Attached files
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EX-31.1 - ZCO LIQUIDATING Corp | v199083_ex31-1.htm |
EX-31.2 - ZCO LIQUIDATING Corp | v199083_ex31-2.htm |
EX-32.1 - ZCO LIQUIDATING Corp | v199083_ex32-1.htm |
EX-32.2 - ZCO LIQUIDATING Corp | v199083_ex32-2.htm |
UNITED
STATES
SECURITIES
AND EXCHANGE COMMISSION
WASHINGTON,
D.C. 20549
FORM
10-Q
QUARTERLY
REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE
ACT
OF 1934
For
the quarterly period ended August 31, 2010
Commission
File Number: 000-53633
OCZ
TECHNOLOGY GROUP, INC.
(Exact
name of Registrant as specified in its charter)
Delaware
(State
or other jurisdiction
of
incorporation or organization)
|
04-3651093
(I.R.S
Employer
Identification
No.)
|
6373
San Ignacio Avenue
San
Jose, California
(Address
of Principal Executive
Offices)
|
95119
(Zip
Code)
|
(408)
733-8400
(Registrant's
telephone number, including zip code)
Indicate
by check mark whether the registrant (1) has filed all reports required to
be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to
such filing requirements for the past 90 days. Yesx
No¨
Indicate
by check mark whether the registrant has submitted electronically and posted on
its corporate Website, if any, every Interactive Data File required to be
submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405
of this chapter) during the preceding 12 months (or for such shorter period
that the registrant was required to submit and post such files). Yes¨
No¨
Indicate
by check mark whether the registrant is a large accelerated filer, an
accelerated filer, a non-accelerated filer, or a smaller reporting company. See
the definitions of "large accelerated filer," "accelerated filer" and "smaller
reporting company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
|
Accelerated filer ¨
|
Non-accelerated filer
¨
(Do
not check if a smaller reporting
company)
|
Smaller reporting company x
|
Indicate
by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). Yes¨ Nox
Indicate
the number of shares outstanding of each of the issuer's classes of common
stock, as of the latest practicable date.
As of
October 12, 2010, there were 26,674,102 shares of the registrant’s common stock,
$0.0025 par value, outstanding, which is the only class of common stock of the
registrant issued.
OCZ
TECHNOLOGY GROUP, INC.
Table
of Contents
Page
|
||||||
PART I.
|
FINANCIAL
INFORMATION
|
|||||
Item
1.
|
Financial
Statements
|
3 | ||||
Item
2.
|
Management’s
Discussion and Analysis of Financial Condition and Results of
Operations
|
20 | ||||
Item
3.
|
Quantitative
and Qualitative Disclosures About Market Risk
|
30 | ||||
Item
4T
|
Controls
and Procedures
|
30 | ||||
PART II.
|
OTHER
INFORMATION
|
|||||
Item
1.
|
Legal
Proceedings
|
30 | ||||
Item
1A.
|
Risk
Factors
|
31 | ||||
Item
2.
|
Unregistered
Sales of Equity Securities and Use of Proceeds
|
31 | ||||
Item
3.
|
Defaults
Upon Senior Securities
|
31 | ||||
Item
4.
|
Removed
and Reserved
|
31 | ||||
Item
5.
|
Other
Information
|
31 | ||||
Item
6.
|
Exhibits
|
32 | ||||
Signatures
|
33 |
2
PART
I. FINANCIAL INFORMATION
Item 1. Financial
Statements
OCZ
Technology Group, Inc.
Consolidated
Balance Sheets
($ in
thousands)
August 31, 2010
|
February 28, 2010
|
|||||||
unaudited
|
||||||||
ASSETS
|
||||||||
Current
Assets:
|
||||||||
Cash
and cash equivalents
|
$ | 2,604 | $ | 1,224 | ||||
Accounts
receivable, net of allowances of $2,108 and $2,853
|
28,107 | 20,380 | ||||||
Inventory,
net
|
15,395 | 9,846 | ||||||
Note
receivable
|
375 | 375 | ||||||
Deferred
tax asset, net
|
- | 836 | ||||||
Prepaid
expenses and other current assets
|
2,514 | 1,811 | ||||||
Total
current assets
|
48,995 | 34,472 | ||||||
Property
and equipment, net
|
2,443 | 2,629 | ||||||
Intangible
asset
|
53 | 88 | ||||||
Goodwill
|
9,989 | 9,954 | ||||||
Investment
|
668 | 668 | ||||||
Other
assets
|
17 | 38 | ||||||
Total
assets
|
$ | 62,165 | $ | 47,849 | ||||
LIABILITIES
AND SHAREHOLDERS' EQUITY
|
||||||||
Current
liabilities:
|
||||||||
Loans
payable
|
$ | 13,074 | $ | 10,354 | ||||
Note
payable
|
250 | 500 | ||||||
Accounts
payable
|
37,543 | 26,318 | ||||||
Accrued
and other liabilities
|
4,572 | 4,389 | ||||||
Total
current liabilities
|
55,439 | 41,561 | ||||||
Common
stock warrant liability
|
529 | - | ||||||
Total
Liabilities
|
55,968 | 41,561 | ||||||
Commitments
and contingencies
|
- | - | ||||||
Stockholders'
equity:
|
||||||||
Preferred
stock, $0.0025 par value; 20,000,000 shares authorized; 0 and
60,990 shares issued and outstanding as of August 31, 2010 and February
28, 2010 respectively
|
- | - | ||||||
Common
stock, $0.0025 par value; 120,000,000 shares authorized; 26,622,436 and
21,278,643 shares issued and outstanding as of August 31, 2010 and
February 28, 2010 respectively
|
66 | 53 | ||||||
Additional
paid-in capital
|
44,196 | 31,862 | ||||||
Accumulated
translation adjustment
|
(166 | ) | (164 | ) | ||||
Accumulated
deficit
|
(37,899 | ) | (25,463 | ) | ||||
Total
stockholders' equity
|
6,197 | 6,288 | ||||||
Total
liabilities and stockholders' equity
|
$ | 62,165 | $ | 47,849 |
See
accompanying notes to the Consolidated Financial Statements.
3
OCZ
Technology Group, Inc.
Consolidated
Statements of Operations
(In
thousands, except per share amount)
Three
Months Ended
|
Six
Months Ended
|
|||||||||||||||
August
31,
|
August
31,
|
|||||||||||||||
unaudited
|
unaudited
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Net
revenues
|
$ | 38,045 | $ | 37,795 | $ | 72,328 | $ | 73,566 | ||||||||
Cost
of revenues
|
36,425 | 31,534 | 66,544 | 63,610 | ||||||||||||
Gross
profit
|
1,620 | 6,261 | 5,784 | 9,956 | ||||||||||||
Sales
and marketing
|
3,642 | 2,552 | 6,377 | 5,208 | ||||||||||||
Research
and development
|
1,694 | 1,204 | 3,258 | 2,694 | ||||||||||||
General,
administrative and operations
|
4,852 | 3,806 | 8,121 | 7,555 | ||||||||||||
Total
operating expenses
|
10,188 | 7,562 | 17,756 | 15,457 | ||||||||||||
Operating
income (loss)
|
(8,568 | ) | (1,301 | ) | (11,972 | ) | (5,501 | ) | ||||||||
Other
income (expense) - net
|
(8 | ) | (65 | ) | (11 | ) | 69 | |||||||||
Interest
and financing costs
|
(626 | ) | (373 | ) | (1,168 | ) | (626 | ) | ||||||||
Adjustment
to the fair value of common stock warrants
|
2,450 | - | 1,551 | |||||||||||||
Income
(loss) before income taxes
|
(6,752 | ) | (1,739 | ) | (11,600 | ) | (6,058 | ) | ||||||||
Income
tax expense (benefit)
|
836 | 836 | (1 | ) | ||||||||||||
Net
income (loss)
|
$ | (7,588 | ) | $ | (1,739 | ) | $ | (12,436 | ) | $ | (6,057 | ) | ||||
Net
income (loss) per share:
|
||||||||||||||||
Basic
|
$ | (0.29 | ) | $ | (0.08 | ) | $ | (0.48 | ) | $ | (0.28 | ) | ||||
Diluted
|
$ | (0.29 | ) | $ | (0.08 | ) | $ | (0.48 | ) | $ | (0.28 | ) | ||||
Shares
used in per share computation:
|
||||||||||||||||
Basic
|
26,600 | 21,300 | 25,800 | 21,300 | ||||||||||||
Diluted
|
26,600 | 21,300 | 25,800 | 21,300 |
See
accompanying notes to the Consolidated Financial Statements.
4
OCZ
Technology Group, Inc.
Consolidated
Statements of Cash Flow
(In
thousands)
Six Months Ended
|
||||||||
August 31,
|
||||||||
2010
|
2009
|
|||||||
unaudited
|
unaudited
|
|||||||
Cash
flows from operating activities:
|
||||||||
Net
income (loss)
|
$ | (12,436 | ) | $ | (6,057 | ) | ||
Adjustments
to reconcile net income/(loss) to net cash provided by operating
activities:
|
||||||||
Depreciation
of property and equipment
|
528 | 483 | ||||||
Amortization
of intangibles
|
35 | 56 | ||||||
Bad
debt expense
|
496 | 232 | ||||||
Stock-based
compensation
|
384 | 390 | ||||||
Fair
value adjustment of stock warrants
|
(1,551 | ) | - | |||||
Adjustment
to deferred tax asset
|
836 | - | ||||||
Non-cash
write-off of leasehold improvements
|
- | 102 | ||||||
Non-cash
inventory reserve
|
2,796 | - | ||||||
Changes
in operating assets and current liabilities:
|
||||||||
Accounts
receivable
|
(8,223 | ) | 3,406 | |||||
Inventory
|
(8,345 | ) | 4,424 | |||||
Prepaid
expenses and other assets
|
(704 | ) | 67 | |||||
Accounts
payable
|
11,225 | (3,568 | ) | |||||
Accrued
and other liabilities
|
183 | 393 | ||||||
Net
cash (used in) provided by operating activities
|
(14,776 | ) | (72 | ) | ||||
Cash
flows from investing activities:
|
||||||||
Purchases
of property and equipment
|
(342 | ) | (555 | ) | ||||
Decrease
(increase) in deposits
|
21 | 39 | ||||||
Business
acquisition earn out payments
|
(35 | ) | (241 | ) | ||||
Net
cash used in investing activities
|
(356 | ) | (757 | ) | ||||
Cash
flows from financing activities:
|
||||||||
Issurance
of common stock
|
13,957 | 8 | ||||||
Proceeds
from employee stock programs
|
87 | - | ||||||
Proceeds
from bank loan, net
|
2,720 | 870 | ||||||
Increase
(repayment) of shareholder loan
|
(250 | ) | 500 | |||||
Net
cash provided by (used in) financing activities
|
16,514 | 1,378 | ||||||
Effect
of foreign exchange rate changes on cash and cash
equivalents
|
(2 | ) | (45 | ) | ||||
Net
increase in cash and cash equivalents
|
1,380 | 504 | ||||||
Cash
and cash equivalents at beginning of period
|
1,224 | 420 | ||||||
Cash
and cash equivalents at end of period
|
$ | 2,604 | $ | 924 | ||||
Supplemental
disclosures:
|
||||||||
Interest
paid
|
$ | 545 | $ | 331 |
See
accompanying notes to the Consolidated Financial Statements.
