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EX-31.2 - ZCO LIQUIDATING Corpv208106_ex31-2.htm
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EX-32.1 - ZCO LIQUIDATING Corpv208106_ex32-1.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 November 30, 2010

Commission File Number:
1-34650

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. Yes x      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 ¨     No x

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.


 
 

 
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
   
21
 
 
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
   
31
 
 
Item 4T
Controls and Procedures
   
31
 
             
PART II. 
OTHER INFORMATION
       
 
Item 1.
Legal Proceedings
   
31
 
 
Item 1A.
Risk Factors
   
32
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
   
32
 
 
Item 3.
Defaults Upon Senior Securities
   
32
 
 
Item 4.
Removed and Reserved
   
32
 
 
Item 5.
Other Information
   
32
 
 
Item 6.
Exhibits
   
33
 
 
Signatures
   
34
 

 
2

 
 
PART I.  FINANCIAL INFORMATION

Item 1.    Financial Statements
 
OCZ Technology Group, Inc.
Consolidated Balance Sheets
($ in thousands)
 
   
November 30, 2010
   
February 28, 2010
 
   
unaudited
       
             
ASSETS
           
Current Assets:
           
Cash and cash equivalents
 
$
20,103
   
$
1,224
 
Accounts receivable, net of allowances of $2,659 and $2,853
   
30,010
     
20,380
 
Inventory, net
   
16,482
     
9,846
 
Note receivable
   
375
     
375
 
Deferred tax asset, net
   
-
     
836
 
Prepaid expenses and other current assets
   
2,756
     
1,811
 
Total current assets
   
69,726
     
34,472
 
Property and equipment, net
   
2,550
     
2,629
 
Intangible asset
   
35
     
88
 
Goodwill
   
9,989
     
9,954
 
Investment
   
668
     
668
 
Other assets
   
42
     
38
 
Total assets
 
$
83,010
   
$
47,849
 
                 
LIABILITIES AND STOCKHOLDERS' EQUITY
               
Current liabilities:
               
Loans payable
 
$
15,437
   
$
10,354
 
Note payable
   
-
     
500
 
Accounts payable
   
38,350
     
26,318
 
Accrued and other liabilities
   
6,560
     
4,389
 
Total current liabilities
   
60,347
     
41,561
 
Common stock warrant liability
   
3,317
     
-
 
Total Liabilities
   
63,664
     
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 November 30, 2010 and February 28, 2010 respectively
   
-
     
-
 
Common stock, $0.0025 par value; 120,000,000 shares authorized; 34,165,718 and 21,278,643 shares issued and outstanding as of November 30, 2010 and February 28, 2010 respectively
   
85
     
53
 
Additional paid-in capital
   
65,707
     
31,862
 
Accumulated translation adjustment
   
(208
)
   
(164
)
Accumulated deficit
   
(46,238
)
   
(25,463
)
Total stockholders' equity
   
19,346
     
6,288
 
Total liabilities and stockholders' equity
 
$
83,010
   
$
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
   
Nine Months Ended
 
   
November 30,
   
November 30,
 
   
unaudited
   
unaudited
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net revenues
 
$
53,222
   
$
38,024
   
$
125,550
   
$
111,591
 
Cost of revenues
   
45,561
     
31,567
     
112,105
     
95,178
 
Gross profit
   
7,661
     
6,457
     
13,445
     
16,413
 
                                 
Sales and marketing
   
4,763
     
2,520
     
11,140
     
7,727
 
Research and development
   
1,914
     
1,328
     
5,172
     
4,023
 
General, administrative and operations
   
5,558
     
3,659
     
13,679
     
11,214
 
Total operating expenses
   
12,235
     
7,507
     
29,991
     
22,964
 
Operating income (loss)
   
(4,574
)
   
(1,050
)
   
(16,546
)
   
(6,551
)
Other income (expense) - net
   
(101
)
   
600
     
(112
)
   
669
 
Interest and financing costs
   
(851
)
   
(522
)
   
(2,020
)
   
(1,148
)
Adjustment to the fair value of common stock warrants
   
(2,788
)
   
-
     
(1,236
)
   
 
Income (loss) before income taxes
   
(8,314
)
   
(972
)
   
(19,914
)
   
(7,030
)
                                 
Income tax expense (benefit)
   
25
     
     
861
     
(1)
 
Net income (loss)
 
$
(8,339)
   
$
(972)
   
$
(20,775)
   
$
(7,029)
 
                                 
Net income (loss) per share:
                               
Basic
 
$
(0.29)
   
$
(0.05)
   
$
(0.78)
   
$
(0.33)
 
Diluted
 
$
(0.29)
   
$
(0.05)
   
$
(0.78)
   
$
(0.33)
 
                                 
Shares used in per share computation:
                               
Basic
   
28,600
     
21,300
     
26,800
     
21,300
 
Diluted
   
28,600
     
21,300
     
26,800
     
21,300
 
 
See accompanying notes to the Consolidated Financial Statements.

