UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

OR

o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from            to

RADISYS CORPORATION

OREGON		93-0945232
(State or other jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification Number)

5445 N.E. Dawson Creek Drive
Hillsboro, OR 97124
(Address of principal executive offices, including zip code)

(503) 615-1100
(Registrant’s telephone number, including area code)

     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 the filing requirements for the past 90 days.  Yes  þ  No  o

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act)  Yes  þ  No  o

Number of shares of Common Stock outstanding as of August 2, 2005: 20,187,195

 

 

RADISYS CORPORATION
FORM 10-Q

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements			3
Consolidated Statements of Operations (unaudited) — Three Months and Six Months Ended June 30, 2005 and 2004			3
Consolidated Balance Sheets — June 30, 2005 (unaudited) and December 31, 2004			4
Consolidated Statement of Changes in Shareholders’ Equity (unaudited) — Six Months Ended June 30, 2005			5
Consolidated Statements of Cash Flows (unaudited) — Six Months Ended June 30, 2005 and 2004			6
Notes to the Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3. Quantitative and Qualitative Disclosures About Market Risk			40
Item 4. Controls and Procedures			42
PART II. OTHER INFORMATION
Item 4. Submission of Matters to a Vote of Security Holders			43
Item 6. Exhibits and Reports on Form 8-K			45
Signatures
EXHIBIT 10.1
EXHIBIT 31.1
EXHIBIT 31.2
EXHIBIT 32.1
EXHIBIT 32.2

PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

RADISYS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Revenues		$	65,956			$	60,253			$	123,473			$	121,368
Cost of sales			46,557				40,231				85,532				82,528
Gross margin			19,399				20,022				37,941				38,840
Research and development			7,292				7,135				14,823				13,479
Selling, general, and administrative			7,708				7,684				14,962				15,361
Intangible assets amortization			513				515				1,026				1,197
Restructuring and other charges (reversals)			1,146				(678	)			1,128				(858	)
Income from operations			2,740				5,366				6,002				9,661
Loss on repurchase of convertible subordinated notes			(1	)			(387	)			(4	)			(387	)
Interest expense			(527	)			(1,049	)			(1,069	)			(2,475	)
Interest income			1,399				772				2,570				1,628
Other (expense) income, net			(113	)			(27	)			(462	)			51
Income before income tax provision			3,498				4,675				7,037				8,478
Income tax provision			933				1,168				1,886				2,123
Net income		$	2,565			$	3,507			$	5,151			$	6,355
Net income per share:
Basic		$	0.13			$	0.19			$	0.26			$	0.34
Diluted		$	0.11			$	0.16			$	0.23			$	0.29
Weighted average shares outstanding:
Basic			19,982				18,826				19,882				18,659
Diluted			24,620				23,833				24,548				23,765

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

RADISYS CORPORATION

CONSOLIDATED BALANCE SHEETS

		June 30,				December 31,
		2005				2004
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	69,184			$	80,566
Short-term investments, net			117,094				78,303
Accounts receivable, net			43,366				42,902
Other receivables			4,991				2,808
Inventories, net			20,149				22,154
Other current assets			1,750				2,675
Deferred tax assets			4,216				4,216
Total current assets			260,750				233,624
Property and equipment, net			14,113				14,002
Goodwill			27,521				27,521
Intangible assets, net			3,185				4,211
Long-term investments, net			25,500				39,750
Long-term deferred tax assets			22,781				23,224
Other assets			3,579				2,906
Total assets		$	357,429			$	345,238
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	36,172			$	31,585
Accrued wages and bonuses			4,800				5,626
Accrued interest payable			355				378
Accrued restructuring			1,281				1,569
Other accrued liabilities			7,459				7,832
Total current liabilities			50,067				46,990
Long-term liabilities:
Convertible senior notes, net			97,213				97,148
Convertible subordinated notes, net			8,776				9,867
Total long-term liabilities			105,989				107,015
Total liabilities			156,056				154,005
Shareholders’ equity :
Preferred stock — $.01 par value, 10,000 shares authorized; none issued or outstanding			—				—
Common stock — no par value, 100,000 shares authorized; 20,145 and 19,655 shares issued and outstanding at June 30, 2005 and December 31, 2004			187,924				182,705
Retained earnings			9,468				4,317
Accumulated other comprehensive income:
Cumulative translation adjustments			3,981				4,211
Total shareholders’ equity			201,373				191,233
Total liabilities and shareholders’ equity		$	357,429			$	345,238

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

RADISYS CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

										Cumulative												Total other
		Common Stock								translation				Retained								comprehensive
		Shares				Amount				adjustments(1)				earnings				Total				income (2)
Balances, December 31, 2004			19,655			$	182,705			$	4,211			$	4,317			$	191,233
Shares issued pursuant to benefit plans			450				4,092				—				—				4,092			$	—
Restricted stock compensation			41				31												31
Restricted stock cancelled			(1	)
Tax benefit associated with stock-based benefit plans			—				1,096				—				—				1,096				—
Translation adjustments			—				—				(230	)			—				(230	)			(230	)
Net income for the period			—				—				—				5,151				5,151				5,151
Balances, June 30, 2005			20,145			$	187,924			$	3,981			$	9,468			$	201,373
Comprehensive income, for the six months ended June 30, 2005																						$	4,921

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

RADISYS CORPORATION

		For the Six Months Ended
		June 30,
		2005				2004
Cash flows from operating activities:
Net income		$	5,151			$	6,355
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			4,022				3,845
Provision for inventory reserves			1,475				1,501
Non-cash restructuring charges (adjustments)			30				(858	)
Non-cash interest expense			122				216
Non-cash amortization of premium on investments			8				912
Loss on disposal of property and equipment			1				3
Loss on early extinguishments of convertible subordinated notes			4				387
Deferred income taxes			444				572
Stock-based compensation expense			31				533
Tax benefit of stock-based benefit plans			1,096				1,720
Other			(286	)			(113	)
Changes in operating assets and liabilities:
Accounts receivable			(498	)			(5,806	)
Other receivables			(2,183	)			(2,627	)
Inventories			530				2,861
Other current assets			1,086				129
Accounts payable			4,609				4,252
Accrued restructuring			(268	)			(1,664	)
Accrued interest payable			(23	)			502
Accrued wages and bonuses			(784	)			(1,211	)
Other accrued liabilities			(355	)			(844	)
Net cash provided by operating activities			14,212				10,665
Cash flows from investing activities:
Proceeds from sale or maturity of held-to-maturity investments			41,500				31,130
Purchase of held-to-maturity investments			(36,499	)			(18,645	)
Proceeds from sale of maturity of auction rate securities			27,400				—
Purchase of auction rate securities			(56,950	)			—
Capital expenditures			(3,083	)			(2,148	)
Other			(29	)			—
Net cash provided by (used in) investing activities			(27,661	)			10,337
Cash flows from financing activities:
Early extinguishments of convertible subordinated notes			(1,115	)			(58,168	)
Borrowings under revolving line of credit			—				13,000
Repayments on revolving line of credit			—				(13,000	)
Proceeds from issuance of common stock			4,092				6,717
Net cash provided by (used in) financing activities			2,977				(51,451	)
Effects of exchange rate changes on cash			(910	)			(169	)
Net decrease in cash and cash equivalents			(11,382	)			(30,618	)
Cash and cash equivalents, beginning of period			80,566				149,925
Cash and cash equivalents, end of period		$	69,184			$	119,307

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

RADISYS CORPORATION

Note 1 — Significant Accounting Policies

          RadiSys Corporation (the “Company”) has adhered to the accounting policies set forth in its Annual Report on Form 10-K for the year ended December 31, 2004 in preparing the accompanying interim Consolidated Financial Statements. The preparation of these statements in conformity with accounting principles generally accepted in the United States of America 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.