5
Note 1
– Basis of
Presentation
The
accompanying interim condensed consolidated financial statements of OCZ
Technology Group, Inc, a Delaware corporation (“OCZ” or the “Company”), are
unaudited and have been prepared in accordance with accounting principles
generally accepted in the United States of America (“GAAP”) for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. In the opinion of management, all adjustments (consisting of
normal and recurring adjustments) considered necessary for a fair statement of
the consolidated financial position of the Company at August 31, 2010, the
consolidated statements of operations for the three and six months ended August
31, 2010 and 2009, and the consolidated results of cash flows for the six months
ended August 31, 2010 and 2009 have been included. These interim condensed
consolidated financial statements do not include all of the information and
footnotes required by GAAP for complete financial statements and, therefore,
should be read in conjunction with the consolidated financial statements and
related notes contained in the Company’s most recent Report on Form 10-K filed
with the Securities and Exchange Commission (“SEC”). The February 28, 2010
balances reported herein are derived from the audited consolidated financial
statements included in the Company’s Form 10-K. The results for the interim
periods are not necessarily indicative of results to be expected for the full
year.
The
condensed consolidated financial statements of the Company include the accounts
of the Company’s subsidiaries. All significant intercompany accounts and
transactions have been eliminated in consolidation.
The
preparation of financial statements in conformity with GAAP requires management
to make certain estimates and assumptions that affect the reported amounts of
assets and liabilities (e.g., sales returns, bad debt and inventory reserves and
asset impairments), disclosure of contingent assets and liabilities at the date
of the financial statements, and the reported amounts of revenues and expenses
during the reporting period. The Company’s reported revenues are net of reserves
for price protection, sales returns and sales and marketing incentives. Actual
results could differ from those estimates.
The
Company incurred losses substantially in excess of our internal forecasts in the
second quarter and in the year to date results largely because of significant
pricing concessions to sell certain portions of its memory
products. The Company is in the process of de-emphasizing a
significant portion of this product line. The results of the
Company’s SSD product sales were a positive development and the Company expects
these results to continue to be strong into the
foreseeable future. The Company expects that it will
continue to incur weak margins on its commodity based DRAM products,
though it believes it has reduced its inventory costs through valuation reserves
recorded in the second quarter of fiscal 2011 such that it will not generate
significant losses on these sales.
The
Company has used $14.7 million of cash in our operating activities for the six
months ended August 31, 2010 compared to $72,000 of cash used in our operating
activities for the six months ended August 31, 2009. This substantial
increase in cash used in operating activities, was financed by the $16.5 million
in cash from financing activities in the six months ended August 31, 2010
compared to $1.4 million in cash flow from financing activities for the six
months ended August 31, 2009. The Company may seek additional credit
availability under our existing Factoring Loan Agreements and will be looking to
generate cash flow from operations to service our debt, support working capital
needs, finance capital investment and increase research and
development. The Company could be required, or could elect, to seek
additional funding through public or private equity or debt financing and
additional funds may not be available on terms acceptable to us or at
all.
The
Company’s ability to generate cash depends on many factors beyond our
control. The Company’s ability to make payments on its
debt and to fund working capital requirements, capital expenditures and research
and development efforts will depend on its ability to generate cash in the
future. The Company’s historical financial results have been, and it
expects its future financial results will be, subject to substantial fluctuation
based upon a wide variety of factors, many of which are not within its
control. If it does not generate sufficient cash flow from operations
to satisfy its debt obligations, it may have to undertake alternative financing
plans, such as refinancing or restructuring our debt, selling assets, reducing
or delaying capital investments or seeking to raise additional
capital. Also, certain of these actions would require the consent of
its lenders. The terms of our financing agreements contain
limitations on its ability to incur debt. The Company cannot provide
assurance that any refinancing would be possible, that any assets could be sold,
or, if sold, of the timing of the sales and the amount of proceeds realized from
those sales, or that additional financing could be obtained on acceptable terms,
if at all, or would be permitted under the terms of its various debt instruments
then in effect. The Company’s inability to generate sufficient cash
flow to satisfy its debt obligations, or to refinance its obligations on
commercially reasonable terms, would have an adverse effect on its business,
financial condition and results of operations.
6
2.
|
Summary
of significant accounting policies
|
Principles
of consolidation
The
consolidated financial statements include the financial statements of OCZ and
its subsidiaries, OCZ Canada and OCZ Ireland. All material
intercompany balances and transactions have been eliminated upon
consolidation.
Use
of estimates
On an
ongoing basis, OCZ evaluates its estimates, including, among others, those
related to bad debts and allowances, inventories and related reserves,
investments, income taxes, warranty obligations, stock compensation,
contingencies and litigation. OCZ bases its estimates on historical
experience and on other assumptions that OCZ believes are reasonable under the
circumstances, the results of which form the basis for OCZ’s judgments about the
carrying values of assets and liabilities when those values are not readily
apparent from other sources. Estimates have historically approximated
actual results. However, actual results will differ from these
estimates under different assumptions and conditions.
Cash
equivalents
For the
purposes of the statement of cash flows, OCZ considers all highly liquid
investments with an original maturity of three months or less to be cash
equivalents.
Concentration
of credit risks
Financial
instruments which potentially subject OCZ to concentrations of credit risk
consist of cash and cash equivalents and accounts receivable. OCZ
maintains credit insurance on the majority of its receivables. During
the periods presented herein, OCZ had deposits in banks in excess of the Federal
Deposit Insurance Corporation insurance limit. OCZ has not
experienced any losses in such accounts, and does not believe it is exposed to
any significant risk on trade receivables, cash and cash
equivalents.
Comprehensive
income
Comprehensive
income consists of net income (loss) and other comprehensive income
(loss). Other comprehensive income (loss) consists of foreign
currency translation adjustments, which are also recognized as a separate
component of stockholders’ equity.
Trade
accounts receivable and allowance for doubtful accounts
Accounts
receivable is stated at the net amount which management expects to collect after
providing allowances for doubtful accounts, sales payments and sales credits
based on an evaluation of a customer’s specific financial
situation. These allowances amounted to approximately $ 2.1 million
as of August 31, 2010 and $2.85 million as of February 28, 2010. Historically,
OCZ has not charged interest on past due accounts.
Notes
Receivable
On August
31, 2009, OCZ was issued notes receivable related to the sale of various
tangible and intangible property. These notes have the following principal
amounts and mature on the following dates: $375,488 due July 31, 2010
which will be extended for one year, $105,727 due August 31, 2011 and $414,200
due August 31, 2014. The non-current notes receivable are shown as part of the
“Investment” caption on the balance sheet and are stated at the net amount which
management expects to collect after providing a valuation
allowance.
7
Inventory
Inventory
is valued at the lower of cost or market with cost determined using the average
cost method. Inventory consists of raw materials, work in progress
and finished goods.
OCZ
writes down inventory for slow moving and obsolete inventory based on
assessments of future demands and market conditions as well as the condition of
product on hand. As stated in our August 24, 2010 announcement, we have
discontinued the sale of certain commodity level DRAM module products, an
inventory reserve of approximately $2.8 million was recorded as of August 31,
2010. This reserve is intended to account for the estimated net realizable value
for pricing and production yield variances.
Property
and equipment
Property
and equipment are carried at cost, net of accumulated
depreciation. The cost of maintenance and repairs is expensed as
incurred. Depreciation of property and equipment is provided using
the straight line method over the estimated useful lives of the assets as
follows:
Vehicles
|
3
years
|
Furniture
and fixtures
|
3 —
5 years
|
Equipment
|
3 —
5 years
|
Leasehold
improvements
|
Shorter
of term of lease or asset
life
|
Goodwill
and Intangibles
Goodwill
represents the excess of the purchase price over the estimated fair value of the
identifiable tangible and intangible net assets acquired in business
acquisitions. Goodwill is reviewed at least annually for impairment
as of the last day of February, or more frequently if events and circumstances
indicate that the asset might be impaired, in accordance with ASC Topic 350,
Intangible – Goodwill and
Other. The brand name intangible assets are being amortized
over a 4-year period. Subsequent payments made for any contingent
consideration are charged to goodwill if the acquisition was made prior to the
fiscal year ended February 28, 2010, in accordance with the December 2007
revisions to SFAS No. 141 (ASC Topic 805). For tax purposes, goodwill
is deductible over a 15-year period.
In
accordance with the provisions of ASC Topic 805, Business Combinations, OCZ
allocates the purchase price to the tangible and intangible assets acquired,
liabilities assumed, and in-process research and development based on its
estimated fair values. Management makes significant estimates and
assumptions, which are believed to be reasonable, in determining the fair values
of certain assets acquired and liabilities assumed, especially with respect to
intangible assets. These estimates are based on historical experience
and information obtained from the management of the acquired companies and are
inherently uncertain. Critical estimates in valuing certain of the
intangible assets include, but are not limited to, future expected cash flows
from product sales, customer relationships, acquired developed technologies and
patents, expected costs to develop the in-process research and development into
commercially viable products and estimated cash flows from the projects when
completed, expected life of the core technology and discount
rates. Unanticipated events and circumstances may occur which may
affect the accuracy or validity of such assumptions, estimates or actual
results.
Impairment
of long-lived assets
OCZ
reviews long-lived assets for impairment whenever events or changes in
circumstances indicate that the carrying amount of the asset may not become
recoverable. If and when the sum of the expected future undiscounted
cash flows is less than the carrying amount of the asset, an impairment loss is
recognized.
8
Income
taxes
Income
taxes are accounted for using an asset and liability approach whereby deferred
tax assets and liabilities are recorded for differences in the financial
reporting bases and tax bases of OCZ’s assets and liabilities. If it
is more likely than not that some portion of deferred tax assets will not be
realized, a valuation allowance is recorded. Due to the additional
losses sustained in the quarter ending August 31, 2010, the valuation allowance
applied to net deferred tax assets was increased by $836,000 resulting in a zero
carrying value for deferred tax assets.
GAAP
prescribes a comprehensive model for how companies should recognize, measure,
present, and disclose in their financial statements uncertain tax positions
taken or expected to be taken on a tax return. Tax positions shall be
initially recognized in the financial statements when it is more likely than not
the position will be sustained upon examination by the tax
authorities. Such tax positions shall be initially and subsequently
measured as the largest amount of tax benefit that is greater than 50% likely of
being realized upon ultimate settlement with the tax authority assuming full
knowledge of the position and all relevant facts. It is management's policy to
recognize interest and penalties related to tax uncertainties to income tax
expense. OCZ has no amounts accrued for interest or penalties as of August 31,
2010 or February 28, 2010 and does not expect the total amount of unrecognized
tax benefits to significantly change in the next 12 months.
OCZ
Canada pays taxes in Canada. OCZ does not file consolidated tax
returns.
All tax
periods after the fiscal year ended December 31, 2005 remain open and subject to
audit by the IRS and the State of California.
Fair
value of financial instruments
OCZ’s
financial instruments consist primarily of cash, cash equivalents, accounts
receivable, accounts payable and bank loans and factoring
arrangements. The carrying values of these financial instruments
approximate fair value as they are short-term to mature.
In
September 2006, the FASB issued FASB Accounting Standards Codification (“ASC”)
820, Fair Value Measurements
and Disclosures, which defines fair value, establishes a framework for
measuring fair value in GAAP, and expands disclosures about fair value
measurements. ASC 820 does not require any new fair value measurements, but
provides guidance on how to measure fair value by providing a fair value
hierarchy used to classify the source of the information.
ASC 820
establishes a fair value hierarchy which prioritizes the inputs to valuation
techniques used to measure fair value into three levels as follows:
§
|
Level
1: Financial assets and liabilities whose values are based on unadjusted
quoted market prices for identical assets and liabilities in an active
market that the Company has the ability to
access.
|
§
|
Level
2: Financial assets and liabilities whose values are based on quoted
prices in markets that are not active or model inputs that are observable
for substantially the full term of the asset or
liability.
|
§
|
Level
3: Financial assets and liabilities whose values are based on prices or
valuation techniques that require inputs that are both unobservable and
significant to the overall fair value
measurement.
|
Level I
|
Level II
|
Level III
|
||||||||||
Fair
Value of common stock warrants
|
- | - | $ | ( 529,000 | ) |
9
OCZ’s
value assigned to the note receivable and investment are based on amounts
determined in conjunction with the sale of various tangible and intangible
assets. A discussion of the valuation technique used to measure fair
value for the common stock warrants is in Note 10 as part of the “Warrants”
section.
