Lazare Kaplan International 10-K 2008
Documents found in this filing:
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Commission file number 1-7848
LAZARE KAPLAN INTERNATIONAL INC.
(Exact name of registrant as specified in its charter)
Registrants telephone number, including area code (212) 972-9700
Securities registered pursuant to Section 12(b) of the Act:
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes o No x
Indicate by check mark whether the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes o No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (check one):
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
As of November 30, 2007 the aggregate market value of voting and non-voting common equity held by non-affiliates of the registrant, computed by reference to the closing price for the registrants common equity on the American Stock Exchange at that date was $23,869,514. As of August 20, 2008, 8,252,679 of the registrants common stock were outstanding
DOCUMENTS INCORPORATED BY REFERENCE
2008 definitive proxy statement to be filed with the Commission - incorporated by reference into Part III.
2008 Annual Report to Stockholders for the fiscal year ended May 31, 2008 to be filed with the Commission-incorporated by reference into Parts II and IV.
Item 1. Business
Lazare Kaplan International Inc. (the Company) was incorporated in 1972 under the laws of the state of Delaware as the successor to a business which was founded by Mr. Lazare Kaplan in 1903. The Company is engaged in the cutting, polishing and selling of branded and non-branded (commercial) diamonds. The Companys 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. Due to these characteristics, Lazare Diamonds command a premium in the marketplace. The Company believes there are only a small number of companies worldwide engaged primarily in the production of ideally proportioned diamonds and that it is one of the largest U.S. providers of ideal cut diamonds. The Company cuts and polishes fine make commercial diamonds at diamond cutting facilities in South Africa, Namibia, and Russia which it markets to wholesalers, distributors and, to a growing extent, retail jewelers. All rough stones purchased by the Company are either selected for manufacturing or resold as rough diamonds in the marketplace. The Company believes that the combination of its cutting and polishing operations and its trading operations enables the Company to purchase larger quantities of rough diamonds from which it may select those rough diamonds best suited for the Companys current needs.
The Companys marketing strategy in the selling of Lazare Diamonds is directed primarily toward quality conscious consumers throughout the United States, South America, the Far East, the Middle East and Europe. The Company focuses its distribution efforts for Lazare Diamonds on selectivity with a view towards helping retailers who carry the product maintain a competitive advantage. Lazare Diamonds can be found at some of the most prestigious jewelry stores around the world, including those with international reputations and those known only in their communities as being the highest quality retail jewelers. This strategy helps ensure that the Companys product is presented in an environment consistent with its superior quality and image. The Company also sells to certain jewelry manufacturers and diamond wholesalers. The Company has developed a comprehensive grading system which, when coupled with the ideal cut standard, allows jewelers to order inventory by category rather than through the more cumbersome process of visual selection. In addition, the Company designs, manufactures (through independent contractors) and sells a line of high quality jewelry which features Lazare Diamonds.
An important element of the Companys strategy is the promotion of the Lazare Diamond brand name. Every Lazare Diamond bears a laser inscription on its outer perimeter, invisible to the naked eye, containing the Lazare Kaplan logo and an identification number unique to the stone. The laser signature also allows consumers to register their Lazare Diamonds with the Company under its program, The Lazare Diamond Registry®, thereby providing proof of ownership in case of loss or theft.
One of the Companys important suppliers of rough diamonds is the Diamond Trading Company (DTC) and its affiliated companies in Southern Africa, the rough diamond sales arm of the De Beers Group. Based on published reports, the Company believes that more than half of the worlds current rough diamond output is currently sold by the DTC. The Company has been a client of the DTC for approximately 60 years. In order to diversify its sources of rough diamond supply, the Company has an office in Antwerp to supplement its rough diamond needs by secondary market purchases and has entered into relationships with other primary source suppliers. 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.
The Company operates various manufacturing facilities. The Companys domestic manufacturing operation is located in Puerto Rico. The Company believes its work force in Puerto Rico is among the most highly skilled in the diamond industry. This facility generally produces polished diamonds having weights of 1/5 of a carat and greater. The Company also operates manufacturing facilities in Moscow and Barnaul, Russia, Namibia and South Africa. The facilities in Russia are operated pursuant to an agreement with AK ALROSA of Russia. The facility in Namibia is operated under a strategic cooperation agreement with NamGem Diamond Manufacturing Company (PTY) Ltd. The facility in South Africa is operated by Nozala Diamonds (Pty) Ltd, a joint cutting and polishing operation with Nozala Investments (Pty) Ltd, a broadly based womens empowerment investment group. The Company is currently constructing a new cutting facility in Botswana.
