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

For the quarterly period ended March 31, 2006

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		(I.R.S. Employer
Incorporation or Organization)		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 a large accelerated filer, an accelerated filer or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

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

Number of shares of common stock outstanding as of May 4, 2006: 21,093,002

 

 

RADISYS CORPORATION
FORM 10-Q

TABLE OF CONTENTS

		Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements			3
Consolidated Statements of Operations (unaudited) — Three Months Ended March 31, 2006 and 2005			3
Consolidated Balance Sheets — March 31, 2006 (unaudited) and December 31, 2005			4
Consolidated Statement of Changes in Shareholders’ Equity (unaudited) — Three Months Ended March 31, 2006			5
Consolidated Statements of Cash Flows (unaudited) — Three Months Ended March 31, 2006 and 2005			6
Notes to the Consolidated Financial Statements			7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19
Item 3. Quantitative and Qualitative Disclosures About Market Risk			32
Item 4. Controls and Procedures			33
PART II. OTHER INFORMATION
Item 1A. Risk Factors			34
Item 6. Exhibits and Reports on Form 8-K			40
Signatures			41
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 March 31,
		2006				2005
Revenues		$	65,811			$	57,517
Cost of sales			48,077				38,975
Gross margin			17,734				18,542
Research and development			9,124				7,532
Selling, general and administrative			8,205				7,254
Intangible assets amortization			325				513
Restructuring and other charges (reversals)			59				(18	)
Income from operations			21				3,261
Loss on repurchase of convertible subordinated notes			—				(3	)
Interest expense			(436	)			(542	)
Interest income			2,236				1,171
Other (expense) income, net			11				(349	)
Income before income tax provision			1,832				3,538
Income tax provision			406				952
Net income		$	1,426			$	2,586
Net income per share:
Basic		$	0.07			$	0.13
Diluted		$	0.07			$	0.12
Weighted average shares outstanding:
Basic			20,699				19,782
Diluted			25,549				24,466

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

RADISYS CORPORATION

CONSOLIDATED BALANCE SHEETS

		March 31,				December 31,
		2006				2005
		(Unaudited)
ASSETS
Current assets:
Cash and cash equivalents		$	91,802			$	90,055
Short-term investments, net			139,400				135,800
Accounts receivable, net			44,586				39,055
Other receivables			4,086				3,886
Inventories, net			13,243				21,629
Assets held for sale			2,105				—
Other current assets			2,778				2,426
Deferred tax assets			7,399				7,399
Total current assets			305,399				300,250
Property and equipment, net			11,518				13,576
Goodwill			27,463				27,463
Intangible assets, net			1,835				2,159
Long-term deferred tax assets			21,233				21,634
Other assets			3,791				3,629
Total assets		$	371,239			$	368,711
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Accounts payable		$	35,127			$	36,903
Accrued wages and bonuses			3,538				4,829
Accrued interest payable			533				224
Accrued restructuring			312				856
Other accrued liabilities			8,969				8,279
Total current liabilities			48,479				51,091
Long-term liabilities:
Convertible senior notes, net			97,312				97,279
Convertible subordinated notes, net			2,501				2,498
Total long-term liabilities			99,813				99,777
Total liabilities			148,292				150,868
Shareholders’ equity:
Preferred stock — $.01 par value, 10,000 shares authorized; none issued or outstanding			—				—
Common stock — no par value, 100,000 shares authorized; 20,920 and 20,703 shares issued and outstanding at March 31, 2006 and December 31, 2005			197,461				193,839
Retained earnings			21,701				20,275
Accumulated other comprehensive income:
Cumulative translation adjustments			3,785				3,729
Total shareholders’ equity			222,947				217,843
Total liabilities and shareholders’ equity		$	371,239			$	368,711

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

RADISYS CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

										Accumulated
										other												Total
		Common stock								comprehensive				Retained								comprehensive
		Shares				Amount				income (1)				earnings				Total				income (2)
Balances, December 31, 2005			20,703			$	193,839			$	3,729			$	20,275			$	217,843
Shares issued pursuant to benefit plans			217				2,326				—				—				2,326			$	—
Stock-based compensation associated with employee benefit plans			—				1,296				—				—				1,296
Translation adjustments			—				—				56				—				56				56
Net income for the period			—				—				—				1,426				1,426				1,426
Balances, March 31, 2006			20,920			$	197,461			$	3,785			$	21,701			$	222,947
Comprehensive income, for the three months ended March 31, 2006																						$	1,482

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

RADISYS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

		For the Three Months Ended
		March 31,
		2006				2005
Cash flows from operating activities:
Net income		$	1,426			$	2,586
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			1,653				2,028
Inventory valuation allowance			1,338				643
Deferred income taxes			401				138
Stock-based compensation expense			1,296				—
Tax benefit of stock-based benefit plans			—				536
Other			(155	)			(38	)
Changes in operating assets and liabilities:
Accounts receivable			(5,603	)			4,180
Other receivables			(200	)			1,320
Inventories			7,049				825
Other current assets			(93	)			579
Accounts payable			(1,781	)			(4,137	)
Accrued restructuring			(556	)			(1,068	)
Accrued interest payable			309				201
Accrued wages and bonuses			(1,296	)			(1,311	)
Other accrued liabilities			434				(175	)
Net cash provided by operating activities			4,222				6,307
Cash flows from investing activities:
Proceeds from held-to-maturity investments			—				34,550
Purchase of held-to-maturity investments			—				(24,779	)
Proceeds from the sale of auction rate securities			14,900				16,200
Purchase of auction rate securities			(18,500	)			(33,800	)
Capital expenditures			(1,307	)			(1,705	)
Other			25				(36	)
Net cash used in investing activities			(4,882	)			(9,570	)
Cash flows from financing activities:
Early extinguishments of convertible subordinated notes			—				(990	)
Proceeds from issuance of common stock			2,326				1,852
Net cash provided by financing activities			2,326				862
Effect of exchange rate changes on cash			81				(580	)
Net increase (decrease) in cash and cash equivalents			1,747				(2,981	)
Cash and cash equivalents, beginning of period			90,055				80,566
Cash and cash equivalents, end of period		$	91,802			$	77,585

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

RADISYS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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, 2005 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 month period ended March 31, 2006, 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, cash flows or shareholders’ equity.

   Inventory Reserves

     The Company records the inventory valuation allowance 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, regulatory requirements effecting components, 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 allowance 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 valuation allowance. This liability, referred to as adverse purchase commitments, is provided for in other accrued liabilities in the accompanying balance sheets. Adverse purchase commitments amounted to $1,252 thousand and $828 thousand at March 31, 2006 and December 31, 2005, respectively. For the three months ended March 31, 2006 and 2005 the Company recorded a net provision for adverse purchase commitments of $424 thousand and $24 thousand, respectively.

   Accrued Restructuring and Other Charges

     Financial Accounting Standard Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 146 “Accounting for Costs Associated with Exit or Disposal Activities,” 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 three months ended March 31, 2006 and 2005 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.

   Guarantees and Indemnification Obligations

     FASB 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 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 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 March 31, 2006

     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 three months ended March 31, 2006 and 2005 (in thousands):

		For the Three Months
		Ended March 31,
		2006				2005
Warranty liability balance, beginning of the period		$	2,124			$	1,719
Product warranty accruals			860				996
Utilization of accrual			(842	)			(775	)
Warranty liability balance, end of the period		$	2,142			$	1,940

     The warranty liability balance is included in other accrued liabilities in the accompanying Consolidated Balance Sheets as of March 31, 2006 and December 31, 2005. 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

     Effective January 1, 2006, the Company adopted the fair value recognition provisions of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), using the modified prospective transition method and therefore has not restated results for prior periods. Under this transition method, stock-based compensation expense for the first quarter of fiscal 2006 includes compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of January 1, 2006, based on the grant date fair value estimated in accordance with the original provision of SFAS No. 123, “Accounting for Stock-Based Compensation” (“SFAS 123”). Stock-based compensation expense for all stock-based compensation awards granted after January 1, 2006 is based on the grant-date fair value estimated in accordance with the provisions of SFAS 123R. The Company recognizes these compensation costs on a straight-line basis over the requisite service period of the award. Prior to the adoption of SFAS 123R, the Company recognized stock-based compensation expense in accordance with Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”). In March 2005, the Securities and Exchange Commission (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. The Company has applied the provisions of SAB 107 in its adoption of SFAS 123R. See Note 2 to the Consolidated Condensed Financial Statements for a further discussion on stock-based compensation.

   Recent Accounting Pronouncements

     There have been no material changes to the recent pronouncements as previously reported in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

Note 2 — Stock-based Compensation

  Stock-Based Employee Benefit Plans

     Equity instruments are granted to employees, directors and consultants in certain instances, as defined in the respective plan agreements. Beginning in the second quarter of 2005, the Company issued equity instruments in the form of stock options, restricted shares and shares issued to employees as a result of the employee stock purchase plan (“ESPP”). Prior to the second quarter of 2005, the Company issued equity instruments in the form of stock options and ESPP shares, only.

  Stock Options and Restricted Shares

     The Company’s 1995 Stock Incentive Plan (“1995 Plan”) and 2001 Nonqualified Stock Option Plan (“2001 Plan”) provide the Board of Directors broad discretion in creating employee equity incentives. Unless otherwise stipulated in the plan document, the Board of Directors, at their discretion, determines stock option exercise prices, which may not be less than the fair market value of RadiSys common stock at the date of grant, vesting periods and the expiration periods which are a maximum of 10 years from the date of grant. Under the 1995 Plan, as amended, 5,425,000 shares of common stock have been reserved and authorized for issuance to any non-employee directors and employees, with a maximum of 450,000 shares in connection with the hiring of an employee and 100,000 shares in any calendar year to one participant. Under the 2001 Plan, as amended, 2,250,000 shares of common stock have been

reserved and authorized for issuance to selected employees, who are not executive officers or directors of the Company. Currently, all non-director stock option grants are issued under an option agreement that provides, among other things, that the option grant vests over a 3 year period; specifically, 33% of the options vest one year after the grant date and approximately 2.75% of the options vest monthly for 24 months after the first year.

     On March 1, 2005, the Compensation and Development Committee of the Board of Directors approved the form of the restricted share 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 vest each year following the date of the grant.

     The table below summarizes the activities related to the Company’s stock plans (in thousands, except weighted average exercise prices):

														Weighted
														Average
		Shares				Stock Options								Remaining				Aggregate
		Available for				Outstanding								Contractual				Intrinsic
		Grant				Number				Average Price				Life (Years)				Value
Balance, December 31, 2005			1,545				3,376			$	16.66
Options granted			(24	)			24			$	18.29
Restricted shares granted			—				—				—
Options forfeited			6				(6	)		$	15.25
Options expired			117				(117	)		$	19.97
Restricted shares canceled			—				—				—
Options exercised			—				(114	)		$	12.20
Balance, March 31, 2006			1,644				3,163			$	16.71				4.51			$	14,311
Vested and expected to vest, March 31, 2006							3,115			$	16.73				4.48			$	14,130
Vested at March 31, 2006							2,380			$	17.24				3.94			$	10,609

     The aggregate intrinsic value in the table above represents the total pretax intrinsic value (the difference between the closing price of RadiSys shares as quoted on NASDAQ for March 31, 2006 and the exercise price, multiplied by the number of in-the-money options) that would have been received by the option holders had all option holders exercised their options on March 31, 2006. The intrinsic value changes based on the fair market value of RadiSys stock. Total intrinsic value of options exercised for the three months ended March 31, 2006 was $796 thousand.

