LAZARE KAPLAN INTERNATIONAL INC.

2007
ANNUAL REPORT

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Lazare Kaplan International Inc. 2007 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® 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, sparkle and fire. In
addition, Lazare Kaplan also cuts and polishes fine make (non-ideal) commercial
diamonds and high pressure, high temperature (HPHT) processed diamonds sold
under the Bellataire® diamonds brand name. These stones are sold through
wholesalers and distributors and, to a growing extent, through retail jewelers.
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, 2007 as
filed with the Securities and Exchange Commission, will be made available to
stockholders without charge. Requests should be directed to the Controller, Mr.
Ned Cochrane, Lazare Kaplan International Inc., 19 West 44th Street,
New York, New York 10036.

Annual MeetingNovember 8, 2007
10 A.M.
Sofitel Hotel
45 West 44th Street
Second floor, Trocadero Room
New York, New York 10036

Market Prices of Common Stock by Fiscal
Quarter

|       |  |              |   |       |  |  |  |   |      |  | 
|------ |  | ------------ | - | ----- |  |  |  | - | ---- |  | 
|       |  | Fiscal
 2007 |  
|       |  |              |  
|       |  | High         |   | Low   | 
|       |  |              |   |       | 
|First  |  |              | $ | 9.70  |  |  |  | $ | 7.88 |  | 
|Second |  |              |   | 9.98  |  |  |  |   | 7.61 |  | 
|Third  |  |              |   | 10.95 |  |  |  |   | 8.40 |  | 
|Fourth |  |              |   | 10.10 |  |  |  |   | 7.56 |  | 

|       |  |             |   |       |  |  |  |   |      |  | 
|------ |  | ----------- | - | ----- |  |  |  | - | ---- |  | 
|       |  | Fiscal 2006 |  
|       |  |             |  
|       |  | High        |   | Low   | 
|       |  |             |   |       | 
|First  |  |             | $ | 11.65 |  |  |  | $ | 8.55 |  | 
|Second |  |             |   | 10.95 |  |  |  |   | 8.12 |  | 
|Third  |  |             |   | 8.95  |  |  |  |   | 7.40 |  | 
|Fourth |  |             |   | 8.79  |  |  |  |   | 7.58 |  | 

As of August
20, 2007 there were 1,710 stockholders of record of the 8,259,300 issued and
outstanding shares of the common stock of the Company, including CEDE & Co.
and other institutional holders who held an aggregate of 3,119,972 shares of
common stock as nominees for an undisclosed number of beneficial holders.

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To Our Shareholders:

The Companys financial year ended May 31, 2007 was one of continuing challenge for LKI and transition for the industry. While overall economic growth in by far the worlds largest market
for polished diamonds, the U.S., remained relatively healthy, progressive monetary tightening and the appearance of strains in certain economic sectors as well as credit markets heightened uncertainty, and signaled a weakening of those conditions
that have underpinned relatively high levels of discretionary consumer spending in recent years. More robust growth in Asia may bode well for the global economy in general and the long-term outlook for diamond consumption in particular, but off a
much lower base than the U.S. where diamond jewellery buying is concerned.

At the same time, a difficult restructuring for the industry continues. Increased margin pressures are strongly evident as the market adjusts to a model based not on upstream buffer stocks and
associated price stability but on ultimate downstream demand and relative price volatility. As global sales of polished diamonds lagged the intake of rough diamonds in many categories during the year under review, leveraging within the manufacturing
and distribution sectors continued to grow, with bank debt in this segment of the pipeline reaching historic highs. The industrys principal source of rough supply, the Diamond Trading Company (DTC), distributed to each of its
sightholders a notice of termination of all supply contracts with effect from the end of 2007, compounding concerns of a consolidation within the sector. The increasing prospect of competition from synthetic diamonds remains a trend to be taken into account. In short, a confluence of factors has substantially raised the systemic level of risk within the industry, without, to date, a corresponding upward recalibration of reward. It seems likely that this equation will lead to
a consolidation of participants in the market, especially if a downturn in the U.S. economy eventuates.

In the face of these challenging conditions, LKI has, during the past year, carefully managed its credit exposure, diversified its customer base, moved to align interests with key stakeholders, and
implemented cost-saving and rationalization measures to visible effect in the second half of the year under review. These moves have not been painless, and have included redundancies, pay cuts, and staff redeployments in several areas. At a
strategic level, we are refocusing the business to take into account the tougher operating context.  The result of these ongoing Company measures, we believe, will be a platform designed both for durability in the face of present challenges, and for
growth as the industry emerges from its present transition. That platform represents a cumulative and continuing significant investment by the Company in the future.

Despite the difficult and uncertain trading conditions, LKI maintains its belief that the long-term fundamentals of the diamond industry remain sound, and that LKI is   positioned to take advantage of
substantial opportunities that will arise both during and after the industrys current transition. Independent projections consistently anticipate that over the coming decade fresh global demand for polished diamonds will exceed new sources of
rough supply, with much of the demand growth coming in Asia where

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LKIs presence is longstanding. LKI is also well-situated in those southern African countries to which the center of gravity of global diamond manufacturing is moving, particularly Namibia and Botswana. As one of the
sightholders historically ranked highly by the DTC, LKI is hopeful that when the new sightholder list is announced toward the end of 2007 its continuation as a  DTC customer through the new three-and-a-half year contractual supply cycle will be
confirmed.

Turning from an overview to specific areas of Company activity: In Namibia, steps toward the restructuring of operations and ownership at NamGem to accommodate an expected increase in the quantity and
quality of goods polished at the factory continue apace. These measures are in line with the Government of Namibias announcement in January 2007 of new marketing arrangements with the DTC, under which a new joint venture company (Namibia
Diamond Trading Company, or NDTC) will be established with the aim, among other things, of supplying a target of $300 million per year in suitable rough supply to the local polishing sector. As an established leader in that sector, NamGem is well
positioned to benefit from these new arrangements, which are scheduled to commence late this year. LKI expects to build on its existing technical role by taking up an approximate 50% ownership interest in NamGem, aligning interests with that
companys existing shareholders. Relatedly, the Company during the financial year entered into a contract with the U.S. Governments Overseas Private Investment Corporation (OPIC) for a ten-year, $25.2 million line of project financing to
be utilized at NamGem. Consummation of this OPIC financing will depend on the entry into a suitable rough diamond supply contract with NDTC.

Implementation of LKIs business plan in Botswana is proceeding on schedule, with prime land for a new polishing factory having now been acquired, and plans for that factory having been submitted
for official approval. As in Namibia, the Government of Botswana has agreed with the DTC on new arrangements for the supply of rough diamonds to local beneficiators licensed by the Government. LKI, through a wholly-owned subsidiary, is one of
sixteen companies that have been issued with such a license. The details of the supply arrangements remain uncertain, but continue to be developed by the DTC and Government and are slated for implementation during the coming calendar year. Building
on its longstanding ties with Botswana-the worlds largest and lowest-cost producer of rough diamonds-LKI continues to engage proactively and constructively with Government and other key stakeholders in the pursuit of value-adding
commercial opportunities throughout the domestic diamond sector.

In South Africa, LKIs joint venture with a broad-based womens empowerment consortium, Nozala Diamonds, continues to develop a niche within the local beneficiation industry. Nozala has won
recognition both within Government and publicly for its innovation in advancing the entry into the mainstream diamond sector of those traditionally confined to the industrys margins, in step with the countrys stated developmental
priorities. South Africas principal diamond polishing factories, including Nozala, face the prospect of potentially diminished supply from the traditional source of most of the nations supply,

4

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the DTC, due to the announced divestiture by DeBeers of a number of its existing South African mines. Nozalas plans for expansion, endorsed by Governmental authorities at both provincial and national level, will depend on
its ability, against the grain of this development, to increase its share of locally available supply.

Angola remains on track to become an ever more important force in the global diamond industry, as the countrys exploration, mining and trading sectors benefit from the countrys peacetime
revival after some three decades of civil war. LKI has built on its established track record in Angola by expanding both the breadth and volume of its activities, beginning with its ongoing contract with SODIAM-the parastatal legally charged
with marketing Angolan diamonds-to buy rough stones produced in the informal sector and sell them globally. Increases in sales volumes through this channel have been enhanced by growth in the marketing of formal mine production by a
freestanding entity, accounted for on an equity method, in which LKI holds a minority interest. Meaningful progress has also been made in diversification into exploration for new diamond deposits, in what are considered by the worlds major
diamond mining companies to be highly attractive conditions geologically. Consistent with its local standing as a leading corporate citizen, LKI is fulfilling its commitments to support post-war reconstruction and development, through a
ground-breaking public-private partnership aimed at improving living standards in Lunda Norte where much of the nations diamond patrimony is located.

Russia is also becoming an increasingly important independent force in the global diamond market, on the back of its large-scale mine output (second only to Botswanas) and its changing downstream arrangements, including a decreasing reliance on sales through the DTC. LKIs
position in Russia remains anchored by its agreement with the countrys major producer, A.K. Alrosa, for local polishing and international distribution of Russian diamonds. Discussions are underway with the relevant authorities on possible
means of expanding and potentially diversifying this successful collaboration.

The variances between rough and polished price movements during the year under review, as well as the imperative of prudent liquidity management, have given rise to rough diamond trading opportunities
which LKI is positioned to take advantage of. LKI continues to focus on its capacity in this area, which remains an important adjunct to its core business in polished diamonds.

LKIs signature product, the branded Lazare Diamond®, is among the most venerable and visible product offerings in the industry, and an integral part of LKIs broader strategy of
pursuing and maintaining market niches that can generate sustainable premiums. LKI continues to expand its chain of branded retail boutiques in Asia, where brand consciousness retains a central importance in the luxury goods market. LKI is also
building its network of dedicated counters and store within a store facilities at leading high-end retail jewellers. At the same time, the Company is expanding its presence in the fine cut, commercial make segment of the market and
strengthening its bulk sales capacity in such established polished trading centres  as Belgium, Israel and Hong Kong. Polished sales

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growth going forward is expected to be targeted largely on the Middle East and Asia. During the year under review the Company streamlined its polished sales functions, and pursued, in an increasingly price-sensitive environment,
more reciprocal customer relationships premised on quality.

LKI continues to rationalize its jewellery lines with the aim of increasing sales velocity, maintaining an emphasis on diamond-centered classical design and larger stones. Another source of
differentiation for the Company is its Bellataire® line of HPHT-processed diamonds. During the year under review LKIs partner in this product offering changed, with Sandvik, a large Swedish group specializing in advanced materials, high
technology and engineering buying out the interest of Littlejohn. Discussions have begun with this new and welcome partner on how to make the most of Bellataires unique, established niche in the market.

LKI has always taken pride in its own intellectual property and technological innovations, especially against the backdrop of progressively increasing industry reliance on technology. In that vein,
the Company continued to invest heavily during Fiscal Year 2007 in protecting its valuable intellectual property rights against infringement. The Gemmological Institute of America (GIA) has been added as a defendant in the suit filed in 2006 against
PhotoScribe Technologies Inc. asserting violation of certain of LKIs patent rights. The Company intends vigorously to pursue this litigation, for which a trial date in early 2008 has now been set.

LKIs polishing factory in Puerto Rico, the first in the industry accorded SA8000 certification status for workplace excellence, represents intellectual capital of a different sort. The workforce there specializes in precision diamond polishing that continues to distinguish the Lazare Diamond and anchor
the brand. However, Puerto Rico is not immune from the forces that are drawing beneficiation away from traditional centers toward lower-cost operations in Asia and greenfields ventures in southern Africa; and the scale of manufacturing at this
factory is accordingly decreasing. Puerto Rico will progressively act as a service center for LKIs distribution and manufacturing facilities elsewhere--a source, in a skills-based business, of valuable human and other resources on which those
operations can draw.

The Company remains committed to upholding the standards and values of transparency, accountability, and good corporate citizenship throughout the many jurisdictions in which it operates. This is a
matter not just of an operating culture cultivated through over a century of straight dealing, but also, increasingly, of necessity for the diamond industry as a whole in an era of heightened consumer and other scrutiny. The Companys
operations are aligned not only with such binding measures as the USA PATRIOT Act and the Kimberley Process, but also with various voluntary systems of warranty, disclosure and proactive engagement developed by such bodies as the World Diamond
Council and the United Nations Global Compact.

Of course, in these matters as in others, and all the more so in challenging trading conditions, it is on the quality and commitment of its people that the Company ultimately depends. LKI thanks all
its employees for their professionalism, theirdedication, and their performance-for all the practical hard work which gives rise to that most impractical and alluring of objects, the diamond.

