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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549



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FORM 10-K



(Mark One)



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



For the fiscal year ended December 31, 2006



OR



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



For the transition period fromto



Commission file number 1-14500



GATEWAY, INC.



|                         |  |                                  
|------------------------ |  | ---------------------------------
|Incorporated in Delaware |  | I.R.S. Employer Number 42-1249184



7565 Irvine Center
Drive, Irvine, CA 92618-2930



Telephone number:
(949) 471-7000



Securities registered pursuant to
Section 12(b) of the Act:



|                                       |  |                                          
|-------------------------------------- |  | -----------------------------------------
|Title of each class                    |  | Name of each exchange on which
registered
|Common Stock, par value $.01 per share |  | New York Stock Exchange                  
|Preferred Share Purchase Rights        |  | New York Stock Exchange                  



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Securities registered pursuant to Section 12(g) of the Act:    None



Indicate by check mark if the registrant is a well-known seasoned issuer, as
defined in Rule 405 of the Securities Act.    Yes x    No ̈.



Indicate by check mark if the registrant is not required to
file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes ̈No x.



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 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 disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrants knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ̈



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.



The aggregate market value of the voting stock held by non-affiliates of the registrant on June 30, 2006, the last business day of the registrants most recently completed second fiscal quarter (based on the
last sale price on the New York Stock Exchange as of such date) was approximately $705,003,902.



As of February 20, 2007 there were 371,517,940 shares of Common Stock outstanding and no shares of Class A Common Stock outstanding.



DOCUMENTS INCORPORATED BY REFERENCE



Portions of Gateways Definitive Proxy Statement to be filed in
connection with our 2007 Annual Meeting of Stockholders subsequent to the date hereof are incorporated by reference in Part III of this Form 10-K. Such Definitive Proxy Statement will be filed with the Securities and Exchange Commission no later
than 120 days after the Registrants year end of December 31, 2006.



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GATEWAY, INC.



FORM 10-K

For the Fiscal Year Ended December 31, 2006



Table of Contents



|           |  |                                                                                                                        |  |     
|---------- |  | ---------------------------------------------------------------------------------------------------------------------- |  | ----
|           |  |                                                                                                                        |  | Page
|PART I     |  |                                                                                                                        |  |     
|           |  |                                                                                                                       
|ITEM 1.    |  | BUSINESS                                                                                                               |  | 1   
|           |  |                                                                                                                       
|ITEM 1A.   |  | RISK FACTORS                                                                                                           |  | 9   
|           |  |                                                                                                                       
|ITEM 1B.   |  | UNRESOLVED STAFF COMMENTS                                                                                              |  | 16  
|           |  |                                                                                                                       
|ITEM 2.    |  | PROPERTIES                                                                                                             |  | 16  
|           |  |                                                                                                                       
|ITEM 3.    |  | LEGAL PROCEEDINGS                                                                                                      |  | 17  
|           |  |                                                                                                                       
|ITEM 4.    |  | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS                                                                    |  | 18  
|           |  |                                                                                                                       
|PART II    |  |                                                                                                                        |  |     
|           |  |                                                                                                                       
|ITEM 5.    |  | MARKET FOR REGISTRANTS COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES           |  | 19  
|           |  |                                                                                                                       
|ITEM 6.    |  | SELECTED CONSOLIDATED FINANCIAL DATA                                                                                   |  | 21  
|           |  |                                                                                                                       
|ITEM 7.    |  | MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS                                  |  | 22  
|           |  |                                                                                                                       
|ITEM 7A.   |  | QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK                                                             |  | 38  
|           |  |                                                                                                                       
|ITEM 8.    |  | CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA                                                               |  | 39  
|           |  |                                                                                                                       
|ITEM 9.    |  | CHANGES IN AND DISAGREEMENTS WITH INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM ON ACCOUNTING AND FINANCIAL DISCLOSURE |  | 72  
|           |  |                                                                                                                       
|ITEM 9A    |  | CONTROLS AND PROCEDURES                                                                                                |  | 72  
|           |  |                                                                                                                       
|ITEM 9B    |  | OTHER INFORMATION                                                                                                      |  | 76  
|           |  |                                                                                                                       
|PART III   |  |                                                                                                                        |  |     
|           |  |                                                                                                                       
|ITEM 10.   |  | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT                                                                     |  | 76  
|           |  |                                                                                                                       
|ITEM 11.   |  | EXECUTIVE COMPENSATION                                                                                                 |  | 76  
|           |  |                                                                                                                       
|ITEM 12.   |  | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS                         |  | 76  
|           |  |                                                                                                                       
|ITEM 13.   |  | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS                                                                         |  | 77  
|           |  |                                                                                                                       
|ITEM 14.   |  | PRINCIPAL ACCOUNTANT FEES AND SERVICES                                                                                 |  | 77  
|           |  |                                                                                                                       
|PART IV    |  |                                                                                                                        |  |     
|           |  |                                                                                                                       
|ITEM 15.   |  | EXHIBITS AND FINANCIAL STATEMENT SCHEDULES                                                                             |  | 78  
|           | 
|SIGNATURES |  | 81                                                                                                                    



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Forward-Looking StatementsThis Annual Report on Form 10-K, including Managements
Discussion and Analysis of Financial Condition and Results of Operations in Item 7, contains forward-looking statements based on Gateways current expectations that are subject to various risks and uncertainties, as well as
assumptions that, if they do not materialize or prove incorrect, could cause our future results to differ materially from those expressed or implied by such forward-looking statements. All statements other than statements of historical fact are
statements that are or could be deemed forward-looking statements, including without limitation any statements relating to future results of operations, plans, outlook or strategies, any statements relating to execution of restructuring plans or
regarding pending claims or disputes and any statements relating to future economic or industry conditions. Factors that might cause such differences include, but are not limited to, those discussed in Risk Factors in Item 1A, or
that are otherwise described from time to time in our reports filed with the Securities and Exchange Commission after this Annual Report. Gateway assumes no obligation to update any forward-looking statements to reflect events that occur or
circumstances that may arise after the date as of which they are made.



Throughout this Annual Report we refer to Gateway, Inc. and its consolidated subsidiaries as Gateway, the company, we, us, and our.



This Annual Report contains the following trademarks and service marks of
Gateway which are registered: Gateway, eMachines, and the Black-and-White Spot Design. These and any other product or brand names of Gateway or of any other company contained herein are trademarks or registered trademarks of their
respective owners.



PART I



Item  1.Business



General



Gateway
directly and indirectly sells its desktop and notebook computers and servers (PCs) and PC-related products and services that are enabled by or connect with PCs to third-party retailers, consumers, businesses, government agencies and
educational institutions. Gateway offers its PCs under two brand names, Gateway and eMachines, and positions each of its products on the basis of relative value for money with eMachines systems being offered at lower price points and Gateway systems
being offered with higher-end chipsets and richer features at attractive prices that represent value. PC-related products and services (Non-PC) consist of all products and services other than the PC, such as stand-alone displays,
peripherals, software, accessories, extended warranty services, training, Internet access, enterprise system and networking products and services. Gateway was the third largest PC company in the U.S. during calendar 2006 and among the top 10
worldwide, with an estimated U.S. market share of approximately 6.7% based on units shipped, according to the most recent data from International Data Corporation.



Gateways strategy is to profitably grow its core PC business by driving to be a low cost provider while improving
operational execution and overall efficiency. Gateway is focused on growing its consumer business through both its Direct and Retail channels via product innovation, retail relationships, an enhanced web presence and leveraging its investments in
the Professional business for profitable growth in targeted markets.



Business Segments



Gateway has three major
business segments: Retail, Professional, and Direct. Further information on Gateways business segments can be found in Item 7 Managements Discussion and Analysis of Financial Condition and Results of Operations and Note
11 to the Consolidated Financial Statements.



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Retail (including International)



The Retail segment is Gateways largest segment. Gateway and eMachines products are sold in more than 7,000 retail
locations in the U.S. and Canada. Gateway sells products directly to consumer electronics stores, computer superstores, and other major retailers such as Best Buy, Circuit City, CompUSA, Costco, Office Depot, Micro Center, Wal-Mart and many others,
as well as selling select Gateway-branded products through television shopping retailers. Sales to Best Buy represented 39% of net sales in 2006 and 34% of net sales in 2005. The companys eMachines-branded products are sold exclusively through
the retail channel. Gateway participates in cooperative advertising and marketing programs with key retail customers, for which it receives marketing development funds from key suppliers to partially pay for advertising that features their brands.



Prior to the acquisition of eMachines in 2004, Gateways
international sales were limited to Canada and Mexico while eMachines sold its products internationally in Japan and the United Kingdom. After the eMachines acquisition, Gateway took advantage of each companys distribution channels and
implemented common supply chain management techniques and service infrastructures to expand distribution within Canada, Japan, Mexico and the United Kingdom. Gateway and eMachines products are sold in more than 3,400 retail locations
internationally.



Substantially all international sales are
through third-party retailers and distributors. Gateway continues to evaluate opportunities to develop and grow the international business, currently focusing on Western Europe and Asia. Approximately 8% of net sales in 2006 and approximately 7% of
net sales in 2005 came from sales to customers outside the U.S. and Canada.



Professional



The Professional segments
sales and marketing activities focus on core market customers: small-to-medium businesses, educational institutions (K-12 and higher education) and government agencies (federal, state and local). Sales are conducted through telephone-based and field
sales teams, complemented by local, regional and national value-added resellers. The company also sells its products to its Professional segment customers through customized websites.



Gateways custom integration solutions program is designed to accommodate the needs of large professional customers who
require specialized hardware, software and services that are not available as part of standard offerings. The companys custom integration solutions program accelerates technology deployment for clients through integration of unique hardware
and software and development of customized services to meet the individual requirements of professional customers.



Direct



The Direct segment is focused on selling individually-customized, Gateway-branded products and services as well as complementary third-party products and services directly to U.S. consumers and small business
customers. The company markets its Direct products through television and print advertising, e-mail, direct mail, Internet advertising, and its website at www.gateway.com.



Gateway sells its Direct products and services in the U.S. primarily through its www.gateway.com website and its
U.S.-based call centers (1-800-GATEWAY).



PC Products, Servers and Storage



Gateway offers its customers a broad line of Gateway and
eMachines-branded PCs and Gateway-branded servers. The company markets its PCs with recommended configurations, but its customers can also



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configure-to-order some Gateway-branded PCs with a choice of microprocessors, memory, storage and optical drives, as well as other options. The following are
the key products within this class:



Desktop
PCs.    Gateway offers a series of desktop PC products, developed to serve targeted customer segments. The company offers a range of standard models for consumers under the eMachines and Gateway brands and for professional
customers under the Gateway brand, with each series having a number of recommended configurations with varying levels of technology and features. Customers can purchase certain models of Gateway-branded PCs that they customize for their particular
needs. Desktops represented approximately 47% of net sales in 2006 and approximately 49% of net sales in 2005.



Notebook PCs.    Gateway offers a series of notebook PC products to provide mobile computing capabilities for both consumer and
professional customers. The systems are generally available with docking stations, wireless enablement and various multimedia applications. As with desktops, notebooks have a range of standard model series, with each series having a number of
recommended configurations. The systems range from convertible tablets to high-performance desktop replacement class notebooks. Notebook PCs represented approximately 36% of net sales in 2006 and approximately 31% of net sales in 2005.



Servers and Storage.    Gateway also offers
Gateway-branded servers and storage products for professional and small business customers. Every Gateway server has an adaptable design and can be custom built with a variety of options to fit the customers needs. Gateway servers can be
ordered in tower-based or rack-mounted configurations, with Microsoft Windows® operating software. Servers and storage products represented approximately 1% of net sales in 2006 and approximately 2% of net sales in 2005.



Non-PC Products and Services



Non-PC products and services consist of all products and services other than the PC, such as stand-alone displays, peripherals, software, accessories,
extended warranty services, training, Internet access, and enterprise system and networking products and services. Non-PC products and services represented approximately 16% of net sales in 2006 and approximately 18% of net sales in 2005.



Stand-Alone Displays, Peripherals, Software and Other
PC-Related Products.    Gateway markets stand-alone displays, printers, projectors, computer memory, scanners, PC accessories, CD and DVD burners, storage devices, surge protectors, and other PC accessories that are
manufactured by leading companies in their respective markets. Gateway offers a complete line of thin film transistor and cathode ray tube displays. These displays are sold with desktop PCs through Gateways channels and are also available
for stand-alone purchase. The company offers a limited number of Non-PC products under the Gateway brand. In addition, we market a broad range of third-party software offerings, from entertainment and productivity applications for the consumer
market to vertical applications for various segments of the commercial and institutional markets.



Service Programs.    Gateway offers value-added, fee-based service and support consisting of Internet access, web portal,
security, extended service plans, including extended technical support and warranty services, accidental damage programs, and learning and tutorial services sold mostly on behalf of third party service providers.



In addition, Gateways Professional segment offers value-added service
and support offerings that are designed to satisfy the needs of businesses throughout the technology lifecycle. Gateway utilizes a network of third-party providers who work with our professional sales force to deliver local consultation and
integration services to business, education and government customers in essentially all the top markets across the United States. In this segment, Gateway offers:



| |  |  | Technology planning services, such as on-site consultation and network design services;
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | Implementation services, such as custom installation and imaging, asset tagging, and hardware and network installation;
| | - |  | -----------------------------------------------------------------------------------------------------------------------



| |  |  | Productivity services, such as customized learning solutions, network and application support, and custom helpdesk solutions;
| | - |  | -----------------------------------------------------------------------------------------------------------------------------



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| |  |  | Maintenance services, such as on-site and product exchange services; and
| | - |  | ------------------------------------------------------------------------



| |  |  | End of life services, such as data migration, deinstallation and asset recovery services.
| | - |  | -----------------------------------------------------------------------------------------



Multi-Channel Delivery.    Gateway delivers
customer service and support at the customers location, at third-party locations and via telephone and the web. Gateway believes the availability of services through multiple channels benefits customers by providing them with a range of
service options. Most support services are provided by third-party vendors, but the company also provides technical telephone support services through its U.S. based Best Practices Center. This Center is made up of Gateway employees who
develop problem resolution procedures and technical solutions for Gateway products which are then distributed to the third-party service providers.



Financing Programs.    Gateway has arrangements with third-party financing institutions that provide financing to Direct and
Professional customers for the purchase or lease of the companys products.



Cooperative Product Development



The PC
industry is characterized by rapid technological advances. Gateways ability to compete successfully is heavily dependent upon the ability to ensure a continuing and timely flow of competitive products and technology to the marketplace. The
companys focus is primarily on coordinating and leveraging the development activities of a number of key technology partners, original design manufacturers and product or component providers. Gateways product development efforts are
focused on designing and developing competitively priced PC systems and Non-PC products that adhere to industry standards and incorporate the technologies and features that Gateway believes are most desired by its customers.



Gateway relies on cooperative relationships with a range of suppliers and
other technology developers for engineering, product development and production support in the fulfillment of its desktop and notebook computer and server product lines. Working with these companies, Gateways engineers manage quality,
integrate technologies and design product and system architecture. Gateway believes that these relationships, together with market information obtained from its customer relationships, allow it to rapidly introduce and deliver appealing new
products, software and services to the marketplace.



Manufacturing



Gateways product needs are fulfilled through
original design manufacturing and distribution relationships in Asia, Europe, Mexico and the United States to meet the needs of key market segments. The companys manufacturing and distribution supply base operates under Gateway work
instructions to assure the functional specifications and quality. In addition, engineering and quality assurance teams help ensure that products meet Gateway specifications and applicable regulatory requirements.



To better serve its Professional and Direct customers, Gateway opened a
dedicated U.S. final assembly facility in 2006 at which Gateway assembles configure-to-order desktops, notebooks and servers according to customer specifications. Gateway also provides custom imaging services and government compliance certification.



Patents, Trademarks and Licenses



Gateway, including AD Technologies LLC (formerly known as Amiga Development
LLC), has over 400 U.S. utility patents and a number of related foreign patents, and Gateway has a significant number of pending U.S. and foreign patent applications. Gateway has a majority equity interest in AD Technologies LLC, a holding company
for intellectual property, which is controlled by Gateways founder, Ted Waitt. A majority of the patents in the portfolio were issued in the last five years. The companys patent strategy focuses on building a



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broad portfolio of patents in the areas of computer related and information processing technologies, consumer electronics and manufacturing processes for
defensive purposes. Generally, Gateways products incorporate industry standard technology rather than proprietary technology it develops.



Gateway owns and uses a number of trademarks, brands and service marks on or in connection with its products and services, including Gateway, eMachines
and the Black-and-White Spot design, among others. Many of these trademarks are registered in the United States and other countries, and numerous trademark applications are pending in the United States and other countries. The company
believes these trademarks have strong brand name recognition in the United States marketplace and in many countries throughout the world.



Gateway also licenses technologies and software from third parties for integration into its products. Some of these technologies are industry standard
technologies which are licensed by many of its competitors. In addition, certain companies are increasingly engaging in the business of acquiring or developing patents to assert offensively against companies such as Gateway, and some of its direct
and indirect competitors seek to license their technology. As a result, Gateway may incur license costs that its competitors do not incur. Gateway generally does not own the software used on its PCs and has entered into software licensing
arrangements with a number of software developers, including Microsoft Corporation for Windows® and Microsoft Office software products, among others.



Competition



The PC industry is characterized by a handful of large competitors, numerous smaller competitors, aggressive pricing, short product life cycles, and price
sensitivity by customers. The level of pricing aggressiveness continues to be intense, particularly in the low-price end of the market. In addition, some of Gateways current and potential partners, including original design manufacturers,
design, manufacture and often market their products under their own or third-party brand names. Many of Gateways competitors are larger and better funded than Gateway.



Gateways primary competitors in the PC area are Dell Inc., Hewlett-Packard Company, Apple Inc., Lenovo Group Limited,
Sony Corporation, Acer Inc. and Toshiba Corporation. In particular regions and outside of the U.S., Gateway faces additional competition from companies such as Fujitsu Limited and Packard Bell. Gateway also faces competition from generically-branded
or white box manufacturers.



Gateway competes
primarily on the basis of customer satisfaction, price, product value, technology, product offerings with innovative performance features, quality, reliability, brand recognition, customer service and support and by maintaining strategic supplier
relationships that enable it to bring products to market quickly.



Historically, Gateway and many of its competitors have regularly lowered prices. Gateway expects these competitive pressures to continue in 2007 and that average sales prices for PCs and Non-PC products will continue to decline.



Environment



Certain of Gateways operations involve the use of substances regulated under various federal, state and international
laws governing the environment, including those governing the discharge of pollutants into the soil, air and water, the management and disposal of hazardous substances and wastes, and the cleanup of contaminated sites. Certain of Gateways
products are subject to various federal, state and international laws governing chemical substances in products, including those regulating the manufacture and distribution of chemical substances and those restricting the presence of certain
substances in electronics products. Gateway also faces increasing complexity in its product design, procurement and operations as it adjusts to new and upcoming requirements relating to the composition of its products, including restrictions on the
use of lead and other substances in electronics that apply to products sold in the European Union after July 1, 2006. In addition,



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Gateway is subject to costs and liabilities in connection with product take-back legislation in certain jurisdictions that impose financial responsibility on
producers of electrical goods for specified collection, recycling, treatment and disposal of covered products. Gateway currently has an incentive program to encourage its PC customers to recycle or donate their old PCs and displays, regardless of
brand, and Gateway is working with its original design manufacturers and suppliers to reduce the use of hazardous substances in its products. Environmental costs are presently not material to Gateways operations or financial position; however,
such costs may become material in the future as compliance obligations continue to increase.



Employees



As of
December 31, 2006, Gateway had approximately 1,700 employees, a reduction from approximately 1,800 employees as of December 31, 2005 and from 1,900 employees as of December 31, 2004, substantially all of whom are located in the United
States. Gateway believes it has generally good relationships with its employees.



Backlog



The backlog of unfilled orders was
approximately $98 million at December 31, 2006 and approximately $73 million at December 31, 2005. Gateway does not believe that backlog is a meaningful indicator of sales that can be expected for any period. There can be no assurance that
the backlog at any point in time will translate into sales in any subsequent period, particularly in light of the companys policy, which allows customers to cancel or reschedule orders.



Seasonality



Historically, revenues in the Retail segment are higher during the second half of the year. Gateways Professional
segment revenues are traditionally stronger in the second and third quarters. However, these patterns are subject to overall general economic market conditions, large bulk buys and technology transitions.



Available Information



You can access additional information about Gateway and its products and services at www.gateway.comand
www.emachines.com.You can also access Gateways Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and any amendments to these reports, free of charge, on Gateways website at
www.gateway.com, after the company files the reports with or furnishes them to the Securities and Exchange Commission. Gateway will also provide these reports in printed form to any stockholder who requests them from Gateway. The information
on the website is not incorporated into this Annual Report.



The SEC also maintains an Internet website that contains reports, proxy and information statements and other information regarding issuers, such as Gateway, that file electronically with the SEC. The SECs Internet website is located
at www.sec.gov.



Corporate Governance



Gateways Board of Directors is elected by Gateways stockholders
and is responsible for directing the management of business and affairs of Gateway. Gateways Chief Executive Officer and senior management run Gateways day-to-day business operations. The Board has adopted formal Corporate Governance
Guidelines which are available at www.gateway.com and will be provided in printed form to any stockholder who requests a copy from Gateway. The guidelines provide that the principal responsibilities of the Board, in addition to its general
oversight responsibilities, include the: (a) selection, evaluation and compensation of the Chief Executive Officer and oversight of the selection and compensation of Gateways senior executive management; (b) oversight of succession
plans for the Chief Executive Officer and key executive positions; (c) review and



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evaluation and, as appropriate, approval of Gateways financial and business performance, operations, key objectives, strategies, plans and actions; and
(d) review of the processes in place to ensure the integrity of Gateways financial, accounting and control systems and the accounting principles and practices used to prepare the financial statements.



The current Board consists of nine directors, eight of whom are independent
directors under the rules of the New York Stock Exchange. The other director, Ed Coleman, is Gateways Chief Executive Officer. In addition, as required by New York Stock Exchange rules, the Board of Directors has affirmatively determined that
each independent director has no material relationship with Gateway (directly or as a partner, stockholder, or officer of any organization that has a relationship with Gateway). The Board meets in regularly scheduled meetings as well as in special
meetings. All independent directors meet without management present during each regularly scheduled Board meeting, with a designated independent Board member chairing that segment of the meeting.



The Board has delegated a number of responsibilities to various committees of
the Board. At the present time, the Board Committees are the Audit, Compensation, and Corporate Governance and Nominating Committees. The members of each committee are appointed by the Board. Each committee consists entirely of independent
directors. Each committee meets on a regularly scheduled basis and operates under a written charter approved by the Board, all of which are available at www.gateway.comand will be provided in printed form to any stockholder who requests a
copy from Gateway.



The Audit Committee represents the Board in
its general oversight of Gateways financial reporting, internal controls and audit functions. The Audit Committee is also directly responsible for the appointment, compensation and oversight of the work of Gateways independent registered
public accounting firm. For both 2005 and 2006, Deloitte & Touche LLP was appointed the independent registered public accounting firm of Gateway. This appointment was also ratified by Gateways stockholders. The Audit Committee has
again appointed Deloitte & Touche LLP as Gateways independent registered public accounting firm for 2007, subject to stockholder approval. The Audit Committee also pre-approves any non-audit services by the independent registered
public accounting firm. The Audit Committee meets regularly in separate sessions with senior management, internal audit staff and Gateways independent registered public accounting firm.



The Compensation Committee reviews and approves salaries, bonuses and other
compensation for the Chief Executive Officer and other senior executive management. In addition, the Compensation Committee administers the 2000 Equity Incentive Plan, including reviewing and granting equity awards to officers and other
employees.



The Corporate Governance and Nominating Committee
reviews and reports to the Board concerning corporate governance matters, conducts an annual evaluation of the performance of the Board, and reviews and reassesses the adequacy of the Corporate Governance Guidelines. In addition, the Corporate
Governance and Nominating Committee recommends to the Board the size and composition of the Board, establishes procedures for consideration of candidates for the Board and recommends specific candidates for election to the Board.



As part of Gateways corporate governance practices, the company
maintains a Code of Ethics that is applicable to all employees, including the Chief Executive Officer, Chief Financial Officer, Principal Accounting Officer and Controller, and the Board of Directors. Gateway provides ethics training to new
employees when they are hired and to existing employees periodically. An Ethics Council, consisting of senior executive officers appointed by the Board, reviews reported ethical issues, including complaints through Gateways confidential ethics
hotline. The Ethics Council advises the Audit Committee with respect to ethical matters. The Audit Committee must evaluate actual or potential waivers of conflicts-of-interest for all executive officers and directors and make recommendations to the
Board concerning any action to be taken. The Board conducts an annual review of the Code of Ethics. Gateways Code of Ethics is available at www.gateway.comand will be provided in printed form to any stockholder who requests it from
Gateway.



In addition, stock ownership guidelines have
been established for directors and senior executive officers to better ensure that they maintain an equity stake in Gateway, and by doing so appropriately link their interests



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with those of the other stockholders. The Board guidelines provide that directors should hold Gateway common stock equal to the lesser of (a) the number
of shares having a value of three times the Board members annual cash retainer, and (b) the number of unrestricted shares granted to the director during the preceding six years. The executive officer guidelines provide that, absent
unusual personal circumstances, Gateways Chief Executive Officer and each Senior Vice President should retain 30 percent of all after tax profit shares from stock options exercised and stock grants (restricted or otherwise) for at least 3
years (from exercise or vesting date) unless the value of his or her ownership in Gateway securities exceeds five times the base salary for the Chief Executive Officer or two and a half times the base salary for Senior Vice Presidents.



Gateway continues to evaluate its corporate governance
practices in light of best practices and changing regulatory requirements and anticipates additional changes as necessary or appropriate. In 2006, Gateway filed with the New York Stock Exchange an executed certification from its then interim Chief
Executive Officer stating that he was not aware of any violation by Gateway of the New York Stock Exchanges corporate governance rules with respect to the 2005 fiscal year.



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Item 1A.Risk Factors



In addition to other information contained in this Annual Report, the following factors could affect Gateways future business, results of
operations, cash flows or financial position, and could cause future results to differ materially from those expressed in any of the forward-looking statements contained in this Annual Report.



The PC industry is extremely competitive and pricing pressures have
reduced Gateways gross profits and challenge its ability to maintain profitability.



Consolidation in the PC industry has resulted in larger and stronger competitors in many of Gateways markets and it continues to experience
increased competition in certain of its business segments. Gateway competes primarily on the basis of customer satisfaction, price, product value, technology, product offerings with innovative performance features, quality, reliability, brand
recognition, customer service and support, and by maintaining strategic supplier relationships that enable it to bring products to market quickly. Gateways management expects these competitive pressures to continue into the foreseeable future.
Gateways management also expects that average sales prices of its PCs will continue to decline, although this may be partially offset by an increased product mix of relatively higher priced notebook PCs, Gateway branded PCs in Retail and
liquid crystal displays. If Gateway continues to reduce PC prices in response to competition, Gateway may be unable to maintain or improve gross profits through cost reductions or offsetting sales of higher margin Non-PC products. Its overall gross
profit as a percentage of sales has declined due to its shift in overall distribution to third party retail and competitive pressures. To the extent Gateway is unable to maintain or grow its revenues and market share and maintain or improve its
gross profits, its business prospects and financial condition would be adversely affected.



Reliance upon third-party patents and intellectual property licensing could limit Gateways ability to innovate and exposes it to actual and potential litigation, which could adversely impact operating
results.



There is no assurance that Gateway will
continue to have access to existing or new third-party technology for use in its products. While it may be necessary in the future to seek or renew licenses relating to various aspects of its products and business methods, Gateways management
believes that based upon past experience and industry practice, such licenses generally can be obtained on commercially reasonable terms. However, there is no assurance that the necessary licenses would be available on acceptable terms. If Gateway
or its suppliers are unable to obtain such licenses, Gateway may be forced to market products without certain desirable technological features. Gateway could also incur substantial costs to redesign its products around other parties protected
technology.



Because of technological changes in the PC
industry and the convergence of PCs with Non-PC products, current extensive patent coverage, and the rapid rate of issuance of new patents, it is possible certain components of Gateways products and business methods may unknowingly infringe
upon existing patents of others. For example, Gateway is a party to various lawsuits and claims, including assertions of patent infringements and intellectual property-related administrative proceedings that arise in connection with its business.
Gateway cannot predict the outcome of these matters with certainty. Some of these lawsuits allege substantial damages and also seek injunctive relief to stop it from selling products alleged to infringe patents of others. If such relief was granted
or substantial damages were incurred, Gateways business and results of operations would be materially adversely affected. In addition, responding to such claims, regardless of their merit, is time consuming, results in significant expenses,
and diverts the attention of management and technical personnel.



Gateway attempts to transfer the risk of inadvertent patent infringement to its original design manufacturers and suppliers via contract. Gateway is not always successful in contractually transferring such risk to its original design
manufacturers and suppliers, and even when it does so it may be unable to enforce their obligations or they may be unable to adequately defend any patent infringement claims against its PCs and Gateway-branded Non-PC products. If Gateway is unable
to impose upon its original design manufacturers and suppliers the costs of patent infringement claims, its future operating results and financial condition could be materially adversely affected.



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Because one customer accounts for a substantial portion of Gateways revenues, the loss of
this customer would cause a significant decline in its revenues.



