<PAGE>


               Lazare Kaplan International Inc. 2001 Annual Report

Lazare Kaplan International Inc. is engaged in the cutting and polishing of
ideal cut diamonds, which it laser inscribes and distributes to quality retail
jewelers internationally under the brand name "Lazare Diamonds'r'". Diamonds,
whatever their size, which are cut and polished by Lazare Kaplan craftsmen, are
finished to precise proportions, bringing out all of the diamond's natural
brilliance, fire and luster. In addition, Lazare Kaplan also cuts and polishes
non-ideal cut (commercial) diamonds. These stones are sold through wholesalers
and distributors and, to a growing extent, through retail jewelers, Lazare
Kaplan's traditional channel of distribution. Lazare Kaplan is also engaged in
the buying and selling of uncut rough diamonds.

                             American Stock Exchange

The Company's common stock is traded on the American Stock Exchange under the
ticker symbol LKI.

                                    Form 10-K

Upon written request, a copy of the Company's Form 10-K Annual Report without
exhibits for the year ended May 31, 2001 as filed with the Securities and
Exchange Commission, will be made available to stockholders without charge.
Requests should be directed to the Controller, Mr. Cochrane, Lazare Kaplan
International Inc., 529 Fifth Avenue, New York, New York 10017.

                                 Annual Meeting
                                November 8, 2001
                                     10 A.M.
                                The Cornell Club
                              Six East 44th Street
                              Third Floor, Library
                            New York, New York 10017

                 Market Prices of Common Stock by Fiscal Quarter

                                   Fiscal 2001
                                   -----------
                                               High      Low
                                              ----------------
                  First                       8.8750    6.0000
                  Second                      6.8125    4.8750
                  Third                       6.2500    4.6250
                  Fourth                      6.0000    5.3000

                                   Fiscal 2000
                                   -----------

                                                High     Low
                                              -----------------
                  First                       11.2500   7.8750
                  Second                       9.5000   7.2500
                  Third                        9.6250   7.1250
                  Fourth                       9.7500   7.0000

As of July 31, 2001 there were 1,756 stockholders of record of the 7,367,691
issued and outstanding shares of the common stock of the Company, including CEDE
& Co. and other institutional holders who held an aggregate of 3,548,735 shares
of common stock as nominees for an undisclosed number of beneficial holders. The
Company estimates that it has in excess of 2,200 beneficial holders.

                                      1







<PAGE>


                              To Our Shareholders:

The fiscal year ended May 31, 2001 saw a substantial decline in global economic
activity. Falling financial markets, more cautious and selective consumer
spending, and an overstocked distribution network meant a reduction in demand
for diamonds and diamond jewelry in all markets, both domestic and overseas.
Total Company revenue in fiscal 2001 was $270,786,000, and net profit was
$1,543,000. Sales of higher gross margin polished diamonds were a record
$193,805,000, a 40% increase over the previous year.

         The diamond industry continues to face important structural changes,
and it remains unclear how these will play out, particularly in this difficult
economic environment. De Beers, the dominant player in the rough diamond
industry, completed its privatization and delisting, further redefining its
previous role as "custodian of the market," to adjust to more competitive supply
realities and attempt to participate in downstream opportunities. Because of
requests for further information by the competition authorities of the European
Union, De Beers delayed the implementation of its "supplier of choice" program.
Their joint venture with LVMH did receive approval and is proceeding. We believe
that LKI remains uniquely positioned to take advantage of the opportunities that
these structural changes will bring.

         In response to a United Nations General Assembly resolution, the
leading diamond producing and trading countries, as well as the industry, are
participating in the "Kimberley Process," a series of meetings and negotiations
leading toward a certification system to reduce the likelihood that the small
percentage of rough diamonds produced in areas of conflict find its way into the
mainstream of diamonds that contribute to growth and development in Africa. The
Company remains committed to doing all it can to ensure the implementation of
the "Kimberley Process" recommendations.

         Within our extensive distribution network, many of the quality jewelry
stores who stock and market the ideal cut "Lazare Diamond'r'" had a slower than
expected Christmas season. Although they are selling through to the consumer,
they are exercising prudence in replenishing their inventories, and we expect
that they will continue to do so for some time. As part of our long-term
commitment to downstream brand marketing we have successfully expanded our
"Lazare Diamond Boutiques," a store-within-a-store concept. There are now 26
Boutiques in place; four more are in the process of being installed, and 121
smaller visual merchandising systems have been introduced in customers' jewelry
stores. We plan further expansion of this program in the U.S. and foreign
markets in the coming year.

         Last year also brought great disappointment to those who felt that
e-commerce would replace the retail jewelry store. Although e-commerce is here
to stay, and will find its place, we opted for a more conservative approach that
at all times was supportive of and non-competitive with our existing retail
customers. We made a modest investment of approximately $400,000 in Enjewel,
which we wrote off in the course of this year when the project turned out not to
be economically viable. Our Company's website is in place and helps direct
additional business to our jewelers.

         The Japanese economy, already depressed after many years of stagnation,
continued to weaken. Japanese consumers have reduced their discretionary
spending, and this is having a major impact on diamond consumption in Japan. We
have shortened our distribution lines and, through Lazare Kaplan Japan Inc., our
wholly owned subsidiary, have direct control over our Japanese marketing
efforts. We have also reduced expenses to bring the operation into equilibrium
as Japan represents an important market for quality diamonds, and the Lazare
Diamond has an established niche.

         The Southeast Asia markets have declined as well, but not to the same
extent as Japan. We have several Lazare Diamond Boutiques in place where
performance is exceeding expectation. Our marketing efforts in Latin America
continue to meet success, and we are currently expanding into the Middle East
market.

         Our cooperation agreement with AK Alrosa in Russia is proceeding well.
Production in the three plants has been ramped up. We are expanding our
marketing efforts for the additional product lines produced by the Russian

                                      2






<PAGE>


operation. The cooperation agreement with AK Alrosa is a ten-year off take
agreement to secure the repayment of loans guaranteed by the Export-Import Bank
of the United States on behalf of Alrosa for the purchase of U.S. manufactured
mining equipment to modernize and expand Alrosa's rough diamond production.

         Last year we successfully shifted a larger portion of our revenue
towards the higher margin polished sector. However, rough trading will continue
to be an important segment of our operation as a source of raw material suitable
for manufacture into ideal cut diamonds as well as a self standing profit
center.

         Our subsidiaries, Pegasus Overseas Limited and Bellataire Inc.,
continued to successfully implement the exclusive ten-year agreement with
General Electric Company (GE). The Bellataire'TM' diamond, an all-natural
diamond that has undergone a proprietary process that improves the color of a
limited group of qualifying gem diamonds, is marketed through a selective retail
distribution network. Each diamond is laser inscribed with a unique logo and a
serial number and is accompanied by a Gemological Institute of America grading
report.

         Our manufacturing facility in Puerto Rico, and its skilled and
experienced work force, continues to produce the ideal cut "Lazare Diamond" --
the World's Most Beautiful Diamond'TM'.

         We are delighted to welcome to our Board of Directors Robert A.
Del Genio, who brings to these responsibilities great skill and experience. We
look forward to benefiting from his contribution and to a fruitful
collaboration.

         Finally, our fellow employees are, as always, the strength and backbone
of the Company. We value their professionalism and deeply appreciate their
dedication and hard work.



Maurice Tempelsman                                    Leon Tempelsman
Chairman of the Board                                 Vice Chairman of the Board

                                      3



<PAGE>


                             Selected Financial Data

<TABLE>
<CAPTION>
-------------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)            2001        2000         1999           1998            1997
-------------------------------------------------------------------------------------------------------------------------------
<S>                                                     <C>         <C>          <C>             <C>            <C>
Net Sales                                               $ 270,786   $ 361,134      $ 261,853       $ 222,617       $ 259,797
-------------------------------------------------------------------------------------------------------------------------------
Income/(loss) from continuing operations before
  income tax provision/(benefit), minority
  interest and cumulative effect of change in
  accounting principle                                  $   2,401   $      97      $ (11,575)      $   2,295       $   8,248
-------------------------------------------------------------------------------------------------------------------------------
Income/(loss) from continuing operations
   before cumulative effect of change in
   accounting principle                                 $   1,543   $     775      $  (6,323)      $   2,724       $  12,100
-------------------------------------------------------------------------------------------------------------------------------
Net Income/(loss)                                       $   1,543   $    (747)(1)  $  (6,323)(2)   $   2,724       $  11,482
-------------------------------------------------------------------------------------------------------------------------------
Basic earnings/(loss) per share from continuing
  operations before cumulative effect of change in
  accounting principle (based on the weighted
  average number of shares)                             $    0.20   $    0.09      $   (0.74)      $    0.32       $    1.69(3)
-------------------------------------------------------------------------------------------------------------------------------
Basic earning/(loss) per share (based on
   weighted average number of shares)                   $    0.20   $   (0.09)     $   (0.74)      $    0.32       $    1.61(3)
-------------------------------------------------------------------------------------------------------------------------------
Diluted earnings/(loss) per share from continuing
  operations before cumulative effect of change in
  accounting principle (based upon the weighted
  average number of shares)                             $    0.20   $    0.09      $   (0.74)      $    0.31       $    1.63(3)
-------------------------------------------------------------------------------------------------------------------------------
Diluted earnings/(loss) per share (based on
   the weighted average number of shares)               $    0.20   $   (0.09)     $   (0.74)      $    0.31       $    1.54(3)
-------------------------------------------------------------------------------------------------------------------------------
At May 31:
Total Assets                                            $ 175,918   $ 202,699      $ 151,913       $ 142,330       $ 130,079
-------------------------------------------------------------------------------------------------------------------------------
Long-term debt                                          $  39,626   $  37,309      $  38,575       $  23,560       $  17,145
-------------------------------------------------------------------------------------------------------------------------------
Working capital                                         $ 101,378   $  98,016      $ 106,581       $ 111,752       $ 105,291
-------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity                                    $  79,934   $  82,807      $  85,994       $  93,460       $  90,544
-------------------------------------------------------------------------------------------------------------------------------
</TABLE>

Note: No cash dividends were declared or paid by the Company during the past
      five fiscal years

(1)  Includes $3.1 million (net of tax) of legal settlement and related costs,
     $0.4 million (net of tax) of benefit relating to insurance policies offset
     by realignment costs and other charges, and $1.5 million (net of tax) of
     cumulative effect of change in accounting principle in 2000.

