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After it released its Q1 2013 earnings report on July 10th, OCZ Technology (NASDAQ:OCZ) dropped over 20% in a matter of days. Importantly, though, the stock did not hit a new 52 week low below $4.14, suggesting that maybe the worst was finally over for long suffering shareholders.

The leading provider of high-performance solid-state drives (SSDs) for computing devices and systems met on the revenue line and missed on the bottom line. So naturally the 20% selloff must've been justified with a earnings miss?

Earnings Miss

The company reported a $0.17 loss versus expectations of a $0.12 loss. The bigger than expected loss cemented all of the fears of the longs and encouraged the shorts to press further on the stock.

OCZ has now missed earnings estimates in three of the last four quarters and in fact reported losses where the market expected slight profits. It didn't, however, justify a 20% drop added on top of a substantial drop year to date.

It continues to chase a huge opportunity that has required ramped up spending. The large increase in bookings should've been enough to encourage investors.

Huge Bookings

More important than the bigger loss was the booking of $140M in orders or roughly $26M higher than the reported revenues. Note that revenues soared 54% in this tough economic environment even without the additional bookings.

An important note to understand with bookings for OCZ is that those are normally shipped within the quarter ordered, with a limited amount of product (around $1-2M) pushed into the next quarter. So why the lack of respect if bookings were off the chart? Investors clearly doubt the ability of this company to turn those bookings into record revenue in Q3.

Parts Shortage

The main culprit for the lack of respect this time was a power regulator shortage. It always seems to be something with this company.

This parts shortage contributed to the larger loss as the company ramped up spending on customer marketing in order to capture revenue from the hard disk drive (HDD) replacement cycle as NAND flash pricing dropped dramatically throughout the quarter. As this price drops, it makes the SSD products produced by OCZ much more price comparative to HDD.

The additional expenses without the corresponding revenue boost created the larger loss. Unfortunately, the company has a history of pumping up current expenses for promised revenue down the road.

Revenue Promises

Investors should be comforted that the company has not failed to deliver on these future revenue promises. For fiscal 2012, the company ended up delivering roughly $30M more than originally forecast on the high end.

The current forecasts for fiscal 2013 suggest a revenue ramp of $140M+ in Q2, $180M in Q3, and $225M in Q4. The company has forecast a roughly doubling of revenues from Q1 to Q4 with increasing margins and a relatively minor bump in operating expenses.

In fact, the numbers suggest a $30M operating profit for Q4, assuming the company can hold expenses down.

Highlights from the Earnings Report

Financial Results:

  • Net revenue in Q1'13 was a record $113.6 million, and increased 54% compared with net revenue of $73.8 million reported in Q1'12.
  • Q1'13 SSD revenue reached a record $106.5 million; an increase of 54% compared with Q1'12 SSD revenue of $69.1 million.
  • Gross margin in Q1'13 25.0% compared with 20.0% in Q1'12
  • Net loss for Q1'13 was $6.3 million or $0.09 loss per share compared with a net loss of $9.1 million or $0.20 loss per share in Q1'12.
  • Achieved Record Bookings in Q1'13.
  • Non-GAAP gross margin was 25.2% compared with 20.0% in Q1'12.
  • Non-GAAP net loss for Q1'13 was $11.5 million or $0.17 loss per share as compared with a non-GAAP net profit for Q1'12 of $0.5 million or $0.01 per share.

Business Outlook and Commentary:

  • OCZ expects net revenue for its second fiscal quarter ending August 31, 2012 (Q2'13), to be in the range of $130 to $140 million.
  • OCZ expects net revenue for its fiscal year ending February 28, 2013 (FY'13) to be in the range of $630 to $700 million. This represents a growth rate of approximately 80% at the midpoint; we expect, based on historical trends, revenue to be weighted to the second half of the year, with approximately 60% to 65% of revenue to occur in the second half of the year.
  • Non-GAAP gross margins are expected to increase in Q213 and to exit the year in excess of 30%, with typical sequential gross margin increases of 100 to 250 basis points per quarter throughout the fiscal year, subject to changes in product mix as the SSD landscape continues to evolve.
  • OCZ expects non-GAAP operating expenses for Q2'13, to be in the range of $38 to $41 million with expenses exiting the year at between $43 and $47 million per quarter, as OCZ continues to invest in its ongoing growth objectives.

