Risk Factors

3. RISK FACfORS
There are a number of risk factors, both specific to the D&O Group and relating to the general business environment, which may have an impact on the operating performance and financial position of the Group and affect the achievability of the forecast. Investors should carefully consider the following factors (which may not be exhaustive), which may have a significant impact on the future performance of the Group before applying for the Public Issue Shares.
3.1 Business Risks
The Group is subject to general business risks as well as certain risks inherent in the industry in which
it operates. For instance, the Group may be affected by a general downturn in the global, regional and
national economies, entry of new players, constraints in labour supply, changes in law and tax
legislation affecting the industry, increase in production and purchasing costs, changes in credit and interest rate conditions and fluctuation in foreign exchange rates.
Any adverse developments in the political situation and economic uncertainties in Malaysia and/or other countries in whieh the Group has business links, directly or indirectly could materially and adversely affcct the financial performance of the Group. These include risks of war, global cconomic downturn, expropriation, nationalisation, unfavourable changes in government policies and regulations such as foreign exch:ange rates and methods of taxation and currency exchange controls. There can be no assurance that allY change to these factors will not have a material adverse effect on the Group’s business.
Although the Group seeks to minimise these business risks through, inter alia, prudent management policies and maintaining good business relationships with its customers and suppliers, no assurance can be givcn that any change in any of these factors will not have a matcrial adverse effect on the Group’s business.
3.2 Rapid Technological Change
The semiconductor industry is characterised by rapidly changing technologies and frequent introduction of new products and services. Advances in technology typically lead to pricc erosion and decreased margins for older range of products and may also cause the capabilities of the Group to be less competitive with new emerging technologies and, sometimes, to even be obsolete.
If the Group fails to develop advanced manufacturing services in a timely manner, or develop and introduce new products to meet customers’ requirements and address technological advancement in a timely and cost-effective manner, the Group may lose existing or potential customers demanding these services or products. Furthermore, the Group may also miss the opportunity to benefit from the higher average selling prices that may be derived from newer and emerging turnkey services.
In order to remain competitive and to keep abreast with the latest technology development, the R&D team constantly evaluates the machinery technology in the market as part of its manufacturing enhancement process, as well as the development of new products or product enhancements that respond to technological changes or customers’ requirements. The R&D team is also continuously looking out for suitable machinery that meets the Group’s budget and technological requirements.
Notwithstanding the above, there can be no assurance that the Group’s products and services will not be rendered obsolete by the emergence of new technologies or new customers’ requirements.
3. RISK FACfORS (Cont’d)
3.3 Competition
The D&O Group faces competition from various local and foreign turnkey service providers in the semiconduClor industry. The Group is operating in an environment that is constantly and rapidly evolving and requires players to be capable of supplying increasingly complex semiconductor components. On the global fronl, emergence of competitors who arc able to provide the same services at a lower cost could polentially result in lhe relocation of MNCs or termination of existing contracts.
The Board of D&O believes that the principal elements of competition among the turnkey contract manufacturing service providers in the semiconductor industry include technical competence, engineering capability, quality. time-to-market, breadth of assembly and lest services. qualily of customer service and competitive pricing. The Group believes tllat its experienced management team, prompt completion and delivery of customers’ orders, consistent quality, innovative designs and ability to offer competitive pricing have been and will conti.nue to be imparlant factors in al1raCling and retaining customers.
Furthermore, the Group has been in business for more tban tcn (10) years and has successfully built up strong relationships with its customers. The Group is also continuously exploring different ways to improve on its prOdUl..1ion processes in order to increase production efficiency and reduce wastage. Despite the aforementioned strategies, there can be no assurance that the Group will not be affected by the competitive strategy adopted by other service providers within the same industry, both locally and overseas.

