DATA I/O CORP - Quarter Report: 2006 September (Form 10-Q)

Commission File No. 0-10394

(425) 881-6444

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes   X No      

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

DATA I/O CORPORATION

FORM 10-Q

For the Quarter Ended September 30, 2006

INDEX

Part II - Other Information

PART I - FINANCIAL INFORMATION

DATA I/O CORPORATION

CONSOLIDATED BALANCE SHEETS

See accompanying notes to consolidated financial statements.

DATA I/O CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

See accompanying notes to consolidated financial statements.

CONSOLIDATED STATEMENTS OF CASH FLOWS

DATA I/O CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(UNAUDITED)

NOTE 1 - FINANCIAL STATEMENT PREPARATION

Data I/O prepared the financial statements as of September 30, 2006 and September 30, 2005, according to the rules and regulations of the Securities and Exchange Commission ("SEC"). These statements are unaudited but, in the opinion of management, include all adjustments (consisting of normal recurring adjustments and accruals) necessary to present fairly the results for the periods presented. The balance sheet at December 31, 2005 has been derived from the audited financial statements at that date. We have condensed or omitted certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America according to such SEC rules and regulations. Operating results for the nine months ended September 30, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. These financial statements should be read in conjunction with the annual audited financial statements and the accompanying notes included in the Company's Form 10-K for the year ended December 31, 2005.

Stock-Based Compensation Expense

On January 1, 2006, the Company adopted Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123(R)”) which requires the measurement and recognition of compensation expense for all share-based payment awards, including employee stock options and employee stock purchases, based on estimated fair values. SFAS 123(R) supersedes the Company’s previous accounting under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”) for periods beginning in fiscal 2006. In March 2005, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 107 (“SAB 107”) relating to SFAS 123(R). The Company has applied the provisions of SAB 107 in its adoption of SFAS 123(R). The Company adopted SFAS 123(R) using the modified prospective method, which requires the application of the accounting standard as of January 1, 2006, the first day of the Company’s fiscal year 2006. The Company’s Consolidated Financial Statements as of and for the three and nine months ended September 30, 2006 reflect the effect of SFAS 123(R). The total net stock-based compensation amount for the three and nine months ended September 30, 2006 was $88,000 and $283,000, respectively.

NOTE 2 - RECLASSIFICATIONS

Certain prior period balances may have been reclassified to conform to the presentation used in the current period.

NOTE 3 - INVENTORIES

Inventories consisted of the following components (in thousands):

NOTE 4 – PROPERTY AND EQUIPMENT, NET

Property and equipment consisted of the following components (in thousands):

NOTE 5 – BUSINESS RESTRUCTURING

During 2005, we took restructuring related charges of $96,000 primarily related to severance and completing actions that had been started in the second half of 2004. This aligned management operations with the changes made in 2004 to control costs in North America and Europe and the need to build staff serving China and Eastern Europe. At December 31, 2005, $33,000 remained as accrued but unpaid restructure charges, which were completed and fully paid out during the first three quarters of 2006.

During the third quarter of 2006, as part of our additional effort to reduce expenses, we incurred a restructuring charge of approximately $152,000, with all but $23,000 paid out during the quarter. The restructuring charge is primarily related to severance charges incurred at our Redmond, Germany and China offices. In view of our declining margins and operating results during the first and second quarters of 2006, actions were taken to reduce expenses and improve margins. The remaining unpaid restructure charge is expected to be paid out in the fourth quarter of 2006.

NOTE 6 – OTHER ACCRUED LIABILITIES

Other accrued liabilities consisted of the following components (in thousands):

The changes in Data I/O’s product warranty liability are as follows (in thousands):

NOTE 7 – LONG-TERM DEBT

On September 27, 2006, the company entered into a five year capital lease agreement in the amount of $591,145. The lease was used to fund new equipment and installation associated with our move to the new facility in July of 2006. The interest rate is 7.69%. As of September 30, 2006, no repayments of principle have been made.

