##### Table of Contents



U.S. SECURITIES AND EXCHANGE COMMISSION
 WASHINGTON, D.C. 20549
 FORM 20-F
 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, 2007
 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
 Hon Tak Ringo NG, CFO
011-852-2764-3622 (telephone)  ringong@ljintl.com (email)  011-852-2764-3783 (facsimile)
 Unit #12, 12/F, Block A
Focal Industrial Centre
21 Man Lok Street
Hung Hom, Kowloon, Hong Kong  (Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)
  Title of each 
class
    
    Name of each exchange
on which registered$.01 Par Value Common Stock
(Common Stock)
    
    NASDAQ
  (Title of Class)
  (Title of Class)
   o þ
 o þ
 þ o
  Large accelerated filer o
    
    Accelerated filer þ
    
    Non-accelerated filer o
  þ
    
    U.S. GAAPo
    
    International Financial Reporting Standards as issued bythe International Accounting Standards Boardo
    
    Other
  o
    
    Item 17o
    
    Item 18
 If this is an annual report, indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). Yes o No þ




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TABLE OF CONTENTS  PART IITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERSITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLEITEM 3. KEY INFORMATIONITEM 4. INFORMATION ON THE COMPANYITEM 4A.UNRESOLVED STAFF COMMENTSITEM 5.OPERATING AND FINANCIAL REVIEW AND PROSPECTSITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEESITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONSITEM 8. FINANCIAL INFORMATIONITEM 9. THE OFFER AND LISTINGITEM 10. ADDITIONAL INFORMATIONITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISKITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIESPART IIITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIESITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDSITEM 15. CONTROLS AND PROCEDURESITEM 16. [RESERVED]ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERTITEM 16B. CODE OF ETHICSITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICESITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEESITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERSPART IIIITEM 17. FINANCIAL STATEMENTSITEM 18. FINANCIAL STATEMENTSITEM 19. EXHIBITSSIGNATURESEXHIBIT INDEXList of Significant Subsidiaries of the CompanyCertification of CEO Pursuant to Rule 13a-14(a)Certification of CFO Pursuant to Rule 13a-14(a)Certification of CEO Pursuant to Rule 13a-14(b)Certification of CFO Pursuant to Rule 13a-14(b)    Table of Contents  SPECIAL NOTE REGARDING
FORWARD-LOOKING STATEMENTS
   
    
    dependence upon certain customers
    
    dependence on key personnel
    
    control by principal shareholder
    
    competitive factors
    
    the operation of our business
    
    general economic conditions
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PART I
 
 ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
  
 ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE
  
 ITEM 3. KEY INFORMATION
 A. SELECTED FINANCIAL DATA.
 SELECTED CONSOLIDATED FINANCIAL DATA
(US Dollars in thousands, except per share amounts)
  Selected Financial Data
 Years ended December 31,2007
    
    
    2006
    
    
    2005
    
    
    2004
    
    
    2003Statement of Operations Data:Revenues
    
    
    152,037
    
    
    
    123,791
    
    
    
    99,646
    
    
    
    77,504
    
    
    
    58,330Cost of Goods sold
    
    
    (112,508
    )
    
    
    (88,867
    )
    
    
    (77,127
    )
    
    
    (61,265
    )
    
    
    (44,947
    )Gross profit
    
    
    39,529
    
    
    
    34,924
    
    
    
    22,519
    
    
    
    16,239
    
    
    
    13,383Operating expensesSelling, general and administrative
    
    
    (30,399
    )
    
    
    (23,114
    )
    
    
    (15,488
    )
    
    
    (11,578
    )
    
    
    (9,133
    )Net (loss) gain on derivatives
    
    
    (4
    )
    
    
    (29
    )
    
    
    8
    
    
    
    199
    
    
    
    87Depreciation
    
    
    (3,095
    )
    
    
    (2,039
    )
    
    
    (1,368
    )
    
    
    (1,032
    )
    
    
    (1,184
    )Impairment on property, plant and equipment
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (84
    )Amortization
and impairment loss on goodwill
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (698
    )
    
    
    (200
    )Operating income
    
    
    6,031
    
    
    
    9,742
    
    
    
    5,671
    
    
    
    3,130
    
    
    
    2,869Other income and expensesInterest income
    
    
    273
    
    
    
    282
    
    
    
    139
    
    
    
    38
    
    
    
    41Interest expenses
    
    
    (3,103
    )
    
    
    (3,258
    )
    
    
    (1,991
    )
    
    
    (902
    )
    
    
    (753
    )Operating income before income taxes,
minority interests, equity in results of
investment securities and extraordinary item
    
    
    3,201
    
    
    
    6,766
    
    
    
    3,819
    
    
    
    2,266
    
    
    
    2,157Income taxes expense
    
    
    (1,711
    )
    
    
    (1,403
    )
    
    
    (739
    )
    
    
    (277
    )
    
    
    (352
    )Income before minority interests, equity in
results of investment securities and
extraordinary item
    
    
    1,490
    
    
    
    5,363
    
    
    
    3,080
    
    
    
    1,989
    
    
    
    1,805Minority interests in consolidated subsidiaries
    
    
    (1
    )
    
    
    (38
    )
    
    
    (20
    )
    
    
    
    
    
    
    8Income before equity in results of investment
securities and extraordinary item
    
    
    1,489
    
    
    
    5,325
    
    
    
    3,060
    
    
    
    1,989
    
    
    
    1,813Equity in results of investment securities
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    133
    
    
    
    (851
    )Income before extraordinary item
    
    
    1,489
    
    
    
    5,325
    
    
    
    3,060
    
    
    
    2,122
    
    
    
    962Extraordinary gain on negative goodwill
    
    
    
    
    
    
    
    
    
    
    1,291
    
    
    
    
    
    
    
    Net income
    
    
    1,489
    
    
    
    5,325
    
    
    
    4,351
    
    
    
    2,122
    
    
    
    962Net income per share:Basic
    
    
    0.07
    
    
    
    0.31
    
    
    
    0.32
    
    
    
    0.19
    
    
    
    0.11Diluted
    
    
    0.07
    
    
    
    0.29
    
    
    
    0.30
    
    
    
    0.18
    
    
    
    0.10Weighted
average number of shares:Basic
    
    
    21,064
    
    
    
    17,390
    
    
    
    13,439
    
    
    
    11,119
    
    
    
    8,757Diluted
    
    
    22,289
    
    
    
    18,303
    
    
    
    14,322
    
    
    
    12,107
    
    
    
    9,706Balance Sheet Data:Working capital
    
    
    62,786
    
    
    
    50,134
    
    
    
    35,554
    
    
    
    23,617
    
    
    
    17,053Total assets
    
    
    134,144
    
    
    
    124,522
    
    
    
    108,230
    
    
    
    73,673
    
    
    
    59,885Long-term obligation
    
    
    1,335
    
    
    
    1,640
    
    
    
    43
    
    
    
    58
    
    
    
    77Total stockholders equity
    
    
    72,668
    
    
    
    59,739
    
    
    
    45,008
    
    
    
    32,790
    
    
    
    27,101
  -3-




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B. CAPITALIZATION AND INDEBTEDNESS.
  C. REASONS FOR THE OFFER AND USE OF PROCEEDS.
  D. RISK FACTORS.
 We depend upon one customer who accounts for at least 10% of our sales. We cannot be certain that
these sales will continue; if they do not, our revenues will likely decline.
  We face significant competition from larger competitors in our wholesale and retail operations.
  -4-




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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.
  Changes to PRC tax laws may adversely affect our financial condition and results of operations in
the future.
  -5-




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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.
  -6-




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The success of our retail store expansion program in China is dependent upon numerous factors over
which we have limited control.
  We rely on short-term financing from banks for our daily operation.
   We rely geographically on the US market for the majority of our revenue.
  Our holding company structure creates restrictions on the payment of dividends.
  -7-




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As a foreign private issuer, we are not subject to certain rules promulgated by Nasdaq that other
Nasdaq-listed issuers are required to comply with.
  
    
    our independent directors do not hold regularly scheduled meetings in executive
session;
    
    the compensation of our executive officers is not determined by an independent
committee of the board or by the independent members of the board of directors, and our
CEO may be present and participate in the deliberations concerning his compensation;
    
    related party transactions are not required to be reviewed or approved by our audit
committee or other independent body of the board of directors; and
    
    we are not required to solicit shareholder approval of stock plans, including those
in which our officers or directors may participate; stock issuances that will result in
a change in control; the issuance of our stock in related party transactions or other
transactions in which we may issue 20% or more of our outstanding shares; or, below
market issuances of 20% or more of our outstanding shares to any person.
  It may be difficult to serve us with legal process or enforce judgments against us or our
management.
  
    
    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.
 -8-




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Some information about us may be unavailable due to exemptions under the Exchange Act for a foreign
private issuer.
  
    
    the rules under the Exchange Act requiring the filing with the Securities and
Exchange Commission of quarterly reports on Form 10-Q or current reports on Form 8-K;
    
    the provisions of Regulation FD aimed at preventing issuers from making selective
disclosures of material information;
    
    the sections of the Exchange Act regulating the solicitation of proxies, consents or
authorizations applicable to a security registered under the Exchange Act; and
    
    the sections of the Exchange Act requiring insiders to file public reports of their
stock ownership and trading activities and establishing insider liability for profits
realized from any short-swing trading transaction.
  Since we are a British Virgin Islands company, the rights of our shareholders may be more limited
than those of shareholders of a company organized in the United States.
   -9-




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Legal proceedings related to our historical reporting of financial results and other issues may
significantly harm our business.
  -10-




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ITEM 4. INFORMATION ON THE COMPANY
 A. HISTORY AND DEVELOPMENT OF THE COMPANY.
  
    
    Lorenzo Jewelry Limited (Lorenzo Jewelry), a company incorporated in Hong Kong on
February 20, 1987
    
    Lorenzo Jewellery (Shenzhen) Co., Ltd.
    
    Lorenzo (Shenzhen) Co., Ltd.
    
    Goldleaves Gems (Shenzhen) Co., Ltd. (98% equity ownership)
   
    
    we invested $670,000 for the purchase of 1,639 square meters of production space in
our Shenzhen, China facility during the fiscal year ended December 31, 2005
    
    we acquired an additional 78% of the equity of Goldleaves International Limited for
$2,827,500 during the fiscal year ended December 31, 2005
    
    we spent $1,105,000 on capital expenditures, excluding inventory, for ENZO retail
store openings during the fiscal year ended December 31, 2006
    
    we spent $1,977,000 on capital expenditures, excluding inventory, for ENZO retail
store openings during the fiscal year ended December 31, 2007
 B. BUSINESS OVERVIEW.
  -11-




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
    
    fine jewelers;
    
    national jewelry chains;
    
    department stores;
    
    TV shopping channels; and
    
    discount chain stores.
   -12-




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Year ended December 31,2007
    
    
    2006
    
    
    2005(in thousands)
    
    US$
    
    US$
    
    US$US & Canada
    
    
    80,572
    
    
    
    76,889
    
    
    
    67,780Europe and other countries
    
    
    32,597
    
    
    
    24,452
    
    
    
    20,527Japan
    
    
    2,206
    
    
    
    2,454
    
    
    
    3,686PRC (including Hong Kong and Macau)
    
    
    36,662
    
    
    
    19,996
    
    
    
    7,653152,037
    
    
    
    123,791
    
    
    
    99,646
 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.
    -13-




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Our Business Strategy
  
    
    increase our market share of moderately priced high-quality gem-set colored and
precious jewelry by capitalizing on our vertically integrated production processes to
produce diamond and high-end precious stone jewelry in addition to high volume,
high-quality colored products;
    
    further develop our existing customer relationships with our specialized services;
and
    
    expand aggressively into new distribution channels, particularly in the United
States, China, Western Europe, Japan, Russia and the Middle East.
  
    
    marketing a line of sterling silver jewelry. These are typically merchandised with
a retail price range of $30 to $150;
    
    adding more lines into our LORENZO branded products with a retail price range of
$199 to $999; and
    
    offering diamond jewelry and expanding this business to our current client base by
adding diamonds to some of our settings, as well as offering newly designed jewelry.
 Our China Retail Sales Strategy
  
    
    significant retail market  Chinas retail sales exceed $600 billion annually,
making China the third largest market in the world.
    
    large and growing jewelry market  we estimate that Chinas jewelry sales totaled
nearly $17 billion in 2006 and $26 billion in 2007.
    
    large pool of consumers  China has a population of more than 1.3 billion people.
We estimate that roughly 160 million Chinese have enough income to purchase luxury
goods.
 -14-




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
    
    favorable regulatory changes  as a member of the World Trade Organization, China is
eliminating many restrictions on foreign ownership and operation of retail stores.
Tariffs on colored gemstones, gold, silver and pearls have been sharply reduced, and
economic and trade relationships between China and Hong Kong have been liberalized.
    
    changing consumer preferences  Chinese consumers are no longer purchasing jewelry
solely as an investment. More Chinese consumers are embracing a more Western view of
jewelry as a fashion accessory and now demand more contemporary, colorful designs.
   
    
    expanding our retail jewelry market in China by planning to open additional ENZO
stores in China during 2008
    
    promoting visits with customers to coordinate and cater to their particular
promotional sales needs and monitoring their on-hand inventory in order to promote more
active sell-through
    
    expanding our distribution channels and further developing business with retail
jewelry chains in the US.
 Our Production Capability
   -15-




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Sales and Marketing
 Wholesale
   
    
    fine jewelers;
    
    national jewelry chains;
    
    department stores;
    
    TV shopping channels; and
    
    discount chain stores.
  Retail
     -16-




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Design and Product Development
    Production Process
  
    
    cutting and polishing colored gemstones;
    
    combining pure gold, platinum or sterling silver with gemstones or diamonds to
produce jewelry; and
    
    finishing operations such as cleaning and polishing, resulting in high quality
finished jewelry.
 Supply
    -17-




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Security
   Insurance
  Competition
  -18-




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C. ORGANIZATIONAL STRUCTURE AS OF DECEMBER 31, 2007.
  LJ INTERNATIONAL INC.
 100%
 
    
    Lorenzo Jewelry Limited(Hong Kong)
    
    Lorenzo Jewellery (Shenzhen) Co., Ltd.(PRC)
    
    Lorenzo (Shenzhen) Co., Ltd.(PRC)98%
    
    Goldleaves Gems (Shenzhen) Co., Ltd.(PRC)
 -19-




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D. PROPERTY, PLANTS AND EQUIPMENT.
   
    
    1,751 square meters for a term of five years expiring June 30, 2011 from an
unaffiliated third party at a rental rate of $3,817 per month;
    
    1,751 square meters for a term of two years expiring August 31, 2008, at a rental
rate of $4,490 per month;
    
    1,799 square meters for a term of three years expiring March 31, 2009, at a rental
rate of $4,381 per month; and
    
    1,886 square meters for a term of three years expiring September 30, 2009 at a
rental rate of $4,593 per month.
   
