Harry Winston Diamond Corporation Announces Third Quarter Fiscal 2008 Results
TORONTO, Dec. 12 /PRNewswire-FirstCall/ — Harry Winston Diamond Corporation (TSX: HW, NYSE: HWD) today reported consolidated earnings from operations of $66.3 million for the third quarter of Fiscal 2008, a 79% increase over the prior year’s comparable period. The operating earnings growth was driven by a 22% increase in sales to $176.5 million and a 44% increase in gross margin to $101.9 million.
Strong operating results were offset by a $40.6 million foreign exchange loss, or $0.70 per share, primarily resulting from the revaluation of future income taxes. During the third quarter that ended October 31, 2007, the Canadian dollar, relative to the U.S. dollar, strengthened to $1.06, representing a 13% increase over the second quarter. As a result, the Company posted a net loss of $7.4 million or $(0.13) per share compared to net earnings of $18.8 million, or $0.32 per share, in the prior year’s period. Excluding the impact of the foreign exchange loss for the third quarter, net earnings would have been $33.2 million, or $0.57 per share.
Rio Tinto Plc, the operator of the Diavik Diamond Mine, has approved a two-year capital programme to complete the development of an underground mine which secures the future of the Diavik Project beyond 2020. With this new development plan in hand, Harry Winston is well advanced in extending its existing debt facilities which, together with cash flow from operations, will fund Harry Winston’s estimated additional $218 million contribution to complete this project having already contributed $77 million over the last year. To ensure prudent fiscal management it is the intention of the Board of Directors to continue to pay dividends of $0.05 per quarter during the construction period. The Board of Directors has, therefore, declared a dividend of $0.05 per share to be paid on January 21, 2008 to shareholders of record on December 28, 2007.
Third Quarter Fiscal 2008 Financial Highlights (US$ in millions except Earnings per Share amounts) ————————————————————————- Three Three Nine Nine months months months months ended ended ended ended Oct. 31, Oct. 31, Oct. 31, Oct. 31, 2007 2006 2007 2006 ————————————————————————- Sales 176.5 145.2 491.1 404.5 —————————————- Earnings from operations 66.3 37.1 158.6 109.6 —————————————- Net earnings (loss) (7.4) 18.8 16.0 77.0 —————————————- Earnings (loss) per share (diluted) $(0.13) $0.32 $0.27 $1.30 —————————————- Currency exchange loss (40.6) (1.6) (65.7) (1.0) —————————————- Currency exchange loss per share $(0.70) $(0.03) $(1.12) $(0.02) ————————————————————————-
“I am pleased with the record quarterly and year-to-date sales and strong earnings from operations. Harry Winston Diamond Corporation’s 79% increase in operational results underscores the importance of our unique marketing position as a pure diamond company. As the diamond production from the Diavik Mine increases, we are poised to take advantage of the growing global demand against a backdrop of diminishing world diamond supply,” said Robert Gannicott, Chairman and Chief Executive Officer. “In addition, our Harry Winston retail business, with an expanding worldwide network of salons, continues to focus on long-term growth and profits.”
Thomas J. O’Neill, President of Harry Winston Diamond Corporation and Chief Executive Officer of Harry Winston Inc., added, “During the quarter, we continued to focus on a calibrated growth strategy and to strengthen our core business. Although we faced a more challenging U.S. environment, we were pleased with our momentum in Asia and Europe for Harry Winston jewelry and watches. We continue to see an increasing demand for our designed and hand-crafted diamond jewelry and watches in our salons and in our select wholesale watch network worldwide.”
Alice Murphy, Chief Financial Officer, said “Although our foreign exchange loss is substantially non-cash, the strengthening of the Canadian dollar throughout the year has dramatically impacted our year-to-date net earnings and entirely masked our strong third quarter operational results. Currently, the foreign exchange rate is close to parity which would support a currency gain in the fourth quarter should this rate continue to January 31, 2008 year end.”
Mining Segment Results
Mining revenues, representing production and sales of rough diamonds, increased 35% or $32 million, to $122.7 million in the third quarter. The Company held three primary rough diamond sales in the third quarter and two primary sales in the comparable quarter of the prior year. In addition, as the Company continues to expand its rough diamond sales network, sales are now conducted throughout the quarter in selling offices in Belgium, Israel and India.
Mining earnings from operations were $70.0 million, representing a 72% increase, or $29.4 million, from the prior year comparable quarter. Additional highlights of the Harry Winston Diamond Corporation’s 40% share of the Diavik Mine production include:
(Reported on a one-month lag) ————————————————————————- Three Three Nine Nine months months months months ended ended ended ended September September September September 30, 2007 30, 2006 30, 2007 30, 2006 ————————————————————————- Diamond recovered (000s carats) 1,249 1,132 3,600 2,934 ————————————————————————- Grade (carats/tonne) 4.75 3.92 4.95 4.02 ————————————————————————- Operating costs, cash ($US millions) 28.2 26.4 79.7 71.1 ————————————————————————- Operating costs per carat, cash ($US) 23 23 22 24 ————————————————————————- Retail Segment Results
Harry Winston’s retail segment reported sales of $53.8 million compared to $54.5 million for the comparable quarter of the prior year, or relatively flat to last year. International sales increased 16%, or $4.8 million, to $34.4 million in the third quarter as a result of increases in existing store sales and sales from three new salons that helped offset the effects of a robbery at the Paris Salon. U.S. third quarter sales decreased 22%, or $5.5 million, from $24.9 million to $19.4 million primarily due to the effect of volatility in the U.S. financial markets. As a result, the segment reported a loss from operations of $3.6 million compared to a loss of $3.5 million in the prior year. In addition, included in last year’s quarterly results was a $6.3 million adjustment for stock compensation triggered by the acquisition of the remaining portion of the Harry Winston Inc. operations.