(2)  Includes $2.8 million of fourth quarter losses incurred in the Company's
     rough buying operations in Angola and $3.4 million of costs associated with
     the realignment of the Company's Japanese distribution in 1999.

(3)  Reflects the impact of the issuance of 2,130,000 additional shares of
     common stock in 1997.

                                      4






<PAGE>


                      Management's Discussion and Analysis

         This Annual Report contains, in addition to historical information,
certain forward-looking statements that involve significant risks and
uncertainties. Such forward-looking statements are based on management's belief
as well as assumptions made by, and information currently available to,
management pursuant to the "safe harbor" provisions of the Private Securities
Litigation Reform Act of 1995. The Company's actual results could differ
materially from those expressed in or implied by the forward-looking statements
contained herein. Factors that could cause or contribute to such differences
include, but are not limited to, those discussed herein and in Item 1 -
"Description of Business", and elsewhere in the Company's Annual Report on Form
10-K for the fiscal year ended May 31, 2001. The Company undertakes no
obligation to release publicly the result of any revisions to these
forward-looking statements that may be made to reflect events or circumstances
after the date of this Annual Report or to reflect the occurrence of other
unanticipated events.

         This discussion and analysis should be read in conjunction with the
Selected Financial Data and the audited consolidated financial statements and
related notes of the Company contained elsewhere in this report. In this
discussion, the years "2001", "2000" and "1999" refer to the fiscal years ended
May 31, 2001, 2000 and 1999, respectively.

                                      5






<PAGE>


Results of Operations

Net Sales

         Net sales in 2001 of $270,786,000 were 25% less than net sales of
$361,134,000 in 2000.

         The Company's net revenue from the sale of polished diamonds of
$193,805,000 in 2001 was 40% greater than 2000 polished sales of $138,568,000.
The increase in polished diamond sales reflects growth in sales of stones
produced in Russia, Lazare Diamonds'r' and Bellataire Diamonds'TM'.

         Rough diamond sales were $76,981,000 in 2001, a decrease of 65%
compared to $222,566,000 in 2000. The decrease from the prior year was primarily
attributable to the termination of the Company's rough buying operation in
Angola during the fourth quarter of the fiscal 2000.

         Net sales in 2000 of $361,134,000 were 38% higher than net sales of
$261,853,000 in 1999.

         The Company's net revenue from the sale of polished diamonds of
$138,568,000 in 2000 was 23% greater than 1999 polished sales. The increase in
polished diamond sales was primarily due to higher sales of polished stones
produced in Russia in 2000, improved sales volume of Lazare Diamonds and
pre-launch sales of Bellataire'TM' diamonds.

         Rough diamond sales were $222,566,000 in 2000, an increase of 49%
compared to $149,280,000 in 1999. The increase from the prior year was primarily
attributable to significantly increased purchases of better quality rough
diamonds from one of the Company's primary rough diamond suppliers, as well as
purchases made in its rough diamond buying operation in Africa.

Gross Profit

         The Company's gross margin on net sales of polished diamonds includes
all overhead costs associated with the purchase, sale and manufacture of rough
stones (the "Polished Diamond Gross Margin"). Polished Diamond Gross Margin for
2001 was 15% as compared to 17% in 2000. In 2001, the decrease in polished gross
margin was primarily due to lower gross margin on sales of smaller stones
produced in Russia, certain Bellataire Diamond sales and polished diamond sales
made in Japan offset, in part, by the effect of inventory reserves recorded in
2000.

         Polished Diamond Gross Margin for 2000 was 17% as compared to 13% in
1999. In 2000, the Polished Diamond Gross Margin was favorably impacted by
increased sales volume of higher margin, large stones produced in Russia. In
addition, the Company realized increased sales of Lazare Diamonds compared to
1999 which contributed positively to the polished gross diamond margin
percentage. The increased margin was partially offset by the effect of recording
certain inventory reserves of approximately $2.0 million.

         The Company's gross margin on sales of rough stones not selected for
manufacturing and sales of rough stones from the rough trading operation,
includes an allocation of overhead costs estimated to be associated with the
purchase and sale of rough stones. In 2001, the rough diamond margin was 2.3%,
compared to 2.7% in 2000. The decline in rough diamond gross margin primarily
reflects a softening of market demand for categories of stones which the Company
normally sells in rough form, offset in part by cost reductions achieved through
the termination of operations in Angola. In 1999, the Company experienced a
negative rough diamond margin of -2% which was caused by adverse results from
the Company's operations in Angola. This was compounded by relatively high fixed
infrastructure and security costs which could not be

                                      6






<PAGE>


quickly reduced, certain purchases which resulted in significant losses upon
resale, and the defection of a significant portion of the Company's expatriate
rough diamond buying team. As a result, the Company incurred a loss of
approximately $4.6 million ($2.8 million, net of tax) from its Angolan
activities which was included in the cost of goods sold for rough diamonds and,
therefore, adversely impacted the rough diamond gross margin.

         During 2001, the overall gross margin on net sales of both polished
diamonds and rough diamonds was 11.1%. This compares to 8.1% in 2000 and 4.5% in
1999. The year to year improvement in overall gross margin in 2001 and 2000
results primarily from a shift in sales mix toward polished sales, which provide
higher margins.

Selling, General and Administrative Expenses

         Selling, general and administrative expenses in 2001 were $23,316,000
compared to $20,608,000 in 2000. Excluding realignment costs and other charges,
approximately $0.8 million of benefit in 2000, selling general and
administrative expenses increased $1.9 million. The increase was primarily
attributable to increased advertising expenditures, higher compensation and
benefit costs (including selling commissions) and a decrease in foreign exchange
gains versus the same period last year. In addition, the fourth quarter of 2001
includes a charge of approximately $0.4 million to fully reserve for the
Company's investment in Enjewel, LLC an internet start-up company.

         Selling, general and administrative expenses in 2000 were $20,608,000
as compared to expenses of $20,691,000 in 1999. Excluding realignment costs and
other charges, approximately $0.8 million of benefit in 2000 and $5.6 million of
expense in 1999 (discussed below), selling, general and administrative expenses
increased approximately $6.3 million during 2000. The increase was primarily
attributable to higher compensation and benefit costs including the building of
the Company's sales force in Japan, increased marketing and advertising expense
and higher depreciation expense resulting from information system upgrades.

Realignment Costs and Other Charges

a.  Japanese Distribution
         In 1999, the Company changed the nature of its distribution in Japan by
assuming control of the distribution of its products and opening its own office.
As a result, the Company recorded a charge of approximately $5.6 million in
1999.

         During 2000, the Company realized approximately $3.0 million as
beneficiary of certain life insurance policies which arose from its relationship
with its former Japanese distributor. The Company also incurred $1.1 million of
additional costs relating to the realignment of its Japanese operations.

b.  Angola
         On December 31, 1999, the Company's license to purchase diamonds in
Angola expired. Through February 2000, the Company continued to operate its
Angolan buying operations. During the fourth quarter of 2000, the Company
terminated its operations in Angola and recorded charges relating to such
operations of $1.1 million.

c.  Other Charges
         The Company recorded charges of $2.0 million in the fourth quarter of
2000 primarily related to year-end inventory adjustments.

         In aggregate, during 2000, realignment costs and other charges resulted

                                      7






<PAGE>


in a decrease of approximately $0.8 million in selling, general and
administrative expenses and an increase of approximately $2.0 million in cost of
sales. For 1999, the net effect was an increase of $5.6 million in selling,
general and administrative expenses.

Legal Settlement and Related Costs

         In October 1999, the Company settled litigation which was commenced
against it and other related parties by International Diamond Traders CY
B.V.B.A. ("IDT") and Avi Neumark, the President and controlling stockholder of
IDT. The total cost of the settlement to the Company was $5,048,000, including
related legal and other expenses.

                                      8






<PAGE>


Interest Expense

         Net interest expense was $4,317,000, $3,621,000 and $2,702,000 in 2001,
2000, and 1999, respectively. The increase in 2001 was due to higher average
balances outstanding on the Company's various lines of credit and lower interest
income compared to 2000, partially offset by the effect of lower interest rates
during 2001.

         The increase in 2000 compared to 1999 was due to higher average
balances outstanding on the Company's various lines of credit compared to 1999,
partially offset by higher interest income in 2000.

Income Taxes

         During 2001, the Company's effective tax rate of 35.7% approximated the
U.S. statutory rate. During 2000 and 1999, the Company's tax provision, which
varied significantly from the U.S. statutory rate, included tax benefits of
$1,126,000, and $5,280,000, respectively, primarily in recognition of the net
operating losses incurred in those years.

