Earnings Call Transcript - STX Q2 2020

Operator, Operator

Good morning, and welcome to the Seagate Technology’s Fiscal Second Quarter 2020 Financial Results Conference Call. My name is Josh, and I'll be your coordinator for today. At this time, all participants are in a listen-only mode. Following the prepared remarks, there will be a question-and-answer session. As a reminder, this conference is being recorded for replay purposes. At this time, I'd like to turn the call over to Shanye Hudson, Vice President, Investor Relations. Please proceed, Shanye.

Shayne Hudson, Vice President, Investor Relations

Thank you. Good morning, everyone, and welcome to today's call. Joining me are Dave Mosley, Seagate's Chief Executive Officer; and Gianluca Romano, our Chief Financial Officer. We posted our earnings press release and detailed supplemental information for our December 2019 quarter on the Investors section of our website. During today's call, we will refer to GAAP and non-GAAP measures. Non-GAAP figures are reconciled to GAAP figures in the earnings press release posted on our website and Form 8-K that was filed with the SEC. We've not reconciled certain non-GAAP outlook measures because material items that may impact these measures are out of our control and/or cannot be reasonably predicted. Therefore, reconciliation to the corresponding GAAP measures is not available without unreasonable efforts. As a reminder, this call contains forward-looking statements, including our March quarter financial outlook and expectations about our financial performance, market demand, industry growth trends, planned product introductions, ability to ramp production, future growth opportunities, and general market conditions. These statements are based on management's current views and assumptions and should not be relied upon as of any subsequent date. Actual results may vary materially from today's statements. Information concerning our risks, uncertainties, and other factors that could cause results to differ from these forward-looking statements are contained in our most recent Form 10-K filed with the SEC and the supplemental information posted on the Investors section of our website. Following today's prepared remarks, we will open the call for questions. And with that, I'll now turn the call over to you, Dave.

