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Atheros Communications, Inc. (NASDAQ:ATHR)

Q1 2007 Earnings Call

April 30, 2007 5:00 pm ET

Executives

Deborah Stapleton - Stapleton Communications Inc.

Craig Barratt - President and CEO

Jack Lazar - Vice President and CFO

Analysts

Tim Luke - Lehman Brothers

Adam Benjamin - Jefferies & Company

Quinn Bolton - Needham & Company

Gary Mobley - A.G. Edwards

Jonathan Goldberg - Deutsche Bank

Allan Mishan - CIBC World Markets

Louis Gerhardy - Morgan Stanley

Amit Kapur - Piper Jaffray

Ramesh Misra - C.E. Unterberg Towbin

Jeremy Bunting - Thomas Weisel Partners

Edwin Mok - Needham & Company

Presentation

Operator

Ladies and gentlemen thank you for standing by. At this time all participants are in listen-only mode. Later we will open the calls to your questions. Instructions for asking questions will be explained at that time. (Operator Instructions). This conference call is being recorded.

I will turn the call over to Ms. Deborah Stapleton, who will introduce today's speakers. Ms. Stapleton you may begin.

Deborah Stapleton

Thank you. Good afternoon everyone and welcome to the Atheros Communications' First Quarter 2007 Financial Results Conference Call. Leading the call today are 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, and product development, the anticipated benefits of our diversification strategy, our customers, our competitive position, our anticipated growth, profitability and leadership position in various markets, and expected shipments in 2007 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, 2006, previously filed with the SEC, and 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 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 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 analyses its operating results. The full reconciliation of 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. All numbers that are discussed in today's conference call are non-GAAP unless otherwise noted.

And with that, I'd like to turn the call over to Dr. Craig Barratt.

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Craig Barratt

Thanks, Deb, and thanks to everyone for joining us today. We are very happy to report record revenue of $95.5 million and record non-GAAP net income of $13.6 million or $0.23 per diluted share. Gross margins were 48%, once again above our target range. Jack will take you through the numbers in greater detail and discuss guidance for the second quarter shortly.

Atheros continues toward our goal of building a broadly diversified communication semiconductor company through organic growth and complementary acquisitions. We are becoming a major communication solutions provider in a variety of markets. Over the past few years we have significantly broadened our product offerings and addressable markets to further expand our revenue opportunities, our strategy remains the same to leverage our unique ability to develop cost-effective, feature-rich integrated communications products in standard digital CMOS for the three primary markets that we serve; PCs, networking and consumer.

The first quarter was yet another important quarter for growth for Atheros. One in which we drove the continued expansion of wireless LAN products and revenue, while also recording our largest revenue ever from products outside of that core wireless LAN market. Our diversification efforts are paying off. PAS, mobile wireless LAN, Ethernet and Bluetooth are important pieces of our expansion strategy and overtime we will introduce additional communication technologies to even better serve our growing blue chip customer base.

By providing a more complete platform of products, we are deepening the relationships with our key customers. Our high touch technical support and customer responsiveness has enabled us to become trusted partners of our OEM and ODM customers.

Our growing portfolio of communication solutions provides us many cross selling opportunities that we expect to leverage for the benefit of both Atheros and our customers.

We are also investing in the people required to achieve our goals. At the end of the first quarter, we had 688 employees with R&D comprising almost 70% of the total headcount. Our employees have expertise in a wide variety of communications technologies and they all share the desire to provide a broad array of innovative solutions that meet the increasing demands of our customers and their markets.

With almost 50% of our employees based outside of the United States, we truly have a global presence. The technologies we have developed today are used by our customers across three primary markets; personal computing, networking and consumer. I would like to spend a few moments reviewing our progress in each of these markets.

Of the three market areas we address, personal computing was the strongest in the first quarter. Virtually all major PC OEMs use a variety of 11g, 11a/g and 11n wireless LAN products from Atheros.

Additionally, we have already demonstrated success in the Ethernet market with our fast and Gigabit Ethernet LOM and PHY products. Later in 2007, we expect to begin shipments of our innovative Bluetooth products to our PC OEM customers.

We are leveraging our portfolio of communication products to expand both our customer base and share at each of those customers. Revenue from our PC business was especially strong in the first quarter, with much of the increase driven by continuing adoption of our 11g solutions and the initial shipments of our Ethernet products to key OEMs.

Several of our customers are moving into volume production with our next generation 11g PCI-Express client solution, the AR 2425, which offers a high degree of integration and superior range in throughput.

This product is ideal for value priced and mid-range laptops, as well as the largely untapped desktop market. Acer, ASUS, Fujitsu and Fujitsu-Siemens are among those currently shipping products, including the 11g solution. And we expect launches from several other customers in the coming quarters.

As we anticipated, overall revenue from our 11n products for PCs was down sequentially in the first quarter, but on target with our expectations. We are very pleased with the adoption of our 11n solutions into a variety of products for both the PC and networking markets. The product pipeline for our 11n products is very strong and our customers' product cycle should drive 11n revenue growth in the second quarter for both the PC and networking markets.

Our newly introduced line of fast and gigabyte Ethernet solutions helped drive our revenue growth in the first quarter. The acquisition and integration of Attansic has been very successful, and in the first quarter, we shipped over 4 million Ethernet ports. These LOM and PHY solutions are shipping in a variety of desktop motherboard products. And we are already gaining significant share in this market.

In the first quarter we saw strong design win activity at multiple customers, and we are confident that these products will be an important part of our long-term revenue growth. Our expanding set of Ethernet solutions will be a significant growth driver for us this year, and we remain on-track to achieve or goal of $25 million in Ethernet revenue during 2007.

In late January, we announced the Atheros AR3011, the first member of our ROCm family of Bluetooth solutions and the industry's first Bluetooth 2.1 + EDR solution for PCs.

