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 OTHER INFORMATION CONTAINED ELSEWHERE IN THIS PROSPECTUS BEFORE INVESTING IN OUR SHARES. If you are in any doubt as to the information contained in this section, you should consult your stockbroker, bank manager, solicitors, accountants or other professional adviser. 4.1 RiSKS RELATING TO OUR BUSINESS 4.1.1 Dependency on the distribution of third party brands of CPG for our brand owners We are involved in the distribution of multiple brand owners’ brands of CPG in Sabah, Sarawak and Labuan which accounted for RM285.65 million or 95.26% of our total revenue for the FYE 30 June 2015. The distribution of multiple brand owners’ brands of CPG in Sabah, Sarawak and Labuan also accounted for RM37.00 million or 90.08% of our total gross profit for the FYE 30 June 2015. As at LPD, some of the third party brands that we distribute for brand owners are Coca-Cola, P&G, Danone Dumex and Wipro Unza, which accounted for more than 10.00% of our total purchases for the past four (4) FYE 30 June 2012 to 2015. In this respect, any disruptions in the business dealings with these brand owners may affect our business and financial performance. In mitigation, we have established close business relationships with P&G, Danone Dumex and Wipro Unza for 33 years, 8 years and 32 years, respectively, with the exception of CocaCola whom we only started the distribution of their beverage products in Kota Kinabalu (designated areas within Kota Kinabalu), Sandakan, Tawau and Labuan in September 2014. The close business relationship will provide us with the basis for continuing distribution of third party brands of CPG for brand owners. In the past financial years under review and up to LPD, we have not experienced any material adverse impact on our financial performance due to the dependency on the distribution of third party brands of CPG for brand owners. Nevertheless, there can be no assurance that the potential risk of business disruption from distribution of third party brands of CPG would not have a material adverse impact on our financial performance in the future.
4.1.2 Dependency on a group of customers Servay Hypermarket (Sabah) Sdn Bhd was our largest customer having accounted for 11.43%, 11.20%, 10.72% and 8.98% of our Group’s total revenue for FYE 30 June 2012, 2013, 2014 and 2015 respectively. In addition, Servay Hypermarket (Sabah) Sdn Bhd has common shareholders with Servay Jaya Supermarket Sdn Bhd, Servay Hypermarket (Sandakan) Sdn Bhd, Parkwell Departmental Store Sdn Bhd, Evergreen (1979) Trading Sdn Bhd, Servay Supermarket Sdn Bhd and Servay Jaya Superstore (Miri) Sdn Bhd (“Servay Group”), all of whom are also our customers. Collectively, the Servay Group of companies accounted for 16.84%,16.59%,15.79% and 13.50% of our Group’s total revenue for FYE 30 June 2012, 2013, 2014 and 2015 respectively. The declining trend in the composition of revenue from the Servay Group of companies for our financial years under review indicates our decreasing dependency on this particular group of customers. Nevertheless, we have been servicing the Servay Group of companies for approximately 18 years, indicating a stable business relationship and providing the basis for a continuing business relationship. 4. RISK FACTORS (Cont’d) For the past financial years under review and up to LPD, our Group has not experienced any loss of major customers and/or intermediaries that had a material ad-verse effect on our Group’s financial performance or operations. Nevertheless, there is no assurance that our dependency on this group of customers would not have an adverse impact on our future business performance. 4.1.3 Disruptions to warehousing facilities, manufacturing facility and business operations Part of our business activities is dependent on the continued operation of our warehousing facilities as well as our manufacturing facility for bakery products. Any disruption to our warehousing facilities and manufacturing facility such as fire, power failure, breakdowns, failures or sub-standard performance of our machineries, will have an adverse impact on our business operations. In mitigating this risk, we carry out regular maintenance of our machineries and equipment as well as timely replacement of parts which are subject to daily wear and tear. In the past financial years under review and up to LPD, we have not encountered any major disruptions to our warehousing facilities. In addition, since the commencement of operation of Creamos Malaysia and up to LPD, we have not encountered any major disruptions to our manufacturing facility. However, there can be no assurance that any major incident