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Atheros Communications, Inc. (NASDAQ:ATHR)

Q2 2007 Earnings Call

July 23, 2007 5:00 pm ET

Executives

Deborah Stapleton - Stapleton Communications Inc.

Craig Barratt - President and CEO

Jack Lazar - VP and CFO

Analysts

Jonathan Goldberg - Deutsche Bank

Adam Benjamin - Jefferies & Co

Romit Shah - Lehman Brothers

Sanjay Dev - Morgan Stanley

Amit Kapur - Piper Jaffray

Ramesh Misra - C.E.Unterburg

Brian Wishart - A. G. Edwards

Edwin Mok - Needham & Company

Presentation

Operator

Excuse me, this is the conference coordinator, and welcome and thank you for standing by for Atheros Conference Call. At this time all participants are in listen-only mode. Later we will open the calls for your questions. Instructions for asking questions will be explained at this time. This conference call is also being recorded.

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

Deborah Stapleton

Thank you. Good afternoon everyone and welcome to the Atheros Communications' Second 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, leadership position in various markets, and expected shipments and product introductions 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 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 or 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 own 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.

Now, I'll turn the call over to Dr. Craig Barratt. Craig?

Craig Barratt

Thanks, Deb, and thanks to everyone for joining us today. We are very happy to report record revenue of $100.8 million and record non-GAAP net income of $14.7 million or $0.25 per diluted share. Gross margins were 49.7%, significantly above both our target range and Q2 guidance.

This was our ninth consecutive quarter of record revenue, and our first quarter with revenue of over $100 million. Our 802.11n product revenue was particularly strong and our 11g revenue continues to grow in the second quarter, once again demonstrating the strength of our wireless business. Jack will take you through the numbers in greater detail, and discuss guidance for the third quarter shortly.

Our second quarter results provide continued evidence of our success in expanding our product platforms, customer base and revenue opportunities in our three key markets PC's, networking and consumer. Let's review some of the highlights in each of these areas. Revenue from our PC business was particularly strong in the second quarter with revenue at records highs in both dollars and as a percentage of revenue.

Our diverse set of products for PC OEM's includes our family of 11g, 11ag and 11n wireless LAN products, as well as Ethernet, PHYs and LOMs, strong demand from our customers for both wireless, LAN and Ethernet products resulted in over 24% sequential growth in revenue to these portion of our business.

Our 11n wireless LAN products fueled much of the growth in our PC business, revenue from 11n PC OEM design grew significantly and we believe we continue to gain market share against our competition.

Revenue from our 11g products once again increased and made up almost 60% of wireless LAN revenue. Shipments of annual low cost 11g products grew sequential in the second quarter. In fact we more than doubled our revenue over the first quarter from the AR 2425 11g PCI-Express single chip client solution. During the second quarter we achieved significant 11g design wins at major PC OEM's and we expect our family of cost effective 11g solutions to continue to be a significant revenue driver for us in the second half of these year. The competitive strength of these products is enabling us to both gain market share and extend the lives of the Atheros 11g product line.

In June, ASUS Stack launched the revolutionary EEPC, which provides uses with the mobile internet experience at a very cost effective price. It is being called the world's most inexpensive laptop, with prices beginning at a $199. And the best part of it is that this new line of laptops incorporates Atheros's 11g Wi-Fi, as well as our fast Ethernet LOM. We are proud to be a part of this important innovation in mobile computing and pleased to see this example of successful cross selling among our expanded product lines.

Our Ethernet business continues to be strong. In the second quarter we shipped more that 6 million ports, bringing out total port shipments in the first half of the year to over 10 million. During the second quarter we further demonstrated the competitiveness of our Ethernet products, by securing our first Ethernet design wins in the laptops from multiple PC OEMS.

In May we announced our next generation Gigabit Ethernet PHY the AR8021, this compact 6x6 48-pin QFN PHY provides robust performance and a rich set of value added features, all in a low cost and low power design. The AR8021 is the world's Smallest Gigabit Ethernet PHY device, offering a reduction of more than 60% in package size compared with the nearest competitive solutions. This industry leading Gigabit Ethernet PHY footprint results in the lowest builder materials costs on the market, reducing price barriers to widespread option of Gigabit Ethernet PHY technology in a wide range of computing and networking applications.

Our Ethernet product line continues to grow and our success with these products further validates our strategy of providing multiple product lines to our world-class set of customers.

During the second quarter, we demonstrated our new Bluetooth products, through a wide variety of PC OEM and other customers at the Computex Trade Show in Taiwan. The initial feedback has been positive and we are sampling to a variety of potential customers.

Atheros's networking business grew again in the second quarter and continued to be the largest portion of our overall business. Growth in networking was driven by continued adoption of 11n in networking products, such as routers, access points and gateways.