We are seeing a lot of interest from leading laptop customers and we believe that our feature-rich, competitively priced Bluetooth solutions will dramatically increase the attach rate in PCs and add yet another form of connectivity to computing platforms.

In summary, our PC business has been particularly strong and we expect continued growth in this area during the second quarter.

The second market Atheros is addressing is networking. Our wireless LAN products are used by customers such as D-Link, NETGEAR, Belkin and Linksys in the retail and consumer electronics products. Partners such as Siemens, 2Wire, ZyXEL and others use Atheros for carrier gateway products that incorporate broadband connections such as ADSL or VDSL with wireless LAN.

A large number of enterprise customers have also selected Atheros to provide wireless LAN as a connectivity solution for their corporate networking products. And of course, Atheros provides the wireless LAN silicon to partners responsible for the growing number of metropolitan Wi-Fi rollouts being deployed throughout the world.

Atheros customers continue to aggressively push 11n solutions in the retail market, resulting in lower price points and increased adoptions by end users. During the quarter, we saw leading OEM such as D-Link break the $80 price barrier for value with their 11n routers, while expanding their portfolio of higher end 11n products.

In addition, more and more favorable reviews of 11n enabled products have been published and we are proud to be the silicon vendor behind many of these products. According to NPD data for North America 11n units purchased in the first quarter increased by over 70% compared with Q4, demonstrating consumers increasing rate of adoption of 11n technology which we believe will continue throughout 2007. While our overall 11n product revenue was down as expected in the first quarter, 11n products sold to retail OEMs was up sequentially.

Earlier this month, we announced the AR2417, our new low cost PCI-based 11g product targeted for retail and carrier gateway solutions. This compact single-chip solution is the newest member of Atheros' AR5007 family of products. With this introduction, Atheros has improved on its most popular selling solutions ever the AR5005G; by significantly increasing integration while delivering the Atheros-class wireless LAN performance our customers have come to expect. This single-chip product is already shipping in volume to leading retail and carrier customers.

For both PC and networking customers, we have delivered new low-cost 11g products that will grow and extend the lifetime of the 11g market. Moreover, prices for these products are relatively stable and volumes continue to increase in Q1, making this an attractive market for Atheros.

Today, we announced our first Ethernet switch solution, the AR8216 which is being marketed to our networking customers. This product was built from the ground up based on our high performance, cost effective PHY technology already being sold to our PC OEM customers today. We are designing our new Ethernet switch into our wireless LAN router reference designs and we expect many of our retail and carrier customers to develop products based on this chip, with volume shipments starting early in the third quarter.

We now offer a complete platform for wireless LAN routers, where every major function, wireless LAN, network processor and Ethernet is supplied by Atheros. At the same time, we will sale this cost effective 10/100 switch throughout our expensive customer base for use in wide products as well. The AR8216 is an important step in building up family of Ethernet products, further diversifying our revenue base and greatly expanding our addressable markets.

One last note on the networking market. A few quarters ago, we announced the partnership with FON, who is using the Atheros' 11g router solutions to power the world's largest Wi-Fi community. Just last week, FON and Time Warner Cable announced an agreement that allows Time Warner's 20 million subscribers access to FON community members, and gives them the ability to enjoy free Wi-Fi access around the world. We are pleased to team-up with FON to encourage the expansion of Wi-Fi access to the mass market, wherever broadband connection exists.

The consumer category consists of our products for the PAS market, our mobile wireless LAN ROCm family of products, and with shipments expected later in the year, our Bluetooth solutions for consumer products. The PAS market was a growth driver in 2006 and we expect it to be a solid revenue contributor this year.

During the first quarter, UTStarcom introduced its new X26 handset, which is powered by Atheros. The X26 is an ultra-slim handset featuring a 1.5-inch color display and support for mp3 ring tones. Although our PAS revenue was down in the first quarter through UTStarcom and other leading providers, we are seeing PAS product cycle that will benefit Atheros in 2007.

We are excited about the many mobile wireless LAN design wins we have across a variety of consumer applications, including handsets, gaming devices, cameras, and smart phones. We have already announced our first ROCm smart phone design win with Fujitsu Siemens and NEC began shipping the ROCm enabled dual-mode N902iL handset during the first quarter. There are many more ROCm enabled handsets to come and we will update you as there products come to market.

We are also excited that Sony recently announced it is now shipping its first wireless enabled digital camera the Cybershot G1, which is powered by Atheros wireless LAN technology. The G1 can communicate with other G1's and can send images wirelessly to a PC.

Our revenue in mobile wireless LAN increased sequentially in the first quarter and we expect it to grow again in the second quarter. As part of our strategy to offer a rich set of products to our key customers we are developing additional Bluetooth products that will target the consumer market. We will be discussing these future Bluetooth product offerings in the quarters to come.

In conclusion, we are well on our way toward our goal of becoming a major communications solution provider to the PC, networking and consumer markets. We are very pleased with our progress this quarter and look forward to continuing success in 2007.

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

Jack Lazar

Thank you Craig and thanks to all of you for joining us today. First I will outline our financial results for the first quarter ended March 31, 2007, and then I will provide our second quarter guidance. Q1 was another very strong quarter for Atheros. This was our eighth consecutive quarter of revenue growth and our seventh sequential increase in both operating and net income.

Revenue was at the high-end of our guidance and gross margins exceeded the high-end of the range we guided to in our last quarterly call. As a result EPS came in $0.02 better than the top and of our guidance. As a reminder, our guidance for Q1 was 5% to 9% revenue growth, gross margins between 46% and 47% and EPS of $0.20 to $0.21.

Q1 revenue increased 9% sequentially and net income was up $900,000 to $13.6 million or $0.23 per diluted share. Gross margins for the quarter were 48%, 300 basis points above the high-end of our target model range.