Scheduled maturities of the capital lease obligation for the years ending December 31 are as follows (in thousands):

NOTE 8 - EARNINGS (LOSS) PER SHARE

Basic earnings (loss) per share is calculated based on the weighted average number of common shares outstanding during each period. Diluted earnings per share is calculated based on these same weighted average shares outstanding plus the effect of potential shares issuable upon assumed exercise of stock options based on the treasury stock method. Potential shares issuable upon the exercise of stock options are excluded from the calculation of diluted earnings per share to the extent their effect would be antidilutive.

The following table sets forth the computation of basic and diluted earnings per share (in thousands, except per share data):

The computation for the three months and nine months ended September 30, 2006 excludes 665,341 and 1,155,261 options, respectively, as these are considered antidilutive. The computation for the three and nine months ended September 30, 2005 excluded 741,534 and 437,016 options, respectively, to purchase common stock as these options were antidilutive.

NOTE 9 – SHARE-BASED COMPENSATION

Effective January 1, 2006, the Company adopted the provisions of SFAS No. 123(R) which requires the measurement and recognition of compensation expense for all share-based payment awards made to our employees and directors including employee stock options, stock awards and employee stock purchases made under our Employee Stock Purchase Plan (“ESPP”). Data I/O previously applied the provisions of APB No. 25 and related Interpretations and provided the required pro forma disclosures under SFAS No. 123(R), “Accounting for Stock-Based Compensation.” The following table illustrates the effect on net income and net income per common share for the three and nine months ended September 30, 2005. No share-based compensation expense was reflected in our results of operations for the three and nine month period ended September 30, 2005 as all options were granted with an exercise price equal to the market value of the underlying common stock on the date of grant. Additionally, option forfeitures were accounted for as they occurred.

Data I/O’s pro forma information follows (in thousands, except per share data):

Data I/O adopted SFAS No. 123(R) using the modified prospective method beginning January 1, 2006. Accordingly, during the three and nine month period ended September 30, 2006, we recorded share-based compensation expense for awards granted prior to but not yet vested as of January 1, 2006 as if the fair value method required for pro forma disclosure under SFAS No. 123(R) were in effect for expense recognition purposes adjusted for estimated forfeitures. For share-based awards granted after January 1, 2006, we have recognized compensation expense based on the estimated grant date fair value method required under SFAS No. 123(R). For these awards we have recognized compensation expense using a straight-line amortization method and reduced for estimated forfeitures. The impact on our results of operations of recording share-based compensation for the three and nine month period ended September 30, 2006 was as follows (in thousands):

Approximately $1,500 and $4,500 of share-based compensation was capitalized within inventory for the three and nine months ended September 30, 2006, respectively.

At September 30, 2006, there were 1,677,600 shares of Common Stock reserved for issuance under Data I/O’s employee stock option plans with 522,339 shares available for grant. Pursuant to the stock option plans, options are granted to our officers and key employees with exercise prices equal to the fair market value of the Common Stock at the date of grant and generally vest over four years. Options granted under the plans generally have a maximum term of six years from the date of grant. Beginning in the second quarter of 2006, we granted restricted stock awards and performance-based stock awards to our officers and key employees at fair

market value. The restricted stock awards vest in equal installments over four years. The performance-based stock awards vest on December 31, 2008 based on obtaining a revenue growth target of $34,694,935 for the fiscal year ending December 31, 2008. For purposes of share-based compensation measurement, we assume that the performance goal will be achieved. If the performance goals are not met, no compensation cost is recognized and any recognized compensation cost will be reversed. Under our Employee Stock Purchase Plan (“ESPP”), 108,071 shares were available for purchase at September 30, 2006. Under the ESPP, purchase options have been granted every six months with a six month term and an exercise price equal to the lower of the fair market value of the Common Stock on the first or last day of the six month period, with a 15% discount. As of August 1, 2006, ESPP purchase options will be granted on the first day of the six month period, with an exercise price equal to the fair market value on the last day of the six month period less a 5% discount.

