##### Table of Contents

---

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



---

FORM 10-Q



---



|x | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ---------------------------------------------------------------------------------------

For the quarterly period ended June 30, 2007

OR



| ̈ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
|- | ----------------------------------------------------------------------------------------

For the transition period from
                     to

Commission file number 1-14500



---

GATEWAY, INC.

(Exact name of registrant as specified in its charter)



---



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|Delaware                                                       |  | 42-1249184                          
|(State or other jurisdiction of incorporation or organization) |  | (I.R.S. Employer Identification No.)

7565 Irvine Center Drive

Irvine, California 92618

(Address of principal executive offices, zip code)

Registrants telephone number, including area code: (949) 471-7000



---

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  x    No ̈

Indicate by check mark if the registrant is a large accelerated filer,
an accelerated filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated filer in Rule 12b-2 of the Exchange Act. (Check one).

Large accelerated filer  x                        Accelerated filer ̈Non-accelerated
filer ̈

Indicate by
check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes ̈No  x

As of July 30, 2007 there were 373,641,481 shares
of our Common Stock, $.01 par value per share, outstanding. As of July 30, 2007 there were no shares of our Class A Common Stock, $.01 par value per share, outstanding.



---



---

##### Table of Contents

GATEWAY, INC.

FORM 10-Q

For the period ended June 30, 2007

Table of Contents



|           |  |                                                                                                             |  |   
|---------- |  | ----------------------------------------------------------------------------------------------------------- |  | --
|           |  | Page                                                                                                       
|Part I     |  | Financial Information                                                                                       |  |   
|           |  |                                                                                                            
|Item 1     |  | Financial Statements                                                                                        |  |   
|           |  |                                                                                                            
|           |  | Consolidated Statements of Operations for the three and six months ended June 30, 2007 and 2006 (Unaudited) |  | 3 
|           |  |                                                                                                            
|           |  | Consolidated Balance Sheets as of June 30, 2007 and December 31, 2006 (Unaudited)                           |  | 4 
|           |  |                                                                                                            
|           |  | Consolidated Statements of Cash Flows for the six months ended June 30, 2007 and 2006 (Unaudited)           |  | 5 
|           |  |                                                                                                            
|           |  | Notes to Consolidated Financial Statements (Unaudited)                                                      |  | 6 
|           |  |                                                                                                            
|Item 2     |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                       |  | 20
|           |  |                                                                                                            
|Item 3     |  | Quantitative and Qualitative Disclosures About Market Risk                                                  |  | 35
|           |  |                                                                                                            
|Item 4     |  | Controls and Procedures                                                                                     |  | 35
|           |  |                                                                                                            
|Part II    |  | Other Information                                                                                           |  |   
|           |  |                                                                                                            
|Item 1     |  | Legal Proceedings                                                                                           |  | 36
|           |  |                                                                                                            
|Item 1A    |  | Risk Factors                                                                                                |  | 36
|           |  |                                                                                                            
|Item 4     |  | Submission of Matters to a Vote of Security Holders                                                         |  | 36
|           |  |                                                                                                            
|Item 6     |  | Exhibits                                                                                                    |  | 37
|           | 
|Signatures |  | 38                                                                                                         



---

##### Table of Contents

I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

GATEWAY, INC.

CONSOLIDATED
STATEMENTS OF OPERATIONS (Unaudited)

For the three and six months ended June 30, 2007 and 2006

(in thousands, except per share amounts)



|                                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|-------------------------------------------- |  | --------------------------- | ------- | - | ------------------------- | - | ------- | ---- |  | - | --------- | - |  | - | --------- | -
|                                             |  | Three Months Ended June 30, |         |   | Six Months Ended June 30, |  
|                                             |  | 2007                        |         |   | 2006                      |   |         | 2007 |  |   | 2006      |  
|Net sales                                    |  | $                           | 840,625 |   |                           | $ | 919,312 |      |  | $ | 1,849,329 |   |  | $ | 1,997,134 |  
|Cost of goods sold                           |  |                             | 776,756 |   |                           |   | 868,736 |      |  |   | 1,735,741 |   |  |   | 1,867,830 |  
|                                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Gross profit                                 |  |                             | 63,869  |   |                           |   | 50,576  |      |  |   | 113,588   |   |  |   | 129,304   |  
|Selling, general and administrative expenses |  |                             | 66,603  |   |                           |   | 66,149  |      |  |   | 131,685   |   |  |   | 169,246   |  
|Microsoft benefit                            |  |                             | 8,625   |   |                           |   | 8,625   |      |  |   | 17,250    |   |  |   | 17,250    |  
|                                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Operating income (loss)                      |  |                             | 5,891   |   |                           |   | (6,948  | )    |  |   | (847      | ) |  |   | (22,692   | )
|Other income (expense), net                  |  |                             | (988    | ) |                           |   | (1,317  | )    |  |   | (281      | ) |  |   | 920       |  
|Minority interest                            |  |                             | (79     | ) |                           |   |        |      |  |   | (108      | ) |  |   |          |  
|                                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Income (loss) before income taxes            |  |                             | 4,824   |   |                           |   | (8,265  | )    |  |   | (1,236    | ) |  |   | (21,772   | )
|Benefit (provision) for income taxes         |  |                             | (2,911  | ) |                           |   | 585     |      |  |   | (5,430    | ) |  |   | 1,755     |  
|                                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Net income (loss)                            |  | $                           | 1,913   |   |                           | $ | (7,680  | )    |  | $ | (6,666    | ) |  | $ | (20,017   | )
|                                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Net income (loss) per common share:          |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Basic                                        |  | $                           | 0.01    |   |                           | $ | (0.02   | )    |  | $ | (0.02     | ) |  | $ | (0.05     | )
|                                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Diluted (Note 7)                             |  | $                           | 0.01    |   |                           | $ | (0.02   | )    |  | $ | (0.02     | ) |  | $ | (0.05     | )
|                                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Weighted average shares outstanding:         |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Basic                                        |  |                             | 371,857 |   |                           |   | 372,089 |      |  |   | 371,666   |   |  |   | 372,531   |  
|                                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Diluted (Note 7)                             |  |                             | 371,928 |   |                           |   | 372,089 |      |  |   | 371,666   |   |  |   | 372,531   |  
|                                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  

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



3



---

##### Table of Contents

GATEWAY, INC.

CONSOLIDATED BALANCE SHEETS (Unaudited)

June 30, 2007 and December 31, 2006

(in thousands, except per share amounts)



|                                                                                                                                                  |  |               |           |   |                   |   |           |  
|------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- | --------- | - | ----------------- | - | --------- | -
|                                                                                                                                                  |  | June 30, 2007 |           |   | December 31, 2006 |  
|ASSETS                                                                                                                                            |  |               |           |   |                   |   |           |  
|Current assets:                                                                                                                                   |  |               |           |   |                   |   |           |  
|Cash and cash equivalents                                                                                                                         |  | $             | 225,621   |   |                   | $ | 345,677   |  
|Marketable securities                                                                                                                             |  |               | 29,611    |   |                   |   | 70,658    |  
|Accounts receivable, net of allowance for doubtful accounts of $6,763 and $2,218 at June 30, 2007 and December 31, 2006,
respectively             |  |               | 314,163   |   |                   |   | 274,782   |  
|Inventory, net                                                                                                                                    |  |               | 160,431   |   |                   |   | 97,187    |  
|Prepaid expenses                                                                                                                                  |  |               | 52,683    |   |                   |   | 40,299    |  
|Receivables from suppliers                                                                                                                        |  |               | 275,136   |   |                   |   | 247,207   |  
|Other                                                                                                                                             |  |               | 116,930   |   |                   |   | 175,283   |  
|                                                                                                                                                  |  |               |           |   |                   |   |           |  
|Total current assets                                                                                                                              |  |               | 1,174,575 |   |                   |   | 1,251,093 |  
|Property, plant and equipment, net                                                                                                                |  |               | 110,158   |   |                   |   | 110,931   |  
|Intangible assets, net                                                                                                                            |  |               | 68,909    |   |                   |   | 75,058    |  
|Goodwill and non-amortizable intangible assets                                                                                                    |  |               | 205,219   |   |                   |   | 205,219   |  
|Restricted cash                                                                                                                                   |  |               | 553       |   |                   |   | 3,266     |  
|Long-term investments                                                                                                                             |  |               | 3,159     |   |                   |   | 3,159     |  
|Deferred debt issue costs                                                                                                                         |  |               | 5,264     |   |                   |   | 6,010     |  
|Other assets, net                                                                                                                                 |  |               | 1,690     |   |                   |   | 1,499     |  
|                                                                                                                                                  |  |               |           |   |                   |   |           |  
|                                                                                                                                                  |  | $             | 1,569,527 |   |                   | $ | 1,656,235 |  
|                                                                                                                                                  |  |               |           |   |                   |   |           |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                                              |  |               |           |   |                   |   |           |  
|Current liabilities:                                                                                                                              |  |               |           |   |                   |   |           |  
|Accounts payable                                                                                                                                  |  | $             | 609,900   |   |                   | $ | 612,639   |  
|Accrued expenses                                                                                                                                  |  |               | 88,972    |   |                   |   | 159,199   |  
|Warranty                                                                                                                                          |  |               | 54,020    |   |                   |   | 46,616    |  
|Restructuring                                                                                                                                     |  |               | 8,075     |   |                   |   | 13,046    |  
|Other accrued liabilities                                                                                                                         |  |               | 8,198     |   |                   |   | 11,254    |  
|Accrued royalties                                                                                                                                 |  |               | 58,916    |   |                   |   | 54,521    |  
|Deferred revenue                                                                                                                                  |  |               | 18,337    |   |                   |   | 27,701    |  
|Income taxes payable                                                                                                                              |  |               | 10,666    |   |                   |   | 91,213    |  
|Other current liabilities                                                                                                                         |  |               | 3,403     |   |                   |   | 2,745     |  
|                                                                                                                                                  |  |               |           |   |                   |   |           |  
|Total current liabilities                                                                                                                         |  |               | 860,487   |   |                   |   | 1,018,934 |  
|Senior convertible notes                                                                                                                          |  |               | 300,000   |   |                   |   | 300,000   |  
|Deferred revenue                                                                                                                                  |  |               | 10,362    |   |                   |   | 14,895    |  
|Warranty                                                                                                                                          |  |               | 15,729    |   |                   |   | 18,223    |  
|Deferred tax liabilities                                                                                                                          |  |               | 19,840    |   |                   |   | 19,840    |  
|Income taxes payable                                                                                                                              |  |               | 88,160    |   |                   |   |          |  
|Other long-term liabilities                                                                                                                       |  |               | 11,291    |   |                   |   | 12,917    |  
|                                                                                                                                                  |  |               |           |   |                   |   |           |  
|Total liabilities                                                                                                                                 |  |               | 1,305,869 |   |                   |   | 1,384,809 |  
|                                                                                                                                                  |  |               |           |   |                   |   |           |  
|Minority interest                                                                                                                                 |  |               | 2,526     |   |                   |   | 2,418     |  
|                                                                                                                                                  |  |               |           |   |                   |   |           |  
|Commitments and contingencies (Note 8)                                                                                                            |  |               |           |   |                   |   |           |  
|Stockholders equity:                                                                                                                             |  |               |           |   |                   |   |           |  
|Common stock, $.01 par value, 1,000,000 shares authorized; 378,989 and 376,989 shares issued at June 30, 2007 and December 31, 2006,
respectively |  |               | 3,790     |   |                   |   | 3,770     |  
|Additional paid-in capital                                                                                                                        |  |               | 978,332   |   |                   |   | 973,895   |  
|Treasury stock, at cost 5,347 shares at June 30, 2007 and December 31, 2006                                                                       |  |               | (26,448   | ) |                   |   | (26,448   | )
|Deferred stock-based compensation                                                                                                                 |  |               | (5,293    | ) |                   |   | (2,746    | )
|Accumulated deficit                                                                                                                               |  |               | (687,736  | ) |                   |   | (678,243  | )
|Accumulated other comprehensive loss                                                                                                              |  |               | (1,513    | ) |                   |   | (1,220    | )
|                                                                                                                                                  |  |               |           |   |                   |   |           |  
|Net stockholders equity                                                                                                                          |  |               | 261,132   |   |                   |   | 269,008   |  
|                                                                                                                                                  |  |               |           |   |                   |   |           |  
|                                                                                                                                                  |  | $             | 1,569,527 |   |                   | $ | 1,656,235 |  
|                                                                                                                                                  |  |               |           |   |                   |   |           |  

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



4



---

##### Table of Contents

GATEWAY, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

For the six months ended June 30, 2007 and 2006

(in thousands)



|                                                                                          |  |                           |          |   |      |   |          |  
|----------------------------------------------------------------------------------------- |  | ------------------------- | -------- | - | ---- | - | -------- | -
|                                                                                          |  | Six Months Ended June 30, |         
|                                                                                          |  | 2007                      |          |   | 2006 |  
|Cash flows from operating activities:                                                     |  |                           |          |   |      |   |          |  
|Net loss                                                                                  |  | $                         | (6,666   | ) |      | $ | (20,017  | )
|Adjustments to reconcile net loss to net cash provided by (used in) operating activities: |  |                           |          |   |      |   |          |  
|Write-down of long-lived assets                                                           |  |                           |         |   |      |   | 1,176    |  
|Depreciation and amortization                                                             |  |                           | 19,339   |   |      |   | 13,471   |  
|Provision for doubtful accounts receivable                                                |  |                           | 8,457    |   |      |   | 2,083    |  
|Stock based compensation                                                                  |  |                           | 2,216    |   |      |   | 2,149    |  
|Loss on sale of investments                                                               |  |                           | 55       |   |      |   | 66       |  
|Loss on disposal of property, plant, and equipment                                        |  |                           | 1        |   |      |   |         |  
|Changes in operating assets and liabilities:                                              |  |                           |          |   |      |   |          |  
|Accounts receivable                                                                       |  |                           | (49,614  | ) |      |   | 23,343   |  
|Inventory                                                                                 |  |                           | (63,244  | ) |      |   | 71,536   |  
|Prepaid expenses                                                                          |  |                           | (12,384  | ) |      |   | 11,735   |  
|Receivables from suppliers                                                                |  |                           | (27,929  | ) |      |   | 68,156   |  
|Restricted cash                                                                           |  |                           | 2,713    |   |      |   | 850      |  
|Other assets                                                                              |  |                           | 60,685   |   |      |   | (25,429  | )
|Accounts payable                                                                          |  |                           | (3,571   | ) |      |   | (162,640 | )
|Accrued liabilities                                                                       |  |                           | (63,173  | ) |      |   | (723     | )
|Accrued royalties                                                                         |  |                           | 4,395    |   |      |   | (1,327   | )
|Other liabilities (see Note 6)                                                            |  |                           | (12,467  | ) |      |   | (25,533  | )
|                                                                                          |  |                           |          |   |      |   |          |  
|Net cash used in operating activities                                                     |  |                           | (141,187 | ) |      |   | (41,104  | )
|                                                                                          |  |                           |          |   |      |   |          |  
|Cash flows from investing activities:                                                     |  |                           |          |   |      |   |          |  
|Proceeds from sales of available-for-sale securities, net                                 |  |                           | 57,894   |   |      |   | 113,121  |  
|Purchases of available-for-sale securities                                                |  |                           | (16,753  | ) |      |   | (48,879  | )
|Purchases of property, plant and equipment                                                |  |                           | (20,093  | ) |      |   | (24,093  | )
|Proceeds from sale of property, plant and equipment                                       |  |                           |         |   |      |   | 3,731    |  
|                                                                                          |  |                           |          |   |      |   |          |  
|Net cash provided by investing activities                                                 |  |                           | 21,048   |   |      |   | 43,880   |  
|                                                                                          |  |                           |          |   |      |   |          |  
|Cash flows from financing activities:                                                     |  |                           |          |   |      |   |          |  
|Repurchase of treasury stock                                                              |  |                           |         |   |      |   | (280     | )
|Proceeds from common stock option exercises                                               |  |                           | 83       |   |      |   | 5        |  
|                                                                                          |  |                           |          |   |      |   |          |  
|Net cash provided by (used in) financing activities                                       |  |                           | 83       |   |      |   | (275     | )
|                                                                                          |  |                           |          |   |      |   |          |  
|Net increase (decrease) in cash and cash equivalents                                      |  |                           | (120,056 | ) |      |   | 2,501    |  
|Cash and cash equivalents, beginning of period                                            |  |                           | 345,677  |   |      |   | 422,488  |  
|                                                                                          |  |                           |          |   |      |   |          |  
|Cash and cash equivalents, end of period                                                  |  | $                         | 225,621  |   |      | $ | 424,989  |  
|                                                                                          |  |                           |          |   |      |   |          |  
|SUPPLEMENTAL DISCLOSURE OF NON-CASH INVESTING AND FINANCING ACTIVITIES                    |  |                           |          |   |      |   |          |  
|Minority interest in earnings                                                             |  | $                         | (108     | ) |      | $ |         |  
|                                                                                          |  |                           |          |   |      |   |          |  
|Value of restricted shares withheld for taxes                                             |  | $                         | 312      |   |      | $ | 2,690    |  
|                                                                                          |  |                           |          |   |      |   |          |  
|SUPPLEMENTAL CASH FLOW INFORMATION                                                        |  |                           |          |   |      |   |          |  
|Cash received for income taxes, net                                                       |  | $                         | 103      |   |      | $ | 153      |  
|                                                                                          |  |                           |          |   |      |   |          |  
|Cash paid for interest                                                                    |  | $                         | 3,437    |   |      | $ | 3,215    |  
|                                                                                          |  |                           |          |   |      |   |          |  