 
4

 
 
OCZ Technology Group, Inc.
Consolidated Statements of Cash Flow
(In thousands)
 
   
Nine Months Ended
 
   
November 30,
 
   
2010
   
2009
 
   
unaudited
   
unaudited
 
             
Cash flows from operating activities:
           
Net income (loss)
 
$
(20,775
)
 
$
(7,029
)
Adjustments to reconcile net income/(loss) to net cash used in operating activities:
               
Depreciation of property and equipment
   
807
     
744
 
Amortization of intangibles
   
53
     
83
 
Bad debt expense
   
931
     
520
 
Stock-based compensation
   
624
     
465
 
Disposition of product line
   
-
     
(668
)
Fair value adjustment of stock warrants
   
1,236
     
-
 
Adjustment to deferred tax asset
   
836
     
-
 
Non-cash inventory reserve
   
3,696
     
-
 
Non-cash asset acquisition
   
644
     
-
 
Changes in operating assets and current liabilities:
               
Accounts receivable
   
(10,561
)
   
736
 
Inventory
   
(10,332
)
   
3,159
 
Prepaid expenses and other assets
   
(945
)
   
(137
)
Accounts payable
   
12,032
     
934
 
Accrued and other liabilities
   
2,171
     
440
 
Net cash (used in) provided by operating activities
   
(19,583
)
   
(1,273
)
                 
Cash flows from investing activities:
               
Purchases of property and equipment
   
(728
)
   
(658
)
(Increase) decrease in deposits
   
(4
)
   
44
 
Asset acquisition earn out payments
   
(35
)
   
(355
)
Net cash (used in) provided by investing activities
   
(767
)
   
(969
)
                 
Cash flows from financing activities:
               
Issuance of common stock
   
34,287
     
8
 
Issuance of preferred stock
   
-
     
40
 
Proceeds from employee stock programs
   
403
     
-
 
Proceeds from bank loan, net
   
5,083
     
2,677
 
(Repayment) increase of shareholder loan
   
(500
)
   
300
 
Net cash provided by (used in) financing activities
   
39,273
     
3,025
 
                 
Effect of foreign exchange rate changes on cash and cash equivalents
   
(44
)
   
(51
)
Net increase in cash and cash equivalents
   
18,879
     
732
 
Cash and cash equivalents at beginning of period
   
1,224
     
420
 
Cash and cash equivalents at end of period
 
$
20,103
   
$
1,152
 
                 
Supplemental disclosures:
               
Interest paid
 
$
888
   
$
571
 
Income taxes paid
 
$
25
   
$
-
 
 
See accompanying notes to the Consolidated Financial Statements.

 
5

 
 
OCZ Technology Group, Inc.
Consolidated Statements of Changes in Stockholders' Equity
(In thousands)

   
Preferred Stock
   
Common Stock
                         
   
Shares Number
   
Shares Amount
   
Shares Number
   
Shares Amount
   
Additional Paid-in Capital
   
Accumulated Other Comprehensive Income (Loss)
   
Retained Earnings
   
Total
 
                                                 
As at March 1, 2009
    -       -       21,278     $ 53     $ 30,911     $ (112 )   $ (11,929 )   $ 18,923  
Components of comprehensive income (loss):
                                                               
Net Loss
    -       -       -       -       -       -       (13,534 )     (13,534 )
Foreign currency translation adjustment
    -       -       -       -       -       (52 )     -       (52 )
Total comprehensive income (loss)
                                                            (13,586 )
Adjustment of exercise of stock options
    -       -       -       -       7       -       -       7  
Issurance of preferred stock
    61       -       -       -       281       -       -       281  
Stock based compensation
    -       -       -       -       663       -       -       663  
As at February 28, 2010
    61       -       21,278       53       31,862       (164 )     (25,463 )     6,288  
Components of comprehensive income (loss):
                                                               
Net Loss
    -       -       -       -       -       -       (20,775 )     (20,775 )
Foreign currency translation adjustment
    -       -       -       -       -       (44 )     -       (44 )
Total comprehensive income (loss)
                                                            (20,819 )
Fair value of warrants issued in connection with stock offering
    -       -       -       -       (2,081 )     -       -       (2,081 )
Issurance of common stock
    -       -       12,385       31       34,256       -       -       34,287  
Issurance of common stock for acquisition
                    160               644                       644  
Issuance of employee stock
                    342       1       402                       403  
Conversion of preferred stock into common
    (61 )     -       -       -       -       -       -       -  
Stock based compensation
    -       -       -       -       624       -       -       624  
As at November 30, 2010
    -       -       34,165     $ 85     $ 65,707     $ (208 )   $ (46,238 )   $ 19,346  

See accompanying notes to the Consolidated Financial Statements
 
 
6

 
 
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 November 30, 2010, the consolidated statements of operations for the three and nine months ended November 30, 2010 and 2009, and the consolidated results of cash flows for the nine months ended November 30, 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 significant losses in the third quarter of fiscal 2011 and in the fiscal 2011 year to date, primarily reflecting higher than anticipated pricing concessions  and inventory reserves associated with its DRAM memory products.  The Company is planning to discontinue the remaining portions of this product line by the end of fiscal 2011.  The  Company’s focus on growing its SSD product sales has had a significant positive impact on its results.  The Company expects that it will continue to incur weak margins on its DRAM products, though it believes it has reduced its inventory costs through valuation reserves recorded in the second and third quarters of fiscal 2011 such that the discontinuance or these products will not generate significant losses.
 
The Company has used $19.6 million of cash in its operating activities for the nine months ended November 30, 2010 compared to $1.3 million of cash used in its operating activities for the nine months ended November 30, 2009.  This substantial increase in cash used for operating activities, was financed by $39.3 million in cash from financing activities in the nine months ended November 30, 2010 compared to $3.0 million in cash flow from financing activities for the nine months ended November 30, 2009.  The Company may seek additional credit availability under its existing Factoring Loan Agreements and will be looking to generate cash flow from operations to service its 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 to support its planned growth and there can be no assurance that additional funds will be available on terms acceptable to it or at all.
 