Cumulative Effect of Change in Method of
Accounting for Start-up Costs

         On June 1, 1999 the Company adopted Statement of Positon (SOP) 98-5,
"Reporting on the Costs of Start-Up Activities", and recorded a non-cash charge
of $1,522,000 (net of tax benefit of $671,000), or $0.18 per share. This amount
is primarily comprised of a) the start-up expenses related to the operations of
the Company's newly formed, wholly owned subsidiary, Pegasus Overseas Ltd. and
the signing and implementation of its ten year agreement with a wholly owned
subsidiary of General Electric Company, and b) the start-up expenses related to
the signing and implementation of the March 1999 Cooperation Agreement with AK
ALROSA of Russia. The adoption of SOP 98-5 did not have a material effect on
income from continuing operations for the year ended May 31, 2001 or 2000.

Earnings/(Loss) Per Share

         During 2001, 2000 and 1999, basic and fully diluted earnings/(loss) per
share was $0.20, $(0.09) and ($0.74), respectively. In 2000, basic and diluted
earnings/(loss) per share before the cumulative effect of change in accounting
principle was $0.09 per share. Basic earnings per share is computed based upon
the weighted average number of common shares outstanding. Diluted earnings per
share includes the impact of dilutive stock options.

Foreign Operations

         International business represents a major portion of the Company's
revenues and profits. All purchases of rough diamonds worldwide are denominated
in U.S. dollars. All of the Company's foreign sales are denominated in U.S.
dollars, with the exception of those sales made by the Company's subsidiary,
Lazare Kaplan Japan, which are denominated in Japanese yen. The functional
currency for Lazare Kaplan Japan is the Japanese yen and, as of May 31, 2001 and
2000, the Company recognized cumulative foreign currency translation adjustments
with regard to the activities of Lazare Kaplan Japan in the amount of
$(118,000)and $239,000 respectively, which are shown as a component of
stockholders' equity in the accompanying balance sheet.

Liquidity - Capital Resources

                                      9






<PAGE>


         The Company's working capital at May 31, 2001 was $101,378,000, which
was $3,362,000 more than its working capital at May 31, 2000. This increase
primarily reflects the repayment of loans with cash generated by operations. The
Company's working capital at May 31, 2000 was $98,016,000, a decrease of
$8,565,000 from May 31, 1999. This decrease was primarily related to the
repurchase of treasury shares, capital expenditures and the reclassification of
a portion of the Company's long-term debt to current.

         Fixed asset additions totaled $1,416,000,$2,716,000 and $4,144,000 in
2001, 2000 and 1999, respectively.

         In November 2000, a subsidiary of the Company entered into a two year
committed revolving loan facility. The facility provides that the subsidiary may
borrow up to 1.1 billion Japanese yen at an interest rate 1% above the Japanese
yen LIBOR. Borrowings under the facility are available for the repayment of
other loans and working capital purposes. The Company guarantees repayment of
amounts borrowed. Borrowings under the loan are used in support of its
operations in Japan.

         The Company has a $40 million unsecured line of credit with a bank. As
of May 31, 2001 and 2000, the balance outstanding under this line of credit was
$2,896,000 and $16,780,000 million, respectively. This line of credit is
available for the Company's working capital requirements.

         The Company has a long-term unsecured, revolving loan agreement with
two banks. The agreement, as amended, provides that the Company may borrow up to
$40,000,000 in the aggregate. The term of the loan is through September 1, 2002.
The proceeds of this facility are available for the Company's working capital
needs. The revolving loan agreement contains certain provisions that require,
among other things, (a) maintenance of defined levels of current working capital
and annual cash flow, (b) limitations of borrowing levels, capital expenditures,
and rental obligations and (c) limitations on restricted payments, including the
amount of dividends. As of May 31, 2001 and 2000 there was an aggregate balance
outstanding of $39,175,000 and $38,135,000, respectively, under this agreement.

         Management believes the Company has the ability to meet its current and
anticipated financing needs for the next twelve months with the facilities in
place and funds from operations.

         Stockholders' equity was $79,934,000 million at May 31, 2001 as
compared to $82,807,000 at May 31, 2000. This decrease primarily reflects the
repurchase of $4,096,000 of treasury stock offset by earnings during this
period. No dividends were paid to stockholders during the year ended May 31,
2001.

         In December 2000, the Company's Board of Directors authorized the
extension of the Company's stock repurchase program through April 6, 2002 for
the repurchase of a total of 2 million shares.

Business Developments

         Under the terms of its agreement with AK ALROSA of Russia, the Company
equipped a diamond cutting factory which was completed in February 1997 within
the ALROSA facility in Moscow. This facility is staffed by Russian technicians
and managed and supervised by Company personnel. ALROSA has agreed to supply a
minimum of $45 million per year of large rough gem diamonds selected by the
Company as being suitable for processing at this facility. In May 1997, the
facility completed the production of its first polished stones and the Company
received its first shipment of polished stones produced at this facility during
November 1997. Since that time the Company has received regular shipments of
polished stones from the ALROSA facility. The Company is

                                      10






<PAGE>


selling the resulting polished gem stones through its worldwide distribution
network. The proceeds from the sale of these polished diamonds, after deduction
of rough diamond cost, generally are shared equally with ALROSA. This agreement
serves as a long-term off-take arrangement to secure the repayment of financing
which has been received by ALROSA from a United States commercial bank and is
guaranteed by the Export-Import Bank of the United States (Eximbank) for the
purchase by ALROSA of U.S. manufactured mining equipment. This equipment is
being used by ALROSA to increase production in its diamond mines.

         In March 1999, (in furtherance of a Memorandum of Understanding signed
by Eximbank, ALROSA and the Company in July, 1998) the Company and ALROSA
entered into a Cooperation Agreement to expand their relationship in the
cutting, polishing and marketing of rough gem diamonds for up to $100 million a
year. Under the terms of this agreement, the Company and ALROSA agreed to
refurbish two new polishing facilities in Russia. Both of these facilities are
fully operational and are in addition to the first joint facility which is
equipped to cut and polish $45 million per year of rough diamonds discussed
above.

         In March 1999, the Company announced that a wholly-owned subsidiary,
Pegasus Overseas Ltd. ("POL") entered into an exclusive ten-year agreement with
a wholly-owned subsidiary of General Electric Company ("GE") under which POL
will market natural diamonds that have undergone a new GE process. The process
is permanent and irreversible and it does not involve treatments such as
irradiation, laser drilling, surface coating or fracture filling and is
conducted before the final cutting and polishing by the Company. The process is
designed to improve the color of qualifying diamonds without reducing their
all-natural content. The process, which was developed by GE, will be used only
on a select, limited range of natural diamonds with qualifying colors, sizes and
clarities for both round and fancy cuts. The estimated number of gemstones with
characteristics suitable for this process is a small fraction of the overall
diamond market. POL will sell only diamonds that have undergone the new GE
process. In December 1999, POL completed the test marketing of these diamonds in
the United States. After careful study, a brand name, Bellataire, was selected
for the consumer launch. The Bellataire diamond is being offered for sale to
U.S. retailers as of June 2000.

         The Company has granted GE a security interest in a portion of POL's
inventory of polished diamonds.

         As a concerned member of the diamond industry and global community at
large, the Company fully supports a policy which prohibits the purchase of
diamonds illicitly seized and sold by rebel forces in Angola, Sierra Leone, and
the Democratic Republic of the Congo. As it has in the past, the Company will
continue to condemn trading in illicit diamonds, a position which reflects the
Company's leadership in the industry. Furthermore, the Company fully complies
with and supports the resolutions adopted by the United Nations as well as
concerned regional and international governments and various industry trade
associations in attempting to isolate and eliminate the trade in illicit stones.

Risks and Uncertainties

         The world's sources of rough diamonds are highly concentrated in a
limited number of countries. Varying degrees of political and economic risk
exist in many of these countries. As a consequence, the diamond business is
subject to various sovereign risks beyond the Company's control, such as changes
in laws and policies affecting foreign trade and investment. In addition, the
Company is subject to various political and economic risks, including the
instability of foreign economies and governments, labor disputes, war and civil
disturbances and other risks that could cause production difficulties or
stoppages, restrict the movement of inventory or

                                      11






<PAGE>


result in the deprivation or loss of contract rights or the taking of property
by nationalization or expropriation without fair compensation.

         The Company's business is dependent upon the availability of rough
diamonds. Based upon published reports, the Company believes that approximately
60% of the world's current diamond output is sold by De Beers Centenary AG and
its affiliated companies. Although De Beers has historically been one of the
Company's major suppliers of rough diamonds, the Company has successfully
diversified its sources of supply by entering into arrangements with other
primary source suppliers and has been able to supplement its rough diamond needs
by purchasing supplies in the secondary market. While the Company believes that
it has good relationships with its suppliers and that its sources of supply are
sufficient to meet its present and foreseeable needs, the Company's rough
diamond supplies, and therefore, its manufacturing capacity, could be adversely
affected by political and economic developments in producing countries over
which it has no control. While the Company believes that alternative sources of
supply may be available, any significant disruption of the Company's access to
its primary source suppliers could have a material adverse effect on its ability
to purchase rough diamonds.

         Further, through its control of the world's diamond output, De Beers
can exert significant control over the pricing of rough and polished diamonds. A
large rapid increase in rough diamond prices could materially adversely affect
the Company's revenue and operating margins if the increased cost of the rough
diamonds could not be passed along to its customers in a timely manner.
Alternatively, any rapid decrease in the price of polished diamonds could have a
material adverse affect on the Company in terms of inventory losses and lower
margins.

         Throughout 1999 and 2000, the Diamond Trading Company ("DTC"), a De
Beers affiliate, conducted a strategic review of its overall business model. In
July 2000, the DTC announced significant changes in its approach to rough
diamond marketing. In brief, the DTC stated that it will stop open market
purchases and alter its market control and pricing policies. Henceforth, the DTC
has said it will focus on selling its own mining productions through its
"supplier of choice" marketing programs. These policy changes are intended to
modernize business practices within the industry, shorten channels of
distribution, lower working diamond stocks, supply clients with downstream
distribution and encourage additional investment in marketing and advertising
programs. The Company believes it is well positioned to benefit from these
changes in the DTC's approach to diamond marketing. However, there can be no
assurance that this policy change will not have a material adverse effect on the
Company's operations.

