CMQ Cathay Merchant Grp.

Overview

     Our primary business involves the manufacturing of aluminium products. Our wholly-owned subsidiary, Cathay Merchant Group Ltd., a company incorporated under the laws of Samoa ("Cathay Ltd."), acquired all of the shares of AWP Aluminium Walzprodukte GmbH and AFM Aluminiumfolie Merseburg GmbH on June 30, 2005. The companies were acquired for a combined purchase price of $18.5 million (€15,300,000). AWP Aluminium Walzprodukte was based in Berlin, Germany, and operated an aluminium rolling mill through its wholly-owned subsidiary, MAW Mansfelder Aluminiumwerke GmbH. In 2006, AWP Aluminium Walzprodukte merged with and into MAW Mansfelder Aluminiumwerke, with MAW Mansfelder Aluminiumwerke continuing on as the surviving corporation. Its products include aluminium sheets, foils, strips and blanks for use by industrial and commercial fabricators of aluminium products. On the same date, we also acquired AFM Aluminiumfolie Merseburg, which operates an aluminium rolling mill factory in Merseburg, Germany and produces aluminium foil for flexible (food and beverage) packaging, pharmaceutical packaging and other technical applications.

     We hold interests in certain land, buildings and capital property where the two aluminium mills are located pursuant to the terms of two lease agreements with Grundstuckfonds Sachsen-Anhalt GmbH, a company wholly-owned by the State of Saxony-Anhalt, Germany ("GSA").

     Total combined production from the two mills during the year ended December 31, 2006 was 28,892 metric tonnes of finished products. The maximum total combined annual production from the two mills is 40,000 metric tonnes. The principal market for all of our aluminium products is primarily Europe.

     We, through Cathay Ltd., acquired all of the outstanding shares of AFM Aluminiumfolie Merseburg, pursuant to a share purchase agreement dated June 30, 2005, from an unrelated third party for a purchase price of $8.5 million. We paid $4.8 million in cash at closing on June 30, 2005 and the balance of the purchase price is evidenced by an unsecured promissory note in the principal amount of $3.7 million (€3,020,000), maturing on June 30, 2008. The note bears interest at the rate of 4.2% per annum, payable annually, and calculated on the basis of the actual number of days elapsed and on the basis of a 365-day year. The note was issued by Cathay Ltd. and is guaranteed by us.

     We acquired all of the outstanding shares of AWP Aluminium Walzprodukte pursuant to a share purchase agreement dated June 30, 2005, between Cathay Ltd. and Blake International, a former wholly-owned subsidiary of KHD Humboldt Wedag International Ltd., for a purchase price of $10.0 million. We paid $4.8 million in cash at closing on June 30, 2005 and the balance of the purchase price is evidenced by an unsecured promissory note in the principal amount of $5.2 million (€4,280,000), maturing on June 30, 2008. The note bears interest at the rate of 4.2% per annum, payable annually, and calculated on the basis of the actual number of days elapsed and on the basis of a 365-day year. The note was issued by Cathay Ltd. and is guaranteed by us. KHD Humboldt Wedag was an affiliate and significant shareholder of our company at the time of the transaction.

     Our aluminium rolled products are semi-finished products including sheets, foils, strips and blanks that constitute the raw materials for the manufacture of finished goods which are completed by our customers. Our aluminium rolling mills produce products for industrial and commercial purposes. The process of producing semi-finished aluminium products requires subsequent rolling, or cold rolling, and finishing steps such as annealing, coating, leveling or slitting to achieve the desired thicknesses and metal properties.

     Aluminium has several characteristics that provide value for diverse applications. Compared to substitute metals, aluminium is light-weight, has a high strength-to-weight ratio and is resistant to corrosion. Aluminium's greatest advantage, however, is that it can be recycled repeatedly without any material decline in performance or quality. Recycling of aluminium provides significant energy savings compared to the production of aluminium from other primary sources with significantly lower capital equipment costs.

     We generally purchase primary aluminium at prices set on the London Metal Exchange plus a premium that varies by geographic region of delivery, form and alloy.

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     Industrial and commercial fabricators in the construction and automotive supply industry represent the largest customers for MAW Mansfelder Aluminiumwerke's products. Aluminium rolled products developed for this market segment are often decorative, offer insulating properties, are durable and corrosion resistant, and have a high strength-to-weight ratio. Aluminium siding, gutters, and downspouts comprise a significant amount of construction volume. Other applications include doors, windows, awnings, canopies, façades, roofing and ceilings. Most of the customers of MAW Mansfelder Aluminiumwerke receive shipments in the form of aluminium sheets, foils, strips and blanks which are later fabricated according to our customers' specifications. Demand for most of MAW Mansfelder Aluminiumwerke's products is seasonal, with higher demand occurring in the spring, summer and fall months and lower demand in the winter months. Accordingly, our aluminium mills typically generate higher revenues in the spring, summer and fall months.

