Harry Winston Diamond Corporation Announces Second Quarter Fiscal 2009 Results

TORONTO, Sept. 9 /PRNewswire-FirstCall/ -- Harry Winston Diamond Corporation (TSX: HW; NYSE: HWD) today reported second quarter results for the period ending JulyÃ‚Â 31, 2008. The Company recorded an increase in consolidated sales for the quarter of 7%, generating a 23% increase in gross margin and a 30% increase in consolidated earnings from operations compared to the results of the second quarter of the prior year. Consolidated quarterly sales totalled $186.1Ã‚Â million with earnings from operations of $73.4 million compared to $173.3 million and $56.2 million, respectively, for the comparable quarter of the prior year.

Net earnings were $49.9 million, or $0.81 per share, compared to net earnings of $20.1 million, or $0.34 per share, respectively, in the second quarter of the prior year. Net earnings for the comparable quarter of the prior year were reduced by a net $11.8 million foreign exchange loss, or $0.20Ã‚Â per share, as a result of the strengthening of the Canadian dollar relative to the US dollar, compared to a net $5.3 million foreign exchange gain in the current quarter, or $0.09 per share.

"The international cachet of the Harry Winston brand has proven its strength despite difficult trading conditions in both the US and Japanese markets. This expanded market place has also delivered strong pricing for our rough diamond sales in the face of lower than anticipated production from the Diavik Mine as we work through the transition from one open pit to the next and the uncertainty in production forecasting that this entails. The construction program to develop the underground portions of the ore bodies that add lifetime and operational security to the project is well advanced and comfortably within schedule and cost budgets," said Robert A. Gannicott, Chairman and Chief Executive Officer.

Thomas J. O'Neill, President of Harry Winston Diamond Corporation added, "Our businesses in Asia, Europe and the Middle East have been sufficient to offset the general market softness in the US and Japan; this contributed to our strong retail finish for second quarter. Together with solid results from the first quarter, the first half of the year has put us on firm footing into the second half of the year."

Earnings from operations for the mining segment increased 27% to $67.5Ã‚Â million compared to the comparable quarter of the prior year. Rough diamond production for the second calendar quarter was down 23% to 1.0 million carats produced versus 1.3 million for the comparable quarter of the prior year resulting from the continuing grade variation in the A-154 South pipe and the initial stripping of low grade A-418 ore mixed with waste overburden material. Mining sales of $105.0 million remained at a consistent level with the prior year as higher diamond prices compensated for reduced volume.

The retail segment recorded a 19% increase in sales to $81.1 million with earnings from operations of $5.9 million compared to earnings from operations of $3.2 million in the comparable quarter of the prior year. Retail segment SG&A as a percentage of sales decreased to 42% in the second quarter from 43% in the comparable quarter of the prior year.

Second Quarter Fiscal 2009 Financial Highlights (US$ in millions except Earnings per Share amounts) ------------------------------------------------------------------------- Three Three Six Six months months months months ended ended ended ended Jul. 31, Jul. 31, Jul. 31, Jul. 30, 2008 2007 2008 2007 ------------------------------------------------------------------------- Sales 186.1 173.3 342.2 314.6 ------------------------------------------------------------------------- Earnings from operations 73.4 56.2 113.0 92.3 ------------------------------------------------------------------------- Net earnings 49.9 20.1 71.2 23.3 ------------------------------------------------------------------------- Earnings per share $0.81 $0.34 $1.17 $0.40 ------------------------------------------------------------------------- Dividend Announcement

Harry Winston Diamond Corporation is pleased to declare an eligible quarterly dividend payment of US$0.05 per share. Shareholders of record at the close of business on October 15, 2008, will be entitled to receive payment of this dividend on October 29, 2008.

Conference Call and Webcast

As previously announced, Harry Winston Diamond Corporation will host a conference call for analysts, investors and other interested parties on Wednesday, September 10, beginning at 10:00AM EDT. Listeners may access a live broadcast of the conference call on the company's investor relations web site at http://investor.harrywinston.com/ or by dialing 866.713.8564 within North America or 617.597.5312 from international locations and entering passcode 73778735.

An online archive of the broadcast will be available by accessing the company's investor relations web site at http://investor.harrywinston.com/. A telephone replay of the call will be available one hour after the call through 11:00PM (EDT), Wednesday, September 24, 2008, by dialing 888.286.8010 within North America or 617.801.6888 from international locations and entering passcode 16919976.

Information in this news release that is not current or historical factual information may constitute forward-looking information or statements within the meaning of applicable securities laws. Implicit in this information, particularly in respect of statements as to future operating results and economic performance of Harry Winston Diamond Corporation and statements about the Diavik Diamond Mine, are assumptions regarding world economic conditions, projected revenue and expenses, diamond prices, construction timelines and budgets, ore grades and the Canadian/US dollar exchange rate. These assumptions, although considered reasonable by Harry Winston Diamond Corporation at the time of preparation, may prove to be incorrect. Forward-looking information is subject to certain factors, including risks and uncertainties, which could cause actual results to differ materially from what we currently expect. These factors include, among other things, the uncertain nature of mining and mine development activities, risks associated with underground construction activities, risks associated with joint venture operations, risks associated with the remote location of the Diavik Diamond Mine site, risks associated with regulatory and financing requirements, fluctuations in diamond prices, changes in world economic conditions, increased competition from other luxury goods retailers, changes in consumer preferences and tastes in jewelry, and the risk of continued fluctuations in the Canadian/US dollar exchange rate.

About Harry Winston Diamond Corporation

Harry Winston Diamond Corporation (TSX: HW; NYSE: HWD) is a specialist diamond enterprise with assets in the mining and retail segments of the diamond industry. The company supplies rough diamonds to the global market from its 40% interest in the Diavik Diamond Mine, located in Canada's Northwest Territories. The company's retail division, Harry Winston, Inc., is a premier jewelry and timepiece retailer with salons in key locations including New York, Paris, London, Beijing, Tokyo and Beverly Hills. For more information, please go to http://www.harrywinston.com/ or for investor information, visit investor.harrywinston.com.

Highlights (All figures are in United States dollars unless otherwise indicated)

The Company recorded an increase in consolidated sales for the quarter of 7%, generating a 23% increase in gross margin and a 30% increase in consolidated earnings from operations compared to the results of the second quarter of the prior year. Consolidated quarterly sales totalled $186.1Ã‚Â million with earnings from operations of $73.4 million compared to $173.3 million and $56.2 million, respectively, for the comparable quarter of the prior year.

The retail segment recorded a 19% increase in sales to $81.1 million, with earnings from operations of $5.9 million compared to earnings from operations of $3.2 million in the comparable quarter of the prior year. Retail segment SG&A as a percentage of sales decreased to 42% in the second quarter from 43% in the comparable quarter of the prior year.

Management's Discussion and Analysis Prepared as of September 9, 2008 (all figures are in United States dollars unless otherwise indicated)

The following is management's discussion and analysis ("MD&A") of the results of operations for Harry Winston Diamond Corporation (the "Company") for the three and six months ended July 31, 2008, and its financial position as at July 31, 2008. This MD&A is based on the Company's consolidated financial statements prepared in accordance with generally accepted accounting principles in Canada ("Canadian GAAP") and should be read in conjunction with the unaudited consolidated financial statements and notes thereto for the three and six months ended July 31, 2008 and the audited consolidated financial statements of the Company and notes thereto for the year ended January 31, 2008. Unless otherwise specified, all financial information is presented in United States dollars. Unless otherwise indicated, all references to "second quarter" refer to the three months ended July 31, 2008 and all references to "international" for the retail segment refer to Europe and Asia.

Certain comparative figures have been reclassified to conform with the current year's presentation.

Caution Regarding Forward-Looking Information

Certain information included in this MD&A may constitute forward-looking information within the meaning of Canadian and United States securities laws. In some cases, forward-looking information can be identified by the use of terms such as "may", "will", "should", "expect", "plan", "anticipate", "believe", "intend", "estimate", "predict", "potential", "continue" or other similar expressions concerning matters that are not historical facts. Forward-looking information may relate to management's future outlook and anticipated events or results, and may include statements or information regarding plans, timelines and targets for construction, mining, development, production and exploration activities at the Diavik Diamond Mine, future mining and processing at the Diavik Diamond Mine, projected capital expenditure requirements and the funding thereof, new salon openings, liquidity and working capital requirements and sources, estimated reserves and resources at, and production from, the Diavik Diamond Mine, the number and timing of expected rough diamond sales, expected diamond prices and expectations concerning the diamond industry, expected cost of sales and gross margin trends in the mining segment, and expected sales trends in the retail segment. Actual results may vary. See "Risks and Uncertainties" on page 18.

Forward-looking information is based on certain factors and assumptions regarding, among other things, mining, production, construction and exploration activities at the Diavik Diamond Mine, credit market conditions and the ability of the Company to refinance its existing credit facilities, the level of worldwide diamond production and world and US economic conditions. Specifically, in estimating Harry Winston Diamond Corporation's projected share of the Diavik Diamond Mine capital expenditure requirements over the next two years, Harry Winston Diamond Corporation has used an average Canadian/US dollar exchange rate of $0.99, and has assumed that construction will continue on schedule and without undue disruption with respect to current underground mining construction initiatives. In making statements regarding estimated production at the Diavik Diamond Mine and future mining activity and mine plans, including plans, timelines and targets for construction, mining, development, production and exploration activities at the Diavik Diamond Mine, and future rough diamond sales, Harry Winston Diamond Corporation has assumed, among other things, that mining operations and construction and exploration activities will proceed in the ordinary course according to schedule and consistent with past results. In making statements regarding expected diamond prices and expectations concerning the diamond industry and expected sales trends in the retail segment, the Company has made assumptions regarding, among other things, world and US economic conditions. While Harry Winston Diamond Corporation considers these assumptions to be reasonable based on the information currently available to it, they may prove to be incorrect. See "Risks and Uncertainties" on page 18.

Forward-looking information is subject to certain factors, including risks and uncertainties, which could cause actual results to differ materially from what we currently expect. These factors include, among other things, the uncertain nature of mining activities, including risks associated with underground construction and mining operations, risks associated with joint venture operations, risks associated with the remote location of and harsh climate at the Diavik Diamond Mine site, risks associated with regulatory requirements, fluctuations in diamond prices and changes in US and world economic conditions, the risk of fluctuations in the Canadian/US dollar exchange rate, financing and credit market risk, risks relating to the Company's salon expansion strategy and the risks of competition in the luxury jewelry segment. Please see page 18 of this Interim Report, as well as the Company's Annual Report, available at http://www.sedar.com/, for a discussion of these and other risks and uncertainties involved in Harry Winston Diamond Corporation's operations.

Readers are cautioned not to place undue importance on forward-looking information, which speaks only as of the date of this Management's Discussion and Analysis, and should not rely upon this information as of any other date. Due to assumptions, risks and uncertainties, including the assumptions, risks and uncertainties identified above and elsewhere in this Management's Discussion and Analysis, actual events may differ materially from current expectations. While Harry Winston Diamond Corporation may elect to, it is under no obligation and does not undertake to update or revise any forward-looking information, whether as a result of new information, future events or otherwise at any particular time, except as required by law. Additional information concerning factors that may cause actual results to materially differ from those in such forward-looking statements is contained in the Harry Winston Diamond Corporation's filings with Canadian and United States securities regulatory authorities and can be found at http://www.sedar.com/ and http://www.sec.gov/, respectively.

Summary Discussion

Harry Winston Diamond Corporation is a specialist diamond company focusing on the mining and retail segments of the diamond industry. The Company supplies rough diamonds to the global market from production received from its 40% ownership interest in the Diavik Diamond Mine, located off Lac de Gras in Canada's Northwest Territories. The Company also owns a 100% interest in Harry Winston Inc., the premier fine jewelry and watch retailer. Harry Winston Diamond Corporation's mission is to deliver shareholder value through the enhanced earning power and longevity of the Diavik Diamond Mine asset as the cornerstone of a profitable synergy with the Harry Winston(R) brand. In a changing diamond market-place, Harry Winston Diamond Corporation has charted a unique course to continue to build shareholder value.

The Company's most significant asset is a 40% interest in the Diavik group of mineral claims. The Diavik Joint Venture (the "Joint Venture") is an unincorporated joint arrangement between Diavik Diamond Mines Inc. ("DDMI") (60%) and Harry Winston Diamond Mines Ltd. (40%) where Harry Winston Diamond Corporation owns an undivided 40% interest in the assets, liabilities and expenses. DDMI is the operator of the Diavik Diamond Mine. Both companies are headquartered in Yellowknife, Canada. DDMI is a wholly owned subsidiary of Rio Tinto plc of London, England, and Harry Winston Diamond Mines Ltd. is a wholly owned subsidiary of Harry Winston Diamond Corporation of Toronto, Canada.

Market Commentary The Diamond Market

The rough diamond market has enjoyed strong price growth during the last six months as purchases from the emerging market economies have more than compensated for the US and Japanese softness in the higher quality stones that are the key component of Harry Winston's rough diamond sales. Lower quality diamonds have seen price declines in some categories despite the price increases in better quality diamonds.

Looking forward, the strengthening US dollar is beginning to drive local currency price increases internationally and a period of gains can be expected in the short term. In the longer term, a continuing shrinkage of mine supply coupled with expanded demand from the BRIC (Brazil, Russia, India, China) economies is expected to underpin further price increases, especially as the US and Japan, historically the world's two largest diamond consumers, return to economic health.

The Retail Jewelry Market

The global luxury diamond jewelry market remains strong, especially in markets outside of the US and Japan. The US and Japanese markets have been negatively impacted, primarily in the lower and mid-range of the retail market, by the challenging macroeconomic environment. Emerging markets in the Asia Pacific region, Russia and the Middle East continue to provide robust demand for luxury products.

