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Atheros Communications Inc. (NASDAQ:ATHR)

Q3 2006 Earnings Call

October 23, 2006, 4:30 pm ET

Executives

Deborah Stapleton - Stapleton Communications Inc.

Craig Barratt - President and CEO

Jack Lazar - Vice President, CFO and Corporate Secretary

Analysts

Mark Edelstone - Morgan Stanley

Gus Richard - First Albany Capital

Charlie Glavin - Needham and Company

Jonathan Goldberg - Deutsche Bank

Ramesh Misra - Unterberg, Towbin

Arnab Chandra - Lehman Brothers

Jenny Hsu -- Thomas Weisel Partners

Shebly Seyrafi - Caris and Company

Rohit Pandey - HSBC

Adam Benjamin - Jefferies

Presentation

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 would now turn the conference over to Ms. Deborah Stapleton who will introduce today's speakers. Ms. Stapleton, you may begin.

Deborah Stapleton, Stapleton Communications Inc.

Thank you, Carolyn. Thanks everybody for joining us this afternoon for Atheros Communications' third 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 and our anticipated growth, profitability and leadership position in various markets, our diversification strategy and the anticipated benefits of the Attansic 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 Form 10-Q for the quarter ended June 30, 2009, both previously filed with the SEC, in 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’ management believes 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.

Now, with all that, I will turn the call over to Dr. Craig Barratt. Go Craig.

Craig Barratt - President and CEO

Thanks, Deb, and thanks to everyone for joining us today. We’re very pleased with our performance in the third quarter which was yet another record quarter. We continue to see strength in our core wireless LAN business in both our 11g and a/g products as well as our new 11n solutions. We expect to see significant growth in 11n during the fourth quarter. Our PAS products continue to gain market share and we expect strong revenue growth from our PAS business in the fourth quarter. In addition, OEM's started shipping our first low power mobile wireless LAN solutions in the third quarter. Overall, we are pleased with our performance both from a financial and design win perspective.

To briefly recap some specifics, we reported record revenue of $79.6 million, record non-GAAP net income of $10.5 million or $0.19 per diluted share, GAAP net income of $6.3 million or $0.11 per diluted share and non-GAAP gross margins of 48%. Our non-GAAP operating income in the third quarter was 14.5%, up from 14.4% last quarter. In addition, we generated over $11 million in free cash flow during the third quarter. Jack will take you through the numbers in greater detail and discuss guidance for the fourth quarter shortly.

Atheros continues marching toward our goal of building a broadly-diversified communication semiconductor company through organic growth as well as complementary acquisitions. Our primary core competency of building wireless solutions in standard digital CMOS is unique and the essential building block for our success, but ambitions don’t begin and end with wireless. We've already begun to leverage our technical skills, customer relationships, and market momentum into several related markets. We are building a number of best-in-class businesses that leverage our core competencies. In fact, we expect to show revenue from five different businesses by the end of 2007.

To that end, today we announced we're acquiring Attansic, a fabless semiconductor company specializing in Fast and Gigabit Ethernet ICs for wireless access points, router applications, and PCs. Attansic is currently majority owned by ASUSTek, the largest PC motherboard manufacturer in the world and has designed teams in Taiwan and Shanghai. It's a proven Ethernet technology leader with the industry's smallest [desizers]. Attansic has several solutions in mass production on motherboards today, and its existing gigabit [NIC] and PHY solutions fit seamlessly into Atheros' product families and sales channels for PC customers. With the addition of Attansic's product lines, Atheros will offer a broader platform of communication solutions to several important market segments including SOHO, PC OEM, consumer, carrier, and enterprise. Gigabit Ethernet is required to realize the full benefits of 802.11n in routers, gateways, and game consoles for rich multimedia applications. We plan to aggressively drive Gigabit Ethernet into these platforms.

Ethernet ICs comprise a multibillion dollar market, and we believe that with this acquisition, our addressable market is expanding by approximately $500 million for PCs and laptops and by approximately $750 million for SOHO routers, gateways, and access points. We can disrupt important segments of these markets by leveraging the strengths of Atheros and Attansic, our leading wireless LAN technology and the highly differentiated and competitive Attansic products, our combined customer relationships and channels, integration skills, culture of innovation, and aggressive cost structure, all of which were forged in the highly competitive wireless LAN market.

Once again, Atheros has chosen to aggressively enter a market that is large and growing. We believe Gigabit Ethernet technology is very important to experiencing the full benefits of emerging 11n routers and clients. And of course, gaming platforms require both wide Ethernet and wireless LAN capabilities. As you can see, this acquisition is yet another milestone on our growth and diversification path enabling us to offer a more comprehensive platform of products to our customers, and importantly, it is an accretive way for us to enter important new markets.

Let's turn next to our core wireless LAN performance for the quarter. We continued to gain market share with our 11g and 11a/g solutions moving us closer to our goal of being number one in wireless LAN. As we anticipated, the retail market in the third quarter was relatively weak and the strength of our products -- of our other product segments more than offset the impact of retail. Overall, wireless LAN revenue increased in both dollars and as a percentage in the third quarter as we again saw strong sales into the PC OEM market and our enterprise and carrier segment.

Over the years, we have developed very strong relationships with the top ODMs and OEMs and now we are able to leverage those relationships and win even more business from them with our expanded product offerings. We have steadily gained a larger footprint with these customers and we expect that trend to continue as we innovate and develop new products and businesses.

In addition, we have been a leader in both technology and cost in the core wireless LAN market. In early 2004, we introduced the world's first single chip 11g PCI based product to the marketplace. The reception was tremendous as customers benefited from our world-class integration skills and the related cost savings these solutions brought them. Our expertise in providing single chip solutions in standard digital CMOS proved to be a strong asset of Atheros as we gained market share in what is one of the most highly competitive semiconductor markets. The benefit to the consumer and OEMs was obvious -- lower cost solutions that enabled a broad adoption of wireless LAN as the standard for home networking.

We are happy to announce today that during the third quarter Atheros realized its 100 millionth dollar of revenue from those first single chip products, the AR5005G and AR5005GS. Our innovation has paid off not only to the OEMs and consumers but also to our investors. We expect to leverage these integration skills as we both drive the adoption of the 11n standard and enter new markets with our unique solutions based on standard digital CMOS.

Another area of innovation from Atheros was the development of single chip PCI Express based products. Atheros started to invest time and resources into the emerging PCI Express wireless LAN market long before its competitors and we are now reaping the benefits of these investments through the strength of our PC OEM business. Our single chip PCI Express based solutions for the 11g and a/g markets are the most highly integrated in the industry.

During each of the past five quarters, Atheros has increased its PC OEM revenue demonstrating the market adoption of our cost-effective, technologically superior solutions. Our expertise in PCI Express and single chip solutions is a significant part of our PC OEM business today and is now being leveraged into new 11n solutions from laptop manufacturers.