Dave Mosley, CEO

Thanks, Shanye. Good morning, everyone, and thanks for joining us. I will begin today's call by highlighting a few key accomplishments for the December quarter and then I will share some perspectives on the market trends and their relevance to Seagate. Afterwards, I will turn the call over to Gianluca to elaborate on our December quarter financial performance and present our March quarter outlook. In the December quarter, we grew revenue to $2.7 billion and drove strong double-digit profit growth on a sequential basis with both non-GAAP operating margin and non-GAAP EPS coming in at the upper end of our guided ranges. Importantly, we have generated nearly $1.2 billion in free cash flow over the past 12 months, underscoring our consistent operational execution. In addition to delivering solid financial results, we achieved record exabyte shipments in the December quarter supported by strong demand for mass capacity storage and the continued successful ramp of our 16-terabyte products. Consistent with our expectations, we shipped 1 million 16-terabyte drives during the quarter to support strong customer demand. We also strengthened our product portfolio announcing the Seagate Lyve Drive Mobile System, a series of seamlessly integrated storage solutions to address the burgeoning need to move data between endpoints, edge, and core cloud environments in an efficient, secure, and cost-effective way. Lyve Drive was one of many products we showcased during the Consumer Electronics Show this past January, which I'll discuss shortly. First, let me comment on some of the trends we're seeing in the market. Our December quarter results highlight the increasing demand for mass capacity storage, which includes nearline, video, and image applications and network-attached storage or NAS. Revenue from mass capacity storage increased 9% quarter-over-quarter and 25% year-over-year, driven by growth across each of these markets. This positive trajectory reflects both ongoing demand recovery as well as secular growth for mass capacity storage. In nearline, we are leading the industry's transition to 16-terabytes, which is the largest capacity drive available in mass volume today, offering the best total cost of ownership opportunity for our customers. In the December quarter, these products represented the highest revenue and highest exabyte shipments of any of our drives. We achieved these results while still at the very early stages of this industry transition. Nearline demand has been on a positive trajectory that we expect will continue through at least the rest of the fiscal year. We are well positioned to address this growing demand as we continue to ramp our 16-terabyte production and launch our 18-terabyte drives, which are based on the same platform, simplifying the manufacturing and qualification processes. The 18-terabyte launch is progressing to plan and we remain on track to begin shipments in the first half of the calendar year 2020. We expect to align our production to meet customers' demand. In video and image applications, we achieved record revenue in the December quarter, driven by strong demand for surveillance drives. As we've shared for multiple quarters now, global uncertainty has created some disruption in typical customer buying patterns within certain markets, including surveillance. However, the underlying demand drivers remain intact, and inventory levels appear to be relatively healthy, supporting our positive view of demand over the long-term. Security surveillance is just one of a growing number of applications adopting high-definition video and image processing, which require mass capacity storage at the edge and in the cloud. Two weeks ago at CES, we demonstrated how video and imaging sensors are being deployed in smart cities and smart factories to collect and analyze massive amounts of data used to improve traffic flow, hasten emergency response times, lower production costs, and improve worker safety. These are real-world use cases spawned by the emergence of IT 4.0, which illustrate how organizations are unlocking value from the data being created by sensors, cameras, and other endpoint devices. The transition to IT 4.0 and trend towards a multi-cloud world create meaningful opportunities for Seagate. We project that a typical smart factory can create 5 petabytes of video data per day, and the smart city could generate 200 petabytes each day. The fully realized data potential, compute, and storage must be moved closer to the source of creation, closer to the edge. At CES, we also showcased how Seagate's storage solutions are enabling IT 4.0 and hybrid cloud environments by leveraging our innovative technologies and expertise in systems’ architectures. We featured our high-density scalable solutions, which offer enterprise customers a cost-effective petabyte solution, ideal for data-rich cloud applications. The unit we displayed at CES was configured with 106 HDDs, including multiple HAMR drives working in real-time. We are on track to release the industry's first commercially available HAMR drive in late calendar 2020 at the 20-terabyte capacity point. Each year, I look forward to the Consumer Electronics Show for the opportunity to interact directly with customers, partners, suppliers, and loyal enthusiasts of Seagate products and hear their feedback firsthand. The consumer market remains a very good business for Seagate. In fact, in the December quarter alone, we shipped 12 exabytes in portable external drives trusted by our user community to move their data. The media and the entertainment professionals, gamers, and prosumers of the Seagate branded storage solutions represent quality, reliability, and simplicity. We designed our Lyve Drive Mobile Solutions with these same principles in mind. As I mentioned earlier, Lyve Drive offers enterprise CIOs a solution for efficiently and cost-effectively managing data between endpoints, edge, and core cloud. Even with a dedicated 10-gigabit per second connection, it would take at least 12 days to upload 1 petabyte of data to the cloud. The cost for sending large amounts of data over a network can be an order of magnitude more expensive than simply physically transporting it. With Lyve Drive, customers can securely transfer data and ingest it into their data centers more quickly and affordably than other available options. Our integrated approach is a first key step towards a unified data experience. Overall, we're excited by the momentum of our 16-terabyte drives, the competitive strength of our technology roadmap, and the breadth of our product portfolio, all of which we believe position Seagate to address the growing demand for mass capacity storage and the need for data management solutions. With that, I'll turn the call over to Gianluca to go into more depth on our December quarter results and share our outlook for the March quarter.

