<PAGE>
SECURITIES AND EXCHANGE COMMISSION
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, 1999
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, 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: (858)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 11, 1999, there were 316,535,076 shares of the Common Stock
of the Company, $.01 par value per share, outstanding. As of November 11, 1999,
there were no shares of the Company's Class A Common Stock, $.01 par value per
share, outstanding.
<PAGE>
I. FINANCIAL INFORMATION
Item 1. Financial Statements
Gateway, Inc.
CONSOLIDATED INCOME STATEMENTS
For the three and nine months ended September 30, 1998 and 1999
(in thousands, except per share amounts)
(Unaudited)
<TABLE>
<CAPTION>
Three Months Ended September 30, Nine Months Ended September 30,
------------------------------------- -------------------------------------
1998 1999 1998 1999
--------------- -------------- -------------- --------------
<S> <C> <C> <C> <C>
Net sales $ 1,815,516 $ 2,178,496 $ 5,162,352 $ 6,194,016
Cost of goods sold 1,437,709 1,698,447 4,114,363 4,842,077
--------------- -------------- -------------- --------------
Gross profit 377,807 480,049 1,047,989 1,351,939
Selling, general and administrative
expenses 264,452 321,270 741,445 929,429
--------------- -------------- -------------- --------------
Operating income 113,355 158,779 306,544 422,510
Other income, net 12,653 18,020 32,918 49,295
--------------- -------------- -------------- --------------
Income before income taxes 126,008 176,799 339,462 471,805
Provision for income taxes 45,363 63,648 122,206 169,850
--------------- -------------- -------------- --------------
Net income $ 80,645 $ 113,151 $ 217,256 $ 301,955
=============== ============== ============== ==============
Share and per share information:
Net income per share:
Basic $ 0.26 $ 0.36 $ .70 $ 0.96
=============== ============== ============== ==============
Diluted $ 0.25 $ 0.35 $ .68 $ 0.94
=============== ============== ============== ==============
Weighted average shares
outstanding:
Basic 311,699 313,719 310,559 313,203
=============== ============== ============== ==============
Diluted 319,036 323,912 317,417 321,755
=============== ============== ============== ==============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements
2
<PAGE>
Gateway, Inc.
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and September 30, 1999
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
--------------- ----------------
(unaudited)
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $1,169,810 $1,014,473
Marketable securities 158,657 200,552
Accounts receivable, net 558,851 708,577
Inventory 167,924 172,042
Other 172,944 477,772
--------------- ----------------
Total current assets 2,228,186 2,573,416
Property, plant and equipment, net 530,988 682,514
Intangibles, net 65,944 55,632
Other assets 65,262 136,920
--------------- ----------------
$2,890,380 $3,448,482
=============== ================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current maturities of long-term obligations $ 11,415 $ 3,957
Accounts payable 718,071 861,333
Accrued liabilities 415,265 520,239
Accrued royalties 167,873 158,664
Other current liabilities 117,050 124,739
--------------- ----------------
Total current liabilities 1,429,674 1,668,932
Long-term obligations, net of current maturities 3,360 3,097
Warranty and other noncurrent liabilities 112,971 121,925
--------------- ----------------
Total liabilities 1,546,005 1,793,954
--------------- ----------------
Contingencies (Note 5)
Stockholders' equity:
Preferred Stock, $.01 par value, 5,000 shares authorized; none
issued - -
Class A Common Stock, nonvoting, $.01 par value, 1,000 shares
authorized; none issued - -
Common Stock, $.01 par value, 1,000,000 shares authorized;
313,138 shares and 314,651 shares issued
in 1998 and 1999, respectively 3,131 3,147
Additional paid-in capital 364,421 372,167
Retained earnings 980,908 1,282,863
Treasury stock, 152 shares in 1999 - (3,802)
Accumulated other comprehensive income (loss) (4,085) 153
--------------- ----------------
Total stockholders' equity 1,344,375 1,654,528
--------------- ----------------
$2,890,380 $3,448,482
=============== ================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
3
<PAGE>
Gateway, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 1998 and 1999
(in thousands)
(Unaudited)
<TABLE>
<CAPTION>
Nine Months Ended September 30,
-------------------------------
1998 1999
----------- ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 217,256 $ 301,955
Adjustments to reconcile net income to net
cash provided by operating activities:
Depreciation and amortization 76,077 99,458
Provision for uncollectible accounts receivable 2,278 17,617
Deferred income taxes (22,906) (13,252)
Other, net 741 367
Changes in operating assets and liabilities:
Accounts receivable (51,137) (167,342)
Inventory 51,208 (4,119)
Other assets (21,826) (77,353)
Accounts payable 187,903 145,090
Accrued liabilities 76,878 105,636
Accrued royalties (45,235) (9,210)
Other current liabilities 16,765 38,554
Other liabilities 6,515 464
----------- ------------
Net cash provided by operating activities 494,517 437,865
----------- ------------
Cash flows from investing activities:
Capital expenditures (136,958) (240,914)
Investment in unconsolidated affiliate - (77,744)
Purchases of available-for-sale securities (142,171) (126,890)
Proceeds from maturity of available-for-sale securities 15,026 85,304
Proceeds from sales of available-for-sale securities 33,898 -
Purchase of financing receivables - (146,991)
Purchase of other assets - (49,511)
Other investments, net (673) (2,884)
----------- ------------
Net cash used in investing activities (230,878) (559,630)
----------- ------------
Cash flows from financing activities:
Purchase of treasury stock - (70,784)
Principal payments on long-term obligations and notes payable (11,693) (7,721)
Stock options exercised 25,699 43,879
----------- ------------
Net cash provided by (used in) financing activities 14,006 (34,626)
Foreign exchange effect on cash and cash equivalents 105 1,054
----------- ------------
Net increase (decrease) in cash and cash equivalents 277,750 (155,337)
Cash and cash equivalents, beginning of period 593,601 1,169,810
----------- ------------
Cash and cash equivalents, end of period $ 871,351 $ 1,014,473
=========== ============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
4
<PAGE>
Notes to Consolidated Financial Statements
1. General:
The accompanying unaudited consolidated financial statements of Gateway,
Inc. (the "Company") as of September 30, 1999 and for the three and nine months
ended September 30, 1998 and 1999 have been prepared on the same basis as the
audited consolidated financial statements for the year ended December 31, 1998
and, in the opinion of management, reflect all adjustments, consisting only of
normal recurring adjustments, necessary to fairly state the consolidated
financial position, 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, 1998, which are included in the Company's 1998 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. Comprehensive Income:
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 for the three and nine month periods ended September
30, 1998 and 1999 was as follows:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
--------------------------------- --------------------------------
1998 1999 1998 1999
------------- ------------ ------------ ------------
(in thousands)
(unaudited)
<S> <C> <C> <C> <C>
Net income $ 80,645 $ 113,151 $ 217,256 $ 301,955
Foreign currency translation 875 5,438 (997) 2,881
Unrealized gains on available-for-sale securities 194 1,357 348 1,357
------------- ------------ ------------ ------------
Total comprehensive income $ 81,714 $ 119,946 $ 216,607 $ 306,193
============= ============ ============ ============
</TABLE>
5
<PAGE>
3. Share and Per Share Information:
Basic earnings per common share is computed using the weighted average
number of common shares outstanding during the period. Diluted earnings per
common share is computed using the combination of the effective dilutive common
stock options and the weighted average number of common shares outstanding
during the period.
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,
---------------------------------- ---------------------------------
1998 1999 1998 1999
------------ ------------- ------------ ------------
(in thousands)
(unaudited)
<S> <C> <C> <C> <C>
Net income for basic and diluted
earnings per share $ 80,645 $ 113,151 $ 217,256 $ 301,955
============ ============= ============ ============
Weighted average shares for basic
earnings per share 311,699 313,719 310,559 313,203
Dilutive effect of stock options 7,337 10,193 6,858 8,552
------------ ------------- ------------ ------------
Weighted average shares for diluted
earnings per share 319,036 323,912 317,417 321,755
============ ============= ============ ============
</TABLE>
4. Selected Balance Sheet Information:
<TABLE>
<CAPTION>
December 31, September 30,
1998 1999
------------ -------------
(unaudited)
(in thousands)
<S> <C> <C>
Accounts receivable, net:
Accounts receivable $ 573,799 $ 730,112
Less allowance for uncollectible (14,948) (21,535)
accounts
------------ -------------
$ 558,851 $ 708,577
============ =============
Inventory:
Components and subassemblies $ 155,746 $ 165,094
Finished goods 12,178 6,948
------------ -------------
$ 167,924 $ 172,042
============ =============
</TABLE>
6
<PAGE>
5. 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 and adversely affect the Company's business,
consolidated financial position, results of operations or cash flows.