A single customer, Best Buy, accounted for approximately 39% of total revenues for 2006, up from 34% of total revenues for 2005, and is expected to continue to be a significant customer in the future. Although Gateway
works to expand and diversify its customer base, reductions or terminations of product purchases by, or pricing pressures from, this customer or other major third-party retailers without an offsetting increase in new sales to other customers, would
result in a substantial decline in revenue and operating results.



Failure to develop and maintain relationships with several key third-party retailers could adversely affect revenues.



Gateways products are sold primarily through direct channels and third-party retailers. Third-party retail sales have expanded significantly since
early 2004. Gateways management expects a substantial portion of its future sales will be to a small number of key third-party retailers. Additionally, third-party retailer orders may vary considerably from quarter to quarter. If the financial
condition of these retailers weakens or if they were to cease or significantly reduce the distribution of Gateways products, Gateways business and financial results could be adversely affected. If significant variability is experienced,
Gateways business and financial results for a particular quarter could be adversely affected. In addition, failure to foster and maintain strategic relationships with these retailers could have a significant adverse impact on Gateways
revenues and operating results.



If Gateway fails to
attract new customers, retain its existing customers and/or replace revenues associated with its higher-margin service revenues, its operating results will be adversely impacted.



The success of Gateways business depends on increasing the overall number of customer transactions in a cost-effective
manner. To do this, Gateway must attract new and repeat customers through its various marketing channels, including its website, its telephone call centers, its professional sales force, and its third-party retail partners, and then convert these
interactions into sales transactions. Gateways reduced marketing expenditures have contributed in part to reduced demand within its Direct and Professional segments and Gateways ability to successfully bid on future public sector
business could be negatively impacted if Gateway fails to perform under any of its existing public sector contracts. Furthermore, some of its third-party retail partners sell or may sell private label PCs at competitive prices and these sales have
the potential to adversely affect Gateways market share. In addition, a portion of Gateways revenue and profit is derived from higher-margin Internet access services and extended warranties sold in prior periods and recognized over time
under its revenue recognition policy, which Gateway expect to decline in the future. If Gateway does not achieve increased transaction volume, or replace its higher margin service revenues with alternative sources of profit margin, its ability to
grow and maintain profitability will be adversely impacted.



Information technology systems integration issues could disrupt Gateways internal operations, which could have significant adverse effects on its profitability and/or may have a material effect on its internal controls over
financial reporting.



Gateway is implementing a new
enterprise resource planning (ERP) system, as well as order capture and customer service applications, and continues to develop and modify certain of its other systems. Gateway has experienced development and implementation delays with
certain projects, and may experience interruptions in availability of portions of its information technology infrastructure, additional delays in development and implementation, or unanticipated system errors. Gateway may not be successful in
implementing these new systems, and transitioning data and other aspects of the process could be expensive, time consuming and disruptive. Any disruptions that may occur in the implementation of these new systems or any future systems could
adversely affect Gateways ability to report in an accurate and timely manner the results of its financial operations and otherwise efficiently operate its business, which could have significant adverse effects on its profitability.



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Gateway started implementing a significant portion of the ERP during December of 2006 which will impact a
number of its internal and reporting controls. While Gateway believes it has adequately planned for the implementation and review of all noted controls, no assurance can be made that it will meet all of its financial control requirements.
Gateway is reporting a material weakness in its design of internal controls in this reporting period related to its receiving and selling of components with its original design manufacturers (see Item 9A).



Gateway is dependent on manufacturing and services provided by a
limited number of third parties and failure to properly manage these relationships could significantly impact its results of operations.



Gateway is dependent upon third-party providers of manufacturing and support services. Gateway currently outsources a substantial portion of its
manufacturing operations, a significant portion of its service and support functions, and some administrative and operational services to third-party providers under contract. Although Gateway has partnered with certain vendors, Gateway has no
assurance that business interruptions will not occur or that these third parties will meet the needs of its business. If Gateway is unable to properly manage its relationships with these third-party providers or accurately forecast its demand
requirements for them, its revenues and gross profits may be adversely affected. Similarly, if its third-party providers do not comply with their contractual obligations, Gateways results of operations could be adversely impacted.



Gateway requires a high volume of quality products and components for its
PC and Non-PC offerings, substantially all of which are obtained from a limited number of original design manufacturers and suppliers. In some circumstances Gateway maintains single or dual-source vendor relationships, such as with Microsoft for
operating system software and Intel and AMD for PC microprocessors. There currently is a lawsuit between AMD and Intel, the outcome of which could impact Gateways results of operations. If the supply of a key material product or component were
delayed or curtailed, Gateways ability to ship the related product in a timely and cost-effective manner could be adversely affected. Gateway seeks to mitigate a portion of these risks in some cases by maintaining insurance to protect itself
against loss of profits due to a vendors inability to perform due to an insurable property loss. In addition, Gateway seeks to mitigate such risks by having dual sources of supply where appropriate. However, even where multiple vendors are
available, Gateway may source from a single vendor to take advantage of volume discounts, for product technical or quality reasons, or to maintain access to certain key components that are at times subject to industry-wide availability and pricing
pressures. In cases where Gateway needs to switch to another original design manufacturer or supplier and alternative sources of supply are available, qualification of the sources and establishment of reliable new or additional production with such
original design manufacturers or suppliers could result in delays and possible reductions in net sales or increases in cost of goods sold. Gateway also receives market development funding from a few of these suppliers in order to promote or develop
markets for computers featuring the suppliers products. If the amount of market development funding were to significantly decline, Gateways results of operations could be adversely affected.



To minimize some of these risks, Gateway monitors the financial status of
certain key original design manufacturers, suppliers and service providers and assesses the likelihood of disruption to the supply of products, components, or services. Certain of its commercial partners are financially weak, and Gateway has
established contingency plans to mitigate its financial and operating exposure. However, such plans for any key commercial partner that experiences financial instability may not prevent delays or curtailments of deliveries of key products,
components or services, or eliminate Gateways financial exposure to future costs such as warranty claims or the write-off of receivables from the sale of components to original design manufacturers, which could adversely affect Gateways
future operating results and financial condition.



Many of
Gateways competitors obtain products or components from the same original design manufacturers and suppliers that Gateway utilizes. Gateways competitors may obtain better pricing and other terms, more favorable allocations of products
and components during periods of limited supply, and could limit Gateways ability to engage in relationships with certain original design manufacturers and suppliers. In addition, certain of Gateways original design manufacturers and
suppliers could decide in the future to not continue



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conducting business with it. Any of these actions by Gateways competitors, original design manufacturers or suppliers could adversely affect its future
operating results and financial condition.



Gateway is
dependent on suppliers for trade credit. If such credit is not available, Gateways liquidity could be adversely affected.



Gateways ability to obtain trade credit from its suppliers is necessary for its ongoing business operations. Some of its suppliers have restricted
the amount and terms of trade credit available to Gateway in response to continued operating losses and the decline in its cash and marketable securities balances. If Gateway continues to experience net losses and see further erosion of its cash
balances, trade credit from suppliers could be further limited. While Gateway believes it will have sufficient cash and financial flexibility to meet its operational cash needs for at least the next twelve months, if it is unable to maintain
sufficient liquidity, its future results of operations and financial condition would be adversely impacted. See Item 7. Managements Discussion and Analysis of Financial Condition and Results of OperationsLiquidity and Capital
Resources for more information.



Gateway opened a
final assembly facility during 2006 which exposes it to additional financial and operational risk.



To better serve its Professional and Direct customers, Gateway opened a dedicated U.S. final assembly facility in 2006. Gateway assembles
configure-to-order desktops, notebooks and servers according to customer specifications at this facility, as well as providing custom imaging services and government compliance certification. This facility is expected to increase Gateways
ability to serve its Professional and Direct customers and improve its cost efficiency. The facility increases Gateways fixed costs, requires additional systems and controls, and requires additional management oversight and expertise. Should
any of these costs or requirements escalate or should anticipated volumes fall below expectations, Gateways results of operations and financial condition could be adversely impacted.



Gateways reliance on original design manufacturers or suppliers
of key products and components exposes it to potential product quality issues and unanticipated warranty costs that could affect the on-time delivery and performance of its products and services, which could adversely impact operating results.



While outsourcing arrangements may lower its product
and operating costs, they also reduce its direct control over production and distribution. If Gateway is unable to ship its products in desired quantities and in a timely manner due to a delay or curtailment of the supply of material products or
components, or product quality issues arise due to faulty products or components manufactured by original design manufacturers or suppliers, the market for its products or services could be adversely affected with a resulting reduction in revenues.
Gateways estimated warranty and extended warranty costs are affected by ongoing product failure rates and specific product class failures. If product failure rates, material usage or service delivery costs exceed its estimates due to faulty
products or components manufactured by original design manufacturers or suppliers, warranty expenses may increase. In many instances Gateway relies on offshore suppliers, particularly from Asia, for product assembly and manufacturing, and risks
associated with transportation, including timely delivery to its primary ports of Los Angeles and Long Beach, California, and other natural or human factors may disrupt the flow of product. If for any reason manufacturing or logistics in any of
these locations or the subsequent transportation to the U.S. or other customer locations were disrupted by economic, business, environmental, political, medical, military or terrorist events, Gateways operations and financial condition could
be adversely affected. In addition, Gateway may experience production and financial difficulties if any of its significant original design manufacturers or suppliers suffer financial instability. This includes its likely inability to obtain
reimbursement for prepaid warranty costs from certain original design manufacturers, should their financial condition deteriorate. Should such original design manufacturers or suppliers fail to either produce or deliver products as scheduled or to
provide prepaid warranty coverage, Gateways operations and financial condition may be adversely affected.



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Failure to develop and introduce new and technologically advanced products in an industry
characterized by short product life cycles could adversely affect Gateways growth and efforts to sustain profitability.



Gateways business model depends on bringing new and innovative products to market quickly. The success of its product introductions depends on many
factors including the availability of new products, successful quality control and launch readiness efforts, its ability to successfully forecast product demand, training of sales and support personnel, and customer acceptance of new technology. In
addition, the introduction of certain new technologies, such as the Microsoft Windows® Vista
operating system, presents Gateway with uncertainties regarding the speed of customer acceptance, software and hardware compatibility, and manufacturing schedules. If Gateway is unable to successfully forecast demand for new products, it may not
properly manage its inventory levels and may have increased exposure to supply shortages, product obsolescence and other supply-related risks.



Short product life cycles resulting from rapid changes in technology and consumer preferences and declining product prices characterize the PC industry.
Gateways internal engineering personnel work closely with product and component suppliers and other technology developers to evaluate the latest developments in PC and Non-PC products. There is no assurance that Gateway will continue to have
access to or the right to use new technology, or be successful incorporating such new technology in its products in a timely manner.



The failure to properly manage inventory could adversely affect operating results.



By distributing many of its products directly to its customers prior to its
acquisition of eMachines, Gateway historically avoided the need to maintain high levels of finished goods inventory. This minimized costs and allowed Gateway to respond more quickly to changing customer demands and reduced its exposure to the risk
of finished product obsolescence. As Gateway increases sales volume into third-party retail channels, managing its inventory effectively has become increasingly important. Third-party retailers may quickly increase orders during periods of product
shortages, cancel orders if their inventory is too high, or delay orders in anticipation of new products. Orders also may be adjusted in response to the supply of Gateways competitors products and seasonal fluctuations in end-user
demand. In addition, Gateway maintains certain component products in inventory. If Gateway is not successful in forecasting component prices or component or product demand, its product costs could be impacted or it could have excess or insufficient
inventory of certain components or products and any excess inventory may result in reduced prices and inventory write-downs, which in turn could result in lower gross profits. A decrease in market demand or a decision to increase supply, among other
factors, could result in higher finished goods and component inventory levels, and a decrease in value of this inventory could have a negative effect on Gateways results of operations. Although Gateways management believes the
companys inventory and related reserve provisions are adequate, given the rapid and unpredictable pace of product obsolescence in the PC industry, no assurance can be given that Gateway will not incur significant additional inventory and
related charges. In addition, by purchasing component parts on behalf of original design manufacturers, Gateway has increased its credit risk with these original design manufacturers.



The failure to attract, retain and motivate key personnel could have a significant near-term adverse impact on
Gateways operations.



Gateways ability to
attract, retain and motivate employees and maintain employee morale has been adversely impacted by a number of factors, including workforce reductions, the closure of facilities and a competitive PC business environment. Gateway has experienced, and
may continue to experience, turnover in senior management and in the general workforce, which may disrupt business operations, internal controls, and relationships with commercial partners and customers. Turnover, particularly among senior
management, can also create distractions and cause operational inefficiencies as replacement personnel become familiar with its business and operations. In addition, manpower in certain areas may be constrained, which could lead to disruptions over
time. There can be no assurance that Gateway will continue to successfully attract or retain the management it needs, or be able to maintain an optimal workforce size. Any inability to attract, retain or motivate such personnel or address manpower
constraints as needed could materially adversely affect its future operating results, internal controls and financial condition.



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Gateway has outsourced operations in countries outside of the U.S. and changes in the political
environment, economic policies and other factors within those countries or the U.S. could adversely affect its business.



Gateway has outsourced a substantial portion of its manufacturing operations to countries in Asia, Eastern Europe, and Mexico. A change in these
countries economic or regulation policies could adversely affect business and economic conditions in the affected country generally and could negatively impact the cost-saving benefits of Gateways outsourced operations overseas. While
Gateways contract obligations are typically in U.S. dollars, changes in currency exchange rates could impact its suppliers and increase prices. Changes in Chinese Yuan remnimbi to United States dollar exchange rate could increase its costs for
products and components sourced from China. Any political instability could also change the present satisfactory legal environment for us through the imposition of restrictions on foreign ownership, repatriation of funds, adverse labor laws, and the
like. Further, risks associated with transportation and other natural or human factors, including disease epidemics, may disrupt operations in and the flow of products from certain countries. Gateway also has outsourced workers in countries outside
of the U.S. in technical support call centers, repair centers, and refurbishment centers. These outsourced operations present Gateway with similar economic and political risks. The political climate in the U.S. also could change, which could
adversely affect Gateways ability to maintain or create low-cost operations outside the U.S.



Environmental laws and regulations and unforeseen costs could impact Gateways future earnings.



Production and marketing of products in certain states and countries may
subject Gateway to environmental and other regulations. Gateway also could face significant costs and liabilities in connection with product take-back legislation, which provides customers the ability to return product at the end of its useful life
and places financial and other responsibility for environmentally safe collection, recycling, treatment and disposal with Gateway. Gateway also faces increasing complexity in its product design and procurement and operations as Gateway adjusts to
new and upcoming requirements relating to the materials composition of its products, including the restrictions on lead and certain other substances that apply to specified electronics products marketed in the European Union as of July 1, 2006.
The European Union has also finalized the Waste Electrical and Electronic Equipment Directive, which makes producers of electrical goods, including computers and printers, financially responsible for specified collection, recycling, treatment
and disposal of past and future covered products. There is substantial complexity associated with compliance with these new regulations and the costs of implementation are not easily quantifiable. Compliance also necessitates its reliance on the
representations made by suppliers as to material composition; while such representations are believed to be accurate, Gateway could face significant costs and liabilities if the representations prove to not be accurate. Furthermore, Gateway must
rely on its suppliers ability to respond to environmental requirements with compliant products and documentation in a timely manner.



Similar laws and regulations have been or may be enacted in other states and countries. Other environmental regulations may require Gateway to reengineer
its products to utilize components which are more environmentally compatible and such reengineering and component substitution may result in additional costs to Gateway. Although Gateway does not anticipate any material adverse effects based on the
nature of its operations and the effect of such laws, there is no assurance that such existing laws or future laws will not have a material adverse effect on Gateway.



Gateway is subject to seasonality which can make it difficult to forecast results of operations and anticipate near
term developments.



Gateways revenues and
operating margins vary among products, distribution channels and the seasonal buying habits of its customers. Historically revenues in the Retail segment are seasonally higher during the second half of the year, and Professional segment revenues are
seasonally higher in the second and third quarters. Consequently, the overall operating margins of Gateway in any given period will depend, in part, on the product, geographic and channel mix reflected in that periods net sales, as well as
seasonality factors related to the time



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of the year. In addition, Gateway typically experiences an increase in sales activity near quarter-end. Developments late in a quarter, such as
lower-than-anticipated demand for Gateways products or late arriving components and scheduling/production delays at its manufacturing or logistics partners, fluctuations in product, geographic and channel mix, and the effect of seasonality on
its sales and operating margins can have significant adverse impacts on Gateway and its results of operations and financial condition for a given reporting period.



Expansion into international markets exposes Gateway to increased risks, which could adversely impact operating
results.



Gateway has expanded sales of PCs and
certain Non-PC products into international markets. International sales are subject to certain inherent risks including unexpected changes in regulatory requirements and tariffs, including antidumping penalties, risks in hedging for foreign currency
fluctuations for non-U.S. dollar sales, difficulties in managing foreign operations, legal remedies that can affect accounts receivable collection and potentially adverse tax consequences. In addition, given that its products in international
markets are sold primarily through a small number of third-party retail partners, Gateways business and financial results could be adversely affected if the financial condition of any of these retailers weakens or if they were to cease or
significantly reduce the distribution of its products. For those international sales not denominated in U.S. dollars, any strengthening of the U.S. dollar relative to the currencies of other countries into which Gateway sell its products and
services could make its products and services more expensive, thereby reducing the price-competitiveness of its products. Should any of these difficulties arise, its results of operations and financial condition could be adversely impacted.



War, terrorist acts and other political and economic
uncertainties may adversely affect Gateways operating results.



War and the related political and economic uncertainties, terrorist attacks, national and international responses to terrorist attacks, and other acts of hostility could materially adversely affect demand for
Gateways products and disrupt its supply chain or customer fulfillment logistics or operations, resulting in an adverse impact on its future operating results and financial condition.



If Gateway cannot sustain profitability and Gateway incurs significant
net losses or negative cash flows, the business could fail.



Gateway experienced net losses in the years ended December 31, 2003 and 2004 of $515 million and $568 million, respectively. While Gateway reported net income of $9.6 million for the year ended December 31, 2006 and $6.1 million
for the year ended December 31, 2005, approximately $35 million and $41 million, respectively, was attributable to the Marketing, Development and Settlement Agreement with Microsoft, which expires in the fourth quarter of 2008 and Gateway
cannot guarantee its future profitability, and additional significant net losses would materially adversely affect Gateways financial condition, results of operations and cash flows.



Its cash and marketable securities balances have declined since the first
quarter of 2004 from historically higher levels due to the eMachines acquisition, restructuring its company, working capital usage in support of expanding its Retail business, and other operating, investing and financing activities. Cash and
marketable securities balances declined materially from December 31, 2005 to December 31, 2006. Gateway may be unable to generate positive cash flow, which would result in declining cash and marketable securities balances. Gateway may be
required to raise additional cash through additional debt or equity instruments. Gateways management believes Gateway will have sufficient cash and financial flexibility to meet its operational cash needs for the next twelve months. If it is
unable to maintain sufficient liquidity or raise additional capital, its future results of operations and financial condition would be adversely impacted.



Gateways failure to protect customer data could adversely affect our sales and reputation.



There have been a number of instances in which personal information
maintained by companies has been lost or stolen. Gateway collects and maintains large amounts of customer data in the normal course of its



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business, and Gateways service providers collect and maintain customer data in the course of providing services to customers on Gateways behalf.
Gateway has policies and procedures in place to protect against inadvertent disclosure of customer data by it and its suppliers. It also proactively searches and seeks to protect against intrusions into its infrastructure to prevent the theft of
customer data. Although Gateway believes it has effective policies, procedures and technology to prevent the disclosure of customer data, the loss or theft of customer data could adversely affect Gateways sales and reputation with its
customers, as well as expose Gateway to potential damages and costs that could be material.



If Gateway does not maintain its reputation and expand its name recognition, Gateway may lose customers which would adversely impact its financial results.



Developing and maintaining awareness of its Gateway and eMachines brand
names is critical to achieving widespread acceptance of its PC and Non-PC offerings. Promotion and enhancement of its brand will depend largely on whether Gateway cost-effectively provides reliable and desirable products and services to customers
and the effectiveness of its marketing efforts. Currently, third-party retailers are often its first points of contact with consumers and these retailers provide much of its product advertising as Gateway has reduced its internal spending on
marketing. If these retailers reduce or cease advertising its products, Gateway may need to increase its own sales and marketing expenses to create and maintain brand awareness among potential consumers. If customers do not perceive Gateways
products to be of high quality, its brand names and reputation could be harmed, which could adversely impact its financial results.



Gateways internal control over financial reporting could be adversely affected by a material weakness in its internal controls. If not
corrected, its operating results and stock price could be adversely affected.



During the course of the 2006 year-end close process, Gateways management examined Gateways processes relating to its receipt of components from original equipment manufacturers (OEMs) and sale of
components to original design manufacturers (ODMs). As a result of that evaluation, management concluded that Gateway did not adequately design controls to ensure the timely accrual of liabilities to OEMs, recording of receivables from ODMs and
receipt of inventory (see Item 9A). While Gateway continues to take steps to remediate this material weakness, there can be no assurance that Gateway will be able to completely remediate it such that management will be able to conclude that its
internal control over financial reporting is effective. The existence of a significant deficiency or a material weakness could result in errors in Gateways financial statements that could result in a restatement, cause Gateway to fail to
timely meet its reporting obligations and cause investors to lose confidence in its reported financial information, leading to a decline in Gateways stock price.



Item 1B.Unresolved Staff Comments



None.



Item  2.Properties



The following are Gateways principal administrative and sales offices, operational facilities and support centers in the following locations:



|                               |  |               |  |                 |  |                                                  |  |                     
|------------------------------ |  | ------------- |  | --------------- |  | ------------------------------------------------ |  | --------------------
|Facilities                     |  | SquareFootage |  | Owned or Leased |  | Description / Property Use                       |  | Segment Use         
|Irvine, California             |  | 98,000        |  | Leased          |  | Corporate headquarters                           |  | All segments        
|                               |  |               |  |                
|Irvine, California             |  | 147,000       |  | Leased          |  | Warehouse and office space                       |  | All segments        
|                               |  |               |  |                
|North Sioux City, South Dakota |  | 352,000       |  | Owned           |  | Customer sales and supportcenter; administration |  | All segments        
|                               |  |               |  |                
|North Sioux City, South Dakota |  | 15,000        |  | Leased          |  | Records storage                                  |  | All segments        
|                               |  |               |  |                
|La Vergne, Tennessee           |  | 94,000        |  | Leased          |  | Assembly                                         |  | Professional, Direct



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Gateway continues to sublease or actively market to sublease or
terminate approximately 22 remaining retail locations throughout the United States, as a result of the closure of all of its retail stores in April 2004. Gateway also continues to lease, sublease and actively market for sale, lease,
or sublease office and distribution facilities in Lake Forest, San Diego and Poway, California; Lakewood and Colorado Springs, Colorado; Kansas City, Missouri, North Sioux City, South Dakota, and Hampton, Virginia.



Gateway believes that its administrative and sales offices, operational
facilities and support centers will be adequate for its business needs in the foreseeable future.



Item  3.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



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 individual members of Gateways board of directors. 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. On November 13, 2006, Gateway filed a motion for an order compelling plaintiff to furnish a bond, pursuant to California Corp. Code § 800(c), and the court has yet to rule on Gateways motion. The parties have
stipulated that the director defendants need not appear in the matter or otherwise respond to the complaint until after a demand-futility motion to be filed by Gateway 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 Technologies, Inc. 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 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 Inc. 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 have been
consolidated into five separate trials, in which a different group of patents will 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 is expected to appeal. The first trial that involves Gateway is scheduled to begin on March 19, 2007, with three additional trials expected to occur in 2007 and possibly
2008.



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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, which was 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. Dispositive motions filed by the defendants were heard and denied by the Court in August 2004 and August 2005. No trial date has been set, but the trial is currently
anticipated to occur sometime in 2007.



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. At least quarterly 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 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.



Item  4.Submission of Matters to a Vote of Security Holders



Not applicable.



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##### Table of Contents

PART II



|Item 5. | Market for Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
|------- | ------------------------------------------------------------------------------------------------------------



Market Information



Gateway common stock is listed on the New York Stock Exchange under the trading symbol GTW. The following table
sets forth the quarterly high and low closing prices per share for Gateways common stock in 2005 and 2006:



|            |  |      |      |     |   |     
|----------- |  | ---- | ---- | --- | - | ----
|            |  | High |      | Low
|2005:       |  |      |      |     |   |     
|1st quarter |  | $    | 5.85 |     | $ | 3.95
|2nd quarter |  | $    | 4.16 |     | $ | 2.85
|3rd quarter |  | $    | 4.08 |     | $ | 2.44
|4th quarter |  | $    | 3.16 |     | $ | 2.48
|2006:       |  |      |      |     |   |     
|1st quarter |  | $    | 2.93 |     | $ | 2.15
|2nd quarter |  | $    | 2.36 |     | $ | 1.53
|3rd quarter |  | $    | 2.09 |     | $ | 1.30
|4th quarter |  | $    | 2.17 |     | $ | 1.60



Holders of Record



As of February 20, 2007, there were 6,862 holders of record of our
common stock. There were no issued and outstanding shares of the Class A Common Stock as of such date.



Dividends



Gateways management believes the best use of cash is to fund internal growth and for general corporate purposes. As a result, it has not declared any cash dividends on its common stock since it was first publicly registered and does
not anticipate paying any cash dividends on its common stock in the foreseeable future. In addition, Gateways credit agreement restricts its ability to pay dividends on its common stock.



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Stock Performance Graph



The following graph shows the cumulative total return assuming the investments of $100 from December 31, 2001 through December 31, 2006 (and
the reinvestment of dividends thereafter) in each of our common stock, the S&P 500 Index and the S&P Computer Hardware Index. Past financial performance should not be considered a reliable indicator of future performance, and investors
should not use historical trends to anticipate results or trends in future periods.



LOGO



20



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##### Table of Contents

Issuer Purchases of Equity Securities



The following table sets forth information with respect to purchases by Gateway of its equity securities registered pursuant
to Section 12 of the Exchange Act during 2006:



|                     |  |                                                        |  |                                                  |      |                                                                                                      |   |                                                                                                                                |  
|-------------------- |  | ------------------------------------------------------ |  | ------------------------------------------------ | ---- | ---------------------------------------------------------------------------------------------------- | - | ------------------------------------------------------------------------------------------------------------------------------ | -
|Period               |  | (a) Total Number of Shares of Common Stock Acquisition |  | (b) Average Price Paid Per Share of Common Stock |      | (c) Total Number of Shares of Common Stock Purchased as Part of
Publicly Announced Plans or Programs |   | (d)Maximum Number (or Approximate Dollar Value of Shares
of Common Stock that May Yet Be Purchased Under the Plans or Programs
|January 1-31, 2006   |  | 996,383                                                |  | $                                                | 2.70 |                                                                                                      |  |                                                                                                                                | 
|February 1-28, 2006  |  |                                                       |  |                                                  |     |                                                                                                      |  |                                                                                                                                | 
|March 1-31, 2006     |  |                                                       |  |                                                  |     |                                                                                                      |  |                                                                                                                                | 
|April 1-30, 2006     |  |                                                       |  |                                                  |     |                                                                                                      |  |                                                                                                                                | 
|May 1-31, 2006       |  |                                                       |  |                                                  |     |                                                                                                      |  |                                                                                                                                | 
|June 1-30, 2006      |  | 167,665                                                |  | $                                                | 1.67 |                                                                                                      |  |                                                                                                                                | 
|July 1-31, 2006      |  |                                                       |  |                                                  |     |                                                                                                      |  |                                                                                                                                | 
|August 1-31, 2006    |  |                                                       |  |                                                  |     |                                                                                                      |  |                                                                                                                                | 
|September 1-30, 2006 |  |                                                       |  |                                                  |     |                                                                                                      |  |                                                                                                                                | 
|October 1-31, 2006   |  | 122,224                                                |  |                                                  | 1.84 |                                                                                                      |  |                                                                                                                                | 
|November 1-30, 2006  |  |                                                       |  |                                                  |     |                                                                                                      |  |                                                                                                                                | 
|December 1-31, 2006  |  |                                                       |  |                                                  |     |                                                                                                      |  |                                                                                                                                | 
|                     |  |                                                        |  |                                                  |      |                                                                                                      |   |                                                                                                                                |  
|Total                |  | 1,286,272                                              |  | $                                                | 2.48 |                                                                                                      |  |                                                                                                                                | 
|                     |  |                                                        |  |                                                  |      |                                                                                                      |   |                                                                                                                                |  



The 996,383 shares of
common stock represents the value of taxes withheld on the aggregate vesting of 2,146,426 shares of restricted stock originally issued in connection with the eMachines acquisition in March 2004. Gateway repurchased 167,665 shares of common
stock in a private transaction from a Gateway executive at a price equal to the market price on June 5, 2006, the date of purchase. The 122,224 shares of common stock represents the value of taxes withheld on the vesting of employee restricted
stock on October 4, 2006.



