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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

Harry Winston Diamond Corporation (HWD) F2Q10 Earnings Call September 11, 2009 9:00 AM ET

Operator

Welcome to Harry Winston Diamond Corporation’s fiscal year 2010 second quarter conference call. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to your host for today’s call, your Chairman and Chief Executive Officer, Mr. Robert Gannicott. Please proceed.

Robert Gannicott

Thank you. Good morning, ladies and gentlemen, and welcome to the Harry Winston Diamond Corporation’s second quarter report call. This second quarter has seen some dramatic changes especially in the rough diamond market from the beginning to the end of the quarter. Our July rough diamond sales realized prices a full 50% higher than those seen in March as the diamond pipeline regained its poise after the near collapse of the previous six months.

The industry is clearly both pleased and surprised by the strength of the

India even though these do not fully compensate for the decline in the more discretionary part of the U.S. market. Domestic consumption in these economies is difficult to measure as many of the purchases are made outside of the respective companies. Even though both DeBeers and Amoroso have returned to the market there is no sign of any over supply weakness at the present time.

Although our retail business has remained unprofitable during the quarter we have seen transactions grow in number as we have introduced new product at more accessible price points into the Asian market. It is the large ticket sales that are being missed during this period as the world struggles to find its economic feet again.

With our own sales recovering in Japan and some improvement in other markets outside the U.S. we believe that we have now passed the low point. It is also really not consistent to contemplate strong recovery in polished diamond demand which in turn drives rough prices while retail sales remain

It is rather the rough supply and pricing is more volatile and therefore inevitably leads the recovery.

The Diavik Mine is now back to full capacity after a 6-week summer shut down. The turmoil in the rough diamond market over the last year has required the Diavik operating team to maintain a flexible and nimble approach to production planning. Since the market has improved substantially and consistently since the end of the first quarter there is now a new mine plan under consideration for the balance of this year and next which would, if adopted, see a reversal of the previously planned year-end shut down and the delivery of around 7.5 million carats or even more during calendar 2010.

I am now going to turn the call over to Alan Mayne to discuss the financial results and then Alan will be followed by Thomas O'Neill to discuss the retail business before I come back again to close the call and invite your questions.

Alan Mayne

Thank you Bob. Good morning. The company’s consolidated results for the second quarter reflected the continuing impact of the weak global economy in the sectors in which we operate. However, while consolidated sales and earnings from operations declined significantly from the second quarter last year the loss from operations was lower than the first quarter of this year.

Our foreign currency exposure had a material influence on our reported earnings. During the second quarter ended July 31, 2009 the Canadian dollar strengthened against the U.S. dollar. This resulted in a net $25.3 million foreign exchange loss in the quarter compared to a net $5.3 million foreign exchange gain in the same period last year. Taking into account this foreign exchange gain, our interest expenses, other income and expenses and income tax recovery we reported a net loss of $24.5 million or $0.32 per share compared to net earnings of $49.9 million or $0.81 per share in the second quarter last year.

Now let me spend a few minutes on the financial review of our mining and retail segments. As highlighted in our results release yesterday, rough diamond sales for the quarter decreased considerably from the same period last year resulting from a combination of the 36% decrease in rough diamond prices and a 31% decrease in carats sold. This decrease in sales had a direct impact on gross margin compared to the same period last year. However, the gross margins in the mining segment did improve in the first quarter of this year.

Retail segment sales decreased to $48.8 million from $81.1 million in the comparable quarter of the prior year. The combination of this sales decrease and fixed cost leverage in cost of sales reduced the gross margin rate to 46.3% in the quarter compared to 49.3% in the same period last year.

On the positive side, SG&A expenses were $5.8 million lower than in the comparable quarter of last year and $2 million lower than in the first quarter of this year. The cost reduction initiatives taken in response to the recession are aimed at delivering a higher level of sustainable profitability during the anticipated economic recovery.

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

Thomas O'Neill

Thanks Alan. Towards the end of the second quarter we started to see an uptick in some markets while trading conditions remained generally challenging for us. We continued to implement significant controls over expenses, reductions in capital expenditures and inventory purchasing in order to maximize our liquidity and minimize the impact of the economic recession on our sales.

During the second quarter our sales were driven down by continued weakness in the U.S. market while sales in other markets were down but to a lesser degree than in the U.S. In Japan we have seen a marked improvement from the first quarter and continued to see promising results early in the current quarter. In Asia, particularly China, other than timing of deliveries, business is fundamentally strong and we continue to look to this market as a growth area for us. Our business in Europe and the Middle East is holding up while our Salon in London is shaping up to be a solid business.

In our wholesale watch business particularly in the U.S. we found that the independent retailers were selling through our watches at a solid rate per month have reduced inventory levels and are only partially replenishing stock. If the trend continues there could quite possible be a shortage of goods at the independent retailers in the holiday season. This could translate into an opportunity for increased sales to replenish lower than normal inventory levels. In our wholesale watch business in other markets we are beginning to see increases in re-stocking efforts.