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



5



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Nature of Operations and
Summary of Significant Accounting Policies

The accompanying unaudited consolidated financial statements of Gateway, Inc.
(Gateway) as of June 30, 2007, and for the three and six months ended June 30, 2007 and 2006 have been prepared on the same basis as the audited consolidated financial statements for the year ended December 31, 2006 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.

Gateway directly
and indirectly sells its desktop and notebook computers and servers (PCs), PC-related products and services that are enabled by or connect with PCs to third-party retailers, consumers, businesses, government agencies and educational
institutions. PC-related products and services (Non-PC) consist of all products and services other than the PC, including stand-alone displays, peripherals, software, accessories, extended warranty services, training, Internet access,
web portals, security services, enterprise system and networking products and services.

Basis of Presentation

The unaudited consolidated financial statements include the accounts of Gateway and its subsidiaries. All intercompany accounts and transactions have been
eliminated in consolidation. These unaudited consolidated financial statements should be read in conjunction with Gateways audited consolidated financial statements and notes thereto for the year ended December 31, 2006, which are
included in Gateways 2006 Annual Report on Form 10-K, filed with the Securities and Exchange Commission.

Use of Estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America
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 revenue and
expenses during the reporting period. Actual results could differ from those estimates. Significant estimates include the fair values ascribed to severable contract elements, provisions for sales returns, bad debts in accounts receivable, excess
and/or obsolete inventory, product warranty costs, customer incentive programs including rebates, employee incentive programs including bonus and options, restructuring activities, deferred tax assets and litigation matters.

Marketable Securities

Included in marketable securities as of June 30, 2007 are unrealized losses of approximately $0.2 million related to securities that have been in an unrealized loss position for greater than 12 months. The underlying securities are
primarily federal, state and municipal, mortgage-backed and corporate debt securities and the unrealized losses are largely due to recent interest rate increases. No single securitys unrealized loss position is considered significant as a
percentage of its cost and management believes Gateway has the ability and intent to hold the underlying securities to maturity, and for this reason, no other-than-temporary impairment charge was recorded during the second quarter of 2007.



6



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Revenue Recognition

Gateway recognizes revenue on PCs and Non-PC products when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed
and determinable, and collectibility is reasonably assured. Revenue from training services is recognized as the services are provided. Revenue from Internet access, web portals, and security services provided by third parties is recognized as the
services are provided based on subscriber counts reported to us by the service providers. Revenue from the sale of other services rendered by third parties, such as installation services, is generally recognized when such services are performed.

Gateway records reductions in revenue in the current period for estimated future product returns and estimated rebate redemption rates
related to current period sales. Management analyzes historical returns, current trends, changes in customer demand and acceptance of Gateway products when evaluating the adequacy of the sales returns allowances in any accounting period. Management
also analyzes historical rebate redemption rates, current trends and the interrelationship of these rates with the current rebate dollar amounts in evaluating rebate allowances. Gateway records reductions to revenue for estimated commitments related
to other customer and sales incentive programs. This includes, among other things, trade-ins and referral credits. Future market conditions and product transitions may require Gateway to increase customer incentive programs that could result in
incremental reductions of revenue at the time such programs are offered, which would affect earnings in the period the adjustments are made.

Gateway records revenue net of sales taxes or valued-added taxes levied by governmental authorities. Such taxes are considered current liabilities and included within accrued expenses until paid.

Adoption of New Accounting Pronouncement

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109 (FIN 48). FIN 48
clarifies the accounting for uncertainty in income taxes by prescribing the recognition threshold a tax position is required to meet before being recognized in the financial statements. It also provides guidance on derecognition, classification,
interest and penalties, accounting in interim periods, disclosure, and transition. The Company adopted FIN 48 effective January 1, 2007, and the provisions of FIN 48 will be applied to all income tax positions commencing from that date.
The Company recognizes potential accrued interest and penalties related to unrecognized beneficial tax positions taken within operations as income tax expense. The cumulative effect of applying the provisions of FIN 48 has been reported as an
adjustment to the opening balance of retained earnings as of January 1, 2007.

As a result of applying the provisions of FIN 48,
Gateway recognized a $2.8 million increase to accumulated deficit as of January 1, 2007. The Companys unrecognized tax benefits totaled $92 million at January 1, 2007 and relate to ongoing audits from various taxing authorities. This
amount included $2.7 million of penalties and $29 million of interest. Gateways continuing practice is to recognize interest and penalties related to income tax matters in income tax expense, which is consistent with FIN 48. Included in the
balance at January 1, 2007 is $92 million of tax benefits that when recognized would reduce the annual effective income tax rate. Included in the balance of unrecognized tax benefits at January 1, 2007, is $84 million related to tax
positions for which it is reasonably possible that the total amounts could significantly change during the next twelve months and Gateway believes will benefit its reported net income. In accordance with FIN 48, this amount was reclassified from
current income taxes payable presented as of December 31, 2006 to non-current income taxes payable on January 1, 2007. Further, this amount represents a decrease in unrecognized tax benefits comprised of items related to settlement
negotiations currently in progress with the Joint Committee of Taxation for tax years 1996-2001 primarily related to utilization of NOLs and expiring statutes in various jurisdictions related to its 2002 return filings (see Note 6).



7



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Recent Accounting Pronouncements

In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instrumentsan amendment of FASB SFAS Nos. 133 and
140 (SFAS 155). This Statement amends FASB SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, and No. 140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. SFAS 155 resolves issues addressed in Statement 133 Implementation Issue No. D1, Application of Statement 133 to Beneficial Interests in Securitized Financial Assets. SFAS 155 is effective for all financial
instruments acquired or issued after the beginning of an entitys first fiscal year that begins after September 15, 2006. The adoption of SFAS 155 did not have a material impact on Gateways consolidated results of operations,
financial position or cash flows.

In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements
(SFAS 157). SFAS 157 provides guidance for using fair value to measure assets and liabilities. It also responds to investors requests for expanded information about the extent to which companies measure assets and
liabilities at fair value, the information used to measure fair value, and the effect of fair value measurements on earnings. SFAS 157 applies whenever other standards require (or permit) assets or liabilities to be measured at fair value, and
does not expand the use of fair value in any new circumstances. SFAS 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007 and is required to be adopted by Gateway in the first quarter of
fiscal 2008. Management does not believe the adoption of SFAS 157 will have a material impact on Gateways consolidated results of operations, financial position or cash flows.

In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilitiesincluding an
amendment of FASB Statement No. 115 (SFAS No. 159). SFAS 159 expands the use of fair value accounting but does not affect existing standards which require assets or liabilities to be carried at fair value. The
objective of SFAS No. 159 is to improve financial reporting by providing companies with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex
hedge accounting provisions. Under SFAS No. 159, a company may elect to use fair value to measure eligible items at specified election dates and report unrealized gains and losses on items for which the fair value option has been elected in
earnings at each subsequent reporting date. Eligible items include, but are not limited to, accounts and loans receivable, available-for-sale and held-to-maturity securities, equity method investments, accounts payable, guarantees, issued debt and
firm commitments. If elected, SFAS No. 159 is effective for fiscal years beginning after November 15, 2007.Management is currently assessing whether fair value accounting is appropriate for any of Gateways eligible items and
cannot estimate the impact, if any, on Gateways consolidated results of operations, financial position or cash flows.

2. Comprehensive gain
(loss)

Comprehensive gain (loss) for Gateway includes net income (loss), foreign currency translation adjustments and net unrealized
gains on available-for-sale securities. Comprehensive gain (loss) for the three and six months ended June 30, 2007 and 2006 is as follows (in thousands):



|                                                      |  |                             |       |   |                           |   |        |      |  |   |        |   |  |   |         |  
|----------------------------------------------------- |  | --------------------------- | ----- | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------- | -
|                                                      |  | Three Months Ended June 30, |       |   | Six Months Ended June 30, |  
|                                                      |  | 2007                        |       |   | 2006                      |   |        | 2007 |  |   | 2006   |  
|Comprehensive gain (loss):                            |  |                             |       |   |                           |   |        |      |  |   |        |   |  |   |         |  
|Net income (loss)                                     |  | $                           | 1,913 |   |                           | $ | (7,680 | )    |  | $ | (6,666 | ) |  | $ | (20,017 | )
|Foreign currency translation                          |  |                             | (453  | ) |                           |   | 338    |      |  |   | (442   | ) |  |   | 673     |  
|Unrealized gain on available-for-sale securities, net |  |                             | 1     |   |                           |   | 291    |      |  |   | 149    |   |  |   | 649     |  
|                                                      |  |                             |       |   |                           |   |        |      |  |   |        |   |  |   |         |  
|                                                      |  | $                           | 1,461 |   |                           | $ | (7,051 | )    |  | $ | (6,959 | ) |  | $ | (18,695 | )
|                                                      |  |                             |       |   |                           |   |        |      |  |   |        |   |  |   |         |  



8



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



The components of other comprehensive loss as of June 30, 2007 and December 31, 2006 are as
follows (in thousands):



|                                                             |  |               |        |   |                   |   |        |  
|------------------------------------------------------------ |  | ------------- | ------ | - | ----------------- | - | ------ | -
|                                                             |  | June 30, 2007 |        |   | December 31, 2006 |  
|Accumulated other comprehensive loss:                        |  |               |        |   |                   |   |        |  
|Foreign currency translation                                 |  | $             | (1,363 | ) |                   | $ | (921   | )
|Unrealized loss on available for sale securities, net of tax |  |               | (150   | ) |                   |   | (299   | )
|                                                             |  |               |        |   |                   |   |        |  
|                                                             |  | $             | (1,513 | ) |                   | $ | (1,220 | )
|                                                             |  |               |        |   |                   |   |        |  

3. Selected Balance Sheet Information(in thousands)

Gateway purchases selected components from suppliers and, where possible, in lieu of a consignment arrangement, resells the components to original design
manufacturers to incorporate into products being manufactured for Gateway. The receivable for the sale of the components is recorded as Receivables from suppliers.



|                                                |  |               |          |   |                   |   |          |  
|----------------------------------------------- |  | ------------- | -------- | - | ----------------- | - | -------- | -
|                                                |  | June 30, 2007 |          |   | December 31, 2006 |  
|Inventory:                                      |  |               |          |   |                   |   |          |  
|Components and subassemblies                    |  | $             | 46,743   |   |                   | $ | 38,414   |  
|Finished goods                                  |  |               | 145,226  |   |                   |   | 82,713   |  
|Inventory reserves                              |  |               | (31,538  | ) |                   |   | (23,940  | )
|                                                |  |               |          |   |                   |   |          |  
|Total inventory                                 |  | $             | 160,431  |   |                   | $ | 97,187   |  
|                                                |  |               |          |   |                   |   |          |  
|Receivables from suppliers                      |  | $             | 275,136  |   |                   | $ | 247,207  |  
|                                                |  |               |          |   |                   |   |          |  
|Other current assets:                           |  |               |          |   |                   |   |          |  
|Assets held for sale                            |  |               | 15,525   |   |                   |   | 14,774   |  
|Vendor rebates                                  |  |               | 35,565   |   |                   |   | 82,545   |  
|Other                                           |  |               | 65,840   |   |                   |   | 77,964   |  
|                                                |  |               |          |   |                   |   |          |  
|Other current assets                            |  | $             | 116,930  |   |                   | $ | 175,283  |  
|                                                |  |               |          |   |                   |   |          |  
|Property, plant and equipment, net:             |  |               |          |   |                   |   |          |  
|Land                                            |  | $             | 1,904    |   |                   | $ | 1,904    |  
|Leasehold improvements                          |  |               | 6,529    |   |                   |   | 5,819    |  
|Buildings                                       |  |               | 26,746   |   |                   |   | 26,746   |  
|Construction in progress                        |  |               | 11,919   |   |                   |   | 61,834   |  
|Internal use software                           |  |               | 262,443  |   |                   |   | 205,848  |  
|Office and production equipment                 |  |               | 39,619   |   |                   |   | 32,290   |  
|Furniture and fixtures                          |  |               | 7,103    |   |                   |   | 7,090    |  
|Vehicles                                        |  |               | 45       |   |                   |   | 45       |  
|                                                |  |               |          |   |                   |   |          |  
|                                                |  |               | 356,308  |   |                   |   | 341,576  |  
|Less: Accumulated depreciation and amortization |  |               | (246,150 | ) |                   |   | (230,645 | )
|                                                |  |               |          |   |                   |   |          |  
|Property, plant and equipment, net              |  | $             | 110,158  |   |                   | $ | 110,931  |  
|                                                |  |               |          |   |                   |   |          |  



9



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Total depreciation expense was $6.4 million and $13 million for the three and six months ended
June 30, 2007, respectively, and $4.5 million and $10 million for the same respective periods of 2006.



|                                                              |  |               |         |   |                   |   |         |  
|------------------------------------------------------------- |  | ------------- | ------- | - | ----------------- | - | ------- | -
|                                                              |  | June 30, 2007 |         |   | December 31, 2006 |  
|Intangible assets (amortizable), net:                         |  |               |         |   |                   |   |         |  
|Customer relationships                                        |  | $             | 48,400  |   |                   | $ | 48,400  |  
|License portfolio                                             |  |               | 30,277  |   |                   |   | 30,277  |  
|Patents and trademarks                                        |  |               | 22,906  |   |                   |   | 22,906  |  
|Accumulated amortization                                      |  |               | (32,674 | ) |                   |   | (26,525 | )
|                                                              |  |               |         |   |                   |   |         |  
|Intangible assets (amortizable), net                          |  | $             | 68,909  |   |                   | $ | 75,058  |  
|                                                              |  |               |         |   |                   |   |         |  
|Goodwill and non-amortizable intangible assets:               |  |               |         |   |                   |   |         |  
|Non-amortizable intangible assets (trademarks and tradenames) |  | $             | 49,600  |   |                   | $ | 49,600  |  
|Goodwill                                                      |  |               | 155,619 |   |                   |   | 155,619 |  
|                                                              |  |               |         |   |                   |   |         |  
|Goodwill and non-amortizable intangible assets                |  | $             | 205,219 |   |                   | $ | 205,219 |  
|                                                              |  |               |         |   |                   |   |         |  

During the second quarter of 2006, Gateway and Hewlett-Packard executed a definitive cross-license
agreement of which $30 million related to a seven year license. Total intangible asset amortization expense was $3.1 million and $6.1 million for the three and six months ended June 30, 2007, and $2.1 million and $3.5 million for the same
respective periods of 2006.

