/FIRST ADD - TO403a - HARRY WINSTON DIAMOND CORPORATION/

Share Name	Share Symbol	Market	Type	Share ISIN	Share Description
Howard Hldg Asd	LSE:HWD	London	Ordinary Share	QQ0031849458	ORD 10P (ASSD RUSHBROOK CASH)

Industry Sector	Turnover	Profit	EPS - Basic	PE Ratio	Market Cap
	0	0		N/A	0

Howard Hldg Asd (LSE:HWD)
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Diamond Prices and Demand for Diamonds The profitability of Harry Winston Diamond Corporation is dependent upon production from the Diavik 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 Harry Winston Diamond Corporation'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 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. Harry Winston Diamond Corporation'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 Mine and the amount of the Company's Canadian dollar liabilities relative to the revenue Harry Winston Diamond Corporation 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 Mine and exploration on the Diavik property require licenses and permits from the Canadian government. Renewal of the Diavik 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 Harry Winston Diamond Corporation anticipates that DDMI, which is also the operator of the Diavik 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 Mine or to further explore and develop the Diavik property. Regulatory and Environmental Risks The operation of the Diavik Mine, exploration activities at the Diavik Project and the manufacturing of jewelry 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 Mine and in the manufacture of jewelry. As well, as Harry Winston Diamond Corporation'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. Harry Winston Diamond Corporation 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 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 Harry Winston Diamond Corporation's business is subject to a number of risks and hazards generally, 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 Mine, personal injury or death, environmental damage to the Diavik property, delays in mining, closing of Harry Winston Inc. manufacturing facilities or salons, monetary losses and possible legal liability. Although insurance is maintained to protect against certain risks in connection with the Diavik Mine, Harry Winston Diamond Corporation's operations and the operations of Harry Winston Inc., 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 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 Mine currently has no hedges for its future anticipated fuel consumption. Reliance on Skilled Employees Production at the Diavik 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 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. Harry Winston Diamond Corporation's success at marketing 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 Harry Winston Diamond Corporation, through its ownership of Harry Winston Inc., is exposed to competition in the retail diamond market from other luxury goods, diamond and jewelry retailers. The ability of Harry Winston Inc. to successfully compete with such luxury goods, diamond and jewelry 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 Harry Winston Diamond Corporation's results of operations will be adversely affected. Changes in Accounting Policies Financial Instruments, Hedges and Comprehensive Income On February 1, 2007, the Company adopted new accounting standards issued by the Canadian Institute of Chartered Accountants ("CICA") on equity, financial instruments, hedges and comprehensive income that require investment securities and hedging derivatives to be accounted for at fair value. These standards are substantially harmonized with US GAAP. The adoption of these new accounting standards has not had a material impact on the financial position of the Company. For a description of the new standards and the impact on the Company's financial statements, please see note 3 to the consolidated financial statements on page 30 of this report. Recently Issued Accounting Standards Inventories In May 2007, the CICA issued 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 cost method for inventories that are not ordinarily interchangeable or goods and 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 new standard will apply to the Company effective February 1, 2008. Financial Instruments - Disclosures In December 2006, the CICA issued Handbook Section 3862, "Financial Instruments - Disclosures", and Handbook Section 3863, "Financial Instruments - Presentation", which supersede Handbook Section 3861, the previously issued standard on financial instruments. 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. Capital Disclosures In December 2006, the CICA issued Handbook Section 1535, "Capital Disclosures". This new standard requires the disclosure of information about an entity's objectives, policies and processes for managing capital. This new standard will apply to the Company effective February 1, 2008. The Company is currently assessing the impact of these new standards on its consolidated financial statements. Outstanding Share Information As at January 31, 2008 ------------------------------------------------------------------------- Authorized Unlimited Issued and outstanding shares 58,372,091 Options outstanding 1,719,338 Fully diluted 60,091,429 ------------------------------------------------------------------------- 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) As at January 31, 2008 2007 ------------------------------------------------------------------------- Assets Current assets: Cash and cash equivalents (note 5) $ 49,628 $ 54,174 Cash collateral and cash reserves (note 5) 25,615 51,448 Accounts receivable 25,505 13,297 Inventory and supplies (note 6) 322,228 273,736 Prepaid expenses and other current assets 58,617 27,683 ------------------------------------------------------------------------- 481,593 420,338 Deferred mineral property costs (note 7) 179,990 188,058 Capital assets (note 8) 548,827 384,532 Intangible assets, net (note 10) 132,628 134,320 Goodwill (note 4) 93,780 98,142 Other assets (note 11) 16,167 18,187 Future income tax asset (note 13) 40,963 44,337 ------------------------------------------------------------------------- $ 1,493,948 $ 1,287,914 ------------------------------ ------------------------------ Liabilities and Shareholders' Equity Current liabilities: Accounts payable and accrued liabilities $ 124,426 $ 118,971 Income taxes payable 48,118 5,776 Bank advances (note 12(ii)) 34,928 29,776 Current portion of long-term debt (note 12) 54,137 95,434 ------------------------------------------------------------------------- 261,609 249,957 Long-term debt (note 12) 255,212 185,446 Future income tax liability (note 13) 370,500 333,498 Other long-term liability 1,730 - Future site restoration costs (note 14) 32,980 17,200 Minority interest 255 85 Shareholders' equity: Share capital (note 15) 305,502 305,165 Contributed surplus 15,614 14,922 Retained earnings 225,334 165,625 Accumulated other comprehensive income 25,212 16,016 ------------------------------------------------------------------------- 571,662 501,728 Commitments and guarantees (note 17) Subsequent events (note 21) ------------------------------------------------------------------------- $ 1,493,948 $ 1,287,914 ------------------------------ ------------------------------ See accompanying notes to consolidated financial statements. On behalf of the Board: Robert A. Gannicott Matthew W. Barrett Director Director Consolidated Statements of Earnings (expressed in thousands of United States dollars, except per share amounts) Years ended January 31, 2008 2007 ------------------------------------------------------------------------- Sales $ 679,307 $ 