3. RISKFACfORS 3. RISKFACfORS Before investing in our Shares, you should pay particular attention to the fact that we, and to a large extent our activities, are subject to the legal, regulatory and business environment in Malaysia. Our business is subject to a number of factors, many of which are outside our control. Prior to making an investment decision, you should carefully consider, along with other matters in this Prospectus, the risks and investment considerations set out below. The risks and investment considerations set out below are not an exhaustive list of the challenges that we currently face or that may develop in the future. Additional risks, whether known or unknown, may in the future have a material adverse effect on us or our Shares. 3.1 General Economic, Political, Legislative, Business and Social Conditions As with any business, our business is not impervious to adverse developments in the economic, socioeconomic, political, legislative and business conditions both on the domestic and international front, and/or other countries which we have and/or may have (in future) business links. Any adverse developments of such nature could materially and adversely affect our bnsiness, operations and financial performance. Amongst the political, economic and social uncertainties include, but are not limited to, the changes in political leadership, war, global economic downturn, expropriation, nationalisation, and unfavourable change in Government policy and regulations on foreign exchange rates and methods, taxation and exchange control restrictions. Our business is also vulnerable to certain risks inherent in the industry in which we operate. We may be affected by entry of new players, constraints in skilled labour supply and increase in labour costs, changes in law and tax legislation affecting the E-Services project and changes in business and credit conditions. We seek to mitigate these risks through prudent management policies, active R&D, securing and maintaining good business relationships with our customers and suppliers, expansion of our client base in the local market and effective human resource management. However, we cannot provide any assurance that our business and operations will not be adversely affected by any change in any of these environments.
3.2 Competition The business environment within the E-Services project in Malaysia is moderately competitive with only 3 players. However, we may encounter competition from companies that provide similar EBPP services to that under the E-5ervices portal. An example of this will be banks and credit card companies offering utility payment facilities either over the counter or through electronic arrangement. These financial institutions may attract new customers by giving away prizes and special gifts to selected customers who pay their bills through them, effectively subsidising the customer. The possibility of increased competition from these competitors may cause us to lose some market share and consequently result in lower profit margins in the provision of such EBPP services. Nevertheless, we are confident that we will be able to maintain our competitive advantage by focusing on providing high value-added services, continuous product development and improvement, iunovative application modules, prompt and efficient delivery of services and effective cost controls. Additionally, the integrated nature of our Group’s services, combining the delivery of both E-Services and related commercial services such as the E-Cover Notes, currently affords us a competitive edge over our competitors. However, there can be no assurance that our Group will not be affected by the competitive strategies adopted by the other Service Providers of the E-Services project. We are unable to provide any assurance that we will always be able to maintain and/or expand our market share in Malaysia. In 2005, our market share in terms of revenue in the local E-Services industry is approximately 45.2%. (Source: Independent Market Research Report) 3. RISK FACfORS (Conl’d)
3.3 Dependence on the Government Concession Presently, our Group’s revenue is substantially derived from the operations under the Government concession. Our concession with the Government provides us with the rights to incorporate services (current and future) under the E-Services project to various government agencies / Service Suppliers over a period of 15 years commencing from the date of the execution of the respective agreements plus an option to extend subject to mutually agreeable terms. We have entered into such agreements with the Government on 23 May 2000 and 28 January 2003, under the Government concession as service providers for JPJ, together with TELEKOM and TNB, and PDRM respectively. We also expect to execute similar agreements with the Government as service providers for DBKL and JIM. Upon expiration of this concession, we will be required to transfer our proprietary software to the Government without compensation. However, physical assets such as systems, servers, routers and test centres, and operational know-how related to the concession shall remain our property. It may be difficult to predict the impact of the expiration of this concession on our business potential. However, the risks arising from the expiration of the concession period is, to some extent, mitigated given that the computerization of governmental services is inevitable because of the greater efficiencies and conveniences afforded by such a process. The provision of E-Services also forms a strategic component in the building of the Government’s technology vision for Malaysia. Therefore, the Government will still require companies like us to continue providing these services to the public. Furthermore, the likelihood of the Government switching to another new Service Provider is unlikely, since we as a Group have proven that we are a reliable Service Provider with the relevant capabilities, expertise and technology to implement the E-Services project, smoothly. Our successful track record would strengthen our position in securing the extension of the Government concession when it expires, and would serve as a strong reference point in the future when we wish to tender for prospective projects in a similar capacity. Through the provision of services under the E-Services project, our Group has also built the existing infrastructure including E-Service Centres and leased lines with the Government. Such features will act as a barrier to entry for potential entrants as the capital investment of developing and constructing the infrastructure is substantial. Meanwhile, to reduce dependency on revenue contribution derived from the operations under the concession agreement, namely the provision of electronic driver licensing services and ancillary services, we have increased and will continue to diversify the breadth of our services. We have identified several Government regulated commercial projects which will diversify our Group’s revenue base, primarily our E-Cover Note services which are already in operations, and also the E-Insurance Intermediary services which we intend to offer to our clients by FYE 2007.
3.4 Acceptance ofthe E-Government Applications The E-Government and E-Services applications cater to the citizens, hence, it is crucial that the projects capture the users’ confidence in continuously accessing such services. The public will not view the project as a success unless the information is sufficient, accurate, up-to-date and secure. Also, due to the computerisation of E-Government applications, E-Services may displace certain occupations such as insurance agents and intermediaries. As such, affected parties may lobby against the introduction of E-Services. 3. RISK FACTORS (Cont’d) We mitigate the above risks by updating the information posted on our portal on real time basis, providing links to the respective Government agencies and guaranteeing the security of our site. Measures taken to secure our site include adopting firewalls and compliance to Secure Sockets Layer certification that creates a secured connection between the citizens, Government and our server, over which any amount of data can be sent securely. Besides that, we will also endeavour to educate the public and business community on the greater efficiencies and conveniences afforded by the EGovernment applications. 3.5 Seasonality Factor Our JPJ-related revenue under the Government concession is subject to seasonality. The demand for new driving licences generally increases in the first half of the year due mainJy to the long school holidays after the Government exams, where most 16-20 year olds would obtain their driving licences between the months of January to June. Therefore, JPJ-related revenue in the first half of the year (January -June) has historically been approximately 50% higher than the JPJ-reiated revenue recorded for the second half of the year (July -December). For FYE 30 June 2006, JPJ-related revenue generated from January 2006 to June 2006 accounted for approximately 53% of our annual revenue. We are endeavouring to mitigate the revenue fluctuation through the diversification of our product offerings with the launch of other services, such as those services under JIM, PDRM, TNB and TELEKOM whereby revenue contribution from these agencies is not materially affected by seasonality, and commercial services with the introduction of the E-Cover Notes. This will, to a certain extent, cushion tbe impact of seasonality on our revenue from JPJ-related services.
3.6 Delays in our R&D Programmes We have on-going R&D programmes with the purpose of developing products and services that meet the dynamic requirements and expectations of the market. There can, however, be no assurance that these R&D programmes can be successfully completed on time so as to enable the rollout of new or enhanced products and services on a timely basis with regards to market requirements and expectations. Additionally, the launches of our new services are, to some extent, dependent on the Government’s decision to introduce any new E-Services under the existing concession and the expected pace in which nationwide implementation of such new E-Services shall be achieved. However, we believe that our current range of products and services are stable and have been wellaccepted by our customers, and as such the effects of any material delay in the roll-out of new or enhanced products is mitigated by continued availability of our existing range of products and services. 3.7 Technological Risks The electronic services market and information technology industry is subject to rapid technological changes. Our ability to keep pace with these technological changcs such as changing market trends, and evolving industry standards, and to remain technologically competitive will influence our revenue and profits. Our future success is dependent on our ability to enhance our products in a timely manner to respond to this changing environment. Even though we are active in R&D of new products, services and technologies, there is no assurance that our R&D efforts will lead to the successful introduction of new and improved products and services. We may encounter delays or problems in connection with our R&D efforts. Delays or deficiencies in development, failure to anticipate and adapt to developing market trends could have a negative effect on our business, operating results or financial condition. 3. RISK FACTORS (Cont’d) Nevertheless, we are actively continuing with our on-going R&D programme to mitigate the effects of rapid technological changes in the ICf industry. We have budgeted an annual R&D expenditure of approximately 2% -6% of our annual consolidated revenue up to FYE 2010 for our R&D activities.
3.8 Possibility of Intellectual Property Infringement The infringement of copyright and illegal copying of proprietary software can be deemed as a major constraint impacting the proprietary software industry. In order to protect its intellectual property rights, it relies on a combination of trade mark and copyright protection. Our success is dependent upon our ability to protect our proprietary technology. However, there is no assurance that we will be able to protect or effectively enforce our proprietary rights against unauthorised third party copying, using or exploiting our software. To mitigate the risks of intellectual property infringement, we procured all our employees to sign agreements, which will effectively limit the possibility of direct copying of our application products (for a limited period) by employees who have resigned. Also, we had on 6 April 2005 submitted applications to the Intellectual Property Corporation of Malaysia for the registration of trade marks in relation to MYEG™ which is pending the issuance of the Certificate of Registration Trade Mark. We also enjoy copyright protection for our entire line of software solutions under the general category of literary work pursuant to the Copyright Act, 1987.
3.9 Security Risks and Systems Interruptions 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. Our products are designed to facilitate the EServices project under the E-Government programme, which involves the provision of personal and confidential particulars such as credit card details, identification card number, and other personal information over the Internet. As a result, the integrity of the security of our software solution is vital to ensure market acceptance and continuous support of our products. Our product may be vulnerable to unauthorised use or other improper activity that could jeopardise the security of information. 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 reasonable 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 with back 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. 3. RISK FACTORS (Com’d)
3.10 Risks Associated with Rented Premises As disclosed in Section 4.4.16 of this Prospectus, we currently run our business operations on leased premises. Therefore, our business, operating results and growth prospects may be affected if we were to experience sudden simultaneous termination of tenancy agreements or if we are unable to reach acceptable agreements regarding the renewal of the lease at the end of the lease term, particularly for branches with high business turnover. Moreover, as disclosed in Section 8 ofthis Prospectus, our E-Service Centre situated in Tapah does not comply with applicable zoning and land use regulations, and has not been issued with certificate of fitness for occupation. An irregularity in the tenancy of our E-Service Centre in Kuantan has also been discovered. Our Directors have decided to relocate such E-Service Centres to another location in the same vicinity in the event the infringements/irregularities cannot be resolved with the specific timeframe given. Additionally, our Directors have taken the initiative to look for alternative sites to rent during this period pending the necessary approvals to rectify the infringements/irregularities. This will provide us with sufficient time to source for new premises, should we be required to relocate. Our Directors do not expect our business operations to be materially affected since the E-Service Centres indicated above are not high business turnover units and they, collectively, contributed less than 5% to our consolidated revenue for the FYE 30 June 2006. Save for the aforementioned E-Service Centres, our Directors are not aware of any breach or infringements which may require us to relocate any of our other E-Service Centres. Shifting our operations or closing down one or more E-Service Centres in the future could entail significant one-time earnings charges to account for severance, write-downs and moving expenses. There is also a ramp-up period of time before we expect a new E-Service Centre to achieve our targeted level of performance due to additional start-up operating costs and other temporary inefficiences. In mitigation of these risks and in order to minimise business disruptions, our Group has put in place the following risk management practices: (i) prior to entering into tenancy agreements, the proposed contractual provisions of the tenancy agreement shall be carefully reviewed by our business legal counsel;
(ii) establishing and enforcing an internal assessment to ensure all properties rented / to be rented by our Group comply with the relevant law, rules and building regulations; and
(iii) as a contingency plan, we will re-evaluate the lease terms of existing tenancy agreements with the respective landlords three (3) months prior to the expiry of the agreements so as to provide us sufficient time to source for alternative locations should we be unable to reach acceptable agreement regarding the renewal of the lease with the landlord. In future, prior to entering into tenancy agreements, we will carry out the abovementioned procedures to minimise the possibility that the premises to be rented are in breach or infringe any relevant land and building rules and regulations. 3. RISK FACTORS (Conl’d)
3.11 Inadequate Insurance Coverage We are aware of the unfavorable consequences arising from inadequate insurance coverage that could impair our business operations. In ensuring that such risks are minimised, we review and ensure adequate coverage for our assets on a continuous basis. At present, our Directors are of the opinion that we are adequately insured against unforeseen events such as fire and lightning, malicious damage, theft and burglary. Although we have taken the necessary steps to mitigate the risk of fire hazards and insure our assets adequately, there can be no assurance that the insurance coverage would be adequate for the replacement cost of our assets or any resulting loss arising from the damage or loss of our assets.
3.12 High Development Cost and Sunk Cost Software development is characterised by substantial economies of scale. The fixed costs of developing software, including applications, are high. By contrast, marginal costs are low. Moreover, the costs of developing software are “sunk” -once expended to develop software, resources so devoted cannot be used for another purpose. The result of economies of scale and sunk costs is that marginal investments in operating cost are minimal. In this respect, the more competitive the environment, the more difficult it would be to enjoy economies of scale in the short-term. A player in the E-Services industry has to have quite a substantial degree of working capital and capital expenditure to sustain itself in the competitive environment before the path of profitability starts to flow in. In this regard, our Directors believe that we have established a reputation as a reliable and quality Service Provider in the E-Services market in respect of the E-Government Initiative. Considering that the E-Government industry is a niche market and competition is moderate, we have been able to maintain our position as a major player in the industry by achieving economies of scale. However, no assurance can be given that high development costs sunk into the development of future application products will not materially affect our business or financial condition, should we encounter delays in or deficiencies during the launch of our new applications or services.
3.13 Dependence on Key Personnel and Skilled Professionals Our continued success depends to a certain extent upon the abilities and continued efforts of our existing Directors, key management and technical personnel. The collective loss of a number of our Executive Directors and members of the key management and technical personnel could negatively affect our Group’s continued ability to manage the operations effectively and competitively. Ief is a K-based industry which requires a number of skilled, professional and knowledge workers with a high level of competence and skill. In the software development industry, knowledge workers such as programmers, software engineers, system architects, content developers are in short supply, especially those with sufficient experience in the design and development of stable, reliable and robust systems. If we are unable to retain our skilled workers, staff replacement costs as well as associated opportunity cost will be considerable. Our Directors recognise the importance of our Group’s ability to attract and retain its key personnel. We have in place a human resource strategy, which includes a suitable compensation package and a human resource training and development programme 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. 3. RISK FACTORS (Conl’d) 3.14 Change in MSC Status We were awarded MSC status on 16 August 2000, which grants us financial and non-financial incentives. At present, these incentives include: (i) a five (5)-year exemption from Malaysian income tax (only on income derived from MSCrelated activities) commencing from the date when MYEG starts generating income, renewable to ten (10) years, or a 100% investment tax allowance on new investments made in designated MSC cyber-cities, commencing from the date on which the first qualifying capital expenditure is incurred. MYEG’s statutory income from pioneer activities during the pioneer period from 18 July 2001 to 17 July 2006 is tax-exempt. We have submitted an application to the MDEC in May 2006 for an extension of another five (5) years until 17 July 2011 for us to continue enjoying the said tax incentives and are currently awaiting the MDEC’s approval on the application. Our Directors do not foresee that the extension will not be granted;
(ii) duty-free importation of multimedia equipment, provided that the equipment is used by the company in the operation of its business, and not for direct sale and trading or use as components in manufactured items;
(iii) R&D grants for MSC small and medium enterprises that are at least 51% Malaysian-owned; and (iv) non-financial incentives (please refer to Section 4.6.6(iii) of this Prospectus for further details). MDEC is the body responsible for monitoring all MSC status companies. MDEC has the right to withdraw any company’s MSC status at any time. There can be no assurance that we will continue to retain our MSC status or that we will continue to enjoy, or we will not experience delays in enjoying the incentives granted to MSC status companies, all of which could materially and adversely affect our business, operating results and financial condition.
3.15 Control by Promoters The promoters, namely AlII, AIEH, Jason Chan Ling Khee, Koh Yeow Lay and Dato’ Dr Ramli Bin Haji Karim, collectively own approximately 51.09% of our issued and paid-up capital after the Public Issue. Because of the size of their shareholdings, they will be able to influence the outcome of certain transactions and matters, including the election of our Directors, by exercising the voting rights attached to their shares. They may be in a position to determine the outcome of transaction matters requiring our shareholders’ approval unless they are required to abstain from voting by law and/or the relevant authorities. With the introduction of corporate governance that requires the formation of the Audit Committee, we have appointed two (2) Independent Non-Executive Directors as a step towards good corporate governance. The above substantial shareholders would also be required to abstain from voting if there is any related-party transaction, which may pose as a conflict to the interest of our Company. 3. RISK FACTORS (Conl’d)
3.16 Borrowing Risks and Restrictive Covenants As at the LPD, our Group has approximately RM0,46 million in outstanding borrowings comprising term loan and leasing facility, all of which are interest bearing. As such, any additional borrowings and/or increase in interest rates may result in an increase in interest expense and affect the profitability of our Group. There can be no assurance that the interest rates will be maintained in the future and/or that any increase in our borrowings will not have a material effect on the performance of our Group. Our credit facilities may also be subject to periodic review by the banks or financiers and contain certain covenants which may limit our operating and financial flexibility. Any act or omission by us that breaches such covenants may give rise to rights by the banks or financiers to terminate the relevant credit facilities and/or enforce any security granted in relation to those credit facilities. This may in tum cause a cross default of other credit facility agreements. These covenants are commonly contained in credit facility agreements in Malaysia. There can be no assurance that our performance will not be adversely affected should we breach such covenants of any of our facility agreement. We are not presently in breach of any such covenants of any credit facility granted to us and will at all times take all reasonable effort to observe such covenants.
3.17 Investment Risks We may from time to time invest in new equipment or new ventures which we believe to be beneficial to our business or is synergistic with our current operations. Although we exercise prudence in our decision-making, there is always the potential risk that the returns from these investments may have a longer payback period than expected or the investments may fail. Although we will mitigate our investment risks by exercising due care in the evaluation of our investments, there can be no assurance that all our future investments will yield positive returns and would not have any adverse material effect on our future financial performance.
3.18 Uncertainty of the Business Development Plan The success of our business development plan and growth strategy will be dependent upon, amongst others, our ability to develop new products by leveraging on core competencies, consistently maintaining a high standard of quality for our products and services, entering into strategic marketing arrangements on a timely basis, monitoring our business growth, hiring and retaining skilled personnel, and obtaining adequate financing when needed. There can be no assurance that we will be able to successfully implement our business development plan or that unanticipated expenses or problems or technical difficulties will not occur which would result in material delays in our implementation or even deviation from our original plans. In addition, the actual results may deviate from the business development plan due to competitive pressure and external market forces beyond our control.
3.19 Profit Forecast This Prospectus contains our consolidated profit forecast (details of which are set out in Section 9.9 of this Prospectus) which have been prepared based on various bases and assumptions that our Directors consider to be reasonable based on the prevailing market and operating conditions. These bases and assumptions are subject to uncertainties and contingencies that are often outside the control of our Group. There can be no assurance that actual results will not differ materially from the consolidated profit forecast in the event that the market and operating conditions vary from those assumed. You are deemed to have read and understood the assumptions and uncertainties underlying the consolidated profit forecast that are contained herein. 3. RISK FACTORS (Conl’d) 3.20 Forward-Looking Statements Certain statements in this Prospectus are based on historical data which may not be reflective of the future results, and others are forward-looking in nature which are subject to uncertainties and contingencies. Forward-looking statements are only predictions and include statements relating to the demand for our products and services, business strategies, plans and objectives for future operations, financial position and future earnings, cash flows and liquidity. All forward-looking statements are based on estimates and assumptions made by our Board, and although believed to be reasonable, are subject to known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements to differ materially from the future results, performance or achievements expressed or implied by such forward-looking statements. Although we believe that the expectations reflected in such forward-looking statements are reasonable at this point in time, there can be no assurance that such expectations will prove to be correct.
3.21 No Prior Market for Our Shares Prior to this Public Issue, there has been no public market for our Shares. The Issue Price of RM0.55 per Share was determined after taking into consideration several factors, including but not limited to, our earnings potential, our financial and operating history and conditions, our future plans and prospects and the future prospects of the industry in which we operate, the proforma consolidated NTA per Share and the prevailing market conditions. The price at which our Shares would trade on the MESDAQ Market after the Public Issue may be influenced by a number of factors, including the liquidity of the market for our Shares, changes in securities analysts’ estimates of our financial results or recommendations and the perception of investors of us. Therefore, there can be no assurance that the Issue Price will correspond to the price at which our Shares will trade on Bursa Securities upon or subsequent to our listing on the MESDAQ Market, 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 be traded may be higher or lower than the Issue Price. 3.22 Delay or Failure to List The occurrence of anyone (1) or more of the following events may cause a delay in or abortion of our Listing: (i) the Underwriter exercising its rights under the Underwriting Agreement and discharges itself from its obligations thereunder;
(ii) the identified investors fail to subscribe for the portion of the Public Issue Shares to be placed to them under the private placement; and
(iii) we are unable to meet the public spread requirement, that is, at least 25% of our entire enlarged issued and paid-up share capital must be held by a minimum of 1,000 public shareholders holding not less than 100 MYEG Shares. Although our Directors will endeavour to ensure compliance by our Company of the various listing requirements, including, inter-alia, the public spread requirement imposed by Bursa Securities for our successful listing, no assurance can be given that the abovementioned events will not occur and cause a delay in or abortion of our Listing.