Revenue
recognition
OCZ
records all of its product sales net of allowances for returns, product rebates,
sales credits, and market development funds. Revenue is recognized
when there is persuasive evidence of an arrangement, product shipment by a
common carrier has occurred, risk of loss has passed, the terms are fixed and
collection is probable. OCZ generally uses customer purchase orders
and/or contracts as evidence of an arrangement and the underlying payment terms
to determine if the sales price is fixed.
Probability
of collection is assessed for each customer as it is subjected to a credit
review process that evaluates its financial position, ability to pay, and the
potential coverage by OCZ’s credit insurer. If it is determined from
the outset of an arrangement that collection is not probable, the customer is
required to pay cash in advance of shipment. OCZ also purchases
credit insurance for the majority of its accounts. OCZ provides for
price protection credits on a case-by-case basis after assessing the market
competition and product technology obsolescence. These credits are
recorded as a reduction to revenue at the time OCZ reduces its product
prices.
Deferred
income
OCZ
offers terms to certain customers which defer recognition of a sale transaction
until such time that OCZ’s customer sells the product to its
customers. At August 31, 2010 and the February 28, 2010, OCZ has
shipped merchandise totaling $854,000 and $453,000, respectively, to a certain
customer under such arrangement. The sales and related cost of
revenues have been removed from the financial statements and the income shown as
deferred income. Deferred income as of August 31, 2010 and February
28, 2010 was $164,000 and $95,000, respectively; which are included in accrued
and other liabilities.
Marketing
cooperative arrangements
OCZ has
arrangements with resellers of its products to reimburse the resellers for
cooperative marketing costs meeting specified criteria. In certain
arrangements, OCZ records advertising costs meeting specified criteria within
sales and marketing expenses in the accompanying consolidated statements of
operations. For those reimbursements that do not meet the criteria
for advertising costs, the amounts are recorded as a reduction to sales in the
accompanying consolidated statements of operations.
Research
and development costs
Costs of
researching and developing new technology or significantly altering existing
technology are expensed as incurred.
Shipping
and handling
Historically,
amounts billed to customers for shipping and handling have been de
minimus. For the six months ended August 31, 2010 and
2009 these amounts were $32,000 and$93,000, respectively, and were
accounted for as a reduction in general, administrative and operations
expense.
Advertising
Advertising
costs are expensed as incurred and in the six months ended August 31, 2010 and
2009 were $1.51 million and$1.46 million, respectively. Advertising
costs are included in sales and marketing expense.
Foreign
currency translation
Substantially
all of OCZ’s sales are invoiced in U.S. dollars.
10
The
accounts of OCZ’s operations in Canada are maintained in Canadian
dollars. All of OCZ’s other accounts are maintained in U.S.
dollars. Assets and liabilities are translated into U.S. dollars at
rates in effect at the balance sheet date. Net revenues, cost of
revenues and expenses are translated at weighted average rates during the
reporting period. Foreign currency transaction gains/(loss) of
approximately $(15,000) and $106,000are included in other income or
expense in the accompanying statement of operations for the six
months ended August 31, 2010 and 2009, respectively.
Product
warranties
OCZ
offers its customers warranties on certain products sold to
them. These warranties typically provide for the replacement of its
products if they are found to be faulty within a specified
period. Concurrent with the sale of products, a provision for
estimated warranty expenses is recorded with a corresponding increase in cost of
goods sold. The provision is adjusted periodically based on
historical and anticipated experience. Actual expense of replacing
faulty products under warranty, including parts and labor, are charged to this
provision when incurred.
Stock-based
compensation
OCZ uses
the Black-Scholes model to determine the fair value of stock options on the date
of grant and recognizes compensation expense for stock options on a
straight-line basis over the period earned and vested. Restricted
stock grants are measured based on the fair market value of the underlying stock
on the date of grant and compensation expense for restricted stock grants is
recognized on a straight-line basis over the requisite service
period.
The
amount of compensation expense recognized using the Black-Scholes model requires
OCZ to exercise judgment and make assumptions relating to the factors that
determine the fair value of its stock option grants. The fair value
calculated by this model is a function of several factors, including the grant
price, the expected future volatility and the expected term of the option and
the risk-free interest rate of the option. The expected term and
expected future volatility of the options require judgment. In
addition, OCZ is required to estimate the expected forfeiture rate and only
recognize expense for those stock options expected to vest. OCZ
estimates the forfeiture rate based on historical experience and to the extent
its actual forfeiture rate is different from its estimate, share-based
compensation expense is adjusted accordingly.
Since
OCZ’s stock-based compensation plan was established in December 2004, all
options have been issued at or above the estimated fair market value so that
there is no intrinsic value to be expensed. Stock based compensation
charged to expenses was $383,000 and $390,000 for the months ended August
31, 2010 and 2009 , respectively. As of the fiscal quarter ended
August 31, 2010, compensation costs related to non-vested options amounted
to approximately $1.415 million and will be recognized in the periods to August
31, 2015 over a weighted average term of 11 months.
The fair
value of options grants was determined using the Black-Scholes option pricing
model with the following weighted average assumptions. There were no grants in
the six months ended August 31, 2010.
Three
Months Ended
|
Six Months Ended
|
Fiscal Year Ended
|
||||||||||
August 31, 2010
|
August 31, 2010
|
February 28, 2009
|
||||||||||
Expected
dividend
|
0 | % | 0 | % | 0 | % | ||||||
Risk
free interest rate
|
2.01 | % | 2.02 | % | 2.80 | % | ||||||
Expected
volatility
|
43 | % | 45 | % | 40 | % | ||||||
Expected
life (in years)
|
4.46 | 4.32 | 4.24 |
11
3.
|
Recent
accounting pronouncements
|
There
were no recent accounting pronouncements which were deemed relevant to OCZ’s
operations.
4.
|
Inventory
|
Inventory
consists of the following:
August 31,
2010
(in thousands)
|
February 28,
2010
(in thousands)
|
|||||||
Raw
materials
|
$ | 5,569 | $ | 3,246 | ||||
Work
in progress
|
7,951 | 5,319 | ||||||
Finished
goods
|
1,875 | 1,281 | ||||||
$ | 15,395 | $ | 9,846 |
The
August 31, 2010 balances are net of a $2.8 million additional inventory reserve
taken in connection with our discontinued commodity level DRAM module
products.
5.
|
Property
and equipment
|
Net
property and equipment consists of the following:
August 31,
2010
(in thousands)
|
February 28,
2010
(in thousands)
|
|||||||
Vehicles
|
$ | 134 | $ | 135 | ||||
Furniture
and fixtures
|
37 | 38 | ||||||
Equipment
|
4,812 | 4,471 | ||||||
Leasehold
Improvements
|
439 | 439 | ||||||
5,422 | 5,083 | |||||||
Less: accumulated
depreciation
|
(2,979 | ) | (2,454 | ) | ||||
$ | 2,443 | $ | 2,629 |
Depreciation
expense for the three months ended August 31, 2010 and 2009 and the fiscal year
ended February 28, 2010 amounted to $528,000, $483,000 and $1.0 million,
respectively.
6.
|
Goodwill
and other intangible assets
|
Goodwill
represents the excess of the purchase price over the estimated fair value of the
identifiable tangible and intangible net assets acquired in business
acquisitions.
An
impairment loss would be recognized to the extent that the carrying amount
exceeds the implied fair value of the goodwill. This is determined in
a two step process. The first step compares the carrying amount of the net
assets (including goodwill) of the reporting unit to its fair
value. If fair value exceeds the carrying amount of net assets,
goodwill is not considered to be impaired and the second step of the impairment
test is not required. If the carrying amount of net assets exceeds
the reporting unit’s fair value, the second step of the impairment test is
undertaken to measure the amount of impairment loss, if any. In
determining fair value, consideration is first given to quoted market prices of
OCZ’s stock and where this is not available the estimate of fair value will be
based upon the best information available and consideration of other valuation
techniques.
12
The
second step measures the amount of impairment loss by comparing the implied fair
value of goodwill with the carrying amount of that goodwill. An
impairment loss is recognized to the extent the carrying amount of goodwill
exceeds the implied fair value of that goodwill. The implied fair
value of goodwill is determined by allocating fair value in a manner similar to
a purchase price allocation applied in a business combination. The
residual fair value after this allocation is the implied fair value of
goodwill.
Once a
goodwill impairment loss is recognized, the adjusted carrying amount of goodwill
shall be the new accounting basis and there is no subsequent reversal of
previously recognized goodwill impairment loss in future years.
Changes
in the carrying amount in goodwill and other intangible assets are summarized as
follows:
Goodwill
(in thousands)
|
Other
Intangible
assets
(in thousands)
|
|||||||
Cost
|
||||||||
As
at February 28, 2010
|
$ | 10,796 | $ | 446 | ||||
Additions
during the period for acquisition earn out payment
|
35 | — | ||||||
As
at August 31, 2010
|
$ | 10,831 | $ | 446 | ||||
Accumulated
Amortization/Impairment
|
||||||||
As
at February 28, 2010
|
$ | 842 | $ | 358 | ||||
Amortization/Impairment
for the period
|
— | 35 | ||||||
As
of August 31, 2010
|
$ | 842 | $ | 393 | ||||
Net
carrying value
|
||||||||
As
at February 28, 2010
|
$ | 9,954 | $ | 88 | ||||
As
at August 31, 2010
|
$ | 9,989 | $ | 53 |
Other
intangible assets
Intangible
assets totaling $280,000(PC Power and Cooling, Inc.) allocated to trade name and
trade marks from the above acquisitions are being amortized over 48 months on
the straight-line basis. The remaining balance of intangible assets
relating to the acquisition of the Hypersonic PC Systems assets was written off
as of February 28, 2010. Amortization expense during the six months
ended August 31, 2010 and 2009 was $35,000 and $56,000,
respectively.
The
expected amortization for the future periods is as follows:
Fiscal years ending February 28,
|
|
|||
(6
months) 2011
|
$
|
35,000
|
||
2012
|
18,000
|
|||
$
|
53,000
|
13
7.
|
Accrued
expenses
|
Accrued
expenses consist of the following:
August 31,
2010
(in thousands)
|
February 28,
2010
(in thousands)
|
|||||||
Professional fees
|
$ | 166 | $ | 230 | ||||
Interest
expense
|
49 | 50 | ||||||
Mail
in rebate provision
|
259 | 544 | ||||||
Sales
marketing program
|
1,461 | 741 | ||||||
Employee
related expenses
|
620 | 522 | ||||||
Customer
warranty provision
|
197 | 358 | ||||||
Uninvoiced
goods and services
|
1,141 | 1,196 | ||||||
Other
liabilities
|
679 | 748 | ||||||
Total
accrued expenses
|
$ | 4,572 | $ | 4,389 |
8.
|
Commitments
and contingencies
|
Lease
commitments.
OCZ and
its subsidiaries lease office and warehouse facilities under lease terms
expiring at various dates through 2013. Rent expense amounted to
$387,000 and $391,000 for the six months ended August 31, 2010 and 2009,
respectively. As of August 31, 2010, the future minimum payments due
under these non cancellable lease agreements are as follows:
Fiscal years ending February 28/29
|
(in thousands)
|
|||
(6
months) 2011
|
$ | 374 | ||
2012
|
380 | |||
2013
|
41 | |||
$ | 795 |
Contingencies.
