UNITED
STATES
 SECURITIES
AND EXCHANGE COMMISSION
 Washington,
D.C. 20549
  
  FORM
10-K/A
 Amendment
No. 2
 
 x
                    ANNUAL
      REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF
      1934.
  For the
fiscal year ended: December 31, 2007
   ̈
                  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: 001-33758
 FUQI
INTERNATIONAL, INC.
 (Exact
name of registrant as specified in its charter)
 
 Delaware
                  (State
      or other jurisdiction of
                  incorporation
      or organization)
                20-1579407
                  (I.R.S.
      Employer
                  Identification
      No.)
 
 5/F.,
      Block 1, Shi Hua Industrial Zone
                  Cui
      Zhu Road North
                  Shenzhen,
      518019
                  People’s
      Republic of China
                
                N/A(Address
      of principal executive offices)
                
                (Zip
      Code)
 
 REGISTRANT’S
TELEPHONE NUMBER, INCLUDING AREA CODE: +86(755)2580-1888
 
 SECURITIES
REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
  Title of Each Class
                        
                        Name of Each Exchange on Which
      RegisteredCommon
      Stock, $0.001 par value
                        
                        NASDAQ
      Global
Market
 
 SECURITIES
REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
  None.
  Indicate by check mark if the
registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. Yes ̈Nox
 
 Indicate by check mark if the
registrant is not required to file reports pursuant to Section 13 or
Section 15(d) of the Act. Yes ̈Nox
  
 
 Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yes xNo  ̈
  Indicate
by check mark if disclosure of delinquent filers pursuant to Item 405 of
Regulation S-K is not contained herein, and will not be contained, to the
best of registrant’s knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K.  ̈
 
 Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of “large accelerated filer,” “accelerated filer” and “smaller
reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
 
 Large accelerated filer  ̈
              Accelerated
      filer  ̈Non-accelerated filer x
              Smaller
      reporting company  ̈(Do not check if a smaller
      reporting company)
 
 Indicate by check mark whether the
registrant is a shell company (as defined in Rule 12b-2 of the
Act). Yes ̈Nox
 
 The aggregate market value of the
voting and non-voting common equity held by non-affiliates of the registrant on
December 31, 2007 (the last business day of the registrant’s most recently
completed fiscal year), was $80,919,190 based on the closing price of the
registrant’s common stock on The Nasdaq Global Market of $8.30 per share. The
registrant’s common stock commenced trading on The Nasdaq Global Market on
October 23, 2007.
 
 DOCUMENTS
INCORPORATED BY REFERENCE:  None
 
 There
were 20,924,843 shares of common stock outstanding as of March 28,
2008.
  
  EXPLANATORY
NOTE
 
 This
Amendment No. 2 on Form 10-K/A amends and restates items identified below with
respect to the Form 10-K filed by the Company with the Securities and Exchange
Commission (the “SEC”) on August 19, 2008, as amended by the Form 10-K/A filed
by the Company with the SEC on April 29, 2008 (collectively, the “Original
Filing”).
 
 This
Amendment No. 2 on Form 10-K/A only amends information in Item 1 (Business),
Item 1A (Risk Factors), Item 6 (Selected Financial Data), Item 7 (Management's
Discussion and Analysis of Financial Condition and Results of Operations), Item
8 (Financial Statements and Supplementary Data), Item 9A (Controls and
Procedures), Item 11 (Executive Compensation), and Item 13 (Certain
Relationships and Related Transactions, and Director
Independence).  As a result of this Amendment No. 2, the
certifications pursuant to Section 302 and Section 906 of the Sarbanes-Oxley Act
of 2002, filed as exhibits to our Original Filing have been revised, re-executed
and re-filed as of the date of this Amendment. Except as stated in this
Amendment No. 2, this Amendment No. 2 continues to describe conditions as of the
respective dates of the Original Filing, and the disclosures contained herein
have not been updated to reflect events, results or developments that have
occurred after the Original Filing, or to modify or update those disclosures
affected by subsequent events unless otherwise indicated in this report. Among
other things, forward-looking statements made in the Original Filing have not
been revised to reflect events, results or developments that have occurred or
facts that have become known to us after the date of the Original Filing, and
such forward-looking statements should be read in their historical context. This
Amendment No. 2 should be read in conjunction with the Company’s filings made
with the SEC subsequent to the Original Filing, including any amendments to
those filings.
  
 
 FUQI
INTERNATIONAL, INC.
  TABLE
OF CONTENTS TO ANNUAL REPORT ON FORM 10-K/A
  For
the Fiscal Year Ended December 31, 2007
  ITEM
                        
                        
                        
                        PagePART
      I
                        
                        
                        
                        1Item
      1.
                        
                        Business
                        
                        1Item
      1A.
                        
                        Risk
      Factors
                        
                        8Item
      1B.
                        
                        Unresolved
      Staff Comments
                        
                        18Item
      2.
                        
                        Properties
                        
                        18Item
      3.
                        
                        Legal
      Proceedings
                        
                        19Item
      4.
                        
                        Submission
      of Matters to a Vote of Security Holders
                        
                        19PART
      II
                        
                        
                        
                        19Item
      5.
                        
                        Market
      for Registrant’s Common Equity, Related Stockholder Matters and Issuer
      Purchases of Equity Securities
                        
                        19Item
      6.
                        
                        Selected
      Financial Data
                        
                        21Item
      7.
                        
                        Management's
      Discussion and Analysis of Financial Condition and Results of
      Operations
                        
                        22Item
      7A.
                        
                        Quantitative
      and Qualitative Disclosures about Market Risk
                        
                        33Item
      8.
                        
                        Financial
      Statements and Supplementary Data
                        
                        34Item
      9.
                        
                        Changes
      in and Disagreements with Accountants on Accounting and Financial
      Disclosure
                        
                        34Item
      9A.
                        
                        Controls
      and Procedures
                        
                        34Item
      9B.
                        
                        Other
      Information
                        
                        36PART
      III
                        
                        
                        
                        37Item
      10.
                        
                        Directors,
      Executive Officers and Corporate Governance
                        
                        37Item
      11.
                        
                        Executive
      Compensation
                        
                        41Item
      12.
                        
                        Security
      Ownership of Certain Beneficial Owners and Management and Related
      Stockholder Matters
                        
                        47Item
      13.
                        
                        Certain
      Relationships and Related Transactions, and Director
      Independence
                        
                        48Item
      14.
                        
                        Principal
      Accounting Fees and Services
                        
                        50PART
      IV
                        
                        
                        
                        51Item
      15.
                        
                        Exhibits
      and Financial Statement Schedules
                        
                        51Signatures
                        
                        51
  
  CAUTIONARY
STATEMENT REGARDING FORWARD-LOOKING STATEMENTS
  The
information contained in this Form 10-K/A, including in the documents
incorporated by reference into this Form 10-K/A, includes some statements that
are not purely historical and that are “forward-looking statements.” Such
forward-looking statements include, but are not limited to, statements regarding
the Company and their management’s expectations, hopes, beliefs, intentions or
strategies regarding the future, including its financial condition, and results
of operations. In addition, any statements that refer to projections, forecasts
or other characterizations of future events or circumstances, including any
underlying assumptions, are forward-looking statements. The words “anticipates,”
“believes,” “continue,” “could,” “estimates,” “expects,” “intends,” “may,”
“might,” “plans,” “possible,” “potential,” “predicts,” “projects,” “seeks,”
“should,” “will,” “would” and similar expressions, or the negatives of such
terms, may identify forward-looking statements, but the absence of these words
does not mean that a statement is not forward-looking.
  The
forward-looking statements contained in this Form 10-K/A are based on current
expectations and beliefs concerning future developments and the potential
effects on the parties and the transaction. There can be no assurance that
future developments actually affecting the Company will be those anticipated.
These forward-looking statements involve a number of risks, uncertainties (some
of which are beyond the parties’ control) or other assumptions that may cause
actual results or performance to be materially different from those expressed or
implied by these forward-looking statements, including the
following:
  ·
                Vulnerability of the Company’s
      business to general economic
downturn;
 
 ·
                Fluctuation and unpredictability
      of costs related the gold, platinum and precious metals and other
      commodities used to make the Company’s
  product;
 
 ·
                Changes in the laws of the PRC
      that affect the Company’s
operations;
 
 ·
                The Company’s inexperience in the
      retail jewelry market;
 
 ·
                The Company’s inability to
      achieve the benefits expected from the Company’s share exchange
      agreement;
 
 ·
                Competition from the Company’s
      competitors;
 
 ·
                Any recurrence of severe acute
      respiratory syndrome (SARS) or Avian
Flu;
 
 ·
                The Company’s ability to obtain
      all necessary government certifications and/or licenses to conduct the
      Company’s business;
 
 ·
                Development of a public trading
      market for the Company’s
securities;
 
 ·
                The cost of complying with
      current and future governmental regulations and the impact of any changes
      in the regulations on the Company’s
  operations;
 
 ·
                Fluctuation of the foreign
      currency exchange rate between U.S. Dollars and Renminbi;
      and
 
 ·
                The other factors referenced in
      this Form 10-K/A, including, without limitation, under the sections
      entitled “Risk Factors,” “Financial Information,” “Management’s Discussion
      and Analysis of Financial Condition and Results of Operations,” and
      “Description of
Business.”
  These
risks and uncertainties, along with others, are also described above under the
heading “Risk Factors.” Should one or more of these risks or uncertainties
materialize, or should any of the parties’ assumptions prove incorrect, actual
results may vary in material respects from those projected in these
forward-looking statements. The Company undertakes no obligation to update or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise, except as may be required under applicable
securities laws.
  
 
  PART
I
  ITEM 1. BUSINESS
  Our
company, Fuqi International, Inc., operates through our wholly-owned subsidiary,
Fuqi International Holdings Co., Ltd., a British Virgin Islands corporation
(“Fuqi BVI”) and its wholly-owned subsidiary, Shenzhen Fuqi Jewelry Co., Ltd., a
company established under the laws of China (“Fuqi China”). Fuqi International,
Inc. effected a reverse merger transaction in November 2006 that resulted in our
current corporate structure and subsequently reincorporated in Delaware on
December 8, 2006. For further information concerning our reverse merger
transaction, see “Management’s Discussion and Analysis of Financial Condition
and Results of Operations — Corporate History.”
  Overview
  We are a
leading designer of high quality precious metal jewelry in China, developing,
promoting, and selling a broad range of products to the luxury goods market in
China. Our products consist of a range of unique styles and designs made from
gold and other precious metals such as platinum and Karat gold
(K-gold).  We also produce jewelry items that contain diamonds and
other precious stones on a custom-order basis. Our design database presently
contains over 28,000 unique products. We continuously innovate and change our
designs based upon consumer trends in China. By continuously creating new
designs and rapidly bringing them to market, we believe we are able to
differentiate ourselves from our competitors and strengthen our brand
identity.
  Our
nationwide distribution network and significant relationships with retailers
allow us to test-market, promote and sell our products in almost every province
in China. We believe our vertically integrated direct sales operations, which
include product development, sales and marketing, and order fulfillment and
delivery, allow us to effectively reach consumers and maximize sales throughout
China.
  We have
historically sold our products directly to distributors, retailers and other
wholesalers, who then sell our products to consumers through both retail
counters located in department stores and in traditional stand-alone jewelry
stores. We sell our products to our customers at price points that reflect the
market price of the base material, plus a mark-up reflecting our design fees and
processing fees. Typically this markup ranges from 8% to 14%. Our customers then
further mark up our products to the consumers up to an additional 30%. Our
target price points for our traditional line of gold jewelry are primarily
designed to appeal to China’s growing middle class, with an emphasis on young
women consumers.
  In order
to capitalize on the substantial growth in consumer spending on luxury goods in
China and to capture the margin appreciation from direct sales to the consumer,
we recently initiated a retail strategy in 2007 in product categories where we
believe we will not compete with our existing sales channels. Our retail
strategy focuses on finished diamond and other gemstone jewelry, which we have
previously provided only on a custom-order basis and which has historically
represented only a nominal percentage of our overall sales.  Our
finished gemstone jewelry products are primarily designed to appeal to China’s
younger, urban customers, who are generally better educated and influenced more
by Western culture than older consumers.
  We intend
to open new retail locations by leasing unoccupied space, acquiring existing
leases from third parties and/or acquiring the existing jewelry operations of
third parties that occupy retail space. During 2008, we intend to open and/or
acquire 60 to 80 retail counters and open 8 to 10 retail stores in
municipalities and provincial capitals throughout China. In January 2008, we
agreed upon the terms to acquire two jewelry companies, Shanghai Tian Mei
Jewelry Co. Ltd. and Beijing Yinzhong Tian Mei Jewelry Co. Ltd., collectively
known as “Temix.” Temix has a total of about 50 jewelry counters and retail
stores located in the Beijing and Shanghai regions. Our proposed acquisition
includes obtaining all of Temix’s stores, counters, and leases registered trade
name, exchange membership, and inventories.
  We
believe our expansion into the retail market will provide us with:
  ·
                direct access to the consumer
      market, allowing us to respond more rapidly to changing consumer
      tastes;
 
 ·
                an opportunity to grow our
      revenue base as we roll out our retail
  strategy;
 
 ·
                improved net margins from higher
      markups in the retail market;
and
 
 ·
                increased brand
      awareness.
  1
 
 Our
company is headquartered in the city of Shenzhen, in southern China, where we
have a large-scale production base that includes a modern factory of more than
53,000 square feet, a dedicated senior design, sales and marketing team, and we
have approximately 540 employees, including approximately 350 company-trained
production workers and 60 production trainees. We believe our current facilities
provide adequate space for our planned expansion of our production lines, which
will include diamond and other finished gemstone jewelry.
  China
Jewelry Industry
  China’s
market for jewelry and other luxury goods is expanding rapidly, due in part to
the country’s rapid economic growth. According to the National Bureau of
Statistics of China, China’s real gross domestic product, or GDP, grew by 11.4%,
11.1%, and 10.4% in 2007, 2006 and 2005, respectively. Economic growth in China
has led to greater levels of personal disposable income and increased spending
among China’s expanding middle-class consumer base. According to Economist
Intelligence Unit (EIU), private consumption has grown at a 9% compound annual
growth rate, or CAGR, over the last decade.
  Currently,
China is the world's third-largest consumer of luxury goods. With higher minimum
wages, expanded welfare payments and reduced income taxes, China’s 1.3 billion
consumers are more able than ever to afford luxury items. China's younger
generations, in particular, have bought into consumerism more than their
predecessors and been lured by flashy products and high-end merchandise marketed
to the wealthy, upper-middle and middle-market consumers.
  The
jewelry industry in China has grown at an annual rate of over 10 percent since
the 1980’s and is expected to be the largest market in the world by 2010. In
2005, domestic sales of jewelry in China amounted to RMB 140 billion, which is
approximately US$19.8 billion, and the industry earned $5.49 billion worth of
foreign exchange for China through exports. In 2007, the growth in China’s
jewelry industry was higher than its general economic growth and China became
the second largest gold consumer in the world, only after India.
  Our
Strategies
  Our goal
is to be the leading vertically-integrated designer, manufacturer, and retailer
of jewelry in China. We intend to achieve our goal by implementing the following
strategies:
  Aggressively
pursue new wholesale distribution channels
  We intend
to broaden the scope of our distribution arrangements to increase sales
penetration in targeted markets. We intend to select additional distributors
based on their access to markets and retail outlets that are candidates for our
jewelry products. Also, we believe that once we have established broad brand
awareness, more distributors from remote areas will seek access to our products
through our wholesale channel.
  Establish
and expand our retail market footprint
  We have
developed and are executing a retail sales plan aimed at gaining market share in
the growing consumer market in China. We intend to acquire leases and open new
stores in markets that we believe have a sufficient concentration of our target
customers. Our retail expansion program is designed to reach new and existing
customers through the opening of new retail locations and through the
introduction of new jewelry designs, including our planned finished gemstone
jewelry line. Retail locations will be determined on the basis of various
factors, including geographic location, demographic studies and other jewelry
stores or counters in the vicinity of a retail location.
  Our
retail expansion strategy is designed not to conflict with our existing
distributors. For example, generally we sell our traditional gold jewelry
products to distributors who then sell them to department stores. The department
stores display these products in a retail counter typically owned by the
department stores. In most cases there are other counters in the department
stores that are owned by third party companies that sell non-competing products
to our gold jewelry products, such as finished gemstone jewelry items. These
third party counters are our target for the acquisition of leases, which means
we will not compete with our distributors or with the department stores. Also,
we initially plan to open stores at retail outlets not currently offering our
products. In this way we hope to increase market penetration and maintain
positive relationships with our distributors.
  We intend
to open new retail locations by leasing unoccupied space, acquiring existing
leases from third parties and/or acquiring the existing jewelry operations of
third parties that occupy retail space. In December 2007, we employed an
experienced senior marketing executive who has over 26 years of experience in
the retail industry to assist in the expansion of our retail operations. We have
also recruited experienced craftsmen, who have worked for foreign jewelry
manufacturers for our planned studded jewelry production line, which will
include diamond and other finished gemstone jewelry products. During 2008, we
intend to open and/or acquire 60 to 80 retail counters and open 8 to 10 retail
stores in municipalities and provincial capitals throughout China.
  We
believe that China represents an excellent retail sales opportunity for our own
expansion into the retail market for various reasons that
include:
  2
 ·
                large pool of potential
      consumers— China has a large population including a rapidly
      expanding middle-class consumer
base.
 
 ·
                changing
      consumer preferences— we believe that Chinese
      consumers are embracing a more Western view of jewelry as a fashion
      accessory while also valuing the more traditional view of jewelry as an
      investment.
 
 ·
                growing
      jewelry market—
      China’s jewelry market has experienced significant year-on-year
      growth.
 
 ·
                large retail
      market— China’s
      retail sales market is one of largest in the
  world.
 
 ·
                favorable
      regulatory changes—
      as a member of the World Trade Organization (WTO), China has eliminated a
      number of restrictions on foreign ownership and operations of retail
      stores. Tariffs on colored gemstones, gold, silver and pearls have been
      reduced in the past and economic and trade relationships between China and
      other major economic powers have generally been
      liberalized.
 
 ·
                increased
      profit potential— we
      believe that the retail market is a viable method to increase our sales
      profitability and market
exposure.
  In
January 2008, we agreed upon the terms to acquire two jewelry companies,
Shanghai Tian Mei Jewelry Co. Ltd. and Beijing Yinzhong Tian Mei Jewelry Co.
Ltd., collectively known as “Temix.” Temix is a branded jewelry store chain with
50 outlets located primarily in the Beijing and Shanghai regions. Out of the 50
outlets, there are 5 stand alone stores and 45 counters located in department
stores. Our proposed acquisition includes obtaining all of Temix’s stores,
counters, and leases registered trade name, exchange membership, and
inventories. The products sold in these outlets are primarily diamond and
gemstone jewelry, including ruby and jade and karat gold. The purchase price for
Temix will be approximately $18.5 million, with approximately $9.5 million being
paid in cash and the remaining being paid in securities. Temix was founded by
Mr. Chujian Huang, who is the Chief Executive Officer of Temix and a 15-year
veteran in China’s jewelry industry, particularly in the Yangtze Delta region.
Mr. Huang will become a full time employee of Fuqi upon the closing of the
acquisition and be responsible for managing the Temix chain. The acquisition is
subject to execution of a definitive agreement and various closing conditions
contained therein, including receiving certain regulatory approvals. We expect
the acquisition to be completed in the second quarter of fiscal
2008.
  Expand
existing and new product offerings
  Since the
commencement of our jewelry operations in 2001, we have expanded our line of
products from basic gold jewelry to a range of products that include rings,
bracelets, necklaces, earrings and pendants made from precious metals such as
platinum, gold, palladium and Karat gold (K-gold). We also manufacture jewelry
with diamond and other precious stone inlays, in addition to gold coins and gold
bars.
  Our
jewelry product series include the following:
  ·
                Gold
      Series.This series
      includes K-gold, 24K gold ornaments, gold bars, gold coins, gifts, other
      gold charms and customized
products.
 
 ·
                Platinum
      Series (pt).This
      series includes pt990, pt950 and pt900 products. The quality markings for
      platinum are based on parts per thousand. For example, the marking pt900
      means that 900 parts out of 1000 are pure platinum, or in other words, the
      item is 90% platinum and 10% other
  metals.
 
 ·
                K-Gold
      Series.This series
      is primarily derived from Italian-influenced arts and
      designs.
 
 ·
                Studded
      Jewelry Series.This
      series is made from pt950, pt900, 18K gold, 14K gold and other
      customer-designated rare metals studded with diamonds, emerald, jade and
      semi-precious stones.  We currently produce studded jewelry
      products on a custom-order basis only, but intend to expand production and
      begin producing a line of studded jewelry
  products.
  Many of
our designs are originated by our in-house designers. They are educated at art
schools or colleges in China and have gained an average of three to five years
of experience from other jewelry companies. In generating new design ideas, our
designers research and study designs that are popular in China and worldwide.
Our designers conduct design and market research through various forms,
including trade expositions, industrial magazines and the Internet. They also
receive feedback from, and respond to, our customers. We continuously design and
produce new styles of jewelry and currently carry more than 28,000 product
styles, which are growing at a rate of approximately 3,600 styles per annum. We
assign serial numbers to each of our products styles, and we maintain an
information management system utilizing a product database.
  3
 
 Since
2004, we have typically provided over three hundred new designs every month to
our wholesale customers.
  In the
coastal cities of China, we believe the demand for platinum and gemstone
products has been increasing. In order to capitalize on the growth of demand, we
intend to develop platinum as the primary metal from which our jewelry is
manufactured. In 2006, we began to shift our product line to produce more
platinum jewelry and we intend to invest in the development of a new production
line to produce studded platinum jewelry. The production cycle of platinum
products is five to seven days while the cycle for gold products is about two
days. As such, more working capital will be needed to support this shift of
product mix.
  As we
expand into retail, we intend to expand new product offerings including diamond,
jade, and other gemstone products. These products usually have a longer turnover
period of at least four to six months but offer higher margins. We believe that
it is critical for us to expand our product lines to include these products to
be sold in our own retail outlets and to our wholesale customers. We will
analyze sales data at all our retail outlets and determine the best product mix
a particular outlet will carry to achieve the highest sales
revenue.
  Through
these retail outlets, we intend to offer our full range of jewelry products to
showcase and sell. Furthermore, we plan to design and manufacture a line of fine
diamond, jade and gemstone jewelry to be sold primarily in our retail
shops.
  Enhance
marketing and promotion efforts to increase brand awareness
  We
continue to devote our efforts towards brand development and utilize marketing
concepts in an attempt to enhance the marketability of our products. During the
past several years, we have carried out a brand development strategy based on
product quality and design excellence. We intend to commence geographical
television advertising campaigns and to promote our jewelry products in major
magazines throughout China. We have also participated and intend to continue to
participate in various exhibitions and similar promotional events to promote our
products and brand. For example, in 2004, we were the laurel sponsor for
multiple beauty pageants, including the “Miss Intercontinental Final” and the
“Miss China Universe.”
  Product
Pricing
  The
wholesale pricing of our products is based on three primary components: price of
raw materials used, processing fee, and design fee. The price of the raw
materials for our jewelry highly depends on the spot price of the raw materials
(e.g., gold and platinum) at the time the jewelry is sold. The amount charged as
a design fee is determined by management based on various criteria, including
market conditions, and production complexity, popularity and uniqueness of the
design. Management meets on a monthly basis to determine the design fees charge
rate, which generally ranges from 6% to 11% of price of raw materials. The
processing fee ranges from 2% to 3% of the price for the raw materials. We pay
business tax on our design fee. We also pay a value added tax on the raw
materials and processing fee, which we bill to our customers and remit to the
local tax authority on a monthly basis. The sales amounts reported in the
statements of income are net of the value added tax. The invoices that we
provide to our wholesale customers itemize these raw material costs and design
and processing fees that make up the total cost charged to them. The retail mark
up from the wholesale price is approximately 30%, depending on the complexity of
design and other factors.
  Credit
Terms
  We offer
certain of our customers credit terms for payment. We typically grant credit to
a customer if the customer has been in existence for at least five years and/or
has been doing business with us for at least three years. We attempt to minimize
credit risk by reviewing a customer’s credit history before extending credit and
by continually monitoring the customer’s credit exposure. We maintain an
allowance for doubtful accounts for estimated losses resulting from the
inability of our customers to make required payments. Allowance for doubtful
accounts is based on our assessment of the collectability of specific customer
accounts, the aging of accounts receivable, our history of bad debts, and the
general condition of the industry. If a major customer’s credit worthiness
deteriorates, or our customers’ actual defaults exceed historical experience,
our estimates could change and impact our reported results. We have not
experienced any significant amount of bad debt in the past.
  Manufacturing
  We have a
large-scale production base that includes a modern factory of more than 53,000
square feet, a dedicated senior design team, and approximately 350
company-trained production workers. We recently analyzed and refined our
production procedures to increase efficiency and reduced the number of trained
workers by approximately 15%. Since 2003, we have held an ISO 9001
accreditation, which is an international standard of quality. The International
Organization for Standardization (ISO)
(http://www.iso.org/iso/en/iso9000-14000/understand/inbrief.html) defines the
ISO 9000 quality management system as one of international references for
quality management requirements in business-to-business dealings. An
organization being accredited by an independent assessment organization has to
fulfill:
  ·
                the customer’s quality
      requirements,
  4
  ·
                applicable regulatory
      requirements, while aiming to enhance customer satisfaction,
      and
 
 ·
                achieving continual improvement
      of its performance in pursuit of these
  objectives.
  The ISO
9000 quality management system is well recognized by People’s Republic of China
(“PRC”)’s governmental bodies and businesses. This accreditation can serve as a
basis for our customers to determine the minimum standard of quality assurance
that we achieve. We believe that this accreditation also indicates to our
customers that we are running an effective system to track quality issues and
possible rework progress of our products. In January 2007, we also achieved the
ISO 14000 accreditation. ISO 14000 is an environmental management system in
which the organization being accredited has to (i) minimize harmful effects on
the environment caused by its activities, and (ii) achieve continual improvement
of its environmental performance.
  We
estimate our maximum annual output capacity of gold jewelry, other rare and
precious metal jewelry, K-gold jewelry and inlaid jewelry to be approximately 30
tons, 15 tons, 5 tons and 60,000 pieces, respectively.
  Sales
and Marketing
  We rely
on our sales and marketing division, which is located at our executive offices
in Shenzhen, China for the distribution of our products in China. We sell our
products primarily to our national and provincial distributors that resell our
products to end customers through their own distribution networks, which are
typically composed of local distributors and retail outlets. Our distribution
network currently includes 30 provincial distributors and more than 700
direct-sales distributors. These distributors sell our products to local
distributors, over 1,000 retail outlets and directly to end users in
China.
  Our
marketing and distribution strategy is to screen and identify the strongest
customers in each distribution channel and to focus on our design and sales
efforts towards the largest and fastest growing retailers and distributors. We
maintain a broad base of customers and concentrate our efforts on department
stores, wholesalers, national jewelry chains, fine jewelers, and stores that
sell fashionable jewelry. We also work closely with our major customers and
attempt to adjust our product strategies and structure based on customer
feedback in order to decrease the likelihood of overstocked, undesired
products.
  Our
traditional gold jewelry products are mainly designed for the middle income
class in China, with an emphasis on young women. Approximately 50% of our
designs are for 20 to 40 year old women, 5% of our designs are for new-born
children, 20% of our designs are for middle-aged men and 25% of our designs are
for middle to older-aged women. Our products are sold in China at average retail
prices equivalent to $200 to $300, including tax. At present, approximately 5 to
6% of our products are marketed on a private label basis, but we anticipate that
this percentage will decrease as we continue to develop the “Fuqi”
brand.
  We
continue to invest in our brand and our marketing ability in order to increase
demand for our products. During the past several years, we have carried out a
brand development strategy based on product quality and design excellence. We
have participated in various marketing activities and exhibitions to promote our
products and brand. For example, in 2004, we were the laurel sponsor for
multiple beauty pageants, including the “Miss Intercontinental Final” and the
“Miss China Universe.” As a laurel sponsor, we designed and crafted the laurels
and/or batons that were presented to a contest winner, in addition to the
contest’s second and third place runner-ups. We have also sponsored numerous
beauty contests such as:
 ·
                the Final of Miss Global of
      WTO;
 
 ·
                the 17th World Miss University
      Contest;
 
 ·
                the 1st China Miss University
      Contest; and
 
 ·
                China Final of Miss
      World.
  We
believe that the laurels and batons created in connection with our sponsorship
of beauty contests provided us an opportunity to showcase our design and
craftsmanship ability, in addition to strengthening our brand
recognition.
  We have
received various governmental awards with respect to our brand, including
recognition by the China Light Product Quality Assurance Center as a “Chinese
Famous Brand,” which is reserved for the top ten most recognized brands of the
jewelry industry in China. We have also received other recognitions, including,
from the Gems & Jewelry Trade Association of China as a “Famous Brand in the
China Jewelry Industry”, from Committee of Shenzhen Famous Brand Accreditation
as a “Shenzhen Well-known Brand”, from the Shenzhen City Enterprises Evaluation
Association as one of the “Shenzhen 300 enterprises with Ultimate Growth” and
from Moody United Certification Ltd as “China Quality Promise Credit Management
Enterprise (Brand)”. In October 2007, “Fuqi” was recognized as a “China Top
Brand” by General Administration of Quality Supervision, Inspection and
Quarantine of the People's Republic of China. We believe that governmental
awards and other forms of recognition raise brand recognition for our
products.
  5
  The
“Fuqi” trademark has been registered in the United States, Italy, Japan, Hong
Kong and China.
  Supply
of Raw Materials
  We are a
full member of the Shanghai Gold Exchange and a standing council member of the
Shenzhen Gold Association of China. The Shanghai Gold Exchange is our primary
supply source for precious metals used in our jewelry offerings.
  We
maintain our supply of raw materials at our warehouse in Shenzhen, China. We
purchase large volumes of precious metals approximately five times per month
from the Shanghai Gold Exchange in advance and in anticipation of orders
resulting from our marketing programs. When we make purchases on the Shanghai
Gold Exchange, the Exchange issues a receipt to us that we can redeem for
precious metals at various commercial banks in Shenzhen.
  To
minimize the risk of storage and devaluation, we only purchase pre-cut
gemstones, including ruby and jade, upon customers’ requests. We do not have a
designated supplier for these pre-cut stones. When a customer places an order
that requires pre-cut stones, we purchase the pre-cut stones as required from
local supplies in Shenzhen.
  Competition
  The
jewelry production industry is highly competitive, and our competitors include
domestic and foreign jewelry manufacturers, wholesalers, and importers who may
operate on a national, regional and local scale. Many of our competitors have
substantially greater financial, technical and marketing resources and personnel
than us. Our strategy is to provide competitively priced, high-quality products
to the high-volume retail jewelry market. We believe competition is largely
based on quality, service, pricing, and established customer
relationships.
  In 2007,
we entered into the retail jewelry industry, which is also highly competitive.
Many of our potential competitors in the retail industry have larger customer
bases, longer operating histories and significantly greater financial,
technical, marketing and other resources. Most of these retailers, including
Chow Sang Sang Group, Luk Fook Jewelry, TSL Jewelry and Hang Fung Gold
Technology, have numerous branches set up across China and may have secured the
most desirable locations for retail stores. It may be difficult for a newcomer
to enter into and expand in the retail industry, but based on our extensive
analysis, market review, and planning, we believe that our established
production and wholesale distribution business will facilitate our entrance into
and expansion in the retail market.
  Major
Customers
  During
the years ended December 31, 2007 and 2006, there were no single customers that
generated more than 10% of the total sales. During the year ended December 31,
2005 approximately 15% of the Company’s sales were generated from one customer,
Beijing Hua Shang Rui Lin Trading Co., Ltd.
  Seasonality
  Our
business is seasonal in nature. Our sales and net income are generally higher in
the fourth calendar quarter than the rest of the year. The primary factors that
affect the seasonal changes in our business operations are holidays and
traditional Chinese festivals. In the fourth quarter, retailers often experience
increased sales due to the week-long public holiday for Chinese National Day, as
well as Christmas and New Year’s Day. In addition, jewelry retailers commonly
stock up from wholesalers in the fourth quarter to prepare for potentially
higher sales in the following quarter for Chinese New Year. This quarter is also
a peak season for marriages and the birth of newborns in China, which have
historically resulted in higher sales. This seasonal trend in our business would
slightly shift in line with the gap between calendar quarter and lunar quarter
and occurred during 2004 and 2005. However, there was a slight variation during
2006. Because of rising precious metal prices in the fourth quarter of 2006,
many customers delayed their orders until the first quarter of 2007, resulting
in lower-than-expected sales volume in the fourth quarter of 2006, and higher
than expected sales in the first quarter of 2007. We experienced increased sales
in the fourth quarter of 2007.
  Government
Regulations
  We are
subject to various laws and regulations in the PRC, affecting all aspects of our
business. In April 2001, the Shenzhen Business Bureau granted our wholly-owned
subsidiary, Fuqi China, the right to operate for a period of ten years from the
date of inception. On May 17, 2006, we converted Fuqi China into a
wholly-foreign-owned enterprise, or WFOE, and formally transferred the ownership
of Fuqi China from the founder, Mr. Yu Kwai Chong, to Fuqi BVI. Neither this
transfer nor the Reverse Merger changed our business plan. The right to operate
as a WFOE expires 30 years from the date of establishment but, based on current
PRC legislation, this right is renewable by application. A WFOE can only conduct
business within its approved business scope, which appears on its business
license. Our license permits us to design, manufacture, sell and market jewelry
products to department stores throughout the PRC, and allows us to engage in the
retail distribution of our products. Any further amendment to the scope of our
business will require additional applications and government approval. We cannot
assure you that we will be able to obtain the necessary government approval for
any change or expansion of our business.
  6
  Under
applicable PRC laws, supplies of precious metals such as platinum, gold and
silver are highly regulated by certain government agencies, such as the People’s
Bank of China. Shanghai Gold Exchange is the only PBOC authorized supplier of
precious metal materials and, therefore, the primary source of supply for our
raw materials, which substantially consist of precious metals. We are required
to obtain several membership and approval certificates from these government
agencies in order to continue to conduct our business. We may be required to
renew such memberships and to obtain approval certificates periodically. If we
are unable to renew these periodic membership or approval certificates, it would
materially affect our business operations. We are currently in good standing
with these agencies.
  We have
also been granted independent import and export rights. These rights permit us
to import and export jewelry in and out of China. With the relatively lower cost
of production in China, we intend to expand into overseas markets after the
launch of our China-based retail plan. We do not currently have plans to import
jewelry into China.
  Our
production facilities in Shenzhen are subject to environmental regulation by the
Environmental Protection Bureau of Shenzhen. We hold all requisite operating
permits from the Environmental Protection Bureau. Our permits confirm that we
are in compliance with local regulations governing waste production and disposal
and that our production facilities meet the public safety regulations regarding
refuse, emissions, lights, noise and radiation. To date, we have never been
cited for any environmental violations.
  Employees
  We have
approximately 540 employees, including approximately 350 company-trained
production workers and 60 production trainees. We recently analyzed and refined
our production procedures to increase efficiency and reduced the number of
trained workers by approximately 15%. In 2008, we began recruiting skilled
laborers to fill vacancies for our new diamond line products. Our employees are
part of a labor association that represents employees with respect to labor
disputes and other employee matters. We have never experienced a work stoppage
or a labor dispute that has interfered with our operations. We believe our
relationship with our employees is good.
  We are
required to contribute a portion of our employees’ total salaries to the Chinese
government’s social insurance funds, including medical insurance, unemployment
insurance and job injuries insurance, and a housing assistance fund, in
accordance with relevant regulations. Total contributions to the funds are
approximately $46,000, $34,000 and $30,000 for the years ended December 31,
2007, 2006 and 2005, respectively. We expect that the amount of our contribution
to the government’s social insurance funds will increase in the future as we
expand our workforce and operations. We also provide housing facilities for our
employees. At present, approximately 95% of our employees live in
company-provided housing facilities.
  Effective
January 1, 2008, PRC introduced a new labor contract law that enhances rights
for the nation's workers, including open-ended work contracts and severance pay.
The legislation requires employers to provide written contracts to their
workers, restricts the use of temporary laborers and makes it harder to lay off
employees. It also requires that employees with short-term contracts become
full-time employees with lifetime benefits after a short-term contract is
renewed twice. Although the new labor contract law would increase our labor
costs, we do not anticipate there will be any significantly effects on our
overall profitability in the near future since such amount was historically not
material to our operating cost. Management anticipates this may be a step toward
improving candidate retention for skilled workers.
  Available
Information
  Our
principal executive offices are located at 5/F., Block 1, Shi Hua Industrial
Zone, Cui Zhu Road North, Shenzhen, 518019, People’s Republic of China. Our
telephone number is +86 (755) 2580-1888. Our Internet address is www.fuqi.com.cn. We
make available free of charge on or through our Internet Website our annual
reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form
8-K, and amendments to those reports filed or furnished pursuant to Section
13(a) or 15(d) of the Securities Exchange Act of 1934 as soon as reasonably
practicable after we electronically file such material with, or furnish it to,
the Securities and Exchange Commission.
  7
  ITEM
1A: RISK FACTORS
  Any
investment in our common stock involves a high degree of risk. Potential
investors should carefully consider the material risks described below and all
of the information contained in this Form 10-K/A before deciding whether to
purchase any of our securities. Our business, financial condition or results of
operations could be materially adversely affected by these risks if any of them
actually occur. Some of these factors have affected our financial condition and
operating results in the past or are currently affecting our company. This
filing also contains forward-looking statements that involve risks and
uncertainties. Our actual results could differ materially from those anticipated
in these forward-looking statements as a result of certain factors, including
the risks faced described below and elsewhere in this Form 10-K/A.
  Risks
Related To Our Operations
  Jewelry
purchases are discretionary, may be particularly affected by adverse trends in
the general economy, and an economic decline will make it more difficult to
generate revenue.
  The
success of our operations depends to a significant extent upon a number of
factors relating to discretionary consumer spending in China. These factors
include economic conditions and perceptions of such conditions by consumers,
employment rates, the level of consumers’ disposable income, business
conditions, interest rates, consumer debt levels, availability of credit and
levels of taxation in regional and local markets in China where we manufacture
and sell our products. There can be no assurance that consumer spending on
jewelry will not be adversely affected by changes in general economic conditions
in China and globally.
  While the
Chinese economy has experienced rapid growth in recent years, such growth has
been uneven among various sectors of the economy and in different geographical
areas of the country. Also, many observers believe that this rapid growth cannot
continue at its current pace and that an economic correction may be imminent.
Rapid economic growth can also lead to growth in the money supply and rising
inflation. During the past two decades, the rate of inflation in China has been
as high as approximately 20% and China has experienced deflation as low as minus
2%. If prices for our products rise at a rate that is insufficient to compensate
for the rise in the costs of supplies such as raw materials, it may have an
adverse effect on our profitability. In order to control inflation in the past,
the PRC government has imposed controls on bank credits, limits on loans for
fixed assets and restrictions on state bank lending. The implementation of such
policies may impede economic growth. In October 2004, the People’s Bank of
China, the PRC’s central bank, raised interest rates for the first time in
nearly a decade and indicated in a statement that the measure was prompted by
inflationary concerns in the Chinese economy. During 2007, the interest rate was
increased from 5.67% to 7.83%. Repeated rises in interest rates by the central
bank could slow economic activity in China which could, in turn, materially
increase our costs and also reduce demand for our products.
  Most
of our sales are of products that include gold, platinum, precious metals and
other commodities, and fluctuations in the availability and pricing of
commodities would adversely impact our ability to obtain and produce products at
favorable prices.
  The
jewelry industry generally is affected by fluctuations in the price and supply
of diamonds, gold, platinum and, to a lesser extent, other precious and
semi-precious metals and stones.  Historically, we have not hedged our
requirements for gold, platinum or other raw materials through the use of
options, forward contracts or outright commodity purchasing.  In the
fourth quarter of 2007, we began to engage in such hedging for gold by entering
into gold futures contracts, but there is no guarantee that we will benefit in
our attempts to hedge against fluctuations in the price or availability of
gold.  A significant disruption in our supply of gold, platinum, or
other commodities could decrease our production and shipping levels, materially
increase our operating costs and materially adversely affect our profit margins.
Shortages of gold, platinum, or other commodities, or interruptions in
transportation systems, labor strikes, work stoppages, war, acts of terrorism,
or other interruptions to or difficulties in the employment of labor or
transportation in the markets in which we purchase our raw materials, may
adversely affect our ability to maintain production of our products and sustain
profitability. Although we generally attempt to pass increased commodity prices
to our customers, there may be circumstances in which we are not able to do so.
In addition, if we were to experience a significant or prolonged shortage of
gold, platinum, or other commodities, we would be unable to meet our production
schedules and to ship products to our customers in timely fashion, which would
adversely affect our sales, margins and customer relations. Furthermore, the
value of our inventory may be affected by commodity prices. We record the value
of our inventory at the lower of cost (using the first-in, first-out method) or
market. As a result, decreases in the market value of precious metals such as
gold and platinum would result in a lower stated value of our inventory, which
may require us to take a charge for the decrease in the value of our
inventory.
  Due
to the geographic concentration of our sales in the northeast region of China,
our results of operations and financial condition are subject to fluctuations in
regional economic conditions.
  A
significant percentage of our total sales are made in the northeast region of
China, particularly in the provinces of Liaoning, Jilin and Heilongjiang, and
the city of Beijing. For the years ended December 31, 2007 and 2006,
approximately 51.1% and 44.9% of revenues, respectively, was generated from this
area. Our concentration of sales in this area heightens our exposure to adverse
developments related to competition, as well as economic and demographic changes
in this region. Our geographic concentration might result in a material adverse
effect on our business, financial condition or results of operations in the
future.
  8
  Our
retail expansion strategy depends on our ability to open and operate a certain
number of new counters and stores each year, which could strain our resources
and cause the performance of our existing operations to suffer.
  We have
historically been engaged only in the manufacture and wholesale distribution of
jewelry products and have only recently begun retail operations. Our retail
expansion strategy will largely depend on our ability to find sites for, open
and operate new retail locations successfully. Our ability to open and operate
new retail locations successfully depends on several factors, including, among
others, our ability to:
  ·
                identify suitable counter and
      store locations, the availability of which is outside our
      control;
 
