4. RISK FACTORS 4. RISK FACTORS Before investing in our Shares, you should pay particular attention to the fact that our Group, and to a large extent our activities, are governed by the legal, regulatory and business environment in Malaysia and other countries in which we operate whether presently or in the future. 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 the other matters set forth in this Prospectus, the risks and investment considerations below. You should note that the following list is not an exhaustive list of all the risks that we face or risks that may develop in the future. Risks relating to the industry in which we operate 4.1.1 Competitive industry We operate in the consumer electronics industry and are subject to competition given that we manufacture and sell products to multinational corporations in the global market place. Our Group faces competition from established original equipment manufacturers both locally and internationally as well as potential new entrants. These original equipment manufacturers compete with one another based on, amongst others, product design, quality, price and range of services. As we also have our in-house electronic products under our FOBO brand, our products also compete with other products of similar functions such as built-in TPMS installed as a factory specification for certain vehicles, other aftermarket TPMS brands as well as other wireless tags or trackers. Our Group’s future success and competitiveness largely depends on, amongst others, our production and R&D capabilities, our technical expertise, our ability to keep abreast with the latest technology, our understanding and ability to respond to the constantly changing economic conditions and changing consumer trends and demand for consumer electronic products, as well as, our planning and marketing strategies. Our Board believes that we will remain competitive and be able to grow our business due to our competitive advantages and key strengths as set out in Section 6.3 of this Prospectus. Nevertheless, there can be no assurance that competition within the consumer electronics sector will not have any material impact on our business and financial performance. 4.1.2 Changes and uncertainties in the IT, telecommunications and electronics industries The market for telecommunications and electronic products is inextricably linked to the continuing evolution in technology and evolving industry standards. In addition, consumers demand more sophisticated technology, user-friendliness as well as comprehensive functionality of products to meet their needs and expectations. As such, it is imperative that our Group keeps abreast with the latest technology and respond to the market trends and development through the adoption, customisation and integration of new technology in a timely and cost effective manner. We risk our existing customers switching to other competitors if we are unable to keep up with the change in technology and market demand. This may adversely affect the operational and financial performance of our business. We believe that such risks may be mitigated as we have more than ten (10) years of experience in the manufacture of consumer electronic products and we are supported by a capable and experienced management team that is familiar with this competitive environment. However, there is no assurance that such risks can be mitigated in the future as it is dependent on our Group’s ability to retain and develop the relevant expertise and capability to keep up with any new technology requirements. 4. RISK FACTORS (Cont’d)
4.1.3 Political, economic and regulatory factors Our Group operates in Malaysia whilst our customers are mainly located overseas with operations in North America, Europe, Australasia, Asia and Africa. Like all other business entities, changes in political, economic and regulatory conditions in Malaysia and the markets in which our customers operate may materially and adversely affect the overall profitability of our business. Amongst the political, economic and regulatory uncertainties that may affect our operations and profitability are the changes in political leadership, changes in interest rates, fluctuation in currency exchange rate, expropriation, nationalisation or nullification of existing sales orders and contracts, as well as the changes in the regulations relating to taxation or licensing in which our Group and our customers operate. We have adopted a proactive approach in keeping abreast with the political, economic and regulatory developments in the relevant jurisdictions reported through various media, participation and attendance in events and seminars hosted by government agencies as well as the provision of relevant trainings to designated employees on any updates to the regulatory requirements in respect of labour, machinery and safety and will continue to ensure material compliance with the legal and regulatory frameworks in the countries in which we and our customers operate. However, there is no assurance that the introduction of new laws or other future economic, political and regulatory conditions will not have a material adverse effect on the business, results of operations or financial condition of our Group. 4.2 Risks relating to our business and our operations 4.2.1 Reliance on our Managing Director I Chief Executive Officer and key management personnel Our Group’s continued success will depend, to a significant extent, upon the abilities, capabilities and continued efforts of our key management personnel comprising our Managing Director / Chief Executive Officer, James Lim, and other senior management professionals from various backgrounds and expertise. The majority of our key management personnel has been attached to our Group for at least ten (10) years and has extensive knowledge and experience in our business operations. Any loss of our key management personnel without suitable and timely replacement may adversely affect our ability to compete effectively in the industry. In recognising the importance of attracting and retaining suitably qualified personnel, we have put in place human resource strategies, which include competitive remuneration packages, the adoption of succession planning for key positions and providing employees with a variety of on-going training programmes to enhance their knowledge and capabilities. However, we cannot provide any assurance that these measures will be successful in attracting and retaining our key management personnel or ensuring a smooth transition should changes occur.
