analysis of prelim final report

Before I begin, let me make a couple of points clear: I have no factual evidence that Anthony Dunlop or any NBS director has breached the corporations act or any listing rule. For all I know, Dunlop and NBS directors are outstanding corporate citizens, and NBSs accounts are perfectly in order. And for all I know, NBS is a company in great shape and has a very promising future.

However, as a market participant and observer, I am permitted to voice reasonable opinion about NBS, even if this is a negative opinion. Furthermore, I am permitted speculate about (what I take to be) oddities in NBS ASX releases in general and in these full year results in particular. This is all Im doing here. I should also add that, while I acknowledge some of my assumptions and/or conclusions may eventually prove to be mistaken, Im not saying anything that I know to be false.

Now to begin. To the untrained/non expert market observer, it looks like NBS may have recently breached listing rule 3.1 with regard to the following:

First, it seems to me that NBS didnt get any where near meeting its dec half forecast. The FY10 Dec half forecast was for a considerable improvement in earnings rate as we progress through FY10. The company also forecast a rebound in revenues in the second half. What we in fact got in the June half was a significant deterioration in both revenue and earnings. Specifically, revenue plunged from $1.92mill (including interest payments) in Dec half, to $510k (including interest payments) in the June half. Normalized earnings plunged from $3.7mill loss in the Dec half to a $6.8mill loss for the June half (= $10.5mill normalized loss for the full year). I would have thought that adherence to listing rule 3.1 would have compelled NBS to inform the market some months ago that their Dec half forecast was wrong, and that its normalized revenue and profit would actually deteriorate further in the June half.

Second, it seems from my reading of ASX releases that NBS failed to inform the market in a timely fashion that the China contract had been suspended. I.e., only yesterday have we learnt that no revenue was collected from the China contract. However, after the FY09 results and the FY10 Dec half results NBS gave every indication that the China contract would be generating significant revenue during FY10. I would have thought that the failure of the China contract to generate revenue is unambiguously a material event, and I would have thought that such an event should have been reported to the market soon after NBS learnt that it would occur (i.e., 3 or 4 months ago).

Funny business:
Buried in the notes of the preliminary final report, NBS announced that it has paid a whopping $35mill for the rights to the China Gas Tank project. NBS doesnt explain this deal. How are we to understand it? Joining a few dots, my guess is that the purchase in question is in fact for the rights to the China contract previously held by TPID (porn king James Mackays former company). Mackay seems to have sold his stake in TPID a couple of years ago to Anthony Dunlop (who I assume is a mate of Dykes) and it was probably through this connection that NBS got involved in the China contract in the first place. But it seems from TPIDs SEC filings that the Dunlop controlled TPID (as well as CITP) ran out of (or never had) the cash required to even start the China contract and also ran into (or always had) technical problems with their scanner. And these problems seem to have motivated the owners of TPID to transfer the rights to the China contract to a BVI company called Saddington (a company James Mackay is not involved in). As Ive speculated in previous posts, my guess is that Saddington was (at that time) backed in some form by another Dunlop controlled entity called TDA tech, which provided some additional technical expertise to try and get the problem-plagued gas tank scanners working. Im also guessing that setting up Saddington was a means of protecting whatever assets belonged to TPID and the China contract from (potentially litigious) US shareholders who had lost everything with the failure of TPID (and its predecessor called SureTrace (the original inventor of this highly problematic technology which Mackay and associates used to raise cash and fleece shareholders as per SEC releases). The trouble with Saddington is that it too had no cash, and, as a private BVI company had no means of raising cash. So I reckon a decision was made to shift Saddington assets into a new Dunlop controlled entity called UKI. In my opinion, UKI was set up with the sole purpose of attracting cash from gullible NBS shareholders. And, as we all know, NBS did indeed try to pay $15mil for a 16% stake in UKI. However, it seems as if major stakeholders were tipped off about the Dunlop TPID/CITP connection by an analyst with his eye on the ball, and these stakeholders subsequently blocked the deal (the failure of the SPP didnt help either).