Item 6.Selected Consolidated Financial Data



The following historical data was derived from Gateways audited consolidated financial statements. This financial data as of December 31, 2006
and 2005 and for the years ended December 31, 2006, 2005 and 2004 should be read in conjunction with Item 8 Consolidated Financial Statements and Supplementary Data of this Annual Report and in conjunction with Item 7
Managements Discussion and Analysis of Financial Condition and Results of Operations of this Annual Report. The information below is not necessarily indicative of the results of future operations.



|                                                                                  |  |                                  |           |      |   |           |  |   |           |   |  |      |           |   |  |   |           |  
|--------------------------------------------------------------------------------- |  | -------------------------------- | --------- | ---- | - | --------- |  | - | --------- | - |  | ---- | --------- | - |  | - | --------- | -
|                                                                                  |  | For the years ended December 31, |          
|                                                                                  |  | 2006                             |           | 2005 |   | 2004 (a)  |  |   | 2003      |   |  | 2002 |          
|Consolidated Statements of Operations Data (in thousands, except per share data): |  |                                  |           |      |   |           |  |   |           |   |  |      |           |   |  |   |           |  
|Net sales                                                                         |  | $                                | 3,980,803 |      | $ | 3,854,061 |  | $ | 3,649,734 |   |  | $    | 3,402,364 |   |  | $ | 4,171,325 |  
|Net income (loss) (b)                                                             |  | $                                | 9,643     |      | $ | 6,161     |  | $ | (567,618  | ) |  | $    | (514,812  | ) |  | $ | (297,718  | )
|Net income (loss) attributable to common shareholders                             |  | $                                | 9,643     |      | $ | 6,161     |  | $ | (475,476  | ) |  | $    | (525,950  | ) |  | $ | (309,041  | )
|Net income (loss) per common share:                                               |  |                                  |           |      |   |           |  |   |           |   |  |      |           |   |  |   |           |  
|Basic                                                                             |  | $                                | 0.03      |      | $ | 0.02      |  | $ | (1.31     | ) |  | $    | (1.62     | ) |  | $ | (0.95     | )
|Diluted                                                                           |  | $                                | 0.03      |      | $ | 0.02      |  | $ | (1.45     | ) |  | $    | (1.62     | ) |  | $ | (0.95     | )



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##### Table of Contents

|                                                |  |                    |           |      |   |           |  |      |           |      |   |           |  |   |          
|----------------------------------------------- |  | ------------------ | --------- | ---- | - | --------- |  | ---- | --------- | ---- | - | --------- |  | - | ---------
|                                                |  | As of December 31,
|                                                |  | 2006               |           | 2005 |   | 2004 (a)  |  | 2003 |           | 2002
|Consolidated Balance Sheet Data (in thousands): |  |                    |           |      |   |           |  |      |           |      |   |           |  |   |          
|Cash and marketable securities                  |  | $                  | 416,335   |      | $ | 585,688   |  | $    | 588,330   |      | $ | 1,051,456 |  | $ | 1,021,847
|Total assets                                    |  | $                  | 1,656,235 |      | $ | 1,921,066 |  | $    | 1,771,787 |      | $ | 2,028,438 |  | $ | 2,509,407
|Senior convertible notes                        |  | $                  | 300,000   |      | $ | 300,000   |  | $    | 300,000   |      | $ |          |  | $ |         
|Series C redeemable convertible preferred stock |  | $                  |          |      | $ |          |  | $    |          |      | $ | 197,720   |  | $ | 195,422  
|Stockholders equity                            |  | $                  | 269,008   |      | $ | 255,274   |  | $    | 245,037   |      | $ | 722,018   |  | $ | 1,246,518

---

|(a) |  | Results for 2004 reflect the inclusion of eMachines activity subsequent to March 11, 2004.
|--- |  | -------------------------------------------------------------------------------------------

|(b) |  | Net income (loss) includes certain restructuring, transformation, integration and other charges of $0.5 million, $13 million, $478 million, $192 million, and $99 million for 2006,
2005, 2004, 2003, and 2002, respectively.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Item 7.Managements Discussion and Analysis of Financial Condition and Results of Operations



The following discussion should be read in conjunction with the Consolidated Financial Statements and the related notes
that appear elsewhere in this document.



This Annual Report
includes forward-looking statements made based on current management 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 Gateways expectations include the factors described in Item 1A Risk Factors of this Annual Report or that are otherwise described from time to time in our reports filed with the Securities
Exchange Commission after this 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.



Managements discussion and analysis that follows is designed to provide
information that will assist readers in understanding our consolidated financial statements, changes in certain items in those statements 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 related 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, and our ability to maneuver quickly and react to product development trends in the rapidly changing PC industry.



Some of the key developments and achievements for 2006 include:



| |  |  | Net income and PC unit saleswe posted net income of $9.6 million or $0.03 per share for the year ended December 31, 2006. Total PC unit sales of
five million were up 12% over 2005.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Continued Cost Structure ImprovementsSG&A expenses for the year were $309 million (including $0.5 million in restructuring, transformation and
integration expenses), compared with $364 million in 2005 (including $13 million in restructuring, transformation and integration expenses). In the fourth quarter we announced plans to further reduce corporate SG&A through a cost reduction
program that will yield $30-35 million in 2007. As a result of further activities, we believe we will achieve cost reductions that will exceed $30-35 million.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | Notebook and Display Sales Growthin 2006, we continued to experience sales momentum with our notebook products and flat panel displays. Notebook unit
sales were up 48% in 2006 compared with 2005 and display sales were up 13% over 2005 sales.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Continued Retail and International Expansion2006 saw continued strong contributions from U.S. Retail as PC unit sales were up by 22% overall, paced by
surging notebook and display sales. Notebook unit sales were up 63% and flat panel display sales were up by nearly 60% over 2005. Based on NPD data, Gateway was the fastest growing notebook brand in U.S. Retail among the top-five vendors.
International retail sales were up in 2006 as well. Gateway exited the year with more than 3,400 stores carrying Gateway and eMachines products in France, Japan, Mexico and the United Kingdom.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | New ProductsGateway introduced a number of new products during 2006, including its flagship Gateway FX530 desktop PC line for digital enthusiasts,
which has been widely acclaimed for delivering maximum performance and setting new standards for value in this high-end category. With this platform, Gateway became the first major PC OEM to offer warranty support for factory over-clocked
processors. Gateway also built on the success of its award-winning 21-inch wide LCD display with a complete line of wide displays at 19-, 22- and 24-inches. Gateway also introduced a number of new notebook products for all sales channels
featuring the latest mobile technology. For Professional customers, Gateways server line-up was redesigned, offering a new industrial design, enhanced serviceability and remote system management. The company also introduced a new storage
area network (SAN) product, which provides enterprise-class storage at an entry-level price without sacrificing performance or reliability.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | New CEOin September 2006, Gateway named Ed Coleman as CEO, replacing Chairman Rick Snyder, who served as interim CEO for most of 2006. A 30-year
veteran of the technology industry, Coleman has broad-based experience that includes sales and marketing, operations, IT services and finance roles with some of the worlds most successful technology companies.
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Board of Directorsin December 2006, Gateway enhanced its Board of Directors by appointing Scott Galloway to the Board. Mr. Galloway, a clinical
associate professor at NYUs Stern School of Business and managing member of Firebrand Partners, brings a strong marketing perspective to the Board.
| | - |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Award-winning North America-based Tech Supportin 2006, Gateway transitioned all of its customer care operations and support for customers in the U.S.
and Canada to North America. As evidenced by the companys improved performance in a number of third-party service-related studies, this move is paying off. In fact, in the two most recent Technology Business Research (TBR) Corporate IT Buying
Behavior and Customer Satisfaction Studies for both desktop and notebook PCs, Gateway earned the number one designation and our North America-based approach to customer care was cited as a key factor in both studies.
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



We continue to face a variety of challenges
and opportunities inherent within the PC industry which is characterized by rapid change, evolving customer demands and intense competition. Key challenges include increasing demand for our products in a highly competitive market, increasing
revenue, lowering costs, managing our supply chain and increasing gross profit. See Item 1A Risk Factors.



Critical Accounting Policies and Estimates



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



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



Revenue Recognition



Gateway recognizes revenue on PCs, servers 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 portal, 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. If the actual subscriber counts or the economics associated
with these subscriber counts prove to be more or less than originally reported by the service providers, we may be required to adjust revenue. In the fourth quarter of 2002, America Online, Inc. (AOL) unilaterally recomputed payments it
had made in 2001 and the first half of 2002 and withheld the claimed overpayments from amounts currently owed to us. We disputed AOLs retroactive adjustment and reached a settlement in November 2004 for $2.5 million related to the contested
period and an additional $1.6 million for subsequent periods through 2004. This was recognized as revenue in 2004. Revenue from the sale of other services rendered by third parties, such as installation services, is generally recognized when such
services are performed.



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 recognized on a straight-line basis over the warranty service period.



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 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. If actual returns exceed estimated returns or if actual rebate redemptions exceed
estimates, we would be required to record additional reductions to revenue which would affect earnings in the period the adjustments are made. Gateway also 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 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.



Gateway records revenue net of sales 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



Gateway maintains 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 specific customer accounts and includes consideration of the
creditworthiness 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



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##### Table of Contents

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.



Inventory Valuation



The business environment in which Gateway operates 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. Gateway 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



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



Internal-use Software



Gateway capitalizes 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. Gateway is 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 a change in the estimated depreciable life which could result in increased depreciation expense in the reporting period that the change was made.



Warranty Provision



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. 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.



Restructuring



Gateway has 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. For a description of our restructuring
actions, refer to our discussion of restructuring charges in the Results of Operations section.



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##### Table of Contents

Long-lived Asset Impairments



Gateway reviews 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 net 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 change of the useful life in a given
reporting period.



Taxes on Earnings



Gateway records 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. 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 carry back 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. 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.



Litigation



Gateway is currently involved in certain legal proceedings (see Note 5 to the Consolidated Financial Statements). 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



On March 11, 2004, Gateway acquired
eMachines, a privately-held PC company, in a transaction valued at approximately $262 million. The acquisition combined Gateways Professional and Consumer (now called Direct) businesses, scale and cash availability with
eMachines low cost structure, profitability, PC market strength, third-party retail network, and international presence. These factors contributed to a purchase price in excess of the fair value of eMachines net tangible and intangible
assets acquired and, as a result, Gateway recorded goodwill of $156 million. Gateway also recorded $50 million in intangible assets related to the eMachines trade name. These intangible assets are not amortized but are reviewed for impairment
annually during the fourth quarter or whenever events or circumstances indicate an event of impairment may have occurred or exist. Gateways fourth quarter review process utilizes multiple methods to estimate fair value based on a discounted
future cash flow approach that relies on estimates about Gateways future revenues (based on assumed market segment growth rates) and costs, discounted at appropriate rates based on Gateways weighted average cost of capital. Future
revenue and cost estimates are based on historical data, various internal estimates and a variety of external sources, and are developed as part of our routine long-range planning process. Gateways fourth quarter of 2006 assessment supported
the conclusion that no impairment of non-amortized intangible asset, including goodwill, existed as of December 31, 2006. A significant change in Gateways Retail business could result in a material impairment of these assets.



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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 we 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. 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. If the company fails 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 Gateway would not be able to record the benefit.



Results of Operations



The following table summarizes Gateways consolidated results of operations and net sales for the past three years (in thousands):



|                                             |  |      |           |    |                  |          |    |      |   |           |                  |  |       |      |  |   |           |   
|-------------------------------------------- |  | ---- | --------- | -- | ---------------- | -------- | -- | ---- | - | --------- | ---------------- |  | ----- | ---- |  | - | --------- | --
|                                             |  | 2006 |           |    | PercentageChange |          |    | 2005 |   |           | PercentageChange |  |       | 2004 | 
|Net sales                                    |  | $    | 3,980,803 |    |                  | 3.3      | %  |      | $ | 3,854,061 |                  |  | 5.6   | %    |  | $ | 3,649,734 |   
|Gross profit                                 |  | $    | 255,361   |    |                  | (20.8    | )% |      | $ | 322,438   |                  |  | 5.0   | %    |  | $ | 307,072   |   
|Percentage of net sales                      |  |      | 6.4       | %  |                  |          |    |      |   | 8.4       | %                |  |       |      |  |   | 8.4       | % 
|Selling, general and administrative expenses |  | $    | 308,738   |    |                  | (15.1    | )% |      | $ | 363,578   |                  |  | (60.0 | )%   |  | $ | 909,050   |   
|Percentage of net sales                      |  |      | 7.8       | %  |                  |          |    |      |   | 9.4       | %                |  |       |      |  |   | 24.9      | % 
|Microsoft benefit                            |  | $    | 34,500    |    |                  | (14.8    | )% |      | $ | 40,500    |                  |  | 100.0 | %    |  |   |          |   
|Percentage of net sales                      |  |      | 0.9       | %  |                  |         |    |      |   | 1.1       | %                |  |      |      |  |   |          |   
|Operating loss*                              |  | $    | (18,877   | )  |                  | (2,849.5 | )% |      | $ | (640      | )                |  | 99.9  | %    |  | $ | (601,978  | ) 
|Percentage of net sales                      |  |      | (0.5      | )% |                  |          |    |      |   | (0.0      | )%               |  |       |      |  |   | (16.5     | )%
|Net income (loss)                            |  | $    | 9,643     |    |                  | 56.5     | %  |      | $ | 6,161     |                  |  | 101.1 | %    |  | $ | (567,618  | ) 
|Units shipped                                |  |      | 5,013     |    |                  | 12.0     | %  |      |   | 4,476     |                  |  | 26.8  | %    |  |   | 3,530     |   

---

|* |  | Includes $0.5 million, $13 million, and $478 million in 2006, 2005, and 2004, respectively, of restructuring, transformation and integration charges. See the Restructuring
Activities section below for additional information.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



Net Sales



2006 vs. 2005



The $127 million increase in 2006 net sales as compared
to 2005 was primarily due to growth in our Retail segment ($381 million), which includes international, partially offset by sales declines in the Direct segment ($163 million) and Professional segment ($91 million).



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



2005 vs. 2004



The $204 million increase in 2005 net sales compared to
2004 was primarily due to growth in our Retail segment ($873 million), partially offset by net sales declines in the Direct segment ($541 million) primarily resulting from the closure of our Gateway retail stores in April 2004 (which contributed
$391 million to net sales in 2004), in addition to less promotion and advertising of low-end opening price points in Direct and our move



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away from Gateway-branded consumer electronic products, as well as declines in the Professional segment ($128 million) primarily due to weaker performance in
the business sector and a trend towards large consolidated discounted purchases in the public sector.



Major Product Groups



The following table summarizes our net sales by major product or service group for the past three years (in thousands):



|                              |  |      |           |      |      |   |      |   |           |  |      |      |  |      |           |  |      |  
|----------------------------- |  | ---- | --------- | ---- | ---- | - | ---- | - | --------- |  | ---- | ---- |  | ---- | --------- |  | ---- | -
|                              |  | 2006 |           | As % |      |   | 2005 |   | As %      |  |      | 2004 |  | As % |          
|Desktops                      |  | $    | 1,868,312 |      | 46.9 | % |      | $ | 1,894,172 |  | 49.2 | %    |  | $    | 1,982,141 |  | 54.3 | %
|Notebooks                     |  |      | 1,437,016 |      | 36.1 | % |      |   | 1,191,898 |  | 30.9 | %    |  |      | 790,159   |  | 21.7 | %
|Servers and other             |  |      | 32,129    |      | 0.8  | % |      |   | 57,392    |  | 1.5  | %    |  |      | 54,474    |  | 1.5  | %
|                              |  |      |           |      |      |   |      |   |           |  |      |      |  |      |           |  |      |  
|Total personal computers (PC) |  |      | 3,337,457 |      | 83.8 | % |      |   | 3,143,462 |  | 81.6 | %    |  |      | 2,826,774 |  | 77.5 | %
|Non-PC                        |  |      | 643,346   |      | 16.2 | % |      |   | 710,599   |  | 18.4 | %    |  |      | 822,960   |  | 22.5 | %
|                              |  |      |           |      |      |   |      |   |           |  |      |      |  |      |           |  |      |  
|Consolidated net revenues     |  | $    | 3,980,803 |      |      |   |      | $ | 3,854,061 |  |      |      |  | $    | 3,649,734 |  |      |  
|                              |  |      |           |      |      |   |      |   |           |  |      |      |  |      |           |  |      |  



Sales of personal
computer products represented approximately 84% of total net sales during 2006, as compared to 82% in 2005. As a percentage of total net sales, notebook computer sales increased 5 percentage points during 2006, 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. Notebook unit sales increased 48% worldwide compared with a 26% worldwide market unit increase based on the most recent International
Data Corporation data.



Sales of non-PC products represented
approximately 16% of total net sales during 2006, as compared to 18% in 2005. The decline is primarily due to 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, including stand-alone displays, peripherals, software, accessories, extended warranty services, training, Internet access, enterprise system, networking products, web portal, and security services. In
2004, we discontinued sales of Gateway branded consumer electronic products.



Net sales of PCs increased in 2004 due to the addition of eMachines PC unit sales subsequent to March 11, 2004 offset by declines in Gateway PC sales due to the closure of the retail stores in April 2004 and
lower average selling prices, as well as market share losses in the Professional and Direct segments.



Gross Profit



2006 vs. 2005



Gross profit was $255 million
in 2006 compared with $322 million in 2005. This decrease in gross profit is largely attributable to lower margins due to competitive pricing pressures in the Retail segment ($19 million), margin pressure in the Professional segment ($29 million),
and decreased Direct business ($19 million). As a percentage of net sales, gross profit for 2006 was 6.4%, compared with 8.4% in 2005. Non-PC sales accounted for 73% and 76% of gross profit during 2006 and 2005, respectively.



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



2005 vs. 2004



Gross profit was $322 million in 2005 compared with $307
million in 2004. This increase in gross profit is largely attributable to declines in restructuring, transformation and integration charges ($86 million) and



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improvements in Retail segment gross profit ($79 million) based on increased Retail unit volumes and sales revenues, and favorable resolution of a royalty
cost dispute ($6 million), partially offset by gross profit declines in the Direct segment ($100 million) due to the closure of our Gateway retail stores in April 2004 ($33 million) and the discontinuation of sale of Gateway-branded consumer
electronics, and gross profit declines in the Professional segment ($50 million) primarily due to price competition. Additionally in 2005, gross profit across all segments was favorably impacted by a change in cost estimate of a certain royalty
obligation ($4 million), offset by the February 2006 Hewlett-Packard agreement related to patent infringement and royalties ($17 million). As a percentage of net sales, gross profit for 2005 was 8.4% the same amount as 2004. Non-PC sales accounted
for approximately 76% and 67% of gross profit during 2005 and 2004, respectively.



Selling, General and Administrative Expenses



2006 vs. 2005



SG&A expenses were $309
million (including $0.5 million in restructuring expenses) in 2006 (7.8% of net sales) compared to $364 million (including $13 million in restructuring expenses) in 2005 (9.4% of net sales). In addition to the decrease in restructuring expenses ($13
million), the decrease in SG&A expense is attributable to an increase in 2005 in the sales tax reserve for a tax dispute related to prior years ($25 million), a 2006 adjustment to the sales tax reserve ($10 million) due to a favorable settlement
from prior year sales tax dispute, decreased headcount-related expenses ($9.7 million) due to reduced headcount, decreased depreciation expense ($8.9 million), and other SG&A cost savings ($3.9 million), partially offset by increases in
litigation settlements and professional fees ($7.8 million) and marketing expense due to increased brand awareness promotions ($7.7 million).



2005 vs. 2004



SG&A expenses were $364 million in 2005 (9.4% of net sales) compared to $909 million in 2004 (24.9% of net sales). The significant decrease in
SG&A expense is attributable to a decrease in restructuring, transformation and integration charges ($379 million), closure of our Gateway retail stores in April 2004 ($60 million), reduced direct marketing costs partially related to the shift
to third-party retail to reduce channel conflict ($47 million), rationalization of IT expenses ($32 million), and reductions in corporate overhead, headcount costs and other SG&A cost savings ($64 million), partially offset by a reserve increase
for a sales tax dispute related to prior years ($25 million) and increased legal spending ($12 million) during 2005.



Restructuring Activities



We have engaged in several restructuring efforts, including actions related to the closure of our Gateway retail stores, outsourcing of certain processes,
workforce reductions and plant closures. We have also incurred costs in connection with certain transformation efforts and our integration with eMachines in 2004. See also Note 13 to the consolidated financial statements. The following table
summarizes restructuring, transformation and other charges recorded by Gateway, by income statement classification, for the past three years (in thousands):



|                                    |  |      |     |      |   |        |      |  |   |        
|----------------------------------- |  | ---- | --- | ---- | - | ------ | ---- |  | - | -------
|                                    |  | 2006 |     | 2005 |   |        | 2004
|Restructuring:                      |  |      |     |      |   |        |      |  |   |        
|Cost of goods sold                  |  | $    |    |      | $ |       |      |  | $ | 74,735 
|Selling, general and administrative |  |      | 479 |      |   | 13,555 |      |  |   | 336,888
|                                    |  |      |     |      |   |        |      |  |   |        
|Total                               |  | $    | 479 |      | $ | 13,555 |      |  | $ | 411,623
|                                    |  |      |     |      |   |        |      |  |   |        
|Transformation and Integration:     |  |      |     |      |   |        |      |  |   |        
|Cost of goods sold                  |  | $    |    |      | $ | (86    | )    |  | $ | 11,251 
|Selling, general and administrative |  |      |    |      |   | (411   | )    |  |   | 54,816 
|                                    |  |      |     |      |   |        |      |  |   |        
|Total                               |  | $    |    |      | $ | (497   | )    |  | $ | 66,067 
|                                    |  |      |     |      |   |        |      |  |   |        



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During the first quarter of 2004, Gateway adopted a restructuring plan to, among other things, close its
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 are now substantially complete. For all restructuring plans, approximate future cash outflows of $13 million, primarily lease liabilities on closed facilities, are exceeded by expected future cash inflows of $15 million from related sublease
recoveries and asset dispositions.



Microsoft Agreement



In April 2005, Gateway entered into a Marketing,
Development and Settlement Agreement with Microsoft Corporation that provides for Microsoft to make aggregate payments to Gateway 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 agreement, Gateway is 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
new Gateway products that run Microsoft products. In 2006 we received and recognized $34.5 million, compared to $40.5 million in 2005. Per the agreement, we expect to receive in cash $8.6 million quarterly through the end of 2008.



Hewlett-Packard Agreement



Following the signing of a binding term sheet in February 2006, Gateway and
Hewlett-Packard executed a definitive agreement during the second quarter of 2006, licensing certain portions of their respective patent portfolios to each other. Under the license agreement, Gateway agreed to pay a total of $47 million, of which
Gateway attributed $16.7 million to resolving, without admission of fault, allegations of past patent infringement, recognizing such cost as a component of cost of goods sold in 2005. The remaining $30.3 million is attributable to the value of the
future seven year cross-licensing agreement.



Operating Income (Loss)



2006 vs. 2005



Operating loss for 2006 totaled $19 million compared with a loss of $1
million in 2005. This reflects a decline in gross profit dollars ($67 million) and benefits related to the April 2005 agreement with Microsoft as discussed in the Microsoft Agreement section above ($6 million), partially offset by an
overall focus on SG&A cost savings ($55 million).



2005
vs. 2004



Operating loss for 2005 totaled $1 million
compared with a loss of $602 million in 2004. This reflects restructuring, transformation and other special charges discussed in the Restructuring Activities section above of $13 million and $478 million in 2005 and 2004,
respectively. In addition to the significant decline in restructuring, transformation and other special charges, the improvement in 2005 operating income reflects $40.5 million of benefits related to the April 2005 agreement with Microsoft
discussed in the Microsoft Agreement section above, as well as the continued positive impact of 2004 initiatives including focus on overall SG&A cost savings, offset by a reserve increase for a prior years sales tax dispute ($25
million) and the entering into an agreement with Hewlett-Packard in February 2006, related to patent infringement and royalties ($17 million).



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##### Table of Contents

Other Income, Net



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



|                                      |  |      |        |   |      |   |        |      |  |   |        |  
|------------------------------------- |  | ---- | ------ | - | ---- | - | ------ | ---- |  | - | ------ | -
|                                      |  | 2006 |        |   | 2005 |   |        | 2004 | 
|Interest income                       |  | $    | 11,871 |   |      | $ | 10,560 |      |  | $ | 14,257 |  
|Gain (loss) on sales of investments   |  |      | (195   | ) |      |   | 1,392  |      |  |   | (44    | )
|Gain on extinguishment of liabilities |  |      |       |   |      |   | 1,229  |      |  |   | 6,886  |  
|Interest expense                      |  |      | (5,720 | ) |      |   | (6,116 | )    |  |   | (823   | )
|Amortization of debt issuance costs   |  |      | (1,591 | ) |      |   | (1,622 | )    |  |   |       |  
|Other, net                            |  |      | (227   | ) |      |   | 1,348  |      |  |   | (29    | )
|                                      |  |      |        |   |      |   |        |      |  |   |        |  
|Total                                 |  | $    | 4,138  |   |      | $ | 6,791  |      |  | $ | 20,247 |  
|                                      |  |      |        |   |      |   |        |      |  |   |        |  



Other income, net
includes primarily interest income and expense, and gains and losses of investments, amortization of debt issuance costs and gain from the extinguishment of liabilities. Other income decreased $3 million in 2006 primarily due to a $1 million gain on
the sale of certain extended service liabilities in the first quarter of 2005 and a $2 million gain on the sale of a single investment during the second quarter of 2005, partially offset by higher interest income resulting from higher interest
rates.



Other income decreased $13 million in 2005 primarily
due to an increase in interest expense, including the amortization of debt issuance costs, as a result of the issuance of $300 million in senior convertible notes in December 2004 and utilization of the revolving credit facility in 2005, a decrease
in interest income and a decrease on gain on extinguishment of liabilities.



Income Taxes



In 2006, we recorded a
tax benefit of $24 million primarily representing a change in tax accrual of $25 million, together with foreign tax refunds recognized of $2.1 million, offset by foreign and state tax accruals from operations of $2.8 million. The change in tax
accrual consists primarily of the reversal of previously accrued tax liabilities resulting from various tax authority settlements of $27 million and recognition of domestic tax refunds of $6.0 million. The benefit was offset by $6.2 million of
interest accruals relating to previously accrued liabilities, and $1.5 million of current year accruals established for anticipated tax liabilities. The domestic tax refunds and accrued tax liability reversals represent various settlements between
Gateway and the Appeals Office of the Internal Revenue Service with respect to multiple domestic and international issues under audit. These agreements are still subject to review of the Joint Committee on Taxation. We believe the review of the
Joint Committee will not adversely impact the recognition of the benefit recorded for these agreements.



In 2005, we recorded a net tax benefit primarily representing the reversal of previously accrued tax liabilities resulting from certain tax authority
settlements partially offset by $1.8 million increase in reserve for a state income and franchise tax dispute. The reversal of the previously accrued tax liabilities represents an agreement between Gateway and the Appeals Office of the Internal
Revenue Service with respect to one of the issues under audit. In the fourth quarter of 2005, the benefit recorded from this agreement is $8.3 million. The agreement is still subject to review of the Joint Committee on Taxation. Gateway believes the
review of the Joint Committee will not adversely impact the recognition of the benefit recorded for this agreement.



Segment Performance



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



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



| |  |  | Internationalincludes international sales and is currently 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;
| | - |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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| |  |  | 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. We evaluate segment performance based on sales, gross profit and segment contribution, but do 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 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 discussed in Restructuring Activities above.



The following table presents key segment performance
indicators for the past three years (in thousands):



|                                       |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  
|-------------------------------------- |  | ---- | --------- | - | ------------------- | -------- | -- | ---- | - | --------- | ------------------- |  | ----- | ---- |  | - | --------- | -
|                                       |  | 2006 |           |   | Increase (Decrease) |          |    | 2005 |   |           | Increase (Decrease) |  |       | 2004 | 
|Net sales:                             |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  
|Retail (including International)       |  | $    | 2,739,884 |   |                     | 16.2     | %  |      | $ | 2,358,669 |                     |  | 58.8  | %    |  | $ | 1,485,715 |  
|Professional                           |  |      | 895,774   |   |                     | (9.2     | )% |      |   | 986,943   |                     |  | (11.4 | )%   |  |   | 1,114,493 |  
|Direct                                 |  |      | 345,145   |   |                     | (32.1    | )% |      |   | 508,449   |                     |  | (51.6 | )%   |  |   | 1,049,526 |  
|                                       |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  
|                                       |  | $    | 3,980,803 |   |                     | 3.3      | %  |      | $ | 3,854,061 |                     |  | 5.6   | %    |  | $ | 3,649,734 |  
|                                       |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  
|Segment gross profit:                  |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  
|Retail (including International)       |  | $    | 118,050   |   |                     | (13.9    | )% |      | $ | 137,076   |                     |  | 137.5 | %    |  | $ | 57,712    |  
|Professional                           |  |      | 62,189    |   |                     | (32.0    | )% |      |   | 91,399    |                     |  | (35.3 | )%   |  |   | 141,301   |  
|Direct                                 |  |      | 75,122    |   |                     | (20.1    | )% |      |   | 93,962    |                     |  | (51.6 | )%   |  |   | 194,049   |  
|                                       |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  
|                                       |  | $    | 255,361   |   |                     | (20.8    | )% |      | $ | 322,437   |                     |  | (18.0 | )%   |  | $ | 393,062   |  
|                                       |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  
|Segment contribution:                  |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  
|Retail (including International)       |  | $    | 96,350    |   |                     | (20.1    | )% |      | $ | 120,536   |                     |  | 179.3 | %    |  | $ | 43,161    |  
|Professional                           |  |      | (6,509    | ) |                     | (138.4   | )% |      |   | 16,937    |                     |  | (71.0 | )%   |  |   | 58,356    |  
|Direct                                 |  |      | 35,379    |   |                     | (15.0    | )% |      |   | 41,601    |                     |  | 65.9  | %    |  |   | 25,070    |  
|                                       |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  
|                                       |  | $    | 125,220   |   |                     | (30.1    | )% |      | $ | 179,074   |                     |  | 41.5  | %    |  | $ | 126,587   |  
|Non-segment expenses and other charges |  |      | (178,607  | ) |                     | (18.9    | )% |      |   | (220,214  | )                   |  | (69.8 | )%   |  |   | (728,565  | )
|                                       |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  
|Microsoft benefit                      |  |      | 34,500    |   |                     | (14.8    | )% |      |   | 40,500    |                     |  | 100   | %    |  |   |          |  
|Consolidated operating loss            |  | $    | (18,887   | ) |                     | (2,851.1 | )% |      | $ | (640      | )                   |  | (99.9 | )%   |  | $ | (601,978  | )
|                                       |  |      |           |   |                     |          |    |      |   |           |                     |  |       |      |  |   |           |  



Retail (including
International)



The Retail segment delivered net sales of
$2.7 billion on shipments of 4,171,000 PC units in 2006 as compared with $2.4 billion on shipments of 3,474,000 PC units in 2005. The increases reflect strong segment performance in the first half of the year due to the continued success of
Gateway-branded products in the retail channel as well as growth in our International business. The fourth quarter was negatively impacted by component shortages and softer than normal fourth quarter retail demand in the U.S. and Japan due to
Microsofts launch of its new Vista operating System in January 2007. Channel inventories closed the quarter at unusually low levels as retailers managed down their inventories of Microsoft XP products in anticipation of the January launch of
Microsoft Vista.



