Good afternoon, everyone, and thank you for participating in today's conference call to discuss Quantum's financial results for the third quarter of fiscal 2022. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference call is being recorded. I would now like to turn the conference over to Brian Cabrera from Quantum.
Good afternoon, and thank you for joining today's conference call to discuss Quantum's third quarter fiscal 2022 financial results. I'm Brian Cabrera, Quantum's Chief Legal and Compliance Officer. Joining me today are Jamie Lerner, Chairman and CEO, and Mike Dodson, CFO. This afternoon, we issued a press release which you can access a copy of on Quantum's website at www.quantum.com under the Investor Relations section. There is also a slide presentation that we will be using in conjunction with today's call that may be accessed through the webcast link on the IR website and is also posted as a PDF in the investor relations section. As a reminder, comments made during today's conference call may include forward-looking statements. All statements other than statements of historical fact could be deemed as forward-looking. Quantum advises caution in reliance on forward-looking statements.
These statements include, without limitation, any projections of revenue, margins, expenses, adjusted EBITDA, adjusted net income, cash flows, or other financial items. Also, any statements concerning the expected development, performance and market share or competitive performance relating to products or services. All forward-looking statements are based on information available to Quantum on the date hereof. These statements involve known and unknown risks, uncertainties and other factors that may cause Quantum's actual results to differ materially from those implied by the forward-looking statement, including unexpected changes in the company's business. More detailed information about these risk factors and additional risk factors are set forth in Quantum's periodic filings with the Securities and Exchange Commission.
These risk factors include, but are not limited to, risks and uncertainties listed in the section entitled Risk Factors in Quantum's quarterly report on Form 10-Q and annual report on Form 10-K as filed with the SEC. Quantum expressly disclaims any obligation to update or alter its forward-looking statements, whether as a result of new information, future events, or otherwise, except as required by applicable law. Additionally, the company's press release and management statements during the conference call will include discussions of certain measures and financial information in GAAP and non-GAAP. Included in the company's press release are definitions and reconciliations of GAAP to non-GAAP items, which provide additional details. For those of you unable to listen to the entire call at this time, a recording will be available for at least 90 days in the investor relations section of Quantum's website.
Now I would like to turn the call over to the Chairman and CEO, Jamie Lerner. Jamie?
Thank you, Brian, and thank you all for joining us today. Earlier this afternoon, we announced results for our third fiscal quarter. Revenue was $95.3 million, with backlog increasing sequentially to $62 million, another quarterly record for the company, with strong demand offset by ongoing supply chain headwinds. Our recurring revenue transition continued to accelerate with more than 255 customers utilizing Quantum's subscription solutions, up 30% sequentially and 98% year-over-year. With more products transitioning to a subscription contract, our year-over-year subscription revenues increased more than 190%. Our flat third quarter revenue results are not indicative of the true underlying demand trends in our business, which have been at historically high levels, but impacted by the unprecedented supply chain headwinds. The third fiscal quarter represents our fifth sequential quarter of bookings exceeding revenue.
As Mike will discuss, we estimate that roughly $26 million of customer orders in the quarter could not be fulfilled, which had a major impact on revenue, gross margins, earnings, and adjusted EBITDA. I'll discuss the supply chain situation and the actions we are taking in more detail shortly. Our hyperscale business grew meaningfully both sequentially and year- over- year despite the supply challenges, and has become less lumpy over the last four quarters. Our media and entertainment vertical has begun to stabilize, while not above pre-COVID levels. Our progress within StorNext, the first point product we transitioned to a subscription model, has begun to take hold. Revenues for StorNext in the third fiscal quarter were flat year- over- year, but the prior year was primarily a product sale, while this quarter we are deferring a portion of the initial upfront revenue due to our shift towards subscriptions.