3.4 Dependence 00 Key Customers
For the financial year ended 31 December 2003, approximately 94% of the revenue of the Group was derived from sales to a few well-known MNC customers. The loss of an)’ of these key customers may adversely affect the performance of the Group.
The risk with the Group’s reliance Oil key customers include the relocation of these MNCs to other
countries or the cessalion of ccrtain product lines by these customers which may result in the Group
losing a substantial portion or its business.
Nevertheless, the Board of D&O believes that the high concentration in a few customers is the norm for contracl manufacturers in thc semiconductor industry and that the dependence on a few key customers will not create significant problems for the Group in view of the length of the Group’s relationships with its customers and its ability 10 mcet the requirements of its customel3 in terms of delivery, quality and pricing. The Board of 0&0 is of the opinion that ils medium-sized customer base has enabled the Group to work closely with ils customers and fully concentrate on meeting their needs.
Over lhe years of operation, the Group has developed long business relationships wilh lhese key customers as evidenced below and the Board is nOI presently aware of and do not foresee any circumstances that could adversely affect the continuation of these business relationships.
LeDgtb of Relatioosbip Customers Country (Years) STMicroelcctronics Sdn Bhd { STMicroeleclronics Malaysia { 10 Pte Ltd Singapore Fairchild Semiconductor (Optoelectronics) Sdn Bhd Malaysia 7 Central Semiconductor Corp. USA 7 Agilenl Technologies (Malaysia) Sdn Bhd Malaysia 5
3. RISK FACTORS (Conl’d)
The continuous orders from the above customers through the years is also a testimony to the strong working relationships between the D&O Group and its customers.
The Group’s risk of losing its customers is also mitigated to a certain extent by the nature of the business contracts it has with its customers, which are mainly based on ‘captive contract’ terms. Under the ‘captive contract’ arrangement, these customers consign all their production equipment to the Group for the purpose of producing scheduled orders. The nature of such an arrangement substantially reduces the likelihood that these cuslomers will terminate the existing business contracts as such a move will involve high relocation costs and disapproval by MNCs’ end customers. to switching manufacturers without strong justification and benefits to the customer in terms of cost, quality, reliability and delivery perfonnance. Re-qualification of any new manufacturer requires a very costly and tedious process, and long quality and reliability tests through the entire end user chain.
In addition, the nature of the industry is such that it involves high vendor switching costs and requires a long gestation period of acceptance. This is because customers normally require a lengthy time to carry out operational and quality audits of the turnkey manufacturers’ production capabilities and facilities, and the ensuing evaluation of the quality of products manufactured. Consequently, it is usual that customers would foster long-term business relationships with their turnkey manufacturers. The D&O Group believes that by fostering a long-term business relationship with its customers, the risk of losing its customers is mitigated to a certain extent.
Nonetheless, there is no assurance that the Group will continue to retain these MNC customers and thai they will maintain or increase their current level of business with the D&O Group in the future. The loss or partial loss of any of these customers would adversely affect the Group’s revenue and operating profits, and force the Group to curtail its growth plans.
The Group is mitigating the risk of over dependency on its existing MNC customers by expanding its OEM product portfolio. The Group’s R&D initiatives focus on the consolidation of its inherent strengths and diversification into designing new product packaging and new tooling for OEM products. The Group has invested continuously in upgrading its existing technology platform to assemble new OEM products. It is anticipated that the revenue contribution from its OEM products will increase from approximately 9% to 23% for the financial years ending 31 December 2004 and 31 December 2005 respectively.

3.5 Macbinery and Equipment
While it is the policy of the Group to own its machinery and equipment as far as possible so as to gain flexibility in its manufacturing operations and develop in-house capability and capacity, it is not uncommon that certain non-standard machinery and equipment are usually consigned from customers. Currently, most machinery and equipment used in the Group’s assembly business arc consigned from its customers. This is a common practice within the industry, particularly in the outsource manufacturing business, where the consignor consigns excess capacity for certain processes to the consignee.
This practice of accepting consigned machinery and equipment from customers has the drawback to the Group of not being able to utilise such machinery and equipment to service the needs of other customers and such machinery and equipment can be removed by the customers who own them at short notice. Nevertheless, the Directors believe that the risk associated with machinery and equipment is mitigated to a certain extent in view of the nature of industry where it involves high vendor switching costs and requires a long gestation period of acceptance. This is because the customers normally require a lengthy time to carry out operational and quality audits of the turnkey manufacturers’ production capabilities and facilities, before accepting the manufacturer as their supplier/manufacturer. Thus, it is usual that customers would foster long term business relationships with their turnkey manufacturers.
3. RISK FACTORS (Conl’d)
I.n the event the manufacturing comraet is terminated, the Group may be given the option to purchase lhe machinery and equipment from cUSIomers. In such event, it will result in a change in the business arrangement where lhc Group may own the production line and caR manufacture for any customers as an OEM coDtracl manufacturer. Further. as part of ils expansion plan, the Group has earmarked an amount of RM21.8 million out of the total proceeds from the Public Issue for the purchase and installation of new production machinery. equipment and tooling.