Another area of particular strength for us in the third quarter was the carrier segment, which is a relatively new market for us. In this market, our customers are benefiting from Atheros' integration skills, which give them a high-performance integrated wireless LAN solutions at a competitive price. Our low-cost single chips are ideal for products such as broadband-enabled access points and routers. The early partnerships we created with top DSL providers and carriers are starting to pay off as an increasing fraction of households receive broadband wireless LAN gateways from their service providers. As evidence of this, for the first time one of our top five customers in the third quarter is primarily engaged in providing our products to suppliers of wireless LAN enabled DSL gateways. Our sales to enterprise and carrier customers has grown in dollars over each of the past seven consecutive quarters, demonstrating our continued success in driving wireless LAN into gateway solutions. Broadband providers partner with Atheros because of our ability to provide unique, cost effective solutions today and our roadmap of products and new technologies such as 11n that will meet their customers' needs tomorrow. With the addition of Attansic's Gigabit Ethernet technology we can offer carriers and our partners in this market even more as they depend upon Ethernet inside their triple-play boxes for video, voice and data.

Last week, we announced our collaboration with FON, the largest Wi-Fi community in the world by providing our single chip 11g router solution for its high-performance Social Routers. We support FON and other OEMs, carriers and municipalities that enable free or extremely low cost Wi-Fi access for their communities.

Our solutions for the carrier market have broadened our customer base and provided yet another expansion area for Atheros. We view this market segment as an important part of our wireless LAN revenue expansion in 2007, and we will introduce additional carrier-focused wireless LAN products and partnerships in the upcoming year.

Unlike others in our industry, we have seen continued strength in the 11n market as we methodically add customers to our group of partners shipping Atheros' leading-edge 11n products. Revenue from our XSPAN family of Draft 11n products was once again strong accounting for 11% of third quarter revenue and growing in dollars over the second quarter.

With multiple retail and PC OEM design wins today, coupled with the upcoming adoption of 11n in the enterprise and carrier segments, we believe, we are positioned well for growth in wireless LAN in the fourth quarter and all of 2007. We anticipate a double-digit percentage increase in revenue for our 11n products in the fourth quarter of this year.

With the continued adoption of our 11n solutions and our anticipated expansion of 11n revenue, we expect to be the clear leader in 11n product shipments during the fourth quarter. Customers have gravitated to our unique triple-radio SST enabled XSPAN designs and view this as a differentiator in the market for these new products. We expect to leverage these products as we push 11n to the forefront in 2007. As we drive 11n routers to use Gigabit Ethernet and with the addition of Attansic's Gigabit Ethernet expertise we expect Atheros' dollar content in each device to increase significantly.

In August, we announced that both our XSPAN draft 11n mini card reference design for laptops and our AR5008 draft 11n chipset have received PCI Express compatibility certification. The Atheros XB72 11n mini card reference design is the first in the industry to achieve such certification, which allows PC manufacturers to minimize product development time and risk of non-compatibility with the PCI Express standard while integrating the reference design into new wireless-enabled laptops.

On October 2, D-Links RangeBooster N650 Wireless Router, which features our XSPAN technology, received LAPTOP Magazine Editor's Choice Award. The editor said that it had the best range of any draft 11n router.

We've already announced our first 11n [cost down] solution, the AR5008V XSPAN chipset featuring a 2x2 MIMO design. This unique chipset is supported by our first family of network processors, the AR7100.

This quarter the Wi-Fi alliance announced it will certify current draft 11n products in the first half of 2007, which we expect to officially validate a wide array of 11n solutions. Our 11n solutions are being adopted into several different product areas driving the technology into the mainstream. 11n solutions will provide us with significant revenue growth opportunities in the fourth quarter, 2007 and beyond. We are confident that revenue opportunities are arising throughout the wireless LAN bill of materials. For example, unlike general purpose CPUs, Atheros' AR7100 network processor family is optimized for wireless LAN router performance, features, and cost. These processes offer an impressive set of features and interfaces including a high-performance MIPS-based processor core, a 33 and 66 megahertz PCI interface, dual Gigabit Ethernet ports for LAN and WAN connectivity, a high-speed 32-bit DDR memory controller to support high bandwidth applications, large caches, and the interfaces for audio and telephony.

The adoption of 11n in the market and it's up to 600 megabits per second of available throughput drives the need for increased processor horsepower. While there are third party products available today that we have utilized in many of our current 11n access point and router reference designs, none provide the combination of features and low cost that we feel are necessary to drive down the price points of 11n solutions and enable mass market adoption. The AR7100 family of products was developed by Atheros over the past year to meet all of the combined processor needs of our OEM customers.

The addition of our own processors is another critical path of our platform strategy as we provide more of the key components required for each access point and router design. The combination of Attansic's Gigabit Ethernet technology and our AR7100 network processor family will allow us to provide best-in-class total router solutions while further increasing the portion of the bill of materials that Atheros realizes from these solutions. And of course, owning the network processor is an integral path of our continuing integration strategy.

Moving next to new markets, just last month we formed a new mobile wireless business unit, which is headed by Dr. Sam Endy, formerly CEO of TeleCIS wireless, a leading developer of broadband wireless access chipset technology. This new business unit demonstrates our continued focus on mobile solutions and is an essential part of our strategy to drive the broad option of our expanding wireless technologies to OEMs, ODMs, and carriers serving the large and rapidly growing worldwide mobile wireless market. The organization includes dedicated engineering and marketing personnel focused on supporting the development of ROCm-based solutions and the acquisition of additional high profile customers in this market.

Our ROCm technology, the first family of embedded solutions to be offered by this new division, enables wireless LAN connectivity for cellular and voiceover IP handsets, media players, digital cameras, and gaming devices and has already achieved a strong position with leading global customers and partners. Today, our design wins have been strong and we continue to view our ROCm products as a key revenue growth driver in 2007.

The first end product to ship that incorporates our ROCm solution is a smart phone from Fujitsu Siemens. They are now shipping Pocket LOOX T Series, our new PDA cellular phones with an impressive array of functions including email, GPS, Bluetooth, and voiceover IP via integrated wireless LAN. These solutions are the first from our partnership with Compal Communications, the ODM that did the development for Fujitsu Siemens.

In the fourth quarter, we anticipate several new handset customers will take delivery of ROCm solutions for their products. One of these solutions was announced in the Japanese press in the past month and it represents an exciting kick-off to dual-mode handset strategy. Also in the fourth quarter, we expect to start shipping our low-power wireless LAN products to a major manufacturer of digital cameras and we recently received prototype orders from our first gaming partner whose production needs will ramp in the middle of 2007. Our ROCm solutions for the embedded market are just beginning to take off. The design wins of the past year will turn into revenue in 2007. We are optimistic about the market for low-power mobile wireless LAN solutions and we believe our hard work over the past two years will be rewarded in the form of significant revenue in the upcoming year.

In the third quarter, we successfully closed our acquisition of ZyDAS, the Taiwan-based design company that specialized in high-performance wireless LAN semiconductor and software solutions for PC, mobile, and embedded applications. The ZyDAS team forms the core of our Taiwan Design Center or TDC and this team is already aggressively designing a series of new Atheros products. The integration of the ZyDAS team into Atheros' Taiwan Design Center has gone quickly and smoothly to-date. TDC achieved an important milestone in the third quarter, the tape-out of its first Atheros solution less than 60 days after the acquisition closed. This tape out and subsequent [power up] of silicon demonstrates the quick and effective integration of TDC into the Atheros culture.

