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RADISYS CORP - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations(Edgar Glimpses Via Acquire Media NewsEdge) You should read the following discussion and analysis in conjunction with our condensed consolidated financial statements and the related notes included in this Report on Form 10-Q and with Management's Discussion and Analysis of Financial Condition and Results of Operations contained in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. Unless required by context, or as otherwise indicated, "we," "us," "our" and similar terms, as well as references to the "Company" and "Radisys" refer to Radisys Corporation and include all of our consolidated subsidiaries. Overview Radisys Corporation (NASDAQ: RSYS) is a provider of wireless infrastructure solutions to the telecom market. Our Media Resource Function ("MRF"), T-Series platform products and Trillium software, coupled with an expert professional services organization, enable our customers to bring high-value products and services to the communications market faster and with lower investment and risk. By leveraging our communications expertise, we are also able to deliver our products and 19 --------------------------------------------------------------------------------capabilities into adjacent markets such as aerospace and defense. These products are targeted throughout the telecommunication network from the Radio Access Network ("RAN") to the Evolved Packet Core ("EPC") to the IP Multimedia Subsystem ("IMS") and include the following: • MRF media processing products, which can be purchased either as a complete system based on our T-Series ATCA platform (MPX-12000) or as virtualized Software MRF when our customers choose to leverage other processing platforms, are designed into the IMS core of telecom networks and provide the necessary media processing capabilities required as service providers deploy applications such as audio conferencing, Voice over Long-Term Evolution ("VoLTE"), Voice over WiFi ("VoWifi"), Rich Communications Services ("RCS") and Web Real-Time Communication ("WebRTC") based services including audio and video conferencing; • T-Series ATCA and Network Appliance products provide the platforms necessary to control and move data in the core of the telecom network enabling network elements within the EPC as well as providing a platform for applications such as Deep Packet Inspection ("DPI") and policy management. When these products are combined with our professional service organization of network experts, we believe our technology enables our customers to bring to market solutions such as intelligent gateways (security, femto, and LTE gateways), intelligent switches and load balancers, at a cost and time to market advantage when compared to internally developed alternatives; • Trillium software is the protocol foundation for a nearly complete optimized application that enables the communication linkage between end user wireless devices and the small cell base stations mobile carriers utilize to optimize radio access spectrum utilization and coverage in both the 3G and LTE networks. Our focus is in providing the software to enable 3G and LTE operator-controlled and low-power wireless base stations that provide improved cellular coverage, capacity and applications for homes and enterprises as well as metropolitan and rural public places (known as small cells, femtocells, enterprise femtocells, picocells and metrocells). We leverage our Trillium technology to enable small cell applications in adjacent markets such as aerospace and defense as well as manufacturing and test. Third Quarter 2014 Summary Revenues for the three and nine months ended September 30, 2014 declined primarily as a result of prior business decisions to exit certain product lines, certain products reaching end of life and an overall softening in the market demand for our audio conferencing products within our Software-Solutions product line. Additionally, continued delays in the deployment of next generation wireless network elements, specifically VoLTE and small cell base stations, combined with later than expected wireless spectrum release in certain geographies, have adversely affected our ability to offset the aforementioned revenue declines. We have seen these trends stabilize as represented by our flattening ATCA product group revenue of $20.7 million, $23.0 million, $23.2 million and $22.3 million over the last four quarters sequentially. Additionally, despite these challenges, third quarter 2014 revenue increased $0.8 million sequentially from the second quarter 2014 from $50.0 million to $50.8 million and net loss per share decreased sequentially from $0.23 to $0.12 per share. This was primarily a result of a $1.2 million increase in our Software-Solutions product group revenues that resulted from the recognition of previously deferred MRF product shipments in support of VoLTE deployments by a large Asian carrier. Additionally, COM Express and Rackmount Server product group revenues increased $2.4 million as the result of increased shipments of end of life products. We expect fourth quarter revenue to be between $47 million and $53 million and net loss per share to range from $0.13 to $0.02. Management's continued focus on driving efficiencies has resulted in meaningful operating expense reductions, with combined R&D and SG&A expense reductions of $5.8 million, or 26.2%, and $14.6 million, or 