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: September 30, 2005
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[ ] TRANSITION REPORT UNDER SECTION 13 OR 15(D) OF THE
EXCHANGE ACT
For the transition period from to
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Commission file number 000-28831
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China Direct Trading Corporation
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(Exact name of small business issuer as
specified in its charter)
Florida 84-1047159
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(State or other jurisdiction (IRS Employer
of incorporation or organization) Identification No.)
10400 Griffin Road, Suite 109, Cooper City, Florida 3328
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(Address of principal executive offices)
(954) 252-3440
Issuer's telephone number
12535 Orange Drive, Suite 613, Davie, Florida 33330
(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: September 30, 2005
Approximately 524,977,610 shares
Transitional Small Business Disclosure Format (check one).
Yes ; No X
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PART I
ITEM 1. FINANCIAL STATEMENTS
CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Unaudited)
September 30, December 31,
2005 2004
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Assets:
Current assets:
Cash $ 30,418 $ 77,503
Advances 17,408 3,062
Prepaid expense - 9,000
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Total Current Assets 47,826 89,565
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Fixed assets:
Computers 2,688 2,688
Less: Accumulated Depreciation (1,568) (897)
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Total Fixed Assets 1,120 1,791
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Other non-current assets:
Deposits 3,550 1,713
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Total other non-current assets 3,550 1,713
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Total assets $ 52,496 $ 93,069
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CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Continued)
(Unaudited)
September 30, December 31,
2005 2004
------------------ ------------------
Liabilities and Stockholders' Deficit:
Current liabilities:
Accounts payable, trade $ 22,439 $ 20,595
Accrued expenses 162,563 170,516
Customer deposits 83,680 83,680
Accrued compensation 150,000 200,000
Related party payables 315,000 315,000
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Total Liabilities 733,682 789,791
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Stockholders' Deficit:
Preferred Stock, par value $.001 per share Authorized 100,000,000 shares,
Issued 8,100 shares at September 30, 2005 and
December 31, 2004 8 8
Common Stock, par value $.0001 per share
Authorized 600,000,000 shares,
Issued 524,977,610 Shares at September 30, 2005 and
December 31, 2004 52,498 51,546
Additional paid-in capital 292,480 93,432
Accumulated deficit (1,026,172) (841,708)
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Total Stockholders' Deficit (681,186) (696,722)
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Total Liabilities and
Stockholders' Deficit $ 52,496 $ 93,069
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See accompanying notes.
CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
-------------------------------------- -------------------------------------
2005 2004 2005 2004
------------------ ------------------ ----------------- -----------------
Revenues $ 256,788 $ 224,018 $ 722,158 $ 898,455
Cost of Sales (215,235) (206,195) (542,611) (630,914)
------------------ ------------------ ----------------- -----------------
Gross Profit 41,553 17,823 179,547 267,541
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Operating Expenses:
Sales and marketing 1,462 5,305 7,588 16,223
Compensation 50,000 - 150,000 -
Other General and administrative 70,331 71,241 205,335 188,306
------------------ ------------------ ----------------- -----------------
Total Operating Expenses 121,793 76,546 362,923 204,529
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Net Operating Income (Loss) (80,240) (58,723) (183,376) 63,012
Other Income (Expense):
Interest income 7 - 18 -
Interest expense (366) (883) (1,106) (2,612)
------------------ ------------------ ----------------- -----------------
Net Income (Loss) $ (80,599) $ (59,606) $ (184,464) $ 60,400
================== ================== ================= =================
Weighted Average
Shares Outstanding 517,232,972 502,748,300 516,348,305 500,482,966
================== ================== ================= =================
Income (Loss) per Common Share $ - $ - $ - $ -
================== ================== ================= =================
See accompanying notes.
CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Nine Months
Ended September 30,
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2005 2004
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CASH FLOWS FROM OPERATING
ACTIVITIES:
Continuing operations:
Net Income (Loss) $ (184,464) $ 60,400
Adjustments necessary to reconcile net loss
to net cash used in operating activities:
Stock issued for expenses 9,000 7,674
Stock issued for accrued compensation 200,000 -
Depreciation 671 672
(Increase) decrease in deposits (1,837) -
(Increase) decrease in advances (14,346) (1,851)
Increase (decrease) in accounts payable 1,844 (2,485)
Increase (decrease) in accrued compensation (50,000) -
Increase (decrease) in accrued expenses (7,953) -
Increase (decrease) in deposits from customers - (895)
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Net Cash Used in continuing operations (47,085) 63,515
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CASH FLOWS FROM INVESTING
ACTIVITIES:
Purchase of fixed assets - (2,688)
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Net cash provided by (used) investing activities - (2,688)
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CASH FLOWS FROM FINANCING
ACTIVITIES:
Proceeds from sale of stock - -
Proceeds from shareholder payables - -
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Net Cash Provided by Financing Activities - -
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Net (Decrease) Increase in
Cash and Cash Equivalents (47,085) 60,827
Cash and Cash Equivalents
at Beginning of Period 77,503 24,841
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Cash and Cash Equivalents
at End of Period $ 30,418 $ 85,668
================= ==================
CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Continued)
For the Nine Months
Ended September 30,
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2005 2004
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SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during the period for:
Interest $ 1,106 $ 2,612
Franchise and income taxes $ - $ -
SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING
ACTIVITIES: NONE
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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 September 30, 2005 and for the
three and nine month periods ended September 30, 2005 and 2004 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 three and nine 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.
