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, the Company's plans and expectations and financial projections. The Company's 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. See "ITEM 1A. RISK FACTORS."

Overview

Fuqi is engaged in the design, manufacture, marketing and wholesale distribution of a full range of precious metal jewelry in China. The Company currently operates through two divisions: (i) production and (ii) sales and marketing. The production division is responsible for manufacturing of the Company's jewelry products and the sales and marketing division is responsible for the selling and marketing functions of the products, including customer relations and customer service. The Company intends to enter into the retail distribution of its jewelry products by opening or acquiring retail stores in China during 2007.

Fuqi generates its revenues primarily from the sale of gold and platinum jewelry. The Company intends to develop platinum as the primary metal from which its jewelry is manufactured to capitalize on the recent increase in consumption of platinum jewelry in China. The Company also will devote resources to strengthen its brand name in the China jewelry industry by expanding the marketing and promotion of its products and maintaining large-scale production of quality products. The Company's operations are subject to all of the risks inherent in establishing a business enterprise in China, particularly one that is dependent, initially, on the ever-changing retail trends in products that are discretionary. If Fuqi does not receive the consumer or business acceptance that it anticipate, its revenues and operating results will likewise not reach the levels it anticipates. In addition, the Company's ability to effectively conduct its operations must be evaluated in light of the problems, expenses, difficulties, complications and delays frequently encountered in connection with establishing a growth business, including uncertainty as to production capabilities, market acceptance, marketing methods, expenses and competition. The Company may not be successful in its proposed new business activities, such as entering the retail market for its products.

The Chinese jewelry industry has recently experienced growth due to a series of governmental reforms, an increase in income levels and growth in the urban population in China. The industry is also highly competitive, and the Company's competitors include domestic and foreign jewelry manufacturers, wholesalers, and importers who may operate on a national, regional and local scale. Many of the Company's competitors have substantially greater financial, technical and marketing resources and personnel than the Company. As the Company believes competition is largely based on quality, service, and pricing, its strategy is to provide competitively priced, moderate- to high-quality products to the high-volume retail jewelry market. The Company also intends to enter into the jewelry retail industry, which is also highly competitive. Many of the Company's potential competitors in the retail industry will have larger customer bases, longer operating histories and significantly greater financial, technical, marketing and other resources. It may be difficult for a newcomer to enter into the retail industry, but the Company believes that its established production and wholesale distribution business will facilitate its entrance into the retail market.

The Company would need to raise additional capital as required to match its expansion plan. The Company anticipates that it would need approximately $40.0 million in additional capital to execute its retail plan for the coming two years. If the Company is able to obtain the additional capital, a substantial portion of it, approximately $20.0 million, would be used to acquire raw materials. A smaller portion of the additional capital, approximately $16.0 million, would be used for the opening or acquiring of retail outlets. Approximately $2.0 million of the additional capital would be used to acquire components and additional toolings while the remaining portion of the additional capital would be applied to working capital for labor to manufacture jewelry and marketing and promotional activities.

Corporate History

Fuqi was originally incorporated in the State of Arizona on September 3, 2004 as VT Marketing Services, Inc. The Company was a wholly-owned subsidiary of Visitalk Capital Corporation ("VCC"), and was formed as part of the implementation of the Chapter 11 reorganization plan (the "Visitalk Plan") of visitalk.com, Inc. ("Visitalk.com"). Visitalk.com filed for Chapter 11 Bankruptcy in November 2000. The Visitalk Plan became effective on September 17, 2004 (the "Effective Date"). On September 22, 2004, Visitalk.com merged into VCC, which was authorized as the reorganized debtor under the Visitalk Plan. As part of the Visitalk Plan, the Company issued shares of its common stock and warrants to purchase shares of its common stock that were distributed to creditors and claimants of Visitalk.com. The Company's original business was to use Visitalk.com's technology to facilitate peer-to-peer marketing activities. On July 21, 2006, the Company sold 1,368,761 shares of common stock (post Reverse Split) to BayPeak, LLC. As part of this transaction (the "Bay Peak Sale"), the Company abandoned its peer-to-peer marketing business, and began to seek companies in Asia with potential, in particular companies based in China, to acquire. The shares issued in the Bay Peak Sale represented 75% of the Company's outstanding shares at the time of issuance. On July 28, 2006, Visitalk.com was granted its Final Decree by the Bankruptcy Court. On November 6, 2006, the Company conducted a reverse stock split of its shares common stock and issued one share for each 15.43 shares of its common stock then outstanding (the "Reverse Split"). No shareholder was reversed below 100 shares in the Reverse Split and the then outstanding Plan Warrants were not affected by the Reverse Split. On November 8, 2006, the Company changed its state of incorporation from Arizona to Nevada.