And let us in closing, on a personal note and on behalf of all the directors of LKI, pay tribute to one of our Board members who passed away during the year under review. We salute Mike Feldman as a distinguished public servant and businessman, a dedicated and longstanding director of LKI, an exemplar of the good conduct to which the Company
aspires, and above all a good friend and human being.

|                       |  |                      
|---------------------- |  | ---------------------
|-s- Maurice Tempelsman |  | -s- Leon Tempelsman  
|Maurice
 Tempelsman    |  | Leon
 Tempelsman     
|Chairman of
 the       |  | Vice
 Chairman of the
|Board                  |  | Board                
|                       |  |                      
|                       |  |                      

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Selected Financial Data

|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|----------------------------------------------------------------------------------------------------------------------------------------------- |  | - | ------- | - | - | ------- |  | - | ------- |  | - | ------- |  | - | ------- | --- | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|(In thousands, except share and per share data)                                                                                                 |  |   | 2007    |   |   | 2006    |  |   | 2005    |  |   | 2004    |  |   | 2003    |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|                                                                                                                                               
|Net sales                                                                                                                                       |  | $ | 434,406 |   | $ | 528,045 |  | $ | 421,411 |  | $ | 235,775 |  | $ | 203,159 |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|                                                                                                                                               
|Income/(loss) before income tax provision/(benefit) and
 cumulative effect of change in accounting principle                                    |  | $ | (4,751  | ) | $ | 766     |  | $ | 7,870   |  | $ | 3,273   |  | $ | 3,256   |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|                                                                                                                                               
|Income/(loss) before cumulative effect of change in
 accounting principle                                                                       |  | $ | (4,751  | ) | $ | 766     |  | $ | 7,870   |  | $ | 2,399   |  | $ | 2,066   |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|                                                                                                                                               
|Net income/(loss)                                                                                                                               |  | $ | (2,976  | ) | $ | 1,528   |  | $ | 5,230   |  | $ | 2,399   |  | $ | 1,094   | (1) | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|                                                                                                                                               
|Basic earnings/(loss) per share before cumulative effect
 of change in accounting principle (based on the weighted average number of
 shares)   |  | $ | (0.36   | ) | $ | 0.18    |  | $ | 0.62    |  | $ | 0.28    |  | $ | 0.24    |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|                                                                                                                                               
|Basic earnings/(loss) per share (based on weighted average
number of shares)                                                                    |  | $ | (0.36   | ) | $ | 0.18    |  | $ | 0.62    |  | $ | 0.28    |  | $ | 0.13    |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|                                                                                                                                               
|Diluted earnings/(loss) per share before cumulative effect
 of change in accounting principle (based on the weighted average number of
 shares) |  | $ | (0.36   | ) | $ | 0.18    |  | $ | 0.60    |  | $ | 0.28    |  | $ | 0.24    |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|                                                                                                                                               
|Diluted earnings/(loss) per share (based on the weighted
 average number of shares)                                                             |  | $ | (0.36   | ) | $ | 0.18    |  | $ | 0.60    |  | $ | 0.28    |  | $ | 0.13    |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|At May 31:                                                                                                                                      |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|Total assets                                                                                                                                    |  | $ | 290,283 |   | $ | 263,712 |  | $ | 250,284 |  | $ | 180,712 |  | $ | 160,411 |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|Long-term debt, long-term portion                                                                                                               |  | $ | 36,060  |   | $ | 64,176  |  | $ | 60,000  |  | $ | 34,726  |  | $ | 16,756  |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|Working capital                                                                                                                                 |  | $ | 105,438 |   | $ | 143,724 |  | $ | 141,556 |  | $ | 110,599 |  | $ | 90,175  |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 
|Stockholders equity                                                                                                                            |  | $ | 92,997  |   | $ | 95,796  |  | $ | 96,305  |  | $ | 92,416  |  | $ | 90,207  |     | 
|                                                                                                                                                |  |   |         |   |   |         |  |   |         |  |   |         |  |   |         |     | 

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


(1) Includes
$1.0 million (net of tax) charge for the cumulative effect of a change in
accounting principle.

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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, 2007. 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 2007, 2006 and 2005 refer to the fiscal years ended May 31,
2007, 2006 and 2005, respectively.

Overview

The
Company is engaged in the cutting, polishing and selling of branded and
non-branded (commercial) diamonds. The Companys premier product line is
comprised of ideally proportioned diamonds which it markets internationally
under the brand name Lazare Diamonds®. Ideally proportioned
diamonds are distinguished from non-ideal cut diamonds by the symmetrical
relationship of their facets, which optimize the balance of brilliance, sparkle
and fire in a polished diamond. The Companys domestic manufacturing facility,
located in Puerto Rico, is believed by the Company to be among the largest
diamond cutting facilities in the United States. In addition, through various
cooperative agreements, the Company cuts and polishes commercial diamonds which
it markets to wholesalers, distributors and retail jewelers. Rough stones
purchased by the Company are either selected for manufacturing or resold as
rough diamonds in the marketplace.

The
Companys overall revenues are, in part, dependent upon the availability of
rough diamonds, the worlds known sources of which are highly concentrated. The
Diamond Trading Company (DTC) is the worlds largest rough diamond selling
organization. The Company has been a client of the DTC for approximately 60
years. The Company supplements its rough diamond needs by secondary market
purchases and has entered into relationships with other primary source
suppliers.

The
Company has a technical assistance and cooperation agreement regarding the
purchasing and marketing of rough diamonds with Sociedade de Comercializacao de
Diamantes de Angola SARL (SODIAM), the government entity responsible for
development and marketing of diamonds produced in Angola. Informal sector rough
diamond buying from this operation commenced during the first fiscal quarter of
2005. During the third fiscal quarter of 2006 the Companys rough buying
operations expanded to include buying in the Angolan formal sector. During the
second fiscal quarter 2007 Angolan formal sector operations were transferred to
separate joint venture companies. The Company is currently negotiating a
further expansion and restructuring of its Angolan operations to include
exploration and development through various additional joint ventures.

The
Company has an agreement with AK ALROSA of Russia, which is the largest
producer of rough diamonds in Russia. Under the terms of this agreement, the
Company sells polished diamonds that are cut in facilities jointly managed and
supervised by the Company and ALROSA personnel. The proceeds from the sale of
these polished diamonds, after deduction of rough diamond cost, generally are
shared equally with ALROSA.

The
Company has signed a strategic cooperation agreement with NamGem Diamond
Manufacturing Company (PTY) Ltd. (NamGem) for the cutting and polishing of
diamonds in Namibia. NamGem is Namibias flagship venture in the international diamond
polishing industry. Under the terms of the agreement, the Company provides
technical manufacturing assistance and supervises the manufacture of the
Companys rough diamonds deemed suitable to cut and polish. Production under
this agreement commenced during the third quarter of 2004.

During
September 2006 the Company and the Overseas Private Investment Corporation, an
independent agency of the United States Government (OPIC) signed a commitment
letter pursuant to

8

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which OPIC committed to
provide approximately $25 million of long-term financing in support of the
acquisition of certain rough diamonds to be cut and polished in Namibia.
Pursuant thereto, a subsidiary of the Company and OPIC entered into a financing
agreement in February 2007. The Company is currently in negotiations with third
parties regarding changes to its existing Namibian operations. Pending a
satisfactory outcome of these negotiations and subject to various conditions
precedent under the financing agreement, the Company anticipates initial
borrowing under the facility to commence during fiscal 2008.

In
November of 2004 the Company signed an agreement with Nozala Investments (Pty)
Ltd., a broadly based womens empowerment investment group, for cooperation in South
Africas diamond sector. The agreement contemplates diamond mining, cutting,
polishing, and distribution. The joint venture is in line with the South
African Governments recently announced program to promote new entrants and
investment in the domestic diamond sector, increasing the sectors contribution
to economic development. Cutting and polishing activities which concentrate on
local sources of rough diamond supply commenced during the third fiscal quarter
of 2006.

In
February 2006, Lazare Kaplan Botswana (Pty) Ltd., a wholly owned subsidiary,
was granted a license from the Government of Botswana to cut and polish
diamonds in that country.

The
Company continues its efforts to develop additional sources of rough diamonds,
including potential opportunities in Africa.

Through
February 2009, the Companys wholly-owned subsidiary, Pegasus Overseas Ltd.
(POL) has an exclusive agreement with Diamond Innovations Inc. (DI) under
which POL will market natural diamonds that have undergone a new high pressure,
high temperature (HPHT) process to improve the color of certain gem diamonds
without reducing their all-natural content. POL sells diamonds that have
undergone the HPHT process under the Bellataire® brand name.

In
November 2005, the Company (including certain of its subsidiaries) amended
certain terms of its agreement with DI relating to the sourcing, manufacture
and marketing of Bellataire diamonds. The amendment and related agreements seek
to increase the sales and profitability of Bellataire diamonds by more closely
aligning the economic interests of the parties through shared management of
product sourcing, manufacturing and marketing as well as the sharing of related
costs.

While
the Company believes that its success in maintaining quantities and qualities
of polished inventory that best meet its customers needs is achieved through
its ability to fully integrate its diverse rough and polished diamond sources,
any significant disruption of the Companys access to its primary source
suppliers could have a material adverse effect on the Company.

Results of Operations

2007 Compared to 2006

Net Sales

Net
sales in 2007 and 2006 were $434.4 million and $528.0 million, respectively.
The decrease in net sales primarily reflects the transfer during the second
fiscal quarter 2007 of certain rough trading operations to a separately
operated joint venture company, which the Company accounts for on the equity
method.

Polished
diamond revenues in 2007 were $143.3 million, as compared to $149.8 million in
2006. This decrease reflects lower sales of branded diamonds partially offset
by increased sales of fine cut commercial diamonds. Factors leading to the
decrease in polished sales include liquidity concerns throughout the diamond
and jewelry distribution chain, reluctance on the part of U.S. retailers to
take stock positions and market resistance to price increases the Company seeks
to pass through to customers.

Rough
diamond sales in 2007 were $291.1 million, as compared to $378.3 million in
2006. The decrease in rough diamond sales reflects the transfer of formal
sector Angolan rough diamond buying and trading operations to a joint venture
entity, which the Company accounts for on the equity method. Rough diamond
revenue for 2007 includes $1.0 million received in connection with certain
sourcing and financing initiatives.

Gross Profit

During
2007 gross margin on net polished sales was 9.9% compared to 13.8% in 2006. The
decrease in polished gross margin reflects a shift in sales mix with a higher
percentage of polished sales derived from fine cut commercial diamonds which
typically carry a lower gross margin than branded

9

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diamonds. This decrease also
reflects increased rough diamond prices which the Company was unable to fully
pass through to customers and efforts by the Company to sell certain slower
moving commercial diamonds at reduced prices. Additionally, polished gross
margin reflects reduced revenue and margin from laser inscription fees (see
Legal Proceedings).

Rough
gross margin during 2007 was 3.0% compared to 2.4% in the prior year. Increased
rough gross margin reflects improving market conditions and a reduction in allocable
sourcing costs incurred by the Companys Angolan informal sector operations.

As
a result of the foregoing, overall gross margin percentage during 2007 was 5.3%
compared to 5.7% in 2006.

Selling, General and Administrative Expenses

Selling,
general and administrative expenses for 2007 were $25.7 million, as compared to
$24.8 million for 2006. The increase for 2007 reflects increased legal costs
associated with litigation the Company initiated to protect certain of its intellectual
property rights offset by a reduction in employee salaries and wages. Selling,
general and administrative expense for 2007 reflects the reimbursement of $1.2
million of costs incurred in connection with certain sourcing and financing
initiatives. Selling, general and administrative expense for 2006 is net of
$1.5 million which a third party agreed to pay the Company in connection with
the settlement of certain contractual obligations.

Interest Expense

Interest
expense for 2007 was $5.9 million, as compared to $3.8 million for 2006. This
increase primarily reflects increased levels of borrowing and higher interest
rates during 2007. Increased borrowings during 2007 primarily related to the
expansion of rough sourcing in Angola.

Equity in (Income) / Loss of Joint Ventures

During
2007 and 2006 the Company entered into several joint venture agreements
relating to sourcing, cutting, polishing, processing and sales of diamonds. The
Companys share of operations aggregated a profit of $3.9 million in 2007 and a
loss of approximately $0.5 million in 2006.

Income Tax

The
Companys 2007 and 2006 income tax benefit primarily reflects its ability to
carryforward certain operating losses for U.S. income tax purposes. For 2006
this tax benefit was partially offset by tax expense attributable to the
repatriation of certain previously untaxed accumulated foreign earnings.

Earnings Per Share

Basic
and fully diluted earnings/(loss) per share were $(0.36) for 2007 and $0.18 for
2006. Basic earnings per share is computed based upon the weighted average
number of common shares outstanding. Diluted earnings per share include the
impact of dilutive stock options.

2006 Compared to 2005

Net Sales

Net
sales in 2006 of $528.0 million were $106.6 million or 25% higher than net
sales in 2005.

Polished
diamond revenues in 2006 were $149.8 million, as compared to $156.9 million in
2005. This decrease reflects lower sales of branded diamonds partially offset
by increased sales of fine cut commercial diamonds. Factors leading to the
decrease in polished sales include an overall slowing of the U.S. economy,
liquidity concerns throughout the diamond and jewelry distribution chain, reluctance
on the part of U.S. retailers to take stock positions prior to the start of the
2006 holiday season, and market resistance to price increases the Company seeks
to pass through to customers.

Rough
diamond sales in 2006 were $378.2 million, an increase of $113.8 million over
2005. The increase in rough diamond sales is primarily related to an increase
in the Companys Angolan rough buying and trading operations. This increase
also reflects an increase in the supply of rough diamonds made available to the
Company by other rough diamond producers.

