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Executives

Robert A. Gannicott - Chairman and Chief Executive Officer

Alan S. Mayne - Chief Financial Officer

Thomas J. O'Neill - President

Analysts

Irene Nattel - RBC Capital Markets

Brian MacArthur - UBS Securities

David Christie - Scotia Capital

John Hayes - BMO Capital

Matthew O'Keefe - Thomas Weisel Partners Canada

[Pharu Hammin] - National Bank Financial

Jacques Wortman - Griffiths McBurney & Partners

John Hughes - Desjardins Securities

Patrick Morgan – RBC Capital Markets

Harry Winston Diamond Corporation (HWD) F3Q09 Earnings Call December 11, 2008 9:00 AM ET

Operator

Good day ladies and gentlemen and welcome to Harry Winston Diamond Corporation fiscal year 2009 third quarter conference call. My name is Carmen and I will be your coordinator for today. (Operator Instructions) I would now like to turn the presentation over to your host for today’s call, your Chairman and CEO, Robert Gannicott.

Robert A. Gannicott

Good morning and welcome to the Harry Winston Diamond Corporation earnings call for the third quarter of the financial year 2009. The third quarter has certainly been a challenge for us operationally, on the mining side of our business and compounded by sharp and unpredictable changes in the rough diamond market as the industry struggles to comprehend the effects of credit constraint and general global economic conditions.

Our sales of jewelry and watches improved during the quarter compared to the prior year and the prices for polished diamonds have only suffered modest declines compared to the more volatile rough diamond market.

Fortunately, mine production levels have returned to normal during October and November at the grade in the A-154 cycle body returned to reserve grade levels and clean mining surfaces became available in the A-418 open pit.

Subsequent to the quarter we suffered an armed robbery in Paris where approximately $13.0 million of inventory at cost was stolen. Our staff, although traumatized and specifically assaulted in a few cases, are recovering well, I am very pleased to say. The loss is insured, and like all such claims, is subject to ongoing investigation.

I am now going to hand the call over to Alan Mayne, our Chief Financial Officer, to discuss the financial results in detail. Tom O’Neill, our President in charge of the jewelry and watch business will follow Alan with an operational view of that business. I am then going to return to discuss the mining and rough diamond sales.

Alan S. Mayne

In the face of a challenging production environment at Diavik, a subdued rough diamond market, and a weakening global economy, consolidated sales decreased 16% and earnings from operations were down 35% for the third quarter this year compared to the prior year.

Our foreign currency exposure has material influence on our reported net earnings. During the third quarter ended October 31, 2008, the Canadian dollar weakened against the U.S. dollar. This resulted in a $49.0 million net foreign exchange gain in the quarter compared to a $40.6 million net foreign exchange loss in the same period last year.

Taking into account this foreign exchange gain, our interest expenses, other income, and income tax expense, we reported net earnings of $71.9 million, or $1.17 per share, compared to a net loss of $7.4 million, or $0.13 per share, in the third quarter last year.

In the third quarter, cash flow from operations decreased 21% to $48.3 million, however, our investment in capital assets decreased to $39.7 million from $60.5 million in the comparable period of the prior year. This decrease occurred in both the mining and retail segments and reflects a decision to incur on the essential capital expenditures.

Net debt, excluding restricted cash balances, as at October 31, 2008, was $278.5 million compared with $294.6 million as at January 31, 2008.

Now let me spend a few minutes on the financial review of our mining and retail segments.

As highlighted in our results for these yesterday, our share of production from Diavik was down 26% in the third calendar quarter. Mining sales were also down 26% as the company reduced the size of its sale of rough diamonds in October to reflect the lower demand associated with the factory closures around Diwali, the Indian festival.

The impact of the decrease in sales was reflected in a reduction in earnings from operations to $47.0 million from $70.0 million in the comparable period last year.

The retail segment recorded an 8% increase in sales in the quarter. Sales for the third quarter started off strong, consistent with the second quarter of this year, but weakened as the global economy declined in the latter part of September.

The gross margin rate, excluding the impact of sales of pre-acquisition inventory, was 48.6% compared to 52.4% in the comparable period last year. This decrease in gross margin is a result of the product mix sold in the quarter, in particular, a lower proportion of higher margin sales in the Japanese market and the higher research and development cost to support the watch business.

The retail segment recorded an increase in SG&A expenses of $2.1 million in the quarter, however, the ratio of SG&A expenses as a percentage of sales remained consistent with the comparable quarter of the prior year at 53%.

I would now like to spend a few minutes discussing the company’s liquidity. The company’s mining and retail segments maintain separate financing arrangements and management assesses liquidity on a segmented basis.

