Dominion Diamond Corporation Reports Fiscal 2017 Second Quarter Results

September 8, 2016

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YELLOWKNIFE, Northwest Territories–(BUSINESS WIRE)–Dominion Diamond Corporation (TSX: DDC, NYSE: DDC) (the “Company” or “Dominion”) today reported its second quarter 2017 (May through July) financial results. Unless otherwise indicated, all financial information is presented in U.S. dollars.

Highlights

(in millions of US dollars except
earnings per share and where
otherwise noted)

 

Three months
ended Jul 31,
2016

 

Three months
ended Jul 31,
2015

 

Six months
ended Jul 31,
2016

 

Six months
ended Jul 31,
2015

Sales 160.0 209.7 338.2 397.4
Gross Margin 0.9 22.7 (18.0) 46.8
Mine standby costs 22.0 22.0
Operating (loss) Profit (30.3) 7.6 (57.2) 23.0
Profit (loss) before income taxes (37.9) 0.6 (73.8) 9.1
Adjusted EBITDA(1) 35.4 60.4 89.7 121.2
Free Cash Flow(1) (20.9) 22.9 (110.9) (70.7)
Earnings (loss) per share (“EPS”) (0.39) (0.21) (0.40) (0.07)

1 These are non-IFRS measures. See “Non-IFRS Measures” below for additional information.

  • First sales of Misery Main production. Commercial production at Misery Main was declared in May 2016, ahead of plan. First sales of pre-commercial production occurred in the second quarter of fiscal 2017 and confirmed modelled prices.
  • Ekati process plant update. The Company currently expects the process plant to restart on or about September 21st at an estimated total cost of repair of $15 million. The process plant shutdown negatively impacted earnings and cash flow in the period. The Company expensed $22.0 million of mine standby costs as a result of the fire in the second quarter.
  • Transitional period at Ekati continues to impact earnings. The transitional period ahead of the sale of the first Misery Main commercial production continued to impact margins at Ekati and resulted in a $6.4 million impairment of available for sale inventory in the period.
  • Positive Jay Feasibility Study approved. The Jay Feasibility Study was approved by the Board of Directors and a decision to proceed with development was made based on positive project economics. The Jay Project provides a platform for future growth at Ekati and development is expected to be funded from existing cash and internally generated cash flows.
  • Well positioned for growth. The Company maintains a strong balance sheet to support the payment of a regular dividend and the substantial capital requirements to advance the Lynx, Sable, Jay, and A-21 projects.
  • Office building sale. The sale of the Company’s downtown Toronto office building for CDN $84.8 million which was completed September 8th, enhances the Company’s strong balance sheet and supports its revised capital allocation strategy.
  • Dividend declared. Interim dividend of $0.20 per share declared by the Board of Directors.

“We are very pleased to announce the sale of the first production from Misery Main, which provides confirmation of our modelled pricing and has given us even more confidence in the positive cash flow impact of Misery Main through the next phase of the Ekati mine,” said Brendan Bell, Chief Executive Officer. “While the process plant fire and the final stage of the transitional period at Ekati weighed on our earnings and cash flow in the quarter, we are encouraged by our ability to generate positive operating cash flow even under these circumstances.”

“During the quarter we also published a positive feasibility study for the Jay Project and outlined a revised capital allocation strategy, which is underpinned by our strong balance sheet and strong cash flow generation capabilities,” added Mr. Bell.

Dividend, Share Repurchase Program and Building Sale

  • On September 8, 2016, the Board of Directors declared an interim dividend of $0.20 per share to be paid in full on November 3, 2016, to shareholders of record at the close of business on October 11, 2016. The dividend will be an eligible dividend for Canadian income tax purposes.
  • During the quarter, Dominion announced the approval of a normal course issuer bid (“NCIB”) to purchase for cancellation up to 6,150,010 common shares, representing approximately 10% of the public float as of July 6, 2016, over a one-year period. Purchases under the NCIB began in August and resulted in the purchase of approximately 0.6 million shares during the month for approximately CDN $6.9 million dollars.
  • The Company intends to outline an enhanced shareholder distribution policy after the Ekati process plant restarts, which is currently expected on or about September 21st.
  • In August, the Company entered into a binding agreement to sell its downtown Toronto office building for approximately CDN $84.8 million. The transaction closed on September 8th and was subject to customary closing conditions and adjustments. The building is reflected as an asset held for sale on the Company’s second quarter balance sheet with net book value of $18.7 million, and associated liabilities of $4.1 million.

Profit (Loss) Before Income Tax and Net Income (Loss)
The Company reported a loss before income taxes of $37.9 million for the quarter and consolidated net loss attributable to shareholders of $32.9 million or negative $0.39 per share for the quarter. Both measures were impacted by:

  • Inventory impairment in the amount of $6.4 million ($0.05 per share after tax) was recorded on available for sale inventory at the Ekati mine. The impairment represents the excess of the inventoried cash and non-cash costs over net realizable value, or the amount the Company realized or expected to realize upon final sorting, valuation and subsequent sale of this inventory in Q3 fiscal 2017.
  • Mine standby costs related to the fire of $22.0 million ($0.17 per share after-tax).
  • Foreign exchange impact on income tax resulting in an income tax expense of $8.8 million or $0.10 per share.

Adjusted EBITDA, Cash flow and Balance Sheet:

  • Second quarter Adjusted EBITDA of $35.4 million remained positive but was negatively impacted by the sale of lower value goods from the Misery Satellites, as well as the process plant fire at the Ekati Diamond Mine which resulted in $22.0 million in mine standby costs being incurred during the quarter. Adjusted EBITDA does not include the impact of significant non-cash costs in the second quarter which impacted gross margins. See “Non-IFRS Measures” below.
  • Negative free cash flow generated in the quarter of $20.9 million was due to cash capital expenditures of $54.8 million offset against positive operating cash flow of $33.9 million. The second quarter was impacted by the cost of repairs and cleaning of the process plant as a result of the process plant fire, and lower sales as a result of a higher proportion of lower value goods from the Misery Satellites available for sale in the quarter. Second quarter capital expenditures include significant investments in the Sable pipe at the Ekati Diamond Mine and in the A-21 pipe at the Diavik Diamond Mine.
  • The Company has a strong balance sheet with total unrestricted cash resources as at July 31, 2016 of $180.4 million, restricted cash of $65.5 million and an undrawn availability of $210.0 million under its corporate revolving credit facility.
  • As at July 31, 2016, the Company had approximately 2.3 million carats of rough diamond inventory available for sale with an estimated market value of approximately $142 million. The Company also had approximately 0.3 million carats of rough diamond inventory that was work in progress.

Sales and Diamond market

  • Sales in the second quarter were lower than the prior year primarily due to a high proportion of lower value goods from the Misery Satellites available for sale in the quarter.
  • After buoyant market conditions in the first quarter, rough prices stabilized in the second quarter supported by stable US retail demand. The positive conditions in the first half of the year reduced inventories throughout the diamond pipeline and improved liquidity in the industry; however, despite the improvements in sentiment, the banks that finance the diamond industry remain cautious. The retail markets outside the US remain impacted by the strong US dollar, making jewelry comparatively expensive in domestic currency terms. Despite declines in the top end luxury sector, retail demand growth in China is focused on the broader commercial sector of the market supported by a growing middle class. Also in the Far East, Japanese demand remains robust supported by luxury tourism from China. Conversely, the retail markets in Europe, Hong Kong and the Middle East remain somewhat subdued.

Production, Development and Exploration

Ekati

  • Throughput was significantly lower in the second quarter as a result of the fire at the Ekati process plant that occurred on June 23, 2016, and the subsequent processing plant shutdown. The restart of processing is expected to commence on or about September 21st at an estimated total cost to repair of $15 million.
  • Mining operations continued during the second quarter with strong performance from both the Koala underground and Misery Main open pit operations. Mining has been paused at the lower value Pigeon and Lynx open pits as a cost reduction measure.
  • During the period, the Ekati Diamond Mine recovered 0.9 million carats from 0.6 million tonnes of ore processed (0.9 million carats from 1.0 million tonnes in Q2 fiscal 2016).
  • Carat production was negatively impacted by the process plant shutdown, but benefited from the processing of higher grade Misery Main ore, despite some continued dilution of initial ore during the mining of preceding benches.
  • During the quarter the Company continued to process significant amounts of low value Misery Satellites material.
  • Approximately 1.4 million tonnes of material remained in stockpiles at the end of the second quarter. Higher value Misery Main and Koala ore is planned to be prioritized throughout the remainder of fiscal 2017 when processing recommences. Gross margin at the Ekati Diamond Mine is expected to improve in the fourth quarter of the fiscal year as more significant amounts of Misery Main ore begin to be processed.
  • Construction of an all-season access road to the Sable project site continued according to plan.
  • An exploration drilling program at Fox Deep was completed in the first quarter, with sample results expected in the fourth quarter.

Diavik

  • Processing volumes in the second calendar quarter of 2016 were 5% lower than in the same quarter of the prior year due to lower ore availability.
  • Diamonds recovered in the second calendar quarter of 2016 were on plan, and were 26% lower than in the same quarter of the prior year. The difference from the prior year is a result of lower processing volumes and lower recovered grades.
  • The development of the A-21 pipe continues to progress according to plan.

Technical Report Update for the Ekati Diamond Mine

  • The Company expects to file a technical report on or about September 15, 2016, under National Instrument 43-101 for the Ekati Diamond Mine which includes an updated mineral reserves and mineral resources statement with an effective date of July 31, 2016. The report, entitled “Ekati Diamond Mine, Northwest Territories, Canada, NI 43-101 Technical Report”, will be available under the Company’s profile on SEDAR and on the Company’s web site at www.ddcorp.ca.

Guidance

Full Year Cost Guidance1

(in millions of US dollars)2

 

Cash Costs of
Production3

  Cost of Sales  

Depreciation &
Amortization in
Cost of Sales

 

Development
Capital
Expenditures

 

Sustaining
Capital
Expenditures

Ekati Diamond Mine (100%)4 224 378 135 165 39
Diavik Diamond Mine (40%) 118 235 92 41 18

1 The guidance provided in the table above for the Diavik Diamond Mine and the Ekati Diamond Mine are for the calendar year ending December 31, 2016, and the fiscal year ending January 31, 2017, respectively.
2 Assuming an average Canadian/US dollar exchange rate of 1.33.
3 The term cash costs of production does not have a standardized meaning according to IFRS. See “Non-IFRS Measures” below for additional information.
4 The cash cost of production and capital expenditure guidance provided in the table above for the Ekati Diamond Mine does not include deferred production stripping costs and mine standby costs which are expected to be $70 million and $55 million, respectively, for fiscal 2017.

See “Caution Regarding Forward-Looking Information” in the Company’s 2017 Second Quarter Management’s Discussion and Analysis for additional information with respect to guidance on projected capital expenditure requirements, expected cost of sales, depreciation & amortization and cash costs of production for the Diavik Diamond Mine and Ekati Diamond Mine.

Updated Full Year Production Guidance1, 3

Ekati Diamond Mine  

Full year production target Fiscal Year 2017

Million carats   Million tonnes
Koala underground operation 0.7 1.3
Pigeon open pit 0.2 0.4
Misery Main open pit 3.0 0.7
Total reserves (base case) 3.9 2.4
Misery South & Southwest kimberlite pipes 0.8 0.4

Total reserves and inferred resources
(operating case)2

4.7 2.8

Diavik Diamond Mine

Full year production target Calendar 2016

Million carats Million tonnes
A-154 South

1.5

0.5

A-154 North 1.6 0.7
A-418 3.9 0.9

Total reserves (excluding coarse ore rejects
(“COR”))

7.0

2.1

1 The guidance provided in the table above for the Diavik Diamond Mine and the Ekati Diamond Mine are for the calendar year ending December 31, 2016, and the fiscal year ending January 31, 2017, respectively.
2 The Company cautions that the Operating Case mine plan for the Ekati Diamond Mine includes inferred resources which are considered too speculative geologically to have the economic considerations applied to them that would enable them to be categorized as mineral reserves, and there is no certainty that the Operating Case mine plan will be realized.
3 Please refer to the Company’s 2017 Second Quarter Management’s Discussion and Analysis for additional information with respect to the full year production targets for the Ekati Diamond Mine and Diavik Diamond Mine.

Appointment of Chief Financial Officer

The Company is pleased to announce the appointment, effective as of September 10, 2016, of Mr. Matthew Quinlan as Chief Financial Officer.

Qualified Person

The scientific and technical information relating to the Ekati Diamond Mine contained in this press release has been prepared and verified by Dominion, operator of the Ekati Diamond Mine, under the supervision of Peter Ravenscroft, FAusIMM, of Burgundy Mining Advisors Ltd., an independent mining consultant, and a Qualified Person within the meaning of National Instrument 43-101 of the Canadian Securities Administrators.

The scientific and technical information relating to the Diavik Diamond Mine contained in this press release has been prepared and verified by Diavik Diamond Mines (2012) Inc., operator of the Diavik Diamond Mine, under the supervision of Calvin Yip, P. Eng., Principal Advisor, Strategic Planning of DDMI, and a Qualified Person within the meaning of National Instrument 43-101 of the Canadian Securities Administrators.

Non-IFRS Measures

The terms Adjusted EBITDA, cash cost of production and free cash flow do not have standardized meanings according to International Financial Reporting Standards. See “Non-IFRS Measures” in the Company’s 2017 Second Quarter Management’s Discussion and Analysis for additional information.

Conference Call and Webcast

Beginning at 8:30AM (ET) on Friday, September 9, the Company will host a conference call for analysts, investors and other interested parties. Listeners may access a live broadcast of the conference call on the Company’s web site at www.ddcorp.ca or by dialing 844-249-9383 within North America or 270-823-1531 from international locations and entering passcode 61866332.

An online archive of the broadcast will be available by accessing the Company’s web site at www.ddcorp.ca. A telephone replay of the call will be available two hours after the call through 11:00PM (ET), Friday, September 23, 2016, by dialing 855-859-2056 within North America or 404-537-3406 from international locations and entering passcode 61866332.

Forward-Looking Information

Certain information included herein that is not current or historical factual information, including information about changes to the Company’s shareholder distribution policy, the timeline for closing the sale of the Company’s office building, the anticipated date for filing an updated technical report for the Ekati Diamond Mine and estimated mine life and other development plans regarding mining activities at the Ekati Diamond Mine, constitute forward-looking information or statements within the meaning of applicable securities laws. Forward-looking information can generally be identified by the use of terms such as “may”, “will”, “should”, “could”, “expect”, “plan”, “anticipate”, “foresee”, “appears”, “believe”, “estimate”, “predict”, “continue”, “modeled”, “hope”, “forecast” or other similar expressions concerning matters that are not historical facts. Forward-looking information is based on certain factors and assumptions including, among other things, the current mine plan for each of the Ekati Diamond Mine and Diavik Diamond Mine; mining, production, construction and exploration activities at the Company’s mineral properties; the timely receipt of required regulatory approvals; mining methods; currency exchange rates; estimates related to the capital expenditures related to bring the Jay and A-21 pipe into production, required operating and capitals costs; labour and fuel costs; world and US economic conditions; future diamond prices; and the level of worldwide diamond production. These assumptions 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 the Company currently expects. 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 Company’s mineral properties, variations in mineral reserves and mineral resources estimates, grade estimates or expected recovery rates, failure of plant, equipment or processes to operate as anticipated, risks resulting from the Eurozone financial crisis, risks associated with regulatory requirements, the risk of fluctuations in diamond prices and changes in US and world economic conditions, the risk of fluctuations in the Canadian/US dollar exchange rate, uncertainty as to whether dividends will be declared by the Company’s board of directors or the Company’s dividend policy will be maintained and cash flow and liquidity risks. Actual results may vary from the forward-looking information. Readers are cautioned not to place undue importance on forward-looking information, which speaks only as of the date of this disclosure, and should not rely upon this information as of any other date. While the Company 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, further 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 Company’s filings with Canadian and United States securities regulatory authorities and can be found at www.sedar.com and www.sec.gov, respectively.

About Dominion Diamond Corporation

Dominion Diamond Corporation is the world’s third largest producer of rough diamonds by value. Both of its production assets are located in the low political risk environment of the Northwest Territories in Canada where the Company also has its head office. The Company is well capitalized and has a strong balance sheet.

The Company operates the Ekati Diamond Mine and also owns 40% of the Diavik Diamond Mine. Between the two mining operations, diamonds are currently produced from a number of separate kimberlite pipes providing a diversity of diamond supply as well as reduced operational risk. It supplies premium rough diamond assortments to the global market through its sorting and selling operations in Canada, Belgium and India.

For more information, please visit www.ddcorp.ca

Second Quarter Fiscal 2017 Highlights

  • Sales – Second quarter diamond sales of $160.0 million reflected a high proportion of lower value goods from the Misery Satellites available for sale in the quarter.
  • Adjusted EBITDA – Second quarter Adjusted EBITDA of $35.4 million remained positive but was negatively impacted by the sale of lower value goods from the Misery Satellites, as well as the process plant fire at the Ekati Diamond Mine, which resulted in $22.0 million in mine standby costs being incurred during the quarter.
  • Gross Margins – Consolidated gross margin of $0.9 million for the quarter was a result of the sale of a lower value product mix at both mines, and also an impairment of available-for-sale inventory from the Ekati Diamond Mine in the amount of $6.4 million ($0.05 per share after tax). Margins continue to be impacted by an increase in non-cash costs in cost of sales as a result of unit-of-production depreciation taken on Misery and Pigeon capitalized stripping.
  • Process Plant Fire – A fire occurred at the Ekati Diamond Mine process plant on June 23, 2016. The resulting damage to the process plant was limited only to a small area with no damage to the main structural components. No injuries were reported. The process plant remains shut down for repairs and is expected to resume operations on or about September 21, 2016 at an estimated total cost of repair of $15 million. Cost savings measures were implemented subsequent to the fire including pausing mining at lower value ore bodies. Mining continued at the higher value Misery Main open pit and Koala underground with the intent to prioritize processing of this material when the plant resumes operations.
  • Profit (Loss) Before Income Taxes and Net (Loss) Income – Second quarter loss before income taxes of $37.9 million and consolidated net loss attributable to shareholders of $32.9 million or negative $0.39 per share for the quarter were impacted by the inventory impairment in the amount of $6.4 million ($0.05 per share after tax) taken at the Ekati Diamond Mine, mine standby costs related to the fire of $22.0 million ($0.17 per share after tax), and by a foreign exchange impact on income tax resulting in an income tax expense of $8.8 million or $0.10 per share.
  • Production
    • Misery Main commenced commercial production in May 2016 with first sales from the pre-commercial production period realized in the second quarter.
    • Ekati Diamond Mine processing volumes were significantly reduced as a result of the fire at the Ekati process plant and subsequent processing shutdown.
    • Diavik Diamond Mine processing volumes remained ahead of plan; however, carats recovered were 26% lower than in the same quarter of the prior year due to the processing of comparatively lower grade ore.
  • Development and Exploration Projects
    • The Company announced its approval to proceed with the development of the Jay Project based on the results of the
      Jay Feasibility Study.
    • The development of the A-21 pipe continues to progress according to plan.
    • Construction of an all-season access road to the Sable Project site progressed according to plan.
  • Balance Sheet – The Company has a strong balance sheet with total unrestricted cash resources of $180.4 million as at July 31, 2016 and $210 million available under its revolving credit facility.
  • Office Building Sale – In August 2016, the Company entered into a binding agreement to sell its downtown Toronto office building for approximately CDN $84.8 million. The transaction closed on September 8th and was subject to customary closing conditions and adjustments.

Market Commentary

After the buoyant market conditions of the first quarter, rough diamond prices stabilized in the second quarter, supported by stable US retail demand. The positive conditions in the first half of the year reduced inventories throughout the diamond pipeline and improved liquidity in the industry; however, despite the improvements in sentiment, the banks that finance the diamond industry remain cautious.

The retail markets outside the US remain impacted by the strong dollar, making jewelry comparatively expensive in domestic currency terms. Despite declines in the top end luxury sector, retail demand growth in China is focused on the more commercial sector of the market, supported by a growing middle class. Also, in the Far East, Japanese demand remains robust, supported by luxury tourism from China. Conversely, the retail markets in Europe, Hong Kong and the Middle East continue to be somewhat subdued.

Management’s Discussion and Analysis
PREPARED AS OF SEPTEMBER 8, 2016 (ALL FIGURES ARE IN UNITED STATES DOLLARS UNLESS OTHERWISE INDICATED)

Basis of Presentation

The following is management’s discussion and analysis (“MD&A”) of the results of operations for Dominion Diamond Corporation (the “Company”) for the three and six months ended July 31, 2016, and its financial position as at July 31, 2016. This MD&A is based on the Company’s unaudited interim condensed consolidated financial statements prepared in accordance with International Accounting Standards 34 (“IAS 34”), as issued by the International Accounting Standards Board (“IASB”), and should be read in conjunction with the unaudited interim condensed consolidated financial statements and related notes thereto for the three and six months ended July 31, 2016 and with the audited consolidated financial statements for the year ended January 31, 2016. These consolidated financial statements are expressed in United States dollars, which is the functional currency of the Company. Unless otherwise specified, all financial information is presented in United States dollars. Unless otherwise indicated, all references to (i) “second quarter,” “Q2 2017” and “Q2 fiscal 2017” refer to the three months ended July 31, 2016; (ii) “Q2 fiscal 2016” and “Q2 2016” refer to the three months ended July 31, 2015; (iii) “YTD Q2 fiscal 2017” refers to the six months ended July 31, 2016 and (iv) “YTD Q2 fiscal 2016” refers to the six months ended July 31, 2015.

