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Full Year Financial Statement And Dividend Announcement 2016

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Full Year Financial Statement And Dividend Announcement 2016

Consolidated Statements of Comprehensive Income for the (US$'000):

Statement of Financial Position as at (US$'000):


* No par value
** Retrospective application regarding initial application of Amendment to IAS 27: Equity Method in Seperate Financial Statements

Review of Performance

Overview

The Group's revenues and operating performance showed significant improvement throughout 2016, and was further manifested in Q4 2016 with record revenues for our fourth quarter.

For the year ended December 31, 2016, the Group reported revenues of US$ 72.5 million, profit from operations of US$ 21.2 million, and net profit of US$ 18.0 million, as compared to revenues of US$ 48.5 million, profit from operations of US$ 5.5 million, and net profit of US$ 3.6 million for the year ended December 31, 2015. The Group reported revenues in Q4 2016 of US$ 18.9 million, profit from operations of US$ 6.3 million and net profit of US$ 5.0 million, as compared to revenues of US$ 12.4 million, profit from operations of US$ 2.0 million and net profit of US$ 1.5 million reported in Q4 2015, and as compared to revenues in Q3 2016 of US$ 17.3 million, profit from operations of US$ 4.5 million, and net profit of US$ 4.0 million.

The ongoing improvement in our business throughout 2016, as further elaborated on in section 10, was primarily due to increased diamond manufacturing equipment sales, including Galaxy™ family systems, as well as due to increased recurring revenues.

Following the challenging FY2015, the Group benefited in FY2016 from positive macroeconomics, continued positive and renewed consumer demand for polished diamonds in key markets, a robust supply of rough diamonds at economically viable prices and no inventory overhang.

The Group delivered a record 84 Galaxy™ family systems in 2016. With record quarterly deliveries in Q4 2016 of 24 Galaxy™ family systems, all to customers, comprising 15 of the new Meteor™ small stone machines, seven Solaris™ machines, one Galaxy™ and one Galaxy™ Ultra system, the Group had an installed base of 299 Galaxy™ family systems as of December 31, 2016. Overall recurring revenues for FY 2016 (including Galaxy™-related, Quazer services, annual maintenance contracts, etc.) represented about 40% of our overall revenue. Overall revenues from our new polished diamond line of products and services, the Sarine Profile and its various components (Sarine Light, Sarine Loupe, Sarine Connect, etc.), hereafter referred to as Trade revenues, represented about 2% of our overall revenue for FY2016.

Balance Sheet and Cash Flow Highlights

As at December 31, 2016, cash and cash equivalents and short-term investments (bank deposits) ("Cash Balances") increased to US$ 38.0 million as compared to US$ 32.6 million as of December 31, 2015. The increase in Cash Balances was primarily due to the Group's improved operating results, lower inventory levels and higher payables, offset by the payment of US$ 12.2 million in dividends in 2016 – the US$ 5.2 million final dividend paid in May 2016 for the fiscal year 2015 and the US$ 7.0 million interim H1 2016 dividend paid in September 2016, the US$ 1.2 million purchase in Q2 2016 of DiaMining's app-based point of sale technology for diamonds, gemstones and jewellery (resulting in an equivalent increase in intangible assets), higher trade receivables (on higher recurring revenues and credit to certain customers) and increased fixed assets, primarily due to the Group's soon to be completed construction of its new facilities in Surat India.

Revenues

The Group reported revenues for the year ended December 31, 2016 of US$ 72.5 million, as compared to revenues of US$ 48.5 million for the year ended December 31, 2015. The Group reported revenues in Q4 2016 of US$ 18.9 million, as compared to revenues of US$ 12.4 million in Q4 2015, and as compared to revenues in Q3 2016 of US$ 17.3 million. The increase in revenues on a year-over-year basis in all geographies, but mainly in India, was primarily due to increased diamond manufacturing equipment sales, including Galaxy™ family systems, as well as due to increased recurring revenues, as noted above. Year-over-year sales in FY2016 of capital equipment increased by approximately 77%, while recurring revenues also increased by some 20%, as compared to FY2015. On a quarterly sequential basis, the increase in revenue was primarily due to higher diamond manufacturing equipment sales, offset somewhat by lower recurring revenues, which resulted, characteristically of Q4, from the Diwali holiday in India.