558,793 Cost of sales 311,187 285,498 ------------------------------------------------------------------------- Gross margin 368,120 273,295 Selling, general and administrative expenses 150,445 126,536 ------------------------------------------------------------------------- Earnings from operations 217,675 146,759 ------------------------------------------------------------------------- Interest and financing expenses (27,858) (21,150) Other income 2,758 5,081 Insurance settlement (note 20) 13,488 - Foreign exchange gain (loss) (43,391) 8,784 ------------------------------------------------------------------------- Earnings before income taxes 162,672 139,474 Income taxes - Current (note 13) 47,516 14,763 Income taxes - Future (note 13) 8,578 20,067 ------------------------------------------------------------------------- Earnings before minority interest 106,578 104,644 Minority interest 170 375 ------------------------------------------------------------------------- Net earnings $ 106,408 $ 104,269 ------------------------------ ------------------------------ Earnings per share Basic $ 1.82 $ 1.79 ------------------------------ ------------------------------ Fully diluted (note 16) $ 1.81 $ 1.76 ------------------------------ ------------------------------ Weighted average number of shares outstanding 58,369,338 58,257,449 ------------------------------ ------------------------------ See accompanying notes to consolidated financial statements. Consolidated Statements of Comprehensive Income (expressed in thousands of United States dollars) Years ended January 31, 2008 2007 ------------------------------------------------------------------------- Net earnings $ 106,408 $ 104,269 Other comprehensive income (loss) Net gain (loss) on translation of net foreign operations (net of tax - nil) 9,196 (328) ------------------------------------------------------------------------- Total comprehensive income $ 115,604 $ 103,941 ------------------------------ ------------------------------ See accompanying notes to consolidated financial statements. Consolidated Statements of Changes in Shareholders' Equity (expressed in thousands of United States dollars) Years ended January 31, 2008 2007 ------------------------------------------------------------------------- Common shares: Balance at beginning of year $ 305,165 $ 300,652 Issued during the year 337 4,513 ------------------------------------------------------------------------- Balance at end of year 305,502 305,165 ------------------------------------------------------------------------- Contributed surplus: Balance at beginning of year 14,922 15,267 Stock option expense 692 (345) ------------------------------------------------------------------------- Balance at end of year 15,614 14,922 ------------------------------------------------------------------------- Retained earnings: Balance at beginning of year 165,625 119,630 Net earnings 106,408 104,269 Dividends paid (46,699) (58,274) ------------------------------------------------------------------------- Balance at end of year 225,334 165,625 ------------------------------------------------------------------------- Accumulated other comprehensive income: Balance at beginning of year 16,016 16,344 Other comprehensive income (loss) Net gain (loss) on translation of net foreign operations (net of tax - nil) 9,196 (328) ------------------------------------------------------------------------- Balance at end of year 25,212 16,016 ------------------------------------------------------------------------- Total shareholders' equity $ 571,662 $ 501,728 ------------------------------ ------------------------------ See accompanying notes to consolidated financial statements. Consolidated Statements of Cash Flows (expressed in thousands of United States dollars) For the years ended January 31, 2008 2007 ------------------------------------------------------------------------- Cash provided by (used in): Operating Net earnings $ 106,408 $ 104,269 Items not involving cash: Amortization and accretion 81,174 68,728 Future income taxes 8,578 20,067 Stock-based compensation 2,422 1,250 Foreign exchange 45,201 (7,617) Loss on write-off of investment - 909 Minority interest 170 352 Change in non-cash operating working capital (50,069) (10,393) ------------------------------------------------------------------------- 193,884 177,565 ------------------------------------------------------------------------- Financing Increase/(decrease) in long-term debt (19,637) 51,062 Increase in revolving credit 52,722 64,716 Dividends paid (46,699) (58,274) Issue of common shares 337 2,918 ------------------------------------------------------------------------- (13,277) 60,422 ------------------------------------------------------------------------- Investing Cash collateral and cash reserve 25,701 (37,172) Deferred mineral property costs (7,522) (16,834) Capital assets (201,845) (119,904) Deferred charges (2,115) (171) Purchase of Harry Winston Inc. - (158,150) ------------------------------------------------------------------------- (185,781) (332,231) ------------------------------------------------------------------------- Foreign exchange effect on cash balances 628 302 Decrease in cash and cash equivalents (4,546) (93,942) Cash and cash equivalents, beginning of year (note 5) 54,174 148,116 ------------------------------------------------------------------------- Cash and cash equivalents, end of year (note 5) $ 49,628 $ 54,174 ------------------------------ ------------------------------ Change in non-cash operating working capital Accounts receivable (8,641) 1,058 Prepaid expenses and other current assets (32,756) 6,157 Inventory and supplies (48,489) (53,807) Accounts payable and accrued liabilities 9,622 34,117 Income taxes payable 30,195 2,082 ------------------------------------------------------------------------- $ (50,069) $ (10,393) ------------------------------------------------------------------------- Supplemental cash flow information Cash taxes paid $ 11,052 $ 11,780 Cash interest paid $ 24,946 $ 18,746 ------------------------------------------------------------------------- See accompanying notes to consolidated financial statements. Notes to Consolidated Financial Statements Years ended January 31, 2008 and 2007 (tabular amounts in thousands of United States dollars, except as otherwise noted) NOTE 1: Change in Name Effective November 9, 2007, Aber Diamond Corporation changed its name to Harry Winston Diamond Corporation. NOTE 2: 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. (formerly Aber Diamond Mines Ltd.) (40%). DDMI is the operator of the Diavik Diamond Mine (the "Diavik 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 name of Aber Diamond Mines Ltd. was changed to Harry Winston Diamond Mines Ltd. on December 3, 2007. The Diavik 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. During fiscal 2007, the Company acquired the remaining 47.17% interest in Harry Winston Inc. that it did not previously own. The results of Harry Winston Inc., located in New York City, US, are consolidated in the financial statements of the Company. NOTE 3: Significant Accounting Policies The consolidated financial statements are prepared by management in accordance with accounting principles generally accepted in Canada. The principal accounting policies presently followed by the Company are summarized as follows: (a) Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its subsidiaries as well as its proportionate share of unincorporated joint arrangements. Subsidiaries A subsidiary is an entity that is controlled by the Company. The consolidated financial statements include all the assets, liabilities, revenues, expenses and cash flows of the Company and its subsidiaries after