Gateway, Inc. reported results for its second quarter ended June 30, 2007. Revenue amounted to $841 million, down from $919 million a year earlier. Retail revenue grew to $614 million from $592 million a year earlier, but was offset by continuing revenue declines in Professional and Direct.
Gross margin for the second quarter was 7.6 percent, compared with 4.9 percent in the prior quarter and 5.5 percent in the second quarter of 2006. Retail gross margin for the second quarter was 5.6 percent, compared with 3.1 percent in the prior quarter and 3.7 percent a year ago. Operating income was $5.9 million, compared to a loss of $6.7 million in the first quarter and a loss of $6.9 million a year earlier.
Net income equaled $1.9 million, or 1 cent per diluted share. This compares with a net loss of $8.6 million, or 2 cents per diluted share in the prior quarter, and a net loss of $7.7 million, or 2 cents per diluted share a year earlier.
"In the quarter in which Gateway sold its 50 millionth PC, we improved our year-over-year operating results for the third consecutive quarter," said Ed Coleman, Gateway's chief executive officer. "We showed revenue growth and significant margin improvement in our Retail business. While revenue declined in our Professional and Direct segments, we significantly increased Professional segment contribution by increasing gross margin and reducing expenses. These improvements, coupled with a continuing focus on managing our costs, resulted in this quarter's profitable performance."
SG&A expense in the second quarter was $66.6 million, or 7.9 percent of revenue, up from $65.1 million in the prior quarter, and up from $66.1 million in the second quarter of 2006. The year-over-year increase is primarily due to an $8.4 million release of a prior disclosed sales tax reserve in 2006, which was not repeated in 2007, and an increase in depreciation expense related to the implementation of a new ERP system, partially offset by reductions in marketing and headcount-related expenses, settlement expenses and legal fees.
As part of Gateway's 2005 Marketing, Development and Settlement Agreement with Microsoft, second quarter results included the continuing quarterly benefit of $8.6 million.
The company sold 1,088,400 PC units in the second quarter, down 13 percent sequentially and down 7 percent year-over-year.
Segment Results
The Retail segment, which includes international sales, delivered second quarter revenue of $614 million, down 20 percent sequentially and up 4 percent year-over-year. Retail PC unit sales equaled 938,700, down 14 percent sequentially and down 1 percent year-over-year. The sequential decrease in units and revenue reflects seasonal factors. The year-over-year decrease in units and increase in revenue reflects a shift to higher opening price points.
Retail gross margin in the second quarter was $34.6 million or 5.6 percent of revenue, up from $23.6 million or 3.1 percent of revenue in the prior quarter, and up from $21.9 million or 3.7 percent of revenue in the second quarter of 2006. Retail segment contribution was $26.0 million (after Retail SG&A expenses of $8.6 million), up from $19.0 million in the prior quarter (after expenses of $4.6 million) and up from $17.2 million a year ago (after expenses of $4.6 million). The sequential and year-over year improvement in gross margin and segment contribution is primarily due to component cost and freight savings, as well as product and brand mix changes within the segment, partially offset by increased SG&A expense.
The Professional segment delivered revenue of $173 million in the second quarter, up 11 percent sequentially and down 31 percent year-over-year. Professional PC unit sales equaled 119,400, up 7 percent sequentially and down 36 percent year-over-year. The sequential increases in revenue and unit sales were predominantly due to seasonal factors and higher average unit prices due to product mix. The year-over-year decreases in revenue and unit sales were due to greater selectivity in contract bidding and desktop production constraints related to the ramp-up of production at our Nashville facility, partially offset by higher average unit prices due to product mix. Production constraints at Nashville resulted in a significantly higher backlog than normal for Professional at the end of the quarter.
Professional gross margin was $21.1 million or 12.2 percent of revenue, up from $10.8 million or 6.9 percent of revenue in the prior quarter and up from $11.1 million or 4.4 percent of revenue in the second quarter of 2006. Professional segment contribution was $8.4 million (after Professional SG&A expenses of $12.7 million), up from a loss of $3.0 million in the prior quarter (after expenses of $13.8 million) and up from a loss of $8.3 million a year ago (after expenses of $19.3 million). The sequential and year-over-year improvements in gross margin and segment contribution were due to management's decision to pursue opportunities on a more selective basis, resulting in better margin management, as well as reduced headcount-related expenses and other expense controls. Additionally, margins in the second quarter of 2006 were negatively impacted by $10 million in one-time warranty and royalty adjustments.
The Direct segment delivered revenue of $54 million, down 38 percent sequentially and down 30 percent year-over-year. Direct PC unit sales equaled 30,300, down 35 percent sequentially and down 15 percent year-over-year. The sequential and year-over-year declines in units and revenue reflect declining marketing spend and desktop production constraints at our Nashville facility, as well as declining deferred extended warranty revenue and Internet access subscription revenue share.
Direct gross margin was $8.2 million or 15.1 percent of revenue, down from $15.3 million or 17.7 percent of revenue in the prior quarter and down from $17.6 million or 22.9 percent of revenue in the second quarter of 2006. Direct segment contribution was $4.1 million (after Direct SG&A expenses of $4.0 million), down from $8.7 million in the prior quarter (after expenses of $6.6 million) and down from $9.3 million a year ago (after expenses of $8.4 million). The sequential and year-over-year decline in gross margin and segment contribution reflects declining deferred extended warranty revenue and Internet access subscription revenue share, partially offset by reduced headcount-related and marketing expenses.
Working Capital
Working capital at the end of the quarter was $314 million, which was unchanged from the end of the first quarter.
Accounts payable and supplier receivables both dropped to more normal levels from the distorted levels caused by component receiving and invoicing delays in the first quarter. Accounts payable were $610 million (71 days) down from $861 million (81 days) as we shortened our payables in support of our ODM relationships. Supplier receivables decreased to $275 million (32 days) from $479 million (45 days) due to timely invoicing of components sales to our ODMs. Accounts payable, net of supplier receivables, decreased to $335 million from $382 million at the end of the first quarter.
Net accounts receivable were $314 million (34 days) up from $303 million (27 days) at the end of the first quarter. Net inventory closed at $160 million (19 days) up from $131 million (12 days) at the end of the first quarter due to increased finished goods inventory. Other current assets dropped to $111 million from $203 million at the end of the first quarter in part due to improved collection of vendor credit programs.
The net result is that cash and marketable securities decreased to $255 million from $317 million at the end of the first quarter, as more working capital was utilized in assets supporting the business.
Cash flow, defined as earnings before interest and taxes, plus depreciation and amortization, minus capital expenditures, rose to $7.7 million, an increase of $17 million from ($9.3) million in the first quarter, and an increase of $23 million from ($15.3) million in the second quarter of 2006. This reflects improvement in operating income, greater depreciation and amortization and a lower capital expenditure budget.
At the end of the second quarter, Gateway had approximately $84 million in income tax reserves attributable to past periods. Gateway is in the process of concluding audits of these past periods and believes that a significant portion of these reserves will be released over the next few quarters, which would benefit its reported net income.-Gateway release
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