6. Investment in Unconsolidated Affiliate:
During the first quarter of 1999, the Company purchased a 19.9% interest in
NECX Direct, LLC, an on-line e-commerce computer peripheral retailer. The
purchase price of approximately $77.7 million includes a two year option to
acquire the remaining 80.1% interest for additional consideration. The
investment is being accounted for using the cost method.
7. Stock Repurchase Program:
During the first nine months of 1999, the Company repurchased 2,153,530
shares of common stock. Of the shares repurchased, 2,001,959 were reissued upon
the exercise of employee stock options. The Company is currently authorized to
repurchase up to the lesser of 20,000,000 shares or $500 million of its
available common stock.
8. Segment Data:
The Company evaluates the performance of its consumer and business segments
based on segment sales and operating income and does not include segment assets
or other income and expense items for management reporting purposes. Operating
income for these segments includes selling, general, and administrative expenses
and other overhead charges directly attributable to the segment and excludes
certain expenses managed outside the reportable segments. Costs excluded from
the consumer and business segments primarily consist of corporate marketing
costs and other general and administrative expenses that are separately managed.
The following table sets forth summary information by segment:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------ ----------------------------
1998 1999 1998 1999
---------- ---------- ---------- ----------
(in thousands)
(unaudited)
<S> <C> <C> <C> <C>
Net sales:
Consumer $ 918,053 $1,177,654 $2,531,587 $3,292,082
Business 897,463 1,000,842 2,630,765 2,901,934
Non-segment - - - -
---------- ---------- ---------- ----------
Consolidated $1,815,516 $2,178,496 $5,162,352 $6,194,016
========== ========== ========== ==========
Operating income:
Consumer $ 111,689 $ 146,380 $ 273,390 $ 404,821
Business 157,215 138,746 445,215 455,176
Non-segment (155,549) (126,347) (412,061) (437,487)
---------- ---------- ---------- ----------
Consolidated $ 113,355 $ 158,779 $ 306,544 $ 422,510
========== ========== ========== ==========
</TABLE>
7
<PAGE>
9. Stock split:
On August 9, 1999, the Company announced that its Board of Directors
approved a two-for-one common stock split to be effected in the form of a stock
dividend. The shares were distributed on September 7, 1999 to stockholders of
record as of August 20, 1999. Share and per share data for all periods presented
herein have been restated to reflect the two-for-one common stock split.
8
<PAGE>
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
This Report includes forward-looking statements made based on current
management expectations pursuant to the safe harbor provisions of the Private
Securities Litigation Reform Act of 1995. These statements are not guarantees
of future performance and actual outcomes may differ materially from what is
expressed or forecasted. There are many factors that affect the Company's
business and its results of operations, including the factors discussed or
referenced below.
Results of Operations
- ---------------------
The following table sets forth, for the periods indicated, certain data
derived from the Company's consolidated statements of operations:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------- -------------------------------------------
1998 Change 1999 1998 Change 1999
---------- -------- ---------- ---------- -------- ----------
<S> <C> <C> <C> <C> <C> <C>
Net sales $1,815,516 20.0% $2,178,496 $5,162,352 20.0% $6,194,016
Gross profit 377,807 27.1% 480,049 1,047,989 29.0% 1,351,939
Percentage of net sales 20.8% 22.0% 20.3% 21.8%
Selling, general and
administrative expenses 264,452 21.5% 321,270 741,445 25.4% 929,429
Percentage of net sales 14.6% 14.7% 14.4% 15.0%
Operating income 113,355 40.1% 158,779 306,544 37.8% 422,510
Percentage of net sales 6.2% 7.3% 5.9% 6.8%
Net income $ 80,645 40.3% $ 113,151 $ 217,256 39.0% $ 301,955
</TABLE>
Net Sales
- ---------
Consolidated net sales increased to $2.2 billion and $6.2 billion in the
third quarter and first nine months of 1999, respectively, representing
increases of 20% over the comparable periods of 1998, and increasing 14% over
the second quarter of 1999. Consumer segment sales were $1.2 billion and
business segment sales were $1.0 billion in the third quarter of 1999,
increasing 28% and 12%, respectively, over the third quarter of 1998. For the
first nine months of 1999, consumer segment sales increased 30% to $3.3 million
while business segment sales increased 10% to $2.9 million over the comparable
period of 1998.
