Harry Winston Diamond Corporation Reports Fiscal 2013 Second Quarter Results (1 of 2)
TORONTO, September 6, 2012 /PRNewswire/ --
Harry Winston Diamond Corporation (TSX: HW, NYSE:HWD) (the "Company") today announced its second quarter Fiscal 2013 results for the quarter ending July 31, 2012.
Robert Gannicott, Chairman and Chief Executive Officer stated, "This quarter has seen transaction numbers and margins grow in our luxury goods segment even as we have withheld rough diamonds, from a soft diamond market, rather than sell at depressed prices."
Second Quarter Highlights:
- Consolidated sales decreased 20% to $176.9 million for the second quarter compared to $222.4 million for the comparable quarter of the prior year.
- Operating profit was $16.4 million compared to $23.1 million in the comparable quarter of the prior year.
- EBITDA decreased 24% to $33.4 million compared to $43.8 million in the comparable quarter of the prior year.
- For the mining segment rough diamond sales for the quarter decreased 31% to $61.5 million, versus $89.6 million in the comparable quarter of the prior year.
- The decrease in sales resulted from a combination of a 24% decrease in volume of carats sold during the quarter and a 10% decrease in achieved rough diamond prices.
- The 24% decrease in the quantity of carats sold was primarily the result of the Company's decision to hold some inventory until stability returns to the rough diamond market. Had the Company sold only the last production shipped for the second quarter, the estimated achieved price would have been approximately $104 per carat based on the prices achieved in the March/April 2012 sale adjusted down by 14% to reflect current market conditions.
- The Company sold approximately 0.43 million carats for an average price of $142 per carat compared to approximately 0.57 million carats for an average price per carat of $157 in the comparable quarter of the prior year. The 10% decrease in the Company's achieved average rough diamond prices in the second quarter resulted from a decrease in the market price for rough diamonds from the peak achieved in July 2011, partially offset by the sale of the higher priced goods held back by the Company in the first quarter of fiscal 2013 due to an observed imbalance in the rough and polished diamond prices for these goods during that period.
- The Company had 0.7 million carats of rough diamond inventory with an estimated current market value of approximately $90 million at July 31, 2012, of which approximately $65 million represents inventory available for sale.
- Rough diamond production for the calendar quarter ended July 31, 2012 was 0.72 million carats (40% basis), which was consistent with the comparable period of the prior year.
- Luxury brand segment sales decreased 13% (11% at constant exchange rates) to $115.4 million compared to $132.8 million in the comparable quarter of the prior year.
- Excluding high-value transactions from both periods, sales increased 25% in the second quarter versus the comparable quarter in the prior year.
- Operating profit for the luxury brand segment increased 16% to $8.0 million in the second quarter compared to $6.9 million in the comparable quarter of the prior year.
- The increase in operating profit was primarily driven by positive product mix and a greater portion of high-value transactions in the comparable quarter of the prior year that generated lower-than-average gross margins.
- On August 30, 2012, the luxury brand segment refinanced its senior secured revolving credit facility by entering into a new secured five-year credit agreement with a consortium of banks led by Standard Chartered Bank establishing a $260 million facility for revolving credit loans. The facility has a maturity date of August 30, 2017.
- Consolidated net profit attributable to shareholders for the second quarter was $4.8 million or $0.06 per share compared to net profit attributable to shareholders of $10.0
- million or $0.12 per share in the comparable quarter of the prior year.
Fiscal 2013 Second Quarter Financial Summary
(US$ in millions except Earnings per Share amounts)
Three months Three months Six months Six months ended ended ended ended July 31, 2012 July 31, 2011 July 31, 2012 July 31, 2011 Sales $176.9 $222.4 $369.4 $366.3 - Mining Segment 61.5 89.6 150.5 151.6 - Luxury Brand Segment 115.4 132.8 218.9 214.7 Operating profit (loss) 16.4 23.1 35.0 27.8 - Mining Segment 11.7 18.5 28.1 22.5 - Luxury Brand Segment 8.0 6.9 15.1 11.1 - Corporate Segment (3.3) (2.3) (8.2) (5.8) Net profit attributable to shareholders 4.8 10.0 16.4 13.6 Earnings per share $0.06 $0.12 $0.19 $0.16
Complete financial statements, MD&A and a discussion of risk factors are included in the accompanying release.
Outlook
The Company issued an updated life-of-mine plan in August for the Diavik Diamond Mine with a $2.6 billion net asset value on a 100% basis based on reserves and resources including A-21.
The plan for calendar 2012 Diavik Diamond Mine production remains at approximately 8 million carats (100% basis).
Looking beyond calendar 2012, the objective is to fully utilize processing capacity with a combination of production from the underground portions of A-154 South, A-154 North and A-418 supplemented by the A-21 open pit. The A-21 pre-feasibility study currently being undertaken assumes that the A-21 pipe will be mined with the open pit methods used for the other pipes. A dike would be constructed similar to the two other pits but smaller in size. Detailed plans are still being refined and optimized and no underground mining is being planned. The capital expenditures are estimated to be in the region of $500 million (100% basis) at an assumed average Canadian/US dollar exchange rate of $1.00.
The Company expects the trend of wealth creation in emerging markets combined with increasing tourism to remain key drivers of increasing demand for luxury jewelry and watch products. Over the long term, consumer brand loyalty for luxury products is expected to remain strong. The Company is well positioned moving into the second half of the year, supported by a strong advertising campaign and product assortment, and its global distribution network in prime locations. A new directly operated salon was opened in the Harrods department store in London, England, in August 2012 and a directly operated salon is expected to be opened early next year in Geneva, Switzerland. A new licensed salon was opened in May in Moscow, Russia. In addition, a new licensed salon is expected to be opened in Kuwait City, Kuwait in late 2013.
The Company also plans to expand by 24 wholesale watch doors to 220 doors by the end of fiscal 2013.
Conference Call and Webcast
Beginning at 8:30AM (ET) on Thursday, September 6th, the Company will host a conference call for analysts, investors and other interested parties. Listeners may access a live broadcast of the conference call on the Company's investor relations web site at http://investor.harrywinston.com or by dialing 866-825-3354 within North America or 617-213-8063 from international locations and entering passcode 42016423.
An online archive of the broadcast will be available by accessing the Company's investor relations web site at http://investor.harrywinston.com. A telephone replay of the call will be available one hour after the call through 11:00PM (ET), Thursday, September 20, 2012 by dialing 888-286-8010 within North America or 617-801-6888 from international locations and entering passcode 24805897.
About Harry Winston Diamond Corporation
Harry Winston Diamond Corporation is a diamond enterprise with premium assets in the mining and retail segments of the diamond industry. Harry Winston supplies rough diamonds to the global market from its 40 percent ownership interest in the Diavik Diamond Mine. The Company's luxury brand segment is a premier diamond jeweler and luxury timepiece retailer with salons in key locations, including New York, Paris, London, Beijing, Shanghai, Hong Kong, Singapore, Tokyo and Beverly Hills.
The Company focuses on the two most profitable segments of the diamond industry, mining and retail, in which its expertise creates shareholder value. This unique business model provides key competitive advantages; rough diamond sales and polished diamond purchases provide market intelligence that enhances the Company's overall performance.
For more information, please visit http://www.harrywinston.com or for investor information, visit http://investor.harrywinston.com.
Highlights
(ALL FIGURES ARE IN UNITED STATES DOLLARS UNLESS OTHERWISE INDICATED)
Consolidated sales were $176.9 million for the second quarter compared to $222.4 million for the comparable quarter of the prior year, resulting in an operating profit of $16.4 million compared to $23.1 million in the comparable quarter of the prior year. Gross margin of $72.2 million was consistent with the comparable quarter of the prior year. Consolidated EBITDA was $33.4 million compared to $43.8 million in the comparable quarter of the prior year. The Company had 0.7 million carats of rough diamond inventory with at an estimated current market value of approximately $90 million at July 31, 2012, of which approximately $65 million represents inventory available for sale.
