| RADISYS CORP Item 1A Risk Factors Related to Our Business 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 2005, we derived 67dtta5prca of our revenues from five customers |
| These five customers were Nokia, Nortel, Comverse, Philips Medical Systems and Avaya |
| During 2005, revenues attributable to Nokia and Nortel were 36dtta2prca and 14dtta3prca, respectively |
| 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 |
| 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 |
| 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 10 _________________________________________________________________ [65]Table of Contents 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 |
| 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 2005, we derived 74dtta6prca and 25dtta4prca 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 Seimens 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 |
| 11 _________________________________________________________________ [66]Table of Contents 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 |
| 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 |
| We are shifting the majority 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 |
| At the end of 2005, our contract manufacturing partners were manufacturing approximately 80prca 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 |
| 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 12 _________________________________________________________________ [67]Table of Contents 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 |
| 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, Artesyn Technologies, Continuous Computing, 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 13 _________________________________________________________________ [68]Table of Contents 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 2005, as measured by delivery destination, we derived 4dtta7prca of our revenues from Canada and Mexico, 50dtta5prca of our revenues from EMEA and 13dtta8prca 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 2005, approximately 39prca 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 |
| So far production at this facility does not make up a meaningful portion of our total revenues |
| 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 dlra29dtta0 million as of December 31, 2005 |
| 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 dlra29dtta6 million on the Consolidated Balance Sheet as of December 31, 2005, and therefore, we may incur an impairment charge in the future |
| 14 _________________________________________________________________ [69]Table of Contents 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 |
| 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 |
| 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 |
| 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 US Securities and Exchange Commission’s rules and 15 _________________________________________________________________ [70]Table of Contents 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 10cmam000cmam000 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 16 _________________________________________________________________ [71]Table of Contents 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 15prca 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 |
| 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 |
| 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 |