##### Table of Contents



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




---



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




---



##### Table of Contents



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




---



##### Table of Contents



Selected Financial Data
 Year ended


    
    
    Eight-month period ended
    
    
    
    Years endedDecember 31,
    
    
    
    December 31,
    
    
    
    April 30,2005
    
    
    2004
    
    
    2003
    
    
    2002
    
    
    
    2002
    
    
    2001
    
    
    
    2002
    
    
    2001(Restated)
    
    
    (Restated)
    
    
    
    
    
    
    (Unaudited)
    
    
    
    
    
    
    
    (Unaudited)Statement of Operations Data:Revenues
    
    
    
    99,646
    
    
    
    77,504
    
    
    
    58,330
    
    
    
    46,207
    
    
    
    
    31,966
    
    
    
    25,135
    
    
    
    
    39,375
    
    
    
    46,347Cost of Goods sold
    
    
    
    (77,127
    )
    
    
    (61,265
    )
    
    
    (44,947
    )
    
    
    (39,951
    )
    
    
    
    (22,820
    )
    
    
    (18,602
    )
    
    
    
    (35,731
    )
    
    
    (31,540
    )Gross profit
    
    
    
    22,519
    
    
    
    16,239
    
    
    
    13,383
    
    
    
    6,256
    
    
    
    
    9,146
    
    
    
    6,533
    
    
    
    
    3,644
    
    
    
    14,807Operating expensesSelling, general and
administrative
    
    
    
    (15,488
    )
    
    
    (11,578
    )
    
    
    (9,133
    )
    
    
    (9,525
    )
    
    
    
    (6,433
    )
    
    
    (5,905
    )
    
    
    
    (8,963
    )
    
    
    (9,398
    )Net gain (loss) on
derivatives
    
    
    
    8
    
    
    
    199
    
    
    
    87
    
    
    
    (975
    )
    
    
    
    (435
    )
    
    
    (119
    )
    
    
    
    (660
    )
    
    
    44Depreciation
    
    
    
    (1,368
    )
    
    
    (1,032
    )
    
    
    (1,184
    )
    
    
    (1,328
    )
    
    
    
    (863
    )
    
    
    (565
    )
    
    
    
    (1,031
    )
    
    
    (808
    )Impairment on property,
plant and equipment
    
    
    
    
    
    
    
    
    
    
    
    (84
    )
    
    
    (417
    )
    
    
    
    (108
    )
    
    
    
    
    
    
    
    (345
    )
    
    
    Amortization and
impairment loss on
goodwill
    
    
    
    
    
    
    
    (698
    )
    
    
    (200
    )
    
    
    (824
    )
    
    
    
    (600
    )
    
    
    (18
    )
    
    
    
    (242
    )
    
    
    (27
    )Operating income (loss)
    
    
    
    5,671
    
    
    
    3,130
    
    
    
    2,869
    
    
    
    (6,813
    )
    
    
    
    707
    
    
    
    (74
    )
    
    
    
    (7,597
    )
    
    
    4,618Other income and expenses
Interest income
    
    
    
    139
    
    
    
    38
    
    
    
    41
    
    
    
    91
    
    
    
    
    48
    
    
    
    172
    
    
    
    
    217
    
    
    
    508Interest expenses
    
    
    
    (1,991
    )
    
    
    (902
    )
    
    
    (753
    )
    
    
    (668
    )
    
    
    
    (441
    )
    
    
    (424
    )
    
    
    
    (652
    )
    
    
    (1,780
    )Impairment loss on
investment security
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (200
    )
    
    
    
    (200
    )
    
    
    
    
    
    
    
    
    
    
    
    Operating income (loss)
before income taxes,
minority interests,
equity in results of
investment securities
and extraordinary item
    
    
    
    3,819
    
    
    
    2,266
    
    
    
    2,157
    
    
    
    (7,390
    )
    
    
    
    314
    
    
    
    (326
    )
    
    
    
    (8,032
    )
    
    
    3,346Incomes taxes (expense)
credit
    
    
    
    (739
    )
    
    
    (277
    )
    
    
    (352
    )
    
    
    39
    
    
    
    
    (101
    )
    
    
    (39
    )
    
    
    
    101
    
    
    
    (211
    )Income (Loss) before
minority interests,
equity in results of
investment securities
and extraordinary item
    
    
    
    3,080
    
    
    
    1,989
    
    
    
    1,805
    
    
    
    (7,351
    )
    
    
    
    213
    
    
    
    (365
    )
    
    
    
    (7,931
    )
    
    
    3,135Minority interests in
consolidated
subsidiaries
    
    
    
    (20
    )
    
    
    
    
    
    
    8
    
    
    
    150
    
    
    
    
    120
    
    
    
    
    
    
    
    
    30
    
    
    
    Income before equity in
results of investment
securities and
extraordinary item
    
    
    
    3,060
    
    
    
    1,989
    
    
    
    1,813
    
    
    
    (7,201
    )
    
    
    
    333
    
    
    
    (365
    )
    
    
    
    (7,901
    )
    
    
    3,135Equity in results of
investment securities
    
    
    
    
    
    
    
    
    
    
    
    133
    
    
    
    (851
    )
    
    
    
    24
    
    
    
    16
    
    
    
    
    26
    
    
    
    34Income before
extraordinary item
    
    
    
    3,060
    
    
    
    2,122
    
    
    
    962
    
    
    
    (7,177
    )
    
    
    
    349
    
    
    
    (339
    )
    
    
    
    (7,867
    )
    
    
    3,135Extraordinary gain on
negative goodwill
    
    
    
    1,291
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Net income (loss)
    
    
    
    4,351
    
    
    
    2,122
    
    
    
    962
    
    
    
    (7,177
    )
    
    
    
    349
    
    
    
    (339
    )
    
    
    
    (7,867
    )
    
    
    3,135Net income (loss) per
share:Basic
    
    
    
    0.32
    
    
    
    0.19
    
    
    
    0.11
    
    
    
    (0.84
    )
    
    
    
    0.04
    
    
    
    (0.04
    )
    
    
    
    (0.91
    )
    
    
    0.37Diluted
    
    
    
    0.30
    
    
    
    0.18
    
    
    
    0.10
    
    
    
    (0.84
    )
    
    
    
    0.04
    
    
    
    (0.04
    )
    
    
    
    (0.90
    )
    
    
    0.37Weighted average number
of sharesBasic
    
    
    
    13,439
    
    
    
    11,119
    
    
    
    8,757
    
    
    
    8,551
    
    
    
    
    8,493
    
    
    
    8,672
    
    
    
    
    8,672
    
    
    
    8,567Diluted
    
    
    
    14,322
    
    
    
    12,107
    
    
    
    9,706
    
    
    
    8,551
    
    
    
    
    8,493
    
    
    
    8,832
    
    
    
    
    8,779
    
    
    
    8,617Balance Sheet Data:Working capital
    
    
    
    35,554
    
    
    
    23,617
    
    
    
    17,053
    
    
    
    11,896
    
    
    
    
    11,896
    
    
    
    18,537
    
    
    
    
    12,115
    
    
    
    20,153Total assets
    
    
    
    108,230
    
    
    
    73,673
    
    
    
    59,885
    
    
    
    48,938
    
    
    
    
    48,938
    
    
    
    51,088
    
    
    
    
    43,557
    
    
    
    48,094Long-term obligation
    
    
    
    43
    
    
    
    58
    
    
    
    77
    
    
    
    
    
    
    
    
    
    
    
    
    12
    
    
    
    
    8
    
    
    
    287Total stockholders
equity
    
    
    
    45,008
    
    
    
    32,790
    
    
    
    27,101
    
    
    
    23,344
    
    
    
    
    23,344
    
    
    
    30,969
    
    
    
    
    23,591
    
    
    
    31,161
 - 4 -




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



Our products are currently made at our production facility located in Shenzhen, China. However,
our insurance may not adequately cover any losses due to fire, casualty or theft.
  Sales of our jewelry to retailers are generally stronger during the quarter ending December 31 of
each year due to the importance of the holiday selling season.
  Our holding company structure creates restrictions on the payment of dividends.
  It may be difficult to serve us with legal process or enforce judgments against us or our
management.
  - 7 -




---



##### Table of Contents




    
    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.
   - 8 -




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



Year ended December 31,2005
    
    
    2004
    
    
    2003US & Canada
    
    
    67,780
    
    
    
    56,186
    
    
    
    42,851Europe and other countries
    
    
    20,527
    
    
    
    13,062
    
    
    
    8,017Japan
    
    
    3,686
    
    
    
    4,158
    
    
    
    5,338PRC (including Hong Kong and Macau)
    
    
    7,653
    
    
    
    4,098
    
    
    
    2,12499,646
    
    
    
    77,504
    
    
    
    58,330
 Our Industry
  
    
    specialty retailers account for $27 billion in sales
    
    mass merchants and department stores account for $12 billion in sales
    
    direct avenues (television shopping, e-commerce, catalogs) account for $6 billion
  
    
    a small number of producers that make and distribute their own jewelry directly to
retailers; and
    
    a large number of wholesalers and distributors who purchase products or portions of
products from third parties and resell those items to retailers.
    - 11 -




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



Insurance
  Competition
    - 16 -




---



##### Table of Contents



C. ORGANIZATIONAL STRUCTURE AS OF DECEMBER 31, 2005:
  LJ INTERNATIONAL INC.
 100%
 - Lorenzo Jewelry Limited
 - Lorenzo Jewellery (Shenzhen) Co., Ltd.
 - Shenzhen PGS Jewelry Mfg.
 - Goldleaves Gems (Shenzhen) Co., Ltd.
 - Lorenzo (Shenzhen) Co., Ltd.
 - Lorenzo Crystal Ltd.
 - Enzo (Shenzhen) Co., Ltd.
 - Enzo Ltd.
 D. PROPERTY, PLANTS AND EQUIPMENT.
   
    
    1,751 square meters for a term of five years expiring August 31, 2007 from an
unaffiliated third party at a rental rate of $3,817 per month;
    
    1,751 square meters for a term of two years expiring June 30, 2006, at a rental rate of
$3,567 per month;
    
    475 square meters for a term of one year expired December 31, 2005, at a rental rate of
$854 per month, extension of lease is under negotiation;
    
    600 square meters for a term of three years expired October 31, 2005, at a rental rate
of $1,333 per month, extension of lease is under negotiation; and
 - 17 -




---



##### Table of Contents




    
    1,886 square meters for a term of three years and eleven months expiring September 30,
2006, at a rental rate of $4,425 per month.
   
 ITEM 4A. UNRESOLVED STAFF COMMENTS
  - 18 -




---



##### Table of Contents



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




---



##### Table of Contents



-20-




---



##### Table of Contents



A. OPERATING RESULTS.
 Reclassifications
  Revenues
 % changeYear ended December 31
    
    
    Years ended December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003RevenueWholesalesJewelry product
    
    $
    95,318
    
    
    $
    72,337
    
    
    $
    55,542
    
    
    
    32
    %
    
    
    30
    %Giftware product
    
    $
    1,827
    
    
    $
    4,359
    
    
    $
    2,788
    
    
    
    -58
    %
    
    
    56
    %$
    97,145
    
    
    $
    76,696
    
    
    $
    58,330
    
    
    
    20
    %
    
    
    32
    %Retail business
    
    $
    2,501
    
    
    $
    808
    
    
    $
    
    
    
    
    210
    %
    
    
    N/A$
    99,646
    
    
    $
    77,504
    
    
    $
    58,330
    
    
    
    29
    %
    
    
    33
    %
    -21-




---



##### Table of Contents



Cost of Sales and Gross Profit
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Cost of sales and gross profitCost of salesWholesales
    
    $
    75,645
    
    
    $
    60,564
    
    
    $
    44,947
    
    
    
    25
    %
    
    
    35
    %% of revenues
    
    
    78
    %
    
    
    79
    %
    
    
    77
    %Retail
    
    $
    1,482
    
    
    $
    701
    
    
    $
    0
    
    
    
    111
    %
    
    
    N/A% of revenues
    
    
    59
    %
    
    
    87
    %
    
    
    0
    %Total
    
    $
    77,127
    
    
    $
    61,265
    
    
    $
    44,947
    
    
    
    26
    %
    
    
    36
    %% of revenues
    
    
    77
    %
    
    
    79
    %
    
    
    77
    %Gross profitWholesales
    
    $
    21,500
    
    
    $
    16,132
    
    
    $
    13,383
    
    
    
    33
    %
    
    
    21
    %% of revenues
    
    
    22
    %
    
    
    21
    %
    
    
    23
    %Retail
    
    $
    1,019
    
    
    $
    107
    
    
    $
    0
    
    
    
    852
    %
    
    
    N/A% of revenues
    
    
    41
    %
    
    
    13
    %
    
    
    0
    %Total
    
    $
    22,519
    
    
    $
    16,239
    
    
    $
    13,383
    
    
    
    39
    %
    
    
    21
    %% of revenues
    
    
    23
    %
    
    
    21
    %
    
    
    23
    %
 -22-




---



##### Table of Contents



Selling, General and Administrative Expenses
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Selling, general and
administrative expensesWholesales business
    
    $
    12,356
    
    
    $
    10,944
    
    
    $
    9,133
    
    
    
    13
    %
    
    
    20
    %Acquired manufacturing
subsidiaries
    
    $
    479
    
    
    $
    0
    
    
    $
    0
    
    
    
    N/A
    
    
    
    N/ARetail business
    
    $
    2,653
    
    
    $
    634
    
    
    $
    0
    
    
    
    318
    %
    
    
    N/A$
    15,488
    
    
    $
    11,578
    
    
    $
    9,133
    
    
    
    34
    %
    
    
    27
    %% of revenues
    
    
    16
    %
    
    
    15
    %
    
    
    16
    %
   -23-




---



##### Table of Contents



Net gain (loss) on derivatives
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Unrealised loss on derivatives
    
    $
    (88
    )
    
    $
    (482
    )
    
    $
    (162
    )
    
    
    -82
    %
    
    
    198
    %% of revenues
    
    
    0
    %
    
    
    -1
    %
    
    
    0
    %(With the hedging mechanism in place,
we have the realised gain on hedging
activities)Realized gain on hedging activities
    
    $
    96
    
    
    $
    681
    
    
    $
    249
    
    
    
    -86
    %
    
    
    173
    %% of revenues
    
    
    0
    %
    
    
    1
    %
    
    
    0
    %Net gain on derivatives and
hedging activities
    
    $
    8
    
    
    $
    199
    
    
    $
    87
    
    
    
    -96
    %
    
    
    129
    %% of revenues
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
    -24-




---



##### Table of Contents



Depreciation
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003DepreciationWholesales
    
    $
    1,154
    
    
    $
    991
    
    
    $
    1,184
    
    
    
    16
    %
    
    
    -16
    %% of revenues
    
    
    1
    %
    
    
    1
    %
    
    
    2
    %Retail
    
    $
    214
    
    
    $
    41
    
    
    $
    0
    
    
    
    422
    %
    
    
    N/A% of revenues
    
    
    9
    %
    
    
    5
    %
    
    
    0
    %Total
    
    $
    1,368
    
    
    $
    1,032
    
    
    $
    1,184
    
    
    
    33
    %
    
    
    -13
    %% of revenues
    
    
    1
    %
    
    
    1
    %
    
    
    2
    %
   Amortization and impairment loss on goodwill
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Amortization
and impairment
loss on goodwill
    
    $
    0
    
    
    $
    698
    
    
    $
    200
    
    
    
    -100
    %
    
    
    249
    %% of revenues
    
    
    0
    %
    
    
    1
    %
    
    
    0
    %
 -25-




---



##### Table of Contents



Interest cost
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Interest expenses
    
    $
    1,991
    
    
    $
    902
    
    
    $
    753
    
    
    
    121
    %
    
    
    20
    %% of revenues
    
    
    2
    %
    
    
    1
    %
    
    
    1
    %
  Income taxes
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Incomes taxes expense
    
    $
    739
    
    
    $
    277
    
    
    $
    352
    
    
    