         In August 2001 the European Commission issued a statement of objections
which identify a number of restrictions and trading conditions in the Supplier
of Choice agreement which appear to violate European competition law, and which
can therefore not benefit from exemption under Article 81(3). A Statement of
Objections is a preliminary step in antitrust proceedings which does not
prejudge the Commission's final decision. At this point, no conclusion can be
reached by the Company as to the ultimate outcome of the Commission's ruling.

                                      12




<PAGE>


                      Consolidated Statements of Operations

<TABLE>
<CAPTION>
                                                                                     Year ended May 31,
--------------------------------------------------------------------------------------------------------------------------
(In thousands, except share and per share data)                                   2001            2000             1999
--------------------------------------------------------------------------------------------------------------------------
                                                                               -------------------------------------------
<S>                                                                            <C>             <C>              <C>
Net Sales                                                                      $ 270,786       $ 361,134        $ 261,853

Cost of Sales                                                                    240,752         331,760          250,035
--------------------------------------------------------------------------------------------------------------------------
                                                                                  30,034          29,374           11,818
--------------------------------------------------------------------------------------------------------------------------

Selling, general and administrative expenses                                      23,316          20,608           20,691
Interest expense, net of interest income                                           4,317           3,621            2,702
Legal settlement and related costs                                                     -           5,048                -
--------------------------------------------------------------------------------------------------------------------------
                                                                                  27,633          29,277           23,393
--------------------------------------------------------------------------------------------------------------------------

Income/(loss) before income tax provision/(benefit)                                2,401              97          (11,575)
Income tax provison/(benefit)                                                        858            (678)          (5,252)
--------------------------------------------------------------------------------------------------------------------------

Income /(loss) before cumulative effect of change in
  accounting principle                                                             1,543             775           (6,323)
Cumulative effect of change in accounting principle                                    -          (1,522)               -
--------------------------------------------------------------------------------------------------------------------------

NET INCOME/(LOSS)                                                              $   1,543       $    (747)       $  (6,323)
--------------------------------------------------------------------------------------------------------------------------
                                                                               -------------------------------------------

EARNINGS/(LOSS) PER SHARE

Basic earnings/(loss) per share before cumulative effect
    of change in accounting principle                                          $    0.20       $    0.09        $   (0.74)
--------------------------------------------------------------------------------------------------------------------------
                                                                               -------------------------------------------

Basic earning/(loss) per share                                                 $    0.20       $   (0.09)       $   (0.74)
--------------------------------------------------------------------------------------------------------------------------
                                                                               -------------------------------------------

Average number of shares outstanding
    during the period                                                          7,657,285       8,212,251        8,488,861
--------------------------------------------------------------------------------------------------------------------------
                                                                               -------------------------------------------

Diluted earnings/(loss) per share before cumulative
   effect of change in accounting principle                                    $    0.20       $    0.09        $   (0.74)
--------------------------------------------------------------------------------------------------------------------------
                                                                               -------------------------------------------

Diluted earnings/(loss) per share                                              $    0.20       $   (0.09)       $   (0.74)
--------------------------------------------------------------------------------------------------------------------------
                                                                               -------------------------------------------

Average number of shares outstanding during the period,
     assuming dilution                                                         7,677,265       8,307,047        8,488,861
--------------------------------------------------------------------------------------------------------------------------
                                                                               -------------------------------------------
</TABLE>

See notes to consolidated financial statements.

                                      13






<PAGE>


                           Consolidated Balance Sheets

<TABLE>
<CAPTION>
                                                                                     May 31,
-------------------------------------------------------------------------------------------------------
(In thousands, except share data)                                                 2001            2000
-------------------------------------------------------------------------------------------------------
<S>                                                                              <C>            <C>
Assets
CURRENT ASSETS:
    Cash and cash equivalents                                                  $  1,128       $  7,254
    Accounts receivables, less allowance for doubtful
       accounts ($1,103 and $1,065 in 2001 and 2000,
       respectively)                                                             60,436         66,258
Inventories, net:
       Rough stones                                                              16,541         31,155
       Polished stones                                                           67,103         57,484
                                                                        -------------------------------
            Total inventories                                                    83,644         88,639
                                                                        -------------------------------
Prepaid expenses and other current assets                                         8,016         12,191
Deferred tax assets-current                                                       4,512          6,257
-------------------------------------------------------------------------------------------------------
                 TOTAL CURRENT ASSETS                                           157,736        180,599

Property, plant and equipment, net                                                9,394          9,554
Other assets                                                                      2,633          7,891
Deferred tax assets, net                                                          6,155          4,655
-------------------------------------------------------------------------------------------------------
                                                                               $175,918       $202,699
-------------------------------------------------------------------------------------------------------
                                                                               ------------------------

Liabilities and Stockholders' Equity
CURRENT LIABILITIES:
    Accounts payable and other current liabilities                             $ 44,287       $ 49,874
      Notes payable-other and current portion of
          long- term debt                                                        12,071         32,709
-------------------------------------------------------------------------------------------------------
                 TOTAL CURRENT LIABLITIES                                        56,358         82,583

Other long-term debt                                                             39,626         37,309
-------------------------------------------------------------------------------------------------------
                 TOTAL LIABILITIES                                               95,984        119,892
-------------------------------------------------------------------------------------------------------

COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
     Preferred stock, par value $.01 per share:
       Authorized, 5,000,000 shares, no shares outstanding                            -              -
     Common stock, par value $1 per share:
       Authorized 20,000,000 shares in 2001 and 2000
        Issued 8,549,441and 8,543,393 shares in 2001 and
       2000, respectively.                                                        8,549          8,543
    Additional paid-in capital                                                   58,213         58,182
    Cumulative translation adjustment                                              (118)           239
    Retained earnings                                                            21,275         19,732
-------------------------------------------------------------------------------------------------------
                                                                                 87,919         86,696
Less treasury stock, 1,181,750 and 498,150 at cost in 2001
   and 2000, respectively                                                        (7,985)        (3,889)
-------------------------------------------------------------------------------------------------------
                 TOTAL STOCKHOLDERS' EQUITY                                      79,934         82,807
-------------------------------------------------------------------------------------------------------
                                                                               $175,918       $202,699
-------------------------------------------------------------------------------------------------------
                                                                               ------------------------
</TABLE>

See notes to consolidated financial statements.

                                      14






<PAGE>


                      Consolidated Statements of Cash Flows

<TABLE>
<CAPTION>
                                                                                        Year ended May 31,
------------------------------------------------------------------------------------------------------------------------
(In thousands)                                                                        2001           2000          1999
------------------------------------------------------------------------------------------------------------------------
<S>                                                                                <C>             <C>         <C>
Cash Flows from Operating Activities:
Net Income/(loss)                                                                  $ 1,543        $  (747)      $(6,323)
Adjustments to reconcile net income/(loss) to net cash
    provided by/(used in) operating activities:
          Depreciation and amortization                                              1,789          2,208           943
          Provision for uncollectible accounts                                         382            863            60
          Benefit from/(provision for) deferred income taxes                           245         (1,126)       (5,480)
          Cumulative effect of change in method of accounting                            -          1,522             -
Changes in operating assets and liabilities:
    Accounts receivable                                                              5,440        (34,219)        4,785
    Rough and polished inventories                                                   4,995         (7,285)          164
    Prepaid expenses and other current assets                                        4,175         (1,741)         (398)
    Other assets                                                                     5,045         (6,219)       (1,704)
    Accounts payable and other current liabilities                                  (5,587)        24,688            26
------------------------------------------------------------------------------------------------------------------------
Net cash provided by/(used in) operating activities                                 18,027        (22,056)       (7,927)
------------------------------------------------------------------------------------------------------------------------

Cash Flows from Investing Activities:
Capital expenditures                                                                (1,416)        (2,716)       (4,144)
------------------------------------------------------------------------------------------------------------------------
Net cash used in investing activities                                               (1,416)        (2,716)       (4,144)
------------------------------------------------------------------------------------------------------------------------

Cash flows from Financing Activities:
Increase/(decrease) in short-term borrowings                                       (20,638)        30,551         2,158
Increase/(decrease) in long-term borrowings                                          2,317         (1,266)       15,015
Purchase of treasury stock                                                          (4,096)        (2,676)       (1,191)
Proceeds from exercise of stock options                                                 37             41             4
                                                                             -------------------------------------------
Net cash provided by/(used in)financing activities                                 (22,380)        26,650        15,986
------------------------------------------------------------------------------------------------------------------------

Effect of cumulative translation adjustment                                           (357)           195            44
                                                                             -------------------------------------------
Net increase/(decrease) in cash and cash equivalents                                (6,126)         2,073         3,959
Cash and cash equivalents at beginning of year                                       7,254          5,181         1,222
                                                                             -------------------------------------------
Cash and cash equivalents at end of year                                           $ 1,128        $ 7,254       $ 5,181
------------------------------------------------------------------------------------------------------------------------
                                                                             -------------------------------------------

Supplemental Disclosures of Cash Flow Information:
Cash paid during the year for:
Interest                                                                           $ 4,193        $ 4,044       $ 2,872
Income taxes                                                                       $   231        $   156       $   129
------------------------------------------------------------------------------------------------------------------------
</TABLE>

See notes to consolidated financial statements.