The Company’s ability to generate cash depends on many factors beyond its 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 additional 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.  
 
 
7

 
 
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 $ 2.66 million as of November 30, 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 was 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.
 
 
8

 
 
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.  OCZ has discontinued the sale of DRAM module products, and, accordingly, inventory reserves of approximately $2.8 million were recorded as of August 31, 2010 and $1.5 million as of November 30, 2010. This overall 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.

 
9

 
 
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.  OCZ has no amounts recorded for deferred tax assets in the quarter ending November 30, 2010.
 
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 November 30, 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
   
-
     
-
   
$
(3,317,000)
 
 
 
10

 

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 November 30, 2010 and the February 28, 2010, OCZ has shipped merchandise totaling $855,000 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 November 30, 2010 and February 28, 2010 was $174,000 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 nine months ended November 30, 2010 and 2009 these amounts were $51,000 and $117,000, respectively, and were accounted for as a reduction in general, administrative and operations expense.
 
Advertising
 
Advertising costs are expensed as incurred and in the nine months ended November 30, 2010 and 2009 were $2.26 million and $2.22 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.

 
11

 
 
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 $(123,000) and  $49,000 are included in other income or expense in the accompanying statement of operations for the nine months  ended November 30, 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 $624,000 and $465,000 for the nine months ended November 30, 2010 and 2009, respectively.  As of the fiscal quarter ended November 30, 2010, compensation costs related to non-vested options amounted to approximately $2.2 million and will be recognized in the periods to November 30, 2015 over a weighted average term of 12 months.
 
The fair value of options grants was determined using the Black-Scholes option pricing model with the following weighted average assumptions. OCZ granted options to purchase an aggregate of 1,337,842 shares of its common stock under OCZ’s stock option plan in the nine months ended November 30, 2010.
 
   
Three
Months Ended
   
Nine Months Ended
   
Fiscal Year Ended
 
   
November 30, 2010
   
November 30, 2010
   
February 28, 2010
 
Expected dividend
   
0
%
   
0
%
   
0
%
Risk free interest rate
   
1.68
%
   
1.90
%
   
2.00
%
Expected volatility
   
45
%
   
45
%
   
58
%
Expected life (in years)
   
4.45
     
4.42
     
4.28
 
 
 
12

 

3.
Recent 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 OCZ’s consolidated results of operations, financial condition or financial disclosures.
 
4.
Inventory
 
Inventory consists of the following:
 
   
November 30,
2010
(in thousands)
   
February 28,
2010
(in thousands)
 
Raw materials
 
$
7,193
   
$
3,246
 
Work in progress
   
7,563
     
5,319
 
Finished goods
   
1,726
     
1,281
 
Total inventory
 
$
16,482
   
$
9,846
 

The November 30, 2010 inventory balances have been reduced by $3.7 million of net inventory reserves related to OCZ’s discontinued DRAM module products.

5.
Property and equipment
 
Net property and equipment consists of the following:
 
   
November 30, 
2010
(in thousands)
   
February 28,
2010
(in thousands)
 
Vehicles
 
$
135
   
$
135
 
Furniture and fixtures
   
40
     
38
 
Equipment
   
5,140
     
4,471
 
Leasehold Improvements
   
491
     
439
 
     
5,805
     
5,083
 
Less:  accumulated depreciation
   
(3,256)
     
(2,454)
 
 Net Property and equipment
 
$
2,550
   
$
2,629
 

Depreciation expense for the nine months ended November 30, 2010 and 2009 and the fiscal year ended February 28, 2010 amounted to $807,000, $744,000 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.
 
 
13

 

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 of February 28, 2010
 
$
10,796
   
$
446
 
Additions during the period for acquisition earn out payment
   
35
     
 
As of November 30, 2010
 
$
10,831
   
$
446
 
                 
Accumulated Amortization/Impairment
               
As of February 28, 2010
 
$
842
   
$
358
 
Amortization/Impairment for the period
   
     
53
 
As of November 30, 2010
 
$
842
   
$
411
 
                 
Net carrying value
               
As of February 28, 2010
 
$
9,954
   
$
88
 
As of November 30, 2010
 
$
9,989
   
$
35
 

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 nine months ended November 30, 2010 and 2009 was $53,000 and $84,000, respectively.
 
The expected amortization for the future periods is as follows:
 
Fiscal years ending February 28,
 
(In thousands)
 
(3 months) 2011
 
$               
17.5
 
2012
   
17.5
 
                                  Total
 
$
35.0
 
 
The Company acquired certain assets of Solid Data Systems in November 2010 and paid approximately $350,000 in cash and 160,000 shares in restricted stock.  The Company determined that it acquired as identifiable assets in process research and development (IPRD) and fixed assets with goodwill also  resulting from the transaction.  The Company has tentatively determined the value of the IPRD and fixed assets to approximate the cash payment.  The Company has further assessed that it will not operate the business and believes that the goodwill and fixed assets are impaired and has written these off.  The Company has also assessed that the IPRD has not met technological feasibility and has written this off based on this stage and its perceived relative immateriality based on the initial valuation amount and the perception of what the maximum level of the final amount might be.  The total write-off related to this in the third quarter is $994,000 which is included in general and administrative expense.
 
