Earnings Call Transcript - QMCO Q2 2023

Brian Cabrera, Chief Administrative Officer

Good afternoon and thank you for joining today's conference call to discuss Quantum's Second Quarter Fiscal Year 2023 Financial Results. I'm Brian Cabrera, Quantum's Chief Administrative Officer. Joining me today are Jamie Lerner, our Chairman and CEO; and Mike Dodson, our CFO. This afternoon, we issued a press release which you can access under the Investor Relations section of our website at www.quantum.com. We are using a slide presentation in conjunction with today's call, also accessible under the same section of our website. During today's call, our comments may include forward-looking statements. All statements other than statements of historical facts should be viewed as forward-looking. These statements include any projections of revenue, margins, expenses, adjusted EBITDA, adjusted net income, cash flows, or other financial items. These statements may also concern the expected development, performance and market share or competitive performance of our products or services. All forward-looking statements are based on information available to Quantum as of today's date. We advise caution in relying on these statements as they involve known and unknown risks and uncertainties we refer to as risk factors. Risk factors may cause our actual results to differ materially from those implied by the forward-looking statements, including unexpected changes in our business. We include detailed information about these and additional risk factors under the sections labeled the Risk Factors in our quarterly report on Form 10-Q and annual report on Form 10-K which we file with the Securities and Exchange Commission. We do not intend to update or alter our forward-looking statements, whether as a result of new information, future events or otherwise, except of course, as we are required by applicable law. Please note that our press release and the management statements we make during today's call will include certain financial information in GAAP and non-GAAP measures. We include definitions and reconciliations of GAAP to non-GAAP items in our press release. If you are unable to listen to the entire call at this time, we will make a recording available for at least 90 days in the Investor Relations section of our website. Now, I would like to turn the call to our Chairman and CEO, Jamie Lerner. Jamie?

Jamie Lerner, Chairman and CEO

Thank you, Brian and thank you all for joining us today. Earlier this afternoon, we announced results for our second quarter of fiscal 2023, with revenue just above the high end of guidance, driven by a record quarter in our hyperscale business as well as sequential improvement in our EBITDA results. The supply chain situation continues to improve, both in terms of tape drive supply and overall availability of materials at more standard pricing and lead times. Our access to tape drives from our largest supplier has shown greater predictability and consistency and we are expecting this incremental improvement in supply to continue in the coming quarters. We are also spending less money on broker fees and expediting fees as a result of our previously implemented initiatives. During the quarter, we also executed additional cost containment measures that lowered our operating expenses to our target quarterly run rate of $35 million which will support driving increased EBITDA as we continue to grow the top line. In addition to our strong revenue, bookings doubled sequentially and contributed to record backlog of $96 million at quarter end. This record backlog was not driven by supply constraints but rather large hyperscale orders for future quarters. Our in-quarter backlog has stabilized as our access to increased supply is allowing us to catch up on shippable backlog which Mike will discuss in more detail. Overall, our robust backlog gives us greater visibility and demonstrates the commitment from our large cloud partners to this business. Also in fiscal Q2, we delivered our sixth consecutive quarter of subscription revenue growth with subscription customers increasing to 554 from 455 last quarter. Delivering our data management solutions as a software subscription is an increasingly important part of how Quantum does business going forward. Our customers are asking for this type of purchasing model, yet they still value running our software on Quantum appliances in order to rely on a single vendor for support. We will continue to drive growth in ARR by driving increases in primary storage and non-hyperscale secondary storage software and systems and introducing new products based on subscription software licensing such as StorNext running on the AWS cloud which was launched in early September. While our near-term goal continues to be doubling of subscription software ARR to the $14 million to $15 million level, we now have a clearer picture of the time required to identify and close on these engagements. Therefore, our achievement of this initial milestone is increasingly likely to take place in early fiscal 2024. Although we have made progress on several of our stated initiatives, there is still more work to be done. During the first half of the year, we talked about expanding the earnings power of Quantum through a combination of pricing and discounting discipline, tighter management of the supply chain and operational expense reduction. As evidenced by my initial comments, we are beginning to see the evidence of these actions in our results. The other lever of utmost importance is expanding our gross margin which is tied very closely to our revenue mix. This applies not only to end market verticals but also from a geographic perspective. As many of you know, we get our best margins in North America as well as from our U.S. federal business. Both of these areas have been relatively weak over the past several quarters. Within the federal business, we've seen some large deals being pushed out and our non-hyperscaler business in the Americas has been impacted during the process of realignment of our sales team and appointment of new leadership. At the same time, our hyperscale business has been and will continue to be a strong growth driver for us, though it is at a relatively lower margin than the rest of our primary and secondary storage revenue. To further punctuate this point, our hyperscale business grew 32% sequentially and 68% year-over-year without a corresponding increase in our U.S. Federal or North America businesses. In order to improve our mix more favorably going forward, we began investing in broadening our sales and leadership teams in these areas over the last few quarters. I believe we are now back up to full strength and are well positioned to drive increased sales and more favorable revenue mix. In conjunction with these efforts, we are also focused on increasing our momentum in the enterprise market, particularly in the Americas. Industry analysts are projecting massive increases in the amount of cold data that must be stored and protected in the enterprise. As the market share leader in cold storage software and solutions and having worked alongside the world's leading hyperscale customers for several years, we have a tremendous opportunity to develop unstructured data solutions for Fortune 500 companies and help them address this massive data explosion taking place. With this greater emphasis on U.S. Federal in North America, we expect to see a more balanced revenue mix and associated margin improvement going forward. To give a broader sense of this opportunity, IDC estimates the worldwide scale-out file and object storage market to be over $30 billion by 2025, with emerging use cases like infrastructure for AI and business intelligence to be major growth drivers. Quantum offers a unique end-to-end portfolio to store, protect and enrich data across its entire life cycle and address critical needs in the enterprise like modernizing infrastructure to enable digital transformation, strengthening cybersecurity and using AI to unlock value in massive unstructured data lakes. We look forward to talking more about our go-forward product and business expansion strategy at our upcoming Analyst Day on November 17. Before turning the call over to Mike, I'd like to take this time to welcome the new additions to our Board of Directors. In August, Christopher Neumeyer joined our Board after serving as an observer since 2016. Having spent a decade at PIMCO and being a big supporter of Quantum's business, he provides a wealth of experience in corporate finance as we focus on delivering improved financial performance and shareholder value. And we recently announced that in November, Don Jaworski and Hu Meyrath will be joining our Board of Directors. Both Don and Hu have a deep understanding of the market trends in our space and have experience in the broad enterprise IT market, having previously held senior leadership roles at companies like NetApp, Dell, Juniper Networks and Brocade. All of these new Board members will help guide our future strategy, particularly as we bring to market new products aimed at high-growth segments like software-defined storage, AI, machine learning, and hybrid cloud. Now, I'd like to turn the call over to Mike to provide more details on the results. Then, we will take questions.

