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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

Edward Sterk – BMO Capital Markets

Terence Ortslan- TSO & Associates

Raymond Goldie – Salman Partners

Tanya Jakusconek - National Bank Financial

Ali Motan – Boston Partners

David Christie - Scotia Capital

Brian MacArthur - UBS Securities

Jacques Wortman - GMP Securities

Harry Winston Diamond Corporation (HWD) F4Q09 Earnings Call April 3, 2009 9:00 AM ET

Operator

Good day ladies and gentlemen and welcome to Harry Winston Diamond Corporation’s fiscal year 2009 fourth quarter conference call. My name is Josh and I will be your conference coordinator for today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes.

Please note that we will be making some forward-looking comments today. Various factors and assumptions were applied in deriving these comments and the actual results could differ materially. The principal factors and assumptions that were applied and risks that could cause our results to differ materially from our current expectations are detailed in our OSC and SEC filings.

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, ladies and gentlemen, and thanks for joining us on this year-end and fourth quarter results call. Obviously for people in the diamond business, or indeed, most other commodity businesses, the present challenge is survival rather than near-term earnings power.

We have taken a conservative approach to the uncertainties of the immediate future and prepared for a prolongation of current conditions rather than the expectation of near-term recovery.

We have paid down debt but are taking write-downs to better align book values with depressed equity market valuations. The majority owner and operator of Diavik Mines, Rio Tinto, has taken the same approach, with deferral of capital expenditures and a reduction in operating costs through production cuts, as all participants in the diamond industry adjust production levels to the diminished needs of their customer base.

Diamond markets have stabilized considerably over the past two months as rough diamond prices adjust against the new levels of polished diamond prices. This means that diamond prices have recovered somewhat from their lows as the supply pipeline has emptied in response to severely diminished credit. It will, however, take a resurgence of consumer demand to return prices to the levels of late last year.

I will next turn the call over to Alan Mayne, our CFO, who will present the year-end and fourth quarter numbers. Alan will be followed by Tom O’Neill, our President responsible for the retail and wholesale businesses. I will then return to wrap up before we take your questions.

Alan S. Mayne

The significant adverse changes in the global economy that began in the third quarter of fiscal 2009 accelerated at an unprecedented pace so that by the fourth quarter conditions in the rough diamond and luxury retail industries were the worst in decades.

The company’s consolidated sales decreased 37% and earnings from operations were down 83% for the fourth quarter this year compared to the comparable quarter of the prior year.

For the quarter, we reported a net loss of $73.0 million, or $1.19 per share, compared to net earnings of $90.4 million, or $1.55 per share, in the fourth quarter last year.

Two significant items had a material influence on our income statement to lower earnings from operations. We recorded an after-tax gain on insurance settlement of $9.9 million, or $0.16 per share, that resulted from the December 2008 robbery at the Harry Winston Paris salon. Also, management assessed the carrying value of its reporting units and determined it was appropriate to take the non-cash write down of the goodwill relating to the retail operations of $93.8 million, or $1.53 per share.

For the year ended January 31, 2009, the company recorded sales and net earnings of $609.2 million and $70.1 million, or $1.15 per share, compared with $679.3 million and $106.4 million, or $1.82 per share, respectively last year.

Now, let me spend a few minutes on the financial review of our mining and retail segment performance in the fourth quarter. During the quarter mining sales decreased to $51.1 million from $103.2 million in the same period last year. This 51% decrease resulted from lower sales volumes and prices compared to the fourth quarter last year.

Notwithstanding this drop in sales, the mining segment recorded a gross margin rate of 32.2%, highlighting the benefit of the low cost producer status that Diavik Diamond Mine enjoys.

The retail segment recorded a 21% decrease in sales in the fourth quarter, to $67.3 million, from $85.0 million last year.

The gross margin rate, excluding the impact of sales of pre-acquisition inventory, was 50.1% compared to 47.4% in the same period last year. Gross margin in the fourth quarter of the prior year was impacted by a significant wholesale transaction of jewelry items to the Russian market, which generated a lower-than-average gross margin.

SG&A expenses in the quarter were $35.0 million compared to $38.9 million in the same period last year.

On March 19, 2009, the company announced a strategic investment by Kinross Gold Corporation. This transaction closed on March 31, 2009, and Kinross made a net investment of $150.0 million to acquire an indirect interest in the Diavik Diamond Mine and a direct equity stake in the company.

With the closing of this transaction, the company repaid the full amount outstanding of $49.2 million under its senior secured term and revolving credit facilities related to the mining segment.

The Kinross transaction will have an impact on our results for the first quarter of fiscal 2010. The company will be required to record the dilution effect on the income statement. To give you a sense of the order of magnitude of this, if the transaction had closed on January 31, 2009, the company would have recorded a non-cash dilution loss of approximately $30.0 million in respect of its interest in the Diavik Diamond Mine.

