Atheros Communications Q2 2006 Earnings Conference Call Transcript (ATHR)

Jul.25.06 | About: Atheros Communications, (ATHR)

Atheros Communications, Inc., (NASDAQ:ATHR)

Q2 2006 Earnings Conference Call

July 24, 2006, 5:00 p.m. EST

Executives:

Deborah Stapleton, Stapleton Communications Inc., Investor Relations

Craig Barratt, President, Chief Executive Officer, Director

Jack Lazar, Chief Financial Officer, Vice President, Secretary

Analysts:

Charlie Glavin, Needham & Company Inc.

Anton Wahlman, ThinkEquity Partners

Jeremy Bunting, Thomas Weisel Partners

Jonathan Goldberg, Deutsche Bank

Adam Benjamin, Jefferies & Co.

Arnab Chandra, Lehman Brothers

Gary Makinson, W. Con

Operator

Ladies and gentlemen, thank you for standing by. At this time, all participants are in a listen-only mode. Later we will open the call to your questions. Instructions for asking questions will be explained at that time. This conference call is being recorded. I will now turn the call over to Ms. Deborah Stapleton, who will introduce today’s speakers. Ms. Stapleton, you may begin.

Deborah Stapleton, Stapleton Communications Inc.

Thank you, good afternoon to everyone and welcome to Atheros Communications Second Quarter 2006 Financial Results Conference Call. Leading the call today is Dr. Craig Barratt, President and CEO, and Jack Lazar, Vice President and Chief Financial Officer. Before we begin, I would like to remind you that various remarks that we make on this call, including those about our future financial results including revenues, sources of revenues and expenses, our future plans, goals and prospects, market trends, design wins and product development, our customers, our competitive position, our anticipated growth, profitability, our leadership position and market share in various markets, our anticipated shipments of products and revenue growth from various products and partnerships in 2006 and beyond, the anticipated widespread of 802.11n and the expected benefits of the ZyDAS acquisition constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act. These forward-looking statements and all other statements that may be made on this call that are not historical facts are subject to a number of risks and uncertainties that may cause actual results to differ materially. We refer you to our annual report on Form 10-K for the year ended December 31, 2005, and our quarterly report on Form 10-Q for the quarter ended March 31, 2006, previously filed with the SEC, and particular to the section entitled ‘risk factors’, and to other reports that we file from time to time with the SEC for additional information on factors that could cause actual results to differ materially from our current expectations. These forward-looking statements speak only as of the date hereof and we disclaim any obligation to update these forward-looking statements.

Atheros reports net income and basic and diluted net income per share in accordance with GAAP and additionally on a non-GAAP basis referred to as pro-forma. Atheros’s management believes that the non-GAAP information is useful because it can enhance the understanding of the Company’s ongoing economic performance, and Atheros therefore uses pro-forma non-GAAP reporting internally to evaluate and manage the Company’s operations. Atheros has chosen to provide this information to investors to enable them to perform comparisons of operating results in a manner similar to how the Company annualizes its operating results.

The full reconciliation of the GAAP to non-GAAP financial data can be found in our earnings release issued earlier today, and we ask that you review it in conjunction with this call. With that, I’ll now turn the call over to Dr. Craig Barratt. Craig…

Craig Barratt, President, Chief Executive Officer, Director

Thanks, Deb and thanks to everyone for joining us today. We’re very pleased with our record second quarter results. Not only did we top last quarter’s revenue, EPS, and operating income, we are also expanding our share of the retail market with both our revolutionary XSPAN 11n and our low cost 11g solutions. Our PAS revenue continued to grow as expected and we are very excited to have just announced the AR6101, the world’s most integrated single chip wireless IP platform designed for a wide variety of Voice-over-IP applications.

To briefly recap our earnings press release, we reported record revenue of $73.2 million, non-GAAP net income of $9.5 million or $0.17 per diluted share, GAAP net income of $6.8 million or $0.12 per diluted share, and non-GAAP gross margins of 49.1%. Our non-GAAP operating income in the second quarter was a record 14.4%, up from 13.6% last quarter. In addition, we generated over $12.3 million in cash during the second quarter. Jack will take you through the numbers in greater detail and discuss guidance for the third quarter shortly.

Over the past few years, we’ve been investing to build a world class, diversified communications semiconductor Company. The investments have come in many forms. First, we have had an unwavering focus on becoming the number one provider of wireless LAN Silicon. Since the launch of our 11g products in 2003, we have steadily increased our market share in one of the most competitive semiconductor markets in the world. We have done so against larger and more diversified competitors because of our focus on delivering superior system solutions based on innovative CMOS chip designs at price and performance points that encourage mass adoption of our customer’s products. With the launch of 802.11n, we expect to continue gaining market share, which will help us achieve our goal of being number one in wireless LAN.

Second, we’ve invested in developing products for new markets that can provide revenue opportunities and the expanding set of customers increasing our TAM. Our past business, which we built organically, is now contributing over 10% of our quarterly revenue and remains a significant growth driver in 2006 and beyond. In addition, our investment in low-power embedded wireless LAN solutions will start to yield results in the second half of 2006 and will become an even larger contributor next year. These markets along with future markets we’re planning to address dramatically increase the revenue opportunities for Atheros.