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Retail segment gross profit was $118 million (4.3% of sales) in 2006 as compared with $137 million (5.8%
of sales) in 2005. The decline reflects competitive pricing pressures in the second half of the year ($18 million), higher than expected costs due in part to component price increases ($17 million), and additional expedited freight and other costs
($2 million), partially offset by gross profit from increased revenue ($16 million) and other savings ($2 million).



Retail segment contribution was $96 million (3.5% of sales) in 2006 as compared with $121 million (5.1 % of sales) in 2005. The decline reflects the same
factors present in the gross profit discussion above, as well as increased selling, general and administrative expenses ($5.2 million).



Professional



The Professional segment generated net sales of $896 million on shipments of 673,000 PC units in 2006 compared with $987 million on shipments of 749,000
PC units in 2005. The $91 million decrease in net sales is the result of greater selectivity in contract bidding ($44 million), declining extended warranty deferred revenue amortization ($10 million), and competitive pricing ($37 million).



Professional segment gross profit was $62 million (6.9% of net
sales) in 2006 compared with $91 million (9.3% of net sales) in 2005. The $29 million decrease in segment gross profit was attributable to reduced sales volume ($9 million), declining extended warranty deferred revenue amortization ($10
million) as stated above, and increases in warranty and royalty expenses ($10 million).



Professional segment contribution was a loss of $7 million (0.7% of net sales) in 2006 compared with a $17 million profit (1.7% of net sales) in 2005. The decline in segment contribution of $24 million is
attributable to the $29 million decrease in gross profit noted above, partially offset by cost savings from headcount reductions ($5 million).



Direct



The Direct segment generated net sales of $345 million on shipments of 169,000 PC units in 2006 compared with $508 million on shipments of 253,000 PC
units in 2005. The decrease in revenue and unit sales is due to a sharp volume decline in telephone based orders ($134 million), declining extended warranty deferred revenue recognition ($18 million), and declining Internet access subscription
revenue ($17 million), partially offset by increased average unit prices ($6 million). The net sales and unit declines were primarily due to marketing that did not drive demand to anticipated levels and our decision at the end of the second quarter
of 2006 to shift away from emphasizing products with low opening price points in favor of offering more fully featured solutions The decline in extended warranty deferred revenue recognition is due to some extended warranty revenue streams reaching
full amortization during the year. Similarly, the decline in Internet access subscription revenue is the result of a shrinking subscriber base.



Direct segment gross profit was $75 million (21.9% of net sales) in 2006 compared with $94 million (18.5% of net sales) in 2005. The decrease in gross
profit of $19 million is primarily attributable to reduced sales volume.



Direct segment contribution was $35 million (10.3% of net sales) in 2006 compared to $42 million (8.2% of net sales) in 2005. The decrease in contribution of $7 million is attributable to the $19 million decrease in
gross profit noted above partially offset by cost savings in variable sales expenses ($8 million), headcount reductions ($2 million), and other expenses ($2 million).



Non-Segment Expenses



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.



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##### Table of Contents

Non-segment expenses and other charges totaled $179 million in 2006 (including $0.5 million) in
restructuring expenses) as compared with $220 million in 2005 (including $13 million in restructuring expenses). The $41 million decrease consists primarily of changes in the sales tax reserve for a tax dispute related to prior years ($25 million),
a 2006 adjustment to the sales tax reserve ($10 million) due to a favorable settlement from prior year sales tax dispute, reductions in restructuring expenses ($13 million), decreased depreciation expense ($8.2 million), decreased headcount-related
expenses ($1.6 million) due to reduced headcount, and other cost savings ($1.1 million), partially offset by increases in litigation settlements and professional fees ($7.8 million), marketing expense ($6.9 million), and relocation and recruiting
costs ($2.4 million).



Liquidity and Capital Resources



As of December 31, 2006, Gateway had
approximately $416 million in cash and marketable securities as compared with $586 million at the end of 2005.



The following table presents selected financial statistics and information related to cash as of December 31 for the periods indicated (dollars in
thousands):



|                                                          |  |                                             |         |   |      |   |         |      |  |   |         |  
|--------------------------------------------------------- |  | ------------------------------------------- | ------- | - | ---- | - | ------- | ---- |  | - | ------- | -
|                                                          |  | For each of the quarters ending December 31 |        
|                                                          |  | 2006                                        |         |   | 2005 |   |         | 2004 | 
|Cash and marketable securities                            |  | $                                           | 416,335 |   |      | $ | 585,688 |      |  | $ | 588,330 |  
|Days of sales in accounts receivable (a)                  |  |                                             | 25      |   |      |   | 28      |      |  |   | 30      |  
|Days inventory on hand (b)                                |  |                                             | 9       |   |      |   | 19      |      |  |   | 19      |  
|Days in accounts payable (c)                              |  |                                             | (58     | ) |      |   | (67     | )    |  |   | (51     | )
|                                                          |  |                                             |         |   |      |   |         |      |  |   |         |  
|Cash conversion cycle before days in supplier receivables |  |                                             | (24     | ) |      |   | (20     | )    |  |   | (2      | )
|Days in supplier receivables (d)                          |  |                                             | 23      |   |      |   | 19      |      |  |   | 8       |  
|                                                          |  |                                             |         |   |      |   |         |      |  |   |         |  
|Cash conversion cycle (e)                                 |  |                                             | (1      | ) |      |   | (1      | )    |  |   | 6       |  
|                                                          |  |                                             |         |   |      |   |         |      |  |   |         |  

---

|(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 of inventory 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) |  | 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 from the sale of the components to the original design manufacturer is recorded in Receivables from suppliers. Supplier receivables amounted to $247 million, $214
million, and $79 million at December 31, 2006, 2005, and 2004, 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 goods sold divided by the number of days in the quarter. The increase in days in receivables from suppliers in 2006 is due to the inclusion of three additional original design manufacturers in Gateways buy-sell
program.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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



We used $69 million in cash in support of operating activities in 2006. Significant factors affecting cash used in operations included net income adjusted for non-cash items of $48 million, and a net decrease in
accounts



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receivable and inventory of $190 million offset by an increase in other assets of $72 million, and a net decrease in accounts payable, accrued liabilities,
accrued royalties and other liabilities of $236 million. The decrease in accounts receivable was due to lower sales activity in the fourth quarter of 2006 as compared to the fourth quarter of 2005 and an increased focus by management to reduce aged
accounts receivables. The decrease in inventory was driven primarily by managements focus on reducing remanufactured units held for sale and in-transit finished goods, while Other Assets increased primarily due to increased
Receivable from suppliers. Accounts payable decreased in connection with managements desire to improve relations with its key vendors by shortening its days in accounts payable. Accrued Liabilities and Royalties decreased due to reduced sales
activity in fourth quarter 2006 as compared to the fourth quarter 2005. Other Liabilities decreased due to a reduction of deferred revenue. We used approximately $55 million in cash for capital expenditures primarily for the development of our new
ERP system and $128 million to purchase marketable securities, offset by proceeds from sales of marketable securities of $222 million. From a financing perspective, we paid $50 million on our line of credit.



We used $25 million in cash in support of operating activities in 2005.
Significant factors affecting cash used in operations included a net increase in accounts receivable, inventory and other assets of $238 million, offset by a net income adjusted for non-cash items of $83 million, and a net increase in accounts
payable, accrued expenses and other liabilities of $130 million. The increase in accounts receivable was driven by an increased mix of Retail sales. The increase in inventory was driven primarily by the increased level of finished products for
Retail as well as an increase in component inventories, while accounts payable increased in connection with new supply and manufacturing agreements. The increase in days in accounts payable of 16 days from 2004 to 2005 was due to changed supplier
terms and conditions. Other assets increased due to the increased sale of components to original design manufacturers to incorporate into products being manufactured for us. We used approximately $40 million in cash for capital expenditures and $45
million to purchase marketable securities, offset by proceeds from sales of marketable securities of $190 million.



We used $434 million in cash in support of operations during 2004, including $271 million of net loss adjusted for non-cash items. Other significant
factors affecting cash used in operations include a net increase in accounts receivable of $59 million (after giving effect for the $120 million in accounts receivable assumed through acquisition of eMachines) due to the shift in our business model
from our former retail stores to third party retail and decreases in current and other liabilities of $209 million (including settlement of most of the $277 million in current liabilities assumed in connection with the eMachines acquisition),
partially offset by declines in inventory and other assets of $104 million (after giving effect for the $153 million in inventory and other assets assumed through acquisition of eMachines). From an investing perspective, we generated proceeds of
approximately $485 million through the liquidation of marketable securities and the sale of an idled facility and used $41 million in acquisition of eMachines, $22 million to settle a shareholder note payable and approximately $35 million in
acquisition of capital assets. From a financing perspective, we generated a net $291 million through a $300 million convertible debt offering, $50 million through borrowings against our credit facility, and $12 million through employee stock option
exercises while using $280 million to purchase treasury stock and redeem the Series A and C Preferred Stock held by AOL and $9 million to pay preferred stock dividends.



Our cash position varies during any particular period, but historically increases at quarter-end due to additional focus by
management on accounts receivable, inventory, accounts payable and credit facility balances. Although our quarter-end cash balance is one analytical measure used by our suppliers in evaluating credit terms, we believe our payment performance is a
more important factor to our suppliers. Accordingly, over the past few quarters we have reduced our days in accounts payable as part of an overall strategy to improve our supplier relations. We also lowered our credit facility borrowings by $50
million during 2006.



Looking to 2007 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.



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##### Table of Contents

We believe that our sources of capital will be sufficient to fund anticipated working capital
requirements, restructuring actions, capital expenditures and cash required for other activities for at least the next twelve months. However, cash flows from future operations and investing activities and the precise amount and timing of our future
financing needs are uncertain. Future cash flow will depend on a number of factors, including our ability to achieve the goals set forth in the preceding paragraph, and those factors set forth in Item 1ARisk Factors. Should we be unable
to meet our cash needs from our current sources of capital, we would most likely incur additional restructuring charges to adjust our expenditures to a level that our cash flows could support and/or seek 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.



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 December 31, 2006 and December 31, 2005, we had $0 and $50 million, respectively in borrowings outstanding under this agreement. The interest rate as of December 31, 2006 was 7.25%. This interest rate adjusts with
changes in the prime rate. We also utilized the credit agreement to support $36 million of stand-by letters of credit and had borrowing availability of $35 million. In addition to usual and customary covenants for an arrangement of its type, the
credit agreement includes certain financial covenants. Gateway renegotiated the credit agreement as of December 26, 2006 to replace the financial covenant that we maintain a certified cash balance of $150 million with covenants that we maintain
a liquidity position of $100 million and negative cash flow not to exceed $40 million and $57 million for the fourth quarter of 2006 and the first quarter of 2007, respectively, and $60 million for each quarter thereafter, with cumulative negative
cash flow not to exceed $120 million. Further, once we have achieved 3 consecutive quarters of positive excess cash flow, the amended credit agreement requires that we maintain positive cash flow in each quarter thereafter. The agreement 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 3 to the Consolidated Financial Statements.



Restructuring Obligations



During the first quarter of 2004, Gateway adopted a restructuring plan to, among other things, close its 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 are now substantially complete.
For all restructuring plans, approximate future cash outflows of $13 million, primarily lease liabilities on closed facilities, are exceeded by expected future cash inflows of $15 million from related sublease recoveries and asset dispositions.
These amounts are included in the Operating lease category in the Contractual Obligations table below. See also Note 13 to the Consolidated Financial Statements.



We believe that our current sources of working capital provide adequate flexibility for our financial needs for at least the
next twelve months. However, any projections of future financial needs and sources of working capital are subject to uncertainty. See Forward Looking Statements and Item 1A Risk Factors for events that could affect our
estimates of future financial needs and sources of working capital.



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##### Table of Contents

Contractual Obligations



The cash impact of our contractual obligations associated with operating leases, royalty and licensing agreements, purchase
obligations and announced restructurings is as follows:



|                                               |  |                                       |         |                  |   |           |  |           |         |                   |   |         |  |   |        |  
|---------------------------------------------- |  | ------------------------------------- | ------- | ---------------- | - | --------- |  | --------- | ------- | ----------------- | - | ------- |  | - | ------ | -
|                                               |  | Payments due by Period (in thousands) |        
|                                               |  | Total                                 |         | Less than 1 Year |   | 2-3 Years |  | 4-5 Years |         | More than 5 Years |  
|Operating leases (1)                           |  | $                                     | 14,904  |                  | $ | 7,659     |  | $         | 12,645  |                   | $ | 1,739   |  | $ | (7,139 | )
|Royalty/Licensing agreements (2)               |  |                                       | 34,710  |                  |   | 25,525    |  |           | 5,652   |                   |   | 3,533   |  |   |       |  
|Debt, including estimated interest obligations |  |                                       | 321,750 |                  |   | 5,250     |  |           | 160,500 |                   |   | 156,000 |  |   |       |  
|Estimated purchase obligations (3)             |  |                                       | 107,270 |                  |   | 107,270   |  |           |        |                   |   |        |  |   |       |  
|                                               |  |                                       |         |                  |   |           |  |           |         |                   |   |         |  |   |        |  
|Total                                          |  | $                                     | 478,634 |                  | $ | 145,704   |  | $         | 178,797 |                   | $ | 161,272 |  | $ | (7,139 | )
|                                               |  |                                       |         |                  |   |           |  |           |         |                   |   |         |  |   |        |  

---

|(1) |  | Represents lease obligations, net of anticipated sublease cash receipts, including amounts that have been accrued in connection with certain restructuring actions. See Notes 5 and
13 to the Consolidated Financial Statements for additional information.
|--- |  | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Includes $22 million payment due to Hewlett-Packard pursuant to the cross-licensing agreement.
|--- |  | ----------------------------------------------------------------------------------------------

|(3) |  | Purchase obligations include agreements to purchase goods or services (such as minimum levels of outsourced support services) that are enforceable, legally binding and specify all
significant terms, including: the quantity to be purchased, the price to be paid and the timing of the purchase. These figures exclude agreements or amounts that are cancelable without penalty. The materials purchase obligation portion of this
amount represents approximately six weeks of supply in our manufacturing channel.
|--- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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 (SPEs) or variable interest entities
(VIEs), 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, sales and/or license of our products, (ii) indemnities to vendors and service providers pertaining to
claims based on the negligence or willful misconduct of Gateway 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 Gateway could be obligated to make.
We have not recorded any liability for these indemnities, commitments and other guarantees in the accompanying consolidated balance sheets.



New Accounting Pronouncements



See Note 1 to the Consolidated Financial Statements in Item 8 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.



Subsequent Event



On February 13, 2007, Gateway received notification from Revenue Ireland, the Irish taxing authority, that it had waived all further consideration
related to possible capital gains treatment resulting from the dissolution and liquidation of certain Gateway entities in Europe. These entities ceased operations in 2001 and have been in the process of liquidation since then. Based on this
notification, Gateway reduced its income taxes payable and increased the related income tax benefit as of and for the year ended December 31, 2006 by $2.7 million.



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##### Table of Contents

Item 7A.Quantitative and Qualitative Disclosures About Market Risk



We are generally not subject to material market risk with respect to our investments classified as marketable securities as such investments are readily
marketable, liquid and do not fluctuate substantially from stated value. Regarding long-term investments, Gateway holds and may continue to consider investments in minority interests in companies having operations or technology in areas within
Gateways strategic focus. Adverse changes in market conditions such as occurred in the years starting in 2000, and poor operating results of certain of these underlying investments, have resulted and may in the future result in Gateway
incurring losses or an inability to recover the original carrying value of our investments. As of December 31, 2006, we held long term investments of approximately $3 million.



In October 2004, Gateway entered into a credit agreement with a major financial institution to provide for a revolving
credit facility of up to an aggregate of $200 million. Borrowings under this agreement bear interest at variable-term LIBOR or prime rates, at Gateways election. As of December 31, 2006 and December 31, 2005, Gateway had $0 and $50
million, respectively in borrowings outstanding under this agreement. The interest rate as of December 31, 2006 was 7.25%. This interest rate adjusts with changes in the prime rate. We also utilized the credit agreement to support $36 million
of stand-by letters of credit and had borrowing availability of $35 million.



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##### Table of Contents

Item 8.Consolidated Financial Statements and Supplementary Data



INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE



Financial Statements:



|                                                                                                                 |  |   
|---------------------------------------------------------------------------------------------------------------- |  | --
|Report of Independent Registered Public Accounting Firm                                                          |  | 40
|Consolidated Statements of Operations for the Years Ended December 31, 2006, 2005, and 2004                      |  | 41
|Consolidated Balance Sheets at December 31, 2006 and 2005                                                        |  | 42
|Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005, and 2004                      |  | 43
|Consolidated Statements of Changes in Stockholders Equity for the Years Ended December 31, 2006, 2005, and 2004 |  | 44
|Notes to Consolidated Financial Statements                                                                       |  | 45



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##### Table of Contents

Report of Independent Registered Public Accounting Firm



To the Board of Directors and Stockholders of Gateway, Inc.



We have audited the accompanying consolidated balance sheets of Gateway, Inc. and subsidiaries (the Company) as of December 31, 2006 and 2005, and the related consolidated statements of operations, cash flows, and
stockholders equity for each of the three years ended December 31, 2006. Our audit also included the accompanying financial statement schedule for the years ended December 31, 2006, 2005, and 2004. These financial statements and the
financial statement schedule are the responsibility of the Companys management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits.



We conducted our audits in accordance with standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test
basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our opinion.



In our opinion, such consolidated financial statements present fairly, in all material respects, the financial position of Gateway, Inc. and subsidiaries as of December 31, 2006 and 2005, and the results of their
operations and their cash flows for each of the three years ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, such financial statement schedule, when
considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.



As discussed in Note 8 to the consolidated financial statements, the Company changed its method of accounting for
share-based payments to conform to Statement of Financial Accounting Standards No. 123(R), Share-based Payment, as of January 1, 2006.



We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the
Companys internal control over financial reporting as of December 31, 2006, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway
Commission and our report dated February 23, 2007 expressed an unqualified opinion on managements assessment of the effectiveness of the Companys internal control over financial reporting and an adverse opinion on the effectiveness
of the Companys internal control over financial reporting.



/s/    DELOITTE & TOUCHE LLP

---



Costa Mesa, California

February 23, 2007



40



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##### Table of Contents

GATEWAY, INC.



CONSOLIDATED
STATEMENTS OF OPERATIONS

For the years ended December 31, 2006, 2005 and 2004

(in thousands, except per share amounts)



|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|----------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                                      |  | 2006 |           |   | 2005 |   |           | 2004 | 
|Net sales                                             |  | $    | 3,980,803 |   |      | $ | 3,854,061 |      |  | $ | 3,649,734 |  
|Cost of goods sold                                    |  |      | 3,725,442 |   |      |   | 3,531,623 |      |  |   | 3,342,662 |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Gross profit                                          |  |      | 255,361   |   |      |   | 322,438   |      |  |   | 307,072   |  
|Selling, general and administrative expenses          |  |      | 308,738   |   |      |   | 363,578   |      |  |   | 909,050   |  
|Microsoft benefit                                     |  |      | 34,500    |   |      |   | 40,500    |      |  |   |          |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Operating loss                                        |  |      | (18,877   | ) |      |   | (640      | )    |  |   | (601,978  | )
|Other income, net                                     |  |      | 4,138     |   |      |   | 6,791     |      |  |   | 20,247    |  
|Minority interest                                     |  |      | (18       | ) |      |   |          |      |  |   |          |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Income (loss) before income taxes                     |  |      | (14,757   | ) |      |   | 6,151     |      |  |   | (581,731  | )
|Income tax benefit                                    |  |      | 24,400    |   |      |   | 10        |      |  |   | 14,113    |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Net income (loss)                                     |  |      | 9,643     |   |      |   | 6,161     |      |  |   | (567,618  | )
|Preferred stock dividends and accretion               |  |      |          |   |      |   |          |      |  |   | (7,991    | )
|Gain on redemption of preferred stock                 |  |      |          |   |      |   |          |      |  |   | 100,133   |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Net income (loss) attributable to common stockholders |  | $    | 9,643     |   |      | $ | 6,161     |      |  | $ | (475,476  | )
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Net income (loss) per common share:                   |  |      |           |   |      |   |           |      |  |   |           |  
|Basic                                                 |  | $    | 0.03      |   |      | $ | 0.02      |      |  | $ | (1.31     | )
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Diluted (Note 1)                                      |  | $    | 0.03      |   |      | $ | 0.02      |      |  | $ | (1.45     | )
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Weighted average shares outstanding:                  |  |      |           |   |      |   |           |      |  |   |           |  
|Basic                                                 |  |      | 373,001   |   |      |   | 371,661   |      |  |   | 363,708   |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  
|Diluted (Note 1)                                      |  |      | 374,023   |   |      |   | 372,167   |      |  |   | 391,115   |  
|                                                      |  |      |           |   |      |   |           |      |  |   |           |  



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



41



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##### Table of Contents

GATEWAY, INC.



CONSOLIDATED
BALANCE SHEETS

December 31, 2006 and 2005

(in thousands, except per share amounts)



|                                                                                                                                  |  |      |           |   |      |   |           |  
|--------------------------------------------------------------------------------------------------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | -
|                                                                                                                                  |  | 2006 |           |   | 2005 |  
|ASSETS                                                                                                                            |  |      |           |   |      |   |           |  
|Current assets:                                                                                                                   |  |      |           |   |      |   |           |  
|Cash and cash equivalents                                                                                                         |  | $    | 345,677   |   |      | $ | 422,488   |  
|Marketable securities                                                                                                             |  |      | 70,658    |   |      |   | 163,200   |  
|Accounts receivable, net of allowance for uncollectible accounts of $2,218 and $6,092 at December 31, 2006 and 2005,
respectively |  |      | 274,782   |   |      |   | 345,288   |  
|Inventory:                                                                                                                        |  |      |           |   |      |   |           |  
|Components and subassemblies                                                                                                      |  |      | 18,181    |   |      |   | 71,163    |  
|Finished goods                                                                                                                    |  |      | 79,006    |   |      |   | 148,181   |  
|                                                                                                                                  |  |      |           |   |      |   |           |  
|Total inventory                                                                                                                   |  |      | 97,187    |   |      |   | 219,344   |  
|Receivables from suppliers                                                                                                        |  |      | 247,207   |   |      |   | 213,901   |  
|Other                                                                                                                             |  |      | 215,582   |   |      |   | 209,851   |  
|                                                                                                                                  |  |      |           |   |      |   |           |  
|Total current assets                                                                                                              |  |      | 1,251,093 |   |      |   | 1,574,072 |  
|Property, plant and equipment, at cost                                                                                            |  |      | 341,576   |   |      |   | 484,535   |  
|Less: Accumulated depreciation and amortization                                                                                   |  |      | (230,645  | ) |      |   | (401,379  | )
|                                                                                                                                  |  |      |           |   |      |   |           |  
|Property, plant and equipment, net                                                                                                |  |      | 110,931   |   |      |   | 83,156    |  
|Intangible assets, at cost                                                                                                        |  |      | 129,277   |   |      |   | 99,000    |  
|Less: Accumulated amortization                                                                                                    |  |      | (67,377   | ) |      |   | (59,538   | )
|                                                                                                                                  |  |      |           |   |      |   |           |  
|Intangible assets, net                                                                                                            |  |      | 61,900    |   |      |   | 39,462    |  
|Goodwill and non-amortizable intangible assets                                                                                    |  |      | 205,219   |   |      |   | 205,219   |  
|Restricted cash                                                                                                                   |  |      | 3,266     |   |      |   | 3,754     |  
|Long-term investments                                                                                                             |  |      | 3,159     |   |      |   | 3,159     |  
|Deferred debt issue costs                                                                                                         |  |      | 6,010     |   |      |   | 7,600     |  
|Other assets, net                                                                                                                 |  |      | 14,657    |   |      |   | 4,643     |  
|                                                                                                                                  |  |      |           |   |      |   |           |  
|                                                                                                                                  |  | $    | 1,656,235 |   |      | $ | 1,921,065 |  
|                                                                                                                                  |  |      |           |   |      |   |           |  
|LIABILITIES AND STOCKHOLDERS EQUITY                                                                                              |  |      |           |   |      |   |           |  
|Current liabilities:                                                                                                              |  |      |           |   |      |   |           |  
|Revolving credit facility                                                                                                         |  | $    |          |   |      | $ | 50,000    |  
|Accounts payable                                                                                                                  |  |      | 612,639   |   |      |   | 761,895   |  
|Accrued expenses                                                                                                                  |  |      | 159,199   |   |      |   | 178,066   |  
|Warranty                                                                                                                          |  |      | 46,616    |   |      |   | 34,615    |  
|Restructuring                                                                                                                     |  |      | 13,046    |   |      |   | 25,897    |  
|Other accrued liabilities                                                                                                         |  |      | 11,254    |   |      |   | 10,533    |  
|Accrued royalties                                                                                                                 |  |      | 54,521    |   |      |   | 68,216    |  
|Deferred revenue                                                                                                                  |  |      | 27,701    |   |      |   | 57,834    |  
|Income taxes payable                                                                                                              |  |      | 91,213    |   |      |   | 113,918   |  
|Other current liabilities                                                                                                         |  |      | 2,745     |   |      |   | 3,993     |  
|                                                                                                                                  |  |      |           |   |      |   |           |  
|Total current liabilities                                                                                                         |  |      | 1,018,934 |   |      |   | 1,304,967 |  
|Senior convertible notes                                                                                                          |  |      | 300,000   |   |      |   | 300,000   |  
|Deferred revenue                                                                                                                  |  |      | 14,895    |   |      |   | 33,226    |  
|Warranty                                                                                                                          |  |      | 18,223    |   |      |   | 2,425     |  
|Deferred tax liabilities                                                                                                          |  |      | 19,840    |   |      |   | 19,840    |  
|Other long-term liabilities                                                                                                       |  |      | 12,917    |   |      |   | 5,334     |  
|                                                                                                                                  |  |      |           |   |      |   |           |  
|Total liabilities                                                                                                                 |  |      | 1,384,809 |   |      |   | 1,665,792 |  
|                                                                                                                                  |  |      |           |   |      |   |           |  
|Minority interest                                                                                                                 |  |      | 2,418     |   |      |   |          |  
|                                                                                                                                  |  |      |           |   |      |   |           |  
|Commitments and contingencies (Note 5)                                                                                            |  |      |           |   |      |   |           |  
|Stockholders equity:                                                                                                             |  |      |           |   |      |   |           |  
|Common stock, $.01 par value, 1,000,000 shares authorized; 376,989 and 377,239 shares issued in 2006 and 2005, respectively       |  |      | 3,770     |   |      |   | 3,773     |  
|Additional paid-in capital                                                                                                        |  |      | 973,895   |   |      |   | 971,761   |  
|Common stock in treasury, at cost, 5,347 and 4,061 shares for 2006 and 2005, respectively                                         |  |      | (26,448   | ) |      |   | (23,253   | )
|Deferred stock-based compensation                                                                                                 |  |      | (2,746    | ) |      |   | (6,352    | )
|Accumulated deficit                                                                                                               |  |      | (678,243  | ) |      |   | (687,886  | )
|Accumulated other comprehensive loss                                                                                              |  |      | (1,220    | ) |      |   | (2,770    | )
|                                                                                                                                  |  |      |           |   |      |   |           |  
|Net stockholders equity                                                                                                          |  |      | 269,008   |   |      |   | 255,273   |  
|                                                                                                                                  |  |      |           |   |      |   |           |  
|                                                                                                                                  |  | $    | 1,656,235 |   |      | $ | 1,921,065 |  
|                                                                                                                                  |  |      |           |   |      |   |           |  



