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Executives

Marlys Johnson, Investor Relations

John Goldsberry, Chief Financial Officer

Richard D. Snyder, Chairman, Interim Chief Executive Officer and President

Analysts

David Bailey - Goldman Sachs

Rebecca Runkle - Morgan Stanley

Bill Fearnley - FTN Midwest Securities

Peter Labe - Nutmeg Securities

Richard Gardner - Citigroup

Andrew Neff - Bear Stearns

Charles Wolf - Needham & Company

William Schmitt - CIBC World Markets

Derrick Weiszhaar

Gateway Inc. (GTW) Q1 2006 Earnings Conference Call April 27, 2006 6:30 PM ET

Operator

Good afternoon. I would like to welcome everyone to the Gateway First Quarter Earnings Conference Call. Your lines have been placed on mute. There will be question and answer session at the end of the speaker’s remark. I would like to turn the program over to Marlys Johnson, with Gateway Investor Relation. Good afternoon Ms. Johnson.

Marlys Johnson

Good afternoon Kevin and thank you. Good afternoon everyone and welcome to Gateway’s first quarter earnings conference call. If you have not seen a copy of today’s earnings release, please go to the news and information pages on our gateway.com website. Joining me today, is Chairman and Interim Chief Executive officer, Rick Snyder, Senior Vice president and Chief Financial Officer John Goldsberry.

Before we begin, I would like to remind the audience that the presentation you are about to hear, contains forward-looking statements based on current management expectation that involves risks and uncertainties, as well as assumptions that if they do not materialize or prove incorrect could cause Gateway’s results to differ materially from those expectations. All statements other than statements of historical facts, are statements that could be deemed forward-looking statements. Information about factors that could cause future results to differ from these expectations can be found in today’s earnings press release and the company’s report that are filed with the Securities and Exchange Commission.

During this call, we may discuss certain non-GAAP financial measures that management uses as a basis to evaluate the company’s financial performance and forecast future period. If applicable, you can find additional information on these non-GAAP measures and a reconciliation of these measures to GAAP measures in either today’s earnings release and/or on the quarterly reports page of our website.

I would now like to turn the meeting over to John Goldsberry, who will review the Gateway’s first quarter financial results followed by Rick Snyder who will provide overall commentary on Q1 development. Thereafter, if time permits we will allow questions from the audience. To allow greater participation, please limit your questions to one per person. John?

John Goldsberry

Thank you Marlys. Let me start by summarizing our overall financial results for Q1. We had a mix quarter. On the one hand, our retail business which accounted progress 70% of our revenue continued to excel both domestically and internationally. Retail exceeded our budgeted revenues, achieved nice market share gains and had good margins. Our direct business had its budgeted sales as we reposition this business. On the other hand, our pro business was short of its budgeted revenues and continued to generate unacceptably low margins.

Simply revenue came in at $1.078 billion, down just 4% from our seasonally strong Q4 and up 29% from a year ago. A year-over-year revenue growth was driven by our retail business but was constrained by continued weakness in direct and pro. We had an operating loss of 15.7 million larger due to losses in pro and 14 million of litigation settlement expenses, with higher other income and tax benefits, we had a net loss of 12.3 million. Diluted EPS came in at a $0.03 loss. Adjusting for the litigation expenses, we essentially broke even in Q1.

Now let me walk through the quarter’s operating results beginning with PC unit volumes. Gateway sold 1,379,000 PC units in Q1, an increase of 1.5% sequentially and up 47% from a year ago. Despite seasonal trends which favored Q4 sales, our unit sales were up sequentially due to market share gains in retail. According to recent preliminary IDC shipment data, Gateway was the fastest growing US PC company among the top 6 with 48% year-over-year growth and an 8% market share which was up 2.3 points from 5.7% a year ago. In addition, Gateway was the only US vendor among the top 6 who grew sequentially in the market with decline 10%. These market share gains are strong evidence that are award winning products continued to be well received in the market place.

Let me add the income statement, Q1 revenue was a 1.78 billion, down 4% from Q4 and up 29% from a year ago, the sequential decline was driven by lower average unit prices which were significantly offset by the market share gains in retail. The year-over-year increase, of course, is driven by market share gains in retail that was partially offset by revenue declines in pro and direct.

Gross margin was 78.7 million in Q1, up from 70 million in Q4 and down from 80.4 million, a year ago. Gross margin percentage increased to 7.3% from 6.2% in Q4 but was down from 9.6% a year ago. The sequential increase in gross margin percentage was due to the 16.7 million charge in Q4 that was associated the HP agreements. The year-over-year declines in gross margins were due to margin weakness in pro as well as strong growth in our retail business which of course has typically lower margins.

