U.S. SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 20-F

[  ] REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2006

OR

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     

Commission file number 0-29620

OR

[  ] SHELL COMPANY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Date of event requiring this shell company report                     

LJ INTERNATIONAL INC.
(Exact name of Registrant as specified in its charter)

LJ INTERNATIONAL INC.
(Translation of Registrant’s name into English)

British Virgin Islands
(Jurisdiction of incorporation or organization)

Unit #12, 12/F, Block A
Focal Industrial Centre
21 Man Lok Street
Hung Hom, Kowloon, Hong Kong
(Address of principal executive offices)

Securities registered or to be registered pursuant to Section 12(b) of the Act.

Title of each		Name of each exchange
class		on which registered
$.01 Par Value Common Stock		NASDAQ
(“Common Stock”)

Securities registered or to be registered pursuant to Section 12(g) of the Act.

None

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act.

None

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report:

18,977,371 Shares of Common Stock as of December 31, 2006

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

     Yes             No X

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

     Yes             No X

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 X       No      

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act.

     Large accelerated filer            Accelerated filer            Non-accelerated filer X

Indicate by check mark which financial statement item the registrant has elected to follow.

     Item 17            Item 18 X

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

     Yes             No X

(APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PAST FIVE YEARS)

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.

     Not Applicable.

SPECIAL NOTE REGARDING
FORWARD-LOOKING STATEMENTS

     This annual report contains forward-looking statements that involve risks and uncertainties. These include statements about our expectations, plans, objectives, assumptions or future events. In some cases, you can identify forward-looking statements by terminology such as “anticipate,” “estimate,” “plans,” “potential,” “projects,” “continuing,” “ongoing,” “expects,” “management believes,” “we believe,” “we intend” and similar expressions. These statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed for the reasons described in this annual report. You should not place undue reliance on these forward-looking statements.

     You should be aware that our actual results could differ materially from those contained in the forward-looking statements due to a number of factors, such as but not limited to:

	•		dependence upon certain customers
	•		dependence on key personnel
	•		control by principal shareholder
	•		competitive factors
	•		the operation of our business
	•		general economic conditions

     You should also consider carefully the statements under “Risk Factors” and other sections of this annual report, which address additional factors that could cause our actual results to differ from those set forth in the forward-looking statements and could materially and adversely affect our business, operating results and financial condition. All subsequent written and oral forward-looking statements attributable to us or persons acting on our behalf are expressly qualified in their entirety by the applicable cautionary statements.

     The forward-looking statements speak only as of the date on which they are made, and, except to the extent required by federal securities laws, we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.

     We may use data and industry forecasts in this annual report which we have obtained from internal surveys, market research, publicly available information and industry publications. Industry publications generally state that the information they provide has been obtained from sources believed to be reliable but that the accuracy and completeness of such information is not guaranteed. Similarly, we believe that the surveys and market research we or others have performed are reliable, but we have not independently verified this information.

PART I

ITEM 1.          IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

     Not applicable.

ITEM 2.          OFFER STATISTICS AND EXPECTED TIMETABLE

     Not applicable.

ITEM 3.          KEY INFORMATION

A. SELECTED FINANCIAL DATA.

SELECTED CONSOLIDATED FINANCIAL DATA
(US Dollars in thousands, except per share amounts)

     The following selected consolidated financial data with respect to eight months ended December 31, 2002 and the four-year period ended December 31, 2006 have been derived from our audited consolidated financial statements. The following selected consolidated financial data should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the Consolidated Financial Statements and Notes included elsewhere in this annual report.

Selected Financial Data

																				Eight-month period									Year
		Years ended																	ended									ended
		December 31,																	December 31,									April 30,
			2006				2005				2004				2003					2002				2001					2002
																								(Unaudited)
Statement of Operations Data:
Revenues				123,791				99,646				77,504				58,330					31,966				25,135					39,375
Cost of Goods sold				(88,867	)			(77,127	)			(61,265	)			(44,947	)				(20,565	)			(16,228	)				(35,731	)
Gross profit				34,924				22,519				16,239				13,383					11,401				8,907					3,644
Operating expenses
Selling, general and administrative				(23,114	)			(15,488	)			(11,578	)			(9,133	)				(8,688	)			(8,279	)				(8,963	)
Net gain (loss) on derivatives				(29	)			8				199				87					(435	)			(119	)				(660	)
Depreciation				(2,039	)			(1,368	)			(1,032	)			(1,184	)				(863	)			(565	)				(1,031	)
Impairment on property, plant and equipment				-				-				-				(84	)				(108	)			-					(345	)
Amortization and impairment loss on goodwill				-				-				(698	)			(200	)				(600	)			(18	)				(242	)
Operating income (loss)				9,742				5,671				3,130				2,869					707				(74	)				(7,597	)
Other income and expenses
Interest income				282				139				38				41					48				172					217
Interest expenses				(3,258	)			(1,991	)			(902	)			(753	)				(441	)			(424	)				(652	)
Operating income (loss) before income taxes, minority interests, equity in results of investment securities and extraordinary item				6,766				3,819				2,266				2,157					314				(326	)				(8,032	)
Income taxes (expense) credit				(1,403	)			(739	)			(277	)			(352	)				(101	)			(39	)				101
Income (Loss) before minority interests, equity in results of investment securities and extraordinary item				5,363				3,080				1,989				1,805					213				(365	)				(7,931	)
Minority interests in consolidated subsidiaries				(38	)			(20	)			-				8					120				-					30
Income before equity in results of investment securities and extraordinary item				5,325				3,060				1,989				1,813					333				(365	)				(7,901	)
Equity in results of investment securities				-				-				133				(851	)				16				26					34
Income before extraordinary item				5,325				3,060				2,122				962					349				(339	)				(7,867	)
Extraordinary gain on negative goodwill				-				1,291				-				-					-				-
Net income (loss)				5,325				4,351				2,122				962					349				(339	)				(7,867	)
Net income (loss) per share:
Basic				0.31				0.32				0.19				0.11					0.04				(0.04	)				(0.91	)
Diluted				0.29				0.30				0.18				0.10					0.04				(0.04	)				(0.90	)
Weighted average number of shares
Basic				17,390				13,439				11,119				8,757					8,493				8,672					8,672
Diluted				18,303				14,322				12,107				9,706					8,493				8,832					8,779
Balance Sheet Data:
Working capital				50,134				35,554				23,617				17,053					11,896				18,537					12,115
Total assets				124,522				108,230				73,673				59,885					48,938				51,088					43,557
Long-term obligation				1,640				43				58				77					-				12					8
Total stockholders’ equity				59,739				45,008				32,790				27,101					23,344				30,969					23,591

Pursuant to the purchase agreement dated January 1, 2005, the Company paid $2,827,500 for new issuance of 3,900 shares of common stock of Goldleaves International Limited (GIL), in which the Company had 20% equity interests and was classified as investment security as of December 31, 2004. The Company then became the major stockholder holding 98% equity interests in GIL, which became a subsidiary of the Company. As of December 31, 2004, this investment was accounted for using the cost method. As appropriate for a step-acquisition, in the 2005 financial statements, the investment has been restated to account for under the equity method.

B.		CAPITALIZATION AND INDEBTEDNESS.
		Not applicable.
C.		REASONS FOR THE OFFER AND USE OF PROCEEDS.
		Not applicable.

D.

RISK FACTORS.

We depend upon one customer who accounts for at least 10% of our sales. We cannot be certain that these sales will continue; if they do not, our revenues will likely decline.

     Although we sell to a large number of customers in a variety of markets, one of our customers accounts for at least 10% of our sales. For the fiscal years ended December 31, 2005 and 2006, this customer accounted for approximately 11% of our 2005 sales and 10% of our 2006 sales. This customer is a non-affiliated third party and is not a related party of the Company or any of its subsidiaries. Although we have maintained good and longstanding relationship with this customer, we do not have any long-term contract with it and it orders only on a “purchase order” basis. The loss of this customer or a significant reduction in its orders would have a materially adverse effect on our revenues.