In addition, we have achieved design wins for some of the former ZyDAS wireless LAN POPs, and we look forward to continued leveraging of our customer strength with their cost-effective wireless LAN solutions. During the fourth quarter, this team will grow larger as we integrate some of the Taiwan-based Attansic personnel into TDC. The combined team will further strengthen our Asian design presence and enable us to quickly and cost effectively bring a wide range of wired and wireless products to the market.

During our last quarterly conference call, we said we anticipated our PAS business would be slightly down in the third quarter due to seasonality. This in fact did occur, and our PAS revenue was in line with our expectations. As we move into the fourth quarter, this business will strengthen, and we expect PAS to represent over 10% of our fourth quarter revenue. This strength is the result of our presence in some of the most popular UTStarcom phones such as the UT117 and the X30 as well as the addition of new PAS customers in the fourth quarter.

Early in the third quarter, we announced that our single chip PAS solution, the AR1900 is featured in UTStarcom's ultra-thin X30 PAS handset. Since its launch in April 2006, the X30 has become a best selling PAS handset model in China. UTStarcom is currently developing additional versions of this handset to leverage the popularity of its attractive form factor and features in the Chinese market. Our PAS solution is also in the UT117 which is the best selling PAS phone in all of China. This simple, low-cost candybar-styled handset has garnered the number one China market share for several months running. While our previous design wins are generating significant revenue today, we have also received additional UT design wins for upcoming PAS handsets.

As we mentioned in our last call, we have also secured design wins with additional customers. Products will begin shipping to these customers in the fourth quarter, and these design wins are also contributing to the strength of our PAS business. Additionally, looking into 2007, we view PAS as a growth business for Atheros as we secure further design wins at UTStarcom and benefit from the shipment of our PAS products to multiple customers.

Since the introduction of our PAS chipsets in the middle of 2005, we have already generated over $30 million in revenue. In just six quarters the investment we made in the development of the industry's first single chip cellular solution has provided us with a positive ROI and a dramatic increase in our profitability. Our PAS products have demonstrated that our highly tuned skills in CMOS integration can provide our shareholders with a dramatic return on investment. It's this ability that we are again leveraging in additional markets to further expand the reach and profitability of Atheros in the coming years.

Q3 was another important growth driver -- sorry, Q3 was another important quarter of growth for Atheros. Our strategy of building a broadly diversified communications semiconductor company has seen continued success. In wireless LAN, we are able to offer -- we are able to offset weakness in the retail sector with strengths in the PC OEM and enterprise and carrier segments and we have continued to gain market share.

Our PAS business is poised for significant growth as we head into the fourth quarter. We were pleased to see shipments of our first ROCm based mobile wireless LAN products, which will be an important growth driver in 2007. And just today, we announced another important step in our diversification plans with the addition of the Attansic team and products, which will enable us to drive the adoption of Gigabit Ethernet solutions. We are excited about our prospects for the fourth quarter and 2007 and we look forward to providing our customers with five distinct product lines in the second half of 2007.

With that, I will hand it off to Jack for a detailed review of the financials. Jack.

Jack Lazar - Vice President, CFO and Corporate Secretary

Thank you, Craig, and thanks all of you for joining us today. Now first, I will outline our financial results for the third quarter ended September 30, 2006, and then I'll provide our Q4 guidance. Unless otherwise noted, all financial data in my remarks is on a pro forma non-GAAP basis and reflects the exclusion of charges related to the acquisition of ZyDAS Technology Corporation, which closed in Q3 and non-cash stock-based compensation charges related to the adoption of FAS 123R.

In summary, our financial results for Q3 were very strong. This quarter represented the sixth consecutive revenue growth -- sixth consecutive quarter of revenue growth and the fifth sequential increase in both operating and net income. Revenue and gross margins were at the high end of the range as we guided to in our last quarterly conference call and EPS was one penny better than our guidance. As a reminder Q3 guidance was for 6% to 10% revenue growth, gross margins of 47% to 48%, and EPS of $0.17 to $0.18. Q3 revenue increased 9% sequentially and net income was up $1 million to $10.5 million or $0.19 per share. Gross margins for the quarter were 48% at the high end of our guidance and 300 basis points above the high end of our target model range.

Revenue was a record 79.6 million in Q3 up 6.4 million from the 73.2 million recorded in the second quarter of 2006. Third quarter revenue increased 74% compared with the 45.8 million recorded in the prior year comparable quarter. The 9% sequential increase in revenue was driven by a further expansion of our core wireless LAN business with particular strength in both our 11a/g and 11n products.

Based on product mix data, the mix of wireless LAN only chipset was as follows -- 11a/g was 37%, 11g was 51%, and 11n was 12%. In dollars, 11a/g solutions increased 7.7 million or 42% from Q2 to Q3 due to the strength of our PC OEM business. 11g solutions were down 1.3 million or 3% while 11n increased in dollars by 3%.

The percentage breakdown of revenue by market segment based on data supplied by our ODMs is as follows: retail was 36% of our Q3 revenue, PC OEM was 28%, enterprise and carrier was 23%, and consumer electronics and other were 13%. Revenue in units shipped to customers in our PC OEM and enterprise carrier segments set record highs. The enterprise and carrier channel was up 4.8 million or 35% sequentially due primarily to our growing presence in broadband wireless LAN gateway solutions. In addition, our PC OEM channel was particularly strong due to the continued adoption of our PCI Express solutions. Revenue in this segment increased over 4.4 million or 25% sequentially.

As anticipated, PAS business was down slightly due to seasonality but the total consumer electronics and other revenue increased by just under 500K as we began ramping shipments of our ROCm line of products.

In Q3, Hon Hai Precision Industry was our only 10% or greater customer. Third quarter gross margins were 48% down 110 basis points from the 49.1% reported in Q2, but were at the high end of our guided range of 47% to 48% and well above our target corporate range.

On a same chip basis excluding the impact of ZyDAS chips, overall blended ASPs decreased 5% sequentially to $6.20 compared with ASPs of $6.51 in Q2. During the third quarter, we shipped our 75th million wireless LAN chipset and we recorded our 100 millionth dollar revenue from our single-chip 11g PCI client solution. Total operating expenses were $26.6 million which represents a 5% from Q2 and was within our guidance of $25.9 million to $26.9 million. Even with the addition of the ZyDAS team in mid-August, operating expenses increased at only approximately one fourth of the rate of increase in Q2.

R&D increased 300,000 or 2% sequentially due to head count additions, ZyDAS related engineering expenses, and consulting fees. As a percentage of revenue, R&D declined from 22% to 21% in Q3. SG&A increased $1 million due to head count additions, professional fees and marketing related expenses.

Operating income for the quarter was 11.5 million, up 9% from the 10.6 million recorded in Q2 and represents a 5 times increase from that recorded in the first 9 months of 2005. Operating income was 14.5% of revenue in the most recent quarter, up from 14.4% in Q2. Net income was 10.5 million or earnings of $0.19 per diluted share for the quarter compared with net income of 9.5 million or earnings of $0.17 per diluted share in Q2. Average shares outstanding were 54 million in both Q3 and Q2.

GAAP net income for the third quarter was 6.3 million or earnings of $0.11 per diluted share. This compares with GAAP net income of 6.8 million or earnings of 12% -- $0.12 per diluted share in the second quarter.