(R) Harry Winston is a registered trademark of Harry Winston Inc. Consolidated Financial Results

Consolidated Financial Results

The following is a summary of the Company's consolidated quarterly results for the eight quarters ended July 31, 2008 following the basis of presentation utilized in the Company's Canadian GAAP financial statements:

(expressed in thousands of United States dollars except per share amounts and where otherwise noted) (quarterly results are unaudited) ------------------------------------------------------------------------- 2009 2009 2008 2008 2008 Q2 Q1 Q4 Q3 Q2 ------------------------------------------------------------------------- Sales $186,119 $156,079 $188,195 $176,478 $173,269 Cost of sales 73,542 73,149 83,637 74,591 81,827 ------------------------------------------------------------------------- Gross margin 112,577 82,930 104,558 101,887 91,442 Gross margin (%) 60.5% 53.1% 55.6% 57.7% 52.8% Selling, general and administrative expenses 39,194 43,285 45,494 35,539 35,201 ------------------------------------------------------------------------- Earnings from operations 73,383 39,645 59,064 66,348 56,241 ------------------------------------------------------------------------- Interest and financing expenses (5,366) (5,453) (7,082) (7,422) (7,222) Other income (expense) 815 246 706 594 545 Insurance settlement - - 13,488 - - Foreign exchange gain (loss) 5,301 155 22,270 (40,584) (11,785) ------------------------------------------------------------------------- Earnings before income taxes 74,133 34,593 88,446 18,936 37,779 Income taxes (recovery) 24,185 13,336 (1,968) 26,197 17,747 ------------------------------------------------------------------------- Earnings (loss) before minority interest 49,948 21,257 90,414 (7,261) 20,032 Minority interest 1 1 (34) 90 (26) ------------------------------------------------------------------------- Net earnings (loss) $ 49,947 $ 21,256 $ 90,448 $ (7,351) $ 20,058 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Basic earnings (loss) per share $ 0.81 $ 0.35 $ 1.55 $ (0.13) $ 0.34 Diluted earnings (loss) per share $ 0.81 $ 0.35 $ 1.54 $ (0.13) $ 0.33 Cash dividends declared per share $ 0.05 $ 0.05 $ 0.05 $ 0.25 $ 0.25 Total assets(i) $ 1,637 $ 1,591 $ 1,494 $ 1,433 $ 1,367 Total long-term liabilities(i) $ 617 $ 634 $ 660 $ 530 $ 486 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Six Six Months Months Ended Ended 2008 2007 2007 July 31, July 31, Q1 Q4 Q3 2008 2007 ------------------------------------------------------------------------- Sales $141,365 $154,328 $145,232 $342,198 $314,634 Cost of sales 71,132 78,559 74,636 146,691 152,959 ------------------------------------------------------------------------- Gross margin 70,233 75,769 70,596 195,507 161,675 Gross margin (%) 49.7% 49.1% 48.6% 57.1% 51.4% Selling, general and administrative expenses 34,211 38,590 33,480 82,479 69,412 ------------------------------------------------------------------------- Earnings from operations 36,022 37,179 37,116 113,028 92,263 ------------------------------------------------------------------------- Interest and financing expenses (6,132) (6,441) (5,570) (10,819) (13,354) Other income (expense) 913 (111) 1,764 1,061 1,458 Insurance settlement - - - - - Foreign exchange gain (loss) (13,292) 9,831 (1,560) 5,456 (25,077) ------------------------------------------------------------------------- Earnings before income taxes 17,511 40,458 31,750 108,726 55,290 Income taxes (recovery) 14,118 13,169 13,005 37,521 31,865 ------------------------------------------------------------------------- Earnings (loss) before minority interest 3,393 27,289 18,745 71,205 23,425 Minority interest 140 (5) (86) 2 114 ------------------------------------------------------------------------- Net earnings (loss) $ 3,253 $ 27,294 $ 18,831 $ 71,203 $ 23,311 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Basic earnings (loss) per share $ 0.06 $ 0.47 $ 0.32 $ 1.17 $ 0.40 Diluted earnings (loss) per share $ 0.05 $ 0.46 $ 0.32 $ 1.17 $ 0.39 Cash dividends declared per share $ 0.25 $ 0.25 $ 0.25 $ 0.10 $ 0.50 Total assets(i) $ 1,315 $ 1,288 $ 1,246 $ 1,637 $ 1,367 Total long-term liabilities(i) $ 408 $ 536 $ 530 $ 617 $ 486 ------------------------------------------------------------------------- (i) Total assets and total long-term liabilities are expressed in millions of United States dollars. The comparability of quarter-over-quarter results is impacted by seasonality for both the mining and retail segments. Harry Winston Diamond Corporation expects that the quarterly results for its mining segment will continue to fluctuate depending on the seasonality of production at the Diavik Diamond Mine, the number of rough diamond sales events conducted during the quarter, and the volume, size and quality distribution of rough diamonds delivered from the Diavik Diamond Mine in each quarter. The quarterly results for the retail segment are also seasonal, with generally higher sales during the fourth quarter due to the holiday season. See "Segmented Analysis" on page 8 for additional information. Three Months Ended July 31, 2008 Compared to Three Months Ended July 31, 2007 Consolidated Net Earnings

The second quarter net earnings of $49.9 million or $0.81 per share represent an increase of $29.9 million or $0.47 per share as compared to the results of the second quarter of the prior year. The increase is primarily due to improved operating performance in the mining and retail segments and a net foreign exchange gain of $5.3 million, or $0.09 per share, in the current quarter compared to an $11.8 million net foreign exchange loss, or $0.20 per share, recognized in the comparable quarter of the prior year related principally to an unrealized non-cash loss on future income taxes payable. For more detail on the impact of the foreign exchange gain on future income taxes payable, see "Consolidated Income Taxes" below.

Consolidated Sales

Sales for the second quarter totalled $186.1 million, consisting of rough diamond sales of $105.0 million and retail segment sales of $81.1 million. This compares to sales of $173.3 million in the comparable quarter of the prior year (rough diamond sales of $105.1 million and retail segment sales of $68.2 million). The Company held two primary rough diamond sales in the second quarter compared to three in the comparable quarter of the prior year. Ongoing quarterly variations in revenues are inherent in the Company's business, resulting from the seasonality of the mining and retail activities as well as from the variability of the rough diamond sales schedule.

Consolidated Cost of Sales and Gross Margin

The Company's second quarter cost of sales was $73.5 million for a gross margin of 60.5% compared to $81.8 million cost of sales and a gross margin of 52.8% for the comparable quarter of the prior year. Included in the second quarter is a $4.3 million insurance settlement relating to an excavator fire that occurred in the fourth quarter of fiscal 2006 at the Diavik Diamond Mine. The settlement represents the recovery of the cost of the excavator that was previously written off along with incremental operating expenses relating to the procurement of a replacement excavator. The Company's cost of sales includes costs associated with mining, rough diamond sorting and retail sales activities. See "Segmented Analysis" on page 8 for additional information.

Consolidated Selling, General and Administrative Expenses

The principal components of selling, general and administrative ("SG&A") expenses include expenses for salaries and benefits, advertising, professional fees, rent and building related costs. The Company incurred SG&A expenses of $39.2 million for the second quarter, compared to $35.2 million in the comparable quarter of the prior year.

Included in SG&A expenses for the second quarter are $5.2 million for the mining segment as compared to $5.9 million for the comparable quarter of the prior year, and $34.0 million for the retail segment as compared to $29.3Ã‚Â million for the comparable quarter of the prior year. For the mining segment, the decrease in SG&A expenses was primarily due to a mark-to-market reduction in stock-based compensation. For the retail segment, the increase in SG&A expenses was as a result of our continued investment in the Harry Winston brand, and reflected an increase in salaries and benefits, rent and building related expenses and depreciation and amortization expense. See "Segmented Analysis" on page 8 for additional information.

Consolidated Income Taxes

The Company recorded a tax expense of $24.2 million during the second quarter, compared to a tax expense of $17.7 million in the comparable quarter of the prior year. The Company's effective income tax rate for the quarter, excluding Harry Winston's retail segment, is 33%, which is based on a statutory income tax rate of 31% adjusted for various items including Northwest Territories mining royalty, impact of foreign exchange, and earnings subject to tax different than the statutory rate.

The Company's functional and reporting currency is US dollars; however, the calculation of income tax expense is based on income in the currency of the country of origin. As such, the Company is continually subject to foreign exchange fluctuations, particularly as the Canadian dollar moves against the US dollar. The weakening of the Canadian dollar during the second quarter resulted in an unrealized foreign exchange gain of $4.4 million on the revaluation of the Canadian denominated future income tax liability, compared to an unrealized foreign exchange loss of $9.6 million recorded in the comparable quarter of the prior year. This unrealized foreign exchange gain is not taxable for Canadian income tax purposes.

The rate of income tax payable by Harry Winston Inc. varies by jurisdiction. Net operating losses are available in certain jurisdictions to offset future income taxes payable in such jurisdictions. The net operating losses are scheduled to expire through 2027.

The Company has provided a table below summarizing the movement from the statutory to the effective income tax rate as a percentage of earnings before taxes:

Three Three Months Months Ended Ended July 31, July 31, 2008 2007 ------------------------------------------------------------------------- Statutory income tax rate 31% 34% Stock compensation -% (1)% Northwest Territories mining royalty (net of income tax relief) 8% 12% Impact of change in future income tax rate -% (2)% Impact of foreign exchange (4)% 6% Earnings subject to tax different than statutory rate (3)% (2)% Changes in valuation allowance 1% -% Benefits of losses recognized through reduction of goodwill -% 2% Other items -% (2)% Effective income tax rate 33% 47% ------------------------------------------------------------------------- Consolidated Interest and Financing Expenses

Interest and financing expenses of $5.4 million were incurred during the second quarter compared to $7.2 million during the comparable quarter of the prior year. The reduction in interest and financing expenses relates primarily to the reduction in debt levels in the mining segment.

Consolidated Other Income

Other income of $0.8 million was recorded during the quarter compared to other income of $0.5 million in the comparable quarter of the prior year.

Consolidated Foreign Exchange Gain

A net foreign exchange gain of $5.3 million was recognized during the quarter compared to a net foreign exchange loss of $11.8 million in the comparable quarter of the prior year. The gain in the current quarter relates principally to the revaluation of the Company's Canadian dollar denominated long-term future income tax liability as a result of the weakening of the Canadian dollar against the US dollar at quarter end. The Company's ongoing currency exposure relates primarily to expenses and obligations incurred in Canadian dollars, as well as the revaluation of certain Canadian monetary balance sheet amounts. The Company does not currently have any significant derivative instruments outstanding.

Six Months Ended July 31, 2008 Compared to Six Months Ended July 31, 2007 Consolidated Net Earnings

Net earnings for the six months ended July 31, 2008 of $71.2 million or $1.17 per share compares to $23.3 million or $0.40 per share for the sixÃ‚Â months ended July 31, 2007. The increase is due primarily to a net foreign exchange gain of $5.5 million, or $0.09 per share, for the six months ended July 31, 2008 compared to a $25.1 million net foreign exchange loss, or $0.43Ã‚Â per share, recognized in the comparable period of the prior year related principally to an unrealized non-cash loss on future income taxes payable.

Consolidated Sales

Sales for the six months ended July 31, 2008 were $342.2 million, representing an increase of 9% over sales of $314.6 million for the six months ended July 31, 2007. Rough diamond sales accounted for $186.4 million of total sales compared to $187.8 million for the comparable period of the prior year. Retail segment sales of $155.8 million accounted for the balance, compared to $126.8 million for the comparable period of the prior year.

Consolidated Cost of Sales and Gross Margin

The Company's cost of sales for the six months ended July 31, 2008 was $146.7 million for a gross margin of 57.1% compared to $153.0 million cost of sales and a gross margin of 51.4% for the comparable period of the prior year. Included in the six months ended July 31, 2008 is a $4.3 million insurance settlement relating to an excavator fire that occurred in the fourth quarter of fiscal 2006 at the Diavik Diamond Mine. The settlement represents the recovery of the cost of the excavator that was previously written off along with incremental operating expenses relating to the procurement of a replacement excavator. The Company's cost of sales includes costs associated with mining, rough diamond sorting and retail sales activities. See "Segmented Analysis" on page 8 for additional information.

Consolidated Selling, General and Administrative Expenses

The Company incurred SG&A expenses of $82.5 million for the six months ended July 31, 2008, compared to $69.4 million for the six months ended JulyÃ‚Â 31, 2007.

Included in SG&A expenses for the six months ended July 31, 2008 are $12.4 million for the mining segment as compared to $10.9 million for the comparable period of the prior year, and $70.1 million for the retail segment as compared to $58.5 million for the comparable period of the prior year. For the mining segment, the increase of $1.4 million was primarily due to higher salaries and benefits. For the retail segment, the increase was as a result of our continued investment in the Harry Winston brand, and reflected an increase in salaries and benefits, rent and building related expenses and depreciation and amortization expense. Retail segment SG&A expenses also included approximately $2.0 million of non-recurring expenses related to restructuring and improvements carried out at the Geneva watch factory. See "Segmented Analysis" on page 8 for additional information.

Consolidated Income Taxes

The Company recorded a tax expense of $37.5 million during the six months ended July 31, 2008, compared to a tax expense of $31.9 million in the comparable period of the prior year. The Company's effective income tax rate for the quarter, excluding Harry Winston's retail segment, is 35%, which is based on a statutory income tax rate of 31% adjusted for various items including Northwest Territories mining royalty, impact of foreign exchange, and earnings subject to tax different than the statutory rate.

