Harry Winston Diamond Corporation (HWD) F3Q08 Earnings Call December 13, 2007 9:00 AM ET
Nancy Murray – V.P. Investor Relations & Communications
Robert Gannicott – Chairman & CEO
Thomas O’Neill – President
Alice Murphy – V.P. & CFO
Welcome to the Harry Winston Diamond Corporation third quarter fiscal 2008 webcast. We are pleased to report strong first quarter operating results. We delivered a 22% increase in consolidated sales and a 79% increase in earnings from operations, both driven by the mining segments carat production and rough diamond sales. While we posted these record results we continue to invest in our retail businesses calibrated salon expansion that positions us for long-term growth.
The agenda for the presentation today includes Bob Gannicott, Chairman and CEO, who will comment on our mining segment. Tom O’Neill, President of Harry Winston Diamond Corporation and CEO of Harry Winston Inc. will discuss the retail segment and then Alice Murphy our CFO will provide the quarterly financial review.
Please note that we will make some forward-looking comments today. The principal risk that could cause our results to differ materially from our current expectations is detailed in the OSC and SEC filings.
Now let me turn the call over to Bob.
Thanks Nancy and good morning. As this is our first earnings call under the new name of Harry Winston Diamond Corporation, I’d like to spend my time today discussing what we know best, which is diamonds. The Diavik Mine continues to exceed expectations by any measurement, whether it is grade, throughput or production of white diamonds and we continue to supply our customers with not only finely delineated assortments, but with the quality of stones that is our hallmark. The [delinkage] of rough diamond sales to the polished diamond purchases of the company, we have continued to more closely align our rough diamond prices with price increases in polished diamonds.
On the mining side, this reported quarter saw a 10% increase in diamonds recovered over the same period last year. Our share of the mine [inaudible] production for the quarter was more than 1.2 million carats. That brings our portion of the year to date production to 3.6 million carats at a grade of 4.95 carats per tonne. Continued improvements in the processing plant have led to increased diamond recovery. The increase in carat production that resulted in higher grade and better plant utilization continues to underscore Diavik’s position as a world class mine and operation.
Production for the quarter was predominantly from the A-154 South pipe to some production from the A-154 North pipe, as it is being prepared for underground mining. In addition, the removal of overburden and waste [inaudible] stripping continued in the A-418 open pit where mining is forecasted to begin during the second calendar quarter of 2008.
Our rough sales business continues to be strong as rough diamond demand outpaces worldwide production. We are focusing our state-of-the-art sorting facility in Toronto on the larger stones for sorting, while adding capacity in other localities for the smaller stones. While we have 10 primary sales during the year, we are moving to a smoother selling schedule by increasing supplementary sales throughout the year from our growing offices in the diamond centers of Israel and India.
During the quarter Rio Tinto plc., the operator of the Diavik Diamond Mine, approved a two-year capital program to complete the development of an underground mine which secures the future of the Diavik project beyond 2020. With this new development plan in hand Harry Winston is now well advanced in extending its existing debt facilities, which together with cash flow from operations, will fund Harry Winston’s $218 million share of the capital investment.
To ensure prudent fiscal management we have elected to reduce the dividend to $0.05 per quarter during this construction period. The important point of the plan is that it takes production underground beginning in calendar 2009. The diversity of both open pit and underground mining supports Diavik’s ability to maintain production through seasonal changes. We would expect the mine to transition fully to underground by 2012 when we will then be able to more fully access the lower portions of the orebodies of A-154 South, A-154 North and A-418. In addition we would expect for the [size], reserve and resource estimate to be completed in the first calendar quarter of 2008.
The investments in Diavik and the Harry Winston brand are important requirements for our future growth and long-term shareholder value. Now let me turn the call over to Tom to discuss the Harry Winston retail business.
Thank you Bob, good morning. The world wide demand for high end diamond jewelry and watches continues to be robust in most markets. We are pleased with our sales for the first nine months and to report $180.6 million in sales which represents and increase of 18% over the comparable period last year. Our sales growth continues to validate our salon expansion program that we are committed to implementing over the next few years.
The year to date sales increases were dampened in the final months of the third quarter by two situations. Our Paris salon, as you may have seen in media reports, was robbed in early October. Our first and always, our primary concern, is for our employees’ and clients’ safety. We were relieved that no one was seriously harmed. Our merchandise in the salon was fully ensured. Second, since the majority of our domestic business is New York City driven, the uncertainties on Wall Street resulted in softer U.S. sales. While we see continued demand for our diamond jewelry and watches, it’s important to note that quarterly variations are a reality in our high end jewelry business. Our growth strategy is consistent with this positioning and it is one that has protected and enhanced the Harry Winston brand over its storied past and its very great future.
Harry Winston is at the very top of the consumer pyramid and our investors understand and endorse this essential position. The very top of the pyramid is supported by the wealthiest people throughout the world. These valued consumers are our clients. Our strategy focuses on three key areas. First, our jewelry is set with the highest quality diamonds available. Second, we remain committed to rarified jewelry and watch designs from the House of Harry Winston. It really is the differentiating factor in our business. Our pieces are limited, handcrafted creations. Third, Harry Winston designs are best presented in a limited number of salons in important locations throughout the world.