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



42



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GATEWAY, INC



CONSOLIDATED
STATEMENTS OF CASH FLOWS

For the years ended December 31, 2006, 2005, and 2004

(in thousands)



|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|------------------------------------------------------------------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                                                                                  |  | 2006 |          |   | 2005 |   |          | 2004 | 
|Cash flows from operating activities:                                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Net income (loss)                                                                                 |  | $    | 9,643    |   |      | $ | 6,161    |      |  | $ | (567,618 | )
|Adjustments to reconcile net income (loss) to net cash provided by(used in) operating activities: |  |      |          |   |      |   |          |      |  |   |          |  
|Write-down of long-lived assets                                                                   |  |      | 1,270    |   |      |   | 16,101   |      |  |   | 156,710  |  
|Depreciation and amortization                                                                     |  |      | 27,578   |   |      |   | 38,816   |      |  |   | 112,225  |  
|Provision for doubtful accounts receivable                                                        |  |      | 2,540    |   |      |   | 5,529    |      |  |   | 11,198   |  
|Stock-based compensation                                                                          |  |      | 5,732    |   |      |   | 13,663   |      |  |   | 13,617   |  
|Loss on sales of investments                                                                      |  |      | 118      |   |      |   | 519      |      |  |   | 46       |  
|(Gain) loss on sale of property, plant and equipment                                              |  |      | (23      | ) |      |   |         |      |  |   | 2,500    |  
|Other, net                                                                                        |  |      | 1,591    |   |      |   | 1,874    |      |  |   | 643      |  
|Changes in operating assets and liabilities, net of the effects of the eMachines acquisition:    |  |      |          |   |      |   |          |      |  |   |          |  
|Accounts receivable                                                                               |  |      | 67,966   |   |      |   | (8,696   | )    |  |   | (59,316  | )
|Inventory                                                                                         |  |      | 122,157  |   |      |   | (23,020  | )    |  |   | 63,512   |  
|Other assets                                                                                      |  |      | (72,197  | ) |      |   | (205,825 | )    |  |   | 40,793   |  
|Accounts payable                                                                                  |  |      | (152,067 | ) |      |   | 222,595  |      |  |   | (94,685  | )
|Accrued expenses                                                                                  |  |      | (23,472  | ) |      |   | (24,721  | )    |  |   | (32,284  | )
|Accrued royalties                                                                                 |  |      | (13,695  | ) |      |   | 26,420   |      |  |   | (19,289  | )
|Other liabilities                                                                                 |  |      | (46,616  | ) |      |   | (94,143  | )    |  |   | (62,250  | )
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash used in operating activities                                                             |  |      | (69,475  | ) |      |   | (24,727  | )    |  |   | (434,198 | )
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Cash flows from investing activities:                                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Purchases of available-for-sale securities                                                        |  |      | (127,813 | ) |      |   | (44,993  | )    |  |   | (113,199 | )
|Sales of available-for-sale securities                                                            |  |      | 221,683  |   |      |   | 189,874  |      |  |   | 586,176  |  
|Purchases of property, plant and equipment                                                        |  |      | (55,435  | ) |      |   | (40,427  | )    |  |   | (34,467  | )
|Proceeds from sale of property, plant and equipment                                               |  |      | 4,504    |   |      |   | 13,875   |      |  |   | 12,086   |  
|Cash paid in acquisition of eMachines, net of cash acquired                                       |  |      |         |   |      |   |         |      |  |   | (41,350  | )
|Payment of shareholder note payable                                                               |  |      |         |   |      |   |         |      |  |   | (22,448  | )
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash provided by investing activities                                                         |  |      | 42,939   |   |      |   | 118,329  |      |  |   | 386,798  |  
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Cash flows from financing activities:                                                             |  |      |          |   |      |   |          |      |  |   |          |  
|Payment of preferred dividends                                                                    |  |      |         |   |      |   |         |      |  |   | (8,840   | )
|Proceeds from stock option exercises                                                              |  |      | 5        |   |      |   | 1,093    |      |  |   | 11,668   |  
|Proceeds from the issuance of senior convertible notes, net                                       |  |      |         |   |      |   |         |      |  |   | 290,862  |  
|Proceeds from revolving credit facility                                                           |  |      |         |   |      |   |         |      |  |   | 50,000   |  
|Payment from revolving credit facility                                                            |  |      | (50,000  | ) |      |   |         |      |  |   |         |  
|Purchase of Series A and C preferred stock                                                        |  |      |         |   |      |   |         |      |  |   | (264,253 | )
|Purchase of treasury stock                                                                        |  |      | (280     | ) |      |   |         |      |  |   | (15,764  | )
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net cash provided by (used in) financing activities                                               |  |      | (50,275  | ) |      |   | 1,093    |      |  |   | 63,673   |  
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Net increase (decrease) in cash and cash equivalents                                              |  |      | (76,811  | ) |      |   | 94,695   |      |  |   | 16,273   |  
|Cash and cash equivalents, beginning of year                                                      |  |      | 422,488  |   |      |   | 327,793  |      |  |   | 311,520  |  
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Cash and cash equivalents, end of year                                                            |  | $    | 345,677  |   |      | $ | 422,488  |      |  | $ | 327,793  |  
|                                                                                                  |  |      |          |   |      |   |          |      |  |   |          |  
|Supplemental disclosure of cash flow information:                                                 |  |      |          |   |      |   |          |      |  |   |          |  
|Cash paid during the period for interest                                                          |  | $    | 6,533    |   |      | $ | 6,858    |      |  | $ | 476      |  
|Cash received during the period for income taxes                                                  |  | $    | 3,957    |   |      | $ | 2,257    |      |  | $ | 2,144    |  
|Supplemental disclosure of non cash investing and financing activities:                           |  |      |          |   |      |   |          |      |  |   |          |  
|Minority interest in earnings                                                                     |  | $    | 18       |   |      | $ |         |      |  | $ |         |  
|Value of common stock issued in acquisition of eMachines                                          |  | $    |         |   |      | $ |         |      |  | $ | 214,623  |  
|Accretion of Series C preferred stock                                                             |  | $    |         |   |      | $ |         |      |  | $ | 2,280    |  
|Value of restricted shares withheld for taxes                                                     |  | $    | 3,195    |   |      | $ | 7,489    |      |  | $ |         |  
|Preferred stock surrendered in payment of receivable due from AOL                                 |  | $    |         |   |      | $ |         |      |  | $ | 35,614   |  



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



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GATEWAY, INC.



CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY

For the years ended December 31, 2006, 2005, and 2004

(in thousands)



|                                                                           |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   |          |  
|-------------------------------------------------------------------------- | ------ | ------------------------ | - | ------ | ------------ | -------- | ------ | -------------- | ------- | ------ | ------------------------ | - | ------ | -------------------------------- | ------ | ----- | -------------------------------------- | ------ | ------- | -------------------------------------------- | ------ | - | --------- | ------ |  | - | ------- | - |  | ------ | -------- | - |  | - | ------ | - |  | - | -------- | -
|                                                                           |        | Series A Preferred Stock |   |        | Common Stock |          |        | Treasury Stock |         |        | AdditionalPaid-InCapital |   |        | DeferredStock- BasedCompensation |        |       | RetainedEarnings (Accumulated Deficit) |        |         | AccumulatedOther Comprehensive Income
(Loss) |        |   | NetEquity |       
|                                                                           | Shares |                          |   | Amount |              |          | Shares |                |         | Amount |                          |   | Shares |                                  | Amount |       |                                        | Amount |         |                                              | Amount |   |           | Amount |  |   | Amount  |   |  | Amount |         
|Balance, January 1, 2004                                                   |        | 50                       |   |        | $            | 200,000  |        |                | 324,392 |        |                          | $ | 3,244  |                                  |        |      |                                        | $      |        |                                              |        | $ | 734,550   |        |  | $ |        |   |  | $      | (218,571 | ) |  | $ | 2,795  |   |  | $ | 722,018  |  
|Net loss                                                                   |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        | (567,618 | ) |  |   |        |   |  |   | (567,618 | )
|Foreign currency translation                                               |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   | (1,643 | ) |  |   | (1,643   | )
|Net unrealized loss on available for sale securities, net of tax           |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   | (728   | ) |  |   | (728     | )
|Total comprehensive loss                                                   |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   | (569,989 | )
|Issuance of stock in acquisition of eMachines                              |        |                          |   |        |              |          |        |                | 42,281  |        |                          |   | 423    |                                  |        |       |                                        |        |         |                                              |        |   | 190,266   |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   | 190,689  |  
|Issuance of restricted stock in acquisition of eMachines                   |        |                          |   |        |              |          |        |                | 5,307   |        |                          |   | 53     |                                  |        |       |                                        |        |         |                                              |        |   | 27,491    |        |  |   | (27,544 | ) |  |        |          |   |  |   |        |   |  |   |         |  
|Issuance of stock through option exercises, including tax benefit of $ 656 |        |                          |   |        |              |          |        |                | 2,959   |        |                          |   | 29     |                                  |        |       |                                        |        |         |                                              |        |   | 12,295    |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   | 12,324   |  
|Redemption of Series A preferred stock                                     |        | (50                      | ) |        |              | (200,000 | )      |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   | (200,000 | )
|Acquisition of treasury stock                                              |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        | 2,725 |                                        |        | (15,764 | )                                            |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   | (15,764  | )
|Gain on redemption of Series A and C preferred stock                       |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        | 100,133  |   |  |   |        |   |  |   | 100,133  |  
|Dividends declared and accretion of redeemable preferred stock             |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        | (7,991   | ) |  |   |        |   |  |   | (7,991   | )
|Compensation expense on stock options and restricted stock                 |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   | 512       |        |  |   | 13,105  |   |  |        |          |   |  |   |        |   |  |   | 13,617   |  
|                                                                           |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   |          |  
|Balance, December 31, 2004                                                 |        |                         |   |        | $            |         |        |                | 374,941 |        |                          | $ | 3,749  |                                  |        | 2,725 |                                        | $      | (15,764 | )                                            |        | $ | 965,114   |        |  | $ | (14,439 | ) |  | $      | (694,047 | ) |  | $ | 424    |   |  | $ | 245,037  |  
|                                                                           |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   |          |  
|Net income                                                                 |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        | 6,161    |   |  |   |        |   |  |   | 6,161    |  
|Foreign currency translation                                               |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   | 517    |   |  |   | 517      |  
|Net unrealized loss on available for sale securities, net of tax           |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   | (3,711 | ) |  |   | (3,711   | )
|Total comprehensive income                                                 |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   | 2,967    |  
|Cancellations of restricted stock                                          |        |                          |   |        |              |          |        |                | (99     | )      |                          |   | (1     | )                                |        |       |                                        |        |         |                                              |        |   | (237      | )      |  |   | 238     |   |  |        |          |   |  |   |        |   |  |   |         |  
|Issuance of stock, including tax benefit of $ 227                          |        |                          |   |        |              |          |        |                | 2,397   |        |                          |   | 25     |                                  |        |       |                                        |        |         |                                              |        |   | 6,884     |        |  |   | (5,589  | ) |  |        |          |   |  |   |        |   |  |   | 1,320    |  
|Acquisition of treasury stock                                              |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        | 1,336 |                                        |        | (7,489  | )                                            |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   | (7,489   | )
|Compensation expense on stock options and restricted stock                 |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   | 13,438  |   |  |        |          |   |  |   |        |   |  |   | 13,438   |  
|                                                                           |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   |          |  
|Balance, December 31, 2005                                                 |        |                         |   |        | $            |         |        |                | 377,239 |        |                          | $ | 3,773  |                                  |        | 4,061 |                                        | $      | (23,253 | )                                            |        | $ | 971,761   |        |  | $ | (6,352  | ) |  | $      | (687,886 | ) |  | $ | (2,770 | ) |  | $ | 255,273  |  
|                                                                           |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   |          |  
|Net income                                                                 |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        | 9,643    |   |  |   |        |   |  |   | 9,643    |  
|Foreign currency translation                                               |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   | 104    |   |  |   | 104      |  
|Net unrealized loss on available for sale securities, net of tax           |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   | 1,446  |   |  |   | 1,446    |  
|Total comprehensive income                                                 |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   | 11,193   |  
|Cancellations of restricted stock                                          |        |                          |   |        |              |          |        |                | (583    | )      |                          |   | (6     | )                                |        |       |                                        |        |         |                                              |        |   | (1,667    | )      |  |   | 1,673   |   |  |        |          |   |  |   |        |   |  |   |         |  
|Issuance of stock, including tax benefit of $ 313                          |        |                          |   |        |              |          |        |                | 333     |        |                          |   | 3      |                                  |        |       |                                        |        |         |                                              |        |   | 668       |        |  |   | (353    | ) |  |        |          |   |  |   |        |   |  |   | 318      |  
|Acquisition of treasury stock                                              |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        | 1,286 |                                        |        | (3,195  | )                                            |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   | (3,195   | )
|Compensation expense on stock options and restricted stock                 |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   | 3,133     |        |  |   | 2,286   |   |  |        |          |   |  |   |        |   |  |   | 5,419    |  
|                                                                           |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   |          |  
|Balance, December 31, 2006                                                 |        |                         |   |        | $            |         |        |                | 376,989 |        |                          | $ | 3,770  |                                  |        | 5,347 |                                        | $      | (26,448 | )                                            |        | $ | 973,895   |        |  | $ | (2,746  | ) |  | $      | (678,243 | ) |  | $ | (1,220 | ) |  | $ | 269,008  |  
|                                                                           |        |                          |   |        |              |          |        |                |         |        |                          |   |        |                                  |        |       |                                        |        |         |                                              |        |   |           |        |  |   |         |   |  |        |          |   |  |   |        |   |  |   |          |  



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



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GATEWAY, INC.



NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS



1.    Nature of Operations and Summary of Significant Accounting Policies:



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.



On March 11, 2004,
Gateway completed its acquisition of eMachines, Inc., a privately-held computer company. These consolidated financial statements include eMachines results of operations subsequent to March 11, 2004 (see Note 10).



During 2006, Gateway entered into a joint venture agreement with a
significant original design manufacturer to provide a dedicated U.S. final assembly facility in LaVergne, Tennessee. Beginning in June 2006 and continuing through October 2006, Gateway invested $5.6 million in this joint venture, known as
Gateway Pro Partners, LLC (GCC). Gateway holds the majority ownership interest in GCC and accounts for this entity as a consolidated subsidiary. GCC assembles configure-to-order desktops, notebooks and servers according to Gateway
customer specifications. GCC also provides custom imaging services and government compliance certification.



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



(a)    Basis of Presentation:



The consolidated financial statements include the accounts of Gateway and
its subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Gateway records minority interest expense related to its consolidated subsidiaries which are not wholly owned.



(b)    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.



(c)    Cash and Cash Equivalents:



Gateway considers all highly liquid investments with original maturities of three months or less to be cash equivalents. The carrying amount of these investments approximates fair value because of their short maturities.



(d)    Marketable Securities:



Marketable securities consist of investments in commercial paper, debt
securities, mutual funds, and equity securities with readily determinable fair values and are classified as available for sale and carried at fair market value based on quoted market prices. Unrealized gains and losses are recorded as a component of
accumulated



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GATEWAY, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



other comprehensive loss. The specific identification method is used to determine the cost basis in computing realized gains or losses on dispositions of
marketable securities.



Gateway regularly monitors and
evaluates the realizable value of its investments. When assessing investments for other-than-temporary declines in value, Gateway considers such factors as, among other things, how significant the decline in value is as a percentage of the original
cost, how long the market value of the investment has been below original cost, Gateways ability and intent to continue holding the investment. If events and circumstances indicate that an other-than-temporary decline in the value of an
investment has occurred, Gateway records an impairment charge to income in that period.



Included in marketable securities as of December 31, 2006 and 2005 are unrealized losses of approximately $0.3 million and $1.7 million, respectively. 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 either
2006 or 2005.



(e)    Inventory:



Inventory, which is comprised of component parts, both owned
and consigned, subassemblies and finished goods, including refurbished PCs, is valued at the lower of weighted average cost or market. Component parts and subassemblies consist of raw materials and products other than the PC such as stand-alone
displays, peripherals, software not included with the PC, and accessories. Gateway performs an assessment of its inventories quarterly, reviewing the amounts of inventory on hand and under commitment against its latest forecasted demand requirements
to determine whether excess or obsolescence write-downs are required.



Inventory-in-transit balances were approximately $9 million and $67 million as of December 31, 2006 and 2005, respectively.



(f)    Receivables from Suppliers:



Gateway purchases selected components from suppliers and resells the components to original design manufacturers to incorporate into products being
manufactured for Gateway. The receivable from these sales of the components is recorded as Receivables from suppliers. If substantial uncertainty regarding the collectibility of these receivables is noted, an appropriate reserve may
be required, which would affect earnings in the period the uncertainty is identified. As of December 31, 2006 and 2005, reserve balances were $0.



(g)    Internal-use Software:



Gateway capitalizes 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.
Gateway is 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 in the reporting period that the change was made.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(h)    Property, Plant and Equipment:



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



|                                |  |                              
|------------------------------- |  | -----------------------------
|                                |  | Estimated Useful Life (Years)
|Office and Production Equipment |  | 1-7                          
|Furniture and Fixtures          |  | 7-10                         
|Internal-use Software           |  | 3-7                          
|Vehicles                        |  | 3                            
|Leasehold Improvements          |  | Lesser of 10 or Lease Life   
|Buildings                       |  | 35                           



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



As part of Gateways 2003 and 2004 restructuring efforts, the estimated
useful lives of certain assets were shortened. These revisions to estimated useful lives resulted in additional depreciation expense of $0, $5 million ($.01 per share), and $31 million ($ .08 per share) for 2006, 2005, and 2004, respectively.



(i)    Intangible Assets and Goodwill:



Intangible assets with finite lives are amortized on a
straight-line basis over their estimated useful lives, generally four to ten years. Intangible assets with indefinite lives such as trade names and goodwill are not amortized. Intangible assets are reviewed for impairment whenever events or
circumstances indicate an event of impairment may exist. During 2004, Gateway revised the estimated useful lives of certain intangible assets based on planned changes in the assets use, resulting in additional amortization expense of $0, $1.1
million and $3.3 million in 2006, 2005 and 2004, respectively (see Note 13). Non-amortizable intangible assets, including goodwill, are reviewed for impairment annually during the fourth quarter (based on a discounted cash flow model under the
income approach) or whenever events or circumstances indicate an event of impairment may exist. Managements fourth quarter 2006 analysis concluded that no condition of non-amortizable intangible asset impairment existed as of December 31,
2006.



Intangible assets with finite lives acquired through the
acquisition of eMachines, including customer-related assets, were assigned useful lives of ten years. Amortization expense related to these assets approximates $4.8 million annually.



Total intangible asset amortization expense was $7.8 million, $6.3 million (including $1.1 million in accelerated
amortization), and $16.6 million (including $3.3 million in accelerated amortization) for 2006, 2005, and 2004, respectively.



(j)    Long-lived Assets:



Gateway reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be
recoverable. An asset is considered to be impaired when the sum of the undiscounted net future cash flows expected to result from the use of the asset and its eventual disposition does not exceed its carrying amount. The amount of impairment loss,
if any, is measured as the difference between the net book value of the asset and its estimated fair value based on appraised or other estimated values. For the years ending December 31, 2006, 2005 and 2004, Gateway recorded $1.3 million, $20
million, and $162 million for impairment of long-lived assets, respectively.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



(k)    Royalties:



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



(l)    Warranty:



Gateway provides standard warranties with the sale of its 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 non-current liabilities, is as follows (in thousands):



|                                               |  |      |         |   |      |   |         |  
|---------------------------------------------- |  | ---- | ------- | - | ---- | - | ------- | -
|                                               |  | 2006 |         |   | 2005 |  
|Accrued warranty, beginning of the year        |  | $    | 37,040  |   |      | $ | 19,291  |  
|Accruals for warranties issued during the year |  |      | 80,697  |   |      |   | 58,746  |  
|Change in management estimate                  |  |      | 12,000  |   |      |   |        |  
|Settlements made                               |  |      | (64,898 | ) |      |   | (40,997 | )
|                                               |  |      |         |   |      |   |         |  
|Accrued warranty, end of the year              |  | $    | 64,839  |   |      | $ | 37,040  |  
|                                               |  |      |         |   |      |   |         |  



(m)    Trade Payables Program:



During 2005 and 2006, Gateway had an accelerated supplier payment program through which certain suppliers could elect to receive advance payment from a designated finance company on invoices due to them by Gateway. Any difference between
the original amount due to the supplier for the goods and/or services received and the amount ultimately required to be repaid by Gateway to the finance company, including fees and interest, is recorded as interest expense (or income, if applicable)
for the period. Included in accounts payable is approximately $44 million and $30 million that was advanced to suppliers and outstanding to the finance company as of December 31, 2006 and 2005, respectively. On January 7, 2007 this program
was discontinued.



(n)    Deferred
Stock-Based Compensation:



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 2.1 million and 2.5 million shares vested on January 1, 2006 and 2005, respectively. 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. The remaining 0.3 million shares vested on January 1, 2007. Deferred stock based compensation was $2.7 million as of December 31,
2006.



(o)    Revenue Recognition:



Gateway recognizes revenue on PCs, servers 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



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GATEWAY, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



provided based on subscriber counts reported to us by the service providers. If the actual subscriber counts or the economics associated with these
subscriber counts prove to be more or less than originally reported by the service providers, Gateway may be required to adjust revenue. In the fourth quarter of 2002, America Online, Inc. (AOL) unilaterally recomputed payments it had
made in 2001 and the first half of 2002 and withheld the claimed overpayments from amounts currently owed to Gateway. Gateway disputed AOLs retroactive adjustment and reached a settlement in November 2004 for $2.5 million related to the
contested period and an additional $1.6 million for subsequent periods through 2004. This was recognized as revenue in 2004. 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 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. If actual returns exceed estimated returns or if actual rebate redemptions exceed estimates, we would be required to record additional reductions to revenue which would affect earnings in the period the
adjustments are made. Gateway also 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 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. Gateway
recorded the following amounts against revenue for rebates for 2006, 2005, and 2004 of $16 million, $69 million, and $105 million, respectively. Gateway recorded the following amounts against revenue for returns for 2006, 2005, and 2004 of $188
million, $186 million, and $226 million, respectively.



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 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 other liabilities and other long-term liabilities and recognition of extended warranty revenue for the periods presented is as follows (in thousands):



|                                                            |  |      |         |   |      |   |          |  
|----------------------------------------------------------- |  | ---- | ------- | - | ---- | - | -------- | -
|                                                            |  | 2006 |         |   | 2005 |  
|Extended warranty deferred revenue, beginning of the period |  | $    | 87,806  |   |      | $ | 178,381  |  
|Additions to extended warranty deferred revenue             |  |      | 10,885  |   |      |   | 23,193   |  
|Extended warranty revenue recognized                        |  |      | (58,652 | ) |      |   | (113,768 | )
|                                                            |  |      |         |   |      |   |          |  
|Extended warranty deferred revenue, end of the period       |  | $    | 40,039  |   |      | $ | 87,806   |  
|                                                            |  |      |         |   |      |   |          |  



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.



(p)    Market Development Funds:



Gateway receives funding from various suppliers generically known as market development funds (MDF) to encourage
it to utilize certain components in the design or manufacture of its products, provide pass-through sales incentives to Gateways customers, or reimburse Gateway for a portion of its qualifying advertising or sales



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



efforts. Typically the vendor allocates these funds to Gateway based on purchase volumes. Gateway considers these funds earned and recognizes these
arrangements when substantially all of the vendors requirements for funding have been satisfied and collection is assured. If the underlying vendor requirement specifies that Gateway incur or spend for qualifying advertising or sales efforts,
these funds are offset against selling, general, and administrative expense, otherwise they are offset against cost of goods sold in the period earned.



(q)    Shipping and Handling:



Shipping and handling costs are included in costs of sales for all periods presented. Shipping and handling costs charged to customers is recorded as
revenue in the period the related product sales revenue is recognized.



(r)    Advertising Costs:



Advertising costs, net of market development funds reimbursement, are charged to expense as incurred and are included within selling, general and administrative expenses. Net advertising expenses were approximately $41 million, $57 million,
and $79 million for 2006, 2005, and 2004, respectively.



(s)    Income Taxes:



The
provision or benefit for income taxes is computed using the liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax
bases of assets and liabilities. Deferred tax assets are reduced by a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. Other current liabilities include tax liabilities
related to current or future federal, state or foreign tax audits. See Note 6.



(t)    Net Income (Loss) Per Share:



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



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GATEWAY, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following table sets forth the computation of basic and diluted income (loss) per share for 2006,
2005, and 2004 (in thousands, except per share amounts):



|                                                              |  |      |         |      |   |         |  |   |          |  
|------------------------------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | - | -------- | -
|                                                              |  | 2006 |         | 2005 |   | 2004    | 
|Basic net income (loss) per share calculation:                |  |      |         |      |   |         |  |   |          |  
|Net income (loss) attributable to common stockholdersbasic   |  | $    | 9,643   |      | $ | 6,161   |  | $ | (475,476 | )
|Weighted average shares outstandingbasic                     |  |      | 373,001 |      |   | 371,661 |  |   | 363,708  |  
|                                                              |  |      |         |      |   |         |  |   |          |  
|Basic net income (loss per) share                             |  | $    | 0.03    |      | $ | 0.02    |  | $ | (1.31    | )
|                                                              |  |      |         |      |   |         |  |   |          |  
|Diluted net income (loss) per share calculation:              |  |      |         |      |   |         |  |   |          |  
|Net income (loss) attributable to common stockholdersbasic   |  | $    | 9,643   |      | $ | 6,161   |  | $ | (475,476 | )
|Preferred stock dividends and accretion                       |  |      |        |      |   |        |  |   | 7,991    |  
|Gain on redemption of preferred stock                         |  |      |        |      |   |        |  |   | (100,133 | )
|                                                              |  |      |         |      |   |         |  |   |          |  
|Net income (loss) attributable to common stockholdersdiluted |  | $    | 9,643   |      | $ | 6,161   |  | $ | (567,618 | )
|                                                              |  |      |         |      |   |         |  |   |          |  
|Weighted average shares outstandingbasic                     |  |      | 373,001 |      |   | 371,661 |  |   | 363,708  |  
|Series A preferred stock                                      |  |      |        |      |   |        |  |   | 21,631   |  
|Series C preferred stock                                      |  |      |        |      |   |        |  |   | 5,776    |  
|Stock options                                                 |  |      | 1,022   |      |   | 506     |  |   |         |  
|                                                              |  |      |         |      |   |         |  |   |          |  
|Weighted average shares outstandingdiluted                   |  |      | 374,023 |      |   | 372,167 |  |   | 391,115  |  
|                                                              |  |      |         |      |   |         |  |   |          |  
|Diluted net income (loss) per share                           |  | $    | 0.03    |      | $ | 0.02    |  | $ | (1.45    | )
|                                                              |  |      |         |      |   |         |  |   |          |  



The 2004 gain on
redemption of the Series A and C preferred stock is included in net income attributable to common shareholders in accordance with EITF Topic D-42 but excluded from the calculation of diluted earnings per share under the if-converted
method of SFAS 128, Earnings Per Share. Diluted shares for 2004 excludes 3,145 weighted average incremental shares related to employee and director stock options despite their exercise prices being below the average market price of
Gateway common stock as their effect on loss per share is anti-dilutive. Diluted shares also excludes 34,762 shares related to the senior convertible notes in 2006, 2005 and 2004, as their effect is anti-dilutive. Gateway has also excluded from
diluted loss per share 26,942 shares, 51,509 shares, and 52,112 shares for 2006, 2005, and 2004, respectively, related to employee and director stock options and non-employee warrants which have exercise prices greater than the average market price
of the common shares for those periods.



(u)    Stock-based Compensation:



Gateways Compensation Committee of the Board of Directors approved the accelerated vesting on October 4, 2005 of all unvested options held by then employees, directors and officers which had exercise prices greater than $2.84 per
share. Because these options had exercise prices significantly in excess of Gateways stock price of $2.84 on the date of approval, Gateway believed that these options did not provide sufficient incentive to the employees when compared with the
potential future compensation expense that would have been attributable to these options. The acceleration resulted in the recognition of an additional $54 million pro-forma pre-tax stock based compensation in 2005. In accordance with current
accounting guidance, this acceleration eliminated the compensation expense Gateway would otherwise recognize in its statement of operations with respect to these options with the implementation of SFAS 123-R in 2006.



On October 4, 2005, 2.0 million shares of restricted stock were
granted to employees. These shares vest in four equal annual installments. A deferred compensation liability of $5.6 million was recorded in the fourth quarter of 2005 balance sheet in association with this restricted stock grant.



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GATEWAY, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



On March 3, 2006, an executive received a grant of 93,023 shares of restricted stock which vests
in 1 year. On September 18, 2006, an executive received a grant of 79,275 shares of restricted stock which vests in 3 equal installments. A deferred compensation liability of $0.4 million was recorded in the 2006 balance sheet in
association with these restricted stock grants.