4. Warranty Liability and Deferred Revenue

Warranty Liability

Gateway
provides standard warranties with the sale of products. The estimated cost of providing the product warranty is recorded at the time revenue is recognized. Gateway maintains product quality programs and processes including monitoring and evaluating
the quality of its suppliers. Estimated warranty costs are affected by ongoing product failure rates, specific product class failures outside of experience and material usage and service delivery costs incurred in correcting a product failure or in
providing customer support. A summary of changes in Gateways accrued warranty liability, which is included in both current liabilities and long-term liabilities, is as follows (in thousands):



|                                          |  |                           |         |   |      |   |         |  
|----------------------------------------- |  | ------------------------- | ------- | - | ---- | - | ------- | -
|                                          |  | Six Months Ended June 30, |        
|                                          |  | 2007                      |         |   | 2006 |  
|Accrued warranty, beginning of the period |  | $                         | 64,839  |   |      | $ | 37,040  |  
|Accruals for warranties during the period |  |                           | 51,802  |   |      |   | 42,015  |  
|Settlements made                          |  |                           | (46,892 | ) |      |   | (25,446 | )
|                                          |  |                           |         |   |      |   |         |  
|Accrued warranty, end of the period       |  | $                         | 69,749  |   |      | $ | 53,609  |  
|                                          |  |                           |         |   |      |   |         |  

Extended Warranty Deferred Revenue

Gateway offers its customers an option to purchase extended warranties. Revenue related to sales of extended warranties sold on behalf of third-parties is
recognized at the time of sale, net of amounts due to the third-party. Revenue from sales of extended warranties where Gateway is the legal obligor is deferred and



10



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



recognized on a straight-line basis over the warranty service period. Gateway expects that deferred revenue, and the revenue stream associated with it, will
continue to decline in future quarters. A schedule of additions to extended warranty deferred revenue which is included in both current liabilities and long-term liabilities and recognition of extended warranty revenue for the periods presented is
as follows (in thousands):



|                                                            |  |                           |         |   |      |   |         |  
|----------------------------------------------------------- |  | ------------------------- | ------- | - | ---- | - | ------- | -
|                                                            |  | Six Months Ended June 30, |        
|                                                            |  | 2007                      |         |   | 2006 |  
|Extended warranty deferred revenue, beginning of the period |  | $                         | 40,039  |   |      | $ | 87,806  |  
|Additions to extended warranty deferred revenue             |  |                           | 2,248   |   |      |   | 4,882   |  
|Extended warranty revenue recognition                       |  |                           | (16,042 | ) |      |   | (34,189 | )
|                                                            |  |                           |         |   |      |   |         |  
|Extended warranty deferred revenue, end of the period       |  | $                         | 26,245  |   |      | $ | 58,499  |  
|                                                            |  |                           |         |   |      |   |         |  

5. Financing Arrangements

On October 30, 2004, Gateway entered into a credit agreement with a major financial institution to provide for a revolving credit facility of up to
$200 million. Borrowings under this agreement bear interest, at Gateways election, based on LIBOR or the prime rate and are secured by substantially all of Gateways accounts receivable, inventory and certain deposit accounts into which
accounts receivable payments are initially deposited. In addition to usual and customary covenants for an arrangement of its type, the credit agreement, as amended, includes certain financial covenants. Gateway must maintain Liquidity (defined as
the sum of Certified Cash and Borrowing Availability) of $100 million. In addition, starting on October 1, 2006, negative cash flow, as defined in the credit agreement, may not exceed $40 million for the three months ended December 31,
2006, $57 million for the six months ended March 31, 2007, and $60 million thereafter, with cumulative negative cash flow not to exceed $120 million. As of the nine months ended June 30, 2007, the cumulative negative cash flow was $14
million. Further, once Gateway has achieved three consecutive quarters of positive excess cash flow, it must maintain positive cash flow in each quarter thereafter. The credit agreement expires on October 31, 2010, at which time all amounts
then outstanding will be due and payable. As of June 30, 2007 and June 30, 2006, Gateway had $0 and $50 million, respectively, in borrowings outstanding under this agreement. The interest rates as of June 30, 2007 and June 30,
2006 were 7.25%. This interest rate adjusts with changes in the prime rate. As of June 30, 2007, Gateway also utilized the credit agreement to support $32 million of stand-by letters of credit and had additional borrowing availability of $82
million based on the borrowing base.

In December 2004, Gateway issued $300 million of senior convertible notes through a private placement
to institutional investors, including $150 million of 1.50% senior convertible notes due December 31, 2009 and $150 million of 2.00% senior convertible notes due December 31, 2011. The notes are direct, unsecured and unsubordinated
obligations of Gateway and rank equal in priority to Gateways existing and future unsecured indebtedness and senior in right of payment to any future subordinated indebtedness. Each $1,000 note is initially convertible into 115.8749 shares of
Gateway common stock based on an initial conversion price of $8.63, or approximately 34.8 million shares in aggregate, at anytime prior to the close of business on the business day immediately prior to scheduled maturity. The conversion rate
and conversion price are subject to customary adjustments upon the occurrence of certain events. Gateway may deliver cash, common shares or a combination of both in settlement of its obligations upon conversion of notes. Note-holders may elect to
convert upon the occurrence of a fundamental change, which is any transaction in which 90% or more of Gateways common stock is exchanged for, converted into, or acquired for consideration which is not at least 90% common stock that
is listed on a United States national securities exchange. Note-holders also may require Gateway to repurchase all or a portion of the notes at 100% of principal plus accrued and unpaid interest upon occurrence of a fundamental



11



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



change or if Gateways common stock ceases to be listed on a United States national securities exchange. The conversion rate also may be adjusted upon
the occurrence of a fundamental change. Gateway may not redeem the notes prior to maturity. Interest is payable semi-annually each June 30 and December 31.

Interest expense (including amortization of debt issue costs and line of credit expenses) was $2.0 million and $4.1 million for the three and six months ended June 30, 2007, and $2.2 million and $4.3 million for
the same respective periods in 2006.

6. Income Taxes

Gateway records a tax provision or benefit for the anticipated tax consequences of its reported results of operations. The provision from 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. Gateway recorded a net tax provision of $5.4 million in the six months
ending June 30, 2007, primarily representing $3.5 million of interest accruals relating to previously accrued liabilities and foreign and state income tax accruals from operations of $1.9 million.

In July 2006, the FASB issued FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement
No. 109 (FIN 48). FIN 48 clarifies the accounting for uncertainty in income taxes by prescribing the recognition threshold a tax position is required to meet before being recognized in the financial statements. It
also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. Gateway adopted FIN 48 effective January 1, 2007, and the provisions of FIN 48 will be applied to
all income tax positions commencing from that date. Gateway recognizes potential accrued interest and penalties related to unrecognized beneficial tax positions taken within operations as income tax expense. The cumulative effect of applying the
provisions of FIN 48 has been reported as an adjustment to the opening balance of retained earnings as of January 1, 2007.

As a
result of applying the provisions of FIN 48, Gateway recognized a $2.8 million increase to accumulated deficit as of January 1, 2007. Gateways unrecognized tax benefits totaled $92 million at January 1, 2007 and relate to ongoing
audits from various taxing authorities. This amount included $2.7 million of penalties and $29 million of interest. Gateways continuing practice is to recognize interest and penalties related to income tax matters in income tax expense, which
is consistent with FIN 48. Included in the balance at January 1, 2007 is $92 million of tax benefits that when recognized would reduce the annual effective income tax rate. Included in the balance of unrecognized tax benefits at January 1,
2007, is $84 million related to tax positions for which it is reasonably possible that the total amounts could significantly change during the next twelve months and Gateway believes will benefit its reported net income. In accordance with FIN 48,
this amount was reclassified from current income taxes payable presented as of December 31, 2006 to non-current income taxes payable on January 1, 2007. Further, this amount represents a decrease in unrecognized tax benefits comprised of
items related to settlement negotiations currently in progress with the Joint Committee of Taxation for tax years 1996-2001 primarily related to utilization of NOLs and expiring statutes in various jurisdictions related to its 2002 return filings.

Gateway files U.S., state and foreign income returns in jurisdictions with varying statutes of limitation. The 1996 through 2006 tax years
generally remain subject to examination by federal and most state taxing authorities. In significant foreign jurisdictions, the 2001 through 2006 tax years generally remain subject to examination by taxing authorities.



12



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Based on consideration of all relevant facts and circumstances, Gateway does not believe the ultimate
resolution of tax issues for all open tax periods will have a materially adverse effect upon its future results of operations. Gateway expects to maintain a full valuation allowance on potential future tax benefits and generally to record no tax
benefit until an appropriate level of profitability is sustained.

7. Stockholders Equity

Net Income (Loss) Per Share

Basic and diluted income (loss) per common share is computed using net income (loss) and the weighted average number of common shares outstanding during the period. Diluted income (loss) per common share (if applicable) is computed using
net income (loss), as adjusted, and the combination of the weighted average number of shares outstanding and all potentially dilutive common shares outstanding during the period unless the inclusion of such shares is anti-dilutive.

The following table sets forth the computation of basic and diluted net loss per share for the periods indicated (in thousands, except per share
amounts):



|                                            |  |                             |         |      |                           |         |      |  |   |         |   |  |   |         |  
|------------------------------------------- |  | --------------------------- | ------- | ---- | ------------------------- | ------- | ---- |  | - | ------- | - |  | - | ------- | -
|                                            |  | Three Months Ended June 30, |         |      | Six Months Ended June 30, |        
|                                            |  | 2007                        |         | 2006 |                           |         | 2007 |  |   | 2006    |  
|Net income (loss)basic and diluted         |  | $                           | 1,913   |      | $                         | (7,680  | )    |  | $ | (6,666  | ) |  | $ | (20,017 | )
|                                            |  |                             |         |      |                           |         |      |  |   |         |   |  |   |         |  
|Weighted average shares outstandingbasic   |  |                             | 371,857 |      |                           | 372,089 |      |  |   | 371,666 |   |  |   | 372,531 |  
|Employee and director stock options         |  |                             | 71      |      |                           |        |      |  |   |        |   |  |   |        |  
|                                            |  |                             |         |      |                           |         |      |  |   |         |   |  |   |         |  
|Weighted average shares outstandingdiluted |  |                             | 371,928 |      |                           | 372,089 |      |  |   | 371,666 |   |  |   | 372,531 |  
|                                            |  |                             |         |      |                           |         |      |  |   |         |   |  |   |         |  
|Net income (loss) per sharebasic           |  | $                           | 0.01    |      | $                         | (0.02   | )    |  | $ | (0.02   | ) |  | $ | (0.05   | )
|Net income (loss) per sharediluted         |  | $                           | 0.01    |      | $                         | (0.02   | )    |  | $ | (0.02   | ) |  | $ | (0.05   | )

Weighted average shares outstanding for three and six months ended June 30, 2007 and 2006
excludes 35 million shares issuable upon conversion of the senior convertible notes. Gateway has also excluded from net income (loss) per share, 30 million shares and 36 million shares for the three months ended June 30, 2007 and
2006, respectively, and 32 million shares and 35 million shares for the six months ended June 30, 2007 and 2006, respectively, related to employee and director stock options which have exercise prices greater than the average market
price of the shares of common stock for those periods. These shares are excluded for these periods as their effect on net loss per share is anti-dilutive.

Deferred Stock-Based Compensation

In March 2004, Gateway issued 5.3 million shares of
restricted stock valued at approximately $27 million to certain executives in connection with its acquisition of eMachines. This amount was recorded as deferred stock-based compensation and is being amortized to compensation expense in accordance
with the vesting schedule. Approximately 2.5 million shares vested on January 1, 2005. During the second quarter of 2005, vesting on approximately 0.4 million shares was accelerated for a departing executive, resulting in an
additional compensation charge of $1.3 million in the quarter. Of the remaining 2.4 million shares, 2.1 million shares vested on January 1, 2006 and the remaining 0.3 million shares vested on January 1, 2007.

In March 2006, Gateway issued 0.1 million shares of restricted stock valued at approximately $0.2 million to an executive as a discretionary bonus.
These shares became fully vested in March 2007. In September 2006,



13



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



Gateway issued 0.1 million shares of restricted stock valued at approximately $0.2 million to Gateways new Chief Executive Officer as a sign-on
bonus. In June 2007, Gateway issued 2.1 million shares of restricted stock valued at approximately $3.5 million to certain employees. Half of these shares will vest in June 2008 and the remaining half will vest in June 2009. These amounts were
recorded as deferred stock-based compensation and are being amortized to compensation expense in accordance with their vesting schedules. Deferred stock-based compensation was $5.3 million as of June 30, 2007.

Gateway estimates the fair value of options granted using the Black-Scholes option valuation model. Gateway estimates the volatility of its common stock
at the date of grant based on historical volatility rate, consistent with SFAS No. 123-R and Securities and Exchange Commission Staff Accounting Bulletin (SAB) No. 107. The dividend yield assumption is zero based on
Gateways historical dividend payment patterns. The risk-free interest rate assumption is based on observed interest rates appropriate for the term of Gateways employee options. Gateway uses historical volatility and the availability and
reliability of historical option exercise to estimate expected option term. Gateway uses historical data to estimate pre-vesting option forfeitures and record share-based compensation expense only for those awards that are expected to vest. For
options granted, Gateway amortizes the fair value on a straight-line basis over the vesting period of the options. Gateway used the following assumptions to estimate the fair value of share-based payment awards for the three and six months ended
June 30, 2007 and 2006:



|                                     |  |                             |   |  |                           |   |  |           |   |  |           |  
|------------------------------------ |  | --------------------------- | - |  | ------------------------- | - |  | --------- | - |  | --------- | -
|                                     |  | Three Months Ended June 30, |   |  | Six Months Ended June 30, |  
|                                     |  | 2007                        |   |  | 2006                      |   |  | 2007      |   |  | 2006      |  
|Dividend yield                       |  |                            |   |  |                          |   |  |          |   |  |          |  
|Risk-free interest rate              |  | 4.8                         | % |  | 5.0                       | % |  | 4.8       | % |  | 4.8       | %
|Expected volatility                  |  | 53                          | % |  | 56                        | % |  | 53        | % |  | 54        | %
|Expected option term (after vesting) |  | 3.5 years                   |   |  | 3.5 years                 |   |  | 3.5 years |   |  | 3.5 years |  

Gateway recorded $0.9 million and $1.5 million in share-based compensation expense for stock
options for the three and six months ended June 30, 2007, respectively, and $0.5 million and $0.9 million for the same respective periods in 2006. Gateway recorded $0.2 million and $0.5 million in share-based compensation expense for
restricted stock awards for the three and six months ended June 30, 2007, respectively, $0.6 million and $1.3 million for the same periods in 2006.