   Employee Stock Purchase Plan

     In December 1995, the Company established an Employee Stock Purchase Plan (“ESPP”). All employees of RadiSys and its subsidiaries who customarily work 20 or more hours per week, including all officers, are eligible to participate in the ESPP. Separate offerings of common stock to eligible employees under the ESPP (also an “Offering”) commence on February 15, May 15, August 15 and November 15 of each calendar year (also “Enrollment Dates”) and continue for a period of 18 months. Multiple separate Offerings are in operation under the ESPP at any given time. An employee may participate in only one Offering at a time and may purchase shares only through payroll deductions permitted under the provisions stipulated by the ESPP. The purchase price is the lesser of 85% of the fair market value of the common stock on date of grant or that of the purchase date (“look-back feature”). Pursuant to the provisions of the ESPP, as amended, the Company is authorized to issue up to 4,150,000 shares of common stock under the plan. For the three months ended March 31, 2006 the Company issued 102,283 shares under the plan. At March 31 2006, 1,474,923 shares are available for issuance under the plan

  Stock-Based Compensation associated with Stock-Based Employee Benefit Plans

     Prior to January 1, 2006, the Company accounted for stock-based compensation associated with its stock-based employee benefit plans using the intrinsic value method in accordance with the provisions of APB 25 and, in accordance with the provisions of SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure, An Amendment of SFAS No. 123,” the Company provided pro forma disclosures of net income (loss) and net income (loss) per common share for periods prior to January 1, 2006 as if the fair value method had been applied in measuring compensation expense in accordance with SFAS 123.

     In December 2004, the FASB issued SFAS 123R, which replaces SFAS 123 and supersedes APB 25. SFAS 123R requires companies to account for stock-based compensation based on the fair value method, which replaces the intrinsic value method. The Company adopted SFAS 123R as of January 1, 2006 using the modified prospective method, which requires that compensation expense be recorded for all unvested stock options and ESPP shares outstanding as of January 1, 2006. Prior periods will not be restated. Beginning January 1, 2006, the pro forma disclosures previously permitted are no longer an alternative to financial statement recognition.

     In 2004, in an effort to reduce the amount of stock-based compensation expense that the Company would include in its financial statements after the effective date of SFAS 123R or January 1, 2006, the Compensation and Development Committee of the Board of Directors approved an acceleration of vesting of those non-director employee stock options with an option price greater than $15.99, which was greater than the fair market value of the shares on that date ($14.23). Approximately 1.1 million options with varying remaining vesting schedules were subject to the acceleration and became immediately exercisable. Historically the Company has not accelerated the vesting of employee stock options. As a result of the acceleration, the Company reduced the stock-based compensation expense that it will include in net income after January 1, 2006. Included in the pro forma stock-based compensation expense for fiscal year 2004 was $6.1 million associated with the acceleration, net of related tax effects. As a result of the acceleration, the Company estimates that stock-based compensation expense was reduced by approximately $1.1 million in the three months ended March 31, 2006 and estimates a reduction of approximately $3.9 million for fiscal year 2006 and approximately $400 thousand for fiscal year 2007.

     In an effort to further reduce the impact of SFAS 123R, based on Board of Director approval received on March 1, 2005, the Company changed its equity instrument compensation structure such that it has reduced the total number of options granted to employees and the number of employees who receive stock-based employee benefit plan awards.

     As a result of adopting SFAS 123R, the impact to the Consolidated Financial Statements for the three months ended March 31, 2006 for income before income taxes and net income for the three months ended March 31, 2006 was $1.3 million and $980 thousand lower, respectively, than if the Company had continued to account for stock-based compensation under APB 25. The impact on both basic and diluted earnings per share for the three months ended March 31, 2006 was $0.05 and $0.03 per share, respectively. In addition, prior to the adoption of SFAS 123R, the Company presented the tax benefit of stock option exercises as operating cash flows. Upon the adoption of SFAS 123R, tax benefits resulting from tax deductions in excess of the compensation cost recognized for those options will be classified as financing cash flows when realized as a reduction of cash taxes owed.

     The Company continues to use the Black-Scholes model to measure the grant date fair value of stock options and ESPP shares. The grant date fair value of stock options that are expected to vest is recognized on a straight-line basis over the requisite service period, which is equal to the option vesting period which is, generally, 3 years. The grant date fair value of ESPP shares that are expected to vest is recognized on a straight-line basis over the requisite service period, which is generally, 18 months, subject to modification at the date of purchase due to the ESPP look-back feature. The Company computes the grant date fair value of restricted stock granted as the closing price of RadiSys shares as quoted on NASDAQ on the date of grant. The grant date fair value of restricted shares that are expected to vest is recognized on a straight-line basis over the requisite service period, which is 3 years. The estimate of the number of options, ESPP shares and restricted stock expected to vest is determined based on historical experience.

     To determine the fair value of the stock options and ESPP shares using the Black-Scholes option pricing model, the calculation takes into consideration the effect of the following:

	•		Exercise price of the option or purchase price of the ESPP share
	•		Price of our common stock on the date of grant
	•		Expected life of the option or share
	•		Expected volatility of our common stock over the expected life of the option or share
	•		Risk free interest rate during the expected life of the option or share

     The calculation includes several assumptions that require management’s judgment. The expected life of the option or share is determined based on assumptions about patterns of employee exercises, and represents a probability-weighted average time-period from grant until exercise of stock options, subject to information available at time of grant. Determining expected volatility generally begins with calculating historical volatility for a similar long-term period and then considering the ways in which the future is reasonably expected to differ from the past.

     As part of its SFAS 123R adoption, the Company also examined its historical pattern of option exercises in an effort to determine if there were any discernable activity patterns based on certain employee populations. From this analysis, the Company identified three employee populations. The expected life computation is based on historical vested option exercise and post-vest forfeiture patterns and included an estimate of the expected life for options that were fully vested and outstanding at March 31, 2006, for each of the three populations identified. The estimate of the expected life for options that were fully vested and outstanding at March 31, 2006 was determined as the midpoint of a range of estimated expected lives determined as follows: the low end of the range assumes the fully vested and outstanding options settle on March 31, 2006 and the high end of the range assumes that these options expire upon contractual term. The risk free interest rate is based on the U.S. Treasury constant maturities in effect at the time of grant for the expected term of the option or share.

     The Company computed the grant date fair value of options and ESPP shares granted during the three months ended March 31, 2006 and 2005, using the Black-Scholes option pricing model with the following weighted-average assumptions:

										ESPP Shares Granted in the
		Options Granted in the Three								Three Months
		Months ended March 31,								Ended March31,
		2006				2005				2006				2005
Expected life (in years)			3.6				4.2				1.5				1.5
Interest rate			4.57	%			3.62	%			4.68	%			2.87	%
Volatility			55	%			57	%			44	%			57	%
Dividend yield			—				—				—				—

     For the three months ended March 31, 2006 and 2005, the total value of the options granted was approximately $197 thousand and $1.3 million, respectively. For the three months ended March 31, 2006 and 2005 the weighted-average valuation per option granted was $8.21 and $7.44, respectively. The total expense associated with ESPP shares granted in the three months ended March 31, 2006 and 2005 was $1.6 million and $130 thousand, respectively.

     The table below summarizes the activities related to the Company’s unvested restricted share grants (in thousands):

						Weighted-Average
		Restricted				Grant Date
		Shares				Fair Value
Balance, December 31, 2005			95			$	16.67
Shares granted			—				—
Shares vested			—				—
Shares canceled			—				—
Balance, March 31, 2006			95			$	16.67

     The pro forma table below reflects net income and basic and diluted net income per share for the three months ended March 31, 2005 had RadiSys accounted for these plans in accordance with SFAS No. 123, as follows: (in thousands, except per share amounts):

		For the Three
		Months Ended
		March 31, 2005
Net income		$	2,586
Add: Stock-based employee compensation expense included in reported net income, net of related tax effects			—
Deduct: Stock-based employee compensation expense determined under fair value method for all awards, net of related tax effects amount to $394			(633	)
Pro forma net income		$	1,953
Net income per share:
Basic		$	0.13
Diluted		$	0.12
Pro forma basic		$	0.10
Pro forma diluted		$	0.09

     For the three months ended March 31, 2006, stock-based compensation under SFAS 123R was recognized and allocated as follows: (in thousands, except per share amounts):

		For the Three
		Months Ended
		March 31, 2006
Cost of sales		$	218
Research and development			388
Selling, general and administrative			690
			1,296
Income tax benefit			(316	)
Total stock-based compensation expense after, income tax benefit		$	980

     For the three months ended March 31, 2006, stock-based compensation associated with stock options, restricted stock and ESPP shares amounted to $707 thousand, $131 thousand and $458 thousand, respectively.

     As of March 31, 2006, $4.2 million of total unrecognized compensation cost related to stock options is expected to be recognized over a weighted-average period of 2.08 years. As of March 31, 2006, there was $1.2 million unrecognized stock-based compensation expense related to unvested restricted shares is expected to be recognized over a weighted-average period of 2.39 years. The Company expects that approximately 94 thousand of the balance of restricted shares at March 31, 2006 will vest.

Note 3 — Investments

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

		March 31,				December 31,
		2006				2005
Short-term held-to-maturity investments		$	39,750			$	39,750
Short-term available-for-sale investments		$	99,650			$	96,050

     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 March 31, 2006 and 2005, the Company did not recognize any gains or losses on the sale 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 March 31, 2006 or December 31, 2005. 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 March 31, 2006, the Company was in compliance with its investment policy.

Note 4 — Accounts Receivable and Other Receivables

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

		March 31,				December 31,
		2006				2005
Accounts receivable, gross		$	45,462			$	39,931
Less: allowance for doubtful accounts			(876	)			(876	)
Accounts receivable, net		$	44,586			$	39,055

     The Company recorded no provisions for allowance for doubtful accounts during the three months ended March 31, 2006 and 2005.

     As of March 31, 2006 and December 31, 2005 the balance in other receivables was $4,086 thousand and $3,886 thousand, respectively. Other receivables consisted primarily of non-trade receivables including receivables for inventory sold to our contract manufacturing partners and sub-lease billings. 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. There is no revenue recorded associated with non-trade receivables.

Note 5 — Inventories

     Inventories consisted of the following (in thousands):

		March 31,				December 31,
		2006				2005
Raw materials		$	16,343			$	20,790
Work-in-process			1,815				2,282
Finished goods			2,495				5,829
			20,653				28,901
Less: inventory valuation allowance			(7,410	)			(7,272	)
Inventories, net		$	13,243			$	21,629

     During the three months ended March 31, 2006 and 2005, the Company recorded provision for excess and obsolete inventory of $1.3 million and $643 thousand, respectively.

Note 6 — Long-lived Assets Held for Sale

     Beginning in 2001, RadiSys made it part of its strategic plan to significantly reduce its costs. As part of its plan to reduce costs RadiSys began in 2004 to outsource the manufacture of most of its products. Through various restructuring activities, facilities requirements for manufacturing and other activities in the Hillsboro, Oregon location have decreased significantly. As a result, management decided to transfer operations currently located in one of the Company’s buildings in Hillsboro, Oregon (“DC3 building”) to its other building located in Hillsboro, Oregon and its contract manufacturing partners.