 ITEM 4A. UNRESOLVED STAFF COMMENTS
  -20-




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ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS
       -21-




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Critical Accounting Policies and Estimates
   Collectibility of Accounts Receivable.
  -22-




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Stock-based Compensation. Share-Based Payment
 Goodwill Impairment.
   Allowance for Obsolete Inventories.
 -23-




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Fair Value of Financial Instruments. Disclosures about Fair Value of Financial Instruments
 A. OPERATING RESULTS.
 Reclassifications
  Revenues
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005
    
    
    2007-2006
    
    
    2006-2005RevenuesWholesaleJewelry product
    
    $
    117,689
    
    
    $
    108,679
    
    
    $
    95,318
    
    
    
    8
    %
    
    
    14
    %Giftware product
    
    $
    
    
    
    $
    
    
    
    $
    1,827
    
    
    
    N/A
    
    
    
    -100
    %$
    117,689
    
    
    $
    108,679
    
    
    $
    97,145
    
    
    
    8
    %
    
    
    12
    %Retail
    
    $
    34,348
    
    
    $
    15,112
    
    
    $
    2,501
    
    
    
    127
    %
    
    
    504
    %$
    152,037
    
    
    $
    123,791
    
    
    $
    99,646
    
    
    
    23
    %
    
    
    24
    %
   -24-




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Cost of Sales and Gross Profit
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005
    
    
    2007-2006
    
    
    2006-2005Cost of sales and gross profitCost of salesWholesale
    
    $
    95,528
    
    
    $
    83,387
    
    
    $
    75,645
    
    
    
    15
    %
    
    
    10
    %% of revenues
    
    
    81
    %
    
    
    77
    %
    
    
    78
    %Retail
    
    $
    16,980
    
    
    $
    5,480
    
    
    $
    1,482
    
    
    
    210
    %
    
    
    270
    %% of revenues
    
    
    49
    %
    
    
    36
    %
    
    
    59
    %Total
    
    $
    112,508
    
    
    $
    88,867
    
    
    $
    77,127
    
    
    
    27
    %
    
    
    15
    %% of revenues
    
    
    74
    %
    
    
    72
    %
    
    
    77
    %Gross profitWholesale
    
    $
    22,161
    
    
    $
    25,292
    
    
    $
    21,500
    
    
    
    -12
    %
    
    
    18
    %% of revenues
    
    
    19
    %
    
    
    23
    %
    
    
    22
    %Retail
    
    $
    17,368
    
    
    $
    9,632
    
    
    $
    1,019
    
    
    
    80
    %
    
    
    845
    %% of revenues
    
    
    51
    %
    
    
    64
    %
    
    
    41
    %Total
    
    $
    39,529
    
    
    $
    34,924
    
    
    $
    22,519
    
    
    
    13
    %
    
    
    55
    %% of revenues
    
    
    26
    %
    
    
    28
    %
    
    
    23
    %
  -25-




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Selling, General and Administrative Expenses
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005
    
    
    2007-2006
    
    
    2006-2005Selling, general and
administrative expensesWholesale
    
    $
    13,072
    
    
    $
    13,324
    
    
    $
    11,545
    
    
    
    -2
    %
    
    
    15
    %Retail
    
    $
    15,251
    
    
    $
    7,562
    
    
    $
    2,653
    
    
    
    102
    %
    
    
    185
    %Corporate
    
    $
    2,076
    
    
    $
    2,228
    
    
    $
    1,290
    
    
    
    -7
    %
    
    
    73
    %$
    30,399
    
    
    $
    23,114
    
    
    $
    15,488
    
    
    
    32
    %
    
    
    49
    %% of revenues
    
    
    20
    %
    
    
    19
    %
    
    
    16
    %
  -26-




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Net gain (loss) on derivatives
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005
    
    
    2007-2006
    
    
    2006-2005Unrealized (loss) gain on
derivatives
    
    $
    (349
    )
    
    $
    190
    
    
    $
    (88
    )
    
    
    -284
    %
    
    
    -316
    %% of revenues
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %(With the hedging mechanism in place,
we have the realized gain on hedging activities)Realized gain (loss) on hedging
activities
    
    $
    345
    
    
    $
    (219
    )
    
    $
    96
    
    
    
    -258
    %
    
    
    -328
    %% of revenues
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %Net (loss) gain on derivatives and
hedging activities
    
    $
    (4
    )
    
    $
    (29
    )
    
    $
    8
    
    
    
    -86
    %
    
    
    -463
    %% of revenues
    
    
    0
    %
    
    
    0
    %
    
    
    0
    %
   -27-




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Depreciation
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005
    
    
    2007-2006
    
    
    2006-2005DepreciationWholesale
    
    $
    1,995
    
    
    $
    1,425
    
    
    $
    1,154
    
    
    
    40
    %
    
    
    23
    %% of revenues
    
    
    2
    %
    
    
    1
    %
    
    
    1
    %Retail
    
    $
    1,100
    
    
    $
    614
    
    
    $
    214
    
    
    
    79
    %
    
    
    187
    %% of revenues
    
    
    3
    %
    
    
    4
    %
    
    
    9
    %Total
    
    $
    3,095
    
    
    $
    2,039
    
    
    $
    1,368
    
    
    
    52
    %
    
    
    49
    %% of revenues
    
    
    2
    %
    
    
    2
    %
    
    
    1
    %
   -28-




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Interest cost
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005
    
    
    2007-2006
    
    
    2006-2005Interest expenses
    
    $
    3,103
    
    
    $
    3,258
    
    
    $
    1,991
    
    
    
    -5
    %
    
    
    64
    %% of revenues
    
    
    2
    %
    
    
    3
    %
    
    
    2
    %
   Income taxes
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005
    
    
    2007-2006
    
    
    2006-2005Income taxes expenseWholesales
    
    $
    1,015
    
    
    $
    682
    
    
    $
    739
    
    
    
    49
    %
    
    
    -8
    %% of revenues
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %Retail
    
    $
    696
    
    
    $
    721
    
    
    $
    0
    
    
    
    -3
    %
    
    
    N/A% of revenues
    
    
    2
    %
    
    
    5
    %
    
    
    0
    %Total
    
    $
    1,711
    
    
    $
    1,403
    
    
    $
    739
    
    
    
    22
    %
    
    
    90
    %% of revenues
    
    
    1
    %
    
    
    1
    %
    
    
    1
    %
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Extraordinary gain on negative goodwill
 % ChangeYears ended
    
    
    Years endedYear ended December 31,
    
    
    December 31,
    
    
    December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005
    
    
    2007-2006
    
    
    2006-2005Extraordinary gain on negative
goodwill
    
    $
    0
    
    
    $
    0
    
    
    $
    1,291
    
    
    
    N/A
    
    
    
    -100
    %% of revenues
    
    
    0
    %
    
    
    0
    %
    
    
    1
    %
   Inflation
  Foreign Exchange
  -30-




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Governmental economic and political policies and factors
  B. LIQUIDITY AND CAPITAL RESOURCES
  Cash Flows
 Years ended December 31,(in thousands)
    
    2007
    
    2006
    
    2005Net cash provided by (used in) operating activities
    
    $
    2,203
    
    
    $
    (6,200
    )
    
    $
    (14,222
    )Net cash used in investing activities
    
    
    (1,806
    )
    
    
    (3,829
    )
    
    
    (4,655
    )Net cash (used in) provided by financing activities
    
    
    (1,309
    )
    
    
    11,096
    
    
    
    20,450Effect of foreign exchange rate change
    
    
    
    
    
    
    
    
    
    
    (5
    )Net (decrease) increase in cash and cash equivalents
    
    
    (912
    )
    
    
    1,067
    
    
    
    1,568
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Operating Activities
 Years ended December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005Cash flows from operating activities:Net income
    
    $
    1,489
    
    
    $
    5,325
    
    
    $
    4,351Adjustments to reconcile income to net cash
provided by (used in) operating activities:Depreciation of property, plant and equipment
and properties held for lease
    
    
    3,095
    
    
    
    2,039
    
    
    
    1,368Extraordinary gain on negative goodwill
    
    
    
    
    
    
    
    
    
    
    (1,291
    )Unrealized (gain) loss on derivatives
    
    
    
    
    
    
    (48
    )
    
    
    88Loss on disposal and write-off of property, plant
and equipment
    
    
    45
    
    
    
    3
    
    
    
    8Reversal of doubtful debts
    
    
    (2
    )
    
    
    (40
    )
    
    
    (72
    )Minority interests
    
    
    1
    
    
    
    37
    
    
    
    20Compensation costs for warrants granted
    
    
    157
    
    
    
    158
    
    
    
    118Compensation expenses recognized during the
year
    
    
    330
    
    
    
    213
    
    
    
    18Changes in operating assets and liabilities:Trade receivables
    
    
    702
    
    
    
    1,106
    
    
    
    (8,607
    )Inventories
    
    
    (13,261
    )
    
    
    (12,810
    )
    
    
    (12,060
    )Prepayments and other current assets
    
    
    596
    
    
    
    (580
    )
    
    
    601Due from related parties
    
    
    21
    
    
    
    463
    
    
    
    7Trade payables
    
    
    9,487
    
    
    
    (2,955
    )
    
    
    1,883Accrued expenses and other payables
    
    
    (1,432
    )
    
    
    272
    
    
    
    (854
    )Income taxes payable and deferred taxation
    
    
    975
    
    
    
    617
    
    
    
    200Net cash provided by (used in) operating
activities
    
    
    2,203
    
    
    
    (6,200
    )
    
    
    (14,222
    )
      -32-




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Investing Activities:
    -33-




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Years ended December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005Land & buildings
    
    $
    
    
    
    $
    
    
    
    $
    617Leasehold improvement
    
    $
    2,156
    
    
    $
    2,852
    
    
    $
    783Furniture, fixtures and equipment
    
    $
    660
    
    
    $
    690
    
    
    $
    1,060Plant and machinery
    
    $
    322
    
    
    $
    260
    
    
    $
    209Motor vehicles
    
    $
    1
    
    
    $
    381
    
    
    $
    200Total
    
    $
    3,139
    
    
    $
    4,183
    
    
    $
    2,869
 Financing Activities:
    Financing Sources
 Banking Facilities and Notes Payables
  -34-




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Years ended December 31,(in thousands)
    
    2007
    
    
    2006
    
    
    2005Letters of credit
    
    $
    38,957
    
    
    $
    41,046
    
    
    $
    31,533Overdraft
    
    $
    4,141
    
    
    $
    3,564
    
    
    $
    3,46143,098
    
    
    
    44,610
    
    
    
    34,994Utilized :Letters of credit utilized
    
    $
    16,653
    
    
    $
    22,344
    
    
    $
    21,887Overdraft utilized
    
    $
    2,977
    
    
    $
    1,591
    
    
    $
    2,02819,630
    
    
    
    23,935
    
    
    
    23,915
    Years ended December 31,(in thousands)
    
    2007
    
    2006
    
    2005Notes payable
    
    $
    5,201
    
    
    $
    5,365
    
    
    $
    3,079
  -35-




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Gold Loan Facilities
 Years ended December 31,(in thousands)
    
    2007
    
    2006
    
    2005Gold loans outstanding (in $)
    
    $
    4,883
    
    
    $
    11,079
    
    
    $
    10,756Gold loans outstanding (in troy ounces)
    
    
    11,150
    
    
    
    26,920
    
    
    
    27,920Gold loan interest rate
    
    
    3.1%-3.3
    %
    
    
    2.6%-3.1
    %
    
    
    2.4%-2.6
    %
  Looking Forward
  Impact of recently issued US GAAP accounting standards
 SFAS No. 157. Fair Value Measurements
 -36-




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SFAS No. 159. The Fair Value Option for Financial Assets and Financial
Liabilities
 SFAS No. 141R. Business Combinations
 SFAS No. 160. Non-controlling Interests in Consolidated Financial Statements
 SFAS No. 161. Disclosures about Derivative Instruments and Hedging Activities  An Amendment
of FASB Statement No. 133
 -37-




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SFAS No. 162. The Hierarchy of Generally Accepted Accounting Principles
 C. RESEARCH AND DEVELOPMENT, PATENTS AND LICENSES, ETC.
  D. TREND INFORMATION.
  E. OFF-BALANCE SHEET ARRANGEMENTS.
  -38-




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F. TABULAR DISCLOSURE OF CONTRACTUAL OBLIGATIONS.
  Payments due by periodLess than
    
    
    
    
    
    
    
    
    
    
    More thanTotal
    
    
    I year
    
    
    1-3 years
    
    
    3-5 years
    
    
    5 yearsUS$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$Long-Term Debt ObligationsCapital (Finance) Lease Obligations
    
    
    273
    
    
    
    92
    
    
    
    160
    
    
    
    21
    
    
    
    Operating Lease Obligations
    
    
    3,299
    
    
    
    1,838
    
    
    
    1,330
    
    
    
    131
    
    
    
    Total
    
    
    3,572
    
    
    
    1,930
    
    
    
    1,490
    
    
    
    152
    
    
    
    
 .
 -39-




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ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
 A. DIRECTORS AND SENIOR MANAGEMENT.
  Name
    
    Age
    
    PositionYu Chuan Yih
    
    
    68
    
    
    Chairman of the Board of Directors, President and
Chief Executive OfficerKa Man Au
    
    
    43
    
    
    Chief Operating Officer, Secretary and DirectorHon Tak Ringo Ng
    
    
    48
    
    
    Chief Financial Officer and DirectorAndrew N. Bernstein
    
    
    55
    
    
    Independent Non-Executive DirectorXiang Xiong Deng
    
    
    43
    
    
    Independent Non-Executive DirectorJin Wang
    
    
    37
    
    
    Independent Non-Executive DirectorJieyun Yu
    
    
    42
    
    
    Independent Non-Executive DirectorPo Yee Elsa Yue
    
    
    43
    
    
    Independent Non-Executive Director (1)Chi Fai Frank Cheung
    
    
    45
    
    
    Independent Non-Executive Director (2) (3)Wing Kwan Ted Lai
    
    
    45
    
    
    Independent Non-Executive Director (3)Kelvin Wong
    
    
    41
    
    
    Independent Non-Executive Director (3)
 
 (1)
    
    Resigned effective June 1, 2007(2)
    
    Appointed effective June 1, 2007(3)
    
    Resigned effective October 15, 2007  Mr. Yih
 Ms. Au
 Mr. Ng
 -40-




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Mr. Bernstein
 Mr. Deng
 Mr. Wang
 Ms. Yu
 Ms. Yue
 -41-




---



##### Table of Contents



Mr. Cheung
 Mr. Lai
 Mr. Wong
 -42-




---



##### Table of Contents



B. COMPENSATION.
  Executive Service Contract
      C. BOARD PRACTICES.
   Audit Committee
  -43-




---



##### Table of Contents




    
    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 US federal and state laws relating to
financial reporting.
 Nominating Committee
  
    
    assess the size and composition of the board of directors in light of our operating
requirements and existing social attitudes and trends;
    
    develop membership qualifications for the board of directors and all board
committees;
    
    monitor compliance with board of director and board committee membership criteria;
    
    review and recommend directors for continued service as required based on our
evolving needs;
    
    coordinate and assist management and the board of directors in recruiting new
members to the board of directors; and
    
    investigate suggestions for candidates for membership on the board of directors and
recommend prospective directors, as required, to provide an appropriate balance of
knowledge, experience and capability on the board of directors, including stockholder
nominations for the board of directors.
 Compensation Committee
  
    
    review and approve corporate goals and objectives relevant to the compensation of
the chief executive officer and other executive officers;
    
    evaluate the chief executive officers performance in light of such goals and
objectives at least annually and communicate the results to the chief executive officer
and the board of directors;
    
    set the chief executive officers compensation levels based on the foregoing
evaluation (including annual salary, bonus, stock options and other direct and indirect
benefits), with ratification by the independent directors of the full board of
directors; and
 -44-




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
    
    set the other executive officers compensation levels (including annual salary,
bonus, stock options and other direct and indirect benefits).
 Nasdaq Requirements
   
    
    our independent directors do not hold regularly scheduled meetings in executive
session;
    
    the compensation of our executive officers is not determined by an independent
committee of the board or by the independent members of the board of directors, and our
CEO may be present and participate in the deliberations concerning his compensation;
    
    related party transactions are not required to be reviewed or approved by our audit
committee or other independent body of the board of directors; and
    
    we are not required to solicit shareholder approval of stock plans, including those
in which our officers or directors may participate; stock issuances that will result in
a change in control; the issuance of our stock in related party transactions or other
transactions in which we may issue 20% or more of our outstanding shares; or, below
market issuances of 20% or more of our outstanding shares to any person.
  D. EMPLOYEES.
  -45-




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##### Table of Contents



E. SHARE OWNERSHIP.
  
    
    each person who is known by us to own beneficially more than 5% of our outstanding
common stock;
    
    each of our current executive officers and directors; and
    
    all executive officers and directors as a group.
    Name of Beneficial Holder
    
    Number
    
    PercentShares Beneficially OwnedYu Chuan Yih
    
    
    2,034,353
    
    
    
    9.1Ka Man Au
    
    
    254,000
    (1)
    
    
    1.1Hon Tak Ringo Ng
    
    
    275,000
    (2)
    
    
    1.2Andrew N. Bernstein
    
    
    0
    
    
    
    
    *Xiang Xiong Deng
    
    
    0
    
    
    

    
    *Jin Wang
    
    
    0
    
    
    
    
    *Jieyun Yu
    
    
    0
    
    
    
    
    *All directors and executive officers as a group (7 persons)
    
    
    2,563,353
    
    
    
    11.4Pacific Growth Developments Ltd.
    