The chart on the left provides a picture of how significant the increase in backlog has been over the last five quarters, while revenue has remained essentially flat. The disconnect between our reported quarterly revenue and acceleration in levels of backlog is due to the unprecedented headwinds we have faced within our supply chain. Also during the quarter, we had multiple shipping partners decide not to accept deliveries on New Year's Eve, a change from years past, which further limited our ability to ship and recognize revenue. We also saw significant cost increases for raw materials needed to fulfill customer orders, coupled with much higher levels of freight and shipping costs that were materially higher than we previously anticipated. Now let me turn to a more detailed discussion of the supply situation, which remains very dynamic, with new challenges being introduced that weren't present even a few months ago.
While supply of tape drives has improved for LTO-7 and LTO-8, the biggest impact to our business remains the quantity of supply, which has not yet returned to normalized levels. During the third quarter, LTO-9 tape drives started shipping, but overall supply of LTO-9 drives has been constrained due to initial manufacturing challenges, which is typical during a transition to a new version of LTO technology. This was especially notable with one of our largest hyperscale customers who converted a large order for LTO-8 drives to LTO-9 drives during the quarter and increased their order by $10 million. Due to the limited availability of LTO-9 drives, this switch impacted our ability to fulfill the order and our reported revenue as our prior guidance included shipments for LTO-8-based drives to this customer.
In addition to the headwinds we are facing in supply of tape drives, we are experiencing broad-based shortages of components for servers, network cards and circuit boards, very consistent with what peers in the storage industry are citing. We continue to work closely with our suppliers as well as our contract manufacturers to mitigate current supply shortages, which as of today, we lack the visibility to state when a more normalized supply chain will return. Under these circumstances, we are immediately implementing a series of cost reduction measures. We are instituting pricing increases across our product categories, and we are focusing on supply chain and operational excellence. Some other highlights from the quarter include continued share gains in the hyperscale tape market.
As of today, four of our hyperscale customers now utilize more than an exabyte of storage capacity, and we continue to view this business as a growth driver in future years. During the third fiscal quarter, we closed a multi-million dollar video surveillance deal at a government agency, which is currently in backlog. This deal highlights our recent success at the cross-selling and upselling occurring between Pivot3 and Quantum-based solutions. Another example of our product cross-selling success we've had to date, we sold StorNext as a subscription combined with tape to create an effective, customer-friendly solution for long-term retention of surveillance data. This was a conversion win utilized by a large distributor in Southern California previously using a competitive solution. The newly deployed solution now captures surveillance data on Quantum software and uses Quantum tape for long-term retention and archiving.
We believe this type of win is very repeatable and only Quantum offers this end-to-end portfolio. Also during the quarter, we closed a multi-million-dollar object storage deal with a genomics research institution and closed our first six-figure software-only object storage win at a large semiconductor manufacturer with a third party providing the hardware component. Both customers are managing large, unstructured data sets, and Quantum Solutions offers unique value in terms of scale, durability, and ease of use. It was also a solid quarter for the H-Series and F-Series within primary storage, mostly within the media and entertainment vertical. We continue to get recognized for our innovation during the quarter as our Ransom Block solution garnered two industry awards, and our solutions for ransomware protection and cyber resilience continue to resonate and gain traction in the market.
Now, I'd like to turn the call over to Mike to provide more detail on the results. We can take questions. Mike.
Thank you, Jamie. Welcome everyone to our call today. Our third fiscal quarter of 2022 represented another quarter of strong customer demand, albeit with continued significant supply chain headwinds, as Jamie summarized earlier on this call. Revenue for the quarter was $95.3 million, up 2% sequentially. Adding to the ongoing supply chain constraints during the quarter was rising cost pressures that impacted our gross margins to a greater extent than expected. As a result of the continued strong customer demand, coupled with the supply chain constraints, the customer order backlog grew over $10 million during the quarter to $62 million from $50 million last quarter and $30 million as of June 30th, 2021. Approximately $26 million of orders in the ending backlog could have been shipped to customers in the third fiscal quarter if we would have had the support from the supply chain.