     In January 2006, RadiSys vacated the DC3 building and put it and the surrounding land, which had previously been held for future expansion, on the market for sale. The assets held for sale had a recorded value of $2.1 million which included land with value of $0.8 million, building and building improvements with net value of $1.3 million, and machinery and equipment with net value of $38 thousand. The Company classified this facility in net assets held for sale as of January 31, 2006.

Note 7 — Accrued Restructuring and Other Charges

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

		March 31,				December 31,
		2006 31,				2005
Second quarter 2005 restructuring charge		$	312			$	803
Fourth quarter 2001 restructuring charge			—				20
Other			—				33
Total		$	312			$	856

     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

     In 2005, the Company entered into a restructuring plan that included the elimination of 93 positions primarily within the Company’s manufacturing operations. These employee positions were to be eliminated as a result of continued outsourcing of production to the Company’s primary manufacturing partners, Celestica and Foxconn.

     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
Additions			219
Expenditures			(355	)
Reversals			(169	)
Balance accrued as of December 31, 2005		$	803
Additions		$	93
Expenditures			(540	)
Reversals			(44	)
Balance accrued as of March 31, 2006		$	312

     Employee termination and related costs include severance and other related separation costs. Additions to the original accrual are primarily attributable to the additional retention bonuses and related expenses for employment terminations to occur later in 2006. The reversal of $44 thousand is associated with employees who have been removed from the restructuring list because they resigned before their planned termination date, they filled an open RadiSys position or their position was re-assessed and the determination was made to keep the position. The Company expects this workforce reduction to be substantially completed by September 30, 2006.

     Fourth Quarter 2001 Restructuring

     The accrual amount remaining as of December 31, 2005 represents lease obligations relating to the facilities in Boca Raton, Florida which were paid in January 2006.

Note 8 — Short-Term Borrowings

     During the quarter ended March 31, 2006, the Company transferred its line of credit facility from its commercial bank to its investment bank, for $20.0 million at an interest rate based on the 30-day London Inter-Bank Offered Rate (“LIBOR”) plus 0.75%. 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, 2006, 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 March 31, 2006 and December 31, 2005, 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 March 31, 2006 and December 31, 2005 the Company had outstanding convertible senior notes with a face value of $100 million. As of March 31, 2006 and December 31, 2005 the book value of the convertible senior notes was $97.3 million and $97.3 million, respectively, net of unamortized discount of $2.7 million and $2.7 million, respectively. Amortization of the discount on the convertible senior notes was $33 thousand and $33 thousand for the three months ended March 31, 2006 and 2005, respectively. The estimated fair value of the convertible senior notes was $100.5 million and $93.5 million at March 31, 2006 and December 31, 2005, 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.

     For the year ended December 31, 2005, the Company repurchased $7.5 million principal amount of the convertible subordinated notes with an associated discount of $69 thousand. The Company repurchased the notes in the open market for $7.4 million and recorded a loss of $50 thousand.

     As of March 31, 2006 and December 31, 2005 the Company had outstanding convertible subordinated notes with a face value of $2.5 million and $2.5 million, respectively. As of March 31, 2006 and December 31, 2005 the book value of the convertible subordinated notes was $2.5 million and $2.5 million, respectively, net of amortized discount of $17 thousand and $20 thousand, respectively. Amortization of the discount on the convertible subordinated notes was $3 thousand and $11 thousand for the three ended March 31, 2006 and 2005, respectively. The estimated fair value of the convertible subordinated notes was $2.5 million and $2.5 million at March 31, 2006 and December 31, 2005, respectively.

     On April 26, 2005 the Board of Directors approved the repurchase of the remaining 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.

     The aggregate maturities of long-term liabilities for each of the years in the five year period ending December 31, 2010 and thereafter are as follows (in thousands):

		Convertible				Convertible
		Senior				Subordinated
For the Years Ending December 31,		Notes				Notes
2006 (remaining nine months)		$	—			$	—
2007			—				2,518
2008 (A)			100,000				—
2009			—				—
2010			—				—
Thereafter			—				—
			100,000				2,518
Less: unamortized discount			(2,688	)			(17	)
Less: current portion			—				—
Long-term liabilities		$	97,312			$	2,501

Note 10 — 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
		March 31,
		2006				2005
Numerator — Basic
Net income, basic		$	1,426			$	2,586
Numerator — Diluted
Net income, basic			1,426				2,586
Interest on convertible notes, net of tax benefit (A)			245				242
Net income, diluted		$	1,671			$	2,828
Denominator — Basic
Weighted average shares used to calculate income per share , basic			20,699				19,782
Denominator — Diluted
Weighted average shares used to calculate income per share , basic			20,699				19,782
Effect of convertible notes (A)			4,243				4,243
Effect of dilutive stock options, ESPP, and unvested restricted stock (B)			607				441
Weighted average shares used to calculate income per share , diluted			25,549				24,466
Net income per share:
Basic		$	0.07			$	0.13
Diluted (A)		$	0.07			$	0.12

Note 11 — Income Taxes

     The Company’s effective tax rate for the three months ended March 31, 2006 and 2005 differs from the statutory rate primarily due to the benefits of lower tax rates on earnings of foreign subsidiaries, the adoption of SFAS 123R, the amortization of goodwill for tax purposes, and the discrete item related to certain state tax refunds. Our effective tax rate for the year ended December 31, 2005 included the tax impact of a decrease in valuation allowance of $9.1 million primarily attributable to a projected increase in future utilization of general business tax credits and certain net operating loss carryforwards.

     The adoption of SFAS 123R related to the expensing of stock options will create differences in book and taxable income on both a permanent and temporary basis. We are projecting a permanent difference of approximately $2.3 million attributable to statutory options and stock option expense related to all non U.S. employees for the year ending 2006. The annual effective tax rate impact for this permanent difference is projected to be approximately 6.0%.

Note 12 — 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
		March 31,
		2006				2005
Hardware		$	63,711			$	55,571
Software royalties and licenses			1,122				1,125
Software maintenance			540				395
Engineering and other services			438				426
Other			—				—
Total revenues		$	65,811			$	57,517

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

		Three Months Ended
		March 31,
		2006				2005
Communications Networking		$	48,836			$	39,201
Commercial Systems			16,975				18,316
Total revenues		$	65,811			$	57,517

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

     Geographic Revenues

		Three Months Ended
		March 31,
		2006				2005
United States		$	18,213			$	21,125
Other North America			2,606				3,335
North America			20,819				24,460
Europe, the Middle East and Africa (“EMEA”)			34,405				27,849
Asia Pacific			10,587				5,208
Total		$	65,811			$	57,517

     Long-lived assets by Geographic Area

		March 31				December 31,
		2006				2005
Property and equipment, net
United States		$	9,370			$	11,372
EMEA			177				170
Asia Pacific			1,971				2,034
Total		$	11,518			$	13,576
Goodwill
United States		$	27,463			$	27,463
Intangible assets, net
United States		$	1,835			$	2,159

     For the three months ended March 31, 2006 and 2005 the following customers accounted for more than 10% of total revenues. These customers accounted for the following percentages of total revenue:

		For the Three Months Ended
		March 31,
		2006				2005
Nokia			41.4	%			28.3	%
Nortel			*				13.8	%

     As of March 31, 2006 and December 31, 2005 the following customers accounted for more than 10% of accounts receivable. These customers accounted for the following percentages of accounts receivable:

		March 31,				December 31,
		2006				2005
Nokia			40.4	%			32.3	%
Nortel			*				12.9	%

Note 13 — Legal Proceedings

     In the normal course of business, the Company periodically becomes involved in litigation. As of March 31, 2006, in the opinion of management, RadiSys had no pending litigation that would have a material adverse effect on the Company’s financial position, results of operations or cash flows.

Note 14 — Subsequent Events

     None.

     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 communications networking and commercial systems markets. Through innovative product planning, intimate customer collaboration, and combining leading edge technologies and system architecture, we help original equipment manufacturers (“OEMs”) accelerate new product deployments by allowing the customer to redirect their product development resources to their core competencies. 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 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, such as specific application software, 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 the following two distinct markets:

•

Communications Networking — The communications networking market primarily includes two sub markets: Wireless infrastructure and IP networking and messaging. The wireless infrastructure sub market includes voice, video and data systems deployed into public networks. The wireless sub-market includes a variety of telecommunications focused applications, including 2, 2.5 and 3G wireless infrastructure products, packet-based switches and unified messaging products for wireless networks. The IP networking and messaging sub-market includes embedded compute, processing and networking systems used in private enterprise IT infrastructure. The IP networking and messaging sub-market consists of a variety of applications including voice messaging, data centers, IP-based Private Branch Exchange (“PBX”) systems, network access and security and switching applications.

•

Commercial Systems — The commercial systems market includes the following sub-markets: medical systems, test and measurement equipment, transaction terminals and industrial automation equipment. Examples of products which incorporate our commercial embedded solutions 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.

Our Market Drivers

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

	•		Increasing desire 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 new products to market faster at a 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-Module Express (“COM Express”) that motivates system makers to take advantage of proven and validated standards-based products.
	•		Increasing demand for new technologies utilizing 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 months ended March 31, 2006 compared to same period in 2005 and for the period ended March 31, 2006 compared to December 31, 2005, 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, 2005.

     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 $65.8 million and $57.5 million for the three months ended March 31, 2006 and 2005, respectively. As of March 31, 2006 and December 31, 2005, backlog was approximately $43.4 million and $25.1 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 revenues for the three months ended March 31, 2006 compared to the same period in 2005 was due to strong demand within the wireless submarket as our product content is more substantial in 2.5 and 3G deployments. Revenues were also higher due to deployments of new products by one of our major customers.

     In 2004 and 2005 we shifted our product development investment from predominantly one-off custom-designed products (“perfect fit solutions”) to standards-based, re-usable platforms and systems (“standards-based solutions”). We believe standards-based solutions 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 product development 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 standards-based solutions, 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 this standards-based model will allow us to provide more integrated higher value solutions to our customers than we have typically delivered under a custom-design model. These higher value solutions provide more product content and drive higher average selling prices and therefore more total revenue opportunity for our products.

     We announced our Promentum™ family of ATCA products plans in 2005. This family of products includes universal carrier cards, switch and control modules, disk storage modules, compute modules, and a 14-slot shelf or chassis. These products are offered individually or integrated together as part of a blade server system known as the Promentum™ SYS-6000. We believe the Promentum™ SYS-6000 system provides customers a highly reliable managed platform on which to build their new voice and data offerings. 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, using carrier grade operating systems and middleware, and will reduce development time and costs, which enhances application portability.

     During the second quarter of 2005, we announced another product in our ATCA family of products, the Promentum™ ATCA-7010. The 7010 is a high-speed packet processing module that provides the highest bandwidth throughput available in a single ATCA slot. This product will significantly increase the packet-processing power of our customers’ systems, while at the same time reducing costs and speeding time to market. The 7010 features Intel^® IXP28xx network processors which are 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.

     During the first quarter of 2006 we announced seven new products in our Promentum family of ATCA solutions. Specifically we announced our new Promentum SYS-6010, the industry’s first 10-gigabit managed ATCA platform that will provide the highest traffic capacity throughput and processing densities available today. Our SYS-6010 is targeted at data plane applications such as IMS, Radio Network and Base Station Controllers, Media Gateways, Call Servers, IPTV among a number of applications.

