Significant Accounting Policies

Radisys Corporation (the “Company” or “Radisys”) has adhered to the accounting policies set forth in its Annual Report on Form 10-K for the year ended December 31, 2017 in preparing the accompanying interim condensed consolidated financial statements. The preparation of these statements in conformity with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues, expenses and related disclosure of contingent assets and liabilities. Actual results could differ from those estimates. Additionally, the accompanying financial data as of March 31, 2018 and for the three months ended March 31, 2018 and 2017 has been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with GAAP have been omitted pursuant to such rules and regulations. However, the Company believes that the disclosures are adequate to make the information presented not misleading. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2017.

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.

Product and Service Revenue

The Company sells its products and services into two primary end markets: telecommunications infrastructure and medical imaging. Sales into the telecommunications infrastructure market spans both of the Company’s operating segments while sales of products into the medical imaging market are associated predominantly with one customer in the Company’s Hardware-Solutions segment. The Company sells its products and services directly to service providers, through channel partners where its products are part of a larger integrated solution, and directly to original equipment and design manufacturers.

Product revenue includes the sale of software, integrated systems, stand-alone hardware and post-sale royalties tied to end-user product deployments. The Company’s products are sold both on a stand-alone basis and bundled with certain other products and services from time to time. Software and hardware products are generally sold for a one-time fee with incremental sales of related products to the same customer tied to expansion needs.

Service revenue is predominantly comprised of professional services and maintenance and support services. Professional services are generally associated with the development and implementation of customer-specific feature requirements on the Company’s products. Maintenance and support services are associated with post-sale product updates, upgrades and enhancements as well as general technical support. The Company’s customers generally enter into annual or semi-annual agreements for maintenance and support services.

Refer to Note 12 - Segment Information for further information, including revenue by geography and product type.

Multiple Performance Obligations

The Company's contracts with customers often include commitments to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. When hardware, software and services are sold in various combinations, judgment is required to determine whether each performance obligation is considered distinct and accounted for separately, or not distinct and accounted for together with other performance obligations.

In instances where the software elements included within hardware for various products are considered to be functioning together with non-software elements to provide the tangible product's essential functionality, these arrangements are accounted for as a single distinct performance obligation.

Judgment is required to determine the stand-alone selling price (SSP) for each distinct performance obligation. When available, Radisys uses observable inputs to determine SSP. In instances where SSP is not directly observable, such as when the Company does not sell the product or service separately, it determines the SSP based on a cost plus model as market or other observable inputs are seldom present based on the proprietary nature of our products.

The Company typically has more than one SSP for individual products and services due to the stratification of those products and services by customers and circumstances. In these instances, the Company may use information such as the size of the customer or level of service provided in determining the SSP.

Revenue Recognition

Revenue is recognized upon transfer of control of products or services to customers in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. The Company enters into contracts that may include various combinations of products and services which are generally capable of being distinct and accounted for as separate performance obligations. Revenue is recognized net of allowances for any taxes collected from customers, which are subsequently remitted to governmental authorities.

Hardware

Hardware revenue is recognized when the Company transfers control to the customer, typically at the time the product is shipped to the customer. The Company accrues the estimated cost of product warranties, based on historical experience at the time the Company recognizes revenue.

Software licenses and royalties

The Company recognizes software license revenue at the time of delivery. The Company defers revenue on arrangements, including specified software upgrades, until the specified upgrade has been delivered. Revenue from customers for prepaid, non-refundable software royalties is recorded when the revenue recognition criteria have been met. Revenue for non-prepaid royalties is recognized at the time the Company is able to estimate the revenue that has been earned in the current period.

Maintenance and support services

Maintenance and support services revenue is recognized as earned on the straight-line basis over the term of the contract.

Professional and other services

Professional services revenue is recognized as services are provided. Other services revenues include hardware repair services and custom software implementation projects, with these services recognized upon delivery to customers.

Revenue from distributors

Revenue associated with distributors is recognized upon shipment. Based on historical activity and contractual rights estimated effects of returns and allowances provided to distributors are considered insignificant. The Company accrues the estimated cost of product warranties, based on historical experience at the time the Company recognizes revenue.

Deferred revenue

Deferred revenue represents amounts received or billed for the following types of transactions:

•Undelivered elements of an arrangement: the Company defers hardware and software arrangements in the event the element is not delivered. For products that are determined not to be distinct in nature, revenue is deferred until all elements that make up the distinct product are delivered.

•Maintenance and support services: the Company has a number of maintenance support agreements with customers for hardware and software maintenance. Generally, these services are billed in advance and recognized over the term of the agreement.

Cost of sales associated with deferred revenue is also deferred. These deferred costs are recognized when the associated revenue is recognized.