The retail segment’s cash requirements are for cash operating expenses, working capital, and capital expenditures. The company believes that cash on hand, cash generated from operations, and access to credit facilities will be sufficient to meet anticipated cash requirements for the retail segment in the next fiscal year.

The Paris robbery does not affect our ability to borrow under the revolving credit facility. The stolen inventory will be replaced in the borrowing base by accounts receivable and the available head room is unchanged. Management expects to operate the retail business to ensure continued compliance with the covenants contained in the revolving credit facility.

The mining segment’s cash requirements are for cash operating expenses, working capital, capital expenditures, and contractual debt repayments. The company believes that cash on hand and cash generated from the sale of rough diamonds will be sufficient to meet anticipated cash requirements for the next fiscal year, excluding certain debt repayments.

The company anticipates refinancing approximately $50.0 million by June 2009, however, the weakening of the global economy could reduce our ability to generate cash from operations, which could require us to refinance approximately $75.0 million by March 2009.

The company is currently in discussions with a credit provider which, if successful, would provide debt financing in an amount sufficient to refinance the $75.0 million of debt in the first quarter of next year. In the interim, the company expects to continue to be in compliance with the covenants contained in the mining segment’s credit facilities.

Now let me turn the presentation over to Tom to discuss the retail business in more detail.

Thomas J. O'Neill

After a very strong first half in our current fiscal year, where we are tracking at a year-on-year sales increase of about 23%, Harry Winston’s retail and wholesale business experienced some impact from the global economic conditions in the third quarter. We experienced relatively strong performances in the U.S. and Asia and in the Middle East, with mixed results in Europe, while we saw continued weakness in Japan. Overall, we continued to show solid results against the previous year but certainly less robust than in the first half of the year.

Our global customer base insulated the core of our business during the third quarter allowing us to record an 8% increase in sales over the same period last year.

The sales breakdown by country, that is to say where the customer is from rather than where the customer shops, continued to rebalance our sales more evenly throughout the world. For example, for third quarter fiscal 2008 our U.S. clients comprised about 35% of our retail store business, while for the third quarter of this fiscal year our U.S. clients dropped 8 points to 27% of total retail sales. Our Japanese clients dropped 3 points, to 34%, while the rest of Asia increased 5 points to 16%. Europe, excluding Russia, increased 2 points to 12%. Russia increased 6 points to 7%, while the Middle East showed a very small decline.

The product sales mix continued to track at the high end through the quarter where we saw an increase of more than 20% in significant sales that we define as greater than US$250,000.

Our business is significantly skewed toward the high end, where margin dollars are considerable while absolute profit percentages tend to be less than at the lower end of the product range.

Our volume was off more in the middle range of price points than in the lower price points. It indicates to us that while our customer base continued to buy in the third quarter, it was the middle of the product range that had been most affected by the economic environment, while products at the entry-level price points and the significant sales at the high end showed comparative strength.

In terms of the Japanese business, which is largely conducted within Japan, exclusive of traveling tourists, any fluctuation in sales has a direct impact on our operating profit. Our business in Japan is much more of a volume at more modest price points that carry larger gross margins than the lower-volume high end of our sales mix.

The weakening of our Japan business in the third quarter, where the sales mix is decidedly at lower price points but with higher margins, then coupled with the increase in our high-end lower-margin business elsewhere in the world, have eroded operating margins for the third quarter.

On December 4 we suffered an armed robbery in our Paris salon, as has been mentioned. And as we have said, our employees are our first concern and we are making every effort to care for our staff. I will tell you that we are working on reopening the salon as soon as possible and we are appreciative of the work of the authorities and our insurance carrier in this very unfortunate matter.

Please note that we do have insurance, however, due to the ongoing investigation, we cannot comment any further than we have, nor can we provide any figures or information beyond what Alan and Bob have reviewed a few moments ago. We continue to cooperate with the authorities in their investigation over the incident.

The challenges that the global economy have presented to us have impacted our business in the third quarter. We don’t see this changing in the fourth quarter and are managing it accordingly. Certainly the setback in Paris will affect our holiday season to some extent but our core business there is with wealthy international clients and can be readily shifted to other locations.

We remain committed to our strategy of strengthening our retail segment through our own network of stores, through our wholesale jewelry business, and through our established watch business, going forward.

Now I will turn it back over to Bob.

Robert A. Gannicott

Production at the Diavik Mine continued well below plans during the third quarter, as Alan referred to. The great shortfall identified in the year continued, with 26% less karats produced than during the prior third quarter.

