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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 1998
Commission file number 0-22784
GATEWAY 2000, INC.
A DELAWARE CORPORATION I.R.S. EMPLOYER NUMBER
42-1249184
4545 Towne Centre Court, San Diego 92121
Telephone number: (619) 799-3401
Securities registered pursuant to Section 12(b) of the Act:
TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED
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COMMON STOCK, PAR VALUE $.01 PER SHARE NEW YORK STOCK EXCHANGE
SECURITIES REGISTERED PURSUANT TO SECTION 12(G) OF THE ACT: NONE
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 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 ___.
-
Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [X]
The aggregate market value of the voting stock held by non-affiliates of
the registrant on March 26, 1999 (based on the last sale price on the New York
Stock Exchange as of such date) was $5,875,005,141. At such date, there were
156,468,709 shares of Common Stock outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of Gateway's definitive proxy statement relating to its 1999
annual meeting of stockholders to be filed with the Securities and Exchange
Commission not later than 120 days after the end of the fiscal year to which
this Report relates, are incorporated by reference in Part III of this Form 10-
K.
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PART I
ITEM 1. BUSINESS
GENERAL
Gateway 2000, Inc. together with its subsidiary companies ("Gateway" or the
"Company") is a leading direct marketer of personal computers ("PCs") and
related products and services. Gateway develops, manufactures, markets, and
supports a broad line of desktop and portable PCs, digital media (convergence)
PCs, servers, workstations and PC-related products used by individuals,
families, businesses, government agencies and educational institutions.
Gateway manages its business activities primarily in two customer-focused
segments: consumer and business.
The Company is one of the leading suppliers of PCs to the U.S. consumer
market, with a market share of approximately 17% in the fourth quarter of 1998,
making Gateway number one in home desktop PCs in the U.S. for the fourth quarter
according to Gartner Group/Dataquest U.S. PC Quarterly Statistics. Gateway's
strategy is to deliver the best value to its customers by offering quality,
high-performance PCs and other products employing the latest technology at
competitive prices and by providing outstanding service and support. Internet
users can access information about Gateway and its products and services at
http://www.gateway.com.
Gateway was incorporated in Iowa on August 15, 1986, merged into a South
Dakota corporation of the same name effective December 29, 1989, and merged into
a Delaware corporation of the same name effective February 20, 1991. Gateway
common stock trades on the New York Stock Exchange under the symbol GTW.
BUSINESS OPERATIONS
Direct Marketing and Distribution. Gateway sells its products directly to
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PC customers through three complementary distribution channels - phone sales,
its internet website, http://www.gateway.com, and the Gateway Country(SM)
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stores. In April 1996, Gateway became the first major PC manufacturer to provide
consumers the ability to custom configure, order and pay for a personal computer
via the World Wide Web. Gateway Country stores allow customers to test the
entire line of Gateway products and have their questions answered by highly
trained sales representatives. Unlike traditional retail stores, Gateway Country
stores do not maintain an inventory of computers for sale, keeping overhead
costs low. Customers can order a computer while at the store, can visit the
Gateway website later and place an order over the internet, or can call to ask
further questions and order their computer over the telephone. Gateway believes
that 50% of its customers take advantage of at least two of these channels
before making their purchases.
Gateway believes that this direct distribution approach provides several
benefits. First, Gateway believes it can offer competitive pricing by avoiding
the additional markups, inventory and occupancy costs associated with
distributors, dealers and traditional retail stores. Second, by alleviating the
need for the high levels of finished goods inventory required by traditional
retail channels, Gateway believes it can respond more quickly to changing
customer demands - offering new products on a timely basis and reducing its
exposure to the risk of product obsolescence. Third, Gateway believes that
working directly with PC customers promotes brand awareness and customer loyalty
as evidenced by the high number of repeat customers.
Gateway markets its products directly to PC customers, primarily by placing
advertisements on television, newspapers, magazines, radio and its internet
website, http://www.gateway.com. These advertisements include product
information and Gateway's toll-free telephone numbers. Gateway also conducts
national consumer-oriented television advertising campaigns. Gateway believes
its creative marketing, including use of its famous trademarked "BLACK AND WHITE
SPOT" Design on product packaging, has helped generate significant brand
awareness and a loyal customer base.
As of December 31, 1998, a sales force of over 3,700 Company employees sold
Company products directly
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to customers over the telephone. Customers can order products over the telephone
up to fifteen hours a day and seven days a week in the U.S. and six days a week
elsewhere in the world. As of December 31, 1998, Gateway utilized over 6,600
customer and technical support representatives providing comprehensive service
and support. Gateway's sales force and customer service staff have continued to
expand to meet increased demand for Gateway products and support services. By
mid-March 1999 Gateway had also expanded its Gateway Country(SM) stores to 153
stores throughout 39 states (from 37 stores at December 31, 1997), allowing
customers direct interaction with sales representatives.
Over 50% of Gateway's business is believed to be attributable to either
previous buyers of Gateway(TM) PCs or new customers referred by previous buyers.
Gateway has sold over 11.8 million PCs to date, and maintains a database of its
customers. To provide a broader range of services to these customers, Gateway
has introduced innovative means of marketing and communication. These include
the Gateway Moola credit card that gives consumers a rebate applicable toward
future Gateway purchases. Since 1995, Gateway has maintained a web site on the
Internet, at the address http://www.gateway.com. Gateway's Internet web site
offers information about Gateway events, new product offerings and technical
support advice. In addition, regular surveys of Gateway's customers also give
Gateway valuable marketing, service and product information.
Business Sales. During 1998, Gateway continued to expand sales and
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marketing efforts directed to its business customers, including small business
and home office as well as to Fortune 1000 customers. To meet the needs of
small business and home office customers, Gateway opened its Gateway Business
Solutions Center in its Country Stores. Each Business Solutions Center allows
potential customers to see the PC solutions for their business needs and discuss
them with trained sales personnel. In addition, for its larger corporate
accounts, Gateway expanded its Gateway Partners program. Gateway Partners uses
third-party resellers to sell to business customers that prefer the extra
services available. To support its traditional Fortune 1000 customer base,
Gateway also increased its major accounts sales force during 1998.
Internet Opportunities - Access and E-Commerce. Gateway began offering
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Internet service in November 1997, when it became the first major PC
manufacturer to offer nationwide Internet provider service directly to its
customers. The gateway.net(SM) Internet service offers electronic mail,
Internet access, and an array of news, entertainment, family-oriented topics,
weather, sports, Internet tips and tutorials.
In February 1999, Gateway purchased a minority ownership share in the e-
commerce operations of NECX Direct, with an option to acquire the remaining
shares in the future. NECX created the first Internet-based, transaction-
capable, e-commerce site in 1993, and today its e-commerce storefront is one of
the highest rated sites on the Web. In 1998, it won the U.S. News and World
Report "Best of the Web" award, PC Magazine's "Editor's Choice" for Computer
Hardware and PC World's "Best" Online Buying Experience award. NECX will help
Gateway develop and launch "SpotShop.com," an e-commerce site that will offer
Gateway branded products as well as complimentary peripherals and software from
leading manufacturers. SpotShop.com will be linked to Gateway's website at
www.gateway.com, which Gateway believes is visited by about 60,000 individuals
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each day. Through SpotShop.com, Gateway customers will be able to personalize
an entire computing solution and receive all of their required products directly
from Gateway in a matter of days.
Your:)Ware Program - Customized Computers. In May 1998, Gateway introduced
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the Your:)Ware(SM) program that combines two unique features to address the
needs of today' computer customers. First, a customer is offered a computer
personalized and built to order, with customized hardware and software, combined
with client-centered service, optional software additions, an optional Internet
connection, and financing options. The second feature of the Your:)Ware program
addresses the growing concern that a computer system purchased today will become
outdated and obsolete. After two years of ownership, a Your:)Ware customer can
trade in the computer toward the purchase of a new system.
In early 1999, Gateway announced the creation of an internal division to
manage the financing of customer PCs under its Your:)Ware program. Gateway
believes that in 1998 third parties originated approximately $1 billion in
financing business related to the Your:)Ware program. The financing division is
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chartered with expanding the financing options available to customers.
Quality Product, Service and Support. Gateway believes that as PC
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customers have become increasingly sophisticated in their purchasing decisions,
quality and reliability have become increasingly important. Gateway works
closely with its suppliers to develop high-quality components, manufactured to
Gateway's specifications. In addition, every Gateway PC undergoes extensive
quality control testing. Gateway believes that customers judge quality by
evaluating the performance and reliability of a company's products, as well as a
company's ability to provide comprehensive service and support for its PCs. To
provide superior service and support to its customers, Gateway utilizes more
than 6,600 customer and technical support representatives specifically trained
to assist customers with the resolution of technical questions relating to
Gateway's products.
Latest Technology. Gateway works directly with a wide range of suppliers
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to evaluate the latest developments in PC-related technology. Gateway believes
that these relationships, together with market information obtained from its
direct customer relationships, the flexibility of build-to-order manufacturing,
low inventory and short production lead times allow Gateway to rapidly introduce
and deliver appealing new products and software.
Competitive Pricing. Gateway offers its products at competitive prices by
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seeking to maintain a low-cost operating structure. First, in addition to the
cost advantages of marketing its products directly to its customers, Gateway
endeavors to minimize overhead expenses. Gateway operates manufacturing
facilities in South Dakota, Virginia, Utah, Ireland and Malaysia, locations with
relatively low costs associated with facilities, work forces and taxes. Second,
Gateway's engineering personnel work closely with component suppliers in
developing and implementing new technology, reducing the investment usually
associated with a traditional, in-house research and development group. Finally,
Gateway believes its large volume of business affords it certain economies of
scale which lower its unit costs and contribute to operating efficiencies.
Growth Initiatives. The growth in Gateway's net sales and earnings to date
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has resulted primarily from the sale of desktop PCs to individuals, home
offices, small businesses and corporate customers, and to governmental entities
and educational and institutions in the U.S. market. Also, growth in net sales
of Gateway's portable products has continued from previous years. Gateway has
continued to expand its product line with the introduction of new products and
services, including financing options, internet access and e-commerce. Gateway
believes that most of its continued growth will come from four areas: (a) the
domestic consumer market, including the developing market for family-use PCs;
(b) businesses and institutions, including home offices; small to medium-size
businesses; as well as Fortune 1000 companies, governmental entities and
educational institutions; (c) the continued expansion of its international
operations; and (d) the expansion of service offerings, including internet
access, e-commerce and financing options offered to customers. Gateway believes
that its growth in these areas will benefit from its Gateway Country(SM) stores,
which allow direct interaction with retail customers, and the enhancement of its
outside sales force which serves businesses, government agencies and educational
institutions.
For a discussion of certain risks associated with Gateway's operations, see
"Management's Discussion and Analysis of Financial Condition and Results of
Operations - Factors That May Affect Future Results" beginning on page 13 of
this Report.
BUSINESS SEGMENTS
Before 1998, Gateway organized its global operations into three operating
regions: (a) the United States, (b) Europe, the Middle East and Africa, and (c)
Asia-Pacific. The administrative headquarters for Gateway is located in San
Diego, California. The European region, which is managed from Dublin, Ireland,
includes the European countries and certain countries in the Middle East and in
Africa. The Asia Pacific region includes operations in Japan, Australia,
Singapore, New Zealand, Malaysia and Hong Kong. Beginning in 1998, Gateway
managed its operations as two customer-focused groups: consumer and business.
For further information on the Company's operating segments see Management's
Discussion and Analysis of Financial Condition and Results of Operations and
Note 12 of the Notes to the Consolidated Financial Statements.
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PRODUCTS
Gateway offers a broad line of PC and PC based products, including desktop
and portable PCs, digital media (convergence) PCs, servers, workstations, and
access to the Internet, as well as peripheral products, third party software,
and service and support programs. Gateway(TM) PCs are custom-configured with a
choice of microprocessors of varying clock speeds, memory and storage
capacities, as well as other options, all as specified by the customer.
Additionally, PCs are available with a wide variety of application software.
Gateway considers substantially all of its product offerings to be in a similar
class of products (PCs and peripheral products and services). The following are
the key products within this class:
Desktop PCs. Gateway has five lines of desktop PCs. The Gateway
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Performance, Select and Essential lines of desktop PCs are primarily designed
for home users and typically include CD-ROM/DVD-ROM, graphics and audio systems.
The E-Series and GP-Series lines of desktop PCs are designed for government,
education and business clients of all sizes, including those with networked
environments. During 1998, all desktop PCs utilized Intel Pentium(R) and
Celeron(R) processors. In early 1999, Gateway continued to expand choices
offered to consumers with the introduction of AMD(TM) processors on selected
systems.
Portable PCs. Gateway's Solo(R) portable PCs provide portable computing
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capabilities for users who operate in both a mobile and networked environment.
