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SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the quarterly period ended March 31, 2004

OR

For the transition period from                      to                     

Commission file number 0-22784

GATEWAY, INC.

(Exact name of registrant as specified in its charter)

14303 Gateway Place

Poway, California 92064

(Address of principal executive offices, zip code)

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

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). Yes x No ¨

As of May 6, 2004 there were 372,392,050 shares of the Common Stock of Gateway, $.01 par value per share, outstanding. As of May 6, 2004 there were no shares of Gateway’s Class A Common Stock, $.01 par value per share, outstanding.

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GATEWAY, INC

FORM 10-Q

For the period ended March 31, 2004

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I. FINANCIAL INFORMATION

GATEWAY, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (Unaudited)

For the three months ended March 31, 2004 and 2003

(in thousands, except per share amounts)

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

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CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

March 31, 2004 and December 31, 2003

(in thousands, except per share amounts)

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

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CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

For the three months ended March 31, 2004 and 2003

(in thousands)

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

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The accompanying unaudited condensed consolidated financial statements of Gateway, Inc. (“Gateway” or “Company”) as of March 31, 2004 and for the three months ended March 31, 2004 and 2003 have been prepared on the same basis as the audited consolidated financial statements for the year ended December 31, 2003 and, in the opinion of management, reflect all adjustments necessary to fairly state the unaudited condensed consolidated financial position, results of operations and cash flows for the interim periods. All adjustments are of a normal, recurring nature excepts as discussed in (h) below. The results for the interim periods are not necessarily indicative of results to be expected for any other interim period or the entire year. These unaudited condensed consolidated financial statements should be read in conjunction with Gateway’s audited consolidated financial statements and notes thereto for the year ended December 31, 2003, which are included in Gateway’s 2003 Annual Report on Form 10-K, filed with the Securities and Exchange Commission (“SEC”).

Gateway is a manufacturer and distributor and direct marketer of personal computers (“PCs”) and PC-related products and services and consumer electronics products and services. Consumer electronics and other non-PC related products and services (“CE/non-PC”) consist of all products and services other than the PC, such as peripherals, software, accessories, extended warranty services, training, internet services, digital TVs, digital cameras and enterprise system and networking products and services.

On March 11, 2004, Gateway completed its acquisition of eMachines, Inc., a privately-held computer manufacturer and distributor. These unaudited condensed consolidated financial statements include eMachines’ condensed consolidated balance sheet and results of operations subsequent to March 11, 2004.

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

The condensed consolidated financial statements include the accounts of Gateway and its majority owned subsidiaries. All intercompany accounts and transactions have been eliminated in consolidation. Certain reclassifications have been made to previously reported information to conform to current presentation. These reclassifications had no impact on previously reported net loss or stockholders’ equity.

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 Company’s provisions for sales returns, bad debts in accounts receivable, inventory obsolescence, product warranties and rebates, restructuring activities, tax assets and litigation matters.

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

Marketable securities consist of mutual funds, equity securities, commercial paper and debt securities that are carried at their market values. Marketable securities are classified as available-for-sale and are adjusted to their fair market values each reporting date using quoted market prices. Long-term investments, including publicly traded equity securities, represent minority investments in other companies. Certain of these long-term investments carried restrictions on immediate disposition and were included within long-term other assets, net. Unrealized gains and losses are recorded as a component of accumulated other comprehensive income. Upon disposition of marketable securities, the specific identification method is used to determine the cost basis in computing realized gains or losses.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Gateway regularly monitors and evaluates the realizable value of its investments. When assessing the 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 less than its original cost, the performance of the investee’s stock price in relation to the stock price of its competitors within the industry and the market in general, analyst recommendations, any news that has been released specific to the investee and the outlook for the overall industry in which the investee operates. Gateway also reviews the financial statements of the investee to determine if the investee is experiencing financial difficulties and considers new products/services that the investee may have forthcoming that will improve its operating results. If events and circumstances indicate that an other-than-temporary decline in the value of these assets has occurred, Gateway records an impairment charge to Other income, net in that period. No impairment charge was necessary or recorded during the first quarter of 2004 or 2003.

Inventory, which is comprised of component parts, both owned and consigned, subassemblies and finished goods, including refurbished PCs, is valued at the lower of first-in, first-out (FIFO) cost or market. Component parts and subassemblies consist of raw materials and products other than the PC such as peripherals, software not included with the PC, accessories, consumer electronics and digital television products. On a quarterly basis, Gateway performs an assessment of its inventories, reviewing the amount of the inventory on hand and under commitment with its latest forecasted requirements to determine whether write-downs are required.

