UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-K

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

For the fiscal year ended December 31, 2004

Commission file number 0-26844

RADISYS CORPORATION

(Exact name of registrant as specified in its charter)

5445 N.E. Dawson Creek Drive

Hillsboro, OR 97124

(Address of principal executive offices, including zip code)

(503) 615-1100

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock

      Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to the filing requirements for the past 90 days.     Yes þ          No o

      Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of Registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or in any amendment to this Form 10-K.     þ

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

      The aggregate market value of the voting stock (based upon the closing price of the Nasdaq National Market on June 30, 2004 of $18.57) of the Registrant held by non-affiliates of the Registrant at that date was approximately $302,056,000. For purposes of the calculation executive officers, directors and holders of 10% or more of the outstanding Common Stock are considered affiliates.

Number of shares of Common Stock outstanding as of March 3, 2005: 19,868,070

DOCUMENTS INCORPORATED BY REFERENCE

RADISYS CORPORATION

FORM 10-K

TABLE OF CONTENTS

PART I

General

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

Our Strategy

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

Our Markets

      We provide advanced embedded solutions to three distinct markets:

Our Market Drivers

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

Products

      We design and manufacture a broad range of products at different levels of integration:

      We have specific technical expertise in the following areas:

Our products fall into two different categories, standard products and perfect fit solutions:

      Standard Products. We believe that we continue to play a leading role in the development and deployment of architectural standards as a premier member of the Intel Communications Alliance, and as a long-time member of the PCI Industrial Computer Manufacturers Group (“PICMG”) and the SA Forum standards bodies.

      In 2004 we shifted more investment from predominantly one-off custom-designed products to standards-based, re-usable platforms and solutions. We believe standards-based platforms provide our customers a number of fundamental benefits. First, by using ready-made platform solutions rather than ground-start custom-designs, our customers can achieve significantly shorter intervals and faster time-to-market. Second, we believe our customers can achieve a lower total cost by using solutions that are leveraged across multiple applications rather than a single-use proprietary solution. By offering standards-

based platforms, we believe we have the opportunity to address a wider range of new market opportunities with the potential for faster time to revenue than with ground-start, custom-designs. We believe this ability to reuse designs makes our business and investment model more scalable. Finally, we believe this standard-focused model will allow us to provide more integrated and higher value solutions to our customers than we have typically delivered under a custom-design model.

      We announced our Promentum^tm family of AdvancedTCA products in 2004. This family of products includes universal carrier cards, switch and control modules, disk storage modules, compute modules, and a 14-slot shelf or chassis. These products will be offered individually or will be integrated together as part of a blade server platform system known as the Promentum-6000. We believe the Promentum-6000 system will provide customers a highly reliable managed platform on which to build their new voice and data offerings. We have significant experience in the design, delivery and deployment of carrier-grade, modular platforms. We believe the ATCA standard increases our opportunity to implement reusable platforms, enabling the deployment of more flexible solutions based on cost-effective commercial technologies. We believe our core ATCA solutions will be applicable across a wide range of customers and applications and are potentially applicable in all three of our defined markets. These integrated hardware and software platforms make extensive use of common architectural and component designs, with carrier grade operating systems and middleware, reducing development time and costs and enhancing application portability.

      In addition to our new ATCA offerings, we recently announced our new Procelerant^tm series of modular computing solutions, which we anticipate will be released in mid 2005, for customers in our commercial systems markets for medical, transaction terminals and test and measurement applications. These new modular products are currently in development and we believe these products will represent a family of high density, flexible solutions that will enable commercial systems customers to achieve more rapid time to market with cost effective designs.

      Perfect Fit Solutions. Our perfect fit solutions are products tailored or customized to meet specific customer or application requirements. These solutions range from modifications of standard or existing products to complete development and supply of customized solutions. We draw on our experience and large design library to create products with varying degrees of customization. We will continue to invest a portion of our resources in perfect fit solutions as these opportunities are an integral part of our business model. We believe our customers will continue to require some customization of our standard platforms for many of their specific applications.

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

      The Company is one operating segment according to the provisions of SFAS No. 131. See Note 18 of the Notes to the Consolidated Financial Statements for segment information and for financial information by geographic area.

