Full Transcript of Gateway’s 3Q05 Conference Call - Q&A (GTW)

Nov.14.05 | About: Gateway Inc. (GTW)

Here’s the entire text of the Q&A from Gateway’s (ticker: GTW) Q3 2005 conference call. The prepared remarks are here. We recognize that this transcript may contain inaccuracies - if you find any, please post a comment below and we’ll incorporate your corrections. And please note: this conference call transcript is a Seeking Alpha product, so feel free to link to it but reproduction is not permitted without the explicit permission of Seeking Alpha.

Question-and-Answer Session


Okay. Thank you, sir. Ladies and gentlemen on the phones, if you’d like to ask a question at this time, please key star then one on your touchtone phone. All questions will be taken in the order in which they are received. Once again, for a comment or a question, it’s star, then one.

Sir, I have your first question today coming to you from Mr. David Bailey.

Q - David Bailey: Yes. Thank you very much. Your retail mix was up only a little bit compared to last quarter, yet your gross margin was down about 170 basis points. Why was it down so much? And what does this mean for gross margin in the retail heavy fourth quarter?

A - John Goldsberry: Okay. So the sequential decline in gross margin percentage was in part due to the increase in retail, which of course has lower margins, but it also reflects declines in our gross margins in professional, and to a lesser extent in retail. The professional business remains a very, very competitive business. We believe that our margins in professional will remain low for some period of time. As concerns that the smaller decline that we saw in retail margins, honestly, I’m not concerned about that. We think those will bounce back. I guess what was not mentioned was our actual margins in direct improved sequentially. So that business is actually showing better margins.

Q - David Bailey: So can you give us some idea of where you directionally, where you think it’s going to go in the fourth quarter given all these factors?

A - John Goldsberry: Well, needless to say, given the likely strength of the retail business in Q4, I would expect mix to drive that margin percentage down further. It is also possible that we could see some modest further decline in margin in professional.

Q - David Bailey: Thank you.


Okay. Thank you. Sir, your next question comes from Rebecca Runkle.

Q - Rebecca Runkle: Good afternoon. Thanks. Just a couple of questions. First, John, just a clarification. The $1 million gain that you alluded to during your discussion, I’m assuming that that’s included in the $0.04, and if we back that out it’s closer to $0.03 from an operating standpoint?

A - John Goldsberry: That would be correct.

Q - Rebecca Runkle: Okay. And then I want to try to get my arms around some of what’s happening in the direct business. You just mentioned that margins went up in the direct business and that was some good news on the margin front; yet if we just looked at pricing, that was down significantly sequentially. So can you just provide more color in terms of what you’re seeing on the pricing front and then what drove the margin improvement?

A - Wayne Inouye: Rebecca, this is Wayne.

Q - Rebecca Runkle: Hi, Wayne.

A - Wayne Inouye: How’s it going? I think if you look at the marketplace today, you’ll see that there’s been a fairly significant shift in the way that brands are now attacking or going after business in the direct market. I’ve said this for a long time. It’s impossible to compete with retailers in the direct space in the popular price segments. So in terms of direct in consumer space, if you want to make any money at all, you really have to sell things to consumer that retailers do not provide. And I believe that you’ll see most advertisements in the marketplace today reflect that, advertising higher end products, more feature-rich and with a focus on higher price notebooks. So, and I believe that will be a trend in the direct space. The area you can make money in the direct space, I believe, is small business. There are still issues that we have internally to focus on that, but I believe that is still a market to target.

Q - Rebecca Runkle: What are you seeing from Acer there, Wayne, in the U.S.?

A - Wayne Inouye: We see them from time to time. They do not represent a big threat to us at this point. But we certainly are not ignoring them.

Q - Rebecca Runkle: Okay. Great. Thank you.


Okay. Thank you, ma'am.

Operator Instructions Sir, I have your next question coming to you from Derek Winder.

Q - Derek Winder: Hi. Three financial questions. The gross interest expense for the quarter, the depreciation and amortization for the quarter, and then the CapEx for the quarter, and the outlook for the calendar year ’05 and ’06 on CapEx.

A - Wayne Inouye: John, I’ll let you answer that.

A - John Goldsberry: Bear with me a second. Okay. Focusing on, I believe your first question was interest expense. Interest expense was 1.6 million in both Q3 as well as in Q2.

Q - Derek Winder: Okay.

A - John Goldsberry: Your next question was depreciation?

Q - Derek Winder: Depreciation and amortization.