This $26 million in unfulfilled orders compares to just over $15 million in unfulfilled orders in the prior quarter. Just over $50 million of the ending backlog represented tape products for which the majority was for orders from our hyperscale customers. As of today, we anticipate that the supply chain constraints will remain challenging, limiting the company's ability to ship against all customer demand and recognize a meaningful portion of the current backlog. During the third fiscal quarter, secondary storage revenues were up 17% sequentially, primarily driven by the increase in hyperscaler revenues, as well as the improving supply of LTO-7 and LTO-8 drives that help support sequential revenue growth.
Primary storage systems saw a sequential decline in revenue, down 17%, partially due to a delay in the recovery within our federal vertical, combined with deferring a portion of revenue as we grow our subscription business with revenues from StorNext. The increase in devices and media during the third quarter, up 20% sequentially, benefited from improved supply of certain tape drives following multiple quarters of headwinds. GAAP and non-GAAP gross margin in the third fiscal quarter was 37%, down over 4 percentage points from the prior quarter. During our call last quarter, we noted our expectations were for cost pressure, which at the time we anticipated could impact our gross margin by as much as 2 percentage points.
However, during the third fiscal quarter, we experienced much higher manufacturing costs, combined with higher freight, warehouse, and other logistics costs that, in total, had a more severe impact than expected on our gross margin in the quarter. Given the increase in costs in virtually all aspects of our supply chain, we are implementing another price increase this quarter. As we mentioned on the call last quarter, we implemented a 5% price increase for our products, but now feel a more substantial additional increase is required to offset the rising cost environment. We expect the benefit from these price increases to take one to two quarters to gain full traction. GAAP operating expenses in the third quarter were $42.4 million, compared to $39.3 million in the prior quarter.
Non-GAAP operating expenses in the third fiscal quarter were $36.4 million, an increase of approximately $1 million sequentially. The increase was primarily due to inclusion of expenses related to a full quarter of Pivot3 and EnCloudEn, increased sales and marketing spend, and increased investment for the development of next generation LTO technology. These increases were partially offset by a non-recurring benefit from reduced ERP support costs related to legacy installation that is being replaced. Given the continued pressure on revenues due to the supply chain constraints, combined with the increasing supply chain cost environment, in addition to increasing our prices, we are also implementing certain operating expense reduction programs in the fourth fiscal quarter. We expect to reduce our operating expense run rate between $1 million and $2 million during the fourth fiscal quarter.
GAAP net loss in the third fiscal quarter was $11.1 million, or a loss of $0.19 per share. This compares to a net loss of $9.3 million, or a loss of $0.16 per share in the prior fiscal quarter, which included a debt extinguishment charge of $15 million, partially offset by a gain of $10 million for the forgiveness of the PPP loan. Excluding stock compensation, restructuring charges, and non-recurring charges, non-GAAP adjusted net loss in the third fiscal quarter was $4.6 million, or a loss of $0.07 per diluted share, compared to adjusted net income of $114,000 or breakeven in the prior quarter.
Adjusted EBITDA in the third fiscal quarter was $0.8 million, reflecting lower than expected revenues and gross margins due to the unprecedented headwinds we have faced related to the supply chain constraints and related increased costs. There's a full reconciliation of our non-GAAP results to the most directly comparable GAAP measure in both the press release and the Form 10-Q released today. Now turning to the balance sheet, liquidity, and cash flows. Cash and cash equivalents and restricted cash were $4.3 million as of December 31st, 2021, compared to $23.2 million on September 30th, 2021. Adjusted working capital, excluding cash and deferred revenue balances, increased by $6.5 million during third fiscal quarter to $62.3 million from $55.8 million at the end of the prior fiscal quarter.
This increase was primarily the result of an increase in accounts receivable, inventories, and other current assets, partially offset by an increase in accounts payable. Outstanding debt as of December 31st, 2021 was $101.7 million after netting $4.6 million in unamortized debt issuance costs, compared to $104.5 million of outstanding debt as of September 30th, 2021, after netting $4.9 million in unamortized debt issuance costs.
