Nu Skin Inventory Red Flags Remain Even After $50 Million Impairment Charge

On July 22, 2014, I warned investors that Utah-based multi-level marketing company Nu Skin Enterprises' (NYSE: NUS) surging inventory levels might lead it "to recognize a material impairment charge against inventory in a future period." On August 4, 2014, in a follow-up blog post co-authored with Zac Prensky, we warned investors about a massive inventory pile up in Mainland China. On August 6, 2014, Nu Skin reported its second quarter 2014 financial results and recorded "a $50 million write-down of Mainland China inventory." However, even after the $50 million inventory impairment charge, the pile of remaining unimpaired inventory is equal to enough merchandise to fulfill 335 days of sales versus only 146 days of sales in the comparable second quarter of the previous year. Therefore, there is a high risk that Nu Skin may have to reduce gross margins to clear out excessive inventories and there remains a high risk that it may have to report another material inventory impairment charge.

Background

Days-Sales-in-Inventory (DSI) measures the number of days it takes for a company to turn its inventory into sales. DSI is computed as follows: (Ending inventory/Cost of goods sold during the period) X number of days in the period. If the DSI number grows over time it indicates that a company's inventory turnover is decreasing because it is taking longer periods of time for a company to turn its inventory into sales. A continuously growing DSI can indicate one or more of the following: inventory mismanagement, potential inventory impairment, OR an overstatement of inventories to inflate profits

Second quarter financial results

In the second quarter of 2014, Nu Skin reported $650.0 million of revenues compared to $671.3 million in the second quarter of 2013. Its revenues were $50 million below the $700 million of guidance it gave investors on May 6, 2014. During the second quarter earnings call, CFO Ritch N. Wood said:
 

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