The fair value of share-based awards for employee stock option awards and employee stock purchases made under our Employee Stock Purchase Plan were estimated using the Black-Scholes valuation model. The following weighted average assumptions were used to calculate the fair value of options granted during the three and nine months ended September 30, 2006 and 2005:

The risk-free interest rate used in the Black-Scholes valuation method is based on the implied yield currently available in U.S. Treasury securities at maturity with an equivalent term. We have not recently declared or paid any dividends and do not currently expect to do so in the future. The expected term of options represents the period that our stock-based awards are expected to be outstanding and was determined based on historical weighted average holding periods and projected holding periods for the remaining unexercised shares. Consideration was given to the contractual terms of our stock-based awards, vesting schedules and expectations of future employee behavior. Expected volatility is based on the annualized daily historical volatility of the Company’s stock over a representative period and includes consideration of the implied volatility for comparable entities within our industry.

The weighted average grant date fair value of options granted under our stock option plans during the nine month period ending September 30, 2006 was $2.24, and $1.67 and $1.61 for the three and nine month period ending September 30, 2005, respectively. There were no stock option grants during the three month period ending September 30, 2006. The weighted average grant date fair value of restricted stock awards and performance-based stock awards for the nine month period ending September 30, 2006 was $3.88. The estimated fair value of purchase rights under the ESPP plan for the nine month period ending September 30, 2006 was $1.62 and $0.96 and $1.08 for the three and nine months ended September 30, 2005, respectively.

The following table summarizes stock option activity under our stock option plans for the three and nine month periods ended September 30, 2006:

The stock options outstanding and exercisable for equity share-based payment awards under our stock option plans as of September 30, 2006 were in the following exercise price ranges:

The aggregate intrinsic value in the table above represents the total pretax intrinsic value, based on the Company closing stock price of $3.75 at September 30, 2006, which would have been received by award holders had all award holders exercised their stock options that were in-the-money as of that date. The aggregate intrinsic value of awards exercised during the six month period ended September 30, 2006 was $69,029.

There were 21,400 shares of restricted stock awards and performance-based stock awards that were granted and 21,150 that are outstanding at September 30, 2006. The unvested share balance at September 30, 2006 is 19,507.

As of September 30, 2006, there was $959,098 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under our stock option plans. That cost is expected to be recognized over a weighted average period of 2.52 years. As of September 30, 2006, there was no unrecognized cost related to the employee stock purchase plan.

NOTE 10 – COMPREHENSIVE INCOME (LOSS)

During the third quarter of 2006 and 2005 total comprehensive income (loss) was comprised of the following (in thousands):

NOTE 11 – FOREIGN CURRENCY TRANSLATION AND DERIVATIVES

Data I/O translates assets and liabilities of foreign subsidiaries at the exchange rate on the balance sheet date. We translate revenues, costs and expenses of foreign subsidiaries at average rates of exchange prevailing during the year. We charge our translation adjustments resulting from this process to other comprehensive income (a component of stockholders’ equity), net of taxes. Realized and unrealized gains and losses resulting from the effects of changes in exchange rates on assets and liabilities denominated in foreign currencies are included in non-operating expense as foreign currency transaction gains and losses.

Data I/O accounts for its hedging activities in accordance with SFAS No. 133, Accounting for Derivatives and Hedging Activities. This statement establishes accounting and reporting standards for derivative instruments and requires recognition of derivatives as assets or liabilities in the statement of financial position and measurement of those instruments at fair value.

Data I/O utilizes forward foreign exchange contracts to reduce the impact of foreign currency exchange rate risks where natural hedging strategies are not effectively employed. All hedging instruments held by us are fair value hedges. Generally, these contracts have maturities less than one year and require us to exchange foreign currencies for U.S. dollars at maturity. The change in fair value of the open hedge contracts as of September 30, 2006 is an unrealized gain of $5,542 included in net loss for the nine months ended September 30, 2006, and it is included in accounts payable on the balance sheet as of September 30, 2006.

