SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
X QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission file number 0-22784
GATEWAY 2000, INC.
(Exact name of registrant as specified in its charter)
Delaware 42-1249184
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
4545 Towne Centre Court
San Diego, California 92121
(Address of principal executive offices, zip code)
Registrant's telephone number, including area code: (619)799-3401
Indicate by check mark whether the registrant (1) has filed
all reports required to be filed by Section 13 or 15(d) of the
Securities Exchange Act of 1934 during the preceding 12 months
(or for such shorter period that the registrant was required to
file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No .
As of November 10, 1998, there were 156,286,837 shares of
the Common Stock of the Company, $.01 par value per share,
outstanding. As of November 10, 1998, there were no shares of
the Company's Class A Common Stock, $.01 par value per share,
outstanding.
I. FINANCIAL INFORMATION
Item 1. Financial Statements
<TABLE>
Gateway 2000, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and nine months ended September 30, 1997 and 1998
(in thousands, except per share amounts)
(Unaudited)
<CAPTION>
Three months Ended September 30, Nine Months ended September 30,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
Net Sales $ 1,504,851 $ 1,815,516 $ 4,316,845 $ 5,162,352
Costs of goods sold 1,309,601 1,437,709 3,595,444 4,114,363
Gross profit 195,250 377,807 721,401 1,047,989
Selling, general and
administrative expenses 219,258 264,452 570,680 741,445
Nonrecurring expenses 113,842 - 113,842 -
Operating income (loss) (137,850) 113,355 36,879 306,544
Other income, net 5,612 12,653 20,195 32,918
Income (loss)before income
taxes (132,238) 126,008 57,074 339,462
Provision (benefit) for income
taxes (25,125) 45,363 40,187 122,206
Net income (loss) $ (107,113) $ 80,645 $ 16,887 $ 217,256
Share and per share information:
Net income (loss) per share:
Basic $ (0.70) $ 0.52 $ 0.11 $ 1.40
Diluted $ (0.68) $ 0.51 $ 0.11 $ 1.37
Weighted average shares
outstanding:
Basic 153,980 155,849 153,761 155,280
Diluted 156,875 159,518 156,373 158,708
</TABLE>
<TABLE>
Gateway 2000, Inc.
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and September 30, 1998
(in thousands, except per share amounts)
<CAPTION>
December 31, September 30,
1997 1998
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 593,601 $ 871,351
Marketable securities 38,648 132,156
Accounts receivable, net 510,679 559,538
Inventory 249,224 198,016
Other 152,531 183,816
Total current assets 1,544,683 1,944,877
Property, plant and equipment, net 336,469 416,044
Internal use software costs, net 39,998 37,704
Intangibles, net 82,590 69,924
Other assets 35,531 43,252
$ 2,039,271 $ 2,511,801
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current maturities of long-
term obligations $ 13,969 $ 9,659
Accounts payable 488,717 677,721
Accrued liabilities 271,250 347,466
Accrued royalties 159,418 114,183
Other current liabilities 70,552 63,977
Total current liabilities 1,003,906 1,213,006
Long-term obligations, net of current maturities 7,240 2,481
Warranty and other noncurrent liabilities 98,081 100,025
Total liabilities 1,109,227 1,315,512
Contingencies (Note 6)
Stockholders' equity:
Preferred Stock, $.01 par value, 5,000 shares
authorized; none issued and outstanding - -
Class A Common Stock, nonvoting, $.01 par
value, 1,000 shares authorized; none issued
and outstanding - -
Common Stock, $.01 par value, 220,000 shares
authorized; 154,128 shares and 156,034
shares issued and outstanding, in 1997 and
1998, respectively 1,541 1,560
Additional paid-in capital 299,483 349,101
Retained earnings 634,509 851,766
Accumulated other comprehensive income (loss) (5,489) (6,138)
Total stockholders' equity 930,044 1,196,289
$ 2,039,271 $ 2,511,801
</TABLE>
<TABLE>
Gateway 2000, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 1997 and 1998