    167
    %
    
    
    -21
    %% of revenues
    
    
    1
    %
    
    
    0
    %
    
    
    1
    %
 -26-




---



##### Table of Contents



Extraordinary gain on negative goodwill
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003
    
    
    2005-2004
    
    
    2004-2003Extraordinary
gain on negative
goodwill
    
    $
    1,291
    
    
    $
    0
    
    
    $
    0
    
    
    
    N/A
    
    
    
    N/A% of revenues
    
    
    1
    %
    
    
    0
    %
    
    
    0
    %
   -27-




---



##### Table of Contents



Inflation
  Foreign Exchange
  Governmental economic and political policies and factors
  B. LIQUIDITY AND CAPITAL RESOURCES
  -28-




---



##### Table of Contents



Cash Flows
 Years ended December 31,(in thousands)
    
    2005
    
    2004
    
    2003Net cash used in operating activities
    
    $
    (14,222
    )
    
    $
    (7,494
    )
    
    $
    (3,571
    )Net cash used in investing activities
    
    
    (4,655
    )
    
    
    (1,179
    )
    
    
    (468
    )Net cash provided by financing activities
    
    
    20,450
    
    
    
    9,179
    
    
    
    5,764Effect of foreign exchange rate change
    
    
    (5
    )
    
    
    
    
    
    
    Net increase in cash and cash equivalents
    
    
    1,568
    
    
    
    506
    
    
    
    1,725
 Operating Activities
 Year ended December 31,(in thousands)
    
    2005
    
    2004
    
    2003Cash flows from operating activitiesNet income
    
    
    4,351
    
    
    
    2,122
    
    
    
    962Adjustments to reconcile income to net cash
(used in) provided by operating activities :Depreciation of property, plant and equipment and
properties held for lease
    
    
    1,368
    
    
    
    1,032
    
    
    
    1,184Impairment loss on property, plant and equipment
    
    
    
    
    
    
    
    
    
    
    84Amortization and impairment loss on goodwill
    
    
    
    
    
    
    698
    
    
    
    200Extraordinary (gain) on negative goodwill
    
    
    (1,291
    )
    
    
    
    
    
    
    Unrealized loss on derivatives
    
    
    88
    
    
    
    482
    
    
    
    162Loss (Gain) on disposal and write-off of property,
plant and equipment
    
    
    8
    
    
    
    (3
    )
    
    
    2Allowance for doubtful debts
    
    
    (72
    )
    
    
    125
    
    
    
    5Minority interests
    
    
    20
    
    
    
    
    
    
    
    (8
    )Compensation costs for warrants granted
    
    
    118
    
    
    
    
    
    
    
    Compensation expenses recognized during the year
    
    
    18
    
    
    
    11
    
    
    
    9Equity in results of investment securities
    
    
    
    
    
    
    (133
    )
    
    
    851Change in operating assets and liabilities :Trade receivables
    
    
    (8,607
    )
    
    
    (535
    )
    
    
    (4,286
    )Inventories
    
    
    (12,060
    )
    
    
    (15,142
    )
    
    
    (3,555
    )Prepayments and other current assets
    
    
    601
    
    
    
    1,187
    
    
    
    (2,493
    )Due from / to related parties
    
    
    7
    
    
    
    17
    
    
    
    3Trade payables
    
    
    1,883
    
    
    
    1,136
    
    
    
    1,797Accrued expenses and other payables
    
    
    (854
    )
    
    
    1,767
    
    
    
    1,168Income taxes payables and deferred taxation
    
    
    200
    
    
    
    (258
    )
    
    
    344Net cash (used in) provided by operating activities
    
    
    (14,222
    )
    
    
    (7,494
    )
    
    
    (3,571
    )
 -29-




---



##### Table of Contents



Investing Activities:
  -30-




---



##### Table of Contents



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




---



##### Table of Contents



Banking Facilities and Notes Payables
   Years ended December 31,(in thousands)
    
    2005
    
    
    2004
    
    
    2003Letters of credit
    
    $
    31,533
    
    
    $
    26,833
    
    
    $
    19,005Overdraft
    
    $
    3,461
    
    
    $
    3,461
    
    
    $
    3,39734,994
    
    
    
    30,294
    
    
    
    22,402Utilized :Letters of credit utilized
    
    $
    21,887
    
    
    $
    15,423
    
    
    $
    13,619Overdraft utilized
    
    $
    2,028
    
    
    $
    607
    
    
    $
    1,31223,915
    
    
    
    16,030
    
    
    
    14,931
    Years ended December 31,(in thousands)
    
    2005
    
    2004
    
    2003Notes payable
    
    $
    3,079
    
    
    $
    2,487
    
    
    $
    1,516
 -32-




---



##### Table of Contents



Gold Loan Facilities
 Years ended December 31,(in thousands)
    
    2005
    
    2004
    
    2003Gold loans outstanding (in $)
    
    $
    10,756
    
    
    $
    6,488
    
    
    $
    3,118Gold loans outstanding (in troy ounces)
    
    
    27,920
    
    
    
    17,920
    
    
    
    10,900Gold loan interest rate
    
    
    2.4%-2.6
    %
    
    
    2.1%-2.5
    %
    
    
    1.6%-2.4
    %
  Looking Forward
  Impact of recently issued US GAAP accounting standards.
  -33-




---



##### Table of Contents



-34-




---



##### 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
    
    1 year
    
    1-3 years
    
    3-5 years
    
    5 yearsUS$
    
    US$
    
    US$
    
    US$
    
    US$Long-Term Debt ObligationsCapital (Finance) Lease Obligations
    
    
    63
    
    
    
    20
    
    
    
    41
    
    
    
    2
    
    
    
    Operating Lease Obligations
    
    
    2,036
    
    
    
    835
    
    
    
    1,070
    
    
    
    131
    
    
    
    Purchase Obligations
    
    
    Other Long-Term Liabilities Reflected on the Companys
    
    
    Balance Sheet under the GAAP of the primary financial statements
    
    
    Total
    
    
    2,099
    
    
    
    855
    
    
    
    1,111
    
    
    
    133
    
    
    
    
 .
 -35-




---



##### Table of Contents



ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
 A. DIRECTORS AND SENIOR MANAGEMENT.
  Name
    
    Age
    
    PositionYu Chuan Yih
    
    
    66
    
    
    Chairman of the Board of Directors, President and Chief Executive OfficerKa Man Au
    
    
    41
    
    
    Chief Operating Officer, Secretary and DirectorHon Tak Ringo Ng
    
    
    46
    
    
    Chief Financial Officer and DirectorPo Yee Elsa Yue
    
    
    41
    
    
    Non-Executive DirectorAndrew N. Bernstein
    
    
    54
    
    
    Non-Executive DirectorWing Kwan Ted Lai
    
    
    43
    
    
    Non-Executive DirectorKelvin Wong
    
    
    39
    
    
    Non-Executive Director
  Mr. Yih
 Ms. Au
 Mr. Ng
 Ms. Yue
 -36-




---



##### Table of Contents



Mr. Bernstein
 Mr. Lai
 Mr. Wong
 B. COMPENSATION.
  Executive Service Contract
    -37-




---



##### Table of Contents



C. BOARD PRACTICES.
    
    
    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;
    
    review compliance with our existing accounting and financial policies;
    
    review the adequacy of our financial organization; and
    
    review our managements procedures and policies relative to the adequacy of our
internal accounting controls and compliance with U.S. federal and state laws relating
to financial reporting.
  
    
    assess the size and composition of the board of directors in light of our operating
requirements and existing social attitudes and trends;
    
    develop membership qualifications for the board of directors and all board
committees;
    
    monitor compliance with board of director and board committee membership criteria;
    
    review and recommend directors for continued service as required based on our
evolving needs;
    
    coordinate and assist management and the board of directors in recruiting new
members to the board of directors; and
    
    investigate suggestions for candidates for membership on the board of directors and
recommend prospective directors, as required, to provide an appropriate balance of
knowledge, experience and capability on the board of directors, including stockholder
nominations for the board of directors.
 -38-




---



##### Table of Contents




    
    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).
 D. EMPLOYEES.
  E. SHARE OWNERSHIP.
  
    
    each person who is known by us to own beneficially more than 5% of our outstanding
common stock;
    
    each of our current executive officers and directors; and
    
    all executive officers and directors as a group.
    -39-




---



##### Table of Contents



Number
    
    PercentName of Beneficial Holder
    
    Shares Beneficially OwnedYu Chuan Yih
    
    
    3,856,353
    (1)(2)
    
    
    22.5
    %Ka Man Au
    
    
    202,000
    (3)
    
    
    1.3
    %Hon Tak Ringo Ng
    
    
    100,000
    (4)
    
    
    *Po Yee Elsa Yue
    
    
    4,000
    (5)
    
    
    *Andrew N. Bernstein
    
    
    100,000
    (6)
    
    
    *Kelvin Wong
    
    
    0
    
    
    
    *Wing Kwan Ted Lai
    
    
    0
    
    
    
    *All directors and executive officers as a group (7 persons)
    
    
    4,262,353
    
    
    
    24.4
    %
 
 *
    
    Represents less than 1% beneficial ownership(1)
    
    Of Mr. Yihs 2,267,853 shares, 1,500,000 shares are owned of record by Pacific Growth
Developments Ltd., a British Virgin Islands corporation, which is owned by Mr. Yih (60%), his
wife Tammy Yih (20%) and an adult daughter, Bianca Tzu Hsiu Yih (20%).(2)
    
    Includes options currently exercisable to acquire: 
    
    766,500 shares of common stock at $2.00 per share at any time until April 30, 2008;
    
    22,000 shares of common stock at $2.25 per share at any time until April 30, 2008;
and
    
    800,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 (3)
    
    Represents options currently exercisable to acquire:
 
    
    27,000 shares of common stock at $2.00 per share at any time until April 30, 2008;
    
    100,000 shares of common stock at $2.25 per share at any time until April 30, 2008;
and
    
    75,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 (4)
    
    Represents options currently exercisable to acquire:
 
    
    25,000 shares of common stock at $2.00 per share at any time until April 30, 2008;
and
    
    75,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 (5)
    
    Represents options currently exercisable to acquire:
 
    
    4,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 (6)
    
    Includes options currently exercisable to acquire:
 
    
    50,000 shares of common stock at $2.00 per share at any time until April 30, 2008.
 -40-




---



##### Table of Contents



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.
    
    
    a total of 2,014,500 stock options, consisting of stock options to purchase 761,000
and 862,000 shares at $2.00 per share through April 30, 2008 and June 30, 2013,
respectively, and 391,500 stock options to purchase 391,500 shares at $2.25 per share
through April 30, 2008. A total of 1,668,500 stock options are held by our directors
and officers as a group.
 -41-




---



##### Table of Contents



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




---



##### Table of Contents



Other Options and Warrants Outstanding
  
    
    warrants to purchase 200,000 shares at $3.00 per share through August 15, 2006 which
we granted to The Bauer Partnership, Inc. on August 16, 2001, in connection with a
proposed debt placement which was never completed
    
    warrants to purchase 429,676 shares at $2.98 per share through September 3, 2009
which we sold to a group of investors pursuant to a private placement offering on
September 1, 2004
    
    warrants to purchase an aggregate of 500,000 shares through April 4, 2008 which we
granted to a consultant pursuant to a consulting agreement dated April 5, 2005 on the
following terms:
 50,000 warrants at $2.80 per warrant150,000 warrants at $3.00 per warrant150,000 warrants at $3.50 per warrant100,000 warrants at $4.00 per warrant50,000 warrants at $4.50 per warrant
 -43-




---



##### Table of Contents



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




---



##### Table of Contents



ITEM 8. FINANCIAL INFORMATION
 A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION.
     B. SIGNIFICANT CHANGES.
  -45-




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



-48-




---



##### Table of Contents



-49-




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### 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.
   -53-




---



##### Table of Contents



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




---



##### Table of Contents



(d) All Other Fees.
  (e) Audit Committee Pre-Approval Policies and Procedures.
     (f).
 
 ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES.
  
 ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS.
  -55-




---



##### Table of Contents



PART III
 
 ITEM 17. FINANCIAL STATEMENTS
  
 ITEM 18. FINANCIAL STATEMENTS
      
        -56-




---



##### Table of Contents



LJ INTERNATIONAL INC.
 INDEX TO FINANCIAL STATEMENTS
 PageReport of Independent Registered Public Accounting Firm
    
    
    F-2Consolidated Statements of Operations
    
    
    F-3  F-4Consolidated Balance Sheets
    
    
    F-5Consolidated Statements of Shareholders Equity and Comprehensive Income
    
    
    F-6  F-7Consolidated Statements of Cash Flows
    
    
    F-8  F-9Notes to and Forming Part of the Financial Statements
    
    
    F-10  F-42
 F-1




---



##### Table of Contents



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




---



##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF OPERATIONS
  Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Notes
    
    
    (Restated)
    
    
    (Restated)Operating revenue
    
    
    2
    (c)
    
    
    99,646
    
    
    
    77,504
    
    
    
    58,330Costs of goods sold (Exclusive of depreciation)
    
    
    
    
    
    
    (77,127
    )
    
    
    (61,265
    )
    
    
    (44,947
    )Gross profit
    
    
    
    
    
    
    22,519
    
    
    
    16,239
    
    
    
    13,383Operating expensesSelling, general and administrative expenses
    
    
    
    
    
    
    (15,488
    )
    
    
    (11,578
    )
    
    
    (9,133
    )Net gain (loss) on derivatives
    
    
    
    
    
    
    8
    
    
    
    199
    
    
    
    87Depreciation
    
    
    
    
    
    
    (1,368
    )
    
    
    (1,032
    )
    
    
    (1,184
    )Impairment on property, plant and equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (84
    )Impairment loss on goodwill
    
    
    8 & 9
    
    
    
    
    
    
    
    (698
    )
    
    
    (200
    )Operating income
    
    
    
    
    
    
    5,671
    
    
    
    3,130
    
    
    
    2,869Other income and expenseInterest income
    
    
    2
    (c)
    
    
    139
    
    
    
    38
    
    
    
    41Interest expenses
    
    
    
    
    
    
    (1,991
    )
    
    
    (902
    )
    
    
    (753
    )Income before income taxes, minority interests, equity in results of investment securities and extraordinary
item
    
    
    
    
    
    
    3,819
    
    
    
    2,266
    
    
    
    2,157Income taxes expense
    
    
    11
    
    
    
    (739
    )
    
    
    (277
    )
    
    
    (352
    )Income before minority interests, equity in results of investment securities and
extraordinary item
    
    
    
    
    
    
    3,080
    
    
    
    1,989
    
    
    
    1,805Minority interests in consolidated subsidiaries
    
    
    
    
    
    
    (20
    )
    
    
    
    
    
    
    8Income before equity in results of investment securities and extraordinary item
    
    
    
    
    
    
    3,060
    
    
    
    1,989
    
    
    
    1,813Equity in results of investment securities
    
    
    
    
    
    
    
    
    
    
    133
    
    
    
    (851
    )Income before extraordinary item
    
    
    
    
    
    
    3,060
    
    
    
    2,122
    
    
    
    962Extraordinary gain on negative goodwill
    
    
    3
    
    
    
    1,291
    
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    4,351
    
    
    
    2,122
    
    
    
    962Numerator:Net income used in computing basic earnings per share
    
    
    
    
    
    
    4,351
    
    
    
    2,122
    
    
    
    962Denominator:Weighted average number of shares used in
calculating basic earnings per share
    
    
    
    
    
    
    13,438,578
    
    
    
    11,118,995
    
    
    
    8,757,266Effect of dilutive potential ordinary shares:Warrants
    
    
    
    
    
    
    28,738
    
    
    
    55,693
    
    
    
    183,151Stock options
    
    
    
    
    
    
    854,568
    
    
    
    932,786
    
    
    
    765,267Weighted average number of shares used in
calculating diluted earnings per share
    
    
    
    
    
    
    14,321,884
    
    
    
    12,107,474
    
    
    
    9,705,684
  F-3




---



##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF OPERATIONS
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Notes
    
    
    (Restated)
    