During the quarter, we introduced our new AR 9001 family of second generation 11n solutions. This product family includes the industry's first 11n system-on-chip, which incorporates our high performance wireless network processor. These products support various configurations for advanced 11n routers and access points, including single and dual band 2-by-2 and 3-by-3 minor configurations, and fast and gigabit Ethernet.

We also introduced, single band 2-by-2 and 1-by-2, and the world's first dual band 11n 2-by-2 USB solutions. We've secured design wins for these products, and we'll be ramping production shipments this quarter.

Our second generation family of 11n products builds on our highly successful first generation XSPAN products, with enhanced performance, higher integration, smaller form factors and lower overall cost. As with our previous XSPAN products, the AR 9001 family complies with the latest IEEE Draft 2.0 11n specification.

Atheros's XSPAN technology achieved industry validation, through our selection into the Wi-Fi certified 11n Draft 2.0 Testing Suite, and our customer's 11n products were among the first to receive Wi-Fi certification.

Also during the quarter, we introduced our first Ethernet switch, the AR8216. Despite port Ethernet switches now included in several of our reference designs and we have designs win with multiple customers, we have already begun volume production, and we look forward to delivering products to customers this quarter. Later this year we expect to introduced our first gigabyte Ethernet switch, an essential building block for next generation high performance 11n routers.

The retail portion of our networking business was especially strong in the second quarter, as we experienced increased demand for our 11n solution. D-Link is now offering Atheros space to 11n 2 by 2 router for $59 down from $79. With prices now ranging from under $60 to around $200 there is a breadth of products and features that will meet every consumer's needs, which we believe will drive mainstream consumers to upgrade their networking equipment and experience.

As you all recall, partners such as Siemens, 2Wire, ZyXEL [Shazam] and others use Atheros solutions for carrier a gateway products, to incorporate broadband connections such as ADSL or VDSL with wireless LAN. We have a variety of new design wins for carrier solutions featuring 11g and 11n and we continue to believe that this will be a growth carrier for us in 2007 and beyond.

As anticipated we did experience a slowdown in carrier revenue as one end customer in particular adjusted his inventory levels. In the third quarter, we anticipate a pickup in demand and a return to growth to this portion of our networking business.

Our consumer business today is made of up ROCm mobile wireless LAN and our PAS products. In the second quarter, this business declined to 5% of revenue, primarily due to softness in our PAS business. The overall PAS market was slow and we believe that our primary OEM partner is experiencing a decline in market share. In addition, the rollout of our AR1900 PAS solution with other OEMs has taken longer than originally anticipated.

While we expect PAS to decline further in the third quarter, we continue to look for additional customer engagements and new PAS based applications without growing our modest PAS operating expenses.

We are seeing a lot of design activity for our ROCm mobile wireless LAN solutions for various categories, including digital cameras, gaming and dual-mode handsets. Consumer electronics products, including cameras from Sony, and digital picture frames from Kodak are now available.

On the cellular front, our dual-mode cellular/Wi-Fi reference platforms developed with QUALCOMM are in growing demand. We secured wins with two of the world's top five handset manufacturers and we expect to begin production shipments later this year.

Consumers increasingly want their mobile handsets to deliver a robust internet experience that only Wi-Fi can provide. As a result, over time we expect the majority of smartphones, as well as feature phones supporting UMA to include Wi-Fi. We look forward to announcing our mobile wireless LAN designs and other ROCm customers in the coming quarters as these products become available to consumers.

In addition to our Bluetooth products for the PC market, later this year we expect to bring additional Bluetooth products to market targeted at the consumer market. We are excited about our opportunities in the Bluetooth market and we continue to believe that Atheros will become a significant player in Bluetooth.

The past 12 months have been the time of exceptional growth for Atheros. Our revenue and operating profit for the first six months of 2007 have increased 46% and 54% year-over-year respectively. And we now have 727 employees compared to 420 at the end of the second quarter 2006.

In order to achieve better scalability and parallelism, we have moved to a business unit structure. We now have three primary business units. Sam Endy leads our Mobile Business. Jason Zheng leads our Asia-Pacific businesses, and just recently Ben Naskar joined Atheros as Vice President and General Manager of our Wireless Networking Business. Ben comes to us from PMC-Sierra where he was Vice President and General Manager of their Communications Business. Previously, Ben held a variety of executive positions at companies including Analog Devices, National Semiconductor, and AMD. We are excited to have Ben join the Atheros team.

Atheros is driving the ongoing market adoption of 11n solutions, with Draft 2.0 certification, and our recently introduced second-generation XSPAN 11n product line, featuring enhanced performance and industry leading integration.