eliminating intercompany balances and transactions. For partly owned subsidiaries, the net assets and net earnings attributable to minority shareholders are presented as minority interests on the consolidated balance sheet and consolidated statement of earnings. Joint Arrangements that Are Not Entities ("Joint Arrangements") The Diavik Joint Venture is an unincorporated joint arrangement. Harry Winston Diamond Corporation owns an undivided 40% interest in the assets, liabilities and expenses of the Joint Venture. Harry Winston Diamond Corporation records its proportionate interest in the assets, liabilities and expenses of the Joint Venture in the Company's consolidated financial statements with a one-month lag. The accounting policies described below include those of the Joint Venture. (b) Measurement Uncertainty The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of earnings, revenues and expenses during the reporting year. Significant areas requiring the use of management estimates relate to the determination of impairment of capital assets, intangible assets, goodwill and deferred mineral property costs, estimation of future site restoration costs and future income taxes. Financial results as determined by actual events could differ from those estimated. (c) Revenue Recognition Revenue from rough diamond sales is recognized upon delivery of merchandise when the customer takes ownership and assumes risk of loss, persuasive evidence of an arrangement exists, the Company's price to the customer is fixed or determinable and collection of the resulting receivable is reasonably assured. Revenue from fine jewelry and watch sales is recognized upon delivery of merchandise when the customer takes ownership and assumes risk of loss, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed or determinable. Sales are reported net of returns. (d) Cash Resources Cash and cash equivalents, and cash collateral and cash reserves, consist of cash on hand, balances with banks and short-term money market instruments (with a maturity on acquisition of less than 90 days), and are carried at cost, which approximates market. Funds in cash collateral and cash reserves are maintained as prescribed under the Company's debt financing arrangements and will become available to Harry Winston Diamond Corporation for general corporate purposes and for debt servicing as prescribed by the terms of credit facility agreements. (e) Trade Accounts Receivable Trade accounts receivable are recorded at the invoiced amount and generally do not bear interest. The allowance for doubtful accounts is the Company's best estimate of the amount of probable credit losses in the existing accounts receivable. The Company reviews its allowance for doubtful accounts monthly. Account balances are written off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. (f) Inventory Rough diamond inventory is recorded at the lower of cost or net realizable value and includes diamonds in process and diamonds held for sale. Cost is determined on an average cost basis including production costs and value-added processing activity. Merchandise inventory is recorded at the lower of cost or net realizable value and includes fine jewelry and watches. Included in merchandise inventory are production costs such as material, labour and overhead costs. Supplies inventory is recorded at the lower of average cost or replacement value and includes consumables and spare parts maintained at the Diavik Mine site and at the Company's sorting and distribution facility locations. (g) Deferred Mineral Property Costs All direct costs relating to mineral properties, including mineral claim acquisition costs, exploration and development expenditures in the pre-production stage, ongoing property exploration expenditures, pre-production operating costs net of any recoveries, interest, and amortization, are capitalized and accumulated on a property-by- property basis. The costs of deferred mineral properties from which there is production are amortized using the units-of-production method based upon estimated proven and probable reserves. General exploration expenditures which do not relate to specific resource properties are expensed in the period incurred. On an ongoing basis, the Company evaluates each property based on results to date to determine the nature of exploration and development activities that are warranted in the future. If there is little prospect of the Joint Venture continuing to explore or develop a property, the deferred costs related to that property are written down to the estimated fair value. (h) Capital Assets Capital assets are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are provided using the units-of-production method or straight-line method as appropriate. The units-of-production method is applied to a substantial portion of Diavik Mine capital assets and, depending on the asset, is based on carats of diamonds recovered during the period relative to the proven and probable ore reserves of the ore deposit being mined or to the total ore deposit. Other capital assets are depreciated using the straight-line method over the estimated useful lives of the related assets, which are as follows: Asset Estimated useful life (years) -------------------------------------------------------------------- Buildings 10-40 Machinery and mobile equipment 3-10 Computer equipment and software 3 Furniture and equipment 2-10 Leasehold and building improvements Up to 20 -------------------------------------------------------------------- Amortization for mine related assets was charged to deferred mineral property costs during the pre-commercial production stage. Maintenance and repair costs are charged to earnings while expenditures for major renewals and improvements are capitalized. The recoverability of the amounts shown for the Diavik Mine capital assets is dependent upon the continued existence of economically recoverable reserves, upon maintaining title and beneficial interest in the property, and upon future profitable production or proceeds from disposition of the diamond properties. The amounts representing Diavik Mine capital assets do not necessarily represent present or future values. Upon the disposition of capital assets, the accumulated amortization is deducted from the original cost and any gain or loss is reflected in current earnings. (i) Intangible Assets Intangible assets acquired individually or as part of a group of other assets are initially recognized and measured at cost. The cost of a group of intangible assets acquired in a transaction, including those acquired in a business combination that meet the specified criteria for recognition apart from goodwill, is allocated to the individual assets acquired based on their fair values at acquisition. Intangible assets with finite useful lives are amortized on a straight-line basis over their useful lives as follows: Asset Estimated useful life (years) -------------------------------------------------------------------- Wholesale distribution network 10 Store leases Up to 9 -------------------------------------------------------------------- The amortization methods and estimated useful lives of intangible assets are reviewed annually. Intangible assets with indefinite useful lives are not amortized and are tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test compares the carrying amount of the intangible asset with its fair value, and an impairment loss is recognized in income for the excess, if any. (j) Goodwill Goodwill is the residual amount that results when the purchase price of an acquired business exceeds the sum of the amounts allocated to the assets acquired, less liabilities assumed, based on their fair values. Goodwill is allocated, as of the date