XNAS:RSYS Radisys Corp Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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 UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
 FORM 10-Q
 
 
 
(Mark one)
[x]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended
June 30, 2012

OR
[ ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
       
For the transition period from
 
to
 
Commission File Number:
0-26844
 
 
RADISYS CORPORATION
(Exact name of registrant as specified in its charter)
  
 
OREGON
 
93-0945232
(State or other jurisdiction of incorporation or organization)
 
(I.R.S. Employer Identification No.)
 
 
 
5435 N.E. Dawson Creek Drive, Hillsboro, OR
 
97124
(Address of principal executive offices)
 
(Zip Code)
 
 
 
(503) 615-1100
(Registrant's telephone number, including area code)
 
 
 
 
(Former name, former address and former fiscal year, if changed since last report)
 
 
 
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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  [x]    No  [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
[ ]
 
Accelerated filer
[x]
Non-accelerated filer
[ ]
(Do not check if a smaller reporting company)
Smaller reporting company
[ ]

Indicate by check mark whether the registrant is a shell company (as defined in rule 12b-2 of the Exchange Act)     Yes  [ ]    No  [x]

Number of shares of common stock outstanding as of August 1, 2012: 28,212,932
 




RADISYS CORPORATION

FORM 10-Q
TABLE OF CONTENTS
 
 
 
Page
PART I. FINANCIAL INFORMATION
 
 
 
 
 
Item 1. Financial Statements (Unaudited)
 
 
Condensed Consolidated Statements of Operations – Three and Six Months Ended June 30, 2012 and 2011
 
Condensed Consolidated Statements of Comprehensive Income (Loss) – Three and Six Months Ended June 30, 2012 and 2011
 
Condensed Consolidated Balance Sheets – June 30, 2012 and December 31, 2011
 
Condensed Consolidated Statements of Cash Flows – Six Months Ended June 30, 2012 and 2011
 
Notes to Consolidated Financial Statements
 
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
 
Item 3. Quantitative and Qualitative Disclosures About Market Risk
 
Item 4. Controls and Procedures
 
 
 
 
PART II. OTHER INFORMATION
 
 
Item 1A. Risk Factors
 
Item 5. Other Information
 
Item 6. Exhibits
 
Signatures
 


2



PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

RADISYS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share amounts, unaudited)
 
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Revenues
$
77,584

 
$
79,856

 
$
153,071

 
$
153,483

Cost of sales:
 
 
 
 
 
 
 
Cost of sales
48,542

 
54,933

 
98,547

 
107,167

Amortization of purchased technology
2,391

 
1,163

 
4,833

 
2,327

Total cost of sales
50,933

 
56,096

 
103,380

 
109,494

Gross margin
26,651

 
23,760

 
49,691

 
43,989

Research and development
11,713

 
9,600

 
24,259

 
18,607

Selling, general and administrative
10,173

 
10,875

 
22,173

 
21,910

Intangible asset amortization
1,304

 
192

 
2,608

 
384

Restructuring and acquisition-related charges, net
1,039

 
2,481

 
2,483

 
2,521

Income (loss) from operations
2,422

 
612

 
(1,832
)
 
567

Interest expense
(422
)
 
(456
)
 
(843
)
 
(952
)
Other income (expense), net
126

 
(12
)
 
290

 
(49
)
Income (loss) before income tax expense (benefit)
2,126

 
144

 
(2,385
)
 
(434
)
Income tax expense (benefit)
819

 
(46
)
 
1,123

 
(95
)
Net income (loss)
$
1,307

 
$
190

 
$
(3,508
)
 
$
(339
)
Net income (loss) per share:
 
 
 
 
 
 
 
Basic
$
0.05

 
$
0.01

 
$
(0.13
)
 
$
(0.01
)
Diluted
$
0.05

 
$
0.01

 
$
(0.13
)
 
$
(0.01
)
Weighted average shares outstanding:
 
 
 
 
 
 
 
Basic
26,759

 
24,334

 
26,708

 
24,341

Diluted
28,256

 
24,475

 
26,708

 
24,341


The accompanying notes are an integral part of these financial statements.


3



RADISYS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands, unaudited)

 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Net income (loss)
1,307

 
190

 
$
(3,508
)
 
$
(339
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Translation adjustments
(769
)
 
125

 
(549
)
 
256

Net adjustment for fair value of hedge derivatives (A)
(846
)
 
(55
)
 
(673
)
 
57

Other comprehensive income (loss)
(1,615
)
 
70

 
(1,222
)
 
313

Comprehensive income (loss)
$
(308
)
 
$
260

 
$
(4,730
)
 
$
(26
)

(A)
For the three months ended June 30, 2012 and 2011, the amounts are net of deferred taxes of $(5) and $10 and for the six months ended June 30, 2012 and 2011 the amounts are net of deferred taxes of $24 and $48.



The accompanying notes are an integral part of these financial statements.


4




RADISYS CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, unaudited)
 
June 30,
2012
 
December 31, 2011 (A)
 
 
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
45,852

  
$
47,770

Accounts receivable, net
48,385

  
49,212

Other receivables
3,405

  
4,036

Inventories, net
22,638

  
27,011

Inventory deposit, net
8,102

 
8,443

Other current assets
5,631

  
5,080

Deferred tax assets, net
5,165

  
5,507

Total current assets
139,178

  
147,059

Property and equipment, net
15,998

  
15,366

Goodwill
29,748

 
29,748

Intangible assets, net
77,603

  
85,043

Long-term deferred tax assets, net
12,266

  
12,266

Other assets
7,358

  
7,791

Total assets
$
282,151

  
$
297,273

 
 
 
 
LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
38,347

  
$
37,874

Accrued wages and bonuses
7,507

  
10,808

Deferred income
8,730

  
11,602

Convertible senior notes
27,000

 

Other accrued liabilities
11,931

  
16,195

Total current liabilities
93,515

  
76,479

Long-term liabilities:
 
 
 
Convertible senior notes
18,000

 
45,000

Other long-term liabilities
8,420

  
9,061

Total long-term liabilities
26,420

  
54,061

Total liabilities
119,935

  
130,540

Commitments and contingencies (Note 9)

 

Shareholders’ equity:
 
 
 
Common stock — no par value, 100,000 shares authorized; 28,173 and 27,949 shares issued and outstanding at June 30, 2012 and December 31, 2011
301,438

  
301,225

Accumulated deficit
(139,720
)
 
(136,212
)
Accumulated other comprehensive income:
 
 
 
Cumulative translation adjustments
1,945

  
2,494

Unrealized loss on hedge instruments
(1,447
)
  
(774
)
Total accumulated other comprehensive income
498

  
1,720

Total shareholders’ equity
162,216

  
166,733

Total liabilities and shareholders’ equity
$
282,151

  
$
297,273

(A)
As adjusted to reflect the impact of additional tax-related adjustments to the Company's purchase accounting for Continuous Computing in accordance with ASC 805-10 "Business Combinations". See Note 2 — Acquisitions for additional information.
The accompanying notes are an integral part of these financial statements.

5




RADISYS CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands, unaudited)
 
For the Six Months Ended
 
June 30,
 
2012
 
2011
Cash flows from operating activities:
 
 
 
Net loss
$
(3,508
)
 
$
(339
)
Adjustments to reconcile net loss to net cash provided by operating activities:
 
 
 
Depreciation and amortization
11,108

 
4,990

Inventory valuation allowance
1,031

 
822

Deferred income taxes
380

 
(69
)
Non-cash interest expense
222

 
224

Loss on disposal of property and equipment
102

 
107

Stock-based compensation expense
(584
)
 
2,137

Other
356

 
243

Changes in operating assets and liabilities:
 
 
 
Accounts receivable
824

 
(5,893
)
Other receivables
536

 
(1,399
)
Inventories
3,276

 
(997
)
Inventory deposit
341

 
(1,190
)
Other current assets
(129
)
 
570

Accounts payable
979

 
8,513

Accrued wages and bonuses
(3,235
)
 
(212
)
Accrued restructuring
(2,183
)
 
(88
)
Deferred income
(3,172
)
 
2,851

Other accrued liabilities
(3,090
)
 
(777
)
Net cash provided by operating activities
3,254

 
9,493

Cash flows from investing activities:
 
 
 
Capital expenditures
(5,831
)
 
(2,142
)
Purchase of long-term assets

 
(500
)
Net cash used in investing activities
(5,831
)
 
(2,642
)
Cash flows from financing activities:
 
 
 
Repurchases of common stock

 
(1,258
)
Proceeds from issuance of common stock
810

 
914

Other financing activities
(42
)
 
(147
)
Net cash provided by (used in) financing activities
768

 
(491
)
Effect of exchange rate changes on cash
(109
)
 
194

Net increase (decrease) in cash and cash equivalents
(1,918
)
 
6,554

Cash and cash equivalents, beginning of period
47,770

 
129,078

Cash and cash equivalents, end of period
$
45,852

 
$
135,632

Supplemental disclosure of cash flow information:
 
 
 
Cash paid during the year for:
 
 
 
     Interest
$
619

 
$
688

     Income taxes
$
624

 
$
355

The accompanying notes are an integral part of these financial statements.