The mining segment recorded sales of $61.5 million, a 31% decrease from $89.6 million in the comparable quarter of the prior year. The decrease in sales resulted from a combination of a 24% decrease in volume of carats sold during the quarter and a 10% decrease in achieved rough diamond prices. Rough diamond production during the second calendar quarter was consistent with the comparable period of the prior year. The mining segment recorded operating profit of $11.7 million compared to $18.5 million in the comparable quarter of the prior year. EBITDA for the mining segment was $24.9 million compared to $36.0 million in the comparable quarter of the prior year.
The luxury brand segment recorded sales of $115.4 million, a decrease of 13% from sales of $132.8 million in the comparable quarter of the prior year (a decrease of 11% at constant exchange rates). The second quarter of the prior year included a greater portion of high-value transactions compared to the current quarter that generated lower-than-average gross margins. Operating profit was $8.0 million for the quarter compared to $6.9 million in the same quarter of the prior year. EBITDA for the luxury brand segment was $11.7 million compared to $10.0 million in the comparable quarter of the prior year.
The corporate segment recorded selling, general and administrative expenses of $3.4 million compared to $2.3 million in the comparable quarter of the prior year.
The Company recorded a consolidated net profit attributable to shareholders of $4.8 million or $0.06 per share for the quarter, compared to a net profit attributable to shareholders of $10.0 million or $0.12 per share in the second quarter of the prior year.
Management's Discussion and Analysis
PREPARED AS OF SEPTEMBER 5, 2012 (ALL FIGURES ARE IN UNITED STATES DOLLARS UNLESS OTHERWISE INDICATED)
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 six months ended July 31, 2012, and its financial position as at July 31, 2012. This MD&A is based on the Company's unaudited interim condensed consolidated financial statements prepared in accordance with International Financial Reporting Standards ("IFRS") and should be read in conjunction with the unaudited interim condensed consolidated financial statements and notes thereto for the three and six months ended July 31, 2012 and the audited consolidated financial statements of the Company and notes thereto for the year ended January 31, 2012. Unless otherwise specified, all financial information is presented in United States dollars. Unless otherwise indicated, all references to "second quarter" refer to the three months ended July 31. Unless otherwise indicated, references to "international" for the luxury brand segment refer to Europe and Asia.
Certain information included in this MD&A may constitute forward-looking information within the meaning of Canadian and United States securities laws. In some cases, forward-looking information can be identified by the use of terms such as "may", "will", "should", "expect", "plan", "anticipate", "foresee", "appears", "believe", "intend", "estimate", "predict", "potential", "continue", "objective", "modeled", "hope" 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 plans, timelines and targets for construction, mining, development, production and exploration activities at the Diavik Diamond Mine, future mining and processing at the Diavik Diamond Mine, projected capital expenditure requirements and the funding thereof, liquidity and working capital requirements and sources, estimated reserves and resources at, and production from, the Diavik Diamond Mine, the number and timing of expected rough diamond sales, the demand for rough diamonds, expected diamond prices and expectations concerning the diamond industry and the demand for luxury goods, expected cost of sales and gross margin trends in the mining segment, targets for compound annual growth rates of sales and operating income in the luxury brand segment, plans for expansion of the luxury brand retail salon network, and expected sales trends and market conditions in the luxury brand segment. Actual results may vary from the forward-looking information. See "Risks and Uncertainties" on page 18 for material risk factors that could cause actual results to differ materially from the forward-looking information.
Forward-looking information is based on certain factors and assumptions regarding, among other things, mining, production, construction and exploration activities at the Diavik Diamond Mine, world and US economic conditions, and the worldwide demand for luxury goods. Specifically, in making statements regarding expected diamond prices and expectations concerning the diamond industry and expected sales trends and market conditions in the luxury brand segment, the Company has made assumptions regarding, among other things, the state of world and US economic conditions, worldwide diamond production levels, and demand for luxury goods. While the Company considers these assumptions to be reasonable based on the information currently available to it, they may prove to be incorrect. See "Risks and Uncertainties" on page 18.
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, including risks associated with the inability to control the timing and scope of future capital expenditures, and risks of changes to the mine plan for the Diavik Diamond Mine, risks associated with the remote location of and harsh climate at the Diavik Diamond Mine site, risks resulting from the Eurozone financial crisis, 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, cash flow and liquidity risks, the risks relating to the Company's expansion strategy and of competition in the luxury jewelry business as well as changes in demand for high-end luxury goods. Please see page 18 of this Interim Report, as well as the Company's current Annual Information Form, available at http://www.sedar.com, for a discussion of these and other risks and uncertainties involved in the Company's operations.
Readers are cautioned not to place undue importance on forward-looking information, which speaks only as of the date of this MD&A, and should not rely upon this information as of any other date. Due to assumptions, risks and uncertainties, including the assumptions, risks and uncertainties identified above and elsewhere in this MD&A, actual events may differ materially from current expectations. The Company uses forward-looking statements because it believes such statements provide useful information with respect to the expected future operations and financial performance of the Company, and cautions readers that the information may not be appropriate for other purposes. While the Company may elect to, it is under no obligation and does not undertake to update or revise any forward-looking information, whether as a result of new information, future events or otherwise at any particular time, except as required by law. Additional information concerning factors that may cause actual results to materially differ from those in such forward-looking statements is contained in the Company's filings with Canadian and United States securities regulatory authorities and can be found at http://www.sedar.com and http://www.sec.gov, respectively.
Summary Discussion
Harry Winston Diamond Corporation is a diamond enterprise with premium assets in the mining and retailing segments of the diamond industry. The Company supplies rough diamonds to the global market from its 40% ownership interest in the Diavik Diamond Mine, located in Canada's Northwest Territories. The Company's luxury brand segment is a premier diamond jeweler and luxury timepiece retailer with salons in key locations including New York, Paris, London, Beijing, Shanghai, Tokyo, Hong Kong and Beverly Hills.
The Company's mining asset is an ownership 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 Limited Partnership ("HWDLP") (40%) where HWDLP holds an undivided 40% ownership interest in the assets, liabilities and expenses of the Diavik Diamond Mine. DDMI is the operator of the Diavik Diamond Mine. DDMI and HWDLP are headquartered in Yellowknife, Canada. DDMI is a wholly owned subsidiary of Rio Tinto plc of London, England.
Market Commentary
The Diamond Market
During the second quarter, rough diamond prices declined due to three factors: the buildup of stock in the cutting and polishing centres; increasingly tight liquidity due to both continued economic instability in Europe and the impact of the significant weakening of the Rupee versus the US dollar on credit availability in India; and challenging retail conditions in India and China. Conversely, the US and Japanese retail markets continue to perform well despite softer conditions in China. The mood within the diamond market remains cautious but it is hoped that the Hong Kong International Jewellery Show will bring more positive movement in retail diamond demand as the markets restock before the Asian wedding and year-end holiday seasons.
The Luxury Jewelry and Timepiece Market
Luxury consumers have become increasingly cautious as a result of the uncertainty in the global economy and volatility in the equity markets and overall demand for luxury products has slowed as a result of the continued economic instability in Europe and the lower economic growth in export-driven emerging markets. However luxury retailers with strong global distribution networks are benefitting from the trend of increased tourism by wealthy consumers from emerging markets, which continues to be a major factor supporting demand for luxury products (the majority of luxury goods purchased by Chinese nationals are purchased while abroad). In addition the market is benefiting from the continued economic recovery in the US while the Japanese market has experienced a strong increase in demand for luxury products compared with the comparable period of the prior year, which was negatively impacted by the earthquake and tsunami.
