##### Table of Contents



U.S. SECURITIES AND EXCHANGE COMMISSION
  FORM 20-F
 [  ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934
  [X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   [  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
   [  ] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
 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 registered$.01 Par Value Common Stock
    
    NASDAQ(Common Stock)
  (Title of Class)
  (Title of Class)
    X
  X
  X
  X
  X
  X




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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 16. [RESERVED]ITEM 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 INDEXEmployment Agreement of Yu Chuan YihList of Significant Subsidiaries of the CompanyCertification 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
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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
(US Dollars in thousands, except per share amounts)
  -3-




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Selected Financial Data
 Eight-month period
    
    
    
    YearYears ended

    ended



endedDecember 31,

    December 31,




April 30,2006
    
    
    2005
    
    
    2004
    
    
    2003
    
    
    
    2002
    
    
    2001
    
    
    
    2002(Unaudited)Statement of
Operations Data:Revenues
    
    
    
    123,791
    
    
    
    99,646
    
    
    
    77,504
    
    
    
    58,330
    
    
    
    
    31,966
    
    
    
    25,135
    
    
    
    
    39,375Cost of Goods sold
    
    
    
    (88,867
    )
    
    
    (77,127
    )
    
    
    (61,265
    )
    
    
    (44,947
    )
    
    
    
    (20,565
    )
    
    
    (16,228
    )
    
    
    
    (35,731
    )Gross profit
    
    
    
    34,924
    
    
    
    22,519
    
    
    
    16,239
    
    
    
    13,383
    
    
    
    
    11,401
    
    
    
    8,907
    
    
    
    
    3,644Operating expensesSelling, general
and administrative
    
    
    
    (23,114
    )
    
    
    (15,488
    )
    
    
    (11,578
    )
    
    
    (9,133
    )
    
    
    
    (8,688
    )
    
    
    (8,279
    )
    
    
    
    (8,963
    )Net gain (loss) on
derivatives
    
    
    
    (29
    )
    
    
    8
    
    
    
    199
    
    
    
    87
    
    
    
    
    (435
    )
    
    
    (119
    )
    
    
    
    (660
    )Depreciation
    
    
    
    (2,039
    )
    
    
    (1,368
    )
    
    
    (1,032
    )
    
    
    (1,184
    )
    
    
    
    (863
    )
    
    
    (565
    )
    
    
    
    (1,031
    )Impairment on
property, plant and
equipment
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    (84
    )
    
    
    
    (108
    )
    
    
    -
    
    
    
    
    (345
    )Amortization and
impairment loss on
goodwill
    
    
    
    -
    
    
    
    -
    
    
    
    (698
    )
    
    
    (200
    )
    
    
    
    (600
    )
    
    
    (18
    )
    
    
    
    (242
    )Operating income
(loss)
    
    
    
    9,742
    
    
    
    5,671
    
    
    
    3,130
    
    
    
    2,869
    
    
    
    
    707
    
    
    
    (74
    )
    
    
    
    (7,597
    )Other income and
expensesInterest income
    
    
    
    282
    
    
    
    139
    
    
    
    38
    
    
    
    41
    
    
    
    
    48
    
    
    
    172
    
    
    
    
    217Interest expenses
    
    
    
    (3,258
    )
    
    
    (1,991
    )
    
    
    (902
    )
    
    
    (753
    )
    
    
    
    (441
    )
    
    
    (424
    )
    
    
    
    (652
    )Operating income
(loss) before
income taxes,
minority interests,
equity in results
of investment
securities and
extraordinary item
    
    
    
    6,766
    
    
    
    3,819
    
    
    
    2,266
    
    
    
    2,157
    
    
    
    
    314
    
    
    
    (326
    )
    
    
    
    (8,032
    )Income taxes
(expense) credit
    
    
    
    (1,403
    )
    
    
    (739
    )
    
    
    (277
    )
    
    
    (352
    )
    
    
    
    (101
    )
    
    
    (39
    )
    
    
    
    101Income (Loss)
before minority
interests, equity
in results of
investment
securities and
extraordinary item
    
    
    
    5,363
    
    
    
    3,080
    
    
    
    1,989
    
    
    
    1,805
    
    
    
    
    213
    
    
    
    (365
    )
    
    
    
    (7,931
    )Minority interests
in consolidated
subsidiaries
    
    
    
    (38
    )
    
    
    (20
    )
    
    
    -
    
    
    
    8
    
    
    
    
    120
    
    
    
    -
    
    
    
    
    30Income before
equity in results
of investment
securities and
extraordinary item
    
    
    
    5,325
    
    
    
    3,060
    
    
    
    1,989
    
    
    
    1,813
    
    
    
    
    333
    
    
    
    (365
    )
    
    
    
    (7,901
    )Equity in results
of investment
securities
    
    
    
    -
    
    
    
    -
    
    
    
    133
    
    
    
    (851
    )
    
    
    
    16
    
    
    
    26
    
    
    
    
    34Income before
extraordinary item
    
    
    
    5,325
    
    
    
    3,060
    
    
    
    2,122
    
    
    
    962
    
    
    
    
    349
    
    
    
    (339
    )
    
    
    
    (7,867
    )Extraordinary gain
on negative
goodwill
    
    
    
    -
    
    
    
    1,291
    
    
    
    -
    
    
    
    -
    
    
    
    
    -
    
    
    
    -Net income (loss)
    
    
    
    5,325
    
    
    
    4,351
    
    
    
    2,122
    
    
    
    962
    
    
    
    
    349
    
    
    
    (339
    )
    
    
    
    (7,867
    )Net income (loss)
per share:Basic
    
    
    
    0.31
    
    
    
    0.32
    
    
    
    0.19
    
    
    
    0.11
    
    
    
    
    0.04
    
    
    
    (0.04
    )
    
    
    
    (0.91
    )Diluted
    
    
    
    0.29
    
    
    
    0.30
    
    
    
    0.18
    
    
    
    0.10
    
    
    
    
    0.04
    
    
    
    (0.04
    )
    
    
    
    (0.90
    )Weighted average
number of sharesBasic
    
    
    
    17,390
    
    
    
    13,439
    
    
    
    11,119
    
    
    
    8,757
    
    
    
    
    8,493
    
    
    
    8,672
    
    
    
    
    8,672Diluted
    
    
    
    18,303
    
    
    
    14,322
    
    
    
    12,107
    
    
    
    9,706
    
    
    
    
    8,493
    
    
    
    8,832
    
    
    
    
    8,779Balance
Sheet Data:Working capital
    
    
    
    50,134
    
    
    
    35,554
    
    
    
    23,617
    
    
    
    17,053
    
    
    
    
    11,896
    
    
    
    18,537
    
    
    
    
    12,115Total assets
    
    
    
    124,522
    
    
    
    108,230
    
    
    
    73,673
    
    
    
    59,885
    
    
    
    
    48,938
    
    
    
    51,088
    
    
    
    
    43,557Long-term obligation
    
    
    
    1,640
    
    
    
    43
    
    
    
    58
    
    
    
    77
    
    
    
    
    -
    
    
    
    12
    
    
    
    
    8Total
stockholders equity
    
    
    
    59,739
    
    
    
    45,008
    
    
    
    32,790
    
    
    
    27,101
    
    
    
    
    23,344
    
    
    
    30,969
    
    
    
    
    23,591
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B.
    
    CAPITALIZATION AND INDEBTEDNESS.Not applicable.C.
    
    REASONS FOR THE OFFER AND USE OF PROCEEDS.Not applicable.
 -5-




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D.
    
    RISK FACTORS.
 We depend upon one customer who accounts 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 face significant competition from larger competitors in our wholesale and retail operations.
  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.
  -6-




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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.
  Changes to PRC tax laws may adversely affect our financial condition and results of operations in
the future.
  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.
  -7-




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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.
  The success of our retail store expansion program in China is dependent upon numerous factors over
which we have limited control.
  We rely on short-term financing from banks for our daily operation.
   We rely geographically on the US market for the majority of our revenue.
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Our holding company structure creates restrictions on the payment of dividends.
  As a foreign private issuer, we are not subject to certain rules promulgated by Nasdaq that other
Nasdaq-listed issuers are required to comply with.
  
    
    our independent directors do not hold regularly scheduled meetings in executive
session;
    
    the compensation of our executive officers is not determined by an independent
committee of the board or by the independent members of the board of directors, and our
CEO may be present and participate in the deliberations concerning his compensation;
    
    related party transactions are not required to be reviewed or approved by our audit
committee or other independent body of the board of directors; and
    
    we are not required to solicit shareholder approval of stock plans, including those
in which our officers or directors may participate; stock issuances that will result in
a change in control; the issuance of our stock in related party transactions or other
transactions in which we may issue 20% or more of our outstanding shares; or, below
market issuances of 20% or more of our outstanding shares to any person.
  It may be difficult to serve us with legal process or enforce judgments against us or our
management.
  -9-




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
    
    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.
 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.
   -10-




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Legal proceedings related to our historical reporting of financial results and other issues may
significantly harm our business.
  -11-




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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. (LSC)
    
    Lorenzo Crystal Ltd.
    
    Enzo (Shenzhen) Co., Ltd. (ESC)
    
    Enzo Ltd.
    
    Goldleaves Gems (Shenzhen) Co., Ltd. (98% equity ownership)
    
    
    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 an additional 78% of the equity of Goldleaves International Limited for
$2,827,500 during the fiscal year ended December 31, 2005
    
    we spent $1,105,000 on capital expenditures, excluding inventory, for ENZO retail
store openings during the fiscal year ended December 31, 2006
 -12-




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B.
    
    BUSINESS OVERVIEW.
     
    
    fine jewelers;
    
    national jewelry chains;
    
    department stores;
    
    TV shopping channels; and
    
    discount chain stores.
   -13-




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Year ended December 31,(in thousands)
    
    
    2006
    
    
    
    2005
    
    
    
    2004US$
    
    
    
    US$
    
    
    
    US$US & Canada
    
    
    76,889
    
    
    
    67,780
    
    
    
    56,186Europe and other countries
    
    
    24,452
    
    
    
    20,527
    
    
    
    13,062Japan
    
    
    2,454
    
    
    
    3,686
    
    
    
    4,158PRC (including Hong Kong and Macau)
    
    
    19,996
    
    
    
    7,653
    
    
    
    4,098123,791
    
    
    
    99,646
    
    
    
    77,504
 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.
  -14-




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Our Business Strategy
  
    
    increase our market share of moderately priced high-quality gem-set colored and
precious jewelry by capitalizing on our vertically integrated production processes to
produce diamond and high-end precious stone jewelry in addition to high volume,
high-quality colored products;
    
    further develop our existing customer relationships with our specialized services;
and
    
    expand aggressively into new distribution channels, particularly in the United
States, China, Western Europe, Japan 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; and
    
    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.
 Our China Retail Sales Strategy
  
    
    significant retail market - Chinas retail sales exceed $600 billion annually,
making China the third largest market in the world.
 -15-




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
    
    large and growing jewelry market - we estimate that Chinas jewelry sales totaled
nearly $17 billion in 2006, up 15% year over year.
    
    large pool of consumers - China has a population of 1.3 billion people. 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, China is
eliminating many restrictions on foreign ownership and operation of retail stores.
Tariffs on colored gemstones, gold, silver and pearls have been sharply reduced, and
economic and trade relationships between China and Hong Kong have been liberalized.
    
    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 at least 100 ENZO
stores in China by the beginning of 2008
    
    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 US.
 Our Production Capability
   -16-




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Sales and Marketing
   
    
    fine jewelers;
    
    national jewelry chains;
    
    department stores;
    
    TV shopping channels; and
    
    discount chain stores.
  Design and Product Development
    -17-




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Production Process
  
    
    cutting and polishing colored 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
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Security
   Insurance
  Competition
    -19-




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C.
    
    ORGANIZATIONAL STRUCTURE AS OF DECEMBER 31, 2006:
  LJ INTERNATIONAL INC.
 100%-
    
    Lorenzo Jewelry Limited(Hong Kong)-
    
    Lorenzo Jewellery (Shenzhen) Co., Ltd.(PRC)-
    
    Shenzhen PGS Jewelry Mfg.(PRC)-
    
    Lorenzo (Shenzhen) Co., Ltd.(PRC)-
    
    Lorenzo Crystal Ltd.(Hong Kong)-
    
    Enzo (Shenzhen) Co., Ltd.(PRC)-
    
    Enzo Ltd.(Macau)98%-
    
    Goldleaves Gems (Shenzhen) Co., Ltd.(PRC)
 -20-




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D.
    
    PROPERTY, PLANTS AND EQUIPMENT.
   
    
    1,751 square meters for a term of five years expiring June 30, 2011 from an
unaffiliated third party at a rental rate of $3,817 per month;
    
    1,751 square meters for a term of two years expiring August 31, 2008, at a rental
rate of $4,490 per month;
    
    1,799 square meters for a term of three years expiring March 31, 2009, at a rental
rate of $4,381 per month; and
    
    1,886 square meters for a term of three years expiring September 30, 2009 at a
rental rate of $4,593 per month.
   
