ATLAS SOUTH SEA PEARL LTD - 20-F - 20060717 - PART_I
PART
I
ITEM
1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS
Not
required.
ITEM
2. OFFER STATISTICS AND EXPECTED TIMETABLE
Not
required.
ITEM
3. KEY INFORMATION
A.
Selected
Consolidated Financial Data
The
selected consolidated financial information set forth below has been derived
from the Company’s audited financial statements and the notes thereto contained
elsewhere herein. The financial statements for the year ended December 31,
2005
have been prepared in accordance with AIFRS. The Company began using AIFRS
effective from January 1, 2005. For comparative purposes, the financial
statements for the year ended December 31, 2004 have been amended to reflect
the
new AIFRS format of reporting. However, any financial information that is
presented in this Annual Report for fiscal years ending on or before December
31, 2003 are reported under AGAAP. The financial information should be read
in
conjunction with, and are qualified in their entirety by reference to, the
Company’s audited consolidated financial statements and notes thereto. The
financial results should not be construed as indicative of financial results
for
subsequent periods. See “Item 4. Information on the Company” and “Item 5.
Operating and Financial Review and Prospects.”
Years
Ended December 31,
Income
Statement Data
2005
(1)
(US$)
2005
(A$)
2004
(A$)
AIFRS
Accounting Principles:
Revenue
$
7,083,830
$
9,847,859
$
6,837,523
Net
income (loss) from operations
1,512,883
2,060,587
(594,274
)
Net
income (loss) from continuing operations
1,512,883
2,060,587
(594,274
)
Net
income (loss)
1,512,883
2,060,587
(594,274
)
Net
income (loss) per share-basic
0.0172
0.0235
(0.0068
)
Net
income (loss) per share-diluted
0.0172
0.0235
(0.0068
)
Weighted
average number of basic ordinary shares outstanding
87,810,254
87,810,254
87,810,254
Weighted
average number of diluted ordinary shares outstanding
87,810,254
87,810,254
87,810,254
3
Years
Ended December 31,
Income
Statement Data
2005
(1)
(US$)
2005
(A$)
2004
(A$)
2003
(A$)
2002
(A$)
2001
(A$)
U.S.
Generally Accepted Accounting Principles:
Revenue
$
7,230,298
$
9,847,859
$
6,837,523
$
9,637,393
$
11,341,448
$
11,335,984
Amortization
of goodwill
(2)
—
—
—
247,777
251,941
—
Gain/(loss)
on foreign exchange derivatives
(3)
—
—
(691,709)
782,327
(6,318
)
205,610
Stock
options issued to employees
—
—
—
—
(36,400
)
(47,250
)
Capitalization
of administration
costs
(4)
—
—
168,508
426,448
487,022
(170,962
)
Foreign
Currency Balances
(5)
—
—
—
(1,116,101
)
320,234
—
Prior
year adjustment
(6)
9,376
12,770
—
—
—
—
Net
income (loss) from operations
1,522,259
2,073,357
(1,117,475
)
1,585,184
4,515,498
4,138,168
Net
income (loss) from continuing operations
1,522,259
2,073,357
(1,117,475
)
1,585,184
4,515,498
4,138,168
Net
income (loss)
1,522,259
2,073,357
(1,117,475
)
1,585,184
4,515,498
4,138,168
Net
income (loss) per share - basic (before cumulative effect of change
in
accounting policy)
0.01725
0.0236
(0.0127
)
0.0181
0.0546
0.0666
Net
income loss) per share - basic (after cumulative effect of change
in
accounting policy)
0.01725
0.0236
(0.0127
)
0.0181
0.0546
0.0678
Net
income (loss) per share - diluted (before cumulative effect of change
in
accounting policy)
0.01725
0.0236
(0.0127
)
0.0181
0.0506
0.0542
Net
income (loss) per share - diluted (after cumulative effect of change
in
accounting policy)
0.01725
0.0236
(0.0127
)
0.0181
0.0506
0.0551
Weighted
average number of basic ordinary shares outstanding
87,810,254
87,810,254
87,810,254
87,810,254
82,724,884
61,013,243
Weighted
average number of diluted ordinary shares outstanding
87,810,254
87,810,254
87,810,254
87,810,254
89,284,659
79,439,026
4
Years
Ended December 31,
Income
Statement Data
2003
(A$)
2002
(A$)
2001
(A$)
Australian
Accounting Principles (AGAAP)
Revenue
$
9,637,393
$
11,341,448
$
11,335,984
Net
income (loss) from operations
1,244,733
3,499,017
4,150,770
Net
income (loss) from continuing operations
1,244,733
3,499,017
4,150,770
Net
income (loss)
1,244,733
3,499,017
4,150,770
Net
income (loss) per share-basic
0.0142
0.0423
0.0680
Net
income (loss) per share-diluted
0.0142
0.0403
0.0510
Weighted
average number of basic ordinary shares outstanding
87,810,254
82,724,884
61,013,243
Weighted
average number of diluted ordinary shares outstanding
87,810,254
87,910,235
88,026,526
At
December 31,
Balance
Sheet Data
2005
(1)
(US$)
2005
(A$)
2004
(A$)
2003
(A$)
2002
(A$)
2001
(A$)
AIFRS
Accounting Principles
Cash
and cash equivalents
1,083,297
1,475,480
3,208,996
Total
assets
17,995,512
24,510,368
17,385,121
Total
current liabilities
4,924,769
6,707,667
1,355,061
Long-term
debt and capital lease
obligations
124,124
169,060
112
Shareholders’
equity (excluding minority interests) (AIFRS or AGAAP)
Shareholders’
equity (excluding minority interests) (AIFRS or AGAAP)
21,301,802
20,935,172
18,176,606
(1)
US
Dollar amounts have been translated at the Noon Buying Rate on December
31, 2005 of A$1.00 = US$0.7342. Such translations are provided for
information purposes only.
(2)
Under
AGAAP, goodwill relating to the acquisition of a business was written
off
on a straight line basis over the period during which the benefits
of the
goodwill are expected to arise which cannot be greater than 20 years.
Effective January 1, 2002, goodwill may not be amortized under US
GAAP but
instead is tested for impairment each year. From January 1, 2005,
AIFRS
treatment of Goodwill is harmonized with US GAAP. However, a retrospective
adjustment to Amortization under AIFRS has only been made from January
1,
2004. Consequently, the amount of goodwill on the balance sheet is
greater
under US GAAP than under AIFRS and there is an adjustment required
under
US GAAP. See Note 35.1 of “Item 17. Financial
Statements.”
(3)
US
GAAP requires that the loss or gain on forward exchange contracts
noted in
Note 35 of “Item 17. Financial Statements” be recognized in the income
statement and reflected on the balance sheet of the Company. This
loss or
gain is not reflected on the income statement or the balance sheet
under
AGAAP prior to 2004. Under AIFRS, any gain or loss on forward exchange
contracts that does not form an effective hedge must be recognized
in the
income statement and recognized on the balance sheet of the Company.
Under
the transition to AIFRS from AGAAP, recording of movements and balances
relating to foreign currency hedging is only required after January
1,
2005. Hence an adjustment to US GAAP still exists for 2004 above.
See Note
35.3 of “Item 17. Financial
Statements.”
(4)
Under
AGAAP, the Company capitalized expenditures into inventory which
were of
an administrative nature for the year 2001. Under US GAAP, expenditures
which are of an administrative nature may not be capitalized into
inventory and must be expensed in the period in which incurred.
Adjustments to net income and total assets were required under US
GAAP in
2001, 2002, 2003 and 2004. See Note 35.5 of “Item 17. Financial
Statements.”
(5)
Under
US GAAP, all balance sheet items that are recorded in a currency
other
than the reporting currency are translated at the spot rate at the
balance
date. This is referred to as the current rate accounting method.
The
foreign currency movements are recorded in a foreign currency revaluation
reserve on the balance sheet. From January 1, 2004, AIFRS follows
the same
accounting treatment as US GAAP and as such the accounting treatment
for
the years 2004 and 2005 does not require
adjustment.
Prior
to January 1, 2004, applying AGAAP, only monetary items that were
stated
in a currency other than Australian Dollars were converted to the
reporting currency at the exchange rate on the balance date. All
other
foreign currency balances were translated to Australian Dollars at
their
historic rate.
(6)
Immaterial
prior year earnings adjustment was accounted for in retained earnings
under AIFRS. Under US GAAP, this is not allowed and an adjustment has
been
made to the current year income statement to reflect
this.
The
Company’s financial statements have been prepared in accordance with either
AIFRS or AGAAP, as stated above. Certain line items have been reconciled to
US
GAAP to assist U.S. persons in evaluating such data. The complete reconciliation
of such line items is set forth in “Item 17. Financial Statements - Note 35 to
Financial Statements.”
6
Exchange
Rates
Solely
for informational purposes, this annual report contains translations of certain
Australian Dollar amounts into or from US Dollars at a specified rate. See
“Introduction.” These translations should not be construed as representations
that the Australian Dollar amounts represent the US Dollar amounts indicated,
or
could be converted into or from US Dollars at the rate indicated. The exchange
rate on June 30, 2006 was A$1.00 = US$0.0.7423.
The
following table sets forth, for the months indicated, certain information
concerning the Noon Buying Rate for Australian Dollars expressed in US Dollars
per A$1.00:
Month
Ending
High
Low
December
31, 2005
$
0.7567
$
0.7261
January
31, 2006
0.7572
0.7379
February
28, 2006
0.7548
0.7363
March
31, 2006
0.7458
0.7056
April
30, 2006
0.7593
0.7177
May
31, 2006
0.7781
0.7509
June
30, 2006
0.7527
0.7284
The
following table sets forth, for the years indicated, certain information
concerning the Noon Buying Rate for Australian Dollars expressed in US Dollars
per A$1.00:
Year
Ended December 31,
Average
(1)
2001
0.5132
2002
0.5448
2003
0.6589
2004
0.7378
2005
0.7620
(1)
Represents
the average of the Noon Buying Rates on the last day of each month
during
the relevant period.
B.
Capitalization
and Indebtedness
Not
required.
C.
Reasons
for the Offer and Use of Proceeds
Not
required.
D.
Risk
Factors
The
Company’s business, financial condition and operating results could be adversely
affected by any of the following factors. The risks and uncertainties described
below are not the only ones that the Company faces. Additional risks and
uncertainties not currently known to the Company’s management, or that the
Company’s management currently thinks are immaterial, may also impair the
Company’s business operations.
7
The
Company’s operations are based in Indonesia, which has been subject to economic
and socio-political disruption in the past.
Some
parts of Indonesia have experienced social, ethnic and economic disruption.
In
November 1999, the Company abandoned its cultivation site in Kupang, W. Timor
in
part due to increasing unrest in the area. The province of West Papua, where
some of the Company’s water leases are located, is agitating for independence.
The Company monitors the socio-political situation closely. In the event of
civil unrest, there is an evacuation plan in place to protect the Company’s
employees. Security personnel are employed to provide protection to employees
and the Company’s assets to the best of their ability. It is difficult to
predict what will occur in the future. If the employees are forced to abandon
any of the farm projects as a result of an emergency, the Company does not
expect it will be able to salvage any of the oysters or pearls and this will
have a material adverse effect on the Company’s business, operations and
financial condition.
The
cultivation process for South Sea pearls requires certain environmental
conditions and
any
change in weather or water conditions could have a material adverse effect
on
the Company’s pearl production
.
The
cultivation process depends on certain environmental factors, including
consistently warm sea water temperature, fully saline water conditions, adequate
tidal flow to distribute the food supply and availability of phytoplankton
food.
There are only a few areas in the world that meet such requirements. The water
areas encompassed by the Company’s water leases present ideal conditions for
pearl cultivation. The conditions in these areas, however, are subject to change
based on normal weather patterns. The Company has no control over these weather
patterns. In 2002, weather patterns caused by
El
Niño
adversely
affected the Company’s ability to raise juvenile oysters. The Company
established operations in Northern Bali primarily for the production of juvenile
oysters in response to this problem. Notwithstanding this action, the Company
anticipates that its rearing of oysters will continue to be affected by natural
weather patterns. If these weather patterns continue, there can be no assurances
that the Company will have access to sources of oysters for the pearl
cultivation process or if available, that they will be available on favorable
terms. The failure to maintain an adequate supply of juvenile oysters for
nucleation could have a material adverse effect on the Company’s pearl
cultivation process.
The
Company’s oysters are sensitive to disease.
The
Company’s oysters are placed in panels in the sea. Although, the Company’s
employees continuously clean the oysters, certain foreign organisms can enter
the oyster and eat the oyster or cause diseases. The cultivation process for
pearls takes approximately two years from the time the oyster is seeded, prior
to the oyster being seeded, it takes two years for the animal to reach maturity.
Therefore, the loss of oysters due to disease could have a material adverse
effect on the Company’s production process and generation of
revenue.
The
sale of pearls is dependent upon a strong economy
.
The
sale of pearls is sensitive to fluctuations in the global economic cycle. Pearls
are categorized as a luxury item and their consumption is dependent upon the
availability of disposable income. Consumption is strongly influenced by fashion
trends. The Company’s pearls compete with several other types of jewelry such as
precious metals and precious gem stones for consumer disposable income.
Unfavorable general economic conditions have an adverse effect on consumer
spending for such items, and therefore on the Company’s sales.
8
The
price for pearls is subject to fluctuation based on supply and quality.
The
price
that the Company can obtain for its pearls is significantly dependent on the
overall supply of available pearls and the quality of the Company’s pearls.
There
has
been an increase in the supply of pearls globally. Most of the increase in
South
Sea pearl production has come from Indonesia and the Philippines, and there
is
evidence of increased production from Australia
.
This
increase in supply has had an adverse effect on pearl prices, but the potential
adverse impact of continued increases in supply cannot be determined with any
certainty. There has also been an increase in supply of fresh water pearls
from
China and black pearls from Tahiti.
In
addition, although the Company closely monitors its pearl cultivation process,
it is difficult to predict the quality of pearls the Company will harvest in
any
given year. Significant increases in the supply of pearls or decreases in the
quality of the Company’s pearls could have a material adverse effect on the
Company’s revenues.
The
Company is dependent on a small number of key expatriate
managers.
The
Company’s cultivation process is very technical. The Company depends on a small
number of key expatriate managers who supervise the cultivation process. Due
in
part to the remote location of the Company’s pearl farms, the Company has
limited access to a skilled work force, and the replacement of these managers
could be difficult. The loss of the services of any of these individuals could
materially and adversely affect the Company’s pearl production, business and
financial condition.
The
Company is exposed
to
fluctuations in exchange rates.
The
majority of the revenues the Company derives from the sale of its pearls occurs
in Japanese Yen. The Company’s revenues are reported, however, in Australian
Dollars. Fluctuation in the exchange rate of Japanese Yen to the Australian
Dollar could have a material adverse effect on the Company’s revenues. The
Company’s operating expenditures are predominantly denominated in Indonesian
Rupiah (“IDR”). Fluctuations in the exchange rate between the IDR and the
Australian Dollar will have an effect on the operating results of the
Company.
The
Company is exposed
to
the volatile inflation rate in Indonesia.
Inflation in Indonesia has varied up to 17% per annum for the period from 2000
to 2005. The official inflation rate in Indonesia for 2005 was 17.1% per annum.
In general, inflation increases all of the Company’s operating costs in
Indonesia, but specifically impacts wages, food and fuel (diesel and benzene).
As the Company’s revenues are derived mostly from sources outside of Indonesia,
the Indonesian inflation rate does not cause a corresponding increase in the
Company’s revenues. As a result, Indonesia’s inflation could have a material
adverse effect on the Company’s expense structure.
ITEM
4. INFORMATION ON THE COMPANY
A.
History
and Development of the Company
The
Company is incorporated as a public company in Australia and operates under
the
Corporations Act 2001. On May 30, 2006, the Company changed its name from Atlas
Pacific Limited to Atlas South Sea Pearl Limited to better reflect its business.
This change in name was made effective on June 9, 2006. The Company operates
under an Australian Company Number ("ACN”) 009 220 053 and an Australian
Business Number ("ABN") 32 009 220 053. The Company is listed on the Australian
Stock Exchange (“ASX”), which is governed by the ASX Listing Rules. The
Company’s domicile is Australia and its registered office and principal place of
business are 43 York Street, Subiaco Western Australia 6008 (telephone: +61
8
9380-9444, facsimile: +61 8 9380-9970).