Prior to the
adoption of SFAS 123-R in 2006, Gateway measured compensation expense for its employee and non-employee director stock-based compensation using the intrinsic value method. Compensation charges related to other non-employee stock-based compensation
are measured using fair value methods. The fair value of options was estimated on the date of grant using the Black-Scholes option pricing model with the following assumptions for the periods indicated:



|                                     |  |                                 |   |  |           |   |  |           |  
|------------------------------------ |  | ------------------------------- | - |  | --------- | - |  | --------- | -
|                                     |  | For the Year Ended December 31, |  
|                                     |  | 2006                            |   |  | 2005      |   |  | 2004      |  
|Dividend yield                       |  |                                |   |  |          |   |  |          |  
|Risk-free interest rate              |  | 5                               | % |  | 4         | % |  | 4         | %
|Expected volatility                  |  | 56                              | % |  | 67        | % |  | 80        | %
|Expected option term (after vesting) |  | 3.5 years                       |   |  | 3.5 years |   |  | 3.5 years |  



Had compensation
expense for employee and director stock options been determined based on the fair value of the options on the date of the grant based on the assumptions outlined in Note 8 and applying graded vesting, net income (loss) and net income (loss) per
share for 2005 and 2004 would have resulted in the following pro forma amounts (in thousands, except per share amounts):



|                                                                                                                                            |  |      |         |   |      |   |          |  
|------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | - | ---- | - | -------- | -
|                                                                                                                                            |  | 2005 |         |   | 2004 |  
|Net income (loss) attributable to common stockholdersas reported                                                                           |  | $    | 6,161   |   |      | $ | (475,476 | )
|Add: compensation expense included in net income, net of related tax effects                                                                |  |      | 13,438  |   |      |   | 13,617   |  
|Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax
effects |  |      | (74,278 | ) |      |   | (46,937  | )
|                                                                                                                                            |  |      |         |   |      |   |          |  
|Net income (loss) attributable to common stockholderspro forma                                                                             |  | $    | (54,679 | ) |      | $ | (508,796 | )
|                                                                                                                                            |  |      |         |   |      |   |          |  
|Basic net income (loss) per shareas reported                                                                                               |  | $    | 0.02    |   |      | $ | (1.31    | )
|                                                                                                                                            |  |      |         |   |      |   |          |  
|Basic net income (loss) per sharepro forma                                                                                                 |  | $    | (0.15   | ) |      | $ | (1.40    | )
|                                                                                                                                            |  |      |         |   |      |   |          |  
|Diluted net income (loss) per shareas reported                                                                                             |  | $    | 0.02    |   |      | $ | (1.45    | )
|                                                                                                                                            |  |      |         |   |      |   |          |  
|Diluted net income (loss) per sharepro forma                                                                                               |  | $    | (0.15   | ) |      | $ | (1.54    | )
|                                                                                                                                            |  |      |         |   |      |   |          |  



(v)    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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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 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. Gateway acquired treasury stock for the above noted purchases and withholdings in the amount of $7.5 million and
$3.2 million in 2005 and 2006, respectively.



(w)    Foreign Currency:



Gateway
considers the U.S. dollar to be its functional currency for certain of its international operations and the local currency for all others. For subsidiaries where the local currency is the functional currency, the assets and liabilities are
translated into U.S. dollars at exchange rates in effect at the balance sheet date. Income and expense items are translated at the average exchange rates prevailing during the period. Gains and losses from translation are included in accumulated
other comprehensive income. Gains and losses resulting from remeasuring monetary asset and liability accounts that are denominated in currencies other than a subsidiarys functional currency are included in other income, net and are not
significant.



(x)    Derivatives and
Hedging:



All derivative transactions are accounted for under
SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, which requires that the Company recognize all derivatives (including derivatives embedded in other contracts) as either assets or liabilities on the balance
sheet and measure those instruments at fair value. The Companys derivative financial instruments consist of forward currency contracts. These contracts are recognized on the balance sheet at their fair value, which is the estimated amount at
which they could be settled based on market rates. Unless special hedge accounting is applied, under SFAS No. 133, the gains and losses do not qualify for hedge accounting. As such, all gains and losses on these contracts are reported in
earnings as Other income, net. As of December 31, 2006, the Company had several of these contracts all scheduled to mature before March 31, 2007.



(y)    Segment Data:



Gateway reports segment data based on the internal reporting that is used by senior management for making operating decisions and assessing performance.
Gateways operating segments are Retail (including International), Professional, and Direct. The International segment currently meets the aggregation criteria of Statement of Financial Accounting Standards No. 131, Disclosures about
Segments of an Enterprise and Related Information and is included in the Retail segment for external reporting purposes. See Note 11.



(z)    New Accounting Pronouncements:



In September 2006, the SEC issued SAB No. 108, "Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current
Year Financial Statements" ("SAB 108"). SAB 108 provides guidance on the consideration of the effects of prior year misstatements in quantifying current year misstatements for the purpose of a materiality assessment. SAB 108
establishes an approach that requires quantification of financial statement errors based on the effects of each of the company's balance sheet and statement of operations and the related financial statement disclosures. Early application of the
guidance in SAB 108 is encouraged in any report for an interim period of the first fiscal year ending after November 15, 2006, and was adopted by Gateway in the fourth quarter of fiscal 2006. The adoption of SAB 108 did not have a
material impact on Gateways consolidated results of operations, financial position or cash flows.



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GATEWAY, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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 2009. 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 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. FIN 48 is effective for fiscal years beginning after December 15, 2006 and is required to be adopted by Gateway
in the first quarter of fiscal 2007. The cumulative effects, if any, of applying FIN 48 will generally be recorded as an adjustment to retained earnings as of the beginning of the period of adoption. Gateway is currently evaluating the effect
that the adoption of FIN 48 will have on its consolidated results of operations and financial condition and is not yet in a position to finalize its determination of such effects.



In February 2006, the FASB issued SFAS No. 155, Accounting for Certain Hybrid Financial Instrumentsan
amendment of FASB SFAS Nos. 133 and 140. 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 Extinguishment 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. Management does not believe the adoption of SFAS 155 will have a material impact on Gateways consolidated
results of operations, financial position or cash flows.



In
September 2006, the FASB issued SFAS No. 158, "Employers' Accounting for Defined Benefit Pension and Other Postretirement PlansAn Amendment of FASB No. 87, 88, 106 and 132(R)" ("SFAS 158"). SFAS 158 requires that the funded
status of defined benefit postretirement plans be recognized on the company's balance sheet, and changes in the funded status be reflected in comprehensive income, effective fiscal years ending after December 15, 2006. SFAS also requires
companies to measure the funded status of the plan as of the date of its fiscal year-end, effective for fiscal years ending after December 15, 2008. Since Gateway does not currently have a defined benefit postretirement plan, the adoption of
SFAS 158 did not have a material impact on Gateways consolidated results of operations, financial position or cash flows.



2.    Selected Balance Sheet Information (in thousands except where otherwise noted):



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, thus, such arrangements have the effect of increasing other current assets and decreasing inventory. The increase in Receivables from suppliers is attributable to Gateway using buy-sell arrangements with
three additional original design manufacturers. Gateway has now moved all their original design manufacturers to this model.



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The $28 million increase in property plant, and equipment, net is due to $52 million of additions in
construction in progress (primarily major software projects placed in service in early 2007), and $8 million of other equipment additions offset by $19 million of depreciation expense, $178 million of disposals of fully depreciated assets, and $13
million of disposals related to the Kansas City facility closure (carrying value of $25 million net of accumulated depreciation of $12 million).



The $27 million decrease in prepaid expenses consists of decreased prepaid royalties ($15 million), decreased prepaid warranty expense ($6 million), and
other prepaid expenses ($6 million).



The $27 million increase
in other assets consists of increased vendor rebate receivables ($11 million), increased forward currency contracts ($20 million), partially offset by a decrease in other current assets ($4 million).



|                                                               |  |      |          |   |      |   |          |  
|-------------------------------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | -
|                                                               |  | 2006 |          |   | 2005 |  
|Receivables from suppliers                                     |  | $    | 247,207  |   |      | $ | 213,901  |  
|                                                               |  |      |          |   |      |   |          |  
|Other current assets:                                          |  |      |          |   |      |   |          |  
|Prepaid expenses                                               |  |      | 40,299   |   |      |   | 67,162   |  
|Assets held for sale                                           |  |      | 14,774   |   |      |   | 9,162    |  
|Other                                                          |  |      | 160,509  |   |      |   | 133,527  |  
|                                                               |  |      |          |   |      |   |          |  
|                                                               |  | $    | 215,582  |   |      | $ | 209,851  |  
|                                                               |  |      |          |   |      |   |          |  
|Property, plant and equipment, net:                            |  |      |          |   |      |   |          |  
|Land                                                           |  | $    | 1,904    |   |      | $ | 1,904    |  
|Leasehold improvements                                         |  |      | 5,819    |   |      |   | 6,344    |  
|Buildings                                                      |  |      | 26,746   |   |      |   | 40,149   |  
|Construction in progress                                       |  |      | 61,834   |   |      |   | 23,103   |  
|Internal-use software                                          |  |      | 205,848  |   |      |   | 248,325  |  
|Office and production equipment                                |  |      | 32,290   |   |      |   | 152,350  |  
|Furniture and fixtures                                         |  |      | 7,090    |   |      |   | 12,047   |  
|Vehicles                                                       |  |      | 45       |   |      |   | 313      |  
|                                                               |  |      |          |   |      |   |          |  
|                                                               |  |      | 341,576  |   |      |   | 484,535  |  
|                                                               |  |     
|Less: Accumulated depreciation and amortization                |  |      | (230,645 | ) |      |   | (401,379 | )
|                                                               |  |      |          |   |      |   |          |  
|Property, plant and equipment, net                             |  | $    | 110,931  |   |      | $ | 83,156   |  
|                                                               |  |      |          |   |      |   |          |  
|Accumulated other comprehensive loss:                          |  |      |          |   |      |   |          |  
|Foreign currency translation                                   |  | $    | (921     | ) |      | $ | (1,025   | )
|Unrealized loss on available-for-sale securities, net of taxes |  |      | (299     | ) |      |   | (1,745   | )
|                                                               |  |      |          |   |      |   |          |  
|                                                               |  | $    | (1,220   | ) |      | $ | (2,770   | )
|                                                               |  |      |          |   |      |   |          |  



3.    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 includes certain financial covenants. Gateway renegotiated the credit agreement as of December 26, 2006 to



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



replace the financial covenant that Gateway maintain a certified cash balance of $150 million with covenants that Gateway maintain a liquidity position of
$100 million and negative cash flow not to exceed $40 million and $57 million for the fourth quarter of 2006 and the first quarter of 2007, respectively, and $60 million for each quarter thereafter, with cumulative negative cash flow not to exceed
$120 million. Further, once Gateway has achieved 3 consecutive quarters of positive excess cash flow, the amended credit agreement requires that Gateway maintain positive cash flow in each quarter thereafter. The agreement expires on
October 31, 2010, at which time all amounts then outstanding will be due and payable. During the second quarter of 2005, Gateway restructured approximately $51 million of its letters of credit, guarantees, and controlled accounts which had
previously been secured by restricted cash on deposit with financial institutions to letters of credit and guarantees secured by a $47 million utilization of the letter of credit line under this revolving credit facility. As of December 31,
2006 and December 31, 2005, Gateway had $0 and $50 million, respectively in borrowings outstanding under this agreement. The interest rate as of December 31, 2006 was 7.25%. This interest rate adjusts with changes in the prime rate. We
also utilized the credit agreement to support $36 million of stand-by letters of credit and had borrowing availability of $35 million.



In December 2004, Gateway completed the sale of $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. Gateway may settle a conversion election in cash, common shares
or a combination of both. Note holders who elect to convert upon the occurrence of any transaction or event in connection with which 90% or more of Gateways common stock is exchanged for, converted into, acquired for or constitutes solely the
right to receive, consideration which is not at least 90% common stock that is listed on a United States national securities exchange or approved for trading on the NASDAQ National Market may be entitled to receive additional shares of Gateway
common stock based on established formulas. Gateway may not redeem the notes prior to maturity but note holders may require Gateway to repurchase all or a portion of the notes at 100% of principal plus accrued and unpaid interest upon occurrence of
certain defined designated events. Interest is payable semi-annually each June 30 and December 31.



Gateway recorded interest expense of $5.7 million, $6.1 million, and $0.8 million for 2006, 2005, and 2004, respectively.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



4.    Marketable Securities and Long-Term Investments:



As of December 31, 2006 and 2005, the carrying value of Gateways
marketable securities and long-term investments is as follows (in thousands):



|                               |  |      |        |                      |   |                                       |  |   |                                       |   |  |                            |      |   |               |   |     |   |  |   |       
|------------------------------ |  | ---- | ------ | -------------------- | - | ------------------------------------- |  | - | ------------------------------------- | - |  | -------------------------- | ---- | - | ------------- | - | --- | - |  | - | ------
|                               |  | 2006
|                               |  | Cost |        | GrossUnrealizedGains |   | GrossUnrealizedLossesLessThan 1 Year |  |   | GrossUnrealizedLossesMorethan 1 Year |   |  | Other thanTemporaryCharges |      |   | CarryingValue
|State and municipal securities |  | $    |       |                      | $ |                                      |  | $ |                                      |   |  | $                          |     |   |               | $ |    |   |  | $ |      
|Mortgage-backed securities     |  |      |       |                      |   |                                      |  |   |                                      |   |  |                            |     |   |               |   |    |   |  |   |      
|U.S. Government and agencies   |  |      | 31,775 |                      |   |                                      |  |   | (27                                   | ) |  |                            | (188 | ) |               |   | (81 | ) |  |   | 31,479
|Corporate debt securities      |  |      | 39,210 |                      |   | 12                                    |  |   | (35                                   | ) |  |                            | (61  | ) |               |   | 53  |   |  |   | 39,179
|                               |  |      |        |                      |   |                                       |  |   |                                       |   |  |                            |      |   |               |   |     |   |  |   |       
|Total marketable securities    |  | $    | 70,985 |                      | $ | 12                                    |  | $ | (62                                   | ) |  | $                          | (249 | ) |               | $ | (28 | ) |  | $ | 70,658
|                               |  |      |        |                      |   |                                       |  |   |                                       |   |  |                            |      |   |               |   |     |   |  |   |       
|Long-term investments, at cost |  | $    | 3,159  |                      | $ |                                      |  | $ |                                      |   |  | $                          |     |   |               | $ |    |   |  | $ | 3,159 
|                               |  |      |        |                      |   |                                       |  |   |                                       |   |  |                            |      |   |               |   |     |   |  |   |       



|                               |  |      |         |                      |   |                                       |  |   |                                       |   |  |                            |     |   |               |   |        |   |  |   |        
|------------------------------ |  | ---- | ------- | -------------------- | - | ------------------------------------- |  | - | ------------------------------------- | - |  | -------------------------- | --- | - | ------------- | - | ------ | - |  | - | -------
|                               |  | 2005
|                               |  | Cost |         | GrossUnrealizedGains |   | GrossUnrealizedLossesLessThan 1 Year |  |   | GrossUnrealizedLossesMorethan 1 Year |   |  | Other thanTemporaryCharges |     |   | CarryingValue
|State and municipal securities |  | $    | 10,950  |                      | $ |                                      |  | $ |                                      |   |  | $                          |    |   |               | $ |       |   |  | $ | 10,950 
|Mortgage-backed securities     |  |      | 29,071  |                      |   | 1                                     |  |   | (330                                  | ) |  |                            | (30 | ) |               |   | (220   | ) |  |   | 28,492 
|U.S. Government and agencies   |  |      | 74,306  |                      |   | 1                                     |  |   | (833                                  | ) |  |                            | (39 | ) |               |   | (91    | ) |  |   | 73,344 
|Corporate debt securities      |  |      | 52,787  |                      |   | 6                                     |  |   | (513                                  | ) |  |                            | (15 | ) |               |   | (1,851 | ) |  |   | 50,414 
|                               |  |      |         |                      |   |                                       |  |   |                                       |   |  |                            |     |   |               |   |        |   |  |   |        
|Total marketable securities    |  | $    | 167,114 |                      | $ | 8                                     |  | $ | (1,676                                | ) |  | $                          | (84 | ) |               | $ | (2,162 | ) |  | $ | 163,200
|                               |  |      |         |                      |   |                                       |  |   |                                       |   |  |                            |     |   |               |   |        |   |  |   |        
|Long-term investments, at cost |  | $    | 3,159   |                      | $ |                                      |  | $ |                                      |   |  | $                          |    |   |               | $ |       |   |  | $ | 3,159  
|                               |  |      |         |                      |   |                                       |  |   |                                       |   |  |                            |     |   |               |   |        |   |  |   |        



Unrealized losses in
mortgage-backed, U.S. government and agency and corporate debt securities are largely due to recent interest rate increases. Management continues to monitor its marketable security portfolio but does not believe the unrealized losses as of
December 31, 2006 and 2005 are other-than-temporary. As a result, no other-than-temporary impairment charges were recorded in 2006 or 2005. The following table summarizes debt maturities, excluding mortgage-backed securities which are not due
on a single maturity date, at December 31, 2006 (in thousands):



|                   |  |               |        |               |   |       
|------------------ |  | ------------- | ------ | ------------- | - | ------
|                   |  | AmortizedCost |        | CarryingValue
|Less than one year |  | $             | 20,034 |               | $ | 20,315
|Due in 2-3 years   |  |               | 32,596 |               |   | 32,214
|Due in 4-5 years   |  |               | 13,375 |               |   | 13,271
|Due after 5 years  |  |               | 4,980  |               |   | 4,858 
|                   |  |               |        |               |   |       
|                   |  | $             | 70,985 |               | $ | 70,658
|                   |  |               |        |               |   |       



Gateway held no
auction rate securities at December 31, 2006. At December 31, 2005, Gateway held approximately $16 million in auction rate securities.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



5.    Commitments, Contingencies and Concentrations:



Commitments



Gateway leases certain operating facilities and equipment under non-cancelable operating leases expiring at various dates
through 2012. Rent expense excluding closed facilities under restructuring plans was approximately $3 million, $3 million, and $11 million for 2006, 2005, and 2004, respectively. Gateway also subleases certain closed facilities.



Gateway has entered into licensing and royalty agreements that allow it to
use certain hardware and software intellectual properties in its products. Total royalty expense in many cases is based on the number of units sold and actual amounts to be paid will be greater than the minimum amount stated in the table below.



Future minimum lease expense and sublease income under terms
of non-cancelable operating lease and sublease agreements, including lease and sublease amounts associated with closed facilities which are included in restructuring liabilities, and minimum royalty expense under royalty agreements as of
December 31, 2006 are as follows (in thousands):



|                          |  |                  |        |                |   |            |  |   |                   |   |  |   |       
|------------------------- |  | ---------------- | ------ | -------------- | - | ---------- |  | - | ----------------- | - |  | - | ------
|Years Ending December 31: |  | LeaseObligations |        | SubleaseIncome |   | Net Leases |  |   | RoyaltyAgreements
|2007                      |  | $                | 22,848 |                | $ | 15,189     |  | $ | 7,659             |   |  | $ | 7,850 
|2008                      |  |                  | 21,236 |                |   | 13,446     |  |   | 7,790             |   |  |   | 7,152 
|2009                      |  |                  | 18,443 |                |   | 13,588     |  |   | 4,855             |   |  |   | 7,152 
|2010                      |  |                  | 16,578 |                |   | 14,021     |  |   | 2,557             |   |  |   | 7,152 
|2011                      |  |                  | 13,308 |                |   | 14,126     |  |   | (818              | ) |  |   | 5,032 
|Thereafter                |  |                  | 5,177  |                |   | 12,316     |  |   | (7,139            | ) |  |   | 5,767 
|                          |  |                  |        |                |   |            |  |   |                   |   |  |   |       
|Total                     |  | $                | 97,590 |                | $ | 82,686     |  | $ | 14,904            |   |  | $ | 40,105
|                          |  |                  |        |                |   |            |  |   |                   |   |  |   |       



Certain of
Gateways operating lease commitments have been accrued for in connection with its restructuring actions. See Note 13 for further information.



Contingencies



Gateway had stand-by letters of credit and guarantees outstanding at December 31, 2006 and 2005, amounting to $36 million and $47 million,
respectively. Beginning in the second quarter of 2005, these letters of credit and guarantees are primarily issued through Gateways revolving credit facility.



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



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 individual members of Gateways board of directors. 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. On November 13, 2006, Gateway filed a motion for an order compelling plaintiff



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to furnish a bond, pursuant to California Corp. Code § 800(c), and the court has yet to rule on Gateways motion. The parties have stipulated that
the director defendants need not appear in the matter or otherwise respond to the complaint until after a demand-futility motion to be filed by Gateway 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 Technologies, Inc. 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 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 Inc. 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 have been
consolidated into five separate trials, in which a different group of patents will 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 is expected to appeal. The first trial that involves Gateway is scheduled to begin on March 19, 2007, with three additional trials expected to occur in 2007 and possibly
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, which was 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. Dispositive motions filed by the defendants were heard and denied by the Court in August 2004 and August 2005. No
trial date has been set, but the trial is currently anticipated to occur sometime in 2007.



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. At least quarterly, 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 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



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



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.



Concentrations



Gateway
depends on many third-party suppliers, service providers and manufacturers for key products and components contained in its products and service solutions offerings. For some of these products and components, Gateway may only use a single source
supplier, in part due to the lack of alternative sources of supply or to obtain favorable pricing. If the supply of a key product or component were to be delayed or curtailed, Gateways ability to ship the related product or solution in desired
quantities and in a timely manner could be adversely affected which, in turn would adversely affect Gateways results of operations. In cases where alternative sources of supply are available, qualification of the sources and establishment of
reliable alternate suppliers could result in delays and possibly adversely affect results of operations.



Gateways retail segment sells its products to a limited number of third-party retailers. One retailer, Best Buy, accounted for 36%, 37% and 30% of
accounts receivable, net as of December 31, 2006, 2005 and 2004, respectively, and 39%, 34% and 23% of consolidated net sales in 2006, 2005 and 2004, respectively.



Similarly, Gateway depends on third-party suppliers of its solutions offerings, including financing and Internet access.
Should any of these sources discontinue the provision of services sold through Gateway or be less willing to offer their services to Gateway for any reason, then this would lead to a reduction in net sales if Gateway is unable to find alternative
sources of these services.



Guarantees



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



6.    Income Taxes:



The components of the income tax benefit are as follows (in thousands):



|                   |  |      |         |   |      |   |     |      |  |   |         |  
|------------------ |  | ---- | ------- | - | ---- | - | --- | ---- |  | - | ------- | -
|                   |  | 2006 |         |   | 2005 |   |     | 2004 | 
|Current            |  |      |         |   |      |   |     |      |  |   |         |  
|United States      |  | $    | (24,856 | ) |      | $ | (10 | )    |  | $ | (14,113 | )
|Foreign            |  |      | 456     |   |      |   |    |      |  |   |        |  
|Deferred           |  |      |        |   |      |   |    |      |  |   |        |  
|                   |  |      |         |   |      |   |     |      |  |   |         |  
|Income tax benefit |  | $    | (24,400 | ) |      | $ | (10 | )    |  | $ | (14,113 | )
|                   |  |      |         |   |      |   |     |      |  |   |         |  



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



A reconciliation of the income tax benefit and the amount computed by applying the federal statutory
income tax rate to income (loss) before income taxes is as follows (in thousands):



|                                           |  |      |         |   |      |   |        |      |  |   |          |  
|------------------------------------------ |  | ---- | ------- | - | ---- | - | ------ | ---- |  | - | -------- | -
|                                           |  | 2006 |         |   | 2005 |   |        | 2004 | 
|Federal income tax at statutory rate       |  | $    | (5,165  | ) |      | $ | 2,153  |      |  | $ | (203,665 | )
|Increase (decrease) in valuation allowance |  |      | 3,108   |   |      |   | (523   | )    |  |   | 215,514  |  
|State income tax, net of federal benefit   |  |      | 318     |   |      |   | 298    |      |  |   | (11,638  | )
|Change in tax accrual                      |  |      | (25,174 | ) |      |   | (185   | )    |  |   | (14,113  | )
|Foreign provision with rate differential   |  |      | 1,596   |   |      |   |       |      |  |   |         |  
|Other, net                                 |  |      | 917     |   |      |   | (1,753 | )    |  |   | (211     | )
|                                           |  |      |         |   |      |   |        |      |  |   |          |  
|Income tax benefit                         |  | $    | (24,400 | ) |      | $ | (10    | )    |  | $ | (14,113  | )
|                                           |  |      |         |   |      |   |        |      |  |   |          |  



In 2006, Gateway
recorded a tax benefit of $24 million primarily representing a change in tax accrual of $25 million, together with foreign tax refunds recognized of $2.1 million, offset by foreign and state tax accruals from operations of $2.8 million. The change
in tax accrual consists primarily of the reversal of previously accrued tax liabilities resulting from various tax authority settlements of $27 million and recognition of domestic tax refunds of $6.0 million. The benefit was offset by $6.2 million
of interest accruals relating to previously accrued liabilities, and $1.5 million of current year accruals established for anticipated tax liabilities. The domestic tax refunds and accrued tax liability reversals represent various settlements
between Gateway and the Appeals Office of the Internal Revenue Service with respect to multiple domestic and international issues under audit. These agreements are still subject to review of the Joint Committee on Taxation. Gateway believes the
review of the Joint Committee will not adversely impact the recognition of the benefit recorded for these agreements.



Deferred tax assets and deferred tax liabilities result from temporary differences in the following accounts (in thousands):



|                               |  |      |          |   |      |   |          |      |  |   |          |  
|------------------------------ |  | ---- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                               |  | 2006 |          |   | 2005 |   |          | 2004 | 
|Deferred tax assets:           |  |      |          |   |      |   |          |      |  |   |          |  
|Inventory                      |  | $    | 7,397    |   |      | $ | 8,278    |      |  | $ | 7,051    |  
|Accounts receivable            |  |      | 3,008    |   |      |   | 4,595    |      |  |   | 6,353    |  
|Accrued liabilities            |  |      | 74,557   |   |      |   | 74,085   |      |  |   | 56,155   |  
|Operating loss carryforwards   |  |      | 366,251  |   |      |   | 364,559  |      |  |   | 396,853  |  
|Property, plant and equipment  |  |      | 23,891   |   |      |   | 23,201   |      |  |   | 15,583   |  
|Intangible assets              |  |      | 9,154    |   |      |   |         |      |  |   |         |  
|Capital loss carryforwards     |  |      | 77,474   |   |      |   |         |      |  |   |         |  
|Investments                    |  |      | 7,055    |   |      |   | 92,337   |      |  |   | 94,166   |  
|Other                          |  |      | 13,617   |   |      |   | 13,617   |      |  |   | 13,617   |  
|                               |  |      |          |   |      |   |          |      |  |   |          |  
|Total deferred tax assets      |  |      | 582,404  |   |      |   | 580,672  |      |  |   | 589,778  |  
|Deferred tax liabilities:      |  |      |          |   |      |   |          |      |  |   |          |  
|Intangible assets              |  |      |         |   |      |   | (43,715  | )    |  |   | (47,139  | )
|Prepaid expenses               |  |      | (3,939   | ) |      |   | (3,939   | )    |  |   | (12,419  | )
|Other                          |  |      | (22,620  | ) |      |   | (36,033  | )    |  |   | (32,712  | )
|                               |  |      |          |   |      |   |          |      |  |   |          |  
|Total deferred tax liabilities |  |      | (26,559  | ) |      |   | (83,687  | )    |  |   | (92,270  | )
|Valuation allowance            |  |      | (575,685 | ) |      |   | (516,825 | )    |  |   | (517,348 | )
|                               |  |      |          |   |      |   |          |      |  |   |          |  
|Net deferred tax liabilities   |  | $    | (19,840  | ) |      | $ | (19,840  | )    |  | $ | (19,840  | )
|                               |  |      |          |   |      |   |          |      |  |   |          |  



Gateway has federal
and state net operating loss carryforwards of approximately $816 million and $1.8 billion, respectively. The federal net operating loss carryforwards begin to expire in 2023 and the state net operating loss carryforwards expire between 2007 and
2021, depending on each states law.



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Gateway has capital loss carryforwards in the amount of $209 million. The capital loss carryforwards
will begin to expire in 2007.



Gateway is subject to ongoing
audits from various taxing authorities in the jurisdictions in which it does business and believes it has adequately provided for income tax issues not yet resolved. As of December 31, 2006, approximately $90 million had been accrued to provide
for such matters. Based on a consideration of all relevant facts and circumstances, the Company 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 or financial condition.



Gateway has a valuation
allowance of approximately $576 million as of December 31, 2006 for net deferred tax assets because of the uncertainty regarding their realization. Gateway expects to maintain a full valuation allowance on future tax benefits until an
appropriate level of profitability is sustained. Until an appropriate level of profitability is sustained, Gateway does not expect to recognize any significant tax benefits from future results of operations.



Gateway reviewed its deferred tax asset and liability balances in connection
with the preparation of the 2006 consolidated financial statements and in preparation for the adoption of FIN 48. This review resulted in a change in estimates related to certain deferred tax assets and liabilities. Because the company has a
valuation allowance, the change in estimate had no effect on the consolidated financial statements as of December 31, 2006.



Also included in Gateways deferred tax asset and liability schedule above are excess tax deductions relating to stock options. When the benefit of
the net operating losses containing these excess tax deductions are realized, the benefit will not affect the Statement of Operations, but rather additional paid in capital. For the year ended December 31, 2006 the excess tax deductions amount
to $5.3 million. These amounts have been excluded from the net operating loss carryforward. The cumulative amount of excess tax deductions presented in the net operating loss carryforward above from years 2001 through 2005 is $8.2 million. To the
extent that such excess tax deductions are realized in the future by virtue of reducing income taxes payable, the Company would expect to increase additional paid in capital by approximately $4.7 million.



Undistributed earnings of the Company's foreign subsidiaries for which no
U.S. federal or state liability has been recorded are considered to be indefinitely reinvested. Accordingly, no provision for U.S. federal and state income taxes or foreign withholding taxes has been provided on such undistributed earnings.



7.    Preferred Stock and Preferred Share Purchase
Rights Plan:



Gateway has 5,000,000 shares of preferred
stock authorized for issuance in one or more series, at a par value of $.01 per share. In conjunction with the distribution of Preferred Share Purchase Rights, Gateways Board of Directors designated 1,000,000 shares of preferred stock as
Series B Junior Participating Preferred Stock and reserved such shares for issuance upon exercise of the Preferred Share Purchase Rights. As of December 31, 2006, 2005 and 2004 no shares of Series B Junior Participating Preferred Stock were
outstanding.



