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Gateway Q2 Call
Q&A, Part 1
By Dale Wettlaufer (TMF Ralegh)
ALEXANDRIA, VA (July 28, 1999) -- The Bore Port today continues its Gateway (NYSE: GTW) Q2 conference call coverage with the conclusion of management's remarks and the first part of the Q&A session. I anticipate concluding this on Friday, but the length constraints of this column will dictate how quickly I can complete this. I'd like to get to American Power Conversion as soon as possible.
A note on Monday's Fool on the Hill, which I wrote before listening to the Q&A session, is in order. In discussing the GE Capital deal (which I thought was really the most important piece of news in the conference call), I made the following comment: "Granted, the company will probably cede some margins on these products by wholesaling to GE, but who cares? The idea isn't to generate pretty margins or even maximize ROIC. The goal is to maximize economic value added..." As you can see below, Gateway's management said that the GE deal is not margin-dilutive. My mistake in opining on that before getting to the Q&A session. So, on with the rest of the call:
"In addition to our alliance with GE Capital, we had talked in the past about building local services relationships with small providers who basically can provide services capabilities for small business customers in the geographies served by our Country Stores. We've added 11 value added-service providers in those Country markets and we have a fairly significant rent coming up behind that in the back half of the year. These folks will be working with our local sales force, delivering total solutions capabilities to that segment of the market that really requires it. We'll ramp it during the remainder of the year and continue to drive growth."
Asian growth continues to be impressive, with units up 77% and revenues up 58%. Japan continues to show great results and is leading the way. "Again, it's execution of strategy we laid out here in a global market. Europe's performance remains an opportunity. We are seeing signs of stronger consumer growth where we've been focusing our efforts [in the UK] and our business initiatives are beginning to see some traction. We told you that Europe would take time to turn and that we'd see better results in late 1999 and we will [see those results]..."
In terms of the Internet, there were a number of positives for the quarter:
- Rapid subscriber growth for the Gateway.net service.
- A greater percent of sales taking place directly over the Web.
- Redesign of Gateway.com site and integrating Spotshop.com capabilities directly into it. That has occurred over the course of the last several weeks and should result in more transactions completed on the Web in all product categories, not just systems.
- For Gateway.net, "We're looking to expand our geographic coverage and will begin marketing to our installed base and eventually to all non-Gateway systems customers. By year-end, we'll double our subscriber base again."
"One of the things we've seen in terms of our Internet access business is that we have a tremendous engine for ISP subscriber acquisition. Because we have our own sales force (there are people out in stores, our people on the telephones, we're selling our own products) and people want complete solutions delivered to them, we can generate a tremendous number of subscribers over the next few years.... At this point, we're not in discussions with anyone regarding potential purchase of an ISP, but we're always looking at ways we can better serve our customers and better maximize the lifetime value of that customer relationship....
"We're extremely excited about our potential in the Internet access business and also our ability to really maximize that lifetime value by tying together a multitude of the devices for the home and the small business market, whether that be a PC, an Internet terminal, an appliance server, to tie those together with Internet access -- whether that's narrowband or broadband -- to really develop an ongoing relationship with our customers in terms of content, commerce, and community, and really to maximize the lifetime value of that customer by giving them tremendous value with all aspects of the Internet solutions platforms we can deliver through our Stores, the phone, and through our Web sales efforts."
Q1 non-systems income was greater than 5%. This quarter was 10%. In dollar terms, the company will continue to grow non-PC income. With regard to GE Capital, "We believe our models fit together.... The deal fit together perfectly. They were looking for a partner who could provide great build-to-order capabilities. They hate to carry any inventory. They hate all the nonsense associated with the other vendors who shove hardware at them.... We thought there was a perfect fit.... They have a very, very large sales force; they basically provide a lot of pre-sale infrastructure analysis; they can network in systems integration; they've got great national and even global service support; they even outsource many of the IT functions -- those are capabilities that we don't have. As we talked about our partner strategy, GE is just the perfect partner for us in that market segment. And so, without assigning specific numbers, we think that this is a very big deal.... You can look at the overall scale of the GE business and therefore you can probably extrapolate where it could potentially lead."