Competition

      We have three different types of competitors:

      We believe that our system level architecture and design expertise, coupled with our extensive library of intellectual property, will enable us to differentiate our products against our competition. We believe our rapid design cycles and standards-based solutions will provide customers with a time to market advantage at a lower total cost.

Customers

      Our customers include many leading system makers in a variety of end markets. Examples of these customers include: Agilent Technologies, Applied Materials, Avaya, Beckman Coulter, Comverse Network Systems, Dictaphone, Diebold, Fluke, Hewlett Packard, IBM, Lucent Technologies, Nokia, Nortel Networks, Philips Medical, Rockwell Automation, Siemens AG, SkyStream Networks, Toshiba, and Universal Instruments.

      Our five largest customers, accounting for approximately 58.2% of revenues in 2004, are listed below with an example of the type of application which incorporates RadiSys products:

      Nokia and Nortel were our largest customers in 2004 accounting for 28.5% and 13.7% of total 2004 revenues, respectively.

Partners

      We believe we are also broadening the scope and value of our standards-based solutions by building a robust ecosystem of partners through our RadiSys Alliance Program (“RAP”). By working closely with our alliance partners, we believe we will provide more complete solutions that enable our customers to simplify their supply chains and achieve lower product costs. The RadiSys Alliance Program is composed of companies that provide leading technologies and services that we believe enhance our solutions. Our RAP partners include:

Research, Development and Engineering

      We believe that our research, development and engineering (“R&D”) expertise represents an important competitive advantage. Our R&D staff consisted of 175 engineers and technicians at February 28, 2005. We currently have design centers located in the United States and China.

      A majority of our R&D efforts are currently focused on the development of standards-based products for a wide variety of applications. This is an important part of our strategy to provide a broader set of products and building blocks which allows deployment of flexible solutions leveraged off of reusable designs and commercially available components. This results in significant savings in development time and investment for our customers and increases the number of applications into which RadiSys solutions can be incorporated. In addition, we are increasingly combining our standards-based products to create more integrated hardware and software based systems.

      A portion of our R&D efforts are focused on “perfect-fit” integrated solutions for our customers, where existing functional building blocks are tailored to meet the customers’ specific needs. For these programs, our engineering team works closely with the customer’s engineering team to architect, develop and deliver solutions that meet their specific requirements using RadiSys functional building blocks. In some cases, the customer will pay non-recurring engineering fees as pre-defined milestones are achieved. We engage in close and frequent communication during the design and supply process, allowing us to operate as a “virtual division” within a customer’s organization. We believe our in-depth understanding of embedded systems provides customers with specialized competitive solutions, earning RadiSys a strong incumbent position for future system development projects.

      It is our objective to retain the rights to technology developed during the design process. In some cases, we agree to share technology rights, manufacturing rights, or both, with the customer. However, we generally retain nonexclusive rights to use any shared technology.

      In 2004, we opened our China Development Center in Shanghai as we moved to strengthen our position globally and grow our presence within the Asia Pacific region. Our first China Development Center product is currently scheduled for release in mid 2005.

      Our research and development is focused on three fundamental applications:

      In 2004, 2003 and 2002, we invested $28.2 million, $22.8 million and $27.7 million, respectively, in research and development.

Sales and Marketing

      Our products are sold through a variety of channels, including direct sales, distributors and sales representatives. The total direct sales and marketing headcount was 75 at February 28, 2005. We use our sales model and dedicated cross-functional teams to develop long-term relationships with our customers, which is a means by which we achieve collaborative success. Our cross-functional teams include sales, marketing, program management, supply chain management, and design engineering. Our teams partner with our customers to combine their development efforts in key areas of competency with our standards-

based or perfect-fit solutions to achieve higher quality, lower development and product cost and faster time to market for their products.

      We market our products in North America, Europe and Israel (“EMEA”), and Asia Pacific. In each of these geographies, products are sold principally through a direct sales force with our sales resources located in the United States, Canada, Europe, Israel, China and Japan. In addition, in each of these geographies we make use of an indirect distribution model and sales representatives to access additional customers. In 2004, global revenues were comprised geographically of 43.8% from North America, 50.1% from EMEA and 6.1% from Asia Pacific.

      Financial information regarding the Company’s domestic and foreign operations is presented in Note 18 of the Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data.

