4.2 RISKS RELATING TO OUR OPERATIONS
4.2.1 Design Failure
We have been able to deliver our obligations in accordance with the terms of the contract with our customers and ensure that our IC design services meet our customers’ requirements. As our Group provides ASIC/SoC design services and IP development specific to customers, we may be subject to risk that our ASIC/SoC design will not satisfactorily perform the function for which they are designed and will not be able to meet performance objectives. This may potentially disrupt the customers’ operations and production. As such, there is no assurance that a design liability suit or action will not be taken against us for design failure. In addition, we also cannot assure that unanticipated technical or other problems will not occur which may potentially result in a material delay in the design development.
In the event that we are liable for any special, incidental, consequential or indirect damages resulting from its performance or failure to perform, whether based on contract or negligence, this may have adverse effect on our reputation and may result in a loss of business. Such negative exposure will affect our reputation and financial position. In an industry where branding and reliability are crucial, our market share may stand to be adversely affected should such negative publicity arises.
As part of our design liability risk management, our service agreements with our customers do not contain warranties for our design and have provisions designed to limit our exposure to consequential damages. To date, there has been no incidence of lawsuits in respect of design failure. In addition, the risk of design failure is minimised as customers will conduct its own testing and quality acceptance test before accepting the final design and any design failure detected during such testing will be rectified by us prior to delivery. Continuous quality checking will be given more emphasis to avoid any unwanted negative publicity.
Our Directors believe that our success depends on our IPs, unique in-house design methodology and proprietary know-how. As such, we need to protect our concepts, idea, design and documentation relating to our proprietary technology from being used by others. However, we cannot assure that other parties will not independently obtain access to our trade secrets and knowhow or independently develop designs or technologies similar to ours.
To mitigate the above risks, we do not provide our source codes, which consist of confidential information to our foundries to protect our proprietary know-how. Furthermore, our employees are bound by their respective confidentiality terms as set out in a separate non-disclosure agreement entered into with our Group. We also maintain a comprehensive log sheet to document our design and updates. If any dispute or claim arises over our IC design, we believe that we would be able to prove in court our proprietary rights over our design.
For the audited 9-month FPE 2007, 99.4% of our direct cost is derived from the outsourcing of development, design and licensing of certain IPs to Key ASIC Inc and 0.6% of our direct cost is derived from outsourcing of wafer fabrication services to Silterra. These outsourcing were entered into on an arms-length basis to develop and design one-off core IPs required in view that we were only a start-up company. Currently, the test and packaging process of our manufactured chips are also outsourced to our strategic partner, ASAT Holdings Limited. We cannot assure that these facilities are available at all times to match our order requirements and we have no control over their timing and cost structure. Failure by our outsourcing partners to deliver may result in a prolonged lag time between our customers’ orders and our delivery time and may also interrupt our business operations.
Outsourcing has became a key trend in our industry which saw an increasing number of design houses outsourcing part or all stages of their design process to independent third parties. This is due to the high capital and labour cost involved and increasing competition which drive companies to reduce costs and shorten time-to-market. Also, our industry entails high expertise to operate and the lack of competitive local IC design support as well as lack of IC design talent both in quantity and experience, has prompted us to outsource our design facilities to overseas expertise which include foundries, and test and packaging houses, all of which are crucial to our operations. In view of this industry norm, it is also part of our business strategy to adopt the outsourcing model as and when required.
Going forward, our Directors are of the opinion that the outsourcing of IP development and design is expected to decline as the basic IPs required for design engagement have been substantially developed in the FYE 2006 and most of these IPs can be re-used for many years. Our cost of sales for the FYE 2006 is RM44 million, while the cost of sales for the 9-month FPE 2007 has declined to about RM14.5 million. Nevertheless, we may continue to outsource certain IP development and design to third parties as and when the need arises and ensure that the arrangements are in the best interests of our Group. Meanwhile, we will continuously recruit experienced technical personnel. We have also taken continuous efforts to strengthen and enhance our relationships with our eXisting outsourcing partners and also build new relationships. This would provide us with a wider range of outsourced facilities and hence, ensure that our operations continue to run smoothly.