          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.

          For the three and six month periods ended June 30, 2005, there have been no changes to these accounting policies.

     Reclassifications

          Certain reclassifications have been made to amounts in prior years to conform to current year presentation. These changes had no effect on previously reported results of operations or shareholders’ equity.

     Inventory Reserves

          The Company records the provision for inventory reserves for estimated obsolete or unmarketable inventories as the difference between the cost of inventories and the estimated net realizable value based upon assumptions about future demand and market conditions. Factors influencing the provision include: changes in demand, rapid technological changes, product life cycle and development plans, component cost trends, product pricing, and physical deterioration. If actual market conditions are less favorable than those projected by management additional provisions for inventory reserves may be required. The Company’s estimate for the provision is based on the assumption that the Company’s customers comply with their current contractual obligations. The Company provides long-life support to its customers and therefore the Company has material levels of customer specific inventory. If the Company’s customers experience a financial hardship or if the Company experiences unplanned cancellations of customer contracts, the current provision for the inventory reserves may be inadequate. Additionally, the Company may incur additional expenses associated with any non-cancelable purchase obligations to our suppliers if they provide customer-specific components.

     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, for which there is no alternative use. As the Company continues to execute its strategy of increasing the level of outsourced manufacturing the liability for adverse purchase commitments will become more significant. 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 liabilities to our excess and obsolete inventory reserve. This liability, referred to as adverse purchase commitments, is provided for in other accrued liabilities. Adverse purchase commitments amounted to $599 thousand and $485 thousand at June 30, 2005 and December 31, 2004, respectively.

     Accrued Restructuring and Other Charges

          In July 2002, the Financial Accounting Standard Board (“FASB”) issued Statement of Financial Accounting Standard (“SFAS”) No. 146 “Accounting for Costs Associated with Exit or Disposal Activities.” SFAS No. 146 requires that liabilities for costs associated with exit or disposal activities be recognized and measured initially at fair value in the period in which the liabilities are incurred. For the six months ended June 30, 2005 and 2004 the Company recorded non-severance related restructuring and other charges in accordance with the provisions of SFAS No. 146. Because the Company has a history of paying severance benefits, the cost of severance benefits associated with a restructuring charge is recorded when such costs are probable and the amount can be reasonably estimated.

          Prior to the year ended December 31, 2003, the Company recorded restructuring charges including employee termination and related costs, costs related to leased facilities, losses on impairment of fixed assets and capitalized software and other accounting and legal fees. Employee termination and related costs were previously recorded in accordance with the provisions of Emerging Issues Task Force No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” For leased facilities that were vacated and subleased, an amount equal to the total future lease obligations from the date of vacating the premises through the expiration of the lease, net of any future sublease income, was recorded as a part of restructuring charges.

     Guarantees and Indemnification Obligations

          In November 2002, the FASB issued FIN No. 45, “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others,” an interpretation of SFAS No. 5, 57, and 107 and rescission of FASB Interpretation No. 34. FIN No. 45 requires that a guarantor recognize, at the inception of a guarantee, a liability for the fair value of the obligation undertaken by issuing the guarantee and requires additional disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees it has issued. The adoption of FIN No. 45 did not have a material effect on the Company’s financial position or results of operations. The following is a summary of the agreements that the Company has determined are within the scope of FIN No. 45.

          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 the 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. As a result of the Company’s insurance policy coverage, 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, 2005.

          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 our business partners or customers, in connection with patent, copyright or other intellectual property infringement claims by any third party with respect to our current products, as well as claims relating to property damage or personal injury resulting from the performance of services by us or our subcontractors. The maximum potential amount of future payments we could be required to make under these indemnification agreements is generally limited. Historically, our costs to defend lawsuits or settle claims relating to such indemnity agreements have been minimal and accordingly the estimated fair value of these agreements is immaterial.

          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 24 months after shipment. Parts and labor are covered under the terms of the warranty agreement. The workmanship of our products produced by contract manufacturers is covered under warranties provided by the contract manufacturer for a specific period of time ranging from 12 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 liability for the six months ended June 30, 2005 and 2004 (in thousands):

		For the Six Months
		Ended June 30,
		2005				2004
Warranty liability balance, beginning of the period		$	1,719			$	2,276
Product warranty accruals			1,678				951
Adjustments for payments made			(1,560	)			(1,639	)
Warranty liability balance, end of the period		$	1,837			$	1,588

          The warranty liability balance is included in other accrued liabilities in the accompanying Consolidated Balance Sheets as of June 30, 2005 and December 31, 2004. The Company offers fixed price support or maintenance contracts to some customers. Revenues from fixed price support or maintenance contracts were not significant to the Company’s operations for the periods reported.

     Stock-based Compensation

          The Company accounts for its stock-based compensation plans using the intrinsic value method and provides pro forma disclosures of net income and net income per common share as if the fair value method had been applied in measuring compensation expense. Equity instruments are granted to employees, directors, and consultants in certain instances, as defined in the respective plan agreements.

          Had the Company accounted for these plans under the fair value method, net income and pro forma net income per share would have been reported as follows (in thousands, except per share amounts):

		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Net income		$	2,565			$	3,507			$	5,151			$	6,355
Add: Stock-based compensation expense included in reported net income, net of related tax effects			19				220				19				329
Deduct: Stock-based compensation expense determined under fair value method for all awards, net of related tax effects			(813	)			(2,015	)			(1,446	)			(3,453	)
Pro forma net income		$	1,771			$	1,712			$	3,724			$	3,231
Net income per share:
Basic		$	0.13			$	0.19			$	0.26			$	0.34
Diluted		$	0.11			$	0.16			$	0.23			$	0.29
Pro forma basic		$	0.09			$	0.09			$	0.19			$	0.17
Pro forma diluted		$	0.08			$	0.08			$	0.17			$	0.16

          During the three and six month periods ended June 30, 2005, the Company incurred $31 thousand of stock-based compensation associated with the issuance of restricted stock. See note 10. During the three and six month periods ended June 30, 2004, the Company incurred $356 thousand and $533 thousand of stock-based compensation expense, respectively. The stock-based compensation expense was associated with shares issued and to be issued pursuant to the Company’s 1996 Employee Stock Purchase Plan (“ESPP”). The Company incurred stock-based compensation expense because the original number of ESPP shares approved by the shareholders were insufficient to meet employee demand for an ESPP offering which was consummated in February 2003 and ended in August 2004. The Company subsequently received shareholder approval for additional ESPP shares in May 2003. The shares issued and to be issued in the February 2003 ESPP offering in excess of the original number of ESPP shares approved at the beginning of the offering (the “shortfall”) triggers recognition of stock-based compensation expense under the intrinsic value method. The shortfall amounted to 138 thousand and 149 thousand shares in May 2004 and August 2004, respectively.

