4. RISK FACTORS 4. RISK FACTORS
Notwithstanding the prospects of our Group as outlined in this Prospectus, you should carefully consider the following risk factors (which may not be exhaustive) that may have a significant impact on our future performance, in addition to all other relevant information contained elsewhere in this Prospectus, before making an application for the IPO Shares. 4.1 RISKS RELATING TO OUR GROUP 4.1.1 Business Risk Our Group is not isolated from general business risks as well as risks inherent in the manufacturing industry and those specific to the furniture industry. For example, our Group may be affected by a general downturn in the global, regional and national economy, higher inflation rate and cost of living, entry of new players, constraints in skilled labour supply, changes in the law and tax legislation affecting the industry, increased production costs, changes in business and credit conditions, fluctuations in foreign exchange rates and introduction of new technologies. Although our Group seeks to limit these risks through, inter-alia, maintaining good business relationships with its customers and suppliers, implementing efficient cost control measures and improving product design and widening market base, no assurance can be given that a change in any of these factors will not have a material adverse effect on our Group’s business.
4.1.2 Dependency on Major Customers With our diversified customer base originating from many different countries and our top customers each currently accounting for less than 20%, we believe we are not overly dependent on any single customer. Notwithstanding that, we have recorded significant revenue contribution from our top two (2) major customers, which collectively contributed 39.4%, 41.4% and 34.0% to our total revenue for the past three (3) FYE 2007 to 2009 respectively. We have had good business relationships with them and have not encountered any major problems in our past dealings with them. In fact, we have been dealing with both of them for more than seven (7) years. We have been successful in our efforts to widen our customer base to lower the dependence on our top two (2) major customers over the last three (3) fmancial years, which we aim to continue. This is an indication of our ability to increase revenue contribution from other customers but at the same time reduce our dependency on our top two (2) major customers. In addition, as part of our expansion plans, we intend to further diversify our customer base and expand our presence particularly in North and South America and Africa which presently has minimal sales contribution and at the same time to continue to identify new customers in countries to which we have been presently exporting. Nonetheless, there can be no assurance that the loss of any of our major customers will not have any adverse impact on our business.
4.1.3 Dependency on Major Suppliers We believe we are not overly dependent on any single supplier. Our main raw materials in the production of upholstered home furniture products include leather, wood and wood frame, foam, PU and fabric which we source from a large pool of suppliers. In the event that any of our Group’s suppliers is unable to meet our demand, we may have to seek alternative sources of supplies, which may be more expensive and therefore cause a negative impact on our costs of purchase and profitability. Further, if our major suppliers are unable to supply the raw materials in a timely manner, our production may be delayed or disrupted, thereby causing a delay or disruption in the delivery of our products to our customers. This would in tum affect customers’ confidence in us and may also expose us to potential liability for failure to meet confirmed orders on a timely basis. As a result, our revenue and profitability would be adversely affected. 4. RISK FACTORS Nevertheless, we have enjoyed good and close business relationships with them over the years and we have not encountered any major problems in our past dealings with them. We also believe that we have the experiences and abilities to source from alternative suppliers should the need arises. 4.1.4 Absence of Long Term Contracts We have not entered into any formal long term contracts with our customers as it is common practice in the industry to manufacture based on confirmed orders. Besides, we also do not have long-term contracts with our suppliers. Therefore, there can be no assurance that the loss of any of our customers or suppliers will not have any adverse impact on our business. Hence, our ability to retain our customers or suppliers and to continue to source for new customers or alternative suppliers are important to the success of our Group. In addition, we place great emphasis in developing long term business relationship with our customers and suppliers as we believe this will ensure our business continuity and growth. This is substantiated by the fact that, to date, all of our top ten (10) customers and seven (7) of our top ten (10) suppliers (for the FYE 2009) have been dealing with our Group for more than three (3) years. As such, we do not expect the absence of long term contracts to have any significant impact on our operations. On a positive note, the absence of long term contracts with our suppliers would enable us to maintain flexibility in sourcing quality suppliers at competitive prices, if necessary.