At the end of the third quarter, the Company operated 16 salons compared to 12 salons in the prior year. In addition, during the third quarter the Company opened a new watch manufacturing facility in Geneva, Switzerland to support increased capacity for the growing timepiece business.
Web cast
As previously announced, Harry Winston Diamond Corporation will host a webcast on Thursday, December 13th beginning at 9:00 AM (EST) to review these results and its outlook. Interested parties may listen to a broadcast on the Company’s website at investor.harrywinston.com. An online archive of the webcast will be available on the Company’s website later the same day. Harry Winston Diamond Corporation’s unaudited consolidated interim financial statements together with Management’s Discussion and Analysis are available on the Company’s web site and on SEDAR (http://www.sedar.com/).
Information in this news release that is not current or historical factual information may constitute forward-looking information or statements within the meaning of applicable securities laws. Implicit in this information, particularly in respect of statements as to future operating results and economic performance of Harry Winston Diamond Corporation, and capital commitments at the Diavik Mine, are assumptions regarding projected revenue and expense, diamond prices, mining and mine construction and development costs and the Canadian/US dollar exchange rate. Specifically, in estimating Harry Winston Diamond Corporation’s share of the Diavik Mine capital expenditure requirements, Harry Winston Diamond Corporation has used a Canadian/US dollar exchange rate of $1.00, and has assumed that construction will continue on schedule and without undue disruption with respect to current underground mining construction initiatives. These assumptions, although considered reasonable by Harry Winston Diamond Corporation at the time of preparation, may prove to be incorrect. Forward-looking information is subject to certain factors, including risks and uncertainties, which could cause actual results to differ materially from what we currently expect. These factors include, among other things, the uncertain nature of mining and mine development activities, risks associated with underground construction activities, risks associated with joint venture operations, risks associated with the remote location of the Diavik Mine site, risks associated with regulatory and financing requirements, fluctuations in diamond prices, changes in world economic conditions and the risk of continued fluctuations in the Canadian/US dollar exchange rate.
About Harry Winston Diamond Corporation
Harry Winston Diamond Corporation (NYSE: HWD; TSX: HW) is a specialist diamond enterprise with assets in the mining and retail segments of the diamond industry. The company supplies rough diamonds to the global market from its 40% interest in the Diavik Diamond Mine, located in Canada’s Northwest Territories. The company’s retail division, Harry Winston, Inc., is a premier jewelry and timepiece retailer with salons in key locations including New York, Paris, London, Beijing, Tokyo and Beverly Hills. For more information, please go to http://www.harrywinston.com/ or for investor information, visit investor.harrywinston.com.
Highlights (All figures are in United States dollars unless otherwise indicated)
The Company achieved record consolidated sales for the second consecutive quarter, generating a 44% increase in gross margin and a 79% increase in consolidated earnings from operations over the comparable quarter of the prior year. Consolidated quarterly sales totalled $176.5 million with earnings from operations of $66.3 million compared to $145.2 million and $37.1 million, respectively, for the comparable quarter of the prior year.
Net earnings results for the quarter include the negative effects of a net $40.6 million foreign exchange loss, or $0.70 per share, compared to a $1.6 million foreign exchange loss, or $0.03 per share, in the comparable quarter of the prior year. The loss is a result of the 13% strengthening of the Canadian dollar relative to the US dollar during the quarter, which ended October 31, 2007. This loss relates principally to the revaluation of the Company’s Canadian dollar denominated long-term future income tax liability. Foreign exchange charges from the revaluation of the Canadian tax liability are not tax deductible, resulting in a quarterly income tax provision of $26.2 million against earnings before income taxes of $18.9 million. Consequently, a net loss of $7.4 million, or $0.13 per share, was incurred in the quarter compared to prior year net earnings of $18.8 million, or $0.32 per share.
The improvement in consolidated sales and earnings from operations was driven by the mining segment, which posted a 35% quarterly increase in sales to $122.7 million, and a 72% increase in earnings from operations to $70.0 million, compared to the same quarter of the prior year. Diamond production at the Diavik Mine, which is recorded on a quarterly calendar basis, increased by 10% to 1.25 million carats for the three months ended September 30, 2007, from 1.13 million carats for the comparable period of the prior year.
Third quarter sales of $53.8 million and a loss from operations of $3.6 million for Harry Winston’s retail segment were marginally weaker than the comparable quarter of last year, primarily due to the effect of volatility in the US financial markets and the business disruption resulting from a significant robbery at the Paris salon. The Company was fully insured for the inventory loss and expects to record a pre-tax gain of approximately $13 million in the fourth quarter reflecting the anticipated settlement of the insurance claim.
Rio Tinto Plc, the operator of the Diavik Diamond Mine, has approved a two-year capital program to complete the development of an underground mine which secures the future of the Diavik Project beyond 2020. With this new development plan in hand, Harry Winston is well advanced in extending its existing debt facilities which, together with cash flow from operations, will fund Harry Winston’s estimated additional $218 million contribution to complete this project having already contributed $77 million over the last year. To ensure prudent fiscal management it is the intention of the Board of Directors to continue to pay dividends of $0.05 per quarter during the construction period. The Board of Directors has, therefore, declared a dividend of $0.05 per share to be paid on January 21, 2008 to shareholders of record on December 28, 2007.
Management’s Discussion and Analysis (all figures are in United States dollars unless otherwise indicated) Prepared as of December 12, 2007
On November 9, 2007, Aber Diamond Corporation changed its name to Harry Winston Diamond Corporation.
The following is management’s discussion and analysis (“MD&A”) of the results of operations for Harry Winston Diamond Corporation (“Harry Winston Diamond Corporation”, or the “Company”) for the three and nine months ended October 31, 2007, and its financial position as at October 31, 2007. This MD&A is based on the Company’s consolidated financial statements prepared in accordance with generally accepted accounting principles in Canada (“Canadian GAAP”) and should be read in conjunction with the unaudited consolidated financial statements and notes thereto for the three and nine months ended October 31, 2007 and the audited consolidated financial statements of the Company and notes thereto for the year ended January 31, 2007. Unless otherwise specified, all financial information is presented in United States dollars. Unless otherwise indicated, all references to “third quarter” refer to the three months ended October 31, 2007. Unless otherwise indicated, references to “international” for the retail segment refer to Europe and Asia.