Third, we are investing in the people required to achieve these goals. At the end of the second quarter, we had 420 employees with R&D comprising 69%. Our pending acquisition of ZyDAS expected to close this quarter not only expands our market reach but also provides us with additional design resources close to our Asian customers. Finally, we have invested in our partners and their channels. From our high touch technical support to our customer responsiveness we believe we have become a trusted partner to our OEM and ODM customers. As we introduce new products and enter new markets in the upcoming years, we believe our partnerships will become even more valuable as leverage towards significant revenue growth.

The investments we are making once again paid off in the second quarter. Our tremendous growth this quarter resulted primarily from continued success in the PAS market and our dramatic expansion of product revenue in our core wireless LAN segment. The wireless LAN strength was driven by both technology and market segments. Sales of our 11g based products were up 17% sequentially demonstrating our continued market share gains. Our retail business was particularly strong in the second quarter due to the strength of our 11g solutions coupled with the launch of our XSPAN 11n products to leading retail customers.

Just last summer the 802.11n standard appeared to be a long way off. While everyone agreed the consumers would benefit greatly from the increased throughput and range that 11n would provide, Company…out to the most effective way to bring this standard to the market. After many months of working together with the dozens of companies involved in the standards process, the first draft standard was unanimously approved by the IEEE in January of this year. From that point on, the leading semiconductor companies raced to deliver their Draft 11n solutions to the market. Atheros of course took a unique approach in developing 11n products, leveraging our ability to do low-cost complex radio solutions in CMOS. We introduced the industry’s only Triple Radio solution compliant with the Draft 11n standard. This unique radio architecture coupled with our Signal Sustained Technology or SST provides leading throughput and coverage and allows our customers to offer differentiated Draft 11n solutions that outperform competing products.

In addition, our products also exhibit superior coexistence with legacy 11a, b, and g equipment by ensuring optimal sharing of spectrum resources within neighboring networks, and ultimately the best end-user wireless experience. Atheros is working with other leading technology companies to secure interoperability among 11n solutions. During the quarter, Atheros and Broadcom performed tests demonstrating interoperability of our respective solutions at throughput speeds greater than 100 megabits per second. Cross-vendor interoperability testing demonstrates the commitment of Atheros and other Wi-Fi technology leaders to meeting growing consumer demand for high-performance standards based products that work seamlessly together.

We are certainly pleased with our success of our 11n family of 11n products. Atheros’ XSPAN 11n products accounted for 13% of our total revenue in the most recent quarter. Our initial products launched with D-Link early in the quarter, shortly thereafter Belkin, Linksys and Trendnet each began shipping products based on the Atheros XSPAN 11n technology. In addition, we have secured 11n design wins with another leading worldwide retailer. And moreover, one of our retail partners won Laptop Magazine’s ultimate choice award for its smooth 150 megabit per second throughput and 1500 feet range.

Three PC OEMs have also selected Atheros as their provider of 11n solutions for their laptop products, and we expect others to follow shortly. In selecting Atheros, these customers once again were drawn to our unique Triple Radio or 3x3 SST technology, which provides the best combination of throughput over range. We expect our PC OEM partners to start shipping PCI express based 11n solutions in the second half of the year, and this will further drive the widespread adoption of 11n.

While 11n was certainly a highlight for us in the second quarter, we also saw tremendous growth in products from our 11g product line. Revenue from 11g based solutions was up over $5 million or 17% sequentially, reaching the highest level in the history of Atheros. We shipped more than 2 million units of 11g Access Point Chipsets to our partners during the quarter. As many of you know, we announced the world’s most integrated single chip 11g Access Point Solution, the AR5007 APG back in late fourth quarter last year. Several of our retail customers have chosen to migrate to this product given its optimal balance of performance and cost. We view the AR5007 APG and other products in our 11g portfolio as keys to gaining further market share in what is still the highest revenue segment of the wireless LAN market.

One particular area of 11g strength for Atheros has been the carrier market. The second quarter marks the seventh consecutive growth of revenue growth for this segment of our wireless LAN business, and we see continued strength going forward. As you may recall, a few years ago, many DSL chip companies were planning to integrate their own Wi-Fi technology. However, it became increasingly difficulty for these companies to keep up with the multiple changes in the 802.11n standards and the withering competition. Indeed, our approach of integrated the MAC based band and radio into one chip made it more cost effective for our partners to leverage our solution than to continue their own wireless LAN development for broadband gateway solutions.

During the last 18 months we have partnered with several leading broadband chipset providers; our joint reference designs are marketed to carrier customers resulting in significant revenue increases. In addition, by working with Atheros, our partners know they will be among the first to have 11n solutions for their customers. We will continue to expand our partnerships in this market segment as we grow our overall carrier business.