Condensed Consolidated Financial Results
The following is a summary of the Company's consolidated quarterly results for the eight quarters ended July 31, 2012 following the basis of presentation utilized in its IFRS financial statements:
(expressed in thousands of United States dollars except per share amounts and where otherwise noted) (quarterly results are unaudited) 2013 2013 2012 2012 2012 Q2 Q1 Q4 Q3 Q2 Sales $ 176,897 $ 192,461 $ 216,017 $ 119,716 $ 222,378 Cost of sales 104,694 119,134 129,807 75,524 150,177 Gross margin 72,203 73,327 86,210 44,192 72,201 Gross margin (%) 40.8% 38.1% 39.9% 36.9% 32.5% Selling, general and administrative expenses 55,819 54,669 55,500 46,155 49,101 Operating profit (loss) 16,384 18,658 30,710 (1,963) 23,100 Finance expenses (4,028) (3,880) (3,481) (4,040) (5,183) Exploration costs (568) (254) (177) (600) (781) Finance and other income 90 65 81 164 83 Foreign exchange gain (loss) 153 (364) 458 436 288 Profit (loss) before income taxes 12,031 14,225 27,591 (6,003) 17,507 Income tax expense (recovery) 7,278 2,615 11,001 (1,272) 7,519 Net profit (loss) $ 4,753 $ 11,610 $ 16,590 $ (4,731) $ 9,988 Attributable to shareholders $ 4,755 $ 11,610 $ 16,602 $ (4,728) $ 9,986 Attributable to non- controlling interest (2) - (12) (3) 2 Basic earnings (loss) per share $ 0.06 $ 0.14 $ 0.20 $ (0.06) $ 0.12 Diluted earnings (loss) per share $ 0.06 $ 0.14 $ 0.19 $ (0.06) $ 0.12 Cash dividends declared per share $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 Total assets (i) $ 1,660 $ 1,716 $ 1,637 $ 1,656 $ 1,671 Total long-term liabilities (i) $ 461 $ 472 $ 670 $ 661 $ 633 Operating profit (loss) $ 16,384 $ 18,658 $ 30,710 $ (1,963) $ 23,100 Depreciation and amortization (ii) 16,980 25,546 27,512 23,121 20,716 EBITDA (iii) $ 33,364 $ 44,204 $ 58,222 $ 21,158 $ 43,816
TABLE CONT'D
Six Six months months ended ended 2012 2011 2011 July 31, July 31, Q1 Q4 Q3 2012 2011 Sales $ 143,932 $ 215,358 $ 140,877 $ 369,358 $ 366,310 Cost of sales 96,452 141,391 84,765 223,828 246,629 Gross margin 47,480 73,967 56,112 145,530 119,681 Gross margin (%) 33.0% 34.3% 39.8% 39.4% 32.7% Selling, general and administrative expenses 42,795 52,722 41,282 110,488 91,896 Operating profit (loss) 4,685 21,245 14,830 35,042 27,785 Finance expenses (3,983) (3,727) (3,835) (7,908) (9,166) Exploration costs (212) (351) (212) (822) (993) Finance and other income 258 278 69 155 341 Foreign exchange gain (loss) (177) 1,392 135 (211) 111 Profit (loss) before income taxes 571 18,837 10,987 26,256 18,078 Income tax expense (recovery) (3,027) 5,137 (2,410) 9,893 4,492 Net profit (loss) $ 3,598 $ 13,700 $ 13,397 $ 16,363 $ 13,586 Attributable to shareholders $ 3,596 $ 13,693 $ 12,657 $ 16,365 $ 13,582 Attributable to non- controlling interest 2 7 740 (2) 4 Basic earnings (loss) per share $ 0.04 $ 0.16 $ 0.15 $ 0.19 $ 0.16 Diluted earnings (loss) per share $ 0.04 $ 0.16 $ 0.15 $ 0.19 $ 0.16 Cash dividends declared per share $ 0.00 $ 0.00 $ 0.00 $ 0.00 $ 0.00 Total assets (i) $ 1,671 $ 1,609 $ 1,584 $ 1,660 $ 1,671 Total long-term liabilities (i) $ 613 $ 603 $ 596 $ 461 $ 633 Operating profit (loss) $ 4,685 $ 21,245 $ 14,830 $ 35,042 $ 27,785 Depreciation and amortization (ii) 20,291 24,635 18,657 42,527 41,007 EBITDA (iii) $ 24,976 $ 45,880 $ 33,487 $ 77,569 $ 68,792
(i) Total assets and total long-term liabilities are expressed in millions of United States dollars. (ii) Depreciation and amortization included in cost of sales and selling, general and administrative expenses. (iii) Earnings before interest, taxes, depreciation and amortization ("EBITDA"). See "Non-IFRS Measure" on page 17. The comparability of quarter-over-quarter results is impacted by seasonality for both the mining and luxury brand 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 Diamond Mine, the number of sales events conducted during the quarter, and the volume, size and quality distribution of rough diamonds delivered from the Diavik Diamond Mine in each quarter. The quarterly results for the luxury brand segment are also seasonal, with generally higher sales during the fourth quarter due to the holiday season. See "Segmented Analysis" on page 8 for additional information.Three Months Ended July 31, 2012 Compared to Three Months Ended July 31, 2011
CONSOLIDATED NET PROFIT ATTRIBUTABLE TO SHAREHOLDERS
The Company recorded a second quarter consolidated net profit attributable to shareholders of $4.8 million or $0.06 per share compared to a net profit attributable to shareholders of $10.0 million or $0.12 per share in the second quarter of the prior year.
CONSOLIDATED SALES
Sales for the second quarter totalled $176.9 million, consisting of rough diamond sales of $61.5 million and luxury brand segment sales of $115.4 million. This compares to sales of $222.4 million in the comparable quarter of the
prior year (rough diamond sales of $89.6 million and luxury brand segment sales of $132.8 million). See "Segmented Analysis" on page 8 for additional information.
CONSOLIDATED COST OF SALES AND GROSS MARGIN
The Company's second quarter cost of sales was $104.7 million for a gross margin of 40.8% compared to a cost of sales of $150.2 million and a gross margin of 32.5% for the comparable quarter of the prior year. The Company's cost of sales includes costs associated with mining, rough diamond sorting and luxury brand activities. See "Segmented Analysis" on page 8 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, advertising and marketing, rent and related costs. The Company incurred SG&A expenses of $55.8 million for the second quarter, compared to $49.1 million in the comparable quarter of the prior year.
Included in SG&A expenses for the second quarter was $3.0 million for the mining segment compared to $3.5 million for the comparable quarter of the prior year, $49.5 million for the luxury brand segment compared to $43.3 million for the comparable quarter of the prior year, and $3.3 million for the corporate segment compared to $2.3 million for the comparable quarter of the prior year. See "Segmented Analysis" on page 8 for additional information.
CONSOLIDATED INCOME TAXES
The Company recorded a net income tax expense of $7.3 million during the second quarter, compared to a net income tax expense of $7.5 million in the comparable quarter of the prior year. The Company's combined federal and provincial statutory income tax rate for the quarter is 26.5%. There are a number of items that can significantly impact the Company's effective tax rate, including foreign currency exchange rate fluctuations, the Northwest Territories mining royalty, earnings subject to tax different than the statutory rate, and the recognition of previously unrecognized benefits. As a result, the Company's recorded tax provision can be significantly different than the expected tax provision calculated based on the statutory tax rate.
The recorded tax provision is particularly impacted by foreign currency exchange rate fluctuations. 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 second quarter, the Canadian dollar weakened against the US dollar. As a result, the Company recorded an unrealized foreign exchange gain of $3.0 million on the revaluation of the Company's Canadian dollar denominated deferred income tax liability. This compares to an unrealized foreign exchange gain of $1.9 million in the comparable quarter of the prior year. The unrealized foreign exchange gain is recorded as part of the Company's deferred income tax recovery, and is not taxable for Canadian income tax purposes. During the second quarter, the Company also recognized a deferred income tax expense of $4.0 million for temporary differences arising from the difference between the historical exchange rate and the current exchange rate translation of foreign currency non-monetary items. This compares to a deferred income tax expense of $4.0 million recognized in the comparable quarter of the prior year. The recorded tax provision in the comparable quarter of the prior year also included a net income tax recovery of $1.2 million relating to foreign exchange differences between income in the currency of the country of origin and the US dollar.
The recorded tax provision of the second quarter included a reversal of $1.0 million tax benefit that was recognized during the first quarter in relation to deductible temporary differences previously not recognized as deferred tax assets.
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 2032.
Due to the number of factors that can potentially impact the effective tax rate and the sensitivity of the tax provision to these factors, as discussed above, it is expected that the Company's effective tax rate will fluctuate in future periods.