9
The
Company was incorporated on February 28, 1987 as Atlas Pacific Gold N.L. for
the
purpose of acquiring all of the capital stock in Sharcon Pty Ltd, (“Sharcon”), a
company that owned options to acquire mineral and precious metal mining
tenements. In June 1987, the Company raised A$5 million through an initial
public offering in Australia and, shortly thereafter, listed its shares on
the
ASX. The Company used the proceeds from this offering to acquire the stock
of
Sharcon and to explore mining tenements from 1987 through 1988. The Company
never commenced mining, and between 1988 and 1993 sold its mining interests
and
investigated other potential business opportunities. The Company did not
generate revenue from its mining operations and has since disposed of all its
mining interests and no longer pursues mineral exploration
activities.
In
1993,
the Company invested in the Indonesian pearling project (the “Pearling Project”)
through its subsidiary Tansim Pty Ltd (“Tansim”), with a number of other joint
venturers. The Pearling Project operates an oyster hatchery and farm business
for the purpose of cultivating South Sea pearls. (See “Business Overview -
Pearling).” On January 20, 1994, the Company changed its status from a No
Liability (N.L.) company to a company limited by shares and changed its name
to
Atlas Pacific Limited.
PT
Cendana Indopearls (“Cendana”), an Indonesian-approved foreign investment
company, owns and operates the Pearling Project. The Company originally acquired
a 75% interest in the Pearling Project by purchasing all of the capital stock
of
Tansim, an Australian corporation, in June 1993. Tansim purchased the remaining
25% interest in Cendana in October 1999. The Company’s principal focus remains
on pearl production in Indonesia. As of December 31, 2005, 59% (A$14.4 million)
of the Company’s total assets were employed in Indonesia, principally in oyster
stocks, plant and equipment. The remaining Company’s assets are made up of
pearls, cash and receivables, predominantly in Australia.
During
the last and current fiscal years, the Company did not receive an indication
of
any public takeover offers by third parties in respect of the Company’s Shares
or by the Company in respect of other companies’ shares.
B.
Business
Overview - Pearling
Introduction
A
pearl
is a lustrous concretion produced by certain bivalve mollusks, including mussels
and oysters. Natural pearls consist almost entirely of nacre, which is the
substance forming the inner layers of the mollusk shells. Nacre, also referred
to as mother-of-pearl, is composed primarily of aragonite crystals. The pearl
is
an abnormal growth resulting from the invasion of the body of the mollusk by
foreign matter, or “nucleus”. The foreign body acts as an irritant in the
mollusk and becomes coated with layer upon layer of nacreous material.
Approximately 30% of cultivated mollusks reject the nucleus and do not produce
pearls. Both marine and freshwater mollusks produce pearls, and the most
commonly used mollusk for the production of pearls is the
oyster.
10
There
are
several types of pearls cultivated around the world. The four major categories
of cultured pearls are (1) Akoya pearls produced in the seas around China and
Japan, (2) freshwater pearls produced mainly in China, (3) South Sea pearls
produced primarily in Australia, Indonesia, Philippines, and Myanmar, and (4)
black pearls produced in Tahiti and several other Pacific Islands.
Prices
of
pearls vary enormously. There are several factors which determine the value
of a
pearl. These factors include size, shape, color, skin quality and luster. As
the
size and other characteristics of a pearl improve, its value increases
exponentially.
With
respect to shape, the most valuable pearls are spherical. Drop and button shapes
are less valuable than spherical pearls, but are still considered to be quality
pearls. Circles and irregular shaped pearls, or baroques, are the least valuable
shapes of pearls.
Pearl
coloration varies widely, with the most valuable shades being gold and silver.
South Sea pearls may be silver, white, cream, yellow or gold. The
Pinctada
maxima
oyster
is the species which produces the South Sea pearl. There are two varieties
of
this oyster. The silver lip variety produces the valuable silver-white pearl
and
the gold lip variety produces cream, yellow and highly sought after gold colored
pearls.
The
final
significant determinant of pearl value is skin quality and luster. The less
blemishes and “pit” marks the greater the value of the pearl. Luster refers to
the appearance of a pearl’s surface judged by its brilliance and ability to
reflect light. The greater the luster, the more valuable the pearl.
Pearl
Cultivation
Pearls
have been cultured successfully since 1920 using a process developed in Japan
in
which the oysters are “nucleated” or “seeded.” In this process, a nucleus is
introduced into the oyster and the oyster then deposits layers of nacre around
the bead. This process takes approximately two years for South Sea pearls.
Today, cultured South Sea pearls are not easily distinguished from naturally
occurring pearls, which are extremely rare.
Pearl
cultivation traditionally relied on the availability of wild oysters, or shells,
which were nucleated to form pearls. However, hatchery-reared oysters have
become an increasingly popular means of cultivating pearls. By using
hatchery-reared oysters, pearl farmers are able to control oyster breeding
to
improve the quality of the oysters that will be nucleated. This, in turn,
produces higher quality pearls.
Pearls
have been successfully cultivated in Japan, China, Tahiti, the Cook Islands,
Myanmar, Australia, the Philippines and Indonesia. Ideal conditions for the
Pinctada
maxima
oyster,
which produces the South Sea pearl, exist in certain select regions of the
world’s equatorial and tropical waters located 20 degrees north and south of the
equator between Myanmar in the west and Northern Australia and the Indonesian
province of West Papua (formerly Irian Jaya) in the east. Indonesia lies in
the
middle of this region. These regions provide the following natural environmental
factors necessary to cultivate pearls: the availability of phytoplankton food
upon which the filter feeding oysters rely; adequate tidal flow to distribute
the supply of food; warmer sea water temperatures without abrupt fluctuations
of
more than a few degrees and fully saline, as opposed to brackish, water
conditions.
11
The
South Sea Pearl Industry
Australia
is traditionally the most successful producer of South Sea pearls in terms
of
quality. The bulk of Australian pearls are produced in Western Australia and
the
Northern Territory. Australian state governments manage the industry on a quota
system, with a total permitted annual catch of 572,000 wild shells shared among
sixteen pearl oyster licenses in Western Australia. In addition to this,
beginning in 1992, Western Australian license holders became entitled to seed
an
additional 350,000 hatchery produced oysters. The quota is not divided equally,
and the two largest pearling operators control over 50% of the quota. Family
groups or small partnerships tightly control the licenses. In 1998, the
authorities in the Northern Territory also issued six pearling licenses for
a
total permitted annual seeding limit of 420,000 seedings for wild and hatchery
produced oysters.
Although
the technology is available to introduce hatchery programs in Western Australia,
high production costs, particularly labor costs, have limited the development
of
such programs. In addition, Western Australia recently extended its quota system
to embrace hatchery-reared oysters in addition to wild shells. Because of the
fixed quota system and restrictive hatchery policy, expansion opportunities
for
Australian pearl producers are limited. The only ways to increase profitability
are through improvement in pearl quality or reduction in costs of production.
Thus, the Australian pearling industry is virtually closed to new participants
unless they are prepared to acquire an existing operation.
By
comparison, the pearling industry in Indonesia is relatively unregulated.
Although there are a few farmers in Indonesia capable of producing quantities
of
pearls equal to the largest Australian operations, there are a lot more pearl
producers in Indonesia, many with small operations. Due to a lesser abundance
of
wild shells and lower labor costs, there is much heavier emphasis on hatchery
breeding programs in Indonesia than in Australia. Production has grown
substantially in the last decade and Indonesia now produces approximately the
same volume of pearls as Australia. The value of such production, however,
is
less than that of Australia due to the lower quality and size of the pearls.
The
Indonesian pearling industry is significantly less regulated than in Australia
and technological improvements in the Indonesian cultivation processes are
taking place.
The
Company believes that the pearling conditions in Indonesia offer some advantages
to those in Australia. The waters are warmer for a longer period of time, which
facilitates a longer growing season for the pearls. The faster growing
conditions, however, result in a less consistent result for pearls produced
from
an oyster that is re-seeded after the first pearl is harvested. This results
in
less high quality large pearls being produced by the Company. There is also
less
variation in water temperature throughout the year, which means that seeding
of
oysters can take place over a longer period of time each year.
12
The
Indonesian government continues to encourage foreign investment. Foreign
investment entities are required to use an investment structure known as a
“PMA”
company, which offers investors, among other things, tax concessions and
remissions on duty of essential imports. Likewise, Indonesia does not levy
sales
tax on exported products, which includes the Company’s pearls. There can be no
assurances, however, that the economic or political environment for pearl
production in Indonesia will remain stable or that the Indonesian government
will maintain favorable investment vehicles for foreign investments.
The
Company still believes that the overall advantages of running its operations
in
Indonesia as compared to Australia, outweigh the disadvantages of operating
in
Indonesia.
13
The
Pearling Project
General
In
1990,
a group of joint venture parties, of which Tansim was a party, commissioned
an
extensive marine review and survey to locate the best possible pearl farm site
within a narrow belt of equatorial waters centered on the Indonesian Islands
and
Northern Australia. Based on the results of such study, they chose a location
for the pearl farm at Lelindo Point near the town of Kupang in West Timor,
Indonesia in 1991. They acquired water leases, constructed pearling
infrastructure and commenced commercial operations. During 1998, the Kupang
area
became a less desirable location for the Company’s operations due to an increase
in local industry which caused pollution and because of increased security
threats. The Company began to develop facilities at Waigeo Island, in the
province of West Papua. By the end of January 1999, the Company had reduced
its
operations at the Kupang facility to hatchery and grow-out facilities only.
The
majority of the nucleated oysters were successfully transported to the Company’s
new pearl farm at Waigeo Island during 1999. In November 1999, the Company
decided to close down the Kupang facility and concentrate its resources on
its
pearl farming activities at the Company’s newer facility in West
Papua.
In
1997,
Cendana entered into water leases for approximately 2,500 hectares at Alyui
Bay,
Waigeo Island, West Papua (formerly known as Irian Jaya) in northern Indonesia.
Cendana also entered into a land lease for five hectares near these water
leases. The leases are for 25 years and expire in September 30, 2022. The
Company developed the site as a pearl farm and hatchery. See “Item 4.D
Information on the Company - Property, Plant and Equipment.”
Alyui
Bay
on the island of Waigeo in West Papua, proved to be a successful pearl farming
site. The Company commenced commercial pearl harvests at this site in 1999,
with
an excellent quality of pearls being produced. Significant infrastructure was
developed at Alyui Bay including three accommodation camps, a modern hatchery,
engineering workshop, fuel storage, operating shed and boat building facilities.
The farm accesses some of its labor force from a nearby village while in excess
of 150 staff are accommodated at the farm camps in fully equipped
facilities.
During
2002, the adverse impact of the
El
Nino
climatic
phenomenon on the production of juvenile oysters at Alyui Bay required the
Company to explore opportunities to source oysters elsewhere. In July 2002,
the
Company entered into an arrangement with an Indonesian company called PT Horiko
Abadi (“Abadi”), which allowed it to have access to a hatchery and associated
sea leases at a location called Banyupoh on the Indonesian island of Bali.
The
Company paid A$90,000 to Abadi for access to this facility for a period of
three
(3) years. This Agreement was terminated in September 2005. Under this contract,
Abadi remained the owner of the land and water leases, but the Company had
a
right to operate from this site and share the output (juvenile oysters) from
this operation in the ratio of 30% to Abadi and 70% for the Company’s Indonesian
subsidiary. The Company was required to contribute 70% of the ongoing operating
costs of this facility, which was approximately A$15,000 per month. Equipment
from the original Kupang hatchery was re-commissioned for use at this facility
at minimal cost. In September 2005, the Company established its own hatchery
and
growout farm at Penyabangan.
14
During
2003, the Company entered into a second joint production arrangement for
juvenile oysters with an Indonesian company called Cahaya Cemerlang
(“Cemerlang”). Cemerlang granted the Company shared access to leases and
facilities which consisted of over 100 hectares of ocean leases and two camps
covering a combined area of four hectares which were located around Bacan Island
in the North Maluku province of Indonesia. In return for access to these
facilities, the Company had to provide Cemerlang with a share of juvenile
production from that site. This share was calculated on the basis of an equal
split if the juveniles that were produced were taken by Cemerlang from this
facility before the oysters reached 12 months of age or a split of 30% to
Cemerlang and 70% to the Company if the oysters were taken from this site after
they turned 12 months of age. During 2003, over 400,000 juvenile oysters were
successfully reared. The Company’s share of this production was over 200,000
juvenile oysters. Due to a high level of juvenile oyster mortality, only 110,000
juvenile oysters were successfully reared from this facility during 2004. The
joint arrangement was for five years, and the Company had an option to extend
the term thereafter for five (5) years on similar terms. Because this site
continuously experienced high levels of mortalities, the use of the site as
a
source of juvenile oysters had became severely restricted. As a result, the
Company reached an agreement with Cemerlang to cease the joint operations by
the
end of November 2005. Juvenile oysters from the 2004/05 hatchery breeding season
were split in accordance with the agreement. All joint assets were also divided
between the Company and Cemerlang. The Company’s share of the oysters and assets
were transferred to Karang Asem in East Bali, which it established in
2005.
In
December 2003, the Company leased an independent juvenile production and
grow-out site in Northern Bali near the village of Penyabangan. The Company
entered into a 30-year lease in relation to 0.2 hectares of land and one hundred
hectares of ocean with the local authorities with payments of approximately
A$15,000 paid up front and A$200 payable per month for the term of the lease.
The Company has the right to construct buildings on the land and use the ocean
for the production and rearing of pearl oysters. A hatchery center and related
support infrastructure for the Company’s boat maintenance/building, seeding
technician training, longline production and support activities was completed
during 2004. The Company transitioned its activities at the Banyupoh facility
to
this hatchery in September 2005. Hatchery production and grow-out of juvenile
oysters at Penyabangan has proven to be successful and the Company further
expanded the site in 2005, which now can accommodate approximately 500,000
oysters. The Company’s transport vessel, the “Sahabat,” then successfully
delivers oysters from Penyabangan to Alyui Bay. Combined production at Alyui
Bay
and Penyabangan allowed seedings in excess of 390,000 oysters in 2005.
Successful spawnings using specially selected brood stock have resulted in
commercial batches of juvenile oysters being produced at the Penyabangan site
in
2004 and 2005.
In
May,
2005, the Company expanded its operations in Bali by opening a new farm site
at
Karang Asem on Bali’s east coast and establishing a pearl oyster lease on Nusa
Lambongan Island in the south of Bali. On May 23, 2005, the Company entered
into
a 30-year water lease comprising 235 hectares (580 acres) and a land lease
for
an additional 2,000 square meters with the local villagers who have ownership
of
the area. Under the lease, the Company paid the local villagers approximately
A$16,000 and will pay approximately A$200 per month for the use of the site.
The
Company has constructed storage, accommodations and oyster meat processing
facilities at the site, which was established for the purpose of farming pearls.
On September 16, 2005, the Company entered into a water lease with local village
leaders on Nusa Lembongan Island in the south of Bali. This lease comprises
a
water area of 157 hectares (388 acres), which will be used to grow pearls.
There
is no fixed term for the water lease. The Company paid approximately A$2,700
to
the local villagers and there are ongoing costs of A$180 per month paid to
local
villagers for the continued use of the water lease. There is no associated
land
lease for this facility as the Company has an agreement with PT Bali Cruises
Nusantara (“Bali Hai Cruises”) to use its land for storage of equipment. Apart
from the obvious benefit of providing a viable alternative source for pearl
production to the main pearling center of Alyui Bay, the facilities at Karang
Asem and Nusa Lambongan, with their close proximity to Denpasar, its ready
and
available workforce, and its cheaper infrastructure costs, have great potential
to reduce the Company’s cost of pearl production.
15
The
Company established a joint hatchery operation in West Lombok in 2005 to replace
the Bacan Island Project. The term of the unexecuted joint operation agreement
with PT Autore Cultured Pearls is for one year and each July will be extended
for another year on mutually agreed upon terms. This facility comprises a small
hatchery, generator facilities, storage and some accommodations on land along
with 125 hectares (309 acres) of ocean-based farm. Under the terms of the
agreement, Cendana contributes half of the costs of operating the facility
and
splits the cost of any capital items purchased during the term of the
arrangement equally with its partner. In exchange, the joint partner and Cendana
are entitled to an equal share of all pearl oysters produced as this
facility.
The
Company is now able to produce its juvenile oysters in its Penyabangan, Bali
and
Lombok facilities. The Company has transformed the Alyui Bay project from a
fully integrated operation covering all the pearl production stages from
hatchery to harvest to a dedicated pearling center concentrating on seeding
and
husbandry of high quality mature pearl oysters. This is delivering an improved
result in terms of productivity (seeding rates are higher than any prior year)
and post-seeding results with a higher retention rate of nuclei being
experienced than in prior periods. Many of the non-essential support tasks
such
as boat building and long-line manufacture have been transferred to the lower
cost center of Penyabangan. In addition to pearl oysters being produced in
Penyabangan and transported to Alyui Bay, almost 50,000 were seeded in
Penyabangan and pearls from these oysters will be farmed at the new locations
of
Karang Asem and Nusa Lembongan.