     In addition to our new ATCA offerings, we announced our new Procelerant™ series of modular computing solutions (“COM Express”), for customers in our commercial systems market for medical, transaction terminals and test and measurement and other commercial applications. These new modular products are now available and we believe this family of high density, flexible solutions will enable commercial systems customers to achieve more rapid time to market with cost effective designs.

     In the first quarter of 2006 we announced another new Procelerant product for our commercial markets including medical imaging. Our new Procelerant 945-GM will be the industry’s first COM Express product that supports low voltage mobile technology. It will provide our customers with greater processing power in a smaller footprint with lower power consumption.

     Net income was $1.4 million and $2.6 million for the three months ended March 31, 2006 and 2005, respectively. Net income per share was $0.07 and $0.07, basic and diluted, respectively, for the three months ended March 31, 2006 compared to net income per share of $0.13 and $0.12, basic and diluted, respectively, for the three months ended March 31, 2005. Net income for the three months ended March 31, 2006 includes a charge for stock-based compensation of $1.3 million. As a result of adopting SFAS 123R, income before income taxes and net income for the three months ended March 31, 2006 was $1.3 million and $980 thousand lower, respectively, than if we had continued to account for stock-based compensation under the intrinsic value method. The impact on basic and diluted earnings per share for the three months ended March 31, 2006 was $0.05 and $0.03 per share, respectively.

     Despite the increase in revenues for the three months ended March 31, 2006 compared to the same period in 2005, gross margins decreased. Gross margins as a percentage of revenue have declined largely due to our product mix, with more revenues coming from higher volume products sold at more competitive prices. Our gross margin as a percentage of revenue has also been negatively impacted by a one-time cost of $691 thousand associated with the write down of raw material inventory that was sold to our contract manufacturing partners. We also continue to incur some redundant manufacturing costs as we move forward with outsourcing our internal manufacturing to our partners Celestica and Foxconn.

     We continue to invest in our research and development activities as we increase our spending on development of standards-based solutions, however, we expect our research and development expenditures to level off on an absolute dollar basis in the second half of 2006.

     Our interest income continues to increase as we continue to generate cash from operations and see the benefit of rising interest rates. Interest expense has decreased over the prior year due to a lower outstanding debt balance.

     Cash and cash equivalents and investments amounted to $231.2 million and $225.9 million at March 31, 2006 and December 31, 2005, respectively. The increase in cash and cash equivalents and investments during the three months ended March 31, 2006, was

primarily due to cash provided from operating activities as well as $2.3 million generated from the issuance of common stock. We generated net cash from operations in excess of net income in the three months ended March 31, 2006. 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.

     The Board of Directors has approved the repurchase of the remaining $2.5 million principal amount of the convertible subordinated notes and also approved the repurchase of up to $25.0 million of our outstanding shares of common stock. We will consider the repurchase of the notes and common stock on the open market or through privately negotiated transactions from time to time subject to market conditions. In addition to the potential repurchase of our securities, we intend to use our working capital to expand our product offerings through research and development, as discussed previously, and for potential acquisitions.

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, 2005. Management believes that other than the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), there have been no significant changes during the three months ended March 31, 2006 to the items that we disclosed as our critical accounting policies and estimates in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report on Form 10-K for the fiscal year ended December 31, 2005.

     Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS 123R, using the modified prospective transition method, and therefore have not restated prior periods’ results. Under this method we recognize compensation expense for all stock-based employee benefit plan equity awards granted after January 1, 2006 and prior to but not yet vested as of January 1, 2006, in accordance with SFAS 123R. Under the fair value recognition provisions of SFAS 123R, we recognize stock-based compensation on a straight-line basis over the requisite service period of the award for those shares expected to vest as described below. Prior to SFAS 123R adoption, we accounted for share-based payments under Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” (“APB 25”).

     We continue to use the Black-Scholes model to measure the grant date fair value of stock options and ESPP shares. The grant date fair value of stock options that are expected to vest is recognized on a straight-line basis over the requisite service period, which is equal to the option vesting period which is generally 3 years. The grant date fair value of ESPP shares that are expected to vest is recognized on a straight-line basis over the requisite service period, which is generally 18 months, is subject to modification at the date of purchase due to the ESPP look-back feature. The grant date fair value of restricted stock is equal to the closing price of RadiSys shares as quoted on NASDAQ on the date of grant. The grant date fair value of restricted shares that are expected to vest is recognized on a straight-line basis over the requisite service period, which is 3 years. The estimate of the number of options, ESPP shares and restricted stock expected to vest is determined based on historical experience.

     To determine the fair value of the stock options and ESPP shares, using the Black-Scholes option pricing model, the calculation takes into consideration the effect of the following:

	•		Exercise price of the option or purchase price of the ESPP share
	•		Price of our common stock on the date of grant
	•		Expected life of the option or share
	•		Expected volatility of our common stock over the expected life of the option or share
	•		Risk free interest rate during the expected life of the option or share

     The calculation includes several assumptions that require management’s judgment. The expected life of the option or share is determined based on assumptions about patterns of employee exercises and represents a probability-weighted average time-period from grant until exercise of stock options, subject to information available at time of grant. Determining expected volatility generally begins with calculating historical volatility for a similar long-term period and then considers the ways in which the future is reasonably expected to differ from the past.

     As part of its SFAS 123R adoption, we also examined its historical pattern of option exercises in an effort to determine if there were any discernable activity patterns based on certain employee populations. From this analysis, we identified three employee populations. The expected life computation is based on historical vested option exercises and post-vest forfeiture patterns and includes an estimate of the expected life for options that were fully vested and outstanding at March 31, 2006 for each of the three populations

identified. The estimate of the expected life for options that were fully vested and outstanding at March 31, 2006 was determined as the midpoint of a range of estimated expected lives determined as follows: the low end of the range assumes the fully vested and outstanding options settle on March 31, 2006 and the high end of the range assumes that these options expire upon contractual term. The risk free interest rate is based on the U.S. Treasury constant maturities in effect at the time of grant for the expected term of the option or share.

     Determining the appropriate fair value model and, as noted above, calculating the fair value of equity instruments associated with our employee benefit plans require the input of highly subjective assumptions. The assumptions used in calculating the fair value of these equity instruments represent management’s best estimates, but these estimates involve inherent uncertainties and the application of management judgment. As a result, if factors change and we use different assumptions our stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those shares expected to vest. If our actual forfeiture rate is materially different from our estimate the stock-based compensation expense could be significantly different from what we have recorded in the current period. See Note 2 to the Consolidated Condensed Financial Statements for a further discussion on stock-based compensation.

     As a result of adopting SFAS 123R income before income taxes and net income for the three months ended March 31, 2006 was $1.3 million and $980 thousand lower, respectively, than if we had continued to account for stock-based compensation under the intrinsic value method. The impact on both basic and diluted earnings per share for the three months ended March 31, 2006 was $0.05 and $0.03 per share, respectively. We estimate income from operations will be reduced by stock-based compensation expense of approximately $6.0 million for the year ended December 31, 2006. However, the actual stock-based compensation expense for 2006 could materially differ from this estimate. Our assessment, which includes an estimate of the timing and number of future options grants and share issuances, is based on the Black-Scholes option pricing model and is affected by our stock price as well as management’s assumptions as described previously.

Results of Operations

     The following table sets forth certain operating data as a percentage of revenues for the three months ended March 31, 2006 and 2005.

		For the Three Months Ended
		March 31,
		2006				2005
Revenues			100	%			100	%
Cost of sales			73.1				67.8
Gross margin			26.9				32.2
Research and development			13.9				13.1
Selling, general, and administrative			12.4				12.6
Intangible assets amortization			0.5				0.9
Restructuring and other charges (reversals)			0.1				—
Income from operations			0.0				5.6
Interest expense			(0.6	)			(0.9	)
Interest income			3.4				2.0
Other (expense) income, net			0.0				(0.6	)
Income before income tax provision			2.8				6.1
Income tax provision			0.6				1.6
Net income			2.2	%			4.5	%

Comparison of Three Months Ended March 31, 2006 and 2005

     Revenues. Revenues increased by $8.3 million or 14.4%, from $57.5 million in the three months ended March 31, 2005 to $65.8 million in the three months ended March 31, 2006. The increase in revenues for the three months ended March 31, 2006 compared to the same period in 2005 is due to an increase in revenues in the communications networking market of $9.6 million offset by a decrease in revenues from the commercial systems market of $1.3 million.

     Revenues in the communications networking market increased in the three months ended March 31, 2006 compared to the same periods in 2005 due to strong demand within the wireless submarket as our product content is more substantial in 2.5 and 3G deployments. Revenues were also higher due to deployments of new products by one of our major customers.

     Revenues in the commercial systems market decreased in the three months ended March 31, 2006 compared to the same period in 2005, primarily due to declines in the transaction terminal and industrial automation submarkets, partially offset by increases within the medical submarket. The decrease in revenues attributable to the transaction terminal submarket was primarily due to design wins nearing the end of their life cycle. The increase in revenues from the medical market was attributable to design wins that ramped into production during 2005.

     Given the dynamics of these markets, we may experience general fluctuations in the percentage of revenue attributable to each market and, as a result, the quarter to quarter comparisons of our markets often are not indicative of overall economic trends affecting the long-term performance of our markets. We currently expect that each of our markets will continue to represent a significant portion of total revenues.

     From a geographic perspective, for the three months ended March 31, 2006 compared to the same period in 2005, the overall increase in revenues was split between customers shipping into the EMEA and Asia Pacific regions, partially offset by a decrease in revenues for customers shipping into the North American region. For the three months ended March 31, 2006 compared to the same period in 2005 revenues as measured by destination in the EMEA region increased by $6.5 million while Asia Pacific revenues increased by $5.4 million. The increase in the EMEA region is mainly attributable to strong demand within the wireless submarket as our product content is more substantial in 2.5 and 3G deployments. The increase to the Asia Pacific region was due to increased shipments to existing multinational customers directly into the Asia Pacific region. For the three months ended March 31, 2006 revenues from North America declined by $3.6 million, compared to the same period in 2005. The decline in this region is attributable to a decrease in sales volumes as a result of the product nearing its end of life. We currently expect continued fluctuations in the percentage of revenue from each geographic region. Additionally, we expect revenues outside of the US to remain a significant portion of our revenues.

     Gross Margin. Gross margin for the three months ended March 31, 2006 was 26.9% compared to 32.2% for the same period in 2005. For the three months ended March 31, 2006, cost of sales includes $218 thousand of stock-based compensation expense which is discussed in “Stock-based Compensation Expense” below. Approximately half of the decrease in gross margin as a percentage of revenues for the three months ended March 31, 2006 compared to the same periods in 2005 was attributable to product mix as more of our revenue is coming from higher volume products with competitive pricing. The remainder of the decrease was associated with a one-time cost of $691 thousand associated with the write down of raw material inventory that was sold to our contract manufacturing partners. We also continued to incur some redundant manufacturing costs as we moved forward with outsourcing our internal manufacturing to our contract manufacturing partners. Finally, we incurred additional manufacturing-related costs in 2006 due to making our products RoHS compliant.

     Based on current forecasted revenue mix, we currently anticipate that gross margins will be in the high 20’s range for the foreseeable future.

