactions have been eliminated. Net Income (Loss) Per Common Share Basic earnings per common share were computed by dividing net loss by the weighted average number of shares of common stock outstanding during the year. Diluted loss per common share for the six months ended June 30, 2006 and 2005 are not presented as it would be anti-dilutive. Concentration of Credit Risk The Company has no significant off-balance-sheet concentrations of credit risk such as foreign exchange contracts, options contracts or other foreign hedging arrangements. Reclassifications Certain reclassifications have been made in the 2005 financial statements to conform with the 2006 presentation. Major Suppliers The Company's major suppliers are from the People's Republic of China and to a lesser extent a variety of Pacific Rim countries. The Company relies on 30 manufacturing concerns in China for its products. The loss of these Chinese manufacturing sources would adversely impact on the business of the Company. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 1 - ORGANIZATION AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (continued) Major Customers At June 30, 2006, Souvenir Direct receives approximately 40% of its gross revenues from its top three accounts. The loss of these customers would adversely impact the business of the Company. Revenue Recognition Sales of merchandise are recorded when goods are shipped, and profit is recognized at that time. Allowances for sales returns, rebates and discounts are recorded as a component on net sales in the period the allowances are recognized. Revenues and related costs for sales and installation of power generators is recognized as the work progresses. Advertising Advertising costs are expensed as incurred. Income Taxes The Company accounts for income taxes under the provisions of SFAS No. 109, "Accounting for Income Taxes." SFAS No.109 requires recognition of deferred income tax assets and liabilities for the expected future income tax consequences, based on enacted tax laws, of temporary differences between the financial reporting and tax bases of assets and liabilities. NOTE 2 - LEASES On September 1, 2005, the Company entered into a lease agreement for approximately 1,200 square feet of office space. The lease requires monthly lease payments of $1,775. The lease expires August 31, 2006. The office space is used as the corporate headquarters. It is located at 10400 Griffin Road, Suite 109, Cooper City, Florida 33328. The Company also rents a storage facility on a month-to-month basis. Monthly rentals for the storage facility are approximately $150. Rental expense under these leases was approximately $11,750 and $7,500 for the six months ended June 30, 2006 and 2005, respectively. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 2 - LEASES (continued) The minimum future lease payments under these leases for the next five years are: Year Ended December 31, -------------------------------------------- 2006 $ 14,200 2007 - 2008 - 2009 - 2010 - --------------- Total minimum future lease payments $ 14,200 =============== The company's majority owned subsidiary, Complete Power Solutions, Inc. entered into a lease agreement April 1, 2006 for its current office space and warehouse facility. The lease requires monthly payments of $7,108. The lease expires March 31, 2009 with an option to extend the lease for three additional years. The facility is located at 1288 S. W. 29th Avenue, Pompasno Beach, Florida 33069. Rental expense under this lease and the previous lease for office and warehouse space which was terminated when the current lease became effective, was approximately $50,558 for the six months ended June 30, 2006. The minimum future lease payments under this lease for the next five years are: Year Ended June 30, -------------------------------------------- 2007 $ 80,818 2008 89,595 2009 69,192 2010 - 2011 - --------------- Total minimum future lease payments $ 239,605 =============== NOTE 3 - COMMITMENTS On December 1, 2003, the Company entered into an employment agreement with Howard Ullman, the Company's President and CEO that provides for annual compensation of $200,000. On January 27, 2006, the Company entered into an employment agreement with William Dato, the President of Complete Power Solutions, the Company's majority-owned subsidiary that provides for annual compensation of $100,000. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4 - STOCK TRANSACTIONS Common Stock On September 9, 2002, the Company issued 100 shares of common stock for $2,774 of start-up expenses. On December 1, 2003, the Company issued 97,000,000 shares of common stock to acquire Souvenir Direct, Inc. in a reverse acquisition. The 100 shares that were previously issued were retroactively adjusted to reflect the equivalent number of shares that were issued in connection with the reverse acquisition. The acquisition was recorded by a credit to common stock of $9,600 and a debit to paid-in capital of $2,674 and a debit to retained earnings of $6,926. Also on December 1, 2003, an additional 414,628,300 shares of common stock were issued to the previous owners of CBQ, Inc. All references to stock reflect the retroactive adjustment to the shares. In January 2005, the Company issued 500,000 shares of common stock to settle a lawsuit. The value of settlement was $28,000. In April 2005, the Company issued 6,940,030 shares of common stock for services valued at $200,000. In May 2005, the Company issued 100,000 shares of common stock for services valued at $3,000. In June 2005, the Company issued 9,523,810 shares of common stock for accrued compensation of $200,000. In June 2005, 6,896,552 shares of common stock were returned to the treasury and cancelled. In October 2005, the Company issued 6,250,000 shares of common stock for accrued compensation of $100,000. In November 2005, the Company issued 588,718 shares of common stock for legal services valued at $12,500. In November 2005, the Company issued 1,140,000 shares of common stock for legal services valued at $28,500. In December 2005, the Company issued 2,300,000 shares of common stock for services valued at $40,000. In December 2005, the Company issued 5,555,555 shares of common stock for accrued compensation of $100,000. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 4 - STOCK TRANSACTIONS (continued) In December 2005, the Company issued 1,666,667 shares of common stock for cash of $30,000. Preferred Stock In February 2004, the Company sold 1,000 shares of preferred stock for cash of $5,000. In June 2004, the Company issued 7,100 shares of preferred stock for services valued at $128. In May 2005, 100 shares of preferred stock were returned to the treasury and cancelled. The preferred shares are convertible into common shares. In January 2006, the Company issued 657,000 shares of preferred stock in exchange for cash of $637,000. In January 2006, the Company issued 600,000 shares of preferred stock valued at $2 per share as part of the acquisition of Complete Power Solutions. Warrants The Company has issued stock warrants to its officers and directors for a total of 5,975,000 shares of the Company's common stock. The warrants expire between November 11, 2011 and July 20, 2014. The warrants have an exercise price of $.03 to $.05. The Company issued a stock warrant to each of two former officers of the Company in December 2003 for a total of 35,000 shares of the Company's common stock. Each of the stock warrants expires on July 20, 2014,and entitles each former officer to purchase 10,000 and 25,000 shares, respectively, of the Company's common stock at an exercise price of $0.05. The Company issued a stock warrant for 50,000,000 shares of common stock to Dutchess Private Equities Fund, II, L.P. ("Dutchess"), as part of an investment agreement between Dutchess and the Company. As part of the agreement, Dutchess was to invest up to $2,500,000 to purchase the Company's common stock. The warrant was to expire August 3, 2014. On February 16, 2005, the Company and Dutchess agreed to postpone the implementation of the foregoing financing arrangement. As of the date of this Report, the Company and Dutchess have agreed not to proceed with this financing arrangement and the aforementioned warrant has been cancelled. NOTE 5 - RELATED PARTY PAYABLES On September 1, 2004, China Pathfinder Fund, LLC., a wholly-owned subsidiary of the Company received loans of $15,000 from shareholders of the Company. The loans carry an interest rate of 5% per annum and are payable in twelve equal monthly installments with the first installment due and payable on January 31, 2006. At June 30, 2006, the total amount due on these loans was $16,011. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 5 - RELATED PARTY PAYABLES (continued) During 2003 and 2004, a former officer of the Company paid $300,000 to settle a previously filed lawsuit on behalf of the Company. This $300,000 has been included in accrued liabilities at June 30, 2006 and December 31, 2005. During the six months ended June 30, 2006, the Company and its subsidiaries have received loans from stockholders totaling $747,500 and other loans from investors totaling $710,100. NOTE 6 - INCOME TAXES As of December 31, 2005, the Company had a net operating loss carryforward for income tax reporting purposes of approximately $1,038,000 that may be offset against future taxable income through 2025. Current tax laws limit the amount of loss available to be offset against future taxable income when a substantial change in ownership occurs. Therefore, the amount available to offset future taxable income may be limited. No tax benefit has been reported in the financial statements, because the Company believes there is a 50% or greater