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OCZ Technology (NASDAQ:OCZ) recently provided an update to its business operations during the Needham Nov. 14, 2012, conference.

The conference theme was that OCZ was focusing on high-end SSD sales (while moving to enterprise SSDs), all the while seeking additional funding (covered below). The enterprise segment might be a tough nut to crack, as it is dominated by Fusion-io (NYSE:FIO) and populated by STEC (NASDAQ:STEC), IBM (NYSE:IBM), and Violin Memory among others. OCZ also announced during the call that its new SSD (called Vector, launched Nov. 13). Vector uses OCZ's in-house controller chip called "Barefoot 3." Using an in-house controller chip rather than a Sandforce or a Marvell chip will increase both gross margins and profits.

OCZ's strategy is logical. If OCZ can reduce costs while focusing on profitable high-end consumer sales via Vector, it may well buy enough time to evolve the company into an enterprise-focused, lean, mean fighting machine -- eventually even dropping consumer sales to focus primarily on enterprise and licensing out controller chips for SSDs. Long term, it will be impossible for OCZ to duke it out in the consumer segment as it will have to take on Micron (NASDAQ:MU) and Samsung, which produce NAND that goes into SSDs and that will always have a price advantage. Intel (NASDAQ:INTC) is also a major player in the SSD game and has deep enough pockets to hire employees as needed, and to engage OCZ in a price war for as long as need be.

Cutting Costs

OCZ recently cut costs via layoffs, but during the conference call, board-member-turned-CEO Ralph Schmitt cast light on additional cost-cutting measures. OCZ has closed down its research and development facility Indilinx in South Korea. According to OCZ, key people from Indilinx have moved to the United States. We can assume that the Indilinx brand and controller development will continue. OCZ also closed an office and distribution center in Canada in order to reduce expenses.

Key Points

  • Schmitt also noted the following:
  • ASP pressure is heavy and SSD's will continue to be commoditized.
  • In Q2, OCZ had record unit shipments.
  • OCZ reduced products in the value segment.
  • OCZ increased pricing on products while reducing discounts.
  • Redistribution of channel products.
  • Moved from a single source of NAND to multiple sources for some situations.
  • Most of the charges for Q2 will be taken in Q3.

He also said: "A big portion of inventory moved through channel at 'better pricing.' It was previously generated revenue due to a sell-through model." And that "production is down from three shifts six days a week to two shifts five days per week."

Assuming operations are up 23 hours per week for the three shifts, that comes out to 138 hours per week vs. 80 hours per week currently. This is a 42% reduction in production. Most likely this is going to affect the mid- to low-range primarily, but should also show up as reduced revenues in the future while increasing gross margins. The company has stated that it intends to focus on the high-end segment of the SSD market.

Capital Infusion

According to OCZ, at 16:46 minutes into the call it was said that "we have drained through a lot of cash" and "will need some level of capital infusion post Q3 earnings" and "we have been able to raise cash through selling inventory."

The real question is: Can OCZ get this needed infusion via the line of credit, or will it dilute shares via another secondary offering? Concerning the restatement of earnings, Schmitt stated that it is "very focused in a small customer and a small amount of time."

Conclusion

Most likely, OCZ is going to report its corrected Q2 earnings before Q3 earnings, which are due in late November. It would be very surprising to see the delayed Q2 earnings slip past Q3 earnings. OCZ (according to Schmitt) "has [until] about mid-December to get in compliance." If it does not get into compliance, it will be delisted. But the odds of this happening due to Q2 numbers slipping past December is very low.

A bigger threat would be the stock slipping under $1, at which point the company will get a warning of possible delistment if it does not get the stock over $1. Slipping under $1 would also bar the company from attempting a secondary offering. Remember, the CEO just told us that OCZ will have to seek additional funding. If the company were to offer 15 million shares, this would dilute shares by 22% (given the current float of 67.65 million shares). Secondary offerings almost always come at a discount to the current stock price. While not pleasant, discounting the current stock price by 2.5% gives us $1.20 a share, which would generate $18 million before underwriters' fees. This would give OCZ a buffer to absorb more losses while the transition to an enterprise-focused company occurs.

Another oddity is why OCZ has not put out a press release for the Vectors launch. It's possible the company is holding off on the news to use it as a counter to balance the delayed negative Q2 numbers.

While OCZ is making some progress, we still cannot recommend OCZ as anything but an extremely speculative stock. We would recommend watching it until the Q2 numbers are fully disclosed and baked into the stock price. Until then, it's just a roll of the dice and a gamble with lady luck.

Source: Will Dilution Wash Out OCZ Technology Shareholders?