##### Table of Contents



U.S. SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 20-F/A
 o
    
    REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g)
OF THE SECURITIES EXCHANGE ACT OF 1934
 OR
 þ
    
    ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the fiscal year ended December 31, 2005
 OR
 o
    
    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 For the transition period from  to
 Commission file number 0-29620
 OR
 o
    
    SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 Date of event requiring this shell company report
 LJ INTERNATIONAL INC.
  LJ INTERNATIONAL INC.
  British Virgin Islands
  Unit #12, 12/F, Block A
Focal Industrial Centre
21 Man Lok Street  Hung Hom, Kowloon, Hong Kong
  Title of each
    
    Name of each exchangeclass
    
    on which registeredNone
    
    N/A
  $.01 Par Value Common Stock (Common Stock)
  None
    o þ
  o þ
  þ o
  o o þ
  o þ
  o þ




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TABLE OF CONTENTS  PART IITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERSITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLEITEM 3. KEY INFORMATIONITEM 4. INFORMATION ON THE COMPANYITEM 4A.UNRESOLVED STAFF COMMENTSITEM 5.OPERATING AND FINANCIAL REVIEW AND PROSPECTSITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEESITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONSITEM 8. FINANCIAL INFORMATIONITEM 9. THE OFFER AND LISTINGITEM 10. ADDITIONAL INFORMATIONITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIESPART IIITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIESITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDSITEM 15. CONTROLS AND PROCEDURESITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERTITEM 16B. CODE OF ETHICSITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICESITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEESITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERSPART IIIITEM 17. FINANCIAL STATEMENTSITEM 18. FINANCIAL STATEMENTSITEM 19. EXHIBITSSIGNATURESEXHIBIT INDEXSubsidiariesCertification of CEO Pursuant to Rule 13a-14(a)Certification of CFO Pursuant to Rule 13a-14(a)Certification of CEO Pursuant to Rule 13a-14(b)Certification of CFO Pursuant to Rule 13a-14(b)    Table of Contents  SPECIAL NOTE REGARDING
FORWARD-LOOKING STATEMENTS
   
    
    dependence upon certain customers
    
    dependence on key personnel
    
    control by principal shareholder
    
    competitive factors
    
    the operation of our business
    
    general economic conditions
    -2-




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##### Table of Contents



PART I
 
 ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
  
 ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
  
 ITEM 3. KEY INFORMATION
 A. SELECTED FINANCIAL DATA.
 SELECTED CONSOLIDATED FINANCIAL DATA
(Dollars in thousands, except per share amounts)
  -3-




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##### Table of Contents



Selected Financial Data
 Eight-month periodYears ended
    
    
    ended
    
    
    Years endedDecember 31,
    
    
    December 31,
    
    
    April 30,2005
    
    2004
    
    2003
    
    2002
    
    
    2002
    
    2001
    
    
    2002
    
    2001(Unaudited)
    
    
    (Unaudited)(Restated)
    
    (Restated)
    
    (Restated)
    
    
    (Restated)
    
    
    
    
    
    
    (Restated)
    
    (Restated)Statement of Operations Data:Operating revenues
    
    
    
    94,612
    
    
    
    77,379
    
    
    
    58,167
    
    
    
    46,007
    
    
    
    
    31,809
    
    
    
    25,042
    
    
    
    
    39,240
    
    
    
    46,285Cost of goods sold
    
    
    
    72,642
    
    
    
    61,265
    
    
    
    44,947
    
    
    
    39,951
    
    
    
    
    22,820
    
    
    
    18,602
    
    
    
    
    35,731
    
    
    
    31,540Gross profit
    
    
    
    21,970
    
    
    
    16,114
    
    
    
    13,220
    
    
    
    6,056
    
    
    
    
    8,989
    
    
    
    6,440
    
    
    
    
    3,509
    
    
    
    14,745Other operating income
    
    
    
    549
    
    
    
    125
    
    
    
    163
    
    
    
    200
    
    
    
    
    157
    
    
    
    93
    
    
    
    
    135
    
    
    
    62Operating expensesSelling, general and administrative
    
    
    
    (15,488
    )
    
    
    (11,578
    )
    
    
    (9,133
    )
    
    
    (9,525
    )
    
    
    
    (6,433
    )
    
    
    (5,905
    )
    
    
    
    (8,963
    )
    
    
    (9,398
    )Net gain (loss) on derivatives
    
    
    
    8
    
    
    
    199
    
    
    
    87
    
    
    
    (975
    )
    
    
    
    (435
    )
    
    
    (119
    )
    
    
    
    (660
    )
    
    
    44Depreciation
    
    
    
    (1,368
    )
    
    
    (1,032
    )
    
    
    (1,184
    )
    
    
    (1,328
    )
    
    
    
    (863
    )
    
    
    (565
    )
    
    
    
    (1,031
    )
    
    
    (808
    )Impairment on property, plant and
    
    
    
    
    
    
    
    
    
    
    
    (84
    )
    
    
    (417
    )
    
    
    
    (108
    )
    
    
    
    
    
    
    
    (345
    )
    
    
    Amortization and impairment loss on
goodwill
    
    
    
    
    
    
    
    
    
    
    
    (200
    )
    
    
    (624
    )
    
    
    
    (400
    )
    
    
    (18
    )
    
    
    
    (242
    )
    
    
    (27
    )Income (loss) from operations
    
    
    
    5,671
    
    
    
    3,828
    
    
    
    2,869
    
    
    
    (6,613
    )
    
    
    
    907
    
    
    
    (74
    )
    
    
    
    (7,597
    )
    
    
    4,618Other income
    
    
    
    139
    
    
    
    38
    
    
    
    41
    
    
    
    91
    
    
    
    
    48
    
    
    
    172
    
    
    
    
    217
    
    
    
    508Interest expenses
    
    
    
    (1,991
    )
    
    
    (902
    )
    
    
    (753
    )
    
    
    (668
    )
    
    
    
    (441
    )
    
    
    (424
    )
    
    
    
    (652
    )
    
    
    (1,780
    )Impairment loss on investment security
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (200
    )
    
    
    
    (200
    )
    
    
    
    
    
    
    
    
    
    
    
    Operating income (loss) before income
taxes, minority interests, equity in
results of
investment securities and
extraordinary item
    
    
    
    3,819
    
    
    
    2,964
    
    
    
    2,157
    
    
    
    (7,390
    )
    
    
    
    314
    
    
    
    (326
    )
    
    
    
    (8,032
    )
    
    
    3,346Incomes taxes (expense) credit
    
    
    
    (739
    )
    
    
    (277
    )
    
    
    (352
    )
    
    
    39
    
    
    
    
    (101
    )
    
    
    (39
    )
    
    
    
    101
    
    
    
    (211
    )Income (Loss) before minority
interests,
equity in results of investment
securities and
extraordinary item
    
    
    
    3,080
    
    
    
    2,687
    
    
    
    1,805
    
    
    
    (7,351
    )
    
    
    
    213
    
    
    
    (365
    )
    
    
    
    (7,931
    )
    
    
    3,135Minority interests in consolidated
    
    
    
    (20
    )
    
    
    
    
    
    
    8
    
    
    
    150
    
    
    
    
    120
    
    
    
    
    
    
    
    
    30
    
    
    
    Income before equity in results of
investment securities and
extraordinary item
    
    
    
    3,060
    
    
    
    2,687
    
    
    
    1,813
    
    
    
    (7,201
    )
    
    
    
    333
    
    
    
    (365
    )
    
    
    
    (7,901
    )
    
    
    3,135Equity in results of investment
securities
    
    
    
    
    
    
    
    133
    
    
    
    (851
    )
    
    
    24
    
    
    
    
    16
    
    
    
    26
    
    
    
    
    34
    
    
    
    Income before extraordinary item
    
    
    
    3,060
    
    
    
    2,820
    
    
    
    962
    
    
    
    (7,177
    )
    
    
    
    349
    
    
    
    (339
    )
    
    
    
    (7,867
    )
    
    
    3,135Extraordinary gain on negative
goodwill
    
    
    
    378
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    
    
    3,438
    
    
    
    2,820
    
    
    
    962
    
    
    
    (7,177
    )
    
    
    
    349
    
    
    
    (339
    )
    
    
    
    (7,867
    )
    
    
    3,135Net income (loss) per share:Basic
    
    
    
    0.26
    
    
    
    0.25
    
    
    
    0.11
    
    
    
    (0.84
    )
    
    
    
    0.04
    
    
    
    (0.04
    )
    
    
    
    (0.91
    )
    
    
    0.37Diluted
    
    
    
    0.24
    
    
    
    0.23
    
    
    
    0.10
    
    
    
    (0.84
    )
    
    
    
    0.04
    
    
    
    (0.04
    )
    
    
    
    (0.90
    )
    
    
    0.37Weighted average number of sharesBasic
    
    
    
    13,439
    
    
    
    11,119
    
    
    
    8,757
    
    
    
    8,551
    
    
    
    
    8,493
    
    
    
    8,672
    
    
    
    
    8,672
    
    
    
    8,567Diluted
    
    
    
    14,322
    
    
    
    12,107
    
    
    
    9,706
    
    
    
    8,551
    
    
    
    
    8,493
    
    
    
    8,832
    
    
    
    
    8,779
    
    
    
    8,617Balance Sheet Data:Working capital
    
    
    
    35,554
    
    
    
    23,617
    
    
    
    17,053
    
    
    
    11,896
    
    
    
    
    11,896
    
    
    
    18,537
    
    
    
    
    12,115
    
    
    
    20,153Total assets
    
    
    
    108,230
    
    
    
    74,371
    
    
    
    59,885
    
    
    
    48,938
    
    
    
    
    48,938
    
    
    
    51,088
    
    
    
    
    43,557
    
    
    
    48,094Long-term obligation
    
    
    
    43
    
    
    
    58
    
    
    
    77
    
    
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    
    8
    
    
    
    287Total stockholders equity
    
    
    
    45,008
    
    
    
    33,488
    
    
    
    27,101
    
    
    
    23,344
    
    
    
    
    23,344
    
    
    
    30,969
    
    
    
    
    23,591
    
    
    
    31,161
  -4-




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##### Table of Contents



B.
    
    CAPITALIZATION AND INDEBTEDNESS.
  C.
    
    REASONS FOR THE OFFER AND USE OF PROCEEDS.
  D.
    
    RISK FACTORS.
 We depend upon three customers who each account for at least 10% of our sales. We cannot be
certain that these sales will continue; if they do not, our revenues will likely decline.
  We are controlled by one of our existing shareholders, whose interests may differ from those of
other shareholders.
  -5-




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We face significant competition from larger competitors.
  There are numerous factors relating to the operations of our business that could adversely affect
our success and results.
  
    
    technological developments in the mass production of jewelry;
    
    our ability to meet the design and production requirements of our customers
efficiently;
    
    the market acceptance of our and our customers jewelry;
    
    increases in expenses associated with continued sales growth;
    
    our ability to control costs;
    
    our managements ability to evaluate the publics taste and new orders to target
satisfactory profit margins;
    
    our capacity to develop and manage the introduction of new designed products; and
    
    our ability to compete.
  Our production facilities are located in China. Our results of operations and financial condition
may, therefore, be influenced by the economic, political, legal and social conditions in China.
  -6-




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##### Table of Contents



Our products are currently made at our production facility located in Shenzhen, China. However,
our insurance may not adequately cover any losses due to fire, casualty or theft.
  Sales of our jewelry to retailers are generally stronger during the quarter ending December 31 of
each year due to the importance of the holiday selling season.
  Our holding company structure creates restrictions on the payment of dividends.
  It may be difficult to serve us with legal process or enforce judgments against us or our
management.
  
    
    judgments of United States courts against us, our directors or our officers based on
the civil liability provisions of the securities laws of the United States or any
state; or
    
    in original actions brought in the British Virgin Islands, China or Hong Kong,
liabilities against us or non-residents based upon the securities laws of the United
States or any state.
 -7-




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Some information about us may be unavailable due to exemptions under the Exchange Act for a foreign
private issuer.
  
    
    the rules under the Exchange Act requiring the filing with the Securities and
Exchange Commission of quarterly reports on Form 10-Q or current reports on Form 8-K;
    
    the provisions of Regulation FD aimed at preventing issuers from making selective
disclosures of material information;
    
    the sections of the Exchange Act regulating the solicitation of proxies, consents or
authorizations applicable to a security registered under the Exchange Act; and
    
    the sections of the Exchange Act requiring insiders to file public reports of their
stock ownership and trading activities and establishing insider liability for profits
realized from any short-swing trading transaction.
  Since we are a British Virgin Islands company, the rights of our shareholders may be more limited
than those of shareholders of a company organized in the United States.
   -8-




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##### Table of Contents



ITEM 4. INFORMATION ON THE COMPANY
 A.
    
    HISTORY AND DEVELOPMENT OF THE COMPANY.
  