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

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

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 tradenames and goodwill are not amortized. Intangible assets including goodwill are reviewed for impairment at least annually and whenever events or circumstances indicate an event of impairment may exist. Amortization expense was $2.8 million and $2.3 million for the first quarter of 2004 and 2003, respectively.

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 future net cash flows expected to result from the use of the asset and its eventual disposition does not exceed its carrying amount. The amount of impairment loss, if any, is measured as the difference between the net book value of the asset and its estimated fair value. An impairment charge of $70 million was recorded in the first quarter of 2004 as a result of its decision to close the retail stores effective April 9, 2004 (see Note 7).

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.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Gateway provides standard warranties with the sale of products. The estimated cost of providing the product warranty is recorded at the time revenue is recognized. Gateway maintains product quality programs and processes including 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. A reconciliation of changes in Gateway’s accrued warranty liability, which is included in accrued liabilities and long-term liabilities, is as follows (in thousands):

Gateway has experienced a significant decline in its warranty provision in recent quarters due to the shortening of PC standard warranty periods and an increase in the amount of warranty costs being reimbursed by its suppliers.

Gateway recognizes revenue when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed and determinable, and collectibility is reasonably assured. Revenue from services that are rendered by Gateway, such as extended warranties, is recognized straight-line over the service period, while training revenue is recognized as the services are provided. The Company offers its customers internet services which are provided by third parties. The revenue associated with these services is recognized as the services are provided based on subscriber counts, which are reported to Gateway by the service providers. Other than internet services, revenue from the sale of services that are rendered by third parties, such as installation, is recognized when such services are delivered.

Gateway records reductions in revenue in the current period for future product returns and rebates related to current period sales. Management analyzes historical returns, current economic trends, changes in customer demand and acceptance of Gateway products when evaluating the adequacy of the sales returns allowances in any accounting period. Gateway records reductions to revenue for estimated commitments related to customer incentive programs, including customer rebates and other sales incentives. This includes, among other things, trade-ins and referral credits.

Gateway offers its customers an option to purchase extended warranties. Revenue from extended warranty sales is deferred and recognized over the warranty service period. Revenue related to sales of extended warranties provided by third-party service providers is recognized at the time of sale. A schedule of additions to extended warranty deferred revenue, which is included in other current liabilities and long-term liabilities, and recognition of extended warranty revenue is as follows (in thousands):

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 earned.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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 5.

Basic loss per common share is computed using net loss attributable to common stockholders and the weighted average number of common shares outstanding during the period. Diluted loss per common share is computed using net loss attributable to common stockholders and the combination of potentially dilutive common stock and the weighted average number of common shares outstanding during the period. Diluted shares for the three months ended March 31, 2004 and 2003 excludes 22,631 and 22,353 weighted average incremental shares, respectively, related to employee and directors stock options and Series A Convertible Preferred Stock. These shares are excluded despite their exercise prices being below the average market price, or assuming the “if converted” method for the Series A Convertible Preferred Stock, as their effect is anti-dilutive. The Series C Redeemable Convertible Preferred Stock is contingently convertible to 5,939 shares and is not included in calculating loss per share as the contingency was not met as of March 31, 2004. In addition, for the three months ended March 31, 2004 and 2003 Gateway has excluded 42,598 and 54,040 shares, respectively, related to non-employee warrants and employee and director stock options which have exercise prices greater than the average market price of the common shares.

Gateway considers the U.S. dollar to be its functional currency for certain of Gateway’s 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 US 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.

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

Gateway uses the disclosure-only provisions of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation.” The fair value of options was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions used for all grants in 2004 and 2003: dividend yield of zero percent; risk-free interest rates ranging from 1.5 to 2.9 percent; and expected lives of the options of three and one-half years. The expected volatility used in estimating the fair market value on the date of grant was 71 percent.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Had compensation expense for employee and director stock options been determined based on the fair value of the options on the date of the grant, net loss and net loss per share would have been (in thousands, except per share amounts):

Gateway reports segment data based on the internal reporting that is used by the chief executive officer for making operating decisions and assessing performance which is designated as the source of Gateway’s reportable operating segments. Gateway’s segments are Consumer and Professional.