We face significant competition from larger competitors in our wholesale and retail operations.

     The making and distribution of jewelry is a highly competitive industry characterized by the diversity and sophistication of the product. We compete with major domestic and international companies with substantially greater financial, technical and marketing resources and personnel than us. There can be no assurance other jewelry makers will not similarly develop low-cost, high-volume production capability or an even better process, providing greater competition for us and materially affecting our business prospects.

There are numerous factors relating to the operations of our business that could adversely affect our success and results.

     As a maker and merchandiser of low-cost, high-quality gem-set jewelry, our existing and future operations are and will be influenced by several factors, including:

	•		technological developments in the mass production of jewelry;
	•		our ability to meet the design and production requirements of our customers efficiently;
	•		the market acceptance of our and our customers’ jewelry;
	•		increases in expenses associated with continued sales growth;
	•		our ability to control costs;
	•		our management’s ability to evaluate the public’s taste and new orders to target satisfactory profit margins;
	•		our capacity to develop and manage the introduction of new designed products; and
	•		our ability to compete.

     Quality control is also essential to our operations since customers demand compliance with design and product specifications and consistency of production. We cannot assure that revenue growth will occur on a quarterly or annual basis.

Our production facilities are located in China. Our results of operations and financial condition may, therefore, be influenced by the economic, political, legal and social conditions in China.

     Since 1978, the Chinese government has been reforming, and is expected to continue to reform, China’s economic and political systems. Such reforms have resulted in significant social progress. Other political, economic and social factors could also lead to further readjustment of the reform measures. This refinement and readjustment process may not always have a positive effect on our operations in China. At times, we may also be adversely affected by changes in policies of the Chinese government such as changes in laws and regulations or their interpretation, the introduction of additional measures to control inflation, changes in the rate or method of taxation and imposition of additional restrictions on currency conversion and remittances abroad.

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

     The National People’s Congress, the Chinese legislature, on March 16, 2007 passed a new enterprise income tax law, which will become effective on January 1, 2008. The new law applies a uniform 25% enterprise income tax rate (“EIT”) to both foreign invested enterprises and domestic enterprises, except that enterprises that were approved to be established prior to March 16, 2007 may continue to enjoy the existing preferential tax treatments until December 31, 2012. An enterprise registered under the laws of a jurisdiction outside China may be deemed a Chinese tax resident if its place of effective management is in China and it will consequently be subject to the EIT upon its worldwide income. Existing companies are required to transition to the new EIT rate over a five-year period starting January 1, 2008. The new Enterprise Income Tax Law empowers the PRC State Council to promulgate detailed implementation rules. Since the implementation rules are not yet promulgated, there is uncertainty as to how the new law will be interpreted or implemented. Although we are carefully monitoring these legal developments and will timely adjust our effective income tax rate when necessary, we cannot assure that the new Enterprise Income Tax Law will not cause increases in the EIT rates applicable to our PRC subsidiaries, which could have a material adverse effect on our financial condition and results of operations.

Our products are currently made at our production facility located in Shenzhen, China. However, our insurance may not adequately cover any losses due to fire, casualty or theft.

     We have obtained fire, casualty and theft insurance aggregating approximately $42 million, covering several of our stock in trade, goods and merchandise, furniture and equipment and production facility in China. The proceeds of such insurance may not be sufficient to cover material damage to, or the loss of, our production facility due to fire, severe weather, flood or other cause, and such damage or loss would have a material adverse effect on our financial condition, business and prospects. Consistent with the customary practice among enterprises in China and due to the cost in relation to the benefit, we do not carry any business interruption insurance in China.

Sales of our jewelry to retailers are generally stronger during the quarter ending December 31 of each year due to the importance of the holiday selling season.

     The approximately 28% of our wholesale sales during the fiscal year ended December 31, 2006 to our TV shopping channel customers was not seasonal in nature. It has been our management’s experience that the remaining 72% of our total wholesale sales is seasonally sensitive and is greater during the quarter ending December 31 of each year.

The success of our retail store expansion program in China is dependent upon numerous factors over which we have limited control.

     The future success of our ENZO retail stores in China is partially dependent upon general economic conditions in China, competitive developments within the retail jewelry sector in China and consumer attitudes, including changes in consumer preferences for certain jewelry styles and materials. In addition, our retail expansion program is also dependent upon a number of factors relating to our stores, including the availability of property, the location of the mall or shopping centre, the availability of desirable locations within a mall, the terms of leases, our relationship with major landlords, and the design and maintenance of our stores.

We rely on short-term financing from banks for our daily operation.

     We rely on short-term borrowings as part of our financing needs. If we fail to achieve timely rollover, extension or refinancing of our short-term debt, we may be unable to meet our obligations in connection with debt service, accounts payable and/or other liabilities when they become due and payable. In addition, we may be exposed to changes in interest rates. If interest rates increase substantially, our results of operations could be adversely affected.

     Certain of our banking facilities that offer short-term borrowings are collateralized by properties owned by Yu Chuan Yih and by his personal guarantee. If Mr. Yih withdraws the properties or his personal guarantee, the banking facilities may no longer remain available for use by us. In that event, our daily operations may be adversely affected.

We rely geographically on the US market for the majority of our revenue.

     Our wholesale business is our major revenue contributor and accounts for 88% of our total revenue. Geographically, North America is a major market for our wholesale business and contributes 71% of our revenues. Accordingly, the revenue of our wholesale business in the US market accounts for 62% of our total revenue. Any substantial decline of the economy may adversely affect the spending patterns of the US consumers which could in turn adversely affect our revenue and the income from the region.

Our holding company structure creates restrictions on the payment of dividends.

     We have no direct business operations, other than the ownership of our subsidiaries, of which we have control over their operation policies including, among others, payment of dividend. While we have no current intention of paying dividends, should we, as a holding company, decide in the future to do so, our ability to pay dividends and meet other obligations depends upon the receipt of dividends or other payments from our operating subsidiaries and other holdings and investments. In addition, our operating subsidiaries are subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants and minimum net worth requirements in loan agreements, restrictions on the conversion of local currency into US dollars or other hard currency and other regulatory restrictions.

As a “foreign private issuer”, we are not subject to certain rules promulgated by Nasdaq that other Nasdaq-listed issuers are required to comply with.

     Our common shares are currently listed on the Nasdaq Global Market and, for so long as our securities continue to be listed, we will remain subject to the rules and regulations established by Nasdaq applicable to listed companies. As permitted under Nasdaq rules applicable to foreign private issuers, we have determined not to comply with the following Nasdaq rules:

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

We may in the future determine to voluntarily comply with one or more of the foregoing provisions.

It may be difficult to serve us with legal process or enforce judgments against us or our management.

     We are a British Virgin Islands holding company, and substantially all of our assets are located in China and Hong Kong. In addition, all but one of our directors and officers are non-residents of the United States, and all or substantial portions of the assets of such non-residents are located outside the United States. As a result, it may not be possible to effect service of process within the United States upon such persons. Moreover, there is doubt as to whether the courts of the British Virgin Islands, China or Hong Kong would enforce:

	•		judgments of United States courts against us, our directors or our officers based on the civil liability provisions of the securities laws of the United States or any state; or
	•		in original actions brought in the British Virgin Islands, China or Hong Kong, liabilities against us or non-residents based upon the securities laws of the United States or any state.

Some information about us may be unavailable due to exemptions under the Exchange Act for a foreign private issuer.