The
Company monitors the socio-political situation in Indonesia closely. The October
2005 terrorist bombings in the Kuta and Jimbaran tourist precincts of Bali
had a
serious detrimental effect on tourism in Bali but no observable effect on the
general business of the Company. Unrest in Kupang was one of the reasons for
the
closure of the Kupang facility in 1999. Indonesia continues to experience
social, ethnic and economic instability. The province of West Papua where the
Company’s pearling leases are located is agitating for independence. It is
difficult to predict how these forces will influence the Pearling
Project.
The
Company attempts to manage the instability in Indonesia by maintaining good
relations with employees, nearby village communities, regional and provincial
authorities and the community at large. The Company continues to work hard
in
the critical areas of government liaison, community relations and security.
The
Company is proud of the success it has had in improving the access of local
communities to facilities such as medical care, education, transportation and
better general living standards.
16
In
the
event civil unrest threatens the Company’s farms at Waigeo Island or North Bali,
there is an evacuation plan in place to protect the expatriate and Indonesian
national employees. If the expatriates are forced to leave, the Company does
not
expect that any of the Pearling Project could be salvaged.
Oyster
Growth and Pearl Cultivation
The
cultivation of pearls is a long and labor intensive process which starts with
the spawning of adult oysters during the months of August to March.
Approximately two dozen adult oysters are placed in tanks in the hatchery where
they spawn to produce oyster larvae. The larvae remain in the hatchery tanks
where they swim and feed on algae. After approximately three weeks, the larvae
stop swimming and settle on netting material located in the tank. The larvae
attach themselves to the nets and continue to grow and feed on increasing
amounts of algae. After about one month, the netting on which they have been
growing is placed in a protective mesh and moved to the nursery in the open
waters. The waters are rich in nutrients so that the juvenile oysters, or
“spat,” are able to grow quickly. The netting is suspended from “long lines”
strung between floats in the water. The spat are left in these net structures
for approximately three to four months. As the spat continue to grow on the
netting, the nursery workers start to thin out the spat and transfer them from
the netting when they are large enough to be placed in “28 pocket panels.” These
panels consist of a metal frame covered in netting that has been divided into
28
separate pockets. These panels are moved out of the nursery area to various
locations of the open-water pearl farms where the spat continue to grow. By
placing the spat in different locations, the Company is able to reduce the
risk
of losing an entire crop due to the presence of adverse conditions in any one
area.
After
approximately a year to fifteen months, the spat, now shells, are too large
for
the 28 pocket panels and are placed into larger “eight pocket panels.” The shell
remain in the eight pocket panels until they are ready to be nucleated at 21-24
months of age.
When
the
shell are ready to be nucleated, they are brought to an operations room.
Technicians then perform the exacting surgical procedure of placing a nucleus
in
the oyster. The first step involves opening the oyster so that a nucleus can
be
implanted. This is accomplished by a procedure referred to as “pegging the
shell.” Workers place wedge shaped pegs in the shells as they open and close
during their normal feeding process. By opening the oysters in this manner
instead of forcing them open, the strong muscle which holds the shell together
is not torn, which is fatal to an oyster. After the oyster has been opened
to a
certain width, the oyster is ready for surgery.
The
oyster is placed in an operating cradle where technicians carefully insert
a
nucleus composed of a bead, made from the shell of a freshwater mussel, into
the
oyster. In addition, they insert a small piece of nacreous tissue, known as
saibo tissue, from a “donor oyster.” Nacreous producing tissue is naturally
found only on the outer lip of the oyster. Therefore, this tissue must also
be
inserted at the same location as the nucleus in order to produce a pearl.
Approximately one out of every 20 oysters is used as a donor from which the
nacreous producing tissue is taken.
After
the
oysters have been nucleated, they are placed in an eight pocket panel and
returned to the ocean where they are hung from the long lines. From the time
of
nucleation, it takes approximately two years to develop a pearl of 10 to 12
millimeters in diameter. Throughout the entire process, workers continuously
clean the shells, the panels and the long lines because naturally occurring
marine growth will compete with the oysters for food. In addition, foreign
organisms can enter the oysters and either eat the oysters or cause disease.
Finally, under normal conditions, approximately 30% of the oysters will reject
the nucleus and an additional 10% to 20% die. The oysters are x-rayed
approximately eight months after being nucleated to determine which animals
have
rejected the nucleus. Any shells which reject the nucleus can be re-nucleated.
Sometimes the oyster will reject the nucleus but the saibo tissue is retained
and a pearl forms around this. A pearl formed in this manner is called a keshi
pearl. This is a “seedless” pearl and it will usually have a slightly irregular
shape.
17
The
environment has enormous influence over the success of pearling. Successful
pearling requires careful consideration of environmental issues and the Company
strives to ensure that its activities have a minimal impact on the environment.
The Company has procedures in place to mitigate any damage to the environment
in
the event of an accidental fuel spillage and it treats all waste in an
environmentally friendly manner. It adheres strictly to the guidelines
established in the environmental report it submitted to the Indonesian
authorities in 2000 as part of its application to obtain a permanent operating
license.
Towards
the end of 2001 and throughout 2002, the Alyui Bay site came under the influence
of
El
Niño,
which
had a dramatic influence on the agricultural sector in Australia and parts
of
South East Asia. The production of juvenile oysters at Alyui Bay, the then
lifeblood of the Company’s pearling operation, was severely curtailed by this
event. The Company took immediate action and was able to source commercial
quantities of juvenile pearl oysters through an arrangement with a third party
hatchery. Although
El
Niño
conditions diminished as 2003 progressed, the Company continues to take steps
to
reduce the risks to future production as a result of insufficient juvenile
oysters being available.
Pearl
Sales and Revenue
Wholesale
pearl sales accounted for 92% of the Company’s revenue in 2005. The majority of
the Company’s pearls are sold in the world pearl wholesale market by the
independent pearl marketing and trading company, Pearlautore International
(“PAI”). On October 11, 2005, the Company renewed its current agreement with PAI
for a period of two additional years commencing on January 1, 2006. According
to
the terms of the agreement, PAI was appointed as the Company’s exclusive valuer
and distributor of South Sea pearls. PAI is to receive a commission of between
7.5% and 25% for cleaning, grading, valuing and selling the Company’s
pearls.
Pearls
have traditionally been sold at auction but are also increasingly offered to
buyers and sold under privately negotiated arrangements. Pearls are harvested
at
various times during the year depending on the seeding date of the oyster.
PAI’s
wholesale customers are from many geographical locations, accordingly the
Company does not rely on a single customer to purchase all of its
pearls.
The
remainder of the Company’s revenue is derived from sales of jewelry, pearl shell
and pearl meat by-products. A major focus for the Company in 2005 was the
development of internal marketing skills including design and manufacture of
pearl jewelry. The Company opened part of the Penyabangan site in North Bali
to
the visiting tourist trade during 2005 as its first exposure to the retail
market. Since then the Company opened a second retail operation at the Company’s
facility on the island of Nusa Lembongan in the south of Bali in 2006. Demand
for the pearl shell (MOP) and pearl meat by-products has increased significantly
in the last 2 years.
18
Competition
and Markets
Competition
in the pearling industry is intense. The Company competes with other South
Sea
pearl farmers, mainly in Australia, Indonesia, the Philippines and other
Southeastern Asian regions. Many of these pearlers have significantly greater
financial resources and experience, and are better known than the Company.
The
Company also competes, although not directly because of product differentiation,
with producers of less expensive types of pearls such as the Akoya, freshwater
and black pearls produced in Japan, China and the South Pacific, respectively.
The Company also competes for consumer disposable jewelry dollars with producers
of other types of gems such as diamonds, other precious stones and precious
metals such as gold. Public demand for fine jewelry, including South Sea pearls,
is influenced by general economic conditions.
An
increase in supply of pearls globally, specifically freshwater and black pearls,
has had an adverse effect on the market price of South Sea pearls. The increase
in supply has also lead to a change in distribution methods within the pearl
industry. Although the auction system has been relied upon for the sale of
pearls in the past, this system has now been complemented with a “value adding”
process where smaller quantities of more discrete pearl types and grades are
sold
through
private negotiation. “Value added” means selecting and placing pearls in a
strand or a set of jewelry.
The
Company expects this method of distribution where there is less reliance on
the
auction system to continue.
The
changes that are being experienced in the pearling industry are not dissimilar
to those experienced in other-commodity based industries. The Company cannot
predict future demand nor how great an effect increases in the supply of South
Sea pearls will have on the market price for such pearls. The pearling industry
and the marketing and distribution arrangements for this product are currently
undergoing significant change, which is likely to result in a rationalization
and restructuring of producers. We believe that the Company, with its focus
being in Indonesia, is well positioned to benefit from any change because of
the
relatively low operating costs compared to Australian producers and its
relatively high quality of production compared to most Indonesian pearl
farmers.
Up
until
the last decade, approximately 90% of Australia’s South Sea pearl production was
sold in Japan. This amount has been reduced as the demand for such pearls has
increased in the emerging markets of Hong Kong, South Korea, Singapore, Taiwan,
Europe and North America. Sales of South Sea pearls are primarily made to the
gem jewelry trade.
The
Company offers its pearls in all the major world markets without placing too
much reliance on any one geographic market. The Company’s principal markets are
Japan, Hong Kong, Europe and North America.
Foreign
Investment Regulations in Indonesia
In
Indonesia, all proposed foreign investment and expansion projects require the
prior approval of the BKPM, Indonesia’s equivalent of a foreign investment
review board. A company may seek such approval by filing an investment plan
with
the BKPM, which contains information regarding the Company’s share capital, loan
capital, technical assistance agreements, and proposed joint venture agreements.
Under previous laws and regulations, the BKPM could require a foreign promoter
of such a project to include a local joint-venture partner.
19
In
July
1993, the Company sought approval from the BKPM for participation by foreign
investors in the Pearling Project. A joint venture agreement and an application
to form Cendana as an approved foreign investment company, or PMA company,
was
lodged with the BKPM. Following approval in 1994, Cendana filed its Articles
of
Association with the Indonesian Ministry of Justice, which were approved in
December 1994.
The
laws
and regulations applicable to PMA companies have, at frequent intervals since
1986, progressively relaxed the restrictions that were imposed by the Indonesian
Law on Foreign Capital Investment of 1967.
These
reform packages were intended to encourage foreign investment in Indonesia
and
to boost exports. In 1999, the BKPM granted permission for the Indonesian
company, Cendana, to become a fully foreign-owned company. At that time, the
Company acquired 100% of its Indonesian subsidiary.
Foreign
Trade Regulations in Indonesia
In
general, Indonesian government policy protects local interests. In 1990,
however, the government implemented certain reforms aimed at facilitating the
flow of imports and exports into and out of Indonesia. With respect to imports,
the deregulation plan included the replacement of non-tariff barriers into
Indonesia with tariffs.
There
are
no restrictions on the export of pearls from Indonesia and no export tax is
payable. Indonesia, however, does impose a provincial “retribution tax,” which
is applicable to the export of pearls. These payments amount to approximately
1.5% of the export value of pearls.
Indonesia
has no exchange controls; therefore, foreigners are able to move funds freely
in
and out of the country through accounts denominated in local or foreign
currency.
Government
Regulation
Australia
The
activities of the Company are subject to numerous laws and regulations,
including those described herein.
The
Australian Corporations and Securities Legislation (“ACSL”) is the main body of
law governing companies incorporated in Australia, such as the Company. The
Australian Securities and Investments Commission is an Australian government
instrumentality that administratively enforces the ACSL. The ACSL covers matters
such as directors’ duties and responsibilities, preparation of accounts, auditor
control, issue and transfer of shares, control of shareholders’ meetings, rights
of minority interests, amendments to capital structure, preparation and filing
of public documents such as annual reports, changes in directors and changes
to
capital.
The
Australian Stock Exchange imposes listing rules on all listed companies, such
as
the Company. The rules cover such issues as immediate notification to the market
of relevant information, periodic financial reporting and the prior approval
of
shareholder reports by the Australian Stock Exchange.
20
The
Company believes that it is in material compliance with the foregoing Australian
laws and regulations and with the rules of the Australian Stock Exchange.
Indonesia
Indonesian
laws require Cendana to obtain certain tax identification numbers and
miscellaneous occupational licenses. Cendana has obtained all licenses from
the
BKPM, including its permanent operating license for the Waigeo and Bali
sites.
The
BKPM
also requires Cendana to have its accounts audited annually by an Indonesian
public accountant. Cendana complies with this requirement. Indonesia maintains
other laws relating to corporate governance that are similar to laws of other
jurisdictions. The Company believes that Cendana is in material compliance
with
these laws and with other applicable Indonesian laws and regulations.
Environmental approvals are issued with the operating permits for each site.
These require regular reporting to authorities in relation to fuel usage for
energy generation, compliance with waste emissions and any incidents that may
have caused harm to the local environment. The Company is in full compliance
with its environmental reporting obligations.
United
States of America
Because
the Company has registered its Shares with the U.S. Securities and Exchange
Commission (“SEC”) and listed the ADRs on the Nasdaq Stock Market (“Nasdaq”),
the Company must comply with U.S. laws and SEC regulations applicable to foreign
companies that trade their securities in the U.S., including the Sarbanes-Oxley
Act of 2002 and the listing requirements of Nasdaq. These laws, regulations
and
requirements cover matters such as independence of directors, audit committee
compensation and duties, codes of ethics, independence of auditors, and
disclosure of fees and services provided by auditors. The Company believes
that
it is in material compliance with these laws, regulations and listing
requirements.
On
December 1, 2004, the Company announced its intention to voluntarily delist
its
ADRs from the Nasdaq Small Cap Market. The Company has not yet finalized all
of
the requirements to complete this process. When the process is completed the
ADRs are expected to be traded on the OTC Bulletin Board. The delisting of
the
ADRs is intended to reduce the Company’s listing costs and allow it to more
easily comply with U.S. listing regulations.
21
C.
Organization
Structure
Atlas
South Sea Pearl Limited owns all of the capital stock of Tansim Pty Ltd, an
Australian company, which in turn owns all of the capital stock of the
Indonesian company, PT Cendana Indopearls. The functional relationship of the
group’s structure is described in the table below.
ATLAS
SOUTH SEA PEARL LTD - Australian Company
Functions
Assets
Risks
1.
Marketing
of pearls - cleaning, sorting and grading.
2.
General
business administration
3.
Financial
reporting and public relations
1.
Marketing
agreements and established marketing network.
2.
Professional
management and technical support with access to industry and business
best
practice.
3.
Listed
on Australian and International stock exchanges, relationships
with
investment brokers and banks.
1.
Fluctuations
in pearl market prices, fluctuations in exchange rates Yen/A$ and
marketing requirements.
2.
Investment
in S.E. Asia and aquaculture industry; market maker and investor/banker
reaction/perception of the business.
TANSIM
PTY LTD (100% owned by Atlas South Sea Pearl Limited) - Australian
Company
Functions
Assets
Risks
1.
Holds
investment in PT Cendana Indopearls
2.
Provided
original project finance.
1.
Investment
in PT Cendana Indopearls
1.
Unable
to recover value of investment
PT
CENDANA INDOPEARLS (100% owned by Tansim Pty Ltd) - Indonesian
Company
Functions
Assets
Risks
1.
Breedng/hatchery
2.
Oyster
farming
3.
Seeding
/ nucleation
4.
Pearl
harvesting
5.
Administration
of operations, security, logistics, community relations.
6.
Retailing
1.
Operational
personnel
2.
Fixed
assets
·
Boats
·
Farm
equipment
·
Hatchery
buildings & equipment
·
Nucleation
equipment
·
Accommodation/support
infrastructure
3.
Jewelry inventory
1.
Environmental
and climatic variations - spat and oyster losses.
2.
Remote
location - limits access to skilled workforce and emergency services,
makes logistics more difficult.
3.
Security
and socio-political issues.
4.
Limited
access to capital.
5.
Stock
redundancy in jewelry retailing.
22
D.
Property,
Plants and Equipment
Subiaco,
W. Australia
The
Company rents office space, consisting of approximately 275 square meters,
in
the suburb of Subiaco, Western Australia, from Mr. David Morrison. The lease
commenced
on July 1, 2004 and has a term of three (3) years with an option to renew the
lease under the same terms for three (3) additional years. The lease provides
for an aggregate rental payment of A$18,000 annually, which rent is paid in
equal monthly installments. The rental payment is subject to annual increases
based upon fair market
value.
Annual rent for the year ended December 31, 2005 was A$18,442.
