DEAR FELLOW SHAREHOLDERS,
For the financial year ended 31 March 2016, The Hour Glass registered a modest 4% contraction in revenues to $707.5 million whilst net profit after tax declined 10% to $53.5 million. Given the intensity of headwinds faced by the global specialty and luxury watch market in the preceding two years, this set of results serve as consolation that The Hour Glass’ business, though impacted, remain resilient and able to withstand the vagaries of the market.
Where we experienced a significant downdraft in demand, management took a contrarian approach and tightened prices. As a result, the Group achieved a 5% gain in gross margins thereby offsetting the drop in sales. While this margin optimization strategy has served us well, we are fully aware that it is also not without limits and in time, we may be required to adjust our tactics.
Part of the expansion of our annual operating expenses, and one that led to the subsequent compression in earnings, can be attributed to a one-time SG50 corporate donation of $5.0 million made to three charitable institutions in Singapore; namely the Community Chest, the National Kidney Foundation and the National Heritage Board. These funds also qualified for the government’s dollar-for-dollar matching grants and so doubled the impact of our donations to $10.0 million. Responsive philanthropy is a value that has been woven into our corporate fabric since its founding and as a Singaporean company that has benefited from the tremendous economic success of this nation, this gift is important as we believe it serves to progress the lives of our fellow Singaporeans.
We employ significant operating leverage in our business, primarily in the manner in which our teams are compensated and our present metric of salaries are set within an acceptable industry range. Where we have to remain more vigilant is in our facilities costs. Due to an intensive network expansion plan over the past five years that saw us opening 16 new boutiques over that period, our rentals as a percentage of sales have risen 60% from FY2012 to the latest financial year.
The momentum in which cash is being absorbed back into the business is decelerating. This is a good thing and it is a key management goal to ensure we continue enhancing both the productivity of our assets and our cash conversion cycle. With 6 new store openings in the last 12 months alone, it has meant that we deployed $36.2 million into capex and working capital to broaden our inventory base. This resulted in stock turn ratios declining by 11% to 1.7 times (our target is 2.0 times). As we reach the end of our 5 year network developmental cycle and transition into an era of slower expansion, we are confident that we will be improving the quality of our free cash flow generation. This is already evident in FY2016 as our free cash flow turned positive from the prior year, producing $10.5 million in free cash.
On a consolidated net asset basis, our corporate net worth increased by $31.1 million to $439.9 million or $0.62 per share. Given our consistent operating performance, the Board of Directors is pleased to recommend a first and final dividend of 2 cents per share amounting to $14.1 million.
2015 saw Swiss watch exports consolidate for the first time in five years falling 3.3%. The pace of decline precipitated into the first quarter of 2016 where exports again fell by another 8.9%. Key markets including Hong Kong, Singapore and the United States contracted by 32%, 15.3% and 15.4% respectively. This is a worrisome trend as it means that the downward pressures continue and that markets have yet to hit bottom. Should the current trajectory of these declines maintain, the Hong Kong market may end 2016 at a level 50% of its peak. We believe these results can be primarily attributed to persistent China weakness as well as a glut of inventory in global wholesale networks. This excess inventory will take at least another 12 to 18 months to regularize as manufacturers dial back production.
If there is a historical analogy that can neatly package the retail mood within the luxury watch industry today, it will have to be the ‘97 / ‘98 Asian Financial Crisis. It is worthwhile noting that though a very unprepared The Hour Glass suffered a 40% drop in revenue during the AFC, we do not anticipate that our sales will chart a downward trajectory to levels experienced then. This view is merely an expression of the prevailing market sentiment prevalent amongst players in the sector.
The watch industry’s current predicament is the product of both cyclical as well as structural forces and this situation is posing an existential threat to many industry participants with brands rethinking their future networks and retailers, their future clients. One thing we are sure of is that when we come out of this, the world is not going to be the same as before. But we are also certain that any re-ordering of the watch industry architecture will gradually unfold over the next several years.
A New World Order
In this new order we see three things occurring. Firstly, as the demand equation rebalances, so will the brand’s production output and distribution as both wholesale and direct owned store networks will be rightsized. Whilst certain watch brands continue to advance their intentions to go the last mile and engage end clients, others have begun the painful process of consolidating their presence and retreat from the problems of over-distribution in markets. In the case of Hong Kong and China where there have been an excess of both multi-brand and monobrand boutiques, we anticipate networks may contract by up to 40% with some historic retailers exiting the market completely.
