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Executives

Robert Gannicott - Chairman and Chief Executive Officer

Cyrille Baudet - Group Chief Financial Officer

Frederic de Narp - Chief Executive Officer of Harry Winston, Inc and President of Harry Winston, Inc

Raymond N. Simpson - Executive Vice President

Mats Heimersson -

Analysts

Des Kilalea - RBC Capital Markets, LLC, Research Division

Irene Nattel - RBC Capital Markets, LLC, Research Division

Oliver Chen - Citigroup Inc, Research Division

Seth Peterson - Berenberg Bank, Research Division

Brian MacArthur - UBS Investment Bank, Research Division

Harry Winston Diamond (HWD) Q4 2012 Earnings Call April 5, 2012 8:30 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Harry Winston Diamond Corporation's Fiscal Year 2012 Fourth Quarter and Year-End Conference Call. My name is Chanel, and I'll 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 actual results could differ materially. The principal factors and assumptions that were applied and risks that could cause our actual results to differ materially from our current expectations are detailed in our filings with Canadian and United States' securities regulatory authorities and can be found at www.sedar.com and www.sec.gov.

During today's call, we will also be discussing certain non-GAAP financial measures such as EBITDA. EBITDA does not have a standardized meaning according to GAAP, and Harry Winston defines it as sale minus cost of sales in selling, general and administrative expenses. Please see the press release and the MD&A we filed yesterday for further information about this non-GAAP measure.

I would now like to turn our presentation over to your host for today's call, the Chairman and CEO, Mr. Robert Gannicott. Please proceed.

Robert Gannicott

Thanks. Well, good morning, everyone, and welcome to this call which, of course, as you've just heard incorporates both the fourth quarter and the year-end results. Before I proceed, I'm just going to introduce some of the other people that I have sitting with me in the room and that are available to help with answering questions at the end of the call. As well as Frédéric de Narp, who runs the -- our luxury goods subsidiary, based in New York; and Cyrille Baudet, who is our Chief Financial Officer, who will be actually speaking on the call. As well as them, I also have Ray Simpson here. Ray leads our M&A Research Group. Richard Chetwode, who now runs our Investor Relations program, as well as our relationships with capital markets generally. Ray, you've -- most of you know, from a quite a long time. Richard has recently joined us. His background is, he came to us from Gem Diamonds, prior to that, a long career with De Beers. And before that, he actually worked in the city of London for James Capel.

Also in the room, I have Mats Heimersson. Mats is a Swedish mining engineer who has always worked in the Arctic. He began his career in Arctic, Sweden. Mats and I then met in the mid 1970s on a project in -- a mining project in West Greenland where Mats introduced a very innovative mining method for one of the ore bodies at the mine. He has since spent his time working on a lot of the Arctic mine startups, including Polaris and Lupin, and having some involvement with Nanisivik as well. And Mats is based in Yellowknife and is our prime resource on mining engineering issues.

So following that introduction, I'm just going to say then that for that -- I meant, well, I'm going to hand over to our CFO, Cyrille Baudet, who's going to review the year from a financial performance point of view. Cyrille will be followed by Frédéric, who will discuss the brand timepiece and jewelry business. And I'm then going to come back to discuss our rough diamond business.

By way of introduction, I'd say the year-end diamonds, generally, and our business in particular, has in large part reflected global economic developments. The early part of the year saw a strong surge in rough diamond prices, as demand anticipated a strong and immediate U.S. recovery, supplementing the new demand from China. This drove our own rough prices up by about 50% between the beginning of the year in July, at which point European debt issues and uncertainty in the U.S. recovery reversed that trend.

In the second half of the year, most, but not all categories of rough diamonds, surrendered about half the gains made in the first half. The most resilient categories being those delivering small high-quality stones used in the watch industry, and the weakest categories being the lower-quality diamonds where competition from the Marange area of Zimbabwe has had an impact as those diamonds have come to market following a resolution of Kimberley Process Certification for them.

The average price for our own assortments of rough diamonds ended the year about a 20% above the beginning of the year, and pricing and demand has now stabilized with most categories showing modest price increases again. Although we would all prefer more stable conditions that we saw over the last year, this experience has given a view of the effect of diamond supply demand imbalance hitting the diamond market.

Our Luxury brand business had shared the experience of other luxury brands, and significant sales growth as you're going to hear from Cyrille and Frédéric. Perhaps more important than the sales growth itself is that we continue to build the foundations of a strong and bridal jewelry and timepiece business to deliver more predictable growth than can be expected from reliance only on high-end sales. Our Japanese business has been particularly effective in this transition despite the challenges of the tsunami tragedy earlier in the year.

I'm now going to turn the call over to Cyrille. He'll be followed by Frédéric, and then I'm going to return later to discuss the mining operation and the diamond market.