     Research and Development. Research and development expenses consist primarily of salary, bonuses and benefits for product development staff, and costs of design and development supplies and equipment, net of reimbursements for non-recurring engineering services. Research and development expenses increased $1.6 million, or 21.1%, from $7.5 million for the three months ended March 31, 2005 to $9.1 million for the three months ended March 31, 2006. For the three months ended March 31, 2006, research and development expenses include $388 thousand of stock-based compensation expense which is discussed in “Stock-based Compensation Expense” below.

     As we increase our investment in the development of standards-based products, such as ATCA, we have hired additional engineering personnel which has resulted in increased research and development expenses for the three months ended March 31, 2006 compared to the same period in 2005. During 2005, we also continued to increase headcount at our Shanghai development center and added other expenses in connection with the development of the infrastructure to support this location. We currently anticipate increasing spending on research and development during the second quarter of 2006 by approximately $1 million compared to spending in the first quarter of 2006.

     Selling, General, and Administrative. Selling, general and administrative (“SG&A”) expenses consist primarily of salary, commissions, bonuses and benefits for sales, marketing, executive and administrative personnel, as well as the costs of professional services and other general corporate activities. SG&A expenses increased by $951 thousand or 13.1%, from $7.3 million for the three months ended March 31, 2005 to $8.2 million for the three months ended March 31, 2006. For the three months ended March 31, 2006, SG&A expenses include $690 thousand of stock-based compensation expense which is discussed in “Stock-based

Compensation Expense” below. The increase in SG&A expense in the three months ended March 31, 2006 compared to the same period in 2005 is primarily associated with $690 thousand of stock-based compensation expense recognized in the first quarter of 2006 and an increase in sales commissions. We currently anticipate increasing spending on SG&A during the second quarter of 2006 by approximately $1 million compared to spending in the first quarter of 2006.

     Stock-based Compensation Expense. Stock-based compensation expense for the three months ended March 31, 2006 consists of amortization of stock-based compensation associated with stock options and ESPP shares unvested and outstanding on January 1, 2006, new stock options and ESPP shares granted in the three months ended March 31, 2006 and unvested restricted shares. During the three months ended March 31, 2006, the Company incurred $1.3 million stock-based compensation. During the three months ended March 31, 2005, we incurred no stock-based compensation expense.

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

		For the Three
		Months Ended
		March 31,
		2006				2005
Cost of sales		$	218			$	—
Research and development			388				—
Selling, general and administrative			690				—
		$	1,296			$	—

     Intangible Assets Amortization. Intangible assets consist of purchased technology, patents and other identifiable intangible assets. Intangible assets amortization expense was $325 thousand and $513 thousand for the three months ended March 31, 2006 and 2005, respectively. Intangible assets amortization decreased due to certain intangible assets becoming fully amortized during 2005 and early 2006. We perform reviews for impairment of the purchased intangible assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable.

     Restructuring and Other Charges (Reversals). We evaluate the adequacy of the accrued restructuring and other charges on a quarterly basis. As a result, we record 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 we determine that expected restructuring and other obligations are less than the amounts accrued. Tables summarizing the activity in the accrued liability for each restructuring event are contained in Note 7 of the Notes to the unaudited Consolidated Financial Statements.

     Interest Expense. Interest expense includes interest incurred on convertible senior and subordinated notes. Interest expense decreased $106 thousand, or 19.6%, from $542 thousand for the three months ended March 31, 2005 to $436 thousand for the three months ended March 31, 2006. The decrease in the interest expense for the three months ended March 31, 2006 compared to the same period in 2005 is due to the decrease in interest expense associated with the convertible subordinated notes as a result of the repurchases of the subordinated convertible notes amounting to $7.5 million repurchased throughout 2005.

     Interest Income. Interest income increased $1.0 million, or 90.9%, from $1.2 million for the three months ended March 31, 2005 to $2.2 million for the three months ended March 31, 2006. Interest income increased as a result of a higher average balance of cash, cash equivalents and investments for the three months ended March 31, 2006 compared to the same period in 2005. Increasing interest rates and a shift in our investment portfolio towards higher yielding auction rate securities has also contributed to the increase in interest income.

     Other Income (Expense), Net. Other income (expense), net, primarily includes foreign currency exchange gains and losses. Other income, net, was $11 thousand for the three months ended March 31, 2006 compared to other expense, net of $349 thousand for the three months ended March 31, 2005. Foreign currency exchange rate fluctuations resulted in a net gain of $11 thousand for the three months ended March 31, 2006 compared to a net loss of $299 thousand for the three months ended March 31, 2005. The change in the foreign currency exchange rate fluctuations is relatively flat for the quarter due to small changes in the Japanese Yen with offsetting changes in the Euro and GBP relative to the U.S. Dollar.

     Income Tax Provision (Benefit). We recorded a tax provision of $406 thousand and a tax provision of $952 thousand for the three months ended March 31, 2006 and 2005, respectively. We expect the effective tax rate for the year ending December 31, 2006 to be in the low to mid 20%’s compared to 6.9% for the year ended December 31, 2005. The increase in the effective tax rate between the

years ended December 31, 2006 and 2005, respectively, is primarily due to the tax impact of a decrease in the valuation allowance at December 31, 2005 attributable to a projected increase in future utilization of general business tax credits and certain net operating loss carryforwards and the adoption of SFAS 123R..

     The Working Families Tax Relief Act of 2004 extended the research and development tax credit through December 31, 2005. As it was done in the past, we expect that Congress will reinstate the tax credit retroactive to January 1^st. However, we are not allowed to record the benefit of this credit until the legislation becomes enacted law.

     The adoption of SFAS 123R related to the expensing of stock options will create differences in book and taxable income on both a permanent and temporary basis. We are projecting a permanent difference of approximately $2.3 million attributable to statutory options and stock option expense related to all non U.S. employees for the year ending 2006. The annual effective tax rate impact for this permanent difference is projected to be approximately 6.0%.

     The 2006 estimated effective tax rate is based on current tax law and the current expected income and assumes that the Company continues to receive the tax benefits associated with certain income associated with foreign jurisdictions. The tax rate may be affected by potential acquisitions, restructuring events or divestitures, the jurisdictions in which profits are determined to be earned and taxed and the ability to realize deferred tax assets.

Liquidity and Capital Resources

     The following table summarizes selected financial information as of the dates indicated and for each of the three months ended on the dates indicated:

		March 31,				December 31,				March 31,
		2006				2005				2005
		(Dollar amounts in thousands)
Working capital		$	256,920			$	249,159			$	190,465
Cash and cash equivalents and investments		$	231,202			$	225,855			$	203,409
Cash and cash equivalents		$	91,802			$	90,055			$	77,585
Short-term investments		$	139,400			$	135,800			$	86,074
Accounts receivable, net		$	44,586			$	39,055			$	38,707
Inventories, net		$	13,243			$	21,629			$	20,686
Long-term investments		$	—			$	—			$	39,750
Accounts payable		$	35,127			$	36,903			$	27,440
Convertible senior notes		$	97,312			$	97,279			$	97,180
Convertible subordinated notes		$	2,501			$	2,498			$	8,890
Days sales outstanding (A)			62				55				61
Days to pay (B)			67				73				64
Inventory turns (C)			14.4				8.4				7.5
Inventory turns — days (D)			25				44				48
Cash cycle time — days (E)			20				26				46

Cash and cash equivalents increased by $1.7 million from $90.1 million at December 31, 2005 to $91.8 million at March 31, 2006. Activities impacting cash and cash equivalents are as follows:

     Cash Flows

		For the Three Months Ended
		March 31,
		2006				2005
		(In thousands)
Cash provided by operating activities		$	4,222			$	6,307
Cash (used in) investing activities			(4,882	)			(9,570	)
Cash provided by financing activities			2,326				862
Effects of exchange rate changes			81				(580	)
Net increase (decrease) in cash and cash equivalents		$	1,747			$	(2,981	)

     We have generated cash from operating activities in amounts greater than net income in the three months ended March 31, 2006 and 2005, driven mainly by improved management of our working capital. We currently believe that cash flows from operations, available cash balances, and short-term borrowings will be sufficient to fund our operating liquidity needs.

     During the three months ended March 31, 2006 and 2005, we used net cash provided by operating activities for capital expenditures amounting to $1.3 million and $1.7 million, respectively. During the three months ended March 31, 2006, capital expenditures were primarily associated with our increased investment in our R&D and marketing efforts as we continue to develop and begin to sell standards-based solutions. During the three months ended March 31, 2005, capital expenditures included our continued investment in equipment to support the Company’s China-based manufacturing partner as well as leasehold improvements, office equipment and software to support our continued growth and productivity.

     Net cash provided by operating activities for the three months ended March 31, 2006 was also used for severance payments amounting to approximately $556 thousand associated with our 2005 restructuring activities. During the three months ended March 31, 2006, cash used for accounts receivable related to an increase in sales as well as a seven-day increase of Days Sales Outstanding. Cash provided by inventory related to the transfer of inventory to contract manufacturers along with the sale of inventory that was strategically held as of December 31, 2005.

     During the three months ended March 31, 2006 and 2005, we received $2.3 million and $1.9 million, respectively, in proceeds from the issuance of common stock through the Company’s stock compensation plans.

     Also during the three months ended March 31, 2005, we used $990 thousand to repurchase our 5.5% convertible subordinated notes. The Board of Directors has approved the repurchase of the remaining $2.5 million principal amount of the convertible subordinated notes and also approved the repurchase of up to $25.0 million of our outstanding shares of common stock. We will consider the repurchase of the notes and common stock on the open market or through privately negotiated transactions from time to time subject to market conditions. In addition to the potential repurchase of our securities, we intend to use our working capital to expand our product offerings through research and development and potential acquisitions.

     Changes in foreign currency rates impacted beginning cash balances during the three months ended March 31, 2006 by $81 thousand. Due to the Company’s international operations where transactions are recorded in functional currencies other than the U.S. Dollar, the effects of changes in foreign currency exchange rates on existing cash balances during any given periods results in amounts on the consolidated statements of cash flows that may not reflect the changes in the corresponding accounts on the consolidated balance sheets.

     As of March 31, 2006 and December 31, 2005 working capital was $256.9 million and $249.2 million, respectively. Working capital increased by $7.7 million due to primarily to our net positive cash flow from operating and financing activities generated during the first quarter of 2006.

     Management believes that cash flows from operations, available cash balances and short-term borrowings will be sufficient to fund our operating liquidity needs for the short-term and long-term future.

     Investments

     Investments consisted of the following (in thousands):

		March 31,				December 31,
		2006				2005
Short-term held-to-maturity investments		$	39,750			$	39,750
Short-term available-for-sale investments		$	99,650			$	96,050

     We invest excess cash in debt instruments of the U.S. Government and its agencies, 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 generally have maturity dates far into the future but due to a resetting interest rate feature associated with these instruments they are readily tradable and rarely have differences between their par value and fair market value. As we do not intend to hold these investments until maturity, they are classified as available-for-sale and any unrealized holding gains and losses are recorded, net of tax, as a separate component of accumulated other comprehensive income. 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 March 31, 2006, the Company was in compliance with its investment policy.

     Line of Credit

     During the quarter ended March 31, 2006, the Company transferred its line of credit facility from its commercial bank to its investment bank for $20.0 million at an interest rate based on the 30-day London Inter-Bank Offered Rate (“LIBOR”) plus 0.75%. 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, 2006, 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 March 31, 2006 and December 31, 2005, 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.