Gianluca Romano, CFO

Thank you, Dave. The December quarter represented another period of solid financial performance and strong free cash flow. On a sequential basis, revenue increased 5% to $2.7 billion. Non-GAAP operating income increased 29% translating to a non-GAAP operating margin of nearly 16% of revenue, and non-GAAP earnings per share increased 31% to $1.35. Our results demonstrate strong operating leverage supported by ongoing expense discipline and a richer revenue mix of mass capacity storage. Mass capacity storage, which includes nearline, video and image application, and NAS drives represented 49% of total December quarter revenue, up from 47% in the prior quarter and 39% in the prior year. Exabyte shipment into this market increased 12% sequentially to 71 exabytes. This strong sequential growth was underpinned by demand for our mass capacity drives. As we shared during our analyst event, we expect that mass capacity revenue will continue to grow quickly over the next several years. Our product portfolio and technology roadmap are well aligned to capture these growth opportunities. Revenue from 16-terabyte drives nearly tripled quarter-over-quarter making them our highest revenue product during the quarter, a trend we expect to persist through the rest of the fiscal year as we continue to ramp this product to support the broadening of customer demand. Increased demand for mid-capacity nearline drives was another highlight for the quarter. Sales of our 4, 6, and 8-terabyte drives moved higher to support enterprise and OEM customers as they build out their own prem and private cloud storage needs. Our cost-reduced mid-capacity product continued to gain momentum offering customers a better TCO relative to prior generation products. In addition to LTE nearline demand, we also realized double-digit revenue and exabyte growth for video and image applications reflecting above-seasonal demand which we expect to normalize moving into the second half of the fiscal year. As Dave shared earlier, with the advent of IT 4.0 and the adoption of video and image sensors across a growing number of applications, we see meaningful growth opportunities for our mass capacity storage solutions in this market. Revenue from the legacy market remained fairly flat on a sequential basis and represented 43% of December quarter revenue, compared with 46% in the September quarter. Exabyte shipment into the legacy market increased 3% sequentially to 36 exabytes. We continue to garner customer and consumer support for our legacy product, which includes mission-critical, desktop, notebook, DVR, and external consumer devices. Seasonal demand for consumer drives combined with higher mission-critical sales largely offset the expected decline in gaming consoles and notebooks. Overall, our total HDD average capacity per drive increased 11% sequentially, and we expect average drive capacity to further increase as demand for mass capacity storage continues to grow. The remaining 8% of December quarter revenue was derived from our non-HDD business, in which revenue increased 14% sequentially, driven by growth in both system and SSD. We're continuing to gain momentum with our system solutions driven by increasing demand for data at the edge and the adoption of private cloud. Enterprise customers are seeking the denser storage solution driving higher system content. This dynamic supported a new exabyte shipment record for system in the December quarter. Non-GAAP gross margin was 28.7%, up 200 basis points sequentially, reflecting a more favorable product mix with a higher contribution from mass capacity drives. Non-GAAP operating expenses were $350 million, down 3% sequentially and slightly below our prior estimate, due mainly to lower discretionary spending. We are evaluating opportunities to drive further operational efficiencies while continuing to invest in areas that support future growth. With a combination of higher gross margin and controlled spending, we delivered non-GAAP operating income of $424 million, up 29% quarter-over-quarter. This translates to a non-GAAP operating margin of approximately 16% of revenue at the top end of our long-term financial model range. Based on a share count of approximately 265 million shares, non-GAAP EPS for the December quarter was $1.35, which surpassed our guidance midpoint. Consistent with our expectation, capital expenditure increased to $194 million to support growing demand for mass capacity storage. We project fiscal year CapEx to be towards the middle of our long-term range of 6% to 8% of revenue. We generated strong free cash flow in the December quarter, fairly stable with the past several quarters, and we continue to deploy capital to reward shareholders through our longstanding capital return program. We utilized $150 million to retire 2.5 million ordinary shares, exiting the quarter with 261 million shares outstanding; and we used $165 million to fund our dividend. Our Board also approved a quarterly dividend payment of $0.65 per share payable on April 8, 2020. As of the end of the quarter, cash and cash equivalents were at $1.7 billion, and we have access to an additional $1.5 billion through our revolver. Gross debt was $4.1 billion, with a net debt of $2.4 billion, both fairly flat with the prior quarter. Adjusted EBITDA increased 23% sequentially to approximately $500 million, and we expect our gross debt leverage ratio to be at or below 2 times within the next few quarters. Looking ahead to our outlook for the March quarter, as the Coronavirus outbreak continues, we have made our first priority the health and wellbeing of our employees and partners. We are also working with our suppliers to meet customer demand and mitigate risk to production. While we currently do not expect any material financial impact in the March quarter, there’s still a lot of uncertainty, and therefore we are widening our revenue and EPS guidance ranges. With this in mind, we expect revenue to be in the range of $2.7 billion plus or minus 7%. At the midpoint of our revenue guidance, we expect non-GAAP operating margin to be at the high end of our long-term target range of 13% to 16% of revenue. And non-GAAP EPS is expected to be $1.35 plus or minus 7%. In general, we're seeing a change in typical seasonality as HDD demand shifts away from consumer-oriented legacy markets and towards mass capacity storage driven by data growth in the cloud and at the edge. The demand environment has continued to steadily improve, particularly for high-capacity nearline drives. With the positive customer momentum we have established for our 16-terabyte products, we continue to expect both revenue and profitability to grow in fiscal 2020 with the second half revenue slightly higher than the first half for this fiscal year.