In 2009,
OCZ received inquiries from the U.S. Department of Commerce and the Federal
Bureau of Investigation regarding the potential re-export of its products from
the United Arab Emirates into Iran. OCZ consequently launched an
internal investigation performed by outside counsel. The
investigation concluded that while between 2004 and 2008, OCZ maintained a
relationship with a distributor in the United Arab Emirates, OCZ has not found
any specific facts confirming these suspicions or any information about when
such re-exports would have occurred or who may have received the
products. However, OCZ did provide approximately $500 in sales
support materials to the distributor in connection with a sales presentation in
Iran. OCZ has terminated its relationship with this
distributor.
The
investigation separately discovered that in 2007 and 2008, in a total of three
instances, OCZ sent one of its high speed Reaper memory module products free of
charge as either samples or replacement parts to individuals in Iran and an
individual who claimed an address in Cuba but subsequently changed the address
to one in Mexico.
OCZ had
also received information that a distributor in Lebanon to whom it sold Neural
Impulse Actuators September 2008 may have re-exported one of these units into
Syria and in general was interested in distributing its products in Syria, but
OCZ has not found specific facts confirming when such re-export would have
occurred or who may have received the product. OCZ has terminated its
relationship with this distributor.
14
OCZ has
voluntarily disclosed these transactions to the U.S. Department of Commerce and
the U.S. Department of the Treasury and has cooperated fully with requests for
information from these entities as well as the Federal Bureau of
Investigation. Should the U.S. government allege that OCZ has
violated the Iranian Transaction Regulations and/or Export Administration
Regulations, the maximum fine for each violation that OCZ could be subject to
would be the greater of $250,000 or two times the value of the illegal
transaction. Based on the list price of the products in question, OCZ
believes the maximum fine per violation would be $250,000. OCZ
believes, however, there is a good faith basis for leniency if any fines are
assessed, given the relatively small number of units and revenue at issue, its
full cooperation with the U.S. government and its immediate attention to
rectifying the underlying causes of the problems. As a result of the
discovery of these events, OCZ has implemented more stringent export control
procedures to prevent inadvertent transfers and retransfers to sanctioned
countries. At this time, OCZ cannot determine an estimated cost, or range of
costs, that may be incurred upon resolution of this
matter. Accordingly, no provision has been provided for this
matter.
In July
2010, OCZ received notice that a former vendor had filed legal proceedings in
Taiwan demanding payment for materials which the Company contends were
defective. While the Company plans to vigorously defend itself, an accrual was
made as of August 31, 2010 for $1.25 million which the Company believes is the
maximum exposure to this matter.
9.
|
Bank
loan and notes payable
|
In
November 2007, OCZ obtained a bank line of credit facility with Silicon Valley
Bank ( “SVB”) in the initial amount of $10 million which was subsequently
increased to $12 million during 2008 (the “SVB Credit Facility”). SVB
had a lien on essentially all OCZ’s assets as collateral and requires periodic
operational reporting in lieu of any financial covenants other than tangible net
worth, as defined. In February 2009, in connection with the execution
of an Amendment, the SVB Credit Facility was reduced to $10 million because OCZ
was not in compliance with two financial covenants that SVB waived.
In order
to replace the SVB Credit Facility, in July 2009, OCZ entered into a Sale of
Accounts and Security Agreement with Faunus Group International, Inc, pursuant
to which OCZ may factor its foreign receivables up to $10 million in the
aggregate (as amended, the “FGI
Agreement”). Additionally, in July 2009, OCZ entered into a Loan
and Security Agreement with Silicon Valley Bank (as amended, the “SVB
Agreement” and collectively with the FGI Agreement, the “Factoring Loan
Agreements”) to factor all its domestic receivables up to $10 million in
the aggregate. The SVB Agreement also capped the aggregate debt under both
Factoring Loan Agreements to $14 million until May 10, 2010 at which time the
$14 million cap was increased to $17.5 million. Under the Factoring Loan
Agreements, OCZ has guaranteed its obligations there under and has pledged
substantially all of its assets as security. As of August 31, 2010, the
outstanding loan balances under the Factoring Loan Agreements were $13 million
in the aggregate.
Under the
SVB Agreement, OCZ can borrow an amount up to75% of the value of its approved
factored customer invoices. Interest is payable monthly on the
aggregate of the face amounts of the unpaid factored customer invoices each
month. SVB also charges a monthly collateral handling fee based upon
the unpaid factored customer invoices each month. The rate of
interest and the amount of the collateral handling fee is dependent upon OCZ’s
Quick Ratio which is defined for this purpose as OCZ’s cash, marketable
securities and accounts receivable divided by its current
liabilities. If OCZ’s Quick Ratio is greater than 0.75:1.00 in any
month, the applicable interest rate is SVB Prime plus 2.25% per annum and the
collateral handling fee is 0.10%. If OCZ Quick Ratio is less than
0.75:1.00 in any month, the applicable interest rate is SVB Prime plus 2.75% per
annum and the collateral handling fee is 0.45%. The SVB Agreement
requires that OCZ maintain a minimum Quick Ratio of at least
0.50:1.00. Receivables are subject to recourse in the event of
nonpayment by the customer.
Under the
FGI Agreement, OCZ can borrow an amount up to 75% of the value of its approved
factored customer invoices. Interest is payable each month on the
aggregate of the face amounts of the unpaid factored customer invoices at a rate
greater of 8.00% per annum or 3.00% above the rate of interest designated by FGI
as its selected “Prime Rate” or “Base Rate”, as the case may be (currently based
upon the Wall Street Journal, Money Rates Section). Additionally, FGI
charges a collateral management fee equal to 0.58% of the average monthly
balance of the face amount of the outstanding unpaid factored customer
invoices. If OCZ fails to maintain minimum monthly borrowings of at
least $2.5 million, FGI will assess a deficiency charge in an amount equal to
charges that would apply had it maintained a $2.5 million borrowing minimum for
the applicable month less the actual charges paid for such month. FGI
has the option under the FGI Agreement of buying customer invoices without
recourse. To date, FGI has not done so and OCZ doesn’t anticipate
that it will do so. Receivables are subject to recourse in the event
of nonpayment by the customer.
15
In order
to provide some bridge financing as these new financing arrangements were
established, in August 2009 OCZ borrowed $500,000 from its Chief
Executive Officer, Ryan M. Petersen, at 7.5% interest per annum. The
loan is repayable in equal installments in February 2010 and September
2010. Mr. Petersen waived payment of the February 2010 installment
until April 2010, at which time he was paid the $250,000 principal amount plus
interest accrued through April 2010. The loan was repaid in full as
scheduled in September 2010.
10.
|
Stockholders’
Equity
|
The
numbers of shares and their prices have been adjusted to reflect a 1-for-2.5
stock reverse split that took place in September 2009.
In
November 2008, OCZ issued 339,200 shares as part of a capitalization of $200,000
of an acquisition related note in favor of Douglas A. Dodson.
During
the quarter ended November 30, 2009, the Board of Directors granted options to
purchase an aggregate of 1,630,400 shares of OCZ’s common stock under OCZ’s
stock option plan with the exercise price of $1.28 per share. These options were
granted in reliance on Rule 701 of the Securities Act.
During
the fiscal year ended February 28, 2010, OCZ issued 60,990 shares of its Series
A preferred stock at $5.00 per share, which were converted into 62,733 shares of
common stock on May 4, 2010. These shares were issued in reliance on
Rule 506 of the Securities Act. In addition, OCZ also issued warrants
to purchase up to 140,520 shares of its Series A preferred stock at $5.00 per
share, which warrants were converted, on May 4, 2010, into warrants to
purchase 144,541 shares of common stock at $4.86 per share. Such
warrants were issued in reliance on Regulation S of the Securities
Act.
During
the fiscal years ended February 28, 2009 and February 29, 2008, approximately
74,000 and 328,528 shares of common stock, respectively, were issued in
connection with the exercise of stock options. There were no stock
option exercises during the fiscal year ended February 28, 2010 or in the three
months ended August 31, 2010
In March
2010, OCZ issued 5,151,662 shares of its common stock at $3.00 per share, and
29,710 shares of common stock in connection with certain services
received. OCZ also issued warrants to purchase up to 2,575,833 shares of
its common stock at $5.25 per share. In addition, OCZ issued to a
placement agent a warrant to purchase up to 154,550 shares of its common stock
at $3.00 per share and, if such a warrant were exercised, the holder of such
warrant would be entitled to receive another warrant to purchase up to 77,275
shares of its common stock at $5.25 per share. See “Warrants” below in
this footnote 10 for more detail. All of these shares of common stock
and warrants were issued in reliance on Rule 506, Regulation D, of the
Securities Act.
In
connection with OCZ’s March 2010 fund raising, OCZ entered into a registration
rights agreement which required OCZ to file a registration statement with the
SEC no later than May 21, 2010, to register 5,151,662 shares of its common stock
and 2,575,833 shares of its common stock issuable upon exercise of certain
warrants. The registration statement was filed with the SEC on May
21, 2010.
In April
2010, OCZ granted options to purchase an aggregate of 330,000 shares of its
common stock under OCZ’s stock option plan with the exercise price of $4.35 per
share, which was the fair market value per share on the date of
grant
16
In May
2010, all shares of OCZ’s Series A preferred stock and all warrants to purchase
shares of Series A preferred stock were converted into shares of common stock
and warrants to purchase shares of common stock, respectively. Under the terms
of OCZ’s certificate of incorporation with respect to OCZ’s Series A Preferred
Stock, each share of Series A Preferred Stock was to be automatically converted
into shares of common stock on the sixtieth (60th ) trading day following the
commencement of trading of OCZ’s common shares on a public stock exchange,
including OTCBB (“ Mandatory
Conversion ”). The trading of OCZ’s common shares commenced on OTCBB on
February 10, 2010, and the 60th trading day following the
commencement of trading was May 4, 2010. The number of shares of OCZ’s common
stock issued upon Mandatory Conversion was determined by dividing $5.00 by the
Denominator Price, which was determined as follows: If the sixty (60) day per
share average closing price of OCZ’s common stock on such public stock exchange
(the “60
Day Average”) is between $3.00 and $5.00, then the Denominator Price will
be the 60 Day Average. Based on the 60 Day Average of $4.86, and after taking
into account fractional shares, on May 4, 2010, 60,990 shares of OCZ’s Series A
preferred stock were converted into 62,733 shares of OCZ’s common stock, and
warrants to purchase 140,520 shares of OCZ’s Series A preferred stock were
converted into warrants to purchase 144,541 shares of OCZ’s common stock at
$4.86 per share.
The
following table summarizes shares outstanding for the six months ended August
31, 2010 and the fiscal year ended February 28, 2010.
Six
Months Ended
|
Fiscal Year Ended
|
|||||||
August 31, 2010
|
February 28, 2010
|
|||||||
(in thousands)
|
(in thousands)
|
|||||||
Shares
outstanding, beginning
|
21,278 | 21,278 | ||||||
Weighted-average
shares issued
|
4,492 | - | ||||||
Series
A Preferred stock converted
|
30 | - | ||||||
Weighted-average
shares, basic
|
25,800 | 21,278 | ||||||
Effect
of dilutive stock options and warrants
|
- | - | ||||||
Weighted-average
shares, diluted
|
25,800 | 21,278 |
Stock
incentive plan
In
December 2004, OCZ adopted a stock incentive plan with 1,800,000 shares of
common stock authorized for issuance. The shares subject to the stock
incentive plan was subsequently increased to 5,232,873. The shares
issued under the plan may be subject to forfeiture conditions, rights
of repurchase, rights of first refusal and other transfer restrictions as the
Board may determine. The options granted will expire in a term not to
exceed 10 years.
The
following table summarizes option activity for the six months ended August 31,
2010.