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

Thomas J. O'Neill

Our fiscal year ending January 31, 2009, on the retail side, can be divided into two distinct parts. The delineator between the two parts was mid-September 2009. Up to this point, our business was remarkably strong. We had seen ourselves grow at an impressive rate of 23% through the first and second quarters of the year. On a stand-alone basis we were tracking at a gross margin of 47.3% and an SG&A of about 45% of sales, with operating profit at $3.5 million, or 2% of revenue.

Our third quarter started out on firm footing but we found ourselves on less solid ground beginning mid-September. Third quarter sales ended at an increase of 8%, pushing our nine-month sales to 18% compared to the previous year.

The trend halfway through the third quarter continued into the fourth quarter. Our sales fell off 21% in the fourth quarter, leaving our year-on-year sales increase at 6%. Our gross margin in the fourth quarter, of 49%, was in line with our expectation and we finished the year with a consolidated gross margin of 47.5%.

SG&A for the fourth quarter came in at 52% and 48% of revenues for the fiscal year, which was consistent with the prior year.

Virtually all of our regional markets, with the exception of Japan, showed strong sales in the first half. Following the shift in consumer spending in mid-September, we experienced a shift in the composition of our retail store customer base.

On an annual basis our Middle East, Russian, and Asian customers increased by 50%, while our Japanese customers fell by 2% and most notably, our U.S. client base fell by 18% for the year.

Strong sales to non-U.S. clients offset the slowdown with our U.S. customers. This has been the discernable trend for the past few years and is at the heart of the client diversification strategies that we have implemented, particularly through our international store expansion program.

Retail store sales volume in the fourth quarter is heavily dependent on gift purchases, which tend to be at the lower end of our price range. Generally, gift purchases have fallen to a price range below US$100,000 and we booked a decrease of about 4% in the segment for the year, while in the segment greater than $650,000 we saw a near doubling of sales, and at a 7% increase in the segment above US$850,000. The largest drop in price point sales was in the $250,000 to $650,000 range and it was down about 13%.

In Paris, sales in the latter part of the year were impacted by the robbery in December. The inventory loss was fully covered under the terms of our insurance contract. We are moving forward to continue our business in Paris, which is an important center for our private jewelry sales.

We opened one store in the fiscal year, in Costa Mesa, California, and it is performing better than we had anticipated, including through the holiday season.

Part of our plan this year is to focus on Asia and we are on schedule to open our new store in Singapore this coming summer. If other opportunities arise in Asia later in the year we would consider them.

This year we have launched our new advertising campaign which highlights our New York heritage and, together with the campaign, we will introduce our new jewelry collection and watches centered on the New York theme.

With the turn in sales that we experienced in the last quarter, we implemented cost control measures and austerity programs, including a higher increase, a redundancy program that resulted in releasing approximately 40 employees, no salary increases, travel restrictions, in addition to reductions in inventory purchases and in capital expenditures, the benefits of which will be realized in the current fiscal year. We are prepared to take further actions in the event that our sales prove softer than we have planned. So far this year we are exactly where we planned to be.

Yesterday was the closing of the Basel Fair in Switzerland where Harry Winston markets our time pieces and jewelry to a limited number of select retailers each year. The mood was discernibly upbeat and our accounts have confirmed current orders and placed new orders that together bode well for later in the year, when the product will be delivered.

Our new Opus 9 limited watch series was a show-stopper and we expect it to be fully subscribed. Our new ladies watch, as well as six high-jewelry watches, were also introduced at the Basel Fair and will be available in our stores and through our retail accounts later in the year.

Times are changing and times are challenging, certainly, and Harry Winston has responded with both intensified marketing efforts and meaningful cost reductions that will position us to weather the economic storm. We believe that the strength of our brand and our international business model places us in an optimum position to benefit as the world’s economies recover.

Our retail and our wholesale business remain fundamentally sound. So now let me turn it back over to Bob.

Robert A. Gannicott

Alan referred earlier to the investment by Kinross in our business. This investment by one of the world’s leading mining companies recognizes the value of our business and the underlying quality of our assets. The Diavik Mine is one of the highest margin diamond producers in the world; even in this very challenging environment it continues to generate a positive margin. We have prepared all of our business segments to weather the uncertainties of the present as we prepare for the earnings power of the future.

The diamond business is underpinned by the secure, historical association of diamonds with marriage ceremonies in many cultures around the world. Diavik is a premium diamond deposit and Harry Winston a premium diamond brand. Together they are the premium diamond investment platform in anticipation of royal commercial recovery.

So thanks for listening to us and we’re now ready to listen to you and to respond to your questions.

Question-and-Answer Session

Operator

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

Irene Nattel - RBC Capital Markets

In your remarks you referred to the changes in demand, on an annual basis, from the different geographic customer segments, but could you talk a little more about what you’ve seen since mid-September and whether we can still see, or expect to see, reasonable demand coming out of non-U.S. and non-Japan customers.