(in thousands)
(Unaudited)
<CAPTION>
Nine Months Ended September 30,
1997 1998
<S> <C> <C>
Cash flows from operating activities:
Net income $ 16,887 $ 217,256
Adjustments to reconcile net income to net
Cash provided by operating activities:
Depreciation and amortization 63,268 76,224
Provision for uncollectible accounts
Receivable 2,422 2,278
Deferred income taxes (63,749) (22,906)
Nonrecurring items 113,842 -
Other, net 256 741
Changes in operating assets and
Liabilities:
Accounts receivable (20,665) (51,137)
Inventory (83,524) 51,208
Other assets (63,679) (21,826)
Accounts payable 41,891 187,903
Accrued liabilities 12,184 76,878
Accrued royalties 5,092 (45,235)
Other current liabilities (30,548) 16,765
Other liabilities 36,894 6,515
Net cash provided by operating
activities 30,571 494,664
Cash flows from investing activities:
Capital expenditures (94,094) (128,983)
Internal use software costs (11,130) (7,927)
Purchases of available-for-sale securities (32,286) (142,171)
Proceeds from maturity of available-for-sale
securities 8,985 15,026
Proceeds from sales of available-for-sale
securities 2,000 33,898
Acquisitions, net of cash acquired (142,320) -
Other, net (2,944) (868)
Net cash used in investing activities (271,789) (231,025)
Cash flows from financing activities:
Proceeds from issuance of notes payable 10,000 -
Principal payments on long-term obligations
and notes payable (13,972) (11,693)
Stock options exercised 5,171 25,699
Net cash provided by financing activities 1,199 14,006
Foreign exchange effect on cash and cash
equivalents (2,354) 105
Net increase (decrease) in cash and cash
equivalents (242,373) 277,750
Cash and cash equivalents, beginning of
Period 516,360 593,601
Cash and cash equivalents, end of period $ 273,987 $ 871,351
</TABLE>
Notes to Consolidated Financial Statements
1. General:
The accompanying unaudited consolidated financial statements
of Gateway 2000, Inc. (the "Company") as of September 30, 1998
and for the three and nine months ended September 30, 1997 and
1998 have been prepared on the same basis as the audited
consolidated financial statements for the year ended December 31,
1997 and, in the opinion of management, reflect all adjustments
(consisting of normal recurring adjustments) necessary to fairly
state the consolidated financial position, and the consolidated
results of operations and cash flows for the interim periods.
The results for the interim periods are not necessarily
indicative of results to be expected for any other interim period
or the entire year. These financial statements should be read in
conjunction with the Company's audited consolidated financial
statements and notes thereto for the year ended December 31,
1997, which are included in the Company's 1997 Annual Report to
the Securities and Exchange Commission on Form 10-K. The
preparation of the consolidated financial statements in
conformity with generally accepted accounting principles requires
management to make estimates and assumptions that affect the
reported amounts of assets and liabilities, disclosure of
contingent assets and liabilities, and the reported amounts of
revenues and expenses during the reported period. Actual results
could differ from those estimates.
2. Nonrecurring Expenses:
The Company recorded several nonrecurring pretax charges
during the third quarter of 1997 totaling $113.8 million. Of the
nonrecurring charges, $59.7 million was for the write-off of in-
process research and development acquired in the purchases of
Advanced Logic Research, Inc. (ALR) and certain assets of Amiga
technologies. Also included in the nonrecurring charges was a
non-cash write-off of $45.2 million resulting from the
abandonment of a capitalized internal-use software project and
certain computer equipment. In addition, $8.6 million was
recorded for severance of employees and the closing of a foreign
office as part of the Company's ongoing global reorganization.