Dave Mosley, CEO

Thanks, Gianluca. In summary, our performance demonstrates our ability to deliver solid financial results and drive cash generation throughout industry cycles. We are continuing to identify ways to drive further operational efficiencies to optimize profitability. We are also leveraging our strong technology roadmap, broad product portfolio, deep customer relationships, and systems architecture expertise to address secular demand for mass capacity storage and emerging opportunities to provide cost-effective data management solutions. I’m confident that Seagate is well positioned to fully capitalize on these growth opportunities while enhancing value for our customers and shareholders. Before opening the call for questions, I would like to take a moment to thank our customers, suppliers, business partners, and employees for their contributions to the ongoing success of our business. Josh, I’ll hand it back to you to lead through the Q&A.

Operator, Operator

Your first question comes from Sidney Ho with Deutsche Bank. Please go ahead. Your line is open.

Unidentified Analyst, Analyst

Hi, this is Jeff on for Sidney. Gross margins were good in the quarter. Can you talk a little bit about any pricing pressure that you were seeing related to high-capacity drives?

Dave Mosley, CEO

I would say that the market in terms of dollars per terabyte, looking back over the past few years, reflects a highly competitive environment. I expect that, in the long run, we will all need to invest in order to meet the demands of that growth. At some point, we will need to continue reducing our costs, which we are currently doing, and navigate through product transitions, which we are also managing. Additionally, we will have to invest capital, and I foresee that we will need to shift our focus from pursuing market share to making those critical investments.

Unidentified Analyst, Analyst

Great. And then just as a follow-up, you mentioned increased demand for midline capacity drives as enterprise and OEMs build out their own storage needs. Can you talk a little more about this opportunity and does this potentially lead to a less reliance on the cloud service providers in the future?

Dave Mosley, CEO

No. I would say, if I go back a year and a half to the peak of the last cycle, thereabout, the market was very strong across the portfolio. I think the highest capacity points typically go to the bigger customers, but I think there are many small customers globally, which are still not as fully represented as they were in the peak of the last cycle, frankly, but are taking all kinds of different capacity points. And so, therefore, it's important to have a broad product portfolio and address them with the right products.

Operator, Operator

Your next question comes from Katy Huberty with Morgan Stanley. Please go ahead. Your line is open.

Katy Huberty, Analyst

Thank you. Good afternoon. Can you just talk about how you see 16-terabyte ramping? In which quarter do you expect the biggest sequential ramp in volume? And then, is there any reason that as 16-terabyte volumes ramp the gross margins wouldn't improve in a fairly linear fashion?

Dave Mosley, CEO

I think we can both take it, Katy, I'll pass it over to Gianluca for the gross margin part. We've said that this is one of the biggest ramps we've ever done, if not the biggest ramp we've ever done at heads and media. We're in the middle of it and to the point of just saying this quarter we will do 1 million and then having done 1 million, that's indicative of the strength of that ramp. The ramp is not over. It's going to keep going. And the way we look at it is, there were many products in our portfolio before, but this platform is the one that's going to take us from 16 to 18 to 20 and beyond. Our ability to leverage costs and the other technology pieces that we have to put in there is great now that we don't have to keep transitioning products, we get a lot of leverage from that. We talked about that in the prepared remarks. So from my perspective, we have that strong portfolio to take us forward. I think Gianluca can speak about gross margins.

Gianluca Romano, CFO

Yes. I'd say in fiscal Q2, the improvement in gross margin is coming partially from the 16-terabyte, but as we said, actually tripled the volume during the quarter but also from an overall cost reduction on several other drives. So, looking at Q3, we will have for sure a higher volume in 16-terabytes that will help our gross margin, but of course depends on the overall mix of the entire volume that we move into the quarter.