After reaching a zenith in August, rough diamond prices sort of stalled out in September and then declined sharply in October, bringing them eventually back to the levels of the prior year. Although painful, this decline is modest compared with other exchange-traded commodities. Each mine produces its own unique mix of diamonds and each producer has its own sales methodology.

Our own system focused on delivery of narrow assortments to long-term customers has certainly moderated the effects of the market turmoil for us, which has been led by auction sales as the rough market struggles to find a new base.

The pricing climate in polished diamonds varies according to size and qualities but it is generally only in the single digits, suggesting that rough prices would recover promptly when liquidity reappears to a depleted pipeline.

At the Diavik Mine the grade in A-154 South is now fully returned to reserve grade levels and the new A-418 pit now has reserve grade ore fully available for mining.

Production in each of October and November exceeded 1.0 million karats and it is reasonable to expect that we will end the year close to the 10.0 million karat forecast.

Capital and operating budgets for the coming year are under review by Rio Tinto, as all businesses throughout the world focus on operational and capital efficiency in challenging times.

To attempt a forward view of the diamond market would be pretty much pointless at this stage. Our key strength, though, is that the Diavik ore bodies are among the highest margin diamond resources in the world. The majority of the world’s diamond production would become unprofitable well before Diavik would lose its cash operating margin. This kind of fundamental resilience is more important than ever in the conditions of the day.

I don’t really want to say any more than that formally but thanks for listening to us, and we are now happy to take your questions to touch on other points of interest.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Irene Nattel - RBC Capital Markets.

Irene Nattel - RBC Capital Markets

I was wondering if you could just address what you are seeing in the market place as we move through Q4, both from the retail demand perspective, as we have seen commodity prices continue to come down, what you are seeing and you’re experiencing from a rough diamond pricing perspective, and whether as we look into FY2010 you would give any consideration to perhaps reducing the number of your rough diamond sales.

Robert A. Gannicott

Just on the rough diamond side, the only bit of, perhaps slight scintilla of good news at the moment, is there does seem to be a sense of some sort of stability returning to some extent. Some customers that had disappeared back in October that have now got their hands up again to come back in on the market, and so on. But I would stress that one has to look pretty hard at the moment for signs of stability.

Going forward from here, obviously the process that is going on at the moment is classic leveraging. There is a diamond supply chain, known as the diamond pipeline, as you know, and that is sort of being emptied out as the jewelers at one end don’t replace sold inventory because of concern about looking forward and that means they don’t reorder jewelry; that means the jewelry manufacturers don’t reorder polished; it means that the people that are polishing rough diamonds don’t be getting rough diamonds in the meantime.

So the market is sort of somewhat stuck at the moment, but perhaps there is a sign of this beginning to open up again.

Would we consider reducing the number of sales? No, because a lot of our regular customers depend on regular supply to feed their factories. And most of these businesses are still moving forward in a quite significant way.

Would we consider holding back some material that is difficult sell during this sort of period? Yes, we would. In fact, we do have some quite modest, but we do have some stocks on hand at the moment.

Thomas J. O'Neill

Alan talked a little bit about the third quarter in terms of our retail segment sales. August, the first month of the quarter, actually was fairly strong. It was consistent with the first six months. Even the first two weeks of September were good for us. We hit a point in mid-September where business became very difficult, but then in October it went up again. So it was spotty for us through the third quarter.

As we go into the fourth quarter, of course, we will recap the fourth quarter at the end of the quarter, but if we look at what happened in terms of the sales in the third quarter, where they are concentrated and where they are focused, we are seeing, strangely enough, at the high end of the market there is still activity and it is good activity for us. And at the lower price points, or the entry-level price points, because it’s a holiday season, we would certainly see that that would be very similar to what it has been in the past.

Irene Nattel - RBC Capital Markets

One of the things that I was thinking about is, at least paradoxically, it could prove to be a bit of a demand boost to your watch business as people perhaps trade sideways. If you get a very beautiful Harry Winston watch the price point is probably lower than a very beautiful Harry Winston piece of jewelry, but yet it is still a beautiful gift. Are you seeing anything like that?

Thomas J. O'Neill

Not really, because the watches probably are less holiday gift-driven, but occasion-driven and pretty much consistent through the year. So not so much. If it were to happen, of course we would be very happy to accommodate the customers on a move over from jewelry to watches, but what we are seeing is, again, at the higher end, the US$250,000.00+, there is activity there.

And this year, like previous holiday seasons, we don’t really get going until about now, around the 10th. You know, the better that retailers get at providing kind of last-minute shopping, the more accustomed our clients become in putting it off until later and later.

