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Atheros Communications Inc (NASDAQ:ATHR)

Q1 2006 Earnings Conference Call

April 24th 2006, 5.00 PM

Executives:

Deborah Stapleton, Stapleton Communications Inc., Investor Relations

Craig Barratt, President, Chief Executive Officer, Director

Jack Lazar, Chief Financial Officer, Vice President, Secretary

Analysts:

Mark Edelstone, Morgan Stanley

Charlie Glavin, Needham & Company Inc.

Arnab Chandra, Lehman Brothers

Jenny Hsu, Thomas Weisel Partners

Presentation

Operator

Ladies and gentlemen, thank you for standing by. Operator instructions. I will now turn the call over to Deborah Stapleton, who will introduce today’s speakers. You may begin.

Deborah Stapleton, Stapleton Communications Inc.

Thank you, and good afternoon to everyone and welcome to Atheros Communications Q1 2006 financial results conference call. Leading the call today is Dr. Craig Barratt, President and CEO, and Jack Lazar, Vice President and Chief Financial Officer. Before we begin, I would like to remind you that various remarks that we make on this call, including those about our future financial results including revenues, sources of revenues and expenses, our future plans, goals and prospects, market trends, design wins and product development, our customers, our competitive position and our anticipated growth, profitability, leadership position in various markets and product announcements and shipments in 2006, and the expected benefits of the ZyDAS acquisition constitute forward-looking statements, for the purposes of safe harbor for 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 quarter ended December 31 2005, 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 of the date hereof and we disclaim any obligation to update these forward-looking statements.

Atheros reports net income and basic and diluted net income per share in accordance with GAAP and additionally on a non-GAAP basis referred to as pro forma. Atheros’s management believes that 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 annualizes its operating results.

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

Craig Barratt, President, Chief Executive Officer, Director

Thanks, Deb, and thanks to everyone for joining us today. We’re very pleased with our record Q1 results. Our financial performance in Q1 was fueled by the large investments we have made over the past two years, both in our core wireless LAN products, as well as in our diversification efforts into the PAS market. With CMOS radio integration skills as our core competency, we continue to demonstrate their value through the success of our various products in the market. To briefly recap our earnings press release, we reported record revenue of $61.1 million, non-GAAP net income of $7.9 million, or $0.14 per diluted share. GAAP net income of $6.8 million, or $0.13 per diluted share, and non-GAAP gross margins of 48.4%. Our non-GAAP operating income in Q1 was a record 14%, up from 10% last quarter, and is now approaching our target model of 16-18%.

In addition, we generated over $12 million in cash during Q1. As you can see, our financial results in Q1 were very strong. Let’s review our Q1 product and customer highlights, then Jack will take you through the numbers in greater detail and discuss guidance for Q2. Our core wireless LAN business continued to strengthen in Q1, driven by our growing family of high-performance, cost effective CMOS-based designs. Particular growth occurred in PC OEMs, through the broad adoption of our Single-Chip PCI and PCI Express products among existing customers and with one of our major new customers. Also, revenue from our low-cost 11g single-chip router and access point solutions continued to grow, despite the seasonal adjustment that typically occurs in retail during Q1.

Moreover, at 38% of our total wireless LAN revenue, shipments of our dual-band 11a/g solutions reached record levels in Q1. The strength of these dual-band solutions was due primarily to the rapid growth of our PC OEM segment. Moving forward, our expertise in both 5GHz and 2.4GHz bands will be a strategic advantage during the upcoming transition to the new 802.11n standard, and in driving that new standard into the mainstream of the wireless LAN industry. As you know in January, Atheros announced its XSPAN family of draft 802.11 wireless LAN solutions, and we demonstrated our unique triple-radio design at the Consumer Electronics Show in Las Vegas. Our first XSPAN chipsets couples the world’s only single-chip triple-radio RF design with our unique baseband architecture. Our baseband features Signal Sustain Technology, or SST, which optimizes connection reliability to achieve higher throughput at greater distances than previously possible. Our 11n solutions deliver roughly six times the throughput of legacy 11g and a/g products with significantly greater range.