    
    (Restated)Basic earnings per share:
    
    
    2
    (g)Income before extraordinary item
    
    
    
    
    
    
    0.23
    
    
    
    0.19
    
    
    
    0.11Extraordinary item
    
    
    
    
    
    
    0.09
    
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    0.32
    
    
    
    0.19
    
    
    
    0.11Diluted earnings per share:
    
    
    2
    (g)Income before extraordinary item
    
    
    
    
    
    
    0.21
    
    
    
    0.18
    
    
    
    0.10Extraordinary item
    
    
    
    
    
    
    0.09
    
    
    
    
    
    
    
    Net income
    
    
    
    
    
    
    0.30
    
    
    
    0.18
    
    
    
    0.10
  F-4




---



##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED
BALANCE SHEETS
  As of December 31,2005
    
    
    2004US$
    
    
    US$Notes
    
    
    (Restated)
    
    
    (Restated)ASSETSCurrent assetCash and cash equivalents
    
    
    
    
    
    
    4,796
    
    
    
    3,228Restricted cash
    
    
    
    
    
    
    5,839
    
    
    
    6,393Trade receivables, net of allowance for doubtful accounts (December 31, 2005: US$212; December 31, 2004: US$284)
    
    
    
    
    
    
    24,960
    
    
    
    15,653Derivatives
    
    
    
    
    
    
    2,034
    
    
    
    Investment in capital guaranteed fund
    
    
    
    
    
    
    2,496
    
    
    
    Inventories
    
    
    5
    
    
    
    55,941
    
    
    
    36,629Prepayments and other current assets
    
    
    
    
    
    
    2,538
    
    
    
    2,539Total current assets
    
    
    
    
    
    
    98,604
    
    
    
    64,442Properties held for lease, net
    
    
    6
    
    
    
    1,400
    
    
    
    1,452Property, plant and equipment, net
    
    
    7
    
    
    
    6,221
    
    
    
    4,673Due from related parties
    
    
    16
    (b)
    
    
    484
    
    
    
    491Goodwill, net
    
    
    8
    
    
    
    1,521
    
    
    
    1,521Investment securities, net
    
    
    9
    
    
    
    
    
    
    
    1,094Total assets
    
    
    
    
    
    
    108,230
    
    
    
    73,673LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesBank overdrafts
    
    
    10
    
    
    
    2,028
    
    
    
    607Notes payable
    
    
    10
    
    
    
    3,079
    
    
    
    2,487Capitalized lease obligation, current portion
    
    
    
    
    
    
    20
    
    
    
    19Letters of credit, gold and others
    
    
    10
    
    
    
    32,643
    
    
    
    21,911Derivatives
    
    
    
    
    
    
    3,567
    
    
    
    1,462Trade payables
    
    
    
    
    
    
    12,168
    
    
    
    9,553Accrued expenses and other payables
    
    
    
    
    
    
    7,280
    
    
    
    4,631Due to related parties
    
    
    16
    (b)
    
    
    1,910
    
    
    
    Income taxes payable
    
    
    
    
    
    
    201
    
    
    
    68Deferred taxation
    
    
    11
    
    
    
    154
    
    
    
    87Total current liabilities
    
    
    
    
    
    
    63,050
    
    
    
    40,825Capitalized lease obligation, non-current
    
    
    
    
    
    
    43
    
    
    
    58Total liabilities
    
    
    
    
    
    
    63,093
    
    
    
    40,883Minority interest
    
    
    
    
    
    
    129
    
    
    
    Commitments and contingencies
    
    
    12Shareholders equityCommon stocks, par value US$0.01 each, Authorized - 100 million shares,
Issued  15,521,203 shares as of December 31, 2005 and 12,304,658 shares as of December 31, 2004
    
    
    13
    
    
    
    155
    
    
    
    123Additional paid-in capital
    
    
    
    
    
    
    31,204
    
    
    
    23,382Accumulated other comprehensive loss
    
    
    
    
    
    
    (156
    )
    
    
    (151
    )Unearned compensation
    
    
    2
    (q)
    
    
    (19
    )
    
    
    (37
    )Retained earnings
    
    
    
    
    
    
    13,824
    
    
    
    9,473Total shareholders equity
    
    
    
    
    
    
    45,008
    
    
    
    32,790Total liabilities and shareholders equity
    
    
    
    
    
    
    108,230
    
    
    
    73,673
  F-5




---



##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
  AccumulatedCommon stock
    
    
    Additional
    
    
    Treasury stock
    
    
    otherNumber
    
    
    Par
    
    
    Paid-in
    
    
    Number
    
    
    
    
    
    
    comprehensive
    
    
    Unearned
    
    
    Retainedof shares
    
    
    Value
    
    
    Capital
    
    
    of shares
    
    
    Cost
    
    
    loss
    
    
    compensation
    
    
    earnings
    
    
    TotalUS$
    
    
    US$
    
    
    
    
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$Notes
    
    
    
    
    
    
    
    
    
    
    (Restated)
    
    
    
    
    
    
    
    
    
    
    (Note 2(y))
    
    
    
    
    
    
    (Restated)
    
    
    (Restated)Balance as of January 1, 2003
    
    
    
    
    
    
    8,671,615
    
    
    
    87
    
    
    
    17,410
    
    
    
    (318,200
    )
    
    
    (391
    )
    
    
    (151
    )
    
    
    
    
    
    
    6,389
    
    
    
    23,344Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    962
    
    
    
    962Issuance of common stock upon exercise of stock options
    
    
    13
    (a)(i)
    
    
    1,122,500
    
    
    
    11
    
    
    
    2,234
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,245Issuance of common stock upon exercise of warrants
    
    
    13
    (a)(i)
    
    
    95,891
    
    
    
    1
    
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Compensation costs for stock-based transactions
    
    
    15
    (b)
    
    
    
    
    
    
    
    
    
    
    9
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    9Sales of treasury stock
    
    
    13
    (b)
    
    
    
    
    
    
    
    
    
    
    150
    
    
    
    318,200
    
    
    
    391
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    541Balance as of December 31, 2003
    
    
    
    
    
    
    9,890,006
    
    
    
    99
    
    
    
    19,802
    
    
    
    
    
    
    
    
    
    
    
    (151
    )
    
    
    
    
    
    
    7,351
    
    
    
    27,101Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,122
    
    
    
    2,122Issuance of common stock on private placement
    
    13
    (a)(ii)
    
    
    1,614,082
    
    
    
    16
    
    
    
    2,730
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,746Issuance of common stock upon exercise of stock options
    
    13
    (a)(iii)
    
    
    405,000
    
    
    
    4
    
    
    
    806
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    810Issuance of common stock upon exercise of warrants
    
    13
    (a)(iii)
    
    
    395,570
    
    
    
    4
    
    
    
    (4
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Stock options granted
    
    
    2
    (q)
    
    
    
    
    
    
    
    
    
    
    48
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (48
    )
    
    
    
    
    
    
    Compensation expense recognized during the year
    
    
    2
    (q)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    11
    
    
    
    
    
    
    
    11Balance as of December 31, 2004
    
    
    
    
    
    
    12,304,658
    
    
    
    123
    
    
    
    23,382
    
    
    
    
    
    
    
    
    
    
    
    (151
    )
    
    
    (37
    )
    
    
    9,473
    
    
    
    32,790
  F-6




---



##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
  AccumulatedCommon stock
    
    
    Additional
    
    
    Treasury stock
    
    
    otherNumber
    
    
    Par
    
    
    Paid-in
    
    
    Number
    
    
    
    
    
    
    comprehensive
    
    
    Unearned
    
    
    Retainedof shares
    
    
    Value
    
    
    Capital
    
    
    of shares
    
    
    Cost
    
    
    loss
    
    
    compensation
    
    
    earnings
    
    
    TotalUS$
    
    
    US$
    
    
    
    
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$Notes
    
    
    
    
    
    
    
    
    
    
    (Restated)
    
    
    
    
    
    
    
    
    
    
    (Note 2(y))
    
    
    
    
    
    
    (Restated)
    
    
    (Restated)Comprehensive income:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,351
    
    
    
    4,351Exchange translation difference
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    (5
    )4,346Issuance of common stock upon exercise of stock options
    
    13
    (a)(iv)
    
    
    3,162,000
    
    
    
    31
    
    
    
    7,542
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,573Issuance of common stock upon exercise of warrants
    
    13
    (a)(iv)
    
    
    54,545
    
    
    
    1
    
    
    
    162
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    163Compensation costs for warrants granted
    
    
    15
    (b)
    
    
    
    
    
    
    
    
    
    
    118
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    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




---



##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Notes
    
    
    (Restated)
    
    
    (Restated)Cash flows from operating activities:Net income
    
    
    
    
    
    
    4,351
    
    
    
    2,122
    
    
    
    962Adjustments to reconcile income (loss) to net cash (used in) provided by operating activities:Depreciation of property, plant and equipment and properties held for lease
    
    
    
    
    
    
    1,368
    
    
    
    1,032
    
    
    
    1,184Impairment loss on property, plant and
equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    84Amortization and impairment loss on goodwill
    
    
    
    
    
    
    
    
    
    
    698
    
    
    
    200Extraordinary gain on negative goodwill
    
    
    
    
    
    
    (1,291
    )
    
    
    
    
    
    
    Unrealized loss on derivatives
    
    
    
    
    
    
    88
    
    
    
    482
    
    
    
    162Loss (Gain) on disposal and write-off of property, plant
and equipment
    
    
    
    
    
    
    8
    
    
    
    (3
    )
    
    
    2Allowance for doubtful debts
    
    
    
    
    
    
    (72
    )
    
    
    125
    
    
    
    5Minority interests
    
    
    
    
    
    
    20
    
    
    
    
    
    
    
    (8
    )Compensation costs for warrants granted
    
    
    
    
    
    
    118
    
    
    
    
    
    
    
    Compensation expenses recognized during the year
    
    
    
    
    
    
    18
    
    
    
    11
    
    
    
    9Equity in results of investment securities
    
    
    
    
    
    
    
    
    
    
    (133
    )
    
    
    851Changes in operating assets and liabilities:Trade receivables
    
    
    
    
    
    
    (8,607
    )
    
    
    (535
    )
    
    
    (4,286
    )Inventories
    
    
    
    
    
    
    (12,060
    )
    
    
    (15,142
    )
    
    
    (3,555
    )Prepayments and other current assets
    
    
    
    
    
    
    601
    
    
    
    1,187
    
    
    
    (2,493
    )Due from related parties
    
    
    
    
    
    
    7
    
    
    
    17
    
    
    
    3Trade payables
    
    
    
    
    
    
    1,883
    
    
    
    1,136
    
    
    
    1,797Accrued expenses and other payables
    
    
    
    
    
    
    (854
    )
    
    
    1,767
    
    
    
    1,168Income taxes payable and deferred taxation
    
    
    
    
    
    
    200
    
    
    
    (258
    )
    
    
    344Net cash used in operating activities
    
    
    
    
    
    
    (14,222
    )
    
    
    (7,494
    )
    
    
    (3,571
    )Cash flows from investing activities:Change in restricted cash
    
    
    
    
    
    
    554
    
    
    
    (462
    )
    
    
    427Net cash inflow from acquisition
    
    
    
    
    
    
    156
    
    
    
    
    
    
    
    Purchase of capital guaranteed fund
    
    
    
    
    
    
    (2,496
    )
    
    
    
    
    
    
    Purchase of property, plant and equipment
    
    
    
    
    
    
    (2,869
    )
    
    
    (727
    )
    
    
    (897
    )Proceeds on disposals of property, plant and
equipment
    
    
    
    
    
    
    
    
    
    
    10
    
    
    
    2Net cash used in investing activities
    
    
    
    
    
    
    (4,655
    )
    
    
    (1,179
    )
    
    
    (468
    )
  F-8




---



##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Notes
    
    
    (Restated)
    
    
    (Restated)Cash flows from financing activities:Change in bank overdrafts
    
    
    
    
    
    
    1,421
    
    
    
    (705
    )
    
    
    (1,795
    )Proceeds from issuance of shares upon exercise of stock options
    
    
    
    
    
    
    7,573
    
    
    
    810
    
    
    
    2,245Proceeds from issuance of share upon exercise of stock warrants
    
    
    
    
    
    
    163
    
    
    
    
    
    
    
    Net proceeds from issuance of shares in private placement
    
    
    
    
    
    
    
    
    
    
    2,746
    
    
    
    Loans acquired
    
    
    
    
    
    
    10,267
    
    
    
    7,624
    
    
    
    1,516Repayment of loans
    
    
    
    
    
    
    (5,424
    )
    
    
    (3,082
    )
    
    
    (1,777
    )Repayment of capitalized lease obligation
    
    
    
    
    
    
    (14
    )
    
    
    (18
    )
    
    
    (26
    )Letter of credit and factoring
    
    
    
    
    
    
    6,464
    
    
    
    1,804
    
    
    
    5,060Sale of treasury stock
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    541Net cash provided by financing activities
    
    
    
    
    
    
    20,450
    
    
    
    9,179
    
    
    
    5,764Effect of foreign exchange rate change
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    Net increase in cash and cash equivalents
    
    
    
    
    
    
    1,568
    
    
    
    506
    
    
    
    1,725Cash and cash equivalents, as of beginning of period
    
    
    
    
    
    
    3,228
    
    
    
    2,722
    
    
    
    997Cash and cash equivalents, as of end of period
    
    
    
    
    
    
    4,796
    
    
    
    3,228
    
    
    
    2,722Supplemental disclosure information:Interest expense
    
    
    
    
    
    
    1,991
    
    
    
    872
    
    
    
    728Income taxes paid
    
    
    
    
    
    
    539
    
    
    
    535
    
    
    
    9Non-cash transactions:Purchase of property, plant and equipment under capitalized leases
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    98
  F-9




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



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




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  
 2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)(q)
    
    Stock-based compensation (Continued)
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$(Restated)
    
    
    (Restated)Income before extraordinary item
    
    
    3,060
    
    
    
    2,122
    
    
    
    962Add :      Stock-based employee compensation
expenses included in reported net
income, net 
          of tax
    
    
    18
    
    
    
    11
    
    
    
    Deduct: Total stock-based employee
compensation expenses determined
under fair value 
          based method for all
awards, net of tax
    
    
    (2,266
    )
    
    
    (159
    )
    
    
    (160
    )Pro forma income before extraordinary item
    
    
    812
    
    
    
    1,974
    
    
    
    802Extraordinary item
    
    
    1,291
    
    
    
    
    
    
    
    2,103
    
    
    
    1,974
    
    
    
    802
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$(Restated)
    
    
    (Restated)Basic earnings per share, as reported:Income before extraordinary item
    
    
    0.23
    
    
    
    0.19
    
    
    
    0.11Extraordinary item
    
    
    0.09
    
    
    
    
    
    
    
    Net income
    
    
    0.32
    
    
    
    0.19
    
    
    
    0.11Diluted earnings per share, as reported:Income before extraordinary item
    
    
    0.21
    
    
    
    0.18
    
    
    
    0.10Extraordinary item
    
    
    0.09
    
    
    
    
    
    
    
    Net income
    
    
    0.30
    
    
    
    0.18
    
    
    
    0.10Basic earnings per share, pro forma:Income before extraordinary item
    
    
    0.06
    
    
    
    0.18
    
    
    
    0.09Extraordinary item
    
    
    0.09
    
    
    
    
    
    
    
    Net income
    
    
    0.15
    
    
    
    0.18
    
    
    
    0.09Diluted earnings per share, pro forma:Income before extraordinary item
    
    
    0.06
    
    
    
    0.16
    
    
    
    0.08Extraordinary item
    
    
    0.09
    
    
    
    
    
    
    
    Net income
    
    
    0.15
    
    
    
    0.16
    
    
    
    0.08
 F - 15




---



##### Table of Contents



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

    3 years
    
    

    3 years
 The weighted average fair value per option granted during the years ended December
31, 2005, 2004 and 2003 was US$0.70, US$1.06 and US$0.14 respectively.(r)
    