 ·
                purchase and negotiate acceptable
      lease terms;
 
 ·
                prepare counters and stores for
      opening within budget;
 
 ·
                source sufficient levels of
      inventory at acceptable costs to meet the needs of new counters and
      stores;
 
 ·
                hire, train and retain
      personnel;
 
 ·
                secure required governmental
      permits and approvals;
 
 ·
                successfully integrate new
      counters and stores into our existing
  operations;
 
 ·
                contain payroll costs;
      and
 
 ·
                generate sufficient operating
      cash flows or secure adequate capital on commercially reasonable terms to
      fund our expansion
plans.
  Any
failure to successfully open and operate new retail counters and stores could
have a material adverse effect on our results of operations. In addition, our
retail expansion program will place increased demands on our operational,
managerial and administrative resources. These increased demands could cause us
to operate our business less effectively, which, in turn, could cause
deterioration in the financial performance of our overall business.
  It is not
our intention to open new retail counters and stores that materially cannibalize
the sales of our existing distributors. However, as with most growing retail
operations, there can be no assurance that sales cannibalization will not
inadvertently occur or become more significant in the future as we gradually
increase our presence in existing markets over time to maximize our competitive
position and financial performance in each market.
  Competition
in the jewelry industry could cause us to lose market share, thereby materially
adversely affecting our business, results of operations and financial
condition.
  The
jewelry industry in China is highly fragmented and very competitive. We believe
that the market may become even more competitive as the industry grows and/or
consolidates. We compete with local jewelry manufacturers and large foreign
multinational companies that offer products that are similar to ours. Some of
these competitors have larger local or regional customer bases, more locations,
more brand equity, and substantially greater financial, marketing and other
resources than we have. As a result of this increasing competition, we could
lose market share, thereby materially adversely affecting our business, results
of operations and financial condition.
  We
may need to raise additional funds in the future. These funds may not be
available on acceptable terms or at all, and, without additional funds, we may
not be able to maintain or expand our business.
  We
believe that we will have sufficient capital to fund our projected operations
for at least the next 12 months. We expect to expend significant resources to
commence our retail distribution of our manufactured jewelry in China. We will
require substantial funds in order to finance our retail distribution, fund
operating expenses, to develop manufacturing, marketing and sales capabilities
and to cover public company costs. In addition to the funds required to open
retail locations, additional working capital will be needed to operate retail
locations due to longer sales and collection cycles and higher inventory levels
required to support retail stores. We also expect to require substantial funds
to change our product mix to include more platinum products. Without these
funds, we may not be able to meet these goals. Also, we expect our general and
administrative costs to substantially increase due to higher salaries to be paid
to our executive officers. See “Executive Compensation — Compensation
Discussion and Analysis.”
  9
 
 We may
seek additional funding through public or private financing or through
collaborative arrangements with strategic partners.
  You
should also be aware that in the future:
  ·
                We cannot be certain that
      additional capital will be available on favorable terms, if at
      all;
 
 ·
                Any available additional
      financing may not be adequate to meet our goals;
  and
 
 ·
                Any equity financing would result
      in dilution to
stockholders.
  If we
cannot raise additional funds when needed, or on acceptable terms, we may not be
able to effectively execute our growth strategy (including expanding our
business to the retail market), take advantage of future opportunities, or
respond to competitive pressures or unanticipated requirements. In addition, we
may be required to scale back or discontinue our production and development
program, or obtain funds through strategic alliances that may require us to
relinquish certain rights.
  Our
ability to maintain or increase our revenue could be harmed if we are unable to
strengthen and maintain our brand image.
  We
believe that primary factors in determining customer buying decisions in China’s
jewelry sector include price, confidence in the merchandise sold, and the level
and quality of customer service. The ability to differentiate our products from
competitors by our brand-based marketing strategies is a key factor in
attracting consumers, and if our strategies and efforts to promote our brand,
such as television and magazine advertising and beauty contest sponsorships,
fail to garner brand recognition, our ability to generate revenue may suffer. If
we are unable to differentiate our products, our ability to sell our products
wholesale and our sale of products retail will be adversely affected. If we fail
to anticipate, identify or react appropriately or in a timely manner to customer
buying decisions, we could experience reduced consumer acceptance of our
products, a diminished brand image, higher markdowns, and costs to recast
overstocked jewelry. These factors could result in lower selling prices and
sales volumes for our products, which could adversely affect our financial
condition and results of operations. This risk is particularly acute because we
rely on a limited demographic customer base for a large percentage of our
sales.
  There
is only one source in China for us to obtain the precious metals used in our
jewelry products; accordingly, any interruptions of our arrangement with this
source would disrupt our ability to fill customer orders and substantially
affect our ability to continue our business operations.
  Under PRC
law, supply of precious metals such as platinum, gold, and silver are highly
regulated by certain government agencies. Shanghai Gold Exchange is the only
authorized source of supply in China for precious metals used in our jewelry
products. We are required to obtain several membership and approval certificates
from government agencies in order to do business involving precious metals. We
may be required to renew such memberships and to obtain approval certificates
periodically. The loss of or inability to renew our membership relationship with
the Shanghai Gold Exchange, or its inability to furnish precious metals to us as
anticipated in terms of cost, quality, and timeliness, would adversely affect
our ability to fill customer orders in accordance with our required delivery,
quality, and performance requirements. If this were to occur, we would not have
any alternative suppliers in China to obtain our raw materials from, which would
result in a decline in revenue and revenue potential and risk the continuation
of our business operations.
  If
we are not able to adapt to changing jewelry trends in China, our inventory may
be overstocked and we may be forced to reduce the price of our overstocked
jewelry or incur the cost to recast it into new jewelry.
  We depend
on consumer fashions, preferences for jewelry and the demand for particular
products in China. Jewelry design trends in China can change rapidly, as
evidenced by the recent increase in the consumption of platinum jewelry in the
Chinese market. The ability to predict accurately future changes in taste,
respond to changes in consumer preferences, carry the inventory demanded by
customers, deliver the appropriate quality, price products correctly and
implement effective purchasing procedures, all have an important influence on
determining sales performance and achieved gross margin. If we fail to
anticipate, identify or react appropriately to changes in styles and trends, we
could experience excess inventories, higher than normal markdowns or an
inability to sell our products. If such a situation exists, we may need to incur
additional costs to recast our products to fit the demand, recovering only the
value of raw material and all labor invested in the product would be
lost.
  Our
failure to manage growth effectively could have an adverse effect on our
employee efficiency, product quality, working capital levels, and results of
operations.
  We intend
to conduct a growth strategy into retail distribution of our products that we
believe will result in rapid growth, which will place significant demands on our
managerial, operational and financial resources. Any significant growth in the
market for our current wholesale business and our planned retail distribution
would require us to expand our employee base for managerial, operational,
financial, and other purposes. During any growth, we may face problems related
to our operational and financial systems and controls, including quality control
and delivery and service capabilities. We would also need to continue to expand,
train and manage our employee base. We currently have approximately 540
employees, which include approximately 350 company-trained workers and 60
production trainees, and, at that size, a rapid increase in the number of our
employees would be difficult to manage. Continued future growth will impose
significant added responsibilities upon the members of management to identify,
recruit, maintain, integrate, and motivate new employees. If we are able to
expand our retail business, we would need to train or hire additional employees
with retail experience.
  10
  Aside
from increased difficulties in the management of human resources, we may also
encounter working capital issues, as we will need increased liquidity to finance
the purchases of raw materials and supplies, development of new products,
establishment of new retail stores, and the hiring of additional employees. Our
failure to manage growth effectively may lead to operational and financial
inefficiencies that will have a negative effect on our profitability. We cannot
assure you that we will be able to timely and effectively meet that demand and
maintain the quality standards required by our existing and potential
customers.
  We
rely on our distribution network for a significant portion of our revenues.
Failure to maintain good distributor relations could materially disrupt our
distribution business and harm our net revenues.
  Our
business has become increasingly dependent on the performance of our
distributors. During the years ended December 31, 2007, 2006, and 2005, 16%,
13%, and 10%, respectively, of our net revenues were generated through our
distributors. We currently have 103 distributors. Our largest distributor
accounted for approximately 7% and 4% of our gross revenues in 2007 and 2006. We
do not maintain long-term contracts with our distributors. Maintaining
relationships with existing distributors and replacing any distributor may be
difficult or time consuming. Our failure to maintain good relationships with our
distributors could materially disrupt our distribution business and harm our net
revenues.
  We
must maintain a relatively large inventory of our raw materials and jewelry
products to support customer delivery requirements, and if this inventory is
lost due to theft, our results of operations would be negatively
impacted.
  We
purchase large volumes of precious metals approximately five times per month and
store significant quantities of raw materials and jewelry products at our
warehouse and show room in Shenzhen, China. Although we have an inventory
security system in place, in the past we have experienced minor inventory theft
at, or in transit to or from, certain of these facilities. We may be subject to
future significant inventory losses due to third-party or employee theft from
our warehouses or other forms of theft. The implementation of security measures
beyond those that we already utilize, which include metal detectors for
employees, security cameras, and alarm systems in our warehouse, would increase
our operating costs. Also, any such losses of inventory could exceed the limits
of, or be subject to an exclusion from, coverage under our insurance policies.
Claims filed by us under our insurance policies could lead to increases in the
insurance premiums payable by us or the termination of coverage under the
relevant policy.
  Substantial
defaults by our customers on accounts receivable could have a material adverse
affect on our liquidity and results of operations.
  A
substantial portion of our working capital consists of accounts receivable from
customers. If customers responsible for a significant amount of accounts
receivable were to become insolvent or otherwise unable to pay for our products,
or unable to make payments in a timely manner, our liquidity and results of
operations could be materially adversely affected. An economic or industry
downturn could materially adversely affect the servicing of these accounts
receivable, which could result in longer payment cycles, increased collections
costs and defaults in excess of management’s expectations. In addition, as we
increase our presence in the retail market, we expect the aging of our accounts
receivable generated from sales through retail counters to increase as
department stores typically defer payments to us of cash receipts collected by
them on our behalf. A significant deterioration in our ability to collect on
accounts receivable could affect our cash flow and working capital position and
could also impact the cost or availability of financing available to
us.
  We
are dependent on certain key personnel and loss of these key personnel could
have a material adverse effect on our business, financial condition and results
of operations.
  Our
success is, to a certain extent, attributable to the management, sales and
marketing, and operational and technical expertise of certain key personnel.
Each of our named executive officers, including our Chief Executive Officer, Mr.
Yu Kwai Chong, performs key functions in the operation of our business. There
can be no assurance that we will be able to retain these officers or that such
personnel may not receive and/or accept competing offers of employment. The loss
of a significant number of these employees could have a material adverse effect
upon our business, financial condition, and results of operations. We do not
maintain key-man life insurance for any of our senior management.
  We
have significant outstanding short-term borrowings, and we may not be able to
obtain extensions when they mature.
  Our notes
payable to banks for short-term borrowings as of December 31, 2007, December 31,
2006 were $17.1 million and $14.1 million, respectively, and bore weighted
average interest rates of 6.68% and 6.14%, respectively. Generally, these
short-term bank loans mature in one year or less and contain no specific renewal
terms. However, in China it is customary practice for banks and borrowers to
negotiate roll-overs or renewals of short-term borrowings on an on-going basis
shortly before they mature. Although we have renewed our short-term borrowings
in the past, we cannot assure you that we will be able to renew these loans in
the future as they mature. In particular, a substantial portion of our
short-term borrowings are arranged or guaranteed by Mr. Yu Kwai Chong, our
controlling stockholder, or one of his affiliated companies. Since Mr. Chong
ceased to be our sole stockholder in November 2006, he may be less inclined to
guarantee our bank borrowings. If we are unable to obtain renewals of these
loans or sufficient alternative funding on reasonable terms from banks or other
parties, we will have to repay these borrowings with the cash on our balance
sheet or cash generated by our future operations, if any. We cannot assure you
that our business will generate sufficient cash flow from operations to repay
these borrowings.
 11
  Our
quarterly results may fluctuate because of many factors and, as a result,
investors should not rely on quarterly operating results as indicative of future
results.
  Fluctuations
in operating results or the failure of operating results to meet the
expectations of public market analysts and investors may negatively impact the
value of our securities. Quarterly operating results may fluctuate in the future
due to a variety of factors that could affect revenues or expenses in any
particular quarter. Fluctuations in quarterly operating results could cause the
value of our securities to decline. Investors should not rely on
quarter-to-quarter comparisons of results of operations as an indication of
future performance. As a result of the factors listed below, it is possible that
in future periods results of operations may be below the expectations of public
market analysts and investors. This could cause the market price of our
securities to decline. Factors that may affect our quarterly results
include:
  ·
                vulnerability of our business to
      a general economic downturn in
China;
 
 ·
                fluctuation and unpredictability
      of costs related to the gold, platinum and precious metals and other
      commodities used to manufacture our
  products;
 
 ·
                seasonality of our
      business;
 
 ·
                changes in the laws of the PRC
      that affect our operations;
 
 ·
                our recent entry into the retail
      jewelry market;
 
 ·
                competition from our
      competitors;
 
 ·
                our ability to obtain all
      necessary government certifications and/or licenses to conduct our
      business; and
 
 ·
                development of a public trading
      market for our
securities.
  Risks
Related To Doing Business In China
  All
of our assets are located in China and all of our revenues are derived from our
operations in China, and changes in the political and economic policies of the
PRC government could have a significant impact upon what business we may be able
to conduct in the PRC and accordingly on the results of our operations and
financial condition.
  Our
business operations may be adversely affected by the current and future
political environment in the PRC. The Chinese government exerts substantial
influence and control over the manner in which we must conduct our business
activities. Our ability to operate in China may be adversely affected by changes
in Chinese laws and regulations, including those relating to taxation, import
and export tariffs, raw materials, environmental regulations, land use rights,
property and other matters. Under the current government leadership, the
government of the PRC has been pursuing economic reform policies that encourage
private economic activity and greater economic decentralization. There is no
assurance, however, that the government of the PRC will continue to pursue these
policies, or that it will not significantly alter these policies from time to
time without notice.
  Our
operations are subject to PRC laws and regulations that are sometimes vague and
uncertain. Any changes in such PRC laws and regulations, or the interpretations
thereof, may have a material and adverse effect on our business.
  The PRC’s
legal system is a civil law system based on written statutes. Unlike the common
law system prevalent in the United States, decided legal cases have little value
as precedent in China. There are substantial uncertainties regarding the
interpretation and application of PRC laws and regulations, including but not
limited to the laws and regulations governing our business, or the enforcement
and performance of our arrangements with customers in the event of the
imposition of statutory liens, death, bankruptcy or criminal proceedings. The
Chinese government has been developing a comprehensive system of commercial
laws, and considerable progress has been made in introducing laws and
regulations dealing with economic matters such as foreign investment, corporate
organization and governance, commerce, taxation and trade. However, because
these laws and regulations are relatively new, and because of the limited volume
of published cases and judicial interpretation and their lack of force as
precedents, interpretation and enforcement of these laws and regulations involve
significant uncertainties. New laws and regulations that affect existing and
proposed future businesses may also be applied retroactively.
  12
  Our
principal operating subsidiary, Fuqi China, is considered a foreign invested
enterprise under PRC laws, and as a result is required to comply with PRC laws
and regulations, including laws and regulations specifically governing the
activities and conduct of foreign invested enterprises. We cannot predict what
effect the interpretation of existing or new PRC laws or regulations may have on
our businesses. If the relevant authorities find us in violation of PRC laws or
regulations, they would have broad discretion in dealing with such a violation,
including, without limitation:
  ·
                levying
      fines;
 
 ·
                revoking
      our business license, other licenses or
  authorities;
 
 ·
                requiring
      that we restructure our ownership or operations;
  and
 
 ·
                requiring
      that we discontinue some or all of our
business.
  A
recent increase in the rate of inflation in the PRC could negatively affect our
profitability and growth.
 
 While the
PRC economy has experienced rapid growth, such growth has been uneven among
various sectors of the economy and in different geographical areas of the
country. Rapid economic growth can lead to growth in the money supply and rising
inflation. According to the National Bureau of Statistics of China, the
inflation rate in China reached a high point of 4.8% in 2007 as compared to the
past several years. The inflation rate in China was 1.8% in 2005 and 1.5% in
2006. The inflation rate is expected to continue to increase in 2008. Many of
our operating expenses were increased and are also expected to increase with
inflation. If prices for our products rise at a rate that is insufficient to
compensate for the rise in the costs of supplies, it may have an adverse effect
on profitability. In order to control inflation in the past, the PRC government
has imposed controls on bank credits, limits on loans for fixed assets and
restrictions on state bank lending. The implementation of such policies may
impede economic growth.
  The
scope of our business license in China is limited, and we may not expand or
continue our business without government approval and renewal,
respectively.
  Our
principal operating subsidiary, Fuqi China, is a wholly foreign-owned enterprise
organized under PRC law, commonly known as a WFOE. A WFOE can only conduct
business within its approved business scope, which ultimately appears on its
business license. Our license permits us to design, manufacture, sell and market
jewelry products to department stores throughout the PRC and to engage in the
retail distribution of our products. Any amendment to the scope of our business
requires further application and government approval. In order for us to expand
our business beyond the scope of our license, we will be required to enter into
a negotiation with the authorities for the approval to expand the scope of our
business. We cannot assure you that Fuqi China will be able to obtain the
necessary government approval for any change or expansion of our business
scope.
  We
will not be able to complete an acquisition of prospective acquisition targets
in the PRC unless their financial statements are able to be reconciled to U.S.
generally accepted accounting principles in a timely manner.
  Companies
based in the PRC may not have properly kept financial books and records that may
be reconciled with U.S. generally accepted accounting principles. If we attempt
to acquire a significant PRC target company and/or its assets, we would be
required to obtain or prepare financial statements of the target that are
prepared in accordance with and reconciled to U.S. generally accepted accounting
principles. Federal securities laws require that a business combination meeting
certain financial significance tests require the public acquirer to prepare and
file historical and/or pro forma financial statement disclosure with the SEC.
These financial statements must be prepared in accordance with, or be reconciled
to U.S. generally accepted accounting principles and the historical financial
statements must be audited in accordance with the standards of the Public
Company Accounting Oversight Board (United States), or PCAOB. If a proposed
acquisition target does not have financial statements that have been prepared in
accordance with, or that can be reconciled to, U.S. generally accepted
accounting principles and audited in accordance with the standards of the PCAOB,
we will not be able to acquire that proposed acquisition target. These financial
statement requirements may limit the pool of potential acquisition targets with
which we may acquire and hinder our ability to expand our retail operations.
Furthermore, if we consummate an acquisition and are unable to timely file
audited financial statements and/or pro forma financial information required by
the Exchange Act, such as Item 9.01 of Form 8-K, we will be ineligible to use
the SEC’s short-form registration statement on Form S-3 to raise capital, if we
are otherwise eligible to use a Form S-3. If we are ineligible to use a Form
S-3, the process of raising capital may be more expensive and time consuming and
the terms of any offering transaction may not be as favorable as they would have
been if we were eligible to use Form S-3.
  13
  Recent
PRC regulations relating to acquisitions of PRC companies by foreign entities
may create regulatory uncertainties that could restrict or limit our ability to
operate. Our failure to obtain the prior approval of the China Securities
Regulatory Commission, or the CSRC, for the listing and trading of our common
stock could have a material adverse effect on our business, operating results,
reputation and trading price of our common stock, and may also create
uncertainties in the future.
  The PRC
State Administration of Foreign Exchange, or “SAFE,” issued a public notice in
November 2005, known as Circular 75, concerning the use of offshore holding
companies in mergers and acquisitions in China. The public notice provides that
if an offshore company controlled by PRC residents intends to acquire a PRC
company, such acquisition will be subject to registration with the relevant
foreign exchange authorities. The public notice also suggests that registration
with the relevant foreign exchange authorities is required for any sale or
transfer by the PRC residents of shares in an offshore holding company that owns
an onshore company. The PRC residents must each submit a registration form to
the local SAFE branch with respect to their ownership interests in the offshore
company, and must also file an amendment to such registration if the offshore
company experiences material events, such as changes in the share capital, share
transfer, mergers and acquisitions, spin-off transactions or use of assets in
China to guarantee offshore obligations.
  On August
8, 2006, the PRC Ministry of Commerce (“MOFCOM”), joined by the State-owned
Assets Supervision and Administration Commission of the State Council, the State
Administration of Taxation, the State Administration for Industry and Commerce,
the China Securities Regulatory Commission and SAFE, released a substantially
amended version of the Provisions for Foreign Investors to Merge with or Acquire
Domestic Enterprises (the “Revised M&A Regulations”), which took effect
September 8, 2006. These new rules significantly revised China’s regulatory
framework governing onshore-to-offshore restructurings and foreign acquisitions
of domestic enterprises. These new rules signify greater PRC government
attention to cross-border merger, acquisition and other investment activities,
by confirming MOFCOM as a key regulator for issues related to mergers and
acquisitions in China and requiring MOFCOM approval of a broad range of merger,
acquisition and investment transactions. Further, the new rules establish
reporting requirements for acquisition of control by foreigners of companies in
key industries, and reinforce the ability of the Chinese government to monitor
and prohibit foreign control transactions in key industries.
  Among
other things, the revised M&A Regulations include new provisions that
purport to require that an offshore special purpose vehicle, or SPV, formed for
listing purposes and controlled directly or indirectly by PRC companies or
individuals must obtain the approval of the CSRC prior to the listing and
trading of such SPV’s securities on an overseas stock exchange. On September 21,
2006, the CSRC published on its official website procedures specifying documents
and materials required to be submitted to it by SPVs seeking CSRC approval of
their overseas listings. However, the application of this PRC regulation remains
unclear with no consensus currently existing among the leading PRC law firms
regarding the scope and applicability of the CSRC approval requirement. Our PRC
counsel, Shujin Law Firm, has advised us that because we completed our
onshore-to-offshore restructuring before September 8, 2006, the effective date
of the new regulation, it is not necessary for us to submit the application to
the CSRC for its approval, and the listing and trading of our common stock does
not require CSRC approval.
  If the
CSRC or another PRC regulatory agency subsequently determines that CSRC approval
was required for our restructuring, we may face regulatory actions or other
sanctions from the CSRC or other PRC regulatory agencies. These regulatory
agencies may impose fines and penalties on our operations in the PRC, limit our
operating privileges in the PRC, or take other actions that could have a
material adverse effect on our business, financial condition, results of
operations, reputation and prospects, as well as the trading price of our Common
Stock.
  Also, if
later the CSRC requires that we obtain its approval, we may be unable to obtain
a waiver of the CSRC approval requirements, if and when procedures are
established to obtain such a waiver. Any uncertainties and/or negative publicity
regarding this CSRC approval requirement could have a material adverse effect on
the trading price of our common stock. Furthermore, published news reports in
China recently indicated that the CSRC may have curtailed or suspended overseas
listings for Chinese private companies.
  It is
uncertain how our business operations or future strategy will be affected by the
interpretations and implementation of Circular 75 and the Revised M&A
Regulations. It is anticipated that application of the new rules will be subject
to significant administrative interpretation, and we will need to closely
monitor how MOFCOM and other ministries apply the rules to ensure that our
domestic and offshore activities continue to comply with PRC law. Given the
uncertainties regarding interpretation and application of the new rules, we may
need to expend significant time and resources to maintain
compliance.
  Failure
to comply with the United States Foreign Corrupt Practices Act could subject us
to penalties and other adverse consequences.
  As our
ultimate holding company is a Delaware corporation, we are subject to the United
States Foreign Corrupt Practices Act, which generally prohibits United States
companies from engaging in bribery or other prohibited payments to foreign
officials for the purpose of obtaining or retaining business. Foreign companies,
including some that may compete with our company, are not subject to these
prohibitions. Corruption, extortion, bribery, pay-offs, theft and other
fraudulent practices may occur from time-to-time in the PRC. We can make no
assurance, however, that our employees or other agents will not engage in such
conduct for which we might be held responsible. If our employees or other agents
are found to have engaged in such practices, we could suffer severe penalties
and other consequences that may have a material adverse effect on our business,
financial condition and results of operations.
  14
 
 Because
our funds are held in banks which do not provide insurance, the failure of any
bank in which we deposit our funds could affect our ability to continue in
business.
 
 Banks and
other financial institutions in the PRC do not provide insurance for funds held
on deposit. A significant portion of our assets are in the form of cash
deposited with banks in the PRC, and in the event of a bank failure, we may not
have access to our funds on deposit. Depending upon the amount of money we
maintain in a bank that fails, our inability to have access to our cash could
impair our operations, and, if we are not able to access funds to pay our
suppliers, employees and other creditors, we may be unable to continue in
business.
  We
had enjoyed certain preferential tax concessions and the loss of these
preferential tax concessions may cause our tax liabilities to increase and our
profitability to decline.
  Our
subsidiary, Fuqi China, is subject to a reduced enterprise income tax rate of
15%, which is granted to all enterprises operating in the Shenzhen Special
Economic Zone. In 2004 and 2005, Fuqi China enjoyed a preferential income tax
rate of 7.5% due to its status as a new business. That status expired effective
January 1, 2006. The expiration of the preferential tax treatment has increased
our tax liabilities and reduced our profitability. Additionally, on March 16,
2007, the National People’s Congress of China enacted a new PRC Enterprise
Income Tax Law, under which foreign invested enterprises and domestic companies
will be subject to enterprise income tax at a uniform rate of 25%. The new law
will become effective on January 1, 2008. During the transition period for
enterprises established before March 16, the tax rate will be gradually
increased starting in 2008 and be equal to the new tax rate in 2012. We believe
that our profitability will be negatively affected in the near future as a
result of the new EIT Law. Any future increase in the enterprise income tax rate
applicable to us or other adverse tax treatments could increase our tax
liabilities and reduce our net income.
  If
we make equity compensation grants to persons who are PRC citizens, they may be
required to register with the State Administration of Foreign Exchange of the
PRC, or SAFE. We may also face regulatory uncertainties that could restrict our
ability to adopt additional equity compensation plans for our directors and
employees and other parties under PRC law.
  On April
6, 2007, SAFE issued the “Operating Procedures for Administration of Domestic
Individuals Participating in the Employee Stock Ownership Plan or Stock Option
Plan of An Overseas Listed Company, also know as “Circular 78.” It is not clear
whether Circular 78 covers all forms of equity compensation plans or only those
which provide for the granting of stock options. For any plans which are so
covered and are adopted by a non-PRC listed company, such as our company, after
April 6, 2007, Circular 78 requires all participants who are PRC citizens to
register with and obtain approvals from SAFE prior to their participation in the
plan. In addition, Circular 78 also requires PRC citizens to register with SAFE
and make the necessary applications and filings if they participated in an
overseas listed company’s covered equity compensation plan prior to April 6,
2007. We believe that the registration and approval requirements contemplated in
Circular 78 will be burdensome and time consuming.
  We intend
to make numerous stock option grants under our equity incentive plan to our
officers and directors, some of whom are PRC citizens and may be required to
register with SAFE. In addition to our officers and directors that received
option grants, future participants of our equity incentive plan or any other
equity compensation plan we may adopt who are PRC citizens may be required to
register with SAFE. If it is determined that any of our equity compensation
plans are subject to Circular 78, failure to comply with such provisions may
subject us and participants of our equity incentive plan who are PRC citizens to
fines and legal sanctions and prevent us from being able to grant equity
compensation to our PRC employees. In that case, our business operations may be
adversely affected.
  Any
recurrence of severe acute respiratory syndrome, or SARS, the Avian Flu, or
another widespread public health problem in the PRC could adversely affect our
operations.
  A renewed
outbreak of SARS, the Avian Flu or another widespread public health problem in
China, where all of our manufacturing facilities are located and where all of
our sales occur, could have a negative effect on our operations. Our business is
dependent upon our ability to continue to manufacture our products. Such an
outbreak could have an impact on our operations as a result of:
  ·
                quarantines
      or closures of our manufacturing facilities or the retail outlets, which
      would severely disrupt our
operations,
 
 ·
                the
      sickness or death of our key officers and employees,
  and
 
 ·
                a
      general slowdown in the Chinese
economy.
 Any of
the foregoing events or other unforeseen consequences of public health problems
could adversely affect our operations.
  15


Because
our business is located in the PRC, we may have difficulty establishing adequate
management, legal and financial controls, which we are required to do in order
to comply with U.S. securities laws.




PRC
companies have historically not adopted a Western style of management and
financial reporting concepts and practices, which includes strong corporate
governance, internal controls and, computer, financial and other control
systems. Most of our middle and top management staff are not educated and
trained in the Western system, and we may have difficulty hiring new employees
in the PRC with such training. In addition, we may need to rely on a new and
developing communication infrastructure to efficiently transfer our information
from retail nodes to our headquarters. As a result of these factors, we may
experience difficulty in establishing management, legal and financial controls,
collecting financial data and preparing financial statements, books of account
and corporate records and instituting business practices that meet Western
standards. Therefore, we may, in turn, experience difficulties in implementing
and maintaining adequate internal controls as required under Section 404 of the
Sarbanes-Oxley Act of 2002. This may result in significant deficiencies or
material weaknesses in our internal controls, which could impact the reliability
of our financial statements and prevent us from complying with SEC rules and
regulations and the requirements of the Sarbanes-Oxley Act of 2002. Any such
deficiencies, weaknesses or lack of compliance could have a materially adverse
effect on our business.




You
may experience difficulties in effecting service of legal process, enforcing
foreign judgments or bringing original actions in China based upon U.S. laws,
including the federal securities laws, or other foreign laws against us or our
management.




All of
our current operations, including the manufacturing and distribution of jewelry,
are conducted in China. Moreover, most of our directors and officers are
nationals and residents of China. All or substantially all of the assets of
these persons are located outside the United States and in the PRC. As a result,
it may not be possible to effect service of process within the United States or
elsewhere outside China upon these persons. In addition, uncertainty exists as
to whether the courts of China would recognize or enforce judgments of U.S.
courts obtained against us or such officers and/or directors predicated upon the
civil liability provisions of the securities laws of the United States or any
state thereof, or be competent to hear original actions brought in China against
us or such persons predicated upon the securities laws of the United States or
any state thereof.




Risks
Related To Our Capital Structure




We
are controlled by one stockholder, whose interests may differ from those of
other stockholders. As a result, we could be prevented from entering into
potentially beneficial transactions if they conflict with our major
stockholder’s interests.




As of
December 31, 2007, Mr. Yu Kwai Chong, our Chief Executive Officer and our
largest stockholder, beneficially owns or control approximately 53.4% of our
outstanding shares. Mr. Chong possesses significant influence over us, giving
him the ability, among other things, to elect all or a majority of the Board of
Directors and to approve significant corporate transactions. Such stock
ownership and control may also have the effect of delaying or preventing a
future change in control, impeding a merger, consolidation, takeover or other
business combination, or discouraging a potential acquirer from making a tender
offer or otherwise attempting to obtain control of our company. Without the
consent of Mr. Chong, we could be prevented from entering into potentially
beneficial transactions if they conflict with our major stockholder’s interests.
The interests of this stockholder may differ from the interests of our other
stockholders.




Our
stock price is volatile and you might not be able to resell your securities at
or above the price you have paid.




Since our
initial public offering and listing of our common stock on the Nasdaq Global
Market on October 23, 2007, the price at which our common stock had traded has
been volatile, with a high and low sales price of $11.75 and $6.02,
respectively, as through March 20, 2008. You might not be able to sell the
shares of our common stock at or above the price you have paid. The stock market
has experienced extreme volatility that often has been unrelated to the
performance of its listed companies. Moreover, only a limited number of our
shares are traded each day, which could increase the volatility of the price of
our stock. These market fluctuations might cause our stock price to fall
regardless of our performance. The market price of our common stock might
fluctuate significantly in response to many factors, some of which are beyond
our control, including the following:


·
              actual
      or anticipated fluctuations in our annual and quarterly results of
      operations;
  ·
              changes
      in securities analysts’
expectations;
  ·
              variations
      in our operating results, which could cause us to fail to meet analysts’
      or investors’ expectations;
  ·
              announcements
      by our competitors or us of significant new products, contracts,
      acquisitions, strategic partnerships, joint ventures or capital
      commitments;
  ·
              conditions
      and trends in our industry;
  ·
              general
      market, economic, industry and political
  conditions;
  16
 
 ·
              changes
      in market values of comparable
companies;
  ·
              additions
      or departures of key personnel;
  ·
              stock
      market price and volume fluctuations attributable to inconsistent trading
      volume levels; and
  ·
              future
      sales of equity or debt securities, including sales which dilute existing
      investors.




The
sale or availability for sale of substantial amounts of our common stock could
adversely affect its market price.




The
market price of our Common Stock could decline as a result of sales of a large
number of shares of our common stock in the market or the perception that these
sales could occur. These sales, or the possibility that these sales may occur,
also might make it more difficult for us to sell equity securities in the future
at a time and at a price that we deem appropriate.




As of
March 15, 2008, we had 20,924,843 shares of Common Stock outstanding, and
approximately 9,740,000 were freely tradable without further restriction under
the Securities Act of 1933, as amended, by persons other than our affiliates
(within the meaning of Rule 144 under the Securities Act). In addition, our
certificate of incorporation permits the issuance of up to approximately
79,075,157 additional shares of common stock. Thus, we have the ability to issue
substantial amounts of common stock in the future, which would dilute the
percentage ownership held by the existing investors.




In
connection with the public offering that we conducted on October 23, 2007, in
which we issued 7,033,816 shares of freely tradable common stock, we, each of
our directors and senior officers, and each holder of 5% or more of our common
stock agreed, with limited exceptions, that we and they will not, without the
prior written consent of the offering’s underwriter, through April 20, 2008,
among other things, directly or indirectly, offer to sell, sell or otherwise
dispose of any of shares of our common stock or file a registration statement
with the SEC. After the lock-up agreements, up to 11,184,066 of the shares that
had been locked up will be eligible for future sale in the public market at
prescribed times pursuant to Rule 144 under the Securities Act, or otherwise,
sales of a significant number of these shares of common stock in the public
market could reduce the market price of the common stock.