During the six months ended July 31, 2008, the Company recorded an unrealized foreign exchange gain of $5.3 million on the revaluation of the Canadian denominated future income tax liability, as compared to an unrealized foreign exchange loss of $23.3 million recorded in the comparable period of the prior year. This unrealized foreign exchange gain is not taxable for Canadian income tax purposes.

The Company has provided a table below summarizing the movement from the statutory to the effective income tax rate as a percentage of earnings before taxes:

Six Six Months Months Ended Ended July 31, July 31, 2008 2007 ------------------------------------------------------------------------- Statutory income tax rate 31% 34% Northwest Territories mining royalty (net of income tax relief) 10% 13% Impact of change in future income tax rate -% (2)% Impact of foreign exchange (4)% 12% Earnings subject to tax different than statutory rate (4)% (3)% Changes in valuation allowance 1% -% Benefits of losses recognized through reduction of goodwill -% 3% Assessments and adjustments 1% -% Other items -% 1% Effective income tax rate 35% 58% ------------------------------------------------------------------------- Consolidated Interest and Financing Expenses

Interest and financing expenses of $10.8 million were incurred during the six months ended July 31, 2008 compared to $13.4 million for the comparable period of the prior year. The reduction in interest and financing expenses relates primarily to the reduction in debt levels in the mining segment.

Consolidated Other Income

Other income, which includes interest income on the Company's various bank balances, was $1.1 million during the six months ended July 31, 2008 compared to $1.5 million for the comparable period of the prior year.

Consolidated Foreign Exchange Gain

A net foreign exchange gain of $5.5 million was recognized during the sixÃ‚Â months ended July 31, 2008 compared to a net foreign exchange loss of $25.1 million recorded during the six months ended July 31, 2007. The current year-to-date gain relates principally to the revaluation of the Company's Canadian dollar denominated long-term future income tax liability as a result of the weakening of the Canadian dollar against the US dollar at July 31, 2008. The Company's ongoing currency exposure relates primarily to expenses and obligations incurred in Canadian dollars, as well as the revaluation of certain Canadian monetary balance sheet amounts. The Company does not currently have any significant derivative instruments outstanding.

Segmented Analysis The operating segments of the Company include mining and retail segments. Mining The mining segment includes the production and sale of rough diamonds. (expressed in thousands of United States dollars) (quarterly results are unaudited) ------------------------------------------------------------------------- 2009 2009 2008 2008 2008 Q2 Q1 Q4 Q3 Q2 ------------------------------------------------------------------------- Sales $105,014 $ 81,393 $103,238 $122,711 $105,071 Cost of sales 32,390 32,150 36,962 45,985 46,217 ------------------------------------------------------------------------- Gross margin 72,624 49,243 66,276 76,726 58,854 Gross margin (%) 69.2% 60.5% 64.2% 62.5% 56.0% Selling, general and administrative expenses 5,151 7,208 5,663 6,748 5,861 ------------------------------------------------------------------------- Earnings from operations $ 67,473 $ 42,035 $ 60,613 $ 69,978 $ 52,993 ------------------------------------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------------------------------------- Six Six Months Months Ended Ended 2008 2007 2007 July 31, July 31, Q1 Q4 Q3 2008 2007 ------------------------------------------------------------------------- Sales $ 82,752 $ 81,035 $ 90,754 $186,407 $187,823 Cost of sales 40,516 39,413 45,461 64,540 86,733 ------------------------------------------------------------------------- Gross margin 42,236 41,622 45,293 121,867 101,090 Gross margin (%) 51.0% 51.4% 49.9% 65.4% 53.8% Selling, general and administrative expenses 5,087 7,397 4,665 12,359 10,948 ------------------------------------------------------------------------- Earnings from operations $ 37,149 $ 34,225 $ 40,628 $109,508 $ 90,142 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Three Months Ended July 31, 2008 Compared to Three Months Ended July 31, 2007 Mining Sales

Rough diamond sales for the second quarter totalled $105.0 million compared to $105.1 million in the comparable quarter of the prior year resulting from lower carat production offset by higher pricing. Rough diamond production decreased 23% in the second calendar quarter from the prior year as a result of the continuing grade variation in the A-154 South kimberlite pipe combined with the initial stripping of low grade A-418 ore mixed with waste overburden material.

The Company held two primary rough diamond sales in the second quarter compared to three in the comparable quarter of the prior year. The Company expects that results for its mining segment will continue to fluctuate depending on the seasonality of production at the Diavik Diamond Mine, the number of primary and secondary sales events conducted at each sales location during the quarter, and the volume, size and quality distribution of rough diamonds delivered from the Diavik Diamond Mine in each quarter.

Mining Cost of Sales and Gross Margin

The Company's second quarter cost of sales was $32.4 million for a gross margin of 69.2% compared to a $46.2 million cost of sales and a gross margin of 56.0% in the comparable quarter of the prior year. The reduction in cost of sales resulted in part from a greater proportion of cost attributable to development activity versus production activity. Also included in the second quarter is a $4.3 million insurance settlement relating to an excavator fire that occurred in the fourth quarter of fiscal 2006 at the Diavik Diamond Mine. The settlement represents the recovery of the cost of the excavator that was previously written off along with incremental operating expenses relating to the procurement of a replacement excavator. Total proceeds of $5.0 million from the insurance settlement are expected to be received in the third quarter, resulting in a gain of approximately $0.7 million. The mining gross margin is anticipated to fluctuate between quarters, resulting from variations in the specific mix of product sold during each quarter and the nature of the mining activities.

A substantial portion of cost of sales is mine operating costs, which are incurred at the Diavik Diamond Mine. Cost of sales also includes rough diamond sorting costs, which consist of the Company's cost of handling and sorting product in preparation for sales to third parties, and amortization and depreciation, the majority of which is recorded using the unit-of-production method over estimated proven and probable reserves.

Mining Selling, General and Administrative Expenses

SG&A expenses for the mining segment decreased by $0.7 million from the comparable period of the prior year primarily due to a mark-to-market reduction to stock-based compensation.

Six Months Ended July 31, 2008 Compared to Six Months Ended July 31, 2007 Mining Sales

Rough diamond sales for the six months ended July 31, 2008 totalled $186.4 million compared to $187.8 million in the comparable period of the prior year resulting from a combination of lower carat production offset by higher pricing. Rough diamond production decreased 27% during the first half of the calendar year from the prior year as the result of the continuing grade variation in the A-154 South kimberlite pipe combined with the initial stripping of low grade A-418 ore mixed with waste overburden material.

The Company held four primary rough diamond sales, one of which was an open-market tender, during the six months ended July 31, 2008, compared to five in the comparable period of the prior year. Harry Winston Diamond Corporation expects that results for its mining segment will continue to fluctuate depending on the seasonality of production at the Diavik Mine, the number of primary and secondary sales events conducted at each sales location during the quarter, and the volume, size and quality distribution of rough diamonds delivered from the Diavik Mine in each quarter.

Mining Cost of Sales and Gross Margin

For the six months ended July 31, 2008, cost of sales was $64.5 million for a gross margin of 65.4% compared to $86.7 million cost of sales and a gross margin of 53.8% in the comparable quarter of the prior year. The reduction in cost of sales resulted primarily from a greater proportion of cost attributable to development activity versus production activity. Also included in the six months ended July 31, 2008, is a $4.3 million insurance settlement relating to an excavator fire that occurred in the fourth quarter of fiscal 2006 at the Diavik Diamond Mine. The settlement represents the recovery of the cost of the excavator that was previously written off along with incremental operating expenses relating to the procurement of a replacement excavator. Total proceeds of $5.0 million from the insurance settlement are expected to be received in the third quarter, resulting in a gain of approximately $0.7 million. The mining gross margin is anticipated to fluctuate between quarters, resulting from variations in the specific mix of product sold during each quarter and the nature of the mining activities.

Mining Selling, General and Administrative Expenses

SG&A expenses for the mining segment increased by $1.4 million from the comparable period of the prior year primarily due to an increase in salaries and benefits.

Retail

The retail segment includes sales from Harry Winston's salons, which are located in prime markets around the world including seven salons in the United States: New York, Beverly Hills, Bal Harbour, Honolulu, Las Vegas, Dallas and Chicago; five salons in Japan: Ginza, Roppongi Hills, Osaka, Omotesando and Nagoya; three salons in Europe: Paris, London and Geneva; and three salons in Asia outside of Japan: Beijing, Taipei and Hong Kong.

(expressed in thousands of United States dollars) (quarterly results are unaudited) ------------------------------------------------------------------------- 2009 2009 2008 2008 2008 Q2 Q1 Q4 Q3 Q2 ------------------------------------------------------------------------- Sales $ 81,105 $ 74,686 $ 84,957 $ 53,767 $ 68,198 Cost of sales 41,152 40,999 46,675 28,606 35,610 ------------------------------------------------------------------------- Gross margin 39,953 33,687 38,282 25,161 32,588 Gross margin (%) 49.3% 45.1% 45.1% 46.8% 47.8% Selling, general and administrative expenses 34,043 36,077 39,831 28,791 29,340 ------------------------------------------------------------------------- Earnings (loss) from operations $ 5,910 $ (2,390) $ (1,549) $ (3,630) $ 3,248 ------------------------------------------------------------------------- ------------------------------------------------------------------------- ------------------------------------------------------------------------- Six Six Months Months Ended Ended 2008 2007 2007 July 31, July 31, Q1 Q4 Q3 2008 2007 ------------------------------------------------------------------------- Sales $ 58,613 $ 73,293 $ 54,478 $155,791 $126,811 Cost of sales 30,616 39,146 29,175 82,151 66,226 ------------------------------------------------------------------------- Gross margin 27,997 34,147 25,303 73,640 60,585 Gross margin (%) 47.8% 46.6% 46.4% 47.3% 47.8% Selling, general and administrative expenses 29,124 31,193 28,815 70,120 58,464 ------------------------------------------------------------------------- Earnings (loss) from operations $ (1,127) $ 2,954 $ (3,512) $ 3,520 $ 2,121 ------------------------------------------------------------------------- ------------------------------------------------------------------------- Three Months Ended July 31, 2008 Compared to Three Months Ended July 31, 2007 Retail Sales

Sales for the second quarter were $81.1 million compared to $68.2 million for the comparable quarter of the prior year, an increase of 19%. Strong overall sales growth in the US and international markets outside of Japan offset slower sales in the Japan market. Sales in the European market increased 49% to $31.6 million, US sales increased 31% to $29.0 million, and Asian sales decreased 17% to $20.5 million.

Retail Cost of Sales and Gross Margin

Cost of sales for Harry Winston Inc. for the second quarter was $41.2Ã‚Â million compared to $35.6 million for the comparable quarter of the prior year. Gross margin for the quarter was $40.0 million or 49.3% compared to $32.6 million or 47.8% for the second quarter of the prior year. Excluding the impact of sales of Harry Winston Inc. pre-acquisition inventory, gross margin for the second quarter and the comparable quarter of the prior year would have been 51.3% and 51.1%, respectively.

Retail Selling, General and Administrative Expenses

With the expansion of the new international salon network, consistent with the Company's retail growth strategy, SG&A expenses increased to $34.0Ã‚Â million from $29.3 million in the comparable quarter of the prior year. The increase, which was primarily due to the continued expansion of the retail salon network, included an increase of $1.0 million in each of rent and building related expenses, salaries and benefits, and depreciation and amortization, an increase of $0.6 million in advertising and selling expenses, an increase of $0.6 million in professional fees and $0.5 million in other expenses. SG&A expenses include depreciation and amortization expense of $3.1Ã‚Â million compared to $2.1 million in the comparable quarter of the prior year. SG&A as a percentage of sales decreased to 42.0% in the second quarter from 43.0% in the comparable quarter of the prior year.

Six Months Ended July 31, 2008 Compared to Six Months Ended July 31, 2007 Retail Sales

Sales for the six months ended July 31, 2008 were $155.8 million compared to $126.8 million for the comparable period of the prior year, an increase of 23%. Strong overall sales growth in the US and international markets outside of Japan offset slower sales in the Japanese market. Sales in the European market increased 45% to $63.3 million, US sales increased 16% to $53.9Ã‚Â million, and Asian sales increased 5% to $38.6 million.

Retail Cost of Sales and Gross Margin

Cost of sales for the six months ended July 31, 2008 was $82.2 million compared to $66.2 million for the six months ended July 31, 2007. Gross margin for the six months ended July 31, 2008 was $73.6 million or 47.3% compared to $60.6 million or 47.8% for the comparable period of the prior year. Excluding the impact of sales of Harry Winston Inc. pre-acquisition inventory, gross margin for the six months ended July 31, 2008 and the comparable period of the prior year would have been 49.4% and 51.3%, respectively. Gross margin for the six months ended July 31, 2008 was impacted by three factors related to the first quarter: an increased contribution of high dollar value transactions, which carry lower-than-average gross margins; an increase in costs related to precious metals and gem stones; and an increase in research and development costs to support the growing watch business.

Retail Selling, General and Administrative Expenses

SG&A expenses increased to $70.1 million for the six months ended JulyÃ‚Â 31, 2008 as compared to $58.6 million in the comparable period of the prior year. However, SG&A as a percentage of sales decreased to 45.0% for the six months ended July 31, 2008 compared to 46.1% in the comparable period of the prior year. The increase, which was primarily due to the continued expansion of the retail salon network, included an increase of $3.3 million in rent and building related expenses, an increase of $2.6 million in salaries and benefits, and an increase of $2.3 million in depreciation and amortization. These increases were partially offset by a $0.5 million decrease in advertising and selling expenses. Additionally, SG&A expenses included approximately $2.0 million of non-recurring expenses related to restructuring and improvements carried out at the Geneva watch factory. SG&A expenses include depreciation and amortization expense of $6.3 million compared to $4.0Ã‚Â million in the comparable period of the prior year.