By offering an extensive family of XSPAN products, combined with our diversification into markets such as Ethernet and Bluetooth, we are becoming an even more significant communications solutions 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 all of you for joining us today. First, I will outline our financial results for the second quarter ended June 30, 2007, and then I will provide our third quarter guidance. Q2 was another very strong quarter for Atheros. This was our ninth consecutive quarter of revenue growth and our eighth sequential quarter increased in both operating and net income. Revenue was towards the high end of our guidance range and gross margin were above it, as a result EPS came in $0.01 better than the top end of our guidance.

As a reminder our Q2 guidance was 4% to 7% revenue growth, gross margin between 47% and 48%, and EPS of $0.23 to $0.24. Q2 revenue increased 6% sequentially and net income was up $1.1 million to $14.7 million or $0.25 per diluted share. In addition to the strong financial results, we're pleased with the progress we've made integrating the Attansic team into Atheros family.

We're proud to have recorded our first $100 million quarter in Q2. Revenue was a record $100.8 million, up $5.3 million from the $95.5 million recorded in the first quarter of 2007 and then increase of 38% comparable with the $73.2 million recorded in the prior year comparable quarter. The 6% sequential increase in revenue was driven by a further expansion of our core wireless LAN business, with particular strength in our 11n and 11g solutions.

Based on products mixed data, the breakdown of revenue for our wireless LAN chips sets was as follows. 11ag was 18% versus 21% in the prior quarter, 11g was 58%, which compares with 61% in Q1, and 11n was 24% in Q2 versus 18% in Q1. Revenue from our 11g and 11m products were record highs in Q2. 11n product revenue increased $7.2 million or 49% sequentially due primarily to the strength of our PC OEM customers, and increased adoption of 11n by retail OEM.

We had record 11g product revenue due to the strength in sales to both our retail and PC OEM customers, partially offset by an expected softness with carriers. Our 11a/g solutions at 18% were in line with our expectations going into the quarter and reflects the continued transition of our PC OEM and retail customers to 11n solutions. The percentage breakdown of revenue by channel based on data supplied by our OEMs is as follows. Networking was 50% of revenue in Q2 versus 52% in Q1, PC OEM was 45% of revenue versus 39% in Q1 and consumer was 5% in Q2 as compared with 9% in Q1.

As a reminder beginning last quarter we began providing you channel information based on our networking, PC OEM and consumer categories. For historical comparison purposes the all retail and enterprise carrier channels form our networking category.

Revenue in units shipped to our networking and PC OEM customers set record highs. Networking revenue increased $1.1 million or 2% sequentially, as we saw strength in shipments of our 11n products to retail OEMs.

Revenue from our PC OEM customers increased $7.8 million or 21% sequentially. A large portion of this increase related to the strength of our 11g and 11n products at several PC OEMs partially offset by an expected reduction in 11a/g shipments. Ethernet revenue was essentially flat sequentially while units increased significantly due to a higher concentration of 10/100 PHY and LOM shipments.

PAS revenue in Q2 came in below our expectations due to our primary OEMs loss of market share and an overall stock miss in the PAS market. In Q2 Hon Hai Precision Industry was our only 10% customer.

First quarter gross margins were 49.7%, above the high-end of our 47% to 48% guided range, well above our corporate target range and up a 170 basis points sequentially.

Our gross margin strength was due to favorable product mix, relatively stable 11g ASPs and increased supply chain efficiencies.

On the later point, we are starting to experience some of the benefits related to scale, as Atheros now ships 50% more chip sets quarterly, than we did just six months ago. The ongoing strength of our wireless LAN business and the addition of our Ethernet product line has enabled to achieve product cost synergies that were previously unavailable to Atheros.

Total operating expenses were$33.9 million, a 6% increase from Q1 and a bit above our guidance of $32.7 million to $33.6 million. R&D increased $1.4 million or 7%sequentially, as we continue to invest in additional headcount tape-outs for new products and software license fees.

As the percentage of revenue R&D increased slightly from 21.6% in Q1 to 21.8% in Q2, SG&A increased just under $500,000 or 4% due to headcount additions and commissions for outside sales reps, partially offset by reduced trade show expenses. SG&A as a percentage of revenue decreased slightly from 11.9% in Q1, to 11.8% in Q2.

Operating income in the quarter was $16.2 million up 17% from the $13.9 million recorded in Q1 and a 54% increase from Q2 '06. Operating income was 16.1% of revenue in the second quarter and was for the first time in our history within our target range of 16% to 18%.

The effective tax rate in Q2 was approximately 23% up from 17% in Q1 as we updated our annual forecast, resulting in cumulative adjustments to our effective tax rate. For the six months ended June 30th, our effective tax rate was 20%.