                                      15






<PAGE>


                 Consolidated Statements Of Stockholders' Equity

<TABLE>
<CAPTION>
                                                  Additional  Cumulative                         Total
                                          Common  Paid-in    Translation   Retained  Treasury  Stockholders'
(In thousands, except share data)         Stock   Capital     Adjustment   Earnings    Stock     Equity
---------------------------------------------------------------------------------------------------------------
<S>                                      <C>      <C>        <C>         <C>         <C>         <C>
Balance, May 31, 1998                   $8,535     $58,145      $   -     $26,802     $   (22) $93,460
Comprehensive income/(loss):
    Net income/(loss)                        -           -          -      (6,323)          -   (6,323)
    Foreign currency translation             -           -         44           -           -       44
                                                                                               -------
Comprehensive income/(loss)                                                                     (6,279)
Exercise of stock options, 944
    shares issued                            -           4          -           -           -        4
Purchase of treasury stock,
     165,150 shares                          -           -          -           -      (1,191)  (1,191)
------------------------------------------------------------------------------------------------------

Balance, May 31, 1999                    8,535      58,149         44      20,479      (1,213)  85,994
Comprehensive income/(loss):
    Net income/(loss)                        -           -          -        (747)          -     (747)
    Foreign currency translation             -           -        195           -           -      195
                                                                                               -------
Comprehensive income/(loss)                                                                       (552)
Exercise of stock options, 7,900
    shares issued                            8          33          -           -           -       41
Purchase of treasury stock, 331,000
   shares                                    -           -          -           -      (2,676)  (2,676)
------------------------------------------------------------------------------------------------------

Balance, May 31, 2000                    8,543      58,182        239      19,732      (3,889)  82,807
------------------------------------------------------------------------------------------------------

Comprehensive income/(loss):
    Net income/(loss)                        -           -          -       1,543          -     1,543
    Foreign currency translation             -           -       (357)          -          -      (357)
                                                                                               -------
Comprehensive income/(loss)                                                                      1,186
Exercise of stock options, 6,048
    shares issued                            6          31          -           -           -       37
Purchase of treasury stock,
    683,600 shares                           -           -          -           -      (4,096)  (4,096)
------------------------------------------------------------------------------------------------------

Balance, May 31, 2001                   $8,549     $58,213      $(118)    $21,275     $(7,985) $79,934
------------------------------------------------------------------------------------------------------
</TABLE>

See notes to consolidated financial Statements.

                                      16







<PAGE>


                   Notes to Consolidated Financial Statements
                     Years ended May 31, 2001, 2000 and 1999


1.  Accounting Policies

a.  The Company and its principles of consolidation

         The Company and its subsidiaries are engaged in the cutting and
polishing of rough diamonds and selling of both polished and uncut rough
diamonds. The consolidated financial statements include the accounts of the
Company and its subsidiaries, all of which are wholly owned. All material
intercompany balances and transactions have been eliminated. In these notes to
consolidated financial statements, the years "2001", "2000" and "1999" refer to
the fiscal years ended May 31, 2001, 2000 and 1999, respectively.

b.  Use of estimates

         The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to make
certain estimates and assumptions that could affect the amounts reported in the
financial statements and accompanying notes. Actual results could differ from
these estimates.

c.  Sales and accounts receivable

         The Company's net sales to customers in each of the following regions
for the years ended May 31, 2001, 2000 and 1999 are set forth below:

<TABLE>
<CAPTION>
                                            2001              2000             1999
-------------------------------------------------------------------------------------
<S>                                          <C>               <C>               <C>
United States                                28%               23%               31%
Far East                                      9%                8%                8%
Europe, Israel & other                       63%               69%               61%
-------------------------------------------------------------------------------------
                                            100%              100%              100%
-------------------------------------------------------------------------------------
</TABLE>

         No single customer of the Company accounted for 10% or more of the
Company's net sales for the fiscal years ended May 31, 2001, 2000 and 1999.
Credit is extended based on an evaluation of each customer's financial condition
and generally collateral is not required on the Company's receivables. Revenue
is recognized when goods are delivered and title and risk of ownership have
passed to the buyer.

d.  Cash and cash equivalents

         The Company considers all highly liquid investments with a maturity of
three months or less when purchased to be cash equivalents.

e.  Inventories

         Inventories are stated at the lower of cost, using the first-in,
first-out method, or market.

                                      17








<PAGE>


f.  Property, plant and equipment

         Property, plant and equipment is stated at cost less accumulated
depreciation and amortization. Depreciation and amortization is computed using
the straight-line method over the shorter of asset lives or lease terms.

g.  Asset impairments

         The Company records impairment losses on long-lived assets used in
operations when events and circumstances indicate that the assets might be
impaired and the undiscounted cash flows estimated to be generated by the
related assets are less than the carrying amounts of those assets.

h.  Foreign currency

         All purchases of rough diamonds worldwide are denominated in U.S.
dollars. All of the Company's foreign sales are denominated in U.S. dollars,
with the exception of those sales made by the Company's subsidiary, Lazare
Kaplan Japan, which are denominated in Japanese yen. The functional currency for
Lazare Kaplan Japan is the Japanese yen and the Company recognizes foreign
currency translation adjustments with regard to the activities of Lazare Kaplan
Japan which are shown as a component stockholders' equity in the accompanying
balance sheets.

i.  Advertising

         Advertising costs are expensed as incurred and were $2,615,000,
$2,480,000 and $1,214,000 in 2001, 2000 and 1999, respectively.

j.  Income taxes

         The Company provides for income taxes in accordance with Statement of
Financial Accounting Standards No. 109, "Accounting for Income Taxes", whereby
deferred income taxes are determined based upon the enacted income tax rates for
the years in which these taxes are estimated to be payable or recoverable.
Deferred income taxes reflect the net tax effects of (a) temporary differences
between the carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes, and (b) operating loss
carryforwards. Realization of the net deferred tax assets is dependent on
generating sufficient taxable income prior to the expiration of net operating
loss carryforwards. Although realization is not assured, management believes it
is more likely than not that the net deferred tax asset will be realized. The
amount of the net deferred tax asset considered realizable, however, could be
reduced in the near term if estimates of future taxable income during the
carryforward period are reduced.

         The Company and its domestic subsidiaries file a consolidated income
tax return. The Company's foreign subsidiaries are not subject to Federal income
taxes and their provisions for income taxes have been computed based on the
effective tax rates, if any, in the foreign countries.

                                      18






<PAGE>


         There were no taxable dividends paid to the Company from foreign
subsidiaries during 2001.

k.  Earnings/(Loss) per share

         The Company computes basic earnings per share based upon the weighted
average number of common shares outstanding, and diluted earnings per share
based upon the weighted average number of common shares outstanding including
the impact of dilutive stock options.

l.  Risks and Uncertainties

         The world's sources of rough diamonds are highly concentrated in a
limited number of countries. Varying degrees of political and economic risk
exist in many of these countries. As a consequence, the diamond business is
subject to various sovereign risks beyond the Company's control, such as changes
in laws and policies affecting foreign trade and investment. In addition, the
Company is subject to various political and economic risks, including the
instability of foreign economies and governments, labor disputes, war and civil
disturbances and other risks that could cause production difficulties or
stoppages, restrict the movement of inventory or result in the deprivation or
loss of contract rights or the taking of property by nationalization or
expropriation without fair compensation.

         The Company's business is dependent upon the availability of rough
diamonds. Based upon published reports, the Company believes that approximately
60% of the world's current diamond output is sold by De Beers Centenary AG and
its affiliated companies. Although De Beers has historically been one of the
Company's major suppliers of rough diamonds, the Company has successfully
diversified its sources of supply by entering into arrangements with other
primary source suppliers and has been able to supplement its rough diamond needs
by purchasing supplies in the secondary market. While the Company believes that
it has good relationships with its suppliers and that its sources of supply are
sufficient to meet its present and foreseeable needs, the Company's rough
diamond supplies, and therefore, its manufacturing capacity, could be adversely
affected by political and economic developments in producing countries over
which it has no control. While the Company believes that alternative sources of
supply may be available, any significant disruption of the Company's access to
its primary source suppliers could have a material adverse effect on its ability
to purchase rough diamonds.

         Further, through its control of the world's diamond output, De Beers
can exert significant control over the pricing of rough and polished diamonds. A
large rapid increase in rough diamond prices could materially adversely affect
the Company's revenue and operating margins if the increased cost of the rough
diamonds could not be passed along to its customers in a timely manner.
Alternatively, any rapid decrease in the price of rough or polished diamonds
could have a material adverse affect on the Company in terms of inventory losses
and lower margins.

         Throughout 1999 and 2000, the DTC, a De Beers affiliate, conducted a
strategic review of its overall business model. In July 2000, the DTC announced
significant changes in its approach to rough diamond marketing. In brief, the
DTC stated that it will stop open market purchases and alter its market control
and pricing policies. Henceforth, the DTC has said it will focus on selling its
own mining productions through its "supplier of choice" marketing programs.
These policy changes are intended to modernize business practices within the
industry, shorten channels of distribution, lower working diamond stocks, supply
clients with downstream distribution and encourage additional investment in
marketing and advertising programs. The Company believes it is well positioned
to benefit from these changes in the DTC approach to diamond marketing. However,
there can be no assurance that this policy change will not have a material
adverse effect on the Company's

                                      19








<PAGE>


operations.

