OCZ Technology Group (OCZ) has had a rough ride over the last several months. Here's a timeline of the hardships that the company and its shareholders have faced over the last several months:
- 5/1- OCZ reports in-line quarter, guides for an in-line FQ1 2013, and issues full-year guidance well above analyst estimates of $512M at $630M - $700M. Reports a wider net loss than expected
- 7/10 - OCZ comes in slightly below the midpoint of analyst estimates on the revenue side while significantly missing on the bottom line. Company notes record bookings, but supply issue involving a voltage regulator prevented the firm from shipping all of its orders
- 8/10 - CFO Arthur Knapp announces his intent to retire
- 9/5 - OCZ issues a revenue warning for FQ2 2013, stating that it will come in at $110M - $120M instead of the guided $130M - $140M. Management claims that this is due to a shortage of NAND flash and that the company achieved bookings in excess of its expectations
- 9/17 - CEO Ryan Petersen announces his resignation and names Alex Mei as interim CEO
Now that both the CEO and the CFO have left the building, the way is paved for new management. Fundamentally, OCZ's main problem has not been with its technology but with its inability to attain profitability. The question is whether OCZ's current strategy will eventually lead to profits or if a major fundamental shift in strategy is necessary.
Gross Margin Expansion: On The Right Track
One thing that OCZ has done right is aggressively pursue vertical integration. The purchase of Indilinx in an all-stock $32M deal gave OCZ the advantage of its own controller technology. Typically, SSD manufacturers, including even the major NAND fabs such as Intel (INTC) and Micron (MU), license controller technology from a third party. OCZ's move to increasingly in-house technology obviously helped the company to gain a margin advantage over the hordes of "me too" SSD makers that licensed technology from Marvell (MRVL) or LSI (LSI).
Further, OCZ was attempting to shift more of its business to the enterprise side, particularly flash caching with PCI-E SSDs and specialized virtualization software (courtesy of the SANRAD acquisition). These areas have much higher gross margins than the consumer space, so success here can certainly improve margins and overall profitability.
Operating Expenses: Expand Or Die
A major point that skeptics and short sellers point to is the massive increase in operating expenses over the last few quarters. However, these operating expenses are primarily due to R&D for next generation SSD controllers and to sales and marketing. In order to maintain a competitive position with internally developed controller technology against giants such as Marvell and LSI, the company needs to spend aggressively. Further, in order to see the continued sales ramp (as evidenced by record bookings in the two most recent quarters), the sales force must be expanded.
Further, for enterprise solutions, R&D must be performed on both the hardware/controller side, as well as the software side. Fusion-io's (FIO) primary competitive advantage is that its software stack is currently unparalleled. However, at the most recent dbAcess 2012 Technology Conference, Ryan Petersen noted that the company has made significant stride to become more competitive on the software side.
In the technology space, cutting down on R&D is the most sure-fire way to ensure that competitors will out-innovate you. OCZ's decision to continue to spend here despite the (hopefully short term) pain on the bottom line is very much the correct one.
OCZ's Problems: It's About NAND
The major disadvantage that OCZ (and all other fabless SSD manufacturers) faces is NAND procurement. OCZ relies on foundries such as Intel, Micron, and Samsung in order to get NAND flash.
In the enterprise flash caching/PCI-E space, the NAND isn't really the biggest problem: the gross margins on the devices themselves are in the 50%+ range and a big part of the solution is actually the software.
However, in the hard-disk replacement (SATA/SAS) space, the NAND flash is the biggest part of the bill-of-materials. The companies that can build their own NAND flash have a natural cost advantage over those companies that need to buy the NAND from the producers. Unfortunately, as OCZ's primary strategic direction involves the high volume hard-disk replacement, which means that getting NAND at competitive prices is critical.
The firm is working on establishing a partnership with a NAND flash fab, and such a deal could prove to be a very significant positive catalyst for the stock as well as gross margins.
Will New Management Make A Difference?
Fundamentally, it seems that OCZ's strategy is as sound as it gets. The firm has done everything reasonably possible to increase gross margins (internal controllers, internal wafer processing, working on NAND deal, and expansion into high margin enterprise). The operating expenses also seem necessary to fuel the technological innovation and sales force needed to grow revenues at a rapid rate.
At this point, OCZ needs to focus on being able to substantially increase revenue, while keeping gross margins in an uptrend. The firm was already on track to do so but was held back by shortages of key components in two consecutive quarters, marring the otherwise stellar bookings.
So, will new management make a difference? Maybe. If OCZ pulls out of the consumer drive segment, focuses on providing full solutions in the enterprise space (like Fusion-io) and in providing controller technology to the hard-disk replacement market (like LSI or Marvell), then the dependence on NAND goes away. In fact, OCZ's highly touted advantages to moving to new NAND nodes more quickly than any other drive makers due to its controller technology could make it a very viable player in the SSD controller market.
This would not be such a high growth area, but the gross margins are very nice, and the "growth" part of the equation could be satisfied by providing solutions exclusively to the enterprise sector.
Selling The Company?
Another move for the company would be to simply sell itself out. SandForce was bought out by LSI for $322M and all it had was a controller (albeit a very popular one), so a similar price for OCZ's Indilinx division is not unreasonable, especially as it proves itself with the fully internally designed "Barefoot 3". Further, OCZ touts its ability to move to new NAND flash nodes faster than any other company, so OCZ's controller technology could potentially be worth even more.
But OCZ also has an entire enterprise product lineup, including very fast PCI-E drives with specialized virtualization software included. At the dbAccess 2012 Technology Conference, Ryan Petersen noted that there were really only two major players in the PCI-E space: itself and Fusion-io, the latter of which is valued at well over $2B as of last close.
High risk speculators may find picking up shares of OCZ on the cheap to be lucrative in the case of a buyout or a merger.
The main problem with the CEO's departure is that he was the founder of the company. The vision was his and with his rather large stake (~4%) in the company, there was a very real push to succeed.
However, there are certainly viable directions that the company can be taken to achieve profitability sooner, as outlined above, and I believe that the board of directors as well as the major institutions will be looking for progress in profitability sooner rather than later. This may very well affect the choice of Petersen's successor as well as very materially affect the company's direction.
Additional disclosure: I may initiate a long position in OCZ over the next 72 hours.