 ITEM 4A.           UNRESOLVED STAFF COMMENTS
  -21-




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ITEM
5.     OPERATING AND FINANCIAL REVIEW AND PROSPECTS
          -22-




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®
   Critical Accounting Policies and Estimates
   Collectibility of Accounts Receivable.
 -23-




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Stock-based Compensation.
    Goodwill Impairment.
  -24-




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Allowance for Obsolete Inventories.
 A.     OPERATING RESULTS.
 Reclassifications
  Revenues
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004
    
    
    2006-2005
    
    
    2005-2004RevenuesWholesaleJewelry product
    
    $
    108,679
    
    
    $
    95,318
    
    
    $
    72,337
    
    
    
    14
    %
    
    
    32
    %Giftware product
    
    $
    -
    
    
    $
    1,827
    
    
    $
    4,359
    
    
    
    -100
    %
    
    
    -58
    %$
    108,679
    
    
    $
    97,145
    
    
    $
    76,696
    
    
    
    12
    %
    
    
    27
    %Retail
    
    $
    15,112
    
    
    $
    2,501
    
    
    $
    808
    
    
    
    504
    %
    
    
    210
    %$
    123,791
    
    
    $
    99,646
    
    
    $
    77,504
    
    
    
    24
    %
    
    
    29
    %
  -25-




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Cost of Sales and Gross Profit
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004
    
    
    2006-2005
    
    
    2005-2004Cost of sales and
gross profitCost of salesWholesale
    
    $
    83,387
    
    
    $
    75,645
    
    
    $
    60,564
    
    
    
    10
    %
    
    
    25
    %% of revenues
    
    
    77%
    
    
    
    78%
    
    
    
    79%Retail
    
    $
    5,480
    
    
    $
    1,482
    
    
    $
    701
    
    
    
    270
    %
    
    
    111
    %% of revenues
    
    
    36%
    
    
    
    59%
    
    
    
    87%Total
    
    $
    88,867
    
    
    $
    77,127
    
    
    $
    61,265
    
    
    
    15
    %
    
    
    26
    %% of revenues
    
    
    72%
    
    
    
    77%
    
    
    
    79%Gross profitWholesale
    
    $
    25,292
    
    
    $
    21,500
    
    
    $
    16,132
    
    
    
    18
    %
    
    
    33
    %% of revenues
    
    
    23%
    
    
    
    22%
    
    
    
    21%Retail
    
    $
    9,632
    
    
    $
    1,019
    
    
    $
    107
    
    
    
    845
    %
    
    
    852
    %% of revenues
    
    
    64%
    
    
    
    41%
    
    
    
    13%Total
    
    $
    34,924
    
    
    $
    22,519
    
    
    $
    16,239
    
    
    
    55
    %
    
    
    39
    %% of revenues
    
    
    28%
    
    
    
    23%
    
    
    
    21%
    -27-




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Selling, General and Administrative Expenses
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004
    
    
    2006-2005
    
    
    2005-2004Selling, general
and
administrative
expensesWholesale
    
    $
    13,324
    
    
    $
    11,545
    
    
    $
    8,981
    
    
    
    15
    %
    
    
    29
    %Retail
    
    $
    7,562
    
    
    $
    2,653
    
    
    $
    634
    
    
    
    185
    %
    
    
    318
    %Corporate
    
    $
    2,228
    
    
    $
    1,290
    
    
    $
    1,963
    
    
    
    73
    %
    
    
    -34
    %$
    23,114
    
    
    $
    15,488
    
    
    $
    11,578
    
    
    
    49
    %
    
    
    34
    %% of revenues
    
    
    19%
    
    
    
    16%
    
    
    
    15%
   -28-




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Net gain (loss) on derivatives
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004
    
    
    2006-2005
    
    
    2005-2004Unrealised
(loss)gain on
derivatives
    
    $
    190
    
    
    $
    (88
    )
    
    $
    (482
    )
    
    
    -316
    %
    
    
    -82
    %% of revenues
    
    
    0%
    
    
    
    0%
    
    
    
    -1%(With the hedging mechanism in place, we have the realised gain on hedging activities)Realized (loss)
gain on hedging
activities
    
    $
    (219
    )
    
    $
    96
    
    
    $
    681
    
    
    
    -328
    %
    
    
    -86
    %% of revenues
    
    
    0%
    
    
    
    0%
    
    
    
    1%Net (loss) gain
on derivatives
and hedging
activities
    
    $
    (29
    )
    
    $
    8
    
    
    $
    199
    
    
    
    -463
    %
    
    
    -96
    %% of revenues
    
    
    0%
    
    
    
    0%
    
    
    
    0%
   -29-




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##### Table of Contents



Depreciation
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004
    
    
    2006-2005
    
    
    2005-2004DepreciationWholesale
    
    $
    1,425
    
    
    $
    1,154
    
    
    $
    991
    
    
    
    23
    %
    
    
    16
    %% of revenues
    
    
    1%
    
    
    
    1%
    
    
    
    1%Retail
    
    $
    614
    
    
    $
    214
    
    
    $
    41
    
    
    
    187
    %
    
    
    422
    %% of revenues
    
    
    4%
    
    
    
    9%
    
    
    
    5%Total
    
    $
    2,039
    
    
    $
    1,368
    
    
    $
    1,032
    
    
    
    49
    %
    
    
    33
    %% of revenues
    
    
    2%
    
    
    
    1%
    
    
    
    1%
   -30-




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Amortization and impairment loss on goodwill
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004
    
    
    2006-2005
    
    
    2005-2004Amortization and
impairment loss
on goodwill
    
    $
    0
    
    
    $
    0
    
    
    $
    698
    
    
    
    N/A
    
    
    
    -100%% of revenues
    
    
    0%
    
    
    
    0%
    
    
    
    1%
  Interest cost
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004
    
    
    2006-2005
    
    
    2005-2004Interest expenses
    
    $
    3,258
    
    
    $
    1,991
    
    
    $
    902
    
    
    
    64%
    
    
    
    121%% of revenues
    
    
    3%
    
    
    
    2%
    
    
    
    1%
  -31-




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Income taxes
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004
    
    
    2006-2005
    
    
    2005-2004Income taxes expenseWholesale
    
    $
    682
    
    
    $
    739
    
    
    $
    277
    
    
    
    -8%
    
    
    
    167%% of revenues
    
    
    1%
    
    
    
    1%
    
    
    
    0%Retail
    
    $
    721
    
    
    $
    0
    
    
    $
    0
    
    
    
    N/A
    
    
    
    N/A% of revenues
    
    
    5%
    
    
    
    0%
    
    
    
    0%Total
    
    $
    1,403
    
    
    $
    739
    
    
    $
    277
    
    
    
    90%
    
    
    
    167%% of revenues
    
    
    1%
    
    
    
    1%
    
    
    
    0%
       -32-




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Extraordinary gain on negative goodwill
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004
    
    
    2006-2005
    
    
    2005-2004Extraordinary
gain on
negative
goodwill
    
    $
    0
    
    
    $
    1,291
    
    
    $
    0
    
    
    
    -100%
    
    
    
    N/A% of revenues
    
    
    0%
    
    
    
    1%
    
    
    
    0%
   Inflation
  Foreign Exchange
  -33-




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Governmental economic and political policies and factors
  B.
    
    LIQUIDITY AND CAPITAL RESOURCES.
  Cash Flows
 Years ended December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004Net cash used in operating activities
    
    $
    (6,200)
    
    
    $
    (14,222)
    
    
    $
    (7,494)Net cash used in investing activities
    
    
    (3,829)
    
    
    
    (4,655)
    
    
    
    (1,179)Net cash provided by financing activities
    
    
    11,096
    
    
    
    20,450
    
    
    
    9,179Effect of foreign exchange rate change
    
    
    -
    
    
    
    (5)
    
    
    
    -Net increase in cash and cash equivalents
    
    
    1,067
    
    
    
    1,568
    
    
    
    506
 -34-




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##### Table of Contents



Operating Activities
 Years ended December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004Cash flows from operating activities:Net income
    
    $
    5,325
    
    
    $
    4,351
    
    
    $
    2,122Adjustments to reconcile income (loss) to net
cash used in operating activities:Depreciation of property, plant and equipment
and properties held for lease
    
    
    2,039
    
    
    
    1,368
    
    
    
    1,032Amortization and impairment loss on goodwill
    
    
    -
    
    
    
    -
    
    
    
    698Extraordinary gain on negative goodwill
    
    
    -
    
    
    
    (1,291)
    
    
    
    -Unrealized (gain) loss on derivatives
    
    
    (48)
    
    
    
    88
    
    
    
    482Loss (Gain) on disposal and write-off of
property, plant and equipment
    
    
    3
    
    
    
    8
    
    
    
    (3)(Reversal of) Allowance for doubtful debts
    
    
    (40)
    
    
    
    (72)
    
    
    
    125Minority interests
    
    
    37
    
    
    
    20
    
    
    
    -Compensation costs for warrants granted
    
    
    158
    
    
    
    118
    
    
    
    -Compensation expenses recognized during the
year
    
    
    213
    
    
    
    18
    
    
    
    11Equity in results of investment securities
    
    
    -
    
    
    
    -
    
    
    
    (133)Changes in operating assets and liabilities:Trade receivables
    
    
    1,106
    
    
    
    (8,607)
    
    
    
    (535)Inventories
    
    
    (12,810)
    
    
    
    (12,060)
    
    
    
    (15,142)Prepayments and other current assets
    
    
    (580)
    
    
    
    601
    
    
    
    1,187Due from related parties
    
    
    463
    
    
    
    7
    
    
    
    17Trade payables
    
    
    (2,955)
    
    
    
    1,883
    
    
    
    1,136Accrued expenses and other payables
    
    
    272
    
    
    
    (854)
    
    
    
    1,767Income taxes payable and deferred taxation
    
    
    617
    
    
    
    200
    
    
    
    (258)Net cash used in operating activities
    
    
    (6,200)
    
    
    
    (14,222)
    
    
    
    (7,494)
   -35-




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Investing Activities:
   -36-




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##### Table of Contents



Years ended December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004Land & buildings
    
    $
    -
    
    
    $
    617
    
    
    $
    -Leasehold improvement
    
    $
    2,852
    
    
    $
    783
    
    
    $
    487Furniture, fixtures and equipment
    
    $
    690
    
    
    $
    1,060
    
    
    $
    189Plant and machinery
    
    $
    260
    
    
    $
    209
    
    
    $
    51Motor vehicles
    
    $
    381
    
    
    $
    200
    
    
    $
    -Total
    
    $
    4,183
    
    
    $
    2,869
    
    
    $
    727
 Financing Activities:
    Financing Sources
 Banking Facilities and Notes Payables
  -37-




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##### Table of Contents



Years ended December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004Letters of credit
    
    $
    41,046
    
    
    $
    31,533
    
    
    $
    26,833Overdraft
    
    $
    3,564
    
    
    $
    3,461
    
    
    $
    3,46144,610
    
    
    
    34,994
    
    
    
    30,294Utilized :Letters of credit utilized
    
    $
    22,344
    
    
    $
    21,887
    
    
    $
    15,423Overdraft utilized
    
    $
    1,591
    
    
    $
    2,028
    
    
    $
    60723,935
    
    
    
    23,915
    
    
    
    16,030
    Years ended December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004Notes payable
    
    $
    3,987
    
    
    $
    3,079
    
    
    $
    2,487
  -38-




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##### Table of Contents



Gold Loan Facilities
 Years ended December 31,(in thousands)
    
    2006
    
    
    2005
    
    
    2004Gold loans outstanding (in $)
    
    $
    11,079
    
    
    $
    10,756
    
    
    $
    6,488Gold loans outstanding (in troy ounces)
    
    
    26,920
    
    
    
    27,920
    
    
    
    17,920Gold loan interest rate
    
    
    2.6%-3.1%
    
    
    
    2.4%-2.6%
    
    
    
    2.1%-2.5%
  Looking Forward
  Impact of recently issued US GAAP accounting standards
   -39-




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-40-




---



##### Table of Contents



C.
    
    RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
  D.
    
    TREND INFORMATION.
  E.
    
    OFF-BALANCE SHEET ARRANGEMENTS.
  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
    
    
    356
    
    
    
    94
    
    
    
    171
    
    
    
    91
    
    
    
    -Operating Lease Obligations
    
    
    4,685
    
    
    
    2,584
    
    
    
    2,101
    
    
    
    -
    
    
    
    -Purchase Obligations
    
    
    -Other Long-Term Liabilities Reflected on the Companys
    
    
    -Balance Sheet under the GAAP of the primary
financial statements
    
    
    -Total
    
    
    5,041
    
    
    
    2,678
    
    
    
    2,272
    
    
    
    91
    
    
    
    -
 .
 -41-




---



##### Table of Contents



ITEM 6.     DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
 A.
    
    DIRECTORS AND SENIOR MANAGEMENT.
  Name
    
    Age
    
    PositionYu Chuan Yih
    
    
    67
    
    
    Chairman of the Board of Directors, President andChief Executive OfficerKa Man Au
    
    
    42
    
    
    Chief Operating Officer, Secretary and DirectorHon Tak Ringo Ng
    
    
    47
    
    
    Chief Financial Officer and DirectorPo Yee Elsa Yue
    
    
    42
    
    
    Independent Non-Executive Director (1)Andrew N. Bernstein
    
    
    54
    
    
    Independent Non-Executive DirectorWing Kwan Ted Lai
    
    
    44
    
    
    Independent Non-Executive Director (3)Kelvin Wong
    
    
    40
    
    
    Independent Non-Executive Director (3)Chi Fai Frank Cheung
    
    
    44
    
    
    Independent Non-Executive Director (2) (3)Xiang Xiong Deng
    
    
    42
    
    
    Independent Non-Executive Director (4)Jin Wang
    
    
    36
    
    
    Independent Non-Executive Director (4)Jieyun Yu
    
    
    41
    
    
    Independent Non-Executive Director (4)
 
 (1)
    
    Resigned effective June 1, 2007(2)
    
    Appointed effective June 1, 2007(3)
    
    Resigned effective October 15, 2007(4)
    
    Appointed effective October 29, 2007  Mr. Yih
 Ms. Au
 Mr. Ng
 -42-




---



##### Table of Contents



Ms. Yue
 Mr. Bernstein
 Mr. Lai
 Mr. Wong
 Mr. Cheung
 -43-




---



##### Table of Contents



Mr. Deng
 Mr. Wang
 Ms. Yu
 -44-




---



##### Table of Contents



B.
    
    COMPENSATION.
  Executive Service Contract
     C.
    
    BOARD PRACTICES.
   Audit Committee
  
    
    recommend annually to the board of directors the appointment of our independent
public accountants;
    
    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;
 -45-




---



##### Table of Contents




    
    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 US federal and state laws relating to
financial reporting.
 Nominating Committee
  
    
    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.
 Compensation Committee
  
    
    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).
 -46-




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##### Table of Contents



Nasdaq Requirements
   
    
    our independent directors do not hold regularly scheduled meetings in executive
session;
    
    the compensation of our executive officers is not determined by an independent
committee of the board or by the independent members of the board of directors, and our
CEO may be present and participate in the deliberations concerning his compensation;
    
    related party transactions are not required to be reviewed or approved by our audit
committee or other independent body of the board of directors; and
    
    we are not required to solicit shareholder approval of stock plans, including those
in which our officers or directors may participate; stock issuances that will result in
a change in control; the issuance of our stock in related party transactions or other
transactions in which we may issue 20% or more of our outstanding shares; or, below
market issuances of 20% or more of our outstanding shares to any person.
  D.
    