Number of
|
Weighted
|
|||||||||||||||||||
Shares
|
shares
|
Average
|
||||||||||||||||||
available
|
under
|
Exercise
|
Total
|
Exercise
|
||||||||||||||||
for grant
|
option
|
Price
|
$
|
Price
|
||||||||||||||||
Balance
at February 28, 2010
|
1,659,614 | 2,779,111 | $ | - | $ | 6,122,218 | $ | 2.20 | ||||||||||||
New
Authorized
|
- | - | - | - | - | |||||||||||||||
Options
granted
|
(632,842 | ) | 632,842 | 4.35 | 1,435,500 | 3.58 | ||||||||||||||
Options
exercised
|
- | (99,688 | ) | .63-1.28 | 162,281 | .97 | ||||||||||||||
Options
forfeited
|
408,015 | (408,015 | ) | $ | 1.05-$8.28 | (812,900 | ) | 2.78 | ||||||||||||
Balance
at August 31, 2010
|
1,434,787 | 2,904,250 | - | $ | 7,157,234 | $ | 2.46 |
17
The
following table summarizes information about stock options outstanding and
exercisable:
August 31, 2010
|
February 28, 2010
|
|||||||
Exercise
price range
|
$ | 0.40-$8.53 | $ | 0.40-$8.53 | ||||
Shares
outstanding
|
2,904,250 | 2,779,111 | ||||||
Weighted
average exercise price
|
$ | 2.46 | $ | 2.20 | ||||
Weighted
average contractual life
|
8.2
years
|
8.4
years
|
||||||
Shares
exercisable
|
1,453,279 | 1,287,695 | ||||||
Weighted
average exercise price
|
$ | 2.72 | $ | 2.76 | ||||
Weighted
average contractual life
|
7.3
years
|
7.5
years
|
Warrants
OCZ
issued warrant instruments on April 28, 2006, June 12, 2006 and October 12, 2006
to Merchant John East Securities Limited (f/k/a John East & Partners
Limited) as part of fee arrangements relating to its initial and follow-on
offerings on AIM and a previous private placement. The remaining warrants are
convertible into an aggregate of 142,577 shares of OCZ’s common stock, of which
warrants to exercise 97,354 shares expire on September 16, 2013, and warrants to
exercise the remaining shares expire on June 21, 2011. The exercise prices of
the shares subject to warrants are 121.88 pence (approximately $1.85 at current
exchange rates) for 45,223 shares, 162.50 pence (approximately $2.47 at current
exchange rates) for 92,194 shares and 200.00 pence (approximately $3.04 at
current exchange rates).
OCZ
issued warrant instruments in January and February 2010 to various investors in
connection with a lockup agreement. These warrants are convertible into an
aggregate of 140,520 shares of OCZ’s Series A preferred stock and expire between
July 20 and August 24, 2010 at the exercise price of $5.00 per share. On May 4,
2010, all of these warrants were converted into warrants to purchase 144,541
shares of OCZ’s common stock with an exercise price of $4.86 per share. None of
the warrants were exercised and they all have expired as of August 31,
2010.
In March
2010, OCZ issued warrants to purchase up to 2,575,833 shares of its common stock
at $5.25 per shares. In addition, OCZ issued to a placement agent a
warrant to purchase up to 154,550 shares of its common stock at $3.00 per share
and, if such a warrant were exercised, the holder of such warrant would be
entitled to receive another warrant to purchase up to 77,275 shares of its
common stock at $5.25 per share. All of these warrants will expire on
March 23, 2015.
The
warrants for the 2,575,833 shares contain certain provisions which cause them to
be classified as derivative liabilities pursuant to Accounting
Standards Codification subtopic 815-40, “Derivatives and hedging—Contracts
in Entity’s Own Equity” (ASC
815-40). Accordingly, upon issuance the warrants were recorded as a
derivative liability and valued at a fair market value of $2,081,000 which also
reduced the proceeds assigned to the equity shares issued in the fund raising.
The fair value of these warrants was decreased to $529,000 at August 31, 2010
which resulted in the recognition of a non-cash adjustment of $1,551,000 in the
Statement of Operations for the six months ended August 31, 2010. OCZ is
required to continue to adjust the warrants to fair value through current period
operations for each reporting period.
The fair
value of the warrants at March 23, 2010 was calculated using the Black-Scholes
model with the following assumptions: Dividend yield: 0%, Volatility: 47%,
Expected life: 5 years, Risk free rate: 2.02%, and a current share price of
$3.00. At August 31, 2010 the assumptions were: Dividend yield: 0%, Volatility:
43%, Expected life: 4.50 years, Risk free rate: 1.33%, and a current share price
of $1.93.
The
following table summarizes warrant activity for the fiscal year ended February
28, 2010 and the six months ended August 31, 2010.
18
Weighted
|
||||||||||||||||
average
|
||||||||||||||||
Number
|
Exercise
|
Total
|
exercise
|
|||||||||||||
of shares
|
price
|
$
|
Price
|
|||||||||||||
Balance
at February 28, 2010
|
283,097 | $ | 2.25-$5.00 | $ | 1,101,028 | $ | 3.89 | |||||||||
Warrants
granted
|
2,807,658 | 3.00-5.25 | 14,392,467 | 5.13 | ||||||||||||
Warrants
exercised
|
- | - | - | - | ||||||||||||
Warrants
forfeited
|
(144,541 | ) | 4.86 | (702,469 | ) | 4.86 | ||||||||||
Balance
at August 31, 2010
|
2,946,214 | $ | 2.25-5.25 | $ | 14,791,026 | $ | 5.02 |
11.
|
Employee
savings and retirement plan
|
OCZ has a
401(k) plan, known as the “OCZ
Pension Plan.” Eligibility to participate in the plan is
subject to certain minimum service requirements. Employees may voluntarily
contribute up to $16,500 per annum (or $22,000 for individuals over 50 years of
age), being the IRS maximum and OCZ may make matching contributions as
determined by the Board in a resolution on or before the end of the fiscal
year. Any contributions by OCZ are immediately 100% vested. OCZ did
not make any contributions in six months ended August 31, 2010 or
2009.
12.
|
Segment
and geographic information
|
OCZ
operates in a single industry segment and has three product groups comprised of
memory processing, power supplies/other, and SSD storage.
The
following table sets forth the revenues for each of OCZ’s product groups for the
six months ended August 31, 2010 and August 31, 2009:
Three Months Ended
|
Six Months Ended
|
|||||||||||||||
August 31,
|
August 31,
|
|||||||||||||||
Product Group
|
2010
|
2009
|
2010
|
2009
|
||||||||||||
(in thousands)
|
(in thousands)
|
|||||||||||||||
SSD
|
$ | 20,187 | $ | 11,146 | $ | 33,536 | $ | 21,631 | ||||||||
Memory
|
12,605 | 17,342 | 27,637 | 34,705 | ||||||||||||
Power
Supplies/other
|
5,253 | 9,307 | 11,155 | 17,230 | ||||||||||||
Total
|
$ | 38,045.00 | $ | 37,795.00 | $ | 72,328.00 | $ | 73,566.00 |
19
OCZ’s
revenues by major geographic area (based on shipping destination) were as
follows:
Three Months Ended
|
Six Months Ended
|
|||||||||||||||
August 31,
|
August 31,
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
(in thousands)
|
(in thousands)
|
|||||||||||||||
United
States
|
$ | 16,955 | $ | 13,645 | $ | 33,578 | $ | 28,532 | ||||||||
Canada
|
2,105 | 2,146 | 4,115 | 3,808 | ||||||||||||
Europe/Middle
East/Africa
|
14,500 | 15,870 | 26,709 | 29,348 | ||||||||||||
Rest
of World
|
4,485 | 6,134 | 7,906 | 11,878 | ||||||||||||
Total
|
$ | 38,045 | $ | 37,795 | $ | 72,308 | $ | 73,566 |
During
the six months ended August 31, 2010 and 2009, sales to one customer represented
20% and 17%, respectively of net revenues.
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
|
Cautionary
Statement
The following is a discussion of the
financial condition and results of operations for our fiscal quarter ended
August 31, 2010, herein referred to as “the August 2010 quarter.” Unless the
context indicates otherwise, as used herein, the terms “we,” “us,” “OCZ,” the
“Company” and “our” refer to OCZ Technology Group, Inc. on a consolidated
basis. References to “$” are to United States
dollars.
You
should read this discussion in conjunction with financial information and
related notes included elsewhere in this report. We operate and report financial
results on a fiscal year ending on the last day of February. Except as
noted, references to any fiscal year mean the twelve-month period ending on
February 28/29 of that year.
Some
of the statements and assumptions included in this Quarterly Report on
Form 10-Q are forward-looking statements within the meaning of
Section 27A of the Securities Act of 1933 or Section 21E of the
Securities Exchange Act of 1934, each as amended, including, in particular,
statements about our plans, strategies and prospects and estimates of industry
growth for the fiscal quarter ending August 31, 2010 and beyond. These
statements identify prospective information and include words such as “expects,”
“plans,” “anticipates,” “believes,” “estimates,” “predicts,” “projects” and
similar expressions. These forward-looking statements are based on information
available to us as of the date of this report. Current expectations, forecasts
and assumptions involve a number of risks, uncertainties and other factors that
could cause actual results to differ materially from those anticipated by these
forward-looking statements. Such risks, uncertainties and other factors may be
beyond our control. In particular, the decline in global economic conditions
poses a risk to our operating and financial performance as consumers and
businesses have, and may continue to, defer purchases in response to tighter
credit and negative financial conditions. Such risks and uncertainties also
include the impact of the variable demand, particularly in view of current
business and economic conditions; dependence on our ability to successfully
qualify, manufacture and sell our disk drive products in increasing volumes on a
cost-effective basis and with acceptable quality, particularly our new disk
drive products with lower cost structures; the impact of competitive product
announcements; our ability to achieve projected cost savings; and our ability to
rapidly increase our manufacturing capacity in pace with our competitors if
demand for disk drives increases. We also encourage you to read our Annual
Report on Form 10-K as filed with the U.S. Securities and Exchange
Commission (“SEC”) on May 20, 2010, as it contains information concerning risk,
uncertainties and other factors that could cause results to differ materially
from those projected in the forward-looking statements. These forward-looking
statements should not be relied upon as representing our views as of any
subsequent date and we undertake no obligation to update forward-looking
statements to reflect events or circumstances after the date they were
made.
20
Our
Management’s Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) is provided in addition to the accompanying condensed
consolidated financial statements and notes to assist readers in understanding
our results of operations, financial condition and cash
flows.
Overview
We are a
leading provider of high performance Solid State Drives (“SSDs”) and
Memory Modules for computing devices and systems. Founded in 2002, we
are incorporated in Delaware and have our headquarters in San Jose, California
and offices in Canada, The Netherlands, and Taiwan. Our fiscal year
ends on the last day of February.
Historically,
we primarily sold high performance memory modules to individual computing
enthusiasts through catalog and online retail channels. However, SSDs
have emerged as a strong market alternative to conventional disk drive
technology and are rooted in much of the same basic technological concepts as
our legacy memory module business. Today, as part of a
diversification strategy, which began in fiscal year 2009, our product mix is
significantly more weighted toward the sale of SSDs and the SSD product line has
become central to our business. In fact, in August 2010, we announced that
we were discontinuing certain commodity level DRAM module products. As a result,
our target customers are increasingly enterprises and original equipment
manufacturers (or “OEMs”).
In
addition to our SSD and Memory Module product lines, we design, develop,
manufacture and sell other high performance components for computing devices and
systems, including thermal management solutions, AC/DC switching power supplies
(or “PSU’s”) and computer gaming solutions. We offer our customers
flexibility and customization by providing a broad array of solutions which are
interoperable and can be configured alone or in combination to make computers
run faster, more reliably, efficiently and cost effectively. Through
our diversified and global distribution channel, we offer more than 450 products
to 323 customers, including leading retailers, etailers, OEMs and computer
distributors.