Gross Profit

During
2006 gross margin on net polished sales was 13.8% compared to 16.2% in 2005.
The decrease in polished gross margin reflects a shift in sales mix toward
lower margin fine cut commercial diamonds, and sales incentives offered to
liquidate slower moving commercial diamond inventory compared to the prior
year.

10

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Rough
gross margin during 2006 was 2.4% compared to 3.5% in the prior year. The
decrease in rough gross margin percentage reflects increased rough costs and
associated fees charged by diamond producers at a time of excess supply and
soft demand from diamond manufacturers.

As
a result of the foregoing, overall gross margin percentage during 2006 was 5.7%
compared to 8.2% in 2005.

Selling, General and Administrative Expenses

Selling,
general and administrative expenses for 2006 were $24.8 million, as compared to
$24.5 million for 2005. The increase for 2006 reflects legal, consulting and
other costs associated with the negotiation and implementation of sourcing and
manufacturing operations in Southern Africa. Additionally, the increase in
costs reflects expenses incurred in connection with the renegotiation of
certain agreements relating to the manufacture and distribution of Bellataire
diamonds and the settlement of certain third party obligations related thereto.
Amounts expensed are net of $1.5 million which a third party has agreed to pay
the Company in connection therewith.

Interest Expense

Interest
expense for 2006 was $3.8 million, as compared to $2.4 million for 2005. This
increase primarily reflects increased levels of borrowing and higher interest
rates during 2006. Increased borrowings during 2006 primarily related to the
expansion of rough sourcing in Angola and cutting and polishing operations in
Namibia.

Equity in (Income) / Loss of Joint Ventures

During
2006 the Company entered into several joint venture agreements relating to
sourcing, cutting, polishing, processing and sales of diamonds. The Companys
share of initial operations aggregated a loss of approximately $0.5 million.

Income Tax

The
Companys 2006 income tax benefit reflects its ability to carryforward certain
operating losses for U.S. income tax purposes, offset in part by tax expense
attributable to the repatriation of certain previously untaxed accumulated
foreign earnings. The tax provision for 2005 generally approximated the U.S.
statutory federal income tax rate.

Earnings Per Share

Basic
and fully diluted earnings per share for 2006 were each $0.18. Basic and fully
diluted earnings per share for 2005 were $0.62 and $0.60, respectively. Basic
earnings per share is computed based upon the weighted average number of common
shares outstanding. Diluted earnings per share include the impact of dilutive
stock options.

New Accounting Pronouncements

In
July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48),
which clarifies the accounting for uncertainty in tax positions. This
Interpretation requires financial statement recognition of the impact of a tax
position if a position is more likely than not of being sustained on audit,
based on the technical merits of the position. Additionally, FIN 48 provides
guidance on measurement, derecognition, classification, accounting in interim
periods and disclosure requirements for uncertain tax positions. The provisions
of FIN 48 will be effective as of the beginning of the Companys fiscal year
2008, with the cumulative effect of the change in accounting principle recorded
as an adjustment to opening retained earnings. The Company is currently
evaluating the impact of FIN 48 on its financial position, results of
operations and cash flows.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which
establishes a framework for measuring fair value in generally accepted accounting
principles and expands disclosures about fair value measurements. SFAS No. 157
defines fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants
at the measurement date. SFAS No. 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. The Company is currently evaluating the impact of SFAS 157
on its financial position, results of operations and cash flows.

In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Asset and Financial Liability: Including an amendment of FASB Statement No. 115 (SFAS 159).
The standard permits all entities to elect to measure certain financial instruments
and other items at fair value with changes in fair value reported in earnings.
SFAS 159 is effective as of the beginning of the first fiscal year that begins
after November 15, 2007. The Company is currently evaluating the impact of SFAS
159 on its financial position, results of operations and cash flows.

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 Inc.,
which are denominated in Japanese yen. The functional currency for Lazare
Kaplan Japan is the Japanese yen and, as of May 31, 2007 and 2006, the Company

11

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recognized
cumulative foreign currency translation adjustments with regard to the
activities of Lazare Kaplan Japan in the amount of $(766,000) and $(425,000)
respectively, which are shown as a component of stockholders equity in the
accompanying balance sheets.

LiquidityCapital Resources

The
Company used $9.3 million and $33.7 million of cash flow from operations in
2007 and 2006, respectively. The Companys usage of cash flow from operations,
funded by an increase in borrowings, was primarily used to expand inventory
sourcing and support increased sales volume.

The
Companys working capital at May 31, 2007, 2006 and 2005 was $105.4 million,
$143.7 million and $141.6 million, respectively. The decrease in working
capital for 2007 primarily reflects a shift in borrowing by the Company with a
greater portion of current year operations financed by short-term loan
facilities.

Fixed
asset additions of $0.5 million in 2007 and $1.8 million in 2006 primarily
reflect the expansion and upgrading of manufacturing facilities and equipment.

The
Company has a $35.0 million long-term unsecured, committed revolving loan
agreement and a $10.0 million unsecured, uncommitted credit agreement. The
Company may borrow under the committed facility (including up to $1.0 million
under letters of credit, $0.7 million issued at May 31, 2007) through December
1, 2008. The loan term may be extended in one-year increments commencing
November 30, 2007, subject to the consent of the lending banks. Borrowings
under both agreements bear interest at (a) the higher of the banks base rate or
one half of one percent above the Federal Funds Effective Rate, or (b) 160
basis points above LIBOR. The applicable interest rate is contingent upon the
method of borrowing selected by the Company. The proceeds of these facilities
are available for the Companys working capital needs. The loan agreements
contain certain provisions that require, among other things, (a) maintenance of
defined levels of working capital, net worth and profitability, and (b)
limitation on other borrowing levels, investments, capital expenditures,
dividends and the repurchase of treasury shares. As of May 31, 2007 and 2006,
the balance outstanding under both facilities was $41.0 million and $38.0
million, respectively.

The
Company maintains an additional unsecured, committed revolving loan agreement
    with a bank. At May 31, 2007 the maximum amount available under the facility
    was $30.0 million. The maximum borrowing limit permitted under the facility
    is scheduled to reduce to $20.0 million on June 30, 2007, with further
    reductions of $1.0 million at the end of September, October and November
    2007, $7.0 million on December 31, 2007 and $5.0 million on each of March
    31, 2008 and June 30, 2008. Borrowings under this agreement bear interest
    at (a) the higher of the banks base rate or one half of one percent above
    the Federal Funds Effective Rate, or (b) 160 basis points above LIBOR. The
    applicable interest rate is contingent upon the method of borrowing selected
    by the Company. The proceeds of this facility are available for working capital
    purposes. The loan agreement contains certain provisions that require, among
    other things, (a) maintenance of defined levels of working capital, net worth
    and profitability, (b) limitations on borrowing levels, investments and capital
    expenditures and (c) limitations on dividends and the repurchase of treasury
    shares. Borrowings under this loan agreement amounted to $26.0 million and
    $29.2 million at May 31, 2007 and 2006, respectively.

The
Company has a $25.0 million and a $45.0 million unsecured, uncommitted line of
credit with a bank. Borrowings under both lines bear interest at a rate 160
basis points above the 90 day LIBOR. As of May 31, 2007 and 2006, the balance
outstanding under both lines of credit was $53.5 million and $40.8 million,
respectively. Borrowings under these lines are available for the Companys
working capital requirements and are payable on demand.

A
subsidiary of the Company maintains a loan facility which enables it to borrow
up to 520 million Japanese yen (approximately $4.3 million U.S. dollars) at an
interest rate 1% above the Japanese yen LIBOR through November 2008. Borrowings
under the facility are available for working capital purposes. The Company
guarantees repayment of amounts borrowed. Borrowings under the loan are used in
support of its operations in Japan. As of May 31, 2007 and 2006 the balance
outstanding under this facility was $1.1 million and $4.2 million U.S. dollars,
respectively.

The
Companys long-term facilities do not contain subjective acceleration clauses
or require the Company to utilize a lockbox whereby remittances from the
Companys customers reduce the debt outstanding.

Long-term
debt of $36.1 million outstanding at May 31, 2007 is scheduled to be repaid in
the fiscal year ended May 31, 2009. At May 31, 2007 the Company was not in
compliance with an annual financial covenant under certain of its loan
facilities.

12

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The Company
has since received waivers from its lenders.

The
following table includes aggregate information about the Companys contractual
obligations including interest as of May 31, 2007 and the periods in which
payments are due. Certain of these amounts are not required to be included in
the Companys consolidated balance sheet (in millions):

|                                    |  |       |       |                   |   |              |  |              |      |               |   |     |  |   |     | 
|----------------------------------- |  | ----- | ----- | ----------------- | - | ------------ |  | ------------ | ---- | ------------- | - | --- |  | - | --- | 
|                                    |  |       |       |                   |   |              |  |              |      |               |   |     |  |   |     | 
|Payments Due by
          Period    |  | Total |       | Less than
 1 year |   | 1 - 3
 years |  | 4 - 5
 years |      | Over 5
 years |  
|                                    |  |       |       |                   |   |              |  |              |      |               |  
|Debt                                |  | $     | 133.2 |                   | $ | 92.2         |  | $            | 41.0 |               | $ |    |  | $ |    | 
|Operating Leases                    |  |       | 8.3   |                   |   | 0.8          |  |              | 1.9  |               |   | 1.3 |  |   | 4.3 | 
|                                    |  |       |       |                   |   |              |  |              |      |               |   |     |  |   |     | 
|Total Contractual Cash
 Obligations |  | $     | 141.5 |                   | $ | 93.0         |  | $            | 42.9 |               | $ | 1.3 |  | $ | 4.3 | 
|                                    |  |       |       |                   |   |              |  |              |      |               |   |     |  |   |     | 

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 $93.0 million at May 31, 2007 as compared to $95.8 million at May
31, 2006. This decrease primarily reflects current year results of operations.
No dividends were paid to stockholders during the year ended May 31, 2007.

Critical Accounting Policies

Use
of Accounting 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.

Revenue
RecognitionThe Company recognizes revenue when title and risk of ownership
have passed to the buyer, the earnings process is complete and the sale price
is fixed or determinable. In addition, in certain instances, the Company may be
entitled to receive incremental profits from its customers on the sale of
certain stones. Such profits are recognized as revenue when realized.
Conversely, in certain instances, the Company is obligated to share profits it
realizes on the sale of stones. This additional cost is included in cost of
sales when the related revenue is recognized. When necessary, the Company
provides for estimated returns (where a right to return exists) in the same
period the revenue is recorded. These estimates are based upon historical
analysis, customer agreements and/or currently known factors that arise in the
normal course of business.

Equity
in (income) / loss of joint ventures  The Company utilizes the equity method
of accounting to record its proportionate share of income and losses from joint
ventures.

InventoriesInventories,
including amounts on consignment with customers, are stated at the lower of
cost or market, using the average cost method. The Company provides an
inventory reserve equal to the difference between the cost of the inventory and
the estimated market value, to ensure inventories are stated at the lower of
cost or market. The determination of market value is highly subjective as it is
based on the relative significance assigned to various attributes of a diamond,
including carat weight, color, clarity and quality of cut. If actual market
conditions are less favorable than those projected by management, inventory
write-downs may be required.

Allowance
for Doubtful AccountsAccounts receivable are reduced by an allowance for
amounts that may be uncollectible in the future. Estimates are used in
determining the allowance for doubtful accounts and are based on the Companys
ongoing credit evaluations of customers, customer payment history and account
aging.

Deferred
Tax Assets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) net operating loss carryforwards. The Company provides a valuation
allowance for the estimated unrecoverable portion of the deferred tax assets.
Factors that the Company considers in assessing the likelihood of future
realization include the forecast of future taxable income and available tax
planning strategies. 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
Company will continue to monitor and assess the recoverability of its deferred
tax assets in the future for changes to the tax code, change in statutory tax
rates and the projected level of taxable income.

Asset
Impairment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

13

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undiscounted
cash flows estimated to be generated by the related assets are less than the
carrying amounts of those assets. In assessing the recoverability of the
Companys long-lived assets, the Company makes assumptions in determining
estimated future sales, profit margin and expenses to arrive at estimated
future cash flows. If the Company determines, based upon such measures, that
the carrying amount is impaired, the long-lived asset will be written down to
its recoverable value based upon either the discounted future cash flows or
appraised fair value. The fair value of assets could be different using
different estimates and assumptions in these valuation techniques.

Business Developments

In
March 1999, the Company and ALROSA entered into a ten year agreement to expand
their relationship in the cutting, polishing and marketing of gem diamonds for
up to $100 million a year. Under the terms of this agreement, the Company and
ALROSA agreed to refurbish certain diamond cutting facilities in Russia. At
present, the Companys operations in Russia are consolidated in two facilities,
both of which are fully operational.

During the fourth quarter of 2004 the
Company signed a four year technical assistance and cooperation agreement
regarding the purchasing and marketing of rough diamonds with SODIAM, the
government entity responsible for the development and marketing of diamonds
produced in Angola. The Company began active buying in the Angolan informal sector
during the first quarter of fiscal 2005. During the third fiscal quarter of
2006 the Companys rough buying operations expanded to include buying in the
Angolan formal sector. During the second fiscal quarter 2007 Angolan formal
sector operations were transferred to separate joint venture companies. The
Company is currently negotiating a further expansion and restructuring of its
Angolan operations to include exploration and development through various
additional joint ventures.

