a note of caution

From my perspective, the most troubling part of the full year results was the recognition of only $3.3mill in revenue from Malaysia, but a massive $43.7mill from China.

The reason why I find this troubling is that up until recently, NBS management were happy for analysts to believe that last FY NBS completed 3 print runs for Malaysia, with each print run apparently generating around $6-7mill in revenue. In addition, revenue was supposed to be booked for the transfer of the relevant software to run Nexcode. So if NBS had in fact done the work for Malaysia that it told analysts it was doing, the company should have booked FY09 revenue from Malaysia in the region of $20-25mill.

Malaysia is on a 30 day billing cycle, and NBS management announced to the market on April 1 that "printing had commenced" for the Malaysian contract (see page 9 of the April Business update). So that fact, which initiated a surge of buying in NBS at the time, led analysts to believe that NBS would fit around three monthly print runs in before June 30. Indeed, one analyst told me back in May that NBS management had informed him/her of this fact.

However, on page 10 of the full year results, under the heading "significant changes in states of affairs", there is NO mention of the start of Malaysian printing. The company only mentions the start of China printing. Did Malaysian printing in fact ever begin??

It is perhaps also significant that April (the month that Malaysian printing began) was also the month when the new Malaysian immigration minister took office (along with a new PM). It is perhaps also significant, that Sovereign Key, who were the original vendors of Nexbis, and who have close ties to the Malaysian govt, began selling their stake in May. Connecting the dots, did the new immigration minister suspend or postpone the Nexcode contract in late April early May? Did Sovereign Key find out about this? Does this explain why they started to sell out at that time? Did John Houston really resign for health and family reasons?

It is also significant I think, that NBS announced the start of printing for China on May 18 (in the full year results, they say printing for China began in April). In the company's May 18 ASX release, management says that "ETC expects to generate around AUD20mill" in revenue from China in FY09.

So, at that time (May 09), everyone, including NBS management, expected the full year revenue distribution to look roughly like this:
China: $20mill
Consulting: $20mill
Malaysia: $25mill

Instead, what we got last week was this:
China: $43.7mill
Consulting: $18.5mill
Malaysia: $3.3mill

What does this paltry Malaysia revenue represent? Half a print run?? The transfer of software only, but no printing?? However you slice it, it now looks like Malaysian contract was suspended or put on ice not long after NBS announced "the start of printing".

And with regard to China, this 5 year contract was supposed to start slowly, but generate around $50mill a year when running at full pace, but NBS management now say that the China contract booked $44mill (nearly a full years worth of revenue) in just 6 weeks (if you assume a May 18 start date) or in just 3 months (if you assume an April start date).

All of this raises the following question. In light of the apparent suspension of the Malaysian contract in April, and in order to meet their profit target, did NBS management then ask China to bring forward certain invoices so expected FY10 revenue could in fact be booked in FY09? In other words, was Chinese work brought forward so the revenue gap left by Malaysia could be filled? It certainly looks this way. In order to do $44mill worth of work in 6-12 weeks, NBS' China printers must have been working 24/7!

China is on a 90 day billing cycle, so the $44mill China owes from FY09 is now past due. The $3.3mill from Malaysia now looks to be impaired, and may be 120 days past due.

Having said all of the above, NBS management have not hinted at any trouble whatsoever in their official ASX releases. So, assuming NBS management are fulfilling their continuous disclosure obligations, investors should conclude that there is no material problem with either Malaysia or China – both contracts are running as per normal and payments are flowing. Indeed, investors should also be expecting three new contracts (which are simply awaiting a final signature) to be announced in the short term.

Furthermore, even if NBS management are in fact hiding certain material problems from the market (and I'm not saying categorically that they are, I'm only speculating and sounding a note of caution), it is still perfectly possible that NBS management will be able to turn things around before the Dec half results.

I rate NBS a highly speculative short term buy on the assumption that China cash will come in this half and new contract wins will soon be announced. But I caution investors that, despite the recent sell off, significant downside risk remains. For example, if the market came to believe that China cash was not forthcoming, NBS sp could easily crash to single digits.