    Income taxesThe Company accounts for income taxes under the liability method. Deferred tax assets
and liabilities are determined based on differences between financial reporting and tax
bases of assets and liabilities and are measured using the enacted tax rates and laws
that will be in effect when the differences are expected to reverse. The Company
provides a valuation allowance, if necessary, to reduce deferred tax assets to their
estimated realizable value.(s)
    
    Foreign currenciesLJI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).(t)
    
    Treasury stockThe Company applies the cost method of accounting for treasury stock. The cost method
requires the Company to record the cost of acquiring treasury stock as a deduction from
the total capital. The treasury stock account is debited for the cost of the shares
acquired and will be credited upon reissuance at cost on a first-in-first-out basis. If
the treasury stock is reissued at a price in excess of acquisition cost, the excess will
be credited to additional paid-in capital in excess of par value from treasury stock.
If the treasury stock is reissued at less than acquisition cost, the deficiency will be
treated first as a reduction of any capital in excess of par related to previous
reissuances or retirements. If the balance in capital in excess of par value from
treasury stock is insufficient to absorb the deficiency, the remainder is recorded as a
reduction of retained earnings.
 F - 16




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  
 2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (u)
    
    Cash equivalentsThe Company considers all short-term, highly liquid investments with an original
maturity date of three months or less to be cash equivalents.(v)
    
    Uses of estimatesThe preparation of the Companys financial statements in conformity with generally
accepted accounting principles requires the Companys management to make estimates and
assumptions that affect the amounts reported in these financial statements and
accompanying notes. Actual amounts could differ from those estimates.(w)
    
    Related partiesParties 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.(x)
    
    DividendsThe 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 10 to the financial statements.(y)
    
    Comprehensive incomeThe Company reports comprehensive income in accordance with SFAS No. 130 Reporting
Comprehensive Income. Accumulated other comprehensive loss represents exchange
translation adjustments and is included in the shareholders equity section of the
balance sheet.(z)
    
    New accounting pronouncementsIn December 2004, the FASB issued Statement of Financial Accounting Standards No. 123
(revised), Share-Based Payment (SFAS No. 123R), which requires all companies to
measure compensation cost for all share-based payments (including employee stock
options) at fair value. In April 2005, the Securities and Exchange Commission
announced that it would provide a phased-in implementation process for SFAS No. 123R.
As a result of this phased-in process, the provisions of SFAS No. 123R must be adopted
by most public entities no later than the beginning of the first fiscal year commencing
after June 15, 2005. SFAS No. 123R applies to all awards granted after the required
effective date and to awards modified, repurchased, or cancelled after that date.Effective for the fiscal year beginning January 1, 2006, the Company will adopt the
provisions of SFAS No. 123R using a modified version of prospective application. Under
this transition method, compensation cost will be recognized on or after the effective
date for the portion of outstanding awards for which the requisite service has not yet
been rendered, based on the grant date fair value of those awards previously calculated
under SFAS No. 148 for pro forma disclosures.
 F - 17




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  
 2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (CONTINUED)
 (z)
    
    New accounting pronouncements (Continued)In November 2004, the FASB issued Statement of Financial Accounting Standards No. 151,
Inventory Costs  an amendment of ARB No. 43, Chapter 4 (SFAS No. 151), which
clarifies that abnormal amounts of idle facility expense, freight, handling costs, and
wasted material (spoilage) should be recognized as a current period expense. In
addition, SFAS No. 151 requires that allocation of fixed production overhead to the
costs of conversion be based on the normal capacity of the production facilities. SFAS
No. 151 is effective for fiscal years beginning after June 15, 2005. The Company does
not believe that the implementation of this standard will have a material impact on its
financial position, results of operations or cash flows of the Company.In December 2004, the FASB issued Statement of Financial Accounting Standards No. 153
Exchanges of Non-monetary Assets  an amendment of APB Opinion No. 29 (SFAS No. 153).
SFAS No. 153 addresses the measurement of exchanges of non-monetary assets. It
eliminates the exception from fair value measurement for non-monetary exchanges of
similar productive assets in paragraph 21(b) of APB Opinion No. 29 Accounting for
Non-monetary Transactions and replaces it with an exception for exchanges that do not
have commercial substance. A non-monetary exchange has commercial substance if the
future cash flows of the entity are expected to change significantly as a result of the
exchange. As required by SFAS No. 153, we will adopt this new accounting standard
effective July 1, 2005. The adoption of SFAS No. 153 is not expected to have a material
impact on the financial position, results of operations or cash flows of the Company.In May 2005, the FASB issued Statement of Financial Accounting Standards
No. 154, Accounting Changes and Error Corrections  a replacement of APB Opinion
No. 20 and FASB Statement No. 3 (SFAS No. 154), which changes the requirements for
the accounting and reporting of a change in accounting principle. The Statement
requires retrospective application to prior periods financial statements of
changes in accounting principle, unless it is impracticable to determine either the
period-specific effects or the cumulative effect of the change. In addition, the
Statement also requires that a change in depreciation or amortization for
long-lived assets be accounted for as a change in accounting estimate effected by a
change in accounting principle. The provisions of SFAS No. 154 are generally
effective for accounting changes and corrections of errors made in fiscal years
beginning after December 15, 2005. The Company does not expect the adoption of
SFAS No. 154 to have a material impact on its financial position or results of
operations.
 3.
    
    ACQUISITIONSOn January 1, 2005, the Company paid US$2,828 for new issuance of 3,900 common stock of
Goldleaves International Limited (GIL), 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.
 F - 18




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  
 3.
    
    ACQUISITIONS (CONTINUED)Details of the 78% share of identifiable assets and liabilities by the Company at the date
of acquisition are as follows:
 As ofJanuary 01,2005US$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$1,291 was included in statement of operations for the year ended
December 31, 2005 as an extraordinary item.The Companys consolidated results of operations have incorporated GILs activity on a
consolidated basis from the date of acquisition, which was January 1, 2005. The following
unaudited consolidated results of operations reflect pro forma results of operations for the
year ended December 31, 2004, as if the acquisition had been completed on January 1, 2004
and after giving effect to purchase accounting adjustments. The pro forma results have been
prepared for comparative purposes only and do not purport to be indicative of what operating
results would have been had the acquisitions actually taken place on January 1, 2004 and may
not be indicative of future operating results.
 Year endedDecember 31,2004US$Pro forma:Operating revenue
    
    
    77,379Net income
    
    
    3,087Earnings per share:Basic
    
    
    0.28Diluted
    
    
    0.25
 F - 19




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  3.
    
    ACQUISITIONS (CONTINUED)In addition, as of December 31, 2004, this investment is accounted for using the cost
method. As appropriate for a step-acquisition, in the 2005 financial statements, the
investment as of December 31, 2004 has been restated to account for under the equity method,
details of which are set out in note 9.Change in accounting treatment for the acquisitionThe Company restated the financial statements for the fiscal years 2005 and 2004 as a result
of change in accounting treatment for the acquisition of GIL, after the Company considered
the interpretation of SFAS 141 to reflect these transactions in their respective years. The
following financial statement line items for fiscal years 2005 and 2004 were affected by
this change.Consolidated statement of operations for the
year ended December 31, 2005
 Asoriginally
    
    
    As
    
    
    Effect ofreported
    
    
    adjusted
    
    
    changeUS$
    
    
    US$
    
    
    US$Impairment loss on goodwill  operating expenses
    
    
    
    
    
    
    
    
    
    
    Extraordinary gain on negative goodwill
    
    
    378
    
    
    
    1,291
    
    
    
    913Net income
    
    
    3,438
    
    
    
    4,351
    
    
    
    913Basic earnings per shareIncome before extraordinary item
    
    
    0.23
    
    
    
    0.23
    
    
    
    Extraordinary item
    
    
    0.03
    
    
    
    0.09
    
    
    
    0.06Net income
    
    
    0.26
    
    
    
    0.32
    
    
    
    0.06Diluted earnings per shareIncome before extraordinary item
    
    
    0.21
    
    
    
    0.21
    
    
    
    Extraordinary item
    
    
    0.03
    
    
    
    0.09
    
    
    
    0.06Net income
    
    
    0.24
    
    
    
    0.30
    
    
    
    0.06
 F - 20




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  3.
    
    ACQUISITIONS (CONTINUED)Consolidated statement of operations for the
year ended December 31, 2004
 Asoriginally
    
    
    As
    
    
    Effect ofreported
    
    
    adjusted
    
    
    changeUS$
    
    
    US$
    
    
    US$Impairment loss on goodwill  operating expenses
    
    
    
    
    
    
    698
    
    
    
    (698
    )Extraordinary gain on negative goodwill
    
    
    
    
    
    
    
    
    
    
    Net income
    
    
    2,820
    
    
    
    2,122
    
    
    
    (698
    )Basic earnings per shareIncome before extraordinary item
    
    
    0.25
    
    
    
    0.19
    
    
    
    (0.06
    )Extraordinary item
    
    
    
    
    
    
    
    
    
    
    Net income
    
    
    0.25
    
    
    
    0.19
    
    
    
    (0.06
    )Diluted earnings per shareIncome before extraordinary item
    
    
    0.23
    
    
    
    0.18
    
    
    
    (0.05
    )Extraordinary item
    
    
    
    
    
    
    
    
    
    
    Net income
    
    
    0.23
    
    
    
    0.18
    
    
    
    (0.05
    )
 Consolidated balance sheet as of December 31, 2005
 Asoriginally
    
    
    As
    
    
    Effect ofreported
    
    
    adjusted
    
    
    changeUS$
    
    
    US$
    
    
    US$Investment securities, net
    
    
    
    
    
    
    
    
    
    
    Total assets
    
    
    108,230
    
    
    
    108,230
    
    
    
    Additional paid-in capital
    
    
    31,419
    
    
    
    31,204
    
    
    
    (215
    )Retained earnings
    
    
    13,609
    
    
    
    13,824
    
    
    
    215Total shareholders equity
    
    
    45,008
    
    
    
    45,008
    
    
    
    
 F - 21




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  3.
    
    ACQUISITIONS (CONTINUED)Consolidated balance sheet as of December 31, 2004
 Asoriginally
    
    
    As
    
    
    Effect ofreported
    
    
    adjusted
    
    
    changeUS$
    
    
    US$
    
    
    US$Investment securities, net
    
    
    1,792
    
    
    
    1,094
    
    
    
    698Total assets
    
    
    74,371
    
    
    
    73,673
    
    
    
    698Additional paid-in capital
    
    
    23,382
    
    
    
    23,382
    
    
    
    Retained earnings
    
    
    10,171
    
    
    
    9,473
    
    
    
    (698
    )Total shareholders equity
    
    
    33,488
    
    
    
    32,790
    
    
    
    (698
    )
 Consolidated statement of cash flows for
the year ended of December 31, 2005
 Asoriginally
    
    
    As
    
    
    Effect ofreported
    
    
    adjusted
    
    
    changeUS$
    
    
    US$
    
    
    US$Cash flows from operating activities:Net income
    
    
    3,438
    
    
    
    4,351
    
    
    
    913Amortization and impairment loss on goodwill
    
    
    
    
    
    
    Extraordinary gain on negative goodwill
    
    
    (378
    )
    
    
    (1,291
    )
    
    
    (913
    )Net cash used in operating activities
    
    
    (14,222
    )
    
    
    (14,222
    )
    
    
    
 Consolidated statement of cash flows for
the year ended of December 31, 2004
 Asoriginally
    
    
    As
    
    
    Effect ofreported
    
    
    adjusted
    
    
    changeUS$
    
    
    US$
    
    
    US$Cash flows from operating activities:Net income
    
    
    2,820
    
    
    
    2,122
    
    
    
    (698
    )Amortization and impairment loss on goodwill
    
    
    
    
    
    
    698
    
    
    
    698Extraordinary gain on negative goodwill
    
    
    
    
    
    
    
    
    
    
    Net cash used in operating activities
    
    
    (7,494
    )
    
    
    (7,494
    )
    
    
    
 F - 22




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  4.
    
    OPERATING RISKS
 (a)
    
    Concentrations of credit risksDetails of major customers from which the Company derived operating revenue are shown
in note 17(b).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 its cash balances and investments in time deposits with various
banks and financial institutions. 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.
 F - 23




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  
 5.
    
    INVENTORIESInventories consisted of the following:
 As of December 31,2005
    
    
    2004US$
    
    
    US$Raw materials
    
    
    38,676
    
    
    
    25,810Work-in-progress
    
    
    2,214
    
    
    
    1,423Finished goods
    
    
    15,051
    
    
    
    9,39655,941
    
    
    
    36,629
 6.
    
    PROPERTIES HELD FOR LEASE, NETThe Company owns leasehold land and buildings in Hong Kong and leases them out for lease
terms of 2 years. Properties held for lease consists of the following:
 As of December 31,2005
    
    
    2004US$
    
    
    US$Leasehold land and buildings
    
    
    2,037
    
    
    
    2,037Less: Accumulated depreciation
    
    
    (637
    )
    
    
    (585
    )1,400
    
    
    
    1,452
 The Company pledged all properties held for lease as collateral for general banking
facilities granted to the Company as of December 31, 2005 and 2004 (see note 10).The future aggregate minimum rental receivables under non-cancellable operating leases are
as follows:
 As of December 31,2005
    
    
    2004US$
    
    
    US$2005
    
    
    
    
    
    
    882006
    
    
    91
    
    
    
    222007
    
    
    32
    
    
    
    123
    
    
    
    110
 F - 24




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  7.
    
    PROPERTY, PLANT AND EQUIPMENT, NETProperty, plant and equipment consist of the following:
 As of December 31,2005
    
    
    2004US$
    
    
    US$Leasehold land and buildings
    
    
    2,405
    
    
    
    1,995Leasehold improvement
    
    
    3,740
    
    
    
    3,326Furniture, fixtures and equipment
    
    
    4,664
    
    
    
    3,656Plant and machinery
    
    
    2,046
    
    
    
    2,493Motor vehicles
    
    
    564
    
    
    
    42313,419
    
    
    
    11,893Less: Accumulated depreciation
    
    
    (7,198
    )
    
    
    (7,220
    )6,221
    
    
    
    4,673
 The Company pledged leasehold land and buildings with net book values of US$2,049 and
US$1,495 as of December 31, 2005 and 2004 respectively as collateral for general banking
facilities granted to the Company (see note 10).8.
    
    GOODWILL, NETAs of December 31, 2005, goodwill is attributed to the acquisition of a jewelry retail
company in 2002.
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Carrying value, beginning of year
    
    
    1,521
    
    
    
    1,521
    
    
    
    1,721Impairment loss
    
    
    
    
    
    
    
    
    
    
    (200
    )Carrying value, end of year
    
    
    1,521
    
    
    
    1,521
    
    
    
    1,521
 The Company conducts annual impairment tests. The testing included the determination of
each reporting units fair value using the market multiples and discount cash flow analysis.
No goodwill impairment charge was necessary for the year ended December 31, 2005. The
accumulated amortization and impairment losses were US$869 and US$869 as of December 31,
2005 and 2004 respectively.
 F - 25




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  
 9.
    
    INVESTMENT SECURITIES, NET
 As of December 31,2005
    
    
    2004US$
    
    
    US$(Restated)Share of net assets
    
    
    
    
    
    
    313Goodwill
    
    
    
    
    
    
    1,679Less: accumulated impairment losses
    
    
    
    
    
    
    (898
    )
    
    
    
    781
    
    
    
    1,094
 During the year ended April 30, 2001, the Company acquired 20% equity interests in a company
whose principal activities are the manufacturing and trading of rough and pre-formed
gemstones, of which the Company had no significant control and influence over its operating
and financial policies, the investment is stated at cost previously.The directors of the Company consider such acquisition would enhance the Company by forward
and backward vertical integration.On January 1, 2005, additional equity interest was acquired in this company, which become a
subsidiary of the Company, details of which is set our in note 3. As appropriate for a
step-acquisition, the interest as of December 31, 2004 was restated to account for under
equity method. Details of the 20% share of identifiable assets and liabilities by the
Company at the date of acquisition are as follows:
 As of April30,
2001US$Net assets acquired:Property, plant and equipment
    
    
    39Inventories
    
    
    1,794Other receivables
    
    
    279Cash and cash equivalents
    
    
    13Trade payables
    
    
    (540
    )Accrued expenses and other payables
    
    
    (604
    )981Goodwill arising from acquisition
    
    
    1,679Total consideration
    
    
    2,660
 Since the acquisition in 2001, the aggregated amount of equity in results of investment
securities of US$668 has been charged to the statements of operations of the Company.Impairment losses on goodwill arising from investment securities of US$Nil , US$698 and
US$Nil were made for the years ended December 31, 2005, 2004 and 2003.
 F - 26




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  
 10.
    