During
the third quarter of 2004 the Company signed a cooperation agreement with
NamGem for the cutting and polishing of diamonds in Namibia. NamGem is
Namibias flagship venture in the international diamond polishing industry.
Under the terms of the agreement the Company provides marketing and technical
manufacturing assistance to NamGem. The Company purchases rough diamonds and
supervises the manufacturing of those deemed suitable to cut and polish. The
Company pays NamGem for manufacturing on a fee for services basis. All rough
and polished diamonds are bought and sold by the Company for its account.

During
September 2006 the Company and the Overseas Private Investment Corporation, an
independent agency of the United States Government (OPIC) signed a commitment
letter pursuant to which OPIC committed to provide approximately $25 million of
long-term financing in support of the acquisition of certain rough diamonds to
be cut and polished in Namibia. Pursuant thereto, a subsidiary of the Company
and OPIC entered into a financing agreement in February 2007. The Company is
currently in negotiations with third parties regarding changes to its existing
Namibian operations. Pending a satisfactory outcome of these negotiations and
subject to various conditions precedent under the financing agreement, the
Company anticipates initial borrowing under the facility to commence during
fiscal 2008.

In
November of 2004 the Company signed an agreement with Nozala Investments (Pty)
Ltd., a broadly based womens empowerment investment group, for cooperation in
South Africas diamond sector. The agreement contemplates diamond mining,
cutting, polishing, and distribution. The joint venture is in line with the
South African Governments recently announced program to promote new entrants
and investment in the domestic diamond sector, increasing the sectors
contribution to economic development. Cutting and polishing activities which
concentrate on local sources of rough diamond supply commenced during the third
fiscal quarter of 2006.

Through
February 2009, the Companys wholly-owned subsidiary, Pegasus Overseas Ltd.
(POL) has an exclusive agreement with Diamond Innovations Inc. (DI) under
which POL will market natural diamonds that have undergone a high pressure,
high temperature (HPHT) process to improve the color of certain gem diamonds
without reducing their all-natural content. 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 will be used only on a
select, limited range of natural diamonds with qualifying colors, sizes and
clarities for both round and fancy shapes. The estimated number of gemstones
with characteristics suitable for this process is a small fraction of the
overall diamond market. POL sells only diamonds that have undergone the HPHT
process under the Bellataire® brand name. In connection with this

14

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agreement, the
Company granted a security interest in POLs diamond inventory amounting to
$13.5 million at May 31, 2006.

In
November 2005, the Company (including certain of its subsidiaries) amended
certain terms of its agreement with DI relating to the sourcing, manufacture
and marketing of Bellataire diamonds. The amendment and related agreements seek
to increase the sales and profitability of Bellataire diamonds by more closely
aligning the economic interests of the parties through shared management of
product sourcing, manufacturing and marketing as well as the sharing of related
costs.

As
a concerned member of the international diamond industry and global community
at large, the Company fully supports and complies with policies which prohibit
the trade in conflict diamonds, prevent money laundering and combat the
financing of terrorism, a position which reflects the Companys leadership in
the industry. The Company fully complies with clean diamond trading and
anti-money laundering legislation adopted by the United States Government such
as the USA PATRIOT ACT and the Clean Diamond Trade Act, and supports relevant
resolutions of concerned regional governments and international organizations
including the OECD and the United Nations. The Company is a founding member of
the United Nations Global Compact which was launched in 2000 to initiate a
global compact of shared values and principles which will give a human face to
the global market. The Company will continue to join various industry and
trade associations in condemning and combating the trade in illicit diamonds
and to comply fully with World Diamond Congress resolutions for industry
self-regulation in respect of the Kimberley Process Certification Scheme,
including implementation of the prescribed System of Warranties and Code of
Conduct. Furthermore, the Company long ago adopted the highest professional and
ethical standards in every aspect of our business and is fully compliant with
the DTCs recently developed Diamond Best
Practices Principles.

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 more than half of the worlds
current diamond output is sold by the Diamond Trading Company (DTC), the
rough diamond sales arm of the De Beers Group. Although the DTC has
historically been one of the Companys major suppliers of rough diamonds, the
Company has 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.

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
drive consumer demand for diamond jewelry by fostering the development of
efficient distribution networks that stimulate demand, support the emergence of
internationally recognized brands to meet consumer needs, supply clients with a
consistent supply of rough diamonds and encourage and support additional
investment in marketing and advertising programs with the goal of developing an
industry led by advertising and marketing support.

Further,
through its control of the worlds diamond output, the DTC could exert
significant control over the pricing of rough and polished diamonds. A large
rapid increase in rough diamond prices could materially adversely affect the

15

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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.

The
Company is currently a DTC Sightholder under the Supplier of Choice Program.
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
addition, the Companys manufacturing, trading and sourcing operations abroad
are 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 cooperation arrangement with ALROSA and its sourcing arrangements in
Angola represent a significant part of its operations. Any interruption in the
supply of diamonds from Russia or Angola could have a material adverse effect
on the Company.

16

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Consolidated Statements of
Operations

|                                                                           |  |                    |           |      |   |           |   |   |           | 
|-------------------------------------------------------------------------- |  | ------------------ | --------- | ---- | - | --------- | - | - | --------- | 
|                                                                           |  | Year ended May 31, |          
|                                                                           |  |                    |          
|(In thousands, except
share and per share data)                            |  | 2007               |           | 2006 |   | 2005      |  
|                                                                           |  |                    |           |      |   |           |  
|                                                                           |  |                    |           |      |   |           |  
|Net sales                                                                  |  | $                  | 434,406   |      | $ | 528,045   |   | $ | 421,411   | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|Cost of sales                                                              |  |                    | 411,523   |      |   | 498,197   |   |   | 386,677   | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|                                                                           |  |                    | 22,883    |      |   | 29,848    |   |   | 34,734    | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|Selling, general and administrative expenses                               |  |                    | 25,691    |      |   | 24,759    |   |   | 24,475    | 
|Interest expense                                                           |  |                    | 5,856     |      |   | 3,786     |   |   | 2,389     | 
|Equity in (income) / loss of joint ventures                                |  |                    | (3,913    | )    |   | 537       |   |   |          | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|                                                                           |  |                    | 27,634    |      |   | 29,082    |   |   | 26,864    | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|Income / (loss) before income tax provision                                |  |                    | (4,751    | )    |   | 766       |   |   | 7,870     | 
|Income tax provison/(benefit)                                              |  |                    | (1,775    | )    |   | (762      | ) |   | 2,640     | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|NET INCOME / (LOSS)                                                        |  | $                  | (2,976    | )    | $ | 1,528     |   | $ | 5,230     | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|EARNINGS / (LOSS) PER SHARE                                                |  |                    |           |      |   |           |   |   |           | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|Basic earnings / (loss) per share                                          |  | $                  | (0.36     | )    | $ | 0.18      |   | $ | 0.62      | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|Average number of shares outstanding during the
period                     |  |                    | 8,207,006 |      |   | 8,291,413 |   |   | 8,448,704 | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|Diluted earnings / (loss) per share                                        |  | $                  | (0.36     | )    | $ | 0.18      |   | $ | 0.60      | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 
|Average number of shares outstanding during the
 period, assuming dilution |  |                    | 8,207,006 |      |   | 8,569,661 |   |   | 8,653,222 | 
|                                                                           |  |                    |           |      |   |           |   |   |           | 

See notes
to consolidated financial statements.

17

---



Consolidated Balance Sheets

|                                                                                                          |  |         |         |      |   |         |  
|--------------------------------------------------------------------------------------------------------- |  | ------- | ------- | ---- | - | ------- | -
|                                                                                                          |  | May 31, |        
|                                                                                                          |  |         |        
|(In thousands, except
share data)                                                                         |  | 2007    |         | 2006 |  
|                                                                                                          |  |         |         |      |  
|                                                                                                          |  |         |         |      |   |         |  
|Assets                                                                                                    |  |         |         |      |   |         |  
|CURRENT ASSETS:                                                                                           |  |         |         |      |   |         |  
|Cash and cash equivalents                                                                                 |  | $       | 7,869   |      | $ | 8,160   |  
|Accounts receivable, less allowance for doubtful accounts
 ($846 and $515 in 2007 and 2006, respectively) |  |         | 133,989 |      |   | 91,403  |  
|Inventories, net:                                                                                         |  |         |         |      |   |         |  
|Rough stones                                                                                              |  |         | 14,300  |      |   | 24,746  |  
|Polished stones                                                                                           |  |         | 97,767  |      |   | 108,368 |  
|                                                                                                          |  |         |         |      |   |         |  
|Total inventories                                                                                         |  |         | 112,067 |      |   | 133,114 |  
|                                                                                                          |  |         |         |      |   |         |  
|Prepaid expenses and other current assets                                                                 |  |         | 10,750  |      |   | 12,763  |  
|Deferred tax assets-current                                                                               |  |         | 1,989   |      |   | 2,024   |  
|                                                                                                          |  |         |         |      |   |         |  
|TOTAL CURRENT ASSETS                                                                                      |  |         | 266,664 |      |   | 247,464 |  
|                                                                                                          |  |         |         |      |   |         |  
|Property, plant and equipment, net                                                                        |  |         | 7,281   |      |   | 8,318   |  
|Other assets                                                                                              |  |         | 6,804   |      |   | 423     |  
|Deferred tax assets, net                                                                                  |  |         | 9,534   |      |   | 7,507   |  
|                                                                                                          |  |         |         |      |   |         |  
|                                                                                                          |  | $       | 290,283 |      | $ | 263,712 |  
|                                                                                                          |  |         |         |      |   |         |  
|                                                                                                          |  |         |         |      |   |         |  
|Liabilities and Stockholders Equity                                                                      |  |         |         |      |   |         |  
|CURRENT LIABILITIES:                                                                                      |  |         |         |      |   |         |  
|Accounts payable and other current liabilities                                                            |  | $       | 75,690  |      | $ | 55,771  |  
|Current portion of long-term debt and lines of
credit                                                     |  |         | 85,536  |      |   | 47,969  |  
|                                                                                                          |  |         |         |      |   |         |  
|TOTAL CURRENT LIABILITIES                                                                                 |  |         | 161,226 |      |   | 103,740 |  
|                                                                                                          |  |         |         |      |   |         |  
|Long-term debt                                                                                            |  |         | 36,060  |      |   | 64,176  |  
|                                                                                                          |  |         |         |      |   |         |  
|TOTAL LIABILITIES                                                                                         |  |         | 197,286 |      |   | 167,916 |  
|                                                                                                          |  |         |         |      |   |         |  
|COMMITMENTS AND CONTINGENCIES                                                                             |  |         |         |      |   |         |  
|                                                                                                          |  |         |         |      |   |         |  
|STOCKHOLDERS EQUITY                                                                                      |  |         |         |      |   |         |  
|Preferred stock, par value $.01 per
share:                                                                |  |         |         |      |   |         |  
|Authorized 1,500,000; no shares
outstanding                                                               |  |         |        |      |   |        |  
|Common stock, par value $1 per
share:                                                                     |  |         |         |      |   |         |  
|Authorized 12,000,000 shares; issued
8,946,845 and
 8,821,345 in 2007 and 2006, respectively              |  |         | 8,947   |      |   | 8,821   |  
|Additional paid-in capital                                                                                |  |         | 63,090  |      |   | 62,187  |  
|Cumulative translation
adjustment                                                                         |  |         | (766    | )    |   | (425    | )
|Retained earnings                                                                                         |  |         | 27,324  |      |   | 30,300  |  
|                                                                                                          |  |         |         |      |   |         |  
|                                                                                                          |  |         | 98,595  |      |   | 100,883 |  
|Less treasury stock, 687,545 and 624,211 shares at cost in
 2007 and 2006, respectively                   |  |         | (5,598  | )    |   | (5,087  | )
|                                                                                                          |  |         |         |      |   |         |  
|TOTAL STOCKHOLDERS
EQUITY                                                                                |  |         | 92,997  |      |   | 95,796  |  
|                                                                                                          |  |         |         |      |   |         |  
|                                                                                                          |  | $       | 290,283 |      | $ | 263,712 |  
|                                                                                                          |  |         |         |      |   |         |  

See notes
to consolidated financial statements.