of the business combination, to the Company's reporting units that are expected to benefit from the synergies of the business combination. Goodwill is not amortized and is tested for impairment annually, or more frequently if events or changes in circumstances indicate that the asset might be impaired. The impairment test is carried out in two steps. In the first step, the carrying amount of the reporting unit is compared with its fair value. When the fair value of a reporting unit exceeds its carrying amount, goodwill of the reporting unit is considered not to be impaired and the second step of the impairment test is unnecessary. The second step is carried out when the carrying amount of a reporting unit exceeds its fair value, in which case the implied fair value of the reporting unit's goodwill is compared with its carrying amount to measure the amount of the impairment loss, if any. The implied fair value of goodwill is determined in the same manner as the value of the goodwill is determined in a business combination, using the fair value of the reporting unit as if it were the purchase price. When the carrying amount of the reporting unit goodwill exceeds the implied fair value of the goodwill, an impairment loss is recognized in an amount equal to the excess and is presented as a separate line item in the consolidated statement of earnings before extraordinary items and discontinued operations. (k) Other Assets Other assets are amortized over a period not exceeding ten years. (l) Future Site Restoration Costs The Company records the fair value of any asset retirement obligation as a long-term liability in the year in which the related environmental disturbance occurs, based on the net present value of the estimated future costs. The fair value of the liability is added to the carrying amount of the deferred mineral property and this additional carrying amount is amortized over the life of the asset based on units of production. The obligation is adjusted periodically to reflect the passage of time and changes in the estimated future cash flows underlying the obligation. If the obligation is settled for other than the carrying amount of the liability, the Company will recognize a gain or loss on settlement. (m) Foreign Currency Translation The functional currency of the Company is the US dollar. At year end, monetary assets and liabilities denominated in foreign currencies are translated to US dollars at exchange rates in effect at the balance sheet date and non-monetary assets and liabilities are translated at rates of exchange in effect when the assets were acquired or obligations incurred. Revenues and expenses are translated at rates in effect at the time of the transactions. Foreign exchange gains and losses are included in earnings. For certain subsidiaries of the Company where the functional currency is not the US dollar, the assets and liabilities of these subsidiaries are translated at the rate of exchange in effect at the balance sheet date. Revenues and expenses are translated at the rate of exchange in effect at the time of the transactions. Foreign exchange gains and losses are accumulated in other comprehensive income under shareholders' equity. (n) Income and Mining Taxes The Company accounts for income taxes under the asset and liability method. Under this method, future tax assets and liabilities are recognized for future tax consequences attributable to differences between the financial statement carrying value and the tax basis of assets and liabilities. Future tax assets and liabilities are measured using enacted or substantively enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. A reduction in respect of the benefit of a future tax asset (a valuation allowance) is recorded against any future tax asset if it is not likely to be realized. The effect on future tax assets and liabilities of a change in tax rates is recognized in earnings in the year during which the change in tax rates is considered to be substantively enacted. (o) Stock-Based Compensation The Company applies the fair value method to all grants of stock options. The fair value of options granted is estimated at the date of grant using a Black-Scholes option pricing model incorporating assumptions regarding risk-free interest rates, dividend yield, volatility factor of the expected market price of the Company's stock, and a weighted average expected life of the options. The estimated fair value of the options is recorded as an expense on a straight-line basis over the vesting period, with an offsetting credit to shareholders' equity. Any consideration received on amounts attributable to stock options is credited to share capital. (p) Restricted and Deferred Share Unit ("RSU" and "DSU") Plans The RSU and DSU Plans are full value phantom shares that mirror the value of Harry Winston Diamond Corporation's publicly traded common shares. 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. Grants under the DSU Plan are awarded to non-executive directors of the Company. Each DSU grant vests immediately on the grant date. (q) Post Retirement Benefits The expected costs of post retirement benefits under defined benefit arrangements are charged to the profit and loss account over the service lives of employees entitled to those benefits. Variations from the regular cost are spread on a straight-line basis over the expected average remaining service lives of relevant current employees. The plan assets and liabilities are valued annually by qualified actuaries. (r) Financial Instruments From time to time, the Company may use a limited number of derivative financial instruments to manage its foreign currency and interest rate exposure. For a derivative to qualify as a hedge at inception and throughout the hedged period, the Company formally documents the nature and relationships between the hedging instruments and hedged items, as well as its risk-management objectives, strategies for undertaking the various hedge transactions and method of assessing hedge effectiveness. Financial instruments qualifying for hedge accounting must maintain a specified level of effectiveness between the hedge instrument and the item being hedged, both at inception and throughout the hedged period. Gains and losses resulting from any ineffectiveness in a hedging relationship must be recognized immediately in net income. The Company does not use derivatives for trading or speculative purposes. (s) Basic and Diluted Earnings per Share Basic earnings per share are computed by dividing net earnings (loss) by the weighted average number of shares outstanding during the year. Diluted earnings per share are prepared using the treasury stock method to compute the dilutive effect of options and warrants. The treasury stock method assumes the exercise of any "in-the-money" options with the option proceeds would be used to purchase common shares at the average market value for the year. Options with an average market value for the year higher than the exercise price are not included in the calculation of diluted earnings per share as such options are not dilutive. (t) Impairment of Long-Lived Assets Long-lived assets, including property, plant and equipment and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed of by sale would be separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposed group classified as held for sale would be presented separately in the appropriate asset and liability sections of the balance sheet. (u) Comparative Figures Certain figures have been reclassified to conform with presentation in the current year. (v) Changes in Accounting Policy On February 1, 2007, the Company adopted three new accounting standards issued by the Canadian Institute of Chartered Accountants ("CICA") on