In our continued effort to curtail costs in the second quarter including capital expenses, we have further reduced our employee ranks, reduced our inventory levels and pulled back on marketing costs as well as limited our store expansion to one salon in Singapore. The Singapore salon was successfully opened on schedule and below the planned capital budget in July. The 1,500 square foot store is located in Singapore’s newest luxury shopping emporium, Ion Orchard. The design of the new store has been updated with new and innovative components aimed at cultivating both the private jewelry business as well as to build up a strong volume driven business. We have been open now for about two months and we are performing better than we had forecasted. Singapore is a convenient springboard for us into other Southeast Asia markets including Malaysia, Indonesia, Thailand and Brunei among others.

Our marketing efforts this year have been reduced in the first two quarters, lowering our operating cost base significantly. We will be focusing our marketing efforts on the second half of the year to support some very important initiatives including the formal launch of our New York Jewelry Collection that includes collaboration with the Guggenheim Museum in New York that has yielded a sub-collection inspired by the unique architecture of its buildings.

The formal launch of the New York collection celebrating the design heritage of the House of Harry Winston of which the immutable Indian designer Shinde is an integral part, will be held in the New York Flagship store and hosted by the acclaimed Indian actress Freida Pinto from the award-winning film Slum Dog Millionaire. That will be this Sunday. The New York collection will hit our stores in middle autumn. We will be fully stocked at that time and anticipate a favorable reception of the new product particularly for the very important holiday season later in the fourth quarter.

We have also collaborated with the Smithsonian Institute in Washington to redesign and reset the irreplaceable Hope Diamond into an American setting conceived and fabricated in our 5th Avenue workshop. We expect to release a line of jewelry inspired by the Hope Diamond at price points accessible to the hundreds of thousands of people who voted on the Smithsonian website for the new Harry Winston design.

You will also see a revamped website online this month featuring many of the newly designed pieces from the New York Collection as well as intensification of our bridal ring assortment into a wider range of price points and sizes as well as design motifs. We have also begun delivering our outstanding Opus 9 mechanical watch that debuted at the Basel Faire earlier this year and we are busy finalizing the design of Opus 10 for next year.

So the first half of the year has been challenging for us. However, we moved quickly and resolutely to mitigate as much of the fall off in sales as we could with operating efficiencies and sizeable cost reductions. In some markets we have begun to see small signs of things getting better but it is too early to say anything more on this front. We remain committed to our cost reduction efforts as well as new and creative products to position the business for renewed sales growth and profitability when the anticipated economic recovery begins.

So thanks for listening and let me turn it back over to Bob.

Robert Gannicott

Rough diamond prices have continued to advance for our August sale, the only one in the third quarter, which will be followed by three sales in the fourth quarter. We believe we are also seeing a continued improvement in our retail business as Tom suggested built on the more predictable base of higher sales volumes of more accessible items. Although it remains difficult to predict the shape of the world’s economic recovery with our new store in Singapore and eight others already established in Asia we are well represented in the center of the world’s economy that is expected to drive new growth.

Thanks for listening to us. We are now ready to listen to you and take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Irene Nattel - RBC Capital Markets.

Irene Nattel - RBC Capital Markets

As we look in the retail business could you give us a bit more color around where you are seeing, I know you said the lower price points seem to be holding up slightly better, but where you are seeing particular strength and weakness both by location and type of jewelry as well as by price point?

Thomas O'Neill

I think in price point it would be in the below $25,000 range focused on newer products. We introduced a new, very nicely designed wedding band in Japan that has been particularly popular with a small, princess-cut diamond embedded in it. The upper end of the market is slow. Certainly this is what is dragging down the results on the retail business. When that will turn around has more to do with the macro economic situation certainly than anything else. The product we have introduced in the past six months and plan to introduce in the next six months will help us I think pretty much along that way.

Irene Nattel - RBC Capital Markets

Continuing with this discussion, both you and Bob have mentioned the idea of more “affordable.” Can you give us an idea of the range of price points in this new line?

Thomas O'Neill

The New York Collection they range from a very small pendant I think just under $2,000 U.S. and it goes up to well into $250,000 U.S. The affordable ranges would be a set of cufflinks, for example, for $18,000 and in the Guggenheim Collection there are a couple of pendants in the $5,000 to $7,000 range. I would say the New York Collection is clustered between just below $5,000 up to around $28,000 or something in there.

Irene Nattel - RBC Capital Markets

It sounds as though again from your commentary and maybe I am reading too much between the lines around where you are seeing more stability in the market as more around significant events, i.e. bridal or maybe significant wedding anniversary?