    
    1,500,000
    
    
    
    6.7
 
 *
    
    Represents less than 1% beneficial ownership(1)
    
    Includes options currently exercisable to acquire: 
    
    150,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 -46-




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##### Table of Contents



(2)
    
    Includes options currently exercisable to acquire:
 
    
    150,000 shares of common stock at $2.00 per share at any time until June 30, 2013.
 The 1998 Stock Compensation Plan
  
    
    encourage ownership of our common stock by our officers, directors, employees and
advisors;
    
    provide additional incentive for them to promote our success and our business; and
    
    encourage them to remain in our employ by providing them with an opportunity to
benefit from any appreciation of our common stock through the issuance of stock
options.
    
    
    a total of 20,000 stock options to purchase 20,000 shares at $2.00 per share through
June 30, 2013, of which no stock options are held by our directors and officers as a
group.
 -47-




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##### 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 433,500 stock options to purchase 433,500 shares at $2.00 per share
through June 30, 2013, of which 300,000 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.
  -48-




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##### Table of Contents



Other Options and Warrants Outstanding
  
    
    warrants to purchase an aggregate of 170,451 shares at $2.98 per share through
September 3, 2009 which we sold to a group of investors as part of a private placement
offering on September 1, 2004
    
    On September 25, 2006, we issued, and 11 institutional investors purchased, an
aggregate of 1,466,668 shares of our common stock at $3.75 per share, as well as an
aggregate of 236,909 warrants to purchase 236,909 shares at an exercise price of $4.221
per share (the Short Term Warrants) and 366,668 warrants to purchase 366,668 shares
at an exercise price of $4.50 per share (the Long Term Warrants). In addition, our
placement agent received 29,333 Long Term Warrants with identical terms to the Long
Term Warrants issued to the investors (the Placement Agent Warrants). The Short Term
Warrants were exercisable at any time through February 5, 2007. The Long Term Warrants
are exercisable at any time on or after March 25, 2007 for a term of five years
thereafter.As of June 1, 2008, the following warrants remained outstanding:
 
    
    333,334 Long Term Warrants
    
    29,333 Placement Agent Warrants
 
 ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
 A. MAJOR SHAREHOLDERS.
 -49-




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B. RELATED PARTY TRANSACTIONS.
    C. INTERESTS OF EXPERTS AND COUNSEL.
  -50-




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ITEM 8. FINANCIAL INFORMATION
 A. CONSOLIDATED STATEMENTS AND OTHER FINANCIAL INFORMATION.
   Securities Litigation. Apple v. LJ International Inc., et al. Cooper v. LJ International, Inc., et al. Lieben v. LJ International
Inc., et. al.
    Derivative Litigation. Vaughn v. Yih, et al. Cooke vs. Yih, et al.
  -51-




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Vaughn Vaughn
 Cooke Vaughn
  Shao v. Yih, et al. Shao v, Yih, et al.
 B. SIGNIFICANT CHANGES.
  -52-




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ITEM 9. THE OFFER AND LISTING
 A. OFFER AND LISTING DETAILS.
  Period
    
    High
    
    LowYear ended December 31, 2003
    
    $
    5.00
    
    
    $
    1.14Year ended December 31, 2004
    
    $
    5.74
    
    
    $
    2.21Year ended December 31, 2005
    
    $
    3.95
    
    
    $
    2.03Year ended December 31, 2006
    
    $
    4.60
    
    
    $
    3.08Year ended December 31, 2007
    
    $
    12.86
    
    
    $
    2.18Quarter ended March 31, 2006
    
    $
    4.16
    
    
    $
    3.34Quarter ended June 30, 2006
    
    $
    3.79
    
    
    $
    3.08Quarter ended September 30, 2006
    
    $
    4.59
    
    
    $
    3.67Quarter ended December 31, 2006
    
    $
    4.60
    
    
    $
    3.71Quarter ended March 31, 2007
    
    $
    12.00
    
    
    $
    4.42Quarter ended June 30, 2007
    
    $
    12.86
    
    
    $
    8.93Quarter ended September 30, 2007
    
    $
    12.37
    
    
    $
    3.99Quarter ended December 31, 2007
    
    $
    6.15
    
    
    $
    2.18Quarter ended March 31, 2008
    
    $
    5.45
    
    
    $
    2.47Quarter ended June 30, 2008*
    
    $
    3.90
    
    
    $
    2.56Month ended December 31, 2007
    
    $
    5.72
    
    
    $
    3.25Month ended January 31, 2008
    
    $
    5.45
    
    
    $
    3.10Month ended February 29, 2008
    
    $
    3.56
    
    
    $
    3.16Month ended March 31, 2008
    
    $
    3.10
    
    
    $
    2.47Month ended April 30, 2008
    
    $
    3.15
    
    
    $
    2.56Month ended May 31, 2008
    
    $
    3.90
    
    
    $
    2.61Month ended June 30, 2008*
    
    $
    3.73
    
    
    $
    2.89
 
 *
    
    Through June 24, 2008 -53-




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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.
  -54-




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-56-




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C. MATERIAL CONTRACTS.
  D. EXCHANGE CONTROLS.
  E. TAXATION.
  -57-




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United States Federal Income Taxation
  
    
    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.
 -58-




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##### Table of Contents



British Virgin Islands Taxation
    F. DIVIDENDS AND PAYING AGENTS.
  G. STATEMENT BY EXPERTS.
  H. DOCUMENTS ON DISPLAY.
  -59-




---



##### Table of Contents



I. SUBSIDIARY INFORMATION.
  
 ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
  
 ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
  
 PART II
 
 ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES
  
 ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS
  
 ITEM 15. CONTROLS AND PROCEDURES
 (a) Disclosure Controls and Procedures.
   -60-




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##### Table of Contents



(b) Managements annual report on internal control over financial reporting.
 in Internal Control-Integrated Framework
   (c) Attestation report of the registered public accounting firm.
  (d) Changes in internal control over financial reporting.
  
 ITEM 16. [RESERVED]
 
 ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT
 -61-




---



##### Table of Contents



ITEM 16B. CODE OF ETHICS
  
 ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES
 (a) Audit Fees.
    (b) Audit  Related Fees.
  (c) Tax Fees.
  (d) All Other Fees.
 -62-




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##### Table of Contents



(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
   -63-




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##### Table of Contents



PART III
 
 ITEM 17. FINANCIAL STATEMENTS
  
 ITEM 18. FINANCIAL STATEMENTS
         -64-




---



##### Table of Contents



LJ INTERNATIONAL INC.
 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-47Schedule II
    
    
    F-48
 F-1




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##### Table of Contents



Internal Control  Integrated
Framework
   
 F-2




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF OPERATIONS
  Year ended
    
    
    Year ended
    
    
    Year endedNotes
    
    
    December 31,
    
    
    December 31,
    
    
    December 31,2007
    
    
    2006
    
    
    2005US$
    
    
    US$
    
    
    US$Operating revenue
    
    
    2 (c)
    
    
    
    152,037
    
    
    
    123,791
    
    
    
    99,646Costs of goods sold (Exclusive of depreciation
shown separately below.)
    
    
    
    
    
    
    (112,508
    )
    
    
    (88,867
    )
    
    
    (77,127
    )Gross profit
    
    
    
    
    
    
    39,529
    
    
    
    34,924
    
    
    
    22,519Operating expensesSelling, general and administrative expenses
    
    
    
    
    
    
    (30,399
    )
    
    
    (23,114
    )
    
    
    (15,488
    )Net (loss) gain on derivatives
    
    
    
    
    
    
    (4
    )
    
    
    (29
    )
    
    
    8Depreciation
    
    
    
    
    
    
    (3,095
    )
    
    
    (2,039
    )
    
    
    (1,368
    )Operating income
    
    
    
    
    
    
    6,031
    
    
    
    9,742
    
    
    
    5,671Other income and expenseInterest income
    
    
    2 (c)
    
    
    
    273
    
    
    
    282
    
    
    
    139Interest expenses
    
    
    
    
    
    
    (3,103
    )
    
    
    (3,258
    )
    
    
    (1,991
    )Income before income taxes, minority interests
and extraordinary item
    
    
    
    
    
    
    3,201
    
    
    
    6,766
    
    
    
    3,819Income taxes expense
    
    
    10
    
    
    
    (1,711
    )
    
    
    (1,403
    )
    
    
    (739
    )Income before minority interests and
extraordinary item
    
    
    
    
    
    
    1,490
    
    
    
    5,363
    
    
    
    3,080Minority interests in consolidated subsidiaries
    
    
    
    
    
    
    (1
    )
    
    
    (38
    )
    
    
    (20
    )Income before extraordinary item
    
    
    
    
    
    
    1,489
    
    
    
    5,325
    
    
    
    3,060Extraordinary gain on negative goodwill
    
    
    3
    
    
    
    
    
    
    
    
    
    
    
    1,291Net income
    
    
    
    
    
    
    1,489
    
    
    
    5,325
    
    
    
    4,351Numerator:Net income used in computing basic earnings
per share
    
    
    
    
    
    
    1,489
    
    
    
    5,325
    
    
    
    4,351Denominator:Weighted average number of shares used in
calculating basic earnings per share
    
    
    
    
    
    
    21,064,253
    
    
    
    17,390,093
    
    
    
    13,438,578Effect of dilutive potential ordinary shares:Warrants
    
    
    
    
    
    
    248,945
    
    
    
    118,717
    
    
    
    28,738Stock options
    
    
    
    
    
    
    975,904
    
    
    
    794,467
    
    
    
    854,568Weighted average number of shares used in
calculating diluted earnings per share
    
    
    
    
    
    
    22,289,102
    
    
    
    18,303,277
    
    
    
    14,321,884
  F-3




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF OPERATIONS
  Year ended
    
    
    Year ended
    
    
    Year endedNotes
    
    
    December 31,
    
    
    December 31,
    
    
    December 31,2007
    
    
    2006
    
    
    2005US$
    
    
    US$
    
    
    US$Basic earnings per share:
    
    
    2 (g)Income before extraordinary item
    
    
    
    
    
    
    0.07
    
    
    
    0.31
    
    
    
    0.23Extraordinary item
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.09Net income
    
    
    
    
    
    
    0.07
    
    
    
    0.31
    
    
    
    0.32Diluted earnings per share:
    
    
    2 (g)Income before extraordinary item
    
    
    
    
    
    
    0.07
    
    
    
    0.29
    
    
    
    0.21Extraordinary item
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    0.09Net income
    
    
    
    
    
    
    0.07
    
    
    
    0.29
    
    
    
    0.30
  F-4




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED BALANCE SHEETS
  As of December 31,Notes
    
    
    2007
    
    
    2006US$
    
    
    US$ASSETSCurrent assetCash and cash equivalents
    
    
    
    
    
    
    4,951
    
    
    
    5,863Restricted cash
    
    
    9 (a)
    
    
    
    4,161
    
    
    
    5,489Trade receivables, net of allowance for doubtful accounts
(December 31, 2007: US$1; December 31, 2006: US$30)
    
    
    
    
    
    
    23,194
    
    
    
    23,894Derivatives
    
    
    
    
    
    
    2,947
    
    
    
    3,400Available-for-sale securities
    
    
    2 (n)
    
    
    
    2,973
    
    
    
    2,596Inventories
    
    
    5
    
    
    
    82,012
    
    
    
    68,751Prepayments and other current assets
    
    
    
    
    
    
    2,522
    
    
    
    3,118Total current assets
    
    
    
    
    
    
    122,760
    
    
    
    113,111Properties held for lease, net
    
    
    6
    
    
    
    1,292
    
    
    
    1,346Property, plant and equipment, net
    
    
    7
    
    
    
    8,460
    
    
    
    8,412Due from related parties
    
    
    16 (b)
    
    
    
    
    
    
    
    21Deferred tax assets
    
    
    
    
    
    
    111
    
    
    
    111Goodwill, net
    
    
    8
    
    
    
    1,521
    
    
    
    1,521Total assets
    
    
    
    
    
    
    134,144
    
    
    
    124,522LIABILITIES AND SHAREHOLDERS EQUITYCurrent liabilitiesBank overdrafts
    
    
    9
    
    
    
    2,977
    
    
    
    1,591Notes payable
    
    
    9
    
    
    
    4,047
    
    
    
    3,987Capitalized lease obligation, current portion
    
    
    11
    
    
    
    92
    
    
    
    94Letters of credit, gold loan and others
    
    
    9
    
    
    
    21,536
    
    
    
    33,423Derivatives
    
    
    
    
    
    
    4,444
    
    
    
    6,034Trade payables
    
    
    
    
    
    
    18,700
    
    
    
    9,213Accrued payroll and staff benefits
    
    
    
    
    
    
    2,686
    
    
    
    2,043Accrued expenses and other payables
    
    
    
    
    
    
    3,434
    
    
    
    5,509Income taxes payable
    
    
    
    
    
    
    1,719
    
    
    
    735Deferred taxation
    
    
    10
    
    
    
    339
    
    
    
    348Total current liabilities
    
    
    
    
    
    
    59,974
    
    
    
    62,977Notes payable, non-current portion
    
    
    
    
    
    
    1,154
    
    
    
    1,378Capitalized lease obligation, non-current portion
    
    
    11
    
    
    
    181
    
    
    
    262Total liabilities
    
    
    
    
    
    
    61,309
    
    
    
    64,617Minority interest
    
    
    
    
    
    
    167
    
    
    
    166Commitments and contingencies
    
    
    12Shareholders equityCommon stocks, par value US$0.01 each,
Authorized - 100 million shares,
Issued 21,437,172 shares as of December 31, 2007 and
18,977,371 shares as of December 31, 2006
    
    
    13
    
    
    
    214
    
    
    
    190Additional paid-in capital
    
    
    
    
    
    
    51,495
    
    
    
    40,456Accumulated other comprehensive income (loss)
    
    
    
    
    
    
    321
    
    
    
    (56
    )Retained earnings
    
    
    
    
    
    
    20,638
    
    
    
    19,149Total shareholders equity
    
    
    
    
    
    
    72,668
    
    
    
    59,739Total liabilities and shareholders equity
    
    
    
    
    
    
    134,144
    
    
    