chance the carryforwards will expire unused. Accordingly, the potential tax benefits of the loss carryforwards are offset by a valuation allowance of the same amount. NOTE 7 - LEGAL SETTLEMENTS In June 2001, ITC/INFO Tech ("Claimant") obtained a default award of $79,000 against the Company. The award was based on non-payment for computer goods shipped by ITC to two subsidiaries of the Company. The Company has offered to settle the award for shares of restricted stock, but the Claimant has refused to accept such an offer to date. The Claimant has made no effort to enforce its award since June 2001. As of June 30, 2006 and December 31, 2005, the award amount has been included in the accrued expenses of the Company. NOTE 8 - CONTINGENCIES Celeste Trust Reg., Esquire Trade, et al. v. CBQ, Inc. (Case# 03 Civ. 9650 RMB; US District Court, SDNY, 12/4/2003). A lawsuit filed against company by three plaintiffs on or about December 4, 2003, but which the company did not receive notice of until the week of February 18, 2004 or thereabouts. The Plaintiffs purchased debentures issued by Socrates Technologies Corporation (STC), a public Delaware corporation in 2000. When the Company purchased the assets of two STC subsidiaries in March 2001, the plaintiffs allege that the Company promised to issue to the Plaintiffs and others the consideration that was to be paid to STC for the acquired assets and to so do in order to compensate the plaintiffs for their investment in the STC debentures, which were apparently in default at that time. The total consideration paid for the STC subsidiaries' assets were 7.65 million shares of company Common Stock and a Promissory Note made by the Company for $700,000 principal amount. The Company has defended against the CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8 - CONTINGENCIES (continued) Plaintiffs' claims to date. If the Plaintiffs win a judgment on their claims, the judgment, if collected, would prove potentially ruinous the Company, unless a settlement involving no cash was arranged between the parties to the lawsuit. The Plaintiff's claims include a claim for receipt of the money due under the Promissory Note with a principal amount of $700,000. The Company lacks the cash flow or cash reserves or funding resources to pay such a claim, either in a lump sum or over time. If the Plaintiffs are awarded the claimed damages against the Company in this lawsuit, the Company would be unable to pay such damages, either in a lump-sum or under a schedule, and would be insolvent. The Plaintiff's complaint in Celeste was dismissed by the U.S. District Court for the Southern District of New York in early 2005 for failure to have all essential parties to the dispute as parties to the lawsuit. The Plaintiffs filed an amended complaint prior to the March 1, 2005 deadline for doing so. The Company currently intends to vigorously defend against the Plaintiff's amended complaint, which adds two former, now defunct, subsidiaries involved in the STC transaction as defendants. The assets of Networkland, Inc. and Technet Computer Services Corporation were acquired by the Company on March 15, 2001 and that transaction is at the heart of the dispute in the Celeste case. Currently, the Company's second motion to dismiss is scheduled to be heard by the Court on or about September 15, 2005. The Court has also heard Plaintiff's motion for default judgment against the subsidiaries involved in the STC transaction. The Court's decision may take several months to be issued. The Company is uncertain at this time of the final outcome of this litigation. Sun Trust Bank Dispute. Sun Trust Bank line of credit and term note: Prior to being acquired by the company, Quantum Technology Group had a $4 million line of credit with Crestar Bank, which was subsequently acquired by Sun Trust. This line of credit was guaranteed by Quantum and five individual guarantors, including Ray Kostkowski, Anne Sigman, Skip Lewis, and Anthony Saunders. This line of credit was opened during April, 2000. On August 8, 2000, the Company acquired all of the shares of Quantum. Sun Trust asserted that $1.3 million of the line of credit had been used, and was owing to Sun Trust, as well as line of credit, a $200,000 term loan from Sun Trust to Quantum, approximately $200,000 in accrued interest and $100,000 in attorney fees -- all of which Suntrust had sought to collect from the individual guarantors. Sun Trust had not sued the Company and has not raised its prior threat to sue in 2005. RAS Investment, Inc., a company affiliated with Anne Sigman, a former employee of the Company, has advised the Company that RAS has acquired the Sun Trust note and has demanded payment in cash or stock. As of the date of this Report, the Company's position remains as before, that is, that the Company is not obligated to pay the Sun Trust debts and any claims made