Net income was $14.7 million or earnings of $0.25 per diluted share for the quarter, compared with net income of $13.6 million or earnings of $0.23 per diluted share in Q1. Average fully diluted share outstanding were $59.1 million Q2 and $58.3 million in Q1.

GAAP net income for the second quarter was $9.3 million or $0.16 per diluted share. This compares with GAAP net income of $7.6 million or $0.13 per diluted share in the first quarter and $6.8 million or $0.12 per diluted share in Q2 06.

Turning to the balance sheet, it was remarkably strong. Cash and marketable securities were a record $228 million at June 30th a $21.8 million increase from Q1. DSO’s based on our quarterly average receivables balances decreased six days to 44, versus 50 days in Q1. This was better than our target range of 45 to 55 days.

Inventory returns for the quarter were 7 times, compared with 6.3 times in Q1, while days of inventory decreased 9% from 57 to 52 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 Q2 were $105 million.

During the second quarter of 2007, our capital expenditures and depreciation were approximately $3.2 million and $1.2 million, respectively. Overall, our cash flow and asset management metrics were strong once again in Q2. And as of June 30th, we have 727 full time employees, compared with 688 at the end of Q1.

I will now move on to our guidance for the third quarter. Q2 was our strongest quarter to-date in terms of revenue and both operating and net income. In Q3, the catalyst for revenue 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.

We expect that the networking portion of our business will be the strongest in Q3, led by an increased demand from both retail and carrier customers for 11g and XSPAN 11n wireless LAN products.

PC OEM revenue is expected to decline from Q2 record highs due to timing of product rollout with some of our customers. Consumer revenue will decline due to a sharp decrease in demand from our primary PAS OEM, although this will be partially offset by increasing product revenue from ROCm mobile wireless LAN solutions.

Accordingly, based on the strength of our combined business, we currently anticipate second quarter revenue to increase between 4% and 6%. We anticipate the gross margins will remain very strong and in a range of 47.5% to 48.5%, and once again above our target model range due to improvements in our supply chain and relatively stable pricing for 11g products.

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 will be in the range of $34 million to $35 million. A majority of these increases will be in research and development, as we increase our tape outs during Q3 to support our long-term products plans.

Our estimated pro forma tax rate for Q3 is approximately 20% and we anticipate EPS for Q3 to be in the range of $0.25 to $0.26 based on fully diluted shares outstanding 59.5 million and 60 million.

Our Q2 results and our Q3 guidance once again reflect the strength of our business, 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

Thank you. (Operator Instructions). Our first question comes from Jonathan Goldberg.

Jonathan Goldberg - Deutsche Bank

Hi guys. Thanks for taking my call.

Craig Barratt

Hey, Jonathan.

Jonathan Goldberg - Deutsche Bank

First a quick question on gross margins. Was there anything anomalous in the quarter, anything one-time, non-recurring? Any changes to accounting that would have driven that?

Jack Lazar

No, I wouldn’t say that there was anything too particular. There was a little NRE that we had in this quarter. But it was relatively minor. This was really more just product driven.

Jonathan Goldberg - Deutsche Bank

Okay. And then I was wondering if you could talk little more about your ROCm design wins on the mobile side. You said you [received] two top five handset vendors. What else can you tell us? Is it going to be in smartphones or is it going to be the mainstream product?

Craig Barratt

Well, it's difficult. And generally we don’t give more color until the end products are actually shipping. Then we will be much happy to tell about the particular products and the targeted carriers are for those products. But, as we mentioned in our prepared remarks a number of these design wins do relate to the joint reference design partnership we have with QUALCOMM. So, a number of these products are generally CDMA based phones, advanced CDMA phones that also include a Wi-Fi capability that if we won't give any extra color on the winds at these points.

Jonathan Goldberg - Deutsche Bank

Can you say their smart functional or mass market?

Craig Barratt

Sort of…

Jonathan Goldberg - Deutsche Bank

Okay. Thank you.

Operator

Thank you. Your next question comes from Adam Benjamin. Your line is open.

Adam Benjamin - Jefferies & Co

Yeah, hey guys, just a follow up on the gross margin improvement in the quarter, Jack you mention kind of three areas, which drove that. On the supply chain efficiencies can you go into little more detail on that one and just, how you seeing that is a, is it built on pricing, on the wafers or other efficiencies in terms of multiple facts that your using. Can you just give some more color there and how we can expect to see that play out into the rest of this year as into years, you become a better company.

Jack Lazar

Yes Adam, happy to comment on that. I think some of these is just a lot big numbers finally starting to give us some advantages is there of. We mention that in the prepared remarks that the numbers of chips sets that’s we're shipping are now 50% greater in this most recent quarters comparable Q4 of last year. So that’s a huge weapon when we go to talk to suppliers. And frankly we're just taken more credibly then we were probably in the past.