Turning to the balance sheet, cash and marketable securities were $191 million at September 30th. A $10.3 million increase in total cash and marketable securities during Q3 was offset by the 17 million in cash consideration paid to the ZyDAS shareholders upon close of the transaction in August. During the quarter, we generated 11.7 million in free cash flow from operations. DSOs based on our quarterly average receivables balance increased to 53 days from 43 days in Q2, reflecting a more linear shipment pattern in Q3. Inventory turns for the quarter increased to 5.2 times compared with 5.0 times in Q2, while days of inventory decreased from 72 to 70 days. Inventory turns remain within our target of 5 to 6 times and the company continues to have virtually no debt.

Total liabilities at the end of Q3 were $61.7 million. During the third quarter of 2006 our capital expenditures and depreciation were approximately $1.3 million and $900,000 respectively.

Our balance sheet continues to be very strong with over 61% of our $309 million in total assets in the form of cash and marketable securities. As of September 30, we had 526 full-time employees compared with 420 at the end of Q2. Most of these additions were R&D personnel with 81 resulting from the close of the ZyDAS acquisition in August.

I'll now move onto our guidance for Q4. Our Q4 guidance does not include the revenue and expenses related to the acquisition of Attansic announced today. We currently anticipate closing this transaction late in Q4. Q3 was our strongest quarter to date in terms of revenue and net income. As we enter the new quarter, we expect the continued benefit from the strong product cycles, especially in 11n and PAS.

Accordingly, we currently anticipate fourth quarter revenue to increase between 6% and 9%. We expect to expand our wireless LAN revenue in the fourth quarter with particular strength in our 802.11 products -- 11n products, which will be over 15% of our quarterly revenue. In addition, we anticipate our PAS business will be over 10% of our total Q4 revenue representing a strong increase from Q3. Gross margins are expected to be in the range of 46.5% to 47.5% 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. In the third quarter, we anticipate total operating expenses to be in the range of $27 million to $28.5 million representing an increase of between 2% to 7%. Virtually all of these increases will be in research and development as we have a significant number of tape outs in Q4 and a full quarter of expenses from our recently closed ZyDAS acquisition.

Our estimated pro forma tax rate in Q4 is approximately 25% and we anticipate our EPS range for Q3 to be in the $0.19 to $0.20 range based on fully diluted shares outstanding of between 56 million and 56.5 million. Our Q3 results and our Q4 guidance reflect the strength of our business, dividends from our diversification strategy, and favorable product cycles that we continue to leverage. We will invest in the further diversification efforts that we believe will help position Atheros for ongoing success and increased shareholder value in 2006 and beyond.

So with that let me hand it back over to Craig.

Craig Barratt - President and CEO

Thanks Jack. As you can see, Atheros is delivering on our promise to expand our core technology strengths into a diversified communication semiconductor company that encompasses several complementary businesses. In addition to our technology leadership, we are becoming highly customer-centric providing a more complete platform of products for our growing customer base. Attansic is an important component of this vision along with other initiatives, some of which we have not yet announced.

One last note, we are proud to be ranked number 26 on Deloitte’s 2006 Technology Fast 500, a ranking of the 500 fastest growing technology, media, telecom, and life sciences companies in North America. Rankings are based on percentage revenue growth over the past five years from 2001 to 2005. Atheros grew 9921% during this period with revenue jumping from $1.8 million to $183.5 million. We would like to thank all of our employees for making this happen.

With that, we are now ready for questions.

Question-and-Answer Session

Operator

Thank you. At this time, we are ready to begin the question-and-answer segment. (Operator Instructions). Our first question will come from Mark Edelstone with Morgan Stanley.

Mark Edelstone - Morgan Stanley

Good afternoon, guys and nice job on the quarter. I just had two questions if I could. The first one relates to the 802.11n market, obviously, you are doing very well there, but can you just talk a little bit about what do you think the ramp of the notebook business will look like there for you and may be some sense as to how broad you --

Craig Barratt

Sorry, Mark. The last part of your question appeared to get cut off.

Operator

One moment please.

Craig Barratt

Sure.

Mark Edelstone - Morgan Stanley

-- in the first half of next year and then just a sense as to how broad your design wins have been so far within the notebook space for it?

Craig Barratt

So I apologize, Mark. We missed the middle part of your question, but you can just paraphrase the question please?

Mark Edelstone - Morgan Stanley

Okay. Sure. So, it just relates to the momentum you are seeing in n for notebooks? What the ramp you think might look like here in Q4 and the first half of next year and just how broad your design wins have been so far within the notebook segment for 802. 11n?

Craig Barratt

As we noted in the call, we do expect our 11n revenue ramp to be quite strong in the fourth quarter in particular. We expect it to grow double digits quarter over quarter, and that’s really due to two factors. We have a broad product presence in the retail market which is the foundation of our 11n business but the additional factor is the ramp of PC customers. We think we have a very nice footprint of customers in this segment. Each customer has a different strategy in terms of the range of platforms that they expect to launch, but during later this quarter and going into next year, we expect many of our customers to begin shipping their first laptop platforms and that’s something that will additionally drive 11n routers in the retail segment as well.

Jack Lazar

Yeah, and Mark it's important to point out that these are embedded, ones that you would expect to see as part of platforms as opposed to kind of add-on options.

Mark Edelstone - Morgan Stanley

Right. And I guess can you maybe put into perspective the breadth of the design wins that you have in the embedded side of notebooks compared to what you've historically been able to achieve with your G, Super G, and AG solutions?

Craig Barratt

Well, it's hard to put color -- specific color on that, but I think I should say we’re very, very comfortable with our 11n position in the PC/laptop market. So, we expect the share in 11n in those markets to be the same or greater than our current share that we've enjoyed for the older 11g and a/g solutions.

Jack Lazar

I guess another way of putting it is that many folks have been caught in the trap of predicting future market share percentages, and I think that what we’re trying to do is just actually focus on getting these design wins out and see what the acceptance will be in the consumer marketplace.

Mark Edelstone - Morgan Stanley

Okay, fair enough, and I just had a question on the Attansic acquisition, can you just give us a sense to what kind of revenue impact we might see from that next year, and what if any earnings impact you might expect as you go through 2007?

Jack Lazar

Hey Mark, this is Jack. From Attansic, I guess the best way of putting it is that we would expect to see certainly at least 25 million in revenue in 2007 from that acquisition assuming we do get closed at the end of Q4 here. Overall the deal certainly will be neutral to maybe slightly accretive next year. As we know though, this is really part of a much bigger strategy for us, so finding the right Gigabit 5 technology was really our quest, and we spent a lot of time, talked to a lot of people, and I think we're very happy with what we ended up with.

Mark Edelstone - Morgan Stanley

Congratulations, guys. Thanks a lot.

Jack Lazar

Thanks.

Craig Barratt

Thanks Mark.

Operator

Thank you. Our next question comes from Gus Richard with First Albany Capital.

Gus Richard - First Albany Capital

Yeah, just a couple of housekeeping questions quickly, embedded revenue in the quarter, roughly what was that?

Jack Lazar

Yeah, we're not going to break out embedded at this point. You can still say it's relatively negligible, though, I mean it's just starting to ramp right now. As we look into next year, we'll be talking obviously in millions and hopefully tens of million of dollars. But as we exit this year, it's really just the design wins that we've been focused on.