We view 11N products as a key driver of revenue growth in 2006 and beyond, and we’re optimistic that our position in this exciting new market will be strong. Earlier this month, D-Link announced it has incorporated Atheros’s AR5008 draft 11n chipset into its first line of XSPAN-powered 11n routers and access points, dubbed the range booster. In addition to D-Link, we are shipping our XSPAN solutions in volume to a wide variety of other T1 customers, and we look forward to some of our other customers’ product announcements in the future. In addition to being the leader in new technologies such as 11n, our position in both the feature-rich and low-cost 11g products continues to strengthen. These 11g products, of course, make up the majority of our existing wireless LAN revenue. In 2004, we introduced the world’s first single-chip 11g client solutions in both standard and Super G flavors. These solutions continue to be our best selling products, and they saw healthy revenue growth in Q1. In late 2004, we introduced the world’s first single-chip 11g access point solution, supporting both standard and Super G configurations and they were quickly adopted by many of the leading retailers.

Over the past year, we’ve continued to invest heavily in highly integrated, single-chip solutions that have enabled our customers to drive greater volumes of product at lower price points to the consumer. In Q4 last year, we announced the AR5007AP-G, which features a complete 11g wireless access point system on a chip. This compact and cost-effective solution combines the wireless network processor, media access controller, baseband and all radio functions up to the antennae in a single chip, including an on-chip power amplifier, low noise amplifiers and an antennae switch. The design win momentum for this solution has been strong, and we began shipping this product in volume during the most recent quarter.

As I mentioned, the PC OEM business was particularly robust in Q1. Much of this success is due to the adoption of our PCI Express-based single-chip client solutions by major PC OEMS. Our highly-integrated, cost effective 11g and 11a/g solutions provide an industry-leading combination of performance and cost for PCI Express-based laptop solutions. During Q1, (IBM Linova?) began shipping the Atheros PCI Express-driven T and X Series ThinkPads. These models joined the Z Series ThinkPad which began shipping in Q4, featuring our PCI Express-based wireless LAN chip. Apple Computer also began shipping products based on our PCI Express single-chip solution in Q1. We continue to view the adoption of PCI Express wireless LAN by leading laptop manufacturers as a significant driver to our core wireless LAN business throughout 2006.

Revenue from our enterprise carrier segment was up again this quarter, in both actual dollars shipped and as a percentage of revenue. We continue to see the adoption of wireless LAN solutions in the workplace through enterprise-class solutions. In addition, Metro Wi-Fi rollouts continue to be strong throughout the world and the coupling of wireless LAN with carrier-based broadband solutions continues to expand rapidly. During Q1 we experienced especially strong growth from both Cisco and Siemens while a variety of other customers, such as 2Wire, 3Com, NECAT and Sagem continue to help drive the expansion of this product segment. New and existing customers in this space are developing innovative products based on Atheros silicon to help address the needs of this market. Atheros continues to be the wireless LAN vendor of choice for these customers, due to our flexible architecture, high performance and low cost.

We’re very pleased to announce today that we have entered into a definitive agreement to acquire ZyDAS Technology Corporation, a private Taiwan-based fabless IC design company, specializing in high performance wireless LAN USB solutions. This acquisition will create a rich set of opportunities in the wireless LAN USB market, and significantly increase our engineering capabilities in Hsinchu Science Park, an area that is physically close to many of our customers and offers a favourable cost structure. With the acquisition of ZyDAS, Atheros will greatly extend its development resources, forming its new Taiwan Research and Development Center. ZyDAS’ revenue base complements ours, since there is little overlap in customers. The ZyDAS value-oriented 11g and 11a/g products will be sold alongside our current Super G and a/g focused USB solutions. In addition, this team will focus on the development of new products, such as 11n USB, while also working on other wireless technologies that will be important to our future.

