Today we published a long report on OCZ Technology (NASDAQ:OCZ), "OCZ - The Master of SSD (Shady, Suspect, Deceitful)" which can be found in its entirety here:
Below is a brief intro of the issues covered in the first few pages of the article, many of which we believe will be helpful reveleations for investors......
Over the last six months, investors have learned a painful and expensive lesson from the following story. A small Chinese company comes public through an RTO (reverse take-over) or a backdoor listing on the OTC Bulletin Board. The story blossoms alongside a rising stock price, riding a new hot theme or even a legitimate end market. Ignoring red flags from management's past, sellside analysts and investors choose to believe the Cinderella tale. The tale itself is always hard to verify, but the detailed insight the CEO shares creates complacency and a willingness to look past obvious risks and financial irregularities. Based on the CEO's story, a cult-like following ensues, and the company is able to raise large sums of capital. The company puts up huge revenue numbers quarter-after-quarter, yet the profitability and cash flows never seem to materialize. And then one day, investors realize that numbers never reconciled and huge accounting inconsistencies existed the whole time. They also realize important facts were never disclosed and the product wasn't what management claimed. Ultimately, investors suffer large losses as the final chapter. OCZ Technology (OCZ) may just be the American version of the story above.
OCZ has parlayed investor and market excitement for solid state drives (SSDs) into an amazing story. From a low of $1.79 last summer, OCZ's stock has steadily climbed more than 350% on a feel good tale told by its CEO. But there is a much darker and sinister side that has been well hidden. It is our opinion that OCZ has misrepresented its SSD growth and has financial irregularities that are nearly impossible to reconcile. We believe that some form of a restatement may be required and that the auditors tick and tie review has some substantial inconsistencies. As such, we have sent our findings to the Securities and Exchange Commission asking for clarification on the multiple sets of numbers that we have uncovered. We believe OCZ's Board has the fiduciary responsibility to form a special committee to examine these discrepancies.
But the misrepresentations are not confined to the financials. A scathing lawsuit and industry reviews suggest OCZ has misrepresented product specs and performance. Additionally, a recently completed secondary failed to disclose the CEO's criminal record, major underwriter conflicts (until the final prospectus), and contained financial results that were different from past filings. And if that is not enough, there are other confusing pieces to the story such as Fusion-io, STEC, and Smart Modular disclosing that they do not see OCZ in competitive situations. Amazingly, we believe most of the interest in OCZ is nothing more than a wise guy backdoor play on the hot Fusion-io deal that should backfire as the OCZ issues get exposed.
As investors begin to recognize that the CEO has told the world that OCZ is trying to get qualified at EMC and IBM (so much for selective disclosure), the last catalyst will have played itself out versus elevated expectations. Although the sellside will likely remain complicit, we believe buyside investors that expect $400 million of revenue, and more importantly $0.75 of earnings in fiscal 2012, will be disappointed. With buyside estimates at unobtainable levels and promotional qual announcements fully priced in, we think the stock will finally be valued on fundamentals. If OCZ trades in-line with the comp group, a generous assumption given OCZ's limited asset value, differentiation, and minimal profitability, a reasonable price target would be between $2.58 and $4.98 per share.
This report will highlight:
1) Huge losses for AIM investors and a previous profitless revenue ramp. OCZ listed its stock on the AIM before moving to a U.S. listing. OCZ management rode a profitless revenue ramp and told a very similar story then to raise money from investors. They proceeded to miss estimates by 40% and delist their shares less than three years after the original listing. OCZ's stock declined 95% from its peak.
2) BCInet - an unusual transaction. OCZ claims to have sold its Neural Impulse Actuator line to a company that was incorporated, at most, just seven days before the sale took place. Public filings show OCZ shares the same address as the purported buyer, a company called BCInet.
3) Accounting Irregularities, SSD growth overstatement, and irreconcilable financials. Based on discrepancies in OCZ's SEC filings, we believe the company has misrepresented its SSD revenue and growth rates. The SSD revenues from past financials do not reconcile with an important segment table they have been providing since January. Based on comments in the MD&A from the 10Q, it appears management has overstated the year-over-year SSD growth rate by over 200%.
4) Irregularities in the prospectus, past filings, and a needed restatement. The prospectus that investors relied upon for the recent secondary appears to have contained material financial inaccuracies. Based upon the financials provided, we are unable to reconcile the Segment attributions with past SEC filings. The prospectus appears to overstate SSD growth for 2010 by 183%. The 8K (from 1/10/11), the 10K, and the revenue from quarterly results reported in each 10Q do not reconcile. Additionally, it appears SSD revenues were somehow reallocated to the PSU segment in some financials and the memory segment in others - with the result being overstated forward revenue growth in SSD. Finally, OCZ's CFO resigned late last year after only 18 months in that role.
5) Material information was withheld about the CEO's past felonious activity. OCZ and the underwriters did not disclose material background information on the CEO's criminal record. While we are sympathetic to mistakes made in the past, we believe the importance of the CEO's credibility is essential given the extreme reliance investors and analysts have placed on his story. A national criminal records search shows the CEO was arrested and/or charged in various Courts for: Grand Theft, Forgery, Unlawful Entry Motor Vehicle, Theft-1, Drug Violations, and Traffic in Stolen Property.