Gus Richard - First Albany Capital

Okay. And sort of where do you start to see that ramping, sort of in the middle of next year, first half of next year?

Jack Lazar

I think it's dependent on the end demand in the marketplace, frankly. What you're starting to see, as we mentioned, there are several handsets that should start shipping this quarter and we mentioned digital cameras today, gaming as we mentioned is more of mid-2007 type of product. So, it really just depends on the acceptance and the breadth of the product lines that include wireless LAN.

Gus Richard - First Albany Capital

Okay. And then shipments in the quarter in terms of units about 12.8, is that about the right number?

Jack Lazar

Yeah, we're actually going to move away from disclosing total overall unit numbers, primarily because our business has become more diversified and frankly will get even more diversified with the addition of the Attansic business. Generally, we shipped probably in the little north of 13 million units for the quarter, but we are going to move away from this as a metric going forward. We will try to continue to give -- we will try to give information which we think is important to investors such as the ASP trends and the variety of different markets and we specifically commented on that again today.

Gus Richard - First Albany Capital

Okay, and then, the new product introductions, we were expecting a new product (inaudible) mid this year, we're into the fourth quarter, any update on when the internally-developed product might be announced?

Craig Barratt

Yeah, Gus, this is Craig. As I mentioned in my presentation, we do expect revenue from five different business areas in the second half of '07 and the area described is expected to be one of those five. The schedule for the announcement is a little bit later than we first anticipated. We believe we will make this announcement in January of next year, early 2007. Part of the reason for this is, we made a very large commitment to the 11n development effort through much of this year and that's something that has made us a little bit slower than we first expected in this marketplace, but we still believe our solutions that we are working on will be highly differentiated and highly competitive and we are still quite bullish about this new area that we'll announce early next year.

Gus Richard - First Albany Capital

Okay. And then, the final one from me is the Attansic acquisition, looks like it's been losing money for ASUSTek for the last few years and they're selling it to you guys. What are you guys going to do to turn that around and make it profitable, is there some -- do you get some economies from the foundries, can you help me out in understanding that?

Jack Lazar

Yeah, Gus, this is Jack. I don’t believe that we disclose nor Attansic disclosed the actual numbers, but what I can tell you is that Attansic, particularly their Gigabit and Fast Ethernet technology has been recently developed and historically Attansic had some older, kind of, glue logic power management type products that we really don’t see as a focus area for us going -- as much going forward. The focus is on the new switching portion of the business. That portion of the business has significant design wins, and I don’t think we would have gone out on the limb and said that we would expect at least 25 million in revenue from this transaction in 2007 if we didn’t think the design wins were there. So, the biggest -- the simplest way to make a company profitable is to ship a lot of product and that’s what we expect to do with them.

Gus Richard - First Albany Capital

Okay. So, the focus will be to exit the legacy businesses and focus purely on the Giga and Fast Ethernet segments of the market and then drive [back] going forward.

Jack Lazar

Yeah. I don’t want to say exit. What I would say is that the focus is on more of the Ethernet portion of the business. So, as you can tell from all the press that we have put out and the comments that Craig made today and we will work with the other piece of the business.

Gus Richard - First Albany Capital

Okay, got it. Thank you.

Operator

Thank you. Our next question comes from Charlie Glavin with Needham and Company.

Charlie Glavin - Needham and Company

Thanks. Jack, maybe into the margin areas and also the R&D, you are talking a lot of -- a significant number of tape outs. Are those mostly going to be cost reductions? I assume that none of those would be the -- Attansic related until after that closes but in terms of those tape outs, are those more for some of the new products or in terms of cost reduction or actual entry into some of the new markets?

Jack Lazar

What I can tell you Charlie is that it’s a variety of answers to that. We have a lot of products taping out this quarter. They are cost downs, they are new products, they are test new products, you've got them all right. There is nothing obviously with Attansic because that won't close until late in the quarter, but it's addressing existing markets, new markets, it’s a lot of products to tape out this quarter.

Charlie Glavin - Needham and Company

Then if I can, if you take a look at your 48% gross margin, but still looking for that to ease -- if I take a look at the cost reduction efforts and your bundling efforts which historically have always tended to forward some of the OEM pressure upon suppliers. Is the majority of that gross margin really going to then come from the richer mix of 11n potentially cannibalizing g, and given the higher costs associated with that, is there going to be a little bit of a bleed down from that before the cost reductions can really catch up?

Jack Lazar

Well we did guide margins down a bit this quarter to 46.5 to 47.5, and we think that’s a -- obviously that’s our best guess of what the range will be based on our mix of products today. There is, as you would imagine, as others have commented too, certainly a little more ASP pressure on 11n, but we’re frankly comfortable with that because we feel that that’s necessary to drive the large volume in that market. So, gross margin stats are something that we try to keep certainly within our target range, and we've done that pretty well over the last couple of quarters being well above that range. I think at these levels it's still significantly positive to the company, and if we can do that and drive the adoption of things like 11n, it's overall a big plus for the company.

Charlie Glavin - Needham and Company

Craig, if I could, in terms of your relationship with Attansic and the OEMs, I think several of the Attansic customers are the ones that you've been working side-by-side, I guess maybe it’s the timing of this acquisition, you moved side by side with some other gigabit providers in the Fast Gigabit and Fast Ethernet was the biggest driver on this more that you've been hunting around, looked for one or was it more of a request from the OEMs that they would like you to bundle more products together because they would rather stick with, say, your wireless LAN solution as opposed to going to an inferior solution but a better bundling from, let's say, is it Broadcom or Valor or even some of the real low cost guys like the Realtek's out there.

Craig Barratt

Yeah, Charlie. I mean certainly we have used a variety of partners in our reference designs primary for Fast Ethernet 10/100 technology. But that contributes a relatively modest dollar amount to the bill-of-materials because the price per port is relatively low. So it's much more of an opportunity around the transition from Fast Ethernet to Gigabit, where the dollar content of those -- of that part of the solution will increase significantly because that the dollars per Gig port are substantially higher than Fast Ethernet. So it is more of the transition to Gigabit Ethernet, which makes this opportunity very attractive to us. And of course, given our integration skills overtime, it makes sense for us to have products that include all of the functionality all the way from wire to RF?

Charlie Glavin - Needham and Company

It was more of a market or it was driven by you and Attansic as opposed to the OEMs saying we need both of these solutions to maintain you guys over the next 12 to 24 months as opposed to you've been looking for this over the last 12 months, thought these guys were the best.

Craig Barratt

I mean it's really -- we really see an opportunity for integration to serve our customers. I don't -- I wouldn't say that it was driven by particular OEM request or demands; we really have a vision about how the components of these solutions will drive together in a common platform. And this is a piece that we really want as the part of our solution.

Charlie Glavin - Needham and Company

Last question in regards to outlook in the PAS market, I think previously you've stated that you expected to get about a quarter of that market, are you now in a position where given your chips and maybe some slips by some of the other competitors out there that you're looking to increase that target market share threshold?