4.1.5 Availability and Volatility in Prices of Raw Materials Prices of certain raw materials used in our production such as leather, wood and wood frame, foam, PU and fabric may fluctuate rapidly due to intervening factors such as global demand and supply conditions. As such, the prices of raw materials at the point of commitment to our customers may differ from those at the time of actual billing. Any shortages or interruptions in the supply of raw materials, such as an outbreak of bovine spongiform encephalopathy (or commonly known as the mad cow disease), may affect the supply and price of leather, one of our main raw materials. If there are significant increases in the costs of our major raw materials and our Group is unable to pass on such increases in the costs to our customers or our Group is unable to find alternative sources for such raw materials at competitive prices, our Group’s financial performance may be adversely affected.
4.1.6 Competition Generally, the upholstered home furniture industry is perceived to have relatively low barriers to entry and therefore, the challenge for furniture manufacturers is to maintain leadership in the market. However, despite the relative ease in entering the market, it is not easy for a company to succeed in this industry. Numerous critical success factors have to be fulfilled before a company can thrive in the industry. The upholstered home furniture manufacturing industry in Malaysia is a largely fragmented and competitive one. At present, there are approximately 60 to 70 medium to large upholstered home furniture manufacturers in Malaysia, out of which more than 80% focus on the manufacture of sofas. (Source: Independent Market Research Report on the Upholstered Furniture Market in Malaysia, Australia and Europe prepared by Frost & Sullivan). We face competition from both existing and new players; domestically, regionally and internationally. Some may have longer operating histories, international brand name recognition and significantly greater fmancial, technical, marketing and public resources than we do. However, it should be highlighted that the threat of competition from these players, especially those from low cost producing countries is not a new phenomenon and has been present for many years. Despite their presence, the performance of our Group is on an increasing trend and has been registering positive annual growth over the years.
4. RISK FACTORS As mentioned above, our success depends on numerous critical success factors which include our ability to develop new and trendy designs with sufficient market appeal, cultivate customer loyalty, ensure prompt delivery, obtain new business by penetrating new markets as well as offer high quality products that meet the demands of our customers at competitive prices. We also believe that our competitive strengths will help distinguish us from our major competitors. Nevertheless, any increase in competition may likely cause us to lose our market share and exert a negative impact on our pricing. If we are unable to compete effectively with our existing or future competitors and adapt quickly to changing market conditions and trends, our business and financial performance will be adversely affected. 4.1.7 Dependency on Key Executives Our present success and achievements are largely attributable to the concerted efforts and invaluable knowledge and experience of our Directors and key management personnel who are familiar with our business and understand our customers’ needs and requirements. Our management team, led by our Managing Director, Chua Fen Fatt, has been instrumental in the success, growth and development of our Group. As such, any loss of our key executives without suitable and timely replacement could have a material adverse impact on our business, performance and continuing ability to compete effectively in the industry. We believe that our continued growth and success in the future will, to a large extent, hinge on our abilities to identify, recruit, develop and retain our existing key management personnel and at the same time attract new skilled personnel to strengthen our workforce. Hence, we have made concerted efforts to identify and groom middle management at all key areas as an integral part of our management succession plan. The plan also includes offering a competitive remuneration and benefits package to and providing training and career development opportunities for our employees in all key functions of our operations. We also endeavour to maintain a conducive working environment for our employees. Further, in conjunction with our Listing, we have allocated a portion of the Public Issue Shares to eligible employees, which include our key management personnel. Should these employees subscribe for our Shares, they will also become stakeholders in our Company and therefore are expected to be motivated to strive even harder for our Group’s success. In the future, we may even implement an employee share option scheme to further motivate our employees in this manner. Consequently, our Group has always enjoyed cordial working relationships with our employees. None of our Group’s employees are represented by any union and there have not been any major disputes between the management and our employees in the past. Notwithstanding, there can be no assurance that we will be able to continue to identify, recruit, develop and retain adequate number of highly skilled and motivated employees in the future.