Infringement of Intellectual Properties by Third Parties
A substantial part of our Group’s revenue is derived from licensing of our IPs to our customers. At present, our Company owns intellectual property rights in the IPs which protection is accorded by copyright laws and the common law, including the Copyright Act 1987. However, the software may not be accorded similar copyright protection laws elsewhere. Despite copyright laws in Malaysia and other countries in which our Group may operate, such laws may not be adequate or effectively enforced against third parties who violate our Company’s copyright by copying or pirating our IPs. Our Company may have to incur unexpected and additional expenses for enforcing its intellectual property rights should such infringement arise in future. This may have an adverse effect on our Group’s future financial performance. This risk is however mitigated through constant enhancements of our proprietary software, rendering it difficult for third parties to copy or pirate our IPs.
Historically, we have taken a prudent approach to refer some of our end customers to Silterra as we do not have the financial capability to purchase and store wafer for the production of chips after the initial design and development stage. However, since the incorporation of KASSB, we are increasing our direct sales of completed chips and wafer to the endcustomers to earn a higher margin and to strengthen our relationships with the end-customers. As such, we might have to bear a higher inventory costs for the completed chips and wafer. In view of the constant change in consumer preferences and demand for consumer electronics products, there is no assurance that our customers will continue their purchases of the completed chips and wafer. As a result, there is a possible risk of slowmoving inventory and higher inventory cost to be borne by us.
Nevertheless, we will strive to balance between sales growth and maintaining a prudent inventory management policy as well as continuously innovating and upgrading our eXisting products and services to be more competitive and more marketable for the consumer electronics products.
Dependence on Key Personnel
Our continued success depends to a certain extent upon the abilities and continued efforts of our existing Directors, key management and technical personnel. The loss of any member of our Directors or key management or technical personnel could negatively affect our Group’s continued ability to manage our operations effectively and competitively.
Our design capabilities depend sUbstantially on the number of skilled, professional and knowledge workers with a high level of competence and commitment. Software engineers, system architects, chip design engineers and developers are highly required in the semiconductor industry. If we are unable to retain our skilled workers, staff replacement costs as well as associated opportunity costs may be considerable.
Our Directors recognise the importance of our Group’s ability to attract and retain its key personnel and retain a sufficient number of highly skilled employees. We have in place a human resource strategy, which includes suitable compensation packages and human resource training and development programmes for all supporting employees in all key functions of our Group’s operation. We have also made continuous efforts to strategically develop a dynamic and strong management team and groom our personnel in assisting senior key personnel to operate and manage our activities. However, there can be no assurance that the above measures will be successful in retaining key personnel or ensuring a smooth transition should changes occur.
Dependence on Key Customer
Our Group is, to a certain extent, dependent on Silterra due to the significant level of sales made to Silterra. Silterra is in the business of semiconductor manufacturing and operates a wafer fabrication foundry in Malaysia. Silterra recorded a contribution to an aggregate of 84% of our Group’s total revenue in the past 9-month FPE 2007, of which 76% revenue from licensing and porting of IP designed specifically for Silterra’s semiconductor manufacturing process technology and 8% revenue from commission eamed for introducing about half of the end customers to Silterra. In the event that Silterra terminates the existing contract with our Group, we may face risk in the transition from Silterra to a new foundry which may take about 3-6 months and also bear the high switching cost.
Our Directors are of the opinion that in our industry, it is a norm for pure IC design houses to form strategic partnership with independent foundries and subcontract its manufacturing work to pure foundry players. At the same time, it is equally important that our chips are designed specifically into the foundry process technology so that foundries also get wafer manufacturing business. This can be seen as an inter-dependent relationship between the design house and the foundry. Such an outsourcing model allows design houses to concentrate on its R&D resources on the end market without committing capital investments to the escalating cost of maintaining a state-of-the-art fabrication facility. The success of such a business model can be seen in Faraday Technology Corporation, a design service company listed in Taipei Stock Exchange, collaborating with United Microelectronics Corporation, a world leading semiconductor foundry in Taiwan, as well as Global Unichip Corporation, the second largest ASIC design service company, collaborating with its major shareholder, TSMC, a leading foundry, both located in Taiwan.
