OCZ: Enterprise Sales Low Due To Inability To Qualify?

Oct.30.12 | About: OCZ Technology (OCZ)

OCZ Technology Group (NASDAQ:OCZ) has taken investors on a wild ride. It has gone from a debt-free, cash-rich, fast growing up-and-comer in the seemingly lucrative consumer and enterprise flash storage business to a broken shell of a company with fleeing executives and almost no cash left from its numerous secondary offerings (timed almost exactly at the peaks). The stock now trades near all time lows at a mere $1.35/share as of last close as it has been unable to file a 10-Q for its latest quarter due to some accounting issues.

While it is clear now that OCZ was not able to (profitably) compete in the consumer SSD segment given that the preliminary Q3 results indicated a negative gross margin for the quarter, the question that still remains is, "where were all the enterprise drive wins?"

Enterprise Was The Key To Profits

While OCZ had been banking on plummeting NAND flash prices, increased in-house controller development, and high volume sales to bring its gross margins and revenue levels to levels that could support profitability, the bet did not pay off. The NAND flash suppliers grew weary of losing money on their products, so they drastically cut supply.

This, of course, was problematic for OCZ as these NAND flash manufacturers also began to price their own drives at similar prices as OCZ's products. Since OCZ pays its competitors for the NAND (and these NAND manufacutrers presumably have a positive gross margin), this business model was clearly unsustainable, especially if the NAND players were already dealing with razor thin margins.

Consumer drives were never supposed to be OCZ's "ace in the hole" - enterprise solutions were. See, a consumer drive is mainly a bunch of NAND flash (by far the most expensive part of the BOM), a controller, and a circuit board to connect to. There's not much room to differentiate/customize here, except from a performance standpoint. Note, though, that speed is a secondary concern at these levels as most modern SSDs are much faster than traditional HDDs.

So the enterprise space - which is all about providing whole, high margin hardware + software solutions - was the ticket to profitability.

OCZ's ex-CEO Claimed Big Clients

In the most recent earnings release on July 10th, OCZ's ex-CEO Ryan Petersen made the was explained about a design win with Microsoft (NASDAQ:MSFT),

In regards to significant customer news, I'd like to confirm that we are expecting Microsoft deployments across a number od discrete opportunities around our Deneva 2 SATA products, our Talos SAS drives, and our Z-Drive R4 PCIe SSD. And this could be material to our business in the near-term and we believe that Microsoft could grow to become one of our most significant clients.

Unfortunately, at the most recent earnings warning, when OCZ's new CEO Ralph Schmitt was asked about the Microsoft deal, the response was simply,

Appreciate the question and understand the detail that you'd like, but I'm not going to comment on that particular customer.

So, it seems that things may not have gone so well on that front. What happened? Let's dig a little deeper into the flash world to see exactly what's going on:

Understanding Qualification Cycles

In the enterprise space, reliability is number one. No respectable firm will deploy any products for enterprise use without extensive qualification. That means testing, testing, and more testing to make sure that these products are reliable enough to deploy.

These cycles are naturally long, and the explanation for the fairly paltry $6.1M in SAN replacement revenues was explained by ex-CEO Ryan Petersen with the following,

Let me remind you, as we previously mentioned, do we -- we do not expect significant SAN replacement sales until our third fiscal quarter. This is due to long qualification cycles associated with these products

This was, of course, a perfectly plausible explanation for the lack of immediate revenue. However, at the latest Fusion-io (NYSE:FIO) earnings call, the truth of what really happened to these sales seemed to appear.

David Flynn's Comment - The Missing Puzzle Piece

Fusion-io CEO David Flynn was asked the following question about OCZ and STEC (NASDAQ:STEC) at its most recent earnings call,

First of all, do you ever see OCZ or STEC in a competitive situation?

The response was quite candid, and shed a lot of light on why OCZ missed heavily on the gross margin and revenue side in FQ3,

There was in the past an interest in the price points that OCZ talked about, more often than not though, it did not work. It was not reliable enough to really go.

So, could that be the answer to the puzzle? It very well could be. The <$10M orders in the SAN replacement segment that OCZ recorded in the past couple of quarters could really mean only one thing - that these were test orders. The fact that OCZ's gross margins for FQ3 were negative and given further that it failed to meet revenue targets further fuels Mr. Flynn's read of the OCZ situation.

The Catch-22

The worst part about OCZ's financial predicament is that it effectively serves to shut the out of the enterprise market. No company will want to buy misson-critical components from a supplier whose future is uncertain. The odds of Fuson-io being around in 5 years are pretty good. The odds of OCZ being around for the next year - let alone 5 - are pretty low.

This will unfortunately lead to a catch-22. OCZ can't survive without high margin enterprise wins, and it likely won't get any of these wins without some reasonable assurance that it will survive.


Now that OCZ has burned most of its cash, has debt, cannot compete profitably in the consumer SSD space, and now has many doubts surrounding its enterprise products and strategy, things are looking even more bleak for the company.

The firm still has some good technology in both controller technology via Indilinx and the team acquired from PLX (NASDAQ:PLXT), and virtualization via SANRAD. The company's best hope is to secure some funding, likely through the issuance of bonds. This would conceivably give the company enough capital to trim down, focus on developing more valuable enterprise-oriented technology, and then eventually sell itself to the highest bidder.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.