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Review and Discussion
of Financial Statements

speaking of numb3r5…

The Marlborough Lines Group recorded earnings after tax of $9.076m for the 2009 financial year. This is a 32.9% decrease over the net income recorded for the previous year, however it is greater than the targeted figure. This result predominantly reflects the reduced levels of non-taxable vested asset income (2009 $3.416m, 2008 $6.587m) received during the year.

Whilst there were increases in network charges across the Group, a Government sponsored campaign to reduce electricity consumption across New Zealand (as previously mentioned in this report) affected revenue growth. The Directors are satisfied with the results, given that the economy has been in ‘slow down' mode for the past nine months and also, that in Marlborough, the regionally significant wine industry is moving towards a more sustainable level of grape production to match processing capacity.

Earnings after tax for the Parent company fell by 31.5% also for the reasons outlined above.

In relation to the need to reach agreement with the Commerce Commission on network revenue streams (as reported last year) the Parent company Marlborough Lines and the OtagoNet Joint Venture are still required to resolve (with the Commission) price path breaches occurring in the 2009 year.

The imported content of maintenance and capital expenditure materials continues to grow at levels far in excess of inflation. The fall in relative value of the New Zealand dollar and fluctuating world prices for raw materials (fuel), have a significant effect on costs incurred at a local level. Currency hedging is undertaken by the Parent company for larger items sourced offshore, such as zone substation transformers.

All companies within the greater Group have been fortunate to retain staff in the face of strong offshore demand for qualified engineering and technical staff. However, there is an escalating cost component associated with the retention of good staff and all companies in the Group have faced increased costs that have offset any revenue gains.

Contracting operations in both the Marlborough and Otago regions experienced strong trading with good resulting profitability. Otago Power Services achieved a strong end of year result despite difficult trading conditions in the first part of the year. In recent years the Southland and Otago economies have experienced with dairying the kind of exponential growth the wine industry brought to Marlborough. The current economic downturn will affect both areas as the increase in activity is checked.

Dividend income flowing from Nelson Electricity to Marlborough Lines remained at $0.9m for the 2009 year. This reflects that company's continuing need to price its network services in line with current price restraint regulations.

This year again, the consolidation process within Marlborough Lines and its subsidiary, Southern Lines, uses equity accounting to bring through the appropriate share of undistributed associate income rather than the more conventional line-by-line consolidation.

The financial statements have been prepared in accordance with the New Zealand equivalents to the International Financial Reporting Standards (NZ IFRS). The use of equity accounting whilst technically correct, results in Group numbers which are only marginally different in a number of key areas from the Parent company accounts. That said, it must be stated that the Company has no choice but to observe the correct interpretations of the International Financial Reporting Standards.

Taxation due to Inland Revenue from the Parent company has in previous years been offset by the effects of accumulated tax losses from the OtagoNet Joint Venture. The joint venture is unincorporated and the tax liability (or benefit) transfers to the investing partners. The adoption of NZ IFRS (as noted in previous years) requires the creation of a substantial deferred tax liability equal to the tax effect of the difference between the accounting and tax values of the revalued infrastructure assets. In the first year of adoption, retrospective adjustment was also required. In the 2007 year this meant retrospective adjustments creating deferred tax liabilities of $40.733m and $44.524m for the Parent and Group respectively. These were effectively transfers from shareholder's equity to term liabilities; a move which, at least in conceptual terms, weakens the net asset position of the balance sheet. In the 2008 and 2009 years both Parent and Group have been required to make smaller transfers to deferred tax reflecting the emerging marginal difference in the two values (accounting and tax). As noted in the 2008 report the extent of deferred tax reduced with the drop in the company tax rate (this is a future tax liability) from 33% to 30% as at 31 March 2008.

Turnover for the Group has risen by $4.008m to $48.355m, mainly as a result of the increases in network charges in both main regions and the consequential uplift in revenue from the OtagoNet investment.

Interest costs for Parent and Group fell marginally as a result of lower net borrowings offset by higher interest rates at the beginning of the year. By year end the effective interest rate had fallen to 3.66% from the 8.67% recorded at 31 March 2008. Marginal rates for the Parent company peaked at 9.21% in April 2008. By 31 March 2009, there were signs that medium to longer term interest rates were approaching the bottom of the curve and management were analysing swap rates on a daily basis to lock in a hedged position for a portion of the debt going forward.