Kupang,
W. Timor
On
October 6, 1992, the Joint Venture (which later became PT Cendana Indopearls)
entered into a 20-year lease for five hectares (12.3 acres) of land at Lelindo
Point and constructed a hatchery, laboratory, administrative offices, workshop,
store room and accommodations for expatriate managers. On September 4, 1994,
it
entered into a 10-year lease for 0.3 hectares (0.74 acres) of land located
on
Kambing Island overlooking the nursery. Ardindo Nusa entered into these land
leases on behalf of the Joint Venture. Pursuant to the Sale Agreement, the
Joint
Venture agreed to transfer all assets, including the land leases, to Cendana.
Accordingly, Ardindo Nusa assigned all beneficial interest in the leases and
any
extensions thereof to the Company.
On
March
10, 1993, Cendana entered into water leases, which leases were later amended.
On
September 4, 1995, Cendana received Presidential approval for its water leases.
The various water leases are located within a four mile radius of the Kupang
hatchery and total 725 hectares (2.8 square miles). The leases are for a term
of
30 years. Cendana used these waters as a nursery for young oysters and as a
pearl farm for the nucleated oysters prior to the closure of the Kupang
facilities in December 1999. The Indonesian government owns all of the land
and
water upon which the Kupang pearl farm was located and leased the property
to
Cendana for a fee of A$8,400 per annum. All of the government leases are
conditioned upon Cendana meeting certain requirements, including the development
and use of the leased property for pearling operations.
During
November 1999, the Company decided to close the facility at Kupang. See “Item 4.
Information on the Company - The Pearling Project.” In December 2000, the
Company finalized negotiations with an Indonesian company for the sub-lease
of
the land, buildings and water leases comprising the Kupang facility for a period
of five years. The sub-lease commenced on February 2001. Cendana received
A$55,192 (US$34,800) per annum under the sub-lease. Pursuant to the terms of
the
sub-lease, on July 10, 2006, Cendana transferred all of its beneficial interest
in the land and water leases, and the building relating to the Kupang facility,
to the sub-lessee upon the Company’s receipt of its final sub-lease payment due
for the five year sub-lease period. The sub-lease arrangement fulfills the
Indonesian government’s conditions. The Company remains primarily liable for the
annual lease payments to be made to the government.
23
Waigeo
Island, W. Papua
Cendana
has water leases that commenced on September 30, 1997 encompassing approximately
2,500 hectares (6,200 acres) on Waigeo Island, in the W. Papua (formerly Irian
Jaya) province of Indonesia. The leases are for a term of 25 years and expire
on
September 30, 2022. This site is approximately 130 kilometers west of Sorong
in
a remote area with excellent waters for pearl farming. It was a condition to
the
Indonesia government’s agreement to enter into the leases that the Company
construct and operate a hatchery at the site. The Company completed construction
of its hatchery in 1998. The hatchery had its initial production run in December
1998. The farm has the capacity to hold up to one million mature adult oysters.
The Company moved its operations and all of its equipment to this site in
November 1999 when it closed its facility in Kupang, West Temor, following
civil
unrest in the area and a deteriation of conditions suitable for
pearling.
In
addition to the hatchery, the Company has constructed an office, workshop,
accommodation buildings and a fuel storage facility over three sites within
Alyui Bay. The Company has a fleet of approximately 25 work vessels of various
sizes and two medium size wooden hull transportation ships. A significant part
of the farm infrastructure is made up of longlines, floats and panels, which
accommodate the oysters while they are being farmed. The Company has expended
approximately A$6.8 million since 1997 to construct and purchase the capital
improvements described above at the Alyui Bay farm. These expenditures were
funded from the Company’s own cash reserves. Although the facilities continue to
be developed, the main infrastructure at the Waigeo site is now
complete.
In
1998,
the Company leased approximately five hectares (12.3 acres) of land and 2,000
hectares (4,920 acres) of water at the Alyui Bay site. The Company pays
3,000,000 Indonesian Rupiah per annum (A$600) to the Kawe Tribe at Selpele
village for the 25-year water and land lease, which both expire on July 1,
2023.
The Company believes that it is in compliance with all of the terms of the
lease.
Bali
In
July
2002, the Company entered into a joint operating arrangement with Abadi whereby
the Company secured an interest in the right to access a small hatchery and
associated sea leases in Northern Bali at Banyupoh (the “Bali Hatchery Joint
Venture”). The infrastructure at Banyupoh occupied approximately two hectares
(4.9 acres), and was relatively simple but has been sufficient for successful
oyster spawnings. In addition to the hatchery, there was a simple grading shed,
accommodations for four employees and an office. Abadi owns all of the land
and
buildings located at Banyupoh. In addition, Abadi owns the majority of the
equipment on the farm. The Company transferred its equipment from the original
Kupang hatchery, which was re-commissioned for use at this facility at minimal
cost, to the farm and paid A$30,000 annually (for three years) for the use
of
the land, buildings and water leases. Abadi also has a sea lease for
approximately 38 hectares (93 acres) adjacent to the land area on which the
hatchery and other infrastructure is built. Abadi pays A$12,500 for the water
lease in Banyupoh, and the leases expire in 2026. The Bali Hatchery Joint
Venture used the water leases to hold longline systems to accommodate the
juvenile oysters once they leave the land-based hatchery. The agreement for
this
joint arrangement was terminated in September 2005.
24
In
addition to the joint operation at Banyupoh, the Company also leased 0.2
hectares of land and 100 hectares of ocean in December 2003 that were developed
as an
independent
juvenile production and grow-out facility in North Bali near the village of
Penyabangan, which is approximately 15km east of Banyupoh. The Company paid
an
upfront lease payment of A$15,000 for both of the leases and has an obligation
to pay approximately A$200 per month for the 30-year term of the leases. The
Company completed the development of the Penyabangan facility during 2004 with
the construction of a low-cost hatchery center, which supports the Company’s
research and development program. The site also supports the Company’s boat
building and other manufacturing/support activities at more remote locations
elsewhere in Indonesia. By developing an independent hatchery facility, Cendana
will no longer be reliant upon its joint venture partner, Abadi, for juvenile
oysters. It is anticipated that this facility will realize 200,000 to 300,000
juveniles each year. The Company moved its operations from Banyupoh to
Penyabangan in September 2005 when it terminated the Bali Hatchery Joint
Venture.
The
Company expanded its operations in Bali by opening a new farm site during 2005
at Karang Asem on Bali’s east coast. On May 23, 2005, the Company entered into a
water lease comprising 235 hectares (580 acres) and a land lease for an
additional 2,000 square meters with the local villagers who have ownership
of
the area. Under the lease, the Company paid the local villages approximately
A$16,000 and will pay approximately A$200 per month for the use of the site
until the expiration of the lease on May 22, 2035. The Company has constructed
storage, accommodations and oyster meat processing facilities at the site.
Infrastructure costs for the first year were approximately A$200,000. The
Company has established the facilities at Karang Asem for the purpose of farming
pearls. It is intended that oysters, which are seeded at Penyabangan in North
Bali, will be shipped to the Karang Asem farm where conditions are more
conducive for mature oyster growth. This site has also been developed to allow
the processing of live oysters to extract the meat for sale as fresh or frozen
produce. This site is located within one hour’s drive of the main city of
Denpasar, which allows for more efficient access to logistical
support.
On
September 16, 2005, the Company entered into a water lease with local village
leaders, Nyoman Murta and Wayan Danglod, on Nusa Lembongan Island in the south
of Bali, for a new pearl production facility. This lease comprises a water
area
of 157 hectares (388 acres). There is no fixed term for the water lease. The
Company paid approximately A$2,700 to the local villagers and there are ongoing
costs of A$180 per month paid to local villagers for the continued use of the
water lease. There is no associated land lease for this facility as the Company
has an agreement with Bali Hai Cruises to use its land for storage of equipment.
There was no development of this facility in 2005. The Company will use the
water lease to grow pearls. In the same way as the Karang Asem farm is used,
Nusa Lembongan will accommodate mature oysters that are transferred from
Penyabangan in North Bali. This site has a strong tidal flow and it is believed
that it will be conducive to the production of high quality pearls.
In
addition to the farming activities at Nusa Lembongan, the Company has also
commenced operation of a small retail operation on the island. This facility
is
located on land owned by a Company called Bali Hai Cruises. The Company entered
into an agreement on March 24, 2006 with Bali Hai Cruises for the Company to
run
the retail facility, which includes a pearling tour and demonstrations of
seeding and harvesting. The term of this agreement is for five years and because
the Company is providing a unique tourist attraction to Bali Hai Cruises, the
Company does not have to pay any rent for the use of approximately 800 square
meters of retail space. This retail facility did not commence until
2006.
25
In
June
2003, the Company moved its Indonesian headquarters from Sorong to Denpasar,
Bali. The office consists of approximately 225 square meters. The term of the
office lease is for three years and four months and rent of A$15,600 per annum
is paid in full in advance for the full term of the lease. The Company’s office
is well located with excellent access to communication and transportation
infrastructure. The Company uses competent local Indonesian staff to manage
the
Indonesian operations from the Denpasar office and the Company’s Managing
Director is based in this office. The Company is developing its internal
marketing team in Bali, which grew from two to seven employees during 2005.
Bacan,
N. Maluku
During
2004, the Company entered into a second joint production arrangement with
Cemerlang. This joint arrangement was for a period of five years, and the
Company had an option to extend the arrangement thereafter for five years on
the
same terms. The Company was granted shared
use
of
the leases and facilities of this operation. The Company was responsible for
the
funding of this operation and for the supply of expatriate and Indonesian
managers for this operation. Cemerlang received a proportion of the juvenile
oysters that were produced from this facility depending upon the age that the
juveniles were taken. The split was equal if the juvenile oysters were
taken from the Bacan facility before they were 12 months of age. After this,
the
oysters were split 70% to Cendana and 30% to Cemerlang. The joint venture
partner continued to retain ownership of the water and land leases and any
assets which were in existence at the commencement of the arrangement. Any
removable infrastructure that was paid for by Cendana during the term of the
agreement was split equally.
Fixed
assets that were paid for by Cendana and could not be removed from the site
at
the end of the agreement were purchased by Cemerlang based on their depreciated
cost value. Although t
he
Bacan
operations had been expected to produce approximately 300,000 juvenile oysters
each year for each of the Company and the joint venture partner, high levels
of
mortalities among juvenile oysters at the site during 2004 forced the Company
to
re-evaluate its continued use of this site. A total of 229,000 juvenile oysters
were delivered to Alyui Bay from the site over the course of operations during
2003 and 2004. By the end of 2005, Cemerlang and the Company terminated the
joint arrangement.
Lombok
Under
an
unexecuted joint operation agreement, the Company shares a land and sea based
facility, which is owned by PT Autore Cultured Pearls, its joint partner, at
Malaka in the north west of Lombok. The term of the joint operation agreement
is
for one year and each July will be extended for another year on mutually agreed
upon terms. This facility comprises a small hatchery, generator facilities,
storage and some accommodations on land along with 125 hectares (309 acres)
of
ocean-based farm. The land and ocean facilities owned by the joint partner
prior
to the commencement of the joint operation agreement will remain the property
of
the joint partner. Under the terms of the agreement, Cendana contributes 50%
of
the costs of operating the facility and splits the cost of any capital items
purchased during the term of the arrangement equally with its partner. In
exchange, the joint partner and Cendana are entitled to an equal share of all
pearl oysters produced as this facility.
26
ITEM
5.
OPERATING
AND FINANCIAL REVIEW AND PROSPECTS
This
is
the first Annual Report for which the Company’s consolidated financial
statements have been prepared in accordance with AIFRS. “AASB 1 First-time
adoption of AIFRS” has been applied in preparing these financial statements.
Certain line items of such financial statements have been reconciled to US
GAAP
to assist U.S. persons in evaluating such data. See “Item 17. Financial
Statements - Note 35 to Financial Statements.” The following discussion
references only the amounts computed in accordance with AIFRS for the years
ended December 31, 2005 and December 31, 2004.
Overview
The
following is an analysis of the Company’s results of operations, liquidity and
capital resources. To the extent that such analysis contains statements that
are
not of a historical nature, such statements are forward-looking statements,
which involve risks and uncertainties. See “Introduction - Forward Looking
Statements.”
In
order
to produce pearls the Company must maintain an ongoing supply of oysters. The
natural cycle of the oyster dictates that it is approximately four years from
the spawning of the oyster until the production of a pearl. See “Item 4.B.
Business Overview.” The Company capitalizes the costs associated with the
rearing, husbandry and nucleating of an oyster over the pearl production cycle.
These capitalized costs are disclosed in the financial statements as “Biological
Assets.” Upon the harvesting of the oyster and the production of the pearl, an
appropriate portion of this cost is transferred to the pearl inventory and
ultimately to the cost of sales when the pearls are sold.
Total
revenue derived by the Company from different sources during its most recent
two
fiscal years is set forth in the following table:
2005
2004
A$
A$
Interest
received
$
101,618
$
156,262
Sales
of oysters
176,577
98,620
Sales
of pearls
9,094,562
5,212,130
Sales
of MOP, meat and jewelry
317,171
508,208
Foreign
exchange gain/(loss)
(24,601
)
790,084
Miscellaneous
182,532
72,219
$
9,847,859
$
6,837,523
27
The
following table provides additional details in relation to the results of the
Company’s pearl sales for its last two fiscal years:
2005
2004
Revenue
from sale of pearls (wholesale)
Sellable
Grade Pearls:
Value
(A$)
$
8,861,360
$
4,288,583
Quantity
(No.)
117,816
57,374
Weight
(Momme)
50,746
27,939
Average
price per momme (A$)
$
175
$
153
Average
weight per pearl (momme)
0.431
0.487
Commercial
Grade Pearls:
Value
(A$)
$
69,090
$
690,879
Quantity
(No)
9,043
59,170
Weight
(Momme)
3,832
23,601
Keshi
(seedless) pearls:
Value
(A$)
$
164,112
$
232,668
Weight
(Momme)
1,386
2,250
A.
Operating
Results
The
total
revenue increased by A$3,010,336, or 44%, from 2004 to 2005. This is mainly
due
to an increase in pearl sales revenue, which increased by A$3,882,432, or 74%,
from 2004 to 2005. The details regarding this movement in each category of
revenue are described below.
Pearl
Sales
The
Company’s revenue from the sale of pearls for 2005 was A$9,094,562, which
represented an increase of A$3,882,432, or 74%, when compared to 2004. This
revenue included revenue from pearls that have been the subject of "value added"
services , such as having been placed in strands or incorporated into jewelry.
The major factors that contributed to the rise in the Company’s sales of pearls
for 2005 include:
·
An
increase in the number of “sellable” grade pearls. The pearls harvested in
2005, although not significantly different in total quantity or size
(sellable and commercial grades combined) when compared to 2004,
were of a
much higher proportion of “sellable” grade. This in turn meant a higher
sales price per pearl. The reason for the improved pearl quality
is
attributed to an improvement in the quality of young oyster stock
and
improved conditions for farming
pearls.
28
·
An
improvement in demand for pearls generally. This has resulted in
some
improvement in prices being achieved for the higher quantity of sellable
pearls.
·
Improved
results achieved by PAI. PAI has made changes in its organization
to
increase its representation world wide with a better exposure to
wholesale
and retail world pearling markets.
·
Continued
efforts of PAI and within the Company to develop “value added” sales
within the category of loose pearls. Value added sales are where
pearls
are worked into strands or jewelry. Both PAI and the Company have
continued to explore alternative sales methods, such as, the creation
and
sale of jewelry that incorporates the Company’s pearls to increase sales
of pearls and gross margins.
In
2004
the lower quality of the Company’s pearls was due to the lower quality of
oysters available for seeding in 2001 and 2002 coupled with the effect of the
El
Nino
climatic
conditions on these oysters in 2002. The oysters that were seeded in 2002 were
smaller than in previous years due to stock availability pressures and because
the oysters from which the Company extracted Saibo tissue in 2001 and 2002
caused a partial deterioration in the quality and color of the pearls that
were
harvested in 2004. Poor quality pearls were also harvested from second operation
oysters in 2004. These are pearls that are produced from oysters, which have
already produced one pearl and which are then re-seeded with a second nucleus.
The average weight of the sellable grade pearls that were harvested in 2004
also
decreased. In prior years, pearls were left unharvested for a longer period
of
time so they were larger. The Company harvested pearls earlier in 2004 because
it was anticipating that there was the potential for its selling agent, PAI,
to
hold an auction in the early part of the year. This did not occur but these
pearls were sold later in 2004. Cumulatively, these factors had an adverse
effect on revenue from the sale of pearls during 2004.
An
improved supply of juvenile virgin oysters to Alyui Bay in 2003 and 2004 allowed
the Company to improve the quality and quantity of the seeding program in 2005
where only the healthiest and best quality oysters were seeded. This started
to
have a direct effect on improved pearl quality in 2005.