          The expense per share is calculated as the difference between 85% of the closing price of RadiSys shares as quoted on NASDAQ on the date that additional ESPP shares were approved (May 2003) and the February 2003 ESPP offering purchase price. Accordingly, the expense per share is calculated as the difference between $8.42 and $5.48. The shortfall of shares is dependent on the amount of contributions from participants enrolled in the February 2003 ESPP offering.

          The Company recognized stock-based compensation expense as follows (in thousands):

		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Cost of sales		$	4			$	34			$	4			$	81
Research and development			13				177				13				251
Selling, general and administrative			14				145				14				201
		$	31			$	356			$	31			$	533

     Recent Accounting Pronouncements

          FASB Staff Position (“FSP”) No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004” (“FSP 109-2”), provides guidance under SFAS No. 109, “Accounting for Income Taxes,” with respect to recording the potential impact of the repatriation provisions of the American Jobs Creation Act of 2004 (the “Jobs Act”) on income tax expense and deferred tax liabilities. The Jobs Act was enacted on October 22, 2004. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Jobs Act on its plan for reinvestment or repatriation of foreign earnings for purposes of applying SFAS No. 109. RadiSys expects to make its repatriation determination by the end of fiscal 2005. Accordingly, as provided for in FSP 109-2, RadiSys has not adjusted its tax expense or deferred tax liability to reflect the repatriation provisions of the Jobs Act.

          In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”). SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the financial statements based on their fair values. The effective date for the Company is the beginning of the first fiscal quarter of 2006. Effective November 12, 2004, RadiSys accelerated the vesting of all outstanding stock options with an option price greater than $15.99 in anticipation of implementation of Statement No. 123R. Such acceleration of vesting was done for the purpose of avoiding future expense associated with any unvested stock options granted prior to the effective date of Statement No. 123R. If we were to continue to use the fair value method currently used for reporting pro forma disclosures of net income (loss) and net income (loss) per common share, we estimate a reduction in stock-based compensation expense associated with the acceleration of approximately $3.7 million for the year ended December 31, 2006.

          In March 2005, the SEC issued Staff Accounting Bulletin No. 107 (“SAB 107”) regarding the SEC’s interpretation of SFAS 123R and the valuation of share-based payments for public companies. RadiSys is evaluating the requirements of SFAS 123R and SAB 107 and expects that the adoption of SFAS 123R on January 1, 2006 will have a material impact on RadiSys’ consolidated results of operations and earnings per share. RadiSys has not yet determined the method of adoption or the effect of adopting SFAS 123R, and it has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures under SFAS 123.

          The following recent accounting pronouncements either did not have a material impact on RadiSys’ results of operations and financial condition upon adoption or in the case of pronouncements not yet effective it is anticipated that adoption will not have a material impact on RadiSys’ results of operations and financial condition:

	•		SFAS No. 153, “Exchanges of Nonmonetary Assets—An Amendment of APB Opinion No. 29, Accounting for Nonmonetary Transactions.”
	•		FSP No. 106-2 (“FSP 106-2”), “Accounting and Disclosure Requirements Related to the Medicare Prescription Drug, Improvement and Modernization Act of 2003” (the “Medicare Act”)
	•		FSP No. 46(R)-5, “Implicit Variable Interests under FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities”
	•		FASB Interpretation No. 47 . “Accounting for Conditional Asset Retirement Obligations an interpretation of FASB Statement No. 143”

          In November 2004, the FASB issued SFAS No. 151, “Inventory Costs—An Amendment of ARB No. 43, Chapter 4” (“SFAS 151”). SFAS 151 amends the guidance in ARB No. 43, Chapter 4, “Inventory Pricing,” to clarify the accounting for abnormal amounts of idle facility expense, freight, handling costs, and wasted material (spoilage). Among other provisions, the new rule requires that items such as idle facility expense, excessive spoilage, double freight, and re-handling costs be recognized as current-period charges regardless of whether they meet the criterion of “so abnormal” as stated in ARB No. 43. Additionally, SFAS 151 requires that the allocation of fixed production overheads to the costs of conversion be based on the normal capacity of the production facilities. SFAS 151 is effective for fiscal years beginning after June 15, 2005 and is required to be adopted by RadiSys in the first quarter of fiscal 2006. RadiSys is currently evaluating the effect that the adoption of SFAS 151 will have on its consolidated results of operations and financial condition and does not expect the adoption to have a material impact.

Note 2 — Investments

          Short-term and long-term investments consisted of the following (in thousands):

		June 30,				December 31,
		2005				2004
Short-term held-to-maturity investments, including unamortized discount of $56 and premium of $103, respectively		$	26,544			$	17,303
Short-term available-for-sale investments		$	90,550			$	61,000
Long-term held-to-maturity investments*		$	25,500			$	39,750

          The Company invests excess cash in debt instruments of the U.S. Government and its agencies, those of high-quality corporate issuers and municipalities. The company’s investments in the debt instruments of municipalities primarily consist of investments in auction rate securities. Auction rate securities have been classified as available-for-sale short-term investments. Available-for-sale securities are recorded at fair value, and unrealized holding gains and losses are recorded, net of tax, as a separate component of accumulated other comprehensive income. For the three months ended June 30, 2005 and 2004 the Company did not recognize any gains or losses on the sales of available-for-sale investments as the fair value of these investments approximated there carrying value. The Company incurred no unrealized gains or losses on investments classified as available-for-sale as of June 30, 2005 or December 31, 2004. As of June 30, 2005, the Company’s long-term held-to-maturity investments had maturities ranging from 13 months to 14 months. The Company’s investment policy requires that the total investment portfolio, including cash and investments, not exceed a maximum weighted-average maturity of 18 months. In addition, the policy mandates that an individual investment must have a maturity of less than 36 months, with no more than 20% of the total portfolio exceeding 24 months. As of June 30, 2005, the Company was in compliance with its investment policy.

Note 3 — Accounts Receivable and Other Receivables

          Accounts receivable consists of trade accounts receivable. Accounts receivable balances consisted of the following (in thousands):

		June 30,				December 31,
		2005				2004
Accounts receivable, gross		$	44,247			$	43,790
Less: allowance for doubtful accounts			(881	)			(888	)
Accounts receivable, net		$	43,366			$	42,902

          The Company recorded no provisions for allowance for doubtful accounts during the six months ended June 30, 2005 and 2004.

          As of June 30, 2005 and December 31, 2004 the balance in other receivables was $4,991 thousand and $2,808 thousand, respectively. Other receivables consists of non-trade receivables. There is no revenue recorded associated with non-trade receivables. At June 30, 2005 and December 31, 2004 other receivables primarily consisted of receivables for the sale of inventory to the Company’s contract manufacturing partners. Sales to the Company’s contract manufacturing partners are based on terms and conditions similar to the terms offered to the Company’s regular customers.

Note 4 — Inventories

          Inventories consisted of the following (in thousands):

		June 30,				December 31,
		2005				2004
Raw materials		$	19,992			$	24,044
Work-in-process			1,925				1,505
Finished goods			4,641				3,958
			26,558				29,507
Less: inventory reserves			(6,409	)			(7,353	)
Inventories, net		$	20,149			$	22,154

          During the three months ended June 30, 2005 and 2004, the Company recorded provision for excess and obsolete inventory of $832 thousand and $785 thousand, respectively. During both the six months ended June 30, 2005 and 2004, the Company recorded provision for excess and obsolete inventory of $ 1.5 million.