financial instruments: (i) Financial Instruments - Recognition and Measurement, (ii) Hedges, and (iii) Comprehensive Income. Financial Instruments This new standard required the Company to revalue certain of its financial assets and liabilities, including derivatives designated in qualifying hedging relationships and embedded derivatives in certain contracts, at fair value on the initial date of implementation and at each subsequent financial reporting date. The adoption of this new standard has not had a material impact on the financial position of the Company. Under the new standard, the Company elected to add transaction costs related to its non- revolving long-term debt to the carrying amount of the debt and was required to reclassify cumulative translation amounts to accumulated other comprehensive income, which resulted in the following adjustments to the consolidated balance sheet on February 1, 2007: As at February 1, 2007 Increase/(Decrease) -------------------------------------------------------------------- Assets Other assets $ (859) Liabilities and Shareholders' Equity Long-term debt $ (859) Cumulative translation adjustment (16,016) Accumulated other comprehensive income 16,016 -------------------------------------------------------------------- This standard has had no material impact on the consolidated statement of earnings. Prior period earnings have not been restated. This standard also required the Company to classify financial assets and liabilities according to their characteristics and management's choices and intentions related thereto for the purposes of ongoing measurement. Subsequent measurement for these assets and liabilities is based on either fair value or amortized cost using the effective interest method, depending upon their classification. In accordance with the new standard, the Company's financial assets and liabilities are generally classified and measured as follows: Asset/Liability Category Measurement Cash and cash equivalents Held for trading Fair value Cash collateral and cash reserves Held for trading Fair value Accounts receivable Loans and Amortized cost receivables Accounts payable and Held for trading Fair value accrued liabilities Income taxes payable Held for trading Fair value Bank advances Held for trading Fair value Long-term debt Other liabilities Amortized cost Hedges This new standard contains new rules for reporting fair value and cash flow hedges. The Company has no significant hedges and therefore this new standard has had no impact on the Company's consolidated financial statements. Comprehensive Income This new standard required the Company to present a new consolidated statement of comprehensive income to detail income items impacting accumulated other comprehensive income, which is reported as part of shareholders' equity. This statement has been included above in the consolidated statement of changes in shareholders' equity. (w) Recently Issued Accounting Standards Inventories In May 2007, the CICA issued 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 cost method for inventories that are not ordinarily interchangeable or goods and 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. NOTE 4: Acquisition On September 29, 2006, the Company acquired the remaining 47.17% ownership of Harry Winston Inc. for $157.2 million, paid in cash on the acquisition date. The final allocation of the purchase price to the fair values of assets acquired and liabilities assumed is set forth in the table below. The valuation of intangible assets has been completed by a third party valuator. Purchase price amounts give rise to future income tax liabilities that have been recorded in the same year in which the intangible assets are separately identified. Cash $ 2,433 Accounts receivable 4,909 Inventory 107,690 Intangibles 92,414 Goodwill(a) 57,230 Other assets 31,835 Accounts payable and accrued liabilities (18,728) Bank loan (54,653) Other liabilities (64,980) ------------------------------------------------------------------------- $ 158,150 ----------- ----------- Cash paid at acquisition $ 157,150 Acquisition and other costs 1,000 ------------------------------------------------------------------------- $ 158,150 ----------- ----------- (a) Tax benefits relating to pre-acquisition net operating losses ("NOLs") at Harry Winston Inc. were not recognized as a separate identifiable asset in the purchase price allocations and consequently are a component of goodwill. Harry Winston Inc. has since recognized benefits of $5.2 million relating to these NOLs (2008 - $4.4 million; 2007 - $0.8 million), which have been recorded as a reduction to goodwill in the applicable periods. NOTE 5: Cash Resources 2008 2007 ------------------------------------------------------------------------- Cash on hand and balances with banks $ 33,028 $ 44,377 Short-term investments(a) 16,600 9,797 ------------------------------------------------------------------------- Total cash and cash equivalents 49,628 54,174 Cash collateral and cash reserves 25,615 51,448 ------------------------------------------------------------------------- Total cash resources $ 75,243 $ 105,622 ------------------------ ------------------------ (a) Short-term investments are held in overnight deposits. NOTE 6: Inventory and Supplies 2008 2007 ------------------------------------------------------------------------- Rough diamond inventory $ 17,097 $ 17,648 Merchandise inventory 254,101 228,157 Supplies inventory 51,030 27,931 ------------------------------------------------------------------------- Total inventory and supplies $ 322,228 $ 273,736 ------------------------ ------------------------ NOTE 7: Deferred Mineral Property Costs 2008 2007 ------------------------------------------------------------------------- Accumulated Net Accumulated Net amorti- book amorti- book Cost zation value Cost zation value ------------------------------------------------------------------------- Diavik Mine $ 271,316 $ 91,326 $ 179,990 $ 265,217 $ 77,159 $ 188,058 ----------------------------------------------------------------- ----------------------------------------------------------------- The Company holds a 40% ownership interest in the Diavik group of mineral claims, which contains commercially mineable diamond reserves. DDMI, a subsidiary of Rio Tinto plc, is the operator of the Joint Venture and holds the remaining 60% interest. The claims are subject to private royalties which are in the aggregate 2% of the value of production. NOTE 8: Capital Assets 2008 2007 ------------------------------------------------------------------------- Accumulated Net Accumulated Net amorti- book amorti- book Cost zation value Cost zation value ------------------------------------------------------------------------- Diavik equipment and leaseholds(a) $586,208 $136,771 $449,437 $422,419 $101,912 $320,507 Furniture, equipment and other(b) 29,163 13,044 16,119 20,193 9,530 10,663 Real property - land and building(c) 97,745 14,474 83,271 64,691 11,329 53,362 ------------------------------------------------------------------------- $713,116 $164,289 $548,827 $507,303 $122,771 $384,532 ---------------------------------------------------------- ---------------------------------------------------------- (a) Diavik equipment and leaseholds are project related assets at the Joint Venture level. (b) Furniture, equipment and other includes equipment located at the Company's diamond sorting facility and at Harry Winston Inc. salons. (c) Real property is comprised of land and a building that houses the corporate activities of the Company and various leasehold improvements to Harry Winston Inc. salons and corporate offices. NOTE 9: Diavik Joint Venture The following represents Harry Winston Diamond Corporation's 40% proportionate interest in the Joint Venture as at December 31, 2007 and 2006: 2008 2007 ------------------------------------------------------------------------- Current assets $ 110,199 $ 66,037 Long-term assets 605,300 477,753 Current liabilities 40,631 35,671 Long-term liabilities and participant's account 674,868 508,119 Year ended: Expenses net of interest income of $0.5 million (2007 - $0.8 million)(a) 177,049 171,429 Cash flows resulting from operating activities (121,440) (76,828) Cash flows resulting from financing activities 290,615 180,252 Cash flows resulting from investing activities (165,645) (100,467) ------------------------------------------------------------------------- (a) The Joint Venture only earns interest income. 