in our warehousing facilities or breakdown in our machineries at our manufacturing facility in the future would not severely disrupt our business operations. We are also aware of the consequences arising from inadequate insurance coverage for any accident and fire outbreak that could disrupt our business and seek to limit this risk through annual reviews of our insurance policies. Hence, we ensure the continuity of our insurance by renewing all the insurances annually. Whilst we have taken the necessary steps to ensure that our warehousing facilities and assets are adequately covered by insurance and although we have not previously experienced any disruptions to our warehousing facilities, our manufacturing facility and business operations, there can be no assurance that any occurrence of such disruptions will not affect our future business performance. 4.1.4 Dependency on external manufacturers We are dependent on external manufacturers for the manufacture of our own brands of CPG, comprising of frozen and dry food as well as beverage products. This is reflected by the fact that purchases from these external manufacturers collectively accounted for RM7.90 million or 2.80% of our total purchases of products, raw materials and services for FYE 30 June 2015. For FYE 30 June 2015, we sourced our frozen and dry foods as well as beverage products from a total of ten (10) external parties which comprised nine (9) external manufacturers in Malaysia and one (1) manufacturer of frozen potato products in Belgium. Revenue derived from the distribution of our own brands of CPG accounted for RM7.95 million or 2.65% of our total revenue for FYE 30 June 2015. In this respect, any disruptions in the business dealings and supply from these external manufacturers may adversely affect our business and financial performance. Our strategy of engaging external manufacturers to produce some of our brands of CPG is to provide a diversity and range of products to the market where it is not practical or economical to invest in machinery and equipment and manufacture a wide range of products in-house. In line with our mode of operations, we will continue to source these existing and new products from external manufacturers in Malaysia for cost efficiency reasons.
4. RISK FACTORS (Cont’d) As at LPD, we did not face any interruptions in the supply of finished goods from external manufacturers for our business operations. The impact of fluctuations in prices of raw materials are minimal to our Group as it only represents a small proportion of 1.13% of our total purchases of products, raw materials and services for FYE 30 June 2015. Nevertheless, there can be no assurance that the potential risk of dependency on external manufacturers would not have a material adverse impact on our financial performance in the future. 4.1.5 Dependency on Executive Directors and key management personnel We believe that human capital is one of our key success factors. Over the years, we have built an experienced management and operations team in the business of distribution and warehousing of third party and our own brands of CPG, the manufacture of bakery products as well as understanding of our customers’ needs and requirements. As such, any loss of our key management personnel, without a suitable and timely replacement, may have a material adverse impact on our business and our continuing ability to compete effectively. The profiles of our Board and key management personnel are set out in Sections 8.2 and 8.4 of this Prospectus. As part of our strategy to retain our employees, we offer competitive remuneration packages to our key management personnel. In addition, we provide a healthy working environment, practise good workplace culture and uphold work ethics to create a sense of belonging and foster good working relationships amongst our employees. We also have in place a management succession plan and provide training and career development opportunities for our employees. Further, in conjunction with our Listing, we have allocated a portion of our IPO Shares to our Eligible Employees, including our key management personnel. Should these employees subscribe for our IPO Shares, they will become shareholders of our Company and may therefore be further motivated to continuously contribute to our success. In the past financial years under review and up to LPD, we have not experienced any loss of our key management personnel which materially impacted our business. Nonetheless, there can be no assurance that the above measures will be successful in attracting and retaining our key management personnel or ensuring a smooth transition should changes occur.