Further,
effective February 15, 2008, the SEC revised Rule 144, which provides a safe
harbor for the resale of restricted securities, shortening applicable holding
periods and easing other restrictions and requirements for resales by our
non-affiliates, thereby enabling an increased number of our outstanding
restricted securities to be resold sooner in the public market. Sales of
substantial amounts of our stock at any one time or from time to time by the
investors to whom we have issued them, or even the availability of these shares
for sale, could cause the market price of our common stock to
decline.




If
we fail to maintain effective internal controls over financial reporting, the
price of our common stock may be adversely affected.




We are
required to establish and maintain appropriate internal controls over financial
reporting. Failure to establish those controls, or any failure of those controls
once established, could adversely impact our public disclosures regarding our
business, financial condition or results of operations. Any failure of these
controls could also prevent us from maintaining accurate accounting records and
discovering accounting errors and financial frauds. Rules adopted by the SEC
pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 require annual
assessment of our internal control over financial reporting, and attestation of
this assessment by our company’s independent registered public accountants. The
SEC extended the compliance dates for non-accelerated filers, as defined by the
SEC. Accordingly, we believe that the annual assessment of our internal controls
requirement will first apply to our annual report for the 2007 fiscal year and
the attestation requirement of management’s assessment by our independent
registered public accountants will first apply to our annual report for the 2008
fiscal year. The standards that must be met for management to assess the
internal control over financial reporting as effective are new and complex, and
require significant documentation, testing and possible remediation to meet the
detailed standards. We may encounter problems or delays in completing activities
necessary to make an assessment of our internal control over financial
reporting. In addition, the attestation process by our independent registered
public accountants will be new to us and we may encounter problems or delays in
completing the implementation of any requested improvements and receiving an
attestation of our assessment by our independent registered public accountants.
If we cannot assess our internal control over financial reporting as effective,
or our independent registered public accountants are unable to provide an
unqualified attestation report on such assessment, investor confidence and share
value may be negatively impacted.




In
addition, management’s assessment of internal controls over financial reporting
may identify weaknesses and conditions that need to be addressed in our internal
controls over financial reporting or other matters that may raise concerns for
investors. Any actual or perceived weaknesses and conditions that need to be
addressed in our internal control over financial reporting, disclosure of
management’s assessment of our internal controls over financial reporting, or
disclosure of our public accounting firm’s attestation to or report on
management’s assessment of our internal controls over financial reporting may
have an adverse impact on the price of our common stock. Our public accountants,
Stonefield Josephson, Inc., identified that our accounting for certain
significant transactions were incorrectly calculated or incorrectly recorded.
Our public accountants informed us that these adjustments reflected significant
deficiencies in our internal controls over accounting and financial reporting
for the year ended December 31, 2007. We are in the process of improving our
internal controls in an effort to improve our control processes and procedures;
however, there can be no guarantee that we will be successful in our attempts to
correct our significant deficiencies.


17


Restrictions
on the convertibility of RMB into foreign currency may limit our ability to make
dividends or other payments in U.S. dollars or fund possible business activities
outside China.




All of
our net revenues are currently generated in RMB. Any future restrictions on
currency exchanges may limit our ability to use net revenues generated in RMB to
make dividends or other payments in U.S. dollars or fund possible business
activities outside China. Although the PRC government introduced regulations in
1996 to allow greater convertibility of RMB for current account transactions,
significant restrictions still remain, including primarily the restriction that
foreign-invested enterprises may only buy, sell and/or remit foreign currencies
at those banks authorized to conduct foreign exchange business after providing
valid commercial documents. In addition, remittance of foreign currencies abroad
and conversion of RMB for capital account items, including direct investment and
loans, is subject to government approval in China, and companies are required to
open and maintain separate foreign exchange accounts for capital account items.
We cannot assure you the Chinese regulatory authorities will not impose more
stringent restrictions on the convertibility of RMB, especially with respect to
foreign exchange transactions.




Because
our revenues are generated in RMB and our results are reported in U.S. dollars,
devaluation of the RMB could negatively impact our results of
operations.




The value
of RMB is subject to changes in China’s governmental policies and to
international economic and political developments. In January, 1994, the PRC
government implemented a unitary managed floating rate system. Under this
system, the People’s Bank of China, or PBOC, began publishing a daily base
exchange rate with reference primarily to the supply and demand of RMB against
the U.S. dollar and other foreign currencies in the market during the previous
day. Authorized banks and financial institutions are allowed to quote buy and
sell rates for RMB within a specified band around the central bank’s daily
exchange rate. On July 21, 2005, PBOC announced an adjustment of the exchange
rate of the U.S. dollar to RMB from 1:8.27 to 1:8.11 and modified the system by
which the exchange rates are determined. This modification has resulted in an
approximate 9.93% appreciation of the RMB against the U.S. dollar from July 21,
2005 to December 31, 2007. While the international reaction to the RMB
revaluation has generally been positive, there remains significant international
pressure on the PRC government to adopt an even more flexible currency policy,
which could result in further fluctuations of the exchange rate of RMB against
the U.S. dollar, including possible devaluations. As all of our net revenues are
recorded in RMB, any future devaluation of RMB against the U.S. dollar could
negatively impact our results of operations.




We
do not foresee paying cash dividends in the foreseeable future and, as a result,
our investors sole source of gain, if any, will depend on capital appreciation,
if any.




We do not
plan to declare or pay any further cash dividends on our shares of common stock
in the foreseeable future and we currently intend to retain any future earnings
for funding growth. Prior to the reverse merger we effected with VT Marketing
Services, the predecessor of Fuqi International, Inc. (the “Reverse Merger”) in
November 2006, we were wholly-owned by our founder and Chief Executive Officer,
Mr. Yu Kwai Chong. During the years ended December 31, 2007, 2006, and 2005, we
paid cash dividends of $0, $2.7 million, and $5.4 million, respectively, to Mr.
Chong as our sole stockholder prior to the Reverse Merger. We currently have no
intention to declare further dividends in the foreseeable future. Payment of
dividends is further restricted under the provisions of our existing loan
agreements, which prohibit Fuqi China from paying any dividends or making any
other distributions to Fuqi BVI without the consent of the lenders. As a result,
you should not rely on an investment in our securities if you require the
investment to produce dividend income. Capital appreciation, if any, of our
shares may be your sole source of gain for the foreseeable future. Moreover, you
may not be able to resell your shares in our company at or above the price you
paid for them.




ITEM
1B. UNRESOLVED STAFF COMMENTS




Not
applicable.




ITEM 2. PROPERTIES




Our
principal executive offices are located at 5/F., Block 1, Shi Hua Industrial
Zone, Cui Zhu Road North, Shenzhen 518019, China. We own approximately 15,000
square feet of office and showroom space at this location.




Our
jewelry production facility is located in Shenzhen, China and, including office
spaces, consists of approximately 66,000 square feet of building space. We own
approximately 33,000 square feet of this space indirectly through our Chairman,
Yu Kwai Chong, and his wife, both of whom hold the property in trust for our
benefit. The remaining 33,000 square feet has been leased by us from Shenzhen
Jin Tong Hai Enterprises Ltd, since July 2005. We use the space for production
facilities, offices and showrooms. Pursuant to the terms of the lease, we lease
the space for approximately $120,000 per annum. The lease agreement will
terminate in June 2010. We have the right to renew the lease prior to its
termination. At the time of renewal, the lease amount will be renegotiated, and
based on the current industrial leasing market, we expect that the lease amount
will be increased by approximately 35% in the year 2010.


18


In
October 2007, we entered into a lease agreement for a 400-square-feet corporate
office in San Jose, California. This office lease has a term of two years,
expiring in October 2009. Monthly rent for this lease is $720.




ITEM 3. LEGAL
PROCEEDINGS




We are
not involved in any material legal proceedings, nor are we aware of any
potential or threatened material litigation, or any asserted claims that may
result in material litigation or other legal proceedings.




ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS




No matter
was submitted to a vote of our security holders during the fourth quarter of the
fiscal year ended December 31, 2007.





PART
II




ITEM 5. MARKET FOR REGISTRANT’S
COMMON STOCK, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY
SECURITIES




Market
Information




Prior to
October 23, 2007, our shares of common stock were not listed or quoted for
trading on any national securities exchange or national quotation system. On
October 23, 2007, we completed the initial public offering and our common stock
began trading on the NASDAQ Global Market under the symbol “FUQI”. The low and
high sales price for our common stock, as reported by NASDAQ, since October 23,
2007 to the fiscal year end December 31, 2007 was $6.02 and $11.75,
respectively. The closing price of our common stock on March 24, 2008 on the
NASDAQ was $6.78. As of March 15, 2008, we had approximately 201 common
stockholders of record.




The stock
market in general has experienced extreme stock price fluctuations in the past
few years. In some cases, these fluctuations have been unrelated to the
operating performance of the affected companies. Many companies have experienced
dramatic volatility in the market prices of their common stock. We believe that
a number of factors, both within and outside its control, could cause the price
of our common stock to fluctuate, perhaps substantially. Factors such as the
following could have a significant adverse impact on the market price of its
common stock:


·
              Our
      ability to obtain additional financing and, if available, the terms and
      conditions of the financing;
 ·
              Our financial position and
      results of operations;·
              Concern
      as to, or other evidence of, the reliability and efficiency of our
      proposed products and services or our competitors’ products and
      services;
 
 ·
              Announcements
      of innovations or new products or services by we or our
      competitors;
 ·
              Federal
      and state governmental regulatory actions and the impact of such
      requirements on our business;
 ·
              The
      development of litigation against
us;
 ·
              Period-to-period
      fluctuations in our operating
results;
 ·
              Changes
      in estimates of our performance by any securities
  analysts;
 ·
              The
      issuance of new equity securities pursuant to a future offering or
      acquisition;
 ·
              Changes
      in interest rates;
 ·
              Competitive
      developments, including announcements by competitors of new products or
      services or significant contracts, acquisitions, strategic partnerships,
      joint ventures or capital
commitments;
 ·
              Investor
      perceptions of our company; and
 ·
              General
      economic and other national
conditions.


Recent
Sales of Unregistered Securities




None.




Dividends




The
Company has not paid or does not expect to declare or pay any cash dividends on
its common stock in the foreseeable future, and it currently intends to retain
future earnings, if any, to finance the expansion of its business. The decision
whether to pay cash dividends on the Company’s common stock will be made by the
Company’s board of directors, in their discretion, and will depend on its
financial condition, operating results, capital requirements and other factors
that the board of directors considers significant. Payment of dividends by Fuqi
China is further restricted under the provisions of our existing loan
agreements, which prohibit Fuqi China from paying any dividends or making any
other distributions to Fuqi BVI without the consent of the
lenders.


19


The
Company’s wholly-owned subsidiary, Fuqi China, prior to merger with the Company,
paid cash dividends of $0, $2,739,726, and $5,421,687 during the years ended
December 31, 2007, 2006 and 2005, respectively. Each of these dividends was paid
by the Company’s subsidiary to Mr. Chong, as its sole stockholder, which offset
partially the amounts due to the Company’s subsidiary by Mr. Chong.




Transfer
Agent and Registrar




The
transfer agent and registrar for our common stock is Computershare Trust
Company, Inc.




Equity
Compensation Plan Information




Our
equity compensation plan information is provided as set forth in Part III, Item
11 herein.


20


ITEM
6.  SELECTED CONSOLIDATED FINANCIAL DATA




The
following consolidated statements of income data for each of the five years
ended December 31, 2007 and the consolidated balance sheet data as of December
31, 2007, 2006, 2005, 2004, and 2003 are derived from our audited consolidated
financial statements. Historical results are not necessarily indicative of the
results of operations for future years. The following data is qualified in its
entirety by and should be read in conjunction with “Management’s Discussion and
Analysis of Financial Condition and Results of Operations” and our consolidated
financial statements and related notes included elsewhere in this Form
10-K/A.




Consolidated
Statement of Income Data:





Years Ended December 31,2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004
                    
                    
                    2003(In
      Thousands, Except Share Amounts and Earnings per Share)Net
      sales
                    
                    $
                    145,559
                    
                    
                    $
                    92,409
                    
                    
                    $
                    72,580
                    
                    
                    $
                    56,765
                    
                    
                    $
                    29,501Cost
      of sales
                    
                    
                    129,045
                    
                    
                    
                    83,619
                    
                    
                    
                    64,964
                    
                    
                    
                    50,862
                    
                    
                    
                    26,019Gross
      profit
                    
                    
                    16,514
                    
                    
                    
                    8,790
                    
                    
                    
                    7,616
                    
                    
                    
                    5,903
                    
                    
                    
                    3,482Operating
      expensesSelling
      and marketing
                    
                    
                    1,105
                    
                    
                    
                    490
                    
                    
                    
                    624
                    
                    
                    
                    549
                    
                    
                    
                    251General
      and administrative
                    
                    
                    2,919
                    
                    
                    
                    794
                    
                    
                    
                    671
                    
                    
                    
                    1,006
                    
                    
                    
                    1,006Total
      operating expenses
                    
                    
                    4,024
                    
                    
                    
                    1,284
                    
                    
                    
                    1,295
                    
                    
                    
                    1,555
                    
                    
                    
                    1,257Income
      from operations
                    
                    
                    12,490
                    
                    
                    
                    7,506
                    
                    
                    
                    6,321
                    
                    
                    
                    4,348
                    
                    
                    
                    2,225Other
      income (expenses):Interest
      expense
                    
                    
                    (1,239
                    )
                    
                    
                    (799
                    )
                    
                    
                    (498
                    )
                    
                    
                    (100
                    )
                    
                    
                    —Interest
      income
                    
                    
                    166
                    
                    
                    
                    70
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    1Change
      of fair value on inventory loan payable
                    
                    
                    (46
                    )
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Loss
      on disposal of fixed assets
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    (45
                    )
                    
                    
                    —Exemption
      of tax liabilities and estimated penalty payable
                    
                    
                    4,162
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Miscellaneous
                    
                    
                    80
                    
                    
                    
                    13
                    
                    
                    
                    (1
                    )
                    
                    
                    4
                    
                    
                    
                    40Total
      other income (expenses)
                    
                    
                    3,123
                    
                    
                    
                    (716
                    )
                    
                    
                    (499
                    )
                    
                    
                    (141
                    )
                    
                    
                    41Income
      before provision for income taxes
                    
                    
                    15,613
                    
                    
                    
                    6,790
                    
                    
                    
                    5,822
                    
                    
                    
                    4,207
                    
                    
                    
                    2,266Provision
      for income taxes
                    
                    
                    2,097
                    
                    
                    
                    995
                    
                    
                    
                    452
                    
                    
                    
                    359
                    
                    
                    
                    193Net
      income
                    
                    
                    13,516
                    
                    
                    
                    5,795
                    
                    
                    
                    5,370
                    
                    
                    
                    3,848
                    
                    
                    
                    2,073Other
      comprehensive income - foreign currency translation
      adjustments
                    
                    
                    2,553
                    
                    
                    
                    288
                    
                    
                    
                    143
                    
                    
                    
                    —
                    
                    
                    
                    —Comprehensive
      income
                    
                    $
                    16,069
                    
                    
                    $
                    6,083
                    
                    
                    $
                    5,513
                    
                    
                    $
                    3,848
                    
                    
                    $
                    2,073Earnings
      per share - basic
                    
                    $
                    0.96
                    
                    
                    $
                    0.51
                    
                    
                    $
                    0.48
                    
                    
                    $
                    0.34
                    
                    
                    $
                    0.19Earnings
      per share - diluted
                    
                    $
                    0.86
                    
                    
                    $
                    0.50
                    
                    
                    $
                    0.48
                    
                    
                    $
                    0.34
                    
                    
                    $
                    0.19Cash
      dividends per share
                    
                    $
                    —
                    
                    
                    $
                    0.24
                    
                    
                    $
                    0.49
                    
                    
                    $
                    0.35
                    
                    
                    $
                    0.15Weighted
      average number of common shares - basic
                    
                    
                    14,105,791
                    
                    
                    
                    11,260,544
                    
                    
                    
                    11,175,543
                    
                    
                    
                    11,175,543
                    
                    
                    
                    11,175,543Weighted
      average number of common shares - diluted
                    
                    
                    15,627,494
                    
                    
                    
                    11,631,459
                    
                    
                    
                    11,175,543
                    
                    
                    
                    11,175,543
                    
                    
                    
                    11,175,543





Consolidated Balance
Sheet Data:




As of December 31,2007
                    
                    
                    2006
                    
                    
                    2005
                    
                    
                    2004
                    
                    
                    2003(In Thousands)Cash
                    
                    $
                    63,294
                    
                    
                    $
                    13,355
                    
                    
                    $
                    71
                    
                    
                    $
                    256
                    
                    
                    $
                    1,294Total
      assets
                    
                    
                    122,715
                    
                    
                    
                    31,125
                    
                    
                    
                    28,115
                    
                    
                    
                    11,230
                    
                    
                    
                    8,579Total
      liabilities
                    
                    
                    25,455
                    
                    
                    
                    20,180
                    
                    
                    
                    20,508
                    
                    
                    
                    8,535
                    
                    
                    
                    5,756Total
      stockholders’ equity
                    
                    
                    97,260
                    
                    
                    
                    10,945
                    
                    
                    
                    7,607
                    
                    
                    
                    2,695
                    
                    
                    
                    2,823


21


ITEM
7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS




The
following discussion contains forward-looking statements that involve risks and
uncertainties. Forward-looking statements include, but are not limited to,
statements regarding future events, our plans and expectations and financial
projections. Our actual results could differ materially from those discussed
herein. Factors that could cause or contribute to such differences include, but
are not limited to, those discussed elsewhere in this Form 10-K/A. See “Risk
Factors” beginning on page 8. Unless the context otherwise requires, the terms
“we,” the “Company,” “us,” or “Fuqi” refers to Fuqi International, Inc. and our
wholly-owned subsidiaries.




Overview




We are a
leading designer of high quality precious metal jewelry in China, developing,
promoting, and selling a broad range of products in the large and rapidly
expanding Chinese luxury goods market. Our products consist of a range of unique
styles and designs made from precious metals such as platinum, gold, and Karat
gold (K-gold).  We also produce jewelry items that contain diamonds
and other precious stones on a custom-order basis. We continuously innovate and
change our designs based upon consumer trends in China. By continuously creating
new designs and rapidly bringing them to market, we are able to differentiate
ourselves from our competitors and strengthen our brand identity. Our design
database presently contains over 28,000 unique products.




We have
historically sold our products directly to distributors, retailers and other
wholesalers, who then sell our products to consumers through both retail
counters located in department stores and in other traditional stand-alone
jewelry stores. In the coastal cities of China, we believe the demand for
platinum and gemstone products has been increasing. In order to capitalize on
the growth in demand, we intend to develop platinum as one of the primary metals
from which our jewelry is manufactured. In 2006, we began to shift our product
line to produce more platinum jewelry and we intend to invest in the development
of a new production line to produce finished gemstone platinum jewelry. The
production lead time of platinum products, starting from purchase of raw
materials and ending with finished products, is about six to eight days, while
the lead time for gold products is about two to four days. Lead time also varies
on the complexity of production and design of our products. As such, we
anticipate that more working capital will be needed to support this shift of
product mix.




Our
wholesale prices are based on the spot prices of the raw material that make up
our products, with the spot price measured at the time our products are sold.
Similarly, the value of our inventory on hand is based on spot prices of the raw
materials that make up the inventory. We record the value of our inventory at
the lower of cost (using the first-in, first-out method) or market. Our gross
margin is therefore affected by changes in the price of raw materials. The
increase in our net sales for the year ended December 31, 2007 and the value of
inventory as of December 31, 2007 was due in part to the general increase in the
market value of precious metals. Any fluctuation in the spot price of precious
metal would result in a change in our wholesales revenue and our gross margin,
as our sales price is based, in part, on the spot price of the precious metal
contained in the product sold. We cannot predict and foresee the volatility of
the market value of precious metals in the future. We closely monitor the market
price of precious metals and, commencing in the fourth quarter of 2007, have
entered into certain gold futures contracts with our supplier, Shanghai Gold
Exchange, in an attempt to manage our consolidated exposure to changes in
inventory values due to fluctuations in market prices.  Gold futures
offered by Shanghai Gold Exchange are designed for full members to hedge or to
acquire inventory at a preset price.  Our futures contracts are not
considered as hedges for accounting purposes.  We do not conduct any
trading or speculating of these precious metals.





In order
to capitalize on the substantial growth in consumer spending within the luxury
goods category in China and to capture the margin appreciation from direct sales
to the consumer, we, in 2007, initiated a retail strategy. In April 2007, we
executed transfer and operation agreements to obtain operating rights for five
jewelry retail counters in department stores located in Beijing and Tianjin
region. On October 28, 2007, after the transferor was not able to complete the
transfer of these five counters in a reasonable period of time, we entered into
a cancellation agreement to terminate the transfer transaction effective
November 30, 2007. Subsequent to the cancellation agreement, we entered into
agreements with two department stores in Shenyang to open retail counters. As of
December 31, 2007, we held a total of six retail counters in two department
stores located in Shenyang. Total retail sales generated by our counters for the
year ended December 31, 2007 was approximately $1,245,000. In 2008, we intend to
open and/or acquire 60 to 80 retail counters and 8 to 10 retail stores. Our
retail operations are discussed more fully below under the caption “Retail
Operations.”




By
initiating our retail strategy, we intend to enhance our profitability in 2008
and further develop our brand reputation. We intend to produce diamond and
platinum jewelry products that appeal to younger, urban consumers who have more
buying power. We believe our new retail strategy creates a significant
opportunity for us to both improve our return on capital and increase
shareholder value. There are, however, risks related to our planned expansion.
Our retail expansion strategy will largely depend on our ability to find sites
for, open and operate new retail locations successfully. Our ability to open and
operate new retail locations successfully depends on several factors, including,
among others, our ability to identify suitable counter and store locations, the
availability of which is outside our control; purchase and negotiate acceptable
lease terms; prepare counters and stores for opening within budget; source
sufficient levels of inventory at acceptable costs to meet the needs of new
counters and stores; secure required governmental permits and approvals;
successfully integrate new counters and stores into our existing operations; and
generate sufficient operating cash flows or secure adequate capital on
commercially reasonable terms to fund our expansion plans. Any failure to
successfully open and operate new retail counters and stores could have a
material adverse effect on our results of operations in the future. In addition,
our retail expansion program will place increased demands on our operational,
managerial and administrative resources. These increased demands could cause us
to operate our business less effectively, which, in turn, could cause
deterioration in the financial performance of our overall
business.


22


Recent
Events




Business
Acquisition




In
January 2008, we agreed upon the terms to acquire two jewelry companies,
Shanghai Tian Mei Jewelry Co. Ltd. and Beijing Yinzhong Tian Mei Jewelry Co.
Ltd., collectively known as “Temix.” Temix is a branded jewelry store chain with
50 outlets located primarily in the Beijing and Shanghai regions. Out of the 50
outlets, there are 5 stand alone stores and 45 counters located in department
stores. Our proposed acquisition includes obtaining all of Temix’s stores,
counters, leases, registered trade name, exchange membership, and inventories.
The products sold in these outlets are primarily diamond and gemstone jewelry,
including ruby and jade and karat gold. The purchase price for Temix will be
approximately $18.5 million, with approximately $9.5 million being paid in cash
and the remaining being paid in securities. The number of our shares to be
issued will be subject to the achievement of certain revenue and net income
performance targets over a three-year period. Temix was founded by Mr. Chujian
Huang, who is the Chief Executive Officer of Temix and a 15-year veteran in
China’s jewelry industry, particularly in the Yangtze Delta region. Mr. Huang
will become a full time employee of Fuqi upon the closing of the acquisition and
be responsible for managing the Temix chain. We expect the acquisition to be
completed in latter part of the second quarter of fiscal 2008. The acquisition
is subject to execution of a definitive agreement and various closing conditions
contained therein, including receiving certain regulatory
approvals.




We
anticipate this addition to our existing wholesale business represents a
strategic opportunity for us to further penetrate an attractive consumer
demographic, diversify our business operations, improve our sales and margin
performance and expand our presence at the retail level. Temix is a well-known,
young, white collar brand in Beijing and Shanghai and we believe that we can
strengthen the performance at each outlet by better capitalizing Temix counters
and stores to ensure they have an appropriate level of inventory, a mix of
fashionable jewelry designs and strong brand promotion.




Initial
Public Offering




On
October 23, 2007, we completed our initial public offering of 7,033,816 shares
of common stock at a per share price of $9.00. On October 25, 2007, the
underwriters elected to fully exercise their over-allotment option to purchase
an additional 1,055,072 shares of our common stock. In total, including the
over-allotment shares, we sold 8,088,888 shares of our common stock at $9.00 per
share. The shares offered were listed and traded on the NASDAQ Global Market
under the ticker symbol “FUQI”. After underwriting discounts and commissions and
offering costs, we received net proceeds of approximately $67.0 million. The
proceeds were intended for use for general corporate purposes, including
expansion of our retail operations, enhancement of our product lines, and for
general working capital purposes.




Reverse
Stock Split




On August
23, 2007, our Board of Directors unanimously authorized a 1.69-to-1 reverse
stock split of our common stock. The reverse stock split became effective on
October 22, 2007. All references to shares in the consolidated financial
statements and the accompanying notes, including but not limited to the number
of shares and per share amounts, unless otherwise noted, have been adjusted to
reflect the reverse stock split retroactively.




Corporate
History




We
operate through our wholly-owned subsidiary Fuqi International Holdings Co.,
Ltd., a British Virgin Islands corporation (“Fuqi BVI”) and its wholly-owned
subsidiary, Shenzhen Fuqi Jewelry Co., Ltd., (“Fuqi China”) a company
established under the laws of the People’s Republic of China. Our company’s
principal office is in the city of Shenzhen, in southern China, where we have a
large-scale production base that includes a modern factory of more than 53,000
square feet, a dedicated senior design, sales and marketing team, and
approximately 540 employees, including approximately 350 company-trained
production workers and 60 production trainees. We believe our current facilities
provide adequate space for our planned expansion of our production lines, which
will include diamond and other finished gemstone jewelry.




On
November 20, 2006, Fuqi BVI entered into a share exchange agreement with VT
Marketing Services, Inc. (“VT”) and Mr. Yu Kwai Chong, who is our current Chief
Executive Officer and Chairman of the Board of the Directors, to effect a
reverse merger transaction (the “Reverse Merger”). Pursuant to the Reverse
Merger, Mr. Chong, as the sole shareholder of Fuqi BVI, agreed to exchange all
of his shares of Fuqi BVI for shares of VT and VT agreed to acquire all of the
issued and outstanding capital stock of Fuqi BVI. VT was formed as part of the
implementation of the Chapter 11 reorganization plan (the “Visitalk Plan”) of
visitalk.com, Inc., which became effective on September 17, 2004. The Reverse
Merger closed on November 22, 2006 and VT issued an aggregate of 11,175,543
shares of common stock in exchange for all of the issued and outstanding
securities of Fuqi BVI. Upon the close of the Reverse Merger, VT became the 100%
parent of Fuqi BVI and assumed the operations of Fuqi BVI and its subsidiary as
its sole business. On November 8, 2006, VT reincorporated from Arizona to Nevada
and on December 8, 2006, after the Reverse Merger, VT reincorporated from the
Nevada to Delaware and changed its corporate name from “VT Marketing Services,
Inc.” to “Fuqi International, Inc.” The transactions contemplated by the Reverse
Merger were intended to be a “tax-free” transaction pursuant to the provisions
of Section 351 of the Internal Revenue Code of 1986, as
amended.


23


For
financial accounting purposes, the Reverse Merger was treated as a reverse
acquisition by Fuqi BVI, under the purchase method of accounting, and was
treated as a recapitalization with Fuqi BVI as the accounting acquirer.
Accordingly, our historical financial statements have been prepared to give
retroactive effect to the reverse acquisition completed on November 22, 2006,
and represent the operations of Fuqi BVI and its wholly-owned subsidiary, Fuqi
China.




Critical
Accounting Policies, Estimates and Assumptions




Management’s
discussion and analysis of results of operations and financial condition are
based upon our consolidated financial statements. These statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America. These principles require management to make certain
estimates and assumptions that affect amounts reported and disclosed in the
financial statements and related notes. The most significant estimates and
assumptions include valuation of inventories, provisions for income taxes,
allowance for doubtful accounts, and the recoverability of the long-lived
assets. Actual results could differ from these estimates. Periodically, we
review all significant estimates and assumptions affecting the financial
statements and record the effect of any necessary adjustments.




The
following critical accounting policies rely upon assumptions and estimates and
were used in the preparation of our consolidated financial
statements:




Revenue
Recognition




Wholesale
revenue is recognized upon delivery and acceptance of jewelry products by our
customers while the retail revenue is recognized upon receipt and acceptance of
jewelry products by our customers, provided in each case that the other
conditions of sales are satisfied: (i) persuasive evidence of an arrangement
exists; (ii) delivery has occurred, upon shipment when title passes, or services
have been rendered; (iii) our price to the buyer is fixed or determinable; and
(iv) collectibility is reasonably assured.




Currency
Reporting




Amounts
reported are stated in U.S. Dollars, unless stated otherwise. Our functional
currency is the RMB. Foreign currency transactions (outside the PRC) are
translated into RMB according to the prevailing exchange rate at the transaction
dates. Assets and liabilities denominated in foreign currencies at the balance
sheet dates are translated into RMB at period-end exchange rates. For the
purpose of preparing the consolidated financial statements, the consolidated
balance sheets of our company have been translated into U.S. dollars at the
current rates as of the end of the respective periods and the consolidated
statements of income have been translated into U.S. dollars at the weighted
average rates during the periods the transactions were recognized. The resulting
translation gain adjustments are recorded as other comprehensive income in the
statements of income and comprehensive income and as a separate component of
statements of stockholders’ equity.




Allowance
for Doubtful Accounts




We
maintain an allowance for doubtful accounts for estimated losses resulting from
the inability of our customers to make required payments. Allowance for doubtful
accounts is based on our assessment of the collectibility of specific customer
accounts, the aging of accounts receivable, our history of bad debts, and the
general condition of the industry. If a major customer’s credit worthiness
deteriorates, or our customers’ actual defaults exceed historical experience,
our estimates could change and impact our reported results. We have not
experienced any significant amount of bad debt in the past.




Inventory




Inventories
are stated at the lower of cost (using the first-in, first-out method) or
market. We continually evaluate the composition of our inventories assessing
slow-moving and ongoing products. Our products contain gold and platinum
material which will not become obsolete and accordingly we do not make any
reserve for slow-moving and obsolete inventory.




Taxation




We are
incorporated in the State of Delaware, and our wholly owned subsidiary, Fuqi
BVI, is a British Virgin Islands company. We are subject to franchise taxes in
Delaware and U.S. federal income taxes, but we are not currently generating any
taxable operating income. We are not subject to taxation in the British Virgin
Islands. Fuqi BVI’s wholly-owned subsidiary, Fuqi China, is a PRC
company.


24


Under
current tax laws in China, the usual statutory income tax rate applicable to PRC
companies is 33%. Fuqi China currently enjoys a reduced enterprise income tax
rate of 15%, which is granted to all enterprises operating in the Shenzhen
Special Economic Zone. Prior to 2006, we were under the preferential income tax
rate of 7.5% in 2005, due to our status of being a new business. That status
expired effective January 1, 2006. Our effective income tax rates for the years
ended December 31, 2007, 2006 and 2005 were 13.4%, 14.7% and 7.8%,
respectively.




On March
16, 2007, the National People’s Congress of China enacted a new PRC Enterprise
Income Tax Law, under which foreign invested enterprises and domestic companies
will be subject to enterprise income tax at a uniform rate of 25%. The new law
will become effective on January 1, 2008. During the transition period for
enterprises established before March 16, the tax rate will be gradually
increased starting in 2008 and be equal to the new tax rate in 2012. We
anticipate that as a result of the new EIT law, our income tax provision will
increase, which could adversely affect our financial condition and results of
operations. We had enjoyed certain preferential tax concessions and the loss of
these preferential tax concessions may cause our tax liabilities to increase and
our profitability to decline.




We are
also subject to a 5% business tax on our design fees and a 17% value added tax
on the processing fee. The 5% business tax is borne by us while the 17% value
added tax is a component of the prices that we charge our customers. The sum of
the design fee, processing fee, and the market price of raw materials used to
manufacture our products is the wholesale price at which we sell our products.
We treat the business tax as a sales-related expense and thus report it under
selling and marketing in our statements of income.




From the
inception of Fuqi China in 2001 to December 31, 2006, we failed to report a
cumulative amount of approximately $26 million in cash revenues related to
design fees. As of December 31, 2006, we had an accrual of approximately $3.8
million in tax liabilities representing business tax and fees of 5.2% and income
tax on the unreported design revenues since inception and an accrual of
approximately $1.1 million in estimated penalties. In April 2006, the Shenzhen
local tax department levied a $1.8 million assessment against us for unpaid
business taxes, fees, and income taxes related to these unreported cash revenues
up to the period from inception to December 31, 2005. The assessment was
originally due at the end of April 2006 and subject to 0.05% per day of interest
and penalties thereafter. On April 28, 2006, we filed for an extension of the
deadline to remit these outstanding taxes payable to December 20, 2006, and the
extension request was approved by the tax department in July 2006. On December
28, 2006, Shenzhen City Tax Bureau granted a further extension to us from
December 20, 2006 to April 25, 2007.




On April
25, 2007, we appointed a registered tax agent to apply on behalf of our company
for a special reduction or exemption for the unpaid tax liabilities for the
period from inception to December 31, 2006. On May 14, 2007, we received a
notice from the Shenzhen tax department accepting our application for a tax
reduction or exemption and were granted an additional period to remit our
outstanding tax liabilities until August 9, 2007. The tax department agreed not
to assess any interest and penalties during this review process until August 9,
2007. On August 10, 2007, we received a notice from the tax department
conditionally agreeing to fully exempt our tax liabilities in the amount of
approximately $3 million on unreported design fee income for the period from
inception of our operations in 2001 to December 31, 2006, provided that our
common stock is successfully listed on a major overseas stock exchange within
180 days from the date of the tax notice. We fulfilled such condition in October
2007 and obtained acknowledgement from the Shenzhen tax department in November
2007. As a result, the accrued business and income tax liabilities, and the
accrued estimated and penalties totaling $4.2 million, was reversed and recorded
as non-operating income in our consolidated statement of income for the year
ended December 31, 2007.




All of
the design fee income for the year of 2007 has been properly reported and
accounted for and has been fully paid by the tax filing deadline.




Derivative
Instruments





During
the forth quarter of 2007, we entered into certain gold future contracts with
our supplier, Shanghai Gold Exchange. Gold futures offered by Shanghai Gold
Exchange are designed for full members to hedge or to acquire inventory at a
preset price. We utilized these future contracts to manage our consolidated
exposure to changes in inventory values due to fluctuations in market prices and
are not considered as hedges for accounting purpose. Our gold futures positions
are marked to market at each reporting date and all unrealized gains and losses
are recognized in earnings currently. These contract positions have not had a
material effect on our consolidated financial position, results of operations,
or cash flows.




Stock-based
Compensation





In
accordance with SFAS No. 123R, “Share-based Payment: An amendment of FASB
Statement No. 123” (“SFAS 123R”), effective January 1, 2006, we are required to
recognize compensation expense related to stock options granted to employees
based on: (a) compensation cost for all share-based payments granted prior to,
but not yet vested as of December 31, 2005, based on the grant date fair value
estimated in accordance with SFAS No 123, “Accounting for Stock-Based
Compensation” (“SFAS 123”), and (b) compensation cost for all share-based
payments granted subsequent to December 31, 2005, based on the grant-date fair
value estimated in accordance with the provisions of SFAS123R. 123R requires
forfeitures to be estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from initial estimates. We did
not issue any stock options in 2005 and 2006 and had no outstanding options as
of December 31, 2006. On October 26, 2007, we granted options to purchase a
total of 1,320,000 shares of our common stock to two executives and four
directors. We expect these options to be fully vested and therefore did not
account for any forfeiture as the vesting periods of these options are
relatively short. We use the Black-Scholes option-pricing model to value stock
option awards and expensed the stock-based compensation based on the vesting
periods.


25


Results
of Operations




The
following table sets forth certain financial information from our audited
consolidated statements of income expressed as a percentage of revenues and
should be read in conjunction with our consolidated financial statements and
notes thereto included elsewhere in this Form 10-K/A.





Years Ended December 31,2007
                                                
                                                
                                                2006
                                                
                                                
                                                2005Net
      sales
                                                
                                                
                                                100.00
                                                %
                                                
                                                
                                                100.00
                                                %
                                                
                                                
                                                100.00
                                                %Cost
      of sales
                                                
                                                
                                                88.65
                                                %
                                                
                                                
                                                90.49
                                                %
                                                
                                                
                                                89.51
                                                %Gross
      profit
                                                
                                                
                                                11.35
                                                %
                                                
                                                
                                                9.51
                                                %
                                                
                                                
                                                10.49
                                                %Operating
      expenses:Selling
      and marketing
                                                
                                                
                                                0.76
                                                %
                                                
                                                
                                                0.53
                                                %
                                                
                                                
                                                0.86
                                                %General
      and administrative
                                                
                                                
                                                2.01
                                                %
                                                
                                                
                                                0.86
                                                %
                                                
                                                
                                                0.92
                                                %Total
      operating expenses
                                                
                                                
                                                2.77
                                                %
                                                
                                                
                                                1.39
                                                %
                                                
                                                
                                                1.78
                                                %Income
      from operations
                                                
                                                
                                                8.58
                                                %
                                                
                                                
                                                8.12
                                                %
                                                
                                                
                                                8.71
                                                %Other
      income (expense), net
                                                
                                                
                                                2.15
                                                %
                                                
                                                
                                                -0.77
                                                %
                                                
                                                
                                                -0.69
                                                %Income
      before provision for income taxes
                                                
                                                
                                                10.73
                                                %
                                                
                                                
                                                7.35
                                                %
                                                
                                                
                                                8.02
                                                %Provision
      for income taxes
                                                
                                                
                                                1.44
                                                %
                                                
                                                
                                                1.08
                                                %
                                                
                                                
                                                0.62
                                                %Net
      income
                                                
                                                
                                                9.29
                                                %
                                                
                                                
                                                6.27
                                                %
                                                
                                                
                                                7.40
                                                %




Year
Ended December 31, 2007 and 2006




Net
sales




Net
sales, which consist of gross sales net of returns, for the year ended December
31, 2007 increased to $146 million, an increase of $54 million, or 59%, from net
sales of $92 million for the year ended December 31, 2006. The increase was
primarily attributable to a combination of an increase in both selling price and
sales volume. The selling price of our jewelry products is based on the market
price of the precious metals (e.g., gold and platinum) in the periods when the
products are sold. During 2007, the average price of gold and platinum increased
by 9.94% and 9.33%, respectively, as compared with 2006. In addition, there was
an increase of 34% in sales volume from approximately 4.4 tons for 2006 to 5.9
tons for 2007 as result of increase in jewelry products demand by our existing
consumers and engaging of new customers. Sales volume of gold and platinum for
the year ended December 31, 2007 increased by 39% and 28% to 5 tons and 736kg
for 2007 from 3.6 tons and 573kg for 2006, respectively.