Treasury Stock

Gateway has acquired shares of its common stock which are held in treasury.
This includes 2.7 million shares repurchased during the fourth quarter of 2004 in connection with the repurchase of the Series A and Series C preferred stock from America Online, Inc. In March 2004, Gateway issued 5.3 million shares of
restricted stock to certain executives in connection with its acquisition of eMachines. In January 2005, approximately 2.5 million of these shares vested and Gateway issued 1.4 million shares of unrestricted stock (subject to certain
limitations on disposition) and withheld the remaining 1.1 million shares to assist the executives in meeting certain tax liabilities associated with such vesting. During the second quarter of 2005, vesting on approximately 0.4 million
restricted shares was accelerated for a departing executive. Approximately 0.2 million shares of these 0.4 million shares were withheld to assist the executive in meeting certain tax liabilities associated with vesting. During 2006,
approximately 2.1 million of the originally issued shares of restricted stock vested and Gateway issued 1.1 million shares of unrestricted stock (subject to certain limitations on disposition) and withheld the remaining 1.0 million
shares to assist the executives in meeting certain tax liabilities associated with such vesting. In June 2006, Gateway repurchased approximately 0.2 million shares of common stock in a private



14



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



transaction from a Gateway executive at a price equal to the market price as of the date of purchase. In October 2006, Gateway withheld approximately
0.1 million shares on the vesting of employee restricted stock. All shares withheld to cover tax liabilities are valued at their fair market value on the vesting date and are included in treasury stock. Treasury stock is accounted for under the
cost method and is available for issuance.

8. Commitments and Contingencies

Gateway had stand-by letters of credit and guarantees outstanding at June 30, 2007, amounting to $32 million. Beginning in the second quarter of
2005, these letters of credit and guarantees are primarily issued through Gateways revolving credit facility.

Legal
Proceedings

Gateway is a party to various lawsuits, claims, including assertions of patent infringements, investigations and
administrative proceedings that arise in connection with its business, including those identified below. Gateway evaluates such matters on a case by case basis, and its policy is to vigorously contest any such claims it believes are without merit.

Litigation

Multimedia Patent Trust v. Microsoft, et. al. is a suit filed on April 24, 2007 in the United States District Court for the Southern District of California against Microsoft Corporation (Microsoft), Dell, Inc. (Dell), and
various Gateway entities. The plaintiff alleges that the defendants have infringed three patents relating to video coding, and seeks unspecified damages and declaratory relief. The plaintiff is a purported trust created by Lucent Technologies, Inc.
(Lucent) prior to Lucents merger with Alcatel, and Lucent is designated as the principal beneficiary of any trust activities. The patents in suit were allegedly transferred to the plaintiff just prior to Alcatel/Lucent merger. The defendants
filed their answers to the plaintiffs complaint on June 29, 2007. No trial date has been set.

Rattner v. Snyder, et
al. is a derivative action filed on September 6, 2006, in California State Superior Court, County of Orange, against Gateway as a nominal defendant and against Gateways board of directors as constituted in August 2006. The suit
alleges that board members breached their fiduciary duties in connection with the Gateways September 1, 2006 announcement that it had rejected an earlier offer by shareholder Lap Shun John Hui to acquire Gateways retail
operations for approximately $450 million. The complaint seeks unspecified damages and declaratory relief. In response to a motion filed by Gateway, the court dismissed the initial complaint for plaintiffs failure to plead demand futility
adequately. The court has given plaintiff leave to file an amended complaint no later than August 31, 2007, at which time Gateway may again move to dismiss based on any continued failure to plead demand futility adequately. The parties have
stipulated that the director defendants need not appear in the matter or otherwise respond to the complaint until after the demand-futility pleading issue is resolved.

Lucent Technologies, Inc. v. Gateway, Inc.is a suit filed on June 6, 2002 in the United States District Court for the Eastern District of Virginia, which was subsequently transferred to the United
States District Court for the Southern District of California, asserting that Gateway infringes seven patents owned by Lucent. On or about February 26, 2003, Microsoft intervened in the action, seeking to challenge Lucents allegations
with respect to five of the seven patents. In addition, on April 8, 2003, Microsoft filed an action against Lucent in the United States District Court for the Southern District of California. The suit seeks declaratory judgment that Microsoft



15



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



products do not infringe patents held by Lucent, including the five patents upon which Microsoft based its intervention in the action Lucent brought against
Gateway. On February 20, 2003, Lucent also sued Dell in the United States District Court for the District of Delaware on six patents, all of which are included in Microsofts declaratory judgment action, and several of which are asserted
by Lucent against Gateway. The suit against Dell was subsequently transferred to the United States District Court for the Southern District of California, where all three actions have been consolidated for discovery purposes. Lucent subsequently
filed amended complaints against Dell and Gateway, respectively, asserting the same patents against each company. Through its amendments, Lucent asserted one additional patent against Dell and four additional patents against Gateway. All of the
patents added through amendment are at issue in the Microsoft declaratory judgment action. The court began conducting a Markman hearing on the asserted patents in August 2003 and conducted over 30 days of hearings before concluding the Markman
hearing in September 2005. In September 2005, the court also granted a summary judgment of invalidity with respect to one of the Lucent patents asserted against Gateway. Discovery is complete. The three actions were originally consolidated into five
separate trials, in which a different group of patents were to be tried to each jury. The first of those trials involved Microsoft only, and was related to audio patents not asserted against Gateway. On February 22, 2007, a jury returned a
verdict of approximately $1.5 billion against Microsoft. Microsoft has moved the trial court to set aside the verdict, and is expected to appeal if the requested relief is not granted. In late February, 2007, the court granted summary judgment on
behalf of Gateway, dismissing Lucents claims on the only remaining patent asserted in the second trial, previously scheduled to begin on March 19, 2007. In March the court granted summary judgment of non-infringement on one patent
asserted against all defendants, and on a second asserted against only Microsoft and Dell. As to a third patent asserted against all defendants, the court granted summary judgment of non-infringement on all but two of the asserted claims. Lucent has
appealed the February and March summary judgment rulings. In June 2007, the court granted summary judgment of non-infringement on an additional patent that had been asserted against Gateway and Dell. The court also rescheduled trial for the five
remaining patents in the case to begin on February 20, 2008.

Dvorchak v. eMachines, Inc., et al. is a shareholder class
action against eMachines, Inc. and others filed in November 2001, in California State Superior Court, County of Orange, relating to a 2001 transaction in which eMachines, then a public company, was taken private. The action originally sought to
enjoin eMachines merger with Empire Acquisition Corp. (the Merger) to effectuate taking eMachines private. The court denied the requested injunction on December 27, 2001, allowing the consummation of the Merger. After the
Merger, plaintiffs filed amended complaints seeking unspecified monetary damages and/or rescission relating to the negotiations for and terms of the Merger through allegations of breaches of fiduciary duties by eMachines, its board members prior to
the Merger, and certain of its officers. The court granted class certification on August 25, 2003. On July 25, 2007, the court granted final approval of a settlement negotiated between the parties to the lawsuit and eMachines
insurance carriers. The settlement provides for a $24 million settlement fund. Neither eMachines nor Gateway is contributing to the settlement fund. A hearing to provide a final accounting in accordance with the settlement is currently scheduled for
January 24, 2008, after which the action is expected to be dismissed pursuant to the settlement. One of the carriers involved, Twin City Fire Insurance Company, is maintaining a related subrogation action against Gateway seeking to recover its
$5 million contribution to the settlement.

In accordance with SFAS No. 5, Accounting for Contingencies, Gateway reserves
for a legal liability when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Quarterly, in addition to when change in facts and circumstances require it, Gateway reviews and adjusts these
reserves to reflect the impacts of negotiations, settlements, rulings, advice of legal counsel and other information and events pertaining to a particular case. The ultimate outcome of such matters cannot presently be determined or estimated.
Gateways management believes that Gateway has sufficiently reserved for legal matters and that



16



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



the ultimate resolution of pending matters will not have a material adverse impact on Gateways consolidated financial position, operating results or
cash flows. However, the results of legal proceedings cannot be predicted with certainty. Should Gateway fail to prevail in current legal matters or should one or more of these legal matters be resolved against Gateway, Gateway could be required to
pay substantial monetary damages or, if injunctive relief is granted, may be prohibited from selling one or more of its products and, in either case, its operating results and cash flows could be materially adversely affected.

9. Restructuring Charges

In 2004 and prior
years, Gateway adopted restructuring plans to, among other things, reduce its workforce and close certain facilities, including its retail stores. The following table summarizes the status of these restructuring plans as of June 30, 2007 (in
thousands):



|                   |  |      |        |  
|------------------ |  | ---- | ------ | -
|                   |  | 2007 |       
|Accrued, January 1 |  | $    | 13,046 |  
|Cash settlements   |  |      | (4,634 | )
|Adjustments        |  |      | (337   | )
|                   |  |      |        |  
|Accrued, June 30   |  | $    | 8,075  |  
|                   |  |      |        |  

For all restructuring plans, approximate future cash outflows of $8.1 million, primarily lease
liabilities on closed facilities, are exceeded by expected future cash inflows of $15 million from related sublease recoveries and asset dispositions. Future cash outflows are projected to be paid as follows: $2.5 million for the remainder of 2007,
$4.2 million in fiscal 2008 and $1.3 million thereafter.

10. Segment and Concentration Data

Gateways sales and operations are delineated by operating segments as follows:



| |  |  | Retailincludes sales through third-party retail channels of both eMachines and Gateway-branded products;
| | - |  | ---------------------------------------------------------------------------------------------------------



| |  |  | Internationalincludes international retail sales and is aggregated within the Retail segment for external reporting purposes as it meets the
aggregation criteria of SFAS 131, Disclosures about Segments of an Enterprise and Related Information;
| | - |  | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Professionalincludes sales to educational institutions (K-12 and higher education), government entities (federal, state and local), small-to-medium
businesses, value-added resellers and certain other resellers; and
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Directincludes consumer and small business sales generated via Gateways web and phone centers as well as legacy revenue streams from
Gateways closed retail stores.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------

Revenues from these segments are derived from sales of PC and Non-PC products and
services. Gateway evaluates the performance of its segments based on net sales, gross profit, and segment contribution, but does not allocate segment assets or other income and expense items for management reporting purposes. Segment contribution
includes selling, general and administrative expenses and other overhead charges directly attributable to the segment and excludes certain expenses managed outside the reporting segment, including corporate selling, general and administrative
expenses, the Microsoft benefit, depreciation and amortization, and the restructuring, transformation and integration charges.



17



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



The following table sets forth summary information by segment (in thousands):



|                                       |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|-------------------------------------- |  | --------------------------- | ------- | - | ------------------------- | - | ------- | ---- |  | - | --------- | - |  | - | --------- | -
|                                       |  | Three Months Ended June 30, |         |   | Six Months Ended June 30, |  
|                                       |  | 2007                        |         |   | 2006                      |   |         | 2007 |  |   | 2006      |  
|Net sales:                             |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Retail (including International)       |  | $                           | 613,705 |   |                           | $ | 592,383 |      |  | $ | 1,380,017 |   |  | $ | 1,359,311 |  
|Professional                           |  |                             | 172,726 |   |                           |   | 249,942 |      |  |   | 328,415   |   |  |   | 452,152   |  
|Direct                                 |  |                             | 54,194  |   |                           |   | 76,987  |      |  |   | 140,897   |   |  |   | 185,671   |  
|                                       |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|                                       |  | $                           | 840,625 |   |                           | $ | 919,312 |      |  | $ | 1,849,329 |   |  | $ | 1,997,134 |  
|                                       |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Segment gross profit:                  |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Retail (including International)       |  | $                           | 34,597  |   |                           | $ | 21,880  |      |  | $ | 58,166    |   |  | $ | 69,486    |  
|Professional                           |  |                             | 21,112  |   |                           |   | 11,052  |      |  |   | 31,928    |   |  |   | 18,721    |  
|Direct                                 |  |                             | 8,160   |   |                           |   | 17,644  |      |  |   | 23,494    |   |  |   | 41,097    |  
|                                       |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|                                       |  | $                           | 63,869  |   |                           | $ | 50,576  |      |  | $ | 113,588   |   |  | $ | 129,304   |  
|                                       |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Segment contribution:                  |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Retail (including International)       |  | $                           | 26,000  |   |                           | $ | 17,233  |      |  | $ | 44,969    |   |  | $ | 58,370    |  
|Professional                           |  |                             | 8,400   |   |                           |   | (8,260  | )    |  |   | 5,416     |   |  |   | (20,488   | )
|Direct                                 |  |                             | 4,121   |   |                           |   | 9,273   |      |  |   | 12,836    |   |  |   | 18,796    |  
|                                       |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|                                       |  |                             | 38,521  |   |                           |   | 18,246  |      |  |   | 63,221    |   |  |   | 56,678    |  
|Non-segment expenses and other charges |  |                             | (41,255 | ) |                           |   | (33,819 | )    |  |   | (81,318   | ) |  |   | (96,620   | )
|Microsoft benefit (See Note 12)        |  |                             | 8,625   |   |                           |   | 8,625   |      |  |   | 17,250    |   |  |   | 17,250    |  
|                                       |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  
|Consolidated operating income (loss)   |  | $                           | 5,891   |   |                           | $ | (6,948  | )    |  | $ | (847      | ) |  | $ | 22,692    |  
|                                       |  |                             |         |   |                           |   |         |      |  |   |           |   |  |   |           |  

The following table summarizes Gateways net sales by major product group (in thousands):



|                              |  |                             |         |                           |   |         |  |      |           |  |   |          
|----------------------------- |  | --------------------------- | ------- | ------------------------- | - | ------- |  | ---- | --------- |  | - | ---------
|                              |  | Three Months Ended June 30, |         | Six Months Ended June 30,
|                              |  | 2007                        |         | 2006                      |   | 2007    |  | 2006
|Desktops                      |  | $                           | 351,513 |                           | $ | 473,727 |  | $    | 853,458   |  | $ | 1,026,893
|Mobiles                       |  |                             | 377,100 |                           |   | 285,739 |  |      | 721,113   |  |   | 622,071  
|Servers and other             |  |                             | 7,262   |                           |   | 8,838   |  |      | 14,383    |  |   | 18,352   
|                              |  |                             |         |                           |   |         |  |      |           |  |   |          
|Total personal computers (PC) |  |                             | 735,875 |                           |   | 768,304 |  |      | 1,588,954 |  |   | 1,667,316
|Non-PC                        |  |                             | 104,750 |                           |   | 151,008 |  |      | 260,375   |  |   | 329,818  
|                              |  |                             |         |                           |   |         |  |      |           |  |   |          
|Total net sales               |  | $                           | 840,625 |                           | $ | 919,312 |  | $    | 1,849,329 |  | $ | 1,997,134
|                              |  |                             |         |                           |   |         |  |      |           |  |   |          

Best Buy accounted for approximately 36% and 39% of total net sales for the three and six months
ended June 30, 2007, respectively, and 34% and 36% for the same respective periods in 2006. Wal-Mart and related companies accounted for approximately 10% of total net sales for the three months ended June 30, 2007. Best Buy also accounted
for approximately 29% and 23% of trade accounts receivable, net at June 30, 2007 and 2006, respectively. Wal-Mart and related companies accounted for approximately 14% of trade accounts receivable, net at June 30, 2006.