    EMPLOYEES.
  -47-




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##### Table of Contents



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
    
    
    1,556,353
    (1)
    
    
    7.9%Ka Man Au
    
    
    116,500
    (2)
    
    
    *Hon Tak Ringo Ng
    
    
    137,500
    (3)
    
    
    *Po Yee Elsa Yue
    
    
    4,000
    (4)
    
    
    *Andrew N. Bernstein
    
    
    0
    
    
    
    *Kelvin Wong
    
    
    0
    
    
    
    *Wing Kwan Ted Lai
    
    
    0
    
    
    
    *Chi Fai Frank Cheung
    
    
    0
    
    
    
    *Xiang Xiong Deng
    
    
    0
    
    
    
    *Jin Wang
    
    
    0
    
    
    
    *Jieyun Yu
    
    
    0
    
    
    
    *All directors and executive officers as a group (8 persons)
    
    
    1,814,353
    
    
    
    9.2%Pacific Growth Developments Ltd.
    
    
    1,500,000
    
    
    
    7.9%
 
 *
    
    Represents less than 1% beneficial ownership(1)
    
    Includes options currently exercisable to acquire:           766,500 shares of common stock at $2.00 per share at any time until April 30, 2008;
and -48-




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##### Table of Contents




    
    22,000 shares of common stock at $2.25 per share at any time until April 30, 2008.
 (2)
    
    Represents options currently exercisable to acquire:
 
    
    4,000 shares of common stock at $2.00 per share at any time until April 30, 2008;
and
    
    112,500 shares of common stock at $2.00 per share at any time until June 30, 2013.
 (3)
    
    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
    
    112,500 shares of common stock at $2.00 per share at any time until June 30, 2013.
 (4)
    
    Represents options currently exercisable to acquire:
 
    
    4,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 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.
   -49-




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##### Table of Contents




    
    a total of 855,500 stock options, consisting of stock options to purchase 444,000
and 20,000 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 795,500 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.
   
    
    a total of 965,500 stock options, consisting of stock options to purchase 943,500
shares at $2.00 per share through June 30, 2013 and 22,000 shares at $2.25 per share
through April 30, 2008. A total of 326,000 stock options are held by our directors and
officers as a group.
 -50-




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##### Table of Contents



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.
   Other Options and Warrants Outstanding
  
    
    warrants to purchase an aggregate of 429,676 shares at $2.98 per share through
September 3, 2009 which we sold to a group of investors as part of a private placement
offering on September 1, 2004.
    
    On September 25, 2006, we issued and 11 institutional investors purchased an
aggregate of 1,466,668 shares of our common stock at $3.75 per share, as well as an
aggregate of 236,909 warrants to purchase 236,909 shares at an exercise price of $4.221
per share (the Short Term Warrants) and 366,668 warrants to purchase 366,668 shares
at an exercise price of $4.50 per share (the Long Term Warrants). In addition, our
placement agent received 29,333 Long Term Warrants with identical terms to the Long
Term Warrants issued to the investors (the Placement Agent
 -51-




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Warrants). The Short Term
Warrants are exercisable at any time through February 5, 2007. The Long Term Warrants
are exercisable at any time on or after March 25, 2007 for a term of five years
thereafter.As of December 31, 2006, the following warrants remained outstanding:
 
    
    236,909 Short Term Warrants
    
    366,668 Long Term Warrants
    
    29,333 Placement Agent Warrants
 -52-




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##### Table of Contents



ITEM 7.     MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
 A.
    
    MAJOR SHAREHOLDERS.
     B. RELATED PARTY TRANSACTIONS.
    C.
    
    INTERESTS OF EXPERTS AND COUNSEL.
  -53-




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ITEM 8.     FINANCIAL INFORMATION
 A.
    
    CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION.
   Derivative Litigation.
   Securities Litigation.
 -54-




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##### Table of Contents



B.
    
    SIGNIFICANT CHANGES.
  -55-




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##### Table of Contents



ITEM 9.     THE OFFER AND LISTING
 A. OFFER AND LISTING DETAILS.
  Period
    
    High
    
    
    LowYear 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
    
    
    
    $2.03Year ended December 31, 2006
    
    
    $4.60
    
    
    
    $3.08Quarter 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
    
    
    
    $3.00Quarter ended March 31, 2006
    
    
    $4.16
    
    
    
    $3.34Quarter ended June 30, 2006
    
    
    $3.79
    
    
    
    $3.08Quarter ended September 30, 2006
    
    
    $4.59
    
    
    
    $3.67Quarter ended December 31, 2006
    
    
    $4.60
    
    
    
    $3.71Quarter ended March 31, 2007
    
    
    $12.00
    
    
    
    $4.42Quarter ended June 30, 2007
    
    
    $12.86
    
    
    
    $8.93Quarter ended September 30, 2007
    
    
    $12.37
    
    
    
    $3.99Month ended January 31, 2007
    
    
    $7.53
    
    
    
    $4.42Month ended February 28, 2007
    
    
    $12.00
    
    
    
    $6.86Month ended March 31, 2007
    
    
    $10.46
    
    
    
    $9.02Month ended April 30, 2007
    
    
    $11.19
    
    
    
    $8.93Month ended May 31, 2007
    
    
    $12.86
    
    
    
    $9.63Month ended June 30, 2007
    
    
    $11.90
    
    
    
    $10.76Month ended July 31, 2007
    
    
    $12.12
    
    
    
    $10.75Month ended August 31, 2007
    
    
    $8.23
    
    
    
    $5.95Month ended September 30, 2007
    
    
    $7.95
    
    
    
    $3.99Month ended October 31, 2007
    
    
    $6.15
    
    
    
    $4.07Month ended November 30, 2007
    
    
    $4.13
    
    
    
    $2.18Month ended December 31, 2007*
    
    
    $5.38
    
    
    
    $3.19
 
 *Through December 20, 2007 -56-




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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.
  -57-




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-58-




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-59-




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C. MATERIAL CONTRACTS.
  D. EXCHANGE CONTROLS.
  E. TAXATION.
  United States Federal Income Taxation
  -60-




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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.
  -61-




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##### Table of Contents



British Virgin Islands Taxation
    F. DIVIDENDS AND PAYING AGENTS.
  G. STATEMENT BY EXPERTS.
  H. DOCUMENTS ON DISPLAY.
  I. SUBSIDIARY INFORMATION.
  -62-




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##### Table of Contents



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.
   (b) Managements annual report on internal control over financial reporting.
  -63-




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##### Table of Contents



ITEM 16.       [RESERVED]
 
 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.
  (c) Tax Fees.
 -64-




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(d) All Other Fees.
  (e) Audit Committee Pre-Approval Policies and Procedures.
     (f).
 
 ITEM 16D.     EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.
  -65-




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ITEM 16E.     PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.
   
 PART III
 
 ITEM 17.     FINANCIAL STATEMENTS
  
 ITEM 18.     FINANCIAL STATEMENTS
        -66-




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LJ INTERNATIONAL INC.
 INDEX TO FINANCIAL STATEMENTS
 PageReports of Independent Registered Public Accounting Firms
    
    F-2  F-3Consolidated Statements of Operations
    
    F-4  F-5Consolidated Balance Sheets
    
    F-6Consolidated Statements of Shareholders Equity and Comprehensive Income
    
    F-7  F-8Consolidated Statements of Cash Flows
    
    F-9  F-10Notes to and Forming Part of the Financial Statements
    
    F-11  F-47
 F-1




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##### Table of Contents



Gruber & Company, LLC
  LJ International Inc.
    Gruber & Company, LLC
   F-2




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##### Table of Contents



(1)
 LJ International Inc.
    Moores Rowland Mazars
  (1)
 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 31,2006
    
    
    2005
    
    
    2004US$
    
    
    US$
    
    
    US$Operating revenue
    
    
    2(c)
    
    
    
    123,791
    
    
    
    99,646
    
    
    
    77,504Costs of goods sold (Exclusive of depreciation
shown separately below.)
    
    
    
    
    
    
    (88,867
    )
    
    
    (77,127
    )
    
    
    (61,265
    )Gross profit
    
    
    
    
    
    
    34,924
    
    
    
    22,519
    
    
    
    16,239Operating expensesSelling, general and administrative expenses
    
    
    
    
    
    
    (23,114
    )
    
    
    (15,488
    )
    
    
    (11,578
    )Net (loss) gain on derivatives
    
    
    
    
    
    
    (29
    )
    
    
    8
    
    
    
    199Depreciation
    
    
    
    
    
    
    (2,039
    )
    
    
    (1,368
    )
    
    
    (1,032
    )Impairment loss on goodwill
    
    
    
    
    
    
    -
    
    
    
    -
    
    
    
    (698
    )Operating income
    
    
    
    
    
    
    9,742
    
    
    
    5,671
    
    
    
    3,130Other income and expenseInterest income
    
    
    2(c)
    
    
    
    282
    
    
    
    139
    
    
    
    38Interest expenses
    
    
    
    
    
    
    (3,258
    )
    
    
    (1,991
    )
    
    
    (902
    )Income before income taxes, minority interests,
equity in results of investment securities
and extraordinary item
    
    
    
    
    
    
    6,766
    
    
    
    3,819
    
    
    
    2,266Income taxes expense
    
    
    10
    
    
    
    (1,403
    )
    
    
    (739
    )
    
    
    (277
    )Income before minority interests, equity in
results of investment securities and
extraordinary item
    
    
    
    
    
    
    5,363
    
    
    
    3,080
    
    
    
    1,989Minority interests in consolidated subsidiaries
    
    
    
    
    
    
    (38
    )
    
    
    (20
    )
    
    
    -Income before equity in results of investment
securities and extraordinary item
    
    
    
    
    
    
    5,325
    
    
    
    3,060
    
    
    
    1,989Equity in results of investment securities
    
    
    
    
    
    
    -
    
    
    
    -
    
    
    
    133Income before extraordinary item
    
    
    
    
    
    
    5,325
    
    
    
    3,060
    
    
    
    2,122Extraordinary gain on negative goodwill
    
    
    3
    
    
    
    -
    
    
    
    1,291
    
    
    
    -Net income
    
    
    
    
    
    
    5,325
    
    
    
    4,351
    
    
    
    2,122Numerator:Net income used in computing basic earnings
per share
    
    
    
    
    
    
    5,325
    
    
    
    4,351
    
    
    
    2,122Denominator:Weighted average number of shares used in
calculating basic earnings per share
    
    
    
    
    
    
    17,390,093
    
    
    
    13,438,578
    
    
    
    11,118,995Effect of dilutive potential ordinary shares:Warrants
    
    
    
    
    
    
    118,717
    
    
    
    28,738
    
    
    
    55,693Stock options
    
    
    
    
    
    
    794,467
    
    
    
    854,568
    
    
    
    932,786Weighted average number of shares used in
calculating diluted earnings per share
    
    
    
    
    
    
    18,303,277
    
    
    
    14,321,884
    
    
    
    12,107,474
  F-4




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LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF OPERATIONS
  Year ended
    
    
    Year ended
    
    
    Year endedNotes
    
    
    December 31,
    
    
    December 31,
    
    
    December 31,2006
    
    
    2005
    
    
    2004US$
    
    
    US$
    
    
    US$Basic earnings per share:
    
    
    2(g)Income before extraordinary item
    
    
    
    
    
    
    0.31
    
    
    
    0.23
    
    
    
    0.19Extraordinary item
    
    
    
    
    
    
    -
    
    
    
    0.09
    
    
    
    -Net income
    
    
    
    
    
    
    0.31
    
    
    
    0.32
    
    
    
    0.19Diluted earnings per share:
    
    
    2(g)Income before extraordinary item
    
    
    
    
    
    
    0.29
    
    
    
    0.21
    
    
    
    0.18Extraordinary item
    
    
    
    
    
    
    -
    
    
    
    0.09
    
    
    
    -Net income
    
    
    
    
    
    
    0.29
    
    
    
    0.30
    
    
    
    0.18
  F-5




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED
BALANCE SHEETS
  As of December 31,Notes
    
    
    2006
    
    
    2005US$
    
    
    US$ASSETSCurrent assetCash and cash equivalents
    
    
    
    
    
    
    5,863
    
    
    
    4,796Restricted cash
    
    
    9(a)
    
    
    
    5,489
    
    
    
    5,839Trade receivables, net of allowance for doubtful accounts
(December 31, 2006: US$30; December 31, 2005: US$212)
    
    
    
    
    
    
    23,894
    
    
    
    24,960Derivatives
    
    
    
    
    
    
    3,400
    
    
    
    2,034Available-for-sale securities
    
    
    2(n)
    
    
    
    2,596
    
    
    
    2,496Inventories
    
    
    5
    
    
    
    68,751
    
    
    
    55,941Prepayments and other current assets
    
    
    
    
    
    
    3,118
    
    
    
    2,538Total current assets
    
    
    
    
    
    
    113,111
    
    
    
    98,604Properties held for lease, net
    
    
    6
    
    
    
    1,346
    
    
    
    1,400Property, plant and equipment, net
    
    
    7
    
    
    
    8,412
    
    
    
    6,221Due from related parties
    
    
    16(b)
    
    
    
    21
    
    
    
    484Deferred tax assets
    
    
    
    
    
    
    111
    
    
    
    -Goodwill, net
    
    
    8
    
    
    
    1,521
    
    
    
    1,521Total assets
    
    
    
    
    
    
    124,522
    
    
    
    108,230LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesBank overdrafts
    
    
    9
    
    
    
    1,591
    
    
    
    2,028Notes payable
    
    
    9
    
    
    
    3,987
    
    
    
    3,079Capitalized lease obligation, current portion
    
    
    11
    
    
    
    94
    
    
    
    20Letters of credit, gold loan and others
    
    
    9
    
    
    
    33,423
    
    
    
    32,643Derivatives
    
    
    
    
    
    
    6,034
    
    
    
    3,567Trade payables
    
    
    
    
    
    
    9,213
    
    
    
    12,168Accrued payroll and staff benefits
    
    
    
    
    
    
    2,043
    
    
    
    1,773Accrued expenses and other payables
    
    
    
    
    
    
    5,509
    
    
    
    5,507Due to related parties
    
    
    15(b)
    
    
    
    -
    
    
    
    1,910Income taxes payable
    
    
    
    
    
    
    735
    
    
    
    201Deferred taxation
    
    
    10
    
    
    
