Vertical Integration Is the Key to OCZ's Success

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The world's largest independent manufacturer of solid-state drives, OCZ Technology (Nasdaq: OCZ  ) surged ahead with record fourth-quarter revenue. Nevertheless, the company's bottom line stayed in the red, thanks to increased spending on research and marketing.

However, despite the losses, the company does seem to be making significant strides toward rapid growth and improving its margins, which should in turn lead to profitability. But before we get into that, let's take a look at OCZ's numbers.

Figuring it out
OCZ's fourth-quarter revenue came in at $110.4 million, a spectacular 71% jump from the prior-year period, driven mainly by its SSD business, which posted a whopping 154% growth over the year-ago quarter. This was in stark contrast to rival STEC (Nasdaq: STEC  ) , whose first-quarter revenue fell 47% from last year.

That said, even OCZ's aggressive growth strategy did not save it from a loss of $10.9 million, as it continued to invest heavily in research and developmental efforts. The company also incurred soaring marketing costs related to the launch of its new products.

On the margin front, however, OCZ did a commendable job. Gross margin received a more than twofold boost to 25%, compared to just 9.9% last year.

So how is OCZ increasing its margins?

Vertically unchallenged
OCZ's ability to source NAND flash directly from suppliers, instead of through middlemen, is contributing to better gross margin for the company. But what really worked in its favor in this regard is vertical integration.

Last year, OCZ acquired Indilinx, the maker of NAND flash controllers. This enabled the company to reduce its dependence on suppliers such as LSI (NYSE: LSI  ) , which manufactures SandForce controllers. Now, thanks to Indilinx's all-new Everest 2 controllers, OCZ enjoys a gross margin of almost 40% on its cutting-edge Vertex 4 SSDs, compared to the 20% that older SandForce-based drives would achieve.

OCZ is also boosting margins in a relatively smaller way by selling controllers used in SSDs to other manufacturers as well. It claims that its Everest 2 controller has already passed qualification by a few SSD makers, and sales fetched gross margins around 60% to 75%. And that's not all.

Enterprising performance
OCZ recently acquired SANRAD, a company known for its caching and virtualization software technology. The technology opens up the possibility of improved data-center performance while reducing overall costs. For OCZ, this increases the adoption of its PCIe-based flash drives.

The Foolish bottom line
OCZ has been growing at a rapid pace and is set for further growth as it attempts to bypass middlemen in the NAND flash purchase process and expand through vertical integration. The company has been sufficiently encouraged (and not without reason) to raise its revenue outlook to a range of $630 million to $700 million for 2012. That roughly translates to a year-over-year growth of 70% on the lower end. While profits might remain illusive, higher gross margins definitely point in the right direction.

OCZ's profitability might just be a matter of time, but you can check out other already-profitable companies in this free Motley Fool report that will help you retire rich. Hurry up and click here before it's gone!

You can also stay up to speed with the latest on OCZ by adding it to your free Watchlist.

Fool contributor Keki Fatakia does not hold shares in any of the companies mentioned in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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