thinks it can play the
game and win -- by the fourth quarter of 2003.
The computer maker walked analysts through a brand-new strategy Wednesday, attempting to reconcile its country-store system with the direct model championed by Dell. After backsliding throughout 2001, Gateway is going to join the fray and recapture its market share at the expense of its gross margin. Along the way, Gateway will be forced to radically alter the outlook it gave in January: While it previously thought it could be profitable by the fourth quarter of 2002, it now expects to incur losses until 2003. Many on Wall Street are interpreting that to mean Gateway will be in the red until the fourth quarter of 2003.
Investors slashed as much as 15% off the company's shares as they wondered how its forecast could be so aggressively altered in five weeks. Gateway shares are down 40% since the beginning of the year.
Gateway issued a profit warning for the year, saying its expects a $200 million to $250 million pro forma loss in 2002, a range between 62 cents a share and 77 cents a share. Those numbers are worlds away from Wall Street expectations of a 17-cents-a-share loss, culled by Thomson Financial/First Call. More disturbing, they don't have anything to do with sales strength; Gateway guided that it would hit $1 billion in revenue en route to reaping $4.5 billion to $5 billion for the full year, both figures that are generally in line with analyst expectations. The company notched $1.14 billion in revenue in the holiday-sales fueled fourth quarter.
Margins apparently are going to be the big difference. Gateway enjoyed a 21.2% gross margin in the fourth quarter because of increased high-end sales and cost reductions, better than its 16.8% margin in the third quarter of 2001. Needham analyst Charlie Wolf explains that hardware gross margins have declined from 15% to under 10% in the consumer business Gateway calls home. While Gateway enjoyed some of the unexpected consumer PC segment health that Dell and
heralded in the fourth quarter, Gateway's margins will suffer from new tactics of lowering its cheapest models 5% below average industry prices.
"Under their new strategy, I have my doubts that they'll return to profitability," says Joe Beaulieu of Morningstar, who advises investors to avoid Gateway shares. "They want to play the low price game with Dell, but it's not going to work. Dell has a much leaner operating structure and more influence over its component manufacturers."
CEO Ted Waitt said in an interview with
Thursday morning that the company had grabbed considerable market share in February. He argued that he was following up a profitable fourth quarter of 2001 and a scale-back of Gateway's cost structure with market share expansion. Investors would be hard pressed to disagree with the notion that Gateway needs to recapture a bigger stake in the market. According to IDC, Gateway's fourth-quarter 2001 U.S. market share fell to 6.3% from 8.8% in the fourth quarter of 2000.
"Gateway is tied very heavily to the consumer market, and as long as consumer demand remains soft, it's going to get hit harder than others that have diversified," says Gartner Dataquest's Mark Margevicius. He doesn't believe Gateway's woes are exclusively the market's fault, however. "My big problem with Gateway is that they've tried to be all things at one point. They're constantly shifting their strategy. At one point they were going for the corporate market, at one point beyond the box, then services, and now we're back to price."
This extends Gateway's reorganization and refocusing efforts to a second year. The company ousted its management team early in 2001, cut back its international competitive efforts and reduced operations by cutting four call centers, laying off 25% of international employees and eliminating 15% of its domestic workforce.