22.0%, for the three and nine months ended September 30, 2014 when compared to the same periods in 2013. We expect R&D and SG&A expense to approximate $16.0 million in the fourth quarter 2014. In addition, during the third quarter of 2014 we substantially completed the transition to our new contract manufacturing partner in Shenzhen. This transition has eliminated site redundancies and, when combined with reduced product cost, is expected to result in approximately $6 million of annualized gross profit savings as we exit 2014. Additionally, this transition has enabled us to reduce our inventory levels on September 30, 2014 to $17.0 million from $25.4 million on December 31, 2013. The following is a summary-level comparison of the three months ended September 30, 2014 and 2013: • Revenues decreased $3.3 million to $50.8 million for the three months ended September 30, 2014 from $54.1 million for the three months ended September 30, 2013. Software-Solutions products revenue increased $2.1 million primarily due to the recognition of previously deferred MRF shipments in support of a customer's VoLTE application. Specifically, we experienced revenue growth of $5.5 million in our targeted VoLTE MRF products primarily as a result of shipments to a large Asian carrier. This increase was offset by an $2.3 million decrease due primarily to audio 20-------------------------------------------------------------------------------- conferencing and other non-VoLTE application market softness within the Software-Solutions products group. COM Express and Rackmount Server product group revenue increased $2.5 million and primarily resulted from last time buy activity as certain products in this product group reached end of life. Our ATCA product group revenue declined $7.0 million primarily due to 2013 network deployments that were not repeated in the current year. • Our gross margin increased 270 basis points ("bps") in the three months ended September 30, 2014 to 28.9% from 26.2% of revenue in the three months ended September 30, 2013. Increased revenues from our higher margin Software-Solutions products accounted for approximately 210 bps of the increase. Additionally, a claim against a vendor on faulty components reduced third quarter 2014 cost of sales, resulting in a 110 bps increase. Finally, the overall decline in revenue and its negative impact on fixed cost absorption resulted in a 150 bps decrease. • R&D expense decreased $3.8 million to $7.7 million for the three months ended September 30, 2014 from $11.5 million for the three months ended September 30, 2013. The expense decrease is attributable to our second half 2013 restructuring efforts including the consolidation of our Shanghai and Penang development sites in our Shenzhen development that enabled the reduction of redundant salary and temporary help. • SG&A expense decreased $2.0 million to $8.6 million for the three months ended September 30, 2014 from $10.5 million for the three months ended September 30, 2013. This decrease was primarily the result of payroll, commissions, and facility expense reductions that resulted from our restructuring activities and closures of our Shanghai, Penang and Dublin sites. • Cash and cash equivalents on September 30, 2014 increased $6.4 million to $31.9 million from $25.5 million on December 31, 2013. We raised $20.6 million in cash as a result of a follow-on public offering of our common stock during the first quarter of 2014. This increase was offset by the consumption of $7.0 million of cash used in operations (including $3.1 million in cash restructuring payments) and $1.9 million of capital expenditures. Further, during the second quarter of 2014 we repaid $5.0 million in debt that was previously outstanding under our Silicon Valley Bank line of credit. Comparison of the Three and Nine Months Ended September 30, 2014 and 2013 Results of Operations The following table sets forth certain operating data as a percentage of revenues for the three and nine months ended September 30, 2014 and 2013: Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 Revenues 100.0 % 100.0 % 100.0 % 100.0 % Cost of sales: Cost of sales 67.0 70.0 69.6 68.2Amortization of purchased technology 4.0 3.8 4.2 3.4 Total cost of sales 71.0 73.8 73.8 71.6 Gross margin 29.0 26.2 26.2 28.4 Research and development 15.1 21.2 16.9 18.7Selling, general, and administrative 16.8 19.4 18.7 16.6 Intangible asset amortization 2.5 2.5 2.5 2.0 Restructuring and other charges, net 2.6 5.3 2.4 2.2 Loss from operations (8.0 ) (22.2 ) (14.3 ) (11.1 ) Interest expense (0.6 ) (0.6 ) (0.7 ) (0.5 ) Other income, net 0.9 0.4 0.5 0.3 Loss before income tax expense (7.7 ) (22.4 ) (14.5 ) (11.3 ) Income tax expense 1.0 1.1 1.4 1.2 Net loss (8.7 )% (23.5 )% (15.9 )% (12.5 )% 21--------------------------------------------------------------------------------Revenues The following table sets forth our revenues by product group for the three and nine months ended September 30, 2014 and 2013 (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 Change 2014 2013 Change ATCA Platforms $ 20,736 $ 27,744 (25.3 )% $ 66,894 $ 94,284 (29.1 )% Software-Solutions 11,620 9,563 21.5 29,861 33,824 (11.7 ) COM Express and Rackmount Server 15,923 13,380 19.0 39,840 42,225 (5.6 ) Other Products 2,526 3,422 (26.2 ) 7,973 17,392 (54.2 ) Total revenues $ 50,805 $ 54,109 (6.1 )% $ 144,568 $ 187,725 (23.0 )% Revenues in the ATCA product group decreased $7.0 million for the three months