We’re excited to welcome more than 70 ZyDAS employees into the Atheros family. As you may recall, our first diversification efforts came in the form of our revolutionary single-chip cellular solution for the PAS market. Atheros’s AR1900 integrates a complete handset solution, including 1.9GHz transceiver, baseband, protocol control block, application processor, voice coder, analogue PAS, polyphonic ring tone generator, power management and LCD keypad and USB interfaces into a single piece of silicon. Our PAS products are optimized for both traditional handsets that utilize the public PAS networks, and home gateways that provide both PAS cordless phone and broadband functionality.

In the middle of last year, we began shipping the AR1900 chip to UTStarcom and since then we’ve experienced strong revenue growth in each consecutive quarter. In Q1, as anticipated, UTStarcom became a greater than 10% customer. They have designed their unique single-chip PAS solution into a portfolio of handsets with models ranging from the very inexpensive to the full featured. In addition, UTStarcom is now deploying PAS QBOX home gateways that provide both PAS cordless phone and broadband functionality. We expect UTStarcom to be a greater than 10% customer again in Q2.

Our second area of diversification relates to our embedded solutions for both mobile communications and consumer electronics devices. Our highly-integrated single-chip Radio-on-Chip for Mobile, or ROCm platform for mobile Wi-Fi applications, continues to gain momentum in nearly every major mobile market segment. During Q1, we announced our collaboration with QUALCOMM, which represents an exciting new opportunity for Atheros in the CDMA and 3G cellular handset markets. Our ROCm solution provides QUALCOMM’s mobile station modem chipsets with a new level of mobility for their customers. The combined solutions will enable dual-mode cellular devices to support 11g and 11a/g wireless LAN connections. Reference designs featuring this combined solution were showcased at multiple trade shows during the most recent quarter.

Atheros’s ROCm solutions offer cellular device OEMs and ODMs to benefit a significant time to market advantage delivered with this turnkey prepackaged high performance Wi-Fi solution. We’ve been working on a wide variety of design wins over the past few quarters, and we expect to ship ROCm products to some of our initial customers during Q2. This is another exciting diversification step for Atheros. We continue to view embedded wireless LAN as an important driver for our future revenue growth. The investments we have made to date have been significant and we expect to benefit from them over the upcoming quarters. Now, Jack will give you details on our Q1 numbers.

Jack Lazar, Chief Financial Officer, Vice President, Secretary

Thank you, Craig, and thanks to all of you for joining us today. First I’ll outline our financial results for Q1 ended March 31 2006, and then I’ll provide Q2 2006 guidance. Unless otherwise noted, all financial data in my remarks is on a pro forma basis and reflects the exclusion of non-cash stock-based compensation charges related to the adoption of FAS123R, the related cumulative effect of the change in accounting principle due to the adoption of FAS123R, and the income tax benefit related to the partial release of our tax valuation allowance.

In summary, our financial results for Q1 were very strong. Revenue, gross margins and net income all came in above the ranges we guided to in our last quarterly conference call. As a reminder, our Q1 guidance was for 7-12% revenue growth, gross margins between 45-46% and EPS of $0.11. Revenue for the quarter increased 15% and net income was $7.9 million, or $0.14 per share. Gross margins for the quarter were 48.4%, 240bps above the high end of our guidance and 340bps above the high end of our target model range. Q1 revenue was a record $61.1 million, up $8 million from $53.1 million recorded in Q4 2005. Q1 2006 revenue increased 48% compared with $41.2 million recorded in the prior year comparable quarter. The 15% sequential increase in revenue was driven by both the further expansion of our core wireless LAN business as well as our fourth consecutive quarter of growth for the PAS business.

Based on the product mix data for our third generation and later chipsets, the mix of wireless LAN chipsets was as follows: a/g multimode was 38% of the mix, compared to 34% in the previous quarter and 11g and the Super G MIMO chips were 62%, versus 66% in the previous quarter. Revenue related to our 11a/g products was particularly strong in Q1, and was primarily driven by the adoption of a/g solutions in an increasing number of our PC OEM customers products. The percentage breakown of revenue by market segment based on data supplied by our ODMS is as follows: retail was 35%, compared to 47% in Q4; PC OEM was 27% and that compares with 22% in the previous quarter, enterprise and carrier was 21%, compared to 21% in the previous quarter and consumer electronics and other was 17%, and that compares with 10% in the previous quarter.