3. Comprehensive Income:
Effective January 1, 1998, the Company adopted Statement of
Financial Accounting Standards (SFAS) No. 130, "Reporting
Comprehensive Income." SFAS 130 establishes new rules for the
reporting of comprehensive income and its components; however the
adoption of this statement had no impact on the Company's current
or previously reported net income or stockholders' equity. SFAS
130 requires the display and reporting of comprehensive income,
which includes all changes in stockholders' equity with the
exception of additional investments by stockholders or
distributions to stockholders. Comprehensive income for the
Company includes net income, foreign currency translation
effects, and unrealized gains or losses on available-for-sale
securities which are charged or credited to the accumulated other
comprehensive income (loss) account within stockholders' equity.
Comprehensive income (loss) for the three and nine month
periods ended September 30, 1997 and 1998 was as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1998 1997 1998
(in thousands)
(unaudited)
<S> <C> <C> <C> <C>
Net income (loss) $ (107,113) $ 80,645 $ 16,887 $ 217,256
Foreign currency translation (3,110) 875 (1,294) (997)
Unrealized gains on available-
for-sale securities 102 194 102 348
Total comprehensive income (loss) $ (110,121) $ 81,714 $ 15,695 $ 216,607
</TABLE>
4. Share and Per Share Information:
In 1997, the Financial Accounting Standards Board (FASB)
issued Statement of Financial Accounting Standard No. 128,
"Earnings per Share" which replaced the calculation of primary
and fully diluted earnings per share with basic and diluted
earnings per share. Unlike primary earnings per share, basic
earnings per share excludes any dilutive effect of options,
warrants and convertible securities. Earnings per share amounts
for all periods presented have been restated to SFAS 128
requirements.
The following table sets forth a reconciliation of shares used in
the computation of basic and diluted earnings per share.
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1998 1997 1998
(in thousands)
(unaudited)
<S> <C> <C> <C> <C>
Net income (loss) for basic
and diluted earnings per
share $ (107,113) $ 80,645 $ 16,887 $ 217,256
Weighted average shares for
basic earnings per share 153,980 155,849 153,761 155,280
Dilutive effect of stock
options 2,895 3,669 2,612 3,428
Weighted average shares for
diluted earnings per
share 156,875 159,518 156,373 158,708
</TABLE>
5. Selected Balance Sheet Information:
December 31, September 30,
1997 1998
(unaudited)
(in thousands)
Accounts receivable, net:
Accounts receivable $ 530,743 $ 576,394
Less allowance for uncollectible
accounts (20,064) (16,856)
$ 510,679 $ 559,538
Inventory:
Components and subassemblies $ 226,588 $ 185,326
Finished goods 22,636 12,690
$ 249,224 $ 198,016
6. Contingencies:
The Company is a party to various lawsuits and
administrative proceedings arising in the ordinary course of its
business. The Company evaluates such lawsuits and proceedings on
a case-by-case basis, and its policy is to vigorously contest any
such claims which it believes are without merit. The Company's
management believes that the ultimate resolution of such pending
matters will not materially adversely affect the Company's
business, financial position, results of operations or cash
flows.