Our customers come to us for very specific jewelry and for our watches, as well as a very specific sales experience that is our hallmark. With our clear strategic focus we believe there are opportunities to expand our current network of salons to about 40 select locations over the next several years. Our growth calls for ongoing investment, both financially and operationally, to successfully broaden our global reach. In this spirit we continued to expand our international presence, by opening a salon in Hong Kong in late September. The Hong Kong salon located in the Peninsula Hotel is boutique-side and its merchandise focus is on specialized jewelry and watches. In addition we opened our timepiece facility in Geneva, Switzerland during the third quarter. This manufacturing operation allows virtually all timepiece operations to be housed in one area and substantially increases our manufacturing capability to support our growing watch business. The facility enables us to bring our timepiece expertise under one roof and provide a streamlined approach that is essential for us to extend our production capacity to meet the growing global demand.
Since the quarter ended, we opened our seventh U.S. salon in late November with a flagship store in Chicago on Oak Street. Later that same week, we opened a salon in Nagoya, Japan, also a flagship, bringing our global network of retail stores to 18. The customer response to our new salons has been positive and we believe we are now well positioned in these new markets.
Again, we are very excited about our business and very focused on our long-term growth opportunities for our unique Harry Winston brand. So now let me turn the call over to Alice to discuss the quarterly results.
Thank you and good morning. It was a strong operational quarter. We posted record consolidated sales, a 910 basis point improvement in gross margin rate and improved our expense leverage as a percentage of sales by 291 basis points. The 79% increase in quarterly consolidated earnings from operations was more than offset below the line with a significant foreign currency loss. As those who follow us know, our foreign currency exposure has a material influence on our reported net earnings. While [inaudible] and reporting currency is in U.S. dollars, our income tax expense is based in the currency of origin. As such, our earnings are continually subject to foreign exchange fluctuations, a large part of which is unrealized. The company’s currency exposure relates mainly to expenses and obligations incurred in Canadian dollars.
During the third quarter which ended October 31, 2007 the Canadian dollar strengthened 13% relative to the U.S. dollar. This resulted in a significant foreign exchange currency loss of $40.6 million or $0.70 per share. That compares to a $1.6 million foreign exchange loss or $0.03 per share in the third quarter fiscal 2007 and represents a $0.67 per share foreign currency loss swing over the prior year. Taking into account this unrealized foreign currency loss, our interest expenses and other income, we reported third quarter earnings before taxes of $18.9 million compared to $31.8 million last year. As the foreign exchange charges are not tax deductible, we recorded a tax provision of $26.2 million in the third quarter this year as compared to a $13 million tax expenses in the prior year’s quarter. Currently the foreign exchange rate is close to par. If this exchange rate were to continue to January 31, 2008 year end, we would expect a foreign exchange gain in the fourth quarter.
Now let me spend a few minutes on the financial review of our individual segments. It was a stellar quarter for the mining operation with diamonds recovered up 10% and operating costs per carat flat to last year. Sales from the mining segment increased to $122.7 million in the third quarter with the company holding three primary sales during the quarter as compared to two primary sales last year. It is important to note that the primary sales will begin to be less of a fixed metric in the future as we can begin to accommodate a more even flow of sales throughout the quarter through our rough sales operations in Belgium and expanding operations in Israel and India.
Mining earnings from operations were $70 million for the quarter representing a 72% increase. This increase was driven by a 12.6% growth in gross margin rate reflecting higher carat production.
Turning to our retail segment, we faced a more challenging environment in the U.S. during the third quarter that offset retail sales gains internationally. Our international business, which consists of 10 salons in Europe and Asia, posted quarterly sales gains of 16% driven by existing salons and three new salons opened abroad since the beginning of the fourth quarter last year. Offsetting strong international sales was the affect of a robbery in our Paris salon in early October. As Tom said, the company is fully ensured for the inventory loss and we expect to record a pre-tax gain of approximately $13 million in the fourth quarter reflecting the anticipated insurance settlement.
In the U.S. where we operated six salons during the quarter we believe sales were negatively impacted by the volatility in the U.S. financial markets. As a result we experienced a 22% or a $5.5 million decrease in sales. Although there was a slight expansion in the retail segment’s gross margin rate and SG&A expenses were relatively flat to last year, the year over year sales decrease resulted in a loss of $3.6 million for the quarter as compared to a $3.5 million loss last year. Included in the prior year’s comparable quarter’s SG&A is a $6.3 million for [sell] compensation triggered by the acquisition of the remaining portion of the Harry Winston Inc. business.
Capital expenditures for the quarter were $61.8 million, was $49.9 million for capital commitments for the mining segment and $11.9 million for new and refurbished retail salons. On a longer term basis our two year $218 million capital commitment to underground mining will be funded from a combination of cash from operations and existing debt facilities.
In closing we would like to thank you again for joining us this morning and for your interest and support in Harry Winston Diamond Corporation. We look forward to sharing our full year results in early March.
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