Net sales
for the years ended December 31, 2007 and 2006 were comprised of the
following:





Years Ended December 31,2007
                                                            
                                                            
                                                            2006Amount in
                                                              Millions
                                                            
                                                            Percentage
                                                            
                                                            
                                                            Amount in
                                                              Millions
                                                            
                                                            PercentagePlatinum
                                                            $
                                                            30.9
                                                            
                                                            21.2
                                                            %
                                                            
                                                            $
                                                            21.0
                                                            
                                                            
                                                            22.7
                                                            %Gold
                                                            
                                                            81.0
                                                            
                                                            55.8
                                                            
                                                            
                                                            
                                                            43.6
                                                            
                                                            
                                                            47.2K-gold
      and Studded Jewelry
                                                            
                                                            33.7
                                                            
                                                            23.0
                                                            
                                                            
                                                            
                                                            27.8
                                                            
                                                            
                                                            30.1Total
                                                            $
                                                            145.6
                                                            
                                                            100.0
                                                            %
                                                            
                                                            $
                                                            92.4
                                                            
                                                            
                                                            100.0
                                                            %


26


Cost
of sales




Cost of
sales is mainly comprised of costs of raw materials, primarily gold and
platinum, in addition to direct manufacturing costs and factory overhead. Cost
of sales for the year ended December 31, 2007 increased to $129 million, an
increase of $45 million, or 54%, from $84 million for the same period in 2006.
The increase in cost of sales, which was consistent with the increase in net
sales, was primarily due to an increase in the cost of raw materials, which
resulted from the increase in sales volume for the year ended December 31,
2007.




Gross
profit





Gross
profit for the year ended December 31, 2007 increased to $16.5 million, an
increase of $7.7 million, or 88%, from $8.8 million for 2006. Gross profit
margin increased to 11.3% for year ended December 31, 2007, compared to 9.5% for
the same period in 2006. The increase in profit margin was primarily derived
from a general increase in the design fees of our products, which resulted
primarily from an increase in design styles, an increase in brand awareness, and
our receipt of various national awards during the year ended December 31, 2007,
partially offset by a slight decrease in profit margin during the fourth quarter
of 2007, which was primarily related to a limited-time, promotional discount on
our design fees and a fluctuation the price of raw materials. We hope that our
gross margin increases in 2008 as we continue to expand our retail operations,
including our proposed acquisition of Temix’s 50 retail stores, which is
expected to close in the latter part of the second quarter of 2008. There can be
no guarantee that the proposed acquisition of Temix will close or that we will
experience an increase in margins.




Selling
and marketing expenses




Selling
and marketing expenses are primarily comprised of business taxes, advertising
expenses, traveling expenses, production costs of marketing materials,
insurance, and delivery expenses. Selling and marketing expenses for the year
ended December 31, 2007 were approximately $1.1 million, an increase of $0.6
million, or 124%, from $0.5 million for 2006. Selling and marketing expenses
were 0.76% of net sales for the year ended December 31, 2007 compared to 0.53%
for the prior year. The slight increase in selling and marketing expenses as a
percentage of net sales was primarily due to our extended advertising campaign
during Chinese New Year in 2007, an increase in utility cost, higher insurance
premium for product delivery, and an increase in retail related
expenses.




General
and administrative expenses




General
and administrative expenses consist primarily of payroll expenses, benefits and
travel expenses for our staff, professional fees including audit, accounting,
legal and financial advisory, depreciation expenses, and general office
expenses. General and administrative expenses for the year ended December 31,
2007 were $2.9 million, an increase of $2.1 million, or 263%, from $0.8 million
for 2006. General and administrative expenses were 2.01% of net sales for the
year ended December 31, 2007 compared to 0.86% for the prior year. The increase
as a percentage of revenue was primarily due to an increase of legal and
professional fees incurred as a result of being a publicly reporting company in
the United States, expenses related to options granted, and increased salaries
to certain executives under the employment agreements executed in October 2007.
We anticipate general and administrative expense to increase in 2008 due to a
full year effect of stock based compensation and compensation cost for our
management executives and increase number of staff to support of our retail
strategy.




Other
income (expense), net




Other
income, net was $3.1 million of income in 2007 compared to $0.7 million of
expense in 2006. The increase was a result of the exemption of tax liabilities
and estimated penalty payable of $4.2 million. See the section entitled
“Taxation,” above, for additional information.




Provision
for income tax




Provision
for income tax expense was approximately $2.1 million for the year ended
December 31, 2007, an increase of $1.1 million, or 111%, from approximately
$995,000 for 2006. The increase was primarily due to an increase in the taxable
income for the year ended December 31, 2007.




Net
income




As a
result of the foregoing, net income increased to $13.5 million in 2007, an
increase of 133% from $5.8 million in 2006.


27


Years
Ended December 31, 2006 and 2005




Net
sales




Net sales
for the year ended December 31, 2006 increased to $92.4 million, an increase of
$19.8 million, or 27.3%, compared to net sales of $72.6 million for the year
ended December 31, 2005. The increase in net sales was primarily the result of
an increase in our prices, which was the result of an increase in the price of
precious metals, and a change in product mix. We sold more platinum jewelry
during the year ended December 31, 2006 as compared to 2005.




Net sales
for the years ended December 31, 2006 and 2005 were comprised of the
following:





Years Ended December 31,2006
                                                    
                                                    
                                                    2005Amount in
                                                      Millions
                                                    
                                                    Percentage
                                                    
                                                    
                                                    Amount in
                                                      Millions
                                                    
                                                    PercentagePlatinum
                                                    $
                                                    21.0
                                                    
                                                    22.7
                                                    %
                                                    
                                                    $
                                                    13.2
                                                    
                                                    
                                                    18.2
                                                    %Gold
                                                    
                                                    43.6
                                                    
                                                    47.2
                                                    
                                                    
                                                    
                                                    34.9
                                                    
                                                    
                                                    48.1K-gold
      and Studded Jewelry
                                                    
                                                    27.8
                                                    
                                                    30.1
                                                    
                                                    
                                                    
                                                    24.5
                                                    
                                                    
                                                    33.7Total
                                                    $
                                                    92.4
                                                    
                                                    100.0
                                                    %
                                                    
                                                    $
                                                    72.6
                                                    
                                                    
                                                    100.0
                                                    %




Cost
of sales




Cost of
sales for the year ended December 31, 2006 increased to $83.6 million, an
increase of $18.6 million, or 28.6%, compared to cost of sales of $65.0 million
for the year 2005. The increase was primarily due to the increase in net sales
for year ended December 31, 2006, with the percentage increase in cost of sales
in line with the increase in net sales. The small difference in the percentage
change was mainly due to increased labor costs required for processing
platinum.




Gross
profit




Gross
profit for the year ended December 31, 2006 increased to $8.8 million, an
increase of $1.2 million, or 15.8%, compared to $7.6 million for the same period
in 2005. The increase in gross profit resulted primarily from the increase in
net sales, which resulted from an increase in precious metal prices. However,
gross profit margin decreased to 9.5% for year ended December 31, 2006, compared
to 10.5% for the same period in 2005. Gross profit as a percentage of net sales
for 2006 decreased by 0.98 basis points from 10.49% for 2005 to 9.51%. The
decrease in gross profit margin was mainly attributable to our decision to
reduce prices in the third quarter of 2006 in an effort to attract more
sales.




Selling
and marketing expenses




Selling
and marketing expenses for the year ended December 31, 2006 were $490,000, a
decrease of $134,000, or 21.5%, as compared to $624,000 for the year ended
December 31, 2005. Selling and marketing expenses were 0.53% of revenues for the
year ended December 31, 2006 compared to 0.86% for the prior year. The decrease
in selling and marketing expenses was primarily due to our more targeted and
focused marketing efforts in 2006.




General
and administrative expenses




General
and administrative expenses for the year ended December 31, 2006 were $793,000,
an increase of $122,000, or 18.2%, as compared to $671,000 for the same period
in 2005. The increase in general and administrative expenses was mainly due to
costs and fees incurred in connection with the Reverse Merger between Fuqi BVI
and the predecessor of our current Delaware-incorporated holding company.
General and administrative expenses were 0.86% of revenues for the year ended
December 31, 2006 compared to 0.92%for the prior year. The slight decrease in
percentage of general and administrative expenses was mainly due to the fact
that the overall costs increased at the lower rate than that of
sales.




Other
income (expense), net




Other
income (expense), net was approximately $717,000 of expense in 2006 compared to
approximately $499,000 of expense in 2005. The increase in expense was primarily
a result of an increase of interest expenses by approximately $301,000, or
60.4%, from year 2005 as a result of an increase in interest rates for short
term bank financing for the year ended December 31, 2006.




Provision
of income tax




Provision
for income tax expense was approximately $995,000 for the year ended December
31, 2006, an increase of $543,000, or 120%, as compared to approximately
$452,000 for the same period in 2005. The increase was primarily due to the
increase in our operating income for the year ended December 31,
2006.


28


Net
income




As a
result of the foregoing, net income increased to $5.79 million in 2006, an
increase of $0.4 million, or 7.4%, from $5.37 million in 2005.




Quarterly
Comparisons





The
following table presents the unaudited consolidated statements of income data
for each of eight fiscal quarters through December 31, 2007, in dollars. The
first quarter is from January 1 to March 31, the second quarter is from April 1
to June 30, the third quarter is from July 1 to September 30, and the fourth
quarter is from October 1 to December 31. In management’s opinion, this
unaudited information has been prepared on the same basis as our audited
consolidated financial statements and includes all adjustments, consisting only
of normal recurring adjustments, necessary for a fair presentation of the
unaudited information for the quarters presented. The results of operations for
any quarter are not necessarily indicative of results that we might achieve for
any subsequent periods. In addition, our operating results have in the past and
may in the future fluctuate significantly as a result of many factors, including
the seasonality of our business and the unpredictable fluctuation of prices of
precious metals. Consequently, we believe that period-to-period comparisons of
our operating results may not necessarily be meaningful, and as a result, you
should not rely on them as an indication of future performance.





Fiscal Year 2007
                      
                      
                      Fiscal Year 2006Q4
                      
                      
                      
                      Q3
                      
                      
                      
                      Q2
                      
                      
                      
                      Q1
                      
                      
                      
                      Q4
                      
                      
                      
                      Q3
                      
                      
                      
                      Q2
                      
                      
                      
                      Q1(in thousands, except for per share data)Net
      sales
                      
                      $
                      55,070
                      
                      
                      $
                      36,248
                      
                      
                      $
                      26,281
                      
                      
                      $
                      27,960
                      
                      
                      $
                      24,802
                      
                      
                      $
                      19,083
                      
                      
                      $
                      24,220
                      
                      
                      $
                      24,304Gross
      profit
                      
                      
                      5,820
                      
                      
                      
                      4,477
                      
                      
                      
                      3,053
                      
                      
                      
                      3,164
                      
                      
                      
                      2,934
                      
                      
                      
                      1,426
                      
                      
                      
                      1,213
                      
                      
                      
                      3,217Net
      profit
                      
                      
                      7,413
                      
                      
                      
                      2,730
                      
                      
                      
                      1,489
                      
                      
                      
                      1,883
                      
                      
                      
                      2,102
                      
                      
                      
                      905
                      
                      
                      
                      514
                      
                      
                      
                      2,274Earnings
      per share - basic
                      
                      
                      0.39
                      
                      
                      
                      0.21
                      
                      
                      
                      0.12
                      
                      
                      
                      0.15
                      
                      
                      
                      0.18
                      
                      
                      
                      0.08
                      
                      
                      
                      0.05
                      
                      
                      
                      0.20Earnings
      per share - diluted
                      
                      
                      0.39
                      
                      
                      
                      0.21
                      
                      
                      
                      0.10
                      
                      
                      
                      0.12
                      
                      
                      
                      0.15
                      
                      
                      
                      0.08
                      
                      
                      
                      0.05
                      
                      
                      
                      0.20




Liquidity
and Capital Resources




At
December 31, 2007, we had retained earnings of $16.8 million and cash and cash
equivalents of $63 million. A substantial majority of our cash was derived from
our initial public offering of a total of 8,088,888 shares of our common stock
at $9.00 per share in October 2007. We intend to use such capital funding for
expanding and financing our retail distribution, enhancing our product lines,
and for general working capital for our retail operations. In connection with
the intended acquisition of Temix, we paid approximately $685,000 in 2007 as
deposit for such acquisition, which we have recorded in prepaid expenses and
other assets in our consolidated balance sheet as of December 31, 2007. We
anticipate paying an additional $8.7 million, of the $16.5 million total
consideration, in cash to acquire Temix. We expect to close the acquisition, and
pay the additional cash consideration, in the latter part of the second quarter
of 2008. In 2008, we plan to open a total of 60 to 80 retail counters and 8 to
10 retail stores. Our retail operations are discussed more fully below under the
caption “Retail Operations.”




At
December 31, 2007, we had working capital of $95.6 million and no long term
liabilities. Except for cash and cash equivalents, a majority of our net working
capital consisted of inventory and accounts receivable, both of which increased
by 389% and 155%, respectively, as of December 31, 2007 as compared to December
31, 2006. Increase in inventory was a result of significant purchases of raw
materials of precious metals incurred towards the end of 2007 upon receipt of
capital funding from the public offering in October 2007. We do not conduct any
trading of our raw materials of precious metals. Substantial increase of
inventory was used for expanding our sales capabilities by accepting larger
sales orders from our customers during the peak holiday season. Increases in
accounts receivable was attributable to substantial increase in revenue
generated in November and December, which is the beginning of our traditional
peak season, and extending credit terms to some of our customers with high
credit standings. We typically offer certain of our customers 30-days credit
terms for payment. We maintain an allowance for doubtful accounts for estimated
losses resulting from the inability of our customers to make required payments.
Allowance for doubtful accounts is based on our assessment of the collectability
of specific customer accounts, the aging of accounts receivable, our history of
bad debts, and the general condition of the industry. If a major customer’s
credit worthiness deteriorates, or our customers’ actual defaults exceed
historical experience, our estimates could change and impact our reported
results. We have not experienced any significant amount of bad debt since the
inception of our operation.


29


We had
outstanding facility lines of credit and short-term notes payables with banks in
an aggregate amount of $17.1million, consisting of $15.7 million in short-term
notes payable to banks and $1.37 million in facility lines of credit. Our loans
are secured by inventory, real property and/or guaranteed by our affiliates and
our controlling stockholder.




We have a
general banking facility line of credit with Agricultural Bank of China pursuant
to a Maximum Banking Facility Agreement dated August 24, 2006 which was renewed
in September 2007. The terms of the agreement enable us to borrow up to a
maximum facility amount of $13.7 million. Maturity dates for each withdrawal
typically range from three to six months and are agreed to by the parties at the
time of withdrawal. We executed notes payable with this bank under this facility
line with terms ranging from five months to one year. As of December 31, 2007,
we had $13.7 million outstanding under the facility, with interest rates ranging
from 6.732% to 8.019%. In addition, we have a line of credit and a bank loan
from China Construction Bank and DBS Bank. As of December 31 2007, we had a
total of $3.4 million outstanding with interest rates ranging from 6.732% to
7.776% from the DBS Bank line of credit and a bank loan from China Construction
Bank. Amounts borrowed under the banking facility lines of credit and short-term
notes payable are secured by our inventory, real property, and/or guaranteed by
our affiliates and our controlling stockholder and have certain restrictions and
covenants. We do not guarantee any indebtedness of our affiliates. The amounts
outstanding under these lines of credit and short-term notes payable are
presented in our financial statements as notes payable and line of
credit.




Prior to
the Reverse Merger, our then sole stockholder, Mr. Yu Kwai Chong, who is also
our President, Chief Executive Officer and Chairman of the Board, made loans to
us on a regular basis to meet short term financing needs of our company.
Typically, these advances were in amounts ranging from $30,000 to $5.5 million,
with no more than $10.0 million outstanding at any time. We did not pay interest
on any of these advances. During the same period, Mr. Chong borrowed from our
company primarily to fund personal liquidity needs. Since the closing of the
Reverse Merger, at which time Mr. Chong ceased to be our sole stockholder, we
have not engaged in any cash advance transactions with Mr. Chong and will not
engage in these transactions in the future. Prior to the Reverse Merger,
effective in November 2006, we paid dividends to our then sole stockholder, Mr.
Chong. During the years ended December 31, 2007, 2006, and 2005, we paid cash
dividends of $0, $2.7 million, and $5.4 million, respectively, to Mr. Chong. We
currently have no intention to declare further dividends in the foreseeable
future. Payment of dividends is further restricted under the provisions of our
existing loan agreements.




On our
consolidated statements of cash flows, we recorded advances by Mr. Chong to us
and related repayments to him as financing activities, and advances by us to Mr.
Chong and related repayments by him as investing activities. Advances and
repayments were not subject to written loan agreements; the advances were
partially repaid within three months while the remaining portions were repaid
over three months. In accordance with SFAS 95, we present the gross amounts of
the advances and repayments in our consolidated statements of cash
flows.




A
substantial portion of our working capital consists of accounts receivable from
customers. If customers responsible for a significant amount of accounts
receivable were to become insolvent or otherwise unable to pay for our products,
or to make payments in a timely manner, our liquidity and results of operations
could be materially adversely affected. An economic or industry downturn could
materially adversely affect the servicing of these accounts receivable, which
could result in longer payment cycles, increased collections costs and defaults
in excess of management’s expectations. In addition, as we increase our presence
in the retail market, we expect the aging of our accounts receivable generated
from sales through retail counters to increase as department stores typically
defer payments to us of cash receipts collected by them on our behalf. A
significant deterioration in our ability to collect on accounts receivable could
affect our cash flow and working capital position and could also impact the cost
or availability of financing available to us.




We expect
to expend significant resources to commence our planned retail distribution of
our manufactured jewelry in China. We will require substantial funds of
approximately $7.2 million in order to finance our planned retail
distribution, fund operating expenses, to develop manufacturing, marketing and
sales capabilities and to cover public company costs.  In addition to
the funds required to open retail locations, we believe that additional working
capital of approximately $24.5 million will be needed to operate retail
locations due to longer sales and collection cycles and higher inventory levels
required to support retail stores. We also expect to require substantial funds
of approximately $10 million to change our product mix to include more
platinum products. Without these funds, we may not be able to meet these goals.
Also, we expect our general and administrative costs to substantially increase
due to higher salaries to be paid to our executive officers further to
employment agreements.





We
believe that our current cash and cash flow from operations will be sufficient
to meet our anticipated cash needs, including our cash needs for working
capital, for the next 12 months.  We believe that the sources of the
funding for our expected expenditures in 2008 include our current cash and cash
flow from operations.  At December 31, 2007, we had cash and cash
equivalents of approximately $63 million and retained earnings of approximately
$16.8 million.  However, net cash used for operating activities for
the year ended December 31, 2007 was approximately $21.7 million, and there is
no guarantee that we be able to generate positive cash flow from operations for
the year ended December 31, 2008.  In addition, we may require
additional cash resources due to our inability to generate positive cash flow
from our operations, changing business conditions or other future developments,
including any investments or acquisitions we may decide to pursue.  We
may seek additional funding through public or private financing or through
collaborative arrangements with strategic partners.  We cannot be
certain that additional capital will be available on favorable terms, if at all,
and any available additional financing may not be adequate to meet our
goals.  Moreover, any equity financing would result in dilution to
stockholders.  If we cannot raise additional funds when needed, or on
acceptable terms, we may not be able to effectively execute our growth strategy
(including expanding our business to the retail market), take advantage of
future opportunities, or respond to competitive pressures or unanticipated
requirements. In addition, we may be required to scale back or discontinue our
production and development program, or obtain funds through strategic alliances
that may require us to relinquish certain rights.


30


The following table sets forth a
summary of our cash flows for the periods indicated:




Years Ended December 31,2007
                                    
                                    
                                    2006
                                    
                                    
                                    2005(In Thousands)Net
      cash (used for) provided by operating activities
                                    
                                    $
                                    (21,737
                                    )
                                    
                                    $
                                    4,037
                                    
                                    
                                    $
                                    3,202Net
      cash (used for) provided by investing activities
                                    
                                    (768
                                    )
                                    
                                    9,613
                                    
                                    
                                    (17,928
                                    )Net
      cash provided by (used for) financing activities
                                    
                                    71,082
                                    
                                    
                                    (595
                                    )
                                    
                                    14,622Effect
      of exchange rate changes on cash
                                    
                                    1,362
                                    
                                    
                                    229
                                    
                                    
                                    (81
                                    )Net
      increase (decrease) in cash
                                    
                                    $
                                    49,939
                                    
                                    
                                    $
                                    13,284
                                    
                                    
                                    $
                                    (185
                                    )Cash
      at beginning of year
                                    
                                    13,355
                                    
                                    
                                    71
                                    
                                    
                                    256Cash
      at end of year
                                    
                                    $
                                    63,294
                                    
                                    
                                    $
                                    13,355
                                    
                                    
                                    $
                                    71




Net cash (used
for) provided by operating activities. Net cash used for operating
activities was $21.7 million for the year ended December 31, 2007, compared to
net cash provided by operations of $4.0 million for the same period in 2006. The
$25.7 million decrease was primarily due to an increase in inventory in the
amount of $22.2 million during the year ended December 31, 2007 compared to an
increase of $109,000 during the same period in 2006, in addition to an increase
of accounts receivable in the amount of $13.6 million during the year 2007
compared to an increase of $1.96 million in the same period in
2006.




Net cash
provided by operating activities was $4.0 million for the year ended December
31, 2006, compared to net cash provided by operations of $3.2 million for the
same period in 2005. Net cash provided increased by $0.8 million primarily
because of (i) the utilization of VAT refundable of $0.4 million, (ii) increase
in inventory of $0.1 million and (iii) recovery of inventory loan receivable of
$0.7 million, in addition to a change in prepaid expenses.




Net cash (used
for) provided by investing activities. Net cash used for investing
activities amounted to approximately $768,000 for the year ended December 31,
2007, compared to net cash provided by investing activities of $9.6 million for
the year ended December 31, 2006. The change was due to an increase in
restricted cash of approximately $395,000, in addition to the absence of loans
and related repayments between our controlling stockholder and us, as had
occurred during the year of 2006.




Net cash
provided by investing activities amounted to $9.6 million for the year ended
December 31, 2006, compared to net cash used for investing activities of $17.9
million for the year ended December 31, 2005. The change was due to a net
repayment of $6.9 million (the amount of repayments over advances) in 2006 by
our majority stockholder, Mr. Yu Kwai Chong, compared to a net advance of $14.4
million (the amount of advances over repayments) to this stockholder in
2005.




Net cash provided
by (used for) financing activities. Net cash provided by financing
activities amounted to $71 million for the year ended December 31, 2007,
compared to net cash used for financing activities of $595,000 for the same
period of 2006. The increase of cash provided was primarily a result of net
proceeds of $67 million raised from the initial public offering of 8,088,888
shares of our common stock, in addition to net proceeds of $2.8 million from the
exercise of warrants that occurred during the second quarter of
2007.




Net cash
used for financing activities amounted to $595,000 for the year ended December
31, 2006, compared to net cash provided by financing activities of $14.6 million
for the year ended December 31, 2005. The change was primarily a result of our
use of short-term and long-term bank financing in a total amount of $8.8 million
in 2005. In addition, we borrowed a net amount of $415,000 from Mr. Yu Kwai
Chong in 2006 compared to $0 in 2005. We also received $4.8 million in capital
contributions from Mr. Chong in 2005 compared to $0 in 2006.




Contractual
obligations




The
following table describes our contractual commitments and obligations as of
December 31, 2007:





Payments due by Period (in $)Contractual Obligations
                        
                        Total
                        
                        
                        Less Than
                          1 Year
                        
                        
                        1 - 3
                          Years
                        
                        
                        3 - 5
                          Years
                        
                        
                        More Than
                          5 YearsShort-term
      borrowings
                        
                        $
                        17,112,504
                        
                        
                        $
                        17,112,504
                        
                        
                        $
                        —
                        
                        
                        $
                        —
                        
                        
                        $
                        —Lease
      of Plant & Office
                        
                        $
                        323,865
                        
                        
                        $
                        131,850
                        
                        
                        $
                        192,015
                        
                        
                        $
                        —
                        
                        
                        $
                        —Lease
      of Staff Dormitory
                        
                        $
                        8,721
                        
                        
                        $
                        8,721
                        
                        
                        
                        —
                        
                        
                        
                        —
                        
                        
                        
                        —$
                        17,445,090
                        
                        
                        $
                        17,253,075
                        
                        
                        $
                        192,015
                        
                        
                        $
                        —
                        
                        
                        $
                        —


31


Employment
Agreements of Executive Officers and New Labor Contract Law




In
October 2007, we entered into three-year employment contracts with our five
executive officers each of which includes a fixed amount of annual salary and
stock options to purchase the Company’s common stock. Details of each executive
officer can be found herein in Part III, Item 11.




Effective
January 1, 2008, PRC introduced a new labor contract law that enhances rights
for the nation's workers, including open-ended work contracts and severance pay.
The legislation requires employers to provide written contracts to their
workers, restricts the use of temporary laborers and makes it harder to lay off
employees. It also requires that employees with short-term contracts become
full-time employees with lifetime benefits after a short-term contract is
renewed twice. Although the new labor contract law would increase our labor
costs, we do not anticipate there will be significantly affect on our overall
profitability in the near future since such amount was historically not material
to our operating cost. Management anticipates this may be a step toward
improving candidate retention for skilled workers.




Retail
Operations




In April
2007, we entered into a transfer agreement with an unrelated party (the
“Transferor”), which has operation agreements with department stores for five
jewelry retail counters. Under the terms of the agreement, the Transferor agreed
to assign all of the operation rights to us for a fee of $400,000, which was
payable in three separate installments. On October 28, 2007, after the
Transferor was not able to complete the transfer of the counters, we entered
into a cancellation agreement with the Transferor to terminate the transfer
transaction as of November 30, 2007. Prior to the termination of the transfer,
we had obtained temporary operation rights from the Transferor to operate these
counters, and revenue derived from these five retail counters from the period of
May to November 2007 amounted to $937,000. Pursuant to the cancellation
agreement, we were not obligated to pay the $400,000 transfer fee of $400,000.
All the inventory remained in the five counter stores at the last day of the
operation was sold to the Transferor based on the pre-determined price. As of
December 31, 2007, the outstanding balance due to the Transferor was
approximately $204,000.




Subsequent
to the cancellation agreement, in November 2007, we entered into one-year
operating agreements to operate 6 retail jewelry counters at two department
stores located in the Shenyang region. We agreed to pay the department stores a
commission fee ranging 4.5% to 8% based on types of jewelry sales generated in
these jewelry counters. Fees paid to the two department stores totaled $20,669
in 2007 and are included in cost of sales expenses. We recognize revenues when
the titles of the merchandises are transferred to the ultimate consumers. Sales
generated from counters in these two department stores totaled $308,000 for the
year ended December 31, 2007.




Seasonality




Our
business is seasonal in nature. Our sales and net income are generally higher in
the fourth calendar quarter than the rest of the year. The primary factors that
affect the seasonal changes in our business operations are holidays and
traditional Chinese festivals. In the fourth quarter, retailers often experience
increased sales due to the week-long public holiday for Chinese National Day, as
well as Christmas and New Year’s Day. In addition, jewelry retailers commonly
stock up from wholesalers in the fourth quarter to prepare for potentially
higher sales in the following quarter for Chinese New Year. This quarter is also
a peak season for marriages and the birth of newborns in China, which have
historically resulted in higher sales. This seasonal trend in our business would
slightly shift in line with the gap between calendar quarter and lunar quarter
and occurred during 2004 and 2005. However, there was a slight variation during
2006. Because of rising precious metal prices in the fourth quarter of 2006,
many customers delayed their orders until the first quarter of 2007, resulting
in lower-than-expected sales volume in the fourth quarter of 2006, and higher
than expected sales in the first quarter of 2007. We experienced increased sales
in the fourth quarter of 2007.




Off-Balance
Sheet Transactions




We have
no material off-balance sheet transactions.




Impact
of Recent Currency Exchange Rate Increase




We use
the U.S. dollar as the reporting currency for our financial statements. Our
operations are conducted through our PRC operating subsidiary, Fuqi China, and
our functional currency is the RMB. On July 21, 2005, the PRC government changed
its policy of pegging the value of the RMB to the U.S. dollar and, as a result,
the RMB has appreciated against the U.S. dollar by approximately 8.26% from
1:8.27 on July 21, 2005 to 1:7.3046 on December 31, 2007. In converting our RMB
income statement amounts into U.S. dollars we used the following RMB/$ exchange
rates: 8.1963 for 2005, 7.959 for 2006 and 7.587 for 2007. Our operating results
in 2005, 2006 and 2007 have benefited as a result of appreciation of the RMB
against the U.S. dollar. There is no guarantee that we will benefit from the
exchange rate in the future and our operations may suffer if a less favorable
exchange rate develops.


32


New Accounting
Pronouncements




In
February 2007, the FASB issued SFAS No. 159, “ The Fair Value Option for Financial
Assets and Financial Liabilities”. The objective of this statement is to
improve financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. This Statement is expected by the FASB to expand the use of fair
value measurement, which is consistent with the FASB’s long-term measurement
objectives for accounting for financial instruments. This statement is effective
for fiscal years beginning after November 15, 2007. The Company is currently
evaluating the impact of adopting this statement and does not expect the
adoption of this provision to have a material effect on its financial position,
results of operations or cash flows.




In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (SFAS 141(R)), which replaces SFAS No. 141, “Business
Combinations.” SFAS 141(R) retains the underlying concepts of SFAS 141 in that
all business combinations are still required to be accounted for at fair value
under the acquisition method of accounting but SFAS 141(R) changed the method of
applying the acquisition method in a number of significant aspects. Acquisition
costs will generally be expensed as incurred; noncontrolling interests will be
valued at fair value at the acquisition date; in-process research and
development will be recorded at fair value as an indefinite-lived intangible
asset at the acquisition date; restructuring costs associated with a business
combination will generally be expensed subsequent to the acquisition date; and
changes in deferred tax asset valuation allowances and income tax uncertainties
after the acquisition date generally will affect income tax expense. SFAS 141(R)
is effective on a prospective basis for all business combinations for which the
acquisition date is on or after the beginning of the first annual period
subsequent to December 15, 2008, with the exception of the accounting for
valuation allowances on deferred taxes and acquired tax contingencies. SFAS
141(R) amends SFAS 109 such that adjustments made to valuation allowances on
deferred taxes and acquired tax contingencies associated with acquisitions that
closed prior to the effective date of SFAS 141(R) would also apply the
provisions of SFAS 141(R). Early adoption is not permitted. We are currently
evaluating the effects, if any, that SFAS 141(R) may not have significant
effects on our financial statements.





In
December 2007, the FASB issued Financial Accounting Standards No. 160,
“Noncontrolling Interests in Consolidated Financial Statements—an amendment of
ARB No. 51.” This statement is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008,
with earlier adoption prohibited. This statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the consolidated
financial statements and separate from the parent’s equity. The amount of net
income attributable to the noncontrolling interest will be included in
consolidated net income on the face of the income statement. It also amends
certain of ARB No. 51’s consolidation procedures for consistency with the
requirements of SFAS 141(R) .This statement also includes expanded disclosure requirements regarding
the interests of the parent and its noncontrolling interest. We are currently
evaluating this new statement and anticipate that the statement will not have a
significant impact on the reporting of our results of operations.




ITEM 7A. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK




Foreign
Exchange Risk




We use
the U.S. dollar as the reporting and functional currency for our financial
statements. As we conduct our operations through our PRC subsidiary, the
functional currency of our PRC subsidiary is RMB. Substantially all our revenue
and related expenses, including cost of revenues and advertising expenses, are
denominated and paid in RMB. Transactions in other currencies are recorded in
RMB at the rates of exchange prevailing when the transactions occur. Monetary
assets and liabilities denominated in other currencies are remeasured into RMB
at rates of exchange in effect at the balance sheet dates. Exchange gains and
losses are recorded in our statements of operations as other comprehensive
income.




The value
of RMB is subject to changes in China’s governmental policies and to
international economic and political developments. In January, 1994, the PRC
government implemented a unitary managed floating rate system. Under this
system, the People’s Bank of China, or PBOC, began publishing a daily base
exchange rate with reference primarily to the supply and demand of RMB against
the U.S. dollar and other foreign currencies in the market during the previous
day. Authorized banks and financial institutions are allowed to quote buy and
sell rates for RMB within a specified band around the central bank’s daily
exchange rate. On July 21, 2005, PBOC announced an adjustment of the exchange
rate of the U.S. dollar to RMB from 1:8.27 to 1:8.11 and modified the system by
which the exchange rates are determined. This modification has resulted in an
approximate 9.93% appreciation of the RMB against the U.S. dollar from July 21,
2005 to December 31, 2007. While the international reaction to the RMB
revaluation has generally been positive, there remains significant international
pressure on the PRC government to adopt an even more flexible currency policy,
which could result in further fluctuation of the exchange rate of RMB against
the U.S. dollar. As all of our net revenues are recorded in RMB, any future
devaluation of RMB against the dollar could negatively impact our results of
operations.


33


Interest
Rate Risk




As of
December 31, 2007, we had $17.1 million outstanding under short term credit
facilities from banks, with interest rates ranging from 6.732% to 8.02%. As all
of these borrowings are short term borrowings, we believe our exposure to
interest rate risk is not material. We do not use any derivative financial
instruments to manage interest rate risks.




Inflation




According
to the National Bureau of Statistics of China, the inflation rate in China
reached a high point of 4.8% in 2007 as compared to the past several years. The
inflation rate in China was 1.8% in 2005 and 1.5% in 2006. The inflation rate is
expected to continue to increase in 2008. Many of our operating expenses were
increased and are also expected to increase with inflation. In management's
opinion, changes in revenues, net earnings and inventory valuation that have
resulted from inflation and changing prices have not been material during the
years presented. Management does not expect that the effect of inflation on our
overall operating costs will be greater for us than for our competitors within
China.




Commodity
Price Sensitivity




We are
exposed to market risk in connection with our inventory balances, which are
comprised primarily of gold, platinum and jewelry made from gold and platinum.
Our inventories are stated at the lower of cost or market using the first in
first out method. If there is a downward change in the market price of gold, we
are required to mark-down the value of our inventory and record a loss in our
statement of income. We have not ever experienced any significant losses due to
changes in the market price of gold or platinum because the prices of gold and
platinum have generally risen since our inception. We cannot predict the extent
to which high raw material price levels will continue in the future. We do not
have any long-term raw material purchase contracts.




In
attempt to protect us against price increases of precious metals, we, in
December 2007, entered into future purchase contracts with our supplier, the
Shanghai Gold Exchange, to purchase raw material of gold. As of December 31,
2007, the fair value of the future gold contracts outstanding was approximately
$498,000 which was recorded as prepaid expenses. The change of its fair value of
$79,000 was classified as miscellaneous income in the accompanying consolidated
statements of income. The future contract was subsequently settled in January
2008.




ITEM
8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA




The
information required by this Item 8 is incorporated by reference to information
begins on Page F-1 at the end of this Form 10-K/A.




ITEM
9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURE




None.




ITEM
9A. CONTROLS AND PROCEDURES.




Disclosure
Controls and Procedures




Disclosure
controls and procedures refer to controls and other procedures designed to
ensure that information required to be disclosed in the reports we file or
submit under the Securities Exchange Act is recorded, processed, summarized and
reported within the time periods specified in the rules and forms of the SEC and
that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as
appropriate, to allow timely decisions regarding required
disclosure.





As
required by Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act, our
management has carried out an evaluation, with the participation and under the
supervision of our Chief Executive Officer and Chief Financial Officer, of the
effectiveness of the design and operation of our disclosure controls and
procedures as of December 31, 2007.   Based upon this evaluation,
our Chief Executive Officer and Chief Financial Officer concluded that the
Company’s disclosure controls and procedures were effective.





Management's
Report on Internal Control over Financial Reporting




Our
management is responsible for establishing and maintaining adequate internal
control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f)
under the Securities Exchange Act.  Because of its inherent
limitations, internal control over financial reporting may not prevent or detect
misstatements. Also, projections of any evaluation of effectiveness to future
periods are subject to the risk that controls may become inadequate because of
changes in conditions, or that the degree of compliance with the policies and
procedures may deteriorate.


34


Our
management has assessed the effectiveness of our internal control over financial
reporting as of December 31, 2007. In making its assessment, management used the
criteria described in Internal Control - Integrated Framework, issued by the
Committee of Sponsoring Organizations of the Treadway Commission, or
COSO.