ended September 30, 2014 from the comparable period in 2013. This was the result of a $3.3 million decrease in revenues from a North American customer due to a network deployment that was completed in 2013. Additionally, we experienced a $3.2 million decrease in revenues from Japanese customers as a result of LTE deployments that were substantially completed in the second half of 2013. Revenues in the ATCA product group decreased $27.4 million for the nine months ended September 30, 2014 from the comparable period in 2013. This was the result of a $13.7 million decrease in revenues from North American customers due to fewer current year network deployments that were substantially completed in the first half of 2013. Additionally, Asia Pacific revenues decreased $12.6 million due to LTE deployments in Japan that were substantially completed in the second half of 2013. Revenues in the Software-Solutions product group increased $2.1 million for the three months ended September 30, 2014 from the comparable period in 2013 due to the recognition of previously deferred MRF product shipments associated with VoLTE deployments by a large Asian carrier. Revenues in the Software-Solutions product group decreased $4.0 million for the nine months ended September 30, 2014 from the comparable period in 2013. We experienced revenue growth of $7.2 million in our targeted VoLTE MRF products primarily as a result of shipments to a large Asian carrier. This increase was offset by an $8.8 million decrease due primarily to audio conferencing and other non-VoLTE application market softness during the first three quarters of 2014 when compared to the same time period in 2013. Additionally, Trillium revenues decreased by $1.7 million primarily due to decreases in license revenue as 4G customers are now in network deployment phases, which, when complete, is expected to drive future Trillium royalty revenue. Revenues in the COM Express and Rackmount Server product group increased $2.5 million for the three months ended September 30, 2014 from the comparable period in 2013 as the result of a $3.2 million increase in sales to a top five customer due primarily to last time buy activity. This increase was offset by a net decrease of $0.7 million from other customers as a result of our strategic decision to manage for cash the value-line of our COM Express modules. Revenues in the COM Express and Rackmount Server product group decreased $2.4 million for the nine months ended September 30, 2014 from the comparable period in 2013 as the result of our strategic decision to manage for cash the value-line of our COM Express modules. The decline was offset by a $7.4 million increase in sales to a top five customer primarily as a result of last time buy activities. Revenues in the Other Products product group decreased $0.9 million and $9.4 million for the three and nine months ended September 30, 2014 from the comparable periods in 2013. The decline in revenues was expected by management as these hardware-centric products trend towards end of life and our largest customer continues to transition to next-generation network elements. 22 --------------------------------------------------------------------------------Revenue by Geography The following tables outline overall revenue dollars and the percentage of revenues, by geographic region, for the three and nine months ended September 30, 2014 and 2013 (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 Change 2014 2013 Change North America $ 17,730 $ 21,975 (19.3 )% $ 54,164 $ 79,189 (31.6 )% Asia Pacific 21,303 19,257 10.6 54,398 65,211 (16.6 ) Europe, the Middle East and Africa ("EMEA") 11,772 12,877 (8.6 ) 36,006 43,325 (16.9 ) Total $ 50,805 $ 54,109 (6.1 )% $ 144,568 $ 187,725 (23.0 )% Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 2014 2013 North America 34.9 % 40.6 % 37.5 % 42.2 % Asia Pacific 41.9 35.6 37.6 34.7 EMEA 23.2 23.8 24.9 23.1 Total 100.0 % 100.0 % 100.0 % 100.0 % North America. Revenues from the North America region decreased $4.2 million and $25.0 million for the three and nine months ended September 30, 2014 from the comparable periods in 2013. Revenues from our ATCA product group decreased $2.1 million and $13.7 due to inconsistent order patterns of a top North American customer who was acquiring hardware in 2013 to support a project to be deployed in 2014. COM Express and Rackmount Server product group sales decreased $0.6 million and $5.8 million as the result of our strategic decision to manage for cash the value-line of our COM Express modules. In addition, our Software-Solutions product group sales decreased $2.1 million and $5.4 million due primarily to audio conferencing and other non-VoLTE application market softness during the first three quarters of 2014 when compared to the same time period in 2013. Asia Pacific. Revenues from the Asia Pacific region increased $2.0 million for the three months ended September 30, 2014 from the comparable period in 2013 and decreased $10.8 million for the nine months ended September 30, 2014 from the comparable period in 2013. Revenues relating to a Japanese LTE deployment decreased $3.2 million and $11.0 million for the three and nine months ended September 30, 2014 as these projects were substantially completed by the end of 2013. EMEA. Revenues from the EMEA region decreased $1.1 million and $7.3 million for the three and nine months ended September 30, 2014 from the comparable periods in 2013 due to $0.6 million and $8.4 million decreases from our Other Products product group as these hardware-centric products trend towards end of life and our largest customer continues to transition to next-generation network elements. This decline was partially offset by a $4.9 million increase in sales for the three and nine months ended September 30, 2014 from the comparable periods in 2013 to a top five customer primarily as a result of last time buys. We currently expect continued fluctuations in the revenue contribution from each geographic region. Additionally, we expect non-U.S. revenues to remain a significant portion of our revenues. 