So we're seeing efficiencies amongst our foundry partners, our backend supply partners, frankly across the whole supply chain and this probably weren’t available to us in the past. And we expect to try and continued to leverage that as we move forward. Of course products make has a big impact on gross margin too, so just maximizing the value some of the efficiencies of the supply chain will get us all the way there, but these certainly a good stuff

Craig Barratt

Yes. Adam these is great I just want to make an extra comment on the supply chain safe side. What we really doing is leveraging our ability to design a single chip single chits and in to straight digital Cmos. We aren’t captive to a particular foundries seem us mix single process and that flexibility and CMOS, so we aren’t captive to a particular foundries, CMOS mixed signal process.

A signal that the fability and agility allowed us to ramp several different foundries into production with quite advanced single chip solution. And the fact that the radios in the single chip solutions has done scale as much with geometry, means in general we're able to enjoy a very nice cost curve on what some people might consider to be trailing semiconductor technologies. So you put those two together and that’s something that’s really allowed our operations team to really optimize the cost structure of our products, and that’s something that we expect to continue to favors us in the coming quarters.

Adam Benjamin - Jefferies & Co

Got you, thanks. Greg lust a follow-up on the PC OEM side. The quarter was obviously very strong in June, but Jack, you mentioned on the guidance that you thought it would be down sequentially. Just trying to reconcile with the normal PC seasonal build for back-to school, would seem like that business should be up sequentially and just trying reconcile that and understand kind of the dynamics going there? I know, you re ramping and there is couple of new customers as well, so just wanted, if can give a little more color there, that will great.

Yeah, there is really not much more we can say other rather it just purely timing of some of the rollout of products that we have. What I would point out is that, keep in mind our PC revenue is going to be above what it was in Q1. And Q1 was an all time record for us at the time too. So, it's not like we’re seeing a massive drop off PC OEM, but we are seeing it will decline a bit from what we’ve had just huge numbers. I mean it's never been anywhere close to 45% or our revenue. So, I wouldn’t look at it as an over trend there, I think it's just a combination of things coming together at this point.

Adam Benjamin - Jefferies & Co

Okay, great. And then, lastly on the gross margin, I know people have asked about this. Have you thought about adjusting that target?

Jack Lazar

So we are just going to comment on the gross margins going forward and obviously for this we see another great quarter for gross margin at 47.5 to 48.5, so we are seeing some benefit there and as business conditions change in the future, which may force us to go back towards our target model. So it really just depends on where we are trying to take the company strategically and what investments we need to make?

Adam Benjamin - Jefferies & Co

Got you, all right Jack thanks.

Jack Lazar

Thank you.

Craig Barratt

Thanks Adam.

Operator

Thank you. Your next question comes from Romit Shah.

Romit Shah - Lehman Brothers

Great thanks for taking my question guys. Just with [zeneros] starting the ramp here into the second half, can you just discuss qualitatively how that's impacting your 11n business and why we shouldn't assume that your G starts the level of from here?

Craig Barratt

Yeah Romit, this is Craig. So Intel's introduction of 11n is actually very positive for our business and we can say that with confidence, because we have been through two previous cycles of Intel introducing Centrino-based products. But remember the only customers they supply are the Centrino-based laptop customers. They don't sell Wi-Fi to any of the other segments and so for 11n their introduction creates a lot more credibility for the transition towards 11n and really drives a sweeping adoption of 11n, not only at PC OEMs which benefits us because Intel of course doesn't fill every socket of those customers.

They don't address all of the laptops and of course their brand doesn't cover desktops, but more importantly the retail and carrier segments, they provide all of the infrastructure product that actually connects to these PCs. ~And so the momentum from that overall is definitely positive for our business and that's a cycle as I said we have seen twice before and its what we expect and are seeing repeat this time around too.

Romit Shah - Lehman Brothers

Okay great and then just a question on ROCm. It sounds like you guys have had very good design win momentum. The question just around when we could see some of those design wins ramp even be hit hard in one particular quarter, do you expect to sort of layer in as we get into 2008?

Jack Lazar

Romit, this is Jack, there is a wide variety of these wins, some are larger than others. You will see them all play out over, certainly over the next year here. But the particular timing for anyone of these or frankly just the overall trend, I don’t think we are in the position to really comment on. We did say ROCm will be up, ROCm product revenue will be up in the next quarter, but other than that I think that’s really the -- the best we can give you for now and as we start stalking the market, we will be clearly more than happy to start talking about them.

Romit Shah - Lehman Brothers

Okay, thank you guys.