To summarize the $18.9 million decrease of net cash used during the quarter, over half of the net use of cash was the net increase in working capital and net pay down of debt, with the remaining use primarily related to the EnCloudEn acquisition of $2.8 million, net cash used by operating activities of $2 million, excluding changes in assets and liabilities, and $1.6 million of CapEx for the quarter. As of the end of the third fiscal quarter, we remained in compliance with all debt covenants. Given our current expectations that the supply chain disruptions we have experienced in the last four quarters will continue in the foreseeable future, we have begun to work with our lenders to address any potential future covenant compliance issues, as well as any potential need for additional liquidity.
We believe this is simply the prudent course to take at this time to get in front of any potential issues as we attempt to work through and address headwinds from the supply chain. Finally, turning to our financial outlook. We do expect continued pressure on revenues due to supply chain constraints combined with the increasing supply chain cost environment. To a lesser extent, we also have lower seasonal demand in the fourth fiscal quarter. Taking these factors into consideration, for the fourth fiscal quarter of 2022, we are guiding revenues of $92 million, ± $5 million, non-GAAP adjusted net loss of $4 million, ± $1 million, non-GAAP adjusted net loss per share of $0.07, ± $0.02, and adjusted EBITDA of breakeven ± $1 million. With that, I'll turn the call back to Jamie for closing comments. Jamie?
Thanks, Mike. We believe the underlying demand trends in our business, strong order flow, and record levels of backlog reflect the positive momentum of our business transformation. Bookings outgrew revenue for the fifth consecutive quarter, and we continue to drive growth across our hyperscale business, demonstrating the value we're delivering for these leading-edge customers. We are also closing a higher number of deals, both in number and dollar value, across a larger customer base. We are continuing to convert more customers to a software subscription-based model. Our business is being limited by this unprecedented supply chain environment, and we are working diligently with our suppliers to manage the situation as effectively as possible. The Quantum team remains committed to delivering continued order momentum, and we are well prepared to exit these constraints at a much higher velocity than just a few quarters ago.
With that, we will now take any questions you may have. Operator?
Thank you. At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. We ask that you limit your questions to one question and one follow-up per person. One moment please while we pull for questions. Our first question is from Craig Ellis of B. Riley. Please proceed with your question.
Yeah, thanks for taking my question. Guys, I wanted to make sure I understood the variance on revenues to start. So I think I heard that there was a $10 million LTO-8 to LTO-9 customer order change issue that impacted sales. Are you saying that that was the reason that revenues were so materially below the guidance midpoint, or is that plus other issues? Can you, Mike, just give us a build-up of what the specifics were between where the guidance midpoint was and where revenues shook out?
Sure. When you look at the guidance of $104-$95, really it was supply chain issues, which we knew going in. Really what was different within the quarter was the transition from LTO-8 to LTO-9 was one big issue, where we had forecasted more LTO-8 revenue, but we had customers that were changing their orders from LTO-8 to LTO-9, and we were constrained in LTO-9. That was one significant difference or issue that drove the decline. The other really is a more broad-based shortage of components, servers, network cards, circuit boards, you know, to a greater extent than we had experienced in the prior quarter. Really was, you know, the other significant contributor to the revenue shortfall from the midpoint.
As a follow-up to that, and before my second question then, can you just comment on how confident you are in the business's ability to forecast demand levels and forecast component needs and really align forecast to customer desires? There are absolutely component constraints out there, and everybody's facing them, but it seems to be impacting Quantum particularly abruptly in the most recent quarter.
Yeah, Craig, I'll speak to that. We've had to take a significant departure from the way we were forecasting previously. The departures are on several levels. The first is very often we would forecast demand, and we would forecast parts that we hoped or expected to arrive. Today we're forecasting off of deals that we've already closed. We're forecasting off of inventory we already have, parts that are either here or on their way here. We've just had so many decommitments, or delivery schedules that our suppliers did not meet or pricing levels that they did not meet. We're now forecasting the 92 off of either orders we already have and parts that are already in inventory. A much higher percentage of that forecast is based on things that we already know versus things we expect.
