Do Nu Skin Inventory Red Flags Spell Trouble Ahead?

  1. A company is mismanaging its inventory,
  2. A company may be required to reduce gross margins in future periods to sell slow moving products to normalize inventory levels,
  3. A company may be required to take a one-time material impairment charge against earnings in a future period to write-down to the cost of slow moving or obsolete inventory to its lower market value, or
  4. A company is possibly inflating inventory numbers to overstate income by either fabricating inventory numbers or by its failure to write-down inventory to market value.

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Note: In Q4 2013, Nu Skin reduced its revenues and selling expense going back at least three years to correct an accounting error in classifying certain rebates. According to the company, the reclassification had no effect on gross profit, operating income, net income or comprehensive income, the consolidated balance sheet or cash flow (2013 10-K report page 50). However, the error caused relatively small changes in previously reported revenues. For 2012 and 2013, I used the revised quarterly revenue numbers tucked inside page 68 of its 2013 10-K report. However, Nu Skin did not disclose the effect of the revenue correction on 2011's quarterly numbers. Therefore, I used 2011's quarterly revenue numbers as they were originally reported in filings with the S.E.C. to make comparisons against management's 2011 quarterly revenue guidance. The error had no effect on DSI calculations.

Huge surge in inventories during latest quarter

In the latest quarter ended March 31, 2014 (Q1 2014), Nu Skin's reported revenues exceeded its maximum revenue projection by $1.1 million. Its cost of goods sold increased by 18.6% over the previous year's first quarter (Q1 2013). However, its inventories mushroomed 175.5% to $410.7 million compared to $149.1 million in the same period of the previous year. It took Nu Skin 346.4 days to turn its inventory into sales in Q1 2014 compared to only 149.1 days in Q1 2013, an increase of 132.3% extra days to sell its products. In Q1 2014, DSI was over three times the level it was in Q1 2011.

Rising inventory levels don't square with management's explanation

In its Q1 2014 10-Q report, Nu Skin claimed that, "we built a large amount of inventory during the first quarter for planned product launches in 2014...." However, its disproportionate buildup in inventories does not square against its own historical numbers, guidance it gave to investors, and analysts' consensus projections. DSI has been progressively growing from 2011 levels. (Click on the image below to enlarge it.)

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