          The following is a summary of the change in the Company’s excess and obsolete inventory reserve for the six months ended June 30 , 2005 and 2004 (in thousands):

		For the Six Months Ended
		June 30,
		2005				2004
Inventory reserve balance, beginning of the quarter		$	7,353			$	9,491
Usage:
Inventory scrapped			(1,667	)			(1,183	)
Inventory consumed through sales			(752	)			(1,952	)
Subtotal — usage			(2,419	)			(3,135	)
Reserve provision			1,475				1,501
Remaining reserve balance, end of the quarter		$	6,409			$	7,857

Note 5 — Goodwill

          The Company tests goodwill for impairment at least annually. Additionally, the Company assesses goodwill for impairment if any adverse conditions exist that would indicate an impairment. Conditions that would trigger an impairment assessment, include, but are not limited to, a significant adverse change in legal factors or in the business climate that could affect the value of an asset or an adverse action or assessment by a regulator. The Company is considered one reporting unit. As a result, to determine whether or not goodwill may be impaired, the Company compares its book value to its market capitalization. If the trading price or the average trading price of the Company’s common stock is below the book value per share for a sustained period, a goodwill impairment test will be performed by comparing book value to estimated market value. The Company’s book value per share was $10.00 at June 30, 2005 which was lower then the trading value of the Company’s common stock during the six month period ended June 30, 2005. Additionally, the Company performs other tests, such as the multiple of revenues and present value of future cash flows to further validate the fair market value of its goodwill. The Company completed its most recent annual goodwill impairment analysis as of September 30, 2004 and concluded that as of September 30, 2004, there was no goodwill impairment.

Note 6 — Intangible Assets

          The following tables summarize details of the Company’s total purchased intangible assets (in thousands):

						Accumulated
		Gross				Amortization				Net
June 30, 2005
Existing technology		$	2,415			$	(1,610	)		$	805
Technology licenses			6,790				(5,847	)			943
Patents			6,647				(5,674	)			973
Trade names			736				(272	)			464
Other			237				(237	)			—
Total		$	16,825			$	(13,640	)		$	3,185

						Accumulated
		Gross				Amortization				Net
December 31, 2004
Existing technology		$	2,415			$	(1,457	)		$	958
Technology licenses			6,790				(5,093	)			1,697
Patents			6,647				(5,590	)			1,057
Trade names			736				(237	)			499
Other			237				(237	)			—
Total		$	16,825			$	(12,614	)		$	4,211

          The Company’s purchased intangible assets have remaining lives ranging from 4 to 11 years. The Company performs reviews for impairment of all its purchased intangible assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. As of June 30, 2005, management concluded there was no indication of events or changes in circumstances indicating that the carrying amount of purchased intangible assets may not be recoverable. The estimated future amortization expense of purchased intangible assets as of June 30, 2005 is as follows (in thousands):

		Estimated
		Intangible
		Amortization
For the years ending December 31,		Amount
2005(remaining six months)		$	1,026
2006			726
2007			526
2008			250
2009			210
Thereafter			447
Total		$	3,185

Note 7— Accrued Restructuring and Other Charges

          Accrued restructuring and other charges consisted of the following (in thousands):

		June 30,				December 31,
		2005				2004
Second quarter 2005 restructuring charge		$	1,083			$	—
Fourth quarter 2004 restructuring charge			54				1,282
Third quarter 2004 restructuring charge			—				86
Fourth quarter 2001 restructuring charge			144				201
Total		$	1,281			$	1,569

          The Company evaluates the adequacy of the accrued restructuring and other charges on a quarterly basis. As a result, the Company records certain reclassifications and reversals to the accrued restructuring and other charges based on the results of the evaluation. The total accrued restructuring and other charges for each restructuring event are not affected by reclassifications. Reversals are recorded in the period in which the Company determines that expected restructuring and other obligations are less than the amounts accrued.

     Second Quarter 2005 Restructuring

     During the second quarter of 2005 the Company entered into a restructuring plan that included the elimination of 93 employees primarily within the Company’s manufacturing operations. These employee positions will be eliminated over the next four quarters in conjunction with continued outsourcing of production to the Company’s primary manufacturing partners, Celestica and Foxconn. The restructuring charge includes severance and other employee-related separation costs of approximately $1.1 million, which will be paid out over the next four quarters. Expenditures in the second quarter of 2005 are associated with severance payments made to employees whose employment terminated in the second quarter.

          The following table summarizes the changes to the second quarter 2005 restructuring costs (in thousands):

		Employee
		Termination and
		Related Costs
Restructuring and other costs		$	1,108
Expenditures			(25	)
Balance accrued as of June 30, 2005		$	1,083

     Fourth Quarter 2004 Restructuring

          During the fourth quarter of 2004 the Company eliminated 58 positions. These reductions resulted from an increase in outsourced manufacturing as well as to continue the Company’s shift of skills required to develop, market, sell, and support more advanced embedded platforms and solutions. As of June 30, 2005 restructuring charges include severance and other employee-related separation costs as well as certain associated legal fees.

          The following table summarizes the changes to the fourth quarter 2004 restructuring costs (in thousands):

		Employee
		Termination and				Other
		Related Costs				Charges				Total
Restructuring and other costs		$	1,630			$	20			$	1,650
Expenditures			(358	)			(10	)			(368	)
Balance accrued as of December 31, 2004			1,272				10				1,282
Additions			16				13				29
Expenditures			(952	)			(23	)			(975	)
Reversals			(33	)			—				(33	)
Balance accrued as of March 31, 2005		$	303			$	—			$	303
Expenditures			(249	)			—				(249	)
Balance accrued as of June 30, 2005		$	54			$	—			$	54

          The restructuring accrual was decreased by $1.2 million during the six months ended June 30, 2005. The $33 thousand reversal recorded in the first quarter of 2005 was due to the retention of an employee who filled a new position within the Company. The remaining accrual balance primarily includes severance costs associated with one employee with a termination date in the third quarter of 2005.

     Third Quarter 2004 Restructuring

          In August 2004, the Company initiated plans to eliminate approximately 14 engineering and marketing positions in its Birmingham, UK office during the fourth quarter of 2004. The Company has integrated the work done by these employees into other RadiSys locations. In conjunction with the elimination of positions, some R&D spending has been re-directed to align with the Company’s strategy to deliver more integrated standards-based solutions. As of June 30, 2005 restructuring charges include severance and other employee-related separation costs for 11 employees as well as certain associated legal fees. Restructuring charges also include a $30 thousand loss on the disposal of certain property and equipment.