SG&A expense for Q1 was 103 million or 9.6% of revenue, down from 113 million in Q4 that also compares to 88.1 million last year; this sequential decrease in this quarter was due to 24.8 million increase in tax accruals in Q4, that was partially offset by the 14 million in litigation expenses that we incurred in Q1.

Net result is we had an operating loss of 15.7 million in Q1 compared to a loss of 29.3 million in Q4 and a loss of 7.8 million in the first quarter of 2005. After other income of 2.2 million and tax benefits of 1.2 million, the Q1 net loss was 12.3 million which compares to a loss of 20.9 million in Q4 and a loss of 5.2 million in Q1 of last year. Q1 diluted EPS for the loss of $0.03 to a large extent reflecting the $0.03 loss associated with the litigation expenses.

Let me now discuss our business unit results. Retail revenue was 767 million in Q1, or down 3% sequentially but up 61% from a year ago. Contribution income was 41.1 million in Q1 which was up 1% from 40.6 million in Q4 and up 52% from Q1 of last year. The sequential decrease in revenue reflects, the lower average unit prices, that however will mitigated by strong market share gains, the year-over-year revenue increases were due to market share gains in US retail. The contribution income, improvement on a year-over-year basis were largely driven by the higher revenue.

According to the most recent MPD data, our US retail PC units were almost 40% year-over-year, our Q1 market share increased to 25.6%, up from 23.1% a year ago. In desktops, we had a year-over-year unit growth of 13.9%. Our market share grew to 35.6%, up from 34.4% a year ago. In notebooks, our unit sales grew to 166%, Q1 market share was 16.1% which was an increase of 7.2 points from 8.9% a year ago. Sequentially, we grew notebooks in US retail by 20% despite the overall market declining 7%. This again, is further evident with our award-winning notebooks are garnering significant attention and integration of retail.

In pro, pro revenue was 2.2 million in Q1, down 7% sequentially and down 4% from a year ago. Contribution income was a loss of 12.2 million in Q1 compared to a loss of 16.3 million in Q4, and a gain of 6.3 million, a year ago. The year-over-year decline in revenue was predominantly due to market share erosion, the year-over-year decline in contribution income was primarily driven by margin declines in response to competitive pricing pressures, and trend in the pro segment towards consolidate purchasing. As Rick will discuss some more detail, we have recently made a management change and professionals and we are aggressively addressing gross margins and cost structures.

In direct, revenue was 1.09 million in Q1, down 6% sequentially and down 27% from a year ago. Contribution income was 9.5 million in Q1, up from 5.7 in Q4, but down from 13.1 million in Q1 of last year. The year-over-year decline was due to changes in our product and marketing strategies, the sequential increase in contribution income was driven by improved gross margins which were offset by lower revenues; the year-over-year decline in contribution income was primarily due to lower revenues.

We also have made a management change in direct and we are repositioning this business to focus on more fully-featured solutions. Now, this is a strategy that worked well for Gateway in the past and also complements our retail business. Regarding our balance sheet, cash and marketable securities increased by 4.5 million to 5.90 million at the end of the quarter, this was largely driven by 37 million decrease in inventory and 20 million decrease in other current assets, offset by a $46 million decrease in accounts payables and a $7 million increase in accounts receivable.

Let me now turn the call over to Rick Snyder who will provide additional commentary on the quarter.

Richard Snyder

Thanks John, but first I would like to thank our shareholders, employees and partners for having us help, have a quarter where we could grow so dramatically. 2 or 3 areas that I would like to cover first is, I’ll talk about some of the business units and sectors and how they performed, because I think that’s important, then I’d like to make some comments on the overall company in terms of some improvements for making their, the CEO search and just some general commentary about the future. First of all, if you look to our business units, John covered each of the 4 major units, I’ll actually start with the most challenged, the positive in terms of, lets get the issues on the table right at the start.

On the professional marketplace, we continue to add margin expense in market share issues, we just need to go and fix pro. The plan is to refocus on profitable growth sectors with the right customer segments to look at our business processes, how we can streamline and make those more efficient, and to have a better cost structure to make the whole things work well together in terms of delivering positive financial results both to the top line and the bottom line. One of the first steps that I wanted to take in addressing these issues that I mentioned from the day I started about the need to fix pro, is we made a leadership change there, Jim Burdick joined us on April 3rd as the FCT a professional, Jim’s got a lot of experience in the Information Technology marketplace, he previously served as a VP of worldwide distribution on America Sales at Agilent, he was an Executive VP of sales and marketing at MesoSystems Technology and then he spend 17 years at Memec Group Holdings which is a company that was in the Semiconductor distribution business. So I am very excited to have Jim on board and he is off to a running start.