Revenue was a record $95.5 million in Q1 up $7.7 million from the $87.8 million we recorded in the fourth quarter of 2006 and an increase of 56% compared with $61.1 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 our 11g and 11a/g solutions and our first full quarter of revenue from our Ethernet products.

Based on the product mix data the breakdown of revenue for our wireless LAN chipsets was as follows. 11a/g was 21% of revenue and that compares to 20% in Q4. 11g was 61% and that compares to 57% in Q4 and 11n came in at 18% compared with 23% in Q4.

Revenue from our 11g solutions increased $6.4 million or 14% versus Q4 levels due primarily to the strength of our retail and PC OEM customers. Partially offset by softness in the enterprise and carrier channel. 11a/g solutions increased in dollars by 9% due primarily to the strength of our PC OEM and retail customers.

11n solutions at 18% of our total wireless LAN revenue were in line with our expectations going into the quarter. The percentage breakdown of revenue by channel based on data supplied by our ODMs is as follows. Retail was 34% of our revenue; this is up from 28% in Q4. PC OEM was 39% up from 36% in Q4; enterprise and carrier was 18%, compared with 25% in Q4; and then consumer electronics and other was 9%, compared with 11% in Q4.

You will note that Craig’s remarks today were focused on three primary markets: personal computing, networking and consumer. Beginning next quarter, we will begin providing new channel information based only on these three categories.

For historical comparison purposes, the retail and enterprise carrier channels form our new networking category, and this channel made up 52% of our Q1 revenue as compared with 53% in Q4.

Revenue in units shipped to our retail and PC OEM customers set record highs. Retail revenue increased $7.8 million or 31% sequentially, as we saw strength in shipments from several of our retail customers for 11g, 11a/g and 11n products.

Revenue from our PC OEM customers increased $5.7 million or 18%. A large portion of this increase related to the strength of our Ethernet, LOM and PHY products, which came in at the high end of our expectations.

The remaining increase was due primarily to the strength of 11g products as several PC OEMs offset by an expected reduction in 11n shipments. The enterprise and carrier segment were down $4.3 million sequentially due to a slowdown in orders at one of our carrier customers during the quarter.

In Q1, Hon Hai Precision Industry was 10% customer. First quarter gross margins were 48%, above the high end of our range of 46% to 47% that we guided to, and a well more above our corporate target range of 43% to 45%. And it was 40 basis points higher the 47.6% recorded in Q4.

Wireless LAN ASPs during the quarter were flat, even though we saw a sequential reduction of higher ASP 11n products as a percentage of our overall Wireless LAN revenue.

Total operating expenses were $32 million, a 13% increase from Q4 and within of our guidance of 31 million to 32 million. R&D increased 2.8 million or 15% sequentially, due to headcount cost primarily related to the addition of Attansic personnel, tape-out cost, and software and licensing fees.

As a percentage of revenue, R&D increased from 20.3% in Q4 to 21.6% in Q1. SG&A increased approximately $900,000 or 8% due to headcount additions, trade show and marketing expenses, and professional fees. SG&A as a percentage of revenue decreased slightly from 12% to 11.9%.

Operating income in the quarter was $13.9 million, up 3% from the 13.4 million recorded in Q4, and a 67% increased from Q1 of 06. Operating income was 14.5% of revenue in the first quarter. Effective tax rate in Q4 was approximately 17% down from 19% in Q4 as we recorded certain discreet tax benefits during the quarter. This favorable tax rate contributed approximately one-half of one penny of EPS during Q1.

Net income was $13.6 million or earnings of $0.23 per diluted share for the quarter, compared with net income $12.7 million or earnings of $0.22 per diluted share in Q4. Average share outstanding were $58.3 million in Q1 and $56.6 million in Q4.

GAAP net income for the first quarter was $7.6 million or $0.13 per diluted share. This compares with GAAP net loss of 1.2 million or a loss of $0.02 per diluted share in the fourth quarter. As a remainder in Q4, we recorded 12.3 million in estimated non-cash acquisition-related charges, resulting primarily from the write off of in-process research and development as part of the Attansic acquisition.

Turning to the balance sheet, cash and marketable securities were a record $206 million at March 31, a $20.5 million increase from Q4. DSO’s based on our quarterly average receivables balances increased three days to 50 versus 47 days in Q4.

Inventory returns for the quarter were 6.3 times, compared with 7.1 times in Q4, while days of inventory increased to 12% from 51 to 57 days. Inventory returns once again exceeded our target of five to six times.

The company continues to have virtually no debt. Total liabilities at the end of Q1 were $113 million and include the additional of $14 million related to the adoption of FIN 48 during the quarter.

During the first quarter of 2007, our capital expenditures and depreciation were approximately $1.6 million and $1 million, respectively. Overall, our cash flow and asset management metrics were strong once again in Q1.

And as of March 31st, we had 688 full-time employees, compared with 660 at the end of Q4. And our headcount has almost doubled year-over-year. Most of the first quarter additions were R&D personnel.

I will now move on to our guidance for the second quarter. Q1 was a great start to the New Year and once again our strongest quarter to-date in terms of revenue and net income. In Q2, the catalyst for overall growth will come from continued strong demand for 11g and 11n wireless LAN solutions, as well as our line of fast and gigabit Ethernet products.

The strength of these products will be reflected in our revenue from PC OEM customers. In Q2, sales to PC OEM customers, will for the first time represent more than 40% of our total revenue mix. Revenue from our networking customers, which includes retail, carrier, enterprise, and Metro Wi-Fi equipment providers should benefit in Q2 primarily from the sale of our XSPAN 11n wireless LAN products.

However, we do expect some softness for 11g solutions with our carrier customers. We expect that our consumer products will see sequential improvements in revenue led by an increase in demand for our ROCm wireless LAN products.