Manufacturing and Supply

      We utilize a combination of internal and outsourced manufacturing. Total manufacturing operations headcount was 217 at February 28, 2005. We currently manufacture approximately 34% of our own products and intend to continue to outsource more of our products to manufacturing services partners for better global customer fulfillment and reduced cost.

      We have an automated ISO9001 certified plant in Hillsboro, Oregon that provides board and systems assembly and test. This plant includes two automated lines for Surface Mount Technology (“SMT”) double-sided board assembly and facilities for systems integration, configuration and test. Because the products into which building blocks are integrated typically have long life reliability requirements, dynamic stress testing of our products must be particularly rigorous. We believe our systems testing processes are a competitive advantage.

      Although many of the raw materials and much of the equipment used in our internal and outsourced manufacturing operations are available from a number of alternative sources, some of these materials and equipment are obtained from a single supplier or a limited number of suppliers. We utilize multiple manufacturing services partners, mainly Celestica Inc., and Hon Hai Precision Industry Co., Ltd. (a.k.a. FoxConn) for outsourced board and system production. If one of these contractors failed to perform, this production could either be transferred internally to our Hillsboro, OR-based plant, or transferred to other contract manufacturers. Such transfers would require technical and logistical activities and would not be instantaneous. We contract with third parties for a continuing supply of the components used in the manufacture of our products. Certain components are supplied by only one supplier. 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 sole source suppliers for other components. Alternative sources of supply for some of these components would be difficult to locate and/or it would require a significant amount of time and resources to establish an alternative supply line.

Backlog

      As of December 31, 2004, our backlog was approximately $22.6 million, compared to $31.8 million as of December 31, 2003. We include in our backlog statistic all purchase orders scheduled for delivery within 12 months. The general trend within our addressable markets is for shorter lead times and supplier managed inventory, which has been decreasing backlog as a percentage of revenue.

Intellectual Property

      We own 23 U.S. utility patents and have four U.S. patent applications pending as well as six foreign patent applications pending; however, we rely principally on trade secrets and rapid time to market for protection and leverage of our intellectual property. We believe that our competitiveness depends much more on the pace of our product development, trade secrets, and our relationships with customers. We have from time to time been made aware of others in the industry who assert exclusive rights to certain

technologies, usually in the form of an offer to license certain rights for fees or royalties. Our policy is to evaluate such claims on a case-by-case basis. We may seek to enter into licensing agreements with companies having or asserting rights to technologies if we conclude that such licensing arrangements are necessary or desirable in developing specific products.

Employees

      As of February 28, 2005 we had 601 employees, of which 533 were regular employees and 68 were agency temporary employees or contractors. We are not subject to any collective bargaining agreement, have never been subject to a work stoppage, and believe that we have maintained good relationships with our employees.

Corporate History

      RadiSys Corporation was incorporated in March 1987 under the laws of the State of Oregon.

FORWARD-LOOKING STATEMENTS

      This Annual Report on Form 10-K may contain forward-looking statements. Our statements concerning our beliefs about the success of our shift in business strategy from perfect fit solutions to standards-based solutions, expectations and goals for revenues, gross margin, research and development expenses, selling, general, and administrative expenses, the impact of our restructuring events on future revenues, the anticipated cost savings effects of our restructuring activities, and our projected liquidity are some of the forward-looking statements contained in this Annual Report on Form 10-K. All statements that relate to future events or to our future performance are forward-looking statements. In some cases, forward-looking statements can be identified by terms such as “may,” “will,” “should,” “expect,” “plans,” “seeks,” “anticipate,” “believe,” “estimate,” “predict,” “potential,” “continue,” “seek to continue,” “intends,” or other comparable terminology. These forward-looking statements are made pursuant to safe-harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties and other factors that may cause our actual results or our industries’ actual results, levels of activity, performance, or achievements to be materially different from any future results, levels of activity, performance, or achievements expressed or implied by these forward-looking statements.

      Forward-looking statements in this Annual Report on Form 10-K include discussions of our goals, including those discussions set forth in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. We cannot provide assurance that these goals will be achieved.

