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

So while we reported gross margin for the quarter 76% without this $50 million inventory charge, gross margin would have been a solid 83.7% that's compared to 83.4% in the prior year.

Ritch Wood was quick to offer up pro forma numbers purporting that Nu Skin's gross profit margins would have been higher excluding the $50 million inventory impairment charge. However, he did not offer the flipside of those same pro forma numbers showing that gross inventory levels continued to grow larger excluding the same impairment charge. Without the impairment charge, inventories would have increased to a record $439.7 million in second quarter of 2014 compared to $410.7 million in the previous first quarter. More significantly, days-sales-in-inventory (DSI) would have grown 158% higher to a record 377 days in the second quarter of 2014 versus 146 days in the comparable second quarter of 2013.



Even if we take into account the $50 million inventory impairment, at the end of the second quarter of 2014 Nu Skin carried enough unimpaired inventories to fulfill 335 days of sales versus only 146 days in the comparable second quarter of 2013. Its days-sales-in-inventory was 129% higher in 2014 compared to 2013.

Note: Days-sales-in-inventory (DSI) excluding the effect of the inventory impairment is calculated as follows: [Ending inventory/ (cost of goods sold - impairment charge)] X 91 days. Cost of goods sold - impairment charge = cost of goods sold for unimpaired inventory. Ending inventory reported by Nu Skin is the same as the carrying value of unimpaired inventory.

Risk of reduced gross margins and another material inventory impairment charge

After inventory is impaired, it still physically exists until it is disposed of by the company. It is merely carried on a company's books at its market value. Initially, a company records its inventory at cost. When the value of inventory declines below cost, the company makes the following entries on its books: (1) increase cost of goods sold and (2) increase inventory reserve account. The inventory reserve account is a "contra-asset account" and it reduces the gross value of inventory reported on a company's balance sheet. The inventory value reported on a company's balance sheet is the net of its gross inventory (at cost) less its inventory reserve account (impairment).

In the second quarter 2014, 10-Q report page 14, Nu Skin disclosed "adjustments" to its inventory "carrying value" but did not make it clear whether the impaired inventory was still on hand for future sale (albeit to recover costs) or was actually discarded (trashed as unsaleable):

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