6



RADISYS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1 — Significant Accounting Policies

Radisys Corporation (the “Company” or “Radisys”) has adhered to the accounting policies set forth in its Annual Report on Form 10-K for the year ended December 31, 2011 in preparing the accompanying interim consolidated financial statements. The preparation of these statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Additionally, the accompanying financial data as of June 30, 2012 and for the three and six months ended June 30, 2012 and 2011 has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2011.

The financial information included herein reflects all normal recurring adjustments that are, in the opinion of management, necessary for a fair presentation of the results for interim periods.

Note 2 — Acquisitions

During the six months ended June 30, 2012, the Company revised the purchase price allocation for the acquisition of Continuous Computing Corporation ("Continuous Computing") as a result of final measurement period adjustments. This revision is the result of finalizing the accounting for certain tax matters, which was completed during the three months ended March 31, 2012. These adjustments resulted in an additional release of the Company's valuation allowance provided against its U.S. net deferred tax assets, which results in additional deferred tax benefit reported in third-quarter 2011 financial information of approximately $2.7 million. As required by ASC 805-10, the Company's December 31, 2011 balance sheet has been revised to reflect the impact of these measurement period adjustments.

The following tables summarize the purchase price allocation and the impact of these measurement period adjustments to the Company's previously filed December 31, 2011 balance sheet:

Total purchase price
 
$
119,731

 
 
 
 
Fair value of net tangible assets acquired and liabilities assumed:
 
 
 
Cash and cash equivalents
$
2,214

 
 
Accounts receivable
13,434

 
 
Inventories
4,036

 
 
Prepaid expenses and other current assets
3,316

 
 
Fixed assets
2,469

 
 
Other assets
614

 
 
Accounts payable
(5,368
)
 
 
Accrued expenses
(6,891
)
 
 
Deferred revenue
(1,825
)
 
 
Other long-term liabilities
(1,226
)
 
 
 
 
10,773

Fair value of identifiable intangible assets acquired
 
89,240

Net deferred tax liability
 
(9,870
)
Goodwill
 
$
29,588



7



 
December 31, 2011 - As reported
 
Purchase accounting entry
 
December 31, 2011 - Revised
Current assets:
 
 
 
 
 
Deferred tax assets, net
$
5,875

 
$
(368
)
 
$
5,507

Total current assets
147,427

 
(368
)
 
147,059

Goodwill
26,599

 
3,149

 
29,748

Total assets
294,492

 
2,781

 
297,273

Current liabilities:
 
 
 
 
 
Other accrued liabilities
16,106

 
89

 
16,195

Total current liabilities
76,390

 
89

 
76,479

Long-term liabilities:
 
 
 
 
 
Other long-term liabilities
9,065

 
(4
)
 
9,061

Total long-term liabilities
54,065

 
(4
)
 
54,061

Total liabilities
130,455

 
85

 
130,540

Shareholders' equity:
 
 
 
 
 
Accumulated deficit
(138,908
)
 
2,696

 
(136,212
)
Total shareholders’ equity
164,037

 
2,696

 
166,733

Total liabilities and shareholders’ equity
294,492

 
2,781

 
297,273


Note 3 — Fair Value of Financial Instruments

The Company measures at fair value certain financial assets and liabilities. GAAP specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company's market assumptions. These two types of inputs have created the following fair-value hierarchy:

Level 1— Quoted prices for identical instruments in active markets;

Level 2— Quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets; and

Level 3— Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable.

Foreign currency forward contracts are measured at fair value using models based on observable market inputs such as foreign currency exchange rates; therefore, they are classified within Level 2 of the valuation hierarchy. The cash surrender value of life insurance contracts is measured at fair value using quoted market prices for similar instruments; therefore, they are classified within Level 2 of the valuation hierarchy.

The Company has obligations ("contingent consideration"), to be paid in cash, related to the acquisition of Continuous Computing based on the amount of product royalty revenues generated by a specified set of contracts associated with certain of Continuous Computing's products over a period of 36 months after closing. The contingent consideration liability was established at the time of acquisition and is evaluated at the end of each reporting period. As the significant inputs used in determining the fair value are unobservable, this liability is classified within Level 3 of the fair value hierarchy.

The fair value of this contingent consideration is determined by calculating the net present value of the expected payments using significant inputs that are not observable in the market, including revenue projections and discount rates consistent with the level of risk of achievement; therefore the Company developed its own assumptions for the expected product royalty revenues generated under the arrangement. The fair value of the contingent consideration is affected most significantly by changes in the amount and timing of the revenue projections. If the revenue projections increase or decrease, the fair value of the contingent consideration will increase or decrease accordingly, in amounts that will vary based on the timing of the projected revenues and the timing of the expected payments.


8




The following table summarizes the fair value measurements for the Company's financial instruments (in thousands):
 
Fair Value Measurements as of June 30, 2012
 
Total
  
Level 1
  
Level 2
  
Level 3
Cash surrender value of life insurance contracts
$
3,450

 
$

 
$
3,450

 
$

Foreign currency forward contracts
(1,119
)
  

  
(1,119
)
  

Contingent consideration liability
(6,556
)
 

 

 
(6,556
)
Total
$
(4,225
)
 
$

 
$
2,331

 
$
(6,556
)

 
Fair Value Measurements as of December 31, 2011
 
Total
  
Level 1
  
Level 2
  
Level 3
Cash surrender value of life insurance contracts
$
3,394

 
$

 
$
3,394

 
$

Foreign currency forward contracts
(647
)
  

  
(647
)
  

Contingent consideration liability
(7,594
)
 
$

 
$

 
(7,594
)
     Total
$
(4,847
)
  
$

  
$
2,747

 
$
(7,594
)

The following table summarizes our Level 3 activity for the Company's contingent consideration liability (in thousands):
 
Level 3
Balance at December 31, 2011
$
7,594

Change in estimate
(1,562
)
Accretion
524

Balance at June 30, 2012
$
6,556

The Company records all changes in estimate and accretion on the contingent consideration liability to restructuring and acquisition-related charges, net in the Condensed Consolidated Statements of Operations. Of the $6.6 million contingent consideration liability, $0.6 million is recorded in other accrued liabilities and $6.0 million is recorded in other long-term liabilities on our Condensed Consolidated Balance Sheet at June 30, 2012.

Note 4 — Accounts Receivable and Other Receivables

Accounts receivable consists of sales to the Company's customers which are generally based on standard terms and conditions. Accounts receivable balances consisted of the following (in thousands):
 
June 30,
2012
 
December 31,
2011
Accounts receivable, gross
$
49,177

 
$
50,040

Less: allowance for doubtful accounts
(792
)
 
(828
)
Accounts receivable, net
$
48,385

 
$
49,212


As of June 30, 2012 and December 31, 2011, the balance in other receivables was $3.4 million and $4.0 million. Other receivables consisted primarily of non-trade receivables including receivables for value-added taxes and inventory transferred to the Company's contract manufacturing partners on which the Company does not recognize revenue. In addition, at December 31, 2011 other receivables included $1.3 million for a sale of components partially fulfilled in 2011 which were not invoiced until the first quarter of 2012 when the remaining components were shipped.