The systems can be designed for either home or business use and are available
with docking stations and various multimedia applications. In 1998, in response
to customer requests, Gateway introduced the Solo 3100, code-named "FireAnt,"
Gateway's thinnest portable yet. Portables are a growing segment of the
business, representing over 13% of sales in 1998.
Digital Media (Convergence) PCs. Digital media (convergence) PCs combine
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home entertainment or business conference room and personal computing
capabilities into a single product. These systems typically can include large
color monitors, wireless keyboard and pointing devices, CD and digital video
disc (DVD) ROM drives, a TV/VGA video card, a high fidelity audio card, and a
communication center with a high speed internet connection. Gateway is a market
leader in this product line.
Servers. For business customers Gateway offers Gateway ALR(R) branded
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servers. Every Gateway ALR server has an adaptable design and can be custom
built with a variety of options to fit the customer's needs.
Peripheral Products and Software. Gateway also offers a variety of
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additional products manufactured by third parties including monitors, printers,
fax/modems, CD-ROM drives, external storage devices, and popular third party
software titles.
PRODUCT DEVELOPMENT
Gateway's expenditures on research, development and engineering in each of
the last three years were less than 1% of net sales. Gateway maintains close and
cooperative relationships with many of its suppliers and with other technology
developers. These relationships and Gateway's own engineering staff have enabled
Gateway to evaluate the latest developments in PC technology and to quickly
introduce new products and new product features to the market. Gateway believes
that its strong relationships with its suppliers will continue to give Gateway
access to new technology and enhance its ability to bring the latest technology
to market on a timely basis. Direct relationships with its customers also enable
Gateway to obtain valuable market information, which it uses to assist in
developing new product offerings.
MANUFACTURING AND MATERIALS
Gateway has designed its manufacturing process to provide products custom-
configured to conform to customer specifications. Gateway uses production teams
to assemble its desktop PCs with each member of a production team trained to do
several tasks, increasing flexibility and efficiency. Third-party suppliers
manufacture the base configuration for portable PCs and Gateway completes final
configuration. Gateway's
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production teams perform quality control tests on each PC, and Gateway's quality
assurance staff inspects samples of completed PCs to ensure that the PCs meet
Gateway's quality specifications and applicable regulatory requirements. Each PC
is shipped from Gateway's manufacturing facilities ready-for-use, with certain
application software already installed. Replacement parts are also generally
shipped directly from Gateway to its customers.
Gateway's desktop and portable computer manufacturing operations in North
Sioux City, South Dakota; Hampton, Virginia; and Malacca, Malaysia have been
assessed and certified as meeting the requirements of the International
Organization for Standardization (ISO) 9002. ISO 9002 certification recognizes
Gateway's compliance with international standards for quality assurance. In
September of 1998, the Company expanded its manufacturing operations with the
opening of a facility in Salt Lake City, Utah.
PRODUCT WARRANTIES AND TECHNICAL SUPPORT
Product Warranties. Gateway believes its product warranties are an
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important part of achieving customer satisfaction and maintaining Gateway's
image. In general, Gateway provides a 30-day money-back guarantee for customer
returns. Shipping and handling charges to and from the customer are non-
refundable. Gateway provides competitive warranty packages on all of its
manufactured products, ranging from one year to five years. In many cases,
customers have the option of customizing their limited warranty to suit their
particular needs. Certain Gateway computers are warranted to correctly process
dates during and after January 1, 2000. This could result in increased customer
claims for year 2000 claims.
On-Board Diagnostic Tools. During 1998, Gateway launched the HelpSpot(TM)
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software tools, which provides customers with a suite of diagnostic tools to
diagnose system problems. The HelpSpot software tools also include tutorial
information to assist customers with system operations.
Other Technical Support Options. Gateway also provides a number of other
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basic technical support options to its customers through its website, as well as
a variety of other methods, including e-mail, fax, and telephone support. Many
of these technical support options are available to customers without charge. To
expand the range of choices available to customers, Gateway has also introduced
a number of fee-based support options, ranging from software tutorial services
for consumers to advanced network support for small and medium sized businesses.
PATENTS, TRADEMARKS AND LICENSES
Gateway holds a number of U.S. and foreign patents and has various U.S. and
foreign patent applications pending. In addition to its own engineering
resources, Gateway works closely with PC component suppliers and other
technology developers to stay abreast of the latest developments in PC
technology. Gateway has obtained patent licenses for certain technologies where
such licenses are necessary or advantageous, some of which require significant
royalty payments. In addition, Gateway has entered into patent cross-licenses to
provide access to other technology. Gateway increased the emphasis on internal
patent generation and the strategic acquisition of patents in 1995 which has
resulted in an increase in the number of patents in the Gateway portfolio.
Gateway owns and uses a number of trademarks on or in connection with its
products, including Gateway, Your:)Ware, AnyKey, "BLACK AND WHITE SPOT" design,
CrystalScan, Destination, Family PC, Gateway 2000, Gateway Gold, "G" Design,
Telepath, Solo, Vivitron and "You've Got a Friend in the Business", among
others. Many of these trademarks are registered. Gateway believes the GATEWAY
and the famous "BLACK AND WHITE SPOT" design trademarks have strong brand name
recognition in the United States marketplace and plans to develop similar
recognition internationally.
Because software used on Company-manufactured PCs may not be Company-owned,
Gateway has entered into software licensing or cross-licensing arrangements with
a number of software developers, including Microsoft Corporation. For example,
Gateway has licenses with Microsoft Corporation for Windows 98, Windows, MS-DOS
and Microsoft Office software products, among others.
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COMPETITION
The PC industry is highly competitive, especially with respect to pricing
and the introduction of new products and product features. Gateway competes
primarily by adding new performance features to products while minimizing
corresponding price increases. Timely introduction of new products or product
features by Gateway cannot be guaranteed. Likewise, no assurance can be given
that Gateway will continue to compete successfully by adding new features to its
products without corresponding price increases. In recent years, Gateway and
many of its competitors have regularly lowered prices, and Gateway expects these
pricing pressures to continue. If cost reductions or changes in product mix do
not mitigate these pricing pressures, these competitive price pressures could
substantially reduce profits.
Competitive factors in Gateway's markets include price, availability of new
technology, variety of products and features offered, availability of peripheral
products and software, marketing and sales capability, service and support.
Gateway believes it competes favorably with respect to each of these factors.
INTERNATIONAL OPERATIONS
Through its wholly owned subsidiaries, Gateway 2000 Ireland Limited and
Gateway 2000 Europe (collectively, "Gateway Ireland"), Gateway opened a sales,
service and production facility in Dublin, Ireland on October 1, 1993. Since
then, Gateway has expanded its operations and facilities into other European
countries and currently has showrooms in Paris, Munich, Cologne, Stockholm,
Amsterdam, and London and other locations in the United Kingdom, and sales and
support facilities in Germany and the United Kingdom. In the last half of 1995,
Gateway entered the Asia Pacific region with sales and support facilities in
Japan, showrooms in Japan and Australia, a manufacturing facility in Malacca,
Malaysia and the acquisition of the business and substantially all of the assets
of Osborne Computer Corporation, an Australian PC maker. Since then, Gateway
has continued to expand in the region, opening a new call center in Kuala
Lumpur, Malaysia to handle direct sales and customer support activities for
Malaysia, Singapore and Hong Kong; administrative offices in Singapore and Hong
Kong; and several showrooms and stores in Japan, Malaysia, Australia, and New
Zealand.
EMPLOYEES
As of December 31, 1998, Gateway had approximately 19,300 full-time
employees, of which 16,000 were in the U.S., 1,900 were in Europe and 1,400 were
in other foreign countries. Gateway believes employee relations are generally
good.
BACKLOG
As of December 31, 1998, Gateway's backlog of unfilled orders was
approximately $100 million, compared with backlog of approximately $135 million
at the end of fiscal 1997. The Company does not believe that backlog is a
meaningful indicator of sales that can be expected for any period, and there can
be no assurance that the backlog at any point in time will translate into sales
in any subsequent period, particularly in light of the Company's policy of
allowing customers to cancel or reschedule orders under certain circumstances.
SEASONALITY
Gateway's operating results have been subject to seasonality and to
quarterly and annual fluctuations in operating results. Factors involved
include new product developments or introductions, availability of components,
changes in product mix and pricing and product reviews and other media coverage.
Historically, Gateway's sales have increased in the third and fourth quarters
due, in part, to back-to-school and holiday spending.
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FACTORS THAT MAY AFFECT GATEWAY'S BUSINESS AND FUTURE RESULTS
The statements contained in this report contain a number of forward-looking
statements based on current management expectations. In addition to other
information contained in this report, the following factors could affect the
Company's future consolidated position, results of operations or cash flows, and
could cause future results to differ materially from those expressed in any of
the forward-looking statements in this report.
Competitive Market Conditions. The Company encounters aggressive competition in
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its industry with numerous competitors vying for market share. Competition is
driven in large part by price and availability of new technology and products.
The Company believes it can counter these competitive forces by continuing to
react quickly to expected and perceived customer product requirements and
desires, and by maintaining relationships with its suppliers to bring products
quickly to market. There can, however, be no assurance that it will be able
successfully to continue to do so in an ever changing marketplace. In addition,
the Company expects the industry trend of declining average unit prices for PCs
to continue to decline. Gateway intends to mitigate the impact of falling prices
by diversifying its revenue stream with software bundles, internet services,
financing and other service offerings. If prices are not offset by reduced costs
or increased sales of higher margin products, Gateway's profits could be
adversely impacted.
Infrastructure Requirements. The Company's rapid growth creates ongoing demands
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for personnel, facilities, information systems and other infrastructure
requirements. If the Company is not successful in continuing to develop its
infrastructure, it could experience disruptions in operations, which could have
an adverse financial impact.
Suppliers. Gateway requires a high volume of quality components for the
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manufacture of its products, substantially all of which it obtains from outside
suppliers. While Gateway attempts to have multiple suppliers for such
components, in some circumstances it maintains single-source supplier
relationships. Failures of suppliers to meet component delivery schedules have
occasionally disrupted normal production schedules at Gateway and Gateway may
continue to experience production disruptions.
Product Cycles. Short product life cycles resulting from rapid changes in
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technology and consumer preferences and declining product prices characterize
the PC industry. Gateway's internal engineering personnel work closely with PC
component suppliers and other technology developers to evaluate the latest
developments in PC-related technology. However, Gateway may not have access to
or the right to use new technology or may be unable to incorporate such new
technology in its products or features in a timely manner.
Access to Technology. There can be no assurance that Gateway will continue to
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have access to existing or new third-party technology for use in its products.
If Gateway or its suppliers were unable to obtain licenses necessary to use
protected technology in Gateway's products on commercially reasonable terms,
Gateway may be forced to market products without certain desirable technological
features. Gateway could also incur substantial costs to redesign its products
around other parties' protected technology or to defend patent or copyright
infringement actions against Gateway.
International Operations. Gateway has expanded its operations into both Europe
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and the Asia-Pacific region and believes that further growth is necessary for
Gateway's success. International expansion involves additional business risks
such as foreign currency fluctuation, government regulation, liability for
foreign taxes and product sales, competition with locally strong competitors,
and delivery and support logistics. There can be no assurance that Gateway will
effectively manage these additional risks.
Financial Instruments. In an effort to minimize the impact of currency
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fluctuations, Gateway engages in hedging programs involving forward exchange
contracts. Factors that could impact the effectiveness of hedging programs,
include volatility of currency markets, reliability of sales forecasts, and
availability of hedging instruments.
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Credit Risk. Gateway has committed to acquire a 100% participation interest in
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a portion of existing Gateway customer loan accounts. Gateway intends to bear
the credit risk of a significant portion of its future customer credit card or
loan accounts as part of its sales and marketing efforts until the obligations
are repaid or sold. Gateway anticipates that customers will be delinquent in
payments on a number of these accounts and that some will ultimately default on
their accounts. There can be no guarantee that the delinquency and default rates
will be maintained at the anticipated rate and not increase, particularly if
general economic conditions worsen.
E-Commerce. Gateway intends to expand its e-commerce business through
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investment in existing companies and the creation of an e-commerce site that
will offer Gateway(TM) branded products as well as complementary products from
other manufacturers. E-commerce is a relatively new and emerging distribution
channel whose success is dependent on a variety of factors, including its
continued acceptance by consumers. Gateway's success using e-commerce depends on
such factors as the satisfactory performance, reliability and availability of
Gateway's Web site; the reliability and efficiency of its computer and
communications hardware systems; its ability to compete with a growing number of
rival e-commerce sites; its ability to evolve, update and improve its services
and offerings in response to changing demands; and the consumer demand for its
products. Expansion into this emerging growth business may require investment in
start-up activities and initial operating losses in this portion of Gateway's
business.