Our ten
largest customers measured by net revenues for our quarter ended August 31, 2010
are listed as follows in alphabetical order:
Amazon.com
|
D
& H Distributing Company
|
Magnell
Associate Inc. dba Newegg.com
|
Maxcom
Memory GmbH
|
MEMORYWORLD
GmbH & Co., KG
|
Micro
Center Corporation
|
Micro
Peripherals LTD
|
Netlink
Computer Inc.
|
SYX
Distribution Inc.
|
Tech
Data Service GmbH
|
These ten
customers represented approximately 53% our net revenue for the six months ended
August 31, 2010. Our largest customer is Magnell Associates Inc. dba
NewEgg.com, which represented approximately 20% of our revenue for the six
months ended August 31, 2010. No other customer was responsible for
10% or more of our net revenues.
We
develop flexible and customizable component solutions quickly and efficiently to
meet the ever changing market needs and provide superior customer
service. We believe our high performance computer components offer
the speed, density, size and reliability necessary to meet the special demands
of:
21
|
§
|
industrial
equipment and computer systems;
|
|
§
|
computer
and computer gaming and
enthusiasts;
|
|
§
|
mission
critical servers and high end
workstations;
|
|
§
|
personal
computer (“PC”)
upgrades to extend the useable life of existing
PCs;
|
|
§
|
high
performance computing and scientific
computing;
|
|
§
|
video
and music editing;
|
|
§
|
home
theatre PCs and digital home convergence products;
and
|
|
§
|
digital
photography and digital image manipulation
computers.
|
We
perform the majority of our research and development efforts in-house, which
increases communication and collaboration between design teams, streamlines the
development process and reduces time-to-market.
We
commenced operations in 2002 and shares of our common stock began trading on AIM
in June 2006. On April 28, 2006, we amended our certificate of
incorporation to, among other matters, effect a 3-for-1 forward stock
split. In May 2007, we acquired PC Power and Cooling, Inc., a
privately-held manufacturer of power supplies that was based in San Diego,
California. We now offer both PC Power and Cooling, Inc. and OCZ
branded power supplies. In October 2007, we acquired substantially
all of the assets of Silicon Data Inc., doing business as Hypersonic PC Systems,
a privately-held manufacturer of high performance gaming PCs and laptops aimed
at the computer gaming community that was based in Great Neck, New
York. In March 2009, we amended our certificate of incorporation
primarily to increase the number of authorized shares and eliminate a number of
provisions which required us to comply with various United Kingdom laws in the
case of, among other things, takeovers and tender offers. On April 1,
2009, following appropriate stockholder approval, we voluntarily delisted our
common stock from trading on AIM. On January 14, 2010, our common
stock was listed on the Over The Counter Bulletin Board (“OTCBB”), and from
February 10, 2010 to April 22, 2010, our common stock was traded on the
OTCBB. Since April 23, 2010, our common stock has been traded on
The NASDAQ Capital Market.
As of
August 31, 2010, we had approximately 360 customers, most of which are
distributors, system integrators, retailers and etailers in 60
countries.
In
September 2009, we sold all inventory, patents and other assets related to our
Neural Impulse Actuator product line to BCInet, Inc., a Delaware corporation, in
exchange for notes with principal amounts in the aggregate of $895,415 and
shares of BCInet, Inc.’s Series A preferred stock, representing a 27% equity
stake in BCInet, Inc. Also in September 2009, we amended our
certificate of incorporation to affect a 1-for-2.5 reverse stock
split. All share amounts in this document have been adjusted for the
effect of this reverse split.
22
Results
of Operations for Three and Six Months Ended August 31, 2010 and
2009
The
following table sets forth our financial results, as a percentage of net
revenues for the periods indicated.
Three Months Ended
|
Six Months Ended
|
|||||||||||||||
August 31,
|
August 31,
|
|||||||||||||||
unaudited
|
unaudited
|
|||||||||||||||
2010
|
2009
|
2010
|
2009
|
|||||||||||||
Net
revenues
|
100.0 | % | 100.0 | % | 100.0 | % | 100.0 | % | ||||||||
Cost
of revenues
|
95.7 | % | 83.4 | % | 92.0 | % | 86.5 | % | ||||||||
Gross
profit
|
4.3 | % | 16.6 | % | 8.0 | % | 13.5 | % | ||||||||
Sales
and marketing
|
9.6 | % | 6.8 | % | 8.8 | % | 7.1 | % | ||||||||
Research
and development
|
4.5 | % | 3.2 | % | 4.5 | % | 3.7 | % | ||||||||
General,
administrative and operations
|
12.8 | % | 10.1 | % | 11.2 | % | 10.3 | % | ||||||||
Total
operating expenses
|
26.8 | % | 20.0 | % | 24.5 | % | 21.0 | % | ||||||||
Operating
income (loss)
|
-22.5 | % | -3.4 | % | -16.6 | % | -7.5 | % | ||||||||
Other
income (expense) - net
|
0.0 | % | -0.2 | % | 0.0 | % | 0.1 | % | ||||||||
Interest
and financing costs
|
-1.6 | % | -1.0 | % | -1.6 | % | -0.9 | % | ||||||||
Adjustment
to the fair value of common stock warrants
|
6.4 | % | 0.0 | % | 2.1 | % | 0.0 | % | ||||||||
Income
(loss) before income taxes
|
-17.7 | % | -4.6 | % | -16.0 | % | -8.2 | % | ||||||||
Income
tax expense (benefit)
|
2.2 | % | 0.0 | % | 1.2 | % | 0.0 | % | ||||||||
Net
income (loss)
|
-19.9 | % | -4.6 | % | -17.2 | % | -8.2 | % |
Comparison
of the Three Months Ended August 31, 2010 and 2009
Historically,
we primarily sold high performance memory modules to individual computing
enthusiasts through catalog and online retail channels. However, SSDs
have emerged as a strong market alternative to conventional disk drive
technology and SSDs are rooted in much of the same basic technological concepts
as our legacy memory module business. Today, as part of a
diversification strategy which began in fiscal year 2009, our product mix is
significantly more weighted toward the sale of SSDs and the SSD product line has
become central to our business. In fact, in August 2010, we announced
that we were discontinuing certain commodity level DRAM module
products. As a result, our target customers are increasingly
enterprises and original equipment manufacturers (or “OEMs”).
Net revenues. Net
revenues increased by $250,000, or 0.7% to $38.0 million for the three months
ended August 31, 2010 compared with $37.8 million for the three months
ended August 31, 2009. Although the increase in net sales was
relatively small, the mix of products sold was significantly different. Memory
net revenues decreased by $4.7 million to $12.6 million for the three months
ended August 31, 2010 compared with $17.3 million for the three months ended
August 31, 2009 as we discontinued the sale of our commodity level DRAM module
products and sold 51% less memory units. Power supplies and other net
revenues also decreased by $4.1 million to $5.2 million for the three months
ended August 31, 2010 compared with $9.39 million for the three months ended
August 31, 2009 due in part to our inability to receive power supply parts in
the quarter in time to meet the market demand for our power
supplies. The decreases in memory and power supplies and other net
revenues was offset by $9.0 million or 81% increase in SSD net revenues to $20.2
million for the six months ended August 31, 2010 compared with $11.2 million for
the six months ended August 31, 2009 due to increased demand in SSD
products.
23
Cost of
revenues. Cost of revenues increased by $4.9 million, or
15.5%, to $36.4 million for the three months ended August 31, 2010 compared with
$31.5 million for three months ended August 31, 2009. Cost of
revenues as a percentage of net revenues was 95.7% for the three months ended
August 31, 2010 compared with 83.4% for the three months ended August 31,
2009. This increase was largely attributable to a $2.8 million
additional inventory reserve taken in connection with our discontinued commodity
level DRAM module products coupled with an 81% increase in the number of SSD
units sold which have a higher cost to manufacture than memory
products.
Sales and marketing
expenses. Sales and marketing expenses increased by $1.1
million, or 42.7%, to $3.7 million for the three months ended August 31, 2010
compared with $2.6 million for the three months ended August 31,
2009. Sales and marketing expenses were 9.6% and 6.8% of net revenues
for the three months ended August 31, 2010 and 2009,
respectively. The increases in both absolute dollars and percentage
were due to higher costs related to our sales and marketing programs primarily
focused on our SSD products.
Sales and
marketing expenses include stock-based compensation expense of $46,000 and
$34,000 for the three months ended August 31, 2010 and 2009,
respectively.
Research and development
expenses. Research and development expenses increased by
$490,000, or 40.7% to $1.7 million for the three months ended August 31, 2010
compared with $1.2 million for the three months ended August 31,
2009. Research and development expenses were 4.5% and 3.2% of net
revenues in the three months ended August 31, 2010 and 2009,
respectively. The increases in both absolute dollars and percentage
were primarily due to additional resources used in the development of our SSD
products.
Research
and development expenses include stock-based compensation expense of $66,000 and
$35,000 for the three months ended August 31, 2010 and 2009,
respectively.
General, administrative and
operations expenses. General, administrative and operations
expenses increased by $1 million, or 27.5%, to $4.8 million for the three months
ended August 31, 2010 compared with $3.8 million for the three months ended
August 31, 2009. General, administrative and operations expenses were
12.8% and 10.1% of net revenues in the three months ended August 31, 2010 and
2009, respectively. The increase in absolute dollars was primarily
due to $200,000 of reduced shipping costs resulting from a higher mix of SSD
sales. This reduction was offset by a $1.25 million charge related to
a legal action asserted by a former product vendor.
General
and administrative expenses include stock-based compensation expenses of $88,000
and $66,000 for the three months ended August 31, 2010 and 2009,
respectively.
Other
income/(expense)-net. Other expense-net increased by $57,000
or 87.7% to ($8,000) for the three months ended August 31, 2010 compared with
($65,000) in the three month ended August 31, 2009. This change was the result
of a $10,000 foreign translation loss and $1,000 other expense in the three
months ended August 31, 2010 compared with a $30,000 foreign translation loss
and $38,000 other expense in the three months ended August 31,
2009.
Interest and Financing
Costs. Interest and financing costs increased $253,000 to
$626,000 for the three months ended August 31, 2010 compared with $373,000 for
the three months ended August 31, 2009. This increase was primarily
due to the higher interest rates and fees charged on borrowed funds payable
under our new credit facilities which began in August 2009 coupled with higher
amounts borrowed.
Adjustment to the fair value of
common stock warrants. On March 23, 2010 we issued warrants to
purchasers of common stock and we are required to adjust the warrants to fair
value through current period operations for each reporting period. Accordingly,
we recorded a non-cash gain of $2.4 million related to a fair value adjustment
as of August 31, 2010 for the embedded derivative in those
warrants. No such warrants were outstanding on August 31, 2009 and
therefore no related charge needed to be recorded.
Provision for Income
taxes. The provision for income taxes increased to $836,000
for the three months ended August 31, 2010 from zero for the three month periods
ended August 31, 2009. This increase was due to the increase in the
valuation allowance for our deferred tax assets due to losses sustained in this
quarter, due partially to the discontinuance of the commodity level DRAM module
products.
24
Comparison
of the Six Months Ended August 31, 2010 and 2009
Net revenues. Net
revenues decreased by $1.2 million, or 1.6% to $72.3 million for the six months
ended August 31, 2010 compared with $73.6 million for the six months ended
August 31, 2009. Although the decrease in net sales was relatively
small, the mix of products sold was significantly different. Memory net revenues
decreased by $7.1 million to $27.6 million for the six months ended August 31,
2010 compared with $34.7 million for the six months ended August 31, 2009 as we
discontinued the sale of our commodity level DRAM module products and sold 59%
less memory units. Power supplies and other net revenues also
decreased by $6.1 million to $11.1 million for the six months ended August 31,
2010 compared with $17.2 million for the six months ended August 31, 2009.
