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).
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
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.
|
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.
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.
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.
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.
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