4.1.6 Potential liability and/or disruption to our business for delay in obtaining the necessary licences We are also dependent on our continued operations and any delay in obtaining the necessary licences or permits may affect the continued operations of our business, such as our trading licences issued by local authority, cold room certificates, license to sell pesticides, wholesaler licenses, food and eating premises licence, certificate of registration of food premises, and halal certificates issued by JAKIM for some of our products. For details of our major licences, permits and registration, please see Section 6.14 of this Prospectus. As at LPD, we have obtained all material licences, permits and registrations for our business operations and have complied with all conditions imposed therein. Our continued compliance with the Food Regulations 1985 for all our F&B products and compliance with requirements set by JAKIM to maintain Halal certification issued by JAKIM for our bakery products manufactured by Creamos Malaysia are important to us. The laws, regulations, standards and policies of the governmental regulatory agencies and professional bodies are sUbject to change, and changes in, or new interpretations of, applicable laws, regulations, standards or policies, or non-compliance with any applicable laws, regulations, standards and policies, could have a material adverse effect on our registrations, licences, accreditations, operations or business costs. 4. RISK FACTORS (Cont’d) Furthermore, findings of non-compliance with these laws, regulations, standards and policies could also result in us being subject to fines, penalties, injunctions, limitations on our operations, termination of our registrations and approvals, revocation of the food standard certification or other censure that could have a material adverse effect on our business, financial condition, results of operations and prospects, apart from product recalls for noncomplying products or products being the subject of investigation or claims of non-compliance by the authorities, including JAKIM. It may be costly for us to comply with any subsequent modifications of, additions or new restrictions to, these compliance standards. Should there be any subsequent modifications of, or additions or new restrictions to the current compliance standards, we may incur additional costs to comply with the new or modified standards, including possible product recalls which may adversely affect our business and financial performance. In the past financial years under review and up to LPD, we have not experienced any fines, penalties, injunctions, limitations on our operations, termination of our registrations and approvals, revocation of the food standard certification or other censure that has materially and adversely affected our business, financial condition and results of operations. Our premises are also governed by the relevant laws and regulations in Malaysia (including land rules and building regulations). As at LPD, we have complied with all the relevant laws and regulations in Malaysia (including land rules and building regulations) as well as the conditions set forth in our licences imposed by the relevant authorities. Whilst we continuously ensure compliance with relevant government regulations, there can be no assurance that any penalties, if imposed, will not have a material adverse impact on our financial performance in the future.
4.1.7 Product Misstatement and Mislabelling Our business is subject to the risk of product misstatement and mislabelling associated with own brands of CPG and bakery products. Revenue from our own brands of CPG and bakery products accounted for RM14.22 million or 4.74% of our total revenue for FYE 30 June 2015. In line with all F&B products, we take due care and consideration in the labelling of content and ingredients of our own brand of food products with the intention to provide information to our consumers. The Food Act 1985 (“Food Act”) provides, among others, that any person who prepares, packages, labels or sells any food in a manner that is false, misleading or deceptive as regards its character, nature, value, substance, quality, composition, merit or safety, strength, purity, weight, origin, age or proportion or in contravention of any regulation which includes Food Regulations 1985 made under the Food Act commits an offence and is liable on conviction to imprisonment for a term not exceeding three years or to a fine or to both in relation to penalties for product misstatement or mislabelling. There is always a potential risk of product mislabelling which, may result in the consumption of ingredients that consumers are allergic to, or which are against their religious or other beliefs or preferences. This would adversely impact on the brand name, reputation and public perception of the operator, manufacturer and/or distributor of any F&B product. The operator, manufacturer and/or distributor may, among others, be forced to recall its F&B products, be subjected to adm inistrative actions and/or penaltieslfines by the relevant authorities, be forced to compensate affected end-consumers, or be subjected to legal action resulting from product liability claims. Should any of the above occur, it may have an adverse effect on the financial performance and future prospects of our Group. 4. RISK FACTORS (Cont’d) For our own brands of CPG, we source the finished products from external manufacturers locally and overseas, which are packed under our own brand. This consists of frozen and dry foods, and beverage products. For the FYE 30 June 2015, we sourced our dry and frozen foods, and beverage products from a total of ten (10) external parties comprising nine (9) external manufacturers in Malaysia and one (1) manufacturer of frozen potato products in Belgium. As at LPD, all our external manufacturers in Malaysia are accredited with the following certifications: • ISO quality assurance certification;
• HACCP certification; and/or
• Halal certified products.