The second thing we're doing, which is a large departure, is we're redesigning our products and the componentry within them. Now, many vendors are having supply chain issues, whether it's Cisco or Ford Motor Company or companies of that size. Now, we do not have the purchasing power that those companies have. What we're doing is we're designing our products to use more popular components that have more supply available and are available at lower prices. Rather than try and get supply chain attention versus Ford and Cisco and others, we're modifying our products so that they use components that are easier to get. That's the second thing that we're doing. I think between the more conservative forecasting method and the way that we're making our products easier to get components for, we hope to get a better result.
Overall, we're choosing a more conservative model, even a more conservative departure from what we were doing previously.
Got it. Thanks for that, Jamie. The second question, Mike, I want two items on the income statement. Gross margins, you were clear that you've got cost pressures, a range of them that have caused gross margin to be down 400 basis points in the quarter. The question is this: When do you expect a material improvement in gross margins? When would you expect that we could see adjusted EBITDA move materially back into the black?
Right. First on the gross margin, as we had talked about last quarter, we had increased our prices across all of our products 5%. With the further increases we saw this quarter, we are rolling out another set of additional increases, which are gonna be higher than that. I would say plus or minus probably at least 10 points additional. The issue is the timing, because you've got outstanding quotes, you've got outstanding POs, and when do you get traction on that? You know, the quotes, if they're not accepted, we can re-quote and re-quote with the higher prices. We do have, in some of our larger contracts, the ability to go back and renegotiate the price when we have significant price increases, cost increases.
We have that available to us right away, and we'll take advantage of that. There's a little bit of traction right away, but I would tell you it's like in my prepared remarks, it's one quarters-two quarters before I really see full traction of that, just because of all the outstanding quotes that are out there already and the business that's in motion before we can, you know, actually get the prices out there and get the benefit.
Are you saying that we're really? Go ahead.
And then-
Go ahead.
the second part of your question was EBITDA?
Yep
Really, when we look at, you know, the EBITDA roll forward, we were expecting $5 million this quarter, right? You know, being lower revenue, we lost $3.3 million of EBITDA. Being a lower rate from 39%, which was 2 points off already to 37%, was another $1.9 million. We lost $5.2 million based on the results of the quarter, and we had $0.8 million actually recorded. You know, we came in at $6 million if we, you know, it would have been at that level. Really it is, you know, first get through the the supply chain constraint period. You know, when that is, it's difficult to forecast, right? In the meantime, we are changing our prices, so we address the gross margin at that level regardless of the revenue level.
We are putting into place cost reduction measures that will be in Q4, $1 million-$2 million. Those are the activities that we believe will help address the EBITDA shortfall.
Got it. Thanks, guys. I'll hop back in the queue with others.
Our next question is from Nehal Chokshi of Northland Capital Markets. Please proceed with your question.
Yep. Thank you. So given the supply chain limitations, it feels almost useless to talk about revenue. You know, the much more important thing here is bookings, and thank you for being transparent about the bookings for the December quarter. What do you expect for the March quarter as far as bookings go?
Hey, Nehal. It's Jamie. We expect another quarter where bookings will be ahead of revenue. We do not expect a major reduction in the backlog, which also speaks to booking strength. You know, we had set a goal for growing our hyperscaler business 15%-20% per year, and we thought that was a pretty aggressive goal. You know, we're above doubling that at this point. We are doing better in our hyperscaler business than we expected. We had set a goal of having a minimum of $8 million in ARR exiting this year in March 31st, and we'll be at or above that goal. We set a goal of $160 million in recurring revenue, and we are gonna be above that goal exiting this year.
We're feeling continued booking strength, and it's a strange way to feel right now, and that we're having some of the best sales results that this company has seen in many, many years, both the size of the results across video surveillance, object storage, hyperscaler enterprise. We're just having very good traction with our orders, but we are having a hell of a time fulfilling those orders. Right now we're gonna continue driving bookings. We're gonna continue driving backlog. We're gonna continue driving our subscription customers, which is going really well. The transition is happening well. Sales results, our new products are resonating. The Ransom Block just won coolest storage product of the year.