On November 20, 2006, the Company entered into a share exchange agreement with Yu Kwai Chong, who is the sole shareholder of Fuqi BVI pursuant to which the Company agreed to acquire all of the issued and outstanding capital stock of Fuqi BVI (the "Exchange Transaction"). The Exchange Transaction closed on November 22, 2006 and, per the terms of the share exchange agreement (the "Share Exchange Agreement"), the Company issued an aggregate of 18,886,666 shares of its common stock (post Reverse Split) in exchange for all of the issued and outstanding securities of Fuqi BVI. Pursuant to the Share Exchange Agreement, BayPeak agreed to cancel 8,761 shares of common stock.

On December 8, 2006, the Company changed its corporate name from "VT Marketing Services, Inc." to "Fuqi International, Inc." and reincorporated from the State of Nevada to the State of Delaware.

For financial accounting purposes, the Exchange Transaction 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 acquirer. Accordingly, the Company's 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, Shenzhen Fuqi Jewelry Co., Ltd. ("Fuqi China"), a company established under the laws of the People's Republic of China. Upon the acquisition of Fuqi BVI, the Company's sole business operations became that of Fuqi BVI.

Critical Accounting Policies, Estimates and Assumptions

Management's discussion and analysis of results of operations and financial condition are based upon the Company's 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 and allowance for doubtful accounts, the recoverability of the long-lived assets. Actual results could differ from these estimates. Periodically, the review all significant estimates and assumptions affecting the financial statements and records the effect of any necessary adjustments.

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

Revenue Recognition. Revenue is recognized upon delivery and acceptance of jewelry products by the Company's customers, provided 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) the Company's 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. The Company's functional currency is reported in Renminbi ("RMB"). Foreign currency transactions (outside 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. The Company's functional currency is RMB. For the purpose of preparing the consolidated financial statements, the consolidated balance sheets of the Company have been translated into U.S. dollars at the current rates as of end of the respective period and the statements of operations 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 shareholders' equity.

Allowance for Doubtful Accounts. The Company maintains an allowance for doubtful accounts for estimated losses resulting from the inability of its customers to make required payments. Allowance for doubtful accounts is based on the Company's assessment of the collectibility of specific customer accounts, the aging of accounts receivable, its history of bad debts, and the general condition of the industry. If a major customer's credit worthiness deteriorates, or the Company's customers' actual defaults exceed historical experience, the Company's estimates could change and impact its reported results. The Company has not been experiencing any significant amount of bad debt in the past.

Inventory. Inventories are stated at lower of cost (using the first-in, first-out method) or market. The Company continually evaluates the composition of its inventories assessing slow-moving and ongoing products. The Company's products contain gold and platinum material which will not become obsolete and accordingly the Company did not provide any reserve for slow-moving and obsolete inventory.

Results of Operations

The following table sets forth the consolidated statements of operations of the Company for the years ended December 31, 2006, 2005 and 2004 U.S. dollars:

                                                       Years Ended December 31,
                                                    2006          2005         2004
                                                            (in thousands)

Net sales                                       $   92,409    $   72,580   $   56,765

Cost of sales                                       83,619        64,964       50,862

Gross profit                                         8,790         7,616        5,903

Operating expenses:
Selling and marketing                                  490           624          549
General and administrative                             794           671        1,006

Total operating expenses                             1,284         1,295        1,555

Income from operations                               7,506         6,321        4,348

Other income (expenses):
Interest expense                                      (799 )        (498 )       (100 )
Interest income                                         70             -            -
Loss on disposal of fixed assets                         -             -          (45 )
Miscellaneous                                           13            (1 )          4

Total other expenses                                  (716 )        (499 )       (141 )

Income before provision for income taxes             6,790         5,822        4,207

Provision for income taxes                             995           452          359

Net income                                           5,795         5,370        3,848


Other comprehensive income - foreign currency
translation adjustments                                288           143            -

Comprehensive income                            $    6,083    $    5,513   $    3,848

Years Ended December 31, 2006 and 2005

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 the Company's prices, which was the result of an increase in the price of precious metals, and a change in product mix. In 2006, the Company sold 572,557 grams platinum jewelry, an increase of 97,519 grams, or 20.5%, compared to 475,038 grams sold in 2005. The sales price per gram for platinum jewelry was higher than that of gold. The Company believes that the change in product mix was the combined effect of narrowing price gap between platinum and gold and marketing efforts.