Risks of Acquisition. Gateway has acquired certain businesses that it believes
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are complementary to its operations and anticipates making possible acquisitions
in the future. While Gateway believes it will effectively integrate such
businesses with its own, Gateway may be unable to successfully do so without
losing key employees or business relationships. In addition, Gateway may be
unable to smoothly integrate the acquired companies' marketing, production,
development, distribution and management systems resulting in our inability to
realize hoped for cost savings and/or sales growth. Gateway's gross margins
could be adversely affected by any problems arising during or from such process
or the inability to effectively integrate any future acquisitions.
Inventory Risks. By distributing directly to its customers, Gateway has been
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able to avoid the need to maintain high levels of inventory. This has minimized
costs and allows Gateway to respond more quickly to changing customer demands,
reducing its exposure to the risk of product obsolescence. A decrease in market
demand or an increase in supply, among other factors, could result in higher
inventory levels which could have a negative effect on Gateway's profitability.
Customer or Geographic Sales Mix. Gateway's profits differ slightly depending on
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the product sold, the customer segment and the geographic market involved. As a
result, Gateway's profitability in any fiscal period will depend, in part, on
the corresponding mix of customers, products and geographic markets.
Key Managers. Certain key management employees, particularly Theodore W. Waitt,
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Chairman and Chief Executive and a founder of Gateway, have been instrumental in
Gateway's success. Gateway has not entered into an employment agreement with
Mr. Waitt. The loss of Mr. Waitt's services could materially and adversely
affect the Company's operations.
Year 2000 Transition. Gateway's Year 2000 Program is discussed in "Management's
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Discussion and Analysis of Financial Condition and Results of Operations Year
2000" at page 16 of this Report. The Year 2000 transition and remediation could
have a material adverse effect on Gateway's business, results of operation and
financial condition.
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ITEM 2. PROPERTIES
Gateway owns space in North Sioux City, South Dakota housing a production
facility, customer sales and support center, training center, administration and
warehouse space. The Company also leases facilities in North Sioux City used
for manufacturing and warehouse space as well as leased space in Vermillion,
South Dakota used for customer service and warehouse space.
Gateway's Sioux Falls, South Dakota facilities serve as a base for the sale
and fulfillment of orders for add-on PC components, the receipt of returned
merchandise and the fulfillment of orders for customer replacement parts. The
Company also leases space in Sioux Falls for remanufacturing operations.
Gateway owns a facility in Kansas City, Missouri housing a customer sales
and support center and owns or leases facilities in Rio Rancho, New Mexico and
Colorado Springs, Colorado for customer support centers. The Company also
leases space in Lakewood, Colorado for an Information Technology and Support
Center, in Irvine, California for its Business operations, and office space in
San Diego, California for its administrative headquarters.
Gateway owns facilities in Hampton, Virginia and Salt Lake City, Utah and
leases space in Irvine, California housing manufacturing, customer support,
sales, warehouse space, and office space at each location respectively. Gateway
also leases Gateway Country(SM) store space in 154 locations throughout the
United States.
Gateway's European operations are based in Dublin, Ireland, where Gateway
owns a facility housing the European headquarters, production facility, customer
sales and support center and warehouse space. The Company also leases office and
showroom space in numerous European locations.
In Malacca, Malaysia, Gateway owns a manufacturing facility designed to
serve Gateway's markets in the Asia Pacific region. Gateway also leases a
showroom and call center space in Kuala Lumpur. In Australia, the company leases
a sales and distribution facility in Sydney as well as showroom space in
numerous Australian locations. In Japan, the company leases facilities in
Yokohama and Tokyo used for a customer sales and support centers and warehouse
space and leases showroom space in Tokyo and Osaka. In Singapore and Hong Kong
the Company leases sales and distribution facilities and in New Zealand the
Company leases facilities for manufacturing, sales, customer support,
administration, showrooms and warehouse space.
ITEM 3. LEGAL PROCEEDINGS
Gateway is a party to various lawsuits and administrative proceedings
arising in the ordinary course of its business. Gateway 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. Gateway's management
believes that the ultimate resolution of such pending matters will not
materially and adversely affect Gateway's business, consolidated financial
position, results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not applicable.
10
<PAGE>
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
MARKET INFORMATION
Gateway common stock has been quoted on the New York Stock Exchange under
the trading symbol "GTW" since May 22, 1997. Before May 22, 1997, Gateway's
common stock was quoted on the NASDAQ National Market under the trading symbol
"GATE". The following table sets forth the quarterly high and low price per
share information for the Common Stock as quoted at the close of trading on such
date in 1996 and 1997 and as adjusted for a two-for-one stock split on June 16,
1997:
<TABLE>
<CAPTION>
High Low
----- ------
<S> <C> <C>
1997:
1st quarter $32.63 $23.81
2nd quarter $37.38 $26.19
3rd quarter $44.75 $31.50
4th quarter $36.13 $25.13
1998:
1st quarter $48.25 $32.50
2nd quarter $58.81 $42.56
3rd quarter $67.13 $46.44
4th quarter $61.63 $41.50
</TABLE>
HOLDERS OF RECORD
As of March 25, 1999, there were 4,226 holders of record of the Common
Stock. There were no issued and outstanding shares of the Class A Common Stock
as of such date.
DIVIDENDS
Gateway management believes the best use of retained earnings is to fund
internal growth and for general corporate purposes. As a result, Gateway has not
declared any cash dividends on Common Stock since it was first publicly
registered and does not anticipate paying any cash dividends in the foreseeable
future.
11
<PAGE>
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following historical data were derived from the Company's consolidated
financial statements, which have been audited by PricewaterhouseCoopers LLP,
independent accountants. This financial data should be read in conjunction with
the consolidated financial statements and notes thereto beginning on page 19 of
this Report and in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" beginning on page 13 of this
Report. The information below is not necessarily indicative of the results of
future operations.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(in thousands, except per share data)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED STATEMENTS OF OPERATIONS DATA:
Net sales $ 2,701,200 $ 3,676,328 $ 5,035,228 $ 6,293,680 $ 7,467,925
Cost of goods sold 2,343,698 3,070,234 4,099,073 5,217,239 5,921,651
------------------- ------------------- ------------------- ---------------- ---------------
Gross profit 357,502 606,094 936,155 1,076,441 1,546,274
Selling, general and
administrative expenses 216,505 357,086 580,061 786,168 1,052,047
Nonrecurring expenses - - - 113,842 -
------------------- ------------------- ------------------- ---------------- ---------------
Operating income 140,997 249,008 356,094 176,431 494,227
Other income, net 5,106 13,085 26,622 27,189 47,021
------------------- ------------------- ------------------- ---------------- ---------------
Income before income
taxes 146,103 262,093 382,716 203,620 541,248
Provision for income taxes 50,130 89,112 132,037 93,823 194,849
------------------- ------------------- ------------------- ---------------- ---------------
Net income $ 95,973 $ 172,981 $ 250,679 $ 109,797 $ 346,399
=================== =================== =================== ================ ===============
Net income per share:
Basic $ .66 $ 1.19 $ 1.64 $ $.71 $ 2.23
=================== =================== =================== ================ ===============
Diluted $ .61 $ 1.09 $ 1.60 $ $.70 $ 2.18
=================== =================== =================== ================ ===============
Weighted average shares
outstanding:
Basic 144,768 145,256 152,745 153,840 155,542
=================== =================== =================== ================ ===============
Diluted 157,313 157,988 156,237 156,201 158,929
=================== =================== =================== ================ ===============
</TABLE>
<TABLE>
<CAPTION>
DECEMBER 31,
-----------
1994 1995 1996 1997 1998
---- ---- ---- ---- ----
(in thousands)
<S> <C> <C> <C> <C> <C>
CONSOLIDATED BALANCE SHEET DATA:
Current assets $654,160 $ 866,189 $1,318,342 $1,544,683 $2,228,186
Total assets $770,579 $1,124,011 $1,673,411 $2,039,271 $2,890,380
Current liabilities $348,875 $ 525,291 $ 799,769 $1,003,906 $1,429,674
Long-term obligations, net of
current maturities $ 27,131 $ 10,805 $ 7,244 $ 7,240 $ 3,360
Stockholders' equity $376,035 $ 555,519 $ 815,541 $ 930,044 $1,344,375
</TABLE>
12
<PAGE>
Item 7. 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. Factors that could cause future results to differ from
the Company's expectations include the following: competitive market conditions;
infrastructure requirements; financial instruments; suppliers; short product
cycles; access to technology; international operations; credit risk; e-commerce
issues; risks of acquisition; inventory risks; customer or geographic sales mix;
loss of key managers; and the Year 2000 transition. For a discussion of these
factors, see "Item 1 Business - Factors that May Affect Gateway's Business and
Future Results" in the Company's Annual Report on Form 10-K.
RESULTS OF OPERATIONS
- ---------------------
The following table sets forth, for the periods indicated, certain data
derived from the Company's consolidated income statements:
<TABLE>
<CAPTION>
INCREASE
1996 (DECREASE) 1997 INCREASE 1998
------------------ -------------- ------------------ -------------- ------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Net sales $5,035,228 25% $6,293,680 19% $7,467,925
Gross profit $ 936,155 15% $1,076,441 44% $1,546,274
Percentage of net sales 18.6% 17.1% 20.7%
Selling, general and
administrative expenses $ 580,061 36% $ 786,168 34% $1,052,047
Percentage of net sales 11.5% 12.5% 14.1%
Nonrecurring expenses -- $ 113,842 --
Percentage of net sales -- 1.8% --
Operating income $ 356,094 (50%) $ 176,431 180% $ 494,227
Percentage of net sales 7.1% 2.8% 6.6%
Net income $ 250,679 (56%) $ 109,797 215% $ 346,399
</TABLE>
SALES
- -----
Gateway added over $1.1 billion in sales in 1998 compared to 1997,
achieving annual sales of $7.47 billion. This represents an increase of 19% over
1997. Sales to the consumer segment represented 53% of total sales while
business segment sales were 47% of total sales. Sales were driven by continued
strong unit growth of 37% in 1998 compared to unit growth of 35% in 1997. The
Company's unit growth outpaced the worldwide market in 1998 by approximately
three times the market growth rate, leading to continued gains in market share.
Based on shipments in the fourth quarter, Gateway improved its ranking to number
3 in the U.S. PC market and was number 6 worldwide. These market share gains
were driven by several top line initiatives including the development and
execution of a new advertising strategy; the Your:)Ware(SM) marketing program;
and significant expansion of Gateway Country Stores. The new marketing strategy
focuses on reaching an expanded customer base through a new branding campaign
and the use of broader advertising media such as television and newspapers. The
Your:)WareSM program offers customers internet access, financing options,
software bundles, and provides for trade-in options. As a result of these
initiatives, Gateway was able to reach a broader cross section of customers in
1998. Partially offsetting strong unit growth, the Company's average unit prices
(AUPs) were approximately 14% lower in 1998 compared to an 8% decline in 1997.
AUPs continued to decline in 1998 due to component cost decreases and
significant growth in the sub $1,000 PC market. The Company expects the industry
trend of declining AUPs to continue and intends to mitigate this by diversifying
its revenue stream with software bundles, internet service, financing and other
service offerings.
13
<PAGE>
The following table summarizes the Company's net sales, for the periods
indicated, by geographic region:
<TABLE>
<CAPTION>
INCREASE
1996 INCREASE 1997 (DECREASE) 1998
-------------------- -------------- ------------------ ----------------- ---------------------
(dollars in thousands)
<S> <C> <C> <C> <C> <C>
Net sales:
United States $4,246,047 25% $5,303,828 21% $6,412,405
Europe 552,671 15% 634,616 (10%) 570,191
Asia Pacific 236,510 50% 355,236 37% 485,329
-------------------- ------------------ ---------------------
Consolidated $5,035,228 25% $6,293,680 19% $7,467,925
==================== ================== =====================
</TABLE>
In the United States unit shipments rose 39% in 1998 and 35% in 1997 due
to the factors discussed above. The Asia Pacific region ("APAC") continued to
achieve significant increases in unit shipments with growth of 63% in 1998 and
84% in 1997. Unit shipments in the European region ("EMEA") increased 5% in 1998
down from 20% in 1997. The Company has put new management in place in EMEA and
is focusing on the top line initiatives previously discussed to address the
declining unit growth.
GROSS PROFIT
- -------------
Gross profit in 1998 rose to $1.55 billion, an increase of approximately
44% from 1997. Gross profit for the consumer and business segments for 1998 was
$760.8 million and $783.3 million, respectively. Approximately 40% of the gross
profit increase was the result of sales growth, while approximately 60% resulted
from margin productivity. Margin productivity was driven by the diversified
revenue stream with Your:)WareSM bundles, effective pricing initiatives,
aggressive supplier management and decreasing component costs. As a percentage
of sales, gross profit for 1998 increased to 20.7% from 17.1% in 1997, improving
sequentially every quarter during 1998. For additional quarterly financial
information, see Note 13 of the notes to the consolidated financial statements.