You know, we feel really good about that side of the business, but clearly we've got to cut costs, we've got to get control of pricing, we've got to get control of the supply of materials and make sure we can just get to the other side. Now, when we get to the other side of this period, there's no doubt that we are dealing with a larger revenue-generating company than when we went into this period. Just the booking strength is. You can just see it no matter if you take the $95 million we did and you add to it the $26 million we couldn't ship, or if you look at it and take the $95 million and add what we grew in backlog.
No matter how you construct the quarter, you can determine that we are selling well above historic levels, and that part I feel good about. The part I'm deeply worried about is we've got to get greater control of our materials. We've got to get greater control of their pricing. Until we do that, we've got to control costs internally, to steer to that, better supply environment.
Right. Understood. By the way, what is the EBITDA covenant that you guys are gonna proactively work towards making sure there's no issue with?
I'm sorry?
I'm not sure we got your question.
I believe there's a debt covenant. Usually there's some debt covenants.
Oh.
on EBITDA. What is that actual debt covenant on the EBITDA?
The covenants? We don't have an EBITDA covenant, strict EBITDA covenant. We've got leverage covenant, fixed charges ratio covenant. We were okay at the end of the quarter. We'll work with our lenders and to the extent that, you know, we need any kind of a waiver or need to work with them, we're highly confident that, you know, we'll be able to negotiate and work with our lenders on that.
Understood. Do you happen to know what are those leverage and fixed charge ratios that must be met?
Yeah. I mean, it's roughly three times. I don't have it right in front of me, right? You know, we met them at the end of the quarter and you know, we'll work closely with the bank to see how our forecasts look and you know, stay ahead of it.
Okay. It's great to see continued traction with the subscription customers. I think you said on the press release it was subscription customers were up 30% Qo Q. Your deferred revenue, though, was up only $0.4 million Qo Q at de minimis amount in terms of percentage. How does that reconcile between the, you know, big increase in subscription customers on Qo Q basis, but we're not seeing that in the full figure in terms of deferred revenue?
Yeah. There's a certain seasonality in the contracts and the signing up the contracts. In the December quarter, it's a little bit slower, and you'll see that peak in the March quarter because it's everyone kind of coming over the calendar year and then signing up their new contracts. It's just a bit of a seasonality because it's based on cash, right? Cash receipts.
Yep, understood. All right, great. Thanks. I'll see you the floor.
Our next question is from George Iwanyc of Oppenheimer. Please proceed with your question.
Thank you for taking my question. Jamie, maybe you can dig up into the primary storage trends a little bit deeper. Can you give us a sense of, you know, how much the pressure you're seeing there is from supply chain? How much was the federal vertical, you know, dynamics as well as what you're seeing with the subscription transition?
Yeah. You know, as I mentioned in my comments, the media and entertainment business, I think is strengthened. It's not at pre-COVID levels, but it is, I would say within 10 or 15% of pre-COVID levels. I think that has recovered relatively well. I think we've gotten stronger at selling StorNext into other verticals, healthcare, surveillance, life sciences. I also think we have a series of new products. We launched StorNext 7 running on Amazon Cloud and AWS. We also did major upgrades to the H2000, H4000, and now we've launched the H4000 Essential, which is StorNext combined with CatDV in a single appliance. Yeah, I'm seeing the sales momentum pick up in those products. We do have supply constraint.
We didn't use to, but now, you know, we're just getting much longer lead times, sometimes as much as five months for just a server, waiting on network cards, power supplies, things of that kind. One of the issues is when you ship to the U.S. government, you need to ship a server that has its whole chain of custody understood. To get those systems quoted, ordered, and shipped, that cycle time has now gone in the five- and six-month level. What's happening in the government is, even though we're getting strong orders, chain-of-custody-based systems, you know, where they're entirely ensured that, you know, they were either entirely made in the United States or no one ever touched them while they were outside the United States, the supply chain turnaround on that is much longer.
We are seeing supply chain headwinds there, but very strong order strength in the business.