    BANKING FACILITIES AND OTHER LOANS
 As of December 31,2005
    
    
    2004Note
    
    
    US$
    
    
    US$Bank overdrafts
    
    
    (a
    )
    
    
    2,028
    
    
    
    607Notes payable:Current portion
    
    
    (b
    )
    
    
    3,079
    
    
    
    2,487Letters of credit, gold and others:Letters of credit and others
    
    
    (a
    )
    
    
    13,048
    
    
    
    9,955Factoring
    
    
    (a
    )
    
    
    8,839
    
    
    
    5,468Gold loan
    
    
    (c
    )
    
    
    10,756
    
    
    
    6,48832,643
    
    
    
    21,911
 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 16(b)).
 F - 27




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  
 10.
    
    BANKING FACILITIES AND OTHER LOANS (CONTINUED)The material provisions of indentures relating to the Companys various banking facility
agreements contain covenants pertaining to (i) maintenance of the net worth of LJI and one
of its subsidiaries amounting to US$25,000 and US$4,487 respectively; and (ii) cross-default
provisions of the subsidiary in the event of default in aggregate of at least US$10,000
under separate loan facilities. In the event of default, the bank would at its discretion
to cancel the facilities and demand immediate repayment of all principal, interest, fees and
other amount outstanding.
 (a)
    
    As of December 31, 2005, the Company had various revolving bank facilities of
overdrafts, letters of credit and factoring facilities granted by banks, amounting to
US$3,461, US$15,987 and US$15,546 respectively.The bank overdrafts are denominated in Hong Kong dollars, bear interest at the
floating commercial bank lending rates in Hong Kong, which ranged from 4.90% to 9.25%
per annum as of December 31, 2005.The factoring facilities granted are limited to the extent of accounts receivable
collateralized to the banks.Under the banking facilities arrangements, the Company is required to maintain
certain cash balances based on the amount of facilities granted. These 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. These loans aggregated to
US$3,079 as of December 31, 2005. The expected maturities of these notes payable are
within one year. Interest charges on these loans ranged from 6.3% to 6.8% per annum as
of December 31, 2005.(c)
    
    The Company had outstanding loans to purchase 27.92 oz of gold as of December
31, 2005 with the related balances being US$10,756. These loans are due within the
following year, however, have been historically renewed. These loans bear interest at
2.4% to 2.6% per annum as of December 31, 2005 and can be repaid in cash at the current
exchange rate of gold any time prior to maturity.
 The weighted average interest rate for the year ended December 31, 2005 was 5.0%.
 F - 28




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  11.
    
    INCOME TAXESThe Company is subject to income taxes on an entity basis on income arising in or derived
from the tax jurisdiction in which it is domiciled and operates. Income tax (expense)
credit comprises of the following:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Current taxes arising in
foreign subsidiaries:For the year
    
    
    (595
    )
    
    
    (299
    )
    
    
    (357
    )(Under)/Over provision in
prior years
    
    
    (77
    )
    
    
    22
    
    
    
    92Total current tax
    
    
    (672
    )
    
    
    (277
    )
    
    
    (265
    )Deferred taxes arising in
foreign subsidiaries:For the year
    
    
    (67
    )
    
    
    
    
    
    
    (87
    )Income taxes (expense) credit
    
    
    (739
    )
    
    
    (277
    )
    
    
    (352
    )
 Reconciliation to the expected statutory tax rate in Hong Kong of 17.5% (2004 and 2003:
17.5%)is as follows:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003%
    
    
    %
    
    
    %Statutory rate
    
    
    17.5
    
    
    
    17.5
    
    
    
    17.5Tax effect of net operating losses
    
    
    21.2
    
    
    
    26.1
    
    
    
    20.0Non taxable profits, net
    
    
    (21.7
    )
    
    
    (33.2
    )
    
    
    (25.8
    )Impairment loss on goodwill
    
    
    
    
    
    
    5.4
    
    
    
    1.6Others
    
    
    2.3
    
    
    
    (3.5
    )
    
    
    3.0Effective rate
    
    
    19.3
    
    
    
    12.3
    
    
    
    16.3
 F - 29




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  11.
    
    INCOME TAXES (CONTINUED)Deferred income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts
used for income tax purposes. Significant components of the Companys deferred tax assets
and liabilities are as follows:
 As of December 31,2005
    
    
    2004US$
    
    
    US$Deferred tax assets:Net operating loss
    
    
    5,069
    
    
    
    2,826Depreciation
    
    
    71
    
    
    
    98Start up costs
    
    
    8
    
    
    
    235,148
    
    
    
    2,947Valuation allowance
    
    
    (5,148
    )
    
    
    (2,911
    )Total deferred tax assets
    
    
    
    
    
    
    36Deferred tax liabilities:Accelerated tax allowance
    
    
    (154
    )
    
    
    (123
    )Net deferred tax liabilities
    
    
    (154
    )
    
    
    (87
    )
 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 increase in valuation allowance for the years ended December 31, 2005, 2004
and 2003, amounted to US$2,237, US$253 and US$790 respectively.Based on the history of the Companys profitability, management believes that it is more
likely than not that the Company will realize the benefits of the deferred tax assets of
US$Nil and US$36, net of valuation allowances as of December 31, 2005 and 2004.
 F - 30




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  
 12.
    
    COMMITMENTS AND CONTINGENCIES
 (a)
    
    CommitmentsThe Company leases certain of its office and factory premises under various operating
leases. Rent expenses under these leases totalled approximately US$1,188, US$717 and
US$657 for the years ended December 31, 2005, 2004 and 2003 respectively. Included
in rent expenses, there were contingent rent expenses approximately US$22, US$Nil and
US$Nil for the years ended December 31, 2005, 2004 and 2003 respectively.Future minimum rental payments under capitalized leases and non-cancellable operating
leases are approximately as follows:
 As of December, 31 2005
    

    
    As of December, 31 2004Capitalized
    
    
    Operating
    
    
    Capitalized
    
    
    Operatingleases
    
    
    leases
    
    
    leases
    
    
    leasesUS$
    
    
    US$
    
    
    US$
    
    
    US$2005
    
    
    
    
    
    
    
    
    
    
    22
    
    
    
    6252006
    
    
    22
    
    
    
    835
    
    
    
    22
    
    
    
    3582007
    
    
    22
    
    
    
    718
    
    
    
    22
    
    
    
    1312008
    
    
    21
    
    
    
    352
    
    
    
    20
    
    
    
    87Thereafter
    
    
    2
    
    
    
    131
    
    
    
    
    
    
    
    Total future
minimum lease
payments
    
    
    67
    
    
    
    2,036
    
    
    
    86
    
    
    
    1,201Less: Amount
representing
interest
    
    
    (4
    )
    
    
    
    
    
    
    (9
    )63
    
    
    
    
    
    
    
    77
 In addition to the above future minimum lease payments, the terms of the leases
in respect of the retail shops in the PRC provide for the payment of contingent
rentals based on a percentage of sales in excess of a stipulated amount.As of December 31, 2005, the Company had capital expenditure commitments of US$31.(b)
    
    ContingenciesAs of December 31, 2005, 2004 and 2003, the Company provided guarantee in respect of
bank mortgage loans granted to a director, Mr. Yih Yu Chuan to the extent of US$237,
US$307 and US$370 respectively.
 F - 31




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  13.
    
    COMMON STOCK AND WARRANTS OTHER THAN STOCK-BASED COMPENSATION
 (a)
    
    Common stock
 (i)
    
    During the year ended December 31 2003, warrants to purchase
150,000 shares of common stock (note 15(b)(iv)) and 1,122,500 stock options
(note 15(a)) were exercised. As a warrant holder elected to take the cashless
exercise of 95,891 shares of common stock, a total of 1,218,391 shares of common
stock of the Company were issued accordingly.(ii)
    
    In September 2004, the Company completed a private placement of
1,614,082 shares of common stock and 484,221 warrants (note 13(c)) at a price of
US$2.20 per share. The Company sold all of the shares and the placement raised
US$2,746 after underwriting discounts and placement costs.(iii)
    
    During the year ended December 31, 2004, warrants to purchase
600,000 shares of common stock (note 15(b)(v)) and 405,000 stock options (note
15(a)) were exercised. As a warrant holder elected to take the cashless exercise
of 395,570 shares of common stock, a total of 800,570 shares of common stock of
the Company were issued accordingly.(iv)
    
    During the year ended December 31, 2005, warrants to purchase
54,545 shares of common stock (note 13(c)) and 3,162,000 stock options (note
15(a)) were exercised. A total of 3,216,545 shares of common stock of the
Company were issued accordingly.As of December 31, 2005, the Company had 15,521,203 shares of common
stock issued.
 (b)
    
    Treasury stockDuring the eight-month period ended December 31, 2002, the Company repurchased,
through open market purchases, 318,200 shares of common stock of the Company at
an aggregate consideration of US$391. In July 2003, the Company sold all these
            shares to a non-affiliated party for a consideration of US$541.
 F-32




---



##### Table of Contents



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

    
    
    
    
    
    
    
    484,221
    
    
    
    Exercised
    
    
    
    
    
    
    (54,545
    )
    
    
    
    
    
    
    Expired
    
    
    
    
    
    
    (1,877,500
    )
    
    
    (45,000
    )
    
    
    (146,000
    )Outstanding, end of year
    
    
    
    
    
    
    429,676
    
    
    
    2,361,721
    
    
    
    1,922,500
  ExerciseNumber of warrants
    
    
    priceDate of grant
    
    outstanding
    
    
    US$
    
    
    Expiration dateSeptember 1, 2004
    
    
    429,676
    
    
    
    2.98
    
    
    September 3, 2009
 
 (i)
    
    On September 1, 2004, the Company issued warrants for the
investors of a private placement to purchase 484,221 shares of the Companys
common stock at an exercise price of US$2.98 per share with an expiration date
of September 3, 2009 (see note (13)(a)(ii)).
  F-33




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  14.
    
    EMPLOYEE RETIREMENT BENEFIT PLANSFollowing the introduction of the Mandatory Provident Fund (MPF) legislation in Hong Kong,
the Company has participated in the defined contribution mandatory provident fund since
December 1, 2000. Both the Company and its employees in Hong Kong make monthly
contributions to the fund at 5% of the employees earnings as defined under Mandatory
Provident Fund legislation. The 5% monthly contribution of the Company and the employees
are subject to a cap of US$0.128 per month and thereafter contributions are voluntary. When
employees leave the MPF scheme prior to vestingfully in voluntary contributions, the contributions payable by the Company are reduced by
the amount of forfeited contributions.The amount of forfeitures in respect of the MPF scheme, which was available to reduce the
Companys contribution payable, for the year ended December 31, 2005, 2004 and 2003 was
US$Nil, US$Nil and US$11 respectively.The full-time employees of the PRC subsidiaries are entitled to staff welfare benefits,
including medical care, welfare subsidies, unemployment insurance and pension benefits.
These companies are required to accrue for these benefits based on certain percentages of
the employees salaries in accordance with the relevant regulations, and to make
contributions to the state-sponsored pension and medical plans out of the amounts accrued
for medical and pension benefits. The state-sponsored retirement plan was responsible for
the entire pension obligations for the actual pension payments or post-retirement benefits
beyond the annual contributions.The Company has adopted Profit Sharing Plan and Trust (Profit Sharing Plan) for the
benefit of substantially all employees in the US that satisfied the age and service
requirements. The Companys contributions are determined according to a discretionary
formula in an amount determined each year by the management and will be allocated to
each Qualifying Participants individual account using the pro rata formula. No profit
sharing expense made during all financial periods since its adoption.Contributions paid and payable by the Company in respect of the employee retirement benefit
plans charged to the consolidated statement of operations were US$831, US$616 and
US$543 for the years ended December 31, 2005, 2004 and 2003 respectively.
 15.
    
    STOCK-BASED COMPENSATION
 (a)
    
    Stock incentive planOn June 1, 1998, the Company adopted a stock option plan (The 1998 Plan) which was
approved by the shareholders on December 9, 1998. The 1998 Plan allows the Board of
Directors, or a committee thereof at the Boards discretion, to provide for a total
of 2,000,000 stock options to officers, directors, key employees and advisors of the
Company. Out of the stock options provided, 1,285,000 stock options were issued in
accordance with the terms of the 1998 Plan on April 12, 1999 to certain officers,
directors, key employees and advisors of the Company at an exercise price of US$5.0
per share (the fair market value of the common stock as of April 12, 1999) and are
exercisable during the period from April 12, 1999 to April 11, 2009.Pursuant to the 1999 Annual Meeting of the Shareholders on December 15, 1999, the
authorized number of stock options was increased from 2,000,000 to 4,000,000. The
purchase price of the shares of the Common Stock covered by the 1998 Plan shall be at
least
 F-34




---



##### Table of Contents

\

LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
      F-35




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  15.
    
    STOCK-BASED COMPENSATION (CONTINUED)
 (a)
    
    Stock incentive plan (Continued)The stock options activities and related information are summarized as follows:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31, 2005
    
    
    December 31, 2004
    
    
    December 31, 2003Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weightedaverage
    
    
    
    
    
    
    average
    
    
    
    
    
    
    averageexercise
    
    
    
    
    
    
    exercise
    
    
    
    
    
    
    exerciseprice
    
    
    
    
    
    
    Price
    
    
    
    
    
    
    priceOptions
    
    
    US$
    
    
    Options
    
    
    US$
    
    
    Options
    
    
    US$Outstanding, beginning of year
    
    
    3,759,000
    
    
    
    2.02
    
    
    
    3,814,000
    
    
    
    2.00
    
    
    
    3,025,500
    
    
    
    2.00Granted
    
    
    3,113,500
    
    
    
    2.44
    
    
    
    350,000
    
    
    
    2.20
    
    
    
    2,000,000
    
    
    
    2.00Exercised (note 13)
    
    
    (3,162,000
    )
    
    
    2.40
    
    
    
    (405,000
    )
    
    
    2.00
    
    
    
    (1,122,500
    )
    
    
    2.00Cancelled
    
    
    (400,000
    )
    
    
    2.18
    
    
    
    
    
    
    
    
    
    
    
    (89,000
    )
    
    
    2.00Outstanding, end of year
    
    
    3,310,500
    
    
    
    2.04
    
    
    
    3,759,000
    
    
    
    2.02
    
    
    
    3,814,000
    
    
    
    2.00Exercise price less than the
market price on date of grant
    
    
    150,000
    
    
    
    2.00
    
    
    
    150,000
    
    
    
    2.00
    
    
    
    
    
    
    
    Exercise price equals to
market price on date of grant
    
    
    701,000
    
    
    
    2.00
    
    
    
    1,369,000
    
    
    
    2.00
    
    
    
    1,739,000
    
    
    
    2.00Exercise price exceeds to
market price on date of grant
    
    
    2,459,500
    
    
    
    2.05
    
    
    
    2,240,000
    
    
    
    2.03
    
    
    
    2,075,000
    
    
    
    2.003,310,500
    
    
    
    2.04
    
    
    
    3,759,000
    
    
    
    2.02
    
    
    
    3,814,000
    
    
    
    2.00Range of exercise price- US$2.00
    
    
    2,797,000
    
    
    
    2.00
    
    
    
    3,559,000
    
    
    
    2.00
    
    
    
    3,814,000
    
    
    
    2.00- US$2.25
    
    
    513,500
    
    
    
    2.25
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    - US$2.35
    
    
    
    
    
    
    
    
    
    
    200,000
    
    
    
    2.35
    
    
    
    
    
    
    
    3,310,500
    
    
    
    2.04
    
    
    
    3,759,000
    
    
    
    2.02
    
    
    
    3,814,000
    
    
    
    2.00Exercisable, end of year- exercise price at US$2.00
    
    
    2,093,125
    
    
    
    2.00
    
    
    
    2,489,500
    
    
    
    2.00
    
    
    
    2,557,000
    
    
    
    2.00- exercise price at US$2.25
    
    
    513,500
    
    
    
    2.25
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,606,625
    
    
    
    2.05
    
    
    
    2,489,500
    
    
    
    2.00
    
    
    
    2,557,000
    
    
    
    2.00Weighted average remaining
contractual life- exercise price at US$2.00
    
    6.09 years
    
    
    
    
    
    6.42 years
    
    
    
    
    
    7.04 years- exercise price at US$2.25
    
    2.33 years
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    - exercise price at US$2.35
    
    
    
    
    
    
    
    
    
    8.50 years
    
    
    
    
    
    
    
  F-36




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  15.
    