4.2.2 Dependence on our major customers Our Group’s major customers comprise mainly multinational corporations dealing in Bluetooth devices such as Plantronics, Jaybird and Sony who had in aggregate, contributed 63.6%, 91.7%, 89.8% and 89.5% to the revenue of our Group for FYE 30 June 2013, 2014 and 2015, as well as the seven (7) months FPE 31 January 2016, respectively. 4. RISK FACTORS (Cont’d) The loss of any of these customers, if not replaced, may adversely affect our financial condition and results of our operations. In addition, as we have no control over the prospects and success of our major customers’ business, our financial performance may be adversely affected if they lose market share, experience financial difficulty or if they are faced with an economic downturn which affects demand for their products. However, our Board is of the view that these risks are mitigated to a certain extent, by the following:(i) we have long(1) established business relationships with our major customers each for three (3) years and above, and have been through several product lifecycles with each of our major customers and therefore, are familiar with their respective requirements and preferences; Note:(1) As the consumer electronics industry is subject to competition, we consider a three (3) to four (4) year relationship with a customer to be “long” as product lifecycles can be as short as six (6) months. For example, over the past three (3) to four (4) years, we have continuously secured orders for subsequent model upgrades and have succeeded in incorporating new technology or features as specified by our major customers. (ii) our track record of being able to offer quality products and services and our strength in R&D will support the growth in product orders from our existing customers for their subsequent model upgrades as well as to attract new customers. Currently, we are on the approved suppliers’ list for Plantronics, Jaybird and Sony; (iii) our Group being involved in the manufacture of other electronic products (non-Bluetooth related devices), precision parts and components for other customers. This provides us with additional sources of revenue and growth opportunities which we hope to be able to leverage on in the future; (iv) we have developed our in-house brand, FOBO and plan to grow the revenue contribution from FOBO in the future;
(v) our continuous investment and upgrade of our technology and manufacturing processes to support our customers’ needs as well as our expenditure in enhancing our R&D capabilities. We have earmarked RM33.2 million of our IPO proceeds for the aforesaid capital and R&D expenditures as detailed in Sections 3.8(ii) and (iii) of this Prospectus; and
(vi) our continued focus on R&D to extend our product range by developing Bluetooth devices and applications for use in other industries.
In addition, our Group has maintained and will continuously strive to meet our customers’ expectations by paying close attention to their feedback and working in tandem with their requirements to further improve our product and service quality. During the financial period under review, we have been able to sustain our business despite the reduced orders from some of our major customers, consequent to the deterioration of their business. Despite our efforts to diversify our revenue stream and customer base, no assurance can be given that the financial performance and operations of our Group will not be adversely affected by our dependence on our major customers. 4. RISK FACTORS (Cont’d)
4.2.3 Credit risk of our customers Our financial performance is dependent, to a certain extent, on the creditworthiness of our customers. If circumstances arise that affect our customers’ ability or willingness to pay us, we may experience payment delays or in more severe circumstances, we may not be able to collect payment from our customers. Accordingly, we would have to make allowance for doubtful debts, or incur debt writeoffs, which may have an adverse impact on our profitability. The abovementioned credit risk may be mitigated on the basis that our major customers are mainly reputable multinational corporations with strong financial standing and these customers have maintained good payment records in their past dealings with us. In addition, we conduct credit risk assessments on our new customers such as assessment on the reputation and financial information of the customers, ownership structure, country of incorporation and credit rating. Further, we monitor the outstanding balance and collection of our trade receivables. For the financial period under review, there were no other allowance for doubtful debts and bad debt write-off which had material adverse impact on our profitability, save for the allowance for doubtful debts of approximately RM5.0 million in FYE 30 June 2013, of which RM3.1 million was subsequently recovered in FYE 30 June 2014 pursuant to an out-of-court settlement.