Katy Huberty, Analyst

Thank you. I’d like to follow up on your comments about the challenges of ramping up hiring in media for the 16-terabyte product. Regarding the demand side, there are some questions about the qualifications coming in. Can you discuss the differences between the U.S. and China and provide general numbers on how many of your major customers have qualified and are currently purchasing that product?

Dave Mosley, CEO

We're quite pleased with the range of qualifications. For specific customers, some may be ready to adopt 16, while others might still be on 8, for instance. Worldwide, there are various reasons why some aren't ready to transition to that architecture, and we understand that. Overall, we are on track with our ramp, and I believe it will continue from this point. The qualifications are progressing well, so I’m not concerned about it at all. When I look at our customer base, previously we discussed everyone quickly adopting the highest capacity point. However, that seems to be happening less often because there are diverse needs, even within individual customer sets. Each customer may have their own specific requirements. As the cloud expands, larger customers have varying needs that we must address. It's not only about developing new solutions; it's a growing landscape. Therefore, we need to collaborate with all our customers to meet their unique needs, and the 16-terabyte option is performing well in that regard.

Operator, Operator

Your next question comes from Ananda Baruah with Loop Capital. Please go ahead. Your line is open.

Ananda Baruah, Analyst

Good afternoon guys. Thanks for taking the question. A couple from me if I could, just sticking on gross margin. I may have missed it, but did you make remarks about what we should expect for gross margin in the March quarter? And then just as a follow-up to that, philosophically, as you can see to improve the yields on 16 and Dave to your point about the platform transition to 18, same platform, why wouldn't the gross margin level up nicely once you get the 16 yields to normalize and then as you transition on to 18 from there, once you have the cost, so the cost situation, yield situation handled?

Dave Mosley, CEO

I believe that as the market continues to grow, supply and demand will be the main factor in these discussions. If the supply-demand scenario increasingly favors higher demand with limited supply, we can start exploring those questions. This situation influences cloud cyclicality, and I will let Gianluca share his thoughts on gross margin.

Gianluca Romano, CFO

Hi Ananda. You know we don't really guide gross margin, but if you look at our revenue and our EPS are fairly aligned quarter-over-quarter. So I'll have to take your assumption, but no, I would not see a major change sequentially.

Dave Mosley, CEO

I think if we see a big demand in the 16-terabyte, the 18-terabyte, once we get there is in high demand, I think we should be able to manage it. I think we talked about that a little bit last quarter as well. And what you described may happen, but I think the broader portfolio from our perspective, and we've said this before, we're really managing for things closer to the bottom line like operating income and now that we're at the top end of our range again, we’re quite happy with that.

Ananda Baruah, Analyst

Great. Then you mentioned positive trajectory for hyperscale from here, you expect June to be up for March as well. I mean I know things can change but just in your base case from an exabyte perspective?

Dave Mosley, CEO

Yes. We’ve talked to the end of the fiscal year that I don't see any reason for the cycle to slow down by the end of the fiscal year. Out the back end of the calendar year, we're not really ready to talk about that yet given all the disruptions that are going on in the market. But I will say this, I'm very happy with our product portfolio going into this next cycle whenever it comes.

Operator, Operator

Your next question comes from Aaron Rakers with Wells Fargo. Please go ahead. Your line is open.

Aaron Rakers, Analyst

Thank you for the question. I'll try to ask two at once. Regarding your last comment about the product cycle setup, you mentioned that you have 18 TB scheduled for shipment in the first half of the year. I want to clarify whether you mean that you anticipate actual shipments in volume during the first half of the calendar year or if you are only referring to shipments that are part of the qualification process. I'm trying to get a better understanding of the timing compared to your competitor.

Dave Mosley, CEO

Well, yes, I don't really want to get into that too much here, but I would say that in my opinion, qualification is volume. I mean it's not one. The qualification test beds if you will are fairly big volume. And so, it's not 1 million per quarter, like we just talked about, a few quarters into the ramp-up of the 16. But, yes, that kind of goes hand in glove.