    
    Lorenzo Jewelry Limited (Lorenzo Jewelry), a company incorporated in Hong Kong
on February 20, 1987
    
    Lorenzo Jewellery (Shenzhen) Co., Ltd.
    
    Shenzhen PGS Jewelry Mfg.
    
    Lorenzo (Shenzhen) Co., Ltd.
    
    Lorenzo Crystal Ltd.
    
    Enzo (Shenzhen) Co., Ltd.
    
    Enzo Ltd.
    
    Goldleaves Gems (Shenzhen) Co., Ltd. (98% equity ownership)
    
    
    we invested $390,000 for the purchase of 1,751 square meters of production space in
our Shenzhen, China facility during the fiscal year ended December 31, 2003
    
    we invested $670,000 for the purchase of 1,639 square meters of production space in
our Shenzhen, China facility during the fiscal year ended December 31, 2005
    
    we acquired additional 78% of the equity of Goldleaves International Limited for
$2,827,500 during the fiscal year ended December 31, 2005
 -9-




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B.
    
    BUSINESS OVERVIEW.
     
    
    fine jewelers;
    
    national jewelry chains;
    
    department stores;
    
    TV shopping channels; and
    
    discount chain stores.
    -10-




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Year ended December 31,2005
    
    
    2004
    
    
    2003US & Canada
    
    
    67,780
    
    
    
    56,186
    
    
    
    42,851Europe and other countries
    
    
    20,527
    
    
    
    13,062
    
    
    
    8,017Japan
    
    
    3,686
    
    
    
    4,158
    
    
    
    5,338PRC (including Hong Kong and Macau)
    
    
    2,619
    
    
    
    3,973
    
    
    
    1,96194,612
    
    
    
    77,379
    
    
    
    58,167
 Our Industry
  
    
    specialty retailers account for $27 billion in sales
    
    mass merchants and department stores account for $12 billion in sales
    
    direct avenues (television shopping, e-commerce, catalogs) account for $6 billion
  
    
    a small number of producers that make and distribute their own jewelry directly to
retailers; and
    
    a large number of wholesalers and distributors who purchase products or portions of
products from third parties and resell those items to retailers.
    -11-




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Our Business Strategy
  
    
    increase our market share of moderately priced high-quality gem-set semi-precious
and precious jewelry by capitalizing on our unique vertically integrated production
processes to produce diamond and high-end precious stone jewelry in addition to high
volume, high-quality semi-precious products;
    
    further develop our existing customer relationships with our specialized services;
and
    
    expand aggressively into new distribution channels, particularly in the United
States and throughout Western Europe, Japan, China, and Australia.
  
    
    marketing a line of sterling silver jewelry. These are typically merchandised with
a retail price range of $30 to $150
    
    adding more lines into our Lorenzo branded products with a retail price range of
$199 to $999
    
    offering diamond jewelry and expanding this business to our current client base by
adding diamonds to some of our settings, as well as offering newly designed jewelry
    
    launching Lorenzo Gold, our new gold jewelry product line
 Our China Retail Sales Strategy
  
    
    enormous retail market  Chinas retail sales exceed $600 billion annually, making
China the third largest market in the world.
    
    large and growing jewelry market  we estimate that Chinas jewelry sales totaled
nearly $15 billion in 2002, up 19% year over year.
    
    huge pool of consumers  China has a population of 1.3 billion persons. We estimate
that roughly 160 million Chinese have enough income to purchase luxury goods.
    
    favorable regulatory changes  as a member of the World Trade Organization (WTO),
China is eliminating many restrictions on foreign ownership and operation of retail
stores. Tariffs on colored gem stones, gold, silver and pearls have been sharply
reduced, and economic and trade relationships between China and Hong Kong have been
liberalized.
 -12-




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##### Table of Contents




    
    changing consumer preferences  Chinese consumers are no longer purchasing jewelry
solely as an investment. More Chinese consumers are embracing a more Western view of
jewelry as a fashion accessory and now demand more contemporary, colorful designs.
   
    
    expanding our retail jewelry market in China by planning to open an additional 20
ENZO stores in China during 2006
    
    promoting visits with customers to coordinate and cater to their particular
promotional sales needs and monitoring their on-hand inventory in order to promote more
active sell-through
    
    expanding our distribution channels to include all major TV shopping programs in
North America, Japan, Korea and Australia and further developing business with top-40
Retail Jewelry Chains in the U.S.
 Our Production Capability
   Sales and Marketing
  -13-




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##### Table of Contents




    
    fine jewelers;
    
    national jewelry chains;
    
    department stores;
    
    TV shopping channels; and
    
    discount chain stores.
   Design and Product Development
    -14-




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Production Process
  
    
    cutting and polishing semi-precious gemstones;
    
    combining pure gold, platinum or sterling silver with gemstones or diamonds to
produce jewelry; and
    
    finishing operations such as cleaning and polishing, resulting in high quality
finished jewelry.
 Supply
       Security
  -15-




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Insurance
  Competition
    -16-




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C.
    
    ORGANIZATIONAL STRUCTURE AS OF DECEMBER 31, 2005:
  LJ INTERNATIONAL INC.
 100%
 - Lorenzo Jewelry Limited
 - Lorenzo Jewellery (Shenzhen) Co., Ltd.
 - Shenzhen PGS Jewelry Mfg.
 - Goldleaves Gems (Shenzhen) Co., Ltd.
 - Lorenzo (Shenzhen) Co., Ltd.
 - Lorenzo Crystal Ltd.
 - Enzo (Shenzhen) Co., Ltd.
 - Enzo Ltd.
 D.
    
    PROPERTY, PLANTS AND EQUIPMENT.
   l
    
    1,751 square meters for a term of five years expiring August 31, 2007 from an
unaffiliated third party at a rental rate of $3,817 per month;l
    
    1,751 square meters for a term of two years expiring June 30, 2006, at a rental rate of
$3,567 per month;
 -17-




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##### Table of Contents



l
    
    475 square meters for a term of one year expired December 31, 2005, at a rental rate of
$854 per month, extension of lease is under negotiation;l
    
    600 square meters for a term of three years expired October 31, 2005, at a rental rate
of $1,333 per month, extension of lease is under negotiation; andl
    
    1,886 square meters for a term of three years and eleven months expiring September 30,
2006, at a rental rate of $4,425 per month.
   
 ITEM 4A.UNRESOLVED STAFF COMMENTS
  -18-




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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
        -19-




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A. OPERATING RESULTS.
 Reclassifications
  Revenues
 % changeYear ended December 31
    
    
    Years ended December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003RevenueExisting customers
    
    $
    86,643
    
    
    $
    64,411
    
    
    $
    52,590
    
    
    
    35
    %
    
    
    22
    %New customersJewelry product
    
    $
    3,641
    
    
    $
    7,801
    
    
    $
    2,789
    
    
    
    -53
    %
    
    
    180
    %Giftware product
    
    $
    1,827
    
    
    $
    4,359
    
    
    $
    2,788
    
    
    
    -58
    %
    
    
    56
    %Total wholesales
business
    
    $
    92,111
    
    
    $
    76,571
    
    
    $
    58,167
    
    
    
    20
    %
    
    
    32
    %Retail business
    
    $
    2,501
    
    
    $
    808
    
    
    $
    
    
    
    
    210
    %
    
    
    N/A$
    94,612
    
    
    $
    77,379
    
    
    $
    58,167
    
    
    
    22
    %
    
    
    33
    %
   -20-




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Cost of Sales and Gross Profit
 % changeYear ended December 31
    
    

Years ended December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Cost of salesWholesales
    
    $
    71,237
    
    
    $
    60,727
    
    
    $
    44,947
    
    
    
    17
    %
    
    
    35
    %Retail
    
    $
    1,405
    
    
    $
    538
    
    
    $
    
    
    
    
    161
    %
    
    
    N/ATotal
    
    $
    72,642
    
    
    $
    61,265
    
    
    $
    44,947
    
    
    
    19
    %
    
    
    36
    %% of revenuesWholesales
    
    
    77
    %
    
    
    79
    %
    
    
    77
    %Retail
    
    
    56
    %
    
    
    67
    %
    
    
    N/ATotal
    
    
    77
    %
    
    
    79
    %
    
    
    77
    %Gross profitWholesales
    
    $
    20,874
    
    
    $
    15,844
    
    
    $
    13,220
    
    
    
    32
    %
    
    
    20
    %Retail
    
    $
    1,096
    
    
    $
    270
    
    
    $
    
    
    
    
    306
    %
    
    
    N/ATotal
    
    $
    21,970
    
    
    $
    16,114
    
    
    $
    13,220
    
    
    
    36
    %
    
    
    22
    %% of revenuesWholesales
    
    
    23
    %
    
    
    21
    %
    
    
    23
    %Retail
    
    
    44
    %
    
    
    33
    %
    
    
    N/ATotal
    
    
    23
    %
    
    
    21
    %
    
    
    23
    %
   -21-




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##### Table of Contents



Selling, General and Administrative Expenses
 % changeYear ended December 31
    
    
    Years ended December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Wholesales business
    
    $
    12,398
    
    
    $
    10,944
    
    
    $
    9,133
    
    
    
    13
    %
    
    
    20
    %Acquired
manufacturing
subsidiaries
    
    $
    479
    
    
    $
    0
    
    
    $
    0
    
    
    
    N/A
    
    
    
    N/ARetail business
    
    $
    2,611
    
    
    $
    634
    
    
    $
    0
    
    
    
    312
    %
    
    
    N/A$
    15,488
    
    
    $
    11,578
    
    
    $
    9,133
    
    
    
    34
    %
    
    
    27
    %% of revenues
    
    
    16
    %
    
    
    15
    %
    
    
    16
    %
   -22-




---



##### Table of Contents



Net gain (loss) on derivatives
 %ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Unrealised loss
on derivatives
    
    $
    (88
    )
    
    $
    (482
    )
    
    $
    (162
    )
    
    
    -82
    %
    
    
    198
    %% of revenues
    
    
    0
    %
    
    
    -1
    %
    
    
    0
    %(With the hedging mechanism in place since 2003, we have the realised gain on hedging activities)Realized gain on
hedging activities
    
    $
    96
    
    
    $
    681
    
    
    $
    249
    
    
    
    -86
    %
    
    
    173
    %% of revenues
    
    
    0
    %
    
    
    1
    %
    
    
    0
    %Net gain on
derivatives and hedging
activities
    
    $
    8
    
    
    $
    199
    
    
    $
    87
    
    
    
    -96
    %
    
    
    129
    %% of revenues
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    -23-




---



##### Table of Contents



Depreciation
 %ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Depreciation
    
    $
    1,368
    
    
    $
    1,032
    
    
    $
    1,184
    
    
    
    33
    %
    
    
    -13
    %% of revenues
    
    
    1
    %
    
    
    1
    %
    
    
    2
    %
   Amortization and impairment loss on goodwill
 %ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Amortization and
impairment loss on
goodwill
    
    $
    0
    
    
    $
    0
    
    
    $
    200
    
    
    
    N/A
    
    
    
    N/A% of revenues
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
  -24-




---



##### Table of Contents



Interest cost
 %ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Interest expenses
    
    $
    1,991
    
    
    $
    902
    
    
    $
    753
    
    
    
    121
    %
    
    
    20
    %% of revenues
    
    
    2
    %
    
    
    1
    %
    
    
    1
    %
  Income taxes
 %ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Incomes taxes expense
    
    $
    739
    
    
    $
    277
    
    
    $
    352
    
    
    
    167
    %
    
    
    -21
    %% of revenues
    
    
    1
    %
    
    
    0
    %
    
    
    1
    %
    -25-




---



##### Table of Contents



Extraordinary gain on negative goodwill
 %ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Extraordinary gain on
negative goodwill
    
    $
    378
    
    
    $
    0
    
    
    $
    0
    
    
    
    N/A
    
    
    
    N/A% of revenues
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
   -26-




---



##### Table of Contents



Inflation
  Foreign Exchange
  Governmental economic and political policies and factors
  B.
    