Accordingly, based on the strength of our combined business, we currently anticipate second quarter revenue to increase between 4% and 7%. 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.

In the second quarter, we anticipate total operating expenses will increase between 2% and 5%. A vast majority of these increases will be research and development related expenses, as we increase our tape outs during Q2 to support our long-term product plans.

Our estimated pro forma tax-rate for Q2 is approximately 20%, we anticipate EPS for Q2 to be between $0.23 and $0.24 based on fully diluted shares of between 59 million and 59.5 million.

Our Q1 results and our Q2 guidance once again reflect the strength of our business, the dividends from our diversification strategy and the favorable product cycles that we continue to leverage. We will continue to invest in further diversification efforts, which we believe will help position Atheros for ongoing success and increase shareholder value in 2007 and beyond.

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

Craig Barratt

Thanks Jack. We are now ready for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Tim Luke with Lehman Brothers. Sir, your line is open.

Tim Luke - Lehman Brothers

Thank you. Congratulations on your quarter end guidance. Craig, I was wondering if you could give us a sense of how you perceive the mix to develop in terms of the ramp up of n through the year? And then I was also wondering Jack if you can just remind us of some of the things that have helped on the gross margin side, and whether we should be beginning to think about you potentially had a room to hold a somewhat elevated gross margin, or maybe some color on what factors might impact it through the year? And lastly just, your inventory days are little higher and how should we think about that going forward? Thank you.

Craig Barratt

Okay. Tim, this is Craig. I will start with the first question and turn the rest over to Jack. Yes, certainly we do expect the 11n to be our strongest growth driver during 2007, and we certainly see that trend continuing into the second quarter. So, overall, yes, we do expect continued adoption in both the PC and the networking markets for 11n. We are not giving particular color on our targets later in the year, but certainly overtime we do expect either later this year or going to next year, the majority of the retail products should be 11n and certainly that crossover will happen in PCs somewhat later. But there is this inevitable trend to adopt 11n across all of these products.

Jack Lazar

Tim, it's Jack. On the gross margins, I think the things have probably helped us the most recent quarter. Interestingly, probably with the 11g, as I mentioned in the prepared remarks, the ASP trends for 11g were actually quite favorable. So, I think not seeing the rapid decrease in ASP for 11g has been favorable for us. We did have a nice 11a/g slog this quarter too, so that was positive. And interestingly, many people think our Ethernet business has to run at very low gross margins. I don't think that's much of a drag on our overall business. So, I think while we didn't have the percentage of 11n that we've had in previous quarters as we expected. We were in a situation where the other products were able to provide nice gross margin additions to us.

As far as inventory, I would remind you that we were at record lows in the fourth quarter. In fact, we specifically tried to work our inventories down significantly. Our inventory returns were over seven and our targets are five to six. So, this quarter, we came in above our five to six range; which this probably be only the second quarter I can remember that we would have been above that range. So, I think the inventory levels they are at a very healthy level. In fact, they are relatively lean right now. So, that's good for the company.

Tim Luke - Lehman Brothers

Thank you, guys.

Craig Barratt

Thanks Tim.

Operator

Our next question comes from Adam Benjamin with Jefferies & Co. Sir, your line is open.

Adam Benjamin - Jefferies & Company

Thanks guys. Just a follow-up on the gross margin a little bit. Where do you see that going, you've outperformed in the last several quarters now and your target I know is significantly lower, and becomes a bigger percentage of your mix as you progress throughout the year. I would assume that should help the margin. So, just help us Jack a little bit trying to understand the moving parts. I know you've got more pieces now with Ethernet and your other businesses. But can you try and give us an idea as to where you think that can go and what are the key elements to move it to a higher target over time?

Jack Lazar

Alright. So it's always been tricky to obviously forecast the gross margins, and now the complexity of our business given the diversification efforts are paying off. It becomes even trickier to figure out where this is going to go.

I think that 11n is a good point Adam. But as you well know our attitude is one where, we are not afraid to drive down ASPs in order to drive the overall growth of a new technology a like 11n. And that strategy has worked well for us in the past. So of course if we are able to do that at the same rate in which we are driving down cost, then that's good for the overall markets, the expansion of 11n etcetera. So clearly a lot of this will relate to 11n, as we move forward. If we are able to do it at higher prices and still get the acceptance that we are looking for that's great for the Company. If we need to do it at lower prices but still get the acceptance we'll do that too. So a lot of this will tie to 11n price declines.

Another thing though, we shouldn't forget that the vast majority of our overall revenue in wireless LAN is coming from 11g today. And so the thing that helped us obviously this quarter was 11g ASP’s did not really decline. And that's very good for us as we move forward. Now can we keep it that way, we'll see. And then as far as the other products like Ethernet, our approach is one where we leverage our ability to really build these solutions in a low cost manner leveraging our CMOS capabilities et cetera.

So we are going to try and maintain good gross margins in that area, but it really is highly dependant on the mix of product there. We haven't have had a nice mix of gigabytes this last quarter. And so that was also favorable to the gross margins. So all I can really see in front of me right now is the upcoming quarter that's what we guided 47 to 48, which is a pretty good range and things look good right now, but it will depend a lot on the mix.

Adam Benjamin - Jefferies & Company

Okay. And then on the PC OEM side Craig, obviously it was very strong this quarter and seems like you expect it to continue to be strong in the Q2 period. Can you just talk a little bit about the dynamics there with Intel coming on and just where that, how that plays out for you guys? Will you continue to seeing g business as well as n I think there has been some views in a marketplace that Intel would takeover that business from you guys, but can you just give us an idea as to what you are seeing there in the marketplace and what you expect as you progress throughout the year in terms of penetration rates for n in laptops?

