Gateway surges after meeting Street's expectations

The PC maker's stock rises more than 18 percent after it matches predictions for its quarterly profits, boasting that it has been unaffected by problems hitting its rivals.

Stephen Shankland principal writer
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Gateway: Bucking the trend?
John Todd, Gateway CFO

Gateway shares surged more than 18 percent Friday after the PC maker matched Wall Street expectations for its quarterly profits, boasting that it has been unaffected by the problems hitting its rivals.

Gateway rose $7.99 to $51.62 in midmorning trading on the New York Stock Exchange on Thursday's earnings news.

Gateway had net income of $152.6 million, or 46 cents per share, on revenue of $2.53 billion, the company said. On average, analysts expected the company to report earnings of 46 cents per share on sales of around $2.5 billion for Gateway's fiscal third quarter ended Sept. 30. In the same quarter last year, the company earned 35 cents per share on sales of $2.18 billion.

"We had a great quarter. We think the overall technology market is stronger than people give it credit for," chief financial officer John Todd said in an interview. "We remain bullish."

On a conference call with analysts, Todd said the company is comfortable with analyst estimates for fourth-quarter revenue and earnings, as well as with analyst estimates for earnings of $2.29 per share for next year.

Consumer sales for the third quarter were up 27 percent compared with the same period last year. The company was also helped by stronger-than-expected sales to businesses, which grew 2 percent when analysts expected no gain at all. Sales to small businesses in particular grew 20 percent from the same period last year, Todd said.

Todd said the company boosted its sales force for small businesses, started advertising to that segment, and began devoting more real estate in its Country Stores to its small-business customers.

Gateway's sales to businesses had shown year-over-year declines for several quarters before turning around in its third quarter.

Third-quarter sales to government and education customers were "solid," Todd added. Sales to large businesses were still somewhat off year-ago levels, although Todd said the business is improving.

The company's stock jumped to $47.50 in after-hours trading, according to Island ECN. It had closed down 99 cents, or 2 percent, at $43.63 in regular trading. The PC maker released its earnings after market close.

Gateway's results come amid a jittery computer market that has been on edge because of profit warnings from Intel, Apple Computer and Dell Computer. But as recently as the middle of last month, Gateway said it was on track to meet Wall Street's expectations.

Vadim Zlotnikov, an analyst with Sanford C. Bernstein, characterized Gateway's results as solid, thanks in part to the improvement in small business sales. However, he cautioned against reading too much into Gateway's earnings because the company has very little presence in the corporate PC market.

"I don't think you can judge the overall health of the PC industry by Gateway's results," Zlotnikov said.

Nonetheless, Merrill Lynch analyst Steven Fortuna said the news will give ammunition to those optimistic about technology stocks and could help other PC stocks, such as Compaq.

"Many analysts and investors have painted too much of a doom and gloom scenario," Fortuna said. "It should help to restore some modicum of confidence, not a lot... PC demand has not fallen off of a cliff."

Gateway did reduce its inventory by two days, a move that Zlotnikov said could explain some of the weakness that are leading to lower-than-expected sales at chip giant Intel. If all PC makers similarly burned off their inventory, Zlotnikov said, it would account for all of Intel's shortfall.

Intel pointed to weak sales in Europe as the culprit for its recent earnings warning. Todd agreed that the European market is soft in general but said Gateway outperformed the market and didn't see the softness.

In fact, the company saw double-digit sales growth in Europe for the third straight quarter.

Stock price from October 1999 to present.  
 Source: Prophet Finance

Gateway has been focusing on making money not just by selling PCs, but also by selling bundled software and services such as Internet access.

More than 50 percent of the company's income was from software and services during the quarter, Gateway said, putting the company ahead of the 45 percent goal it set for the next quarter.

"The hardware itself is becoming more of a commodity each day," chief executive Jeff Weitzen said on the conference call.

But Weitzen said Gateway is not scared of the change, rather seeing it as a way to develop more long-term business. "The stronger our relationship with the customer," he said, "the more profitable our relationship over time."

Todd noted that this year's third quarter faced a tough comparison with last year's, when Gateway's sales were driven by the advent of a $400 Internet service provider rebate and the introduction of sub-$600 PCs, as well as early buying in advance of Y2K-related buying freezes.

"The sky is not falling," Todd said. "The market is still solid."

News.com's Sandeep Junnarkar contributed to this report.