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations
Results of Operations
The following table sets forth, for the periods indicated,
certain data derived from the Company's consolidated statements
of operations, expressed as a percentage of net sales:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
1997 1998 1997 1998
<S> <C> <C> <C> <C>
Net sales 100.0% 100.0% 100.0% 100.0%
Cost of goods sold 87.0% 79.2% 83.3% 79.7%
Gross profit 13.0% 20.8% 16.7% 20.3%
Selling, general and administrative
expenses 14.6% 14.6% 13.2% 14.4%
Nonrecurring items 7.6% - 2.6% -
Operating income (loss) (9.2)% 6.2% 0.9% 5.9%
Other income, net 0.4% 0.7% 0.4% 0.7%
Income (loss) before income taxes (8.8)% 6.9% 1.3% 6.6%
Provision (benefit) for income taxes (1.7)% 2.5% 0.9% 2.4%
Net income (loss) (7.1)% 4.4% 0.4% 4.2%
</TABLE>
Third Quarter 1998 Compared to Third Quarter 1997 and Second
Quarter 1998
Sales increased 21% in the third quarter of 1998 to $1.82
billion from $1.50 billion in the third quarter of 1997. Unit
shipments in the third quarter of 1998 increased 43% to
approximately 887,000 units from approximately 622,000 units in
the third quarter of 1997. Continued unit growth was primarily
the result of the strong performance in the Americas region,
accounting for 89% of total unit sales. Weighted average unit
prices (AUP's) were approximately 15% lower in the third quarter
of 1998 versus the comparable period of 1997. These declines
were caused by continuing industry-wide trends to lower priced
PCs and continued reductions in component costs that have not
been offset by the introduction of newer technologies. Sales in
the Americas region for the third quarter of 1998 increased to
$1.61 billion, an increase of 24% versus the $1.30 billion
recorded in the third quarter of 1997 and unit shipments grew 46%
over the prior quarter. Sales in the European region in the
third quarter of 1998 were $106.8 million, down approximately 16%
compared to the third quarter of 1997 while unit shipments in the
region were flat. Sales in the Asia Pacific region grew to
$101.8 million, an increase of 26% versus the comparable period
of 1997 while unit shipments for the third quarter of 1998 grew
54% over the third quarter of 1997.
Sales and units shipped in the third quarter of 1998
increased 12% and 21%, respectively, from the second quarter of
1998. AUP's in the third quarter of 1998 decreased 7%
sequentially. Sales in the Americas region in the third quarter
of 1998 increased 17% from the second quarter of 1998 while units
shipped increased 27%. In the European region, sales and units
shipped decreased 18% and 15%, respectively, from the second
quarter of 1998. Sales in the Asia Pacific region in the third
quarter of 1998 decreased 13% from the second quarter of 1998,
while unit shipments decreased 11%.
In addition to robust desktop unit sales, unit sales of the
Company's portable products hit record levels in the quarter,
increasing 96% and 38%, respectively, over the
third quarter of 1997 and the second quarter of 1998, accounting
for 11% of total unit sales. Server unit sales increased 297%
over the third quarter of 1997 when the Company entered the
server market with the acquisition of Advanced Logic Research.
On a sequential basis, server unit sales increased 27%.
Shipments of the Company's convergence products increased 80% and
48%, respectively, over the third quarter of 1997 and the second
quarter of 1998.
Gross profit in the third quarter of 1998 rose to $377.8
million, an increase of approximately 93% from the third quarter
of 1997 and an increase of approximately 13% versus the second
quarter of 1998. As a percentage of sales, gross profit for the
third quarter of 1998 increased to 20.8% from 13.0% and 20.6%,
respectively, in the third quarter of 1997 and the second quarter
of 1998. The increase over the third quarter of 1997 is
partially attributable to the adverse effects of excess
inventories experienced in the third quarter of 1997. During the
third quarter of 1997 there were significant declines in the
market value of many inventory components. In order to mitigate
the impact of these excess inventories, the Company sold product
with profit margins below targeted levels. In addition, reserves
were recorded against excess and obsolete inventories still on
hand at the end of the third quarter of 1997. Continued gross
profit improvement is also attributable to higher margin products
sold under new marketing initiatives as well as the benefits of
the direct model and decreasing component costs. Demand for the
Company's products was consistent throughout the third quarter of
1998; however, the Company experienced a number of component
quality and shortage problems causing backlog to increase by 40%
over the end of the second quarter of 1998.
Selling, general and administrative (SG&A) expenses for the
third quarter of 1998 increased approximately 21% and 6%,
respectively, versus the third quarter of 1997 and second quarter
of 1998. The increase is attributable to the strong unit growth
experienced during the quarter. In support of the continued
growth, the Company also opened a new manufacturing and sales
facility in Salt Lake City later in the quarter. As a percentage
of sales, SG&A in the third quarter of 1998 was approximately
14.6%, flat compared to the third quarter of 1997 and a decline
from 15.4% in the second quarter of 1998. SG&A increased less
than previously anticipated by management due to continuing
emphasis on cost control measures.