The Companys overall revenues are, in part, dependent upon the availability of rough diamonds, the worlds known sources of which are highly concentrated. Based upon published reports, the Company believes that Angola, Australia, Botswana, Brazil, Canada, Ghana, Guinea, Ivory Coast, Namibia, Republic of the Congo, Russia, Sierra Leone and South Africa account for more than 90% of present world rough gem diamond production. The DTC is the primary world-wide marketing mechanism of the rough diamond industry. Sales for the DTC are made in London, South Africa, Namibia, and Botswana, to a select group of clients (sightholders) which, according to published reports, number approximately 80, including the Company. Based upon published reports, the Company believes that more than half of the worlds current rough diamond output is sold by the DTC and its affiliated companies. In order to maintain their purchasing relationship, the DTCs clients have traditionally been expected to purchase substantially all of the diamonds offered to them by the DTC. Companies that are not sightholders must either purchase their requirements from sightholders or seek access to that portion of the world supply not marketed by the DTC.
The DTC has been and continues to be an important supplier of rough diamonds to the Company. The DTC periodically invites its clients to submit their requirements as to the amount and type of stones they wish to purchase. Employees of the Company attend offerings of rough diamonds (sights) held by the DTC periodically during the year in London. At sights, the Company purchases, at the DTCs stated price, an assortment of rough diamonds known as a series, the composition of which attempts to take into account the qualitative and quantitative requirements of the Company based on requests submitted to the DTC by the Company. The Company has been a sightholder for approximately 60 years. The loss of its status as a sightholder could have a material adverse effect on the Company.
In 2000, the DTC announced significant changes in its approach to rough diamond marketing. In brief, the DTC stated that it would stop open market purchases, alter its market control and pricing policies and focus on selling its own mining productions through its Supplier of Choice marketing programs. These policy changes were 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.
In 2007 all then existing DTC clients (Sightholders) received notification of termination effective in December. In April 2008 the DTC confirmed the list of Sightholders for the new three-year 2008 2011 Supplier of Choice contract period, which according to published reports number approximately 80. These arrangements mark a new approach to the DTCs distribution of rough diamonds globally, with the establishment of independent joint-venture sales organizations including the DTC Botswana (DTCB) and the Namibia Diamond Trading Company (NDTC). The DTC in London continues to distribute rough to those Sightholders with sights in both London and Canada, and the restructured DTC South Africa distributes to Sightholders in South Africa. Because of its core strengths in the diamond industry, including technical ability, distribution and marketing ability, financial strength and ethical accountability, the Company has been appointed an approved Sightholder in London (LKI), Botswana (Lazare Kaplan Botswana PTY, Ltd.), Namibia (NAMGEM Trading) and South Africa (Nozala Diamonds PTY, LTD). Through its active beneficiation activities in southern Africa, the Company is well position to contribute to regional value added and technical skills transfer aspirations.
The Company signed a cooperation agreement with NamGem for the cutting and polishing of diamonds in Namibia. NamGem is Namibias 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 supervises 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 (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 2009.
During the fourth quarter of fiscal 2004 the Company signed a four year technical cooperation agreement regarding the marketing of rough diamonds purchased in the informal sector with SODIAM, the government entity responsible for the development and marketing of diamonds produced in Angola. The Company began active buying operations in the Angolan informal sector during the first quarter of fiscal 2005. During the third fiscal quarter of 2006 the Companys rough buying operation 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 which includes exploration and development through various additional joint ventures.
The Company has an agreement with Nozala Investments (PTY) LTD., a broadly based womens empowerment investment group, for cooperation in South Africas diamond sector. The agreement contemplates diamond mining, cutting, polishing, and distribution. The joint venture is in line with the South African Governments recently announced program to promote new entrants and investment in the domestic diamond sector, increasing the sectors 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 order to diversify its sources of supply, the Company has entered into arrangements with other primary source suppliers and manufacturers. The Company also has established an office in Antwerp to supplement its rough and polished diamond needs by making purchases in the secondary market.
Through February 2009, the Companys 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 is used only on a select, limited range of natural diamonds with qualifying colors, sizes and clarities for both round and fancy cuts. The estimated number of gemstones with characteristics suitable for this process is a small fraction of the overall diamond market. POL sells only diamonds that have undergone the HPHT process and markets under the brand name Bellataire®. Each Bellataire diamond is laser inscribed with a unique identification number.
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.
The Company has rough diamond supply arrangements in Russia for the cutting and polishing of diamonds in Russia. See Cutting and Polishing.
The Company believes that it has good relations with its suppliers, that its trade reputation and established customer base will continue to assure access to primary sources of diamonds and that its sources of supply are sufficient to enable the Company to meet its present and foreseeable needs. However, the Companys sources of supply could be affected by political and economic developments in producing countries over which the Company has no control. While the Company believes that alternative sources of supply may be available, any significant disruption of the Companys access to its primary source suppliers could have a material adverse effect on the Companys opertaions.
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 Companys 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, such as The Council for Responsible Jewelry Practices, 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 DTCs Diamond Best Practices Principles Assurance Program.