Mike Dodson, CFO

Thank you, Jamie. Welcome and thank you for joining the call today. Now turning to the results for the second quarter. Revenue came in just above the high end of the guidance at $99.1 million, representing an increase of 6% year-over-year and 2% compared to $97.1 million in the prior quarter. As Jamie mentioned, the supply chain continued to improve throughout the quarter, coupled with continued strong demand from our hyperscale customers. We had very strong bookings during the quarter which nearly doubled sequentially and contributed to a record backlog of $96.1 million as of September 30. The current quarter increase to a record backlog reflected the timing of several large purchase orders from hyperscale customers for future periods to ensure continuity of supply as opposed to being a result of supply chain constraints. We ended the quarter with approximately $25 million of shippable backlog and ended the second quarter with approximately $20 million which wasn't shipped during the quarter primarily due to lead times. Similar to prior quarters, approximately 85% of the backlog was with hyperscale customers. Although we anticipate supply chain constraints will remain, we do not expect this to significantly limit our ability to ship against customer demand. In the second quarter, secondary storage revenues were up 33% sequentially to 44% of revenue, primarily driven by ongoing strong demand from hyperscale customers and, to a lesser extent, an increase in enterprise, backup and data protection products. Primary storage systems declined 37% sequentially which reflects a combination of decreased shipments of our video surveillance solutions following our fulfillment of a large order last quarter, combined with soft media and entertainment and U.S. federal business. In terms of the supplemental metrics we use to track our ongoing transition to emphasize our recurring software subscription model, Annual Recurring Revenue, or ARR, increased 14% sequentially to $9.4 million. As a reminder, this figure includes recurring software subscription revenue across all of our transition product offerings, including StorNext, ActiveScale, DXI and CatDV. Additionally, at quarter end, the cumulative number of customers under a subscription contract increased to just over 550 active customers which represents a 180% year-over-year growth and sequential growth of 22%. In terms of total contract value, TCV, increased 9% sequentially to $17.5 million at the end of the second quarter, up from $16 million in the prior quarter. Although we anticipated a slight sequential improvement in non-GAAP gross margin, we ended the quarter at 35% or flat with the prior quarter. While we have seen benefits from our previously implemented initiatives related to price increases, prudent management of discounting, reductions in PPV and other related supply chain costs, these were collectively offset during the quarter by approximately 2 percentage point gross margin decrease as a result of a less favorable product mix that was more heavily weighted towards our hyperscale customers. As I just mentioned, secondary storage was 44% of our revenue which compares to 34% last quarter due to the significant increase in the hyperscale business. Next quarter, we expect this strong growth in hyperscale revenue to continue offsetting the realized benefits from our cost initiatives and favorable pricing and therefore, expect gross margins to remain flat with the second quarter. Improving our revenue mix remains a critical focus area to help expand gross margin in order to drive improved operating performance and increased EBITDA. As Jamie mentioned, in order to improve the revenue mix, we are focused on building our enterprise IT business and have recruited top sales talent with years of experience selling into this market as well as recruiting new reseller partners focused in this space. Another key growth driver is selling our end-to-end portfolio into our existing customer base, effectively broadening our footprint within our existing customers and using this as a key leverage point. Also impacting GAAP gross margins during the quarter was an extraordinary inventory reserve provision of $6.9 million. There were 2 primary factors that contributed to the need for this inventory provision. First, due to longer purchasing lead times of up to 52 weeks during the pandemic and subsequent changes in customer requirements over this extended timeframe, certain inventory had become obsolete due to next-generation products being released and the related legacy products being discontinued. In addition, following our integration of several past acquisitions, certain legacy products were discontinued and replaced with updated product offerings rendering the related inventory obsolete. We do not believe that the magnitude of this inventory charge is indicative of the company's performance and is not expected to be repeated in the near term. To meet the ongoing supply chain challenges, we have focused on supply chain excellence over the past year, including the following: first, establishing supply chain analytics to enable improved reaction time to supply chain disruptions, market demand changes and early technology transitions. And second, product management and supply chain are working closely together to reduce complexity, both in product SKU count and the supply base through supplier consolidation with the objective of being able to use components across multiple product lines. On the supply side, we will focus on supply partners for appliances that draw upon higher volume, more industry common platforms in which the supplier holds inventory until we need the appliance. We are also extending lead times on products that have lumpier demand and are more customized to the customer solution to reduce risk of holding inventory through technology transitions. GAAP operating expenses in the second quarter were $39 million compared to $41.1 million in the prior quarter. The non-GAAP expenses for the second quarter sequentially decreased $1.5 million to $34.8 million or just below our targeted run rate of $35 million. I want to further emphasize that $35 million was our target for the end of fiscal 2023. Therefore, we achieved this level effectively 2 quarters earlier than initially planned. The decrease in operating expenses were primarily due to lower headcount levels and higher cost geographies. GAAP net loss in the second quarter was $11.9 million or a loss of $0.13 per share compared to a net loss of $10.6 million or a loss of $0.13 per share in the prior quarter. Excluding stock compensation, restructuring charges and nonrecurring charges, non-GAAP adjusted net loss in the second quarter was $0.5 million or $0.01 per share compared to adjusted net loss of $3.6 million or $0.04 per share in the prior quarter. Adjusted EBITDA for the second quarter was $4.1 million compared to $0.3 million in the prior quarter. Included in the second quarter adjusted EBITDA was $2.4 million of other income related primarily to a benefit from foreign currency exchange rates and the sale of certain intangible assets compared to $0.8 million of other income in the prior quarter, related primarily to a benefit from fluctuations in foreign currency exchange rates. As we have discussed previously, driving improvement in our adjusted EBITDA remains one of our highest priorities. With our lowered operating expense run rate and continued top line growth, as we outlined earlier, improving gross margin will be the key factor to fully realizing increased improvements in our quarterly EBITDA results. 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. Cash and cash equivalents at the end of the second quarter were $25.9 million compared to $26.8 million in the prior quarter. Outstanding term debt at the end of the second quarter decreased by $1.2 million to $77.2 million from $78.4 million at the end of the prior quarter. At the end of the second quarter, the outstanding balance on the company's revolving line of credit was $21.5 million compared to $17.3 million in the prior quarter. Interest expense in the second quarter was $2.7 million compared to $2.1 million in the prior quarter and $3.1 million during the same quarter a year ago. Our cash and cash equivalents decreased by $0.9 million during the quarter. Net cash provided by operating activities during the current quarter was $0.4 million and represents a significant improvement over the $18.3 million net cash used in operating activities in the prior quarter. The fiscal year-to-date net cash used in operating activities was $17.9 million. And this use of cash approximated the $17.7 million decline in deferred revenue that was primarily driven by seasonality. As we mentioned on the call last quarter, historically, the heaviest bookings for service contract renewals have been the December and March quarters with decreases in bookings in the June and September quarters. Net cash used in investment activities was $4.8 million which represents CapEx. The net cash provided by financing activities during the quarter was $3.4 million and primarily represented increased borrowings and the revolving line of credit of approximately $4.2 million, offset by $1.2 million used to pay down outstanding term debt. Now turning to our financial outlook. As previously outlined, our fiscal 2023 objectives remain to continue growing revenue while realizing identified cost reductions. Although the pressure on gross margins associated with revenue mix remains a near-term challenge, we believe we are positioned to realize improvements in the coming quarters as our sales teams ramp and secure additional wins for our higher-margin products and solutions. For our third fiscal quarter, we expect revenue to be $103 million, plus or minus $3 million. Non-GAAP adjusted net loss is expected to be $1.5 million, plus or minus $1 million; adjusted net loss per share of $0.01, plus or minus $0.01 per share, using an anticipated basic share count of 91.3 million shares. We expect adjusted EBITDA in the third quarter to be approximately $3.5 million. With that, I'll turn the call back to Jamie for closing remarks.