Certain comparative figures have been reclassified to the current year’s presentation.
CAUTION REGARDING FORWARD-LOOKING INFORMATION
Certain information included in this MD&A may constitute forward-looking information within the meaning of securities laws. In some cases, forward-looking information can be identified by the use of terms such as “may”, “will”, “should”, “expect”, “plan”, “anticipate”, “believe”, “intend”, “estimate”, “predict”, “potential”, “continue” or other similar expressions concerning matters that are not historical facts. Forward-looking information may relate to management’s future outlook and anticipated events or results, and may include statements or information regarding projected capital expenditure requirements, the operation of the Geneva watch factory, estimated reserves and resources at, and production from, the Diavik Mine in 2007, potential improvements in grade and tonnage at the Diavik Mine, the expected life of the Diavik Mine, the timing of a revised resource statement, plans, timelines and targets for construction, mining, development, production and exploration activities at the Diavik Mine, future mining and processing at the Diavik Mine, the number and timing of expected rough diamond sales, projected sales growth and new store openings at Harry Winston, expected gross margin and expense trends in the retail segment, expected diamond prices and expectations concerning the diamond industry.
Forward-looking information is based on certain factors and assumptions regarding, among other things, mining, production, construction and exploration activities at the Diavik Mine, world and US economic conditions, and the level of worldwide diamond production, the expected sales mix at Harry Winston’s retail segment, expected salon openings and potential improvements in sourcing and purchasing polished diamonds. Specifically, in estimating Harry Winston Diamond Corporation’s projected share of the Diavik Mine capital expenditure requirements, Harry Winston Diamond Corporation has used a Canadian/US dollar exchange rate of $1.00, and has assumed that construction will continue on schedule and without undue disruption with respect to current underground mining construction initiatives. In making statements regarding estimated production at the Diavik Mine, potential improvements in grade and tonnage at the Diavik Mine, future mining activity and mine plans and future rough diamond sales, Harry Winston Diamond Corporation has assumed that mining operations and exploration activities will proceed in the ordinary course according to schedule and consistent with past results.
Forward-looking information is subject to certain factors, including risks and uncertainties, which could cause actual results to differ materially from what we currently expect. These factors include, among other things, the uncertain nature of mining activities including risks associated with underground construction and mining operations, risks associated with joint venture operations, risks associated with the remote location of and harsh climate at the Diavik Mine site, risks associated with regulatory requirements, fluctuations in diamond prices and changes in US and world economic conditions, the risk of fluctuations in the Canadian/US dollar exchange rate, risks relating to the Company’s salon expansion strategy and the risks of competition in the luxury jewelry segment. Please see page 21 of this interim report, as well as the Company’s annual report, available at http://www.sedar.com/, for a more comprehensive discussion of these and other risks and uncertainties involved in Harry Winston Diamond Corporation’s operations.
You should not place undue importance on forward-looking information and should not rely upon this information as of any other date. While Harry Winston Diamond Corporation may elect to, it is under no obligation and does not undertake to update this information at any particular time, except as required by law.
————————————————————————- Summary Discussion
Prior to November 9, 2007, Harry Winston Diamond Corporation was known as Aber Diamond Corporation. The name change reflects the rebranding of the Company and its international position as a premier diamond company.
Harry Winston Diamond Corporation is a specialist diamond company focusing on the mining and retail segments of the diamond industry. The Company supplies rough diamonds to the global market from production received from its 40% ownership interest in the Diavik Diamond Mine (the “Diavik Mine”), located off Lac de Gras in Canada’s Northwest Territories. Harry Winston Diamond Corporation also owns a 100% interest in Harry Winston Inc., the premier fine jewelry and watch retailer. Harry Winston Diamond Corporation’s mission is to deliver shareholder value through the enhanced earning power and longevity of the Diavik Mine asset as the cornerstone of a profitable synergy with the Harry Winston brand. In a changing diamond market-place, Harry Winston Diamond Corporation has charted a unique course to continue to build shareholder value.
The Company’s most significant asset is a 40% interest in the Diavik group of mineral claims. The Diavik Joint Venture (the “Joint Venture”) is an unincorporated joint arrangement between Diavik Diamond Mines Inc. (“DDMI” – 60%) and Harry Winston Diamond Mines Ltd. (formerly Aber Diamond Mines Ltd.) (40%) where Harry Winston Diamond Corporation owns an undivided 40% interest in the assets, liabilities and expenses. DDMI is the operator of the Diavik Mine. Both companies are headquartered in Yellowknife, Canada. DDMI is a wholly owned subsidiary of Rio Tinto plc of London, England, and Harry Winston Diamond Mines Ltd. is a wholly owned subsidiary of Harry Winston Diamond Corporation of Toronto, Canada. The name of Aber Diamond Mines Ltd. was changed to Harry Winston Diamond Mines Ltd. on December 3, 2007.
Market Commentary The Diamond Market
During the third quarter, demand for rough diamonds continued to increase across all ranges, leading to higher rough diamond prices.
Steady demand for polished diamonds in the US market and continued growth from Asia supported higher polished diamond prices. This was particularly evident in the better quality white goods, three carats and above. Strong demand in these ranges is expected to lead to further price increases before the end of the year.
The Retail Jewelry Market
Sales in the luxury retail jewelry and watch sector were generally robust worldwide despite the volatility in the US financial markets.