The Company recorded several nonrecurring pretax charges
totaling $113.8 million for the third quarter of 1997. Of the
nonrecurring charges, $59.7 million was for the write-off of in-
process research and development acquired in the purchase of ALR
and certain assets of Amiga Technologies. Also included in the
nonrecurring charges was a non-cash write-off of $45.2 million
resulting from the abandonment of a capitalized internal-use
software project and certain computer equipment. In addition,
$8.6 million was recorded for severance of employees and the
closing of a foreign office as part of the Company's global
reorganization.
Due to the factors discussed above, operating income in the
third quarter of 1998 increased by $251.3 million to $113.4
million from the operating loss of $137.9 million in the third
quarter of 1997 and increased 35% from the second quarter of
1998. As a percentage of sales, operating income for the third
quarter of 1998 increased to 6.2% from (9.2%) in the third
quarter of 1997 and 5.2% in the second quarter of 1998.
Other income, net includes other income net of expenses,
such as interest income and expense and foreign exchange
transaction gains and losses. Other income, net increased to
$12.7 million from $5.6 million and $10.9 million, respectively,
in the third quarter of 1997 and second quarter of 1998,
primarily due to the additional interest income generated by
increases in cash balances and marketable securities.
The Company's annualized effective tax rate was 36% for the
third quarter of 1998, consistent with the second quarter of
1998. The effective tax (benefit) rate for the third quarter of
1997 was (19.0%), representing the income tax benefit from the
net loss.
First Nine Months of 1998 Compared to First Nine Months of 1997
For the first nine months of 1998, sales increased 20% to
$5.16 billion from $4.32 billion in the comparable period of
1997. The increase is primarily due to strong consumer demand
for the Company's products and the continued growth in sales of
the Company's portable and server products. Unit shipments for
the first nine months of 1998 increased 38% to 2,390,000 units
from 1,736,000 units in the comparable period of 1997. AUP's
were approximately 13% lower in the first nine months of 1998
versus the same period of 1997. Sales in the Americas region
grew 23% versus the comparable period of 1997 to $4.44 billion
and unit shipments increased 42%. Sales for the first nine
months of 1998 for the European region were $400.5 million, a
decrease of 14% versus the first nine months of 1997 while unit
shipments remained flat. Sales in the Asia Pacific region grew
to $322.0 million in the first nine months of 1998, an increase
of 30% versus the comparable period of 1997 while unit shipments
increased 58%.
Gross profit in the first nine months of 1998 increased to
$1.05 billion from $721.4 million in the first nine months of
1997. As a percentage of sales, gross profit for the first nine
months of 1998 was 20.3%, up from 16.7% in the comparable period
of 1997. Gross profit percentages were impacted favorably by
higher margin products encompassed under new marketing programs
as well as declines in component costs.
SG&A expenses in the first nine months of 1998 increased 30%
to $741.4 million from $570.7 million in the first nine months of
1997. As a percentage of sales, SG&A increased to 14.4% from
13.2% recorded in the comparable period of 1997. The increase in
SG&A represents increases in personnel expenses reflecting the
general growth of the business and marketing expenses
attributable to an investment in the Company's brand and new
product initiatives.
As noted above, the Company recorded several nonrecurring
pretax charges totaling $113.8 million for 1997.
Due to the factors discussed above, operating income for the
first nine months of 1998 increased 731% to $306.5 million from
$36.9 million in the first nine months of 1997. As a percentage
of sales, operating income increased to 5.9% from 0.9% in the
comparable period of 1997.
Other income, net increased in the first nine months of 1998
to $32.9 million from $20.2 million during the comparable period
of 1997. The increase results from additional interest income
generated by increased cash balances and marketable securities.
The Company's annualized effective tax rate was 36.0% for
the first nine months of 1998 compared to 70.4% recorded in the
first nine months of 1997. The abnormally high 1997 effective
rate was due to nondeductible expenses for income tax purposes
resulting from the write-off of in-process research and
development from the acquisitions of ALR and certain assets of
Amiga Technologies during third quarter 1997.
