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SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q

Commission file number 0-22784

GATEWAY, INC.
(Exact name of registrant as specified in its charter)

14303 Gateway Place
Poway, California 92064
(Address of principal executive offices, zip code)

Registrant's telephone number, including area code: (858) 848-3401

        Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No o.

        As of November 12, 2002, there were 324,052,520 shares of the Common Stock of the Company, $.01 par value per share, outstanding. As of November 12, 2002, there were no shares of the Company's Class A Common Stock, $.01 par value per share, outstanding.

I. FINANCIAL INFORMATION

Item 1. Financial Statements

Gateway, Inc.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the three and nine months ended September 30, 2002 and 2001
(in thousands, except per share amounts)
(unaudited)

The accompanying notes are an integral part of the consolidated financial statements.

2

Gateway, Inc.
CONSOLIDATED BALANCE SHEETS
September 30, 2002 and December 31, 2001
(in thousands, except per share amounts)

The accompanying notes are an integral part of the consolidated financial statements

3

Gateway, Inc.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the nine months ended September 30, 2002 and 2001
(in thousands)
(unaudited)

The accompanying notes are an integral part of the consolidated financial statements

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NOTES TO CONSOLIDATED FINANCIAL STATEMENT
(unaudited)

1. General:

        The accompanying unaudited consolidated financial statements of Gateway, Inc. (the "Company") as of September 30, 2002 and for the three and nine months ended September 30, 2002 and 2001 have been prepared on the same basis as the audited consolidated financial statements for the year ended December 31, 2001 and, in the opinion of management, reflect all adjustments necessary to fairly state the consolidated financial position, results of operations and cash flows for the interim periods. All adjustments are of a normal, recurring nature. The results for the interim periods are not necessarily indicative of results to be expected for any other interim period or the entire year. These financial statements should be read in conjunction with the Company's audited consolidated financial statements and notes thereto for the year ended December 31, 2001, which are included in the Company's 2001 Annual Report on Form 10-K, filed with the Securities and Exchange Commission.

        The significant accounting policies used in the preparation of the consolidated financial statements of the Company are as follows:

(a)

Basis of Presentation:

        The consolidated financial statements include the accounts of the Company and its majority owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. Certain reclassifications have been made to prior years' financial statements to conform to current year presentation. These reclassifications had no impact on previously reported net loss or stockholders' equity.

(b)

Use of Estimates:

        The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates under different assumptions or conditions.

(c)

Cash and Cash Equivalents:

        The Company considers all highly liquid debt instruments and money market funds with an original maturity of three months or less to be cash equivalents. The carrying amount approximates fair value because of the short maturities of these instruments.

(d)

Marketable Securities and Long-Term Investments:

        Marketable securities consist of mutual funds, equity securities, commercial paper and debt securities, with market values that approximate their amortized cost. Long-term investments, including publicly traded equity securities, represent minority investments in companies having operations or technology in areas within or adjacent to Gateway's strategic focus. Marketable securities are classified as available-for-sale and are adjusted to their fair market value using quoted market prices. Investments in public companies with restrictions related to the Company's ability to dispose of the investment within one year are classified as available-for-sale and are adjusted to their fair value based on one of the following methods: (i) quoted market prices; (ii) current rates for similar issues; (iii) recent transactions for similar issues; or (iv) present value of expected cash flows. Unrealized gains and losses are recorded as a component of accumulated other comprehensive income. Upon disposition of these investments, the specific identification method is used to determine the cost basis in computing realized gains or losses. Declines in value that are considered to be other than temporary are reported in other

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income (loss), net. Held-to-maturity securities are recorded at amortized cost. Amortization of related discounts or premiums is included in the determination of other income (loss), net.

(e)

Inventory:

        Inventory, which is comprised of component parts, subassemblies and finished goods, is valued at the lower of first-in, first-out (FIFO) cost or market. On a quarterly basis, the Company compares on a part by part basis, the amount of the inventory on hand and under commitment with its latest forecasted requirements to determine whether write-downs for excess or obsolete inventory are required. Although the writedowns for excess or obsolete inventory reflected in the Company's consolidated balance sheet at September 30, 2002 and December 31, 2001 are considered adequate by the Company's management, there can be no assurance that these writedowns will prove to be adequate over time to cover ultimate losses in connection with the Company's inventory.

(f)

Property, Plant and Equipment:

        Property, plant and equipment are stated at cost. Depreciation is provided using the straight-line method over the asset's estimated useful lives, as follows:

        Upon sale or retirement of property, plant and equipment, the related costs and accumulated depreciation or amortization are removed from the accounts and any gain or loss is included in the determination of net income (loss).

(g)

Intangible Assets:

        Intangible assets are amortized on a straight-line basis over four to ten years.