Consolidated Financial Results
The following is a summary of the Company’s consolidated quarterly results for the eight quarters ended October 31, 2007 following the basis of presentation utilized in its Canadian GAAP financial statements:
(expressed in thousands of United States dollars, except per share amounts and where otherwise noted)(unaudited) 2008 2008 2008 Q3 Q2 Q1 ————————————————————————- Sales $176,478 $173,269 $141,365 Cost of sales 74,591 81,827 71,132 ————————————————————————- Gross margin 101,887 91,442 70,233 Gross margin (%) 57.7% 52.8% 49.7% Selling, general and administrative expenses 35,539 35,201 34,211 ————————————————————————- Earnings from operations 66,348 56,241 36,022 ————————————————————————- ————————————————————————- Interest and financing expenses (7,422) (7,222) (6,132) Other income (expense) 594 545 913 Foreign exchange gain (loss) (40,584) (11,785) (13,292) ————————————————————————- Earnings before income taxes 18,936 37,779 17,511 Income taxes 26,197 17,747 14,118 ————————————————————————- Earnings (loss) before minority interest (7,261) 20,032 3,393 Minority interest 90 (26) 140 ————————————————————————- Net earnings (loss) $ (7,351) $ 20,058 $ 3,253 ————————————————————————- ————————————————————————- Basic earnings (loss) per share $ (0.13) $ 0.34 $ 0.06 Diluted earnings (loss) per share $ (0.13) $ 0.33 $ 0.05 Cash dividends declared per share $ 0.25 $ 0.25 $ 0.25 Total assets(i) $ 1,433 $ 1,367 $ 1,315 Total long-term liabilities(i) $ 530 $ 486 $ 408 ————————————————————————- 2007 2007 2007 2007 Q4 Q3 Q2 Q1 ————————————————————————- Sales $154,328 $145,232 $139,962 $119,271 Cost of sales 78,559 74,636 68,458 63,845 ————————————————————————- Gross margin 75,769 70,596 71,504 55,426 Gross margin (%) 49.1% 48.6% 51.1% 46.5% Selling, general and administrative expenses 38,590 33,480 27,171 27,295 ————————————————————————- Earnings from operations 37,179 37,116 44,333 28,131 ————————————————————————- ————————————————————————- Interest and financing expenses (6,441) (5,570) (4,805) (4,334) Other income (expense) (111) 1,764 1,805 1,623 Foreign exchange gain (loss) 9,831 (1,560) 2,619 (2,106) ————————————————————————- Earnings before income taxes 40,458 31,750 43,952 23,314 Income taxes 13,169 13,005 9,692 (1,036) ————————————————————————- Earnings (loss) before minority interest 27,289 18,745 34,260 24,350 Minority interest (5) (86) (5) 471 ————————————————————————- Net earnings (loss) $ 27,294 $ 18,831 $ 34,265 $ 23,879 ————————————————————————- ————————————————————————- Basic earnings (loss) per share $ 0.47 $ 0.32 $ 0.59 $ 0.41 Diluted earnings (loss) per share $ 0.46 $ 0.32 $ 0.58 $ 0.40 Cash dividends declared per share $ 0.25 $ 0.25 $ 0.25 $ 0.25 Total assets(i) $ 1,288 $ 1,246 $ 1,116 $ 1,111 Total long-term liabilities(i) $ 536 $ 530 $ 460 $ 460 ————————————————————————- Nine Nine Months Months Ended Ended 2006 Oct. 31, Oct. 31, Q4 2007 2006 ————————————————————————- Sales $125,891 $491,112 $404,465 Cost of sales 52,782 227,550 206,939 ————————————————————————- Gross margin 73,109 263,562 197,526 Gross margin (%) 58.1% 53.7% 48.8% Selling, general and administrative expenses 36,654 104,951 87,944 ————————————————————————- Earnings from operations 36,455 158,611 109,582 ————————————————————————- ————————————————————————- Interest and financing expenses (4,511) (20,776) (14,709) Other income (expense) 1,767 2,052 5,191 Foreign exchange gain (loss) (5,392) (65,661) (1,049) ————————————————————————- Earnings before income taxes 28,319 74,226 99,015 Income taxes 10,534 58,062 21,662 ————————————————————————- Earnings (loss) before minority interest 17,785 16,164 77,353 Minority interest 2,876 204 379 ————————————————————————- Net earnings (loss) $ 14,909 $ 15,960 $ 76,974 ————————————————————————- ————————————————————————- Basic earnings (loss) per share $ 0.26 $ 0.27 $ 1.32 Diluted earnings (loss) per share $ 0.27 $ 0.27 $ 1.30 Cash dividends declared per share $ 0.25 $ 0.75 $ 0.75 Total assets(i) $ 1,044 $ 1,433 $ 1,246 Total long-term liabilities(i) $ 434 $ 530 $ 530 ————————————————————————- (i) Total assets and total long-term liabilities are expressed in millions of United States dollars.
The comparability of quarter-over-quarter results is impacted by seasonality for both the mining and retail segments. Harry Winston Diamond Corporation expects that the quarterly results for its mining segment will continue to fluctuate depending on the seasonality of production at the Diavik Mine, the number of primary and secondary sales events conducted at each sales location during the quarter, and the volume, size and quality distribution of rough diamonds delivered from the Diavik Mine in each quarter. The quarterly results for the retail segment are also seasonal, with generally higher sales during the fourth quarter due to the holiday season.
Three Months Ended October 31, 2007 Compared to Three Months Ended October 31, 2006 Consolidated Net Earnings
The third quarter consolidated net loss of $7.4 million or $0.13 per share compares to net earnings of $18.8 million or $0.32 per share in the prior period last year. This reduction in net earnings is substantially due to a $40.6 million foreign exchange loss related principally to an unrealized non-cash cost on future income taxes payable, as discussed under “Consolidated Income Taxes” below, as compared to a foreign exchange loss of $1.6 million in the comparable period last year. The comparable quarter of the prior year included a $6.3 million adjustment for stock compensation triggered by the acquisition of the remaining portion of the Harry Winston Inc. retail operations.