Jamie Lerner, Chairman and CEO

Thanks, Mike. As indicated by our comments today, the team remains highly focused on executing and driving increased profitability in our business. Our end-to-end data management solutions are resonating with customers and partners. And we are actively expanding our software and systems business along with driving future growth in the federal and enterprise markets to increase our margins and improve our overall revenue mix. We are well positioned with record backlog which enables greater visibility into the long-term orders of our large hyperscale customers. With our expectation for continued improvements in the supply chain, we are guiding revenue for the third quarter to be above $100 million at the midpoint which will be the first time since 2019. With that, let's open it up for questions.

Operator, Operator

Our first question comes from Craig Ellis with B. Riley Securities.

Craig Ellis, Analyst

Congratulations on the significant surge in the backlog. I wanted to start there. So of the two components, the shippable component declined, it looks like by about 20% and it's around $20 million, while the future period is up about 3x. So Mike, what caused the mix of backlog to shift so much towards future and our customers just starting to do more order pipelining? And if so, why are they doing that now versus earlier when components might have been a bigger issue?

Mike Dodson, CFO

Yes. First, regarding the shippable backlog, we have observed a steady decline over the last few quarters, dropping from $32 million to $25 million and now to $20 million. Looking ahead to next quarter, we anticipate a further decline of about $5 million, bringing us close to a normalized shippable backlog level. The significant increase in future orders can primarily be attributed to our large hyperscalers wanting to ensure a stable supply. As a result, they are placing large orders with us for future delivery. This provides us with excellent visibility and aids in our planning, and it is not due to supply constraints as it had been previously.

Jamie Lerner, Chairman and CEO

And Craig, there's one other interesting development: we've been serving our largest hyperscaler for almost 4 years. So we're starting to see them begin to not only make additional capacity buys but starting to replace and upgrade some of the equipment that's 4 years old. So now we're getting both new orders as well as refresh and upgrade orders for the massive installed base that's there. So our quarterly sales to them are going up because it's including both new capacity and upgrades and refreshes to the capacity that's now coming up on 4 years old and some of it is out of service.

Craig Ellis, Analyst

Yes, a nice dynamic to have. So with that, well, one clarification. So Mike, for the backlog, how long do those orders extend out? Is that a 12-month backlog, a 24-month backlog? What's the duration of the orders in that extended backlog?

Mike Dodson, CFO

It's about 3 quarters.

Craig Ellis, Analyst

Three quarters, okay. So that is something I want to tie in to the gross margin point that you made with gross margins in the third quarter being flattish. So if we got a backlog that's $97 million and with that being a 3-quarter backlog, how is it that mix will shift to allow gross margins to go up over the next 3 quarters? Or are we really looking at flattish gross margins over the next 3 quarters until we get through what is a very robust period of secondary demand where mix is really working against the blended gross margin average?