A
significant deficiency (within the meaning of PCAOB Auditing Standard No. 5) is
a deficiency, or a combination of deficiencies, in internal control over
financial reporting that is less severe than material weakness, yet important
enough to merit attention by those responsible for oversight of our financial
reporting. The following significant deficiencies have been identified and
included in our management’s assessment as of December 31, 2007:




1.
            We did not maintain effective
      controls over the financial closing process to ensure the accurate and
      timely preparation of local financial statements and financial data which
      is necessary for preparation of consolidated financial statements due to
      an insufficient complement of local financial and accounting staffs who
      are knowledgeable of local accounting rules to support the size of our
      company’s current organizational structure;
  and




2.
            We did not maintain effective
      internal audit function due to the lack of qualified internal auditors who
      are familiar with internal audit, and we did not implement adequate and
      proper supervisory review to ensure that the significant internal control
      deficiencies can be detected or
  prevented.





3.
            Our independent auditors,
      Stonefield Josephson, Inc., identified that our accounting on certain
      significant transactions were incorrectly calculated or incorrectly
      recorded. During the course of the audit field work, our independent
      auditors discovered these errors. The independent auditors discussed these
      matters with our Chief Financial Officer, and we subsequently reevaluated
      the transactions and recorded the necessary adjustments. The auditors
      believe that these adjustments reflected significant deficiencies in our
      internal controls over accounting and financial
      reporting.




Our
management believes that none of these internal control deficiencies are
identified as material weakness or has had a material effect on our financial
condition or results of operations or caused our financial statements as of and
for the year ended December 31, 2007 to contain a material
misstatement.  Based on our management’s assessment of the
effectiveness of our internal control over financial reporting, our management
has concluded that, as of December 31, 2007, the Company’s internal control over
financial reporting was effective.





This
annual report on Form 10-K does not include an attestation report of our
registered independent public accounting firm regarding management's assessment
of our internal control over financial reporting. Management's report was not
subject to audit by our registered independent public accounting firm pursuant
to rules of the Securities and Exchange Commission that permit us to provide
only management's report in this annual report. Beginning with the year ended
December 31, 2008, Section 404 of the Sarbanes-Oxley Act will require our
independent registered public accounting firm to provide an attestation report
regarding management's assessment of our internal control over financial
reporting as of the end of our fiscal year ended December 31, 2008 with our
annual report on Form 10-K.




Remediation
Measures of Significant Deficiencies




To
remediate the first identified significant deficiency, we, in connection with
the preparation of our annual report for 2007, implemented additional controls
to accurately and consistently identify required adjustments through period-end
account analysis and detailed reconciliation processes. We improved our closing
process and we hired a US qualified accountant in January 2008 with relevant
accounting experience, skills and knowledge in the preparation of financial
statements under the requirements of US GAAP and financial reporting disclosure
under the requirement of SEC rules, which will enhance the supervision control
over financial data prepared by local financial and accounting
staffs.




In
addition, since 2007, our management has or plans to implement the measures
described below under the supervision and guidance of our audit committee to
remediate such ineffectiveness and to strengthen our internal controls over
financial reporting. As of the date of the filing, our management has
implemented, or is in the process of implementing, the following
measures:




1.
            We increased the level of
      interaction among our management, audit committee, independent auditors
      and other external advisors;





2.
            We recruited a Financial
      Controller, who will commence work in the latter part of the second
      quarter of 2008, to enhance financial reporting function of China
      operation;





3.
            We evaluated the sufficiency of
      local financial and accounting staff, and, based on that evaluation, we
      hired and continue to hire additional accounting
    staff;





4.
            We plan to re-evaluate the
      sufficiency of local financial and accounting staff upon the completion of
      our intended acquisition in retail business in
  2008;


35


5.
            We are in the process of
      enhancing training programs on accounting principles and procedures for
      our existing staffs;





6.
            We are in the process of
      standardizing the monthly and quarterly data collection timetable and
      procedures, and assigning data collection responsibilities to designated
      personnel;





7.
            We are in the process of
      negotiating with a professional advisory firm on outsourcing part of our
      internal audit function;





8.
            We are
      negotiating employment terms with an internal audit
      staff accountant to assist us improve our internal audit
      function; and





9.
            We are in the process of
      recruiting a qualified and experienced internal auditor to implement the
      internal audit function, and we plan to provide additional training to
      this internal auditor on appropriate controls and procedures necessary to
      document and evaluate our internal control
    procedures.





We
believe that we are taking the steps necessary for remediation of the
significant deficiencies identified above, and we will continue to monitor the
effectiveness of these steps and to make any changes that our management deems
appropriate




Changes
in Internal Controls over Financial Reporting




Due to
the implementation of the remedial measures to address the significant
deficiencies identified above, there were changes in our internal controls over
financial reporting during the fourth quarter of fiscal 2007 that have
materially affected, or are reasonably likely to materially affect our internal
control over financial reporting.




ITEM
9B. OTHER INFORMATION





On
October 10, 2007, we entered into a lease agreement for a 400-square-feet
corporate office in San Jose, California. This office lease has a term of two
years, expiring in October 2009. Monthly rent for this lease is $720. A copy of
the lease is attached hereto as Exhibit
10.16.





On
February 20, 2008, we entered into a lease agreement for 817 square-feet of
office space located in Hong Kong. The lease commenced on March 3, 2008 and
expires on February 28, 2010. Monthly base rent is approximately $1,470, in
addition to other monthly charges equal to approximately $373. A copy of the
lease is attached hereto as Exhibit
10.17.


36





PART
III





ITEM
10. DIRECTORS, EXECUTIVE OFFICERS, AND CORPORATE GOVERNANCE




Directors
and Executive Officers





The
following individuals compose our current board of directors and executive
officers.





Name
                    
                    Age
                    
                    PositionYu
      Kwai Chong
                    
                    48
                    
                    President,
      Chief Executive Officer and Chairman of the BoardChing
      Wan Wong
                    
                    40
                    
                    Chief
      Financial Officer and DirectorLie
      Xi Zhuang
                    
                    39
                    
                    Chief
      Operating Officer and DirectorXi
      Zhou Zhuo
                    
                    39
                    
                    Marketing
      DirectorHeung
      Sang Fong
                    
                    48
                    
                    Executive
      Vice President of Corporate DevelopmentHon.
      Lily Lee Chen
                    
                    71
                    
                    DirectorVictor
      A. Hollander
                    
                    75
                    
                    DirectorEileen
      B. Brody
                    
                    46
                    
                    DirectorJeff
      Haiyong Liu
                    
                    45
                    
                    Director





Yu
Kwai Chong





Mr. Yu
Kwai Chong is the principal founder of our company and has served as President,
Chief Executive Officer and Chairman of the Board of Directors since April 2001.
As the principal founder and Chief Executive Officer, Mr. Chong is dedicated to
develop our company as the leader of the Chinese jewelry industry; in day-to-day
operations, Mr. Chong is responsible for the strategic planning, marketing and
overall growth of our company. Mr. Chong has significant experience in the
Chinese jewelry industry, having established the first gold jewelry
manufacturing and sales company in Shenzhen over 20 years ago. Since January
1995, Mr. Chong has served as the Chief Executive Officer and Chairman of the
Board of Directors of Shenzhen Rong Xing (Group) Co., Ltd. Mr. Chong is also the
Permanent Director of the Gems & Jewelry Trade Association of China,
Permanent Director of the Gems & Jewelry Trade Association of Guangdong and
Associate President of Shenzhen Gold Jewelry Association. Mr. Chong also
currently serves as a director at a number of private companies that he owns in
China, including Shenzhen Rongxing (Group) Limited, Shenzhen Xinke Investment
Co., Ltd.





Ching
Wan Wong





Mr. Wong
has served as our Chief Financing Officer since January 2004. In addition, Mr.
Wong has worked as a tax consultant at the Guandong Yuexin Registered Tax Agent
Co., Ltd. from April 2002 to the present. From September 2000 to March 2002, Mr.
Wong served as the Finance Director of MindShare China, a communications firm.
From 1995 to 2000, before serving MindShare, Mr. Wong served as Finance Director
 — China operation for Carat Media Representative (Asia) Limited, a
multinational media company and Head of Finance — China for a foreign
invested media company. Mr. Wong received his Bachelor of Business
Administration in Accounting from the Chinese University of Hong Kong in 1989
and his Bachelor of Commerce from University of Southern Queensland in 1992. He
is a Certified Practicing Accountant in Australia, Certified Public Accountant
in Hong Kong, and Certified General Accountant in Canada, and is experienced in
international financial reporting and management.





Lie
Xi Zhuang





Mr.
Zhuang is a co-founder and has served as our Chief Operating Officer since April
2001 with responsibility for production management and cost control. From 1997
to 2000, Mr. Zhuang served as the Business Manager of Shenzhen Ping Shen Gold
and Silver Jewelry Co., Ltd., and from 1993 to 1997, Mr. Zhuang acted as the
Business Manager of Shenzhen Gao De Gold and Silver Jewelry Company. Mr. Zhuang
is certified with a Higher Diploma in Management by Hunan Xiang Tan
University.




Mr.
Xi Zhou Zhuo





Mr. Zhuo
is a co-founder and has served as our Marketing Director since 2001 with
responsibility for marketing and customer relations management. From 1997 to
2000, Mr. Zhuo served as the Deputy General Manager of Shenzhen Ping Shen Gold
and Silver Jewelry Co., Ltd., and from 1993 to 1997, Mr. Zhuo was the Sales
Manager of Shenzhen GaoDe Gold and Silver Jewelry Company. Mr. Zhuo has over 15
years of experience in sales and marketing of jewelry in China.


37





Heung
Sang Fong





Mr. Fong
has served as the Executive Vice President of Corporate Development of our
company since December 2006 and is responsible for our corporate development
program, including investor relations. From January 2004 to November 2006, Mr.
Fong served as the managing partner of Iceberg Financial Consultants, a
financial advisory firm based in China that advises Chinese clients in capital
raising activities in the United States. From December 2001 to December 2003,
Mr. Fong was the Chief Executive Officer of Holley Communications, a Chinese
company that engaged in CDMA chip and cell phone design. From March 2002 to
March 2004, he served as Chief Executive Officer of Pacific Systems Control
Technology, Inc. From May 2001 to November 2001, Mr. Fong was the Director of
Finance of PacificNet, Inc., a customer relationship management, mobile
internet, e-commerce and gaming technology based in China and listed on the
Nasdaq Global market. From December 1998 to April 2001, he was the Group
Financial Controller of Oregon Scientific, a wholly-owned subsidiary of IDT, a
Hong Kong Stock Exchange-listed company. Mr. Fong is a U.S. CPA and has held
various positions in such capacity with accounting firms in the United States
and Hong Kong, including Deloitte and Touche, Ernst and Young, and KPMG Peat
Marwick. Mr. Fong also currently serves as an independent director and audit
committee member of a Hong Kong public company, Universal Technology Inc.
(HK:8091). Mr. Fong also serves as a director and audit committee chairman, for
each of Diguang International Development Co., Ltd. (OTCBB: DGNG) and Kandi
Technology Corp. (NASDAQ-CM: KNDI), both U.S. publicly-traded companies. Mr.
Fong graduated from the Hong Kong Baptist College with a diploma in History in
1982. He also received an MBA from the University of Nevada at Reno in 1989 and
a Masters degree in Accounting from the University of Illinois at Urbana
Champaign in 1993.





Hon.
Lily Lee Chen





Hon. Ms.
Chen has served as a director since June 2007. She is presently Vice-Chair for
the Asian-Pacific-USA Chamber of Commerce. She is a Commissioner for the
California Commission on Aging. In 1982, Ms. Chen was elected to the Monterey
Park City Council. In 1984, she became mayor of Monterey Park, California. Hon.
Ms. Chen’s public service includes positions in: the Advisory Committee on the
rights Right and Responsibilities of Women, as appointed by President Ford; the
National Advisory Council on Adult Education, as appointed by President Carter;
California State World Trade Commission as the appointed Assembly Speaker; Women
in the Services (DACOWITS) as an Advisor appointed by Secretary of Defense Perry
and the Board of Governor’s of the East-West Center in Hawaii, as appointed by
President Clinton and Secretary of State Albright. Hon. Ms. Chen earned her
bachelor’s degree in communications and a Master’s in social work from the
University of Washington, Seattle. Ms. Chen began her professional career in
1964, working for the Los Angeles County where she directed operations, program
and grants management for numerous County programs. Her responsibilities
included the management and supervision of a seventy million dollar budget and
over four hundred employees.





Victor
A. Hollander





Mr.
Hollander, a CPA, has served as a director since June 2007. With nearly 50 years
of experience working with privately owned and public SEC reporting companies
worldwide, Mr. Hollander has been involved in a substantial number of initial
and secondary public offerings. In addition, he regularly assists companies with
accounting issues relating to public and private offerings and reverse mergers,
corporate reorganizations and acquisitions, and other fund raising and
regulatory matters. Mr. Hollander began his public accounting career in 1954 at
Joseph S. Herbert & Co., a prominent New York accounting firm. He has
specialized in capital raises and merger and acquisition matters since 1962 when
he started the firm Berger, Turner & Hollander. At this firm, he was the
audit partner of the first Los Angeles ladies dress manufacturer to go public.
In 1966, he joined Brout & Company and opened their offices in Los Angeles.
During this time, he was the audit partner for many public companies listed on
the New York Stock Exchange and the American Stock Exchange. In 1975, he joined
an international public accounting firm, Lester Witte, as the firm’s Senior
Securities Partner. In 1978 he formed his own practice, Hollander, Gilbert &
Company. It was this practice that Mr. Hollander merged, as Managing Director of
the West Coast Group, with Weinberg & Company. Mr. Hollander, after
attending the University of Illinois, University of California at Los Angeles
and after completing military service, graduated from California State
University, Los Angeles in 1958 with a Bachelor of Arts degree in Accounting. He
has served on the Securities, Ethics and Accounting and Auditing Committees of
various organizations, including the American Institute of Certified Public
Accountants and California State Society of Certified Public Accountants. In
addition, Mr. Hollander has served as a director, including as Chair of the
audit committee, of several SEC reporting companies. He currently serves as a
director and member of the audit committee of China Direct, Inc. (AMEX: CDS) and
Micro Imaging Technology, Inc. (OTCBB: MMTC).




Eileen
B. Brody





Ms. Brody
has served as a director since June 2007. Since August, 2005, Ms. Brody has been
President of Dawson-Forte Cashmere, an apparel trading company that sources the
majority of their cashmere products from China. From 1997 to 2004, she was the
Vice President of Merchandising and Planning for Carter's Retail division of The
William Carter Company. From 1992 to 1997, she held various management positions
for Melville Corporation, a multi-billion dollar retailer. From 1983 to 1990,
Ms. Brody worked for KPMG Peat Marwick in various positions including as a
Senior Manager. While at KPMG, she was responsible for audit services for a
diverse clientele of large Fortune 500 companies as well as small publicly
traded companies and provided due diligence services on a wide variety of
acquisitions. Ms. Brody is a Certified Public Accountant. She is the recipient
of the Fitzie Foundation-Harvard Business School award and the 2006 NCCE CO-OP
Hall of Fame Award. She received her Undergraduate and MBA degrees from Pace
University and a second MBA from the Harvard Graduate School of Business in
1992. Ms. Brody is also a member of the board of directors of American Oriental
Bioengineering Inc. (NYSE: AOB).


38





Jeff
Haiyong Liu





Jeff
Haiyong Liu has served as a director of our company since June 2007. Mr. Liu,
who is a U.S. citizen born in China, is General Manager of DBS (China)
Investment Ltd., which is a wholly owned subsidiary of Singapore DBS Bank Group
in China from December 2005 to the present. Prior to joining DBS, Mr. Liu served
as a Vice President of SIG Group based in Shanghai from June 2000 to November
2005, where he focused on China Banking and trust and financial services
opportunities. From January 1994 to September 1995, Mr. Liu worked in a Hong
Kong based investment firm headquartered in Mainland China and was in charge of
investment business for real estate and capital markets. In 1992, he served as
Director of Securities Dept. of Shaanxi International Trust and Investment Corp.
Ltd. and assisted in bringing the company's stock public in a $40 million public
offering. Prior to 1992, Mr. Liu was Deputy Manager of International Banking
Department of China Construction Bank, Shaanxi. Mr. Liu received an MBA from
Indiana University at Bloomington, majoring in finance. He graduated from
undergraduate school in 1985 in Xi'an, Shaanxi, majoring in
finance.





Our
directors are elected annually and hold office until their successors have been
elected or qualified or until the earlier of their death, resignation,
retirement, disqualification or removal.





Board
Member Independence





Subject
to certain exceptions, under the listing standards of the Nasdaq Global Market,
within one year of the effectiveness of a registration statement filed with the
Securities and Exchange Commission in connection with a public offering of
securities, a listed company’s board of directors must consist of a majority of
independent directors. As a “controlled” company under such listing standards,
we are not required to comply with this requirement. However, we have determined
to do so in the interests of good corporate governance and accountability to all
of our stockholders. Our board of directors has determined that four of the
seven members of our Board of Directors are independent under NASDAQ standards,
as follows: Hon. Lily Lee Chen, Victor A. Hollander, Eileen B. Brody and Jeff
Haiyong Liu.





Family
Relationships





There are
no family relationships among the individuals comprising our Board of Directors
and executive officers.





Duties
of Directors





Under
Delaware corporate law, our directors have a duty of loyalty to act honestly in
good faith with a view to our best interests. Our directors also have a duty to
exercise care, diligence and skills that a reasonably prudent person would
exercise in comparable circumstances. In fulfilling their duty of care to us,
our directors must ensure compliance with our bylaws. A company has the right to
seek damages if a duty owed by our directors is breached.





The
functions and powers of our board of directors include, among other
things:




•
              convening shareholders’ meetings
      and reporting its work to shareholders at such
      meetings;
 
 •
              implementing shareholders’
      resolutions;
 
 •
              approving our business plans and
      investment proposals;
 
 •
              approving our profit distribution
      plans and loss recovery
plans;
 
 •
              approving our debt and finance
      policies and proposals for the increase or decrease in our registered
      capital and the issuance of
debentures;
 
 •
              approving our major acquisition
      and disposition plans, and plans for merger, division or
      dissolution;
  39
  •
              proposing amendments to our
      certificate of incorporation or bylaws;
  and
 
 •
              exercising any other powers
      conferred by the shareholders’ meetings or under our
      bylaws.





Board
Committees





Audit
Committee. We established our audit committee in June 2007. The audit
committee consists of Eileen B. Brody, Victor A. Hollander, and Jeff Haiyong
Liu, each of whom is an independent director. Mr. Hollander, Chairman of the
audit committee, and Ms. Brody are “audit committee financial experts” as
defined under Item 407(d) of Regulation S-K. The purpose of the audit committee
is to represent and assist our board of directors in its general oversight of
our accounting and financial reporting processes, audits of the financial
statements and internal control and audit functions. Pursuant to our audit
committee charter, which was adopted by our Board of Directors in June 2007, the
audit committee’s responsibilities include:




•
              The appointment, replacement,
      compensation, and oversight of work of the independent auditor, including
      resolution of disagreements between management and the independent auditor
      regarding financial reporting, for the purpose of preparing or issuing an
      audit report or performing other audit, review or attest
      services.
 
 •
              Reviewing and discussing with
      management and the independent auditor various topics and events that may
      have significant financial impact on our company or that are the subject
      of discussions between management and the independent
      auditors.





Compensation
Committee. We established our compensation committee in June 2007. The
compensation committee consists of Eileen B. Brody, Victor A. Hollander and Jeff
Hiayong Liu, each of whom is an independent director. Mr. Liu is the Chairman of
the compensation committee. Pursuant to our compensation committee charter,
which was adopted by our Board of Directors in June 2007, the compensation
committee is responsible for the design, review, recommendation and approval of
compensation arrangements for our directors, executive officers and key
employees, and for the administration of our 2006 Equity Incentive Plan,
including the approval of grants under the plan to our employees, consultants
and directors. The compensation committee also reviews and determines
compensation of our executive officers, including our Chief Executive
Officer.





Nominating and
Corporate Governance Committee. We established our nominating and
corporate governance committee in June 2007. The nominating and corporate
governance committee consists of Hon. Lily Lee Chen, Eileen B. Brody and Jeff
Haiyong Liu, each of whom is an independent director. Eileen B. Brody is the
Chairman of the nominating and corporate governance committee. Pursuant to our
nominating and corporate governance committee charter, which was adopted by our
Board of Directors in June 2007, the nominating and corporate governance
committee assists in the selection of director nominees, approves director
nominations to be presented for stockholder approval at our annual general
meeting and fills any vacancies on our board of directors, considers any
nominations of director candidates validly made by stockholders, and reviews and
considers developments in corporate governance practices.





Section
16(A) Beneficial Ownership Reporting Compliance





Section
16(a) of the Exchange Act requires our directors and executive officers to file
reports of holdings and transactions in our stock with the SEC. Based on a
review of written representations from our executive officers and directors,
other than (i) a Form 4 for one transaction by each of Ching Wan Wong, Hon. Lily
Lee Chen, Victor A. Hollander, Eileen B. Brody, and Jeff Haiyong Liu, and (ii) a
Form 3 and one transaction on Form 4 of Heung Sang Fong, we believe that during
the fiscal year ended December 31, 2007, our directors, officers and owners of
more than 10% of our common stock complied with all applicable filing
requirements.





Code
of Business Conduct and Ethics





Our Board
of Directors has adopted a code of ethics, which is applicable to our senior
executive financial officers. In addition, our Board of Directors has adopted a
code of conduct, which is applicable to all of our directors, officers and
employees. We have made our code of ethics and our code of conduct publicly
available on our website at www.fuqi.com.cn. We
will provide our code of ethics in print without charge to any stockholder who
makes a written request to: Chief Financial Officer, Fuqi International, Inc.,
5/F., Block 1, Shi Hua Industrial Zone, Cui Zhu Road North, Shenzhen, 518019,
People’s Republic of China. Any waivers of the application and any amendments to
our code of ethics must be made by our board of directors. Any waivers of, and
any amendments to, our code of ethics will be disclosed promptly on our
website.




Remuneration





The
directors may determine remuneration to be paid to the directors. The
compensation committee will assist the directors in reviewing and approving the
compensation structure for the directors.


40





ITEM
11. EXECUTIVE COMPENSATION





Compensation
Discussion and Analysis





General





Prior to
completion of our Reverse Merger with VT Marketing Services, Inc. in November
2006, our Chairman, Chief Executive Officer, and President, Mr. Yu Kwai Chong,
determined the compensation for our executive officers that was earned and paid.
Prior to the year of 2007, the compensation consisted solely of each executive
officer’s salary, other than an automobile allowance for Mr. Chong, and none of
our executive officers received a cash bonus. We believe that the salaries paid
to our executive officers during 2006, 2005, and 2004 were indicative of the
fair value of the services provided to us, as measured by the local market in
China.





After
completion of the Reverse Merger, compensation packages for fiscal 2007 were
proposed by Mr. Chong, and subsequently reviewed and approved by our
Compensation Committee after its formation in June 2007. In September 2007, we
entered into three-year employment agreements (the “Employment Agreements”) with
each of our executive officers. The level and components of the compensation
packages for our executive officers under the Employment Agreements were
primarily determined based upon comparisons with the compensation packages of
certain public companies in the United States and Hong Kong, in addition to the
compensation packages of private Chinese jewelry companies with which Mr. Chong
had a relationship and was able to obtain such information. We reviewed and
evaluated the compensation packages of specialty jewelry manufacturers,
distributors and retailers, in addition to other Chinese specialty companies
engaged in the manufacture and distribution of consumer products. As a result of
these criteria, we reviewed the following companies:




•
              Jewelry
      companies listed in the United States: LJ International, Inc.
      (NasdaqNM: JADE), Man Sang Holdings, Inc. (Amex: MHJ), House of Taylor
      Jewelry, Inc. (NasdaqSC: HOTJ), and Finlay Enterprises, Inc.
      (NasdaqNM:FNLY).
 
 •
              Hong Kong /
      Chinese jewelry companies: Chow Sang Sang Holdings
      International Ltd. (SSEHK:116), Luk Fook Holdings International Ltd.
      (SSEHK:590), Ming Fung Jewelery Group Limited. (SSEHK:860), and Hang Fung
      Gold Technology Limited
(SSEHK:870).
 
 •
              Hong Kong /
      Chinese companies listed in the United States: Wonder Auto Technology, Inc.
      (NasdaqNM:WATG — manufacturer of automotive electrical parts in
      China), SORL Auto Parts, Inc. (NasdaqNM:SORL — manufacturer and
      distributor of commercial vehicle air brake valves and related components
      in China and internationally), and Orsus Xelent Technologies, Inc.
      (Amex:ORS — designer for retail and wholesale distribution of
      cellular phones).




We
focused our evaluation and analysis on companies of similar market size and
stage of growth, while taking into account our relative performance and our own
strategic goals. We believe that the companies that we evaluated are comparable
to us and provided valuable guidance to us in setting the appropriate levels and
form of compensation for our executive officers. After reviewing the salary and
equity components of compensation from these companies, Mr. Chong proposed the
levels of compensation of our executive officers based upon this information.
Our Compensation Committee reviewed and approved the compensation packages and
the Employment Agreements, and we subsequently entered into the Employment
Agreements. The Employment Agreements provide for substantially higher
compensation packages for our executive officers as compared to previous years.
The increase in compensation is primarily due to the increased level of
responsibilities to be assumed by each of these executives after we become a
publicly-listed company. In the future, the Compensation Committee will
determine compensation packages for our executive officers, which may be based
upon recommendations or proposals from Mr. Chong or other executive
officers.




Employment
Agreements




Below is
a summary of the compensation packages to our executive officers under the
Employment Agreements, each effective as of October 23, 2007.





Yu Kwai
Chong, our Chief Executive Officer, receives an annual salary of $200,000 and an
automobile allowance of approximately $52,000 as well as stock options to be
granted on an annual basis to acquire shares of the common stock with a market
value of 2% of our annual profit, approximately, before tax, not exceeding
$200,000 in value as set forth in our annual report on Form 10-K for the
relevant year, starting with fiscal 2008, as filed with the SEC. The stock
options will have a life of 10 years and an exercise price equal to 110% of the
fair market value of our common stock on the date of the grant.





Ching Wan
Wong, our Chief Financial Officer, receives an annual salary of $160,000 and was
granted, on the effective date of the employment agreement, stock options with
three-year terms to acquire 600,000 shares of common stock at a per share
exercise price of $9.00, representing the market value on the date of the grant.
One-third of the stock options were vested upon the effective date of the
employment agreement and the remaining two-thirds will vest in two equal annual
installments over the 24-month period after the date of grant.


41





Each of
Lie Xi Zhang, our Chief Operating Officer, and Xi Zhou Zhuo, our Marketing
Director, receives an annual salary of $120,000 and stock options to be granted
on an annual basis to acquire shares of common stock with a market value of 1%
of our annual profit before tax, not exceeding $120,000 in value as set forth in
our annual report on Form 10-K for the relevant year, starting with fiscal 2008,
as filed with the SEC. The stock options have a life of 10 years and an exercise
price equal to 100% of the fair market value of our common stock on the date of
the grant.





Heung
Sang Fong, our Vice President of Corporate Development, receives an annual
salary of $120,000 and stock options with three-year terms to acquire 600,000
shares of common stock at $9.00, representing the market value on the date of
the grant. One-third of the stock options were vested upon the date of grant and
the remaining two-thirds will vest in two equal annual installments over the
24-month period after the grant date.





Objectives
and Components of Executive Compensation





Our
Compensation Committee determines compensation for our executive officers with
the goal of attracting and retaining high quality executive officers and
encouraging them to work as effectively as possible on our behalf. Compensation
is designed to reward executive officers for successfully meeting their
individual functional objectives and for their contributions to our overall
development. Key areas of corporate performance taken into account in setting
compensation policies and decisions are profitability, growth of sales, and cost
control. The key factors may vary depending on areas of business in which the
executive officer’s work is focused on. Compensation for our Chief Executive
Officer, Chief Operating Officer, and Marketing Director consists of salary and
equity compensation. While salary is a set amount, as described above, the
equity compensation is directly tied to our performance for each fiscal year.
Our annual profit before tax will determine the value of options to be granted
to our Chief Executive Officer, Chief Operating Officer, and Marketing Director.
We will annually grant to our Chief Executive Officer stock options to acquire
shares of common stock with a market value of 2% of our annual profit before
tax, not exceeding $200,000, and a similar grant of options will be made to each
of our Chief Operating Officer and Marketing Director, except that the options
will be to purchase shares of common stock having a market value of 1% of our
annual profit before tax, not to exceed $120,000.





Our
Compensation Committee performs, at least annually, a review of the compensation
program for our executive officers to determine whether it provides adequate
incentives and motivation to our executive officers. For officers other than our
Chief Executive Officer, Chief Operating Officer, and Marketing Director, the
Compensation Committee evaluates profitability, growth of sales, and cost
control as a measurement of company performance in determining if, and at what
amounts, stock option grants should be made. Commencing with fiscal 2008, we
intend to establish a policy of setting company performance targets and budgets
prior to each fiscal year and then having the Compensation Committee use these
targets and budgets at the end of the respective fiscal year as a factor in
determining whether our salary and equity compensation is adequate.





Our
Compensation Committee, in its annual review, will also determine if our
compensation is adequate as relative to comparable officers in other companies
with which we compete for executives. Those companies to be evaluated and
analyzed will consist of specialty jewelry manufacturers, distributors and
retailers, in addition to other Chinese specialty companies in the manufacture
and distribution of consumer products of similar market size and stage of
growth. The companies may or may not be public companies or companies located in
the PRC or even, in all cases, companies in the jewelry business. The companies
that the Compensation Committee reviews will include the comparable companies
listed above. In addition, the Compensation Committee will review other
companies of a size, scope and magnitude similar to us at the time of our
Compensation Committee conducts its annual review, which may include companies
not currently listed or reporting. We believe that the companies that our
Compensation Committee evaluates are comparable to us and can provide valuable
guidance to us in determining whether the levels and forms of compensation for
our executive officers are adequate. Based on its review of these companies, the
Compensation Committee will determine the compensation packages for our
executive officers for the relevant fiscal year.





The
primary elements of compensation of our executive officers are salary and stock
option grants. We do not have formal policies relating to the allocation of
total compensation among salary and stock options. However, we believe that
certain senior executive positions such as Chief Executive Officer, Chief
Operating Officer, and Marketing Director have a more direct influence over our
financial performance, as these positions have more influence on the business
direction of our company more than other positions. For example, our Chief
Executive Officer, Chief Operating Officer and Marketing Director determine the
prices at which we sell our products, the prices at which we procure our raw
materials, the relationship with our customers and the types of products we
products.  Because we believe that these individuals have more control
over the business decisions of our company, we believe that they have a more
direct influence on the Company’s financial results than other officers. As
such, we believe a greater portion of the compensation for our Chief Executive
Officer, Chief Operating Officer and our Marketing Director should be at-risk
based on Company performance. Compensation arrangements established in September
2007 for these positions are more heavily weighted on incentive compensation. As
indicated above, our Chief Executive Officer, Chief Operating Officer, and
Marketing Director will be granted stock options on an annual basis that have a
market value, not to exceed a pre-determined amount, that is based on our annual
profit before tax as set forth in our annual report on Form 10-K as filed with
the SEC for the respective fiscal year. Other positions that we believe have
less of a direct influence over our financial performance, such as Chief
Financial Officer and Vice President of Corporate Development, will receive
stock options that are not based on financial performance.


42


Salary





Salary is
designed to attract, as needed, individuals with the skills necessary for us to
achieve our business plan, to motivate those individuals, to reward those
individuals fairly over time, and to retain those individuals who continue to
perform at or above the levels that we expect. When setting and adjusting
individual executive salary levels, we consider the relevant established salary
range, the named executive officer’s responsibilities, experience, potential,
individual performance and contribution. We also consider other factors such as
our overall corporate budget for annual merit increases, unique skills, demand
in the labor market and succession planning. Such factors were considered when
the compensation packages under the Employment Agreements were created and
approved.





Equity
Compensation





We
believe that long-term performance is aided by the use of stock-based awards,
which we believe create an ownership culture among our named executive officers
that fosters beneficial, long-term performance by our company. We adopted the
Fuqi International, Inc. 2007 Equity Incentive Plan (“2007 EIP”) on October 22,
2007. The 2007 EIP has a total of 2,366,864 shares of common stock authorized
for grant under the plan.





We
believe the 2007 EIP provides our employees, including our named executive
officers, as well as our directors and consultants, with incentives to help
align their interests with the interests of stockholders. The Compensation
Committee believes that the use of stock-based awards promotes our overall
executive compensation objectives and expects that stock options will become a
significant source of compensation for our executives.





We do not
have a general equity grant policy with respect to the size and terms of option
grants, but our Compensation Committee will evaluate our achievements for the
fiscal year based on performance factors and results of operations such as
revenues generated, cost of revenues, and net income. We do not currently have
established quantitative targets. Commencing with fiscal 2008, we intend to
establish a policy of setting company performance targets and budgets prior to
each fiscal year and then having the Compensation Committee use these targets
and budgets at the end of the respective fiscal year as a factor in determining
if, and at what amount, a stock option grant should be made to each of our
executive officers. We expect our established targets and budgets to be
challenging yet achievable by our company and executive officers. In addition,
we expect to set a minimum threshold for stock option grants at a certain
percentage of the target and budget, yet to be determined. Based on the target
and budget goals, the Compensation Committee will have discretion in determining
what stock option grants are appropriate for the fiscal year.





We also
conduct an annual evaluation of the achievement level of an executive based on
individual performance measurements, such as contribution to the achievement of
the company’s goals and individual performance metrics based on their positions
and responsibilities. Stock options will generally be made at the end of each
fiscal year.





As
indicated above, our Chief Executive Officer, Chief Operating Officer, and
Marketing Director were granted stock option grants that have a market value,
not to exceed a pre-determined amount, that is based on our annual profit before
tax as set forth in our annual report on Form 10-K as filed with the SEC for the
respective fiscal year. In addition, our Chief Financial Officer and Vice
President of Corporate Development each received 600,000 stock options at a per
share exercise price of $9.00 with a three-year term, with one-third vesting
upon the date of grant and the remaining two-thirds vesting in two equal annual
installments over the 24-month period after the date of grant. We believe that
our Chief Financial Officer and Vice President of Corporate Development played
pivotal roles in the planning, execution, and completion of our recent public
offering that was completed on the date of grant and the stock options were
intended to reward them for such contributions and the vesting schedule is
intended to encourage continued contributions in the near future.




As
permitted under the 2007 EIP, we expect that the vesting schedule for option
grants will differ in light of the purpose for the option grant. The option
grants to our Chief Financial Officer and Vice President of Corporate
Development, as described above, have shorter vesting schedules to reward them
for contributions to our public offering and encourage continued contributions
in the near future. The Compensation Committee will determine the vesting
schedule of option grants and tie the vesting schedule to the purpose of the
grant. For example, we expect to have extended vesting schedules for normal
option grants to provide incentives for long-term performance.





Summary
Compensation Table





The
following table sets forth information concerning the compensation for the three
fiscal years ended December 31, 2007, 2006, and 2005 of the principal executive
officer, principal financial officer, in addition to, as applicable, our three
most highly compensated officers whose annual compensation exceeded $100,000,
and up to two additional individuals for whom disclosure would have been
required but for the fact that the individual was not serving as our executive
officer at the end of the last fiscal year (collectively, the “Named Executive
Officers”).


43




Name
      and Position
                                  
                                  Year
                                  
                                  Salary
                                    ($)
                                  
                                  
                                  Bonus
                                    ($)
                                  
                                  
                                  Options
                                    Award
                                    ($)
                                  
                                  
                                  All
      Other
                                    Compensation
                                    ($)
                                  
                                  
                                  Total
                                    ($)Yu
      Kwai Chong
                                  
                                  2007
                                  
                                  
                                  56,050
                                  (1)
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  $
                                  31,400
                                  (2)(3)
                                  
                                  
                                  87,450President,
      CEO and
                                    Chairman
      of the Board
                                  
                                  2006
                                  
                                  
                                  7,384
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  31,400
                                  (2)(3)
                                  
                                  
                                  38,7842005
                                  
                                  
                                  5,000
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  31,400
                                  (2)(3)
                                  
                                  
                                  36,400Ching
      Wan Wong
                                  
                                  2007
                                  
                                  
                                  87,450
                                  (4)
                                  
                                  
                                  87,941
                                  (5)
                                  
                                  $
                                  321,392
                                  (6)
                                  
                                  
                                  —
                                  
                                  
                                  
                                  496,783Chief
      Financial Officer
                                  
                                  2006
                                  
                                  
                                  56,410
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  56,4102005
                                  
                                  
                                  8,000
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  8,000Heung
      Sang Fong(7)
                                  
                                  2007
                                  
                                  
                                  76,154
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  321,392
                                  (6)
                                  
                                  
                                  —
                                  
                                  
                                  
                                  397,546Executive
      Vice President of
                                  
                                  2006
                                  
                                  
                                  5,026
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  5,026Corporate
      Development
                                  
                                  2005
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —
                                  
                                  
                                  
                                  —


(1)
                                                                                                                                                            Effective October 23, 2007, Mr.
      Chong’s annual salary was increased to
  $200,000.
 (2)
                                                                                                                                                            Excludes dividends paid to Mr.
      Chong, as the sole stockholder of Fuqi’s subsidiary, totaling $0,
      $2,739,726, and $5,421,687, during the years ended December 31, 2007,
      2006, and 2005,
respectively.
 (3)
                                                                                                                                                            We acquired a new company car
      costing approximately $157,000 for the use of Mr. Chong in 2005. The value
      of the car is being amortized over 5
  years.
 (4)
                                                                                                                                                            Effective October 23, 2007, Mr.
      Wong’s annual salary was increased to
  $160,000.
 (5)
                                                                                                                                                            Represents a one-time
      discretionary bonus of $89,941 in connection with the exercise of Series C
      Plan and Series E Plan warrants in June 2007. We provided a notice of
      redemption, and upon expiration of the call period on June 8, 2007,
      warrants had been exercised for a total of 579,138 shares of our common
      stock for total gross proceeds from conversion of $2,931,357; all other
      remaining Series C Plan and Series E Plan warrants expired
      unexercised.
 (6)
                                                                                                                                                            Valuation based on the amount of
      option grants recognized for financial statement reporting purposes
      pursuant to SFAS 123(R). The assumptions used with respect to the
      valuation of option grants are set forth in our Annual Report under Item 8
      “Fuqi International, Inc. Consolidated Financial Statements—Notes to
      Financial Statements—Note 1— Summary of Significant Accounting
      Policies—Stock Based
Payments.”
 (7)
                                                                                                                                                            Mr. Fong joined the Company in
      December
2006.




