Form F1 Management Discussion and Analysis For Stornoway Diamond Corporation

Transcription

1 YE MD&A version 3 Reviewed by JCD on June 8, 2015 Form F1 For Stornoway Diamond Corporation ( Stornoway or the Corporation ) of Consolidated Financial Condition and Results of Operations As at and for the three and six months ended (All monetary figures are expressed in Canadian dollars unless otherwise stated) The following interim management discussion and analysis ( MD&A ) of the Corporation s financial condition and results of operations for the three and six months ended should be read in conjunction with the unaudited condensed interim consolidated financial statements for the three and six months ended, together with the notes thereto. These financial statements have been prepared in Canadian dollars, which is the Corporation s presentation and functional currency, in accordance International Accounting Standards 34, Interim Financial Reporting ( IAS 34 ) and International Financial Reporting Standards ( IFRS ), as issued by the International Accounting Standards Board ( IASB ). The Corporation s significant accounting policies are set out in Note 2 of the audited consolidated financial statements for the year ended December 31, and, where required, in Notes 2 and 3 of the unaudited condensed interim consolidated financial statements for the three and six months ended. Additional information on the Corporation, including the most recently filed Corporation s Annual Information Form ( AIF ) and other continuous disclosure documents can be accessed through the System for Electronic Document Analysis and Retrieval ( SEDAR ) website at and from the Corporation s website at To the extent applicable, updated information contained in this MD&A supersedes older information contained in previously filed continuous disclosure documents. Information contained on the Corporation s website is not incorporated by reference herein and does not form part of this MD&A. This MD&A contains forward looking statements that are based on certain estimates and assumptions and involve risks and uncertainties. Actual results may vary materially from management s expectations. See the Forward Looking Statements section later in this MD&A for further information. Unless otherwise noted, all amounts are presented in Canadian Dollars. Disclosure of a scientific or technical nature in this MD&A was prepared under the supervision of Mr. Patrick Godin, P.Eng. (Quebec), Chief Operating Officer. Stornoway s exploration programs are supervised by Mr. Robin Hopkins, P.Geol. (NT/NU), Vice President, Exploration. Each of Mr. Godin and Mr. Hopkins are qualified persons under National Instrument , Standards of Disclosure for Mineral Projects. The Board of Directors approved this MD&A on August 9,. Page 1 of 30

2 As at and for the three and six months ended OVERVIEW Stornoway is a Canadian diamond mining Corporation listed on the Toronto Stock Exchange ( TSX ) and headquartered in Longueuil, Quebec. Stornoway s principal focus is its 100% owned Renard Diamond Mine located in north central Quebec. Stornoway formally declared commercial production at Renard effective January 1,. Stornoway s strategy is to build a growth oriented Corporation that succeeds in the business of mining and selling rough diamonds. Stornoway s long term view of the rough diamond market is positive, based on its outlook for a tightening mine supply and growing demand, particularly in developing markets, which is expected to support real, long term price growth. The Corporation has a management team with experience at each stage of the diamond pipeline, from exploration through development, mine construction, operations and marketing. On July 8, 2014, Stornoway entered into definitive agreements to provide a comprehensive funding package for the construction of the Renard Diamond Project, for total gross proceeds funded or to be funded of $946 million (assuming a US$1.00:CAD$1.10 conversion), through a combination of senior and subordinated debt facilities, equity issuance, a forward sale of diamonds (the Stream ), and an equipment finance facility (collectively the Financing Transactions ). In addition, prior to their expiry on July 8, 2016, 91,912,732 common share purchase warrants were exercised at a price of $0.90 per share for total proceeds to the Corporation of $82.7 million. Subsequently, in, the Corporation terminated their $48 million cost overrun facilities. Funds received were used to support the completion of the construction of the Renard Mine, which commenced on July 10, First ore delivery to the Renard diamond process plant was achieved on July 15, 2016, and commercial production was formally declared on January 1,, a five month improvement over what was originally contemplated. Page 2 of 30

