DEAR FELLOW SHAREHOLDERS,

For the Financial Year ended 31st March, the Group reported a modest increase in sales of 4% to $720.9 million with profit-after-tax rising 41% to $71.4  million. We view this set of results very positively following the transformational agenda that we had established three years ago. Sales advanced across all business units even   as we expanded our gross  margins  from  24.2%  to  27.0%. This was a deliberate calibration that required tremendous organisational discipline to achieve. Whilst  we foresee that moving forward, this level of margin accretion will begin to taper, we are determined to hold them at these levels.

The Group continued to reduce its leverage, repaying $33.6 million of borrowings throughout the financial year. At the end of it, loans totalled $15.0 million whilst cash and cash equivalents stood at $181.0 million. As our balance sheet and cash profile strengthens, so does our resolve to maintain prudence in the management of our financial affairs and prepare for any economic downturn that may manifest in the proceeding years.

On a consolidated net asset basis, the Group increased its corporate net worth by $53.1 million to $560.2 million or $0.79 per share. In view of the improvements made in our operating performance and overall profitability, the Board of Directors is pleased to recommend a first and final dividend of 3.0 cents per ordinary share amounting to $21.2 million.

 
GENERAL COMMENTARY

After several years of persistent economic and political volatility – with the odd rude shock in between – the Swiss watch industry continued on the path to recovery, with watch exports expanding by 6.3% in 2018 to reach CHF21.2 billion. Having endured the steepest export decline in 2016, the business appears to have turned a corner. At the same time, the 2016 correction eliminated the inventory overhang in the luxury and prestige segment, and those segments have since been growing at the fastest clip. From a geographical perspective, whilst Singapore produced a tepid 0.6% year-on-year growth in Swiss watch imports, partly reflecting the state of consumer confidence in the country, Hong Kong and China remained heavyweights in this global equation, growing by 19.1% and 11.7% respectively. Combined, these two markets contributed 52.8% of the overall growth in Swiss exports for 2018.

Much of this growth in domestic Chinese consumption was driven by policy efforts of the Chinese government to rein in overseas spending by citizens, especially on luxury goods,  and  instead  redirect  it  homeward.  Multiple measures were enacted simultaneously, including the reduction in import duties for watches from the high of 20% in 2012 to 8-15% from 1 January 2019 along with cuts in the VAT rate from 16% to 13%. This had the positive effect of nudging brands into adjusting retail prices in China downwards to match the change in tax policy. Whilst outbound travel for Chinese tourists increased by 12.4% in 2018, the tightening of overseas credit limits on Chinese credit and debit cards, combined with stringent customs checks on returning travellers, reduced the propensity of the Chinese to shop lavishly while travelling. A new e-commerce law was also passed at the start of 2019, requiring all sellers of goods and services online to apply for a trading licence, which will inevitably be subject to taxes. For good measure, a highly punitive deterrent was added: any evasion  of  the  new  law  is  punishable  with imprisonment. This will most certainly curtail the thriving business of  Chinese  Daigou  operators,  who  shop overseas on behalf of clients at home. Daigou are estimated to resell around US$10 billion of luxury goods in China every year. As a final measure to spur domestic luxury goods consumption, the government had also committed itself to allow more duty-free outlets in airports and designated free-trade areas, meaning we will be seeing more tax-free shopping enclaves like that found on Hainan island springing up across the country.

Looking forward, whilst we expect continuing geo- political  tensions  and  volatile  stock  markets,  and  so anticipate an overall deceleration in the growth of Swiss watch exports to approximately 3% for 2019, all major watch producers realise that Asian demand will remain the key driver of growth for the next decade and beyond. In response, they are deliberately channelling merchandise to  the  countries  where  true  demand originates. Where we sit, so long as we continue to collaborate with the right partners, we are cautiously optimistic the ensuing years will bode well for the Group.

