Greentech Media

As LDK Solar faces allegations of inconsistencies in its silicon inventory, the company said it counts among its inventory materials that critics say are unusable.

In an invitation-only conference-call on Thursday, a recording of which was obtained by Greentech Media, LDK Chief Financial Officer Jack Lai said the company includes wire-saw slurry and so-called off-spec broken wafers in its silicon inventory.

But while he said wire-saw slurry - the sawdust produced when silicon is cut - is not booked in the inventory until it is processed into a usable form, Lai said that off-spec broken wafers - broken pieces of wafers that didn't meet performance specifications - are recorded as part of the inventory right away.

Analysts say these off-spec broken wafers can't yet be refined into usable silicon without great expense.

"When [wafers] are purchased, they will be booked as inventory and they will be processed to check the … receptivity and to prepare to be ready for production usage," Lai said.

Lai didn't say how much of the inventory is made up of off-spec broken wafers and the company didn't respond to calls asking for clarification by press time.

A Piper Jaffray report last week included allegations by Charley Situ, a former financial controller at LDK, of inconsistencies in the company's inventory of solar-grade silicon.

LDK said an internal investigation revealed no discrepancies (see LDK Says Inventory Discrepancy Allegations Have 'No Merit'). The company also told the Associated Press on Monday that an independent audit of the inventory would likely be published "in a matter of days."

Still, LDK's stock plummeted about 26.4 percent Monday to $37.50 per share. It traded as high as $69.39 per share Wednesday before the allegations came out.

Shareholders care about the company's silicon inventory because - with a worldwide shortage of solar-grade silicon - sales, margins and profits all directly relate to the amount of silicon a company is able to obtain and the price it must pay to get it.

LDK claims it pays less for silicon than some of its competitors because only 10 to 25 percent of its silicon is so-called "virgin" silicon, or the unused, high-grade silicon favored by most solar manufacturers. The company says it buys used silicon for less and recycles it, processing it into a usable form.

But the allegations raise questions about whether LDK's future margins will be as lucrative as expected.

During the conference call, Lai said he didn't know how Situ got his numbers and repeated that the inventory matches LDK's ledger.

"In my personal opinion, he has many, many misperceptions about the inventory," Lai said. "My understanding is that he does not understand the different grades of silicon material we have in the warehouse.

"And if you are not familiar yet, the LDK business model is to use mostly recyclable materials rather than virgin silicon. … I think he misunderstood the definition of polysilicon material in LDK."

Aside from the different types of silicon in LDK's warehouse, another potential misunderstanding by Situ might be related to silicon being transported to the warehouse, Lai said.

LDK books silicon in its inventory once it pays for the material, even though it isn't physically in the warehouse yet, Lai said.

He compared it to buying something from a department store and having left the store, but not having brought it home yet. Once the company assumes the title - and the liability - the silicon is LDK's property and can be included in the books appropriately, he said.

About one-fifth of the company's silicon is in transit, Lai said.

Do Off-Spec Wafers Count?

Analysts said the main question is whether LDK is justified in counting in its inventory silicon that it might not be able to use yet, but that it expects to be able to use one day.

Michael Rogol, managing director of Photon Consulting, said LDK - along with competitor ReneSola - have been particularly successful in removing impurities so far.

"This issue is complex because LDK is very good at using silicon that other companies often can't use," he said. "What one company would call waste silicon and write off, LDK is sometimes able to turn into solar wafers. … That makes it harder to account for the silicon."

But Paula Mints, principal solar analyst at Navigant Consulting, called the practice of including off-spec broken wafers "highly questionable."

She said it is "highly unlikely" off-spec broken wafers will be usable without undergoing a "very expensive purifying process that probably wouldn't be worth doing."

While Mints said she isn't familiar with inventory rules in China, she said it is typical for U.S. and European companies to write off any off-spec equipment, raw material or product right away.

Mark Cox, CEO of New Energy Fund, said it's clear the stock market doesn't believe the company is being disciplined enough in looking after its silicon.

The company should consider the amount of money it will cost to purify any lower-quality silicon and find a way to include that cost in its inventory accounting, he said.

Travis Bradford, president of the Prometheus Institute, which is a Greentech Media partner, said the real issue is whether LDK bought material it can't use.

"If so, they need to take the earnings hit and write down their inventory," he said. "The point is that they may have done that because they wanted to show they were more profitable than they were, or they might have done that because they believe the inventory is still usable."