      Although forward-looking statements help provide complete information about us, investors should keep in mind that forward-looking statements are only predictions, at a point in time, and are inherently less reliable than historical information. In evaluating these statements, you should specifically consider the risks outlined above and those listed under “Risk Factors.” These risk factors may cause our actual results to differ materially from any forward-looking statement.

      We do not guarantee future results, levels of activity, performance or achievements and we do not assume responsibility for the accuracy and completeness of these statements. The forward-looking statements contained in this Annual Report on Form 10-K are based on information as of the date of this report. We assume no obligation to update any of these statements based on information after the date of this report.

RISK FACTORS

Risk Factors Related to Our Business

      During 2004, we derived 58.2% of our revenues from five customers. These five customers were Nokia, Nortel, IBM, Comverse and Diebold. During 2004, revenues attributable to Nokia and Nortel were 28.5% and 13.7%, 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.

      We are shifting our business from predominately perfect fit solutions to more standards-based solutions, such as ATCA 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 allow us to grow on a long-term basis. Revenues from some of these investments, such as ATCA, 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.

      If a product development project actually ramps into production, the average ramp into production begins about 12 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.

      We derive our revenues from a number of diverse end markets, some of which are subject to significant cyclical changes in demand. In 2004, we derived 43.4%, 31.9% and 24.7% of our revenues from the service provider, the commercial and the enterprise systems markets, respectively. We believe that our revenues will continue to be derived primarily from these three markets. Service provider revenues include, but are not limited to, telecommunications sales to 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. Enterprise systems revenues include, but are not limited to, sales to Avaya, IBM and Nortel. 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.

      Most of our major customers have contracts but these contracts do not commit them to purchase a minimum amount of our products. These contracts generally require our customers to provide us with forecasts of their anticipated purchases. However, our recent experience indicates that customers can change their purchasing patterns quickly in response to market demands and therefore these forecasts may not be relied upon to accurately forecast sales. From time to time we provide projections to our shareholders and the investment community of our future sales and earnings. Since we do not have long-term purchase commitments from our major customers and the customer order cycle is short, it is difficult for us to accurately predict the amount of our sales and related earnings in any given period. Our projections are based on management’s best estimate of sales using historical sales data, information from customers and other information deemed relevant. These projections are highly subjective since sales to our customers can fluctuate substantially based on the demands of their customers and the relevant markets. If our actual sales or earnings are less than the projected amounts, the price of our common stock may be adversely affected.

      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 are dependent solely on Intel for the supply of some microprocessors and other components, and we depend 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 supply for some of these components would be difficult to locate and/or it would require a significant amount of time and resources to establish an alternative supply line. 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 contact 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 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 2004, our contract manufacturing partners were manufacturing approximately

66% of all of our unit volume. We expect to increase our outsourcing to our contract manufacturers to 70% or more of our unit volume by the end of 2005. 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. 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 contact 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.

      We compete with a number of companies providing embedded systems, including Advantech Co., Artesyn Technologies, Continuous Computing, Embedded Communications Computing Group , a unit of Motorola, Hewlett Packard, divisions within Intel Corporation and IBM, Kontron AG, Mercury Computer Systems, Performance Technologies and SBS Technologies. 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:

      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.

      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. Moreover, to the extent that any proposed acquisition or strategic investment is not favorably received by shareholders, analysts and others in the investment community, the price of our common stock could be adversely affected. In addition, acquisitions or strategic investments involve numerous risks, including:

      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.

      In 2004, we derived 5.0% of our revenues from Canada and Mexico, 50.1% of our revenues from EMEA and 6.1% from Asia Pacific. In addition, during 2004 we opened a development center in Shanghai, China and began to utilize a contract manufacturer in Shenzhen, China. As a result, 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 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 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.

      We cannot provide absolute assurance that we will generate sufficient taxable income to fully utilize the net deferred tax assets of $27.4 million as of December 31, 2004. 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 $31.7 million on the Consolidated Balance Sheet as of December 31, 2004, and therefore, we may incur an impairment charge in the future.

      We provide long-life support to our customers and therefore we have material levels of customer-specific inventory. A financial hardship experienced by our customers could materially affect the viability of the dedicated inventory, and ultimately adversely impact our profitability.