 
The Signal

The rate of digitalisation within the luxury sector is gathering speed as brands commit themselves towards online engagement  and  transactions.  Today, e-commerce is 10% of the US$400 billion luxury goods market and forecast to rise to 12% by 2025. Our assumption is that before the end of the next decade, luxury goods sold online will be 20% of the overall market. This means that we could see the value of luxury goods purchased  through  digital  platforms  rise  to US$100 billion – a plausible explanation as to why Richemont is anxious to capture a share of this potential with its investment in Yoox Net-a-Porter, its fashion ecommerce portal.

As of 2018, e-commerce at luxury groups such as Kering and LVMH account for some 6-7% of total group revenues. Richemont’s online business registered US$2.5 billion in net revenue primarily driven by Yoox Net-a-Porter whilst  competing  platforms  such  as  Farfetch reported US$1.4 billion in gross merchandise value. Combined, online sale at these four companies was US$8.5 billion. The signal is clear – online luxury commerce is here to stay.

These numbers, though large, is not what piques our curiosity. What interests us is the impact “going digital” has on the watch industry and more specifically, how it will shape purchasing behaviour of consumers today and tomorrow. More and more watch brands are prioritizing spending in digital marketing and developing advanced analytical tools to capture customer data for an “always on” shopping experience. Already 50% of all in-store transactions for  luxury  goods  are  influenced  by information gleaned online, and for the watch business, that rises to 84%, likely due to the technical nature of the product itself. So, our customers’ discovery phase is now inherently digital. But the question we have to ask is does this translate into a sustainable primary market, meaning more sales of new watches through official channels online?

In a  recent  survey  on  digital  shopping  behaviour conducted by McKinsey, it was reported that whilst 54% of the respondents based their purchasing decisions on peer reviews  with  a  similar  number  saying  that e-commerce sites aided in research of product facts, these factors alone were insufficient motivation for them to go the last mile and close the transaction online. What was most surprising is that 90% of all respondents stated that they considered the in-store, in-person experience still the most critical source of influence when making purchasing decisions. In other words, what customers desire is information online and shopping offline. This fact is evidenced by the recent news of the world’s largest online watch resource Hodinkee announcing its entry into traditional bricks and mortar retailing. It demonstrates that even with the largest and most captive watch audience in the world, there is a cap to the potential of pure-play e-commerce, and growing beyond a niche requires a physical space.

 
And the Noise

The secondary market for watches, encompassing pre- owned, the grey market, and everything in between, is as old as the watch industry itself. But it is only in the last couple of years that it has seized headlines, because of the vast sums of money being invested in the sector, which its proponents say is worth anywhere between US$50 billion up to US$500 billion a year. Hong Kong based Watchbox had supposedly received commitments of US$100 million in 2017, and last year Richemont completed its acquisition of the world’s most important pre-owned platform Watchfinder for a reputed US$250 million. But it is our view that the size of the pre-owned watch market is perhaps not as large as the headlines imply.

Bain & Company’s fall-winter 2018 report on the global luxury goods market estimates the total market size of the second-hand trade to be US$25 billion and that the watch and jewellery category accounts for 80% of the market. That  means  both  watches  and  jewellery  combined are a US$20 billion market. But because jewellery is three times larger than the watch market, the size of the pre-owned watch market is more likely to be closer to US$7 billion than it is to US$50 billion. It may even be far less as it is a fragmented market that is geographically localised, since taxes and security make moving watches across borders difficult. Proof is in the major watch buying cities in Asia – Hong Kong has dozens of pre-owned watch retailers while in Tokyo, it counts into the hundreds.