9




Note 5 — Inventories

Inventories consisted of the following (in thousands):
 
June 30,
2012
 
December 31,
2011
Raw materials
$
10,385

 
$
10,925

Work-in-process
705

 
599

Finished goods
14,012

 
20,127

 
25,102

 
31,651

Less: inventory valuation allowance
(2,464
)
 
(4,640
)
Inventories, net
$
22,638

 
$
27,011

 
June 30,
2012
 
December 31,
2011
Inventory deposit (A)
$
11,091

 
$
11,578

Less: inventory deposit valuation allowance
(2,989
)
 
(3,135
)
Inventory deposit, net
$
8,102

 
$
8,443

 

(A)
The Company is contractually obligated to reimburse its contract manufacturers for the cost of excess inventory that has been purchased as a result of the Company's forecasted demand when there is no alternative use. The Company's inventory deposit represents a cash deposit paid to its contract manufacturers for inventory in excess of near term demand. The deposit is recorded net of adverse purchase commitment liabilities, and therefore the net balance of the deposit represents inventory the Company believes will be utilized. The deposit will be applied against future adverse purchase commitments owed to the Company's contract manufacturers or reduced based on the usage of inventory. See Note 9 - Commitments and Contingencies for additional information regarding the Company's adverse purchase commitment liability.

Consigned inventory is held at third-party locations, including the Company's contract manufacturing partners and customers. The Company retains title to the inventory until purchased by the third-party. Consigned inventory, consisting of raw materials and finished goods, was $0.7 million and $3.8 million at June 30, 2012 and December 31, 2011.

The Company recorded the following charges associated with the valuation of inventory, inventory deposit and the adverse purchase commitment liability (in thousands):
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Inventory, net
$
578

 
$
364

 
$
1,031

 
$
822

Inventory deposit, net
64

 
193

 
363

 
408

Adverse purchase commitments
(102
)
 
546

 
(28
)
 
797


Note 6 — Accrued Restructuring

Accrued restructuring, which is included in other accrued liabilities in the accompanying Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011, consisted of the following (in thousands):
 
June 30,
2012
  
December 31,
2011
2009 restructuring charges
$

  
$
84

Fourth quarter 2010 restructuring charge
22

 
218

Continuous Computing restructuring
664

 
3,900

2012 lease abandonment charge
1,333

 

Total accrued restructuring charges
$
2,019

  
$
4,202


10




The Company evaluates the adequacy of the accrued restructuring charges on a quarterly basis. Reversals are recorded in the period in which the Company determines that expected restructuring obligations are less than the amounts accrued.

2009 Restructurings

During 2012, all remaining activities related to the 2009 plan were completed.

Fourth Quarter 2010 Restructuring

During the six months ended June 30, 2012, the Company recorded a net reversal of $4,000 for previously estimated amounts associated with the fourth quarter 2010 restructuring plan. The activity reflects the re-assignment of employees initially included in the plan and changes in previously estimated amounts for employee severance and associated payroll costs.

The following table summarizes the changes to the fourth quarter 2010 restructuring costs during the six months ended June 30, 2012, (in thousands):
 
Employee
Termination and
Related Costs
Balance accrued as of December 31, 2011
$
218

Additions
15

Reversals
(19
)
Expenditures
(192
)
Balance accrued as of June 30, 2012
$
22


Continuous Computing Related Restructuring

In the second quarter of 2011, the Company initiated a restructuring plan associated with the acquisition of Continuous Computing. The plan included the identification of 117 positions at various locations that will be eliminated. The primary intent of these integration activities was to eliminate the staffing redundancies that resulted from the Company's acquisition of Continuous Computing. In addition, these integration activities align with the Company's corporate objective to transfer a significant portion of its research and development activities to lower cost geographies. To date, under this plan, the Company has incurred restructuring costs of $5.9 million, which consisted of severance and related payroll costs as well as healthcare benefits and legal fees. The Company expects additional charges associated with the restructuring plan to be substantially complete by the third quarter of 2012.

During the six months ended June 30, 2012, under the Continuous Computing restructuring plan, the Company recorded net expense of $0.9 million for the severance of a named executive officer and various other employees, net of the reduction resulting from the re-assignment of employees initially included in the plan and changes in previously estimated amounts for employee severance and associated payroll costs.

The following table summarizes activity associated with the Continuous Computing restructuring plan during the six months ended June 30, 2012, (in thousands):
 
Employee
Termination and
Related Costs
Balance accrued as of December 31, 2011
$
3,900

Additions
1,032

Reversals
(165
)
Expenditures
(4,103
)
Balance accrued as of June 30, 2012
$
664

  




11



2012 Lease Abandonments

During the six months ended June 30, 2012 the Company recorded charges of $1.3 million related to the abandonment of two leased facilities. The charges recorded represent the present value of the remaining rental obligations and lease exit charges for these facilities, offset by estimated sublease income during the remaining lease term.

The following table summarizes the activity associated with the 2012 lease abandonments restructuring costs during the six months ended June 30, 2012, (in thousands):
 
Lease Charges
Additions
$
1,333

Balance accrued as of June 30, 2012
$
1,333


Note 7 — Short-Term Borrowings

Silicon Valley Bank

The Company has a $40.0 million secured revolving line of credit agreement (as amended, the “Agreement”) with Silicon Valley Bank (“SVB”) maturing on September 30, 2014. The secured revolving credit facility is available for cash borrowings, with $20.0 million of the Agreement available on a non-formula basis and the remaining $20.0 million subject to a borrowing formula based upon eligible accounts receivable. Eligible accounts receivable (as defined in the Agreement) include 80% of US and 65% of foreign accounts receivable for our U.S. companies, limited to concentration by certain customers, not greater than 60 days past due and no greater than 120 days from original invoice date. Borrowings under the Agreement bear interest at the prime rate, which was 3.25% as of June 30, 2012, or LIBOR, which was 0.24% as of June 30, 2012, plus 1.25%, with either interest rate determined by the Company's election. The Company is required to make interest payments monthly. The Company was further required to pay a commitment fee equal to $35,000 on the closing date of the Agreement and annually thereafter and to pay quarterly in arrears an unused facility fee in an amount equal to 0.375% per year of the unused amount of the facility.

The Agreement requires the Company to make and maintain certain financial covenants, representations, warranties and other agreements that are customary in credit agreements of this type. The Agreement also requires the Company to maintain the following specific financial covenants:
    
minimum quarterly liquidity ratio of 1.25 during the term of the Agreement. The liquidity ratio is defined as cash, cash equivalents and short term investments (with cash and cash equivalents held by the Company's foreign subsidiaries not to exceed $10.0 million and excluding any investments held by the Company's foreign subsidiaries) plus eligible accounts receivable (as defined in the Agreement), divided by the sum of obligations owing to SVB under the Agreement;
minimum two quarter positive rolling EBITDA (earnings before interest, taxes, depreciation, amortization, stock based compensation, goodwill impairment charges, and non-cash restructuring and integration expenses associated with the acquisition of Continuous Computing) of $3.0 million beginning with the quarter ending December 31, 2012. Prior to December 31, 2012, the minimum two quarter rolling EBITDA requirements increase on a quarterly basis with the quarter ending September 30, 2011 as follows: ($8.3) million, $(8.5) million ($2.1) million, ($0.5) million and $2.0 million; and
capital expenditures may not exceed $20.0 million during the period January 1, 2011 to December 31, 2012 and $8.0 million in subsequent years.

As of June 30, 2012 and December 31, 2011, the Company had no outstanding balances or letters of credit issued on its behalf under the Agreement. At June 30, 2012, the Company had $40.0 million of available capacity under the Agreement. As of June 30, 2012, the Company was in compliance with all covenants.