Operational Update

Harry Winston Diamond Corporation's results of operations include results from its mining and retail operations.

Mining Segment

During the second calendar quarter of 2008, the Diavik Diamond Mine produced 2.5 million carats from 0.72 million tonnes of ore sourced predominantly from the A-154 South kimberlite pipe, with small volumes sourced from the A-154 North and A-418 kimberlite pipes. Rough diamond production decreased 23% in the second calendar quarter from the prior year as the result of the continuing grade variation in the A-154 South kimberlite pipe combined with the initial stripping of low grade A-418 ore mixed with waste overburden material.

Ore was recovered from the A-418 kimberlite pipe as part of the ongoing pre-stripping of waste overburden to prepare the pipe for open pit production. This initial ore is low grade, weathered kimberlite capping the A-418 pipe, diluted with overlying glacial till. Sustainable full-scale open pit production from A-418 is scheduled to begin before the end of the calendar year.

Work continued on schedule and on budget to prepare the Diavik Diamond Mine site for underground mining. Below surface, tunnelling work passed 8Ã‚Â kilometres, with tunnel advance rates accelerating during the second calendar quarter. Construction progressed as planned on the new crusher and paste backfill plant, on expansions to the water treatment and power plants, and on additional permanent accommodation facilities. Diamond production from underground mining is scheduled to begin in calendar 2009, and is expected to replace open pit mining by calendar 2012.

A $50 million capital expenditure for a small diamond recovery project was approved during the second calendar quarter to make additions and modifications to the ore processing plant to recover very small diamonds, reflecting the demand for this product. The first recovery of small diamonds is expected in calendar 2010. The Company estimates its share of this capital expenditure to be approximately $20 million.

Harry Winston Diamond Corporation's 40% Share of Diavik Diamond Mine Production (reported on a one-month lag) Three Three Six Six Months Months Months Months Ended Ended Ended Ended June 30, June 30, June 30, June 30, 2008 2007 2008 2007 ------------------------------------------------------------------------- Diamonds recovered (000s carats) 1,009 1,317 1,723 2,351 Grade (carats/tonne) 3.52 5.12 3.74 5.05 ------------------------------------------------------------------------- Retail Segment

For the three months ended July 2008, the retail segment recorded strong results despite the tough economic and retail environment, a reflection of the strength of the Harry Winston brand. Sales increased by 19% over the comparable quarter of the prior year. Strong overall sales growth in the US and international markets outside of Japan offset slower sales in the Japanese market. Gross margin showed significant improvement from the first quarter as a result of the mix of product sold as well as selective price increases consistent with the direction of market trends. Harry Winston Inc. operated a network of 18 retail salons during the quarter compared to 15 salons in the comparable quarter of the prior year. A new salon was opened in August 2008 in Costa Mesa, California.

Liquidity and Capital Resources Working Capital

As at July 31, 2008, the Company had unrestricted cash and cash equivalents of $56.3 million and contingency cash collateral and reserves of $25.3 million as required under the Company's debt arrangements, compared to $49.6 million and $25.6 million, respectively, at January 31, 2008. The Company had cash on hand and balances with banks of $56.3 million and short-term investments of $nil at July 31, 2008 compared to $33.0 million and $16.6Ã‚Â million, respectively, at January 31, 2008. Short-term investments are held in overnight deposits. Total cash resources at July 31, 2008 were $81.6Ã‚Â million, $6.4 million higher than the total cash resources of $75.2Ã‚Â million at January 31, 2008.

Working capital decreased to $212.7 million at July 31, 2008 from $220.0Ã‚Â million at January 31, 2008.

The Company's working capital and working capital requirements fluctuate from quarter to quarter depending on, among other factors, the seasonality of production at the Diavik Diamond Mine, the number of sales events conducted during the quarter and the volume, size and quality distribution of rough diamonds delivered from the Diavik Diamond Mine in each quarter, along with the seasonality and salon expansion in the retail segment. The Company's principal working capital needs include investments in inventory, prepaid expenses and other current assets, and accounts payable and income taxes payable. The Company's cash requirements are driven by differences in the timing of cash receipts and the cash outflows. The Company has the ability, under certain conditions, to draw on its various credit facilities to finance these timing differences.

Cash Flow from Operations

During the quarter ended July 31, 2008, the Company generated $46.2Ã‚Â million in cash from operations, compared to $29.8 million in the comparable quarter of the prior year.

During the second quarter, the Company increased accounts receivable by $6.5 million, decreased prepaid expenses and other current assets by $6.0Ã‚Â million, increased inventory by $4.4 million, decreased accounts payable and accrued liabilities by $3.9 million, and decreased income taxes payable by $2.9 million.

The liquidity and capital requirements of the Company vary by quarter depending on the seasonal and production variability of its mining and retail segments. Timing differences in cash flow are financed by drawing down on the Company's credit facilities. Over the course of a fiscal year, the Company does not expect the fluctuations to be material. Over the next two fiscal years, capital requirements for the mining segment are expected to increase significantly in accordance with the expected investment program at the Diavik Diamond Mine. Thereafter, capital requirements for the mining segment are expected to moderate and the mining segment is expected to generate sufficient cash flow to finance its operations and capital expenditure requirements. The capital requirements for the retail segment are ordinary in course and are not expected to fluctuate materially over the next few years. The retail segment will finance its operations and capital requirements during these years from operating cash flow and its credit facilities. The Company may, from time to time, supplement its liquidity by financing in the capital markets.

Financing Activities

During the second quarter, the Company repaid $14.7 million of its senior secured term facilities. At July 31, 2008, the Company had $49.2 million outstanding on its senior secured term credit facilities and $50.0 million outstanding on its senior secured revolving credit facility. In comparison, at January 31, 2008, $76.4 million was outstanding on the term credit facilities and $50.0 million was outstanding on the secured revolving credit facility.

As at July 31, 2008, Harry Winston Inc. had $166.1 million outstanding on its $250.0 million secured five-year revolving credit facility, which is used to fund salon inventory and capital expenditure requirements. This represents an increase of $12.1 million from the amount outstanding at January 31, 2008.

Also included in long-term debt of the Company's retail operations is a 25-year loan agreement for 17.5 million CHF used to finance the construction of the new watch factory in Geneva, Switzerland. At July 31, 2008, $16.6Ã‚Â million had been drawn against the facility compared to $16.1 million at January 31, 2008. The bank has a secured interest in the factory building. On June 26, 2008, the bank further extended a demand credit facility for 2.0Ã‚Â million CHF. The new facility is supported by a $2.0 million standby letter of credit. At July 31, 2008, $0.2 million was drawn against this demand credit facility.

Harry Winston Japan, K.K. maintains secured and unsecured credit agreements with three banks amounting to (Yen)2,075 million. At July 31, 2008, $19.2 million had been drawn against these facilities, $4.6 million of which is long term, payable on June 28, 2010, with the balance of $14.6 million classified as bank advances. At January 31, 2008, $19.4 million had been drawn against these facilities, $4.7 million of which is long term with the balance of $14.7 million classified as bank advances.

At July 31, 2008, $22.6 million and $6.4 million were drawn under the Company's revolving financing facilities relating to its Belgian subsidiary, Harry Winston Diamond International N.V., and its Israeli subsidiary, Harry Winston Diamond (Israel) Limited, respectively. At January 31, 2008, $10.5Ã‚Â million and $9.4 million were drawn under the Company's revolving financing facilities relating to Harry Winston Diamond International N.V. and Harry Winston Diamond (Israel) Limited, respectively.

During the second quarter, the Company made dividend payments of $3.1Ã‚Â million or $0.05 per share to its shareholders.

Investing Activities

During the second quarter, the Company purchased capital assets of $67.7Ã‚Â million, of which $63.3 million were purchased for the mining segment and $4.4 million for the retail segment.

Contractual Obligations

The Company has contractual payment obligations with respect to long-term debt and, through its participation in the Joint Venture, future site restoration costs at the Diavik Diamond Mine. Additionally, at the Joint Venture, contractual obligations exist with respect to operating purchase obligations, as administered by DDMI, the operator of the mine. In order to maintain its 40% ownership interest in the Diavik Diamond Mine, the Company is obligated to fund 40% of the Joint Venture's total expenditures on a monthly basis. Based on the current mine plan, the Company's current projected share of the planned capital expenditures at the Diavik Diamond Mine, which are not reflected in the table below, including capital expenditures for the fiscal years 2009 to 2013, is approximately $340 million assuming, among other factors, a Canadian/US average exchange rate of $0.96 for the five years. The most significant contractual obligations for the ensuing five-year period can be summarized as follows:

Contractual Obligations (expressed in thousands of United States Less than Year Year After dollars) Total 1 year 2-3 4-5 5 years ------------------------------------------------------------------------- Long-term debt(a)(b) $356,974 $ 82,810 $ 63,278 $ 20,807 $190,079 Environmental and participation agreements incremental commitments(c) 95,445 74,994 3,906 1,953 14,592 Operating lease obligations(d) 119,637 17,267 28,325 18,185 55,860 Capital lease obligations(e) 1,984 921 1,063 - - ------------------------------------------------------------------------- Total contractual obligations $574,040 $175,992 $ 96,572 $ 40,945 $260,531 ------------------------------------------------------------------------- ------------------------------------------------------------------------- (a) Long-term debt presented in the foregoing table includes current and long-term portions. The mining segment's credit agreements are comprised of two senior secured term credit facilities and a senior secured revolving credit facility. The existing facilities have a maturity date of December 15, 2009. At July 31, 2008, $49.2 million in total was outstanding on the senior secured term credit facilities, and $50.0 million was outstanding on the senior secured revolving credit facility. Scheduled repayments on the senior secured term credit facilities commenced March 15, 2008 with $12.5 million in repayments due every quarter. The maximum amount permitted to be drawn under the senior secured revolving credit facility will be reduced by $12.5 million on a quarterly basis commencing March 15, 2009. The Company's first mortgage on real property has scheduled principal payments of approximately $0.1 million quarterly, and may be prepaid after 2009. On July 31, 2008, $8.4 million was outstanding on the mortgage payable. On February 22, 2008, Harry Winston Inc. entered into a new credit agreement with a syndicate of banks for a $250.0 million, five-year revolving credit facility. There are no scheduled repayments required before maturity. At July 31, 2008, $166.1 million had been drawn against this secured credit facility which expires on March 31, 2013. Also included in long-term debt of Harry Winston Inc. is a 25-year loan agreement for 17.5 million CHF used to finance the construction of the new watch factory in Geneva, Switzerland. The bank has a secured interest in the factory building. The loan agreement is comprised of a 3.5 million CHF loan and a 14.0 million CHF loan. The 3.5 million CHF loan bears interest at a rate of 3.9% and matures on April 22, 2010. The 14.0 million CHF loan bears interest at a rate of 3.55% and matures on January 31, 2033, with quarterly payments commencing on June 30, 2008. At July 31, 2008, $16.6 million was outstanding on this loan agreement. On June 26, 2008, the bank further extended a demand credit facility for 2.0 million CHF. The new facility is supported by a $2.0 million standby letter of credit and bears interest at a rate of 5.0% per annum. (b) Interest on long-term debt is calculated at various fixed and floating rates. Projected interest payments on the current debt outstanding were based on interest rates in effect at July 31, 2008 and have been included under long-term debt in the table above. Interest payments for the next 12 months are estimated to be $13.7 million. (c) The Joint Venture, under environmental and other agreements, must provide funding for the Environmental Monitoring Advisory Board. These agreements also state the Joint Venture must provide security deposits for the performance by the Joint Venture of its reclamation and abandonment obligations under all environmental laws and regulations. The Joint Venture has fulfilled its obligations for the security deposits by posting letters of credit of which the Company's share as at July 31, 2008 was $73.6 million. The requirement to post security for the reclamation and abandonment obligations may be reduced to the extent of amounts spent by the Joint Venture on those activities. The Joint Venture has also signed participation agreements with various native groups. These agreements are expected to contribute to the social, economic and cultural well-being of area Aboriginal bands. The amounts reflected as contractual obligations in the table above represent obligations that are in addition to the $73.6 million in letters of credit posted. The actual cash outlay for the Joint Venture's obligations under these agreements is not anticipated to occur until later in the life of the Diavik Diamond Mine. (d) Operating lease obligations represent future minimum annual rentals under non-cancellable operating leases for Harry Winston Inc. salons and office space. (e) Capital lease obligations represent future minimum annual rentals under non-cancellable capital leases for Harry Winston Inc. retail exhibit space. Outlook Mining Production

Rough diamond production decreased 27% in the first half of the calendar year from the prior year as a result of the continuing grade variation in the A-154 South kimberlite pipe combined with the initial stripping of low grade A-418 production of ore mixed with waste overburden material. The Company expects the grade variation in the A-154 South kimberlite pipe to persist for the balance of the year. Detailed sampling of the area already mined shows sample grades ranging from as low as 2 carats per tonne to over 9 carats per tonne, with an average of 4 carats per tonne. This short-range grade variation within the longer range ore reserve is a common feature of diamond mineralization due to the size range and distribution of the diamonds within the host rock. This shortfall is not expected to persist through the balance of the A-154 South kimberlite pipe. A program of detailed drilling to confirm the A-154 South underground reserve grade will be undertaken from the pit floor after open pit mining finishes. Given that it has been the active mining area, there has been less definition drilling on this pipe than on A-154 North and A-418 kimberlite pipes that make up the bulk of the underground mining reserve.