     Convertible Senior Notes

     During November 2003, we 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 our common stock and rank equally in right of payment with all of our 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 our 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 our common stock under certain circumstances that include but are not limited to (i) conversion due to the closing price of our 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. We may redeem all or a portion of the notes at our option on or after November 15, 2006 but before November 15, 2008 provided that the closing price of our 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, we 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.

     As of March 31, 2006 and December 31, 2005 the Company had outstanding convertible senior notes with a face value of $100 million. As of March 31, 2006 and December 31, 2005 the book value of the convertible senior notes was $97.3 million and $97.3 million respectively, net of unamortized discount of $2.7 million and $2.7 million, respectively. The estimated fair value of the convertible senior notes was $100.5 million and $93.5 million at March 31, 2006 and December 31, 2005, respectively.

     Convertible Subordinated Notes

     During August 2000, we completed a private offering of $120 million aggregate principal amount of 5.5% convertible subordinated notes due August 15, 2007 to qualified institutional buyers. The discount on the convertible subordinated notes amounted to $3.6 million.

     Convertible subordinated notes are unsecured obligations convertible into our common stock and are subordinated to all present and future senior indebtedness of RadiSys. 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 our 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 our 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 we may redeem all or a portion of the notes at our 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.

     On April 26, 2005 the Board of Directors approved the repurchase of the remaining principal amount of the convertible subordinated notes. In 2005 we repurchased $7.5 million principal amount of the convertible subordinated notes, with an associated discount of $69 thousand. We repurchased the notes in the open market for $7.4 million and, as a result, recorded a loss of $50 thousand.

     In 2004, we repurchased $58.8 million principal amount of the convertible subordinated notes, with an associated discount of $897 thousand. We repurchased the notes in the open market for $58.2 million and, as a result, recorded a loss of $387 thousand.

     In 2003, we repurchased $10.3 million principal amount of the convertible subordinated notes, with an associated discount of $212 thousand. We repurchased the notes in the open market for $9.2 million and, as a result, recorded a gain of $825 thousand. In 2002, we repurchased $21.0 million principal amount of the convertible subordinated notes, with an associated discount of $587 thousand for $17.5 million in cash as part of negotiated transactions with third parties. The early extinguishments of the notes resulted in a gain of $3.0 million. In 2000, we repurchased $20.0 million principal amount of the convertible subordinated notes, with an associated discount of $581 thousand for $14.3 million as part of a negotiated transaction with a third party. The early extinguishment of the notes resulted in a gain of $5.1 million.

     As of March 31, 2006 and December 31, 2005 we had outstanding convertible subordinated notes with a face value of $2.5 million and $2.5 million, respectively. As of March 31, 2006 and December 31, 2005 the book value of the convertible subordinated notes was $2.5 million and $2.5 million, respectively, net of amortized discount of $17 thousand and $20 thousand, respectively. The estimated fair value of the convertible subordinated notes was $2.5 million and $2.5 million at March 31, 2006 and December 31, 2005, respectively.

     Stock Repurchase Program

     On October 25, 2005 the Board of Directors authorized an increase in the repurchase of our outstanding shares of common stock from a previously approved $5 million to $25 million. The Company will consider the purchase of common stock on the open market or through privately negotiated transactions from time to time subject to market conditions.

     Contractual Obligations

     The following summarizes the Company’s contractual obligations at March 31, 2006 and the effect of such on its liquidity and cash flows in future periods (in thousands).

		2006*				2007				2008				2009				2010				Thereafter
Future minimum lease payments		$	2,212			$	2,927			$	2,903			$	2,846			$	2,658			$	1,707
Purchase obligations (A)			24,795				—				—				—				—				—
Interest on convertible notes			1,135				1,513				1,375				1,375				1,375				17,875
Convertible senior notes (B)			—				—				100,000				—				—				—
Convertible subordinated notes (B)			—				2,518				—				—				—				—
Total		$	28,142			$	6,958			$	104,278			$	4,221			$	4,033			$	19,582

     Off-Balance Sheet Arrangements

     We do not engage in any activity involving special purpose entities or off-balance sheet financing.

     Liquidity Outlook

     We believe that our current cash and cash equivalents and investments amounting to $231.2 million at March 31, 2006 and cash generated from operations will satisfy our short and long-term expected working capital needs, capital expenditures, stock and debt repurchases, and other liquidity requirements associated with our existing business operations. Capital expenditures are expected to range from $1 million to $1.5 million per quarter.

FORWARD-LOOKING STATEMENTS

     This Quarterly Report on Form 10-Q may contain forward-looking statements. Some of the forward-looking statements contained in this Quarterly Report on Form 10-Q include:

	•		Our statements concerning our beliefs about the success of our shift in business strategy from perfect fit solutions to standards-based solutions;
	•		The adoption by our customers of standards-based solutions and ATCA;
	•		The size of the addressable market for ATCA;
	•		Expectations and goals for revenues, gross margin, research and development expenses, selling, general, administrative expenses and profits;
	•		Estimates and impact of stock-based compensation expense;
	•		The impact of our restructuring events on future revenues; and
	•		Our projected liquidity.

     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,” “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.

     Forward-looking statements in this Quarterly Report on Form 10-Q include discussions of our goals, including those discussions set forth in Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. We cannot provide assurance that these goals will be achieved.

     Although forward-looking statements help provide complete 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. In evaluating these statements, you should specifically consider the risks outlined above and those listed under “Risk Factors.” These risk factors may cause our actual results to differ materially from any forward-looking statement.

     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 Quarterly Report on Form 10-Q are 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.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

     We are exposed to market risk from changes in interest rates, foreign currency exchange rates, and equity trading prices, which could affect our financial position and results of operations.

     Interest Rate Risk. We invest 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. We attempt to protect and preserve our invested funds by limiting default, market, and reinvestment risk. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair value adversely affected due to a rise in interest rates while floating rate securities may produce less income than expected if interest rates decline. Due to the short duration of most of the investment portfolio, an immediate 10% change in interest rates would not have a material effect on the fair value of our investment portfolio. Therefore, we would not expect our operating results or cash flows to be affected, to any significant degree, by the effect of a sudden change in market interest rates on the securities portfolio. The estimated fair value of our debt securities that we have invested in at March 31, 2006 and December 31, 2005 was $207.1 million and $202.6 million, respectively. The effect of an immediate 10% change in interest rates would not have a material effect on our operating results or cash flows.

     Foreign Currency Risk. We pay the expenses of our international operations in local currencies, namely, the Japanese Yen, Canadian Dollar, British Pound, New Shekel, Chinese Yuan and Euro. The international operations are subject to risks typical of an international business, including, but not limited to: differing economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility. Accordingly, future results could be materially and adversely affected by changes in these or other factors. We are also exposed to foreign exchange rate fluctuations as the balance sheets and income statements of our foreign subsidiaries are translated into U.S. dollars during the consolidation process. Because exchange rates vary, these results, when translated, may vary from expectations and adversely affect overall expected profitability. Foreign currency exchange rate fluctuations resulted in a net gain of $11 thousand for the three months ended March 31, 2006 and a net loss of $299 thousand for the three months ended March 31, 2005.

     Convertible Senior Notes. During November 2003, we 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 our common stock and rank equally in right of payment with all of our 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, unless previously redeemed or repurchased, into shares of our 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 our common stock under certain circumstances that include but are not limited to (i) conversion due to the closing price of our 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. We may redeem all or a portion of the notes at our option on or after November 15, 2006 but before November 15, 2008 provided that the closing price of our 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, we 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 fair value of the convertible senior notes is sensitive to interest rate changes. Interest rate changes would result in increases or decreases in the fair value of the convertible senior notes, due to differences between market interest rates and rates in effect at the inception of the obligation. Unless we elect to repurchase our convertible senior notes in the open market, changes in the fair value of convertible senior notes have no impact on our cash flows or consolidated financial statements. The estimated fair value of the convertible senior notes was $100.5 million and $93.5 million at March 31, 2006 and December 31, 2005, respectively.

     Convertible Subordinated Notes. Convertible subordinated notes are unsecured obligations convertible into our common stock and are subordinated to all present and future senior indebtedness of RadiSys. 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 our 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 our 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 we may redeem all or a portion of the notes at our 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 fair value of the convertible subordinated notes is sensitive to interest rate changes. Interest rate changes would result in increases or decreases in the fair value of the convertible subordinated notes, due to differences between market interest rates and rates in effect at the inception of the obligation. Unless we elect to repurchase our convertible subordinated notes in the open market, changes in the fair value of convertible subordinated notes have no impact on our cash flows or consolidated financial statements. The estimated fair value of the convertible subordinated notes was $2.5 million and $2.5 million at March 31, 2006 and December 31, 2005, respectively.

     As of March 31, 2006 we have cumulatively repurchased convertible subordinated notes in the amount of $117.5 million, face value, for $106.9 million. We received board authorization to repurchase all remaining convertible subordinated notes. We may elect to use a portion of our cash and cash equivalents and investment balances to buy back additional amounts of the convertible subordinated notes. As of March 31, 2006, our aggregate cash and cash equivalents and investments were $231.2 million.

Item 4. Controls and Procedures

     Based on their evaluation as of the end of the period covered by this Quarterly Report on Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s “disclosure controls and procedures” (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) are effective to ensure that information required to be disclosed by the Company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms.

     In connection with the evaluation described above, we identified no change in our internal control over financial reporting that occurred during the three months ended March 31, 2006, and that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II

Item 1A. Risk Factors

Because of our dependence on certain customers, the loss of, or a substantial decline in sales to, a top customer could have a material adverse effect on our revenues and profitability.

     During the three months ended March 31, 2006, we derived 67.2% of our revenues from five customers. These five customers were Nokia, Nortel, Comverse, Siemens and Philips Medical Systems. During the three months ended March 31, 2006 revenues attributable to Nokia were 41.4%. We believe that sales to these customers will continue to be a substantial percentage of our revenues. A financial hardship experienced by, or a substantial decrease in sales to any one of our top customers could materially affect revenues and profitability. Generally, these customers are not the end-users of our products. If any of these customers’ efforts to market the end products we design and manufacture for them or the end products into which our products are incorporated are unsuccessful in the marketplace our sales and profitability will be significantly reduced. Furthermore, if these customers experience adverse economic conditions in the markets into which they sell our products (end markets), we would expect a significant reduction in spending by these customers. Some of the end markets that these customers sell our products into are characterized by intense competition, rapid technological change and economic uncertainty. Our exposure to economic cyclicality and any related fluctuation in demand from these customers could have a material adverse effect on our revenues and financial condition. Finally, a financial hardship experienced by one of our top customers could materially affect revenues and profitability.

Our business depends on the communications networking and commercial systems markets in which demand can be cyclical, and any inability to sell products to these markets could have a material adverse effect on our revenues.

     We derive our revenues from a number of diverse end markets, some of which are subject to significant cyclical changes in demand. In the three months ended March 31, 2006, we derived 74.2% and 25.8% of our revenues from the communications networking and commercial systems markets, respectively. We believe that our revenues will continue to be derived primarily from these two markets. Communications networking revenues include, but are not limited to, sales to Avaya, Comverse, Lucent, Nokia and Nortel. Commercial systems revenues include, but are not limited to, sales to Agilent Technologies, Beckman Coulter, Diebold, Philips Medical and Siemens AG. Generally, our customers are not the end-users of our products. If our customers experience adverse economic conditions in the markets into which they sell our products (end markets), we would expect a significant reduction in spending by our customers. Some of these end markets are characterized by intense competition, rapid technological change and economic uncertainty. Our exposure to economic cyclicality and any related fluctuation in customer demand in these end markets could have a material adverse effect on our revenues and financial condition. Significant reduction in our customers’ spending, such as what we experienced in 2001 and 2002, will result in decreased revenues and earnings. We continue to execute on our strategy of expanding into new end markets either through new product development projects with our existing customers or through new customer relationships, but no assurance can be given that this strategy will be successful.