Data I/O does not hold or issue derivative financial instruments for trading purposes. The purpose of our hedging activities is to reduce the risk that the valuation of the underlying assets, liabilities and firm commitments will be adversely affected by changes in exchange rates. Our derivative activities do not create foreign currency exchange rate risk because fluctuations in the value of the instruments used for hedging purposes are offset by fluctuations in the value of the underlying exposures being hedged.

NOTE 12 – RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued Interpretation No. 48, “Accounting for uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (FIN 48). This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” This Interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This Interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. Data I/O is currently evaluating the impact of FIN 48 on its consolidated results of operations and financial condition.

In September 2006, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 157, “Fair Value Measurements,” which establishes guidelines for measuring fair value and expands disclosures regarding fair value measurements. SFAS No. 157 does not require any new fair value measurements but rather it eliminates inconsistencies in the guidance found in various prior accounting pronouncements. SFAS No. 157 is effective for fiscal years beginning after November 15, 2007. Earlier adoption is encouraged, provided the company has not yet issued financial statements, including for interim periods, for that fiscal year. We are still evaluating the potential effects of this standard.

In September 2006, the Securities and Exchange Commission released Staff Accounting Bulletin No. 108, “Quantifying Financial Statement Misstatements” (“SAB 108”). SAB 108 gives guidance on how errors, built up over time in the balance sheet, should be considered from a materiality perspective and corrected. SAB 108 provides interpretive guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a current year misstatement. SAB 108 represents the SEC Staff’s views on the proper interpretation of existing rules and as such has no effective date. We are currently evaluation the impact of SAB No. 108 on our consolidated results of operations and financial condition.

General

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. This Act provides a “safe harbor” for forward-looking statements to encourage companies to provide prospective information about themselves as long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact made in this Quarterly Report on Form 10-Q are forward-looking. In particular, statements herein regarding industry prospects or trends; expected level of expense; future results of operations, breakeven point, or financial position; changes in gross margin; integration of acquired products and operations; market acceptance of our newly introduced or upgraded products; development, introduction and shipment of new products; and any other guidance on future periods are forward-looking statements. Forward-looking statements reflect management’s current expectations and are inherently uncertain. Although Data I/O believes that the expectations reflected in these forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance, achievements, or other future events. Moreover, neither Data I/O nor anyone else assumes responsibility for the accuracy and completeness of these forward-looking statements. Data I/O is under no duty to update any of these forward-looking statements after the date of this report. The reader should not place undue reliance on these forward-looking statements. The discussions above and in the section in Item 1A. Risk Factors “Cautionary Factors That May Affect Future Results” in the Company’s Annual report on Form 10-K for the year ended December 31, 2005 describe some, but not all, of the factors that could cause these differences.

OVERVIEW

Our primary goal is to manage the business to achieve profitable operations, while developing, launching and enhancing products to drive revenue and earnings growth. Our challenge continues to be operating in a cyclical and challenging industry environment, while positioning Data I/O to take advantage of any growth in capital spending. We began to see a recovery in growth in capital spending during 2005. During the first nine months of 2006, we experienced a 9% increase in orders over the same period of 2005. We anticipate that demand for programming capacity should continue to show improvement during the balance of 2006, in part based on third party forecasted increased 2006 unit sales for the semiconductor industry and the business outlook for target customer segments.

Following our losses during the first two quarters of 2006, we launched an initiative to lower the quarterly revenue breakeven point to below $7 million, as it rose to a calculated $7.6 million for the second quarter of 2006. This higher breakeven point was due especially to the lower gross margins, as well as the higher development and other operating expenses, we experienced during the first half of 2006. During the third quarter, we successfully reduced the breakeven point below our goal of $7 million through a combination of margin improvements and expense reductions. We have taken actions to improve the effectiveness of our sales organization. We have reduced expenses by reducing personnel costs, moving to a new much smaller facility and moderating our development materials and patent related spending.