Although the estimated rough diamond production for calendar 2008 remains at approximately 10.0 million to 10.5 million carats, the transition from mining the bottom of the A-154 pit to the commencement of mining A-418 open pit has attendant risks to achieving production goals. Third quarter production to date from the A-154 South kimberlite pipe has been lower than anticipated due to engineering challenges in mining the constricted final benches of the A-154 open pit. Price increases achieved year to date suggest that any potential production shortfall may be partially mitigated.

Pre-stripping of the A-418 kimberlite pipe continues, with some commercial production from the A-418 open pit anticipated by the end of the calendar year. The expected start date of 2009 for underground production from A-154 South, A-154 North and A-418 remains unchanged. These development programs remain on schedule and on budget. The Company expects rough diamond prices to remain robust with softness in the US being offset by strong demand in the world economy, especially in the Far East.

Cost of Sales

The continuation of pre-stripping of the A-418 kimberlite pipe is expected to result in lower cost of sales in calendar 2008 than previously anticipated. Cost of sales will also be impacted by any reduction in production from current estimates. The Company continues to expect cost of sales to peak in calendar 2009, followed by an anticipated decline in cost of sales over the following two years as the overlap between open pit and underground mining diminishes.

Capital Expenditures

The surface and underground capital programs remain on schedule and on budget. The Company expects to make capital contributions of approximately $221 million during fiscal 2009 and 2010 in support of the underground development project. Financing for this capital contribution is expected to be drawn from a combination of cash from operations, proceeds from the March 2008 common share private placement and refinancing of the Company's credit facility. Based on the current mine plan, the Company's portion of planned capital expenditures at the Diavik Diamond Mine for fiscal 2009 to 2013 is expected to be approximately $340 million at a Canadian/US dollar average exchange rate of $0.96. Included in this capital contribution is $20 million relating to the small diamond project approved in the second quarter of fiscal 2009. This project comprises additions and modifications to the ore processing plant for the recovery of very small diamonds. This project has commenced, with first recovery of small diamonds expected in calendar 2010.

Rough Diamond Sales Cycle

The Company is expecting to hold two primary rough diamond sales in the third quarter and three in the fourth. Sales are now conducted throughout the quarter in each of the Company's three selling offices located in Belgium, Israel and India.

Retail

Harry Winston Inc. expects sales in the luxury jewelry industry to remain robust. The retail segment is strategically well positioned to withstand regional economic disruptions as a result of its diverse global distribution network. Continued strong demand for luxury diamond jewelry and watches from markets in Asia, Russia and the Middle East is expected to offset the difficult retail environment in the US and Japanese markets. The sales performance in the first six months of fiscal 2009 leaves us well positioned to achieve our annual sales growth objective of in excess of 15%.

Harry Winston Inc. will continue its plan to strengthen its brand and expand its retail salon network and product offering over the next several years. One salon was opened in Costa Mesa, California during August 2008.

Related Parties

Transactions with related parties for the three months ended July 31, 2008 include $0.3 million of rent ($0.7 million for the six months ended JulyÃ‚Â 31, 2008) relating to the New York salon, payable to a Harry Winston Inc. employee.

Critical Accounting Estimates

Management is often required to make judgments, assumptions and estimates in the application of Canadian generally accepted accounting principles that have a significant impact on the financial results of the Company. Certain policies are more significant than others and are, therefore, considered critical accounting policies. Accounting policies are considered critical if they rely on a substantial amount of judgment (use of estimates) in their application or if they result from a choice between accounting alternatives and that choice has a material impact on the Company's reported results or financial position. There have been no changes to the Company's critical accounting policies or estimates from those disclosed in the Company's MD&A for its fiscal year ended January 31, 2008.

Changes in Accounting Policies Capital Disclosures

Effective February 1, 2008, the Company adopted new accounting recommendations from the Canadian Institute of Chartered Accountants ("CICA"), Handbook Section 1535, "Capital Disclosures". This new standard specifies the requirements for disclosure of both qualitative and quantitative information to enable users of financial statements to evaluate the Company's objectives, policies and processes for managing capital. This disclosure is contained in note 12 to the interim consolidated financial statements.

Inventories

Effective February 1, 2008, the Company adopted new accounting recommendations from the CICA, Handbook Section 3031, "Inventories", which supersedes the previously issued standard on inventory. The new standard introduces significant changes to the measurement and disclosure of inventory. The measurement changes include: the elimination of LIFO, the requirement to measure inventories at the lower of cost and net realizable value for inventories that are not ordinarily interchangeable and goods or services produced for specific purposes, the requirement for an entity to use a consistent cost formula for inventory of a similar nature and use, and the reversal of previous write-downs to net realizable value when there is a subsequent increase in the value of inventories. Disclosures of inventories have also been enhanced. Inventory policies, carrying amounts, amounts recognized as an expense, write-downs and the reversals of write-downs are required to be disclosed. This standard has had no material impact on the consolidated financial statements.

Financial Instruments

Effective February 1, 2008, the Company adopted new accounting recommendations from the CICA, Handbook Section 3862, "Financial Instruments - Disclosures" and Handbook Section 3863, "Financial Instruments - Presentation". Section 3862 provides guidance on disclosure of risks associated with both recognized and unrecognized financial instruments and how the Company manages these risks. Section 3863 details financial instruments presentation requirements, which are unchanged from those discussed in SectionÃ‚Â 3861, "Financial Instruments - Disclosure and Presentation". This disclosure is contained in notes 13 and 14 to the interim consolidated financial statements.

Recently Issued Accounting Standards Goodwill and Intangibles

On February 1, 2008 the CICA issued Handbook Section 3064, "Goodwill and Intangible Assets". This Section establishes revised standards for the recognition, measurement, presentation and disclosure of goodwill and intangible assets. Concurrent with the introduction of this standard, the CICA withdrew EIC 27, "Revenues and Expenses During the Pre-operating Period," which eliminates the ability for companies to defer costs and revenues incurred prior to commercial production at new mine operations. The changes are effective for interim and annual financial statements beginning January 1, 2009. The Company is currently assessing the impact of this standard on its consolidated financial statements.

International Financial Reporting Standards ("IFRS")

The Company plans to report under International Financial Reporting Standards ("IFRS") as of February 1, 2011. Changing from Canadian GAAP to IFRS could materially affect the Company's reported financial position and results of operations. During the second quarter of fiscal 2009, the Company commenced preparation of its changeover plan. The Company intends to engage a third party advisor to assist with the plan. Over the next few months, specific actions include identifying the major accounting differences between current Canadian GAAP and IFRS as they affect the Company and determining resource requirements over the next two years as the Company implements its transition plan.

Risks and Uncertainties

Harry Winston Diamond Corporation is subject to a number of risks and uncertainties as a result of its operations. In addition to the other information contained in this Management's Discussion and Analysis and the Company's other publicly filed disclosure documents, readers should give careful consideration to the following risks, each of which could have a material adverse effect on the Company's business prospects or financial condition:

Nature of Mining

The operation of the Diavik Diamond Mine is subject to risks inherent in the mining industry, including variations in grade and other geological differences, unexpected problems associated with required water retention dikes, water quality, surface and underground conditions, processing problems, equipment performance, accidents, labour disputes, risks relating to the physical security of the diamonds, force majeure risks and natural disasters. Particularly with underground mining operations, inherent risks include variations in rock structure and strength as it impacts on mining method selection and performance, de-watering and water handling requirements, achieving the required paste backfill strengths, and unexpected local ground conditions. Hazards, such as unusual or unexpected rock formations, rock bursts, pressures, collapses, flooding or other conditions, may be encountered during mining. Such risks could result in personal injury or fatality; damage to or destruction of mining properties, processing facilities or equipment; environmental damage; delays, suspensions or permanent reductions in mining production; monetary losses; and possible legal liability.

The Diavik Diamond Mine, because of its remote northern location and access only by winter road or by air, is subject to special climate and transportation risks. These risks include the inability to operate or to operate efficiently during periods of extreme cold, the unavailability of materials and equipment, and increased transportation costs due to the late opening and/or early closure of the winter road. Such factors can add to the cost of mine development, production and operation and/or impair production and mining activities, thereby affecting the Company's profitability.

Nature of Joint Arrangement with DDMI

The Company owns an undivided 40% interest in the assets, liabilities and expenses of the Diavik Diamond Mine and the Diavik group of mineral claims. The Diavik Diamond Mine and the exploration and development of the Diavik group of mineral claims is a joint arrangement between DDMI (60%) and Harry Winston Diamond Mines Ltd. (40%), and is subject to the risks normally associated with the conduct of joint ventures and similar joint arrangements. These risks include the inability to exert influence over strategic decisions made in respect of the Diavik Diamond Mine and the Diavik group of mineral claims. By virtue of DDMI's 60% interest in the Diavik Diamond Mine, it has a controlling vote in virtually all Joint Venture management decisions respecting the development and operation of the Diavik Diamond Mine and the development of the Diavik group of mineral claims. Accordingly, DDMI is able to determine the timing and scope of future project capital expenditures, and therefore is able to impose capital expenditure requirements on the Company that the Company may not have sufficient cash to meet. The Company's contribution to capital requirements to complete the underground development and supporting infrastructure contemplated by the new mine plan is estimated to be $221 million during fiscal 2009 and 2010, with funding expected to be provided in part from a CAD $75 million private placement completed on MarchÃ‚Â 14, 2008, cash flow from operations and a refinancing of the Company's credit facilities. There can be no assurance that the Company will be able to refinance its current credit facilities on satisfactory terms and conditions, or at all. A failure by the Company to meet capital expenditure requirements imposed by DDMI could result in the Company's interest in the Diavik Diamond Mine and the Diavik group of mineral claims being diluted.

Diamond Prices and Demand for Diamonds

The profitability of the Company is dependent upon production from the Diavik Diamond Mine and on the results of the operations of its retail operations. Each in turn is dependent in significant part upon the worldwide demand for and price of diamonds. Diamond prices fluctuate and are affected by numerous factors beyond the control of the Company, including worldwide economic trends, particularly in the US, Japan, China and India, worldwide levels of diamond discovery and production and the level of demand for, and discretionary spending on, luxury goods such as diamonds and jewelry. Low or negative growth in the worldwide economy, prolonged credit market disruptions or the occurrence of terrorist or similar activities creating disruptions in economic growth could result in decreased demand for luxury goods such as diamonds and jewelry, thereby negatively affecting the price of diamonds and jewelry. Similarly, a substantial increase in the worldwide level of diamond production could also negatively affect the price of diamonds. In each case, such developments could materially adversely affect the Company's results of operations.

Currency Risk

Currency fluctuations may affect the Company's financial performance. Diamonds are sold throughout the world based principally on the US dollar price, and although the Company reports its financial results in US dollars, a majority of the costs and expenses of the Diavik Diamond Mine, which are borne 40% by the Company, are incurred in Canadian dollars. Further, the Company has a significant future income tax liability that has been incurred and will be payable in Canadian dollars. The Company's currency exposure relates primarily to expenses and obligations incurred by it in Canadian dollars and, secondarily, to revenues of Harry Winston Inc. in currencies other than the US dollar. The appreciation of the Canadian dollar against the US dollar, and the depreciation of such other currencies against the US dollar, therefore, will increase the expenses of the Diavik Diamond Mine and the amount of the Company's Canadian dollar liabilities relative to the revenue the Company will receive from diamond sales, and will decrease the US dollar revenues received by Harry Winston Inc. From time to time, the Company may use a limited number of derivative financial instruments to manage its foreign currency exposure.

Licenses and Permits

The operation of the Diavik Diamond Mine and exploration on the Diavik property require licenses and permits from the Canadian government. Renewal of the Diavik Diamond Mine Type "A" Water License was granted by the regional Wek'eezhii Land and Water Board on November 1, 2007 for an eight-year period. While the Company anticipates that DDMI, which is also the operator of the Diavik Diamond Mine, will be able to renew this license and other necessary permits in the future, there can be no guarantee that DDMI will be able to do so or obtain or maintain all other necessary licenses and permits that may be required to maintain the operation of the Diavik Diamond Mine or to further explore and develop the Diavik property.

Regulatory and Environmental Risks

The operation of the Diavik Diamond Mine, exploration activities at the Diavik Project and the manufacturing of jewelry and watches are subject to various laws and regulations governing the protection of the environment, exploration, development, production, taxes, labour standards, occupational health, waste disposal, mine safety, manufacturing safety and other matters. New laws and regulations, amendments to existing laws and regulations, or more stringent implementation or changes in enforcement policies under existing laws and regulations could have a material adverse impact on the Company by increasing costs and/or causing a reduction in levels of production from the Diavik Diamond Mine and in the manufacture of jewelry and watches. As well, as the Company's international operations expand, it or its subsidiaries become subject to laws and regulatory regimes which differ materially from those under which they operate in Canada and the US.

Mining and manufacturing are subject to potential risks and liabilities associated with pollution of the environment and the disposal of waste products occurring as a result of mining and manufacturing operations. To the extent that the Company's operations are subject to uninsured environmental liabilities, the payment of such liabilities could have a material adverse effect on the Company.

Climate Change

Canada ratified the Kyoto Protocol to the United Nations Framework Convention on Climate Change in late 2002 and the Kyoto Protocol came into effect in Canada in February 2005. The Canadian government is currently developing a number of policy measures in order to meet its emission reduction guidelines. While the impact of these measures cannot be quantified at this time, the likely effect will be to increase costs for fossil fuels, electricity and transportation, restrict industrial emission levels, impose added costs for emissions in excess of permitted levels and increase costs for monitoring and reporting. Compliance with these initiatives could have a material adverse effect on the Company's results of operations.