4.2.4 Foreign exchange risks Our sales and purchases are denominated in various currencies, mainly USD and RM. We are therefore mainly exposed to USD fluctuations against the RM. Any significant change in USD foreign exchange rate may affect our Group’s financial results. Our revenue denominated in foreign currencies is approximately 81.4%, 98.6%, 98.5% and 99.5% for FYE 30 June 2013, 2014 and 2015, as well as the seven (7) months FPE 31 January 2016, respectively. Meanwhile, the direct material purchases of our Group denominated in foreign currencies is approximately 80.9%, 91.7%, 80.9% and 96.1% for FYE 30 June 2013,2014 and 2015, as well as the seven (7) months FPE 31 January 2016, respectively. Nonetheless, we have not been materially and adversely affected by fluctuations in foreign exchange rates during the financial period under review as set out in Section 11.3.4(iii) of this Prospectus. We have recorded net gain on foreign exchange, inclusive of net fair value gain on derivative financial instruments of approximately RMO.24 million, RMO.16 million and RM1.65 million for FYE 30 June 2013, 2014 and 2015, respectively. For the seven (7) months FPE 31 January 2016, we have recorded net loss on foreign exchange, inclusive of net fair value gain on derivative financial instruments of approximately RM 1.15 million. Our Group has a natural hedge arising from our sales and purchases being denominated in the same foreign currency. Additionally, we also enter into foreign currency forward exchange contracts with banking institutions to sell foreign currencies, in particular, USD at agreed prices for fixed periods of time to minimise the net exposure of our receivables and payables, as and when necessary. Our Group mitigates the foreign exchange risk through a natural hedge via operating foreign currency accounts using deposits received from its export proceeds to pay imported purchases, with the net exposure covered by foreign currency forward contracts. Nonetheless, there can be no assurance that any future fluctuations in exchange rates will not have a material and adverse impact on our financial performance. 4. RISK FACTORS (Cont’d)
4.2.5 Non-availability, poor quality and/or fluctuations in prices of raw materials We rely on reputable third-party suppliers for electronic and electro-mechanical components and other raw materials to support our business activities. We purchase all our raw materials on an order-by-order basis and have no long-term contracts with any of our suppliers. If they fail to provide timely delivery of the raw materials or if they deliver raw materials of poor quality or if the cost rises significantly, our business, financial conditions and results of operations could be adversely affected. These risks are mitigated by our standard operating procedures that assess and screen potential suppliers and our quality control procedures to determine the quality of the incoming materials. Further, some of our customers have their own designated list of approved suppliers or specified suppliers, from whom we may source our materials from, which further ensures the quality of the raw materials sourced. We also have a dedicated department which employs various inventory management techniques such as just-in-time and ship-to-stock programmes to plan material ordering with our approved suppliers to secure materials on a timely basis. There were no occurrences of non-availability, poor quality and/or fluctuations in prices of raw materials which had materially and adversely affected our financial performance for the financial period under review. However, no assurance can be given that the abovementioned risks will not materially impact the profitability and operations of our Group.
4.2.6 Technology obsolescence Our Group operates in a market where the products and services are prone to frequent new technology introductions and enhancements. Our Group’s future growth and success would depend on our ability to keep abreast with the latest technology to develop new products and services to meet the needs of our customers. The design and development of a new or enhanced product may be a time-consuming and uncertain process. We may also encounter complexities in the manufacturing, sales and marketing processes which may further delay the introduction or delivery of our new or enhanced products to the market in a timely and efficient manner. Our ability to grow is also subject to the risk of future disruptive technology that may unexpectedly displace the current technology. Such disruptive technology could adversely affect the competitiveness of our Group if we are unable to respond to the new technology accordingly. We seek to limit these risks by actively engaging in R&D activities that focus on developing new products and services as well as enhancing our proprietary solutions and process technology. We also maintain a good relationship with our customers to keep abreast with the latest trends and technology in the consumer electronic industry. In addition, prior to the commencement of any product design and/or developments, we have extensive discussions on the technological requirements with our customers, which would aid us to consider any potential changes in the technology employed or to adjust the scope of product design and/or development accordingly. Such close collaborations with our customers during the design stage for new products is beneficial to our Group as it will give us greater awareness and understanding of the latest technological trends and developments. However, there can be no assurance that we would be able to design and develop new products and services in a timely and cost effective basis. Such circumstances may in turn adversely affect our business operations and financial performance. 4. RISK FACTORS (Cont’d)
4.2.7 Disruptions to manufacturing and business operations Any fire outbreaks, power outages, disruptions of water supply, system malfunction, natural disasters and other causes may disrupt the manufacturing and business operations of our Group and consequently affect the financial performance and the reputation of our Group. Taking cognisance of such risks, our Group has a regular maintenance schedule for our machineries and equipment and has taken precautionary steps to minimise the risk of fire outbreaks through the installation of fire hydrants, fire extinguishers and the dispersal of the storage of raw materials and finished products at various premises. In addition, our Group also ensures that all our machineries and equipment are insured for any potential losses or physical damages due to fire outbreaks. We have not experienced any material disruption in our manufacturing operations during the financial period under review. Nevertheless, there is no assurance that any security and system disruptions will not materially affect our Group’s business in the future.