Liquidity and Capital Resources
At September 30, 1998, the Company had cash and cash
equivalents of $871.4 million, marketable securities of $132.2
million and an unsecured committed credit facility with certain
banks aggregating $225 million, consisting of a revolving line of
credit facility and a sub-facility for letters of credit. At
September 30, 1998, no amounts were outstanding under the
revolving line of credit. Approximately $3.5 million was
committed to support outstanding standby letters of credit.
Management believes the Company's current sources of working
capital, including amounts available under existing credit
facilities, will provide adequate flexibility for the Company's
financial needs for at least the next 12 months.
The Company generated $494.7 million in cash from operations
during the first nine months of the year, including $273.6
million of net income adjusted for non-cash items. Other
significant factors increasing available cash include a decrease
in inventory levels of $51.2 million and an increase of accounts
payable and other accrued liabilities of $242.8 million,
partially offset by an increase in accounts receivable and other
assets. The decrease in inventory levels and increase in
accounts payable and other accrued liabilities is attributable to
the Company's increased focus on working capital management. The
Company used approximately $136.9 million for the construction of
new facilities, information systems and equipment and $93.2
million to purchase investments in marketable securities, net of
proceeds of securities sold. The Company continued to expand the
retail Gateway Country stores with 27 new stores added during the
third quarter of 1998, bringing the total number of stores to 85.
At September 30, 1998, the Company had long-term
indebtedness and capital lease obligations of approximately $12.1
million. These obligations relate to the Company's investments
in equipment and facilities. The Company anticipates that it
will retain all earnings in the foreseeable future for
development of its business and will not distribute earnings to
its stockholders as dividends.
New Accounting Pronouncements
In June of 1998 the Financial Standards Board issued SFAS
No. 133 "Accounting for Derivative Instruments and Hedging
Activities" (FAS 133) which is effective for fiscal years
beginning after June 15, 1999. The objective of the statement is
to establish accounting and reporting standards for derivative
instruments and hedging activities. The Company uses foreign
currency forward contracts, a derivative instrument, to hedge
foreign currency transactions and anticipated foreign currency
transactions. The adoption of this new accounting pronouncement
is not expected to be material to the Company's financial
position or results of operations.
In 1998, the Accounting Standards Committee issued Statement
of Accounting Position ("SOP") No. 98-1, "Accounting for the
Costs of Computer Software Developed or Obtained for Internal
Use," which is effective for fiscal years beginning after
December 15, 1998. The SOP provides guidance on when costs
incurred for internal-use computer software are and are not
capitalized, and on the accounting for such software that is
marketed. The Company plans to adopt the provisions of this SOP
in 1998 and the adoption is not expected to have an impact on its
consolidated financial position, results of operations or cash
flows.
Year 2000
The "Year 2000" issue has arisen because many existing computer
programs and chip-based embedded technology systems use only the
last two digits to refer to a year, and therefore, do not
properly recognize a year that begins with "20" instead of the
familiar "19." If not corrected, many computer applications could
fail or create erroneous results.
State of Readiness The Company has adopted a seven-step process
toward Year 2000 readiness consisting of the following: (i)
awareness: fostering an understanding of and commitment to the
problem and its potential risks; (ii) inventory: identifying and
locating systems and technology components that may be affected;
(iii) assessment: reviewing these components for Year 2000
compliance and assessing the scope of potential Year 2000 issues;
(iv) planning: defining the technical solutions labor and work
plans necessary for each affected system; (v)
remediation/replacement: completing the programming to upgrade or
replace the problem software or hardware; (vi) testing and
compliance validation: conducting testing followed by independent
validation by a separate internal verification team; and (vii)
implementation: placing the corrected systems and technology back
into the business environment with a management monitoring system
to ensure ongoing compliance.