Recently our AR5006 APG was selected as the chip of choice for 11g routers from an innovative company named Fon, whose investors include Skype and Google. Fon is a popular Wi-Fi community dedicated to providing worldwide wireless Internet access. Members sign up for free and can receive a wireless LAN router for as little as $5. These members can then access other Fon routers throughout the world at no cost and can share in revenue generated by the Fon network. We support the efforts of Fon to proliferate low-cost wireless LAN access throughout the world.

The existing 11g and 11a/g markets are a critical part of our revenue expansion strategy. Our solutions are being adopted by leading OEMs and we will continue to leverage our single chip advantage to increase our market share. As expected, revenue from our single chip PAS solution increased in the second quarter and UTStarcom was once again a greater than 10% customer. Our partnership with UTStarcom continues to be strong, and together we’re working on new and innovative PAS solutions.

We are pleased to report that several of UTStarcom’s best selling phones are based on Atheros Silicon. One of these, the X30 is razor thin and weighs less than 60 grams. This feature rich handset boasts a 1.5 inch color display, support for MP3 ring tones and SMS messaging, and provides impressive battery life of up to 300 hours of standby or 7 hours of talk time. By leveraging the Atheros solution, UTStarcom has been able to introduce a wide variety of PAS handsets and dramatically improve the operating margins of its PAS handset business.

Even though the third quarter is the seasonally softest quarter for PAS shipments in general, we expect our third quarter PAS revenues to decline only slightly. We continue to drive the expansion of our overall PAS business, both throughout our strong relationship with UTStarcom and by addressing new customers. Recently, we received design wins from new PAS customers and we expect to begin shipping to these handset makers in the second half of the year. The PAS market continues to be an important component of our growth and diversification strategy.

During the second quarter we began commercial shipment of our AR6001 ROCm chip to several leading ODM and OEM customers. And ODM of particular note, Compow, one of the world’s largest producers of mobile phones, has completed its first Atheros-based handset product and will begin volume shipments in the third quarter. We expect Compow and other customers to ramp additional ROCm based handset solutions this year. Aside our mobile phone wins, we have achieved design wins in mobile consumer electronics and entertainment products with additional tier 1 customers. Overall, we are excited with the progress of our low power embedded wireless LAN business and we believe that our dedication to this market will pay dividends in the second half of 2006 and beyond. We will update you with OEM and design details as these products are introduced into the market.

Last week, we announced our single chip wireless ROCm platform for the Voice-over-IP phone market, the AR6101. Like our single chip PAS product, it is a complete end-to-end handset solution that enables an unprecedented truly mobile Wi-Fi experience. With this new platform, Atheros is building on its history of innovation and success in developing custom built low-cost mobile communication solutions, by integrating all of the complex functions such as computing, DSP, keypad, audio, and display interfaces in addition to mix signal and RF onto a single chip; we can enable the development of the smallest and cheapest Wi-Fi phones on the market.

Last quarter, we announced our acquisition of ZyDAS Technology Corporation, a privately held Taiwanese fabulous IC company specializing in high performance 802.11 wireless LAN, semiconductor, and software solutions for PC, mobile, and embedded applications. Through this acquisition we are strengthening our USP capabilities and product offerings as well as gaining an experienced engineering team in Taiwan Hsinchu Science Park, one of the world’s most active areas for semiconductor design and manufacturing. We recently received the final regulatory approvals and we anticipate closing this transaction in August. Integration plans are on track and we believe the synergies of our engineering teams will broaden our product offerings in the quarters to come.

Now, Jack will give you details on our second quarter numbers.

Jack Lazar, Chief Financial Officer, Vice President, Secretary

Thank you, Craig, and thanks to all of you for joining us today. First, I’ll outline our financial results for the second quarter ended June 30, 2006, and then I’ll provide the third quarter 2006 guidance. Unless otherwise noted, all financial data in my remarks is on a pro-forma non-GAAP basis and reflects the exclusion of non-cash stock-based compensation charges related to the adoption of FAS 123R and in the first quarter the income benefit related to the partial release of our tax valuation allowance.

In summary, our financial results for the second quarter were very strong. Revenue, gross margins, and net income all came in above the ranges we guided to in our last quarterly conference call. As a reminder, our second quarter guidance was for 10-15% revenue growth, gross margins between 46.5% and 47.5%, and EPS of $0.15 to $0.16. Revenue for the quarter increased 20% over the first quarter and net income was $9.5 million or $0.17 per share. Gross margins for the quarter were 49.1%, 160 basis points above the high end of our guidance and 410 basis points above the high end of our target model range.

The second quarter revenue was a record $73.2 million, up $12.1 million from the $61.1 million we recorded in the first quarter of 2006. Second quarter revenue increased 69% compared with the $43.4 million recorded in the prior year comparable quarter. The 20% sequential increase in revenue was driven by both a further expansion of our core wireless LAN business including our first shipments of 11n products as well as the fifth consecutive quarter of growth for our PAS business.

