創力 (LTRX) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen. Welcome to the first-quarter fiscal 2006 results conference call. My name is Beth, and I will be your coordinator for today. At this time, all participants are in listen-only mode. We will be conducting a question-and-answer session towards the end of this conference. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the presentation over to your host for today's call, Mr. Marc Nussbaum, CEO of Lantronix. Please proceed, sir.

Thank you very much, Operator. Good afternoon, everyone, and welcome to today's conference call. This is Marc Nussbaum, Chief Executive Officer of Lantronix. An archived webcast of this call will be available on the Company's website at www.Lantronix.com, beginning today at 7 PM Eastern Time and thereafter. There will also be an audio playback beginning today at 7 PM Eastern Time and running through 7 PM tomorrow, November 11. The number to call is 1-88 8-286-8010, and the pass code is 48715383. International callers should dial 001-617-801-6888 and use the same access code 48715383.

Last quarter, we had an audible static and transmission problem during the call. We have changed carriers. A few moments ago, we performed a two-way audio check before starting the conference to ensure audio quality. Feel free to interrupt or signal the operator if it appears our line has problems.

Before we begin, I would like to remind you that during the course of this conference call, we will be making forward-looking statements in our comments and in response to your questions concerning among other matters the business environment, market opportunities for Lantronix products and technology, cost savings from expense reductions, cash usage and cash breakeven, gross margins, financial performance, product development, new product introductions, engineering and design activities, manufacturing, flexibility, the stock market and shareholder value.

These forward-looking statements are based on Lantronix's current expectations and are subject to a number of risks and uncertainties. Actual results could differ material as a result of several factors. We encourage you to read the risk section in our report on Form 10-Q for the period ended September 30, 2005 and our other SEC filings for an understanding of the factors that may affect our business results or cause actual results to differ.

We undertake no obligation to update this webcast or any forward-looking statements to reflect new information or events or for any other reason. You should not assume later in the quarter that the comments we make today are still valid. That ends our housekeeping section, and we will now move on to business.

Joining me today are Jim Kerrigan, Chief Financial Officer; Bob Cross, Senior Vice President of R&D; David Shafer, Senior Vice President of Worldwide Sales, and John Warwick, Senior Vice President of Operations.

We're pleased with the results for our first fiscal quarter. And it is indicated in today's news release Lantronix delivered solid growth in top-line revenues and in fact record growth in our device networking product lines.

We delivered a second consecutive quarter of cash positive results with a cash balance at the end of September of $6.9 million. The Company also moved closer to profitability with a net loss of $0.02 per share for fiscal Q1 compared to a net loss of $0.06 per share for the same period 1 year ago.

For a while now, we have been executing a strategy to increase exposure in the machine-to-machine device networking and data center markets, while simultaneously transitioning our product mix away from no growth product lines.

During the quarter, this strategy delivered real results. Our mix shifted significantly to high-growth products like XPort, and this allowed unit volume to drive revenues more effectively than at any other time in the past 3 years. Overall revenues increased by 11% year over year consistent with achieving our previously-issued annual guidance. This is a gratifying result. especially since sales in the summer quarter are typically slower than the rest of the year due to seasonality.

September quarter results were driven by our device networking products, which grew by a record 33% year over year or $2 million. This was offset by a decrease of $300,000 in IT management, a decline of about $500,000 in non-core products.

Over the last four quarters, revenues from device networking increased an average of 18% compared to the same periods last year. This is significantly ahead of the Company's largest competitors' organic growth, and we believe it validates our approach to addressing the market. This past quarter, device networking represented 67% of our total revenues, up from 56% in the same period a year ago. We're now shipping more XPorts, device servers, and network chips than at any time in the Company's history.

Device networking unit shipments in the September quarter was stellar, up approximately 70% over the same period last year. This compares to an average unit growth rate of about 44% for the full year of fiscal 2005.

With strong year-over-year results for the quarter, we're off to a good start for the fiscal year. I believe the Company's performance this past period reflects the reality of the market opportunity we have been evangelizing in that Lantronix is now effectively translating this opportunity into financial results.