Jack Lazar

Well, I think the 25 % of market that we've referred to Charlie is really related to our exit through this year. And I would say we're definitely on track for making that happen. So we've -- very quickly as we mentioned on the call today, we've already had $30 million of revenue, this has become a positive ROI to the company. We view this is an expanding market next year, so clearly we're expecting to be more than 25% of the market in 2007. So, I think the thing is -- the PAS market is trending the way in which we'd like to see it trend, and hopefully, we're able to take advantage of that with the products that we have.

Charlie Glavin - Needham and Company

Would the growth be in more market share gains and not necessarily end market growth next year?

Jack Lazar

Absolutely, I mean we're not focused on end market growth, and in fact, a lot of the growth that you see today really is related to a replacement adds and that we're benefiting from that.

Charlie Glavin - Needham and Company

Great. Thanks Guys.

Jack Lazar

Thank you.

Craig Barratt

Thanks.

Operator

Thank you. Our next question comes from Jonathan Goldberg with Deutsche Bank.

Jonathan Goldberg - Deutsche Bank

Thanks for taking my call. Just had some questions about ROCm, it sounds to me like your outlook for the embedded product is accelerated a little bit, it sounds like [2000] outlook is better than we had expected originally, so I was wondering is that so, have you seen anything in the last three months that's changed your outlook, improved your outlook on ROCm and then, what are your thoughts on wireless carrier adoptions for dual-mode handsets going forward?

Craig Barratt

I mean I think the main dynamic is we're simply further along in the design cycle. Post design win, there is a reasonably a long path to market, and as each quarter goes by we're closer to actually ramping these customers. We saw the Fujitsu Siemens products start to come out and we have quite a nice pipeline. So, that makes the revenue outlook similar to our expectations before but more tangible because we can see these products getting closer to market.

You're correct that there is an increasing interest in the carrier segment for dual-mode cell phone Wi-Fi capability, and an interesting point is that our increasing presence in the gateway side of the connection allows us to inject features into the carrier's CPE or the carrier's gateway that will enhance the experience in areas such as battery life and security and voice quality for those subscribers. And so, we think there is a very interesting tie-in as we start to get our devices into both ends of that connection, both the gateway and the handset devices.

Jonathan Goldberg - Deutsche Bank

When do you see that carrier adoption really kicking in?

Craig Barratt

I mean, actually I think the other products are probably ones that will have the greatest revenue growth in the shorter term, though I think dual-mode cellular phones will be a larger market in '08 and '09. Certainly '07 we'll have some revenue, but devices such as gaming devices, music players, and other devices really would be where there is growth as well. So the long-term big market is dual-mode cell phones certainly, but the adoption rate will be somewhat meted during 2007, primarily because the carriers don’t yet have the end-to-end solution and service offering for their subscribers in place.

Jonathan Goldberg - Deutsche Bank

And finally, quick question on Attansic, what are your gross margins? What do the gross margins in that business look like?

Jack Lazar

Yeah, I wouldn’t expect them to be any significantly off of our standard corporate gross margins.

Jonathan Goldberg - Deutsche Bank

Great. Thank you.

Operator

Thank you. Our next question comes from Ramesh Misra with Unterberg, Towbin.

Ramesh Misra - Unterberg, Towbin

Good afternoon, Craig and Jack. I had a question in regards to the delay in the ratification of the 11n standard, what impact, if any, has it had on you and what impact do you anticipate happening in the future and then I had a follow-up?

Craig Barratt

Yeah, the delay on the standards really has no impact. Essentially the -- what it means is the differences between the current draft 11n standards and the final 11n standard are more or less becoming irrelevant to the market. We have retail who is broadly launched, we've PC OEMs who are preparing platforms for launch, and what that means is it's very unlikely that there will be any significant differences between the draft and 11n standards. And of course, the Wi-Fi alliance has announced that they will actually logo and certify these draft 11n products. So, the timing of the final standard is actually becoming quite irrelevant now and completely decoupled for the growth of the market.

Ramesh Misra - Unterberg, Towbin

I see. So in terms of the final standard, do you anticipate that pretty much a software-based upgrade, should pretty much bring it in line with (inaudible).

Craig Barratt

Certainly that is the expectation. I should say that no one player can 100% guarantee that, but the industrial momentum suggests that it's becoming extremely unlikely for any material change to be made to the standard as it moves to completion.

Ramesh Misra - Unterberg, Towbin

Okay, and then finally in terms of, I know Jack you deferred from talking too much in terms of detailed gross margins, but are there any meaningful differences between the n and the a/g products in terms of margins?

Jack Lazar

I don’t think we’re going to get to that level of granularity. I think we've done a pretty good job of running the gross margins of the company over the last couple of quarters. So we’re really focused on more of the corporate average.

Ramesh Misra - Unterberg, Towbin

Okay. Alright, thanks very much and congratulations.

Jack Lazar

Thank you.

Craig Barratt

Hey, thanks Ramesh.

Operator

Thank you. Our next question comes from Arnab Chandra with Lehman Brothers.

Arnab Chandra - Lehman Brothers

Thank you. Question for either Jack or Craig. First of all in wireless LAN, it seems like the level of competition in n is significantly less, and you also had shipments in all segments of the market, especially with the ROCm, do you think that -- but at the same time some of your older competitors have retrieved from g. So is the end transition going to likely keep your share constant, gain? I know you don’t want to talk about specifics given some of your competitors' somewhat misleading statements. So, could you give us a sense of that whether that benefits you in the ASP as well as units, that would be great? Thank you.

Jack Lazar

Hey Arnab, it's Jack. Obviously 11n benefits us from an ASP perspective, and really what we believe, and one of the reasons behind the Attansic deal today is really that we want to drive 11n, and we think for 11n, Gigabit is a necessary requirement of that, not necessarily so much today, but certainly as we move through 2007. So, I think we're pretty comfortable with what's happened so far in 11n. I definitely would not go to the extent of saying competition is easier. We compete with some of the best semiconductor companies in the world in Broadcom and Marvell, and I don’t think that’s ever easy. But we’re confident but cautious about what we can achieve in 11n and so far things have kind of fallen our way nicely but there is a long road to go on 11n.

Craig Barratt

And Arnab, I think certainly our goal in 11n overtime is to have a market share design win position which is materially better than our existing market share. And so we’re trying to use 11n as a weapon to further increase our share of market, and I think the numbers we’re starting to demonstrate are certainly showing that that’s coming to pass.

Arnab Chandra - Lehman Brothers

Great. Just moving quickly to the Attansic deal, I'm not too familiar with the company, but just checking the website cluster it seems like the company has actually been -- the Ethernet Technology is mostly 5 or sort of PC-controller related. I am just curious if you could talk a little bit, I would guess one of the reasons you are acquiring is because of switching technology. Is that something you will co-develop with them? You talked about 25 million next year. I remember seeing something what, a little bit less than 10 million last year. This is not a company given maybe you are a little bit US focused, we are not really aware of. So just want to make sure that this is something that -- you don’t have to rejigger the company to sort of do what you want to do, if you could talk qualitatively, even that will be great?