The increase over 1997 is partially attributable to the adverse effects of
excess inventories experienced in the third quarter of 1997.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
- ---------------------------------------------
To support its significant growth during 1998, the Company made
investments in infrastructure, personnel, marketing and internet development
which contributed to an increase of 34% in selling, general and administrative
expenses over 1997. Gateway opened a new manufacturing and sales facility in
Salt Lake City, an administrative headquarters in San Diego and a new
Information Technology and Support facility in Lakewood, Colorado. In addition,
the Company made a significant investment in new employees, including the
expansion of its executive management team. As a result, personnel costs
increased 35% in 1998 compared to 1997. The Company expects selling, general and
administrative expenses to continue to increase in support of its anticipated
growth, but at a rate below that of anticipated revenue growth.
OPERATING INCOME
- ----------------
Strong unit growth and gross margin efficiencies contributed to a 180%
increase in operating income for 1998. In addition, the increase is attributable
to the nonrecurring pre-tax charges recorded in the third quarter of 1997.
Operating income improved to 6.6% in 1998 from 2.8% in 1997. Operating income in
1998 for the consumer and business segments were $461.4 million and $600.8
million, respectively, while operating expenses in 1998 not allocated to a
segment were $568.0 million. Operating income for the consumer and business
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.
14
<PAGE>
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 $47.0 million in 1998 from $27.2 million in 1997,
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 decreased to 36% for 1998 from
the 46.1% recorded in 1997. The effective tax rate for 1997 was impacted
unfavorably by the nonrecurring expenses relating to the write-off of in-process
research and development arising in connection with the acquisitions of ALR and
certain assets of Amiga Technologies which were nondeductible for income taxes.
LIQUIDITY AND CAPITAL RESOURCES
- -------------------------------
The following table presents selected financial statistics and information
for the periods indicated:
<TABLE>
<CAPTION>
1996 1997 1998
----------------------- ----------------------- -------------------------
(dollars in thousands)
<S> <C> <C> <C>
Cash and marketable securities $ 516,360 $ 632,249 $ 1,328,467
Days of sales in accounts receivable 26 23 22
Inventory turnover 21 21 40
Days in accounts payable 29 27 36
</TABLE>
At December 31, 1998, the Company had cash and cash equivalents of $1.17
billion, marketable securities of $158.7 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
December 31, 1998, no amounts were outstanding under the revolving line of
credit. Approximately $2.0 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 $907.7 million in cash from operations during the
year, including $398.3 million of net income adjusted for non-cash items. Other
significant factors increasing available cash include a decrease in inventory
levels of $81.3 million and an increase in accounts payable and other accrued
liabilities of $479.8 million, partially offset by an increase in accounts
receivable. The decrease in inventory levels, decrease in days sales in accounts
receivable and increase in days purchases in accounts payable is attributable to
the Company's increased focus on working capital management. The Company used
approximately $235.4 million for the construction of new facilities, information
systems and equipment and $120.0 million to purchase investments in marketable
securities, net of proceeds of securities sold. As discussed previously, the
Company continued to expand the retail Gateway Country stores with 107 new
stores added in 1998, bringing the total number of stores to 144 as of December
31, 1998.
At December 31, 1998, the Company had long-term indebtedness and capital
lease obligations of approximately $14.8 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.
As of February 28, 1999, the Company has made a commitment to purchase
$290 million of consumer finance receivables used to purchase the Company's
products which were originated by a financial institution on behalf of Gateway.
NEW ACCOUNTING PRONOUNCEMENTS
- -----------------------------
15
<PAGE>
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, 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 consolidated
financial position or results of operations.
In 1998, the Accounting Standards Executive Committee (AcSEC) issued
Statement of Accounting Position ("SOP") No. 98-1, "Accounting Executive 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 to be capitalized, and on the accounting for such software that is marketed
to customers. The adoption of this SOP is not expected to have a material impact
on the Company's consolidated financial position or results of operations.
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 fourth quarter, the Company believes the Awareness and
Inventory phases are complete for both IT systems and building systems and 50%
complete for business processes. For IT systems, the Company believes the
assessment, planning and remediation/replacement phases are over 65% complete
with testing and compliance validation complete for 20% of the inventory. For
business processes and building systems, the Company believes the assessment and
planning phases are over 40% complete with a substantial amount of work in
process. The progress level for remediation/replacement and testing and
compliance validation is currently at 20%. 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.
16
<PAGE>
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 1998, the Company expensed incremental costs of
approximately $3.3 million related to the Year 2000 remediation efforts, and has
expensed $3.6 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(R) family of Pentium processors
(Pentium(R), Pentium(R) Pro, Pentium II(R), Pentium(R)II Xeon(TM) and
Celeron(TM) 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.
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
- --------------------------------------------------------------------
The results of the Company's foreign operations are affected by changes in
exchange rates between certain foreign currencies and the United States dollar.
The functional currency for most of the Company's foreign operations is the U.S.
dollar. The functional currency for the remaining operations is the local
currency in which the subsidiaries operate. Sales made in foreign currencies
translate into higher or lower sales in U.S. dollars as the U.S. dollar
strengthens or weakens against other currencies. Therefore, changes in exchange
rates may negatively affect the Company's consolidated net sales (as expressed
in U.S. dollars) and gross margins from foreign operations. The majority of the
Company's component purchases are denominated in U.S. dollars.
17
<PAGE>
The Company uses foreign currency forward contracts to hedge foreign
currency transactions and probable anticipated foreign currency transactions.
These forward contracts are designated as a hedge of international sales by U.S.
dollar functional currency entities and intercompany purchases by certain
foreign subsidiaries. The principal currencies hedged are the British Pound,
Japanese Yen, French Franc, Australian Dollar, Singapore Dollar, and the
Deutsche Mark over periods ranging from one to six months. Forward contracts
are accounted for on a mark-to-market basis, with realized and unrealized gains
or losses recognized currently. Gains or losses arising from forward contracts
that are effective as a hedge are included in the basis of the designated
transactions. Fluctuations in U.S. dollar currency exchange rates did not have
a significant impact on the Company's consolidated financial position, results
of operations or cash flows in any given reporting period. Forward contracts
designated to hedge foreign currency transaction exposure of $257,051,000 and
$266,471,000 were outstanding at December 31, 1997 and 1998, respectively. The
estimated fair value of these forward contracts at December 31, 1997 and 1998
was $253,519,000 and $271,573,000, respectively, based on quoted market prices.
Foreign currency exchange contracts are sensitive to changes in foreign
currency exchange rates. At December 31, 1998, a hypothetical 10% adverse
change in foreign currency exchange rates underlying the Company's open forward
contracts would result in an unrealized loss of approximately $29.1 million.
Unrealized gains/losses in foreign currency exchange contracts represent the
difference between the hypothetical rates and the current market exchange rates.
Consistent with the nature of an economic hedge any unrealized gains or losses
would be offset by corresponding decreases or increases, respectively, of the
underlying transaction being hedged.
The Company is not subject to material market risk with respect to its
investment in marketable securities.
18
<PAGE>
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE
FINANCIAL STATEMENTS:
Report of Independent
Accountants............................................................ 20
Consolidated Income Statements for the years
ended December 31, 1996, 1997 and 1998............................ 21
Consolidated Balance Sheets at December 31, 1997 and 1998.............. 22
Consolidated Statements of Cash Flows for the years
ended December 31, 1996, 1997 and 1998............................ 23
Consolidated Statements of Changes in Stockholders' Equity
and Comprehensive Income for the years ended December 31,
1996, 1997 and 1998............................................... 24
Notes to Consolidated Financial
Statements............................................................. 25
FINANCIAL STATEMENT SCHEDULE:
Schedule VIII -Valuation and Qualifying Accounts........................ 39
19
<PAGE>
REPORT OF INDEPENDENT ACCOUNTANTS
To the Stockholders and Board of Directors of Gateway 2000, Inc.
In our opinion, the consolidated financial statements listed in the accompanying
index in Item 8. Financial Statements and Supplementary Data, herein present
fairly, in all material respects, the consolidated financial position of Gateway
2000, Inc. at December 31, 1997 and 1998, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
In addition, in our opinion, the financial statement schedule listed in the
accompanying index presents fairly, in all material respects, the information
set forth therein when read in conjunction with the related consolidated
financial statements. These financial statements and the financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule based on our audits. We conducted our audits of these statements in
accordance with generally accepted auditing standards which require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for the opinion expressed
above.
/s/ PricewaterhouseCoopers, LLP
PricewaterhouseCoopers LLP
San Diego, California
January 21, 1999
20
<PAGE>
GATEWAY 2000, INC.
CONSOLIDATED INCOME STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
1996 1997 1998
--------------------- ---------------------- --------------------
<S> <C> <C> <C>
Net sales $ 5,035,228 $ 6,293,680 $ 7,467,925
Cost of goods sold 4,099,073 5,217,239 5,921,651
--------------------- ---------------------- --------------------
Gross profit 936,155 1,076,441 1,546,274
Selling, general and
administrative expenses 580,061 786,168 1,052,047
Nonrecurring expenses - 113,842 -
--------------------- ---------------------- --------------------
Operating income 356,094 176,431 494,227
Other income, net 26,622 27,189 47,021
--------------------- ---------------------- --------------------
Income before income taxes 382,716 203,620 541,248
Provision for income taxes 132,037 93,823 194,849
--------------------- ---------------------- --------------------
Net income $ 250,679 $ 109,797 $ 346,399
===================== ====================== ====================
Net income per share:
Basic $ 1.64 $ .71 $ 2.23
===================== ====================== ====================
Diluted $ 1.60 $ .70 $ 2.18
===================== ====================== ====================
Weighted average shares outstanding:
Basic 152,745 153,840 155,542
===================== ====================== ====================
Diluted 156,237 156,201 158,929
===================== ====================== ====================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
21
<PAGE>
GATEWAY 2000, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1997 AND 1998
(in thousands, except per share amounts)
<TABLE>
<CAPTION>
1997 1998
-------------------------------------------
<S> <C> <C>
ASSETS
Current assets:
Cash and cash equivalents $ 593,601 $1,169,810
Marketable securities 38,648 158,657
Accounts receivable, net 510,679 558,851
Inventory 249,224 167,924
Other 152,531 172,944
-------------------------------------------
Total current assets 1,544,683 2,228,186
Property, plant and equipment, net 376,467 530,988
Intangibles, net 82,590 65,944
Other assets 35,531 65,262
-------------------------------------------
$2,039,271 $2,890,380
===========================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Current liabilities:
Notes payable and current maturities of long-term
obligations $ 13,969 $ 11,415
Accounts payable 488,717 718,071
Accrued liabilities 271,250 415,265
Accrued royalties 159,418 167,873
Other current liabilities 70,552 117,050
-------------------------------------------
Total current liabilities 1,003,906 1,429,674
Long-term obligations, net of current maturities 7,240 3,360
Warranty and other liabilities 98,081 112,971
-------------------------------------------
Total liabilities 1,109,227 1,546,005
-------------------------------------------
Commitments and Contingencies (Notes 3 and 4)
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 156,569 shares
issued and outstanding, respectively 1,541 1,566
Additional paid-in capital 299,483 365,986
Retained earnings 634,509 980,908
Accumulated other comprehensive loss (5,489) (4,085)
-------------------------------------------
Total stockholders' equity 930,044 1,344,375
-------------------------------------------
$2,039,271 $2,890,380
===========================================
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
22
<PAGE>
GATEWAY 2000, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(in thousands)
<TABLE>
<CAPTION>
1996 1997 1998
----------------- ------------------ -----------------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 250,679 $ 109,797 $ 346,399
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization 61,763 86,774 105,524
Provision for uncollectible accounts receivable 20,832 5,688 3,991
Deferred income taxes (13,395) (63,247) (58,425)
Other, net 1,986 42 770
Nonrecurring expenses -- 113,842 --
Changes in operating assets and liabilities:
Accounts receivable (66,052) (41,950) (52,164)
Inventory (54,261) 59,486 81,300
Other assets (13,311) (54,513) 451
Accounts payable 176,724 66,253 228,921
Accrued liabilities 51,390 48,405 144,899
Accrued royalties 1,885 34,148 8,455
Other current liabilities 43,057 35,816 76,278
Warranty and other liabilities 22,699 42,256 21,252
------------ ------------- -------------
Net cash provided by operating activities 483,996 442,797 907,651
------------ ------------- -------------
Cash flows from investing activities:
Capital expenditures (143,746) (175,656) (235,377)
Purchases of available-for-sale securities -- (49,619) (168,965)
Proceeds from maturities or sales of available-for- 48,924
sale securities 3,030 10,985
Acquisitions, net of cash acquired -- (142,320) --
Other, net 2,667 (4,055) (992)
------------ ------------- -------------
Net cash used in investing activities (138,049) (360,665) (356,410)
------------ ------------- -------------
Cash flows from financing activities:
Proceeds from issuances of notes payable 10,000 10,000 --
Principal payments on long-term obligations and
notes payable (14,047) (15,588) (13,173)
Stock options exercised 9,520 5,741 36,159
------------ ------------- -------------
Net cash provided by financing activities 5,473 153 22,986
------------ ------------- -------------
Foreign exchange effect on cash and cash
equivalents (1,457) (5,044) 1,982
------------ ------------- -------------
Net increase in cash and cash equivalents 349,963 77,241 576,209
Cash and cash equivalents, beginning of year 166,397 516,360 593,601
------------ ------------- -------------
Cash and cash equivalents, end of year $ 516,360 $ 593,601 $ 1,169,810
============ ============= =============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
23
<PAGE>
GATEWAY 2000, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY AND COMPREHENSIVE
INCOME
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(in thousands)
<TABLE>
<CAPTION>
Accumulated
Additional Other
Common Stock Paid-in Retained Comprehensive
Shares Amount Capital Earnings Income (Loss)
-------------- ------------ -------------- --------------- ------------------
<S> <C> <C> <C> <C> <C>
Balances at December 31, 1995 149,106 $ 1,492 $ 279,701 $ 274,033 $ 293
Comprehensive income:
Net income -- -- -- 250,679 --
Other comprehensive income:
Foreign currency translation -- -- -- -- 225
Unrealized gain on available
for-sale securities -- -- -- -- 31
Comprehensive income
Stock issuances under employee
plans, including tax benefit of
$30,451 6,545 66 39,905 -- --
Stock retirement (2,139) (22) (30,862) -- --
-------------- ------------ -------------- --------------- ------------------
Balances at December 31, 1996 153,512 1,536 288,744 524,712 549
Comprehensive income:
Net income -- -- -- 109,797 --
Other comprehensive income:
Foreign currency translation -- -- -- -- (6,053)
Unrealized gain on available-
for-sale securities -- -- -- -- 15
Comprehensive income
Stock issuances under employee
plans, including tax benefit of
$5,003 616 5 10,739 -- --
-------------- ------------ -------------- --------------- ------------------
Balances at December 31, 1997 154,128 1,541 299,483 634,509 (5,489)
Comprehensive income:
Net income -- -- -- 346,399 --
Other comprehensive income:
Foreign currency translation -- -- -- -- 1,549
Unrealized loss on available-
for-sale securities -- -- -- -- (145)
Comprehensive income
Stock issuances under employee
plans, including tax benefit of
$29,769 2,423 24 65,904 -- --
Stock issued to officer 18 1 599 -- --
-------------- ------------ -------------- --------------- ------------------
Balances at December 31, 1998 156,569 $ 1,566 $ 365,986 $ 980,908 $ (4,085)
============== ============ ============== =============== ==================
<CAPTION>
Total
---------------
<S> <C>
Balances at December 31, 1995 $ 555,519
Comprehensive income:
Net income 250,679
Other comprehensive income:
Foreign currency translation 225
Unrealized gain on available
for-sale securities 31
---------------
Comprehensive income 250,935
Stock issuances under employee
plans, including tax benefit of $30,541 39,971
Stock retirement (30,884)
---------------
Balances at December 31, 1996 815,541
Comprehensive income:
Net income 109,797
Other comprehensive income:
Foreign currency translation (6,053)
Unrealized gain on available
for-sale securities 15
---------------
Comprehensive income 103,759
Stock issuances under employee
plans, including tax benefit of $5,003 10,744
---------------
Balances at December 31, 1997 930,044
Comprehensive income:
Net income 346,399
Other comprehensive income:
Foreign currency translation 1,549
Unrealized loss on available
for-sale securities (145)
---------------
Comprehensive income 347,803
Stock issuances under employee
plans, including tax benefit of $29,769 65,928
Stock issued to officer 600
---------------
Balances at December 31, 1998 $ 1,344,375
===============
</TABLE>
The accompanying notes are an integral part of the consolidated financial
statements.