    124,522
  F-5




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
  AccumulatedCommon stock
    
    
    Additional
    
    
    otherNumber
    
    
    Par
    
    
    Paid-in
    
    
    comprehensive
    
    
    Unearned
    
    
    RetainedNotes
    
    of shares
    
    
    Value
    
    
    Capital
    
    
    income (loss)
    
    
    compensation
    
    
    earnings
    
    
    TotalUS$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$(Note 2(x))Balance as of January 1, 2005
    
    
    
    
    12,304,658
    
    
    
    123
    
    
    
    23,382
    
    
    
    (151
    )
    
    
    (37
    )
    
    
    9,473
    
    
    
    32,790Comprehensive income, net of tax:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,351
    
    
    
    4,351Exchange translation difference
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (5
    )
    
    
    
    
    
    
    
    
    
    
    (5
    )4,346Issuance of common stock upon exercise of stock options
    
    13(a)(ii)
    
    
    3,162,000
    
    
    
    31
    
    
    
    7,542
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    7,573Issuance of common stock upon exercise of warrants
    
    13(a)(ii)
    
    
    54,545
    
    
    
    1
    
    
    
    162
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    163Compensation costs for warrants granted
    
    15(b)(ii)
    
    
    
    
    
    
    
    
    
    
    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
    
    
    
    45,008Comprehensive income, net of tax:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    5,325
    
    
    
    5,325Unrealized holding gain on investment in
available-for-sale securities
    
    2(n)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    100
    
    
    
    
    
    
    
    
    
    
    
    1005,425Issuance of common stock on private placement
    
    13(a)(iii)
    
    
    1,466,668
    
    
    
    15
    
    
    
    4,176
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    4,191Issuance of common stock upon exercise of stock options
    
    13(a)(iv)
    
    
    1,489,500
    
    
    
    15
    
    
    
    2,989
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    3,004Issuance of common stock upon exercise of warrants
    
    13(a)(iv)
    
    
    500,000
    
    
    
    5
    
    
    
    1,735
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,740Elimination of unearned compensation
    
    2(q)
    
    
    
    
    
    
    
    
    
    
    (19
    )
    
    
    
    
    
    
    19
    
    
    
    
    
    
    
    Compensation costs for warrants granted
    
    15(b)(ii)
    
    
    
    
    
    
    
    
    
    
    158
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    158Stock-based compensation
    
    2(q)
    
    
    
    
    
    
    
    
    
    
    213
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    213Balance as of December 31, 2006
    
    
    
    
    18,977,371
    
    
    
    190
    
    
    
    40,456
    
    
    
    (56
    )
    
    
    
    
    
    
    19,149
    
    
    
    59,739
  F-6




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF SHAREHOLDERS EQUITY AND COMPREHENSIVE INCOME
  AccumulatedCommon stock
    
    
    Additional
    
    
    otherNumber
    
    
    Par
    
    
    Paid-in
    
    
    comprehensive
    
    
    Unearned
    
    
    RetainedNotes
    
    of shares
    
    
    Value
    
    
    Capital
    
    
    income (loss)
    
    
    compensation
    
    
    earnings
    
    
    TotalUS$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$
    
    
    US$(Note 2(x))Balance as of December 31, 2006
    
    
    
    
    18,977,371
    
    
    
    190
    
    
    
    40,456
    
    
    
    (56
    )
    
    
    
    
    
    
    19,149
    
    
    
    59,739Comprehensive income, net of tax:Net income
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    1,489
    
    
    
    1,489Unrealized holding gain on investment in
available-for-sale securities
    
    2(n)
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    377
    
    
    
    
    
    
    
    
    
    
    
    3771,866Issuance of common stock upon exercise of stock options
    
    13(a)(v)
    
    
    1,897,000
    
    
    
    19
    
    
    
    8,485
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    8,504Issuance of common stock upon exercise of warrants
    
    13(a)(v)
    
    
    562,801
    
    
    
    5
    
    
    
    2,067
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,072Compensation costs for warrants granted
    
    15(b)(ii)
    
    
    
    
    
    
    
    
    
    
    157
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    157Stock-based compensation
    
    2(q)
    
    
    
    
    
    
    
    
    
    
    330
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    330Balance as of December 31, 2007
    
    
    
    
    21,437,172
    
    
    
    214
    
    
    
    51,495
    
    
    
    321
    
    
    
    
    
    
    
    20,638
    
    
    
    72,668
  F-7




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2007
    
    
    2006
    
    
    2005US$
    
    
    US$
    
    
    US$Cash flows from operating activities:Net income
    
    
    1,489
    
    
    
    5,325
    
    
    
    4,351Adjustments to reconcile income (loss) to net cash
provided by (used in) operating activities:Depreciation of property, plant and equipment
and properties held for lease
    
    
    3,095
    
    
    
    2,039
    
    
    
    1,368Extraordinary gain on negative goodwill
    
    
    
    
    
    
    
    
    
    
    (1,291
    )Unrealized (gain) loss on derivatives
    
    
    
    
    
    
    (48
    )
    
    
    88Loss on disposal and write-off of property,
plant and equipment
    
    
    45
    
    
    
    3
    
    
    
    8Reversal of doubtful debts
    
    
    (2
    )
    
    
    (40
    )
    
    
    (72
    )Minority interests
    
    
    1
    
    
    
    37
    
    
    
    20Compensation costs for warrants granted
    
    
    157
    
    
    
    158
    
    
    
    118Compensation expenses recognized during the year
    
    
    330
    
    
    
    213
    
    
    
    18Changes in operating assets and liabilities:Trade receivables
    
    
    702
    
    
    
    1,106
    
    
    
    (8,607
    )Inventories
    
    
    (13,261
    )
    
    
    (12,810
    )
    
    
    (12,060
    )Prepayments and other current assets
    
    
    596
    
    
    
    (580
    )
    
    
    601Due from related parties
    
    
    21
    
    
    
    463
    
    
    
    7Trade payables
    
    
    9,487
    
    
    
    (2,955
    )
    
    
    1,883Accrued expenses and other payables
    
    
    (1,432
    )
    
    
    272
    
    
    
    (854
    )Income taxes payable and deferred taxation
    
    
    975
    
    
    
    617
    
    
    
    200Net cash provided by (used in) operating activities
    
    
    2,203
    
    
    
    (6,200
    )
    
    
    (14,222
    )Cash flows from investing activities:Change in restricted cash
    
    
    1,328
    
    
    
    350
    
    
    
    554Net cash inflow from acquisition
    
    
    
    
    
    
    
    
    
    
    156Purchase of available-for-sale securities
    
    
    
    
    
    
    
    
    
    
    (2,496
    )Purchase of property, plant and equipment
    
    
    (3,139
    )
    
    
    (4,183
    )
    
    
    (2,869
    )Proceeds on disposals of property, plant and
equipment
    
    
    5
    
    
    
    4
    
    
    
    Net cash used in investing activities
    
    
    (1,806
    )
    
    
    (3,829
    )
    
    
    (4,655
    )
  F-8




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##### Table of Contents



LJ INTERNATIONAL INC.
 CONSOLIDATED STATEMENTS OF CASH FLOWS
  Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2007
    
    
    2006
    
    
    2005US$
    
    
    US$
    
    
    US$Cash flows from financing activities:Change in bank overdrafts
    
    
    1,386
    
    
    
    (437
    )
    
    
    1,421Proceeds from issuance of shares upon exercise of
stock options
    
    
    8,504
    
    
    
    3,004
    
    
    
    7,573Proceeds from issuance of share upon exercise of
stock warrants
    
    
    2,072
    
    
    
    1,740
    
    
    
    163Net proceeds from issuance of shares in private
placement
    
    
    
    
    
    
    4,191
    
    
    
    Repayment of amount due to related parties
    
    
    
    
    
    
    (1,910
    )
    
    
    Loans acquired
    
    
    14,334
    
    
    
    11,092
    
    
    
    10,267Repayment of loans
    
    
    (24,833
    )
    
    
    (8,117
    )
    
    
    (5,424
    )Repayment of capitalized lease obligation
    
    
    (83
    )
    
    
    (73
    )
    
    
    (14
    )Letter of credit and factoring
    
    
    (5,691
    )
    
    
    457
    
    
    
    6,464Proceeds from sale of derivatives net of
retirement of embedded derivatives
    
    
    3,002
    
    
    
    1,149
    
    
    
    Net cash (used in) provided by financing activities
    
    
    (1,309
    )
    
    
    11,096
    
    
    
    20,450Effect of foreign exchange rate change
    
    
    
    
    
    
    
    
    
    
    (5
    )Net (decrease) increase in cash and cash
equivalents
    
    
    (912
    )
    
    
    1,067
    
    
    
    1,568Cash and cash equivalents, as of beginning of year
    
    
    5,863
    
    
    
    4,796
    
    
    
    3,228Cash and cash equivalents, as of end of year
    
    
    4,951
    
    
    
    5,863
    
    
    
    4,796Supplemental disclosure information:Interest expense
    
    
    3,103
    
    
    
    3,258
    
    
    
    1,991Income taxes paid
    
    
    736
    
    
    
    786
    
    
    
    539Non-cash transactions:Purchase of property, plant and equipment under
capitalized leases
    
    
    
    
    
    
    366
    
    
    
    
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1.
    
    NATURE OF BUSINESS AND BASIS OF FINANCIAL STATEMENTSLJ International Inc. (LJI), its subsidiaries and variable interest entities (VIEs)
(collectively referred as the Company) are principally involved in the design, manufacture,
marketing, sale of precious and color gemstones as well as diamond jewelry. While the
Company is based in Hong Kong, its manufacturing operations are in the Peoples Republic of
China (PRC) and most of its sales are currently in the United States of America (US). The
retail shops are located in the PRC, Hong Kong and Macau. The Company also owns certain
commercial and residential properties located in Hong Kong, which are held primarily for
lease.2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
 (a)
    
    Basis of accountingThe financial statements are prepared in accordance with US generally accepted
accounting principles (US GAAP).(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.The Company adopted Financial Accounting Standards Board (FASB)
Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest
Entities, an Interpretation of ARB No. 51 (FIN 46(R)). FIN 46(R) requires certain
variable interest entities to be consolidated by the primary beneficiary of the
entity if the equity investors in the entity do not have the characteristics of a
controlling financial interest nor do not have sufficient equity at risk for the
entity to finance its activities without additional subordinated financial support
from other parties.VIEs are owned by individuals, who are acting as agents for the Company.
The Company does not have any ownership interest in VIEs. LJI is incorporated in
the BVI and is considered a foreign entity under the PRC laws. Prior to 2006, due
to the restrictions on foreign ownership on the retail business of jewelry, the
Company, through loans to the agents, established VIEs to carry out the retail
business of jewelry in the PRC. Pursuant to various agreements entered into
between the Company, the owners of VIEs and VIEs, the Company generally has control
of VIEs, absorbs majority of expected losses and receives majority of residual
return of VIEs. The Company is therefore considered the primary beneficiary of
VIEs. Accordingly, the results of VIEs have been consolidated in the financial
statements of the Company since they become VIEs of the Company. With the
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2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 relaxation of the restrictions on foreign ownership on retail business, the agents of
one of the VIE have transferred the ownership of the VIE back to the Company in
September 2006, the agents of another VIE are in the process of transferring the
ownership of the VIE back to the Company.The application of the consolidation provisions of FIN 46(R) resulted in an
increase in assets and an increase in liabilities as of December 31, 2007 by
US$5,632 and US$5,682 respectively and an increase in assets and an increase in
liabilities as of December 31, 2006 by US$3,098 and US$1,358 respectively and
increase in net loss of US$473 and US$580 and US$1,248 for each of three years
ended December 31, 2007, 2006 and 2005 respectively.Goodwill represents the excess of the aggregate purchase price over the fair value of
the net assets acquired in a purchase businesses combination. Goodwill is reviewed for
impairment at least annually in accordance with the provisions of FASB Statement No.
142, Goodwill and Other Intangible Assets. The goodwill impairment test is a two-step
test. Under the first step, the fair value of the reporting unit is compared with its
carrying value (including goodwill). If the fair value of the reporting unit is less
than its carrying value, an indication of goodwill impairment exists for the reporting
unit and the enterprise must perform step two of the impairment test (measurement).
Under step two, an impairment loss is recognized for any excess of the carrying amount
of the reporting units goodwill over the implied fair value of that goodwill. The
implied fair value of goodwill is determined by allocating the fair value of the
reporting unit in a manner similar to a purchase price allocation, in accordance with
FASB Statement No. 141, Business Combinations. The residual fair value after this
allocation is the implied fair value of the reporting unit goodwill. Fair value of the
reporting unit is determined using a discounted cash flow analysis. If the fair value
of the reporting unit exceeds its carrying value, step two does not need to be
performed.The Company performed its annual impairment review of goodwill, and
resulting in US$Nil in 2007 and 2006, US$1,291 included in statement of operations
as an extraordinary item in 2005.
 (c)
    
    Revenue recognitionOperating revenue represents:
 Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,2007
    
    
    2006US$
    
    
    US$Product sales
    
    
    161,375
    
    
    
    128,118Services income
    
    
    
    
    
    
    4,130Rental income
    
    
    126
    
    
    
    124161,501
    
    
    
    132,372Less: Sales return allowance
    
    
    (9,464
    )
    
    
    (8,581
    )152,037
    
    
    
    123,791
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2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (i)
    
    Product salesProduct sales represent the invoiced value of products sold, net of value added
taxes (VAT). The Company recognizes revenue from the sale of products when the
following criteria are met: 1) persuasive evidence of an arrangement exists (sales
agreements and customer purchase orders are used to determine the existence of an
arrangement); 2) delivery of the product has occurred and risks and benefits of
ownership have been transferred, which is when the product is received by the
customer at its or a designated location in accordance with the sales terms; 3) the
sales price is fixed or determinable; and 4) collectibility is probable.In the PRC, VAT at a general rate of 17% on invoice amount is collected on behalf of
tax authorities in respect of the sales of products and is not recorded as revenue.
VAT collected from customers, net of VAT paid for purchases, is recorded as a
liability in the consolidated balance sheets until it is paid to the authorities.(ii)
    
    Service incomeService income represents services performed for improving and upgrading gemstones
into saleable quality. On August 11, 2006 the Company entered into a Joint
Collaboration Agreement (the Agreement) with an Agent who is not a related party.
The Company was responsible for and paid the cost of servicing and upgrading
performed to bring gemstones to the form of fine jewelry ready for sale.The servicing income in the amount of $4,130 was included in servicing income on the
consolidated statement of operations for the year ended December 31, 2006.(iii)
    
    Rental incomeRental income receivable under operating lease is recognized in the consolidated
statements of income in equal installments over the period covered by the
lease term.(iv)
    
    Other income represents:Interest income is accrued on a time proportion basis on the principal outstanding
and at the interest rate applicable.
 (d)
    
    Sales return 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.
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (e)
    
    Shipping and handling costsThe shipping and handling costs are included in cost of goods sold. Shipping and
handling costs were US$2,580, US$2,991 and US$3,135 for the years ended December 31,
2007, 2006 and 2005 respectively.(f)
    
