Leading semiconductor manufacturer Intel (NASDAQ:INTC) reported a strong Q2 2014, with an 8% annual growth in revenue ($13.8 billion) backed by improving PC sales, strong growth in data center products and increasing Internet-of-Things (IoT) revenue. At 64.5%, Intel’s gross margin increased by 5 points sequentially due to lower 14-nanometer start-up costs, high platform volumes and lower platform unit costs, which were partially offset by lower platform average selling prices. Net income ($2.8 billion) and earnings per share ($0.55) for the quarter were up 40% and 41% annually, respectively.
The persistent decline in PC shipments, combined with increasing investment in building out its technology, impacted Intel’s revenue growth as well as bottom line over the last two years. The company has performed well in the first half of 2014, with revenue and net income up 5% and 17%, respectively, so far this year. Though the PC environment remains challenging, Intel’s expanding reach, from the smallest energy-efficient embedded machines to the most powerful supercomputers, helps the company retain its leading position in the semiconductor industry.
2013 was a year of transition for Intel. It made significant progress in alternative markets with new platforms, product launches and design wins, which increased its competitiveness in the semiconductor industry. Intel believes that the macro situation is improving in 2014 as the industry accepts innovative form factors, including ultrabooks, convertibles and detachables. The company also is benefiting as it expands its presence in new growth markets.
Our current price of $27 for Intel is at an approximate 15% discount to the current market price. We are in the process of updating our model.
Stabilizing PC Business - Intel Gained Market Share In 1H 2014
Intel’s PC client group revenue increased 6.2% year-on-year on account of the improving economic environment, an ongoing PC refresh, form factor innovation and the end-of-life of Windows XP. Both desktop and notebook platform revenue grew. The group reported its third consecutive quarter of year-over-year unit growth in Q2 2014, with volumes increasing 9% annually. The PC platform average selling prices declined 4% on a year-on-year basis.
Having grown at a robust rate for many years, PC sales started declining 2011 onward. As per research firm IDC, PC shipments declined 3.7% and 10.3%, in 2012 and 2013 respectively. The rate of decline dropped down to 4.4% in Q1 2014 and remained flat in Q2 2014, as Windows XP migration (to machines running newer operating systems) and commercial spending helped offset the weak consumer PC demand.  
According to Intel, the installed base of PCs that are at least four years old is now roughly 600 million units. The company claims to be seeing clear signs of a refresh in the enterprise segment as well as in small and medium businesses. However, the consumer segment remains challenging, especially in emerging markets. The consumer PC business accounts for roughly 60% of Intel’s PC business, while the enterprise segment accounts for the remaining 40%. 
Intel is working to reinvent PC computing with new form factor innovation, lower price points, longer battery life and an OS of choice. It believes that the innovative two-in-one devices and lower price points has helped it gain market share so far this year. Intel expects more than 70 2-in-1 designs running on Intel processors for the back-to-school selling season, which can help spur demand for its processors.
The Data Center Group Remains Strong
Intel’s data center business continues to see robust growth as a result of the build-out of the cloud and exposure of devices that compute and connect to the Internet. The business reported a 19% annual growth in revenue ($3.5 billion), with platform volumes up 9% and average selling prices up 11% year-on-year. Cloud, networking, high-performance computing and enterprise revenue all grew more than 15% in the quarter.
Last year, Intel extended its leadership at the high end as well as at the leading edge of the market with the launch of the Ivy Bridge-based Xeon product line and Avoton (which targets the micro-server market), respectively. It introduced the Ivy Bridge-EX, which brings the largest generation-to-generation improvement in Server performance, this year. The company claims that its new E7 line, which features the largest memory footprint in the industry, saw particularly strong reception from enterprise as a result of its high speed, real-time data analytic capabilities. The new products drive a strong return on investment for Intel customers to upgrade their infrastructure.
Q2 2014 saw some specific purchasing by some of the large cloud providers, which probably won’t re-occur in the second half of 2014. Nevertheless, Intel expects its data center business to grow in the low double digits going forward.
Intel On Track To Ship 40 Million Tablets In 2014
Intel shipped 10 million tablets in Q2 2014 compared to 5 million in Q1 2014, which the company believes keeps it on track of its target of shipping 40 million units in 2014. Intel presently accounts for 4% – 5% of the global tablet market. If the company meets its target of shipping 40 million tablet chips by the end of 2014, its market share would increase to approximately 15%.
In Q2 2014, Intel announced a strategic agreement with Rockchip, a leading Chinese fabless semiconductor company and mobile-internet system on a chip (SoC) solution provider, to expand its low-cost tablet offerings. The two companies plan to deliver an Intel-branded quad-core mobile SoC platform integrated with Intel’s 3G modem technology, targeted primarily at the low-cost Android tablet segment. Intel and Rockchip will sell the quad-core SoFIA 3G into each other's existing customer base (OEMs and ODMs). By expanding its reach in sockets that typically sell for $10-$20, the Rockchip deal will help Intel gain a considerable share in the Chinese market. 
Intel’s mobile and communications group revenue declined by 83% annually in Q2 2014, as the higher tablet volumes were offset with the increase in contra revenue dollars. With contra revenue, Intel is paying tablet makers to cover the additional bill of materials (NYSEARCA:BOM) costs. However, the company believes that it will no longer have to pay the subsidies when its new products hit the market toward the end of 2014. The bill of materials cost for a Broxton tablet will be $20 less than for Bay Trail, and SoFIA, with its greater integration and smaller die size, is expected to cost even less. 
Q3 2014 Outlook
Midpoint of the revenue range at $14.4 billion, a 4% increase over Q2 2014. Midpoint of the gross margin range at 66%, up 1.5% compared to Q2 2014.
Disclosure: No positions.