24
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Gateway 2000, Inc. (the "Company") is a direct marketer of personal
computers ("PCs") and PC-related products. The Company develops, manufactures,
markets and supports a broad line of desktop and portable PCs, digital media
(convergence) PCs, servers, workstations and PC-related products used by
individuals, families, businesses, government agencies and educational
institutions.
The significant accounting policies used in the preparation of the
consolidated financial statements of the Company are as follows:
(a) Principles of Consolidation:
The consolidated financial statements include the accounts of the Company
and its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated.
(b) Use of Estimates and Certain Concentrations:
The preparation of 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 and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Certain components used by the Company in manufacturing of PC systems are
purchased from a limited number of suppliers. An industry shortage or other
constraints of any key component could result in delayed shipments and a
possible loss of sales, which could affect operating results adversely.
(c) Cash and Cash Equivalents:
The Company considers all highly liquid debt instruments and money market
funds with an original maturity of three months or less to be cash equivalents.
The carrying amount approximates fair value because of the short maturities of
these instruments.
(d) Marketable Securities:
The carrying amounts of marketable securities used in computing unrealized
and realized gains and losses are determined by specific identification. Fair
values are determined using quoted market prices. For available-for-sale
securities, which are carried at fair value at the balance sheet dates, net
unrealized holding gains and losses are reported in accumulated other
comprehensive income (loss). Held-to-maturity securities are recorded at
amortized cost. Amortization of related discounts or premiums is included in
the determination of net income.
Marketable securities at December 31, 1998 consisted of available-for-sale
mutual funds, commercial paper and debt securities, with a market value of
$158,657,000 and an amortized cost of $158,788,000, with variable maturities
through 1999. Realized and unrealized gains and losses are not material for any
of the periods presented.
25
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(e) Inventory:
Inventory, which is comprised of component parts, subassemblies and
finished goods, is valued at the lower of first-in, first-out (FIFO) cost or
market. On a quarterly basis, the Company compares on a part by part basis, the
amount of the inventory on hand and under commitment with its latest forecasted
requirements to determine whether write-downs for excess or obsolete inventory
are required.
(f) Property, Plant and Equipment:
Property, plant and equipment are stated at cost. Depreciation is provided
using straight-line and accelerated methods over the assets' estimated useful
lives, ranging from four to forty years. Amortization of leasehold improvements
is computed using the shorter of the lease term or the estimated useful life of
the underlying asset. Upon sale or retirement of property, plant and equipment,
the related costs and accumulated depreciation or amortization are removed from
the accounts and any gain or loss is included in the determination of net
income.
The Company capitalizes costs of purchased software and, once technological
feasibility has been established, costs incurred in developing software for
internal use. Amortization of software costs begins when the software is placed
in service and is computed on a straight-line basis over the estimated useful
life of the software, generally from three to five years.
(g) Intangible Assets:
Intangible assets principally consist of technology, a customer base and
distribution network, an assembled work force and trade name obtained through
acquisition. The cost of intangible assets is amortized on a straight-line
basis over the estimated periods benefited, ranging from three to ten years.
(h) Long-lived Assets:
The Company reviews for the impairment of long-lived assets whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. An impairment loss would be recognized when the sum of the
expected undiscounted future net cash flows expected to result from the use of
the asset and its eventual disposition is less than its carrying amount.
(i) Royalties:
The Company has royalty-bearing license agreements that allow the Company
to sell certain hardware and software which is protected by patent, copyright or
license. Royalty costs are accrued and included in cost of goods sold when
products are shipped or amortized over the period of benefit when the license
terms are not specifically related to the units shipped.
(j) Warranty and Other Post-sales Support Programs:
The Company provides currently for the estimated costs that may be incurred
under its warranty and other post-sales support programs.
26
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(k) 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.
(l) Revenue Recognition:
Sales are recorded when products are shipped. A provision for estimated
sales returns is recorded in the period in which related sales are recognized.
Revenue from separately priced extended warranty programs is deferred and
recognized over the extended warranty period on a straight-line basis.
(m) Income Taxes:
The provision for income taxes is computed using the liability method,
under which deferred tax assets and liabilities are recognized for the expected
future tax consequences of temporary differences between the financial reporting
and tax bases of assets and liabilities. Deferred tax assets are reduced by a
valuation allowance when it is more likely than not that some portion or all of
the deferred tax assets will not be realized.
(n) Net Income Per Share:
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 dilutive common stock
equivalents 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>
1996 1997 1998
----------------------- ------------------------- -----------------------
(in thousands)
<S> <C> <C> <C>
Net income for basic and diluted
earnings per share $ 250,679 $ 109,797 $ 346,399
======================= ========================= =======================
Weighted average shares for basic
earnings per share 152,745 153,840 155,542
Dilutive effect of stock options 3,492 2,361 3,387
----------------------- ------------------------- -----------------------
Weighted average shares for diluted
earnings per share 156,237 156,201 158,929
======================= ========================= =======================
</TABLE>
All references in the financial statements to number of common shares and
per share amounts have been retroactively restated to reflect a two-for-one
common stock split effective in June 1997.
27
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(o) Stock-based Compensation
The Company measures compensation expense for its employee stock-based
compensation using the intrinsic value method. Compensation charges related to
non-employee stock-based compensation are measured using fair value methods.
(p) Foreign Currency:
The Company uses the U.S. dollar as its functional currency for the
majority of its international operations. For subsidiaries where the local
currency is the functional currency, the assets and liabilities are translated
into U.S. dollars at exchange rates in effect at the balance sheet date. Income
and expense items are translated at the average exchange rates prevailing during
the period. Gains and losses from translation are included in accumulated other
comprehensive income (loss). Gains and losses resulting from remeasuring
monetary asset and liability accounts that are denominated in currencies other
than a subsidiary's functional currency are included in "Other income, net".
The Company uses foreign currency forward contracts to hedge foreign
currency transactions and probable anticipated foreign currency transactions.
These forward contracts are designated as a hedge of international sales by U.S.
dollar functional currency entities and intercompany purchases by certain
foreign subsidiaries. The principal currencies hedged are the British Pound,
Japanese Yen, French Franc, Australian Dollar, Singapore Dollar and the Deutsche
Mark over periods ranging from one to six months. Forward contracts are
accounted for on a mark-to-market basis, with realized and unrealized gains or
losses recognized currently. Gains or losses arising from forward contracts
which are effective as a hedge are included in the basis of the designated
transactions. The related receivable or liability with counterparties to the
forward contracts is recorded in the consolidated balance sheet. Cash flows
from settlements of forward contracts are included in operating activities in
the consolidated statements of cash flows. Aggregate transaction gains and
losses included in the determination of net income are not material for any
period presented. Forward contracts designated to hedge foreign currency
transaction exposure of $257,051,000 and $266,471,000 were outstanding at
December 31, 1997 and 1998, respectively. The estimated fair value of these
forward contracts at December 31, 1997 and 1998 was $253,519,000 and
$271,573,000, respectively, based on quoted market prices.
The Company continually monitors its positions with, and the credit quality
of, the major international financial institutions which are counterparties to
its foreign currency forward contracts, and does not anticipate nonperformance
by any of these counterparties.
(q) Segment Data:
During 1998, the Company adopted SFAS No. 131, "Disclosures about Segments
of an Enterprise and Related Information." SFAS No. 131 supercedes SFAS No. 14,
"Financial Reporting for Segments of a Business Enterprise", replacing the
"industry segment" approach with the "management" approach. The management
approach designates the internal reporting that is used by management for making
operating decisions and assessing performance as the source of the Company's
reportable segments. SFAS 131 also requires disclosures about products and
services, geographic areas and major customers. The adoption of SFAS 131 did
not affect the consolidated financial position or results of operations of the
Company but did affect its disclosure of segment information (Note 12).
28
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
(r) 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, 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 consolidated
financial position or results of operations.
In 1998, the Accounting Standards Executive Committee (AcSEC) 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 to be
capitalized, and on the accounting for such software that is marketed to
customers. The adoption of this SOP is not expected to have a material impact on
the Company's consolidated financial position or results of operations.
2. FINANCING ARRANGEMENTS:
(a) Credit Agreement:
The Company is party to an unsecured bank credit agreement (the
"Agreement"), totaling $225 million. The Agreement consists of (1) a revolving
line of credit facility for committed loans and bid loans; and (2) a sub-
facility for letters of credit. Borrowings under the agreement bear interest at
the banks' base rate or, at the Company's option, borrowing rates based on a
fixed spread over the London Interbank Offered Rate (LIBOR). The Agreement
requires the Company to maintain a minimum tangible net worth and maximum debt
leverage ratio, as well as minimum fixed charge coverage. There were no
borrowings outstanding at the end of 1997 and 1998.
At December 31, 1997 and 1998, approximately $3,515,000 and $2,000,000,
respectively, was committed to support outstanding standby letters of credit.