      We develop and supply a mix of perfect fit and standards-based products. Standards-based products for embedded computing applications are often based on industry standards, which are continually evolving. Our future success in these products will depend, in part, upon our capacity to invest in, and successfully develop and introduce new products based on emerging industry standards. Our inability to invest in or conform to these standards could render parts of our product portfolio uncompetitive, unmarketable or obsolete. As our addressable markets develop new 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.

      We are a technology dependent company, and our success depends on developing and protecting our intellectual property. We rely on patents, copyrights, trademarks and trade secret laws to protect our intellectual property. At the same time, our products are complex, and are often not patentable in their entirety. We also license intellectual property from third parties and rely on those parties to maintain and protect their technology. We cannot be certain that our actions will protect proprietary rights. If we are unable to adequately protect our technology, or if we are unable to continue to obtain or maintain licenses for protected technology from third parties, it could have a material adverse effect on our results of operations.

      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 service provider, commercial and enterprise systems markets in general. Shareholders should be willing to incur the risk of such fluctuations.

      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:

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

      The foregoing provisions of Oregon law and our articles of incorporation and bylaws could limit the price that investors might be willing to pay in the future for shares of our common stock.

      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 affect on our business, financial condition and results from operations.

      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. Proposed changes to accounting rules, including proposals to account for employee stock options as a compensation expense, could materially increase the expense that we report under generally accepted accounting principles and adversely affect our operating results.

INTERNET INFORMATION

      Copies of our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934 are available free of charge through our website (www.radisys.com) as soon as reasonably practicable after we electronically file the information with, or furnish it to, the Securities and Exchange Commission.

      Information concerning our principal properties at December 31, 2004 is set forth below:

      In addition to the above properties, we own two parcels of land adjacent to our Hillsboro, Oregon facility, which are being held for future expansion. We also lease sales offices in the United States located in San Diego, California; Cheshire, Connecticut and Marlborough, Massachusetts. We have international

sales offices located in Munich, Germany; Tokyo, Japan; Birmingham, United Kingdom; and Dublin, Ireland. We have two offices to support our contract manufacturing partners and these offices are located in Charlotte, North Carolina and in Shenzhen, China. We also lease an office in Shanghai, China for our China-based Development Center.

      Beginning in the first quarter of 2001, we initiated a restructuring of our operations. As a result, we committed to vacate properties according to our restructuring plans. We partially vacated facilities in Boca Raton, Florida and fully vacated facilities in Campbell, California and Houston, Texas. At the end of 2004, we were utilizing or subleasing the majority of space in our facilities that were not vacated as a result of our restructuring plans.

      In the opinion of management, there is no material litigation pending.

      Not applicable.

PART II

      Our Common Stock is traded on the Nasdaq National Market under the symbol “RSYS.” The following table sets forth, for the periods indicated, the highest and lowest closing sale prices for the Common Stock, as reported by the Nasdaq National Market.

      The closing price as reported on NASDAQ on March 3, 2005 was $15.28 per share. As of March 3, 2005, there were approximately 350 holders of record of our common stock. We believe that the number of beneficial owners is substantially greater than the number of record holders because a large portion of our outstanding Common Stock is held of record in broker “street names” for the benefit of individual investors.

Dividend Policy

      We have never paid any cash dividends on our common stock and do not expect to declare cash dividends on the common stock in the foreseeable future in compliance with our policy to retain all of our earnings to finance future growth.

Overview

      Total revenue was $245.8 million, $202.8 million and $200.1 million in 2004, 2003 and 2002, respectively. Backlog was approximately $22.6 million, $31.8 million and $23.8 million at December 31, 2004, 2003 and 2002, respectively. Backlog includes all purchase orders scheduled for delivery within 12 months. The general trend within our addressable markets is for shorter lead times and supplier-managed inventory, which has been decreasing backlog as a percentage of revenue. We believe the increase in revenues from 2002 to 2003 reflected our improving position in a number of diverse and improving end markets and the success of new product introductions. The increase in revenues for 2004

compared to 2003 was primarily attributable to sales volume increases driven by improved infrastructure capital spending in our end markets and shipments of new products that were completed in 2003 ramping into production in 2004.We believe that our customers’ end markets that we serve will continue to see growth in 2005 and that our position in these markets will continue to strengthen with our commitment to providing leading embedded solutions. We currently believe that our customers’ end markets will experience mid to high single digit growth rates in 2005 and that we will grow faster than our customers’ end markets in 2005. We anticipate growth due to new product introductions and we expect to design and supply more of our customers’ solutions.