Emulating these successful business models, we have signed a Foundry Service Sales Representative Agreement with Silterra, whereby we are appointed as marketing representative for Silterra in certain countries, and we will be paid a commission for acquiring the sale of silicon wafers fabricated by Silterra. We have also entered into IP Porting Services Agreement and CPU Agreement with Silterra, whereby we shall provide design services and license of IP to Silterra whilst Silterra shall undertake to manufacture the chips designed by our Group containing the ported IP using only manufacturing process specified in such agreements. Such agreements will not prevent customers from placing orders directly to us. We will also establish new business relationships with other foundries such as Chartered Semiconductor Manufacturing Pte Ltd in Singapore and Semiconductor Manufacturing International Corporation in China as part of our measures to manage our dependency on Silterra.
Changes in MSC Status
We were awarded the MSC status on 14 April 2006 by MDeC. Presently, all MSC status companies are granted financial and non-financial incentives. The MSC status granted to us is sUbject to continuous fulfilment of certain criteria.
MDeC, being the body responsible for monitoring all MSC designated companies, has the right to withdraw the MSC status of any company at any given time. Given the criteria to be complied, there can be no assurance that we will continue to retain our individual MSC status or that our Company will continue to enjoy or not experience any delays in enjoying the MSC incentives outlined, all of which may materially affect our Group’s business, operating results and financial condition. Furthermore, there can be no assurance that the MSC incentives will not be changed or modified in any way in the future.
In addition, in the event that the MSC status is withdrawn by MDeC, we would have to comply with the 30% Bumiputera equity requirement and as such, there may be a potential dilution of shareholdings should an offer for sale or private placement exercise are implemented.
Limited Operating History
We were incorporated on 22 August 2005 while our subsidiary, KASSB, was incorporated on 7 June 2007. Our Group’s limited operating history makes it difficult to evaluate the risks and uncertainties, particularly those encountered by companies in the early stages of development in the new and rapid evolving semiconductor industry. However, our Group has proven its capability to generate net profits of RM5.64 million for the audited FYE 2006 and RM12.84 million for the 9-month FPE 2007. In addition, our Group’s key management and key technical personnel comprise persons who have been involved in the semiconductor industry for an average of 15 years each. Our Directors believe that the risk of our limited operating history is mitigated by the experience, knowledge and business expertise of our key management and key technical personnel.
Delay in R&D
Our Group is involved in a rapidly changing industry and our success is largely dependent on speed and ability to meet the requirements and expectations of the market. We face the risk of not being able to meet targeted launch dates due to a variety of reasons such as changes to design specifications, human resource constraints, new technology announcement and evolving customers’ needs.
Our Group has set up its in-house R&D team to carry out research and development in our design activities. Our Group’s R&D team is able to assist and support the implementation of our Group’s business plan to meet the demands of our Group’s customers. However, completion and successful implementation of R&D may require a long lead-time. Although our Group seeks to mitigate this risk by effectively allocating its resources and focusing on servicing customers and prospects with better return (in order not to exhaust our Group’s resources or sacrifice quality of our design development), there can be no assurance that there will not be any delays in the completion of its R&D efforts and that any delays in its R&D efforts will not have any material adverse effect on our Group’s business and financial performance.
Significant Influence of the Controlling Shareholder Over Our Business and Policies
Eg Kah Yee will, directly and indirectly, hold 51.31% of our Shares upon completion of the Public Issue. Through his equity interest in Key ASIC, he will be able to influence the outcome of certain matters requiring our shareholders’ approval, including election of directors and approval of certain corporate exercises or other business transactions, unless he is required to abstain from voting by law or any applicable requirements.
Nevertheless, we have appointed 4 independent non-executive Directors as a step towards good corporate governance. Our structure is such that members of our Board and key management have their own independent functions but overall decisions are made on a collective basis which will be congruent with our objectives. There are also control procedures in place to ensure business decisions and outcomes are made on a rational and independent basis and not through undue influence.
Security and System Disruption
We operate in an environment where our operations are exposed to risks of computer viruses, industrial espionage, theft, hacking and fraud. Security breaches on our software may lead to unexpected capital expenditure and cause a loss in revenue and reputation. Problems caused by security breaches could result in loss of or delay in revenue, loss of market share, failure to achieve market acceptance, diversion of R&D resources, harm to our reputation, customer claims, increased insurance costs and other related costs, legal suits and warranty costs.
Nevertheless, we are undertaking efforts to minimiSe potential security breaches by the use of appropriate security systems and firewalls, and all other necessary steps to minimise the risk of any potential security breaches. In addition, our valuable data is stored and backed-up on a regular basis to mitigate against system disruptions. To date, there has not been any material disruption or damage to our computer systems.