to collect that debt could be defeated by several potential defenses and counterclaims. The Company is a defendant to another lawsuit concerning a trade show contract for approximately $25,000, but the Company does not believe that this lawsuit is material in respect of potential liability of the Company. The Company has been and intends to vigorously defend itself in this lawsuit. In August 2006, the Company settled this lawsuit for $25,000. CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS NOTE 8 - CONTINGENCIES (continued) As reported previously, the Company has received two claims from certain former shareholders of Cyberquest, Inc. that they hold or own approximately 70,000 shares of a class of the Company's redeemable preferred stock that was issued in the Company's 1998 acquisition of Cyberquest. Cyberquest ceased operations in 2000-2001 period. The Company has investigated these claims and has not been able to date to substantiate any of the claims to date and the claimants have not pursued their claims beyond an initial communication asserting ownership of these shares of serial preferred stock. NOTE 9 - SUBSIDIARY In February 2004, the Company established a new subsidiary, China Pathfinder Fund, LLC, a Florida limited liability company. During 2005, the name was changed to Overseas Building Supplies, LLC to reflect its shift in business lines from business development to trading Chinese-made building supplies. NOTE 10 - ACQUISITIONS On March 18, 2005, the Company entered into an agreement whereby the Company was to acquire 40% of the outstanding shares of Beijing Hua Wei Furniture Manufacture Co., Ltd., ("HWFM"), a company organized under the laws of the People's Republic of China. The Company was to issue common stock valued at $1,325,000 at closing to acquire its 40% interest in HWFM. On July 20, 2005, the Company announced the termination of this agreement because HWFM failed to satisfy one of the conditions to consummation of the acquisition. On January 27, 2006, the Company entered into a Purchase Agreement (the "Purchase Agreement") with William Dato and Complete Power Solutions ("CPS") pursuant to which the Company acquired 51% of the member interests of CPS owned by Mr. Dato for a purchase price consisting of the payment of $637,000 in cash and the delivery of 600,000 shares of Company's Series A Convertible Preferred Stock (the "Series A Preferred Stock") having a stated value of $1,200,000, which Series A Preferred Stock are convertible into 50,739,958 shares of the Company's Common Stock at the demand of Mr. Dato. The cash paid in the transaction was obtained from capital provided to the Company for use in connection with acquisitions by Howard Ullman, our Chief Executive Officer and President, and certain of our directors and principal shareholders. The Company recognized goodwill of $1,567,214 as part of the transaction. The Company is currently evaluating the value of the goodwill. ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION GENERAL - This discussion should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations in the Company's annual report on Form 10-KSB for the year ended December 31, 2005. PLAN OF OPERATIONS. The Company's plan of operations is to focus on expanding OBS' building supplies business and CPS's power generator distribution business as the primary business lines of t he Company. The Company will devote its available resources and funding to the expansion of OBS and CPS. Except for occasional short-term loans from Mr. Ullman, SDI will have to support its operations from cash flow from operations. The Company's current plan of operations also includes actively reviewing mergers and acquisitions and investment opportunities like CPS, which opportunities are in industries that complement the ability of the Company to trade Chinese-made products in North America. The Company is seeking opportunities that potentially and immediately enhance our sales revenues and net worth as well as possibly contribute a positive cash flow and enhance shareholder value beyond the capability of our current core business line. As such, we are interested in investing in or acquiring companies that could benefit from exploiting the Company's financial and contacts with Chinese manufacturing firms. Our strategic plan has traditionally been to remain a trading company with low overhead and focused on exploiting its contacts with Chinese manufacturers to meet our customers' needs. We have concluded that ownership of or investment in companies that are established distributors in the U.S. and potential distribution channels of Chinese-made products in the U.S. should be considered as part of the overall strategy to exploit our contacts with over 30 Chinese manufacturing companies. We received in early January 2006, a credit line commitment of $500,000 (increased to $647,000) from