    348
    
    
    
    154Total current liabilities
    
    
    
    
    
    
    62,977
    
    
    
    63,050Notes payable, non-current portion
    
    
    
    
    
    
    1,378
    
    
    
    -Capitalized lease obligation, non-current portion
    
    
    11
    
    
    
    262
    
    
    
    43Total liabilities
    
    
    
    
    
    
    64,617
    
    
    
    63,093Minority interest
    
    
    
    
    
    
    166
    
    
    
    129Commitments and contingencies
    
    
    12Shareholders equityCommon stocks, par value US$0.01 each,
Authorized - 100 million shares,
Issued 18,977,371 shares as of December 31, 2006 and
15,521,203 shares as of December 31, 2005
    
    
    13
    
    
    
    190
    
    
    
    155Additional paid-in capital
    
    
    
    
    
    
    40,456
    
    
    
    31,204Accumulated other comprehensive loss
    
    
    
    
    
    
    (56
    )
    
    
    (156
    )Unearned compensation
    
    
    2(q)
    
    
    
    -
    
    
    
    (19
    )Retained earnings
    
    
    
    
    
    
    19,149
    
    
    
    13,824Total shareholders equity
    
    
    
    
    
    
    59,739
    
    
    
    45,008Total liabilities and shareholders equity
    
    
    
    
    
    
    124,522
    
    
    
    108,230
  F-6




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED
STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
  AccumulatedotherCommon stock
    
    Additional
    
    
    comprehensiveNumber
    
    
    Par
    
    
    Paid-in
    
    
    income (loss)
    
    
    Unearned
    
    
    RetainedNotes
    
    
    of shares
    
    
    Value
    
    
    Capital
    
    
    US$
    
    
    compensation
    
    
    earnings
    
    
    TotalUS$
    
    
    US$
    
    
    (Note 2(x))
    
    
    US$
    
    
    US$
    
    
    US$Balance as of January 1, 2004
    
    
    
    
    
    
    
    9,890,006
    
    
    
    99
    
    
    
    19,802
    
    
    
    (151
    )
    
    
    -
    
    
    
    7,351
    
    
    
    27,101Comprehensive income, net of tax:Net income
    
    
    
    
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    2,122
    
    
    
    2,122Issuance of common stock on private placement
    
    
    13(a)(i)

    
    
    
    1,614,082
    
    
    
    16
    
    
    
    2,730
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    2,746Issuance of common stock upon exercise of stock options
    
    
    13(a)(ii)

    
    
    
    405,000
    
    
    
    4
    
    
    
    806
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    810Issuance of common stock upon exercise of warrants
    
    
      13(a)(ii)

    
    
    
    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
    )
    
    
    9,473
    
    
    
    32,790Comprehensive income, net of tax:Net income
    
    
    
    
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    4,351
    
    
    
    4,351Exchange translation difference
    
    
    
    
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    (5
    )
    
    
    -
    
    
    
    -
    
    
    
    (5
    )Issuance of common stock upon exercise of stock options
    
    
      13(a)(iii)


    

    
    
    3,162,000
    
    
    
    31
    
    
    
    7,542
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    7,573Issuance of common stock upon exercise of warrants
    
    
      13(a)(iii)

    
    
    
    54,545
    
    
    
    1
    
    
    
    162
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    163Compensation costs for warrants granted
    
    
    
    15(b)
    
    
    
    -
    
    
    
    -
    
    
    
    118
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    118Compensation expense recognized during the year
    
    
    
    2(q)
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    18
    
    
    
    -
    
    
    
    18Balance as of December 31, 2005
    
    
    
    
    
    
    
    15,521,203
    
    
    
    155
    
    
    
    31,204
    
    
    
    (156
    )
    
    
    (19
    )
    
    
    13,824
    
    
    
    45,008
  F-7




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED
STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
   AccumulatedCommon stock
    
    Additional
    
    
    otherNumber
    
    
    Par
    
    
    Paid-in
    
    
    comprehensive
    
    
    Unearned
    
    
    RetainedNotes
    
    
    of shares
    
    
    Value
    
    
    Capital
    
    
    income (loss)
    
    
    compensation
    
    
    earnings
    
    
    TotalUS$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$Balance as of December 31, 2005
    
    
    
    
    
    
    15,521,203
    
    
    
    155
    
    
    
    31,204
    
    
    
    (156
    )
    
    
    (19
    )
    
    
    13,824
    
    
    
    45,008Comprehensive income, net of tax:Net income
    
    
    
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    5,325
    
    
    
    5,325Unrealized holding gain on investment in 
available-for-sale securities
    
    
    2(n)
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    100
    
    
    
    -
    
    
    
    -
    
    
    
    100Issuance of common stock on private placement
    
    

    13(a)(iv)
    
    
    
    1,466,668
    
    
    
    15
    
    
    
    4,176
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    4,191Issuance of common stock upon exercise of stock options
    
    
    13(a)(v)
    
    
    
    1,489,500
    
    
    
    15
    
    
    
    2,989
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    3,004Issuance of common stock upon exercise of warrants
    
    
    13(a)(v)
    
    
    
    500,000
    
    
    
    5
    
    
    
    1,735
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    1,740Elimination of unearned compensation
    
    
    2(q)
    
    
    
    -
    
    
    
    -
    
    
    
    (19
    )
    
    
    -
    
    
    
    19
    
    
    
    -
    
    
    
    -Compensation costs for warrants granted
    
    
    15(b)
    
    
    
    -
    
    
    
    -
    
    
    
    158
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    158Stock-based compensation
    
    
    2(q)
    
    
    
    -
    
    
    
    -
    
    
    
    213
    
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    213Balance as of December 31, 2006
    
    
    
    
    
    
    18,977,371
    
    
    
    190
    
    
    
    40,456
    
    
    
    (56
    )
    
    
    -
    
    
    
    19,149
    
    
    
    59,739
  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 312006
    
    
    2005
    
    
    2004US$
    
    
    US$
    
    
    US$Cash flows from operating activities:Net income
    
    
    5,325
    
    
    
    4,351
    
    
    
    2,122Adjustments to reconcile income (loss) to net cash
(used in) provided by operating activities:Depreciation of property, plant and equipment
and properties held for lease
    
    
    2,039
    
    
    
    1,368
    
    
    
    1,032Amortization and impairment loss on goodwill
    
    
    -
    
    
    
    -
    
    
    
    698Extraordinary gain on negative goodwill
    
    
    -
    
    
    
    (1,291
    )
    
    
    -Unrealized (gain) loss on derivatives
    
    
    (48
    )
    
    
    88
    
    
    
    482Loss (Gain) on disposal and write-off of property,
plant and equipment
    
    
    3
    
    
    
    8
    
    
    
    (3
    )(Reversal of) Allowance for doubtful debts
    
    
    (40
    )
    
    
    (72
    )
    
    
    125Minority interests
    
    
    37
    
    
    
    20
    
    
    
    -Compensation costs for warrants granted
    
    
    158
    
    
    
    118
    
    
    
    -Compensation expenses recognized during the year
    
    
    213
    
    
    
    18
    
    
    
    11Equity in results of investment securities
    
    
    -
    
    
    
    -
    
    
    
    (133
    )Changes in operating assets and liabilities:Trade receivables
    
    
    1,106
    
    
    
    (8,607
    )
    
    
    (535
    )Inventories
    
    
    (12,810
    )
    
    
    (12,060
    )
    
    
    (15,142
    )Prepayments and other current assets
    
    
    (580
    )
    
    
    601
    
    
    
    1,187Due from related parties
    
    
    463
    
    
    
    7
    
    
    
    17Trade payables
    
    
    (2,955
    )
    
    
    1,883
    
    
    
    1,136Accrued expenses and other payables
    
    
    272
    
    
    
    (854
    )
    
    
    1,767Income taxes payable and deferred taxation
    
    
    617
    
    
    
    200
    
    
    
    (258
    )Net cash used in operating activities
    
    
    (6,200
    )
    
    
    (14,222
    )
    
    
    (7,494
    )Cash flows from investing activities:Change in restricted cash
    
    
    350
    
    
    
    554
    
    
    
    (462
    )Net cash inflow from acquisition
    
    
    -
    
    
    
    156
    
    
    
    -Purchase of available-for-sale securities
    
    
    -
    
    
    
    (2,496
    )
    
    
    -Purchase of property, plant and equipment
    
    
    (4,183
    )
    
    
    (2,869
    )
    
    
    (727
    )Proceeds on disposals of property, plant and
equipment
    
    
    4
    
    
    
    -
    
    
    
    10Net cash used in investing activities
    
    
    (3,829
    )
    
    
    (4,655
    )
    
    
    (1,179
    )
  F-9




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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 31,2006
    
    
    2005
    
    
    2004US$
    
    
    US$
    
    
    US$Cash flows from financing activities:Change in bank overdrafts
    
    
    (437
    )
    
    
    1,421
    
    
    
    (705
    )Proceeds from issuance of shares upon
exercise of stock options
    
    
    3,004
    
    
    
    7,573
    
    
    
    810Proceeds from issuance of share upon
exercise of stock warrants
    
    
    1,740
    
    
    
    163
    
    
    
    -Net proceeds from issuance of shares in
private placement
    
    
    4,191
    
    
    
    -
    
    
    
    2,746Repayment of amount due to related parties
    
    
    (1,910
    )
    
    
    -
    
    
    
    -Loans acquired
    
    
    11,092
    
    
    
    10,267
    
    
    
    7,624Repayment of loans
    
    
    (8,117
    )
    
    
    (5,424
    )
    
    
    (3,082
    )Repayment of capitalized lease obligation
    
    
    (73
    )
    
    
    (14
    )
    
    
    (18
    )Letter of credit and factoring
    
    
    457
    
    
    
    6,464
    
    
    
    1,804Proceeds from sale of derivatives net of
retirement of embedded derivatives
    
    
    1,149
    
    
    
    -
    
    
    
    -Net cash provided by financing activities
    
    
    11,096
    
    
    
    20,450
    
    
    
    9,179Effect of foreign exchange rate change
    
    
    -
    
    
    
    (5
    )
    
    
    -Net increase in cash and cash equivalents
    
    
    1,067
    
    
    
    1,568
    
    
    
    506Cash and cash equivalents, as of beginning
of year
    
    
    4,796
    
    
    
    3,228
    
    
    
    2,722Cash and cash equivalents, as of end of year
    
    
    5,863
    
    
    
    4,796
    
    
    
    3,228Supplemental disclosure information:Interest expense
    
    
    3,258
    
    
    
    1,991
    
    
    
    872Income taxes paid
    
    
    786
    
    
    
    539
    
    
    
    535Non-cash transactions:Purchase of property, plant and equipment
under capitalized leases
    
    
    366
    
    
    
    -
    
    
    
    -
  F-10




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##### Table of Contents



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, sale of precious and color 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
retail shops are located in the PRC, Hong Kong and Macau. The Company also owns certain
commercial and residential properties located in Hong Kong, which are held primarily for
lease.2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 (a)
    
    Basis of accounting

The financial statements are prepared in accordance with US generally accepted
accounting principles (US GAAP).(b)
    
    Principles of consolidation and goodwill
 The 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.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.VIEs are owned by individuals, who are acting as agents for the Company.
The Company does not have any ownership interest in VIEs. LJI is incorporated in
the BVI and is considered a foreign entity under the PRC laws. Prior to 2006, due
to the restrictions on foreign ownership on the retail business of jewelry, the
Company, through loans to the agents, established VIEs to carry out the retail
business of jewelry in the PRC. Pursuant to various agreements entered into
between the Company, the owners of VIEs and VIEs, the Company generally has control
of VIEs, absorbs majority of expected losses and receives majority of residual
return of VIEs. The Company is therefore considered the primary beneficiary of
VIEs. Accordingly, the results of VIEs have been consolidated in the financial
statements of the Company since they become VIEs of the Company. With the
 
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 relaxation of the restrictions on foreign ownership on retail business, the agents of
one of the VIE have transferred the ownership of the VIE back to the Company in
September 2006, the agents of another VIE are in the process of transferring the
ownership of the VIE back to the Company.The application of the consolidation provisions o FIN 46(R) resulted in a
decrease in assets and an increase in liabilities as of December 31, 2006 by
US$3,098 and US$1,358 respectively and a decrease in assets and an increase in
liabilities as of December 31, 2005 by US$4,586 and US$1,882 respectively and
increase in net loss of US$580 and US$1,248 and US$223 for each of three years
ended December 31, 2006, 2005 and 2004 respectively.(b)
    
    Principles of consolidation and goodwill (Continued)Goodwill represents the excess of the aggregate purchase price over the fair value of
the net assets acquired in a purchase businesses combination. Goodwill is reviewed
for impairment at least annually in accordance with the provisions of FASB
Statement No. 142, Goodwill and Other Intangible Assets(Statement 142). The
goodwill impairment test is a two-step test. Under the first step, the fair value
of the reporting unit is compared with its carrying value (including goodwill). If
the fair value of the reporting unit is less than its carrying value, an indication
of goodwill impairment exists for the reporting unit and the enterprise must
perform step two of the impairment test (measurement). Under step two, an
impairment loss is recognized for any excess of the carrying amount of the
reporting units goodwill over the implied fair value of that goodwill. The
implied fair of goodwill is determined by allocating the fair value of the
reporting unit in a manner similar to a purchase price allocation, in accordance
with FASB Statement No. 141, Business Combinations. The residual fair value after
this allocation is the implied fair value of the reporting unit goodwill. Fair
value of the reporting unit is determined using a discounted cash flow analysis.
If the fair value of the reporting unit exceeds its carrying value, step two does
not need to be performed.The Company performed its annual impairment review of goodwill, and
resulting in US$NiI in 2006, US$1,291 included in statement of operations as an
extraordinary item in 2005 and US$698 impairment loss in 2004.(c)
    
    Revenue recognition

Operating revenue represents:
 Year endedDecember 31,2006US$Product Sales
    
    
    128,118Services Income
    
    
    4,130Rental Income
    
    
    124132,372Less:
    
    Sales return allowance
    
    
    (8,581
    )123,791
 F-12




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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (i)
    
    Product sales

Product sales represent the invoiced value of products sold, net of value added taxes
(VAT). The Company recognizes revenue from the sale of products when the following
criteria are met: 1) persuasive evidence of an arrangement exists (sales agreements
and customer purchase orders are used to determine the existence of an arrangement);
2) delivery of the product has occurred and risks and benefits of ownership have been
transferred, which is when the product is received by the customer at its or a
designated location in accordance with the sales terms; 3) the sales price is fixed
or determinable; and 4) collectibility is probable.In the PRC, VAT at a general rate of 17% on invoice amount is collected on behalf of
tax authorities in respect of the sales of products and is not recorded as revenue.
VAT collected from customers, net of VAT paid for purchases, is recorded as a
liability in the consolidated balance sheets until it is paid to the authorities.(ii)
    
    Service Income
Service income represents services performed for improving and upgrading gemstones
into saleable quality. On August 11, 2006 the Company entered into a Joint
Collaboration Agreement (the Agreement) with an Agent who is not a related party.
The Company was responsible for and paid the cost of servicing and upgrading
performed to bring gemstones to the form of fine jewelry ready for sale. The servicing income in the amount of $4,130 is included in servicing income on the
consolidated statement of operations.(iii)
    
    Rental income
 Rental income receivable under operating lease is recognized in the consolidated
statements of income in equal installments over the period covered by the
lease term.(iv)
    
    Other income represents:Interest income is accrued on a time proportion basis on the principal outstanding
and at the interest rate applicable.
 (d)
    
    Sales return reserve

The 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 costs
 The shipping and handling costs are included in cost of goods sold. Shipping and
handling costs were US$2,991, US$3,135 and US$2,779 for the years ended December 31,
2006, 2005 and 2004, respectively.
 