Cutting and Polishing
In March 1999, the Company and ALROSA entered into a ten year agreement (the ALROSA Agreement) to expand their relationship in the cutting, polishing and marketing of rough gem diamonds for up to $100 million a year. Under the terms of the ALROSA Agreement, the Company and ALROSA agreed to refurbish certain diamond cutting facilities in Russia. At present, the Companys operations in Russia are consolidated in two facilities, both of which are fully operational. These facilities are staffed by Russian technicians and jointly managed and supervised by the Company and ALROSA personnel. Under the ALROSA agreement, the Company sells the resulting polished diamonds through its worldwide distribution network. The proceeds from the sale of these polished diamonds, after deduction of rough diamond cost, are generally shared equally with ALROSA. This agreement does not require the Company to advance funds for the purchase of rough diamonds. Any interruption in the supply of diamonds from Russia could have a material adverse effect on the Company.
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 Namibias 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 Companys rough diamonds deemed suitable to cut and polish.
The Company believes that its factory in Puerto Rico is among the largest cutting and polishing facilities in the United States. Each diamond received in Puerto Rico is evaluated against strict management standards designed to maximize its potential economic contribution to the Company. Expert technicians, assisted by computer software, determine whether to cut the diamond to ideal or commercial proportions or resell the diamond. The shape of the diamond, its color, clarity, size, potential profitability and salability are among the criteria used in making such determinations.
Rough diamonds selected for cutting are analyzed and where desirable are sorted for sawing to achieve the desired shape and to eliminate imperfections. They are then cut and polished into finished gems. Each finished ideal cut diamond (weighing .18 carats and larger) which is marketed as a Lazare Diamond is inscribed with the Lazare Kaplan logo and its own identification number by the Companys patented laser inscription process. The Company believes its work force in Puerto Rico is one of the most highly skilled in the diamond industry.
The Company believes that it is recognized in the diamond industry for the high quality and brilliance of the gems it cuts and that it also enjoys a reputation as an imaginative and innovative cutter of large and difficult diamonds.
Rough Diamond Prices
Through its control of more than half of the value of the current world rough diamond output, the DTC can exert significant control over the pricing of rough and polished diamonds by adjusting the quantity and pricing of rough diamonds it supplies to the marketplace. Rough diamond prices established by the DTC have been characterized historically by steady increases over the long term; however, prices in the secondary market have experienced a greater degree of volatility, particularly during the late 1970s. Traditionally, the Company has been able to pass along such price increases to its customers. From time to time, however, the Company has absorbed these price increases in the short term to maintain an orderly pricing relationship with its customers. This has, in the past, caused temporary adverse effects on the Companys earnings. A large rapid increase in rough diamond prices could materially adversely affect the Companys revenues and operating margins if the increased cost of rough diamonds could not be passed along to its customers in a timely manner.
According to published reports, during 1995 there was an emergence of a two-tier market for rough diamonds. The first tier is comprised of better quality rough diamonds, where supply and demand appear to be in balance. The Company
conducts its cutting and polishing operations almost exclusively in this segment of the market. The second tier is comprised of small, less expensive, imperfect rough diamonds which the Company has traditionally sold as rough diamonds. The prices for these diamonds have been considerably more volatile since 1995. The Company believes that long-term these types of diamonds are more potentially vulnerable to synthetic substitution. Because the Companys cutting operations focus primarily on better quality rough diamonds, this volatility has not had a significant effect on the Company. However, a significant decrease in the price of better quality rough diamonds could materially adversely affect the Companys revenues, operating margins and inventory value.
Polished Diamond Prices
Over the past 60 years, increases in the price of rough diamonds have generally resulted in a corresponding increase in the price of polished diamonds. However, during periods of economic uncertainty, there may be a significant time lag before the Company is able to increase polished diamond prices. During the period of high inflation in the late 1970s, investors speculated in hard assets, driving polished diamond prices to exceptionally high levels which in turn caused significant increases in the cost of rough diamonds. However, the moderation of inflation during the early 1980s resulted in a sudden and massive shift of investments from hard assets to financial instruments, resulting in dramatic price declines for polished diamonds which caused a market liquidity crisis as prices of some categories of polished diamonds fell below the inventory costs of such diamonds. Since this period in the early 1980s, the Company believes the pricing of polished diamonds has returned to its historical pattern of generally responding to increases in the pricing of rough diamonds. The Company has broadened its sales base and implemented strict inventory, pricing and purchasing controls which it believes could lessen the impact of fluctuations in the price of rough and polished diamonds. These include computerized rough diamond evaluation programs and inventory utilization programs. However, there can be no assurance that volatility in the price of polished diamonds could not occur again. Any rapid decrease in the price of polished diamonds could have a material adverse effect on the Company in terms of inventory reserves, lower sales and lower margins.