Consolidated Revenue
Revenue for the third quarter totalled $176.5 million, representing a 22% increase over the comparable quarter last year of $145.2 million. On a segment basis, rough diamond sales were $122.7 million and sales from Harry Winston’s retail salons were $53.8 million as compared to $90.8 million and $54.5 million, respectively, for the comparable quarter of the prior year. Retail segment sales for the quarter were marginally lower than the comparable quarter of last year, reflecting the effect of volatility in the US financial markets and a significant robbery at the Paris salon. Ongoing quarterly variations in revenues are inherent in Harry Winston Diamond Corporation’s business, resulting from the seasonality of the mining and retail activities as well as from the variability of the rough diamond sales schedule.
Consolidated Cost of Sales and Gross Margin
The Company’s third quarter cost of sales was $74.6 million consistent with the comparable quarter of the prior year, however gross margin increased significantly to 57.7% from 48.6% as a result of strong mining segment sales. The Company’s cost of sales includes cash and non-cash costs associated with mining, sorting and retail sales activities. See “Segmented Analysis” on page 11 for additional information.
Consolidated Selling, General and Administrative Expenses
The principal components of selling, general and administrative (“SG&A”) expenses include expenses for salaries and benefits (including salon personnel), advertising, professional fees, rent and building related costs. SG&A expenses for the third quarter were $35.5 million as compared to $33.5 million for the comparable quarter of the prior year. The increase in SG&A expenses relates to both the mining segment and the retail segment. For the mining segment, the increase was as a result of the continued development of our global selling, marketing and administrative operations. For the retail segment the increase was as a result of our expanded salon retail base, and reflected an increase in salaries and benefits, rent and building related expenses and depreciation and amortization expense. The comparable quarter of the prior year for the retail segment included a $6.3 million stock compensation charge triggered by the acquisition of the remaining portion of the Harry Winston Inc. retail operations. See “Segmented Analysis” on page 11 for additional information.
Consolidated Income Taxes
Harry Winston Diamond Corporation recorded a tax expense of $26.2 million during the third quarter of fiscal 2008, compared to a tax expense of $13.0 million in the comparable quarter of the previous year.
The Company’s functional and reporting currency is US dollars; however, the calculation of income tax expense is based on income in the currency of the country of origin. As such, the Company is continually subject to foreign exchange fluctuations, particularly as the Canadian dollar moves against the US dollar. During the third quarter of fiscal 2008, the Canadian dollar strengthened by 13% relative to the US dollar during the quarter. As a result, the Company recorded a foreign exchange loss of $40.6 million, of which $31.4 million was unrealized and resulted from the revaluation of the Company’s Canadian dollar denominated future income tax liability. This foreign exchange loss is not deductible for Canadian income tax purposes, as the loss does not exist when calculating the income of the Company in Canadian dollars, which is the basis of income tax expense computation.
Because of the significant non-deductible unrealized non-cash foreign exchange loss incurred during the third quarter, the Company’s effective income tax rate for the quarter is substantially inflated. The foreign exchange loss resulted in a considerably lower net income before tax in US dollars relative to the net income before tax in the currency of the country of origin in which income tax expense is calculated. Consequently, all reconciliation items, when presented as a percentage of the US dollar net income, become much higher in the current quarter. For the third quarter of fiscal 2008, the Company’s effective income tax rate is 138%. The impact of foreign exchange accounted for 69% of the overall effective tax rate for the third quarter. The Northwest Territories mining royalty in the current quarter, as a percentage of the US dollar net income, is also much higher as the royalty is computed based on income in Canadian dollars.
The rate of income tax payable by Harry Winston Inc. varies by jurisdiction. Net operating losses are available in certain jurisdictions to offset future income taxes payable in such jurisdictions. The net operating losses are scheduled to expire through 2027.
The Company has provided a table below summarizing the movement from the statutory to the effective income tax rate as a percentage of earnings before taxes:
Three Three Months Months Ended Ended Oct. 31, Oct. 31, 2007 2006 ————————————————————————- Statutory income tax rate 34% 37% Stock compensation 2% 1% Northwest Territories mining royalty (net of income tax relief) 33% 12% Impact of foreign exchange 69% (4)% Earnings subject to tax different than statutory rate (15)% (4)% Changes in valuation allowance 10% 2% Other items 5% (3)% Effective income tax rate 138% 41% ————————————————————————- Consolidated Interest and Financing Expenses
Interest and financing expenses of $7.4 million were incurred during the third quarter compared to $5.6 million during the comparable quarter of the prior year. The increase in interest and financing expenses is mainly due to higher debt levels at Harry Winston’s retail segment to finance increased inventory levels and salon openings.
Consolidated Other Income
Other income, which includes interest income on the Company’s various bank balances, was $0.6 million during the third quarter compared to $1.8 million in the comparable quarter of the prior year. The reduction in other income is due to higher cash balances held in the comparable quarter of the prior year in advance of the Harry Winston Inc. acquisition.
In October 2007, approximately $23.2 million in Company-owned retail inventory at cost was stolen during a robbery at the Harry Winston Paris salon, and charged to other income during the quarter. The Company is fully insured against the loss, and has offset the inventory write-off by setting up a receivable of equal value in respect of the insurance proceeds. The insurance claim is subject to investigation by the insurance company and is scheduled to be concluded during the fourth quarter of fiscal 2008, at which time the claim will be settled. The insurance settlement is expected to result in the recording of a gain in the fourth quarter of approximately $13 million pre-tax in retail segment other income, representing the difference between the cost of the inventory stolen and the insurance proceeds received.