3 As at and for the three and six months ended SUMMARY OF SIGNIFICANT OPERATIONAL AND FINANCIAL HIGHLIGHTS On January 1,, the Corporation adopted IFRS 9, Financial Instruments ( IFRS 9 ), and IFRS 15, Revenue from Contracts with Customers ( IFRS 15 ). IFRS 9 replaces IAS 39, Financial Instruments: Recognition and Measurement, and was applied retrospectively. IFRS 15 supersedes IAS 11, Construction Contracts, IAS 18, Revenue (hereinafter referred to as legacy standards ) and related Interpretations, and was applied using the modified retrospective method. The adoption impacts are detailed in Note 3 to the unaudited condensed interim consolidated financial statements for the three and six months ended. For the three months ended ( Current Quarter ), Stornoway reported net loss of $35.9 million ($0.04 per share on a basic and fully diluted basis), compared to net income of $3.1 million for the three months ended ( Comparative Quarter ; $Nil per share on a basic and fully diluted basis). Adjusted net loss 1 for the Current Quarter was $31.3 million compared to $5.0 million for the Comparative Quarter. During the quarter, two tender sales totalling 201,283 carats were completed for gross proceeds 2 of $28.6 million 3 at an average price of US$109 per carat ($142 per carat 3 ). Revenue recognized was $56.9 million derived from the sale of 328,899 carats of run of mine production in three tender sales at an average achieved price 1 of US$115 per carat ($147 per carat 1,4 ), and the sale of 41,979 carats of incidental production in one out of tender contract sale at an average price of US$19 per carat ($25 per carat 5 ). Second quarter diamond production was 223,351 carats produced from the processing of 562,060 tonnes of ore at an average grade of 40 carats per hundred tonnes ( cpht ). Grade and carat recoveries during the quarter reflect the processing of lower grade production ore and ore stockpiles as the Renard Mine transitions from open pit to underground mining. Underground mining during the quarter comprised 366,550 tonnes, with 296,637 tonnes of ore extracted. Ramp up of the underground mine production during the quarter was impeded by equipment availability and drawpoint management. Subsequent to quarter end, mining rates at or above the 6,000 tonnes per day design capacity have been successfully achieved. Commissioning of the ore sorting plant, which commenced in March, was completed during the quarter, is now fully operational. Waste rejected represents between 15% and 30% of material sorted, with 1 2% kimberlite content in the reject stream. Cash operating costs per tonne processed 1 were $58.69 per tonne ($ per carat) and capital expenditures 1 were $19.9 million. For the Current Quarter, the Corporation reported adjusted EBITDA 1 of $(6.4) million, or (13.1)% of Adjusted Revenues 1, which includes a $10.9 million write down of cash costs to bring inventory to its net realizable value. For the Comparative Quarter, adjusted EBITDA 1 was $16.8 million, or 39.5% of revenues. At quarter end, cash and cash equivalents stood at $31.6 million and Available Liquidity 1, including available credit facilities, stood at $46.5 million. 1 See Non IFRS Financial Measures section 2 Before stream and royalty. 3 Based on an average $:US$ conversion rate of $ Based on an average $:US$ conversion rate of $ Based on an average $:US$ conversion rate of $1.33 Page 3 of 30

4 As at and for the three and six months ended KEY OPERATIONAL AND FINANCIAL HIGHLIGHTS For the three months ended For the six months ended OPERATIONAL HIGHLIGHTS Lost time incidents rate ( LTI ) Average daily manpower (workers) Open pit tonnes mined (tonnes) 613,683 1,328,580 1,038,606 2,574,525 Underground ore tonnes mined (tonnes) 296,637 22, ,435 36,568 Ore processed (tonnes) 562, ,005 1,124, ,238 Carats recovered (carats) 223, , , ,513 Carats sold (carats) 370, , , ,285 Capital expenditures 1 19,921 28,804 50,975 48,065 Underground development (meters) 976 1,198 2,278 2,424 FINANCIAL HIGHLIGHTS Revenues 56,911 42, ,860 91,042 Cost of goods sold 74,902 32, ,219 65,900 Selling, general and administrative expenses 5,892 4,203 9,943 9,323 Exploration expenses 1, ,699 1,581 Financial expenses (income) 19,614 2,211 37,454 (519) Foreign exchange loss (gain) 2,294 (3,241) 5,453 (4,260) Gain on sale of interests in exploration properties (400) Net (loss) income before tax (47,664) 6,168 (60,908) 19,417 Income tax (recovery) expense (11,800) 3,056 (14,064) 17,480 Net (loss) income (35,864) 3,112 (46,844) 1,937 Loss per share Basic and diluted (0.04) Nil/Nil (0.06) Nil/Nil Adjusted net loss 1 (31,272) (4,981) (45,231) (7,510) Adjusted EBITDA 1 (6,403) 16, ,093 Adjusted EBITDA margin (%) 1 (13.1)% 39.5% 1.1% 41.8% OTHER SELECTED FINANCIAL INFORMATION. December 31, Cash, cash equivalents and short term investments 31,612 81,039 Total assets 1,303,400 1,256,300 Current monetary liabilities 6 86,489 65,753 Total debt 7 310, ,107 Equity 538, ,207 Number of common shares outstanding 835,875, ,263,337 6 Includes payables and accrued liabilities, the current portion of long term debt, and the fair value of derivative financial liabilities with maturities of 12 months or less. 7 Consists of long term debt, including current portion of long term debt, and the convertible debentures Page 4 of 30