    LIQUIDITY AND CAPITAL RESOURCES.
  -27-




---



##### Table of Contents



Cash Flows
 Years ended December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003Net cash (used in) provided
by operating activities
    
    $
    (7,758
    )
    
    $
    (5,690
    )
    
    $
    1,489Net cash used in investing
activities
    
    
    (4,655
    )
    
    
    (1,179
    )
    
    
    (468
    )Net cash provided by
financing activities
    
    
    13,986
    
    
    
    7,375
    
    
    
    704Effect of foreign exchange
rate change
    
    
    (5
    )
    
    
    
    
    
    
    Net increase in cash and
cash equivalents
    
    
    1,568
    
    
    
    506
    
    
    
    1,725
 Operating Activities:
 Year ended December 31,(in thousands )
    
    2005
    
    2004
    
    2003Cash flows from operating activitiesNet income
    
    
    3,438
    
    
    
    2,820
    
    
    
    962Adjustments to reconcile income to net cash
(used in) provided by operating activities :Depreciation of property, plant and equipment
and properties held for lease
    
    
    1,368
    
    
    
    1,032
    
    
    
    1,184Impairment loss on property, plant and equipment
    
    
    
    
    
    
    
    
    
    
    84Amortization and impairment loss on goodwill
    
    
    
    
    
    
    
    
    
    
    200Extraordinary (gain) on negative goodwill
    
    
    (378
    )
    
    
    
    
    
    
    Unrealized loss on derivatives
    
    
    88
    
    
    
    482
    
    
    
    162Loss (Gain) on disposal and write-off of
property, plant and equipment
    
    
    8
    
    
    
    (3
    )
    
    
    2
 -28-




---



##### Table of Contents



Year ended December 31,(in thousands )
    
    2005
    
    2004
    
    2003Allowance for doubtful debts
    
    
    (72
    )
    
    
    125
    
    
    
    5Minority interests
    
    
    20
    
    
    
    
    
    
    
    (8
    )Compensation costs for warrants granted
    
    
    118
    
    
    
    
    
    
    
    Compensation expenses recognized during the year
    
    
    18
    
    
    
    11
    
    
    
    9Equity in results of investment securities
    
    
    
    
    
    
    (133
    )
    
    
    851Change in operating assets and liabilities :Trade receivables
    
    
    (8,607
    )
    
    
    (535
    )
    
    
    (4,286
    )Inventories
    
    
    (12,060
    )
    
    
    (15,142
    )
    
    
    (3,555
    )Prepayments and other current assets
    
    
    601
    
    
    
    1,187
    
    
    
    (2,493
    )Due from / to related parties
    
    
    7
    
    
    
    17
    
    
    
    3Trade payables
    
    
    1,883
    
    
    
    1,136
    
    
    
    1,797Accrued expenses and other payables
    
    
    (854
    )
    
    
    1,767
    
    
    
    1,168Letters of credit and others
    
    
    6,464
    
    
    
    1,804
    
    
    
    5,060Income taxes payables and deferred taxation
    
    
    200
    
    
    
    (258
    )
    
    
    344Net cash (used in) provided by operating activities
    
    
    (7,758
    )
    
    
    (5,690
    )
    
    
    1,489
       -29-




---



##### Table of Contents



Investing Activities:
    Years ended December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003Land & buildings
    
    $
    617
    
    
    $
    
    
    
    $
    330Leasehold improvement
    
    $
    783
    
    
    $
    487
    
    
    $
    190Furniture, fixtures and equipment
    
    $
    1,060
    
    
    $
    189
    
    
    $
    250Plant and machinery
    
    $
    209
    
    
    $
    51
    
    
    $
    93Motor vehicles
    
    $
    200
    
    
    $
    
    
    
    $
    133Total
    
    $
    2,869
    
    
    $
    727
    
    
    $
    996
 -30-




---



##### Table of Contents



Financing Activities:
     Financing Sources
 Banking Facilities and Notes Payables
   Years ended December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003Letters of credit
    
    $
    31,533
    
    
    $
    26,833
    
    
    $
    19,005Overdraft
    
    $
    3,461
    
    
    $
    3,461
    
    
    $
    3,39734,994
    
    
    
    30,294
    
    
    
    22,402Utilized :Letters of credit utilized
    
    $
    21,887
    
    
    $
    15,423
    
    
    $
    13,619Overdraft utilized
    
    $
    2,028
    
    
    $
    607
    
    
    $
    1,31223,915
    
    
    
    16,030
    
    
    
    14,931
  -31-




---



##### Table of Contents



Years ended December 31,(in thousands)
    
    2005
    
    2004
    
    2003Notes payable
    
    $
    3,079
    
    
    $
    2,487
    
    
    $
    1,516
  Gold Loan Facilities
 Years ended December 31,(in thousands)
    
    2005
    
    2004
    
    2003Gold loans outstanding (in $)
    
    $
    10,756
    
    
    $
    6,488
    
    
    $
    3,118Gold loans outstanding (in troy
ounces)
    
    
    27,920
    
    
    
    17,920
    
    
    
    10,900Gold loan interest rate
    
    
    2.4%-2.6
    %
    
    
    2.1%-2.5
    %
    
    
    1.6%-2.4
    %
  -32-




---



##### Table of Contents



Looking Forward
  Impact of recently issued US GAAP accounting standards.
     -33-




---



##### Table of Contents



C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
  D. TREND INFORMATION.
  E. OFF-BALANCE SHEET ARRANGEMENTS.
  -34-




---



##### Table of Contents



F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS.
  Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    I year
    
    1-3 years
    
    3-5 years
    
    5 yearsUS$
    
    US$
    
    US$
    
    US$
    
    US$Long-Term Debt ObligationsCapital (Finance) Lease Obligations
    
    
    63
    
    
    
    20
    
    
    
    41
    
    
    
    2
    
    
    
    Operating Lease Obligations
    
    
    2,036
    
    
    
    835
    
    
    
    1,070
    
    
    
    131
    
    
    
    Purchase Obligations
    
    
    Other Long-Term Liabilities Reflected on the Companys
    
    
    Balance Sheet under the GAAP of the primary financial statements
    
    
    Total
    
    
    2,099
    
    
    
    855
    
    
    
    1,111
    
    
    
    133
    
    
    
    
 .
 
 ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
 A.
    
    DIRECTORS AND SENIOR MANAGEMENT.Our senior management and directors are as follows:
 Name
    
    Age
    
    PositionYu Chuan Yih
    
    66
    
    Chairman of the Board of Directors, President and Chief Executive OfficerKa Man Au
    
    41
    
    Chief Operating Officer, Secretary and DirectorHon Tak Ringo Ng
    
    46
    
    Chief Financial Officer and DirectorPo Yee Elsa Yue
    
    41
    
    Non-Executive DirectorAndrew N. Bernstein
    
    53
    
    Non-Executive DirectorWing Kwan Ted Lai
    
    43
    
    Non-Executive DirectorKelvin Wong
    
    39
    
    Non-Executive Director
  -35-




---



##### Table of Contents



Mr. Yih
 Ms. Au
 Mr. Ng
 Ms. Yue
 Mr. Bernstein
 Mr. Lai
 Mr. Wong
 -36-




---



##### Table of Contents



B. COMPENSATION.
  Executive Service Contract
    C. BOARD PRACTICES.
    
    
    recommend annually to the board of directors the appointment of our independent
public accountants;
 -37-




---



##### Table of Contents




    
    discuss and review the scope and the fees of the prospective annual audit and review
the results with the independent public accountants;
    
    review and approve non-audit services of the independent public accountants;
    
    review compliance with our existing accounting and financial policies;
    
    review the adequacy of our financial organization; and
    
    review our managements procedures and policies relative to the adequacy of our
internal accounting controls and compliance with U.S. federal and state laws relating
to financial reporting.
  
    
    assess the size and composition of the board of directors in light of our operating
requirements and existing social attitudes and trends;
    
    develop membership qualifications for the board of directors and all board
committees;
    
    monitor compliance with board of director and board committee membership criteria;
    
    review and recommend directors for continued service as required based on our
evolving needs;
    
    coordinate and assist management and the board of directors in recruiting new
members to the board of directors; and
    
    investigate suggestions for candidates for membership on the board of directors and
recommend prospective directors, as required, to provide an appropriate balance of
knowledge, experience and capability on the board of directors, including stockholder
nominations for the board of directors.
  
    
    review and approve corporate goals and objectives relevant to the compensation of
the chief executive officer and other executive officers;
    
    evaluate the chief executive officers performance in light of such goals and
objectives at least annually and communicate the results to the chief executive officer
and the board of directors;
    
    set the chief executive officers compensation levels based on the foregoing
evaluation (including annual salary, bonus, stock options and other direct and indirect
benefits), with ratification by the independent directors of the full board of
directors; and
    
    set the other executive officers compensation levels (including annual salary,
bonus, stock options and other direct and indirect benefits).
 -38-




---



##### Table of Contents



D. EMPLOYEES.
  E. SHARE OWNERSHIP.
  
    
    each person who is known by us to own beneficially more than 5% of our outstanding
common stock;
    
    each of our current executive officers and directors; and
    
    all executive officers and directors as a group.
    Name of Beneficial Holder
 Number
    
    PercentShares Beneficially OwnedYu Chuan Yih
    
    
    3,856,353
    (1)(2)
    
    
    22.5
    %Ka Man Au
    
    
    202,000
    (3)
    
    
    1.3
    %Hon Tak Ringo Ng
    
    
    100,000
    (4)
    
    
    *Po Yee Elsa Yue
    
    
    4,000
    (5)
    
    
    *Andrew N. Bernstein
    
    
    100,000
    (6)
    
    
    *Kelvin Wong
    
    
    0
    
    
    
    *Wing Kwan Ted Lai
    
    
    0
    
    
    
    *All directors and executive officers as a group (7 persons)
    
    
    4,262,353
    
    
    
    24.4
    %
 
 *
    
    Represents less than 1% beneficial ownership -39-




---



##### Table of Contents



(1)
    
    Of Mr. Yihs 2,267,853 shares, 1,500,000 shares are owned of record by Pacific Growth
Developments Ltd., a British Virgin Islands corporation, which is owned by Mr. Yih (60%), his
wife Tammy Yih (20%) and an adult daughter, Bianca Tzu Hsiu Yih (20%).(2)
    
    Includes options currently exercisable to acquire:
 
    
    766,500 shares of common stock at $2.00 per share at any time until April 30, 2008;
    
    22,000 shares of common stock at $2.25 per share at any time until April 30, 2008;
and
    
    800,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 (3)
    
    Represents options currently exercisable to acquire:
 
    
    27,000 shares of common stock at $2.00 per share at any time until April 30, 2008;
    
    100,000 shares of common stock at $2.25 per share at any time until April 30, 2008;
and
    
    75,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 (4)
    
    Represents options currently exercisable to acquire:
 
    
    25,000 shares of common stock at $2.00 per share at any time until April 30, 2008;
and
    
    75,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 (5)
    
    Represents options currently exercisable to acquire:
 
    
    4,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 (6)
    
    Includes options currently exercisable to acquire:
 
    
    50,000 shares of common stock at $2.00 per share at any time until April 30, 2008.
 The 1998 Stock Compensation Plan
  
    
    encourage ownership of our common stock by our officers, directors, employees and
advisors;
    
    provide additional incentive for them to promote our success and our business; and
    
    encourage them to remain in our employ by providing them with an opportunity to
benefit from any appreciation of our common stock through the issuance of stock
options.
  -40-




---



##### Table of Contents




    
    a total of 2,014,500 stock options, consisting of stock options to purchase 761,000
and 862,000 shares at $2.00 per share through April 30, 2008 and June 30, 2013,
respectively, and 391,500 stock options to purchase 391,500 shares at $2.25 per share
through April 30, 2008. A total of 1,668,500 stock options are held by our directors
and officers as a group.
 The 2003 Stock Compensation Plan
  
    
    encourage ownership of our common stock by our officers, directors, employees and
advisors;
    
    provide additional incentive for them to promote our success and our business; and
    
    encourage them to remain in our employ by providing them with an opportunity to
benefit from any appreciation of our common stock through the issuance of stock
options.
  -41-




---



##### Table of Contents




    
    a total of 1,296,000 stock options, consisting of stock options to purchase
1,174,000 shares at $2.00 per share through June 30, 2013 and 122,000 shares at $2.25
per share through April 30, 2008. A total of 434,000 stock options are held by our
directors and officers as a group.
 The 2005 Stock Compensation Plan
  
    
    encourage ownership of our common stock by our officers, directors, employees and
advisors;
    
    provide additional incentive for them to promote our success and our business; and
    
    encourage them to remain in our employ by providing them with an opportunity to
benefit from any appreciation of our common stock through the issuance of stock
options.
 -42-




---



##### Table of Contents



Other Options and Warrants Outstanding
  
    
    warrants to purchase 200,000 shares at $3.00 per share through August 15, 2006 which
we granted to The Bauer Partnership, Inc. on August 16, 2001, in connection with a
proposed debt placement which was never completed
    
    warrants to purchase 429,676 shares at $2.98 per share through September 3, 2009
which we sold to a group of investors pursuant to a private placement offering on
September 1, 2004
    
    warrants to purchase an aggregate of 500,000 shares through April 4, 2008 which we
granted to a consultant pursuant to a consulting agreement dated April 5, 2005 on the
following terms:
 
 -43-




---



##### Table of Contents



ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
 A.
    
    MAJOR SHAREHOLDERS.
     B.
    
    RELATED PARTY TRANSACTIONS.
   
 C. INTERESTS OF EXPERTS AND COUNSEL.
  -44-




---



##### Table of Contents



ITEM 8. FINANCIAL INFORMATION
 A.
    
    CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION.The Consolidated Financial Statements are filed in this Annual Report as Item 18.Export sales constitute significantly all of our total sales volume.
   B.
    
    SIGNIFICANT CHANGES.
  -45-




---



##### Table of Contents



ITEM 9. THE OFFER AND LISTING
 A.
    
