Predictions are a dodgy business. Make an optimistic one, and the market may reward your stock richly. Of course, then you're on the hook to deliver.
Fortunately for shareholders of computer maker Gateway (NYSE:GTW), management delivered the goods in last Thursday's earnings report -- even if the stock's price isn't reflecting it just yet. As you'll recall from last week's Foolish Forecast, I noted that two quarters ago, then-interim CEO Rick Snyder had promised to return the firm's two least impressive divisions -- Professional and Direct -- "to profitability over the next three to four quarters."
Snyder subsequently vacated the CEO's chair before he could accomplish that goal in full. But between his continuing efforts as chairman and those of new CEO Ed Coleman -- formerly of Arrow Electronics (NYSE:ARW), Computer Sciences (NYSE:CSC), and IBM (NYSE:IBM) -- Gateway achieved its goal a full quarter ahead of schedule last week. For the third quarter, management announced that its most profitable segment, Retail, remained so; its Direct business also remained profitable by a thread, with earnings of just $353,000); and its Professional unit turned the corner to report a whopping $18.2 million operating profit. Nice.
Won the battle; now for the war
Of course, it wasn't all ice cream and cotton candy for Gateway shareholders. They had to swallow some pretty foul-tasting news along with the sweet taste of success. For one thing, the company badly missed expectations on sales, which declined 5.5% year over year.
Worst of all to this Fool's mind, operating cash flow evaporated, and capital expenses nearly doubled in comparison with last year. The result: Free cash flow ran more than eight times as negative as it was running by this time last year; it now totals negative $136.1 million year to date. Most of the damage here, it seems, came from reducing accounts payable considerably -- and rather than a mark of honest business practices, in investing circles, it's often considered a sign of weakness when a firm has to pay its bills more quickly.
Yet despite the cash drain, Gateway's balance sheet looks stronger today than it did one year ago. Accounts payable aren't the only thing falling, you see. Accounts receivable also declined 10%, and the firm worked its inventories down an incredible 37% -- far faster than sales declined. With the stronger balance sheet, the renewed focus on profitable operations, and management that has now proved it will stand by its word and even better it, I'm feeling more than impressed with Gateway's Q3 performance -- enough so that I intend to head right over to Motley Fool CAPS right now and affix an "outperform" rating to this stock.
Will Gateway help or hurt Rich's current rank as the 64th (out of 12,265) best stock rater on CAPS? Check out his profile -- TMFDitty -- to find out.
Fool contributor Rich Smith does not own shares of any company named above.