5 As at and for the three and six months ended OPERATIONAL HIGHLIGHTS Environment, Health, Safety and Communities One lost time incident ( LTI ) was recorded during the quarter, for a year to date LTI rate of 1.3 for both contractors and Stornoway employees. Stornoway employees stood at 570 as at, including 507 mine located employees, of which 13% were Crees, 23% were from Chibougamau and Chapais, and 64% were from outside the region. No incidences of environmental non compliance were reported in the quarter. Mining and Processing During the second quarter, 613,682 tonnes were mined from the Renard 3 and Renard 65 open pits, with 156,813 tonnes of ore extracted. A total of 366,550 production and development tonnes were mined from the Renard 2 underground mine during the quarter, of which 296,637 tonnes ore were extracted, including 295,846 tonnes of ore delivered to the process plant. Production during the quarter was 223,351 carats recovered from the processing of 562,060 tonnes of ore at an attributable grade of 40 cpht. Grade and carat recoveries during the quarter reflect the processing of lower grade ore as the Renard Mine transitions from open pit to underground mining. Open pit mining at Renard 3 was completed in April. Ore processed during the quarter was sourced primarily from the underground mine, from low grade stockpiles, and from the Renard 65 open pit. Ramp up of the Renard 2 underground mine production progressed during the second quarter. The development of an Assisted Block Cave as the principal mining method in the underground mine continued, with a focus on achieving optimum granulometry for the blasted ore and opening up multiple panels to support the planned mining rate. The rates of ramp up in the underground mine during the quarter were impeded by lengthening lead times on mobile mining equipment deliveries affecting equipment availability. The first mining panels opened up at the margin of the orebody at the 290 meter production level are composed of highly diluted lower grade ore, which has impacted carat production. As expected, however, grades have increased as additional panels have been opened in less diluted ore within the main body of the kimberlite. Subsequent to the quarter end, sufficient draw points have been opened, the minimum required equipment has been delivered, with the remainder expected to be delivered over the next two quarters, and improved manpower levels have been established to allow the underground mine ore production to be reached at or above the 6,000 tonnes per day design capacity. Processing rates in the quarter averaged 6,460 tonnes per day compared to an annual plan of 7,000 tonnes per day. The new ore sorting plant at Renard was commissioned during the quarter, and has been processing ore on a consistent basis since mid May. The volume and quality of waste segregated from the ore feed has exceeded expectations, with waste rejected representing between 15% and 30% of material sorted. Kimberlite content in the waste stream has averaged between 1% and 2%. This has resulted in a significant reduction in process plant head feed and opened up new plant capacity for future exploitation. Because the waste within the Renard ore is hard and difficult to crush, its rejection from the main process plant has also resulted in a net reduction in power consumption for processing even with the addition of the new sorting circuit. Page 5 of 30

6 As at and for the three and six months ended OPERATIONAL HIGHLIGHTS continued Mining and Processing continued Considering the highly abrasive characteristics of the ore processed to date through the ore sorting plant, consisting mainly of highly diluted, low grade material, the diamonds recovered since its introduction have exhibited lower levels of breakage than observed previously with comparable feed composition. Diamond Sales During the quarter, two tender sales totalling 201,283 carats were completed for gross proceeds 2 of $28.6 million 3 at an average price of US$109 per carat ($142 per carat 1,3 ). Revenue recognized during the quarter was derived from 328,899 carats of run of mine production recovered between January and March. Gross proceeds 2 were $48.4 million 4 at an average price 1 of US$115 per carat ($147 per carat 4 ). These results include sales from the third tender sale of the first quarter, being 127,616 carats sold at an average price of US$123 per carat ($156 per carat 8 ), which were recorded as revenues as deliveries to clients were made at the beginning of the second quarter. In addition to the sale of run of mine production, an additional 41,979 carats of diamonds smaller than the 7 DTC sieve size were sold during the quarter in an out of tender contract sale for gross proceeds 2 of $1.0 million 5 at an average price of US$19 per carat ($25 per carat 5 ). These represent recoveries of small diamond incidentals produced between March and May that are in excess of that expected from the Renard Mineral Resource. The sale of such incidentals represents incremental revenue above that provided for in Stornoway s FY segmented sales guidance. On a segmented basis, including the results of the third tender of the first quarter and including the sale of incidentals, 240,463 carats of +7 DTC sieve size diamonds were sold at an average price of US$149 per carat ($192 per carat 4 ), and 130,415 carats of 7 DTC sieve size diamonds were sold at an average price of US$19 per carat ($25 per carat 3 ). Capital Projects Capital expenditures 1 of $19.9 million in the quarter were principally related to the development of the underground mine, open pit development in Renard 65, as well as the construction and commissioning of the ore waste sorting circuit. Capital expenditures in the underground mine during the second quarter focussed on lateral development on the 290 meter level access and drilling drifts for the upper portion of the mine, as well as development of the main ramp towards the 470 meter level. A total of 976 meters of lateral development were completed. Underground mine development in the third quarter will focus on development of the ramp towards 470 meter level and level access to the Renard 3 kimberlite. As the mine completes its transition from open pit to underground mining operations, the second half of the year is expected to see a reduction in development capital expenditures, with emphasis placed on ore production. 8 Based on an average $: US$ conversion rate of $1.26 Page 6 of 30

7 As at and for the three and six months ended OPERATIONAL HIGHLIGHTS continued Exploration On January 18,, Stornoway announced an exploration program to both develop existing resource upside potential at the Renard Mine and to make new discoveries. A total budget of $4.6 million has been allocated to complete this work, which commenced during the first quarter and is ongoing. Preliminary results are as follows. RIL Project The RIL Property was identified by Stornoway from grassroots exploration, and is located approximately 80km north of the town of Elliot Lake, Ontario. The area is notable for good access infrastructure, with the nearest known cluster of kimberlite intrusions more than 130 km away. A single geophysical target under a small lake was tested by drilling in February. Although no diamonds were recovered from 150kg of rock submitted for microdiamond recovery, or from a 1.3t mini bulk sample processed for macrodiamond recovery, kimberlite clusters commonly comprise bodies with variable diamond contents. Detailed aeromagnetic surveying completed during the quarter confirms the presence of additional promising targets on Stornoway s current 8,590 ha claim package. Final results of the geophysical survey are pending, but new staking to cover more targets identified from preliminary data is underway. Renard Brownfields Exploration The Renard Property comprises more than 600 mineral claims representing about 33,600 ha of ground centred on the Renard Diamond Mine. In addition to the nine known kimberlite pipes in the Renard core area (five of which are in the present mine plan), there are at least eleven additional kimberlite dykes on the property. The brownfields drill program focussed on geophysical responses indicative of pipelike kimberlite bodies, with the size and tonnage potential to provide meaningful new sources of ore feed to the centrally located Renard mine process plant. During March and April, three light reverse circulation (RC) drill rigs tested a total of 91 geophysical anomalies with 95 holes. Kimberlite chips were recovered at three targets, indicating the presence of dyke like bodies, and chips of country rock breccia or related alteration were recovered at nine targets. While RC drilling facilitates rapid cost effective preliminary testing of targets, core drilling will be required to follow up the CRB discoveries for adjacent or blind kimberlite diatremes. Renard Resource Development In addition to brownfield exploration at Renard, a separate program of underground drilling will test the depth potential of the Renard 3 kimberlite below the base of the currently defined Mineral Reserves. The objective of this drill program is the conversion of Inferred Mineral Resources and Targets for Further Exploration ( TFFE ) to Indicated Mineral Resource and, if warranted, new Mineral Reserves, with a view to the acceleration and expansion of underground mining of the high grade Renard 3 kimberlite in the Renard mine plan. A budget of $0.6 million has been allocated to complete this work, and drilling activities are underway. Page 7 of 30