But with the funds from the UKI deal blocked, there was probably no realistic way that Dunlop could get the China contract going. And if Dunlop was to lose access to the China contract, then Im guessing so too would NBS. (I.e., the contract, or at least the aspect of the contract that is genuine, would probably go to a new party).

(Incidentally, it seems to me that the reason why NBS were so confident in the Dec half forecast that revenue for the China contract would flow in the June half is that at that time they thought that the UKI deal would go through and that TPID/CITP would get its cash, and that would in turn trigger an event that would allow NBS to recognise some china revenue (Furthermore, perhaps some of the cash that NBS was going to pay UKI could also be recycled back onto NBSs books?? Who knows.).

In any event, with the UKI deal blocked, it would seem that NBS needed another way to give Dunlop his $15mill and get the china contract going. And if my guesswork here is broadly accurate, the solution these guys came up with is truly breathtaking. Without announcing anything to the market, subsequent to June 30 they quietly (and quickly) set up a new controlling entity for the China contract called Beijing Zhong Te Hong Xin Technology Development Co Ltd. The preliminary report says that NBS has a 70% stake in this joint venture company. My guess is that it is Dunlop and associated partners (i.e., the rump of TPID/UKI) that control the other 30%. (Remember that when the lapsed UKI deal was announced on April 5, NBS said it would continue to explore mutually beneficial opportunities to work together. I believe that this new JV is the outcome of this working together" with UKI). It also looks to me that NBS paid $34.5mill for this 70% stake. And this $34.5mill has come directly from operating cash flows from the China contract!! In other words, the money owed to NBS from its China counterparty (CITP-formally directed by Dunlop) has immediately been reinvested back into a new Dunlop-influenced joint venture.

So now it looks as if NBS are themselves 70% owners of the original TPID/sure trace technology (which has been recently modified by TDA tech and then housed in UKI). This is what I think Young means when he claims in the commentary that NBS itself will be manufacturing and installing the physical markers on the gas tanks. Manufacturing and testing of marker equipment is expected to commence in November with integration testing expected to follow. And with control over both TPID/CITP as well as the card printing part of the contract, Young can now claim that NBS has direct control over project scope, implementation rollout and long-term management.

One final oddity about the full year result: NBS payments to suppliers and employees (page 6) looks suspiciously high at $16.6mill. Given Malaysia and China were effectively on ice for FY10, which suppliers and which employees received the bulk of this cash??

So what does the future hold for NBS?
First, while NBS has made some very bullish statements regarding China and Malaysia (as I predicted they would in my last post), on the basis of NBSs short history as well as the longer history of TLE and ETC, it would take a very brave soul to take anything NBS now says at face value. The full year report + commentary, like all of NBSs reports/commentary, seems designed to do all it can to hide the truth without getting the auditor in trouble.

Second, while my gut tells me that at least some aspects of the China Gas Tank contract are probably genuine (I read a translated Chinese language report dated mid last year about a regional govt wanting to trial some new technologies in this area), the suretrace/TPID/TDA tech/UKI technology platform is evidently problem plagued. It is always possible that the technicians at TDA tech will fix these problems, but I wouldnt be holding my breath.

If NBS is going to generate any genuine revenue in the near term, my guess is that it will be from the Malaysian govt throwing them a bone.

Finally, in my opinion NBS needs cash urgently: Although the company claims $10.2mill in cash, I estimate that it in fact only has around $6mill at present. I say this because the $10.2 figure includes a $2mill payment to TrustDefender (held in escrow). And NBS should have made at least one further $2mill payment to TD since June 30. Add in generous directors fees, other operating costs, further $2mill TD payments every 3 months (plus 7.5% pa interest!!), and, unless NBS gets a near term cash injection from China or Malaysia, youd have to say that the company will run out of cash before the end of this calendar year (so the TD purchase is now looking shaky). I rate the chances of NBS getting a near term cash injection at no more than 50%.

On the basis of all of the above, no matter how low NBS share price falls, I maintain that it is a long term sell.