In December 2003, the Financial Accounting Standards Board issued a revised interpretation of FIN 46, “Consolidation of Variable Interest Entities” (“FIN 46-R”). FIN 46 requires certain variable interest entities (“VIEs”) to be consolidated by the primary beneficiary of the entity if the equity investors in the entity do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk in the entity to finance its activities without additional subordinated financial support from the other parties and was effective for the Company for all VIE arrangements entered into after January 31, 2003. FIN 46-R was effective for the Company in the first quarter 2004 and neither the adoption of FIN 46 or FIN 46-R had a material impact on its results of operations, financial position or cash flow.

In December 2003, the SEC issued Staff Accounting Bulletin (“SAB”) No. 104, “Revenue Recognition”, which supersedes SAB 101, “Revenue Recognition in Financial Statements”. SAB 104 rescinds the accounting guidance contained in SAB 101 specifically related to multiple element revenue arrangements, but leaves the remaining SAB 101 principles largely unchanged. The adoption of SAB 104 did not have a material impact on Gateway’s consolidated results of operations or financial position.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Comprehensive loss for Gateway includes net loss, foreign currency translation adjustments and net unrealized gains or losses on available-for-sale securities. Comprehensive loss for the three and nine months ended March 31, 2004 and 2003 is as follows (in thousands):

The increase in accounts receivable is driven by the acquisition of eMachines partially offset by a decrease in net term sales in the first quarter of 2004 as compared to the fourth quarter of 2003.

The increase in inventory is primarily driven by the acquisition of eMachines. The Company expects that, with the addition of eMachines, its future inventory levels will be higher than levels historically maintained by Gateway alone due to eMachines’ operational fulfillment model in support of distribution to third-party retailers.

The decrease in property, plant and equipment is primarily the result of the impairment of long-lived assets associated with the closure of the Company’s retail stores. See Note 7 for additional information.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The increase in intangible assets results from the acquisition of eMachines. See Note 9 for additional information.

The increase in accounts payable is driven primarily by the acquisition of eMachines.

The increase in other long-term liabilities is due to a deferred income tax liability associated with the acquisition of eMachines.

On February 2, 2001, Gateway received $200 million in exchange for a convertible note due December 22, 2020 in connection with the second closing of the investment agreement with America Online, Inc. (“AOL”). In December 2001, this convertible note was extinguished through the issuance of 50,000 shares of non-voting Series C Redeemable Convertible Preferred Stock (“Series C Preferred Stock”). The Series C Preferred Stock had a fair value on the date of issuance of approximately $193 million. The fair value of $193 million is being accreted to the face value of $200 million through 2004 using the interest method. The Series C Preferred Stock bears dividends at an annual rate of 1.5% paid semi-annually. The holder can put the Series C Preferred Stock to Gateway in December 2004, 2009 and 2014 at face value and Gateway can satisfy this put option in cash or registered common stock or some combination thereof at its option. The holder can convert the Series C Preferred Stock to 5,938,948 shares of common stock at any time prior to December 2014, provided Gateway’s common stock trades over $33.68 for 5 consecutive days. In addition, Gateway can redeem the Series C Preferred Stock at any time after December 2004 for the face value plus accrued and unpaid dividends.

Gateway issued 50,000 shares of nonvoting Series A Convertible Preferred Stock (“Series A Preferred Stock”) to AOL in exchange for $200 million in December 2001. This issuance was the third and final funding under the investment agreement which, among other things, reduced the total investment amount to $600 million for AOL. The Series A Preferred Stock will automatically convert into common stock of Gateway in December 2004 at a conversion rate between $8.99 and $10.07 per share based on the fair value of Gateway’s common stock at the date of conversion. If the Company’s common stock price on that date is comparable to its common stock price as of March 31, 2004, the Series A would convert into a total of 22,238,283 shares of common stock. The Series

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

A Preferred Stock is convertible earlier than December 2004 at the option of AOL in the event of certain circumstances. The Series A Preferred Stock bears dividends at an annual rate of 2.92% paid quarterly.

Holders of Preferred Stock are entitled to receive dividends when and as declared by the Board of Directors. If dividends on the Preferred Stock are not paid, they continue to accrue and, in general, the Company may not buy back its common stock while any such dividends remain unpaid. In addition, if dividends remain unpaid for (i) any two consecutive quarters or (ii) three quarterly payment periods in any six consecutive quarterly payment periods, then (1) if such dividends are unpaid on the Series A Preferred Stock, the holder has the option to convert the Series A Preferred Stock into 22,238,283 shares of Gateway common stock based on a conversion price of $8.99 per share, and (2) certain restrictions on the transfer of the Preferred Stock and the Gateway common stock held by the holder of the Preferred Stock are lifted.