The seasonal decline in our retail wireless LAN segment was more than offset by the strength of the PC OEM and enterprise and carrier segments. Consumer electronics was up over 100% sequentially in Q1, driven primarily by increased revenue related to our AR1900 PAS products. In Q1 we have four 10% or greater customers: Alpha Networks, Askey Computer, Hon-Hai Precision Industry and UTStarcom. Q1 gross margins were 48.4%, up 170bps from the 46.7% reported in Q4 and above our target range of 43-45%. Overall blended ASPs declined by 8% sequentially, to $6.35, compared with ASPs of $6.93 in Q4. Total chipsets shipped in Q1 were approximately 9.6 million, up 25% from the 7.7 million chipsets shipped in Q4 2005 and 105% higher than the corresponding number of chipsets shipped in Q1 2005. Total operating expenses were up $21.2 million, which represented an increase of 8% from Q4 and was at the high end of our 3-8% guidance.

R&D increased 10% sequentially due to both an increased number of tape outs and head count additions. As a percentage of revenue, R&D declined from 24% in Q4 to 23% in Q1. Operating income for the quarter was $8.3 million, up 62% from $5.1 million recorded in Q4 2005 and 476% greater than the $1.4 million recorded in the prior year comparable quarter. Operating income was 14% of revenue in the most recent quarter, and is now approaching our target operating model of 16-18%. Income taxes for Q1 were $2.2 million, representing a 22% pro forma tax rate. Pro forma income taxes exclude a $1.4 million non cash tax benefit resulting from the partial release of our deferred tax asset valuation allowance due to our achievement of profitability milestones in Q1.

Net income was $7.9 million or earnings of $0.14 per diluted share for the quarter, compared with net income of $5.9 million or earnings of $0.11 per diluted share in Q4. Average shares outstanding were 54.5 million in Q1, compared with 53.8 million in Q4. GAAP net income Q1 was $6.8 million, or earnings of $0.13 per diluted share. This compares with GAAP net income of $13.1 million or earnings of $0.24 per diluted share in Q4. Turning to the balance sheet, cash and marketable securities were a record $185.7 million at March 31. Total cash and marketable securities increased $12.1 million and during the quarter we generated $7.9 million in free cash flow from operations. DSOs based on our quarterly average receivables balance decreased to 45 days, versus 48 days in Q4, reflecting the more linear pattern of our shipments in Q1. Inventory terms for the quarter decreased to 5.1 times, compared with 5.5 times in Q4 as we built additional inventory to meet the Q2 order demand. Inventory terms continue to be within our target of 5-6 times.

The company continues to have virtually no debt. Total liabilities at the end of Q1 were $48.6 million and during Q1 2006 our capital expenditures and depreciation were approximately $1.2 million and $635,000 respectively. Our balance sheet continues to be very strong with 71% of our $260 million in total assets in the form of cash and marketable securities. As of March 31, we had 353 full time employees, compared with 327 at the end of Q4. Most of these additions were R&D personnel. I’ll now move on to our guidance for Q2. Q1 was our strongest quarter to date in terms of both revenue and net income. The strength of our product cycles offset the seasonal declines that are traditionally present in Q1. As we enter the new quarter, we anticipate a continued benefit from the strong product cycles. Accordingly, we currently anticipate Q2 revenue to increase 10-15% sequentially. We expect to expand both our wireless LAN and PAS revenue in Q2. Gross margins are expected to be in the range of 46.5-47.5% and once again above our target model range.

We will continue to invest in the people, product tape outs and infrastructure necessary to support our continued growth and entry into new markets. In Q2, we anticipate the following functional expense breakdowns: R&D, between $14.25-15.25 million and SG&A at $7.75-8.25 million. Total operating expenses are anticipated to increased between 4-10%. Our estimated pro forma tax rate for Q2 is approximately 25%. We anticipate our EPS range for Q2 to be $0.15-0.16 based on shares outstanding of approximately 56.5 million. Our Q2 guidance does not reflect the potential impact of completing the announced acquisition of ZyDAS. We anticipate closing this transaction in late Q2 and therefore it’s not anticipated to have a material impact on the quarter. Our Q1 results and our Q2 guidance reflect the strength of our business and the initial dividends from our diversification strategy. We will continue to invest in further diversification efforts that we believe will help position Atheros for ongoing success and increased shareholder value in 2006 and beyond. With that, let me hand it back over to Craig.