And now with also the kind of globalization of our business, there is a much longer holiday selling period. Fifteen or twenty years ago you could pretty much say by December 24 the business is going to do what it is going to do and that’s it. But we have now the Eastern European customers, so we have the Orthodox Christian New Year and Christmas. We have the Japanese gift-giving opportunities around the first of the calendar year, and as we push toward the end of January, which is our last fiscal month of the year and the quarter, we have the starting of Chinese gift-giving, or Chinese New Year.

So it’s a different landscape for global companies now. And while certainly December is quite important for us, January becomes increasingly important for us.

Irene Nattel - RBC Capital Markets

I know you said you weren’t going to provide any more color around the whole issue of the robbery, but can you tell us whether the insurance is at cost or at something approaching more retail value?

Alan S. Mayne

I think, sadly, we have a precedent for this type of incident and I think that is all I would say. I would sort of guide you to the precedent and leave it at that.

Operator

Your next question comes from Brian MacArthur - UBS Securities.

Brian MacArthur - UBS Securities

I was wondering if we could flush out the near-term refinancing a little bit more. If I look at this correctly you have got $25.0 million in debt repayments under the large loan you have to do in the next two quarters. You are going to obviously still generate pretty good cash from the mining, as you said, from the point of your margins, while maybe they are down they are still very high. But I am surprised you have to refinance in the next little while and it would be as high as $75.0 million. Is this just a working capital problem, getting everything up the road? Or can you just go through a little more, as much as you can, exactly what is happening there? I know there is capex over the next few years of $180.0 million, maybe it all comes in the first two quarters. But I’m just surprised, is this just a near-term issue? Because I’m surprised if you’re looking at an annual basis that you are facing that.

Alan S. Mayne

There are a couple of things. Right now we are sort of saying that that schedule is such that by the end of the year, on the mining side, we will have about $75.0 million due: $25.0 million due in March; roughly $20.0 million in June; $15.0 million in September and $15.0 million in December.

The one thing that you may not have taken into account are the cash taxes, which are, as you know, expected to be fairly significant next year, and they will happen certainly by the first half of the year.

So based on where we have modeled and taking into account significant cash taxes, we would be looking at refinancing at least the $50.0 million that would be remaining outstanding as at June 30, 2009.

Brian MacArthur - UBS Securities

So it’s the cash tax relating that you’re paying in the early part of next year for this year effectively.

Alan S. Mayne

Essentially, yes.

Brian MacArthur - UBS Securities

And I assume there is just a bit of working capital draw over the winter as you pull everything up to the mine as well, too, and it’s those two things that really.

Alan S. Mayne

Yes, there is. But the cash taxes are the sort of the plug in the model that is a significant cash outflow next year. And just to be clear, on the revised numbers we have given on capex, again, a lot of that is going to occur next year as the underground development is largely completed.

Brian MacArthur - UBS Securities

So the majority of that, your share of [1A], there will be a big hunk of it again next year.

Alan S. Mayne

Absolutely. I mean, out of that probably, depending on the exchange rate you use, about $83.0 million for the underground and probably another $20.0 million for sustaining. So you have probably got $100.0 million next year and then roughly $20.0 million of sustaining thereafter. So I think that is a good indication of the cash-flow profile, but next year is big on capex and cash taxes.

Robert A. Gannicott

Could I just add one slight caution to that? The Rio Tinto’s capital budget for next year is under constant review and it is going to remain that way, frankly. Under the kind of circumstances of the markets of the day, Rio will continually look at the capital program and there may well be, in fact there almost inevitably will be, changes as we go along. So you shouldn’t regard it as something that is carved in stone for the year.

Brian MacArthur - UBS Securities

To some extent you have to keep the development of that underground going so you don’t get behind in the future, right?

Robert A. Gannicott

Sure. On the things that are needed to actually keep the project intact, including its future intact, will be done. But there are other sort of more elective things that could be deferred.

Brian MacArthur - UBS Securities

Just to be very clear, the $83.0 million and $20.0 million you are talking about, was that US at a Canadian $0.95 exchange rate again?

Alan S. Mayne

I think the $83.0 million is at $0.98 and the $20.0 million is about $0.98 as well.

Operator

Your next question comes from David Christie - Scotia Capital.

David Christie - Scotia Capital

The security at the Paris facility, you had a robbery a couple of years ago. What did you do after that for security and what will you be doing in the future?

Robert A. Gannicott

I’m sorry but we can’t discuss it at all. Obviously we can’t discuss what our security arrangements are, but during the insurance investigation we just can’t say a thing. I don’t want you to think we are being rude but we’re just not allowed to.

David Christie - Scotia Capital

On the debt that you do have outstanding, could you give us an idea what the covenants are on the various debts?