The Company has grouped its systems and technology into the
following three categories for purposes of Year 2000 compliance:
(i) information resource applications and technology consisting
of enterprise-wide systems supported by the Company's centralized
information technology organization (IT); (ii) business
processes consisting of hardware, software, and associated
computer chips as well as external vendors used in the operation
of the Company's core business functions; and (iii) building
systems consisting of non-IT equipment at properties that use
embedded computer chips such as elevators, automated room key
systems and HVAC equipment. The Company is prioritizing its
efforts based on the severity with which non compliance would
affect service, core business processes or revenues, and whether
there are viable, non-automated fallback procedures (Mission
Criticality).
As of the end of the third quarter, the Company believes the
Awareness and Inventory phases are complete for both IT systems
and building systems and 50 percent complete for business
processes. For IT systems, the Company believes the assessment,
planning and remediation/replacement phases are each over 50
percent complete with testing and compliance validation ready to
begin on numerous systems. For business processes and building
systems, the Company believes the assessment and planning are
over 25 percent complete with a substantial amount of work in
process. The progress level for remediation/replacement and
testing and compliance validation has not yet been documented and
quantified. The Company plans to complete the
remediation/replacement and testing phases for its mission
critical IT systems by the end of the second quarter of 1999 with
the remaining half of 1999 reserved for unplanned contingencies
and compliance validation and quality assurance. For mission
critical business processes and building systems, the same level
of completion is targeted for October 1999.
The Company has also initiated Year 2000 compliance
communications with its significant third party suppliers,
vendors and business partners. The Company is focusing its
efforts on the business interfaces most critical to its customer
service, core business processes and revenues, including those
third parties that support the most critical enterprise-wide IT
Systems, the Company's primary suppliers of non-IT products, or
provide the most critical payment processing functions. Responses
have been received from a majority of the third parties that
comprise this group.
Costs During the first nine months of 1998, the Company expensed
incremental costs of approximately $2.5 million related to the
Year 2000 remediation efforts, and has expensed $2.8 million on a
life-to-date basis. The current total estimated cost to complete
the Year 2000 remediation efforts is from $14 to $16 million,
exclusive of upgrades to existing applications and implementation
of new systems. Internal and external costs specifically
associated with modifying internal-use software for the Year 2000
will be charged to expense as incurred. All of these costs are
being funded through operating cash flows.
Year 2000 Contingency Plans The Company is reviewing its existing
contingency plans for potential modification to address specific
Year 2000 issues as they arise and expects to continue this
process during the next four fiscal quarters.
Company Products with respect to PC products sold to customers,
for all the Company hardware based on the Intel family of
Pentium processors (Pentium[Registered Trademark], Pentium[Registered
Trademark] Pro, Pentium[Registered Trademark] II, Pentium [Registered
Trademark] II Xeon[Trademark] and Celeron[Trademark] processors)
and using an operating system provided by the Company, the Company
warrants to customers that such systems sold after January 1, 1997
will process dates correctly before, during, and after January 1, 2000.
This warranty applies to desktop, portable, Destination, and server
products, and it is governed by the terms and conditions outlined
in the original system warranty. It does not include application
software, or non-Company branded external hardware peripherals such as
printers, scanners, and joysticks. Because the company does not
control the design of these products, it cannot ensure how they
access or calculate date information in the computer. Certain hardware
sold before January 1, 1997 will require remediation or replacement to
become Year 2000 compliant. While the Company believes it is not
legally responsible for costs incurred by customers to become
Year 2000 Compliant or Year 2000 failures resulting from software or
non-Company branded external hardware peripherals, the Company may experience
increased customer claims as a result.