During
2005, the Company seeded 376,325 virgin, or first-time seeded, pearl oysters.
This compares to 342,164 in 2004. Growing conditions for oysters during 2004
and
2005 were favorable for both juvenile and mature pearl oysters at Alyui Bay
and
Bali, which has led to high survival, excellent health and improved growth
results. It is anticipated that these improved seeding and oyster growing
conditions will improve the adverse results that were experienced in sales
revenue decline during 2004. The average pearl size and the pearl quality is
expected to improve as a result of seeding better quality oysters.
The
Company remains committed to the production of high quality pearls. To this
end,
the Company is focusing primarily on the production of pearls in white and
silver color from first time operated pearl oysters. The Company believes that
these pearls generate the best yield for the cost and that these products remain
in strong demand. To support this endeavor, the Company will maintain the
diversified growing centers developed in previous years and continue to
investigate new opportunities as they emerge. The Company has also committed
to
significant research and development projects aimed at enhancing oyster
selection for improved pearl production.
29
MOP,
Oyster Meat and Jewelry
Revenue
from the sale of MOP, oyster meat and jewelry decreased in 2005 by A$191,037,
or
38%, from A$508,208 in 2004, to A$317,171 in 2005. In 2004 there was an improved
demand and price for raw MOP, which allowed the Company to significantly reduce
its accumulated stockpile. In 2005, the Company had insufficient raw MOP to
meet
the increased demand, which resulted in lower sales. In 2005, the Company
focused on developing new markets and products for “value added” pearl and MOP
jewelry. For instance, the Company now manufactures its own jewelry and gift
wares from MOP shell and pearls that are produced from its oysters. As a result,
the Company has recruited a new marketing manager, and increased the number
of
staff in this area from two to seven, as well as opened the Penyabangan site
in
northern Bali to the visiting public. Although these efforts are expected to
improve sales of jewelry in future years, sales of jewelry in 2005 remaind
flat
compared to 2004.
Juvenile
Oysters Sales
The
Company sold approximately 20,000 juvenile oysters during 2005, compared to
approximately 11,000 oysters sold in 2004. This resulted in an increase in
revenue of 79%, from A$98,620 in 2004 to A$176,577 in 2005. These oysters were
sold to other pearl farmers in Bali and West Papua. The price for the sale
of
oysters did not change significantly between 2004 and 2005.
Interest
Income
Interest
income decreased by A$54,644, or 34%, from A$156,262 in 2004 to A$101,618 in
2005, as cash reserves were used to fund operations.
Foreign
Exchange Gains/Losses
In
2005,
there was a loss of A$(24,601) resulting from foreign exchange movements
compared to a gain in 2004 of A$790,084. In 2004, the Company had all of its
JPY
receivables hedged at a rate of approximately JPY70:AUD1. There was a
significant appreciation in the Austrailian Dollar during 2004 and because
the
Company was able to utilize the currency hedging that was in place, there was
a
gain from exchange rate movements. There was substantially less foreign currency
hedging available in 2005 to shelter the Company’s sales from the relatively
strong Australian Dollar. The gain from foreign exchange hedging contracts
and
other foreign currency movements relating to pearl sales for 2005 was A$349,300.
The Company was required to account for any mark-to-market gains or losses
in
its hedging portfolio in 2005 for the first time under AIFRS. This accounted
for
a loss of A$(334,000) at the end of 2005. The remaining A$(39,900) in foreign
currency loss for 2005 was generated from adjustments required to the Company’s
foreign currency denominated assets and liabilities being revalued at the end
of
the year.
30
Cost
of Goods
Sold
The
cost
of goods sold decreased marginally from A$4,414,357 in 2004 to A$4,275,378
in
2005. This was despite a higher number of total sellable and commercial pearls
being produced in 2005. The overall reduction in unit cost of production is
a
result of economies of scale from higher oyster quantities and this is expected
to continue to flow through to lower production costs of pearls in the future.
This benefit will be in part offset with increasing production costs. Inflation
in Indonesia was 17.1% in 2005 compared to 6.4% in 2004. In addition, high
world
fuel and commodity prices continue to put upward pressure on costs. The Company
cannot estimate the impact of inflation on its cost of goods sold in 2006 and
beyond.
Marketing
Costs
Marketing
costs increased by A$305,800, or 54%, from A$564,743 in 2004 to A$870,543 in
2005. The increase in revenue from pearl sales is directly related
to
commissions
applied to pearl sales. During the negotiation of the new marketing agreement
with PAI in 2005, it was agreed that commission rates for pearl sales would
increase from 5 % to 7.5% for loose pearls and from 12.5% to 15% for pearls
that
are used in the value adding process. This has contributed and will continue
to
contribute to higher marketing costs. Also linked to sales commissions and
higher marketing costs is the fact that more of the Company’s loose pearls are
being allocated to the value adding process that is undertaken by PAI on behalf
of the Company. The Company expects to be able to achieve a premium of bet6ween
10-15% for the pearls it sells in the value added category through PAI. This
enhances revenues and gross margins, but requires additional marketing, which
incurs a higher commission rate.
Administration
Costs
Administration
expenses increased by 5.9% from A$1,632,767 in 2004, to A$1,730,268 in 2005.
This was in line with overall group inflation in Australia and Indonesia
combined.
Other
Expenses
Other
expenses decreased by 14% from A$722,984 in 2004 to A$615,544 in 2005. In 2004,
the Company wrote-down its oyster inventory by A$224,000 to its expected
net
realized value
and
further wrote-down the same oyster inventory by A$317,000 in reconciliation
of
the accounting treatment for the capitalization of inventory under Indonesian
and Australian Accounting Principles. These write-downs resulted in higher
other
expenses during 2004.
In
2005,
other expenses also included research and development costs of A$87,500,
relating to the project that is being undertaken with James Cook University,
which costs were not incurred in 2004.
The
Company recorded a pre-tax operating profit of A$2,356,126 in 2005 compared
to a
pre-tax operating loss of A$(497,329) in 2004. This increase of A$2,853,454,
is
primarily due to the increase in revenue from the sale of pearls due to the
improvement in pearl quality.
In
2004,
the Company’s income tax expense for 2005 was A$295,539 compared to A$96,946 for
2004. The Company has had an ongoing review of its Indonesian income tax
position by the Indonesian Income Tax Authorities. In 2004, a provision was
made
for prior year income tax that resulted in an income tax expense for 2004
despite a consolidated loss before tax. In 2005, as a result of concluding
this
audit, the income tax expense was reduced from A$706,838 to A$295,539 for 2005
with the reversal of an overstatement of tax for the prior period of A$373,047.
The net after tax profit for 2005 was A$2,060,587 compared to a net loss after
tax of A$(594,274) in 2004.
31
Future
Business Potential and Constraints
The
Company remains focused on growing its business within the pearling industry.
The Company has identified key factors that led to a decline in its revenue
in
prior years and implemented steps to address these problems. As a result of
the
effort to ensure a continuous supply of oysters for its Alyui Bay production
facility, the Company has been able to increase the number of virgin oysters
seeded each year, improve the quality of juvenile oysters being produced and
develop new farm sites in the Bali region. The Company views the maintenance
of
a supply of juvenile oysters as a key to the success of the business growth
in
the future.
Future
growth is expected from the ongoing development of the Company’s own hatchery
and oyster grow-out farm at Penyabangan in North Bali and the development of
a
new farm site at Karang Asem on Bali’s east coast and the establishment of a
pearl oyster lease on Nusa Lembongan in the south of Bali. In addition, a new
joint hatchery operation was established in West Lombok, which follows the
termination of the Bacan venture, which did not perform to expectations. The
Company will continue to seek out further joint venture and self-owned and
operated farm sites for expansion of production. This will be done within the
current resource capabilities of the Company.
Research
continues to be done on improvements in pearl oyster husbandry and production
techniques to assist the Company in bringing high quality product to the market
in the future. A research and development program commenced in late 2004 with
James Cook University in Queensland, Australia looking into genetic marker
identification to improved pearl quality and consistency. This has progressed
well with all the major breeding milestones having been achieved during 2005.
The first survival and growth results have been collected and are currently
being analyzed. The technique for DNA pedigree assignment of the offspring
created for this program has been proven and the Company is looking forward
to
further developments during 2006.
The
increase in seedings from 284,000 in 2003 to 342,000 in 2004 (20%) and 376,000
in 2005 (10%) should continue to improve the economies of scale and quantity
of
pearls the Company produces. The production of a pearl is a natural process,
which means that the predictability of quality is uncertain. The Company adopts
best practice farming techniques to try to limit poor quality but it cannot
influence environmental conditions that may affect the production
process.
The
absence of production quotas in Indonesia ensures that the quantity of oysters
that the Company can nucleate is limited mainly by the Company’s ability to
produce juvenile oysters and the biomass limitations of the various pearl
production sites, rather than government regulation. This provides the Company
with a competitive advantage not available to its Australian competitors. The
quantity and quality of the Company’s pearl production is also determined by the
techniques it employs in the nucleation and husbandry of its oysters. Climatic
and environmental conditions will affect its future results; these factors
can
only be managed but not controlled by the Company.
32
The
Company continues to monitor foreign exchange rates against the Australian
Dollar, especially that of the Japanese Yen, which is the currency in which
most
of the Company’s revenue is denominated. The Company uses forward foreign
exchange contracts and some derivative products, with terms of not more than
two
years, to hedge these risks. Derivative financial instruments are not held
for
speculative purposes. Although the Company makes efforts to limit its exposure
to adverse movements in the Japanese Yen against the Australian Dollar, these
exchange rates are subject to market influences over which the Company has
no
control.
Many
Asia
Pacific countries, including Indonesia, have experienced economic difficulties
including liquidity problems, volatility in prices and significant slowdowns
in
business activity in prior years. Operating costs in Indonesia, including wages,
employee amenities and fuel, have been subject to inflation of 17.1% in 2005.
Resolution of difficult economic conditions that exist in Indonesia depend
to a
large degree on fiscal and monetary measures that may be taken by the Indonesian
government. Such actions are beyond the Company’s control, and the Company
cannot predict whether the government will be successful in initiating and
achieving economic reforms. The Company also cannot determine the future effects
that the ongoing adverse economic conditions may have on the Company’s liquidity
and earnings. The ability of the Company to sell its assets in Indonesia depends
to a large extent on events beyond the Company’s control. If the Company was
forced to abandon its pearl farms due to political unrest, the Company would
likely not recover any of its investment in its Indonesian assets.
B.
Liquidity
and Capital Resources
Net
cash
flow provided from operating activities declined from an inflow of A$95,791
in
2004 to an outflow of A$(190,691) in 2005. Overall there was an increase in
cash
flow due to an increase in proceeds from pearl sales of A$1,366,792 in 2005.
A
significant part of the increase in pearl revenue is reflected in the trade
receivables which increased by A$2,367,291 to A$4,301,651 at December 31, 2005.
This increase in cash flow was offset by payments to suppliers, which increased
by A$912,037 during 2005 resulting in a reduction in cash flow and accounts
payable at December 31, 2005 by A$337,394 to A$682,975. There was a significant
decline in proceeds from other operating revenue during 2005 of A$691,036,
which
also reduced cash flow. The majority of this decline represented a reduction
in
the net foreign exchange gains of A$783,245.
Net
cash
flow used in investing activities declined from A$824,200 in 2004 to A$753,588
in 2005. The Company used cash from investment activities in 2005 primarily
to
purchase new property, plant and equipment in the amount of A$832,582 compared
to A$778,641 in 2004. Most of this expenditure related to equipment and
infrastructure expenses in Alyui Bay, Panyabangan and Denpasar, as well as
the
development of the Company’s new pearling interests in Karang Asem and Nusa
Lembongan in Indonesia.
At
December 31, 2005, the Company had net short term borrowings of A$78,994
compared with nominal borrowing at December 31, 2004. These borrowings are
unsecured and represent premium funding on insurance costs. In addition to
this,
the Company has a borrowing facility in place with a major Australian bank
with
a limit of A$2,000,000 to allow it to undertake factoring of its accounts
receivables and supply letters of credit. To date, this facility has not been
utilized. The facility is secured by the assets of the Company.
33
The
Company paid a dividend of A$878,103 in 2005; it did not pay a dividend in
2004.
The payment of dividends in future periods is dependent upon the availability
of
surplus cash and the outlook for future profits. The Company also paid a
dividend of A$1,359,154 in June 2006.
The
Company had cash reserves of A$1,475,480 and trade receivables of $A4,301,651
at
December 31, 2005 compared to December 31, 2004 where there was a cash reserve
of A$3,208,996 and trade receivables of $A1,934,360. In contrast, trade
payables, borrowings and other current provisions at December 31, 2005 were
A$1,032,134 compared to A$1,355,061 in the prior year. On a comparative basis,
this represents an improvement in the Company’s working capital (which excludes
current biological assets as these are not considered to be liquid in nature)
from A$4,822,977 to A$5,963,503. This is primarily due to an increase in
accounts receivable from higher sales during 2005. The Company has continued
to
fund its pearling operations from operational cash flow and cash reserves and
did not raise any additional capital or long term debt in 2005 or 2004.
Future
investments are currently expected to be funded through operational cash flows
and cash reserves. The Company believes it has sufficient working capital for
its present requirements.
The
Company has budgeted to spend approximately A$230,000 on new capital
infrastructure works at Karang Asem and Nusa Lembongan in 2006. Of this amount,
A$85,000 will be spent on a new building, A$95,000 on new farm based equipment,
such as longlines and oyster panels, and A$50,000 will be on new vessels and
oyster cleaning equipment. An further A$45,000 is expected to be spent on
replacing longlines and panel replacement at Alyui Bay and Penyabangan in
2006.
C.
Research
and Development
In
June
2004, the Company entered into an agreement with James Cook University to obtain
information regarding the genetics of silver/gold lipped pearl oyster
(
Pinctada
maxima
)
populations in Indonesia. This research program is to be undertaken over a
period of four years. The aim and scope of this research is to develop molecular
tools and acquire statistical information to allow a well designed selective
breeding program to be commenced. There are a series of components to this
research:
·
Identification
of the founder genetic base;
·
Identification
of the influence that the environment has on family
ranking;
·
Estimation
of the heritability and genetic
correlations;
·
Genetic
diversity analysis; and
·
Development
of a DNA parentage determination marker
suite.
The
research has progressed well with all the major breeding milestones achieved
during 2005. The first survival and growth results have been collected and
are
currently being analyzed. The technique for DNA pedigree assignment of the
offspring created for this program has been proven and the Company is looking
forward to further developments during 2006. Specific results from this research
will not be realized for some years, but practical techniques for the
improvement of breeding have already been learned from the work done to
date.
34
The
Company has committed to an amount of A$150,000 in cash, A$50,000 per year
over
four years, from 2006 to 2008 plus the resources of its staff and facilities
in
Bali, estimated at A$63,000 per annum, as a co-contribution to this research
over the four years of the project. Additional funds are being provided by
the
Australian government and James Cook University is providing the research
expertise and personnel for this project at its own cost.
As
part
of its ordinary operations, the Company continues to test and monitor shell
growth rates, pearl growth rates, pearl quality, hatchery cleanliness and the
suitability of the surrounding waters as to temperature, pollution and water
currents. The Company’s in-house marine scientists also continually study and
test innovative ways to improve shell husbandry, and consequently, the
production of quality pearls.
The
Company provides research opportunities for promising Indonesian and Australian
students in conjunction with universities and fisheries
departments.
Expenditures
incurred on research and development in the Company’s last two fiscal years have
been treated as ordinary operating expenses, and are expensed when incurred.
Expenses that are identified as pearl production costs are capitalized. See
“Overview” and “Item 17. Financial Statements.”
D.
Trend
Information
The
Company’s pearl farm and operations are now well established. In 2002, the
Company experienced the negative impact of climatic and environmental factors,
such as
El
Nino
,
that
reduced the size and quality of the pearls the Company produced in its 2003
and
2004 harvests. In addition, these factors adversely affected the Company’s
production of juvenile oysters required for future pearl
production.
The
Company has implemented a number of initiatives to ensure that it has an
adequate supply of oysters for future pearl production by diversifying the
areas
from which it can source juvenile oysters. The Company has also refined the
focus of its pearl production facility at Alyui Bay to maximize the number
of
specially selected oysters that can be seeded and to maintain practices that
will maximize the health of these oysters during the growth and development
of
the pearls. The Company has also continued to develop its hatchery and pearl
farm at Penyabangan, Bali. The increased number of oysters that the Company
has
seeded in the last three years combined with improved pearl retention rates
and
better quality oysters should increase the Company’s production of pearls in the
longer term. The Company believes that the Alyui Bay site has reached its
potential in terms of the number of oysters that it can effectively manage
in a
sustainable way. In 2005, the Company opened a new farm site at Karang Asem
on
Bali’s east coast and established a pearl oyster lease on Nusa Lembongan Island
in the South of Bali. Almost 50,000 pearl oysters were seeded in Bali during
2005. The Company also established a new joint hatchery operation in West Lombok
during 2005. Future growth will come from pearl quality improvement and
expansion into these new pearl production farm sites in Indonesia.