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 10: Intangible Assets Accumulated Amortization amorti- period Cost zation 2008 net 2007 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 (1,369) 4,206 4,763 Store leases 65 to 105 months 5,639 (2,577) 3,062 4,197 ------------------------------------------------------------------------- Intangible assets $ 136,574 $ (3,946) $ 132,628 $ 134,320 ------------------------------------------- ------------------------------------------- Amortization expense for 2008 was $1.7 million (2007 - $1.0 million). NOTE 11: Other Assets 2008 2007 ------------------------------------------------------------------------- Prepaid pricing discount(a), net of accumulated amortization of $4.6 million (2007 - $3.1 million) $ 7,440 $ 8,880 Other assets 2,512 5,220 Refundable security deposits 6,215 4,087 ------------------------------------------------------------------------- $ 16,167 $ 18,187 ------------------------ ------------------------ (a) Prepaid pricing discount represents funds paid to Tiffany & Co. ("Tiffany") by the Company to amend its rough diamond supply agreement. The amendment eliminated all pricing discounts on future sales. The payment has been deferred and is being amortized on a straight-line basis over the remaining life of the contract. NOTE 12: Long-Term Debt and Bank Advances (i) Long-Term Debt 2008 2007 -------------------------------------------------------------------- Credit facility(a) $ 125,677 $ 158,140 Harry Winston Inc. credit facilities(b) 174,850 114,782 First mortgage on real property 8,822 7,958 -------------------------------------------------------------------- Total long-term debt 309,349 280,880 -------------------------------------------------------------------- Less current portion (54,137) (95,434) -------------------------------------------------------------------- $ 255,212 $ 185,446 ------------------------ ------------------------ (a) Credit Facility The Company's credit agreement includes two senior secured term facilities and a senior secured revolving facility. The facilities have underlying interest rates, which at the option of the Company are either LIBOR plus a spread of 1.25% to 2.375%, or US Base Rate plus a spread of 0.25% to 1.375%. On May 31, 2007, Harry Winston Diamond Corporation amended its existing credit facility to extend the maturity date to December 15, 2009 from December 15, 2008. The senior secured revolving facility has a standby fee on undrawn amounts up to 1.5%, dependent on certain financial ratios, payable quarterly. The Company is required to comply with certain financial and non-financial covenants. These covenants include consolidated tangible net worth at the Harry Winston Diamond Corporation level, and debt to free cash flow, current assets to current liabilities, mine life protection ratio, historical debt service coverage ratio and annual loan life coverage ratio at the Harry Winston Diamond Mines Ltd. level. Under the facilities, the Company is required to establish a debt reserve account of $25.0 million and an amount equal to the billing delivered by DDMI reflecting estimated operating expenses, maintenance capital expenditures and other capital expenditures of the Diavik Mine for 30 days following each reporting period. The effective interest rate at January 31, 2008 was 4.53%. Scheduled amortization of the Company's senior secured term facilities is $12.5 million payable quarterly commencing March 2008 with the remaining balance due in December 2009. The maximum amount permitted to be drawn under the senior secured revolving facility is reduced by $12.5 million quarterly, commencing March 2009. As at January 31, 2008, the Company had $76.4 million of senior secured term facilities and had $50.0 million drawn under its senior secured revolving facility. Interest and financing charges include interest incurred on long-term debt, as well as amortization of deferred financing charges. (b) Harry Winston Inc. Credit Facilities (i) Harry Winston Inc. and Harry Winston Japan, K.K. amended its $140.0 million secured credit agreement on April 23, 2007 with a syndicated group of banks to increase it to $200.0 million effective April 30, 2007. The credit agreement includes both a revolving line of credit and fixed rate loans. At January 31, 2008, $154.0 million had been drawn against the facility. The amount available under this facility is subject to availability determined using a borrowing formula based on certain assets owned by Harry Winston Inc. and Harry Winston Japan, K.K. The amendment further extends the additional facility of $10.0 million scheduled to expire on April 30, 2007 to March 31, 2008. The amended credit facility is supported by a $20.0 million limited guarantee provided by Harry Winston Diamond Corporation. The Harry Winston Inc. and Harry Winston Japan, K.K. credit facility, which expired on March 31, 2008, has no scheduled repayments required before that date. The credit agreement contains affirmative and negative financial and non-financial covenants, which apply to the retail segment. These provisions include minimum net worth, minimum coverage of fixed charges, leverage ratio, minimum EBITDA and limitations on capital expenditures and certain investments. The outstanding borrowings under the credit facility are secured by inventory and accounts receivable of Harry Winston Inc. and inventory of Harry Winston Japan, K.K. The common stock of Harry Winston Inc. and 65% of the common stock of Harry Winston Inc.'s foreign subsidiaries are also pledged to the bank to secure the loan. The facility provides for fixed rate loans and floating rate loans, which bear interest at 2.25% above LIBOR and 1.00% above the bank's prime rate, respectively. The effective interest rate at January 31, 2008 was 9.0% for the revolving line of credit loans and 7.46% for the fixed rate loans. On February 22, 2008 Harry Winston Inc. refinanced its secured credit agreement by entering into a new secured five-year agreement with a consortium of banks, establishing a $250.0 million facility for revolving credit loans. The new facility expires on March 31, 2013. In addition, Harry Winston Inc. may increase the credit facility by an additional $50.0 million to $300.0 million during the term of the facility. There are no scheduled repayments required before maturity. The new credit facility is supported by a $20.0 million limited guarantee provided by Harry Winston Diamond Corporation. The amount available under this facility is subject to a borrowing base formula based on certain assets of Harry Winston Inc. The new credit agreement contains affirmative and negative non-financial and financial covenants, which apply to the retail segment. These provisions include consolidated minimum tangible net worth, minimum coverage of fixed charges, leverage ratio and limitations on capital expenditures and certain investments. The credit agreement also includes a change of control provision, which would result in the entire