     We are a foreign private issuer within the meaning of the rules under the Exchange Act. As such, we are exempt from certain provisions applicable to United States domestic public companies, including:

	•		the rules under the Exchange Act requiring the filing with the Securities and Exchange Commission of quarterly reports on Form 10-Q or current reports on Form 8-K;
	•		the provisions of Regulation FD aimed at preventing issuers from making selective disclosures of material information;
	•		the sections of the Exchange Act regulating the solicitation of proxies, consents or authorizations applicable to a security registered under the Exchange Act; and
	•		the sections of the Exchange Act requiring insiders to file public reports of their stock ownership and trading activities and establishing insider liability for profits realized from any “short-swing” trading transaction.

Because of these exemptions, investors are not provided with the same information which is generally available about domestic public companies organized in the United States.

Since we are a British Virgin Islands company, the rights of our shareholders may be more limited than those of shareholders of a company organized in the United States.

     Under the laws of most jurisdictions in the United States, majority and controlling shareholders generally have certain fiduciary responsibilities to the minority shareholders. Shareholder action must be taken in good faith, and actions by controlling shareholders which are obviously unreasonable may be declared null and void. British Virgin Islands law protecting the interests of minority shareholders may not be as protective in all circumstances as the law protecting minority shareholders in US jurisdictions. In addition, the circumstances in which a shareholder of a BVI company may sue the company derivatively, and the procedures and defenses that may be available to the company, may result in the rights of shareholders of a BVI company being more limited than those of shareholders of a company organized in the US.

     Furthermore, our directors have the power to take certain actions without shareholder approval which would require shareholder approval under the laws of most US jurisdictions. The directors of a BVI corporation, subject in certain cases to court approval but without shareholder approval, may implement a reorganization, merger or consolidation, the sale of any assets, property, part of the business, or securities of the corporation. Our ability to amend our

Memorandum of Association and Articles of Association without shareholder approval could have the effect of delaying, deterring or preventing a change in our control without any further action by the shareholders, including a tender offer to purchase our common stock at a premium over then current market prices.

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

     Several lawsuits have been filed against us and current officers and members of the Board of Directors, alleging false representations and material omissions in connection with press releases, SEC filings and other statements that purportedly overstated the Company’s business prospects and financial results. These lawsuits are described more fully in Part I, Item 8 and in Part III, Item 18, Note 12 to our consolidated financial statements contained in this Form 20-F. Defending these lawsuits will result in significant expenditures and the diversion of our management’s time and attention from the operation of our business, which could have a negative effect on our business operations. From time to time, we may become involved in other litigation or other proceedings. Matters arising out of or related to the delayed filing of our audited financial statements, the outcome of our delisting proceedings and the outcome of litigation could possibly harm our future results of operations or financial condition due to expenses we may incur to defend ourselves or the ramifications of an adverse decision.

ITEM 4.         INFORMATION ON THE COMPANY

A.

HISTORY AND DEVELOPMENT OF THE COMPANY.

               LJ International Inc. (“we”) was incorporated as an international business company under the International Business Companies Act of the British Virgin Islands on January 30, 1997. As of December 31, 2006, we owned all of the issued share capital in the following significant subsidiaries except Goldleaves Gems (Shenzhen) Co., Ltd.:

	•		Lorenzo Jewelry Limited (“Lorenzo Jewelry”), a company incorporated in Hong Kong on February 20, 1987
	•		Lorenzo Jewellery (Shenzhen) Co., Ltd.
	•		Shenzhen PGS Jewelry Mfg.
	•		Lorenzo (Shenzhen) Co., Ltd. (“LSC”)
	•		Lorenzo Crystal Ltd.
	•		Enzo (Shenzhen) Co., Ltd. (“ESC”)
	•		Enzo Ltd.
	•		Goldleaves Gems (Shenzhen) Co., Ltd. (98% equity ownership)

              Due to the restrictions on foreign ownership on the retail business of jewelry, the Company, through loans to the agents, established ESC to carry out the retail business of jewelry in the PRC. Pursuant to various agreements entered into between the Company, its agents and ESC on July 14, 2005, the Company has control of ESC, absorbs the majority of any expected losses and receives the majority of residual return of ESC. The Company is, therefore, considered the primary beneficiary of ESC. Accordingly, ESC is consolidated in the financial statements of the Company since July 14, 2005.

              Our principal place of business and our executive office is located at Unit #12, 12/F, Block A, Focal Industrial Centre, 21 Man Lok Street, Hung Hom, Kowloon, Hong Kong, telephone: (011) 852-2764-3622. We have designated CT Corporation, 111 Eighth Avenue, New York, New York 10011 as our agent for service of process in the United States.

              During our last three fiscal years, we have made the following significant capital expenditures:

	•		we invested $670,000 for the purchase of 1,639 square meters of production space in our Shenzhen, China facility during the fiscal year ended December 31, 2005
	•		we acquired an additional 78% of the equity of Goldleaves International Limited for $2,827,500 during the fiscal year ended December 31, 2005
	•		we spent $1,105,000 on capital expenditures, excluding inventory, for ENZO retail store openings during the fiscal year ended December 31, 2006

B.

BUSINESS OVERVIEW.

     We are a vertically integrated company that designs, brands, markets, distributes and retails a complete range of fine jewelry. While we specialize in the colored jewelry segment, we also offer high-end pieces set in yellow gold, white gold, platinum or sterling silver and adorned with colored stones, diamonds, pearls and precious stones. We distribute to fine jewelers, department stores, national jewelry chains and electronic and specialty retailers throughout North America and Western Europe; and we conduct our jewelry retail business through the ENZO brand in the Asia Pacific region, with the primary focus in the PRC market, which we regard as having one of the largest and fastest growing consumer demands for luxury items. Our product lines incorporate all major categories sought by major retailers, including earrings, necklaces, pendants, rings and bracelets.

     We believe that our vertically integrated structure provides significant advantages over our competitors. All profits from value added processes are captured internally, rather than shared with third party manufacturers. This results in very competitive pricing for the retailer and enhanced profits for us. Innovative processes in stone cutting and production further enhance our competitive position.

     We employ an international design team and all of our designs and merchandising strategies are proprietary. The exclusive and innovative concepts that we create offer brand potential. Our primary marketing focus has been in North America where we have sold directly to certain high volume customers that need specialized product development services, and through a marketing relationship with International Jewelry Connection (“IJC”) for those customers that need higher levels of service and training.

     We organize our marketing and distribution strategies by retail distribution channels. Concepts are developed for the specific needs of different market segments. We have identified the following as prime retail targets:

	•		fine jewelers;
	•		national jewelry chains;
	•		department stores;
	•		TV shopping channels; and
	•		discount chain stores.

     For the years ended December 31, 2005 and 2006, approximately 72% and 62% of our sales were in North America.

     In addition to our “wholesale” line of business involving direct sales to retailers, we have expanded into the “retail sales” line of business involving direct sales to consumers in China through company-owned retail stores under the brand name ENZO. In March 2004, we opened our first retail store in Hong Kong and opened our flagship store in Shanghai in November 2004. As of December 10, 2007, we currently operate 88 ENZO retail stores across Hong Kong, China and Macau, and we expect to open and operate a total of at least 100 stores by the beginning of 2008.

     The following is a breakdown of our total revenues by geographic market for each of our past three financial years:

		Year ended December 31,
(in thousands)			2006				2005				2004
			US$				US$				US$
US & Canada			76,889				67,780				56,186
Europe and other countries			24,452				20,527				13,062
Japan			2,454				3,686				4,158
PRC (including Hong Kong and Macau)			19,996				7,653				4,098
			123,791				99,646				77,504

Our Industry

     The US jewelry industry is a highly fragmented $45 billion market, with no single entity having more than 6% market share. The industry consists primarily of three retail sectors:

	•		specialty retailers account for $27 billion in sales
	•		mass merchants and department stores account for $12 billion in sales
	•		direct avenues (television shopping, e-commerce, catalogs) account for $6 billion

     The US jewelry industry is comprised of two major groups that distribute finished jewelry to retailers in the United States:

	•		a small number of producers that make and distribute their own jewelry directly to retailers; and
	•		a large number of wholesalers and distributors who purchase products or portions of products from third parties and resell those items to retailers.