The truly global pre-owned watch  merchants  are  few  and far between. The most obvious are the  auction  houses like Christie’s, Phillips and Sotheby’s, which perhaps sell some US$350 million in watches between them each year. Then there are various online retailers which, in aggregate, transact anywhere between US$1 billion to US$1.5 billion in gross revenue. This is a substantial market, but several things are clear.  Firstly, the localisation characteristics of the secondary market means there is no first mover advantage.  The  internet has exacerbated this by lowering barriers to entry to almost zero; today a shop front can be no more than just an Instagram account. Second, because buyers of pre- owned watches are intrinsically more price sensitive, the market is more commoditised; in short, the cheapest wins. And the final point is that the quality of sourcing is crucial. Even though selling pre-owned watches is a commodity business, sourcing them is  the  opposite, since a good nose and sharp eyes are required to distinguish authenticity, condition, provenance, accessories and the like. Together, that means the business ends up in the same situation as many other e-tailers – low or no margins accompanied by the relentless pursuit of growth, funded by repeated rounds   of fundraising. As Amazon has demonstrated, that model works well in a very, very, very  large  market, which is selling basically everything to customers everywhere (with the exception of China of course). The watch business on the other hand is too small to sustain that, at least for now.

Retail Darwinism

The watch industry is undergoing a series of rapidly occurring, transformational shifts that will inevitably fracture the  traditional  retail  infrastructure.  As  an industry, we are past the inflection point, migrating from a unipolar system of wholesale distribution through to a multi-conceptual order where some of the most desired brands are retreating, several in entirety, from multi- brand retailers to pursue sales exclusively in their own contained brand environments and online platforms, or selectively consolidating their distribution to focus on their strongest regional multi-brand retail partners. This has obviously heightened friction between long-time partners and will of course result in scores of smaller retailers exiting the industry entirely.

By extension, the way brands approach trade fairs have also been altered. The biggest news of 2018 has arguably nothing to do with watches or watchmakers, but instead centres on the MCH Group, the Swiss exhibitions company that owns Art Basel and Baselworld. The latter was once the mighty champion of watch fairs that commanded a global audience. But over a lazy Sunday last summer, Nick Hayek, chief executive of the Swatch Group, declared that all of his 18 brands would no longer participate in Baselworld, a massive shock that reverberated across the watch industry. Within days the chief executive of MCH had resigned, while Baselworld’s board of directors swiftly promised reforms to address the issues that Mr Hayek cited as the reasons for his departure. Baselworld still took place in March 2019, but on a far smaller scale. The number of exhibitors is down 75% from a decade ago. Instead of showing at Baselworld, the Swatch Group staged an exhibition of its own construct in Zurich while Breitling announced it will leave Baselworld 2020 and instead produce its own travelling roadshow. But the twin Geneva giants, Rolex and Patek Philippe, remained the anchors at Baselworld and have given every indication they plan to continue. The fair’s travails illustrate a broader and more salient point: the disintermediation of watch fairs, with brands going direct to retailers, media, and even clients. Personally, I have been travelling to Baselworld every year for more than four decades now, and it has become a place where I look forward to seeing old friends and colleagues. The relationships that are built on this annual meeting at Baselworld cannot be underestimated and I for one hope the fair will continue.

Then the inevitable question: will watch retailers also fall victim to this level of disintermediation? The answer, in my view, is no. While only a couple of major brands are extracting themselves from multi-brand watch retailers, others such as Patek Philippe, Rolex and Hublot remain firmly committed to the wholesale distribution model. More importantly, it appears that the world’s largest luxury brands – and not mere watch brands – are coming to the realisation that the retail of watches is distinct from that for “soft” luxury like bags and clothing, particularly when it comes to mechanical watches for men. Although brands like Chanel and Hermes have the financial firepower to open a constellation of watch boutiques, both are gradually and selectively expanding their third-party watch distribution networks. That, in all likelihood, is recognition of the knowledge, goodwill, and client base that watch retail specialists possess. Even Francois-Henri Pinault, the Chairman of Kering, has stated that  the  luxury  watch  business  cannot  be managed on the same terms as his flagship fashion brands Gucci and Saint Laurent.

In an age of digital disruption, specialty watch retailers can no longer content themselves with living in a purely transactional world; we need to adapt or be faced with the prospect of extinction. For traditional specialist watch retailers to thrive, us included, there has to be a wholesale reorganisation of the manner in which we approach our prospects and clients. Whilst I’m a believer in the marriage of digital content and commerce, I’m an even bigger believer in the sector for primary market, specialty watch  retail.  At  the  furthest  end  of the equation, this sales channel will  continue  to  contribute to 80% or more of any luxury watch brand’s business.