         In August 2001 the European Commission issued a statement of objections
which identify a number of restrictions and trading conditions in the Supplier
of Choice agreement which appear to violate European competition law, and which
can therefore not benefit from exemption under Article 81(3). A Statement of
Objections is a preliminary step in antitrust proceedings which does not
prejudge the Commission's final decision. At this point, no conclusion can be
reached by the Company as to the ultimate outcome of the Commission's ruling.

m.  Stock Incentive Plans

         The Company accounts for its stock-based compensation plans using the
intrinsic value method prescribed in Accounting Principles Board Opinion No. 25
"Accounting for Stock Issued to Employees" and related interpretations and makes
certain pro forma disclosures (see Note 10).

n.  Comprehensive Income/(Loss)

         The Company reports "Comprehensive Income/(Loss)" in accordance with
Statement of Financial Accounting Standards No. 130, which requires foreign
currency translation adjustments to be included in other comprehensive income.
For the years ended May 31, 2001 and 2000, total comprehensive income/(loss) was
$1,186,000 and ($552,000), respectively.

o.  New Accounting Pronouncements

         In June 1998, the Financial Accounting Standards Board issued Statement
No.133, "Accounting for Derivative Instruments and Hedging Activities," and its
amendments Nos. 137 and 138, ("Statements 133") in June 1999 and June 2000
respectively. Statement 133 requires the Company to recognize all derivatives on
the balance sheet at fair value. Derivatives that are not hedges must be
adjusted to fair value through income. If the derivative is a hedge, depending
on the nature of the hedge, a change in fair value of the derivative is either
offset against the change in fair value of the hedged item and reflected in
earnings (fair value hedge), or recognized in other comprehensive income until
the hedged item is reflected in earnings (cash flow hedge). The ineffective
portion (that is, the change in fair value of the derivative that does not
offset the change in fair value of the hedged item) of a derivative's change in
fair value will be immediately recognized in earnings. The Company is required
to adopt Statement 133 in the first quarter of fiscal year ended May 31, 2002
and does not believe that it will have a material impact on its results of
operations.

         In July, 2001, the Financial Accounting Standards Board issued
Financial Accounting Standards No. 142, Goodwill and Other Intangible Assets
("Statements 142"). Under Statement 142, goodwill and indefinite lived
intangible assets are no longer amortized but are reviewed annually (or more
frequently if impairment indicators arise) for impairment. The amortization
provisions of Statement 142 apply to goodwill and intangible assets acquired
after June 30, 2001. With respect to goodwill and intangible assets acquired
prior to July 1, 2001, companies are required to adopt statement 142 in their
fiscal year beginning after December 15, 2001. Early adoption is permitted for
companies with fiscal years beginning after March 15, 2001 provided that their
first quarter financial statements have not been issued. The Company is not
required to adopt this new standard until fiscal year ended May 31,2003 and is
currently evaluating its impact.

P.  Reclassifications

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

                                      20







<PAGE>


2.  Property, Plant and Equipment

         Property, plant and equipment consists of (in thousands):

<TABLE>
<CAPTION>
                                                         May 31,
------------------------------------------------------------------------------
                                                 2001               2000
------------------------------------------------------------------------------
<S>                                             <C>               <C>
Land and buildings                             $ 2,715            $ 2,693
Leasehold improvements                           2,210              2,209
Machinery, tools and equipment                   5,641              4,924
Furniture and fixtures                           1,853              1,877
Computer hardware and equipment                  7,516              6,877
                                                19,935             18,580

Less accumulated depreciation
  and amortization                              10,541              9,026
------------------------------------------------------------------------------
                                               $ 9,394            $ 9,554
------------------------------------------------------------------------------
</TABLE>

<TABLE>
<S>                                                              <C>
Depreciation and amortization rates:
Buildings                                                              2% to 3.7%
Leasehold improvements                                                3.7% to 20%
Machinery, tools and equipment                                         10% to 25%
Furniture and fixtures                                                 10% to 20%
Computer hardware and equipment                                        10% to 33%
</TABLE>

         Depreciation expense for 2001, 2000 and 1999 was $1,576,000, $1,313,000
and $727,000, respectively.

                                      21








<PAGE>


3.  Income Taxes

         The items comprising the Company's net deferred tax assets are as
follows (in thousands):

<TABLE>
<CAPTION>
                                                            May 31,
--------------------------------------------------------------------------------
                                                        2001               2000
--------------------------------------------------------------------------------
<S>                                                 <C>                <C>
Deferred tax assets:
  Operating loss and other
    carryforwards                                    $ 6,618            $ 9,181
  Other                                                4,062              2,129
Deferred tax liabilities:
   Depreciation                                          120                265
--------------------------------------------------------------------------------
                                                     $10,800             11,045
Less: Valuation allowance                               (133)              (133)
--------------------------------------------------------------------------------
Net deferred tax assets                              $10,667            $10,912
--------------------------------------------------------------------------------
</TABLE>


         The income tax provision/(benefit) is comprised of the following (in
thousands):

<TABLE>
<CAPTION>
                                                  Year ended May 31,
--------------------------------------------------------------------------------
                                           2001           2000            1999
--------------------------------------------------------------------------------
<S>                                          <C>            <C>          <C>
Current:
Federal                                    $375           $  48         $  --
State and local                              93             327              28
Foreign                                     145              73            --
--------------------------------------------------------------------------------
                                            613             448              28
--------------------------------------------------------------------------------

Deferred:
Federal, state and local                    245          (1,126)         (5,280)
--------------------------------------------------------------------------------
                                           $858         $  (678)        $(5,252)
--------------------------------------------------------------------------------
</TABLE>

         Income/(loss) before income taxes from the Company's domestic and
foreign operations was $1,588,000 and $813,000, respectively for the year ended
May 31, 2001, ($408,000) and $505,000, respectively for the year ended May 31,
2000 and ($11,102,000) and ($473,000), respectively for the year ended May 31,
1999.

                                      22









<PAGE>


         The tax provision/(benefit) is different from amounts computed by
applying the Federal income tax rate to the income before taxes as follows (in
thousands):

<TABLE>
<CAPTION>
--------------------------------------------------------------------------------
                                              2001         2000           1999
--------------------------------------------------------------------------------
<S>                                          <C>          <C>           <C>
Tax provision/(benefit)
 at statutory rate                            $ 816       $    33       $(3,936)
(Decrease)/increase in
 taxes resulting from:
 Differential attributable
   to foreign operations                       (131)         (174)          (58)
 State and local taxes,
   net of Federal benefit                       145           164          (578)
 Permanent items                                 28        (1,001)         --
 Change in valuation allowance
   for deferred tax asset                      --             300          (680)
--------------------------------------------------------------------------------
Actual tax provision/(benefit)                $ 858       $  (678)      $(5,252)
--------------------------------------------------------------------------------
</TABLE>

         The Company has available Federal net operating losses to offset future
taxable income which expire as follows (in thousands):


<TABLE>
<CAPTION>
                                                                        Net
                                                                     Operating
Year                                                                   Losses
--------------------------------------------------------------------------------
<S>                                                                <C>
2013                                                                 $ 2,054
2019                                                                  12,268
2020                                                                     298
--------------------------------------------------------------------------------
                                                                     $14,620
--------------------------------------------------------------------------------
</TABLE>


         In addition, the Company has New York State and New York City net
operating loss carryforwards of approximately $6,597,000 each, expiring in
2019. The Company has Puerto Rico net operating loss carryforwards of
approximately $1,800,000 expiring from 2002 through 2005.

4.  Accounts Payable and Other Current Liabilities

Accounts payable and other current liabilities consist of (in thousands):

<TABLE>
<CAPTION>
                                          2001          2000
---------------------------------------------------------------
<S>                                     <C>           <C>
Accounts payable                        $ 2,831        $10,745
Accrued expenses                         41,456         39,129
---------------------------------------------------------------
                                        $44,287        $49,874
---------------------------------------------------------------
</TABLE>


5.  Lines of Credit

         The Company has a long-term unsecured, revolving loan agreement with
two banks. The agreement, as amended, provides that the Company may borrow up to
$40,000,000 in the aggregate, at an interest rate of any of a) one-eighth of one
percent above the bank's prime rate, b) 160 basis points above the London
Interbank Offered Rate (LIBOR), or c) 160 basis points above the bank's cost of
funds rate. The applicable interest rate is contingent upon the method of
borrowing selected by the Company. The term of the loan is through September 1,
2002. The proceeds of this facility are available for the Company's working
capital needs. The revolving loan agreement contains certain

                                      23







<PAGE>


provisions that require, among other things, (a) maintenance of defined levels
of current working capital and annual cash flow, (b) limitations of borrowing
levels, capital expenditures, and rental obligations and (c) limitations on
restricted payments, including dividends. As of May 31, 2001 and 2000 there was
an aggregate balance outstanding of $39,175,000 and $38,135,000, respectively,
under this agreement. At May 31, 2001, $9,175,000 of the outstanding balance was
classified as current. The weighted average interest rate during 2001 and 2000
on the Company's revolving loan was 8.38% and 7.43%, respectively.

         In December 1999, a subsidiary of the Company borrowed, at a fixed
exchange rate, 1.1 billion Japanese yen under a loan facility with one of its
primary commercial bank lenders. The Company repaid 96,250,000 yen during 2000
and repaid the balance of the loan due during 2001. In connection therewith, in
November 2000 a subsidiary of the Company entered into a two year loan facility
which enables the subsidiary to borrow up to 1.1 billion Japanese yen at an
interest rate 1% above Japanese LIBOR. The loan contains provisions that, among
other things, require the Company to maintain a minimum debt to equity ratio.
Borrowings under the facility are available for general working capital purposes
and are guaranteed by the Company. At May 31, 2001, the outstanding balance of
1.1 billion Japanese yen ($9,072,000) was classified as noncurrent.

         In June 2000, the Company entered into an interest rate swap agreement
with one of its primary commercial bank lenders which had the effect of
converting the December 1999 loan to a fixed interest rate loan. The swap
agreement which expires in December 2001 had an immaterial effect on the result
of operations in 2000 and 2001.