4.1.8 Foreign Currency Exchange Risks Most of our products are exported to foreign countries, primarily those in Europe, Australasia, North and South America, Asia and Africa while certain raw materials like leather, PU and fabric are sourced from foreign countries such as Vietnam, Korea, Thailand, India and China. We are exposed to foreign currency exchange risks as approximately 99% and 53% of our revenue and total purchases respectively are denominated in USD for the FYE 2009. Fluctuations in USD exchange rate will have an impact on the prices of imported raw materials as well as export earnings, which will in turn affect the profitability of our Group. Our profit margin is generally expected to improve if the USD strengthens against RM which will then increase our profitability. Conversely, the weakening of USD against RM would generally reduce our profitability due to lower profit margin, dependent on the extent and effectiveness of our hedging strategies adopted. 4. RISK FACTORS At present, we have credit lines for foreign exchange forward contracts with several financial institutions. Should the need arises, our management can readily utilise such forward contracts to hedge the fluctuations in exchange rates between RM and USD, after taking into account the exposure period and the related transaction costs. Further, we also maintain a foreign currency account to facilitate the receipt of revenue collections which are denominated in USD to pay for some of our purchases which are also denominated in USD. Thus, it provides some form of natural hedging against any adverse foreign exchange fluctuations. Notwithstanding the above, there is no assurance that any adverse fluctuations in foreign exchange rates would not have a material impact on our fmancial performance. 4.1.9 Changes in the Sentiments of the Furniture Industry, Consumer Preferences and Spending Trends Demand for the furniture which we design and sell is significantly dependent on consumer preferences and spending trends. These are influenced by external factors including, amongst others, the state of the economy, the income level of consumers and the markets’ demographic profiles. These changes may have significant impact on the sales of our home furniture products and the marketing strategies which we employ. A weak global economic condition in general would lead to poor market sentiments, resulting in lower consumer spending. This may in turn lead to a lower demand for our brand of furniture, which would adversely affect our profitability. Our Group’s prospects, financial position and profitability may be materially and adversely affected in the event that we are unable to respond promptly to the changing requirements of our customers or if we make any inaccurate response to the changing consumer preferences. However, to minimise risk, we have established effective marketing strategies to maintain and increase our customer base, to capture a bigger market share and increase our revenue. Notwithstanding the above, there is no assurance that any adverse changes in the market sentiment of the furniture industry, consumer preferences and spending trends would not have a material impact on our financial performance.
4.1.10 Labour Market The furniture industry is a labour intensive one. As such, we are subject to risk of labour shortages and increase in labour costs. In addition, we have to resort to recruiting foreign workers as we face difficulty in employing local workforce. As at the Latest Practicable Date, we have more than 380 foreign workers. Hence, we are required to comply with the policies imposed by the Government of Malaysia with regards to the employment of these foreign workers. Any future changes to such policies may adversely affect our ability to employ foreign workers. In such event, if we are unable to fmd suitable replacements, our production would be interrupted and consequently, our revenue and profits would be adversely affected as well. As at the Latest Practicable Date, all our foreign workers are legally employed. We would actively liaise with the relevant Government and recruitment agencies for timely renewals of work permits of such foreign workers in adherence to the Government’s policies. In addition, we endeavour to ensure all our foreign workers operate in a safe and conducive working environment. Measures we have implemented include the enforcement of stringent safety measures to prevent hazards or any untoward events from occurring in the work environment, provision of access to medical treatment when necessary as well as satisfactory housing quarters and transportation for all our foreign workers. Competitive remuneration and benefits packages, as well as training and career development opportunities are also extended to our foreign workers. We have an Administration and Human Resources Manager to spearhead our efforts towards compliance with the Government’s foreign worker policies. Consequently, all our efforts have resulted in our Group enjoying a cordial working relationship with our foreign workers. As mentioned above, there have not been any major disputes between the management and our employees; foreign workers included, in the past. 4. RISK FACTORS Nevertheless, the risk of over dependence on labour is partly mitigated by the usage of automated equipment and machinery where possible in certain manufacturing processes of our Group. Through our research activities, we would also endeavour to review our production process flow to increase efficiency and minimise human handling through improved manufacturing processes and techniques where possible. 4.1.11 Liability Claims We may face claims from our customers if our products are found to be unfit for use, contain defects or if our customers had faced anything detrimental as a result of its use. Consequently, we may have to spend a significant amount of management time and resources to defend ourselves regardless of the authenticities of such claims. Should these claims prove to be true, we may have to recall our products from overseas, causing negative publicity. This will affect our fmancial and business performance in the long run as existing customers may not be inclined to place repeat orders and there may be less referrals for new orders. This will also affect the long-term branding strategy and development of our own brand name which we are planning to use to market our products internationally. In addition, we also face potential claims or legal suits in relation to infringement of intellectual property rights. To counteract this risk, we include an indemnity clause in our proforma invoices with our customers stating that they shall fully indemnify, defend and hold us and our officers, Directors and employees harmless from and against all liabilities, demands, claims, fines, losses, damages, costs and expenses (including reasonable solicitor’s fees), whether direct or indirect, arising from or relating to a claim brought by a third party claiming that the manufacture, use or sale of our products (whether or not incorporated in other products) constitutes infringement of intellectual property rights of such third party. 4.1.12 Production or Operational Risks Our revenue is dependent on our production process running smoothly and efficiently. As such, certain events which are beyond our control such as fue, theft, energy or water supply crisis, flood, industrial accidents or breakdown of our production machineries can cause significant loss and interruptions to our business. In attempting to address these inherent risks, our Group has in place the following risk management practices/plans:(a) Safety workplace policy and procedures.