    Advertising and promotion costsAdvertising and promotion expenses are generally expensed when incurred. Advertising
costs were US$2,242, US$1,321 and US$1,092 for the years ended December 31, 2007, 2006
and 2005 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. 329,334 warrants were not included
in the computation of diluted earnings per share for the year ended December 31, 2007
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 receivableTrade receivables are recorded at the invoiced amount and do not bear
interest. Amounts collected on trade receivables are included in net cash provided
by operating activities in the consolidated statements of cash flows. The Company
maintains an allowance for doubtful accounts for estimated losses inherent in its
trade receivable portfolio and purchases trade credit insurance to cover the risk
of collectibilities. In establishing the required allowance, management considers
historical losses, current receivables aging, and existing industry and national
economic data. The Company reviews its allowance for doubtful accounts regularly.
Past due balances over 120 days and over a specified amount are reviewed
individually for collectibility. All other balances are reviewed on a pooled basis
by aging of such balances. Account balances are charged off against the allowance
after all means of collection have been exhausted and the potential for recovery is
considered remote. The Company does not have any off-balance-sheet credit exposure
related to its customers, except for outstanding bills discounted with banks (see
Note 9), that are subject to recourse for non-payment.
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (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. In case of inventory which have been written down below cost at
the close of a fiscal year, such reduced amount forms a new cost basis that
subsequently cannot be marked up based on changes in underlying facts and
circumstances. The Company estimates the loss/write-down on the basis of its
assessment of the inventorys net realizable value based upon current market
conditions and historical experience.Effective January 1, 2005, the Company changed its method of valuing its inventory from
the first-in, first-out method to the monthly weighted average costing method.
Management believes the weighted average costing method results in a better
matching of current costs with current revenues and minimizes the effect of price
level changes on inventory valuation. The cumulative effect of this accounting
change for years prior to 2005 and the effects of retroactive application of the
weighted average costing method to prior years are immaterial. The effect of the
change in 2005 was to increase net income of the Company by US$35.(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.
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (l)
    
    Property, plant and equipment (PPE) and depreciationPPE are stated at cost less accumulated depreciation and accumulated impairment
loss, and include expenditure that substantially increases the useful lives of existing
assets. Maintenance and repairs are charged to current operations as incurred. Upon
sale, retirement, or other disposition of these assets, the cost and related accumulated
depreciation and accumulated impairment loss are removed from the respective accounts,
and any gain or loss is included in the consolidated statement of operations. Plant and
equipment under capital leases are stated at the present value of minimum lease
payments.Depreciation on PPE is calculated by using the straight-line method (after taking
into account their respective estimated residual values) over the estimated useful lives
of the related assets at the following annual rates:
 Leasehold land and buildings
    
    2% or over the unexpired term of leasesLeasehold improvement
    
    shorter of 10% or the unexpired term of leasesFurniture, fixtures and equipment
    
    20% to 50%Plant and machinery
    
    
    
    10%Motor vehicles
    
    10% to 20%
 Depreciation on PPE attributable to manufacturing activities is capitalized as part
of inventory, and expensed to cost of goods sold as inventory is sold. Depreciation
related to abnormal amounts from idle capacity is charged to cost of goods sold for the
period incurred. Total depreciation for the years ended December 31, 2007, 2006 and
2005 were US$ 3,095, US$2,039 and US$1,368 respectively.(m)
    
    Impairment of long-lived assetsIn accordance with Statement of Financial Accounting Standards (SFAS)
No. 144 (SFAS 144), Accounting for the Impairment or Disposal of Long-Lived
Assets, long-lived assets, such as property, plant and equipment, are reviewed for
impairment whenever events or changes in circumstances indicate that the carrying
amount of an asset may not be recoverable. If circumstances require a long-lived
asset be tested for possible impairment, the Company first compares undiscounted
cash flows expected to be generated by an asset to the carrying value of the asset.
If the carrying value of the long-lived asset is not recoverable on an
undiscounted cash flow basis, an impairment is recognized to the extent that the
carrying value exceeds it fair value. Fair value is determined through various
valuation techniques including discounted cash flow models, quoted market values
and third-party independent appraisals, as considered necessary.
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (n)
    
    Available-for-sale securitiesThe Company classifies its investment in capital guaranteed fund as available-for-sale
securities. The fund is restricted and secures obligations under trade credit banking
facilities. It is carried at market value with a corresponding recognition of net
unrealized holding gain or loss (net of tax) as a separate component of shareholders
equity until realized. Unrealized losses are charged against net earnings when a
decline in fair value is determined to be other than temporary. Gains and losses on
sales of securities are computed on a specific identification basis. Available-for-sale
securities comprise:
 As of December 31,2007
    
    
    2006US$
    
    
    US$Quoted capital guaranteed fund, at cost
    
    
    2,496
    
    
    
    2,496Gross unrealized gains
    
    
    477
    
    
    
    100Fair value of available-for-sale securities
    
    
    2,973
    
    
    
    2,596
 (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).
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (q)
    
    Stock-based compensation
 Statement of Financial Accounting Standards No. 123 (Revised 2004), Share-Based
Payment, (SFAS 123(R)) requires the Company to measure the cost of employee services
received in exchange for an award of equity instruments based on the grant-date fair
value of the award. The Company records the cost as expense over the offering period
and vesting term in connection with compensation expense for stock-based employee
compensation plans.Effective January 1, 2006, the Company began recording compensation expense for
stock-based employee compensation plans in accordance with SFAS 123(R) as interpreted
by SEC Staff Accounting Bulletin No. 107. The Company adopted the modified prospective
transition method provided for under SFAS 123(R), and consequently has not
retroactively adjusted results from prior periods. Under this transition method,
compensation expense for stock-based employee compensation plans recognized for the
year ended December 31, 2006 now includes estimated expense for the portion of stock
options vesting in the period for options granted prior to, but not vested as of
January 1, 2006, based on the grant date fair value estimated in accordance with the
original provisions of Statement of Financial Accounting Standards No. 123, Accounting
for Stock-Based Compensation (SFAS 123).As of December 31, 2007, the Company has three stock-based employee compensation plans,
details of which are set out in note 15(a).During the year ended December 31, 2007, the Company has granted 1,500,000 stock
options to the employees. The fair value of these options was estimated on the date of
grant using a Binomial pricing model with the following weighted-average assumptions:
 Year endedDecember 31,2007Expected dividend yield
    
    
    Expected stock price volatility
    
    
    33.2
    %Risk-free interest rate
    
    
    4.90
    %Expected life of options
    
    1 month
 The weighted average fair value per option granted during the years ended December 31,
2007 was US$0.22.Prior to 1 January, 2006, the Company records compensation expense for stock-based
employee compensation plans using the intrinsic value method pursuant to APB Opinion
No. 25 in which compensation expense is measured as the excess of the market price of
the stock over the exercise price of the plan on the measurement date. Compensation
expense is charged to income as when incurred if the benefit was fully vested at the
date of grant or is recognized proportionately over the vesting period. Unearned
compensation is shown separately as a reduction of the shareholders equity.
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (q)
    
    Stock-based compensation (Continued)
 In 2004, the Company recorded an unearned compensation of US$48 in the shareholders
equity in relation to the option to purchase 150,000 shares of the common stock of the
Company granted to an employee, for which the exercise price was below the market price
of the underlying stock at the date of grant. This amount is accrued proportionately
as compensation expense over the vesting period. For each of the two years ended
December 31, 2005 and 2004, the Company recognized compensation expense of US$18 and
US$11 respectively in its statement of operations. Following the adoption of SFAS
123(R), the unearned compensation has been eliminated against the additional paid-in
capital. Other than the above, the exercise price of the Companys incentive stock
options was same as or higher than the market price of the underlying stock on the date
of grant, no compensation expense was recognized for these stock options granted to
employees.Had compensation expense for the same stock options been determined based on the fair
value on the date of grant and been amortized over the period from the date of grant to
the date that the award is vested, consistent with the provisions of SFAS No. 123, the
Companys net income and earnings per share would have been reported as follows:
 Year endedDecember 31,2005US$Income before extraordinary item
    
    
    3,060Add : Stock-based employee compensation
expenses included in reported net
income, net of tax
    
    
    18Deduct: Total stock-based employee
compensation expenses determined
under fair value based method for all awards, net of tax
    
    
    (2,266
    )Pro forma income before extraordinary item
    
    
    812Extraordinary item
    
    
    1,2912,103
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (q)
    
    Stock-based compensation (Continued)
 Year endedDecember 31,2005US$Basic earnings per share, as reported:Income before extraordinary item
    
    
    0.23Extraordinary item
    
    
    0.09Net income
    
    
    0.32Diluted earnings per share, as reported:Income before extraordinary item
    
    
    0.21Extraordinary item
    
    
    0.09Net income
    
    
    0.30Basic earnings per share, pro forma:Income before extraordinary item
    
    
    0.06Extraordinary item
    
    
    0.09Net income
    
    
    0.15Diluted earnings per share, pro forma:Income before extraordinary item
    
    
    0.06Extraordinary item
    
    
    0.09Net income
    
    
    0.15
 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 endedDecember 31,2005Expected dividend yield
    
    
    Expected stock price volatility
    
    
    52
    %Risk-free interest rate
    
    
    4.37
    %Expected life of options
    
    2 years
 The weighted average fair value per option granted during the year ended December 31,
2005 was US$0.70.
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (r)
    
    Income taxesIncome taxes are accounted for under the asset and liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences attributable to
differences between the financial statement carrying amounts of existing assets and
liabilities and their respective tax bases and operating loss and tax credit carry
forwards. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that includes
the enactment date. The Company provides a valuation allowance, if necessary, to reduce
deferred tax assets to their estimated realizable value.(s)
    
    Foreign 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).The aggregate transaction loss included in determining net income were US$453,
US$465 and US$273 for each of the three years ended December 31, 2007, 2006 and 2005
respectively.
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (t)
    
    Cash equivalents and Pledged Bank DepositsCash consists of cash on hand, cash in bank accounts and interest-bearing savings
accounts. Cash deposits that are restricted as to withdrawal or pledged as security, are
disclosed separately on the face of the consolidated balance sheet, and not included in
the cash total for the purpose of the consolidated statements of cash flow.(u)
    
    Uses of estimatesThe preparation of the consolidated financial statements, in accordance
with US GAAP, requires management to make estimates and assumptions that affect the
amounts reported in the consolidated financials statements and accompanying notes.
Significant items subject to such estimates and assumptions include the carrying
amount of property, plant and equipment and goodwill; valuation allowance for
receivables, inventories and deferred income tax asset; valuation of derivative
instruments; valuation of share-based compensation. Actual results could differ
from those estimates.(v)
    
    Related 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.(w)
    
    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 9 to the financial statements.
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (x)
    
    Comprehensive incomeThe Company reports comprehensive income in accordance with SFAS No. 130 Reporting
Comprehensive Income. Accumulated other comprehensive gain represents exchange
translation adjustments and unrealized holding gains on investment, and is included in
the shareholders equity section of the balance sheet.(y)
    
    New accounting pronouncementsIn September 2006, the FASB issued Statement of Financial Accounting Standards No. 157
(SFAS No. 157), Fair Value Measurements, which defines fair value, provides a framework
for measuring fair value, and expands the disclosures required for fair value
measurements. SFAS No. 157 applies to other accounting pronouncements that require fair
value measurements and does not require any new fair value measurements. SFAS No. 157 is
effective for fiscal year beginning after November 15, 2007. We are required to adopt
SFAS No. 157 beginning on January 1, 2008. SFAS No. 157 is required to be applied
prospectively, except for certain financial instruments. Any transition adjustment will
be recognized as an adjustment to opening retained earnings in the year of adoption. In
November 2007, the FASB proposed a one-year deferral of SFAS No. 157s fair value
measurement requirements for non-financial assets and liabilities that are not required
or permitted to be measured at fair value on a recurring basis. The Company does not
expect the adoption of SFAS No. 157 will have a material impact on its financial
statements.In February 2007, the FASB issued Statement of Financial Accounting Standards No.
159 (SFAS No. 159), The Fair Value Option for Financial Assets and Financial
Liabilities. SFAS No. 159 is effective for fiscal years beginning after November 15,
2007. SFAS No. 159 allows entities to choose, at specified election dates, to measure
eligible financial assets and liabilities at fair value that are not otherwise required
to be measured at fair value. If a company elects the fair value option for an eligible
item, changes in that items fair value in subsequent reporting periods must be
recognized in current earnings. SFAS No. 159 also establishes presentation and
disclosure requirements designed to draw comparison between entities that elect
different measurement attributes for similar assets and liabilities. The Company does
not expect the adoption of SFAS No. 159 will have a material impact on its financial
statements.In December 2007, the FASB issued Statement of Financial Accounting Standards No.
141R (SFAS No. 141R), Business Combinations, which is a revision of SFAS No. 141,
Business Combinations. This statement establishes principles and requirements for how an
acquirer recognizes and measures in its financial statements the identifiable assets
acquired, the liabilities assumed and any non-controlling interest in the acquiree;
recognizes and measures the goodwill acquired in the business combination or a gain from
a bargain purchase; and determines what information to disclose to enable users of the
financial statements to evaluate the nature and financial effects of the business
combination.
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##### Table of Contents



2.
    
    SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
 (y)
    
    New accounting pronouncements (Continued)This new standard is effective prospectively to business combinations for which the
acquisition date is on or after the beginning of the annual reporting period beginning
on or after December 15, 2008. Early adoption is prohibited. The Company is currently
evaluating the impact of the adoption of SFAS No. 141R on its consolidated financial
statements.In December 2007, the FASB issued Statement of Financial Accounting Standards No.
160 (SFAS No. 160), Non-controlling Interests in Consolidated Financial Statements. SFAS
No. 160 establishes accounting and reporting standards for ownership interests in
subsidiaries held by parties other than the parent, the amount of consolidated net
income attributable to the parent and to the non-controlling interest, changes in a
parents ownership interest and the valuation of retained non-controlling equity
investments when a subsidiary is deconsolidated. SFAS No. 160 also establishes
disclosure requirements that clearly identify and distinguish between the interests of
the parent and the interests of the non-controlling owners. This new standard is
effective for fiscal years, and interim periods within those fiscal years, beginning on
or after December 15, 2008. The Company is currently evaluating the impact of the
adoption of SFAS No. 160 on its consolidated financial statements.In March 2008, the FASB issued Statement of Financial Accounting Standards No. 161
(SFAS No. 161), Disclosures about Derivative Instruments and Hedging Activities  An
Amendment of FASB Statement No. 133. SFAS No. 161 requires enhanced disclosures on
derivative and hedging activities by requiring objectives to be disclosed for using
derivative instruments in terms of underlying risk and accounting designation. This
statement requires disclosures on the need of using derivative instruments, accounting
of derivative instruments and related hedged items, if any, under SFAS No. 133 and the
effect of such instruments and related hedge items, if any, on the financial position,
financial performance and cash flows. This new statement is effective for fiscal years
beginning after November 15, 2008. The Company is currently evaluating the impact of the
adoption of SFAS No. 161 on its consolidated financial statements.In May 2008, the FASB issued Statement of Financial Accounting Standards No. 162
(SFAS No. 162), The Hierarchy of Generally Accepted Accounting Principles. The new
standard is intended to improve financial reporting by identifying a consistent
framework, or hierarchy, for selecting accounting principles to be used in preparing
financial statements that are presented in conformity with U.S. generally accepted
accounting principles for non-governmental entities. SFAS No. 162 is effective 60 days
following the SECs approval of the Public Company Accounting Oversight Board amendments
to AU Section 411, The Meaning of Present Fairly in Conformity with Generally Accepted
Accounting Principles. The Company is currently evaluating the impact of the adoption of
SFAS No. 162 on its consolidated financial statements.
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3.
    