As discussed on our last conference call, we estimate that the size of the target market for Lantronix device networking products is about $12 billion today. We estimate only about 2% of these target devices are currently attached to the network, which is only the beginning of what should become a long-term mega trend within the data management and networking industry segments.

Now, I would like to turn the call over to Jim, who will review our financial results. Jim?

Thank you, Marc, and good afternoon to everyone. As we discussed in our news release today, for the first quarter of fiscal 2006, Lantronix recorded revenues of $12.2 million and a net loss of 1.3 million or $0.02 per share compared with revenues of $11 million and a net loss of 3.6 million or $0.06 per share for the same period last year.

With respect to the sources of revenues, approximately 8.3 million came from our device networking category, 2.6 million came from the IT management category, and 1.2 million from non-core or other product lines. A year earlier in fiscal 2005, 6.2 million came from device networking, 3.1 million came from IT management and 1.7 million came from non-core product lines. Sales in the Americas accounted for 67% of revenues, and international sales were 33% of revenues.

Our GAAP gross margin for the quarter ended September 30, 2005 was 50.0% compared to 50.3% for the quarter ended September 30, 2004. Operating expenses for the September 2005 quarter were on target at 7.4 million compared with 9.1 million for the September 2004 quarter. Note that these expenses for the September 2005 quarter include additional compensation expense for stock options as required by new accounting rules. We're doing well at managing our operating expense to approximately $7 million model for cash expenses. Of course, operating expenses vary every quarter for one reason one reason or another because of billing differences.

For example, in addition to the share base compensation charge we include now, we changed our recognition for accounting fees. And the audit fees for our fiscal 2005 year were paid primarily in the September quarter. Many expenses are not incurred on a level basis by quarter.

SG&A expenses for the quarter, including some of the new expenses just mentioned, were 6.1 million. This compared to 6.9 million for the same period 1 year ago. R&D expenses were 1.4 million for the quarter compared to 2.3 million a year earlier.

Total share base compensation for the quarter totaled $239,000 or less than $0.005 per share. For Q2, we expect share base compensation to be in the same general range. This impact is relatively small compared to many other companies.

This new share-based compensation accounting method went into effect July 1, and we're one of the first companies to adopt this format. As such, we have new financial disclosure regarding this category of expense. And this will be included in Note 9 of the notes to the financial statements in our 10-Q for the September quarter.

In our financial statements, you will note that share-based compensation is now broken out as separate line items as part of cost of revenues, as part of SG&A expenses, and again a separate charge associated with research and development. When we speak of $239,000, that's the total for all three categories of that expense. For us, the amounts currently involved don't impact our statements much, and we will not talk about this charge regularly going forward.

Our balance sheet remains strong with reasonable balances in our accounts receivable, payable and the inventory accounts. Net inventories were $6.2 million compared to $6.8 million a year earlier. Accounts receivable balances showed DSOs of about 20 days, an improvement from 22 days last quarter.

We ended the September quarter with $6.9 million in cash, cash equivalents and marketable securities -- a positive gain of approximately $170,000 from the June quarter when we reported 6.8 million. In our published cash flow statement, we show net positive cash provided by operating activities of $110,000 for the quarter compared to a loss of $2.4 million a year earlier.

It is evident that Lantronix delivered improved financial results this past quarter on almost all fronts. We anticipate a financially healthy fiscal 2006 as our target markets continue to grow.

Now I will turn the call back to Marc.

Thank you very much, Jim. Last year, shipments of our new products ramped very nicely. However, the Company's financial results were dominated by the large amount of sales from our slow or negative growth product lines. Looking at the business today, new product lines count for 61% of our total revenues in the first quarter, a significant increase from 49% in the first quarter fiscal 2005 and 38% in the same period of fiscal 2004.

These new products are delivering healthy double-digit growth. As a result of this mix change, we did a much better job this past quarter. In fact, almost twice as good of job of converting unit growth into revenues compared to last fiscal year. We expect this mix shift to continue throughout the year with resulting improvement helping to drive even higher gains of revenue for each incremental unit shipped.