The accretion and dividends on preferred stock are subtracted from net loss in calculating net loss attributable to common stockholders for the purposes of computing loss per share.

Gateway records a tax provision or benefit for the anticipated tax consequences of its reported results of operations. The 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. Gateway recorded a tax benefit of approximately $13 million for the reversal of previously accrued tax liabilities resulting from recent tax authority settlements during the first quarter of 2004. Additionally, Gateway recorded a $19.8 million deferred tax liability related to the eMachines’ purchase accounting. eMachines will be included in Gateway’s federal consolidated income tax return effective March 12, 2004, with their taxable income being offset by anticipated losses incurred by Gateway for 2004. In the first quarter of 2003, Gateway recorded no tax benefit. Gateway expects to maintain a full valuation allowance on future tax benefits until an appropriate level of profitability is sustained.

Gateway had Standby Letters of Credit and Guarantees outstanding at March 31, 2004, amounting to $31 million.

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.

Hewlett-Packard Development Company, L.P. v. Gateway, Inc. is a suit filed in the United States District Court in the Southern District of California on March 24, 2004. The complaint alleges that Gateway infringed six patents related to keyboard password functions, cursor generation in a graphics display, computer housing access doors, notebook computers, and power management. On or about April 5, 2004, Hewlett-Packard Development Company, L.P. (“HPDC”) amended its complaint to allege the infringement of four additional patents. Those patents concern video display systems, configuration of computer systems and circuit boards, concurrent bus operations, and initialization of a multiple processor computer system. HPDC seeks damages, including treble damages, an injunction, prejudgment interest, costs and attorneys fees. Gateway has answered the complaint denying the allegations and alleging numerous affirmative defenses, and has asserted counterclaims against HPDC and Hewlett-Packard Company asserting patent infringement and seeking damages, including treble damages, an injunction, prejudgment interest, costs and attorneys fees. On May 6, 2004, Hewlett-Packard Company and HPDC also filed a complaint with the International Trade Commission asserting that Gateway products infringe on seven patents. Those patents concern generally notebook computer heat-transfer optimization, boot methods from CD-ROM or tape, preserving cache memory under processor resets, and DMA oversight of data transfer. The Commission has not yet determined whether to institute an investigation. If it does so, Gateway will respond appropriately.

Intergraph Hardware Technologies Company v. Dell Computer Corporation, Hewlett-Packard, Inc. & Gateway, Inc. is a suit filed in the United States District Court in the Eastern District of Texas on December 16, 2002. The suit alleges Gateway infringed three patents related to cache memory. Intergraph seeks damages (including enhanced damages), an injunction, prejudgment interest, costs and attorneys fees. Gateway had answered the complaint denying all allegations and alleging numerous affirmative defenses, and had asserted counterclaims for declaratory judgment. The parties are currently engaged in settlement discussions. Trial is set for August 2004.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Lucent Technologies, Inc. v. Gateway, Inc. is a suit filed on June 6, 2002 in the United States District Court in the Eastern District of Virginia which was subsequently transferred to the United States District Court in the Southern District of California. 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 Computer 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, to assert now the same patents against each. 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 three actions, which have been consolidated for all purposes but trial, are currently set for trial in October 2005.

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 transaction in which eMachines 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 and/or recessionary damages 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. After initially denying class certification, on August 25, 2003, the court granted class certification. The court has yet to set a trial date.

Gateway’s management believes 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 any of these legal matters or should several of these legal matters be resolved against Gateway in the same reporting period, the operating results of a particular reporting period could be materially adversely affected.