Based on the product mix data for our third-generation and later chipsets, the mix of wireless LAN chipsets was as follows: a/g multimode chipsets were 29% of revenue, 11g was 58%, and 11n was 13%. The percentage breakdown of revenue by market segment based on data supplied by our ODMs is as follows: retail was 44% of revenue, PC OEM was 24%, enterprise and carrier were 19%, and consumer electronics and others were 13%. Our retail wireless LAN segment was up primarily as a result of strong shipments of 11g products and the introduction of our XSPAN 11n solutions. In the second quarter we had four 10% or great customers -- Askey Computer, Cameo Communications, Hon-Hai Precision Industry, and UTStarcom. The units shipped to customers in each of our retail, PC OEM and enterprise segments all set record highs.

Second quarter gross margins were 49.1%, up 70 basis points from the 48.4% reported in the first quarter and above our target range of 43% to 45%. Overall blended ASPs increased 3% sequentially to $6.51, compared with ASPs of $6.35 in the first quarter. This increase was due to the introduction of higher ASP 11n products and less ASP erosion in our 11g and 11a/g product lines. In the second quarter, we shipped 11.2 million chipsets, up 17% from the 9.6 million shipped during the first quarter, and 97% higher than the corresponding number in the first quarter of 2005. Total operating expenses were $25.4 million, which represented a 19.5% increase from the first quarter and exceeded our guidance of $22 million to $23.5 million.

R&D increased $2.3 million or 17% sequentially due to increased tape out cost, head count additions, and a variety of engineering expenses primarily related to the launch of our 11n products. As a percentage of revenue, R&D declined from 23% in the first quarter to 22% in the second quarter. SG&A increased $1.8 million due to higher than anticipated professional fees, head count additions, and a variety of nonrecurring expenses.

Operating income for the quarter was $10.6 million, up 27% from the $8.3 million recorded in the first quarter. The second quarter’s operating income was 143% of the amount recorded for the full year of 2005. Operating income was 14.4% of revenue in the most recent quarter, and that is up 80 basis points from the 13.6% in the first quarter. Income taxes for the second quarter were $3.2 million, representing a 25% annual pro-forma tax rate. Net income was $9.5 million or earnings of $0.17 per diluted share for the quarter, compared with net income of $7.9 million or earnings of $0.14 per diluted share in the first quarter. Average shares outstanding were 55.4 million in the second quarter, compared with 54.5 million in the first quarter. GAAP net income for the second quarter was $6.8 million or earnings of $0.12 per diluted share, and this compares with GAAP net income of $6.8 million or earnings of $0.13 per diluted share for the first quarter.

Turning to the balance sheet, cash and marketable securities were a record $198 million as of June 30th. Total cash and marketable securities increased $12.4 million and during the quarter we generated $8 million in free cash flow from operations. DSOs based on our quarterly average receivables balance decreased to 43 days versus 45 days in the first quarter, reflecting the more linear pattern of our shipments in the second quarter. Inventory terms for the quarter decreased to 5.0 times, compared with 5.1 times in the first quarter, as we built additional inventory to meet or third quarter order demand.

Inventory terms continue to be within our 5-6 times target and the company continues to have virtually no debt. Total liabilities at the end of the second quarter were $54.3 million and during the second quarter of 2006 our capital expenditures and depreciation were approximately $2 million and $750,000 respectively. Our balance sheet continues to be very strong with over 70% of our $282 million in total assets in the form of cash and marketable securities. As of June 30th, we had 420 full time employees compared with 353 at the end of the first quarter. Most of these additions were R&D personnel.

I’ll now move on to our guidance for the third quarter. The second quarter was our strongest quarter to date in terms of revenue and net income, and was we entered this new quarter we anticipate a continued benefit from strong product cycles. Accordingly, we currently anticipate third quarter revenues to increase between 6% and 10%. We expect to expand our wireless LAN revenue in the third quarter and despite the third quarter being a seasonally slow quarter for PAS in general we anticipate only a slight decline in our PAS revenue. Gross margins are expected to be in the range of 47% to 48% and once again above our target model range.

We will continue to invest in the people, product tape outs, and infrastructure necessary to support our continued growth and entry into new markets, but in the third quarter we anticipate the following functional expense breakdowns: R&D between $17.5 million and $18 million and SG&A of $8.5 million to $9 million. Total operating expenses are anticipated to increase between 2% and 6%. Our estimated pro-forma tax rate for the third quarter is approximately 25%, and we anticipate our EPS range for third quarter to be in the $0.17 to $0.18 based on fully diluted shares outstanding of approximately 56 million.

Our third quarter guidance does include approximately one month of assumed ZyDAS revenue and the corresponding expenses as we anticipate closing this transaction in August. Our second quarter results and our third quarter guidance reflect the strength of our business, dividends from our diversification strategy, and the favorable product cycles that we continue to leverage. We will invest in further diversification efforts that we believe will help position Atheros for ongoing success and increase shareholder value in 2006 and beyond. With that, let me hand it back over to Craig.

Craig Barratt, President, Chief Executive Officer, Director

Thanks, Jack. The continuing growth of our business allows us to make significant investments in products for new markets. In the markets we enter, we expect to offer differentiated CMOS based solutions leveraging our competitive skills, culture of innovation, aggressive cost structure, and strong customer relationships, all of which were forged in the highly competitive wireless LAN market.

