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Contributors: Douglas McIntyre Jon C. Ogg

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Friday, August 04, 2006

Gateway: Is This the Beginning of the End?

Gateway (GTW) lost another $7.7 million in yesterday's earnings report on revenues of $919 million. Last year the second quarter revenues were $873 million. The difference from then to now is that last year they posted EPS of $0.05 for the quarter, and this time it was -$0.02 EPS.Yes Dell (DELL) has issues currently, and Hewlett-Packard (HPQ) and even Apple (AAPL) have had to endure rough times. The difference between those companies and Gateway is that Gateway is irrelevant and the others are not. The world doesn't need Gateway and any shareholders who have bought in the past wished to the heavens that they would have thought they needed the shares too.

There have been times in the past that the company has made a lot of money for investors. In early 2003 some investors made 200% as it went from just over $2.00 to over $6.00. It was rangebound for the year after that and the last 2-years look like a stair case going down, down, down.

The company in the release stated that according to preliminary IDC data, Gateway was the fastest growing PC company in the U.S. among the top five vendors on a year-over-year basis. The company sold 1,170,500 PC units in the second quarter, down 15 percent sequentially, and up 16 percent year-over-year. Gateway was the third largest PC company in the U.S. with an estimated 6.5 percent market share in the second quarter, up from 6.0 percent a year ago. Gross margin for the second quarter was 5.5 percent, compared with 7.3 percent in the prior quarter and 10.0 percent in the second quarter of 2005.

Look at the segment reviews. RETAIL: The Retail segment delivered revenue of $592 million, down 23 percent sequentially and up 21 percent year-over-year. Retail PC unit sales equaled 949,000, down 18 percent sequentially and up 27 percent year-over-year. PROFESSIONAL: The Professional segment delivered revenue of $250 million, up 24 percent sequentially and down 8 percent year-over-year. Professional PC unit sales equaled 186,000, up 18 percent sequentially and down 12 percent year-over-year. DIRECT: The Direct sales segment delivered revenue of $77 million, down 29 percent sequentially and 31 percent year-over-year. Direct PC unit sales equaled 36,000, down 39 percent sequentially and 26 percent year-over-year. PERIPHERALS: Total non-PC revenue, which includes sales of stand-alone monitors, software, peripherals, services and accessories, was down 16 percent sequentially and was essentially flat year-over-year, excluding consumer electronics (CE). Non-PC sales, excluding CE, represented 16 percent of total revenue in the second quarter, flat with the first quarter, compared with 18 percent a year earlier.

What this is showing you is pure volatility and a business manager’s nightmare. Here is what the company said: "While we are disappointed with our performance in the second quarter, we believe that our efforts in the first half of the year are beginning to resonate with customers and move us in a positive direction," said Rick Snyder, Gateway's chairman and interim chief executive officer. "Our Professional business showed solid improvement and our Direct business is repositioned to regain positive momentum. In addition, we have strong initiatives in marketing, manufacturing and tech support that will launch during the second half of the year. Although we're pleased with Retail revenue growth and progress in Professional and Direct, it is clear that we must continue to improve our overall business performance." You can say that again. You can say that again.


June 30, 2006
Current assets:
Cash and cash equivalents $424,989
Marketable securities 99,540
Accounts receivable, net 319,862
Inventory 147,808
Other 345,496
Total current assets 1,337,695
Property, plant, and equipment, net 85,205
Intangibles, net 66,540
Goodwill and non-amortizable
intangible assets 205,219
Other assets 18,688
TOTAL ASSETS $1,713,347

December 31, 2005 Total assets were $1,921,065 with higher assets in ALL sectors of the Current Assets.

Current liabilities:
Notes payable $50,000
Accounts payable 601,272
Accrued liabilities 248,387
Accrued royalties 66,889
Other current liabilities 152,474
Total current liabilities 1,119,022
Long-term debt 300,000
Other long-term liabilities 58,564
Total liabilities 1,477,586
Stockholders' equity 235,761
Total L& E $1,713,347

The only good thing here is that their current liabilities declined in all areas except notes payable.

Unfortunately you can't even make the argument any longer that the company should just try to renegotiate all of their longer-term obligations and then just return the cash to holders. This was sort of more feasible in the past, but not now. Even if the company could get maximum value stated on the books at $235 million of equity, that translates to less than 50 cents on the dollar since it has a $532 million market cap.