12



Note 8 - Convertible Debt

2013 Convertible Senior Notes

During February 2008, the Company offered and sold in a public offering pursuant to the shelf registration statement $55.0 million aggregate principal amount of 2.75% convertible senior notes due 2013 (the “2013 convertible senior notes”). Interest is payable semi-annually, in arrears, on each August 15 and February 15, beginning on August 15, 2008, to the holders of record at the close of business on the preceding August 1 and February 1, respectively. The 2013 convertible senior notes mature on February 15, 2013. Holders of the 2013 convertible senior notes may convert their notes into a number of shares of the Company's common stock determined as set forth in the indenture governing the notes at their option on any day to and including the business day prior to the maturity date. The 2013 convertible senior notes are initially convertible into 76.7448 shares of the Company's common stock per $1,000 principal amount of the notes (which is equivalent to a conversion price of approximately $13.03 per share), subject to adjustment upon the occurrence of certain events. Upon the occurrence of a fundamental change, holders of the 2013 convertible senior notes may require the Company to repurchase some or all of their notes for cash at a price equal to 100% of the principal amount of the notes being repurchased, plus accrued and unpaid interest, if any. In addition, if certain fundamental changes occur, the Company may be required in certain circumstances to increase the conversion rate for any 2013 convertible senior notes converted in connection with such fundamental changes by a specified number of shares of the Company's common stock. The 2013 convertible senior notes are the Company's general unsecured obligations and rank equal in right of payment to all of its existing and future senior indebtedness, and senior in right of payment to the Company's future subordinated debt. The Company's obligations under the 2013 convertible senior notes are not guaranteed by, and are effectively subordinated in right of payment to all existing and future obligations of its subsidiaries and are effectively subordinated in right of payment to its future secured indebtedness to the extent of the assets securing such debt.

In connection with the issuance of the 2013 convertible senior notes, the Company entered into a capped call transaction with a hedge counterparty. The capped call transaction is expected to reduce the potential dilution upon conversion of the 2013 convertible senior notes in the event that the market value per share of the Company's common stock, as measured under the terms of the capped call transaction, at the time of exercise is greater than the strike price of the capped call transaction of approximately $13.03. The strike price of the capped call transaction corresponds to the initial conversion price of the 2013 convertible senior notes and is subject to certain adjustments similar to those contained in the notes. The capped call transaction provides for net-share settlement in the event that the volume-weighted average price per share of the Company's common stock on the settlement date exceeds the strike price of approximately $13.03 per share. In such event, the hedge counterparty would deliver to the Company a number of shares equal to a formula determined by the quotient resulting from (a) the shares being settled times the difference between the volume-weighted average price on the settlement date and the strike price of approximately $13.03 per share, divided by (b) the volume-weighted average price on the settlement date. If the volume-weighted average price on the settlement date equals or exceeds the cap price of $23.085 per share, the difference in (a) would be $23.085 minus $13.03, or $10.055. If the market value per share of the Company's common stock exceeds the cap price of the capped call transaction of $23.085, as measured under the terms of the capped call transaction, the dilution mitigation under the capped call transaction will be limited, which means that there would be dilution to the extent that the then market value per share of the Company's common stock exceeds the cap price of the capped call transaction. Although the capped call transaction covers approximately 4.2 million shares, in order to facilitate an orderly settlement process, the shares are divided into tranches of approximately 211,000 shares each, settling on the twenty consecutive trading days prior to the date of maturity of the Company's convertible notes. Thus, on each settlement date, approximately 211,000 shares would be settled, assuming a volume-weighted average price on such settlement date of $23.085. Assuming a volume-weighted average price of $23.085, the
hedge counterparty would deliver to the Company approximately 91,904 shares on each settlement date, calculated as follows: 211,000 x ($23.085 - $13.03)/$23.085 = 91,904.

The following table outlines the effective interest rate, contractually stated interest costs, and costs related to the amortization of issuance costs for the Company's 2013 convertible senior notes:


For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Effective interest rate
3.73
%
 
3.64
%
 
3.73
%
 
3.64
%
Contractually stated interest costs
$
309

 
$
344

 
$
618

 
$
688

Amortization of interest costs
$
111

 
$
112

 
$
221

 
$
224



13



During the six months ended June 30, 2012, the Company exchanged, in a private offering, $18.0 million aggregate principal amount of the 2013 convertible senior notes for $18.0 million aggregate principal amount of 4.50% convertible senior notes due 2015 (the “2015 convertible senior notes”). The Company accounted for the exchange in accordance with the relevant accounting guidance for debt exchanges and modifications. Refer below for further details of the 2015 convertible senior notes.

2015 Convertible Senior Notes

On June 20, 2012, the Company entered into subscription agreements with certain holders of the Company's 2013 convertible senior notes. Pursuant to the subscription agreements, on June 29, 2012 the Company exchanged $18.0 million aggregate principal amount of the 2013 convertible senior notes for $18.0 million aggregate principal amount of the Company's 2015 convertible senior notes. The 2015 convertible senior notes mature on February 15, 2015. Holders of the 2015 convertible senior notes may convert their notes into a number of shares of the Company's common stock determined as set forth in the indenture governing the notes at their option on any day to and including the business day prior to the maturity date. The 2015 convertible senior notes are initially convertible into 117.2333 shares of the Company's common stock per $1,000 principal amount of the notes (which is equivalent to a conversion price of approximately $8.53 per share), subject to adjustment upon the occurrence of certain events. Upon the occurrence of a fundamental change, holders of the 2015 convertible senior notes may require the Company to repurchase some or all of their notes for cash at a price equal to 100% of the principal amount of the notes being repurchased, plus accrued and unpaid interest, if any. In addition, if certain fundamental changes occur, the Company may be required in certain circumstances to increase the conversion rate for any 2015 convertible senior notes converted in connection with such fundamental changes by a specified number of shares of the Company's common stock. The 2015 convertible senior notes are the Company's general unsecured obligations and rank equal in right of payment to all of its existing and future senior indebtedness, and senior in right of payment to the Company's future subordinated debt. The Company's obligations under the 2015 convertible senior notes are not guaranteed by, and are effectively subordinated in right of payment to all existing and future obligations of its subsidiaries and are effectively subordinated in right of payment to its future secured indebtedness to the extent of the assets securing such debt.

As of June 30, 2012 and December 31, 2011, the Company had outstanding 2013 and 2015 convertible senior notes with a combined face value of $45.0 million, of which $27.0 million was classified as current liabilities as of June 30, 2012 in the Condensed Consolidated Balance Sheets. As of June 30, 2012 and December 31, 2011, the fair value of the Company's 2013 and 2015 convertible senior notes were $44.1 million and $41.8 million, which is based on quoted prices of the Company's publicly traded debt on each balance sheet date.

Note 9 - Commitments and Contingencies

Adverse Purchase Commitments

The Company is contractually obligated to reimburse its contract manufacturers for the cost of excess inventory used in the manufacture of the Company's products, if there is no alternative use. This liability, referred to as adverse purchase commitments, is presented in other accrued liabilities in the accompanying Condensed Consolidated Balance Sheets. Estimates for adverse purchase commitments are derived from reports received on a quarterly basis from the Company's contract manufacturers. Increases to this liability are charged to cost of goods sold. When and if the Company takes possession of inventory reserved for in this liability, the liability is transferred from other accrued liabilities to the excess and obsolete inventory valuation allowance (Note 5 —Inventories).

Guarantees and Indemnification Obligations

As permitted under Oregon law, the Company has agreements whereby it indemnifies its officers, directors and certain finance employees for certain events or occurrences while an officer, director or employee is or was serving in such capacity at the request of the Company. The term of the indemnification period is for the officer's, director's or employee's lifetime. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is unlimited; however, the Company has a Director and Officer insurance policy that limits its exposure and enables the Company to recover a portion of any future amounts paid. To date, the Company has not incurred any costs associated with these indemnification agreements and, as a result, management believes the estimated fair value of these indemnification agreements is minimal. Accordingly, the Company has not recorded any liabilities for these agreements as of June 30, 2012.


14



The Company enters into standard indemnification agreements in its ordinary course of business. Pursuant to these agreements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified party for losses suffered or incurred by the indemnified party, generally the Company's business partners or customers, in connection with patent, copyright or other intellectual property infringement claims by any third party with respect to the Company's current products, as well as claims relating to property damage or personal injury resulting from the performance of services by us or the Company's subcontractors. The maximum potential amount of future payments the Company could be required to make under these indemnification agreements is generally limited. Historically, the Company's costs to defend lawsuits or settle claims relating to such indemnity agreements have been minimal and accordingly management believes the estimated fair value of the agreements is immaterial.