8 As at and for the three and six months ended FINANCIAL HIGHLIGHTS Current Quarter Revenues Revenues during the Current Quarter totalled $56.9 million, compared to $42.6 million in the Comparative Quarter. Revenues in the Current Quarter include $13.5 million recognized from the contract liabilities related to the upfront proceeds received by the Corporation under the Renard Stream agreement in consideration for future commitments to deliver diamonds at contracted prices ($5.1 million in the Comparative Quarter). The increase in revenue from contract liabilities reflects the modified retrospective adoption of IFRS 15. Before Stream and royalty, revenue recognized during the Current Quarter was derived from 328,899, carats of run of mine production included in three tender sales events, with gross proceeds 2 of $48.4 million 4 at an average achieved price 1 of US$115 per carat ($147 per carat 4 ). In addition, during the quarter, the Corporation sold 41,979 carats of incidental production in one out of tender contract sale at an average price of US$19 per carat ($25 per carat 5 ). This compares to 350,159 carats sold in two tender sales events in the Comparative Quarter, with gross proceeds 2 of $40.9 million at US$87 per carat ($117 per carat 9 ). Cost of goods sold The Corporation s cost of goods sold were $74.9 million (Comparative Quarter $32.3 million) related to mining, processing, rough diamond sorting activities, site services and depreciation. Included in cost of goods sold is $1.3 million of operating expenses related to low grade ore stockpiles to be processed towards the end of the mine life, and therefore treated directly as a production cost. Cost of sales for the Current Quarter includes a $18.3 million write down to bring stockpile, work in progress and finished goods inventories to their net realizable value. Depreciation included in cost of goods sold was $27.4 million (Comparative Quarter $11.7 million). The increase in cost of goods sold from the Comparative Quarter mainly relates to the inventory write down and the processing of a higher proportion of lower grade ore. The remainder of the variation relates to the transition to underground mining, and is in line with expectations. For the Current Quarter, cash operating cost per tonne processed 1 was $58.69, compared to $44.69 per tonne in the Comparative Quarter. The increase in cost per tonne is explained by the transition to underground mining. Cash operating cost per carat recovered 1 was $147.69, compared to $54.83 in the Comparative Quarter. The increase is explained by lower carat recoveries due to the processing of lower grade ore. Cost of goods sold also includes a 2% royalty interest on diamond sales (calculated as 2% of the actual gross selling price in Canadian Dollars, minus the lesser of a 3% marketing charge and the actual diamond selling cost). In the Current Quarter, a royalty expense of $1.0 million (Comparative Quarter $0.8 million) was payable to Diaquem, a related party. 9 Based on an average $:US$ conversion rate of $1.34 Page 8 of 30

9 As at and for the three and six months ended FINANCIAL HIGHLIGHTS continued Current Quarter continued Selling, general and administrative expenses Selling, general and administrative expenses represent a portion of the Corporation s operating costs for its head and regional offices, including salaries, benefits, director fees and share based compensation, and all expenses incurred related to the diamond sales process. Total expenses of $5.9 million increased by $1.7 million from $4.2 million in the Comparative Quarter, mainly attributable to the new Performance Share Unit ( PSU ) and Deferred Share Unit ( DSU ) plans, which represent an expense of $1.0 million for the quarter. Exploration expenses Exploration expenses of $1.9 million were primarily related to work done on new targets on the Corporation s Renard property (see Exploration Update). In the Comparative Quarter, exploration expenses totalled $0.9 million, primarily related to work done on the Corporation s Adamantin property. Financial expenses (income) Financial expenses for the Current Quarter were $19.6 million, and were influenced by the application of IFRS 15, which increased accretion expenses on contract liabilities by $14.5 million. Excluding the impact of IFRS 15, financial expenses stood at $5.1 million for the Current Quarter, compared to $2.2 million in the Comparative Quarter. The difference is mainly attributable to $2.0 million in finance expenses, mainly incurred towards the Senior Secured Loan entered into at the end of the Comparable Quarter, partially offset by a decrease in interest expense related to an unsecured loan that was retired in the Comparative Quarter. The remaining difference is due primarily to a $1.5 million decrease in unrealized gains in respect of the convertible debentures. Foreign exchange (loss) gain A net foreign exchange loss of $2.3 million in the Current Quarter (Comparative Quarter $3.2 million gain) was mainly due to a $1.6 million foreign exchange loss on the convertible debentures (Comparative Quarter $2.3 million), and a $0.8 million foreign exchange loss on the equipment financing facility (Comparative Quarter $0.8 million gain), which are denominated in US dollars, reflecting the depreciation of the Canadian dollar relative to the US dollar. Income taxes During the Current Quarter, the Corporation recognized a deferred and income tax recovery of $11.8 million, representing an effective tax rate of 24.8% (Comparative Quarter $3.1 million expense, representing an effective tax rate of 49.6%), compared to the combined Canadian federal and provincial statutory income tax rate of 26.7%. The lower effective rate compared to the statutory rate for the Current Quarter is due to non deductible expenses. For the Comparative Quarter, the higher effective rate compared to the statutory rate is due provincial mining taxes. Page 9 of 30