Cyrille Baudet

Thank you, Bob, and good morning, everyone. As Bob and Frédéric will discuss our segment result and operational performance for the quarter, full year and outlook in detail, I'd like to speak about the consolidated and additional financial result for the same periods. Some new items to note this quarter. We have improved the way we are reporting regional sales and segments to provide you with added disclosure. Mining and Luxury brand segments now disclose sales by 4 geographical region, being North America, Europe, Asia, excluding Japan, and Japan. Our geographic regions now reflect where the item was sold. Previously, our sales were based on where delivery took place. We also decided to break out Japan from Asia to better inform you of the source of our pan-Asian sales. As most of you are aware, we are well-established in Japan. The rest is Asia where we have only fairly recently started to develop our business. Additionally, the company now reports a third segment, Corporate, separate from the Mining and Luxury segments to improve visibility on our core businesses. The Corporate segment capture costs not specifically related to operations of the Mining or Luxury brand segment. The Corporate segment mainly attract SG&A.

Also, just a point of clarification, we define high-value transactions as sales in excess of USD $5 million. Now to the results.

For the fourth quarter, our consolidated sales were $216 million with $102 million from the Mining segment and $114 million from the Luxury brand segment. This was slightly up at 4.3% in reported currency or down 3% on a constant currency basis. Higher sales in the Mining segment fully offset sales decline in Luxury brand segments.

Our consolidated gross margin in Q4 were 39.9% of sales, up 560 basis points from the comparable quarter of the prior year at 34.3%. This was driven by the higher gross margin for both the Mining and Luxury brand segments.

Mining gross margin, as a percent of sales in the fourth quarter, was 28.8%. That is 25.2% in the comparable prior year period. Gross margins for Mining benefited from both higher average sales price per carat sold and higher volume of carat sold.

The Luxury brand segment gross margin as a percentage of sale was 49.9% versus 40.1% in the comparable prior year period. The 9.8-point of improvement in the quarter was driven by the product mix, with a higher proportion of sales in fiscal 2011 coming from high-value transaction, which carry lower-than-average gross margin.

During the most recent quarter, there were $6.7 million of high-value transaction compared to -- compared with $48 million in the comparable period of the prior year.

Consolidated SG&A expenses increased 5% to $55.5 million in the fourth quarter, versus $52.7 million in prior year period. SG&A for the Mining segment decreased $1 million in the quarter due to a reduction in professional fees, and on the Luxury brand side, SG&A increased by approximately $2 million in the fourth quarter versus the prior year. The increase was primarily due to higher advertising, marketing and selling expenses and increased rent and building-related expenses. As a result of the sales decrease in the quarter, SG&A as a percentage of sales increased to 44% of sales versus 36% in the prior year period.

Corporate SG&A increased $1.6 million for the quarter, primarily due to travel expenses and salaries and benefits related to additional corporate employees.

Consolidated operating profit for the quarter was up 45% to $30.7 million versus $21.2 million in the prior year, and EBITDA was up 27% to $58.2 million versus $45.9 million in the prior year.

As we have already mentioned on the calls, we believe it's better to evaluate our result on a four quarter basis as the timing of high-value transaction can skew in the middle of a quarter.

Now, to talk about the fiscal year. For fiscal 2012, our consolidated sales were $702 million, an increase of 13%, or 9% on a constant currency basis. These are very good results when you consider disruption during the fall in the rough diamond market and the fact that we held back inventory during the third quarter to wait for better market conditions. Fiscal year Mining sales increased 4% and Luxury brand sales increased 19% or 12% at constant exchange rate.

Our fiscal 2012 consolidated gross margin were $35.6 million. Recall in the third quarter of this year, we took a non-cash paste plant derecognition charge of $13 million. Excluding this charge, our consolidated gross margin would have been $37.5 million, versus the comparable prior year period of $37.9 million. Excluding the paste plant derecognition charge, Mining gross profit margin decreased 50 basis points to 25.9% of sales versus the prior period at -- of 26.4% of sales. The decrease was driven by the result of higher volume of production from the higher cost underground mine.

Consolidated fiscal year SG&A increased by 15% to $193.6 million compared to $168 million in the prior year. Mining SG&A increased by about $2 million due to stock-based compensation and executive severance cost. For the Luxury segment, SG&A spending increased by $20.8 million or 14% for the year, but this was at a pace less than our sales growth for the year of 19%. We ran at a 41% of sales rate for the Luxury brand in the current year versus 43% in the prior year period. The increase in Luxury brand spending was due primarily to higher advertising, marketing and selling expenses, higher variable compensation expenses resulting from higher sales, and increased rent and building-related expenses. The SG&A spending is supporting our growth strategy including storage expansion and ground-building initiatives.

Corporate SG&A increased $2.9 million during the year, primarily due to stock-based compensation, travel expense and salaries and benefits, related to additional Corporate employees.