Assets Recognized from Costs to Obtain a Contract with a Customer

We apply the practical expedient to expense costs as incurred for costs to obtain a contract with a customer when the amortization period would be one year or less. These costs include our internal sales force compensation program and certain partner sales incentive programs as we have determined annual compensation is commensurate with annual sales activities. Costs incurred to obtain a contract in excess of one year are insignificant.

Backlog

Backlog as of March 31, 2018 was $32.3 million. Backlog is defined as purchase orders the Company has received and expects to fulfill over the next 12 months.

Capitalized Software Development Costs

The Company does not capitalize internal software development costs incurred in the production of computer software as the Company does not incur any material costs between the point of technological feasibility and general release of the product to customers in the future. As such software development costs are expensed as research and development (“R&D”) costs.

Shipping Costs

Radisys does not consider shipping and handling to be a separate performance obligation but as activities to fulfill the entity’s promise to transfer the good. In instances where revenue is recognized prior to incurring shipping costs, Radisys will accrue for those costs in the period revenue is recognized.

Advertising Costs

The Company expenses advertising costs as incurred. Advertising costs consist primarily of media, display, web, and print advertising, along with trade show costs and product demos and brochures.

Cash Equivalents

The Company considers all highly liquid investments purchased with an original maturity of three months or less at the date of purchase to be cash equivalents.

Restricted Cash

As part of the debt financing completed on January 3, 2018, the Company is required to maintain a restricted cash balance of $4.0 million through June 30, 2018 and $6.0 million on and after July 1, 2018, which will secure both the obligations under the Notes and the ABL Facility.

Accounts Receivable

Trade accounts receivable are stated at invoice amount net of an allowance for doubtful accounts and do not bear interest. An allowance for doubtful accounts is maintained for estimated losses resulting from the inability of customers to make required payments. Management reviews the allowance for doubtful accounts quarterly for reasonableness and adequacy. If the financial condition of the Company’s customers were to deteriorate resulting in an impairment of their ability to make payments, additional provisions for uncollectible accounts receivable may be required. In the event the Company determined that a smaller or larger reserve was appropriate, it would record a credit or a charge in the period in which such determination is made. In addition to specific customer reserves, the Company maintains a non-specific bad debt reserve for all customers. This non-specific bad debt reserve is calculated based on the Company's historical pattern of bad debt write-offs as a percentage of gross accounts receivable for the current rolling eight quarters, which percentage is then applied to the current gross accounts receivable. The Company’s customers are concentrated in the technology industry and the collection of its accounts receivable are directly associated with the operational results of the industry.

Inventories

Inventories are stated at the lower of cost, determined on the first-in, first-out (FIFO) basis, or net realizable value, net of an inventory valuation allowance. The Company uses a standard cost methodology to determine the cost basis for its inventories. The Company evaluates inventory on a quarterly basis for obsolete or slow-moving items to ascertain if the recorded allowance is reasonable and adequate. Inventory is written down for estimated obsolescence or unmarketable inventory equal to the difference between the cost of inventory and the estimated net realizable value based upon assumptions about future demand and market conditions. The Company's inventory valuation allowances establish a new cost basis for inventory.

Long-Lived Assets

Long-lived assets, such as property and equipment and definite-life intangible assets are evaluated for impairment whenever events or changes in circumstances indicate the carrying value of an asset may not be recoverable. The Company assesses the impairment of the assets based on the undiscounted future cash flow the assets are expected to generate compared to the carrying value of the assets. If the carrying amount of the assets is determined not to be recoverable, a write-down to fair value is recorded. Management estimates future cash flows using assumptions about expected future operating performance. Management’s estimates of future cash flows may differ from actual cash flow due to, among other things, technological changes, economic conditions or changes to the Company’s business operations.

Intangible assets with estimable useful lives are amortized on a straight-line basis over their respective estimated life and reviewed for impairment when certain triggering events suggest impairment has occurred. The Company did not identify a triggering event during the three months ended March 31, 2018 to suggest an impairment has occurred.

Property and Equipment

Property and equipment is recorded at historical cost and is depreciated or amortized on a straight-line basis according to the table below. In certain circumstances where the Company is aware that an asset’s life differs from the general guidelines set forth in its policy, management adjusts its depreciable life accordingly, to ensure expense is being recognized over the appropriate future periods. Ordinary maintenance and repair expenses are expensed when incurred.



Machinery, equipment, furniture and fixtures		5 years
Software, computer hardware and manufacturing test fixtures		3 years
Engineering demonstration products and samples		1 year
Leasehold improvements		Lesser of the lease term or estimated useful lives

Leases

The Company leases all of its facilities, certain office equipment and vehicles under non-cancelable operating leases that expire at various dates through 2022, along with options that permit renewals for additional periods. Rent escalations are considered in the determination of straight-line rent expense for operating leases. Leasehold improvements made at the inception of or during the lease are amortized over the shorter of the asset life or the lease term.