The Company's core growth engine continues to be the device networking business. As I mentioned, unit shipments were up over 70%, and revenues were up 33% year over year. Combined XPort and WiPort offerings delivered even more impressive performance with unit shipments up over 200% or about three times as many units shipped this past quarter than the same period last year. This 200% increase in units drove XPort and WiPort revenues up by over 170% from a year ago. This product family is a powerful growth engine within the business and is a scale to the point that is now having a substantial positive impact on the top line. Today, XPort and WiPort account for approximately 20% of our total Company revenues, up from only 9% a year ago.

Someone pointed out to me the other day that the Lantronix device networking business could be viewed in isolation as a stand-alone entity, delivering $33 million a year in revenues on a run rate basis with a demonstrated average growth rate of 18% addressing a $12 billion potential market that is 98% underserved with the potential for significantly accelerated adoption rates in the future.

Going forward, the Company's financial results should benefit from several factors. One, the device networking business should continue to grow, becoming an even larger percentage of total revenues. Two, the negative impact of our non-core lines will continue to diminish. Three, slow or stagnant sales of older products within the core lines of device networking and IT management will complete their lifecycle. Four, while we were disappointed with IT management revenues in the quarter, the mix of products in this category should continue to shift and we eventually expect an improvement within IT management similar to what we have experienced in device networking. Growth in our IT management datacenter products should at least offset the declines in other IT management product lines and begin to drive incremental revenue in the next few quarters.

The M2M market is expected to accelerate to higher growth rates over the next several years. Last quarter, I discussed additional S-Shape technology adoption curve and observed that historic adoption levels were sometimes useful indicators of future growth. Device networking may follow a pattern similar to those of other networking revolutions, such as the spread of corporate LANs, the build-out of the Internet infrastructure, the adoption of storage area networks, and the spread of wireless technology.

Today, we're reconfirming our guidance for full-year revenue growth in fiscal 2006 of 10 to 15%. We also expect to continue generating cash each quarter and believe profitability is possible later in the fiscal year.

In establishing this revenue growth range, we considered -- one, that the market will accelerate over 3-year horizon; two, that Lantronix year-over-year growth was likely to accelerate as the year progressed; and three, that total Company performance will reflect a blended mix of the different growth rates in each of our product segments.

Our 10 to 15% range for total Company annual growth is driven by an outlook of about 14 to 19% growth in our core products, offset by a decline of about 4% as a result of our small but rapidly declining non-core lines. As a reference, our year-over-year growth in core revenues fiscal Q1 was 18% consistent with this model.

At a recent technology conference, Bill Joy, former founder and Chief Categral (ph) Officer of Sun Microsystems, talked about four major mega trends that are driving the build-out of the next stage of the Internet -- personalization, real-time interactivity, rich data types, and machine connectivity.

Machine connectivity of course is the primary target of our device networking strategy. As this mega trend accelerates, we believe it is reasonable for Lantronix to move towards achieving growth rates north of 20% as the Company continues to benefit from both market adoption and improvements in product mix. Again, the device connectivity market is just beginning and should provide a diverse and rapid growth opportunity over the next several years.

Now before I open the call for questions, I'll provide a brief update on our Investor Relations activities. First, this last quarter, coverage was initiated on Lantronix by two equity research firms. Second, our winter schedule includes presentations of Lantronix's story on the East Coast starting next week and also at the Needham Growth Conference this January in New York. We are also planning a West Coast roadshow for mid-January timeframe.

Finally, we are in the process of transitioning to a new IR firm, the Piacente Group, as part of an effort to expand our activities in this area over the next several months. To schedule time or to recommend other investors that might be interested in Lantronix, please contact myself, Jim Kerrigan, or Brandi Piacente. Brandi can be reached at 212-481-2050. Both Jim and I make it a point to be readily available for investor inquiries, so please don't hesitate to contact us or send others our way.

With that, I'll open up the call to question. Operator, you may have the phone.

(OPERATOR INSTRUCTIONS). Evan Curts (ph), Hudson Square Research.

Just a quick question -- a couple actually. One, any updates on the SEC investigation?