4.2.8 Contractual risks We have entered into contracts and agreements with our customers and suppliers which contain specific terms and conditions, obligations and undertakings. Any material failure on our part to perform our contractual obligations (including, amongst others, obligations to deliver products on time, to maintain the relevant operating licences and quality certifications at all times, to maintain confidentiality, to maintain sufficient insurance coverage and to honour warranties), may result in termination of the relevant contract and/or contractual liability for loss and damage, and expose us to the threat of litigation in addition to tarnishing our reputation and brand. We take cognisance of the terms of the contracts and agreements entered into by us, and will endeavour to comply with such terms and maintain good relations with our customers and suppliers to ensure the commercial continuity of our contracts and agreements. Although there has not been any material non-performance of contractual obligations for the financial period under review, no assurance can be given that we are able to fully perform all our contractual obligations in the future.
4.2.9 Delays, cancellations, and product complexities Our business is sUbject to the following risks:(i) customers may resort to cancellation, postponement or scaling down of the volume of product orders due to various reasons which include, amongst others, change in customer’s requirements and specifications, change in the key management of our customers, change in commercial viability of their products and change in the economic environment in which they operate in. Such cancellations, postponements or scaling down of the volume of product orders may affect our profit margin and delay our recognition of revenues;
(ii) the under-estimation of product complexities may delay the commencement of the production which in turn delays the delivery of our end products to customers. Further, unanticipated changes in product design and/or specifications nearing the commencement of production may cause us to incur higher costs; and
(iii) there may be disputes with our clients on the scope or quality of work carried out by us which may lead to unbudgeted additional costs at our end. 4. RISK FACTORS (Cont’d) We have not encountered any delays and cancellations as mentioned above that had materially and adversely affected our financial performance for the financial period under review. Our key management personnel always work closely with our customers to ensure that work requirements and quality expectations are met. Further, we also have standard operating procedures in place for production management. I\lotwithstanding the above, there can be no assurance that we will not encounter the above risks.
4.2.10 Product defect liabilities and warranty claims We are required to meet the strictest specifications for each product to ensure functionality and high performance. It is therefore crucial that we have the expertise and equipment to manufacture our products with high precision and accuracy as we are responsible for potential defects in relation to our design, poor workmanship and the quality of material used, as well as products that are not manufactured in accordance to the product specifications. In the event of such defects, we may have to rectify the defects at our own costs and this may result in lower profitability. Any unusual or excessive defects may damage the reputation of our Group as a manufacturer of electronic products and our FOBO brand. For the past three (3) FYE 30 June 2013,2014 and 2015, as well as the seven (7) months FPE 31 January 2016, the percentage of defective products returned is less than 0.5% of the total products shipped for the respective financial years/period under review. We generally provide warranties of up to eighteen (18) months for most of our products for external brands and warranties ranging from twelve (12) months to thirty (30) months for FOBO products depending on our export markets. These warranties do not cover any consequential losses, normal wear and tear or damage to the product due to negligence by the end user. For the financial period under review, we have not suffered from any material warranty claims. These risks are mitigated by conducting amongst others, careful prototyping, comprehensive in-process and final testing of our products, adequate training of our employees, sourcing of raw materials from reputable suppliers as well as working closely with our customers to ensure that all specifications are met. Further, we employ lean management principles and the Six Sigma methodology in our manufacturing processes. However, no assurance can be given that such risks will not adversely impact the profitability of our Group in the future.
