A painful homecoming

POWAY, Calif.--After Ted Waitt returned from a year's absence as chief executive, it wasn't hard for Gateway employees to figure out where their staff meetings were being held.

All they had to do was follow the blaring song that was always piped in to signal his arrival--"All Star" by pop group Smash Mouth.

"He acted like he was a rock star," one former executive said of the PC maker's pony-tailed founder.

It was to be the triumphant homecoming of Gateway's prodigal son, who took his business from a one-man operation in an Iowa farmhouse to a $2 billion global enterprise before retiring two years ago. But today, deep into his encore performance, Waitt is finding his first act difficult to follow.

Since his return in January 2001, Gateway has lost U.S. market share in PC sales, revenue has continued to decline, and the company's stock price has fallen nearly 70 percent. Meanwhile, the tech-heavy Nasdaq has declined 30 percent, and competitor Dell Computer is slightly up. This month, Moody's Investors Service followed Standard & Poor's in lowering the company's credit rating to junk bond status.

Although many of its problems can be blamed on the overall economic slowdown, Gateway has been hit much harder than other PC makers--so much so that some Wall Street analysts give the company only a 50-50 chance of survival. The company has already warned that it won't meet earlier revenue projections when it releases fourth-quarter numbers Thursday.

"Expectations were high when Ted came back. He was viewed as the savior," said Brett Miller, an analyst with A.G. Edwards. "He told people it wasn't going to be easy to fix the company, but no one was thinking it was going to get this bad...He hasn't been able to put the screws to the market like some people thought he would."

Investors and employees had hoped the 39-year-old CEO would reinvigorate the company much the way Steve Jobs came out of retirement to rescue Apple Computer. So far, however, Waitt's return has not been met with nearly as much enthusiasm--despite some similarities between their two companies.

Both Apple and Gateway have focused on individual consumers rather than businesses, and both have opened retail stores to bolster their presence in that market. But Gateway's computers do not have the specialty image or historic following of the Macintosh, and its use of Microsoft's ubiquitous Windows operating systems makes its PCs a relative commodity.

That has made it especially vulnerable to archrival Dell. Although both PC makers started off with similar strategies as direct mail-order companies, they grew in opposite directions. Both were created in the mid-1980s, when Waitt was selling his computers out of an Iowa farmhouse.

Michael Dell, CEO and founder of the franchise that bears his name, said the main difference between his company and Gateway is simple. "Consumer was always a part of our business but never a very large part. Gateway, they opened stores but didn't really develop the (corporate) business," he said.

A risky business
Indeed, those stores--which Waitt once touted as Gateway's greatest hope--have arguably turned out to be its largest liability. Industry analysts, investors and former executives question the viability of his plan to drive sales of PCs and related products through the company's costly chain of 296 Gateway Country stores.

In an interview here at the company's new headquarters in suburban San Diego, Waitt stresses that he never said there were any quick fixes to Gateway's problems.

"We're engaged on a long-term transformation of the business," Waitt says. He's sitting on the wooden patio outside his office, where lush ferns and sego palms belie the anxious atmosphere inside the building. "When I came back, I basically told everybody that we gave out a round of options, to put these in a drawer and don't look at them for two years," he says, taking a drag from a Camel Light.

"This was not part of my grand plan to end up in this role. I executed a succession plan, and I stepped down as CEO in the end of 1999. That was my long-term plan, my long-term goal," says Waitt, who still owns a third of the company. "I've matured and learned more and studied more about business over the last 15 years of actually doing it and looking at a number of other businesses out there."

If part of that growing process is scaling back one's ambitions, Waitt has matured a lifetime in the last year. Once full of limitless optimism, he cut his work force by 26 percent in August as part of a major campaign to save an annual $300 million in operational costs. The company eliminated its international presence, consolidated call centers, and closed several manufacturing sites.

To his credit, Waitt has tried to instill a culture of accountability. One of his first sweeping actions occurred on the second day he returned as CEO, when he initiated a management shake-up that left only two of the 14 members of the previous executive management team.

"Get real, get radical and get results" is a pledge each member of Gateway's senior management team had to sign in September, said Jack Van Berkel, senior vice president of human resources. "You can be a cowboy, but you have to be accountable."

Some of the more visible signs of its accountability efforts are the giant computer screens stationed high in the second-story warehouse headquarters above a sea of desks. The screens post statistics on Gateway's financial performance from the past day, such as the best- and worst-performing stores and regional sales breakdowns.