Derivative Liability

In connection with the issuance of the Notes, on January 3, 2018, the Company issued to an affiliate of Hale Capital and another purchaser Warrants to purchase up to 6,006,667 shares of common stock at an exercise price equal to $1.00 per share (the “Warrants”).

The Warrants contain a cash settlement feature contingent upon the occurrence of certain events defined in the Warrants. As a result of this cash settlement feature, the Warrants are subject to derivative accounting as prescribed under ASC 815. Accordingly, the fair value of the Warrants on the date of issuance was recorded in the Company’s condensed consolidated balance sheets as a liability.

The Warrant liability was recorded in the Company's condensed consolidated balance sheets at its fair value on the date of issuance and is revalued on each subsequent balance sheet date until such instrument is exercised or expires, with any changes in the fair value between reporting periods recorded in the condensed consolidated statements of operations.

The Company estimates the fair value of this liability using a Monte Carlo pricing model that is based on the individual characteristics of the Warrants on the valuation date, which includes assumptions for expected volatility, expected life and risk-free interest rate, as well as the present value of the minimum cash payment component of the instrument. Changes in the assumptions used could have a material impact on the resulting fair value. The primary inputs affecting the value of the Warrant liability are the Company’s stock price and expected future volatility in the Company's stock price. Increases in the fair value of the underlying stock or increases in the volatility of the stock price generally result in a corresponding increase in the fair value of the Warrant liability; conversely, decreases in the fair value of the underlying stock or decreases in the volatility of the stock price generally result in a corresponding decrease in the fair value of the Warrant liability.

Restructuring and Other Charges

The Company has engaged, and may continue to engage, in restructuring and other actions, which require the Company to make significant estimates in several areas including: realizable values of assets made redundant or obsolete; expenses for severance and other employee separation costs; the ability and timing to generate sublease income, as well as the Company's ability to terminate lease obligations at the amounts estimated; and other costs. Should the actual amounts differ from the estimates, the amount of the restructuring and other charges could be materially impacted.

Restructuring and other charges may include costs incurred for employee severance, acquisition or divestiture activities, excess facility costs, certain legal costs, asset related charges and other expenses associated with business integration or restructuring activities. Costs associated with exit or disposal activities are recognized when probable and estimable because the Company has a history of paying severance benefits.

Warranty

The Company provides for the estimated cost of product warranties at the time it recognizes revenue. Products are generally sold with warranty coverage for a period of 12 or 24 months after shipment. On a quarterly basis the Company assesses the reasonableness and adequacy of the warranty liability and adjusts such amounts as necessary. Warranty reserves are included in other accrued liabilities and other long-term liabilities in the accompanying condensed consolidated balance sheets.

Research and Development

Research, development and engineering ("R&D") costs are expensed as incurred. R&D expenses consist primarily of salary, bonuses and benefits for product development staff, and cost of design and development supplies and equipment, net of reimbursements for non-recurring engineering services.

Income Taxes

Income tax accounting requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement carrying amounts and tax bases of assets and liabilities. Valuation allowances are established to reduce deferred tax assets if it is “more likely than not” that all or a portion of the asset will not be realized due to inability to generate sufficient taxable income in the relevant period to utilize the deferred tax asset. Tax law and rate changes are reflected in the period such changes are enacted. The Company recognizes uncertain tax positions after evaluating whether certain tax positions are more likely than not to be sustained by taxing authorities. In addition, the Company recognizes potential accrued interest and penalties related to unrecognized tax benefits in income tax expense.

Comprehensive Loss

The Company reports accumulated other comprehensive loss in its condensed consolidated balance sheets. Comprehensive loss includes net loss, translation adjustments and unrealized gains (losses) on hedging instruments net of their tax effect. The cumulative translation adjustments consist of unrealized gains (losses) for foreign currency translation.

Stock-Based Compensation

The Company measures stock-based compensation at the grant date, based on the fair value of the award, and recognizes expense on a straight-line basis over the employee's requisite service period. For performance-based restricted stock unit awards ("PRSUs"), the requisite service period is equal to the period of time over which performance objectives underlying the award are expected to be achieved and vested. The number of shares that ultimately vest depends on the achievement of certain performance criteria over the measurement period. For non-market performance-based restricted stock, quarterly, we reevaluate the period during which the performance objective will be met and the number of shares expected to vest. The amount of quarterly expense recorded each period is based on our estimate of the number of awards that will ultimately vest.

The Company estimates the fair value of stock options and purchase rights under our employee stock purchase plans using a Black-Scholes option-pricing model. The Black-Scholes option-pricing model incorporates several highly subjective assumptions including expected volatility, expected term and interest rates.

In reaching our determination of expected volatility, we use the historic volatility of our shares of common stock. We base the expected term of our stock options on historic experience. The expected term for purchase rights under our employee stock plans is based on the 18 month offering period. The risk-free 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 calculation includes several assumptions that require management's judgment. The expected term 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.