Craig Barratt

Thanks, Jack. Atheros continues to have three primary growth drivers in 2006. First, we anticipate owning a significant share of the overall PAS market, through the adoption of our cost-effective, feature-rich PAS solutions. Second, we anticipate continued growth in our core wireless LAN market, through market share gains in low-cost 11g products, the adoption of our PCI Express wireless LAN single-chip by new and existing customers and also from the introduction and adoption of our XSPAN 11n solutions by a wide variety of customers. Third, our embedded wireless LAN solutions will add incremental revenue to Atheros, with initial shipments in 2006, and their impact will be substantially greater in 2007. We are continuing development of products for as yet unannounced markets, that we expect to contribute to additional revenue growth in 2007. Our financial results for the most recent quarter and the guidance that Jack just provided reflect the impact of these growth drivers. We’re now ready for questions.

Questions and Answers

Operator

Operator Instructions. Our first question comes from Mark Edelstone with Morgan Stanley. Your line is open.

Q – Mark Edelstone, Morgan Stanley

Hey, guys, nice job on the quarter.

A – Craig Barratt

Thanks, Mark.

Q – Mark Edelstone, Morgan Stanley

Can you give us a little bit of additional insight into ZyDAS and obviously, this would really pertain to the second half of the year, but can you talk about their cost structure, in the context of how those 70 heads would compare to 70 heads at Atheros? And what type of revenue run rate is that company on today?

A – Jack Lazar

Mark, this is Jack. As far as ZyDAS and the cost structure, obviously one of the reasons – I mean, there were two primary reasons that the people in Taiwan were important to us. One was that they’re very close to a large portion of our customer base. Clearly the second is that it is a more cost-effective place to do some of our engineering. As far as the actual ratios, you’re looking at certainly, in the ballpark of probably maybe less than half. It’s significantly less. What I can tell you as far as revenue is at this point we’re really not going to break out the size of the business. We’ll start to incorporate it in our future guidance, but I would say that we paid in the standard multiples for this type of business.

Q – Mark Edelstone, Morgan Stanley

Which would be a couple of times sales? Or…

A – Jack Lazar

Yes. Maybe slightly less than that.

Q – Mark Edelstone, Morgan Stanley

OK, fair enough. Then can you just give us your sense on – obviously two of the important products here for you as you go through this year and through next, will be the 802.11 and also ROCm. Can you give us a sense as to what you think that ramp looks like here in the second half of this year and into the early part of next year?

A – Craig Barratt

Mark, this is Craig. In terms of actually quantifying the ramp we haven’t obviously given any guidance beyond 2Q, nor broken that down by individual products. I think if 11n is accepted well in the marketplace, there’s every chance that it could be perhaps 20-25% of the retail segment of wireless LAN by 4Q. 11n could enjoy significant growth through this year. As I mentioned in the call, of course, we are in volume shipments already, so this will be contributing revenue to us during the current quarter. With regard to ROCm, while we are beginning production shipments this quarter to some initial customers, really we think the opportunity here is certainly longer-term. The development cycle for these products tends to be long. We have a number of end products that will start shipping during this year, but I think this is a longer-term gain, so we expect significant growth in 2007 for our ROCm products, and it will be somewhat more modest in 2006. I think it’s more about design wins and launching products this year, and the volume will follow in 2007.

Q – Mark Edelstone, Morgan Stanley

Great. Just a last question, Craig, I don’t know if you have a sense as to what kind of market share you think is reasonable for you to have in US retail this year, based on the design wins you have and your knowledge of the market. But it you could take some type of swing at that, that’d be great.