4.2.13 Breakout of Fire, Energy Crisis and Other Emergencies
All businesses face the risk of losses arising from emergencies such as breakout of fire and energy crisis. Our Group has taken note of such risks and has taken various steps to reduce such risks by having proper firefighting systems, dispersing the storing of our network equipment and carrying out periodical review on our security and maintenance. We have also taken insurance coverage such as the Electronic Equipment Insurance Policy to mitigate financial losses from such happenings where possible. In addition, we have back-up storage located in different geographical locations to minimise risks relating to the breakout of fire, energy crisis and other emergencies.
4.3 RISKS RELATING TO OUR INDUSTRY
4.3.1 Rapid Technology Changes
The semiconductor industry is characterised by rapid technological developments, evolving industry standards, changes in design methodologies, changes in customer requirements and frequent new product introductions and enhancements. Our Group’s design services may become less competitive and less marketable due to the rapidly changing technology. If we do not stay up-to-date with technological advances and be sensitive to the market trends or if one or more of our Group’s competitors introduce products and design services that can better address customers’ needs, it may adversely affect our Group’s competitiveness and therefore may affect our Group’s business, operating conditions and financial results.
Our Group minimises our exposure to technological obsolescence through our ongoing R&D effort to introduce a design that is capable of high performance with a small die size and low power consumption using the latest technology which our Directors believe will adequately address the changing needs of the marketplace while keeping the cost to customers relatively low. Our Group has an experienced and skilled team of R&D personnel, which constantly endeavours to keep abreast with contemporary leading-edge technologies and carry out the necessary research to capitalise on such technologies that are suitable for our future business. We constantly encourage our key management and technical personnel to frequently attend microelectronics conference or trade shows, if necessary. However, there can be no assurance that our Group will be able to keep abreast with the changes in the technologies and that such changes would not affect our Group’s competitiveness in the semiconductor industry.
4.3.2 Cyclical Nature of the Semiconductor Industry
The semiconductor industry is cyclical in nature, generally characterised by 4 recurring year cycles. Typically, these cycles had in the past recorded 2 strong years of growth, 1 year of slow growth and 1 year of flat or declining growth. The cyclical nature of the semiconductor industry poses a challenge for chip design service providers as the demand for chips is largely dependent on the performance of the global computer, communication and consumer markets.
Nonetheless, we intend to diversify our chip design products to various applications from consumer electronics to computer and communications, and to take advantage of the future growth in the industry, which would be strongly driven by the wireless and personal computer markets. This would be further augmented by the growth in the consumer electronic products as demand for new technology and multi-functional devices such as camera phones, PDAs, MP3 players and portable DVDs gains momentum.
Although we are taking the above step to mitigate the cyclical nature of the industry, we cannot assure that the measures we have taken will be adequate if there is an industry downturn and that it will not have a material adverse effect on us.
Inability to Achieve Economies of Scale
Although it would appear that our Group as a design house needs to only concentrate on designing chips, R&D and marketing, we also need to focus on achieving volume business, through negotiations with the foundries on favourable volume purchase. For an ASIC designer like us, since the products are “application-specific” and we are not able to enjoy wider applications as compared to the “general all-purpose” counterparts, it is essential to target large volume to achieve economies of scale for its products. In addition, ASIC designs involve a high initial design cost, including non-recurring engineering cost, which makes it profitable only if the product is able to reach high volumes with low cost. Hence, we may risk not being able to achieve economies of scale if we are not able to leverage on large volumes of designs.
To mitigate this risk, we intend to leverage on large volume production to provide us with sizeable recurring revenue. Our Group aims to capture the next version of high volume production chips and optimise the design to have higher performance, lower power consumption and small die size. We will also try to design our chips within budget or at lower costs and increase our marketing aggressiveness in order to compete with other players.
Lack of Control over IC Production
Unlike the IDM which is able to coordinate the various stages of IC manufacturing internally including design, manufacturing, test and packaging, and sales of IC products, our Group, as an independent IC design house does not rely on the manufacturing activities. IDMs are capable of controlling the timing and cost structure of IC production and hence, they can control a share of the marketing profits. Through growing production capability and financial clout, they can expand the size of their operations to cover increasingly greater varieties of products. Our Group seeks to mitigate this risk through continuous R&D in improving our eXisting design and services, maintaining good relationships with our existing foundry, creating highly skilled and qualified personnel and have efficient cost control within our Group.