CONSOLIDATED FINANCE EXPENSES
Finance expenses of $4.0 million were incurred during the second quarter compared to $5.2 million during the comparable quarter of the prior year.
CONSOLIDATED EXPLORATION EXPENSE
Exploration expense of $0.6 million was incurred during the second quarter compared to $0.8 million in the comparable quarter of the prior year.
CONSOLIDATED FINANCE AND OTHER INCOME
Finance and other income of $0.1 million was recorded during the second quarter, which was consistent with the comparable quarter of the prior year.
CONSOLIDATED FOREIGN EXCHANGE
A net foreign exchange gain of $0.2 million was recognized during the second quarter compared to a net foreign exchange gain of $0.3 million in the comparable quarter of the prior year. The
Company does not currently have any significant foreign exchange derivative instruments outstanding.
Six Months Ended July 31, 2012 Compared
to
Six Months Ended July 31, 2011
CONSOLIDATED NET PROFIT ATTRIBUTABLE TO SHAREHOLDERS
The Company recorded a consolidated net profit attributable to shareholders of $16.4 million or $0.19 per share for the six months ended July 31, 2012, compared to a net profit attributable to shareholders of $13.6 million or $0.16 per share in the comparable period of the prior year.
CONSOLIDATED SALES
Sales totalled $369.4 million for the six months ended July 31, 2012, consisting of rough diamond sales of $150.5 million and luxury brand segment sales of $218.9 million. This compares to sales of $366.3 million in the comparable period of the prior year (rough diamond sales of $151.6 million and luxury brand segment sales of $214.7 million). See "Segmented Analysis" on page 8 for additional information.
CONSOLIDATED COST OF SALES AND GROSS MARGIN
The Company's cost of sales was $223.8 million for the six months ended July 31, 2012, for a gross margin of 39.4% compared to a cost of sales of $246.6 million and a gross margin of 32.7% for the comparable period of the prior year. The Company's cost of sales includes costs associated with mining, rough diamond sorting and luxury brand activities. See "Segmented Analysis" on page 8 for additional information.
CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
The principal components of SG&A expenses include expenses for salaries and benefits, advertising and marketing, rent and related costs. The Company incurred SG&A expenses of $110.5 million for the six months ended July 31, 2012, compared to $91.9 million in the comparable period of the prior year.
Included in SG&A expenses for the six months ended July 31, 2012, was $5.5 million for the mining segment compared to $8.1 million for the comparable period of the prior year, $96.8 million for the luxury brand segment compared to $78.0 million for the comparable period of the prior year, and $8.2 million for the corporate segment compared to $5.8 million for the comparable period of the prior year. See
"Segmented Analysis" on page 8 for additional information.
CONSOLIDATED INCOME TAXES
The Company recorded a net income tax expense of $9.9 million during the six months ended July 31, 2012, compared to a net income tax expense of $4.5 million in the comparable period of the prior year. The Company's combined federal and provincial statutory income tax rate for the six months ended July 31, 2012 is 26.5%. There are a number of items that can significantly impact the Company's effective tax rate, including foreign currency exchange rate fluctuations, the Northwest Territories mining royalty, earnings subject to tax different than the statutory rate, and the recognition of previously unrecognized benefits. As a result, the Company's recorded tax provision can be significantly different than the expected tax provision calculated based on the statutory tax rate.
The recorded tax provision is particularly impacted by foreign currency exchange rate fluctuations. 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 six months ended July 31, 2012, the Canadian dollar did not move against the US dollar. As a result, the Company did not record any unrealized foreign exchange gain or loss on the revaluation of the Company's Canadian dollar denominated deferred income tax liability. This compares to an unrealized foreign exchange loss of $9.8 million in the comparable period of the prior year. During the six months ended July 31, 2012, the Company recognized a deferred income tax expense of $2.5 million for temporary differences arising from the difference between the historical exchange rate and the current exchange rate translation of foreign currency non-monetary items. This compares to a deferred income tax recovery of $8.6 million recognized in the comparable period of the prior year. The recorded tax provision during the six months ended July 31, 2012 also included a net income tax recovery of $2.0 million relating to foreign exchange differences between income in the currency of the country of origin and the US dollar. This compares to a net income tax recovery of $3.2 million recognized in the comparable period of the prior year.
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 2032.
Due to the number of factors that can potentially impact the effective tax rate and the sensitivity of the tax provision to these factors, as discussed above, it is expected that the Company's effective tax rate will fluctuate in future periods.
CONSOLIDATED FINANCE EXPENSES
Finance expenses of $7.9 million were incurred during the six months ended July 31, 2012, compared to $9.2 million during the comparable period of the prior year.
CONSOLIDATED EXPLORATION EXPENSE
Exploration expense of $0.8 million was incurred during the six months ended July 31, 2012, compared to $1.0 million in the comparable period of the prior year.
CONSOLIDATED FINANCE AND OTHER INCOME
Finance and other income of $0.2 million was recorded during the six months ended July 31, 2012, compared to $0.3 million in the comparable period of the prior year.
CONSOLIDATED FOREIGN EXCHANGE
A net foreign exchange loss of $0.2 million was recognized during the six months ended July 31, 2012, compared to a net foreign exchange gain of $0.1 million in the comparable period of the prior year. The
Company does not currently have any significant foreign exchange derivative instruments outstanding.
Segmented Analysis
The operating segments of the Company include mining, luxury brand and corporate segments. The corporate segment captures costs not specifically related to operations of the mining or luxury brand segments.
Mining
The mining segment includes the production, sorting and sale of rough diamonds.
(expressed in thousands of United States dollars) (quarterly results are unaudited) 2013 2013 2012 2012 2012 Q2 Q1 Q4 Q3 Q2 Sales America $ 2,269 $ 7,432 $ 2,727 $ 8,835 $ 447 Europe 50,514 54,370 78,846 21,993 80,131 Asia 8,690 27,207 20,659 5,411 9,030 Total sales 61,473 89,009 102,232 36,239 89,608 Cost of sales 46,784 70,099 72,783 34,112 67,613 Gross margin 14,689 18,910 29,449 2,127 21,995 Gross margin (%) 23.9% 21.2% 28.8% 5.9% 24.5% Selling, general and administrative expenses 2,966 2,525 2,061 3,274 3,489 Operating profit (loss) $ 11,723 $ 16,385 $ 27,388 $ (1,147) $ 18,506 Depreciation and amortization(i) 13,160 22,172 24,284 19,932 17,461 EBITDA(ii) $ 24,883 $ 38,557 $ 51,672 $ 18,785 $ 35,967
TABLE CONT'D
Six Six months months ended ended 2012 2011 2011 July 31, July 31, Q1 Q4 Q3 2012 2011 Sales America $ 3,009 $ 2,689 $ 2,560 $ 9,701 $ 3,456 Europe 50,752 75,715 50,353 104,884 130,883 Asia 8,274 4,293 7,795 35,897 17,304 Total sales 62,035 82,697 60,708 150,482 151,643 Cost of sales 53,443 61,822 45,039 116,883 121,056 Gross margin 8,592 20,875 15,669 33,599 30,587 Gross margin (%) 13.9% 25.2% 25.8% 22.3% 20.2% Selling, general and administrative expenses 4,630 3,017 3,031 5,491 8,119 Operating profit (loss) $ 3,962 $ 17,858 $ 12,638 $ 28,108 $ 22,468 Depreciation and amortization (i) 17,083 20,669 15,428 35,332 34,544 EBITDA (ii) $ 21,045 $ 38,527 $ 28,066 $ 63,440 $ 57,012
(i) Depreciation and amortization included in cost of sales and selling, general and administrative expenses. (ii) Earnings before interest, taxes, depreciation and amortization ("EBITDA"). See "Non-IFRS Measure" on page 17.Three Months Ended July 31, 2012 Compared to Three Months Ended July 31, 2011
MINING SALES
During the second quarter the Company sold approximately 0.43 million carats for a total of $61.5 million for an average price per carat of $142 compared to approximately 0.57 million carats for a total of $89.6 million for an average price per carat of $157 in the comparable quarter of the prior year. The 24% decrease in the quantity of carats sold was primarily the result of the Company's decision to hold some inventory until stability returns to the rough diamond market. The 10% decrease in the Company's achieved average rough diamond prices in the second quarter resulted from a decrease in the market price for rough diamonds from the peak achieved in July 2011, partially offset by the sale of the higher priced goods held back by the Company in the first quarter of fiscal 2013 due to an observed imbalance in the rough and polished diamond prices for these goods during that period.