 F-13




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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (f)
    
    Advertising and promotion costs

Advertising and promotion expenses are generally expensed when incurred. Advertising
costs were US$1,321, US$1,092 and US$364 for the years ended December 31, 2006, 2005 and
2004, 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. 396,001 warrants were not included
in the computation of diluted earnings per share for the year ended December 31, 2006
because to do so would have been anti-dilutive for the year.(h)
    
    Fair value of financial instruments

The 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 receivable

Trade receivables are recorded at the invoiced amount and do not bear
interest. Amounts collected on trade receivables are included in net cash provided
by operating activities in the consolidated statements of cash flows. The Company
maintains an allowance for doubtful accounts for estimated losses inherent in its
trade receivable portfolio and purchases trade credit insurance to cover the risk
of collectibilities. In establishing the required allowance, management considers
historical losses, current receivables aging, and existing industry and national
economic data. The Company reviews its allowance for doubtful accounts regularly.
Past due balances over 120 days and over a specified amount are reviewed
individually for collectibility. All other balances are reviewed on a pooled basis
by aging of such balances. Account balances are charged off against the allowance
after all means of collection have been exhausted and the potential for recovery is
considered remote. The Company does not have any off-balance-sheet credit exposure
related to its customers, except for outstanding bills discounted with banks (see
Note 9), that are subject to recourse for non-payment.
 
 F-14




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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (j)
    
    Inventories

Inventories 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.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.
 F-15




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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (k)
    
    Properties held for lease

Properties 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 depreciation

PPE 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. Plant and
equipment under capital leases are stated at the present value of minimum lease
payments.Depreciation on PPE is calculated by using the straight-line method (after taking into
account their respective estimated residual values) 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
    
    10% to 20%
 Depreciation on PPE attributable to manufacturing activities is capitalized as part of
inventory, and expensed to cost of goods sold as inventory is sold. Depreciation
related to abnormal amounts from idle capacity is charged to cost of goods sold for the
period incurred. Total depreciation for the years ended December 31, 2006, 2005 and
2004 were US$ 2,039, US$1,368 and US$1,032, respectively.(m)
    
    Impairment of long-lived assets

In accordance with Statement of Financial Accounting Standards (SFAS)
No. 144 (SFAS 144), Accounting for the Impairment or Disposal of Long-Lived
Assets, long-lived assets, such as property, plant and equipment, are reviewed for
impairment whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. If circumstances require a long-lived
asset be tested for possible impairment, the Company first compares undiscounted
cash flows expected to be generated by an asset to the carrying value of the asset.
If the carrying value of the long-lived asset is not recoverable on an
undiscounted cash flow basis, an impairment is recognized to the extent that the
carrying value exceeds it fair value. Fair value is determined through various
valuation techniques including discounted cash flow models, quoted market values
and third-party independent appraisals, as considered necessary.
 
 F-16




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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (n)
    
    Available-for-sale securities
The Company classifies its investment in capital guaranteed fund as available-for-sale
securities. The fund is restricted and secures obligations under trade credit banking
facilities. It is carried at market value with a corresponding recognition of net
unrealized holding gain or loss (net of tax) as a separate component of shareholders
equity until realized. Unrealized losses are charged against net earnings when a
decline in fair value is determined to be other than temporary. Gains and losses on
sales of securities are computed on a specific identification basis. Available-for-sale
securities comprise:
 As of December 31,2006
    
    
    2005US$
    
    
    US$Quoted capital guaranteed fund, at cost
    
    
    2,496
    
    
    
    2,496Gross unrealized gains
    
    
    100
    
    
    
    -Fair value of available-for-sale securities
    
    
    2,596
    
    
    
    2,496
 (o)
    
    Gold loans and embedded derivative

Gold 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)
    
    Derivatives

The 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).
 F-17




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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (q)
    
    Stock-based compensation (continued)

Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based
Payment, (SFAS 123(R)) requires the Company to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant-date fair
value of the award. The Company records the cost as expense over the offering period
and vesting term in connection with compensation expense for stock-based employee
compensation plans.Effective January 1, 2006, the Company began recording compensation expense for
stock-based employee compensation plans in accordance with SFAS 123(R) as interpreted
by SEC Staff Accounting Bulletin No. 107. The Company adopted the modified prospective
transition method provided for under SFAS 123(R), and consequently has not
retroactively adjusted results from prior periods. Under this transition method,
compensation expense for stock-based employee compensation plans recognized for the
year ended December 31, 2006 now includes estimated expense for the portion of stock
options vesting in the period for options granted prior to, but not vested as of
January 1, 2006, based on the grant date fair value estimated in accordance with the
original provisions of Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation (SFAS No. 123).There were no new stock options granted during the year ended December 31, 2006. As of
December 31, 2006, the Company has three stock-based employee compensation plans,
details of which are set out in note 14(a).Prior to 1 January, 2006, the 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 plan 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 shareholders equity.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. Following the adoption of SFAS
 F-18




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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (q)
    
    Stock-based compensation (Continued)123(R), the unearned compensation has been eliminated against the additional paid-in
capital. 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:
 Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,2005
    
    
    2004US$
    
    
    US$Income before extraordinary item
    
    
    3,060
    
    
    
    2,122Add :
    
    Stock-based employee compensation
expenses included in reported net
income, net of tax
    
    
    18
    
    
    
    11Deduct:
    
    Total stock-based employee
compensation expenses determined
under fair value based method for all
awards, net of tax
    
    
    (2,266
    )
    
    
    (159
    )Pro forma income before extraordinary item
    
    
    812
    
    
    
    1,974Extraordinary item
    
    
    1,291
    
    
    
    -2,103
    
    
    
    1,974
 (q)
    
    Stock-based compensation (Continued)
 Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,2005
    
    
    2004US$
    
    
    US$Basic earnings per share, as reported:Income before extraordinary item
    
    
    0.23
    
    
    
    0.19Extraordinary item
    
    
    0.09
    
    
    
    -Net income
    
    
    0.32
    
    
    
    0.19Diluted earnings per share, as reported:Income before extraordinary item
    
    
    0.21
    
    
    
    0.18Extraordinary item
    
    
    0.09
    
    
    
    -Net income
    
    
    0.30
    
    
    
    0.18
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (q)
    
    Stock-based compensation (Continued)
 Basic earnings per share, pro forma:Income before extraordinary item
    
    
    0.06
    
    
    
    0.18Extraordinary item
    
    
    0.09
    
    
    
    -Net income
    
    
    0.15
    
    
    
    0.18Diluted earnings per share, pro forma:Income before extraordinary item
    
    
    0.06
    
    
    
    0.16Extraordinary item
    
    
    0.09
    
    
    
    -Net income
    
    
    0.15
    
    
    
    0.16
 The fair value of these options was estimated on the date of grant using a
Black-Scholes option pricing model with the following weighted-average assumptions:
 Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,2005
    
    
    2004Expected dividend yield
    
    
    -
    
    
    
    -Expected stock price volatility
    
    
    52
    %
    
    
    61
    %Risk-free interest rate
    
    
    4.37
    %
    
    
    4.15
    %Expected life of options
    
    2 years
    
    3 years
 The weighted average fair value per option granted during the years ended December 31,
2005 and 2004 was US$0.70 and US$1.06 respectively.
 (r)
    
    Income taxes
 Income taxes are accounted for under the asset and liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences attributable
to differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases and operating loss and tax credit
carry forwards. Deferred tax assets and liabilities are measured using enacted tax
rates expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date. The Company provides a valuation
allowance, if necessary, to reduce deferred tax assets to their estimated
realizable value.(s)
    
    Foreign currencies

LJIs functional currency is United States dollars. Transactions denominated in
currencies other than U.S. dollars are translated into U.S. dollars at the exchange rate
prevailing at the dates of transactions. Foreign currency transaction gains and losses
are included in the consolidated statement of operations. The assets and liabilities of
subsidiaries whose functional currencies are other than U.S. dollars, are translated at
the exchange rates in effect at the balance sheet date and related revenue and expenses
are translated at average exchange rates during the year. Related transaction gains or
losses are reported as a separate component of accumulated other comprehensive income
(loss).
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2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (s)
    
    Foreign currencies (Continued)The aggregate transaction loss included in determining net income were US$465, US$273
and US$214 for each of the three years ended December 31, 2006, 2005 and 2004
respectively.(t)
    
    Cash equivalents and Pledged Bank DepositsCash consists of cash on hand, cash in bank accounts and interest-bearing savings
accounts. Cash deposits that are restricted as to withdrawal or pledged as security, are
disclosed separately on the face of the consolidated balance sheet, and not included in
the cash total for the purpose of the consolidated statements of cash flow.(u)
    
    Uses of estimates
The preparation of the consolidated financial statements, in accordance
with U.S. GAAP, requires management to make estimates and assumptions that affect
the amounts reported in the consolidated financials statements and accompanying
notes. Significant items subject to such estimates and assumptions include the
carrying amount of property, plant and equipment and goodwill; valuation allowance
for receivables, inventories and deferred income tax asset; valuation of derivative
instruments; valuation of share-based compensation. Actual results could differ
from those estimates.(v)
    
    Related parties
Parties are considered to be related if one party has the ability, directly or
indirectly, to control the other party, or exercise significant influence over the other
party in making financial and operating decisions. Parties are also considered to be
related if they are subject to common control or common significant influence.(w)
    
    Dividends
The Directors of the Company have never declared or paid any cash dividends on the
Companys capital stock and do not anticipate paying cash dividends in the foreseeable
future. The ability to pay dividends depends upon receipt of dividends or other
payments from subsidiaries and other holdings and investments. In addition, the
operating subsidiaries from time to time may be subject to restrictions on their ability
to make distributions to the Company, including as a result of restrictive covenants in
loan agreements, restrictions on the conversion of local currency into US dollars or
other currencies and other regulatory restrictions. Currently, none of the subsidiaries
has such restriction during the periods presented except for the covenants as set out in
note 9 to the financial statements.
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2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (x)
    
    Comprehensive income
The Company reports comprehensive income in accordance with SFAS No. 130 Reporting
Comprehensive Income. Accumulated other comprehensive loss represents exchange
translation adjustments and unrealised holding gains on investment, and is included in
the shareholders equity section of the balance sheet.(y)
    
    New accounting pronouncements
In July 2006, the FASB issued Interpretation No. 48 (FIN 48), Accounting for
Uncertainty in Income Taxes, which clarifies the accounting for uncertainty in income
taxes recognized in the financial statements in accordance with FASB Statement No. 109,
Accounting for Income Taxes. FIN 48 provides guidance on the financial statement
recognition and measurement of a tax position taken or expected to be taken in a tax
return. FIN 48 also provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosures, and transition. FIN 48 is
effective for years beginning after December 15, 2006. The Company does not expect the
adoption of FIN 48 will have a material impact on its financial statements.In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements (SFAS 157),
which defines fair value, establishes a framework for measuring fair value in generally
accepted accounting principles, and expands disclosures about fair value measurements.
SFAS 157 applies under other existing accounting pronouncements that require or permit
fair value measurements, the FASB having previously concluded in those accounting
pronouncements that fair value is the relevant measurement attribute. Accordingly,
SFAS 157 does not require any new fair value measurements. However, the application of
this statement may change the current practice for fair value measurements. SFAS 157 is
effective for financial statements issued for fiscal years beginning after November 15,
2007, and interim periods within those fiscal years. The Company does not expect the
adoption of SFAS 157 will have a material impact on its financial statements.In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities (SFAS 159) which permits entities to choose to measure
many financial instruments and certain other items at fair value that are not currently
required to be measured at fair value. SFAS 159 will be effective for the Company on
January 1, 2008. The Company does not expect the adoption of SFAS 159 will have a
material impact on its financial statements.
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3.
    
    ACQUISITIONSOn January 1, 2005, the Company paid US$2,828 for new issuance of 3,900 common stock of
Goldleaves International Limited (GIL), a company whose principal activities are the
manufacturing and trading of rough and pre-formed gemstones, in which the Company had 20%
equity interests and is classified as investment securities as of December 31, 2004. The
Company then became the major stockholder holding 98% equity interest in GIL, which became a
subsidiary of the Company. The directors of the Company consider such acquisition would
enhance the Company by forward and backward vertical integration.Details of the 78% share of identifiable assets and liabilities by the Company at the date
of acquisition are as follows:
 As ofJanuary 1,2005US$Net assets acquired:Property, plant and equipment
    
    
    119Trade receivables
    
    
    490Inventories
    
    
    5,657Other receivables
    
    
    2,674Cash and cash equivalents
    
    
    122Trade payables
    
    
    (572
    )Accrued expenses and other payables
    
    
    (4,221
    )4,269Negative goodwill arising from acquisition
    
    
    (1,441
    )Total consideration
    
    
    2,828
 None of the amount of goodwill is expected to be taxable or tax deductible.Negative goodwill was arisen from the acquisition of GIL, US$150 of which was directly
written off against the Companys share of properties, plants and equipments acquired. The
remaining balance of US$1,291 was included in statement of operations for the year ended
December 31, 2005 as an extraordinary item.
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4.
    