18

---



Consolidated Statements of Cash Flows

|                                                                               |  |                    |         |      |   |         |   |   |         |  
|------------------------------------------------------------------------------ |  | ------------------ | ------- | ---- | - | ------- | - | - | ------- | -
|                                                                               |  | Year ended May 31, |        
|                                                                               |  |                    |        
|(In thousands)                                                                 |  | 2007               |         | 2006 |   | 2005    |  
|                                                                               |  |                    |         |      |   |         |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|Cash Flows from Operating Activities:                                          |  |                    |         |      |   |         |   |   |         |  
|Net
    income/(loss)                                                          |  | $                  | (2,976  | )    | $ | 1,528   |   | $ | 5,230   |  
|Adjustments to reconcile net income to net cash used in
 operating activities: |  |                    |         |      |   |         |   |   |         |  
|Depreciation and amortization                                                  |  |                    | 1,518   |      |   | 1,310   |   |   | 1,159   |  
|Provision for uncollectible
accounts                                           |  |                    | 358     |      |   | 168     |   |   | 59      |  
|Compensation expense - noncash                                                 |  |                    | 124     |      |   |        |   |   | 329     |  
|Deferred income taxes                                                          |  |                    | (1,992  | )    |   | (1,585  | ) |   | 2,289   |  
|Equity
    in earnings of unconsolidated affiliates                            |  |                    | (3,913  | )    |   | 537     |   |   |        |  
|Changes in operating assets and liabilities:                                   |  |                    |         |      |   |         |   |   |         |  
|Accounts receivable                                                            |  |                    | (42,944 | )    |   | (4,581  | ) |   | (25,237 | )
|Rough and polished inventories                                                 |  |                    | 21,047  |      |   | (8,530  | ) |   | (31,207 | )
|Prepaid expenses and other current
assets                                      |  |                    | 2,013   |      |   | (944    | ) |   | (5,779  | )
|Other assets                                                                   |  |                    | (2,489  | )    |   | (124    | ) |   | 45      |  
|Accounts payable and other current
liabilities                                 |  |                    | 19,919  |      |   | (21,470 | ) |   | 30,564  |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|Net cash used in operating activities                                          |  |                    | (9,335  | )    |   | (33,691 | ) |   | (22,548 | )
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|Cash Flows from Investing Activities:                                          |  |                    |         |      |   |         |   |   |         |  
|Capital expenditures                                                           |  |                    | (460    | )    |   | (1,839  | ) |   | (1,790  | )
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|Net cash used in investing activities                                          |  |                    | (460    | )    |   | (1,839  | ) |   | (1,790  | )
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|Cash Flows from Financing Activities:                                          |  |                    |         |      |   |         |   |   |         |  
|Increase in borrowings                                                         |  |                    | 9,451   |      |   | 35,407  |   |   | 35,119  |  
|Purchase of treasury stock                                                     |  |                    | (511    | )    |   | (1,968  | ) |   | (1,973  | )
|Proceeds from exercise of stock options                                        |  |                    | 905     |      |   | 115     |   |   | 258     |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|Net cash provided by financing activities                                      |  |                    | 9,845   |      |   | 33,554  |   |   | 33,404  |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|Effect of exchange rate changes on cash                                        |  |                    | (341    | )    |   | (184    | ) |   | 45      |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|Net increase/(decrease) in cash and cash
equivalents                           |  |                    | (291    | )    |   | (2,160  | ) |   | 9,111   |  
|Cash and cash equivalents at beginning of year                                 |  |                    | 8,160   |      |   | 10,320  |   |   | 1,209   |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|Cash and cash equivalents at end of year                                       |  | $                  | 7,869   |      | $ | 8,160   |   | $ | 10,320  |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  
|Supplemental Disclosures of Cash Flow
 Information:                            |  |                    |         |      |   |         |   |   |         |  
|Cash paid during the year for:                                                 |  |                    |         |      |   |         |   |   |         |  
|Interest                                                                       |  | $                  | 5,558   |      | $ | 3,363   |   | $ | 2,532   |  
|Income taxes                                                                   |  | $                  | 211     |      | $ | 508     |   | $ | 449     |  
|                                                                               |  |                    |         |      |   |         |   |   |         |  

See notes
to consolidated financial statements.

19

---



Consolidated Statements of Stockholders
Equity

|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|------------------------------------------------ |  | ------------- | ----- | ---------------------------- | - | ----------------------------------- |  | ------------------ | ---- | --------------- | - | ---------------------------- | - | - | ------ | - | - | ------ | -
|(In thousands,
 except share data)               |  | Common
 Stock |       | Additional
 Paid-in
 Capital |   | Cumulative
 Translation
 Adjustment |  | Retained
 Earnings |      | Treasury
 Stock |   | Total
 Stockholders
 Equity |  
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |  
|Balance, May 31, 2004                            |  | $             | 8,711 |                              | $ | 61,595                              |  | $                  | (286 | )               | $ | 23,542                       |   | $ | (1,146 | ) | $ | 92,416 |  
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Comprehensive income:                            |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Net income                                       |  |               |      |                              |   |                                    |  |                    |     |                 |   | 5,230                        |   |   |       |   |   | 5,230  |  
|Foreign currency translation                     |  |               |      |                              |   |                                    |  |                    | 45   |                 |   |                             |   |   |       |   |   | 45     |  
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Comprehensive income                             |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   | 5,275  |  
|Exercise of stock options, 92,060 shares issued  |  |               | 92    |                              |   | 495                                 |  |                    |     |                 |   |                             |   |   |       |   |   | 587    |  
|Purchase of treasury stock,197,273 shares        |  |               |      |                              |   |                                    |  |                    |     |                 |   |                             |   |   | (1,973 | ) |   | (1,973 | )
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Balance, May 31, 2005                            |  | $             | 8,803 |                              | $ | 62,090                              |  | $                  | (241 | )               | $ | 28,772                       |   | $ | (3,119 | ) | $ | 96,305 |  
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Comprehensive income:                            |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Net income                                       |  |               |      |                              |   |                                    |  |                    |     |                 |   | 1,528                        |   |   |       |   |   | 1,528  |  
|Foreign currency translation                     |  |               |      |                              |   |                                    |  |                    | (184 | )               |   |                             |   |   |       |   |   | (184   | )
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Comprehensive income                             |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   | 1,344  |  
|Exercise of stock options, 18,666 shares issued  |  |               | 18    |                              |   | 97                                  |  |                    |     |                 |   |                             |   |   |       |   |   | 115    |  
|Purchase of treasury stock, 216,838 shares       |  |               |      |                              |   |                                    |  |                    |     |                 |   |                             |   |   | (1,968 | ) |   | (1,968 | )
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Balance, May 31, 2006                            |  | $             | 8,821 |                              | $ | 62,187                              |  | $                  | (425 | )               | $ | 30,300                       |   | $ | (5,087 | ) | $ | 95,796 |  
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Comprehensive
    loss:                          |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Net
    loss                                     |  |               |      |                              |   |                                    |  |                    |     |                 |   | (2,976                       | ) |   |       |   |   | (2,976 | )
|Foreign currency translation                     |  |               |      |                              |   |                                    |  |                    | (341 | )               |   |                             |   |   |       |   |   | (341   | )
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Comprehensive
    loss                           |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   | (3,317 | )
|Exercise of stock options, 125,500 shares issued |  |               | 126   |                              |   | 779                                 |  |                    |     |                 |   |                             |   |   |       |   |   | 905    |  
|Share
    based compensation expense             |  |               |       |                              |   | 124                                 |  |                    |      |                 |   |                              |   |   |        |   |   | 124    |  
|Purchase of treasury stock, 63,334 shares        |  |               |      |                              |   |                                    |  |                    |     |                 |   |                             |   |   | (511   | ) |   | (511   | )
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  
|Balance, May 31, 2007                            |  | $             | 8,947 |                              | $ | 63,090                              |  | $                  | (766 | )               | $ | 27,324                       |   | $ | (5,598 | ) | $ | 92,997 |  
|                                                 |  |               |       |                              |   |                                     |  |                    |      |                 |   |                              |   |   |        |   |   |        |  

See notes to consolidated
financial statements.

20

---



Notes to Consolidated Financial StatementsYears ended
May 31, 2007, 2006 and 2005

|                       
|-----------------------
|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
wholly-owned subsidiaries. All material intercompany balances and transactions
have been eliminated. In these notes to consolidated financial statements, the
years 2007, 2006 and 2005 refer to the fiscal years ended May 31, 2007,
2006 and 2005, 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

Sales arrangements with
customers:

The
Companys polished diamond and diamond jewelry customers consist primarily of
wholesale and retail clients. The Companys rough diamond customers consist
primarily of rough diamond cutters. The Company generally ships polished
diamond inventory to customers subject to verification of the diamond
particulars.

The
Companys policy is to recognize revenue when title and risk of ownership have
passed to the buyer, the earnings process is complete and the sale price is
fixed and determinable. Polished diamond sales includes revenue derived from
the sale of polished diamonds and the cutting, polishing and laser inscription
of polished diamonds. In addition, in certain instances, the Company may be
entitled to receive incremental profits from its customers on the sale of
certain stones. Such profits are recognized as revenue when realized. Where the
Company acts as a principal in the sales transaction, takes title to the
product and has risks and rewards of ownership, the gross value of diamonds
invoiced is recorded as sales with the portion of profits allocable to others
(where applicable) included in cost of sales.

Where
the Company believes profitability can be maximized, the Company may combine,
and jointly sell, certain of its diamonds with those of other wholesalers. In
such instances, the Company is obligated to share profits it realizes on the
sale of such stones. Typically, the participating wholesaler is required to
advance funds to the Company equal to their proportional interest in the
underlying diamonds.

The
Company has an arrangement with a diamond producer whereby the Company sells
certain polished diamonds that are cut and polished in Russia. The risk and
rewards of ownership of these diamonds is transferred to the Company upon
delivery to the Company of the diamonds in polished form. Generally, upon
receipt, the Company pays a negotiated base price and the producer receives an
economic interest in future profits associated with the diamonds.

The
Company has a technical cooperation agreement with an entity responsible for
the development and marketing of diamonds produced in Angola. Pursuant to this
agreement the Company has established a joint buying and rough diamond trading
operation. The Company takes title to the diamonds upon acquisition in Angola
and assumes responsibility for risk of loss. Sales by the Company are recorded
at their gross invoice value. Profits in excess of operating and rough
acquisition costs as defined are allocated between parties with such costs
classified as cost of sales by the Company.

The Companys net sales to
customers in each of the following regions for the years ended May 31, 2007,
2006 and 2005 are set forth below:

|                       |  |      |     |      |  |      |   |  |     |  
|---------------------- |  | ---- | --- | ---- |  | ---- | - |  | --- | -
|                       |  |      |     |      |  |      |  
|                       |  | 2007 |     | 2006 |  | 2005 |  
|                       |  |      |     |      |  |      |  
|United States          |  |      | 15  | %    |  | 13   | % |  | 20  | %
|Far East               |  |      | 8   | %    |  | 7    | % |  | 9   | %
|Europe, Israel & Other |  |      | 77  | %    |  | 80   | % |  | 71  | %
|                       |  |      |     |      |  |      |   |  |     |  
|                       |  |      | 100 | %    |  | 100  | % |  | 100 | %
|                       |  |      |     |      |  |      |   |  |     |  

No
single customer of the Company accounted for 10% or more of the Companys net
sales for the fiscal years ended May 31, 2007, 2006 and 2005. Where the Company
believes profitability can be

21

---



maximized, the Company may
combine, and jointly sell, certain of its rough stones with those of other
wholesalers. Under certain circumstances, primarily related to foreign sales,
the wholesaler assumes responsibility for billing and collection efforts. While
the ultimate sales are made to multiple third parties the resulting accounts
receivable are aggregated for purposes of determining concentration of credit
risk. One customer accounted for 34.1% of accounts receivable at May 31, 2007.
Two customers accounted for 15.2% and 11.5% of accounts receivable at May 31,
2006.

Accounts
receivable are reduced by an allowance for amounts that may be uncollectible in
the future. Estimates are used in determining the allowance for doubtful
accounts and are based on the Companys ongoing credit evaluations of
customers, customer payment history and account aging.

Credit
is extended based on an evaluation of each customers financial condition and
generally collateral is not required on the Companys receivables

d. Customer rebates

From
time to time the Company has had arrangements whereby it would rebate to a
customer a percentage of certain of its qualifying purchases. The Company
characterizes such rebates as a reduction of sales.

e. Cash and cash equivalents

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

f. Inventories

Inventories,
including amounts on consignment with customers, are stated at the lower of
cost or market, using the average cost method.

g. 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.

h. Asset impairments

The
Company records impairment losses on long-lived assets with finite lives 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. If the
Company determines, based upon such measures, that the carrying amount is
impaired the long-lived asset will be written down to its recoverable value
based upon either the discounted future cash flows or appraised fair value.

i. 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 as a component
of stockholders equity in the accompanying balance sheets.

j. Advertising and incentive programs

The
Company participates in cooperative advertising arrangements with customers in
order to build brand awareness and product acceptance. Under such an
arrangement a customer is eligible to receive an allowance of up to a specified
percentage of its purchases from the Company if certain qualitative advertising
criteria are met and if specified amounts are spent on qualifying advertising.
The Company characterizes as selling, general and administrative expense the
consideration it pays to customers for cooperative advertising.

In
addition, the Company offers programs whereby certain sales staff employed by
the Companys customers can receive consideration for sales of the Companys
products. The Company characterizes as selling, general and administrative
expense the consideration it pays to the salesperson.

k. Consideration received from vendors

Periodically,
the Company negotiates agreements with vendors to share certain promotional
costs. The Company classifies amounts expended on such promotions as selling
general and administrative expense when incurred. Similarly, amounts reimbursed
by vendors are characterized as a reduction of selling, general and
administrative expense.

Advertising
costs are expensed as incurred and were $2.3 million, $2.6 million and $2.8
million in 2007, 2006 and 2005, respectively.