(h)

Long-lived Assets:

        The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. An asset is considered to be impaired when the sum of the undiscounted future net cash flows expected to result from the use of the asset and its eventual disposition does not exceed its carrying amount. The amount of impairment loss, if any, is measured as the difference between the net book value of the asset and its estimated fair value.

(i)

Royalties:

        The Company has royalty-bearing license agreements that allow the Company to sell certain hardware and software which is protected by patent, copyright or license. Royalty costs are accrued and included in cost of goods sold when products are shipped or amortized over the period of benefit when the license terms are not specifically related to the units shipped.

(j)

Warranty:

        The Company provides currently for the estimated costs that may be incurred under its standard warranty obligations.

(k)

Revenue Recognition:

        The Company recognizes revenue from product sales upon delivery of the product to its customers. Revenue from services that are rendered by the Company, such as extended warranty, training and

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Internet service, is recognized as the services are provided. Revenue from the sale of services that are rendered by third parties are generally recognized at the time of sale. For sales involving multiple elements, revenue is allocated to each element based on fair value. Discounts related to coupons and mail-in rebates are recorded as a reduction of revenue at the time of sale. Estimates of future product returns are recorded as a reduction to revenue at the time of sale based on historical experience.

(l)

Advertising Costs:

        Advertising costs are charged to expense as incurred.

(m)

Income Taxes:

        The provision for income taxes is computed using the liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Income taxes payable includes potential tax liabilities related to current or future federal, state or foreign tax audits.

(n)

Stock-based Compensation:

        The Company measures compensation expense for its employee and non-employee director stock-based compensation using the intrinsic value method. Compensation charges related to other non-employee stock-based compensation are measured using fair value methods.

(o)

Segment Data:

        The Company reports segment data based on the internal reporting that is used by management for making operating decisions and assessing performance which is designated as the source of the Company's reportable operating segments.

2. Comprehensive Income (Loss):

        Comprehensive income (loss) for the Company includes net income (loss), foreign currency translation effects, unrealized gains or losses on derivatives qualifying as hedges, unrealized gains or losses on available-for-sale securities and realized gains in the statement of operations when the available-for-sale securities are sold. The cumulative effect of these items has been charged or credited to the accumulated other comprehensive income account within stockholders' equity.

        Comprehensive income (loss) for the three and nine month periods ended September 30, 2002 and 2001 was as follows (in thousands):

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3. Share and Per Share Information:

        Basic earnings per common share is computed using net income (loss) attributable to common stockholders and the weighted average number of common shares outstanding during the period. Diluted earnings per common share is computed using net income (loss) attributable to common stockholders and the combination of dilutive common stock equivalents and the weighted average number of common shares outstanding during the period. Diluted shares for the three months ended September 30, 2002 and 2001 excludes 22,268,084 and 930,501 weighted average incremental shares, respectively, and for the nine months ended September 30, 2002 and 2001 excludes 22,304,626 and 1,300,205 weighted average incremental shares, respectively, related to employee and director common stock options and Series A Convertible Preferred Stock. These shares are excluded despite their exercise prices being below the average market price or assuming the "if converted" method for the Series A Convertible Preferred Stock as their effect is anti-dilutive. The Series C Redeemable Convertible Preferred Stock is contingently convertible to 5,938,948 shares and is not included in calculating earnings per share as the contingency was not met as of September 30, 2002. In addition, for the three months ended September 30, 2002 and 2001 the Company has excluded 57,396,974 shares and 53,947,804 shares, respectively, and for the nine months ended September 30, 2002 and 2001 excluded 58,163,781 shares and 53,320,358 shares, respectively, related to non-employee warrants and employee and director stock options which have exercise prices greater than the average market price of the common shares.

4. Changes in Accounting Principles:

        In the first quarter of 2001, the Company adopted Statement of Financial Standards No. 133 "Accounting for Derivative Instruments and Hedging Activities" (FAS 133). Under FAS 133, as amended, all derivative instruments (including certain derivative instruments embedded in other contracts) are recognized in the balance sheet at their fair values. Changes in fair values are recognized immediately in earnings, unless the derivatives qualify as hedges of future cash flows. For derivatives qualifying as hedges of future cash flows, the effective portion of changes in fair value is recorded temporarily in other comprehensive income (loss), then recognized in earnings along with the related effects of the hedged items after the transaction occurs. Any ineffective portion of a hedge is reported in earnings as it occurs.

        The Company used foreign currency forward contracts to hedge foreign currency transactions. These forward contracts were designated as cash flow hedges and generally had three to six month terms. Additionally, the Company holds warrants as investments in connection with certain strategic relationships. On January 1, 2001, the Company's financial statements were adjusted by $37 million, of which $4 million is related to the Company's hedges and warrants mentioned above, and $33 million is related to the Company's long-term investments, to record the cumulative effect of adopting this accounting change.