On the direct side of the business, our goal to return to our roofs, our legacy of being a successful high-end solution provider to PC enthusiast and other high-end users, I believe this will be a complement to our retail business in the sense of, instead of overlapping with our retail business which repositioned at the higher end, so then we can serve customers from top to bottom in the market place. The strategy would also help us with our supply base I believe, by allowing us to be more involved in brining leading-edge technology at the marketplace and really being a disruptor out there in terms of brining unchanged and making more exciting things happen in the PC market. And to help make all this happen, again I mentioned, we’ve made a leadership change in pro, we’ve done the same thing in the direct sector and to do that, and we are able to get Bart Brown to rejoin Gateway.

Bart is a longtime Gateway veteran. He actually joined Gateway originally back in 1987 before it was called Gateway. He came up through the sales ranks, he then ran operations on the product marketing side and the marketing side of the business, and then in 2000 he was the Senior Vice President, in-charge of our consumer and direct businesses, the phone business. So I am excited to have Bart on board, to come take charge of that business and make things happen. So both the troublesome areas, I think we are making good progress, we are taking action steps and we are going to continue that process, outlining more detail plans as we evolve.

Turning to the other business units on the positive side, only actually the very positive side would be our retail and international performance, we continued very strong performance in growth, John mentioned those, the numbers, the market share growth and the sequential increases. We thought those were great results and very excited about how we achieved that. And we also did very well in notebooks, we did very well in the TFT business in terms of our monitors, we were up a 114% year-over-year in the TFT side of our business.

The international business continues to go, go well in terms of growing and being strong. We entered new geographies, we entered the French market with a couple of hundred stores with, in each case with two different retailers so we’ve got over 400 stores now selling Gateway products through retail France. We continued to do well in the UK and Japan in terms of extending in our outlets there, and working with people on those marketplaces.

Let me just make a couple of comments about some overall operational improvements we’re working on in the company. There are two dimensions specifically one of which we’ve previously announced, which is the idea of having a dedicated assembly facility in the United States. We believe that will be on very important to the professional and direct sales efforts and then improving bottom line and top line performance. We think we will be able to add better customer experiences for people, better customization and better delivery times for people. So we are excited about the ability there to assemblers again in the US and leverage vendor names, inventory sides in a positive manner. I would expect to have further information and announce the specifics on this during the month of May. We’ve even communicate the detailed plans on what we are doing on that front.

Another area we are exploring, we are not in a position to announce the details of this one but we are looking strongly at having Gateway get back in the tacticular business in a positive way. What we would like to do is to establish a best practices tacticular center, staffed like Gateway employees to work with our outsource partners. The ideas of small center that would automated tools on board, to offer better customer experiences to the extent they want to use automated tools and to the extent they still want to talk on the phone they can talk directly to Gateway employees which I believe will get us better efficiencies in terms of feedback to our supply base and our engineering staff on how to improve our products and also provide great learning tools to our outsource partners.

In addition to that, we continue to work on several key IT projects that will be taking place over the next 12 months. I believe we’re making good progress on those products and they will be fundamental to some exciting developments in the company I believe over the next year and further.

On one topic that often comes up is the issue of the CEO search, because I’m interim CEO and why I would say I’m that, is there is a broad base search taking place to find a permanent CEO. The timeline for the search is hopefully to have a permanent CEO on board by the end of the summer, when I say hopefully that’s a normal timeframe to look at something like that. I’m actually enjoying my experience here and I think we are seeing positive results and I’m actively involved in the company and will continue that path. But I look forward to having more talent join the company as we get into later in the summer. And when that happens, I hope to continue as Chairman in the board and be available for that person to make sure there is a successful transition.

With respect to looking further out in the future, our retail and international business units are growing and doing extremely well. As I said, to start challenges pro and direct and we have been struggling with those for several quarters. I think we are fundamentally digging down to the issues, making the changes we need to make that will allow those units to become successful. I think we are going jump on these but its going to take the next three or four quarters, of gradual improvements until we start getting kind of results I would like to see in terms of good top line growth and good profitability. Well, I think we are on our path to get there and I’m excited about those prospects for the future.