    ACQUISITIONSOn January 1, 2005, the Company paid US$2,828 for new issuance of 3,900 common stock of
Goldleaves International Limited (GIL), a company whose principal activities are the
manufacturing and trading of rough and pre-formed gemstones, in which the Company had 20%
equity interests and is classified as investment securities as of December 31, 2004. The
Company then became the major stockholder holding 98% equity interest in GIL, which became a
subsidiary of the Company. The directors of the Company consider such acquisition would
enhance the Company by forward and backward vertical integration.Details of the 78% share of identifiable assets and liabilities by the Company at the date
of acquisition are as follows:
 As ofJanuary 1,2005US$Net assets acquired:Property, plant and equipment
    
    
    119Trade receivables
    
    
    490Inventories
    
    
    5,657Other receivables
    
    
    2,674Cash and cash equivalents
    
    
    122Trade payables
    
    
    (572
    )Accrued expenses and other payables
    
    
    (4,221
    )4,269Negative goodwill arising from acquisition
    
    
    (1,441
    )Total consideration
    
    
    2,828
 None of the amount of goodwill is expected to be taxable or tax deductible.Negative goodwill was arisen from the acquisition of GIL, US$150 of which was directly
written off against the Companys share of properties, plants and equipments acquired. The
remaining balance of US$1,291 was included in statement of operations for the year ended
December 31, 2005 as an extraordinary item.
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4.
    
    OPERATING RISKS
 (a)
    
    Concentrations of credit risksDetails of major customers from which the Company derived operating revenue are shown
in note 18(a).Credit risk represents the accounting loss that would be recognized at the reporting
date if counterparties failed completely to perform as contracted. Concentrations of
credit risk (whether on or off balance sheet) that arise from financial instruments
exist for groups of customers or counterparties when there are similar economic
characteristics that would cause their ability to meet contractual obligations to be
similarly affected by changes in economic or other conditions. The major concentration
of credit risk arises from the Companys receivables. Even though the Company does
have major customers, it does not consider itself to be exposed to significant credit
risk with regards to collection of the related receivables. Historical losses have not
been significant.(b)
    
    Country risksThe Company may also be exposed to certain risks as a result of its manufacturing
operation being located in the PRC and its properties held for lease in Hong Kong which
are not typically associated with companies operating in North America and Western
Europe. These include risks associated with, among others, the political, economic and
legal environments and foreign currency exchange. The Companys results may be
adversely affected by changes in the political and social conditions in the PRC, and by
changes in governmental policies with respect to laws and regulations,
anti-inflationary measures, currency conversion and remittance abroad, and rates and
methods of taxation, among other things. The Companys management believe these risks
not to be significant. There can be no assurance, however, that changes in political,
social and other conditions will not result in any adverse impact.(c)
    
    Cash and time depositsThe Company maintains majority of its cash balances and investments in time deposits
with various banks and financial institutions in Hong Kong. In common with local
practice, such amounts are not insured or otherwise protected should the financial
institutions be unable to meet their liabilities. There has been no history of credit
losses.
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5.
    
    INVENTORIESInventories consist of the following:
 As of December 31,2007
    
    
    2006US$
    
    
    US$Raw materials
    
    
    42,052
    
    
    
    44,001Work-in-progress
    
    
    2,600
    
    
    
    2,417Finished goods
    
    
    37,360
    
    
    
    22,33382,012
    
    
    
    68,751
 6.
    
    PROPERTIES HELD FOR LEASE, NETThe Company owns leasehold land and buildings in Hong Kong and leases them out for lease
term of 2 years. Properties held for lease consists of the following:
 As of December 31,2007
    
    
    2006US$
    
    
    US$Leasehold land and buildings
    
    
    2,037
    
    
    
    2,037Less: Accumulated depreciation
    
    
    (745
    )
    
    
    (691
    )1,292
    
    
    
    1,346
 The Company pledged all properties held for lease as collateral for general banking
facilities granted to the Company as of December 31, 2007 and 2006 (see note 9).The future aggregate minimum rental receivables under non-cancellable operating leases are
as follows:
 As of December 31,2007
    
    
    2006US$
    
    
    US$2007
    
    
    
    
    
    
    882008
    
    
    74
    
    
    
    242009
    
    
    32
    
    
    
    106
    
    
    
    112
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7.
    
    PROPERTY, PLANT AND EQUIPMENT, NETProperty, plant and equipment consist of the following:
 As of December 31,2007
    
    
    2006US$
    
    
    US$Leasehold land and buildings
    
    
    2,405
    
    
    
    2,405Leasehold improvement
    
    
    8,610
    
    
    
    6,591Furniture, fixtures and equipment
    
    
    5,282
    
    
    
    5,342Plant and machinery
    
    
    2,509
    
    
    
    2,264Motor vehicles
    
    
    844
    
    
    
    94519,650
    
    
    
    17,547Less: Accumulated depreciation
    
    
    (11,190
    )
    
    
    (9,135
    )8,460
    
    
    
    8,412
 The Company pledged leasehold land and buildings with net book values of US$1,318 and
US$1,385 as of December 31, 2007 and 2006 respectively as collateral for general banking
facilities granted to the Company (see note 9).
 8.
    
    GOODWILL, NETAs of December 31, 2007, goodwill is attributed to wholesale segment of the acquisition of a
jewelry company in 2002.
 Year ended December 31,2007
    
    
    2006US$
    
    
    US$Carrying value, beginning of year
    
    
    1,521
    
    
    
    1,521Impairment loss
    
    
    
    
    
    
    Carrying value, end of year
    
    
    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, 2007. The
accumulated amortization and impairment losses were US$869 and US$869 as of December 31,
2007 and 2006 respectively.
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9.
    
    BANKING FACILITIES AND OTHER LOANS
 As of December 31,2007
    
    
    2006Notes

    
    
    US$
    
    
    US$Bank overdrafts
    
    
    (a)
    
    
    
    2,977
    
    
    
    1,591Notes payable:Current portion
    
    
    (b)
    
    
    
    4,047
    
    
    
    3,987Letters of credit, gold and others:Letters of credit
    
    
    (a)
    
    
    
    12,108
    
    
    
    19,562Factoring
    
    
    (a)
    
    
    
    4,545
    
    
    
    2,782Gold loan
    
    
    (c)
    
    
    
    4,883
    
    
    
    11,07921,536
    
    
    
    33,423
 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)).The material provisions of indentures relating to the Companys various banking facility
agreements contain covenants pertaining to (i) maintenance of the tangible net worth of LJI
and one of its subsidiaries amounting to US$50,000 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, 2007, the Company had various revolving bank facilities of
overdrafts, letters of credit and factoring facilities granted by banks, amounting to
US$4,141, US$20,526 and US$18,431 respectively.The bank overdrafts are denominated in Hong Kong dollars, bear interest at the
floating commercial bank lending rates in Hong Kong, which ranged from 4.4% to 8%
per annum as of December 31, 2007.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 and investment in capital guaranteed fund based on the amount
of facilities granted. The cash balances are reflected as restricted cash in the
balance sheet.
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9.
    
    BANKING FACILITIES AND OTHER LOANS (Continued)
 (b)
    
    The Company also had term loans classified under notes payable which are
related to the Companys leasehold land and buildings (see note 7). These loans
aggregated to US$5,201 as of December 31, 2007. The expected maturities of these notes
payable are within 1-5 years. Interest charges on these loans ranged from 5.6% to 8.8%
per annum as of December 31, 2007.(c)
    
    The Company had outstanding loans to purchase 11.15oz of gold as of December
31, 2007 with the related balances being US$4,883. These loans are due within the
following year, however, have been historically renewed. These loans bear interest at
3.1% to 3.3% per annum as of December 31, 2007 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,
2007 and 2006 were 5.5% and 4.9% per annum respectively.
 10.
    
    INCOME TAXESIncome taxes are accounted for under the asset and liability method. Deferred tax
assets and liabilities are recognized for the future tax consequences attributable to
temporary differences between the financial statement carrying amounts of existing assets
and liabilities and their respective tax bases and operating losses and tax credit carry
forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected
to apply to taxable income in the years in which those temporary differences are expected to
be recovered or settled. The effect on deferred assets and liabilities of a change in tax
rates is recognized in income in the period that includes the enactment date.The Company is subject to income taxes on an entity basis on income arising in or derived
from the tax jurisdiction in which it is domiciled and operates. Income tax expense
comprises of the following:
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10.
    
    INCOME TAXES (Continued)
 Year ended December 31,2007
    
    
    2006
    
    
    2005US$
    
    
    US$
    
    
    US$Current taxes arising in foreign
subsidiaries:For the year
    
    
    (1,525
    )
    
    
    (1,248
    )
    
    
    (595
    )Under provision in prior years
    
    
    (195
    )
    
    
    (72
    )
    
    
    (77
    )Total current tax
    
    
    (1,720
    )
    
    
    (1,320
    )
    
    
    (672
    )Deferred taxes arising in foreign
subsidiaries:For the year
    
    
    9
    
    
    
    (83
    )
    
    
    (67
    )Income taxes expense
    
    
    (1,711
    )
    
    
    (1,403
    )
    
    
    (739
    )
 Reconciliation to the expected statutory tax rate in Hong Kong of 17.5% (2006 and 2005:
17.5%)is as follows:
 Year ended December 31,2007
    
    
    2006
    
    
    2005%
    
    
    %
    
    
    %Statutory rate
    
    
    17.5
    
    
    
    17.5
    
    
    
    17.5Tax effect of net operating losses
    
    
    43.8
    
    
    
    16.6
    
    
    
    21.2Non taxable profits, net
    
    
    (13.3
    )
    
    
    (14.4
    )
    
    
    (21.7
    )Others
    
    
    5.4
    
    
    
    1.0
    
    
    
    2.3Effective rate
    
    
    53.4
    
    
    
    20.7
    
    
    
    19.3
 Deferred income taxes reflect the net tax effects of temporary differences between the
carrying amounts of assets and liabilities for financial reporting purposes and the amounts
used for income tax purposes. Significant components of the Companys deferred tax assets
and liabilities are as follows:
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10.
    
    INCOME TAXES (Continued)
 As of December 31,2007
    
    
    2006US$
    
    
    US$Deferred tax assets:Net operating loss
    
    
    4,957
    
    
    
    4,099Depreciation
    
    
    61
    
    
    
    53Others
    
    
    60
    
    
    
    585,078
    
    
    
    4,210Valuation allowance
    
    
    (4,967
    )
    
    
    (4,099
    )Total deferred tax assets
    
    
    111
    
    
    
    111Deferred tax liabilities:Accelerated tax allowance
    
    
    (202
    )
    
    
    (237
    )Others
    
    
    (137
    )
    
    
    (111
    )Net deferred tax liabilities
    
    
    (339
    )
    
    
    (348
    )
 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 year ended December 31, 2007 was
US$868; for December 31, 2006 and 2005, there were (decrease) increase in valuation
allowance amounted to (US$1,049) and US$2,237 respectively.Based on the history of the Companys profitability, management believes that it is more
likely than not that the Company will realize the benefits of the deferred tax assets of
US$111 and US$111, net of valuation allowances as of December 31, 2007 and 2006.11.
    
    LEASEThe Company is obligated under capital leases covering certain motor vehicles and
office equipment that expire at various dates during the next five years. At December 31,
2007 and 2006, the gross amount of motor vehicles and office equipment and related
accumulated amortization recorded under capital leases were as follows:
 As of December 31,2007
    
    
    2006US$
    
    
    US$Motor vehicles
    
    
    493
    
    
    
    493Furniture, fixtures and equipment
    
    
    19
    
    
    
    19512
    
    
    
    512Less accumulated amortization
    
    
    (245
    )
    
    
    (143
    )267
    
    
    
    369
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11.
    
    LEASE (Continued)Amortization of assets held under capital leases is included with depreciation expenses.The Company leases certain of its office and factory premises under various
operating leases which the rent payables are charged to statements of operations on a
straight-line basis over the term of the relevant leases including any periods of free
rent. In addition to the future minimum lease payments, the terms of the leases in
respect of the retail shops in the PRC and Hong Kong provide for the payment of
contingent rentals based on a percentage of sales in excess of a stipulated amount.
Rental expenses for operating leases for the years ended December 31, 2007, 2006 and
2005 consisted of the following:
 Year ended December 31,2007
    
    
    2006
    
    
    2005US$
    
    
    US$
    
    
    US$Minimum rentals
    
    
    5,486
    
    
    
    3,222
    
    
    
    1,166Contingent rentals
    
    
    722
    
    
    
    105
    
    
    
    22Rental expenses
    
    
    6,208
    
    
    
    3,327
    
    
    
    1,188
 Future minimum capital lease payments under capitalized leases and non-cancellable
operating leases are approximately as follows:
 As of December 31, 2007
    
    
    As of December 31, 2006Capitalized
    
    
    Operating
    
    
    Capitalized
    
    
    Operatingleases
    
    
    leases
    
    
    leases
    
    
    leasesUS$
    
    
    US$
    
    
    US$
    
    
    US$2007
    
    
    
    
    
    
    
    
    
    
    110
    
    
    
    2,5842008
    
    
    106
    
    
    
    1,838
    
    
    
    106
    
    
    
    1,7412009
    
    
    87
    
    
    
    913
    
    
    
    87
    
    
    
    3602010
    
    
    85
    
    
    
    417
    
    
    
    106
    
    
    
    Thereafter
    
    
    21
    
    
    
    131
    
    
    
    
    
    
    
    Total future
minimum lease
payments
    
    
    299
    
    
    
    3,299
    
    
    
    409
    
    
    
    4,685Less: Amount
representing
interest (at rates
ranging from 0% to
4.95%)
    
    
    (26
    )
    
    
    
    
    
    
    (53
    )Present value of
net minimum capital
lease payments
    
    
    273
    
    
    
    
    
    
    
    356Less current
instatements of
obligations under
capital leases
    
    
    (92
    )
    
    
    
    
    
    
    (94
    )Obligations under
capital leases,
excluding current
instalments
    
    
    181
    
    
    
    
    
    
    
    262
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11.
    
    LEASE (Continued)The Company leases certain of its office and quarters from related party with two years
lease terms expiring in 2008 and 2009. Rental expenses for operating leases paid to related
party are included in the data presented above. Total rent expense associated with these
leases was US$245, US$227 and US$150 for the years ended December 31, 2007, 2006 and 2005
respectively.12.
    
    COMMITMENTS AND CONTINGENCIES
 (a)
    
    CommitmentsAs of December 31, 2007, the Company had capital expenditure commitments of US$9.(b)
    
    ContingenciesAs of December 31, 2007, 2006 and 2005, the Company provided guarantee in respect of
bank mortgage loans granted to a director, Mr. Yih Yu Chuan to the extent of US$79,
US$158 and US$237 respectively.(c)
    
    Legal ProceedingsSecurities Litigation. In September 2007, several shareholder class actions were
filed in the United States District Court for the Central District of California
against the Company and certain officers and directors of the Company, entitled Apple
v. LJ International Inc., et al. (No. 07-06076), Cooper v. LJ International, Inc., et
al. (No. 07/06213), and Lieben v. LJ International Inc., et. al. (No. 07-06216). On
February 8, 2008, the judge to whom the cases were referred consolidated the cases
and appointed lead plaintiff and lead counsel. On April 8, 2008, the lead plaintiff
filed an amended and consolidated complaint (the Complaint.)The Complaint alleges that the defendants violated Sections 10(b) and 20(a) of the
Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder. It seeks an
unspecified amount of damages on behalf of all persons who purchased LJ common stock
during the period from February 15, 2007, to September 6, 2007 (the Class Period).
The Complaint alleges that the Companys February 15, 2007 press release, which
provided financial guidance for the Companys fourth quarter and year-end 2006 net
income and earnings, contained materially false and misleading statements.
Specifically, paragraph 10 of the Complaint alleges that the press release failed to
disclose known uncertainties, such as applicable tax provisions, that had material,
adverse effects on LJs 2006 fourth quarter and full year earnings and net income.
The Complaint alleges that the defendants overstated the Companys fiscal 2006
financial results, and thereby artificially inflated the market price of LJs common
stock throughout the Class Period.On May 27, 2008, the Company (the only defendant served with the Complaint) moved to
dismiss the Complaint pursuant to Rule 12(b) of the Federal Rules of Civil Procedure.
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12.
    