(b) Long-term Obligations:
The carrying amount of the Company's long-term obligations approximates
fair value, which is estimated based on current rates offered to the Company for
obligations of the same remaining maturities. Long-term obligations consist of
the following:
<TABLE>
<CAPTION>
DECEMBER 31,
1997 1998
--------- ---------
(in thousands)
<S> <C> <C>
Notes payable through 2001 with interest rates ranging from zero to 7.03% $ 20,568 $ 14,408
Obligations under capital leases, payable in monthly installments at fixed rates
ranging from 3.28% to 15.33% through 2002 (Note 3) 641 367
--------- ---------
21,209 14,775
Less current maturities 13,969 11,415
--------- ---------
$ 7,240 $ 3,360
========= =========
</TABLE>
29
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The long-term obligations, excluding obligations under capital leases, have
the following maturities as of December 31, 1998:
<TABLE>
<CAPTION>
(in thousands)
<S> <C>
1999 $11,085
2000 2,841
2001 482
2002 --
2003 --
------------
$14,408
============
</TABLE>
3. COMMITMENTS:
The Company leases certain operating facilities and equipment under
noncancelable operating leases expiring at various dates through 2013. Rent
expense was approximately $11,873,000, $16,105,000, and $25,713,000 for 1996,
1997 and 1998, respectively.
Future minimum lease payments under terms of these leases as of December
31, 1998 are as follows:
<TABLE>
<CAPTION>
CAPITAL LEASES OPERATING LEASES
-------------------- --------------------
(in thousands)
<S> <C> <C>
1999 $ 330 $ 39,400
2000 38 39,695
2001 12 38,794
2002 1 36,256
2003 -- 26,523
Thereafter -- 25,910
-------------------- -------------------
Total minimum lease payments $ 381 $ 206,578
===================
Less amount representing interest 14
--------------------
Present value of net minimum lease payments $ 367
====================
</TABLE>
The Company has entered into licensing and royalty agreements which allow
it to use certain hardware and software intellectual properties in its products.
Minimum royalty payments due under these agreements for the period 1999 through
2002 total approximately $350,000,000. Total royalty expense is expected to be
greater than this minimum amount for these periods.
4. 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.
30
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
5. INCOME TAXES:
The components of the provision for income taxes are as follows:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
1996 1997 1998
------------ ------------ ------------
(in thousands)
<S> <C> <C> <C>
Current:
United States $ 140,451 $ 154,049 $ 244,076
Foreign 4,981 3,021 9,198
Deferred:
United States (1,727) (49,564) (40,055)
Foreign (11,668) (13,683) (18,370)
--------- --------- ---------
$ 132,037 $ 93,823 $ 194,849
========= ========= =========
</TABLE>
Income before income taxes included approximately $2,400,000, ($24,000,000)
and ($13,100,000) related to foreign operations for the years ended December 31,
1996, 1997 and 1998, respectively.
A reconciliation of the provision for income taxes and the amount computed
by applying the federal statutory income tax rate to income before income taxes
is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
------------ ------------ ------------
(in thousands)
<S> <C> <C> <C>
Federal income tax at
statutory rate $ 133,951 $ 71,267 $ 189,437
Nondeductible purchased
research and development
costs -- 20,704 --
Other, net (1,914) 1,852 5,412
--------- --------- ---------
Provision for income taxes $ 132,037 $ 93,823 $ 194,849
========= ========= =========
</TABLE>
31
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Deferred tax assets and deferred tax liabilities result from temporary
differences in the following accounts:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
---------- ----------
(in thousands)
<S> <C> <C>
U.S. deferred tax assets:
Inventory $ 20,572 $ 17,721
Accounts receivable 6,775 5,206
Accrued liabilities 35,793 52,143
Other liabilities 36,912 60,539
Other 3,612 8,048
---------- ----------
Total U.S. 103,664 143,657
Foreign deferred tax assets:
Operating loss carryforwards 17,832 33,454
Other 2,459 5,207
---------- ----------
Total foreign 20,291 38,661
---------- ----------
Total deferred tax assets 123,955 182,318
---------- ----------
U.S. deferred tax liabilities:
Intangible assets 34,006 29,440
Property, plant & equipment 2,668 4,104
Other 3,439 6,507
---------- ----------
Total deferred tax liabilities 40,113 40,051
---------- ----------
Net deferred tax assets $ 83,842 $ 142,267
========== ==========
</TABLE>
The Company has foreign net operating loss carryforwards of $67,600,000.
Of this amount, $10,500,000 expires in the year 2000, $27,400,000 in the year
2002, $14,300,000 in the year 2006 and $7,100,000 in the year 2008. The
remaining $8,300,000 can be carried forward indefinitely. The Company has
assessed its forecast of future taxable income and the expiration of
carryforwards and has determined that is it more likely than not that the
deferred tax asset relating to foreign net operating loss carryforwards will be
realized.
6. STOCK OPTION PLANS:
The Company maintains various stock option plans for its employees.
Employee options are generally granted at the fair market value of the related
common stock at the date of grant. These options generally vest over a four-
year period from the date of grant or the employee's initial date of employment.
In addition, these options expire, if not exercised, ten years from the date of
grant. The Company also maintains option plans for non-employee directors.
Option grants to non-employee directors generally have an exercise price equal
to the fair market value of the related common stock on the date of grant.
These options generally vest over one to three-year periods and expire, if not
exercised, ten years from the date of grant.
For all of the Company's stock option plans, options for 1,283,000,
2,582,000 and 2,728,000 shares of common stock were exercisable at December 31,
1996, 1997 and 1998 with a weighted average exercise price of $4.28, $9.86 and
$17.42, respectively. In addition, options for 672,000, 556,000 and 280,000
shares of Class A common stock were exercisable at December 31, 1996, 1997 and
1998 with a weighted average exercise price of $2.06, $2.01 and $1.93,
respectively. Class A common stock may be converted into an equal number of
shares of common stock at any time. There were 12,309,000, 8,328,000 and
11,265,000 shares of common stock available for grant under the plans at
December 31, 1996, 1997 and 1998, respectively.
32
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table summarizes activity under the stock option plans for
1996, 1997 and 1998 (in thousands, except per share amounts):
<TABLE>
<CAPTION>
Weighted- Class A Weighted-
Common Average Common Average
Stock Price Stock Price
-------- ----------- --------- -----------
<S> <C> <C> <C> <C>
Outstanding, December 31, 1995 8,739 $ 3.16 962 $ 2.14
Granted 3,260 15.75 -- --
Exercised (6,305) 1.43 (241) 2.13
Forfeited (254) 14.15 (8) 3.25
-------- ---------
Outstanding, December 31, 1996 5,440 12.20 713 2.12
-------- ---------
Granted 5,253 36.08 -- --
Exercised (463) 11.56 (153) 2.50
Forfeited (775) 23.69 -- --
-------- ---------
Outstanding, December 31, 1997 9,455 22.98 560 2.02
-------- ---------
Granted 6,118 45.17 -- --
Exercised (2,143) 16.59 (280) 2.10
Forfeited (1,103) 32.76 -- --
-------- ---------
Outstanding, December 31, 1998 12,327 $ 34.19 280 $ 1.93
======== =========
</TABLE>
The following table summarizes information about the Company's Common Stock
options outstanding at December 31, 1998 (in thousands, except per share
amounts):
<TABLE>
<CAPTION>
Options Outstanding Options Exercisable
Range of Exercise Prices Number Weighted-Average Number Weighted-
Outstanding at Remaining Weighted- Exercisable at Average
12/31/98 Contractual Life Average Price 12/31/98 Price
- -----------------------------------------------------------------------------------------------------------------
<S> <C> <C> <C> <C> <C>
$ 1.19 - 13.38 1,928 5.57 $ 9.01 1,259 $ 6.76
13.44 - 29.07 2,287 7.65 22.93 939 20.01
29.31 - 33.75 2,405 8.87 33.06 267 32.35
34.00 - 44.75 2,811 8.94 39.55 262 43.88
45.06 - 62.50 2,896 9.68 55.56 1 61.75
</TABLE>
The weighted average fair value per share of options granted during 1996,
1997 and 1998 was $9.65, $21.61 and $27.33, respectively. The fair value of
these options was estimated on the date of grant using the Black-Scholes option
pricing model with the following weighted-average assumptions used for all
grants in 1996, 1997 and 1998: dividend yield of zero percent; expected
volatility of 60 percent; risk-free interest rates ranging from 4.7 to 7.2
percent; and expected lives of the options of three and one-half years from the
date of vesting.
33
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
Since all stock options have been granted with exercise prices equal to the
fair market value of the related common stock at the date of grant, no
compensation expense has been recognized under the Company's stock option plans.
Had compensation cost under the plans been determined based on the estimated
fair value of the stock options granted in 1996, 1997 and 1998, net income and
net income per share would have been reduced to the pro forma amounts indicated
below:
<TABLE>
<CAPTION>
1996 1997 1998
-------------- -------------- --------------
(in thousands, except per share amounts)
<S> <C> <C> <C>
Net income - as reported $250,679 $109,797 $346,399
Net income - pro forma $241,729 $ 85,804 $297,470
Net income per share - as reported
Basic $ 1.64 $ .71 $ 2.23
Diluted $ 1.60 $ .70 $ 2.18
Net income per share - pro forma
Basic $ 1.58 $ .56 $ 1.91
Diluted $ 1.55 $ .55 $ 1.87
</TABLE>
The pro forma effect on net income for 1996, 1997 and 1998 is not fully
representative of the pro forma effect on net income in future years because it
does not take into consideration pro forma compensation expense related to the
vesting of grants made prior to 1995.
7. RETIREMENT SAVINGS PLAN:
The Company has a 401(k) defined contribution plan which covers employees
who have attained 18 years of age and have been employed by the Company for at
least six months. Participants may contribute up to 20% of their compensation in
any plan year and receive a 50% matching employer contribution of up to 6% of
their annual eligible compensation. The Company contributed $871,000,
$2,068,000, and $4,730,000 to the Plan during 1996, 1997 and 1998, respectively.
8. NONRECURRING EXPENSES:
The Company recorded several nonrecurring pretax charges during the third
quarter of 1997 totaling approximately $113,800,000. Of the nonrecurring
charges, approximately $59,700,000 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 approximately $45,200,000 resulting from the abandonment of a capitalized
internal use software project and certain computer equipment. In addition,
approximately $8,600,000 was recorded for severance of employees and the closing
of a foreign office.
9. ACQUISITION:
During the third quarter of 1997, the Company acquired substantially all of
the outstanding shares of common stock of Advanced Logic Research, Inc. (ALR), a
manufacturer of network servers and personal computers, for a cash purchase
price of approximately $196,400,000. The operating results of ALR were not
material for all periods presented.
34
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
10. SELECTED BALANCE SHEET INFORMATION:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
---------- ----------
(in thousands)
<S> <C> <C>
Accounts receivable, net:
Accounts receivable $ 530,743 $ 573,799
Allowance for uncollectible accounts (20,064) (14,948)
---------- ----------
$ 510,679 $ 558,851
========== ==========
Inventory:
Components and subassemblies $ 215,318 $ 155,746
Finished goods 33,906 12,178
---------- ----------
$ 249,224 $ 167,924
========== ==========
Property, plant and equipment, net:
Land $ 21,431 $ 21,784
Leasehold improvements 21,666 57,118
Buildings 162,318 186,361
Construction in progress 15,448 74,105
Internal use software 81,412 94,306
Office and production equipment 186,281 249,924
Furniture and fixtures 42,055 66,578
Vehicles 4,105 15,402
---------- ----------
534,716 765,578
Accumulated depreciation and amortization (158,249) (234,590)
---------- ----------
$ 376,467 $ 530,988
========== ==========
</TABLE>
35
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
11. SUPPLEMENTAL STATEMENTS OF CASH FLOWS INFORMATION:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------
1996 1997 1998
---------- ---------- ----------
(in thousands)
<S> <C> <C> <C>
Supplemental disclosure of cash flow information:
Cash paid during the year for interest $ 665 $ 716 $ 930
Cash paid during the year for income taxes $ 101,774 $ 163,710 $ 200,839
Supplemental schedule of noncash investing and
financing activities:
Capital lease obligations incurred for the
purchase of new equipment $ 3,126 $ 4,593 $ 6,741
Acquisitions
Fair value of assets acquired $ 271,189
Less: Liabilities assumed 70,773
Cash acquired 58,096
----------
Acquisitions, net of cash acquired $ 142,320
</TABLE>
12. SEGMENT DATA:
Prior to 1998, the Company managed its business segments principally on a
geographic basis. The reportable segments were comprised of the United States;
Europe, Middle East and Africa ("EMEA"); and Asia Pacific ("APAC"). During 1998,
the Company began to manage its business activities primarily in two customer
focused segments: consumer and business. The accounting policies of the various
segments are the same as those described in the "Summary of Significant
Accounting Policies" in Note 1. The Company evaluates the performance of its
consumer and business segments based on segment sales, gross profit 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. Prior periods'
segment information has not been restated to reflect the consumer and business
segments as it is impractical to do so.