Overall, I’m excited the future for Gateway and confident that we can do the right things to make things happen. I’ve been interim CEO now for 2 months. I’ve seen many, many positives the strength in our brand, the strength of our team. We have a great group of people here that are excited about the opportunities in front us. And I think they are prepared up to take on the challenges we have. So what we need to do is just get the business back to a simpler and more focused basis and then execute really, really well. And so we are going to go back our roots more and more in the sense that lets just find something simple to do in terms of the highest customer satisfaction with the latest technology products, deliver great value and quality and be successful.

I think we are the stars on the path and I think we can deliver on that path. So with that, I think we’d be happy to take some questions.

Question and Answer Session

Operator

(Operator Instructions).

And your first question comes from the line of David Bailey.

David Bailey - Goldman Sachs

Yeah, thank you very much. Just one quick clarification and then a question. The clarification is could you tell us what the cash flow from operations were this quarter? And then also, you said in the press release and that you are directing commercial business that are strategic to your future success and I was hoping if you could help us understand that a little bit and might it be better off that you may be close one of those businesses down to improve your profitability?

Richard Snyder

David this is Rick, I will take the second further question first. As we get the information for you on the other part. I think it’s critical that we look at bringing back direct and pro, I think the strongest client computer companies for the future and our industry will be one that can service multiple sectors effectively. And I actually believe they compliment one and other. I think there is a strong correlation between having direct these successful at the high-end and then support it through the middle and the entry levels in the market by a strong retail business. Both of those have opportunities to allow us to have better and stronger cost in the professional sector through economies of scale and learning. So, I think its really important to look at how we can leverage these businesses in a positive way, I don’t think its something we should give up on and I think we should work hard on that in the next few quarters of showing some positive results to the whole world that this can work well. And the second piece with your question…

John Goldsberry

That concerns the cash flow from operations in Q1 that was a positive 9.7 million.

David Bailey - Goldman Sachs

Great thank you very much.

Operator

Your next question comes from the line of Rebecca Runkle.

Rebecca Runkle - Morgan Stanley

Good afternoon. Just 2 quick questions, first Rick, you’ve commented that the ongoing CEO search are somewhat different in the last time we spoke, is it relates to you specifically, I was hoping if could just tell but, more clear that how you view your role, is it truly as interim CEO or do you still consider yourself a potential candidate for the full time success start and then I have a follow up.

Richard Snyder

I appreciate that question Rebecca as you recall at the main criteria that I had with respect to potentially being the permanent CEO was a family concern, a family issue and really looking at that. We look to that question and I have three children and it just was not going to work out for them.

Rebecca Runkle - Morgan Stanley

Yep.

Richard Snyder

So, in terms of prioritories in one’s life which is part of the values here at Gateway, as I always encourage people that family does need to come first, I mean I love what I do for living but you have to have your priorities. That, that wasn’t possible to move out of Michigan to make this happen. I am sure to that, as you can see from the some of the activities going on; I am actively engaged here as CEO and making things happen in building plans for the future and excited about it. And our key part of the search will be hopefully finding the right profiled person that can get excited about what I viewed are fairly commonsense plans. Someone can also by and to and be excited about.

Rebecca Runkle - Morgan Stanley

And I guess just a follow up as it relate to that, it sounds as one of that one on the, the top three records as, as you look for Canada is going to be someone here could encourage with you in the direction that you’ve already laid out in terms of direct and pro, et cetera and can carry that forward as supposed to shifting gears again in 6 months?

Richard Snyder

I would clearly echo that one. And again, I would reinforce that, I think most of what we’re doing commonsense, so that would be another benchmark I would use in terms of finding the right person. But this company does not need to take any more right or left turns; we need to go upward into the right in a very positive and aggressive fashion.

John Goldsberry

I would like at that as well.

Rebecca Runkle - Morgan Stanley

Last quick question, if you bear with me, and I just hope it goes to some of your comments about the direct strategy, will they mark, how are there would be helpful, I just, from the perspective that A), what are the growth in this industry today is coming from lower market segment and while the higher end signal offers a lot potential, we’re officing a lot of vendors move in that direction, you got the success of that or you guys dealt trying to make a move up there, you got the, the private gaming companies that are doing recently well, what’s the strategy to differentiate Gateway and actually for getting around the map in that sector, in a more meaningful way?