Cost of sales and gross profit

Cost of sales for the year ended December 31, 2016 increased to US$ 22.2 million, versus US$ 15.9 million for the year ended December 31, 2015, with gross profit margins of 69% in 2016 versus 67% in 2015. Cost of sales in Q4 2016 increased to US$ 5.3 million, as compared to US$ 4.3 million in Q4 2015, with a gross profit margin of 72% in Q4 2016 versus 65% in Q4 2015. The increase in cost of sales on a year-over-year basis, and the increased gross profit margin was primarily due to significantly higher sales volumes in FY2016 as compared to FY2015. On a sequential basis, cost of sales decreased in Q4 2016 to US$ 5.3 million, as compared to US$ 5.4 million in Q3 2016, with a gross profit margin of 72% in Q4 2016 versus 69% in Q3 2016. The decrease in cost of sales on a sequential basis, and the improved gross profit margin, was primarily due to higher sales volumes and product mix.

Research and development expenses

Research and development expenses for the year ended December 31, 2016 were US$ 10.8 million as compared to US$ 10.6 million for the year ended December 31, 2015. Research and development expenses for Q4 2016 were US$ 2.7 million, as compared to US$ 2.5 million in Q4 2015 and US$ 2.8 million in Q3 2016. Research and development expenses for FY2016 and for Q4 2016 increased on a year-over-year basis primarily on higher employee-related expenses, mainly higher incentive-based compensation expenses. Research and development expenses in Q4 2016 decreased minimally on a sequential basis as compared to Q3 2016, primarily due to lower outsourcing-related expenses. The Group continues to focus its research and development expenditures on the development of future growth products and services, primarily as related to its new Trade offerings.

Sales and marketing expenses

Sales and marketing expenses for the year ended December 31, 2016 were US$ 13.6 million as compared to US$ 12.6 million for the year ended December 31, 2015. Sales and marketing expenses for Q4 2016 were US$ 3.5 million, as compared to US$ 2.7 million in Q4 2015 and US$ 3.3 million in Q3 2016. The increase in sales and marketing expenses on a year-over-basis was primarily due to higher incentive-based compensation, higher sales commissions, increased marketing expenses and the absence of a reversal of certain miscellaneous accruals in the comparable period last year. The sequential increase in sales and marketing expenses for Q4 2016 as compared to Q3 2016 was primarily due to higher incentive-based compensation and sales commissions.

General and administrative expenses

General and administrative expenses for the year ended December 31, 2016 were US$ 4.7 million as compared to US$ 3.9 million for the year ended December 31, 2015. General and administrative expenses for Q4 2016 were US$ 1.1 million, as compared to US$ 0.8 million in Q4 2015 and US$ 1.1 million in Q3 2016. The increase in general and administrative expenses on a year-over year basis was due to higher incentive-based compensation and increased third-party professional fees. The sequential increase in quarterly general and administrative expenses for Q4 2016 was primarily due to increased third-party professional fees.

Profit from operations

Profit from operations for the year ended December 31, 2016 was US$ 7857 million as compared to US$ .5. million for the year ended December 31, 2015. Profit from operations for Q4 2016 was US$ 356 million as compared to US$ 2.0 million in Q4 2015 and US$ 4.5 million in Q3 2016. The increase in profit from operations on a year-over-year and sequential bases was primarily due to increased revenues, as detailed above.

Net finance income (expense)

Net finance income for the year ended December 31, 2016 was US$ 0.8 million versus an expense of US$ 0.2 million for the year ended December 31, 2015. Net finance expense for Q4 2016 was US$ 2 thousand as compared to an expense of US$ 43 thousand in Q4 2015. Net finance income in FY 2016 included a reversal of US$ 0.4 million in interest charges relating to prior period tax assessments under dispute in India.