Jamie Lerner, Chairman and CEO

Craig, it's Jamie. The reason for the gross margin pressure is that as we increase our hyperscaler sales, every additional $1 million that we bring in dilutes gross margin because it's margin-dilutive business. So to offset that, we need to sell a mix of North American enterprise sales and U.S. federal sales which are among our highest margin business. Now our sales there, if you look in primary have fallen off a bit. And some of that is a result of us moving our sales organization from single product sellers to portfolio sellers, right? Our strategy is to sell our customers a full end-to-end portfolio of unstructured data products. So we've been shifting our sales force to a, I would say, a more capable enterprise seller. But when you transition the sales team, the new team needs to get up to speed, get going. And we're transitioning that North America team and our U.S. Federal team. Now we've made the hires. We've brought them through training. And we expect them to come on. And as they begin to sell at a higher level than our previous teams did, we're going to restore that mix. So it's really about less of a market condition. It's more a result of us making pretty significant changes in the makeup of our North American and U.S. federal sales organization.

Craig Ellis, Analyst

Okay, Jamie. So just to tie that in with some of the numbers from the investor presentation then. After a quarter or two, if primary kind of stays at this $10 million level, you'd expect it to get back to the mid-teens? And with that, you'd get some upward mix pressure on gross margins. Is that how we should look at it?

Jamie Lerner, Chairman and CEO

Yes. I believe you will see an increase in primary storage. Additionally, I expect sales of secondary storage to rise within the enterprise sector and the U.S. federal government. This is how we plan to restore our margins. We typically operate with margins in the mid-40s for the U.S. enterprise and in the 60s or even 70s for certain specialized government programs. The influence of a 70-point margin business is significant, especially when it's offsetting margins of 18% to 20% in the hyperscale segment. Even a few million dollars from that business can greatly impact our overall margin. It’s really about the mix. We are confident in the strength of our cloud business and are dedicating substantial effort to enhance our North America enterprise and U.S. Federal business. Our goal is to improve the mix to drive margins back up into the 40s, and ideally, we aim to reach the 50s.

Craig Ellis, Analyst

Got it, okay. And then last one before I hop back in the queue. The subscription customers, again, I think for about the third consecutive quarter, up by about 100, so nice to see. But Mike, you indicated that your expectation for that ARR target was pushed out from the end of this year to early '24. And so it seems like that 100 or that 100-quarter-pacing or the value per deal or in aggregate, just isn't pacing as you'd expected. Can you talk about what it will take to accelerate the customer adds from 100? I know I've asked about that before. But it seems a very critical question for getting the business to that 60% gross margin target very long term.

Mike Dodson, CFO

Yes, we're pleased that our new customers are transitioning to subscription, and they're generally receptive to it without much resistance. However, as you mentioned, we need to increase our momentum. We're exploring several initiatives to help with this. Some of our long-term customers, who have been with us for 10 to 15 years, are accustomed to their current purchasing methods. Transitioning them to subscription entails a different pricing structure than they are used to. Therefore, we're considering various incentives for customers, sales teams, and channels to encourage this transition. We have plans to implement these programs to speed up the adoption of our new business model because we are confident in our products and business model, but we need to improve the pace at which customers adopt the new model.

Operator, Operator

Our next question comes from the line of Ryan Meyers with Lake Street Capital Markets.

Ryan Meyers, Analyst

Just one for me. I was just wondering if you could highlight your operating expense reduction efforts. And if you feel like there's opportunity to reduce this even further. It sounds like you made some positive strides here during the quarter. Just kind of curious if you think there's opportunity to lower those even more.

Mike Dodson, CFO

Yes. Thanks, Ryan. Yes, as we reported, coming in at $35 million was the target that we had for the end of the year. So we're 2 quarters ahead there. And we still will continue to optimize, look at what we can do, where we can do it. If we can do things in lower-cost geographies, we'll take advantage of that, look to optimize our facility footprint further. So we would expect to keep at this level, if not do better, as we go forward. That's definitely our target.

Operator, Operator

Our next question comes from the line of George Iwanyc with Oppenheimer.

George Iwanyc, Analyst

Jamie, maybe just expanding on the economy and what you're seeing there. I know you talked about the sales transitions with the new hires and all of that. But are you seeing any areas where macro headwinds are impacting the business?