Thomas J. O'Neill

Yes, I think that’s what’s happening in the market and I think if you follow the luxury bids in the retail sector so you see that it’s fairly consistent with what’s happening in the world.

Irene Nattel - RBC Capital Markets

And just looking at the credit situation in the retail piece, you’ve drawn just about $200.0 million of your credit facilities and we’re now heading into the part of the year where typically we see the weakest results for the next six months. Could you talk a little about how you expect your credit position to evolve and whether you think that you’re going to actually have to dip into the amount above $250.0 million.

Thomas J. O'Neill

Let me take you through the components of the retail debt, just so you’ve got it. I mean, the retail debt is comprised, at the year end, of about $180.0 million drawn on the syndicated credit facility, so whilst you have total debt of about $218.0 million. Only $180.0 million is drawn on the syndicated credit. So we’ve got quite a bit of capacity there.

There is a mortgage, as you know, on the Geneva watch facility for $15.0 million and then there are some drawings that we took down locally in Japan for about $25.0 million. Of that, $5.5 million is in long-term debt and $11.3 million is in bank advances.

So what I would say to you is, we have about $70.0 million of capacity to the credit limit on the retail side. Obviously, as you know, there is a borrowing base driven off eligible inventory and receivable that is lower than that limit, but again, based on our modeling, we do not expect to draw even anywhere near what our eligible borrowing base is.

And I think the reason for that is we do have the proceeds in from the insurance settlement. We are going to be judicious in terms of replenishing inventory and on making any capital expenditures this year.

Operator

Your next question comes from Edward Sterk – BMO Capital Markets.

Edward Sterk – BMO Capital Markets

You have already sort of touched on the impacts of the disposal of the share in Diavik to Kinross. Could you be more specific in what the carrying value of the assets of what’s being disposed of is?

Thomas J. O'Neill

First of all, what I would say is it was not a disposal, it was an issuance of new treasury units in the partnership. Just to be absolutely clear.

I guess you can derive the carrying value if you want to get to that $30.0 million. I mean, the subscription was for 22.5% for $104.0 million. Grossing that up, you get an implied value for 100% of the asset and you have the dilution loss of 22% at $30.0 million.

So it implies a book value of around $600.0 million for the investment.

Edward Sterk – BMO Capital Markets

Versus the $800.0 million that you’re carrying in excessive limits.

Thomas J. O'Neill

No.

Edward Sterk – BMO Capital Markets

You also highlight that you have some losses that you can offset against future income taxes in certain jurisdictions. Could you possible elaborate on which jurisdictions those would be?

Thomas J. O'Neill

They were primarily in the United States in the retail business. And obviously that will be dependent upon future profitability of our salons in the United States.

Edward Sterk – BMO Capital Markets

And also, just on Diavik, obviously I know that the plans are fluid at the moment an at the end of April they will be more detailed, but you highlight capex for this year as being around $175.0 million. How much of that is likely to be eliminated from the curtailments of the underground developments? Or considering the fact that underground development is going to be seen through to completion just before going into full production, how most of it will be spent?

Robert A. Gannicott

We can’t really be numeric about that. It’s not because we’re being coy, we just don’t have it yet. But we’re on our way up to Yellowknife Mine this weekend to actually sit down and find out what can be found out at this stage.

And what I would stress is that Rio, very sensibly, responded rapidly, have determined that they, by making these production cutbacks, that there are real savings to be made, and also by deferring a substantial amount of the underground capital, there are real savings to be made.

They have also determined that in doing so, the whole objective of this was to keep the project—if you take capital and operating expenditures to make sure that the project remained cash positive through the next two years. That’s their objective and they believe that they will achieve that.

However, the details—there is some flexibility on which ore bodies ore can be released from throughout the year. The high grade section of A-124 South is one of those, there is lower grade material in A-148. So that in delivering the same tonnage of ore to the mill, there is a flexibility in how many carats can be produced. And that will be dependent on the appetite of the diamond market as we go forward from here.

So the whole intent is to cut down capital expenditure to a minimum, reduce operating costs, but to remain flexible to changes in the diamond market driven by world economic conditions.

Beyond that I’m not sure. I’m quite happy to try and deal with any specific things you have but you can sort of see that we don’t have much more to put on this than that at the moment.

Edward Sterk – BMO Capital Markets

When is the Singapore salon to open? And circling back on things, could you speculate on what the impact on operating costs would be from a shut down, the two shut-down periods that you intend to undertake.

Robert A. Gannicott

Since I’m already talking, I’ll talk about the shut downs. Here again, it’s the same problem, I’m afraid. There will be some numbers presented to us over the next week or so, but I don’t know what they are yet.

Thomas J. O'Neill

As far as Singapore goes, we’re hoping to open in the summer.

Operator

Your next question comes from Terence Ortslan- TSO & Associates.

Terence Ortslan- TSO & Associates

I was wondering if you have to Basel the jewelry show. I really don’t understand what it means, from your point of view, for your business specifically and for business in general. Obviously it’s quite a prominent show in Basel and I just wanted to get to the bottom of what it means to you specifically and to the market.