Resource and Reserve Estimates

The Company's figures for mineral resources and ore reserves on the Diavik group of mineral claims are estimates, and no assurance can be given that the anticipated carats will be recovered. The estimation of reserves is a subjective process. Forecasts are based on engineering data, projected future rates of production and the timing of future expenditures, all of which are subject to numerous uncertainties and various interpretations. The Company expects that its estimates of reserves will change to reflect updated information. Reserve estimates may be revised upward or downward based on the results of current and future drilling, testing or production levels and on changes in mine design. In addition, market fluctuations in the price of diamonds or increases in the costs to recover diamonds from the Diavik Diamond Mine may render the mining of ore reserves uneconomical.

Mineral resources that are not mineral reserves do not have demonstrated economic viability. Due to the uncertainty that may attach to inferred mineral resources, there is no assurance that mineral resources at the Diavik property will be upgraded to proven and probable ore reserves.

Insurance

The Company's business is subject to a number of risks and hazards, including adverse environmental conditions, industrial accidents, labour disputes, unusual or unexpected geological conditions, risks relating to the physical security of diamonds and jewelry held as inventory or in transit, changes in the regulatory environment and natural phenomena such as inclement weather conditions. Such occurrences could result in damage to the Diavik Diamond Mine, personal injury or death, environmental damage to the Diavik property, delays in mining, closing of Harry Winston Inc.'s manufacturing facilities or salons, monetary losses and possible legal liability. Although insurance is maintained to protect against certain risks in connection with the Diavik Diamond Mine and, the Company's operations, the insurance in place will not cover all potential risks. It may not be possible to maintain insurance to cover insurable risks at economically feasible premiums.

Fuel Costs

The Diavik Diamond Mine's expected fuel needs are purchased periodically during the year for storage, and transported to the mine site by way of the winter road. These costs will increase if transportation by air freight is required due to a shortened "winter road season" or unexpectedly high fuel usage.

The cost of the fuel purchased is based on the then prevailing price and expensed into operating costs on a usage basis. The Diavik Diamond Mine currently has no hedges for its future anticipated fuel consumption.

Reliance on Skilled Employees

Production at the Diavik Diamond Mine is dependent upon the efforts of certain skilled employees of DDMI. The loss of these employees or the inability of DDMI to attract and retain additional skilled employees may adversely affect the level of diamond production from the Diavik Diamond Mine. Currently, there is significant competition for skilled workers in remote northern operations due to the significant number of large-scale construction projects ongoing and planned in Canada's north, including the various construction projects relating to the development of the oil sands in northern Alberta.

The Company's success at marketing rough diamonds and in operating the business of Harry Winston Inc. is dependent on the services of key executives and skilled employees, as well as the continuance of key relationships with certain third parties, such as diamantaires. The loss of these persons or the Company's inability to attract and retain additional skilled employees or to establish and maintain relationships with required third parties may adversely affect its business and future operations in marketing diamonds and in operating its retail segment.

Expansion of the Existing Salon Network

A key component of the Company's retail strategy is the expansion of its existing salon network. This strategy requires the Company to make ongoing capital expenditures to build and open new salons, to refurbish existing salons from time to time, and to incur additional operating expenses in order to operate the new salons. To date, much of this expansion has been financed through borrowings by Harry Winston Inc. There can be no assurance that the expansion of the salon network will prove successful in increasing annual sales or earnings from the retail segment, and the increased debt levels resulting from this expansion could negatively impact the Company's liquidity and its results from operations in the absence of increased sales and earnings.

Competition in the Luxury Jewelry Segment

The Company is exposed to competition in the retail diamond market from other luxury goods, diamond, jewelry and watch retailers. The ability of Harry Winston Inc. to successfully compete with such luxury goods, diamond, jewelry and watch retailers is dependent upon a number of factors, including the ability to source high-end polished diamonds and protect and promote its distinctive brand name and reputation. If Harry Winston Inc. is unable to successfully compete in the luxury jewelry segment, then the Company's results of operations will be adversely affected.

Outstanding Share Information As at July 31, 2008 ------------------------------------------------------------------------- Authorized Unlimited Issued and outstanding shares 61,372,091 Options outstanding 1,619,338 Fully diluted 62,991,429 ------------------------------------------------------------------------- Additional Information

Additional information relating to the Company, including the Company's most recently filed annual information form, can be found on SEDAR at http://www.sedar.com/, and is also available on the Company's website at http://investor.harrywinston.com/.