Accrued Warranty

The Company provides for the estimated cost of product warranties at the time it recognizes revenue. Products are generally sold with warranty coverage for a period of 12 months to 24 months after shipment. Parts and labor are covered under the terms of the warranty agreement. The workmanship of the Company's products produced by contract manufacturers is covered under warranties provided by the contract manufacturer for a specified period of time ranging from 12 months to 15 months. The warranty provision is based on historical experience by product family. The Company engages in extensive product quality programs and processes, including actively monitoring and evaluating the quality of its components suppliers; however ongoing failure rates, material usage and service delivery costs incurred in correcting product failure, as well as specific product class failures out of the Company's baseline experience affect the estimated warranty obligation. If actual product failure rates, material usage or service delivery costs differ from estimates, revisions to the estimated warranty liability would be required.

The following is a summary of the change in the Company's warranty accrual reserve (in thousands):
 
For the Six Months Ended
 
June 30,
 
2012
 
2011
Warranty liability balance, beginning of the period
$
3,438

 
$
3,025

Product warranty accruals
1,759

 
1,286

Utilization of accrual
(2,301
)
 
(1,521
)
Warranty liability balance, end of the period
$
2,896

 
$
2,790


The warranty liability balance is included in other accrued liabilities in the accompanying Condensed Consolidated Balance Sheets as of June 30, 2012 and December 31, 2011.



15



Note 10 — Basic and Diluted Net Income (Loss) per Share

A reconciliation of the numerator and the denominator used to calculate basic and diluted net income (loss) per share is as follows (in thousands, except per share amounts):
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
Numerator — Basic
 
 
 
 
 
 
 
Net income (loss)
$
1,307

 
$
190

 
$
(3,508
)
 
$
(339
)
Numerator — Diluted
 
 
 
 
 
 
 
Net income (loss)
$
1,307

 
$
190

 
$
(3,508
)
 
$
(339
)
Interest on convertible notes, net of tax benefit (B)

 

 

 

Net income (loss), diluted
$
1,307

 
$
190

 
$
(3,508
)
 
$
(339
)
Denominator — Basic
 
 
 
 
 
 
 
Weighted average shares used to calculate net income (loss)
 
 
 
 
 
 
 
   per share, basic
26,759

 
24,334

 
26,708

 
24,341

Denominator — Diluted
 
 
 
 
 
 
 
Weighted average shares used to calculate net income (loss)
 
 
 
 
 
 
 
   per share, basic
26,759

 
24,334

 
26,708

 
24,341

Effect of escrow shares (A)
1,344

 

 

 

Effect of convertible notes (B)

 

 

 

Effect of dilutive restricted stock (C) (D)
78

 
122

 

 

Effect of dilutive stock options (C)
75

 
19

 

 

Weighted average shares used to calculate net income (loss)
 
 
 
 
 
 
 
   per share, diluted
28,256

 
24,475

 
26,708

 
24,341

Net income (loss) per share
 
 
 
 
 
 
 
Basic
$
0.05

 
$
0.01

 
$
(0.13
)
 
$
(0.01
)
Diluted (A), (B)
$
0.05

 
$
0.01

 
$
(0.13
)
 
$
(0.01
)
 

(A)
For the six months ended June 30, 2012, the 1.3 million contingently issuable shares were excluded from the calculation as their effect would have been anti-dilutive.

(B)
For the three and six months ended June 30, 2012 and 2011, 3.5 million and 3.8 million as-if converted shares associated with the Company's 2013 and 2015 convertible senior notes were excluded from the calculation as their effect would have been anti-dilutive.

(C)
For the three and six months ended June 30, 2012 and 2011, the following equity awards, by type, were excluded from the calculation, as their effect would have been anti-dilutive (in thousands):

 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
  
2011
Dilutive stock options
2,330

 
2,369

 
2,400

  
2,495

Dilutive restricted stock units
399

 
80

 
478

  
401

Total equity award shares excluded
2,729

 
2,449

 
2,878

  
2,896


(D)
For the three and six months ended June 30, 2012 and 2011 the Company excluded restricted shares of 728,700 and 847,900 granted under the Long-Term Incentive Plan, as the performance criteria required for issuance of the awards was not satisfied as of these dates.


16



Note 11 — Income Taxes

The Company's effective tax rate for the three months ended June 30, 2012 and 2011 differs from the statutory rate primarily due to a full valuation allowance provided against its United States (“U.S.”) net deferred tax assets, Canadian research and experimental development claims, the impact of stock option expense, the amortization of goodwill for tax purposes and taxes on foreign income that differ from the U.S. tax rate.  The Company utilizes the asset and liability method of accounting for income taxes. The Company records deferred tax assets to the extent it believes these assets will more likely than not be realized. In making such determination, the Company considers all available positive and negative evidence, including scheduled reversals of deferred tax liabilities, projected future taxable income, tax planning strategies, and recent financial performance. Based upon the Company's review of all positive and negative evidence, including its three year U.S. cumulative pre-tax book loss and taxable loss, it concluded that a full valuation allowance should continue to be recorded against its U.S. net deferred tax assets at June 30, 2012. In certain other foreign jurisdictions, where the Company does not have cumulative losses or other negative evidence, the Company had net deferred tax assets of $17.4 million at June 30, 2012 and $18.1 million at December 31, 2011.  In the future, if the Company determines that it is more likely than not that it will realize its U.S. net deferred tax assets, it will reverse the applicable portion of the valuation allowance and recognize an income tax benefit in the period in which such determination is made.

The Company's unrecognized tax benefits and related interest and penalties during the three months ended June 30, 2012 decreased by $0.1 million primarily due to the India income tax examination for the financial year 2007. The ending balance for the unrecognized tax benefits was approximately $2.6 million at June 30, 2012. The related interest and penalties were $0.3 million and $0.2 million, respectively. The uncertain tax positions that are reasonably possible to decrease in the next twelve months are insignificant.

The Company is currently under tax examination in India. The periods covered under examination are the Company's financial years 2005 through 2008. The examination is in various stages of appellate proceedings and all material uncertain tax positions associated with the examination have been taken into account in the ending balance of the unrecognized tax benefits at June 30, 2012. As of June 30, 2012, the Company is not under examination by tax authorities in any other jurisdictions.
 
Note 12 — Stock-based Compensation

The following table summarizes the awards granted under the Radisys Corporation 2007 Stock Plan (in thousands):
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
  
2011
 
2012
 
2011
Stock options
29

 
53

 
73

 
61

Restricted stock
63

 
196

 
77

 
196

Total
92

 
249

 
150

 
257


Stock-based compensation was recognized and allocated as follows (in thousands):
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
  
2011
 
2012
 
2011
Cost of sales
$
(134
)
  
$
170

 
$
(205
)
 
$
355

Research and development
(296
)
  
293

 
31

 
606

Selling, general and administrative
(1,076
)
  
273

 
(410
)
 
1,176

Total
$
(1,506
)
  
$
736

 
$
(584
)
 
$
2,137


In the second quarter of 2012, the Company determined that it was improbable that the long-term incentive plan ("LTIP") performance goal would be attained prior to the end of the measurement period and, as a result, reversed life-to-date LTIP expense of $2.4 million. To achieve the minimum threshold for share vesting under the LTIP, the Company must achieve a minimum level of non-GAAP earnings per share (including the application of a 20% tax rate as stated in the LTIP versus current financial projections of 5%) on a rolling four quarter basis by December 31, 2012. 


17



Note 13 — Common Stock Repurchase Program

In December 2010, the Board of Directors authorized the repurchase of up to $20.0 million of the Company's common stock through open-market transactions and privately negotiated transactions from time to time at the discretion of management. The duration of the repurchase program is two years, although it may be extended, suspended or discontinued without prior notice, at the discretion of the Board of Directors. Under the program, the Company repurchased common stock with a value of $3.9 million in 2011, leaving $16.1 million available for future repurchases of the Company's common stock. No amounts were repurchased during the six months ended June 30, 2012.