          The following table summarizes the changes to the third quarter 2004 restructuring costs (in thousands):

		Employee
		Termination and				Other
		Related Costs				Charges				Total
Restructuring and other costs		$	410			$	18			$	428
Additions			24				30				54
Expenditures			(254	)			(48	)			(302	)
Reversals			(94	)			—				(94	)
Balance accrued as of December 31, 2004			86				—				86
Additions			—				72				72
Expenditures			—				(17	)			(17	)
write-offs			—				(30	)			(30	)
Reversals			(86	)			—				(86	)
Balance accrued as of March 31, 2005		$	—			$	25			$	25
Additions			—				38				38
Expenditures			—				(63	)			(63	)
Balance accrued as of June 30, 2005		$	—			$	—			$	—

          During the six months ended June 30, 2005, $86 thousand in severance and related costs was reversed as one of the effected employees was retained to fill a new position within the Company. Additions to the restructuring accrual were primarily due to relocation costs and the write-offs that resulted from losses incurred on the disposal of property and equipment. During the first quarter of 2005 the Redditch, U.K. office was vacated and property and equipment that was not transferred to other locations was either disposed or sold. The disposal or sale of this property and equipment resulted in a net loss of $30 thousand. Additions to the reserve during second quarter of 2005 include $12 thousand in relocation expenses and $26 thousand paid for repairs associated with the vacated Redditch office building.

     Fourth Quarter 2001 Restructuring

          The following table summarizes the changes to the fourth quarter 2001 restructuring costs (in thousands):

		Employee
		Termination and								Property and				Other
		Related Costs				Facilities				Equipment				Charges				Total
Restructuring costs		$	914			$	2,417			$	463			$	132			$	3,926
Expenditures			(452	)			—				—				—				(452	)
Write-offs			—				—				(463	)			—				(463	)
Balance accrued as of December 31, 2001			462				2,417				—				132				3,011
Expenditures			(395	)			(931	)			—				(27	)			(1,353	)
Reversals			(67	)			—				—				—				(67	)
Balance accrued as of December 31, 2002			—				1,486				—				105				1,591
Expenditures			—				(576	)			—				(14	)			(590	)
Reversals			—				(1	)			—				(1	)			(2	)
Balance accrued as of December 31, 2003			—				909				—				90				999
Expenditures			—				(428	)			—				(90	)			(518	)
Expenditures — lease buy-out			—				(53	)			—				—				(53	)
Recoveries			—				141				—				—				141
Reversals			—				(368	)			—				—				(368	)
Balance accrued as of December 31, 2004			—				201				—								201
Expenditures			—				(33	)			—				—				(33	)
Balance accrued as of March 31, 2005		$	—			$	168			$	—			$				$	168
Expenditures			—				(24	)			—				—				(24	)
Balance accrued as of June 30, 2005		$	—			$	144			$	—			$				$	144

          The accrual amount remaining as of June 30, 2005 represents mainly lease obligations relating to the facilities in Boca Raton, Florida expected to be paid monthly for the next 7 months.

Note 8 — Short-Term Borrowings

     During the quarter ended March 31, 2005, the Company renewed its line of credit facility, which expires on March 31, 2006, for $20.0 million at an interest rate based upon the lower of the London Inter-Bank Offered Rate (“LIBOR”) plus 1.0% or the bank’s prime rate. The line of credit is collateralized by the Company’s non-equity investments and is reduced by any standby letters of credit. At March 31, 2005, the Company had a standby letter of credit outstanding related to one of its medical insurance carriers for $105 thousand. The market value of non-equity investments must exceed 125.0% of the borrowed facility amount, and the investments must meet specified investment grade ratings.

     As of June 30, 2005 and December 31, 2004, there were no outstanding balances on the line of credit or any draws under the standby letter of credit and the Company was in compliance with all debt covenants.

Note 9 — Long-Term Liabilities

Convertible Senior Notes

     During November 2003, the Company completed a private offering of $100 million aggregate principal amount of 1.375% convertible senior notes due November 15, 2023 to qualified institutional buyers. The discount on the convertible senior notes amounted to $3 million.

     Convertible senior notes are unsecured obligations convertible into the Company’s Common Stock and rank equally in right of payment with all existing and future obligations that are unsecured and unsubordinated. Interest on the senior notes accrues at 1.375% per year and is payable semi-annually on May 15 and November 15. The convertible senior notes are payable in full in November 2023. The notes are convertible, at the option of the holder, at any time on or prior to maturity under certain circumstances, unless previously redeemed or repurchased, into shares of the Company’s Common Stock at a conversion price of $23.57 per share, which is equal to a conversion rate of 42.4247 shares per $1,000 principal amount of notes. The notes are convertible prior to maturity into shares of the Company’s Common Stock under certain circumstances that include but are not limited to (i) conversion due to the closing price of the Company’s Common Stock on the trading day prior to the conversion date reaching 120% or more of the conversion price of the notes on such trading date and (ii) conversion due to the trading price of the notes falling below 98% of the conversion value. Upon conversion the Company will have the right to deliver, in lieu of Common Stock, cash or a combination of cash and Common Stock. The Company may redeem all or a portion of the notes at its option on or after November 15, 2006 but before November 15, 2008 provided that the closing price of the Company’s Common Stock exceeds 130% of the conversion price for at least 20 trading days within a period of 30 consecutive trading days ending on the trading day before the date of the notice of the provisional redemption. On or after November 15, 2008, the Company may redeem the notes at any time. On November 15, 2008, November 15, 2013, and November 15, 2018, holders of the convertible senior notes will have the right to require the Company to purchase, in cash, all or any part of the notes held by such holder at a purchase price equal to 100% of the principal amount of the notes being purchased, together with accrued and unpaid interest and additional interest, if any, up to but excluding the purchase date. The accretion of the discount on the notes is calculated using the effective interest method.

     As of June 30, 2005 and December 31, 2004 the Company had outstanding convertible senior notes with a face value of $100 million. As of June 30, 2005 and December 31, 2004 the book value of the convertible senior notes was $97.2 million and $97.1 million, respectively, net of unamortized discount of $2.8 million and $2.9 million, respectively. Amortization of the discount on the convertible senior notes was $33 thousand and $36 thousand for the three months ended June 30, 2005 and 2004, respectively. Amortization of the discount on the convertible senior notes was $66 thousand and $68 thousand for the six months ended June 30, 2005 and 2004, respectively. The estimated fair value of the convertible senior notes was $97.8 million and $106.8 million at June 30, 2005 and December 31, 2004, respectively.

Convertible Subordinated Notes

     Convertible subordinated notes are unsecured obligations convertible into the Company’s Common Stock and are subordinated to all present and future senior indebtedness of the Company. Interest on the subordinated notes accrues at 5.5% per year and is payable semi-annually on February 15 and August 15. The convertible subordinated notes are payable in full in August 2007. The notes are convertible, at the option of the holder, at any time on or before maturity, unless previously redeemed or repurchased, into shares of the Company’s Common Stock at a conversion price of $67.80 per share, which is equal to a conversion rate of 14.7484 shares per $1,000 principal amount of notes. If the closing price of the Company’s Common Stock equals or exceeds 140% of the conversion price for at least 20 trading days within a period of 30 consecutive trading days ending on the trading day before the date on which a notice of redemption is mailed, then the Company may redeem all or a portion of the notes at its option at a redemption price equal to the principal amount of the notes plus a premium (which declines annually on August 15 of each year), together with accrued and

unpaid interest to, but excluding, the redemption date. The accretion of the discount on the notes is calculated using the effective interest method.

     In the three months ended June 30, 2005, the Company repurchased $125 thousand principal amount of the convertible subordinated notes at face value for a loss of $1 thousand.