Richard Snyder

Yeah I feel good about that. I mean we have to make that map. So and the people coming back in borrow this one of the, the creators of that map. So I think we understand that very well. In terms of going back to that market place, it goes back to fundamentals of having fully featured solutions that when people look at them, they say, “Hey! This is just what I really want to buy”. Its very straight forward at that end of the marketplace to say let’s setup configuration starting as high as $4000 running down and to the sub 1000 point but not much below that or basically you have great configurations that get people excited. I think we can really make that happen, personally because of the size we are at now. I mean we did a 109 million in Q1 through direct. There is tremendous room for us to grow there in terms of opportunity and compared to the size of the direct marketplace particularly, we can leverage our size to be working strongly with the supply based, to be bringing new technologies and appropriately the right way, I don’t think we want to be the super ultra high-end that you might find with some of the specialty people. But there is kind of a mass markets in the enthusiast sector that was our core business in the past and I think we need to earn that back. But I think it’s available to us if we earn our stripes the right way by executing really well. And again, the people coming into this business know how to execute really well to go along with the great operations and actually executional things we’ve seen on the retail and international sides of our business. So that’s where the back of them and of our business is proven out through the great retail mile that we can leverage by putting the best of the two worlds together.

Rebecca Runkle - Morgan Stanley

Valuable, thanks gentlemen.

Operator

Your next comes from the line of Bill Fearnley, FTN Midwest Security.

Bill Fearnley - FTN Midwest Securities

Yes, good afternoon. Couple of questions here, one on the margin side. How did you folks find the component pricing environment for RAM, Hard Drive LCDs and then did you get any leverage from working from, with multiple processor vendors during this quarter? And where do you see the trend as we get ready for, back to school and that’s half of the thing and then I have a follow-up thanks.

John Goldsberry

Okay what we continue to see on average, something like 1.5% price drops per month during the quarter. So, from in my point of view that has followed the fairly normal pattern, there have been a few exceptions for that as that relates to processor situation, we continue to use both of the major processor companies are mix various quarter-to-quarter, we found processors availability to be much improved this quarter as compared with last.

Bill Fearnley - FTN Midwest Securities

Okay and then also on the unit breakout desktop versus notebook, can you give any more, can you give any more color on a segment basis, how the desktop notebook broke out for a segment?

Richard Snyder

Let me stop shy of conveying specific percentages; let’s just say that it tends to be highest in our direct business.

Bill Fearnley - FTN Midwest Securities

What tends to be highest in the direct?

Richard Snyder

The, the note notebook percentage has been highest in our direct business, followed by somewhat lesser percentages in pro and retail.

Bill Fearnley - FTN Midwest Securities

Okay and then one other question, you talked about the unit management I mean staffing changes. How is employee turnover, overall versus historical norms, as you change in the management teams, is turnover accelerating or just pulling down or is it staying the same? Thanks.

Richard Snyder

It’s largely stayed the same during the transition period, I would say one of the initiatives that I want to see in this company is to get people more fired up, so I think we are doing a lot of good employee programs and working hard to make this a more exiting and fun place to work. I mean that was one of the four or five things I covered when I started the position as to say, we just need to have more fun in the company and that’s not to say we having parties but to get people excited about seeing the opportunity here really enjoying what they are doing, because I think that’s an important element in seeing success in the company.

Bill Fearnley - FTN Midwest Securities

Thanks.

John Goldsberry

Well, maybe just to answer your question a slightly different way, I think people have responded very well to the management change, I think there was a feeling that we needed to bring in additional people to help us address our challenges in pro and to a lesser extent in direct, I think there’s a lot of enthusiasm for the fact that we are taking action to address those, those issues and people are therefore increasingly optimistic about the future of the company.

Bill Fearnley - FTN Midwest Securities

Then do you expect to use roughly the same rank in file staff to run the direct and professional business, as you go to recover the business here over the next two, three, four quarters.

Richard Snyder

We have a good team of people here and so that the issue is, yeah, we want to fully utilize the people we have as we grow those sectors will have to look at the question that how can we best leverage and move people around and I would hope over the longer term we’ll be adding people to the company.

Bill Fearnley - FTN Midwest Securities

Okay.

Operator

Your next comes from the line of Peter Labe of Nutmeg Securities.

Peter Labe - Nutmeg Securities

Yeah thanks. Rick, maybe you give us little help on resource question, but it seems to me that the direct business is just a huge opportunity for you, on the other hand they have to think of, advertising spending, how are you getting reengaged in that market, without spending much more?