In addition, with our manufacturing operations, we practice proper product labelling for our bakery products. Since the commencement of our own brands of CPG and bakery products up to LPD, our Group complies with product labelling of food products and we have not faced any liabilities for product misstatement or mislabelling from the governing authority that have a material adverse impact on our financial performance. Nevertheless, there can be no assurance that there will be no occurrence of misstatement and mislabelling, which may not have a material adverse impact on our brand name, reputation, or ultimately, our business and financial performance in the future.
4.1.8 Product Liability As a provider of market access and coverage, we are involved in the distribution of third party brands and our own brands of CPG, as well as bakery products. As such, we are potentially exposed to the risk of product liability which may impact on our revenue and profitability. Product liability is generally stemming from, among others, manufacturing defects, design defects or defective warnings or instructions, product contamination, inadvertent use of unsafe ingredients, sabotage and product mislabelling. Members of the public claiming damages from these defects may take legal action against an operator, which may have an adverse financial impact on its business, as well as create bad publicity that may damage the brand and reputation. While manufacturers are likely to be the most directly exposed to the risk of public liability (as the party manufacturing products), operators involved in branding and marketing, and distribution may also face legal action for negligence. Operators in the CPG industry may mitigate the risk posed by product liability by obtaining product liability insurance. We are currently covered by product liability insurance of up to RM1 million for bakery products and up to RM2 million for the distribution of our own brand of products, as well as up to RM1 million for the distribution of third party brands of products. There can be no assurance that the amount insured by us is sufficient to cover the entire amount of claims on third party or our own brands of CPG, as well as our bakery products. As such, there can be no assurance that any successful product liability claim would not have a material adverse impact on our business performance. For the past financial years under review and up to LPD, we have not experienced any product liability claims from our distribution of CPG and manufacturing business operations. 4.1.9 Negative Perception and Publicity on our Reputation The reputation of operators in the CPG industry is sensitive to public perception. For example, F&B products that are consumed directly by the general public, possibly resulting from improper processing, storage or handling during the processing, manufacturing or distribution phases that may cause F&B products to become contaminated, resulting in food poisoning or other illnesses. Likewise, personal care products can potentially cause allergic reaction or have an adverse impact on sensitive skin. As such, any adverse public opinions on any products, brand or effects of any ingredients could have impact on the affected operator, from manufacturers, distributors up to retailers. 4. RISK FACTORS (Cont’d) In addition, CPG operators may become the target of malicious sabotage or rumours intended to damage their reputation. In this respect, operators may experience harmful substances being maliciously introduced into an operator’s products or subjected to market rumours based on unfounded daims of harm resulting from consuming an operator’s products. These incidences of contamination, sabotage or rumours may have an adverse impact on the brand name, reputation and public perception of the operator, which in turn, may have a negative effect on the demand for their products. This may culminate in the recall of products from the market, and in addition, the operator may be subjected to administrative action by the relevant authorities. As a result, these types of incidences may have an adverse effect on the financial performance and future prospects of an operator in the CPG industry. As a provider of market access and coverage of CPG including third party and our own brands as well as the manufacture of bakery products, we may be exposed to potential reputation risk associated with third party brands and/or our own brands of CPG as well as our brand of bakery products. In August 2013, we were involved in assisting one of our suppliers, a brand owner of milk powder to facilitate their product recall in Sabah and Labuan. The said product recall was made as a precautionary measure against a potential contamination scare. This product recall had impacted on our revenue for milk powder which decreased by 8.83% from RM54.79 million for FYE 30 June 2013 to RM49.95 million for FYE 30 June 2014. Save for the recall in August 2013, we have not experienced any recall of third party brands or our own brands of CPG as well as our brand of bakery products or subject to any administrative action by relevant authorities of F&B contamination, sabotage or rumours for the past financial year under review up to LPD. Nonetheless, there can be no assurance that the risk in reputation resulting from negative perception and publicity would not have a material adverse impact on our business and financial performance.