    STOCK-BASED COMPENSATION (CONTINUED)
 (b)
    
    Warrants
 (i)
    
    On March 22, 2000, the Company issued warrants to a placement
agent to purchase 35,000 shares of the Companys common stock at an exercise
price of US$6.94 per share with an expiration date of March 31, 2005, as partial
compensation for its services. As of December 31, 2005, all expired.(ii)
    
    On May 26, 2001, the Company entered into a consulting agreement
with a consultant for a period of 24 months commencing on June 1, 2001.
Pursuant to the agreement, the Company issued to the consultant warrants to
purchase 260,000 shares of common stock of the Company on June 1, 2001. Of the
warrants issued on June 1, 2001, the warrantholder is entitled to:
 
    
    purchase 100,000 shares at US$2.29 per share exercisable through May
31, 2003 (expired, as of December 31, 2005);
    
    purchase 80,000 shares at US$3.43 per share exercisable through May 31,
2004 (expired, as of December 31, 2005);
    
    purchase 80,000 shares at US$4.57 per share exercisable through May 31,
2005. (expired, as of December 31, 2005);
 (iii)
    
    On August 16, 2001, the Company issued to an agent warrants to
purchase 200,000 shares of common stock of the Company at US$3.00 per share
exercisable through August 15, 2006 in consideration for consultancy services.(iv)
    
    On April 15, 2002, in accordance with a common stock purchase
agreement, the Company issued to an investor warrants to purchase 150,000 shares
of common stock of the Company at US$1.79 per share exercisable through April
14, 2005. The warrants were exercised in July 2003 and 95,891 shares of common
stock were issued accordingly pursuant to the cashless exercise.(v)
    
    Pursuant to a strategic advisory services agreement dated July 1,
2003, the Company issued to a consultant warrants to purchase 600,000 shares of
common stock of the Company at US$2 per share exercisable through March 31,
2004. The warrants were exercised in January 2004 and 395,570 shares of common
stock were issued accordingly pursuant to the cashless exercise.(vi)
    
    Pursuant to a media relation services agreement dated April 5,
2005, the Company issued to a consultant warrants to purchase 50,000 shares,
150,000 shares, 150,000 shares, 100,000 shares and 50,000 shares of common stock
of the Company at US$2.80, US$3.00, US$3.50, US$4.00 and US$4.50 respectively
per share exercisable through April 4, 2008.
 F-37




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  15.
    
    STOCK-BASED COMPENSATION (CONTINUED)
 (b)
    
    Warrants (Continued)Save as disclosed above, none of the warrants as aforesaid was exercised for the
three years ended December 31, 2005, 2004 and 2003. The costs associated with these
transactions are accounted for based on fair value of the warrants on the date of
grant.The fair value of warrants granted during the year ended December
31, 2005 and December 31, 2003 was estimated as US$472 and US$9 respectively by
using the Black-Scholes option pricing model with the following weighted-average
assumptions:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003Expected dividend yield
    
    
    
    
    
    
    
    
    
    
    Expected stock price volatility
    
    
    61
    %
    
    
    
    
    
    
    9
    %Risk-free interest rate
    
    
    3.91
    %
    
    
    
    
    
    
    1.07
    %Expected life of warrants
    
    3 years
    
    
    
    
    
    
    0.25 years
 16.
    
    RELATED PARTY TRANSACTIONS
 (a)
    
    Names and relationship of related parties:
 Existing relationships with the CompanyYih Yu Chuan
    
    Director and major shareholder of the CompanyGemological Institute of
America, Hong Kong Limited
    
    Common directorTanzanite (H.K.) Limited
    
    Common directorsOsorio Mendes Quintino Neto
    
    Director and minor shareholder of a subsidiary of the Company
 F-38




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  16.
    
    RELATED PARTY TRANSACTIONS (CONTINUED)
 (b)
    
    Summary of balances with related parties:
 As of December 31,2005
    
    
    2004Note
    
    
    US$
    
    
    US$Due from related parties:Gemological Institute of America,
Hong Kong Limited
    
    
    
    
    
    
    463
    
    
    
    464Tanzanite (H.K.) Limited
    
    
    
    
    
    
    21
    
    
    
    27(i)
    
    
    
    484
    
    
    
    491Due to a related party:Osorio Mendes Quintino Neto
    
    
    (i)
    
    
    
    1,910
    
    
    
    Certain banking facilities
granted to the Company
collateralized by properties
owned by Yih Yu Chuan and his
personal guarantee to the extent
of
    
    
    
    
    
    
    21,244
    
    
    
    12,971
 (c)
    
    Summary of related party transactions:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Rental expense to
Tanzanite (H.K.)
Limited
    
    
    150
    
    
    
    77
    
    
    
    23
 
 (i)
    
    The amounts due from/ to related parties represent unsecured advances which
are interest-free and repayable on demand.
 17.
    
    SEGMENT 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.Contributions of the major activities, profitability information and asset information are
summarized below:
 F-39




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  17
    
    SEGMENT INFORMATION (CONTINUED)
 (a)
    
    Business:
 Year ended December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Revenues from external customers:Manufacture and wholesale
    
    
    97,145
    
    
    
    76,696
    
    
    
    58,330Retail
    
    
    2,501
    
    
    
    808
    
    
    
    99,646
    
    
    
    77,504
    
    
    
    58,330Operating income (loss):Manufacture and wholesale
    
    
    7,518
    
    
    
    3,673
    
    
    
    2,869Retail
    
    
    (1,847
    )
    
    
    (543
    )
    
    
    5,671
    
    
    
    3,130
    
    
    
    2,869Depreciation:Manufacture and wholesale
    
    
    1,154
    
    
    
    991
    
    
    
    1,184Retail
    
    
    214
    
    
    
    41
    
    
    
    1,368
    
    
    
    1,032
    
    
    
    1,184Interest expense:Manufacture and wholesale
    
    
    1,991
    
    
    
    902
    
    
    
    753Retail
    
    
    
    
    
    
    
    
    
    
    1,991
    
    
    
    902
    
    
    
    753Capital expenditure:Manufacture and wholesale
    
    
    1,864
    
    
    
    560
    
    
    
    996Retail
    
    
    1,005
    
    
    
    167
    
    
    
    2,869
    
    
    
    727
    
    
    
    996
 As of December 31,2005
    
    
    2004US$
    
    
    US$Segment assets:Manufacture and wholesale
    
    
    101,260
    
    
    
    72,309Retail
    
    
    6,970
    
    
    
    1,364108,230
    
    
    
    73,673Long-lived assets (excluded goodwill):Manufacture and wholesale
    
    
    6,703
    
    
    
    6,311Retail
    
    
    918
    
    
    
    1277,621
    
    
    
    6,438
 F-40




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
  17.
    
    SEGMENT INFORMATION (CONTINUED)
 (b)
    
    Geographical areas:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    US$
    
    
    US$Revenue from external
customers:US & Canada
    
    
    67,780
    
    
    
    56,186
    
    
    
    42,851Europe and other countries
    
    
    20,527
    
    
    
    13,062
    
    
    
    8,017Japan
    
    
    3,686
    
    
    
    4,158
    
    
    
    5,338PRC (including Hong Kong
and Macau)
    
    
    7,653
    
    
    
    4,098
    
    
    
    2,12499,646
    
    
    
    77,504
    
    
    
    58,330
 As of December 31,2005
    
    
    2004US$
    
    
    US$(Restated)Carrying amount of long-lived assets:Hong Kong
    
    
    3,492
    
    
    
    3,238PRC
    
    
    3,933
    
    
    
    2,922US
    
    
    196
    
    
    
    278Total long-lived assets (excluding goodwill)
    
    
    7,621
    
    
    
    6,438Reconciling items:Others
    
    
    100,609
    
    
    
    67,235Total consolidated assets
    
    
    108,230
    
    
    
    73,673
 (c)
    
    The Company derived operating revenue from the following major
customers, which accounted for over 10% of operating revenue.
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2005
    
    
    2004
    
    
    2003US$
    
    
    %
    
    
    US$
    
    
    %
    
    
    US$
    
    
    %Customer A
    
    
    13,093
    
    
    
    13
    
    
    
    8,482
    
    
    
    11
    
    
    
    5,164
    
    
    
    9Customer B
    
    
    10,772
    
    
    
    11
    
    
    
    7,234
    
    
    
    9
    
    
    
    5,870
    
    
    
    10Customer C
    
    
    9,247
    
    
    
    9
    
    
    
    6,454
    
    
    
    8
    
    
    
    5,869
    
    
    
    10
 F-41




---



##### Table of Contents



LJ INTERNATIONAL INC.
 NOTES TO AND FORMING PART OF THE FINANCIAL STATEMENTS
   18.
    
    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-42




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
(Incorporated in the British Virgin Islands with limited liability)
 DIRECTORS REPORT AND ACCOUNTS
FOR THE YEAR ENDED 31 DECEMBER 2004
 
 Certified Public Accountants
 Hong Kong




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 REPORT OF THE DIRECTORS
  Principal activities
  Results and appropriations
   Reserves
  Fixed assets
  Share capital
  Directors
  QUINTINO NETO Osorio Mendes
    
    (Removed on 1 January 2005)AU Ka Man
    
    (Appointed on 1 January 2005)NG Hon Tak Ringo
    
    (Appointed on 1 January 2005)
  - 1 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 REPORT OF THE DIRECTORS (CONT.)
 Directors interests
     Management contracts
  Auditors
     - 2 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
  Respective responsibilities of directors and auditors
   Basis of opinion
   Opinion
   
  - 3 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 CONSOLIDATED INCOME STATEMENT
FOR THE YEAR ENDED 31 DECEMBER 2004
 2004
    
    
    2003Note
    
    
    HK$
    
    
    HK$Turnover
    
    
    3
    
    
    
    44,943,011
    
    
    
    44,185,211Cost of sales (after making specific provision
for stocks of HK$Nil (2003: HK$28,316,057))
    
    
    
    
    
    
    (34,281,677
    )
    
    
    (71,823,277
    )Gross profit/(loss)
    
    
    
    
    
    
    10,661,334
    
    
    
    (27,638,066
    )Other revenue
    
    
    3
    
    
    
    34,973
    
    
    
    202,520Distribution costs
    
    
    
    
    
    
    (174,016
    )
    
    
    (357,027
    )Administrative expenses
    
    
    
    
    
    
    (4,011,676
    )
    
    
    (4,043,030
    )Operating profit/(loss)
    
    
    4
    
    
    
    6,510,615
    
    
    
    (31,835,603
    )Finance costs
    
    
    5
    
    
    
    (1,230,900
    )
    
    
    (1,356,413
    )Profit/(Loss) before taxation
    
    
    
    
    
    
    5,279,715
    
    
    
    (33,192,016
    )Taxation
    
    
    7
    
    
    
    (91,939
    )
    
    
    Profit/(Loss) after taxation
    
    
    15
    
    
    
    5,187,776
    
    
    
    (33,192,016
    )
 - 4 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 CONSOLIDATED BALANCE SHEET
AS AT 31 DECEMBER 2004
 2004
    
    
    2003Note
    
    
    HK$
    
    
    HK$Non-current assetsFixed assets
    
    
    9
    
    
    
    1,196,602
    
    
    
    938,702Current assetsStocks
    
    
    11
    
    
    
    56,569,495
    
    
    
    64,117,844Due from director
    
    
    
    
    
    
    2,000
    
    
    
    2,000Accounts receivable & deposits
    
    
    
    
    
    
    9,465,864
    
    
    
    10,351,133Taxation recoverable
    
    
    
    
    
    
    
    
    
    
    174,335Bank balances and cash
    
    
    
    
    
    
    1,214,081
    
    
    
    635,58267,251,440
    
    
    
    75,280,894Current liabilitiesUnsecured loans
    
    
    
    
    
    
    (8,546,000
    )
    
    
    (8,546,000
    )Due to director
    
    
    17
    
    
    
    (26,952,792
    )
    
    
    (27,098,628
    )Accounts payable and accruals
    
    
    12
    
    
    
    (18,237,098
    )
    
    
    (26,640,408
    )Bills payable
    
    
    
    
    
    
    (2,432,605
    )
    
    
    (7,063,518
    )Taxation payable
    
    
    
    
    
    
    (91,939
    )
    
    
    Current portion of obligation under finance lease
    
    
    13
    
    
    
    (29,160
    )
    
    
    (56,289,594
    )
    
    
    (69,348,554
    )Net current assets
    
    
    
    
    
    
    10,961,846
    
    
    
    5,932,340Total assets less current liabilities
    
    
    
    
    
    
    12,158,448
    
    
    
    6,871,042Non-current liabilitiesObligation under finance lease
    
    
    13
    
    
    
    (99,630
    )
    
    
    Net assets
    
    
    
    
    
    
    12,058,818
    
    
    
    6,871,042
 - 5 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 CONSOLIDATED BALANCE SHEET
AS AT 31 DECEMBER 2004 (CONTINUED)
 2004
    
    
    2003Note
    
    
    HK$
    
    
    HK$Financed by:Share capital
    
    
    14
    
    
    
    773
    
    
    
    773Share premium
    
    
    15
    
    
    
    20,561,645
    
    
    
    20,561,645Accumulated losses
    
    
    15
    
    
    
    (8,503,600
    )
    
    
    (13,691,376
    )DirectorShareholders funds
    
    
    
    
    
    
    12,058,818
    
    
    
    6,871,042
 - 6 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 BALANCE SHEET
AS AT 31 DECEMBER 2004
 2004
    
    
    2003Note
    
    
    HK$
    
    
    HK$Non-current assetsFixed assets
    
    
    
    
    
    
    23,184
    
    
    
    Interests in subsidiaries
    
    
    10
    
    
    
    18,879,348
    
    
    
    18,898,69318,902,532
    
    
    
    18,898,693Current assetsAccount receivable
    
    
    
    
    
    
    6,570
    
    
    
    280Due from director
    
    
    16
    
    
    
    2,000
    
    
    
    2,000Bank balances
    
    
    
    
    
    
    3,821
    
    
    
    1,00612,391
    
    
    
    3,286Current liabilitiesAccounts payable and accruals
    
    
    12
    
    
    
    (54,772
    )
    
    
    (20,000
    )Net current liabilities
    
    
    
    
    
    
    (42,381
    )
    
    
    (16,714
    )Net assets
    
    
    
    
    
    
    18,860,151
    
    
    
    18,881,979Financed by:Share capital
    
    
    14
    
    
    
    773
    
    
    
    773Share premium
    
    
    15
    
    
    
    20,561,645
    
    
    
    20,561,645Accumulated losses
    
    
    15
    
    
    
    (1,702,267
    )
    
    
    (1,680,439
    )DirectorShareholders funds
    
    
    
    
    
    
    18,860,151
    
    
    
    18,881,979
 - 7 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 CONSOLIDATED STATEMENT OF CHANGES IN EQUITY
FOR THE YEAR ENDED 31 DECEMBER 2004
 2004
    
    
    2003HK$
    
    
    HK$Total equity as at 1 January
    
    
    6,871,042
    
    
    
    40,063,058Net profit/(loss) for the year
    
    
    5,187,776
    
    
    
    (33,192,016
    )Total equity as at 31 December
    
    
    12,058,818
    
    
    
    6,871,042
 - 8 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 CONSOLIDATED CASH FLOW STATEMENT
FOR THE YEAR ENDED 31 DECEMBER 2004
 2004
    
    
    2003HK$
    
    
    HK$Net cash inflow/(outflow) from operating activities (note 20)
    
    
    2,173,157
    
    
    
    (22,670,512
    )Returns on investments and servicing of financeInterest received
    
    
    1,932
    
    
    
    1,550Interest paid
    
    
    (1,213,867
    )
    
    
    (1,249,297
    )Net cash outflow from returns on investments
and servicing of finance
    
    
    (1,211,935
    )
    
    
    (1,247,747
    )TaxationHong Kong profits tax refunded/(paid)
    
    
    174,335
    
    
    
    (364,870
    )Overseas tax paid
    
    
    
    
    
    
    174,335
    
    
    
    (364,870
    )Investing activitiesPayments to acquire fixed assets
    
    
    (540,012
    )
    
    
    (11,019
    )Funds (repaid to)/received from director (net)
    
    
    (145,836
    )
    
    
    24,083,369Net cash (outflow)/inflow from investing activities
    
    
    (685,848
    )
    
    
    24,072,350Net cash inflow/(outflow) before financing
    
    
    449,709
    
    
    
    (210,779
    )FinancingNew finance lease
    
    
    145,800
    
    
    
    Capital element of finance lease rental payments
    
    
    (17,010
    )
    
    
    Net cash inflow from financing
    
    
    128,790
    
    
    
    Increase/(Decrease) in cash and cash equivalents
    
    
    578,499
    
    
    
    (210,779
    )Cash and cash equivalents at 1 January
    
    
    635,582
    
    
    
    846,361Cash and cash equivalents at 31 December
    
    
    1,214,081
    
    
    
    635,582Analysis of the balances of cash and cash equivalents
Cash and bank balances
    
    
    1,214,081
    
    
    
    635,582
 - 9 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 1.
    