We are shifting a significant portion of our manufacturing to third party contract manufacturers and our inability to properly transfer our manufacturing or any failed or less than optimal execution on their behalf could adversely affect our revenues and profitability.

     We have traditionally manufactured a substantial portion of our products. To lower our costs and provide better value and more competitive products for our customers and to achieve higher levels of global fulfillment, we are shifting a significant amount of our manufacturing to third party contract manufacturers. As of March 31, 2006, our contract manufacturing partners were manufacturing over 80% of all of our unit volume. We expect to increase our outsourcing to our contract manufacturers throughout 2006. If we do not properly transfer our manufacturing expertise to these third party manufacturers or they fail to adequately perform, our revenues and profitability could be adversely affected. Among other things, inadequate performance from our contract manufacturers could include the production of products that do not meet our high quality standards or unanticipated scheduling delays in production and delivery or cause us to invest in additional internal resources as we lose productivity on other important projects. Additionally, inadequate performance by our contract manufacturers may result in higher than anticipated costs. We also rely on contract manufacturers as the sole suppliers of certain RadiSys products. For example, FoxConn produces certain products that we do not produce internally and that no other contract manufacturer produces for us. Alternative sources of supply for the RadiSys products that our contract manufacturers produce would be difficult to locate and/or it would require a significant amount of time and resources to establish an alternative supply line, including transitioning the products to be internally produced. We currently utilize several contract manufacturers for outsourced board and system production; however, we depend on two primary contract manufacturing partners, FoxConn, and Celestica, Inc.

Because of our dependence and our contract manufacturers’ dependence on a few suppliers, or in some cases one supplier, for some of the components we use, as well as our dependence on a few contract manufacturers to supply a majority of our products, a loss of a supplier, a decline in the quality of these components, a shortage of any of these components, or a loss or degradation in performance of a contract manufacturer could have a material adverse effect on our business or our financial performance.

     We depend on a few suppliers, or in some cases one supplier, for a continuing supply of the components we use in the manufacture of our products and any disruption in supply could adversely impact our financial performance. For example, we currently rely on Intel for the supply of some microprocessors and other components, and we rely on LSI, Epson Electronic America, Broadcom, NEC, Chen Ming, Triax and Texas Instruments as the sole source suppliers for other components such as integrated circuits and mechanical assemblies. Alternative sources of components that are procured from one supplier or a limited number of suppliers would be difficult to locate and/or it would require a significant amount of time and resources to establish. We also rely on contract manufacturers with sole sourcing for certain RadiSys products. Alternative sources of manufacturing services for the RadiSys products could require significant time and resources to establish, including transitioning the products to be internally produced. In addition, any decline in the quality of components supplied by our vendors or products produced by our contracting manufacturing partners could adversely impact our reputation and business performance.

Unexpected changes in customer demand or our inability to accurately forecast customer demand or unexpected changes in design could have a material adverse effect on our gross margins and profitability.

     We typically sell our products pursuant to purchase orders that customers can cancel or defer delivery on short notice without incurring a significant penalty. Order cancellations or deferrals and/or design changes could cause us or our contract manufacturers to hold excess or obsolete inventory that may not be salable to other customers on commercially reasonable terms, and which could require inventory valuation write downs that reduce our gross margin and profitability. This risk is exacerbated by a current trend from our customers of requiring shorter lead times between placing orders with us and the shipment date. That typically necessitates in increase in our inventory or inventory of our products at our contract manufacturers’ locations, raising the likelihood that upon cancellation or deferral, we may be holding greater amounts of inventory and/or incurring additional costs. Our contract manufacturers as well as our internal manufacturing department depend on our ability to accurately forecast our customers’ demand so that they can procure materials and manufacture product to meet such demand. Thereby, we are contractually obligated to reimburse our contract manufacturers for the cost of excess inventory used in the manufacture of our products for which there is no forecasted or alternative use. Unexpected decreases in customer demand or our inability to accurately forecast customer demand could result in increases in our adverse purchase commitment liability and have a material adverse effect on our gross margins and profitability. If we underestimate customer demand, the contract manufacturers may not have adequate inventories, which could interrupt manufacturing of our products and result in delays in shipments to our customers and revenue recognition.

We are shifting our business from predominately perfect fit solutions to more standards-based products, such as ATCA and COM Express. This requires substantial expenditures for research and development that could adversely affect our short-term earnings and, if this strategy is not successful could have a material adverse effect on our long-term revenues, profitability and financial condition.

     We are shifting our business from predominately perfect fit solutions to more standards-based solutions, such as ATCA and COM Express products. There can be no assurance that this strategy will be successful. This strategy requires us to make substantial expenditures for research and development in new technologies that we reflect as a current expense in our financial statements. We believe that these investments in standards-based products and new technologies will allow us to provide a broader set of products and building blocks to take to market and position us to grow on a long-term basis. Revenues from some of these investments, such as ATCA and COM Express, are not expected to result in any significant revenue opportunities for at least twelve to eighteen months. Accordingly, these expenditures could adversely affect our short-term earnings. In addition, there is no assurance that these new products and technologies will be accepted by our customers and, if accepted, how large the market will be for these products or what the timing will be for any meaningful revenues. If we are unable to successfully develop and sell standards-based products to our customers, our revenues, profitability and financial condition could be materially adversely affected. Additionally, if we successfully develop standards-based products we may incur incremental research and development expenses as we tailor the standards-based products for our customers. Furthermore, we are building standards-based products to meet industry standards that define the basis of compatibility in operation and communication of a system supported by different vendors. Those standards constantly change and new competing standards emerge. The development or adaptation of products and technologies require us to commit financial resources, personnel and time significantly in advance of sales. In order to compete, our decisions with respect to those commitments must

accurately anticipate, sometimes two years or more in advance, both future demand and the technologies that will win market acceptance to meet that demand.

Our projections of future revenues and earnings are highly subjective and may not reflect future results which could cause volatility in the price of our common stock.

     Most of our major customers have contracts but these contracts do not commit them to purchase a minimum amount of our products. These contracts generally require our customers to provide us with forecasts of their anticipated purchases. However, our experience indicates that customers can change their purchasing patterns quickly in response to market demands and therefore these forecasts may not be relied upon to accurately forecast sales. From time to time we provide projections to our shareholders and the investment community of our future sales and earnings. Since we do not have long-term purchase commitments from our major customers and the customer order cycle is short, it is difficult for us to accurately predict the amount of our sales and related earnings in any given period. Our projections are based on management’s best estimate of sales using historical sales data, information from customers and other information deemed relevant. These projections are highly subjective since sales to our customers can fluctuate substantially based on the demands of their customers and the relevant markets. In addition and as stated above, we have a high degree of customer concentration. Any significant change in purchases by any one of our largest customers can significantly affect our sales and profitability. We have recently experienced significant changes in purchases by one of our large customers which adversely impacted the fiscal period in which it occurred. If our actual sales or earnings are less than the projected amounts, the price of our common stock may be adversely affected and accordingly our shareholders should not place undue reliance on these projections.

Not all new product development projects ramp into production, and if ramped into production the volumes derived from such projects may not be as significant as we had originally estimated, which could have a substantial negative impact on our anticipated revenues and profitability.

     If a product development project actually ramps into production, the average ramp into production begins about 12 to 18 months after the project launch, although some more complex projects can take up to 24 months or longer. After that, there is an additional time lag from the start of production ramp to peak revenue. Not all projects ramp into production and even if a project is ramped into production, the volumes derived from such projects may not be as significant as we had originally estimated. Projects are sometimes canceled or delayed, or can perform below original expectations, which can adversely impact anticipated revenues and profitability.

In recent years, various state, federal and international laws and regulations governing the collection, treatment, recycling and disposal of certain materials used in the manufacturing of electrical and electronic components have been enacted. In support of these laws and regulations, we will incur significant additional expenditures and we may incur additional capital expenditures and asset impairments to ensure that our products and our vendor’s products are in compliance with these regulations, and we may also incur significant penalties in connection with any violations of these laws. Additionally, failure to comply with these regulations could have an adverse effect on our business, financial condition and results of operations. As a result, our financial condition or operating results may be negatively impacted.

     The most significant pieces of legislation relate to two European Union (“EU”) directives aimed at wastes from electrical and electronic equipment (“WEEE”) and the restriction of the use of certain hazardous substances (“RoHS”). Specifically, the RoHS directive prohibits the use of certain types of materials, such as lead, in the manufacturing of electronic products. As of July 1, 2006 products sold within the EU, a market in which we sell a significant amount of our products, must be RoHS compliant. Failure to comply with such legislation could result in our customers refusing to purchase our products and subject us to significant monetary penalties in connection with a violation, both of which could have a materially adverse effect on our business, financial condition and results from operations.

Competition in the market for embedded systems is intense, and if we lose our market share, our revenues and profitability could decline.

     We compete with a number of companies providing embedded systems, including Advantech Co., Continuous Computing, Emerson Electric Co., Hewlett Packard, divisions within Intel Corporation and IBM, Kontron AG, Mercury Computer Systems, Motorola ECC, Performance Technologies, SBS Technologies and divisions within Sun Microsystems. Because the embedded systems market is growing, it is attracting new non-traditional competitors. These non-traditional competitors include contract manufacturers that provide design services and Asian-based original design manufacturers. Some of our competitors and potential competitors have a number of significant advantages over us, including:

	•		a longer operating history;
	•		greater name recognition and marketing power;
	•		preferred vendor status with our existing and potential customers; and
	•		significantly greater financial, technical, marketing and other resources, which allow them to respond more quickly to new or changing opportunities, technologies and customer requirements.

     Furthermore, existing or potential competitors may establish cooperative relationships with each other or with third parties or adopt aggressive pricing policies to gain market share.

     As a result of increased competition, we could encounter significant pricing pressures. These pricing pressures could result in significantly lower average selling prices for our products. We may not be able to offset the effects of any price reductions with an increase in the number of customers, cost reductions or otherwise. In addition, many of the industries we serve, such as the communications industry, are encountering market consolidation, or are likely to encounter consolidation in the near future, which could result in increased pricing pressure and additional competition.

Potential acquisitions and partnerships may be more costly or less profitable than anticipated and may adversely affect the price of our company stock.

     Future acquisitions and partnerships may involve the use of significant amounts of cash, potentially dilutive issuances of equity or equity-linked securities, issuance of debt and amortization of intangible assets with determinable lives. We may also be required to charge against earnings upon consummation of the acquisition the value of an acquired business’ technology that does not meet the accounting definition of “completed technology.” Moreover, to the extent that any proposed acquisition or strategic investment is not favorably received by shareholders, analysts and others in the investment community, the price of our common stock could be adversely affected. In addition, acquisitions or strategic investments involve numerous risks, including:

	•		difficulties in the assimilation of the operations, technologies, products and personnel of the acquired company;
	•		the diversion of management’s attention from other business concerns;
	•		risks of entering markets in which we have no or limited prior experience;
	•		the potential loss of key employees of the acquired company; and
	•		performance below expectations by an acquired business.