On January 19, 2000, the Board of Directors
implemented a Preferred Share Purchase Rights Plan (Rights Plan) to protect stockholders rights in the event of a proposed non-consensual takeover of Gateway believed not to be in the stockholders best interests. Under the Rights Plan,
Gateway declared a dividend of one preferred share purchase right (a Right) for each share of Gateways common stock outstanding. Pursuant to the Rights Plan, each Right entitles the registered holder to purchase from Gateway one one-thousandth
of a share of Series B Junior Participating Preferred Stock, $0.01 par value per share, at a purchase price of $350. In general, with certain exceptions, the Rights are exercisable only if a person or group (an Acquiring Person) acquires beneficial
ownership of 15% or more of Gateways outstanding shares of common stock. Upon exercise, holders, other than



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the Acquiring Person, will have the right, subject to termination, to receive Gateways common stock or other securities, cash or other assets having a
market value, as defined, equal to twice such purchase price. The Rights, which expire on January 18, 2010, are redeemable in whole, but not in part, at Gateways option for a price of $0.001 per Right. Under an agreement with a
stockholder group, the Board of Directors agreed to review the Rights Plan before the 2007 annual meeting of stockholders.



During 1999, Gateway entered into a strategic relationship with America Online, Inc. (AOL) to leverage certain of the companies sales
and distribution channels and capabilities. Under this agreement, Gateway sold $200 million of common stock to AOL, issued 50,000 shares of non-voting Series C Redeemable Convertible Preferred Stock (Series C Preferred Stock) and issued
50,000 shares of non-voting Series A Convertible Preferred Stock (Series A Preferred Stock) in exchange for $600 million in cash and shares of AOL.



On December 22, 2004, Gateway repurchased from AOL all of the outstanding Series A and Series C Preferred Stock plus 2.7 million shares of
common stock for $316 million. Consideration included $280 million in cash to AOL and the application of a $36 million credit towards amounts due to Gateway from AOL. The Company recognized a $100 million gain available for common shareholders on
the repurchase of the preferred stock. This gain was included in net income attributable to common shareholders in accordance with EITF Topic D-42 but excluded from the calculation of diluted earnings per share under the if-converted
method of SFAS 128, Earnings Per Shares. As of December 31, 2004, the Series A and C preferred shares were cancelled and the 2.7 million shares of common stock are held in treasury.



8.    Stock Option Plans, Employee Stock Purchase Plan, Restricted
Stock and Warrants:



Gateway maintains various stock
option plans for its employees. Employee options are granted at the fair market value of the common stock at the date of grant. These options generally vest over a four-year period from the date of grant. In addition, these options generally expire,
if not exercised, ten years from the date of grant. Gateway also maintains option plans for non-employee directors. Option grants to non-employee directors generally have an exercise price equal to the fair market value of the common stock on the
date of grant. These options generally vest over one to three-year periods and generally expire, if not exercised, ten years from the date of grant.



Gateways Compensation Committee of the Board of Directors approved the accelerated vesting on October 4, 2006 of all unvested options held by
then employees, directors and officers which had exercise prices greater than $2.84 per share. Because these options had exercise prices significantly in excess of Gateways stock price of $2.84 on the date of approval, Gateway believed that
these options did not provide sufficient incentive to the employees when compared with the potential future compensation expense that would have been attributable to these options. The acceleration resulted in the recognition of an additional $54
million pro-forma pre-tax stock based compensation in 2005.



For all of Gateways stock option plans, options for 24,441,000 shares, 51,226,000 shares, and 21,933,000 shares of common stock were exercisable as of December 31, 2006, 2005 and 2004, respectively, with a weighted-average
exercise price of $11.57, $9.76, and $20.53, respectively. There were 40,468,000 shares, 24,489,000 shares, and 21,113,000 shares of common stock reserved and available for future grant under Gateways stock option plans as of those dates,
respectively.



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GATEWAY, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following table summarizes activity under the stock option plans for 2006, 2005 and 2004 (in
thousands, except per share amounts):



|                                               |  |                |   |  |                                 |       |                                            |      |                         |   |  
|---------------------------------------------- |  | -------------- | - |  | ------------------------------- | ----- | ------------------------------------------ | ---- | ----------------------- | - | -
|                                               |  | Shares         |   |  | Weighted- averageexercise price |       | Weighted- Averageremainingcontractual term |      | Aggregateintrinsicvalue
|                                               |  | (in thousands) |   |  |                                 |       | (in years)                                 |      | (in thousands)         
|Outstanding, January 1, 2004                   |  | 52,730         |   |  | $                               | 15.29 |                                            |      |                         |   |  
|Granted                                        |  | 35,092         |   |  |                                 | 5.07  |                                            |      |                         |   |  
|Exercised                                      |  | (2,959         | ) |  |                                 | 3.94  |                                            |      |                         |   |  
|Forfeited                                      |  | (21,258        | ) |  |                                 | 14.18 |                                            |      |                         |   |  
|                                               |  |                |   | 
|Outstanding, December 31, 2004                 |  | 63,605         |   |  |                                 | 10.50 |                                            | 4.33 |                         | $ | 
|                                               |  |                |   |  |                                 |       |                                            |      |                         |   |  
|Granted                                        |  | 9,172          |   |  |                                 | 4.24  |                                            |      |                         |   |  
|Exercised                                      |  | (380           | ) |  |                                 | 2.88  |                                            |      |                         |   |  
|Forfeited                                      |  | (16,518        | ) |  |                                 | 11.60 |                                            |      |                         |   |  
|                                               |  |                |   | 
|Outstanding, December 31, 2005                 |  | 55,879         |   |  |                                 | 9.20  |                                            | 3.16 |                         | $ | 
|                                               |  |                |   |  |                                 |       |                                            |      |                         |   |  
|Granted                                        |  | 12,276         |   |  |                                 | 1.91  |                                            |      |                         |   |  
|Exercised                                      |  | (38            | ) |  |                                 | 2.46  |                                            |      |                         |   |  
|Forfeited                                      |  | (30,800        | ) |  |                                 | 7.41  |                                            |      |                         |   |  
|                                               |  |                |   | 
|Outstanding, December 31, 2006                 |  | 37,317         |   |  | $                               | 8.28  |                                            | 6.26 |                         | $ | 
|                                               |  |                |   |  |                                 |       |                                            |      |                         |   |  
|Vested or expected to vest, December, 31, 2006 |  | 34,599         |   |  | $                               | 8.77  |                                            | 6.05 |                         | $ | 
|                                               |  |                |   |  |                                 |       |                                            |      |                         |   |  
|Options exercisable, December, 31, 2006        |  | 24,441         |   |  | $                               | 11.57 |                                            | 4.89 |                         | $ | 
|                                               |  |                |   |  |                                 |       |                                            |      |                         |   |  



The weighted average
fair value of options granted during 2006, 2005, and 2004 is $0.87, $2.15, and $2.90 respectively. The aggregate intrinsic value of options outstanding at December 31, 2006 was calculated as the difference between the exercise price of the
underlying options and the market price of our common stock for the 37.3 million shares that had exercise prices that were lower than the $2.01 market price of our common stock at December 31, 2006. The total intrinsic value of options
exercised during 2006, 2005, and 2004 was $0, $0.4 million, and $4.4 million respectively, determined as of the date of exercise.



The following table summarizes information about Gateways Common Stock options outstanding as of December 31, 2006 (in thousands, except per
share amounts):



|                         |  |                     |  |                                            |  |                                 |       |                   |        |                                 |   |      
|------------------------ |  | ------------------- |  | ------------------------------------------ |  | ------------------------------- | ----- | ----------------- | ------ | ------------------------------- | - | -----
|                         |  | Options Outstanding |  | Options Exercisable                       
|Range of Exercise Prices |  | NumberOutstanding   |  | Weighted-Average RemainingContractual Life |  | Weighted-Average Exercise Price |       | NumberExercisable |        | Weighted-Average Exercise Price
|$  0.00-$  8.25          |  | 31,306              |  | 7.00                                       |  | $                               | 3.69  |                   | 18,430 |                                 | $ | 4.85 
|$  8.25-$16.50           |  | 670                 |  | 0.64                                       |  |                                 | 14.67 |                   | 670    |                                 |   | 14.67
|$16.50-$24.75            |  | 2,217               |  | 2.78                                       |  |                                 | 20.02 |                   | 2,217  |                                 |   | 20.02
|$24.75-$33.00            |  | 1,534               |  | 2.06                                       |  |                                 | 31.17 |                   | 1,534  |                                 |   | 31.17
|$33.00-$41.25            |  | 10                  |  | 2.28                                       |  |                                 | 35.81 |                   | 10     |                                 |   | 35.81
|$41.25-$49.50            |  | 297                 |  | 2.87                                       |  |                                 | 44.63 |                   | 297    |                                 |   | 44.63
|$49.50-$57.75            |  | 699                 |  | 2.72                                       |  |                                 | 55.02 |                   | 699    |                                 |   | 55.02
|$57.75-$66.00            |  | 9                   |  | 3.18                                       |  |                                 | 63.95 |                   | 9      |                                 |   | 63.95
|$66.00-$74.25            |  | 575                 |  | 3.31                                       |  |                                 | 67.38 |                   | 575    |                                 |   | 67.38
|                         |  |                     |  |                                            |  |                                 |       |                   |        |                                 |   |      
|Totals                   |  | 37,317              |  | 6.26                                       |  |                                 | 8.28  |                   | 24,441 |                                 |   | 11.57
|                         |  |                     |  |                                            |  |                                 |       |                   |        |                                 |   |      



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The fair value of these options was estimated on the date of grant, with the following assumptions
used under the Black-Scholes option pricing model:



|                                     |  |                                 |   |  |           |   |  |           |  
|------------------------------------ |  | ------------------------------- | - |  | --------- | - |  | --------- | -
|                                     |  | For the Year Ended December 31, |  
|                                     |  | 2006                            |   |  | 2005      |   |  | 2004      |  
|Dividend yield                       |  |                                |   |  |          |   |  |          |  
|Risk-free interest rate              |  | 5                               | % |  | 4         | % |  | 4         | %
|Expected volatility                  |  | 56                              | % |  | 67        | % |  | 80        | %
|Expected option term (after vesting) |  | 3.5 years                       |   |  | 3.5 years |   |  | 3.5 years |  



Gateway offered
eligible employees the opportunity to acquire shares under an employee stock purchase plan. Under the plan, shares of Gateways common stock may be purchased at 100% of fair market value around the last business day of each month. Employees
could purchase shares having a value up to 20% of their salary, subject to certain statutory limits. Total shares purchased for participating employees under the plan were 4,359 shares, 38,740 shares, and 65,894 shares for 2006, 2005, and 2004,
respectively. Employee withholdings under the plan were terminated effective December 31, 2005 and the plan was terminated effective October 24, 2006.



On October 4, 2005, 2.0 million shares of restricted stock were granted to employees. These shares vest in four equal annual installments.



On March 3, 2006, an executive received a grant of 93,023
shares of restricted stock which vests in 1 year. On September 18, 2006, an executive received a grant of 79,275 shares of restricted stock which vests in 3 equal installments. A deferred compensation liability of $0.4 million was
recorded in the 2006 balance sheet in association with these restricted stock grants.



The following table summarizes information about Gateways restricted stock outstanding as of December 31, 2006 and 2005 (in thousands, except per share amounts):



|                                              |  |                  |   |  |                |      |             |   |         |                                           |  |                         |  |   |       
|--------------------------------------------- |  | ---------------- | - |  | -------------- | ---- | ----------- | - | ------- | ----------------------------------------- |  | ----------------------- |  | - | ------
|                                              |  | Number of shares |   |  | Price pershare |      | Grant value |   |         | Weighted averageremainingcontractual term |  | Aggregateintrinsicvalue
|                                              |  | (in thousands)   |   |  |                |      |             |   |         |                                           |  | (in thousands)         
|Outstanding, January 1, 2004                  |  |                 |   |  | $              |     |             | $ |        |                                           |  |                        |  | $ |      
|                                              |  |                  |   |  |                |      |             |   |         |                                           |  |                         |  |   |       
|Granted                                       |  | 5,307            |   |  |                | 5.19 |             |   | 27,544  |                                           |  |                         |  |   |       
|Restriction Lapse                             |  |                 |   |  |                |     |             |   |        |                                           |  |                         |  |   |       
|Forfeited                                     |  |                 |   |  |                |     |             |   |        |                                           |  |                         |  |   |       
|                                              |  |                  |   |  |                |      |             |   |         |                                           |  |                         |  |   |       
|Outstanding, December 31, 2004                |  | 5,307            |   |  |                | 5.19 |             |   | 27,544  |                                           |  | 1.16                    |  |   | 31,896
|                                              |  |                  |   |  |                |      |             |   |         |                                           |  |                         |  |   |       
|Granted                                       |  | 1,982            |   |  |                | 2.84 |             |   | 5,629   |                                           |  |                         |  |   |       
|Restriction Lapse                             |  | (2,904           | ) |  |                | 5.19 |             |   | (15,069 | )                                         |  |                         |  |   |       
|Forfeited                                     |  | (103             | ) |  |                | 2.84 |             |   | (294    | )                                         |  |                         |  |   |       
|                                              |  |                  |   |  |                |      |             |   |         |                                           |  |                         |  |   |       
|Outstanding, December 31, 2005                |  | 4,282            |   |  |                | 4.16 |             |   | 17,810  |                                           |  | 1.74                    |  |   | 10,748
|                                              |  |                  |   |  |                |      |             |   |         |                                           |  |                         |  |   |       
|Granted                                       |  | 172              |   |  |                | 2.05 |             |   | 353     |                                           |  |                         |  |   |       
|Restriction Lapse                             |  | (2,499           | ) |  |                | 4.86 |             |   | (12,143 | )                                         |  |                         |  |   |       
|Forfeited                                     |  | (583             | ) |  |                | 2.84 |             |   | (1,656  | )                                         |  |                         |  |   |       
|                                              |  |                  |   |  |                |      |             |   |         |                                           |  |                         |  |   |       
|Outstanding, December 31, 2006                |  | 1,372            |   |  | $              | 3.18 |             | $ | 4,364   |                                           |  | 2.06                    |  | $ | 2,757 
|                                              |  |                  |   |  |                |      |             |   |         |                                           |  |                         |  |   |       
|Vested or expected to vest, December 31, 2006 |  | 6,540            |   |  | $              | 4.73 |             | $ | 30,936  |                                           |  | 0.34                    |  | $ | 24,998
|                                              |  |                  |   |  |                |      |             |   |         |                                           |  |                         |  |   |       



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GATEWAY, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Gateway issued warrants to purchase 850,191 shares of common stock at $5.97 per share in exchange for
certain consulting services during 2002. These warrants expired unexercised on April 5, 2006. Prior to 2002, Gateway had issued warrants to purchase 624,750 shares of common stock at $8.92 per share. These warrants expired on September 4,
2005.



9.    Retirement Savings Plan:



Gateway has a 401(k) defined contribution plan, which covers employees who
have attained 18 years of age. Employees are eligible to participate on the first day of employment and may contribute up to 50% of their compensation to the plan in any plan year, subject to certain tax limitations. Participants receive a 50%
matching employer contribution of up to 6% of their annual eligible compensation which vests over two years. Gateway made matching contributions of $2.8 million, $2.7 million, and $3.6 million during 2006, 2005, and 2004, respectively.



10.    Acquisition:



On March 11, 2004, Gateway completed its acquisition of eMachines,
Inc., a privately-held PC company. The acquisition combined Gateways Professional and Consumer (now called Direct) businesses, scale and cash availability with eMachines low cost structure, profitability, PC market strength,
third-party retail network, and international presence. These factors contributed to a purchase price in excess of the fair value of eMachines net tangible and intangible assets acquired and, as a result, Gateway recorded goodwill in
connection with this transaction.



The total purchase price of
$262 million consisted of $41 million of cash, approximately $215 million in common stock and direct transaction costs of approximately $6 million. The consideration included approximately 5.3 million shares of restricted common stock issued to
certain members of eMachines management and contingent upon continued employment of five of these executives through 2005 and two of these executives through 2006. The value of the common stock was determined based on the average market price
of Gateways common stock over the 2-day period prior to and 2-day period following January 30, 2004, the date the acquisition was announced. The value assigned to the restricted shares was approximately $27 million and will continue
to be amortized to operating expense through 2007. The unamortized balance as of December 31, 2006 associated with the restricted shares is shown in Deferred stock-based compensation in the accompanying consolidated balance sheet.



The purchase price was allocated to the identifiable assets acquired and
liabilities assumed based on the fair value of eMachines assets and liabilities as follows (in thousands):



|                                                            |  |   |          |  
|----------------------------------------------------------- |  | - | -------- | -
|Cash acquired                                               |  | $ | 3,589    |  
|Tangible assets acquired                                    |  |   | 304,524  |  
|Amortizable intangible assets (customer relationships)      |  |   | 48,450   |  
|Indefinite-lived intangible assets (trademarks/trade names) |  |   | 49,600   |  
|Goodwill                                                    |  |   | 155,619  |  
|Liabilities assumed                                         |  |   | (300,064 | )
|                                                            |  |   |          |  
|Total consideration                                         |  | $ | 261,718  |  
|                                                            |  |   |          |  



The amortizable
intangible assets consisting of customer-related intangible assets were assigned an estimated useful life of 10 years which will create approximately $4.8 million in additional amortization expense annually through 2014. Goodwill represents the
excess of the purchase price over the fair value of the net



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



tangible and intangible assets acquired and is not tax deductible. Goodwill will not be amortized and will be tested for impairment at least annually or
whenever events or circumstances indicate an event of impairment may exist.



Goodwill has been assigned to the Retail reporting segment which is consistent with the segment presentation of eMachines activities.



The results of operations of eMachines have been included in Gateways consolidated statements of operations since the
completion of the acquisition on March 11, 2004. The following unaudited pro forma information presents a summary of the results of operations of Gateway assuming the acquisition of eMachines occurred on January 1, 2004 (in thousands,
except per share amounts):



|                                             |  |      |           |  
|-------------------------------------------- |  | ---- | --------- | -
|                                             |  | 2004 |          
|Net sales                                    |  | $    | 3,984,264 |  
|Net loss attributable to common stockholders |  | $    | (463,139  | )
|Basic loss per share                         |  | $    | (1.24     | )
|Diluted loss per share                       |  | $    | (1.39     | )



11.    Segment
Data:



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



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



| |  |  | Internationalincludes international sales and is currently 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 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 discussed in Note 13.



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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



The following table presents revenue and operating income information by segment (in thousands):



|                                       |  |      |           |   |      |   |           |      |  |   |           |  
|-------------------------------------- |  | ---- | --------- | - | ---- | - | --------- | ---- |  | - | --------- | -
|                                       |  | 2006 |           |   | 2005 |   |           | 2004 | 
|Net sales:                             |  |      |           |   |      |   |           |      |  |   |           |  
|Retail (including International)       |  | $    | 2,739,884 |   |      | $ | 2,358,669 |      |  | $ | 1,485,715 |  
|Professional                           |  |      | 895,774   |   |      |   | 986,943   |      |  |   | 1,114,493 |  
|Direct                                 |  |      | 345,145   |   |      |   | 508,449   |      |  |   | 1,049,526 |  
|                                       |  |      |           |   |      |   |           |      |  |   |           |  
|                                       |  | $    | 3,980,803 |   |      | $ | 3,854,061 |      |  | $ | 3,649,734 |  
|                                       |  |      |           |   |      |   |           |      |  |   |           |  
|Segment gross profit:                  |  |      |           |   |      |   |           |      |  |   |           |  
|Retail (including International)       |  | $    | 118,050   |   |      | $ | 137,076   |      |  | $ | 57,712    |  
|Professional                           |  |      | 62,189    |   |      |   | 91,399    |      |  |   | 141,300   |  
|Direct                                 |  |      | 75,122    |   |      |   | 93,962    |      |  |   | 194,049   |  
|                                       |  |      |           |   |      |   |           |      |  |   |           |  
|                                       |  | $    | 255,361   |   |      | $ | 322,437   |      |  | $ | 393,062   |  
|                                       |  |      |           |   |      |   |           |      |  |   |           |  
|Segment contribution:                  |  |      |           |   |      |   |           |      |  |   |           |  
|Retail (including International)       |  | $    | 96,350    |   |      | $ | 120,536   |      |  | $ | 43,161    |  
|Professional                           |  |      | (6,509    | ) |      |   | 16,937    |      |  |   | 58,356    |  
|Direct                                 |  |      | 35,379    |   |      |   | 41,601    |      |  |   | 25,070    |  
|                                       |  |      |           |   |      |   |           |      |  |   |           |  
|                                       |  | $    | 125,220   |   |      | $ | 179,074   |      |  | $ | 126,587   |  
|Non-segment expenses and other charges |  |      | (178,607  | ) |      |   | (220,214  | )    |  |   | (728,565  | )
|                                       |  |      |           |   |      |   |           |      |  |   |           |  
|Microsoft benefit                      |  |      | 34,500    |   |      |   | 40,500    |      |  |   |          |  
|Consolidated operating loss            |  | $    | (18,887   | ) |      | $ | (640      | )    |  | $ | (601,978  | )
|                                       |  |      |           |   |      |   |           |      |  |   |           |  



The following table
presents a reconciliation of segment operating income to consolidated income (loss) before income taxes (in thousands):



|                                               |  |      |          |   |      |   |          |      |  |   |          |  
|---------------------------------------------- |  | ---- | -------- | - | ---- | - | -------- | ---- |  | - | -------- | -
|                                               |  | 2006 |          |   | 2005 |   |          | 2004 | 
|Segment operating income                       |  | $    | 125,220  |   |      | $ | 179,074  |      |  | $ | 126,587  |  
|Non-segment operating expenses:                |  |      |          |   |      |   |          |      |  |   |          |  
|Restructuring and other charges:               |  |      |          |   |      |   |          |      |  |   |          |  
|Cost of goods sold                             |  |      |         |   |      |   | 86       |      |  |   | (85,986  | )
|Selling, general and administrative expenses   |  |      | (479     | ) |      |   | (13,144  | )    |  |   | (391,704 | )
|Other non segment operating expenses           |  |      | (178,118 | ) |      |   | (207,155 | )    |  |   | (250,875 | )
|Microsoft benefit                              |  |      | 34,500   |   |      |   | 40,500   |      |  |   |         |  
|Other income, net                              |  |      | 4,138    |   |      |   | 6,791    |      |  |   | 20,247   |  
|Minority interest                              |  |      | (18      | ) |      |   |         |      |  |   |         |  
|                                               |  |      |          |   |      |   |          |      |  |   |          |  
|Consolidated income (loss) before income taxes |  | $    | (14,757  | ) |      | $ | 6,151    |      |  | $ | (581,731 | )
|                                               |  |      |          |   |      |   |          |      |  |   |          |  



The following table
presents net sales by major group of products and services (in thousands):



|                              |  |      |           |      |   |           |  |   |          
|----------------------------- |  | ---- | --------- | ---- | - | --------- |  | - | ---------
|                              |  | 2006 |           | 2005 |   | 2004     
|Desktops                      |  | $    | 1,868,312 |      | $ | 1,894,172 |  | $ | 1,982,141
|Notebooks                     |  |      | 1,437,016 |      |   | 1,191,898 |  |   | 790,159  
|Servers and other             |  |      | 32,129    |      |   | 57,392    |  |   | 54,474   
|                              |  |      |           |      |   |           |  |   |          
|Total personal computers (PC) |  |      | 3,337,457 |      |   | 3,143,462 |  |   | 2,826,774
|Non-PC                        |  |      | 643,346   |      |   | 710,599   |  |   | 822,960  
|                              |  |      |           |      |   |           |  |   |          
|Consolidated net revenues     |  | $    | 3,980,803 |      | $ | 3,854,061 |  | $ | 3,649,734
|                              |  |      |           |      |   |           |  |   |          



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GATEWAY, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



Gateway had long-lived assets of $111 million, $83 million, and $103 million as of December 31,
2006, 2005, and 2004, respectively.



Best Buy accounted for
approximately 36%, 37% and 30% of accounts receivable, net, as of December 31, 2006, 2005 and 2004, respectively, and 39%, 34% and 23% of consolidated net sales for the year ended December 31, 2006, 2005 and 2004, respectively.



12.    Selected Quarterly Financial Data (Unaudited):



The following tables contain selected unaudited
consolidated quarterly financial data for Gateway for the periods indicated (in thousands, except per share data):



|                                                                                      |  |             |           |   |             |   |          |             |  |   |             |   |  |   |           |  
|------------------------------------------------------------------------------------- |  | ----------- | --------- | - | ----------- | - | -------- | ----------- |  | - | ----------- | - |  | - | --------- | -
|                                                                                      |  | 1st Quarter |           |   | 2nd Quarter |   |          | 3rd Quarter |  |   | 4th Quarter |  
|Year Ended December 31, 2006:                                                         |  |             |           |   |             |   |          |             |  |   |             |   |  |   |           |  
|Net sales                                                                             |  | $           | 1,077,822 |   |             | $ | 919,312  |             |  | $ | 963,162     |   |  | $ | 1,020,506 |  
|Gross profit                                                                          |  |             | 78,728    |   |             |   | 50,576   |             |  |   | 73,370      |   |  |   | 52,687    |  
|Operating (loss) income                                                               |  |             | (15,743   | ) |             |   | (6,948   | )           |  |   | 7,929       |   |  |   | (4,114    | )
|Net (loss) income                                                                     |  |             | (12,335   | ) |             |   | (7,680   | )           |  |   | 18,170      |   |  |   | 11,489    |  
|Basic net (loss) income per share                                                     |  |             | (0.03     | ) |             |   | (0.02    | )           |  |   | 0.05        |   |  |   | 0.03      |  
|Diluted net (loss) income per share                                                   |  |             | (0.03     | ) |             |   | (0.02    | )           |  |   | 0.05        |   |  |   | 0.03      |  
|Basic weighted average shares outstanding                                             |  |             | 372,982   |   |             |   | 372,089  |             |  |   | 371,846     |   |  |   | 371,690   |  
|Diluted weighted average shares outstanding                                           |  |             | 372,982   |   |             |   | 372,089  |             |  |   | 407,612     |   |  |   | 372,429   |  
|                                                                                      |  |             |           |  
|                                                                                      |  | 1st Quarter |           |   | 2nd Quarter |   |          | 3rd Quarter |  |   | 4th Quarter |  
|Year Ended December 31, 2005:                                                         |  |             |           |   |             |   |          |             |  |   |             |   |  |   |           |  
|Net sales                                                                             |  | $           | 837,781   |   |             | $ | 873,112  |             |  | $ | 1,018,973   |   |  | $ | 1,124,194 |  
|Gross profit                                                                          |  |             | 80,365    |   |             |   | 87,414   |             |  |   | 84,693      |   |  |   | 69,966    |  
|Operating (loss) income                                                               |  |             | (7,761    | ) |             |   | 17,620   |             |  |   | 18,765      |   |  |   | (29,263   | )
|Net (loss) income                                                                     |  |             | (5,186    | ) |             |   | 17,188   |             |  |   | 15,061      |   |  |   | (20,902   | )
|Basic net (loss) income per share                                                     |  |             | (0.01     | ) |             |   | 0.05     |             |  |   | 0.04        |   |  |   | (0.06     | )
|Diluted net (loss) income per share                                                   |  |             | (0.01     | ) |             |   | 0.05     |             |  |   | 0.04        |   |  |   | (0.05     | )
|Basic weighted average shares outstanding                                             |  |             | 371,152   |   |             |   | 371,198  |             |  |   | 371,166     |   |  |   | 373,115   |  
|Diluted weighted average shares outstanding                                           |  |             | 371,152   |   |             |   | 406,568  |             |  |   | 406,354     |   |  |   | 409,250   |  
|                                                                                      |  |             |           |  
|                                                                                      |  | 1st Quarter |           |   | 2nd Quarter |   |          | 3rd Quarter |  |   | 4th Quarter |  
|Year Ended December 31, 2004:                                                         |  |             |           |   |             |   |          |             |  |   |             |   |  |   |           |  
|Net sales                                                                             |  | $           | 868,383   |   |             | $ | 837,592  |             |  | $ | 915,132     |   |  | $ | 1,028,627 |  
|Gross profit                                                                          |  |             | 108,329   |   |             |   | 16,058   |             |  |   | 92,094      |   |  |   | 90,591    |  
|Operating loss                                                                        |  |             | (187,695  | ) |             |   | (337,491 | )           |  |   | (61,674     | ) |  |   | (15,118   | )
|Net loss                                                                              |  |             | (168,743  | ) |             |   | (335,791 | )           |  |   | (56,476     | ) |  |   | (6,599    | )
|Preferred stock dividends and accretion, net of gain on redemption of preferred stock |  |             | (2,789    | ) |             |   | (2,790   | )           |  |   | (2,792      | ) |  |   | 100,513   |  
|Net income (loss) attributable to common stockholders                                 |  |             | (171,532  | ) |             |   | (338,581 | )           |  |   | (59,268     | ) |  |   | 93,914    |  
|Basic net income (loss) per share                                                     |  |             | (0.51     | ) |             |   | (0.91    | )           |  |   | (0.16       | ) |  |   | 0.25      |  
|Diluted net income (loss) per share                                                   |  |             | (0.51     | ) |             |   | (0.91    | )           |  |   | (0.16       | ) |  |   | (0.02     | )
|Basic weighted average shares outstanding                                             |  |             | 335,399   |   |             |   | 372,436  |             |  |   | 372,940     |   |  |   | 373,844   |  
|Diluted weighted average shares outstanding                                           |  |             | 335,399   |   |             |   | 372,436  |             |  |   | 372,940     |   |  |   | 398,958   |  



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GATEWAY, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



13.    Restructuring and Other Special Charges:



Gateway recorded $0.5 million, $13 million, and $412 million in net
restructuring, transformation and integration charges during 2006, 2005 and 2004, respectively, which are included in cost of goods sold and selling, general, and administrative expenses.