         The Company has a $30 million and a $10 million unsecured line of
credit with a bank. Borrowings under the 30 million line bear interest at a rate
150 basis points above the bank's base rate. Borrowings under the $10 million
line bear interest at a rate 160 basis points above the 90 day LIBOR. As of May
31, 2001, the balance outstanding under both lines was $2.9 million. Borrowings
under these lines are available for the Company's working capital requirements.

6.  Senior Notes

         During 2001 and 2000, the Company had outstanding unsecured 9.97%
Senior Notes. The notes were fully repaid on May 15, 2001. The balance
outstanding on May 31, 2000 was $4,290,000.

7.  Legal Settlement and Related Costs

         A settlement agreement, dated October 18, 1999, was signed which
settled all of the various disputes among the Company and other related parties
and International Diamond Traders CY B.V.B.A. ("IDT") and Avi Neumark, the
President and controlling stockholder of IDT. The Company agreed to pay the
parties the sum of $3,275,000 over a period of 40 months. The balance
outstanding on May 31, 2001 and 2000 was $1,317,000 and $1,975,000,
respectively. The total cost of the settlement to the Company during the year
ended May 31, 2000 was $5,048,000, including related legal and other expenses.

8.  Realignment Costs and Other Charges

a.  Japanese Distribution

         In 1999, the Company changed the nature of its distribution in Japan by
assuming control of the distribution of its products and opening its own

                                      24








<PAGE>


office. As a result, the Company recorded a charge of approximately $5.6 million
in 1999.

         During 2000, the Company realized approximately $3.0 million as
beneficiary of certain life insurance policies which arose from its relationship
with its former Japanese distributor. The Company also incurred $1.1 million of
additional costs relating to the realignment of its Japanese operations.

b.  Angola

         On December 31, 1999, the Company's license to purchase diamonds in
Angola expired. Through February 2000, the Company continued to operate its
Angolan buying operations. During the fourth quarter of 2000, the Company
terminated its operations in Angola and recorded charges relating to such
operations of $1.1 million.

c.  Other Charges

         The Company recorded charges of $2.0 million in the fourth quarter of
2000 primarily related to year-end inventory adjustments.

         In aggregate, during 2000, the life insurance proceeds net of
realignment costs and other charges resulted in a decrease of approximately $0.8
million in selling, general and administrative expenses and an increase of
approximately $2.0 million in cost of sales. In 1999, the net effect was an
increase of $5.6 million in selling, general and administrative expenses.

9.  Cumulative Effect of Change in Method of Accounting for Start-up Costs

         On June 1, 1999, the Company adopted Statement of Position (SOP) 98-5,
"Reporting on the Costs of Start-Up Activities", and recorded a non-cash charge
of $1,522,000 (net of tax benefit of $671,000). This amount is primarily
comprised of a) the start-up expenses related to the operations of the
Company's, wholly owned subsidiary, Pegasus Overseas Ltd. and the signing and
implementation of its ten year agreement with a wholly owned subsidiary of
General Electric Company, and b) the start-up expenses related to the signing
and implementation of the March 1999 Cooperation Agreement with AK ALROSA of
Russia. The adoption of SOP 98-5 did not have a material effect on income from
continuing operations for the year ended May 31, 2001 or 2000.

10.  Stock Incentive Plans

         A Stock Option Incentive Plan was approved by the Board of Directors on
March 11, 1988 (the 1988 Plan). The 1988 Plan has reserved 650,000 shares of the
common stock of the Company for issuance to key employees of the Company

                                      25








<PAGE>


and its subsidiaries. No future grants may be made under the 1988 Plan, although
outstanding options may continue to be exercised.

         A Long-Term Stock Incentive Plan was approved by the Board of Directors
on April 10, 1997 (the 1997 Plan). The 1997 Plan has reserved 600,000 shares of
the common stock of the Company for issuance to key employees of the Company and
its subsidiaries. An increase to 1,350,000 shares reserved for issuance under
the 1997 Plan was approved by the Board of Directors on May 16, 2001 and is
subject to stockholder approval at the 2001 Annual Meeting.

         The purchase price of each share of common stock subject to an
incentive option under each of the plans is not to be less than 100 percent of
the fair market value of the stock on the day preceding the day the option is
granted (110 percent for 10 percent beneficial owners). The Stock Option
Committee determines the period or periods of time during which an option may be
exercised by the participant and the number of shares as to which the option is
exercisable during such period or periods, provided that the option period shall
not extend beyond ten years (five years in the case of 10 percent beneficial
owners) from the date the option is granted.

         The Company does not recognize compensation expense when the exercise
price of the Company's stock options equals the market price of the underlying
stock on the date of the grant. Under Statement of Financial Accounting
Standards No. 123 "Accounting for Stock-Based Compensation", pro forma
information regarding net income and earnings per share is required as if the
Company had accounted for its employee stock options under the fair value method
of the Statement. For purposes of pro forma disclosures, the Company estimated
the fair value of stock options granted in 2001, 2000 and 1999 at the date of
the grant using the Black-Scholes option pricing model. The estimated fair value
of the options is amortized as an expense over the options' vesting period for
the pro forma disclosures.

         The Black-Scholes option valuation model was developed for use in
estimating the fair value of traded options which have no vesting restrictions
and are fully transferable. In addition, option valuation models require the
input of highly subjective assumptions including the expected stock price
volatility. Because the Company's employee stock options have characteristics
significantly different from those traded options, and because changes in the
subjective input assumptions can materially affect the fair value estimate in
management's opinion, the existing models do not necessarily provide a reliable
single measure of the fair value of its employee stock options.

         The following summarizes the assumptions used to estimate the fair
value of stock options granted in each year and certain pro forma information:


<TABLE>
<CAPTION>
----------------------------------------------------------------------------------------
                                                     2001        2000          1999
----------------------------------------------------------------------------------------
<S>                                                <C>         <C>           <C>
Risk-free interest rate                              6.00%       6.00%         6.00%
Expected option life                                 5 years     5 years       5 years
Expected volatility                                 38.20%      35.80%        37.30%
Expected dividends per share                          $0.00       $0.00         $0.00
Weighted average estimated fair value
  per share of options granted at market
  price                                               $2.15        $3.00         $3.13
Weighted average estimated fair value
  per share of options granted above market
  price                                                   -        $2.66             -
Pro forma net income/(loss) (000's)                  $1,350      $(1,106)      $(6,857)
Pro forma basic earnings/(loss) per share            $ 0.18      $ (0.13)      $ (0.81)
Pro forma diluted earnings/(loss)
  per share                                          $ 0.18      $ (0.13)      $ (0.81)
----------------------------------------------------------------------------------------
</TABLE>

         As any options granted in the future will also be subject to the fair
value pro forma calculations, the pro forma adjustments for 2001, 2000 and 1999
may not be indicative of future years.

                                      26









<PAGE>


         A summary of the Plans' activity for each of the three years in the
period ended May 31, 2001 is as follows:

<TABLE>
<CAPTION>
                                       Number                               Weighted average
                                     of shares       Option price            price per share
----------------------------------------------------------------------------------------------
<S>                                  <C>             <C>                       <C>
Outstanding - June 1, 1998           635,324          $5.125-$16.225            $10.456
Options expired                       (8,834)         $6.375-$ 7.625            $ 7.578
Options issued                         6,500          $7.375-$ 7.375            $ 7.375
Options exercised                     (5,666)         $6.000-$ 6.375            $ 6.044
----------------------------------------------------------------------------------------------
Outstanding - May 31, 1999           627,324          $5.125-$16.225            $10.505
Options expired                       (1,300)         $7.625-$10.375            $ 9.318
Options issued                       141,300          $7.000-$ 9.000            $ 7.414
Options exercised                     (7,900)         $5.125-$ 5.125            $ 5.125
----------------------------------------------------------------------------------------------
Outstanding - May 31, 2000           759,424          $5.125-$16.225            $ 9.988
----------------------------------------------------------------------------------------------
Outstanding - May 31, 2001
Options expired                      (92,100)         $7.000-$14.750            $ 9.523
Options issued                       101,800          $5.000-$ 8.438            $ 5.168
Options exercised                    (30,600)         $5.125-$ 6.375            $ 6.150
Outstanding-May 31,2001              738,524          $5.000-$16.225            $ 9.830
----------------------------------------------------------------------------------------------
Exercisable options                  542,423
                                     -------
----------------------------------------------------------------------------------------------
</TABLE>

         The following table summarizes information about stock options at May
31, 2001:

<TABLE>
<CAPTION>
Outstanding stock options                         Exercisable stock options
-------------------------                         -------------------------
                                     Weighted
                                     average                    Weighted
                                    remaining                   average
Range of                           contractual                  exercise
prices            Shares              life          Shares        price
---------------------------------------------------------------------------
<S>               <C>              <C>              <C>         <C>
$ 5.000-$6.375    220,381          5.75 years       123,581     $ 5.90
$ 7.000-$8.438    157,143          6.29 years        64,509     $ 7.41
$ 9.000-$11.413   157,500          4.83 years       150,833     $10.76
$14.750-$16.225   203,500          2.39 years       203,500     $15.76
---------------------------------------------------------------------------
</TABLE>

11. Commitments and Contingencies

         Future minimum payments (excluding sub-lease income) under
noncancelable operating leases with initial terms of more than one year consist
of the following at May 31, 2001 (in thousands):

<TABLE>
<CAPTION>
                                             Operating
Year                                         leases
------------------------------------------------------
<S>                                          <C>
2002                                          $ 539
2003                                            355
2004                                             93
------------------------------------------------------
                                              $ 987
------------------------------------------------------
</TABLE>

         Rental expense, including additional charges paid for increases in real
estate taxes and other escalation charges and credits for the years ended May
31, 2001, 2000 and 1999, was approximately $878,000, $842,000 and $542,000,
respectively.

