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Gateway earnings may shed light on health of PC industry

The company's report should provide insight into questions about the industry, including PC demand, the status of component shortages, and the state of the battle between Intel and AMD.

The PC industry will begin its quarterly health check later today, when Gateway reports its second-quarter earnings.

The direct PC seller is expected to post earnings of 36 cents per share and revenue around $2.1 billion when it releases its results after the close of regular trading. For the same quarter a year ago, Gateway reported earnings of 28 cents a share on revenue of $1.9 billion.

Yesterday, the stock closed at $70.94, up $3.56, or about 5 percent, from the day before.

In the first three months of the year, consumer PC demand for the industry at large was stronger than anticipated, while sales to businesses sank. Analysts and PC company executives have said these trends seem to have reversed somewhat in the second quarter, with business sales recovering slightly and consumer sales going soft.

Still, overall demand in the past three months probably dipped, as it typically does in the second quarter.

Gateway, which focuses on consumer sales and has been trying to jump-start its business division, is expected to experience the brunt of these fluctuations. Earnings and revenue are expected to show a decline from the first quarter, when the company reported earnings of 41 cents a share.

Nonetheless, analysts anticipate positive notes lurking in Gateway's numbers. Despite the seasonal dip in U.S. sales, "we expect a continued positive trend in Europe, which is finally executing after a weak 1998 and 1999," Don Young, a PaineWebber analyst, wrote in a research note yesterday. "We expect Asia/Pacific should also show strong results, consistent with what we are hearing from other PC vendors."

Gateway's revenue and profit from Internet access services, training and other "beyond the box" sources should also be up sequentially in a year-to-year comparison, he noted. Last quarter, non-PC sales accounted for 25 percent of overall income. Gateway has set a goal of obtaining 40 percent of its income from these sources by the end of the year.

Earlier this week, Merrill Lynch analyst Steve Fortuna offered a bullish outlook for the PC industry in general and Gateway specifically.

"We think the bottom line, 36 cents (a share), is a virtual lock," Fortuna said in a conference call. "This is a must-own stock at these levels, in light of the fact the company is going to muscle sales in the back half of the year through aggressive expansion in retail outlets."

Since Gateway last reported earnings in April, the stock has risen 19.5 percent from $51.44.

One of the prospects that has analysts particularly interested in Gateway is its increased retail presence, with both its own stores and the store-within-a-store model it began on a test basis with OfficeMax.

"We are bullish on the future contributions from the OfficeMax (deal)...and on the potential for Gateway to partner with other retailers," Young said.

How chipmakers measure up
Gateway's financial results should also provide insight into the battle between Intel and AMD in the PC processor arena. In January, Gateway began to once again use processors from AMD amid a shortage of Pentium III and Celeron chips.

Since then, the PC maker has become AMD's largest customer for the Athlon processor, according to AMD. In May, Gateway CFO John Todd predicted the company would double the amount of AMD chips it uses this quarter.

Insight into how much deeper the Gateway-AMD relationship has grown will therefore shed some light on what might occur next week, when Intel and AMD report their earnings on July 18 and 19, respectively.

Continued success, however, won't be easy. Gateway's management may cut revenue estimates for the second half, predicted Kurt King, an analyst for Banc of America Securities.

"The expectation for a 'strong second half' that's been behind the recent buying is already very much assumed in estimates," King wrote. "According to our model, revenues up 19 percent sequentially in (the third quarter) would be the highest Gateway has ever reported for this period."