18



---

##### Table of Contents

GATEWAY, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)

(Unaudited)



11. Related Party Transactions

Through its acquisition of eMachines, Gateway acquired preferred stock in Alorica, Inc. that is convertible into approximately 17% of the common stock of
Alorica, a company that provides reverse logistics, product registration, technical support, parts sales, PC refurbishing, software development, and other related services to Gateway and its customers. Gateway paid approximately $15 million and $26
million to Alorica for services during the three and six months ended June 30, 2007, respectively, and $13 million and $29 million for the same respective periods of 2006.

12. Microsoft Agreement

Gateway receives funding on a quarterly basis through 2008 from
Microsoft under a Marketing, Development and Settlement Agreement (the Agreement). The Agreement requires that Gateway use a substantial majority of the $144 million proceeds to fund various marketing and promotional initiatives,
including advertising, sales training and consulting, as well as the research, development and testing of new Gateway products that run Microsoft products and releases Microsoft from all antitrust claims Gateway had made. Although the Agreement
contains future marketing and development as well as historical legal components, the relative fair value of these components could not be comprehensively determined. As a result, these two components were not bifurcated for purposes of income
statement presentation. Gateway recognizes the funding received under this arrangement as a reduction of operating expenses under the line item Microsoft benefit upon the later of qualifying spend or cash receipt. In the three and six
months ended June 30, 2007, Gateway received and recognized $8.6 million and $17 million, respectively. Gateway received and recognized the same amounts in 2006. Per the Agreement, Gateway expects to receive in cash $8.6 million quarterly
through the end of 2008.



19



---

##### Table of Contents

|ITEM 2. | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|------- | -------------------------------------------------------------------------------------

The following discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and the related notes that appear elsewhere in
this document as well as our 2006 Annual Report on Form 10-K filed with the Securities Exchange Commission (SEC) in February 2007.

This Quarterly Report includes forward-looking statements based on managements current expectations. These statements are not guarantees of future performance and actual outcomes may differ materially from what is expressed or
forecasted. Factors that could cause future results to differ from our expectations include the factors described in Part 1, Item 1A Risk Factors of our 2006 Annual Report or that are otherwise described from time to time in our
reports filed with the SEC after such Annual Report. We assume no obligation to update any forward-looking statements to reflect events that occur or circumstances that arise after the date as of which they are made.

Our managements discussion and analysis that follows is designed to provide information that will assist readers in understanding our unaudited
consolidated financial statements, changes in certain items in those statements during the quarter and from year to year and the primary factors that caused those changes and how certain accounting principles, policies and estimates affect our
financial statements.

Overview

Since
its founding in 1985, Gateway has focused on marketing PCs and Non-PC products and services at a price that represents value to consumers, businesses, government offices and educational institutions.

We manage our business through our three major business segments: Retail (including International), Professional and Direct. Our strengths include our
strong brand name recognition, our value-based product lines, our sales channels, and our ability to maneuver quickly and react to product development trends in the rapidly changing PC industry.

Some recent key developments and achievements include:



| |  |  | 50 millionth PC soldIn the second quarter, Gateway sold the 50 millionth PC in its 22-year history.
| | - |  | ----------------------------------------------------------------------------------------------------



| |  |  | Margin ImprovementIn the second quarter, we saw marked margin improvement, with overall gross margin improving to 7.6%, up from 4.9% in the first
quarter and 5.5% a year ago. Retail gross margin was 5.6%, up from 3.1% in the first quarter and 3.7% a year ago. Professional margin was 12%, up from 6.9% in the first quarter and 4.4% a year ago.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Notebook Sales GrowthIn the second quarter, we continued to experience sales momentum with our notebook products as evidenced by notebook unit sales
rising by 43% compared with the second quarter of 2006.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Strong Retail PerformanceQuarterly Retail revenue grew 3.6% compared with the second quarter of 2006.
| | - |  | ------------------------------------------------------------------------------------------------------



| |  |  | New ProductsDuring the second quarter of 2007, we brought Gateways award-winning FX line of high-performance PCs to the retail channel,
delivering the first Quad-Core desktop in retail stores from a top tier manufacturer. We also introduced new retail lines of Gateway and eMachines PCs for the back-to-school buying season. On the professional side of the business, we launched
a number of new products and solutions for Gateways key targeted segments. We introduced a new line of notebooks designed from the ground up for professional customers, combining IT-friendly features with widescreen displays, enhanced
security, leading graphics and more than 10 1/2 hours of battery life in a durable design. We introduced a new 12-inch thin and light convertible notebook, and enhanced our 14-inch convertible notebook with the latest technology. In addition, we
expanded our offerings for the healthcare industry with Electronic Medical Record (EMR) software and launched a new 1:1 computing solution for the education market.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



20



---

##### Table of Contents

| |  |  | #1 in Customer SatisfactionGateway once again earned the number one designation in Technology Business Researchs (TBR) corporate IT
buying behavior and customer satisfaction studies for notebooks and desktops. This is also the third consecutive quarter Gateway has been recognized by TBR. Customer satisfaction and the quality of customer care is an important differentiator for
the company.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

We continue to face a variety of challenges and opportunities inherent within the PC industry which is
characterized by rapid technological change, evolving customer demands and intense competition. Key challenges include stimulating demand for our products in a highly competitive market, increasing revenue, lowering costs, managing our supply chain
and increasing gross profit.

Critical Accounting Policies and Estimates

Managements Discussion and Analysis of Financial Condition and Results of Operations contains a discussion of our unaudited consolidated financial
statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of financial statements and related disclosures in conformity with generally accepted accounting principles and
our discussion and analysis of our financial condition and results of operations requires our management to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes.

Management believes the following are critical accounting policies whose application has a material impact on our financial presentation.
That is, they are both important to the portrayal of our financial condition and results, and they require management to make judgments and estimates about matters that are inherently uncertain.

Revenue Recognition

We
recognize revenue on PCs and Non-PC products when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed and determinable, and collectibility is reasonably assured. Revenue from training services are recognized
as the services are provided. Revenue from Internet access, web portals, and security services provided by third parties is recognized as the services are provided based on subscriber counts reported to us by the service providers. Revenue from the
sale of other services rendered by third parties, such as installation services, is generally recognized when such services are performed.

We record reductions in revenue in the current period for estimated future product returns and estimated rebate redemption rates related to current period sales. Management analyzes historical returns, current trends, changes in customer
demand and acceptance of our products when evaluating the adequacy of the sales returns allowances in any accounting period. Management also analyzes historical rebate redemption rates, current trends and the interrelationship of these rates with
the current rebate dollar amounts in evaluating rebate allowances. We record reductions to revenue for estimated commitments related to other customer and sales incentive programs. This includes, among other things, trade-ins and referral credits.
Future market conditions and product transitions may require us to increase customer incentive programs that could result in incremental reductions of revenue at the time such programs are offered, which would affect earnings in the period the
adjustments are made.

We record revenue net of sales taxes or valued-added taxes levied by governmental authorities. Such taxes are
considered current liabilities and included within accrued expenses until paid.

Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. The
estimate is based on managements assessment of the collectibility of



21



---

##### Table of Contents

specific customer accounts and includes consideration of the credit worthiness and financial condition of those specific customers. We record an allowance to
reduce the specific receivables to the amount that is reasonably believed to be collectible. We also record an allowance for all other trade receivables based on multiple factors including historical experience with bad debts, the general economic
environment, the financial condition of our customers, and the aging of such receivables. If there is a deterioration of a major customers financial condition or we become aware of additional information related to the credit worthiness of a
major customer, or if future actual default rates on trade receivables in general differ from those currently anticipated, we may have to adjust our allowance for doubtful accounts, which would affect earnings in the period the adjustments are made.
Best Buy accounted for approximately 29% and 23% of trade accounts receivable, net at June 30, 2007 and 2006, respectively. Wal-Mart and related companies accounted for approximately 14% of trade accounts receivable, net at June 30, 2006.

Inventory Valuation

The business environment in which we operate is subject to rapid changes in technology and customer demand. We record write-downs for components and products which have become obsolete or are in excess of anticipated demand or net
realizable value. We perform an assessment of inventory each quarter, which includes a review of, among other factors, inventory on hand and forecast requirements, product life cycle (including end of life product) and development plans, component
cost trends, product pricing and quality issues. Based on this analysis, we record an adjustment for excess and obsolete inventory. We may be required to record additional write-downs if actual demand, component costs or product life cycles differ
from estimates, which would affect earnings in the period the write-downs are made.

Receivables from Suppliers

We purchase selected components from suppliers and resell the components to original design manufacturers to incorporate into products being
manufactured for us. The receivable from these sales of the components is recorded as Receivables from suppliers. If substantial uncertainty regarding the collectibility of these receivables exist, an appropriate reserve may be
required, which would affect earnings in the period the uncertainty is identified.

Internal-Use Software

We capitalize only those direct costs associated with the actual development or acquisition of computer software for internal use, including costs
associated with the design, coding, installation and testing of the system. Costs associated with preliminary development, such as the evaluation and selection of alternatives, as well as training, maintenance and support are expensed as incurred.
We are currently migrating to a new enterprise resource planning system as well as new order-capture and back-end service and support systems. A significant change to the planned use of internal-use software could result in a material impairment
charge or change in the estimated depreciable life which could result in increased depreciation expense in the reporting period that the change was made.

Warranty Provision

We provide standard warranties with the sale of products. The estimated
cost of providing the product warranty is recorded at the time revenue is recognized. We maintain product quality programs and processes, including actively monitoring and evaluating the quality of suppliers. Estimated warranty costs are affected by
ongoing product failure rates, specific product class failures outside of experience and material usage and service delivery costs incurred in correcting a product failure or in providing customer support. If actual product failure rates, material
usage or service delivery costs differ from the estimates, revisions to the estimated warranty liability would be required and would affect earnings in the period the adjustments are made.



22



---

##### Table of Contents

Restructuring

We have engaged and may continue to engage in restructuring actions which require our management to make significant estimates related to realizable values of assets made redundant or obsolete, expenses for severance
and other employee separation costs, lease cancellation and other exit costs, and estimates of future rental income that may be generated through the subleasing of excess facilities. Should the actual amounts differ from our estimates, the amount of
the restructuring charges could be materially impacted.

Long-lived Asset Impairments

We review long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable. This process requires management to make assumptions and estimates related to estimated future cash flows to be generated and used by an asset or asset group as well as the expected or future use of such assets and/or their estimated
future useful lives. Actual results could differ from the assumptions and estimates used and a significant change to the planned use of an asset or asset group could result in a material impairment charge in a given reporting period.

Taxes on Earnings

We record a
tax provision or benefit for the anticipated tax consequences of our reported results of operations. The provision for (benefit from) 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 computed pursuant to FIN 48. We record a valuation allowance to reduce our deferred tax assets to the amount
that we believe is more likely than not to be realized. We consider our ability to carryback historical losses, cumulative losses in recent years, forecasted earnings and future taxable income and feasible tax planning strategies in determining the
need for and amount of a valuation allowance. If we determine that it is more likely than not that our net deferred tax assets will be realized, our valuation allowance would be reversed, resulting in a positive adjustment to earnings in the period
such determination is made. We expect to maintain a full valuation allowance on potential future tax benefits and generally to record no tax benefit until an appropriate level of profitability is sustained.

Litigation

We are currently
involved in certain legal proceedings. When a loss is considered probable in connection with litigation or governmental proceedings and the loss amount can be reasonably estimated within a range, we record the minimum estimated liability related to
the claim if there is no best estimate in the range. As additional information becomes available, we assess the potential liability related to the legal proceedings and revise those estimates. Revisions in estimates of the potential liability could
materially impact our results of operations in the period of adjustment.

Non-Amortized Intangible Assets Including Goodwill

We capitalized $50 million related to the eMachines tradename and $156 million in goodwill in connection with our acquisition of
eMachines in March 2004. These intangible assets are not amortized but are reviewed for impairment annually during the fourth quarter or whenever events or circumstances indicated an event of impairment may have occurred or exist. Our fourth quarter
review process utilizes multiple methods to estimate fair value based on a discounted future cash flow approach which relies on estimates about our future revenues (based on assumed market segment growth rates) and costs, discounted at appropriate
rates based on our weighted average cost of capital. Future revenue and cost estimates are based on historical data, various internal estimates and a variety of external sources. A significant adverse change in our Retail business could result in a
material impairment of these assets.



23



---

##### Table of Contents

Microsoft Agreement

We receive funding on a quarterly basis through 2008 from Microsoft under a Marketing, Development and Settlement Agreement (the Agreement).
The Agreement requires that we use a substantial majority of the proceeds ($144 million) to fund various marketing and promotional initiatives, including advertising, sales training and consulting, as well as the research, development and testing of
our new products that run Microsoft products and releases Microsoft from all antitrust claims that we had made. Although the Agreement contains future marketing and development as well as historical legal components, the relative fair value of these
components could not be definitively determined. As a result, these two components were not bifurcated for purposes of income statement presentation. We recognize the funding received under this arrangement as a reduction of operating expenses under
the line item Microsoft benefit upon the later of qualifying spend or cash receipt. In the three and six months ended June 30, 2007, we received and recognized $8.6 million and $17 million, respectively. We received and recognized
the same amounts in 2006. Per the Agreement, we expect to receive in cash $8.6 million quarterly through the end of 2008. If we fail to incur sufficient qualifying spend or if Microsoft fails to fund such spend on a timely basis, this could result
in a material adverse impact to the financial results because we would not be able to record the benefit.