Continued investments in our Company, our people, and our technologies are critical to our long-term growth. Our third quarter guidance and record second quarter results demonstrate further strong steps towards our goal of becoming a leading and diversified communications company. We are now ready for questions.

Question-and-Answer Session

Operator

Thank you. We will now begin the question and answer session. If you would like to ask a question, please press * and 1 on your telephone keypad. If you wish to cancel your request, press * and 2. If you are on a speaker phone you may need to lift your telephone receiver before making your selection. Our first question comes from Charlie Glavin of Needham & Company; go ahead please with your question.

Charlie Glavin, Needham & Company Inc.

Hi, nice to see you reporting the storm. Jack, maybe if I can ask a question relative to the gross margin guidance, even though that’s going to be within your longer term range, the drop relative to the second quarter, does that have anything to do from the retail channel fill going into some early ramps of other products on the 11n? I’m a little surprised given also the PAS market that was that much of a shift on a sequential basis.

Jack Lazar, Chief Financial Officer, Vice President, Secretary

Obviously on the gross margin side of things we’ve been very focused on expanding our 11g footprint and I think we’ve been pretty successful with that. Sometimes that comes at a gross margin penalty but a gross margin dollar addition. So, that’s part of what goes into our outlook for next quarter. We of course will be putting in only a month’s worth, but ZyDAS will be hitting in the third quarter and that is lower margin product in general. And then with PAS you got to understand we are guiding that down slightly for the upcoming quarter, and PAS does have a favorable impact on the gross margins. I think overall if you take a look back from where we’ve gone to where we are, clearly our gross margins were very high this most recent quarter; 11n certainly helps that. As we move forward while we do have ongoing orders for 11n, kind of follow on orders, we do have different product mixes that will affect the gross margins in the upcoming quarter.

Charlie Glavin, Needham & Company Inc.

And there’s been a lot of chatter in regards to the PAS market, a lot upstairs, indicating that because of your exposure not only with PAS with certain customers it’s been negative, can you give us some indication now particularly given some of the softness that’s occurred within the H market, how you guys are looking at the PAS market overall, how much is the flattish type of growth or slightly down growth due to expanding to new customers, and then the third leg being how much even within UTStarcom now that your exclusive contract is starting to wind down?

Craig Barratt, President, Chief Executive Officer, Director

Charlie, I’ll take that. I think there are several factors here. Certainly, the main determinant of our PAS business really is market share where it’s still less subject to the overall macro picture, and as you know of course historically we have had one and only one customer, and UTStarcom will continue to be our key and critical customer. We have a very strong relationship with them. But that said, I think our future growth later this year and beyond for PAS for us will come through market share gains, primarily at new customers. That said, UTStarcom is still shipping legacy solutions even today, and I think there is opportunity for us to continue modest improvements in our share even at UTStarcom as well. So, overall I think we can increase our share at current and future customers.

Jack Lazar, Chief Financial Officer, Vice President, Secretary

One of the things, Charlie, is actually interesting as we mentioned the X30 on the phone call today, the X30 is a prime example of what we were trying to achieve when we got into this market. We have delivered what is a relatively high margin product to UTStarcom. They in turn have been able to benefit financially from that, and then in turn the market has really received that product very well. So, it’s an extremely popular phone that is very thin in its nature and our design is the only one that would actually support that type of handset. So, I think we’re going to continue to try and come up with innovative products with UT like that, and of course as time goes by we’ll be looking for more and more customers too.

Charlie Glavin, Needham & Company Inc.

If I can, Craig or Jack, in terms of just trying to get a gauge as far as how much of the market share, without you guys maybe giving a specific number yourself, is there one that’s used by a third party or something in terms of the PAS market that an investor should kind of look as far as this is what to expect within the PAS market and use that backdrop in terms of your market share expansion?

Craig Barratt, President, Chief Executive Officer, Director

Our first goal is to get to 25% market share, which we think we are on track to achieving this year, and certainly our goal is to do everything we can to drive our market share higher than that over time.

Charlie Glavin, Needham & Company Inc.

For the growth of the PAS market itself?

Craig Barratt, President, Chief Executive Officer, Director

We think overall units will increase modestly year over year, but certainly over time we’re also looking for opportunities beyond the public PAS market including things like the QBOX, broadband, modem that supports home cordless telephony and other opportunities that can try to increase the TAM as well.

Charlie Glavin, Needham & Company Inc.

Great, I’ll pass it on, thanks guys.

Operator

Your next question comes from Anton Wahlman of ThinkEquity; go ahead please.

Anton Wahlman, ThinkEquity Partners

Jack and Craig, can you hear me?

Craig Barratt, President, Chief Executive Officer, Director

Yes, we can Anton.

Anton Wahlman, ThinkEquity Partners

Quickly just a few things on the end markets; first of all, I don’t know if you ever got some form of novelty design with Sony, but where do you see the embedded market for high definition television sets in the future, is that a market that you think will develop for you by 2007 and do you view that as a large and important market for you to want to try to pursue sort of sooner as opposed to later?