There isn't much of an update I can give you at this point in time. As an investigation, we're not really allowed to talk much about it. But things progress and discussions continue.

On the IT management side, you released a new product this quarter, the SecureLinx SLM. Do you think that may have pushed some of the revenue from Q1 to Q2 if people were holding off on purchases because of that?

I don't think so. The impact due to the SLM product, which is our SecureLinx Management Appliance, we will see happen over the next several years as that SLM Appliance allows us to address the needs of even larger datacenters than we have been addressing. So it will represent incremental revenue, and it allows us to get into some accounts where we had to have a management appliance like that in order to compete effectively. But I don't think it affects any kind of shifts from the immediate quarters.

I'd like to interrupt a little bit. When I read the breakout of revenues for this past quarter, I gave an incorrect number. I read 2.6 million from IT management, and it was actually 2.8 million. I just want to make that correction. That press release is correct.

J.D. Kritzna (ph), Steelhead Partners.

I was wondering if you guys could give some color on your revenue breakdown kind of between the OEM segment and the VAR and maybe just talk a little bit about what the margin differential is between those two areas?

First on a margin basis, the margins are very similar across all of our products interestingly enough, even whether they are OEM or VAR related. The OEM products tend to be things like our XPort and WiPort in the embedded side of the business. And we don't really have a breakdown I can give you between those segments. But a rough idea would probably be on the order of I'm going to say -- on the order of about 70 or 75% being on the VAR side and the rest being OEM.

So we have a very healthy VAR or branded product line or serious product lines that we address. And that's why getting to all of our resellers with our marketing programs is a critical component of our marketing strategy.

A follow-up question, I was just wondering what you guys are seeing on pricing. And that's obviously a result of competition. I was wondering what the competitive landscape looks like at this point. Are any of the larger players like a Cisco or someone like that getting into this niche -- what's a niche right now?

We don't see a tremendous amount of pressure on pricing across the portfolio of products that we offer. Things have been pretty stable. My definition of that is on the order of less than 10% on any given product on an annual basis.

I think what's important is I expect that there will be over time pricing pressure on our higher volume products as volume does in fact ramp and demand builds in the industry. At the same time, we expect to be able to drive costs in parallel with that. We are very early in the learning curve on the manufacturing side of these products. So I would expect that we're able to offset price declines with cost reductions and maintain margins pretty much as we go forward.

By that, you are implying that you have deals structured with your EMS company that provides for cost reduction as volume ramps?

I would not say that it is a prearranged deal, but the reality is that as we ramp volume, all of the components that we buy and our contract manufacturing relationships will allow for flexibility in driving prices down.

Going forward, what would you guys say is your products' biggest competitive advantage vis-à-vis other products out there?

Our strategy is to deliver total solutions. So when you buy a products from Lantronix, you get all the pieces necessary to implement a communication solution then connect up to the network. Whereas most of our competitors are selling what I would call a bag of parts. You buy a chip from one person; firmware from another person; another an IP stack, which is another piece of firmware from another person; connectors.

So the advantage of working with Lantronix is we can get our customers to market much quicker and often can get them at better price because I'm buying these things in bulk volume and pass a lot of that cost advantages through to our customers.

Jeb Besser, Manchester Management.

First of all, congratulations. This is by far the most cogent and exciting release that you guys have put out to date. And I think we look forward to a lot more like it.

As far as the XPort and WiPort revenues, I know device networking was 7.9 million in the last quarter if I'm not mistaken? What--?

8.3 million.

8.3 in fiscal Q1.

Correct.

But in fiscal Q4, what was it? I'm just wondering what the sequential growth was in the XPort and WiPort lines? Because we don't have -- I do not think we have -- I do not see that number in the release. I'm just curious -- interested to start tracking how much this is accelerating. I mean in absolute dollar terms, clearly it's going very well.

Right. It went from 7.9 to 8.3, so about a 5% growth sequentially.

Right, in the overall device networking. But what about WiPort/XPort?