Craig Barratt

Yes. Arnab, I think one of the key elements here is the 5 technology. That’s a necessary ingredient in client-side NIC type devices and also a critical ingredient in switch-based products, and Attansic has the world's best and most competitive 5 technology in Gigabit Ethernet. And so that provides a very good foundation. The revenue for next year will be primarily related to their existing products, which are NIC and 5-based products for PC customers. And clearly they have a number of design wins and are shipping products with Asustek who is the largest PC motherboard manufacturer in the world. The development of switch products is something that is already underway, something that we will accelerate with them. And of course, we have a platform of 11n and other wireless solutions and a customer base which I think will allow us to ramp those products very rapidly as they become available.

Jack Lazar

Yeah. I think the important thing to point out with these guys is that, once again you see us going after a more mature market, one that is still growing at a nice pace. We have taken something what we think is special, the Attansic technology. We are going to, obviously, leverage that into an existing customer base in a much more significant way right away. But then we will also blow it out into products that are really strategic to the growth of the overall Atheros entity. So I think the combination of all of this really made this a deal that we just could not pass out.

Arnab Chandra - Lehman Brothers

Thanks. Jack and Craig, and last question about PAS, obviously, you have certainly outperformed lot of expectations and some of the skepticism that's been out there, it does appear that the subscriber numbers are declining there. So do you think some time in '07 would you penetrate enough or you would reflect the market or is it still beyond '07 when it is market share versus end market growth that’s the driver for you?

Craig Barratt

PAS will grow in '07. It's really that simple. I mean, we are focused on taking market share. We have clearly done a pretty good job with UT. I think it has benefited both parties. We are looking at other customers. We already have design wins with other customers. There is a long way to go and really a lot of the overall PAS market is not -- people are too fixated on the net subscriber ads. There is 100 million subscribers almost out there who like PAS, who replace their phones, and the opportunities within the churn are extremely good. So, those upgrades really are the path to expansion of our business and we are going to continue to focus on that. Certainly on the long term, we certainly know that the market will start to slow down for PAS but we just don’t see that happening for us in 2007.

Arnab Chandra - Lehman Brothers

Jack, just one quick follow up. Could you give us some idea about if not the subscriber base, is there a rate of growth of units of phones or something like that that -- because part of it is we don’t get -- we don’t see that data. So, is there something you could share with us about the growth rate of units for PAS phones or something over the last few years or in the future?

Jack Lazar

There is market data that we use and it is available from third parties. Some of the estimates of the replacement handset market are based internally or they are based on customer data. If you look at the broad cellular market, look at the replacement rate in that market, it's certainly higher than PAS, but in the broad cellular marker, we are not adding a billion subscribers to GSM and CDMA per year. Clearly, the bulk of that are replacement handsets. So, that becomes an increasingly important part of the shipments as the market matures.

Arnab Chandra - Lehman Brothers

Thanks Craig.

Craig Barratt

Great. Thanks.

Operator

Thank you. Our next question comes from Jenny Hsu with Thomas Weisel Partners.

Jenny Hsu -- Thomas Weisel Partners

Hi. Thanks for taking my question. First, I just want to clarify the Attansic projected revenues for next year, around 25 million now, you said the majority of that is going to related to the switches and not the legacy power management?

Jack Lazar

No, what we said is that the majority of it will be related to Ethernet, and we'll have -- the initial focus is really on the PC accounts where there is design wins already in place for the 5.

Jenny Hsu - Thomas Weisel Partners

Okay.

Craig Barratt

Yes, I think, it's mostly the existing products that already have design wins in the channel.

Jenny Hsu - Thomas Weisel Partners

Okay. And then, at the end of the quarter you had 526 employees, 81 of which from ZyDAS, how many people would we expect for you to bring on because of Attansic and how would --?

Jack Lazar

Yeah Jenny, it will be under 100. So, probably the same type of ballpark as the ZyDAS deal, which is slightly some more.

Jenny Hsu - Thomas Weisel Partners

Okay. And then, right --

Craig Barratt

Additionally, we'll be hiring people in addition to the Attansic acquisition during the fourth quarter but we don’t give headcount guidance.

Jenny Hsu - Thomas Weisel Partners

Okay. Then what is your strategy looking forward for the R&D, you have three design centers now, one in Taiwan, one in the U.S., how can we think about your strategy in terms of utilizing both of those centers to develop new products going forward?

Craig Barratt

I mean we expect to leverage each of those geographic centers. Additionally, we have significant teams in India and also in Shanghai. So in some business areas, we will focus our development in those geographies because of the proximity of the customers, for example most of our PAS development is occurring in our Shanghai office. And so, we'll leverage customer proximity, we'll leverage the talent pool in each of these areas, and the whole goal here is to create more and more parallelism in our business. So, multiple parallel teams serving product development needs for multiple businesses as we grow. And that’s very much our strategy to do that in several geographies in parallel. I should mention that roughly 30% of our total headcount is now located in Asia, primarily Taiwan, Shanghai, and India and certainly we expect that percentage to increase.

Jenny Hsu - Thomas Weisel Partners

Okay. And then just one last question on the model for '07, what kind of a tax ratio will we be looking at?

Jack Lazar

Yeah, we'll update you with that as we get closer to '070. We don't have much of and update right now.

Jenny Hsu - Thomas Weisel Partners

Alright. Thanks.

Operator

Thank you. Our next question comes from Shebly Seyrafi with Caris and Company.

Shebly Seyrafi - Caris and Company

Yes. Thank you very much. So looking at my model, the enterprise carrier segment grew quite well for you, that's a higher margin segment independently as well, and yet, the corporate gross margin declined, I am wondering what accounts for the decline in gross margin? And secondly looking forward, do you expect to eventually approach your -- I guess your target, your stated target of 43% to 45%, particularly since 11n is going to ramp over the next few quarters?

Jack Lazar

Shebly, this is Jack. First of all, as far as the carrier business, it's not necessarily at a higher gross margin. In fact, we can be extremely competitive. You can imagine these guys are putting xDSL box -- gateways with wireless LAN into your home and basically charging you nothing for it. So that can be a very, very competitive business. We haven't had very competitive products for that, but the gross margins on that aren't necessarily high. The other thing I would point out is that gross margins this last quarter went down more so due to product mix, less PAS, little more clients, less retail APs. APs tend to be a little better than clients and so the combination of all of those really probably drove the margins down a bit this last quarter.

Shebly Seyrafi - Caris and Company

Okay, and separately, I think there has been talk or speculation that you might enter the Bluetooth or GPS market soon, do you think that this Attansic acquisition changes your thoughts about entering those markets anytime soon?

Craig Barratt

No, the Attansic acquisition does not change our propensity to execute on new markets. We think there are many attractive markets out there that we don’t currently serve, some of them are large growing markets, and [over] time, we think a number of those are very attractive to us, we have an increasing presence among the key customers and OEMs that will serve us well as we broaden our product portfolio for these customers. So that propensity for both organic diversification and additional diversifications or acquisition has certainly not changed.

Shebly Seyrafi - Caris and Company

And finally from me, I think a prior question touched on this, your embedded or actually your ROCm business, I'm wondering how I can estimate that business next year as it takes off could this be 20-50 million per year, possibly?

Craig Barratt

Well, considering we’re starting from a very small number this year, 20-50 million would be even greater than the ramp in our PAS business this year. So, we think we have some good design wins, they are going to play out over the next couple of quarters, and I think as we get closer and closer, it will be a little easier for everybody to actually put some quantitative metrics on what the impact is going to be. We would not dedicate people, resources and create a business unit for our mobile business if we did not see significant revenue opportunities in 2007 and beyond. That being said, I think it’s a little too early to predict out into 2007 as to what the ROCm business is going to be.