Secondly, we need to recognize that there is a generational shift in the status quo. As has been repeated time and again to our senior team, there will be more of them (the millennials) and less of us (Baby Boomers and Gen Xers). Anecdotally, this is also reflected in our organization’s composition where millennials make up 40% of the team, Gen Xers 45% and Baby Boomers 15%. Within five years, millennials will constitute over 45% of the team. So the basis is that we cannot expect the younger generation to adapt to us, it is us who must adapt to them. This transition will have a profound impact in the manner in which we engage our future clients. At both the brand and retail levels, the watch industry still exist in a pre-digital era and most have not fully embraced the challenge head on. Physical showrooms alone are no longer the final retail solution and our watch retail business model will begin to alter form. With the internet of things, how traditional brick and mortar retailers deliver an integrated online-offline service to their clients will determine the winners in this new world order. ‘Disrupt yourself before someone disrupts you’ has never been a more appropriate maxim.
Lastly, every luxury consumer today is a global shopper. And as technology continues to discombobulate shopping in the form of online category killer classifieds, online marketplaces and price comparison apps offering enhanced object recognition software, we believe that brands will trend towards ensuring that there is less retail pricing dissonance globally and advance towards a higher degree of pricing parity between markets. External factors that will also have to be closely monitored are how exchange rate fluctuations contribute almost immediately to the flow of shoppers to the lowest priced markets. We witnessed that when both the Yen and Australian Dollar depreciated against the US Dollar and the Hong Kong Dollar. Overnight, tourist spend in our boutiques in Japan and Australia rose to 40% of overall sales. So how a brand sets their prices in each capital city will have to take account such flows as the sophisticated Asian luxury shopper traverses the world seeking arbitrage.
Doubt Is The Origin Of Wisdom
I will be the first in my organization to admit that in the months that have passed since the beginning of 2014, our executive committee have engaged in many moments of deep reflection and examination. As financial market volatility and economic uncertainty cast a wet shroud over the enthusiasm of global luxury shoppers, questions over the veracity and validity of our assumptions and the developmental road map we drew up in 2012 have been raised.
Principal to this was defining the point in the economic cycle we were currently in. Though none of us are trained economists, our modus operandi has always been to deploy capital during down cycles. In 2012, we were accurate with our assessment of the macro environment and anticipated an impending softening of the markets. Our view stood that at the very latest, the market will have bottomed out by year-end 2015 and mapped our growth plans on that basis to capture the upswing that would ensue (As an aside, one must appreciate that opening a retail store doesn’t happen overnight; it can take as long as 3 years of planning and negotiations). We certainly did not anticipate major structural shifts to occur in the global economy but by mid-2014, were persuaded that post 1990 Japan may not have been an isolated case and the world’s economies were entering a period of secular stagnation characterized by low growth, low consumption and low returns. Singapore and Hong Kong are prime examples where we are already experiencing a slow-burn recession like environment.
Over the past decade, most of what our senior teams have engaged in is managing the business to capture the rising markets. The time has come to refactor our thinking and adapt ourselves to managing a downturn, transforming the way we do our business. One key action in such a situation is to focus on being micro-prudential and upping of the intensity of our operational efficiency. In this respect, we began with an internal review of all our policies and processes. Within our human resource framework in Singapore alone, we have been able to fix legacy systems and save over 30 man days every year just from reorganizing our data and approval flow for payroll. We have also successfully introduced an entirely new employee development initiative aimed at ensuring retail succession and create multiple career pathways for our sales personnel to remain committed to the organization. Slower periods also enable us to begin with new upgrade cycles for our technological platforms and base ERP infrastructure. Our aim is to complete the implementation of this programme and the training of our teams by 2020 at the latest. Most importantly though, recognizing that access to funding may be possibly curtailed in the coming years, we worked with our banks to prepare extra lines of credit and launched a $500 million medium term note programme in the event we need to respond to any opportunity that may arise in the coming years.