 

3.6 Abseoce of Long Term Contracts
To the best of the Directors’ knowledge, it is not a common practice for MNCs to enter into formal long term contracts with their turnkey manufacturers. Nonnally. the MNCs will provide forecast purchase order for one (1) to three (3) months and the confirmed order will be given to the Company on a weekly basis. In general, the Group operates on a justĀ·inĀ·time manufacturing concept and maintains a minimum level of finished goods in its warehouses. The 0&0 Group WQrks closely with its MNC customers to monitor their production schedules, stock levels and also impending requirements to ensure that there are sufficient stocks to meet the customers’ requirement. Currently, there are manufacturinglsubcontraeting contracts entered inlo by the D&O Group with its major MNC customers. where the Group is appointed as thc authorised manufacturer/service provider until the contracts are terminated by either the Group or the customers. Nonetheless, these manufaduringlsubcontracting contracts do nollantamountto long term contracts as sales are normally confirmed via purchase orders from these: customers.
The Board of 0&0 believes that the Group has established long (erm business relationships with its
existing customers and has a proven track record of deli.vering quality produds at competitive prices in
a timely manner, thus enabling the long-standing business retationships to continue.
Further, as stated ill Section 3.4 above, it is usual that customers would foster long lerm business relationships with their turnkey manufacturers, after having gone through a lengthy process to carry out operational and quality audits of the turnkey manufacturers’ production capabilities and facilities, and the ensuing evaluation of the quality of products manufactured, before selecting the manufacturer as their suppl ier/manufacturer.
3.7 Soun’es and Availability of Raw Materials
To maintain competitive manufacturing operations, it is crucial that the Group must be able to obtain sufficient quantity of quality materials at acceptable prices in a timely manner. The major raw materials used in the Group’s manufacturing are leadframes, headers, silver preform, metal caps. solder bars, mould compound. resin, hardener, silver epoxy, aluminum wire and gold wire. The Group sources most of its materials from both local and overseas suppUers by way of a blanket purchase order for a one (I)-year delivery followed by oonfinned quantities on a monthly basis. Certain suppliers enter into a consignment supply contract/agreement with the Group whereby the suppliers will keep their stock in the Group’s warehouse and only issue invoices based on actual quantily used at the end of each month. The average stock holding level is equivalent to two (2) months’ average consumption level. The management of the Group does not foresee any difficulty in procuring raw materials as il sources ils raw materials from various suppliers and is confideot that it is able to identi.fy additional suppliers should the need arise.
The Group is also exposed to the risk of fiuetuatjon in prices of raw materials. Notwiths1anding lhis risk, the Group may still be able to maintain reasonable profits if it can pass the increase in costs to its customers. Currently, the Group adjusts its selling price with its customers in the event of an increase in the cost of raw materials. Furthermore, the Group has extensive experience in purchasing raw materials and is well versed with the market trends of raw material prices and their availability.
3. RISK FACTORS (Conl’d)
Over the years, the Group has always been able to source most of its raw materials from an approved list of vendors both locally and overseas. The Group has followed a policy of prompt payment within the credit period and hence has established a good repulation amongst its suppliers. The Group docs not expect its performance to be significantly affected by the termination of its business relationship with any of its suppliers. Due to its strong relationship with key suppliers, the Group has not, nor is it likely to be threatened by any shortages in raw materials.
However, no assurance can be given that the Group will not be adversely affected should any of its major suppliers choose not to extend their business ties with the Group in the future.