Shebly Seyrafi - Caris and Company

Thank you very much.

Jack Lazar

Thank you.

Craig Barratt

Thank you.

Operator

Our next question comes from Rohit Pandey with HSBC.

Rohit Pandey - HSBC

Thank you. A couple of questions for either Jack or Craig. You guys were able to lower your cost per unit by about 30% in both 2004 and 2005 and seems like you again will be in the 20% to 30% range this year. So, two questions here, should we expect this pace to continue? And secondly, what are the key drivers which would enable you to lower cost at this pace next year?

Jack Lazar

Well Rohit, it's essentially the strategy that we have laid out. As we go to 11n, we have started with a two-chip solution just for the wireless LAN piece. And the other pieces of silicon in our customers' products are the network processor and the Ethernet side -- the Ethernet 5 and switch. And so, we have essentially laid out a strategy that allows us to achieve exactly what you suggest, which is by having each of these pieces, we can offer a platform of solutions which overtime we can apply our integration prowess to combining those into fewer and fewer chips at lower and lower costs. So, we think there is a very nice runway ahead of doing exactly what you say. Now of course, it's not just about costs. Cost is important, cost is important for margins and winning new customers but technology differentiation is important as well. So, by having best-in-class solutions in the network processor, the Ethernet and Wi-Fi we can put all of those together and produce the best products at the lowest cost. So, yes, it was absolutely a runway to further reducing our cost.

Rohit Pandey - HSBC

Okay. And given that the single chip is already above 30% of -- above 70% of the total shipments, that wouldn’t be a hindrance to continue lowering cost?

Jack Lazar

No. That’s certainly the case. I mean, we actually have multiple generations of single chips coming out. So, even having a single chip is not the end of the line. There is additional parts of the bill-of-materials that can be integrated into that platform. So, we can integrate the power amplifier and other devices in client-side, and we can integrate now everything on the router side. So there's a lot of potential for integration even when we’re already at single chip.

Rohit Pandey - HSBC

And one quick one, the corporate [branded] ASP declined by about 5%, so can you highlight which segments where the ASP declined the most?

Craig Barratt

So a question about ASP decline, so the 5% same chip ASP decline, Jack, you have a comment on that?

Jack Lazar

Yeah, I'd say that the 11g portion of the market, actually, frankly the PAS portion of our overall ASPs -- let me take a step back, sorry. So if you look at ASPs and the decline in the most recent quarter stripping out TDC, so that we have an apples-to-apples comparison, the 5% decline was more focused in 11g than 11a/g, which you would expect. There is more competition on 11g. And we were shipping more clients as opposed to access points for 11g. So, the mix of the more competitive technology and clients versus access points. I should mention though that we did provide some price declines in our PAS market this most recent quarter, and frankly that was to garner more volume, and so we do the calculation as many of you know where we just effectively see what kind of contribution margin dollars we can get if we do lower the prices a bit. So that’s kind of the background on ASPs this last quarter.

Rohit Pandey - HSBC

Sure. Got it. Thank you.

Operator

Thank you. Our final question comes from Adam Benjamin with Jefferies.

Adam Benjamin - Jefferies

Thanks guys. A couple of questions, just follow up on Attansic, you're going to be a 25 million I guess for all of '07. I'm assuming it starts off at a lower base and kind of grows throughout the year. So at what point does it get neutral to earnings?

Craig Barratt

I think the best time to comment on Attansic is as we close the acquisition. We are dedicated to actually driving it to being neutral to accretive in 2007. And so there is design wins in place. The design wins should be leveraged right away, and we certainly will see more growth in the back half of the year as we expand the product offerings from Attansic. But even right away I wouldn't expect much of a draw if any from the deal itself.

Adam Benjamin - Jefferies

Okay. And then with respect to PAS, Jack you talked a little bit about the churn rate. Can you give us your rough estimate as to where that churn rate is on a percentage basis right now?

Jack Lazar

Yes. Our estimates will be nothing other than estimates at this point. What we see are -- we track sell through, we track obviously the data related to the PAS market and I think to get into detail on that in the middle of a call is probably -- probably not the appropriate time. But I think overall our focus is on market share expansion. So we expand the market with both UTStarcom that's clearly our primary customer in this space. But also add new customers and between that -- between those two approaches we think there is plenty of growth for 2007.

Adam Benjamin - Jefferies

Okay. And just last question on n pricing. I know people have talked in the past about kind of a 3x pricing environment [versus g], $5 of $6 and a 3x of $15 or so. Where is that pricing today and what do you expect for next year? We've heard all kinds of different things of some of the laptop OEMs pricing things below $10 and just wanted to get your idea where pricing is today and what you expect for '07? Thanks.

Jack Lazar

For competitive reasons, we are not going to get into what pricing is going to be in '07 obviously. And frankly, we are not really going get into it as what it is today. I think the best thing to tell you is that we've told folks in the past that 11n pricing would be in the $15 to $20 range in the previous quarter. This quarter, we saw a very similar range, but clearly hitting more on the decline. As we move forward, there is a direct correlation between a reduced price and the increase in the amount of volume that we can do for 11n and we believe that it's important to push the 11n standard forward as the next big standard for wireless LAN. So, we're going to continue driving prices down, we are also going to continue optimizing the cost of our products, and hopefully we are systematic about it in the way we are maintaining our margins and providing the most contribution margin dollar opportunities for the company.

Adam Benjamin - Jefferies

One just last follow-up and -- you are obviously seeing some strength on the laptop side from one specific customer, can you talk a little bit about just the pricing for the laptop or PC OEM side versus the router market just percentage wise roughly what the dynamic is there in terms of the spread between the two? Thanks.

Jack Lazar

Yes. So, actually two things. First of all, we did not say we are seeing it from one particular customer. So I want to make sure that that’s clear, we have many different PC OEM customers who are taking 11n products from us. Now I think overall if you look at PCs versus retail, retail tends to be one that corrects more on a quarterly basis as far as pricing, whereas PC OEMs generally lock into a price point and they will have far less ASP decline overtime, so when you first get into PC OEMs, there are going to be at lower price points probably than the retail market, but retail has a way of catching up for that. It's kind of -- it all becomes pretty similar over the long haul.

Operator

Thank you. That does conclude today's question-and-answer segment. I would now like to turn the conference over to Dr. Craig Barratt.

Craig Barratt

Thank you. I would like to thank all of you for joining us today. And a special thanks to all of our employees for their continued dedication and hard work. The third quarter was a great quarter for Atheros and we are enthusiastic about the fourth quarter and beyond. Over the next few months, we will be attending several investor conferences including the AEA Classic Conference in November 6 and 7 in Monterey, the Prudential Technology Investor Day, November 9 in New York, and the UBS Global Communications and Technology Conference, November 14 also in New York. In addition, we will present at the Lehman Brothers Conference in San Francisco, December 6 through 8 and at the Raymond James Conference in New York on December 13. If any of you are interested in arranging a call or 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. Good bye for now.

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Source: Atheros Communications Q3 2006 Earnings Call Transcript
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