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.
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.
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 nine months ended
September 30, 2005 include the accounts of the parent entity and its
subsidiaries Souvenir Direct, Inc. and China Pathfinder Fund, LLC.
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 three and nine months ended
September 30, 2005 and 2004 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 2004 financial
statements to conform with the 2005 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 September 30, 2005, the Company receives approximately 36% 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 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.
Advertising
Advertising costs are expensed as incurred. Advertising expense was
$7,588 and $16,223 for the nine months ended September 30, 2005 and 2004,
respectively.
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
The lease expires in August 2005. On September 1, 2005, the Company
entered into a new lease agreement for approximately 1,200 square feet of office
space. The lease requires monthly lease payments of $1,300. 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 $23,610 and $13,966
for the nine months ended September 30, 2005 and 2004, 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,
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2005 $ 17,400
2006 10,400
2007 -
2008 -
2009 -
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Total minimum future lease payments $ 27,800
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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.
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 April 2004, 440,000 shares of common stock were returned to the
treasury and cancelled.
In May 2004, the Company issued 1,500,000 shares of common stock for
services valued at $27,000.
In June 2004, the Company issued 2,000,000 shares of common stock for
services valued at $36,000. As of December 31, 2004, expense of $27,000 and
prepaid expense of $9,000 was recorded.
In June 2004, the Company issued 200,000 shares of common stock for
services valued at $3,600.
CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 4 - STOCK TRANSACTIONS (continued)
In July 2004, the Company issued 138,000 shares of common stock for
services valued at $5,520.
In September 2004, the Company issued 240,000 shares of common stock
for services valued at $7,200.
In November 2004, the Company issued 187,500 shares of common stock for
services valued at $9,375.
In June 2005, the Company issued 9,523,810 shares of common stock for
accrued compensation of $200,000.
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. The preferred shares are convertible to common
shares at a conversion ratio of 1,000 shares of common stock for each share of
preferred stock.
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.
CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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, 2005. The monthly installments due and payable from January 2005
through September 2005 have been deferred by mutual agreement of China
Pathfinder Fund, LLC and the lending shareholders.
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 related party payables at September 30, 2005 and December 31,
2004.
NOTE 6 - INCOME TAXES
As of December 31, 2004, the Company had a net operating loss
carryforward for income tax reporting purposes of approximately $455,000 that
may be offset against future taxable income through 2024. 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 September 30, 2005 and December 31, 2004, 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 CBQ, Inc.
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
CHINA DIRECT TRADING CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 8 - CONTINGENCIES (continued)
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 CBQ, Inc. for $700,000
principal amount. The Company is currently contesting the lawsuit. On April 15,
2004, the Court denied the plaintiffs' motion for default judgment and set the
case for discovery and trial.
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 have filed an amended complaint with the Court on or about February
24, 2005. The Company has filed a motion to dismiss the plaintiff's amended
complaint, which motion has not be 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.
NOTE 9 - SUBSIDIARY
In February 2004, the Company established a new subsidiary, China
Pathfinder Fund, LLC, a Florida limited liability company. The purpose of this
new subsidiary is to pursue the business of acting as a funding and
merger-and-acquisition agent in the United States and China.
NOTE 10 - ACQUISITION
On March 18, 2005, the Company entered into an agreement whereby the
Company will 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.
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, 2004.
PLAN OF OPERATIONS. The Company's plan of operations is to: (a) expand SDI's
existing gift, souvenir and promotional product line and expand SDI's
geographical markets by increased marketing of SDI at U.S. and International
gift, souvenir and/or promotional product trade shows and more extensive
face-to-face marketing of SDI to targeted U.S. corporate accounts; (b) establish
CPF's business development business by more extensive face-to-face marketing of
potential customers in China by CPF's new Beijing office; and (c) establish CPF
as a second trading company operation that trades in non-SDI products,
especially trading Chinese commodities and manufactured goods in the U.S.
through sales to wholesalers and distributors as well as sales to end- user
customers. The Company is seeking to accomplish its expansion of its business
lines by internal growth through enhanced, expanded marketing and sales efforts
and diversification of product lines, and by acquiring other companies through
stock-for-stock exchanges.