A - John Goldsberry: Okay. Depreciation and amortization, as you probably already know, was 14.7 in Q2 but declined to 10.5 in Q3.

Q - Derek Winder: Okay. And then CapEx, what was it for the quarter, and then the outlook for calendar year ’05 and ’06?

A - John Goldsberry: Okay. CapEx increased from 4.8 to 8.2. And I guess we’re going to refrain from making a projection of that figure for Q4 or for next year.

Q - Derek Winder: Okay. Thank you very much.


Okay. Thank you, sir. Your next question comes to you from Mr. Charles Wolf.

Q - Charles Wolf: Yes. What percentage of your gross profits came from beyond the box this quarter?

A - Wayne Inouye: That’s a great question, Charles.

Q - Charles Wolf: You’ve reported it in every past quarter, so I -- but I couldn’t find it in the release.

A - Wayne Inouye: We refrained from publishing it this quarter. I can tell you that the revenue on what we call non-PC products, beyond the box products, on a sequential basis grew about 10.2 percent, and on a year-over-year basis it’s up close to 6 percent.

A - John Goldsberry: Was your question in terms of gross margin dollars or revenue?

Q - Charles Wolf: My question was gross profit dollars.

A - John Goldsberry: Okay. I’ll interpret that as gross margin dollars.

Q - Charles Wolf: Fine.

A - John Goldsberry: Yes. 70% was from non-PC --

Q - Charles Wolf: Does that include CE as well?

A - Wayne Inouye: There’s virtually no CE. I mean, CE is --

Q - Charles Wolf: Okay, fine.

A - Wayne Inouye: CE year-over-year is down by about 94 percent.

Q - Charles Wolf: So it’s essentially out of there?

A - Wayne Inouye: That’s correct.

Q - Charles Wolf: Okay. Fine. Thank you.

A - Wayne Inouye: You’re welcome.


Okay. Thank you. We’ll go to Mr. Michael DelBono.

Q - Michael: Hi, there. I was just trying to understand a little bit more the plans to invest in this plant in the U.S. Two quick questions on that. One, why build in the U.S. when you’re right next door to a great cheap labor location? And two, you’re talking about you’re building this to serve the professional segment, which you pointed out during your presentation was a little margin and will continue to be a little margin segment in the foreseeable future. So why focus on that -- I guess the question is, why focus on that segment and then why build the plant when you have a cheaper alternative just a few miles down the road?

A - Wayne Inouye: This is Wayne Inouye. One, we’ve never said we’re going to build a plant. All right.

Q - Michael DelBono: Manufacturing facility, I’m sorry.

A - Wayne Inouye: Yes. We’re committed to a manufacturing facility. But it’s a lot different than spending money to build a facility.

Q - Michael DelBono: Fair enough.

A - Wayne Inouye: One. Number two, in terms of cheap labor, the labor rates in Mexico are less expensive. We have had difficulties managing the quality of the product coming out of Mexico. And we believe that there’s zero tolerance for product quality issues in the professional sector. So we have taken essentially a zero tolerance policy on quality. Right now, with a great deal of supervision, we’re getting it out of Mexico. We believe long term we are better off managing this ourselves. If you look at the component of labor of any products that we sell now, it’s a relatively small part of the product. And we believe that the quality issues offsetting service costs will far outweigh a location in the United States. We also believe the supply chain is much better positioned in the U.S. versus Mexico.

Q - Michael DelBono: Okay. Thank you.


Okay. Thank you, sir. Sir, your next question comes from Les Santiago.

Q - Les Santiago: Hello. Could you give me some more color on the outlook for the direct segment? I mean, do you expect margins to continue going up next quarter? Is this sustainable, this trend that you saw this quarter? And when exactly do you expect to see small business kind of kick in as far as the segment is concerned?

A - Wayne Inouye: Hey, Les, this is Wayne. How you doing?

Q - Les Santiago: Good, thank you.

A - Wayne Inouye: A couple of things. On direct, our focus is, one, on a year-over-year basis, we’re still down. We believe that it will take some time to get back to former levels in the direct business. But our real focus in the direct market is to figure out how to make money, or not lose money in the direct segment. And I believe we’re very, very close to doing that. So really our focus is not so much revenue but it is on the overall operations and profit that we can generate in the direct segments.

Q - Les Santiago: Okay. And then as far as SNB is concerned, you don’t expect that to become a big driver in the near term? It will take a few quarters?

A - Wayne Inouye: Yes. Well, the end part is not something that we’re focused on through our direct channels; it’s really the yes part. You know, it’s really 100 case and below. We do believe it will take some time to ramp that business.