Marketing, Sales and Distribution
The Companys sales strategy is directed primarily toward quality conscious consumers throughout the United States, South America, the Far East, the Middle East and Europe. The Company focuses its distribution efforts for Lazare Diamonds on selectivity with a view to helping retailers who carry the product maintain a competitive advantage. Lazare Diamonds can be found at some of the most prestigious jewelry stores around the world, including both those with international reputations and those recognized only in their local communities as being the highest quality retail jewelers. This strategy helps ensure that the Companys product is presented in an environment consistent with its superior quality and image.
The Company also sells to certain jewelry manufacturers and diamond wholesalers. The Company has developed a comprehensive grading system for its diamonds which, when coupled with the ideal cut standard, allows jewelers to order inventory by category rather than through the more cumbersome process of visual selection. In addition, the Company designs, manufactures (through independent contractors) and sells a line of high quality jewelry that features Lazare Diamonds.
A key element of the Companys strategy is the promotion of the Lazare Diamond brand name directly to consumers. The Company is able to market its diamonds under a brand name to retailers because (a) the ideal cut differentiates the Companys diamonds from commercial diamonds in the marketplace and (b) each Lazare Diamond is inscribed with the Companys logo and identification number using the Companys patented laser inscription process, thus authenticating the diamonds.
The Companys decision to pursue the brand name strategy is reinforced by two factors - a rising trend among informed consumers to purchase quality, brand name products, and the need among upscale jewelers to set themselves apart in an increasingly competitive market by carrying and promoting a highly differentiated product.
Building awareness and acceptance of the Lazare Diamond brand name is accomplished through a comprehensive marketing program which includes sales training, cooperative advertising, sales promotion and public relations. A wide assortment of sales promotion materials has been designed to facilitate jewelers sales of the Companys diamonds and fine jewelry line to consumers. Public relations events are offered which help build traffic in retail stores. The Company has a
program to build both free-standing and in-counter boutiques in the stores of a select group of its retail clients. The Company believes these marketing programs have been and will continue to be instrumental in increasing sales. The Company intends to continue concentrating its Lazare Diamond® marketing efforts towards the quality retail jeweler.
The Lazare Diamond Registry program has been established by the Company to enable consumers to register their Lazare Diamonds with the Company using the laser inscribed identification number, thereby providing proof of ownership in case of loss or theft.
The Company markets high quality commercial cut diamonds and diamond jewelry through its worldwide distribution network to wholesalers, jewelry manufacturers, distributors and retailer jewelers.
In addition, Bellataire® diamonds and jewelry are marketed through upscale retailers and select distributors throughout the world. Bellataire diamonds are all-natural diamonds that have been restored to their intrinsic beauty through a patented high pressure, high temperature (HPHT) process that improves the color of a limited group of gem diamonds.
The Company has developed its own E-commerce site (www.lazarediamonds.com). This site directly links the Company to its retailers, which serves to further strengthen the ties with its retail client base.
Sales and Distribution
While the purchase and sale of rough diamonds is concentrated among relatively few parties, based on published reports industry wide retailing of polished diamonds occurs through over 40,000 jewelry stores in the United States, over 25,000 retailers in Japan and over 60,000 retail stores in Europe. The Companys sales efforts for its polished diamonds are directed primarily toward the fine quality segment of these retailers (the majority of which are independently owned and operated), wholesalers and distributors and, to a lesser extent, to jewelry manufacturers. Full time regional sales representatives located throughout the United States, Latin America, Japan, Hong Kong and Europe, are generally compensated, in whole or in part, on a commission or incentive basis and handle sales throughout the respective territories in which they operate.
The Companys U.S. sales force is supported by a New York based in-house sales and service department. Sales to certain of the Companys largest accounts are handled by headquarters personnel. Most of the Companys major accounts are customers of long standing.
The Company has been actively working to expand its foreign business activities, particularly in the Far East countries of Japan, Singapore, Taiwan, Korea, China and Malaysia and recently throughout the Middle East.
The Company uses a comprehensive sorting and inventory classification system for grading color and clarity of its ideal cut polished diamonds. This system, combined with the fact that the Companys stones are uniformly cut to ideal proportions, reduces and in some cases eliminates the need for customers to view diamonds before placing orders. The system enables customers to standardize their inventories, order by mail or telephone and minimize their inventory investment.
The percentages of the Companys total domestic and foreign net sales to its customers, which include a combination of both rough diamonds and polished diamonds sales taken together, for the past three fiscal years are set forth below:
The worlds rough diamond trading markets are primarily located in Belgium, India, and Israel; therefore, the majority of the Companys rough diamond sales have been transacted with foreign customers.
The Company believes that due to the possible international resale of diamonds by its customers, the above percentages may not represent the final location of retail sales of its product. All of the Companys foreign sales, other than those made in Japan, are denominated in United States dollars. The profitability of foreign sales of either polished or rough diamonds is consistent with that of domestic sales of similar merchandise.