All right. Thank you for that. With, you know, the Pivot3 assets and what you're doing on the video surveillance side, can you give us an update there? You know, how is the customer engagement going? What are you seeing from a cross-sell perspective?
Yeah. I'm really encouraged. I mean, I said in my comments, we closed a $4 million surveillance deal with a government entity. We just didn't have the technology to do things like that prior to Pivot3. You know, the Pivot3 business is running ahead of the plan. You know, we put together a three-year pro forma prior to acquiring a business, and we are exceeding that from a bookings perspective, obviously struggling to fulfill all those orders. Servers used to, we would order them, and we get them two weeks-three weeks later. We're just not in that kind of period any longer. The Pivot3 business from a bookings perspective is ahead of plan. I feel really good about that business. Like our other businesses, we're just chasing materials and have to ship product.
All right. Mike, just one question for you. With the $1 million-$2 million savings that you're expecting this quarter, is that all gonna be encompassed in this quarter, or do you expect to continue to make cuts for maybe a quarter or two?
Yeah. I mean, we will continue to always optimize and reduce our expenses, especially when we're under the pressure of the supply constraints. Yeah, we would expect that would continue.
Thank you.
Thanks.
All right. Our next question is from Eric Martinuzzi of Lake Street Capital Markets. Please proceed with your question.
Yeah. I wanted to go a layer deeper on the cuts. You talk in the press release about, you know, cost reduction measures across product categories. Is this potentially eliminating certain products that maybe haven't been as productive or the demand hasn't been there? Or is this really, you know, kind of, it's pretty much people, and we're doing kind of across the board CapEx, OpEx reductions. What's the focus of the reductions?
Yeah. Well, first there is the across all product lines, that's a price increase, right? We're looking at price increases across all products. We had announced 5% last quarter, and we're putting into place a richer program that I think on average will probably net out about 10 additional points. That's to help on the gross margins with the higher costs we're seeing there. The cost reduction programs. You know, part of it is doing things like shutdowns, right? And then it's looking at, you know, your typical items that you look at, the temporary employees, the contractors. You look at all your discretionary spending. You look at all of your contracts and where can you renegotiate or postpone or push out. It's all those types of areas.
I mean, we continuously look at how to optimize our expense base. For example, we just at the end of January completed our move-out of the Bellevue facility, for example, which was our largest facility, most expensive lease, right? We'll get benefits for that going forward as well. As we haven't signed up for a new lease there, but it'll be much, much smaller lease in that facility. It's all of these areas that we continuously look at to optimize our spend, to reduce our costs. The other thing that we do across the board is, you know, try to leverage lower cost geographies, right? We've been successful at, you know, moving some back office areas to offshore locations, which is also, you know, that's always an ongoing activity that we have in that area.
This $1 million-$2 million savings in Q4, if I'm starting from a Q3 OpEx of $36.4 million, and that includes EnCloudEn and that includes, Pivot3, is that then to say that this $36.4 million maybe gets reduced by $1.5 million, so $35 million is the new run rate, and that we get that, you know, kind of $4 million-$8 million of annualized saving? Is that the right way to think of that?
Yeah. I mean, some of the cost savings we're doing, you know, unless you repeat them, you know, such as a shutdown, right, you need to do other measures. We've got other measures in place as well. Yes, I mean, you're thinking of it correctly.
Okay. My last question on the supply chain issues. I know we don't have a real large sample set here, but from my experience, the decommits can be driven by a couple of things. One can be your supplier is shopping that supply to get a better price, and you weren't able to meet the better price. Or it can be, hey, they just didn't have it, even though they had, quote-unquote, committed to you. I'm just wondering if behavior on decommits has changed in 2022 versus calendar 2021.
Yeah. I think it has. We have some products that we have received consistently for 20+ years, and our suppliers have just come forward and said, "We're not gonna make it anymore. We have other products we're gonna make that are more profitable." They just stopped making a part that we have orders going out, some cases well over a year.