Consolidated Balance Sheets (expressed in thousands of United States dollars) July 31, January 31, 2008 2008 (unaudited) ------------------------------------------------------------------------- Assets Current assets: Cash and cash equivalents (note 3) $ 56,318 $ 49,628 Cash collateral and cash reserves (note 3) 25,303 25,615 Accounts receivable 30,152 25,505 Inventory and supplies (note 4) 345,213 322,228 Prepaid expenses and other current assets 59,609 58,617 ------------------------------------------------------------------------- 516,595 481,593 Mining capital assets 765,996 658,200 Retail capital assets 73,667 70,617 Intangible assets, net (note 6) 131,574 132,628 Goodwill 93,780 93,780 Other assets 16,603 16,167 Future income tax asset 38,302 40,963 ------------------------------------------------------------------------- $ 1,636,517 $ 1,493,948 --------------------------- --------------------------- Liabilities and Shareholders' Equity Current liabilities: Accounts payable and accrued liabilities $ 137,069 $ 124,426 Income taxes payable 54,013 48,118 Bank advances 43,742 34,928 Current portion of long-term debt (note 7) 69,121 54,137 ------------------------------------------------------------------------- 303,945 261,609 Long-term debt (note 7) 225,403 255,212 Future income tax liability 356,079 370,500 Other long-term liability 2,015 1,730 Future site restoration costs 33,826 32,980 Minority interest 257 255 Shareholders' equity: Share capital (note 8) 381,541 305,502 Contributed surplus 15,906 15,614 Retained earnings 290,398 225,334 Accumulated other comprehensive income 27,147 25,212 ------------------------------------------------------------------------- 714,992 571,662 Commitments and guarantees (note 9) ------------------------------------------------------------------------- $ 1,636,517 $ 1,493,948 --------------------------- --------------------------- See accompanying notes to consolidated financial statements. Consolidated Statements of Earnings (expressed in thousands of United States dollars, except per share amounts) (unaudited) Three Months Three Months Six Months Six Months Ended Ended Ended Ended July 31, July 31, July 31, July 31, 2008 2007 2008 2007 ------------------------------------------------------------------------- Sales $ 186,119 $ 173,269 $ 342,198 $ 314,634 Cost of sales (note 15) 73,542 81,827 146,691 152,959 ------------------------------------------------------------------------- Gross margin 112,577 91,442 195,507 161,675 Selling, general and administrative expenses 39,194 35,201 82,479 69,412 ------------------------------------------------------------------------- Earnings from operations 73,383 56,241 113,028 92,263 ------------------------------------------------------------------------- Interest and financing expenses (5,366) (7,222) (10,819) (13,354) Other income 815 545 1,061 1,458 Foreign exchange gain (loss) 5,301 (11,785) 5,456 (25,077) ------------------------------------------------------------------------- Earnings before income taxes 74,133 37,779 108,726 55,290 Income tax expense - Current 27,589 25,091 49,089 42,531 Income tax recovery - Future (3,404) (7,344) (11,568) (10,666) ------------------------------------------------------------------------- Earnings before minority interest 49,948 20,032 71,205 23,425 Minority interest 1 (26) 2 114 ------------------------------------------------------------------------- Net earnings $ 49,947 $ 20,058 $ 71,203 $ 23,311 ------------------------------------------------------- ------------------------------------------------------- Earnings per share Basic $ 0.81 $ 0.34 $ 1.17 $ 0.40 ------------------------------------------------------- ------------------------------------------------------- Fully diluted $ 0.81 $ 0.33 $ 1.17 $ 0.39 ------------------------------------------------------- ------------------------------------------------------- Weighted average number of shares outstanding 61,372,091 58,371,004 60,655,424 58,366,574 ------------------------------------------------------- ------------------------------------------------------- See accompanying notes to consolidated financial statements. Consolidated Statements of Comprehensive Income (expressed in thousands of United States dollars) (unaudited) Three Months Three Months Six Months Six Months Ended Ended Ended Ended July 31, July 31, July 31, July 31, 2008 2007 2008 2007 ------------------------------------------------------------------------- Net earnings $ 49,947 $ 20,058 $ 71,203 $ 23,311 Other comprehensive income Net gain on translation of foreign operations (net of tax - nil) (654) 609 1,935 2,600 ------------------------------------------------------------------------- Total comprehensive income $ 49,293 $ 20,667 $ 73,138 $ 25,911 ------------------------------------------------------- ------------------------------------------------------- See accompanying notes to consolidated financial statements. Consolidated Statements of Changes in Shareholders' Equity (expressed in thousands of United States dollars) (unaudited) Three Months Three Months Six Months Six Months Ended Ended Ended Ended July 31, July 31, July 31, July 31, 2008 2007 2008 2007 ------------------------------------------------------------------------- Common shares: Balance at beginning of period $ 381,541 $ 305,208 $ 305,502 $ 305,165 Issued during the period - 294 76,039 337 ------------------------------------------------------------------------- Balance at end of period 381,541 305,502 381,541 305,502 ------------------------------------------------------------------------- Contributed surplus: Balance at beginning of period 15,769 15,107 15,614 14,922 Stock option expense 137 132 292 317 ------------------------------------------------------------------------- Balance at end of period 15,906 15,239 15,906 15,239 ------------------------------------------------------------------------- Retained earnings: Balance at beginning of period 243,521 154,285 225,334 165,625 Net earnings 49,947 20,058 71,203 23,311 Dividends paid (3,070) (14,591) (6,139) (29,184) ------------------------------------------------------------------------- Balance at end of period 290,398 159,752 290,398 159,752 ------------------------------------------------------------------------- Accumulated other comprehensive income: Balance at beginning of period 27,801 18,007 25,212 16,016 Other comprehensive income Net gain on translation of foreign operations (net of tax - nil) (654) 609 1,935 2,600 ------------------------------------------------------------------------- Balance at end of period 27,147 18,616 27,147 18,616 ------------------------------------------------------------------------- Total shareholders' equity $ 714,992 $ 499,109 $ 714,992 $ 499,109 ------------------------------------------------------- ------------------------------------------------------- See accompanying notes to consolidated financial statements. Consolidated Statements of Cash Flows (expressed in thousands of United States dollars) (unaudited) Three Months Three Months Six Months Six Months Ended Ended Ended Ended July 31, July 31, July 31, July 31, 2008 2007 2008 2007 ------------------------------------------------------------------------- Cash provided by (used in): Operating Net earnings $ 49,947 $ 20,058 $ 71,203 $ 23,311 Items not involving cash: Amortization and accretion 16,778 20,054 30,733 39,657 Future income taxes (3,404) (7,344) (11,568) (10,538) Stock-based compensation and pension expense 222 132 579 1,405 Foreign exchange (5,677) 11,439 (6,251) 24,901 Loss on disposal of assets 19 - 489 - Minority interest 1 (26) 2 114 Change in non-cash operating working capital (11,679) (14,507) (4,671) (34,726) ------------------------------------------------------------------------- 46,207 29,806 80,516 44,124 ------------------------------------------------------------------------- Financing Decrease in long- term debt (14,691) (5,368) (27,168) (8,994) Increase in revolving credit 25,235 35,734 180,425 54,746 Repayment of Harry Winston Inc. revolving credit - (159,109) Dividends paid (3,070) (14,591) (6,139) (29,184) Issue of common shares - 294 76,039 337 ------------------------------------------------------------------------- 7,474 16,069 64,048 16,905 ------------------------------------------------------------------------- Investing Cash collateral and cash reserve 8,635 13,679 312 25,938 Mining capital assets (63,284) (39,761) (129,908) (72,630) Retail capital assets (4,413) (8,556) (7,656) (17,034) Other assets - 345 (1) (745) ------------------------------------------------------------------------- (59,062) (34,293) (137,253) (64,471) ------------------------------------------------------------------------- Foreign exchange effect on cash balances (77) 538 (621) 916 Increase/(decrease) in cash and cash equivalents (5,458) 12,120 6,690 (2,526) Cash and cash equivalents, beginning of period (note 3) 61,776 39,528 49,628 54,174 ------------------------------------------------------------------------- Cash and cash equivalents, end of period (note 3) $ 56,318 $ 51,648 $ 56,318 $ 51,648 ------------------------------------------------------- ------------------------------------------------------- Change in non-cash operating working capital Accounts receivable (6,459) (993) (4,727) (5,279) Prepaid expenses and other current assets 5,969 (15,646) 1,534 (14,135) Inventory and supplies (4,409) (3,995) (22,986) (47,576) Accounts payable and accrued liabilities (3,864) (11,744) 14,835 7,166 Income tax payable (2,916) 17,871 6,673 25,098 ------------------------------------------------------------------------- $ (11,679) $ (14,507) $ (4,671) $ (34,726) ------------------------------------------------------------------------- Supplemental cash flow information Cash taxes paid $ 30,373 $ 2,305 $ 42,568 $ 3,041 Cash interest paid $ 4,390 $ 5,463 $ 8,798 $ 11,206 ------------------------------------------------------------------------- See accompanying notes to consolidated financial statements. Notes to Consolidated Financial Statements July 31, 2008 with comparative figures (tabular amounts in thousands of United States dollars, except as otherwise noted) NOTE 1: Nature of Operations Harry Winston Diamond Corporation (the "Company") is a specialist diamond company focusing on the mining and retail segments of the diamond industry. The Company's most significant asset is a 40% interest in the Diavik group of mineral claims. The Diavik Joint Venture (the "Joint Venture") is an unincorporated joint arrangement between Diavik Diamond Mines Inc. ("DDMI") (60%) and Harry Winston Diamond Mines Ltd. (40%). DDMI is the operator of the Diavik Diamond Mine. Both companies are headquartered in Yellowknife, Canada. DDMI is a wholly owned subsidiary of Rio Tinto plc of London, England, and Harry Winston Diamond Mines Ltd. is a wholly owned subsidiary of Harry Winston Diamond Corporation of Toronto, Canada. The Diavik Diamond Mine is located 300 kilometres northeast of Yellowknife in the Northwest Territories. The Company records its proportionate interest in the assets, liabilities and expenses of the Joint Venture in the Company's financial statements with a one-month lag. The Company also owns a 100% interest in Harry Winston Inc., the premier fine jewelry and watch retailer. The results of Harry Winston Inc., located in New York City, US, are consolidated in the financial statements of the Company. Certain comparative figures have been reclassified to conform with the current year's presentation. NOTE 2: Significant Accounting Policies The interim consolidated financial statements are prepared by management in accordance with accounting principles generally accepted in Canada. The interim consolidated financial statements include the accounts of the Company and all of its subsidiaries as well as its proportionate interest in the assets, liabilities and expenses of joint arrangements. Intercompany transactions and balances have been eliminated. The interim consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto in the Company's Annual Report for the year ended January 31, 2008, since these interim financial statements do not include all disclosures required by Canadian generally accepted accounting principles ("GAAP"). Excluding adoption of the new accounting standards described below, these statements have been prepared following the same accounting policies and methods of computation as the consolidated financial statements for the year ended January 31, 2008. Adoption of New Accounting Standards and Developments Capital Disclosures Effective February 1, 2008, the Company adopted new accounting recommendations from the Canadian Institute of Chartered Accountants ("CICA"), Handbook Section 1535, "Capital Disclosures". This new standard specifies the requirements for disclosure of both qualitative and quantitative information to enable users of financial statements to evaluate the Company's objectives, policies and processes for managing capital. This disclosure is contained in note 12 to the interim consolidated financial statements. Inventories Effective February 1, 2008, the Company adopted new accounting recommendations from the CICA, Handbook Section 3031, "Inventories", which supersedes the previously issued standard on inventory. The new standard introduces significant changes to the measurement and disclosure of inventory. The measurement changes include: the elimination of LIFO, the requirement to measure inventories at the lower of cost and net realizable value for inventories that are not ordinarily interchangeable and goods or services produced for specific purposes, the requirement for an entity to use a consistent cost formula for inventory of a similar nature and use, and the reversal of previous write-downs to net realizable value when there is a subsequent increase in the value of inventories. Disclosures of inventories have also been enhanced. Inventory policies, carrying amounts, amounts recognized as an expense, write-downs and the reversals of write-downs are required to be disclosed. This standard has had no material impact on the consolidated financial statements. Financial Instruments Effective February 1, 2008, the Company adopted new accounting recommendations from the CICA, Handbook Section 3862, "Financial Instruments - Disclosures" and Handbook Section 3863, "Financial Instruments - Presentation". Section 3862 provides guidance on disclosure of risks associated with both recognized and unrecognized financial instruments and how the Company manages these risks. Section 3863 details financial instruments presentation requirements, which are unchanged from those discussed in Section 3861, "Financial Instruments - Disclosure and Presentation". This disclosure is contained in notes 13 and 14 to the interim consolidated financial statements. Recently Issued Accounting Standards Goodwill and Intangibles On February 1, 2008 the CICA issued Handbook Section 3064, "Goodwill and Intangible Assets". This Section establishes revised standards for the recognition, measurement, presentation and disclosure of goodwill and intangible assets. Concurrent with the introduction of this standard, the CICA withdrew EIC 27, "Revenues and Expenses During the Pre-operating Period," which eliminates the ability for companies to defer costs and revenues incurred prior to commercial production at new mine operations. The changes are effective for interim and annual financial statements beginning January 1, 2009. The Company is currently assessing the impact of this standard on its consolidated financial statements. International Financial Reporting Standards ("IFRS") The Company plans to report under International Financial Reporting Standards ("IFRS") as of February 1, 2011. Changing from Canadian GAAP to IFRS could materially affect the Company's reported financial position and results of operations. During the second quarter of fiscal 2009, the Company commenced preparation of its changeover plan. The Company intends to engage a third party advisor to assist with the plan. Over the next few months, specific actions include identifying the major accounting differences between current Canadian GAAP and IFRS as they affect the Company and determining resource requirements over the next two years as the Company implements its transition plan. NOTE 3: Cash Resources July 31, January 31, 2008 2008 ------------------------------------------------------------------------- Cash on hand and balances with banks $ 56,318 $ 33,028 Short-term investments(a) - 16,600 ------------------------------------------------------------------------- Total cash and cash equivalents 56,318 49,628 Cash collateral and cash reserves 25,303 25,615 ------------------------------------------------------------------------- Total cash resources $ 81,621 $ 75,243 --------------------------- --------------------------- (a) Short-term investments are held in overnight deposits. NOTE 4: Inventory and Supplies July 31, January 31, 2008 2008 ------------------------------------------------------------------------- Rough diamond inventory $ 13,169 $ 17,097 Merchandise inventory 260,202 254,101 Supplies inventory 71,842 51,030 ------------------------------------------------------------------------- Total inventory and supplies $ 345,213 $ 322,228 --------------------------- --------------------------- NOTE 5: Diavik Joint Venture The following represents Harry Winston Diamond Corporation's 40% proportionate interest in the Joint Venture as at June 30, 2008 and December 31, 2007: July 31, January 31, 2008 2008 ------------------------------------------------------------------------- Current assets $ 123,496 $ 110,199 Long-term assets 714,708 605,300 Current liabilities 48,504 40,631 Long-term liabilities and participant's account 789,700 674,868 ------------------------------------------------------------------------- Three Three Six Six Months Months Months Months Ended Ended Ended Ended July 31, July 31, July 31, July 31, 2008 2007 2008 2007 ------------------------------------------------------------------------- Expenses net of interest income of $0.1 million (2007 - $0.1 million) (a)(b) 43,671 47,609 77,630 87,710 Cash flows resulting from (used in) operating activities (33,830) (39,941) (61,221) (83,983) Cash flows resulting from financing activities 86,377 79,454 175,501 143,726 Cash flows resulting from (used in) investing activities (50,181) (38,191) (114,973) (67,813) ------------------------------------------------------------------------- (a) The Joint Venture only earns interest income. (b) Expenses net of interest income for the six months ended July 31, 2008 of $0.2 million (2007 - $0.2 million). The Company is contingently liable for the other participant's portion of the liabilities of the Joint Venture and to the extent the Company's participating interest has increased because of the failure of the other participant to make a cash contribution when required, the Company would have access to an increased portion of the assets of the Joint Venture to settle these liabilities. NOTE 6: Intangible Assets Accum- ulated July January Amortization Amorti- 31, 31, Period Cost zation 2008 net 2008 net ------------------------------------------------------------------------- Trademark indefinite life $ 112,995 $ - $ 112,995 $ 112,995 Drawings indefinite life 12,365 - 12,365 12,365 Wholesale distribution network 120 months 5,575 (1,647) 3,928 4,206 Store leases 65 to 105 months 5,639 (3,353) 2,286 3,062 ------------------------------------------------------------------------- Intangible assets $ 136,574 $ (5,000) $ 131,574 $ 132,628 ------------------------------------------- ------------------------------------------- Amortization expense for the six months ended July 31, 2008 was $1.1 million (2007 - $0.8 million). NOTE 7: Long-Term Debt July 31, January 31, 2008 2008 ------------------------------------------------------------------------- Mining credit facilities $ 98,790 $ 125,677 Retail credit facilities and loans 187,351 174,850 First mortgage on real property 8,383 8,822 ------------------------------------------------------------------------- Total long-term debt 294,524 309,349 ------------------------------------------------------------------------- Less current portion (69,121) (54,137) ------------------------------------------------------------------------- $ 225,403 $ 255,212 --------------------------- --------------------------- On February 22, 2008, Harry Winston Inc. entered into a new credit agreement with a syndicate of banks for a $250.0 million, five-year revolving credit facility. There are no scheduled repayments required before maturity. At July 31, 2008, $166.1 million had been drawn against this secured credit facility, which expires on March 31, 2013. NOTE 8: Share Capital (a) Authorized Unlimited common shares without par value. (b) Issued Number of Shares Amount --------------------------------------------------------------------- Balance, January 31, 2008 58,372,091 $ 305,502 Shares issued for: Cash 3,000,000 76,039 --------------------------------------------------------------------- Balance, July 31, 2008 61,372,091 $ 381,541 ----------------------- ----------------------- (c) RSU and DSU Plans RSU Number of Units --------------------------------------------------------------------- Balance, January 31, 2008 143,715 Awards and payouts during the period (net): RSU awards (net of forfeitures) (4,805) RSU payouts (32,616) --------------------------------------------------------------------- Balance, July 31, 2008 106,294 ----------------------- ----------------------- DSU Number of Units --------------------------------------------------------------------- Balance, January 31, 2008 72,198 Awards during the period (net): DSU awards 20,715 --------------------------------------------------------------------- Balance, July 31, 2008 92,913 ----------------------- ----------------------- Three