Craig Barratt

Right, I mean certainly Intel's introduction of their 11n solution we think is overall positive in terms of increasing the awareness and demand among PC OEMs and then customers for 11n connectivity. With that said 11n will be reserved for the mid to higher end range of the laptop market. And I think even though WiFi attach is already close to 100% across all laptops. I think the mid and low end segments are really trying to drive end user prices down and we think our low cost 11g solutions, we are seeing really tremendous uptake there.

So, the Intel dynamic with 11n is both positive in terms of driving more 11n into the market, but it also better defines this low cost tier, which we are very strong in. The other dynamic in the PC markets is that the desktop market is one that we expect significant growth in.

As you know of course there is no Centrino brand or label that encompasses the desktop chipsets. So, while the WiFi attached in those platforms is low today. There's a very large and generally untapped opportunity there. And once again our low cost is really the drivers. So, we think 11g and 11n will be important growth areas in desktop. And of course desktop is where our Ethernet growth is coming from today. We expect to be able to push that into laptops during the later part of this year.

Adam Benjamin - Jefferies & Company

Craig speaking of the desktop side, can you give us an idea of what kind of revenue you have there today, and what kind of penetration rates you are seeing overall for the market, and what do you expect as you go throughout year as well?

Craig Barratt

We don’t actually break that out. I would say that our overall connect rate on the wireless LAN side is still quite low, and we see that as just a large on untapped opportunity. On the Ethernet side I've mentioned we shipped in excess of $4 million Ethernet ports, and all of those went into client applications of PC motherboards.

Jack Lazar

Yeah, I’d reemphasize one thing too, we said this in the script related to low cost g. The 2425 which we announced back in November is really targeted towards all these value-oriented desktops and laptops, and I think that’s one of the ways in which we see a lot of penetration of those markets is through the 2425. The product is selling extremely well right now, and I think we are very happy with the success of it so far.

Adam Benjamin - Jefferies & Company

Just one last question on ROCm in terms of where the ramp is right now in terms of your expectations? Is it tracking in line with what you guys have been thinking or a little bit behind or better?

Jack Lazar

We have high expectations. I think design win wise we had a very good quarter, and what we can't control is the end market. We are seeing new products out there, we mentioned the NEC phone and some other things the cameras, and actually there are some other products that have just recently come out. So I'd say that we are making a lot investment in ROCm, we see a pay-off coming; it's just a matter of when it really hit hard.

Adam Benjamin - Jefferies & Company

Great, thanks a lot guys.

Jack Lazar

Thanks Adam.

Craig Barratt

Thanks Adam.

Operator

Our next question comes from Quinn Bolton with Needham & Co. Sir your line is open.

Quinn Bolton - Needham & Company

Hi Craig, hi Jack. You talked about the flat pricing in 802.11g and just kind of wondered if you could expand there. Did you see a favorable mix say between PC and networking wireless versus retailer, or some shift that we should be aware of there? And then I have got a second question on the Bluetooth. Looks like you're targeting the PC market initially, and then you mentioned that you will be targeting consumer applications later in the year with some new products. Kind of wondering from a product perspective, what's different about the consumer product that requires a re-design or new spin, is it a lower power or is it some other feature that warrants a separate product design? Thanks.

Craig Barratt

So Quinn maybe I’ll start up. On the 11g mix the pricing by segment is not necessarily substantially different, what has happened is redeemed production of about two new more highly integrated low cost 11g solutions the AR2425 and the 2417; one for PCs, one retail career we've been able to substantially reduce the total bill of materials. Meaning our customer's pricing has been able to improve significantly as they adopt these solutions. But we've been able to do that through integration, not necessarily by producing substantially the price of our chips. So we can offer lower cost solution without necessarily having to do that through lower cost chips. And so that dynamic has helped us in both of those markets to deliver more competitive solutions without the traditional just ASP reductions.

For the Bluetooth question, Bluetooth market consists of several submarkets clearly handsets, headsets, gaming devices, and PCs represents some of the major segments. And each of those have different requirements in terms of interfaces, features, the partitioning of software between the Bluetooth device and the host processor and that necessitates to be really competitive. That necessitates having customized solutions for reach sub-market. So, the first Bluetooth product we announced, the 3011, has enough integrated features to eliminate the external flash, which is typically used in these PC solutions.

So, we've developed a product, which substantially reduces the price to our customer, once again, not necessarily by having a lower priced chip, but by having a lower solution cost. And we are taking that approach in each of the markets.

The consumer market includes the other Bluetooth markets. And so, we are developing products to target several of the additional Bluetooth sub-markets and we will announce those as they become available during the year.

Quinn Bolton - Needham & Company

Is it safe to assume that you guys will look for some of that peripheral circuit thread that you can integrate into your consumer specific devices, similar to what you did with the flash in the PC application?

Craig Barratt

Exactly, if it's a way of producing a better and differentiated product, that has a lower solution cost to the customer, that's what we'll do.

Quinn Bolton - Needham & Company

Great. And than just lastly you've mentioned sort of the flattish 802.11g. Any expectations as we head into the second quarter? Do you think you can keep it flat or do you think we start to see a more typical price decline curve begin again?

Jack Lazar

Well, I think when we look at 11g for the upcoming quarter, there may be some price declines, but I don't think we are going to see any sizable price declines. To a large extent 11g is a technology now that is very well developed, obviously, and so the existing markets that it serves are ones where there is not as much of a need for price declines.

However, as we move in to some of these new markets with 11g, witnessed the carrier business we've opened up over the last couple of years or the last year. And some of the other places that we're heading into, things like desktops, etcetera. If the elasticity is there to create contribution margin dollars for the company we will do it. So, our job is to make sure that we optimize our supply chain in that case, so that it is beneficial to the overall company.

Quinn Bolton - Needham & Company

Okay. Great, thank you.

Operator

Our next question comes from Gary Mobley with AG Edwards. Sir your line is open.