    OPERATING RISKS
 (a)
    
    Concentrations of credit risksDetails of major customers from which the Company derived operating revenue are shown
in note 16(c).Credit risk represents the accounting loss that would be recognized at the reporting
date if counterparties failed completely to perform as contracted. Concentrations of
credit risk (whether on or off balance sheet) that arise from financial instruments
exist for groups of customers or counterparties when there are similar economic
characteristics that would cause their ability to meet contractual obligations to be
similarly affected by changes in economic or other conditions. The major concentration
of credit risk arises from the Companys receivables. Even though the Company does
have major customers, it does not consider itself to be exposed to significant credit
risk with regards to collection of the related receivables. Historical losses have not
been significant.(b)
    
    Country risksThe Company may also be exposed to certain risks as a result of its manufacturing
operation being located in the PRC and its properties held for lease in Hong Kong which
are not typically associated with companies operating in North America and Western
Europe. These include risks associated with, among others, the political, economic and
legal environments and foreign currency exchange. The Companys results may be
adversely affected by changes in the political and social conditions in the PRC, and by
changes in governmental policies with respect to laws and regulations,
anti-inflationary measures, currency conversion and remittance abroad, and rates and
methods of taxation, among other things. The Companys management believe these risks
not to be significant. There can be no assurance, however, that changes in political,
social and other conditions will not result in any adverse impact.(c)
    
    Cash and time depositsThe Company maintains majority of its cash balances and investments in time deposits
with various banks and financial institutions in Hong Kong. In common with local
practice, such amounts are not insured or otherwise protected should the financial
institutions be unable to meet their liabilities. There has been no history of credit
losses.
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5.
    
    INVENTORIESInventories consist of the following:
 As of December 31,2006
    
    
    2005US$
    
    
    US$Raw materials
    
    
    44,001
    
    
    
    38,676Work-in-progress
    
    
    2,417
    
    
    
    2,214Finished goods
    
    
    22,333
    
    
    
    15,05168,751
    
    
    
    55,941
 During the years ended December 31, 2006, 2005 and 2004, the Company made a net write-down
of inventories, amounting to (US$497), US$2,102 and (US$155) respectively.6.
    
    PROPERTIES HELD FOR LEASE, NETThe Company owns leasehold land and buildings in Hong Kong and leases them out for lease
term of 2 years. Properties held for lease consists of the following:
 As of December 31,2006
    
    
    2005US$
    
    
    US$Leasehold land and buildings
    
    
    2,037
    
    
    
    2,037Less: Accumulated depreciation
    
    
    (691
    )
    
    
    (637
    )1,346
    
    
    
    1,400
 The Company pledged all properties held for lease as collateral for general banking
facilities granted to the Company as of December 31, 2006 and 2005 (see note 9).The future aggregate minimum rental receivables under non-cancellable operating leases are
as follows:
 As of December 31,2006
    
    
    2005US$
    
    
    US$2006
    
    
    -
    
    
    
    912007
    
    
    88
    
    
    
    322008
    
    
    24
    
    
    
    -112
    
    
    
    123
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7.
    
    PROPERTY, PLANT AND EQUIPMENT, NETProperty, plant and equipment consist of the following:
 As of December 31,2006
    
    
    2005US$
    
    
    US$Leasehold land and buildings
    
    
    2,405
    
    
    
    2,405Leasehold improvement
    
    
    6,591
    
    
    
    3,740Furniture, fixtures and equipment
    
    
    5,342
    
    
    
    4,664Plant and machinery
    
    
    2,264
    
    
    
    2,046Motor vehicles
    
    
    945
    
    
    
    56417,547
    
    
    
    13,419Less: Accumulated depreciation
    
    
    (9,135
    )
    
    
    (7,198
    )8,412
    
    
    
    6,221
 The Company pledged leasehold land and buildings with net book values of US$1,385 and
US$2,049 as of December 31, 2006 and 2005 respectively as collateral for general banking
facilities granted to the Company (see note 9).8.
    
    GOODWILL, NETAs of December 31, 2006, goodwill is attributed to the acquisition of a jewelry retail
company in 2002.
 Year ended December 31,2006
    
    
    2005
    
    
    2004US$
    
    
    US$
    
    
    US$Carrying value, beginning of year
    
    
    1,521
    
    
    
    1,521
    
    
    
    1,521Impairment loss
    
    
    -
    
    
    
    -
    
    
    
    -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, 2006. The
accumulated amortization and impairment losses were US$869 and US$869 as of December 31,
2006 and 2005 respectively.
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9.
    
    BANKING FACILITIES AND OTHER LOANS
 As of December 31,2006
    
    
    2005Note
    
    US$
    
    
    US$Bank overdrafts
    
    (a)
    
    
    1,591
    
    
    
    2,028Notes payable:Current portion
    
    (b)
    
    
    3,987
    
    
    
    3,079Letters of credit, gold and others:Letters of credit
    
    (a)
    
    
    19,562
    
    
    
    13,048Factoring
    
    (a)
    
    
    2,782
    
    
    
    8,839Gold loan
    
    (c)
    
    
    11,079
    
    
    
    10,75633,423
    
    
    
    32,643
 The Companys banking facilities are collateralized by leasehold land and buildings (see
notes 6 and 7), restricted cash deposits, factored receivables, and personal guarantees of
and properties owned by a director (see note 15(b)).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, 2006, the Company had various revolving bank facilities of
overdrafts, letters of credit and factoring facilities granted by banks, amounting to
US$3,564, US$22,615 and US$18,431 respectively.The bank overdrafts are denominated in Hong Kong dollars, bear interest at the
floating commercial bank lending rates in Hong Kong, which ranged from 4.4% to 9% per
annum as of December 31, 2006.The factoring facilities granted are limited to the extent of accounts receivable
collateralized to the banks.
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##### Table of Contents



9.
    
    BANKING FACILITIES AND OTHER LOANS (CONTINUED)
 Under the banking facilities arrangements, the Company is required to maintain
certain cash balances and investment in capital guaranteed fund based on the amount
of facilities granted. The cash balances are reflected as restricted cash in the
balance sheet.(b)
    
    The Company also had term loans classified under notes payable which are
related to the Companys leasehold land and buildings (see note 7). These loans
aggregated to US$5,365 as of December 31, 2006. The expected maturities of these notes
payable are within 1-5 years. Interest charges on these loans ranged from 6.4% to 8%
per annum as of December 31, 2006.(c)
    
    The Company had outstanding loans to purchase 26.92oz of gold as of December
31, 2006 with the related balances being US$11,079. These loans are due within the
following year, however, have been historically renewed. These loans bear interest at
2.6% to 3.1% per annum as of December 31, 2006 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,
2006 and 2005 were 4.9% and 5.0% per annum respectively.
 10.
    
    INCOME TAXESIncome taxes are accounted for under the asset and liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences attributable to
temporary differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases and operating losses and tax credit carry
forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected
to apply to taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.The 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
comprises of the following:
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10.
    
    INCOME TAXES (CONTINUED)
 Year ended December 31,2006
    
    
    2005
    
    
    2004US$
    
    
    US$
    
    
    US$Current taxes arising in foreign 
subsidiaries:For the year
    
    
    (1,248
    )
    
    
    (595
    )
    
    
    (299
    )(Under) Over provision in prior 
years
    
    
    (72
    )
    
    
    (77
    )
    
    
    22Total current tax
    
    
    (1,320
    )
    
    
    (672
    )
    
    
    (277
    )Deferred taxes arising in foreign 
subsidiaries:For the year
    
    
    (83
    )
    
    
    (67
    )
    
    
    -Income taxes expense
    
    
    (1,403
    )
    
    
    (739
    )
    
    
    (277
    )
 Reconciliation to the expected statutory tax rate in Hong Kong of 17.5% (2005 and 2004:
17.5%)is as follows:
 Year ended December 31,2006
    
    
    2005
    
    
    2004%
    
    
    %
    
    
    %Statutory rate
    
    
    17.5
    
    
    
    17.5
    
    
    
    17.5Tax effect of net operating losses
    
    
    16.6
    
    
    
    21.2
    
    
    
    26.1Non taxable profits, net
    
    
    (14.4
    )
    
    
    (21.7
    )
    
    
    (33.2
    )Impairment loss on goodwill
    
    
    -
    
    
    
    -
    
    
    
    5.4Others
    
    
    1.0
    
    
    
    2.3
    
    
    
    (3.5
    )Effective rate
    
    
    20.7
    
    
    
    19.3
    
    
    
    12.3
 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:
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10.
    
    INCOME TAXES (CONTINUED)
 As of December 31,2006
    
    
    2005US$
    
    
    US$Deferred tax assets:Net operating loss
    
    
    4,099
    
    
    
    5,069Depreciation
    
    
    53
    
    
    
    71Others
    
    
    58
    
    
    
    84,210
    
    
    
    5,148Valuation allowance
    
    
    (4,099
    )
    
    
    (5,148
    )Total deferred tax assets
    
    
    111
    
    
    
    -Deferred tax liabilities:Accelerated tax allowance
    
    
    (237
    )
    
    
    (154
    )Others
    
    
    (111
    )
    
    
    -Net deferred tax liabilities
    
    
    (348
    )
    
    
    (154
    )
 In assessing the realizability of deferred tax assets, management considers whether it is
more likely than not that some portion or all of the deferred tax assets will not be
realized. The ultimate realization of deferred tax assets is dependent upon the generation
of future taxable income during the periods in which those temporary differences become
deductible. The decrease in valuation allowance for the year ended December 31, 2006 was
US$1,049; for December 31, 2005 and 2004, increase in valuation allowance amounted to
US$2,237 and US$253 respectively.Based on the history of the Companys profitability, management believes that it is more
likely than not that the Company will realize the benefits of the deferred tax assets of
US$111 and US$Nil, net of valuation allowances as of December 31, 2006 and 2005.11.
    
    LEASEThe Company is obligated under capital leases covering certain motor vehicles and
office equipment that expire at various dates during the next five years. At December 31,
2006 and 2005, the gross amount of motor vehicles and office equipment and related
accumulated amortization recorded under capital leases were as follows:
 As of December 31,2006
    

    
    2005US$
    
    
    US$Motor vehicles
    
    
    493
    
    
    
    112Furniture, fixtures and equipment
    
    
    19
    
    
    
    19512
    
    
    
    131Less accumulated amortization
    
    
    (143
    )
    
    
    (53
    )369
    
    
    
    78
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Year
ended December 31,2006
    
    
    2005
    
    
    2004US$
    
    
    US$
    
    
    US$Minimum rentals
    
    
    3,222
    
    
    
    1,166
    
    
    
    717Contingent rentals
    
    
    105
    
    
    
    22
    
    
    
    -Rental expenses
    
    
    3,327
    
    
    
    1,188
    
    
    
    717
  As of December 31, 2006
    
    
    As of December 31, 2005Capitalized
    
    
    Operating
    
    
    Capitalized
    
    
    Operatingleases
    
    
    leases
    
    
    leases
    
    
    leasesUS$
    
    
    US$
    
    
    US$
    
    
    US$2006
    
    
    -
    
    
    
    -
    
    
    
    22
    
    
    
    8352007
    
    
    110
    
    
    
    2,584
    
    
    
    22
    
    
    
    7182008
    
    
    106
    
    
    
    1,741
    
    
    
    21
    
    
    
    3522009
    
    
    87
    
    
    
    360
    
    
    
    2
    
    
    
    131Thereafter
    
    
    106
    
    
    
    -
    
    
    
    -
    
    
    
    -Total future
minimum lease 
payments
    
    
    409
    
    
    
    4,685
    
    
    
    67
    
    
    
    2,036Less: Amount
representing 
interest (at rates
ranging from 0% to
4.95%)
    
    
    (53
    )
    
    
    
    
    
    
    (4
    )Present value of
net minimum capital
lease payments
    
    
    356
    
    
    
    
    
    
    
    63Less current
instatements 
of obligations under 
capital leases
    
    
    (94
    )
    
    
    
    
    
    
    (20
    )Obligations under
capital leases,
excluding current 
instalments
    
    
    262
    
    
    
    
    
    
    
    43
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The Company leases certain of its office and quarters from related party with two years
lease terms expiring in 2007 and 2008. Rental expenses for operating leases paid to related
party are included in the data presented above. Total rent expense associated with these
leases was US$227, US$150 and US$77 for the years ended December 31, 2006, 2005 and 2004,
respectively.12.
    