Underlining our view that retail is still important, the value we can add as a specialist luxury watch retailer is our expertise and ability to create physical environments where consumers can engage with a human being. We seek to contextualise the wristwatch across different universes and hence, have developed differentiated retail  experiences  with  our  thematic salons. At The Hour Glass, we advance watch culture by building communities, empowering their constituents with the sharing of specialist knowledge and at the same time, engaging them with tailored experiences that enrich their lives with passion. We aim to transform every member of our sales team into individuals who can provide these constituents with specialist consultations, comparing and contrasting one to several watches for them. We view our single biggest weapon against any future channel threat to be our army of watch specialists  and  have  continued  to  invest  extensively in the area of qualitative learning and development.

 
ROUNDING OFF

I wish to begin by offering gratitude to the trust bestowed on us by our principal brand partners, the incredible commitment of our retail and management teams and the counsel I have received from our Board of Directors. It is the combined effort of this incredibly important group of people that has allowed us to accomplish many of our goals.

I also wish to acknowledge Andrew Siaw, a senior member of our retail management team who has decided to retire after 47 years in the watch industry. Andrew started his career at the age of 21 in my father’s watch business as a junior sales associate but  as  he tells it, his primary responsibility for the first 3 years was delivering watches to clients… on a bicycle! After having developed an impressive set of quadriceps, he was one of the first employees of The Hour Glass and over the last four decades, become a model member of the team. His one defining trait is that he was always prepared to  improve  himself.  Always  putting  the company’s interests first, and when necessary, taking on some of the most challenging boutiques and deftly turning them around. Andrew went out of his way to mentor younger members of the team and like the many colleagues he’s touched over his time with The Hour Glass, I will miss his can-do spirit.

And as old soldiers  fade,  there  is  a  new  generation  of industry leaders firmly established at the helm of their respective watch companies. Thierry Stern, owner and President of Patek Philippe; Jean-Frederic Dufour, CEO of Rolex; Jerome Lambert, CEO of Richemont; Frederic Arnault, scion of the LVMH Group; Stephane Bianchi, the recently appointed President of LVMH’s Watch & Jewellery division; and Ricardo Guadalupe, CEO of Hublot – they represent the generation who will direct and shape the watchmaking landscape for the coming decades. I am excited at the prospect of collaborating with these individuals and what it will mean for all of us, especially since we all share a common set of values – integrity, quality consciousness and a commitment to long term partnerships.

E-commerce is a new sales channel in development over the past two decades. In contrast, the pre-owned watch market, like the market for new watches, is anything but new. In the past few years, we’ve heard enough brand and retailer CEOs declare both their anxiety and excitement about the prospects for both e-commerce and the Certified Pre-Owned market. This moment reminds me of a very similar situation that arose ten years ago with the emergence of home-sharing platforms. When Airbnb arrived, hoteliers the world over panicked and predicted the disruption to their industry would mean impending doom to their business; and that if they did not enter into the fray, they would be missing out on the next big thing. Companies like Hyatt and Hilton rushed to invest in a variety of home sharing start-ups. A decade on, these same hospitality groups are jettisoning their stakes, declaring that they are unable to see a clear path to profitability for such businesses. And as hoteliers that cater to a premium clientele, the value proposition didn’t match with their company’s customer promise.

The true digital world is still terra incognita for our Group. But we are slowly and surely piecing together the parts that will ensure our strategic approach towards it yields long term success. And so, with the insights we have gleaned from other industries that were disrupted far earlier than ours, we feel it is best for us to adhere to the sagely advice proffered by the Chinese philosopher Lao Tzu: “Trying to understand is like straining through muddy water. Have the patience to wait. Be still and allow the mud to settle.”

HENRY TAY YUN CHWAN
Executive Chairman
31 May 2019