We are continuing our efforts to balance increasing costs and strategic investments in our business with the level of demand and mix of business we expect. We are focusing our research and development efforts in our strategic growth markets, namely new programming technology, in-system programming (“ISP”) ImageWriter technology, and automated programming systems for the manufacturing environment, particularly the new FLX 500 desktop automated programming system, and extending the capabilities and support for our FlashCORE architecture and the ProLINE-RoadRunner and PS families. To better support our customers in their geographic areas and time zones, we are investing in tools and device support operations in Germany, India and Shanghai, China.

Our customer focus has been on strategic high volume manufacturers in key market segments like wireless, automotive, industrial controls and programming centers and supporting NAND Flash and microcontrollers on our newer products to gain new accounts and break into new market areas, such as microcontrollers for the automotive market. We have expanded our China operations during 2006 to take advantage of the growth of manufacturing in China. Our switch to a new distributor in Japan, Toyo Corporation, is intended to help recapture business in the Japanese market and coordinate Japanese related business in other countries. We worked with Toyo Corporation on introductions, training, integration and transitions in the second and third quarter of 2006. We continue our efforts to partner with selected semiconductor manufacturers to better serve our mutual customers and announced two additional members of the Preferred Partnership Program in the third quarter of 2006. The Preferred Partnership Program formalizes our mutual support relationship and is designed to increase collaboration between the semi conductor vendor and Data I/O to better serve our customers.

BUSINESS RESTRUCTURING

During 2005, we took restructuring related charges of $96,000 primarily related to severance and completing actions that had been started in the second half of 2004. This aligned management operations with the changes made in 2004 to control costs in North America and Europe and the need to build staff serving China and Eastern Europe. At December 31, 2005, $33,000 remained as accrued but unpaid restructure charges, which were completed and fully paid out during the first three quarters of 2006.

During the third quarter of 2006, as part of our additional effort to reduce expenses, we incurred a restructuring charge of approximately $152,000, with all but $23,000 paid out during the quarter. The restructuring charge is primarily related to severance charges incurred at our Redmond, Germany and China offices. In view of our declining margins and operating results during the first and second quarters of 2006, actions were taken to reduce expenses and improve margins, thereby reducing our quarterly revenue breakeven point to below $7 million for the quarter. The remaining unpaid restructure charge is expected to be paid out in the fourth quarter of 2006.

CRITICAL ACCOUNTING POLICY JUDGMENTS AND ESTIMATES

The Company’s critical accounting policies are disclosed in the Company’s Form 10-K for the year ended December 31, 2005 and have not materially changed as of September 30, 2006, with the exception of the following:

Stock-based Compensation: We estimate the fair value of stock options using the Black-Scholes valuation model consistent with the provisions of SFAS 123(R), SEC SAB 107 and our prior period pro forma disclosures of net earnings, including stock-based compensation (determined under a fair value method as prescribed by SFAS 123). The Black-Scholes model requires the input of highly subjective assumptions, including the option’s expected life and the price volatility of the underlying stock. The expected stock price volatility assumption was determined using a combination of historical and implied volatility of the Company’s common stock. Changes in the subjective assumptions required in the valuation model may significantly affect the estimated value of the awards, the related stock-based compensations expense and, consequently, our results of operations. Beginning in the second quarter of 2006, restricted stock awards and performance-based stock awards were granted. The vesting of the performance-based stock awards is based on attaining a particular revenue growth target during the three year period ending December 31, 2008. We assume that the performance goal will be achieved. If the performance goals are not met, no compensation cost is recognized and any recognized compensation cost will be reversed.