Consolidated Foreign Exchange Loss
A foreign exchange loss of $40.6 million was recognized during the third quarter compared to a loss of $1.6 million in the comparable quarter of the prior year. The current quarter loss is comprised of a realized foreign exchange gain of $1.0 million and an unrealized, non-cash loss of $41.6 million relating principally to the revaluation of the Company’s Canadian dollar denominated long-term future income tax liability stemming from the strengthening of the Canadian dollar against the US dollar at quarter end. Harry Winston Diamond Corporation’s ongoing currency exposure relates primarily to expenses and obligations incurred in Canadian dollars, as well as to the revaluation of certain Canadian monetary balance sheet amounts. The Company does not currently have any significant derivative instruments outstanding.
Nine Months Ended October 31, 2007 Compared to Nine Months Ended October 31, 2006 Consolidated Net Earnings
Net earnings for the nine months ended October 31, 2007 of $16.0 million or $0.27 per share compares to $77.0 million or $1.32 per share for the nine months ended October 31, 2006. This reduction in net earnings is substantially due to a significant foreign exchange loss of $65.7 million related principally to an unrealized non-cash cost on future income taxes payable as compared to a foreign exchange loss of $1.0 million in the comparable year-to-date period last year. The comparable nine-month period of the prior year included a $6.3 million adjustment to stock compensation triggered by the acquisition of the remaining portion of the Harry Winston Inc. retail operations. In addition, the comparable year-to-date period included a future income tax recovery of $17.0 million attributable to reductions in future income tax rates.
Consolidated Revenue
Revenue for the nine months ended October 31, 2007 was $491.1 million, representing an increase of 21% over revenue of $404.5 million for the nine months ended October 31, 2006. Rough diamond sales accounted for $310.5 million of this revenue compared to $251.5 million for the comparable period of the prior year. Retail segment sales of $180.6 million accounted for the balance, compared to $152.9 million for the comparable period of the prior year. Year-to-date sales performance for the retail segment was negatively impacted by certain third quarter events, namely the effect of volatility in the US financial markets and the impact of the Paris salon robbery.
Consolidated Cost of Sales and Gross Margin
The Company recorded cost of sales of $227.6 million during the nine months ended October 31, 2007 compared to $206.9 million during the nine months of the prior year, and gross margin increased significantly to 53.7% from 48.8% as a result of strong year-to-date mining segment sales. The Company’s cost of sales includes cash and non-cash costs associated with mining, sorting and retail sales activities.
Consolidated Selling, General and Administrative Expenses
Harry Winston Diamond Corporation incurred SG&A expenses of $105.0 million for the nine months ended October 31, 2007, compared to $87.9 million for the nine months ended October 31, 2006. SG&A expenses for the current nine months included $17.7 million for the mining segment and $87.3 million for the retail segment as compared to $13.8 million and $74.1 million, respectively, for the comparable nine-month period of the prior year. The principal components of SG&A expenses are salaries (including salon personnel), advertising, professional fees, rent, and related office costs.
The increase in SG&A expenses was primarily a result of Harry Winston’s retail expansion strategy, which included the opening of additional salons, and the growing international presence of our mining sales segment. The increase of $17.1 million in SG&A expenses from the comparable period of the prior year included an increase of $4.5 million in advertising and selling expenses, $4.1 million in rent and building related expenses, and $2.9 million in amortization expense. Included in the comparable nine-month period of the prior year was a $6.3 million adjustment to stock compensation triggered by the acquisition of the remaining portion of the Harry Winston Inc. operations, which was partially offset by the reversal of a specific provision against accounts receivable of $2.2 million.
Consolidated Income Taxes
The Company recorded a tax expense of $58.1 million during the nine months ended October 31, 2007, compared to $21.7 million for the comparable period of the prior year. The Company’s effective income tax rate for the nine months ended October 31, 2007 was 78%, which was based on a statutory income tax rate of 34% adjusted for the Northwest Territories mining royalty, items that are not deductible for income tax purposes, impact of foreign exchange, earnings subject to tax different than the statutory income tax rate, and impact of changes in future income tax rates. During the nine months ended October 31, 2007, the Company recorded a future tax recovery of $0.9 million as a result of the decrease in the Federal corporate income tax rates commencing January 1, 2011, which was substantively enacted during the period. This compares with a future tax recovery of $17.0 million recorded in the comparable period of the prior year, which resulted from the decrease in Northwest Territories and Federal corporate income tax rates and the elimination of Federal surtax.
During the nine months ended October 31, 2007, the Company recorded an unrealized non-cash foreign exchange loss of $54.7 million on the revaluation of the Canadian dollar denominated future income tax liability, which is not deductible for Canadian income tax purposes. The significant unrealized foreign exchange loss is the primary reason for the increase of the overall effective income tax rate in the current period.
The rate of income tax payable by Harry Winston Inc. varies by jurisdiction. Net operating losses are available in certain jurisdictions to offset future income taxes payable in such jurisdictions. The net operating losses are scheduled to expire through 2027.
The Company has provided a table below summarizing the movement from the Company’s statutory to the effective income tax rate as a percentage of earnings before taxes:
Nine Nine Months Months Ended Ended Oct. 31, Oct. 31, 2007 2006 ————————————————————————- Statutory income tax rate 34% 37% Stock compensation 0% 1% Northwest Territories mining royalty (net of income tax relief) 18% 9% Impact of change in future income tax rate (1)% (17)% Impact of foreign exchange 27% (3)% Earnings subject to tax different than statutory rate (6)% (4)% Changes in valuation allowance 1% 0% Benefits of losses recognized as reduction of goodwill 2% 0% Other items 3% (1)% Effective income tax rate 78% 22% ————————————————————————- Consolidated Interest and Financing Expenses
Interest and financing expenses of $20.8 million were incurred during the nine months ended October 31, 2007 compared to $14.7 million for the comparable period of the preceding year. The increase in interest and financing expenses is due to a combination of higher debt levels at Harry Winston’s retail segment to finance increased inventory levels and salon openings, an increased drawdown of Harry Winston Diamond Corporation’s expanded credit facility related to the Harry Winston Inc. retail acquisition, and higher interest rates.