Craig Barratt, President, Chief Executive Officer, Director

Absolutely, Anton, we really believe that multimedia and video are really driven by the adoption of 11n. We will find a very important market in HDTV and multimedia around the house. Certainly the adoption of 11n will initially start with retail and PC customers, but going into the second half of ’07 and after that we think adoption in multimedia will be a very important growth driver. So, you are correct, HDTV, multimedia, and video is a very important application. Certainly, copy protection issues and ease of interoperability, simple config technologies allowing these networks to be easily assembled are key pieces to enable this market.

Anton Wahlman, ThinkEquity Partners

Does Intel with sort of to that program fall into this bucket as well or will you try in your mind segment this further between lower class video and really very high grade multi-numerous 10’s of megabit type video, do you view that as a separate market or do they fall into the same bucket?

Craig Barratt, President, Chief Executive Officer, Director

We view them as different players with different strategies for attacking the same market. So, companies with more of a PC centric background are looking towards that PC platform to become the media server for the house, but clearly the set-top box and broadband companies and additionally the game console companies are all trying to be the foundation of that network, and all of those represent opportunities for our products, all of those segments of the industry really passionately believe in wireless being the preferred delivery vehicle around the house for those services. So, we’re actually hedged in a sense. We don’t mind who wins the battle, all of them will use WiFi to deliver their content over that last 10 or 20 meters.

Anton Wahlman, ThinkEquity Partners

And if you throw in sort of both the Live and regular TVs, is PAM in the hundreds of millions of units a year?

Craig Barratt, President, Chief Executive Officer, Director

That’s correct. I think it’s an opportunity which in total magnitude is perhaps a little smaller than the overall cellphone market just because those numbers maybe a factor of four to five times larger, but the attach rates in this market could be high. We think that even the desktop opportunity itself is actually an important one because it is the foundation for these media type services.

Anton Wahlman, ThinkEquity Partners

Absolutely, just one clarification, Jack, what was the ASP you said?

Jack Lazar, Chief Financial Officer, Vice President, Secretary

ASP is for the quarter where it was 651 I believe versus 635 last quarter; so we are actually up 3%.

Anton Wahlman, ThinkEquity Partners

Okay, that’s all for me, thank you.

Operator

Your next question comes from Jeremy Bunting of Thomas Weisel.

Jeremy Bunting, Thomas Weisel Partners

Hi, thank you very much. One question on 11n and one question on PAS. On 11n, Craig, what do you think that the dynamics of the market will be through the remake of the year? Do you think there will be a bit of an ease in semiconductors from the third quarter where initial products kind of flow into the retail market or do you think it will actually move forward and kind of grow quarter by quarter?

Craig Barratt, President, Chief Executive Officer, Director

Yeah, I think it’s difficult for us to tell the exact trajectory. Certainly over the next few quarters we certainly expect very, very strong growth. I think the drivers in the short term will be that…one of customers D-Link already has retail router products on the market for under $100 and that was something that really wasn’t expected until Christmas later in the year. So, I think the price points we’re getting to will be drivers for adoption. I think the interoperability efforts even though they are not formal industry efforts is also something that will increase the acceptance of these products in the market place, and I think the other dynamic is that several important PC OEMs will launch platforms in the second half of the year. That does two things. That creates more pool for the retail products, the routers, the connectors, those laptops, but of course it’s another channel in which to ramp our product volumes. So, I think overall we’re quite optimistic about the adoption. It’s a little bit harder to tell the exact dynamics in the third quarter, but I should say that we’re certainly very comfortable with the order activity that we see around 11n, so certainly we’re optimistic.

Jeremy Bunting, Thomas Weisel Partners

Thank you. Back to PAS, could you just reline this, how formal was your relationship with UTStarcom as you only supplied UTStarcom with your products? You mentioned earlier about selling to other OEMs, have you been engaged with other OEMs for some period of time, is that a new dynamic for you, and how is your relationship with UTStarcom changed?

Craig Barratt, President, Chief Executive Officer, Director

It’s obviously not appropriate for me to go into particular details with a particular customer, but let me just say that we’ve had a very, very close and long-term relationship with UT that we expect to continue. Essentially the genesis of the relationship was that if we built the world’s best and cheapest PAS product, they would use it in significant quantities, and that’s essentially what’s transpired. So, we see that relationship as strong. Certainly, we are in a position and we have been engaging with additional customers and we think as those products come to market that will be an additional way for us to drive our share of the market upwards.

Jeremy Bunting, Thomas Weisel Partners

Jack, remind me, did you say that you will shipping to other PAS OEMs by the end of the year?

Jack Lazar, Chief Financial Officer, Vice President, Secretary

We said during the second half of the year, yes.

Operator

Your next question comes from Jonathan Goldberg of Deutsche Bank.

Jonathan Goldberg, Deutsche Bank

Hi, can you hear me?

Craig Barratt, President, Chief Executive Officer, Director

Hi, Jonathan.

Jonathan Goldberg, Deutsche Bank

Thanks for taking my call. Quick question, the ASPs went up this quarter, do you think that can happen again?