Grants of Plan-Based
Awards in 2007




The
following table summarizes our awards made to our named executive officers under
the 2007 Equity Incentive Plan.




Grant Date
                      
                      
                      Number of
                        Shares of
                        Common
                        Stock
                        Underlying
                        Options
                      
                      
                      Exercise of
                        Base Price of
                        the Options
                        Award ($/Sh)
                      
                      
                      Grant date of
                        Fair Value of
                        Stock and
                        Options
                        AwardedYu
      Kwai Chong
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —
                      
                      
                      
                      —Ching
      Wan Wong
                      
                      10/26/07
                      
                      
                      
                      600,000
                      (1)
                      
                      $
                      9.00
                      (2)
                      
                      $
                      826,436
                      (3)Heung
      Sang Fong
                      
                      10/26/07
                      
                      
                      
                      600,000
                      (1)
                      
                      $
                      9.00
                      (2)
                      
                      $
                      826,436
                      (3)


(1)
                                                        Valuation assumptions are found
      in our Annual Report for the year ended December 31, 2007 under Item 8
      “Fuqi International, Inc. Consolidated Financial Statements —Notes to
      Financial Statements—Note 1—Summary of Significant Accounting
      Policies—Stock-Based
Payments.”
 (2)
                                                        Equal to the per share offering
      price of our shares of common stock in our initial public offering that
      closed on October 26, 2007.
 (3)
                                                        One-third of the stock options
      were vested on date of grant and the remaining two-thirds will vest in two
      equal annual installments over the 24-month period after the date of
      grant.


44





Outstanding
Equity Awards at Fiscal Year-End





The
following table presents the outstanding equity awards held by each of the named
executive officers as of the fiscal year ended December 31, 2007.




Option
      AwardsName
                    
                    Number
      of
                      securities
                      underlying
                      unexercised
                      options
      (#)
                      exercisable
                    
                    
                    Number
      of
                      securities underlying
                      unexercised options
                      (#) unexercisable
                    
                    
                    Equity incentive
                      plan awards:
                      Number
      of
                      securities
                      underlying
                      unexercised
                      unearned options
                      (#)
                    
                    
                    Option exercise
                      price ($)
                    
                    
                    Option
                      expiration dateYu
      Kwai Chong
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —
                    
                    
                    
                    —Ching
      Wan Wong(1)
                    
                    
                    200,000
                    
                    
                    
                    400,000
                    
                    
                    
                    —
                    
                    
                    $
                    9.00
                    
                    
                    10/26/2010Heung
      Sang Fong(1)
                    
                    
                    200,000
                    
                    
                    
                    400,000
                    
                    
                    
                    —
                    
                    
                    $
                    9.00
                    
                    
                    10/26/2010







(1)
                    One-third of the stock options
      were vested upon dated of grant and the remaining two-thirds will vest in
      two equal annual installments over the 24-month period after the date of
      grant.





Option
Exercises and Stock Vested in Fiscal 2007





There
were no option exercises or stock vested in 2007.





Director
Compensation





For the
year ended December 31, 2006, none of the members of our Board of Directors
received compensation for his or her service as a director. In June 2007, we
adopted a director compensation policy. We currently pay our non-employee
directors the following compensation:


•
                Base Annual
      Board Service Fee:
      Each independent director is paid $5,000 per quarter (or $20,000
      annually).
 •
                In-Person
      Board Meeting Fee:
      Each independent director is paid $2,000 for in-person attendance at each
      in-person board meeting. No fees are paid for telephonic meetings or
      telephonic attendance at in-person board
  meetings.
 •
              Base Annual
      Committee Service Fee: Each member of the compensation
      committee receives $2,000 annually and each member of the audit committee
      receives $2,500 annually for committee service. In addition, the chairman
      of the audit committee receives $3,000
  annually.
 
 •
              Expenses: Each director
      receives expense reimbursement for reasonable travel for in-person board
      and committee meeting
attendance.




Independent
directors are eligible to receive, from time to time, grants of options to
purchase shares under our 2007 Equity Incentive Plan as determined by the board
of directors.




Name
                  
                  Fees Earned
                    or Paid in
                    Cash
                    ($)
                  
                  Stock
                    Awards
                    ($)
                  
                  Option
                    Awards
                    ($)(1)
                  
                  Non-Equity
                    Incentive Plan
                    Compensation
                    ($)
                  
                  Change in
                    Pension
                    Value and
                    Nonqualified
                    Deferred
                    Compensation
                    Earnings
                  
                  All Other
                    Compensation
                    ($)
                  
                  Total
                    ($)Hon.
      Lily Lee Chen
                  
                  
                  10,000
                  
                  -
                  
                  $
                  14,804
                  
                  -
                  
                  
                  -
                  
                  -
                  
                  
                  24,804Victor
      A. Hollander
                  
                  
                  13,750
                  
                  -
                  
                  $
                  14,804
                  
                  -
                  
                  
                  -
                  
                  -
                  
                  
                  28,554Eileen
      B. Brody
                  
                  
                  12,250
                  
                  -
                  
                  $
                  14,804
                  
                  -
                  
                  
                  -
                  
                  -
                  
                  
                  27,054Jeff
      Haiyong Liu
                  
                  
                  12,250
                  
                  -
                  
                  $
                  14,804
                  
                  -
                  
                  
                  -
                  
                  -
                  
                  
                  27,054


45





(1)
              At the closing of our public
      offering in October 2007, the Board granted ten-year stock options to each
      independent director to purchase 30,000 shares of our common stock, at an
      exercise price equal to $9.00 per share, with 15,000 shares vest
      immediately and the remaining 15,000 shares to vest in equal quarterly
      installments over one year from the date of the grant. Valuation based on
      the amount of option grants recognized for financial statement reporting
      purposes pursuant to SFAS 123(R). The assumptions used with respect to the
      valuation of option grants are set forth in our Annual Report under Item 8
      “Fuqi International, Inc. Consolidated Financial Statements—Notes to
      Financial Statements—Note 1— Summary of Significant Accounting
      Policies—Stock Based
Payments.”


Equity
Incentive Plans





We
adopted the Fuqi International, Inc. 2007 Equity Incentive Plan (“2007 EIP”) in
October 2007. We had a 2006 Equity Incentive Plan (“2006 EIP”), which we
canceled and terminated immediately prior to the adoption of the 2007 EIP.
Summaries of the pertinent provisions of both the 2006 EIP and 2007 EIP appear
below.





2006
Equity Incentive Plan (terminated in 2007)





In
November 2006, our stockholders approved an equity incentive plan (“2006 EIP”)
for employees, non-employee directors and other service providers covering
1,775,148 shares of common stock. Any options granted under the 2006 EIP may
have been either “incentive stock options,” as defined in Section 422A of the
Internal Revenue Code, or “nonqualified stock options,” subject to Section 83 of
the Internal Revenue Code, at the discretion of our board of directors and as
reflected in the terms of the written option agreement. We cancelled and
terminated the 2006 EIP on October 22, 2007. There are no options outstanding
under the 2006 EIP.





2007
Equity Incentive Plan (adopted in 2007)





We
adopted the 2007 EIP in October 2007. Our employees, officers and directors
(including employees, officers and directors of our affiliates) are all eligible
to participate in the 2007 EIP. Administration of the 2007 EIP is carried out by
our Board of Directors or any committee of the Board of Directors to which the
Board of Directors has delegated all or a portion of responsibility for the
implementation, interpretation or administration of the equity incentive plan.
The administrator of the 2007 EIP will select the participants who are granted
stock options or stock awards and, consistent with the terms of the equity
incentive plan, will establish the terms of each stock option or stock award.
The maximum period in which a stock option may be exercised will be fixed by the
administrator, but in no event longer than ten years.





The 2007
EIP authorizes the issuance of options to purchase shares of common stock under
the Option Grant Program and the grant of stock awards under the Stock Issuance
Program. Although the administrator determines the exercise prices of options
granted under the 2007 EIP, the exercise price per share may not be less than
100% of the “fair market value,” as defined in the equity incentive plan, on the
date of grant. Options that are granted under the equity incentive plan vest and
terminate over various periods at the discretion of the Board of Directors or
any committee authorized by the Board of Directors, but subject to the terms of
the plan. Under the Stock Issuance Program, shares of our common stock may be
issued through direct and immediate issuance without any intervening options
grants.





The 2007
EIP will terminate upon the earliest of (i) the expiration of the ten year
period measured from the date we adopt the plan, (ii) the date on which all
shares available under the plan have been issued as vested shares, or (iii) the
termination of all outstanding options in connection with a change in our
ownership or control. Nevertheless, options granted under the 2007 EIP may
extend beyond the date of termination.  The maximum number of
securities, including common stock and stock options, that is authorized to be
issued under the 2007 EIP is 2,366,864. There were 1,320,000 options, each
exercisable at $9.00 per share, outstanding under the 2007 EIP as of December
31, 2007.




Indemnification
of Directors and Executive Officers and Limitations of Liability





In
December 2006, we changed our state of incorporation from Nevada to Delaware and
we are now governed by Delaware law and the certificate of incorporation and
bylaws of the new Delaware corporation. Under Section 145 of the General
Corporation Law of the State of Delaware, we can indemnify our directors and
officers against liabilities they may incur in such capacities, including
liabilities under the Securities Act of 1933, as amended (the “Securities Act”).
Our certificate of incorporation provides that, pursuant to Delaware law, our
directors shall not be liable for monetary damages for breach of the directors’
fiduciary duty of care to us and our stockholders. This provision in the
certificate of incorporation does not eliminate the duty of care, and in
appropriate circumstances equitable remedies such as injunctive or other forms
of non-monetary relief will remain available under Delaware law. In addition,
each director will continue to be subject to liability for breach of the
director’s duty of loyalty to us or our stockholders for acts or omissions not
in good faith or involving intentional misconduct or knowing violations of the
law, for actions leading to improper personal benefit to the director, and for
payment of dividends or approval of stock repurchases or redemptions that are
unlawful under Delaware law. The provision also does not affect a director’s
responsibilities under any other law, such as the federal securities laws or
state or federal environmental laws.


46





Our
bylaws provide for the indemnification of our directors to the fullest extent
permitted by the Delaware General Corporation Law. Our bylaws further provide
that our Board of Directors has discretion to indemnify our officers and other
employees. We are required to advance, prior to the final disposition of any
proceeding, promptly on request, all expenses incurred by any director or
executive officer in connection with that proceeding on receipt of an
undertaking by or on behalf of that director or executive officer to repay those
amounts if it should be determined ultimately that he or she is not entitled to
be indemnified under the bylaws or otherwise. We are not, however, required to
advance any expenses in connection with any proceeding if a determination is
reasonably and promptly made by our Board of Directors by a majority vote of a
quorum of disinterested Board members that (i) the party seeking an advance
acted in bad faith or deliberately breached his or her duty to us or our
stockholders and (ii) as a result of such actions by the party seeking an
advance, it is more likely than not that it will ultimately be determined that
such party is not entitled to indemnification pursuant to the applicable
sections of our bylaws.





We have
been advised that in the opinion of the Securities and Exchange Commission,
insofar as indemnification for liabilities arising under the Securities Act may
be permitted to our directors, officers and controlling persons pursuant to the
foregoing provisions, or otherwise, such indemnification is against public
policy as expressed in the Securities Act and is therefore unenforceable. In the
event a claim for indemnification against such liabilities (other than our
payment of expenses incurred or paid by our director, officer or controlling
person in the successful defense of any action, suit or proceeding) is asserted
by such director, officer or controlling person in connection with the
securities being registered, we will, unless in the opinion of our counsel the
matter has been settled by controlling precedent, submit to a court of
appropriate jurisdiction the question of whether such indemnification by us is
against public policy as expressed in the Securities Act and will be governed by
the final adjudication of such issue.





We may
enter into indemnification agreements with each of our directors and officers
that are, in some cases, broader than the specific indemnification provisions
permitted by Delaware law, and that may provide additional procedural
protection. As of the Effective Time of the Reverse Merger, we had not entered
into any indemnification agreements with our directors or officers, but may
choose to do so in the future. Such indemnification agreements may require us,
among other things, to:




•
              indemnify officers and directors
      against certain liabilities that may arise because of their status as
      officers or directors;
 
 •
              advance expenses, as incurred, to
      officers and directors in connection with a legal proceeding, subject to
      limited exceptions; or
 
 •
              obtain directors’ and officers’
      insurance.




At
present, there is no pending litigation or proceeding involving any of our
directors, officers or employees in which indemnification is sought, nor are we
aware of any threatened litigation that may result in claims for
indemnification.




ITEM
      12.
              SECURITY
      OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED
      STOCKHOLDER MATTERS




Beneficial
ownership is determined in accordance with the rules of the SEC. In computing
the number of shares beneficially owned by a person and the percentage of
ownership of that person, shares of common stock subject to options and warrants
held by that person that are currently exercisable or become exercisable within
60 days of April 25, 2008 are deemed outstanding even if they have not actually
been exercised. Those shares, however, are not deemed outstanding for the
purpose of computing the percentage ownership of any other person.





The
following table sets forth certain information with respect to beneficial
ownership of our common stock based on 20,924,843 issued and outstanding shares
of common stock as of April 25, 2008, by:




•
              Each person known to be the
      beneficial owner of 5% or more of the outstanding common stock of our
      company;
 
 •
              Each executive
      officer;
 
 •
              Each director;
      and
 
 •
              All of the executive officers and
      directors as a group.




Unless
otherwise indicated, the persons and entities named in the table have sole
voting and sole investment power with respect to the shares set forth opposite
the stockholder’s name, subject to community property laws, where applicable.
Unless otherwise indicated, the address of each stockholder listed in the table
is c/o Fuqi International, Inc., 5/F., Block 1, Shi Hua Industrial Zone, Cui Zhu
Road North, Shenzhen, 518019, People’s Republic of China.


47





Name and Address of
                                            Beneficial Owner
                                          
                                          Title
                                          
                                          Number of
                                            Shares
                                            Beneficially
                                            Owned
                                          
                                          
                                          Percent of Class
                                            Beneficially OwnedDirectors and Executive OfficersYu
      Kwai Chong
                                          
                                          President,
      Chief Executive
                                            Officer
      and Chairman
                                            of
      the Board
                                          
                                          
                                          11,175,543
                                          
                                          
                                          
                                          53.4
                                          %Lie
      Xi Zhuang
                                          
                                          Chief
      Operating Officer and
                                            Director
                                          
                                          
                                          —
                                          
                                          
                                          
                                          —Ching
      Wan Wong
                                          
                                          Chief
      Financial Officer and
                                            Director
                                          
                                          
                                          200,000
                                          (1)
                                          
                                          
                                          *Xi
      Zhou Zhuo
                                          
                                          Marketing
      Director
                                          
                                          
                                          —
                                          
                                          
                                          
                                          —Heung
      Sang Fong
                                          
                                          Executive
      Vice President,
                                            Corporate
      Development
                                          
                                          
                                          200,000
                                          (1)
                                          
                                          
                                          *Hon.
      Lily Lee Chen
                                          
                                          Director
                                          
                                          
                                          22,500
                                          (1)
                                          
                                          
                                          *Eileen
      B. Brody
                                          
                                          Director
                                          
                                          
                                          22,500
                                          (1)
                                          
                                          
                                          *Victor
      A. Hollander
                                          
                                          Director
                                          
                                          
                                          22,500
                                          (1)
                                          
                                          
                                          *Jeff
      Haiyong Liu
                                          
                                          Director
                                          
                                          
                                          22,500
                                          (1)
                                          
                                          
                                          *Officers
      and Directors as a group
                                            (total
      of 9 persons)
                                          
                                          
                                          
                                          
                                          11,665,543
                                          (2)
                                          
                                          
                                          53.4
                                          %











*
              Indicates less than
      1%.
 (1)
              Consists of shares of common
      stock underlying options that are currently exercisable or exercisable
      within 60 days of April 25,
2008.
 (2)
              Includes 490,000 shares of common
      stock underlying options that are currently exercisable or exercisable
      within 60 days of April 25,
2008.




ITEM 13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS





Fuqi
BVI Share Exchange Agreement




On
November 20, 2006, Fuqi BVI effected the Reverse Merger by entering into a share
exchange agreement with VT Marketing Services, Inc. (“VT”) and Mr. Yu Kwai
Chong, who is our current Chief Executive Officer and Chairman of the Board of
the Directors. Pursuant to the Reverse Merger, Mr. Chong, as the sole
shareholder of Fuqi BVI, agreed to exchange all of his shares of Fuqi BVI for
shares of VT and VT agreed to acquire all of the issued and outstanding capital
stock of Fuqi BVI. VT was formed as part of the implementation of a Chapter 11
reorganization plan of visitalk.com, Inc., which became effective on September
17, 2004. The Reverse Merger closed on November 22, 2006 and VT issued an
aggregate of 11,175,543 shares of common stock in exchange for all of the issued
and outstanding securities of Fuqi BVI. Upon the close of the Reverse Merger, VT
became the 100% parent of Fuqi BVI and assumed the operations of Fuqi BVI and
its subsidiary as its sole business. We issued to Mr. Yu Kwai Chong, who was the
sole Fuqi BVI stockholder, 11,175,543 shares of common stock in exchange for all
of the issued and outstanding shares of capital stock of Fuqi BVI. The new
shares issued to Mr. Chong represented 91.2% of our voting capital stock
immediately after the Reverse Merger. Mr. Chong is also the Chairman of Fuqi BVI
and our Chief Executive Officer and Chairman of the Board. Prior to the
effective date of the Reverse Merger, Bay Peak LLC (“Bay Peak”) beneficially
owned substantially all of our capital stock. Bay Peak currently owns
approximately 3.8% of our issued and outstanding shares of common
stock.





Transactions
with Bay Peak





On July
21, 2006, VT Marketing Services Inc. (“VT”), the predecessor of Fuqi
International, Inc., sold 809,918 shares of common stock to Bay Peak, of which
5,184 shares were subsequently cancelled upon the close of the Reverse Merger.
The shares issued to Bay Peak represented 75% of the outstanding shares of VT at
that time. Cory Roberts, the President of Bay Peak and former President of VT,
resigned from VT upon the closing of the Reverse Merger on November 22,
2006.





On May 2,
2007, we entered into a letter agreement with Bay Peak to assist us in the
potential exercise of outstanding Series C Plan Warrants and Series E Plan
Warrants (the “Warrants”). We issued a notice of redemption on May 10, 2007
pursuant to which the Warrants would be redeemed on June 8, 2007. Pursuant to
the letter agreement, Bay Peak provided advisory services with respect to the
redemption and potential exercise of the Warrants prior to the redemption. We
agreed to pay Bay Peak an advisory fee of $10,000, a bonus fee of 6% of the
gross proceeds from the exercise of the Warrants (approximately $178,000) and
out-of-pocket expenditures of $10,000.


48





Further
to a registration rights agreement with Bay Peak, we agreed to register shares
of our common stock held by it upon request after the expiration of the 180-day
lock-up period commencing from the date of the initial public offering if we are
then eligible to use Form S-3 and if such shares are not then saleable under
Rule 144.





Yu
Kwai Chong





Mr. Yu
Kwai Chong, who is our controlling stockholder, President, Chief Executive
Officer and Chairman of the Board, has conducted various related party
transactions with our company in the past. These transactions include the
following:




•
              During the period from the
      inception of Fuqi China in April 2001 until November 22, 2006, when Mr.
      Chong ceased to be our sole stockholder, Mr. Chong collected a portion of
      our revenues directly from our customers as the primary contact with our
      customers. During the years ended December 31, 2007, 2006 and 2005, our
      total net sales amounted to $0, $92.4 million, and $72.6 million, and the
      amounts collected by Mr. Chong totaled $0, $3.0 million, and $6.1 million,
      respectively. Beginning December 2006, Mr. Chong stopped collecting cash
      revenue on behalf of our company and all revenues are now deposited into
      our bank accounts. The revenues collected by Mr. Chong were included in
      the total revenue amounts in our audited consolidated financial statements
      for the years ended December 31, 2007, 2006, and
    2005.
 
 •
              Prior to December 31, 2006, Mr.
      Chong frequently borrowed from us since the inception of our operations to
      fund personal liquidity needs. As of December 31, 2006, we permanently
      discontinued this practice and Mr. Chong repaid the balance to us in full.
      On aggregate, we loaned $0, $51.5 million, and $90.0 million to Mr. Chong,
      and collected $0, $58.4 million, and $75.6 million, during the years ended
      December 31, 2007, 2006, and 2005, respectively. Outstanding balance due
      from Mr. Chong to us was $nil as of December 31, 2007 and
      2006.
 
 •
              We have frequently borrowed from
      Mr. Chong since the inception of our operations to satisfy our short-term
      working capital needs. On aggregate, we borrowed $0, $23.5 million, and
      $0, from Mr. Chong and repaid $0, $23.1 million, and $0 during the years
      ended December 31, 2007, 2006, and 2005. Outstanding loans payable to Mr.
      Chong amounted to $0 and $422,909 as of December 31, 2007 and 2006,
      respectively.
 
 •
              Prior to the Reverse Merger, we
      declared dividends to Mr. Chong, as our sole stockholder, totaling $0,
      $2.7 million, and $5.4 million during the years ended December 31, 2007,
      2006, and 2005, respectively, which offset the amounts due from Mr.
      Chong.
 
 •
              Rong Xing (Group) Co., LTD., a
      company owned and controlled by Mr. Chong, guarantees and provides real
      property to secure loan facilities that we have taken with several banks.
      The guarantee is provided at no charge to
  us.




We did
not charge any interest on receivable from nor pay any interest on amount due to
related parties.





Heung
Sang Fong





Our
current Executive Vice President of Corporate Development, Heung Sang Fong, was
the managing partner of Iceberg Financial Consultants (“IFC”), a financial
advisory firm based in China that advises Chinese clients in capital raising
activities in the United States. In April 2006, IFC was engaged to assist in the
Reverse Merger between Fuqi BVI, Mr. Yu Kwai Chong, and VT Marketing Services,
Inc. The Reverse Merger closed in November 2006. For the year ended December 31,
2006, we paid IFC a total of $0 in compensation for its services.





Ching
Wan Wong





Our Chief
Financial Officer, Ching Wan Wong was paid a one-time discretionary bonus of
$89,941 in connection with the exercise of Series C Plan and Series E Plan
warrants in June 2007. We provided a notice of redemption, and upon expiration
of the call period on June 8, 2007, warrants had been exercised for a total of
579,138 shares of our common stock for total gross proceeds from conversion of
$2,931,357; all other remaining Series C Plan and Series E Plan warrants expired
unexercised.





Policy
for Approval of Related Party Transactions





Our
written Audit Committee Charter includes our policy regarding the approval of
related party transactions.  It is our policy is to have our Audit
Committee review and pre-approve any related party transactions and other
matters pertaining to the integrity of management, including potential conflicts
of interest, or adherence to standards of business conduct as required by our
policies.


49





ITEM 14. PRINCIPAL ACCOUNTING FEES AND
SERVICES.




The
following table presents fees, including reimbursements for expenses, for
professional audit services rendered by Stonefield Josephson, Inc. for the
audits of the Company’s annual financial statements and interim reviews of the
Company’s quarterly financial statements for the years ended December 31, 2007
and December 31, 2006 and fees billed for other services rendered by Stonefield
Josephson, Inc. during those periods.




Year ended December 31,2007
                            
                            2006Audit
      Fees(1)
                            
                            $
                            305,950
                            
                            
                            $
                            161,155Audit-Related
      Fees(2)
                            
                            
                            152,150
                            
                            
                            
                            10,770Tax
      Fees(3)
                            
                            
                            23,700
                            
                            
                            
                            -All
      Other Fees
                            
                            
                            -
                            
                            
                            
                            -Total
                            
                            $
                            481,800
                            
                            
                            $
                            171,925














(1)
              Audit
      Feesconsist of fees
      billed for professional services rendered for the audit of the Company's
      consolidated annual financial statements and review of the interim
      consolidated financial statements included in quarterly reports and
      services that are normally provided by Stonefield Josephson, Inc. in
      connection with statutory and regulatory filings or
      engagements.
 (2)
              Audit-Related
      Feesconsist of fees
      billed for assurance and related services that are reasonably related to
      the performance of the audit or review of the Company's consolidated
      financial statements and are not reported under "Audit
      Fees."
 (3)
              Tax
      Feesconsist of fees
      billed for corporate tax return preparation for the years ended December
      31, 2006, 2005 and
2004.


Pre-Approval
Policies and Procedures





Under the
Sarbanes-Oxley Act of 2002, all audit and non-audit services performed by our
auditors must be approved in advance by our audit committee to assure that such
services do not impair the auditors’ independence from us. In accordance with
its policies and procedures, our audit committee pre-approved the audit service
performed by Stonefield Josephson, Inc. for our consolidated financial
statements as of and for the year ended December 31, 2007. As our audit
committee was formed only in June 2007, there was no such pre-approval by our
audit committee before Stonefield Josephson, Inc. performed their audit in years
2006.


50


PART
IV




ITEM
15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES





1.
Financial Statements: See “Index to Consolidated Financial Statements” in Part
II, Item 8 of this annual report on Form 10-K/A.





2.
Financial Statement Schedule: See “Schedule II—Valuation and Qualifying
Accounts” on page F-26 of the Financial Statements of this annual report on Form
10-K/A.





3.
Exhibits: The exhibits listed in the accompanying “Index to Exhibits” are filed
or incorporated by reference as part of this Form 10-K/A.





SIGNATURES





Pursuant
to the requirements of Section 13 or 15(d) of the Securities Exchange Act of
1934, the Registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized, in the City of Shenzhen, People’s
Republic of China, on March 9, 2009.





FUQI
      INTERNATIONAL, INC.By:
                    /s/
      Yu Kwai ChongName
      Yu Kwai ChongTitle:
      Chief Executive Officer and
President




Pursuant
to the requirements of the Securities Exchange Act of 1934, this report has been
signed below by the following persons on behalf of the Company in the capacities
and on the dates indicated.




SIGNATURE
                                        
                                        TITLE
                                        
                                        DATE/s/
      Yu Kwai Chong
                                        
                                        Chief
      Executive Officer and President (Principal
                                          Executive
      Officer)
                                        
                                        March
      9, 2009Yu
      Kwai Chong/s/
      Ching Wan Wong
                                        
                                        Chief
      Financial Officer and Director (Principal
                                          Financial
      Officer and Accounting Officer)
                                        
                                        March
      9, 2009Ching
      Wan Wong*
                                        
                                        Chief
      Operating Officer and Director
                                        
                                        March
      9, 2009Lie
      Xi Zhuang*
                                        
                                        Director
                                        
                                        March
      9, 2009Lily
      Lee Chen*
                                        
                                        Director
                                        
                                        March
      9, 2009Eileen
      B. Brody/s/
      Victor A. Hollander
                                        
                                        Director
                                        
                                        March
      9, 2009Victor
      A. Hollander*
                                        
                                        Director
                                        
                                        March
      9, 2009Jeff
      Haiyong Liu




*By:
                        /s/    Yu
      Kwai ChongYu
      Kwai Chong, Attorney-in-Fact


51




EXHIBIT
INDEX





Exhibit Number
                    
                    Description of Exhibit2.1
                    
                    Share
      Exchange Agreement dated November 20, 2006 by and between Fuqi
      International, Inc., a Delaware corporation (f/k/a VT Marketing Services,
      Inc.) (the “Registrant”) and Fuqi International Holdings Ltd., a British
      Virgin Islands company (incorporated by reference from Exhibit 2.1 to the
      Registrant’s Form 10 filed with the Securities and Exchange Commission on
      December 29, 2006).3.1
                    
                    Certificate
      of Incorporation of the Registrant (incorporated by reference from Exhibit
      3.1 to the Registrant’s Form 10 filed with the Securities and Exchange
      Commission on December 29, 2006).3.1(a)
                    
                    Amendment
      of the Certificate of Incorporation of the Registrant dated February 21,
      2007 to increase authorized shares (incorporated by reference from Exhibit
      3.1(a) to the Registrant’s Form S-1/A (file no. 333-144290) filed with the
      Securities and Exchange Commission on August 28, 2007).3.2
                    
                    Bylaws
      of the Registrant (incorporated by reference from Exhibit 3.2 to the
      Registrant’s Form 10 filed with the Securities and Exchange Commission on
      December 29, 2006).4.1
                    
                    Specimen
      Common Stock Certificate (incorporated by reference from Exhibit 4.1 to
      the Registrant’s Form S-1/A (file no. 333-144290) filed with the
      Securities and Exchange Commission on July 2, 2007).10.1
                    
                    Plan
      Warrant Agreement (incorporated by reference from Exhibit 10.1 to the
      Registrant’s Form 10 filed with the Securities and Exchange Commission on
      December 29, 2006).10.2
                    
                    2006
      Equity Incentive Plan (incorporated by reference from Exhibit 10.2 to the
      Registrant’s Form 10 filed with the Securities and Exchange Commission on
      December 29, 2006).10.3
                    
                    Real
      Property Lease dated May 8, 2005 (incorporated by reference from Exhibit
      10.3 to the Registrant’s Form 10 filed with the Securities and Exchange
      Commission on December 29, 2006).10.4
                    
                    Employment
      Agreement dated August 30, 2007 entered into by and between the Company
      and Yu Kwai Chong (incorporated by reference from Exhibit 10.1 to the
      Registrant’s Form 8-K filed with the Securities and Exchange Commission on
      September 6, 2007).10.5
                    
                    Employment
      Agreement dated August 30, 2007 entered into by and between the Company
      and Ching Wan Wong (incorporated by reference from Exhibit 10.2 to the
      Registrant’s Form 8-K filed with the Securities and Exchange Commission on
      September 6, 2007).10.6
                    
                    Employment
      Agreement dated August 30, 2007 entered into by and between the Company
      and Lie Xi Zhuang (incorporated by reference from Exhibit 10.3 to the
      Registrant’s Form 8-K filed with the Securities and Exchange Commission on
      September 6, 2007).10.7
                    
                    Employment
      Agreement dated August 30, 2007 entered into by and between the Company
      and Heung Sang Fong (incorporated by reference from Exhibit 10.4 to the
      Registrant’s Form 8-K filed with the Securities and Exchange Commission on
      September 6, 2007).10.8
                    
                    Employment
      Agreement dated August 30, 2007 entered into by and between the Company
      and Xi Zhou Zhuo (incorporated by reference from Exhibit 10.5 to the
      Registrant’s Form 8-K filed with the Securities and Exchange Commission on
      September 6, 2007).10.9
                    
                    Registration
      Rights Agreement dated September 18, 2007 entered into by and between the
      Company and Bay Peak, LLC (incorporated by reference from Exhibit 10.9 to
      the Registrant’s Form S-1/A (file no. 333-144290) filed with the
      Securities and Exchange Commission on October 2,
  2007).


52




Exhibit Number
                    
                    Description of Exhibit10.10
                    
                    Maximum
      General Facility Agreement dated September 27, 2007 entered into by and
      between the Company and Agriculture Bank of China (incorporated by
      reference from Exhibit 10.10 to the Registrant’s Form S-1/A (file no.
      333-144290) filed with the Securities and Exchange Commission on October
      2, 2007).10.11
                    
                    2007
      Equity Incentive Plan (incorporated by reference from Exhibit 99.1 to the
      Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities
      and Exchange Commission on August 28, 2007).10.12
                    
                    Form
      of Notice of Grant of Stock Option for the 2007 Equity Incentive Plan
      (incorporated by reference from Exhibit 99.2 to the Registrant’s Form
      S-1/A (file no. 333-144290) filed with the Securities and Exchange
      Commission on August 28, 2007).10.13
                    
                    Form
      of Stock Option Agreement (including Addendum) for the 2007 Equity
      Incentive Plan (incorporated by reference from Exhibit 99.3 to the
      Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities
      and Exchange Commission on August 28, 2007).10.14
                    
                    Form
      of Stock Issuance Agreement (including Addendum) for the 2007 Equity
      Incentive Plan (incorporated by reference from Exhibit 99.4 to the
      Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities
      and Exchange Commission on August 28, 2007).10.15
                    
                    Form
      of Stock Purchase Agreement (including Addendum) for the 2007 Equity
      Incentive Plan (incorporated by reference from Exhibit 99.5 to the
      Registrant’s Form S-1/A (file no. 333-144290) filed with the Securities
      and Exchange Commission on August 28, 2007).10.16**
                    
                    Lease
      agreement dated October 10, 2007 for office space in San Jose,
      California.10.17**
                    
                    Lease
      agreement dated February 20, 2008 for office space in Hong
      Kong.10.18
                    
                    Asset
      Purchase Agreement dated April 18, 2008 entered into between the Fuqi
      International Holdings Co., LTD., Beijing Yinzhong Tianmei Jewelry Co.,
      LTD., Shanghai Tianmei Jewelry Co., LTD., and Chujian Huang (incorporated
      by reference from Exhibit 10.1 to the Registrant’s Current Report on Form
      8-K filed with the Securities and Exchange Commission on April 21,
      2008)10.19
                    
                    Intellectual
      Property Transfer Agreement dated April 18, 2008 entered into between the
      Registrant, the Fuqi International Holdings Co., LTD., and Chujian Huang
      (incorporated by reference from Exhibit 10.2 to the Registrant’s Current
      Report on Form 8-K filed with the Securities and Exchange Commission on
      April 21, 2008).21.1
                    
                    List
      of Subsidiaries of the Registrant (incorporated by reference from Exhibit
      21.1 to the Registrant’s Form 10 filed with the Securities and Exchange
      Commission on December 29, 2006).23.1
                    
                    Consent
      of Stonefield Josephson, Inc.31.1
                    
                    Certification
      of Chief Executive Officer pursuant to Item 601(b)(31) of Regulation S-K,
      as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002.31.2
                    
                    Certification
      of Chief Financial Officer pursuant to Item 601(b)(31) of Regulation S-K,
      as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of
      2002.32.1*
                    
                    Certifications
      of Chief Executive Officer and Chief Financial Officer pursuant to 18
      U.S.C. Section 1350 as adopted pursuant to Section 906 of the
      Sarbanes-Oxley Act of
2002.








* This
exhibit shall not be deemed "filed" for purposes of Section 18 of the Securities
Exchange Act of 1934 or otherwise subject to the liabilities of that section,
nor shall it be deemed incorporated by reference in any filing under the
Securities Act of 1933 or the Securities Exchange Act of 1934, whether made
before or after the date hereof and irrespective of any general incorporation
language in any filings.


**Previously
filed.





53




FUQI
INTERNATIONAL, INC.





CONSOLIDATED
FINANCIAL STATEMENTS





INDEX
TO FINANCIAL STATEMENTS





PageReport
      of Independent Registered Public Accounting Firm
                    F-2Financial
      Statements:Consolidated
      Balance Sheets as of December 31, 2007 and 2006
                    F-3Consolidated
      Statements of Income and Comprehensive Income for the years ended December
      31, 2007, 2006, and 2005
                    F-4Consolidated
      Statements of Stockholders’ Equity for the years ended December 31, 2007,
      2006, and 2005
                    F-5Consolidated
      Statements of Cash Flows for the years ended December 31, 2007, 2006, and
      2005
                    F-6Notes
      to Consolidated Financial Statements
                    F-8Schedule
      II — Valuation and Qualifying Accounts and
    Reserves
                    F-26





F-1





REPORT
OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM




Board of
Directors


Fuqi
International, Inc.


Shenzhen,
China




We have
audited the accompanying consolidated balance sheets of Fuqi International, Inc.
and subsidiaries as of December 31, 2007, and 2006 and the related consolidated
statements of income and comprehensive income, stockholders’ equity and cash
flows for each of the three years in the period ended December 31, 2007. Our
audits also included the financial statement schedule listed on page F-26. These
financial statements and schedule are the responsibility of the Company’s
management. Our responsibility is to express an opinion on these financial
statements and schedule based on our audits.




We
conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audits to obtain reasonable assurance about whether the
financial statements are free of material misstatement. We were not engaged to
perform an audit of the Company’s internal control over financial reporting. Our
audits included consideration of internal control over financial reporting as a
basis for designing audit procedures that are appropriate in the circumstances,
but not for the purpose of expressing an opinion on the effectiveness of the
Company’s internal control over financial reporting. Accordingly, we express no
such opinion. An audit also includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements, assessing
the accounting principles used and significant estimates made by management, as
well as evaluating the overall financial statement presentation. We believe that
our audits provide a reasonable basis for our opinion.




In our
opinion, the consolidated financial statements referred to above present fairly,
in all material respects, the financial position of Fuqi International, Inc. and
subsidiaries as of December 31, 2007 and 2006, and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2007 in conformity with accounting principles generally accepted in
the United States of America. Also, in our opinion, the related financial
statement schedule, when considered in relation to the basic financial
statements taken as a whole, presents fairly in all material respects the
information set forth therein.




/s/
      Stonefield Josephson, Inc.Wanchai,
      Hong KongMarch
      27, 2008


F-2





FUQI
INTERNATIONAL, INC.