Risks of the Company's Year 2000 Issues Based on current
information, the Company believes that the Year 2000 problem will not
have a material adverse effect on the Company, its consolidated financial
position, results of operations or cash flows. However, there is no
assurance that Year 2000 remediation by the Company or third parties
will be properly and timely completed, and failure to do so could have
a material adverse effect on the Company, its business, results of operations,
and its financial condition, as could the potential impact of
increased customer claims. The Company cannot predict the effects that
Year 2000 non-compliance would have on it, which would ultimately depend on
numerous uncertainties such as: (i) the factors listed above
under Costs; (ii) whether significant third parties, including suppliers,
properly and timely address the Year 2000 issue; (iii) whether broad-based or
systemic economic failures may occur, and the severity and
duration of such failures, including loss of utility and/or
telecommunications services, and errors or failures in financial
transactions or payment processing systems such as credit cards;
and (iv) whether the Company becomes the subject of litigation or
other proceedings regarding any Year 2000-related events and the
outcome of any such litigation or proceedings.
Note: Intel and Pentium are registered trademarks, and Pentium II
Xeon and Celeron are trademarks of Intel Corporation.
Factors That May Affect Future Results
The above statements include forward-looking statements
based on current management expectations. Factors that could
cause future results to differ from the Company's expectations
include the following: growth in the personal computer industry;
competitive factors and pricing pressures; component supply
shortages; inventory risks due to shifts in market demand;
changes in the product, customer or geographic sales mix in any
particular period; the outcome of pending and future litigation;
access to necessary intellectual property rights; changes in
government regulation; foreign currency fluctuations; risks of
acquired businesses; and general domestic and international
economic conditions.
In addition to other information contained in this Report,
the following factors, among others, sometimes have affected, and
in the future could affect, the Company's actual consolidated
financial position, results of operations or cash flows, and
could cause future results to differ materially from those
expressed in any forward looking statement made by, or on behalf
of the Company.
The Company has experienced, and may continue to experience,
problems with respect to the size of its work force and
production facilities and the adequacy of its management
information and other systems, purchasing and inventory controls,
and the forecasting of component part needs. These problems can
result in high backlog of product orders, delays in customer
support response times and increased expense levels.
Short product life cycles characterize the PC industry,
resulting from rapid changes in technology and consumer
preferences and declining product prices. The Company's in-house
engineering personnel work closely with PC component suppliers
and other technology developers to evaluate the latest
developments in PC-related technology. There is no assurance
that the Company will continue to have access to or the right to
use new technology or will be successful in incorporating such
new technology in its products or features in a timely manner.
Item 3. Quantitative and Qualitative Disclosures About Market
Risk
There has not been a material change in the Company's
exposure to foreign currency risks since December 31, 1997.
II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit Description of Exhibits
No.
27.1 Financial Data Schedule
(b) Reports on Form 8-K:
No Reports on Form 8-K were filed by the Company during the
quarter ended September 30, 1998.
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act
of 1934, the registrant has duly caused this report to be signed
on its behalf by the undersigned, thereunto duly authorized.
Gateway 2000, Inc.
Date: November 16, 1998 By: /s/ John J. Todd
John J. Todd
Senior Vice President, Chief
Financial Officer and
Treasurer (authorized
officer and chief accounting
officer)
Exhibit INDEX TO EXHIBITS
No.
27.1 Financial Data Schedule
<TABLE> <S> <C>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GATEWAY 2000,
INC.'S CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER
30, 1998 AND THE CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1998 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<CIK> 0000895812
<NAME> GATEWAY 2000, INC.
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-END> SEP-30-1998
<CASH> 871,351
<SECURITIES> 132,156
<RECEIVABLES> 576,394
<ALLOWANCES> 16,856
<INVENTORY> 198,016
<CURRENT-ASSETS> 1,944,877
<PP&E> 667,701
<DEPRECIATION> 213,953
<TOTAL-ASSETS> 2,511,801
<CURRENT-LIABILITIES> 1,213,006
<BONDS> 2,481
0
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<COMMON> 1,560
<OTHER-SE> 1,194,729
<TOTAL-LIABILITY-AND-EQUITY> 2,511,801
<SALES> 5,162,352
<TOTAL-REVENUES> 5,162,352
<CGS> 4,114,363
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<LOSS-PROVISION> 2,278
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<INCOME-PRETAX> 339,462
<INCOME-TAX> 122,206
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