Note 14 — Hedging

The Company’s activities expose it to a variety of market risks, including the effects of changes in foreign currency exchange rates. The Company manages these risks through the use of forward exchange contracts, designated as foreign-currency cash flow hedges, in an attempt to reduce the potentially adverse effects of foreign currency exchange rate fluctuations that occur in the normal course of business. As such, the Company’s hedging activities are all employed solely for risk management purposes. All hedging transactions are conducted with, in the opinion of management, financially stable and reputable financial institutions. As of June 30, 2012 and December 31, 2011, the only hedge instruments executed by the Company are associated with its exposure to fluctuations in the Canadian Dollar and Indian Rupee which result from obligations such as payroll and rent paid in these respective currencies.

These derivatives are recognized on the balance sheet at their fair value. Unrealized gain positions are recorded as other current assets and unrealized loss positions are recorded as other current liabilities. Changes in the fair values of the outstanding derivatives that are highly effective are recorded in other comprehensive income until net income is affected by the variability of the cash flows of the hedged transaction. Typically, hedge ineffectiveness could result when the amount of the Company’s hedge contracts exceed the Company’s forecasted or actual transactions for which the hedge contracts were designed to hedge. Once a hedge contract matures, the associated gain (loss) on the contract will remain in other comprehensive income (loss) until the underlying hedged transaction affects net income (loss), at which time the gain (loss) will be recorded to the expense line item being hedged, which is primarily research and development expense. The Company only enters into derivative contracts in order to hedge foreign currency exposure, and these contracts do not exceed two years from inception. If the Company entered into a contract for speculative reasons or if the Company’s current hedge position becomes ineffective, changes in the fair values of the derivatives would be recognized in earnings in the current period.

The Company assesses, both at the inception of the hedge and on an ongoing basis, whether the derivatives that are used in hedging transactions have been highly effective in offsetting changes in the cash flows of hedged items and whether those derivatives are expected to remain highly effective in future periods. For the six months ended June 30, 2012 and 2011 and for the year ended December 31, 2011 the Company had no hedge ineffectiveness.

During the three and six months ended June 30, 2012, the Company entered into 20 and 41 new foreign currency forward contracts, with total notional contractual values of $2.4 million and $6.9 million. During the three months ended June 30, 2011, the Company did not enter into any new foreign currency contracts, while during the six months ended June 30, 2011, the Company entered into 12 new foreign currency forward contracts, with total notional contractual values of $2.2 million.

 A summary of the aggregate contractual or notional amounts, balance sheet location and estimated fair values of derivative financial instruments designated as cash flow hedges at June 30, 2012 is as follows (in thousands):
 
Contractual/Notional
Amount
  
Condensed Consolidated Balance Sheet
Classification
  
Estimated Fair Value
Type of Cash Flow Hedge
Asset
  
(Liability)
Foreign currency forward exchange contracts
$
14,649

  
Other accrued liabilities
  
$

  
$
(1,119
)

A summary of the aggregate contractual or notional amounts, balance sheet location and estimated fair values of derivative financial instruments designated as cash flow hedges at December 31, 2011 is as follows (in thousands):
 
Contractual/Notional
Amount
  
Condensed Consolidated Balance Sheet
Classification
  
Estimated Fair Value
Type of Cash Flow Hedge
Asset
  
(Liability)
Foreign currency forward exchange contracts
$
15,480

  
Other accrued liabilities
  
$

  
$
(647
)


18



The effect of derivative instruments on the consolidated financial statements for the three months ended June 30, 2012 was as follows (in thousands):
 
Effective Portion
 
Ineffective Portion
Type of Cash Flow Hedge
Hedge Loss
Recognized in
Other
Comprehensive
Loss
 
Condensed Consolidated Statements of
Operations Classification of Gain
(Loss) Reclassified from
Accumulated Other Comprehensive
Income
 
Hedge Gain (Loss) Reclassified from
Accumulated
Other
Comprehensive
Income
 
Condensed Consolidated
Statements of
Operations
Classification
of Gain (Loss)
Recognized
 
Hedge Gain
(Loss)
Recognized
Foreign currency forward exchange contracts
$
(846
)
  
 
  
 
 
 
  
 
 
 
  
Cost of sales
  
$
76

 
None
  
$

 
 
  
Research and development
  
37

 
None
  

 
 
  
Selling, general and administrative
  
(25
)
 
None
  


The effect of derivative instruments on the consolidated financial statements for the six months ended June 30, 2012 was as follows (in thousands):
 
Effective Portion
 
Ineffective Portion
Type of Cash Flow Hedge
Hedge Loss
Recognized in
Other
Comprehensive
Loss
 
Condensed Consolidated Statements of
Operations Classification of Gain
(Loss) Reclassified from
Accumulated Other Comprehensive
Income
 
Hedge Gain (Loss) Reclassified from
Accumulated
Other
Comprehensive
Income
 
Condensed Consolidated
Statements of
Operations
Classification
of Gain (Loss)
Recognized
 
Hedge Gain
(Loss)
Recognized
Foreign currency forward exchange contracts
$
(673
)
  
 
  
 
 
 
  
 
 
 
  
Cost of sales
  
$
68

 
None
  
$

 
 
  
Research and development
  
46

 
None
  

 
 
  
Selling, general and administrative
  
(16
)
 
None
  


The effect of derivative instruments on the consolidated financial statements for the three months ended June 30, 2011 was as follows (in thousands):
 
Effective Portion
 
Ineffective Portion
Type of Cash Flow Hedge
Hedge Loss
Recognized in
Other
Comprehensive
Loss
 
Condensed Consolidated Statements of
Operations Classification of Gain
(Loss) Reclassified from
Accumulated Other Comprehensive
Income
 
Hedge Gain Reclassified from
Accumulated
Other
Comprehensive
Income
 
Condensed Consolidated
Statements of
Operations
Classification
of Gain (Loss)
Recognized
 
Hedge Gain
(Loss)
Recognized
Foreign currency forward exchange contracts
$
(55
)
  
 
  
 
 
 
  
 
 
 
  
Cost of sales
  
$
20

 
None
  
$

 
 
  
Research and development
  
127

 
None
  

 
 
  
Selling, general and administrative
  
31

 
None
  



19



The effect of derivative instruments on the consolidated financial statements for the six months ended June 30, 2011 was as follows (in thousands):
 
Effective Portion
 
Ineffective Portion
Type of Cash Flow Hedge
Hedge Gain
Recognized in
Other
Comprehensive
Loss
 
Condensed Consolidated Statements of
Operations Classification of Gain
(Loss) Reclassified from
Accumulated Other Comprehensive
Income
 
Hedge Gain Reclassified from
Accumulated
Other
Comprehensive
Income
 
Condensed Consolidated
Statements of
Operations
Classification
of Gain (Loss)
Recognized
 
Hedge Gain
(Loss)
Recognized
Foreign currency forward exchange contracts
$
57

  
 
  
 
 
 
  
 
 
 
  
Cost of sales
  
$
35

 
None
  
$

 
 
  
Research and development
  
230

 
None
  

 
 
  
Selling, general and administrative
  
74

 
None
  


Over the next twelve months, the Company expects to reclassify into earnings a loss of approximately $0.8 million currently recorded as other comprehensive loss, as a result of the maturity of currently held forward exchange contracts.

The bank counterparties in these contracts expose the Company to credit-related losses in the event of their nonperformance. However, to mitigate that risk, the Company only contracts with counterparties who meet its minimum requirements regarding counterparty credit worthiness. In addition, the Company monitors credit ratings, credit spreads and potential downgrades prior to entering into any new hedging contracts.

Note 15 — Segment Information

The Company's Chief Operating Decision Maker, our Chief Executive Officer, reviews our results of operations on a consolidated level. Therefore, the Company is one operating segment. Key resources, decisions, and assessment of performance are also analyzed on a company-wide level.

