MEMC's Accounting Gymnastics (NYSE: WFR)

NEW YORK - Two days after MEMC Electronics popularly known as Wafer announced profits of $11 million it also announced that it expected Wafer prices to decline 15 to 20% this year. The company reported some peculiar Non-GAAP projections for 2011. While the company expects GAAP earnings between 25 and 55 cents a share it expects Non GAAP earnings from $1.00 to $1.35 a share. The company announced that they expect $ 0.2 billion of revenue from direct sales and $0.4 billion of revenue from sales leasebacks which are not counted in GAAP revenue. They expect GAAP revenue of $2.8 billion.

We do not have a problem with including the non-GAAP direct direct sales of $0.2 billion for 2011 since the company is not recognizing revenue because of accounting requirements regarding real estate. This means the company is building solar equipment on the land and would normally estimate how much profit they estimate they will make when the job is completed but because they are considered to be making the land more valuable they have to follow real estate accounting. Which means they cannot estimate the profits they will make from the sale until the job is completed. This seems to be improper accounting practice.

The company also expects $0.4 billion of revenue from sales leasebacks. This is not inccluded in GAAP net income which we view as correct. A sales leaseback is when a company sells equipment it currently owns then leases it back. For simplicity lets say MEMC has equipment that is worth around $180 million but it sells it for $200 million but then leases it back forcing the company to pay $200 million of payments to the company that now leases them the equipment. The difference is an unrealized profit which MEMC is likely counting today for non GAAP purposes as profit instead of the GAAP procedure which holds it in an unrealized account . After the current year the unrealized profit lowers the depreciation expense of the company but no real profit is realized from the transaction.

If you bought a bagel for $1 and sold it for $1000 and then leased it back for $1000 you would have $999 of unrealized profit but it would be unacceptable to really think you made money over the whole ordeal. Sales leaseback give companies liquidity as the lessor will gladly make interest on your equipment and the lessee is happy to get the money up front which it can use for other purposes. So we have a problem with MEMC saying its non-GAAP earnings will be $1.00 to $1.35. We believe the company should focus on GAAP policies instead of distorting accounting truths. MEMC says it will recognize revenue on this because "the present value of the lease payments are less than the amount recorded as debt." but this makes little sense since unless they buyout the contract before its due, everyone knows the present value of a $1,000 bond on the day its due is $1,000.

To see the full MEMC report click here.