23 --------------------------------------------------------------------------------Gross Margin The following table summarizes our cost of sales and gross margin for the three and nine months ended September 30, 2014 and 2013 (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 Change 2014 2013 Change Cost of Sales $ 34,052 $ 37,874 (10.1 )% $ 100,551 $ 127,936 (21.4 )% Amortization of Purchased Technology 2,056 2,069 (0.6 ) 6,165 6,504 (5.2 ) Total Cost of Sales $ 36,108 $ 39,943 (9.6 ) $ 106,716 $ 134,440 (20.6 ) Gross Margin 28.9 % 26.2 % 10.3 % 26.2 % 28.4 % (7.7 )% Gross margin as a percentage of revenues increased 270 bps for the three months ended September 30, 2014 from the comparable period in 2013. Increased revenues of higher margin Software-Solutions products accounted for approximately 210 bps of the increase. Additionally, a vendor claim on faulty components reduced third quarter 2014 cost of sales, resulting in a 110 bps increase. Finally, the overall decline in revenue and its negative impact on fixed cost absorption resulted in a 150 bps decrease. Gross margin as a percentage of revenues decreased 220 bps for the nine months ended September 30, 2014 from the comparable periods in 2013. Decreased revenues of higher margin Software-Solutions products accounted for approximately 150 bps of the change. Additionally, the overall decline in revenue and its negative impact on fixed cost absorption accounted for 190 bps of the decrease. These decreases were offset by a $2.0 million vendor claim on faulty components, reducing cost of sales and resulting in a 90 bps increase. Operating Expenses The following table summarizes our operating expenses for the three and nine months ended September 30, 2014 and 2013 (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 Change 2014 2013 Change Research and development $7,657 $11,456 (33.2)% $24,484 $35,011 (30.1)% Selling, general and administrative 8,554 10,522 (18.7) 27,103 31,145 (13.0) Intangible asset amortization 1,260 1,303 (3.3) 3,817 3,911 (2.4) Restructuring and other charges, net 1,329 2,881 (53.9) 3,444 4,037 (14.7) Total $18,800 $26,162 $58,848 $74,104 Research and Development R&D expenses consist primarily of personnel costs, product development costs, and related equipment expenses. R&D expenses decreased $3.8 million and $10.5 million for the three and nine months ended September 30, 2014 from the comparable periods in 2013. The expense decrease is attributable to our restructuring efforts in the second half of 2013, which included the consolidation of our Shanghai and Penang development sites in our Shenzhen development that enabled the reduction of redundant salary and temporary help expense of $2.1 million and $6.1 million for the three and nine months ended September 30, 2014 from the comparable periods in 2013. R&D headcount decreased year over year at September 30, 2014 from 439 to 417. Additionally facility rent and overhead expenses decreased $0.2 million and $0.4 million from the comparable periods in 2013. 24 --------------------------------------------------------------------------------Selling, General, and Administrative SG&A expenses consist primarily of salary, commissions, bonuses and benefits for sales, marketing and administrative personnel, as well as professional service providers and the costs of other general corporate activities. SG&A expenses decreased $2.0 million and $4.0 million for the three and nine months ended September 30, 2014 from the comparable periods in 2013. Restructuring efforts in the second half of 2013 drove headcount reductions and contributed to a decrease in salary expense of $1.0 million and $2.7 million for the three and nine months ended September 30, 2014 when compared to the same periods in 2013. SG&A headcount on September 30, 2014 decreased year over year from to 191 to 168. Additionally, commission expense decreased $0.1 million and $0.9 million for the three and nine months ended September 30, 2014 from the comparable periods in 2013 as a result of lower attainment of our revenue-based commission plan. Further, stock compensation decreased $0.5 million and $0.2 million for the three and nine months ended September 30, 2014 from the comparable periods in 2013 primarily as a result of a decrease in our stock price and changes in objective attainment estimates, both of which resulted in lower long term incentive plan ("LTIP") equity award expense in the current year as compared to the prior year. Intangible Asset Amortization Intangible asset amortization for the three and nine months ended September 30, 2014 was comparable with the same periods in 2013 due to routine amortization of acquired intangible assets. During the quarter ended September 30, 2014, we analyzed our long-lived assets for impairment and concluded there that there was none. Restructuring and Other