Craig Barratt

Romit, I didn’t answer your question on 11g. You said will the transition to 11n create more pressure on the 11g business? But actually to some extent we believe the answer to that is actually no and part of the reason is that to such a drive to develop very, very low-cost laptop platform, we've talked about the AssistTech $199 laptop.

And what we’re finding is that this drive towards lower cost platform is something that is closing the lower end part of the market to grow quite rapidly and that’s generally not a Centrino branded segments. Centrino is more of a premium segment, and so I think we are seeing a lot of growth in 11g because of that drive towards low-cost platforms and that somewhat independent of the drive to 11n in the mid-range and high-end.

Romit Shah - Lehman Brothers

Okay, thanks a lot Craig.

Operator

Thank you. Our next question comes from Louis Gerhardy.

Sanjay Dev - Morgan Stanley

Hi guys this is actually Sanjay Dev behalf of Louis Gerhardy. Just a couple of quick questions, sorry to beat a dead horse, but just getting back to the gross margins. If I look at the 49.7 that you did this quarter and then the mid-point of the outlook about 48% there it's about 170 basis point drop, I was kind of hoping I may be able to reconcile -- the push it takes that kind of go into that potential drop assuming that that’s what it comes out to be. I am just kind of having a hard time to see how it's going to drop, given the incremental revenue, the growth. As well as I am assuming a richening mix of n versus g, and I was just kind of hoping if you kind of walk me through that?

Jack Lazar

Sure. I mean when we come up with guidance for the quarter it's actually based on the forecast that we have, and that of course includes the lot of products that’s already on order and so, it's reality that what we see right now. I think the puts and takes of it -- clearly, we don’t expect much out of PAS this quarter and PAS is a higher margin business for us. So that clearly has some effect downward on the growth margins.

The rest of it just gets down to product mix. If we sell more to certain channels, for example, the carrier business doesn’t tend to be as high margin as some of the other businesses and we're increased happening in the carrier business in this most recent quarter.

We also see Ethernet, which generally doesn’t run at 49 point margins, as much as I would like it to. It is increasing in this quarter. So, I see plenty of things that can pull down the margins in this upcoming quarter.

That being said, let's now reside to the fact that we are guiding to 47.5% to 48.5% gross margins, which I think should be pretty favorably received by folks, because we have never really guided to a number that high. And it's significant lay above what we have guided to in the past.

Sanjay Dev - Morgan Stanley

Right, I understood. I appreciate the input. I just wanted to reconcile it for myself. And then just one more follow up for Jack, if I could. I was wondering if you just kind of talk about the opportunity in the desktop. Obviously, with some Centrino coming on, you talked about how that should benefit you, how it's benefited you two previous cycles before. But, if you just kind of talk about some more of your opportunities in the desktop space and kind of help us get a handle on that?

Craig Barratt

Yeah. I think the desktop area is still an opportunity. We are focused it. But, I think lower cost laptops are really something that’s really come to play out in the last few months, as we have seen from a number of product announcements. And so, certainly we do have wins in the desktop space. We are optimistic that, that will grow. But, I think it will modest compared with the opportunity and very, very low cost laptop platforms, as laptops really drive further down into the market.

Sanjay Dev - Morgan Stanley

Okay. All right. Thank you very much. That’s all I had.

Craig Barratt

Thanks Sanjay.

Operator

Thank you. Your next question comes from Amit Kapur.

Amit Kapur - Piper Jaffray

Great. Thanks a lot guys. I was wondering in terms of Bluetooth and ROCm. I know there is still little bit of handset inventory during Q2, and obviously with the iPhone launched it seem to create a little more buzz in the market. And the people you deal with, did you see any changes in the handset portfolios or changes in design activities throughout the quarter or think seem to be kind of still on track?

Craig Barratt

I think it's more difficult for us to judge on overall trends. I think with the advent of the iPhone and even prior to that I think the interest in having much more richly featured handsets, the interest in that is definitely increasing in the market. So, the percentage of the market that is smartphone based which will have a higher touch of Wi-Fi is definitely seen to trend up. And so, I think the richness of the user experience is definitely something that's in the forefront of the cellular handset companies.

Amit Kapur - Piper Jaffray

Great, thanks. And may be just kind of again turning to the PAS market, you kind of mentioned that you are not expecting a lot out of the coming quarter. How shall we think about that beyond that? Is it kind of decline in the PAS market you saw during Q2, to start off something permanent and should we continue to model it at roughly at 5% of revenue going forward or you think it will bounce back?

Jack Lazar

So, remember in the consumer numbers there is actually the ROCm numbers too. So, it's not all of that 5% as PAS. And certainly, we do expect the PAS revenue to go down next quarter. I think we're realistic about PAS. I've certainly spoken to a lot of you about this and Craig spoken to you a lot of view about these. We've looked at PAS as an opportunities to show off our ability to do integrated solution in CMOS. We look at it’s a opportunities to put financial strength into the company and it's clearly served its purpose.