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

      We announced our Promentum^tm family of AdvancedTCA products in 2004. This family of products includes universal carrier cards, switch and control modules, disk storage modules, compute modules, and a 14-slot shelf or chassis. These products will be offered individually or will be integrated together as part of a blade server platform system known as the Promentum-6000. We believe the Promentum-6000 system will provide customers a highly reliable managed platform on which to build their new voice and data offerings. We have significant experience in the design, delivery and deployment of carrier-grade, modular platforms. We believe the ATCA standard increases our opportunity to implement reusable platforms, enabling the deployment of more flexible solutions based on cost-effective commercial technologies. We believe our core ATCA solutions will be applicable across a wide range of customers and applications and are potentially applicable in all three of our defined markets. These integrated hardware and software platforms make extensive use of common architectural and component designs, with carrier grade operating systems and middleware, reducing development time and costs and enhancing application portability.

      In addition to our new ATCA offerings, we recently announced our new Procelerant^tm series of modular computing solutions, which we anticipate will be released in mid 2005, for customers in our commercial systems markets for medical, transaction terminals and test and measurement applications. These new modular products are currently in development and we believe these products will represent a family of high density, flexible solutions that will enable commercial systems customers to achieve more rapid time to market with cost effective designs.

      Income from continuing operations was $13.0 million in 2004, $6.0 million in 2003 and a net loss from continuing operations of $1.8 million in 2002. Income per share from continuing operations was $0.69 and $0.59, basic and diluted, respectively, for 2004 compared to $0.34 and $0.32, basic and diluted, respectively, in 2003. Net loss per share from continuing operations was $0.10, basic and diluted, in 2002. In light of overall market conditions and the economic downturn during 2001 and 2002, we initiated several cost reduction measures. Beginning in 2001, we initiated a restructuring of our operations, and as a result, we recorded several restructuring charges in 2001, 2002 and 2003. The restructuring activities occurring prior to 2004 included workforce reductions, consolidation of certain facilities, fixed asset and capitalized software write-downs, and other costs, and were largely intended to align our capacity and infrastructure to anticipated near-term demand for our products. We realized the effect of reducing our cost structure beginning in 2002 and continued to see cost structure reductions in 2003. We also recorded restructuring charges in 2004 which were not associated with cost reduction measures but were instead related to the continued effort to develop the skills necessary to support our shift in business strategy from

predominately custom-designed solutions to more standards-based solutions. The 2004 restructurings were also initiated as a result of the level of increased outsourcing which has partially reduced our need for internal resources. In early 2002 we initiated an aggressive strategic plan to reduce material costs, which began to show results in the latter half of 2002 and in 2003. We also instituted other cost cutting measures during 2002 and 2003, including office closures and tighter controls on discretionary spending. These general cost cutting measures resulted in higher margins and lower operating expenses in 2003 than in previous years. During 2002 we completed the sale of our Multibus business unit and during 2003 we completed the sale of our Savvi business, to allow us to focus on our core embedded systems business and core Tier 1 OEM customers within our three primary markets. The increase in income from continuing operations in 2004 compared to 2003 was primarily due to growing our revenues without proportionately increasing our operating expenses. We have engaged in several actions that have further improved our profitability in 2004 compared to 2003, including increasing the level of outsourced manufacturing to further control product costs, continuing the initiative to reduce material costs, and initiating other operating cost cutting and control measures, including office space reductions and closures and tighter controls on discretionary spending.

      Net income was $13.0 million and $1.3 million in 2004 and 2003, respectively, and net loss was $3.3 million in 2002. Net income per share was $0.69 and $0.59, basic and diluted, respectively, in 2004 compared to $0.07, basic and diluted, in 2003. Net loss per share was $0.19, basic and diluted, in 2002. During the first quarter of 2003, we completed the sale of our Savvi business which allowed us to focus on our core embedded systems business within our three primary markets. The $4.7 million loss from discontinued operations recorded in the first quarter of 2003 includes a $4.3 million loss on the sale of the Savvi business as well as $393 thousand of net losses incurred by the business unit during the quarter.