Alan S. Mayne

A qualitative overview, our mining credit facilities are filed on FADER. I think the thresholds on the covenant are probably unavailable. But we have certain covenants there that are related driven off net present value calculations of the value of the mine, which are confidential between ourselves and our banks. There are other more traditional coverage covenants there and they are largely historically-looking. As I mentioned in my comments, we are in compliance and expect to be in compliance with those covenants.

On the retail side, the covenants are of a more traditional nature. There is a tangible net worth covenant, a leverage covenant, and a fixed charge covenant that is driven by EBITDA and interest expense. So the thresholds remain confidential but what I will say is that we know what the covenants are, we have a number of scenarios at which we can manage the retail business to ensure that we continue to be in compliance with those covenants.

David Christie - Scotia Capital

If you had like a 5% negative growth in retail sales in 2009 are you going to have a problem?

Alan S. Mayne

No, because the covenants are just driven off, I mean, sales obviously flows through the EBITDA but there are other metrics in the mix that management has discretion over the amount of those metrics and we can make adjustments there. And as I say, we have run our own models and there are levers we can pull to ensure that we stay in compliance next year.

David Christie - Scotia Capital

And when are you going to know for sure whether you are refinancing those amounts? Are you in negotiations now or is that planning you are waiting to do later?

Alan S. Mayne

No, we are in discussions right now and we expect those discussions, if successful, to be concluded into the first quarter. If we get to a point where we are in the process whereby it is either prudent or required for us to disclose the status of those discussions, then we will do so.

David Christie - Scotia Capital

And it’s all over debt repayment and schedule, basically, you need to refinance?

Alan S. Mayne

Essentially, in a nutshell, what we are aiming to do is shift $75.0 million of principal payments that come due next year out certainly beyond next year. That is the major objective of the refinancing exercise.

Operator

Your next question comes from John Hayes - BMO Capital.

John Hayes - BMO Capital

I have a question on this new mine plan. As I am reading through the commentary on the forecast, going forward in the outlook, I notice there is a section saying you are hoping that you will reduce the capex and the operating costs. I’m just reading into this a bit, but I was wondering if you could help me out here. Does that mean there is going to be a greater reliance on open-pit mining at 418 for the next period of time and could we see a further push out of the underground mining?

Robert A. Gannicott

We don’t actually have the plan in hand yet. We expect it right around the end of the year. As I say, you should also recognize that it is subject to change. If things get better, then more will be done, if the market for both diamonds and for debts frankly, remains more of as it is now, well probably less will get done.

But what I am expecting is, yes, more reliance on 418, but also there it seems we probably can make more from 154 site available than was originally in the mine plan. This has to do with the basic stability of the pit walls being better than had conservatively estimated, and therefore there are a couple of more patches available there.

It does imply pushing the underground mining out, certainly into the final quarter of the year; third quarter to towards the end of the year. And I am going to say there is a possibility of that even getting shifted right to the end of the year or perhaps into the following year.

And that’s about all the precision I can put on it.

John Hayes - BMO Capital

So this kind of goes back to your need for capital and refinancing. So even anticipating that some of this gets pushed out, you will still need this money.

Robert A. Gannicott

We just feel that we don’t wish to be in the risky position of being reliant on it getting pushed out. We are trying to put ourselves in a position where we are comfortably funded to deal with a capital program that could possibly change the other way.

John Hayes - BMO Capital

Fuel and FX are clearly moving in your favor there as a Canadian producer. What kind of impact do you see that having on your operating costs at the mine?

Robert A. Gannicott

We haven’t been able to measure it yet, because a lot of the fuel is not yet purchased so it is a timing thing and you’re right, it has been working in our favor.

Also, there has been a significant cushion of fuel available at the sites, on the order of 20.0 million liters. The operator feels that we don’t really need to keep 20.0 million liters additional to probably pretty conservative estimates of that consumption anyway.

So yes, there will be certainly some significant impact on the fuel consumption, fuel pricing, and you’re right, FX. But I think you have to take your own view of what the FX ratio would be for the coming year.

Alan S. Mayne

I think the only fine point I would put on it is that the cost of fuel that flows through the income statement, as you know, isn’t necessarily based on the price that we will pay this year, because we do have an inventory at older, more historical prices. But certainly from a cash-flow perspective, as we purchase fuel this year, that is going to have a significant positive impact on us.

Robert A. Gannicott

I guess you would say perhaps it is a very good thing that we don’t have a winter road during the months when the oil prices goes through $140.

Operator

Your next question comes from Matthew O'Keefe - Thomas Weisel Partners Canada.