A Bite Of History
My parents established our family’s roots in the watch retail trade in Singapore in 1942, opening a humble kiosk in the New World Amusement Park selling entry level Swiss watches such as Enicar, Titoni and Titus. Shortly after, the Japanese occupation forced them to cease all operations and it was not till 1946 that they were able to re-open their first physical store at 100 North Bridge Road. Trading under the name ‘Lee Chay & Co’, the store presented an assortment of merchandise including electrical appliances, watches, clocks and writing instruments. On a visit to Singapore in 1948, the founder of Rolex S.A. Mr Hans Wilsdorf called on my parents and they had a positive exchange. Seeing that we were already representing Swiss brands, Mr Wilsdorf confidently opened a dealership account with Lee Chay to retail Rolex watches. I still retain fond memories of those pioneering years as Mr Wilsdorf made it a point to visit the market annually. Each time he came, I would find myself perched on his lap whilst he held discussions with my parents. This fortuitous opening of the Rolex dealership was shortly followed by the representation of Patek Philippe in the early 50s when Mr Henri Stern was then President of the manufacture. Being of a similar vintage, I was fortunate to later acquaint myself with his son, Philippe who had also begun touring Singapore and the Far East.
In 1971, upon the completion of our university degrees, both Jannie and I decided to return to Singapore. It was truly then that we spawned an active interest in watches and the broader luxury goods market. During that period, I maintained the pursuit of my medical practice whilst Jannie, a then lecturer at the University of Singapore, was fascinated by the opportunities presented by the business environment and readily spent her days off classes at Lee Chay selling watches. It was against this backdrop that in 1979, Jannie and I decided to follow in the footsteps of my parents and strike out on our own by co-founding The Hour Glass. We were uncertain of the challenges that lay ahead but we were absolutely clear that success was within the envelope of outcomes. The rest, as it is said, is history.
After 36 years of dedicated service to the Company, Jannie has chosen to relinquish her executive functions within the Group and retire as the Executive Vice-Chairman of The Hour Glass Limited. We are happy she continues to remain on the Board as a Non-Independent and Non-Executive Director and serves in the capacity of Senior Advisor to The Hour Glass.
As many of us who have had the privilege to work alongside her, Jannie’s entrepreneurial vigour and persistence, her inspirational “never say die” attitude, transparent, inclusive and motherly management style helped forge a corporate culture that till today remains the bedrock of our company. In the foundational years, our roles were divided. Jannie was The Hour Glass’ front facing spokesperson whilst I was happy contributing from behind the scenes. We formed a formidable partnership and that was a decisive element in our ability to scale the business in a relatively short period of time. In rapid succession, Jannie led the establishment of The Hour Glass into the then emerging luxury markets of Australia, Malaysia and Thailand. All major pillars of our Group today. She has developed an impressive curriculum vitae that includes her being the longest serving President of the Singapore Retailers Association, won multiple international business awards and has a veritable list of achievements and accolades that can fill notebooks. But I personally believe that her singular most important accomplishment, and what will be regarded as the legacy of her life, is that she shaped an organization that will survive well beyond her. On behalf of the Board of Directors, management and team at The Hour Glass, we wish her a well-deserved retirement and success in all her future endeavours.
Since January 2016, we began a new tradition at our weekly Monday operations meetings. We now close each session with every member of the team offering appreciation and gratitude to an individual or an event that occurred the week before. A statement shared where more often than not, is in recognition of another co-worker’s exceptional contribution, a client’s generosity or simply, how they enjoyed downtime with the family. At a time where pressing competition and the volatility of the markets can impair sentiment and create negative clouds in the mind, this humble exercise serves a greater purpose. It encourages the development of humility and compassion within our team. That at the start of each week, it allows us to focus on reinforcing the positive. It is with this positive cast I wish to conclude this year’s letter.
We offer gratitude to our clients who continue to choose to patronize our boutiques, our brand partners for ensuring that we have the merchandise to support our business goals, our independent directors and our teams who contribute so much of themselves and their lives to the purposeful advancement of our organization.
To our recently departed friend and business partner Mr Jopie Ong – who in 1979 took that initial leap of faith and invested behind Jannie and myself, believing in what we both dreamt of building. Without him, The Hour Glass will not exist in its current form. Jopie, thank you for making our dreams real.
HENRY TAY YUN CHWAN
31 May 2016