     In the event that an acquisition or a partnership does occur and we are unable to successfully integrate operations, technologies, products or personnel that we acquire, our business, results of operations and financial condition could be materially adversely affected. We may expend additional resources without receiving benefit from strategic alliances with third parties.

Our international operations expose us to additional political, economic and regulatory risks not faced by businesses that operate only in the United States.

     In the three months ended March 31, 2006, as measured by delivery destination, we derived 4.0% of our revenues from Canada and Mexico, 52.3% of our revenues from EMEA and 16.1% from Asia Pacific. In addition, during 2004 we opened a development center in Shanghai, China and began to utilize a contract manufacturer in Shenzhen, China. In the first quarter of 2006, approximately 51% of our total revenues were associated with products produced at our China contract manufacturer. In 2005 we began migrating products to a Celestica facility in Mexico. In the first quarter of 2006 approximately 10% of our total revenues were associated with our Mexican contract manufacturer. As a result of all these activities, we are subject to worldwide economic and market condition risks generally associated with global trade, such as fluctuating exchange rates, tariff and trade policies, domestic and foreign tax policies, foreign governmental regulations, political unrest, wars and other acts of terrorism and changes in other economic conditions. These risks, among others, could adversely affect our results of operations or financial position. Additionally, some of our sales to overseas customers are made under export licenses that must be obtained from the United States Department of Commerce. Protectionist trade legislation in either the United States of America or other countries, such as a change in the current tariff structures, export compliance laws, trade restrictions resulting from war or terrorism, or other trade policies could adversely affect our ability to sell or to manufacture in international markets. Furthermore, revenues from outside the United States of America are subject to inherent risks, including the general economic and political conditions in each country. These risks, among others, could adversely affect our results of operations or financial position.

If we are unable to generate sufficient income in the future, we may not be able to fully utilize our net deferred tax assets or support our current levels of goodwill and intangible assets on our balance sheet.

     We cannot provide absolute assurance that we will generate sufficient taxable income to fully utilize the net deferred tax assets of $28.6 million as of March 31, 2006. We may not generate sufficient taxable income due to earning lower than forecasted net income or incurring charges associated with unusual events, such as restructurings and acquisitions. Accordingly, we may record a full valuation allowance against the deferred tax assets if our expectations of future taxable income are not achieved. On the other hand, if we generate taxable income in excess of our expectations, the valuation allowance may be reduced accordingly. We also cannot provide absolute assurance that future income will support the carrying amount of goodwill and intangibles of $29.3 million on the Consolidated Balance Sheet as of March 31, 2006, and therefore, we may incur an impairment charge in the future.

Our products for embedded solutions are based on industry standards, which are continually evolving, and any failure to conform to these standards or lack of success of these standards could have a substantial negative impact on our revenues and profitability.

     We develop and supply a mix of perfect fit and standards-based products. Standards-based products for embedded computing applications are often based on industry standards, which are continually evolving. Our future success in these products will depend, in part, upon our capacity to invest in, and successfully develop and introduce new products based on emerging industry standards. Our inability to invest in or conform to these standards could render parts of our product portfolio uncompetitive, unmarketable or obsolete. As new standards are developed for our addressable markets standards, we may be unable to successfully invest in, design and manufacture new products that address the needs of our customers or achieve substantial market acceptance.

If we are unable to protect our intellectual property, we may lose a valuable competitive advantage or be forced to incur costly litigation to protect our rights.

     We are a technology dependent company, and our success depends on developing and protecting our intellectual property. We rely on patents, copyrights, trademarks and trade secret laws to protect our intellectual property. At the same time, our products are complex, and are often not patentable in their entirety. We also license intellectual property from third parties and rely on those parties to maintain and protect their technology. We cannot be certain that our actions will protect proprietary rights. If we are unable to adequately protect our technology, or if we are unable to continue to obtain or maintain licenses for protected technology from third parties, it could have a material adverse effect on our results of operations. In addition, some of our products are now designed, manufactured and sold outside of the United States of America. Despite our precautions to protect our intellectual property, this international exposure may reduce or limit protection of our intellectual property which is more prone to design piracy.

Changes in stock-based compensation accounting rules have adversely impacted our operating results and may adversely impact our stock price.

     On December 16, 2004, the Financial Accounting Standards Board issued SFAS 123R. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized as expense in the financial statements based on their fair values and does not allow the proforma disclosure previously used as an alternative to financial statement recognition.

     We were required to adopt SFAS 123R in the first quarter of 2006. Under SFAS 123R, we applied the Black-Scholes valuation model in determining the fair value of share-based payments, with adjustments to the methodology as necessary for reporting under SFAS 123R guidelines. As a result, our operating results for the first quarter of fiscal 2006 contain, and our operating results for future periods will contain, a charge for share-based compensation related to stock options and ESPP shares. SFAS 123R had a significant impact on our operating results for the first quarter of fiscal 2006, with SFAS 123R charges of $1.3 million reducing operating income to $1.4 million, and we expect the adoption of SFAS 123R will continue to have a significant adverse impact on our operating results in the future. We cannot predict the effect that this adverse impact on our reported operating results will have on the trading price of our common stock.

Decreased effectiveness of share-based payment awards could adversely affect our ability to attract and retain employees.

     We have historically used stock options and other forms of share-based payment awards as key components of our total rewards employee compensation program in order to retain employees and provide competitive compensation and benefit packages. In accordance with SFAS 123R, we began recording charges to earnings for stock-based compensation expense in the first quarter of fiscal 2006. As a result, we will incur increased compensation costs associated with our stock-based compensation programs making it more expensive for us to grant share-based payment awards to employees in the future. Like other companies, we have reviewed our equity compensation strategy in light of the current regulatory and competitive environment and have decided to reduce the total

number of options granted to employees and the number of employees who receive share-based payment awards. Due to this change in our stock-based compensation strategy, we may find it difficult to attract, retain and motivate employees, and any such difficulty could materially adversely affect our business.

Our period-to-period revenues, operating results and earnings per share fluctuate significantly, which may result in volatility in the price of our common stock.

     The price of our common stock may be subject to wide, rapid fluctuations. Our period-to-period revenues and operating results have varied in the past and may continue to vary in the future, and any such fluctuations may cause our stock price to fluctuate. Fluctuations in the stock price may also be due to other factors, such as changes in analysts’ estimates regarding earnings, or may be due to factors relating to the commercial systems and communication networking markets in general. Shareholders should be willing to incur the risk of such fluctuations.

We depend on the recruitment and retention of qualified personnel, and our failure to attract and retain such personnel could seriously harm our business.

     Due to the specialized nature of our business, our future performance is highly dependent upon our ability to attract and retain qualified engineering, manufacturing, marketing, sales and management personnel for our operations. Competition for personnel is intense, and we may not be successful in attracting and retaining qualified personnel. Our failure to compete for these personnel could seriously harm our business, results of operations and financial condition. In addition, if incentive programs we offer are not considered desirable by current and prospective employees, we could have difficulty retaining or recruiting qualified personnel. If we are unable to recruit and retain key employees, our product development, and marketing and sales could be harmed.

Our disclosure controls and internal control over financial reporting do not guarantee the absence of error or fraud.

     Disclosure Controls are procedures designed to ensure that information required to be disclosed in our reports filed under the Exchange Act, such as this Annual Report, is recorded, processed, summarized and reported within the time periods specified in the U.S. Securities and Exchange Commission’s rules and forms. Disclosure Controls are also designed to ensure that the information is accumulated and communicated to our management, including the CEO and CFO, as appropriate to allow timely decisions regarding required disclosure.

     Internal control over financial reporting (Internal Controls) are procedures which are designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America and includes those policies and procedures that: (1) pertain to the maintenance of records that in reasonable detail accurately and fairly reflect the transactions and dispositions of the assets of RadiSys; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of RadiSys are being made only in accordance with authorizations of management and directors of RadiSys; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of RadiSys’ assets that could have a material effect on the financial statements. To the extent that components of our Internal Controls are included in our Disclosure Controls, they are included in the scope of our quarterly controls evaluation.

     Our management, including the CEO and CFO, do not expect that our Disclosure Controls or Internal Controls will prevent all error and all fraud. A control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and breakdowns can occur because of simple error or mistake. Controls can also be circumvented by the individual acts of some persons, by collusion of two or more people, or by management override of the controls. The design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and we cannot assure that any design will succeed in achieving its stated goals under all potential future conditions. Over time, controls may become inadequate because of changes in conditions or deterioration in the degree of compliance with policies or procedures. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Oregon corporate law, our articles of incorporation and our bylaws contain provisions that could prevent or discourage a third party from acquiring us even if the change of control would be beneficial to our shareholders.

     Our articles of incorporation and our bylaws contain anti-takeover provisions that could delay or prevent a change of control of our company, even if a change of control would be beneficial to our shareholders. These provisions:

	•		authorize our board of directors to issue up to 10,000,000 shares of preferred stock and to determine the price, rights, preferences, privileges and restrictions, including voting rights, of those shares without prior shareholder approval to increase the number of outstanding shares and deter or prevent a takeover attempt;
	•		establish advance notice requirements for nominations for election to our board of directors or for proposing matters that can be acted upon by shareholders at shareholder meetings;
	•		prohibit cumulative voting in the election of directors, which would otherwise allow less than a majority of shareholders to elect director candidates; and
	•		limit the ability of shareholders to take action by written consent, thereby effectively requiring all common shareholder actions to be taken at a meeting of our common shareholders.

     In addition, if our common stock is acquired in specified transactions deemed to constitute “control share acquisitions,” provisions of Oregon law condition the voting rights that would otherwise be associated with those common shares upon approval by our shareholders (excluding, among other things, the acquirer in any such transaction). Provisions of Oregon law also restrict, subject to specified exceptions, the ability of a person owning 15% or more of our common stock to enter into any “business combination transaction’” with us. The foregoing provisions of Oregon law and our articles of incorporation and bylaws could limit the price that investors might be willing to pay in the future for shares of our common stock.

  Other Risk Factors Related to Our Business

     Other risk factors include, but are not limited to, changes in the mix of products sold, regulatory and tax legislation, changes in effective tax rates, inventory risks due to changes in market demand or our business strategies, potential litigation and claims arising in the normal course of business, credit risk of customers and other risk factors. Additionally, proposed changes to accounting rules could materially affect what we report under generally accepted accounting principles and adversely affect our operating results.

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

Exhibit
No				Description
	10.1			Form of Restricted Stock Agreement, as amended
	31.1			Certification of the Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2			Certification of the Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1			Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2			Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

     Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

		RADISYS CORPORATION
Dated: May 9, 2006		By:		/s/ SCOTT C. GROUT
				Scott C. Grout
				President and Chief Executive Officer
Dated: May 9, 2006		By:		/s/ JULIA A. HARPER
				Julia A. Harper
				Vice President of Finance and
				Administration
				and Chief Financial Officer

EXHIBIT INDEX

Exhibit No				Description
	10.1			Form of Restricted Stock Agreement, as amended
	31.1			Certification of the Chief Executive Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	31.2			Certification of the Chief Financial Officer required by Rule 13a-14(a) or Rule 15d-14(a) of the Exchange Act pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
	32.1			Certification of the Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
	32.2			Certification of the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.