    OFFER AND LISTING DETAILS.
  Period
    
    High
    
    LowYear ended April 30, 2001
    
    $
    3.88
    
    
    $
    1.63Year ended April 30, 2002
    
    $
    2.79
    
    
    $
    1.18Year ended December 31, 2002
    
    $
    1.56
    
    
    $
    1.11Year ended December 31, 2003
    
    $
    5.00
    
    
    $
    1.14Year ended December 31, 2004
    
    $
    5.74
    
    
    $
    2.21Year ended December 31, 2005
    
    $
    3.95
    
    
    $
    2.03Quarter ended March 31, 2004
    
    $
    5.74
    
    
    $
    3.75Quarter ended June 30, 2004
    
    $
    4.23
    
    
    $
    3.14Quarter ended September 30, 2004
    
    $
    3.79
    
    
    $
    2.25Quarter ended December 31, 2004
    
    $
    3.36
    
    
    $
    2.21Quarter ended March 31, 2005
    
    $
    3.59
    
    
    $
    2.68Quarter ended June 30, 2005
    
    $
    2.80
    
    
    $
    2.07Quarter ended September 30, 2005
    
    $
    3.19
    
    
    $
    2.03Quarter ended December 31, 2005
    
    $
    3.95
    
    
    $
    3.00Month ended September 30, 2005
    
    $
    3.19
    
    
    $
    2.79Month ended October 31, 2005
    
    $
    3.19
    
    
    $
    3.00Month ended November 30, 2005
    
    $
    3.81
    
    
    $
    3.08Month ended December 31, 2005
    
    $
    3.95
    
    
    $
    3.26Month ended January 31, 2006
    
    $
    3.50
    
    
    $
    3.34Month ended February 28, 2006
    
    $
    4.16
    
    
    $
    3.50
 -46-




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##### Table of Contents



B. PLAN OF DISTRIBUTION.
  C. MARKETS.
  D. SELLING SHAREHOLDERS.
  E. DILUTION.
  F. EXPENSES OF THE ISSUE.
  
 ITEM 10. ADDITIONAL INFORMATION
 A. SHARE CAPITAL.
  B. MEMORANDUM AND ARTICLES OF ASSOCIATION.
  -47-




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##### Table of Contents



-48-




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##### Table of Contents



-49-




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##### Table of Contents



C. MATERIAL CONTRACTS.
  D. EXCHANGE CONTROLS.
  E. TAXATION.
  United States Federal Income Taxation
  -50-




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##### Table of Contents




    
    a court within the United States is able to exercise primary supervision over its
administration; and
    
    one or more United States persons have the authority to control all of its
substantial decisions.
      
    
    is a corporation or comes within other exempt categories; or
    
    provides a correct taxpayer identification number, certifies that such holder is not
subject to backup withholding and otherwise complies with the backup withholding rules.
  -51-




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##### Table of Contents



British Virgin Islands Taxation
    F. DIVIDENDS AND PAYING AGENTS.
  G. STATEMENT BY EXPERTS.
  H. DOCUMENTS ON DISPLAY.
  -52-




---



##### Table of Contents



I. SUBSIDIARY INFORMATION.
  
 ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
  
 PART II
 
 ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
  
 ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
  
 ITEM 15. CONTROLS AND PROCEDURES
 (a) Disclosure Controls and Procedures.
  -53-




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##### Table of Contents



(b) Managements annual report on internal control over financial reporting.
  
 ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
  
 ITEM 16B. CODE OF ETHICS
  
 ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
 (a) Audit Fees.
  (b) Audit  Related Fees.
  -54-




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##### Table of Contents



(c) Tax Fees.
  (d) All Other Fees.
  (e) Audit Committee Pre-Approval Policies and Procedures.
     (f).
 
 ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.
  -55-




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##### Table of Contents



ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.
   
 PART III
 
 ITEM 17. FINANCIAL STATEMENTS
  
 ITEM 18. FINANCIAL STATEMENTS
        -56-




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##### Table of Contents



LJ INTERNATIONAL INC.
 INDEX TO FINANCIAL STATEMENTS
 PageReport of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Statements of Operations
    
    
    F-3  F-4Consolidated Balance Sheets
    
    
    F-5Consolidated Statements of Shareholders Equity and Comprehensive Income
    
    
    F-6  F-7Consolidated Statements of Cash Flows
    
    
    F-8  F-9Notes to and Forming Part of the Financial Statements
    
    
    F-10  F-36
 F-1




---



##### Table of Contents



REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
 LJ International Inc.
    Moores Rowland Mazars  Chartered Accountants
Certified Public Accountants, Hong Kong
  F-2




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF OPERATIONS
  Year ended
    
    
    Year ended
    
    
    Year endedNotes
    
    
    December 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$(Restated)
    
    (Restated)Operating revenue
    
    
    2
    (c)
    
    
    94,612
    
    
    
    77,379
    
    
    
    58,167Costs of goods sold (Exclusive of depreciation)
    
    
    
    
    
    
    (72,642
    )
    
    
    (61,265
    )
    
    
    (44,947
    )Gross profit
    
    
    
    
    
    
    21,970
    
    
    
    16,114
    
    
    
    13,220Other operating income
    
    
    
    
    
    
    549
    
    
    
    125
    
    
    
    163Operating expensesSelling, general and administrative expenses
    
    
    
    
    
    
    (15,488
    )
    
    
    (11,578
    )
    
    
    (9,133
    )Net gain (loss) on derivatives
    
    
    
    
    
    
    8
    
    
    
    199
    
    
    
    87Depreciation
    
    
    
    
    
    
    (1,368
    )
    
    
    (1,032
    )
    
    
    (1,184
    )Impairment on property, plant and equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (84
    )Impairment loss on goodwill
    
    
    8
    
    
    
    
    
    
    
    
    
    
    
    (200
    )Operating income
    
    
    
    
    
    
    5,671
    
    
    
    3,828
    
    
    
    2,869Other income and expenseInterest income
    
    
    2
    (c)
    
    
    139
    
    
    
    38
    
    
    
    41Interest expenses
    
    
    
    
    
    
    (1,991
    )
    
    
    (902
    )
    
    
    (753
    )Income before income taxes, minority interests,
equity in results of investment securities and
extraordinary item
    
    
    
    
    
    
    3,819
    
    
    
    2,964
    
    
    
    2,157Income taxes expense
    
    
    11
    
    
    
    (739
    )
    
    
    (277
    )
    
    
    (352
    )Income before minority interests, equity in
results of investment securities and
extraordinary item
    
    
    
    
    
    
    3,080
    
    
    
    2,687
    
    
    
    1,805Minority interests in consolidated subsidiaries
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    8Income before equity in results of investment
securities and extraordinary item
    
    
    
    
    
    
    3,060
    
    
    
    2,687
    
    
    
    1,813Equity in results of investment securities
    
    
    
    
    
    
    
    
    
    
    133
    
    
    
    (851
    )Income before extraordinary item
    
    
    
    
    
    
    3,060
    
    
    
    2,820
    
    
    
    962Extraordinary gain on negative goodwill
    
    
    3
    
    
    
    378
    
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    3,438
    
    
    
    2,820
    
    
    
    962Numerator:Net income used in computing basic earnings per share
    
    
    
    
    
    
    3,438
    
    
    
    2,820
    
    
    
    962Denominator:Weighted average number of shares used in
calculating basic earnings per share
    
    
    
    
    
    
    13,438,578
    
    
    
    11,118,995
    
    
    
    8,757,266Effect of dilutive potential ordinary shares:Warrants
    
    
    
    
    
    
    28,738
    
    
    
    55,693
    
    
    
    183,151Stock options
    
    
    
    
    
    
    854,568
    
    
    
    932,786
    
    
    
    765,267Weighted average number of shares used in
calculating diluted earnings per share
    
    
    
    
    
    
    14,321,884
    
    
    
    12,107,474
    
    
    
    9,705,684
  F-3




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Year ended
    
    
    Year ended
    
    
    Year endedNotes
    
    
    December 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Basic earnings per share:
    
    
    2
    (g)Income before extraordinary item
    
    
    
    
    
    
    0.23
    
    
    
    0.25
    
    
    
    0.11Extraordinary item
    
    
    
    
    
    
    0.03
    
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    0.26
    
    
    
    0.25
    
    
    
    0.11Diluted earnings per share:
    
    
    2
    (g)Income before extraordinary item
    
    
    
    
    
    
    0.21
    
    
    
    0.23
    
    
    
    0.10Extraordinary item
    
    
    
    
    
    
    0.03
    
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    0.24
    
    
    
    0.23
    
    
    
    0.10
  F-4




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED BALANCE SHEETS
  As of December 31,Notes
    
    
    2005
    
    
    2004US$
    
    
    US$(Restated)ASSETSCurrent assetCash and cash equivalents
    
    
    
    
    
    
    4,796
    
    
    
    3,228Restricted cash
    
    
    
    
    
    
    5,839
    
    
    
    6,393Trade receivables, net of allowance for
doubtful accounts (December 31, 2005: US$212; December 31, 2004: US$284)
    
    
    
    
    
    
    24,960
    
    
    
    15,653Derivatives
    
    
    
    
    
    
    2,034
    
    
    
    Investment in capital guaranteed fund
    
    
    
    
    
    
    2,496
    
    
    
    Inventories
    
    
    5
    
    
    
    55,941
    
    
    
    36,629Prepayments and other current assets
    
    
    
    
    
    
    2,538
    
    
    
    2,539Total current assets
    
    
    
    
    
    
    98,604
    
    
    
    64,442Properties held for lease, net
    
    
    6
    
    
    
    1,400
    
    
    
    1,452Property, plant and equipment, net
    
    
    7
    
    
    
    6,221
    
    
    
    4,673Due from related parties
    
    
    16
    (b)
    
    
    484
    
    
    
    491Goodwill, net
    
    
    8
    
    
    
    1,521
    
    
    
    1,521Investment securities, net
    
    
    9
    
    
    
    
    
    
    
    1,792Total assets
    
    
    
    
    
    
    108,230
    
    
    
    74,371LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesBank overdrafts
    
    
    10
    
    
    
    2,028
    
    
    
    607Notes payable
    
    
    10
    
    
    
    3,079
    
    
    
    2,487Capitalized lease obligation, current portion
    
    
    
    
    
    
    20
    
    
    
    19Letters of credit, gold and others
    
    
    10
    
    
    
    32,643
    
    
    
    21,911Derivatives
    
    
    
    
    
    
    3,567
    
    
    
    1,462Trade payables
    
    
    
    
    
    
    12,168
    
    
    
    9,553Accrued expenses and other payables
    
    
    
    
    
    
    7,280
    
    
    
    4,631Due to related parties
    
    
    16
    (b)
    
    
    1,910
    
    
    
    Income taxes payable
    
    
    
    
    
    
    201
    
    
    
    68Deferred taxation
    
    
    11
    
    
    
    154
    
    
    
    87Total current liabilities
    
    
    
    
    
    
    63,050
    
    
    
    40,825Capitalized lease obligation, non-current
    
    
    
    
    
    
    43
    
    
    
    58Total liabilities
    
    
    
    
    
    
    63,093
    
    
    
    40,883Minority interest
    
    
    
    
    
    
    129
    
    
    
    Commitments and contingencies
    
    
    12Shareholders equityCommon stocks, par value US$0.01 each,
Authorized - 100 million shares,
Issued  15,521,203 shares as of
December 31, 2005 and 12,304,658 shares
as of December 31, 2004
    
    
    13
    
    
    
    155
    
    
    
    123Additional paid-in capital
    
    
    
    
    
    
    31,419
    
    
    
    23,382Accumulated other comprehensive loss
    
    
    
    
    
    
    (156
    )
    
    
    (151
    )Unearned compensation
    
    
    2
    (q)
    
    
    (19
    )
    
    
    (37
    )Retained earnings
    
    
    
    
    
    
    13,609
    
    
    
    10,171Total shareholders equity
    
    
    
    
    
    
    45,008
    
    
    
    33,488Total liabilities and shareholders equity
    
    
    
    
    
    
    108,230
    
    
    
    74,371
  F-5




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
  AccumulatedCommon stock
    
    
    Additional
    
    
    Treasury stock
    
    
    otherNumber
    
    
    Par
    
    
    Paid-in
    
    
    Number
    
    
    
    
    
    
    comprehensive
    
    
    Unearned
    
    
    RetainedNotes
    
    
    of shares
    
    
    Value
    
    
    Capital
    
    
    of shares
    
    
    Cost
    
    
    loss
    
    
    compensation
    
    
    earnings
    
    
    TotalUS$
    
    
    US$
    
    
    
    
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$(Note 2(y))
    
    
    
    
    
    
    (Restated)
    
    
    (Restated)Balance as of January 1, 2003
    
    
    
    
    
    
    8,671,615
    
    
    
    87
    
    
    
    17,410
    
    
    
    (318,200
    )
    