(b) The factory premises are guarded 24 hours by a total of 9 guards.
(c) Fire fighting systems including fue hydrants and hose reels, fue extinguishers and sprinkler systems are installed in our factory premises and corporate offices. In addition, our Factories A, B and C have been certified by the Fire and Rescue Department of Malaysia for compliance with life safety, fue prevention, fire protection and fire-fighting requirements subject to annual renewal.
(d) Maintain adequate insurance coverage for damages / loss to our properties, machinery and inventories.
However, with all the precautions we have taken to limit these risks, there is no assurance that these production or operational risks will not materially affect our business and/or the insurance coverage we have taken would be comprehensive enough to reflect the replacement cost of the assets or any consequential loss we have suffered from these events. Apart from a minor flood incident that took place in FYE 2007 which did not result in any material losses, we have not encountered any such incidents for the past three (3) years. 4. RISK FACTORS 4.1.13 Reliance on Intellectual Property Rights Including Our Trademarks Within the next five (5) years, we aim to manufacture and sell 50% of the total upholstered home furniture under our own brand name. To realise this goal, we have created our own brand name “ERITZ” in January 2008. The “ERITZ” trademark has already been registered in Australia, New Zealand and Malaysia (for Class 20). In addition, we are planning to register the trademark in other countries particularly in the European region in the FYE 2010. Therefore, effective enforcement of intellectual property rights is important for the protection of our interests as we consider the recognition of our trademarks to be vital in the marketing and sales of our products in the future. Unauthorised use of our trademarks may damage our brand name, recognition and reputation of our Group. In certain jurisdictions which do not have developed intellectual property laws or a record of protecting intellectual property rights, we may face considerable difficulties and costly litigation in order to protect and enforce such rights. In the event that we are not able to protect our intellectual property rights, our brand name may be affected and there may be an adverse effect on our business, financial condition, operating results and viability. 4.1.14 Shipping Disruptions As a majority of our finished products are exported, directly or indirectly, to overseas countries, there is reliance on marine transportation for this purpose. Hence, we are subject to shipping disruptions that may arise as a result of weather conditions, political turmoil, pirate attacks, social unrest, port strikes, oil spills, delayed or lost shipments, which may have an adverse impact on our business. However, we always ensure that all our products are adequately insured to minimise any potential cost or liability. In addition, the shipping related costs of some of our products are borne by our customers. Nonetheless, any major fluctuation in charter and freight rates may have a substantial impact on our costs. If we are unable to pass on the increase in such costs to our customers, our profitability may be adversely affected. 4.1.15 Credit Risks For the FYE 2009, 81.8% of our revenue is transacted based on cash terms whilst we provide credit terms to certain customers on the remaining 18.2% sales. The credit periods to such customers range from 30 to 90 days, which we believe is the industry norm. In line with increasing revenue, we may be exposed to higher credit risks as our customer base grows. We have not written off any significant sum of bad debts nor have we been required to provide for any doubtful debts in our books over the past three (3) financial years and most of our customers who are granted credit terms normally settle their debts in a timely manner within our credit period. This is a testament of our ability in managing credit risks and undertaking good credit control measurements. Notwithstanding, we realise the importance of credit control and are continuously monitoring our outstanding trade debts to ensure that the trade debts are maintained at a manageable level at all times. In general, the Group requires an advance deposit ranging from 25% to 40% of the purchase order amount as confirmation of orders. However, we do not impose any deposit on orders on certain long established overseas customers due to our long term business relationships and good payment records. In addition to advance deposit collection, we also undertake the following measures to minimise the credit risk of our overseas customers:(a) Close monitoring of our customers’ accounts and follow-up to ensure that full payment of the remaining sales amount is received within two (2) to three (3) weeks after copies of the shipping documents are made available to them.