4.2.11 Revocation, suspension or non-renewal of major licences As set out in Section 6.15 of this Prospectus, our Group has been granted various licences which include, amongst others, the manufacturing licence for Bluetooth related devices, warehouse licence and manufacturing warehouse licence. Some of these licences are subject to periodic renewals. There can be no assurance that we will be able to renew such licences from the authorities, particularly if any new terms or conditions are imposed in the future; or that our licences from authorities will not be revoked or suspended prior to their expiration. However, our Group seeks to limit this risk by endeavouring to ensure compliance to the terms and conditions as set out in these licences and any other licences with the respective authorities. We have not encountered any revocation, suspension or nonrenewal of major licenses in the past and have not experienced nor do we anticipate any major difficulty in obtaining approvals and renewal for the necessary licences within a reasonable timeframe which may impact the business continuity of our Group. 4. RISK FACTORS (Cont’d)
4.2.12 Inadvertent infringement of third party intellectual property rights In the development and introduction of any new products, particularly the FOBO series, there is a possibility that our new products could inadvertently infringe one or more intellectual property rights held by a third party. This would lead to the risk of legal action against us that may be costly and time consuming. If a third party successfully establishes that we have infringed its intellectual property, we may suffer significant liabilities, litigation costs, or licensing expenses or be prevented from selling our products. Our Group promotes and supports original ideas in the design and development of our products to prevent any third party intellectual property rights infringement. As at the LPD, we have not inadvertently infringed any third party intellectual property rights but there can be no assurance that there will be no risk of infringement in the future.
4.2.13 Potential intellectual property rights infringement by third-parties As set out in Section 6.16 of th is Prospectus, we have filed twenty four (24) patent applications for five (5) different inventions relating to our FOBO products in various countries. Additionally, we have been granted nine (9) trademark rights and one (1) industrial design rights that are recognised in various countries where these applications were filed. These patents, trademarks and industrial design registrations grant us intellectual property rights, thereby protecting our FOBO products. Patent registration is a lengthy process as it entails substantive review and examination by the respective national patent office. Therefore, many of our patent applications are still pending registration with the national patent office in the respective countries. There is no assurance that all our pending patents will be successfully registered in the future. The patents, trademarks and industrial designs that were granted to Salutica Allied are still susceptible to unlawful imitation and infringement. There can be no guarantee that third parties will not make an inferior or modified replica of our products and pass-off their products under the FOBO brand or otherwise obtain and use such trademarks without authorisation. In the event of imitation and infringement, we may need to engage in costly litigations to protect and enforce our intellectual property rights. If no legal action is taken on a timely basis, there is a possibility that imitations of our products may be widely distributed and sold in the market. Customers who inadvertently purchase these imitation products from third parties may be disgruntled by, amongst others, the inferior quality and performance of such products, and may then spread negative word-of-mouth that will tarnish the reputation of our Group and may consequently reduce the market demand for our products. As at the LPD, we are unaware of any intellectual property rights infringement by third parties that may adversely affect the profitability of our Group. Our management acknowledges the importance of safeguarding our intellectual property rights and has been working closely with our legal advisors in securing our intellectual property rights and will take appropriate measures and/or seek legal recourse in the event of any third parties’ breach of our intellectual property rights. 4. RISK FACTORS (Cont’d)
4.2.14 Security breaches and failure to protect our proprietary and customers’ information We face the risks of exposure of our proprietary information or exclusive information of our customers or trade secrets due to security breaches and employee negligence and/or errors which would result in the risks of legal action taken against us by our customers arising therefrom. In order to mitigate any security breaches, our management has put in place several safeguard measures, which include installation of comprehensive firewall systems, enforcement of authentication and user access restrictions at each workstation, regular examination of security logs, constant monitoring of network traffic, installation of closed circuit cameras within the office premise as well as ensuring the isolation of workspace and allocating independent workforce for each project and/or customer. Further thereto, our Group provides manufacturing services of Bluetooth headsets to different customers who may be each other’s competitors. Our Group endeavours to minimise any potential leak or transfer of confidential information on the production processes and specifications by separating the assembly lines into different production floors with restricted access with each assembly line being operated by independent teams. In the event of our failure to protect the confidential information of our customers due to security breaches, negligence or disclosure by our Group, potential risks such as litigation or disputes as well as loss of confidence from our customers may arise. As at the LPD, we have not experienced any security breaches and have not failed to protect our proprietary and customers’ information which may adversely affect our financial performance and/or result in an adverse impact on our reputation. Despite our endeavours and procedures put in place to minimise security breaches, there can be no assurance that we will not be adversely affected by the aforesaid risks in the future.