First Quarter 2004 Plan (“Q1 2004 Plan”):

During the first quarter of 2004, Gateway approved a restructuring plan to, among other things, close its 188 retail stores. A charge of $73 million ($3 million in cost of goods sold and $70 million in sales, general and administrative expenses), including $70 million related to store fixed assets, display equipment and inventories and $3 million in severance costs was recorded in the first quarter of 2004 to provide for these actions. The significant retail restructuring actions were initiated in the first quarter of 2004 and substantially completed by early in the second quarter of 2004. Additional charges of approximately $85 million representing primarily severance costs and lease obligations related to the stores, will be recorded under this plan in the second quarter of 2004. In addition to the $73 million, Gateway recorded $8 million ($2 million in cost of goods sold and $6 million in selling, general and administrative) in charges associated with previous restructuring activities, as well as $23 million ($6 million in cost of goods sold and $17 million in selling, general and administrative expenses) in outsourcing and other expenses related to its transformation.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

The following table summarizes the charges recorded in the first quarter of 2004 for the Q1 2004 Plan (in millions):

Third Quarter 2003 Plan (“Q3 2003 Plan”):

During the third quarter of 2003, Gateway approved a restructuring plan to, among other things, reduce its workforce and close certain facilities. A charge of $10 million was recorded in the first quarter of 2004 related to these actions. The $10 million charge includes $4 million related to severance costs for notified employees with longer transition times and $6 million related to accelerated depreciation on certain IT assets resulting from outsourcing activities. The significant restructuring activities related to this charge were initiated in the third quarter of 2003 and related actions will continue through the second quarter of 2004.

The following table summarizes charges recorded in the first quarter of 2004 for the Q3 2003 Plan (in millions):

First Quarter 2003 Plan (“Q1 2003 Plan”):

During the first quarter of 2003, Gateway approved a restructuring plan to close 76 retail stores (in addition to the four stores previously announced). The Company also continued its focus on other cost reductions, resulting in a workforce reduction of approximately 1,900 employees. A reduction of $2 million was recorded in selling, general and administrative expenses in the first quarter of 2004 related to these actions based on lower than estimated severance related costs. The significant restructuring activities were completed during the first quarter of 2003; however, payments are expected to continue through 2005.

The following table summarizes adjustments recorded during the first quarter of 2004 for the Q1 2003 Plan (in millions):

First Quarter 2002 Plan (“Q1 2002 Plan”):

During the first quarter of 2002, Gateway approved a restructuring plan to, among other things, reduce its workforce and close certain retail stores and other company sites. The significant restructuring activities were completed during 2002; however, payments are expected to continue through 2004.

The following table summarizes payments recorded during the first quarter of 2004 for the Q1 2002 Plan (in millions):

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

Third Quarter 2001 Plan (“Q3 2001 Plan”):

During the third quarter of 2001, Gateway approved a restructuring plan to, among other things, reduce its workforce, close certain retail stores, consolidate facilities, redefine its information technology strategy and exit certain other activities, including its then company-owned international operations.

The amounts charged against the provision during the first quarter of 2004 were as follows (in millions):

First Quarter 2001 Plan (“Q1 2001 Plan”):

During the first quarter of 2001, Gateway approved a restructuring plan to, among other things, reduce its workforce, close certain retail stores, consolidate facilities, redefine its information technology strategy and exit certain other activities.

No charges were made against the provision during the first quarter of 2004. The accrual is as follows (in millions):

Gateway manages its business by customer class, Consumer and Professional. Revenues from both segments are derived from sales of its PC and CE/Non-PC products and services. Gateway evaluates the performance of its Consumer and Professional segments based on sales and operating income, and does not include segment assets or other income and expense items for management reporting purposes. Segment operating income includes selling, general and administrative expenses and other overhead charges directly attributable to the segment and excludes certain expenses managed outside the reporting segment, such as depreciation and amortization. Other costs excluded from the segments primarily consist of general and administrative expenses that are managed on a corporate-wide basis and the restructuring, transformation and other charges discussed in Note 7.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

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

Substantially all of Gateway’s sales for the first quarter 2004 and 2003 originated from North America. From time to time, certain segment information may be reclassed between segments or non-segment operations. When this occurs, previously reported amounts are recast to conform to current period presentation.

No single customer accounted for more than 10% of revenues for the first quarter of 2004 or 2003. Amounts owed from two customers accounted for 35% of accounts receivable at March 31, 2004.

On March 11, 2004, Gateway completed its acquisition of eMachines, Inc., a privately-held computer manufacturer and distributor. The acquisition combines Gateway’s professional and consumer businesses, consumer electronics leadership, scale and cash availability with eMachines’ low cost structure, proven profitability, PC market strength, third-party retail network, international presence and need for additional capital. These factors contributed to a purchase price in excess of the fair value of the eMachines’ net tangible and intangible assets acquired and, as a result, Gateway has recorded goodwill in connection with this transaction.