A – Craig Barratt

Well, we think for low-end 11g, we think our market share is increasing. We have some pretty exciting new products that are launching this quarter using our low-cost 11g router, so we think we’re on a trajectory of increasing share in the 11g market. For 11n, obviously you’ve seen a flurry of press activity, but this battle is fought and won over really getting the volume business. I think that’s something that will take some time to play out. We have, obviously, a product with significant performance differentiation, and we think we can capture significant share there. It’s kind of ironic, this is a market where multiple players can have 50%, 60%, 70% market share. I think, we heard some claims last week of 75% share in 11n from a competitor. I would like to refer everyone to a press release , in fact the earnings release from Broadcom on January 27 2004, a little over two years ago, where they claimed 78% market share in 11g. That was a year after 11g started shipping. If that really turned out to be the case and if that market share was preserved, of course Atheros wouldn’t exist today. I think we certainly will enjoy a very, very strong position in 11n. It’s obviously important to us that our share in 11n matches or exceeds our share in the general market. This is a game that will take some time to play out.

Mark Edelstone, Morgan Stanley

Great. Thanks a lot, guys.

Operator

Our next question comes from Charlie Glavin with Needham & Company. Your line is open.

Q – Charlie Glavin, Needham & Company Inc.

Thanks, guys, and let me echo Mark. If you, just logistically, could give a little bit more of a breakdown between the cash and stock payment you paid for ZyDAS?

A – Jack Lazar

Yes, sure. Actually, the stock component is about 250,000 shares.

Q – Charlie Glavin, Needham & Company Inc.

Jack, and in terms of some of the thresholds that you’re looking for, are these going to be more revenue-based design wins, or revenue thresholds as far as something incremental, bonus on that, or are these going to be more design wins relative to ZyDAS?

A – Jack Lazar

They’re more revenue based.

Q – Charlie Glavin, Needham & Company Inc.

OK. And in terms of the USB side, given their expertise, any particular markets – certainly this is something that as far as embedding in USB and USB2 on the go is – and I believe it’s something that Broadcom’s still buying third party. Are you finding that there’s something that you could differentiate relative to customers, or is it something that more the embedded market OEMs were requiring in order to have you designed in?

A – Craig Barratt

In the vanilla wireless LAN market, there is quite an important segment for USB wireless LAN, especially carrier markets, fixed desktop, PC attachments and so on, so it’s a very interesting opportunity. But your observation is certainly correct. More and more portable devices will use USB technology in one flavor or another, and certainly we see that’s an important added element given the expertise there.

Q – Charlie Glavin, Needham & Company Inc.

And that would be something, Craig, if I understand, you guys would be the only ones to be able to combine both the integrated USB2 product along with the wireless LAN for embedded, correct?

A – Craig Barratt

Well no, a number of companies in the space do have USB solutions today, so I didn’t quite understand your point…

Q – Charlie Glavin, Needham & Company Inc.

As far as saying that as opposed to a third party integrated, this would be more the single-chip solution as opposed to a two or three-chip solution, that I believe others who have been incorporating USB were…

A – Craig Barratt

Well, certainly the USB interface is absolutely integrated into the wireless LAN chip, but I do believe a number of companies in this space have taken that architectural approach. Their first products were likely discreet, but many of them have actually integrated, but I wouldn’t characterize that particular capability as unique.

Q – Charlie Glavin, Needham & Company Inc.

Then last thing, in terms of the gross margins, you seem to be hedging off as far as actually raising your operating margin guidance. When you take a look at the current mix, particularly on the a/g solutions going to the PC OEM and then the rollout within the 11n and your disclaimer as far as the ebbs and flows on the market share, can we expect to see this sort of mix not only carry through with the a/g, but also carry over into the 11n and expect the margins to hold above your original target levels for a sustainable period?

A – Jack Lazar

As we said for the last couple of quarters now, I think it’s still a little too early to declare this a trend. I think that while we’re experiencing some nice gross margin expansion right now, there were a lot of things working in our favor this quarter too. I mean, the a/g mix was relatively high and that tends to have a better impact on our overall gross margin then, if it was lower. The other thing is that we’re actually expecting some pretty substantial growth in 11g in the upcoming quarter. I would suspect that a/g might not be at this high of a level in Q2 as far as the overall mix. Again, really what it gets down to is the overall mix of products and right now, the gross margin guidance that we gave really is just an indicator of what we’re seeing for the upcoming quarter.