Interest cover for the Group at 8.64 times, was consistent with the 2008 level of 9.03 times.

The Parent company's level of tax expense for the 2008 year of $2.108m grew to $2.927m for the Group with the addition of Southern Lines' tax liability arising on income from the OtagoNet Joint Venture.

Interest is payable from Southern Lines to Marlborough Lines on term and shareholder debt provided by the Parent. With significant reductions in interest rates and increased revenue from the Otago investments, the transfers from Southern Lines to Marlborough Lines needed to be split this year into interest and loan replacements. Alternatively these funds could have been transferred as dividends (without imputation credits) shifting tax liability from Southern Lines to Marlborough Lines. In general terms, the tax liability accrues to the Group. In previous years, tax credits accumulated in Southern Lines from the higher tax depreciation uptake in the OtagoNet Joint Venture. These credits were used to offset tax liabilities arising in the Parent company. With revaluations in the joint venture, the accumulated tax credits are now steadily reducing.

Cash Flow - a business necessity

Group and Parent net cash flows from operating activities for 2009 increased by $3.12m and $1.42m respectively. This was again largely due to network charge increases in Marlborough and increased surplus distribution from OtagoNet. As noted previously, vesting income was reduced and there were checks to profitability through increased payments to suppliers and employees. Interest received fell by $614,000 in the Parent as $1.95m of revenue was diverted to loan repayments. Payments from investments in the OtagoNet Joint Venture and Otago Power Services have traditionally been received by Southern Lines and transferred to Marlborough Lines as interest on shareholder debt.

There was a significant increase in investment in inventories ($1.634m) as the Parent company gears up for the tower replacement project (see Case Study - Pole Design) but marginal change only in other working capital items.

Dividend receipts totalled $1.206m in the 2009 year, representing dividends from Nelson Electricity of $0.9m and dividends from Otago Power Services of $306,000. For the 2009 year Group operating cash flow of $13.698m was applied against the purchase of plant, property and equipment ($10.985m) and a net reduction of $2.250m in term borrowings.

Expenditure on plant, property and equipment (substantially network system assets) at a Group level of $10.985m, is a reduction over the previous year and is also well short of the target of $14.410m. Significant projects to upgrade zone (33/11kV) substations were delayed due to transformer supply delays and further sections of the tower to pole replacement project were delayed due to significant surface contamination on the outsides of the imported new octagonal steel poles. These works have been transferred into the 2010 capital expenditure budget which has a target total spend of $15.189m.

Capital expenditure projections are the same for the Group and Parent since the introduction of NZ IFRS because the joint venture assets are no longer proportionately consolidated as in the past. The joint venture result is equity accounted instead, and this affects investment values rather than the carrying values for plant, property and equipment.

As noted, Parent company (and Group) term debt was reduced by $2.25m to $21.100m. Dividends paid to the Marlborough Electric Power Trust remained at the same level as the previous year ($250,000).

Assets and Liabilities - what we own
and what we owe

Group and Parent total assets increased by 6.34% and 4.68% respectively, as a result of capital expenditure in excess of the respective depreciation charges and equity accounting additions to the values of the investments held (see ‘Accounting for Investments' in Review of Investments). A breakdown of capital expenditure requirements is provided in note 6 of the supplementary information provided on page 93 of the annual report.

The most recent asset management plan for the Marlborough Lines network completed in March/April 2009, indicates capital expenditure proceeding in the range of $10m to $13m in each of the next five years. The Company has a continuing network expansion programme running to ensure capacity is available for increased loads arising from the wine industry, a strong regional economy and the consequential population growth.

Total Group current assets increased from $8.909m to $9.543m at 31 March 2009, due predominantly to the increase in inventories previously noted.

Under NZ IFRS, goodwill is subject to an annual impairment review rather than automatic amortisation as under the previous financial reporting standards. Goodwill exists in the OtagoNet Joint Venture balance sheet and also as part of the Parent company investment in Nelson Electricity. For the year in review there is no diminution in goodwill values.

The Group and Parent debt to debt plus equity ratios improved to 9.45% (2008:10.78%) and 9.94% (2008: 11.24%) respectively as at 31 March 2009.

© Marlborough Lines 2009