We have some sub-$2 and $3-dollar components, think of them as like a socket connector, where the supplier came back and said, We'd like $150 now for that part. We have some orders that we made over a year ago, so plenty of lead time, where our partner came back and said, Yeah, we have none of that part for you, and we cannot tell you when you will get it. We have another major partner who just said, We're giving you six weeks notice that we're increasing prices 25%. We did not see that in previous quarters and previous times. That these are. There are more of these occurring, they're occurring more quickly, and that's why we're moving very swiftly on pricing increases. We're also taking those very troubling components, and we are ripping them out of our products.
We can't be in a position where we're held for ransom quarter- after- quarter. We're actually taking those very troubling components rather than negotiating for them, 'cause we're never gonna have the negotiating power of a Cisco or a Ford Motor Company. We're actually taking the component out of the product, redesigning it with another component that is much easier to procure.
Okay. I said that was my last one, but I do have one more. A risk of substitution for Quantum product, specifically in the hyperscalers. I'm thinking they've kinda designed for Quantum, so this is very low risk, but, any behavior there that would indicate otherwise?
Yeah. I mean, it is a theoretical possibility. I wanna recognize that. I have not seen any order switching, order cancellation because most of the components that are in short supply are made by a single supplier, so no other supplier is advantaged. I have not seen people flip-flopping orders to other suppliers so far.
Okay. Thanks for taking my question.
Thanks, Eric.
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Thanks for taking the follow-up. Mike, I wanted to just touch on the trends in the service revenue line. You know, we had a nice gradual climb as we were going from late fiscal 2021 through the fiscal second quarter of 2022, and in December, we pulled back a little bit. Can you just talk about some of the puts and takes that we saw in services in the quarter and do you expect that we'll get back on that growth glide path, or where do we go from here in services?
Yeah. I mean, similar to signing up new contracts, there is a bit of seasonality there that if they don't sign, we can't recognize the revenue. Historically, you've got a little bit of seasonality in there. You know, we always have underneath, you know, the golden glide that is always trying to pull that down, right? Then we're signing up new services and growing in other areas, right? It's kind of an offset in that and just a touch of seasonality.
Is there any impact from supply chain there? Is there any parts or components, spares, et cetera, in that line, or is that all true services?
It doesn't have a material impact. It did, cost-wise, where we saw some of our costs because the margins came down.
Yeah.
Not really a top line.
Got it. Just on that margin point, I think 57% in the quarter, a year ago we were at 60%. What's your expectation for the margin trajectory in services from here?
Yeah. I mean, we've got also some programs to reduce costs on the gross margin line, but those are tougher, and some of those are longer range to put into place. It's gonna be, you know, really pricing driven, and we are looking at increasing our prices on services as well. Really, that's more along the lines of discounting less is what we're putting into place. You know, we'll do what we can and get what traction we can to get those margins back up to 60%.
Yep. How would you break out the drivers to the decrease from 60% to 57%?
We have a, for example, a repair organization, so repair costs increased, warehousing costs increased. All the logistics of our spares organization increased. You know, those are some of the key areas that we saw the costs go up.
Got it. It's just better execution on those variables to drive it back to 60%.
Yeah. Yeah.
Okay. Got it. Okay. Thanks, Mike.
Okay.
We have reached the end of the question and answer session. I will now turn the call back over to Jamie Lerner for closing remarks.
Thank you. You know, while our bookings were at the highest level they've been at in years, we have to recognize that the global supply situation put us in a position where the results have fallen beneath all of our expectations. I'm confident in the underlying strength of this business. Our bookings levels, our hyperscaler wins, the strides we're making in video surveillance tell me that we have a growing business. Now, I'm also realistic. We've got to make some very, very quick cost-cutting and sizable cost-cutting. We've got to get our pricing in line with what our suppliers are doing with many of our components going up as much as 25%. We've got to work very hard with our suppliers to make sure we get our fair share of componentry.
I think we can take those measures, we can do them quickly, and see this to the other side of this supply chain. When we do, I think Quantum's gonna be a larger company, a better company, and a bigger company. We've got a few tough quarters to get through, and we're taking the measures to see that the company can do that in a healthy way. With that, thanks everyone for attending today.
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