Richard Snyder

Good question Peter, I appreciate the support to say there is a large market opportunity, I think that’s one of the areas we’ll be looking at as we come up with plans to say, my guess is, will meet the incremental investments in marketing to make this happen. But I think we can be cost efficient on how we approach these things. I think we can better deploy some of the marketing dollar we historically have deployed, I am looking to more of the viral tools, public relations as supposed to TV, people running through fields with boxes, I didn’t really view that as very high value-add marketing, at the extent we can take those dollars and use them more effectively, I think we can get real ROI.

Peter Labe - Nutmeg Securities

Okay thanks.

Operator

Your next question comes from the line of Richard Gardner.

Richard Gardner - Citigroup

Okay thank you, I think these are probably best for John. John first of all a simple one, I was wondering how much of the 14 million in litigation expenses is going to be recurring? And then secondly, as I take a look at your PC gross margin trying to back out the margin contribution from non-PC items, it looks like its down to about 2%, PC gross margin in the current quarter, down from 3% in the prior year and 7% the year before that, and I am just wondering what it is that causes your gross margin to be so much lower than the competition which is generally in the 10% to 15% range, is it extra inventory observations in our model, is it price protection, is it lack of scale, is it for curement practices and, what can you do to get that gross margin out in PCs over time?

John Goldsberry

You ask 2 questions, as it relates to the non-recurring element of the 14 million; I would describe that as all non-recurring. I want to make it clear that does not include what we would regard as continuing expenses associated with our legal stuff. Okay, as concerns the margins, I guess I am not sure, exactly how your are coming up with your figures, as it relates to our margin picture versus other players in the industry, needless to say, you have a very different margin structure associated with retail as compared with direct and professional. In the retail space, we are very comfortable with margins in the neighborhood of 6%. And we were very, very happy with the margins that we achieved this quarter, in retail and by that I mean both domestic and international retail. Our margin challenges really are not in retail, I would describe our margin challenges as being primarily in pro to a small degree also in, in direct. Direct margins were just a little bit below were we wanted them to be, our biggest, our biggest challenge is really in professional were we’re seeing, fairly significant margin declines reflecting competitive pressures and as we mentioned a trend towards both files. Having said that, those margins are at this point unacceptably low and we’re working to address ways to get those too much more acceptable levels.

Richard Gardner - Citigroup

But John, if you take a look at it not, not so much by customer segment, but just relative to your competition the margins are, are three or four times lower than your competition. Is it, and I am just wondering if you have any sort of sense of weather which related to scale or…

John Goldsberry

No, I mean there is no questions about it, there are some places where we have scale disadvantages vis-à-vis, vis-à-vis, the largest player in, in the PC space. I think it would be misleading however to suggest that the, the differences between our current margins and theirs are all due to scale. You can probably identify 4 to 5 points worth of, perhaps advantages that might be scale related. But at this point our margins are lower than that and I think to some extent our margins in pro are the result of our own making and what we’ve got to do is manage them better and identify segments where, where we resonate with our customers, focus on profitable segments with the due towards getting those up. As we’ve clearly indicated, we have made a management change there and we feel that those margins can be better managed then they were being previously.

Richard Gardner - Citigroup

And if I could just one more, and that is, you said that the margin issues in pro were somewhat of your own making, does that suggest that you’ve pursued some business that maybe even, is not producing the margins that you would like currently and if that’s the case, how long does it take to renegotiate this contracts or to get them turned around, so that you can improve the profitability profile of the business or, you just have to do that slowly every time as you bring on new customers.

Richard Snyder

I think in retrospective, its clear that there is some business we took on that was unprofitable business, we need better margin controls on that and we are taking a tougher attitude towards trying to do business just to drive revenue, I think the issues associated with getting our margins out are many, not particularly complicated. But they will take time to address, our view is getting professional to where we wanted to be is probably going to take, 3 or 4 quarters.

Richard Gardner - Citigroup

Okay thank you.

Operator

Your next question comes from the line of Andrew Neff. Andrew your line is open.

Andrew Neff - Bear Stearns

Sure. I guess if you can make any comments on the, just want to make sure that in you’re not in the guidance business anymore, any sort of forward-looking comments you want to make, I mean on the trends or tones or things like that.

Richard Snyder

Andrew as you know at the end of Q3, we adopted a policy of not giving guidance, we made an exception for Q4 just from a transition point of view, but we are going to stick with our policy of not giving guidance.

Andrew Neff - Bear Stearns

I guess the other thing is just; can you give a breakout of US versus international? Hello?

Richard Snyder

Yeah, we don’t want to be specific about that, if you look at our overall retail business as a rough indication, I would say 90% of it is domestic.