The company's expectation on the above deal is that it will be margin-neutral on all products.
"In terms of acquisitions, we have historically taken an approach [of making acquisitions] that are typically very small and very accretive. We don't see any major changes to that approach. We see a tremendous opportunity for long-term upside in our business driven by the Internet, by getting customers on the Internet and then continuing that Internet relationship with our customers. We will look to shore up our capabilities in ways that will allow us to maximize the lifetime value of that customer -- and if necessary we have to acquire that. We're willing to do it if it's in the best interests of our shareholders. We don't have any definite plans and we're not in any discussions right now, but we're not precluding anything."
On Europe: "We've talked previously about Europe [not being] a quick turnaround situation. We originally said we expected to make a lot more progress towards the back-end of the year. Where we've focused, which has been the consumer market, we've begun to see some pretty good results. We actually added three Country Stores in the UK this past quarter, where we're up to 13 now.... We've early indications here, particularly in the last month of this past quarter, as well as in the first couple weeks of this quarter, that we're beginning to get some very good traction in this business. We're very confident that, by the end of this year, we're going to be seeing some good positive comps year-over-year in Europe."
On price points: "Obviously, we have been in the sub-$1,000 market now for probably 7-8 months. [We have products] that do run down to about the $899 price point (of course, that does include a monitor). As we go forward into the third and fourth quarters, our expectation is that prices will come down below that level, but at this point in time, we really can't comment on where we'll see price points or where we'll see models in that fourth quarter."
"In terms of GE Capital, we actually see this as being a very cooperative relationship. In accounts where we have relatively longstanding relationships, we would take the lead, and in accounts where they have the longstanding relationship, they would take the lead and we would be supportive of them. As you probably know, we do not have a large portion of our business that comes out of that Fortune 1000 segment, and we really have no plants to dramatically increase our sales force in that segment of the market. So it's really 'who's got the relationship?' and we've got a deal worked so that there should not be conflict between the two of us at all. It should be a very complementary relationship."
"It's fair to say" that margin expansion this quarter came from both hardware and software, "probably close to a 50/50 mix."
The company's Profile desktop model has generated a lot of interest from both the business and consumer press. Gateway has not heavily promoted this product yet. "You will see even more innovative products coming from Gateway in the coming months as we get ready for the back half of the year. We'll be able to lower price points, we'll add more innovation into the products, increase the ease of use of the products, set up [the customer] getting on the Internet. We see a lot of customer demand in those types of categories."
The company doesn't see any significant advantage in stocking the Country Stores with increased inventory.
As online companies are coming to see having a retail presence as a strategic asset, Gateway believes that Gateway Country stores "...become a more and more powerful element of the distribution mix. As we've done market research and as we talk around the industry, we just think it's going to be more and more recognized as to how powerful Country is as a demonstrator of the power of the Internet. As the Internet moves from narrowband to broadband, just the demonstration capabilities where the customers can actually see what the difference is in the user experience is incredibly important. That also is a huge advantage for us with our Country capability."
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Stock Change Bid APCC - 5/16 21.50 BRKb -26 2163.00 CSL - 1/4 47.19 GTW +3 5/8 78.50
Day Month Year History BORING -0.20% 2.23% 6.22% 42.62% S&P: +0.19% -0.54% 11.66% 127.52% NASDAQ: +0.99% 0.75% 23.40% 159.94% Rec'd # Security In At Now Change 8/13/96 200 Carlisle C 26.32 47.19 79.25% 4/20/99 460 American P 14.48 21.50 48.52% 2/9/99 100 Gateway 20 72.38 78.50 8.46% 12/31/98 12 Berkshire 2276.17 2163.00 -4.97% Rec'd # Security In At Value Change 8/13/96 200 Carlisle C 5264.99 9437.50 $4172.51 4/20/99 460 American P 6659.25 9890.00 $3230.75 2/9/99 100 Gateway 20 7237.50 7850.00 $612.50 12/31/98 12 Berkshire 27314.00 25956.00 -$1358.00 CASH $18177.16 TOTAL $71310.66
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