10 As at and for the three and six months ended FINANCIAL HIGHLIGHTS continued Current Quarter continued Net loss and Adjusted net loss The Corporation reported net loss of $35.9 million (Comparative Quarter $3.1 million net income), and Adjusted Net Loss 1 of $31.3 million (Comparative Quarter $5.0 million). The $26.3 million increase in Adjusted Net Loss relates mainly to a decrease in gross profit by $35.1 million (before $8.0 million of additional revenues and $1.2 million of additional depreciation expense under IFRS 15), which includes an $18.3 million write down to bring stockpile, work in progress and finished goods inventories to their net realizable value. This was partially offset by a $12.8 million increase in deferred and income tax recovery (before $2.0 million of additional deferred tax recovery under IFRS 15). Including the above, the variation in net loss relates mainly to a $1.5 million decrease in the unrealized gain on fair value of the convertible debentures, a $5.5 million increase in the foreign exchange loss, and a net $5.6 million unfavourable impact related to the application of IFRS 15. Adjusted EBITDA The Corporation reported adjusted EBITDA 1 of $(6.4) million representing (13.1)% of adjusted revenues 1 (Comparative Quarter $16.8 million representing 39.5% of revenues). The decrease in adjusted EBITDA as compared to the Comparative Quarter relates mainly to a $6.3 million increase in adjusted revenues, offset by a $26.8 million increase in operating expenses, which includes a $10.9 million write down of cash costs included in inventory, to bring stockpile, work in progress and finished goods inventories to their net realizable value related to the processing of a higher proportion of lower grade ore in the Current Quarter. See Cost of Goods Sold under Financial Highlights for more information. Year to date Revenues Revenue during the six months ended ( Current Period ), totalled $112.9 million compared to $91.0 million for the six months ended ( Comparative Period ). It includes $35.5 million recognized from the contract liabilities related to the upfront proceeds received by the Corporation under the Renard Stream agreement (Comparative Period $11.9 million). Increase in revenue from contract liabilities reflects the modified retrospective adoption of IFRS 15. Revenue recognized to date was derived from 600,417 carats of run of mine production included in five tender sales events, with gross proceeds 2 of $85.2 million 4 at an average achieved price 1 of US$111 per carat ($142 per carat 10 ). In addition, the Corporation sold 84,643 carats of incidental production in two out of tender contract sales at an average price of US$19 per carat ($24 per carat 11 ). This compares to 809,285 carats sold in five tender sales events in the comparative period of, with gross proceeds of $85.4 million at US$79 per carat ($106 per carat 1,5 ). 10 Based on an average $: US$ conversion rate of $ Based on an average $: US$ conversion rate of $1.31 Page 10 of 30

11 As at and for the three and six months ended FINANCIAL HIGHLIGHTS continued Year to date continued Cost of goods sold For the Current Period, the Corporation s cost of goods sold were $118.2 million (Comparative Period $65.9 million). Included in cost of goods sold is $3.2 million of operating expenses related to low grade ore stockpiles to be processed towards the end of the mine life, and therefore treated directly as a production cost. Cost of sales for the Current Period includes a $22.1 million write down to bring stockpile, work in progress and finished goods inventories to their net realizable value. Depreciation included in cost of goods sold was $44.3 million. The increase in cost of goods sold from the Comparative Period mainly relates to the inventory write down and the processing of a higher proportion of lower grade ore. The remainder of the variation relates to the transition to underground mining, and is in line with expectations. For the Current Period, cash operating cost per tonne processed 1 was $55.53, compared to $48.28 per tonne for the Comparative Period. The increase in cost per tonne is explained by the transition to underground mining. Cash operating cost per carat recovered 1 was $122.64, compared to $56.03 for the six Comparative Period. The increase is explained by lower carat recoveries due to the processing of lower grade ore. During the Current Period, a royalty expense of $1.7 million (Comparative Period $1.7 million) was payable to Diaquem, a related party. Selling, general and administrative expenses Selling, general and administrative expenses of $9.9 million increased by $0.6 million from $9.3 million for the Comparative Period, mainly attributable to the new PSU and DSU plans, which represent an expense of $1.0 million. Exploration expenses Exploration expenses for the Current Period were $2.7 million primarily related to work done on new targets on the Corporation s Renard property (see Exploration Update). For the Comparative Period, exploration expenses totalled $1.6 million, primarily related to work done on the Corporation s Adamantin property. Page 11 of 30