Aaron Rakers, Analyst

Okay, fair enough. And then, as we think about the trajectory of the business, I'm just curious now that you're breaking it out a little bit differently between mass capacity versus legacy, as we model going forward, we talk a lot about nearline, but I'm curious of how you think about the rate of decline in the legacy business as we move out over the next couple of quarters or if you want to take a stab longer-term?

Dave Mosley, CEO

It's interesting to consider the legacy businesses; we're not investing much operating expenditure into them anymore, but we have a diverse customer base that still requires these products as they transition from old client-server IT to the new landscape. We need to continue supporting these customers and maintaining those relationships. Sometimes we see unexpected downsides, and at other times, we see surprising upsides depending on how they are navigating their markets. In most of the legacy area, there is a mix-up occurring. Even though unit sales are decreasing, the mix is improving, and the use cases remain relevant for some. There are hundreds of millions of available slots for these form factors worldwide, and the support for them represents a long tail. As this mix evolves, it may become relatively more stable. So, while it's not disappearing soon, we're also not making investments; we are just committed to servicing it consistently.

Gianluca Romano, CFO

Yes. I think it’s raising a very good point. You should look at the importance of the legacy business in terms of free cash flow, considering where the OpEx and the CapEx is fairly low in that area. It's still a good contributor to our free cash flow in general. So, it’s still very important to us.

Operator, Operator

Your next question comes from Steven Fox with Cross Research. Please go ahead. Your line is open.

Steven Fox, Analyst

Hi. Good afternoon. I hope this question wasn't answered. Got disconnected a couple of times. But in terms of looking at the competitive environment, your largest competitor has talked about maybe regaining some market share down the road this year as they launch 16 TB products and above, suggesting that maybe you're overperforming on market share right now, but at the same time you're talking about ramping more of 16-terabyte volume and 18 TB is ramping. So, I guess without throwing too many stones, I’m just curious what you would say about just your relative market share potential for the rest of the year?

Dave Mosley, CEO

I would say that market share isn't necessarily our main goal. We made a deliberate decision a few quarters ago to shift from some lower capacity products to the 16 platform, which we communicated openly because we anticipated that it would allow us to leverage the 18s and 20s as we've discussed. As this takes shape, I believe our customers will increasingly push us for more of that demand. The fluctuations you've noticed in market share may shift somewhat, but our priority is to remain predictable for our customers and provide them with exactly what they need. I am confident in our plans because we already have the capacity to support this ramp-up, making it very predictable.

Steven Fox, Analyst

Okay. That's helpful. Just on a couple of follow-ups. First, on what you just said about pivoting away from lower capacity points, I guess I was under the impression that a lot of that was in the rearview mirror. But you're saying you still may do more of that as we look out over the next 12 months to 18 months, and then I had a quick follow-up?

Dave Mosley, CEO

No, sorry. Well, there are still customers that need those products for various reasons, right, because of their architectures or what have you. But no, what I said in particular is if I go back nine months, we were very vocal about moving to 16s to these new platforms. And we've been focusing all of our operational resources and heads and media and things like that on those new platforms.

Steven Fox, Analyst

I understand now. Regarding gross margins, I know you don't want to provide guidance on them. However, you've mentioned several factors that could potentially improve your gross margins significantly in the coming quarters. What challenges, aside from macroeconomic issues, should we be concerned about that might negatively impact the gross margins?

Dave Mosley, CEO

I'll let Gianluca answer, but you're hitting the right theme, which comes down to supply and demand. So for specific products or for the cloud cyclicality, as we've talked about before, if we've got supply and demand pretty well balanced, we should be able to manage exactly like you described, but go ahead, Gianluca.

Gianluca Romano, CFO

Well, I would say that we expect high volume from our 16 terabyte and the mass capacity storage drives in general. We think our cost is declining fairly well. Of course, when you talk about gross margin, the other variable is pricing and now we will have to wait and see how the pricing will be during the quarter and that will determine our gross margin at the end.

Dave Mosley, CEO

I think we have mentioned previously that particularly during a downturn like we experienced in early 2019, our primary focus has been on managing free cash flow and operating income. As the cloud market rebounds to a peak cycle, we will reassess how to balance our portfolio. However, it begins with understanding our customers' needs and ensuring we provide them with the resources they require to meet their business goals, while remaining aware of demand cyclicality.

Operator, Operator

Your next question comes from Jim Suva, Citigroup. Please go ahead. Your line is open.

Jim Suva, Analyst

Thank you very much. If I understand it correctly, your 18-platform is going to be on the same platform as 16. And if so, when we think about that, I would assume that means that there is lower yield issues, lower risk and things like that or is there additional complexity you should be aware of? And when we think about once it's ramping and more volume, would the profitability be similar or why wouldn't it actually be higher, just kind of talking kind of longer term?

Dave Mosley, CEO

So, in theory, you're right. I would say, if we look back over multiple generations in the industry, all the way back to 2-terabytes or 3-terabytes, we were changing platforms quite frequently, more heads and media, more different technologies being brought to bear and things like that. It's a new mechanical platform, so a lot of parts we're changing. Exactly to your point, we've been talking about this with the 16. We think it's a highly leverageable platform for many years. There will be subtle changes, but I think that most of the parts are not changing, and that helps our ability to ramp, our ability to yield, and our ability to scale for the customers, be more flexible, actually if we can move most of our product portfolio over there. So it does provide opportunities, but again, supply and demand is the key driver there. Gianluca, do you have something to add there?

Gianluca Romano, CFO

No, I think you made the point.

Dave Mosley, CEO

Okay. Does that make sense, Jim?

Jim Suva, Analyst

It does. Lastly, anything on tax rate we should be aware of for kind of longer-term modeling for tax rate?

Gianluca Romano, CFO

No, I don't expect any change in our tax rate.

Operator, Operator

Your next question comes from Patrick Ho with Stifel. Please go ahead. Your line is open.

Patrick Ho, Analyst

Thank you very much. Dave, maybe first off, in terms of the transition from 16-terabytes to 18-terabytes, you mentioned some of the ease for customers. How do we look at it from a new customer or share win standpoint, given that the transition to existing customers probably is easy. But how do you look at it from a new customer win standpoint? Does the success of 16-terabyte help validate it for the new customers?

Dave Mosley, CEO

In some cases, because of the leverage, especially on a firmware basis and things like that, the feature sets, etc. But no, in general, most customers are going to every new qualification with a discerning eye. They want to make sure that they do all the things right to integrate it into their data center. And again, data centers are not one size fits all; there are many different applications. Some of the big customers have so many different applications, they have to worry about being able to plug this into legacy architectures or new architectures, or things like that, and globally there are many different BIOSes being used, chipsets being used, etc. So there is some leverage for sure; people know the family now, they're already comfortable with the family. There is some leverage, and then there is some element of a new customer, you have to go through the same amount of work.

Gianluca Romano, CFO

Yes. Probably, the mix is a major driver in the cost reduction at this point.

Operator, Operator

Your next question comes from Munjal Shah with UBS. Please go ahead. Your line is open.

Munjal Shah, Analyst

I had two. One on the surveillance demand. Is there anything going on with the large customers you think that there is all in or any thoughts for trend in the quarter? And then I have another one for Gianluca. Your comments suggest that gross margin should improve sequentially, and your EPS guidance is flat sequentially. I was just wondering if there is anything that's an offset in here?

Dave Mosley, CEO

Yes, I think relative to surveillance, we have over the years seen some, I'll call it, seasonality around government buying cycles at the end of the calendar year. And as the market moves towards some smart city applications, especially globally, I think there are markets that we're seeing now that people are investing quite a bit for smart cities. You do see that cyclicality. The market is growing. I would argue that from a units perspective, it's probably, there have been peaks that are bigger than the one we're in from an exabyte perspective; obviously, we are in a growth period, in this one with a record exabytes. So the way I look at it every year gets a little bit stronger, but there is still some seasonality cyclicality.

Shayne Hudson, Vice President, Investor Relations

And then, Munjal, just to clarify on your second question, I got the second part, you were saying guidance on the EPS side is flat. Could you repeat the first part of your question?

Munjal Shah, Analyst

The comments imply that gross margin is expected to improve because the mix of 16-terabyte sales will likely increase in March. Is there any offset affecting the gross margin?

