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Gateway Gets Profit Lift

But the PC maker's third-quarter revenue is lower than it was a year ago.

Updated from 5:22 p.m. EDT



third-quarter sales declined year over year, but the PC maker delivered a profit that surpassed Wall Street's expectations.

Flat unit shipments of PCs and a sharp drop-off in the Irvine, Calif., company's direct-sales business kept revenue under pressure during the quarter. Revenue totaled $963 million in the three months ended Sept. 30, down roughly 5% from the same period last year, and below analysts' expectation of $1.05 billion in sales.

But Gateway said Thursday that it earned $18.1 million in net income, or 5 cents a share, during the third quarter, whereas analysts polled by Thomson Financial expected the PC maker to have a break-even quarter.

A net tax benefit of $8.2 million helped Gateway shore up its earnings. But the company's bottom line also benefited from increasing sales of notebook PCs and flat-panel displays, and a focus on cost controls.

While the 7.6% gross margin was down year over year, it was a marked improvement from the 5.5% margin that Gateway reported during its second quarter.

Shares of Gateway gained 4.9%, or 8 cents, to $1.72 in extended trading.

Ed Coleman, who was appointed CEO in September, said he was taking a hard look at the company's business model and its internal performance.

"I come to Gateway with a sense of urgency," said Coleman in his first postearnings conference call since taking the helm of the company. "While we have many strengths, business as usual is the farthest thing from my mind."

He said that immediate opportunities for improvement were apparent, adding that Gateway's cost structure is too high, and signaling that layoffs were in the offing. Coleman said Gateway launched a restructuring plan on Wednesday designed to save $35 million in annual savings beginning in 2007.

Gateway has been under fire from various investors for the past several months owing to its mediocre performance.

In August, eMachines co-founder Lap Shun "John" Hui

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offered to buy Gateway's retail operations for $450 million -- an offer Gateway's board of directors rejected.

And also Wednesday, a group of activist investors signaled their intention to

wage a proxy battle to secure three seats on Gateway's board of directors.

Acknowledging the critics, Coleman said there was "no shortage of outside opinion about how best to move the company forward." But he stressed that his priority was to focus on Gateway's performance rather than to evaluate "other alternatives."

He might start with the direct sales business, which sells PCs through Internet and telephone orders and which saw its revenue plummet 44% year over year to $75 million during the third quarter.

Gross margins in the direct group -- Gateway's most profitable segment -- slid to 16.8% compared with 27.3% in the year-ago period.

And the company's professional segment saw its sales decline 8% year over year, although the $263 million in revenue was up 5% sequentially. Gross margin within the professional group reached 13.1%, up sequentially and year over year.

Coleman said the company would double-down on its areas of strength in the professional business, namely public sector institutions such as schools and state governments, which account for roughly 80% of the group's sales.

"We're doing a better job of identifying who our key accounts are, and selling to them in a concentrated, dedicated way," said Coleman.

Gateway's retail business, which accounts for 65% of the company's overall sales, logged a 4% increase in revenue year over year, and a slight sequential improvement in gross margin, which the company ascribed to greater sales of notebook PCs than desktops.

While the company did not provide financial guidance for the quarter under way, management cautioned that retail sales in the fourth quarter could suffer from the delay of


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Vista operating system and supply constraints of certain PC components.