Charges, Net Restructuring and other charges, net includes expenses associated with restructuring activities and other non-recurring gains and losses which are not indicative of our ongoing business operations. We evaluate the adequacy of the accrued restructuring charges on a quarterly basis. As a result, we record reversals to the accrued restructuring in the period in which we determine that expected restructuring and other obligations are less than the amounts accrued. The increase in restructuring and other charges, net for the three and nine months ended September 30, 2014 from the comparable periods in 2013 is primarily due to restructuring actions associated with our Shanghai and Penang development site closures. Restructuring and other charges, net for the three months ended September 30, 2014 include the following: • $0.3 million net expense relating to the severance of employees in connection with the previously reported Penang site closure, as well as severance for four additional employees, net of reductions resulting from changes in previously estimated amounts for employee severance and associated payroll costs; • $0.4 million legal expenses associated with non-operating strategic projects; and • $0.7 million integration-related net expense principally associated with asset write-offs and personnel overlap resulting from resource consolidation primarily associated with our Penang site closure. Restructuring and other charges for the three months ended September 30, 2013 include the following: • $0.3 million integration-related net expense principally associated with asset write-offs and personnel overlap resulting from resource consolidation primarily associated with our Penang site closure; • $0.2 million gain resulting from the revision of prior sublease assumptions for a previously abandoned facility; • $0.2 million legal expenses associated with a non-operating strategic project; • $0.4 million gain due to the decrease in fair value of the Continuous Computing contingent consideration liability. We assessed the fair value of the contingent consideration liability on a quarterly basis, adjusting the liability to fair value based on a detailed analysis of all expected contingent consideration eligible revenues; and • $2.9 million net expense for severance and benefits associated with employee restructuring actions. Restructuring and other charges, net for the nine months ended September 30, 2014 include the following: • $1.5 million net expense relating to the severance of employees in connection with the previously reported Penang site closure, as well as severance for 18 additional employees, net of reductions resulting from changes in previously estimated amounts for employee severance and associated payroll costs; • $1.7 million integrated-related net expense principally associated with asset write-offs and personnel overlap resulting from resource consolidation primarily associated with our Penang site closure; • $0.4 million legal expenses associated with non-operating strategic projects; and 25--------------------------------------------------------------------------------• $0.2 million gain due to the decrease in fair value of the Continuous Computing contingent consideration liability. Restructuring and other charges, net for the nine months ended September 30, 2013 include the following: • $2.9 million write off of our SEG purchased technology asset due to management's decision to abandon future development of this technology; • $1.5 million net gain from the sale of our OS-9 software assets; • $1.7 million gain due to the decrease in fair value of the Continuous Computing contingent consideration liability; and • $4.1 million net expense for the severance and benefits associated with employee restructuring actions. Stock-based Compensation Expense Included within cost of sales, R&D and SG&A are stock-based compensation expenses that consists of the amortization of unvested stock options, restricted stock units and employee stock purchase plan ("ESPP") expense. We incurred and recognized stock-based compensation expense as follows (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 Change 2014 2013 Change Cost of sales $ 44 $ 167 (73.7 )% $ 326 $ 408 (20.1 )% Research and development 131 361 (63.7 ) 684 844 (19.0 ) Selling, general and administrative 603 1,111 (45.7 ) 2,349 2,509 (6.4 ) Total $ 778 $ 1,639 (52.5 )% $ 3,359 $ 3,761 (10.7 )% Stock-based compensation expense decreased $0.9 million and $0.4 million for the three and nine months ended September 30, 2014 from the comparable periods in 2013. Expense associated with LTIP performance stock awards decreased $0.4 million and $0.3 million primarily as a result of a decrease in the Company's stock price and changes in objective attainment estimates both of which resulted in lower LTIP equity awards expense in the current year as compared to the prior year. Expense associated with restricted stock awards also decreased $0.2 million and $0.4 million due to a reduction in restricted stock awards granted since the third quarter of 2012. Non-Operating Expenses The following table summarizes our non-operating expenses (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 Change 2014 2013 Change Interest expense $ (317 ) $ (300 ) 5.7 % $ (949 ) $ (913 ) 3.9 % Interest income 15 1 1,400.0 25 24 4.2 Other income, net 448 199 125.1 774 549 41.0 Total $ 146 $ (100 ) (246.0 )% $ (150 ) $ (340 ) (55.9 )% Interest Expense Interest expense includes interest incurred on our convertible senior notes and our revolving line of credit. The balance and interest rate on the line of credit was $10.0 million and 4.0% at September 30, 2014 compared to $15 million and 2.18% at September 30, 2013. Other Income, Net For the three and nine months ended September 30, 2014, other income increased $0.2 million from the comparable periods in 2013 primarily due to a life insurance benefit of $0.4 million that was realized in the third quarter of 2014. This income was offset primarily by unfavorable Indian Rupee exchange rates against the US Dollar. 