Caution Regarding Forward-Looking Information

Certain information included in this MD&A constitutes forward-looking information within the meaning of Canadian and United States securities laws. Forward-looking information can generally be identified by the use of terms such as “may,” “will,” “should,” “could,” “would,” “expect,” “plan,” “anticipate,” “foresee,” “appears,” “believe,” “intend,” “estimate,” “predict,” “potential,” “continue,” “objective,” “modelled,” “hope,” “forecast” or other similar expressions concerning matters that are not historical facts. Forward-looking information relates to management’s future outlook and anticipated events or results, and can include statements or information regarding plans for mining, development, production and exploration activities at the Company’s mineral properties, projected capital expenditure requirements, liquidity and working capital requirements, estimated production from the Ekati Diamond Mine and Diavik Diamond Mine, expectations concerning the diamond industry, and expected cost of sales, cash operating costs and gross margin. Forward-looking information included in this MD&A includes the estimated timeline to complete repairs to the Ekati process plant and the completion of the sale of the Company’s office building, as well as the current production forecast, cost of sales, cash cost of production, and gross margin estimates and planned capital expenditures for the Diavik Diamond Mine and other forward-looking information set out under “Diavik Operations Outlook,” and the current production forecast, cost of sales, cash cost of production, and gross margin estimates and planned capital expenditures for the Ekati Diamond Mine and other forward-looking information set out under “Ekati Operations Outlook.”

Forward-looking information is based on certain factors and assumptions described below and elsewhere in this MD&A, including, among other things, the current mine plans for each of the Ekati Diamond Mine and the Diavik Diamond Mine; mining, production, construction and exploration activities at the Company’s mineral properties; the timely receipt of required regulatory approvals; mining methods; currency exchange rates; estimates related to the capital expenditures required to bring the Jay, Sable, and A-21 pipes into production; management’s assessment of the extent of damage to the Ekati process plant and the estimated timeframe to complete the necessary repairs; required operating and capital costs, labour and fuel costs, world and US economic conditions, future diamond prices, and the level of worldwide diamond production. While the Company considers these assumptions to be reasonable based on the information currently available to it, they may prove to be incorrect. Forward-looking information is subject to certain factors, including risks and uncertainties that could cause actual results to differ materially from what the Company currently expects. 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, including risks associated with the inability to control the timing and scope of future capital expenditures; risks associated with the estimates related to the capital expenditures required to bring the Jay, Sable and A-21 pipes into production; the risk that the operator of the Diavik Diamond Mine may make changes to the mine plan and other risks arising because of the nature of joint venture activities; risks associated with the remote location of, and harsh climate at, the Company’s mineral property sites; variations in mineral resource and mineral reserve estimates or expected recovery rates; failure of plant, equipment or processes to operate as anticipated; risks resulting from the Eurozone financial crisis and macro-economic uncertainty in other financial markets; risks associated with regulatory requirements and the ability to obtain all necessary regulatory approvals; the risk that diamond price assumptions may prove to be incorrect; modifications to existing practices so as to comply with any future permit conditions that may be imposed by regulators; delays in obtaining approvals and lease renewals; the risk of fluctuations in diamond prices and changes in US and world economic conditions; uncertainty as to whether dividends will be declared by the Company’s Board of Directors or whether the Company’s dividend policy will be maintained; the risk of fluctuations in the Canadian/US dollar exchange rate; and cash flow and liquidity risks. Please see page 31 of this MD&A, as well as the Company’s current Annual Information Form, available at www.sedar.com and www.sec.gov, for a discussion of these and other risks and uncertainties involved in the Company’s operations. Actual results may vary from the forward-looking information.

Readers are cautioned not to place undue importance on forward-looking information, which speaks only as of the date of this MD&A – they 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 MD&A, actual events may differ materially from current expectations. The Company uses forward-looking statements because it believes such statements provide useful information with respect to the currently expected future operations and financial performance of the Company, and cautions readers that the information may not be appropriate for other purposes. While the Company may elect to do so, 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.

Business Overview

The Company is focused on the mining and marketing of rough diamonds to the global market. The Company supplies rough diamonds to the global market from its operation of the Ekati Diamond Mine (in which it owns a controlling interest) and its 40% ownership interest in the Diavik Diamond Mine. Both mineral properties are located at Lac de Gras in Canada’s Northwest Territories.

The Company controls the Ekati Diamond Mine as well as the associated diamond sorting and sales facilities in Toronto and Yellowknife, Canada; Mumbai, India; and Antwerp, Belgium. The Company acquired its initial interest in the Ekati Diamond Mine on April 10, 2013. The Ekati Diamond Mine consists of the Core Zone, which includes the current operating mine and other permitted kimberlite pipes, as well as the Buffer Zone, an adjacent area hosting kimberlite pipes having both development and exploration potential, such as the Jay kimberlite pipe and the Lynx kimberlite pipe. The Company controls and consolidates the Ekati Diamond Mine; the interests of minority shareholders are presented as non-controlling interests in the consolidated financial statements.

The Company has an ownership interest in the Diavik group of mineral claims. The Diavik Joint Venture (the “Diavik Joint Venture”) is an unincorporated joint arrangement between Diavik Diamond Mines (2012) Inc. (“DDMI”) (60%) and Dominion Diamond Diavik Limited Partnership (“DDDLP”) (40%), a wholly owned subsidiary of the Company, where DDDLP holds an undivided 40% ownership interest in the assets, liabilities and expenses of the Diavik Diamond Mine. DDMI is the operator of the Diavik Diamond Mine and DDMI is a wholly owned subsidiary of Rio Tinto plc of London, England. The Company receives 40% of the diamond production from the Diavik Diamond Mine.

In January 2016, the management committee of the Buffer Zone approved a program and budget for the Buffer Zone for fiscal year 2017. In March 2016, Archon Minerals Limited (“Archon”) provided notice to Dominion Diamond Ekati Corporation (“DDEC”), the operator of the Buffer Zone, of its objection to certain elements of the fiscal 2017 program and budget, and indicated that it was only prepared to contribute to certain portions of the program and budget. Accordingly, the Company has elected to fund all of the cash calls for those elements of the fiscal 2017 program and budget that will not be funded by Archon. Archon has asserted that its objection to the fiscal 2017 program and budget was based on its position that certain proposed expenditures in the fiscal 2017 program and budget were in breach of the terms of the Buffer Zone Joint Venture agreement, and as such, the management committee of the Buffer Zone was not permitted to approve those aspects of the fiscal 2017 program and budget. A revised program and budget for fiscal year 2017 is expected to be presented to the management committee of the Buffer Zone in the third quarter of fiscal 2017 to incorporate changes to the mine plan impacting the Lynx Project in the Buffer Zone. Dilution of Archon’s participating interest in the Buffer Zone had been expected in the second quarter of fiscal 2017, but has been temporarily withheld until Archon re-confirms its intentions with respect to funding the revised program and budget.

In the second quarter of fiscal 2017, the Company announced its approval to proceed with the development of the Jay Project based on the results of the Jay Feasibility Study and has delivered the Jay Feasibility Study to Archon. The Company expects an investment decision from Archon with respect to the Jay Project at the end of fiscal 2017.

CONSOLIDATED FINANCIAL HIGHLIGHTS
(expressed in millions of United States dollars, except per share amounts and where otherwise noted)
(unaudited)

     

Three months
ended
July 31,
2016

 

Three months
ended
July 31,
2015

(Restated)(i)

   

Six months
ended
July 31,
2016

 

Six months
ended
July 31,
2015

(Restated)(i)

Sales $ 160.0 $ 209.7 $ 338.2 $ 397.4
Cost of sales 159.1 187.0 356.2 350.6
Gross margin 0.9 22.7 (18.0) 46.8
Gross margin (%) 0.5% 10.8% (5.3)% 11.8%
Selling, general and administrative expenses 9.2 15.1 17.2 23.9
Mine standby costs 22.0 22.0
Operating (loss) profit (30.3) 7.6 (57.2) 23.0
Financing expense (2.5) (2.9) (5.0) (5.7)
Exploration expense (1.4) (1.9) (5.0) (7.2)
Finance and other income 0.8 1.2 0.1
Foreign exchange (loss) gain (4.5) (2.2) (7.8) (1.0)
(Loss) profit before income taxes (37.9) 0.6 (73.8) 9.1
Royalty tax expense (recovery) 1.2 5.5 (4.1) 5.9
Income tax (recovery) expense (1.2) 14.0 (26.5) 10.7
Net (loss) income attributable to shareholders (32.9) (18.1) (34.0) (6.2)
Earnings (loss) per share attributable to shareholders(ii) (0.39) (0.21) (0.40) (0.07)
Adjusted EBITDA(iii) 35.4 60.4 89.7 121.2
Adjusted EBITDA margin (%)(iii) 22% 29% 27% 30%
Free cash flow(iii) (20.9) 22.9 (110.9) (70.7)
Capital expenditures 60.0 40.4 208.8 108.5
Depreciation and amortization   59.4   52.8   120.9   98.2

(i) Prior year figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.
(ii) Earnings per share for the second quarter decreased by $0.18 per share due to the expensing of mine standby costs, impairment of available-for-sale inventory, and continued sales of production from lower value Misery Satellites. The impact to the six months ended July 31, 2016 was a decrease of $0.33 per share.
(iii) The terms “Adjusted EBITDA,” “Adjusted EBITDA margin” and “free cash flow” do not have standardized meanings according to IFRS. See “Non-IFRS Measures” for additional information.

Three Months Ended July 31, 2016, Compared to Three Months Ended July 31, 2015

CONSOLIDATED SALES

Consolidated sales for the second quarter totalled $160.0 million (Q2 fiscal 2016 – $209.7 million), consisting of Ekati Diamond Mine rough diamond sales of $83.3 million (Q2 fiscal 2016 – $137.7 million) and Diavik rough diamond sales of $76.7 million (Q2 fiscal 2016 – $72.0 million).

The Company expects that the results for its mining operations will fluctuate depending on the seasonality of production at its mineral properties; the number of sales events conducted during the quarter; rough diamond prices; and the volume, size and quality distribution of rough diamonds delivered from the Company’s mineral properties and sold by the Company in each quarter. See the “Segmented Analysis” section for additional information.

CONSOLIDATED COST OF SALES AND GROSS MARGIN

The Company’s cost of sales includes costs associated with mining and rough diamond sorting activities. Consolidated cost of sales and gross margin in the period were negatively impacted by continued sales of production from lower value Misery Satellites. A $19.6 million and a $6.4 million impairment of available-for-sale inventory from the Ekati Diamond Mine were recorded in Q1 fiscal 2017 and Q2 fiscal 2017 respectively.

CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

The principal components of selling, general and administrative (“SG&A”) expenses include expenses for salaries and benefits, professional fees, consulting and travel. SG&A decreased by $5.9 million over Q2 fiscal 2016 primarily due to a charge in the prior year incurred in connection with the departure of the Company’s former Chief Executive Officer.

CONSOLIDATED OPERATING (LOSS) PROFIT

Consolidated operating (loss) profit decreased by 37.9 million over Q2 fiscal 2016 primarily due to the expensing of $22.0 million of mine standby costs incurred as a result of the suspension of processing at the Ekati Diamond Mine following the process plant fire on June 23, 2016. Mine standby costs include approximately $5.0 million of expenditure relating to repairs and cleaning as a result of the fire.

CONSOLIDATED FINANCE EXPENSE

Finance expense in the second quarter decreased by $0.4 million over Q2 fiscal 2016 mainly as a result of fluctuations in the accretion expense of the Company’s asset retirement obligation (“ARO”). The ARO liabilities are the associated costs relating to site closure, restoration and reclamation activities. The ARO liabilities are denominated in Canadian dollars and are translated to US dollars at the period-end exchange rate.

CONSOLIDATED EXPLORATION EXPENSE

The exploration program and related expenses for Q2 fiscal 2017 focused primarily on work performed at Fox Deep (underground) within the Core Zone at the Ekati Diamond Mine. Exploration costs were in the amount of $1.4 million (Q2 fiscal 2016 – $1.9 million) and were incurred for drilling, with the objective to better understand the grade of material of the existing resource which is located at the bottom of the existing pit. With the completion of the Jay Project Pre-feasibility Study, and subsequently the Sable Pre-feasibility Study, which established probable reserves for both kimberlite pipes, the Company has been capitalizing costs related to these development assets in accordance with the Company’s accounting policies.

CONSOLIDATED FINANCE AND OTHER INCOME (LOSS)

Finance and other income increased by $0.8 million compared to Q2 fiscal 2016.

CONSOLIDATED FOREIGN EXCHANGE

A net foreign exchange loss of $4.5 million was recognized during the second quarter (Q2 fiscal 2016 – $2.2 million). The Company does not currently have any foreign exchange derivative instruments outstanding.

CONSOLIDATED INCOME TAXES

The Company recorded a net income tax expense of $nil during the second quarter (Q2 fiscal 2016 – $19.5 million). Included in the net income tax is a net Northwest Territories mining royalty expense of $1.2 million (Q2 fiscal 2016 – $5.5 million). The Company’s combined Canadian federal and provincial statutory income tax rate for the quarter was 26.5% (Q2 fiscal 2016 – 26.5%). There are a number of items that can significantly impact the Company’s effective tax rate, including foreign currency exchange rate fluctuations, the Northwest Territories mining royalty, earnings subject to tax at rates different than the statutory rate and unrecognized tax benefits. As a result, the Company’s recorded tax provision can be significantly different than the expected tax provision calculated based on the statutory tax rate.

The recorded tax provision is particularly impacted by foreign currency exchange rate fluctuations. 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, a substantial portion of which is denominated in Canadian dollars. As such, the Company is continually subject to foreign exchange fluctuations, particularly as the Canadian dollar moves against the US dollar. During the second quarter, foreign currency exchange rate fluctuations resulted in $8.8 million increase (Q2 fiscal 2016 – $22.8 million increase) in the Company’s net income tax expense. This foreign exchange impact reduced what would have been a tax recovery of $8.8 million to $nil.

Due to the number of factors that can potentially impact the effective tax rate and the sensitivity of the tax provision to these factors, as discussed above, it is expected that the Company’s effective tax rate will fluctuate in future periods.

NET (LOSS) INCOME ATTRIBUTABLE TO SHAREHOLDERS

Included in net loss attributable to shareholders was the foreign exchange impact on income tax expense. The weakening of the Canadian dollar relative to the US dollar during the quarter resulted in additional income tax expense of $8.8 million or $0.10 per share (Q2 fiscal 2016 – $22.8 million or $0.27 per share); with $2.8 million of expense or $0.03 per share for the quarter (Q2 fiscal 2016 – $14.0 million of expense or $0.16 per share) relating to revaluations of foreign currency non-monetary items and of the deferred tax liability, both of which are non-cash items.

Six Months Ended July 31, 2016, Compared to Six Months Ended July 31, 2015

CONSOLIDATED SALES

Consolidated sales during the YTD Q2 fiscal 2017 period totalled $338.2 (YTD Q2 fiscal 2016 – $397.4 million), consisting of Ekati Diamond Mine rough diamond sales of $188.4 million (YTD Q2 fiscal 2016 – $265.0 million) and Diavik Diamond Mine rough diamond sales of $149.8 million (YTD Q2 fiscal 2016 – $132.4 million). See “Segmented Analysis” on page 9 for additional information.

CONSOLIDATED COST OF SALES AND GROSS MARGIN

The Company’s cost of sales includes costs associated with mining and rough diamond sorting activities. Consolidated cost of sales and gross margin in the period were negatively impacted by continued sales of production from lower value Misery Satellites. A $19.6 million and a $6.4 million impairment of available-for-sale inventory from the Ekati Diamond Mine were recorded in Q1 fiscal 2017 and Q2 fiscal 2017 respectively.

CONSOLIDATED SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

The principal components of selling, general and administrative (“SG&A”) expenses include expenses for salaries and benefits, professional fees, consulting and travel. SG&A decreased by $6.7 million over YTD Q2 fiscal 2016 primarily due to a charge in the prior year incurred in connection with the departure of the Company’s former Chief Executive Officer.

CONSOLIDATED OPERATING (LOSS) PROFIT

Consolidated operating (loss) profit decreased by $80.2 million over YTD Q2 fiscal 2016 primarily due to the expensing of $22.0 million of mine standby costs incurred as a result of the suspension of processing at the Ekati Diamond Mine following the process plant fire on June 23, 2016. Mine standby costs include approximately $5.0 million of expenditure relating to repairs and cleaning as a result of the fire.

CONSOLIDATED FINANCE EXPENSE

Finance expense during YTD Q2 fiscal 2017 decreased by $0.7 million over YTD Q2 fiscal 2016 mainly as a result of fluctuations in the accretion expense of the Company’s asset retirement obligation (“ARO”). The ARO liabilities are the associated costs relating to site closure, restoration and reclamation activities. The ARO liabilities are denominated in Canadian dollars and are translated to US dollars at the period-end exchange rate.

CONSOLIDATED EXPLORATION EXPENSE

The exploration program and related expenses for YTD Q2 fiscal 2017 focused primarily on work performed at Fox Deep (underground) within the Core Zone at the Ekati Diamond Mine. Exploration costs were in the amount of $5.0 million (YTD Q2 fiscal 2016 – $7.2 million) and were incurred for drilling, with the objective to better understand the grade of material of the existing resource which is located at the bottom of the existing pit. With the completion of the Jay Project Pre-feasibility Study, and subsequently the Sable Pre-feasibility Study, which established probable reserves for both kimberlite pipes, the Company has been capitalizing costs related to these development assets in accordance with the Company’s accounting policies.

CONSOLIDATED FINANCE AND OTHER INCOME (LOSS)

Finance and other income increased by $1.1 million compared to YTD Q2 fiscal 2016.

CONSOLIDATED FOREIGN EXCHANGE

A net foreign exchange loss of $7.8 million was recognized during YTD Q2 fiscal 2017 (YTD Q2 fiscal 2016 – $1.0 million). The Company does not currently have any foreign exchange derivative instruments outstanding.

CONSOLIDATED INCOME TAXES

The Company recorded a net income tax recovery of $30.6 million during the YTD Q2 fiscal 2017 period (YTD Q2 2016 – tax expense of $16.6 million). Included in the net income tax recovery is a net Northwest Territories mining royalty recovery of $4.1 million (YTD Q2 2016 – an expense of $5.9 million). The Company’s combined Canadian federal and provincial statutory income tax rate for the quarter was 26.5% (2016 – 26.5%). There are a number of items that can significantly impact the Company’s effective tax rate, including foreign currency exchange rate fluctuations, the Northwest Territories mining royalty, earnings subject to tax at rates different than the statutory rate and unrecognized tax benefits. As a result, the Company’s recorded tax provision can be significantly different than the expected tax provision calculated based on the statutory tax rate.

The recorded tax provision is particularly impacted by foreign currency exchange rate fluctuations. 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, a substantial portion of which is denominated in Canadian dollars. As such, the Company is continually subject to foreign exchange fluctuations, particularly as the Canadian dollar moves against the US dollar. During the YTD Q2 fiscal 2017 period, foreign currency exchange rate fluctuations resulted in a $12.8 million decrease (YTD Q2 2016 – $13.0 million increase) in the Company’s net income tax expense.

Due to the number of factors that can potentially impact the effective tax rate and the sensitivity of the tax provision to these factors, as discussed above, it is expected that the Company’s effective tax rate will fluctuate in future periods.

NET (LOSS) INCOME ATTRIBUTABLE TO SHAREHOLDERS

Included in net loss attributable to shareholders was the foreign exchange impact on income tax expense. The strengthening of the Canadian dollar relative to the US dollar during YTD Q2 fiscal 2017 resulted in additional income tax recovery of $12.8 million or $0.15 per share (YTD Q2 fiscal 2016 – expense of $13.0 million or $0.15 per share); with $14.0 million of recovery or $0.16 per share (YTD Q2 fiscal 2016 – $2.5 million of expense or $0.03 per share) relating to revaluations of foreign currency non-monetary items and of the deferred tax liability, both of which are non-cash items.

Segmented Analysis

The operating segments of the Company include the Ekati Diamond Mine, the Diavik Diamond Mine and the Corporate segment. The Corporate segment captures costs not specifically related to operating the Ekati and Diavik mines.

EKATI DIAMOND MINE (100% SHARE)
(expressed in millions of United States dollars, except per share, per tonne or per carat amounts and where otherwise noted)
(unaudited)

   

Three months
ended
July 31,
2016

 

Three months
ended
July 31,
2015

(Restated)(ii)

   

Six months
ended
July 31,
2016

 

Six months
ended
July 31,
2015

(Restated)(ii)

Sales $ 83.3 $ 137.7 $ 188.4 $ 265.0
Carats sold (000s) 668 511 2,213 1,220
Cost of sales 106.1 133.6 243.1 247.6
Gross margin (22.8) 4.1 (54.7) 17.5
Gross margin (%) (27.4)% 3.0% (29.0)% 6.6%
Average price per carat 125 269 85 217
Selling, general and administrative expenses 1.0 1.6 1.7 3.0
Mine standby costs 22.0 22.0
Operating (loss) profit (45.8) 2.5 (78.4) 14.5
Finance expenses (1.4) (1.8) (2.8) (4.1)
Exploration costs (1.4) (1.9) (5.0) (7.1)
Finance and other income 0.3 0.7 0.1
Foreign exchange gain (loss) 8.1 3.4 (9.5) (0.1)
Segmented (loss) profit before income taxes   (40.3)   2.1   (95.1)   3.3
Cash cost of production(i) 61.2 83.1 135.5 166.1
Cash cost per tonne processed(i) 101.8 86.4 86.1 91.6
Non-cash cost per tonne processed(i) 68.4 33.5 48.2 36.0
Cash cost per carat(i) 72.6 91.9 71.2 98.0
Adjusted EBITDA(i) 1.0 36.9 26.9 77.6
Adjusted EBITDA margin (%)(i) 1% 27% 14% 29%
Capital expenditures 48.0 32.9 170.5 87.9
Depreciation and amortization   40.3   34.5   79.3   63.1

(i) The terms “cash cost of production,” “cash cost per tonne processed,” “non-cash cost per tonne processed,” “cash cost per carat,” “Adjusted EBITDA” and “Adjusted EBITDA margin” do not have standardized meanings according to IFRS. See “Non-IFRS Measures” for additional information.
(ii) Figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.

Three Months Ended July 31, 2016, Compared to Three Months Ended July 31, 2015

EKATI SALES

The $54.4 million decrease in sales for Q2 fiscal 2017 reflected a high proportion of lower value goods from the Misery Satellites available for sale in the quarter. Excluded from sales recorded in the second quarter were 0.1 million carats produced from the Misery Main pipe during the pre-commercial production period for proceeds of $8.3 million (Q2 fiscal 2016 – $5.2 million from Misery Northeast). Sales of diamonds recovered during the pre-commercial production period have been applied as a reduction of capitalized stripping assets. The increase in number of carats sold and decrease in average price per carat reflects the expected shift in the mine plan beginning in fiscal 2016 from higher value production from the Koala, Koala North and Fox ore bodies to the lower value material from Misery Satellites and coarse ore rejects (“COR”) while pre-stripping was being completed in the higher value Misery Main open pit.