The following table sets forth summary information by segment:
<TABLE>
<CAPTION>
Consumer Business Non-segment Consolidated
------------ ------------ --------------- ----------------
(in thousands)
<S> <C> <C> <C> <C>
1998:
Net sales $ 3,945,071 $ 3,522,854 $ -- $ 7,467,925
Gross profit 760,816 783,262 2,196 1,546,274
Operating income (loss) $ 461,351 $ 600,844 $ (567,968) $ 494,227
</TABLE>
36
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
The following table sets forth information about the Company's operations
by geographic area:
<TABLE>
<CAPTION>
Inter-segment
United States EMEA APAC Eliminations Consolidated
--------------- ------------ ------------ -------------- --------------
(in thousands)
<S> <C> <C> <C> <C> <C>
1998:
Net sales to external
customers $ 6,412,405 $ 570,191 $ 485,329 $ -- $ 7,467,925
Net sales between
geographic segments 53,073 22,298 11,358 (86,729) --
Operating income
(loss) 500,881 (6,685) 1,233 (1,202) 494,227
Segment assets 2,473,627 209,820 206,933 -- 2,890,380
Long-lived assets 522,972 57,548 30,184 -- 610,704
Other income, net 44,524 1,380 2,041 (924) 47,021
Income taxes 205,129 (3,048) (7,232) -- 194,849
Depreciation and
amortization 84,378 9,820 12,318 (992) 105,524
1997:
Net sales to external
customers $ 5,303,828 $ 634,616 $ 355,236 $ -- $ 6,293,680
Net sales between
geographic segments 56,922 16,163 21,071 (94,156) --
Operating income
(loss) 198,638 (11,566) (9,733) (908) 176,431
Non-recurring expenses 111,394 1,100 1,348 -- 113,842
Segment assets 1,701,654 187,215 150,402 -- 2,039,271
Long-lived assets 380,757 59,261 34,278 -- 474,296
Other income, net 25,223 2,946 (798) (182) 27,189
Income taxes 104,552 568 (11,297) -- 93,823
Depreciation and
amortization 67,895 6,695 12,292 (108) 86,774
1996:
Net sales to external
customers $ 4,246,047 $ 552,671 $ 236,510 $ -- $ 5,035,228
Net sales between
geographic segments 30,208 23,538 4,087 (57,833) --
Operating income
(loss) 347,348 19,930 (9,946) (1,238) 356,094
Segment assets 1,349,781 178,988 144,642 -- 1,673,411
Long-lived assets 248,272 48,025 44,815 -- 341,112
Other income, net 24,533 2,108 (19) -- 26,622
Income taxes 138,724 1,572 (8,259) -- 132,037
Depreciation and
amortization 46,688 4,236 10,839 -- 61,763
</TABLE>
Net sales between geographic segments are recorded using internal transfer
prices set by the Company. The United States operating income is net of
corporate expenses. Export sales from the United States to unaffiliated
customers are not material for any period presented.
37
<PAGE>
GATEWAY 2000, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED)
13. SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED):
The following tables contain selected unaudited consolidated quarterly
financial data for the Company:
<TABLE>
<CAPTION>
1st Quarter 2nd Quarter 3rd Quarter 4th Quarter
------------ ------------ ------------ ------------
(in thousands, except per share amounts)
<S> <C> <C> <C> <C>
1998:
Net sales $1,727,927 $1,618,909 $1,815,516 $2,305,573
Gross profit 336,494 333,688 377,807 498,285
Operating income 109,201 83,989 113,355 187,682
Net income 75,871 60,740 80,645 129,143
Net income per share:
Basic $ .49 $ .39 $ .52 $ .83
Diluted $ .48 $ .38 $ .51 $ .81
Weighted average shares
outstanding:
Basic 154,548 155,427 155,849 156,324
Diluted 157,575 158,887 159,518 159,567
Stock sales price per share:
High $ 48.25 $ 58.81 $ 67.13 $ 61.63
Low $ 32.50 $ 42.56 $ 46.44 $ 41.50
1997:
Net sales $1,419,336 $1,392,658 $1,504,851 $1,976,835
Gross profit 265,793 260,358 195,250 355,040
Nonrecurring expenses -- -- 113,842 --
Operating income (loss) 94,878 79,851 (137,850) 139,551
Net income (loss) 67,516 56,483 (107,113) 92,910
Net income (loss) per share:
Basic $ .44 $ .37 $ (.70) $ .60
Diluted $ .43 $ .36 $ (.68) $ .59
Weighted average shares
outstanding:
Basic 153,557 153,740 153,980 153,840
Diluted 157,291 156,231 156,875 156,526
Stock sales price per share:
High $ 32.63 $ 37.38 $ 44.75 $ 36.13
Low $ 23.81 $ 26.19 $ 31.50 $ 25.13
</TABLE>
14. SUBSEQUENT EVENT (UNAUDITED):
As of February 28, 1999, the Company has made a commitment to purchase
approximately $290 million of consumer finance receivables used to purchase the
Company's products which were originated by a financial institution on behalf of
Gateway. These receivables have terms of two to four years and earn interest at
rates ranging from 14.9% to 26.99%.
38
<PAGE>
GATEWAY 2000, INC.
SCHEDULE VIII - VALUATION AND QUALIFYING ACCOUNTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(in thousands)
<TABLE>
<CAPTION>
Balance at Additions Deductions Balance at
Beginning of Charged to from End of
Period Expense Allowance Period
-------------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Year ended December 31, 1996:
Allowance for uncollectible accounts
(deducted from accounts receivable) $ 11,554 $ 20,832 $ 13,418 $ 18,968
========= ======== ======== ========
Year ended December 31, 1997:
Allowance for uncollectible accounts
(deducted from accounts receivable) $ 18,968 $ 5,688 $ 4,592 $ 20,064
========= ======== ======== ========
Year ended December 31, 1998:
Allowance for uncollectible accounts
(deducted from accounts receivable) $ 20,064 $ 3,586 $ 8,702 $ 14,948
========= ======== ======== ========
</TABLE>
39
<PAGE>
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Part III of this report is incorporated by reference to Gateway's definitive
Proxy Statement relating to its Annual Meeting of Stockholders, which will be
filed with the Commission within 120 days of the end of fiscal year 1998.
PART IV
ITEM 14. EXHIBITS, FINANCIAL SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as a part of this Report:
(1) Financial Statements and Financial Statement Schedule. See Index to
Consolidated Financial Statements and Financial Statement Schedule
at Item 8 on page 19 of this Report.
(2) Exhibits. Exhibits identified in parentheses below, on file with
the Securities and Exchange Commission are incorporated herein by
reference as exhibits hereto.
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
--- -----------------------
3.1 Amended and Restated Certificate of Incorporation of Gateway 2000,
Inc. (Exhibit No. 3.2 to Amendment No. 1 to Registration Statement
No. 3-70618)
3.2 Amended and Restated Bylaws of Gateway 2000, Inc. (Exhibit No. 3.2
to Form 10-K for 1995)
10.1 Tax Indemnification Agreement dated as of December 6, 1993 between
Gateway 2000, Inc., and Theodore W. Waitt and the Norman W. Waitt,
Jr. S Corp. Trust. (Exhibit No. 10.1 Form 10-K for 1993)*
10.2 Indemnification Agreement dated as of December 6, 1993 between
Gateway 2000, Inc. and Theodore W. Waitt. (Exhibit No. 10.2 to 10-K
for 1995)*
10.3 Registration Agreement dated February 22, 1991 between Gateway
2000, Inc., Theodore W. Waitt and Norman W. Waitt, Jr. as the sole
trustee and sole beneficiary of the Norman W. Waitt, Jr. S Corp.
Trust, together with Amendment No. 1 to the Registration Agreement
dated as of October 19, 1993 (Exhibit 10.11 to Form S-1)*
10.4 Gateway 2000, Inc. 1992 Stock Option Plan. (Exhibit No. 10.4 to
Registration Statement No. 33-70618 (the "Form S-1")*
10.5 Gateway 2000, Inc. 1993 Stock Option Plan for Executives and Key
Employees. (Exhibit No. 10.6 to the Form S-1)*
10.6 Gateway 2000, Inc. 1993 Non-Employee Director Stock Option Plan and
Form of Option Grant Letter (Exhibit No. 10.8 to the Form S-1)*
10.7 Gateway 2000, Inc. 1993 Employee Stock Purchase Equity Plan.
(Exhibit No. 10.9 to the Form S-1)*
10.8 Gateway 2000, Inc. 1996 Long-Term Incentive Equity Plan, as amended
and restated (Exhibit No. 10.19 to Form 10-Q for the period ended
June 30, 1998)*
10.9 Gateway 2000, Inc. 1996 Non-Employee Directors Stock Option Plan as
amended. (Exhibit No. 10.20 to Form 10-Q for the period ended June
30, 1998)*
10.10 Gateway 2000, Inc. Management Incentive Plan as (Exhibit 10.9 to
the Form 10-K for 1996)*
10.11 Gateway 2000, Inc. Deferred Compensation Plan, as amended. (filed
herewith)*
10.12 Gateway 2000, Inc. Retirement Savings Plan. (Exhibit No. 10.16 to
Form 10-K for 1995)*
40
<PAGE>
EXHIBIT
NO. DESCRIPTION OF EXHIBITS
--- -----------------------
10.13 Credit Agreement dated as of December 27, 1995 between Gateway
2000, Inc., Norwest Bank Iowa, National Association, as
Administrative Agent, and certain financial institutions named
therein. (Exhibit No. 4.2 to Form 10-K for 1995)
10.14 1997 Amended and Restated Credit Agreement dated as of September
25, 1997 among the Company, the banks party thereto, Norwest Bank
Iowa, N.A., as Administrative Agent and Bank of America National
Trust and Savings Association as Documentation Agent (Exhibit 10.13
to Form 10-Q for period ended September 30, 1997)
10.15 Consultation and Noncompetition Agreement dated as of August 28,
1997 between the Company and Richard D. Snyder. (Exhibit 10.14 to
Form 10-Q for period ended September 30, 1997)*
10.16 Employment Agreement between Gateway 2000, Inc. and Jeffrey Weitzen
dated January 22, 1998 (Exhibit 10.16 to Form 10-K for 1997). *
10.17 Employment Agreement between Gateway 2000, Inc. and David J. Robino
dated January 22, 1998, (Exhibit 10.17 to Form 10-K for 1997)*
10.18 Amendment No. 1 to 1997 Amended and Restated Credit Agreement,
dated as of January 19, 1998, among the Company, the banks party
thereto, Norwest Bank Iowa, N.A., as Administrative Agent and Bank
of America National Trust and Savings Association as Documentation
Agent (Exhibit 10.18 to Form 10-Q for period ended March 31, 1998)
21.1 List of subsidiaries, filed herewith.
23.1 Consent of PricewaterhouseCoopers LLP, filed herewith.
24.1 Powers of attorney, filed herewith.
27.1 Financial Data Schedule and Financial Data Schedules restated
pursuant to SFAS 128, filed herewith (EDGAR version only).
41
<PAGE>
*Indicates a management contract or compensatory plan.
Gateway will furnish upon request any exhibit described above upon
payment of Gateway's reasonable expenses for furnishing such exhibit.
(b) Reports on Form 8-K.
No reports on Form 8-K were filed by Gateway during the quarter ended
December 31, 1998.
This report contains the following trademarks and service marks of Gateway, many
of which are registered: GATEWAY, Your:) Ware, AnyKey, "BLACK AND WHITE SPOT"
Design, CrystalScan, Destination, gateway.net, Family PC, GATEWAY 2000, Gateway
Country, Gateway Gold, "G" Design, TelePath, Solo, Vivitron and "You've Got a
Friend in the Business". The following trademarks of other companies also
appear in this Report: Intel, AMD, Microsoft and Pentium. These and any other
product or brand names contained herein are trademarks or registered trademarks
of their respective owners.
<PAGE>
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, on March 30, 1999.
GATEWAY 2000, INC.
By: /s/ Theodore W. Waitt
---------------------
Theodore W. Waitt
Chairman of the Board and
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Registrant in the capacities indicated on the dates indicated below:
DATE SIGNATURE TITLE
Chairman of the Board,
Chief Executive Officer
(Principal Executive
Officer) and Director
/s/ Theodore W. Waitt
------------------------------
Theodore W. Waitt
President, Chief Operating
Officer and Director
/s/ Jeffrey Weitzen
------------------------------
Jeffrey Weitzen
Senior Vice President,
Chief Financial Officer
and Treasurer (Principal
Financial Officer and
Principal Accounting Officer)
/s/ John J. Todd
------------------------------
John J. Todd
*
------------------------------
Charles G. Carey Director
*
------------------------------
George H. Krauss Director
*
------------------------------
Douglas L. Lacey Director
*
------------------------------
James F. McCann Director
*
------------------------------
Richard D. Snyder Director
*By: /s/ William M. Elliott
-----------------------
William M. Elliott
(Attorney-in-fact)
43
<PAGE>
Exhibit 10.11
GATEWAY 2000, INC.