Matthew O'Keefe - Thomas Weisel Partners Canada

I have been reading a bit about the Indian diamond industry and there has been a one-month moratorium imposed on diamond buying. Would you be able to elaborate on that a bit and how it will affect your Q4 rough diamond sales?

Robert A. Gannicott

First of all, it was a moratorium that was imposed by the sort of Indian industry themselves, in other words it wasn’t a government-imposed thing. Actually, I’m not sure that formally they have announced it is being lifted but certainly you can make exports of diamonds again to India. In fact, we are doing that ourselves, I think today.

So the idea was what the Indian community was trying to do was keep everybody on a level playing field while they went through a prolonged Diwali holiday shutdown. But that can only go on for so long because these workers that are employed in these polishing factories eventually start to shift off to other industries or back to agriculture and so on if they can’t be employed. So the factories are gearing up again and there is a demand. They have actually just shortened the period of this embargo as we understand it.

Matthew O'Keefe - Thomas Weisel Partners Canada

So you hadn’t had any of your customers say to hold off on any shipments and you don’t expect to see that?

Robert A. Gannicott

We have had that. We don’t expect to see it going forward.

Matthew O'Keefe - Thomas Weisel Partners Canada

Can you remind us again how much of your production is moving in that direction or is going to the Indian clientele versus other parts of the world?

Robert A. Gannicott

It’s typically about 60% to 65%.

Matthew O'Keefe - Thomas Weisel Partners Canada

But you think you won’t basically see a drop in that sales over the quarter?

Robert A. Gannicott

The production is picked up. In fact, production is picked up to actually in front of the production levels that were anticipated for this quarter, this final quarter, so far.

So we are getting bigger delivery of diamonds. The diamond market itself is very tight. We have been holding some stock and I am not going to be predictive about the ability to sell it all going forward. I’m not that concerned about it because in a sense I feel it is a good thing that the diamond pipeline sort of empties itself out to some extent.

As with all of these sort of commodity gains that have been happening in the last six months, there have been a lot material that is sort of being held within the supply pipelines because the prices were rising. And so this formed a kind of speculation. I think it is a healthy thing that that empty that but I am not going to be predictive about exactly when that is going to happen.

My expectation is that the holiday sales, as it affects the broader diamond industry, will probably bring, just the reality, the measurement of those sale, will bring a kind of base to the industry again and it will march forward after that. But I think to say anything beyond that would just be getting too far out line.

Matthew O'Keefe - Thomas Weisel Partners Canada

We have heard about Rio selling a lot of assets, is there a right of first refusal for either of you on the sale of your portion of the Diavik mine?

Robert A. Gannicott

Yes, there is.

Matthew O'Keefe - Thomas Weisel Partners Canada

Does it go both ways?

Robert A. Gannicott

Yes, it does.

Matthew O'Keefe - Thomas Weisel Partners Canada

On the retail end, can you remind us again how many stores you plan to open in calendar 2009 and if you are still going to proceed with that.

Robert A. Gannicott

We are. We’re opening one store in Singapore.

Alan S. Mayne

The reason we are doing that is it was fully committed before the world turned pear-shaped. But it is a good location and we are not really too worried about doing it. The expense of opening a store is almost 90% is putting inventory in it and 10% is sort of actually creating the store. So what we will do, of course, is use inventory from the rest of the network for a while until the world gets back to rights again.

Operator

Your next question comes from [Pharu Hammin] - National Bank Financial.

[Pharu Hammin] - National Bank Financial

In terms of the potential of financing pressure or financing shortfall, is there a potential to cut the remaining dividend to get another $12.0 million to $13.0 million?

Alan S. Mayne

Well, we have just announced a dividend payment, as you know. I guess we feel that in times like this we have a good toolbox of things that are available to us and some of them less attractive than others and cutting the dividend would be one of the less attractive ones.

But I think, here again, in times like this when you can’t really see your way forward, you can’t really give guarantees about anything like that. But we have no formed intention to meddle with the dividend in the near future.

[Pharu Hammin] - National Bank Financial

In your press release you mentioned that if acceptable terms for debt are not found that you will pursue alternatives, potentially sale of assets. Could you give some more color on that?

Robert A. Gannicott

Not really. I think it’s obvious what the assets are that we have. And again, we don’t have any kind of list together of what we will, we are not looking to sell anything at the moment. If we felt we were getting close to that kind of pass then we would certainly start some more serious thought about it, but no, we don’t have that intention.

[Pharu Hammin] - National Bank Financial

On polished prices, from our own research, looking at Rappaport, a few other sources, we are seeing about a 5% decrease in polished prices over the last couple of months. Is that consistent with what you are seeing?