Approximately $4.0 million of this decrease was due to less Flash memory sales
with the increased SSD revenues. The remaining decline was due in part to our
inability to receive power supply parts in time to meet the market demand for
our power supplies. The decreases in memory and power supplies and
other net revenues was offset by a $11.9 million or 55% increase in SSD net
revenues to $33.5 million for the six months ended August 31, 2010 compared with
$21.6 million for the six months ended August 31, 2009 due to increased demand
in SSD products.
Cost of
revenues. Cost of revenues increased by $2.9 million, or 4.6%,
to $66.5 million for the six months ended August 31, 2010 compared with $63.6
million for six months ended August 31, 2009. Cost of revenues as a
percentage of net revenues was 92.0% for the six months ended August 31, 2010
compared with 86.5% for the six months ended August 31, 2009. This
increase was largely attributable to a $2.8 million inventory reserve taken in
connection with our discontinued commodity level DRAM module products coupled
with an 85% increase in SSD units sold which have a higher cost to manufacturer
than memory products.
Sales and marketing
expenses. Sales and marketing expenses increased by $1.2
million, or 22.5%, to $6.4 million for the six months ended August 31, 2010
compared with $5.2 million for the six months ended August 31,
2009. Sales and marketing expenses were 8.8% and 7.1% of net revenues
for the six months ended August 31, 2010 and 2009, respectively. The
increases in both absolute dollars and percentage were due to higher costs
related to our sales and marketing programs primarily focused on our SSD
products.
Sales and
marketing expenses include stock-based compensation expense of $88,000 and
$103,000 for the six months ended August 31, 2010 and 2009,
respectively.
Research and development
expenses. Research and development expenses increased by
$546,000, or 21.0% to $3.3 million for the six months ended August 31, 2010
compared with $2.7 million for the six months ended August 31,
2009. Research and development expenses were 4.5% and 3.7% of net
revenues in the six months ended August 31, 2010 and 2009,
respectively. The increases in both absolute dollars and percentage
were primarily due to additional resources used in the development of our SSD
products.
Research
and development expenses include stock-based compensation expense of $127,000
and $109,000 for the six months ended August 31, 2010 and 2009,
respectively.
General, administrative and
operations expenses. General, administrative and operations
expenses increased by $566,000, or 7.5%, to $8.1 million for the six months
ended August 31, 2010 compared with $7.6 million for the six months ended August
31, 2009. General, administrative and operations expenses were 11.2%
and 10.3% of net revenues in the six months ended August 31, 2010 and 2009,
respectively. The increase in absolute dollars was primarily due to
$480,000 of reduced shipping costs resulting from a higher mix of SSD sales and
$245,000 of lower legal and accounting expenses. This reduction was offset by a
$1.25 million charge related to a legal action asserted by a former product
vendor.
General
and administrative expenses include stock-based compensation expenses of
$169,000 and $178,000 for the three months ended August 31, 2010 and 2009,
respectively.
Other
income/(expense)-net. Other expense-net increased by $80,000
or 116.4% to ($11,000) for the six months ended August 31, 2010 from a $69,000
gain in the six month ended August 31, 2009. This change was the result of a
$15,000 foreign translation loss in the six months ended August 31, 2010
compared with a $106,000 foreign translation gain in the six months ended August
31, 2009.
25
Interest and Financing
Costs. Interest and financing costs increased $542,000 to $1.2
million for the six months ended August 31, 2010 compared with $626,000 for the
six months ended August 31, 2009. This increase was primarily due to
the higher interest rates and fees charged on borrowed funds payable under our
new credit facilities which began in August 2009 coupled with higher amounts
borrowed.
Adjustment to the fair value of
common stock warrants. On March 23, 2010 we issued warrants to
purchasers of common stock which required us to record a non-cash gain of $1.6
million related to a fair value adjustment as of August 31, 2010 for the
embedded derivative in those warrants. No such warrants were
outstanding on August 31, 2009 and therefore no related charge needed to be
recorded.
Provision for Income
taxes. The provision for income taxes increased $837,000
to $836,000 for the six months ended August 31, 2010 compared with $1,000 tax
benefit for the six months ended August 31, 2009. This increase was due to the
increase in the valuation allowance for our deferred tax assets due to losses
sustained in this quarter, due partially to the discontinuance of the commodity
level DRAM module products.
Liquidity
and Capital Resources
Since our
inception, we have historically not generated cash from operations and have
relied upon funds from equity offerings and debt financing.
Operating Activities.
Net cash provided (used) by operating activities was ($14,776) million and
($72,000) for the six months ended August 31, 2010 and 2009, respectively.
Net cash was used by operating activities during six months ended August 31,
2010 in a number of ways. We had a $12.4 million loss for the six
months ended August 31, 2010. Additionally, cash was used to increase
accounts receivable by $8.2 million, inventory by $8.3 million and prepaid
expenses by $704,000. We also had a $1.6 million non-cash gain for stock
warrants which needs to be excluded when analyzing cash used by operating
activities. These cash uses for the six months ended August 31, 2010 were
partially offset by an increase in accounts payable of $11.2 million as we were
able to establish more industry typical credit terms with its vendors. In late
August, the Company issued a standby letter of credit for $600,000 which enabled
access to a new vendor’s credit line of which $2.1 million was utilized as of
August 31, 2010. As collateral for the standby letter of credit, the
Company has deposited $600,000 into a separate money market account at SVB as
collateral for the standby letter of credit. The cash uses were also offset by
increases in accrued and other liabilities by $183,000. The cash uses
were further offset by a $2.8 million charge for inventory reserves, $563,000 of
depreciation and amortization expenses, $496,000 for bad debt expense and
$384,000 for non-cash stock based compensation. These cash uses
primarily reflect us using the $13.9 million of net proceeds raised in March
2010 to bolster working capital as we increased inventory for future sales, sold
additional product on credit and bought additional raw materials from vendors on
credit. Net cash used by operating activities for the six
months ended August 31, 2009 was due primarily to a $6.0 million loss coupled
with a $3.6 million decrease in accounts payable partially offset by a decrease
in accounts receivable of $3.4 million, a decrease in inventory of $4.4
million, a decrease in prepaid expenses and other assets of $67,000 and an
increase in accrued and other liabilities of $393,000. The decreases
in accounts receivable and inventory for the six months ended August 31,
2009 were primarily due to better collection efforts and higher sales of
existing inventory.
Investing activities.
Net cash used by our investing activities was $356,000, and $757,000 for the six
months ended August 31, 2010 and 2009, respectively. Of these amounts,
$342,000 and $555,000, respectively, were related to the purchase of fixed
assets including those needed to support our growth and establish our warehouse
and manufacturing facility in Taiwan. These amounts also include earn out
payments for the 2007 acquisition of PC Power & Cooling of $35,000 and
$241,000 for the six months ended August 31, 2010 and 2009,
respectively.
26
Financing activities.
Net cash provided (used) by our financing activities was $16.5 million and $1.4
million for the six months ended August 31, 2010 and 2009, respectively.
Cash provided by financing activities in the six months ended August 31, 2010
primarily reflects our common stock issuance of $13.9 million (net of expenses)
and $2.7 million of additional bank loans, partially offset by the $250,000
principal payment of a shareholder loan from our Chief Executive Officer, Ryan
Petersen. In March 2010, we issued an aggregate of 5,151,662 shares of our
common stock at $3.00 per share in connection with a private placement, whereby
we received gross proceeds of $15.45 million and incurred $1.58 million of fund
raising costs. The $13.9 million (net of expenses) sale of common stock
also included the issuance of warrants to purchase up to (i) 2,575,833 shares of
our common stock at $5.25 per share and (ii) 154,550 shares of our common stock
at $3.00 per share. The net cash provided by financing activities of
$1.4 million for the six months ended August 31. 2009 was due to $870,000 of
additional bank loans and $500,000 from the proceeds of a loan to the Company by
our Chief Executive Officer, Ryan Petersen.
Other
factors affecting liquidity and capital resources.
We have
historically not generated cash from operations and have relied upon equity
offerings and debt financing to support our growth objectives. In July
2009, we entered into a Sale of Accounts and Security Agreement with Faunus
Group International, Inc, pursuant to which we may factor our foreign
receivables up to $10 million in the aggregate (as amended, the “FGI
Agreement”). Additionally, in July 2009, we entered into a Loan and
Security Agreement with Silicon Valley Bank (as amended, the “SVB
Agreement” and collectively with the FGI Agreement, the “Factoring Loan
Agreements”) to factor all our domestic receivables up to $10 million in
the aggregate. The SVB Loan Agreement caps the aggregate debt under both
Factoring Loan Agreements to $17.5 million. Under the Factoring Loan
Agreements we have guaranteed our obligations there under and have pledged
substantially all of our assets as security. As of August 31, 2010 and
February 28, 2010, the aggregate outstanding loan balances under the Factoring
Loan Agreement were $13.0 million and $10.4 million, respectively. While
there is still borrowing capability of $4.4 million as of August 31, 2010, in
the existing Factoring Loan Agreements, we may need additional capacity under
the lines to help finance the expected growth of the SSD market in the next
twelve months.
Under the
SVB Agreement, we can borrow an amount up to 75% of the value of our approved
factored customer invoices. Interest is payable monthly on the
aggregate of the face amounts of the unpaid factored customer invoices each
month. SVB also charges a monthly collateral handling fee based upon
the unpaid factored customer invoices each month. The rate of
interest and the amount of the collateral handling fee is dependent upon our
Quick Ratio which is defined for this purpose as our cash, marketable securities
and accounts receivable divided by our current liabilities. If our Quick Ratio
is greater than 0.75:1.00 in any month, the applicable interest rate is SVB
Prime plus 2.25% per annum and the collateral handling fee is
0.10%. If our Quick Ratio is less than 0.75:1.00 in any month, the
applicable interest rate is SVB Prime plus 2.75% per annum and the collateral
handling fee is 0.45%. The SVB Agreement requires a minimum Quick
Ratio of 0.50:1.00. As of August 31, 2010 our Quick Ratio was
55.4%. Receivables are subject to recourse in the event of nonpayment
by the customer.
Under the
FGI Agreement, we can borrow an amount up to 75% of the value of its approved
factored customer invoices. Interest is payable each month on the
aggregate of the face amounts of the unpaid factored customer invoices at a rate
greater of 8.00% per annum or 3.00% above the rate of interest designated by FGI
as its selected “Prime Rate” or “Base Rate”, as the case may be (currently based
upon the Wall Street Journal, Money Rates Section). Additionally, FGI
charges a collateral management fee equal to 0.58% of the average monthly
balance of the face amount of the outstanding unpaid factored customer
invoices. If we fail to maintain minimum monthly borrowings of at
least $2.5 million, FGI will assess a deficiency charge in an amount equal to
charges that would apply had we maintained a $2.5 million borrowing minimum for
the applicable month less the actual charges paid for such month. FGI
has the option under the FGI Agreement of buying customer invoices without
recourse. To date, FGI has not done so and we do not anticipate that
it will do so. Receivables are subject to recourse in the event of
nonpayment by the customer.
In order
to provide some bridge financing as these new financing arrangements were
established, in August 2009 we borrowed $500,000 from our Chief Executive
Officer, Ryan M. Petersen, at 7.5% interest per annum. The loan is
repayable in equal installments in February 2010 and September 2010. Even
though the first installment of the loan to Mr. Petersen was due in February,
Mr. Petersen waived payment until April 2010, at which time he was paid the
first installment amount plus interest accrued through April 2010. In
September 2010, the loan from Mr. Petersen and all related interest was paid in
full. Also, we may incur additional debt in the future, subject to
certain limitations contained in our debt instruments.