unpaid principal and all accrued interest of the facility becoming due immediately upon change of control, as defined. Any material adverse change, as defined, in the retail segment's business, assets, liabilities, consolidated financial position or consolidated results of operations constitutes default under the agreement. The retail segment has pledged 100% of Harry Winston Inc.'s common stock and 66 2/3% of the common stock of its foreign subsidiaries to the bank to secure the loan. Inventory and accounts receivable of Harry Winston Inc. are pledged as collateral to secure the borrowings of Harry Winston Inc. In addition, an assignment of proceeds on insurance covering security collateral was made. Loans under the credit facility can be either fixed rate loans or revolving line of credit loans. The fixed rate loans will bear interest within a range of 1.50% to 2.25% above LIBOR based upon a pricing grid determined by the fixed charge coverage ratio. Interest under this option will be determined for periods of either one, two, three or six months. The revolving line of credit loans will bear interest within a range of 0.50% to 0.75% above the bank's prime rate based upon a pricing grid determined by the fixed charge coverage ratio as well. (ii) Harry Winston S.A. has entered into a 25-year loan agreement to finance the construction of a new watch factory in Geneva, Switzerland for 17.5 million CHF. The watch factory has been pledged to secure the loan. The loan agreement bears interest at 3.55% and matures on January 31, 2033. Under this agreement approximately $16.1 million is outstanding at January 31, 2008. Quarterly payments on the loan are scheduled to begin on June 30, 2008. (iii) On October 31, 2007, Harry Winston Japan, K.K. entered into a secured credit facility for $5.4 million ((Yen)575 million). This credit agreement is secured solely by the inventory of Harry Winston Japan, K.K. This credit facility expires on June 20, 2008, and bears interest at 1.91%. Under this agreement, $5.4 million was outstanding at January 31, 2008, of which $0.7 million was classified as bank advances. (c) Required Principal Repayments 2009 $ 54,137 2010 77,500 2011 5,857 2012 1,236 2013 1,292 Thereafter 169,327 --------------------------------------------------------------- $ 309,349 ---------- ---------- (ii) Bank Advances The Company operates two other revolving financing facilities. The Company has available $45.0 million (utilization in either US dollars or Euros) and $10.0 million for inventory and receivables funding in connection with marketing activities through its Belgian subsidiary, Harry Winston Diamond International N.V. and its Israeli subsidiary, Harry Winston Diamond (Israel) Limited, respectively. Borrowings under the Belgium facility bear interest at the bank's base rate plus 1.5% and borrowings under the Israeli facility bear interest at LIBOR plus 1%. At January 31, 2008, $19.9 million was drawn under these two facilities. The Belgium facility has an annual commitment fee of 0.75% per annum. Both facilities are guaranteed by Harry Winston Diamond Corporation. Harry Winston Japan, K.K. maintains unsecured credit agreements with two banks each amounting to $7.0 million ((Yen)750 million). The credit facilities bear interest at 2.13% and 2.38% per annum and expire on June 2, 2008 and June 28, 2010, respectively. Under these agreements, bank advances of $14.0 million were outstanding at January 31, 2008. NOTE 13: Income Tax The future income tax asset of the Company is $41.0 million, of which $18.1 million relates to Harry Winston Inc. Included in the future tax asset is $13.2 million that has been recorded to recognize the benefit of $40.2 million of net operating losses that Harry Winston Inc. has available for carry forward to shelter income taxes for future years. The net operating losses are scheduled to expire between 2021 and 2027. The future income tax liability of the Company is $370.5 million of which $73.0 million relates to Harry Winston Inc. Harry Winston Inc.'s future income tax liabilities include $57.1 million from the purchase price allocation. The Company's future income tax asset and liability accounts are revalued to take into consideration the change in the Canadian dollar compared to the US dollar and the unrealized foreign exchange gain or loss is recorded in net earnings for each year. (a) The income tax provision consists of the following: 2008 2007 -------------------------------------------------------------------- Current expense $ 47,516 $ 14,763 Future expense 8,578 20,067 -------------------------------------------------------------------- $ 56,094 $ 34,830 ------------------------ ------------------------ (b) The tax effects of temporary differences that give rise to significant portions of the future tax assets and liabilities at January 31, 2008 and 2007 are as follows: 2008 2007 -------------------------------------------------------------------- Future income tax assets: Net operating loss carryforwards $ 23,458 $ 36,589 Capital assets 1,158 770 Future site restoration costs 13,135 6,948 Other future income tax assets 6,409 5,125 -------------------------------------------------------------------- Gross future income tax assets 44,160 49,432 Valuation allowance (3,197) (5,095) -------------------------------------------------------------------- Future income tax assets 40,963 44,337 Future income tax liabilities: Deferred mineral property costs (56,776) (78,634) Capital assets (160,319) (102,261) Retail inventory (13,781) (19,530) Goodwill (57,718) (61,460) Unrealized foreign exchange gains (3,194) (871) Other future income tax liabilities (78,712) (70,742) -------------------------------------------------------------------- Future income tax liabilities (370,500) (333,498) -------------------------------------------------------------------- Future income tax liability, net $ (329,537) $ (289,161) ------------------------ ------------------------ (c) The difference between the amount of the reported consolidated income tax provision and the amount computed by multiplying the earnings before income taxes by the statutory tax rate of 34% (2007 - 37%) is a result of the following: 2008 2007 -------------------------------------------------------------------- Expected income tax expense $ 55,308 $ 51,605 Non-deductible (non-taxable) items 9,773 (6,032) Northwest Territories mining royalty (net of income tax relief) 18,856 12,631 Impact of changes in future corporate income tax rates (11,697) (16,949) Earnings subject to tax different than statutory rate (5,293) (7,965) Benefit on losses recognized through reduction of goodwill 4,362 840 Assessments and adjustments (11,649) - Change in valuation allowance (2,477) 363 Other (1,089) 337 -------------------------------------------------------------------- Recorded income tax expense $ 56,094 $ 34,830 ------------------------ ------------------------ (d) The Company has net operating loss carryforwards for Canadian income tax purposes of approximately $23.9 million. Harry Winston Inc. has net operating loss carryforwards for US income tax purposes of $32.2 million and $8.0 million for other foreign jurisdiction tax purposes. NOTE 14: Future Site Restoration Costs 2008 2007 ------------------------------------------------------------------------- At February 1, 2007 and 2006 $ 17,200 $ 15,316 Revision of previous estimates 14,897 - Accretion of provision 883 1,884 ------------------------------------------------------------------------- At January 31, 2008 and 2007 $ 32,980 $ 17,200 ------------------------ ------------------------ The Joint Venture has an obligation under various agreements (note 17) to reclaim and restore the lands disturbed by its mining operations. The Company's