Q - Les Santiago: Okay. And then as far as your SG&A expenses are concerned, where exactly do you see further potential reductions? I mean, you’re running very, very lean right now. And I’m just wondering is there potential for further reductions, or are you pretty much done as far as that SG&A line is concerned?

A - Wayne Inouye: I’ll let John respond to most of that. But I do believe there are still opportunities for us as a company. And more importantly, I believe that we can sell a whole lot more product with the number of people we have in place. The math ratios would indicate that we can drive our SG&A down as a percentage of our business considerably from the point we are today. But I’ll let John answer the -- answer your questions direct.

A - John Goldsberry: Yes. If you look at the SG&A expense, it declined for a couple of reasons, but it was mostly in corporate G&A. BU expenses which are largely selling expenses were flat or even up. Our corporate G&A expenses declined for a variety of reasons including lower headcount expense, lower deferred compensation expense, lower legal expenses, relocation costs and various other items. There’s no question in my mind that we can continue to drive our corporate G&A expense down. Some of those things, to be honest, will happen quite naturally. If you look, for example, at our deferred compensation expense, which largely has to do with stock that was granted to eMachines executives in the context of the merger; that has been vesting over time, and so we’ve been taking a deferred comp expense. And that will largely be behind us by the end of this year. But in addition to that, which will happen naturally, we’re certainly committed to driving our SG&A expense down further, and believe there are opportunities to do so.

Q - Les Santiago: Okay. Thank you.


Okay. Thank you. Operator Instructions Sir, I have a question from Mr. Charles Wolf.

Q - Charles Wolf: Yes. I’m trying to understand this Microsoft arrangement. As I understand, you have to spend the money in order to get the reimbursement. But why do you have a separate line item for Microsoft if indeed you’re spending that money on whatever, SG&A?

A - Wayne Inouye: It wasn’t by our choice.

A - John Goldsberry: Well, let me attempt an explanation. We negotiated the Microsoft agreement as a strategic alliance, market development type agreement. But it was negotiated in the context of legal claims that we had in connection with past activity. The agreement as a result is a strategic alliance agreement, but it’s one that combines elements both of a strategic alliance agreement as well as a settlement of claims. The net result is in today’s accounting environment, we’re no longer allowed to make a judgment call as to how to apportion it between these two different aspects. And therefore, unfortunately, we need to leave it to investors to make their own assessment as to how to apportion the agreement between the two different characteristics. But I guess what I would tell you is, one, as you make your own assessment, you got to keep in mind that this agreement is a strategic alliance market development type agreement despite also including a settlement of claims element. That’s one. Two, we certainly continue to get support from Microsoft as has been mentioned at other times in this conference call in terms support for our advertising campaign for the tablet. Okay. And then lastly, it’s cash, which we’re certainly delighted to get.

Q - Charles Wolf: Okay. Thanks a lot.


Okay. Thank you, sir. Sir, I have your next question from Michael DelBono.

Q - Michael DelBono: Hi. I had another question, please. You said during the call at one point we’re one of the lowest cost providers. And – other you’ve issued. Would you be willing to help us understand a little bit by segment how your costs would compare to, say, an HP, or by product line? I don’t know. Whatever.

A - Wayne Inouye: Yes. We don’t break that down.

Q - Michael DelBono: Would it be fair to say that your costs are lower than someone like HP?

A - Wayne Inouye: I believe that would be a fair assessment.

A - John Goldsberry: I know one thing certainly, what you can very easily do is look at our SG&A expense as a percentage of revenue and compare that to HP’s documents. That’s obviously only one component of the overall cost comparison, but it certainly is an important one.

Q - Michael DelBono: Right. I was thinking a little bit about more about COGS. Okay. Thanks.


Okay. Thank you, sir. Ladies and gentlemen, if there are no further questions, I’d like to turn the conference back to Ms. Marlys Johnson.

Marlys Johnson, Investor Relations

Thank you, Rob, and thank you everyone for joining us today. A replay of this conference call will be available on the home page of the www.gateway.com website for 24 hours, and thereafter archived on the investor relations web pages. There will be a telephonic playback of this conference call beginning tonight at 7:30 p.m. Eastern time and running until midnight Eastern Time on Sunday, October 30th. That number is 617-801-6888, and the pass code is 56128850. Have a good evening.


Okay. Thank you, ma'am. And thank you again ladies and gentlemen. This brings your conference call to a close. Please feel free to disconnect your lines now at any time.