     We believe that vertically integrated companies that control costs by performing all value added processes enjoy a distinct competitive advantage over wholesalers and distributors who pay premium acquisition prices for items that they intend to resell. We further believe that large retailers want to rely upon prime producers because they believe that prime producers are reliable and low cost producers who can accommodate the large quantities of production that large retailers commonly purchase.

     The Chinese jewelry industry has experienced rapid development due to a series of major reforms, including the liberalization of China’s gold market, the lowering of tariff rates, and the decision of the Chinese Government to open up the retail sector to international companies.

     In addition, rising income levels coupled with the growing urban population in China has helped the jewelry market record double-digit growth annually. The continuing acceleration of the urbanization trend in China will likely result in improved income levels, thereby increasing private consumption. The Chinese Government has also encouraged consumer spending by instituting longer national holidays and increasing the salary of civil servants.

     Management believes that China is the largest consumer of platinum and jade in the world for the past three years, the largest consumer of diamonds in Asia, and the fourth largest consumer of gold in the world.

Our Business Strategy

     Our business strategy is to:

	•		increase our market share of moderately priced high-quality gem-set colored and precious jewelry by capitalizing on our vertically integrated production processes to produce diamond and high-end precious stone jewelry in addition to high volume, high-quality colored products;
	•		further develop our existing customer relationships with our specialized services; and
	•		expand aggressively into new distribution channels, particularly in the United States, China, Western Europe, Japan and Australia.

     We are aggressively developing new product lines in exotic stones, which have high perceived values among colored stones. We continue to expand into new product categories by:

	•		marketing a line of sterling silver jewelry. These are typically merchandised with a retail price range of $30 to $150;
	•		adding more lines into our “LORENZO” branded products with a retail price range of $199 to $999; and
	•		offering diamond jewelry and expanding this business to our current client base by adding diamonds to some of our settings, as well as offering newly designed jewelry.

Our China Retail Sales Strategy

     In 2004, we initiated a retail sales strategy aimed at gaining market share in the rapidly growing consumer market in China. We opened three ENZO stores, two in China (including a flagship store in Shanghai) and one in Hong Kong. We believe that China represents an excellent retail sales opportunity for several reasons:

•

significant retail market - China’s retail sales exceed $600 billion annually, making China the third largest market in the world.

	•		large and growing jewelry market - we estimate that China’s jewelry sales totaled nearly $17 billion in 2006, up 15% year over year.
	•		large pool of consumers - China has a population of 1.3 billion people. We estimate that roughly 160 million Chinese have enough income to purchase luxury goods.
	•		favorable regulatory changes - as a member of the World Trade Organization, China is eliminating many restrictions on foreign ownership and operation of retail stores. Tariffs on colored gemstones, gold, silver and pearls have been sharply reduced, and economic and trade relationships between China and Hong Kong have been liberalized.
	•		changing consumer preferences - Chinese consumers are no longer purchasing jewelry solely as an investment. More Chinese consumers are embracing a more Western view of jewelry as a fashion accessory and now demand more contemporary, colorful designs.

     We are expanding into China by means of Company-owned and -operated retail stores and supplier relationships with leading retailers, such as Carrefour.

     We intend to implement our business strategy by:

	•		expanding our retail jewelry market in China by planning to open at least 100 ENZO stores in China by the beginning of 2008
	•		promoting visits with customers to coordinate and cater to their particular promotional sales needs and monitoring their on-hand inventory in order to promote more active sell-through
	•		expanding our distribution channels to include all major TV shopping programs in North America, Japan, Korea and Australia and further developing business with top-40 Retail Jewelry Chains in the US.

Our Production Capability

     We have established a sophisticated facility in China that performs stone cutting and polishing and jewelry production. The facility is located in the city of Shenzhen in Guangdong Province, China. Our production facility in Shenzhen has been operating for eight years and has more than 14,000 square meters of production space. We currently employ approximately 3,000 skilled gemstone cutters and production personnel and turned out approximately two million pieces of finished fine jewelry during the fiscal year ended December 31, 2006.

     We purchase imported choice gemstone material, which are from mines located in Africa, China and South America, especially those concentrated in Brazil. We source our diamonds mainly from suppliers in India and Africa. Gemstone craftsmen are trained to ensure that the highest levels of cutting and polishing quality are achieved. The professional skills possessed by our cutters are applied to a wide variety of shapes and sizes, maximizing the yield and value of the gemstone material that we purchase. By performing internally the value-added processes of cutting and polishing our colored gemstones, we maximize quality control and improve our

profitability. We specialize in a wide range of popular and exotic colored gemstones ranging from amethyst, aquamarine and peridot to tanzanite and tourmaline.

Sales and Marketing

     Our merchandising strategy is to provide unique and differentiated products that are enhanced by the favorable pricing that results from our vertically integrated structure. We invest significant effort in design and model making to produce items which are distinctly different from those of our competitors. We continue to devote our efforts towards brand development and utilize marketing concepts to enhance the saleability of our products. We recognize that retailers favor certain price points. As part of our product development strategy, we strive to align our wholesale prices to match retailers’ target prices as a means of achieving these popular price targets.

     Our sales and marketing team is located in our executive office in Hong Kong. Our marketing and distribution strategy is to identify the strongest retail customers in each distribution channel and to focus design and sales efforts towards the largest and fastest growing retailers. We maintain a broad base of customers and concentrate our efforts on five major jewelry market segments:

	•		fine jewelers;
	•		national jewelry chains;
	•		department stores;
	•		TV shopping channels; and
	•		discount chain stores.

     Our sales promotion efforts include attendance by our representatives at US and international trade shows and conventions, including Las Vegas, Orlando, New York, Basel, Switzerland, Hong Kong and Japan. In addition, we advertise actively in trade journals and related industry publications.

Design and Product Development

     We have 20 internationally trained designers who work in our Hong Kong, US and China offices. Our designers create styles that have been accepted by our various clients worldwide. Our design teams attend trade fairs worldwide to gather product ideas and monitor the latest product trends.

     We provide our customers with a broad selection of high-quality 10, 14 and 18 karat gold, platinum and sterling silver jewelry products that incorporate traditional yet fashionable styles and designs. We currently offer more than 50,000 different styles of rings, bracelets, necklaces, earrings, pendants and matching sets that are contemporary and desired in the market.

     We study product trends that are emerging in the international market and adapt these trends to the needs of our retail customers. The jewelry offered for sale considers colored, fabric

and fashion trends, which are projected over a two-year period. We market our products as lifestyle inspired.

Production Process

     We produce our jewelry at our facility in Shenzhen, China. Our production processes combine vertical integration, modern technology, mechanization and handcraftsmanship to turn out contemporary and fashionable jewelry. Our production operations basically involve:

	•		cutting and polishing colored gemstones;
	•		combining pure gold, platinum or sterling silver with gemstones or diamonds to produce jewelry; and
	•		finishing operations such as cleaning and polishing, resulting in high quality finished jewelry.

Supply

     We cut our own colored stones. We purchase imported gemstones which are from South America, Africa and China. South America is the major source of ametrine, amethyst, aquamarine, imperial topaz, tourmaline and white topaz, and Africa is the main source of tanzanite, mandarine garnet, aquamarine and topaz. We also purchase imported aquamarine, peridot and topaz from China. We source our diamonds mainly from suppliers in India and Africa. We believe that we have good relationships with our suppliers, most of whom have supplied us for many years.

     We maintain our supply of inventory at our warehouse. The amount of our inventory of a particular gemstone determines the extent and size of our marketing program for that product. We purchase our gemstones and diamonds in advance and in anticipation of orders resulting from our marketing programs.

     We purchase our gold from banks, gold refiners and commodity dealers who supply substantially all of our gold needs, which we believe is sufficient to meet our requirements.