4.2 RISKS RELATING TO OUR INDUSTRY 4.2.1 Competition from Operators in the CPG Market We face competition from other providers of market access and coverage of CPG in the market. If we fail to be competitive with the other providers, this would affect our financial performance. According to the IMR Report, distributors that provide market access and coverage of CPG in Malaysia face normal competitive conditions, whereby the industry is subjected to normal supply and demand conditions moderated by the price mechanism. In addition to our group of companies, some of the other distributors of CPG in East Malaysia includes (as listed in alphabetical order) Austar Marketing Sdn Bhd, Choon Hua Trading Corporation Sdn Bhd, DKSH Holdings (Malaysia) Berhad, Harrisons Holdings (Malaysia) Bhd, Li & Fung Group, Moh Heng Company Sdn Bhd, Syarikat Lui Kim Chock Sdn Bhd and TLS Marketing Sdn Bhd. However, we believe that our competitive advantages and key strengths, such as covering a wide range of products and coverage of recognisable brands, our wide distribution network, established track record, economies of scale and experienced Directors and key management personnel would provide us with the platform to compete effectively within the industry and continue to grow our business. For further details on our competitive advantages and key strengths, please refer to Section 6.1 of this Prospectus. 4. RISK FACTORS (Cont’d) 4.2.2 Impact by Changes in Economic, Political and Social Conditions and Discretionary Consumer Spending Our business is subject to prevailing economic and social conditions. Any adverse developments in the above conditions may have a negative impact on our financial position and business prospects. The risks include, among others, unemployment levels, the risk of war or civil disturbance, changes in political leadership, changes in foreign exchange rate policy, changes in interest rates, methods of taxation and unfavourable changes in government policies such as introduction of new regulations, import restrictions and duties, export restrictions and duties, and tariffs. However, some of our CPG, especially food and household products are non-discretionary items. As such, these items would continue to be purchased although consumers may switch to lower priced items during an economic slowdown. Nevertheless, there is no assurance that any economic, political or social conditions would not adversely affect our business performance. 4.2.3 Direct Sourcing from Brand Owners We face the risk of being disregarded by some larger retail outlets. According to the IMR Report, modern retail trade particularly chain hypermarkets, supermarkets and convenience stores have greater purchasing power where they are able to directly source CPG from brand owners in place of distributors that provide market access and coverage. In some situations, these large retail chains have started their own in-house brands and obtained supplies directly from their contract manufacturers. The shift towards direct sourcing by larger retail chains may have a negative impact on our business operations and financial performance. Despite the shift towards direct sourcing by larger retail chains, these represent a smaller proportion of the market and there are still a large proportion of other retailers that are spread across urban and rural areas in Malaysia that would require the services of distributors. While it may be possible to directly source some products from the brand owners, it is not possible to source all the CPG items in the hypermarket or supermarket and deal directly with the respective brand owners locally as well as overseas. Therefore distributors would continue to playa role in the provision of market access and coverage of CPG. Brand owners that sell directly to larger retail chains would also need to ensure the availability of stocks and deliveries on a regular basis as well as provide administrative and promotional support services. In situations like these, brand owners may find it more effective and efficient to appoint distributors to undertake all these activities. As a provider of market access and coverage of CPG, we distribute approximately 194 third party brands and 10,348 SKU of CPG covering various locations within Sabah, Sarawak and Labuan. In addition to our coverage of products and brands as well as our distribution network, we have a stable long-term relationship with some of our major suppliers, most of whom are brand owners. We believe that our competitive advantages would provide us a steady platform to grow our business. Nevertheless, there can be no assurance that the continuing direct sourcing of products from brand owners would not impact on our future financial performance. 4. RISK FACTORS (Cont’d) 4.2.4 Increase in Buying Power of Hypermarkets and Other Chain Retailers Our business is subject to various terms and conditions and costs associated with the provision of market access and coverage of CPG. According to the IMR Report, distributors that provide market access and coverage of CPG may be subjected to various terms, conditions and costs associated with the distribution of CPG to major retail outlets that commands high volume sales. This is attributed to the increase in the buying power of hypermarkets and other chain retailers such as convenience stores. In this respect, the increase in the buying power of retail outlets may impact on the overall margins of providers of market access and coverage of CPG where they are subjected to various terms and fees including, among others, longer payment terms, shelf space display fees, contribution to advertising and promotional fees. The reduction in overall margin is sometimes compensated with volume sales from these hypermarkets and chain retailers. However, all distributors that provide market access and coverage of CPG to retail outlets are equally affected. In some situations, distributors that represent internationally renowned or highly visible brands of CPG would have stronger bargaining power against these retail outlets and therefore may pay lower shelf space display fee. (Source: IMR report prepared by Vital Factor Consulting Sdn Bhd) As a provider of market access and coverage of CPG, our competitive advantage of distributing a diversity of products and brands covering approximately 10,348 SKU of CPG and 194 third party brands as at LPD respectively, provide us with a stronger bargaining power to obtain shelf space and better commercial terms with these retail outlets. Nevertheless, there can be no assurance that the potential risk of the increasing buying power of hypermarkets and other chain retailers would not have a material adverse impact on our business performance.
4.2.5 Depreciation in Value of the RM Our business may be affected by the continuing depreciation of the value of RM against other currencies. The CPG industry in Malaysia imports a large proportion of its products from overseas. As such, a weak RM relative to other overseas countries, especially exporting countries, has resulted in an increase in the prices of imported CPG. This may reduce the propensity for consumers to buy such products, thus negatively affecting the entire value chain including distributors of CPG. Similarly, if local products source a certain proportion of their ingredients or raw materials from overseas, then such products may also factor in these price increases at the retail sector. Thus, a weak RM may also have consequential effect of increasing the prices of local products. At the end of August 2015, the exchange rate of the RM to USD was RM4.20 to USD1.00, com pared to RM3.15 to USD1.00 at the corresponding period in 2014. (Source: Bank Negara Malaysia) This represented a decline of approximately 25% in the value of the RM relative to the USD. There is a risk that a sustained weak RM would reduce the demand for CPG, thus negatively affecting, among others, distributors of CPG. However, there is a wide range of choices of CPG in the market where consumers may select different products to fit their budgetary requirements. These choices include, among others, switching to lower priced brands, buying a smaller quantity and/or switching to locally made products. In addition, many of the CPG products are deemed as necessities in a modern society like Malaysia. As such, while purchases of CPG may be lowered, consumers will always require CPG for their everyday use and consumption. (Source: IMR Report) 4. RiSK FACTORS (Cont’d) Nevertheless, there can be no assurance that our future business performance may not be affected by the continuing depreciation in the value of the RM against other currencies. For FYE 30 June 2015, 3.97% or RM11.21 million of our total purchases were transacted in USD and Euro. This was mainly for the purchases of third party brand of oral care products and own brands of frozen food. All of our revenue was transacted in RM for FYE 30 June 2015. As we only have minimal transactions in foreign currency, the fluctuations in foreign exchange rate would have minimum impact on the performance of our business. Nevertheless, there can be no assurance that the potential risk in foreign exchange fluctuations such as an unfavourable foreign exchange movement against the RM would not have an impact on our business and financial performance. Notwithstanding the above measures, steps and efforts undertaken by our Group to mitigate the abovementioned risks relating to our business and industry, there can be no assurance and guarantee that we can successfully manage all the risks including our ability to compete successfully in the future, and our ability to obtain sufficient supply of raw materials from our regular suppliers. Further, there is no assurance that our customers will continue to place orders with us in the future and at the same levels as they had previously, or our ability to successfully manage our exposure to financial risks or our ability to attract and to retain our key management personnel with similar level of experience and capabilities. Failure to do so could have a material and adverse impact on our business, financial condition and the results of our operations. THE REST OF THIS PAGE HAS BEEN INTENTIONALLY LEFT BLANK