    COMMITMENTS AND CONTINGENCIES
 (a)
    
    Commitments
As of December 31, 2006, the Company had capital expenditure commitments of US$152.(b)
    
    Contingencies
As of December 31, 2006, 2005 and 2004, the Company provided guarantee in respect of
bank mortgage loans granted to a director, Mr. Yih Yu Chuan to the extent of US$158,
US$237 and US$307 respectively.(c)
    
    Legal ProceedingsDerivative Litigation.Two purported shareholder derivative lawsuits, Vaughn v. Yih,
et al. (Los Angeles Superior Court No. BC 378903) and Cooke vs. LJ, et al. (Los
Angeles Superior Court No. BC 380214), were filed in California in Los Angeles County
Superior Court on October 10 and November 5, 2007, respectively.The Plaintiffs in both actions, who purport to bring suit on behalf of the Company
against various of its officers and directors, did not make any demand on the Board
of Directors, nor did they apply for permission to the High Court of the British
Virgin Islands to bring this action. The complaints in the derivative actions allege,
among other things, that the defendants caused the Company to issue a series of press
releases, Securities and Exchange Commission filings and other statements that
significantly overstated the Companys business prospects and financial results. They
further allege that, as a result of these statements, the Companys share price
traded at artificially inflated levels, and that defendants actions led to a delay
in the release of the Companys financial statements for the fiscal fourth quarter of
2006 and the fiscal first quarter of 2007. Plaintiffs purport to state causes of
action for breach of fiduciary duty, waste of corporate assets and unjust enrichment.
By their complaints, they seek, among other relief, unspecified damages to be paid to
the Company, corporate governance reforms, and equitable and injunctive relief,
including restitution and the creation of a constructive trust.The Defendants have not yet responded to the complaints. Initial responses to the
complaints are due in January 2008. The Company intends to vigorously defend against
the lawsuits. However, the ultimate outcome of these matters cannot be predicted with
certainty.Securities Litigation.In September 2007, several plaintiffs filed shareholder class
actions in the United States District Court for the Central District of California
against
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the Company and certain of its officers and directors, entitled Apple v. LJ
International, Inc., et al. (No. 07-06076), Cooper v. LJ International, Inc., et al.
(No. 07-06213), and Lieben v. LJ International Inc. et al. (No. 07-06216) (the Class
Actions). The Class Actions generally allege, on behalf of all persons who purchased
LJ common stock during the period from February 15, 2007 to September 6, 2007 (the
Class Period), that LJ and the individual defendants made misleading statements and
omissions of material fact, overstating the Companys fiscal 2005 and 2006 financial
results, and thereby artificially inflated the market price of LJs common stock
throughout the Class Period.  Plaintiffs further allege that defendants violated
Sections 10(b) and 20(a) of the Securities and Exchange Act of 1934 and Rule 10b-5
promulgated thereunder by releasing fiscal 2006 earnings and EPS results that
significantly understated the Companys tax liability and that overstated its
earnings and EPS, that the Companys internal controls were inadequate, and that, as
a result, defendants engaged in improper accounting practices. Plaintiffs seek an
unspecified amount of damages.
 The cases have all been referred to one judge and competing motions for appointment
as lead plaintiff and lead counsel are pending. The Company anticipates that,
following those appointments, the district court will consolidate the cases and set a
deadline for lead plaintiff to file an amended, consolidated class action complaint
that will supersede the pending complaints.The Company intends to vigorously defend against the Class Actions. However, the
ultimate outcome cannot be predicted with certainty.Besides the above-mentioned legal proceedings, we are exposed to certain asserted and
unasserted potential claims. There can be no assurance that, with respect to
potential claims made against us, we could resolve such claims under terms and
conditions that would not have a material adverse effect on our business, our
liquidity or financial results. Periodically, we review the status of each
significant matter and assess its potential financial exposure. If the potential loss
from any claim or legal proceeding is considered probable and a range of possible
losses can be estimated, we then accrue a liability for the estimated loss. Any
liability for estimated loss is based on the criteria in SFAS No. 5, Accounting for
Contingencies. Legal proceedings are subject to uncertainties, and the outcomes are
difficult to predict. Because of such uncertainties, accruals are based only on the
best information available at the time. As additional information becomes available,
we reassess the potential liability related to pending claims and litigation and may
revise estimate. Presently, no accrual has been estimated under SFAS No. 5 for
potential losses that may or may not arise from the current lawsuits in which we are
involved. Accruals include billings for legal services preformed to date and expected
to be performed in the future in connection with the matters described above.
 13.
    
    COMMON STOCK AND WARRANTS OTHER THAN STOCK-BASED COMPENSATION
 (a)
    
    Common stock
 (i)
    
    In September 2004, the Company completed a private placement of
1,614,082 shares of common stock and 484,221 warrants (note 13(b)(i)) 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.
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13.
    
    COMMON STOCK AND WARRANTS OTHER THAN STOCK-BASED COMPENSATION (CONTINUED)
 (a)
    
    Common stock (Continued)
 (ii)
    
    During the year ended December 31, 2004, warrants to purchase
600,000 shares of common stock (note 15(b)(ii)) and 405,000 stock options (note
14(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.(iii)
    
    During the year ended December 31, 2005, warrants to purchase
54,545 shares of common stock (note 13(b)) and 3,162,000 stock options (note
14(a)) were exercised. A total of 3,216,545 shares of common stock of the
Company were issued accordingly.(iv)
    
    In September 2006, the Company entered into a securities purchase
agreement with certain institutional investors for the issuance of shares of
common stock and warrants to purchase shares of common stock.  The Company sold
to the investors an aggregate of 1,466,668 units at a purchase price of $3.75
per unit, each unit consisting of one share of common stock and a short-term
warrant and a long-term warrant (note 13(b)(ii)).(v)
    
    During the year ended December 31, 2006, warrants to purchase
500,000 shares of common stock (note 15 (b)(iii)) and 1,489,500 stock options
(note 15 (a)) were exercised. A total of 1,989,500 shares of common stock of the
Company were issued accordingly.
 As of December 31, 2006, the Company had 18,977,371 shares of common stock issued.(b)
    
    Warrants other than stock-based compensation
 As of December 31,2006
    
    
    2005
    
    
    2004Number of
    
    
    Number of
    
    
    Number ofwarrants
    
    
    warrants
    
    
    warrantsOutstanding, beginning of year
    
    
    429,676
    
    
    
    2,361,721
    
    
    
    1,922,500Granted
    
    
    632,910
    
    
    
    -
    
    
    
    484,221Exercised
    
    
    -
    
    
    
    (54,545
    )
    
    
    -Expired
    
    
    -
    
    
    
    (1,877,500
    )
    
    
    (45,000
    )Outstanding, end of year
    
    
    1,062,586
    
    
    
    429,676
    
    
    
    2,361,721
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13.
    
    COMMON STOCK AND WARRANTS OTHER THAN STOCK-BASED COMPENSATION (CONTINUED)
 (b)
    
    Warrants other than stock-based compensation (Continued)The following table shows the warrants outstanding as of December 31,
2006.
 Number ofwarrantsDate of grant
    
    Note
    
    outstanding
    
    
    Exercise price
    
    
    Expiration dateSeptember 1, 2004
    
    (i)
    
    
    429,676
    
    
    
    US$2.98
    
    
    September 3, 2009September 25, 2006
    
    (ii)
    
    
    396,001
    
    
    
    US$4.50
    
    
    March 25, 2012September 25, 2006
    
    (ii)
    
    
    236,909
    
    
    
    US$4.221
    
    
    February 5, 2007
 (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.(ii)
    
    On September 25, 2006, the Company issued long-term and
short-term warrants to the investors of a private placement. The
long-term warrants represent a five-year option to purchase in the aggregate up
to 366,668 shares of common stock at $4.50 per share at any time during the
period from March 25, 2007 until March 25, 2012, and the short-term warrants
represent an option to purchase in the aggregate up to 236,909 shares of common
stock at $4.221 per share at any time during the period from September 25, 2006
until February 5, 2007.The Company has also issued warrants to the placement agent of the private
placement to purchase 29,333 shares of the Company. The warrants issued to
the placement agent are identical to the long-term warrants.
 The fair value of warrants was valued using the Black Scholes option valuation model
with resulting allocation of the aggregate proceeds from private placement between
common stock and the underlying warrants, and which have been included in the
additional paid-in capital.
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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$0.128 per month and thereafter contributions are voluntary. When
employees leave the MPF scheme prior to vesting fully in voluntary contributions, the
contributions payable by the Company are reduced by the amount of forfeited contributions.The amount of forfeitures in respect of the MPF scheme, which was available to reduce the
Companys contribution payable, for the year ended December 31, 2006, 2005 and 2004 was
US$Nil, US$Nil and US$Nil 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$1,317, US$831 and
US$616 for the years ended December 31, 2006, 2005 and 2004 respectively.15.
    
    STOCK-BASED COMPENSATION
 (a)
    
    Stock incentive plan
On 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
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15.
    
    STOCK-BASED COMPENSATION (CONTINUED)
 (a)
    
    Stock incentive plan (Continued)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 100% of the fair market value per share of such shares on the date of grant,
with a term of ten years.On July 1, 2003, the Company adopted the second stock plan (The 2003 Plan) which was
approved by the shareholders on December 5, 2003. The 2003 Plan allows the Board of
Directors, or a committee thereof at the Boards discretion, to provide for a total
of 4,000,000 stock options to officers, directors, key employees and advisors of the
Company. The purchase price of the shares of the Common Stock covered by The 2003
Plan could be less than, equal to or greater than 100% of the fair market value of
the Common Stock at the time of grant, with a term of ten years.On July 1, 2005, the Company adopted and approved the third stock plan (The 2005
Plan) which was approved by the shareholders on September 26, 2005. The Company
believes that a new plan is necessary since there are only a minimal number of
options remaining under The 1998 Plan and 2003 Plan. The Company believes that the
grant of stock options is accomplishing its purposes, which is to promote the Company
and the shareholders interests by providing key employees with an opportunity to
acquire a proprietary interest in the Company and to develop a stronger incentive to
put forth maximum effort for the Company continued success and growth. In addition,
the opportunity to acquire a propriety interest in the Company aids the Company in
attracting and retaining key personnel of outstanding ability.Options granted under The 2005 Plan will constitute either incentive stock options
within the meaning of Section 422 of the United States Internal Revenue Code of 1986,
as amended, or options which constitute nonqualified options at the time of issuance
of such options. The 2005 Plan provides that incentive stock options and/or
nonqualified stock options may be granted to our officers, directors, employees and
advisors selected by the compensation committee. A total of 4,000,000 shares of
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15.
    
    STOCK-BASED COMPENSATION (CONTINUED)
 (a)
    
    Stock incentive plan (Continued)common stock are authorized and reserved for issuance during the term of The 2005
Plan, which expires in June 2015. The compensation committee has the sole authority
to interpret The 2005 Plan and make all determinations necessary or advisable for
administering The 2005 Plan. The exercise price for any incentive option and
nonqualified option may be less than, equal to or greater than 100% and 110%
respectively of the fair market value of the shares as of the date of grant. Upon
the exercise of the option, the exercise price must be paid in full either in cash, shares of the Companys stock or combination. If any option is not exercised for any
reason, such shares shall again become available for the purposes of The 2005 Plan.
As of December 31, 2006, no options had been granted under The 2005 Plan.The stock options activities and related information are summarized as follows:
 Year ended
    
    Year ended
    
    Year endedDecember 31, 2006
    
    December 31, 2005
    
    December 31, 2004Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    Weightedaverage
    
    
    
    
    
    average
    
    
    
    
    
    averageexercise
    
    
    
    
    
    exercise
    
    
    
    
    
    exerciseOptions
    
    
    price
    
    Options
    
    
    Price
    
    Options
    
    
    priceUS$
    
    
    
    
    
    US$
    
    
    
    
    
    US$Outstanding, beginning of year
    
    
    3,310,500
    
    
    2.04
    
    
    3,759,000
    
    
    2.02
    
    
    3,814,000
    
    
    2.00Granted
    
    
    -
    
    
    
    
    
    3,113,500
    
    
    2.44
    
    
    350,000
    
    
    2.20Exercised (note 12(a)(v))
    
    
    (1,489,500
    )
    
    2.02
    
    
    (3,162,000
    )
    
    2.40
    
    
    (405,000
    )
    
    2.00Cancelled
    
    
    -
    
    
    
    
    
    (400,000
    )
    
    2.18
    
    
    -
    
    
    -Outstanding, end of year
    
    
    1,821,000
    
    
    2.06
    
    
    3,310,500
    
    
    2.04
    
    
    3,759,000
    
    
    2.02Exercise price less than the
market price on date of grant
    
    
    150,000
    
    
    2.00
    
    
    150,000
    
    
    2.00
    
    
    150,000
    
    
    2.00Exercise price equals to
market price on date of grant
    
    
    409,000
    
    
    2.00
    
    
    701,000
    
    
    2.00
    
    
    1,369,000
    
    
    2.00Exercise price exceeds to
market price on date of grant
    
    
    1,262,000
    
    
    2.08
    
    
    2,459,500
    
    
    2.05
    
    
    2,240,000
    
    
    2.031,821,000
    
    
    2.06
    
    
    3,310,500
    
    
    2.04
    
    
    3,759,000
    
    
    2.02Range of exercise price- US$2.00
    
    
    1,407,500
    
    
    2.00
    
    
    2,797,000
    
    
    2.00
    
    
    3,559,000
    
    
    2.00- US$2.25
    
    
    413,500
    
    
    2.25
    
    
    513,500
    
    
    2.25
    
    
    -
    
    
    -- US$2.35
    
    
    -
    
    
    -
    
    
    -
    
    
    -
    
    
    200,000
    
    
    2.351,821,000
    
    
    2.06
    
    
    3,310,500
    
    
    2.04
    
    
    3,759,000
    
    
    2.02Exercisable, end of year- exercise price at US$2.00
    
    
    1,041,125
    
    
    2.00
    
    
    2,093,125
    
    
    2.00
    
    
    2,489,500
    
    
    2.00- exercise price at US$2.25
    
    
    413,500
    
    
    2.25
    
    
    513,500
    
    
    2.25
    
    
    -
    
    
    -
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15.
    
    STOCK-BASED COMPENSATION (CONTINUED)
 (a)
    
    Stock incentive plan (Continued)
 Year ended
    
    Year ended
    
    Year endedDecember 31, 2006
    
    December 31, 2005
    
    December 31, 2004Weighted
    
    
    
    
    
    Weighted
    
    
    
    
    
    Weightedaverage
    
    
    
    
    
    average
    
    
    
    
    
    averageexercise
    
    
    
    
    
    exercise
    
    
    
    
    
    exerciseOptions
    
    
    price
    
    Options
    
    
    Price
    
    Options
    
    
    priceUS$
    
    
    
    
    
    US$
    
    
    
    
    
    US$1,454,625
    
    
    2.07
    
    
    2,606,625
    
    
    2.05
    
    
    2,489,500
    
    
    2.00Weighted average remaining
contractual life- exercise price at US$2.00
    
    4.87 years
    
    
    
    6.09 years
    
    
    
    6.42 years- exercise price at US$2.25
    
    1.33 years
    
    
    
    2.33 years
    
    
    
    
    -- exercise price at US$2.35
    
    
    -
    
    
    
    
    
    -
    
    
    
    
    8.50 years
 All options issued, other than 366,375 options, are immediately exercisable as of
December 31, 2006. The 366,375 options are issued and outstanding but only vest in
additional increments of 319,500 and 46,875 upon 2007 and 2008 respectively.
 (b)
    
    Warrants
 (i)
    
    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
and which have been expired as of December 31, 2006.(ii)
    
    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.(iii)
    
    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. These warrants were exercised
during the year and 500,000 shares of common stock were issued accordingly.(iv)
    
    In connection with private placement to investors completed in
September 2006, the Company issued to a consultant warrants to purchase 29,333
shares of common stock of the Company at US$4.5 per share exercisable through
March 25, 2012.
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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, 2006, 2005 and 2004. 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, 2006 and December 31, 2005 was estimated as US$47 and US$472 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 31,2006
    
    
    2005
    
    
    2004Expected dividend yield
    
    
    -
    
    
    
    -
    
    
    
    -Expected stock price volatility
    
    
    42.5%
    
    
    
    61%
    
    
    
    -Risk-free interest rate
    
    
    4.67%
    
    
    
    3.91%
    
    
    
    -Expected life of warrants
    
    
    5.5 years
    
    
    
    3 years
    
    
    
    -
 16.
    