Gary Mobley - A.G. Edwards

Hi. I was hoping that well maybe you won't specifically breakout the revenue between Ethernet and the other portions of business. But, may be you can give us the sense of what the organic growth rates were for Ethernet products and what was there before?

Jack Lazar

This is Jack, Gary. So, I guess it's kind of hard do that because we didn't have, so we are not going to be breaking out Ethernet. What I did comment on is that it was at the high-end of our expectations during the most recent quarter. I think we were very happy with the way in which the Ethernet business is transferred into Atheros.

When we look out, when we acquired these guys they had some nice design wins at places like ASUS, of course. And I think it's important that we start to see some of the leverage there in the most recent quarter.

So, we are getting into a lot of different designs at multiple OEMs and that has been very good for us. At the same time our wireless LAN business was very strong this last quarter and it did grow. It was up from Q4. It grew in the Q1 here. So, we are seeing kind of the combination of the two happening here. So, organically business is very good. The piece that came from Attansic has also been very good for us.

Gary Mobley - A.G. Edwards

Okay. And the Ethernet products are all categorized in the PC OEM segment. Is that correct?

Jack Lazar

Today they are in the PC OEM segment, but as we move forward we also announced a switch something that we obviously were very focused on first 10/100 switch. And this low cost 10/100 switch is something that's going to be in our reference designs for our retail products. And so in that case, it would actually end up in the networking category, because it's been sold to retail customers or maybe even carrier type customers too.

Gary Mobley - A.G. Edwards

Okay, thank you.

Jack Lazar

Thank you.

Operator

Our next question comes from Jonathan Goldberg with Deutsche Bank. Sir, your line is open.

Jonathan Goldberg - Deutsche Bank

Hi, thanks for taking my call. In the script, you mentioned shipping wireless LAN products into all the major PC OEMs. I think historically you had limited presence of some of the major U.S. vendors, excluding Apple. Has something changed, are you getting in sockets now, let's say Dell or HP, is that partly related to Attansic, is it a final thing to come?

Jack Lazar

Jay, it's Jack. And the word I used was virtually all. So, traditionally, we have been in places like Dell in the past. So, if you're eluding RV and Dell, no we don't have any substantial business with Dell today. But effectively every other PC OEM out there we’re doing substantial amounts of business with including people like HP, which I believe you mentioned. So I don't think there's been any material change there.

Jonathan Goldberg - Deutsche Bank

Do you foresee the relationship with Attansic, helping you in that regard?

Jack Lazar

I think that Attansic is important because what it gives us is breadth of products. And those breadth of products are something that PC OEM customers absolutely want to see from a supplier like Atheros. So, yes, of course, we believe that will help us. It will take us some time, of course, because today most of our Ethernet business is focused on the desktop, and more so, on the white box side of the desktop market. But overtime, we do expect to get penetration into some of the major OEMs.

Craig Barratt

Yeah, to emphasize that point further Jonathan. We do have some wins and some progress in the Ethernet business that gives us confidence that overtime we will have an increasing footprint among the Tier-1 OEMs for Ethernet.

Jonathan Goldberg - Deutsche Bank

Okay. And then just real quick, what process technology nodes are your wireless LAN products on and what's the roadmap for shrinking those?

Craig Barratt

So, historically, most of our productions through 2006 was primarily the volume was in 0.18. And so, we are designing most of our newer chips at finer geometries. But unlike some of our larger competitors, we are not existing at the very leading edge of process technology. And that's actually a deliberate decision. And there are couples of reasons for that, one is that our design ability allows us to design chips that use completely vanilla digital CMOS.

So, even though we are integrating radios and analog circuits on to those chips, we can take those chips and manufacture them at a variety of foundries. And that gives us a lot of flexibility exploiting the very competitive middle part of the process technology market. So, as additional foundries come on line with technology, there is terrific price competition, which we were really enjoying, previously in 0.18 and in the future at new technologies.

Since most of our chips are single chips solutions, that combined radio, analog functions with digital, the amount of scaling you get going down to 65-nanometer or below is not as large as you would expect and we think we have an extremely competitive solution and strategy with regard to our foundry selection and process choices.

Jonathan Goldberg - Deutsche Bank

But you don't think that operating at that note puts a cap on gross margin relative to the larger competitors at leading edge?

Craig Barratt

I think that it actually give us an advantage in gross margins, because there are opportunities in the supply chain that we can exploit by having designs that we can flexibly target to different foundries.

Jack Lazar

Sorry, Jay, it's Jack. The thing I want to point out and really what Craig was hitting on is that you go where the supply is, right. It's as simple as you want to find the most capacity because the most capacity creates the competition which creates the lowest price. And clearly it's going to solve your needs, right. We have to be at a geometry that’s going to work from us for us from a product perspective, but if we can be at a trailing geometry then it actually is favorable impact on us from a cost structure wise because we have so much competition at that geometry. So there are times when we want to jump ahead. We do have products all the way from 90 nanometers, while we have some older products that are at 0.25. But the blood and guts of what we sell is from [90] to 0.18. So we make decisions at any one time, but we make them in conjunction we take into account all of the different pieces as we decide what geometry to go to. So we don’t go to leading edge geometries just to be able to get up here and tell we are at a leading edge geometry.

Jonathan Goldberg - Deutsche Bank

Great, thank you.

Jack Lazar

Thanks Jay.

Operator

Our next question comes from Allan Mishan with CIBC World Markets. Sir your line is open.

Allan Mishan - CIBC World Markets

Hi guys, couple of questions. First of those 4 million Ethernet ports how many were GigE and how many PASe. And then second is how big is the ASUS Stack, the Ethernet business? Was it substantially all of it or half of it? Any color will be helpful?

Craig Barratt

So we are not breaking out the mix between Fast and Gigabit Ethernet, certainly which Jack did mention earlier that Gigabit Ethernet was quite strong in the first quarter and we certainly don’t talk about individual customers business either.