35
The
Company believes pearl prices may have stabilized after a decline in prices
for
South Sea pearls from 2000 - 2004. This is due to a small improvement in demand
and a relatively static level of supply. The pearl market continues to be highly
competitive. South Sea pearls compete directly with other types of pearls
including freshwater pearls from China, Akoya pearls from Japan and black pearls
from Tahiti and other South Pacific nations. Pearls also compete directly with
other gem stones that are used in the jewelry trade. There has been a
significant shift in the distribution networks for pearls as the industry
matures and becomes more competitive. The Company continues to target the
production of pearls it believes will be most sought after by the market and
the
least subject to these price pressures. However, the lead time for the
production of a pearl is at least two years, and, as such, it is difficult
to
react quickly to changes in market trends if they occur.
The
Company continues to enhance its marketing skills. It is investigating more
opportunities to add value to its products by becoming more directly involved
in
the distribution process for some part of its pearl production. In this regard,
the Company established a visitor center at its Penyabangan farm in N. Bali,
which incorporates a small retail operation. The center attracts tourists who
are staying in the N. Bali region and provides them with an industrial tourism
experience to gain a greater appreciation for pearls. Visitors are able to
view
and purchase loose pearls and pearl jewelry as well as MOP giftware and jewelry.
The
Company includes all of the revenue, expenses, assets and liabilities of its
joint ventures in its consolidated financial statements. As a result, the
Company does not have any off-balance sheet arrangements required to be
disclosed pursuant to Commission rules.
E.
E.
Tabular
disclosure of contractual obligations
Payments
due by period
Contractual
obligations
Total
less
than
1
year
1-3
years
3-5
years
more
than
5
years
Long
term debt obligations
—
—
—
—
—
Capital
(finance) lease obligations
—
—
—
—
—
Operating
lease obligations
A$28,875
A$18,964
A$9,911
—
—
Purchase
obligations
(1)
A$125,000
A$50,000
A$75,000
—
—
Total
A$153,875
A$68,964
A$84,911
—
—
(1)
This
obligation relates to the collaborative genetic research agreement with James
Cook University.
ITEM
6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES
A.
Directors
and Senior Management
The
following sets forth the names of the members of the Company’s Board of
Directors and its senior management. Generally, each member of the Board of
Directors (except the Managing Director) serves for a three-year term. Such
term
may be shortened, in certain instances, in accordance with the Company’s
Constitution and the ACSL. The term of office of a certain number of Directors
expires each year; consequently, the number of Directors who stand for
re-election each year may vary. The Company’s executive officers are appointed
by, and serve at the pleasure of, the Board.
36
GEORGE
ROBERT WARWICK SNOW, Bachelor in Economics, Fellow of the Australian Institute
of Company Directors (60 years old)
.
Mr.
Snow has served as a director since October 28, 1997 and was appointed Chairman
of the Board of Directors on July 28, 2004 and was last re-elected as a director
on May 30, 2006. Mr. Snow is a graduate in Economics from the Australian
National University and has had 29 years experience in finance, property
development, real estate management and equity finance. Mr. Snow is the managing
director of the Sydney-based Dampier Investment Group Pty Limited, an equity
financier involved in strategic company management and which is a substantial
shareholder in the company.
STEPHEN
JOHN ARROW (45 years old).
Mr.
Arrow
has served as a director since June 29, 1999 and was last re-elected as a
director May 5, 2005. Mr. Arrow has 25 years experience in the pearling industry
in Western Australia and the Northern Territory and is managing director and
owner of Arrow Pearl Co Pty Ltd. He has extensive pearling experience from
many
regions in the world as well as contacts in the industry.
IAN
McKENZIE MURCHISON Bachelor in Commerce, Fellow of Chartered Accountants,
Diploma of Nautical Science (55 years old).
Mr.
Murchison was appointed a director on July 28, 2004 and last re-elected as
a
director May 5, 2005. Mr. Murchison has had over 26 years experience in finance
and investment, and has been a director of both listed and unlisted companies
in
Australia and overseas. He was an investment director and founding partner
of
the Western Australia based private equity investment fund, Foundation Capital,
and was founding partner of the national chartered accounting firm of
Southertons. He has been a certified charter accountant for over 30
years.
STEPHEN
PAUL BIRKBECK (46 years old).
Mr.
Birkbeck was appointed as a director on April 15, 2005 and was re-elected as
a
director on May 30, 2006. Mr Birkbeck is the founder and former CEO of Mt
Romance Australia Pty Ltd, an Australian company, which is one of the world’s
largest producers of sandalwood oil. Mr Birkbeck has extensive experience in
the
marketing of luxury goods in overseas markets, especially Europe.
JOSEPH
JAMES UEL TAYLOR, B.Sc. (Biology), Ph.D. (39 years old)
.
Dr.
Taylor has served as a director since September 13, 2000. He was appointed
to
the role of Managing Director effective September 1, 2001. Dr. Taylor is a
marine biologist and aquaculturist whose Ph.D. research specialized in the
husbandry of
Pinctada-maxima
pearl
oysters. Since 1989, Dr. Taylor has been involved in the management of
aquaculture operations, mainly associated with South Sea pearl farming. He
has
acquired extensive knowledge about the biology of pearl oysters and has
presented many research papers on this subject. Dr. Taylor commenced employment
with the Company in 1996 and has overseen the development of the project to
its
current level of production.
From
1996
to 2000, Dr. Taylor held the position of Project Manager with the
Company.
Prior
to
this, he spent 3 years working for PT Mutiara Cemerlang, which is an Indonesian
pearl company. The constitution of the Company does not require the Managing
Director to retire by rotation.
37
SIMON
CHARLES BUNBURY ADAMS, B.Bus, M.Acc, ACIS (40 years old).
Mr.
Adams was appointed as the Chief Financial Officer on January 2, 2000 and
Company’s Secretary on February 1, 2001. He has more than 10 years experience in
corporate management in the industries of pearling, mining and engineering.
He
has been employed with the Company since January 2000
.
Prior
to
joining the Company, Mr. Adams worked for 2 1/2 years as the chief accountant
of
Advanced Energy Systems, Ltd, an engineering firm, which specialised in
renewable energy systems, and for 5 years before that Mr. Adams worked for
Transcontinental Resources Group, an organization that had several real estate
and mining interests.
JAN
SEIR JORGENSEN (40 years old).
Mr.
Jorgensen has been involved in the pearling industry for more than 15 years.
He
has worked on pearl farms in Australia and Indonesia where he has held senior
management positions. Mr. Jorgensen has worked for the Company since 1994 with
the exception of 2 years in 2003 and 2004 when he worked for an Australian
pearling company. He is currently responsible for the Company’s pearl production
in Indonesia.
JENS
KNAUER, B.Sc (Biochemistry), M.Sc., Ph.D. (40 years old).
Dr
Knauer has extensive biological experience within a number of marine species.
Dr
Knauer's PhD studies involved work with tropical fish species. He has also
filed
teaching roles on the area of marine biology, specifically with Giant Clams.
His
extensive research and technical training, combined with a high level of
practical knowledge, has contributed significantly to the company's ongoing
research programs. He has worked for the company since 1999 in various
managerial positions and is currently responsible for research and development
and for juvenile oyster production in Bali.
There
are
no arrangements or understandings with major shareholders, customers, suppliers
or others by which any director or member of senior management was appointed
to
his position. There are no family relationships between any directors or
executive officers and any other directors or executive officers.
B.
Compensation
The
total
remuneration paid to each of the Company’s directors and senior managers for
services in all capacities during 2005 is set forth below:
R
ESPONSIBILITIES
D
IRECTORS
F
EES
A$
O
THER
A$
S
UPER
-A
NNUATION
A$
T
OTAL
A$
G.R.W.
Snow
Chairman
60,000
—
5,400
65,400
S.J.
Arrow
Non-Executive
Director
30,000
—
2,700
32,700
I.M.
Murchison
Non-Executive
Director
36,000
3,240
39,240
S.P.
Birkbeck
(1)
Non-Executive
Director
21,250
—
1,913
23,163
J.J.U.
Taylor
Managing
Director
—
253,557
4,075
257,632
S.C.B.
Adams
Chief
Financial Officer
—
110,000
9,900
119,900
J.S.
Jorgensen
Pearl
Production Manager
—
183,775
—
183,775
J.
Knauer
Technical
Manager
—
129,837
—
129,837
(1)
Appointed
a director of the Company on April 15, 2005.
38
There
are
no agreements between the Company and any director or senior manager which
provide for benefits upon termination or retirement.
The
Company makes compulsory superannuation contributions (retirement benefit
contributions) based on a percentage of salary for its Australian directors,
employees and executive officers. These plans are Australian-mandated retirement
plans.
39
C.
Board
Practices
Name
Position
with the Company
Term
Expires
George
Robert Warwick Snow
(3)
Chairman
of the Board since July 28, 2004 and a Director since October 28,
1997.
2009
Stephen
John Arrow
(3)
Director
since June 29, 1999.
2008
Ian
McKenzie Murchison
(3)
Director
since July 28, 2004.
2007
Stephen
Paul Birkbeck
(3)
Director
since April 15, 2005.
2009
Joseph
James Taylor
Managing
Director since August 31, 2001 and a Director since September 13,
2000.
(1)
Simon
Charles Bunbury Adams
Chief
Financial Officer since January 2, 2000 and Secretary since February
1,
2001.
(2)
Jan
Seir Jorgensen
Project
Manager since October 2002 and Pearl Production Manager since February
2006.
(2)
Jens
Knauer
Technical
Manager since March, 2005.
(2)
(1)
The
Constitution of the Company stipulates that the Managing Director
does not
have to retire and be re-appointed. Mr. Taylor’s employment contract has a
term of three years and expires on December 31, 2007, unless extended
by
the mutual agreement of the
parties.
(2)
These
are executive positions within the Company which have no fixed term
of
employment.
(3)
Members
of the audit committee.
There
are
no agreements between the Company and any director which provide for benefits
upon termination or retirement.
The
audit
committee is made up of the four (4) non-executive Directors, and the chair
of
the audit committee is Mr. Murchison. The role of the committee is to advise
on
the establishment and maintenance of a framework of internal control in relation
to the financial reporting of the Company’s business activities. The activities
of the committee ensure that the financial information prepared for use by
the
Board in determining policies or for inclusion in the Company’s financial
reports is of the highest quality and is as reliable as possible. The committee,
from time to time, requests the external auditor and the Company’s Chief
Financial Officer to provide information at its meetings.
The
Company does not have a compensation committee. Remuneration of executives
is
set by the Board and when the issue of compensation for the Managing Director
is
discussed, the Managing Director abstains from the meeting and is not present
during such discussions. Compensation for the Directors is set in line with
current industry standards.
40
D.
Employees
The
table
below sets forth the number of employees of the Company at the end of the
indicated year
by
general category of job position.
Number
of Employees
2005
2004
2003
Australia
-
management, administration and support
4
4
5
Indonesia
-
Expatriates
- management and technical support
8
7
7
Indonesian
locals
463
432
339
Administration
21
14
11
Hatchery
4
5
4
Farm
and Growout
202
250
206
Operations
and Harvests
19
14
10
Logistics
55
59
42
Electrical
and Building
97
23
18
Mechanical
and engineering
20
20
16
Security
and Community Relations
45
47
32
The
Company continued to promote Indonesian staff into senior positions during
2005.
With the development of
additional
operations
in Bali
,
several
key national staff and experienced expatriate managers have been relocated
to
these
projects, and these relocations have created opportunities for the more
experienced Indonesian staff to take on senior positions at Alyui
Bay.
The
number of employees has increased as a result of the Company’s additional
operations in Bali and Lombok.
The
employees are not represented by unions and union membership is not compulsory
in Indonesia.
E.
Share
Ownership
The
following table sets forth the number of ordinary shares of common stock and
the
percentage of total ordinary shares outstanding beneficially owned by each
of
the Company’s directors and senior management as of June 30, 2006.
Name
No.
of Shares
Beneficially
Owned
Percentage
of Shares Outstanding
George
Robert Warwick Snow
(1)
14,384,556
15.88
%
Stephen
John Arrow
1,952,934
2.16
%
Stephen
Paul Birkbeck
790,000
0.87
%
Ian
McKenzie Murchison
650,000
0.72
%
Joseph
James Uel Taylor
1,020,000
1.10
%
Simon
Charles Bunbury Adams
400,000
0.44
%
Jan
Seir Jorgensen
650,000
0.72
%
Jens
Knauer
650,000
0.72
%
(1)
Based
on Shares outstanding as of June 30, 2006.
41
There
are
currently no outstanding options to purchase Shares of the Company. In May
2006,
the shareholders approved an Employee Share Plan which allows for the allocation
of up to 4,000,000 new shares to senior employees.Of these shares, 2.8
million were issued upon the shareholders’ approval of the plan
at the Company's Annual General Meeting in May 2006. The employees who are
entitled to these shares are provided with an interest free non-recourse
loan to
purchase the shares. Half of the shares vest to the employee after two
years of employment after issuance and the remaining 50% vest to the employee
after three years of employment after issuance.
ITEM
7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS
A.
Major
Shareholders
The
following table sets out certain information with respect to each person or
group of affiliated persons who is currently known to the Company to be the
beneficial owner of 5% or more of the Shares of the Company.
Title
of Class
Identity
of Person
or
Group
Amount
Owned
Percentage
of
Class
(1)
Ordinary
Shares
Dampier
Investment Group.
(2)
14,384,556
15.88
%
(1)
Based
on Shares outstanding as of June 30, 2006.
(2)
Includes
Dampier Investments Pty Ltd and Tempest Pty Ltd. Mr. George Snow
is the
beneficial owner of the shares held by the Dampier Investment
Group.
All
Shares owned by Dampier Investment Group have the same voting rights as the
Company’s other Shares.
To
the
best of the Company’s knowledge, it is not owned or controlled, directly or
indirectly, by another corporation or by any foreign government.
To
the
best of the Company’s knowledge, there are no agreements in place which could
result in a change of control of the Company.
As
of May
31 2006, 2,207,300 Shares, or 2.5%, were held on record by 205 persons with
U.S.
addresses. In addition, 20 persons with U.S. addresses were record holders
of
3,962,820 ADSs as of May 31, 2006. Accordingly, the Company has a minimum of
225
U.S. record holders, who own at least 6,170,120 Shares, or 6.81%, of the
Company’s Ordinary Shares.
B.
Related
Party Transactions
In
March
1999, the Company entered into a consulting agreement with Arrow Pearl Co Pty
Ltd (“Arrow”), a company owned by Mr. Arrow and for which he serves as managing
director. Mr. Arrow is a director of the Company. Pursuant to this agreement,
staff of the Company are trained as pearl operation technicians at the
Indonesian pearl farm. The Company paid Arrow A$150,820, A$189,030 and A$177,566
during the years 2005, 2004, and 2003 respectively, under the terms of the
agreement. We believe the terms of the consulting agreement are at or below
market rate. The agreement expires in 2009.
42
During
the year, sales of individual pearls of small quantities were made to some
staff
and Directors on normal commercial terms.
The
Company purchases pearls to the value of A$4,342,019 from its wholly owned
controlled entity Cendana. These transactions are in the normal course of
business. There are loans and receivables in place between the Company and
its
subsidiaries.
C.
Interest
of Experts and Counsel
Not
required.
ITEM
8. FINANCIAL INFORMATION
A.
Consolidated
Statements and Other Financial Information
Please
see Item 17. for a list of the financial statements filed as part of this Annual
Report.
Legal
Proceedings
The
Company is not a party to any material legal proceedings, and was not a party
to
any material legal proceedings during 2005.
Dividend
Policy
The
Company paid a dividend of one (1) cent per share (A$878,103 in total) in 2005.
The Company did not pay any dividends during 2004. The Company paid one dividend
in April 2003 amounting to A$878,103. In deciding whether to declare a dividend,
the Company compares the amount of its profits to its anticipated cash needs
for
ongoing working capital, taxes and anticipated capital expenditures, and
evaluates these factors in view of global environmental, political and market
uncertainties. A dividend of 1.50 cent per share (A$1,359,154) was declared
by
the Company on May 30, 2006. The Board of Directors has not stated whether
any
further dividends will be paid in 2006.
B.
Significant
Changes
There
have been no significant subsequent events following the close of 2005 up to
the
date of this Annual Report that are known to us and which require disclosure
in
this Annual Report.