Had the Company sold only the last production shipped in the second quarter, the estimated achieved price would have been approximately $104 per carat based on the prices achieved in the March/April 2012 sale adjusted down by 14% to reflect current market conditions.
The Company expects that results for its mining segment will continue to fluctuate depending on the seasonality of production at the Diavik Diamond Mine, the number of sales events conducted during the quarter, rough diamond prices and the volume, size and quality distribution of rough diamonds delivered from the Diavik Diamond Mine and sold by the Company in each quarter.
MINING COST OF SALES AND GROSS MARGIN
The Company's second quarter cost of sales was $46.8 million resulting in a gross margin of 23.9% compared to a cost of sales of $67.6 million and a gross margin of 24.5% in the comparable quarter of the prior year. Cost of sales for the second quarter included $12.5 million of depreciation and amortization compared to $16.8 million in the comparable quarter of the prior year. The mining gross margin is anticipated to fluctuate between quarters, resulting from variations in the specific mix of product sold during each quarter and rough diamond prices.
A substantial portion of cost of sales is mining operating costs, which are incurred at the Diavik Diamond Mine. During the second quarter, the Diavik cash cost of production was $40.6 million compared to $40.5 million in the comparable quarter of the prior year. Cost of sales also includes sorting costs, which consists of the Company's cost of handling and sorting product in preparation for sales to third parties, and depreciation and amortization, the majority of which is recorded using the unit-of-production method over estimated proven and probable reserves.
The Company's MD&A refers to cash cost of production, a non-IFRS performance measure, in order to provide investors with information about the measure used by management to monitor performance. This information is used to assess how well the Diavik Diamond Mine is performing compared to the mine plan and prior periods. Cash cost of production includes mine site operating costs such as mining, processing and administration, but is exclusive of amortization, capital, and exploration and development costs. Cash cost of production does not have any standardized meaning prescribed by IFRS and differs from measures determined in accordance with IFRS. This performance measure is intended to provide additional information and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with IFRS. This measure is not necessarily indicative of net profit or cash flow from operations as determined under IFRS. The following table provides a reconciliation of cash cost of production to the mining segment cost of sales disclosed in the interim condensed consolidated financial statements for the three months ended July 31, 2012 and 2011.
(expressed in thousands Three months ended Three months ended of United States dollars) July 31, 2012 July 31, 2011 Diavik cash cost of production $ 40,594 $ 40,542 Private royalty 1,089 1,718 Other cash costs 602 940 Total cash cost of production 42,285 43,200 Depreciation and amortization 16,015 17,963 Total cost of production 58,300 61,163 Adjusted for stock movements (11,516) 6,450 Total cost of sales $ 46,784 $ 67,613
MINING SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SG&A expenses for the mining segment decreased by $0.5 million from the comparable quarter of the prior year.
Six Months Ended July 31, 2012 Compared to Six Months Ended July 31, 2011
MINING SALES
During the six months ended July 31, 2012, the Company sold approximately 1.45 million carats for a total of $150.5 million for an average price per carat of $104 compared to approximately 1.04 million carats for a total of $151.6 million for an average price per carat of $146 in the comparable period of the prior year. The 39% increase in the quantity of carats sold was primarily the result of the sale of almost all of the remaining lower priced goods originally held back in inventory by the Company at October 31, 2011 due to an oversupply in the market at that time, along with higher production in the six-month period compared to the same period of the prior year. The 29% decrease in the Company's achieved average rough diamond prices in the six-month period resulted from a combination of two factors: first, the sale of the lower priced goods originally held back in inventory by the Company at October 31, 2011; and second, a decrease in the market price for rough diamonds from the peak achieved in the comparable period of the prior year.
MINING COST OF SALES AND GROSS MARGIN
The Company's cost of sales was $116.9 million during the six months ended July 31, 2012, resulting in a gross margin of 22.3% compared to a cost of sales of $121.1 million and a gross margin of 20.2% in the comparable period of the prior year. Cost of sales for the six months ended July 31, 2012, included $34.0 million of depreciation and amortization compared to $33.2 million for the comparable period of the prior year. The mining gross margin is anticipated to fluctuate between quarters, resulting from variations in the specific mix of product sold during each quarter and rough diamond prices.
A substantial portion of cost of sales is mining operating costs, which are incurred at the Diavik Diamond Mine. During the six months ended July 31, 2012, the Diavik cash cost of production was $84.6 million compared to $85.1 million in the comparable period of the prior year. Cost of sales also includes sorting costs, which consists of the Company's cost of handling and sorting product in preparation for sales to third parties, and depreciation and amortization, the majority of which is recorded using the unit-of-production method over estimated proven and probable reserves.
The following table provides a reconciliation of cash cost of production to the mining segment cost of sales disclosed in the interim condensed consolidated financial statements for the six months ended July 31, 2012 and 2011.
(expressed in thousands Six months ended Six months ended of United States dollars) July 31, 2012 July 31, 2011 Diavik cash cost of production $ 84,630 $ 85,132 Private royalty 3,727 3,296 Other cash costs 2,031 1,946 Total cash cost of production 90,388 90,374 Depreciation and amortization 29,786 33,686 Total cost of production 120,174 124,060 Adjusted for stock movements (3,291) (3,004) Total cost of sales $ 116,883 $ 121,056
MINING SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SG&A expenses for the mining segment decreased by $2.6 million from the comparable period of the prior year primarily due to executive severance incurred in the first quarter of the prior year.
MINING SEGMENT OPERATIONAL UPDATE
Ore production for the second calendar quarter consisted of 1.5 million carats produced from 0.44 million tonnes of ore from the A-418 kimberlite pipe, 0.2 million carats produced from 0.07 million tonnes of ore from the A-154 North kimberlite pipe, and 0.1 million carats produced from 0.03 million tonnes of ore from the A-154 South kimberlite pipe. During the second calendar quarter, there was no production from reprocessed plant rejects ("RPR"). RPR are not included in the Company's reserves and resource statement and are therefore incremental to production. Rough diamond production was consistent with the comparable calendar quarter of the prior year.
HARRY WINSTON DIAMOND LIMITED PARTNERSHIP'S 40% SHARE OF DIAVIK DIAMOND MINE PRODUCTION
(reported on a one-month lag)
Three months Three months Six months Six months ended ended ended ended June 30, June 30, June 30, June 30, 2012 2011 2012 2011 Diamonds recovered (000s carats) 716 716 1,359 1,256 Grade (carats/tonne) 3.34 3.29 3.19 3.06
During the second quarter, the Company expanded its Mumbai, India, office to the Bharat Diamond Bourse in Bandra, India. The new office will continue to support the Company's polished buying and rough sorting and sales expansion in India.
Mining Segment Outlook
PRODUCTION
The plan for calendar 2012 foresees Diavik Diamond Mine production remaining at approximately 8 million carats from the mining of 2.0 million tonnes of ore and processing of 2.2 million tonnes of ore. Open pit mining of approximately 1.0 million tonnes is expected to be exclusively from A-418. Underground mining of approximately 1.0 million tonnes is expected to be sourced principally from the A-154 South and A-154 North kimberlite pipes with some production from A-418 in the latter half of the year. Included in the estimated production for calendar 2012 is approximately 1.0 million carats from RPR and 0.1 million carats from the implementation of an improved recovery process for small diamonds. These RPR and small diamond recoveries are not included in the Company's reserves and resource statement and are therefore incremental to production.
The Company issued an updated life-of-mine plan in August for the Diavik Diamond Mine with a $2.6 billion net asset value on a 100% basis based on reserves and resources including A-21.