 
14

 

7.
Accrued expenses
 
Accrued expenses consist of the following:
 
   
November 30,
2010
(in thousands)
   
February 28,
2010
(in thousands)
 
Professional fees
 
$
241
   
$
230
 
Interest expense
   
41
     
50
 
Mail in rebate provision
   
330
     
544
 
Sales and marketing programs
   
2,197
     
741
 
Employee related expenses
   
941
     
522
 
Customer warranty provision
   
249
     
358
 
Uninvoiced goods and services
   
1,661
     
1,196
 
Other liabilities
   
901
     
748
 
 Total accrued expenses
 
$
6,560
   
$
4,389
 

Sales and marketing programs increased to $2.2 million from $741,000 compared November 30, 2010 with February 28, 2010.  The increase was due to higher costs related to our sales and marketing programs primarily focused on our SSD products.

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 $595,000 and $590,000 for the nine months ended November 30, 2010 and 2009, respectively.  As of November 30, 2010, the future minimum payments due under these non cancellable lease agreements are as follows:
 
Fiscal years ending February 28/29
 
(in thousands)
 
(3 months) 2011
 
$               
215
 
2012
   
486
 
2013
   
110
 
                                   Total
 
$
811
 

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.
 
 
15

 
 
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, a total accrual of $1.35 million has been made as of November 30, 2010 which the Company believes is the maximum exposure in 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 November 30, 2010, the outstanding loan balances under the Factoring Loan Agreements were $15.4 million in the aggregate which are the same as the fair value. 

Under the SVB Agreement, OCZ can borrow an amount up to 75% 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.  As of November 30, 2010, OCZ’s Quick Ratio was 0.83:1:00.  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.
 
 
16

 
 
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 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 nine months ended November 30, 2010, 343,010 shares of common stock were issued in connection with the exercise of stock options. There were no stock option exercises during the fiscal year ended February 28, 2010. 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.  
 
In March 2010, OCZ consummated a private placement financing pursuant to which it issued 5,151,662 shares of its common stock at $3.00 per share. OCZ received gross proceeds of approximately $15.45 million. In connection with the financing, 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 described below under “Warrants.”. The registration statement was filed with the SEC on May 21, 2010  and remained effective as of January 13, 2011. Also in March 2010, OCZ issued 29,710 shares of common stock in connection with certain services received.
   
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.

In June 2010, OCZ granted options to purchase an aggregate of 202,842 shares of its common stock under OCZ’s stock option plan with the exercise price of $3.06 per share, which was the fair market value per share on the date of grant.

In August 2010, OCZ granted options to purchase an aggregate of 100,000 shares of its common stock under OCZ’s stock option plan with the exercise price of $2.09 per share, which was the fair market value per share on the date of grant.

In October 2010, OCZ granted options to purchase an aggregate of 705,000 shares of its common stock under OCZ’s stock option plan with the exercise price of $2.83 per share, which was the fair market value per share on the date of grant. 
 
 
17

 

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.

On November 2, 2010, OCZ consummated a private placement financing pursuant to which it issued 7,139,960 shares of its common stock at $3.08125 per share.  OCZ received gross proceeds of approximately $22.0 million.  In connection with the financing, OCZ entered into a registration rights agreement which required OCZ to file a registration statement with the SEC no later than December 17, 2010, to register the 7,139,960 shares and 1,784,996 shares of its common stock issuable upon exercise of certain warrants, described below under “Warrants.”  The registration statement was filed with the SEC on December 10, 2010 and remained effective as of January 13, 2011.

On November 15, 2010 OCZ issued 160,000 shares of its common stock in connection with acquisition of certain intellectual property from Solid Data Systems, Inc. Of this amount issued, 38,000 shares are subject to various escrow provisions for a 3-year period with a potential release of 50% of the shares after 18 months.

The following table summarizes shares outstanding for the nine months ended November 30, 2010 and the fiscal year ended February 28, 2010.
 
   
Nine
Months Ended
   
Fiscal Year Ended
 
   
November 30, 2010
   
February 28, 2010
 
   
(in thousands)
   
(in thousands)
 
Shares outstanding, beginning
   
21,278
     
21,278
 
Weighted-average shares issued
   
5,474
     
-
 
Series A Preferred stock converted
   
48
     
-
 
Weighted-average shares, basic
   
26,800
     
21,278
 
Effect of dilutive stock options and warrants
   
-
     
-
 
Weighted-average shares, diluted
   
26,800
     
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 7,532,873.  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 nine months ended November 30, 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
   
2,500,000
     
-
     
-
     
-
     
-
 
                                         
Options granted
   
(1,337,842
)
   
1,337,842
     
2.09-4.35
     
4,260,547
     
3.18
 
                                         
Options exercised
   
-
     
(343,010
)
   
0.40-2.50
     
(560,903)
     
1.24
 
                                         
Options forfeited
   
451,685
     
(451,685
)
 
$
1.05-8.28
     
(1,188,195
)
   
2.63
 
                                         
Balance at November 30, 2010
   
3,273,457
     
3,322,257
     
-
   
$
8,769,779
   
$
2.64
 
 
 
18

 

The following table summarizes information about stock options outstanding and exercisable:
 
   
November 30, 2010
   
February 28, 2010
 
Exercise price range
            $0.40-8.53               $0.40-8.53  
Shares outstanding
            3,322,257               2,779,111  
Weighted average exercise price
            $2.64               $2.20  
Weighted average contractual life
         
8.41 years
           
8.4 years
 
Shares exercisable
            1,391,997               1,287,695  
Weighted average exercise price
            $2.94               $2.76  
Weighted average contractual life
         
7.25 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) for 5,160 shares.