We have not broken that out separately yet. The product sales are way too lumpy to look in an individual quarter and expect sequential growth. I think we have to look out on a year-over-year basis or at least look at it from multiple quarters on a four-quarter basis.

But we recognize -- to clarify -- we recognize revenue on sell-through. So when our distributors sell it to their customer, we recognize on point-of-sale reports. So again, one order for a couple $100,000 could easily move this segment as it crosses a boundary at the end of the quarter.

Evan Curts, Hudson Square Research.

One more question for you guys. Yesterday, you announced a co-marketing partnership with ACCA Networks in Japan. I was wondering if you can maybe provide a little color about what that relationship means for you. And if that is something -- an avenue you are pursuing with service providers and the telecom providers in the US as well?

There's a number of -- what was unique about the particular opportunity and arrangement was it was one of the first times that we dealt with a carrier directly that is going to leverage their existing infrastructure and has recognized the relationship -- the value of the relationship with Lantronix to help them get their network converted over. Because of their position in Japan as a major DSL provider, with all of their both some -- a lot of commercial and industrial customers, we think it is going to be a great advantage for us and outlook for us over time.

With regard to other kinds of opportunities like that, there are other things like that out there. A number of the carriers are starting to wake up to the opportunity in M2M for existing traffic. Although, it's much more aggressively happening I believe both in Japan and also in Europe to a large extent. I think the carriers here in the US have been a little slow to adopt.

Brian Cullowich (ph), WestPark Capital.

Fairly new to the Company and space, so I'm wondering if you could maybe give me a little help in the way you are segmenting your revenue in terms of core growth products and non-core products. Help me understand which products you put into each category, please?

Sure, my pleasure, Brian. The core products consist of two major subcategories. One is the device networking products and the other one is the IT management products. If we go back in history to about 3 years ago, we made a decision to focus on those two pieces of business, those two markets. We continue to invest R&D in those two areas, and we believe those are both growth opportunities for us. To clarify further within the device networking piece of that core business, we do both embedded products as well as external products to put devices on the network.

Our non-core products consist of about four or five miscellaneous categories of things like visualization, print servers, serial I/O boards, things like that we have chosen not to invest in -- in fact, have not invested in at all really over the last 3 years. But they are very profitable product lines, well north of 50% margin on any one of them. So we continue to sell them, but we don't invest in them on an R&D basis for the future.

What is the approximate revenue mix between what your calling core and non-core at this point?

Non-core is about 10%.

10%?

Correct. And 90% obviously for the core.

So your expectation is that 90% of the revenue is going to grow somewhere mid-to-high teens over the next year?

That is correct.

A clarification on your comments on pricing. Mentioned that there wasn't any significant pressure on pricing in response to a previous question. But I'm confused by the obvious significant increase in unit volume, which is pretty substantially higher than the revenue in those areas. Can you help me understand it; how that's not reflective of pricing pressure?

Yes, it is a very important part of the story, Brian; I am glad you asked that. What the Company has been going through the last several years -- when I got here, we had some fantastic customers, great position with those customers. And they were buying product from us that had an average selling price of let's say around $200 for argument's sake -- 100 to $200.

Those customers over the last couple of years transitioned away from that product to our lower-priced, newer technology products like XPort. We introduced XPort to be a disruptive influence in the market at a new price point. In doing so, of course, we got a lot of new customers. But we also then had our older customers transitioning to this lower-priced product. There's a term for that probably referred to as eating your own children, I believe.

And we did that again on purpose. It was a good strategy for us because it really opened the market and established our position in the embedded space. So what the Company has been dealing with the last couple of years is that transition. As we completed the conversion of existing customers to these lower-priced products, we no longer had the influence of the selling price to those old customers coming down dramatically, and that then allowed us to improve our revenue per unit of incremental shipment.

Okay, I understand how a shift would cannibalize some of your revenue base. One more question if you will allow me. Do you have a feeling for what percentage of the customers you retain as they switch from an external networking solution to a more embedded solution?

I couldn't quote you an exact number on that. But Brian, we've got a very good track record of that. Most of the customers we're dealing with today in the industry have been with us for a very long time. The Company does a very good job of retaining its customers as we transition.