Consolidated Other Income
Other income, which includes interest income on the Company’s various bank balances, was $2.1 million during the nine months ended October 31, 2007 compared to $5.2 million for the comparable period of the preceding year. The reduction in income is due to higher cash balances held in the comparable period of the prior year in advance of the Harry Winston Inc. acquisition.
Consolidated Foreign Exchange Gain (Loss)
A foreign exchange loss of $65.7 million was recognized during the nine months ended October 31, 2007 compared with a loss of $1.0 million recorded during the nine months ended October 31, 2006. The current year-to-date loss is comprised of a realized foreign exchange gain of $0.8 million and an unrealized, non-cash loss of $66.5 million relating principally to the revaluation of the company’s Canadian dollar denominated long-term future income tax liability as a result of the strengthening of the Canadian dollar against the US dollar at quarter end. The Company’s ongoing currency exposure relates primarily to expenses and obligations incurred in Canadian dollars, as well as the revaluation of certain Canadian monetary balance sheet amounts. The Company does not currently have any significant derivative instruments outstanding.
Segmented Analysis The operating segments of the Company include mining and retail segments. Mining The mining segment includes the production and sale of rough diamonds. (expressed in thousands of United States dollars) (unaudited) 2008 2008 2008 Q3 Q2 Q1 ————————————————————————- Sales $122,711 $105,071 $ 82,752 Cost of sales 45,985 46,217 40,516 ————————————————————————- Gross margin 76,726 58,854 42,236 Gross margin (%) 62.5% 56.0% 51.0% Selling, general and administrative expenses 6,748 5,861 5,087 ————————————————————————- Earnings from operations $ 69,978 $ 52,993 $ 37,149 ————————————————————————- ————————————————————————- 2007 2007 2007 2007 Q4 Q3 Q2 Q1 ————————————————————————- Sales $ 81,035 $ 90,754 $ 91,476 $ 69,308 Cost of sales 39,413 45,461 43,256 38,749 ————————————————————————- Gross margin 41,622 45,293 48,220 30,559 Gross margin (%) 51.4% 49.9% 52.7% 44.1% Selling, general and administrative expenses 7,397 4,665 4,373 4,787 ————————————————————————- Earnings from operations $ 34,225 $ 40,628 $ 43,847 $ 25,772 ————————————————————————- ————————————————————————- Nine Nine Months Months Ended Ended 2006 Oct. 31, Oct. 31, Q4 2007 2006 ————————————————————————- Sales $ 62,528 $310,534 $251,538 Cost of sales 22,780 132,718 127,466 ————————————————————————- Gross margin 39,748 177,816 124,072 Gross margin (%) 63.6% 57.3% 49.3% Selling, general and administrative expenses 8,221 17,696 13,824 ————————————————————————- Earnings from operations $ 31,527 $160,120 $110,248 ————————————————————————- ————————————————————————- Three Months Ended October 31, 2007 Compared to Three Months Ended October 31, 2006 Mining Revenue
Sales for the third quarter totalled $122.7 million compared to $90.8 million in the comparable quarter of the prior year. The Company held three primary rough diamond sales in the current quarter and two primary sales in the comparable quarter of last year. With Harry Winston Diamond Corporation’s continued expansion of its global rough diamond sales network, sales are now conducted throughout the quarter in each of the Company’s three selling offices located in Belgium, Israel and India. Harry Winston Diamond Corporation expects that the quarterly results for its mining segment will continue to fluctuate depending on the seasonality of production at the Diavik Mine, the number of primary and secondary sales events conducted at each sales location during the quarter, and the volume, size and quality distribution of rough diamonds delivered from the Diavik Mine in each quarter.
Mining Cost of Sales and Gross Margin
Cost of sales includes cash operating costs of $23.6 million, non-cash operating costs of $20.0 million and private production royalties of $2.4 million compared to $28.5 million, $15.3 million and $1.7 million, respectively, in the same period of the prior year. A substantial portion of cost of sales is mining operating costs, which are incurred at the Diavik Mine. The third quarter of the prior year was negatively impacted by higher cash operating costs incurred as a result of the early closure of the 2006 winter road. Cost of sales also includes sorting costs, which consist of Harry Winston Diamond Corporation’s cost of handling and sorting product in preparation for sales to third parties. Non-cash costs include amortization and depreciation, the majority of which is recorded using the unit-of- production method over estimated proven and probable reserves. Private production royalties are recorded based on actual production during each accounting period.
The third quarter gross margin was 62.5% compared to 49.9% in the comparable quarter of the prior year. The increase in the gross margin percentage is driven by higher carat production, reflecting both higher grade and enhanced diamond recovery resulting from processing improvements. The mining gross margin is anticipated to fluctuate between quarters, resulting from variations in the specific mix of product sold during each quarter.
Mining Selling, General and Administrative Expenses
SG&A expenses for the mining segment increased $2.0 million to $6.7 million from $4.7 million in the comparable quarter of the prior year primarily due to the continued development of our global selling, marketing and administrative operations.
Nine Months Ended October 31, 2007 Compared to Nine Months Ended October 31, 2006 Mining Revenue
Sales for the nine months ended October 31, 2007 totalled $310.5 million compared to $251.5 million for the nine months ended October 31, 2006. The Company held eight primary diamond sales year-to-date and seven primary sales in the comparable period of the prior year. With Harry Winston Diamond Corporation’s continued expansion of its global rough diamond sales network, sales are now conducted throughout the quarter in each of the Company’s three selling offices located in Belgium, Israel and India. Harry Winston Diamond Corporation expects that results for its mining segment will continue to fluctuate depending on the seasonality of production at the Diavik Mine, the number of primary and secondary sales events conducted at each sales location during the quarter, and the volume, size and quality distribution of rough diamonds delivered from the Diavik Mine in each quarter.