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5. Finance Receivables:

        Finance receivables, included in other current assets in the December 31, 2001 balance sheet, consist of receivables due from customer installment purchases of the Company's products and services, net of allowance for losses. In the first quarter of 2002, the Company sold its remaining finance receivables portfolio at book value with no recourse.

6. Selected Balance Sheet Information (in thousands):

        The increase in accounts receivable reflects an increased mix of business sales in the third quarter of 2002 versus the fourth quarter of 2001, which typically have longer payment terms versus consumer sales which typically have shorter payment terms.

        The decrease in inventory on hand reflects inventory reduction efforts throughout the supply chain, particularly in components and subassemblies.

        The decrease in income tax receivable reflects the net income tax refunds received by the Company. Prepaid expenses increased due to prepayment of hardware royalty obligations.

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        The decrease in property, plant and equipment reflects the net impact of asset write-downs taken in the restructuring and other special charges, as well as asset additions and depreciation expense.

        The decrease in accrued liabilities reflects a decline in the warranty accrual attributable to the reduction in unit sales relative to 2001 levels. The restructuring accrual declined due to restructuring related payments made during 2002 net of additional accruals. See Note 11 for further information.

        The increase in other current liabilities is primarily due to an increase in the accrual for tax liabilities.

        The increase in deferred revenue is primarily due to the insourcing of certain extended warranty service plans. The decrease in other liabilities reflects the settlement of an acquisition liability as well as a decrease in the long-term warranty accrual attributable to a shift to one year standard warranties as compared to the three year standard warranties previously offered by the Company.

7. Preferred Stock:

        On February 2, 2001, the Company received $200 million in exchange for a convertible note due December 22, 2020 in connection with the second closing of an investment agreement with America Online, Inc. ("AOL"). In December 2001, this convertible note was extinguished through the issuance of 50,000 shares of non-voting Series C Redeemable Convertible Preferred Stock ("Series C Preferred Stock"). The Series C Preferred Stock had a fair value on the date of issuance of approximately $193 million. The fair value of $193 million will be accreted to the face value of $200 million through 2004 using the effective interest method.

        The Company issued 50,000 shares of non-voting Series A Convertible Preferred Stock ("Series A Preferred Stock") to AOL in exchange for $200 million in cash in December 2001.

8. Stock Option Plans:

        The Company uses the disclosure-only provisions of SFAS 123, "Accounting for Stock-based Compensation." The fair value of options was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for all grants in 2002 and 2001: dividend yield of zero percent; risk-free interest rates ranging from 1.7 to 6.6 percent; and

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expected lives of the options of three and one-half years. The expected volatility used in estimating the fair market value on the date of grant was 71 percent in 2002 and 73 percent in 2001.

        Had compensation expense for employee and director stock options been determined based on the fair value of the options on the date of the grant, net loss attributable to common stockholders and net loss per share would have resulted in the pro forma amounts indicated below (in thousands, except per share amounts):

        The pro forma effect on net loss for 2002 and 2001 is not fully representative of the pro forma effect on net income (loss) in future years because it does not take into consideration pro forma compensation expense related to the vesting of grants made prior to 1997.

9. Income Taxes:

        The Company recorded a tax benefit of $28 million, or 37%, for the third quarter of 2002 and a tax benefit of $134 million, or 37%, for the first nine months of 2002 compared to a tax benefit of $134 million, or 20.5%, for the third quarter of 2001 and a tax benefit of $279 million, or 21.5%, for the first nine months of 2001. The tax benefit for the first nine months of 2001 is net of a tax assessment in a foreign subsidiary and an increase in the deferred tax valuation allowance for certain of the restructuring and other special charges, losses related to the Company's foreign operations and unrealized capital losses associated with the investment impairment. The change in the valuation allowance was the result of management's assessment that the tax benefit associated with these items was no longer more likely than not to be realized. Management believes that the realization of the remaining deferred tax assets is more likely than not. In the event that management does not believe in the future that the realization is more likely than not due to, among other factors, either expiration of the five year net operating loss carryback for tax years ending after December 31, 2002, or the Company being unable to attain profitability in the near term, additional valuation allowances for all or a portion of the remaining net deferred tax assets will be required.

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10. Contingencies:

        On December 7, 2000, James Burton filed a purported class action complaint against Gateway, one of its former officers, and one director, in the United States District Court for the Southern District of California for alleged violation of federal securities laws. Thereafter, six similar cases were filed in the same court by other plaintiffs. On July 16, 2001, the complaints were consolidated and amended to allege among other things that the defendants misrepresented Gateway's financial performance in securities filings and in statements to the public, and purport to be class actions on behalf of purchasers of Gateway's stock between April 14, 2000 and February 28, 2001 (the "class period"), the date when the Company announced tha