Looking beyond calendar 2012, the objective is to fully utilize processing capacity with a combination of production from the underground portions of A-154 South, A-154 North and A-418 supplemented by the A-21 open pit. The A-21 pre-feasibility study currently being undertaken assumes that the A-21 pipe will be mined with the open pit methods used for the other pipes. A dike would be constructed similar to the two other pits but smaller in size. Detailed plans are still being refined and optimized although no underground mining is being planned. The capital expenditures are estimated to be in the region of $500 million (100% basis) at an assumed average Canadian/US dollar exchange rate of $1.00.
PRICING
Rough diamond prices have softened during the first six months of fiscal 2013. Based on prices from the Company's last complete rough diamond sale in March/April 2012 and the current diamond recovery profile of the Diavik processing plant, the Company has modeled the approximate average rough diamond price per carat as of March/April 2012 for each of the Diavik ore types in the table that follows. The Company estimates that with the softening rough diamond market, the current market prices have declined by approximately 14% from March/April 2012.
March/April 2012 average price per carat Ore type (in US dollars) A-154 South $ 160 A-154 North 205 A-418 A Type Ore 145 A-418 B Type Ore 100 RPR 55
COST OF SALES AND CASH COST OF PRODUCTION
The Company expects cost of sales in fiscal 2013 to be approximately $330 million. Included in this amount is depreciation and amortization of approximately $110 million at an assumed average Canadian/US dollar exchange rate of $1.00. If the current softening of the rough diamond market continues, the Company may elect to hold more rough diamond inventory than normal at January 31, 2013. Depending on the amount of rough diamond inventory carried over into fiscal 2014, a portion of the $330 million cost of sales forecasted for fiscal 2013 would be recognized in fiscal 2014. At July 31, 2012, the Company had approximately 0.7 million carats of rough diamond inventory with an estimated current market value of approximately $90 million, of which approximately $65 million represents inventory available for sale.
The Company's share of the cash cost of production at the Diavik Diamond Mine for calendar 2012 is expected to be approximately $173 million at an assumed average Canadian/US dollar exchange rate of $1.00.
CAPITAL EXPENDITURES
During fiscal 2013, HWDLP's 40% share of the planned capital expenditures at the Diavik Diamond Mine is expected to be approximately $78 million at an assumed average Canadian/US dollar exchange rate of $1.00. HWDLP's share of capital expenditures was $14.8 million for the three months ended July 31, 2012, and $30.4 million for the six months ended July 31, 2012.
Luxury Brand
The luxury brand segment includes sales from 21 Harry Winston salons, which are located in prime markets around the world, including eight salons in the United States: New York, Beverly Hills, Bal Harbour, Honolulu, Las Vegas, Dallas, Chicago and Costa Mesa; five salons in Japan: Ginza, Roppongi Hills, Osaka, Omotesando and Nagoya; two salons in Europe: Paris and
London; and six salons in Asia outside of Japan: Beijing, two in Shanghai, Taipei, Hong Kong and Singapore.
(expressed in thousands of United States dollars) (quarterly results are unaudited) 2013 2013 2012 2012 2012 Q2 Q1 Q4 Q3 Q2 Sales America $ 35,759 $ 32,286 $ 41,537 $ 28,817 $ 27,183 Europe 15,636 30,054 31,204 19,561 26,098 Asia excluding Japan) 33,956 20,385 17,272 13,133 59,056 Japan 30,073 20,727 23,772 21,966 20,433 Total sales 115,424 103,452 113,785 83,477 132,770 Cost of sales 57,910 49,035 57,024 41,378 82,513 Gross margin 57,514 54,417 56,761 42,099 50,257 Gross margin (%) 49.8% 52.6% 49.9% 50.4% 37.9% Selling, general and administrative expenses 49,495 47,311 49,929 40,635 43,331 Operating profit $ 8,019 $ 7,106 $ 6,832 $ 1,464 $ 6,926 Depreciation and amortization [(i)] 3,681 3,235 3,089 3,048 3,115 EBITDA [(ii)] $ 11,700 $ 10,341 $ 9,921 $ 4,512 $ 10,041
TABLE CONT'D
Six Six months months ended ended 2012 2011 2011 July 31, July 31, Q1 Q4 Q3 2012 2011 Sales America $ 35,487 $ 46,489 $ 20,977 $ 68,045 $ 62,670 Europe 17,446 15,701 27,155 45,690 43,544 Asia excluding Japan) 14,354 50,817 16,671 54,341 73,410 Japan 14,610 19,654 15,366 50,800 35,043 Total sales 81,897 132,661 80,169 218,876 214,667 Cost of sales 42,958 79,518 39,675 106,945 125,472 Gross margin 38,939 53,143 40,494 111,931 89,195 Gross margin (%) 47.5% 40.1% 50.5% 51.1% 41.6% Selling, general and administrative expenses 34,716 47,866 34,942 96,806 78,046 Operating profit $ 4,223 $ 5,277 $ 5,552 $ 15,125 $ 11,149 Depreciation and amortization (i) 3,069 3,688 2,882 6,916 6,184 EBITDA (ii) $ 7,292 $ 8,965 $ 8,434 $ 22,041 $ 17,333
(i) Depreciation and amortization included in cost of sales and selling, general and administrative expenses. (ii) Earnings before interest, taxes, depreciation and amortization ("EBITDA"). See "Non-IFRS Measure" on page 17.Three Months Ended July 31, 2012 Compared to Three Months Ended July 31, 2011
LUXURY BRAND SALES
Sales for the second quarter were $115.4 million compared to $132.8 million
for the comparable quarter of the prior year, a decrease of 13% (a decrease of 11% at constant exchange rates). Sales in America increased 32% to $35.8 million, European sales decreased 40% to $15.6 million, sales in Asia (excluding Japan) decreased 43% to $34.0 million and sales in Japan increased 47% to $30.1 million, each as compared to the comparable quarter of the prior year. The second quarter of the prior year included a high-value transaction in Asia (excluding Japan) that was not repeated in the current quarter. The Japanese market continued to rebound strongly from the impact of the earthquake and tsunami that occurred in early 2011. During the second quarter, there were $19.1 million of high-value transactions, which generally carry lower-than-average gross margins, compared with $55.6 million in the comparable quarter of the prior year. The total number of units sold increase by 40% over the comparable quarter of the prior year.
LUXURY BRAND COST OF SALES AND GROSS MARGIN
Cost of sales for the luxury brand segment for the second quarter was $57.9 million compared to $82.5 million for the comparable quarter of the prior year. Gross margin for the quarter was $57.5 million or 49.8% compared to $50.3 million or 37.9% for the second quarter of the prior year. The improvement in gross margin was primarily due to product mix and a greater portion of high-value transactions in the comparable quarter of the prior year that generated lower-than-average gross margins.
LUXURY BRAND SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SG&A expenses increased by 14% to $49.5 million from $43.3 million in the comparable quarter of the prior year. The increase was due primarily to higher advertising, marketing and selling expenses. Fixed costs accounted for $4.3 million of the increase, while variable expenses linked to volume of sales accounted for $1.9 million of the increase. Fixed costs include salaries and benefits, advertising and marketing, rent and related costs and depreciation and amortization. SG&A expenses included depreciation and amortization expense of $3.4 million compared to $3.0 million in the comparable quarter of the prior year.
Six Months Ended July 31, 2012 Compared to Six Months Ended July 31, 2011
LUXURY BRAND SALES
Sales for the six months ended July 31, 2012, were $218.9 million compared to $214.7 million for the comparable period of the prior year, an increase of 2% (4% at constant exchange rates). Sales in America increased 9% to $68.0 million, European sales increased 5% to $45.7 million, sales in Asia (excluding Japan) decreased 26% to $54.3 million and sales in Japan increased 45% to $50.8 million, each as compared to the comparable period of the prior year. The comparable period of the prior year included high-value transactions in Asia (excluding Japan) that were not repeated in the current period. The Japanese market continued to rebound strongly from the impact of the earthquake and tsunami that occurred in early 2011. During the six months ended July 31, 2012, there were $19.1 million of high-value transactions, which generally carry lower-than-average gross margins, compared with $60.8 million in the comparable period of the prior year. The total number of units sold increase by 43% over the comparable period of the prior year.