its chief executive officer and president, Howard Ullman, and three Company directors, Jeffrey Postal, Lorenzo Lamadrid and Laurie Holtz (collectively, the "lenders"). The credit line is to be used solely to fund the cash portion of any acquisition or investment by the Company The funding was used to acquire the 51% membership interest in CPS. Under the credit line, the Company has 4 years to repay any advances of credit, which repayment shall be made in calendar quarterly interest-only payments for the first 24 months of the term and equal calendar quarterly principal and interest installment payments for the last 24 months of the term. The interest rate is 8.5% per annum. Upon demand, any lender may convert all or a portion of any unpaid principal or interest into "restricted" shares (as defined in Rule 144 of the Securities Act of 1933, as amended) of a new class of the Company preferred stock ("Series B Convertible Preferred Stock"). The rights, designations and privileges of the Series B Preferred Stock will be negotiated between the Company and the lenders; provided, however, that the Preferred Stock is convertible into "restricted" shares of Company Common Stock, $0.0001 par value per share, ("Common Stock") at a conversion ratio that entitles the lenders to receive an aggregate of 33,333,333 "restricted" shares of Common Stock (to be adjusted for any future stock split or recapitalization). The conversion ratio is based on the principal amount of the debt ($647,000) divided by $0.015 per share of Common Stock. Any shares of Common Stock issued in a conversion of the Series B Preferred Stock have piggyback registration rights under the agreement between the Company and the lenders for the credit line. The Company may incur significant post-merger or acquisition registration costs in the event management wishes to register a portion of their shares for subsequent sale. The Company will also incur significant legal and accounting costs in connection with the acquisition including the costs of preparing post- effective amendments, Forms 8-K, agreements and related reports and documents. While the Company believes that SDI and CPS will be able to generate sufficient cash flow to pay for their respective direct overhead costs and internal planned growth in fiscal year 2006, neither SDI nor our company's interest in CPS generate sufficient cash flow at this time to fund an acquisition program, or fund of the proposed enhanced and expanded marketing and sales efforts for OBS and the overhead of our company. The Company will not have sufficient funds (unless it is able to raise funds in a private placement or debt financing) to undertake any significant business development, or extensive marketing, in terms of scope of campaign and geographical reach, of new products. Accordingly, following any future acquisition, the Company will, in all likelihood and unless the acquired business generates sufficient cash flow and profits, be required to either seek debt or equity financing or obtain funding from third parties, in exchange for which the Company may be required to give up a substantial portion of its interest in the acquired product or to issue large number of shares of its capital stock. There is no assurance that the Company will be able either to obtain additional financing or interest third parties in providing funding for the further development, marketing and manufacturing of any products acquired. RESULTS OF OPERATIONS - For the six months ended June 30, 2006, the Company had net income of approximately $418,000. For the six months ended June 30, 2005, the Company had a net loss of approximately $104,000. Total Revenues - For the six months ended June 30, 2006 and 2005, the Company had total sales of approximately $6,482,000 and $465,000 respectively, for an increase of approximately $6,017,000. The increase in revenues was due to the acquisition of Complete Power Solutions. Costs and Expenses - For the six months ended June 30, 2006 and 2005, the Company had cost of sales of approximately $4,043,000 and $327,000, respectively. The increase in the cost of sales was due the acquisition of Complete Power Solutions. Operating expenses increased approximately $1,258,000, from $241,000 for the six months ended June 30, 2005 to $1,499,000 for the six months ended June 30, 2006. This increase is attributable primarily to the acquisition of Complete Power Solutions. The cost of rent and other general and administrative costs also increased in for the six months ended June 30, 2006 as compared to the same period in 2005. Liquidity and Capital Reserves. Historically, the Company has not generated enough cash flow from operations to cover its overhead costs and the cost of growth. The inadequacy of cash flow and the inability of the Company to consistently obtain funding and ongoing funding on commercially