6) Controversial geographic disclosures suggest all of the growth is from EMEA. Despite cagy references to HP, Yahoo, and other U.S.-based enterprise wins, close to 100% of OCZ's growth has come from the Middle East, Africa, and Europe. Based on public disclosures by the CFO, for the numbers to reconcile, SSD business outside of the U.S. is somehow growing nearly 3x faster than U.S. SSD growth. The company's comments about SSD attributions imply North American non-SSD revenues would have fallen between 53% and 92% sequentially, while that same non-SSD business was flattish outside of the U.S. While unrelated, it is worth noting that OCZ has received inquiries from the FBI about product sales into the Middle East.[i]
7) Claiming to triple capacity out of thin air. OCZ has publicly stated multiple times that they expanded capacity by 3x in the third fiscal quarter. We have been unable to find the associated expenses or capital expenditures supporting that level of capacity expansion. In fact, PP&E declined by $10,000 from Q1 to Q3, while capex was only $728,000 for the entire first nine months of the fiscal year.
8) Hype aside, OCZ looks ugly next to STEC. Despite a rocky road ahead for STEC, the side-by-side comparisons are alarming for OCZ investors that believe the company has the infrastructure and support to establish large revenue agreements with OEM's (qualification announcement do not equal revenue). STEC employs 250% more heads in R&D and spends nearly 90% more per such employee. Further, STEC spent more than 400% more on R&D in 2010 than OCZ spent in the previous four years combined. When taking all of OCZ's options and warrants into consideration, the enterprise value of OCZ is now just $250 million less than STEC.
9) OCZ's appears delusional and does not seem to play in the high-end enterprise SSD sandbox. Don't take our word for it, look at the supposed competition. In public filings, OCZ claims to compete with Fusion-io, STEC and Smart Modular. However, none of those three list OCZ as a competitor in their public filings. Additionally the "wise guy" investors that have bought OCZ as a backdoor to Fusion-io are likely to be sorely disappointed if they actually compare the financial profiles and end markets of the two companies.
10) Industry reviews accuse OCZ of disingenuous specs and "shady" marketing. The CEO of DDRdrive and the industry review website Storage Review have accused OCZ of knowingly publishing disingenuous product specifications. OCZ's decision to deceptively market new products with legacy specs and marketing material led one industry website to warn (talking about the product, not the stock) "At this point it is buyer beware until OCZ steps up and reveals some degree of transparency."[ii]
11) OCZ is being sued for Negligent Misrepresentation and Deceptive Advertising Practices. OCZ failed to disclose any of the details behind the lawsuit filed against them in U.S. District Court less than three weeks ago. The lawsuit provides great detail into OCZ's decision to change the number of modules, the densities, and the nodes of its flash cells without disclosing such changes to customers. The lawsuit accuses OCZ of Deceptive Advertising and Negligent Misrepresentation, among six total claims, "OCZ's advertisings and marketing representations concerning the storage capacity and performance of the Products are false, misleading, and deceptive."
12) The Indilinx acquisition - fuzzy math and a bleak revenue picture. Despite management's rosy comments around Indilinx and future accretion, public SEC filings portray Indilinx as a company that was quite challenged. In 2010, Indilinx revenues fell by 69% to just $2 million. Excluding the decline in revenue from OCZ, their sales still fell 46% compared to 2009. We are unsure how management defines "accretive" and do not think Indilinx can generate the required $1.7 million of EBIT to offset the dilution from the deal.
13) OCZ will not come close to hitting buyside expectations. We have carefully analyzed buyside expectations for revenues this year (FY'12) of $400 million and pro forma earnings of $0.77 per share. We believe that buyside investors are making a major error extrapolating the contribution margins that are implied in the fourth quarter from management's two press releases. Further, we believe management may need to rely on a) selling DRAM inventories at 100% gross margins that had previously been reserved against, and b) the possible reversal of an accrual taken for lack of payment to a supplier. We slice the numbers several different ways and think buyside revenues may be attainable, but the company will come nowhere close to making $0.77 of earnings.
14) The co-founders aggressive selling may be one step ahead of investors. The spate of insider selling could raise some flags. CEO Ryan Petersen sold nearly two million shares a few months ago in private transactions and the open market at levels 50% lower than where the stock currently trades. Also, one of OCZ's co-founder's recently sold most of his stock below $4.00 (he may have sold 100% of his stock, but we can not confirm that yet).
15) Why was the Merriman Capital relationship not disclosed in the preliminary prospectus? For some reason the lengthy and intertwined relationship between OCZ and Merriman Capital did not appear to get disclosed in the preliminary prospectus. Given the depth of the relationships, the Chairman's significant stake in OCZ, and the bullish support from research, we are unsure why the relationship was not initially disclosed.
Disclaimer – As of the publication date, the author of this report has a short position in the company covered herein and stands to realize gains in the event that the price of the stock declines. The author does not use options to establish positions prior to a report’s publication. The author does not discuss unpublished reports, or provide any advanced warning of future reports to others. Following publication, the author may transact in the securities of the company, and may be long, short, or neutral at any time hereafter regardless of our initial opinion. The author of this report has obtained all information herein from sources believed to be accurate and reliable. The author of this report makes no representations, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice and the author does not undertake to update or supplement this report or any of the information contained herein. This is not an offer to buy any security, nor shall any security be offered or sold to any person, in any jurisdiction in which such offer would be unlawful under the securities laws of such jurisdiction.