LUXURY BRAND COST OF SALES AND GROSS MARGIN
Cost of sales for the luxury brand segment for the six months ended July 31, 2012, was $106.9 million compared to $125.5 million for the comparable period of the prior year. Gross margin for the six months ended July 31, 2012, was $111.9 million or 51.1% compared to $89.2 million or 41.6% for the comparable period of the prior year. The improvement in gross margin was primarily due to product mix and a greater portion of high-value transactions in the comparable period of the prior year that generated lower-than-average gross margins.
LUXURY BRAND SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SG&A expenses increased by 24% to $96.8 million from $78.0 million in the comparable period of the prior year. The increase was due primarily to higher advertising, marketing and selling expenses. Fixed costs accounted for $14.9 million of the increase, while variable expenses linked to volume of sales accounted for $3.9 million of the increase. Fixed costs include salaries and benefits, advertising and marketing, rent and related costs and depreciation and amortization. SG&A expenses included depreciation and amortization expense of $6.3 million compared to $6.0 million in the comparable quarter of the prior year.
LUXURY BRAND SEGMENT OPERATIONAL UPDATE
The luxury brand segment opened a new directly operated salon in the Harrods department store in London, England, in August. A new licensed salon was opened in May in Moscow, Russia. In addition, the Company has entered into a lease to open a new directly operated salon on Rue du Rhone in Geneva, Switzerland. This salon is expected to open in early calendar 2013. At July 31, 2012, the luxury brand segment's distribution network consisted of 21 directly operated salons, five licensed salons (in Manila, Philippines; Kiev, Ukraine; Moscow, Russia; and two in Dubai, United Arab Emirates) and 196 wholesale watch doors around the world.
On August 30, 2012, the Company's luxury brand subsidiary, Harry Winston Inc., refinanced its senior secured revolving credit facility by entering into a new secured five-year credit agreement with a consortium of banks led by Standard Chartered Bank establishing a $260 million facility for revolving credit loans. The facility has a maturity date of August 30, 2017.
Luxury Brand Segment Outlook
The Company expects the trend of wealth creation in emerging markets combined with increasing tourism to remain key drivers of increasing demand for luxury jewelry and watch products. Over the long term, consumer brand loyalty for luxury products is expected to remain strong. In the near term, the sovereign debt crisis in Europe and the resulting slower growth in the export-driven emerging markets represent challenges that could impact demand for luxury jewelry and watch products. The Company is well positioned moving into the second half of the year, supported by a strong advertising campaign and product assortment, and its global distribution network in prime locations. A new directly operated salon was opened in the Harrods department store in London, England, in August 2012 and a directly operated salon is expected to be opened early next year in Geneva, Switzerland. In addition, a new licensed salon is expected to be opened in Kuwait City, Kuwait in late fiscal 2013.
The Company also plans to expand by 24 wholesale watch doors to 220 doors by the end of fiscal 2013. The luxury brand segment continues to make strategic investments in the brand in the areas of new product development, systems, training and infrastructure, new distribution offices in Hong Kong, Hong Kong, and Miami, US, as well as new salons in China. SG&A expenses are planned to increase through fiscal year 2014 and then plateau as the luxury brand segment begins to leverage its fixed costs.
It is expected that through this period of investment, the brand will continue to grow, however the true benefits of this investment will be achieved beginning in fiscal 2015, when the luxury brand segment begins to leverage its fixed costs.
Corporate
The corporate segment captures costs not specifically related to operations of the mining or luxury brand segments.
(expressed in thousands of United States dollars) (quarterly results are unaudited) 2013 2013 2012 2012 2012 Q2 Q1 Q4 Q3 Q2 Sales $ - $ - $ - $ - $ - Cost of sales - - - 34 51 Gross margin - - - (34) (51) Gross margin (%) -% -% -% -% -% Selling, general and administrative expenses 3,358 4,833 3,510 2,246 2,281 Operating loss $ (3,358) $ (4,833) $ (3,510) $ (2,280) $ (2,332) Depreciation and amortization (i) 139 139 139 141 140 EBITDA (ii) $ (3,219) $ (4,694) $ (3,371) $ (2,139) $ (2,192)
TABLE CONT'D
Six Six months months ended ended 2012 2011 2011 July 31, July 31, Q1 Q4 Q3 2012 2011 Sales $ - $ - $ - $ - $ - Cost of sales 51 51 51 - 101 Gross margin (51) (51) (51) - (101) Gross margin (%) -% -% -% -% -% Selling, general and administrative expenses 3,449 1,839 3,309 8,191 5,731 Operating loss $ (3,500) $ (1,890) $ (3,360) $ (8,191) $ (5,832) Depreciation and amortization (i) 139 278 347 279 279 EBITDA (ii) $ (3,361) $ (1,612) $ (3,013) $ (7,912) $ (5,553)
(i) Depreciation and amortization included in cost of sales and selling, general and administrative expenses. (ii) Earnings before interest, taxes, depreciation and amortization ("EBITDA"). See "Non-IFRS Measure" on page 17.Three Months Ended July 31, 2012 Compared to Three Months Ended July 31, 2011
CORPORATE SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SG&A expenses for the corporate segment increased by $1.1 million from the comparable quarter of the prior year due to travel expenses and salaries and benefits related to additional corporate employees.
Six Months Ended July 31, 2012 Compared to Six Months Ended July 31, 2011
CORPORATE SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
SG&A expenses for the corporate segment increased by $2.5 million from the comparable period of the prior year due to severance costs and to travel expenses and salaries and benefits related to additional corporate employees.
Liquidity and Capital Resources
Working Capital
As at July 31, 2012, the Company had unrestricted cash and cash equivalents of $74.6 million compared to $78.1 million at January 31, 2012. The Company had cash on hand and balances with banks of $69.3 million and short-term investments of $5.3 million at July 31, 2012.
During the quarter ended July 31, 2012, the Company reported cash from operations of $8.6 million compared to $36.4 million in the comparable quarter of the prior year. The decrease resulted primarily from the Company's decision to hold rough diamond inventory due to market conditions. At July 31, 2012, the Company had 0.7 million carats of rough diamond inventory with an estimated current market value of approximately $90 million, of which approximately $65 million represents inventory available for sale.
Working capital decreased to $241.9 million at July 31, 2012 from $439.0 million at January 31, 2012. As at July 31, 2012, current liabilities include $204.0 million relating to the luxury brand segment's five-year revolving credit facility (January 31, 2012 - $nil), which was originally to mature on March 31, 2013, but which was refinanced on August 30, 2012. During the quarter, the Company increased accounts receivable by $3.0 million, decreased other current assets by $6.3 million, decreased inventory and supplies by $4.4 million, decreased trade and other payables by $17.1 million and decreased employee benefit plans by $1.0 million.
The Company's liquidity requirements fluctuate from quarter to quarter depending on, among other factors, the seasonality of production at the Diavik Diamond Mine, seasonality of mine operating expenses, capital expenditure programs, the number of rough diamond sales events conducted during the quarter and the volume, size and quality distribution of rough diamonds delivered from the Diavik Diamond Mine and sold by the Company in each quarter, along with the seasonality of sales and salon expansion in the luxury brand segment. The Company's principal working capital needs include investments in inventory, other current assets, and trade and other payables and income taxes payable.
The Company assesses liquidity and capital resources on a consolidated basis. The Company's requirements are for cash operating expenses, working capital, contractual debt requirements and capital expenditures. The Company believes that it will generate sufficient liquidity to meet its anticipated requirements for the next twelve months.
Financing Activities
The mining segment maintains a senior secured revolving credit facility with Standard Chartered Bank. At July 31, 2012, $50.0 million was outstanding.
As at July 31, 2012, $6.6 million and $nil was outstanding under the Company's revolving financing facility relating to its Belgian subsidiary, Harry Winston Diamond International N.V., and its Indian subsidiary, Harry
Winston Diamond (India) Private Limited, respectively, compared to $nil and $4.3 million at January 31, 2012.