Andrew Neff - Bear Stearns

Just, I just trying to get some at the sequential growth was most of it attributable, was how much of it attributable to international? Just trying to sense your, your non seasonality just what was, just and how much of that just new markets that you added in are things like that.

Richard Snyder

You are talking about on sequential basis?

Andrew Neff - Bear Stearns

Sequentially, yes.

Richard Snyder

On a sequential basis where we saw growth in units was in the US.

Andrew Neff - Bear Stearns

Okay, and the reason, you are not going to give a US versus international that’s truly fairly standard breakdown is that, is there any reason you don’t even want to break that out?

Richard Snyder

Simply because we learn from the gather for our external reporting purposes and we just assume to stick with that.

Andrew Neff - Bear Stearns

Okay, and the option expense in the quarter, can you…

Richard Snyder

Very minor, as I think you know we accelerated options in Q3. So, the only option expense that we have relates to either, some options were that had strike prices below the level at which we accelerated options and then some options that were issued to later and the year and early this year.

Andrew Neff - Bear Stearns

Great, thank you.

Operator

Your next question comes from the line of Charles Wolf.

Charles Wolf - Needham & Company

Yes, I was looking at the segment results and I, that raises the question, I know this at the average selling price at retail is $660 whereas in direct its $1879, and I was wondering what are the reasons for that lot disparity professional, it’s just, I mean direct just about three times retail in terms of the ASP?

Richard Snyder

I think there are couple of factors that enter into that. One is the retail business tends to certainly have a heavy emphasis on the retail by its nature. It tends to have a heavy emphasis on opening price points. Having said that, I think we have done a very good job moving our retail business from being traditionally under sort of, eMachines models, heavily focused on opening price points. At this point, about half of our retail business in terms of revenues is Gateway branded which is at higher price point. Despite that, I would say that our direct business would have higher price points for a couple of reasons, one that certainly a formula significant attach rate which you see with direct sales as suppose to retail, where essentially the retailer gets the benefit of all of the attach. As was mentioned earlier in this conversation, the notebook desktop mix is heavily, is more heavily notebook-oriented in direct than it is in retail. And of course given differences in price points between direct and notebooks that also favors a higher price point in direct. So I think it’s a combination of those things.

Charles Wolf - Needham & Company

Okay thanks a lot.

Operator

Your next question comes from the line of William Schmitt.

William Schmitt - CIBC World Markets

Hi. Just a couple of quick ones, I was just wondering on the day sales outstanding, they went up sequentially, I wish that seems a little bit unusual for me, just giving truly your unusual, well the upside that you guys have in sales from the first quarter. Can you just talk a little bit of what you think that was related to, or was it mainly related to, the additional doors in international?

Richard Snyder

I guess, if you are talking about accounts receivable days outstanding, I’m sure about being, 29 days versus 28 days at the end of Q4, that’s all within, what I would describe as reasonable noise levels.

William Schmitt - CIBC World Markets

Got you, so that there is no particular field on these, I think you’ve had 500 additional stores internationally?

Richard Snyder

I wouldn’t attribute to that.

William Schmitt - CIBC World Markets

Okay, that’s okay, and then getting in numbers on what do you think your door potential is at retail?

Richard Snyder

I am sorry.

William Schmitt - CIBC World Markets

The door potential, so I mean, you’ve got what 95, 100 doors now on the retail space, I mean, do you have any target for where you think that number is going to be?

Richard Snyder

Okay, I think as it relates to US retail, I am sure all of you know, who are the mayor players, major players are in US retail buying large; we are engaged with all of the major players. I think our potential for market share gains really related to what percentage of their business do we get versus other people. And of course that varies, retailer-by-retailer and it also varies notebook versus desktops. As you recall, our market share continues to be higher in desktops than it is in notebooks that we have certainly made very significant strides in notebooks and certainly our expectation over time would be to get our market shares in notebooks up closer to the levels that where in that we have in desktops. But, the opportunity to increase the number of stores that we are in, I think is somewhat limited, we are in most, we are in all the major retailers.

William Schmitt - CIBC World Markets

Okay and then just as far as the assets you guys have in the balance sheets $393 million, now it’s down year-over-year. Can you give some color granularity as, I mean is there any, is there any really large and makes up with bulk or better assets number?

Richard Snyder

Yeah, I mean a significant chunk of that is what we called ODM receivables. We are increasingly buying components from the OEM’s and then selling them into our ODM’s so we are the ones who actually manufacture our PC’s, we are, it’s advantageous to do that because we can further reduce costs.

William Schmitt - CIBC World Markets

Those mainly are functionally outsourcing continuing on some.

