Harry Winston: 'The Worst Sale They Ever Made'?

Dec.15.08 | About: Dominion Diamond (DDC)

When a diamond is stolen in the diamond industry, insiders often joke that it was “the best sale they ever made”—because they don’t have to work to sell it now, it’s covered by insurance. It may not turn out that way this time. Harry Winston (HWD) says the recent robbery at its Paris shop was unfortunate, but was covered by insurance and so not a cause for worry.

Newspaper reports peg the value of the jewels stolen at $103 million. On its recent FQ309 conference call, company officials said::

Subsequent to the quarter we suffered an armed robbery in Paris where approximately $13.0 million of inventory at cost was stolen... The loss is insured.

Q: Can you tell us whether the insurance is at cost or at something approaching more retail value?

A: Sadly, we have a precedent for this type of incident… I would sort of guide you to the precedent and leave it at that.

This same Harry Winston store was robbed little more than a year ago, with the thieves making off then with $25 million in jewelry, taking pieces worth between $2,500-$4 million.

On Harry Winston’s FQ308 conference call last year:

Offsetting strong international sales was the affect of a robbery in our Paris salon in early October... The company is fully ensured for the inventory loss and we expect to record a pre-tax gain of approximately $13 million in the fourth quarter reflecting the anticipated insurance settlement.

There’s an ongoing investigation to the recent robbery, so executives couldn’t confirm whether insurance covers cost or retail value. It would certainly appear, however, from the newspaper valuation of the robbery and last year’s conference call report of a $13 million settlement, that the cost of the jewels and not the retail value is covered.

It's doubtful that HWD makes 900% profit on their retail goods (as per the discrepancy between newspaper reports of $103 million, and company estimates of $13 million). Chalk that up to inflated newspaper reports on the recent heist. But if the theft insurance covers only the cost of the jewels and not their retail value, how will that affect margins in terms of borrowing?

HWD is trying to pay down debt now, saying debt-carrying costs are high. This robbery could cost them a hefty penny in margins, at least until all of the jewels are replaced. Borrowing under lower margin stats, even temporarily, may affect that ability: From the FQ309 call:

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 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.

Margins:

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.

Q: Your margins… 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? …I know there is CapEx over the next few years of $180.0 million, maybe it all comes in the first two quarters… Is this just a near-term issue? Because I’m surprised if you’re looking at an annual basis that you are facing that.

A: 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.