The polished and rough diamond business is highly competitive. While the Company believes that it has achieved a reputation as a leading cutter and distributor of high quality diamonds, it faces competition in sales to its customers in the United States and abroad from many other suppliers. In addition, the Company sells rough diamonds in the competitive world market. A substantial number of cutters and polishers and traders, some of which the Company believes to be larger or to have greater financial resources than the Company, sell diamonds of all qualities to the Companys customers.
The Company believes there are significant barriers to entry by potential competitors into the business of manufacturing and distributing high quality cut diamonds. Among the most important of these barriers are the need for significant working capital to purchase rough diamonds and hold polished inventory, the long-term relationships required to have access to adequate supplies of rough diamonds, the limited number of persons with the skills necessary to consistently cut significant amounts of high quality cut diamonds, the difficulty in obtaining access to upscale channels of distribution, the importance of public recognition of an established brand name, a reputation for diamond cutting excellence, and the procurement of computer systems to report on and monitor the manufacturing and distribution network.
At July 31, 2008, the Company had 148 full-time employees. The Company maintains an apprenticeship program at its facility in Puerto Rico, through which it trains its cutters, who are highly skilled workers. The Company provides paid vacations, sick leave, group life, disability, hospitalization and medical insurance for its employees. The Company has a 401(k) retirement plan for its U.S. and Puerto Rico employees. The Company believes that it has satisfactory relationships with its employees. None of the Companys employees are represented by a union.
Item 1A. Risk Factors
The worlds sources of rough diamonds are highly concentrated in a limited number of countries. Varying degrees of political and economic risk exist in these countries. As a consequence, the diamond business is subject to various sovereign risks beyond the Companys 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. Any significant disruption of the Companys sources of supply, or restriction of inventory movement could have a material adverse effect on the Company.
Based upon published reports, the Company believes that more than half of the worlds current diamond output is sold by the Diamond Trading Company (DTC), the rough diamond sales arm of the De Beers Group. The DTC is the primary world-wide marketing mechanism of the rough diamond industry. DTC sales are conducted in London, South Africa, Namibia and Botswana to a select group of Sightholders, which, according to published reports number approximately 80, including the Company and its affiliates. The DTC has been and continues to be an important supplier of rough diamonds to the Company. The Company has been a sightholder for approximately 60 years. The loss of its status as a sightholder could have a material adverse effect on the Company.
The Companys 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.
Through its control of more than half of the value of the current world rough diamond output, the DTC can exert significant control over the pricing of rough and polished diamonds by adjusting the quantity and pricing of rough diamonds it supplies to the marketplace. Historically, the Company has been able to pass along such price increases to its customers. From time to time, however, the Company has absorbed these price increases in the short term to maintain an orderly pricing relationship with its customers. This has, in the past, caused temporary adverse effects on the Companys earnings. A large rapid increase in rough diamond prices could materially adversely affect the Companys revenues and operating margins if the increased cost of rough diamonds could not be passed along to its customers in a timely manner. Conversely, a significant decrease in the price of better quality rough diamonds could materially adversely affect the Companys revenues, operating margins and inventory value.
Any rapid decrease in the price of polished diamonds could have a material adverse effect on the Company in terms of inventory reserves, lower sales and lower margins.
The polished and rough diamond business is highly competitive. A substantial number of cutters and polishers and traders, some of which the Company believes to be larger or to have greater financial resources than the Company, sell diamonds of all qualities to the Companys customers.
Item 1B. Unresolved Staff Comments
Item 2. Properties
In June 2003, the Company entered into a lease for 17,351 square feet of office space, a portion of which will be devoted to sales rooms, at 19 West 44th Street, New York City, for a term expiring September 30, 2019 at an annual rental rate of approximately $594,000 (subject to escalations). This location serves as the Companys corporate headquarters.
The Company also owns a manufacturing facility in Caguas, Puerto Rico. The Caguas facility consists of approximately 12,650 square feet.
The Company leases office space in Antwerp, Belgium for a term expiring May 31, 2015 at an annual rental rate of approximately $50,000. The Company has the right to terminate the lease on May 31, 2009, and 2012.
The Company also leases office space in Antwerp, Belgium for a term expiring August 11, 2013 at an annual rental rate of approximately 52,000 Euros (approximately $64,000). The lease is cancelable by either the Company or the landlord on August 11, 2008 and 2010.
The Company owns a 330 square meter office in Antwerp, Belgium, a portion of which is devoted to sales rooms.
The Company leases office space in Hong Kong for a term expiring May 31, 2010 at an annual rental rate of 1,386,000 Hong Kong dollars (approximately $178,000).
The Company leases office space in Tokyo for a term expiring August 31, 2010 at an annual rental rate of 16,500,000 Japanese Yen (approximately $150,000).