4.3.5 Political, Economic and Regulatory Considerations in Malaysia
Given the nature of the industry, in which our Group operates, our operations are closely linked to the political, economic and regulatory conditions in Malaysia and other countries. Any adverse developments or uncertainties in the political, and/or international events, economic and regulatory conditions in Malaysia and other countries may adversely affect the performance of our Group. These include, among others, the risk of war, riots, expropriation, nationalisation, renegotiation or nullification of existing contracts and arrangements, global economic downturn and unfavourable changes in governmental policy such as changes in interest rates, inflation rates and methods of taxation, changes in managed foreign exchange rate and regulation or other legal, administrative, political, economic or social developments. There can be no assurance that any changes to these factors will not have an adverse effect on our Group’s business and financial performance. The success of the Public Issue depends also on the prevailing market conditions which are unpredictable and volatile.
4.4 OTHER RISKS
4.4.1 Foreign Exchange Fluctuations
We sell our design services to various overseas customers. Our sales in these markets are predominantly transacted in USD. As such, our exposure to the fluctuation in foreign exchange rates may be significant and any material fluctuation in the exchange rates could have a significant impact on our profitability.
The risk of foreign exchange fluctuation is however, mitigated by the managed float mechanism adopted by Bank Negara Malaysia since July 2005 on the RM-USD conversion rate which may prevent extreme exchange rate fluctuation. At the same time, we also license our IPs from overseas and outsource certain design works to Key ASIC Inc.. These costs of sales are also denominated in USD, which provides a natural hedge, ensuring that our Group is not adversely affected by unfavourable foreign currency movements. We also maintain all our currency in RM whilst maintaining a USD foreign currency account for trade-related transactions in foreign currency.
4.4.2 Actual Results Differ from the Prospective Financial Information
We wish to highlight that our consolidated profit estimate and forecast for the FYE 2007 and FYE 2008 as set out in Section 11.7 of this Prospectus are based on assumptions made by our Directors which they believe to be reasonable at that point in time. The assumptions reflect the current judgement of our Directors on the expected conditions and course of action which are subject to uncertainties and contingencies. Many of these factors are beyond our control and some of the assumptions with respect to future business decisions and strategies are subject to changes. As such, our actual results may differ from such estimate and forecast, and the differences may be material and may affect our share price and dividend payout, if any, in the future.
You should note the bases and assumptions made with respect to the consolidated profit estimate and forecast as well as our Reporting Accountants’ letter on the consolidated profit estimate and forecast as set out in Section 11.6 of this Prospectus.
Uncertainty in the 3-Year Business Development Plan
Our Group’s future plans and prospects will depend on our ability to successfully execute the product road map; enhance or improve on our existing IPs; continue to port new IPs with our foundries, production of lower power chip and smaller die size; enhance our R&D activities; enter into strategic marketing and business development strategy; enhance our competitive strength; hire and retain skilled management as well as financial, technical, marketing and other personnel; successfully managed growth (including monitoring operations, controlling costs and maintaining effective quality and service controls); and obtain adequate financing as and when needed. Nevertheless, there can be no assurance that our Group will be able to successfully implement its business plan or that unanticipated expenses or problems or technical glitches will not occur which would result in delays in its implementation or even deviation from its original plans. In addition, the actual results may deviate from our business plan due to rapid technological changes, market changes as well as competitive environment.
Forward Looking Statements
This Prospectus contains forward-looking statements. All statements, other than statements of historical facts, included in this Prospectus that address activities, events or developments that we expect or anticipate will or may occur in the future are forward-looking statements. Such forward-looking statements are made based on assumptions that our management believes to be reasonable as at the date hereof. Forward-looking statements can be identified by the use of forward-looking terminology such as words “may”, “will”, “would”, “could”, “believe”, “expect”, “anticipate”, “intend”, “estimate”, “aim”, “plan”, “forecast” or similar expressions and include all statements that are not historical facts. We expressly disclaim any obligation or undertaking to release publicly any update or revision to any forward-looking statement contained in this Prospectus to reflect any change in our expectations with regard thereto or change in events, conditions or circumstances on which such statement is based.