    RELATED PARTY TRANSACTIONS
 (a)
    
    Names and relationship of related parties:
 Existing relationships with the CompanyYih Yu Chuan
    
    Director and major beneficial shareholder
of the CompanyGemological Institute of
America, Hong Kong Limited
    
    Common directorTanzanite (H.K.) Limited
    
    Common directorsOsorio Mendes Quintino Neto
    
    Minor shareholder and former director of a
subsidiary of the CompanyAndrew N. Bernstein
    
    Non-executive director
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16.
    
    RELATED PARTY TRANSACTIONS(CONTINUED)
 (b)
    
    Summary of balances with related parties:
 As of December 31,2006
    
    
    2005Note
    
    
    US$
    
    
    US$Due from related parties:Gemological Institute of America,
Hong Kong Limited
    
    
    
    
    
    
    -
    
    
    
    463Tanzanite (H.K.) Limited
    
    
    (i)
    
    
    
    21
    
    
    
    2121
    
    
    
    484Due to a related party:Osorio Mendes Quintino Neto
    
    
    (i)
    
    
    
    15
    
    
    
    1,910Certain banking facilities
granted to the
Company collateralized by
properties owned by
Yih Yu Chuan and his personal
guarantee to the
extent of
    
    
    
    
    
    
    23,161
    
    
    
    21,244Guarantee to a bank in respect of mortgage
loan granted to Yih Yu Chuan
    
    
    
    
    
    
    158
    
    
    
    237
 (c)
    
    Summary of related party transactions:
 Year ended December 31,2006
    
    
    2005
    
    
    2004US$
    
    
    US$
    
    
    US$Sales:- to Osorio Mendes Quintino Neto
    
    
    940
    
    
    
    -
    
    
    
    -Expenses:Rental expense to Tanzanite (H.K.)
Limited
    
    
    227
    
    
    
    150
    
    
    
    77Consultant fee to Osorio Mendes
Quintino Neto
    
    
    180
    
    
    
    135
    
    
    
    -Legal fee and directors fee to
Andrew N. Bernstein
    
    
    116
    
    
    
    80
    
    
    
    -523
    
    
    
    365
    
    
    
    77
 The Company leases certain of its office and quarter from the related party. The
leases are for two years term expiring in 2007 and 2008. The Company may terminate
these tenancy at any time after the expiration of the first 12 months after the
commencement of the term of tenancy, by giving the landlord no less than two months
prior notice.(i) The amounts due from/ to related parties represent unsecured advances which are
interest-free and repayable on demand.
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17.
    
    SEGMENT INFORMATIONThe Company has adopted SFAS No. 131, Disclosures about Segments of an Enterprise
and Related Information, which establishes annual reporting standards for enterprise
business segments and related disclosures about its products and services, geographic
areas and major customers. SFAS No. 131 defines operating segments as components of an
enterprise about which separate financial information is available that is evaluated
regularly by the chief operating decision maker in deciding how to allocate resources
and in assessing performance.The Company evaluates segment performance and allocates resources based on several
factors of which the primary financial measures are revenues from external customers
and operating income. As a result, the Company considers that it has two operating
segments, (i) manufacture and wholesale of jewelry products, and (ii) retail of jewelry
products.
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17.
    
    SEGMENT INFORMATION(CONTINUED)Contributions of the major activities, profitability information and asset information are
summarized below:
 Manufactureandwholesale
    
    
    Retail
    
    
    Corporate
    
    
    TotalUS$
    
    
    US$
    
    
    US$
    
    
    US$Year ended December 31, 2006Segment revenue from external customers
    
    
    108,679
    
    
    
    15,112
    
    
    
    -
    
    
    
    123,791Income (loss) from operations
    
    
    10,514
    
    
    
    1,456
    
    
    
    (2,228
    )
    
    
    9,742Interest income
    
    
    277
    
    
    
    1
    
    
    
    4
    
    
    
    282Interest expenses
    
    
    (3,258
    )
    
    
    -
    
    
    
    -
    
    
    
    (3,258
    )Income before income taxes, minority
interests, equity in results of
investment securities and
extraordinary item
    
    
    7,533
    
    
    
    1,457
    
    
    
    (2,224
    )
    
    
    6,766Incomes taxes
    
    
    (682
    )
    
    
    (721
    )
    
    
    -
    
    
    
    (1,403
    )Minority interests in consolidated
subsidiaries
    
    
    (38
    )
    
    
    -
    
    
    
    -
    
    
    
    (38
    )Net income
    
    
    6,813
    
    
    
    736
    
    
    
    (2,224
    )
    
    
    5,325Significant non-cash items:-Depreciation
    
    
    1,425
    
    
    
    614
    
    
    
    -
    
    
    
    2,039-Minority interests
    
    
    38
    
    
    
    -
    
    
    
    -
    
    
    
    38-Stock-based compensation cost
    
    
    89
    
    
    
    -
    
    
    
    281
    
    
    
    370Segment assets
    
    
    103,220
    
    
    
    21,302
    
    
    
    -
    
    
    
    124,522Total expenditures for additions to
long-lived assets
    
    
    3,078
    
    
    
    1,105
    
    
    
    -
    
    
    
    4,183Depreciation and amortization
    
    
    1,425
    
    
    
    614
    
    
    
    -
    
    
    
    2,039
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17.
    
    SEGMENT INFORMATION(CONTINUED)
 Manufactureandwholesale
    
    
    Retail
    
    
    Corporate
    
    
    TotalUS$
    
    
    US$
    
    
    US$
    
    
    US$Year ended December 31, 2005Segment revenue from external customers
    
    
    97,145
    
    
    
    2,501
    
    
    
    -
    
    
    
    99,646Income (loss) from operations
    
    
    8,808
    
    
    
    (1,847
    )
    
    
    (1,290
    )
    
    
    5,671Interest income
    
    
    139
    
    
    
    -
    
    
    
    -
    
    
    
    139Interest expenses
    
    
    (1,991
    )
    
    
    -
    
    
    
    -
    
    
    
    (1,991
    )Income before income taxes, minority
interests, equity in results of
investment securities and extraordinary
item
    
    
    6,956
    
    
    
    (1,847
    )
    
    
    (1,290
    )
    
    
    3,819Incomes taxes
    
    
    (739
    )
    
    
    -
    
    
    
    -
    
    
    
    (739
    )Minority interests in consolidated
subsidiaries
    
    
    (20
    )
    
    
    -
    
    
    
    -
    
    
    
    (20
    )Equity in results of investment securities
    
    
    -
    
    
    
    -
    
    
    
    -
    
    
    
    -Extraordinary gain on negative goodwill
    
    
    1,291
    
    
    
    -
    
    
    
    -
    
    
    
    1,291Net income
    
    
    7,488
    
    
    
    (1,847
    )
    
    
    (1,290
    )
    
    
    4,351Significant non-cash items:-Depreciation
    
    
    1,154
    
    
    
    214
    
    
    
    -
    
    
    
    1,368-Extraordinary gain on negative goodwill
    
    
    (1,291
    )
    
    
    -
    
    
    
    -
    
    
    
    (1,291
    )-Minority interests
    
    
    20
    
    
    
    -
    
    
    
    -
    
    
    
    20-Stock-based compensation cost
    
    
    -
    
    
    
    -
    
    
    
    136
    
    
    
    136Segment assets
    
    
    101,260
    
    
    
    6,970
    
    
    
    -
    
    
    
    108,230Total expenditures for additions to
long-lived assets
    
    
    1,864
    
    
    
    1,005
    
    
    
    -
    
    
    
    2,869Depreciation and amortization
    
    
    1,154
    
    
    
    214
    
    
    
    -
    
    
    
    1,368
 F-44




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17.
    
    SEGMENT INFORMATION(CONTINUED)
 Manufactureandwholesale
    
    
    Retail
    
    
    Corporate
    
    
    TotalUS$
    
    
    US$
    
    
    US$
    
    
    US$Year ended December 31, 2004Segment revenue from external customers
    
    
    76,696
    
    
    
    808
    
    
    
    -
    
    
    
    77,504Income (loss) from operations
    
    
    5,636
    
    
    
    (543
    )
    
    
    (1,963
    )
    
    
    3,130Interest income
    
    
    38
    
    
    
    -
    
    
    
    -
    
    
    
    38Interest expenses
    
    
    (902
    )
    
    
    -
    
    
    
    -
    
    
    
    (902
    )Income before income taxes, minority
interests, equity in results of
investment securities and extraordinary
item
    
    
    4,772
    
    
    
    (543
    )
    
    
    (1,963
    )
    
    
    2,266Incomes taxes
    
    
    (277
    )
    
    
    -
    
    
    
    -
    
    
    
    (277
    )Equity in results of investment securities
    
    
    133
    
    
    
    -
    
    
    
    -
    
    
    
    133Net income
    
    
    4,628
    
    
    
    (543
    )
    
    
    (1,963
    )
    
    
    2,122Significant non-cash items:-Depreciation
    
    
    991
    
    
    
    41
    
    
    
    -
    
    
    
    1,032-Amortization and impairment loss on
goodwill
    
    
    698
    
    
    
    -
    
    
    
    -
    
    
    
    698-Stock-based compensation cost
    
    
    -
    
    
    
    -
    
    
    
    11
    
    
    
    11Segment assets
    
    
    72,309
    
    
    
    1,364
    
    
    
    -
    
    
    
    73,673Total expenditures for additions to
long-lived assets
    
    
    560
    
    
    
    167
    
    
    
    -
    
    
    
    727Depreciation and amortization
    
    
    991
    
    
    
    41
    
    
    
    -
    
    
    
    1,032
 (a)
    
    Geographical areas:The following summarizes the Companys revenue from the following
geographic areas (based on the location of the customer).
 Year ended December 31,2006
    
    
    2005
    
    
    2004US$
    
    
    US$
    
    
    US$Revenue from external customers:US & Canada
    
    
    76,889
    
    
    
    67,780
    
    
    
    56,186Europe and other countries
    
    
    24,452
    
    
    
    20,527
    
    
    
    13,062Japan
    
    
    2,454
    
    
    
    3,686
    
    
    
    4,158PRC (including Hong Kong and
Macau)
    
    
    19,996
    
    
    
    7,653
    
    
    
    4,098123,791
    
    
    
    99,646
    
    
    
    77,504
 F-45




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##### Table of Contents



17.
    
    SEGMENT INFORMATION(CONTINUED)
 (a)
    
    Geographical areas (Continued):
 As of December 31,2006
    
    
    2005US$
    
    
    US$Carrying amount of long-lived assets:Hong Kong
    
    
    5,485
    
    
    
    3,492PRC
    
    
    4,163
    
    
    
    3,933US
    
    
    110
    
    
    
    196Total long-lived assets (excluding goodwill)
    
    
    9,758
    
    
    
    7,621Reconciling items:Others
    
    
    114,764
    
    
    
    100,609Total consolidated assets
    
    
    124,522
    
    
    
    108,230
 18.
    
    SIGNIFICANT CONCENTRATIONS AND RISKS
 (a)
    
    Revenue concentrationsThe 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 31,2006
    
    2005
    
    2004US$
    
    
    %
    
    US$
    
    
    %
    
    US$
    
    
    %Customer A
    
    
    12,700
    
    
    
    10
    
    
    10,772
    
    
    
    11
    
    
    5,671
    
    
    
    7Customer B
    
    
    10,334
    
    
    
    8
    
    
    13,093
    
    
    
    13
    
    
    7,234
    
    
    
    9Customer C
    
    
    8,523
    
    
    
    7
    
    
    9,247
    
    
    
    9
    
    
    8,482
    
    
    
    11
 Trade receivables related to these major customers were US$1,397, US$1,247 and US$763
as of December 31, 2006 respectively and US$5,492, US$1,643 and US$1,160 as of December
31, 2005 respectively.(b)
    
    Dependence on suppliersGold is the major raw material used in the production of the Companys Jewelry
products. The Company purchased gold from banks, gold refiners and commodity
dealers who supplied substantially all of the Companys gold needs, which the Company
believed was sufficient to meet its requirement.
 F-46




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##### Table of Contents



18.
    
    SIGNIFICANT CONCENTRATIONS AND RISKS(CONTINUED)
 (b)
    
    Dependence on suppliers (Continued)The major suppliers of gold accounted 10% or more of total purchases:
 Year ended
    
    Year ended
    
    Year endedDecember 31,
    
    December 31,
    
    December 31,2006
    
    2005
    
    2004US$
    
    
    %
    
    US$
    
    
%
    
    US$
    
    
    %Supplier A
    
    
    30,150
    
    
    
    37
    
    
    18,031
    
    
    
    25
    
    
    *Supplier B
    
    
    3,425
    
    
    
    4
    
    
    9,656
    
    
    
    14
    
    
    20,067
    
    
    
    32*New supplier since 2005
 Trade payables related to these major suppliers were US$Nil and US$Nil as of December
31, 2006 and 2005 respectively.
 19.
    
    RECLASSIFICATIONSCertain prior year amounts in the consolidated statements of operations have been reclassified
from other non-operating income to operating revenue to conform to the current year presentation.
In addition, certain items categorized as cash flows from operating activities in prior year have
been reclassified as cash flows from financing activities in order to conform to current years
presentation in the consolidated statements of cash flows.
 F-47




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##### Table of Contents



ITEM 19.       EXHIBITS
 The following exhibits are being filed as part of this Annual Report on Form 20-F:
 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 Registrant8.1
    
    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.
 -114-




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##### Table of Contents



SIGNATURES
  LJ INTERNATIONAL INC.
(Registrant)Date:
December 28, 2007
    
    
    
    By:
    
    /s/ YU CHUAN YIHYu Chuan YihChairman




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##### Table of Contents



EXHIBIT INDEX
 ExhibitNumber
    
    Description of Exhibit1.1
    
    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 Registrant8.1
    
    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.