Robert A. Gannicott

The problem with this kind of conversation is that, as you know, when we are talking about rough diamonds or polished diamonds, there is this sort of huge spectrum of different things. But that is consistent with what you might call the bread-and-butter diamond supply, that we see. Even for our own Harry Winston supply, which of course is very much at the top end but does go through a huge variety of sizes. We are buying very small diamonds to go into watch dials and dressing watches and so on, and we are also dealing with some of the very big one and then a whole range of things in between.

I think that would be about right. I think some of the really big things have gone to very speculative levels, they are more like art works, really. They have seen falls of 5%. Specialty items, if you want to buy gauged diamonds to go in watch dials or watch bands, they haven’t gone down 5%, they are still the same price they were. And then there is a sort of range in between.

[Pharu Hammin] - National Bank Financial

In terms of cost, looking at a cost structure next year, with the deferral of underground mining, are we assuming that costs are coming down? This may depend on Rio Tinto.

Robert A. Gannicott

Yes, certainly capital costs and operating costs are targeted to be reduced by then. They have now announced that in a press release that they made yesterday evening. But like I say, the extent of it is still a [inaudible] process. And I think you can understand why, as operator, they would want to have that flexibility, going through the next six months. I completely understand that.

Operator

Your next question is a follow-up from Irene Nattel - RBC Capital Markets.

Irene Nattel - RBC Capital Markets

In the press release you addressed the issue of the goodwill around the retail acquisition. You say you did the test at the end of Q3, everything is fine, you are going to test again at year end. Is that just more of what I would think of as boiler plate in the press release or is that something we really need to be concerned about?

Alan S. Mayne

No, it’s not boiler plate. Under both Canadian and U.S. GAAP are circumstances under which you need to do a goodwill impairment test, other than at year end and those circumstances were present in the form of the decline in the global economy and the impact that that was having on the retail business. So no, it wasn’t just boiler plate. We did conduct the exercise and concluded that the goodwill was not impaired. We would, in the ordinary course, do it in Q4 anyhow and that is what we will be doing because in this environment and the volatility we are dealing with, it is entirely possible that with the conditions that were present to underpin the analysis in Q3 may be different in Q4. So it is real work, it is real analysis and it is not boiler plate.

Operator

Your next question comes from Jacques Wortman - Griffiths McBurney & Partners.

Jacques Wortman - Griffiths McBurney & Partners

A question more for Bob. The diamond pipeline, I guess in the middle area of the diamond pipeline, with the cutting and the polishing, this area is known to rely heavily on credit, as I understand it. And there are only a few institutions that I see lend to it. Could you give any color on the availability of credit to the pipeline right now, especially in the middle?

Robert A. Gannicott

The two principle diamond banks are ABN AMRO and then the Antwerp Diamond Bank. I have talked to the senior people in those very recently. They are committed to maintaining their credit availability to their customers, but they are not interested in extending beyond the normal levels.

More recently, there are other players in the banking side of it. Some of the Indian banks, of course, play a role in this. But I believe everybody is taking a pretty conservative view. The way that they do it is their business is to finance somebody’s ongoing business. In other words, the purchase, the polishing, and the sale, and to finance that pipeline. What they are not interested in doing is financing any of their customers holding stocks. Which is a very reasonable position. Which is why I say the pipeline is definitely being emptied because basically nobody can use conventional banking facilities to fund stocks and I doubt there is very little other credit available to anyone.

Does that answer what you were after?

Jacques Wortman - Griffiths McBurney & Partners

Yes, that is excellent. There has been a lot of commentary that that availability of credit, even for ongoing businesses, has dried up to a large extent and that was certainly having a limiting factor on the entire diamond pipeline and pushing down prices of both polished and rough as the commentary had gone.

Robert A. Gannicott

I think it is a very interesting part of this business because clearly the people that are polishing are still selling through. There are several people that we deal with, like specialty items. There is one guy that sticks in my mind that purchases some triangular models of rough diamonds from us because he finds them ideal for making triangular earrings. It’s a specialty business and it’s a niche and he hasn’t seen any decrease in his business at all and he still buys exactly the same thing and still pays the same price he was paying back in August.

Jacques Wortman - Griffiths McBurney & Partners

As it stand right now, I understand that the mine plan is subject to change, but can you just give us in rough terms what you see as being the mix of tons that you would take from 418, 154 South and underground, and would you just point us in the direction of the feasibility study grades from these three?