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 newly converted common stock warrants were exercised and they all 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 share. These warrants are subject to certain anti-dilution adjustments and,  as a result of the November 2, 2010 financing, these warrants were subject to a price adjustment calculation which resulted in a new exercise price of $4.87 per share. In connection with the March 2010 financing, 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, at the time of such exercise, to receive a subsequent warrant to purchase up to an additional 77,275 shares of the Company’s common stock at $5.25 per share. The placement agent warrants contain certain piggyback registration rights. All of these warrants will expire on March 23, 2015 and may be exercised by the holders on a cashless basis.

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 increased to $3,317,000 at November 30, 2010 which resulted in a non-cash expense adjustment of $1,236,000 in the Statement of Operations for the nine months ended November 30, 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 the issue date of 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 November 30, 2010 the assumptions were: Dividend yield: 0%, Volatility: 45%, Expected life: 4.31 years, Risk free rate: 1.35%, and a current share price of $4.05.

In November 2010, OCZ issued warrants to purchase up to an aggregate of 1,784,996 shares of its common stock at an exercise price of $5.25 per share.  These warrants will become exercisable on May 3, 2011.

In connection with the November 2010 financing, OCZ issued to a placement agent a warrant to purchase up to 214,198 shares of the Company’s common stock at an exercise price of $3.08125 per share and, at the time of such exercise, to receive a subsequent warrant to purchase up to an additional 53,549 shares of the Company’s common stock at an exercise price of $5.25 per share.  The placement agent warrants contain certain piggyback registration rights. All of these warrants will expire on November 2, 2015 and may be exercised by the holders on a cashless basis.

The following table summarizes warrant activity for the nine months ended November 30, 2010.

 
19

 

                     
Weighted
 
                     
average
 
   
Number
   
Exercise
   
Total
   
exercise
 
   
of shares
   
price
   
$
   
Price
 
Balance at  February 28, 2010
   
274,695
   
$
2.25-$5.00
   
$
1,082,123
   
$
3.93
 
                                 
Warrants granted
   
4,860,401
     
3.00-5.25
     
23,728,367
     
4.88
 
                                 
Warrants exercised
   
-
     
-
     
-
     
-
 
                                 
Warrants forfeited
   
(144,541
)
   
4.86
     
(702,469
)
   
4.86
 
                                 
Balance at November 30, 2010
   
4,990,555
   
$
2.25-5.25
   
$
24,108,021
   
$
4.83
 
 
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 nine months ended November 30, 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. As previously discussed, the DRAM memory products will be discontinued after the fiscal 2011.
 
The following table sets forth the revenues for each of OCZ’s product groups for the nine months ended November 30, 2010 and November 30, 2009:
 
   
Three Months Ended
   
Nine Months Ended
 
   
November 30,
   
November 30,
 
Product Group
 
2010
   
2009
   
2010
   
2009
 
   
(in thousands)
   
(in thousands)
 
                         
SSD
 
$
41,471
   
$
21,281
   
$
75,007
   
$
55,986
 
Memory
   
6,261
     
9,756
     
33,898
     
31,387
 
Power Supplies/other
   
5,490
     
6,987
     
16,645
     
24,218
 
Total
 
$
53,222
   
$
38,024
   
$
125,550
   
$
111,591
 
 
 
20

 

OCZ’s revenues by major geographic area (based on shipping destination) were as follows:

   
Three Months Ended
   
Nine Months Ended
 
   
November 30,
   
November 30,
 
   
2010
   
2009
   
2010
   
2009
 
   
(in thousands)
   
(in thousands)
 
                         
United States
 
$
15,195
   
$
18,716
   
$
48,772
   
$
47,249
 
Canada
   
2,563
     
1,503
     
6,678
     
5,311
 
Europe/Middle East/Africa
   
30,315
     
15,267
     
57,024
     
44,615
 
Rest of World
   
5,149
     
2,538
     
13,075
     
14,416
 
Total
 
$
53,222
   
$
38,024
   
$
125,550
   
$
111,591
 

During the nine months ended November 30, 2010 and 2009, sales to one customer represented 19% and 18%, 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 November 30, 2010, herein referred to as “the November 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 November 30, 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 and statements made in other subsequent filings, as they contain 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.

 
21

 

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 the strategy we implemented 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. Then, on January 10, 2011 we announced that the remaining DRAM modules products would be discontinued after fiscal 2011. 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 340 customers, including leading retailers, etailers, OEMs and computer distributors.

Our ten largest customers measured by net revenues for our nine months ended November 30, 2010 are listed as follows in alphabetical order:
 
 
§
BAS Group
 
§
D & H Distributing Company
 
§
INGRAM MICRO
 
§
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.
  
These ten customers represented approximately 52% our net revenue for the nine months ended November 30, 2010.  Our largest customer is Magnell Associates Inc. dba NewEgg.com, which represented approximately 19% of our revenue for the nine months ended November 30, 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:

 
22

 
 
 
§
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 November 30, 2010, we had approximately 340 customers, most of which are distributors, system integrators, retailers and etailers in 55 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.