Robert A. Gannicott

It’s actually a location where more than 80% of our orders for our watch business, which is in turn a very big segment of our jewelry and of our retail and wholesale business.

Thomas J. O'Neill

It’s also a place where we preview the new designs to the press, and obviously that has value in getting things ready for when they’re in-store as well as unlimited amount of jewelry that we make available to a very few number of retail partners.

Robert A. Gannicott

Just to make it clear, our watch business is primarily a wholesale business as opposed to our jewelry business, which is primarily a retail business. So it’s at the Basel Fair that the wholesale transactions are committed for the watch business.

Thomas J. O'Neill

This is where the retailers come to see the new merchandise and then to place subsequent orders.

Terence Ortslan- TSO & Associates

I was trying to gauge the way you saw the market this year, for you. That’s what I trying to get to the bottom in terms of commercial velocity, let’s say.

Thomas J. O'Neill

Based on volume?

Terence Ortslan- TSO & Associates

Yes.

Thomas J. O'Neill

Well, it’s anecdotal, really. It was quite busy for us. We didn’t see a noticeable fall-off in traffic into the installation from which we display our pieces and take our order book. As you can understand—I don’t know if you’ve ever been there. It’s a huge complex of probably seven or eight exhibition halls and we live in the watch exhibition hall.

Robert A. Gannicott

I guess where you’re trying to is so what do we think the impact of current circumstances are on the watch business in general, and ours in particular, and I think the answer is about 25% in all cases. Is that what you were trying to ask?

Terence Ortslan- TSO & Associates

Yes. Just one other thing. I guess the market shift, Singapore, great idea. Are you ready for the Chinese market? And any joint venture partners, for that matter, for that market so you could penetrate it.

Thomas J. O'Neill

On the retail side?

Terence Ortslan- TSO & Associates

Yes.

Thomas J. O'Neill

China is a market that we are interested in and we have one wholly-owned location in Beijing and we have a distributor-operated watch boutique in Shanghai. Opportunities will come up, certainly, between now and the end of this fiscal year in Asia and in my comments I had said we have targeted Asia as a place that’s interesting for us because we have had very good success, even during these trying times.

So we are keen on expanding the business in China. And we will look at opportunity to opportunity. If there is a wholesale opportunity, and I think that’s what you mean when you say partner, then we would certainly consider it. We do have two or three formidable distributors now in Asia, including China, and we work with them quite closely.

So if opportunities come up, we will certainly look at them. And we would look at Asia first before we would look anywhere else.

Robert A. Gannicott

Of course, we do also have a store in Hong Kong, a store in Taiwan, and now a store in Singapore coming up the track. It’s already servicing Mainland Chinese customers as well.

Operator

Your next question comes from Raymond Goldie – Salman Partners.

Raymond Goldie – Salman Partners

I have a question about your annual report that I know is consistent with what you’ve done before, but I have to admit I haven’t been sure of, and it’s how to interpret the phrase reported on a one-month lag in page 12 of the current annual report, the presentation of Diavik’s financials.

Can I divide your 2009 Q4 diamond sales, on page 9, which are $51.1 million in fiscal Q4 2009, by the diamonds recovered, 1.039 million carats on page 12, to get the average value per carat of diamonds?

Robert A. Gannicott

I think I’ll just start off by saying that the reason for the lag is because Rio Tinto are on a calendar year end.

Raymond Goldie – Salman Partners

I appreciate the reason but I’m not sure whether it means you’re actually reporting the Diavik’s numbers for the quarter ended January or not.

Alan S. Mayne

No. Diavik are on a calendar year end so for our January year end we pick up their twelve-month results ended December 31, 2008. But as you can appreciate, we do not obviously pick up any revenue, essentially. We pick up effectively costs and our share of the 40% interest in Diavik.

As it relates to revenue, that’s driven by our own sales cycle, which is linked to the production cycle, but otherwise is independent of the reporting measurement period for Diavik.

Robert A. Gannicott

Can I suggest that if you want to get further into that, you might want to just call back in afterwards and talk to Alan or myself.

Operator

Your next question comes from Tanya Jakusconek - National Bank Financial.

Tanya Jakusconek - National Bank Financial

I just have a few questions, one on the retail side and then obviously coming back to Diavik.

I just want to know, on the retail side, just two things. What is the sustaining capital that we need right now, just to keep the stores going? We had previously talked about $12.0 million per annum. I notice that it seems to be a bit lower, about $9.0 million. Is sort of $10.0 million the running rate that we should look at?

Thomas J. O'Neill

I wouldn’t look at $10.0 million. And that $10.0 million involved an opening in the finalization of capex on the Geneva watch factory. We are opening one salon, one is planned this year, which we can build out for around $1.0 million. We have the discretion on how we stock that, which doesn’t flow through the capex line, anyhow, so we can manage that.