    
    (391
    )
    
    
    (151
    )
    
    
    
    
    
    
    6,389
    
    
    
    23,344Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    962
    
    
    
    962Issuance of common stock
upon exercise of stock
options
    
    
    13(a)(i)
    
    
    1,122,500
    
    
    
    11
    
    
    
    2,234
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,245Issuance of common stock
upon exercise of warrants
    
    
    13(a)(i)
    
    
    95,891
    
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Compensation costs for
stock-based transactions
    
    
    15(b)
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9Sales of treasury stock
    
    
    13(b)
    
    
    
    
    
    
    
    
    
    
    150
    
    
    
    318,200
    
    
    
    391
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    541Balance as of December 31,
2003
    
    
    
    
    
    
    9,890,006
    
    
    
    99
    
    
    
    19,802
    
    
    
    
    
    
    
    
    
    
    
    (151
    )
    
    
    
    
    
    
    7,351
    
    
    
    27,101Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,820
    
    
    
    2,820Issuance of common stock on
private placement
    
    
    13(a)(ii)
    
    
    1,614,082
    
    
    
    16
    
    
    
    2,730
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,746Issuance of common stock
upon exercise of stock
options
    
    
    13(a)(iii)
    
    
    405,000
    
    
    
    4
    
    
    
    806
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    810Issuance of common stock
upon exercise of warrants
    
    
    13(a)(iii)
    
    
    395,570
    
    
    
    4
    
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock options granted
    
    
    2(q)
    
    
    
    
    
    
    
    
    
    
    48
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (48
    )
    
    
    
    
    
    
    Compensation expense
recognized during the year
    
    
    2(q)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    11Balance as of December 31,
2004
    
    
    
    
    
    
    12,304,658
    
    
    
    123
    
    
    
    23,382
    
    
    
    
    
    
    
    
    
    
    
    (151
    )
    
    
    (37
    )
    
    
    10,171
    
    
    
    33,488
  F-6




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
  AccumulatedCommon stock
    
    
    Additional
    
    
    Treasury stock
    
    
    otherNumber
    
    
    Par
    
    
    Paid-in
    
    
    Number
    
    
    
    
    
    
    comprehensive
    
    
    Unearned
    
    
    RetainedNotes
    
    
    of shares
    
    
    Value
    
    
    Capital
    
    
    of shares
    
    
    Cost
    
    
    loss
    
    
    compensation
    
    
    earnings
    
    
    TotalUS$
    
    
    US$
    
    
    
    
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$(Note 2(y))
    
    
    
    
    
    
    (Restated)
    
    
    (Restated)Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,438
    
    
    
    3,438Exchange
translation
difference
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    (5
    )3,833Issuance of common
stock upon exercise
of stock options
    
    13(a)(iv)
    
    
    3,162,000
    
    
    
    31
    
    
    
    7,542
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,573Issuance of common
stock upon exercise
of warrants
    
    13(a)(iv)
    
    
    54,545
    
    
    
    1
    
    
    
    162
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    163Compensation costs
for warrants granted
    
    15(b)

    
    
    
    
    
    
    
    
    
    
    118
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    118Equity in capital
transaction of
investment
securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    215
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    215Compensation expense
recognized during
the year
    
    2(q)

    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    18
    
    
    
    
    
    
    
    18Balance as of
December 31, 2005
    
    
    
    
    
    
    15,521,203
    
    
    
    155
    
    
    
    31,419
    
    
    
    
    
    
    
    
    
    
    
    (156
    )
    
    
    (19
    )
    
    
    13,609
    
    
    
    45,008
  F-7




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003Notes
    
    
    US$
    
    
    US$
    
    
    US$(Restated)
    
    
    (Restated)Cash flows from operating activities:Net income
    
    
    
    
    
    
    3,438
    
    
    
    2,820
    
    
    
    962Adjustments to reconcile income (loss) to net cash (used
in) provided by operating activities:Depreciation of property, plant and equipment and
properties held for lease
    
    
    
    
    
    
    1,368
    
    
    
    1,032
    
    
    
    1,184Impairment loss on property, plant and
equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    84Amortization and impairment loss on goodwill
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    200Extraordinary gain on negative goodwill
    
    
    
    
    
    
    (378
    )
    
    
    
    
    
    
    Unrealized loss on derivatives
    
    
    
    
    
    
    88
    
    
    
    482
    
    
    
    162Loss (Gain) on disposal and write-off of property, plant
and equipment
    
    
    
    
    
    
    8
    
    
    
    (3
    )
    
    
    2Allowance for doubtful debts
    
    
    
    
    
    
    (72
    )
    
    
    125
    
    
    
    5Minority interests
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    (8
    )Compensation costs for warrants granted
    
    
    
    
    
    
    118
    
    
    
    
    
    
    
    Compensation expenses recognized during the year
    
    
    
    
    
    
    18
    
    
    
    11
    
    
    
    9Equity in results of investment securities
    
    
    
    
    
    
    
    
    
    
    (133
    )
    
    
    851Changes in operating assets and liabilities:Trade receivables
    
    
    
    
    
    
    (8,607
    )
    
    
    (535
    )
    
    
    (4,286
    )Inventories
    
    
    
    
    
    
    (12,060
    )
    
    
    (15,142
    )
    
    
    (3,555
    )Prepayments and other current assets
    
    
    
    
    
    
    601
    
    
    
    1,187
    
    
    
    (2,493
    )Due from related parties
    
    
    
    
    
    
    7
    
    
    
    17
    
    
    
    3Trade payables
    
    
    
    
    
    
    1,883
    
    
    
    1,136
    
    
    
    1,797Accrued expenses and other payables
    
    
    
    
    
    
    (854
    )
    
    
    1,767
    
    
    
    1,168Letters of credit and others
    
    
    
    
    
    
    6,464
    
    
    
    1,804
    
    
    
    5,060Income taxes payable and deferred taxation
    
    
    
    
    
    
    200
    
    
    
    (258
    )
    
    
    344Net cash (used in) provided by operating activities
    
    
    
    
    
    
    (7,758
    )
    
    
    (5,690
    )
    
    
    1,489Cash flows from investing activities:Change in restricted cash
    
    
    
    
    
    
    554
    
    
    
    (462
    )
    
    
    427Net cash inflow from acquisition
    
    
    
    
    
    
    156
    
    
    
    
    
    
    
    Purchase of capital guaranteed fund
    
    
    
    
    
    
    (2,496
    )
    
    
    
    
    
    
    Purchase of property, plant and equipment
    
    
    
    
    
    
    (2,869
    )
    
    
    (727
    )
    
    
    (897
    )Proceeds on disposals of property, plant and
equipment
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    2Net cash used in investing activities
    
    
    
    
    
    
    (4,655
    )
    
    
    (1,179
    )
    
    
    (468
    )
  F-8




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003Notes
    
    
    US$
    
    
    US$
    
    
    US$(Restated)
    
    
    (Restated)Cash flows from financing activities:Change in bank overdrafts
    
    
    
    
    
    
    1,421
    
    
    
    (705
    )
    
    
    (1,795
    )Proceeds from issuance of shares upon
exercise of stock options
    
    
    
    
    
    
    7,573
    
    
    
    810
    
    
    
    2,245Proceeds from issuance of share upon
exercise of stock warrants
    
    
    
    
    
    
    163
    
    
    
    
    
    
    
    Net proceeds from issuance of shares in
private placement
    
    
    
    
    
    
    
    
    
    
    2,746
    
    
    
    Loans acquired
    
    
    
    
    
    
    10,267
    
    
    
    7,624
    
    
    
    1,516Repayment of loans
    
    
    
    
    
    
    (5,424
    )
    
    
    (3,082
    )
    
    
    (1,777
    )Repayment of capitalized lease obligation
    
    
    
    
    
    
    (14
    )
    
    
    (18
    )
    
    
    (26
    )Sale of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    541Net cash provided by financing activities
    
    
    
    
    
    
    13,986
    
    
    
    7,375
    
    
    
    704Effect of foreign exchange rate change
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    Net increase in cash and cash equivalents
    
    
    
    
    
    
    1,568
    
    
    
    506
    
    
    
    1,725Cash and cash equivalents, as of
beginning of period
    
    
    
    
    
    
    3,228
    
    
    
    2,722
    
    
    
    997Cash and cash equivalents, as of end of
period
    
    
    
    
    
    
    4,796
    
    
    
    3,228
    
    
    
    2,722Supplemental disclosure information:Interest expense
    
    
    
    
    
    
    1,991
    
    
    
    872
    
    
    
    728Income taxes paid
    
    
    
    
    
    
    539
    
    
    
    535
    
    
    
    9Non-cash transactions:Purchase of property, plant and
equipment under capitalized leases
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    98
  F-9




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  1.
    
    NATURE OF BUSINESS AND BASIS OF FINANCIAL STATEMENTSLJ International Inc. (LJI), its subsidiaries and variable interest entities (VIEs)
(collectively referred as the Company) are principally involved in the design, manufacture,
marketing and sale of precious and semi-precious gemstones as well as diamond jewelry.
While the Company is based in Hong Kong, its manufacturing operations are in the Peoples
Republic of China (PRC) and most of its sales are currently in the United States of America
(US). The Company also owns certain commercial and residential properties located in Hong
Kong, which are held primarily for investment purposes.2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 (a)
    
    Basis of accountingThe financial statements are prepared in accordance with U.S. generally accepted
accounting principles.(b)
    
    Principles of consolidation and goodwillThe consolidated financial statements include the financial information of LJI, its
subsidiaries and VIEs for which the Company is the primary beneficiary. The results of
subsidiaries and VIEs acquired or disposed of during the year are consolidated from or
to their effective dates of acquisition or disposal respectively. All material
intercompany balances and transactions have been eliminated on consolidation.During 2004, the Company adopted Financial Accounting Standards Board (FASB)
Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51 (FIN 46(R)). FIN 46(R) requires certain
variable interest entities to be consolidated by the primary beneficiary of the
entity if the equity investors in the entity do not have the characteristics of a
controlling financial interest nor do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial support
from other parties.Lorenzo (Shenzhen) Co., Ltd. (LSC) and Enzo (Shenzhen) Co., Ltd. (ESC) are VIEs that
each of them is owned by 2 individuals, who are acting as agents for the Company.
The Company does not have any ownership interest in LSC and ESC. The Company is
incorporated in the BVI and is considered a foreign entity under the PRC laws. Due
to the restrictions on foreign ownership on the retail business of jewelries, the
Company, through loans to the agents, established LSC and ESC to carry out the
retail business of jewelries in the PRC. Pursuant to various agreements entered
into between the Company, the agents and LSC on May 21, 2004, the agents and ESC on
July 14, 2005, the Company generally has control of LSC and ESC, absorbs majority
of expected losses and receives majority of residual return of LSC and ESC. The
Company is therefore considered the primary beneficiary of LSC and ESC.
Accordingly, the results of LSC and ESC are consolidated in the financial
statements of the Company since May 21, 2004 and July 14, 2005 respectively.
 F-10




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (b)
    
    Principles of consolidation and goodwill (Continued)The application of the consolidation provisions of FIN 46(R) resulted in a decrease in
assets and an increase in liabilities as of December 31, 2005 by US$4,586 and US$1,882
respectively and a decrease in assets and an increase in liabilities as of December 31,
2004 by US$141 and US$82 respectively and an increase in net loss of US$1,248 and US$223
for each of two years ended December 31, 2005 and 2004 respectively.Goodwill represents the excess of cost over fair value of acquired net assets and is
subject to annual impairment tests. As part of an ongoing review of the valuation of
goodwill, management assesses the fair value of the reporting units to determine if
changes in facts and circumstances suggest that they may be impaired. If this review
indicates that the goodwill is not recoverable, as determined by a discounted cash flow
analysis, the carrying value of the Companys goodwill would be reduced accordingly.(c)
    
    Revenue recognitionOperating revenue represents:
   (i)
    
    Rental income from investment properties under operating leases is
recognized in the period in which the properties are let out and on the
straight-line basis over the lease term.(ii)
    
    Net gain from the trading of precious and semi-precious gemstones is
recognized when gemstones are delivered and the title has passed to customers; and(iii)
    
    Subcontracting income is recognized in the period when services are
rendered.
   (d)
    
    Sales return reserveThe Company has allowed sales returns and its sales generally include specified return
policy for certain customers. The Company reserves for sales returns as a reduction of
revenue at the time the operating revenue is recognized based on historical sales return
experience and agreed terms of sales return stated in the contracts with certain
specific customers.(e)
    
    Shipping and handling costsThe shipping and handling costs are included in costs of goods sold. The amounts of
revenue received for shipping and handling are included in operating revenue.
 F-11




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (f)
    
    Advertising and promotion costsAdvertising and promotion expenses are generally expensed when incurred. Advertising
costs were US$1,092, US$364 and US$871 for the years ended December 31, 2005, 2004 and
2003, respectively.(g)
    