Allan Mishan - CIBC World Markets

Okay, have you been able to dig out how come net carrier and enterprise business was down. I guess it was over 20% and was primarily carrier, primarily enterprise, what exactly happened there?

Jack Lazar

Yeah, it actually was down 20% and it was carrier, it was enterprise and it was isolated to really one particular customer who had softness at one of their customer and so that was substantially most of the softness during the quarter. We do know that its not a design win issue for us, it is an end user or end customer issue that we expect to see comeback. We just don't know exactly when that timeframe will be.

Allan Mishan - CIBC World Markets

Okay, great then last question for you; the ROCm wireless LAN, are we above the million dollar revenue level yet?

Craig Barratt

Sorry we don't get down to that level of granularity. What all I can tell you is that it is progressing along pretty much as we had expected during the year.

Allan Mishan - CIBC World Markets

Okay, fair enough, thanks very much.

Jack Lazar

Thanks Allan.

Operator

Our next question comes from Louis Gerhardy with Morgan Stanley. Sir your line is open.

Louis Gerhardy - Morgan Stanley

Yeah, nice quarter. Just wanted to ask you on the carrier and enterprise again, you described what happened in Q1, but I think you mentioned in Q2, you think the g business there will be a little bit softened if you could just elaborate on that?

Jack Lazar

It's basically a dock time issue. So we are not seeing any widespread issues, but we have one larger customer that is having softness and they are effectively correcting for it towards the end of Q1 and into Q2. Overall, we are very committed to our carrier strategy; we announced the 2417 during the quarter, which has been very well received from both our partners and the end OEMs. So I think we don't see this as a change in strategy issue, this is just a correction for one of our customers.

Louis Gerhardy - Morgan Stanley

Okay, and if I could ask a question on the end business as we move through the year and specifically on elasticity here and the relationship of prices coming down and units going up. Is that relationship in your view going to be pretty linear throughout the year or is there going to be a step function change at some point and if so when might that happen.

Craig Barratt

I think we actually don't really know the answer to that I think it's unlikely to be, I think it's less a step function, I think there’s more a continuum of steady games. We have retail bringing price points down, which as you saw it from the NPD data is driving adoption. We have PC OEMs who are now rolling out 11n across more of their product family, and so all of those created this inevitable increase in the 11n business. It's hard to suggest that there is a single event or turning point or price point that dramatically makes the adoption hard. We lived through this several years ago with the 11g ramp, and so I think 11n is progressing in very much a similar way.

Louis Gerhardy - Morgan Stanley

Yeah. Okay, great, a quick follow-up. Is your visibility for Q2 -- are you more or less dependent on turns than you were in Q1?

Jack Lazar

Yeah we've never really commented on turns, since we went public. But we do have a record of a consecutive quarter of revenue growth now. So I think that we try to give realistic expectations when we give our guidance at the beginning of the quarter.

Louis Gerhardy - Morgan Stanley

Thank you.

Jack Lazar

Thanks Louis

Operator

Our next question comes from Amit Kapur with Piper Jaffray. Your line is open sir.

Amit Kapur - Piper Jaffray

Great, thanks a lot. Hi Craig, Hi Jack,

Craig Barratt

Hi, Amit

Jack Lazar

Hi, Amit

Amit Kapur - Piper Jaffray

Hi. My questions have been answered, but in terms of the Bluetooth product development that you are working on for other end markets, we have seen some hinted inventory that's out there that some of your Bluetooth competitors have kind of talked about impacting some of the near term flow. Have you adjusted some of your product development in anticipation of some of that or no real changes there?

Craig Barratt

No real changes. One of the advantages of having zero revenue today in this business is that it's all upside to us. And so even if the market has some challenges, I think we can navigate our customer engagements to best work around any issues like those, and so this is definitely an opportunity for us, and certainly not a challenge or problem at this point.

Amit Kapur - Piper Jaffray

Right, thanks. And may be a quick follow-up, in terms of the PAS market, how should we think about that playing out in 2007 and then perhaps beyond?

Craig Barratt

Well as I mentioned the PAS market was down sequentially in the first quarter. We expect it to be probably somewhat flat in the second quarter. As we mentioned in our call each of the other products categories we do expect growth in the second quarter. I think there are some opportunities for PAS to grow, such as Dual-Mode, our products that might include the cellular technology together with PAS.

We are looking at some other applications; home gateway applications including cordless, telephony and so on. So I think there are over the next two years opportunities to this technology to create segments where we'll grow. But overall the PAS business today is essentially slow and we are working to increase our share in the market, but the overall market is flat to perhaps somewhat down. And as you can see from our numbers, it obviously does represent a smaller percentage of our business because our revenue continues to grow overall.

Amit Kapur - Piper Jaffray

Great. Thanks a lot.

Craig Barratt

Hey thanks Amit.

Operator

Our next question comes from Ramesh Misra with C.E. Unterberg Towbin. Your line is open sir.

Ramesh Misra - C.E. Unterberg Towbin

Okay. Good afternoon guys. My first question was in relation to your ROCm product line. What kind of target do you have for the year end for that business?

Jack Lazar

Hi Ramesh, it's Jack. We actually have not set any formal forecast out there for our ROCm products for the year.

Craig Barratt

Right, I would like to say that certainly our internal goal by the end of this year is to have a trajectory of shipping products and wins that will allow ROCm specifically mobile wireless LAN ROCm to be one of our significant growth drivers for 2008. So that's absolutely a goal of ours.

Ramesh Misra - C.E. Unterberg Towbin

Okay. Now, you have focused primarily on purely at those CMOS based solution. Can you qualitatively talk about the power advantages or disadvantages of using CMOS versus a dual-chip solution? So, clearly, I guess everyone understands that using a purely CMOS-based solution allows for a fairly small form factor. What role does it play on the power consumption?