3.8 Fluctuation in Prices of Products
Fluctuation in the prices of the Group’s products is a normal occurrence in industries where its price is determined by the forces of global supply and demand. The overhang in stockpile of semiconductor products worldwide has led many MNCs to implement just-in-time stock control. The implementation of just-in-time has resulted in reduced volatility of semiconductor prices. However, as the Group is a contract manufacturcr, pricing is fixed at the point of contract agreement. Any price revision will be on the basis of official notification and upon quotation by either party and acceptance by both parties after negotiation.
3.9 Foreign Exchange Risk
The Group is exposed to foreign exchange fluctuations through its exports and to a lesser extent, its imports. The risk of foreign exchange fluctuation has been minimised since the introduction of capital controls by the Government in 1998 whereby the Ringgit has been pegged to the US Dollar at RM3.80 to USD1.00. Nevertheless, there can be no assurance that any future significant fluctuations in exchange rates will not have an impact on the financial performance of the Group.

3.10 Dependence on Key Personnel
The Group believes that its continued success will depend, to a certain extent, upon the abilities and continued efforts of its existing key management team. The loss -of any of the Group’s key management team could adversely affect the Group’s continued ability to compete effectively in the semiconductor industry. The Board of D&O recognises the importance of the Group’s ability to attract and retain its key personnel and has in place a human resource strategy, which includes a suitable compensation package, a structured training and grooming program and a conducive working environment. The ESOS, which was implemented by the Company, is designed to reward and retain key personnel of the D&O Group in recognition of their contribution which is considered vital to the operations and continued growth of the Group.

3.11 Availability ofSkiUed Labour
Semiconductor assembly and testing are complex processes which inv-olve significant tcchnological expertise and specialised equipment. As at 15 October 2004, more than 90% of the 0&0 Group’s employees are skilled workers. The performance of the D&O Group may be affccted by the shortage of suitably qualified skilled personnel and may suffer from inferior product quality, production downtime, failure in meeting delivery schedules and loss of customers’ confidence. As in any other industry, there is competition for highly skilled employees.
The management of the Group recognises the importance of human resource training to stay ahead in technological advancement. The Group also believes in investing in its workforce. On the job training is viewed as one of the more effective training tools for its employees. The employees of the Group arc subject to work orientation programs, on the job training and cross training in the various processes.
3. RISK FACTORS (Cont’d)
Allhough lhe D&O Group seeks 10 limit the above business risk, no assutance can be given that any changc to this factor will not have a material adverse effecl on the Group’s business.

3.12 Availability of Foreign Labour
Government regulations on foreign labour can severely affect the manufacturing industry as most manufacturers employ a significant number of foreign workers, Regl,llations which have been introduced to limit the recruitment of foreign workers may affect the industry’s expansion as it could lead to a shortage of workers. All the foreign production workers of the Group hold valid working permits in Malaysia. The Group has not, in the past, experienced any shortage of foreign labour which has materially affected the Group’s business growth or caused interruptions in its operations.
Although the Group seeks to limit the reliance on foreign labour through automating the [abOl,lr intensive operations, there can be no assl,lrance that any changes to current immigration rules and policies adopted by the Government will not have an adverse impact on the Grol,lP’S labour force.

3.13 Political and Economic Considerations
Any adverse development in the political situation and economic uncertainties in Malaysia and other countries which Ihe Group has business links, directly or indirectly could materially and adversely affect the financial performance of the Group. These include risks of war, global economic downturn, expropriation, nationalisation, unfavourable change in government policies and regulations such as foreign exchange rates, methods of taxation and currency exchange controls. There can be no assurance that any changes to these factors will not have a material adverse effect on the Grol,lp’S business.

3.14 Adequacy of Insurance Coverage and Risk of Business Disruption
The Group is aware of the adverse consequences arising from inadequate insurance coverage that col,lld adversely affect its business operations. In ensuring that such risks are minimised, the Group reviews and ensures coverage for its assets on a continl,lOus basis. At present, the Directors believe that the Group is adequately insured against unforeseen events such as fire, malicious damage, theft and burglary. The Group has also installed adequate fire fighting systems, such as sprinkler systems, fire hydrants, hose reels and fire extinguishers, in the building premises and exercise stringent safely measures to minimis.e the risk of fire.
The Group did not experience any disruption in business arising from energy disruptions which have a significant impact on the Group’s operations in the past twelve (12) months.