The increased consolidated net sales for the third quarter and first nine
months of 1999 over the comparable periods of 1998 were primarily driven by
continued strong unit growth in the United States and continued momentum in the
Asia Pacific region ("APAC"). Unit shipments grew to 1,234,500 in the third
quarter of 1999 and 3,323,500 for the first nine months of the year,
representing 39% increases over the comparable periods of 1998. Increases in
unit sales were attributed to several key elements including execution of the
Company's unique multi-channel strategy, including sales from phone, Web, and
Gateway Country(SM) stores, and continued focus on delivering superior products
and services, most notably through the Your:)Ware(SM) consumer and business
programs.
9
<PAGE>
The effect of increased unit sales on consolidated net revenue for the
third quarter and first nine months of 1999 were partially offset by a decline
in average unit prices (AUPs) of 14% compared to the third quarter and first
nine months of 1998. The Company expects the industry trend of declining AUPs to
continue due to component cost decreases and broadened product offerings in the
sub $1,000 PC market and intends to mitigate this by diversifying its revenue
stream with software bundles, Internet service, financing and other service
offerings.
The following table summarizes the Company's net sales, for the periods
indicated, by geographic region:
<TABLE>
<CAPTION>
Three Months Ended Nine Months Ended
September 30, September 30,
-------------------------------------------------------- ------------------------------------------------
1998 Change 1999 1998 Change 1999
------------------- ------------ ------------------ ------------------ ------------ -------------
<S> <C> <C> <C> <C> <C> <C>
Net sales
United States $1,606,913 18.2% $1,899,761 $4,439,806 19.5% $5,306,240
Europe 106,828 11.2% 118,835 400,518 (6.9%) 372,803
Asia Pacific 101,775 57.1% 159,900 322,028 59.9% 514,973
------------------- ------------ ------------------ ------------------ ------------ -----------
Consolidated $1,815,516 20.0% $2,178,496 $5,162,352 20.0% $6,194,016
=================== ============ ================== ================== ============ ===========
</TABLE>
In the United States unit shipments rose 37% in the third quarter of 1999
and 39% for the first nine months of 1999 over the comparable periods of 1998,
while increasing 28% over the second quarter of 1999. The APAC region continued
to achieve significant increases in unit shipments with growth of 72% and 81%
for the third quarter and first nine months of 1999, respectively, over the
comparable periods of 1998. Unit shipments in the European region ("EMEA") rose
38% in the third quarter of 1999 and 11% for the first nine months of 1999 over
the comparable periods of 1998.
Gross Profit
- ------------
Gross profit in the third quarter of 1999 increased 27% over the comparable
period of 1998 to $480.0 million and increased 14% over the second quarter of
1999. For the first nine months of 1999, gross profit increased 29% over the
comparable 1998 period to $1.35 billion while increasing from 20.3% to 21.8% as
a percentage of sales. Year over year margin productivity was driven by pricing
discipline, focused vendor management, solid execution, and increased non-system
revenue. As a percentage of sales, gross profit for the third quarter of 1999
was 22.0%, up from the 20.8% in the third quarter of 1998 and flat compared to
the second quarter of 1999, representing the seventh consecutive quarter of
year-over-year gross profit improvement.
Selling, General and Administrative Expenses
- --------------------------------------------
The Company remained ahead of plan for selling, general and administrative
("SG&A") expenses in the third quarter of 1999 as SG&A expenses increased 22% to
$321.3 million over the third quarter of 1998 and increased 8% over the second
quarter of 1999. While continuing to invest in long-term, strategic initiatives,
the Company experienced a reduction in SG&A expenses as a percentage of sales
versus the second quarter of 1999. As a percentage of sales, SG&A expenses were
14.7% for the third quarter of 1999, compared to 14.6% and 15.6% in the third
quarter of 1998 and second quarter of 1999, respectively. For the first nine
months of 1999, SG&A expenses increased 25% to $929.4 million over the
comparable period of 1998 while increasing from 14.4% to 15.0% as a percentage
of sales.