 
23

 

Results of Operations for Three and Nine Months Ended November 30, 2010 and 2009

The following table sets forth our financial results, as a percentage of net revenues for the periods indicated.
 
   
Three Months Ended
   
Nine Months Ended
 
   
November 30,
   
November 30,
 
   
unaudited
   
unaudited
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net revenues
   
100.0
%
   
100.0
%
   
100.0
%
   
100.0
%
Cost of revenues
   
85.6
%
   
83.0
%
   
89.3
%
   
85.3
%
Gross profit
   
14.4
%
   
17.0
%
   
10.7
%
   
14.7
%
                                 
Sales and marketing
   
8.9
%
   
6.6
%
   
8.9
%
   
6.9
%
Research and development
   
3.6
%
   
3.5
%
   
4.1
%
   
3.6
%
General, administrative and operations
   
10.4
%
   
9.6
%
   
10.9
%
   
10.0
%
Total operating expenses
   
23.0
%
   
19.7
%
   
23.9
%
   
20.6
%
Operating income (loss)
   
-8.6
%
   
-2.8
%
   
-13.2
%
   
-5.9
%
Other income (expense) - net
   
-0.2
%
   
1.6
%
   
-0.1
%
   
0.6
%
Interest and financing costs
   
-1.6
%
   
-1.4
%
   
-1.6
%
   
-1.0
%
Adjustment to the fair value of common stock warrants
   
-5.2
%
   
0.0
%
   
-1.0
%
   
0.0
%
Income (loss) before income taxes
   
-15.6
%
   
-2.6
%
   
-15.9
%
   
-6.3
%
                                 
Income tax expense (benefit)
   
0.0
%
   
0.0
%
   
0.7
%
   
0.0
%
Net income (loss)
   
-15.7
%
   
-2.6
%
   
-16.5
%
   
-6.3
%
 
Comparison of the Three Months Ended November 30, 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  strategy  we implemented 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. Then, on January 10, 2011 we announced that the remaining DRAM modules products would be discontinued after fiscal 2011. As a result, our target customers are increasingly enterprises and original equipment manufacturers (or “ OEMs ”).
 
Net revenues.  Net revenues increased by $15.2 million, or 39.97% to $53.2 million for the three months ended November 30, 2010 compared with $38.0 million for the three months ended November 30, 2009, The increased in net sales was due to increased demand in SSD. Memory net revenues decreased by $3.5 million to $6.3 million for the three months ended November 30, 2010 compared with $9.8 million for the three months ended November 30, 2009 as we discontinued the sale of our commodity level DRAM memory module products and sold 57% less memory units.  Power supplies and other net revenues also decreased by $1.5 million to $5.5 million for the three months ended November 30, 2010 compared with $7.0 million for the three months ended November 30, 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 $20.2 million or 95% increase in SSD net revenues to $41.5 million for the three months ended November 30, 2010 compared with $21.3 million for the three months ended November 30, 2009.
 
 
24

 

Cost of revenues.  Cost of revenues increased by $14.0 million, or 44.3%, to $45.6 million for the three months ended November 30, 2010 compared with $31.6 million for three months ended November 30, 2009.  Cost of revenues as a percentage of net revenues was 85.6% for the three months ended November 30, 2010 compared with 83.0% for the three months ended November 30, 2009.  This increase was largely attributable to a $1.5 million additional inventory reserve taken in connection with our discontinued  DRAM module products.

            Sales and marketing expenses.  Sales and marketing expenses increased by $2.2 million, or 89.0%, to $4.8 million for the three months ended November 30, 2010 compared with $2.5 million for the three months ended November 30, 2009.  Sales and marketing expenses were 8.9% and 6.6% of net revenues for the three months ended November 30, 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 $58,000 and $19,000 for the three months ended November 30, 2010 and 2009, respectively.
 
Research and development expenses.  Research and development expenses increased by $0.6 million, or 44.1% to $1.9 million for the three months ended November 30, 2010 compared with $1.3 million for the three months ended November 30, 2009.  Research and development expenses were 3.6% and 3.5% of net revenues in the three months ended November 30, 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 $84,000 and $21,000 for the three months ended November 30, 2010 and 2009, respectively.
 
General, administrative and operations expenses.  General, administrative and operations expenses increased by $1.9 million, or 51.9%, to $5.6 million for the three months ended November 30, 2010 compared with $3.7 million for the three months ended November 30, 2009.  General, administrative and operations expenses were 10.4% and 9.6% of net revenues in the three months ended November 30, 2010 and 2009, respectively.  The increase in absolute dollars was primarily due to $994,000 of charges from the acquisition of certain intellectual property and other intangibles from Solid Data Systems, Inc., $323,000 of executive severance costs and $157,000 of increased shipping costs resulting from higher sales.
 
General and administrative expenses include stock-based compensation expenses of $98,000 and $34,000 for the three months ended November 30, 2010 and 2009, respectively.
  
Other income (expense) - net.  Other expense-net increased by $701,000 or 116.8% to ($101,000) for the three months ended November 30, 2010 compared with $600,000 in the three month ended November 30, 2009. This change was the result of a $108,000 foreign translation loss and $7,000 other income in the three months ended November 30, 2010 compared with a $58,000 foreign translation loss and $658,000 other income in the three months ended November 30, 2009 including the recognition of $668,000 of gain from the sale of all inventory, patents and goodwill related to our Neural Impulse Actuator product line to BCInet, Inc., a Delaware corporation.