Results of Operations

The following table sets forth, for the periods indicated, certain data derived from our consolidated statements of operations and certain such data
expressed as a percentage of net sales (in thousands):



|                                             |  |                             |         |    |                           |   |         |                     |  |       |      |  |   |           |    |  |                     |           |    |  |       |   
|-------------------------------------------- |  | --------------------------- | ------- | -- | ------------------------- | - | ------- | ------------------- |  | ----- | ---- |  | - | --------- | -- |  | ------------------- | --------- | -- |  | ----- | --
|                                             |  | Three Months Ended June 30, |         |    | Six Months Ended June 30, |  
|                                             |  | 2007                        |         |    | 2006                      |   |         | Increase (Decrease) |  |       | 2007 |  |   | 2006      |    |  | Increase (Decrease) |          
|Net sales                                    |  | $                           | 840,625 |    |                           | $ | 919,312 |                     |  | (8.6  | )%   |  | $ | 1,849,329 |    |  | $                   | 1,997,134 |    |  | (7.4  | )%
|Gross profit                                 |  |                             | 63,869  |    |                           |   | 50,576  |                     |  | 26.3  | %    |  |   | 113,588   |    |  |                     | 129,304   |    |  | (12.2 | )%
|Percentage of net sales                      |  |                             | 7.6     | %  |                           |   | 5.5     | %                   |  |       |      |  |   | 6.1       | %  |  |                     | 6.5       | %  |  |       |   
|Selling, general and administrative expenses |  | $                           | 66,603  |    |                           | $ | 66,149  |                     |  | 0.7   | %    |  | $ | 131,685   |    |  | $                   | 169,246   |    |  | (22.2 | )%
|Percentage of net sales                      |  |                             | 7.9     | %  |                           |   | 7.2     | %                   |  |       |      |  |   | 7.1       | %  |  |                     | 8.5       | %  |  |       |   
|Microsoft benefit                            |  | $                           | 8,625   |    |                           | $ | 8,625   |                     |  |      | %    |  | $ | 17,250    |    |  | $                   | 17,250    |    |  |      | % 
|Percentage of net sales                      |  |                             | 1.0     | %  |                           |   | 0.9     | %                   |  |       |      |  |   | 0.9       | %  |  |                     | 0.9       | %  |  |       |   
|Operating income (loss)                      |  | $                           | 5,891   |    |                           | $ | (6,948  | )                   |  | 184.8 | %    |  | $ | (847      | )  |  | $                   | (22,692   | )  |  | 96.3  | % 
|Percentage of net sales                      |  |                             | (0.7    | )% |                           |   | (0.8    | )%                  |  |       |      |  |   | (0.0      | )% |  |                     | (1.1      | )% |  |       |   
|Net income (loss)                            |  | $                           | 1,913   |    |                           | $ | (7,680  | )                   |  | 124.9 | %    |  | $ | (6,666    | )  |  | $                   | (20,017   | )  |  | 66.7  | % 
|PC units sold                                |  |                             | 1,088   |    |                           |   | 1,171   |                     |  | (7.1  | )%   |  |   | 2,340     |    |  |                     | 2,550     |    |  | (8.2  | )%

Net Sales

Consolidated net sales of $841 million in the second quarter of 2007 represents a 8.6% decline from net sales of $919 million for the same period last
year. The year-over-year decline reflects declines in the Professional ($77 million) and Direct ($23 million) segments, partially offset by growth in the Retail segment ($21 million), which includes International.

Consolidated net sales of $1.849 billion in the first six months of 2007 represents a 7.4% decline from net sales of $1.997 billion for the same period
last year. The year-over-year decline reflects declines in the Professional ($124 million) and Direct ($45 million) segments, partially offset by growth in the Retail segment ($21 million), which includes International.

See Segment Performance below for further discussion of net sales performance on a segment basis.



24



---

##### Table of Contents

Gross Profit

Gross profit was $64 million (7.6% of net sales) in the second quarter of 2007 as compared with $50 million (5.5% of net sales) for the same period last year. This increase in gross profit is largely attributable to
improvement in the Retail ($13 million) and Professional ($10 million) segments, partially offset by a decline in the Direct segment ($9.5 million).

Gross profit was $114 million (6.1% of sales) in the first six months of 2007 as compared with $129 million (6.5% of sales) for the same period last year. The decline in gross profit is due to declines in the Direct
($18 million) and Retail ($12 million) segments, partially offset by improvement in the Professional segment ($13 million).

See
Segment Performance below for further discussion of gross profit performance on a segment basis.

Selling, General and
Administrative Expense

Selling, general and administrative (SG&A) expense totaled $67 million (7.9% of net sales)
in the second quarter of 2007 as compared with $66 million (7.2% of net sales) for the same period last year. The increase in SG&A expense in the second quarter of 2007 versus the second quarter of 2006 was due to an $8.4 million release in
sales tax reserve in 2006, which was not repeated in 2007, plus an increase in bad debt reserve ($2.9 million), and an increase in depreciation expenses ($2.0 million) related to the implementation of our new ERP system on January 1st,
partially offset by reductions in headcount related expenses ($4.1 million), marketing expenses ($3.1 million), litigation and settlement expenses ($2.7 million), a reduction in the restructuring reserve ($0.3 million) and other savings ($2.6
million).

Selling, general and administrative (SG&A) expense totaled $132 million (7.1% of net sales) in the first six
months of 2007 as compared with $169 million (8.5% of net sales) for the same period last year. The decrease in SG&A expense in the first six months of 2007 consists primarily of reductions in litigation and settlement expenses ($23 million),
headcount and recruiting related expenses ($13 million), marketing and research expenses ($12 million), restructuring expenses ($0.8 million) and other cost savings ($4.6 million), partially offset by a release in sales tax reserve in 2006, which
was not repeated in 2007 ($8.4 million), an increase in depreciation expenses ($3.2 million) related to the implementation of our new ERP system on January 1st, and an increase in bad debt reserve ($3.1 million). We anticipate SG&A expense
to continue at current levels.

Microsoft Agreement

In April 2005, we entered into the Microsoft Agreement that provides for Microsoft to make aggregate payments to us of $150 million (less $6 million paid
directly to our outside legal counsel) on a quarterly basis through the end of 2008. The Microsoft Agreement requires that we use a substantial majority of the proceeds ($144 million) to fund various marketing and promotional initiatives, including
advertising, sales training and consulting, as well as the research, development and testing of our new products that run Microsoft products and releases Microsoft from all antitrust claims that we had made. In the three and six months ended
June 30, 2007, we received and recognized $8.6 million and $17 million, respectively. We received and recognized the same amounts in 2006. Per the Microsoft Agreement, we expect to receive in cash $8.6 million quarterly through the end of 2008.



25



---

##### Table of Contents

Other Income, Net

The following table presents the components of other income, net for the periods indicated (in thousands):



|                                      |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|------------------------------------- |  | --------------------------- | ------ | - | ------------------------- | - | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                      |  | Three Months Ended June 30, |        |   | Six Months Ended June 30, |  
|                                      |  | 2007                        |        |   | 2006                      |   |        | 2007 |  |   | 2006   |  
|Interest income                       |  | $                           | 1,024  |   |                           | $ | 3,157  |      |  | $ | 2,411  |   |  | $ | 5,834  |  
|Gain (loss) on sales of investments   |  |                             | (7     | ) |                           |   | (30    | )    |  |   | (55    | ) |  |   | (66    | )
|Gain on extinguishment of liabilities |  |                             |       |   |                           |   |       |      |  |   |       |   |  |   |       |  
|Interest expense                      |  |                             | (1,418 | ) |                           |   | (1,462 | )    |  |   | (3,019 | ) |  |   | (2,801 | )
|Amortization of debt issuance costs   |  |                             | (348   | ) |                           |   | (398   | )    |  |   | (746   | ) |  |   | (795   | )
|Foreign exchange gain (loss)          |  |                             | (440   | ) |                           |   | (2,270 | )    |  |   | 788    |   |  |   | (1,282 | )
|Line of credit costs                  |  |                             | (187   | ) |                           |   | (162   | )    |  |   | (377   | ) |  |   | (348   | )
|Other, net                            |  |                             | 388    |   |                           |   | (152   | )    |  |   | 717    |   |  |   | 378    |  
|                                      |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  
|Total                                 |  | $                           | (988   | ) |                           | $ | (1,317 | )    |  | $ | (281   | ) |  | $ | 920    |  
|                                      |  |                             |        |   |                           |   |        |      |  |   |        |   |  |   |        |  

Other Income, net increased by $0.3 million in the second quarter and decreased $1.2 million in
the first half as compared with the same periods last year. The increase in the second quarter was attributable to smaller foreign exchange losses ($1.8 million) due to the effect of a generally weaker US dollar on higher international receivables
and an increase in Other, net ($0.5 million), partially offset by lower interest income ($2.1 million) due to lower cash and marketable securities balances. The decrease in the first half was attributable to lower interest income ($3.4 million) due
to lower cash and marketable securities balances, partially offset by foreign exchange gains ($2.1 million) due to the effect of a generally weaker US dollar on higher international receivables and higher Other, net ($0.3 million).

Income Taxes

We record a tax
provision or benefit for the anticipated tax consequences of its reported results of operations. The provision from 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. We recorded a net tax provision of $5.4 million in the six months ending June 30, 2007, primarily representing $3.5
million of interest accruals relating to previously accrued liabilities and foreign and state income tax accruals from operations of $1.9 million.

As a result of applying the provisions of FIN 48, we recognized a $2.8 million increase to accumulated deficit as of January 1, 2007. Our unrecognized tax benefits totaled $92 million at January 1, 2007 and relate to ongoing
audits from various taxing authorities. This amount included $2.7 million of penalties and $29 million of interest. Our continuing practice is to recognize interest and penalties related to income tax matters in income tax expense, which is
consistent with FIN 48. Included in the balance at January 1, 2007 is $92 million of tax benefits that when recognized would reduce the annual effective income tax rate. Included in the balance of unrecognized tax benefits at January 1,
2007, is $84 million related to tax positions for which it is reasonably possible that the total amounts could significantly change during the next twelve months and we believe will benefit our reported net income. In accordance with FIN 48, this
amount was reclassified from income taxes payable presented as of December 31, 2006 to non-current deferred tax liabilities as of March 31, 2007. Further, this amount represents a decrease in unrecognized tax benefits comprised of items
related to settlement negotiations currently in progress with the Joint Committee of Taxation for tax years 1996-2000 primarily related to utilization of NOLs and expiring statutes in various jurisdictions related to its 2002 return filings (see
Note 6).

We file U.S., state and foreign income returns in jurisdictions with varying statutes of limitation. The 1996 through 2006 tax
years generally remain subject to examination by federal and most state taxing authorities. In significant foreign jurisdictions, the 2001 through 2006 tax years generally remain subject to examination by taxing authorities.



26



---

##### Table of Contents

Based on consideration of all relevant facts and circumstances, we do not believe the ultimate resolution
of tax issues for all open tax periods will have a materially adverse effect upon our future results of operations. We expect to maintain a full valuation allowance on potential future tax benefits and generally to record no tax benefit until an
appropriate level of profitability is sustained.

Segment Performance

The following table presents our net sales and operating results for the periods indicated by reportable segment (in thousands):



|                                       |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   
|-------------------------------------- |  | --------------------------- | ------- | - | ------------------------- | - | ------- | ------------------- |  | ----- | ---- |  | - | --------- | - |  | ------------------- | --------- | - |  | ----- | --
|                                       |  | Three Months Ended June 30, |         |   | Six Months Ended June 30, |  
|                                       |  | 2007                        |         |   | 2006                      |   |         | Increase (Decrease) |  |       | 2007 |  |   | 2006      |   |  | Increase (Decrease) |          
|Net sales:                             |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   
|Retail (including International)       |  | $                           | 613,705 |   |                           | $ | 592,383 |                     |  | 3.6   | %    |  | $ | 1,380,017 |   |  | $                   | 1,359,311 |   |  | 1.5   | % 
|Professional                           |  |                             | 172,726 |   |                           |   | 249,942 |                     |  | (30.9 | )%   |  |   | 328,415   |   |  |                     | 452,152   |   |  | (27.4 | )%
|Direct                                 |  |                             | 54,194  |   |                           |   | 76,987  |                     |  | (29.6 | )%   |  |   | 140,897   |   |  |                     | 185,671   |   |  | (24.1 | )%
|                                       |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   
|                                       |  | $                           | 840,625 |   |                           | $ | 919,312 |                     |  | (8.6  | )%   |  | $ | 1,849,329 |   |  | $                   | 1,997,134 |   |  | (7.4  | )%
|                                       |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   
|Segment gross profit:                  |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   
|Retail (including International)       |  | $                           | 34,597  |   |                           | $ | 21,880  |                     |  | 58.1  | %    |  | $ | 58,166    |   |  | $                   | 69,486    |   |  | (16.3 | )%
|Professional                           |  |                             | 21,112  |   |                           |   | 11,052  |                     |  | 91.0  | %    |  |   | 31,928    |   |  |                     | 18,721    |   |  | 70.5  | % 
|Direct                                 |  |                             | 8,160   |   |                           |   | 17,644  |                     |  | (53.8 | )%   |  |   | 23,494    |   |  |                     | 41,097    |   |  | (42.8 | )%
|                                       |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   
|                                       |  | $                           | 63,869  |   |                           | $ | 50,576  |                     |  | 26.3  | %    |  | $ | 113,588   |   |  | $                   | 129,304   |   |  | (12.2 | )%
|                                       |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   
|Segment contribution:                  |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   
|Retail (including International)       |  | $                           | 26,000  |   |                           | $ | 17,233  |                     |  | 50.9  | %    |  | $ | 44,969    |   |  | $                   | 58,370    |   |  | (23.0 | )%
|Professional                           |  |                             | 8,400   |   |                           |   | (8,260  | )                   |  | 201.7 | %    |  |   | 5,416     |   |  |                     | (20,488   | ) |  | 126.4 | % 
|Direct                                 |  |                             | 4,121   |   |                           |   | 9,273   |                     |  | (55.6 | )%   |  |   | 12,836    |   |  |                     | 18,796    |   |  | (31.7 | )%
|                                       |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   
|                                       |  |                             | 38,521  |   |                           |   | 18,246  |                     |  | 111.1 | %    |  |   | 63,221    |   |  |                     | 56,678    |   |  | 11.5  | % 
|Non-segment expenses and other charges |  |                             | (41,255 | ) |                           |   | (33,819 | )                   |  | (22.0 | )%   |  |   | (81,318   | ) |  |                     | (96,620   | ) |  | 15.8  | % 
|Microsoft benefit (See Note 12)        |  |                             | 8,625   |   |                           |   | 8,625   |                     |  |      | %    |  |   | 17,250    |   |  |                     | 17,250    |   |  |      | % 
|                                       |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   
|Consolidated operating income (loss)   |  | $                           | 5,891   |   |                           | $ | (6,948  | )                   |  | 184.8 | %    |  | $ | (847      | ) |  | $                   | (22,692   | ) |  | 96.3  | % 
|                                       |  |                             |         |   |                           |   |         |                     |  |       |      |  |   |           |   |  |                     |           |   |  |       |   

Retail (including International)

The Retail segment delivered net sales of $614 million on PC shipments of 938,700 during the second quarter of 2007 as compared with $592 million on unit
shipments of 949,200 for the same period last year. Average unit price (AUP) was $654 in the second quarter of 2007 as compared with $624 for the same period in the prior year. Revenue increased due to an increase of average unit price
of $30, or $28 million, offset by a decrease of unit volume (10,500 units or $6.9 million). The increase of average unit price reflects product mix change in favor of notebooks and higher price points.

Retail net sales revenue in the first six months of the year was $1.380 billion on PC shipments of 2,031,400 as compared with $1.359 billion on unit
shipments of 2,112,000 for the same period last year. Average unit price was $679 in the first two quarters of 2007 compared to $643 for the same period last year. Revenue increased due to an increase of average unit price of $36, or $75 million,
largely attributable to increased notebook mix offset with a decrease in unit volume of 80,500 units or $55 million. We anticipate Retail sales volume will improve in the second half of 2007 with the increase demand and following the seasonality of
the retail market.