The Company believes that its facilities are fully equipped and adequate to fulfill its operating and manufacturing needs.
On May 25, 2006, the Company filed a complaint in the United States District Court for the Southern District of New York against Photoscribe Technologies, Inc. (Photoscribe). The complaint asserted infringement of the Companys intellectual property rights by Photoscribe with respect to two of the Companys patents (the patents-in-suit). The patents-in-suit have claims relating to methods of, and apparatus for, laser inscribing gemstones, as well as the inscribed gemstones themselves.
On November 22, 2006, the Company amended its complaint against Photoscribe to include the Gemological Institute of America (the GIA) as a co-defendant. As of February 1996, the Company and the GIA entered into an exclusive United States inscription agreement (except for the Companys own use) with respect to certain intellectual property, which is owned by the Company relating to certain laser inscription equipment and methods (the Inscription Agreement) and which includes the patents-in-suit. The GIA has purportedly terminated the Inscription Agreement as of July 31, 2006 under its terms. The GIA then began to commercially use Photoscribe equipment to inscribe gemstones, thus providing the basis to include the GIA in the suit. In addition to the same charges of patent infringement that were originally made against Photoscribe, the amended complaint also charges the GIA with breach of the exclusive license agreement prior to its purported termination and breach of a letter agreement by which GIA was to maintain in good working order the Companys equipment that it had been using. The amended complaint further charges Photoscribe with tortious interference with the Companys business relationship with the GIA.
On July 19, 2007, the Company filed a Second Amended Complaint which included Mr. David Benderly, President of Photoscribe, as an additional individual defendant, based on discovery during the case, which showed that Mr. Benderly controlled and directed the infringing activity of Photoscribe, and is thus personally liable for patent infringement. Further, the Second Amended Complaint charged Mr. Benderly with fraud based on a demonstration of Photoscribe equipment he gave in 2000 to counsel for the Company to show that the equipment did not infringe the Companys patents. However, discovery has indicated that he setup the machine for use during the demonstration to give the impression that the Photoscribe equipment could not operate to infringe the Companys patents when he knew that it could.
In the Photoscribe-GIA-Benderly litigation the Company sought injunctive relief, as well as damages, including inscription fees and lost profits based on lost sales and the value added to inscribed gemstones by reason of the use of infringing systems by Photoscribe and the GIA. The Company also sought to recover damages it suffered as a result of Mr. Benderlys fraud.
GIA, Photoscribe and Benderly answered the Second Amended Complaint and denied liability for the charges made by the Company. GIA also filed counterclaims alleging non-infringement, invalidity and unenforceability of the patents-in-suit. Further, GIA asserted counterclaims for (i) breach of contract based on the allegation that the Company failed to provide operative equipment or to maintain the equipment and (ii) false marking for allegedly placing patent numbers on equipment that was not covered by the patents. GIA additionally filed a counterclaim for equitable estoppel and implied license on the basis that the Company has submitted diamonds to GIA to be graded and these stones may be inscribed by GIA on Photoscribe equipment. The Company moved to strike this defense.
Photoscribe and David Benderly alleged counterclaims for non-infringement, invalidity and unenforceability of the patents-in-suit. Further, Photoscribe and Benderly asserted a counterclaim which charged the Company with an antitrust violation under Section 2 of the Sherman Act for monopolizing the laser inscription market. The antitrust claim was bifurcated from the main case and may be considered separately.
A two week trial of the Companys contract and patent suit against Photoscribe, the GIA and David Benderly began in a federal district court on February 25, 2008. On March 7, 2008 the jury returned a verdict in which they found that all of the asserted claims of the Companys patents, except one claim, were valid. However, the jury also found that the claims were not infringed by the defendants. The Company is considering its options in view of the verdict.
Prior to the conclusion of the trial the parties settled most of their contract claims, but certain issues that had been bifurcated still remain to be resolved. These include GIAs liability for repair of the Companys equipment that was returned after the license agreement, the fraud claim against Benderly, and the antitrust claim against the Company. Eventually, the fraud claim against Benderly was dropped, as was the antitrust claim against the Company.
At a bench trial held on April 16, 17 and May 1 and 2, the Court determined that the patents in the suit were unenforceable for inequitable conduct. On August 14, 2008, the Court held a hearing, after which the Court determined that due to the finding of inequitable conduct, the case was exceptional within the meaning of 35 U.S.C. § 285 and that the defendants should be awarded their reasonable attorneys fees. At this time, defendants have not made a formal request for a specific amount of fees and the Court has not made a finding of an amount. There still remains to be tried the issue of breach of the letter agreement by which GIA was to maintain in good working order certain laser equipment leased to it by the Company, but which did not work when it was returned to the Company. No date is currently scheduled for a bench trial on this issue.