Fiscal 2012 consolidated operating profit was $56.5 million or $69.5 million, just 10% of sales, when excluding the paste plant derecognition charge. Operating profit excluding the paste plant derecognition charge is up in the last, but down 1 margin percentage point versus the prior year operating profit of $68.3 million, or 11% of sales in fiscal 2011.

Operating profit decreased on the Mining side essentially due to the paste plant derecognition charge and due to the increase in SG&A described previously. On the Luxury brand side, operating profit increased both as a percentage of sales and in absolute dollars. Our profits are still largely being driven by the Mining segment, as the Luxury brand is in a major growth phase. The evolution of Luxury brand profit and EBITDA is very positive, and we continue to be in the free cash-flow generation phase on the Mining side.

When excluding the paste plant derecognition charge, consolidated net profit decreased versus the prior year, primarily due to non-operating items, including higher income tax expense, higher financing expenses related to the Kinross buy-back transaction with the final payment made in August 2011, and the higher mining exploration expenses. The higher income tax expenses, primarily resulted from the revaluation of both non-monetary assets and liabilities, and of the net deferred income tax liability due to foreign exchange fluctuations.

Consolidated EBITDA was $148.2 million this year compared to $145.4 million in the prior year, an increase of 2%. Mining EBITDA was $127.4 million versus $125.7 million, and Luxury brand EBITDA was $31.8 million for this past year versus $27.2 million in the comparable prior year, which is up by 17%. Our liquidity is solid with cash of $78 million and availability under our credit facilities of $124.5 million as of January 31.

As mentioned previously, during the year, we repaid the Kinross promissory note of $70 million plus all accrued interest from cash on hand. The income -- the company is already is in the process of refinancing its senior credit facility for the Luxury brand segment, and the senior secured mining facility has another 2 years expansion available beyond next year's maturity.

Now I would like to turn it over to Frédéric.

Frederic de Narp

Thank you, Cyrille. Overall, this past year has certainly been very good for global brands that sell luxury products. Luxury retailers have recorded strong year-over-year growth in sales. During the year, the industry was confronted by the challenges of the earthquake and tsunami in Japan, as well as the impact of the sovereign debt crisis in Europe. More than offsetting these challenges, the creation of new, young, wealthy consumers in emerging markets continues. These new consumers have a desire for branded luxury products that reflect their status. Tourism from emerging markets, especially from China, has fueled a significant increase in demand for luxury products around the world. These new wealthy consumers are driving demand for branded luxury products in Europe and in the United States, as well as in their local markets. The long-term trend of wealth creation, which is translating into demand for local products is firmly in place. We believe that Harry Winston is very well-positioned to benefit from this trend, which will support our objective of driving sales and profitability growth over the coming years. I will speak more about the next year in a moment, but first I would like to discuss our sales results for the fourth quarter and the past fiscal year.

As you know, each quarter's sales will have variability depending upon the timing of certain high-value transactions. Now the fourth quarter, the sales during the fourth quarter were $114 million, down 14% on a current exchange basis, and lower by 18% on a constant exchange basis. While sales declined in the fourth quarter versus the prior year, gross margin increased to $57 million versus $53 million in the prior year, primarily due to product mix shift.

During the fourth quarter of the prior year, several significant high-value transactions were generated from our Court of Jewels event that were not repeated in the current period. The significant sales were generated in America and in Asia, outside of Japan. The Court of Jewels event were the one-week event held in New York during November 2010 where the company displayed a collection of jewelry and watches with the retail value well in excess of $1 billion, including the historic Hope Diamond, to an audience of celebrities, journalists, and important clients.

Excluding these prior year highlighted transactions, our bridal, timepieces and jewelry collections all performed well, generating significant growth over the prior year. Regionally, and at constant exchange rate, sales for the fourth quarter in Europe were up 79%. Japan was up 10%. North America was down by 11%, and Asia, outside of Japan, was down 68%.

During the fourth quarter, we introduced a new timepiece collection, the Ocean Sports, as well as high-jewelry collection ultimate adornments. We've continued to expand our distribution network with the opening of a new salon in Shanghai in the Peninsula Hotel, as well as a second-licensed salon in Dubai during the quarter.

Gross margin percent for the quarter was 49.9%, representing a significant improvement over the prior year gross margin of 40.1%. As I mentioned, the improvement in margin was driven by product mix, as well as a successful launching of new products, supported by a strong advertising campaign. Operating profit in the quarter was up to $6.8 million, or 6% of sales, compared with $5.3 million and 4% of sales in the prior year quarter.

Now the fiscal year. The sales for the fiscal year were $412 million, up 19% of current exchange rate, and 12% on a constant exchange rate basis. Similar to the quarter, change in the product mix contributed to the 16% increase in gross margin to $188 million versus $163 million in the prior year. All regions generated increased sales over the prior year period on a constant exchange basis.