Otherwise, it’s periodic capex for things that we really need to replace. So I think in the current economic environment, it would probably be conservative from your perspective, from a modeling point of view, to be putting $10.0 million in. I mean, we envisage a much lower capital expenditure number this year.

Tanya Jakusconek - National Bank Financial

Would half be reasonable then? $5.0 million.

Thomas J. O'Neill

I would say that I would like to keep it under half but half wouldn’t be unreasonable.

Tanya Jakusconek - National Bank Financial

And then I guess the same coming to the mine. We had once talked about sustaining capital for the entire mine at US$39.0 million, or US$40.0 million, but that was running at the 2.3 million tons per annum rate. What would be the minimum sustaining that we would kind of need right now to keep that mine going, even with the 12-week shut down?

Robert A. Gannicott

We just don’t have a number on it. You’re just going to have to give us some time to be able to sit down with Diavik and even then I think this is going to be something that evolves through the year. I think you can sort of appreciate that instead of having a fixed plan, a fixed already schedule, a fixed amount of tons going through the mill, this is a kind of we’re going to equip—the mine is being equipped to operate as lean and mean as possible whilst still keeping the ability to accelerate again quickly if the diamond market improves.

So I’m afraid it’s going to be a bit like that. But we will give you access to everything that we get on this. I mean, I fully sympathize with the frustration of us not being able to be as numeric as we would like to be about it, but I’m afraid that’s just the way the world is blowing.

Tanya Jakusconek - National Bank Financial

Well, maybe then just a generality on the mine. What percentage of your overall cost affects versus variable. Is 70% of the costs up there fixed that you’re going to have carry no matter what?

Robert A. Gannicott

So you sort of understand then that the reason you save money when you go shut-down in a remote location like this so if you weren’t in a very remote location you might well elect to actually just reduce production to a lower level because you draw lower electricity demand off whatever grid is supplying you, for example.

At a remote location like this, if you can actually shut down the main power plant and just run on the sort of reserve power plant because you’re not operating the mill at all, then you make some significant savings. And those large items that would normally be considered fixed cost items. So we are digging into fixed cost items but I can’t—I don’t think we can tell you at the moment how deeply we’re going to be digging into them.

Tanya Jakusconek - National Bank Financial

So all of these numbers before the end of April will be given to us?

Robert A. Gannicott

Yes, as soon as we get something. But don’t expect the precision that you’ve been used to before, as it were, because there will be a flexibility built into this.

Tanya Jakusconek - National Bank Financial

And my last question, to do with the diamond market, De Beers has mentioned that they don’t see a recovery until December 2010. Is that your view? Or what view would you have?

Robert A. Gannicott

I don’t think I’m going to take a view forward. What I would like to do is tell you we are somewhat uniquely in the position, selling rough diamonds, we buy polished diamonds, and we sell jewelry. And that’s a sort of very unique perspective on this business.

We track all of these things of course, and in the last month that was the first month since the middle of last year where we didn’t see a decline in a single one of the polished diamond categories that we tracked and purchased.

And the other thing is over the last two months the sale—not the sale that we just recently completed but the one prior to that—one could see a sort of firming in the rough market but only in the sense that things were not falling further and there was some limited demand for some of the kind of items that could be very quickly turned into polished diamonds that are the core of the sort of the bridal business, engagement ring demand. That was two months ago.

This last month that demand had become much broader across all diamond categories and prices even up a little bit more. This is really, though, I just would emphasize that we view this as rough prices that have really collapsed in a big way pulling themselves back up to being a balance with the level of polish demands and polished prices.

Polished prices, you know how complex this business is, some polished items haven’t gone down hardly at all, some have gone down a lot, and I guess if you wanted to take a stab at what the average is, it’s somewhere in the 15% to 20% level that polished prices are down.

Rough prices have gone down more like between 40% and 50%, so they have now come back up to sort of meet the level of the polished pricing. And the reason that that has happened is because on the retail side of selling the actual jewelry, the broader experience such as the Harry Winston experience, but the broader experience is while demand probably about 25%. While people still get engaged and still get married, it’s the broader discretionary items that have fallen away, but there is still this core underpinning in this business and there has been a severe cutback by all the diamond producers.

De Beers and Alrosa almost departed the scene here. De Beers cites very small mine shut down. Alrosa hasn’t been selling into the market, they’ve been just stockpiling and then, of course, the production cutbacks in Canada and sales to Diavik.

So probably those production cuts are more severe than the decline in the uptake at the retail end but that was intentional in that it allows the pipeline to empty out.

That’s our view of the world. Is this a bottom? We would love to think so. If it’s not a bottom, it’s certainly a plateau and I would say that the fact that the people that are buying rough diamonds and have to polish them and be there for the time period that it takes to polish and sell them, the fact that they’re back in the market and prepared to pay a bit more indicates that they at least have some confidence that this is probably a bottom. That doesn’t mean that any of us are right.