4.2.15 Non-viability or non-successful implementation of our future plans As part of our future plans as set out in Section 6.20.1 of this Prospectus, we intend to invest in, amongst others, new machinery and equipment, sales and marketing and R&D, which we believe will be beneficial to our Group. Although we endeavour to exercise due care in assessing the risks and merits of investing in the above, future events may also affect the implementation of our future plans, such as changes in technology or changes in general market conditions. Although we will take active steps to mitigate such investment risk, there can be no assurance that our future plans will materialise or that all our future investments will yield positive returns and will not have any adverse effect on our future financial performance.
4.2.16 Inadequate insurance coverage We are aware of the adverse consequences arlsmg from inadequate insurance coverage. Hence, we regularly review and ensure that our insurance coverage is adequate for our major assets on a continuous basis. The major assets of our Group include, amongst others, our manufacturing facility, plant and machinery and inventories. Our Group conducts regular servicing and maintenance procedures on our major assets to minimise the risk of machinery breakdowns which may adversely affect the business operations of our Group. 4. RISK FACTORS (Cont’d) All our major assets are adequately covered with insurance against fire, consequential loss and equipment and office risk. We also ensure strict adherence to the OHSAS 18001 Occupational Health and Safety Management Systems Requirements at all times. For the financial period under review, there have not been any material incidents or accidents to our assets. However, in the event of any unforeseen incidents, there can be no assurance that the existing insurance coverage would be adequate for the replacement of our assets or any consequential losses arising therefrom.
4.2.17 Dependence on the supply of workers Our manufacturing operations are dependent on the supply of workers. As at the LPD, we employ 220 local and 384 foreign workers. We also source workers from reliable third party agents to further support our manufacturing operations when required. For information purposes, the hiring of foreign workers in the manufacturing industry is subject to certain conditions imposed by the relevant authorities which may change from time to time. Any restriction on the number of foreign workers that our Group is allowed to employ or changes in the conditions imposed may increase the difficulties for our Group to hire sufficient workers. Such restrictions and/or changes may materially interrupt our manufacturing processes and affect our ability to deliver our products on time which may have a material adverse impact on the profitability and financial position of our Group. Risks relating to our Shares
4.3.1 There has been no public market for our Shares There has been no public market for our Shares. There can be no assurance as to the liquidity of any market that may develop for our Shares, the ability of holders to sell their Shares or the prices at which holders would be able to sell their Shares. Our Shares could trade at prices that may be lower than the IPO Price depending on many factors, including prevailing economic and financial conditions in Malaysia, our operating results and the markets for similar securities. In addition, the market for securities in emerging markets has been subject to disruptions that have caused intense volatility in the prices of securities similar to our Shares. There can be no assurance that the market for our Shares, if any, will not be subject to similar disruptions. Any disruption in such markets may have a material and adverse effect on the holders of our Shares.
4.3.2 Potential delay or failure of the Listing The occurrence of anyone or more of the following events, which may not be exhaustive, may cause a delay in our Listing or our Listing to be aborted: (i) the identified investors fail to subscribe to their portion of IPO Shares which they have undertaken to subscribe for;
(ii) our Underwriter exercising their rights pursuant to the Underwriting Agreement to discharge themselves from their obligations thereunder; or
(iii) we are unable to meet the public spread requirements as determined by Bursa Securities i.e. at least 25.0% of our enlarged issued and paid-up share capital must be held by a minimum of 200 public shareholders holding not less than 100 Shares each at the point of Listing.