Plus North America was up by 23%, benefiting from tourists from emerging markets. In addition, we generated significant increases in our bridal and timepieces business, supported by a strong advertising campaign.

In the European region, sales increased by 8% as a result of increasing demand for luxury products from clients from Eastern Europe, the Middle East and Asia, offsetting the challenges of the sovereign debt crisis. Europe's reserves benefited from 2 new licensed salons in Dubai.

In Japan, sales rebounded strongly, increasing by 13% over the prior year, in spite of the impact of the earthquake and tsunami. In Asia, outside Japan, sales were up for the year by 5%. We are focused on expanding our distribution network in China, with the opening of our salon in the Peninsula Hotel in Shanghai in January and our flagship Shanghai salon that just opened last weekend.

Gross margin percent for the year was 45% compared with 47.2% in the prior year. The gross margin increased to $188 million from $163 million. The gross margin percent was impacted by several high-value transactions that generated lower-than-average margins, as well as the cost to launch our new watch collections. We had $67.5 million in high-value transactions this year, versus $54 million in the prior year period. Gross margin benefited from higher sales and improved product mix. Operating profit for the year was $19.4 million and 4.7% of sales, compared with $14.9 million and 4.3% of the -- for the prior year. This past year represents the second consecutive year of increasing sales and profitability for the company.

Let's talk about the outlook now. We believe that the underlying economic fundamentals in place indicate that demand for luxury products will continue to increase over the long term. In the new fiscal year, we will continue to execute our long-term strategy by expanding our distribution network, introducing new jewelry and watch products, using only the finest materials and craftsmanship, increasing financial commitment to promoting the brand, hosting powerful branding events and continuing to strengthen our supply chain. We are thrilled to have opened our largest salon in the world in Shanghai this past weekend, with our grand opening celebration gala scheduled for April 27. The new salon in Harrods in London is scheduled to open during the month of July, increasing our directly operated salons to 22. In addition, we plan to open one licensed salon in Russia in May, and one in Kuwait in the fall, bringing the total of licensed salon to 6. Our wholesale distribution network is planned to expand by 25 to 30 doors to approximately, a total of 220 doors by year end.

We have just returned from the BASELWORLD Fair. The fair represents most important watch event of the year. The overall mood at the fair was very positive. Our new innovative and high-design timepiece products were very well received. We received a great deal of favorable press regarding our new Opus 12, the unique feather watch collection, and our older watch products.

We are reconfirming our long-term vision through 2016 as follows. Growing sales at a compound annual growth in the mid-teens; improving our gross margin to the low 50s; and improving our operating profit margin to the low- to mid-teens. We plan to expand our distribution network to approximately 35 directly operated salons and 15 licensed salons, and to grow to 300 wholesale timepiece doors by the end of fiscal 2016.

These are exciting times. We believe that we have positioned the Harry Winston brand for significant growth in sales and profitability over the coming years. I'm very confident we will achieve our objectives. I would like to pass the call back to Bob.

Robert Gannicott

Thanks, Frédéric. Thank you, Cyrille, as well.

As you see -- would have seen in our press release, our originally planned presentation of a life-of-mine plan has been delayed in recognition of Rio Tinto's announcement of a strategic review of its diamond business, which obviously raises the prospect of possible disposals. We have, of course, presented a forecasted diamond production and operating budget for the coming year, and we would expect to supplement this information at the year and Rio's process proceeds. But in the meantime, I won't make any further comments about the mine, at this time, except to say that A-21. To discuss A-21 a little, the development of the A-21 open pit has completed an advanced initial review already and will now proceed to a, therefore, a shortened final feasibility review. Although the capital cost for this projects -- for this project, I mean, in common with virtually any other capital project in the mining business these days, were higher than has earlier been expected. The return is still very definitely positive, and we believe that these higher costs are definitely realistic in the current environment.

The importance of the A-21 pit is that it brings ore feed to keep the processing plant filled as the underground mine becomes deeper, and the -- therefore, extended hole [indiscernible] distances put pressure on getting tonnes out of the underground.

Looking ahead then, we've already seen the Oppenheimer family surrender their helmsmanship of the diamond business, with the sale of the family's ownership of De Beers to Anglo America and the government of Botswana. The European industry certainly owes them a debt of gratitude for expanding the horizons of diamonds as blood tokens from the restricted market of royal families to their use of most of the developed world's marriage ceremonies. This market expansion roll though is now ably accomplished by the marketing campaigns of the luxury brands.

We now also see the 2 -- the world's 2 largest mining companies both seeking to divest their diamond businesses and the realization that they are not at the scale of their bulk commodity businesses. Diamonds, as a product, are too complex to be treated as a commodity. It's a business for specialists in diamond mining, and particularly, processing and marketing, and/or combinations of those elements. Harry Winston, of course, is one of those specialists. We, therefore, look forward to an interesting and productive year ahead in both segments of our business.