     Gold acquired for production is at least .995 fine and is combined with other metals to produce 10, 14 and 18 karat gold. The term “karat” refers to the gold content of alloyed gold, measured from a maximum of 24 karats, which is 100% fine gold. Varying quantities of metals such as silver, copper, nickel and zinc are combined with fine gold to produce 14 karat gold of different colors. These alloys are in abundant supply and are readily available to us.

     We purchase our gold requirements within a reasonable period after each significant purchase order is received. We believe that any change in the price of gold would have had little, if any, impact on the valuation of our inventories.

     We purchase supplies and raw materials from a variety of suppliers and we do not believe the loss of any of the suppliers would have a material adverse effect on our business. Alternative sources of supply for raw materials for production of jewelry are readily available.

Security

     We have installed certain measures at our Shenzhen, China, production and our Hong Kong facilities to protect against loss, including multiple alarm systems, infrared motion detectors and a system of closed circuit television cameras, which provide surveillance of all critical areas of our premises.

     We carefully inspect all materials sent and received from outside suppliers, monitor the location and status of all inventory, and have strict internal control procedures of all jewelry as it proceeds through the production process. A complete physical inventory of gold and gemstones is taken at our production and facilities on a quarterly basis.

Insurance

     We maintain primary all-risk insurance, with limits which may be less than our current inventory levels, to cover thefts and damage to inventory located on our premises. We also maintain insurance covering thefts and damage to our owned inventory located off-site. The amount of coverage available under such policies is limited and may vary by location, but is generally in excess of the value of the gold, diamonds and gemstones supplied by us. We carry transit insurance, the coverage of which includes the transportation of jewelry outside of our office.

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. Our competitive strategy is to provide competitively priced, high-quality products to the high-volume retail jewelry market. According to our management, competition is based on pricing, quality, service and established customer relationships. We believe that we have positioned ourselves as a low-cost producer without compromising our quality. Our ability to conceive, design and develop products consistent with the requirements of each retail distribution channel represents a competitive advantage.

     We believe that few competitors have the capacity and production skills to be effective competitors. We believe that our vertically integrated production capabilities distinguish us from most of our competitors and enable us to produce very competitively priced, high quality and consistent products.

     The North American market is highly fragmented but does contain a number of major competitors, many of whom import much of their product from the Far East and many of whom sell higher priced items. The key United States competitor is E.E.A.C. Inc. International competitors include Pranda International and Beauty Gems Limited. Most of these manufacturers/wholesalers have been successful vendors for many years and enjoy good relations with their clients. Although it may be difficult for a newcomer to break into established relationships, we have already made substantial inroads in the North American jewelry market

and we believe we can remain competitive, based on our vertically integrated, low-cost, high-volume and high-quality production process.

     Regarding the China retail jewelry market, there are many Hong Kong, local and foreign competitors. Those competitors may have product type, price range, market segment, target customer, size, history, strategy and background similar to or different from ENZO. Hong Kong competitors include Hong Kong-listed chain store operators such as Chow Sang Sang, Tse Sui Luen and Luk Fook; the local Chinese retail competitor is Laofengxiang; and foreign competitors include Tiffany, Cartier and Bvlgari.

C.

ORGANIZATIONAL STRUCTURE AS OF DECEMBER 31, 2006:

     The following diagram provides a listing of our significant subsidiaries. The respective country of organization/incorporation is shown in brackets.

LJ INTERNATIONAL INC.
(British Virgin Islands)

		100%
-		Lorenzo Jewelry Limited (Hong Kong)
-		Lorenzo Jewellery (Shenzhen) Co., Ltd. (PRC)
-		Shenzhen PGS Jewelry Mfg. (PRC)
-		Lorenzo (Shenzhen) Co., Ltd. (PRC)
-		Lorenzo Crystal Ltd. (Hong Kong)
-		Enzo (Shenzhen) Co., Ltd. (PRC)
-		Enzo Ltd. (Macau)
98%
-		Goldleaves Gems (Shenzhen) Co., Ltd. (PRC)

D.

PROPERTY, PLANTS AND EQUIPMENT.

     Our principal executive office is located at Unit #12, 12/F, Block A, Focal Industrial Centre, 21 Man Lok Street, Hung Hom, Kowloon, Hong Kong. We own approximately 11,100 square feet of office and showroom at this location.

     Our jewelry production facility in Shenzhen, China consists of 14,080 square meters of building space located inside of and close to the Shatoujiao Free Trade Zone, Shenzhen. We own approximately 6,893 square meters of this space. We also currently lease:

	•		1,751 square meters for a term of five years expiring June 30, 2011 from an unaffiliated third party at a rental rate of $3,817 per month;
	•		1,751 square meters for a term of two years expiring August 31, 2008, at a rental rate of $4,490 per month;
	•		1,799 square meters for a term of three years expiring March 31, 2009, at a rental rate of $4,381 per month; and
	•		1,886 square meters for a term of three years expiring September 30, 2009 at a rental rate of $4,593 per month.

     We own two warehouse facilities in Hung Hom and Aberdeen consisting of 5,432 square feet and 5,200 square feet. We also own additional properties in Sai Kung and Hung Hom. We lease all four of these properties to non-affiliated third parties. We have pledged all of our land and buildings to collateralize general banking facilities granted to us.

     Our production facilities are currently utilized for one shift per day but are capable of being expanded to accommodate three shifts per day as necessary.

ITEM 4A.           UNRESOLVED STAFF COMMENTS

     Not applicable.

ITEM 5.     OPERATING AND FINANCIAL REVIEW AND PROSPECTS

The following discussion and analysis should be read in conjunction with our financial statements and notes to the financial statements appearing elsewhere in this Form 20-F. See “Special Note Regarding Forward-looking Statements.”

     LJ International Inc, via its operating subsidiaries, designs, manufactures, distributes and markets a full range of fine jewelry through both wholesale and retail channels under the tradenames of LORENZO and ENZO, respectively. In term of sales revenue, geographically the US and the PRC are the two major contributors.

     The product types include rings, bracelets, necklaces, earrings and pendants, and we are one of the strongest companies in colored gemstones that employs the mine-to-market strategy. Substantially all of our colored gemstones are imported from Brazil and Africa which supplies the best colored gemstones in the world, the choices of which to customers are many and diversified that includes, amongst others, ametrine, amethyst, aquamarine, imperial topaz, tourmaline, white topaz, tanzanite, mandarine garnet, topaz, ruby, sapphire and emerald.

     Our wholesale customers comprise fine jewelers, national jewelry chain stores, department stores and television shopping networks in North America, Western Europe, Japan and China.

     Our retail customers in China are individual consumers. Under the segment of retail business, besides classic affordable luxury jewelry items that are available in our ENZO retail shops, the Company also operates the ENZO Signature line that represents a luxury premium line of jewelries that comprises, amongst others, diamonds, rubies, sapphire and tourmaline.

     The sales of ENZO Signature are made by invitation to customers, at sales events such as the Millionaire Fair; and via jewelry exhibitions such as The JCK Show, Hong Kong International Jewellery Show, Basel Show and VicenzaOro. Customers of our ENZO Signature line are primarily international tycoons, high net worth individuals, royalty and celebrities.

     Our business strategies include broadening the retail product line, and diversifying our customer base. Besides focusing on our traditional color gemstone jewelry business, we are also contnuing to develop our diamond jewelry business at our ENZO stores. Product initiatives include a variety of different sizes, shape and cutting methods. Successful examples include our ENZO88 and Gabrielle Diamond lines. The expansion of our diamond jewelry business will diversify our already strong presence in colored jewelry, offering increasing choices of jewelry products to our customers.  

     We are based in Hong Kong. The revenue mix of the two streams of business of LORENZO (wholesale) and ENZO (retail) were roughly in the ratio of 88% to 12% for the year ended December 31, 2006.  