(b) Upon receiving full payment, only then will the original shipping documents; namely bills of lading, invoices and packaging lists be made available to our customers, without which they will not be able to take delivery of their cargo from the ports.
4. RISK FACTORS (c) Collection of letters of credit (at sight) in favour of our Company which are issued by financial institutions. These are essentially written payment undertakings given by these financial institutions on behalf of the overseas customers. Nonetheless, there can be no assurance that any event of late payment or non-collection of debts in the future would not have any adverse impact on our cash flow and profitability. 4.1.16 Interest Rate Risks Our primary interest rate risk relates to interest-bearing debt obtained from financial institutions in Malaysia. We have no substantial long-term interest-bearing assets at financial year end. The investments in financial assets, i.e. deposits placed with licensed banks are short-term in nature and are not held for speculative purposes. We do not hedge interest risk, but ensure that we obtain borrowings at competitive interest rates under the most favourable and competitive terms and conditions. Nevertheless, there can be no assurance that additional credit facilities will be available (if required) at commercially viable rates to fund our future expansion or working capital requirements. 4.1.17 Disputes or Legal Proceedings Due to the nature of our business, we may, from time to time, be subject to potential claims, disputes, or other legal proceedings, relating to labour and employment matters, personal injury or property damage, environmental matters and other matters, as discussed in other risk factors disclosed in this Prospectus. These disputes can harm our business by distracting management from the operation of our business. Legal proceedings may involve significant expenditures by us and could have a material adverse effect on our future revenue and profitability ofthe Group. Besides that, as most of our customers are domiciled overseas, in the case of any disputes, it may take a longer time for us to effect service of legal processes overseas, or to enforce a judgement obtained in Malaysia against these customers. Customer risks are more prominent in the event of economic downturn in their respective countries or regions. Nevertheless, since the commencement of our business, we have not been involved in any claims, disputes or legal proceedings. 4.1.18 Future Plans and Strategies As set out in Section 6.18 entitled “Future Plans and Strategies” in this Prospectus, our Directors intend to, amongst others, increase our existing production capacity by constructing a new plant in Malaysia and setting up manufacturing operations in Vietnam, conduct R&D in new product designs, diversify our customer base and place greater emphasis and focus on our brand. Our growth and future success will be dependent on, amongst others, the successful completion of such expansion projects without incurring any significant increase in costs, the sufficiency of demand for our new product and designs as well as successful venture into new markets. Should we fail to successfully implement any of our future plans and strategies, our business, results of operation and financial position may be materially and adversely affected. 4.1.19 Manufacturing operations in Vietnam As one of our expansion plans, we intend to set up manufacturing operations in Vietnam to increase our production capacity. This will involve considerable investment including capital expenditure and working capital requirements. Like any other foreign investments, it will be dependent on the local political and economic conditions of the country such as changes in political leaderships, changes in interest rates and inflation rates, taxation, tariffs and duties, currency exchange rules and trade restrictions.
4. RISK FACTORS There can be no assurance that any changes to the political and economic conditions of Vietnam will not materially and adversely affect our expansion plan into that country. In addition, no assurance can be given that we will be successful in the foreign manufacturing operations. 4.1.20 Unfavourable Economic, Social and Political Conditions Any adverse change in the political, economic and regulatory environment and uncertainties in Malaysia and regions where we operate could have unfavourable effect on our fmancial and business prospects. These include but not limited to the risk of war, terrorist attacks, riots, changes in political leadership, global economic downturn and unfavourable changes in government policies such as changes in the methods of taxation, interest rates, licensing or introduction of new regulations. Whilst we would continue to take effective measures such as prudent financial management and continue seeking new markets, there is no assurance that any change to these factors will not materially and adversely affect our fmancial position or business in the future 4.2 RISKS RELATING TO THE INVESTMENT IN OUR SHARES
4.2.1 No Prior Market for Our Shares Prior to our Listing, there was no public trading for our Shares. Accordingly, there can be no assurance that an active market for our Shares will develop upon our Listing or, if developed, that such market will be sustained. The IPO Price ofRMO.65 per Share was determined after taking into consideration a number of factors including but not limited to our historical earnings, prospects and future plans, our financial and operating history and the market value of our assets. There can be no assurance that the IPO Price will correspond to the price at which our Shares will be traded on the Main Market of Bursa Securities upon or subsequent to our Listing or that an active market for our Shares will develop and continue upon or subsequent to our Listing. The price at which our Shares will trade on the Main Market of Bursa Securities after the IPO may be influenced by a number of factors including, amongst others, the depth and liquidity of the market for our Shares, investors’ individual perceptions of our Group, market and economic conditions.