Sales for the years ended December 31, 2006 and 2005 were comprised of the following (expressed in millions of dollars):

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

Cost of sales is mainly comprised of costs of raw materials, primarily gold and platinum, in addition to direct manufacturing costs and factory overhead, which accounted for approximately 1% of the cost of sales for the year December 31, 2006. 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, and the percentage of the increase in cost of sales was relatively close to the increase in net sales. The small difference in change in percentage was mainly generated by more labor hours for processing platinum.

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. The decrease in gross profit margin was mainly attributed to the Company's intended reduction in its margin to attract more sales in order to reduce the adverse effects caused by wide fluctuation of precious metal prices during the second and the third quarters in 2006. There was a general decrease in total demand caused by wide fluctuation in precious metal prices. The Company decreased its margin to encourage retailers to replenish their inventory through increased buying during the period of uncertain fluctuations in the prices of precious metal prices. However, the Company did not experience a significant effect in attracting sales by lowering its gross margin and the Company reinstated its normal gross margin rates in the fourth quarter of 2006.

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, 2006 were $490,191, a decrease of $133,940, or 21.5%, as compared to $624,131 for the year ended December 31, 2005. The decrease in selling and marketing expenses was primarily due to the Company's more targeted and focused marketing efforts. The Company expects a higher selling and marketing expenses due to higher business taxes in line with increase of sales. In addition, the Company expects to spend more on advertising expenses in an attempt to strengthen brand awareness and establish and maintain a strong market position.

General and administrative expenses consist primarily of payroll compensation, benefits and travel expenses for the Company's staff, professional fees such as accountants and financial advisors, depreciation expenses, as well as administrative office expenses. General and administrative expenses for the year ended December 31, 2006 were $793,453, an increase of $122,262, or 18.2%, as compared to $671,191 for the same period in 2005. The increase in general and administrative expenses was mainly due to costs and fees incurred in connection with a reverse merger with a U.S. corporation. The Company expects its general and administrative expenses will increase due to the various additional legal, accounting and other requirements applicable to a public company in the United States and those incremental costs being incurred in retail establishments and operations. The Company expects general and administrative expenses will be higher because more professional costs will be incurred to improve the Company's ability to meet requirements of a public company in the US.

Interest expenses were approximately $799,000 for the year ended December 31, 2006, an increase of $301,000, or 60.4%, as compared to $498,000 for year ended December 31, 2005. The increase in interest expense was primarily a result of the Company's increase in interest rate of short term bank financing for the year ended December 31, 2006.

Provision for income tax expense was approximately $995,000 for the year ended December 31, 2006, an increase of $542,000, or 119.6%, as compared to approximately $453,000 for the same period in 2005. The increase was primarily due to the increase in the Company's operating income for the year ended December 31, 2006. Companies in China are generally subject to a 30% state enterprise income tax and a 3% national income tax. The Company's subsidiary, Fuqi China, enjoyed a reduced enterprise income tax rate of 15%, which is granted to all enterprises operating in Shenzhen Special Economic Zone. Prior to 2006, the Company was under the preferential income tax rate of 7.5% in 2005 and 2004 due to its status of being a new business. That status expired effective January 1, 2006. Because of the recent announcement in income tax rate restructure, the Company will be subject to an income tax rate of 25%. However, the impacts will depend on the timing for Shenzhen city to apply the new tax rate.

Net income increased to $5.8 million for year ended December 31, 2006 from $5.4 million for the year ended December 31, 2005, an increase of $0.4 million, or 7.4%. The Company believes that, taking into account the increase of expenses should be able to maintain the net income to sales ratio of 2007 as that of 2006.

Other comprehensive income was $288,000 during 2006, an increase of $144,000 or 100%, as compared to $144,000 during 2005. The China government maintained a relatively fixed exchange rate against U.S. dollars until the end of the third quarter of 2005. The China government exchange rate continued to appreciate during the year ended December 31, 2006.

Years Ended December 31, 2005 and 2004

Net sales for the year ended December 31, 2005 increased to $72.6 million, an increase of $15.8 million, or 27.9%, compared to net sales of $56.8 million for the year ended December 31, 2004. The increase in net sales was primarily the result of an increase in the quantity of jewelry that the Company sold, which increased primarily because it lengthened the accounts receivable period.