26 --------------------------------------------------------------------------------Income Tax Provision The following table summarizes our income tax provision (in thousands): Three Months Ended Nine Months Ended September 30, September 30, 2014 2013 Change 2014 2013 Change Income tax expense $ 512 $ 624 (17.9 )% $ 1,968 $ 2,230 (11.7 )% We recorded tax expense of $0.5 million and 2.0 million for the three and nine months ended September 30, 2014. Our effective tax rates for the three months ended September 30, 2014 and 2013 were 12.9% and 5.2%. The effective tax rate fluctuation is mainly due to income tax rate differences among the jurisdictions in which pretax income (loss) is generated as well as the impact of valuation allowances against our U.S. and Canadian net deferred tax assets. Liquidity and Capital Resources The following table summarizes selected financial information as of the dates indicated (in thousands): September 30, December 31, September 30, 2014 2013 2013 Cash and cash equivalents $ 31,938 $ 25,482 $ 31,559 Working capital 24,444 26,920 36,199 Accounts receivable, net 43,860 41,359 42,496 Inventories, net 17,046 25,409 26,221 Accounts payable 31,559 35,081 36,619 Line of credit 10,000 15,000 15,000 2015 convertible senior notes 18,000 18,000 18,000 Cash Flows As of September 30, 2014, the amount of cash held by our foreign subsidiaries was $7.9 million. It is not our intent to permanently reinvest funds in certain of our foreign entities, and we expect to repatriate cash from these foreign entities on an ongoing basis in future periods. Repatriation of funds from these foreign entities is not expected to result in actual cash tax payments due to the utilization of previously generated operating losses and credits of our U.S. entity. Cash and cash equivalents increased by $6.4 million to $31.9 million as of September 30, 2014 from $25.5 million as of December 31, 2013. Activities impacting cash and cash equivalents were as follows (in thousands): Nine Months Ended September 30, 2014 2013 Operating Activities Net loss $ (23,114 ) $ (23,389 ) Non-cash adjustments 22,330 21,741Changes in operating assets and liabilities (6,188 ) 5,553 Cash provided by (used in) operating activities (6,972 ) 3,905 Cash used in investing activities (1,861 ) (3,236 ) Cash provided by (used in) financing activities 15,530 (2,076 ) Effects of exchange rate changes (241 ) (216 ) Net increase in cash and cash equivalents $ 6,456 $ (1,623 ) Cash used in operating activities during the nine months ended September 30, 2014 was $7.0 million. For the nine months ended September 30, 2014, primary impacts to changes in our working capital consisted of the following: 27 -------------------------------------------------------------------------------- • Other receivables increased $3.3 million as the result of the sale of inventory to our new contract manufacturer for which we expect to be reimbursed during the fourth quarter of 2014; • Inventory decreased by $6.2 million due to the sale of inventory to our new contract manufacturer; and • Accounts payable decreased $3.4 million due to increased payments made to our contract manufacturing partners; • Accrued restructuring decreased $1.6 million due primarily to payments made for employee-related restructuring activities; and • Deferred revenue decreased $2.0 million due primarily to MRF product shipments that have met revenue recognition criteria. Cash used in investing activities during the nine months ended September 30, 2014 of $1.9 million was associated with capital expenditures. Cash generated by financing activities during the nine months ended September 30, 2014 of $15.5 million is attributable to $20.6 million of cash generated from the issuance of 6.6 million newly issued shares of our common stock which was partially offset by paying down the Silicon Valley Bank line of credit by $5.0 million. Line of Credit Silicon Valley Bank At the beginning of the first quarter of 2014, we had a $35.0 million secured revolving line of credit agreement (as amended, the "Agreement") with Silicon Valley Bank ("SVB") with a stated maturity date of July 28, 2016. On March 14, 2014, we entered into an amended and restated $25.0 million secured revolving line of credit agreement (as amended, the "2014 Agreement") with SVB that replaces the Agreement and has a stated maturity date of July 28, 2016. On May 30, 2014 the 2014 Agreement was amended to increase the letter of credit sublimit under the secured revolving credit facility from $1,000,000 to $2,000,000. The secured revolving credit facility under the 2014 Agreement is available for cash borrowings and is subject to a borrowing formula based upon eligible accounts receivable less outstanding letters of credit (aggregate letters of credit are not to exceed $2,000,000). Eligible accounts receivable include 80% of U.S and 