Revenues on a product and services basis are as follows (in thousands):
 
For the Three Months Ended

For the Six Months Ended
 
June 30,

June 30,
 
2012

2011

2012
  
2011
Hardware
$
62,170

 
$
71,227

 
$
125,640

 
$
139,692

Software royalties and licenses
7,162

 
4,508

 
11,413

 
5,991

Technical support services
3,740

 
2,664

 
7,276

 
5,039

Engineering and other services
4,512

 
1,457

 
8,742

 
2,761

Total revenues
$
77,584

 
$
79,856

 
$
153,071

  
$
153,483


Generally, the Company's customers are not the end-users of its products. The Company ultimately derives revenues from the four product groups as follows (in thousands):
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
  
2011
ATCA Platforms
36,518

 
22,891

 
$
74,181

 
$
50,460

COM Express and Rackmount Server
11,931

 
14,124

 
24,103

 
27,041

Software-Solutions
16,102

 
9,925

 
28,162

 
13,533

Other Products
13,033

 
32,916

 
26,625

 
62,449

Total revenues
$
77,584

 
$
79,856

 
$
153,071

 
$
153,483



20



Information about the Company’s geographic revenues and long-lived assets by geographical area is as follows (in thousands):

Geographic Revenues
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
  
2011
 
2012
 
2011
United States
$
25,530

 
$
23,651

 
$
54,291

 
$
42,357

Other North America
861

 
252

 
1,661

 
592

North America
26,391

  
23,903

 
55,952

 
42,949

Europe, the Middle East and Africa (“EMEA”)
12,371

 
16,340

 
31,819

 
41,796

Asia Pacific
38,822

 
39,613

 
65,300

 
68,738

Total
$
77,584

  
$
79,856

 
$
153,071

 
$
153,483


Long-lived assets by Geographic Area
 
 
June 30,
2012
  
December 31,
2011
Property and equipment, net
 
  
 
United States
$
8,808

  
$
8,748

Other North America
521

  
568

EMEA
2,899

  
2,928

Asia Pacific
3,770

  
3,122

Total property and equipment, net
$
15,998

  
$
15,366

Goodwill
 
  
 
United States
$
29,588

 
$
29,588

EMEA
160

  
160

Total goodwill
$
29,748

  
$
29,748

Intangible assets, net
 
  
 
United States
$
75,878

  
$
82,975

Other North America
299

  
386

EMEA
1,426

  
1,682

Total intangible assets, net
$
77,603

  
$
85,043


The following customers accounted for more than 10% of the Company's total revenues:

For the Three Months Ended

For the Six Months Ended
 
June 30,

June 30,
 
2012
 
2011

2012
 
2011
Nokia Siemens Networks
20.3
%
 
51.9
%

22.8
%
 
47.3
%
NEC
16.3
%
 
NA

 
11.8
%
 
NA


The following customer accounted for more than 10% of accounts receivable:
 
 
June 30, 2012

 
December 31, 2011
Nokia Siemens Networks
 
23.2
%
 
23.4
%



21




Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Introduction

You should read the following discussion and analysis in conjunction with our condensed consolidated financial statements and the related notes thereto included in this Report on Form 10-Q and with Management’s Discussion and Analysis of Financial Condition and Results of Operations contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.
This report contains forward-looking statements including:

expectations and goals for revenues, gross margin, research and development expenses ("R&D"), selling, general, and administrative expenses ("SG&A") and profits;
the impact of our restructuring events on future operating results;
our projected liquidity;
future operations and market conditions;
industry trends or conditions and the business environment;
future levels of inventory and backlog and new products introductions;
expected synergies and other expense savings and operational and administrative efficiencies, opportunities, timing, expense and effects of the acquisition of Continuous Computing;
financial performance, revenue growth, management changes or other attributes of Radisys following the acquisition; and
other statements that are not historical facts.

All statements that relate to future events or to our future performance are forward-looking statements. In some cases, forward-looking statements can be identified by terms such as “may,” “will,” “should,” “expect,” “plans,” “seeks,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” “seek to continue,” “consider”, “intends,” or other comparable terminology. These forward-looking statements are made pursuant to safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results or our industries’ actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements.

These factors include, among others, the Company's high degree of customer concentration, the Company's transition to one contract manufacturer and use of the single contract manufacturer for a significant portion of the production of our products, key employee attrition, the anticipated amount and timing of revenues from design wins due to the Company's customers' product development schedule, cancellations or delays, matters affecting the embedded system industry, including changes in industry standards, changes in customer requirements and new product introductions, currency exchange rate fluctuations, changes in tariff and trade policies and other risks associated with foreign operations, actions by regulatory authorities or other third parties, actions by Continuous Computing's former shareholders, costs and difficulties related to integration of acquired businesses, delays, costs and difficulties related to the transaction, market conditions, the Company's ability to successfully integrate the business and operations of Continuous Computing and higher than expected costs of integration, the Company's ability to successfully manage the transition from 10G to 40G ATCA product technologies, performance and customer acceptance of the Trillium line of products, the combined companies' financial results and performance, satisfaction of closing conditions, and other factors described in "Risk Factors" and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2011, as updated in the subsequent quarterly reports on Form 10-Q. Although forward-looking statements help provide additional information about us, investors should keep in mind that forward-looking statements are only predictions, at a point in time, and are inherently less reliable than historical information.

We do not guarantee future results, levels of activity, performance or achievements, and we do not assume responsibility for the accuracy and completeness of these statements. The forward-looking statements contained in this report are made and based on information as of the date of this report. We assume no obligation to update any of these statements based on information after the date of this report.

Unless required by context, or as otherwise indicated, “we,” “us,” “our” and similar terms, as well as references to the “Company” and “Radisys” refer to Radisys Corporation and include all of our consolidated subsidiaries.



22



Overview

Radisys Corporation is a leading provider of embedded wireless infrastructure solutions for telecom, aerospace, defense and public safety applications. Radisys' market-leading Advanced Telecommunications Computing Architecture (“ATCA”), Internet Protocol (“IP”) Media Server, Computer-on-Module (“COM”) Express, Rackmount Server platforms and world-renowned Trillium software coupled with an expert professional services organization and market expertise enable Radisys customers to bring high-value products and services to market faster with lower investment and risk. Radisys solutions are used in a wide variety of 3G & 4G / Long-Term Evolution ("LTE") mobile network applications including: Radio Access Networks ("RAN") solutions from femtocells to picocells and macrocells, wireless core network applications, Deep Packet Inspection ("DPI") and policy management, conferencing and media services including voice, video and data, as well as customized mobile network applications that support the aerospace, defense and public safety markets.

As disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011, in the first quarter of 2012 we changed our revenue reporting to align with how management began assessing revenues in 2012. Specifically, revenue will be disclosed in the following four product groups: ATCA Platforms, COM Express and Rackmount Server Products, Software-Solutions and Other Products. The total ATCA Platforms and Software-Solutions revenue represents the previously disclosed Next Generation Communications Networks revenue; COM Express and Rackmount Server revenue represents most of the previously disclosed Commercial Products revenue and Other Products revenue represents the previously disclosed Legacy Communications revenue as well as previously reported Commercial Products revenue that is not COM Express or Rackmount Server products. We have conformed prior period presentation to align our management's discussion and analysis with our new revenue reporting policy.

Second Quarter 2012 Summary

Revenues decreased $2.3 million to $77.6 million for the three months ended June 30, 2012 from $79.9 million for the three months ended June 30, 2011. The decrease was primarily the result of an expected decline in Other Products revenue as these hardware centric products trend towards end of life. This decline was offset by an increase in ATCA and Software-Solutions revenue due to the July 2011 acquisition of Continuous Computing Corporation ("Continuous Computing").

Our gross margin increased 4.6 percentage points in the three months ended June 30, 2012 to 34.4% from 29.8% of revenue in the three months ended June 30, 2011. The increase reflects favorable product mix towards our ATCA and Software-Solutions products and the impact of synergy cost savings resulting from the integration of Continuous Computing.

R&D expense increased $2.1 million to $11.7 million for the three months ended June 30, 2012 from $9.6 million for the three months ended June 30, 2011 due to the acquisition of Continuous Computing and increased product development costs associated with the development of our T-series 40G ATCA products. These increases were offset by a lower cost structure per employee resulting from the transition of R&D resources to lower cost geographies.