    Organisation and operationsGoldleaves International limited (the company) was incorporated in the British Virgin
Islands on 8 July 1998. The company is an investment holding company. Its subsidiaries are
principally engaged in trading and manufacturing of precious and semi-precious stones.2.
    
    Principal accounting policiesThe principal accounting policies adopted in the preparation of these accounts are set out
below:
 (a)
    
    Basis of preparationThe accounts have been prepared in accordance with accounting principles generally
accepted in Hong Kong and comply with accounting standards issued by the Hong Kong
Institute of Certified Public Accountants (HKICPA). They have been prepared under
the historical cost convention.The HKICPA has issued a number of new and revised Hong Kong Financial Reporting
Standards and Hong Kong Accounting Standards (new HKFRSs) which are effective for
accounting periods beginning on or after 1 January 2005.The Group has not early adopted these new HKFRSs in the financial statements for the
year ended 31 December 2004. The Group has already commenced an assessment of the
impact of these new HKFRSs but is not yet in a position to state whether these new
HKFRSs would have a significant impact on its results of operations and financial
position.(b)
    
    ConsolidationThe consolidated accounts include the accounts of the company and its subsidiaries
made up to 31 December. Subsidiaries are those entities in which the group controls
the composition of the board of directors, controls more than half the voting power
or holds more than half of the issued share capital.The results of subsidiaries acquired or disposed of during the year are included in
the consolidated income statement from the effective date of acquisition or up to the
effective date of disposal, as appropriate.All significant intercompany transactions and balances within the group are
eliminated on consolidation.The gain or loss on the disposal of a subsidiary represents the difference between
the proceeds of the sale and the groups share of its net assets together with any
unamortised goodwill or negative goodwill or goodwill/negative goodwill taken to
reserves and which was not previously charged or recognised in the consolidated
income statement.
 - 10 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 2.
    
    Principal accounting policies (Cont.)
 (b)
    
    Consolidation (Cont.)In the companys balance sheet the investments in subsidiaries are stated at cost
less provision for impairment losses, if any. The results of subsidiaries are
accounted for by the company on the basis of dividends received and receivable.(c)
    
    Revenue recognitionRevenue from the sale of goods is recognised on the transfer of risks and rewards of
ownership, which generally coincides with the time when the goods are delivered to
customers and title has passed.Revenue from subcontracting service is recognised when the services are rendered and
billable.Interest income is recognised on a time proportion basis, taking into account the
principal amounts outstanding and the interest rates applicable.(d)
    
    Fixed assetsFixed assets are stated at cost less accumulated depreciation and accumulated
impairment losses, if any.Depreciation is calculated to write off the cost of fixed assets over their estimated
useful lives on a straight line basis at the following annual rates:-
 Plant and machineries
    
    
    20%Furniture, decoration and equipment
    
    
    10% - 20
    %Motor vehicle
    
    
    331/3%
 Major costs incurred in restoring fixed assets to their normal working condition are
charged to the income statement. Improvements are capitalised and depreciated over
their expected useful lives to the group.(e)
    
    Impairment and gain or loss on saleAt each balance sheet date, both internal and external sources of information are
considered to assess whether there is any indication that assets included in the
balance sheet are impaired. If any such indication exists, the recoverable amount of
the asset is estimated and where relevant, an impairment loss is recognised to reduce
the asset to its recoverable amount. Such impairment losses are recognised in the
income statement except where the asset is carried at valuation and the impairment
loss does not exceed the revaluation surplus for that same asset, in which case it is
treated as a revaluation decrease.
 - 11 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 2.
    
    Principal accounting policies (Cont.)
 (e)
    
    Impairment and gain or loss on sale (Cont.)The gain or loss on disposal of a fixed asset is the difference between the net sales
proceeds and the carrying amount of the relevant asset, and is recognised in the
income statement. Any revaluation reserve balance remaining attributable to the
relevant asset is transferred to retained earnings and is shown as a movement in
reserves.(f)
    
    Related partiesRelated parties are individuals and companies, where the company 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, or vice versa, or
where the company and the party are subject to common control or common significant
influence. Related parties may be individuals or other entities.(g)
    
    StocksStocks are stated at the lower of cost and net realisable value.Cost is based on the weighted average cost formula and comprises all costs of
purchases, costs of conversion and other costs incurred in bringing the stocks to
their present location and condition.Net realisable value is determined on the basis of estimated normal selling price
less further costs expected to be incurred to completion and disposal. Provision is
made for obsolete, slow-moving or defective items where appropriate.(h)
    
    Foreign currenciesIndividual companies within the group maintain their books and records in Hong Kong
dollars.Transactions in foreign currencies are translated into Hong Kong dollars at exchange
rates ruling at the transaction dates. Monetary assets and liabilities denominated
in foreign currencies at the balance sheet date are translated into Hong Kong dollars
at rates of exchange ruling at that date. Exchange differences arising in these
cases are dealt with in the income statement.(i)
    
    Cash and cash equivalentsCash and cash equivalents are carried in the balance sheet at cost. For the purposes
of the cash flow statement, cash and cash equivalents comprise cash on hand, deposits
held at call with banks less bank overdrafts and advances from banks repayable within
three months from the date of the advances.
 - 12 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 2.
    
    Principal accounting policies (Cont.)
 (j)
    
    ProvisionsIn accordance with SSAP 28, provisions are recognised when the group has a present
legal or constructive obligation as a result of past events, it is probable that an
outflow of resources will be required to settle the obligation, and a reliable
estimate of the amount can be made. Where the group expects a provision to be
reimbursed, for example under an insurance contract, the reimbursement is recognised
as a separate asset but only when the reimbursement is virtually certain.(k)
    
    Accounts receivableProvision is made against accounts receivable to the extent they are considered to be
doubtful. Accounts receivable in the balance sheet are stated net of such provision.(l)
    
    Contingent liabilities and contingent assetsA contingent liability is a possible obligation that arises from past events and
whose existence will only be confirmed by the occurrence or non-occurrence of one or
more uncertain future events not wholly within the control of the group. It can also
be a present obligation arising from past events that is not recognised because it is
not probable that outflow of economic resources will be required or the amount of
obligation cannot be measured reliably. A contingent liability is not recognised but
is disclosed in the notes to the accounts. When a change in the probability of an
outflow occurs so that outflow is probable, they will then be recognised as a
provision.A contingent asset is a possible asset that arises from past events and whose
existence will be confirmed only by the occurrence or non-occurrence of one or more
uncertain events not wholly within the control of the group.Contingent assets are not recognised but are disclosed in the notes to the accounts
when an inflow of economic benefits is probable. When inflow is virtually certain,
an asset is recognised.(m)
    
    TaxationIncome tax expense represents the sum of the tax currently payable and deferred tax.The tax currently payable is based on taxable profit for the year. Taxable profit
differs from net profit as reported in the income statement because it excludes items
of income or expense that are taxable or deductible in other years and it further
excludes items that are never taxable or deductible. The companys liability for
current tax is calculated using tax rates that have been enacted or substantively
enacted by the balance sheet date.
 - 13 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 2.
    
    Principal accounting policies (Cont.)
 (m)
    
    Taxation (Cont.)Deferred tax is the tax expected to be payable or recoverable on differences between
the carrying amount of assets and liabilities in the accounts and the corresponding
tax bases used in the computation of taxable profit, and is accounted for using the
balance sheet liability method. Deferred tax liabilities are generally recognised for
all taxable temporary differences, and deferred tax assets are recognised to the
extent that it is probable that taxable profits will be available against which
deductible temporary differences can be utilised. Such assets and liabilities are
not recognised if the temporary difference arises from goodwill (or negative
goodwill) or from the initial recognition (other than in a business combination) of
other assets and liabilities in a transaction that affects neither the tax profit nor
the accounting profit.The carrying amount of deferred tax assets is reviewed at each balance sheet date and
reduced to the extent that it is no longer probable that sufficient taxable profit
will be available to allow all or part of the asset to be recovered.Deferred tax is calculated at the tax rates that are expected to apply in the period
when the liability is settled or the asset is realised. Deferred tax is charged or
credited in the income statement, except when it related to items charged or credited
directly to equity, in which case the deferred tax is also dealt with in equity.(n)
    
    Operating leasesLeases where substantially all the rewards and risks of ownership of assets remain
with the leasing company are accounted for as operating leases. Payments made under
operating leases net of any incentives received from the leasing company are charged
to the income statement on a straight line basis over the lease periods.(o)
    
    Employee benefitsEmployee entitlements to annual leave and long service leave are recognised when they
accrue to employees. A provision is made for the estimated liability for annual
leave and long service leave as a result of services rendered by employees up to the
balance sheet date. Employee entitlements to sick leave and maternity or paternity
leave are not recognised until the time of leave.(p)
    
    Borrowing costsBorrowing costs that are directly attributable to the acquisition, construction or
production of an asset that necessarily takes a substantial period of time to get
ready for its intended use or sale are capitalised as part of the cost of that asset.All other borrowing costs are charged to the income statement in the year which they
are incurred.
 - 14 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 2.
    
    Principal accounting policies (Cont.)
 (q)
    
    Finance leasesLeases that substantially transfer to the company all the risks and rewards of
ownership of assets are accounted for as finance leases. Finance leases are
capitalised at the inception of the leases at the lower of the fair value of the
leased assets or the present value of the minimum lease payments. Each lease payment
is allocated between the capital and finance charges so as to achieve a constant rate
on the capital balances outstanding. The corresponding rental obligations, net of
finance charges, are included in long-term liabilities. The finance charges are
charged to the income statement over the lease periods.Assets held under finance leases are depreciated over the shorter of their estimated
useful lives or the lease periods.(r)
    
    Retirement benefits schemeThe group operates defined contribution pension schemes under the Mandatory Provident
Fund Schemes Ordinance (the MPF Schemes) for its employees, the assets of which are
held separately from those of the company in independently administered funds. The
MPF Schemes have operated since 1 December 2000. Contributions to the MPF Schemes
are made based on a percentage of the eligible employees salaries and are charged to
the income statement as they become payable in accordance with the rules of the MPF
Scheme. The groups employer contributions vest fully with the employees when
contributed into the MPF Schemes, except for the groups employer voluntary
contributions, which are refunded to the group when the employee leaves employment
prior to the contributions vesting fully, in accordance with the rules of the MPF
Schemes.The employees of the companys subsidiary which operates in the Peoples Republic of
China (the PRC) are required to participate in a central pension scheme operated by
the local municipal government. The PRC subsidiary is required to contribute certain
percentage of its payroll costs to the central pension scheme.
 - 15 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 3.
    
    Turnover and revenueTurnover represents the net invoiced value of goods sold and subcontracting income.An analysis of the groups turnover and revenue is as follows:-
 2004
    
    
    2003HK$
    
    
    HK$Turnover Sales of goods
    
    
    43,012,309
    
    
    
    43,791,510 Rendering of services
    
    
    1,930,702
    
    
    
    393,70144,943,011
    
    
    
    44,185,211Revenue Interest income
    
    
    1,932
    
    
    
    1,550 Commission income
    
    
    20,798
    
    
    
     Rental income
    
    
    
    
    
    
    161,000 Other income
    
    
    12,243
    
    
    
    39,97034,973
    
    
    
    202,520Total revenues
    
    
    44,977,984
    
    
    
    44,387,731
 - 16 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 4.
    
    Operating profit/(loss)
 Group2004
    
    
    2003HK$
    
    
    HK$The groups operating profit/(loss) is stated:-after creditingInterest on bank deposits
    
    
    1,932
    
    
    
    1,550Rental income from subletting of property
    
    
    
    
    
    
    161,000and after chargingAuditors remuneration
    
    
    68,707
    
    
    
    68,424Bad debts provision
    
    
    540,163
    
    
    
    Exchange loss (net)
    
    
    96,588
    
    
    
    77,676Depreciation Owned assets
    
    
    272,392
    
    
    
    359,366 Leased assets
    
    
    9,720
    
    
    
    Staff (excluding directors) costs (Note 6)
    
    
    5,216,907
    
    
    
    4,982,182Directors remuneration Fees
    
    
    
    
    
    
     Other emoluments
    
    
    1,404,000
    
    
    
    1,404,000 Pension costs
    
    
    
    
    
    
    Operating lease rental for land & buildings
    
    
    861,570
    
    
    
    1,040,370Specific provision for stocks
    
    
    
    
    
    
    28,316,057
 5.
    
    Finance costs
 Group2004
    
    
    2003HK$
    
    
    HK$Interest expense on bank loans and overdraft
    
    
    
    
    
    
    Interest expense on other loans
without fixed repayment terms
    
    
    1,167,200
    
    
    
    1,249,297Other finance cost
    
    
    63,700
    
    
    
    107,1161,230,900
    
    
    
    1,356,413
 - 17 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 6.
    
    Staff costs (excluding directors)
 2004
    
    
    2003HK$
    
    
    HK$Wages and salaries
    
    
    4,756,743
    
    
    
    4,518,574Welfare, recruitment and training
    
    
    20,265
    
    
    
    4,866Pension and social security costs
    
    
    439,899
    
    
    
    458,7425,216,907
    
    
    
    4,982,182
 7.
    
    TaxationNo provision for Hong Kong profits tax has been made in the Hong Kong subsidiarys accounts
as the subsidiary incurred loss for taxation purposes for the year (2003: Nil).No provision for profits tax has been made in the companys accounts as the company has no
assessable income for taxation purpose for the year (2003: Nil).Subsidiary in the PRC is subject to tax laws applicable to foreign investment enterprises in
the PRC and is fully exempt from PRC enterprise income tax of 15% for two years starting
from the first profit-making year followed by a 50% reduction for the next three years,
commencing from the first profitable year after offsetting all unexpired tax losses carried
forward from the previous years.No provision for PRC profits tax has been made in the accounts as the PRC subsidiary has
loss for taxation purpose, as calculated by a certified accountant in the Peoples Republic
of China, for the year
(2003: Nil).The amount of taxation charged to the income statement represents:-
 2004
    
    
    2003HK$
    
    
    HK$Current taxation for Hong Kong profits tax
    
    
    
    
    
    
    Current taxation overseas
    
    
    91,939
    
    
    
    Deferred taxation
    
    
    
    
    
    
    91,939
    
    
    
    
 - 18 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 7.
    