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 will be able to generate sufficient
cash flow to pay for SDI's and the Company's direct overhead costs and, with
respect to SDI, its internal planned growth in fiscal year 2005, SDI does not
generate sufficient cash flow at this time to fund an acquisition program, and
funding of the proposed enhanced and expanded marketing and sales efforts for
SDI and CPF. The Company will not have sufficient funds (unless it is able to
raise funds in a private placement or in connection with an acquisition) to
undertake any significant business development, or extensive marketing, in terms
of scope of campaign and geographical reach, of new products. Accordingly,
following the acquisition, the Company will, in all likelihood, 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 three and nine months ended September 30, 2005,
the Company had a net loss from operations of approximately $81,000 and
$184,000, respectively. For the three months ended September 30, 2004, the
Company had a net loss from operations of approximately $60,000. For the nine
months ended September 30, 2004, the Company had net income from operations of
approximately $60,000.
Total Revenues - For the nine months ended September 30, 2005 and 2004, the
Company had total sales of approximately $722,000 and $898,000, respectively,
for a decrease of approximately $176,000. The decrease in revenues was mainly
due to a one-time order for $90,000 during the nine months ended September 30,
2004.
Costs and Expenses - For the nine months ended September 30, 2005 and 2004, the
Company had cost of sales of approximately $543,000 and $631,000, respectively.
As a percentage of sales, cost of sales increased from approximately 70% for the
nine months ended September 30, 2004 to approximately 75% for the nine months
ended September 30, 2005. The increase in the cost of sales for the nine months
ended September 30, 2005 as compared to the same period in 2004 is due to
advanced payments made by the Company to factories for manufacturing. General
and administrative expenses increased approximately $167,000, from $188,306 for
the nine months ended September 30, 2004 to $355,335 for the nine months ended
September 30, 2005. This increase is attributable primarily to an increase in
officer compensation as well as an increase in legal and professional fees. The
cost of rent and other general and administrative costs also increased for the
nine months ended September 30, 2005 as compared to the nine months ended
September 30, 2004.
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. As of the date of this Report, these two positions are held by
Howard Ullman. The Company is seeking to find a qualified chief financial
officer for the Company.
(a) Evaluation of Disclosure Controls and Procedures
The Company's management has reviewed the effectiveness of its
disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e)
under the Securities Exchange Act of 1934, as amended) and internal control over
financial reporting (as defined in Securities Exchange Act of 1934, as amended,
Rules 13a-15(f) and 15d-15(f)) as of the fiscal quarter end of this quarterly
report on Form 10-QSB.
No matter how well conceived and operated, an internal control system
can provide only a certain level of confidence in the ability of the internal
controls to identify errors. In light of the inherent limitations in all
internal control systems and procedures, and the limitations of the Company's
resources, no evaluation of internal controls can provide absolute assurance
that all defects or errors in the operation of the Company's internal control
systems are immediately identified. These inherent limitations include the
realities that subjective judgments in decision- making in this area can be
faulty and that a breakdown in internal processes can occur because of simple,
god faith error or mistake. No design can in all instances immediately
accommodate changes in regulatory requirements or changes in the business and
financial environment of a company. Such
inherent limitations in a control system means that inadvertent misstatements
due to error or fraud may occur and not be immediately or in a timely manner
detected. Nonetheless, the Company recognizes its ongoing obligation to use its
best efforts to design and apply internal controls and procedures that are as
effective as possible in identifying errors or breakdowns in the internal
controls system and procedures.
(b) Changes in Internal Controls
Based on a recent review by the Company, the Company has concluded that
additional resources need to be assigned to internal controls and procedures.
Such additional investment will be used primarily to recruit an experienced
chief financial officer or outside public auditor/consultant to enhance the
design and implementation of the Company's internal controls and procedures and
to work with the Audit Committee to enhance the scope and thoroughness of the
internal review process and the level of the that committee's expertise.
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.
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
3.1 Articles of Incorporation of the Company **
2.2 By-laws of the Company****
10.1 Investment Agreement, dated August 5, 2004, by the Company and
Dutchess Private Equities Fund, II, LP++
10.2 Registration Rights Agreement, dated August 5, 2004, by the
Company and Dutchess Private Equities Fund, II, LP +++
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 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 H the Special Meeting Proxy
Statement, dated April 15, 2004, filed by China Direct Trading
Corporation with the Commission on April 20, 2004.
+ Filed Herein
++ Incorporated by reference to Exhibit 10.1 to the Form 8-K
Report, dated August 5, 2004, as filed by China Direct Trading
Corporation on August 10, 2004
+++ Incorporated by reference to Exhibit 10.2 to the Form 8-K
Report, dated August 5, 2004, as filed by China Direct Trading
Corporation on August 10, 2004
++++ 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.
i) Item 8.01 - Other Events. Report filed September 26, 2005.
ii) Item 1.01 - Material Definitive Contracts. Report filed September 28, 2005.
iii) Item 1.01 - Material Definitive Contracts. Report filed October 5, 2005.
iv) Item 7.01 - Regulation FD Disclosure. Report filed October 11, 2005.
v) Item 8.01 - Other Events. Report filed October 11, 2005
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 14th day of November, 2005.
China Direct Trading Corporation
November 14, 2005
/s/ Howard Ullman
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Howard Ullman
CEO, President and Chairman
(Principal Executive Officer)
(Principal Financial and Accounting Officer)