Interest and Financing Costs.  Interest and financing costs increased $329,000 to $851,000 for the three months ended November 30, 2010 compared with $522,000 for the three months ended November 30, 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 under the foreign line, which bears a higher effective cost.  

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 loss of $2.8 million related to a fair value adjustment as of November 30, 2010 for the embedded derivative in those warrants.  No such warrants were outstanding on November 30, 2009 and therefore no related charge needed to be recorded.
 
 
25

 
 
Comparison of the Nine Months Ended November 30, 2010 and 2009

Net revenues.  Net revenues increased by $14.0 million, or 12.5% to $125.6 million for the nine months ended November 30, 2010 compared with $111.6 million for the nine months ended November 30, 2009.   Memory net revenues increased by $2.5 million to $33.9 million for the nine months ended November 30, 2010 compared with $31.4 million for the nine months ended November 30, 2009 as we discontinued the sale of certain of our commodity level DRAM module products and sold 59% less memory units while the ASP increased 57% in the nine months ended November 30, 2010.  Power supplies and other net revenues decreased by $7.6 million to $16.6 million for the nine months ended November 30, 2010 compared with $24.2 million for the nine months ended November 30, 2009. SSD net revenues increased by $19 million to $75 million for the nine months ended November 30, 2010 compared with $56 million for the nine months ended November 30, 2009 due to increased demand in SSD products.   

Cost of revenues.  Cost of revenues increased by $16.9 million, or 17.8%, to $112,000 million for the nine months ended November 30, 2010 compared with $95.2 million for nine months ended November 30, 2009.  Cost of revenues as a percentage of net revenues was 89.3% for the nine months ended November 30, 2010 compared with 85.3% for the nine months ended November 30, 2009.  This increase was largely attributable to a $4.3 million inventory reserve taken in connection with our discontinued DRAM module products.
 
            Sales and marketing expenses.  Sales and marketing expenses increased by $3.4 million, or 44.2%, to $11.1 million for the nine months ended November 30, 2010 compared with $7.7 million for the nine months ended November 30, 2009.  Sales and marketing expenses were 8.9% and 6.9% of net revenues for the nine months ended November 30, 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 $146,000 and $122,000 for the nine months ended November 30, 2010 and 2009, respectively.
 
Research and development expenses.  Research and development expenses increased by $1.1 million, or 28.6% to $5.2 million for the nine months ended November 30, 2010 compared with $4.0 million for the nine months ended November 30, 2009.  Research and development expenses were 4.1% and 3.6% of net revenues in the nine months ended November 30, 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 $211,000 and $130,000 for the nine months ended November 30, 2010 and 2009, respectively.
 
General, administrative and operations expenses.  General, administrative and operations expenses increased by $2.5 million, or 22.0%, to $13.7 million for the nine months ended November 30, 2010 compared with $11.2 million for the nine months ended November 30, 2009.  General, administrative and operations expenses were 10.9% and 10.0% of net revenues in the nine months ended November 30, 2010 and 2009, respectively.  The increase in absolute dollars was primarily due to $1.35 million charge related to a legal action asserted by a former product vendor, $994,000 of charges from the acquisition of certain intellectual property and other intangibles from Solid Data Systems, Inc. and $323,000 of executive severance costs.  This increase was partially offset by $324,000 of reduced shipping costs resulting from a higher mix of SSD sales and $311,000 of lower legal and accounting expenses.
 
General and administrative expenses include stock-based compensation expenses of $267,000 and $213,000 for the nine months ended November 30, 2010 and 2009, respectively.
  
Other income (expense) - net.  Other expense-net increased by $781,000 or 116.7% to ($112,000) for the nine months ended November 30, 2010 from a $669,000 gain in the nine month ended November 30, 2009. This change was the result of a $123,000 foreign translation loss in the nine months ended November 30, 2010 compared with a $49,000 foreign translation gain in the nine months ended November 30, 2009. In addition, OCZ recognized $668,000 of gain from the sale of all inventory, patents and goodwill related to our Neural Impulse Actuator product line to BCInet, Inc., a Delaware corporation in the nine months ended November 30, 2009.

 
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Interest and financing costs.  Interest and financing costs increased $872,000 to $2.0 million for the nine months ended November 30, 2010 compared with $1.2 million for the nine months ended November 30, 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 loss of $1.2 million related to a fair value adjustment as of November 30, 2010 for the embedded derivative in those warrants.  No such warrants were outstanding on November 30, 2009 and therefore no related charge needed to be recorded.
 
Provision for income taxes.  The provision for income taxes increased $862,000 to $861,000 for the nine months ended November 30, 2010 compared with $1,000 tax benefit for the nine months ended November 30, 2009. This increase was due to the increase in the valuation allowance for our deferred tax assets due to losses sustained in the period, due partially to the discontinuance of the 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 ($19.6) million and ($1.3) million for the nine months ended November 30, 2010 and 2009, respectively.  Net cash was used by operating activities during nine months ended November 30, 2010 in a number of ways.  We had a $20.8 million loss for the nine months ended November 30, 2010.  Additionally, cash was used to increase accounts receivable by $10.6 million, inventory by $10.3 million and prepaid expenses by $945,000. These cash uses for the nine months ended November 30, 2010 were partially offset by an increase in accounts payable of $12.0 million as we were able to establish more industry typical credit terms with our vendors. In the nine months ended November 30, 2010, we issued standby letters of credit for $1 million which enabled access to a new vendor’s higher credit line.  We have deposited $1 million 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 $2.2 million.  The cash uses were further offset by non-cash related expenses, a $3.7 million charge for inventory reserves, a $1.2 million non-cash loss for stock warrants, $931,000 for bad debt expenses, $836,000 of increase deferred tax asset valuation allowance, $860,000 of depreciation and amortization expenses, $644,000 non-cash acquisition of certain intellectual property from Solid Data Systems, Inc. and $624,000 for non-cash stock based compensation.  These cash uses primarily reflect utilization of the $13.9 million and $20.5 million of net proceeds raised in March 2010 and November 2010 to bolster working capital as we increased inventory for future sales, sold additional product on trade credit terms and bought additional raw materials from vendors on trade credit.   