Jamie Lerner, Chairman and CEO

Our business may not be as large as others facing challenges, and while I'm not an economist, I haven't observed significant delays due to economic concerns. Projects aren't being postponed or canceled in our sectors, particularly in data protection. I don't see any reduction in media and entertainment, as shows and news programs continue. In the areas we operate, such as critical video surveillance, police departments aren’t reducing their budgets, nor are television stations canceling shows. There’s no evidence of cutbacks on anti-ransomware or data protection efforts either. Perhaps it's due to the sectors we serve or the value of our products. After spending time with our sales team, I'm not witnessing delays or cancellations. That's why we've consistently raised our revenue outlook for several quarters now; our challenges have primarily been supply-related, and as those issues have improved, we're experiencing a surge in sales.

George Iwanyc, Analyst

All right. And just following on that supply challenges. Good to see the improvement. Are there areas where you're still seeing any decommits or areas where you're still a bit concerned? Or is the visibility definitely a lot clearer at this point?

Jamie Lerner, Chairman and CEO

It's a little hard to answer, right? Because we've had the rug pulled out from us multiple times. So today, we have good visibility. We are not seeing people asking the outrageous prices that were being asked. We're not seeing the need to do these very expensive expediting of shipment. We're not seeing the brokers out there charging massive fees. So that has come down now that can start again in a minute if somebody decommits. But so far, we're a month into this quarter. We're not seeing decommits. We're not seeing broker fees. We're not seeing expediting fees. And we're receiving materials as expected. The only thing that I would say we see a bit of is some products have slightly longer lead times. Products we used to see in 2 to 4 weeks are now 4 to 8 weeks. And that's why we're kind of moving to more of a more natural shippable backlog of $10 million or $12 million when we used to be down to $2 million or $3 million because products where we get orders in the last 2 or 3 weeks of the quarter, we're not going to pay expediting fees to get that. We'd just rather roll that into the next quarter and get better linearity and better predictability in our business.

George Iwanyc, Analyst

All right. And just my last question. You highlighted the AWS marketplace availability of StorNext and the extended partnership. How is the ecosystem evolving? Where are you focused on adding new partners? And how long do you kind of expect that effort to last before you start seeing some new customer gains from that?

Jamie Lerner, Chairman and CEO

Yes. The way I would characterize our partner ecosystem is Quantum 4 years ago was a niche vendor. We sold to media and entertainment. And we sold in new certain backup use cases. Today, we're an end-to-end provider. We provide a full suite of offerings during every life cycle stage for unstructured data. So now we're working with different partners. We're way more relevant to the enterprise than we used to be. So our largest effort globally in all our theaters which are North America, Asia Pac, and EMEA, we are recruiting new channel partners that are more enterprise-oriented, that are more broad in their scope than the niche partners that we worked with historically. And we think that is where we're going to see the most margin expansion. And I think that's where we're going to see the most revenue expansion is being much more relevant with more products to the general enterprise.

Operator, Operator

Our next question comes from the line of David Duley with Steelhead Securities.

David Duley, Analyst

Yes. Congratulations on the nice results sequentially. A couple of questions from me. As far as your hyperscale business, you're kind of seeing a little bit of a slowdown in the growth rates of North American customers and I think some slowdowns internationally as well. How should we translate that into the growth rate of your business into this area? And I guess maybe if you could look into next calendar year or just help us maybe understand what the growth will actually be this calendar year?

Jamie Lerner, Chairman and CEO

Yes, I can explain why this happened. We are not experiencing a slowdown in the economy. We are in the process of transforming our long-standing sales force from single product sellers to portfolio sellers. This transition naturally brings about some slowdowns as we adapt a legacy sales team into a next-generation team. We've had to replace some team members, and there's a learning curve involved. I think this is just a typical phase we are going through. Mike can provide details on growth rates, but I don't believe we have offered any future guidance on growth rates beyond the current quarter.

Mike Dodson, CFO

But to that point, Dave, we are having our Analyst Day on November 17. So we'll be looking out 5 years and we'll go year by year. So we definitely can give a lot more color as we go through that presentation.

David Duley, Analyst

Yes. No, for calendar 2022, you just gave guidance for the December quarter and I don't have the numbers in front of me. What do you think the hyperscale business did in calendar 2022 or will do if you hit your guidance?

Mike Dodson, CFO

We do not provide details on individual groups like that. However, you can look at the secondary data and see that the hyperscalers are the largest segment within that business unit.

Jamie Lerner, Chairman and CEO

How much did the secondary grow and that's been growing significantly.

Mike Dodson, CFO

Yes. I mean it grew 33%, while the hyperscalers grew 33%, the secondary grew.