65% of foreign accounts receivable (80% in certain cases), not greater than 60 days past original invoice date. The interest rate is dependent upon the Company's Liquidity (as defined in the 2014 Agreement) when compared to a pre-determined threshold (the "Liquidity Threshold"), which is defined in the 2014 Agreement as $15.0 million, with the exception of the last month end of each quarter, where it is defined as $20.0 million. Liquidity is calculated under the 2014 Agreement as unrestricted cash plus unused availability on the revolving line of credit; however if the 2015 convertible senior notes are not renewed or refinanced 120 days prior to their maturity date, which is February 15, 2015, Liquidity (for purposes of testing against the Liquidity Threshold) will be reduced by the outstanding principal amount of the 2015 convertible senior notes. The calculation of interest under the 2014 Agreement is as follows: • When Liquidity is above the Liquidity Threshold, the interest rate is the prime rate (as published in Wall Street Journal) plus 0.75%; and • When Liquidity is below the Liquidity Threshold, the interest rate is the prime rate (as published in Wall Street Journal) plus 2.25%. Under the 2014 Agreement, we are required to make interest payments monthly. We were further required to pay a loan modification fee of $35,000 and a commitment fee equal to $35,000 on July 29, 2014 and will be required to pay the commitment fee annually thereafter. Under the 2014 Agreement we are required to pay the higher of actual monthly interest incurred or the interest equivalent of $10.0 million in average monthly borrowings. If we terminate the commitment under the 2014 Agreement prior to the maturity date, we are required to pay a cancellation fee equal to 1.5% of the commitment under the 2014 Agreement. The 2014 Agreement requires us to make certain representations, warranties and other agreements that are customary in credit agreements of this type. The 2014 Agreement also includes a financial covenant that requires us to maintain minimum Liquidity of $10.0 million tested monthly. As of September 30, 2014 and December 31, 2013, we had outstanding balances of $10.0 million and $15.0 million under the 2014 Agreement and the Agreement. At September 30, 2014, we had $14.0 million of total borrowing availability remaining under the Agreement. At September 30, 2014, we were in compliance with all covenants under the 2014 Agreement. 28 --------------------------------------------------------------------------------2013 Convertible Senior Notes On February 15, 2013, we repaid at maturity the entire $16.9 million outstanding balance of the 2.75% convertible senior notes due 2013 (the "2013 convertible senior notes") in accordance with the terms thereof. 2015 Convertible Senior Notes On June 20, 2012, we entered into subscription agreements with certain holders of the 2013 convertible senior notes. Pursuant to the subscription agreements, on June 29, 2012 we exchanged $18.0 million aggregate principal amount of the 2013 convertible senior notes for $18.0 million aggregate principal amount of the new 2015 convertible senior notes. The 2015 convertible senior notes mature on February 15, 2015 and have a coupon rate of 4.5%. Holders of the 2015 convertible senior notes may convert their notes into a number of shares of our common stock determined as set forth in the indenture governing the notes at their option on any day to and including the business day prior to the maturity date. The 2015 convertible senior notes are initially convertible into 117.2333 shares of our common stock per $1,000 principal amount of the notes (which is equivalent to a conversion price of approximately $8.53 per share), subject to adjustment upon the occurrence of certain events. Upon the occurrence of a fundamental change, holders of the 2015 convertible senior notes may require us to repurchase some or all of their notes for cash at a price equal to 100% of the principal amount of the notes being repurchased, plus accrued and unpaid interest, if any. In addition, if certain fundamental changes occur, we may be required in certain circumstances to increase the conversion rate for any 2015 convertible senior notes converted in connection with such fundamental changes by a specified number of shares of our common stock. The 2015 convertible senior notes are general unsecured obligations and rank equal in right of payment to all of our existing and future senior indebtedness, and senior in right of payment to any future subordinated debt. Our obligations under the 2015 convertible senior notes are not guaranteed by, and are effectively subordinated in right of payment to all existing and future obligations of its subsidiaries and are effectively subordinated in right of payment to its future secured indebtedness to the extent of the assets securing such debt. As of September 30, 2014 and December 31, 2013, we had outstanding 2015 convertible senior notes with a face value of $18.0 million. As of September 30, 2014 and December 31, 2013, the fair values of our 2015 convertible senior notes were $17.9 million and $17.8 million, which are based on the most recent quoted prices of our publicly traded debt on each balance sheet date. Contractual Obligations Our contractual obligations as of December 31, 2013 are summarized in Item 7 - "Management's Discussion and Analysis of Financial Condition and Results of Operations - Liquidity and Capital