43
ITEM
9. THE OFFER AND LISTING
Trading
Market for American Depositary Receipts (ADRs)
The
Shares trade in the United States in the form of ADRs issued by the Bank of
New
York. Each ADR represents a specified number of ADSs, which each evidence
ownership of 20 Shares of the Company. On May 31, 1995, the Company’s ADRs began
trading on the over-the-counter bulletin board service of the National
Association of Securities Dealers under the symbol APCFY. On September 12,
1996,
the Company’s ADRs were listed and began trading on the SmallCap Market of the
National Association of Securities Dealers, Inc. under the symbol APCFY. On
December 1, 2004, the Company announced its intention to voluntarily delist
its
ADRs from the Nasdaq Small Cap Market. Such delisting has not yet been
finalized.
The
quotations set forth below represent the high and low closing prices of the
Company’s ADRs for the periods specified and, are inter-dealer quotations,
without retail mark-ups, mark-downs or commissions, do not necessarily represent
actual transactions, and may reflect only fluctuations in exchange rates between
the US Dollar and Australian Dollar:
For
the Year Ended:
High
Closing Price
Low
Closing Price
(US$)
(US$)
2001
$
4.09
$
2.00
2002
5.55
3.60
2003
4.91
2.65
2004
4.19
2.21
2005
4.05
2.25
For
the Quarter Ended:
High
Closing Price
Low
Closing Price
(US$)
(US$)
2004
March
31
$
4.19
$
2.88
June
30
3.35
2.21
September
30
2.85
2.23
December
31
2.79
2.31
2005
March
31
$
3.80
$
2.25
June
30
3.39
2.80
September
30
3.75
2.92
December
31
4.05
3.15
44
For
the
Month
Ended:
High
Closing Price
Low
Closing Price
(US$)
(US$)
December
31, 2005
$
4.05
$
3.15
January
31, 2006
4.80
3.90
February
28, 2006
6.09
4.20
March
31, 2006
5.42
4.23
April
30, 2006
4.88
4.32
May
31, 2006
4.86
4.20
Trading
Market for the Shares
The
principal non-United States trading market for the Shares is the Australian
Stock Exchange. The Company cannot practicably determine what percentage of
its
Shares traded on the Australian Stock Exchange are held by U.S. persons. The
quotations set forth below represent the high and low closing sales prices
of
the Company’s Shares during the periods indicated:
For
the Year Ended:
High
Closing Sale Price
Low
Closing Sale Price
(A$
)
(A$
)
2001
$
0.42
$
0.18
2002
0.52
0.35
2003
0.40
0.20
2004
0.27
0.15
2005
0.27
0.17
For
the Quarter Ended:
High
Closing Sale Price
Low
Closing Sale Price
(A$
)
(A$
)
2004
March
31
$
0.27
$
0.20
June
30
0.22
0.15
September
30
0.19
0.16
December
31
0.18
0.16
2005
March
31
$
0.24
$
0.17
June
30
0.23
0.20
September
30
0.25
0.20
December
31
0.27
0.22
For
the Months Ended:
High
Closing Sale Price
Low
Closing Sale Price
(A$
)
(A$
)
December
31, 2005
$
0.27
$
0.23
January
31, 2006
0.31
0.26
February
28, 2006
0.36
0.31
March
31, 2006
0.36
0.31
April
30, 2006
0.34
0.30
May
31, 2006
0.34
0.29
45
ITEM
10. ADDITIONAL INFORMATION
A.
Share
Capital
Not
required.
B.
Memorandum
and Articles of Association
A
description of the Company’s Constitution is contained in Item 10B of its Annual
Report on Form 20-F for the fiscal year ended December 31, 2001 (Registration
No. 000-28186), which was filed with the Commission on July 18, 2002. Item
10B
of the Company’s 2001 Annual Report is incorporated by reference
herein.
C.
Material
Contracts
Office
Rental Agreement Denpasar Bali
In
June
2003, Cendana entered into a rental agreement with Nyoman Ardana for the use
of
an office building of approximately 225 square meters located at Jalan Sekar
Jepun V Nomor 21 Gatot Subroto Timur - Denpasar 80237 Bali, Indonesia. This
rental agreement is for a term of three years and four months. The annual rental
is equivalent to A$15,600 per annum and is paid in advance for the full term
of
the lease.
Production
and Grow-out site, Penyabangan, North Bali
In
December 2003, the Company obtained approval from the Indonesian authorities
and
the local village for the establishment of a water lease near the coastal
village of Penyabangan in Northern Bali. The Company secured this lease to
ensure its access to juvenile oyster production facilities in the area when
the
arrangement at Banyupoh ceases in 2005.
In
March
2004, another lease was granted by the local village for the exclusive use
of a
parcel of land adjacent to the ocean lease that was secured in December 2003.
Development
of this facility included a low cost hatchery center, which was completed in
2004. The Company intends to develop the site to support its future boat
building and other manufacturing/support activities for the more remote
locations elsewhere in Indonesia. The agreements are for a term of 30-years
in
relation to 0.2 hectares of land and one hectare of ocean, with payments of
approximately A$15,000 paid up front and A$200 payable per month for the term
of
the lease.
The
Bacan Joint Production Agreement
In
March
2004, the Company entered into a joint production agreement with Cahaya
Cemerlang to access the leases and facilities located around Bacan Island in
the
province of North Maluku, Indonesia. In return for the use of the facilities
and
leases the Company funded and provided the technical input for the production
of
juvenile oysters. Oysters that were produced at this site were divided
equally after the age of 6 months. Any oysters that were not removed from
the site before 12 months were divided in the ratio of 70% to Cendana and
30% to Cahaya Cemerlang. The arrangement had a 5 year term and an option to
extend if both parties agreed at the end of the arrangement. Cemerlang and
the
Company terminated the joint arrangement at the end of November
2005.
46
Pearl
Distribution Agreement between the Company and Pearlautore International Pty
Ltd
The
Company appointed Pearlautore International Pty Ltd as its exclusive valuer
and
distributor of South Sea pearls on January 1, 2000. This agreement was renewed
in January 2004 on substantially the same terms for a period of two years,
as
neither party exercised its option to terminate the agreement. In 2005, this
agreement was renegotiated again for a further period of two years. Pearlautore
International Pty Ltd receives a commission of between 7.5% and 25% for
cleaning, grading, valuing and selling the Company’s pearls.
Employment
Agreement between the Company and Dr. Joseph James Uel
Taylor
The
Company and Dr. Taylor entered into an employment agreement effective September
1, 2001 and renewed it effective on January 1, 2004, pursuant to which Dr.
Taylor serves as the Company’s Managing Director. The Agreement provides for the
payment of approximately A$250,000 in salary per year. The agreement may be
terminated by either party upon four months’ notice. Dr. Taylor now resides in
Indonesia and as such, part of his salary is paid by Cendana, and the balance
is
paid by Atlas South Sea Pearl Limited. The contract is bifurcated to reflect
the
payments from the different entities within the group.
Director’s
Access, Insurance and Indemnity Deed between the Company and each Director
On
May
29, 2003, the Company entered into a contract with each of its directors whereby
the Company indemnifies each director against all liabilities to another person
(other than the Company or a related body corporate) that may arise from his
position as a director, except where the liability arises out of conduct which
involves negligence, default, breach of duty or a lack of good faith. The
agreement states that the Company will pay the full amount of any such
liabilities, including advancing amounts the director to pay for the costs
and
expenses of defending any such action.
Lease
Agreement between the Company and Mr. David Morrison
In
June
2004, the Company entered into a lease agreement with Mr. David Morrison for
office space at 43 York Street, Subiaco, Western Australia. The lease
arrangement commenced on July 1, 2004 and is for a period of three (3) years.
The Company will pay an amount of A$18,000 per annum in equally monthly
installments for the term of the lease. The lease has an option which allows
the
arrangement to be extended for an additional three (3) years under similar
terms. The office space is approximately 275 square meters in area.
Collaborative
Research Agreement between the Company and James Cook University
In
June
2004, the Company entered into a Collaborative Research Agreement with the
James
Cook University of Townsville, Queensland Australia. The agreement has been
undertaken to investigate options for the genetic improvement of the silver/gold
lip oyster and to provide the Company with information on the genetics of its
oyster population. The Company has agreed to fund the research project. The
total amount of research funds for the research project under this agreement
is
A$50,000 per annum for 4 years.
47
Stand-by
Finance and Foreign Currency Dealing Agreement between the Company and
Australian and New Zealand Banking Group Ltd
In
October 2004, the Company entered into a Stand-by Finance and Foreign Currency
Dealing Agreement with Australian and New Zealand Banking Group Limited (the
“ANZ Facility”). The purpose of the ANZ Facility is to finance certain of the
Company’s exports. This facility has a limit of A$1,700,000. In addition,
A$300,000 has been negotiated to assist with working capital requirements.
The total of these two financing facilities is A$2,000,000 - See Note 25.3
of “Item 17. Financial Statements.” An additional credit facility with a limit
of A$1,500,000 is in place for the purpose of Foreign Currency Dealing which
enables the Company to enter into foreign currency contracts to hedge its
foreign exchange exposure. The total value of these facilities amounts to
A$3,500,000.
Pearl
Cultivation Farm Site, Nusa Lembongan Island, South
Bali
On
September 16, 2005, the Company entered into a water lease with local village
leaders, Nyoman Murta and Wayan Danglod on Nusa Lembongan Island in the south
of
Bali. This water lease comprises a water area of 157 hectares (388 acres).
There
is no associated land lease as there is an agreement with the Bali Hai Beach
Club for the Company to use its land for storage of equipment. There is no
fixed
term for the water lease. The Company paid approximately A$2,700 to the local
villagers and there are ongoing costs of A$180 per month paid to local villagers
for the continued use of the water leases. There was no development of this
facility in 2005. The Company will use the water lease to grow pearls. In the
same way as the Karang Asem farm is used, Nusa Lembongan will accommodate mature
oysters that are transferred from Penyabangan in North Bali. This site has
a
strong tidal flow and it is believed that it will be conducive to the production
of high quality pearls.
Pearling
based Tourism and Retail Agreement
On
March
24, 2006, the Company entered into an agreement with PT Bali Cruises Nusantara
to develop a pearling based tourism and retail venture within the grounds of
the
Bali Hai Beach Club “Hai Tide Huts” facility on Nusa Lembongan Island. Under the
terms of the agreement, the Company will develop a technical/operational
facility for seeding, harvesting and grading of pearl oysters and a visitor
center which will include interpretive material on pearl farming, a pearl
display, retail area for pearls, MOP jewelry and other associated products,
as
well as an audio visual theater. The term of this agreement is for five years
and because the Company is providing a unique tourist attraction to Bali Hai
Cruises, the Company does not have to pay any rent for the use of approximately
800 square meters of retail space.
Pearl
Cultivation Farm Site, Karang Asem, East Bali
On
May
23, 2005, the Company expanded its operations in Bali by opening a new farm
site
at Karang Asem on Bali’s east coast. The Company entered into water lease
comprising 235 hectares (580 acres) and a land lease for an additional 2,000
square meters with the local villagers who have ownership of the area. Under
the
lease, the Company paid the local villages approximately A$16,000 and will
pay
approximately A$200 per month for the use of the site until the expiration
of
the lease on May 22, 2035. The Company has constructed storage, accommodation
and oyster meat processing facilities at the site. Infrastructure costs for
the
first year were approximately A$200,000. The Company has established the
facilities at Karang Asem for the purpose of farming pearls. The Company intends
that oysters, which are seeded at Penyabangan in North Bali, will be shipped
to
the Karang Asem farm where conditions are more conducive for mature oyster
growth. This site has also been developed to allow the processing of live
oysters to extract the meat for sale as fresh or frozen produce. This site
is
located within one hour’s drive of the main city of Denpasar, which allows for
more efficient access to logistical support.
48
The
West Lombok Joint Production Agreement
The
Company began jointly operating with PT Autore Cultured Pearls a land and
sea based facility located in West Lombok, Nusa Tenggara Barat. The Company
and
its joint partner breed and rear pearl oysters at the facility. Under the terms
of an unexecuted joint operation agreement, the Company shares a land and sea
based facility, which is owned by the joint partner, at Malaka in the north
west
of Lombok. The term of the joint operation agreement is for one year and each
July will be extended for another year on mutually agreed upon terms. This
facility comprises of a small hatchery, generator facilities, storage and some
accommodation on land along with 125 hectares (309 acres) of ocean based farm.
The land and ocean facilities owned by the joint partner prior to the
commencement of the joint operation agreement will remain the property of the
joint partner. Under the terms of the agreement, Cendana contributes 50% of
the
costs of operating the facility and splits the cost of any capital items
purchased during the term of the arrangement equally with the joint
partner. In exchange, the joint partner and Cendana are entitled to an equal
share of all pearl oysters produced as this facility.
Executive
Share Plan Rules and Loan Scheme
On
May
30, 2006, the shareholders approved the Executive Share Plan Rules and Loan
Scheme, which permits a maximum of 4,000,000 new Shares of the Company to be
offered to the Company’s senior employees. The purpose of the plan is a means of
rewarding existing senior employees and providing them with an incentive to
remain with the Company for the long term as well as aligning the incentives
of
the senior employees selected to participate in the plan more closely with
the
shareholders. The initial duration of the plan is for three years, which may
be
extended by the Company at its general meeting for additional periods of up
to
three years each. Upon approval of the plan by the shareholders at the Company's
Annual Meeting in May 2006, 2,800,000 of these shares were issued at an issue
price of A$0.29 per share to Dr. Joseph Taylor, Mr. Jan Jorgensen, Mr. Jens
Knauer, Mr. Simon Adams, and Mr. Karl Pearce. The employees who are entitled
to
these shares are provided with an interest free non-recourse loan to purchase
the shares. Half of the shares vest to the employee after two years of
employment after issuance and the remaining 50% vest to the employee after
three
years of employment after issuance.
49
D.
Exchange
Controls and Other Limitations Affecting Security Holders
Australia
has largely abolished exchange controls on investment transactions. The
Australian Dollar is freely convertible into US Dollars. In addition, there
are
currently no specific rules or limitations regarding the export from Australia
of profits, dividends, capital, or similar funds belonging to foreign investors,
except that certain payments to non-residents must be reported to the Australian
Cash Transaction Reports Agency, which monitors such transactions.
The
Australian Foreign Acquisitions Act (the “Act”) sets forth limitations on the
rights of non-Australian residents to own or vote the ordinary shares of an
Australian company. The Act permits the Commonwealth Treasurer to examine
acquisitions and arrangements that could result in foreign persons controlling
an Australian business. The Commonwealth Treasurer may prohibit a proposed
takeover if it would lead to a change of control of a business where the
resultant control would be against the national interest. The Act contains
divestiture provisions to ensure it can be enforced, as well as stringent
monetary-penalty provisions for breaches and the making of false or misleading
statements.
The
Act
requires the prior approval of the Commonwealth Treasurer for certain classes
of
persons to enter into an agreement to acquire shares of an Australian company,
if, after the acquisition, such person or corporation would hold a substantial
interest in such corporation, as explained herein. The foregoing approval
requirement applies to the following classes of persons: (i) any natural person
not ordinarily resident in Australia, (ii) any corporation in which either
a
natural person not ordinarily resident in Australia or a foreign corporation
(as
defined in the Act) holds a substantial interest, and (iii) two or more such
persons or corporations which hold an aggregate substantial
interest.
A
person
holds a “substantial interest” in a corporation if the holder alone or together
with any associates (as defined in the Act) controls 15% or more of the voting
power in the corporation or holds 15% or more of the issued shares in that
corporation. Two or more persons hold an aggregate substantial interest in
a
corporation if they, together with any associates (as so defined), control
40%
or more of the voting power, or own 40% or more of the issued shares, in such
corporation.
The
Act
requires foreign persons or foreign-controlled entities to give 40 days’ notice
to the Commonwealth Treasurer of a proposal to acquire or increase (or offer
to
acquire or increase) a single interest of 15% or more of the ownership or voting
power of an Australian company. If two or more foreign persons or
foreign-controlled entities are acting together, the threshold is 40% in the
aggregate.
The
Constitution of the Company does not contain any additional limitations on
a
nonresident’s right to hold or vote the Company’s securities.
E.
Taxation
The
following discussion summarizes certain U.S. federal and Australian tax
consequences of the ownership of Shares (or ADRs representing them) by a person
(“U.S. Portfolio Stockholder”) that: (i) is a citizen or resident of the U.S., a
U.S. corporation or that otherwise will be subject to U.S. federal income tax
on
a net income basis in respect of the Shares or ADRs; (ii) is not a resident
of
Australia for Australian tax purposes; (iii) has not, within the preceding
5
years, beneficially owned 10% of the issued capital or voting stock in the
Company; and (iv) has not used the Shares or ADRs in carrying on a trade or
business, wholly or partly through a permanent establishment in
Australia.