CONSOLIDATED
BALANCE SHEETS





As
      of December 31,2007
                                  
                                  
                                  2006ASSETSCurrent
      assets:Cash
                                  
                                  $
                                  63,293,653
                                  
                                  
                                  $
                                  13,354,981Restricted
      cash
                                  
                                  
                                  410,700
                                  
                                  
                                  
                                  -Accounts
      receivable, net of allowance for doubtful accounts of $470,000 and
      $195,000 for 2007 and 2006
                                  
                                  
                                  23,864,141
                                  
                                  
                                  
                                  9,363,397Value added taxes
      receivable
                                  
                                  
                                  2,094,946
                                  
                                  
                                  
                                  -Inventories
                                  
                                  
                                  29,639,236
                                  
                                  
                                  
                                  6,066,213Prepaid
      expenses and other current assets
                                  
                                  
                                  1,700,432
                                  
                                  
                                  
                                  89,362Deposits
      related to borrowings on notes payable/ long term debt
                                  
                                  
                                  -
                                  
                                  
                                  
                                  736,358Deferred
      taxes
                                  
                                  
                                  79,402
                                  
                                  
                                  
                                  29,198Total
      current assets
                                  
                                  
                                  121,082,510
                                  
                                  
                                  
                                  29,639,509Property,
      equipment, and improvements, net
                                  
                                  
                                  1,495,861
                                  
                                  
                                  
                                  1,354,313Deposits
                                  
                                  
                                  97,706
                                  
                                  
                                  
                                  91,398Other
      assets
                                  
                                  
                                  38,513
                                  
                                  
                                  
                                  40,122$
                                  122,714,590
                                  
                                  
                                  $
                                  31,125,342LIABILITIES
      AND STOCKHOLDERS' EQUITYCurrent
      liabilities:Notes
      payable
                                  
                                  $
                                  15,743,504
                                  
                                  
                                  $
                                  14,086,852Line
      of credit
                                  
                                  
                                  1,369,000
                                  
                                  
                                  
                                  -Accounts
      payable and accrued liabilities
                                  
                                  
                                  662,662
                                  
                                  
                                  
                                  215,092Accrued
      business tax
                                  
                                  
                                  498,792
                                  
                                  
                                  
                                  1,084,078Accrued
      penalties
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1,119,201Accrued
      value added taxes
                                  
                                  
                                  -
                                  
                                  
                                  
                                  133,010Customer
      deposits
                                  
                                  
                                  5,278,534
                                  
                                  
                                  
                                  1,234,424Income
      tax payable
                                  
                                  
                                  1,902,443
                                  
                                  
                                  
                                  1,884,837Due
      to stockholder
                                  
                                  
                                  -
                                  
                                  
                                  
                                  422,909Total
      current liabilities
                                  
                                  
                                  25,454,935
                                  
                                  
                                  
                                  20,180,403STOCKHOLDERS'
      EQUITYPreferred
      stock, $0.001 par value, 5,000,000 shares authorized, none issued and
      outstanding
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Common
      stock, $0.001 par value, 100,000,000 shares authorized for 2007 and
      75,000,000 shares authorized for 2006, shares issued and outstanding -
      20,924,843 shares for 2007 and 12,257,624 shares for 2006
                                  
                                  
                                  20,925
                                  
                                  
                                  
                                  12,258Additional
      paid in capital
                                  
                                  
                                  77,449,355
                                  
                                  
                                  
                                  7,212,130Accumulated
      foreign currency translation adjustments
                                  
                                  
                                  2,985,035
                                  
                                  
                                  
                                  432,125Retained
      earnings
                                  
                                  
                                  16,804,340
                                  
                                  
                                  
                                  3,288,426Total
      stockholders' equity
                                  
                                  
                                  97,259,655
                                  
                                  
                                  
                                  10,944,939$
                                  122,714,590
                                  
                                  
                                  $
                                  31,125,342




The
accompanying notes form an integral part of these consolidated financial
statements




F-3




FUQI
INTERNATIONAL, INC.




CONSOLIDATED
STATEMENTS OF INCOME AND COMPREHENSIVE INCOME





Years
      Ended December 31,2007
                                              
                                              
                                              2006
                                              
                                              
                                              2005Net
      sales
                                              
                                              $
                                              145,558,667
                                              
                                              
                                              $
                                              92,408,539
                                              
                                              
                                              $
                                              72,580,171Cost
      of sales
                                              
                                              
                                              129,044,877
                                              
                                              
                                              
                                              83,618,526
                                              
                                              
                                              
                                              64,963,978Gross
      profit
                                              
                                              
                                              16,513,790
                                              
                                              
                                              
                                              8,790,013
                                              
                                              
                                              
                                              7,616,193Operating
      expenses:Selling
      and marketing
                                              
                                              
                                              1,105,168
                                              
                                              
                                              
                                              490,191
                                              
                                              
                                              
                                              624,131General
      and administrative
                                              
                                              
                                              2,919,140
                                              
                                              
                                              
                                              793,453
                                              
                                              
                                              
                                              671,191Total
      operating expenses
                                              
                                              
                                              4,024,308
                                              
                                              
                                              
                                              1,283,644
                                              
                                              
                                              
                                              1,295,322Income
      from operations
                                              
                                              
                                              12,489,482
                                              
                                              
                                              
                                              7,506,369
                                              
                                              
                                              
                                              6,320,871Other
      income (expenses):Interest
      expense
                                              
                                              
                                              (1,238,505
                                              )
                                              
                                              
                                              (798,868
                                              )
                                              
                                              
                                              (497,901
                                              )Interest
      income
                                              
                                              
                                              166,230
                                              
                                              
                                              
                                              69,628
                                              
                                              
                                              
                                              -Change
      of fair value of inventory loan payable
                                              
                                              
                                              (46,083
                                              )
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -Exemption
      of tax liabilities and estimated penalty payable
                                              
                                              
                                              4,161,533
                                              
                                              
                                              
                                              -
                                              
                                              
                                              
                                              -Miscellaneous
                                              
                                              
                                              80,307
                                              
                                              
                                              
                                              12,564
                                              
                                              
                                              
                                              (664
                                              )Total
      other income (expenses)
                                              
                                              
                                              3,123,482
                                              
                                              
                                              
                                              (716,676
                                              )
                                              
                                              
                                              (498,565
                                              )Income
      before provision for income taxes
                                              
                                              
                                              15,612,964
                                              
                                              
                                              
                                              6,789,693
                                              
                                              
                                              
                                              5,822,306Provision
      for income taxes
                                              
                                              
                                              2,097,050
                                              
                                              
                                              
                                              995,462
                                              
                                              
                                              
                                              452,538Net
      income
                                              
                                              
                                              13,515,914
                                              
                                              
                                              
                                              5,794,231
                                              
                                              
                                              
                                              5,369,768Other comprehensive
      income - foreign currency translation adjustments
                                              
                                              
                                              2,552,910
                                              
                                              
                                              
                                              288,419
                                              
                                              
                                              
                                              143,706Comprehensive
      income
                                              
                                              $
                                              16,068,824
                                              
                                              
                                              $
                                              6,082,650
                                              
                                              
                                              $
                                              5,513,474Earnings
      per share - basic
                                              
                                              $
                                              0.96
                                              
                                              
                                              $
                                              0.51
                                              
                                              
                                              $
                                              0.48Earnings
      per share - diluted
                                              
                                              $
                                              0.86
                                              
                                              
                                              $
                                              0.50
                                              
                                              
                                              $
                                              0.48Weighted
      average number of common shares - basic
                                              
                                              
                                              14,105,791
                                              
                                              
                                              
                                              11,260,544
                                              
                                              
                                              
                                              11,175,543Weighted
      average number of common shares- diluted
                                              
                                              
                                              15,627,494
                                              
                                              
                                              
                                              11,631,549
                                              
                                              
                                              
                                              11,175,543




The
accompanying notes form an integral part of these consolidated financial
statements





F-4





FUQI
INTERNATIONAL, INC.


CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY


Years
Ended December 31, 2007, 2006 and 2005




Common
      StockShares
                              
                              
                              Amount
                              
                              
                              Additional
                                Paid
      in
                                Capital
                              
                              
                              Other
                                Comprehensive
                                Income
                              
                              
                              Retained
                                Earnings
                              
                              
                              Total
                                Stockholders'
                                EquityBalance,
      December 31, 2004
                              
                              
                              11,175,543
                              
                              
                              $
                              11,176
                              
                              
                              $
                              2,398,463
                              
                              
                              $
                              -
                              
                              
                              $
                              285,840
                              
                              
                              $
                              2,695,479Capital
      contributions
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              4,819,277
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              4,819,277Dividend
      paid
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (5,421,687
                              )
                              
                              
                              (5,421,687
                              )Foreign
      currency translation adjustments
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              143,706
                              
                              
                              
                              -
                              
                              
                              
                              143,706Net
      income
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              5,369,768
                              
                              
                              
                              5,369,768Balance,
      December 31, 2005
                              
                              
                              11,175,543
                              
                              
                              
                              11,176
                              
                              
                              
                              7,217,740
                              
                              
                              
                              143,706
                              
                              
                              
                              233,921
                              
                              
                              
                              7,606,543Reverse
      acquisition of Fuqi BVI
                              
                              
                              1,082,081
                              
                              
                              
                              1,082
                              
                              
                              
                              (5,610
                              )
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (4,528
                              )Dividend
      paid
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              (2,739,726
                              )
                              
                              
                              (2,739,726
                              )Foreign
      currency translation adjustments
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              288,419
                              
                              
                              
                              -
                              
                              
                              
                              288,419Net
      income
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              5,794,231
                              
                              
                              
                              5,794,231Balance,
      December 31, 2006
                              
                              
                              12,257,624
                              
                              
                              
                              12,258
                              
                              
                              
                              7,212,130
                              
                              
                              
                              432,125
                              
                              
                              
                              3,288,426
                              
                              
                              
                              10,944,939Issuance
      of common stock related to initial public offering, net of financing
      cost
                              
                              
                              8,088,888
                              
                              
                              
                              8,089
                              
                              
                              
                              66,780,438
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              66,788,527Issuance
      of common stock for exercise of stock warrants
                              
                              
                              578,331
                              
                              
                              
                              578
                              
                              
                              
                              2,754,931
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              2,755,509Fair
      value of stock options granted to executives and directors
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              701,856
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              701,856Foreign
      currency translation adjustments
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              2,552,910
                              
                              
                              
                              -
                              
                              
                              
                              2,552,910Net
      income
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              -
                              
                              
                              
                              13,515,914
                              
                              
                              
                              13,515,914Balance,
      December 31, 2007
                              
                              
                              20,924,843
                              
                              
                              $
                              20,925
                              
                              
                              $
                              77,449,355
                              
                              
                              $
                              2,985,035
                              
                              
                              $
                              16,804,340
                              
                              
                              $
                              97,259,655




The accompanying notes form an
integral part of these consolidated financial statements





F-5





FUQI
INTERNATIONAL, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


Increase
(Decrease) in Cash




Years
      Ended December 31,2007
                                
                                
                                2006
                                
                                
                                2005Cash
      flows provided by operating activities:Net
      income
                                
                                $
                                13,515,914
                                
                                
                                $
                                5,794,231
                                
                                
                                $
                                5,369,768Adjustments
      to reconcile net income to net cash provided by (used for) operating
      activities:Depreciation
      and amortization
                                
                                
                                326,784
                                
                                
                                
                                326,852
                                
                                
                                
                                239,449Provision
      for bad debt
                                
                                
                                251,746
                                
                                
                                
                                (115,592
                                )
                                
                                
                                7,320Stock
      based compensation
                                
                                
                                701,856
                                
                                
                                
                                -
                                
                                
                                
                                -Exemption
      of tax liabilities and estimated penalty payable
                                
                                
                                (4,161,534
                                )
                                
                                
                                -
                                
                                
                                
                                -Changes
      in operating assets and liabilities:Accounts
      receivable
                                
                                
                                (13,590,622
                                )
                                
                                
                                (1,958,441
                                )
                                
                                
                                (2,277,877
                                )Value added taxes
      receivable
                                
                                
                                (2,153,866
                                )
                                
                                
                                387,787
                                
                                
                                
                                (192,867
                                )Inventories
                                
                                
                                (22,292,543
                                )
                                
                                
                                (109,243
                                )
                                
                                
                                (850,319
                                )Inventory
      loan receivable
                                
                                
                                -
                                
                                
                                
                                697,530
                                
                                
                                
                                (677,335
                                )Prepaid
      expenses and other current assets
                                
                                
                                (1,553,191
                                )
                                
                                
                                (24,903
                                )
                                
                                
                                (105,106
                                )Deposits
      - short term
                                
                                
                                757,875
                                
                                
                                
                                (376,932
                                )
                                
                                
                                (335,517
                                )Deferred
      taxes
                                
                                
                                (46,395
                                )
                                
                                
                                (5,654
                                )
                                
                                
                                (488
                                )Deposits
      related to borrowings on notes payable/ long term debt
                                
                                
                                -
                                
                                
                                
                                (8,004
                                )
                                
                                
                                (3,497
                                )Other
      assets
                                
                                
                                4,215
                                
                                
                                
                                (35,504
                                )
                                
                                
                                (3,748
                                )Accounts
      payable, accrued expenses, accrued business taxes, and accrued estimated
      penalties
                                
                                
                                906,006
                                
                                
                                
                                257,800
                                
                                
                                
                                132,890Customer
      deposits
                                
                                
                                3,811,563
                                
                                
                                
                                (1,614,529
                                )
                                
                                
                                1,491,538Income
      tax payable
                                
                                
                                1,785,619
                                
                                
                                
                                821,571
                                
                                
                                
                                408,461Net
      cash provided by (used for) operating activities
                                
                                
                                (21,736,573
                                )
                                
                                
                                4,036,969
                                
                                
                                
                                3,202,672Cash
      flows provided by (used for) investing activities:Purchase
      of property, equipment and improvements
                                
                                
                                (373,080
                                )
                                
                                
                                (31,873
                                )
                                
                                
                                (838,959
                                )Disbursements
      on loans to stockholder
                                
                                
                                -
                                
                                
                                
                                (51,529,693
                                )
                                
                                
                                (90,007,069
                                )Proceeds
      from collections on loans to stockholder
                                
                                
                                -
                                
                                
                                
                                58,409,847
                                
                                
                                
                                75,644,023Decrease
      (Increase) in restricted cash
                                
                                
                                (395,413
                                )
                                
                                
                                2,764,166
                                
                                
                                
                                (2,726,146
                                )Net cash (used for) provided by
      investing activities
                                
                                
                                (768,493
                                )
                                
                                
                                9,612,447
                                
                                
                                
                                (17,928,151
                                )




F-6





FUQI
INTERNATIONAL, INC.


CONSOLIDATED
STATEMENTS OF CASH FLOWS


Increase
(Decrease) in Cash - continued





Year
      Ended December 31,2007
                                  
                                  
                                  2006
                                  
                                  
                                  2005Cash
      flows provided by (used for) financing activities:Proceeds
      from short-term borrowing
                                  
                                  $
                                  1,977,066
                                  
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  7,572,297Proceeds
      from exercise of warrants, net of financing cost
                                  
                                  
                                  2,755,509
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Proceeds
      from long-term debt
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  1,239,157Reverse
      acquisition of Fuqi BVI
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (4,528
                                  )
                                  
                                  
                                  -(Repayment
      to) loan from a related party
                                  
                                  
                                  -
                                  
                                  
                                  
                                  (1,005,151
                                  )
                                  
                                  
                                  991,326Proceeds
      from capital contribution
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  4,819,277Issuance
      of common stock related to initial public offering, net of financing
      cost
                                  
                                  
                                  66,788,527
                                  
                                  
                                  
                                  -
                                  
                                  
                                  
                                  -Proceeds
      from loans borrowed from stockholder
                                  
                                  
                                  203,506
                                  
                                  
                                  
                                  23,545,485
                                  
                                  
                                  
                                  -Repayments
      to loans payable to stockholder
                                  
                                  
                                  (642,295
                                  )
                                  
                                  
                                  (23,130,562
                                  )
                                  
                                  
                                  -Net
      cash provided by (used for) financing activities
                                  
                                  
                                  71,082,313
                                  
                                  
                                  
                                  (594,756
                                  )
                                  
                                  
                                  14,622,057Effect
      of exchange rate changes on cash
                                  
                                  
                                  1,361,425
                                  
                                  
                                  
                                  228,842
                                  
                                  
                                  
                                  (80,775
                                  )Net
      increase (decrease) in cash
                                  
                                  
                                  49,938,672
                                  
                                  
                                  
                                  13,283,502
                                  
                                  
                                  
                                  (184,197
                                  )Cash,beginning of
      year
                                  
                                  
                                  13,354,981
                                  
                                  
                                  
                                  71,479
                                  
                                  
                                  
                                  255,676Cash,end of
      year
                                  
                                  $
                                  63,293,653
                                  
                                  
                                  $
                                  13,354,981
                                  
                                  
                                  $
                                  71,479Supplemental
      disclosure of cash flow information:Interest
      paid
                                  
                                  $
                                  1,210,667
                                  
                                  
                                  $
                                  786,941
                                  
                                  
                                  $
                                  476,399Income
      taxes paid
                                  
                                  $
                                  357,826
                                  
                                  
                                  $
                                  71,479
                                  
                                  
                                  $
                                  34,103Non-cash
      activities:Decrease
      in due from stockholder for dividend declared and paid
                                  
                                  $
                                  -
                                  
                                  
                                  $
                                  2,739,726
                                  
                                  
                                  $
                                  5,421,687




The
accompanying notes form an integral part of these consolidated financial
statements




F-7




FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





(1)  Summary
of Significant Accounting Policies:





Organization,
Nature of Business and Basis of Presentation




Fuqi
International, Inc. (“Fuqi” or “the Company”) operate through our wholly-owned
subsidiary Fuqi International Holdings Co., Ltd., a British Virgin Islands
corporation (“Fuqi BVI”) and its wholly-owned subsidiary, Shenzhen Fuqi Jewelry
Co., Ltd., (“Fuqi China”) a company established under the laws of the People’s
Republic of China.




On
November 20, 2006, Fuqi BVI entered into a share exchange agreement with VT
Marketing Services, Inc. (“VT”) and Mr. Yu Kwai Chong, who is our current Chief
Executive Officer and Chairman of the Board of the Directors, to effect a
reverse merger transaction (the “Reverse Merger”). Pursuant to the Reverse
Merger, Mr. Chong, as the sole shareholder of Fuqi BVI, agreed to exchange all
of his shares of Fuqi BVI for shares of VT and VT agreed to acquire all of the
issued and outstanding capital stock of Fuqi BVI. VT was formed as part of the
implementation of the Chapter 11 reorganization plan (the “Visitalk Plan”) of
visitalk.com, Inc., which became effective on September 17, 2004. The Reverse
Merger closed on November 22, 2006 and VT issued an aggregate of 11,175,543
shares of common stock in exchange for all of the issued and outstanding
securities of Fuqi BVI. Upon the close of the Reverse Merger, VT became the 100%
parent of Fuqi BVI and assumed the operations of Fuqi BVI and its subsidiary as
its sole business. On November 8, 2006, VT reincorporated from Arizona to Nevada
and on December 8, 2006, after the Reverse Merger, VT reincorporated from the
Nevada to Delaware and changed its corporate name from “VT Marketing Services,
Inc.” to “Fuqi International, Inc.” The transactions contemplated by the Reverse
Merger were intended to be a “tax-free” transaction pursuant to the provisions
of Section 351 of the Internal Revenue Code of 1986, as amended.




For
financial accounting purposes, the Reverse Merger was treated as a reverse
acquisition by Fuqi BVI, under the purchase method of accounting, and was
treated as a recapitalization with Fuqi BVI as the accounting acquirer.
Accordingly, our historical financial statements have been prepared to give
retroactive effect to the reverse acquisition completed on November 22, 2006,
and represent the operations of Fuqi BVI and its wholly-owned subsidiary, Fuqi
China.





The
Company currently operates in two divisions: (i) production and (ii) sales and
marketing. The production division is responsible for all manufacturing of
jewelry products, while the sales and marketing division is responsible for all
of the selling and marketing functions of the products, including customer
relationships and customer service. The Company has been selling its products to
wholesalers and distributors since the inception of its operations. In April
2007, the Company began to sell its products through retail counters in
department stores. The Company grants credit to the majority of its wholesale
and distribution customers, which are located throughout the People’s Republic
of China (“PRC”), and the Company does not generally require
collateral.





Consolidation
Policy:





The
consolidated financial statements include the consolidated financial statements
of Fuqi International and its wholly owned subsidiaries, Fuqi BVI and Shenzhen
Fuqi. All significant intercompany accounts and transactions have been
eliminated in preparation of the consolidated financial statements.





Cost
of Sales:





Cost of
sales includes raw material, direct labor and overhead costs. Overhead costs
consist of depreciation for improvements related to the Company’s factory and
machinery and equipment, indirect labor, utilities, factory rent and warehouse
costs and occupancy costs at department stores. The Company does not incur any
significant amount of inbound freight charges, purchasing and receiving costs
since the Company’s raw material, including primarily gold and platinum, are
handled by the Company’s operation manager. All the costs related to the
Company’s distribution network are included in the cost of sales.





Operating
Costs:





Selling
and marketing expenses include salaries and employee benefits, advertising,
travel and entertainment, insurance, amortization of cost for operation rights
acquired, and business taxes.





F-8





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




General
and administrative expenses include management and office salaries and employee
benefits, deprecation for office facility and office equipment, travel and
entertainment, insurance, legal and accounting, consulting fees, workers’
compensation insurance, and other office expenses.





Revenue
Recognition





Wholesale
revenue is recognized upon delivery and acceptance of jewelry products by the
customers while retail revenue is recognized upon receipts and acceptance of
jewelry products by the customers, provided that the other conditions of sales,
as established by the Securities and Exchange Commission’s Staff Accounting
Bulletin (“SAB”) No. 104, are satisfied:


·
              persuasive evidence of an
      arrangement exists;
 
 ·
              delivery has occurred, upon
      shipment when title passes, or services have been
      rendered;
 
 ·
              the seller’s price to the buyer
      is fixed or determinable;
and
 
 ·
              collectibility is reasonably
      assured.




Value
Added Taxes represent amounts collected on behalf of specific regulatory
agencies that require remittance by a specified date. These amounts are
collected at the time of sales and are detailed on invoices provided to
customers. In compliance with the Emerging Issues Task Force consensus on issue
number 06-03 (EITF 06-03), the Company accounts for value added taxes on a net
basis.





Currency
Reporting





The
Company’s operations in China use the local currency - Renminbi (“RMB”) as their
functional currency whereas amounts reported in the accompanying consolidated
financial statements and disclosures are stated in United States Dollars, the
reporting currency of the Company, unless stated otherwise. As such, the
consolidated balance sheets of the Company have been translated into U.S.
dollars at the current rates as of December 31, 2007 and 2006 and the
consolidated statements of income have been translated into U.S. dollars at the
weighted average rates during the periods the transactions were
recognized.





The
resulting translation gain adjustments are recorded as other comprehensive
income in the consolidated statements of income and comprehensive income and as
a separate component of consolidated statements of stockholders’
equity.





Reverse
Stock Split





On August
23, 2007, the Company’s Board of Directors unanimously authorized a 1.69-to-1
reverse stock split of the Company’s common stock. The reverse stock split
became effective on October 22, 2007. All references to shares in the
consolidated financial statements and the accompanying notes, including but not
limited to the number of shares and per share amounts, unless otherwise noted,
have been adjusted to reflect the reverse stock split
retroactively.





F-9





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Basic
and Diluted Earnings Per Share





The basic
earnings per common share is computed by dividing net income available to common
stockholders by the weighted average number of common shares outstanding.
Diluted income per common share is computed similarly to basic income per common
share, except that the denominator is increased to include the number of
additional common shares that would have been outstanding if the potential
common shares had been issued and if the additional common shares were dilutive.
In accordance with the Visitalk Plan (See Note 8), the Company issued six series
of common stock purchase warrants allowing holders to purchase additional shares
of common stock (“Plan Warrants”). As of December 31, 2007 and 2006, the Company
had common stock equivalents of 0 and 9,968,628 shares, respectively, upon the
exercise of the plan warrants. The Company delivered a notice of redemption to
the warrant holders in May 2007, and all of the warrants were either exercised
or redeemed and cancelled in June 2007. As of December 31, 2007 and 2006, the
Company had common stock equivalents of 1,320,000 and 0, respectively, upon the
exercise of the stock options which were excluded from the computation of
diluted earnings per share as their effect is not dilutive. The computation of
dilutive potential common shares for the periods is shown as
follows:





December
      31,2007
                          
                          
                          2006
                          
                          
                          2005Basic
      weighted average shares
                          
                          
                          14,105,791
                          
                          
                          
                          11,260,544
                          
                          
                          
                          11,175,543Effect
      of dilutive securities
                          
                          
                          1,521,703
                          
                          
                          
                          370,915
                          
                          
                          
                          —Dilutive
      potential common shares
                          
                          
                          15,627,494
                          
                          
                          
                          11,631,459
                          
                          
                          
                          11,175,543





Share-Based
Payment





In
accordance with SFAS No. 123R, “Share-based Payment: An amendment of FASB
Statement No. 123” (“SFAS 123R”), effective January 1, 2006, the Company is
required to recognize compensation expense related to stock options granted to
employees based on: (a) compensation cost for all share-based payments granted
prior to, but not yet vested as of December 31, 2005, based on the grant date
fair value estimated in accordance with SFAS No 123, “Accounting for Stock-Based
Compensation” (“SFAS 123”), and (b) compensation cost for all share-based
payments granted subsequent to December 31, 2005, based on the grant-date fair
value estimated in accordance with the provisions of SFAS123R. 123R requires
forfeitures to be estimated at the time of grant and revised, if necessary, in
subsequent periods if actual forfeitures differ from initial estimates. We did
not issue any stock options in 2005 and 2006 and had no outstanding options as
of December 31, 2006. On October 26, 2007, the Company granted options to
purchase a total of 1,320,000 shares of its common stock to two executives and
four directors. The Company expects these options to be fully vested and
therefore did not account for any forfeiture as the vesting periods of these
options are relatively short. The Company uses the Black-Scholes option-pricing
model to value stock option awards and expensed the stock-based compensation
based on the vesting periods.




The fair
value of these options was calculated using a Black-Scholes option pricing model
using the following assumptions: (1) risk-free interest rates of 3.8% to
4.0%, (2) an expected life of one to two years, (3) expected
volatility of 28%, (4) expected forfeitures of 0%, and (5) a dividend
yield of 0%. Because there was no public market or trading history at the time
of the grant in October 2007 and in accordance with SFAS 123R, we computed the
expected volatility based on the average historical volatilities of entities in
the similar industries and sizes. For the year ended December 31, 2007,
approximately $702,000 was expensed related to the grant of these
options.




Use
of Estimates





The
preparation of consolidated financial statements in conformity with GAAP
requires management to make estimates and assumptions that affect the reported
amounts of assets and liabilities at the dates of the consolidated financial
statements and the reported amounts of revenues and expenses during the
reporting periods. Actual results could differ from those
estimates.





Cash





For
purposes of the consolidated statements of cash flows, cash equivalents include
all highly liquid debt instruments with original maturities of three months or
less which are not securing any corporate obligations. The Company had no cash
equivalents at December 31, 2007 and 2006. As of December 31, 2007 and 2006,
majority of the cash, including restricted cash, were in RMB dollars maintained
by the PRC financial institutions under the Company’s wholly PRC subsidiary,
Shenzhen Fuqi. Cash remittance in or out of PRC are subject to PRC foreign
exchange control regulations pursuant to which PRC government approval is
required for Fuqi China to receive funds from or distribute funds to outside
PRC.





Restricted
Cash





As of
December 31, 2007 and 2006, the Company was required to maintain a fixed deposit
of $410,700 and $0 respectively as a condition to borrow under a bank loan
agreement. The amount was classified as restricted cash as of December 31, 2007
and 2006.





F-10





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS





Comprehensive
Income





Statement
on Financial Accounting Standards (“SFAS”) No. 130, “Reporting Comprehensive
Income,” establishes standards for the reporting and display of comprehensive
income and its components in the financial statements. For the years ended
December 31, 2007, 2006, and 2005, other comprehensive income includes foreign
currency translation adjustments.





Commitments
and Contingencies





Liabilities
for loss contingencies arising from claims assessments and litigation and other
sources are recorded when it is probable that a liability has been incurred and
the amount of assessment can be realized. In the opinion of management, after
consultation with legal counsel, there are no claims assessments and litigation
against the Company.





Fair
Value Disclosures of Financial Instruments





The
Company has estimated the fair value amounts of its financial instruments using
the available market information and valuation methodologies considered to be
appropriate and has determined that the book value of the Company’s accounts
receivable, Value added taxes
receivable, inventories, due from/to stockholder, notes payable,
accounts payable and accrued expenses, accrued business tax, accrued penalties,
customer deposits, and income tax payable at December 31, 2007 and 2006
approximate fair value.





Accounts
Receivable





The
Company provides an allowance for doubtful accounts equal to the estimated
uncollectible amounts. The Company’s estimate is based on historical collection
experience and a review of the current status of trade accounts receivable. It
is reasonably possible that the Company’s estimate of the allowance for doubtful
accounts will change. Accounts receivable are presented net of an allowance for
doubtful accounts of approximately $470,000 and $195,000 at December 31, 2007
and 2006, respectively.





Concentration
of Credit Risk





The
Company’s product revenues are concentrated in production and sales of fine
jewelry products, which are highly competitive with frequent changes in styles
and fashion. Significant customer preference changes in the industry or customer
requirements, or the emergence of competitive products with better marketing
strategies and more well-known brand names, could adversely affect the Company’s
operating results.





Financial
instruments that potentially subject the Company to concentration of credit risk
consist principally of trade accounts receivable from jewelry retailers located
throughout China. The credit risk in the Company’s accounts receivable is
mitigated by the fact that the Company performs ongoing credit evaluations of
its customers’ financial condition and that accounts receivable are primarily
derived from large credit-worthy companies throughout the PRC. In addition, the
Company has a diversified customer base. Historically, the Company has not
experienced significant losses related to trade receivables. Generally, no
collateral is required.





Derivative
Instruments





SFAS No.
133, “Accounting for Derivative Instruments and Hedging Activities”, establishes
accounting and reporting standards for derivative instruments as either assets
or liabilities in the statement of financial position based on their fair
values. Changes in the fair values are required to be reported in earnings or
other comprehensive income depending on the use of the derivative and whether it
qualifies for hedge accounting. Derivative instruments are designated and
accounted for as a hedge of a recognized asset or liability (fair value hedge),
a hedge of a forecasted transaction (cash flow hedge) or a hedge of a foreign
currency transaction (foreign currency hedge). For derivatives designated as
effective cash flow hedges or foreign currency hedge, changes in fair values are
recognized in other comprehensive income. Changes in fair values related to fair
value hedges as well as the ineffective portion of cash flow hedges are
recognized in earnings. For derivatives not designated as a hedging instrument,
changes in fair values are recognized in earnings in the period of
change.





During
the fourth quarter of 2007, the Company entered into certain gold future
contracts with its supplier, Shanghai Gold Exchange. Gold futures offered by
Shanghai Gold Exchange are designed for full members to hedge or to acquire
inventory at a preset price. The Company utilized these future contracts to
manage its consolidated exposure to changes in inventory values due to
fluctuations in market prices and is not considered as hedges. The Company’s
gold futures positions are marked to market at each reporting date and all
unrealized gains and losses are recognized in earnings currently. These contract
positions have not had a material effect on the Company’s consolidated financial
position, results of operations, or cash flows.





F-11





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Major
Customer




During
the year ended December 31, 2007, 9.5% of the Company sales were generated from
one customer, which had an outstanding sales deposit of $342,666 as of December
31, 2007. During the year ended December 31, 2006, 9% of the Company sales were
generated from one customer. Accounts receivable from this customer totaled
$2,234,959, which represented 22% of the total accounts receivable as of
December 31, 2006. During the year ended December 31, 2005, 15% of the Company
sales were generated from one customer. Accounts receivable from this customer
totaled $949,453, which represented 14% of the total accounts receivable as of
December 31, 2005.





Major
Supplier





Under PRC
law, supply of precious metals such as platinum, gold, and silver are highly
regulated under certain government agencies. The Shanghai Gold Exchange is the
Company’s primary source of supply for its raw materials, which consist of
precious metals. The Company is required to obtain several memberships and
approval certificates from these government agencies in order to continue to do
business involving precious metals. The Company may be required to renew such
memberships and to obtain approval certificates periodically. If the Company is
unable to renew these periodic membership or approval certificates, it could
materially affect the Company’s business operations. The Company was in good
standing with these agencies as of December 31, 2007 and 2006.





Inventories





Inventories
consist of raw material, direct labor and manufacturing overhead
costs.  Inventories are primarily comprised of precious metals valued
at the lower of cost (first-in, first-out) or fair market value method and
include raw materials, work in process, and finished goods.





Property,
Equipment and Improvements





Property,
equipment and improvements are valued at cost. Depreciation and amortization are
computed on the straight-line method based on the estimated useful life of
respective assets.




The
estimated service lives of property, equipment, and improvements are as
follows:




Production
                        
                        5
      yearsOffice,
      furniture and fixture
                        
                        5
      yearsComputer
      hardware
                        
                        5
      yearsComputer
      software
                        
                        5
      yearsLeasehold
      improvements
                        
                        2 - 4
      yearsBuilding
                        
                        20
      years




Long-Lived
Assets





In
accordance with Statement of Financial Accounting Standards (“SFAS”) No. 144,
“Accounting for the Impairment or Disposal of Long-Lived Assets,” long-lived
assets to be held and used are analyzed for impairment whenever events or
changes in circumstances indicate that the carrying amount of an asset may not
be recoverable. SFAS No. 144 relates to assets that can be amortized and for
which the life can be determinable. The Company evaluates at each balance sheet
date whether events and circumstances have occurred that indicate possible
impairment. If there are indications of impairment, the Company uses future
undiscounted cash flows of the related assets or asset grouping over the
remaining life in measuring whether the assets are recoverable. In the event
such cash flows are not expected to be sufficient to recover the recorded asset
values, the assets are written down to their estimated fair value. Long-lived
assets to be disposed of are reported at the lower of the carrying amount or
fair value of asset less disposal costs. The Company determined that there was
no impairment of long-lived assets as of December 31, 2007 and
2006.





F-12





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




Advertising





The
Company expenses advertising costs when incurred. The Company incurred
approximately $177,000, $33,000, and $132,000 of advertising expense for the
years ended December 31, 2007, 2006, and 2005, respectively.





Income
Taxes





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. Deferred tax
assets, including tax loss and credit carryforwards, and liabilities are
measured using enacted tax rates in the applicable tax jurisdiction 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. Deferred income tax expense represents the change
during the period in the deferred tax assets and deferred tax liabilities. The
components of the deferred tax assets and liabilities are individually
classified as current and non-current based on their characteristics.
Realization of the deferred tax asset is dependent on generating sufficient
taxable income in future years.





Segment
Reporting





Based on
the Company’s integration and management strategies, the Company operated in a
single business segment. All of the Company’s sales are generated in the PRC and
substantially all of the Company’s assets are located in the PRC.




New
Accounting Pronouncements





In
February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for
Financial Assets and Financial Liabilities”. The objective of this statement is
to improve financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. This Statement is expected by the FASB to expand the use of fair
value measurement, which is consistent with the FASB’s long-term measurement
objectives for accounting for financial instruments. This statement is effective
for fiscal years beginning after November 15, 2007. The Company is currently
evaluating the impact of adopting this statement and does not expect the
adoption of this provision to have a material effect on its financial position,
results of operations or cash flows.





In
December 2007, the FASB issued SFAS No. 141 (revised 2007), “Business
Combinations” (SFAS 141(R)), which replaces SFAS No. 141, “Business
Combinations.” SFAS 141(R) retains the underlying concepts of SFAS 141 in that
all business combinations are still required to be accounted for at fair value
under the acquisition method of accounting but SFAS 141(R) changed the method of
applying the acquisition method in a number of significant aspects. Acquisition
costs will generally be expensed as incurred; noncontrolling interests will be
valued at fair value at the acquisition date; in-process research and
development will be recorded at fair value as an indefinite-lived intangible
asset at the acquisition date; restructuring costs associated with a business
combination will generally be expensed subsequent to the acquisition date; and
changes in deferred tax asset valuation allowances and income tax uncertainties
after the acquisition date generally will affect income tax expense. SFAS 141(R)
is effective on a prospective basis for all business combinations for which the
acquisition date is on or after the beginning of the first annual period
subsequent to December 15, 2008, with the exception of the accounting for
valuation allowances on deferred taxes and acquired tax contingencies. SFAS
141(R) amends SFAS 109 such that adjustments made to valuation allowances on
deferred taxes and acquired tax contingencies associated with acquisitions that
closed prior to the effective date of SFAS 141(R) would also apply the
provisions of SFAS 141(R). Early adoption is not permitted. We are currently
evaluating the effects, if any, that SFAS 141(R) may not have significant
effects on our financial statements.





In
December 2007, the FASB issued Financial Accounting Standards No. 160,
“Noncontrolling Interests in Consolidated Financial Statements—an amendment of
ARB No. 51.” This statement is effective for fiscal years, and interim
periods within those fiscal years, beginning on or after December 15, 2008,
with earlier adoption prohibited. This statement requires the recognition of a
noncontrolling interest (minority interest) as equity in the consolidated
financial statements and separate from the parent’s equity. The amount of net
income attributable to the noncontrolling interest will be included in
consolidated net income on the face of the income statement. It also amends
certain of ARB No. 51’s consolidation procedures for consistency with the
requirements of SFAS 141(R) .This statement also includes expanded disclosure requirements regarding
the interests of the parent and its noncontrolling interest. We are currently
evaluating this new statement and anticipate that the statement will not have a
significant impact on the reporting of our results of
operations.





F-13





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




(2)
Inventories:





A summary
of inventory is as follows:





December
      31,2007
                        
                        2006Raw
      Materials
                        
                        $
                        61,570
                        
                        
                        $
                        743Work
      in progress
                        
                        
                        12,588,152
                        
                        
                        
                        3,917,795Finished
      goods
                        
                        
                        16,989,514
                        
                        
                        
                        2,147,675$
                        29,639,236
                        
                        
                        $
                        6,066,213




(3)
Property, Equipment and Improvements:





A summary
of property, equipment and improvements is as follows:





December
      31,2007
                          
                          
                          2006Production
      equipment
                          
                          $
                          1,108,045
                          
                          
                          $
                          950,479Computers
                          
                          
                          52,697
                          
                          
                          
                          14,976Office
      equipment and furniture
                          
                          
                          114,403
                          
                          
                          
                          101,289Automobiles
                          
                          
                          486,539
                          
                          
                          
                          254,841Leasehold
      improvement
                          
                          
                          448,000
                          
                          
                          
                          382,963Building
                          
                          
                          582,886
                          
                          
                          
                          545,2572,792,570
                          
                          
                          
                          2,249,805Less
      accumulated depreciation and amortization
                          
                          
                          1,296,709
                          
                          
                          
                          895,492$
                          1,495,861
                          
                          
                          $
                          1,354,313





Depreciation
and amortization expense for property, equipment, and improvements amounted to
approximately $327,000, $327,000, and $239,000 for the years ended December 31,
2007, 2006, and 2005, respectively.