22

---



l. Shipping and handling:

Shipping
and handling costs incurred by the Company to deliver product to customers,
$0.3 million in 2007, $0.4 million in 2006 and $0.3 million in 2005, are
classified in the Companys income statement as selling, general and
administrative expense.

m. Equity investments

The
Company utilizes the equity method of accounting to record its proportionate
share of income and losses from joint ventures

n. 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 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.

Earnings
from foreign subsidiaries are intended to be reinvested indefinitely with the
exception that Pegasus Overseas Ltd., a wholly owned foreign subsidiary,
declared on May 1, 2006 a dividend in the amount of $8.0 million. The Company
provided $0.4 million for U.S. income taxes related to the dividend in 2006.

o. Earnings 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.

|                                                                         |  |      |           |      |  |           |  |  |           | 
|------------------------------------------------------------------------ |  | ---- | --------- | ---- |  | --------- |  |  | --------- | 
|                                                                         |  | 2007 |           | 2006 |  | 2005      | 
|                                                                         |  |      |           |      |  |           | 
|                                                                         |  |      |           |      |  |           |  |  |           | 
|Average number of shares outstanding during the period                   |  |      | 8,207,006 |      |  | 8,291,413 |  |  | 8,448,704 | 
|                                                                         |  |      |           |      |  |           |  |  |           | 
|Effect of dilutive stock options                                         |  |      |          |      |  | 278,248   |  |  | 204,518   | 
|                                                                         |  |      |           |      |  |           |  |  |           | 
|Average number of shares outstanding during the period assuming
dilution |  |      | 8,207,006 |      |  | 8,569,661 |  |  | 8,653,222 | 
|                                                                         |  |      |           |      |  |           |  |  |           | 

Antidilutive options of
926,451 were not included in the computation of dilutive earnings per share for
2007 because the Company had a net loss for the year. For 2006 and 2005 601,800
and 352,000 antidilutive options, respectively were not included in the
computation of diluted earnings per share because the exercise price of the
options were greater than the average market price of the common shares.

p. 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 more than half of the worlds
current diamond output is sold by the Diamond Trading Company (DTC), the
rough diamond sales arm of the De Beers Group. Although the DTC has
historically been one of the Companys major suppliers of rough diamonds, the
Company has 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

23

---



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.

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
drive consumer demand for diamond jewelry by fostering the development of
efficient distribution networks that stimulate demand, support the emergence of
internationally recognized brands to meet consumer needs, supply clients with a
consistent supply of rough diamonds and encourage and support additional
investment in marketing and advertising programs with the goal of developing an
industry led by advertising and marketing support.

Further,
through its control of a significant portion of the worlds diamond output, the
DTC could 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.

All
current DTC sightholders have received notice of termination of the current
contract effective December 31, 2007. It is expected that new sightholder
appointments will be made in December 2007. The Company is hopeful it will be
reappointed as a sightholder at that time. If the Company is not reappointed as
a sightholder it could have a material adverse effect on its ability to purchase
rough diamonds. 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 operations.

The
Company has an agreement with AK ALROSA of Russia, which is the largest
producer of rough diamonds in Russia. The Companys cooperation arrangement
with ALROSA is a significant part of its operations. Any interruption in the
supply of diamonds from Russia could have a material adverse effect on the
Companys operations.

q. Stock Incentive Plans

Through
2006, the Company accounted 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. The
following disclosures are computed as if the Company recorded compensation
expense based on the fair value for stockbased awards or grants.

|                                                                                                                  |  |                     |       |      |   |       | 
|----------------------------------------------------------------------------------------------------------------- |  | ------------------- | ----- | ---- | - | ----- | 
|                                                                                                                  |  | Year ended
 May 31, |      
|                                                                                                                  |  |                     |      
|                                                                                                                  |  | 2006                |       | 2005 |  
|                                                                                                                  |  |                     |       |      |  
|Net income, as reported                                                                                           |  | $                   | 1,528 |      | $ | 5,230 | 
|Add: Compensation expense, net of related taxes                                                                   |  |                     |      |      |   | 184   | 
|Deduct: Stock-based employee compensation expense determined under
 fair value method, net of related tax effects |  |                     | 522   |      |   | 509   | 
|                                                                                                                  |  |                     |       |      |   |       | 
|                                                                                                                  |  |                     |       |      |   |       | 
|Proforma net income                                                                                               |  | $                   | 1,006 |      | $ | 4,905 | 
|                                                                                                                  |  |                     |       |      |   |       | 
|Earnings per share as reported:                                                                                   |  |                     |       |      |   |       | 
|Basic                                                                                                             |  | $                   | 0.18  |      | $ | 0.62  | 
|Diluted                                                                                                           |  | $                   | 0.18  |      | $ | 0.60  | 
|                                                                                                                  |  |                     |       |      |   |       | 
|Basic and diluted earnings pro forma:                                                                             |  |                     |       |      |   |       | 
|Basic                                                                                                             |  | $                   | 0.18  |      | $ | 0.58  | 
|Diluted                                                                                                           |  | $                   | 0.12  |      | $ | 0.57  | 

Effective
    June 1, 2006, the Company adopted SFAS No. 123(R), Accounting for share-based
    Payment, which requires companies to measure and recognize compensation
    expense for all stock-based payments at fair value. Under SFAS 123(R), using
    the modified prospective method, compensation expense is recognized for all
    share-based payments granted prior to, but not yet vested as of June 1, 2006
    and compensation cost for all share-based payments granted subsequent to
    June 1, 2006 based on the grant-date fair value in accordance with the provisions
    of SFAS No 123(R). During 2005 the Companys
    Stock Option Committee modified the vesting period applicable to certain
    stock options granted in 2004. The effect of this modification was to accelerate
    the vesting of options which would have vested on December 15, 2006 to vest
    on May 31, 2006. The purpose of accelerating the vesting of these options
    was to mitigate the costs associated with adopting SAFS No 123 (R). The Company
    recognized incremental stock-based compensation expense of $0.1 million during
    2007 as a result of the adoption of SFAS No 123(R), included in selling,
    general and adminstrative expense.

24

---



r.
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, 2007, 2006 and 2005, total comprehensive income/(loss) was
$ (3.3) million, $1.3 million, and $5.3 million, respectively.

s.
Reclassifications

Certain
prior year amounts have been reclassified to conform to current year
presentation. t. New Accounting Pronouncements

In
July 2006, the Financial Accounting Standards Board (FASB) issued FASB
Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48),
which clarifies the accounting for uncertainty in tax positions. This
Interpretation requires financial statement recognition of the impact of a tax
position if a position is more likely than not of being sustained on audit,
based on the technical merits of the position. Additionally, FIN 48 provides
guidance on measurement, derecognition, classification, accounting in interim
periods and disclosure requirements for uncertain tax positions. The provisions
of FIN 48 will be effective as of the beginning of the Companys fiscal year
2008, with the cumulative effect of the change in accounting principle recorded
as an adjustment to opening retained earnings. The Company is currently
evaluating the impact of FIN 48 on its financial position, results of
operations and cash flows.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements, which
establishes a framework for measuring fair value in generally accepted accounting
principles and expands disclosures about fair value measurements. SFAS No. 157
defines fair value as the price that would be received to sell an asset or paid
to transfer a liability in an orderly transaction between market participants
at the measurement date. SFAS No. 157 is effective for financial statements issued
for fiscal years beginning after November 15, 2007, and interim periods within
those fiscal years. The Company is currently evaluating the impact of SFAS 157
on its financial position, results of operations and cash flows.

In February 2007, the FASB issued SFAS 159, The Fair Value Option for Financial Asset and Financial Liability: Including an amendment of FASB Statement No. 115 (SFAS 159).
The standard permits all entities to elect to measure certain financial instruments
and other items at fair value with changes in fair value reported in earnings.
SFAS 159 is effective as of the beginning of the first fiscal year that begins
after November 15, 2007. The Company is currently evaluating the impact of SFAS
159 on its financial position, results of operations and cash flows.

|                                
|--------------------------------
|2. Property, Plant and Equipment
|                                

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

|                                                |  |         |        |      |   |        | 
|----------------------------------------------- |  | ------- | ------ | ---- | - | ------ | 
|                                                |  | May 31, |       
|                                                |  |         |       
|                                                |  | 2007    |        | 2006 |  
|                                                |  |         |        |     
|Land and buildings                              |  | $       | 2,328  |      | $ | 2,115  | 
|Leasehold improvements                          |  |         | 2,637  |      |   | 2,633  | 
|Machinery, tools and
 equipment                 |  |         | 7,793  |      |   | 8,775  | 
|Furniture and fixtures                          |  |         | 1,317  |      |   | 1,357  | 
|Computer hardware, software
 and equipment      |  |         | 7,995  |      |   | 8,257  | 
|                                                |  |         |        |      |   |        | 
|                                                |  |         | 22,070 |      |   | 23,137 | 
|Less accumulated
 depreciation and amortization |  |         | 14,789 |      |   | 14,819 | 
|                                                |  |         |        |      |   |        | 
|                                                |  | $       | 7,281  |      | $ | 8,318  | 
|                                                |  |         |        |      |   |        | 

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, software and equipment | 10 to 33  | %

Depreciation
and amortization expense for 2007, 2006 and 2005 was $1.5 million, $1.3 million
and $1.2 million, respectively.

|               
|---------------
|3. Income Taxes
|               

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

|                                       |  |         |        |      |   |        |  
|-------------------------------------- |  | ------- | ------ | ---- | - | ------ | -
|                                       |  | May 31, |       
|                                       |  |         |       
|                                       |  | 2007    |        | 2006 |  
|                                       |  |         |        |     
|Deferred tax
 assets:                  |  |         |        |      |   |        |  
|Operating loss and other carryforwards |  | $       | 11,325 |      | $ | 8,801  |  
|Other                                  |  |         | 1,998  |      |   | 2,004  |  
|Deferred tax
 liabilities:             |  |         |        |      |   |        |  
|Depreciation                           |  |         | (942   | )    |   | (1,141 | )
|                                       |  |         |        |      |   |        |  
|                                       |  |         | 12,381 |      |   | 9,664  |  
|Less:
 Valuation allowance             |  |         | (858   | )    |   | (133   | )
|                                       |  |         |        |      |   |        |  
|Net deferred
 tax assets               |  | $       | 11,523 |      | $ | 9,531  |  
|                                       |  |         |        |      |   |        |  

25

---



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

|                         |  |                     |        |      |   |        |   |   |       | 
|------------------------ |  | ------------------- | ------ | ---- | - | ------ | - | - | ----- | 
|                         |  | Year ended
 May 31, |       
|                         |  |                     |       
|                         |  | 2007                |        | 2006 |   | 2005   |  
|                         |  |                     |       
|Current:                 |  |                     |        |      |   |        |   |   |       | 
|Federal                  |  | $                   |       |      | $ | 408    |   | $ | 98    | 
|State and local          |  |                     | 105    |      |   | 277    |   |   | 117   | 
|Foreign                  |  |                     | 112    |      |   | 138    |   |   | 136   | 
|                         |  |                     |        |      |   |        |   |   |       | 
|                         |  |                     | 217    |      |   | 823    |   |   | 351   | 
|Deferred:                |  |                     |        |      |   |        |   |   |       | 
|Federal, state and local |  |                     | (1,992 | )    |   | (1,585 | ) |   | 2,289 | 
|                         |  |                     |        |      |   |        |   |   |       | 
|                         |  | $                   | (1,775 | )    | $ | (762   | ) | $ | 2,640 | 
|                         |  |                     |        |      |   |        |   |   |       | 

Income/(loss)
     before income taxes from the Companys domestic and foreign operations
     (in thousands):

|         |  |                     |        |      |   |        |   |   |       | 
|-------- |  | ------------------- | ------ | ---- | - | ------ | - | - | ----- | 
|         |  | Year ended
 May 31, |       
|         |  |                     |       
|         |  | 2007                |        | 2006 |   | 2005   |  
|         |  |                     |       
|Domestic |  | $                   | (5,936 | )    | $ | (4,647 | ) | $ | 6,008 | 
|Foreign  |  |                     | 1,185  |      |   | 5,413  |   |   | 1,862 | 
|         |  |                     |        |      |   |        |   |   |       | 
|         |  | $                   | (4,751 | )    | $ | 766    |   | $ | 7,870 | 
|         |  |                     |        |      |   |        |   |   |       | 

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

|                                                |  |   |        |   |   |        |   |   |       |  
|----------------------------------------------- |  | - | ------ | - | - | ------ | - | - | ----- | -
|                                                |  |   |       
|                                                |  |   | 2007   |   |   | 2006   |   |   | 2005  |  
|                                                |  |   |       
|Tax provision / (benefit)
 at statutory rate    |  | $ | (1,615 | ) | $ | 260    |   | $ | 2,676 |  
|(Decrease) / increase in
 taxes resulting from: |  |   |        |   |   |        |   |   |       |  
|Differential attributable to foreign
operations |  |   | (291   | ) |   | (1,724 | ) |   | (497  | )
|Tax on repatriated dividends                    |  |   |       |   |   | 408    |   |   |      |  
|State and local taxes, net of Federal
benefit   |  |   | 104    |   |   | 267    |   |   | 443   |  
|Permanent items                                 |  |   | 27     |   |   | 27     |   |   | 18    |  
|                                                |  |   |        |   |   |        |   |   |       |  
|Tax provision                                   |  | $ | (1,775 | ) | $ | (762   | ) | $ | 2,640 |  
|                                                |  |   |        |   |   |        |   |   |       |  