Resources - Contractual Obligations," of the Company's Annual Report on Form 10-K for the year ended December 31, 2013. For the nine months ended September 30, 2014, there have been no material changes in our contractual obligations outside the ordinary course of business. As of September 30, 2014, we have agreements regarding foreign currency forward contracts with total contractual values of $17.4 million that mature through 2015. In addition to the above, we have approximately $3.4 million associated with unrecognized tax benefits. We are not able to reasonably estimate when we would make any cash payments required to settle these liabilities, but do not believe the ultimate settlement of our obligations will materially affect our liquidity. Off-Balance Sheet Arrangements We do not engage in any activity involving special purpose entities or off-balance sheet financing. Liquidity Outlook At September 30, 2014, our cash and cash equivalents amounted to $31.9 million. We believe that our current cash and cash equivalents combined with the remaining credit available under our line of credit facility will satisfy our expected short and long-term working capital, capital expenditures, and other liquidity requirements associated with our existing business operations and the repayment of the 2015 convertible senior notes. We anticipate maintaining covenant compliance throughout the duration of our anticipated borrowing, ensuring our current borrowing level and available borrowing capacity remains available to us. 29--------------------------------------------------------------------------------Critical Accounting Policies and Estimates We reaffirm our critical accounting policies and use of estimates as reported in our Annual Report on Form 10-K for the year ended December 31, 2013. There have been no significant changes during the three months ended September 30, 2014 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 year ended December 31, 2013. "Safe Harbor" Statement under the Private Securities Litigation Reform Act of 1995 This report contains forward-looking statements including: • expectations and goals for revenues, gross margin, research and development ("R&D") expenses, selling, general and administrative ("SG&A") expenses and profits; • the impact of our restructuring events on future operating results; • timing of revenue recognition; • expected customer orders; • our projected liquidity; • future operations and market conditions; • industry trends or conditions and the business environment; • future levels of inventory and backlog and new product introductions; • financial performance, revenue growth, management changes or other attributes of Radisys following acquisition or divestiture activities; and • other statements that are not historical facts. All statements that relate to future events or to our future performance are forward-looking statements. In some cases, forward-looking statements can be identified by terms such as "may," "will," "should," "expect," "plans," "seeks," "anticipate," "believe," "estimate," "predict," "potential," "continue," "seek to continue," "consider," "intends," or other comparable terminology. These forward-looking statements are made pursuant to safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results or our industries' actual results, levels of activity, performance or achievements to be materially different from any future results, levels of activity, performance or achievements expressed or implied by these forward-looking statements. These factors include, among others, the Company's high degree of customer concentration, the use of a single contract manufacturer for a significant portion of the production of our products, as well as the success of transitioning contract manufacturing partners, key employee attrition, the anticipated amount and timing of revenues from design wins and product orders due to the Company's customers' product development schedule, cancellations or delays, market conditions, matters affecting the embedded system industry, including changes in industry standards, changes in customer requirements and new product introductions, currency exchange rate fluctuations, changes in tariff and trade policies and other risks associated with foreign operations, actions by regulatory authorities or other third parties, the Company's ability to successfully manage the transition from 10G to 40G ATCA product technologies, cash generation, the Company's ability to successfully complete any restructuring, acquisition or divestiture activities and other factors described in "Risk Factors" and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2013, as updated in the subsequent quarterly reports on Form 10-Q. Although forward-looking statements help provide additional information about us, investors should keep in mind that forward-looking statements are only predictions, at a point in time, and are inherently less reliable than historical information. We do not guarantee future results, levels of activity, performance or achievements, and we do not assume responsibility for the accuracy and completeness of these statements. The forward-looking statements contained in this report are made and based on information as of the date of this report. We assume no obligation to update any of these statements based on information after the date of this report. 30-------------------------------------------------------------------------------- |