(4)
Operation Agreements - Retail Jewelry Counters:




In April
2007, the Company entered into a transfer agreement with an unrelated party (the
“Transferor”), which has operation agreements with department stores for five
jewelry retail counters. Under the terms of the agreement, the Transferor agreed
to assign all of the operation rights to the Company for a fee of $400,000. The
fee is payable in three separate installments. The first payment of $120,000 is
due upon completion of the transfer of the operation rights by the department
stores to the Company. The second installment of $120,000 is due within 30 days
after the remittance of the first installment while the final installment of
$160,000 is due within 90 days after the remittance of the first
installment.




During
the time of finalizing the transfer of operation rights by the department stores
to the Company, the Company obtained temporary operation rights from the
Transferor to operate these counters. Revenue derived from these five retail
counters from the period of May to November 2007 (before execution of the
cancellation agreement) amounted to $937,000.





F-14





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




On
October 28, 2007, due to the operation rights not being properly transferred
from the Transferor to the Company within a reasonable period of time, the
Company entered into a cancellation agreement with the Transferor to terminate
the transfer transaction effective November 30, 2007. Pursuant to the
cancellation agreement, the Company was not obligated to pay the transfer fee of
$400,000. All the inventory remained in the five counter stores at the last day
of the operation was sold to the Transferor based on the pre-determined price.
As of December 31, 2007, the outstanding balance due to the Transferor was
approximately $204,000.




In
November 2007, the Company entered into operating agreements to operate retail
jewelry counters at two department stores located in Shenyang region. The
agreement has a term of one year and expires in November 2008. In accordance to
the terms of this agreement, the Company pays the department stores a commission
fee ranging 4.5% to 8% based on types of jewelry sales generated in these
jewelry counters. Fees paid to the two department stores totaled $20,669 in 2007
and are included in cost of sales expenses. Fuqi recognizes revenues when the
titles of the merchandises are transferred to the ultimate consumers. Fuqi
determines the product pricing, provides staff training at the counters,
controls merchandising and display at the counters, manages inventory, and
controls and pays for all the advertising and marketing campaign with respect to
Fuqi merchandise. Sales generated from these two retail counters totaled
$308,000 for the year ended December 31, 2007.




(5) Line of
Credit:




In
February 2007, the Company entered into a facility line of credit with a bank.
Under the terms of the agreement, the Company can borrow a maximum amount of
$2,053,501 (RMB 15,000,000) and each of the borrowings cannot be less than
$136,900 and have a maturity of less than 90 days. This facility line of credit
expires in February 2012 and is secured by an affiliated company and certain
real properties owned by an affiliated company. Interest is charged at 1.2 times
the bank’s prime rate (7.776% at December 31, 2007). The facility line of credit
agreement has certain conditions for the Company to fulfill prior to the
withdrawals and to continue to borrow from the bank, including execution of the
fixed deposit agreement and maintaining approximately $684,500 (RMB 5,000,000)
in fixed deposit with this bank. During the year, the bank has allowed the
Company to draw on the line of credit without fulfilling these conditions. The
facility line of credit agreement also has certain restrictions and covenants
with which the Company must comply during the terms of the agreement. The
outstanding balance as of December 31, 2007 was $1,369,000. Subsequent to the
year end, the facility line of credit agreement was amended under which the
maximum borrowing amount was decreased to $1,369,000 (RMB 10,000,000) and the
requirement of fixed deposit amounted $684,500 was removed.




(6)
Notes Payable:




As of
December 31, 2007 and 2006, outstanding notes payable to the bank consisted of
loan agreements that are covered by a Maximum Banking Facility Agreement dated
August 24, 2006 which was renewed on September 27 2007 with the Agricultural
Bank of China under the agreement, the maximum facility amount, which was
$13,690,000 and $12,806,229 (RMB100,000,000) at December 31, 2007 and 2006
respectively, is secured by the Company’s inventories. The agreement has certain
restrictions and covenants, including restriction on dividend payment. The
Company has been in compliance with these restrictions and covenants since the
execution of the agreement. As of December 31, 2007 and 2006, the Company had
outstanding loan balances with this bank totaling $13,690,000 and $12,806,229,
respectively.




2006
Notes Payable also included a loan amounted $1,204,819 (RMB10,000,000) borrowed
from Shenzhen Commercial Bank that bears interest at a rate of 5.76% per annum.
The outstanding balance is secured by certain cash deposits, which were
classified as Deposits related to borrowings on notes payable in the
accompanying consolidated balance sheets as of December 31, 2006, certain real
estate properties owned by an affiliate and is personally guaranteed by the
controlling stockholder of the Company. As of December 31, 2006, the outstanding
balance of the loan was $1,280,623 which was fully repaid in January
2007.




In
January 2007, the Company entered into a note payable with Construction Bank in
the amount of $2,053,501 (RMB15,000,000) that bears interest at 1.1 times of
prime rate. As of December 31, 2007, the outstanding balance of the loan was
$2,053,501 which was fully repaid in January 2008 and was not
renewed.





F-15





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




December
      31,2007
                            
                            
                            2006A
      note payable with interest at a rate of 5.76%, secured by the Company’s
      inventories and certain real estate properties owned by an affiliated
      company, matured in January 2007. The loan was repaid.
                            
                            
                            —
                            
                            
                            
                            1,280,623Two
      notes payable with interest at a rate of 5.85%, guaranteed by affiliated
      companies and personally guaranteed by the Company’s controlling
      stockholder, matured in February 2007. The loan was
repaid.
                            
                            
                            —
                            
                            
                            
                            2,561,246Four
      notes payable with interest at a rate of 5.832%, secured by the Company’s
      inventories and certain real estate properties owned by an affiliated
      company and guaranteed by affiliated companies and personally guaranteed
      by the Company’s controlling stockholder, matured in January 2007. The
      loan was repaid.
                            
                            
                            —
                            
                            
                            
                            3,841,869A
      note payable with interest at a rate of 6.138%, guaranteed by affiliated
      companies and secured by certain real estate properties owned by an
      affiliated company, matured in March 2007. The loan was
      repaid.
                            
                            
                            —
                            
                            
                            
                            1,280,623A
      note payable with interest at a rate of 6.732%, guaranteed by affiliated
      companies and secured by the Company’s inventories and certain real estate
      properties owned by an affiliated company and personally guaranteed by the
      Company’s controlling stockholder, matured in July 2007. The loan was
      repaid.
                            
                            
                            —
                            
                            
                            
                            960,467A
      note payable with interest at a rate of 6.732%, secured by the Company’s
      inventories and certain real estate properties owned by the affiliated
      companies, guaranteed by affiliated companies and personally guaranteed by
      the Company’s controlling stockholder, matured in September 2007. The loan
      was repaid.
                            
                            
                            —
                            
                            
                            
                            960,467A
      note payable with interest at a rate of 6.426%, secured by the Company’s
      inventories and certain real estate properties owned by the affiliated
      companies, guaranteed by affiliated companies and personally guaranteed by
      the Company’s controlling stockholder, matured in September 2007. The loan
      was repaid.
                            
                            
                            —
                            
                            
                            
                            1,024,498A
      note payable with interest at a rate of 6.426%, secured by the Company’s
      inventories and certain real estate properties owned by the affiliated
      companies, guaranteed by affiliated companies and personally guaranteed by
      the Company’s controlling stockholder, matured in October 2007. The loan
      was repaid.
                            
                            
                            —
                            
                            
                            
                            896,436A
      note payable with interest at a rate of 6.732%, secured by the Company’s
      inventories, guaranteed by affiliated companies and personally guaranteed
      by the Company’s controlling stockholder, matured in December 2007. The
      loan was repaid.
                            
                            
                            —
                            
                            
                            
                            1,280,623A
      note payable with interest at a rate of 6.732%, secured by the Company’s
      inventories and certain real estate properties owned by affiliated
      companies, guaranteed by affiliated companies and personally guaranteed by
      the Company’s controlling stockholder, matures in January 2008. The loan
      was repaid.
                            
                            
                            1,848,150
                            
                            
                            
                            —A
      note payable with interest at a rate of 6.732%, guaranteed by affiliated
      companies, matures in January 2008. The loan was repaid.
                            
                            
                            2,053,501
                            
                            
                            
                            —A
      note payable with interest at a rate of 7.227%, secured by the Company’s
      inventories and certain real estate properties owned by affiliated
      companies, guaranteed by affiliated companies and personally guaranteed by
      the Company’s controlling stockholder, matures in February 2008. The loan
      was repaid.
                            
                            
                            1,026,750
                            
                            
                            
                            —A
      note payable with interest at a rate of 7.227%, secured by the Company’s
      inventories and certain real estate properties owned by affiliated
      companies, guaranteed by affiliated companies and personally guaranteed by
      the Company’s controlling stockholder, matures in February 2008. The loan
      was repaid.
                            
                            
                            889,850
                            
                            
                            
                            —A
      note payable with interest at a rate of 6.030%, secured by the Company’s
      inventories, guaranteed by affiliated companies and personally guaranteed
      by the Company’s controlling stockholder, matures in January 2008. The
      loan was repaid.
                            
                            
                            1,369,000
                            
                            
                            
                            —A
      note payable with interest at a rate of 6.030%, secured by the Company’s
      inventories and certain real estate properties owned by affiliated
      companies, guaranteed by affiliated companies and personally guaranteed by
      the Company’s controlling stockholder, matures in February 2008. The loan
      was repaid.
                            
                            
                            2,121,951
                            
                            
                            
                            —A
      note payable with interest at a rate of 8.019%, secured by the Company’s
      inventories and guaranteed by affiliated companies and personally
      guaranteed by the Company’s controlling stockholder, matures
      in October 2008.
                            
                            
                            1,369,000
                            
                            
                            
                            —A
      note payable with interest at a rate of 8.019%, secured by the Company’s
      inventories, certain real estate properties owned by affiliated companies,
      guaranteed by affiliated companies and personally guaranteed by the
      Company’s controlling stockholder, matures in May
    2008.
                            
                            
                            958,300
                            
                            
                            
                            —A
      note payable with interest at a rate of 8.019%, secured by the Company’s
      inventories, guaranteed by affiliated companies and personally guaranteed
      by the Company’s controlling stockholder, matures in June
      2008.
                            
                            
                            1,369,000
                            
                            
                            
                            —A
      note payable with interest at a rate of 7.29%, secured by the Company’s
      inventories, guaranteed by affiliated companies and personally guaranteed
      by the Company’s controlling stockholder, matures in July
      2008.
                            
                            
                            2,738,002
                            
                            
                            
                            —$
                            15,743,504
                            
                            
                            $
                            14,086,852




F-16





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




(7)
Related-Party Transactions:





In
December 2005, the Company received an unsecured non-interest bearing loan from
a related party in the amount of $991,326. There was no formal written agreement
entered into between the Company and this related party. This loan was
short-term in nature and was repaid in 2006.




The
Company earned certain cash revenues from its customers that were subsequently
collected by its controlling stockholder. Total cash revenues amounted to $0,
$5,896,354, and $6,100,298 and the amounts collected by its controlling
stockholder totaled $0, $3,018,144, and $6,100,298, respectively, for the years
ended December 31, 2007, 2006, and 2005. Beginning December 2006, this
stockholder is no longer collecting cash revenue on behalf of the Company and
all the cash revenues are deposited through the Company’s bank
accounts.




The
Company’s controlling stockholder borrowed from the Company on a non-interest
bearing and frequent basis since the inception of its operations. Since the end
of 2006 and during 2007, the Company discontinued such practice and the
receivable balance due from the controlling stockholder was repaid to the
Company in full. For the years ended 31 December 2007, 2006 and 2005, the
Company loaned an aggregate amount of $0, $51,529,693 and $90,007,069 to the
controlling stockholder, and collected $0, $58,409,847, and $75,644,023,
respectively. As at December 31, 2007 and 2006, the outstanding balance due from
the controlling stockholder was $0.




The
Company borrowed from its controlling stockholder at a non-interest bearing
basis to satisfy the Company’s short term capital needs since the inception of
its operations. The Company borrowed $203,506, $23,545,485, and $0 from the
controlling stockholder and repaid $642,295, $23,130,562, $0 during the years
ended December 31, 2007, 2006, and 2005. Outstanding loan payable to the
controlling stockholder amounted to $0 and $422,909 as of December 31, 2007 and
2006, respectively.




The
Company declared and paid dividends to its controlling stockholder, prior to the
closing of the Share Exchange Agreement and Reverse Split, totaling $0,
$2,739,726 and $5,421,678 for the years ended December 31, 2007, 2006, and 2005
which offset the amounts due from this stockholder.




(8)
Stockholders’ Equity:




(a)
Common Stock




On
February 23, 2007, the Company filed an amendment to its certificate of
incorporation to increase its authorized shares. Upon the amendment, the total
number of shares of stock which the Company has the authority to issue is one
hundred and five million (105,000,000) shares. The Company is authorized to
issue two classes of shares of stock, designated, “Common Stock” and “Preferred
Stock.” The Company is authorized to issue one hundred million (100,000,000)
shares of Common Stock, each share to have a par value of $.001 per share, and
Five Million (5,000,000) shares of Preferred Stock, each share to have a par
value of $.001 per share.





On August
23, 2007, the Company’s Board of Directors unanimously authorized a 1.69-to-1
reverse stock split of the Company’s common stock. The reverse stock split
became effective on October 22, 2007. All references to shares in the
consolidated financial statements and the accompanying notes, including but not
limited to the number of shares and per share amounts, unless otherwise noted,
have been adjusted to reflect the reverse stock split retroactively. Previously
awarded warrants to purchase the Company’s common shares have been also
retroactively adjusted to reflect the reverse stock split.




On
October 23, 2007, the Company publicly offered 7,033,816 shares of the Company’s
common stock at $9.00 per share. On October 25, 2007, the Company’s underwriters
elected to fully exercise their over-allotment option to purchase an additional
1,055,072 shares of the Company’s common stock. In total, including the
over-allotment shares, the Company sold 8,088,888 shares of the Company's common
stock at $9.00 per share. The shares offered were listed and traded on the
NASDAQ Global Market under the ticker symbol “FUQI”. After underwriting
discounts and commissions and estimated offering costs, the Company received net
proceeds of approximately $67.0 million





F-17





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




(b)
Stock Options




In
November 2006, the Company’s stockholders approved an equity incentive plan
(“2006 EIP”) for employees, non-employee directors and other service providers
covering 1,775,148 shares of common stock. Prior to this, the Company had an
approved 2004 Equity Incentive Plan, which was replaced by the 2006 EIP. Any
options to be granted under the 2006 EIP may be either “incentive stock
options,” as defined in Section 422A of the Internal Revenue Code, or
“nonqualified stock options,” subject to Section 83 of the Internal Revenue
Code, at the discretion of the Company’s board of directors and as reflected in
the terms of the written option agreement. In the case of incentive stock
options, the option price shall not be less than 100% of the fair market value
of the optioned common stock on the date the option is granted. In the case of
incentive stock options, the option price shall not be less than 110% of the
fair market value of the optioned common stock for an optionee holding at the
time of grant, more than 10% of the total combined voting power of all classes
of its stock. Options become exercisable based on the discretion of its board of
directors and must be exercised within ten years of the date of
grant.




On
October 22, 2007, the Company’s Board of Directors adopted the 2007 Plan and the
Company received the written consent of the holders of a majority of its
outstanding common stock authorizing the 2007 Plan.  Under the 2007
Plan, the maximum number of shares of common stock that may be subject to stock
options or stock awards is 2,366,864. Immediately prior to the adoption of the
2007 Plan, the Company cancelled and terminated its 2006 Equity Incentive Plan
(“2006 Plan”). There were no options or other securities outstanding under the
2006 Plan at the time of termination and no future grants or issuance of
securities may be made under the 2006 Plan.




On
October 26, 2007, the Company granted each of its Chief Financial Officer and
the Executive Vice President, Corporate Development, options to purchase 600,000
shares of the Company’s common stock at $9.00 per share. Options to purchase
200,000 shares of the Company’s common stock vested immediately upon grant and
the remaining options to purchase 400,000 shares will vest in two equal annual
installments over the 24-month period following the date of the
grant.




On
October 26, 2007, the Company also granted each of the Company’s four
independent director’s options to purchase 30,000 shares of the Company’s common
stock at $9.00 per share. Of the options granted to each of the directors,
options to purchase 15,000 shares of common stock vested immediately upon grant
and the remaining options to purchase 15,000 shares will vest in equal quarterly
installments over the one-year period following the date of the
grant.




Options
granted for 2007 were valued in accordance with SFAS 123R. The fair value of
each stock option is estimated on the date of grant during the year ended
December 31, 2007 using the Black-Scholes pricing model that uses the
assumptions noted in the following table:





Dividend
      yield
                  
                  
                  0.0
                  %Expected
      volatility
                  
                  
                  28.0
                  %Risk-free
      interest rate
                  
                  
                  3.8%
      - 4
                  %Expected
      term (in years)
                  
                  
                  1 -
      2Forfeiture
      rate
                  
                  
                  0.0
                  %Weighted
      average fair value of stock options granted
                  
                  $
                  0.86
      - 1.37




The
dividend yield is 0.0% since there is no history of paying dividends and the
Company currently does not have plan to do so. Because there was no public
market or trading history at the time of the grant in October 2007 and in
accordance with SFAS 123R, we computed the expected volatility based on the
average historical volatilities of entities in the similar industries and sizes.
The risk-free interest rate is the treasury-bill rate for the period equal to
the expected term based on the Treasury note strip principal rates as reported
in the website of U.S Department of Treasury. The expected term is the average
of the contractual term of the option and the vesting period. Forfeiture rate is
determined based on the expected turnover rate of officers and directors whom
granted stock options during the year.





F-18





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




A summary
of stock option activity and related information for the year ended December 31,
2007 is as follows:





Shares
                                      
                                      Weighted
                                        average
                                        exercise
      price
                                      
                                      Weighted
                                        average
                                        remaining
                                        contractual
      life
                                        (in
      years)
                                      
                                      Aggregate
                                        Intrinsic
      ValueOutstanding
      at beginning of year
                                      
                                      —
                                      
                                      
                                      —Granted
                                      
                                      1,320,000
                                      
                                      $
                                      9.00
                                      
                                      7.49Forfeited
      or Expired
                                      
                                      —
                                      
                                      
                                      —
                                      
                                      —Exercised
                                      
                                      —
                                      
                                      
                                      —
                                      
                                      —Outstanding
      at year-end
                                      
                                      1,320,000
                                      
                                      $
                                      9.00
                                      
                                      7.49
                                      
                                      $
                                      —Option
      exercisable at year-end
                                      
                                      460,000
                                      
                                      $
                                      9.00
                                      
                                      7.49
                                      
                                      $
                                      —




A summary
of the status of the Company’s nonvested shares as of December 31, 2007 and
changes during the year ended December 31, 2007, is presented as
below:





Non-vested shares
                                
                                Shares
                                
                                
                                Weighted-
                                  average grant-
                                  date fair valueNon-vested
      at beginning of year
                                
                                
                                —
                                
                                
                                
                                —Granted
                                
                                
                                1,320,000
                                
                                
                                $
                                1.33Vested
                                
                                
                                (460,000
                                )
                                
                                
                                1.33Forfeited
                                
                                
                                —
                                
                                
                                
                                —Non-vested
      at end-year
                                
                                
                                860,000
                                
                                
                                $
                                $1.33




For the
year ended December 31, 2007, approximately $702,000, representing the
total fair value of shares vested was recognized as stock-based compensation
expense under SFAS 123(R). As of December 31, 2007, there was
approximately $1.1 million of total unrecognized compensation cost related to
nonvested share-based compensation arrangements granted under the Plan. The cost
is expected to be recognized over a weighted-average period of 1.2
years.




(c)
Stock Purchase Warrants




In
accordance with the Visitalk Plan, the Company issued six series of common stock
purchase warrants allowing holders to purchase additional shares of common stock
(“Plan Warrants”). Each Plan Warrant provides for the purchase of one share of
common stock and is callable by the Company for a price of $.0001 per warrant at
any time. The Plan Warrants are governed by a Warrant Agreement. Currently, the
Company is acting as the Warrant Agent but has the right to appoint an
alternative Warrant Agent in accordance with the Visitalk Plan. The board of
directors can extend the expiration date of the Plan Warrants or reduce the
exercise price of any warrant on a temporary or permanent basis. The Company has
actually issued 4,014,801 Plan Warrants in each series to 240 claimants under
the Visitalk Plan. In connection with the execution of the Share Exchange
Agreement on November 20, 2006 referred to in Note (1), four series of the Plan
Warrants (series A, B, D and F) were called and expired. In substance, three of
Visitalk Plan’s warrants were exchanged for each of the Company’s warrants. As
of December 31, 2006, a total of 9,968,628 series C and series E warrants
remained outstanding.




In May
2007, the Company delivered a notice of redemption to the warrant holders
pursuant to the terms of the Warrant Agreement and the Visitalk Plan. Upon
expiration of the call period on June 8, 2007, series C warrants had been
exercised for 578,177 shares of the Company’s common stock, for total gross
proceeds from conversion of $2,931,360. The remaining unexercised warrants were
redeemed at $0.0001 per share by the Company. No warrants remained outstanding
after the closing of the call.





F-19





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




The
Company issued a total of 578,177 shares of common stock to existing warrant
holders upon the exercise of warrants under the registration exemption offered
under Section 1145(a)(1) of the United States Bankruptcy Code, as
amended.




A summary
of the Plan Warrants is as follows:





A
      & B
                            Warrants
                          
                          
                          C
      & D
                            Warrants
                          
                          
                          E
      & F
                            WarrantsWarrants outstanding,
      December 31,
      2005
                          
                          
                          9,968,628
                          
                          
                          
                          9,968,628
                          
                          
                          
                          9,968,628Granted
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Exercised
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Expired
      or Forfeited
                          
                          
                          (9,968,628
                          )
                          
                          
                          (4,984,314
                          )
                          
                          
                          (4,984,314
                          )Warrants outstanding,
      December 31,
      2006
                          
                          
                          —
                          
                          
                          
                          4,984,314
                          
                          
                          
                          4,984,314Granted
      (unaudited)
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Exercised
      (unaudited)
                          
                          
                          —
                          
                          
                          
                          (578,177
                          )
                          
                          
                          —Expired or Forfeited or
      redeemed (unaudited)
                          
                          
                          —
                          
                          
                          
                          (4,406,137
                          )
                          
                          
                          (4,984,314
                          )Warrants outstanding,December 31,
      2007
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          —Exercise
      Price
                          
                          
                          N/A
                          
                          
                          $
                          5.07
                          
                          
                          $
                          6.76Expiration
      Date
                          
                          
                          N/A
                          
                          
                          August
      31, 2007
                          
                          
                          August
      31, 2007




(d) Dividend
Payment Restrictions




Substantially
all of our retained earnings as well as net assets are attributable to the PRC
wholly subsidiary, Shenzhen Fuqi. Payment of dividends by Shenzhen Fuqi is not
permitted and restricted by the Maximum Banking Facility Agreement executed with
Agricultural Bank as disclosed in Note 6.




(9)
Income Taxes:




The
Company adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income
Taxes—an Interpretation of FASB Statement No. 109,or FIN 48, on January
1, 2007. This interpretation requires companies to determine whether it is more
likely than not that a tax position will be sustained upon examination by the
appropriate taxing authorities before any part of the benefit can be recorded in
the financial statements.




Management,
in conjunction with input from its U.S. and Chinese tax advisors, has performed
an analysis of its tax positions, in accordance with FIN 48, and has determined
that the Company has no material uncertain tax positions which are less than
more-likely-than-not of being sustained for the full amount claimed, or to be
claimed, on its applicable tax returns for the year ended December 31,
2007.




The
Company reversed the estimated interest and penalties payable related to
unreported design fees as non-operating income related to the unreported design
fee income prior to December 31, 2006. As of December 31, 2007, all the income
has been fully reported to the tax department and all the prior unreported
revenues have been settled.





F-20





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




The
Company’s income tax provision amounted to $2,097,050, $995,462, and $452,538,
respectively, for the years ended December 31, 2007, 2006, and 2005 (an
effective rate of 13.4% for 2007, 14.7% for 2006, and 7.8% for 2005). A
reconciliation of the provision for income taxes, with amounts determined by
applying the statutory U.S. federal income tax rate to income before income
taxes, is as follows:




Year
      Ended December 31,2007
                          
                          
                          2006
                          
                          
                          2005Computed
      tax at federal statutory rate of 34%
                          
                          $
                          5,308,408
                          
                          
                          $
                          2,308,496
                          
                          
                          $
                          1,979,589Tax
      rate difference between US and PRC on foreign earnings
                          
                          
                          (3,305,659
                          )
                          
                          
                          (1,290,042
                          )
                          
                          
                          (1,106,241
                          )Effect
      of tax holidays for new business
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          (436,613
                          )Effect
      of statutory rate change
                          
                          
                          (13,751
                          )
                          
                          
                          (22,992
                          )
                          
                          
                          —Additional
      tax liabilities based on tax notice
                          
                          
                          —
                          
                          
                          
                          —
                          
                          
                          
                          15,803Exemption
      of business tax liabilities and estimated penalty payable
                          
                          
                          (456,867
                          )
                          
                          
                          —
                          
                          
                          
                          —Other
                          
                          
                          (112,893
                          )
                          
                          
                          —
                          
                          
                          
                          —Change
      in Valuation Allowance
                          
                          
                          677,812
                          
                          
                          
                          —
                          
                          
                          
                          —$
                          2,097,050
                          
                          
                          $
                          995,462
                          
                          
                          $
                          452,538





Year
      Ended December 31,2007
                        
                        2006
                        
                        2005Current
                        
                        $
                        2,147,254
                        
                        
                        $
                        1,001,782
                        
                        
                        $
                        451,427Deferred
                        
                        
                        (50,204
                        )
                        
                        
                        (6,320
                        )
                        
                        
                        1,111$
                        2,097,050
                        
                        
                        $
                        995,462
                        
                        
                        $
                        452,538





Year
      Ended December 31,2007
                        
                        2006
                        
                        2005Federal
                        
                        $
                        800
                        
                        
                        $
                        —
                        
                        
                        $
                        —Foreign
                        
                        
                        2,096,250
                        
                        
                        
                        995,462
                        
                        
                        
                        452,538$
                        2,097,050
                        
                        
                        $
                        995,462
                        
                        
                        $
                        452,538




The
regular federal income tax in Shenzhen, China, is 15%. As a new business, the
Company was exempted from paying any income taxes for the first two years of its
operations (2 years from the inception of the business, years ended December 31,
2001 and 2002), and enjoyed a discounted income tax rate of 7.5% of pretax
income during the third, fourth and fifth years of its operations (the three
years ended December 31, 2003, 2004 and 2005). Beginning January 1, 2006, the
Company became subject to the regular rate of 15% on its pretax
income.




The
Company did not report certain cash revenues related to fees charged to its
customers for product design. Such fee revenues are subject to business tax and
service charges in China at an aggregate rate of 5.2%. The Company has not
reported such revenues since the inception of its operations in 2001. The
Company has recorded in its consolidated financial statements the tax
liabilities representing business tax and fees of 5.2% and income tax on the
unreported design revenues since the inception of its business in 2001. During
the years ended December 31, 2006, 2005, and 2004, the Company recorded
$312,002, $302,409, and $234,261, respectively, for business tax and fees and
$900,118, $393,806, and $337,877, respectively, for income tax related to these
revenues. In addition, per advice of a registered tax agent in China in 2004,
the Company accrued 100% of the unpaid tax amounts as the maximum penalties
which could be assessed by the local tax department through the periods ended
December 31, 2004.





F-21





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




In April
2006, the Shenzhen local tax department made an assessment of the total tax
liabilities related to the cash revenues. Per the tax assessment notice dated
April 24, 2006, the Company is obligated to pay a total of $1,754,802
(RMB14,161,249) including business tax, fees and income taxes related to these
cash revenues through December 31, 2005. If the Company did not pay off these
tax liabilities by April 30, 2006, the Company would be subject to 0.05% per day
of interest and penalties of the unpaid tax and fee liability amount from the
due date (April 30, 2006).




On April
28, 2006, the Company filed an extension to remit these outstanding tax
liabilities to December 20, 2006 and was approved by the tax department in July
2006.




On
December 28, 2006, the Shenzhen local tax department granted a further extension
to the Company to remit the tax liabilities from December 20, 2006 to April 25,
2007. The Company would not be subject to any penalties and interest if all the
outstanding taxes are remitted to the Tax Department prior to the revised due
date on April 25, 2007.




On April
25, 2007, the Company appointed its registered tax agent to apply on behalf of
the Company for a special reduction or exemption for the unpaid tax liabilities
for the period from inception to December 31, 2006. On May 14, 2007, the Company
received a notice from the Shenzhen local tax department to accept the Company’s
application for a tax reduction or exemption and was granted an additional
period to remit its outstanding tax liabilities until August 9, 2007. The tax
department agreed not to assess any interest and penalties during this review
process until August 9, 2007. Accordingly, the Company did not accrue any
interest and penalties related to these outstanding tax liabilities in the
accompanying condensed consolidated financial statements.




On August
10, 2007, the Company received a notice from the tax department conditionally
agreeing to exempt the Company’s tax liabilities in the amount of approximately
$3 million on unreported design fee income for the period from the inception of
the Company’s operations in 2001 to December 31, 2006, provided that the
Company’s common stock is successfully listed on a major overseas stock exchange
within 180 days from the date of the tax notice. Due to such condition being
fulfilled in October 2007 and acknowledged by the Shenzhen tax department in
November 2007, the accrued business and income tax liabilities, and the accrued
estimated and penalties totaling $4.2 million was fully reversed and recorded as
non-operating income in the consolidated statement of income for the year ended
December 31, 2007.




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:





Year
      Ended December 31,2007
                              
                              
                              2006Deferred
      tax assets:Allowance
      for doubtful accounts
                              
                              $
                              84,582
                              
                              
                              $
                              29,198Net
      operating loss
                              
                              
                              419,823
                              
                              
                              
                              —Stock-based
      payment
                              
                              
                              300,675
                              
                              
                              
                              —Other
                              
                              
                              6,892
                              
                              
                              
                              —Total
      deferred tax assets
                              
                              
                              811,972
                              
                              
                              
                              29,198Deferred
      tax liabilitiesState
      deferred taxes
                              
                              
                              (49,577
                              )
                              
                              
                              —Other
                              
                              
                              (5,181
                              )Total
      deferred tax liabilities
                              
                              
                              (54,758
                              )
                              
                              
                              —Net
      deferred tax assets before valuation allowance:
                              
                              
                              757,214
                              
                              
                              
                              29,198Valuation
      allowance
                              
                              
                              (677,812
                              )
                              
                              
                              —$
                              79,402
                              
                              
                              $
                              29,198




F-22





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




The
Company has established a valuation allowance against its net deferred tax
assets, due to uncertainty regarding their future realization. In assessing the
realizability of its deferred tax assets, management considers the scheduled
reversal of deferred tax liabilities, projected future taxable income, and tax
planning strategies. Based on the projections for future taxable income over the
periods in which the deferred tax assets are realizable and the full utilization
of the Company’s loss carryback potential, management concluded that a full
valuation allowance on the deferred tax assets and liabilities of the Company’s
US holding entity since the Company does not expect any net profits generated
from this entity in the near future.




Realization
of deferred tax assets is dependent on future earnings, if any, the timing and
amount of which is uncertain.





The
Company intends to permanently reinvest the earnings of its foreign
subsidiaries, as such no deferred taxes have been provided on such amounts under
APB 23.




At
December 31, 2007, the Company has available unused net operating losses
carryforwards of $975,000 related to loss incurred after the reverse merger with
Fuqi BVI in November 2006 that may be applied against future taxable income and
will begin to expire in 2028 for federal and 2013 for California. Section 382 of
the Internal Revenue Code limits the use of net operating loss and tax credit
carryforwards in certain situations where changes occur in the stock ownership
of a company. In the event such ownership changes of the Company have occurred,
the utilization of the carryforwards could be restricted.




Section
382 of the Internal Revenue Code limits the use of net operating loss and tax
credit carryforwards in certain situations where changes occur in the stock
ownership of a company. In the event such ownership changes of the Company have
occurred, the utilization of the carryforwards could be restricted.





The
Company recorded the interest on underpayment of income taxes as interest
expense under Other Income (Expenses) and estimated penalties on underpayment of
income taxes as penalty expenses under General and Administrative Expenses in
the consolidated statements of Income and Comprehensive Income.  No
interest or penalties were accrued for the years ended December 31, 2007, 2006
or 2005.  The estimated penalties payable of $1,119,201 on the balance
sheet as of December 31, 2006 were accrued for the periods up to December 31,
2004.  As disclosed in the previous paragraph, in April 2006, the
Shenzhen local tax department made the determination not to impose any penalties
on the unpiad taxes.  Accordingly, the Company did not accrue
additional penalties for the year ended December 31, 2005 and all the subsequent
years.  The estimated penalties payable were derecognized in October
2007 when the condition set forth by the Shenzhen local tax department was
fulfilled and the assessment and settlement became final.





The
Company files U.S. and foreign income tax returns in jurisdictions with varying
statutes of limitations. The fiscal 2002 through 2007 tax years generally remain
subject to examination by federal and foreign tax
authorities.





The
Company made investments in its foreign subsidiaries.  The amount of
the unrecognized deferred tax liability for temporary differences related to
investments in foreign subsidiaries that are essentially permanent in duration
cannot be practically determined.





(10)
Commitments:




Employment
Agreements




In
October 2007, the Company entered into three-year employment contracts with the
Company’s five executive officers each of which includes a fixed amount of
annual salary and stock options to purchase the Company’s common stock. Details
of each executive officer are summarized as follows:




·
              Yu Kwai Chong, our Chief
      Executive Officer, receives an annual salary of $200,000 and an automobile
      allowance of approximately $52,000 as well as stock options to be granted
      on an annual basis to acquire shares of the common stock with a market
      value of 2% of our annual profit, approximately, before tax, not exceeding
      $200,000. The stock options have a life of 10 years and its exercise price
      shall be equal to 110% of the fair market value of our common stock on the
      date of the grant.
 
 ·
              Ching Wan Wong, our Chief
      Financial Officer, receives an annual salary of $160,000 and is granted,
      on the effective date of the employment agreement, stock options with
      three-year terms to acquire 600,000 shares of common stock at a per share
      exercise price of $9.00.
 
 ·
              Each of Lie Xi Zhang, our Chief
      Operating Officer, and Xi Zhou Zhuo, our Marketing Director, receives an
      annual salary of $120,000 and stock options to be granted on an annual
      basis to acquire shares of common stock with a market value of 1% of our
      annual profit before tax, not exceeding $120,000. The stock options have a
      life of 10 years and its exercise price shall be equal to 100% of the fair
      market value of our common stock on the date of the
      grant.
  F-23
  ·
              Heung Sang Fong, our Vice
      President of Corporate Development, receives an annual salary of $120,000
      and stock options with three-year terms to acquire 600,000 shares of
      common stock at $9.00.




Pursuant
to the employment contracts, either the Company or employee can terminate the
employment with 60 to 90 days advance notice.




Facility Operating
Leases




The
Company leases certain facilities under various long-term noncancellable and
month-to-month leases. These leases are accounted for as operating leases. Rent
expense amounted to $171,160, $158,399, and $98,715 for the years ended 2007,
2006 and 2005, respectively.





F-24





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




A summary
of the future minimum annual rental commitments under the operating leases is as
follows:





Year
      Ending December 31,2008
                    
                    $
                    140,5712009
                    
                    
                    130,4102010
                    
                    
                    61,6052011
      or after
                    
                    
                    -$
                    332,586




(11)
Subsequent Events:




Effective
January 1, 2008, the National People’s Congress of China enacted a new PRC
Enterprise Income Tax Law, under which foreign invested enterprises and domestic
companies will be subject to enterprise income tax at a uniform rate of 25%.
During the transition period for enterprises established before March 16, the
tax rate will be gradually increased to coincide with the new tax rate within 5
years starting from 2008 and reaching the uniform rate of 25% in
2012.




On
January 17, 2008, the Company signed a Term Sheet with Mr. Chujian Huang,
pursuant to which the Company will acquire 100% operating interest of two
jewelry companies, Shanghai Tian Mei Jewelry Co. Ltd. and Beijing Yinzhong Tian
Mei Jewelry Co. Ltd., collectively known as Temix. Total purchase price for
Temix is approximately RMB 135 million (approximately USD$18.5 million, based on
a conversion rate of 1 USD to 7.3RMB). $9.5 million of the purchase price will
be paid in cash while the remaining price will be paid in restricted common
stock. The number of the Company’s shares to be issued as part of this purchase
price is subject to the achievement of certain revenue and net income
performance targets over a three year period.





F-25





FUQI
INTERNATIONAL, INC.


NOTES
TO CONSOLIDATED FINANCIAL STATEMENTS




SCHEDULE
II




FUQI
INTERNATIONAL, INC.


Valuation
and Qualifying Accounts and Reserves


Years
Ended December 31, 2007, 2006 and 2005





Balance
      at the
                        Beginning of
                        the
      Year
                      
                      Provision
      for
                        bad
      debts
                      
                      Write
      off and
                        other
                        deductions
                      
                      Balance
      at the
                        End of
      the YearAllowance
      for Doubtful Accounts:Year
      ended December 31, 2005
                      
                      
                      $
                      287,000
                      
                      
                      $
                      15,000
                      
                      
                      $
                      —
                      
                      
                      $
                      302,000Year
      ended December 31, 2006
                      
                      
                      
                      302,000
                      
                      
                      
                      —
                      
                      
                      
                      (107,000
                      )
                      
                      
                      195,000Year
      ended December 31, 2007
                      
                      
                      
                      195,000
                      
                      
                      
                      275,000
                      
                      
                      
                      —
                      
                      
                      
                      470,000





F-26