Charlie Glavin, Needham & Company Inc.

Great, thanks, Jack, thanks, Craig.

Operator

Our next question comes from Arnab Chandra with Lehman Brothers. Your line’s open.

Q – Arnab Chandra, Lehman Brothers

Thank you. A couple of questions. I think everybody has 100% share in most markets right?

A – Craig Barratt

That’s especially true in this market, yes.

Q – Arnab Chandra, Lehman Brothers

Exactly. That’s always fun, but I wanted to address share a little differently. You said you’re getting share in g and maybe even a/g in the PC as well as retail market. Can you talk about what the genesis of that is? Is that less competition, you know, your integration and do you think that’s the sale as we go forward? And I have a couple of other questions.

A – Craig Barratt

I think it’s a combination of things. Certainly we do have differentiated products, we can not only deliver products with a very favorable price and of course a low-cost structure for us, but really with performance differentiation and feature differentiation, over time the cumulative effects allow us to increase our share. And that’s true of each of the segments you mentioned. The a/g area, I think, relates primarily to PCI Express in laptops. We see actually the desktop opportunity for wireless LANs, fixed desktop, to actually be a very exciting one later this year. In low-cost 11g, we think we have the lowest cost, most integrated router solution so that allows us to materially increase our share. So best products, and you know, I think favorable product cycles are helping us win share.

Q – Arnab Chandra, Lehman Brothers

Thanks. A question about PAS, if you look at the type of guidance you’re looking for, maybe your internal goals, what do you think your share in PAS is right now? And do you think – where could that be, I think you threw out a 50% number at some point, I don’t know whether I misunderstood that or not. Can you address that a little bit?

A – Jack Lazar

It’s difficult to say what our share is right now, because it’s obviously increasing as we move through each one of these quarters. I think the thing to focus on, what we’ve told folks is that we’d like to see – we’d love to be in a position this year where we could be 20-25% of the overall PAS market. So this is all the players in the market. If we could get to that spot in one year, I think we would declare that a success.

Q – Arnab Chandra, Lehman Brothers

Thanks. A question about your most exciting product name, ROCm. Who are you planning to rock in that market? Is it QUALCOMM related? Is it basically handsets, is it g versus b, if you could address that? Thank you.

A – Craig Barratt

It’s really a whole variety. There is, of course, the mobile segment which is mainly handset devices, dual-mode devices, and of course the mobile consumer market, things like digital cameras, game devices and so on. With regard to QUALCOMM, we are working together with QUALCOMM to deliver integrated reference designs to customers. That will happen basically this quarter, but the design in cycle for the handsets after that is, of course, six to nine months after that. The QUALCOMM relationship won’t product ROCm revenue until 2007, but we do see it’s a good way of scaling across multiple customers. So the products that will be introduced this year are ones that we have design wins from last year and have been working closely with. It’s basically a set of products in a whole variety of the segments that I mentioned.

Q – Arnab Chandra, Lehman Brothers

Then did you say it was g versus b?

A – Craig Barratt

All of our products are either g or a/g, so many of them are g products, some of them are dual-band a/g products. We, of course, don’t do the only products for any of our product families.

Arnab Chandra, Lehman Brothers

Thanks, Craig.

Craig Barratt

Thanks, Arnab.

Operator

Our next question comes from Adam Benjamin with Jefferies. Your line is open.

Q - Adam Benjamin, Jefferies & Co.

Thanks, guys, nice quarter. A couple of questions. First, on ZyDAS, just to follow up there, is that going to be accretive out of the box in Q3?

A – Jack Lazar

That’ll be kind of neutral to the year, Adam.

Q - Adam Benjamin, Jefferies & Co.

OK. Then what about 2007?

A – Jack Lazar

It’ll be accretive in 2007.

Q - Adam Benjamin, Jefferies & Co.