     The wholesale business focuses on the US market with sales made to those $100 Million Supersellers such as Sterling Jewelers Inc., Fred Meyer Jewelers, Helzberg Diamonds,

ShopNBC, Zales Corporation, QVC, Wal-Mart, Finlay Fine Jewelry, Home Shopping Network, Ben Bridge Jeweler, Kohl’s Corporation, Macy’s East, Macy’s West and J.C. Penney. The turnover of our sales to those Supersellers in the US and Canada amounted to $76.9 million for 2006 compared to $67.8 million in 2005, an increase of 13%.  

     Employing the brand new ENZO name, the retail business operates in the Asia Pacific region, with a primary focus on the PRC market. On August 28, 2007, we opened a 1,000-square-foot ENZO store at The Venetian^® Macau, a 3,000-room resort hotel being built by Las Vegas Sands Corp. ENZO currently has 83 stores in the PRC, two stores in Macau and three stores in Hong Kong, totaling 88 stores. ENZO is steadily and progressively achieving the target number of at least 100 retail stores by the beginning of 2008. ENZO now has one or more retail locations in China’s richest and largest population cities, including Shanghai, Beijing, Harbin, Qingdao, Shenyang, Ningbo, Chengdu, Changsha, Wuxi, Tianjin, Dalian, Shenzhen, Changchun, Tangshan, Guiyang, Xian and Jinan. The best selling jewelry are in the price range of $300 to $500, and the population groups with monthly income of $800 to $1,200 are most eager to buy fine jewelry. 18K gold is the most popular, followed by 24K jewelry. The most popular diamonds are of 0.21 carats to 0.49 carats in size.

     The launch of the ENZO Signature reiterates ENZO renowned brand recognition as well as the development of a portfolio of new customers with the greatest spending power. Since the inception of the business in the fourth quarter of 2006, ENZO Signature generated sales of over $4 million and $13 million in 2006 and 2007, respectively. As a result of our initial success with our high-end jewelry and the subsequent continued success we are experiencing in 2007, we have branded this new high-end line as ENZO Signature to signify its importance to the Company and the devotion of resources, time and concentration to it.

Certain prior year amounts have been reclassified to conform to the current year presentation.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements requires us to make estimate and judgments that affect the reported amounts of our assets, liabilities, revenue and expenses. These estimates are based on our historical experience and on various other assumptions that we believe to be reasonable. Estimates are evaluated on an ongoing basis, but actual results may differ from these estimates.

Critical accounting policies are those that, in management’s view, are most important in the portrayal of our financial condition and results of operations. Those that require significant judgments and estimates include:

Collectibility of Accounts Receivable. Our management has a credit policy in place and the exposure to credit risk is monitored on an ongoing basis. Credit evaluations are performed on all customers requiring credit over a certain amount. Our international sales are settled via letter of credit or open account. For export sales on open account, we purchased trade credit insurance to cover the risk of collectability, the insured percentage is 85% on the invoiced amount to

customers. Past due balances over 90 days and over a specified amount are reviewed individually for collectability.

We make specific allowance for doubtful accounts based on our best estimate of the amount of losses that could result from the inability or intention of our existing customers not to make the required payments. We generally review the allowance by taking into account factors such as historical experience, age of the accounts receivable balances and economic conditions that may affect a customer’s ability to pay.

Stock-based Compensation. Prior to 2006, we applied the intrinsic value method as allowed in APB Opinion No. 25, Accounting for Stock in accounting for stock options. Under the intrinsic value method, compensation cost for stock options is measured as the excess, if any, of the quoted market price of our common stock at the date of the grant over the amount an employee must pay to acquire the stock. Compensation cost is recognized on a straight line basis over the requisite service period, which is generally the same as the vesting period.

Effective January 1, 2006, we adopted SFAS No. 123R, Share-Based Payment (“SFAS No. 123R”). SFAS No. 123R replaces SFAS No. 123. SFAS No. 123R requires that all stock-based compensation be recognized as an expense in the consolidated financial statements and that such cost be measured at the fair value of the award and requires compensation cost to reflect estimated forfeitures. SFAS No. 123R was adopted using the modified prospective method of application. Under this method, we recorded stock-based compensation expense for awards granted prior to, but not yet vested as of January 1, 2006 and for stock-based awards granted after January 1, 2006. Compensation cost is recognized on a straight line basis over the requisite service period, which is generally the same as the vesting period.

We currently use authorized and unissued shares to satisfy share award exercises.

The adoption of SFAS No. 123R effective January 1, 2006 did not result in any recognition of any incremental stock-based compensation expense since there were no stock options granted for the year ended December 31, 2006.

Goodwill Impairment. Goodwill is tested for impairment at least annually based on a two-step approach. The first step is conducted by comparing the fair value of each reporting unit to its carrying amount. If the fair value of a reporting unit is less than its carrying amount, the second step requires a comparison of the implied fair value of goodwill to its carrying value. The excess of the fair value of the reporting unit over the amounts assigned to the assets and liabilities is the implied fair value of goodwill. This allocation process is only performed for purposes of evaluating goodwill impairment and does not result in an entry to adjust the value of any assets or liabilities. An impairment loss is recognized for any excess in the carrying value of goodwill over its implied fair value.

We have determined that iBBC Inc. is the reporting unit for goodwill impairment testing. The fair value of iBBC Inc. is determined based on the discounted expected cash flow method. The discount rate was based on the subsidiary’s weighted average cost of capital. The use of

discounted cash flow methodology requires significant judgments including estimation of future revenues and costs, industry economic factors, future profitability, determination of iBBC Inc’s weighted average cost of capital and other variables. Although we believe that the assumptions adopted in our discounted cash flow model are reasonable, those assumptions are inherently unpredictable and uncertain.

We had goodwill of US$1,521,000 as of December 31, 2005 and 2006. The estimated fair value of the reporting unit exceeded its carrying value at December 31, 2006. Consequently, no goodwill impairment has been recognized.

Allowance for Obsolete Inventories. We established inventory allowance for unmarketable inventory in an amount equal to the difference between the cost of inventory and its estimated net realizable value based upon assumptions about future demand and market conditions. Management records a write-down against inventory based on several factors, including expected sales price of the item and the length of time the item has been in inventory. If actual demand and market conditions are less favorable than those projected by management, additional inventory allowance could be required. In that event, our gross margin would be reduced.

A.     OPERATING RESULTS.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year presentation.

Revenues

														% Change
														Years ended				Years ended
		Year ended December 31,												December 31,				December 31,
(in thousands)		2006				2005				2004				2006-2005				2005-2004
Revenues
Wholesale
Jewelry product		$	108,679			$	95,318			$	72,337				14	%			32	%
Giftware product		$	-			$	1,827			$	4,359				-100	%			-58	%
		$	108,679			$	97,145			$	76,696				12	%			27	%
Retail		$	15,112			$	2,501			$	808				504	%			210	%
		$	123,791			$	99,646			$	77,504				24	%			29	%

     The increase in revenue of jewelry product of wholesale of $13,361,000 or 14% to $108,679,000 for the year ended December 31, 2006, compared to the year ended December 31,

2005, was primarily attributable to the increase in average selling price of 1% , increase in order quantity of 7% and increase of $3.2 million from newly launched gold jewelry product line.

     The increase in revenue of jewelry product of wholesale of $22,981,000 or 32% to $95,318,000 for the year ended December 31, 2005, compared to the year ended December 31, 2004, was attributable to an increase in average selling price of 2% and increase in order quantity of 34%.

     The decrease in revenue of giftware product of wholesale of $2,532,000 for the year ended December 31, 2005, compared to the year ended December 31, 2004, was due to the closure of this product line with low profit margin during the third quarter of 2005.