EKATI COST OF SALES AND GROSS MARGIN

Gross margin decreased from $4.1 million to negative $22.8 million at the Ekati Diamond Mine as a result of two factors. First, more than half of the Misery Main ore processed and all of the Misery Main carats sold as of July 31, 2016 were mined prior to the commencement of commercial production of the Misery Main pipe in May 2016. For accounting purposes, sales of these diamonds, net of related costs, have been applied as a reduction of capitalized stripping costs. As a result, second quarter sales and available-for-sale diamond inventory as at July 31, 2016 continued to reflect a relatively high percentage of lower value Misery South & Southwest material. Secondly, second quarter production was negatively impacted by a decrease in tonnage processed as a result of a planned four-day maintenance shutdown in May and processing inefficiencies driven by batch processing of unblended ore from Misery Main and Pigeon, which resulted in the equivalent of approximately three days of plant downtime in order to purge the plant during this testing. Decreased production results in higher cash and non-cash cost per carat as operating costs that are largely fixed, and depreciation costs that are calculated on a straight-line basis, are spread over a lower volume of production. These factors resulted in an available-for-sale inventory impairment charge of $6.4 million recorded in cost of sales in Q2 fiscal 2017. The impairment represented the excess of the inventoried cash and non-cash costs over net realizable value, or the amount the Company realized or expected to realize upon final sorting, valuation and subsequent sale of this inventory in Q3 fiscal 2017. The gross margin is anticipated to fluctuate between quarters, resulting from variations in the volume, size and quality distribution of rough diamonds sold by the Company in each quarter and variation in rough diamond prices.

The $21.9 million decrease in cash cost of production from Q2 fiscal 2016 is due primarily to the production shutdown in July as a result of the process plant fire, combined with a weaker Canadian dollar. A majority of mine operating costs, including labour and overhead costs, are incurred in Canadian dollars. See “Non-IFRS Measures” for additional information. Cost of sales also includes sorting costs, which represent the Company’s cost of handling and sorting product in preparation for sales to third parties, and depreciation and amortization, the majority of which is recorded using the straight-line method over the remaining mine life of management approved projects. Capitalized costs of new pit or underground development are amortized on a unit-of-production basis as the associated material is processed. Non-cash depreciation increased in Q2 fiscal 2017 following the commencement of commercial production of Misery Main as a result of depreciation of the related deferred stripping asset.

As at July 31, 2016, the Company had 1.5 million carats of Ekati Diamond Mine–produced rough diamond inventory available for sale with an estimated market value of approximately $89 million, including approximately 0.2 million carats and $15 million of Misery Main pre-production inventory (April 30, 2016 – 1.2 million carats and $96 million, respectively, including no Misery Main pre-production inventory). Approximately 0.1 million carats of Misery Main pre-production inventory were sold in Q2 fiscal 2017. The Company also had approximately 0.2 million carats of rough diamond inventory that was work in progress (April 30, 2016 – 0.4 million carats). Inventory classified as available for sale represents carats that have completed the sorting and valuation process. Carats still undergoing sorting and valuation are classified as work-in-progress inventory.

(expressed in millions of United States dollars)

    Ekati

carats (millions)

  Ekati

cost

Diamond inventory available for sale, April 30, 2016 1.2 $ 96.3
Transfer from work in progress 1.1 89.0
Cost of sales(i) (0.8)   (112.0)
Diamond inventory available for sale, July 31, 2016 1.5 $ 73.3

(i) Includes $6.4 million impairment of available-for-sale inventory recorded in Q2 fiscal 2017.

SEGMENTED (LOSS) PROFIT BEFORE INCOME TAXES

Segmented (loss) profit before income taxes during the quarter decreased by $42.3 million, which was primarily driven by the sale of lower value material when compared to the second quarter of fiscal 2016. Refer to the “Ekati Sales” section above for a detailed explanation. Additionally, $22.0 million of mine standby costs were incurred in Q2 fiscal 2017 as a result of the suspension of processing at the Ekati Diamond Mine following the process plant fire on June 23, 2016. Mine standby costs include approximately $5.0 million of expenditure relating to repairs and cleaning as a result of the fire.

Six Months Ended July 31, 2016, Compared to Six Months Ended July 31, 2015

EKATI SALES

Sales from the Ekati segment decreased $76.6 million over YTD Q2 fiscal 2016. Excluded from sales in the current period were 0.2 million carats for proceeds of $12.7 million which were carats produced and sold from the processing of materials from Misery Main, Misery Northeast and Pigeon pipes during their respective pre-commercial production periods (2016 – 0.1 million carats for proceeds of $5.5 million from Misery Northeast).

Carats sold increased by 81% and price per carat decreased by 61% compared to YTD Q2 fiscal 2016 due to the change in the ore mix with more production coming from sources with a lower average price.

EKATI COST OF SALES AND GROSS MARGIN

Gross margin decreased from 6.6% to a negative 29.0% at the Ekati Diamond Mine primarily due to a change in the ore mix with more production coming from sources with a lower average price. Gross margin was also negatively impacted by a $19.6 million and $6.4 million impairment of available-for-sale inventory recorded in cost of sales in Q1 fiscal 2017 and Q2 fiscal 2017 respectively. The impairment represents the excess of the inventoried cash and non-cash costs over net realizable value, or the amount the Company realized or expected to realize upon final sorting, valuation and subsequent sale of this inventory. The impairment primarily resulted from production in the first half of the fiscal year having a relatively high proportion of Misery South & Southwest material.

Cost of sales includes mine operating costs incurred at the Ekati Diamond Mine. During YTD Q2 fiscal 2017, the Ekati cash cost of production was $135.5 million (2016 – $166.1 million). Cost of sales also includes sorting costs, which comprise the Company’s cost of handling and sorting product in preparation for sales to third parties, and depreciation and amortization, the majority of which is recorded using the straight-line method over the remaining mine life of management approved projects. See “Non-IFRS Measures” for additional information.

As at July 31, 2016, the Company had 1.5 million carats of Ekati Diamond Mine–produced rough diamond inventory available for sale with an estimated market value of approximately $89 million, including approximately 0.2 million carats and $15 million of Misery Main pre-production inventory (January 31, 2016 – 1.0 million carats and $66 million, respectively, including no Misery Main pre-production inventory). Approximately 0.1 million carats of Misery Main pre-production inventory were sold in Q2 fiscal 2017. The Company also had approximately 0.2 million carats of rough diamond inventory that was work in progress (January 31, 2016 – 1.1 million carats). Inventory classified as available for sale represents carats that have completed the sorting and valuation process. Carats still undergoing sorting and valuation are classified as work-in-progress inventory.

(expressed in millions of United States dollars)

    Ekati

carats (millions)

  Ekati

cost

Diamond inventory available for sale, January 31, 2016 1.0 $ 65.6
Transfer from work in progress 2.9 257.0
Cost of sales(i) (2.4)   (249.3)
Diamond inventory available for sale, July 31, 2016 1.5 $ 73.3

(i) Includes $19.6 million and $6.4 million impairment of available-for-sale inventory recorded in Q1 fiscal 2017 and Q2 fiscal 2017 respectively.

SEGMENTED (LOSS) PROFIT BEFORE INCOME TAXES

Segmented (loss) profit before income taxes during the six months ended July 31, 2016 decreased by $98.3 million, which was primarily driven by the production of lower value material when compared to the six months ended July 31, 2015. Refer to the “Ekati Sales” section above for a detailed explanation. Additionally, $22.0 million of mine standby costs were expensed in Q2 fiscal 2017 as a result of the suspension of processing at the Ekati Diamond Mine following the process plant fire on June 23, 2016.

Operational Update

A fire occurred at the Ekati Diamond Mine process plant on June 23, 2016. The resulting damage to the process plant was limited only to a small area with no damage to the main structural components. No injuries were reported. The process plant was subsequently shut down with repairs currently ongoing, including the replacement of one of the main degritting screens and associated components, as well as some electrical wiring and related infrastructure. The process plant is expected to resume operations on or about September 21, 2016 at an estimated total cost of repair of $15 million. Cost savings measures were implemented subsequent to the fire, including pausing mining at lower value ore bodies, a deferral of non-essential sustaining capital and a temporary layoff of affected staff across the Company.

Mining activities during the second quarter were initially focused on ore production from the Pigeon and Misery Main open pits and Koala underground operations. Lynx pre-stripping also continued ahead of plan in May and June. Subsequent to the process plant fire, mining operations continued but were paused at lower value Pigeon and Lynx open pits in order to minimize costs and prioritize production at the higher value Misery Main open pit and Koala underground. Ore mined during the process plant downtime will be stockpiled.

During the second quarter of fiscal 2017, prior to the process plant shutdown, the Ekati Diamond Mine produced (on a 100% basis) 0.7 million carats from the processing of 0.5 million tonnes of ore from mineral reserves. The Company recovered 0.2 million carats from the processing of 0.1 million tonnes of material excavated from the Misery South & Southwest Extension pipes. Carat production was negatively impacted by the process plant shutdown, but benefited from the processing of higher grade Misery Main ore, despite dilution of initial ore as a result of sloughing during the mining of preceding benches.

During the second quarter of fiscal 2017, environmental performance at the Ekati Diamond Mine continued to be strong. With respect to health and safety performance, the Company recorded one lost time injury, corresponding to a frequency rate per 200,000 hours worked (“LTIFR”) of 0.19 (Q2 fiscal 2016 – one lost time injury and an LTIFR of 0.24).

The charts below show the Ekati Diamond Mine carat production, ore processed and recovered grade for the eight most recent quarters.

EKATI DIAMOND MINE PRODUCTION (100% SHARE) – CARATS
Please see associated chart titled “Ekati Diamond Mine Production (100% Share) – CARATS”

EKATI DIAMOND MINE PRODUCTION (100% SHARE) – ORE PROCESSED AND RECOVERED GRADE
Please see associated chart titled “Ekati Diamond Mine Production (100% Share) – ORE PROCESSED AND RECOVERED GRADE”

Ekati Operations Outlook

KEY MINING AND PIPE ACTIVITIES

Pipe   Q1 FY17   Q2 FY17   Q3 FY17   Q4 FY17
Misery Main First ore Commercial production(i), processing suspended(ii)   Processing resumes
Pigeon Continuing production Mining and processing suspended(ii) Continuing mining
Lynx Waste stripping Mining and processing suspended(ii) Waste stripping, first ore
Koala Continuing production Continuing mining, processing suspended(ii) Processing resumes
Misery South & Southwest Continuing production Continuing mining, processing suspended(ii) Continuing mining
Sable Mobilization Road construction   Preparation for site construction Site construction
Jay Report of Environmental Assessment, mobilization Feasibility study, interim land use permit   Interim land use permit Water licence application process

(i) Commencement of “commercial” production is defined as three consecutive months of production above 60% of nameplate capacity. The Company defines “capacity” as the average monthly production for the open pit/underground source over the life of mine.
(ii) Processing is suspended following the fire that occurred at the Ekati process plant on June 23, 2016 and is expected to resume in late September 2016. Mining has also been paused at Lynx and Pigeon pipes during this period.

Changes were made to the mine plan in the second quarter of fiscal 2017 as a result of the fire at the Ekati process plant on June 23, 2016, resulting in an approximate three-month shutdown. Mining operations continue at the higher value Koala underground and Misery Main open pit and were paused at the lower value Pigeon and Lynx open pits as a cost reduction measure. Mining at Pigeon and Lynx is expected to re-commence in Q3 fiscal 2017, with first ore at Lynx expected to be achieved in late Q4 fiscal 2017.

Ore mined during the process plant downtime will be stockpiled and higher value ore from Koala underground and Misery Main open pit will be prioritized for the remainder of fiscal 2017 when the plant resumes operations, expected to be in late September 2016. Following completion of sorting and valuation, the initial diamonds recovered upon re-commencement of processing are expected to be sold in late Q4 fiscal 2017.

A fine dense media separation (DMS) unit is also planned to be commissioned in the process plant in Q4 fiscal 2017 in order to improve the recovery of smaller sized diamonds.

PRODUCTION

    Full year production target fiscal 2017
Carats   Million tonnes
Koala underground operation 0.7 1.3
Pigeon open pit 0.2 0.4
Misery Main open pit 3.0 0.7
Total reserves (base case) 3.9 2.4
Misery South & Southwest kimberlite pipes 0.8 0.4
Total reserves and inferred resources (operating case) 4.7 2.8

The full year production target for fiscal year 2017 foresees Ekati Diamond Mine production of approximately 3.9 million carats from the mining and processing of approximately 2.4 million tonnes of mineral reserves (the base case). Average grade from Koala underground is expected to be lower than that achieved in fiscal 2016 as the mine plan expects the processing of a higher proportion of ore from lower grade phases. Misery Main open pit commenced commercial production in May 2016 and initial sales began in Q2 fiscal 2017. For accounting purposes, sales of diamonds recovered during the pre-commercial production period prior to May 2016 have been applied as a reduction of capitalized stripping costs. Upon re-commencement of processing following the estimated three-month shutdown beginning in late June 2016, carats planned to be recovered from higher value Misery Main open pit and Koala underground will not be sold until late Q4 fiscal 2017 and Q1 fiscal 2018 following completion of the sorting and valuation process.

In addition to the mineral reserves noted above, in the first half of fiscal 2017 the Ekati Diamond Mine processed inferred mineral resources from the Misery South & Southwest kimberlite pipes that were made available as the Misery reserves were accessed (the operating case). When this additional resource material from the Misery South & Southwest pipes is included, the production target for fiscal 2017 foresees total Ekati Diamond Mine production of approximately 4.7 million carats from the mining and processing of approximately 2.8 million tonnes of mineral reserves and resources. No further processing of material from the Misery South & Southwest pipes is planned for fiscal 2017. The Company cautions that inferred mineral resources are considered too speculative geologically to have the economic considerations applied to them that would enable them to be categorized as mineral reserves.

Approximately 0.5 million tonnes of ore are expected to be mined and stockpiled from July through September during the process plant shutdown, with the intention of processing a blend of high-value Misery Main and Koala ore when processing recommences. COR are not planned to be processed in fiscal 2017.

First ore is expected to be mined from Lynx open pit at the end of fiscal 2017 but its tonnage contribution is expected to be negligible.

As part of the Koala and Pigeon mining, a small portion of inferred mineral resource is extracted along with the mineral reserves. This material is not included in the current production estimate, but will be processed along with the mineral reserves ore and will be incremental to production. Mineral resources that are not mineral reserves do not have demonstrated economic viability.

The foregoing scientific and technical information for the Ekati Diamond Mine was prepared and verified by the Company, the operator of the Ekati Diamond Mine, under the supervision of Peter Ravenscroft, FAuslMM, of Burgundy Mining Advisors Ltd., an independent mining consultancy. Mr. Ravenscroft is a Qualified Person within the meaning of National Instrument 43-101 of the Canadian Securities Administrators.

CAPITAL EXPENDITURES

The planned capital expenditures excluding capitalized depreciation at Ekati Diamond Mine for fiscal 2017 (on a 100% basis) are expected to be approximately $204 million at an estimated average Canadian/US dollar exchange rate of 1.33. Capital expenditures include development projects, sustaining capital and capitalized evaluation activities. Expectations have been updated in the second quarter to reflect changes in the mine plan and cost savings measures implemented as a result of the Ekati process plant fire on June 23, 2016 and subsequent shutdown, expected to last approximately three months. Capital expenditure in fiscal 2017 includes the costs associated with the pre-stripping of waste at the Misery Main and Lynx open pits prior to commercial production. The table below does not include production stripping of waste in open pits that have achieved commercial production. These production stripping cash costs totalled $16 million in YTD Q2 fiscal 2017, and are expected to be $70 million for the full year. Production stripping costs are capitalized as deferred stripping assets and amortized on a unit-of-production basis as the associated material is processed. Capital expenditure in the table below also contains mobilization and initial construction for the Jay and Sable Projects. A fine dense media separation (DMS) unit is also planned to be commissioned in the process plant in late fiscal 2017. The table below sets out the currently planned capital expenditure by project for fiscal 2017 at the Ekati Diamond Mine (100%).

(expressed in millions of United States dollars)

Capital expenditure

   

YTD fiscal 2017
actuals(i)

    Fiscal 2017

guidance(ii)

Misery Main(iii) $ 26 $ 30
Lynx 18 22
Sable 26 55
Jay 27 44
Fine DMS 8 14
Sustaining   23   39

(i) Calculated excluding capitalized depreciation and excluding adjustments for pre-production revenue.
(ii) Calculated at an estimated average Canadian/US dollar exchange rate of 1.33.
(iii) Misery Main achieved commercial production in May 2016. Remaining planned expenditure in fiscal 2017 relates to infrastructure.

In the second quarter of fiscal 2017, capital expenditure included the construction of the Sable all-season access road and waste stripping at Lynx open pit. Misery Main commenced commercial production in May 2016, earlier than planned, with remaining planned expenditure in fiscal 2017 relating to infrastructure.

PRICING

Based on the average prices per carat achieved by the Company in the July 2016 sale, the Company has modelled the approximate rough diamond price per carat for the Ekati kimberlite process plant feed types below. The pricing below is modelled to reflect the current recovery profile of the Ekati process plant using diamond samples for each ore source, marked to market to reflect the average realized price from the July 2016 sale.

Feed type    

July 2016
sales cycle
average price
per carat

Koala $ 314
Misery Main 71
Misery South 54
Misery Southwest Extension 42
COR 60–115
Pigeon   158

COST OF SALES, CASH COST OF PRODUCTION AND GROSS MARGIN

Based on current sales expectations for the Ekati Diamond Mine segment for fiscal 2017, the Company expects cost of sales to be approximately $378 million (on a 100% basis) (including depreciation and amortization of approximately $135 million). Based on the current mine plan for the Ekati Diamond Mine for fiscal 2017, the cash cost of production is expected to be approximately $224 million (on a 100% basis) at an estimated average Canadian/US dollar exchange rate of 1.33. Expectations have been revised to reflect the estimated three-month shutdown of the Ekati process plant following the fire on June 23, 2016, which will negatively impact the volume of production available for sale in fiscal 2017. Expectations have also been updated to reflect a revised mine plan with suspended mining activity at Lynx and Pigeon open pits in order to prioritize stockpiling of higher value Misery Main and Koala ore, which will be prioritized upon recommissioning of the process plant, expected to be in late September 2016. Cash cost of production does not include mine standby costs as a result of the process plant fire. These are expected to be approximately $55 million in fiscal 2017. A majority of Ekati Diamond Mine operating costs are incurred in Canadian dollars. In fiscal 2017, a one-cent change in the quarterly average Canadian/US dollar exchange rate is expected to result in an estimated $0.5 million movement in cash production costs in that quarter.

Ekati Diamond Mine depreciation is calculated primarily on a straight-line basis, which is computed using the life of mine plan containing only management approved projects. In February 2016, the expected mine life of the Ekati Diamond Mine was extended by three years to 2023 following completion of the Sable Project Pre-feasibility Study and the start of major construction work on that project. In July 2016, the mine life was extended a further 11 years to 2034 following the completion of the Jay Project Feasibility Study and a decision to proceed with construction of the Jay Project. As a result, non-cash depreciation per year for certain existing assets has been significantly reduced, and has been incorporated into the Company’s cost of sales expectations. However, depreciation is expected to increase in fiscal 2017 following the commencement of commercial production of Misery Main as a result of depreciation of the related capitalized stripping asset. This non-cash depreciation will begin to be realized in cost of sales in the second half of fiscal 2017 as Misery Main carats mined during the commercial production period are processed and sold.

The cost of sales, cash cost of production and gross margin targets for fiscal 2017 incorporate the impact of the mild weather conditions in Q1 fiscal 2017 which resulted in the annual winter road to the mine being open for a reduced period of time. More stringent weight restrictions for a period following the opening of the road resulted in an increased number of partial loads, which increased freight costs by approximately $5 million.

Gross margin is expected to improve in the fourth quarter of the fiscal year as more significant amounts of Misery Main ore begin to be processed following the recommissioning of the process plant, expected to be in late September 2016. The Company expects gross margin as a percentage of sales to fluctuate depending on, among other things, production volumes, product mix, diamond prices and cost of production.

DIAVIK DIAMOND MINE (40% SHARE)
(expressed in millions of United States dollars, except per share, per tonne or per carat amounts and where otherwise noted)
(unaudited)

   

Three months
ended
July 31,
2016

 

 

Three months
ended
July 31,
2015

(Restated)(ii)

   

Six months
ended
July 31,
2016

  Six months
ended
July 31,
2015

(Restated)(ii)

Sales $ 76.7 $ 72.0 $ 149.8 $ 132.4
Carats sold (000s) 673 412 1,727 956
Cost of sales 53.0 53.4 113.1 103.0
Gross margin 23.7 18.6 36.7 29.4
Gross margin (%) 30.9% 25.8% 24.5% 22.2%
Average price per carat 114 175 87 138
Selling, general and administrative expenses 0.8 1.0 1.7 1.9
Operating profit 22.8 17.6 35.0 27.5
Finance expenses (1.1) (1.1) (2.1) (1.6)
Exploration costs
Finance and other income 0.5 0.5
Foreign exchange (loss) gain (12.5) (5.6) 1.7 (0.9)
Segmented profit before income taxes   9.7   10.9   35.1   25.0
Cash cost of production(i) 29.1 29.7 60.4 62.9
Cash cost per tonne processed(i) 136.0 131.3 138.3 151.0
Non-cash cost per tonne processed(i) 76.6 101.2 84.8 93.1
Cash cost per carat(i) 49.3 35.7 46.4 45.0
Adjusted EBITDA(i) 42.0 35.7 76.5 62.2
Adjusted EBITDA margin (%)(i) 55% 50% 51% 47%
Capital expenditures 11.7 7.5 38.0 19.7
Depreciation and amortization   19.2   18.1   41.6   34.8

(i) The terms “cash cost of production,” “cash cost per tonne processed,” “non-cash cost per tonne processed,” “cash cost per carat,” “Adjusted EBITDA” and “Adjusted EBITDA margin” do not have standardized meanings according to IFRS. See “Non-IFRS Measures” for additional information.
(ii) Figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.

Three Months Ended July 31, 2016, Compared to Three Months Ended July 31, 2015

DIAVIK SALES

During the second fiscal quarter of 2017, the Company sold approximately 0.7 million carats (Q2 fiscal 2016 – 0.4 million carats) from the Diavik Diamond Mine for a total of $76.7 million (Q2 fiscal 2016 – $72.0 million). The decrease in average price per carat sold is a result of lower-than-average priced inventory held back in the prior year due to market conditions.

DIAVIK COST OF SALES AND GROSS MARGIN

Cost of sales in the second quarter of 2017 included $19.1 million of depreciation and amortization expense (Q2 fiscal 2016 – $18.0 million). The Diavik segment generated a gross margin and Adjusted EBITDA margin of 30.9% and 55%, respectively (Q2 fiscal 2016 – 25.8% and 50%).

A substantial portion of cost of sales is mine operating costs incurred at the Diavik Diamond Mine. During the second quarter of 2017, the Diavik cash cost of production was $29.1 million (Q2 fiscal 2016 – $29.7 million). The cash cost of production has remained consistent and mainly comprises costs that are denominated in Canadian dollars. The term “cash cost of production” does not have a standardized meaning according to IFRS. See “Non-IFRS Measures” for additional information. Cost of sales also includes sorting costs, which represent the Company’s cost of handling and sorting product in preparation for sales to third parties, and depreciation and amortization, the majority of which is recorded using the unit-of-production method over estimated proven and probable reserves.

At July 31, 2016, the Company had 0.8 million carats of Diavik Diamond Mine–produced rough diamond inventory available for sale with an estimated market value of approximately $53 million (April 30, 2016 – 1.0 million carats and $71 million, respectively). The Company also had approximately 0.1 million carats of inventory classified as work in progress (April 30, 2016 – nil carats). Inventory classified as available for sale represents carats that have completed the sorting and valuation process. Carats still undergoing sorting and valuation are classified as work-in-progress inventory.

   

Diavik

carats (millions)

  Diavik
cost
Diamond inventory available for sale, April 30, 2016 1.0 $ 47.5
Transfer from work in progress 0.5 38.4
Cost of sales(i) (0.7)   (51.2)
Diamond inventory available for sale, July 31, 2016 0.8 $ 34.7

(i) Does not include royalties, which are recorded directly to cost of sales.

SEGMENTED PROFIT (LOSS) BEFORE INCOME TAXES

Segmented profit before income taxes during the quarter decreased by $1.1 million from the comparable quarter of the prior year. The decrease was primarily driven by a foreign exchange loss of $12.5 million offset by an increase in sales. Refer to the “Diavik Sales” section above for a detailed explanation.

Six Months Ended July 31, 2016, Compared to Six Months Ended July 31, 2015

DIAVIK SALES

Sales during the YTD Q2 fiscal 2017 period have increased by $17.4 million primarily due to some improvement over a weakened diamond market in the prior year. Carats sold increased by 81% and price per carat decreased by 37% compared to YTD Q2 fiscal 2016, primarily due to a decision in the prior year to hold back lower-than-average priced inventory due to market conditions.

DIAVIK COST OF SALES AND GROSS MARGIN

Cost of sales during the YTD Q2 fiscal 2017 period included $41.3 million of depreciation and amortization (YTD Q2 fiscal 2016 – $34.5 million). The Diavik segment generated a gross margin and EBITDA margin of 24.5% and 51%, respectively (YTD Q2 fiscal 2016 – 22.2% and 47%). The gross margin is anticipated to fluctuate between quarters, resulting from variations in the specific mix of product produced and sold during each quarter and variation in rough diamond prices.

A substantial portion of consolidated cost of sales is mine operating costs incurred at the Diavik Diamond Mine. During the YTD Q2 fiscal 2017 period, the Diavik cash cost of production was $60.4 million (YTD Q2 fiscal 2016 – $62.9 million). The reduction in cash cost of production is partially due to operational improvements at the mine and the weakening of the Canadian dollar. The term cash cost of production does not have a standardized meaning according to IFRS. See “Non-IFRS Measures” for additional information. Cost of sales also includes sorting costs, which comprise the Company’s cost of handling and sorting product in preparation for sales to third parties, and depreciation and amortization, the majority of which is recorded using the unit-of-production method over estimated proven and probable reserves.

At July 31, 2016, the Company had 0.8 million carats of Diavik Diamond Mine–produced rough diamond inventory available for sale with an estimated market value of approximately $53 million (January 31, 2016 – 1.0 million carats and $40 million, respectively). The Company also had approximately 0.1 million carats of inventory classified as work in progress (January 31, 2016 – 0.2 million carats). Inventory classified as available for sale represents carats that have completed the sorting and valuation process. Carats still undergoing sorting and valuation are classified as work-in-progress inventory.

    Diavik

carats (millions)

  Diavik
cost
Diamond inventory available for sale, January 31, 2016 1.0 $ 29.0
Transfer from work in progress 1.5 115.4
Cost of sales(i) (1.7)   (109.7)
Diamond inventory available for sale, July 31, 2016 0.8 $ 34.7

(i) Does not include royalties, which are recorded directly to cost of sales.

SEGMENTED PROFIT (LOSS) BEFORE INCOME TAXES

Segmented profit before income taxes during the six months ended July 31, 2016 increased by $10.1 million from the comparable period of the prior year. The increase was primarily driven by increased sales during the first half of fiscal year 2017 and foreign exchange gains. Refer to the “Diavik Sales” section above for a detailed explanation.

Operational Update

During Q2 calendar 2016, the Diavik Diamond Mine produced (on a 100% basis) 1.6 million carats from 0.6 million tonnes of ore processed (Q2 calendar 2015 – 2.1 million carats and 0.6 million tonnes, respectively). Total production includes COR, which is not included in the Company’s reserve and resource statements and is therefore incremental to production.

Processing volumes in Q2 calendar 2016 were 5% lower than in the same quarter of the prior year due to lower ore availability. Diamonds recovered in the second calendar quarter of 2016 were on plan, and were 26% lower than in the same quarter of the prior year as a result of lower processing volumes and lower recovered grades.

The development of the A-21 pipe continues to progress according to plan.

The charts below show the Company’s 40% share of Diavik Diamond Mine carat production, ore processed and recovered grade for the eight most recent calendar quarters.

DOMINION DIAMOND DIAVIK LIMITED PARTNERSHIP’S 40% SHARE OF DIAVIK DIAMOND MINE PRODUCTION – CARATS
(reported on a one-month lag)

Please see associated chart titled “DOMINION DIAMOND DIAVIK LIMITED PARTNERSHIP’S 40% SHARE OF DIAVIK DIAMOND MINE PRODUCTION – CARATS (reported on a one-month lag)”

DOMINION DIAMOND DIAVIK LIMITED PARTNERSHIP’S 40% SHARE OF DIAVIK DIAMOND MINE PRODUCTION – ORE PROCESSED AND RECOVERED GRADE
(reported on a one-month lag)

Please see associated chart titled “DOMINION DIAMOND DIAVIK LIMITED PARTNERSHIP’S 40% SHARE OF DIAVIK DIAMOND MINE PRODUCTION – ORE PROCESSED AND RECOVERED GRADE (reported on a one-month lag)”

Diavik Operations Outlook

PRODUCTION

The mine plan for calendar 2016 foresees Diavik Diamond Mine production (on a 100% basis) of approximately 7.0 million carats from the mining and processing of approximately 2.1 million tonnes of ore. Mining activities will be exclusively underground.

    Full year production target calendar 2016
Carats   Million tonnes
A-154 South

1.5

0.5

A-154 North 1.6 0.7
A-418 3.9 0.9
Total reserves (excluding COR)

7.0

2.1

The aforementioned mine plan for the Diavik Diamond Mine was prepared and verified by DDMI, operator of the Diavik Diamond Mine, under the supervision of Calvin Yip, P. Eng., Principal Advisor, Strategic Planning of DDMI, who is a Qualified Person within the meaning of National Instrument 43-101 of the Canadian Securities Administrators.

CAPITAL EXPENDITURES

The Company currently expects DDDLP’s 40% share of the planned capital expenditures for the Diavik Diamond Mine in fiscal 2017 to be approximately $59 million at an estimated average Canadian/US dollar exchange rate of 1.33. The table below sets out DDDLP’s 40% share of capital expenditures incurred by the Company during YTD fiscal 2017 and the planned capital expenditures for full year fiscal 2017:

(expressed in millions of United States dollars)

Capital expenditures     YTD fiscal 2017
actuals
   

Fiscal 2017
guidance(i)

A-21 $ 21 $ 41
Sustaining   10   18

(i) Calculated at an estimated average Canadian/US dollar exchange rate of 1.33.

PRICING

Based on the average prices per carat achieved by the Company in the latest sale, held in July 2016, the Company has modelled the approximate rough diamond price per carat for each of the Diavik kimberlite process plant feed types in the table that follows.

Feed type     July 2016

sales cycle

average price
per carat

A-154 South $ 127
A-154 North 168
A-418 92
COR   46

COST OF SALES, CASH COST OF PRODUCTION AND GROSS MARGIN

Based on current sales expectations for the Diavik Diamond Mine segment for fiscal 2017, the Company expects cost of sales to be approximately $235 million (including depreciation and amortization of approximately $92 million). Based on the current mine plan for the Diavik Diamond Mine for calendar 2016, the Company’s 40% share of the cash cost of production at the Diavik Diamond Mine is expected to be approximately $118 million at an estimated average Canadian/US dollar exchange rate of 1.33.

The Company expects gross margin as a percentage of sales to fluctuate depending on, among other things, production volumes, diamond prices and cost of production. Gross margin as a percentage of sales in fiscal 2017 is expected to be slightly higher than that achieved in fiscal 2016, as production volumes are expected to increase year over year.

CORPORATE SEGMENT

(expressed in millions of United States dollars)

    Three months
ended
July 31, 2016
  Three months
ended
July 31, 2015
  Six months
ended
July 31, 2016
  Six months
ended
July 31, 2015
Selling, general and administrative expenses $ 7.4 $ 12.5 $ 13.7 $ 18.9

Three Months Ended July 31, 2016, Compared to Three Months Ended July 31, 2015

CORPORATE SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

SG&A expenses for the Corporate segment during the quarter decreased by $5.1 million over Q2 fiscal 2016 primarily due to a charge in the prior year incurred in connection with the departure of the Company’s former Chief Executive Officer.

Six Months Ended July 31, 2016, Compared to Six Months Ended July 31, 2015

CORPORATE SELLING, GENERAL AND ADMINISTRATIVE EXPENSES

SG&A expenses for the Corporate segment during the YTD Q2 fiscal 2017 period decreased by $5.2 million over the comparable period in fiscal 2016 primarily due to a charge in the prior year incurred in connection with the departure of the Company’s former Chief Executive Officer.

Liquidity and Capital Resources

The following chart shows the Company’s working capital balances for the eight most recent quarters, as well as the working capital ratios for the same periods. Working capital is calculated as total current assets less total current liabilities, and working capital ratio is calculated as total current assets divided by total current liabilities.

WORKING CAPITAL AND WORKING CAPITAL RATIO(i)

Please see associated chart titled “WORKING CAPITAL AND WORKING CAPITAL RATIO”

(i) The terms “working capital” and “working capital ratio” do not have standardized meanings according to IFRS. See “Non-IFRS Measures” for additional information.

CASH FLOW MOVEMENT
(expressed in millions of United States dollars)
(unaudited)

     

Six months
ended
July 31,
2016

Opening cash at February 1, 2016 $ 320.0
Cash provided by operating activities before interest and taxes 103.0
Capital expenditures for the period (174.6)
Cash tax paid for the period (50.5)
Net interest paid during the period (0.7)
Repayment of debt (10.9)
Contributions from and distributions made to minority partners, net (2.9)
Net proceeds from pre-production sales 11.9
Other (14.9)
Closing cash at July 31, 2016 $ 180.4

Working Capital

As at July 31, 2016, the Company had unrestricted cash and cash equivalents of $180.4 million and restricted cash of $65.5 million, compared to $320.0 million and $63.3 million, respectively, as at January 31, 2016. The restricted cash is used to support letters of credit to the Government of the Northwest Territories (“GNWT”) in the amount of CDN $25 million to secure the reclamation obligations for the Ekati Diamond Mine and CDN $60 million to secure reclamation obligations at the Diavik Diamond Mine.

During Q2 fiscal 2017, the Company reported cash flow provided from operations of $33.9 million, compared to cash flow provided from operations of $52.8 million in Q2 fiscal 2016.

Working capital decreased to $428.9 million at July 31, 2016 from $578.5 million at January 31, 2016. During Q2 fiscal 2017, the Company’s non-cash operating working capital fluctuations were as follows: accounts receivable increased by $1.4 million, other current assets increased by $10.4 million, inventory and supplies increased by $44.2 million and trade and other payables decreased by $46.0 million.

At July 31, 2016, the Company had approximately 66 million litres of diesel fuel at the Ekati Diamond Mine site and 9.5 million litres in Yellowknife. Additional fuel purchases have been deferred until later in the fiscal year. The Ekati Diamond Mine used 19.1 million litres of diesel fuel in Q2 2017.

The June 23, 2016 process plant fire at the Ekati Diamond Mine has resulted in a suspension of processing with the plant expected to resume operations at full capacity in late September 2016. The Ekati Diamond Mine is a significant source of cash flow for the Company and the processing shutdown is expected to have a negative impact on cash flow provided from operations in the second half of fiscal 2017. No insurance recoveries have been recorded in Q2 fiscal 2017.

The Company’s liquidity requirements fluctuate year over year and quarter over quarter depending on, among other factors, the seasonality of production at the Company’s mineral properties; the seasonality of mine operating expenses; capital expenditure programs; the number of rough diamond sales events conducted during the year; and the volume, size and quality distribution of rough diamonds delivered from the Company’s mineral properties and sold by the Company in the year.

The Company assesses liquidity and capital resources on a consolidated basis. The Company’s requirements are for cash operating expenses, working capital, contractual debt requirements and capital expenditures. The Company believes that it will generate sufficient liquidity to meet its anticipated requirements for at least the next 12 months.

Financing Activities

During the second quarter, the Company had a cash outflow from financing activities of $26.7 million, which included dividend payments of $17.1 million, repayment of debt of $10.8 million, distributions to minority partners of $1.8 million and contributions from minority partners of $2.9 million.

On April 7, 2015, the Company entered into a $210 million senior secured corporate revolving credit facility with a syndicate of commercial banks. The facility has a four-year term, and it may be extended for an additional period of one year with the consent of the lenders. Proceeds received by the Company under the credit facility are to be used for general corporate purposes. Accommodations under this credit facility may be made to the Company, at the Company’s option, by way of an advance or letter of credit, and the interest payable will vary in accordance with a pricing grid ranging between 2.5% and 3.5% above LIBOR. The Company is in compliance with the required financial covenants, which are customary for a financing of this nature. As at July 31, 2016, no amounts were outstanding under the Company’s senior secured corporate revolving credit facility.

On April 13, 2016, the Board of Directors declared a dividend of $0.20 per share, which represented the final portion of the $0.40 per share annual dividend for fiscal 2016. This dividend was paid on June 2, 2016 to shareholders of record at the close of business on May 17, 2016. The dividend was an eligible dividend for Canadian income tax purposes.

On September 8, 2016, the Board of Directors declared an interim dividend of $0.20 per share to be paid in full on November 3, 2016, to shareholders of record at the close of business on October 11, 2016. The dividend will be an eligible dividend for Canadian income tax purposes.

On July 15, 2016, the Toronto Stock Exchange (“TSX”) approved the Company’s normal course issuer bid (“NCIB”) to purchase for cancellation up to 6,150,010 common shares, representing approximately 10% of the public float as of July 6, 2016, from July 20, 2016 to no later than July 19, 2017. On July 28, 2016, the TSX accepted the Company’s entry into an automatic securities purchase plan in order to facilitate repurchases under the NCIB. Common shares repurchased under the NCIB will be cancelled. Purchases under the NCIB may be made through the facilities of the TSX, the New York Stock Exchange or alternative trading platforms in Canada or the United States by means of open market transactions or by such other means as may be permitted by the TSX and applicable US securities laws. There were no repurchases made under the NCIB as of July 31, 2016. Purchases under the NCIB began in August 2016 and resulted in the purchase of approximately 0.6 million shares during the month for approximately CDN $6.9 million. A shareholder of the Company may obtain a copy of the notice filed with the TSX in relation to the NCIB, without charge, by contacting the Corporate Secretary of the Company at P.O. Box 4569, Station “A,” Toronto, Ontario M5W 4T9.

Investing Activities

During the second quarter, the Company had additions to property, plant and equipment of $62.9 million, of which $50.9 million related to the Ekati Diamond Mine and $12.0 million related to the Diavik Diamond Mine. Expenditures related primarily to construction and pit development at both mines.

In January 2016, the management committee of the Buffer Zone approved a program and budget for the Buffer Zone for fiscal year 2017. In March 2016, Archon provided notice to DDEC, the operator of the Buffer Zone, of its objection to certain elements of the fiscal 2017 program and budget, and indicated that it was only prepared to contribute to certain portions of the program and budget. Accordingly, the Company has elected to fund all of the cash calls for those elements of the fiscal 2017 program and budget that will not be funded by Archon. Archon has asserted that its objection to the fiscal 2017 program and budget was based on its position that certain proposed expenditures in the fiscal 2017 program and budget were in breach of the terms of the Buffer Zone Joint Venture agreement, and as such, the management committee of the Buffer Zone was not permitted to approve those aspects of the fiscal 2017 program and budget. A revised program and budget for fiscal year 2017 is expected to be presented to the management committee of the Buffer Zone in the third quarter of fiscal 2017 to incorporate changes to the mine plan impacting the Lynx Project in the Buffer Zone. Dilution of Archon’s participating interest in the Buffer Zone had been expected in the second quarter of fiscal 2017 but has been temporarily withheld until Archon re-confirms its intentions with respect to funding the revised program and budget.

In the second quarter of fiscal 2017, the Company announced its approval to proceed with the development of the Jay Project based on the results of the Jay Feasibility Study and has delivered the Jay Feasibility Study to Archon. The Company expects an investment decision from Archon with respect to the Jay Project at the end of fiscal 2017.

In August 2016, the Company entered into a binding agreement to sell its downtown Toronto office building for approximately CDN $84.8 million. The building is reflected as an asset held for sale on the Company’s second quarter balance sheet with a net book value of $18.7 million, and associated liabilities of $4.1 million. The transaction closed on September 8th and was subject to customary closing conditions and adjustments.

Contractual Obligations

The Company has contractual payment obligations with respect to interest-bearing loans and borrowings and, through its participation in the Diavik Joint Venture and the Ekati Diamond Mine, future site restoration costs at both the Ekati and Diavik Diamond Mines. Additionally, at the Diavik 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, DDDLP is obligated to fund 40% of the Diavik Joint Venture’s total expenditures on a monthly basis. The most significant contractual obligations for the ensuing five-year period can be summarized as follows:

(expressed in thousands of United States dollars)

    Less than   Year   Year   After
    Total   1 year   2–3   4–5   5 years
Loans and borrowings (a)(b) $ 23,596 $ 22,367 $ 1,229 $ $
Environmental and participation agreements incremental commitments (c) 94,154 5,634 13,720 20,019 54,781
Operating lease obligations (d) 19,539 7,345 6,511 5,683
Capital commitments (e) 36,501 36,501
Other   820   820      
Total contractual obligations $ 174,610 $ 72,667 $ 21,460 $ 25,702 $ 54,781

(a) (i) Loans and borrowings presented in the foregoing table include current and long-term portions.

(ii) The Company has available a $210 million senior secured corporate revolving credit facility (available in either US or CDN dollars) with a syndicate of commercial banks for general corporate purposes. At July 31, 2016, no amounts were outstanding under this facility.

(iii) The Company’s first mortgage on real property has scheduled principal payments of approximately $0.2 million quarterly, which may be prepaid at any time, and matures on September 1, 2018. On July 31, 2016, $1.9 million was outstanding on the mortgage payable.

(iv) The Company issued a promissory note on October 15, 2015 in the amount of $42.2 million for the base purchase price for the acquisition of an additional 8.889% interest in the Core Zone. The promissory note is payable in instalments over 31 months and the Company has the right, but not the obligation, to satisfy one or more instalments due under the promissory note in common shares of the Company. On July 31, 2016, $21.5 million, which represents the principal amount of the note plus accrued interest, was outstanding.

(b) Interest on loans and borrowings 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, 2016, and have been included under loans and borrowings in the table above. Interest payments for the next 12 months are estimated to be approximately $0.6 million.

(c) Both the Diavik Joint Venture and the Ekati Diamond Mine, under environmental and other agreements, must provide funding for the Environmental Monitoring Advisory Board and the Independent Environmental Monitoring Agency, respectively. These agreements also state that the mines must provide security deposits for the performance of their reclamation and abandonment obligations under all environmental laws and regulations.

The Company posted surety bonds with the GNWT in the aggregate amount of CDN $253 million to secure the obligations under its Water Licence to reclaim the Ekati Diamond Mine. The Company provided letters of credit, secured by restricted cash, in the amount of CDN $60 million and CDN $25 million to the GNWT as security for the reclamation obligations for the Diavik Diamond Mine and Ekati Diamond Mine, respectively. The Company has also provided a guarantee of CDN $20 million for other obligations under the environmental agreement for the Ekati Diamond Mine.

Both the Diavik and Ekati Diamond Mines have also signed participation agreements with various Aboriginal communities. These agreements are expected to contribute to the social, economic and cultural well-being of these communities. The actual cash outlay for obligations of the Diavik Joint Venture under these agreements is not anticipated to occur until later in the life of the mine. The actual cash outlay under these agreements in respect of the Ekati Diamond Mine includes annual payments and special project payments during the operation of the Ekati Diamond Mine.

(d) Operating lease obligations represent future minimum annual rentals under non-cancellable operating leases at the Ekati Diamond Mine.

(e) The Company has various long-term contractual commitments related to the acquisition of property, plant and equipment. The commitments included in the table above are based on expected contract prices.

Other Obligations

In July 2016, the mine life of the Ekati Diamond Mine was extended a further 11 years to 2034 following the completion of the Jay Project Feasibility Study and a decision to proceed with construction of the Jay Project. This extension required an update of the Company’s provision for the Ekati Diamond Mine ARO and employee benefit plan obligations with respect to the timing of estimated future cash flows and benefit payments. In Q2 fiscal 2017, the Ekati Diamond Mine ARO liability increased by $14.2 million and was capitalized to the carrying value of the related assets. The non-current provision for employee benefit plan obligations increased by $3.9 million and was recorded in other comprehensive income.

Non-IFRS Measures

In addition to discussing earnings measures in accordance with IFRS, the MD&A provides the following non-IFRS measures, which are also used by management to monitor and evaluate the performance of the Company.

Cash Cost of Production

The MD&A refers to cash cost of production, a non-IFRS performance measure, in order to provide investors with information about the measure used by management to monitor performance. This information is used to assess how well each of the Diavik Diamond Mine and Ekati Diamond Mine is performing compared to the respective mine plan and prior periods. Cash cost of production includes mine site operating costs such as mining, processing and administration, but is exclusive of amortization, capital, and exploration and development costs. Mine standby costs incurred during the period when the Ekati Diamond Mine processing plant is temporarily shut down have been excluded from cash cost of production. The majority of mine operating costs, relating primarily to labour and overhead costs, are incurred in Canadian dollars and will therefore increase or decrease in US dollar terms as the Canadian dollar strengthens or weakens. Cash cost of production does not have any standardized meaning prescribed by IFRS and differs from measures determined in accordance with IFRS. This performance measure is intended to provide additional information and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with IFRS. This measure is not necessarily indicative of net profit or cash flow from operations as determined under IFRS.

The following table provides a reconciliation of cash cost of production to the Ekati Diamond Mine’s cost of sales disclosed for the three and six months ended July 31, 2016 and July 31, 2015.

(expressed in thousands of United States dollars)

(unaudited)

    Three months ended

July 31, 2016

  Three months ended

July 31, 2015

  Six months ended

July 31, 2016

  Six months ended

July 31, 2015

Ekati cash cost of production $ 61,157 $ 83,082 $ 135,475 $ 166,052
Other cash costs   1,008   1,946   2,073   3,459
Total cash cost of production 62,165 85,028 137,548 169,511
Depreciation and amortization   41,094   32,183   75,769   65,177
Total cost of production 103,259 117,211 213,317 234,688
Impairment loss on inventory 6,414 26,017
Adjusted for stock movements   (3,577)   16,379   3,735   12,887
Total cost of sales $ 106,096 $ 133,590 $ 243,069 $ 247,575

The following table provides a reconciliation of cash cost of production to the Diavik Diamond Mine’s cost of sales disclosed for the three and six months ended July 31, 2016 and July 31, 2015.

(expressed in thousands of United States dollars)
(unaudited)

    Three months ended

July 31, 2016

  Three months ended

July 31, 2015

  Six months ended

July 31, 2016

  Six months ended

July 31, 2015

Diavik cash cost of production $ 29,103 $ 29,671 $ 60,408 $ 62,886
Private royalty 1,472 491 2,929 1,649
Other cash costs   576   422   931   918
Total cash cost of production 31,151 30,584 64,268 65,453
Depreciation and amortization   16,393   22,865   37,032   38,751
Total cost of production 47,544 53,449 101,300 104,204
Adjusted for stock movements   5,468   (51)   11,816   (1,196)
Total cost of sales $ 53,012 $ 53,398 $ 113,116 $ 103,008

Cash Cost per Tonne Processed, Non-Cash Cost per Tonne Processed and Cash Cost per Carat

The MD&A refers to the terms “cash cost per tonne processed,” “non-cash cost per tonne processed” and “cash cost per carat,” which are non-IFRS financial measures, in order to provide investors with information about the measures used by management to monitor performance. The Company believes these measures will assist analysts, investors and other stakeholders in understanding the costs associated with extracting diamonds. This information is used to assess how well each of the Diavik Diamond Mine and Ekati Diamond Mine is performing compared to the respective mine plan and prior periods. Cash cost per tonne processed is calculated by dividing cash cost of production by total tonnes processed, and the non-cash cost per tonne processed is calculated by dividing depreciation and amortization by total tonnes processed. The cash cost per carat processed is calculated by dividing cash cost of production by total carats produced. Cash cost per tonne processed, non-cash cost per tonne processed and cash cost per carat do not have any standardized meanings prescribed by IFRS and differ from measures determined in accordance with IFRS. These performance measures are intended to provide additional information and should not be considered in isolation or as a substitute for measures of performance prepared in accordance with IFRS. These measures are not necessarily indicative of net profit or cash flow from operations as determined under IFRS.

The following table demonstrates our calculation of cash cost per tonne processed, non-cash cost per tonne processed and cash cost per carat at the Ekati Diamond Mine disclosed for the three and six months ended July 31, 2016 and July 31, 2015. Ekati cash cost of production, depreciation and amortization, and total cash cost of production are reconciled to each segment’s cost of sales above.

(expressed in thousands of United States dollars, except total tonnes processed and cash cost per tonne)
(unaudited)

    Three months ended

July 31, 2016

  Three months ended

July 31, 2015

  Six months ended

July 31, 2016

  Six months ended

July 31, 2015

Ekati cash cost of production $ 61,157 $ 83,082 $ 135,475 $ 166,052
Total tonnes processed   601   962   1,573   1,813
Ekati cash cost per tonne processed $ 101.76 $ 86.37 $ 86.13 $ 91.61

(expressed in thousands of United States dollars, except total tonnes processed and non-cash cost per tonne)
(unaudited)

    Three months ended

July 31, 2016

  Three months ended

July 31, 2015

  Six months ended

July 31, 2016

  Six months ended

July 31, 2015

Depreciation and amortization $ 41,094 $ 32,183 $ 75,768 $ 65,177
Total tonnes processed   601   962   1,573   1,813
Ekati non-cash cost per tonne processed $ 68.38 $ 33.46 $ 48.17 $ 35.96

(expressed in thousands of United States dollars, except total carats produced and cash cost per carat)
(unaudited)

    Three months ended

July 31, 2016

  Three months ended

July 31, 2015

  Six months ended

July 31, 2016

  Six months ended

July 31, 2015

Total cash cost of production $ 62,165 $ 85,028 $ 137,548 $ 169,511
Total carats produced   856   925   1,932   1,730
Ekati cash cost per carat $ 72.62 $ 91.93 $ 71.21 $ 97.99

The following table demonstrates our calculation of cash cost per tonne processed, non-cash cost per tonne processed and cash cost per carat at the Diavik Diamond Mine disclosed for the three and six months ended July 31, 2016 and July 31, 2015. Diavik cash cost of production, depreciation and amortization, and total cash cost of production are reconciled to each segment’s cost of sales above.

(expressed in thousands of United States dollars, except total tonnes processed and cash cost per tonne)
(unaudited)

    Three months ended

July 31, 2016

  Three months ended

July 31, 2015

  Six months ended

July 31, 2016

  Six months ended

July 31, 2015

Diavik cash cost of production $ 29,103 $ 29,671 $ 60,408 $ 62,886
Total tonnes processed   214   226   437   416
Diavik cash cost per tonne processed $ 136.00 $ 131.29 $ 138.30 $ 151.02

(expressed in thousands of United States dollars, except total tonnes processed and non-cash cost per tonne)

(unaudited)

    Three months ended

July 31, 2016

  Three months ended

July 31, 2015

  Six months ended

July 31, 2016

  Six months ended

July 31, 2015

Depreciation and amortization $ 16,393 $ 22,865 $ 37,032 $ 38,751
Total tonnes processed   214   226   437   416
Diavik non-cash cost per tonne processed $ 76.60 $ 101.17 $ 84.78 $ 93.06

(expressed in thousands of United States dollars, except total carats produced and cash cost per carat)
(unaudited)

    Three months ended

July 31, 2016

  Three months ended

July 31, 2015

  Six months ended

July 31, 2016

  Six months ended

July 31, 2015

Total cash cost of production $ 31,151 $ 30,584 $ 64,268 $ 65,453
Total carats produced   632   856   1,386   1,456
Diavik cash cost per carat $ 49.32 $ 35.71 $ 46.38 $ 44.97

EBITDA, EBITDA Margin, Adjusted EBITDA and Adjusted EBITDA Margin

The term “EBITDA” is a non-IFRS financial measure, which is defined as earnings before interest expense (income), income taxes and depreciation and amortization. EBITDA margin is calculated by dividing EBITDA by total sales for the period.

The Company has also disclosed Adjusted EBITDA, which removes the effects of impairment charges, foreign exchange gains (losses) and exploration costs from EBITDA. Impairment charges and foreign exchange gains or losses, both of which are non-cash items, are not reflective of the Company’s ability to generate liquidity by producing operating cash flow. Exploration costs do not reflect the underlying operating performance of our business and are not necessarily indicative of future operating results. The Company believes that these adjustments will result in more meaningful valuation measures for investors and analysts to evaluate our performance and assess our ability to generate liquidity. Adjusted EBITDA margin is calculated by dividing Adjusted EBITDA by total sales for the period.

Management believes that EBITDA, EBITDA margin, Adjusted EBITDA and Adjusted EBITDA margin are important indicators commonly reported and widely used by investors and analysts as an indicator of the Company’s operating performance and ability to incur and service debt, and also as a valuation metric. The intent of EBITDA, EBITDA margin, Adjusted EBITDA and Adjusted EBITDA margin is to provide additional useful information to investors and analysts, and such measures do not have any standardized meaning under IFRS. These measures should not be considered in isolation or as a substitute for measures of performance prepared in accordance with IFRS. Other issuers may calculate EBITDA, EBITDA margin, Adjusted EBITDA and Adjusted EBITDA margin differently.

The following table provides a reconciliation of consolidated and segmented EBITDA and Adjusted EBITDA for the last eight quarters.

CONSOLIDATED
(expressed in thousands of United States dollars)
(quarterly results are unaudited)

  2017   2017   2016   2016   2016   2016   2015   2015  

Six
months
ended
July 31,

  Six
months
ended
July 31,
    Q2   Q1   Q4   Q3(i)   Q2(i)   Q1(i)   Q4(i)   Q3(i)   2016   2015(i)
Segment net (loss) profit $ (37,949) $ (5,302) $ (37,763) $ 6,469 $ (18,894) $ 11,396 $ 2,182 $ 34,731 $ (43,247) $ (7,502)

Finance expense (income)

1,670 2,117 2,123 1,966 2,907 2,746 3,758 2,271 3,786 5,653
Income tax expense (recovery) 45 (30,610) 9,896 733 19,485 (2,869) 47,101 25,875 (30,566) 16,614
Depreciation and amortization   59,369   61,544   53,647   39,595   52,746   45,460   43,007   47,011   120,912   98,204
EBITDA 23,135 27,749 27,903 48,763 56,244 56,733 96,048 109,888 50,885 112,969
Foreign exchange loss (gain) 4,446 3,360 2,022 (268) 2,174 (1,157) (2,523) (1,868) 7,804 1,017
Exploration costs 1,447 3,581 (734) 576 1,935 5,249 2,110 7,359 5,028 7,184
Impairment losses on inventory   6,414   19,603   19,838             26,017  
Adjusted EBITDA $ 35,442 $ 54,293 $ 49,029 $ 49,071 $ 60,353 $ 60,825 $ 95,635 $ 115,379 $ 89,734 $ 121,170

(i) Figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.

EKATI DIAMOND MINE SEGMENT
(expressed in thousands of United States dollars)
(quarterly results are unaudited)

  2017   2017   2016   2016   2016   2016   2015   2015  

Six
months
ended
July 31,

  Six
months
ended
July 31,
    Q2   Q1   Q4   Q3(i)   Q2(i)   Q1(i)   Q4(i)   Q3(i)   2016   2015(i)
Segment net (loss) profit $ (31,534) $ (29,847) $ (22,508) $ (4,578) $ (5,659) $ 422 $ 15,828 $ 23,445 $ (61,384) $ (5,237)
Finance expense (income) 1,102 1,059 2,072 905 1,841 2,123 3,130 2,052 2,160 3,964
Income tax (recovery) expense (8,733) (24,965) (1,617) 1,095 7,734 773 31,863 16,219 (33,698) 8,507
Depreciation and amortization   40,334   38,949   34,744   24,985   34,448   28,653   20,612   26,495   79,283   63,102
EBITDA 1,169 (14,804) 12,691 22,407 38,364 31,971 71,433 68,211 (13,639) 70,336
Foreign exchange (gain) loss (8,072) 17,548 (2,797) (429) (3,393) 3,501 (11,160) (1,311) 9,475 108
Exploration costs 1,445 3,590 (780) 550 1,935 5,199 2,215 7,412 5,035 7,134
Impairment losses on inventory   6,414   19,603   19,838             26,017  
Adjusted EBITDA $ 956 $ 25,937 $ 28,952 $ 22,528 $ 36,906 $ 40,671 $ 62,488 $ 74,312 $ 26,888 $ 77,578

(i) Figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.

DIAVIK DIAMOND MINE SEGMENT
(expressed in thousands of United States dollars)
(quarterly results are unaudited)

  2017   2017   2016   2016   2016   2016   2015   2015  

Six
months
ended
July 31,

  Six
months
ended
July 31,
    Q2   Q1   Q4   Q3(i)   Q2(i)   Q1(i)   Q4(i)   Q3(i)   2016   2015(i)
Segment net (loss) profit $ (988) $ 29,212 $ (8,732) $ 15,961 $ (4,062) $ 15,703 $ (8,257) $ 16,061 $ 28,230 $ 11,641
Finance expense (income) 568 1,058 51 1,061 1,066 623 627 220 1,626 1,689
Income tax expense (recovery) 10,734 (3,963) 13,866 1,413 15,058 (1,938) 17,184 11,376 6,771 13,120
Depreciation and amortization   19,162   22,402   18,643   14,267   18,110   16,651   22,086   20,223   41,563   34,761
EBITDA 29,476 48,709 23,828 32,702 30,172 31,039 31,640 47,880 78,190 61,211
Foreign exchange loss (gain) 12,518 (14,188) 4,819 161 5,567 (4,658) 8,637 (558) (1,671) 909
Exploration costs   2   (9)   46   26     50   (105)   (52)   (7)   50
Adjusted EBITDA $ 41,996 $ 34,512 $ 28,693 $ 32,889 $ 35,739 $ 26,431 $ 40,172 $ 47,270 $ 76,512 $ 62,170

(i) Figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.

CORPORATE SEGMENT
(expressed in thousands of United States dollars)
(quarterly results are unaudited)

  2017   2017   2016   2016   2016   2016   2015   2015  

Six
months
ended
July 31,

  Six
months
ended
July 31,
    Q2   Q1   Q4   Q3(i)   Q2(i)   Q1(i)   Q4(i)   Q3(i)   2016   2015(i)
Segment net (loss) profit $ (5,426) $ (4,667) $ (6,524) $ (4,916) $ (9,174) $ (4,733) $ (5,392) $ (4,775) $ (10,093) $ (13,907)
Income tax (recovery) expense (1,957) (1,682) (2,352) (1,773) (3,307) (1,706) (1,944) (1,721) (3,639) (5,013)
Depreciation and amortization   (127)   193   261   341   188   154   311   293   66   342
EBITDA   (7,510)   (6,156)   (8,615)   (6,348)   (12,293)   (6,285)   (7,025)   (6,203)   (13,666)   (18,578)
Adjusted EBITDA $ (7,510) $ (6,156) $ (8,615) $ (6,348) $ (12,293) $ (6,285) $ (7,025) $ (6,203) $ (13,666) $ (18,578)

(i) Figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.

Free Cash Flow and Free Cash Flow per Share

The term “free cash flow” is a non-IFRS measure, which is defined as cash provided from (used in) operating activities, less sustaining capital expenditure and less development capital expenditure. Free cash flow per share is calculated by dividing free cash flow by the weighted average basic shares outstanding.

Management believes that free cash flow is a useful indicator of the Company’s ability to operate without reliance on additional borrowing or usage of existing cash. The intent of free cash flow and free cash flow per share is to provide additional useful information to investors and analysts and such measures do not have any standardized meaning under IFRS. These measures should not be considered in isolation or as a substitute for measures of performance prepared in accordance with IFRS. Other issuers may calculate free cash flow and free cash flow per share differently.

CONSOLIDATED
(expressed in thousands of United States dollars)
(unaudited)

  2017   2017   2016   2016   2016   2016   2015   2015   Six
months
ended
July 31,
  Six
months
ended
July 31,
    Q2   Q1   Q4   Q3(i)   Q2(i)   Q1(ii)   Q4(ii)   Q3(ii)   2016   2015

Cash provided from (used in)

operating activities

$ 33,872 $ 17,961 $ 83,625 $ 60,867 $ 52,780 $ (29,285) $ 134,462 $ 70,539 $ 51,832 $ 23,495
Sustaining capital expenditure   (25,162)   (44,161)   (8,014)   (15,044)   (6,955)   (22,609)   (17,786)   (15,658)   (69,323)   (29,564)
Free cash flow before development $ 8,710 $ (26,200) $ 75,611 $ 45,823 $ 45,825 $ (51,894) $ 116,676 $ 54,881 $ (17,491) $ (6,069)

Development and exploration capital

expenditure((i))   (29,605)   (63,754)   (48,129)   (37,293)   (22,953)   (41,667)   (9,034)   (7,072)   (93,359)   (64,620)
Free cash flow $ (20,895) $ (89,954) $ 27,482 $ 8,530 $ 22,872 $ (93,561) $ 107,642 $ 47,809 $ (110,850) $ (70,689)
Free cash flow per share $ (0.24) $ (1.05) $ 0.32 $ 0.10 $ 0.27 $ (1.10) $ 1.26 $ 0.56 $ (1.30) $ (0.83)

(i) Development capital expenditure is calculated net of proceeds from pre-production sales.
(ii) Figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.

Sustaining Capital Expenditure

Sustaining capital expenditure is generally defined as expenditures that support the ongoing operation of the assets or business without any associated increase in capacity, life of assets or future earnings. This measure is used by management and investors to assess the extent of non-discretionary capital spending being incurred by the Company each period.

Development and Exploration Capital Expenditure

Development capital expenditure is generally defined as capital expenditures that expand existing capacity, increase life of assets and/or increase future earnings. Exploration and evaluation capital expenditure is defined as capital expenditures that relate to activities involved in evaluating the technical feasibility and commercial viability of extracting mineral resources and these activities are only capitalized when the activity relates to proven and probable reserves. This measure is used by management and investors to assess the extent of discretionary capital spending being undertaken by the Company each period.

Working Capital and Working Capital Ratio

Working capital is calculated as current assets less current liabilities. Working capital ratio is calculated as current assets divided by current liabilities. The Company believes working capital is a useful supplemental measure as it provides an indication of our ability to settle our debts as they come due. Our calculation of working capital is provided in the table below.

CONSOLIDATED
(expressed in thousands of United States dollars)
(unaudited)

  2017   2017   2016   2016   2016   2016   2015   2015
    Q2   Q1   Q4   Q3   Q2   Q1   Q4   Q3
Current assets $ 588,120 $ 698,417 $ 769,296 $ 816,525 $ 825,822 $ 898,685 $ 970,424 $ 840,808
Less: Current liabilities   (159,260)   (218,404)   (190,775)   (179,952)   (135,668)   (206,374)   (219,986)   (212,986)
Working capital $ 428,860 $ 480,013 $ 578,521 $ 636,573 $ 690,154 $ 692,311 $ 750,438 $ 627,822
Working capital ratio   3.69   3.19   4.03   4.54   6.09   4.35   4.41   3.95

Risks and Uncertainties

The Company is subject to a number of risks and uncertainties as a result of its operations. In addition to the other information contained in this MD&A 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 Company’s mining operations are 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 they impact on mining method selection and performance, de-watering and water handling requirements, achieving the required crushed rock-fill 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 Company’s mineral properties, because of their remote northern location and access only by winter road or by air, are 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.

Joint Ventures

The Company’s participation in the mining sector of the diamond industry is through its ownership interest in the Ekati Diamond Mine and the Diavik group of mineral claims. The Company holds a controlling interest in the Ekati Diamond Mine property through its interests in the Core Zone Joint Venture and the Buffer Zone Joint Venture, with the remaining interests held by other minority joint venture parties. DDDLP holds 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 DDDLP (40%).

The Company’s joint venture interests in the Ekati Diamond Mine and the Diavik Diamond Mine are subject to the risks normally associated with the conduct of joint ventures, including: (i) disagreement with a joint venture partner about how to develop, operate or finance operations; (ii) that a joint venture partner may not comply with the underlying agreements governing the joint ventures and may fail to meet its obligations thereunder to the Company or to third parties; (iii) that a joint venture partner may at any time have economic or business interests or goals that are, or become, inconsistent with the Company’s interests or goals; (iv) the possibility that a joint venture partner may become insolvent; and (v) the possibility of litigation with a joint venture partner. Archon, which is a joint venture partner in the Buffer Zone Joint Venture, has objected to certain elements of the fiscal 2017 program and budget for the Buffer Zone Joint Venture. A revised program and budget for fiscal year 2017 is expected to be presented to the management committee of the Buffer Zone in the third quarter of fiscal 2017 to incorporate changes to the mine plan impacting the Lynx Project in the Buffer Zone. Dilution of Archon’s participating interest in the Buffer Zone had been expected in the second quarter of fiscal 2017 but has been temporarily withheld until Archon re-confirms its intentions with respect to funding the revised program and budget.

Diamond Prices and Demand for Diamonds

The profitability of the Company is dependent upon the Company’s mineral properties and 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, worldwide levels of diamond discovery and production, and the level of demand for, and discretionary spending on, luxury goods such as diamonds. Low or negative growth in the worldwide economy, renewed or additional credit market disruptions, natural disasters or the occurrence of terrorist attacks or similar activities creating disruptions in economic growth could result in decreased demand for luxury goods such as diamonds, thereby negatively affecting the price of diamonds. Similarly, a substantial increase in the worldwide level of diamond production or the release of stocks held back during periods of lower demand could also negatively affect the price of diamonds. In each case, such developments could have a material adverse effect on the Company’s results of operations.

Cash Flow and Liquidity

The Company’s liquidity requirements fluctuate from quarter to quarter and year to year depending on, among other factors, the seasonality of production at the Company’s mineral properties; the seasonality of mine operating expenses; exploration expenses; capital expenditure programs; the number of rough diamond sales events conducted during the quarter; and the volume, size and quality distribution of rough diamonds delivered from the Company’s mineral properties and sold by the Company in each quarter. The Company’s principal working capital needs include development and exploration capital expenditures, investments in inventory, prepaid expenses and other current assets, and accounts payable and income taxes payable. There can be no assurance that the Company will be able to meet each or all of its liquidity requirements. A failure by the Company to meet its liquidity requirements could result in the Company failing to meet its planned development objectives, or in the Company being in default of a contractual obligation, each of which could have a material adverse effect on the Company’s business prospects or financial condition.

Dividends

The decision to pay dividends and the amount of such dividends are subject to the discretion of the Board of Directors based on numerous factors and may vary from time to time. The amount of cash available to the Company to pay dividends, if any, can vary significantly from period to period for a number of reasons, including, among other things: our operational and financial performance, fluctuations in diamond prices, the amount of cash required to fund capital expenditures and working capital requirements, access to capital markets, foreign exchange rates, and the other risk factors set forth in the Company’s Annual Information Form.

In addition, the level of dividends per common share will be affected by the number of outstanding common shares and other securities that may be entitled to receive cash payments. Dividends may be increased, reduced or suspended depending on our operational success. The market value of the common shares may deteriorate if the Company is unable to meet dividend expectations in the future.

Economic Environment

The Company’s financial results are tied to the global economic conditions and their impact on levels of consumer confidence and consumer spending. The global markets have experienced the impact of a significant US and international economic downturn since autumn 2008. A return to a recession or a weak recovery, due to recent disruptions in financial markets in the United States, the Eurozone and elsewhere, budget policy issues in the United States, political upheavals in the Middle East and Ukraine, and economic sanctions against Russia, could cause the Company to experience revenue declines due to deteriorated consumer confidence and spending, and a decrease in the availability of credit, which could have a material adverse effect on the Company’s business prospects or financial condition. The credit facilities essential to the diamond polishing industry are partially underwritten by European banks that are currently under stress. The withdrawal or reduction of such facilities could also have a material adverse effect on the Company’s business prospects or financial condition. The Company monitors economic developments in the markets in which it operates and uses this information in its continuous strategic and operational planning in an effort to adjust its business in response to changing economic conditions.

Synthetic Diamonds

Synthetic diamonds are diamonds that are produced by artificial processes (e.g., laboratory grown) as opposed to natural diamonds, which are created by geological processes. An increase in the acceptance of synthetic gem-quality diamonds could negatively affect the market prices for natural stones. Although significant questions remain as to the ability of producers to produce synthetic diamonds economically within a full range of sizes and natural diamond colours, and as to consumer acceptance of synthetic diamonds, synthetic diamonds are becoming a larger factor in the market. Should synthetic diamonds be offered in significant quantities or consumers begin to readily embrace synthetic diamonds on a large scale, demand and prices for natural diamonds may be negatively affected. Additionally, the presence of undisclosed synthetic diamonds in jewelry would erode consumer confidence in the natural product and negatively impact demand.

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 Company’s mineral properties are incurred in Canadian dollars. Further, the Company has a significant deferred income tax liability that has been incurred and will be payable in Canadian dollars. The Company’s currency exposure relates to expenses and obligations incurred by it in Canadian dollars. From time to time, the Company may use a limited number of derivative financial instruments to manage its foreign currency exposure.

Licences and Permits

The Company’s mining operations require licences and permits from the Canadian and Northwest Territories governments, and the process for obtaining and renewing such licences and permits often takes an extended period of time and is subject to numerous delays and uncertainties. Such licences and permits are subject to change in various circumstances. Failure to comply with applicable laws and regulations may result in injunctions, fines, criminal liability, suspensions or revocation of permits and licences, and other penalties. There can be no assurance that DDMI, as the operator of the Diavik Diamond Mine, or the Company has been or will be at all times in compliance with all such laws and regulations and with their applicable licences and permits, or that DDMI or the Company will be able to obtain on a timely basis or maintain in the future all necessary licences and permits that may be required to explore and develop their properties, to commence construction or operation of mining facilities and projects under development, and to maintain continued operations.

Regulatory and Environmental Risks

The operations of the Company’s mineral properties 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 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 effect on the Company by increasing costs and/or causing a reduction in levels of production from the Company’s mineral properties.

Mining is subject to potential risks and liabilities associated with pollution of the environment and the disposal of waste products occurring as a result of mining 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.

The environmental agreements relating to the Diavik Diamond Mine and the Ekati Diamond Mine require that security be provided to cover estimated reclamation and remediation costs. On August 25, 2015, the Company reached an agreement with the operator of the Diavik Joint Venture whereby DDDLP was required to post its proportionate share of the security deposit used to secure the reclamation obligations for the Diavik Diamond Mine. The Company has provided letters of credit in the amount of CDN $60 million to the GNWT as security for the reclamation obligations for the Diavik Diamond Mine. For the Ekati Diamond Mine, the amount of financial security required under the Water Licence is currently set at CDN $256.6 million. This represents an increase of CDN $3.1 million from the CDN $253.5 million that was determined by the WLWB on June 17, 2013. In order to secure its obligation under the Water Licence, the Company has posted surety bonds with the GNWT in the aggregate amount of CDN $253.5 million and an irrevocable letter of credit (“ILOC”) in the aggregate amount of CDN $3.1 million. The Company also has provided a guarantee of CDN $20 million for other obligations under the environmental agreement for the Ekati Diamond Mine.

The reclamation and remediation plans for the Ekati Diamond Mine and the Diavik Diamond Mine, as well as the costs of such plans, are subject to periodic regulatory review, which could result in an increase to the amount of security required to be posted in connection with the operation of each of the Ekati Diamond Mine and the Diavik Diamond Mine. This could result in additional constraints on liquidity.

Climate Change

The Canadian government has established a number of policy measures in response to concerns relating to climate change. 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 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. Estimates made at a given time may change significantly in the future when new information becomes available. The Company expects that its estimates of reserves will change to reflect updated information as well as to reflect depletion due to production. 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 Company’s mineral properties may render the mining of ore reserves uneconomical. Any material changes in the quantity of mineral reserves or resources or the related grades may affect the economic viability of the Company’s mining operations and could have a material adverse effect on the Company’s business, financial condition, results of operations or prospects.

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 will be upgraded to proven and probable ore reserves. Inferred mineral resources are considered too speculative geologically to have economic considerations applied to them that would enable them to be categorized as mineral 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 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 Company’s mineral properties, personal injury or death, environmental damage to the Company’s mineral properties, delays in mining, monetary losses and possible legal liability. Although insurance is maintained to protect against certain risks in connection with the Company’s mineral properties 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 expected fuel needs for the Company’s mineral properties 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 if there is unexpected 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 Company’s mineral properties currently have no hedges for future anticipated fuel consumption.

Reliance on Skilled Employees

Production at the Company’s mineral properties is dependent upon the efforts of certain skilled employees. The loss of these employees or the inability to attract and retain additional skilled employees may adversely affect the level of diamond production.

The Company’s success in marketing rough diamonds 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.

Labour Relations

The Company is party to a collective bargaining agreement at its Ekati Diamond Mine operation which was due to expire on August 31, 2014. The Company entered into negotiations on August 6, 2014, and on August 26, 2014 a Memorandum of Agreement was signed which suspended negotiations until the latter part of February 2015. During this period, all provisions in the current collective bargaining agreement continued. The Company participated in mediation with the union in January 2016, the result of which was a decision to resume negotiations. Accordingly, the Company and the union met from February 16, 2016 through February 18, 2016 to resume negotiations and again from April 26, 2016 through April 28, 2016. The result of the last set of negotiations was agreement by the union to have its members vote on the Company’s proposal. On June 14, 2016, the Company received confirmation from the union that the Company’s proposal was rejected by its members. Additional negotiating dates were therefore scheduled for July 18 and 19, 2016 and there are dates currently being confirmed for further negotiations in late September 2016. If the Company is ultimately unable to renew this agreement, or if the terms of any such renewal are materially adverse to the Company, then this could result in work stoppages and/or other labour disruptions, all of which could have a material adverse effect on the Company’s business, results of operations and financial condition.

Changes in Internal Controls over Financial Reporting

During the second quarter of fiscal 2017, there were no changes in the Company’s disclosure controls and procedures or internal controls over financial reporting that materially affected, or are reasonably likely to materially affect, the Company’s disclosure controls and procedures or internal control over financial reporting.

Critical Accounting Estimates

Management is often required to make judgments, assumptions and estimates in the application of IFRS 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 financial performance or financial position.

The critical accounting estimates applied in the preparation of the Company’s unaudited interim condensed consolidated financial statements are consistent with those applied and disclosed in the Company’s MD&A for the year ended January 31, 2016.

Changes in Accounting Policies

Except as described below, the accounting policies applied by the Company in these condensed consolidated interim financial statements are the same as those applied by the Company in its annual audited consolidated financial statements for the year ended January 31, 2016.

(a) Change in Accounting Policies

Effective February 1, 2016, the Company has early adopted the requirements of IFRS 9, Financial Instruments (2014) (“IFRS 9”). This standard replaces the guidance in IAS 39, Financial Instruments: Recognition and Measurement (“IAS 39”), relating to the classification and measurement of financial assets and liabilities. IFRS 9 uses a single approach to determine whether a financial asset is classified and measured at amortized cost or fair value, based on how an entity manages its financial instruments and the contractual cash flow characteristics of the financial asset. Most of the requirements in IAS 39 for classification and measurement of financial liabilities were carried forward in IFRS 9.

IFRS 9 introduced a single expected credit loss impairment model, which is based on changes in credit quality since initial recognition. The adoption of the expected credit loss impairment model did not have a significant impact on the Company’s financial statements.

IFRS 9 changes the requirements for hedge effectiveness and consequently for the application of hedge accounting. The IAS 39 effectiveness test is replaced with a requirement for an economic relationship between the hedged item and hedging instrument, and for the “hedged ratio” to be the same as that used by the entity for risk management purposes. Certain restrictions that prevented some hedging strategies and hedging instruments from qualifying for hedge accounting were also removed under IFRS 9. Generally, the mechanics of hedge accounting remain unchanged.

Cash and cash equivalents were previously designated at fair value through profit or loss under IAS 39. Upon adoption of IFRS 9, the Company has elected to classify cash and cash equivalents including restricted cash as measured at amortized cost using the effective interest rate method. There was no change to the classification of accounts receivable, trade and other payables, and loans and borrowings as a result of the adoption of IFRS 9. The accounting policy note 4(c), “Cash and cash equivalents” and 4(k), “Financial instruments” in the annual report were updated as a result of the adoption of IFRS 9 in the current interim period. See changes below:

Note 4(c) Cash and cash equivalents

Cash and cash equivalents consist of cash on hand, balances with banks and short-term money market instruments (with a maturity on acquisition of less than 90 days).

Note 4(k) Financial instruments

The Company’s financial instruments include cash and cash equivalents including restricted cash, accounts receivable, trade and other payables, and loans and borrowings.

Financial assets and liabilities are recognized when the Company becomes party to the contractual provisions of the instrument. Financial assets are derecognized when the rights to receive cash flows from the assets have expired or are assigned and the Company has transferred substantially all risks and rewards of ownership in the asset. Financial liabilities are derecognized when the related obligation is discharged, cancelled or expires.

Classification of financial instruments in the Company’s financial statements depends on the purpose for which the financial instruments were acquired or incurred. The classification of financial instruments is determined at initial recognition.

Financial assets measured at amortized cost include cash and cash equivalents, restricted cash and accounts receivable. These amounts are initially recorded at fair value less any directly attributable transaction costs. Subsequently, these financial assets are measured at amortized cost using the effective interest rate method, less impairment allowance, if any.

Financial liabilities measured at amortized cost include trade and other payables and loans and borrowings. These amounts are initially recorded at fair value less any directly attributable transaction costs. Subsequently, these financial liabilities are measured at amortized cost using the effective interest rate method.

The accounting policy for financial instruments has been adopted retrospectively as a result of the early adoption of IFRS 9. The change did not result in a change in carrying value of any financial instruments on the effective date of February 1, 2016.

(b) New Accounting Standards Issued but Not Yet Effective

Standards issued but not yet effective up to the date of issuance of the consolidated financial statements are listed below. The listing is of standards and interpretations issued that the Company reasonably expects to be applicable at a future date. The Company intends to adopt those standards when they become effective.

IFRS 2 – SHARE-BASED PAYMENTS

In June 2016, the IASB issued final amendments to IFRS 2, Share-Based Payments (“IFRS 2”). IFRS 2 is effective for annual periods beginning on or after January 1, 2018. IFRS 2 clarifies the classification and measurement of share-based payment transactions. These amendments deal with variations in the final settlement arrangements including: (a) accounting for cash-settled share-based payment transactions that include a performance condition, (b) classification of share-based payment transactions with net settlement features, and (c) accounting for modifications of share-based payment transactions from cash-settled to equity. The Company is currently evaluating the impact the final standard is expected to have on its consolidated financial statements.

IFRS 15 – REVENUE FROM CONTRACTS WITH CUSTOMERS

In May 2014, the IASB issued IFRS 15, Revenue from Contracts with Customers (“IFRS 15”). IFRS 15 is effective for periods beginning on or after January 1, 2018 and is to be applied retrospectively. IFRS 15 clarifies the principles for recognizing revenue from contracts with customers. The Company intends to adopt IFRS 15 in its financial statements for the annual period beginning February 1, 2018. The extent of the impact of the adoption of IFRS 15 has not yet been determined.

IFRS 16 – LEASES

In January 2016, the IASB issued IFRS 16, Leases (“IFRS 16”), which replaces IAS 17, Leases, and its associated interpretative guidance. IFRS 16 applies a control model to the identification of leases, distinguishing between a lease and a services contract on the basis of whether the customer controls the assets being leased. For those assets determined to meet the definition of a lease, IFRS 16 introduces significant changes to the accounting by lessees, introducing a single, on-balance-sheet accounting model that is similar to current finance lease accounting, with limited exceptions for short-term leases or leases of low value assets. Lessor accounting remains similar to current accounting practice. The standard is effective for annual periods beginning on or after January 1, 2019, with early application permitted for entities that have also adopted IFRS 15. The Company is currently evaluating the impact the standard is expected to have on its consolidated financial statements.

CONSOLIDATED FINANCIAL RESULTS

The following is a summary of the Company’s consolidated quarterly results for the most recent eight quarters ended July 31, 2016.
(expressed in thousands of United States dollars except per share amounts and where otherwise noted)
(quarterly results are unaudited)

  2017   2017   2016   2016   2016   2016   2015   2015   Six
months
ended
July 31,
  Six
months
ended
July 31,
    Q2   Q1   Q4   Q3(iii)   Q2(iii)   Q1(iii)   Q4(iii)   Q3(iii)   2016   2015(iii)
Sales $ 159,970 $ 178,259 $ 178,145 $ 145,024 $ 209,676 $ 187,723 $ 240,582 $ 222,335 $ 338,229 $ 397,399
Cost of sales   159,108   197,077   191,801   126,538   186,987   163,595   178,753   146,063   356,185   350,581
Gross margin 862 (18,818) (13,656) 18,486 22,689 24,128 61,829 76,272 (17,956) (46,818)
Gross margin (%) 0.5% (10.6)% (7.7)% 12.7% 10.8% 12.9% 25.7% 34.3% (5.3)% 11.8%
Selling, general and
administrative expenses
9,175 8,036 10,800 9,010 15,082 8,769 9,201 7,904 17,211 23,852
Mine standby costs   22,028                 22,028  
Operating (loss) profit   (30,341)   (26,854)   (24,456)   9,476   7,607   15,359   52,628   68,368   (57,195)   22,966
Finance expenses (2,476) (2,488) (1,208) (2,950) (2,871) (2,869) (4,177) (3,053) (4,964) (5,740)
Exploration costs (1,447) (3,581) 734 (576) (1,935) (5,249) (2,110) (7,359) (5,028) (7,184)
Finance and other income 806 371 (915) 984 (36) 123 419 782 1,178 87
Foreign exchange (loss) gain   (4,446)   (3,360)   (2,022)   268   (2,174)   1,157   2,523   1,868   (7,804)   (1,017)
(Loss) profit before income taxes (37,904) (35,912) (27,867) 7,202 591 8,521 49,283 60,606 (73,813) 9,112
Current income tax expense 10,139 6,676 9,570 7,679 14,923 15,294 9,611 51,661 16,814 30,216

Deferred income tax expense
(recovery)

  (10,094)   (37,286)   326   (6,946)   4,562   (18,163)   37,490   (25,786)   (47,380)   (13,602)
Net (loss) profit $ (37,949) $ (5,302) $ (37,763) $ 6,469 $ (18,894) $ 11,390 $ 2,182 $ 34,731 $ (43,247) $ (7,502)
Net profit (loss) attributable to:
Shareholders $ (32,931) $ (1,044) $ (34,927) $ 7,170 $ (18,167) $ 11,968 $ (2,155) $ 26,518 $ (33,970) $ (6,198)
Non-controlling interest   (5,018)   (4,258)   (2,836)   (701)   (727)   (578)   4,337   8,213   (9,277)   (1,304)
Earnings (loss) per share
attributable to shareholders
Basic $ (0.39) $ (0.01) $ (0.41) $ 0.08 $ (0.21) $ 0.14 $ (0.03) $ 0.31 $ (0.40) $ (0.07)
Diluted $ (0.39) $ (0.01) $ (0.41) $ 0.08 $ (0.21) $ 0.14 $ (0.03) $ 0.31 $ (0.40) $ (0.07)
Cash dividends declared per share $ $ 0.20 $ $ 0.20 $ $ 0.40 $ $ $ 0.20 $ 0.40
Total assets(i) $ 2,060 $ 2,179 $ 2,165 $ 2,216 $ 2,193 $ 2,312 $ 2,346 $ 2,350 $ 2,060 $ 2,193
Total long-term liabilities(i) $ 564 $ 590 $ 581 $ 602 $ 613 $ 642 $ 646 $ 659 $ 568 $ 613
Adjusted EBITDA(ii) $ 35,442 $ 54,293 $ 49,029 $ 49,071 $ 60,353 $ 60,819 $ 95,635 $ 115,379 $ 85,734 $ 121,170

(i) Total assets and total long-term liabilities are expressed in millions of United States dollars.
(ii) The term “Adjusted EBITDA” does not have a standardized meaning according to IFRS. See “Non-IFRS Measures” for additional information.
(iii) Figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.

Ekati Diamond Mine

This segment includes the production, sorting and sale of rough diamonds from the Ekati Diamond Mine.
(expressed in thousands of United States dollars)
(quarterly results are unaudited)

  2017   2017   2016   2016   2016   2016   2015   2015   Six
months
ended
July 31,
  Six
months
ended
July 31,
    Q2   Q1   Q4   Q3(ii)   Q2(ii)   Q1(ii)   Q4(ii)   Q3(ii)   2016   2015(ii)
Sales
Europe $ 72,609 $ 99,203 $ 104,760 $ 81,860 $ 135,282 $ 123,122 $ 155,696 $ 137,769 $ 171,812 $ 258,404
India   10,680   5,928   6,879   6,305   2,390   4,251   3,423   4,163   16,608   6,641
Total sales 83,289 105,131 111,639 88,165 137,672 127,373 159,119 141,932 188,420 265,045
Cost of sales   106,096   136,973   135,933   88,896   133,590   113,985   116,622   93,558   243,069   247,575
Gross margin (22,807) (31,842) (24,294) (731) 4,082 13,388 42,497 48,374 (54,649) 17,470
Gross margin (%) (27.4)% (30.3)% (21.8)% (0.8)% 3.0% 10.5% 26.7% 34.1% (29.0)% 6.6%

Selling, general and administrative
expenses

957 778 1,335 1,727 1,624 1,370 617 557 1,735 2,994
Mine standby costs   22,028                 22,028  
Operating (loss) profit $ (45,792) $ (32,620) $ (25,629) $ (2,458) $ 2,458 $ 12,018 $ 41,880 $ 47,817 $ (78,412) $ 14,476
Adjusted EBITDA(i)   956   25,937   28,952   22,528   36,906   40,671   62,488   74,312   26,888   77,578
Capital expenditures $ 48,038 $ 122,483 $ 59,955 $ 48,715 $ 32,865 $ 54,994 $ 28,576 $ 26,951 $ 170,521 $ 87,859

(i) The term “Adjusted EBITDA” does not have a standardized meaning according to IFRS. See “Non-IFRS Measures” for additional information.
(ii) Figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.

Diavik Diamond Mine

This segment includes the production, sorting and sale of rough diamonds from the Diavik Diamond Mine.
(expressed in thousands of United States dollars)
(quarterly results are unaudited)

  2017   2017   2016   2016   2016   2016   2015   2015   Six
months
ended
July 31,
  Six
months
ended
July 31,
    Q2   Q1   Q4   Q3(ii)   Q2(ii)   Q1(ii)   Q4(ii)   Q3(ii)   2016   2015(ii)
Sales
Europe $ 70,195 $ 68,695 $ 61,629 $ 52,119 $ 70,099 $ 57,223 $ 78,049 $ 74,310 $ 138,890 $ 127,322
India   6,486   4,433   4,877   4,740   1,905   3,127   3,413   6,094   10,919   5,032
Total sales 76,681 73,128 66,506 56,859 72,004 60,350 81,462 80,404 149,809 132,354
Cost of sales   53,012   60,104   55,867   37,642   53,398   49,610   62,130   52,506   113,116   103,008
Gross margin 23,669 13,024 10,639 19,217 18,606 10,740 19,332 27,898 36,693 29,346
Gross margin (%) 30.9% 17.8% 16.0% 33.8% 25.8% 17.8% 23.7% 34.7% 24.5% 22.2%
Selling, general and administrative
expenses
  835   909   589   594   977   960   1,247   851   1,744   1,937
Operating profit $ 22,834 $ 12,115 $ 10,050 $ 18,623 $ 17,629 $ 9,780 $ 18,085 $ 27,047 $ 34,949 $ 27,409
Adjusted EBITDA(i)   41,996   34,512   28,693   32,889   35,739   26,431   40,172   47,270   76,512   62,170
Capital expenditures $ 11,675 $ 26,329 $ 14,243 $ 9,445 $ 7,470 $ 12,232 $ 6,339 $ 4,601 $ 38,004 $ 19,702

(i) The term “Adjusted EBITDA” does not have a standardized meaning according to IFRS. See “Non-IFRS Measures” for additional information.
(ii) Figures have been restated as a result of retrospective application of a voluntary change in accounting policy related to asset retirement obligations (“ARO”). For further details, refer to note 3 of the condensed consolidated interim financial statements for the three and six months ended July 31, 2016 and the consolidated financial statements for the year ended January 31, 2016.

Corporate

The Corporate segment captures costs not specifically related to the operations of the Diavik and Ekati Diamond Mines.
(expressed in thousands of United States dollars)
(quarterly results are unaudited)

  2017   2017   2016   2016   2016   2016   2015   2015   Six
months
ended
July 31,
  Six
months
ended
July 31,
    Q2   Q1   Q4   Q3   Q2   Q1   Q4   Q3   2016   2015
Sales $ $ $ $ $ $ $ $ $ $
Cost of sales                    
Gross margin
Gross margin (%) % % % –% –% –% –% –% % %
Selling, general and administrative expenses   7,383   6,349   8,876   6,689   12,481   6,439   7,336   6,496   13,732   18,920
Operating loss $ (7,383) $ (6,349) $ (8,876) $ (6,689) $ (12,481) $ (6,439) $ (7,336) $ (6,496) $ (13,732) $ (18,920)
EBITDA(i)   (7,510)   (6,156)   (8,615)   (6,348)   (12,293)   (6,285)   (7,025)   (6,203)   (13,666)   (18,578)
Capital expenditures $ 332 $ $ 1,321 $ 131 $ 112 $ 780 $ $ 19 $ 332 $ 892

(i) The term “EBITDA” does not have a standardized meaning according to IFRS. See “Non-IFRS Measures” for additional information.

Outstanding Share Information

    As at September 8, 2016
Authorized Unlimited
Issued and outstanding shares

84,845,851

Options and Restricted Share Units outstanding 2,972,274
Fully diluted

87,818,125

Additional Information

Additional information relating to the Company, including the Company’s most recently filed Annual Information Form, can be found on SEDAR at www.sedar.com, and is also available on the Company’s website at www.ddcorp.ca.

Condensed Consolidated Interim Balance Sheets
(UNAUDITED) (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)

      July 31, 2016     January 31, 2016
ASSETS
Current assets
Cash and cash equivalents (note 5) $ 180,401 $ 320,038
Accounts receivable 11,818 11,528
Inventory and supplies (note 6) 357,247 416,146
Other current assets 19,959 21,584
Assets held for sale (note 8)   18,695  
588,120 769,296
Property, plant and equipment 1,376,392 1,305,143
Restricted cash (note 5) 65,521 63,312
Other non-current assets 21,285 22,752
Deferred income tax assets   8,706   4,327
Total assets $ 2,060,024 $ 2,164,830
 
LIABILITIES AND EQUITY
Current liabilities
Trade and other payables $ 110,562 $ 114,589
Employee benefit plans 810 3,142
Income taxes payable 22,649 51,195
Current portion of loans and borrowings 21,111 21,849
Liabilities associated with assets held for sale (note 8)   4,128  
159,260 190,775
Loans and borrowings 11,922
Deferred income tax liabilities 164,606 209,826
Employee benefit plans 20,838 14,319
Provisions   385,282   344,658
Total liabilities   729,986   771,500
Equity
Share capital 509,633 509,506
Contributed surplus 30,197 29,020
Retained earnings 700,992 752,028
Accumulated other comprehensive loss   (10,905)   (10,027)
Total shareholders’ equity 1,229,917 1,280,527
Non-controlling interest   100,121   112,803
Total equity   1,330,038   1,393,330
Total liabilities and equity $ 2,060,024 $ 2,164,830

The accompanying notes are an integral part of these condensed consolidated interim financial statements.

Condensed Consolidated Interim Statements of (Loss) Income
(UNAUDITED) (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT SHARES AND PER SHARE AMOUNTS)

   

Three months
ended
July 31, 2016

  Three months
ended
July 31, 2015

(Restated – note 3)

  Six months
ended
July 31, 2016
  Six months
ended
July 31, 2015

(Restated – note 3)

Sales $ 159,970 $ 209,676 $ 338,229 $ 397,399
Cost of sales   159,108   186,988   356,185   350,581
Gross margin 862 22,688 (17,956) 46,818
Selling, general and administrative expenses 9,175 15,082 17,211 23,852
Mine standby costs (note 12)   22,028     22,028  
Operating (loss) profit (30,341) 7,606 (57,195) 22,966
Finance expenses (2,476) (2,871) (4,964) (5,740)
Exploration costs (1,447) (1,935) (5,028) (7,184)
Finance and other income (loss) 806 (36) 1,178 87
Foreign exchange (loss) gain   (4,446)   (2,174)   (7,804)   (1,017)
(Loss) profit before income taxes (37,904) 590 (73,813) 9,112
Current income tax expense 10,139 14,924 16,814 30,216
Deferred income tax (recovery) expense   (10,094)   4,563   (47,380)   (13,602)
Net (loss) income $ (37,949) $ (18,897) $ (43,247) $ (7,502)
Net (loss) income attributable to:
Shareholders $ (32,931) $ (18,168) $ (33,970) $ (6,198)
Non-controlling interest   (5,018)   (729)   (9,277)   (1,304)
(Loss) earnings per share
Basic (0.39) (0.21) (0.40) (0.07)
Diluted   (0.39)   (0.21)   (0.40)   (0.07)
Basic weighted average number of shares outstanding   85,329,701   85,224,446   85,323,314   85,220,779

The accompanying notes are an integral part of these condensed consolidated interim financial statements.

Condensed Consolidated Interim Statements of Comprehensive
(Loss) Income
(UNAUDITED) (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)

   

Three months
ended
July 31, 2016

  Three months
ended
July 31, 2015

(Restated – note 3)

  Six months
ended
July 31, 2016
  Six months
ended
July 31, 2015

(Restated – note 3)

Net (loss) income $ (37,949) $ (18,897) $ (43,247) $ (7,502)
Other comprehensive income (loss)
Items that may be reclassified to profit (loss)
Net gain (loss) on translation of foreign operations
(net of tax of $nil)
1,287 (1,370) 3,246 (485)

Items that will not be reclassified to profit (loss)

 

Actuarial loss on employee benefit plans
(net of tax of $2.2 million; 2015 – $0.3 million)

  (4,640)   (643)   (4,640)   (643)
Total comprehensive (loss) income $ (41,302) $ (20,910) $ (44,641) $ (8,630)
Comprehensive (loss) income attributable to:
Shareholders $ (35,767) $ (20,181) $ (34,847) $ (7,326)
Non-controlling interest   (5,535)   (729)   (9,794)   (1,304)

The accompanying notes are an integral part of these condensed consolidated interim financial statements.

Condensed Consolidated Interim Statements of Changes in Equity
(UNAUDITED) (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)

      Six months
ended
July 31, 2016
    Six months
ended
July 31, 2015

(Restated – note 3)

Common shares:
Balance at beginning of period $ 509,506 $ 508,573
Issued during the period   127   472
Balance at end of period   509,633   509,045
Contributed surplus:
Balance at beginning of period 29,020 25,855
Stock-based compensation expense 1,177 1,830
Exercise of stock options     (131)
Balance at end of period   30,197   27,554
Retained earnings:
Balance at beginning of period 752,028 837,117
Net (loss) income attributable to common shareholders (33,970) (6,198)
Dividends (note 13)   (17,066)   (34,082)
Balance at end of period   700,992   796,837
Accumulated other comprehensive loss:
Balance at beginning of period (10,027) (6,957)
Items that may be reclassified to profit (loss)
Net gain (loss) on translation of net foreign operations (net of tax of $nil) 3,246 (485)
Items that will not be reclassified to profit (loss)
Actuarial loss on employee benefit plans
(net of tax of $2.2 million; 2015 – $0.3 million)
  (4,124)   (643)
Balance at end of period   (10,905)   (8,085)
Non-controlling interest:
Balance at beginning of period 112,803 114,781
Net (loss) income attributed to non-controlling interest (9,277) (1,304)
Other comprehensive loss attributed to non-controlling interest (518)
Contributions made by minority partners 2,879 16,178
Distributions to minority partners   (5,766)   (10,074)
Balance at end of period   100,121   119,581
Total equity $ 1,330,038 $ 1,444,932

The accompanying notes are an integral part of these condensed consolidated interim financial statements.

Condensed Consolidated Interim Statements of Cash Flows
(UNAUDITED) (EXPRESSED IN THOUSANDS OF UNITED STATES DOLLARS)

     

Three months
ended
July 31, 2016

  Three months
ended
July 31, 2015

(Restated – note 3)

   

Six months
ended
July 31, 2016

  Six months
ended
July 31, 2015

(Restated – note 3)

Cash provided by (used in)  
OPERATING
Net (loss) income $ (37,949) $ (18,897) $ (43,247) $ (7,502)
Depreciation and amortization 57,176 55,516 115,620 102,172
Deferred income tax (recovery) expense (10,094) 4,563 (47,380) (13,602)
Current income tax expense 10,139 14,924 16,814 30,216
Finance expenses 2,476 2,871 4,964 5,740
Stock-based compensation 360 (199) 1,177 1,831
Other non-cash items (568) 707 2,962 3,366
Unrealized foreign exchange (gain) loss (469) 2,490 8,867 1,348
Loss (gain) on disposition of assets 259 494 (34)
Impairment losses on inventory 6,414 26,017
Interest paid (653) (168) (747) (1,325)
Income and mining taxes paid (3,170) (15,339) (50,455) (98,628)
Change in non-cash operating working capital, excluding taxes

and finance expenses

  9,951   6,312   16,746   (87)
Net cash provided by operating activities   33,872   52,780   51,832   23,495
FINANCING
Repayment of interest-bearing loans and borrowings (10,757) (190) (10,944) (374)
Transaction costs relating to financing activities 128 (3,054)
Dividends paid (17,066) (34,082) (17,066) (34,082)
Distributions to and contributions from minority partners, net 1,096 (6,363) (2,887) (1,786)
Issue of common shares, net of issue costs     126   127   344
Cash (used in) provided by financing activities   (26,727)   (40,381)   (30,770)   (38,952)
INVESTING
(Increase) decrease in restricted cash 2,392 2,392 (2,619)
Net proceeds from pre-production sales 8,129 4,204 11,870 4,454
Purchase of property, plant and equipment (62,896) (34,113) (174,552) (98,640)
Other non-current assets   49   (152)   1,485   (152)
Cash used in investing activities   (52,326)   (30,061)   (158,805)   (96,957)
Foreign exchange effect on cash balances (872) (5,825) (1,894) (1,315)
Decrease in cash and cash equivalents (46,053) (23,487) (139,637) (113,729)
Cash and cash equivalents, beginning of period   226,454   367,692   320,038   457,934
Cash and cash equivalents, end of period $ 180,401 $ 344,205 $ 180,401 $ 344,205
Change in non-cash operating working capital, excluding taxes and
finance expenses

Accounts receivable

1,395 (7,048) 930 (998)
Inventory and supplies 44,186 45,249 31,946 28,824
Other current assets 10,444 13,362 1,668 8,265
Trade and other payables (46,007) (45,171) (15,792) (33,759)
Employee benefit plans   (67)   (80)   (2,006)   (2,419)
  $ 9,951 $ 6,312 $ 16,746 $ (87)

The accompanying notes are an integral part of these condensed consolidated interim financial statements.

Notes to Condensed Consolidated Interim Financial Statements
JULY 31, 2016 WITH COMPARATIVE FIGURES
(UNAUDITED) (TABULAR AMOUNTS IN THOUSANDS OF UNITED STATES DOLLARS, EXCEPT AS OTHERWISE NOTED)

Note 1:
Nature of Operations

Dominion Diamond Corporation (the “Company”) is focused on the mining and marketing of rough diamonds to the global market.

The Company is incorporated and domiciled in Canada and its shares are publicly traded on the Toronto Stock Exchange and the New York Stock Exchange under the symbol “DDC.” The address of its registered office is Toronto, Ontario.

The Company has ownership interests in the Diavik and the Ekati group of mineral claims. The Diavik Joint Venture (the “Diavik Joint Venture”) is an unincorporated joint arrangement between Diavik Diamond Mines (2012) Inc. (“DDMI”) (60%) and Dominion Diamond Diavik Limited Partnership (“DDDLP”) (40%), where DDDLP holds an undivided 40% ownership interest in the assets, liabilities and expenses of the Diavik Diamond Mine. DDMI is the operator of the Diavik Diamond Mine. DDMI is a wholly owned subsidiary of Rio Tinto plc of London, England, and DDDLP is a wholly owned subsidiary of Dominion Diamond Corporation. The Company records its interest in the assets, liabilities and expenses of the Diavik Joint Venture in its consolidated financial statements with a one-month lag. The accounting policies described below include those of the Diavik Joint Venture.

As of July 31, 2016, the Ekati Diamond Mine consists of the Core Zone, which includes the current operating mines and other permitted kimberlite pipes, as well as the Buffer Zone, an adjacent area hosting kimberlite pipes having both development and exploration potential. Subsequent to the acquisition, the Company owns an 88.9% interest in the Core Zone and a 65.3% interest in the Buffer Zone. The Company controls and consolidates the Ekati Diamond Mine; the interests of minority shareholders are presented as non-controlling interests within the consolidated financial statements.

In January 2016, the management committee of the Buffer Zone approved a program and budget for the Buffer Zone for fiscal year 2017. In March 2016, Archon Minerals Limited (“Archon”) provided notice to DDEC, the operator of the Buffer Zone, of its objection to certain elements of the fiscal 2017 program and budget, and indicated that it was prepared to contribute only to certain portions of the program and budget. Accordingly, the Company has elected to fund all of the cash calls for those elements of the fiscal 2017 program and budget that will not be funded by Archon. A revised program and budget for fiscal year 2017 is expected to be presented to the management committee of the Buffer Zone in the third quarter of fiscal 2017 to incorporate changes to the mine plan impacting the Lynx Project in the Buffer Zone. Dilution of Archon’s participating interest in the Buffer Zone had been expected in the second quarter of fiscal 2017, but has been temporarily withheld until Archon re-confirms its intentions with respect to funding the revised program and budget.

A fire occurred at the Ekati Diamond Mine process plant on June 23, 2016. The resulting damage to the process plant was limited only to a small area with no damage to the main structural components. No injuries were reported. The process plant remains shut down for repairs and is expected to resume operations at full capacity in late September 2016.

On July 15, 2016, the Toronto Stock Exchange (“TSX”) approved the Company’s normal course issuer bid (“NCIB”) to purchase for cancellation up to 6,150,010 common shares, representing approximately 10% of the public float as of July 6, 2016, from July 20, 2016 to no later than July 19, 2017. On July 28, 2016, the TSX accepted the Company’s entry into an automatic securities purchase plan in order to facilitate repurchases under the NCIB. Common shares repurchased under the NCIB will be cancelled. Purchases under the NCIB may be made through the facilities of the TSX, the New York Stock Exchange or alternative trading platforms in Canada or the United States by means of open market transactions or by such other means as may be permitted by the TSX and applicable US securities laws. There were no repurchases made under the NCIB as of July 31, 2016. Purchases under the NCIB began in August 2016 and resulted in the purchase of approximately 0.6 million shares during the month for approximately CDN $6.9 million.

Note 2:
Basis of Preparation

(a) Statement of compliance

These unaudited condensed consolidated interim financial statements (“interim financial statements”) have been prepared in accordance with International Accounting Standard 34, Interim Financial Reporting (“IAS 34”). The accounting policies applied in these unaudited interim financial statements are consistent with those used in the annual audited consolidated financial statements for the year ended January 31, 2016 except for changes indicated in note 4(a) which are a result of the adoption of IFRS 9.

These interim financial statements do not include all disclosures required by International Financial Reporting Standards (“IFRS”) for annual financial statements and, accordingly, should be read in conjunction with the Company’s annual audited consolidated financial statements for the year ended January 31, 2016 prepared in accordance with IFRS as issued by the International Accounting Standards Board (“IASB”).

(b) Currency of presentation

These interim financial statements are expressed in United States dollars, which is the functional currency of the Company. All financial information presented in United States dollars has been rounded to the nearest thousand.

(c) Use of estimates, judgments and assumptions

The preparation of the interim financial statements in conformity with IFRS requires management to make judgments, estimates and assumptions that affect the application of accounting policies and reported amounts of assets, liabilities and contingent liabilities at the date of the consolidated financial statements, as well as the reported amounts of sales and expenses during the period. Estimates and assumptions are continually evaluated and are based on management’s experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. However, actual outcomes can differ from these estimates.

Note 3:
Change in Accounting Policy and Retrospective Restatement

The condensed consolidated interim financial statements reflect the retrospective application of a voluntary change in accounting policy adopted at the end of fiscal 2016 to treat, in the Condensed Consolidated Interim Balance Sheets and the Condensed Consolidated Interim Statements of (Loss) Income, the asset retirement obligation (“ARO”) as a monetary liability that is revalued using period-end exchange rates, instead of being treated as a non-monetary liability recorded at historical exchange rates, as previously reported. The change in accounting policy has been adopted in accordance with IAS 8, as IAS 37 provides a policy choice to treat an ARO liability as a monetary or non-monetary liability. The Company considers this revised treatment of ARO liability as the most useful to financial statement users and, consequently, the revised treatment results in more reliable and relevant information.

a) The following table outlines the effect of this accounting policy change on the condensed consolidated interim statements of (loss) income for the three months ended July 31, 2015 and six months ended July 31, 2015.

For the three months ended July 31, 2015     Prior to restatement     Restatement impact     July 31, 2015
Cost of sales $ 189,758 $ (2,770) $ 186,988
Finance expenses (3,529) 658 (2,871)
Deferred income tax recovery 820 3,743 4,563
Net (loss) income (18,581) (316) (18,897)
 
Net (loss) income attributable to:
Shareholders (17,641) (527) (18,168)
Non-controlling interest (940) 211 (729)
Basic earnings per share   (0.21)     (0.21)
For the six months ended July 31, 2015     Prior to restatement     Restatement impact     July 31, 2015
Cost of sales $ 354,549 $ (3,968) $ 350,581
Finance expenses (7,059) 1,319 (5,740)
Deferred income tax recovery (14,956) 1,354 (13,602)
Net (loss) income (11,435) 3,933 (7,502)
 
Net (loss) income attributable to:
Shareholders (9,900) 3,702 (6,198)
Non-controlling interest (1,535) 231 (1,304)
Basic earnings per share   (0.12)   0.05   (0.07)

b) The following table outlines the effect of this accounting policy change on the condensed consolidated interim statements of changes in equity for the six months ended July 31, 2015.

For the six months ended July 31, 2015     Prior to restatement     Restatement impact     July 31, 2015
Retained earnings at beginning of period $ 836,201 $ 916 $ 837,117
Net (loss) income attributable to common shareholders (9,900) 3,702 (6,198)
Retained earnings at end of period 792,219 4,618 796,837
Non-controlling interest at beginning of period 114,236 545 114,781
Net (loss) income attributable to non-controlling interest (1,535) 231 (1,304)
Non-controlling interest at end of period   118,805   776   119,581

c) The following table outlines the effect of this accounting policy change on the condensed consolidated interim statements of cash flow for the three months ended July 31, 2015 and six months ended July 31, 2015.

For the three months ended July 31, 2015     Prior to restatement     Restatement impact     July 31, 2015
Net (loss) income for the period $ (18,581) $ (316) $ (18,897)
Deferred income tax recovery 820 3,743 4,563
Finance expenses (3,529) (658) 2,871
Change in non-cash operating working capital 9,081 (2,769) 6,312
Net change in operating activities   52,780     52,780
For the six months ended July 31, 2015     Prior to restatement     Restatement impact     July 31, 2015
Net (loss) income for the period $ (11,435) $ 3,933 $ (7,502)
Deferred income tax recovery (14,956) 1,354 (13,602)
Finance expenses 7,059 (1,319) 5,740
Change in non-cash operating working capital 3,881 (3,968) (87)
Net change in operating activities   23,496     23,496

Note 4:
Significant Accounting Policies

(a) New accounting standards adopted during the period

Effective February 1, 2016, the Company has early adopted the requirements of IFRS 9, Financial Instruments (2014) (“IFRS 9”). This standard replaces the guidance in IAS 39, Financial Instruments: Recognition and Measurement (“IAS 39”), relating to the classification and measurement of financial assets. Under IFRS 9, a financial asset is classified based on how an entity manages its financial assets and the contractual cash flow characteristics of the financial asset. Most of the requirements in IAS 39 for classification and measurement of financial liabilities were carried forward in IFRS 9.

IFRS 9 introduced a single expected credit loss impairment model, which is based on changes in credit quality since initial recognition. The adoption of the expected credit loss impairment model did not have a significant impact on the Company’s financial statements.

IFRS 9 changes the requirements for hedge effectiveness and consequently for the application of hedge accounting. The IAS 39 effectiveness test is replaced with a requirement for an economic relationship between the hedged item and hedging instrument, and for the ‘‘hedged ratio” to be the same as that used by the entity for risk management purposes. Certain restrictions that prevented some hedging strategies and hedging instruments from qualifying for hedge accounting were also removed under IFRS 9. Generally, the mechanics of hedge accounting remain unchanged.

Cash and cash equivalents were previously designated at fair value through profit or loss under IAS 39. Upon adoption of IFRS 9, the Company has classified cash and cash equivalents including restricted cash as measured at amortized cost using the effective interest rate method. There was no change to the classification of accounts receivable, trade and other payables, and loans and borrowings as a result of the adoption of IFRS 9. The accounting policy note 4(c), “Cash and cash equivalents” and 4(k), “Financial instruments” in the annual report were updated as a result of the adoption of IFRS 9 in the current interim period. See changes below:

Note 4(c) Cash and cash equivalents

Cash and cash equivalents consist of cash on hand, balances with banks and short-term money market instruments (with a maturity on acquisition of less than 90 days).

Note 4(k) Financial instruments

The Company’s financial instruments include cash and cash equivalents including restricted cash, accounts receivable, trade and other payables, and loans and borrowings.

Financial assets and liabilities are recognized when the Company becomes party to the contractual provisions of the instrument. Financial assets are derecognized when the rights to receive cash flows from the assets have expired or are assigned and the Company has transferred substantially all risks and rewards of ownership in the asset. Financial liabilities are derecognized when the related obligation is discharged, is cancelled or expires.

Classification of financial instruments in the Company’s financial statements depends on the purpose for which the financial instruments were acquired or incurred. The classification of financial instruments is determined at initial recognition.

Financial assets measured at amortized cost include cash and cash equivalents, restricted cash and accounts receivable. These amounts are initially recorded at fair value less any directly attributable transaction costs. Subsequently, these financial assets are measured at amortized cost using the effective interest rate method, less impairment allowance, if any.

Financial liabilities measured at amortized cost include trade and other payables and loans and borrowings. These amounts are initially recorded at fair value less any directly attributable transaction costs. Subsequently, these financial liabilities are measured at amortized cost using the effective interest rate method.

The accounting policy for financial instruments has been adopted retrospectively as a result of the early adoption of IFRS 9. The change did not result in a change in carrying value of any financial instruments on the effective date of February 1, 2016.

(b) Standards issued but not yet effective

Standards issued but not yet effective up to the date of issuance of the consolidated financial statements are listed below. The listing is of standards and interpretations issued that the Company reasonably expects to be applicable at a future date.

IFRS 2 – SHARE-BASED PAYMENTS

In June 2016, the IASB issued final amendments to IFRS 2, Share-Based Payments (“IFRS 2”). The amendments to IFRS 2 are effective for annual periods beginning on or after January 1, 2018. The amendments to IFRS 2 clarify the classification and measurement of share-based payment transactions. These amendments deal with variations in the final settlement arrangements including: (a) accounting for cash-settled share-based payment transactions that include a performance condition, (b) classification of share-based payment transactions with net settlement features, and (c) accounting for modifications of share-based payment transactions from cash-settled to equity. The Company is currently evaluating the impact the amendments to the standard are expected to have on its consolidated financial statements.

IFRS 15 – REVENUE FROM CONTRACTS WITH CUSTOMERS

In May 2014, the IASB issued IFRS 15, Revenue from Contracts with Customers (“IFRS 15”). IFRS 15 is effective for periods beginning on or after January 1, 2018 and is to be applied retrospectively. IFRS 15 clarifies the principles for recognizing revenue from contracts with customers. The Company intends to adopt IFRS 15 in its financial statements for the annual period beginning February 1, 2018. The extent of the impact of the adoption of IFRS 15 has not yet been determined.

IFRS 16 – LEASES

In January 2016, the IASB issued IFRS 16, Leases (“IFRS 16”), which replaces IAS 17, Leases, and its associated interpretative guidance. IFRS 16 applies a control model to the identification of leases, distinguishing between a lease and a services contract on the basis of whether the customer controls the assets being leased. For those assets determined to meet the definition of a lease, IFRS 16 introduces significant changes to the accounting by lessees, introducing a single, on-balance-sheet accounting model that is similar to current finance lease accounting, with limited exceptions for short-term leases or leases of low value assets. Lessor accounting remains similar to current accounting practice. The standard is effective for annual periods beginning on or after January 1, 2019, with early application permitted for entities that have also adopted IFRS 15. The Company is currently evaluating the impact the final standard is expected to have on its consolidated financial statements.

Note 5:
Cash and Cash Equivalents and Restricted Cash

    July 31, 2016     January 31, 2016
Cash and cash equivalents $ 180,401 $ 320,038
Restricted cash   65,521   63,312
Total cash resources $ 245,922 $ 383,350

Note 6:
Inventory and Supplies

    July 31, 2016     January 31, 2016
Stockpile ore $ 42,740 $ 7,030
Rough diamonds – work in progress 18,749 119,165
Rough diamonds – finished goods (available for sale) 108,136 94,631
Supplies inventory   187,622   195,320
Total inventory and supplies $ 357,247 $ 416,146

Total supplies inventory are net of a write-down for obsolescence of $9.2 million at July 31, 2016 ($7.5 million at January 31, 2016). In the three months ended July 31, 2016, the cost of inventories recognized as an expense and included in cost of sales was $151.2 million (three months ended July 31, 2015 – $186.5 million). For the six months ended July 31, 2016, the cost of inventories recognized as an expense and included in cost of sales was $327.2 million (six months ended July 31, 2015 – $348.9 million).

Cost of sales for the quarter ended July 31, 2016 includes a $6.4 million (three months ended July 31, 2015 – $nil) write-down in the Ekati segment to bring available-for-sale inventories to their net realizable value. Cost of sales for the six months ended July 31, 2016 includes a $26.0 million (six months ended July 31, 2015 – $nil) write-down in the Ekati segment to bring available-for-sale inventories to their net realizable value.

Note 7:
Diavik Joint Venture and Ekati Diamond Mine

DIAVIK JOINT VENTURE

The following represents DDDLP’s 40% interest in the net assets and operations of the Diavik Joint Venture as at June 30, 2016 and December 31, 2015:

    June 30, 2016     December 31, 2015
Current assets $ 82,080 $ 89,433
Non-current assets 512,046 513,413
Current liabilities (28,711) (35,153)
Non-current liabilities and participant’s account   (565,415)   (567,693)
    Three months
ended
June 30, 2016
  Three months
ended
June 30, 2015
  Six months
ended
June 30, 2016
  Six months
ended
June 30, 2015
Expenses net of interest income(i) $ 45,190 $ 50,549 $ 90,486 $ 97,955
Cash flows used in operating activities(i) (40,307) (41,311) (58,979) (78,372)
Cash flows provided by financing activities 54,094 47,166 90,797 96,765
Cash flows used in investing activities   (13,831)   (7,449)   (32,066)   (19,599)

(i) The Diavik Joint Venture earns interest income only as diamond production is distributed to participants.

DDDLP is contingently liable for DDMI’s portion of the liabilities of the Diavik Joint Venture, and to the extent DDDLP’s participating interest could increase because of the failure of DDMI to make a cash contribution when required, DDDLP would have access to an increased portion of the assets of the Diavik Joint Venture to settle these liabilities. Additional information on commitments and guarantees related to the Diavik Joint Venture is found in note 10.

EKATI DIAMOND MINE
The following represents a 100% interest in the net assets and operations of the Ekati Diamond Mine as at July 31, 2016 and January 31, 2016:

    July 31, 2016     January 31, 2016
Current assets $ 278,473 $ 384,099
Non-current assets 837,678 666,931
Current liabilities (178,807) (159,742)
Non-current liabilities and participant’s account   (937,344)   (891,288)
    Three months
ended
July 31, 2016
  Three months
ended
July 31, 2015
  Six months
ended
July 31, 2016
  Six months
ended
July 31, 2015
Revenue $ 76,917 $ 119,579 $ 195,541 $ 296,100
Expenses (119,936) (133,456) (299,168) (304,284)
Net income (loss) (43,019) (13,877) (103,627) (8,184)
Cash flows (used in) provided by operating activities (49,976) 36,361 41,834 126,312
Cash flows provided by (used in) financing activities 45,700 (76,637) 9,826 (63,446)
Cash flows (used in) provided by investing activities   (45,806)   (26,663)   (132,287)   (79,176)

Note 8:
Assets Held for Sale

During the first quarter of fiscal 2017, the Company formalized its decision to divest a non-core asset, which is owned by 6019838 Canada Inc., a wholly owned subsidiary of the Company. In August 2016, the Company entered into a binding agreement to sell its downtown Toronto office building for approximately CDN $84.8 million. The building is reflected as an asset held for sale on the Company’s second quarter balance sheet with a net book value of $18.7 million, and associated liabilities of $4.1 million. The transaction closed on September 8, 2016 and was subject to customary closing conditions and adjustments. The following table represents the related assets held for sale and the liabilities associated with assets held for sale as at July 31, 2016:

    July 31, 2016
Assets
Property, plant and equipment $ 18,695
Total assets held for sale $ 18,695
Liabilities
Trade and other payables $ 2,259
Current portion of loans and borrowings 823
Loans and borrowings   1,046
Total liabilities associated with assets held for sale $ 4,128

Note 9:
Related Party Disclosure

There were no material related party transactions in the three and six-month periods ended July 31, 2016 and July 31, 2015 other than compensation of key management personnel.

Operational information
The Company had the following investments in significant subsidiaries at July 31, 2016:

Name of company   Effective interest   Jurisdiction of formation
Dominion Diamond Holdings Ltd. 100% Northwest Territories
Dominion Diamond Diavik Limited Partnership 100% Northwest Territories
Dominion Diamond (India) Private Limited 100% India
Dominion Diamond International N.V. 100% Belgium
Dominion Diamond Marketing Corporation 100% Canada
Dominion Diamond (UK) Limited 100% England
6019838 Canada Inc. 100% Canada
Dominion Diamond Ekati Corporation 100% Canada
Dominion Diamond Marketing N.V. 100% Belgium

Note 10:
Commitments and Guarantees

CONTRACTUAL OBLIGATIONS

    Less than   Year   Year   After
    Total   1 year   2–3   4–5   5 years
Loans and borrowings (a) $ 23,596 $ 22,367 $ 1,229 $ $
Environmental and participation agreements incremental commitments (b)(c) 94,154 5,634 13,720 20,019 54,781
Operating lease obligations (d) 19,539 7,345 6,511 5,683
Capital commitments (e) 36,501 36,501
Other   820   820      
Total contractual obligations $ 174,610 $ 72,667 $ 21,460 $ 25,702 $ 54,781

(a) Promissory note

The Company issued a promissory note on October 15, 2014 in the amount of $42.2 million in connection with its acquisition of an additional 8.889% interest in the Core Zone at the Ekati Diamond Mine. The promissory note is payable in instalments over 31 months and the Company has the right, but not the obligation, to satisfy one or more instalments due under the promissory note in common shares of the Company. On July 31, 2016, $21.5 million, which represents the principal amount of the note plus accrued interest, was outstanding.

(b) Environmental agreements

Through negotiations of environmental and other agreements, both the Diavik Joint Venture and the Ekati Diamond Mine must provide funding for the Environmental Monitoring Advisory Board and the Independent Environmental Monitoring Agency, respectively. Further funding will be required in future years; however, specific amounts have not yet been determined. These agreements also state that the mines must provide security for the performance of their reclamation and abandonment obligations under environmental laws and regulations.

The Company posted surety bonds with the Government of the Northwest Territories (“GNWT”) in the aggregate amount of CDN $253 million to secure the obligations under its Water Licence to reclaim the Ekati Diamond Mine. The Company provided letters of credit, secured by restricted cash, in the amount of CDN $60 million and CDN $25 million to the GNWT as security for the reclamation obligations for the Diavik Diamond Mine and Ekati Diamond Mine, respectively. The Company has also provided a guarantee of CDN $20 million for other obligations under the environmental agreement for the Ekati Diamond Mine.

(c) Participation agreements

Both the Diavik Joint Venture and the Ekati Diamond Mine have signed participation agreements with various Aboriginal communities. These agreements are expected to contribute to the social, economic and cultural well-being of these communities. The Diavik participation agreements are for an initial term of 12 years and shall be automatically renewed on terms to be agreed upon for successive periods of six years thereafter until termination. The Diavik participation agreements terminate in the event that the Diavik Diamond Mine permanently ceases to operate. The Ekati Diamond Mine participation agreements are in place during the life of the Ekati Diamond Mine and the agreements terminate in the event the mine ceases to operate.

(d) Operating lease obligations

The Company has entered into non-cancellable operating leases for the rental of fuel tanks and office premises for the Ekati Diamond Mine, which expire at various dates through 2021. The leases have varying terms, escalation clauses and renewal rights. Any renewal terms are at the option of the lessee at lease payments based on market prices at the time of renewal. Minimum rent payments under operating leases are recognized on a straight-line basis over the term of the lease, including any periods of free rent.

(e) Capital commitments

The Company has various long-term contractual commitments related to the acquisition of property, plant and equipment. The commitments included in the table above are based on contract prices.

Note 11:
Financial Instruments

The Company has various financial instruments comprising cash and cash equivalents, restricted cash, accounts receivable, trade and other payables, and loans and borrowings.

The fair value of cash and cash equivalents and restricted cash approximates its carrying 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 Company’s loans and borrowings are for the most part fully secured, hence the fair values of these instruments at July 31, 2016 and January 31, 2016 are considered to approximate their carrying values.

The carrying values and estimated fair values of these financial instruments are as follows:

    July 31, 2016   January 31, 2016
    Estimated

fair value

    Carrying

value

  Estimated

fair value

    Carrying

value

Financial assets
Cash and cash equivalents, including restricted cash $ 245,922 $ 245,922 $ 383,350 $ 383,350
Accounts receivable   11,818   11,818   11,528   11,528
  $ 257,740 $ 257,740 $ 394,878 $ 394,878
Financial liabilities
Trade and other payables $ 110,562 $ 110,562 $ 114,589 $ 114,589
Loans and borrowings   21,111   21,111   33,771   33,771
  $ 131,673 $ 131,673 $ 148,360 $ 148,360

The Company has available a $210 million senior secured corporate revolving credit facility with a syndicate of commercial banks. The facility has a four-year term expiring on April 7, 2019, and it may be extended for an additional period of one year with the consent of the lenders. Proceeds received by the Company under the credit facility are to be used for general corporate purposes. Accommodations under this credit facility may be made to the Company, at the Company’s option, by way of an advance or letter of credit, and the interest payable will vary in accordance with a pricing grid ranging between 2.5% and 3.5% above LIBOR. The Company is in compliance with the financial covenants associated with the facility and is able to access the full amount of funds available under the facility. As at July 31, 2016, no amounts were drawn under the credit facility.

Note 12:
Mine Standby Costs

The Company experienced a fire at the Ekati Diamond Mine processing plant on June 23, 2016, resulting in a temporary shutdown of the plant to repair one of the main degritting screens, associated components, electrical wire and related infrastructure, as well as to clean up. The Company incurred and expensed $22.0 million of related costs in the period as a result of the processing plant’s temporary shutdown. No insurance recoveries have been recorded in Q2 fiscal 2017.

Note 13:
Dividends

On April 13, 2016, the Company’s Board of Directors declared a dividend of $0.20 per share, which was the final dividend for fiscal 2016, and was payable to shareholders of record at the close of business on May 17, 2016, and paid on June 2, 2016. This dividend was an eligible dividend for Canadian income tax purposes.

On September 8, 2016, the Board of Directors declared an interim dividend of $0.20 per share to be paid in full on November 3, 2016, to shareholders of record at the close of business on October 11, 2016. The dividend will be an eligible dividend for Canadian income tax purposes.

Note 14:
Segmented Information

The reportable segments are those operations whose operating results are reviewed by the Chief Operating Decision Makers to make decisions about resources to be allocated to the segment and assess its performance provided those operations pass certain quantitative thresholds. Operations whose revenues, earnings or losses, or assets exceed 10% of the total consolidated revenue, earnings or losses, or assets are reportable segments.

In order to determine reportable segments, management reviewed various factors, including geographical locations and managerial structure. Management determined that the Company operates in three segments within the diamond industry – Diavik Diamond Mine, Ekati Diamond Mine and Corporate – for the three and six months ended July 31, 2016 and 2015.

The Diavik segment consists of the Company’s 40% ownership interest in the Diavik group of mineral claims and the sale of rough diamonds. The Ekati segment consists of the Company’s ownership interest in the Ekati group of mineral claims and the sale of rough diamonds. The Corporate segment captures all costs not specifically related to the operations of the Diavik and Ekati Diamond Mines.

For the three months ended July 31, 2016

    Diavik     Ekati     Corporate     Total
Sales
Europe $ 70,195 $ 72,609 $ $ 142,804
India   6,486   10,680     17,166
Total sales   76,681   83,289     159,970
Cost of sales
Depreciation and amortization 19,054 40,164 59,218
Inventory impairment 6,414 6,414
All other costs   33,958   59,518     93,476
Total cost of sales   53,012   106,096     159,108
Gross margin 23,669 (22,807) 862
Gross margin (%) 30.9% (27.4)% –% 0.5%
Selling, general and administrative expenses
Selling and related expenses 835 957 1,792
Mine standby costs 22,028 22,028
Administrative expenses       7,383   7,383
Total selling, general and administrative expenses   835   22,985   7,383   31,203
Operating profit (loss) 22,834 (45,792) (7,383) (30,341)
Finance expenses (1,058) (1,418) (2,476)
Exploration costs (2) (1,445) (1,447)
Finance and other income 490 316 806
Foreign exchange (loss) gain   (12,518)   8,072     (4,446)
Segment profit (loss) before income taxes $ 9,746 $ (40,267) $ (7,383) $ (37,904)
Segmented assets as at July 31, 2016
Canada $ 716,361 $ 1,152,689 $ 80,389 $ 1,949,439
Other foreign countries   55,781   54,804     110,585
  $ 772,142 $ 1,207,493 $ 80,389 $ 2,060,024
Capital expenditures $ 11,675 $ 48,038 $ 322 $ 60,035
Inventory 103,317 253,930 357,247
Total liabilities 248,953 473,005 10,599 732,557
Other significant non-cash items:
Deferred income tax recovery   (1,242)   (8,852)     (10,094)

For the three months ended July 31, 2015

    Diavik     Ekati     Corporate     Total
Sales
Europe $ 70,099 $ 135,282 $ $ 205,381
India   1,905   2,390     4,295
Total sales   72,004   137,672     209,676
Cost of sales
Depreciation and amortization 18,016 34,259 52,275
All other costs   35,382   99,331     134,713
Total cost of sales   53,398   133,590     186,988
Gross margin 18,606 4,082 22,688
Gross margin (%) 25.8% 3.0% –% 10.8%
Selling, general and administrative expenses
Selling and related expenses 977 1,624 2,601
Administrative expenses       12,481   12,481
Total selling, general and administrative expenses   977   1,624   12,481   15,082
Operating profit (loss) 17,629 2,458 (12,481) 7,606
Finance expenses (1,054) (1,817) (2,871)
Exploration costs (1,935) (1,935)
Finance and other income (loss) (12) (24) (36)
Foreign exchange (loss) gain   (5,567)   3,393     (2,174)
Segment profit (loss) before income taxes $ 10,996 $ 2,075 $ (12,481) $ 590
Segmented assets as at July 31, 2015
Canada $ 783,218 $ 1,268,560 $ 20,300 $ 2,072,078
Other foreign countries   60,507   60,588     121,095
  $ 843,725 $ 1,329,148 $ 20,300 $ 2,193,173
Capital expenditures $ 7,470 $ 32,865 $ 112 $ 40,447
Inventory 112,862 326,625 439,487
Total liabilities 274,127 463,754 10,794 748,675
Other significant non-cash items:
Deferred income tax expense   694   3,869     4,563

For the six months ended July 31, 2016

    Diavik     Ekati     Corporate     Total
Sales
Europe $ 138,890 $ 171,812 $ $ 310,702
India   10,919   16,608     27,527
Total sales   149,809   188,420     338,229
Cost of sales
Depreciation and amortization 41,347 78,936 120,283
Inventory impairment 26,017 26,017
All other costs   71,769   138,116     209,885
Total cost of sales   113,116   243,069     356,185
Gross margin 36,693 (54,649) (17,956)
Gross margin (%) 24.5% (29.0)% –% (5.3)%
Selling, general and administrative expenses
Selling and related expenses 1,744 1,735 3,479
Mine standby costs 22,028 22,028
Administrative expenses       13,732   13,732
Total selling, general and administrative expenses   1,744   23,763   13,732   39,239
Operating profit (loss) 34,949 (78,412) (13,732) (57,195)
Finance expenses (2,137) (2,827) (4,964)
Exploration costs 7 (5,035) (5,028)
Finance and other income 511 667 1,178
Foreign exchange gain (loss)   1,671   (9,475)     (7,804)
Segment profit (loss) before income taxes $ 35,001 $ (95,082) $ (13,732) $ (73,813)
Segmented assets as at July 31, 2016
Canada $ 716,361 $ 1,152,689 $ 80,389 $ 1,949,439
Other foreign countries   55,781   54,804     110,585
  $ 772,142 $ 1,207,493 $ 80,389 $ 2,060,024
Capital expenditures $ 38,004 $ 170,521 $ 322 $ 208,847
Inventory 103,317 253,930 357,247
Total liabilities 248,953 473,005 10,599 732,557
Other significant non-cash items:
Deferred income tax recovery   (13,729)   (33,651)     (47,380)

For the six months ended July 31, 2015

    Diavik     Ekati     Corporate     Total
Sales
Europe $ 127,322 $ 258,404 $ $ 385,726
India   5,032   6,641     11,673
Total sales   132,354   265,045     397,399
Cost of sales
Depreciation and amortization 34,541 62,694 97,235
All other costs   68,466   184,880     253,346
Total cost of sales   103,007   247,574     350,581
Gross margin 29,347 17,471 46,818
Gross margin (%) 22.2% 6.6% –% 11.8%
Selling, general and administrative expenses
Selling and related expenses 1,937 2,995 4,932
Administrative expenses       18,920   18,920
Total selling, general and administrative expenses   1,937   2,995   18,920   23,852
Operating profit (loss) 27,410 14,476 (18,920) 22,966
Finance expenses (1,630) (4,110) (5,740)
Exploration costs (50) (7,134) (7,184)
Finance and other income (loss) (59) 146 87
Foreign exchange gain (loss)   (909)   (108)     (1,017)
Segment profit (loss) before income taxes $ 24,762 $ 3,270 $ (18,920) $ 9,112
Segmented assets as at July 31, 2015
Canada $ 783,218 $ 1,268,560 $ 20,300 $ 2,072,078
Other foreign countries   60,507   60,588     121,095
  $ 843,725 $ 1,329,148 $ 20,300 $ 2,193,173
Capital expenditures $ 19,701 $ 87,858 $ 892 $ 108,451
Inventory 112,862 326,625 439,487
Total liabilities 274,127 463,754 10,794 748,675
Other significant non-cash items:
Deferred income tax (recovery) expense   (15,051)   1,449     (13,602)
Category: General