Gateway (NYSE: GTW), the No. 2 direct seller of personal computers, reported estimate-beating earnings last night of $0.37 a share, 32% higher than last year's EPS, with net income up 36% to $122 million and revenue up 12% to $2.14 billion.
The company's generally successful quarter may serve as a positive indicator for other companies in the computer hardware industry. Consumer PC demand is strong, which confirms earlier statements from Gateway competitor Dell (Nasdaq: DELL), and may signal strong sales growth for chip-maker Advanced Micro Devices (NYSE: AMD), which counts Gateway as one of its largest customers.
First, the death of the PC industry has been greatly exaggerated numerous times over the years. Last summer, the much-ballyhooed "free PC" trend was allegedly going to cause all sorts of problems for the boxmakers, but there's little sign of it these days. Gateway reported that its average unit price (AUP) was $1,830 in the second quarter, 4% lower than last year and only 1% lower than the previous quarter. This compares well to a year ago, when AUPs declined 13% from the year before that. This relatively stable pricing environment is part of the reason why Gateway's gross margins hit a record level of 23.3%. (Gateway's increasing revenue from services and other "beyond-the-box" businesses also played a large part.)
Similar trends are evident in the broader industry. PC prices as a whole increased 3% in the first three weeks of June, according to a CNET report last week. And while Dell is continuing to suffer from parts shortages, the company described demand two weeks ago as "robust." Gateway's 39% increase in unit shipments to consumers would seem to confirm that. Dell is scheduled to report earnings August 10.
Meanwhile, chipmaker AMD, which traded up $2 1/8 this morning, may already be reacting positively to Gateway's news. After struggling with component shortages from Intel (Nasdaq: INTC) earlier this year, Gateway began buying more chips from AMD, becoming the largest customer of its Athlon processors. In May, Gateway's CFO stated that the company would "probably" double the number of AMD chips in its consumer division this quarter. Both Intel and AMD will report earnings next week.
Of course, Gateway's report also bodes pretty well for itself. The company seems to be succeeding in its efforts to move "beyond the box" by offering services such as financing, warranties, and Internet connectivity. Gateway earned 40% of its income from these services, up from 25% in the first quarter and ahead of its own schedule, which called for the 40% target to be hit by the end of the year. In addition, half the income is "recurring," most of it presumably from its co-branded ISP with America Online (NYSE: AOL), which is an excellent cushion for a company in the seasonal business of PC sales.
Finally, the company also maintained control over its expenses, with sales, general & administrative (SG&A) costs declining slightly as a percentage of revenues. That's a good sign, given that the company is expanding its "bricks and mortar" retail operations, with its own "Gateway Country" stores and its store-within-a-store outlets at 92 OfficeMax locations in the U.S., and several hundred others worldwide.
Gateway's success hasn't been a secret, and the company's shares have jumped over 25% in the past couple of months, only to lose about 5% this morning. Most analysts reiterated their generally positive ratings on the stock today, but Banc of America Securities downgraded to the company to a "buy" from a "strong buy" based on valuation concerns.
Gateway traded at approximately 39x this year's estimated EPS of $1.83 at yesterday's close, roughly in line with its 32% EPS growth in the past two quarters. Fools interested in the company will have to decide for themselves whether that's too expensive for them.
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