3.15 Seasonal Sales
The Group’s products are employed in the prodl,letion of most industrial, consumer, telecommunication and electronic equipment. The Group’s revenue is thus directly or indirectly related to capital expenditures of government, public and private sectors which may be subject to fluctuation as a consequence of general economic conditions and industry patterns. The Group’s revenue may also fluctuate as a consequence of seasonal sales. To the best of the Directors’ knowledge, demand for semiconductor products will, traditionally, soften in the third quarter of a calendar year and further decline in the fourth quarter dl,lc to the build-up in the stockpile of MNCs and the long year-end holidays observed in the USA. Such seasonal sales trends are still prevalent in today’s market. However, the volatility of demand for semiconductor products which are associated to seasonal sales has been substantially reduced with the implementation of just-in~timestock control by the MNCs.
3. RISK FACTORS (COnl’d)

 

3.16 Control by Substantial Shareholders
Upon completion of the Public Issue, the substantial shareholders of 0&0, namely, ORSB, PRTC, Goh Nan Yang, Urn Yam Chiew, Dr Lim Thian Soo, Urn Thiam Cheok, Lim Yam Poh, Dalo’ Mohammed Azlan bin Hashim, Datin Nonadiah binti Abdullah and MRSB will collectively hold, directly and indirectly, apprOldmalely 70.8% of the Company’s issued and paid up capital. Cmsequently, the aforesaid shareholders may be able to influence the outcomc of certain matters such as the election of Ihe Directors and the approval of business ventures requiring the vote of the Company’s shareholders unless they are required to abstain from voting by law and/or by the relevant authorities.
Adherence 10 corporate governance principles and best practice is expected 10 promole greater accountability alld transpareocy. Additionally, the formation of the Audil Committee, which comprises Independent Directors. may effectively help to promote transparency in all material transactions and the D&O Group’s accountability, thereby protecting the interests of shareholders. The subslantial shareholders would also be required to abstain from voting if there are any relaled party nansaetions, which may pose as a conflict to the interest of the Company.

3.17 No frior Market for tbe Sbares
Prior to the Public Issue, there has been no public market for D&O Snares.. There can be no assurance that an active market for 0&0 Shares will develop upon its listing on the Second Board of Bursa Securities or, if developed, that such a market will sustain. The Issue Price has been determined after taking into consideration a number of factors, including but not limited to, the Group’s financial and operating history and conditions, the prospects of the industry in which the Group operates, the management of the Group, the market prices for shares of comparties involved in businesses similar to tha1 of the Group and the prevailing market conditions. There can be no assurance that the Issue Price will correspond to the price at which 0&0 Shares will trade on the Second Board of Bursa Securities upon or subsequent 10 its listing.

3.18 Profit EstilDJIte and Forecast
This Prospectus contains the consolidatcd profit estimate and forecast of D&O that are based on assumptions which the Directors deem to be reasonable, but which nevertheless are subject to uncertainties and arc contingent in nature. Due to the subjective judgements and inherent uncertainties of the consolidated profil estimate and forecast and as events and circumstances frequenlly do not occur as expected, there can be no assurance that lhe consolidated profit estimate and forecast contained herein will be realised and actual results may be malerially differenl from the forecast. Investors are deemed to have read and understood the assumptions and uncertainties underlying the consolidated profit (;:stimate and forecast that are contained herein. Investors arc advised to read carefully the assumptions made in this Prospectus of the consolidated profit estimate and forecast as sct out in Section 9.6.2 of this Prospectus.

3.19 Forward Looking Statements
Certain statements in this Prospectus are based on historical data which may not be reflective of tbe future results, and others are forward-looking in nature which are subject to uncertainties and contingencies. All forward-looking statements arc based on estimates and assumptions made by the Board. and although believed to be reasonable, arc subject to known and unknown risks, uncertainties and Olher factors wh..ich may cause the actual results. performance or achievements to differ materially from the future results, performance or achievements expressed or implied in such forward-looking statements. Although the 0&0 Group believes that lhc expectations reflected in such forward-looking statements are reasonable at this point in time. there can be no assurance that such expectations will prove to be correct.

 

 

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