OK. With respect to gross margin in the quarter, obviously we saw a big jump up versus the prior quarter and versus your guidance. Can you kind of quantify it, Jack? You know, is it 50% due to a mix issue, or – kind of give us some way we can get a better handle on that?

A – Jack Lazar

Clearly at this point, we’re not in an environment where we’re seeing rapid decline in costs, so it’s obviously not driven from the actual decline in product costs. It’s more just mix related. As we’ve said over time, over the last couple of quarters, the PAS business is clearly ramping up right now, it’s kind of at or above the corporate gross margin model. That’s incremental to the overall business. Then of course the a/g mix was very strong this last quarter, which once again is typically the sign of stronger gross margin type products. In any particular quarter, it can be a wide variety of things, because we now have such a wide variety of products that we’re shipping. In this quarter, it happened to have lined up pretty nicely.

Q - Adam Benjamin, Jefferies & Co.

OK. With respect to the ASPs on the core wireless LAN business, you guys have been tracking about 5% ASP declines. Is that consistent in this quarter as well?

A – Jack Lazar

For this most recent quarter that we’ve just completed it was 8%. In the upcoming quarter, I would say that we wouldn’t expect it to be more than 8%.

Q - Adam Benjamin, Jefferies & Co.

On the PC OEM side, we saw some big strengths there, obviously coming from Apple, up over 40% sequentially. Do you expect the PC OEM side to grow sequentially again in Q2?

A – Jack Lazar

I don’t think we want to give that level of guidance out at this point. There’s a wide variety of things that really impact what products ship in the upcoming quarter. As we’ve been saying for a couple of quarters, the PC OEM business is a strong area for the company, as you know it does go in cycles at times and right now we happen to be experiencing a nice cycle up.

Q - Adam Benjamin, Jefferies & Co.

OK, last question. On the PAS side, did you ship to anyone outside UTStarcom in the quarter, or do you expect to ship in the June quarter?

A – Jack Lazar

We, to date, are completely focused on UTStarcom. We have been shipping products to them for this next quarter will be close to a year. Our primary goal is to make UTStarcom successful. As far as other customers in that space, I don’t think this would be the right time or place to comment on something like that.

Adam Benjamin, Jefferies & Co.

Great, thanks.

Operator

Operator instructions. Our next question comes from Jenny Hsu, with Thomas Weisel Partners. Your line is open.

Q – Jenny Hsu, Thomas Weisel Partners

Hi, just a quick question on what you’re seeing as supply chain rate. Are you seeing any sort of constraints, at either the back end or the front end?

A – Craig Barratt

I think it has been somewhat tight both front end and back end, that said we have very, very committed suppliers and so at this point we are comfortable with the supplier situation. The industry as a whole, definitely the technologies we’re using does seem to be quite tight, both front end and back end.

A – Jack Lazar

Yes, but I think if you look at our numbers that we just reported, you know, 5.1 times inventory turns, inventory was up in the most recent quarter. We’re trying to plan as carefully as possible to make sure that we have the right level of supply for our customers. So far it’s worked out pretty well, but there are a lot of variables in the chain.

Jenny Hsu, Thomas Weisel Partners

All right, thank you.

Craig Barratt

Thanks, Jenny.

Operator

I’ll now turn the call back over to Dr. Craig Barratt.

Craig Barratt

Thanks to all of you for joining us today, and a special thanks to all of our employees for their continued dedication and hard work. Q1 was a great quarter for Atheros, and we’re enthusiastic about Q2 and beyond. Over the next few months, we’ll be attending several investor conferences, including the Credit Suisse Global Semiconductor Conference on May 3rd in New York, the Lehman Brothers Wireless Conference, May 22nd & 23rd in New York, and the SG Cowen Annual Technology Conference, May 31st in New York. If any of you are interested in arranging a call or meeting, please contact Deborah Stapleton, our IR council, at deb@stapleton.com. We thank you for your interest in Atheros and we look forward to speaking to you along the way. Goodbye for now.

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Source: Atheros Communications Inc Q1 2006 Earnings Conference Call Transcript (ATHR)
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