During the quarter, the Company's luxury brand subsidiary, Harry Winston Inc., increased the amount outstanding on its secured five-year revolving credit facility to $204.0 million from $200.5 million at January 31, 2012. On August 30, 2012, Harry Winston Inc. refinanced its senior secured revolving credit facility by entering into a new secured five-year credit agreement with a consortium of banks led by Standard Chartered Bank establishing a $260 million facility for revolving credit loans. The facility has a maturity date of August 30, 2017.
Investing Activities
During the quarter, the Company purchased property, plant and equipment of $17.8 million, of which $15.8 million was purchased for the mining segment and $2.0 million for the luxury brand segment.
Contractual Obligations
The Company has contractual payment obligations with respect to interest-bearing loans and borrowings and, through its participation in the Joint
Venture, future site restoration costs at the Diavik Diamond Mine level. Additionally, at the Joint Venture level, contractual obligations exist with respect to operating purchase obligations, as administered by DDMI, the operator of the mine. In order to maintain its 40% ownership interest in the Diavik Diamond Mine, HWDLP is obligated to fund 40% of the Joint Venture's total expenditures on a monthly basis. Not reflected in the table below are capital expenditures for the calendar years 2012 to 2016 of approximately $140 million assuming a Canadian/US average exchange rate of $1.00 for each of the five years relating to HWDLP's current projected share of the planned capital expenditures excluding the A-21 pipe at the Diavik Diamond Mine. The most significant contractual obligations for the ensuing five-year period can be summarized as follows:
Contractual Obligations (expressed in thousands Less than Year Year After of United States dollars) Total 1 year 2-3 4-5 5 years Interest-bearing loans and borrowings (a)(b) $ 355,069 $ 42,404 $ 70,442 $ 223,955 $ 18,268 Environmental and participation agreements incremental commitments (c) 93,322 82,668 4,844 - 5,810 Operating lease obligations (d) 261,447 26,581 54,140 47,952 132,774 Total contractual obligations $ 709,838 $ 151,653 $ 129,426 $ 271,907 $ 156,852
(a) Interest-bearing loans and borrowings presented in the foregoing table include current and long-term portions. The mining segment maintains a senior secured revolving credit facility with Standard Chartered Bank for $125.0 million. The facility has an initial maturity date of June 24, 2013 with two one-year extensions at the Company's option. There are no scheduled repayments required before maturity. At July 31, 2012, $50.0 million was outstanding.
The Company has available a $45.0 million revolving financing facility (utilization in either US dollars or Euros) with Antwerp Diamond Bank for inventory and receivables funding in connection with marketing activities through its Belgian subsidiary, Harry Winston Diamond International N.V., and its Indian subsidiary, Harry Winston Diamond (India) Private Limited. Borrowings under the Belgian facility bear interest at the bank's base rate plus 1.5%. Borrowings under the Indian facility bear an interest rate of 12.50%. At July 31, 2012, $6.6 million and $nil were outstanding under this facility relating to its Belgian subsidiary, Harry Winston Diamond International N.V., and its Indian subsidiary, Harry Winston Diamond (India) Private Limited, respectively. The facility is guaranteed by Harry Winston Diamond Corporation.
Harry Winston Inc. maintains a credit agreement with a syndicate of banks for a $250.0 million five-year revolving credit facility, which expires on March 31, 2013. There are no scheduled repayments required before maturity. At July 31, 2012, $204.0 million had been drawn against this secured credit facility.
On August 30, 2012, Harry Winston Inc. refinanced its secured revolving credit facility by entering into a new secured five-year credit agreement with a consortium of banks led by Standard Chartered Bank establishing a $260.0 million facility for revolving credit loans. The new facility expires on August 30, 2017. There are no scheduled repayments required before maturity. The new credit facility is available to Harry Winston Inc. for general corporate purposes. As with the previous agreement, the new credit facility is supported by a $20.0 million limited guarantee provided by Harry Winston Diamond Corporation. The amount available under this facility is subject to a borrowing base formula based on certain assets of the luxury brand segment.
The new credit agreement contains affirmative and negative non-financial and financial covenants, which apply to the luxury brand segment. These provisions include consolidated minimum tangible net worth, minimum coverage of fixed charges, leverage ratio and limitations on capital expenditures and certain investments. The new credit agreement also includes a change of control provision, which would result in the entire unpaid principal and all accrued interest of the facility becoming due immediately upon change of control, as defined. Any material adverse change, as defined, in the luxury brand segment's assets, liabilities, consolidated financial position or consolidated results of operations constitutes default under the agreement.
The luxury brand segment has pledged 100% of Harry Winston Inc.'s common stock and 66 2/3% of the common stock of its foreign subsidiaries to the bank to secure the loan. Inventory and accounts receivable of Harry Winston Inc. are pledged as collateral to secure the borrowings of Harry Winston Inc. In addition, an assignment of proceeds on insurance covering security collateral was made.
Loans under the new credit facility can be either fixed rate loans or revolving line of credit loans. The fixed rate loans will bear interest within a range of 2.50% to 3.25% above LIBOR based upon a pricing grid determined by the fixed charge coverage ratio. Interest under this option will be determined for periods of either one, two, three or six months. The revolving line of credit loans will bear interest within a range of 1.50% to 2.25% above the bank's prime rate based upon a pricing grid determined by the fixed charge coverage ratio as well.
Also included in long-term debt of Harry Winston Inc. is a 25-year loan agreement for CHF 17.5 million ($17.7 million) used to finance the construction of the Company's watch factory in Geneva, Switzerland. The loan agreement is comprised of a CHF 3.5 million ($3.5 million) loan and a CHF 14.0 million ($14.2 million) loan. The CHF 3.5 million loan bears interest at a rate of 3.15% and matures on April 22, 2013. The CHF 14.0 million loan bears interest at a rate of 3.55% and matures on January 31, 2033. At July 31, 2012, an aggregate of $15.2 million was outstanding. The bank has a secured interest in the factory building.
Harry Winston S.A. has a CHF 0.5 million ($0.5 million) finance lease for machinery located at the watch factory in Geneva, Switzerland. The finance lease has an interest rate of 1.97% and matures on April 1, 2017. At July 31, 2012, $0.4 million was outstanding.
Harry Winston Japan, K.K. maintains unsecured credit agreements with three banks, amounting to ¥1,275 million ($16.3 million). Harry Winston Japan, K.K. also maintains a secured credit agreement amounting to ¥575 million ($7.4 million). This facility is secured by inventory owned by Harry Winston Japan, K.K. At July 31, 2012, $23.7 million was outstanding.
The Company's first mortgage on real property has scheduled principal payments of approximately $0.2 million quarterly, may be prepaid at any time, and matures on September 1, 2018. On July 31, 2012, $6.0 million was outstanding on the mortgage payable.
(b) Interest on loans and borrowings is calculated at various fixed and floating rates. Projected interest payments on the current debt outstanding were based on interest rates in effect at July 31, 2012, and have been included under interest-bearing loans and borrowings in the table above. Interest payments for the next twelve months are approximated to be $10.7 million.
(c) The Joint Venture, under environmental and other agreements, must provide funding for the Environmental Monitoring Advisory Board. These agreements also state that the Joint Venture must provide security deposits for the performance by the Joint Venture of its reclamation and abandonment obligations under all environmental laws and regulations. The operator of the Joint Venture has fulfilled such obligations for the security deposits by posting letters of credit of which HWDLP's share as at July 31, 2012 was $81.1 million based on its 40% ownership interest in the Diavik Diamond Mine. There can be no assurance that the operator will continue its practice of posting letters of credit in fulfillment of this obligation, in which event HWDLP would be required to post its proportionate share of such security directly, which would result in additional constraints on liquidity. The requirement to post security for the reclamation and abandonment obligations may be reduced to the extent of amounts spent by the Joint Venture on those activities. The Joint Venture has also signed participation agreements with various native groups. These agreements are expected to contribute to the social, economic and cultural well-being of area Aboriginal bands. The actual cash outlay for the Joint Venture's obligations under these agreements is not anticipated to occur until later in the life of the Diavik Diamond Mine.
(d) Operating lease obligations represent future minimum annual rentals under non-cancellable operating leases for Harry Winston Inc. salons and office space.
CONT'D
SOURCE Harry Winston Diamond Corporation