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

|     |  |   |                      | 
|---- |  | - | -------------------- | 
|Year |  |   | NetOperating
 Losses | 
|     | 
|     |  |   |                      | 
|2019 |  | $ | 8,690                | 
|2020 |  |   | 298                  | 
|2021 |  |   | 120                  | 
|2022 |  |   | 10,190               | 
|2023 |  |   | 25                   | 
|2026 |  |   | 4,066                | 
|2027 |  |   | 5,509                | 
|     |  |   |                      | 
|     |  | $ | 28,898               | 
|     |  |   |                      | 

In
addition, the Company has New York State and New York City net operating loss
carryforwards of approximately $16.9 million each, expiring from 2022 through
2027.

|                                                 
|-------------------------------------------------
|4. Accounts Payable and Other Current Liabilities
|                                                 

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

|                    |  |   |        |  |   |        | 
|------------------- |  | - | ------ |  | - | ------ | 
|                    |  |   | 2007   |  |   | 2006   | 
|                    | 
|Accounts
 payable   |  | $ | 21,693 |  | $ | 6,608  | 
|Advances and
 other |  |   | 43,282 |  |   | 42,458 | 
|Accrued
 expenses   |  |   | 10,715 |  |   | 6,705  | 
|                    |  |   |        |  |   |        | 
|                    |  | $ | 75,690 |  | $ | 55,771 | 
|                    |  |   |        |  |   |        | 

Advances
and other, primarily relating to the purchase, manufacture and sale of
inventory, includes $31.3 million and $12.0 million payable to two parties for
2007. For 2006, $22.5 million and $15.4 million was payable to two parties.

|                  
|------------------
|5. Lines of Credit
|                  

The
Company has a $25.0 million and a $45.0 million unsecured, uncommitted line of
credit with a bank. Borrowings under both lines bear interest at a rate 160
basis points above the 90 day LIBOR. As of May 31, 2007 and 2006, the balance
outstanding under both lines was $53.5 million and $40.8 million, respectively.
Borrowings under these lines are available for the Companys working capital
requirements and are payable on demand.

The Company
has a $35.0 million long-term unsecured, committed revolving loan agreement and
a $10.0 million unsecured, uncommitted credit agreement. The Company may borrow
under the committed facility (including up to $1.0 million under letters of
credit, $0.7 million issued at May 31, 2007) through December 1, 2008. The loan
term may be

26

---



extended in
one year increments commencing November 30, 2007, subject to the consent of the
lending banks. Borrowings under both agreements bear interest at (a) the higher
of the banks base rate or one half of one percent above the Federal Funds
Effective Rate, or (b) 160 basis points above LIBOR. The applicable interest
rate is contingent upon the method of borrowing selected by the Company. The
proceeds of these facilities are available for working capital purposes. The
loan agreements contain certain provisions that require, among other things,
(a) maintenance of defined levels of working capital, net worth and
profitability, (b) limitations on borrowing levels, investments and capital
expenditures and (c) limitations on dividends and the repurchase of treasury
shares. As of May 31, 2007 and 2006, the balance outstanding under both
facilities was $41.0 million and $38.0 million, respectively.

The
Company maintains an additional unsecured, committed revolving loan agreement with a bank.
At May 31, 2007 the maximum amount available under the facility was $30.0 million. The maximum borrowing limit permitted under the facility is scheduled to reduce to $20.0 million on June 30, 2007, with further reductions of $1.0 million at the end of September, October and November 2007, $7.0 million on December 31, 2007 and $5.0 million on each of March 31, 2008 and June 30, 2008. Borrowings under
this agreement bear interest at (a) the higher of the banks base rate or one
half of one percent above the Federal Funds Effective Rate, or (b) 160 basis
points above LIBOR. The applicable interest rate is contingent upon the method
of borrowing selected by the Company. The proceeds of this facility are
available for working capital purposes. The loan agreement contains certain
provisions that require, among other things, (a) maintenance of defined levels
of working capital, net worth and profitability, (b) limitations on borrowing
levels, investments and capital expenditures and (c) limitations on dividends
and the repurchase of treasury shares. Borrowings under this loan agreement
amounted to $26.0 million and $29.2 million at May 31, 2007 and 2006,
respectively.

A
subsidiary of the Company maintains a loan facility which enables it to borrow
up to 520 million Japanese yen (approximately $4.3 million U.S. dollars) at an
interest rate 1% above the Japanese yen LIBOR through November 2008. Borrowings
under the facility are available for working capital purposes. The Company
guarantees repayment of amounts borrowed. Borrowings under the loan are used in
support of its operations in Japan. As of May 31, 2007 and 2006, the balance
outstanding under this facility was $1.1 million and $4.2 million U.S. dollars,
respectively.

The
weighted average interest rate for all outstanding borrowings under the
Companys credit facilities was 6.9% at May 31, 2007.

Long-term
debt of $36.1 million outstanding at May 31, 2007 is scheduled to be repaid in
the fiscal year ended May 31, 2009. At May 31, 2007 the Company was not in
compliance with an annual financial covenant under certain of its loan
facilities. The Company has since received waivers from its lenders.

The
Company guarantees a portion of certain indebtedness ($0.1 million at May 31,
2007) relating to a joint diamond cutting and polishing operation in South
Africa. The fair value of the guarantee is immaterial.

The
Companys long-term facilities do not contain subjective acceleration clauses
or require the Company to utilize a lock box whereby remittances from the
Companys customers reduce the debt outstanding.

|                        
|------------------------
|6. 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 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 1,350,000 shares of the
common stock of the Company for issuance to directors, officers, key employees
and consultants of the Company and its subsidiaries.

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.

Prior
to 2007, the Company did 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. In

27

---



accordance
with SFAS123(R) the Company has provided pro forma information regarding net
income and earnings per share 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 2006 and 2005 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.
Commencing with its first quarter 2007 the Company began recording compensation
expense under Statement of Financial Accounting Standards No. 123 (SFAS123)
Accounting for Stock-Based Compensation.

The
following summarizes the assumptions used to estimate the fair value of stock
options granted in each year:

|                                                 |  |      |          |      |   |          |  |   |          |  
|------------------------------------------------ |  | ---- | -------- | ---- | - | -------- |  | - | -------- | -
|                                                 |  |     
|                                                 |  | 2007 |          | 2006 |   | 2005     | 
|                                                 |  |     
|Risk-free interest rate                          |  |      | n/a      |      |   | n/a      |  |   | 3.85     | %
|Expected option life                             |  |      | 5
 years |      |   | 5
 years |  |   | 5
 years |  
|Expected volatility                              |  |      |         |      |   |         |  |   | 30.30    | %
|                                                 |  |      |          |      |   |          |  |   |          |  
|Expected dividends per
 share                    |  | $    |         |      | $ |         |  | $ |         |  
|                                                 |  |      |          |      |   |          |  |   |          |  
|Options Granted                                  |  |      |         |      |   |         |  |   | 360,000  |  
|                                                 |  |      |          |      |   |          |  |   |          |  
|Weighted average estimated
 fair value per share |  | $    |         |      | $ |         |  | $ | 2.81     |  
|                                                 |  |      |          |      |   |          |  |   |          |  
|Total intrinsic value of
 options exercised      |  | $    | 102,921  |      | $ | 63,350   |  | $ | 706,453  |  

A
summary of the Plans activity for the year ended May 31, 2007 is as follows:

|                                                                                                                          |  |                  |           |                                  |   |                                                       |  |                           |      |  |   |         | 
|------------------------------------------------------------------------------------------------------------------------- |  | ---------------- | --------- | -------------------------------- | - | ----------------------------------------------------- |  | ------------------------- | ---- |  | - | ------- | 
|                                                                                                                          |  | Number
of
shares |           | Weighted
average price
per share |   | Weighted average
remaining
contractual life
remaining |  | Aggregate
Intrinsic
Value |     
|                                                                                                                          | 
|Outstanding - May 31, 2004                                                                                                |  |                  | 1,158,683 |                                  | $ | 8.21                                                  |  |                           |      |  |   |         | 
|                                                                                                                          |  |                  |           |                                  |   |                                                       |  |                           |      |  |   |         | 
|Options expired/cancelled                                                                                                 |  |                  | (9,300    | )                                | $ | 7.72                                                  |  |                           |      |  |   |         | 
|Options issued                                                                                                            |  |                  | 360,000   |                                  | $ | 9.31                                                  |  |                           |      |  |   |         | 
|Options exercised                                                                                                         |  |                  | (169,265  | )                                | $ | 6.70                                                  |  |                           |      |  |   |         | 
|                                                                                                                          |  |                  |           |                                  |   |                                                       |  |                           |      |  |   |         | 
|Outstanding - May 31, 2005                                                                                                |  |                  | 1,340,118 |                                  | $ | 8.70                                                  |  |                           |      |  |   |         | 
|                                                                                                                          |  |                  |           |                                  |   |                                                       |  |                           |      |  |   |         | 
|Options expired/cancelled                                                                                                 |  |                  | (17,001   | )                                | $ | 6.61                                                  |  |                           |      |  |   |         | 
|Options issued                                                                                                            |  |                  |          |                                  | $ |                                                      |  |                           |      |  |   |         | 
|Options exercised                                                                                                         |  |                  | (18,666   | )                                | $ | 6.23                                                  |  |                           |      |  |   |         | 
|                                                                                                                          |  |                  |           |                                  |   |                                                       |  |                           |      |  |   |         | 
|Outstanding - May 31, 2006                                                                                                |  |                  | 1,304,451 |                                  | $ | 8.70                                                  |  |                           |      |  |   |         | 
|                                                                                                                          |  |                  |           |                                  |   |                                                       |  |                           |      |  |   |         | 
|Options expired/cancelled                                                                                                 |  |                  | (252,500  | )                                | $ | 11.25                                                 |  |                           |      |  |   |         | 
|Options issued                                                                                                            |  |                  |          |                                  | $ |                                                      |  |                           |      |  |   |         | 
|Options exercised                                                                                                         |  |                  | (125,500  | )                                | $ | 7.20                                                  |  |                           |      |  |   |         | 
|                                                                                                                          |  |                  |           |                                  |   |                                                       |  |                           |      |  |   |         | 
|Outstanding - May 31, 2007                                                                                                |  |                  | 926,451   | *                                | $ | 8.29                                                  |  |                           |      |  |   |         | 
|                                                                                                                          |  |                  |           |                                  |   |                                                       |  |                           |      |  |   |         | 
|                                                                                                                         
|Non-Vested                                                                                                                |  |                  | 100,000   |                                  | $ | 7.77                                                  |  |                           | 7.95 |  | $ | 93,000  | 
|Vested                                                                                                                    |  |                  | 826,451   |                                  | $ | 8.36                                                  |  |                           | 4.37 |  | $ | 284,829 | 
|                                                                                                                          |  |                  |           |                                  |   |                                                       |  |                           |      |  |   |         | 
|Total                                                                                                                     |  |                  | 926,451   | *                                | $ | 8.29                                                  |  |                           | 4.76 |  | $ | 377,829 | 
|                                                                                                                          |  |                  |           |                                  |   |                                                       |  |                           |      |  |   |         | 
|                                                                                                                         
|* Includes 190,000 warrants
 of which 90,000 are vested and 100,000 will vest upon meeting certain
 contigent conditions.

As of May 31, 2007 there was no unrecognized compensation costs related to non-vested
    awards.

|                                
|--------------------------------
|7. 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, 2007 (in thousands):

| |            |  |                 |       | 
| | ---------- |  | --------------- | ----- | 
| | Year       |  | OperatingLeases |      
| |            | 
| | 2008       |  | $               | 789   | 
| | 2009       |  |                 | 665   | 
| | 2010       |  |                 | 599   | 
| | 2011       |  |                 | 623   | 
| | 2012       |  |                 | 633   | 
| | Thereafter |  |                 | 4,935 | 
| |            |  |                 |       | 
| |            |  | $               | 8,244 | 
| |            |  |                 |       | 

In
June 2003, the Company entered into a lease for office space which serves as
its corporate headquarters. The term of the lease is through September 30, 2019
at an average annual base rental rate of approximately $0.6 million per year.

Rental expense, including additional charges paid for increases in real estate
taxes and other escalation charges and credits for the years ended May 31,
2007, 2006, and 2005 was approximately, $1.0 million, $1.0 million and $0.9
million, respectively. As of May 31, 2007 approximately $11.5 million of
inventory owned by Pegasus Overseas, Ltd., a wholly owned subsidiary, is
subject to a security interest by a third party.

As of May 31, 2007 approximately $11.5 million of
inventory owned by Pegasus Overseas, Ltd., a wholly owned subsidiary, is
subject to a security interest by a third party.

|                      
|----------------------
|8. 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 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
$3.5 million. The Company did not make a matching contribution in 2006 and does
not anticipate making a contribution for the 2007 plan year. The Company made a
matching contribution for the 2005 plan year of approximately $40,000.