Richard Snyder

Inflated to our ODM strategy, yes.

William Schmitt - CIBC World Markets

Okay. And then last one, just on the Microsoft, can you refresh my memory, I don’t know, I can’t remember, I don’t have my mind even break at this number, I just thought that maybe you have that. But just what we can expect as far as, how if that’s going to trend, tail off eventually before that’s just assumption here with the revenue you guys are going to do going forward?

Richard Snyder

Our agreement with Microsoft is attached to our Q2 and Q filing, I’m sorry, our Microsoft agreement is attached to our second quarter 10-Q last year. And there is a schedule in that that details out, how much Microsoft will be paying us over time. This year and next year and the year after, it’s flat at 8.625 million a quarter.

William Schmitt - CIBC World Markets

Okay, all right great. I’ll take a look at that, hey thanks guys.

Operator

Your next question comes from the line of Derrick Weiszhaar.

Derrick Weiszhaar

Yes thank you, a couple of financial questions.

Richard Snyder

Can you speak up?

Derrick Weiszhaar

Yes what was the depreciation and amortization for the quarter, the capital expenditures for the quarter and the outlook for the year and the gross interest expense for the quarter?

John Goldsberry

Hold on. Okay so depreciation for Q1 was 6.7 million, CapEx was 9.2 million, and then your last question was interest expense.

Derrick Weiszhaar

Actually, gross interest expense, amortizations for the quarters well and the CapEx outlook for the year?

John Goldsberry

Well, the 6.7 is depreciation and amortization side. I am sorry that was for the quarter, we are not forecasting a number for the year.

Derrick Weiszhaar

On the CapEx?

John Goldsberry

No I am sorry let me repeat. For Q1 depreciation and amortization was 6.7 million.

Derrick Weiszhaar

Correct.

John Goldsberry

And for Q1 CapEx was $9.2 million.

Derrick Weiszhaar

Now, gross expense for the quarter and the capital expenditure outlook for the year?

Richard Snyder

Okay we are not giving out the CapEx figures for the year, and as it relates to interest expense, its 1.3 million in Q1.

Derrick Weiszhaar

Okay thank you.

Operator

Your next question comes from the line Bill Fearnley.

Bill Fearnley - FTN Midwest Securities

Yes I had a quick question for you on vendor on reseller concentration. Can you break out what percentage Best Buy was this quarter and then also can you break out what percentage of your revenues through retail went through your top 5 resellers?

Richard Snyder

Yeah I’m afraid we don’t have that right at our finger tips. So let us, once get that information and then, typically it will be in the queue. Okay, I guess someone is pointing out here if you look at the 10-K we’ve filed recently for last year, it’s about 35% Best Buy.

Bill Fearnley - FTN Midwest Securities

Okay but is that staying the same or what’s the trend here in the first quarter. I understand it was published for last year but what about this quarter?

Rcihard Snyder

I don’t have that number readily available, I just make a general comment that our certainly our business with Best Buy continue to be strong.

Bill Fearnley - FTN Midwest Securities

Okay and then if I can get that detail, how would you seeing the price competition in retail and what affect from the other new comers of the US channel specifically Acer and Lenovo affected your results at first quarter, I mean if you can make comment about Acer, Lenovo, Hewlett-Packard and if you need these specific on particular vendors?

Richard Snyder

Okay, well the retail business has always been extremely competitive and nonetheless that’s an environment that we do extremely well in. As it relates to the first quarter, we were very pleased with our, our sales through retail, our market shares increased 40% year-over-year. We actually our units increased quarter-over-quarter despite the normal seasonal trends; we feel we continued to compete very, very effectively in retail. As concerns, some of the new recent entrance and I am not going to comment on, one competitor or another, we certainly expect to continue to compete in the marketplace and to grow our business.

Bill Fearnley - FTN Midwest Securities

Yeah thanks.

Operator

And there are not further question as this time. Ms. Johnson do you have any further remarks?

Marlys Johnson

Yes thank you Kevin. Thank you everyone for joining with us today. A replay of this conference call will be available on the home page of gateway.com website for 24 hours, and thereafter archived on the Investor Relations pages. There will also be a telephonic playback of this conference call beginning tonight at 7:30 p.m. Eastern Time and running until midnight Eastern Time on Saturday April 29. That number is 706-645-9291. Have a good evening.

Operator

This concludes today’s Gateway First Quarter Earnings Conference Call. You may now disconnect.

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Source: Gateway Inc. Q1 2006 Earnings Conference Call Transcript (GTW)
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