The input factors used in the valuation model are based on subjective future expectations combined with management's judgment. If there is a difference between the assumptions used in determining stock-based compensation cost and the actual factors which become known over time, we may change the input factors used in determining stock-based compensation costs. These changes may materially impact the results of operations in the event such changes are made. In addition, if we were to modify any awards, additional charges would be taken.

Net loss per share

Basic loss per share amounts are computed based on the weighted average number of common shares outstanding. Diluted net loss per share incorporates the incremental shares issuable upon the assumed exercise of stock options, Warrants granted under Note Purchase Agreement, and the incremental shares associated with the assumed vesting of restricted stock.

Derivatives

The Company hedges exposure to changes in exchange rates from the U.S. Dollar to the Indian Rupee. These derivatives are recognized on the balance sheet at their fair value. Unrealized gain positions are recorded as other current assets and unrealized loss positions are recorded as other accrued liabilities. Changes in the fair values of the outstanding derivatives that are highly effective are recorded in other comprehensive loss until net income (loss) is affected by the variability of the cash flows of the hedged transaction. Hedge ineffectiveness could result when the amount of the Company’s hedge contracts exceed the Company’s forecasted or actual transactions for which the hedge contracts were designed to hedge. Once a hedge contract matures the associated gain (loss) on the contract will remain in accumulated other comprehensive income (loss) until the underlying hedged transaction affects net income (loss), at which time the gain (loss) will be recorded to the expense line item being hedged, which is primarily cost of sales, research and development and selling, general and administrative. The Company only enters into derivative contracts in order to hedge foreign currency exposure. If the Company entered into a contract for speculative reasons or if the Company’s current hedge position becomes ineffective, changes in the fair values of the derivatives would be recognized in earnings in the current period.

Foreign currency translation

Assets and liabilities of international operations using a functional currency other than the U.S. dollar are translated into U.S. dollars at exchange rates. Income and expense accounts are translated into U.S. dollars at the average daily rates of exchange prevailing during the period. Adjustments resulting from translating foreign functional currency financial statements into U.S. dollars are recorded as a separate component in shareholders’ equity. Foreign exchange transaction gains and losses are included in other expense, net, in the condensed consolidated statements of operations.

Adoption of New Accounting Policies

In November 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash (“ASU 2016-18”), which requires that restricted cash and cash equivalents be included as components of total cash and cash equivalents as presented on the statement of cash flows. ASU 2016-18 is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and a retrospective transition method is required. The Company adopted this guidance in the first quarter of 2018 using the retrospective approach. The Company has not historically had restricted cash resulting in no impact to previously reported periods. This new guidance did not impact the Company’s financial results, but did result in a change in the presentation of restricted cash and restricted cash equivalents within the statement of cash flows.

In May 2014, FASB issued ASU 2014-09, "Revenue from Contracts with Customers (Topic 606)," that has superseded all existing revenue recognition guidance under U.S. GAAP. The standard's core principle is that a company recognizes revenue when it transfers promised goods or services to a customer in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date," which was issued in August 2015, revised the effective date for this ASU to annual and interim periods beginning on or after December 15, 2017.

The new guidance, which includes several amendments, replaces most of the prior revenue recognition guidance under U.S. Generally Accepted Accounting Principles. The Company adopted the new guidance as of January 1, 2018 using the modified retrospective method, as applied to all contracts. As a result, the Company has changed its accounting policy for revenue recognition.

Aspects of the new standard that have impacted the Company include a change in the timing of certain usage-based royalties. Historically revenue was not recognized until fixed and determinable; however, the new ASU requires the Company to estimate using either the probability weighted expected amount or the most likely amount and estimate the transaction price to recognize when or as control is transferred to the customer. Additionally, for certain professional services with no VSOE under ASC 605, certain licenses were deferred and recognized with the associated software. Such contracts represent a small subset of the Company's total portfolio. Refer to the Company's policy over revenue recognition above for further detail.

Due to the immaterial nature from the impact on the timing of revenue recognition based on the cumulative effect of adopting this guidance, an adjustment to the balance of retained earnings as of January 1, 2018 was not required. The comparative information for the three months ended March 31, 2017, including disclosures, has not been restated and continues to be reported under the accounting standards in effect for that period.

Recent Accounting Pronouncements

In February 2016, the FASB issued ASU 2016-02, “Leases (Topic 842).” ASU 2016-02 requires lessees to recognize a lease liability and a right-of-use asset on the balance sheet and aligns many of the underlying principles of the new lessor model with those in Accounting Standards Codification Topic 606, Revenue from Contracts with Customers. ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. The Company is currently evaluating the requirements of ASU 2016-02 and has not yet determined its impact on the condensed consolidated financial statements.