Gateway adopted restructuring plans in 2004 and prior years to, among other things, reduce its workforce and close certain
facilities, including closing 264 retail stores, and consolidate facilities. Adjustments of $1 million were recorded in 2006 primarily related to better than expected recovery on Gateway retail store lease buyouts. The following table summarizes the
status of all remaining restructuring plans as of December 31, 2006 (in millions):



|                     |  |      |     |   |      |   |     |  
|-------------------- |  | ---- | --- | - | ---- | - | --- | -
|                     |  | 2006 |     |   | 2005 |  
|Accrued, January 1   |  | $    | 26  |   |      | $ | 79  |  
|Charges              |  |      |    |   |      |   | 19  |  
|Cash settlements     |  |      | (12 | ) |      |   | (42 | )
|Non-cash settlements |  |      |    |   |      |   | (17 | )
|Adjustments          |  |      | (1  | ) |      |   | (13 | )
|                     |  |      |     |   |      |   |     |  
|Accrued, December 31 |  | $    | 13  |   |      | $ | 26  |  
|                     |  |      |     |   |      |   |     |  



For all restructuring
plans, approximate future cash outflows of $13 million, primarily lease liabilities on closed facilities, are exceeded by expected future cash inflows of $15 million from related sublease recoveries and asset dispositions.



The following table outlines the anticipated future net cash inflows,
including amounts included in the lease payment tables provided in Note 5, associated with all restructuring plans (in thousands):



|                                      |  |   |        |  
|------------------------------------- |  | - | ------ | -
|Years Ending December 31:             |  |   |       
|2007                                  |  | $ | (7,067 | )
|2008                                  |  |   | 3,415  |  
|2009                                  |  |   | 1,426  |  
|2010                                  |  |   | 1,050  |  
|2011                                  |  |   | (552   | )
|                                      |  |   |        |  
|Thereafter                            |  |   |       |  
|                                      |  |   |        |  
|Total accrued restructuring liability |  | $ | (1,728 | )
|                                      |  |   |        |  



14.    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. Between April 2004 and May 2005, the majority common stock shareholder of Alorica, Andy Lee, was employed as Gateways Senior Vice President of Information Technology/Web.
Gateway implemented additional procedures to provide for independent senior management review of any commercial relationships between Gateway and Alorica. Gateway paid approximately $45 million, $54 million, and $43 million for the services
described above during the years ended December 31, 2006, 2005, and 2004, respectively.



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GATEWAY, INC.



NOTES TO CONSOLIDATED FINANCIAL STATEMENTS(Continued)



15.    Subsequent Events:



On February 13, 2007, Gateway received notification from Revenue Ireland, the Irish taxing authority, that it had
waived all further consideration related to possible capital gains treatment resulting from the dissolution and liquidation of certain Gateway entities in Europe. These entities ceased operations in 2001 and have been in the process of liquidation
since then. Based on this notification, Gateway reduced its income taxes payable and increased the related income tax benefit as of and for the year ended December 31, 2006 by $2.7 million.



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GATEWAY, INC.



VALUATION AND QUALIFYING ACCOUNTS

For the years ended December 31, 2006, 2005 and 2004

(in thousands)



|                                                |  |                                |       |                              |   |                           |  |   |                          |   |  |   |      
|----------------------------------------------- |  | ------------------------------ | ----- | ---------------------------- | - | ------------------------- |  | - | ------------------------ | - |  | - | -----
|                                                |  | Balance at Beginning of
Period |       | Additions Charged to Expense |   | Deductions from Allowance |  |   | Balance at End of Period
|Year ended December 31, 2004:                   |  |                                |       |                              |   |                           |  |   |                          |   |  |   |      
|Allowance for uncollectible accounts receivable |  | $                              | 9,526 |                              | $ | 11,333                    |  | $ | (15,746                  | ) |  | $ | 5,113
|                                                |  |                                |       |                              |   |                           |  |   |                          |   |  |   |      
|Year ended December 31, 2005:                   |  |                                |       |                              |   |                           |  |   |                          |   |  |   |      
|Allowance for uncollectible accounts receivable |  | $                              | 5,113 |                              | $ | 5,552                     |  | $ | (4,573                   | ) |  | $ | 6,092
|                                                |  |                                |       |                              |   |                           |  |   |                          |   |  |   |      
|Year ended December 31, 2006:                   |  |                                |       |                              |   |                           |  |   |                          |   |  |   |      
|Allowance for uncollectible accounts receivable |  | $                              | 6,092 |                              | $ | 2,560                     |  | $ | (6,434                   | ) |  | $ | 2,218
|                                                |  |                                |       |                              |   |                           |  |   |                          |   |  |   |      



|Item 9. | Changes in and Disagreements with Independent Registered Public Accounting Firm on Accounting and Financial Disclosure
|------- | ----------------------------------------------------------------------------------------------------------------------



None



|Item 9A. | Controls and Procedures
|-------- | -----------------------



Evaluation of Disclosure Controls and Procedures



We evaluated the design and operating effectiveness of our disclosure controls and procedures as of December 31, 2006,
pursuant to Rule 13a-15(b) of the Securities Exchange Act of 1934, as amended (the Securities Exchange Act). Based on this evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, because of the
material weakness in our internal control over financial reporting described below, our disclosure controls and procedures as defined in Rule 13a-15(e) were not effective. Notwithstanding the material weakness in our internal control over
financial reporting as of December 31, 2006 described below, we believe that the consolidated financial statements contained in this report present fairly our financial condition, results of operations, and cash flows for the fiscal years
covered thereby in all material respects. To address the material weakness in our internal control over financial reporting described below, management performed additional manual procedures and analysis and other post-closing procedures in order to
prepare the consolidated financial statements included in this Annual Report on Form 10-K.



Managements Report on Internal Control Over Financial Reporting



Management is responsible for establishing and maintaining an adequate system of internal control over financial reporting, pursuant to
Rule 13a-15(c) of the Securities Exchange Act, in order to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting
principles generally accepted in the United States (GAAP). A companys internal control over financial reporting includes policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail,
accurately and fairly reflect the transactions and dispositions of the assets of the company, (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with
accounting principles generally accepted in the United States, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company, and (iii) provide reasonable
assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of the companys assets that could have a material effect on the financial statements.



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In accordance with the internal control reporting requirements of the Securities and Exchange Commission,
management completed an assessment of the effectiveness of our internal control over financial reporting as of December 31, 2006. In making this assessment, management used the criteria set forth in the Internal ControlIntegrated
Framework by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The COSO framework summarizes each of the components of a companys internal control system, including the: (i) control environment,
(ii) risk assessment, (iii) information and communication, and (iv) monitoring (collectively, the entity-level controls), as well as (v) a companys control activities (process-level controls).
Managements evaluation of the design and operating effectiveness of our internal controls over financial reporting identified a material weakness resulting from design deficiencies in the internal control system related to the recording of
liabilities, receivables from suppliers and component inventory. A material weakness is defined as a significant deficiency or combination of significant deficiencies, that results in more than a remote likelihood that a material
misstatement of the annual or interim financial statements will not be prevented or detected.



Specifically, during the course of the year-end close process, management examined our processes relating to our receipt of components from original equipment manufacturers (OEMs) and sale of components to original
design manufacturers (ODMs). As a result of that evaluation, management concluded that we did not adequately design controls to ensure the timely accrual of liabilities to OEMs, recording of receivables from ODMs and receipt of inventory through;
(a) timely reconciliation of open purchase orders to OEMs with inventory delivered to ODMs, and (b) timely review and resolution of discrepancies between OEM invoices and ODM receiving data. As a result of these deficiencies, management
posted a material closing adjustment to the balance sheet as of December 31, 2006.



In addition to posting the appropriate adjustment, management also is taking the following steps to remediate this material weakness in 2007:



| |  |  | Structural and operational review of current procurement and receiving procedures.
| | - |  | ----------------------------------------------------------------------------------



| |  |  | Review and re-design of process level controls in Gateways procurement, receiving and accounts payable functions.
| | - |  | ------------------------------------------------------------------------------------------------------------------



| |  |  | Weekly review and comparison of OEM shipment reports to the open purchase order report.
| | - |  | ---------------------------------------------------------------------------------------



| |  |  | Monthly review and follow-up by accounting management to ensure appropriate reconciliation and accrual of un-vouchered invoices as required at period-end.
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | Assessment and adjustment of current staffing in accounting and operational areas as necessary.
| | - |  | -----------------------------------------------------------------------------------------------



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Report of Independent Registered Public Accounting Firm



To the Board of Directors and Stockholders of Gateway, Inc.



We have audited management's assessment, included in the
accompanying Managements Report on Internal Control Over Financial Reporting, appearing in Item 9a, that Gateway, Inc. and subsidiaries (the Company) did not maintain effective internal control over financial reporting as of
December 31, 2006, because of the effect of the material weakness identified in management's assessment based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the
Treadway Commission (COSO). The Company's management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our
responsibility is to express an opinion on management's assessment and an opinion on the effectiveness of the Company's internal control over financial reporting based on our audit.



We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States).
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of
internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances.
We believe that our audit provides a reasonable basis for our opinions.



A company's internal control over financial reporting is a process designed by, or under the supervision of, the company's principal executive and principal financial officers, or persons performing similar functions, and effected by the
company's board of directors, management, and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted
accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts
and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or
disposition of the company's assets that could have a material effect on the financial statements.



Because of the inherent limitations of internal control over financial reporting, including the possibility of collusion or improper management override
of controls, material misstatements due to error or fraud may not be prevented or detected on a timely basis. Also, projections of any evaluation of the effectiveness of the internal control over financial reporting to future periods are subject to
the risk that the controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.



A material weakness is a significant deficiency, or combination of significant deficiencies, that results in more than a
remote likelihood that a material misstatement of the annual or interim financial statements will not be prevented or detected. The following material weakness has been identified and included in management's assessment:



During the course of the year-end close process, Gateways management
identified and concluded that in its receiving and selling of components with original design manufacturers, they did not adequately design controls to ensure the timely accrual of liabilities, recording of receivables from suppliers and receipt of
inventory. As a result of these deficiencies, management posted a material closing adjustment to the balance sheet as of December 31, 2006.



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This material weakness was considered in determining the nature, timing, and extent of audit tests
applied in our audit of the consolidated financial statements as of and for the year ended December 31, 2006, of the Company and this report does not affect our report on such consolidated financial statements.



In our opinion, management's assessment that the Company did not maintain
effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring
Organizations of the Treadway Commission. Also in our opinion, because of the effect of the material weakness described above on the achievement of the objectives of the control criteria, the Company has not maintained effective internal control
over financial reporting as of December 31, 2006, based on the criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.



We have also audited, in accordance with the standards of the Public Company
Accounting Oversight Board (United States), the consolidated financial statements and financial statement schedule as of and for the year ended December 31, 2006, of the Company and our report dated February 23, 2007 expressed an
unqualified opinion on those financial statements.



/s/    DELOITTE & TOUCHE LLP

---



Costa Mesa, California

February 23, 2007



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|Item 9B. | Other Information
|-------- | -----------------



None.



PART III



|Item 10. | Directors and Executive Officers of the Registrant
|-------- | --------------------------------------------------



Information regarding our directors and executive officers is to be incorporated by reference from Gateways 2007 Proxy
Statement, which is to be filed with the Securities Exchange Commission not later than April 30, 2007 (120 days after the end of the fiscal year covered by this Form 10-K).



|Item 11. | Executive Compensation
|-------- | ----------------------



Information regarding the compensation of our directors and executive officers is to be incorporated by reference from Gateways 2007 Proxy
Statement, which is to be filed with the Securities Exchange Commission not later than April 30, 2007 (120 days after the end of the fiscal year covered by this Form 10-K).



|Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
|-------- | ----------------------------------------------------------------------------------------------



Information regarding ownership of our common stock by certain persons and
equity compensation plan information is to be incorporated by reference from Gateways 2006 Proxy Statement, which is to be filed with the Securities Exchange Commission not later than April 30, 2007 (120 days after the end of the fiscal
year covered by this Form 10-K).



EQUITY COMPENSATION PLAN
INFORMATION



The following table summarizes information, as
of December 31, 2006, relating to equity compensation plans of Gateway pursuant to which grants of options, warrants or other rights to acquire shares may be granted from time to time.



|                                                              |  |                                                                                                            |  |                                                                               |       |                                                                                                                                                         |     
|------------------------------------------------------------- |  | ---------------------------------------------------------------------------------------------------------- |  | ----------------------------------------------------------------------------- | ----- | ------------------------------------------------------------------------------------------------------------------------------------------------------- | ----
|Plan category                                                 |  | (a) Number of securities to beissued upon exercise ofoutstanding options, warrantsand rights (in millions) |  | (b) Weighted-average exerciseprice of outstandingoptions, warrants and rights |       | (c) Number of securities remainingavailable for future issuanceunder equity compensationplans (in millions,
excludingsecurities reflected in column(a))
|Equity compensation plans approved by security holders(1)     |  | 38.0                                                                                                       |  | $                                                                             | 7.56  |                                                                                                                                                         | 40.5
|Equity compensation plans not approved by security holders(2) |  | 0.4                                                                                                        |  | $                                                                             | 56.72 |                                                                                                                                                         |     
|Total                                                         |  | 38.4                                                                                                       |  | $                                                                             | 8.04  |                                                                                                                                                         | 40.5

---

|(1) |  | These plans are Gateways 1996 Non-Employee Director Stock Option Plan, 1996 Long-Term Incentive Equity Plan and 2000 Equity Incentive Plan.
|--- |  | --------------------------------------------------------------------------------------------------------------------------------------------

|(2) |  | Gateways sole equity compensation plan not previously submitted to stockholders for approval is our 2000 Employee Equity Incentive Plan, which was only used as an interim
vehicle prior to the submission of our 2000 Equity Incentive Plan for stockholder approval. The 2000 Employee Equity Incentive Plan, which covered approximately 800,000 common stock shares at a weighted average exercise price of $56.67, was
terminated upon receiving such stockholder approval.
|--- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



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|Item 13. | Certain Relationships and Related Transactions
|-------- | ----------------------------------------------



Information regarding relationships or transactions between our affiliates and us is to be incorporated by reference from Gateways 2007 Proxy
Statement, which is to be filed with the Securities Exchange Commission not later than April 30, 2007 (120 days after the end of the fiscal year covered by this Form 10-K).



|Item 14. | Principal Accountant Fees and Services
|-------- | --------------------------------------



Information regarding principal accountant fees and services is to be incorporated by reference from Gateways 2007 Proxy Statement, which is to be
filed with the Securities Exchange Commission not later than April 30, 2007 (120 days after the end of the fiscal year covered by this Form 10-K).



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PART IV



|Item 15. | Exhibits and Financial Statement Schedules
|-------- | ------------------------------------------



(a) The following documents are filed as a part of this Report:



(1) Financial Statements and Financial Statement Schedule. See Index to Consolidated Financial Statements
and Financial Statement Schedule at Item 8 of this Annual Report.



(2) Exhibits. Exhibits identified below as on file with the Securities and Exchange Commission are incorporated herein by reference as exhibits hereto.



|              |  |                                                                                                                                                                                                                                                                                                |  |                           |  |             |  |                                                
|------------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | ----------- |  | -----------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                                                                                                                                            |  | Incorporated by Reference
|              |  | Form                                                                                                                                                                                                                                                                                           |  | Exhibit(s)                |  | Filing Date
|2.1           |  | Agreement and Plan of Merger, dated as of January 30, 2004, by and among Gateway, Inc., Gateway Sub, LLC, Gateway Sub II, LLC and EM Holdings, Inc.                                                                                                                                            |  | 8-K                       |  | 2.1         |  | February 3, 2004                               
|              |  |                                                                                                                                                                                                                                                                                                |  |                          
|3.1           |  | Restated Certificate of Incorporation of Gateway, Inc., as amended                                                                                                                                                                                                                             |  | 10-K                      |  | 3.1         |  | February 12, 2002                              
|              |  |                                                                                                                                                                                                                                                                                                |  |                          
|3.2           |  | Amended and Restated Bylaws of Gateway, Inc.                                                                                                                                                                                                                                                   |  | 8-K                       |  | 3.2         |  | December 11, 2006                              
|              |  |                                                                                                                                                                                                                                                                                                |  |                          
|4.1           |  | Rights Agreement, dated as of January 19, 2000, between Gateway, Inc. and UMB Bank, N.A., as Rights Agent, including all exhibits thereto.                                                                                                                                                     |  | 8-A                       |  | 1.0         |  | February 4, 2000                               
|              |  |                                                                                                                                                                                                                                                                                                |  |                          
|4.2           |  | Registration Agreement dated February 22, 1991 between Gateway, Inc., Theodore W. Waitt and Norman W. Waitt, Jr. as the sole trustee and sole beneficiary of the Norman W. Waitt, Jr. S Corp.
Trust, together with Amendment No. 1 to the Registration Agreement dated as of October 19, 1993* |  | S-1                       |  | 10.11       |  | October 21, 1993                               
|              |  |                                                                                                                                                                                                                                                                                                |  |                          
|4.3           |  | Form of Stockholders and Registration Rights Agreement, by and among Gateway, Inc., Mr. Lap Shun (John) Hui and certain Gateway, Inc. stock recipients                                                                                                                                        |  | 8-K                       |  | 2.1         |  | February 3, 2004 (Exhibit B within Exhibit 2.1)
|              |  |                                                                                                                                                                                                                                                                                                |  |                          
|4.4           |  | Registration Rights Agreement, dated as of March 22, 2005, between Theodore W. Waitt and Gateway, Inc.                                                                                                                                                                                         |  | 8-K                       |  | 10.1        |  | March 25, 2005                                 
|              |  |                                                                                                                                                                                                                                                                                                |  |                          
|4.5           |  | Indenture between Gateway, Inc. and U.S. Bank National Association, as Trustee (including form of 1.50% Senior Convertible Notes due 2009 and form of 2.00% Senior Convertible Notes due 2011),
dated as of December 21, 2004                                                                  |  | 8-K                       |  | 10.1        |  | December 21, 2004                              
|              |  |                                                                                                                                                                                                                                                                                                |  |                          
|10.1          |  | Tax Indemnification Agreement, dated as of December 6, 1993 between Gateway, Inc., and Theodore W. Waitt and the Norman W. Waitt, Jr. S Corp. Trust.*                                                                                                                                          |  | 10-K                      |  | 10.1        |  | March 31, 1994                                 
|              |  |                                                                                                                                                                                                                                                                                                |  |                          
|10.2          |  | Indemnification Agreement dated as of December 6, 1994 between Gateway, Inc., and Theodore W. Waitt.*                                                                                                                                                                                          |  | 10-K                      |  | 10.2        |  | March 31, 1995                                 



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|              |  |                                                                                                                                                                                                                                                                            |  |                           |  |             |  |                  
|------------- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | ----------- |  | -----------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                                                                                                                        |  | Incorporated by Reference
|              |  | Form                                                                                                                                                                                                                                                                       |  | Exhibit(s)                |  | Filing Date
|10.3          |  | Gateway, Inc. 1996 Long-Term Incentive Equity Plan, as amended and restated*                                                                                                                                                                                               |  | 10-K                      |  | 10.7        |  | March 5, 2001    
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.4          |  | Gateway, Inc. 2000 Equity Incentive Plan, as amended and restated*                                                                                                                                                                                                         |  | 10-Q                      |  | 10.18       |  | August 14, 2000  
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.5          |  | Gateway, Inc 1996 Non-Employee Directors Stock Option Plan as amended.*                                                                                                                                                                                                    |  | 10-Q                      |  | 10.20       |  | August 14, 1998  
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.6          |  | Form of Gateway, Inc. Restricted Stock Grant Notice*                                                                                                                                                                                                                       |  | 10-Q                      |  | 10.2        |  | November 8, 2005 
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.7          |  | Gateway, Inc. Management Incentive Plan, as amended*                                                                                                                                                                                                                       |  | 10-Q                      |  | 10.10       |  | July 24, 2001    
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.8          |  | Change in Control Compensation Plan, as amended*                                                                                                                                                                                                                           |  | 10-K                      |  | 10.12       |  | April 15, 2003   
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.9          |  | Non-Competition Agreement, dated as of January 30, 2004, by and between Mr. Lap Shun (John) Hui and Gateway, Inc.                                                                                                                                                          |  | 10-K                      |  | 10.18       |  | February 27, 2004
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.10         |  | Non-Competition Agreement, dated as of January 30, 2004, by and between Mr. Wayne R. Inouye and Gateway, Inc.*                                                                                                                                                             |  | 10-K                      |  | 10.19       |  | February 27, 2004
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.11         |  | Credit Agreement dated October 30, 2004, among Gateway, Inc, Gateway Professional LLC, Gateway Manufacturing LLC, eMachines, Inc.; other Credit Parties signing the Credit Agreement; General
Electric Capital Corporation; and other Lenders signing the Credit Agreement |  | 8-K                       |  | 10.1        |  | November 2, 2004 
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.12         |  | Amendment No. 2 dated June 28, 2006 to Credit Agreement, dated October 30, 2004, among Gateway, Inc, Gateway Professional LLC, Gateway Manufacturing LLC, Gateway US Retail, Inc., and General
Electric Capital Corporation, as agent and lender                           |  | 8-K                       |  | 10.1        |  | June 30, 2006    
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.13         |  | Amendment No. 3 dated December 26, 2006 to Credit Agreement, dated October 30, 2004, among Gateway, Inc, Gateway Professional LLC, Gateway Manufacturing LLC, Gateway US Retail, Inc., and General
Electric Capital Corporation, as agent and lender                       |  | 8-K                       |  | 10.1        |  | January 3, 2007  
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.14         |  | Stock Purchase Agreement between America Online, Inc. and Gateway, Inc. dated as of November 1, 2004                                                                                                                                                                       |  | 8-K                       |  | 10.1        |  | November 5, 2004 
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.15         |  | Stock Transfers and Future Payments Agreement between America Online, Inc. and Gateway, Inc. dated as of November 1, 2004                                                                                                                                                  |  | 8-K                       |  | 10.2        |  | November 5, 2004 
|              |  |                                                                                                                                                                                                                                                                            |  |                          
|10.16         |  | Marketing, Development and Settlement Agreement, dated as of April 7, 2005, by and between Microsoft Corporation and Gateway, Inc.                                                                                                                                         |  | 10-Q                      |  | 10.1        |  | August 15, 2005  



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|              |  |                                                                                                                                                                                                                                         |  |                           |  |             |  |                                                                         
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------------- |  | ----------- |  | ------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit Description                                                                                                                                                                                                                     |  | Incorporated by Reference
|              |  | Form                                                                                                                                                                                                                                    |  | Exhibit(s)                |  | Filing Date
|10.17         |  | Employment Offer Agreement, dated as of April 26, 2006, by and between Richard D. Snyder and Gateway, Inc.*                                                                                                                             |  | 8-K                       |  | 10.1        |  | April 27, 2006                                                          
|              |  |                                                                                                                                                                                                                                         |  |                          
|10.18         |  | Stock Option Agreement, dated as of April 26, 2006, by and between Richard D. Snyder and Gateway, Inc.*                                                                                                                                 |  | 8-K                       |  | 10.2        |  | April 27, 2006                                                          
|              |  |                                                                                                                                                                                                                                         |  |                          
|10.19         |  | Separation Agreement, effective as of April 30, 2006, by and between Scott Bauhofer and Gateway, Inc.*                                                                                                                                  |  | 8-K                       |  | 10.1        |  | April 28, 2006                                                          
|              |  |                                                                                                                                                                                                                                         |  |                          
|10.20         |  | Separation Agreement, effective as of April 29, 2006, by and between Bruce Smith and Gateway, Inc.*                                                                                                                                     |  | 8-K                       |  | 10.2        |  | April 28, 2006                                                          
|              |  |                                                                                                                                                                                                                                         |  |                          
|10.21         |  | Separation Agreement, effective as of February 8, 2006, by and between Wayne R. Inouye and Gateway, Inc.*                                                                                                                               |  | 10-Q                      |  | 10.1        |  | May 9, 2006                                                             
|              |  |                                                                                                                                                                                                                                         |  |                          
|10.22         |  | Employment Offer Letter by and between J. Edward Coleman and Gateway, Inc., dated September 1, 2006*                                                                                                                                    |  | 8-K                       |  | 10.1        |  | September 7, 2006                                                       
|              |  |                                                                                                                                                                                                                                         |  |                          
|10.23         |  | Gateway, Inc. 2006 Change In Control Compensation Plan, effective as of September 29, 2006*                                                                                                                                             |  | 8-K                       |  | 10.1        |  | October 5, 2006                                                         
|              |  |                                                                                                                                                                                                                                         |  |                          
|10.24         |  | Form of Individual Change In Control Agreement*                                                                                                                                                                                         |  | 8-K                       |  | 10.2        |  | October 5, 2006                                                         
|              |  |                                                                                                                                                                                                                                         |  |                          
|10.25         |  | Agreement, dated December 5, 2006, among Gateway, Inc., Scott Galloway and Firebrand Partners III, LLC, Harbinger Capital Partners Master Fund I, Ltd., and Harbinger Capital Partners Special
Situations Fund, L.P. and its affiliates |  | 8-K                       |  | 10.1        |  | December 11, 2006                                                       
|              |  |                                                                                                                                                                                                                                         |  |                          
|21.1          |  | List of subsidiaries                                                                                                                                                                                                                    |  |                           |  |             |  | Filed herewith                                                          
|              |  |                                                                                                                                                                                                                                         |  |                          
|23.1          |  | Consent of Deloitte & Touche LLP                                                                                                                                                                                                        |  |                           |  |             |  | Filed herewith                                                          
|              |  |                                                                                                                                                                                                                                         |  |                          
|24.1          |  | Powers of attorney                                                                                                                                                                                                                      |  |                           |  |             |  | Included herein on the signature page of this Annual Report on Form 10-K
|              |  |                                                                                                                                                                                                                                         |  |                          
|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.                                                                                                     |  |                           |  |             |  | Filed herewith                                                          
|              |  |                                                                                                                                                                                                                                         |  |                          
|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.                                                                                                     |  |                           |  |             |  | Filed herewith                                                          
|              |  |                                                                                                                                                                                                                                         |  |                          
|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.                                                                                                          |  |                           |  |             |  | Furnished herewith                                                      
|              |  |                                                                                                                                                                                                                                         |  |                          
|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.                                                                                                          |  |                           |  |             |  | Furnished herewith                                                      

---

|* |  | Indicates a management contract or compensatory plan.
|- |  | -----------------------------------------------------



Gateway will furnish upon request any exhibit described above upon payment of Gateways reasonable expenses for furnishing such exhibit.



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SIGNATURES



Pursuant to the
requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on February 23, 2007.



GATEWAY, INC.By:

/s/    JOHN P.
GOLDSBERRYJohn P. Goldsberry Senior Vice President and Chief Financial Officer (Principal Financial
Officer)




By:

/s/    NEAL E.
WESTNeal E. West Vice President and Controller (Principal Accounting Officer)




Each person
whose signature appears below constitutes and appoints John P. Goldsberry, Michael R. Tyler and Mark Dickey or any one of them, his attorney-in-fact, for such person in any and all capacities, to sign any amendments to this report and to file the
same, with exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, hereby ratifying and confirming all that said attorneys-in-fact, or substitute or substitutes, may do or cause to be done by
virtue hereof.



Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant in the capacities indicated as of February 23, 2007:



|                                             |  |                                                                                
|-------------------------------------------- |  | -------------------------------------------------------------------------------
|Signature                                    |  | Title                                                                          
|                                             | 
|/s/    J. EDWARD
COLEMAN J. Edward Coleman   |  | Chief Executive Officer and Director (Principal Executive Officer)             
|                                             | 
|/s/    JOHN P.
GOLDSBERRY John P. Goldsberry |  | Senior Vice President and Chief Financial Officer (Principal Financial Officer)
|                                             | 
|/s/    NEAL E.
WEST Neal E. West             |  | Vice President and Controller (Principal Accounting Officer)                   
|                                             | 
|/s/    QUINCY L.
ALLEN Quincy L. Allen       |  | Director                                                                       
|                                             | 
|/s/    JANET M.
CLARKE Janet M. Clarke       |  | Director                                                                       
|                                             | 
|/s/    SCOTT
GALLOWAY Scott Galloway         |  | Director                                                                       
|                                             | 
|/s/    GEORGE H.
KRAUSS George H. Krauss     |  | Director                                                                       
|                                             | 
|/s/    DOUGLAS L.
LACEY Douglas L. Lacey     |  | Director                                                                       



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|                                                   |  |                      
|-------------------------------------------------- |  | ---------------------
|Signature                                          |  | Title                
|                                                   | 
|/s/    JOSEPH G. PARHAM,
JR. Joseph G. Parham, Jr. |  | Director             
|                                                   | 
|/s/    RICHARD D.
SNYDER Richard D. Snyder         |  | Chairman of the Board
|                                                   | 
|/s/    PAUL E.
WEAVER Paul E. Weaver               |  | Director             



82