     In the three months ended March 31, 2005, the Company repurchased $1.0 million principal amount of the convertible subordinated notes, with an associated discount of $12 thousand. The Company repurchased the notes in the open market for $990 thousand and, as a result, recorded a loss of $3 thousand.

     For the year ended December 31, 2004, the Company repurchased $58.8 million principal amount of the convertible subordinated notes, with an associated discount of $897 thousand. The Company repurchased the notes in the open market for $58.2 million and, as a result, recorded a loss of $387 thousand.

     On April 26, 2005 the Board of Directors approved the repurchase of the remaining $8.9 million principal amount of the convertible subordinated notes. The Company will consider the purchase of the notes on the open market or through privately negotiated transactions from time to time subject to market conditions.

     As of June 30, 2005 and December 31, 2004 the Company had outstanding convertible subordinated notes with a face value of $8.9 million and $10.0 million, respectively. As of June 30, 2005 and December 31, 2004 the book value of the convertible subordinated notes was $8.8 million and $9.9 million, respectively, net of amortized discount of $92 thousand and $126 thousand, respectively. Amortization of the discount on the convertible subordinated notes was $10 thousand and $46 thousand for the three ended June 30, 2005 and 2004, respectively and $21 thousand and $118 thousand for the six months ended June 30, 2005 and 2004, respectively. The estimated fair value of the convertible subordinated notes was $8.9 million and $10.0 million at June 30, 2005 and December 31, 2004, respectively.

     The aggregate maturities of long-term liabilities for each of the years in the five year period ending December 31, 2009 and thereafter are as follows (in thousands):

		Convertible				Convertible
		Senior				Subordinated
For the Years Ending December 31,		Notes				Notes
2005 (remaining six months)		$	—			$	—
2006			—				—
2007			—				8,868
2008(1)			100,000				—
2009			—				—
Thereafter			—				—
			100,000				8,868
Less: unamortized discount			(2,787	)			(92	)
Less: current portion			—				—
Long-term liabilities		$	97,213			$	8,776

Note 10 —Restricted Stock

     On March 1, 2005, the Compensation and Development Committee of the Board of Directors approved the form of the restricted stock agreement to be used in connection with restricted stock awards to be granted to employees of the Company under the terms of the Company’s 1995 Stock Incentive Plan. The agreement provides, among other things, that 33% of the shares will vest each year following the date of the grant. During the second quarter employees that have historically been awarded compensation in the form of stock options were allowed to elect to receive restricted stock that approximated the value of stock options that otherwise would have been awarded. Any employee selecting restricted stock received 1 share of restricted stock for every 3 stock options they would have

otherwise received. Effective May 2, 2005 the Compensation and Development Committee approved the grant of restricted stock awards to certain employees totaling 40,502 shares. The Company recorded $31 thousand of stock-based compensation related to the issuance of restricted stock for the three and six months ended June 30, 2005. The Company did not incur any stock-based compensation expense associated with restricted stock for the three and six months ended June 30, 2004.

Note 11 —Basic and Diluted Income Per Share

     A reconciliation of the numerator and the denominator used to calculate basic and diluted income per share is as follows (in thousands, except per share amounts):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Numerator — Basic
Net income, basic		$	2,565			$	3,507			$	5,151			$	6,355
Numerator — Diluted
Net income, basic			2,565				3,507				5,151				6,355
Interest on convertible notes, net of tax benefit(1)			242				232				485				479
Net income, diluted		$	2,807			$	3,739			$	5,636			$	6,834
Denominator — Basic
Weighted average shares used to calculate income per share , basic			19,981				18,826				19,882				18,659
Denominator — Diluted
Weighted average shares used to calculate income per share , basic			19,981				18,826				19,882				18,659
Effect of convertible notes(1)			4,243				4,243				4,243				4,243
Effect of dilutive stock options(2)			394				764				422				863
Effect of dilutive unvested restricted stock			2				—				1				—
Weighted average shares used to calculate income per share , diluted			24,620				23,833				24,548				23,765
Net income per share:
Basic		$	0.13			$	0.19			$	0.26			$	0.34
Diluted(1)		$	0.11			$	0.16			$	0.23			$	0.29

Note 12 — Income Taxes

     The Company’s effective tax rate for the three month ended June 30, 2005 and 2004 differs from the statutory rate primarily due to tax benefits related to certain foreign sales, the amortization of goodwill for tax purposes, and tax benefits associated with research and development credits. The Company’s effective tax rate for the six months ended June 30, 2005 and 2004 differed from the statutory rate due to tax benefits related to certain foreign sales and other permanent differences.

     On October 22, 2004, the President of the United States signed the American Jobs Creation Act of 2004 (the “Act”). One of the key provisions of the Act includes a repeal of the extraterritorial income exclusion with certain transitional rules. In its place, the Act provides a relief provision for domestic manufacturers by providing a new domestic manufacturing deduction. The Act also includes a temporary incentive for U.S. multinationals to repatriate foreign earnings and other international tax reforms designed to improve the global competitiveness of U.S. multinationals. The Company is currently evaluating the impact of the Act on its effective tax rate, cash flows and financial statements and expects to complete the evaluation by the end of 2005.

Note 13 — Segment Information

     The Company has adopted SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information.” SFAS No. 131 establishes standards for the reporting by public business enterprises of information about operating segments, products and services, geographic areas, and major customers. The method for determining what information to report is based upon the way that management organizes the segments within the Company for making operating decisions and assessing financial performance.

     The Company is one operating segment according to the provisions of SFAS No. 131.

     Revenues on a product and services basis are as follows (in thousands):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Hardware		$	64,079			$	57,496			$	119,650			$	115,743
Software royalties and licenses			1,114				1,609				2,239				3,067
Software maintenance			409				279				804				620
Engineering and other services			354				868				780				1,934
Other			—				1				—				4
Total revenues		$	65,956			$	60,253			$	123,473			$	121,368

     Generally, the Company’s customers are not the end-users of its products. The Company ultimately derives its revenues from three end markets as follows (in thousands):

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Service Provider Systems		$	33,142			$	24,479			$	59,887			$	51,839
Commercial Systems			15,412				18,973				33,728				37,904
Enterprise Systems			17,402				16,801				29,858				31,625
Total revenues		$	65,956			$	60,253			$	123,473			$	121,368

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

Geographic Revenues

		Three Months Ended								Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
United States		$	21,469			$	24,750			$	42,594			$	47,604
Other North America			3,922				3,010				7,257				7,248
North America			25,391				27,760				49,851				54,852
Europe, the Middle East and Africa (“EMEA”)			33,976				28,962				61,825				59,635
Asia Pacific			6,589				3,531				11,797				6,881
Total		$	65,956			$	60,253			$	123,473			$	121,368

Long-lived assets by Geographic Area

		June 30,				December 31,
		2005				2004
Property and equipment, net
United States		$	11,855			$	12,031
EMEA			148				351
Asia Pacific			2,110				1,620
Total		$	14,113			$	14,002
Goodwill
United States		$	27,521			$	27,521
Intangible assets, net
United States		$	3,185			$	4,211

     Two customers accounted for more than 10% of total revenues in the three and six months ended June 30, 2005 and 2004. These customers accounted for the following percentages of total revenue:

		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Nokia			35.5	%			25.0	%			32.2	%			25.9	%
Nortel			18.5	%			15.6	%			16.3	%			17.2	%

     As of June 30, 2005 and December 31, 2004 the following customers accounted for more than 10% of accounts receivable. These customers accounted for the following percentages of accounts receivable:

		June 30,				December 31,
		2005				2004
Nokia			39.9	%			32.3	%
Nortel			17.5	%			*
Diebold			*				12.9	%

Note 14 —Legal Proceedings

     In the normal course of business, the Company periodically becomes involved in litigation. As of June 30, 2005, management believes that the Company has no pending litigation that would have a material effect on the Company’s financial position, results of operations or cash flows.