W also view it though as a market where we can continue to take revenue and gross margin and add to the strength of Atheros. Now, do we look it is an area where we investing a lot of resources? No. That’s clearly not the case. We have a nominal amount of resources on it and really what we're trying to do is penetrate some of these other customers in more volume. And we think that will have the biggest impact on PAS.

So I think we're probably, clearly this quarter is going to be an extremely low quarter for PAS, but as we look forward we would expected to pick back up with it, and over time its not going to grow at the same rate as the business, but it should be a nice slug of revenue and certainly high margin business that will help us drive some profitability for the company.

Amit Kapur - Piper Jaffray

Great. Thanks a lot guys.

Jack Lazar

Thank you.

Operator

Thank you. Your next question comes from Ramesh Misra of C.E.Unterburg

Ramesh Misra - C.E.Unterburg

Hi. Good afternoon guys. Thanks for taking my question. First was a clarification, Jack could you provide us sense of how large the Attansic contribution was during the quarter? And talk about pricing trends in 11n in Q2 and also forward and if there's any reason you might think could be any different from PAS option and I have a follow up.

Jack Lazar

Okay. So in short no, I can’t really give any comments on Ethernet, we're not going to be reporting that out. I think we're on track to do our 25 million. And as we said, units were up significantly and revenue was relatively flat sequentially. We also did say that we would expect the Ethernet to be in area of strength as we move through to our Q3.

So I think that’s really all the comments we have reason it unfortunately at this point.

Our 11n pricing, we did see certainly some pretty decent declines in 11n and as we have said over and over and over again, we plan on driving those prices down. We believe that you need to get these $60 routers out in the market place in order to drive the adoption of 11n and the way in which we are doing that is by doing multiple generations of products faster than our competitors.

So we have the only SoC out there in the marketplace today, that’s bring down the overall bond pricing for 11n and we gave some of those benefits to our customers. So clearly 11n is dropping at a rate greater than say 11g at this point, but that’s what you would expect if we are going to continue to drive this adoption of the standard.

Ramesh Misra - C.E.Unterburg

Okay. In regards to ROCm wins, can you guys say if it was for the UMA architecture phones or was this basically for data networking/web surfing?

Craig Barratt

I think as we answered before, we’re not giving specific color on wins. Our policy very much as we don’t talk about those until the end products are shipping and we’ll be happy to give you a lot more details when those products are out on the market.

Ramesh Misra - C.E.Unterburg

Okay, great. Cut out try. Thanks very much.

Craig Barratt

No problem.

Operator

Thank you. Your last question comes from [Brian Wishart] of A. G. Edwards.

Brian Wishart - A. G. Edwards

Hi, this is Bryan Wishart for Gary Mobley. In your wireless LAN division, how would you describe the net effect of the market share type of war going on during the most recent notebook refresh period?

Craig Barratt

I think our general sense is we are growing our revenue in wireless LAN faster than the overall growth in the market and so consequently our conclusion is that we are in general increasing our share in that market. I think, as we reflected in our prepared remarks we’re definitely excited and positive about a number of the top tier PCM OEM wins that we have that will start shipping later this year.

Brian Wishart - A. G. Edwards

Okay and can you give us any idea on Ethernet, of your penetration and other PC OEMs beyond the ASUS Stack?

Craig Barratt

So we definitely have wins with additional customers and once again when those end products actually ship we'll be happy to talk about those customers.

Jack Lazar

But it is a variety here too its folks like in a ASUS Stack, there is other players in their core market, but also laptop manufacturers who are now incorporating our Ethernet into their laptops and that's a significant step for us, because in order to broaden the actual addressable market for us, we need to be able to ship both OEMs and the PCMs like an ASUS Stack, so couple that with the fact that our switching solutions are now about ready to ramp with their end production volume production right, so as those hit the market and start shipping with our wireless LAN access points and routers, we truly see an opportunity to expand the Ethernet business as we look forward.

Brian Wishart - A. G. Edwards

Okay. And then just one final question, would you say that your trends in overall average selling prices would that be down?

Jack Lazar

Well I don't know. The overall average selling price is actually relatively meaningless to us at this point, because we have business like Ethernet that sell at dramatically different prices than say wireless LAN. So I think we have to look at it on a piece-by-piece basis and when we look at wireless LAN I think we are happy with the trends that we saw on the most recent quarter.

And with Ethernet, I think we feel like we can be very competitive and the trends we are seeing there are relatively positive, then of course this PAS and PAS just doesn't change much in pricing, and so overall when I look at the segments I think that we relatively happy with the way ASP is trading in the most recent quarter.