Results of Operations

The revenue increase for the third quarter of 2006 compared to the third quarter of 2005 relates primarily to higher sales of our ProLINE-RoadRunner, offset by lower sales of our PS Series products and adapters. However, on a year-to-date basis, the revenue increase can be attributed to an increase of PS Series product sales offset in part by a decrease in ProLINE-RoadRunner product sales. In the third quarter of 2006, we experienced increased sales in the Americas and China, partially offset by lower sales in Europe. Domestic sales increased approximately 13.5% in the third quarter of 2006, compared to the third quarter of 2005, primarily due to additional ProlLINE-RoadRunner product sales. Programming centers, electronic manufacturing services (EMS) companies and semiconductor factory programming represented our main automation equipment customers. During the third quarter of 2006, we sold automated systems to several new accounts. Although orders booked during both the third quarters of 2006 and 2005 were $7.8 million, on a year-to-date basis orders increased from $20.4 million in 2005 to $22.2 million in 2006. We increased our backlog of orders during the third quarter of 2006 by $700,000. The relatively high level of unshipped orders resulted primarily from orders taken for our new FLX-500 product, which we began shipping during October, as well as later customer delivery requirements and a distributor’s orders being on hold due to credit issues not resolved until October.

In 2006, we introduced our new FLX-500 desktop automated programming system, as well as a new version of our ProLINE-RoadRunner for Siemens X-Series (SMT) feeder. During 2005, we began shipping other new products including the PS-588 automated programming system and the ImageWriter-300, our In-System Programming solution. We limited our sales efforts on ImageWriter products in the second quarter while we resolved issues affecting our customers’ out-of-box experience. These ImageWriter improvements were completed, and although sales efforts resumed for the third quarter of 2006, we have not yet experienced significant ImageWriter sales growth. We expect these products to increase our revenues; however, partially offsetting this expected increase is the expected continuing trend of declining sales of our older non-automated product lines.

For the first nine months of 2006 compared to the same period of 2005, sales increased slightly, with the third quarter sales increase offsetting the first quarter sales decline. There have been significant product mix shifts with higher sales of PS Systems and FlashPAK programmers and lower sales of ProLINE-RoadRunner products, adapters and older legacy programmer products. China sales grew 25%, offset by declines in the rest of Asia. Sales in the Americas grew 6%, with Mexico and Canada sales offsetting the U.S sales decline. European sales declined 13%. Programming centers, EMS companies and semiconductor factory programming represented our main automation customer groups in 2006. Order bookings for the first nine months of 2006 were up 8.8% compared to the first nine months of 2005.

Gross margins decreased as a percentage of sales compared to the third quarter of 2005 but increased in dollars compared to the third quarter of 2005. The overall gross margin percentage decrease primarily relates to product mix shifts and lower average selling prices as well as certain unfavorable operating variances during the quarter. The product mix shift relates to decreased sales volume of higher margin Unifamily and aftermarket products, with offsetting increased sales volume of ProLINE-RoadRunner and FlashPAK non-automated programmer. The lower average selling prices related primarily to the effect of increased indirect channel sales, especially in China. In addition, the third quarter of 2006 had $282,000 of less favorable or negative operations variances and $155,000 of increased operations labor and overhead spending, particularly at the Brazil operations, compared to the third quarter of 2005, offset by favorable manufacturing labor and overhead variance of $113,000.

For the first nine months of 2006 compared to the same period of 2005, the lower gross margin dollars and gross margin as a percentage of sales are primarily due to the decrease in sales volume of higher margin ProLINE-RoadRunner and aftermarket products with offsetting increased sales volume of lower margin PS Series products and FlashPAK non-automated programmer. For the first nine months of 2006 there were $520,000 of less favorable or negative operations variances and $346,000 of increased labor & overhead costs, due primarily to Brazil operations, compared to the third quarter of 2005.

Research and development (“R&D”) spending for the third quarter and first nine months of 2006 compared to the same periods of 2005 increased in dollars and as a percentage of sales due to the higher spending associated with the development of the FLX-500. We expect that the spending in R&D should moderate as a percentage of sales as the development of new platforms, such as the FLX-500 and ImageWriter, come to completion and the engineering focus moves from significant platform development to product enhancements and extensions.