Gateway shares steady despite wild market

Shares closed regular trading today down 56 cents, to $51.44.

Although sales to business customers were slower than expected, Gateway was able to hit analysts' expectations yesterday because of continued strong growth in the consumer market and sales of "beyond-the-box" items such as Internet services.

The San Diego-based computer maker earned $136 million, or 41 cents per share for the first quarter, an increase of 32 percent over the 31 cents earned for the same period last year. Revenue totaled $2.34 billion, an 11 percent increase over the same period last year.

The earnings-per-share figure matched expectations of analysts polled by First Call.

Analysts and investors reacted to the results with optimism. Gateway was up $1 to $53 in a morning trading today, one of the few tech stocks to maintain an increase on a gloomy market day. Analysts also largely reiterated "buy" and "strong buy" ratings this morning.

"We believe that the Gateway story remains very much intact," wrote Richard Gardner of Salomon, Smith Barney in a research note. "Consumer, small to mid-sized business, international, expanded distribution and beyond-the-box are the core value drivers in the Gateway story, not large accounts."

Others, however, added that continued earnings growth will depend on gaining market share in the consumer market as well as increasing eyond-the-box revenue.

The results presented a mixed bag for the company, as sales to business customers dropped by 19 percent. The company also cut back on discretionary spending and travel so it could hit the expected earnings mark, said John Todd, Gateway's CFO, which means profits didn't come purely through growth.

"While we're clearly disappointed with our business performance for the first quarter, we're continuing to intensify our focus on our target markets of small and medium businesses, government and education," CEO Jeff Weitzen said in a statement.

But the business drop was partly made up by a 27 percent increase in sales for the consumer market. Overall, Gateway shipped 1.3 million PCs during the quarter, a 16 percent increase from last year. Sales outside of North America grew by more than 25 percent.

Sales of Internet services, training and other non-PC items--many of which come with higher margins than PCs--also grew. Approximately 300,000 ISP customers were added in the quarter. Non-PC income accounted for 25 percent of Gateway's overall income, the company said.

"With each passing quarter, we are less reliant on box revenues to meet our goals," Weitzen said in a conference call following the earnings announcement. Gateway's goal is to boost net income from non-PC sources to 40 percent of overall income by the end of the year, he said.

So far, most non-PC sales efforts have been directed at consumers. In the future, many of these services will be directed more toward small businesses and European customers. "You are going to see us focus on small businesses with a whole lot of services," said Todd.

One indication of the growth of the non-PC revenue comes in an increase in the average price of Gateway systems. What is called the "average unit price" for systems grew 2.8 percent to $1,851, with the increase attributed to the inclusion of added services aside from hardware, such as Internet access.

These non-PC revenues will become increasingly important in the long term, as revenue is expected to dip in the fourth quarter. Gateway typically sees a seasonal slowdown in the second quarter. Gardner, among others, believes slow sales generally will be offset by non-PC items. Nearly 45 percent of Gateway customers finance their computer purchases, he stated. Gateway retains roughly 10 to 15 percent of the gross interest on these purchases.

Whether Gateway can continue to grow non-PC revenues and boost computer sales remains an open question. Gaining market share is going to become increasingly difficult in the future for Gateway, according to Ashok Kumar, an analyst at Piper Jaffray. Gateway management has also stated that they want to grow faster than the industry as a whole, which means stealing market share.

For its part, Gateway management said that revenues will decline in the second quarter. Nonetheless, Weitzen said Gateway is still on track to report earnings of $1.83 per share for the year, the estimate before the conference call. Along with new services for small businesses, Gateway said it expects to see some benefits from alliances with Sun Microsystems and GE Capital for selling to large organizations.

An effort to push into the Canadian market will also kick off soon, said Todd, and will be followed by plans to enter markets in Mexico and Brazil.

Gateway will also get into the device market toward the end of the year. The company will introduce a kitchen countertop Internet terminal around Christmas while a web pad will come out in the first quarter of 2001. AOL will partner with Gateway to provide services.

The introduction of these appliances will come later than expected. "The market will take some time to understand what these devices are," said Weitzen.

Last quarter, the company was stung by a shortage of Intel processors. Excluding charges related to an Internet service deal with America Online, Gateway earned 42 cents per share, matching lowered estimates.