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

Introduction and Overview

     RadiSys is a leading provider of advanced embedded solutions for the service provider, commercial and enterprise systems markets. Through intimate customer collaboration, and combining innovative technologies and industry leading architecture, we help original equipment manufacturers (“OEMs”) bring better products to market faster and more economically. Our products include embedded boards, software, platforms and systems, which are used in today’s complex computing, processing and network intensive applications.

Our Strategy

     Our strategy is to provide customers with advanced embedded solutions in our target markets. We believe this strategy enables our customers to focus their limited resources and development efforts on their key areas of competency allowing them to provide higher value systems with a time-to-market advantage and a lower total cost of ownership. Historically, system makers had been largely vertically integrated, developing most, if not all, of the functional building blocks of their systems. System makers are now more focused on their core expertise and are looking for partners like RadiSys to provide them with merchant-supplied building blocks for a growing number of processing and networking functions.

Our Markets

     We provide advanced embedded solutions to three distinct markets:

•		Service Provider Systems — The service provider systems market includes voice, video and data systems deployed into public networks. The service provider systems market consists of a variety of telecommunications focused applications, including 2, 2.5 and 3G wireless infrastructure products, wireline infrastructure products, packet-based switches and unified messaging products.
•		Commercial Systems — The commercial systems market includes the following sub-markets: medical, transaction terminals, industrial automation equipment and test and measurement equipment. Examples of products into which our commercial systems embedded solutions are incorporated include ultrasound equipment, immunodiagnostics and hematology systems, CAT Scan (“CT”) imaging equipment, ATM’s, point of sale terminals, semiconductor manufacturing equipment, electronics assembly equipment and high-end test equipment.
•		Enterprise Systems — The enterprise systems market includes embedded compute, processing and networking systems used in private enterprise IT infrastructure. The enterprise systems market consists of a variety of applications, including voice messaging, storage, data centers, Private Branch Exchange (“PBX”) systems, network access and security and switching applications.

     Starting in the third quarter of 2005 we will be changing our revenue reporting by market. We are seeing growing commonality and a convergence of technology and products within our current Service Provider and Enterprise markets. Based on this, we will be combining these two markets and report the underlying revenue associated with these markets as Communications Networking starting in the third quarter of 2005. We will also begin reporting a new sub-segment of the Communications Networking market for IP network and messaging revenues. Our Commercial market reporting will remain unchanged.

Our Market Drivers

     We believe there are a number of fundamental drivers for growth in the embedded solutions market, including:

	•		Increasing focus by OEMs to utilize outsourced modular building blocks to develop new systems. We believe OEMs are combining their internal development efforts with merchant-supplied platforms from partners like RadiSys to deliver more systems to market, faster at lower total cost of ownership.
	•		Increasing levels of programmable, intelligent and networked functionality embedded in a variety of systems, including systems for monitoring and control, real-time information processing and high-bandwidth network connectivity.

	•		Increasing demand for standards-based solutions, such as Advanced Telecommunications Architecture (“ATCA”), and Computer-on-Modules (“COM”) Express that motivates system makers to take advantage of proven and validated standards-based products.
	•		Increasing demand for new technologies that utilize network processors, such as security and high-volume networking applications.

     In the following discussion of our financial condition and results of operations, we intend to provide information that will assist in understanding our financial statements, the changes in certain key items in those financial statements for the three and six months ended June 30, 2005 compared to same periods in 2004 and for the period ended June 30, 2005 compared to December 31, 2004, and the primary factors that accounted for those changes. This discussion should be read in conjunction with our consolidated financial statements and the related notes included elsewhere in this filing, and in our annual report on Form 10-K for the year ended December 31, 2004.

     Certain statements made in this section of the report may be deemed to be forward-looking statements. Please see the information contained in the section entitled “FORWARD-LOOKING STATEMENTS” and the “RISK FACTORS.”

Overview

     Total revenue was $66.0 million and $60.3 million for the three months ended June 30, 2005 and 2004, respectively. Total revenue was $123.5 million and $121.4 million for the six months ended June 30, 2005 and 2004, respectively. As of June 30, 2005 and June 30, 2004, backlog was approximately $25.3 million and $30.9 million, respectively. We include all purchase orders scheduled for delivery within 12 months in backlog. The general trend within our addressable markets is for shorter lead times and supplier managed inventory, which will generally decrease backlog as a percentage of revenue. The increase in revenue for the three months ended June 30, 2005 compared to the same period in 2004 was primarily driven by strong demand within the wireless market as our product content continues to expand with 2.5 and 3G deployments. We currently believe that the end markets that we serve will strengthen in 2005 and will experience mid to high single digit growth rates in 2005 as compared to 2004. We expect to grow faster than our customers’ end markets in 2005 due to new product introductions and increasing content in our customers’ solutions.

     In 2004 we shifted more of our investments from predominantly one-off custom-designed products to standards-based, re-usable platforms and solutions. We believe standards-based platforms provide our customers a number of fundamental benefits. First, by using ready-made platform solutions rather than ground-start custom-designs, our customers can achieve significantly shorter intervals and faster time-to-market. Second, we believe our customers can achieve a lower total cost by using solutions that are leveraged across multiple applications rather than a single-use proprietary solution. By offering ready-made platforms, we believe we have the opportunity to address a wider range of new market opportunities with the potential for faster time to revenue than with ground-start, custom-designs. We believe this ability to reuse designs makes our business and investment model more scalable. Finally, we believe a more standard product focused model will allow us to provide more integrated higher value solutions to our customers than we have typically delivered under a custom-design model.

     In 2004 we announced our Promentum™ family of ATCA products and in June 2005 we recorded our first revenue associated with these products. The Promentum™ family of products includes universal carrier cards, switch and control modules, disk storage modules, compute modules, and a 14-slot shelf or chassis. The Promentum™ SYS-6000 integrates these individual products into a blade server platform system. We believe the Promentum™ SYS-6000 system will provide customers a highly reliable managed platform on which to build their new voice and data offerings. During the second quarter of 2005 the Company announced the Promentum™ ATCA-7010, a packet processing module that allows the highest bandwidth available in a single ATCA® slot. This product is the latest addition to the Company’s family of ATCA-compliant products featuring dual Intel® IXP28xx network processors and is designed to address 10 Gbps wirespeed packet processing in network applications that demand high bandwidth throughput such as security gateways, GGSN’s, Broadband-Remote Access Servers, edge routers and session controllers. We have significant experience in the design, delivery and deployment of carrier-grade, modular platforms. We believe the ATCA standard increases our opportunity to implement reusable platforms, enabling the deployment of more flexible solutions based on cost-effective commercial technologies. We believe our core ATCA solutions will be applicable across a wide range of customers and applications and are potentially applicable in all of our defined markets. These integrated hardware and software platforms make extensive use of common architectural and component designs, usingcarrier grade operating systems and middleware, and will reduce development time and costs, which enhances application portability.