     The majority of our products are sold to two subsidiaries of Mass Financial Corp., which provide services and sell the products. Mass Financial currently holds 5,256,844, or 27.8%, of our common shares as of November 5, 2007.

     The aluminium rolled products market is highly competitive. We face competition from a number of companies in Germany and from European companies selling their products to our markets. Our primary competitors in Europe are Norsk Hydro A.S.A., Alcan, Alcoa, Novelis and Corus. We compete based on our price, product quality, the ability to meet customers' specifications, short delivery times and range of products offered. We also use sophisticated technical equipment and focus on high-end niche markets in order to maintain our competitive advantage.

     In addition to competition from within the aluminium rolled products industry, we face competition from non-aluminium materials, as fabricators and end-users have, in the past, demonstrated a willingness to substitute other materials for aluminium. Aluminium competes with plastic and steel in building products applications. Factors affecting competition with substitute materials include price, ease of manufacture, consumer preference and performance characteristics.

     The following discussion and analysis of the results of operations and financial condition of our company for the three months ended September 30, 2007 should be read in conjunction with the consolidated financial statements and related notes included in this quarterly report, as well as our most recent annual report on Form 10-KSB for the year ended December 31, 2006 filed with the United States Securities and Exchange Commission.

Results Of Operations – Nine Months Ended September 30, 2007

     Net product sales for the nine months ended September 30, 2007 were $84.6 million, compared to $73.0 million in the same period in 2006. Cost of goods for the nine months ended September 30, 2007 were $80.0 million, compared to $69.5 million in the same period in 2006.

     AFM Aluminiumfolie Merseburg's products include those that utilize aluminium foil because of its light weight, recyclability and formability and because it has a wide variety of uses in packaging. Aluminium foil can be processed to create a very thin foil that can be plain or printed and is typically laminated to plastic or paper to form an internal seal for a variety of packaging applications including flexible (food and beverage) packaging, pharmaceutical packaging and other technical applications. Customers typically order coils of such foil in a range of thicknesses from 6 microns to 50 microns. AFM Aluminiumfolie Merseburg enters into annual supply agreements with a majority of its larger customers that are typically concluded during the fall and winter months to cover the customers' requirements for the following year. This makes AFM Aluminiumfolie Merseburg's revenues relatively predictable at an early time in the year.

     The aluminium products of MAW Mansfelder Aluminiumwerke are sold to distributors, as well as end-users, principally for use by industrial and commercial fabricators of aluminium products whereas the aluminium products of AFM Aluminiumfolie Merseburg are sold exclusively to industrial fabricators.

     General and administrative expenses for the nine months ended September 30, 2007 were $4.3 million, compared to $3.8 million in the same period in 2006.

     In July 2007, the German tax authority announced a change of the Corporation tax rate, effective January 1, 2008, whereby the total tax rate will be reduced approximately from 39% to 29%. We reduced our deferred tax assets by $0.3 million partially because of this change.

     We reported a net income of $0.2 million, or $0.01 per common share, for the nine months ended September 30, 2007, compared to a net loss of $0.7 million, or $0.04 per common share, in the same period in 2006.

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Results of Operations – Three Months Ended September 30, 2007

     Net product sales for the three months ended September 30, 2007 were $27.7 million, compared to $27.4 million in the same period in 2006. Cost of goods sold for the three months ended September 30, 2007 were $26.3 million, compared to $25.9 million in the same period in 2006.

     All of our revenues during the quarter ended September 30, 2007 were generated by our two aluminium rolling mills.

     General and administrative expenses were $1.4 million for the three months ended September 30, 2007, compared to $1.0 million in the same period ended September 30, 2006.

     We reported a net loss of $5,000, or $0.00 per common share, for the three months ended September 30, 2007, compared to a net income of $0.3 million, or $0.02 per common share, in the same period in 2006.

LIQUIDITY AND CAPITAL RESOURCES

     At September 30, 2007, we had a working capital deficiency of $12.4 million, compared to a working capital deficiency of $1.3 million at December 31, 2006.

     We anticipate that cash generated from our operations will not be able to cover all of our projected operating expenses and projected expenditures in the following twelve months. We may try to raise funds to meet our future cash requirements by extension of debt or equity financing or we may sell some of our investments. However, we can offer no assurance that we will be successful in raising cash in such methods.

Operating Activities

     Operating activities used cash of $0.8 million for the nine months ended September 30, 2007, and provided cash of $1.6 million in the same period ended 2006.

Investing Activities

     Investing activities used cash of $0.3 million for the nine months ended September 30, 2007, compared to $0.4 million in the same period ended 2006, as a result of the purchase of fixed assets.

Financing Activities

     Financing activities provided cash of $0.2 million for the nine months ended September 30, 2007, compared to $88,000 in the same period ended 2006.