    Earnings per shareThe calculation of basic earnings per share is based on net income for the year
attributable to shareholders and on the weighted average number of ordinary shares
outstanding during the year.The calculation of diluted earnings per share is based on net income for the year
attributable to shareholders and on the weighted average number of ordinary shares
outstanding during the year, adjusted for the effects of all dilutive potential ordinary
 shares. The dilutive effect of convertible securities is reflected in diluted earnings
per share by application of the if-converted method. 300,000 warrants that could
potentially dilute basic earnings per share in the future were not included in the
computation of diluted earnings per share for the year ended December 31, 2005 because
to do so would have been anti-dilutive for the year.(h)
    
    Fair value of financial instrumentsThe financial instruments used by the Company in the normal course of business,
including cash and cash equivalents, trade receivables, trade payables, notes payable
and letter of credit, gold and other loans, have fair values which approximate their
recorded value as the financial instruments are either short term in nature or carry
interest rate that approximate market rates.(i)
    
    Accounts receivableAccounts receivable are stated at the amount billed to customers, net of discounts. The
Company provides an allowance for doubtful accounts, which is based upon a review of
outstanding receivables, historical collection information and existing economic
conditions. No interest is chargeable to customers for accounts that are unpaid after
the due date. Accounts past due more than one year are considered delinquent.
Delinquent receivables are written off based on individual credit evaluation and
specific circumstances of the customer.(j)
    
    InventoriesInventories are stated at the lower of cost and market. Cost, which comprises all
costs of purchase and, where applicable, costs of conversion and other costs that
have been incurred in bringing the inventories to their present location and
condition, including inbound freight charges, purchasing and receiving cost,
inspection costs and internal transfer costs, is calculated using the weighted
average costing method. Estimated losses on inventories represent reserves for
obsolescence, excess quantities, irregulars and slow moving inventory , and which
are charged to cost of goods sold. The Company estimates the loss/write-down on the
basis of its assessment of the inventorys net realizable value based upon current
market conditions and historical experience.
 F-12




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (j)
    
    Inventories (Continued)Effective January 1, 2005, the Company changed its method of valuing its inventory from
the first-in, first-out method to the monthly weighted average costing method.
Management believes the weighted average costing method results in a better matching of
current costs with current revenues and minimizes the effect of price level changes on
inventory valuation. The cumulative effect of this accounting change for years prior to
2005 and the effects of retroactive application of the weighted average costing method
to prior years are immaterial. The effect of the change in 2005 was to increase net
income of the Company by US$35.(k)
    
    Properties held for leaseProperties held for lease are carried at cost, less accumulated depreciation, which is
computed using the straight-line method over the estimated useful lives of the assets.
Rental income from these properties is recorded on a monthly basis in accordance with
the lease terms.(l)
    
    Property, plant and equipment (PPE) and depreciationPPE are stated at cost, less accumulated depreciation and accumulated impairment loss,
and include expenditure that substantially increases the useful lives of existing
assets. Maintenance and repairs are charged to current operations as incurred. Upon
sale, retirement, or other disposition of these assets, the cost and related accumulated
depreciation and accumulated impairment loss are removed from the respective accounts,
and any gain or loss is included in the consolidated statement of operations.Depreciation is provided by using the straight-line method over the estimated useful
lives of the related assets at the following annual rates:
 Leasehold land and buildings
    
    2% or over the unexpired term of leasesLeasehold improvement
    
    shorter of 10% or the unexpired term of leasesFurniture, fixtures and equipment
    
    20% to 50%Plant and machinery
    
    10%Motor vehicles
    
    20%
 (m)
    
    Impairment of long-lived assetsLong-lived assets are review at least annually for impairment whenever events or changes
in circumstances indicate that the carrying amount of the asset may not be recoverable.
Recoverability of assets to be held and used is measured by a comparison of the carrying
amount of an asset to undiscounted future net cash flows expected to be generated by the
asset. If such assets are considered to be impaired, impairment is measured as the
difference between the carrying amount and fair value of the asset.(n)
    
    Investment securitiesPrior to January 1, 2005, investment in non-marketable securities held for an identified
long term purpose are stated at cost and subject to impairment review at each reporting
date to reflect any diminution in their value, which is expected to be other than
temporary. The amount of impairment is recognized as an expense in the period in which
the decline occurs. On January 1, 2005, as set out in
note 3, the Company acquired additional shares in this non-marketable securities and
became the major shareholder.As appropriate for a step-acquisition, the investment was restated to account for
under the equity method for periods before January 1, 2005.
 F-13




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (o)
    
    Gold loans and embedded derivativeGold loans are commodity-indexed debts with an embedded derivative. The loan is
recorded at its original amount and adjusted for additional borrowings and repayments.
The embedded derivative component was valued at fair value, considering the market price
of gold, volatility of gold and the time value of money. Any changes in fair value of
embedded derivative are included in the consolidated statement of operations and an
asset or liability representing the value of the embedded derivative portion is included
in the consolidated balance sheet.(p)
    
    DerivativesThe Company enters into derivative contracts to hedge the future settlement of gold
loans in order to mitigate the risk of market price fluctuations. They consist of
contracts that are used to hedge against changes in the fair value of gold price when
the Company settles the gold loans.The derivative contracts and the embedded derivative are valued at fair value. Changes
in fair value of derivative contracts are included in the consolidated statement of
operations, net of changes in fair value of embedded derivative set out in note 2(o).(q)
    
    Stock-based compensationThe Company records compensation expense for stock-based employee compensation plans
using the intrinsic value method pursuant to APB Opinion No. 25 in which compensation
expense is measured as the excess of the market price of the stock over the exercise
price of the award on the measurement date. Compensation expense is charged to income
as when incurred if the benefit was fully vested at the date of grant or is recognized
proportionately over the vesting period. Unearned compensation is shown separately as a
reduction of the stockholders equity.As of December 31, 2005, the Company has three stock-based employee compensation plans,
details of which are set out in note 14(a).In 2004, the Company recorded an unearned compensation of US$48 in the shareholders
equity in relation to the option to purchase 150,000 shares of the common stock of the
Company granted to an employee, for which the exercise price was below the market price
of the underlying stock at the date of grant. This amount is accrued proportionately
as compensation expense over the vesting period. For each of the two years ended
December 31, 2005 and 2004, the Company recognized compensation expense of US$18 and
US$11 respectively in its statement of operations. Other than the above, the exercise
price of the Companys incentive stock options was same as or higher than the market
price of the underlying stock on the date of grant, no compensation expense was
recognized for these stock options granted to employees.Had compensation expense for the same stock options been determined based on the fair
value on the date of grant and been amortized over the period from the date of grant to
the date that the award is
vested, consistent with the provisions of SFAS No. 123, the Companys net income and
earnings per share would have been reported as follows:
 F-14




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (q)
    
    Stock-based compensation (Continued)
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$(Restated)
    
    
    (Restated)Income before extraordinary item
    
    
    3,060
    
    
    
    2,820
    
    
    
    962Add : Stock-based employee compensation
expenses included in reported net
income, net of tax
    
    
    18
    
    
    
    11
    
    
    
    Deduct: Total stock-based employee
compensation expenses determined
under fair value based method for all
awards, net of tax
    
    
    (2,266
    )
    
    
    (159
    )
    
    
    (160
    )Pro forma income before extraordinary item
    
    
    812
    
    
    
    2,672
    
    
    
    802Extraordinary item
    
    
    378
    
    
    
    
    
    
    
    1,190
    
    
    
    2,672
    
    
    
    802
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$(Restated)
    
    
    (Restated)Basic earnings per share, as reported:Income before extraordinary item
    
    
    0.23
    
    
    
    0.25
    
    
    
    0.11Extraordinary item
    
    
    0.03
    
    
    
    
    
    
    
    Net income
    
    
    0.26
    
    
    
    0.25
    
    
    
    0.11Diluted earnings per share, as reported:Income before extraordinary item
    
    
    0.21
    
    
    
    0.23
    
    
    
    0.10Extraordinary item
    
    
    0.03
    
    
    
    
    
    
    
    Net income
    
    
    0.24
    
    
    
    0.23
    
    
    
    0.10Basic earnings per share, pro forma:Income before extraordinary item
    
    
    0.06
    
    
    
    0.24
    
    
    
    0.09Extraordinary item
    
    
    0.03
    
    
    
    
    
    
    
    Net income
    
    
    0.09
    
    
    
    0.24
    
    
    
    0.09Diluted earnings per share, pro forma:Income before extraordinary item
    
    
    0.06
    
    
    
    0.22
    
    
    
    0.08Extraordinary item
    
    
    0.02
    
    
    
    
    
    
    
    Net income
    
    
    0.08
    
    
    
    0.22
    
    
    
    0.08
 F-15




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (q)
    
    Stock-based compensation (Continued)
  Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    Expected stock price volatility
    
    
    52
    %
    
    
    61
    %
    
    
    9
    %Risk-free interest rate
    
    
    4.37
    %
    
    
    4.15
    %
    
    
    3.56
    %Expected life of options
    
    2 years
    
    3 years
    
    3 years
  (r)
    
    Income taxes
  (s)
    
    Foreign currencies
  (t)
    
    Treasury stock
  F-16




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (u)
    
    Cash equivalents
  (v)
    
    Uses of estimates
  (w)
    
    Related parties
  (x)
    
    Dividends
  (y)
    
    Comprehensive income
  (z)
    
    New accounting pronouncements
   F-17




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (z)
    
    New accounting pronouncements (Continued)
    3.
    
    ACQUISITIONS
   F-18




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  3. ACQUISITIONS (CONTINUED)
 As
of January 1, 2005US$Net assets acquired:Property, plant and equipment
    
    
    150Trade receivables
    
    
    615Inventories
    
    
    7,107Other receivables
    
    
    3,360Cash and cash equivalents
    
    
    153Trade payables
    
    
    (718
    )Accrued expenses and other payables
    
    
    (5,304
    )5,363Negative goodwill arising from acquisition
    
    
    (528
    )Total consideration*
    
    
    4,835
 
 *
    
    representing equity method investment as of
January 1, 2005 of US$2,007 and consideration
of US$2,828    Year endedDecember 31,2004US$Pro forma:Operating revenue
    
    
    77,379Net income
    
    
    3,087Earnings per share:Basic
    
    
    0.28Diluted
    
    
    0.25
 F-19




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  3.
    
    ACQUISITIONS (CONTINUED)
  4.
    
    OPERATING RISKS
 (a)
    
    Concentrations of credit risks
   (b)
    
    Country risks
  (c)
    
    Cash and time deposits
  F-20




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  5.
    
    INVENTORIES
 Inventories consisted of the following:
 As of December 31,2005
    
    
    2004US$
    
    
    US$Raw materials
    
    
    38,676
    
    
    
    25,810Work-in-progress
    
    
    2,214
    
    
    
    1,423Finished goods
    
    
    15,051
    
    
    
    9,39655,941
    
    
    
    36,629
 6.
    
    PROPERTIES HELD FOR LEASE, NET
 The Company owns leasehold land and buildings in Hong Kong and leases them out for lease
terms of 2 years. Properties held for lease consists of the following:
 As of December 31,2005
    
    
    2004US$
    
    
    US$Leasehold land and buildings
    
    
    2,037
    
    
    
    2,037Less: Accumulated depreciation
    
    
    (637
    )
    
    
    (585
    )1,400
    
    
    
    1,452
 The Company pledged all properties held for lease as collateral for general banking
facilities granted to the Company as of December 31, 2005 and 2004 (see note 10).The future aggregate minimum rental receivables under non-cancellable operating leases are
as follows:
 As of December 31,2005
    
    
    2004US$
    
    
    US$2005
    
    
    
    
    
    
    882006
    
    
    91
    
    
    
    222007
    
    
    32
    
    
    
    123
    
    
    
    110
 F-21




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  7.
    
    PROPERTY, PLANT AND EQUIPMENT, NET
 Property, plant and equipment consist of the following:
 As of December 31,2005
    
    
    2004US$
    
    
    US$Leasehold land and buildings
    
    
    2,405
    
    
    
    1,995Leasehold improvement
    
    
    3,740
    
    
    
    3,326Furniture, fixtures and equipment
    
    
    4,664
    
    
    
    3,656Plant and machinery
    
    
    2,046
    
    
    
    2,493Motor vehicles
    
    
    564
    
    
    
    42313,419
    
    
    
    11,893Less: Accumulated depreciation
    
    
    (7,198
    )
    
    
    (7,220
    )6,221
    
    
    
    4,673
 The Company pledged leasehold land and buildings with net book values of US$2,049 and
US$1,495 as of December 31, 2005 and 2004 respectively as collateral for general banking
facilities granted to the Company (see note 10).
 8.
    