Income tax expense

The statutory corporate tax rate in Israel in FY2016 decreased to 25% (from 26.5% in FY2015). The Group's effective tax rate is a blend of the statutory tax rate in Israel reduced by substantial tax benefits, in accordance with tax directives enacted in Israel as of 2011, accorded to our export-oriented revenue mix (taxed at between 9%-16%), offset by the higher statutory tax rate in India (34%).

Income tax expense was US$ 4.0 million for the year ended December 31, 2016 versus US$ 1.7 million forthe year ended December 31, 2015. Income tax expense was US$ 1.3 million for Q4 2016 as compared to an expense of US$ 0.5 million for Q4 2015 and US$ 0.9 million in Q3 2016. The increase in income tax expense was primarily due to higher pre-tax profitability, as discussed above, and was also due to the write down of certain deferred tax assets.

Profit for the period

Net profit for the year ended December 31, 2016 was US$ 18.0 million as compared to US$ 3.6 million for the year ended December 31, 2015. Net profit for Q4 2016 was US$ 5.0 million as compared to US$ 1.5 million in Q4 2015 and US$ 4.0 million in Q3 2016. The increase in net profit on a year-over-year and sequential bases was primarily due to increased revenues, as detailed above.

Commentary

We expect the following industry trends to continue influencing our business:

  1. Fundamental global economic indicators continue to be overall positive.

  2. In the U.S. diamond jewellery sales during the key Fall 2016 holiday season were slightly weaker than expected, but industry sentiment is, overall, optimistic and positive for 2017. In the second largest market for polished diamond jewellery, China, year-end results were not conclusive, with both positive and negative quarterly results reported by major retailers. Interestingly, Hong Kong's jewellery and luxury sales rose for the first time in more than two years in December 2016, as tourist numbers increased and consumer sentiment improved. Mainland Chinese New Year sales were improved over last year's, and sentiment is overall optimistic and positive in China as in the U.S. In other key APAC markets sales remain on a positive track.

  3. During the fourth quarter of the year rough diamond sales continued to show a marked recovery over 2015, as pricing remained stable (for both rough and polished diamonds) and no inventory issues hampered sales, even as sights continued, as in the third quarter, to realise volumes less than those in the first six months of the year. De Beers' first sight for 2017 was in excess of US$ 720 million, almost a third higher than at the corresponding sight in 2016. The second sight for the year ended just Friday of last week, with formal data not yet available. We believe, based on preliminary anecdotal information, that the sight was in line with January's sight, both as far as quantities sold and the prices at which they were sold, which would further indicate an overall positive industry sentiment. We expect rough diamond sales and the consequent polishing activity to continue similarly for the rest of the year, as there are no significant negatives impairing profitability throughout the diamond industry value chain.

  4. There are no known polished diamond inventory issues of substance at this time.

  5. The trends noted above, positive macroeconomics, continued positive consumer demand for polished diamonds in key markets, a robust supply of rough diamonds at favourable prices and no inventory overhang, should underpin continued healthy industry activity in 2017, and, by extension, Group sales. Incidentally, we have had no substantial negative impact from India's demonetization program, as evidenced by our record fourth quarter.

  6. With deliveries in Q4 2016 of a new record 24 Galaxy™ family systems to customers, comprising 15 Meteor™ systems, 7 Solaris™ systems, one Galaxy™ and one Galaxy™ Ultra system, the Group had an installed base of 299 Galaxy™ family systems as of 31 December 2016. We delivered a record 84 systems in 2016, but looking forward to 2017 we do not necessarily expect that record to be replicated (or broken). Some of the demand may have come from our launch of the Meteor™ under attractive introductory terms, which are no longer offered. Additionally, as of 1 January 2017 we have also updated our pricing of the various models' ongoing use fees, and, as to be expected, this has slowed new orders in the short term, as the market adapts to our new terms.

