Listed on the Second Board of the KLSE on June 1997, Zaitun was the pioneer producer and market leader for toiletries and cosmetics in the Muslim segment. Its products were exported to countries such as Brunei, Singapore, Indonesia, etc under its own brand name of `Zaitun'. With its leadership position in the Muslim segment, prospects for the group then were indeed bright. Unfortunately, the rosy outcome was not to be and the group, on Feb 2001, was deemed an affected listed issuer under the PN4 category. In fact, Zaitun had incurred losses in every year since its 1997 listing and as a result, its shareholders' funds of RM41.4 mln in 1997 started to decline and by 2001, Zaitun had a deficit of RM29.2 mln - see figure 1.

Figure 1 : Financial highlights of Zaitun (RM mln)

Unlike previous examples, Zaitun's fall from grace was not immediate, but rather like dying a slow and painful death. The group lamented that their earnings had been adversely affected by the economic downturn in the Malaysian economy, the depreciation of the Ringgit, depressed consumer demands and constant rising cost of operations. Then again, these factors were not uncommon to the other businesses that managed to ride out the storm. What went wrong with Zaitun ? Upon closer scrutiny, we unfolded some possible flaws in its business model and some rather questionable share trading activities. Collectively, these factors triggered the collapse of the company.

a) Flaws in the Business Model

Red Flags

As part of its listing, Zaitun forecasted pretax profits of RM8.27 mln for 1997, RM8.46 mln for 1998 and RM8.46 mln for 1999. It even gave profit guarantees equivalent to 90% of the forecasts. The actual outcome was vastly different from these rosy forecasts. While one could blame external factors for this dismal performance, a reading of its 1997 annual report had already raised some red flags. Sales for fiscal year 1997 were RM39.35 mln but trade debtors totalled RM37.21 mln, about 95% of sales. This is an extraordinary level of debtors in relation to sales and was certainly a warning sign over the health of its business, as confirmed later by the many changes in its exclusive distributors. The impression created was that Zaitun was able to create sales only by giving credit liberally. To add to the worries, Zaitun had RM45.46 mln in borrowings in 1997, more than its total sales.

Disputes With Exclusive Distributors

Unlike most manufacturing and trading companies, Zaitun does not have a strong and efficient marketing arm of its own. Although the group had launched a marketing programme for its products in 1998, it relied heavily on agency houses or exclusive distributors to market its products. Despite its reliance on sole distributors and the way the business and marketing functions were set up, the group was constantly in dispute with its distributors. This was what took place between 1998 and 2001 when Zaitun unceremoniously changed its exclusive distributors 3 times and locked itself in numerous legal proceedings and wrangling, which deeply affected its operations and cashflows. For instance, its sales plunged 41% from RM39.3 mln in 1997 to RM23.2 mln in 1998 as Zaitun was in dispute with its former stockist, Boustead Trading S/B. Apparently, an amount of RM31.2 mln was due by the former stockist, arising from disputed debit notes issued by them. A protracted legal tussle ensued with claims and counter claims made by both parties.

Multiple Changes in Exclusive Distributor

In Nov 1998, Zaitun Marketing S/B appointed a new sole distributor, Harrisons Holdings (M) S/B, to market the group's products in Malaysia. However, Zaitun terminated this distributorship agreement in Oct 1999 and started legal proceedings against the group. As a result of the dispute, sales for the year were hampered. Zaitun subsequently announced the appointment of Harpers Trading (M) S/B as the new exclusive distributor in Dec 1999 but unfortunately, Harpers terminated the distributorship on Jan 2000. A legal claim was filed against Harpers for a sum of RM263 mln in damages.

Reorganization of Operations

Following the termination, the management decided to revamp and reorganize major operational functions and started to commence selling and distributing its products on its own as a short-term measure to minimize the loss of sales during the transition period. In Nov 1999, the group introduced a multi-level marketing programme to replace the existing single-level marketing system. The group subsequently appointed Sime Darby Marketing S/B as its new exclusive distributor in August 2001.

Too Little, Too Late

The above disputes with its former exclusive distributors and the delay in appointing a sole agent to distribute its products had a devastating effect on its operations. The group suffered from an acute shortage of working capital (deficit of RM62.76 mln in 2001), which arose from the loss of guaranteed monthly payments of RM2.0 mln each from its distributors, its high borrowings and debtors, losses from its share trading and poor management. In addition, its efforts to market its own products were unsuccessful with sales dropping 80% from RM30.2 mln in 1999 to only RM6.01 mln in 2001. Compounded by its huge debt (see figure 2) and distinct lack of cashflows, the group defaulted on its interest and principal repayments and consequently, its operations were compromised. Hence, on Feb 2001, the group was deemed an affected listed issuer under the PN4 category as its external auditors had raised serious doubts as to the group's ability to operate as a going concern.

Figure 2 : Debt Obligations vs Annual Turnover of Zaitun (RM mln)

b) Losses from Share Trading Activities

Purchases of Quoted Shares via Margin Financing

The management, headed by a father and son team, decided to engage in share trading, funded by a margin facility of RM20 mln granted by TA Securities. In 1997, the group purchased quoted shares worth RM21.8 mln. Not only were the reasons behind such a move puzzling (no disclosures then) but the size of the purchases was staggering, considering it was equivalent to 53% of its shareholders' funds and 55% of its annual turnover in 1997. The group later sold some of these shares, costing RM11.2 mln, for RM4.3 mln, resulting in a loss of RM6.9 mln. A further provision for diminution in the value of investment of RM1.4 mln was made for the shares held as short-term investments at the end of the fiscal year. Members in a general meeting as required by the Companies Act, 1965, did not approve these substantial share transactions. Its shareholders only ratified them in 1999.

In 1998, the group further reported losses due to its share trading, consisting of [1]. RM0.3 man loss on disposal of quoted investments and [2]. RM4.1 man from write-down of cost of investment in quoted shares. Its interest on the share financing facility itself amounted to RM1.3 mln. Nevertheless, between Nov 1998 and Apr 1999, the securities firm force-sold the group's entire investment in quoted shares (including shares pledged as securities) at its net realizable value of RM4.4 mln.

In a 1999 disclosure, the group revealed that during Sep-Nov 1997, it purchased 13.7% interest in Hai Ming Holdings for RM13.7 mln and 1.48% of Grand Central Enterprises (GCE) for RM3.0 mln. These shares were later disposed for RM6.5 mln, which equalled a net loss of RM10.2 mln. Prior to the acquisition, Dato Mohd Kamal had a 6% interest in GCE's paid-up capital.

Public Reprimand and Fine

Zaitun was subsequently fined RM296,000 on 9 Mar 1999 for failure to obtain shareholders' approval in respect of the share acquisitions, which also involved a director of Zaitun. On Sep 2000, the KLSE and the Securities Commission publicly reprimanded Zaitun for breach of Clauses 3.16(2) and 3.16(3) of the KLSE 2nd Board Listing Requirements, in relation to the lack of immediate announcements regarding the acquisitions and disposals of shares. A fine of RM150,000 was later imposed.