    COMMITMENTS AND CONTINGENCIES (Continued)
 (c)
    
    Legal proceedings (Continued)
 At this time, the Company is unable to form a professional judgment as to whether
unfavorable outcomes are either probable or remote.Derivative Litigation. Two purported shareholder derivative lawsuits, Vaughn v.
Yih, et al. (Los Angeles Superior Court No. BC 378903) and Cooke v. Yih, et al.
(Los Angeles Superior Court No. BC 380214), were filed in California in Los Angeles
County Superior Court on October 10 and November 5, 2007, respectively.The complaints in the derivative actions allege, among other things, that various
officers and directors of the Company caused the Company to issue a series of press
releases, Securities and Exchange Commission filings, and other statements that
significantly overstated the Companys business prospects and financial results.
They further allege that, as a result of these statements, the Companys share price
traded at artificially inflated levels, and that defendants actions led to a delay
in the release of the Companys financial statements for the fiscal fourth quarter
of 2006 and the fiscal first quarter of 2007. The plaintiffs purport to state causes
of action for breach of fiduciary duty, waste of corporate assets, and unjust
enrichment. By their complaints, they seek among other relief, unspecified damages
to be paid to the Company, corporate governance reforms, and equitable and
injunctive relief, including restitution and the creation of a constructive trust.On May 9, 2009, the court in the Vaughnaction sustained the defendants demurrer
without leave to amend on the ground that the plaintiff failed to obtain the
required leave from the High Court of the British Virgin Islands to file the
derivative action. The Vaughnaction was dismissed pursuant to the order sustaining
the demurrer. On May 15, 2008, the plaintiff filed a notice of appeal from the order
of dismissal.In May 2008, the Cookeaction was reassigned to the same judge that presided over
the Vaughnaction. The Company anticipates that the court will set a status
conference in due course.At this time, the Company is unable to form a professional judgment as to whether
unfavorable outcomes are either probable or remote.Shao v. Yih, et al.On October 28, 2007, the former chief executive officer of
Lorenzo USA, Inc. (a wholly-owned subsidiary of LJ), sued LJ, Lorenzo USA, Inc., and
LJs Chief Executive Officer Yu Chuan Yih in Los Angeles Superior Court, Shao v,
Yih, et al., Case No. BC379851. The plaintiff claimed that the defendants wrongfully
refused to honor his valid exercise of options for the purchase of LJ stock. On
April 25, 2008, the parties agreed to settle the dispute at mediation. A Request for
Dismissal was filed in May 2008.Besides the above-mentioned legal proceedings, the Company is exposed to certain asserted
and unasserted potential claims. There can be no assurance that, with respect to
potential claims made against the Company, the Company could resolve such claims under terms and
conditions that would not have a material adverse effect on its
business, its
liquidity or financial results. Periodically, the Company reviews the status of each
significant matter and assesses its potential financial exposure. If the potential
loss from any claim or legal proceeding is considered probable and a range of
possible losses can be estimated, the Company then accrues a liability for the estimated
loss. Any liability for estimated loss is based on the criteria in SFAS No. 5,
Accounting for Contingencies. Legal proceedings are subject to uncertainties,
and the outcomes are difficult to predict. Because of such uncertainties, accruals
are based only on the best information available at the time. As additional
information becomes available, the Company reassesses the potential liability related to
pending claims and litigation and may revise estimate. Presently, no accrual has
been estimated under SFAS No. 5 for potential losses that may or may not arise
from the current lawsuits in which the Company is involved. Accruals include billings for
legal services performed to date and expected to be performed in the future in
connection with the matters described above.
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13.
    
    COMMON STOCK AND WARRANTS OTHER THAN STOCK-BASED COMPENSATION
 (a)
    
    Common stock
       (b)
    
    Warrants other than stock-based compensation
 As of December 31,2007
    
    
    2006
    
    
    2005Number of
    
    
    Number of
    
    
    Number ofwarrants
    
    
    warrants
    
    
    warrantsOutstanding, beginning of year
    
    
    1,062,586
    
    
    
    429,676
    
    
    
    2,361,721Granted
    
    
    
    
    
    
    632,910
    
    
    
    Exercised
    
    
    (562,801
    )
    
    
    
    
    
    
    (54,545
    )Expired
    
    
    
    
    
    
    
    
    
    
    (1,877,500
    )Outstanding, end of year
    
    
    499,785
    
    
    
    1,062,586
    
    
    
    429,676
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13.
    
    COMMON STOCK AND WARRANTS OTHER THAN STOCK-BASED COMPENSATION (Continued)
 (b)
    
    Warrants other than stock-based compensation (Continued)
 The following table shows the warrants outstanding as of December
31, 2007.
 Number ofwarrantsDate of grant
    
    Notes
    
    outstanding
    
    
    Exercise price
    
    
    Expiration dateSeptember 1, 2004
    
    (i)
    
    
    170,451
    
    
    US$2.98
    
    
    September 3, 2009September 25, 2006
    
    (ii)
    
    
    329.334
    
    
    US$4.50
    
    
    March 25, 2012September 25, 2006
    
    (ii)
    
    
    
    
    
    US$4.221
    
    
    February 5, 2007
 
 (i)
    
    On September 1, 2004, the Company issued warrants for the
investors of a private placement to purchase 484,221 shares of the Companys
common stock at an exercise price of US$2.98 per share with an expiration date
of September 3, 2009.(ii)
    
    On September 25, 2006, the Company issued long-term and
short-term warrants to the investors of a private placement. The long-term
warrants represent a five-year option to purchase in the aggregate up to
366,668 shares of common stock at $4.50 per share at any time during the period
from March 25, 2007 until March 25, 2012, and the short-term warrants represent
an option to purchase in the aggregate up to 236,909 shares of common stock at
$4.221 per share at any time during the period from September 25, 2006 until
February 5, 2007.The Company has also issued warrants to the placement agent of the private
placement to purchase 29,333 shares of the Company. The warrants issued to
the placement agent are identical to the long-term warrants. The fair value of warrants was valued using the Black Scholes option valuation model
with resulting allocation of the aggregate proceeds from private placement between
common stock and the underlying warrants, and which have been included in the
additional paid-in capital.
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14.
    
    EMPLOYEE RETIREMENT BENEFIT PLANSFollowing the introduction of the Mandatory Provident Fund (MPF) legislation in Hong Kong,
the Company has participated in the defined contribution mandatory provident fund since
December 1, 2000. Both the Company and its employees in Hong Kong make monthly
contributions to the fund at 5% of the employees earnings as defined under Mandatory
Provident Fund legislation. The 5% monthly contribution of the Company and the employees
are subject to a cap of US$0.128 per month and thereafter contributions are voluntary. When
employees leave the MPF scheme prior to vesting fully in voluntary contributions, the
contributions payable by the Company are reduced by the amount of forfeited contributions.The amount of forfeitures in respect of the MPF scheme, which was available to reduce the
Companys contribution payable, for the year ended December 31, 2007, 2006 and 2005 was
US$27, US$Nil and US$Nil, respectively.The full-time employees of the PRC subsidiaries are entitled to staff welfare benefits,
including medical care, welfare subsidies, unemployment insurance and pension benefits.
These companies are required to accrue for these benefits based on certain percentages of
the employees salaries in accordance with the relevant regulations, and to make
contributions to the state-sponsored pension and medical plans out of the amounts accrued
for medical and pension benefits. The state-sponsored retirement plan was responsible for
the entire pension obligations for the actual pension payments or post-retirement benefits
beyond the annual contributions.The Company has adopted Profit Sharing Plan and Trust (Profit Sharing Plan) for the
benefit of substantially all employees in the US that satisfied the age and service
requirements. The Companys contributions are determined according to a discretionary
formula in an amount determined each year by the management and will be allocated to
each Qualifying Participants individual account using the pro rata formula. No profit
sharing expense made during all financial periods since its adoption.Contributions paid and payable by the Company in respect of the employee retirement benefit
plans charged to the consolidated statement of operations were US$1,505, US$1,317 and
US$831 for the years ended December 31, 2007, 2006 and 2005 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.
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##### Table of Contents



15.
    
    STOCK-BASED COMPENSATION (Continued)
 (a)
    
    Stock incentive plan (Continued)Out of the stock options provided, 1,285,000 stock options were issued in accordance
with the terms of the 1998 Plan on April 12, 1999 to certain officers, directors,
key employees and advisors of the Company at an exercise price of US$5.0 per share
(the fair market value of the common stock as of April 12, 1999) and are exercisable
during the period from April 12, 1999 to April 11, 2009.Pursuant to the 1999 Annual Meeting of the Shareholders on December 15, 1999, the
authorized number of stock options was increased from 2,000,000 to 4,000,000. The
purchase price of the shares of the Common Stock covered by the 1998 Plan shall be
at least 100% of the fair market value per share of such shares on the date of
grant, with a term of ten years.On July 1, 2003, the Company adopted the second stock plan (The 2003 Plan) which was
approved by the shareholders on December 5, 2003. The 2003 Plan allows the Board of
Directors, or a committee thereof at the Boards discretion, to provide for a total
of 4,000,000 stock options to officers, directors, key employees and advisors of the
Company. The purchase price of the shares of the Common Stock covered by The 2003
Plan could be less than, equal to or greater than 100% of the fair market value of
the Common Stock at the time of grant, with a term of ten years.On July 1, 2005, the Company adopted and approved the third stock plan (The 2005
Plan) which was approved by the shareholders on September 26, 2005. The Company
believes that a new plan is necessary since there are only a minimal number of
options remaining under The 1998 Plan and 2003 Plan. The Company believes that the
grant of stock options is accomplishing its purposes, which is to promote the
Company and the shareholders interests by providing key employees with an
opportunity to acquire a proprietary interest in the Company and to develop a
stronger incentive to put forth maximum effort for the Company continued success and
growth. In addition, the opportunity to acquire a propriety interest in the Company
aids the Company in attracting and retaining key personnel of outstanding ability.Options granted under The 2005 Plan will constitute either incentive stock
options within the meaning of Section 422 of the United States Internal Revenue Code
of 1986, as amended, or options which constitute nonqualified options at the time of
issuance of such options. The 2005 Plan provides that incentive stock options
and/or nonqualified stock options may be granted to our officers, directors,
employees and advisors selected by the compensation committee. A total of
4,000,000 shares of common stock are authorized and reserved for issuance
during the term of The 2005 Plan, which expires in June 2015. The compensation
committee has the sole authority to interpret The 2005 Plan and make all
determinations necessary or advisable for administering The 2005 Plan. The exercise
price for any incentive option and nonqualified option may be less than, equal to or
greater than 100% and 110% respectively of the fair market value of the shares as of
the date of grant.
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15.
    
    STOCK-BASED COMPENSATION (Continued)
 (a)
    
    Stock incentive plan (Continued)Upon the exercise of the option, the exercise price must be paid in
full either in cash, shares of the Companys stock or combination. If any
option is not exercised for any reason, such shares shall again become
available for the purposes of The 2005 Plan. As of December 31, 2007,
1,500,000 options had been granted under The 2005 Plan.The stock options activities and related information are summarized as follows:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31, 2007
    
    
    December 31, 2006
    
    
    December 31, 2005Weighted
    
    
    
    
    
    
    Weighted
    
    
    
    
    
    
    Weightedaverage
    
    
    
    
    
    
    average
    
    
    
    
    
    
    averageexercise
    
    
    
    
    
    
    exercise
    
    
    
    
    
    
    exerciseOptions
    
    
    price
    
    
    Options
    
    
    Price
    
    
    Options
    
    
    priceUS$
    
    
    
    
    
    
    US$
    
    
    
    
    
    
    US$Outstanding, beginning of year
    
    
    1,821,000
    
    
    
    2.06
    
    
    
    3,310,500
    
    
    
    2.04
    
    
    
    3,759,000
    
    
    
    2.02Granted
    
    
    1,500,000
    
    
    
    5.14
    
    
    
    
    
    
    
    
    
    
    
    3,113,500
    
    
    
    2.44Exercised (note 13(a)(v))
    
    
    (1,897,000
    )
    
    
    4.48
    
    
    
    (1,489,500
    )
    
    
    2.02
    
    
    
    (3,162,000
    )
    
    
    2.40Cancelled
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    (400,000
    )
    
    
    2.18Outstanding, end of year
    
    
    1,424,000
    
    
    
    2.07
    
    
    
    1,821,000
    
    
    
    2.06
    
    
    
    3,310,500
    
    
    
    2.04Exercise price less than the
market price on date of grant
    
    
    150,000
    
    
    
    2.00
    
    
    
    150,000
    
    
    
    2.00
    
    
    
    150,000
    
    
    
    2.00Exercise price equals to
market price on date of grant
    
    
    404,000
    
    
    
    2.00
    
    
    
    409,000
    
    
    
    2.00
    
    
    
    701,000
    
    
    
    2.00Exercise price exceeds to
market price on date of grant
    
    
    870,000
    
    
    
    2.12
    
    
    
    1,262,000
    
    
    
    2.08
    
    
    
    2,459,500
    
    
    
    2.051,424,000
    
    
    
    2.07
    
    
    
    1,821,000
    
    
    
    2.06
    
    
    
    3,310,500
    
    
    
    2.04Range of exercise price- US$2.00
    
    
    1,010,500
    
    
    
    2.00
    
    
    
    1,407,500
    
    
    
    2.00
    
    
    
    2,797,000
    
    
    
    2.00- US$2.25
    
    
    413,500
    
    
    
    2.25
    
    
    
    413,500
    
    
    
    2.25
    
    
    
    513,500
    
    
    
    2.251,424,000
    
    
    
    2.07
    
    
    
    1,821,000
    
    
    
    2.06
    
    
    
    3,310,500
    
    
    
    2.04Exercisable, end of year- exercise price at US$2.00
    
    
    963,625
    
    
    
    2.00
    
    
    
    1,041,125
    
    
    
    2.00
    
    
    
    2,093,125
    
    
    
    2.00- exercise price at US$2.25
    
    
    413,500
    
    
    
    2.25
    
    
    
    413,500
    
    
    
    2.25
    
    
    
    513,500
    
    
    
    2.251,377,125
    
    
    
    2.08
    
    
    
    1,454,625
    
    
    
    2.07
    
    
    
    2,606,625
    
    
    
    2.05Weighted average remaining
contractual life- exercise price at US$2.00
    
    3.32 years
    
    
    
    
    
    
    4.87 years
    
    
    
    
    
    6.09 years- exercise price at US$2.25
    
    0.33 year
    
    
    
    
    
    
    1.33 years
    
    
    
    
    
    2.33 years
 All options issued, other than 46,875 options, are immediately exercisable as of
December 31, 2007. The 46,875 options are issued and outstanding but only vest in
2008.
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##### Table of Contents



15.
    