Conference Call

Anybody seriously interested in this stock should listen to the conference call. A lot more information is contained in the call that doesn't make the press release. (This fact holds true for most companies.)

The most important news was that the company expects to win up to 4 or 5 sizable deals with Microsoft (NASDAQ:MSFT) with a couple already won as the sole source provider. The value of any deals is not even included in the revenue guidance for FY13, as the company is unsure whether the revenue will materially ship in Q4 '13 or Q1 '14.

The other main question answered on the call was why guidance wasn't raised for Q2 after $26M of bookings were pushed into the quarter. Management was clear that the product has already shipped and the only reason for not upping guidance was an unwillingness to push up full year guidance that already factors in huge growth. In essence, the CEO virtually agreed with an analyst that revenue should hit over $160M.

Management doesn't want to end up reporting 80% growth for the year and disappoint the market after pushing numbers up to 90%. Probably a prudent move by a management team always criticized for what doesn't happen even after smashing growth.

Competition

For now the sector is dominated by relatively young competitors. Fusion-io (NYSE:FIO) is the unquestioned market leader though OCZ has taken the market share lead. Private company Violin Memory gets high praise and STEC (NASDAQ:STEC) remains a viable competitor. See the review of the top SSD companies by StorageSearch.com.

Fusion-io will always remain a formidable competitor with backing by Steve Wozniak as the Chief Scientist and key customers in Facebook (NASDAQ:FB) and Apple (NASDAQ:AAPL).

STEC on the other hand could be facing a tough road with the CEO facing civil charges from the SEC for alleged insider trading.

The perplexing part of the industry is that analysts continue to forecast nearly $1 in earnings for OCZ next year while clearly not pushing the stock. Those earnings would quickly surpass that forecast for Fusion-io trading at $19. Also OCZ only has a market cap of $400M while private Violin Memory had a recent fund raise that priced the company at over $800M.

The disconnect on valuation with OCZ suggests that the company would be better off being private. Even StorageSearch.com suggested the company could sell the recently purchased Idillinx controller for over $600M, or nearly double the companies valuation prior to the jump the last two trading days.

As another point on relative valuation, Palo Alto Networks (NYSE:PANW) went public on Friday at a market cap of over $4B despite having a smaller revenue base and the same profitability issues as OCZ.

Buyout Rumor

OCZ surged 30% on Thursday and Friday due to ongoing rumors that Seagate (NASDAQ:STX) had made an offer to buy OCZ. Initially this had adjusted the analysis that OCZ lacks respect from the market. After some thought, it actually further highlights the respect issue.

Though analysts forecast 77% revenue growth this year, the stock recently traded at 0.5x sales. An absurdly low figure for a fast growing tech stock. As an example, STEC still trades at 1.7X this years revenue forecast even with the CEO facing insider trading charges and revenue plunging 35%.

Even with a buyout rumor stoked rally the stock still doesn't get a respectable valuation. Investors would do best to ignore the rumors and focus on the potential.

Conclusion

OCZ remains one of the most perplexing stocks in the market. The company is growing like a weed in one of the hottest sectors in tech. The company has been very aggressive in increasing research and development (grew 350% YoY) and marketing costs. These moves have left the company on the precipice of another major ramp in revenue.

The market is correct to question the ability of the company to keep costs down going forward. On a relative basis though, the market has now discounted it to the tune of the technology being virtually worthless. The stock should never trade at less than 1x last year sales not to mention at half this year's.

The incredibly ironic move by analysts after the Q1 2013 report has been to lower revenue estimates. Huh? The company flat out proclaimed orders overwhelmed available parts.

The Seagate buyout would make logical sense for the buyer, but at this point OCZ shareholders would not likely obtain a reasonable premium. Until the stock gets back to the recent secondary price of $9, the company just doesn't get enough respect to make any offer reasonable.

Disclaimer: Please consult your financial advisor before making any investment decisions.

Source: OCZ Technology Gets No Respect