share of the total undiscounted amount of the future cash flows that will be required to settle the obligation incurred at January 31, 2008 is estimated to be $53.4 million of which approximately $33.1 million is expected to occur at the end of the mine life. The revision of previous estimates in fiscal 2008 reflects anticipated higher costs for fuel, labour and equipment based on a significant escalation in these key operating costs in recent years. The anticipated cash flows relating to the obligation at the time of the obligation have been discounted at a credit adjusted risk-free interest rate of 5.57%. NOTE 15: Share Capital (a) Authorized Unlimited common shares without par value. (b) Issued Number of shares Amount -------------------------------------------------------------------- Balance, January 31, 2006 58,133,780 $ 300,652 Shares issued for: Exercise of options 226,975 4,513 -------------------------------------------------------------------- Balance, January 31, 2007 58,360,755 $ 305,165 Shares issued for: Exercise of options 11,336 337 -------------------------------------------------------------------- Balance, January 31, 2008 58,372,091 $ 305,502 ------------------------------ ------------------------------ (c) Stock Options Under the Employee Stock Option Plan, approved in February 2001, the Company may grant options for up to 4,500,000 shares of common stock. Options may be granted to any director, officer, employee or consultant of the Company or any of its affiliates. Options granted to directors vest immediately and options granted to officers, employees or consultants vest over three to four years. The maximum term of an option is ten years. The number of shares reserved for issuance to any one optionee pursuant to options cannot exceed 2% of the issued and outstanding common shares of the Company at the date of grant of such options. The exercise price of each option cannot be less than the fair market value of the shares on the last trading day preceding the date of the grant. The Company's shares are primarily traded on a Canadian dollar based exchange, and accordingly stock option information is presented in Canadian dollars, with conversion to US dollars at the average exchange rate for the year. Compensation expense for stock options was $0.2 million for fiscal 2008 (2007 - $2.9 million) and is presented as a component of both cost of sales and selling, general and administrative expenses. The amount credited to share capital for the exercise of the options is the sum of (a) the cash proceeds received and (b) the amount debited to contributed surplus upon exercise of stock options by optionees (2008 - $0.1 million; 2007 - $1.6 million). Changes in share options outstanding are as follows: 2008 2007 ----------------------------------------------------- Weighted average Weighted average Options exercise price Options exercise price -------------------------------------------------------------------- 000s CDN$ US$ 000s CDN$ US$ -------------------------------------------------------------------- Outstanding, beginning of year 1,631 $ 23.43 $ 20.63 1,959 $ 23.34 $ 20.49 Granted 100 25.52 24.08 - - - Exercised (11) 27.01 25.48 (227) 14.65 12.90 Expired (1) 26.45 24.95 (101) 41.39 36.49 -------------------------------------------------------------------- 1,719 $ 23.52 $ 22.19 1,631 $ 23.43 $ 20.63 ----------------------------------------------------- ----------------------------------------------------- The following summarizes information about stock options outstanding at January 31, 2008: Options outstanding Options exercisable ------------------------------------------------------------ Weighted average Weighted Weighted Range of remaining average average exercise Number contractual exercise Number exercise prices outstanding life price exercisable price CDN$ 000s in years CDN$ 000s CDN$ ------------------------------------------------------------------------- $9.10-$9.15 268 1.8 $ 9.15 268 $ 9.15 10.60-12.45 302 2.9 12.36 302 12.36 17.50-17.50 39 3.8 17.50 39 17.50 23.35-29.25 765 5.3 25.36 665 25.34 36.38-40.00 110 5.9 39.67 105 39.83 41.45-41.95 235 6.4 41.66 177 41.66 ------------------------------------------------------------------------- 1,719 $ 23.52 1,556 $ 22.67 ------------------------------------------------------------ ------------------------------------------------------------ (d) Stock-Based Compensation The Company applies the fair value method to all grants of stock options. The fair value of options granted during the years ended January 31, 2008 and 2007 was estimated using a Black-Scholes option pricing model with the following weighted average assumptions. The Company did not grant any options during fiscal 2007. 2008 2007 -------------------------------------------------------------------- Risk-free interest rate 3.45% - Dividend yield 0.00% - Volatility factor 39.18% - Expected life of the options 3.6 years - Average fair value per option, CDN $ 8.53 $ - Average fair value per option, US $ 8.50 $ - -------------------------------------------------------------------- (e) RSU and DSU Plans RSU Number of units -------------------------------------------------------------------- Balance, January 31, 2006 103,959 Awards during the year (net): RSU 70,431 -------------------------------------------------------------------- Balance, January 31, 2007 174,390 Awards and payouts during the year (net): RSU awards 21,873 RSU payouts (52,548) -------------------------------------------------------------------- Balance, January 31, 2008 143,715 ---------------- ---------------- DSU Number of units -------------------------------------------------------------------- Balance, January 31, 2006 41,079 Awards during the year (net): DSU 18,070 -------------------------------------------------------------------- Balance, January 31, 2007 59,149 Awards and payouts during the year (net): DSU awards 21,626 DSU payouts (8,577) -------------------------------------------------------------------- Balance, January 31, 2008 72,198 ---------------- ---------------- During the fiscal year, the Company granted 21,873 RSUs (net of forfeitures) and 21,626 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. 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 the 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 the grant. The Company recognized a recovery of $0.1 million (2007 - expense of $3.1 million) for the twelve months ended January 31, 2008. NOTE 16: Earnings per Share The following table sets forth the computation of diluted earnings per share: 2008 2007 ------------------------------------------------------------------------- Numerator: Net earnings for the year $ 106,408 $ 104,269 ------------------------ ------------------------ Denominator (thousands of shares): Weighted average number of shares outstanding 58,369 58,257 Dilutive effect of employee stock options 530 1,022 ------------------------------------------------------------------------- 58,899 59,279 ------------------------ ------------------------ Number of anti-dilutive options - - ------------------------ ------------------------ NOTE 17: 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. Harry Winston Diamond Corporation'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 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. Harry Winston Diamond Corporation's share of the Joint Venture's letters of credit outstanding with respect to the environmental agreements as at January 31, 2008 was $61.5 million. The agreement specifically provides that these funding requirements 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. DATASOURCE: HARRY WINSTON DIAMOND CORPORATION CONTACT: PRNewswire - - 04/08/2008

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