    STOCK-BASED COMPENSATION (Continued)
 (b)
    
    Warrants
 (i)
    
    On August 16, 2001, the Company issued to an agent warrants to
purchase 200,000 shares of common stock of the Company at US$3.00 per share
exercisable through August 15, 2006 in consideration for consultancy services
and which have been expired as of December 31, 2006.(ii)
    
    Pursuant to a media relation services agreement dated April 5,
2005, the Company issued to a consultant warrants to purchase 50,000 shares,
150,000 shares, 150,000 shares, 100,000 shares and 50,000 shares of common
stock of the Company at US$2.80, US$3.00, US$3.50, US$4.00 and US$4.50
respectively per share exercisable through April 4, 2008. These warrants were
exercised during the year ended December 31, 2006 and 500,000 shares of common
stock were issued accordingly.(iii)
    
    In connection with private placement to investors completed in
September 2006, the Company issued to a consultant warrants to purchase 29,333
shares of common stock of the Company at US$4.50 per share exercisable through
March 25, 2012.
 Save as disclosed above, none of the warrants as aforesaid was exercised for
the three years ended December 31, 2007, 2006 and 2005. 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 years ended December
31, 2006 and December 31, 2005 was estimated as US$47 and US$472 respectively
by using the Black-Scholes option pricing model with the following
weighted-average assumptions:
 Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,2006
    
    
    2005Expected dividend yield
    
    
    
    
    
    
    Expected stock price volatility
    
    
    42.5
    %
    
    
    61
    %Risk-free interest rate
    
    
    4.67
    %
    
    
    3.91
    %Expected life of warrants
    
    5.5 years
    
    3 years
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16.
    
    RELATED PARTY TRANSACTIONS
 (a)
    
    Names and relationship of related parties:
 Existing relationships with the CompanyYih Yu Chuan
    
    Director and major beneficial shareholder of
the CompanyTanzanite (H.K.) Limited
    
    Common directorsOsorio Mendes Quintino Neto
    
    Minor shareholder and former director of a
subsidiary of the CompanyAndrew N. Bernstein
    
    Non-executive director
 (b)
    
    Summary of balances with related parties:
 As of December 31,2007
    
    
    2006Note
    
    US$
    
    
    US$Due from related parties:Tanzanite (H.K.) Limited
    
    (i)
    
    
    
    
    
    
    21Due to a related party:Osorio Mendes Quintino Neto
    
    (i)
    
    
    
    
    
    
    15Certain banking facilities granted to the
Company collateralized by properties owned by
Yih Yu Chuan and his personal guarantee to the
extent of
    
    
    
    
    14,708
    
    
    
    23,161Guarantee to a bank in respect of mortgage
loan granted to Yih Yu Chuan
    
    
    
    
    79
    
    
    
    158
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16.
    
    RELATED PARTY TRANSACTIONS (Continued)
 (c)
    
    Summary of related party transactions:
 Year ended December 31,2007
    
    
    2006
    
    
    2005US$
    
    
    US$
    
    
    US$Sales:- to Osorio Mendes Quintino Neto
    
    
    
    
    
    
    940
    
    
    
    Expenses:Rental expense to Tanzanite (H.K.)
Limited
    
    
    245
    
    
    
    227
    
    
    
    150Consultant fee to Osorio Mendes
Quintino Neto
    
    
    75
    
    
    
    180
    
    
    
    135Legal fee and directors fee to
Andrew N. Bernstein
    
    
    155
    
    
    
    116
    
    
    
    80475
    
    
    
    523
    
    
    
    365
 The Company leases certain of its office and quarter from the related party. The
leases are for two years term expiring in 2008 and 2009. The Company may terminate
these tenancies at any time after the expiration of the first 12 months after the
commencement of the term of tenancy, by giving the landlord no less than two months
prior notice.(i) The amounts due from/ to related parties represent unsecured advances which are
interest-free and repayable on demand.
 17.
    
    SEGMENT INFORMATIONThe Company has adopted SFAS No. 131, Disclosures about Segments of an Enterprise
and Related Information, which establishes annual reporting standards for enterprise
business segments and related disclosures about its products and services, geographic
areas and major customers. SFAS No. 131 defines operating segments as components of an
enterprise about which separate financial information is available that is evaluated
regularly by the chief operating decision maker in deciding how to allocate resources
and in assessing performance.The Company evaluates segment performance and allocates resources based on several
factors of which the primary financial measures are revenues from external customers
and operating income. As a result, the Company considers that it has two operating
segments, (i) manufacture and wholesale of jewelry products, and (ii) retail of jewelry
products.
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##### Table of Contents



17.
    
    SEGMENT INFORMATION (Continued)Contributions of the major activities, profitability information and asset information are
summarized below:
 Manufactureandwholesale
    
    
    Retail
    
    
    Corporate
    
    
    TotalUS$
    
    
    US$
    
    
    US$
    
    
    US$Year ended December 31, 2007Segment revenue from external customers
    
    
    117,689
    
    
    
    34,348
    
    
    
    
    
    
    
    152,037Income (loss) from operations
    
    
    7,090
    
    
    
    1,017
    
    
    
    (2,076
    )
    
    
    6,031Interest income
    
    
    265
    
    
    
    6
    
    
    
    2
    
    
    
    273Interest expenses
    
    
    (3,103
    )
    
    
    
    
    
    
    
    
    
    
    (3,103
    )Income before income taxes and
minority interests
    
    
    4,252
    
    
    
    1,023
    
    
    
    (2,074
    )
    
    
    3,201Incomes taxes
    
    
    (1,015
    )
    
    
    (696
    )
    
    
    
    
    
    
    (1,711
    )Minority interests in consolidated
subsidiaries
    
    
    (1
    )
    
    
    
    
    
    
    
    
    
    
    (1
    )Net income
    
    
    3,236
    
    
    
    327
    
    
    
    (2,074
    )
    
    
    1,489Significant non-cash items:-Depreciation
    
    
    1,995
    
    
    
    1,100
    
    
    
    
    
    
    
    3,095-Minority interests
    
    
    1
    
    
    
    
    
    
    
    
    
    
    
    1-Stock-based compensation cost
    
    
    25
    
    
    
    162
    
    
    
    300
    
    
    
    487Segment assets
    
    
    97,715
    
    
    
    36,429
    
    
    
    
    
    
    
    134,144Total expenditures for additions to
long-lived assets
    
    
    1,162
    
    
    
    1,977
    
    
    
    
    
    
    
    3,139Depreciation and amortization
    
    
    1,995
    
    
    
    1,100
    
    
    
    
    
    
    
    3,095
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17.
    
    SEGMENT INFORMATION (Continued)
 Manufactureandwholesale
    
    
    Retail
    
    
    Corporate
    
    
    TotalUS$
    
    
    US$
    
    
    US$
    
    
    US$Year ended December 31, 2006Segment revenue from external customers
    
    
    108,679
    
    
    
    15,112
    
    
    
    
    
    
    
    123,791Income (loss) from operations
    
    
    10,514
    
    
    
    1,456
    
    
    
    (2,228
    )
    
    
    9,742Interest income
    
    
    277
    
    
    
    1
    
    
    
    4
    
    
    
    282Interest expenses
    
    
    (3,258
    )
    
    
    
    
    
    
    
    
    
    
    (3,258
    )Income before income taxes and
minority interests
    
    
    7,533
    
    
    
    1,457
    
    
    
    (2,224
    )
    
    
    6,766Incomes taxes
    
    
    (682
    )
    
    
    (721
    )
    
    
    
    
    
    
    (1,403
    )Minority interests in consolidated
subsidiaries
    
    
    (38
    )
    
    
    
    
    
    
    
    
    
    
    (38
    )Net income
    
    
    6,813
    
    
    
    736
    
    
    
    (2,224
    )
    
    
    5,325Significant non-cash items:-Depreciation
    
    
    1,425
    
    
    
    614
    
    
    
    
    
    
    
    2,039-Minority interests
    
    
    38
    
    
    
    
    
    
    
    
    
    
    
    38-Stock-based compensation cost
    
    
    89
    
    
    
    
    
    
    
    281
    
    
    
    370Segment assets
    
    
    103,220
    
    
    
    21,302
    
    
    
    
    
    
    
    124,522Total expenditures for additions to
long-lived assets
    
    
    3,078
    
    
    
    1,105
    
    
    
    
    
    
    
    4,183Depreciation and amortization
    
    
    1,425
    
    
    
    614
    
    
    
    
    
    
    
    2,039
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17.
    
    SEGMENT INFORMATION (Continued)
 Manufactureandwholesale
    
    
    Retail
    
    
    Corporate
    
    
    TotalUS$
    
    
    US$
    
    
    US$
    
    
    US$Year ended December 31, 2005Segment revenue from external customers
    
    
    97,145
    
    
    
    2,501
    
    
    
    
    
    
    
    99,646Income (loss) from operations
    
    
    8,808
    
    
    
    (1,847
    )
    
    
    (1,290
    )
    
    
    5,671Interest income
    
    
    139
    
    
    
    
    
    
    
    
    
    
    
    139Interest expenses
    
    
    (1,991
    )
    
    
    
    
    
    
    
    
    
    
    (1,991
    )Income before income taxes, minority
interests and extraordinary item
    
    
    6,956
    
    
    
    (1,847
    )
    
    
    (1,290
    )
    
    
    3,819Incomes taxes
    
    
    (739
    )
    
    
    
    
    
    
    
    
    
    
    (739
    )Minority interests in consolidated
subsidiaries
    
    
    (20
    )
    
    
    
    
    
    
    
    
    
    
    (20
    )Extraordinary gain on negative goodwill
    
    
    1,291
    
    
    
    
    
    
    
    
    
    
    
    1,291Net income
    
    
    7,488
    
    
    
    (1,847
    )
    
    
    (1,290
    )
    
    
    4,351Significant non-cash items:-Depreciation
    
    
    1,154
    
    
    
    214
    
    
    
    
    
    
    
    1,368-Extraordinary (gain) on negative goodwill
    
    
    (1,291
    )
    
    
    
    
    
    
    
    
    
    
    (1,291
    )-Minority interests
    
    
    20
    
    
    
    
    
    
    
    
    
    
    
    20-Stock-based compensation cost
    
    
    
    
    
    
    
    
    
    
    136
    
    
    
    136Segment assets
    
    
    101,260
    
    
    
    6,970
    
    
    
    
    
    
    
    108,230Total expenditures for additions to
long-lived assets
    
    
    1,864
    
    
    
    1,005
    
    
    
    
    
    
    
    2,869Depreciation and amortization
    
    
    1,154
    
    
    
    214
    
    
    
    
    
    
    
    1,368
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17.
    
    SEGMENT INFORMATION (Continued)
 (a)
    
    Geographical areas:The following summarizes the Companys revenue from the following
geographic areas (based on the location of the customer).
 Year ended December 31,2007
    
    
    2006
    
    
    2005US$
    
    
    US$
    
    
    US$Revenue from external customers:US & Canada
    
    
    80,572
    
    
    
    76,889
    
    
    
    67,780Europe and other countries
    
    
    32,597
    
    
    
    24,452
    
    
    
    20,527Japan
    
    
    2,206
    
    
    
    2,454
    
    
    
    3,686PRC (including Hong Kong and
Macau)
    
    
    36,662
    
    
    
    19,996
    
    
    
    7,653152,037
    
    
    
    123,791
    
    
    
    99,646
 As of December 31,2007
    
    
    2006US$
    
    
    US$Carrying amount of long-lived assets:Hong Kong
    
    
    5,117
    
    
    
    5,485PRC
    
    
    4,600
    
    
    
    4,163US
    
    
    35
    
    
    
    110Total long-lived assets (excluding goodwill)
    
    
    9,752
    
    
    
    9,758Reconciling items:Others
    
    
    124,392
    
    
    
    114,764Total consolidated assets
    
    
    134,144
    
    
    
    124,522
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18.
    
    SIGNIFICANT CONCENTRATIONS AND RISKS
 (a)
    
    Revenue concentrationsThe Company derived operating revenue from the following major customers,
which accounted for over 10% of operating revenue.
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2007
    
    
    2006
    
    
    2005US$
    
    
    %
    
    
    US$
    
    
    %
    
    
    US$
    
    
    %Customer A
    
    
    14,840
    
    
    
    10
    
    
    
    9,894
    
    
    
    8
    
    
    
    5,975
    
    
    
    6Customer B
    
    
    11,993
    
    
    
    8
    
    
    
    12,700
    
    
    
    10
    
    
    
    10,772
    
    
    
    11Customer C
    
    
    8,564
    
    
    
    6
    
    
    
    10,334
    
    
    
    8
    
    
    
    13,093
    
    
    
    13
 Trade receivables related to these major customers were US$398, US$1,455 and US$1,569
as of December 31, 2007 respectively and US$204, US$1,397 and US$1,247 as of December
31, 2006 respectively.
 (b)
    
    Dependence on suppliersGold is the major raw material used in the production of the Companys jewelry
products. The Company purchased gold from banks, gold refiners and commodity dealers
who supplied substantially all of the Companys gold needs, which the Company believed
was sufficient to meet its requirement.The major suppliers of gold accounted 10% or more of total purchases:
 Year ended
    
    
    Year ended
    
    
    Year endedDecember 31,
    
    
    December 31,
    
    
    December 31,2007
    
    
    2006
    
    
    2005US$
    
    
    %
    
    
    US$
    
    
    %
    
    
    US$
    
    
    %Supplier A
    
    
    25,841
    
    
    
    26
    
    
    
    367
    
    
    
    1
    
    
    
    *Supplier B
    
    
    11,348
    
    
    
    11
    
    
    
    30,150
    
    
    
    37
    
    
    
    18,031
    
    
    
    25Supplier C
    
    
    1,048
    
    
    
    1
    
    
    
    3,425
    
    
    
    4
    
    
    
    9,656
    
    
    
    14
 
 *
    
    New supplier since 2006 Trade payables related to these major suppliers were US$187 and US$9 as of December 31,
2007 and 2006 respectively.
 19.
    
    RECLASSIFICATIONSCertain prior year amounts have been reclassified to confirm to the current year
presentation.
 F-47




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##### Table of Contents



Schedule II
 Valuation and Qualifying Accounts
  Sales return reservesBalance at December 31, 2004
    
    $
    524Charges to operations
    
    
    8,154Deductions
    
    
    (6,474
    )Balance at December 31, 2005
    
    
    2,204Charges to operations
    
    
    8,581Deductions
    
    
    (8,348
    )Balance at December 31, 2006
    
    
    2,437Charges to operations
    
    
    9,464Deductions
    
    
    (10,348
    )Balance at December 31, 2007
    
    
    1,553
 F-48




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##### Table of Contents



ITEM 19. EXHIBITS
  1.1
    
    Memorandum of Association of the Company*1.2
    
    Articles of Association of the Company*1.3
    
    Amendment to Articles of Association of the Company*4.1
    
    Employment Agreement of Yu Chuan Yih with the Registrant**8.1
    
    List of Significant Subsidiaries of the Company11.1
    
    Code of Ethics***12.1
    
    Certification of Chief Executive Officer Pursuant to Rule 13a-14(a)12.2
    
    Certification of Chief Financial Officer Pursuant to Rule 13a-14(a)13.1
    
    Certification of Chief Executive Officer Pursuant to Rule
13a-14(b) and 18 U.S.C. 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, 2006.***
    
    Incorporated by reference to the Exhibits to our Annual Report on Form 20-F for the fiscal year
ended December 31, 2003. -113-




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##### Table of Contents



SIGNATURES
  LJ INTERNATIONAL INC.
(Registrant)Date:  June 27, 2008
    By:
    /s/ YU CHUAN YIHYu Chuan YihChairman




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##### Table of Contents



EXHIBIT INDEX
 ExhibitNumber
    
    Description of Exhibit1.1
    
    Memorandum of Association of the Company*1.2
    
    Articles of Association of the Company*1.3
    
    Amendment to Articles of Association of the Company*4.1
    
    Employment Agreement of Yu Chuan Yih with the 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, 2006.***
    
    Incorporated by reference to the Exhibits to our Annual Report on Form 20-F for the fiscal
year ended December 31, 2003.