David Duley, Analyst

Okay. Is the hybrid business primarily focused in North America, or are there any potential risks from international restrictions in China and elsewhere?

Jamie Lerner, Chairman and CEO

Yes, it's an international business. We have Chinese hyperscalers, U.S. hyperscalers. We have Telcos that are trying to be hyperscalers. So it's an international business. Cape which is predominantly what we sell is a product that the Chinese government has said they will not be trying to make. Similarly, India is saying that is a product they're not trying to make themselves. So they have made a decision to import that from the West.

David Duley, Analyst

Okay. And then finally for me, you touched upon it a little bit. But you've talked about how your federal business is weak and your media and entertainment business was weaker in your U.S. non-hyperscale enterprise businesses. What would be the timing or your best guess as to see when those segments start to improve sequentially or year-over-year? Or how are you look at them?

Jamie Lerner, Chairman and CEO

Right now, we're guiding to a $103 million, and we believe we'll continue to increase our guidance. We've hired over 15 new sales reps. Last quarter, with the $99 million, those 15 sales reps contributed nothing. Now, as the new hires are getting up to speed, we anticipate their contributions will be significant, especially since we've projected they could generate over $3 million each annually. We're optimistic about the hires we've made and the training programs implemented. These new reps will be entering established territories that were nurtured before their arrival, with substantial existing customer bases. This is partly why we've exceeded our range and are raising our guidance.

Operator, Operator

And our next question comes from the line of John Fichthorn with Dialectic Capital.

John Fichthorn, Analyst

Yes. Guys, nice work in the backlog and hitting the numbers. I guess everybody is trying to kind of get to the same answer here. And so I'll ask the same question in a different way which is you're guiding to $103 million, it's great. And Dave just asked about kind of the mix here with hyperscalers or tape. And so you're forecasting growth but you're forecasting flat gross margins which would imply that all of the growth is coming from hyperscalers and yet you're also talking about these 15 new sales guys which I'm excited about, gaining traction in things like primary storage and federal and media and entertainment and that somehow should imply higher gross margins. So I can't quite square that circle.

Jamie Lerner, Chairman and CEO

Yes, you are correct that we have been expanding our hyperscaler business while experiencing some historical declines in our most profitable, high-margin sectors. To improve our margins, we need to increase sales in North America and the U.S. Federal space, and another factor is boosting service sales, which is somewhat challenging in the short term. We anticipated this situation over a year ago, so we've focused on recruiting, hiring, and training, and the new team members are now ready to begin contributing. However, we are uncertain about the speed of their integration and forecasting their impact, which is why we are guiding toward strong EBITDA. Additionally, looking at the $96 million in backlog indicates that if it's primarily from hyperscalers, not only have hyperscaler sales increased this quarter, but they are likely to continue rising in upcoming quarters. This creates an additional challenge as we need to sell more to balance out the dilution from increased hyperscaler sales, which we haven’t fully assessed yet. Therefore, while an EBITDA of $3.5 million is solid, there is an element of caution since we don't have a definitive timeline or effectiveness for the new sales representatives. I've met with them personally, and I can say that this team is more experienced and mature in enterprise sales than previously, which gives me optimism; however, it’s too early to evaluate their performance accurately.

John Fichthorn, Analyst

In the case of federal, focusing on that specific area, this was the quarter we had. Do you believe your new sales representatives will be able to drive growth in federal, maybe on a year-over-year basis, but perhaps not sequentially, as this quarter didn’t seem particularly strong for federal?

Jamie Lerner, Chairman and CEO

It's interesting to note that many companies, including Dell and Cisco, had deals influenced by U.S. Federal budgets, which are ongoing. Typically, the government operates on a use-it-or-lose-it principle for budget spending by September 30. However, due to the continuing resolution, they are carrying over funds from the previous year. This gives me confidence in our U.S. Federal business, especially with the programs we're involved in and the potential for significant budget refreshes. I feel optimistic about our U.S. Federal operations, especially because of the strong leadership in that segment and excellent new hires. I'm looking forward to how this team will perform. Additionally, the U.S. government hasn't followed the typical use-it-or-lose-it rule; they have retained most of the funds allocated last year that weren't spent.

Operator, Operator

And our final question comes from the line of Nehal Chokshi with Northland Capital Markets.

Nehal Chokshi, Analyst

Yes. My congrats on the strong bottom line. There's a lot of discussion here on the new quota sales reps here. Just to level set, how many total quota carrying sales reps do you have now?