reasonable terms have undermined the former business operations of the Company and forced the Company to obtain funding from management and through the sale of Company securities. As a small business and a penny stock company, the Company will continue to face difficulty in obtaining financing or funding on reasonable commercial terms. The Company expects future development and expansion will be financed through cash flow from operations and other forms of financing such as the sale of additional equity and debt securities, capital leases and other credit facilities. There are no assurances that such financing will be available on terms acceptable or favorable to the Company. Further, the increase in the number of shares of common stock in the public markets may reduce the ability or appeal of the Company to future sources of possible financing or funding. Government Regulations. The Company is subject to all pertinent Federal, State, and Local laws governing its business. The Company is subject to licensing and regulation by a number of authorities in its State or municipality. These may include health, safety, and fire regulations. Impact of Inflation. To date, the Company has not experienced any significant effect from inflation. The Company's major expenses have been the cost of marketing its product lines to customers in North America. That effort involves mostly Mr. Ullman traveling to make direct marketing and sales pitches to customers and potential customers as well as showing the SDI products at industry trade shows around North America and visiting China to maintain and expand SDI's distribution and manufacturing relationships and channels. The Company generally has been able to meet increase in costs by raising prices of its products. Country Risks. Almost all of the Company's contract manufacturing operations and sources of products are located in China. As such, the Company is subject to significant risks not typically faced by companies operating in or obtaining products from North America and Western Europe. Political, economic and trade conflicts between the United States and China, including possible conflict over North Korea's nuclear weapons program or the independence of Taiwan, could severely hinder the ability of the Company to obtain products and fill customer orders from the Company's current Chinese manufacturing sources. Further, Chinese commercial law is still evolving to accommodate increasing capitalism in Chinese society, especially in terms of commercial relationships and dealings with foreign companies, and can be unpredictable in application or principal. The same unpredictability exists with respect to the central Chinese government, which can unilaterally and without prior warning impose new legal, economic and commercial laws, policies and procedures. This element of unpredictability heightens the risk of doing business in China. China is also under international pressure to value its currency in a manner that would increase the value of Chinese currency in respect of other world currencies and thereby increase the cost of Chinese goods in the world market. The Company does not believe that such revaluation of Chinese currency would adversely impact its business because of the low-cost nature of the Company's products and the fact that U.S. dollars is the currency of use in all of the Company's commercial transactions. ITEM 3. CONTROLS AND PROCEDURES The Company's Chief Executive Officer and Chief Financial Officer are responsible for establishing and maintaining disclosure controls and procedures for the Company. (a) Evaluation of Disclosure Controls and Procedures As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company's management, including the Company's President, of the effectiveness of the design and operation of the Company's disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Based upon the evaluation, the Company's President concluded that, as of the end of the period, the Company's disclosure controls and procedures were effective in timely alerting him to material information relating to the Company required to be included in the reports that the Company files and submits pursuant to the Exchange Act. (b) Changes in Internal Controls Based on his evaluation as of June 30, 2006, there were no significant changes in the Company's internal controls over financial reporting or in any other areas that could significantly affect the Company's internal controls subsequent to the date of his most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS On January 25, 2005, the U.S. District Court for the Southern District of New York dismissed without prejudice the lawsuit against China Direct Trading Corporation in the previously-reported civil case styled CELESTE TRUST REG., ESQUIRE TRADE, ET AL. V. CBQ, INC. (Case# 03 Civ. 9650 RMB; US District Court, Southern District