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Merrill Lynch changes Gateway estimate

The investment bank revises its fourth-quarter estimates for Gateway based on a profit warning the PC maker issued yesterday.

Merrill Lynch today revised its fourth-quarter estimates for Gateway based on a profit warning the PC maker issued yesterday.

The San Diego-based computer manufacturer surprised Wall Street by warning that fourth-quarter financial results would fall below expectations, and hinted of a rift with chip giant Intel.

Gateway blamed the problems on a shortage of Intel processors and a Y2K-related slowdown. Gateway said it lost about $200 million to $250 million in business because of a shortage of 400-MHz Celeron and 450-MHz Pentium III chips and another $100 million to $150 million due to customer jitters over Y2K.

Those shortages, particularly the 450-MHz Pentium III processor, hit Gateway hard, said Merrill Lynch analyst Steve Fortuna. About 40 percent of Gateway's third-quarter sales were $1,299 systems using that processor.

"Many customers call wanting a machine in the $1,000 to $1,300 price range but don't want a Celeron-based box," Fortuna wrote in a report issued today. Since about 65 percent of Gateway's fourth-quarter sales take place during the four weeks before Christmas, the shortages could not have occurred at a worse time, Fortuna said.

Gateway blamed the problems on a shortage of Intel processors and a Y2K-related slowdown. Gateway said it lost about $200 million to $250 million in business because of a shortage of 400-MHz Celeron and 450-MHz Pentium III chips and another $100 million to $150 million due to customer jitters over Y2K.

Merrill Lynch cut its fourth-quarter sales estimate for Gateway to $2.65 billion from $2.76 billion, or a decline from an estimated 20 percent year-over-year growth to 15 percent. The analyst left at "neutral" his rating for Gateway shares and fourth-quarter estimate of 49 cents a share, due to higher margins. Merrill Lynch warned Gateway's first-quarter sales would likely be flat, at $2.45 billion.

In a conference call yesterday, Gateway chief executive Jeff Weitzen strongly hinted that the company would turn to an alternative processor supplier. Gateway was using AMD chips until recently.

"We're all intensely frustrated by the supply situation we were put in. We're not about to stand by and let the actions of other companies dictate what Gateway products our customers can buy," he said, adding: "In the next week or so, you're going to hear about some definitive and aggressive steps we are going to take to make sure this will never occur again."

Gateway said it expected revenues of about $2.45 billion for the fourth quarter, a 6 percent increase over the same period a year ago.

After adjusting for a previously announced charge associated with Gateway's new alliance with America Online, the PC maker said it expects earnings of about 37 cents per share--a full 7 cents below analyst consensus.

The announcement, which occurred after the stock market closed, caused Gateway shares to fall in after-hours trading.

Other Gateway announcements could follow. The PC maker has been talking to AMD about integrating its touted Athlon processor into Gateway PCs again, according to sources. Gateway dropped AMD chips from its lineup earlier this year and short-circuited plans to adopt the Athlon. The chip shortage could heat those discussions. AMD will come out with an 800-MHz Athlon tomorrow, which IBM and Compaq Computer will adopt.

Other companies, including Compaq, could be affected by the shortage of Intel processors too, speculated Jonathan Ross, a financial analyst at ABN AMRO.

The Gateway annoucement surprised many analysts. "The magnitude of [Gateway's] fall caught a lot of people by surprise," Ross said. He also questioned why Gateway partly blamed Y2K concerns for its expected sales shortfall, an issue the company has failed to raise in the past. "I was a bit surprised," he said. "They hadn't mentioned that before."

Intel declined to comment on Gateway's announcement, adding that the company is currently in a quiet period. In November, however, the company admitted that it was facing processor supply contstraints.

Analysts have been predicting since last month that Gateway could have a shortfall this quarter because of processor shortages.

"Though Gateway appears to have DRAM [memory chip] pricing and LCD [screen] availability under control, the company is being impacted significantly by continued problems in getting the required supply of Intel processors, most notably the Pentium III 450 MHz, and to a lesser extent, the Celeron 400 MHz," Merrill Lynch vice president Steven Fortuna said in a report in mid-December.

Two analysts--Ashok Kumar at USBancorp Piper Jaffray and Richard Gardner of Salomon Smith Barney--also warned about a revenue hit because of chip shortages. At the time, however, Gateway predicted that earnings would likely remain unscathed.

Although component shortage issues are common in the PC industry, they can be especially onerous for build-to-order manufacturers such as Gateway and Dell, which stock less inventory than traditional manufacturers. Dell similarly took a hit in the fall because of a shortage of memory and the delay of Rambus-based PCs.

In October Gateway said it would take a restructuring charge of $26 million related to the AOL deal. The company also said it was comfortable with the current analysts consensus for the first quarter and year 2000 earnings per share of $0.41 and $1.83, respectively.

Separately, Gateway said it added 400,000 new subscribers in the quarter to its combined Internet service with AOL, doubling its rate from the previous quarter and bringing the company's subscriber base to 1 million. The company also said it increased sales over the Web by more than 100 percent over the previous year.