    GOODWILL, NET
 As of December 31, 2005, goodwill is attributed to the acquisition of a jewelry retail
company in 2002.
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Carrying value, beginning of year
    
    
    1,521
    
    
    
    1,521
    
    
    
    1,721Impairment loss
    
    
    
    
    
    
    
    
    
    
    (200
    )Carrying value, end of year
    
    
    1,521
    
    
    
    1,521
    
    
    
    1,521
 The Company conducts annual impairment tests. The testing included the determination of
each reporting units fair value using the market multiples and discount cash flow
analysis. No goodwill impairment charge was necessary for the year ended December 31,
2005. The accumulated amortization and impairment losses were US$869 and US$869 as of
December 31, 2005 and 2004 respectively.
 F-22




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  9.
    
    INVESTMENT SECURITIES, NET
 As of December 31,2005
    
    
    2004US$
    
    
    US$(Restated)Share of net assets
    
    
    
    
    
    
    313Goodwill
    
    
    
    
    
    
    1,479
    
    
    
    1,792
    10.
    
    BANKING FACILITIES AND OTHER LOANS
 As of December 31,2005
    
    2004Note
    
    US$
    
    US$Bank overdrafts
    
    (a)
    
    2,028
    
    607Notes payable:Current portion
    
    (b)
    
    3,079
    
    2,487Letters of credit, gold and others:Letters of credit and others
    
    (a)
    
    13,048
    
    9,955Factoring
    
    (a)
    
    8,839
    
    5,468Gold loan
    
    (c)
    
    10,756
    
    6,48832,643
    
    21,911
  F-23




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  10.
    
    BANKING FACILITIES AND OTHER LOANS (CONTINUED)
 The material provisions of indentures relating to the Companys various banking facility
agreements contain covenants pertaining to (i) maintenance of the net worth of LJI and one
of its subsidiaries amounting to US$25,000 and US$4,487 respectively; and (ii)
cross-default provisions of the subsidiary in the event of default in aggregate of at least
US$10,000 under separate loan facilities. In the event of default, the bank would at its
discretion to cancel the facilities and demand immediate repayment of all principal,
interest, fees and other amount outstanding.
 (a)
    
    As of December 31, 2005, the Company had various revolving bank facilities of
overdrafts, letters of credit and factoring facilities granted by banks, amounting to
US$3,461, US$15,987 and US$15,546 respectively.
    (b)
    
    The Company also had term loans classified under notes payable which are
related to the Companys leasehold land and buildings. These loans aggregated to
US$3,079 as of December 31, 2005. The expected maturities of these notes payable are
within one year. Interest charges on these loans ranged from 6.3% to 6.8% per annum
as of December 31, 2005.(c)
    
    The Company had outstanding loans to purchase 27.92 oz of gold as of December
31, 2005 with the related balances being US$10,756. These loans are due within the
following year, however, have been historically renewed. These loans bear interest at
2.4% to 2.6% per annum as of December 31, 2005 and can be repaid in cash at the
current exchange rate of gold any time prior to maturity.
 The weighted average interest rate for the year ended December 31, 2005 was 5.0%.
 F-24




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  11.
    
    INCOME TAXESThe Company is subject to income taxes on an entity basis on income
arising in or derived from the tax jurisdiction in which it is
domiciled and operates. Income tax (expense) credit comprises of the
following:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Current taxes arising in foreign
subsidiaries:For the year
    
    
    (595
    )
    
    
    (299
    )
    
    
    (357
    )(Under)/Over provision in prior years
    
    
    (77
    )
    
    
    22
    
    
    
    92Total current tax
    
    
    (672
    )
    
    
    (277
    )
    
    
    (265
    )Deferred taxes arising in foreign
subsidiaries:For the year
    
    
    (67
    )
    
    
    
    
    
    
    (87
    )Income taxes (expense) credit
    
    
    (739
    )
    
    
    (277
    )
    
    
    (352
    )
 (2004 and 2003:
17.5%)
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003%
    
    
    %
    
    
    %Statutory rate
    
    
    17.5
    
    
    
    17.5
    
    
    
    17.5Tax effect of net operating losses
    
    
    21.2
    
    
    
    19.9
    
    
    
    20.0Non taxable profits, net
    
    
    (21.7
    )
    
    
    (25.3
    )
    
    
    (25.8
    )Impairment loss on goodwill
    
    
    
    
    
    
    
    
    
    
    1.6Others
    
    
    2.3
    
    
    
    (2.8
    )
    
    
    3.0Effective rate
    
    
    19.3
    
    
    
    9.3
    
    
    
    16.3
 F-25




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  11.
    
    INCOME TAXES (CONTINUED)Deferred income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts
used for income tax purposes. Significant components of the Companys deferred tax assets
and liabilities are as follows:
 As of December 31,2005
    
    
    2004US$
    
    
    US$Deferred tax assets:Net operating loss
    
    
    5,069
    
    
    
    2,826Depreciation
    
    
    71
    
    
    
    98Start up costs
    
    
    8
    
    
    
    235,148
    
    
    
    2,947Valuation allowance
    
    
    (5,148
    )
    
    
    (2,911
    )Total deferred tax assets
    
    
    
    
    
    
    36Deferred tax liabilities:Accelerated tax allowance
    
    
    (154
    )
    
    
    (123
    )Net deferred tax liabilities
    
    
    (154
    )
    
    
    (87
    )
   F-26




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  12.
    
    COMMITMENTS AND CONTINGENCIES
 (a)
    
    CommitmentsThe Company leases certain of its office and factory premises under various operating
leases. Rent expenses under these leases totalled approximately US$1,188, US$717 and
US$657 for the years ended December 31, 2005, 2004 and 2003 respectively. Included
in rent expenses, there were contingent rent expenses approximately US$22, US$Nil and
US$Nil for the years ended December 31, 2005, 2004 and 2003 respectively.Future minimum rental payments under capitalized leases and non-cancellable operating
leases are approximately as follows:
 As of December, 31 2005
    
    
    As of December, 31 2004Capitalized
    
    
    Operating
    
    
    Capitalized
    
    
    Operatingleases
    
    
    leases
    
    
    leases
    
    
    leasesUS$
    
    
    US$
    
    
    US$
    
    
    US$2005
    
    
    
    
    
    
    
    
    
    
    22
    
    
    
    6252006
    
    
    22
    
    
    
    835
    
    
    
    22
    
    
    
    3582007
    
    
    22
    
    
    
    718
    
    
    
    22
    
    
    
    1312008
    
    
    21
    
    
    
    352
    
    
    
    20
    
    
    
    87Thereafter
    
    
    2
    
    
    
    131
    
    
    
    
    
    
    
    Total future
minimum lease
payments
    
    
    67
    
    
    
    2,036
    
    
    
    86
    
    
    
    1,201Less: Amount
representing
interest
    
    
    (4
    )
    
    
    
    
    
    
    (9
    )63
    
    
    
    
    
    
    
    77
   (b)
    
    ContingenciesAs of December 31, 2005, 2004 and 2003, the Company provided guarantee in respect of
bank mortgage loans granted to a director, Mr. Yih Yu Chuan to the extent of US$237,
US$307 and US$370 respectively.
 F-27




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  13.
    
    COMMON STOCK AND WARRANTS OTHER THAN STOCK-BASED COMPENSATION
 (a)
    
    Common stock
 (i)
    
    During the year ended December 31 2003, warrants to purchase
150,000 shares of common stock (note 15(b)(iv)) and 1,122,500 stock options
(note 15(a)) were exercised. As a warrant holder elected to take the cashless
exercise of 95,891 shares of common stock, a total of 1,218,391 shares of common
stock of the Company were issued accordingly.(ii)
    
    In September 2004, the Company completed a private placement of
1,614,082 shares of common stock and 484,221 warrants (note 13(c)) at a price of
US$2.20 per share. The Company sold all of the shares and the placement raised
US$2,746 after underwriting discounts and placement costs.(iii)
    
    During the year ended December 31, 2004, warrants to purchase
600,000 shares of common stock (note 15(b)(v)) and 405,000 stock options (note
15(a)) were exercised. As a warrant holder elected to take the cashless exercise
of 395,570 shares of common stock, a total of 800,570 shares of common stock of
the Company were issued accordingly.(iv)
    
    During the year ended December 31, 2005, warrants to purchase
54,545 shares of common stock (note 13(c)) and 3,162,000 stock options (note
15(a)) were exercised. A total of 3,216,545 shares of common stock of the
Company were issued accordingly.
  (b)
    
    Treasury stockDuring the eight-month period ended December 31, 2002, the Company repurchased,
through open market purchases, 318,200 shares of common stock of the Company at
an aggregate consideration of US$391. In July 2003, the Company sold all these shares to a non-affiliated party for a consideration of US$541.
 F-28




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  13.
    
    COMMON STOCK AND WARRANTS OTHER THAN STOCK-BASED COMPENSATION (CONTINUED)
 (c)
    
    Warrants other than stock-based compensation
 As of December 31,2005
    
    
    2004
    
    
    2003Number of
    
    
    Number of
    
    
    Number ofNote
    
    
    warrants
    
    
    warrants
    
    
    warrantsOutstanding, beginning of year
    
    
    
    
    
    
    2,361,721
    
    
    
    1,922,500
    
    
    
    2,068,500Granted
    
    
    (i)

    
    
    
    
    
    
    
    484,221
    
    
    
    Exercised
    
    
    
    

    
    
    (54,545
    )
    
    
    
    
    
    
    Expired
    
    
    
    
    
    
    (1,877,500
    )
    
    
    (45,000
    )
    
    
    (146,000
    )Outstanding, end of year
    
    
    
    
    
    
    429,676
    
    
    
    2,361,721
    
    
    
    1,922,500
  Number of warrants
    
    
    ExerciseDate of grant
    
    outstanding
    
    
    price
    
    
    Expiration dateUS$September 1, 2004
    
    
    429,676
    
    
    
    2.98
    
    
    September 3, 2009
 (i)
    
    On September 1, 2004, the Company issued warrants for the
investors of a private placement to purchase 484,221 shares of the Companys
common stock at an exercise price of US$2.98 per share with an expiration date
of September 3, 2009 (see note (13)(a)(ii)).
  F-29




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  14.
    
    EMPLOYEE RETIREMENT BENEFIT PLANSFollowing the introduction of the Mandatory Provident Fund (MPF) legislation in Hong Kong,
the Company has participated in the defined contribution mandatory provident fund since
December 1, 2000. Both the Company and its employees in Hong Kong make monthly
contributions to the fund at 5% of the employees earnings as defined under Mandatory
Provident Fund legislation. The 5% monthly contribution of the Company and the employees
are subject to a cap of US$0.128 per month and thereafter contributions are voluntary. When
employees leave the MPF scheme prior to vesting fully in voluntary contributions, the contributions payable by the Company are reduced by
the amount of forfeited contributions.The amount of forfeitures in respect of the MPF scheme, which was available to reduce the
Companys contribution payable, for the year ended December 31, 2005, 2004 and 2003 was
US$Nil, US$Nil and US$11 respectively.The full-time employees of the PRC subsidiaries are entitled to staff welfare benefits,
including medical care, welfare subsidies, unemployment insurance and pension benefits.
These companies are required to accrue for these benefits based on certain percentages of
the employees salaries in accordance with the relevant regulations, and to make
contributions to the state-sponsored pension and medical plans out of the amounts accrued
for medical and pension benefits. The state-sponsored retirement plan was responsible for
the entire pension obligations for the actual pension payments or post-retirement benefits
beyond the annual contributions.The Company has adopted Profit Sharing Plan and Trust (Profit Sharing Plan) for the
benefit of substantially all employees in the US that satisfied the age and service
requirements. The Companys contributions are determined according to a discretionary
formula in an amount determined each year by the management and will be allocated to
each Qualifying Participants individual account using the pro rata formula. No profit
sharing expense made during all financial periods since its adoption.Contributions paid and payable by the Company in respect of the employee retirement benefit
plans charged to the consolidated statement of operations were US$831, US$616 and
US$543 for the years ended December 31, 2005, 2004 and 2003 respectively.
 15.
    
    STOCK-BASED COMPENSATION
 (a)
    
    Stock incentive planOn June 1, 1998, the Company adopted a stock option plan (The 1998 Plan) which was
approved by the shareholders on December 9, 1998. The 1998 Plan allows the Board of
Directors, or a committee thereof at the Boards discretion, to provide for a total
of 2,000,000 stock options to officers, directors, key employees and advisors of the
Company. Out of the stock options provided, 1,285,000 stock options were issued in
accordance with the terms of the 1998 Plan on April 12, 1999 to certain officers,
directors, key employees and advisors of the Company at an exercise price of US$5.0
per share (the fair market value of the common stock as of April 12, 1999) and are
exercisable during the period from April 12, 1999 to April 11, 2009.Pursuant to the 1999 Annual Meeting of the Shareholders on December 15, 1999, the
authorized number of stock options was increased from 2,000,000 to 4,000,000. The
purchase price of the shares of the Common Stock covered by the 1998 Plan shall be at
least
 F-30




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
      F-31




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  15.
    