10
<PAGE>
Operating Income
- ----------------
Due to the strong unit growth and gross margin efficiencies discussed above
operating income increased 40% to $158.8 million in the third quarter of 1999
compared to the third quarter of 1998. As a percentage of sales, operating
income increased to 7.3% in the third quarter of 1999 from 6.2% in the third
quarter of 1998 and increased from 6.4% in the second quarter of 1999. For the
first nine months of 1999, operating income increased 38% to $422.5 million over
the comparable 1998 period. Operating income for the consumer and business
segments in the third quarter of 1999 was $146.4 million and $138.7 million,
respectively, while operating expenses not allocated to a segment were $126.3
million. Operating income for the consumer and business segments includes SG&A
expenses and other overhead charges directly attributable to the segment and
excludes certain expenses managed outside the reportable segments. Costs
excluded from the consumer and business segments primarily consist of corporate
marketing costs and other indirect SG&A expenses that are separately managed.
Other Income
- ------------
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 $18.0 million in the third quarter of 1999 from $12.7
million in the third quarter of 1998 and $16.5 million in the second quarter of
1999. For the first nine months of 1999, other income, net increased to $49.3
million from $32.9 million reported in the comparable 1998 period. The increases
were primarily due to the additional interest income generated by increases in
cash balances and marketable securities.
Income Taxes
- ------------
The Company's annualized effective tax rate was 36.0% for the quarter and
first nine months of 1999, flat compared to the comparable periods of 1998 and
second quarter of 1999.
Liquidity and Capital Resources
- -------------------------------
The following table presents selected financial statistics and information
for the periods indicated:
<TABLE>
<CAPTION>
Three Months Ended September 30,
---------------------------------------------------------------
1998 1999
----------------------------- -----------------------------
(dollars in thousands)
<S> <C> <C>
Cash and marketable securities $1,003,507 $1,215,025
Days of sales in accounts receivable 28 29
Inventory turnover 33 46
Days in accounts payable 42 46
</TABLE>
At September 30, 1999, the Company had cash and cash equivalents of $1.0
billion, marketable securities of $200.6 million and an unsecured committed
credit facility with certain banks of $225 million, consisting of a revolving
line of credit facility and a sub-facility for letters of credit. At September
30, 1999, no amounts were outstanding under the revolving line of credit.
Approximately $1.75 million was committed to support outstanding standby letters
of credit.
11
<PAGE>
The Company generated $437.9 million in cash from operations during the
first nine months of 1999, including $406.1 million of net income adjusted for
non-cash items. Increases in inventory turns and days purchases in accounts
payable balances are attributable to the Company's increased focus on working
capital management and were partially offset by an increase in accounts
receivable. The Company used approximately $240.9 million in cash for
facilities, equipment, and software; $41.6 million to purchase investments in
marketable securities, net of proceeds of securities sold; $146.9 to purchase
financing receivables; and $49.5 million to purchase other investments.
During the first quarter of 1999, the Company purchased a 19.9% interest in
NECX Direct, LLC, an on-line e-commerce computer peripheral retailer. The
purchase price of approximately $77.7 million includes a two year option to
acquire the remaining 80.1% interest for additional consideration.
At September 30, 1999, the Company had long-term indebtedness and capital
lease obligations of approximately $7.1 million. These obligations relate
primarily to the Company's expansion of international operations and its
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.
On April 30, 1999, the Company filed a universal shelf registration
statement which contemplates that the Company may from time to time sell up to
$1.0 billion of debt or equity securities, which will provide the Company with
greater flexibility to respond to acquisition and market opportunities.
In October 1999, the Company announced a strategic relationship with
America Online, Inc. to combine the companies sales and distribution channels
and capabilities in the development of hardware, software and Internet content.
As part of the agreement, America Online, Inc. will invest $800 million in the
Company over a two-year period, in a combination of cash and $180 million in
America Online, Inc. stock.
Management believes the Company's current and anticipated sources of
working capital, including net cash provided by operating activities and amounts
available under existing credit facilities, will provide adequate flexibility
for the Company's financial needs for at least the next 12 months.
New Accounting Pronouncements
- -----------------------------
In June of 1998, the Financial Accounting Standards Board issued SFAS No.
133, "Accounting for Derivative Instruments and Hedging Activities" which is
effective for fiscal years beginning after June 15, 2000. 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 consolidated
financial position or results of operations.
12
<PAGE>
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 internal 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 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 has completed all phases of
its Year 2000 readiness program for the defined mission critical and mission
impact assets. For the remainder of the year, the Company will be retesting its
ERP packages to ensure all changes made since the previous testing did not
negatively impact the Year 2000 test results. The Company will also be selecting
key contingency plans for practice and will be defining the processes to be used
by the core team during the actual turn of the century.