The Company plans to vigorously seek to have the adverse rulings overturned. In particular, it plans to file post-trial motions to try to have the determination of non-infringement and invalidity overturned. In addition, the Company plans to appeal the jury verdict on the basis of errors committed by the trial court and the trial courts finding of inequitable conduct.
Consistent with the opinion of counsel, the Companys management believes it is likely that the finding of inequitable conduct will be reversed on appeal and; as such, any award of attorneys fees would be vacated.
On September 1, 2006, Fifth Avenue Group, LLC (Fifth Avenue), a stockholder of the Company, filed a Complaint for a Declaratory Judgment and Other Relief in the Supreme Court of the State of New York, County of New York, against the Company and Mellon Investor Services. The Complaint seeks a declaratory judgment that 1,180,000 shares of the Companys stock purchased by Fifth Avenue from the Company in a private sale in January 2002 are not restricted stock pursuant to Rule 144(k) of the Securities Exchange Act of 1934 and that any subsequent purchaser of such shares would not be subject to an irrevocable proxy granted to Messrs. Maurice and Leon Tempelsman by Fifth Avenue in connection with the private sale. The Company intends to vigorously pursue all defenses and counterclaims available to it.
Item 4. Submission of Matters to a Vote of Security Holders
Executive Officers of the Company
The following table sets forth information regarding executive officers of the Company.
All officers were elected by the Board of Directors at its meeting following the Annual Meeting of Stockholders held in November 2007. All officers hold office until the Board of Directors meeting following the next Annual Meeting of Stockholders and until their respective successors have been duly elected and qualified.
Maurice Tempelsman is the Chairman of the Board and a director of the Company and a general partner of Leon Tempelsman & Son (LTS), a partnership with interests in real estate, venture capital, investments and an ownership interest in the Company. He has held these positions since 1984. Maurice Tempelsman is the father of Leon Tempelsman.
Leon Tempelsman is the Vice Chairman of the Board, the President and a director of the Company and a general partner of Leon Tempelsman & Son. He has held these positions since 1984. Leon Tempelsman is the son of Maurice Tempelsman.
The Company believes that neither the Tempelsmans nor LTS currently engages directly or indirectly in any activities competitive with those of the Company.
William H. Moryto has been Vice President and Chief Financial Officer since May 2000.
Item 5. Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The Companys common stock (par value $1 per share) is traded on the American Stock Exchange.
Market prices and other information with respect to the Companys common stock are hereby incorporated by reference to the Companys Annual Report.
On April 8, 2008, the Board of Directors of the Company adopted a resolution to continue to purchase in the open market, at any time and from time to time during the fiscal year ending May 31, 2009, shares of the Companys common stock with an aggregate value not to exceed $2.0 million. On November 11, 2007, the Company affected a reverse / forward stock split of the Company stock, resulting in a cost savings to the Company and enabling a number of small shareholders to cash out their holdings of stock without incurring transaction costs. This transaction resulted in the Company adding 8,621 shares to treasury stock at an average cost of $8.06 per share.
The following graph compares the market performance of the Common Stock for the previous five fiscal years to the American Stock Exchange Market Value Index (the AMEX Index) and a peer group of companies in the fine jewelry and accessories industry (the Peer Group).
The Peer Group consists of the following companies: A.T. Cross Company and Tiffany & Co. The Companys management is of the opinion that despite the existence of some similarities between the group of companies comprising the Peer Group and the Company, the Company is unique because of the products that it produces, the markets in which its products are sold, and its position as the only publicly traded company in the United States predominately engaged in diamond cutting, polishing and rough trading. Thus, comparisons made between the Company and the Peer Group are not necessarily accurate or reliable and do not necessarily reflect the relative performance data for the Companys primary competition.
Item 6. Selected Financial Data
Selected financial data are hereby incorporated by reference to the Companys Annual Report.
Item 7. Managements Discussion and Analysis of Financial Condition and Results of Operations
Managements discussion and analysis of financial condition and results of operations is hereby incorporated by reference to the Companys Annual Report.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk
I Debt and Interest Rate Risk
At May 31, 2008 and May 31, 2007, the Company had borrowings of $81.5 million and $121.6 million outstanding under various revolving credit agreements. Under its agreements, the Company may pay down and re-draw borrowings
during the year at any time. The interest rates on these borrowings are variable and accordingly interest expense is impacted by both changes in interest rates and the level of outstanding borrowings. Increases in interest expense resulting from an increase in interest rates could adversely impact the Companys results of operations. The Companys policy is to take actions that would mitigate such risk when appropriate. These actions include staggering the term and rate of its borrowings to match anticipated cash flow.
The applicable interest rate is contingent upon the method of borrowing selected by the Company.
The Company believes that a 100 basis point increase in market interest rates occurring on May 31, 2008, would result in an increase in interest expense of approximately $0.4 million.