DEFERRED COMPENSATION PLAN, AS AMENDED
1. Purpose
The name of this Plan is the Gateway 2000, Inc. Deferred Compensation Plan
(the "Plan"). Its purpose is to provide certain key employees of Gateway
2000, Inc. and its subsidiaries (the "Company") the opportunity to defer
any sign-on bonus, future payments under the Management Incentive Plan
and/or base salary otherwise payable to them.
2. Effective Date and Duration
The Plan, upon adoption by the Compensation Committee of the Board of
Directors (the "Committee") will be effective March 25, 1996. The Plan
will remain in effect until it is terminated by the Committee.
3. Eligibility
Eligibility to participate in the Plan shall extend to employees who have
been designated as eligible for awards under the Management Incentive Plan.
A "Participant" in the Plan means an eligible employee who has elected to
defer receipt or payment of all or a portion of any sign-on bonus, base
salary and/or awards under the Management Incentive Plan under the terms of
the Plan.
4. Deferral Elections
This deferral is effected by executing a Deferred Compensation Agreement
("Agreement"). The form of the Agreement will be established by the
Committee. Each participant electing to participate will complete an
Agreement and return it to Corporate Human Resources prior to the
applicable date specified below. An election to defer, filed in accordance
with this section, is binding and irrevocable except as specified below.
New elections must be made each year. Election may be made as follows:
a) Base Salary-- Prior to the beginning of each
calendar year, a Participant may elect to defer
payment of 10 percent or more of their salary
to be paid for that year or any portion of that
year to a date or dates specified by the
Participant in the Agreement, provided that the
deferral period is not less than 24 months.
<PAGE>
b) Prior to the beginning of the Management Incentive
Plan fiscal year a Participant may elect to defer
25% or more in equal 5% increments up to and
including 100% of the amount to be paid to the
individual pursuant to such Plan for such year to
a date or dates specified by the Participant in the
Agreement, provided that the payment(s) does not
commence during the tax year in which it is earned.
c) Prior to receipt of any sign-on bonus, a participant
may elect to defer 25% or more in equal 5% increments
up to and including 100% of the amount to be paid
to the individual.
5. Modifying a Deferral Election
A Participant may modify their deferral election for base salary with
respect to the following calendar year and for an Award under the
Management Incentive Plan with respect to the following fiscal year. This
is done by notifying Corporate Human Resources in writing prior to the
beginning of the calendar or fiscal year in which the Participant wishes to
make a change. No change may be made to an election which has been filed
for a calendar year or fiscal year once that calendar year or fiscal year
has begun.
6. Deferred Compensation Accounts
The Company will establish and maintain a separate deferred compensation
account ("Account") for each Participant. On the first business day of each
calendar year and on the date of final payment from the Account, the
Company will credit the Account with interest on the outstanding account
balance (principal and interest to date). The annual rate of interest will
be established by the Committee prior to the election period. The Committee
may establish additional investment options for Participant Accounts.
7. Payment of Deferred Compensation
A Participant may elect to receive the payment(s) of deferred compensation
only in cash in annual installments as elected on the Deferred Compensation
Agreement or in a lump sum.
8. Termination of Employment
a) Retirement -- In the event that a Participant retires before all
deferred compensation is paid from the Account, the Account balance
shall continue to be maintained by the Company for the benefit of the
Participant and paid in accordance with the Agreement.
b) Other Termination -- In the event a Participant dies or leaves the
Company for any other reason, the full Account balance will be paid
within 90 days of the date of death or termination. In the event of
death, payment will be made to the designated beneficiary (or
beneficiaries) or the Participant's estate. In the event of
termination due to total disability, payment will be made to the
Participant or the Participant's legal representative. Interest shall
be credited through the date of termination at the rate applicable at
that time. Total disability is defined as any condition that would
qualify a participant to receive benefits
45
<PAGE>
from the Company's Long Term Disability Plan.
9. Benefit Plans
The amount of a Participant's base salary and/or award under the Management
Incentive Plan which is deferred under the Plan shall be deemed to be
compensation for purposes of calculating benefits under any other plan(s)
of the Company, such compensation prior to deferral is deemed eligible in
such other plan(s).
10. Financial Hardship
Notwithstanding the time and frequency of the date of payment of deferred
compensation designated in the Agreement or in paragraph 6 thereof, the
Committee may authorize, upon written application by the Participant, the
acceleration of deferred payments (including a lump sum payment), provided
that the requesting party can substantiate to the reasonable satisfaction
of the Committee that the adherence to the Agreement would result in severe
financial hardship to the Participant. A bonafide financial hardship must
be the result of an unanticipated event. This accelerated payment shall not
exceed the amount required to meet the financial need of the Participant.
11. Early Withdrawal Penalty
Notwithstanding the provisions of paragraph 10 and subject to a penalty
equal to 10 percent of the amount withdrawn, a Participant may request the
early distribution of all or any portion of the Account balance (amounts
less than $5,000 will be paid out in full) at any time in the sole
discretion of the Committee. This request must be made in writing to the
Committee. The amount requested, less the 10 percent penalty and applicable
tax withholding, will be distributed to the Participant within 30 days of
Committee approval. Interest will be credited through the date the payment
is made.
12. Participant's Rights
Establishment of or participation in the Plan in no way constitutes a
contract or agreement of continued employment of the Participant by the
Company for any fixed period of time or the right to receive any benefits
not specifically provided in the Plan. All Deferred Compensation shall
remain the sole property of the Company, subject to the claims of its
general creditors and available for its use for whatever purposes are
desired. With respect to amounts deferred or otherwise held for the account
of a Participant, the Participant is a general creditor of the Company. The
obligation of the Company thereunder is purely contractual and shall not be
funded or secured in any way. The Company shall not segregate assets,
create any security interest or encumber its assets in order to provide for
the payment(s) of the balance(s). Notwithstanding the preceding sentence,
the Company may in its sole discretion establish an irrevocable grantor
trust, the assets of which shall not be subject to the claims of the
Company's creditors in the event of the Company's bankruptcy or insolvency.
If such a trust is established, benefits payable under the Plan shall be
paid from this trust to the extent not otherwise paid from the Company's
general assets.
46
<PAGE>
13. Non-alienability and Non-transferability
The rights of a Participant to the payment of deferred compensation as
provided in the Plan shall not be assigned, transferred, pledged or
encumbered or be the subject in any manner to alienation or anticipation.
No Participant may borrow against the deferred Account.
14. Administration
The Compensation Committee of the Board of Directors is responsible for the
Plan administration and is authorized to interpret the terms and provisions
of the Plan and to adopt such rules and regulations for the administration
of the Plan as it deems advisable. It may delegate routine administrative
matters as appropriate. The decisions of the Committee are binding on all
parties.
15. General Provisions
Except to the extent superseded by federal law, the laws of the State of
South Dakota will be controlling in all matters relating to the Plan. To
the extent required by the laws in effect at the time the compensation is
earned or deferred compensation payments are made, the Company shall
withhold from current compensation, or the deferred compensation payments,
any taxes required to be withheld for federal, state or local government
purposes.
16. Amendment and Termination
The Committee may, at any time or from time to time, amend, modify, or
terminate the Plan, and pay Participants the balance in their Accounts in
the event changes in regulations or control of the Company (as defined by
the Committee) make continued deferrals undesirable. However, no amendment,
modification or termination of the Plan will, without the consent of a
Participant, adversely affect the Participant's rights with respect to
amounts then accrued in the Account.
<PAGE>
Exhibit 21.1
SUBSIDIARIES OF GATEWAY 2000, INC.
NAME JURISDICTION
---- ------------
Advanced Logic Research (Deutschland) Gmbh Germany
Advanced Logic Research International, Inc. Virgin Islands
Advanced Logic Research International, Pte Singapore
Advanced Logic Research, Inc. Delaware
Advanced Logic Research, Inc. (U.K.) Limited United Kingdom
Cowabunga Enterprises, Inc. Delaware
Gateway 2000 (M) Sdn. Bhd. Malaysia
Gateway 2000 Asia Pte. Ltd. Singapore
Gateway 2000 Asia, Inc. Delaware
Gateway 2000 Computers GmbH Germany
Gateway 2000 Computers Limited (UK) United Kingdom
Gateway 2000 Cyprus Limited Greece
Gateway 2000 Europe Ireland
Gateway 2000 France SARL France
Gateway 2000 Hong Kong Limited Hong Kong
Gateway 2000 International Limited (Netherlands Resident) Ireland
Gateway 2000 Ireland Limited Ireland
Gateway 2000 Marketing Services, Inc. Delaware
Gateway 2000 Netherlands BV The Netherlands
Gateway 2000 New Zealand Limited New Zealand
Gateway 2000 Pty (Australia) Australia
Gateway 2000 Sweden AB Sweden
Gateway 2000 Wholesale Pty. Ltd. Australia
Gateway Companies, Inc. Delaware
Nihon Gateway Nisen Kabushiki Kaisha (Gateway Japan) Japan
Over the Moon Productions, Inc. Texas
49
<PAGE>
Exhibit 23.1
CONSENT OF INDEPENDENT ACCOUNTANTS
We consent to the incorporation by reference in the registration statements of
Gateway 2000, Inc. on Forms S-8 (File Nos. 33-08837, 33-84116, 33-84118, 33-
84120, 33-84122, 33-84124, 333-33231 and 333-36071) of our report dated January
21, 1999, on our audits of the consolidated financial statements and financial
statement schedule of Gateway 2000, Inc. as of December 31, 1997 and 1998, and
for each of the three years in the period ended December 31, 1998, which report
is included in this Annual Report on Form 10-K.
/s/ PricewaterhouseCoopers LLP
PRICEWATERHOUSECOOPERS LLP
San Diego, California
March 29, 1999
<PAGE>
Exhibit 24.1
Gateway 2000, Inc.
From 10-K; Power of Attorney
Each of the undersigned constitutes and appoints William M. Elliott and
Stephanie G. Heim, or either of them, as the undersigned's true and lawful
attorney-in-fact and agent, with full power of substitution, in the
undersigned's name, place and stead, in any and all capacities, to sign an
Annual Report on Form 10-K of Gateway 2000, Inc. (the "Company") for the
Company's fiscal year ended December 31, 1998, and any amendment thereto, and to
file the same, with all exhibits thereto and other documents in connection
therewith (collectively, the "Form 10-K"), with the Securities and Exchange
Commission, the New York Stock Exchange and such other state and federal
government commissions and agencies as required under the Securities Act of
1934, as amended, the regulations thereunder and other applicable law.
Dated: January 20, 1999
TITLE
/s/ Theodore W. Waitt Chairman of the Board, Chief Executive
- -----------------------------
Theodore W. Waitt Officer (Principal Executive Officer)
and Director
/s/ Jeffrey Weitzen President, Chief Operating Officer and
- -----------------------------
Jeffrey Weitzen Director
/s/ Charles G. Carey Director
- -----------------------------
Charles G. Carey
/s/ George H. Krauss Director
- -----------------------------
George H. Krauss
/s/ Douglas L. Lacey Director
- -----------------------------
Douglas L. Lacey
/s/ James F. McCann Director
- -----------------------------
James F. McCann
/s/ Richard D. Snyder Director
- -----------------------------
Richard D. Snyder
51
<TABLE> <S> <C>
<PAGE>
<ARTICLE> 5
<LEGEND>
THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM GATEWAY
2000, INC.'S CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE TWELVE MONTHS ENDED
DECEMBER 31, 1998 AND THE CONSOLIDATED BALANCE SHEET AS OF DECEMBER 31, 1998 AND
IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS.
</LEGEND>
<MULTIPLIER> 1,000
<S> <C>
<PERIOD-TYPE> YEAR
<FISCAL-YEAR-END> DEC-31-1998
<PERIOD-START> JAN-01-1998
<PERIOD-END> DEC-31-1998
<CASH> 1,169,810
<SECURITIES> 158,657
<RECEIVABLES> 573,799
<ALLOWANCES> 14,948
<INVENTORY> 167,924
<CURRENT-ASSETS> 2,228,186
<PP&E> 765,578
<DEPRECIATION> 234,590
<TOTAL-ASSETS> 2,890,380
<CURRENT-LIABILITIES> 1,429,674
<BONDS> 3,360
0
0
<COMMON> 1,566
<OTHER-SE> 1,342,809
<TOTAL-LIABILITY-AND-EQUITY> 2,890,380
<SALES> 7,467,925
<TOTAL-REVENUES> 7,467,925
<CGS> 5,921,651
<TOTAL-COSTS> 5,921,651
<OTHER-EXPENSES> 0
<LOSS-PROVISION> 3,991
<INTEREST-EXPENSE> 930
<INCOME-PRETAX> 541,248
<INCOME-TAX> 194,849
<INCOME-CONTINUING> 346,399
<DISCONTINUED> 0
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> 346,399
<EPS-PRIMARY> 2.23
<EPS-DILUTED> 2.18
</TABLE>