Robert A. Gannicott

Sitting in this room with that significant number of documents in front of me, no, I can’t. And I would still say to you it is variable. And the A-154 site is definitely going to be a kind of suck-it-and-see kind of project. In other words, it is going to be take out one lift and then stop for a while and see whether the ground conditions are maintaining before going to the next lift and if there is any problem with the ground condition, stopping altogether, switching more over to 418. It is going to be that kind of a year.

But if you would care to call me back in the office, probably tomorrow would be best, I will see if I can do a bit better for you.

Jacques Wortman - Griffiths McBurney & Partners

So that means the vast majority of the first half will obviously come from 418 and a little bit of 154 South.

Robert A. Gannicott

Yes, that is correct.

Jacques Wortman - Griffiths McBurney & Partners

Have you provided just your overall guidance for calendar production?

Robert A. Gannicott

No we haven’t because we don’t have it yet.

Operator

Your next question is a follow-up from Brian MacArthur - UBS Securities.

Brian MacArthur - UBS Securities

Going forward, as you spend capital on the mines, should I just continue to assume that you are going to have no deferred tax benefit? I mean, your slip between current and deferred will continue to be a drawn deferred, is that sort of the way it is going to work out the next year, from a cash perspective?

Alan S. Mayne

No. As you know, certainly deferred taxes are a complicated subject in what I call a traditional industrial manufacturing company. All I can tell you is it is that times ten in the mining industry. So it’s not a straight-forward don’t assume that we don’t have any deferred taxes. I think, as Bob mentioned earlier, I don’t have the current mine model in front of me, but give me a shout and I can give you more color on that. But it is very difficult with respect to current and deferred to make some very simplistic assumptions about it.

Brian MacArthur - UBS Securities

I realize that and that’s why I was asking a bit forward because I can’t do it from the external but obviously in the cash flow here, at the moment, it’s $74.0 million payable at the moment. It is kind of critical that works out over the next six to eight months.

Alan S. Mayne

What I can tell you is that a significant amount of that would be due and payable before the first half of next year.

Operator

Your next question comes from John Hughes - Desjardins Securities.

John Hughes - Desjardins Securities

Everyone is struggling a little bit, I think, trying to come up with some type of production for next year, given the deferral of the underground and what will be filling what. Just in terms, at least starting at the top, tons moved. Is it reasonable to assume, at least from what you know today going forward, that you will move as many tons in next year that you did this year?

Robert A. Gannicott

The processing plant should run at about the same capacity. I can see that you are struggling and I don’t want to give you a guidance number but sort of point you towards, what we are looking at internally here at the moment, absent further advice from Rio, and as I say, it is going to be changeable through the year, I think I would be using something more like on the order of 8.0 million karats.

John Hughes - Desjardins Securities

If Rio Tinto is indeed in the process of trying to sell their interest in Diavik, would you want to maintain your 40% direct interest in the event someone else is operating the mine?

Robert A. Gannicott

If that were the case, and I will just stress that I am not aware of that, by the way, but if it is the case we would seek actually to increase our interest.

Operator

Your next question is a follow-up from David Christie - Scotia Capital.

David Christie - Scotia Capital

On the right of first refusal on your side, if you wanted to make an offer for Harry Winston, is there some kind of underlying right of first refusal on the asset that supersedes the offer for the company?

Robert A. Gannicott

That is a difficult question to actually answer. There are parts of the joint venture agreement that under certain circumstances, that could well be the case.

David Christie - Scotia Capital

I thought there was some kind of change of control thing.

Robert A. Gannicott

Yes.

David Christie - Scotia Capital

And on the purchase of fuel and steel for 2009, I know you have stock piles, but are you filling them with fuel during the fall months?

Robert A. Gannicott

There was some filling of some of the tanks during unpleasant fuel prices, but not a whole lot. And for obvious reasons, when the fuel price looked as if it was going to moderate, they stopped and thought to do it on a just-in-time basis.

I can’t tell you really what percentage of the fuel is already in the onlife. At this point it is probably close to half, though.

David Christie - Scotia Capital

So I can assume some of that was bought at the lower end and some at the higher end.

Robert A. Gannicott

That’s right.

Operator

Your last question comes from Patrick Morgan – RBC Capital Markets.

Patrick Morgan – RBC Capital Markets

That $83.0 million in capex and $20.0 million sustaining, is that on 100% basis?

Alan S. Mayne

No, that is our share.

Operator

There are no further questions for today.

Robert A. Gannicott

Thanks very much for joining us today and if anybody thinks of anything subsequently, Alan and I both are here in Toronto for the balance of this week. And Tom is more difficult to get a hold of, he’s in Paris at the moment.

Operator

This concludes today’s conference call.

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Source: Harry Winston Diamond Corporation F3Q09 (Qtr End 10/31/08) Earnings Call Transcript
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