28

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|                                 
|---------------------------------
|9. Geographic Segment Information
|                                 

Revenue,
gross profit and income/(loss) before income tax provision for each of the
three years in the period ended May 31, 2007 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):

|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|------------------------------------ |  | -------------- | ------- | ------ | - | ------- |  | --------- | ------- | --------------- | - | --------------- | - | - | -------- | - | - | ------- | -
|                                     |  | North
 America |         | Europe |   | Africa  |  | Far
 East |         | Elimi-
 nations |   | Consoli-
 dated |  
|                                     | 
|Year ended May 31, 2007              |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Net sales to unaffiliated customers  |  | $              | 98,701  |        | $ | 318,365 |  | $         | 1,000   |                 | $ | 16,340          |   | $ |         |   | $ | 434,406 |  
|Transfers between geographic areas   |  |                | 105,887 |        |   |        |  |           | 184,220 |                 |   |                |   |   | (290,107 | ) |   |        |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Total revenue                        |  | $              | 204,588 |        | $ | 318,365 |  | $         | 185,220 |                 | $ | 16,340          |   | $ | (290,107 | ) | $ | 434,406 |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Gross profit                         |  | $              | 13,764  |        | $ | 2,938   |  | $         | 2,252   |                 | $ | 3,923           |   | $ | 6        |   | $ | 22,883  |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Income/(loss) before income
 taxes   |  | $              | (11,518 | )      | $ | 316     |  | $         | 6,356   |                 | $ | 89              |   | $ | 6        |   | $ | (4,751  | )
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Identifiable assets at May
 31, 2006 |  | $              | 151,452 |        | $ | 92,441  |  | $         | 38,609  |                 | $ | 7,829           |   | $ | (48      | ) | $ | 290,283 |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Year ended May 31, 2006              |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Net sales to unaffiliated customers  |  | $              | 103,914 |        | $ | 390,599 |  | $         | 17,196  |                 | $ | 16,336          |   | $ |         |   | $ | 528,045 |  
|Transfers between geographic areas   |  |                | 147,120 |        |   | 524     |  |           | 232,498 |                 |   | 9               |   |   | (380,151 | ) |   |        |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Total revenue                        |  | $              | 251,034 |        | $ | 391,123 |  | $         | 249,694 |                 | $ | 16,345          |   | $ | (380,151 | ) | $ | 528,045 |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Gross profit                         |  | $              | 21,281  |        | $ | 2,593   |  | $         | 2,174   |                 | $ | 3,785           |   | $ | 15       |   | $ | 29,848  |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Income/(loss) before income
 taxes   |  | $              | (1,382  | )      | $ | 297     |  | $         | 1,881   |                 | $ | (45             | ) | $ | 15       |   | $ | 766     |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Identifiable assets at May
 31, 2006 |  | $              | 167,267 |        | $ | 58,600  |  | $         | 29,081  |                 | $ | 8,819           |   | $ | (55      | ) | $ | 263,712 |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Year ended May 31, 2005              |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Net sales to unaffiliated customers  |  | $              | 108,378 |        | $ | 295,743 |  | $         |        |                 | $ | 17,290          |   | $ |         |   | $ | 421,411 |  
|Transfers between geographic areas   |  |                | 167,634 |        |   | 1,501   |  |           | 113,610 |                 |   | 45              |   |   | (282,790 | ) |   |        |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Total revenue                        |  | $              | 276,012 |        | $ | 297,244 |  | $         | 113,610 |                 | $ | 17,335          |   | $ | (282,790 | ) | $ | 421,411 |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Gross profit                         |  | $              | 28,189  |        | $ | 2,601   |  | $         | (931    | )               | $ | 4,818           |   | $ | 57       |   | $ | 34,734  |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Income/(loss) before income
 taxes   |  | $              | 8,175   |        | $ | 365     |  | $         | (1,231  | )               | $ | 504             |   | $ | 57       |   | $ | 7,870   |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  
|Identifiable assets at May
 31, 2005 |  | $              | 153,640 |        | $ | 59,096  |  | $         | 29,964  |                 | $ | 7,654           |   | $ | (70      | ) | $ | 250,284 |  
|                                     |  |                |         |        |   |         |  |           |         |                 |   |                 |   |   |          |   |   |         |  

Revenue and
 gross profit for each of the three years in the period ended May 31, 2007
 classified by product were as follows (in thousands):

|                        |  |          |         |       |   |         |  |   |         | 
|----------------------- |  | -------- | ------- | ----- | - | ------- |  | - | ------- | 
|                        |  | Polished |         | Rough |   | Total   | 
|                       
|Year ended May 31, 2007 |  |          |         |       |   |         |  |   |         | 
|Net sales               |  | $        | 143,342 |       | $ | 291,064 |  | $ | 434,406 | 
|                        |  |          |        
|Gross profit            |  | $        | 14,199  |       | $ | 8,684   |  | $ | 22,883  | 
|                        |  |          |         |       |   |         |  |   |         | 
|Year ended May 31, 2006 |  |          |         |       |   |         |  |   |         | 
|Net sales               |  | $        | 149,767 |       | $ | 378,278 |  | $ | 528,045 | 
|                        |  |          |        
|Gross profit            |  | $        | 20,606  |       | $ | 9,242   |  | $ | 29,848  | 
|                        |  |          |         |       |   |         |  |   |         | 
|Year ended May 31, 2005 |  |          |         |       |   |         |  |   |         | 
|Net sales               |  | $        | 156,904 |       | $ | 264,507 |  | $ | 421,411 | 
|                        |  |          |        
|Gross profit            |  | $        | 25,480  |       | $ | 9,254   |  | $ | 34,734  | 
|                        |  |          |         |       |   |         |  |   |         | 

29

---



|                                                
|------------------------------------------------
|10. Investments in Unconsolidated Joint Ventures
|                                                

The
Company utilizes the equity method of accounting to record its proportionate
share of income and losses from joint ventures. During 2007 and 2006 the
Company entered into several joint venture agreements relating to sourcing,
cutting, polishing, processing and sales of diamonds. Combined condensed
financial information concerning the Companys unconsolidated joint venture
activities is as follows: (in thousands)

|                         |  |      |         |      |   |         |  
|------------------------ |  | ---- | ------- | ---- | - | ------- | -
|                         |  |      |        
|                         |  | 2007 |         | 2006 |  
|                         |  |      |        
|Revenues                 |  | $    | 416,151 |      | $ | 128,784 |  
|Gross profit             |  |      | 36,395  |      |   | 1,238   |  
|Income/(loss) before tax |  |      | 13,682  |      |   | (633    | )
|Net income/(loss)        |  |      | 13,682  |      |   | (633    | )
|                         |  |      |         |      |   |         |  
|Current assets           |  |      | 88,381  |      |   | 13,154  |  
|Non-current assets       |  |      | 1,285   |      |   | 410     |  
|                        
|Current liabilities      |  |      | 77,530  |      |   | 8,547   |  
|Non-current liabilities  |  |      | 12,123  |      |   |        |  

|                        
|------------------------
|11. Sale of Common Stock
|                        

During
2007 and 2006 the Company purchased 63,334 and 216,838 shares, respectively, of
its common stock which was shown as a reduction of stockholders equity.

In
February 2002, pursuant to a stock purchase agreement (SPA), the Company sold
1,305,000 shares of its common stock, consisting of 1,180,000 of previously repurchased
treasury shares and 125,000 authorized but unissued shares, in a private
transaction. The SPA provides for, among other things, a ten-year standstill
period whereby the purchaser and its affiliates will not acquire 24.9% or more
of the outstanding shares of common stock, participate in any proxy disputes or
transfer their stock except as provided for in the SPA. In connection
therewith, the purchaser delivered an irrevocable proxy to the Chairman and
President of the Company to vote the 1,180,000 shares, subject to certain
limitations, through February 2010.

|                                     
|-------------------------------------
|12. Transactions with related parties
|                                     

A
member of the Companys Board of Directors is of counsel to a law firm which
serves as counsel to the Company. Amounts paid to the law firm during 2007,
2006 and 2005 were $0.9 million, $0.6 million and $0.5 million, respectively.

During
2006 and 2005 the Company sold approximately $0.4 and $1.7 million,
respectively, of jewelry to a relative of a non-employee member of the Companys
Board of Directors.

30

---



13. Quarterly Results of Operations
(Unaudited)

The
following is a summary of the results of operations for the years ended May 31,
2007 and 2006 (in thousands, except per share data):

| |                                    |  |       |         |        |   |        |   |        |         |  |   |         | 
| | ---------------------------------- |  | ----- | ------- | ------ | - | ------ | - | ------ | ------- |  | - | ------- | 
| |                                    | 
| |                                    |  | First |         | Second |   | Third  |   | Fourth |        
| |                                    | 
| | 2007                               |  |       |         |        |   |        |   |        |         |  |   |         | 
| | Net sales                          |  | $     | 138,884 |        | $ | 94,411 |   | $      | 104,257 |  | $ | 96,854  | 
| | Gross profit                       |  | $     | 5,245   |        | $ | 4,929  |   | $      | 7,277   |  | $ | 5,432   | 
| | Net income/(loss)                  |  | $     | (1,825  | )      | $ | (1,363 | ) | $      | 58      |  | $ | 154     | 
| | Basic
 earnings/(loss) per share   |  | $     | (0.22   | )      | $ | (0.17  | ) | $      | 0.01    |  | $ | 0.02    | 
| | Diluted
 earnings/(loss) per share |  | $     | (0.22   | )      | $ | (0.17  | ) | $      | 0.01    |  | $ | 0.02    | 
| | 2006                               |  |       |         |        |   |        |   |        |         |  |   |         | 
| | Net sales                          |  | $     | 138,856 |        | $ | 96,275 |   | $      | 157,912 |  | $ | 135,002 | 
| | Gross profit                       |  | $     | 8,982   |        | $ | 6,054  |   | $      | 8,909   |  | $ | 5,903   | 
| | Net income/(loss)                  |  | $     | 908     |        | $ | (407   | ) | $      | 510     |  | $ | 517     | 
| | Basic
 earnings/(loss) per share   |  | $     | 0.11    |        | $ | (0.05  | ) | $      | 0.06    |  | $ | 0.06    | 
| | Diluted
 earnings/(loss) per share |  | $     | 0.10    |        | $ | (0.05  | ) | $      | 0.06    |  | $ | 0.06    | 

31

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Report of Independent Registered Public
Accounting Firm

Board of Directors and Stockholders 
Lazare Kaplan International Inc.
New York, NY

We
have audited the accompanying consolidated balance sheets of Lazare Kaplan
International Inc. as of May 31, 2007 and 2006 and the related consolidated
statements of operations, stockholders equity, and cash flows for each
of the three years in the period ended May 31, 2007. 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 the standards of the Public Company
Accounting Oversight Board (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. The Company is not
required to have, nor were we engaged to perform, an audit of its internal
control over financial reporting. An audit includes consideration of internal
control over financial reporting as a basis for designing audit procedures that
are appropriate in the circumstances, but not for the purpose of expressing an
opinion on the effectiveness of the Companys internal control over financial
reporting. Accordingly, we express no such opinion. An audit also includes
examining, on a test basis, evidence supporting the amounts and disclosures in
the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.

In
    our opinion, the consolidated financial statements referred to above present
    fairly, in all material respects, the financial position of Lazare Kaplan
    International Inc. at May 31, 2007 and 2006 and the results of its operations
    and its cash flows for each of the three years in the period ended May 31,
    2007, in conformity with accounting principles generally accepted in the
    United States.

| |                             
| | ----------------------------
| | BDO Seidman, LLP            
| |                             
| | New York, NY
August 28, 2007

32

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Corporate Information

|                                                                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  |                                                                                                                                                                                                                                                                                             
|------------------------------------------------------------------------ |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Corporate
 Headquarters                                                  |  | Directors
 and Officers                                                                                                                                                                                                                                                                                                                                                                                                                                        |  | Registrar
 and Transfer Agent                                                                                                                                                                                                                                                               
|                                                                         |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                                |  |                                                                                                                                                                                                                                                                                             
|19 West 44th
 Street
 New York, New York 10036
 Telephone (212) 972-9700 |  | Maurice Tempelsman Director;
 Chairman of the BoardLeon TempelsmanDirector;
 Vice Chairman of the Board
 and PresidentLucien BursteinDirector;
 Secretary
 Of Counsel
 Warshaw Burstein Cohen
 Schlesinger & Kuh, LLP
 (attorneys)Richard A. BerensonDirector;
 Former Managing Partner
 Berenson & Company, LLPRobert A. Del GenioDirector;
 Co-Founder
 Conway, Del Genio,
 Gries & Company, LLCWilliam H. MorytoVice President and
 Chief Financial Officer |  | BNY Mellon Shareholder
 Services
 480 Washington Boulevard
 Jersey City, NJ 07310-1900Counsel

 Warshaw Burstein
 Cohen
 Schlesinger & Kuh, LLP
 555 Fifth Avenue
 New York, New York 10017Registered Public Accounting Firm

BDO Seidman, LLP
 330 Madison Avenue
 New York, New York 10017
|                                                                         | 
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|                                                                         | 

33

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