Net cash used by operating activities for the nine months ended November 30, 2009 was due primarily to a $7.0 million loss coupled with a $3.1 million decrease in inventory, a $216,000 decrease in accounts receivable, an increase in accounts payable of $934,000 million and an increase in accrued and other liabilities of $440,000, partially offset by an in increase in prepaid expenses and other assets of $137,000.  The decreases in accounts receivable and inventory for the nine months ended November 30, 2009 were primarily due to effective collection efforts and higher sales of existing inventory.  
 
Investing activities.  Net cash used by our investing activities was $767,000 and $969,000 for the nine months ended November 30, 2010 and 2009, respectively.  Of these amounts, $728,000 and $658,000, 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 certain assets of PC Power & Cooling of $35,000 and $355,000 for the nine months ended November 30, 2010 and 2009, respectively.

 
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Financing activities.  Net cash provided (used) by our financing activities was $39.3 million and $3.0million for the nine months ended November 30, 2010 and 2009, respectively.  Cash provided by financing activities in the nine months ended November 30, 2010 primarily reflects our common stock issuance of $34.3million (net of expenses) and $5.1 million of additional bank loans, partially offset by the $500,000 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 a purchase price of $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.  In the March 2010 private placement, we also issued warrants (i) to investors to purchase up to  2,575,833 shares of our common stock at $5.25 per share to investors and (ii) to a placement agent to purchase up to 154,550 shares of our common stock at $3.00 per share and, at the time of such exercise, to receive a subsequent warrant to purchase up to an additional 77,275 shares of the Company’s common stock at $5.25 per share.  All of the warrants issued in the March 2010 financing will expire on November 2, 2015 and may be exercised by the holders on a cashless basis. In November 2010, we issued an aggregate of 7,139,960 shares of our common stock at a purchase price of $3.08125 per share in connection with a private placement, whereby we received gross proceeds of $22.0 million and incurred approximately $1.7 million of fundraising costs.  In the March 2010 private placement, we also issued warrants to investors to purchase up to (i) 1,784,996 shares of our common stock at $5.25 per share and (ii) to a placement agent to purchase up to 214,198 shares of our common stock at $3.08125 per share and, at the time of such exercise, to receive a subsequent warrant to purchase up to an additional 53,549 shares. The warrants issued to the investors will become exercisable on May 3, 2011.  All of the warrants issued in the November 2010 financing will expire on November 2, 2015, and may be exercised by the holders on a cashless basis.

The net cash provided by financing activities of $3.0 million for the nine months ended November 30, 2009 was due to $2.7 million of additional bank loans and $500,000 from the proceeds of a loan to the Company by our Chief Executive Officer, Ryan Petersen offset by repayment of a $200,000 note payable.
 
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 November 30, 2010 and February 28, 2010, the aggregate outstanding loan balances under the Factoring Loan Agreement were $15.4 million and $10.4 million, respectively. While there is still borrowing capability of $2.1 million as of November 30, 2010, in the existing Factoring Loan Agreements, we may need additional borrowing capacity under the lines to help finance the expected growth of the SSD market in the next twelve months. Also, we may incur additional debt in the future, subject to certain limitations contained in our debt instruments.


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 November 30, 2010 our Quick Ratio was 0.83:1:00.  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 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 was 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.  

 
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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 significant losses in the third quarter of fiscal 2011 and in the fiscal 2011 year to date, primarily reflecting higher than anticipated pricing concessions and inventory reserves associated with our DRAM memory products.  We are planning to discontinue the remaining portions of this product line by the end of fiscal 2011.  Our focus on growing SSD product sales has had a significant positive impact on our results.  We expect that we will continue to incur weak margins on DRAM products, though we believes we has reduced our inventory costs through valuation reserves recorded in the second and third quarters of fiscal 2011 such that the discontinuance or these products will not generate significant losses.

  We have used $19.6 million of cash in our operating activities for the nine months ended November 30, 2010 compared to $1.3 million of cash used in our operating activities for the nine months ended November 30, 2009.  This substantial increase in cash used in operating activities, was financed by the $39.3 million raised from financing activities in the nine months ended November 30, 2010 compared to $3.0 million in cash flow from financing activities for the nine months ended November 30, 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 may be required, or may elect, to seek additional funding through public or private equity or debt financing to support our planned growth and there can be no assurance that additional funds will be available on terms acceptable to us or at all.

 
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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 November 30, 2010:

PAYMENTS DUE BY PERIOD

(in thousands)
 
Total
   
Less
than 1
year
   
1-3
years
   
3-5
years
   
More
than 5
years
 
                                         
Operating lease obligations
 
$
811
   
$
679
   
$
132
     
-