Jack Lazar, Chief Financial Officer, Vice President, Secretary

Historically we’ve never given out ASP guidance on a go-forward basis. Clearly, we always anticipate increasing units and we’re looking at a 6-10% revenue increase. So, I think that one of the characteristics we saw in the most recent quarter is that the 11g and 11a/g ASPs did not go down all that much, kind of below 5% for both of those. So, if we can keep those trends going forward then it will be much easier to actually keep the ASPs going up a bit, but we do expect erosion in the 11n market. Craig mentioned that D-Link is shipping $99 11n products and we want to encourage that. We think that that’s critical to growing the market. So, ASPs are something that essentially just fall out of the overall aggressiveness of the market.

Jonathan Goldberg, Deutsche Bank

And then I know it’s very early for this, but I was wondering if you could help us think about how do we look at long-term growth for embedded, for ROCm, and how should we be thinking about that over the long term?

Craig Barratt, President, Chief Executive Officer, Director

It really relates to several product categories. I mean there’s the mobile communications market, so that is obviously initially products like Smartphones but certainly moving into mainstream cellphones. So, if we look out a number of years we see a large percentage of the total sell to market as being a potential target for attaching Wi-Fi devices. So, the potential TAM there is certainly very, very large. The standalone Wi-Fi market effectively is an upgrade over placement to cordless telephony and that market is the one that our just announced AR6101 product is directed at. For addressing that mainstream sell to market, we have two primary strategies: one is to directly work with OEMs to integrate our products, and we have several engagements of that kind, but the second mechanism which creates more scalability is to partner with the best in class semiconductor companies in the cellular space. So, the most important relationship we have there is QUALCOMM and through QUALCOMM we have joint reference designs that allow us to address those customers who are using CDMA- and WCDMA-based products. We also expect to have engagements in other cellular technology areas as well. The other major category is the mobile consumer market. So, these are products such as digital cameras, camcorders, and of course game devices and music players, MP3 and media and video players, and over time there’s a compelling case for all of these devices to have a Wi-Fi capability. It’s not just eliminating the cables for synchronization, but is for doing things like streaming, for doing multiplayer gaming and so on, so there’s really a compelling case over time for many, many of these products. So, in aggregate the TAM here of course is very, very large. The big question is how quickly will the attach rates grow. This year, the attach rates will be quite low because I think people are still wanting to figure out what the services are that they offer, but in ’07 and ’08 I think attach rates will certainly ramp as compelling services and capabilities are offered to consumers. So, we think that market overall is very, very exciting and we think we’re very well positioned in that market as well.

Jonathan Goldberg, Deutsche Bank

Great, thank you Craig.

Operator

Your next question comes from Ramesh Mishra of C.E. Unterberg, go ahead. Mr. Mishra, go ahead. Our next question comes from Adam Benjamin, go ahead please.

Adam Benjamin, Jefferies & Co.

Thanks guys, nice quarter. Just two questions, one on wireless LAN and one on PAS; with respect to wireless LAN and the commentary we’ve been hearing in the market place with one of your competitors and just what the sell through is to date and given what you guys reported in the quarter, it looks like somewhere in the magnitude of 600,000 quarter units you shipped and one of your competitors shipped over 1 million or so into the channel so far, and the sell through is somewhere in the magnitude of thousands per week from what we’re hearing. I’m just trying to reconcile all that with your guidance as to what you’re seeing in the third quarter and whether you’re going to see a pause in whether there’s been a channel fill that’s occurred in the second quarter or not.

Jack Lazar, Chief Financial Officer, Vice President, Secretary

Adam, our third quarter guidance is based on orders, so I think that’s probably the most important thing to point out; I mean we’re getting follow on orders from our customers. Clearly, we can’t say what the sell through of 11n is going to be. We do know that we have a very unique product. We also know that our customers are taking an aggressive stand in pushing 11n products out into the market place. So, we’re going to have to wait and see what that sell through is really going to look like. If you couple that with the fact that we’ve announced three…we mentioned today three PC OEMs that are going to be shipping 11n products, as you heard from our remarks there are more to follow that will be happening this week and later. I think we’re at the edge of the rollout of 11n here, so we do have to be cognizant of sell through as we move through the quarter and future quarters, but I think in general we are pretty happy with our position in the market.

Craig Barratt, President, Chief Executive Officer, Director

And one clarification, I think the 1 million number obviously included presumably some shipments in the third quarter as well since that press release was made recently. We think we’re happy with our shipments, we think our customers like D-Link are getting to price points which will allow them to ramp their business, and just to reinforce that point, PC OEMs will start ramping shipments in the second half of the year, and I think that’s another area where we expect to see growth.

Adam Benjamin, Jefferies & Co.

Great, on the PAS side, you guys had previously said that if you are able to continue garnering greater than 50% of UT’s business, you would not look elsewhere for other customers. You’ve announced today that you are working with other customers, so should we assume that you do expect to just garner 50% of UT’s volume going forward?