27
The SVB
Agreement replaced our prior agreement with Silicon Valley Bank. Since we
entered into this new agreement, we have been in full compliance with all of its
requirements. However, under our prior agreement, we had certain measures
of financial performance that we were required to meet and, on occasion, with
which we were unable to comply. In February through May of 2009, we did
not meet a minimum required threshold as set forth in the original Silicon
Valley Bank agreement for a financial performance ratio called a ‘quick ratio’
which is the ratio of our cash, marketable securities and accounts receivable
divided by our liabilities, and Silicon Valley Bank granted us a waiver for
these months. In addition, in May 2009, we did not meet a threshold
requirement for a minimum amount of earnings before interest, taxes,
depreciation and amortization (“EBITDA”)
and Silicon Valley Bank also granted us a waiver in this instance as well.
Although the ‘quick ratio’ test remains in our current SVB Agreement, it does
not contain a minimum EBITDA covenant.
The SVB
Agreement also has a number of other requirements, also called covenants, with
which we are required to comply, including among other things:
|
§
|
delivery
of monthly and annual financial
statements;
|
|
§
|
tax,
deposit account and insurance
requirements;
|
|
§
|
restrictions
on our ability to complete dispositions, debt incurrence, distributions,
investments, liens, mergers and acquisitions;
and
|
|
§
|
certain
financial covenants that are tested on a monthly
basis.
|
The FGI
Agreement has a number of covenants with which we are required to comply,
including among other things:
|
§
|
delivery
of monthly and annual financial
statements;
|
|
§
|
giving
notice if we have a material adverse change and under other circumstances;
and
|
|
§
|
restrictions
on our ability to complete dispositions, debt incurrence, distributions,
investments and other liens.
|
There is
no assurance that we will be able to comply with one or more covenants of our
Factoring Loan Agreements in the future. If we violate one or more
covenants in the Factoring Loan Agreements and do not receive a waiver, the
lender could choose to accelerate payment effectively causing all loan balances
to become due.
We
incurred losses substantially in excess of our internal forecasts in the second
quarter and in the year to date results largely because of significant pricing
concessions to sell certain portions of our memory products. We are in the
process of de-emphasizing a significant portion of this product line. The
results of our SSD product sales were a positive development and we expect these
results to continue to be strong into the foreseeable future. We expect that we
will continue to incur weak margins on our commodity based DRAM
products, though we believe we have reduced our inventory costs through
valuation reserves recorded in the second quarter of fiscal 2011 such that we
will not generate significant losses on these sales.
We have
used $14.7 million of cash in our operating activities for the six months ended
August 31, 2010 compared to $72,000 of cash used in our operating activities for
the six months ended August 31, 2009. This substantial increase in
cash used in operating activities, was financed by the $16.5 million in cash
from financing activities in the six months ended August 31, 2010 compared to
$1.4 million in cash flow from financing activities for the six months ended
August 31, 2009. We may seek additional credit availability under our
existing Factoring Loan Agreements and will be looking to generate cash flow
from operations to service our debt, support working capital needs, finance
capital investment and increase research and development. We could be
required, or could elect, to seek additional funding through public or private
equity or debt financing and additional funds may not be available on terms
acceptable to us or at all.
28
Our
ability to generate cash depends on many factors beyond our
control. Our ability to make payments on our debt and to fund working
capital requirements, capital expenditures and research and development efforts
will depend on our ability to generate cash in the future. Our
historical financial results have been, and we expect our future financial
results will be, subject to substantial fluctuation based upon a wide variety of
factors, many of which are not within our control. If we do not
generate sufficient cash flow from operations to satisfy our debt obligations,
we may have to undertake alternative financing plans, such as refinancing or
restructuring our debt, selling assets, reducing or delaying capital investments
or seeking to raise additional capital. Also, certain of these
actions would require the consent of our lenders. The terms of our
financing agreements contain limitations on our ability to incur
debt. We cannot assure you that any refinancing would be possible,
that any assets could be sold, or, if sold, of the timing of the sales and the
amount of proceeds realized from those sales, or that additional financing could
be obtained on acceptable terms, if at all, or would be permitted under the
terms of our various debt instruments then in effect. Our inability
to generate sufficient cash flow to satisfy our debt obligations, or to
refinance our obligations on commercially reasonable terms, would have an
adverse effect on our business, financial condition and results of
operations.
Off-Balance
Sheet Arrangements
We do not
have any off-balance sheet arrangements.
Contractual
Obligations
The
following table summarizes our outstanding contractual obligations as of August
31, 2010:
PAYMENTS
DUE BY PERIOD
(in thousands)
|
Total
|
Less
than 1
year
|
1-3
years
|
3-5
years
|
More
than 5
years
|
|||||||||||||||
Current
debt obligations
|
$
|
250
|
$
|
250
|
$
|
-
|
$
|
-
|
$
|
-
|
||||||||||
Operating
lease obligations
|
$
|
795
|
$
|
661
|
$
|
134
|
-
|
-
|
||||||||||||
Total
|
$
|
1,045
|
$
|
911
|
$
|
134
|
$
|
-
|
$
|
-
|
Inflation
Inflation
was not a material factor in either revenues or operating expenses during the
six months ended August 31, 2010 and 2009.
Critical
Accounting Policies and Estimates
Our
discussion and analysis of our financial condition and results of operations are
based upon our consolidated financial statements, which have been prepared in
accordance with GAAP. The preparation of these financial statements
requires us to make estimates and judgments that affect the reported amount of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and the reported amount of revenues and
expenses for each period. Information with respect to our critical
accounting policies which we believe could have the most significant effect on
our reported results and require subjective or complex judgments is contained in
the notes to the consolidated financial statements in our Annual Report on Form
10-K for the fiscal year ended February 28, 2010 which was filed with the SEC on
May 20, 2010. These critical accounting policies relate to revenue
recognition, inventory, income taxes, goodwill and other intangibles, and share
based compensation. There have been no material changes to our
critical accounting policies since February 28, 2010.
29
New
Accounting Pronouncements
In
January 2010, the FASB issued a new accounting standards update for fair value
measurements and disclosures. A reporting entity should disclose
separately the amounts of significant transfers in and out of Level 1 and Level
2 and describe the reasons for the transfers. A reporting entity
should separately disclose information about purchases, sales, issuances and
settlements for Level 3 reconciliation disclosures. The new
disclosures and clarifications of existing disclosures are effective for
financial statements issued interim or annual financial periods ending after
December 15, 2009, with the exception for the reconciliation disclosures for
Level 3, which are effective for financial statements issued interim or annual
financial periods ending after December 15, 2010. The adoption of the new
accounting standards update did not have a material impact on our consolidated
results of operations, financial condition or financial
disclosures.
Item
3. Quantitative and Qualitative Disclosures About Market
Risk
Foreign
Currency Exchange Risk
Although
the functional currency of our foreign offices is their local currency, we bill
almost all of our sales for our products in U.S.
dollars. Accordingly, our results of operations and cash flows are
subject to a limited extent to fluctuations due to changes in foreign currency
exchange rates. In the event our foreign sales and expenses increase,
and we also increase our sales denominated in currencies other than U.S.
dollars, our operating results may be more affected by fluctuations in the
exchange rates of other currencies. The volatility of applicable
rates is dependent on many factors that we cannot forecast with reliable
accuracy. At this time we do not, but we may in the future, invest in
derivatives or other financial instruments in an attempt to hedge our foreign
currency exchange risk.
Interest
Rate Sensitivity
Interest
income and expense are sensitive to changes in the general level of U.S.
interest rates. However, because our interest income historically has
been negligible, we believe that there is no material risk of
exposure.
Item
4T. Controls and Procedures
Evaluation
of disclosure Controls and Procedures
Based on
management’s evaluation (with the participation of our Chief Executive Officer
(“CEO”) and Chief Financial Officer (“CFO”)), at the end of the period covered
by this report, our CEO and CFO have concluded that our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act)
are effective.
Changes
in Internal Control over Financial Reporting
There
were no changes to our internal control over financial reporting (as defined in
Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the
second quarter of our fiscal year ended February 28, 2011 that have materially
affected, or are reasonably likely to materially affect, our internal control
over financial reporting.
PART
II. OTHER INFORMATION
Item
1. Legal Proceedings.
On July
23, 2010, a former product vendor, Akust Technology Co., Ltd. filed a lawsuit
against us in the Taiwan Taoyuan District Court in Taiwan claiming approximately
$1.25 million in damages plus interest. Akust claims that it was
entitled to receive the $1.25 million as payment for various shipments of
products it claimed it made to us in 2008. We intend to fully defend
ourselves against this claim.
30
In 2009,
we received inquiries from the U.S. Department of Commerce and the Federal
Bureau of Investigation regarding the potential re-export of our products from
the United Arab Emirates into Iran. We consequently launched an
internal investigation performed by outside counsel. The
investigation concluded that while between 2004 and 2008, we maintained a
relationship with a distributor in the United Arab Emirates, we have not found
any specific facts confirming these suspicions or any information about when
such re-exports would have occurred or who may have received the
products. However, we did provide approximately $500 in sales support
materials to the distributor in connection with a sales presentation in
Iran. We have terminated our relationship with this
distributor.
The
investigation separately discovered that in 2007 and 2008, in a total of three
instances, we sent one of our high speed Reaper memory module products free of
charge as either samples or replacement parts to individuals in Iran and an
individual who claimed an address in Cuba but subsequently changed the address
to one in Mexico.
We also
have received information that a distributor in Lebanon to whom we sold Neural
Impulse Actuators September 2008 may have re-exported one of these units into
Syria and in general was interested in distributing our products in Syria, but
we have not found specific facts confirming when such re-export would have
occurred or who may have received the product. We have terminated our
relationship with this distributor.
We have
voluntarily disclosed these transactions to the U.S. Department of Commerce and
the U.S. Department of the Treasury and have cooperated fully with requests for
information from these entities as well as the Federal Bureau of Investigation.
Should the U.S. government allege that we have violated the Iranian Transaction
Regulations and/or Export Administration Regulations, the maximum fine for each
violation that we could be subject to would be the greater of $250,000 or two
times the value of the illegal transaction. Based on the list price
of the products in question, we believe the maximum fine per violation would be
$250,000. We believe, however, there is a good faith basis for
leniency if any fines are assessed, given the relatively small number of units
and revenue at issue, our full cooperation with the U.S. government and our
immediate attention to rectifying the underlying causes of the problems. As a
result of the discovery of these events, we have implemented more stringent
export control procedures to prevent inadvertent transfers and retransfers to
sanctioned countries.
Item
1A. Risk Factors.
The Risk
Factors included in our Annual Report on Form 10-K for the fiscal year ended
February 28, 2010, which was filed with the SEC on May 20, 2010, have not
materially changed.
Item
2. Unregistered Sales of Equity Securities and Use of
Proceeds.
Not applicable.
Item
3. Defaults Upon Senior Securities.
Not applicable.
Item
4. Removed and Reserved.
Item
5. Other Information.
Not
applicable.
31
Item
6. Exhibits.
Exhibit No.
|
Description
|
|
31.1*
|
Certification
of Chief Executive Officer Pursuant to Rule 13-14(a) of the Securities
Exchange Act of 1934 as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
31.2*
|
Certification
of Chief Financial Officer Pursuant to Rule 13-14(a) of the Securities
Exchange Act of 1934 as Adopted Pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.
|
|
32.1**
|
Certification
of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
|
32.2**
|
Certification
of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted
Pursuant to Section 906 of the Sarbanes-Oxley Act of
2002.
|
*
|
Filed
herewith
|
**
|
Furnished
herewith
|
32
SIGNATURES
Pursuant to the requirements of the
Securities Exchange Act of 1934, the registrant has duly caused this report to
be signed on its behalf by the undersigned thereunto duly
authorized.
OCZ
TECHNOLOGY GROUP, INC.
|
|
/s/ Ryan M.
Petersen
|
|
Ryan
M. Petersen,
|
|
President
and Chief Executive Officer
|
|
/s/ Arthur F. Knapp,
Jr.
|
|
Arthur
F. Knapp, Jr.
|
|
Chief
Financial Officer
|
Date: October
15, 2010
33