     The Company’s retail business increased by $12,611,000, or 504%, from 2005 to $15,112,000 for the year ended December 31, 2006. This increase was primarily due to the successful launch of the new ENZO Signature line of high-end jewelry which accounted for $4,130,000 of the Company’s retail business in 2006. The remaining increase was due to the Company’s new ENZO retail store openings and the continued operation of its existing 26 ENZO retail stores, that is, a total of 44 ENZO retail stores in full operation compared to a total of 18 ENZO retail stores on December 31, 2005.

     The revenue of retail business increased by $1,693,000 or 210% for the year ended December 31, 2005 from the revenue of $808,000 for the year ended December 31, 2004. The retail business was newly launched in 2004 which involved direct sales to consumers in Hong Kong and China through company-owned retail stores under the brand name ENZO. Due to the expansion, the number of retail stores was increased to 18 ENZO retail stores in Hong Kong and China at December 31, 2005, compared to three stores at December 31, 2004.

Cost of Sales and Gross Profit

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

     The gross profit margin of wholesale increased to 23% for the year ended December 31, 2006 from 22% for the year ended December 31, 2005 and was attributable to the sales of a higher-end product mix.

     The gross profit margin of wholesale increased to 22% for the year ended December 31, 2005 from 21% for the year ended December 2004 and was attributable to the sales of a higher-end product mix.

     The gross profit margin of our ENZO retail operation increased to 64% for the year ended December 31, 2006 compared to 41% for the year ended December 31, 2005 and was attributable to the launch of our new ENZO Signature line of jewelry products which substantially increased the retail division’s gross profit margins.

     The gross profit margin of retail increased to 41% for the year ended December 31, 2005 from 13% for the year ended December 31, 2004 and was due to the low profit margin at the beginning of the new business at 2004.

Selling, General and Administrative Expenses

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

     Selling, general and administrative expenses increased by 49% for the year ended December 31, 2006, compared to the year ended December 31, 2005. For the wholesale business, the selling, general and administrative expenses increased by 15% for the year ended December 31, 2006, compared to the same of year 2005. The increase mainly comprised 2% increase in selling and distribution expenses which varied to sales revenues, 2% increase in manpower on development of new products, designs and markets and 5% increase in staff cost. The expenses incurred by the retail business of $7,562,000, or 185% increase of the same for the year ended December 31, 2005, comprised advertising cost of $1,142,000, rental cost of $2,454,000, staff cost of $2,198,000 and other expenses of $1,768,000 as a result of higher sales and increased store counts. The corporate expenses included items of corporate overheads, such as charges for legal and professional advisory services.

     Selling, general and administrative expenses increased by 34% for the year ended December 31, 2005, compared to the year ended December 31, 2004. For the wholesale business, the selling, general and administrative expenses increased by 29% for the year ended December 31, 2005, compared to the same of year 2004. It mainly comprised 1% increase in selling and distribution expenses which varied to sales revenues, 5% increase in manpower on development of new products, designs and markets, 13% increase in staff cost and 5% increase or $479,000 contributed to expenses incurred by the acquired subsidiaries engaged in manufacturing activities for wholesale business. The expenses incurred by the retail business of $2,653,000 comprising advertising cost of $816,000, rental cost of $275,000, staff cost of

$727,000 and other expenses of $835,000, or 318% increase of the same for retail for the year ended December 31, 2004. The corporate expenses included items of corporate overheads, such as charges for legal and professional advisory services.

Net gain (loss) on derivatives

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

     We have secured “gold loan” facilities with various banks in Hong Kong, which typically bear a below-market interest rate. Under the gold loan arrangements, we may defer the purchase until such time as we decide appropriate, the price to be paid being the current market price at time of payment. The gold loan, however, does expose us to certain market risks associated with potential future increases in the price of gold. In the past, we did not hedge against such risks and at the close of each reporting period, the gold loan was valued at fair value with changes reflected on the income statement.

     Since 2003, we have commenced hedging the fluctuations in the price of gold related to the gold loans by entering into contracts with financial institutions for the future purchase of gold. With the hedging mechanism in place, we have incurred an unrealized gain of $190,000 for the year ended December 31, 2006, and an unrealized loss of $88,000 and $482,000 for each of the years ended December 31, 2005 and 2004 respectively; and a realized loss of $219,000 for the year ended December 31, 2006, and a realized gain of $96,000 and $681,000 on derivatives for each of the years ended December 31, 2005 and 2004 respectively.

     The hedging mechanism has been in place since 2003. We secured position of a net loss of $29,000 for the year ended December 31, 2006 and a net gain on derivative hedging activities of $8,000 and $199,000 for each of the years ended December 31, 2005 and 2004 respectively.

Depreciation

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

     Depreciation of wholesale business increased by 23% to $1,425,000 for the year ended December 31, 2006 from $1,154,000 for the year ended December 31, 2005, and reflected the amortization on the on-going capital expenditures, renovation and new motor vehicles. Depreciation of retail business increased by 187% to $614,000 for the year ended December 31, 2006 from $214,000 for the year ended December 31, 2005 and reflected the amortization of the capital expenditures of renovation on the increased number of retail stores during the year.

     Depreciation of wholesale increased by 16% to $1,154,000 for the year ended December 31, 2005 from $991,000 for the year ended December 31, 2004, and reflected the amortization on the on-going capital expenditures, capitalized computer system. Depreciation of retail business increased by 422% to $214,000 for the year ended December 31, 2005 from $41,000 for the year ended December 31, 2004, and reflected the amortization of the capital expenditures of renovation on the opening of new retail stores during the year.

Amortization and impairment loss on goodwill

														% Change
														Years ended				Years ended
		Year ended December 31,												December 31,				December 31,
(in thousands)		2006				2005				2004				2006-2005				2005-2004
Amortization and impairment loss on goodwill		$	0			$	0			$	698				N/A				-100%
% of revenues			0%				0%				1%

               In April 2001, we acquired a 20% equity interest in a company whose principal activities are the manufacturing and trading of rough and pre-formed gemstones, of which we had no significant control and influence over its operating and financial policies, the investment is stated at cost previously. On January 1, 2005, an additional equity interest was acquired in this company, which become a subsidiary of the Company. As appropriate for a step-acquisition, the interest as of December 31, 2004 was restated to account for under equity method. As a result, an impairment loss of $698,000 arising from investment securities was charged for the year ended December 31, 2004.

Interest cost

														% Change
														Years ended				Years ended
		Year ended December 31,												December 31,				December 31,
(in thousands)		2006				2005				2004				2006-2005				2005-2004
Interest expenses		$	3,258			$	1,991			$	902				64%				121%
% of revenues			3%				2%				1%

     Interest expenses increased for the years ended December 31, 2006, 2005 and 2004 reflecting the continuous increase in interest rates and a higher utilization level of credit line facilities as working capital.

Income taxes

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

     We were incorporated in the British Virgin Islands and, under current law of the British Virgin Islands, are not subject to tax on income or on capital gains.

     For our subsidiaries in Hong Kong, the prevailing corporate income tax rate is 17.5%.

     Three of our subsidiaries in China are registered to be qualified as Foreign Investment Enterprises in China and are eligible for certain tax holidays and concessions. Accordingly, certain of our Chinese subsidiaries are exempt from Chinese income tax for two years starting from their first profit-making year, followed by a 50% reduction of tax for the next three years.

     One of our subsidiaries in China has its tax exemption and concessions expired at the end of 2004. Another subsidiary in China is enjoying the tax holiday as its first profit-making year in 2004 and another subsidiary in China is enjoying the tax holiday as its first profit-making year in 2005. PRC income tax is calculated at the applicable rates relevant to these subsidiaries which currently are 15%.

     For other subsidiaries in China, the prevailing corporate income tax rate is 33%. The prevailing corporate income rate is 15% for companies operating in special economic zones of China.