Jack Lazar, Chief Financial Officer, Vice President, Secretary

Well, just to be clear, Adam, what we’ve said all the while has been that we would expect to get virtually all of the business at UTStarcom, and if we were not in a position to get 80% or 90% of the overall business then we would go out and look to other customers. UT is certainly the company that we believe in more so than others, obviously they have a huge position in the market place and we work very closely with them. I think we’ve established a great relationship and one that’s been mutually beneficial. We are going to continue leveraging that going forward. We still have the lowest cost solutions in the market place. We have to be responsible to our investors and that is to go out and grow this PAS business to be something more substantial for the company, so I think that’s the best way of addressing the situation with UT.

Adam Benjamin, Jefferies & Co.

Great, thanks a lot guys.

Operator

Your next question comes from Arnab Chandra of Lehman.

Arnab Chandra, Lehman Brothers

Thanks. A question for either Craig or Jack, you guys have done very well in a/g as well, is 11n expanding the wireless LAN markets or in other words the growth of 11n does not necessarily imply sort of slow downs or transitions from one to the other, could you talk a little bit about that; how you see that dynamic over the next couple of quarters? And I have a follow up.

Craig Barratt, President, Chief Executive Officer, Director

Arnab, I think initially 11n is coming in, although it is $99 or a bit over $100, it is coming in a premium type price point, so there are segments in the Wi-Fi market. 11b used to be the low end and 11a/g was the high end, and now all that is shifting down; 11b has gone. So, it’s a natural rider passage where new technologies come in at high price points and generally don’t cannibalize the main part of the market which is at the next price point. So, we think a good part of it is additive. There is a whole upgrade cycle which I think creates additive business. If there is some small overlap I think it’s modest; it’s my guess, it’s pretty hard to quantify though.

Arnab Chandra, Lehman Brothers

Thanks, and Jack a question regarding gross margins, it seems like you are kind of substantially past your sort of target, even the high end of the target, do you think that at times you’ll revisit the target or do you think that you are in kind of a benign time in pricing and that may change? I know it’s hard to predict but I was just curious as to how you address that, thanks.

Jack Lazar, Chief Financial Officer, Vice President, Secretary

I mean, it’s a relevant question, Arnab, and certainly one that is fair asking. I think that overall obviously things like PAS have been very beneficial to the gross margin expansion of the company; 11n certainly doesn’t hurt that. I think that what we really have to do is take a look back in a quarter or two and see what’s happening in the overall wireless LAN market as far as the transition from 11g and 11a/g to 11n and how much of our overall business is going to be PAS. I think for now we’re more comfortable just kind of guiding for the short term which at 47% and the 48% is clearly above the target margin, but at some point we will have to reevaluate that.

Arnab Chandra, Lehman Brothers

Thanks and just one last question, maybe either for Craig or Jack, regarding PAS you are definitely still in market share gain mode, UTStarcom is a major player in the market, you are suggesting you are adding one new customer at least, maybe multiple this year. Should we expect you to sort of reflect the dynamics of the market as we get into ’07, is the rest of the year still…it’s not a question of the markets and more a question of your own share, sort of what time frame should we assume that? Thanks.

Craig Barratt, President, Chief Executive Officer, Director

Certainly over the next year our goal is to really focus on market share, maybe later next year we might be in a position where the macro picture is more relevant to us, and then of course we’ll be exploring ways to expand the addressable market for PAS. It could be things like dual mode cell phones, it could be cordless telephony in some other areas, so overall we’re committed to having this be a growing business for us.

Arnab Chandra, Lehman Brothers

Thanks, Jack and Craig.

Operator

Your next question comes from Gary Makinson of W. Con.

Gary Makinson, W. Con

Yes, just to clarify, could you talk about what your relative shares are, UTStarcom in the PAS market right now, and you guys have a single chip solution and they don’t, is that correct?

Jack Lazar, Chief Financial Officer, Vice President, Secretary

Yes, we have the world’s only single chip solution for PAS. As far as market share at UT, we just don’t get into that level of detail. What we do is we try to get as many handset designs as possible and hopefully those handset designs will generate very good revenue streams. We’re seeing some positives obviously from the X30 and other products that they’re shipping today. We anticipate doing better in the future. But as far as breaking down the market share, I don’t think that that would be appropriate.

Gary Makinson, W. Con

Okay, thanks.

Operator

All right and we are showing no further questions on the phone line. We’ll turn it back over to you for any further comments you may have.

Craig Barratt, President, Chief Executive Officer, Director

Thanks to all of you for joining us today and a special thanks to our employees for their continued dedicated and hard work. The second quarter was a great quarter for Atheros and we’re enthusiastic about the third quarter and beyond. Over the next few months we’ll be attending several investor conferences including the Kauffman Brothers Conference September 6th through 7th in New York and the ThinkEquity G4 Conference on September 11th in San Francisco. If any of you are interested in arranging a call or a meeting, please contact Deborah Stapleton our IR counsel at deb@stapleton.com. We thank you for your interest in Atheros and we look forward to speaking to you along the way. Goodbye for now.

Operator

This concludes today’s conference call. We thank you for your participation. You may disconnect at this time.

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