4.2.2 Failure / Delay in or Abortion of the Listing Our Listing is exposed to the risk that it may be aborted or delayed on the occurrence of anyone or more of the following events:(a) Force majeure events or events/circumstances including war, riot, flood, fire, storm, hijacking, sabotage crime, epidemic and acts of God, which are beyond the control of our Company and/or the Sole Underwriter, arising prior to our Listing;
(b) The identified investors fail to subscribe for the portion of the Offer Shares allocated to them pursuant to the Offer for Sale;
(c) The Sole Underwriter exercising its rights pursuant to the Underwriting Agreement discharging itself from the obligations therein; and
(d) We are unable to meet the public shareholding spread requirement, which is at least 25% of our total number of Shares for which listing is sought must be held by a minimum number of 1,000 public shareholders holding not less than 100 shares each upon the completion of the IPO and at the point of Listing.
In this respect, we will exercise our best endeavour to comply with the various regulatory requirements, including, inter-alia, the public shareholding spreads requirement in paragraph (d) above. However, there can be no assurance that the abovementioned factors/events will not cause a delay in or nonimplementation of our Listing. 4. RISK FACTORS In the event of the failure of our Listing, we will return in full without interest, monies paid by the investors in respect of all applications in accordance with the provision of sub-Section 243(2) of the Capital Markets and Services Act, 2007. 4.2.3 Dividend Payment Our Company, an investment holding company, derives its income mainly from dividends received from our subsidiary companies. Hence, our ability to pay future dividend and our ability to sustain our dividend policy in the future are largely dependent on the performance of our subsidiary companies. In determining the size of any dividend recommendation, we will also take into consideration a number of factors, including but not limited to our fmancial performance, cash flow requirements, debt servicing and financing commitments, availability of distributable reserves and tax-exempt profits/tax credits, future expansion plans, loan covenants and compliance with regulatory requirements. 4.2.4 Continued Control by Promoters Upon Listing, the Promoters will collectively hold a total of approximately 74.9% of our enlarged issued and paid-up share capital. Depending on how they choose to vote and because of their shareholdings, these shareholders will generally be expected to have significant influence on the outcome of certain matters requiring the vote of our shareholders unless they are required to abstain from voting by law and/or as required by the relevant authorities. Nevertheless, as a step towards good corporate governance, we have appointed 3 Independent Non-Executive Directors and set up an Audit Committee to ensure that, inter-alia, all future transactions involving related parties are entered into at arm’s length basis, on normal commercial terms which are not more favourable to the related parties than those generally available to the public and are not to the detriment of our minority shareholders. 4.3 OTHER RISKS 4.3.1 Forward-Looking / Prospective Statements Certain statements in this Prospectus are based on historical data which may not be reflective of future results and others are forward-looking in nature that are based on assumptions and subject to uncertainties and contingencies which mayor may not be achievable. Whether such statements would ultimately prove to be accurate depends upon a variety of factors that may affect our businesses and operations, and such forward-looking statements also involve known and unknown risks, uncertainties and other factors which may cause our actual results, performance and achievements, or industry results, to be materially different from any future results, plans, performances and achievements, expressed or implied, by such prospective statements. Although we believe that the expectations reflected in such future statements are reasonable at this time, there can be no assurance that such prospective statements or expectations will prove to be correct in the future. Any deviation from the expectations may have a material adverse effect on our business and financial performance. The above is not an exhaustive list of challenges we are currently facing or that may develop in the future. Additional risks whether known or unknown, may in the future have a material adverse effect on us and/or our Shares. [ The rest ofthis page is intentionally left blankJ