    Taxation (Cont.)The charge for the year can be reconciled to the profit/(loss) before taxation per the
consolidated income statement as follows:
 2004
    
    
    2003HK$
    
    
    %
    
    
    HK$
    
    
    %Profit/(Loss) before taxation
    
    
    5,279,715
    
    
    
    
    
    
    
    (33,192,016
    )Income tax at applicable tax rate
rate of 15% (2003: 15%)
    
    
    791,957
    
    
    
    15.0
    
    
    
    (4,978,802
    )
    
    
    (15.0
    )Tax effect of income not taxable for tax purposes
    
    
    (70
    )
    
    
    
    
    
    
    (8
    )
    
    
    Effect of different tax rates of subsidiary in
other jurisdiction
    
    
    
    
    
    
    
    
    
    
    (1,579
    )
    
    
    Tax effect of loss/expenses not deductible for
tax purpose
    
    
    3,274
    
    
    
    
    
    
    
    122,780
    
    
    
    0.4Tax effect of temporary differences and tax loss
not recognised
    
    
    (795,161
    )
    
    
    (15.0
    )
    
    
    4,857,609
    
    
    
    14.6Over-provision of PRC income tax in the
current year
    
    
    91,939
    
    
    
    1.7
    
    
    
    
    
    
    
    Taxation for the year
    
    
    91,939
    
    
    
    1.7
    
    
    
    
    
    
    
    
 At 31 December 2004, the company and the Hong Kong subsidiary had no significant deferred
taxation (2003: Nil). The PRC subsidiary had deferred tax asset relating to estimated tax
losses which are mainly subject to a time limit of five years. However, this deferred tax
asset is not recognised in the accounts in view of the fact that an inflow of economic
benefit is virtually uncertain. There was no other significant potential deferred taxation
at the balance sheet date.8.
    
    Profit attributable to shareholdersThe profit attributable to shareholders is dealt with in the accounts of the company to the
extent of loss of HK$21,828 (2003: loss of HK$818,530).
 - 19 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 9.
    
    Fixed assets
 Furniture,Motor
    
    
    Plant &
    
    
    decoration &vehicle
    
    
    machineries
    
    
    equipment
    
    
    TotalThe Group
    
    HK$
    
    
    HK$
    
    
    HK$
    
    
    HK$CostAt 31 December 2003
    
    
    
    
    
    
    976,062
    
    
    
    1,504,198
    
    
    
    2,480,260Additions
    
    
    34,776
    
    
    
    90,366
    
    
    
    414,870
    
    
    
    540,012At 31 December 2004
    
    
    34,776
    
    
    
    1,066,428
    
    
    
    1,919,068
    
    
    
    3,020,272Accumulated depreciationAt 31 December 2003
    
    
    
    
    
    
    828,224
    
    
    
    713,334
    
    
    
    1,541,558Charge for the year
    
    
    11,592
    
    
    
    79,043
    
    
    
    191,477
    
    
    
    282,112At 31 December 2004
    
    
    11,592
    
    
    
    907,267
    
    
    
    904,811
    
    
    
    1,823,670Net book valueAt 31 December 2004
    
    
    23,184
    
    
    
    159,161
    
    
    
    1,014,257
    
    
    
    1,196,602At 31 December 2003
    
    
    
    
    
    
    147,838
    
    
    
    790,864
    
    
    
    938,702Net book value of leased assetAt 31
December 2004
    
    
    
    
    
    
    
    
    
    
    136,080
    
    
    
    136,080At 31 December 2003
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
 MotorvehicleThe company
    
    HK$CostAt 31 December 2003
    
    
    Addition
    
    
    34,776At 31 December 2004
    
    
    34,776Accumulated depreciationAt 31 December 2003
    
    
    Charge for the year
    
    
    11,592At 31 December 2004
    
    
    11,592Net book valueAt 31 December 2004
    
    
    23,184At 31 December 2003
    
    
    
 - 20 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 10.
    
    Interests in subsidiariesIn the companys balance sheet, interests in subsidiaries comprised:
 2004
    
    
    2003HK$
    
    
    HK$Unlisted investment at cost
    
    
    5,000,002
    
    
    
    5,000,002Due from the subsidiaries
    
    
    14,180,654
    
    
    
    29,922,429Due to the subsidiary
    
    
    (301,308
    )
    
    
    (16,023,738
    )18,879,348
    
    
    
    18,898,693
 All the advances from/(to) subsidiaries were unsecured, non-interest bearing and without
pre-determined repayment terms.The underlying value of interests in subsidiaries was, in the opinion of the directors, not
less than the companys carrying value as at 31 December 2004.Details of the subsidiaries as at 31 December 2004 were as follows:
 Issued and
    
    Proportion ofPlace of
    
    fully paid
    
    nominal valueIncorporation/
    
    share
    
    of issued capital held
    
    PrincipalName of subsidiary
    
    operations
    
    capital
    
    by the company
    
    activitiesHK$
    
    %Goldleaves Gems
    
    The Peoples
    
    5,000,000
    
    100
    
    Trading and(Shenzhen) Co. Ltd
    
    Republic of
    
    
    
    
    
    manufacturing of(CHINESE CHARACTERS)
    
    China
    
    
    
    
    
    precious and semi-
precious stonesGoldleaves Trading
    
    Hong Kong
    
    2
    
    100
    
    Trading ofLimited
    
    
    
    
    
    
    
    precious and semi-precious stones
 All subsidiaries were directly held by the company
 - 21 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 11.
    
    StocksStocks included in the consolidated balance sheet comprised raw material of HK$25,388,476
(2003: HK$35,245,353), work-in-progress of HK$16,284,188 (2003: HK$14,331,415) and finished
goods of HK$14,896,831 (2003: HK$14,541,076).The amount of stocks (included above) carried at the net realisable value was HK$48,852,766
(2003: HK$54,500,105).12.
    
    Accounts payable and accruals
 2004
    
    
    2003HK$
    
    
    HK$Included in accounts payable and accruals are amount
due to related company which is related to transactions
entered under normal course of business of the group. Group
    
    
    80,748
    
    
    
    456,140 Company
    
    
    
    
    
    
    
 Unsecured loan represented advances which bore interest at commercial rate and have no fixed
repayment terms.13.
    
    Obligations under finance lease
 Group2004
    
    
    2003HK$
    
    
    HK$Wholly repayable within five years
Obligations under finance leases
    
    
    128,790
    
    
    
    Amounts due within one year included
under current liabilities
    
    
    29,160
    
    
    
    99,630
    
    
    
    
 - 22 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 13.
    
    Obligations under finance lease (Cont.)At 31 December 2004, the groups finance lease liabilities were repayable as follows:
 2004
    
    
    2003HK$
    
    
    HK$Within one year
    
    
    29,160
    
    
    
    In the second year
    
    
    29,160
    
    
    
    In the third to fifth year
    
    
    70,470
    
    
    
    After the fifth year
    
    
    
    
    
    
    128,790
    
    
    
    Future finance charges on finance leases
    
    
    
    
    
    
    Present value of finance lease liabilities
    
    
    128,790
    
    
    
    The present value of finance lease liabilities is as follows:Within one year
    
    
    29,160
    
    
    
    In the second year
    
    
    29,160
    
    
    
    In the third to fifth year
    
    
    70,470
    
    
    
    After the fifth year
    
    
    
    
    
    
    Present value of finance lease liabilities
    
    
    128,790
    
    
    
    
 The companys subsidiary leases a copying machine under finance lease arrangement expiring
in
5 years. At the end of the lease term the subsidiary has the option to purchase the copying
machine at a price deemed to be a bargain purchase option. The lease does not include
contingent rentals. The leased copying machine secures the above lease obligations.14.
    
    Share capital
 Number of
    
    
    Valueshares
    
    
    HK$Authorised:Ordinary shares of US$1 eachBalance at 31 December 2003 and
31 December 2004
    
    
    50,000
    
    
    
    386,500Issued and fully paid:Ordinary shares of US$1 eachBalance at 31 December 2003 and
31 December 2004
    
    
    100
    
    
    
    773
 - 23 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 14.
    
    Share capital (Cont.)No shares were issued during the year ended 31 December 2003 and 2004.On 1 January 2005, 3,900 ordinary shares of US$1 each were issued at a premium of US$724
each to one of the existing shareholders of the company. The new proceeds of approximately
HK$22 million were used for repayment of unsecured loan and general working capital. All
the new shares rank pari passu in all respects with the existing ordinary shares.15.
    
    Reserves
 (Accumulatedloss)/Share
    
    
    Share
    
    
    Retainedcapital
    
    
    premium
    
    
    earnings
    
    
    TotalHK$
    
    
    HK$
    
    
    HK$
    
    
    HK$The groupAt 1 January 2003
    
    
    773
    
    
    
    20,561,645
    
    
    
    19,500,640
    
    
    
    40,063,058Net loss for the year
    
    
    
    
    
    
    
    
    
    
    (33,192,016
    )
    
    
    (33,192,016
    )At 31 December 2003
    
    
    773
    
    
    
    20,561,645
    
    
    
    (13,691,376
    )
    
    
    6,871,042At 1 January 2004
    
    
    773
    
    
    
    20,561,645
    
    
    
    (13,691,376
    )
    
    
    6,871,042Net profit for the year
    
    
    
    
    
    
    
    
    
    
    5,187,776
    
    
    
    5,187,776At 31 December 2004
    
    
    773
    
    
    
    20,561,645
    
    
    
    (8,503,600
    )
    
    
    12,058,818The companyAt 1 January 2003
    
    
    773
    
    
    
    20,561,645
    
    
    
    (861,909
    )
    
    
    19,700,509Net loss for the year
    
    
    
    
    
    
    
    
    
    
    (818,530
    )
    
    
    (818,530
    )At 31 December 2003
    
    
    773
    
    
    
    20,561,645
    
    
    
    (1,680,439
    )
    
    
    18,881,979At 1 January 2004
    
    
    773
    
    
    
    20,561,645
    
    
    
    (1,680,439
    )
    
    
    18,881,979Net loss for the year
    
    
    
    
    
    
    
    
    
    
    (21,828
    )
    
    
    (21,828
    )At 31 December 2004
    
    
    773
    
    
    
    20,561,645
    
    
    
    (1,702,267
    )
    
    
    (18,860,151
    )
 - 24 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 16.
    
    Loans to directorParticulars of loan to director are detailed as follows:-
 Term
    
    Maximum
    
    Amount
    
    Amountof
    
    outstanding
    
    outstanding at
    
    outstanding atName
    
    Lender
    
    loans
    
    during the year
    
    31 December 2003
    
    31 December 2004HK$
    
    HK$
    
    HK$Quintino Neto
    
    Company
    
    Unsecured,
    
    2,000
    
    2,000
    
    2,000Osorio Mendes
    
    
    
    interest free andno fixed repaymentterms
 17.
    
    Due to directorAmount due to director represents unsecured advances which are interest free and have no
fixed repayment terms.18.
    
    CommitmentsExcept for the operating lease commitments noted below, the group did not have any
commitments at 31 December 2004.At 31 December 2004, the group had future aggregate minimum lease payments under
non-cancellable operating leases for land and buildings as follows:
 Group2004
    
    
    2003HK$
    
    
    HK$Leases expiring in the first year
    
    
    435,761
    
    
    
    522,913 in the second to fifth years inclusive
    
    
    
    
    
    
    435,761 after the fifth year
    
    
    
    
    
    
    435,761
    
    
    
    958,674
 The group leases a number of warehouse and factory facilities under operating leases. The
leases typically run for an initial period of 3 year, without an option to renew the leases
after the date at which time all terms are renegotiated. None of the leases includes
contingent rentals.During the year, a subsidiary paid rental expenses of HK60,000 (2003: HK$200,000) and
received rental income of HK$25,000 (2003: HK$161,000) from subletting of the same office.
No committed tenancy agreement has been signed in respect of these rental expense and rental
income.
 - 25 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 NOTES TO THE ACCOUNTS
 19.
    
    Related party transactionsExcept for the transactions noted below, the group and the company have not been a party to
any material related party transaction during the year ended 31 December 2004.
 a)
    
    During the year, the group purchased goods totaling HK$3,732,205 (2003:
HK$1,279,829) from Color Gems Ltda, a company in which Mr. Quintino Neto Osorio Mendes
has interests.b)
    
    Information regarding loans to director and balance with related party is
detailed in note 16 and note 12 respectively.
 In the opinion of the companys directors, the above transactions were carried out in the
usual course of business and on normal commercial terms.20.
    
    Notes to the consolidated cash flow statementReconciliation of (loss)/profit before taxation to net cash outflow from operating
activities:
 2004
    
    
    2003HK$
    
    
    HK$Profit/(Loss) before taxation
    
    
    5,279,715
    
    
    
    (33,192,016
    )Provision for stocks
    
    
    
    
    
    
    28,316,057Depreciation
    
    
    282,112
    
    
    
    359,366Interest income
    
    
    (1,932
    )
    
    
    (1,550
    )Interest expense
    
    
    1,167,200
    
    
    
    1,249,297Decrease/(Increase) in stocks
    
    
    7,548,349
    
    
    
    (5,436,989
    )Decrease/(Increase) in accounts
receivable and deposits
    
    
    885,269
    
    
    
    (3,575,155
    )Decrease in accounts payable and accruals
    
    
    (8,356,643
    )
    
    
    (11,902,551
    )Decrease in unsecured loans
    
    
    
    
    
    
    (1,000,000
    )(Decrease)/Increase in bills payable
    
    
    (4,630,913
    )
    
    
    2,513,029Net cash inflow/(outflow) from operating activities
    
    
    2,173,157
    
    
    
    (22,670,512
    )
 21.
    
    Approval of accountsThe accounts were approved and authorised for issue by the board of directors on 24 March
2005.
 - 26 -




---



##### Table of Contents



GOLDLEAVES INTERNATIONAL LIMITED
 DETAILED INCOME STATEMENT
FOR THE YEAR ENDED 31 DECEMBER 2004
  HK$
    
    HK$IncomeBank interest income
    
    
    
    
    
    
    Administrative expensesAudit fee
    
    
    (9,996
    )Depreciation
    
    
    (11,592
    )(21,588
    )Finance expensesBank charges
    
    
    (240
    )(21,828
    )Loss before taxation
    
    
    
    
    
    
    (21,828
    )Taxation
    
    
    
    
    
    
    Loss after taxation
    
    
    
    
    
    
    (21,828
    )




---



##### Table of Contents



Sales return reserves
 Balance at December 31, 2002
    
    $
    425Charges to operations
    
    
    3,361Deductions
    
    
    (3,030
    )Balance at December 31, 2003
    
    
    756Charges to operations
    
    
    4,999Deductions
    
    
    (5,231
    )Balance at December 31, 2004
    
    
    524Charges to operations
    
    
    8,154Deductions
    
    
    (6,474
    )Balance at December 31, 2005
    
    
    2,204
 -127-




---



##### Table of Contents



ITEM 19. EXHIBITS
  1.1
    
    Memorandum of Association of the Company*1.2
    
    Articles of Association of the Company*1.3
    
    Amendment to Articles of Association of the Company*4.1
    
    Employment Agreement of Yu Chuan Yih with the Registrant**8.1
    
    List of Significant Subsidiaries of the Company11.1
    
    Code of Ethics**12.1
    
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)12.2
    
    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)13.1
    
    Certification of Chief Executive
Officer Pursuant to Rule 13a-14(b) and 18 U.S.C. 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. -128-




---



##### Table of Contents



SIGNATURES
  LJ INTERNATIONAL INC. (Registrant)Date: May 24, 2007
    By:
    /s/ YU CHUAN YIHYu Chuan YihChairman




---



##### Table of Contents



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