    STOCK-BASED COMPENSATION (CONTINUED)
 (a)
    
    Stock incentive plan (Continued)The stock options activities and related information are summarized as follows:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31, 2005
    
    
    December 31, 2004
    
    
    December 31, 2003Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weightedaverage
    
    
    
    
    
    
    average
    
    
    
    
    
    
    averageexercise
    
    
    
    
    
    
    exercise
    
    
    
    
    
    
    exerciseOptions
    
    
    price
    
    
    Options
    
    
    Price
    
    
    Options
    
    
    priceUS$
    
    
    
    
    
    
    US$
    
    
    
    
    
    
    US$Outstanding, beginning of year
    
    
    3,759,000
    
    
    
    2.02
    
    
    
    3,814,000
    
    
    
    2.00
    
    
    
    3,025,500
    
    
    
    2.00Granted
    
    
    3,113,500
    
    
    
    2.44
    
    
    
    350,000
    
    
    
    2.20
    
    
    
    2,000,000
    
    
    
    2.00Exercised (note 13)
    
    
    (3,162,000
    )
    
    
    2.40
    
    
    
    (405,000
    )
    
    
    2.00
    
    
    
    (1,122,500
    )
    
    
    2.00Cancelled
    
    
    (400,000
    )
    
    
    2.18
    
    
    
    
    
    
    
    
    
    
    
    (89,000
    )
    
    
    2.00Outstanding, end of year
    
    
    3,310,500
    
    
    
    2.04
    
    
    
    3,759,000
    
    
    
    2.02
    
    
    
    3,814,000
    
    
    
    2.00Exercise price less than the market price
on date of grant
    
    
    150,000
    
    
    
    2.00
    
    
    
    150,000
    
    
    
    2.00
    
    
    
    
    
    
    
    Exercise price equals to market price on
date of grant
    
    
    701,000
    
    
    
    2.00
    
    
    
    1,369,000
    
    
    
    2.00
    
    
    
    1,739,000
    
    
    
    2.00Exercise price exceeds to market price on
date of grant
    
    
    2,459,500
    
    
    
    2.05
    
    
    
    2,240,000
    
    
    
    2.03
    
    
    
    2,075,000
    
    
    
    2.003,310,500
    
    
    
    2.04
    
    
    
    3,759,000
    
    
    
    2.02
    
    
    
    3,814,000
    
    
    
    2.00Range of exercise price- US$2.00
    
    
    2,797,000
    
    
    
    2.00
    
    
    
    3,559,000
    
    
    
    2.00
    
    
    
    3,814,000
    
    
    
    2.00- US$2.25
    
    
    513,500
    
    
    
    2.25
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    - US$2.35
    
    
    
    
    
    
    
    
    
    
    200,000
    
    
    
    2.35
    
    
    
    
    
    
    
    3,310,500
    
    
    
    2.04
    
    
    
    3,759,000
    
    
    
    2.02
    
    
    
    3,814,000
    
    
    
    2.00Exercisable, end of year- exercise price at US$2.00
    
    
    2,093,125
    
    
    
    2.00
    
    
    
    2,489,500
    
    
    
    2.00
    
    
    
    2,557,000
    
    
    
    2.00- exercise price at US$2.25
    
    
    513,500
    
    
    
    2.25
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,606,625
    
    
    
    2.05
    
    
    
    2,489,500
    
    
    
    2.00
    
    
    
    2,557,000
    
    
    
    2.00Weighted average remaining contractual life- exercise price at US$2.00
    
    6.09 years
    
    
    
    
    
    6.42 years
    
    
    
    
    
    7.04 years- exercise price at US$2.25
    
    2.33 years
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    - exercise price at US$2.35
    
    
    
    
    
    
    
    
    
    8.50 years
    
    
    
    
    
    
    
  F-32




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  15.
    
    STOCK-BASED COMPENSATION (CONTINUED)
 (b)
    
    Warrants
 (i)
    
    On March 22, 2000, the Company issued warrants to a placement
agent to purchase 35,000 shares of the Companys common stock at an exercise
price of US$6.94 per share with an expiration date of March 31, 2005, as partial
compensation for its services. As of December 31, 2005, all expired.(ii)
    
    On May 26, 2001, the Company entered into a consulting agreement
with a consultant for a period of 24 months commencing on June 1, 2001.
Pursuant to the agreement, the Company issued to the consultant warrants to
purchase 260,000 shares of common stock of the Company on June 1, 2001. Of the
warrants issued on June 1, 2001, the warrantholder is entitled to:
 
    
    purchase 100,000 shares at US$2.29 per share exercisable through May
31, 2003 (expired, as of December 31, 2005);
    
    purchase 80,000 shares at US$3.43 per share exercisable through May 31,
2004 (expired, as of December 31, 2005);
    
    purchase 80,000 shares at US$4.57 per share exercisable through May 31,
2005.
(expired, as of December 31, 2005);
 (iii)
    
    On August 16, 2001, the Company issued to an agent warrants to
purchase 200,000 shares of common stock of the Company at US$3.00 per share
exercisable through August 15, 2006 in consideration for consultancy services.(iv)
    
    On April 15, 2002, in accordance with a common stock purchase
agreement, the Company issued to an investor warrants to purchase 150,000 shares
of common stock of the Company at US$1.79 per share exercisable through April
14, 2005. The warrants were exercised in July 2003 and 95,891 shares of common
stock were issued accordingly pursuant to the cashless exercise.(v)
    
    Pursuant to a strategic advisory services agreement dated July 1,
2003, the Company issued to a consultant warrants to purchase 600,000 shares of
common stock of the Company at US$2 per share exercisable through March 31,
2004. The warrants were exercised in January 2004 and 395,570 shares of common
stock were issued accordingly pursuant to the cashless exercise.(vi)
    
    Pursuant to a media relation services agreement dated April 5,
2005, the Company issued to a consultant warrants to purchase 50,000 shares,
150,000 shares, 150,000 shares, 100,000 shares and 50,000 shares of common stock
of the Company at US$2.80, US$3.00, US$3.50, US$4.00 and US$4.50 respectively
per share exercisable through April 4, 2008.
 F-33




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  15.
    
    STOCK-BASED COMPENSATION (CONTINUED)
 (b)
    
    Warrants (Continued)Save as disclosed above, none of the warrants as aforesaid was exercised for the
three years ended December 31, 2005, 2004 and 2003. The costs associated with these
transactions are accounted for based on fair value of the warrants on the date of
grant.The fair value of warrants granted during the year ended December
31, 2005 and December 31, 2003 was estimated as US$472 and US$9 respectively by
using the Black-Scholes option pricing model with the following weighted-average
assumptions:
 Year ended
    
    Year ended
    
    Year endedDecember 31,
    
    December 31,
    
    December 31,2005
    
    2004
    
    2003Expected dividend yield
    
    
    
    
    
    
    
    
Expected stock price volatility
    
    
    
    61%
    
    
    
    
    
    
    9%Risk-free interest rate
    
    
    
    3.91%
    
    
    
    
    
    
    1.07%Expected life of warrants
    
    3 years
    
    
    
    
    
    0.25 years
 16.
    
    RELATED PARTY TRANSACTIONS
 (a)
    
    Names and relationship of related parties:
 Existing relationships with the CompanyYih Yu Chuan
    
    Director and major shareholder of the CompanyGemological Institute of America,
    
    Common directorHong Kong LimitedTanzanite (H.K.) Limited
    
    Common directorsOsorio Mendes Quintino Neto
    
    Director and minor shareholder of a subsidiary of theCompany
 F-34




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  16.
    
    RELATED PARTY TRANSACTIONS (CONTINUED)
 (b)
    
    Summary of balances with related parties:
 As of December 31,2005
    
    
    2004Note
    
    
    US$
    
    
    US$Due from related parties:Gemological Institute of America,
Hong Kong Limited
    
    
    
    
    
    
    463
    
    
    
    464Tanzanite (H.K.) Limited
    
    
    
    
    
    
    21
    
    
    
    27(i
    )
    
    
    484
    
    
    
    491Due to a related party:Osorio Mendes Quintino Neto
    
    
    (i
    )
    
    
    1,910
    
    
    
    Certain banking facilities
granted to the Company
collateralized by properties
owned by Yih Yu Chuan and his
personal guarantee to the extent
of
    
    
    
    
    
    
    21,244
    
    
    
    12,971
 (c)
    
    Summary of related party transactions:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US $
    
    
    US$
    
    
    US$Rental expense to
Tanzanite (H.K.)
Limited
    
    
    150
    
    
    
    77
    
    
    
    23
 (i)  The amounts due from/ to related parties represent unsecured advances which
are interest-free and repayable on demand. 17.
    
    SEGMENT INFORMATIONAs over 90% of the Companys turnover and contribution to operating results are derived from
the business segment of manufacture and sales of jewelry, the Company considered that it has
only one business segment. In respect of geographical areas, revenues are based on the
country in which the customer is located. Long-lived assets are where the assets are
located.
 (a)
    
    Geographical areas:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Revenue from external
customers:US & Canada
    
    
    67,780
    
    
    
    56,186
    
    
    
    42,851Europe and
other
countries
    
    
    20,527
    
    
    
    13,062
    
    
    
    8,017Japan
    
    
    3,686
    
    
    
    4,158
    
    
    
    5,338PRC (including Hong
Kong and Macau)
    
    
    2,619
    
    
    
    3,973
    
    
    
    1,96194,612
    
    
    
    77,379
    
    
    
    58,167
 F-35




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##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  17.
    
    SEGMENT INFORMATION (CONTINUED)
 As of December 31,2005
    
    
    2004US $
    
    
    US$(Restated)Carrying amount of long-lived assets:Hong Kong
    
    
    3,492
    
    
    
    4,717PRC
    
    
    3,933
    
    
    
    2,922US
    
    
    196
    
    
    
    278Total long-lived assets (excluding goodwill)
    
    
    7,621
    
    
    
    7,917Reconciling items:Others
    
    
    100,609
    
    
    
    66,454Total consolidated assets
    
    
    108,230
    
    
    
    74,371
 (b)
    
    The Company derived operating revenue from the following major
customers, which accounted for over 10% of operating revenue.
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    %
    
    
    US$
    
    
    %
    
    
    US$
    
    
    %Customer A
    
    
    13,093
    
    
    
    14
    
    
    
    8,482
    
    
    
    11
    
    
    
    5,164
    
    
    
    9Customer B
    
    
    10,772
    
    
    
    11
    
    
    
    7,234
    
    
    
    9
    
    
    
    5,870
    
    
    
    10Customer C
    
    
    9,247
    
    
    
    10
    
    
    
    6,454
    
    
    
    8
    
    
    
    5,869
    
    
    
    10
  18.
    
    RECLASSIFICATIONSCertain prior year amounts have been reclassified to conform to the current year
presentation.
 F-36




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##### Table of Contents



ITEM 19. EXHIBITS
  1.1
    
    Memorandum of Association of the Company*1.2
    
    Articles of Association of the Company*1.3
    
    Amendment to Articles of Association of the Company*4.1
    
    Employment Agreement of Yu Chuan Yih with the Registrant**8.1
    
    List of Significant Subsidiaries of the Company11.1
    
    Code of Ethics**12.1
    
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)12.2
    
    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)13.1
    
    Certification of Chief Executive Officer Pursuant to Rule
13a-14(b) and 18 U.S.C. Section135013.2
    
    Certification of Chief Financial Officer Pursuant to Rule
13a-14(b) and 18 U.S.C. Section 1350
 
 *
    
    Incorporated by reference to the Exhibits to our Registration Statement on Form F-1 and
pre-effective and post-effective amendments thereto, SEC File No. 333-7912, declared effective
on April 15, 1998.**
    
    Incorporated by reference to the Exhibits to our Annual Report on Form 20-F for the fiscal year
ended December 31, 2003. -113-




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##### Table of Contents



SIGNATURES
  LJ INTERNATIONAL INC.
(Registrant)Date:  February 6 2007
    By:
    /s/ YU CHUAN YIHYu Chuan YihChairman




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##### Table of Contents



EXHIBIT INDEX
 Exhibit
    
    
    
    PageNumber
    
    Description of Exhibit
    
    Number1.1
    
    Memorandum of Association of the Company
    
    *1.2
    
    Articles of Association of the Company
    
    *1.3
    
    Amendment to Articles of Association of the Company
    
    *4.1
    
    Employment Agreement of Yu Chuan Yih with the Registrant
    
    **8.1
    
    List of Significant Subsidiaries of the Company11.1
    
    Code of Ethics
    
    **12.1
    
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)12.2
    
    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)13.1
    
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(b)
and 18 U.S.C. Section 135013.2
    
    Certification of Chief Financial Officer Pursuant to Rule 13a-14(b)
and 18 U.S.C. Section 1350
 
 *
    
    Incorporated by reference to the Exhibits to our Registration Statement on Form F-1 and
pre-effective and post-effective amendments thereto, SEC File No. 333-7912, declared effective
on April 15, 1998.**
    
    Incorporated by reference to the Exhibits to our Annual Report on Form 20-F for the fiscal
year ended December 31, 2003.