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Foreign currency

     All of our operations are conducted in Europe and our consolidated financial results are subject to foreign currency exchange rate fluctuations.

     We translate assets and liabilities of our foreign subsidiaries whose functional currencies are other than United States dollars into United States dollars at the rate of exchange on the balance sheet date. Revenues and expenses are translated at the average rate of exchange prevailing during the period. Unrealized gains or losses from these translations, or currency translation adjustments, are recorded under the shareholders’ equity section on the balance sheet and do not affect the net earnings as reported in our consolidated statements of income. As our revenues are received in Euros, our financial position for any given period, when reported in United States dollars, can be significantly affected by the fluctuation of the exchange rates for Euros during that period.

     Based upon the average exchange rates for the nine months ended September 30, 2007, the United States dollar decreased by approximately 7.5% in value against the Euro, compared to the average exchange rates for the nine months ended September 30, 2006. As at September 30, 2007, the United States dollar decreased by approximately 7.2% in value against the Euro since December 31, 2006.

     For the nine months ended September 30, 2007, we reported approximately a net $1.1 million currency translation adjustment gain and, as a result, our cumulative currency translation adjustment gain at September 30, 2007 was $2.2 million, compared to a cumulative gain of $1.1 million at December 31, 2006.

Off-Balance Sheet Arrangements

     Our company has no outstanding derivative financial instruments, off-balance sheet guarantees, interest rate swap transactions or foreign currency contracts. Our company does not engage in trading activities involving non-exchange traded contracts.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

     The preparation of financial statements in conformity with generally accepted accounting principles requires management of our company 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 periods.

     Our management routinely makes judgments and estimates about the effects of matters that are inherently uncertain. As the number of variables and assumptions affecting the probable future resolution of the uncertainties increase, these judgments become even more subjective and complex. We are currently in the aluminium manufacturing and trading business and have identified certain accounting policies, described below, that are the most important to the portrayal of our current financial condition and results of operations.

Revenue Recognition

     Our primary business is aluminium manufacturing and trading and our revenue primarily comes from the sale of aluminium products produced and sold. We receive orders from customers, process and convert the raw materials into finished goods, and ship the finished goods at the instructions of our customers. It is a simple manufacturing and trading process. The revenue is recognized when the finished goods are delivered, the terms of the sales are known and complied with and no significant obligations remain. Management believes that the risk of misstating the revenue is very remote and the only major misstatement, if any, comes from the period-end cut-off.

     Our return policy is governed by the provisions of the German Civil Code and the German Commercial Code. It stipulates that the seller has to transfer the product free from defects in materials and workmanship to the purchaser. To be deemed free from defects, the product has to be of the quality the two parties agreed on in their contract, when being transferred. If the product is not free from defects during the warranty period of two years, German law offers four possible claims to the purchaser:

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• Subsequent improvements or subsequent delivery to the choice of the purchaser. Other options for the purchaser only arise if the seller subsequently fails to perform his contractual duty.

• After unsuccessfully requesting improvements of the product, the purchaser may withdraw from the contract, in which case a full cash refund is mandatory and the product has to be returned to the seller.

• Instead of withdrawing, the purchaser may keep the product and consider a reduction of the purchase price.

• The purchaser might claim compensation for the non-performance of the sale.

     Once an order has been placed by the purchaser and accepted by the seller the purchaser has no legal right to withdraw from the contract, unless the seller fails to perform his duties. A mutual cancellation is subject to the acceptance of the seller and depends on the individual situation.

Goodwill Impairment

     A goodwill impairment loss should be recognized when the carrying amount of the goodwill exceeds the fair value of the goodwill. An impairment loss should not be reversed if the fair value subsequently increases. We consider, but such consideration is not limited to, the following factors to determine the goodwill impairment:

• a significant adverse change in legal factors or in the business climate;

• an adverse action or assessment by a regulator;

• unanticipated competition;

• loss of key personnel;

• a more-likely-than-not expectation that a significant portion or all of a reporting unit will be sold or otherwise disposed of;

• the testing for write-down or impairment of a significant asset group within a reporting unit; or

• the recognition of a goodwill impairment loss in its separate financial statements by a subsidiary that is a component of the reporting unit.

Impairment of Long-Lived Assets

     We periodically evaluate long-lived assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. In performing the review of recoverability, we estimate future cash flows expected to result from the use of the asset and its eventual disposition. The estimates of future cash flows, based on reasonable and supportable assumptions and projections, require our management to make subjective judgments. In addition, the time periods for estimating future cash flows is often lengthy, which increases the sensitivity of the assumptions made. Depending on the assumptions and estimates used, the estimated future cash flows projected in the evaluation of long-lived assets can vary within a wide range of outcomes. Our management considers the likelihood of possible outcomes in determining the best estimate of future cash flows.