Jamie Lerner, Chairman and CEO

Well, we have outside and inside quota-carrying reps but rough and tough, I'd say it's about between 50 and 55 quota-carrying people.

Nehal Chokshi, Analyst

Okay. And prior to the restructuring, where were you at?

Jamie Lerner, Chairman and CEO

We currently have around 50 to 55 quota-carrying salespeople, primarily focused on specific products like DXI and StorNext for media and entertainment. The new sales team members come from companies such as Cisco and Dell, which offer extensive product portfolios. These new hires tend to be more experienced and slightly more expensive, but they also have higher sales targets and engage in more targeted account selling compared to our previous approach of selling broadly to anyone available. Our new representatives focus on a more limited number of named accounts, usually between 20 to 25, allowing them to delve deeper into those accounts.

Nehal Chokshi, Analyst

Okay. And just to be clear then, prior to the restructuring, each quota-carrying sales rep was effectively a point product salesperson. And you converted most of them to a multi-product salesperson. Those that weren't converted were let go and you hired a new 15?

Jamie Lerner, Chairman and CEO

I mean the number is about 15 in North America. But I think of it as some of our salespeople made the transition from being maybe focused on a certain area to being more generalists. I think everyone knows that there's been a lot of turnover in all U.S. businesses. So we've had a certain amount of turnover ourselves. We've had certain people that just weren't successful here. So we had a series of reasons of why we've cycled people over. But in that process, we've moved to end-to-end sellers versus point product sellers. A lot of them are new. And right now, it's a race to get them up to speed, get them up to quota. And we're investing in training boot camps, all the things we could do to get them up to quota as fast as we can. And we think that will rebalance the mix. And by rebalancing the mix, the margins should go up. But I think 35%, we're expecting 35% to be the low point. And we just got to bring it up from here.

Nehal Chokshi, Analyst

Yes, absolutely. Okay. And just to be clear, you believe you're not seeing any negative macro signs at this point in time?

Jamie Lerner, Chairman and CEO

I'm not in a position to see the broader picture like a large company such as Dell, Cisco, or HP. However, based on my recent travels to Asia, Europe, and various U.S. cities including Atlanta, New York, L.A., and Seattle, and having met with over 30 customers in person, I haven't encountered discussions about needing to slow down or pause. My perspective is likely limited compared to the CEOs of these larger firms.

Nehal Chokshi, Analyst

Yes, understood. Can you provide an update on the PIVOT 3 acquisition and the performance of that asset?

Jamie Lerner, Chairman and CEO

Yes, those guys are doing phenomenal. They just won another significant award from the Department of Homeland Security and are doing really well. They have some long lead time products because video surveillance technology is evolving, and most Video Management Systems now require many GPUs to analyze video, which is extending the product lead times. We won’t be pre-buying systems due to the inventory risks involved, but I like the direction that business is heading. Additionally, we recently held meetings across Asia, Europe, and three different locations in the U.S. for our annual Elevate Conference. We brought together over 100 partners in Asia, 150 in Europe, and about 200 in New York, L.A., and D.C. The product generating the most excitement among partners, especially in Asia, is video surveillance. We've even scheduled additional meetings focused on surveillance because of the enthusiasm it’s generated. I believe this is a valuable opportunity for us, and we have significant innovation in this area. Our focus has now shifted to the Unified Surveillance Platform, which integrates PIVOT 3 with the cloud and assets, allowing the software to operate on any server or hypervisor that can virtualize in the cloud. I believe the technical architecture is in a strong leadership position and is the preferred platform for scenarios where you cannot afford to lose any video frames. For police departments, homeland security, the defense department, casinos, banks, or any setting where video loss is unacceptable, the PIVOT-3 platform stands out as the leading solution.

Operator, Operator

And we have reached the end of the question-and-answer session. I'll now turn the call back over to Jamie Lerner for closing remarks.

Jamie Lerner, Chairman and CEO

All right. Well, thanks, everyone. It feels great to be back beating guidance and raising our revenue. And I think that trend is one we plan to continue, yet being conservative and recognizing the fact that there are still supply chain disruptions. There's still a lot of uncertainty. But our products are value-oriented. We think they do well when customers have to spend wisely and we like how our products are positioned for this market. And we look forward to speaking to you all on November 17, where we'll be having our Annual Investor Day. And we'll be updating our 5-year model with what we've learned over the last year. So I look forward to seeing you all then. Until then, thanks so much and we'll talk soon.

Operator, Operator

This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation.