Why does Intel expect its gross margin to increase in Q2?

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Intel expects its gross margins to increase from 60% in Q1 2014 to 63% in Q2 2014

In the last article of this series, we discussed Intel’s (INTC) Q1 2014 earnings, which were better than expected. The results benefited from a slower-than-expected PC market decline, strong growth in data centers, and the newly reported segment Internet-of-Things, but the company’s penetration in mobile devices continued to lag behind. Here, we’ll discuss Intel’s outlook in Q2 and why Intel expects its gross margins to increase sequentially from 60% in Q1 2014 to 63% in Q2 2014.

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Intel faces tough competition in the semiconductors market—although it’s still the leader. As the below chart shows, Intel leads this market, with a share of 15%. But Samsung, Qualcomm (QCOM), SK Hynix, Micron (MU), Toshiba, Texas Instruments (TXN) and Broadcom (BRCM) are some of the other important players in this market.

Semiconductor market shares

The gross margin increase will be driven by the lower factory startup costs associated with Intel’s 14-nanometer products

Intel forecasts its revenues to grow at a nominal rate of 2% from $12.8 billion in Q1 2014 to the midpoint of the revenue range of $13.0 billion in Q2 2014. However, it expects its gross margins to increase from 60% in Q1 2014 to midpoint range of 63% in Q2 2014, driven primarily by the lower factory startup costs associated with its 14-nanometer products.

According to Intel’s management, “We’ll see costs coming down from Q1 to Q2 and Q3 and then in Q4, we’ll see a lot of volume coming out of multiple factories on 14-nanometer. And so you get a bit of a mix up in cost from those early wafers coming off of 14-nanometer and again that’s a phenomenon you’d see from us in the past, we’d expect that to come down pretty rapidly after that, but the first quarter tends to be pretty expensive.”

Intel’s increased presence in the tablet market will be a negative for its gross margins

As per Intel, the gross margin increase associated with Intel’s 14-nanometer products would be offset by the low margin business of tablets chipsets. According to Intel’s management, “On the minus side it’s two things. One, the tablet volume is backend loaded for us. Again as you’d expect it’s primarily a consumer product, so we’ll see in the back half of the year the ramp of tablets and the associated contra revenue dollars so that’s a bit of an offset.”

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