So thanks for listening to us and we're now ready to take your questions. I'm going to apologize in advance for the fact that we have to close the call at 9:25 because we all have to attend the Board meeting. But we've got 25 minutes to deal with questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Des Kilalea from RBC.

Des Kilalea - RBC Capital Markets, LLC, Research Division

Bob, a couple of questions, if I may. The first is, just to read through the release, and maybe you could talk to the CapEx and A-21? And then maybe take us through, if you can, I'm making an assumption that -- the decision as you kind of suggested not to release the mine plan is solely because we have -- would have asked you to, maybe take us through what -- where Harry Winston has rights should Rio decide to dispose -- do you have a right of first refusal, maybe just put in place where you stand on that?

Robert Gannicott

Okay, thanks. There's -- so, 2 questions and I will start off with A-21 now and Ray's going to give you a breakdown of that.

Raymond N. Simpson

Sure, Des, above our line to date, process is just not as if you would do a normal mine development with a very clear-cut pre-feasibility feasibilities. So -- but one of the reasons why the capital has gone up, it's not just inflation. It's -- we were looking with what the different choices we have at the dike that we will put around the pits and mine it. And we've -- now we're now looking at a, I suppose we could say, lower risk option but that is increasing the capital. So we're still going to finalize that capital, and both companies still have to approve that final project. But we hope that, that project will start at the back end of this year, because we need to have some long lead items come up the winter road. Mats, I don't know whether you want to add anything to that?

Robert Gannicott

Okay, thanks. Okay, on the second question, as I recall, first one was whether Rio has specifically asked us if we would defer the presentation of the mining plan, and the answer is yes. They did, understandably. The second question is, rights that we have under the joint venture agreement? But the joint venturer agreement, of course, is a confidential document, but we have in the past said, that we do indeed have a first right to refusal, not of course on Rio's entire diamond business, but a first right of refusal on their 60% interest in Diavik. Does that get us there, Des?

Des Kilalea - RBC Capital Markets, LLC, Research Division

Yes, I suppose. Because of the confidentiality, you wouldn't be able to go any further into whether the change of control, if indeed, there was a change of control. At a beneficial level or a natural asset level, are you able to go into any of those kind of details? Or is that treading into confidential also?

Robert Gannicott

I think there's just -- getting a bit too lawyerly for this conversation. No, I mean, it's obviously the intent of the -- of a first right of refusal is clear, and I would stress that we've always -- we've never had any issues in both Rio Tinto and ourselves treating one another properly with regard to the intent of the joint venture.

Operator

Your next question comes from the line of Irene Nattel, RBC Capital Markets.

Irene Nattel - RBC Capital Markets, LLC, Research Division

Just following up on a similar line of questioning. In the past, Bob, you've said that you were interested in acquiring pre-production assets. Has your view changed, given the recent announcements out of BHP and Rio?

Robert Gannicott

No, it hasn't changed, but I mean obviously, we're interested in -- at any assets like that, that are relevant to our sphere of expertise, which it's certainly, we've got a Northern Canadian focus to it. But brownfields projects, greenfields projects, as long as they're well defined, we're certainly interested.

Irene Nattel - RBC Capital Markets, LLC, Research Division

That's great. And if we could just switch gears for a moment to focus on the Q4 results and the trends in Q1, both in terms of rough diamond demand and also luxury goods demand. As we're seeing some better overall tone in the economy, certainly, we see it in the equity market, can you comment on the nature of demand that you're seeing, where you're seeing the biggest growth. You noted in the press release that we are seeing some strengthening coming out of the U.S. If you could speak to that, please?

Robert Gannicott

Let me just speak to -- Frédéric will speak to that, with respect to the brand business, of course. But if you like, we see the same thing, of course, on the rough diamond side. One thing I would stress is, the first is the watch, the demand for watches. That with many of the loved one -- many of the watches for ladies being dressed with diamonds has had a dramatic effect on the pricing of those, the raw material for those stones. And -- so that in fact, they're the prime example of an item that went shooting up in price in the first half of the year, and has not given up any of those gains at all. In fact, it has added more to it. At the other end of the scale though, of course, the cheaper goods that face both competition from Marange and perhaps some wobbles in consumer markets like India, have a been more challenging in their price. But the -- unfortunately, these items don't mean a lot to our own production. But Frédéric, you want to comment from the retail side?

Frederic de Narp

Yes, I mean, exactly what you're seeing on the watch segment, we've seen, during the BASEL show, I mean, a large move and shift after SIHH and the BASEL fair which are the 2 watch salons yearly, we've seen many watch brands that are permanently men's watch brands changing and targeting the feminine segment, much more than ever this year, so that also shooting the demand for diamonds, for the watch segment. For the bridal segment, it's been steady. With or without any crisis, Bridle is still growing on and on. We see it in our bridal segment. We see in the marketplace, not only in China, that is a market discovering the diamond as a symbol of love, the engagement ring. Still we see about -- -- only 30% of the Chinese women with an engagement rings, while in America, and in Japan, you have more than what -- 80% of the women with an solitaire engagement rings. But at this very moment, we see a large demand. For the brand Harry Winston, it's reinforced. The bridal segment is increasing and the rate of increase is even stronger for engagement ring under $80,000 for the most accessible segment for us, which is extremely exciting.

Operator

Your next question comes from Oliver Chen, Citibank.

Oliver Chen - Citigroup Inc, Research Division

On regarding the Mining segment and thinking about the inventory that you may have held over in terms of selling in '12, what's the context of that happening? And also, are there any more Zimbabwe, kind of, overhang on the average price per carat which may impact the average price per carat of '12? Do you feel like into the 120 that just occurred, as a base from which the price may increase?

Robert Gannicott

Okay, well, first of all, our price per carat, of course, is made up -- is affected greatly by the mix of material that actually goes through the processing plants. Some parts of the -- we're mining from 3 different ore bodies, and in fact, that they were also reprocessing some material from the early days of the mine, which have [indiscernible] almost constitutes a fourth orebody in [indiscernible]. So there are at least different sources that go through the mill, and the proportions that go through the processing plant determine the proportions of small versus larger diamonds that come out of the end, and that very largely affects the price. In terms of the -- of our stockpiling, if you like, we have pulled that down substantially since the beginning of the year. And we actually only have only a couple of tens of millions now of stock beyond what we have in normal working stock, work in progress, as it were. We don't -- we're not doing this because the diamond, because we couldn't sell it. We're doing it because having the advantage of having the Luxury brand business and its demand for polished diamonds, we're able to have a view, a very quick and early view of what items are in demand. And therefore, which items are going to rise in price in the rough diamond end. And it sometimes, it makes more sense to hold onto the diamonds while the price rises, rather than realizing the value and then receiving very little interest for the cash instead of putting into the bank. So that's how we manage our stock piling process. Zimbabwe production, the merengue production, the issues during the last year was that the goods piled up in Zimbabwe because they were not granted export permits and certification under the Kimberley Process. Since about the third quarter of last year, the export licenses were granted, certification was given, so that we now have a steady flow of these goods coming out of the Marange fields in Zimbabwe. And although they are taking their place in the diamond markets, they're not really displacing very much of their material. Other than perhaps, the very, very cheap and where prices have gone down quite a bit. I mean, I don't mean these are not material that are making gems. They're material was used in industrial bort. Things like that. But it doesn't really affect us very much going forward. But our realized diamond price is very much a factor of what the ore release is from the individual ore zones within the mine and how much of the reprocessed material is added into the processing plant as well. So you can just refer to our year forecast and the diamond prices that are attached to that and actually make your own estimate for the year.

Oliver Chen - Citigroup Inc, Research Division

And my second question is related to the M&A market at large in the market place. Could you comment broadly on what you're seeing in valuation multiples and also given the limited and special nature of diamond supply, and what do you think about the marketplace and potential bidders? It feels like there's a wide spectrum of potentially interested parties from strategics to financials?

Robert Gannicott

I don't -- Look, I'm not going to comment too much on this for obvious reasons. But I guess what I would say is, it looks to me like a narrowed field. I mean obviously, when at the time when there were 3 large, 3 of the world's largest mining companies and role players in diamonds that this was a broader field than it is now, where there's only one of the super majors, if you like, Anglo American is the only one that's actually a part of that diamond business now. And I think it's my own view is it is a very specialized business. The mining part of it is pretty much the same as it is, for anything else, but beyond that to be able to process the ore properly, to be able to sort, sell, to realize the full market price for rough diamonds is a very specialist trade. It's not something that's easily undertaken by someone that's just a financial investor that wants to be invested in the diamond business. I think we will always require at least the strategic partnership of someone that's got the broader knowledge base.

Oliver Chen - Citigroup Inc, Research Division

And finally on the luxury side, we were very impressed with the product portfolio at BASEL. A couple of questions, in terms of watches, as a percentage of mix, what -- how many basis points do you think that watches will increase as a percentage of mix in '12 approximately? And then lastly, on luxury, in terms of our financial modeling, on a go forward basis, are there any quarters in which we should think about potential high-value sales occurring? And also, you gave some great information about high-value sales from last year, are we anniversarying any high-value sales that we should know about, in particular quarters in the year that we just closed?

Frederic de Narp

Right. The first question on the watch mix. Watches are still representing a very small part of the business of our own salons. So we weren't going to tackle that. It's too minor, and we should be able to sell minimal watches. So we are starting a new experience, it was the -- by opening the largest salon in the world. I was talking about in Shanghai, Xin Tian Di, last weekend. This is a real first salon where you have an entire watch salon inside our own salons, which watch advisers, watch assortments, watch strategy around it. So we want to sell more watches through our own salons. That's the first part, to create more traction on this watch segment. The watch segment today is less than 1/3 of our business well under 1/3 of our business and there is no limit to what watch could represent for our brands that has such perception in the watch segment and I see it when we sell watches at $250,000 like le Opus [ph] and they are all sold out for this time at Basel, for example. So watch is still an -- is a superstrong priority for the next 24 months. High-value transactions, not that I can share with you at this very moment, what I can tell is that we did a quote. We want to do a regularly huge event, we did the Court of Jewels huge event in November 2010. Now our huge event of the year takes place at 27th of April, and again, we want to leverage this event worldwide. We will have press from all over the world, and VIP clients from all over the world. And do expect from this moment, yes. So potentially, second quarter but not that I can share more.

Operator

Your next question comes from the line of Seth Peterson, Berenberg Bank.

Seth Peterson - Berenberg Bank, Research Division

Two questions, one regarding the mine and one regarding luxury. When we talk about the mix of ore coming from the different pipes, if I understood in the release today, there'll be approximately 1 million carats coming from the A-154, and 1 million coming from the A-418. And I believe you've said that approximately half of the carats coming from A-154 will be from South and about 50% will be coming from North. Do you have a similar waiting for A-418 that you could give us? And did I interpret that correctly?

Robert Gannicott

Well I'll ask Ray to comment on the actual numbers but just to point out A-418, there is only one A-418. Part of it is being mined on open pit and part from underground. But it's only one orebody, one ore-type now. Whereas A-154 South does have a North pipe and a South pipe, A-154, sorry. I said, North pipe and a South pipe. And they are -- they behave differently in a mining sense and the diamonds in them are different, too. A-154 North are the best diamonds that we have in the entire suite. But it's somewhat lower grade. So you've got sort of lower carats per ton but a higher value per or carat. A-154 South is the one that's got the highest grade. A-418 has a good grade, but the diamond production is finer, so the average price is lower. Ray, do you want to comment on the mix?

Raymond N. Simpson

Just to add to Bob's comment there. The A-418 orebody, we used to define it in 2 different types, the A type and the B type. The B type had lower-value diamonds, really was a 5 distribution, a smaller average size for those goods. When mining this pipe, they found it quite difficult during the mining process to differentiate between the 2 types of ore. So in our outlook, we didn't want to split those 2 types of ore because the mining engineers and the operators were not sure exactly, of that mix. So going forward, we intended to look at this orebody as a whole, as Bob described, as one orebody that has these 2 parts. And we may well change it in the future when we give an indication of diamond price for each of the pipes we may well roll those 2 parts together. But other than that, I think your numbers were pretty much right, and understanding the difference between the grade and the tonnage between each of the pipes. So the only thing we have to accept with the change before looking at 418 as one orebody is a little less accuracy of forecasting of value. But of course, we don't intend to put that in our releases, anyway. so Mats, I don't know whether you've got anything to add?

Mats Heimersson

Not really. I think it covers the [indiscernible].

Seth Peterson - Berenberg Bank, Research Division

And then the question regarding luxury, should we assume that there will be a continued increase in marketing expenditures this year and should we assume that in percentage terms, the amount will be similar to what it was last year? Or will it be higher?

Frederic de Narp

Well, now entering this new year, you should expect the gross margin to increase and the mix shift, the mix and product shifting having great result to the bottom line. So quarter-after-quarter, and therefore, while we're increasing our gross margin, we will be increasing a little bit on marketing spend quarter-after-quarter. Cyrille, you want to bring some more color?

Cyrille Baudet

Yes, if you want to look at our SG&A, you -- because of these huge cost base that we have in Switzerland, you really want to look at that on a constant exchange basis. And the number that you have from FY '12 to -- FY '11 to FY '12, is at constant exchange basis on sales, have increased 12%. Our gross margin have increased 8% and our SG&A have also increased 8%. So we have preserved our ability to deliver operating result and we've not increased it. And of course, the intention is to grow the SG&A at a lower pace than gross margin. But in order to do that, we need to carry on changing the product mix in ourselves and we need to gain some more volumes in order to have some scalability, if you want.

Seth Peterson - Berenberg Bank, Research Division

In theory, in any given quarter, we may see some fluctuations. But for the year, we should assume that in percentage terms, there will be no major increase?

Frederic de Narp

Yes, there should be an increase that goes at a slower pace than the increase in margin. Of course, as we're opening stores, we're going to expense new rent, expense new depreciation. But the objective is clearly to start growing the margin at a much faster pace than the growth of SG&A.

Seth Peterson - Berenberg Bank, Research Division

To be clear then, is that the objective for the current fiscal year? Or is that more likely to be something that will happen in coming years?

Frederic de Narp

It's an objective that should materialize in the current fiscal year.

Operator

Your next question comes from the line of Brian MacArthur, UBS.

Brian MacArthur - UBS Investment Bank, Research Division

I just want to explore the plant rejects. Basically, you're talking about getting what looks like to be 1 million carats from that this year, and from 200,000 -- an extra 200,000 tonnes of process which indicates as a fair bit of this. Can you just tell me whether that's likely to continue for a while, like how much of this stuff is lying around, because yes, it's lower valued carat, but it's meaningful volume. And B the second question, is whether it's on your balance sheet anywhere in broken ore or anything like that? Is just this kind of like a free option to the mine plan going forward?

Robert Gannicott

yes, first of all, let's talk about where it came from, is that in the early years of the mine when it was very easy to get large tonnages of high-grade material out of the top of the A-154 set, basically, the processing plant was running at high capacity. With -- and intentionally not reprocessing course rejects. In other words, the material that floated in the dense media separation that was in the cut above 6 millimeters, was actually being put out into a separate pile in the not really the tailings area, but alongside it. So these -- we always knew they were there. We knew why were there. it's not because there was something wrong with the plant. It was a conscious decision in order to get a higher velocity of primary processing through the plant. And not using the plant capacity to deal with recrushed material, particularly at a time when small diamonds were not of the same price as they are today. What I talked about earlier on the call, the demand driven by the watch business for small white stones has increased the prices for lots -- so these are an attractive product. They are not an ore reserve. They don't constitute any kind of measured resource. They are, as you said, like a bonus as it were. How much is there of it? Ray do you have a?

Raymond N. Simpson

Sure. Yes, so this year, is the peak production, probably for specific diamonds. So we will hope to get more diamonds again next year, but at a lower level and we'll have a little bit left in the 2014 to clear up. I would also add though, that particularly with the small diamonds doing well in pricing, we are going to be developing and adding circuits to the recovery plant that will help recover small diamonds. So what you will see is an increased recovery rate for the small diamonds on an ongoing basis. So this isn't specifically from the RPR. It's just from normal production, but it's beyond what we're recovering in a moment. And that should flow forward through the rest of the life of the mine. So again, just to summarize, back to the RPR, it's at its peak level this year. It will come down to something like 20%, 25% next year on a volume basis, and then there's a little bit left on the first year after that, in 2014.

Brian MacArthur - UBS Investment Bank, Research Division

And sorry, just to follow up, when you give the diamond price guides from the pipes right now then, would any of those small diamonds be weighted into that average price?

Raymond N. Simpson

No, they're not currently. They are based upon the sort of like, if you like a reserve statement average price.

Robert Gannicott

We'll take one more question, and then I can see that we've got 3, I think questions queued on the screen here. And I, just to apologize to anybody that we don't get to, and we will put you at the top of the list, once we get out of our Board meeting.

Operator

The next question is from Des Kilalea of RBC.

Des Kilalea - RBC Capital Markets, LLC, Research Division

Bob and Ray, could you please just repeat, sort of speak to the liquidity and the cutting centers, and whether you see any kind of restrictions, particularly in India, to normal trade the rest of this year?

Robert Gannicott

Well, I've got some perspective on that from what -- we have an office in India as you know. Certainly, I think liquidity has eased from the very tight conditions that were imposed, much earlier in the year. But because the debt facilities are provided that are provided to that part of the diamond industry tend to be from the European banks, there's obviously still some nervousness about banking in Europe in general. But as that nervousness eases, with the kind of the Euro crisis getting at least put on -- put in abeyance for a while, there has been more credit available to the industry. So I don't really see it is a constraint, I actually see it as something that has helped the industry to get itself out of bad habits of, you're pretty well aware Des, I mean, the polishing industry used to be providing goods into, particularly North America on like 180-day credit terms. And even if they weren't met they just rolled over the credit facility, well that, it’s now become much more of a cash business and short-term credit, which is healthier all around in my view.

I'm afraid then we'll have to close the questioning now. Well, I want to thank you all for joining us. We're happy to take follow-up questions. If you direct the follow-up questions through either Richard Chetwode or through Laura Kiernan in New York, or Kelley Stamm, here in Toronto, they'll make sure that they quickly get answered. I would also like to draw your attention to the fact that we are running an Analyst and Investor Day in New York on May 10 where we're not just going to discuss the company, but we're going to discuss the diamond industry broadly, and set the what we do in the company into that context. It'll be an opportunity to meet the broader management team in North America, as well as where we plan to showcase some of our products there, of course. And if you'd like to attend that, then please contact Kelley, Kelley Stamm, who is sort of keeping the book on registration for us. So thanks very much for joining us.

Operator

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.

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