"When Ted came back in January, I think a lot of it was unfinished business, the unfulfilled potential of the company," said Mike Flanary, vice president of Gateway's communications business and an executive at the company for four years.

Mr. Fix-it or flop?
But the message backfired among some key executives, who found Waitt's management style offensive and his directives unrealistic.

"He told everyone that we could sell better than anyone else and cheaper," one former executive said. "But Dell gets their components cheaper because they are larger, and Gateway can never compete on price."

To manage the bottom line, Waitt has been forced to continue cutting costs and shrinking the company--a historically perilous course in the computer hardware business. Veteran executives and industry analysts note that shrinking PC companies often fade into oblivion.

With $1 billion in cash, Waitt says, Gateway is in no danger of dying anytime soon. "We can see tremendous deterioration in our business, which is not going to happen based on the way we're managing it over the next few years. And even if we didn't change anything and did everything stupid, everything just really stupid, we'd still have a lot of cash," he says.

Many believe that Gateway would be a natural target for acquisition if a buyer could be found, something that investment bankers say is no easy task.

Things have changed drastically from only a few years ago. In 1997, Waitt rejected a proposed merger with Compaq Computer, a deal that would have made Gateway the consumer end to the world's largest PC operation at the time. Waitt rejected that offer to stay independent and came up with a six-point plan that would allow Gateway to expand "beyond the box" and into software and services such as training, financing and Internet connections.

Beyond the box
The company began recruiting professional management, bringing in Jeff Weitzen as president and chief operating officer. From 1998 into the first half of 2000, the "beyond the box" strategy worked smoothly and improved Gateway's bottom line. Weitzen was named CEO in early 2000.

Toward the end of that year, Weitzen and Waitt engineered a partnership with America Online for a number of joint initiatives, including a line of consumer electronics. Gateway was to get an $800 million AOL investment as part of the deal.

But the "beyond the box" strategy was predicated on selling an ever-rising demand for PCs--which never materialized. And price competition from Dell and Hewlett-Packard, combined with complaints about Gateway's customer service, inflicted damage that continues to be felt today.

Waitt has turned again to his old six-point playbook as part of his restructuring plan, with one major change: The company is eliminating portions that drove revenue but not profits, such as providing financing for its customers. Gateway now uses another company to underwrite its loans while collecting finder's fees and a cut of the interest payments. In addition, though it continues to offer bundled packages, Gateway is more willing to sell a piece of the beyond-the-box concept that does not even need to include a PC.

Waitt hopes to improve revenue on several fronts, including customer service and communications such as broadband connections.

"Today it's much more open. If someone wants to just get broadband from us, and they become a customer that way, that's fine. If someone just wants to take a training course from us and wants to become a business customer that way, that's fine too," Waitt says. "So you're seeing a broader array...based on recurring revenue streams and longtime value of that customer relationship."

Gateway is even planning to come out with innovative types of hardware in the coming years, as well as redoubling its efforts to lure small and medium businesses through targeted marketing and its stores.

Getting there
"The fourth quarter will be the first time that Ted will need to execute on the restructuring they've put in place, and it will be telling of what we can expect from the company in the future," said A.G. Edwards' Miller. "This will tip the scales of the 50-50 chance in one direction or the other."

Others are willing to give Gateway a little more time before rendering a verdict. Dan Niles, an analyst with Lehman Brothers, said Wall Street wants to see results from Gateway's restructuring efforts in the next six months, especially revenue growth.

"They have gone through the cost-cutting to get them to profitability," he said. "But at the end of the day, revenues are the lifeblood of a company."

Early indications don't look hopeful. Gateway warned this month that fourth-quarter revenue would fall short of analysts' expectations, from an expected $1.35 billion to $1.16 billion. Gateway's PC shipments fell 15 percent from the third to fourth quarters--a "gross divergence" from its usual 15 percent to 20 percent increase for the traditionally strong holiday season--as other PC makers fared relatively well, according to Charles Wolf, an analyst with Needham.

Still, Waitt remains determined to prove skeptics wrong in achieving profitability beyond the fourth quarter. While last year was about scaling back, he says, this year "will be about stabilizing the model and executing, and we're starting to do that right now."

That forward-looking approach is a consistent theme for Waitt, one that applies to his personal performance as well. "Do I feel there were a lot of things we could have done better or whatever? I don't look back. I look at where we are today," he says.

When asked whether he might be removed as chief executive, Waitt laughs and notes that it's still the title on his business card. "You can ask my board if they think I'm the right man for the job."