Warnings echoed throughout Maurice Tempelsman’s message to Lazare Kaplan investors about the near term outlook for the global diamond industry. Tempelsman, who is chairman of diamond producer and marketer Lazare Kaplan – a DTC Sightholder, said that the diamond industry is in the midst of a cyclical downturn.

 

Further, he noted, this is the first downturn that has occurred since the diamond industry moved into the Supplier of Choice environment. Thus, the industry is in uncharted territory that will provide a survival test to those in the diamond pipeline.

 

Because of Lazare Kaplan’s long term track record and its solid strategic market position, it will weather the current downturn successfully, stated Tempelsman. But his overall tone was pessimistic, in our opinion, as he provided a dose of reality to investors about problems confronting the diamond and jewelry industry, including the following:

 

• Rough diamond prices that rose to unsustainable levels over the past few years, and have only now begun to retreat.
• Margin pressures that these diamond prices placed on participants in the diamond pipeline.
• Liquidity issues – “overwhelming” debt levels – throughout the diamond pipeline that threaten the core of the diamond business.
• More conservative re-stocking by retail jewelers, especially in the U.S., in the face of an uncertain economy that has left some diamond suppliers – including Lazare Kaplan – with potentially bloated inventory levels. 
• An industry in transition from supply-driven to demand-driven.

Cyclical Downturn Underway

We are “beginning to feel the effect of a change in the overall economic environment,” said Tempelsman, chairman of Lazare Kaplan. As it becomes more restrictive with higher interest rates, Tempelsman expects both his company and the industry to experience significant pressure on growth and margins.

 

Tempelsman predicts “an extremely challenging environment for the foreseeable future.” The short term will be very difficult, he said.

 

Our analysis of Tempelsman’s comments conclude the following:

 

• His pessimistic (or realistic, depending on your point of view) comments about the near term prospects for the diamond industry were the most negative we have heard from him in several years.
• He offered no upbeat (or hopeful) prognosis for the industry longer term.

Rough Diamond Prices Down, But Not By Enough

Tempelsman said that rough diamond prices appear to have declined by 4-5 percent overall in the past few months, after rising to “unsustainable levels” over the past few years. However, Tempelsman said that smaller commodity stones had fallen in price by significantly more than the average while high-quality, larger stones have continued to rise in price. Because Lazare Kaplan deals mostly in larger, better-quality stones, Tempelsman warned investors that his company’s margins will remain under pressure for the foreseeable future.

 

Despite the recent decline in rough diamond prices, Tempelsman said that the current situation is not sustainable. He offered three prospects for the future:

 

• The market will self-correct.
• Diamonds and diamond trading will become much more of a commodity
• The transition toward Supplier of Choice will move beyond the level that De Beers envisioned and become more of a “franchise relationship” between diamond suppliers and their customers.

Lazare Kaplan Ends Fiscal Year on a Sour Note

Revenue growth came nearly to a halt in the fourth quarter, and virtually every operating margin was below the prior year, both for the fourth quarter and full year.

 

• Sales momentum slowed dramatically in the fourth fiscal quarter ended May. Revenues advanced by only 4 percent, one of the smallest gains of the year. For the full fiscal year ended May, LKI’s revenues were up by 45 percent.
• Margins slid, both for the fourth quarter and full year.
• For the fourth quarter, the company’s gross margin was 4.4 percent versus the prior year’s 6.9 percent. Its operating margin fell to 1 percent versus 1.3 percent last year, and its pretax margin showed a loss of 0.5 percent versus a profit of 0.8 percent in 2005. All margins in the fourth quarter were below the average category margins for the full year.
• For the full year, LKI’s gross margin was 5.7 percent versus 8.2 percent last year. Its operating margin was 1 percent versus 2.4 percent a year ago. Its pretax margin was 0.1 percent versus 1.9 percent in 2005.
• Polished diamond margins were 11.3 percent in the fourth quarter, down dramatically from last year’s 15.9 percent. Polished diamond margins for the full year were 13.8 percent versus 16.2 percent for 2005.
• Rough diamond margins in the fourth quarter were 2.1 percent, down from the prior year’s 2.3 percent. Rough diamond trading margins for the full year were 2.4 percent, down from 2005’s 3.5 percent.
• The company’s balance sheet showed the impact of slowing sales and challenging industry liquidity. Customer receivables were up 5 percent; that was greater than the fourth quarter sales gain and indicates that customers are paying more slowly. Lazare Kaplan’s inventories of both rough and polished diamonds rose by 8 percent and 6 percent respectively.

The following tables summarize financial results for both the fourth quarter and full year for Lazare Kaplan.