Marc, I appreciate the time and look forward to following up with you offline.

Bill Kitchell (ph), Mill Lace (ph).

Actually the prior question addressed some of my questions -- dramatic unit growth there in WiPort in the quarter. I wonder if you could flush out sort of penetration of VAR's penetration of opportunities. Any kind of more color you can provide that would give us a sense as to the rate of adoption at VARs or customers directly.

In specifically with the device networking products for the embedded or--?

Yes, with the XPort and WiPort products.

Sure. Some people measure this based on the number of design wins they have had. And what we have found in the past is that design wins can be very misleading. We look at a -- as the equivalent version of that for Lantronix, which is the number of kits that are ordered every quarter, which are basically evaluation kits. Over the last year, we shipped roughly about 1,000 evaluation kits for the XPort. And probably a third to maybe half that kind of range for the WiPort, the wireless version of the product.

Last quarter, we continued to ship well over -- somewhere over 200 units in that period. So the shipment rate of our valuation kits has remained pretty constant over the last year.

In Digi's most recent quarter, they had some good results in some of this networking side and have a fairly bullish tone on this business. Do you think we are nearing an inflection point, where there is going to be broader adoption? Or where do you think we are in the learning curve?

It is hard to pinpoint when that inflection point is actually going to occur. But the model that I have been talking and we think informs is that technology adoption -- when adoption reaches somewhere between 3 and 10% -- that is where between 3 and 10% of technology target users actually are using a product -- there tends to be a rapid acceleration. This is born through with a lot of different technology adoptions; there's been books written about this.

Today, we estimate that we are somewhere around 2% adopted. So the 3% adoption point will happen sometime. The next 9 months or so, we should hit the 3% point. At some point obviously thereafter that, we'll hit the 10% point. So we are getting close, but I couldn't tell you it is going to happen -- which quarter it is going to happen in. But certainly sometime over the next couple of years, we're going to see that inflection point hit.

Going to the IT management business, you have talked about the mix should improve. Could you expand on that a little bit and your visibility to that mix improvement?

Sure. The datacenter products today within the IT management segment represents about one-third of the revenues of the IT management business. That grew over this past fiscal year that was just completed about 10% compared to the year prior. So if you look at our internal models, you would see that we obviously predict that to continue to grow. We predict the other piece of the business to decline, not as rapid a rate, and there will start to be a crossover point.

Frankly, I don't expect there to be huge growth numbers coming out of IT management out of Lantronix over the next year. But I do expect some small growth on a quarterly basis -- year-over-year basis I should say, starting sometime in the next couple quarters.

So it's very similar to what we've just been through in device networking. At some point, the Company will definitely see -- I would assume we are going to start to see significant contribution from that mix change, even within the IT management business.

Jim, terrific job on operating expenses. Where are we on a run rate going forward? As we start to grow, how should we be thinking about operating expenses?

Well, as we indicated, our current model is about 7 million in cash expenses, and we think we're right on track with that. If you look back over the past several quarters, we have been under this quarter. We are right there or maybe a little bit favorable.

I think we are in good control. On a non-cash charge basis, we've absorbed this share-based compensation accounting and it's not a big impact. I think right now, we don't anticipate any big changes going forward right now.

(OPERATOR INSTRUCTIONS). Winder Hughes, Hughes Capital.

A couple questions. The first one for Jim. With the legacy business, Jim, I wonder if there's an argument for you guys to just have a reserve, write it off and have it basically as a discontinued business. That way, when you start reporting the total top-line numbers, that segment does not mask growth rate that is happening kind of everywhere else. Because if you did have it out of the books this quarter, then the business would have gone like from 9 million to like $11.1 million. So is there an argument for (technical difficulty) written off altogether and just have the discontinued business?

We have actually -- I won't say -- we have investigated this from the standpoint of alternatives -- as well as looking at alternates. First of all, the non-core business still represents a value to the Company from the standpoint of the gross contribution it provides every quarter. Obviously, it is going down. At some future point, it will go away.