The total purchase price of $262 million consists 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 such executives through the next two to three years. The value of the common stock was determined based on the average market price of Gateway’s common stock over the 5-day period prior to and following January 30, 2004, the date the acquisition was announced. The value assigned to the restricted shares was approximately $27 million and will be amortized to operating expenses over the next two to three years.

The preliminary allocation of purchase price is subject to revision for approximately 1 year as more detailed analysis is completed and additional information regarding the fair value of the assets acquired and liabilities assumed becomes available. The preliminary allocation of the purchase price to the identifiable assets acquired and liabilities assumed based on the fair value of eMachines is as follows (in thousands):

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS—(Continued)

(Unaudited)

A preliminary estimate of $48 million has been allocated to amortizable intangible assets consisting of customer-related intangible assets with an estimated useful life of 10 years which will create approximately $4.8 million in additional amortization expense annually during that period. Goodwill represents the excess of the purchase price over the fair value of the net tangible and intangible assets acquired and is not tax deductible. Goodwill will not be amortized and will be tested for impairment at least annually. Any change in the fair value of the net assets of eMachines resulting from additional analysis or information obtained for the next 12 months will change the amount of purchase price allocable to goodwill.

The results of operations of eMachines have been included in Gateway’s unaudited condensed 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, 2003 (in thousands, except per share amounts):

Included in the $187 million pro forma net loss for the first quarter 2004 is a one-time $34 million charge recorded by eMachines related to its former phantom stock plan and triggered by Gateway’s acquisition of eMachines.

Through its acquisition of eMachines, Gateway acquired an approximate 17% interest (as-converted basis) in another company that provides reverse logistics, product registration, technical support, parts sales, PC refurbishing and other related services to Gateway and its customers. The controlling shareholder of this company was named to the Gateway management team in March 2004 and is not involved in any management capacity with decisions or supervision of the services provided by the related party. Gateway paid approximately $3.1 million to this company for the services described during the first quarter of 2004 based on the fair market value of such services. No amounts were paid to this company in the first quarter of 2003.

As of March 31, 2004, Gateway owed $15 million to Lap Shun Hui, a significant shareholder, in connection with Gateway’s acquisition of eMachines. This amount is due and payable before the end of the second quarter of 2004.

On April 1, 2004, Gateway announced the closure of its remaining 188 Gateway-branded retail stores effective April 9, 2004. The Company plans to pursue wider distribution of its products through strategic third-party retail partners in the United States and internationally and continue to direct-sell products to consumers and businesses via its website and phone centers. This decision resulted in approximately 2,500 retail positions being eliminated in April. The Company recorded an impairment charge of $73 million in the first quarter of 2004 primarily related to store fixed assets and leasehold improvements. Additional charges for employee severance costs and lease liabilities of approximately $85 million will be recorded during the second quarter of 2004.

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The following discussion should be read in conjunction with the Unaudited Condensed Consolidated Financial Statements and the related notes that appear elsewhere in this document as well as our 2003 Annual Report on Form 10-K filed with the SEC in February 2004.

This Quarterly 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 under “Factors that May Affect Gateway’s Business and Future Results” beginning on page 26 of this Report or that are otherwise described from time to time in our reports filed with the Securities and Exchange Commission after this 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.

This Quarterly Report contains certain non-GAAP financial information relating to restructuring and transformation expenses which are included in cost of goods sold and selling, general and administrative expenses in the accompanying financial statements. This non-GAAP financial information is provided as supplementary information and is not an alternative to GAAP. This non-GAAP financial information is used by management to analyze Gateway’s baseline performance before charges and expenses that are considered by management to be outside of Gateway’s core operating results, notwithstanding the fact that such restructuring charges and transformation expenses may be recurring. This non-GAAP information is among the primary indicators management uses as a basis for evaluating Gateway’s financial performance as well as for forecasting of future periods. The presentation of this additional information is not meant to be considered in isolation or as a substitute for reported results determined in accordance with GAAP.

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

Overview

Since its founding in 1985, Gateway has been a technology and direct-marketing pioneer, using our call centers, web site and retail stores to build direct customer relationships. As a provider of personalized PC and consumer electronics products and services, we offer consumers, businesses, and government and educational institutions a wide range of plasma and LCD TVs, digital photo and video solutions, enterprise networking systems and services and other products which integrate with and complement our award-winning line of PCs. With the addition of eMachines, we significantly enhance our ability to compete and gain greater access to a wider distribution network.