     In addition to our new ATCA offerings, we announced our new Procelerant™ series of modular computing solutions for customers in our commercial systems markets for medical, transaction terminals and test and measurement applications. During the second quarter of 2005 we closed our first Procelerant™ application and are seeing a strong demand for evaluation units. We believe these new modular products will represent a family of high density, flexible solutions that will enable commercial systems customers to achieve more rapid time to market with cost effective designs.

     Net income was $2.6 million and $3.5 million for the three months ended June 30, 2005 and 2004, respectively. Net income per share was $0.13 and $0.11, basic and diluted, respectively, for the three months ended June 30, 2005 compared to net income per share of $0.19 and $0.16, basic and diluted, respectively, for the three months ended June 30, 2004. Net income was $5.2 million for the six months ended June 30, 2005 compared to net income of $6.4 million for the six months ended June 30, 2004. Net income per share was $0.26 and $0.23, basic and diluted, respectively, for the six months ended June 30, 2005 compared to net income per share of $0.34 and $0.29, basic and diluted, respectively, for the six months ended June 30, 2004. During the second quarter of 2005 the Company recorded a $1.1 million restructuring charge for severance and related expenses for 93 employees primarily within the Company’s manufacturing operations, where positions will be eliminated over the next four quarters in conjunction with continued outsourcing of production to the Company’s manufacturing partners. The restructuring is necessary to balance our production capacity with our level of outsourced manufacturing and the Company currently expects to incur additional restructuring charges over the next four quarters totaling approximately $200 thousand.

     Due to the restructuring charge taken in the second quarter of 2005, a lower average gross margin, and higher research and development spending on standards-based products, our profitability has decreased in the first and second quarters of 2005 compared to the same periods in 2004. The increase in expenses associated restructuring and research and development have been partially offset by lower interest expense associated with a lower outstanding debt balance in the first six months of 2005 as well as an increase in interest income due to higher yields and a higher balance of invested cash. Revenues in the first six months of 2005 were up compared to the same period in 2004 but due to a lower gross margins as a percentage, our profitability was not significantly impacted by the increase in revenue. Our gross margin as a percentage of revenue declined primarily due to product mix as well as changes in our excess and obsolete inventory provision and purchase commitment liabilities associated with our manufacturing transfers to our contract manufacturing partners. Product mix has impacted our gross margin as a percentage of revenue due to a higher percentage of revenue coming from higher volume products with competitive pricing. We also continue to incur some redundant manufacturing costs as we move forward with outsourcing our internal manufacturing to our partners Celestica and Foxconn.

     In November 2003, we completed a private offering of 1.375% convertible senior notes due November 15, 2023 to qualified institutional buyers, resulting in net proceeds of $97 million. We plan to use the proceeds of the offering for general corporate purposes including working capital, potential acquisitions, partnership opportunities, repayment of existing debt obligations, and the purchase of outstanding common stock. During 2004, we repurchased $58.8 million principal amount of the 5.5% convertible subordinated notes in the open market for $58.2 million. During the first quarter of 2005, we repurchased $1 million principal amount of the convertible subordinated notes in the open market for $990 thousand. On April 26, 2005 the Board of Directors approved the repurchase of the remaining $8.9 million principal amount of the convertible subordinated notes. On May 20, 2005 we repurchased an additional $125 thousand principal amount of the convertible subordinated notes. If and when we repurchase the remaining convertible subordinated notes, we anticipate incurring a small loss on the repurchase of the notes.

     In addition, on April 26, 2005 the Board of Directors also authorized the repurchase of up to $5 million of our outstanding shares of common stock. The Company currently intends to purchase the notes and stock on the open market or through privately negotiated transactions from time to time subject to market conditions.

     During the second quarter of 2005 we issued 40 thousand shares of restricted stock and incurred $31 thousand in stock-based compensation associated with this issuance. We anticipate incurring approximately $530 thousand in compensation expense over the next three years associated with the unvested shares included in this grant. During the three and six months ended June 30, 2004, we incurred $356 and $533 thousand of stock-based compensation expense associated with shares to be issued pursuant to the Company’s 1996 Employee Stock Purchase Plan (“ESPP”). We incurred stock-based compensation expense because the original number of ESPP shares approved by the shareholders was insufficient to meet employee demand for an ESPP offering which was consummated in February of 2003 and ended in August of 2004. The Company subsequently received shareholder approval for additional ESPP shares in May 2003.

     Cash and cash equivalents and investments amounted to $211.8 million and $198.6 million at June 30, 2005 and December 31, 2004, respectively. The increase in cash and cash equivalents and investments during the six months ended June 30, 2005, was

primarily due to cash provided from operating activities. We generated net cash from operations in excess of net income in the six months ended June 30, 2005. Management believes that cash flows from operations, available cash and investment balances, and short-term borrowings will be sufficient to fund our operating liquidity needs for the short-term and long-term.

Critical Accounting Policies and Estimates

     The Company reaffirms its critical accounting policies and use of estimates as reported in the Company’s Annual Report on Form 10-K for the year ended December 31, 2004. As a result of our continued execution on our strategy of increasing the level of outsourced manufacturing the Company now considers our policies and estimates associated with our adverse purchase commitments reserve to be critical.

Adverse Purchase Commitments

     We are contractually obligated to reimburse our contract manufacturers for the cost or liability for excess inventory used in the manufacture of our products, for which there is no alternative use. As we continue to execute on our strategy of increasing the level of outsourced manufacturing the liability for adverse purchase commitments will become more significant. This will offset, however, by lower required reserves for escess and obsolete exposure on lower amount of Company-owned inventory. Estimates for adverse purchase commitments are derived from reports received from our 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 liabilities to our excess and obsolete inventory reserve. This liability, referred to as adverse purchase commitments, is provided for in other accrued liabilities. Adverse purchase commitments amounted to $599 thousand and $485 thousand at June 30, 2005 and December 31, 2004, respectively.

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, 2005 and 2004.

		For the Three Months Ended								For the Six Months Ended
		June 30,								June 30,
		2005				2004				2005				2004
Revenues			100	%			100	%			100	%			100	%
Cost of sales			70.6				66.8				69.3				68.0
Gross margin			29.4				33.2				30.7				32.0
Research and development			11.1				11.8				12.0				11.1
Selling, general, and administrative			11.7				12.7				12.1				12.6
Intangible assets amortization			0.8				0.9				0.8				1.0
Restructuring and other charges (reversals)			1.7				(1.1	)			0.9				(0.7	)
Income from operations			4.1				8.9				4.9				8.0
Loss on repurchase of convertible subordinated notes			—				(0.6	)			—				(0.3	)
Interest expense			(0.8	)			(1.7	)			(0.9	)			(2.0	)
Interest income			2.1				1.2				2.1				1.3
Other (expense) income, net			(0.2	)			—				(0.4	)			—
Income before income tax provision			5.2				7.8				5.7				7.0
Income tax provision			1.4				2.0				1.5				1.8
Net income			3.8	%			5.8	%			4.2	%			5.2	%