Three Six Six Months Months Months Months Ended Ended Ended Ended July 31, July 31, July 31, July 31, Expense for the Period 2008 2007 2008 2007 --------------------------------------------------------------------- RSU $ (174) $ 295 $ 335 $ 460 DSU (330) 76 237 3 --------------------------------------------------------------------- $ (504) $ 371 $ 572 $ 463 ----------------------------------------------- ----------------------------------------------- During the six months ended July 31, 2008, the Company granted (4,805) RSUs (net of forfeitures) and 20,715 DSUs under an employee and director incentive compensation program, respectively. The RSU and DSU Plans are full value phantom shares that mirror the value of Harry Winston Diamond Corporation's publicly traded common shares. In addition, 32,616 RSUs vested during the six months ended July 31, 2008, resulting in a payout of $0.8 million. Grants under the RSU Plan are on a discretionary basis to employees of the Company subject to Board of Director approval. Each RSU grant vests on the third anniversary of the grant date, subject to special rules for death and disability. The Company anticipates paying out cash on maturity of RSUs and DSUs. Only non-executive directors of the Company are eligible for grants under the DSU Plan. Each DSU grant vests immediately on the grant date. The expenses related to RSUs and DSUs are accrued based on the price of Harry Winston Diamond Corporation's common shares at the end of the period and on the probability of vesting. This expense is recognized on a straight-line basis over the term of vesting. NOTE 9: Commitments and Guarantees (a) Environmental Agreement Through negotiations of environmental and other agreements, the Joint Venture must provide funding for the Environmental Monitoring Advisory Board. The Company's share of this funding requirement was $0.2 million for calendar 2008. Further funding will be required in future years; however, specific amounts have not yet been determined. These agreements also state that the Joint Venture must provide security deposits for the performance by the Joint Venture of its reclamation and abandonment obligations under all environmental laws and regulations. The Company's share of the Joint Venture's letters of credit outstanding with respect to the environmental agreements as at July 31, 2008 was $73.6 million. The agreement specifically provides that these funding obligations will be reduced by amounts incurred by the Joint Venture on reclamation and abandonment activities. (b) Participation Agreements The Joint Venture has signed participation agreements with various native groups. These agreements are expected to contribute to the social, economic and cultural well-being of the Aboriginal bands. The agreements are each for an initial term of twelve years and shall be automatically renewed on terms to be agreed for successive periods of six years thereafter until termination. The agreements terminate in the event the mine permanently ceases to operate. (c) Commitments Commitments include the cumulative maximum funding commitments secured by letters of credit of the Joint Venture's environmental and participation agreements at the Company's 40% share, before any reduction of future reclamation activities, and future minimum annual rentals under non-cancellable operating and capital leases for retail salons and corporate office space, and are as follows: 2009 $ 93,182 2010 93,974 2011 91,261 2012 89,961 2013 89,149 Thereafter 151,305 --------------------------------------------------------------------- NOTE 10: Employee Benefit Plans Three Three Six Six Months Months Months Months Ended Ended Ended Ended July 31, July 31, July 31, July 31, Expenses for the Period 2008 2007 2008 2007 ------------------------------------------------------------------------- Defined benefit pension plan - Harry Winston retail segment $ 403 $ 6 $ 814 $ 12 Defined contribution plan - Harry Winston retail segment 235 390 469 600 Defined contribution plan - Diavik Diamond Mine 285 238 497 401 ------------------------------------------------------------------------- $ 923 $ 634 $ 1,780 $ 1,013 ----------------------------------------------- ----------------------------------------------- NOTE 11: Related Parties Transactions with related parties for the six months ended July 31, 2008 include $0.7 million payable of rent ($0.9 million for the six months ended July 31, 2007) relating to the New York salon, payable to a Harry Winston Inc. employee. NOTE 12: Capital Management The Company's capital includes cash and cash equivalents, short-term debt, long-term debt and equity, which includes issued common shares, contributed surplus and retained earnings. The Company's primary objective with respect to its capital management is to ensure that it has sufficient cash resources to maintain its ongoing operations, to provide returns to shareholders and benefits for other stakeholders, and to pursue growth opportunities. To meet these needs, the Company may from time to time raise additional funds through borrowing and/or the issuance of equity or debt or by securing strategic partners, upon approval by the Board of Directors. The Board of Directors reviews and approves any material transactions out of the ordinary course of business, including proposals on acquisitions or other major investments or divestitures, as well as annual capital and operating budgets. The Company is subject to externally imposed capital requirements related to its senior secured term and revolving credit facilities, whereby it is required to maintain a consolidated tangible net worth in excess of $250 million. There has been no change with respect to the Company's overall capital risk management strategy. At July 31, 2008, the Company is in compliance with this covenant. NOTE 13: Financial Instruments The Company has various financial instruments comprised of cash and cash equivalents, cash collateral and cash reserves, accounts receivable, accounts payable and accrued liabilities, bank advances and long-term debt. Cash and cash equivalents consist of cash on hand and balances with banks and short-term investments held in overnight deposits with a maturity on acquisition of less than 90 days. Cash and cash equivalents are designated as held-for-trading and are carried at fair value. The fair value of accounts receivable is determined by the amount of cash anticipated to be received in the normal course of business from the financial asset. The carrying values of these financial instruments are as follows: July 31, 2008 January 31, 2008 Estimated Carrying Estimated Carrying Fair Value Value Fair Value Value ------------------------------------------------------------------------- Financial Assets: Cash and cash equivalents $ 56,318 $ 56,318 $ 49,628 $ 49,628 Cash collateral and cash reserves 25,303 25,303 25,615 25,615 Accounts receivable 30,152 30,152 25,505 25,505 ------------------------------------------------------------------------- $ 111,773 $ 111,773 $ 100,748 $ 100,748 --------------------------------------------------- --------------------------------------------------- Financial Liabilities: Accounts payable and accrued liabilities $ 137,069 $ 137,069 $ 124,426 $ 124,426 Bank advances 43,742 43,742 34,928 34,928 Long-term debt 294,524 294,524 309,349 309,349 ------------------------------------------------------------------------- $ 475,335 $ 475,335 $ 468,703 $ 468,703 --------------------------------------------------- --------------------------------------------------- NOTE 14: Financial Risk Exposure and Risk Management The Company is exposed, in varying degrees, to a variety of financial instrument related risks by virtue of its activities. The Company's overall financial risk management program focuses on the preservation of capital and protecting current and future Company assets and cash flows by minimizing exposure to risks posed by the uncertainties and volatilities of financial markets. The Company's Audit Committee has responsibility to review and discuss significant financial risks or exposures and to assess the steps management has taken to monitor, control, report and mitigate such risks to the Company. Financial risk management is carried out by the Finance department, which identifies and evaluates financial risks and establishes controls and procedures to ensure financial risks are mitigated. The types of risk exposure and the way in which such exposures are managed are as follows: i) Currency Risk The Company's sales are predominately denominated in US dollars. As the Company operates in an international environment, some of the Company's financial instruments and transactions are denominated in currencies other than the US dollar. The results of the Company's operations are subject to currency transaction risk and currency translation risk. The operating results and financial position of the Company are reported in US dollars in the Company's consolidated financial statements. The Company's primary foreign exchange exposure impacting pre-tax earnings arises from the following sources: Net Canadian dollar denominated monetary assets and liabilities. The most significant exposure relates to its Canadian dollar future income tax liability. The Company's functional and reporting currency is US dollars; however, the calculation of income tax expense is based on income in the currency of the country of origin. As such, the Company is continually subject to foreign exchange fluctuations, particularly as the Canadian dollar moves against the US dollar. The weakening/strengthening of the Canadian dollar versus the US dollar results in an unrealized foreign exchange gain/loss on the revaluation of the Canadian dollar denominated future income tax liability. Committed or anticipated foreign currency denominated transactions, primarily Canadian dollar costs at the Diavik Diamond Mine. Based on the Company's net exposure to Canadian dollar monetary assets and liabilities at July 31, 2008, a one-cent change in the exchange rate would have impacted pre-tax net earnings for the quarter by $2.9 million. ii) Interest Rate Risk Interest rate risk is the risk borne by an interest-bearing asset or liability as a result of fluctuations in interest rates. Financial assets and financial liabilities with variable interest rates expose the Company to cash flow interest rate risk. The Company's most significant interest rate risk arises from its various credit facilities which bear variable interest based on LIBOR. iii) Concentration of Credit Risk Credit risk is the risk of a financial loss to the Company if a customer or counterparty to a financial instrument fails to meet its contractual obligation. Financial instruments that potentially subject the company to credit risk consist of trade receivables from retail segment clients. While economic factors can affect credit risk, the Company manages risk by providing credit terms on a case-by-case basis only after a review of the client's financial position and past credit history. The Company has not experienced significant losses in the past from its customers. The Company's exposure to credit risk in the mining segment is minimized by its sales policy, which requires receipt of cash prior to the delivery of rough diamonds to its customers. The Company manages credit risk, in respect of short-term investments, by maintaining bank accounts with Tier 1 banks and investing only in term deposits or banker's acceptances with highly rated financial institutions that are capable of prompt liquidation. The Company monitors and manages its concentration of counterparty credit risk on an ongoing basis. At July 31, 2008, the Company's maximum counterparty credit exposure consists of the carrying amount of cash and cash equivalents and accounts receivable, which approximates fair value. iv) Liquidity Risk Liquidity risk is the risk that the Company will not be able to meet its financial obligations as they fall due. The Company manages its liquidity by ensuring that there is sufficient capital to meet short and long-term business requirements, after taking into account cash flows from operations and the Company's holdings of cash and cash equivalents. The Company also strives to maintain sufficient financial liquidity at all times in order to participate in investment opportunities as they arise, as well as to withstand sudden adverse changes in economic circumstances. Management forecasts cash flows for its current and subsequent fiscal years to predict future financing requirements. Future requirements are met through a combination of committed credit facilities and access to capital markets. At July 31, 2008, the Company had $56.3 million of cash and cash equivalents and $41.7 million available under credit facilities. The following table summarizes the aggregate amount of contractual future cash outflows for the Company's financial liabilities: (expressed in thousands of United Less than Year Year After States dollars) Total 1 year 2-3 4-5 5 years ------------------------------------------------------------------------- Accounts payable and accrued liabilities $137,069 $137,069 $ - $ - $ - Income taxes payable 54,013 54,013 - - - Bank advances 43,742 43,742 - - - Long-term debt(a) 356,974 82,810 63,278 20,807 190,079 Environmental and participation agreements incremental commitments 95,445 74,994 3,906 1,953 14,592 Operating lease obligations 119,637 17,267 28,325 18,185 55,860 Capital lease obligations 1,984 921 1,063 - - ------------------------------------------------------------------------- (a) Includes projected interest payments on the current debt outstanding based on interest rates in effect at July 31, 2008. NOTE 15: Insurance Claim Included in cost of sales for the mining segment is a $4.3 million insurance settlement relating to an excavator fire that occurred in the fourth quarter of fiscal 2006 at the Diavik Diamond Mine. The settlement represents the recovery of the cost of the excavator that was previously written off along with incremental operating expenses relating to the procurement of a replacement excavator. Total proceeds of $5.0 million from the insurance settlement are expected to be received in the third quarter, resulting in a gain of approximately $0.7 million. NOTE 16: Segmented Information The Company operates in two segments within the diamond industry, mining and retail, for the three months ended July 31, 2008. The mining segment consists of the Company's rough diamond business. This business includes the 40% interest in the Diavik group of mineral claims and the sale of rough diamonds in the market-place. The retail segment consists of the Company's ownership in Harry Winston Inc. This segment consists of the marketing of fine jewelry and watches on a worldwide basis. For the three months ended July 31, 2008 Mining Retail Total ------------------------------------------------------------------------- Sales Canada $ 105,014 $ - $ 105,014 United States - 28,984 28,984 Europe - 31,636 31,636 Asia - 20,485 20,485 Cost of sales 32,390 41,152 73,542 ------------------------------------------------------------------------- Gross margin 72,624 39,953 112,577 Gross margin (%) 69.2% 49.3% 60.5% Selling, general and administrative expenses 5,151 34,043 39,194 ------------------------------------------------------------------------- Earnings from operations 67,473 5,910 73,383 ------------------------------------------------------------------------- Interest and financing expenses (2,648) (2,718) (5,366) Other income (expense) 816 (1) 815 Foreign exchange gain 5,187 114 5,301 ------------------------------------------------------------------------- Segmented earnings before income taxes $ 70,828 $ 3,305 $ 74,133 ----------------------------------------- ----------------------------------------- Segmented assets as at July 31, 2008 Canada $ 969,164 $ - $ 969,164 United States - 464,792 464,792 Other foreign countries 35,200 167,361 202,561 ------------------------------------------------------------------------- $ 1,004,364 $ 632,153 $ 1,636,517 ------------------------------------------------------------------------- Goodwill as at July 31, 2008 $ - $ 93,780 $ 93,780 Capital expenditures $ 63,284 $ 4,413 $ 67,697 Other significant non-cash items: Income tax recovery - Future $ (3,111) $ (293) $ (3,404) Amortization and accretion $ 13,689 $ 3,089 $ 16,778 ------------------------------------------------------------------------- Sales to one customer in the mining segment totalled $6.7 million for the three months ended July 31, 2008 ($8.1 million for the three months ended July 31, 2007). For the three months ended July 31, 2007 Mining Retail Total ------------------------------------------------------------------------- Sales Canada $ 105,071 $ - $ 105,071 United States - 22,162 22,162 Europe - 21,248 21,248 Asia - 24,788 24,788 Cost of sales 46,217 35,610 81,827 ------------------------------------------------------------------------- Gross margin 58,854 32,588 91,442 Gross margin (%) 56.0% 47.8% 52.8% Selling, general and administrative expenses 5,861 29,340 35,201 ------------------------------------------------------------------------- Earnings from operations 52,993 3,248 56,241 ------------------------------------------------------------------------- Interest and financing expenses (3,982) (3,240) (7,222) Other income 356 189 545 Foreign exchange gain (loss) (11,985) 200 (11,785) ------------------------------------------------------------------------- Segmented earnings before income taxes $ 37,382 $ 397 $ 37,779 ----------------------------------------- ----------------------------------------- Segmented assets as at July 31, 2007 Canada $ 761,976 $ - $ 761,976 United States - 470,233 470,233 Other foreign countries 8,284 126,773 135,057 ------------------------------------------------------------------------- $ 770,260 $ 597,006 $ 1,367,266 ------------------------------------------------------------------------- Goodwill as at July 31, 2007 $ - $ 96,575 $ 96,575 Capital expenditures $ 39,761 $ 8,556 $ 48,317 Other significant non-cash items: Income tax recovery - Future $ (7,122) $ (222) $ (7,344) Amortization and accretion $ 17,969 $ 2,086 $ 20,054 ------------------------------------------------------------------------- For the six months ended July 31, 2008 Mining Retail Total ------------------------------------------------------------------------- Sales Canada $ 186,407 $ - $ 186,407 United States - 53,910 53,910 Europe - 63,266 63,266 Asia - 38,615 38,615 Cost of sales 64,540 82,151 146,691 ------------------------------------------------------------------------- Gross margin 121,867 73,640 195,507 Gross margin (%) 65.4% 47.3% 57.1% Selling, general and administrative expenses 12,359 70,120 82,479 ------------------------------------------------------------------------- Earnings from operations 109,508 3,520 113,028 ------------------------------------------------------------------------- Interest and financing expenses (5,127) (5,692) (10,819) Other income (expense) 1,448 (387) 1,061 Foreign exchange gain 5,261 195 5,456 ------------------------------------------------------------------------- Segmented earnings (loss) before income taxes $ 111,090 $ (2,364) $ 108,726 ----------------------------------------- ----------------------------------------- Segmented assets as at July 31, 2008 Canada $ 969,164 $ - $ 969,164 United States - 464,792 464,792 Other foreign countries 35,200 167,361 202,561 ------------------------------------------------------------------------- $ 1,004,364 $ 632,153 $ 1,636,517 ------------------------------------------------------------------------- Goodwill as at July 31, 2008 $ - $ 93,780 $ 93,780 Capital expenditures $ 129,908 $ 7,656 $ 137,564 Other significant non-cash items: Income tax recovery - Future $ (9,739) $ (1,829) $ (11,568) Amortization and accretion $ 24,428 $ 6,305 $ 30,733 ------------------------------------------------------------------------- Sales to one customer in the mining segment totalled $10.3 million for the six months ended July 31, 2008 ($12.7 million for the six months ended July 31, 2007). For the six months ended July 31, 2007 Mining Retail Total ------------------------------------------------------------------------- Sales Canada $ 187,823 $ - $ 187,823 United States - 46,503 46,503 Europe - 43,595 43,595 Asia - 36,713 36,713 Cost of sales 86,733 66,226 152,959 ------------------------------------------------------------------------- Gross margin 101,090 60,585 161,675 Gross margin (%) 53.8% 47.8% 51.4% Selling, general and administrative expenses 10,948 58,464 69,412 ------------------------------------------------------------------------- Earnings from operations 90,142 2,121 92,263 ------------------------------------------------------------------------- Interest and financing expenses (7,657) (5,697) (13,354) Other income 1,122 336 1,458 Foreign exchange gain (loss) (25,296) 219 (25,077) ------------------------------------------------------------------------- Segmented earnings (loss) before income taxes $ 58,311 $ (3,021) $ 55,290 ----------------------------------------- ----------------------------------------- Segmented assets as at July 31, 2007 Canada $ 761,976 $ - $ 761,976 United States - 470,233 470,233 Other foreign countries 8,284 126,773 135,057 ------------------------------------------------------------------------- $ 770,260 $ 597,006 $ 1,367,266 ------------------------------------------------------------------------- Goodwill as at July 31, 2007 $ - $ 96,575 $ 96,575 Capital expenditures $ 72,630 $ 17,034 $ 89,664 Other significant non-cash items: Income tax recovery - Future $ (9,805) $ (861) $ (10,666) Amortization and accretion $ 35,659 $ 3,998 $ 39,657 -------------------------------------------------------------------------

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