12. Profit Sharing Plan

         The Company has a profit sharing and retirement plan subject to Section
401(k) of the Internal Revenue Code. The plan covers all full-time employees in
the United States and Puerto Rico who complete at least one year of service.
Participants may contribute up to a defined percentage of their annual
compensation through salary deductions. The Company intends to match

                                      27






<PAGE>


employee contributions in an amount equal to $0.50 for every pretax dollar
contributed by the employee up to 6% of the first $20,000 of compensation,
provided the Company's pretax earnings for the fiscal year that ends in the plan
year exceed $3,500,000. The Company did not make a matching contribution during
the last three years.

13. Geographic Segment Information

         Revenue, gross profit and income/(loss) before income tax provision and
minority interest for each of the three years in the period ended May 31, 2001
and identifiable assets at the end of each of those years, classified by
geographic area, which was determined by where sales originated from and where
identifiable assets are held, were as follows (in thousands):





                                      28






<PAGE>


<TABLE>
<CAPTION>
                                         North                             Far       Elimini-      Consoli-
                                        America      Europe     Africa     East      nations        dated
------------------------------------------------------------------------------------------------------------
                                       ---------------------------------------------------------------------
<S>                                      <C>         <C>       <C>       <C>        <C>           <C>
Year ended May 31, 2001
-----------------------
Net sales to unaffiliated customers    $128,021    $114,606   $ 12,093   $16,066    $       -      $270,786
Transfers between geographic areas       46,545      25,330          -       461      (72,336)           -
                                       ---------------------------------------------------------------------
        Total revenue                  $174,566    $139,936   $ 12,093   $16,527    $ (72,336)     $270,786
                                       ---------------------------------------------------------------------
 Gross profit                          $ 23,166    $  2,177   $  2,257   $ 2,434    $       -      $ 30,034
 Income/(loss)from continuing
     operations before income tax
     provision                         $  3,032    $     98   $  1,166   $(1,895)   $       -      $  2,401
                                       ---------------------------------------------------------------------

Identifiable assets at May 31, 2001    $154,187    $ 35,886   $ 18,395   $ 9,926    $ (42,476)     $175,918
------------------------------------------------------------------------------------------------------------
                                       ---------------------------------------------------------------------

Year ended May 31, 2000
-----------------------
Net sales to unaffiliated customers    $106,848    $236,327   $    208   $17,751    $       -      $361,134
Transfers between geographic areas       25,275       6,646    132,627         -     (164,548)           -
                                       ---------------------------------------------------------------------
        Total revenue                  $132,123    $242,973    132,835   $17,751    $(164,548)     $361,134
                                       ---------------------------------------------------------------------
 Gross profit                          $ 23,650    $  1,560   $    498   $ 3,666            -      $ 29,374
 Income/(loss)from continuing
     operations before income tax
     provision and cumulative effect
     of change in accounting principle $  1,915    $   (172)  $ (1,121)  $  (525)           -      $     97
                                       ---------------------------------------------------------------------

Identifiable assets at May 31, 2000    $167,472    $ 51,982   $ 12,635   $13,479    $ (42,869)     $202,699
------------------------------------------------------------------------------------------------------------
                                       ---------------------------------------------------------------------

Year ended May 31, 1999
-----------------------
Net sales to unaffiliated customers    $113,017    $ 98,339   $ 36,206   $14,291    $       -     $261,853
Transfers between geographic areas       22,798       9,432     70,913         -     (103,143)           -
                                       ---------------------------------------------------------------------
Total revenue                          $135,815    $107,771   $107,119   $14,291    $(103,143)     $261,853
                                       ---------------------------------------------------------------------
Gross profit/ (loss)                   $ 11,791    $    689   $ (3,001)  $ 2,692    $    (353)     $ 11,818
Income/(loss)from continuing
     operations before income tax
     provision and minority interest   $ (7,361)   $    (96)  $ (3,713)  $   (52)   $    (353)     $(11,575)
                                       ---------------------------------------------------------------------

Identifiable assets at May 31, 1999    $145,493    $ 22,602   $ 34,096   $ 9,719    $ (59,997)     $151,913
------------------------------------------------------------------------------------------------------------
                                       ---------------------------------------------------------------------
</TABLE>

         The identifiable assets which are included in the elimination primarily
represent advances to affiliates. These advances are included therein since the
Company, which is the parent company, finances the operations of these
affiliates.

                                      29






<PAGE>


         Revenue and gross profit for each of the three years in the period
ended May 31, 2001 classified by product were as follows (in thousands):

<TABLE>
<CAPTION>
                                     Polished      Rough       Total
----------------------------------------------------------------------
<S>                                 <C>          <C>          <C>
Year ended May 31, 2001
Net sales                           $193,805     $ 76,981     $270,786
                                    ----------------------------------
Gross Profit                        $ 28,294     $  1,740     $ 30,034
----------------------------------------------------------------------
Year ended May 31, 2000
Net sales                           $138,568     $222,566     $361,134
                                    ----------------------------------
Gross profit                        $ 23,333     $  6,041     $ 29,374
----------------------------------------------------------------------
Year ended May 31, 1999
Net sales                           $112,573     $149,280     $261,853
                                    ----------------------------------
Gross profit                        $ 14,415     $ (2,597)    $ 11,818
----------------------------------------------------------------------
</TABLE>

14. Treasury Stock

         The Board of Directors authorized the repurchase, at management's
discretion, of up to 2,000,000 shares of the Company's common stock from time to
time through April 16,2002. During 2001 and 2000, the Company purchased 683,600
and 331,000 shares, respectively, of its common stock which are shown as a
reduction of stockholders' equity in the accompanying balance sheets.

15. Quarterly Results of Operations (Unaudited)

         The following is a summary of the results of operations for the years
ended May 31, 2001 and 2000 (in thousands, except per share data):

<TABLE>
<CAPTION>
                                                          Quarter
--------------------------------------------------------------------------------------
                                    First         Second         Third        Fourth
--------------------------------------------------------------------------------------
<S>                                 <C>           <C>           <C>           <C>
2001
----
Net sales                           $77,575       $ 78,317      $ 55,064      $59,830
Gross profit                        $ 8,704       $  9,016      $  6,935      $ 5,379
Net income/(loss)                   $ 1,033       $    725      $    250      $  (465)
Basic earnings/(loss) per share     $  0.13       $   0.09      $   0.03      $ (0.06)
Diluted earnings/(loss) per share   $  0.13       $   0.09      $   0.03      $ (0.06)

2000
----
Net sales                           $69,742       $111,906      $106,238      $73,248
Gross profit                        $ 6,492       $  8,195      $  8,875      $ 5,812
Income/(loss) before cumulative
 effect of change in accounting
 principle                          $ 1,016 (1)  ($    861)(2)  $  2,834(3)  ($ 2,214)(4)
Net income/(loss)                  ($   506)(1)  ($    861)(2)  $  2,834(3)  ($ 2,214)(4)
Basic earnings/(loss) per share    ($  0.06)     ($   0.10)     $   0.35     ($  0.27)
Diluted earnings/(loss) per share  ($  0.06)     ($   0.10)     $   0.35     ($  0.27)
</TABLE>

(1) Includes $1.5 million (net of tax) related to the cumulative effect of a
change in method of accounting and $0.5 million (net of tax) of costs associated
with a legal settlement.

(2) Includes $2.6 million (net of tax) of costs associated with a legal
settlement.

(3) Includes $1.6 million of benefits from certain life insurance policies.

(4) Includes $1.4 million of benefits from certain life insurance policies
offset by $2.6 million (net of tax) in costs to realign operations and other
charges.

                                      30






<PAGE>


                          Independent Auditors' Report


Board of Directors and Stockholders
Lazare Kaplan International Inc.


         We have audited the accompanying consolidated balance sheets of Lazare
Kaplan International Inc. and subsidiaries as of May 31, 2001 and 2000 and the
related consolidated statements of operations, stockholders' equity and cash
flows for each of the three years in the period ended May 31, 2001. These
financial statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.

         We conducted our audits in accordance with auditing standards generally
accepted in the United States. Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements. An
audit also includes assessing the accounting principles used and significant
estimates made by management, as well as evaluating the overall financial
statement presentation. We believe that our audits provide a reasonable basis
for our opinion.

         In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the consolidated financial position of
Lazare Kaplan International Inc. and subsidiaries at May 31, 2001 and 2000 and
the consolidated results of their operations and their cash flows for each of
the three years in the period ended May 31, 2001, in conformity with accounting
principles generally accepted in the United States.



                                            Ernst & Young LLP


New York, New York
August 9, 2001


                                      31





<PAGE>



Corporate Information



Corporate Headquarters

529 Fifth Avenue
New York, New York 10017
Telephone (212) 972-9700


Directors and Officers

Maurice Tempelsman
Director;
Chairman of the Board

Leon Tempelsman
Director;
Vice Chairman of the Board and President

Lucien Burstein
Director;
Secretary
Partner
Warshaw Burstein Cohen Schlesinger & Kuh, LLP (attorneys)

Myer Feldman
Director;
Attorney, self-employed

Robert A. Del Genio
Director;
Co-Founder
Conway, Del Genio, Gries & Company, LLC

Robert Speisman
Director;
Senior Vice President-Sales

William H. Moryto
Vice President and
Chief Financial Officer


                                      32





<PAGE>




Registrar and Transfer Agent

ChaseMellon Transfer Services, LLC
85 Challenger Road
Overpeck Center
Ridgefield Park, NJ 07660


Counsel

Warshaw Burstein Cohen Schlesinger & Kuh, LLP
555 Fifth Avenue
New York, New York 10017


Independent Auditors

Ernst & Young LLP
787 Seventh Avenue
New York, New York 10019





                                      33