SG&A expense decreased $0.7 million to $10.2 million for the three months ended June 30, 2012 from $10.9 million for the three months ended June 30, 2011. The decrease is the result of a decrease in restructuring related expenses as well as the reversal of Long Term Incentive Plan ("LTIP") stock compensation expense. These decreases are offset by the increase in expenses related to the acquisition of Continuous Computing.

Cash and cash equivalents decreased $1.9 million to $45.9 million at June 30, 2012 from $47.8 million at December 31, 2011. The decrease in cash and cash equivalents was primarily due to capital expenditures associated with the build out of our international facilities, other integration related activities associated with the acquisition of Continuous Computing and the addition of 40G ATCA test equipment.


23



Comparison of the Three and Six Months Ended June 30, 2012 and 2011

Results of Operations

The following table sets forth certain operating data as a percentage of revenues for the three and six months ended June 30, 2012 and 2011:
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
  
2011
 
2012
 
2011
Revenues
100.0
 %
 
100.0
 %
 
100.0
 %
 
100.0
 %
Cost of sales:
 
 
 
 
 
 
 
Cost of sales
62.5

 
68.7

 
64.3

 
69.8

Amortization of purchased technology
3.1

 
1.5

 
3.2

 
1.5

Total cost of sales
65.6

 
70.2

 
67.5

 
71.3

Gross margin
34.4

 
29.8

 
32.5

 
28.7

Research and development
15.1

 
12.1

 
15.8

 
12.1

Selling, general, and administrative
13.1

 
13.6

 
14.5

 
14.3

Intangible asset amortization
1.7

 
0.2

 
1.7

 
0.3

Restructuring and acquisition-related charges, net
1.4

 
3.1

 
1.7

 
1.6

Income (loss) from operations
3.1

 
0.8

 
(1.2
)
 
0.4

Interest expense
(0.6
)
 
(0.6
)
 
(0.6
)
 
(0.6
)
Interest income

 

 

 

Other income (expense), net
0.2

 

 
0.2

 
(0.1
)
Income (loss) before income tax expense (benefit)
2.7

 
0.2

 
(1.6
)
 
(0.3
)
Income tax expense (benefit)
1.0

 

 
0.7

 
(0.1
)
Net income (loss)
1.7
 %
 
0.2
 %
 
(2.3
)%
 
(0.2
)%
 
Revenues

The following table sets forth our revenues by market (in thousands) for the three and six months ended June 30, 2012 and 2011:
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
Change
 
2012
 
2011
 
Change
ATCA Platforms ("ATCA")
$
36,518

 
$
22,891

 
59.5
 %
 
$
74,181

 
$
50,460

 
47.0
 %
COM Express and Rackmount Server
11,931

 
14,124

 
(15.5
)
 
24,103

 
27,041

 
(10.9
)
Software-Solutions
16,102

 
9,925

 
62.2

 
28,162

 
13,533

 
108.1

Other Products
13,033

 
32,916

 
(60.4
)
 
26,625

 
62,449

 
(57.4
)
Total revenues
$
77,584

 
$
79,856

 
(2.8
)%
 
$
153,071

 
$
153,483

 
(0.3
)%

Revenues in the ATCA product group increased $13.6 million and $23.7 million for the three and six months ended June 30, 2012 from the comparable periods in 2011. Increased deployment to customers in the Japanese market to alleviate network capacity constraints resulted in an increase to ATCA revenue of $4.9 million and $3.5 million for the three and six months ending June 30, 2012. In addition, the July 2011 acquisition of Continuous Computing contributed $14.0 million and $24.0 million to ATCA revenue for the three and six months ending June 30, 2012. This increase is offset by softening of demand from our existing customer base due to weakening telecom spending. We expect telecom spending to remain weak throughout the remainder of 2012; however, we expect 10-15% long-term revenue growth in our ATCA product group.

Revenues in the COM Express and Rackmount Server product group decreased $2.2 million and $2.9 million for the three and six months ended June 30, 2012 from the comparable periods in 2011. We expect revenues from the Rackmount Server

24



product line to decline in 2012; however, in 2011 we began reinvesting in this product line and expect revenue growth to resume in 2013.

Revenues in the Software-Solutions product group increased $6.2 million and $14.6 million for the three and six months ended June 30, 2012 from the comparable periods in 2011. The increase in revenue reflects the addition of Trillium products as a result of the acquisition of Continuous Computing which contributed $4.9 million and $9.5 million for the three and six months ended June 30, 2012. In addition, strong demand for our Media Server products resulting from timing of deployments by our largest customer resulted in an increase of $1.4 million and $5.6 million for the three and six months ended June 30, 2012 from the comparable periods in 2011. A decline in Software-Solutions revenues is expected during the second half of 2012 due to the timing of deployments with our largest customers; however, we expect 10-15% long-term revenue growth in our Software-Solutions product group.

Revenues in the Other Products product group decreased $19.9 million and $35.8 million for the three and six months ended June 30, 2012 from the comparable periods in 2011, as these hardware centric products trend towards end of life.

Revenue by Geography

The following tables outline overall revenue dollars and the percentage of revenues, by geographic region, for the three and six months ended June 30, 2012 and 2011:
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
Change
 
2012
 
2011
 
Change
North America
$
26,391

 
$
23,903

 
10.4
 %
 
$
55,952

 
$
42,949

 
30.3
 %
Europe, the Middle East and Africa ("EMEA")
12,371

 
16,340

 
(24.3
)
 
31,819

 
41,796

 
(23.9
)
Asia Pacific
38,822

 
39,613

 
(2.0
)
 
65,300

 
68,738

 
(5.0
)
Total
$
77,584

 
$
79,856

 
(2.8
)%
 
$
153,071

 
$
153,483

 
(0.3
)%

 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
2012
 
2011
North America
34.0
%
 
29.9
%
 
36.5
%
 
28.0
%
EMEA
15.9

 
20.5

 
20.8

 
27.2

Asia Pacific
50.1

 
49.6

 
42.7

 
44.8

Total
100.0
%
 
100.0
%
 
100.0
%
 
100.0
%

North America. Revenues from the North America region increased $2.5 million and $13.0 million for the three and six months ended June 30, 2012 from the comparable periods in 2011. ATCA products decreased $1.3 million and increased $7.3 million for the three and six months ended June 30, 2012 compared to the comparable periods of 2011 due to timing of deployments with our largest customers as shipments to these customers were heavily weighted towards the first quarter of 2012. In addition, Software-Solutions revenue for the three and six months ended June 30, 2012 increased $5.7 million and $9.3 million from the comparable periods in 2011 due to the addition of Trillium products and timing of deployments with our largest Media Server customers.
  
EMEA. Revenues from the EMEA region decreased $4.0 million and $10.0 million for the three and six months ended June 30, 2012 from the comparable periods in 2011. The decrease is attributable to continued softening demand from telecom providers due to economic uncertainty in Europe.

Asia Pacific. Revenues from the Asia Pacific region decreased $0.8 million and $3.4 million for the three and six months ended June 30, 2012 from the comparable periods in 2011. The decrease reflects a decline of $11.8 million and $17.9 million in Other Products revenue for the three and six months ended June 30, 2012 from the comparable periods in 2011 due to an expected decline in revenues as these hardware centric products trend towards end of life. This decrease was offset by increases in ATCA revenue of $13.8 million and $17.8 million for the three and six months ended June 30, 2012 from the comparable periods in 2011 as a result of deployments by our Japanese customers.


25



We currently expect continued fluctuations in the percentage of revenue from each geographic region. Additionally, we expect non-U.S. revenues to remain a significant portion of our revenues.
 
Gross Margin
 
For the Three Months Ended
 
For the Six Months Ended
 
June 30,
 
June 30,
 
2012
 
2011
 
Change
 
2012
 
2011
 
Change
Cost of Sales
$
48,542

 
$
54,933

 
(11.6
)%
 
$
98,547

 
$
107,167

 
(8.0
)%
Amortization of Purchased Technology
2,391