From an accounting standpoint, the technical rules regarding what can be classified as a discontinued operation -- there are technical rules that require basically that a segment that's discontinued be accounted for and operated as a separate unit of a business. That is, it is operated separately by perhaps even separate management, separate P&Ls, allocated expenses and so on. And we have not broken out any of our components of our revenues into segments that would allow that classification right now.

We were able to do it with Premise when we sold off Premise because that was an acquired company that we did account for separately. So that was the last thing that we had as a discontinued operation.

Unfortunately, the accounting rules don't allow us to do what you suggested is what it comes down to. One thing I could add though -- based on the decline rate that we've got in the business, which we continue to project going forward, this time next year I would expect that the non-core is down under 5% of our total revenues. So it is rapidly becoming irrelevant.

With the previous question about the operating expenses, there has been some talk from you all that your business could go from the $50 million rate to 90 to say 100 million without much increase in OpEx. I think that is what the previous caller was really asking.

So what would be the relationship for each new dollar of revenue that you get from this point whereby OpEx would go up a number whereby it is flat until it hits $90 million and then it grows 10% on (technical difficulty) the additent (ph) numbers there?

We have talked a little bit about this before on previous conference calls. We believe that we're at a situation today where we can about double the revenues of the Company without a significant increase in our operating expenses. However, we will actually as we start to grow, I will put some more money back in the business, particularly in the research and development area.

So if you look at the structure of the organization that we've put in place, we go through resellers and selling partners out there, where we do have some incremental expense obviously in commissions as we sell. But I don't have to hire additional salespeople to grow the business where we are that coverage on regions, etc. I also don't need any kind of manufacturing or significant capital investment to scale the business, generally, because again I am going through contract manufacturers.

So it really comes down to engineering. At this point in time, I don't want to commit a number to it. But certainly, as we started to -- as we were on the other side of profitability and we start to grow some significant numbers, we are putting some of the money back into engineering. But there will still be a significant improvement that we expect -- a dramatic improvement, frankly, in net returns. So I would now expect that we take our expenses up to the point that we wouldn't have significant improvement in net profit.

Last question -- which industries and which geographies have you all been seeing the largest amount of either design wins -- if that's not the right word -- or like evaluation kits that are using this technology for their very first time? Where do you find how the pregnant industries in the pregnant parts of the world?

We've talked a lot before about the verticals. And we have identified security --

But I'm talking brand -- if the market right now is like 3% penetrated -- or is it less than that -- it's going to require new industries, right? So where do you see new stuff where they are networking, where they have never done it in the past?

Well, geographically, let me go there first. Adoption is globally spread. But we see a lot of adoption rapidly happening in Europe. Probably our biggest growth segment has been Europe, followed by the Americas and also Japan being very rapid as well, a lot less in Southeast Asia or other parts. So I think that's got to do with the cost of energy and some of the other things that drive adoption.

On the vertical front, we're seeing a lot of adoption recently in the medical space. I think that that's going to be a huge growth market for the Company. And there's a lot of compelling reasons for why medical applications either hospital-based, home-based, other types of medical equipment in doctor offices are all going to wind up eventually being on the network. So entire classes of products are going there.

The other thing that is emerging recently we are seeing is the telematics space. This is the area, where you have got moving vehicles. And that's got to do with a drive in wireless technology in both cellular-based as well as local area network based technology is finding its way into those applications. So that's a recently -- recent activity there has been very promising for us.

We continue to focus on point-of-sale applications, security applications, industrial automation. All of those continue to be hot beds. I think over the next year or so, we are probably going to gain more revenue volume shipping into existing verticals, where adoptions already happened over the last couple of years -- things like security and point-of-sale industrial automation -- than necessarily the other ones that are just starting now. Because again, it takes a couple of years for them to really gestate and move their products into high volume when they are new to a technology like this.

There are no further questions in queue. Marc, please proceed to closing remarks.

Thank you very much, Operator. Thank you, everybody, for being on the call today. Jim and I look forward to reporting to you on our results in the second quarter of fiscal 2006 and early February. Thank you very much for being here. Appreciate your attention. Have a great night. Bye-bye.

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.