27



---

##### Table of Contents

Retail segment gross profit was $35 million (5.6% of net sales) in the second quarter of 2007 as
compared with $22 million (3.7% of net sales) for the same period in 2006. The increase in gross profit reflected cost reductions of $18 million due to component cost savings, $8.1 million due to freight cost savings, $1.4 million royalty
savings, $1.2 million in marketing development funds from marketing partners offset with $15 million of increased devaluation cost of refurbished products, and $1.5 million of increased service costs.

Retail segment gross profit was $58 million (4.2% of net sales) in the first six months of 2007 as compared with $69 million (5.1% of net
sales) for the same period last year. The gross profit decrease in the first two quarters was largely attributable to $21 million of increased devaluation cost of refurbished products, $8.0 million due to competitive pricing, $4.4 million
due to increase service cost, $1.4 million reduction of rebate reserve in the period ending March 31, 2006 due to lower redemption rate offset with $10 million of component cost savings, $6.9 million of marketing development funds from
marketing partners, $4.9 million of freight cost savings, and $1.4 million of royalty savings. For the rest of the year, we expect gross profit percentage to be slightly lower than the second quarter due to increasing component purchase cost.

Retail segment contribution for the three months ended June 30, 2007 was $26 million (4.2% of net sales) as compared with $17 million
(2.9% of net sales) for the same period last year. The increase of the contribution margin reflects the increase of gross profit, partially offset by $3.4 million increase in bad debt reserve due to a change in managements assessment of the
collectibility of accounts receivable for certain customers and $0.5 million due to increased marketing and selling costs.

Retail segment
contribution for the first six months of 2007 was $45 million (3.3% of net sales) as compared with $58 million (4.3% of net sales) for the same period last year. The decrease of the contribution margin reflects the decrease of gross profit, $3.4
million increase in bad debt reserve due to a change in managements assessment of the collectibility of accounts receivable for certain customers, and $0.3 million due to increase in selling expense partially offset with $1.0 million savings
in marketing primarily due to a reduction in advertising expense. For the rest of the year, we anticipate segment SG&A to be lower and contribution margin percentage to be flat.

Professional

The Professional
segment delivered net sales of $173 million on PC shipments of 119,400 during the second quarter of 2007 as compared with $250 million on unit shipments of 185,700 for the same period last year. Average unit price was $1,446 in the second quarter of
2007 compared to $1,346 for the same period last year. The decrease in net sales was largely attributable to the production transition and ramp up issues at Gateway Configuration Center ($60 million), and greater selectivity in contract bidding ($17
million). The $100 increase in average unit price is primarily due to the mix increase in notebooks which have higher average selling price.

Professional net sales revenue in the first six months of 2007 was $328 million on PC shipments of 231,300 as compared with $452 million on unit shipments of 343,700 for the same period last year. Average unit price was $1,420 in the first
two quarters of 2007 compared to $1,316 for the same period last year. The decrease in net sales was primarily the result of production constrains as stated above ($60 million) and greater selectivity in contract bidding ($64 million). The $104
increase in average unit price is largely attributable to better discounting control and increased notebook mix. We anticipate Professional sales volume will improve in the second half of 2007 due to increased production throughput at Gateways
Configuration Center.

Professional segment gross profit was $21 million (12% of net sales) in the second quarter of 2007 as
compared with $11 million (4.4% of net sales) for the same period last year. The gross profit increase in the second quarter was largely attributable to one-time warranty and royalty reserve increases in the second of quarter of 2006 ($10
million); in addition, it also reflects managements decision to pursue opportunities on a more selective basis, which resulted in lower sales volume but higher average unit price and unit margin ($2.9 million), offset by increased service and
other operations costs ($3.0 million).



28



---

##### Table of Contents

Professional segment gross profit was $32 million (9.7% of net sales) in the first six months
of 2007 as compared with $19 million (4.1% of net sales) for the same period last year. The gross profit increase in the first two quarters was mostly the result of one-time warranty and royalty reserve increases in the second quarter of
2006 as stated above ($10 million) and margin improvements with managements focus in increased deal selectivity ($7.3 million), which is partially offset by increased service and other operations costs ($4.3 million). We anticipate
Professional gross profit should increase in the second half of 2007 following the improvement in sales volume.

Professional segment
contribution was a profit of $8.4 million (4.9% of net sales) in the second quarter of 2007 as compared with a loss of $8.3 million ((3.3%) of net sales) for the same period last year. The difference is largely attributable to the factors
affecting gross profit described above, as well as managements focus on reducing segment SG&A expenses in the second quarter of 2007 ($6.6 million). The decrease in segment SG&A expenses is a result of reduced headcount ($3.1 million),
savings in marketing expenses ($1.6 million), and better control in travel and other expenses ($1.9 million).

Professional segment
contribution was a profit of $5.4 million (1.6% of net sales) in the first two quarters of 2007 as compared with a loss of $20 million ((4.5)% of net sales) for the same period last year. The difference is largely attributable to the
factors affecting gross profit for the first six months described above, as well as managements focus on reducing segment SG&A expenses in first six months of 2007 ($13 million). The decrease in segment SG&A expenses is a result of
reduced headcount ($7.8 million), savings in marketing expenses ($2.4 million), and better control in travel and other expenses ($2.5 million). Professional SG&A expenses should remain stable on a dollar basis for the remainder of the year.
Contribution margin should increase in line with gross profit increases.

Direct

The Direct segment delivered net sales of $54 million on PC shipments of 30,300 during the second quarter of 2007 as compared with net sales of $77
million on unit shipments of 35,600 for the same period last year. Average unit price was $1,786 in the second quarter of 2007 as compared with $2,163 for the same period in the prior year. Net sales for the first six months of 2007 declined versus
prior year as a result of the drop in shipments ($8.6 million); reduced revenue share from Internet access partners due to subscription expirations/cancellations ($6.0 million) and reduced amortization of extended warranty revenue ($4.0 million)
associated with closed Gateway retail stores; and lower system AUPs than prior year on both desktop and notebook units ($4.1 million). Second quarter PC shipments declined versus prior year primarily due to desktop production issues, while notebook
volume increased slightly as compared with prior year. Desktops fell from 51% of product mix in the second quarter 2006 to 30% in the second quarter of 2007, largely due to lower consideration as a result of long lead times, reduced promotional
activity, and production constraints.

Direct segment net sales for the first six months of 2007 were $141 million on PC shipments of
77,100 as compared with net sales of $186 million on PC shipments of 93,900 for the same period in 2006. For the first six months of 2006, average unit price was $1,828, as compared with $1,976 for the same period in the prior year. Net sales for
the first six months of 2007 declined versus prior year as a result of the drop in shipments ($27 million) as well as reduced revenue share from Internet access partners due to subscription expirations/cancellations ($9.7 million) and reduced
amortization of extended warranty revenue ($8.6 million) associated with closed Gateway retail stores. Management expects PC sales to follow seasonal trends of higher volumes in quarters three and four, but expects Internet access revenue sharing
and extended warranty revenue recognition associated with closed Gateway retail stores to continue to decline over the course of the year.

Direct segment gross profit was $8.2 million (15% of net sales) in the second quarter of 2007 as compared with $18 million (22.9% of net sales) for the same period last year. The decline in gross profit was driven by reduced revenue
share from Internet access partners due to subscription expirations and cancellations ($6.0 million), reduced amortization of extended warranty revenue ($2.6 million), and decreased shipment volume ($0.9 million).



29



---

##### Table of Contents

Direct segment gross profit for the first six months of 2007 was $23 million (17% of net sales) as
compared with $41 million (22% of net sales) in the same period of the prior year. The year over year decline in net profit for the first half of the year is primarily due to reduced revenue received from one of Gateways Internet access
partners as a result of subscription expirations/cancellations ($9.7 million), reduced shipments ($5.2 million) and reduced amortization of extended warranty revenue ($3.4 million). Management expects gross profit to follow seasonal trends, but
expects Internet access revenue sharing and extended warranty revenue recognition associated with closed Gateway retail stores to continue to decline over the course of the year.

Direct segment contribution was $4.1 million (7.6% of net sales) in the second quarter of 2007 as compared with $9.3 million (12% of net sales) for the
same period last year. The decline in gross profit discussed above was partially offset by segment SG&A savings, specifically marketing expense ($1.8 million) and compensation and fringes expense ($2.5 million) as compared to the prior year.
Marketing savings are due to our decision to run fewer marketing programs and the savings in compensation and fringes is driven by the closure of a call center in the first half of 2006.

Contribution margin for the first six months of the year was $13 million (9.1% of net sales) as compared with $19 million (10% of net sales) for the same
period in the prior year. The decline in gross profit discussed above was partially offset by segment SG&A savings, specifically marketing expenses ($6.6 million), compensation and other savings ($4.6 million) as compared to the prior year. The
year over year decrease in marketing reflects scaled back brand marketing programs, and the savings in compensation is driven by the closure of a call center in the first half of 2006. Segment SG&A is expected to be consistent for remainder of
year, varying with revenue due to sales-driven expenses such as credit card transaction fees and sales commissions. Contribution margin will decline in line with gross profit.

Non Segment Expenses and Other Charges

Non-segment expenses and other charges are the costs excluded from our operating segments and primarily consist of general and administrative expenses that are managed on a corporate-wide basis.

Non-segment expenses and other charges totaled $41 million in the second quarter of 2007 as compared with $34 million in the second quarter of 2006. The
increase in non-segment expenses in the second quarter of 2007 versus the second quarter of 2006 was due to an $8.4 million release in sales tax reserve in 2006, which was not repeated in 2007, plus an increase in depreciation expenses ($2.0
million) related to the implementation of our new ERP system on January 1st, and headcount-related ($1.1 million) expenses, partially offset by reductions in litigation and settlement expenses ($2.1 million), a reduction in the restructuring
reserve ($0.3 million) and other savings ($1.6 million).

Non-segment expenses and other charges totaled $81 million in the first six
months of 2007 as compared with $97 million in the first six months of 2006. The decrease in non-segment expenses in the first six months of 2007 consists primarily of a reduction in litigation and settlement expenses ($22 million), research expense
($1.8 million), restructuring expenses ($0.8 million) and other cost savings ($2.6 million), partially offset by a release in sales tax reserve in 2006, which was not repeated in 2007 ($8.4 million), and an increase in depreciation expenses ($3.2
million) related to the implementation of our new ERP system on January 1st. We anticipate SG&A expense to continue at current levels.



30



---

##### Table of Contents

Major Product Groups

The following table summarizes our net sales by major product group (in thousands):



|                              |  |                             |         |      |                           |   |      |   |         |  |      |      |  |      |           |  |      |   |      |   |           |  |      |  
|----------------------------- |  | --------------------------- | ------- | ---- | ------------------------- | - | ---- | - | ------- |  | ---- | ---- |  | ---- | --------- |  | ---- | - | ---- | - | --------- |  | ---- | -
|                              |  | Three Months Ended June 30, |         |      | Six Months Ended June 30, |  
|                              |  | 2007                        |         | As % |                           |   | 2006 |   | As %    |  |      | 2007 |  | As % |           |  | 2006 |   | As % |  
|Desktops                      |  | $                           | 351,513 |      | 41.8                      | % |      | $ | 473,727 |  | 51.5 | %    |  | $    | 853,458   |  | 46.1 | % |      | $ | 1,026,893 |  | 51.4 | %
|Mobiles                       |  |                             | 377,100 |      | 44.9                      | % |      |   | 285,739 |  | 31.1 | %    |  |      | 721,113   |  | 39.0 | % |      |   | 622,071   |  | 31.1 | %
|Servers and other             |  |                             | 7,262   |      | 0.9                       | % |      |   | 8,838   |  | 1.0  | %    |  |      | 14,383    |  | 0.8  | % |      |   | 18,352    |  | 0.9  | %
|                              |  |                             |         |      |                           |   |      |   |         |  |      |      |  |      |           |  |      |   |      |   |           |  |      |  
|Total personal computers (PC) |  |                             | 735,875 |      | 87.6                      | % |      | $ | 768,304 |  | 83.6 | %    |  |      | 1,588,954 |  | 85.9 | % |      | $ | 1,667,316 |  | 83.4 | %
|Non-PC                        |  |                             | 104,750 |      | 12.4                      | % |      |   | 151,008 |  | 16.4 | %    |  |      | 260,375   |  | 14.1 | % |      |   | 329,818   |  | 16.6 | %
|                              |  |                             |         |      |                           |   |      |   |         |  |      |      |  |      |           |  |      |   |      |   |           |  |      |  
|Total net sales               |  | $                           | 840,625 |      | 100                       | % |      | $ | 919,312 |  | 100  | %    |  | $    | 1,849,329 |  | 100  | % |      | $ | 1,997,134 |  | 100  | %
|                              |  |                             |         |      |                           |   |      |   |         |  |      |      |  |      |           |  |      |   |      |   |           |  |      |  

Sales of personal computer products represented approximately 88% and 86% of total net sales
during the three and six months ended June 30, 2007, respectively, as compared to 84% and 83% for the same periods in the prior year. As a percentage of total net sales, notebook computer sales increased 14 percentage points during the second
quarter and 8 percentage points during the first six months of 2007 relative to the same periods in the prior year, due to our continued efforts to focus on the notebook computer market and the continued success of our Gateway-branded products in
third-party retail.

Sales of Non-PC products represented approximately 12% and 14% of total net sales during the three and six months
ended June 30, 2006, respectively, as compared to 16% and 17% for the same respective periods in the prior year. These declines are primarily due to the decreasing unit sales in Direct, which generally yields a higher percentage of Non-PC sales
than other segments. Non-PC offerings include all products and services other than the PC, such as peripherals, software, accessories, extended warranty services, training, Internet access, enterprise system, networking products and services and
consumer electronics products from prior periods.

Liquidity and Capital Resources

As of June 30, 2007, Gateway had approximately $255 million in cash and marketable securities, a decrease of $161 million as compared with $416
million at the end of 2006.

We used $141 million of cash in support of our operating activities in the first half of 2007. Significant
factors affecting cash used in operations included increases in inventory ($63 million), mostly in the form of finished goods in the UK and Mexico as well as components held at Gateways Configuration Center, and accounts receivable ($50
million), due to an increased mix in international Professional customers versus Direct consumers. Other significant uses of cash in the first half included a decrease in accrued liabilities ($63 million) and an increase in receivables from
suppliers ($28 million), which were partially offset by a decrease in other assets ($61 million), primarily due to the collection of vendor rebates.

We used approximately $20 million in cash for capital expenditures in the first half of 2007, primarily for the continuing development of our ERP system, which compares to the same amount of depreciation and
amortization during the period. We used $17 million to purchase available-for-sale securities, and generated $58 million in proceeds from the sale of such securities. In total, in the first half, we generated $21 million in cash from investing
activities. There was virtually no cash provided by financing activity in the first half.