II Foreign Currency Risk
The Companys foreign sales are denominated in U.S. dollars, with the exception of those sales made by the Companys 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, 2008 and May 31, 2007, the Company recognized cumulative foreign currency translation adjustments with regard to the activities of Lazare Kaplan Japan in the amount of $(0.2) million and $(0.8) million respectively, which are shown as a component of stockholders equity in the accompanying balance sheets.
III Commodity Risk
The principal commodity risk for the Company relates to market price fluctuations in diamonds and precious metals. The Company seeks to pass along price increases to its customers to mitigate this risk. The Company currently does not purchase or sell financial instruments for purpose of hedging commodity risk. At May 31, 2008, the Company had borrowings totaling approximately $81.5 million outstanding under various credit agreements. The interest rates on these borrowings are variable and therefore the general level of U.S. and foreign interest rates affects interest expense. Increases in interest expense resulting from an increase in interest rates could impact the Companys results of operations. The Companys policy is to take actions that would mitigate such risk when appropriate. These actions include staggering the term and rate of its borrowings to match anticipated cash flow. International business represents a major portion of the Companys revenues and profits. All purchases of rough diamonds worldwide are denominated in U.S. dollars. All of the Companys foreign sales are denominated in U.S. dollars, with the exception of those sales made by the Companys 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, 2008 and 2007, the Company recognized cumulative foreign currency translation adjustments with regard to the activities of Lazare Kaplan Japan in the amount of $(331,000) and $(766,000) respectively, which are shown as a component of stockholders equity in the accompanying balance sheets.
Item 8. Financial Statements and Supplementary Data
(a) The following financial statements and supplementary data are hereby incorporated by reference to the Companys Annual Report.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A(T). Controls and Procedures
Evaluation of Disclosure Controls and Procedures
The Company, under the supervision and with the participation of its management, including its principal executive officer and principal financial officer, evaluated the effectiveness of the design and operation of its disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) to the Securities Exchange Act of 1934 [the Exchange Act]) as of the fiscal year ended May 31, 2008. The purpose of disclosure controls and procedures is to ensure that information required to be disclosed in our reports filed with or submitted to the Securities and Exchange Commission (the SEC) under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SECs rules and forms. Disclosure controls and procedures are also designed to ensure that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, to allow timely decisions regarding required disclosure.
Based on this evaluation, the principal executive officer and principal financial officer concluded that the Companys disclosure controls and procedures were effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time period specified in the SEC rules and forms, and to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is accumulated and communicated to the Companys management, including its principal executive and principal financial officers, as appropriate, to allow timely decisions regarding disclosure.
Managements Report on Internal Control Over Financial Reporting
The Companys management is responsible for establishing and maintaining adequate internal control over financial reporting (Internal Control). The Companys Internal Control is a process designed under the supervision of the Companys chief executive and chief financial officers to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Companys financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles (GAAP).
As of May 31, 2008, management conducted an assessment of the effectiveness of the Companys Internal Control based on the framework set forth in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has determined that the Companys Internal Control as of May 31, 2008 is effective to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Companys financial statements for external reporting purposes in accordance with GAAP.
This Form 10-K does not include an attestation report of the Companys registered public accounting firm regarding Internal Control. Managements report was not subject to attestation by the Companys registered public accounting firm pursuant to temporary rules of the SEC that permit the Company to provide only managements report in this Form 10-K.
The principal executive officer and principal financial officer also conducted an evaluation of the Companys Internal Control to determine whether any changes in Internal Control occurred during the quarter ended May 31, 2008 that may have materially affected or which are reasonably likely to materially affect Internal Control. Based on that evaluation, there has been no change in the Companys Internal Control during the quarter ended May 31, 2008 that has materially affected, or is reasonably likely to affect, the Companys Internal Control.
Item 9B. Other Information
Except for information regarding Executive Officers of the Company, which, in accordance with Instruction G to Form 10-K, is included in Part I hereof, the information called for by Part III (Items 10, 11, 12, 13, and 14) is incorporated by reference herein to the Companys definitive proxy statement to be filed with the Commission within 120 days after the close of its fiscal year ended May 31, 2008.
Item 15. Exhibits and Financial Statement Schedules
Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
of Lazare Kaplan International Inc.
The audits referred to in our report dated September 4, 2008 relating to the consolidated financial statements of Lazare Kaplan International Inc., which are incorporated in Item 8 of the Form 10-K by reference to the annual report to stockholders for the year ended May 31, 2008 also included the audits of the financial statement schedule listed in the accompanying index. This financial statement schedule is the responsibility of the Companys management. Our responsibility is to express an opinion on this financial statement schedule based upon our audits.
In our opinion such financial statement schedule when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
BDO Seidman, LLP
New York, NY
September 4, 2008
LAZARE KAPLAN INTERNATIONAL INC.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS
Item 15. Exhibits and Financial Statement Schedules (continued)
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.