Tanya Jakusconek - National Bank Financial

And the lag between the rough to the polished pricing is in, you opinion, how long? In terms of by the time the rough pricing has dropped and by the time it kind of gets through the pipeline to the polisher.

Robert A. Gannicott

I think there is certainly a lot items, the pipeline has seen that already. Obviously there are some items that it hasn’t but I think we’re well on the way.

Tanya Jakusconek - National Bank Financial

What would you say would be the rough timing?

Robert A. Gannicott

I don’t know. As I say, I think we’re almost there. Maybe there’s another two or three months before actually across absolutely everything.

Operator

Your next question comes from Ali Motan – Boston Partners.

Ali Motan – Boston Partners

Am I correct in assuming that ex-retail we will be sitting with Kinross at approximately an $80.0 million to $100.0 million net cash position?

Thomas J. O'Neill

Let me just do the quick mental math. I would say it’s probably $10.0 million higher than that.

Ali Motan – Boston Partners

Okay. So $110.0 million net cash. And now, as we look at capex, I think you mentioned was potentially $70.0 million this year, or $80.0 million.

Thomas J. O'Neill

Well, again, I think as Bob has mentioned . . .

Ali Motan – Boston Partners

The high end was $80.0 million.

Alan S. Mayne

Well, it will certainly come down from that but I can’t tell positively tell you how much.

Ali Motan – Boston Partners

Okay, so the high end was $80.0 million. Cash taxes, we’re going to have a nice payment due this year, that’s correct, right?

Alan S. Mayne

That’s correct.

Ali Motan – Boston Partners

So what is the range of that? That’s more predictable, right?

Alan S. Mayne

That will be approximately, call it US$48.0 million.

Ali Motan – Boston Partners

So between capex and cash taxes, I mean, theoretically we would wipe out all the cash, but I don’t think that’s happening. But then there’s the operating performance of the mine. Now, if you take into account a 20% to 25% decline in volume, 20% to 25% decline in pricing, we had a 50% decline in revenues in this quarter, which was probably the worst quarter I would imagine because it was right in the heart of the financial crisis, and we still made $12.0 million from that mine. Is it unreasonable to assume that at the very least that mine will be able to produce, because even if we shut down, we’re shutting down effectively 20% of the year, which is in accordance with volumes, that that mine will be able to produce at least 4 times that $12.0 million, because that’s 50% and even taking those declines, I assume gives you only a 40% decline.

Alan S. Mayne

I think, there again, it might be wiser to call back in after the call. But Bob, do you want to try?

Robert A. Gannicott

I think what—I know where you’re going because you annualized out performance. I mean, obviously, it depends on where we end up on a mine plan in terms of what ore bodies are going to be mined. Because as you know, there’s different grades and also different costs associated with mining the different pipes.

For example, A-154 South where we’re near the bottom of that pipe, it’s got a very low stripping ratio, very low cost of production. You’re into A-418 where we’ve been putting the capex and we had all the pre-stripping costs in the capital, when you look at the full cost, including depreciation, there is a different cost profile associated with A-418 versus A-154 South. And there’s a different revenue per carat profile.

I think what I can safely say, but I think the Diavik mine, I think would, even under the potential plans we’re seeing, would have a positive gross margin. I think it’s difficult to estimate the fully costed—for example, including depreciation gross margin—because that’s going to depend on the pipes we mine and also which parts of the pipes we’re mining.

But on a cash basis, which we don’t report non-GAAP measures here, but on a cash basis, looking at the potential range of options here, we believe the Diavik Mine would have a positive cash margin.

Ali Motan – Boston Partners

And it would be unreasonable to take that $12.0 million? Because that’s off a 50% decline and I understand that there’s different productivity of the different sections, so what’s your take on the operating profit? I mean, you had a 50% decline this year, as you talk about the way the numbers play through so far, from a polished and the trends playing out. What about operating profit? Even on a low range.

Robert A. Gannicott

As we said earlier on the call, how can you deal with operating profit when you don’t have the cost side? And that’s what we’re going to Yellowknife next week to start to get into.

It’s like I say, don’t think we’re being coy; we just don’t have it yet.

Operator

Your next question comes from David Christie - Scotia Capital.

David Christie - Scotia Capital

Let me just understand, first of all, for the April, I understand we are going to get some kind of press release before the end of April, you will be able to tell us by then some kind of carat range or production from Diavik.

Robert A. Gannicott

Yes. And it will be a range.

David Christie - Scotia Capital

It’s always a range, right?

Robert A. Gannicott

Yes, but more so because there is the optionality here to deliver ore from A-154 where there is no further stripping to be done and the grade is very high. The other option is to mine from A-418 where the grade is lower and there is stripping to be done. And the choice between the two is based on a view of what the appetite of the diamond market is at the time.