  7. We are bolstering our enforcement of our intellectual property (IP) rights to preclude unauthorised use of our inclusion mapping technology. We intend to seek remedies against those who illegally compete with us by violating our IP rights, by making, selling, renting, buying, using or using the output from infringing products and pirated software. In particular, but not only, with respect to the operator in India, who, as reported upon in our Q1 2016 announcement of 8 May 2016, was and is suspected to be operating (and now is attempting to sell) a number of devices, which we believe are infringing upon the core patented (including in India) processes of our inclusion mapping. We shall leverage the patent granted us in India, as well as the inherent copyright of the Advisor™ planning software, which without infringing upon said copyright (a criminal offense in India) the inclusion mapping results cannot be input into the planning process, to protect our IP aggressively.

  8. Sales programs utilising Sarine Profile™ by retailers in the U.S and the Asia Pacific (APAC) region continue to expand. Programs with retailers in the U.S. are gaining momentum slower than those in the APAC region, due to various reasons including the average quality of stones sold and other corporate and consumer cultural issues. Notwithstanding this, we are seeing a significant growth in interest in the Sarine Profile™ compared to a year ago, with growing momentum both with large regional and national chains and high-end independents. We hope to double the number of stones scanned for the Sarine Profile™ in 2017 and expect its contribution to overall Group sales to be around 5%.

  9. Our new technology for the automated, objective and consistent mapping and identification of a polished diamond's inclusions and the subsequent derivation of its Clarity grade continues in large-scale testing in India, and is on track for commercialisation in Q3 2017. Likewise for the Color grading technology, which is in parallel testing. We are considering various commercialisation avenues based on a recurring revenue model per carat weight of each stone graded. Typical customers could be existing players in this domain – gemmological laboratories, large chain retailers with existing in-house gem labs, large manufacturers who already prefer self-certification, etc.

  10. The Allegro™ system has demonstrated yield benefits for both high-end sophisticated manufacturers and lower-end manufacturing of standard sized stones, where the emphasis is more on accurate dimensions with maximal weight and less on perfection. However, given the significantly longer processing time required by the Allegro™ and the hands-on approach preferred by many cutters, market potential is still an issue. We have decided to de-emphasise this program in 2017 and focus on our new polished diamond offerings, Clarity and Color grading, as detailed above, which have more immediate upside potential for the Group.

  11. We will focus our research and development initiatives on the following projects:

    • Polished diamond trade systems:
      • Expansion of our operational infrastructure for Sarine Profile™;
      • Continued enhancement of Sarine Profile™ in order to provide additional capabilities for customer programs, as required, mainly additional shapes – current work continues on less ubiquitous shapes, such as Ovals, Pears, Marquises and Hearts.
      • Integration of the recently acquired Sarine Connect™ (previously known as DiaMining) technology to enhance Sarine Profile™ with mobile device capabilities, as well as virtual inventory functionalities, while also augmenting Sarine Connect™'s interface with more retail-oriented features.
      • Enhancement of Sarine Profile™ to support the display of jewellery pieces and not just loose polished diamonds. As retail businesses display set jewellery by far more often than loose stones, this will significantly broaden the appeal and applicability of Sarine Profile™.
      • Development of the software infrastructure for the Clarity and Color grading capabilities in testing, including process management, data security, etc.

    • Manufacturing products: Overall ongoing improvements to our Advisor™ rough planning software continue to enhance its capabilities and productivity along with refined IP protection. We have completed development of the ability to predict the planned polished diamond's light performance during its planning stage. We are now working on the capability to plan a polished diamond to meet desired light performance grades in general (e.g., Ultimate) or specific grades of specific sub-parameters of light performance (e.g., Ultimate Fire). Completion of the integration of these new capabilities with Advisor™ and our faceting quality control software (Instructor™), so as to allow manufacturers to incorporate light performance into their manufacturing criteria and develop enhanced Cuts based on light performance as well as proportions and symmetry, will be released in Advisor™ 7.0, scheduled for mid-2017.

    • Non-diamond gemstones: Possibly work on increasing the Allegro's throughput, so as to increase its market viability, as a back-burner endeavour.