The Company is nearing completion of the Year 2000 compliance
communications with its significant third party suppliers, vendors and business
partners. The Company focused 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 over
95% of the third parties that comprise this group.
Costs: During the first nine months of 1999, the Company expensed
incremental costs of approximately $9.3 million related to the Year 2000
remediation efforts, and has expensed $13.0 million on a life-to-date basis. The
current remaining estimated cost for the Year 2000 remediation effort is $3.6
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 are charged to expense as incurred. All
of these costs are being funded through operating cash flows.
13
<PAGE>
Year 2000 Contingency Plans: The Company has completed the review of its
existing contingency plans for potential modification to address specific Year
2000 issues as they arise and, as stated earlier, plans to select key plans to
be practiced during the fourth quarter.
Company Products: With respect to PC products sold to customers, for all
the Company hardware based on the Intel(R) family of Pentium processors
(Pentium(R), Pentium(R) Pro, Pentium II(R), Pentium(R)II Xeon and Celeron
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(R), 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.
The Company may experience increased customer claims for Year 2000 failures for
these products and for failures resulting from software or non-Company branded
external hardware peripherals. Additional information concerning the Year 2000
issue and the Company's compliance program is available on the Company's website
at www.gateway.com.
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 are no assurances 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 and its financial condition. 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) whether significant
third parties properly and timely address the Year 2000 issue; (ii) 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 (iii) 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.
Factors That May Affect Future Results
Factors that could impact the Company's results of operations, cash flows
or financial position and cause future results to differ from the Company's
expectations include the following: competitive market conditions;
infrastructure requirements; component supply shortages; short product cycles;
access to technology; risks of international expansion; foreign currency
fluctuations; credit risk of consumer loan accounts; the success of e-commerce;
risks of acquired businesses, joint ventures and strategic alliances; increased
inventory costs; changes in customer or geographic sales mix; costs associated
with the Year 2000 transition; general domestic and international economic
conditions; as well as risks identified in the Company's Annual Report on Form
10-K for the fiscal year ended December 31, 1998 and other filings with the
Securities and Exchange Commission.
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.
14
<PAGE>
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 can be 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, 1998.
15
<PAGE>
II. OTHER INFORMATION
Item 1. Legal Proceedings
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 and adversely affect the Company's business,
consolidated financial position, results of operations or cash flows.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits:
Exhibit Description of Exhibits
-----------------------
No.
---
27.1 Financial Data Schedule, filed herewith.
(b) Reports on Form 8-K:
No Reports on Form 8-K were filed by the Company during the quarter
ended September 30, 1999.
16
<PAGE>
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, Inc.
Date: November 15, 1999 By: /s/ John J. Todd
----------------------------------------
John J. Todd
Senior Vice President and Chief Financial Officer
(authorized officer and chief accounting officer)
17
<PAGE>
Exhibit INDEX TO EXHIBITS
-----------------
No.
---
27.1 Financial Data Schedule
18
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THE SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GATEWAY,
INC.'S CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE NINE MONTHS ENDED SEPTEMBER
30, 1999 AND THE CONSOLIDATED BALANCE SHEET AS OF SEPTEMBER 30, 1999 AND IS
QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> 9-MOS
<FISCAL-YEAR-END> DEC-31-1999
<PERIOD-START> JAN-01-1999
<PERIOD-END> SEP-30-1999
<CASH> 1,014,473
<SECURITIES> 200,552
<RECEIVABLES> 730,112
<ALLOWANCES> 21,535
<INVENTORY> 172,042
<CURRENT-ASSETS> 2,573,416
<PP&E> 1,003,110
<DEPRECIATION> 320,596
<TOTAL-ASSETS> 3,448,482
<CURRENT-LIABILITIES> 1,668,932
<BONDS> 3,097
0
0
<COMMON> 3,147
<OTHER-SE> 1,651,381
<TOTAL-LIABILITY-AND-EQUITY> 3,448,482
<SALES> 6,194,016
<TOTAL-REVENUES> 6,194,016
<CGS> 4,842,077
<TOTAL-COSTS> 4,842,077
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 17,617
<INTEREST-EXPENSE> 726
<INCOME-PRETAX> 471,805
<INCOME-TAX> 169,850
<INCOME-CONTINUING> 301,955
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 301,955
<EPS-BASIC> 0.96
<EPS-DILUTED> 0.94
</TABLE>