Sales for the years ended December 31, 2005 and 2004 were comprised of the following (expressed in million of dollars):

                                           Year Ended December 31,
                                       2005                      2004
                               Amount in $       %       Amount in $       %
Platinum                              13.2      18.2             9.3      16.4
Gold                                  34.9      48.1            26.3      46.3
K-gold and Studded Jewelry            24.5      33.7            21.2      37.3
Total                                 72.6     100.0            56.8     100.0

Cost of sales for the year ended December 31, 2005 increased to $65.0 million, an increase of $14.1 million, or 27.7%, compared to cost of sales of $50.9 million for the year ended December 31, 2004. The increase was primarily due to the increase in net sales for the year ended December 31, 2005, and the percentage of the increase in cost of sales was relatively level with the increase in net sales. To the extent that inflation effected the cost of raw materials, the extra cost caused by inflation was shifted to customers. The increase in cost of sales is in proportion to the increase in net sales. The Company obtained short term bank financings to acquire raw materials to meet the demands.

Gross profit for the year ended December 31, 2005 increased to $7.6 million, an increase of $1.7 million, or 28.8%, compared to $5.9 million for the year ended December 31, 2004. The increase in gross profit resulted primarily from the increase in net sales. Gross profit margin remained relatively stable at 10.5% for the year ended December 31, 2005, compared to 10.4% for the year ended December 31, 2004.

Selling and marketing expenses for the year ended December 31, 2005 were $624,000, an increase of $75,000, or 13.7%, as compared to $549,000 for the year ended December 31, 2004. The increase in selling and marketing expenses was primarily due to the increase of promotion and advertising activities.

General and administrative expenses for the year ended December 31, 2005 were $671,000, a decrease of $335,000, or 33.3%, as compared to $1,006,000 for the year ended December 31, 2004. The decrease in general and administrative expenses was mainly due to a decrease in legal and professional fees in the year ended December 31, 2005 as majority of the audit fees for the historical financial statement were incurred in 2005. In addition the Company accrued estimated penalties on unpaid business taxes related to the cash revenues in 2004. The Company settled the outstanding taxes amount with the tax authority during 2006 and as a result, no penalties were assessed. Accordingly, no penalties were accrued for the year of 2005.

Interest expenses were approximately $498,000 for the year ended December 31, 2005, an increase of $398,000, or 398%, as compared to $100,000 for year ended December 31, 2004. The increase in interest expense was primarily a result of increased bank loans borrowed in the year ended December 31, 2005.

Provision for income tax expense was approximately $452,000 for the year ended December 31, 2005, an increase of $93,000, or 25.9%, as compared to approximately $359,000 for the year ended December 31, 2004. The increase was primarily due to the increase in the Company's operating income for the year ended December 31, 2005.

Other comprehensive income increased by $143,000 during 2005 compared to $0 during 2004. The China government maintained a relatively fixed exchange rate against U.S. dollars until the end of the third quarter of 2005 and therefore there were no adjustments related to foreign currency translations during 2004.

Net income increased to $5.4 million for the year ended December 31, 2005 from $3.8 million for the year ended December 31, 2004, an increase of $1.6 million, or 42%.

Liquidity and Capital Resources

At December 31, 2006, Fuqi had retained earnings of $3,288,426 and had cash of $13,354,981. Fuqi has historically financed its operations with cash flows generated from operations, as well as through the borrowing of long term or short term bank loans. The Company uses its inventory as a guarantee to loans.

The Company currently has current loan payables in an aggregate amount of $14,086,852, which consists of (i) a note for $1,280,623 with an interest rate of 5.76% that matured in January 2007, (ii) two notes for $2,561,246 with an interest rate of 5.85% that is due in February 2007, (iii) four notes for $3,841,869 with an interest rate of 5.832% that is due in January 2007, (iv) a note for $1,280,623 with an interest rate of 6.138% that is due in March 2007,
(v) a note for $960,467 with an interest rate of 6.732% that is due in July 2007, (vi) a note for $960,467 with an interest rate of 6.732% that is due in September 2007, (vii) a note for $1,024,498 with an interest rate of 6.426% that is due in September 2007, (viii) a note for $896,436 with an interest rate of 6.426% that is due in October 2007 and (ix) a note for $1,280,623 with an interest rate of 6.732% that is due in December 2007. The Company's loans are secured by inventory, real property and/or guaranteed by the Company's affiliates.

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) decrease 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. During 2006, precious metal prices fluctuated widely from the second quarter to end of third quarter. As a result, most of the customers did not purchase in the same pattern of the previous year, the Company's jewelry stock moved slowly, and its level of inventory increased to a high level prior to the extended holidays in China (such as the Labor Day and the National Day). During this period, the timeliness of the Company's receipt of payment was also affected. As a result, the Company experienced a use of cash of $2.8 million by accounts receivable and of $1.6 million by decreased sales deposits. Since the Company does not use hedging tools for precious metals, it continued to acquire some inventory when . . .