So now what? The company lost its chance in Q4 2001. The economy was reeling from massive job cuts after the September 11, 2001 attacks sent a weak economy right into the toilet. The company had the opportunity at the time to change its entire marketing campaign. At that juncture they did not own e-Machines, its cheap brand of PC's made for in-store sales that are manufactured much cheaper overseas. The company could have made the claim in 2001 "We are the ONLY US PC Manufacturer who manufactures all of its PC's in the United States"....."Buy American"..... At the time there was a large domestic desire for Americans to be Patriotic but the company just stuck with their cow advertising campaigns. It worked for Chick-Fil-A, but it hasn’t worked for a computer company. Hopefully the company doesn’t read into this and decide a pig might be better. There would have been a two-year window for the company to go after the patriotism play before the elections came into play and the country went back to being divided again. They could have even done the boxes with Red and blue in the cow spots instead of the black cow patches. None of this matters, because now the company is at the worst levels ever in memory.

In 2000, this was a $60 stock. Dell was in the $40 to $60 range back then for some fair comparisons, and it now sits around $22.00. Hewlett-Packard had traded well north of $70 in 2000, and it has now climbed back from under $20 to over $32.00 today. Gateway sits at $1.40 today. It is genuinely unclear what this company can or will be able to do to get out of the dungeon.

The company failed miserably in almost all of its big pushes. Its own branded Gateway stores centers initiative was a terrible outcome. Its Plasma TV initiative has not been a winner either, probably because many of the units they resell take 2 to 4 weeks to ship per the company website; and who wants to wait that long after plunking down that much cash. It isn't even evident that they were able to get Uncle Sam to switch to their branded models made here after all of the concerns that have arisen from the recently past publicity about US embassies and agencies being at risk because Lenovo PC's were made in China. Its eMachines purchase may be the only saving grace. Out of all the people I know I do know one that owns an eMachine, but not one single acquaintance I know of owns a Gateway computer.

I was reviewing this earnings report last night and I originally wanted to make this a funny tale of an example of how poorly some companies are. Unfortunately, it just isn't even funny any longer. It is sad. It is hard to imagine how the board members do not go to bed crying every night.

When I used to be a moderator for a brokerage firm's conference calls I used to say Gateway was the best short sale stock in the entire PC-related group. That was when it was at $5.00, then at $6.00, then at $4.00, then at $5.00, and so on. They missed their window and that was obvious then. I can not in good faith go out with the same call here because if the company can pull a rabbit out of its hat or do a hail mary pass that works, then calling it a short after it is what appears to be either a decade low or all-time low would be too risky.

Would anyone be willing to step in to buy them? It is hard to even imagine a private equity firm wanting to even attempt to do something here. It is possible, but they would have to be incredibly visionary and not afraid to meet the guillotine. Besides that, private equity firms like stead cash flow and value. A public company may have a real hard time with its shareholders being happy about a deal after the "Gateway-sucks" stigma has been associated with it for so long. Activist shareholders such as ValueAct and others would likely not want to be tied to this because they ultimately want to make somewhat easy money too. And this is really going to need a lot more than just a call for more activism. Dell has shown that there are problems in the industry across the board and top to bottom, and Hewlett Packard has long been rumored and thought of as a problem if they didn't have their printing an imaging operations contributing to the bottom line. If there are issues there, then imagine how someone may feel trying to step in here at this company.

So what can the company do? It is getting to the point that whatever efforts are made, it may just be too little and too late. They are even getting to the point that the NYSE may boot their listing if things get worse, and that would not be good by any means. It is sad to say a company and its products are irrelevant, but sometimes things just are what they are. With this stock down this low, it is tempting to try to think of a way to discuss the unprecedented valuation and massive upside that patient and visionary investors could see. But whatever the company is doing now is just wrong and it is just hard to think of them doing well. This really is now an at risk company, and if they do not have a "going concern" from their auditors it is getting to the point that they may get one. Its eMachines unit probably still has some value and some relevance, but the core just isn't pretty.

Will Gateway survive as we know it?

Jon C. Ogg
August 4, 2006

Jon Ogg can be reached at and he has no positions in any of the stocks he discusses.

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