50
The
statements regarding U.S. and Australian tax laws set forth herein are based
on
those laws as in force on the date of this document and are subject to changes
to those laws subsequent to the date of this document that may affect the tax
consequences described herein (some of which may have retroactive effect).
This
summary is not exhaustive of all possible tax considerations and investors
are
advised to satisfy themselves as to the overall tax consequences, including
specifically the consequences under U.S., state, local and other laws, of the
acquisition, ownership and disposition of Shares or ADRs by consulting their
own
tax advisors.
IRS
Circular 230 Disclosure: To ensure compliance with requirements imposed by
the
U.S. Internal Revenue Service, this is to advise you that the following summary
of U.S. federal tax consequences is not intended or written to be used, and
cannot be used, for the purpose of avoiding tax-related penalties.
Taxation
of Gains on Sale
A
U.S.
Portfolio Stockholder is not subject to Australian income tax on the sale of
its
Shares or ADRs in the Company.
Passive
Foreign Investment Company Status
The
following discussion of “passive foreign investment companies” (“PFICs”) is of
particular interest for U.S. Portfolio Stockholders in 2005 whose holding period
in their Shares or ADRs extends back to 1996.
A
foreign
corporation is classified as a passive foreign investment company (a “PFIC”) in
any year in which at least 75 percent of its gross income is passive income,
on
the average percentage of assets held during the taxable year that produce
passive income or that are held for the production of passive income is at
least
50 percent. Passive income includes interest income from cash holdings and
profits from the sale of marketable securities, even if derived from an active
business. During 1995 and 1996, substantially all of the Company’s gross income
was passive income derived from the sale of its investment securities and from
interest income. Therefore, the Company has determined that it was a PFIC during
1995 and 1996. However, the Company has not been a PFIC since 1996. While no
absolute assurance can be given, the Company believes that it most likely will
have a sufficiently high percentage of non-passive gross income (sales minus
cost of sales) derived from the sale of pearls, and sufficiently high percentage
of assets producing non-passive income, for 2005 and for the foreseeable period
thereafter, to avoid PFIC status in 2005 and for the foreseeable period
thereafter.
However,
under a special “once a PFIC - always a PFIC” rule contained in the Internal
Revenue Code, if a foreign corporation is a PFIC during any year in which a
U.S.
shareholder owned shares or ADRs in that foreign corporation, that U.S.
shareholder forever continues to be subject to the special adverse PFIC tax
regime with respect to those ADRs or Shares, even if the foreign corporation
is
no longer a PFIC, unless a special “purging election” has been made. Thus, a
U.S. Portfolio Stockholder who owned Shares or ADRs in 1996 will be subject
to
the special PFIC rules on gain from the sale of those Shares or ADRs, even
if
they are sold in 2005 or thereafter, and even if the Company is not a PFIC
during 2005 and thereafter, unless that U.S. Portfolio Stockholder has made
the
special “purging” election. By contrast, a U.S. Portfolio Stockholder whose
holding period in its Shares or ADRs began after 1996 will not be subject to
the
PFIC rules, if, as anticipated by the Company, the Company is no longer a PFIC
during 2005 and thereafter. In December, 2005, the Treasury issued final
Treasury Regulation 1.1298-3, which provides additional guidance with respect
to
the “once a PFIC - always a PFIC,” and expands upon the previously issued
regulations. These regulations permit U.S. Portfolio Stockholders to make deemed
dividend or deemed sale elections to purge a foreign corporation under certain
circumstances.
51
Under
the
PFIC rules applicable in 2005 and thereafter to a U.S. Portfolio Stockholder
who
owned Shares or ADRs in 1996 but does not make a “purging election,” that U.S.
Portfolio Stockholder who sells the Shares or ADRs at a gain, whether in 2005
or
thereafter, will be subject to a special additional tax. To compute this
additional tax, (i) the gain is allocated ratably over the U.S. Portfolio
Stockholder’s holding period for the ADRs or Shares, (ii) the amount allocated
to the current taxable year is taxed as ordinary income, and (iii) the amount
allocated to other taxable years is taxed at the highest applicable marginal
rate in effect for each year and an interest charge is imposed to recover the
deemed benefit from the deferred payment of the tax attributable to each year.
Such a U.S. Portfolio Stockholder will also be subject to a special additional
tax on certain excess distributions from the Company, will be denied a step-up
in tax basis on Shares and ADRs on the death of a U.S. individual shareholder,
and will be required to comply with burdensome annual reporting
requirements.
A
U.S.
Portfolio Stockholder in 2005 who owned Shares or ADRs in 1996 could have
avoided the “once a PFIC - always a PFIC” rule, and thus avoided the PFIC rules
for post-1996 years, by making a “purging election.” Additional information
concerning the “purging election” is found in Treasury Regulation 1.1297-3T,
which expands the number of elections available to U.S. Portfolio Stockholders.
In addition to the “qualified electing fund election” and the “mark-to-market
election,” each as described below, and the former purging elections, the
temporary regulations provide a purging election specifically for U.S. Portfolio
Stockholders subject to the so-called “controlled foreign corporation - passive
foreign investment company rule” (the “overlapping purging elections”), which
were not clearly addressed in prior regulations. Specifically, the new temporary
regulations permit a U.S. Portfolio Stockholder to make a deemed dividend or
deemed sale purging election if certain conditions are satisfied.
Another
election that in some cases can reduce the adverse impact of the PFIC rules
is
the “qualified electing fund election.” The qualified electing fund election
would require the U.S. Portfolio Stockholder to provide an analysis of the
Company’s earnings on a U.S. tax basis, and the Company will not provide this
analysis. Therefore, the Company expects that the “qualified electing fund”
election will not be available to its U.S. Portfolio Stockholders.
Another
election that in some cases is available to a U.S. shareholder of a PFIC is
the
“mark-to-market” election. Under this election, the excess of the fair market
value of the PFIC stock at the end of the tax year over its adjusted basis
(as
increased to reflect net previous inclusions of “mark-to-market” gains over
previous “mark-to-market” losses) is included as ordinary income in the current
year. Additional information concerning the “mark-to-market” election is
contained in Treasury Regulations 1.1296-1 and 1.1296-2. There are some
technical uncertainties as to the application of the “mark-to-market” rules for
Atlas shares in 2005, due to the fact that Treasury Regulation 1.1296-1 applies
to taxable years beginning on or after May 3, 2005, and due to some uncertainty
as to the circumstances in which NASDAQ-traded ADR’s of Australian Stock
Exchange - traded companies qualify under Treasury Regulation 1.1296-2 to be
subjects of the “mark-to-market” election.
52
The
foregoing is a general summary of the implications of the PFIC rules. Special
rules may apply to specific types of investors, such as dealers in securities.
The PFIC rules have been amended frequently, and future amendments are quite
possible. U.S. Portfolio Stockholders in 2005 whose holding period in its Shares
or ADRs extends back to 1996 should consult their own tax advisers as to the
potential application of the PFIC rules as well as the impact of any proposed
legislation that could affect them.
Taxation
of Dividends
In
IRS
Notices 2004-70, 2003-69, 2003-71, and 2003-79, the Internal Revenue Service
set
forth the criteria it would apply to determine if dividends paid by an
Australian or other foreign corporation, such as the Company, can qualify for
the reduced 2003-2008 individual U.S. tax rates (generally 15%) applicable
to
qualifying dividends. Under Notices 2003-69, 2003-71 and 2003-79, an Australian
corporation is a “qualified foreign corporation” whose dividends can qualify for
the reduced tax rate if the Australian corporation qualifies as a resident
of
Australia, and qualifies under the limitations of benefits clause, for the
benefits of the Australian - U.S. income tax treaty. An Australian corporation
can also qualify if the ADR on which the dividend is paid is readily tradable
on
NASDAQ or other established securities market in the U.S. Further, to pay
qualifying dividends, the Australian corporation must not be, for the taxable
year of the Australian corporation in which the dividend was paid, or the
preceding taxable year, a foreign personal holding company, a foreign investment
company, or a PFIC. Certain holding period requirements must also be met. With
respect to individuals whose holding period in the Company stock began after
the
Company’s 1996 PFIC year, the Company believes that its dividends can qualify
for the reduced post-2002 individual tax rates applicable to qualifying
dividends.
The
Company’s dividends to its U.S. Portfolio Stockholders would be exempt from
Australian dividend withholding tax to the extent such dividends are considered
to be “franked” for Australian tax purposes. A dividend is considered to be
“franked” to the extent that such dividend is paid out of the Company’s income
on which Australian corporate tax has been levied. Even if not “franked,” a
dividend will be exempt from Australian dividend withholding tax if it is paid
out of the Company’s non-Australian-source dividend income and the Company
specifies a “foreign dividend account declaration percentage” for such purpose.
The Company anticipates that when it pays dividends, such dividends would likely
be either “franked,” or paid from the Company’s non-Australian source dividend
income as specified in the foreign dividend account declaration percentage,
and
therefore would be exempt from Australian dividend withholding tax.
53
If,
however, dividends are paid by the Company that are not “franked,” nor paid from
the Company’s non-Australian source dividend income as specified in the foreign
dividend account declaration percentage, such dividend would then be subject
to
Australian dividend withholding tax. However, in accordance with the provisions
of the Australia/United States Income Tax Treaty, Australian withholding tax
on
dividend income derived by a U.S. shareholder would be limited to 15% of the
gross amount of the dividend. Subject to certain limitations, any Australian
dividend withholding tax may be claimed as a credit against the federal income
tax liability of the U.S. shareholder. The overall limitation on non-U.S. taxes
eligible for U.S. credit is calculated separately with respect to specific
classes, or “baskets” of income. For this purpose, dividends distributed by the
Company will generally constitute “passive income” or, in the case of certain
U.S. Portfolio Stockholders, “financial services income.” The U.S. tax credits
allowable with respect to each income basket cannot exceed the U.S. federal
income tax payable with respect to such income. The consequences of the separate
limitation calculation will depend on the nature and sources of each U.S.
Portfolio Stockholder’s income and the deductions allocable
thereto.
Distributions
on the Shares or ADRs will constitute dividends for U.S. federal income tax
purposes to the extent paid out of current or accumulated earnings and profits
of the Company, as determined for U.S. federal income tax purposes. If the
Company pays a dividend, such dividend would likely be paid in Australian
dollars. The amount of dividend income for a U.S. Portfolio Stockholder will
be
the US Dollar value of the dividend payment on the date of receipt, even if
the
dividend is not converted into US Dollars. Gain or loss, if any, realized on
a
sale or other disposition of Australian Dollars will be ordinary income or
loss
to the U.S. Portfolio Stockholder. Dividends paid by the Company will not be
eligible for the “inter-corporate dividends received” deduction allowed to U.S.
corporations.
As
mentioned above in connection with the PFIC discussion, an excess distribution
by the Company on a Share or ADR that was owned by the U.S. Portfolio
Stockholder recipient during 1996 or any subsequent year in which the Company
is
a PFIC may be subject to additional U.S. taxes. An excess distribution generally
includes any annual distribution in excess of 125 percent of the average
distributions received by the U.S. Portfolio Stockholder from the PFIC stock
during the three preceding taxable years.
Estate
and Gift Tax
Australia
does not impose any estate, inheritance or gift taxes. Therefore, no Australian
estate tax, inheritance tax or gift tax will be imposed on the death of, or
upon
a lifetime gift by, a U.S. Portfolio Stockholder.
F.
Dividends
and Paying Agents
Not
required.
G.
Statement
by Experts
Not
required.
54
H.
Documents
on Display
The
Company files annual and semi-annual reports and other information with the
SEC.
You may read and copy any report or document the Company files, including the
exhibits, at the SEC’s public reference room located at 450 Fifth Street, N.W.,
Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further
information on the public reference rooms. Such materials can also be obtained
on the SEC’s site on the internet at
http://www.sec.gov
.
The
Company will also provide without charge to each person, including any
beneficial owner, upon written or oral request of that person, a copy of any
and
all of the information that has been incorporated by reference in this Annual
Report. Please direct such requests to the Managing Director, Atlas South Sea
Pearl Limited, 43 York Street, Subiaco Western Australia 6008, telephone number
(61) (8) 9380-9444 or facsimile number (61) (8) 9380-9970.
I.
Subsidiary
Information
Not
required.
55
ITEM
11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Interest
Rate Risk
The
following table sets forth the types of instruments held by the Company that
are
subject to fluctuation in interest rates as of December 31, 2005 and the terms
of such instruments:
Fair
Value at
Dec.
31, 2005
Fair
Value at
Dec.
31, 2004
Terms
A$
A$
Cash
in hand and at bank
$
660,373
$
1,908,996
Current
account with interest receivable at 3.22% (2004 - 3.66%) and cash
on hand
Fixed
Term Deposit
815,107
1,300,000
Interest
receivable at 5.58% (2004 - 5.23%) maturing within one
month
$
1,475,480
$
3,186,833
The
carrying amount of trade accounts payable and trade accounts receivable
approximate their fair values. See “Item 17. Financial Statements - Note 33 -
Additional Financial Instruments Disclosure.”
The
Australian Dollar equivalents of unhedged amounts payable or receivable in
foreign currencies, calculated at year end exchange rates, are as
follows:
2005
2004
A$
A$
Amounts
receivable:
Indonesia
Rupiah
$
3,466
$
75,543
Japanese
Yen
126,261
537,846
US
Dollars
19,488
6,696
$
149,215
$
620,085
Amounts
Payable:
Indonesian
Rupiah
$
19,718
$
945,232
Commodity
Price Risk
The
Company is subject to the risk of price changes in the pearl market. The market
price of South Sea pearls is similarly determined at auctions held throughout
the year, although some pearls are now being sold at private events in
negotiated transactions. The prevailing market price is largely determined
by
the quality and the quantity of pearls available. This commodity price risk
is
not actively managed by the Company.
Foreign
Currency Exchange Rate Risk
The
Company’s functional currency is Australian Dollars although a portion of the
business is transacted in foreign currencies. The Company is exposed to foreign
currency fluctuations as a result of operations in Indonesia and receipt of
pearl sales proceeds predominantly in Japanese Yen.
56
The
Company operates pearl farms in Indonesia. As a result a significant proportion
of the Company’s ongoing operating expenses are incurred in Indonesian Rupiah.
Accordingly, the Company is exposed to the risk of adverse changes occurring
in
the Indonesian Rupiah/Australian Dollar exchange rate. The Company’s investment
in its Indonesian subsidiary is accounted for by the current accounting method
and foreign exchange translation gains and losses are taken in to the Company’s
current year’s financial statements. The Company does not hedge against this
investment.
Nearly
all pearl sales are denominated in Japanese Yen. The Company has entered into
foreign exchange contracts to hedge certain anticipated sale commitments
denominated in foreign currencies, particularly Japanese Yen. The terms of
these
commitments are not more than 24 months. See “Item 17. Financial Statements -
Note 33 to Financial Statements.”
The
net
foreign exchange gain/(loss) incurred, as a result of movements of both the
Japanese Yen and the Indonesian Rupiah against the Australian Dollar, in 2004
and 2005 was A$541,363 and A$(24,601) respectively.
The
Company’s policy is to enter into forward foreign exchange contracts to hedge up
to 70% and 40% of foreign currency sales expected within 12 and between 12
and
24 months, respectively. The amount of anticipated future sales is forecast
in
light of current conditions in foreign markets and experience in the pearling
industry.
The
following table sets forth the gross value in Australian Dollars to be received
under foreign currency contracts, the weighted average contracted exchange
rates
and the settlement periods of outstanding contracts for the Company (as of
December 31):
Weighted
average
exchange rate
Gross
Value
A$
2005
2004
2005
2004
Sell
Japanese Yen - Settlement Period
Not
later than one year
JPY84.60
JPY73.50
$
3,566,985
$
3,384,800
Buy
Indonesian Rupiah - Settlement Period
Not
later than one year
IDR7,623
—
$
1,600,000
—
57
These
forward exchange contracts are hedging anticipated sales that are due within
12
months. Any unrealized gains and losses on the hedging contracts, together
with
the costs of the contracts, will be recognized in the financial statements
at
the time the underlying transaction occurs.
The
gross
unrealized gains and losses as of December 31, 2005 and 2004 on hedges of
foreign currency sales anticipated to take place in the future are set forth
below
:
Gains
A$
Losses
A$
2005
2004
2005
2004
Expected
Sale Year
Not
later than one year
—
$
289,911
—
—
The
future income of the Company may be adversely affected by adverse movements
in
the Japanese Yen/Australian Dollar exchange rate.
ITEM
12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES
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