     Incomes taxes included tax under provision adjustment of $71,000 and $88,000 for the years ended December 31, 2006 and 2005 respectively, and tax overprovision adjustment of $22,000 for the year ended December 31, 2004, after the finalization of tax assessment for prior years.

Extraordinary gain on negative goodwill

														% Change
														Years ended				Years ended
		Year ended December 31,												December 31,				December 31,
(in thousands)		2006				2005				2004				2006-2005				2005-2004
Extraordinary gain on negative goodwill		$	0			$	1,291			$	0				-100%				N/A
% of revenues			0%				1%				0%

     Extraordinary gain on negative goodwill of $1,291,000 was arisen from the sequential acquisition of a company whose principal activities are the manufacturing and trading of rough and pre-formed gemstones (the Investee).

     Pursuant to the purchase agreement dated January 1, 2005, the Company paid US$2,827,500 to the Investee for the issuance of 3,900 new shares therein, in which the Company had 20% equity interests. The Company then became the major stockholder holding 98% equity interests in the Investee, which became a subsidiary of the Company.

Inflation

     We do not consider inflation to have had a material impact on our results of operations over the last three years.

Foreign Exchange

     Approximately 86% of our sales are denominated in US Dollars whereas the other sales are basically denominated in Hong Kong Dollars and Renminbi. The largest portion of our expenses are denominated in Hong Kong Dollars, followed by US Dollars and Renminbi. The exchange rate of the Hong Kong Dollar is currently pegged to the US Dollar, but during the past several years the market exchange rate has fluctuated within a narrow range. The Chinese government principally sets the exchange rate between the Renminbi and all other currencies. As a result, the exchange rates between the Renminbi and the US Dollar and the Hong Kong Dollar have fluctuated in the past and may fluctuate in the future. If the value of the Renminbi or the Hong Kong Dollar depreciates relative to the US Dollar, such fluctuation may have a positive effect on the results of our operations. If the value of the Renminbi or the Hong Kong Dollar appreciates relative to the US Dollar, such fluctuation may have a negative effect on the results of our operations. We do not currently hedge our foreign exchange positions.

Governmental economic and political policies and factors

     For information regarding governmental economic, fiscal, monetary and political policies that could materially affect our operations, directly or indirectly, please refer to the “Risk Factors” section on pages 7 to 12.

B.

LIQUIDITY AND CAPITAL RESOURCES.

     We have no direct business operations other than the ownership of our subsidiaries and investment securities. Our ability to pay dividends and meet other obligations depends upon our receipt of dividends or other payments from our operating subsidiaries and investment securities. Our operating subsidiaries are subject to restrictions on their ability to make distributions to us, including as a result of restrictive covenants and minimum net worth requirements in loan agreements, restrictions on the conversion of local currency into US dollars or other hard currency and other regulatory restrictions.

Cash Flows

		Years ended December 31,
(in thousands)		2006				2005				2004
Net cash used in operating activities		$	(6,200)			$	(14,222)			$	(7,494)
Net cash used in investing activities			(3,829)				(4,655)				(1,179)
Net cash provided by financing activities			11,096				20,450				9,179
Effect of foreign exchange rate change			-				(5)				-
Net increase in cash and cash equivalents			1,067				1,568				506

Operating Activities:

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

     Net cash used in operating activities was net income (loss) adjusted for certain non-cash items and changes in assets and liabilities.

     For the year ended December 2006, net cash used in operating activities was comprised of a net income of $5,325,000, non-cash adjustment of $2,362,000 including adjustment of $2,039,000 for depreciation.

     For the year ended December 2005, net cash used in operating activities was comprised of a net income of $4,351,000, non-cash adjustment of $257,000 including adjustment of $1,368,000 for depreciation and $1,291,000 for extraordinary gain on negative goodwill.

     Significant changes in assets and liabilities were as follows:

     Trade receivables were decreased by $1,106,000 for the year ended December 31, 2006, and increased by $8,607,000 for the year ended December 31 2005. It was mainly due to the sales of the last quarter of 2005 near the year end, accumulating higher level of trade receivables at the end of 2005.

     Inventory balance was increased by $12,810,000 and $12,060,000 for the year ended December 31, 2006 and 2005 respectively. It was the accumulation of inventory of gemstones in anticipation of significant increase in sales for the new fiscal year, and the build up of inventory for retail business in Hong Kong, Macau and China, the rise in the cost of gold and rough gemstones, the build-up of more sample lines of jewelry and the maintaining of sufficient inventory for block-orders.

     Trade payables decreased by $2,955,000 for the year ended December 31, 2006 due to reduced level of material purchases during last quarter of the year. The increase by $1,883,000 for the year ended December 31, 2005 was primarily due to the better credit term obtained from suppliers.

Investing Activities:

     For the year ended December 31, 2006, net cash used in investing activities was for capital expenditures and partially offset by the deduction in restricted cash. Capital expenditures were mainly for on-going improvements of the existing production facilities in Shenzhen, and other business necessities including computer system upgrade, acquisition of motor vehicles, and renovation of stores for the retail business.

     For the year ended December 31, 2005, net cash used in investing activities was for capital expenditures and the purchase of a capital guaranteed fund, which was partially offset by the deduction in restricted cash. Capital expenditures were mainly for acquisition of a production facility in Shenzhen, renovation and improvement of the existing production facilities in Shenzhen, other ongoing business necessities, including a new computer system and a motor vehicle and the renovation of shops for our new retail business. The capital guaranteed fund was purchased from banks for securing new banking facilities.

     Our capital expenditures by category for the periods presented were:

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

Financing Activities:

     Net cash provided by financing activities for the year ended December 31, 2006 was $11,096,000, which included proceeds of $4,191,000 from issuance of shares in private placement, proceeds of $4,744,000 from issuance of shares upon exercise of stock options and warrants, sales proceeds of derivatives, increase of new loans and offset by the repayment of matured bank loans, change in letter of credit and factoring and decrease in bank overdrafts utilization level.

     Net cash provided by financing activities for the year ended December 31, 2005 was $20,450,000, which included proceeds of $7,736,000 from issuance of shares upon exercise of stock options and warrants, increase of new loans and offset by the repayment of matured bank loans, change in letter of credit and factoring and increase in bank overdrafts utilization level.

     Our cash and cash equivalents are mainly held in US dollars and HK dollars.

Financing Sources

Banking Facilities and Notes Payables

     We have various letters of credit, factoring facilities and overdrafts under banking facilities. The banking facilities are collateralized by land and buildings, investment properties, restricted cash deposits, factored receivables and personal guarantees of and properties owned by one of our directors.

Letters of Credit, overdrafts and others:

		Years ended December 31,
(in thousands)		2006				2005				2004
Letters of credit		$	41,046			$	31,533			$	26,833
Overdraft		$	3,564			$	3,461			$	3,461
			44,610				34,994				30,294
Utilized :
Letters of credit utilized		$	22,344			$	21,887			$	15,423
Overdraft utilized		$	1,591			$	2,028			$	607
			23,935				23,915				16,030

     The letters of credit and bank overdrafts are denominated in HK dollars and US dollars, bear interest at the floating commercial bank lending rates in Hong Kong, and are renewable annually with the consent of the relevant banks.

     The factoring facilities granted are limited to the extent of accounts receivable collateralized to the banks.

     Notes payable:

		Years ended December 31,
(in thousands)		2006				2005				2004
Notes payable		$	3,987			$	3,079			$	2,487

     We have term loans classified under notes payable which are related to the Group’s properties. These loans are denominated in HK dollars and Renminbi and bear interest at pre-fixed rates in Hong Kong and China upon renewal.

Gold Loan Facilities:

		Years ended December 31,
(in thousands)		2006				2005				2004
Gold loans outstanding (in $)		$	11,079			$	10,756			$	6,488
Gold loans outstanding (in troy ounces)			26,920				27,920				17,920
Gold loan interest rate			2.6%-3.1%				2.4%-2.6%				2.1%-2.5%