Our cash position varies during any particular
period, but historically it has increased at quarter-end due to additional focus on working capital management. Although our quarter-end cash balance is one analytical measure used by our suppliers and original design manufacturers (ODMs) in
evaluating credit terms, we believe our payment performance is a more important factor. Accordingly, we have sought to reduce our days in accounts payable in an effort to further improve our relationship with suppliers and ODMs. Invoicing and
settlement delays associated with the implementation of our new ERP system degraded our days payable from 58



31



---

##### Table of Contents

in the fourth quarter of 2006 to 81 days in the first quarter of 2007, although days payable declined to 71 days in the second quarter of 2007. Days in
supplier receivables also rose from 23 to 45 between the fourth quarter of 2006 and the first quarter of 2007, but improved to 32 in the second quarter of 2007. Days payable, net of supplier receivables, rose by 4 days between the fourth quarter of
2006 and the second quarter of 2007.

Liquidity Metrics

The following table presents selected liquidity statistics and information for the quarters as indicated (dollars in thousands):



|                                                          |  |               |         |   |                   |   |         |  
|--------------------------------------------------------- |  | ------------- | ------- | - | ----------------- | - | ------- | -
|                                                          |  | June 30, 2007 |         |   | December 31, 2006 |  
|Cash and marketable securities                            |  | $             | 255,232 |   |                   | $ | 416,335 |  
|Days of sales in accounts receivable (a)                  |  |               | 34      |   |                   |   | 25      |  
|Days inventory on hand (b)                                |  |               | 19      |   |                   |   | 9       |  
|Days in accounts payable (c)                              |  |               | (71     | ) |                   |   | (58     | )
|                                                          |  |               |         |   |                   |   |         |  
|Cash conversion cycle before days in supplier receivables |  |               | (18     | ) |                   |   | (24     | )
|Days in supplier receivables (d)                          |  |               | 32      |   |                   |   | 23      |  
|                                                          |  |               |         |   |                   |   |         |  
|Cash conversion cycle (e)                                 |  |               | 14      |   |                   |   | (1      | )
|                                                          |  |               |         |   |                   |   |         |  

---

|(a) | Days of sales in accounts receivable measures the average number of days receivables are outstanding and is calculated by dividing accounts receivable (net of allowances for
doubtful accounts) by the most recent quarterly net sales divided by the number of days in the quarter.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(b) | Days inventory on hand measures the average number of days from product procurement to sale and is calculated by dividing inventory by the most recent quarterly cost of goods sold
divided by the number of days in the quarter.
|--- | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(c) | Days in accounts payable measures the average number of days our accounts payable balances are outstanding and is calculated by dividing accounts payable by the most recent
quarterly cost of goods sold divided by the number of days in the quarter.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(d) | We purchase selected components from suppliers and, where possible, in lieu of a consignment arrangement, resell the components to original design manufacturers to incorporate into
products being manufactured for us. The receivable from the sale of the components to the original design manufacturer is recorded in Receivables from suppliers. Supplier receivables amounted to $275 million and $247 million at
June 30, 2007 and December 31, 2006, respectively. Days in supplier receivables measures the average number of days supplier receivables are outstanding and is calculated by dividing supplier receivables by the most recent quarterly cost
of sales divided by the number of days in the quarter.
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(e) | The cash conversion cycle is the sum of days in accounts receivable and inventory on hand in supplier receivables less days in accounts payable and effectively measures the number
of days from component purchases to cash collection on customer sales.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Our goal is to reverse the negative cash flows from
operations through improving our overall financial results by improving product sales and gross profit, reducing SG&A costs, improving management of working capital and aggressively defending litigation matters to minimize or avoid settlement
charges. However, we can give no assurance that we will be successful in achieving any of these goals.

We believe that our sources of
capital will be sufficient to fund anticipated working capital requirements, capital expenditures and cash required for other activities for at least the next 12 months. However, cash flows from future operations and the amount and timing of our
future financing needs are uncertain. Future cash flow will depend on a number of factors, including our future operating results, our capital expenditures, the need to supply credit to our customers, the continued availability of trade credit from
our suppliers and bank credit from lenders, and possible restructurings of our business. These factors, especially our future operating results, will depend on our ability to achieve the goals set forth in the preceding paragraph, and those factors
set forth in



32



---

##### Table of Contents

Item 1ARisk Factors of Part II of our Annual Report on Form 10-K for the year ended December 31, 2006. We are exploring the possibility of
raising approximately $100 million of additional debt or equity capital depending on market conditions. Should our sources of capital be insufficient to meet our cash needs as we currently conduct our business, we would most likely have to reduce
the scope of our business, re-assess our business strategy, and re-address how we conduct our business to adjust our expenditures to a level that our cash flows could support and/or seek additional financing from other sources, including additional
equity offerings. Given our history of sales declines and losses, there is no assurance that, if needed, we would be able to obtain financing from external sources, or maintain current credit lines with vendors or lenders.

We continue to assess our business strategy and may engage in future restructuring actions or strategic transactions, which would require us to recognize
significant cash and non-cash charges.

Microsoft Agreement

In April 2005, we entered into the Microsoft Agreement that provides for Microsoft to make aggregate payments to us of $150 million (including $6 million
paid directly to our outside legal counsel) on a quarterly basis through the end of 2008. As part of the Microsoft Agreement, we are required to use the remaining $144 million to fund various marketing and promotional initiatives including
advertising, sales training and consulting, as well as the research, development, and testing of our new products that run Microsoft products. We expect to receive $8.6 million quarterly through the end of 2008 in cash from Microsoft under this
agreement.

Trade Credit

Our accounts payable balance as of June 30, 2007 was $610 million, as compared to $613 million as of December 31, 2006. Accounts payable, net of receivables from suppliers, decreased from $365 million at the end of 2006 to $335
million. Our access to trade credit is, in part, dependent on our ability to operate profitably. A significant change in trade credit terms available from suppliers would require us to commit more of our cash reserves to support our working capital
requirements.

Debt

In
October 2004, we entered into a credit agreement with a major financial institution that provides for a borrowing base under a revolving credit facility of up to $200 million. Our borrowing base fluctuates primarily as a function of our outstanding
accounts receivable. Borrowings under this agreement bear interest at variable-term LIBOR or prime rates, at our election. As of June 30, 2007 and June 30, 2006, we had $0 and $50 million, respectively, in borrowings outstanding under this
agreement. The interest rates as of June 30, 2007 and June 30, 2006 were 7.25%. This interest rate adjusts with changes in the prime rate. As of June 30, 2007, we also utilized the credit agreement to support $32 million of stand-by
letters of credit and had additional borrowing availability of $82 million based on the borrowing base. In addition to usual and customary covenants for an arrangement of its type, the credit agreement, as amended includes certain financial
covenants. Gateway must maintain Liquidity (defined as the sum of Certified Cash and Borrowing Availability) of $100 million. In addition, starting on October 1, 2006, negative cash flow, as defined in the credit agreement, may not exceed $40
million for the three months ended December 31, 2006, $57 million for the six months ended March 31, 2007, and $60 million thereafter, with cumulative negative cash flow not to exceed $120 million. As of the nine months ended June 30,
2007, the cumulative negative cash flow was $14 million. Further, once Gateway has achieved three consecutive quarters of positive excess cash flow, it must maintain positive cash flow in each quarter thereafter. The agreement, as amended, expires
on October 31, 2010, at which time all amounts then outstanding will be due and payable.

In December 2004, we completed the sale of
$300 million of senior convertible notes through a private placement to institutional investors, including $150 million at 1.5% per year due December 31, 2009 and $150 million at 2.0% per year due December 2011. Additional information
regarding our convertible debt can be found in Note 5 to the Consolidated Financial Statements.



33



---

##### Table of Contents

Restructuring Obligations

During the first quarter of 2004, we adopted a restructuring plan to, among other things, close our remaining 188 retail stores, reduce its workforce,
consolidate facilities and outsource certain operating activities. This plan was in addition to previous restructuring plans that were adopted in 2003, 2002 and 2001. All significant restructuring actions under this restructuring plan are now
substantially complete. For all current restructuring plans, approximate future cash outflows of $8.1 million, primarily lease liabilities on closed facilities, are exceeded by expected future cash inflows of $15 million from related sublease
recoveries and asset dispositions.

We continue to assess our business strategy and may engage in future restructuring actions or strategic
transactions, which would require us to recognize significant cash and non-cash charges.

Income Taxes Payable

We are subject to ongoing audits from various taxing authorities and believe we have adequately provided for income tax issues not yet resolved. As of
June 30, 2007, approximately $96 million has been accrued to provide for such matters. Based on a consideration of all relevant facts and circumstances, we do believe the ultimate resolution of tax issues for all open tax periods will not have
a materially adverse effect upon our cash position.

Contractual Obligations

Our future contractual obligations related to operating leases, royalty and licensing agreements, and purchase obligations did not materially change from
the amounts reported in our 2006 Annual Report on Form 10-K except for supplier purchase commitments. We utilize several contract manufacturers and suppliers who acquire components and materials and build product based on demand forecasts supplied
by us typically covering periods from 15 to 90 days. Outstanding third-party manufacturing purchase commitments totaled approximately $66 million at June 30, 2007.

Off-Balance Sheet Arrangements and Other

We do not participate in transactions that generate
relationships with unconsolidated entities or financial partnerships, such as special purpose entities or variable interest entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other limited
purposes.

During the normal course of business, we make certain indemnities, commitments and guarantees under which we may be required to
make payments in relation to certain transactions. These include: (i) intellectual property indemnities to our customers and licensees in connection with the use, sale and/or license of our products, (ii) indemnities to vendors and service
providers pertaining to claims based on our negligence or willful misconduct and (iii) indemnities involving the accuracy of representations and warranties in certain contracts. In addition, we have made contractual commitments to several
employees providing for payments upon the occurrence of certain prescribed events. The majority of these indemnities, commitments and guarantees do not provide for any limitation of the maximum potential for future payments we could be obligated to
make. We have not recorded any liability for these indemnities, commitments and other guarantees in the accompanying consolidated balance sheets.

Related Party Transactions

Through our acquisition of eMachines, we acquired preferred stock in Alorica, Inc. that
is convertible into approximately 17% of the common stock of Alorica, a company that provides reverse logistics, product registration, technical support, parts sales, PC refurbishing, software development and other related services to us



34



---

##### Table of Contents

and our customers. We paid approximately $15 million and $26 million to Alorica for services during the three and six months ended June 30, 2007,
respectively, and $13 million and $29 million for the same respective periods of 2006.

Recent Accounting Pronouncements

See Note 1 to the Consolidated Financial Statements in Item 1 for a full description of recent accounting pronouncements, including the expected
dates of adoption and estimated effects on results of operations and financial position, which is incorporated herein by reference.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

For quantitative and qualitative
disclosures about market risk affecting Gateway, see Item 7A Quantitative and Qualitative Disclosures About Market Risk of our Annual Report on Form 10-K for the year ended December 31, 2006. Our exposure to market risks has
not changed materially since December 31, 2006.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our management, including our chief executive officer (CEO) and chief financial officer
(CFO), we conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the
Exchange Act), as of the end of the period covered by this Quarterly Report (the Evaluation Date).

The evaluation
of our disclosure controls and procedures was performed in conjunction with the Audit Committee of our Board of Directors and included a review of whether there were any significant deficiencies in the design or operation of such controls and
procedures, material weaknesses in such controls and procedures, any corrective actions taken with regard to such deficiencies and weaknesses and any fraud involving management or other employees with a significant role in such controls and
procedures.

Based on this evaluation, our CEO and CFO concluded that as of the Evaluation Date, our disclosure controls and procedures
were effective and designed to ensure that the information relating to us, including our consolidated subsidiaries, required to be disclosed in our SEC reports (i) is recorded, processed, summarized and reported within the time periods
specified in SEC rules and forms, and (ii) is accumulated and communicated to our management, including our CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

Changes in Internal Controls over Financial Reporting

As of December 31, 2006, management identified inadequate controls related to the timely accrual of certain liabilities to our component suppliers, and the recording of related receivables from our original
design manufacturers (ODMs). To remediate this weakness, management implemented additional control procedures within our procurement, inventory and accounts payable processes. These controls were tested by our Internal Audit function and
found to be operating effectively during the quarter. Management believes we have made significant progress in addressing the material weakness, and will continue to monitor such controls throughout the year.

There were no changes in our internal controls over financial reporting identified in connection with managements evaluation during the most recent
fiscal quarter that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.



35



---

##### Table of Contents

II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

The information set forth under Note 8 to the unaudited consolidated financial statements of this Quarterly Report on Form 10-Q is incorporated herein by
reference. Readers are also directed to the Legal Proceedings section in our Annual Report on Form 10-K for the year ended December 31, 2006.

ITEM 1A. RISK FACTORS

Readers are directed to the Risk Factors section of our 2006 Annual
Report on Form 10-K for a description of material risks facing us.

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.

Gateway held its annual meeting of
stockholders on May 16, 2007 in Irvine, California.

At the 2007 annual meeting, the stockholders elected the following individuals to
the Board of Directors as Class II directors:



|                  |  |             |  |               
|----------------- |  | ----------- |  | --------------
|Name              |  | Votes For   |  | Votes Withheld
|J. Edward Coleman |  | 235,990,054 |  | 68,448,090    
|Scott Galloway    |  | 236,042,850 |  | 68,395,294    
|Dave Russell      |  | 299,508,273 |  | 4,929,871     
|Paul E. Weaver    |  | 234,472,961 |  | 69,965,183    

At the 2007 annual meeting of stockholders, stockholders took the following actions:



| |  |  | The stockholders approved the ratification of the appointment of Deloitte & Touche LLP as our independent registered public accounting firm for the 2007
fiscal year. There were 300,406,844 votes cast for the ratification, 3,165,078 votes cast against the ratification and 866,222 abstentions.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | The stockholders approved a proposal to amend Gateways certificate of incorporation and bylaws to provide for the annual election of directors, effective
December 31, 2007. There were 300,318,489 votes cast for the proposal, 3,637,503 votes cast against the proposal and 482,151 abstentions.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



36



---

##### Table of Contents

ITEM 6. EXHIBITS



|               |  |                                                                                                                                    
|-------------- |  | -----------------------------------------------------------------------------------------------------------------------------------
|Exhibit    No. |  | Description of Exhibits                                                                                                            
|*31.1          |  | Certification by CEO pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|               | 
|*31.2          |  | Certification by CFO pursuant to Rule 13a-14(a) or 15d-14(a), as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
|               | 
|**32.1         |  | Certification by CEO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.     
|               | 
|**32.2         |  | Certification by CFO pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.     

---

|* | Filed herewith.
|- | ---------------

|** | Furnished herewith.
|-- | -------------------



37



---

##### Table of Contents

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly
caused this Quarterly Report to be signed on its behalf by the undersigned, thereunto duly authorized.



|                     |  |  |  |               |  |                                                                                                                       |  | 
|-------------------- |  |  |  | ------------- |  | --------------------------------------------------------------------------------------------------------------------- |  | 
|                     |  |  |  | GATEWAY, INC.
|                     |  |  | 
|Date: August 3, 2007 |  |  |  | By:           |  | /s/    JOHN P.
GOLDSBERRY                                                                                            
|                     |  |  |  |               |  | John P. Goldsberry Senior Vice President and Chief Financial Officer (authorized officer and chief financial
officer)
|                     |  |  | 
|Date: August 3, 2007 |  |  |  | By:           |  | /s/    NEAL E. WEST                                                                                                  
|                     |  |  |  |               |  | Neal E. West Vice President and Controller (principal accounting officer)                                            



38