In other words, normally we at least have a fixed already scheduled of where tons are going to come from and then of course, the inaccuracy then creeps in is the accuracy of the ore reserve calculation itself and the accuracy of whether or not we can perform against plan. But this year there’s the additional thing of we’ve actually got choices about what type of ore is taken.

David Christie - Scotia Capital

And I guess A-154 has a little higher value per carat, too?

Robert A. Gannicott

Yes. There are two rough units in A-148. One has a lower value per carat because it’s finer grained. The other one has about the same, or perhaps slightly better value than A-154 South. At least on the basis of the sample.

David Christie - Scotia Capital

I guess then if you mine more A-154 South you’re going to get a grade well over 4 carats per ton for the year.

Robert A. Gannicott

Yes, if the current working phase in A-154 South, it’s more like 6 carats a ton.

David Christie - Scotia Capital

And if you mix up a bit you’ll be lower. That will be an important number to know. Will you be able to give us some cost guides on a per ton basis?

Robert A. Gannicott

Absolutely. We will be better on that. Obviously there will be a cost schedule put together, both capital and operating, and we should be able to nail that one pretty well.

David Christie - Scotia Capital

And of course, capex. I’ve got to move to the retail side. In the past you have given us some guidance on expected margins or your forecasted SG&A percentage of sales. Do you have any guidance on any of that stuff?

Alan S. Mayne

I think in the current environment we are in, with the visibility the way it is, we are not going to give any guidance on where sales targets are, margins, or SG&A ratios. We are mindful of what you need, but as we get through the year we might be able to sharpen that but right now we’re really only two months in so we can’t give you anything specific.

Robert A. Gannicott

Because on the retail side, the way retail watches it, the way I would characterize it is what we’re doing here is watching very carefully and with a flexible budget in order to preserve our operating capacity, both in manufacturing and retailing and keeping the image of the brand nicely shined up while making sure that it doesn’t suck any money from us. That’s really, I would say, the core objective for this year.

David Christie - Scotia Capital

And all the determiner revolving debt is gone on the senior side there for the mine. You have a little more capacity as a company that way, too.

Alan S. Mayne

Yes.

Operator

Your next question comes from Brian MacArthur - UBS Securities.

Brian MacArthur - UBS Securities

You talked about that $48.0 million cash payment in taxes this year. I assume that’s over and above the $76.0 million that’s coming out for the deferred, that’s on your account payable right now? So is that $48.0 million going to be this year or next January.

Alan S. Mayne

No, the $48.0 million is part of the $76.0 million that’s in income taxes payable.

Brian MacArthur - UBS Securities

So the rest of that is what I thought you always paid on a year delay. Why don’t you have to pay all of that within the year, if you know what I’m saying?

Alan S. Mayne

Let’s put it this way. We have the option not to pay that. The amount we definitely have to pay is about $48.0 million. We have the option not to pay the balance.

Brian MacArthur - UBS Securities

I know you can’t talk about Diavik, but just try to give us a best feel. You talk about A-154 South has about 0.7 million tons at 6.1 carats per ton and then the rest of the open pit is A-418. That’s obviously what you’re going to mine from this year if we’re not going to do the underground. But if I remember correctly, A-154 South originally had like about $20 to $25 per carat more value. Now, we have talked about how the market’s imploded.

Obviously there is a different mix in diamonds and I understand A-418 is different, have all those sort of come down the same amount or is there another equation there that you have more flexibility, that there’s better diamonds in one of the pipes which will give you more value, and when you say you’re going to match it to the diamond market, you are talking about matching it by value class, if I want to call it that way, as well, too. Or should I just simply cut everything down proportionately?

Robert A. Gannicott

First of all, it’s not that we don’t want to talk about Diavik. We are telling you everything we know about it.

The key difference is between these working phases at the moment is, A-154 South, the stripping is finished. In other words, the rest of the ore is basically just taken by over-deepening the bottom of the open pit. My recollection, off the top of my head, is that there is about on the order of 400,000 tons available, to be taken out in that way. The grade is higher than the reserve grade, at least as it’s seen in the working phase at the moment. The value of the diamonds, let’s call it, they are the higher valued diamonds.

However, over in A-418, as opposed to A-154 South, which is really one rock unit basically. At least on the basis of the reserve, it’s carried as one rock unit. Over in A-418 that’s not the case. There are two distinct rock units. One of them is finer-grained than the other. Because it is finer-grained, the diamonds have a finer size distribution than that, means the value is lower. And the contribution, as it were, the decrease in value as a result of that size frequencyare two distinct rock units. one , it'h is really one block unit basically. at ailable, to be taken out in that way. the manufac distribution, is about 20% lower than the equivalents of A-154 South.

The other rock unit at A-418 has about the same size distribution as A-154 South and at the moment, although we have not yet got really production run qualities of diamonds, seems to be somewhat better quality than A-154 South. So should be slightly higher priced per carat. But, as I say, we haven’t had production scale runs of diamonds to sell from that particular rock unit yet.