for New York, 12/4/2003). The lawsuit was dismissed in a response to China Direct Trading Corporation's motion to dismiss. The Plaintiffs can refile the lawsuit if they a complaint on or before March 1, 2005. The Plaintiffs filed an amended complaint with the Court on or about February 24, 2005. While the Company currently intends to defend against the Amended Complaint, and without admitting any liability in the matter, the Company may also explore settlement of the litigation in order to avoid any further drain by this federal lawsuit on the Company's resources. The Company has filed a motion to dismiss the plaintiff's amended complaint, which motion has not yet been heard or ruled upon by the Court. As reported previously, the Company has received two claims from certain former shareholders of Cyberquest, Inc. that they hold or own approximately 70,000 shares of a class of the Company's redeemable preferred stock that was issued in the Company's 1998 acquisition of Cyberquest. Cyberquest ceased operations in 2000-2001 period. The Company has investigated these claims and has not been able to date to substantiate any of the claims to date and the claimants have not pursued their claims beyond an initial communication asserting ownership of these shares of serial preferred stock. The Company is a defendant to another lawsuit concerning a trade show contract, but the Company does not believe that this lawsuit is material in respect of potential liability of the Company. The Company intends to vigorously defend itself in this lawsuit. In August 2006, the Company settled this lawsuit for $25,000. No director, officer or affiliate of the Company, or owner of record of more than five percent (5%) of the securities of the Company, or any associate of any such director, officer or security holder is a party adverse to us or has a material interest adverse to us in reference to pending litigation. We are not currently a party to any other legal proceedings that we believe will have a material adverse effect on our financial condition or results of operations. ITEM 2. CHANGES IN SECURITIES None. ITEM 3. DEFAULTS UPON SENIOR SECURITIES None/Not Applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS None/Not Applicable. ITEM 5. OTHER INFORMATION None ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS 2.1 Purchase Agreement, dated January 27, 2006, by and among China Direct Trading Corporation, William Dato and Complete Power Solutions, LLC. + 3.1 Articles of Incorporation of the Company * 3.1.1 Articles of Incorporation of China Direct Trading Company, a Wholly-owned subsidiary of the Company ** 3.2 By-laws of the Company*** 10.1 Voting Agreement, dated January 27, 2006, by and among China Direct Trading Corporation, William Dato and Howard Ullman. ***** 10.2 Operating Agreement, dated January 27, 2006, for Complete Power Solutions, LLC. ***** 10.3 Employment Agreement, dated January 27, 2006, among William Dato, China Direct Trading Corporation and Complete Power Solutions, LLC. ***** 10.4 Form of July 20, 2005 sales agency agreement between China Direct Trading Corporation and Sutter's Mill Specialties. ***** 14 Code of Ethics, dated November 21, 2003, ++++ 31 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.+ 32 Certification Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.+ --------------- * Incorporated by reference to Annex C to the Special Meeting Proxy Statement, dated April 15, 2004, filed by China Direct Trading Corporation with the Commission on April 20, 2004. ** Incorporated by reference to Annex G to the Special Meeting Proxy Statement, dated April 15, 2004, filed by China Direct Trading Corporation with the Commission on April 20, 2004. *** Incorporated by reference to Annex D the Special Meeting Proxy Statement, dated April 15, 2004, filed by China Direct Trading Corporation with the Commission on April 20, 2004. **** Incorporated by reference to Annex H the Special Meeting Proxy Statement, dated April 15, 2004, filed by China Direct Trading Corporation with the Commission on April 20, 2004. ***** Incorporated by reference to Form 10KSB, dated April 17, 2006. + Filed Herein ++++ Incorporated by reference to Exhibit 14 to the Company's Form 10-KSB for the fiscal year ending December 31, 2003, as filed by China Direct Trading Company with the Commission on April 20, 2004. (b) Reports on Form 8-K filed. The following reports were filed on Form 8-K during the second quarter of the 2006 fiscal year: May 1, 2006, May 12, 2006, May 16, 2006 and August 8, 2006. SIGNATURES In accordance with the requirements of the Exchange Act, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, this 24th day of August, 2006. China Direct Trading Corporation August 24, 2006 /s/ Howard Ullman Howard Ullman CEO, President and Chairman (Principal Executive Officer) (Principal Financial and Accounting Officer)