Brian Wishart - A. G. Edwards

Okay, that’s all, thanks a lot.

Jack Lazar

Okay, thank you.

Craig Barratt

Thanks Brian.

Operator

Thank you. Your last final question comes from Edwin Mok of Needham & Company.

Jack Lazar

You there Edwin?

Edwin Mok - Needham & Company

Hi, can you hear me?

Jack Lazar

Yes.

Edwin Mok - Needham & Company

Yes sorry about that. First question for longer-term, longer-term obviously you guys have been able to integrate more component to your chips and it would drive and keep a good ASPs or take the market share from customers, what's your FAB of integrating since you guys already have two wireless LAN and Ethernet, what's your thought on integrating two the wireless meant together? And also what is the next step for you or your thoughts in 11n you guys have especially with the write down solutions, so what's your next step away to your thought 11n and does it integrating more gigabyte Ethernet switches something like that?

Jack Lazar

Glad to say Edwin we certainly see the attach rate, the connect rate for a lot of these features in many devices increasing and that therefore means longer-term integration certainly makes a lot of sense. However, in growing new businesses, our goal is not only to developed technologies just to integrate, and the reason for that is that for the next several years a lot of these technologies actually have very different attach rates in devices. So for example in PCs, Ethernet is a 100%, Wi-Fi is now close to 100%, now the Bluetooth is a lot of less than that may be 25% to 30% across all those laptops and even less if you include desktops.

And so integrated products prematurely bought to market could have difficulties because not every customer needs all of the features together. So our discipline is to build a stand-alone business with extremely competitive products that we can attack the market with such as Ethernet and Bluetooth to supplement Wi-Fi and of course longer-term we will look at integration opportunities.

Clearly, this Ethernet Wi-Fi integration in routers and in mobile devices over time more and more of them will have both Wi-Fi and Bluetooth and perhaps other technologies as well. And so, we want to be positioned to be a strong player as integrated devices come to market. But, we do want to express some caution about how quickly integrated devices really become relevant.

If we go back three years ago and look at DSL gateways everyone knew that Wi-Fi attaching those gateways was going to go up. And amazingly all of the DSL providers all had Wi-Fi businesses in-house. And none of them really probably other than one were able to stay competitive in Wi-Fi and eventually they actually dropped out of that business and failed to bring integrated products to market quickly enough. And so, that’s a market that was expected to be completely integrated by now and players without those technologies were expected to be uncompetitive. And we have pushed the standards ahead fast enough to where our innovation rate has allowed us to keep that market favoring leading solutions rather than integrated solutions.

In terms of the road map with 11n which was your second question. We have SoC, we have USB products. We have variety of second-generation product. Certainly, that’s a stepping stunt for us. Clearly, greater levels of integration, high-levels of performance are absolutely possible and we expect to create more leadership in the market from both the feature performance point of view and also a price point of view as well. And so, this is just one step in the journey and it’s a journey that we've traveled and followed several times before with each previous generation of Wi-Fi.

Edwin Mok - Needham & Company

Craig, you don’t want to touch on the timeline right now. Do you? In terms of…

Craig Barratt

We will announce products as we are sampling and ramping them. So, we won’t give any more color other than that.

Edwin Mok - Needham & Company

Great. That’s fine one question for Jack. I know Jack you don’t want to give the overall ASP. But, may be you can give little bit of just a trend in terms of ASP for your three product group, the AG and the G and also [11n]. Did you see ASP decline in all three groups? Or did you see once that they grew all, any group that actually see a flattish growth in ASP?

Jack Lazar

Well, I think in any quarter we would expect to see some level of ASP decline in every one of our product groups. But, clearly the ASPs will decline more in certain technologies than others. And of, course the one that would come to mind is one that’s priced the highest, which would be 11n.

So we are focused on really driving down the price for 11n. That makes sense because we have the cost effective solutions, we have the integrated solutions. So, that’s the one where you saw the most pricing pressure. I think I commented on the call that 11g was relatively benign pricing and AG is increasingly less important.

So, g and n affect us the most. To make n successful we will continue to drive down the price and the cost. With 11g I think we have some of the best solutions in the marketplace. We are seeing that was pretty amazing design wins that we've had against competition.

Edwin Mok - Needham & Company

I think you're right way. Fortunately you are doing pretty well. So, thanks for answering my question.

Craig Barratt

Thanks Edwin. So, we did 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 September we will be attending the AG Edward’s Growth Conference in New York and the ThinkEquity Fifth Annual Growth Conference in San Francisco, as well as marketing in various parts of the country. If you are interested in a call or a meeting, please contact Stapleton Communications.

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 Q2 2007 Earnings Call Transcript
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