So that takes you now to the problem of what do you do as far as looking forward this year. Well, I’m afraid that the ore release has this optionality in it, it won’t be as sophisticated as if the diamond market thinks it would like bigger, whiter diamonds, we will have to go and mine those. I’m afraid it’s just going to be if the diamond market is starting to pick up fairly strongly, well then production will be switched over into A-154 South because for every ton that’s mined and processed it delivers almost twice as many diamonds. And if the diamond market is softer than that, then we’ll stay in A-418.

But we can’t be selective between the rough units in A-418. That whole lift has to be mined regardless of whether it’s about 20% of one rock unit and 80% of the other or the reverse. You’ve simply got to go down the pipe and take what’s in front of you.

Brian MacArthur - UBS Securities

So for the bear I should just take whatever [inaudible] I think and take it all out of A-154, A-418 basically, run it at lower carats per ton and then if we get more bullish that’s your flex. You go back into A-154 South and flip it up. There’s not a value flip there or anything you can do as well either.

Robert A. Gannicott

Not really.

Brian MacArthur - UBS Securities

You talk about remaining flexible and I just wanted to be clear. Like normally you have to send everything up to winter road and fuel and everything, did we send up fuel this year to run it at 2.3 million tons or could you actually conserve cash if you get at it early enough to save it or is it all set up for the maximum, if for some reason we’re all wrong and the world gets better in a hurry or something.

Robert A. Gannicott

Certainly some of the original scheduled fuel delivery was reduced but it was actually reduced not because of this but because we ended up with a bigger amount of fuel residing on site from last year than had been anticipated. So there was a reduction in the amount that was forecasted to go up there.

However, no, we do have fuel on site to run at 2.4 million tons for the full year. So that presumably will translate into a reduced fuel delivery at will, translated to a reduced fuel delivery the next winter road.

Brian MacArthur - UBS Securities

Basically, where tie up a bit of working capital would have flexibility here I guess is the way to look at it, is that right?

Robert A. Gannicott

That’s right. But there will be a summer shut down. I mean, obviously, even if the diamond market were to get better, significantly better in the next month, so that employees have to be able to plan their lives as well, so there will be a summer shut down for sure.

I would say there’s probably some optionality on the winter one but it’s too early to really get predictive about that.

Brian MacArthur - UBS Securities

Originally, if I remember, I thought sometime this year, and I realized the world has changed, but I’m just curious what happened. 8/21 there were going to be some valuations done and you were going to get some sample. Did that every happen?

Robert A. Gannicott

Yes.

Brian MacArthur - UBS Securities

Did you get valuations and what actually were they based on? Was it a time when you got realistic today’s diamond market values or was it done like four or five months ago?

Robert A. Gannicott

Well, we do have the diamonds now. We have not yet done the valuations. But we’re ready to do it and I think we’re pretty sure that it’s going to turn out about like A-154 South at this stage.

And the other interesting thing that’s come up there, but I wouldn’t get too carried away on it, there is the consideration of a mining method that doesn’t require the construction of a water-tight dyke. It requires the construction of a burn to prevent sediment leaking out of the lake but it doesn’t require a diaphragm wall dyke, which is the expensive part of dyke building.

And this is being reviewed at the moment. And there will be some months before the operator can settle on whether or not they can feasibly do this and at what cost, but it does look attractive at this stage.

Brian MacArthur - UBS Securities

And just to be clear, when you said it would turn out more like A-154 South, you were talking value distribution.

Robert A. Gannicott

Roughly [inaudible] dollars per carat.

Operator

Your last question comes from Jacques Wortman - GMP Securities.

Jacques Wortman - GMP Securities

I’m just trying to dig down on the carat, the realized price on the carats, how the trend went over the course of the quarter and looking out to sales versus production. The current inventory seems to be essentially unchanged so should we assume that you sold about 1.0 million carats at something like $50 a carat or could sales have been lower than your proportionate share of the fiscal Q4 production?

Alan S. Mayne

We sold about 60% to 61% of the production that you see in the release.

Jacques Wortman - GMP Securities

Was that disclosed in your stuff?

Alan S. Mayne

No, we don’t usually disclose the carats sold. But given the variance to production, it’s a fair question and our sales were about 61% of production.

Jacques Wortman - GMP Securities

I really appreciate that because I didn’t think you had a $50 carat . . .

Robert A. Gannicott

That’s right. We always have a struggle with this issue that we cannot disclose the price that we achieve because we sell the same product into the same marketplace and for anti-trust reasons we can’t tip through public disclosure. It’s awkward for us, it’s a pain for you guys, and I’m sorry about it.

Jacques Wortman - GMP Securities

That’s fine. I’m just happy that you’ve provided this disclosure now.

Operator

There are no further questions in the queue.

Robert A. Gannicott

Thank you all very much and onwards and upwards.

Operator

This concludes today’s conference call.

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Source: Harry Winston Diamond Corporation F4Q09 (Qtr End 01/31/09) Earnings Call Transcript
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