We manage our business along our operating segments: Consumer and Professional. Our strengths revolve around our strong name recognition, our innovative product lines, and ability to maneuver quickly in the rapidly changing PC and consumer electronics industries.

Some of the key developments, highlights and achievements for the first quarter 2004 include:

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The next several quarters will be periods of continued transition for Gateway. We face a variety of challenges and opportunities inherent within the PC and consumer electronics industries which are characterized by rapid change, evolving customer demands and intense competition. Key challenges include our ability to increase demand for Gateway products, our ability to successfully integrate with eMachines and simplify our business, lower costs, manage our outsourced manufacturing suppliers, customer service and administrative relationships, anticipate changing customer demands, maintain and grow PC market share (reversing market share declines) in the face of intense competition, and continue to grow our consumer electronics business. See additional discussion in “Factors That May Affect Gateway’s Business and Future Results.”

Outlook

We expect to incur new restructuring and transformation charges totaling approximately $400 to $450 million for full year 2004 in addition to approximately $25 million of restructuring and transformation costs previously announced (see Note 7 for a description of amounts recorded in the first quarter of 2004 related to these actions). We are still assessing the estimated incidence of the restructuring and transformation expenses in the second quarter of 2004. These charges will be associated with the exiting of our retail stores, the rationalization of our facilities and service and support contracts, the streamlining of Gateway’s IT infrastructure and further reductions in our selling, general and administrative (“SG&A”) structure.

We have established several milestones in connection with our on-going integration and transformation efforts:

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Critical Accounting Policies and Estimates

Management’s Discussion and Analysis of Financial Condition and Results of Operations discusses Gateway’s unaudited condensed 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. Note 1 to the unaudited condensed consolidated financial statements in Item 1 of this Form 10-Q Quarterly Report summarizes the significant accounting policies and methods used in the preparation of Gateway’s consolidated financial statements.

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 when persuasive evidence of an arrangement exists, delivery has occurred, the sales price is fixed and determinable, and collectibility is reasonably assured. Revenue from services that are rendered by us, such as extended warranties, is recognized straight-line over the service period, while training revenue is recognized as the services are provided. Other than internet services, revenue from the sale of services that are rendered by third parties such as installation services and third-party administered extended warranties is generally recognized when delivered. We offer our customers Internet services which are provided by third parties. The revenue associated with these services 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 have disputed AOL’s retroactive adjustment to the mutually agreed and previously paid amounts and are pursuing formal dispute resolution proceedings as required by our agreement.

Gateway records reductions in revenue in the current period for estimated future product returns and rebates related to current period revenue. Management analyzes historical returns, current economic trends, changes in customer demand and acceptance of our products when evaluating the adequacy of the sales returns allowances in any accounting period. If actual returns exceed estimated returns, we would be required to record additional reductions to revenue.

Gateway records reductions to revenue for estimated commitments related to customer incentive programs, customer rebates and other sales incentives. 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. Additionally, certain incentive programs require management to estimate the number of customers who will actually redeem the incentive based on historical experience and the specific terms and conditions of the particular incentive programs. If a greater than estimated proportion of customers redeem such incentives, we would be required to record additional reductions to revenue which would affect earnings in the period the adjustments are made.

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 credit worthiness and financial condition of those specific customers. We record an allowance to reduce the specific receivables to the amount that is reasonably believed to be collectible. We also record an allowance for all other trade receivables based on multiple factors including historical experience with bad debts, the general economic environment, the financial condition of our customers, and the aging of such receivables. If there is a deterioration of a major customer’s financial condition or we become aware of additional information related to the credit worthiness of a major customer, or if future actual default rates on trade receivables in general differ from those currently anticipated, we may have to adjust our allowance for doubtful accounts, which would affect earnings in the period the adjustments are made.

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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.

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 utilize 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 full description of our restructuring actions, refer to our discussion of restructuring charges in the Results of Operations section.

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 cash flows to be generated and used by an asset or asset group as well as the expected or future use of such assets and/or their estimated future useful lives. Actual results could differ from the assumptions and estimates used and a significant change to the planned use of an asset or asset group could result in a material impairment charge in a given reporting period.

Taxes on Earnings

Gateway records a tax provision/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 carryback losses, 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.

Litigation

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

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Results of Operations

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