Gianluca Romano, CFO

No, as I said before, we have an assumption on pricing of course, and it can be different when we go through the quarter. But with a fairly flat revenue, we expect a fairly flat EPS quarter-over-quarter.

Operator, Operator

Your next question comes from Nehal Chokshi with Maxim Group. Please go ahead. Your line is open.

Nehal Chokshi, Analyst

I understand that you are still experiencing growth in hyperscale demand and nearline growth. However, the current exabytes compared to the last peak have only increased by 10% relative to previous peaks, and peak-to-peak growth is approximately 2 times. Considering the possibility of entering a digestion phase in the second half of 2020, I would like to know your thoughts on why the potential peak-to-peak growth does not appear as strong as in earlier peaks.

Dave Mosley, CEO

Yes. It's quite interesting. I didn't say that we were in a digestion phase then, but I think we've seen that cyclicality before. It's dangerous to say that will happen exactly again because there has been a different reason for the cyclicality every time it hits. That said, I do think that the demand is growing. I think that the customers are broadening. And I also think that their ability to use higher and higher capacity points is actually getting bigger. So once upon a time, people couldn't use more than 4-terabytes, and while most of the market was on 8s, you're starting to see people shift over to bigger capacity points as well. So, I do think exabyte growth is still going to continue. I don't think I'm calling the top of the peak at 10% yet.

Operator, Operator

Your last question comes from Karl Ackerman with Cowen. Please go ahead. Your line is open.

Karl Ackerman, Analyst

I wanted to maybe shift gears a little bit and talk about something that hasn't been asked yet. But just on the systems business that was up 14% sequentially, pretty good performance. I'm guessing that segment also performed well from systems revenue, selling your high-capacity offerings. But maybe you could just discuss some of the traction you're seeing in SSDs and kind of what you're seeing for that broad segment, how we should think about that in the March quarter?

Dave Mosley, CEO

Yes, from a systems perspective, we're pleased with the progress we've made with our portfolio. We no longer produce boxes without Seagate products; now we are creating boxes filled with Seagate products, often containing over 100 drives. This change allows us to quickly introduce higher capacity drives into the market, and I'm satisfied with the shift the team has executed. I also see potential for growth. On the SSD side, our customers seem very pleased with our offerings, and we will continue to serve them effectively. Additionally, it appears that the market is stabilizing compared to a year ago. We remain committed to supporting our customers in a significant way.

Karl Ackerman, Analyst

Just maybe one last one if I may. CapEx did spike up a little bit this quarter. When we think about the forward trajectory, are you adding capacity for 16 and 18-terabyte that speaks to what's to come in the back half of the calendar year, or are you suggesting a breadth of SKUs is needed as enterprise customers’ capacity needs are bifurcating between high and mid-range SKUs? Thanks.

Dave Mosley, CEO

Actually interesting. I think the first one, and it's not just that, it's also the transition that we have to make to HAMR. We think that long lead time capital is the important stuff, the heads and media to get it online for the growth that we see in the cloud and we're investing for it. So we are confident in our 16, 18, 20-terabyte ramps, same platform like we've been talking about. We need to make the heads and media investments to make sure that we have enough in the market when the demand is out there.

Gianluca Romano, CFO

Yes. Let me add that we are still focusing on keeping the CapEx in the range that we gave at the Analyst Day, so between 6% and 8% of our revenue. We don't expect to go above this range in any quarter.

Operator, Operator

There are no further questions. I'll turn the call back to management for closing remarks.

Dave Mosley, CEO

Okay. Thanks, Josh. To summarize, we're continuing to manage the business well optimizing profitability and generating cash to fund our future growth and deliver value to our customers and our shareholders. And the world is just creating data at a breakneck pace, which in turn drives secular growth for mass capacity storage and needs for cost-effective data management solutions, and I believe in our technology roadmap, our product portfolio. I think Seagate is very well positioned to capitalize on all these trends. So I'd like to once again thank all our customers, suppliers, business partners, and employees for their contributions to our performance and also like to thank the shareholders for their ongoing support. Thank you.

Operator, Operator

This concludes today's conference call. Thank you for joining. You may now disconnect.