12 As at and for the three and six months ended FINANCIAL HIGHLIGHTS continued Year to date continued Financial expenses (income) Financial expenses for the Current Period were $37.5 million, and were impacted by the modified retrospective adoption of IFRS 15, which increased accretion expenses in respect of contract liabilities by $29.0 million. Excluding the impact of IFRS 15, financial expenses were $8.4 million for the Current Period, compared to a financial income of $0.5 million for the Comparative Period. The increase is largely attributable to a $6.6 million decrease in unrealized gains in respect of the convertible debentures. The remaining difference is primarily due to $3.5 million in incremental financial expenses related to the Senior Secured Loan entered into at the end of the second quarter of, partially offset by a decrease in interest expense related to an unsecured loan that was concurrently settled. Foreign exchange (loss) gain A net foreign exchange loss of $5.5 million for the Current Period (Comparative Period $4.3 million gain) was mainly due to a $3.8 million foreign exchange loss on the convertible debentures, and a $1.7 million foreign exchange loss on the equipment financing facility, which are denominated in US dollars, reflecting the depreciation of the Canadian dollar relative to the US dollar. Income taxes During the Current Period, the Corporation recognized a deferred and income tax recovery of $14.1 million, representing an effective tax rate of 23.1% (Comparative Period $17.5 million expense, representing an effective tax rate of 90.0%), compared to the combined Canadian federal and provincial statutory income tax rate of 26.7%. The lower effective rate compared to the statutory rate for the Current Period is due to non deductible expenses. For the Comparative Period, the higher effective rate compared to the statutory rate is due to provincial mining taxes and to a mining tax credit of $9.8 million recognized as a credit against property, plant and equipment that was received in the first quarter of, as it relates to costs incurred towards the construction of the Route 167 Extension from November 1, 2012 to October 31, As a result, a $9.8 million deferred income tax liability was recognized to reflect the relinquishing of future Quebec mining tax deductions. Page 12 of 30

13 As at and for the three and six months ended FINANCIAL HIGHLIGHTS continued Year to date continued Net loss and Adjusted net loss For the Current Period, the Corporation reported net loss of $46.8 million (Comparative Period $1.9 million net income), and Adjusted Net Loss 1 of $45.2 million (Comparative Period $7.5 million). The $37.7 million increase in Adjusted Net Loss relates mainly to a decrease in gross profit by $53.4 million (before $25.3 million of additional revenues and $2.4 million of additional depreciation expense under IFRS 15), which includes a $22.1 million write down to bring stockpile, work in progress and finished goods inventories to their net realizable value. This was partially offset by a $20.2 million increase in deferred and income tax recovery (before $1.6 million of additional deferred tax recovery under IFRS 15 in the Current Period, and $9.8 million of additional deferred tax expense related to a mining tax credit recognized in the Comparative Period). Including the above, the variation in net loss relates mainly to a $6.6 million decrease in the unrealized gain on fair value of the convertible debentures, a $9.8 million increase in the foreign exchange loss, a net $4.5 million unfavourable impact related to the application of IFRS 15, and a $9.8 million decrease in deferred tax expense related to a mining tax credit recognized in the Comparative Period. Adjusted EBITDA For the Current Period, the Corporation reported adjusted EBITDA 1 of $1.0 million representing 1.1% of adjusted revenues 1 (Comparative Period $38.1 million representing 41.8% of revenues). The decrease in adjusted EBITDA relates mainly to a decrease in adjusted revenues 1 of $3.5 million and by a $31.8 million increase in operating expenses, which includes a $13.6 million write down of cash costs included in inventory, to bring stockpile, work in progress and finished goods inventories to their net realizable value related to the processing of a higher proportion of lower grade ore during the Current Period. See Cost of Goods Sold under Financial Highlights for more information. Page 13 of 30

14 As at and for the three and six months ended LIQUIDITY AND CAPITAL RESOURCES Liquidity risk is the risk that an entity will encounter difficulty in meeting obligations associated with financial liabilities that are settled by delivering cash or another financial asset. Longer term risks associated with satisfying its contractual obligations in respect of its debt and convertible debentures are dependent on the Corporation s ability to generate future cash flows. The Corporation manages its liquidity risk by forecasting cash flow requirements for its planned operating activities as well as its investing and financing activities. On June 26,, the Corporation received deferral of principal payments totalling $10.4 million for the unsecured debt facility and the senior secured loan from to, but excluding, September 30,. In order to comply with these covenants in future periods, the Corporation will need to execute on its cash flow estimates and on management s plans for future actions. Diaquem also agreed to waive the obligation of the Corporation to meet the historical debt service coverage ratio and the projected debt service coverage ratio until, but excluding, September 30, (see Note 9d of the unaudited condensed interim consolidated financial statements for the three and six months ended ). Management believes that the assumptions used by the Corporation in preparing its estimates are reasonable and plans for future actions are feasible (see Going Concern under Risks and Uncertainties for more information). Failure to comply with these covenants in the future may result in an event of default. If such event of default is not cured or waived, the Corporation may suffer adverse effects on its operations, business or financial condition, including termination of the debt facilities and acceleration of debts, and being required to return non offset portions of the deposit received on the stream agreement to the streamers (with an applicable rate of interest from the payment date of the deposit) due to cross default provisions. In such situation, there can be no assurance that the assets of the Corporation would be sufficient to repay such indebtedness or any non offset portions of the deposit received on the stream agreement in full, and such default could result in secured creditors realization of collateral. As a result, the Corporation is engaging in discussions with its lenders to amend the terms of certain of its financing agreements to better suit its working capital requirements as an operator in light of revised guidance and to support further growth of the Corporation s business. Page 14 of 30

15 As at and for the three and six months ended LIQUIDITY AND CAPITAL RESOURCES continued Consolidated cash flows Below is a summary of the Corporation s cash flow activities: For the three months ended For the six months ended Cash flow provided by (used in) operating activities, before changes in non cash working capital (15,239) 8,591 (17,674) 20,519 Changes in non cash working capital 13,706 (7,959) 20,746 9,097 Cash provided by (used in) operating activities (1,533) 632 3,072 29,616 Cash provided by (used in) investing activities (15,151) (21,908) (30,719) (42,521) Cash provided by (used in) financing activities (3,355) 14,082 (6,195) 11,355 Effect of foreign exchange rate changes on cash and cash equivalents (7) (24) Net decrease in cash and cash equivalents (20,003) (7,167) (33,849) (1,574) Cash and cash equivalents Beginning of Period 51,615 47,886 65,461 42,293 Cash and cash equivalents End of Period 31,612 40,719 31,612 40,719 Current quarter During the current quarter, the Corporation s cash and cash equivalents decreased by $20.0 million. Cash flows provided by operating activities Cash used in operating activities was $1.5 million in the Current Quarter (Comparative Quarter cash provided by operating activities was $0.6 million), explained by operating cash outflows before changes in non cash working capital of $15.2 million (Comparative Quarter $8.6 million inflows), largely driven by a $11.6 million decrease in cash gross profit, and changes in non cash working capital of $13.7 million (Comparative Quarter $(8.0) million). This is mainly explained by a $12.6 million decrease in inventory and a $1.5 million decrease in receivables. Cash flows used in investing activities Cash used in investing activities was $15.2 million in the Current Quarter (Comparative Quarter $21.9 million), reflecting cash outlays of $22.8 million for property, plant and equipment (Comparative Quarter $27.5 million). Cash flows used in financing activities Cash used in by financing activities was $3.4 million in the Current Quarter (Comparative Quarter cash provided by investing activities was $14.1 million). The Corporation made $3.5 million in principal repayments on long term debt during the Current Quarter. The inflows of the Comparative Quarter are explained by a draw of $50.0 million on the Senior Secured Loan net of financing fees of $2.5 million, which was offset by the repayment of Unsecured Debt Facility #2 in the amount of $30.1 million. Page 15 of 30

16 As at and for the three and six months ended LIQUIDITY AND CAPITAL RESOURCES continued Consolidated cash flows continued Year to date During the Current Period, the Corporation s cash and cash equivalents decreased by $33.8 million. Cash flows provided by operating activities During the Current Period, cash provided by operating activities was $3.1 million (Comparative Period $29.6 million), explained by operating cash outflows before changes in non cash working capital of $17.7 million (Comparative Period $20.5 million inflows), largely driven by a $8.8 million decrease in cash gross profit, and changes in non cash working capital of $20.7 million (Comparative Period $9.1 million). This is mainly explained by an $11.8 million increase in payables and accrued liabilities and a $7.7 million decrease in inventory. Cash flows used in investing activities During the Current Period, cash used in investing activities was $30.7 million (Comparative Period $42.5 million), reflecting cash outlays of $54.9 million for property, plant and equipment (Comparative Quarter $75.9 million). In addition, the Corporation received, during the Comparative Period, a mining tax credit of $9.8 million relating to the construction of the Route 167 Extension road, which was credited against property, plant and equipment. Cash flows used in financing activities During the Current Period, cash used in financing activities was $6.2 million (Comparative Period cash provided by financing activities was $11.4 million). The Corporation made $6.5 million in principal repayments on long term debt during the Current Period. The cash inflows of the Comparative Period are explained by a draw of $50.0 million on the Senior Secured Loan, net of financing fees of $2.5 million, which was offset by the repayment of Unsecured Debt Facility #2 in the amount of $30.1 million. Page 16 of 30

17 As at and for the three and six months ended LIQUIDITY AND CAPITAL RESOURCES continued Commitments and obligations In the normal course of business, the Corporation enters into contracts that give rise to commitments. The following table summarizes the Corporation s contractual obligations (see Note 7 of the condensed interim consolidated financial statements for the quarter ended ): Up to 1 year 1 5 years Over 5 years Total Unsecured debt facility (# 1) 6,001 9,910 15,911 Other secured debt 1,571 6,286 7,072 14,929 Renard mine road debt facility 6,000 32,552 46,372 84,924 Senior secured loan 36,263 92,888 19, ,799 Obligations under finance leases (1) 12,245 31,623 1,323 45,191 Convertible debentures (1) 6, , ,235 Operating Lease Payments ,018 Other operating commitments (see below) 6,798 22,160 19,387 48,345 75, ,558 93, ,352 (1) Amounts in US dollars are subject to variable interest rates and are determined based on the current spot rate at. Other Operating Commitments Under its long term contractual agreement for the supply of liquefied natural gas ( LNG ), the Corporation must set aside an amount of $2.0 million in restricted cash. The future minimum payments are based on the estimated minimum obligations over the term of the contractual agreement. Impact and Benefits Agreement In March 2012, the Corporation entered into an impact and benefits agreement (the Mecheshoo Agreement ) for the Renard Diamond Mine with the Cree Nation of Mistissini and the Grand Council of the Crees (Eeyou Istchee)/Cree Regional Authority. The Mecheshoo Agreement is a binding agreement that will govern the long term working relationship between the Corporation and the Cree parties during all phases of the Renard Diamond Mine. It provides for training, employment and business opportunities for the Cree during the Renard Diamond Mine construction, operation and closure, and sets out the principles of social, cultural and environmental respect under which the project will be managed. The Mecheshoo Agreement includes a mechanism by which the Cree parties will benefit financially from the success of the project on a long term basis, consistent with the mining industry s best practices for engagement with First Nations communities. Royalty The Renard Diamond Mine is subject to a 2% royalty interest on diamond sales (calculated as 2% of the actual gross selling price in Canadian Dollars, minus the lesser of: 3% marketing costs and the actual diamond selling costs) and a 2% NSR on minerals other than diamonds. Page 17 of 30

18 As at and for the three and six months ended LIQUIDITY AND CAPITAL RESOURCES continued Commitments and obligations continued Financial Guarantee SDCI is required to provide a financial guarantee to the Québec government of $15.2 million with respect to the Closure Plan for the Renard Diamond Project. In connection with the surety bond, SDCI provided cash collateral of $3.0 million to the underwriter of the surety bond. This amount is recorded in Other Financial Assets on the Interim Consolidated Statements of Financial Position. Other Commitment As at, SDCI has signed commitments of $16.3 million for the purchase of property, plant and equipment, which are expected to be incurred in. Contingencies Pursuant to flow through financing agreements entered into with investors in 2013 under the look back rules, the Corporation committed to incur, in 2014, Canadian Exploration Expenses with specific criteria in accordance with Canadian tax laws. In January, the Corporation received from the Canada Revenue Agency ( CRA ) a proposed assessment denying eligibility of certain expenses, representing $6.1 million of Canadian Exploration Expenses renounced to the investors. Subsequent to the quarter end, the Corporation received a revised proposed assessment from the CRA denying eligibility of further expenses related to the same flow through financing, which now represent in the aggregate approximately $9.7 million. At this stage, management maintains its position that the expenses were incurred as proper Canadian Exploration Expenses, and does not agree with the position of the CRA. The Corporation is continuing its discussions with CRA in an effort to reach a favourable outcome for the Corporation and is rigorously defending its position. Should the Corporation not be successful in its representation, a reassessment could give rise to indemnification obligations of the Corporation under the applicable flow through subscription agreements. At this time, given the facts and circumstances, while the outcome cannot be predicted with certainty, it is management's opinion that the outcome will not have a material adverse effect on the Corporation's financial statements, and as such, no provision has been recognized as at for this matter. No assurance can be made that the CRA will ultimately agree with the Corporation s position. FINANCIAL INSTRUMENTS The Corporation s financial instruments consist of cash and cash equivalents, short term investments, receivables, other financial assets, publicly traded securities, accounts payable and accrued liabilities, long term debt, and convertible debentures. The Corporation s financial instruments and risk management disclosure can be found in Note 9 of the audited consolidated financial statements for the year ended December 31,. Page 18 of 30

19 As at and for the three and six months ended FINANCIAL INSTRUMENTS continued The Corporation is exposed to foreign currency risk principally as its revenues are denominated in US dollars, while the majority of the Corporation s current and anticipated capital and operating expenditures are in Canadian dollars. From time to time, the Corporation mitigates its foreign exchange exposure to US dollar denominated sales by entering into forward foreign exchange and option contracts. The Corporation s risk management policy authorizes hedging up to 75% of its foreign currency exposure, on a rolling 24 month basis. For the three months ended, no material changes were identified in respect of the Corporation s risk management. Details of changes in financial instruments can be found in Notes 2, 3 and 7 of the Condensed Interim Consolidated Financial Statements. SELECTED QUARTERLY INFORMATION The following table sets out selected unaudited interim consolidated quarterly financial information of Stornoway covering the last eight quarters and is derived from the unaudited interim consolidated financial statements of the Corporation. Revenues Net (Loss) Income Basic Earnings (Loss) per share Diluted Earnings (Loss) per share 56,911 (35,864) (0.04) (0.04) March 31, 55,949 (10,980) (0.01) (0.01) December 31, 55,483 (118,570) (0.14) (0.14) September 30, 49,977 2,000 Nil Nil 42,550 3,112 Nil Nil March 31, 48,492 (1,175) Nil (0.01) December 31, 2016 Nil 52, September 30, 2016 Nil (15,548) (0.02) (0.02) Changes in the Corporation s quarterly results are largely driven, in and, by the number of tender sales events concluded during each quarter, as well as the number of carats included in each of these tenders, due to changes in grade. Fluctuations in the diamond market, for certain diamond categories and the prevalence of certain diamond categories, due to changes in recoveries profile, may also impact quarterly results, as well as foreign exchange rates, given the Corporation s revenues and certain debt instruments are denominated in the US Dollar, and changes in the fair value of derivatives. Additionally, results in have been influenced by the application of IFRS 15, and an impairment charge on the Corporation s property, plant and equipment recognized in December, has impacted results for the fourth quarter of. Given the Corporation officially declared commercial production effective January 1,, in 2016, quarterly results were mainly influenced by the Corporation s operation, exploration, development and financing activities. Historically, exploration and evaluation expenses, share based compensation expenses, changes in the fair value of derivatives, and foreign exchange variations, had the most significant impact on the Corporation s quarterly results, followed by general and administrative expenses. Page 19 of 30