Thomas O'Neill

Sorry, you had asked that the first time around. The bridal business is a significant one for us. I think the competition is tough for the bridal business but then I think what customers are looking for us innovative design. The quicker we can produce and introduce and introduce it into the market we have been able to see an uptick in that area. Certainly the ring business for Harry Winston is strong and continues to be strong. So bridal certainly is driving a good part of that. Also the fashion content of what we are introducing in new product is driving considerable volume particularly in the Asian market and in Japan to be specific.

Irene Nattel - RBC Capital Markets

I know in the past you really haven’t wanted to provide much color around what proportion of your business might be in that under $100,000 versus over $100,000 but if we were to assume that the over $100,000 would be about half of your business by revenues would that be reasonable?

Thomas O'Neill

I think we stay away from that because I don’t have the numbers. Maybe we can have a follow-up call. I don’t have those sorts of numbers right in front of me.

Operator

The next question comes from the line of Brian MacArthur - UBS Securities.

Brian MacArthur - UBS Securities

I was wondering if we can focus on costs in the mining segment and I realize currencies are changing and inventory is changing and oil price has been changing. Obviously with volumes coming down your costs have been squeezed the last two quarters. As we move forward assuming we have an economic rebound and we run the mine at a steady state of 2 million tons and we have our blend of underground, open pit and you are going to run it at a flex, you talked in the future that maybe underground is steeper than open pit mining costs. If you can’t give us value per ton guidance which you probably don’t want to do at least conceptually go through how you see that changing over the next little while? The variability has become higher and higher over the last 8-9 quarters and I realize there are some extenuating circumstances but it has been pretty hard to actually machinate what original feasibility and everything were.

Robert Gannicott

It is not that we are reluctant to give you that kind of guidance. It is still subject to quite a lot of change. Diavik are working on a revised mine plan now which is still going through various iterations. However, having said that the objective is that the change of course is the diamond markets improved. What we are expecting is there won’t be a shut down at the end of the year. That therefore makes sort of operating costs a much smoother thing. There is also now an effort to essentially remove what would have been the crown pillar at the bottom of the A154 pit between the bottom of the pit and the underground workings to actually trick that [inaudible] pillar earlier on than later.

That is obviously pretty cheap to get at. We don’t have numbers yet that reflect a blended operating cost per ton for next year or the year after. Clearly underground is more expensive than open pit. However, as we have said before in this environment where a lot of the costs are fixed and are related to the operation of a remote site the difference between underground and open pit is not as dramatic as one might expect. Of course the other initiative is just being picked up now is whether or not there are operating synergies that can be captured between the Diavik site and the [Acadia] site. Clearly there are some but the investigative work for this has not yet started. It is obviously going to have an effect on operating costs otherwise they won’t be implemented. So that will have a positive impact rather than anything negative. That is almost as close as I can get unless you wanted something more specifically numeric out of Alan.

Brian MacArthur - UBS Securities

As we go forward and think you said the difference between underground and open pit is not going to be that huge but underground is going to be more expensive. If you run at a steady state you should be able to take some of the variability out that you have been seeing over the next little while especially since you can work in the winter underground as opposed to open pit where you historically have had some challenges in the early months of the year. I assume that is where you are trying to get to?

Robert Gannicott

That is right. The open pit mining you are right there are some challenges in the earlier months of the year and there is also open pit challenges in the middle months of the year when the frost comes out of the hold roads on the ramp. That has actually been a more difficult time for us. Anyway, yes it does remove that variability and as I said I think inevitably there will be some cost reductions captured by connectivity between the two sites if that is achieved.

Brian MacArthur - UBS Securities

Back to accounting for a minute are we talking about going as far as buying together or transporting stuff more efficiently or are we actually talking about sending different stuff from maybe [Misery] to your plant and things like that?

Robert Gannicott

I think it is all on the table. I think you start with the shopping and say well what is the obvious thing? For instance, there are two large power plants both of which have got to have standby generators that are actually physically spinning all the time. Obviously the connection between the two has some charm to say the least. There are two administration units and so on. Going down to the far end of the scale I suppose there is a possibility that one uses a common processing plant but that is at the far end of the scale and there are other easier, near-term things at the very front end of the scale.

Brian MacArthur - UBS Securities

This dilution gain on the Kinross I thought it was just kind of a one-time event in the first quarter and now there is a little tag in the second quarter. Is that just clean up or is that going to be an ongoing thing?

Alan Mayne

As you know in a lot of these transactions there is a working capital adjustment so that is what that reflects. There will be no further entries through the P&L with respect to valuation on that transaction.

Operator

At this time there are no other questions in the queue. I would like to turn the call over to Mr. Robert Gannicott.

Robert Gannicott

Thanks very much. It must have been a very complete either set of writing or what we had to say. Thank you all for joining the call.

Operator

Ladies and gentlemen thank you all for your participation in today’s conference call. This concludes the presentation and you may now disconnect.

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Source: Harry Winston Diamond Corporation F2Q10 (Qtr End 07/31/09) Earnings Call Transcript
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