Mining Cost of Sales and Gross Margin
Cost of sales includes cash operating costs of $76.1 million, non-cash operating costs of $50.8 million and private production royalties of $5.8 million compared to $84.5 million, $38.0 million and $5.0 million, respectively, for the same nine-month period of the prior year. A substantial portion of cost of sales is mining operating costs, which are incurred at the Diavik Mine. Prior year cash operating costs were negatively impacted by higher expenditures resulting from the early closure of the 2006 winter road. Cost of sales also includes sorting costs, which consist of Harry Winston Diamond Corporation’s cost of handling and sorting product in preparation for sales to third parties. Non-cash costs include amortization and depreciation, the majority of which is recorded using the unit-of-production method over estimated proven and probable reserves. Private production royalties are recorded based on actual production during each accounting period.
For the nine months ended October 31, 2007, gross margin was 57.3% compared to 49.3% in the comparable period of the prior year. The increase in the gross margin percentage is driven by higher carat production, reflecting both higher grade and enhanced diamond recovery resulting from processing improvements. The mining gross margin is anticipated to fluctuate during the year, resulting from variations in the specific mix of product sold during the period.
Mining Selling, General and Administrative Expenses
SG&A expenses for the mining segment increased by $3.9 million to $17.7 million from $13.8 million in the comparable period of the prior year primarily due to the continued development of our global selling, marketing and administrative operations.
Retail
The retail segment includes sales from Harry Winston’s 16 salons, which are located in New York, Honolulu, Bal Harbour, Beverly Hills, Las Vegas, Dallas, Paris, London, Geneva, Tokyo (Ginza, Omotesando and Roppongi), Osaka, Taipei, Beijing and Hong Kong.
(in thousands of United States dollars) (unaudited) 2008 2008 2008 Q3 Q2 Q1 ————————————————————————- Sales $ 53,767 $ 68,198 $ 58,613 Cost of sales 28,606 35,610 30,616 ————————————————————————- Gross margin 25,161 32,588 27,997 Gross margin (%) 46.8% 47.8% 47.8% Selling, general and administrative expenses 28,791 29,340 29,124 ————————————————————————- Earnings (loss) from operations $ (3,630) $ 3,248 $ (1,127) ————————————————————————- ————————————————————————- 2007 2007 2007 2007 Q4 Q3 Q2 Q1 ————————————————————————- Sales $ 73,293 $ 54,478 $ 48,486 $ 49,963 Cost of sales 39,146 29,175 25,202 25,096 ————————————————————————- Gross margin 34,147 25,303 23,284 24,867 Gross margin (%) 46.6% 46.4% 48.0% 49.8% Selling, general and administrative expenses 31,193 28,815 22,798 22,508 ————————————————————————- Earnings (loss) from operations $ 2,954 $ (3,512) $ 486 $ 2,359 ————————————————————————- ————————————————————————- Nine Nine Months Months Ended Ended 2006 Oct. 31, Oct. 31, Q4 2007 2006 ————————————————————————- Sales $ 63,363 $180,578 $152,927 Cost of sales 30,002 94,832 79,473 ————————————————————————- Gross margin 33,361 85,746 73,454 Gross margin (%) 52.7% 47.5% 48.0% Selling, general and administrative expenses 28,433 87,255 74,120 ————————————————————————- Earnings (loss) from operations $ 4,928 $ (1,509) $ (666) ————————————————————————- ————————————————————————- Three Months Ended October 31, 2007 Compared to Three Months Ended October 31, 2006 Retail Revenue
Global sales for the third quarter were $53.8 million compared to $54.5 million for the comparable quarter of the prior year. International sales increased 16% to $34.4 million in the quarter as a result of existing and new salon openings offsetting the effects of a robbery at the Paris salon in October 2007. See “Consolidated Other Income” discussion on page 7 for additional information. US sales decreased 22% from $24.9 million to $19.4 million primarily due to the effect of volatility in the US financial markets.
Retail Cost of Sales and Gross Margin
Cost of sales for the third quarter were $28.6 million compared to $29.2 million for the comparable quarter of the prior year. Gross margin for the quarter was $25.2 million and 46.8% compared to $25.3 million and 46.4% for the third quarter of the prior year. Excluding the impact of sales of Harry Winston Inc. pre-acquisition inventory, gross margin rate for the third quarter and the comparable quarter of the prior year would have been 52.4% and 49.9%, respectively.
Retail Selling, General and Administrative Expenses
Third quarter SG&A expenses were flat at $28.8 million compared to the same quarter of the prior year, which included a $6.3 million adjustment to stock compensation triggered by the acquisition of the remaining portion of the Harry Winston Inc. operations. The effective increase in SG&A expenses during the quarter as compared to the same quarter of the prior year primarily reflects an increase in salaries and benefits of $2.7 million, an increase in rent and building related expenses of $2.0 million and an increase in depreciation and amortization expense of $0.8 million, as a result of our expanded salon retail base and continued commitment to global expansion. SG&A expenses include depreciation and amortization expense of $2.1 million compared to $1.4 million in the comparable quarter of the prior year.
Nine Months Ended October 31, 2007 Compared to Nine Months Ended October 31, 2006 Retail Revenue
Sales for the nine months ended October 31, 2007 were $180.6 million compared to $152.9 million for the nine months ended October 31, 2006. This 18% increase in retail sales was driven by a 3% increase in US sales from $64.3 million to $65.9 million and a 29% increase in international sales from $88.7 million to $114.7 million. Same store sales and contributions from new salons during the first nine months were negatively impacted by the Paris salon robbery in the third quarter.
Retail Cost of Sales and Gross Margin
Cost of sales for the nine months ended October 31, 2007 were $94.8 million compared to $79.5 million for the nine months ended October 31, 2006. Year to date gross margin increased 17% to $85.7 million from $73.5 million in