Craig Barratt

Well, so, apples-to-apples an equivalent design in CMOS might have high power consumption in the analog circuits. But, the difference between different process technologies for analog is smaller than the difference between clever architectural purchase and not so clever architectural purchase.

So, we can design chips with clever partitioning of digital and analog processing and do things in a way that can allow us to get extremely competitive power consumption overall for our product. As an example, our first generation ROCm wireless LAN product is actually a 0.18 product and it is highly competitive, even compared with other company's CMOS solutions at much smaller process geometries.

So, that comes from using very clever architectures and design techniques. And so we believe that our single-chip CMOS solutions can be extremely competitive from a power consumption point of view, simply by differentiating using our design abilities.

Ramesh Misra - C.E. Unterberg Towbin

Okay. And then just one final question. Well, congratulations on a win at Sony or seeing that in actual production. In the near-term or maybe even through the rest of the year, where do you see most of your wins coming in? Is it in the handset side or is it on consumer products such as the camera? Thanks very much guys.

Craig Barratt

So, we have a significant important wins already under our belt in several of the market categories including smart phones, game devices, cell phones, and so on. So, it's hard for us to put color on one specific category or another. We think many of these markets will adopt wireless LAN and we are very excited about the design wins that we have.

Ramesh Misra - C.E. Unterberg Towbin

Okay. Thanks

Operator

Our next question comes from Jeremy Bunting with Thomas Weisel Partners. Sir your line is open.

Jeremy Bunting - Thomas Weisel Partners

Thanks very much. Would you say that the PAS business in Q1 was a little bit lighter than you originally anticipated?

Jack Lazar

Yeah. I think that's the case, because we actually in Q4 gave guidance that we thought that all of the lines of business would be up. But, in the case of PAS, we didn't think it would be up much. But, it was a little bit softer than we thought.

Jeremy Bunting - Thomas Weisel Partners

Do you know kind of what particular reason that might have been?

Jack Lazar

There is a variety of different things that can affect the PAS market. I think it wasn't exactly the strongest quarter for PAS in Q1. Overall, I think our design win presence is pretty good. We are a little bit slower than we had anticipated with one of the other OEMs that we have launching products. So, that probably had some factors in it.

But, overall, our goal is to just continue growing the company and whatever pieces can help us grow the company those are ones we are going to leverage as much as possible.

Jeremy Bunting - Thomas Weisel Partners

Right, sure. One last question. It looks like the Ethernet business really did like you stated increase in revenues and it was quoted under your umbrella. Could you just comment on what is the value proposition for those product lines in the eyes of the ODMs that you are selling it to?

Craig Barratt

Well, the initial Ethernet products are on the client side and clearly 100 megabit and gigabit Ethernet is quiet mature in most platforms from a feature point of view. There are some of higher end enterprise features, but the dominant part of market is pretty stable from a feature point of view. And so, that makes us straight off feature differentiation a bit more challenging.

So, fundamentally, we have the world's smallest and most compact solution for Ethernet, evidenced both by the dye size but also the package size for our solution. So, we have the better solution, that's cheaper, and we know the customers in this space very, very well and so it represents a relatively simple cost selling opportunity into the customer base. And our customers really like having suppliers that they can work within leverage across multiple product line. So, it's a very natural fit for us, and we hope to extend that same model to our Bluetooth products overtime as well.

Jeremy Bunting - Thomas Weisel Partners

Thanks Craig. Thank you very much.

Craig Barratt

Thank you.

Operator

Our next question comes from Edwin Mok with Needham & Company. Your line is open sir.

Edwin Mok - Needham & Company

Hi, Craig. Hi, Jack. Just a question on 11n, you mentioned in the last conference call you expect 11n to be about 50% of your wireless LAN revenue exceeding the year, are you still looking for that?

Jack Lazar

No, I think personally proposes by saying that 11n is happening just the way and much we had hoped and anticipated. But I would correct you; I mean what we have said is that our goal is to see 11n. We will consider it a very favorable outcome; in fact I think the words we've used are stretch, if we were able to get to 50% 11n by the fourth quarter timeframe. So, pretty much this quarter happened exactly the way in which we thought. We see strength for 11n for Q2. I think our designs wins are really playing out nicely right now. So, 11n is really on track and it's great news both for us and for the industry.

Edwin Mok - Needham & Company

That's great. A question on the PAS market, are you guys expecting to see some kind of growth next quarter?

Jack Lazar

We didn't really pull PAS out in any of our commentary as far as the forecast, so I think if it is relatively flat.

Edwin Mok - Needham & Company

And one last thing now for the Ethernet business it sounds like since you guys have introduced some new product, alright, are you guys just thinking about the $25 million target for year, or are you actually looking for the full year revenue to be more in the $25 million target?

Craig Barratt

Currently, as we mentioned we still think we're on track to that $25 million number, we are not changing it. As you saw from the announcement this afternoon, we are developing a variety of additional Ethernet products, both on the client side and on the infrastructure side. And of course, those products will start to produce some revenue later in the year, but at this point, we are not changing or modifying our original guideline of $25 million for the year.

Edwin Mok - Needham & Company

Sounds great. Thanks very much.

Craig Barratt

Thanks Edwin.

Operator

Thank you. Now, I would like to turn the call back over to Dr. Craig Barratt.

Craig Barratt

Thank you. As you can see, Atheros is delivering on its promise to expand our core technology strength into a global 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.

I would like to thank all of you for joining us today, with a special thanks to all of our employees for their continued dedication and hard work. In May, we will be attending several investor conferences including Piper Jaffray, Oppenheimer, Credit Suisse, Deutsche Bank, Cowen, Lehman Brothers, and CIBC. In addition, we will be attending the NASDAQ Investor Conference in London in the middle of June. 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 Q1 2007 Earnings Call Transcript
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