      In the second quarter of 2004, we bought out the remaining lease obligations for the Houston, Texas manufacturing facility at a discount. The Houston facility was vacated as part of the second quarter of 2002, fourth quarter of 2001 and first quarter of 2001 restructuring events.

      In August 2004, we announced plans to eliminate approximately 14 engineering and marketing positions in our Birmingham, UK office during the fourth quarter of 2004. We have integrated the work done by these employees into other RadiSys locations. In conjunction with these position eliminations, some R&D spending will be re-directed to align with our strategy to deliver more integrated standards-based solutions.

      In October 2004, we announced plans to eliminate approximately 55 to 65 positions during the fourth quarter of 2004 and to record a restructuring charge in the fourth quarter of 2004. These reductions were a result of the increase in outsourced manufacturing as well as to continue our shift of skills required to develop, market, sell, and support more advanced embedded platforms and solutions. We expect the workforce reduction to be substantially completed by March 31, 2005. As we continue to execute on our strategy of increasing the level of outsourced manufacturing, we may incur additional restructuring charges.

      We have also begun to invest in infrastructure in emerging markets such as China. We continue to ramp up the hiring of engineers for our Shanghai R&D center. A significant portion of our products are currently assembled by our China-based manufacturing partner’s China-based facilities and we expect to increase this outsourcing activity in 2005. We have hired employees in China to support the outsourcing initiative, and we have also added sales and marketing support personnel in China to focus on selling product into this region.

      We expect a combined overall decrease in research and development and sales, marketing and administrative expenses of between $100 thousand and $200 thousand for the first quarter of 2005 compared to the fourth quarter of 2004. The decrease is the result of a reduction in costs associated with the implementation of the Sarbanes-Oxley Act and reduced spending associated with the development and fourth quarter 2004 launch of our ATCA family of products.

      In November 2003, we completed a private offering of 1.375% convertible senior notes due November 15, 2023 to qualified institutional buyers, resulting in net proceeds of $97 million. We plan to

use the proceeds of the offering for general corporate purposes including working capital, potential acquisitions, partnership opportunities and potential repayment of existing debt obligations. In early 2004, we incurred expenses of $619 thousand to evaluate a potential acquisition that did not occur. We plan to actively continue evaluating potential acquisitions and partnership opportunities. During the second quarter of 2004, we repurchased $58.8 million principal amount of the 5.5% convertible subordinated notes in the open market for $58.2 million.

      During 2004, we incurred $841 thousand of stock-based compensation expense associated with shares issued pursuant to the Company’s 1996 Employee Stock Purchase Plan (“ESPP”). We incurred stock-based compensation expense because the original number of ESPP shares approved by the shareholders was insufficient to meet employee demand for an ESPP offering consummated in February 2003 and ending in August 2004. We subsequently received shareholder approval for additional ESPP shares in May 2003. We currently do not anticipate incurring stock-based compensation expense subsequent to 2004 associated with our ESPP under the intrinsic value method. Beginning in the third quarter of 2005 the Company will recognize stock-based compensation expense based on the fair value method, as required by SFAS No. 123 (revised 2004), “Share-Based Payment” (“SFAS 123R”), which replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” (“SFAS 123”) and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.”

      On November 12, 2004, the Compensation and Development Committee of the Board of Directors approved an acceleration of vesting of those employee stock options with an option price greater than $15.99, which was greater than the fair market value of the shares on that date ($14.23). Approximately 1.1 million options with varying remaining vesting schedules were subject to the acceleration and became immediately exercisable. As a result of the acceleration, we expect to reduce our exposure to the effects of the Financial Accounting Standards Board (“FASB”) proposal to require companies to recognize stock-based compensation expense associated with stock options based on the fair value method. The FASB proposal will be effective beginning the second half of fiscal year 2005. Upon adoption of this proposal we must determine the appropriate fair value model to be used for valuing share-based payments. If we were to continue to use the fair value method currently used for reporting pro forma disclosures of net income (loss) and net income (loss) per common share, we estimate a reduction in stock-based compensation expense associated with the acceleration of approximately $2.1 million for the last six months of 2005 and $3.7 million for the year ended December 31, 2006.

      Cash, cash equivalents and investments amounted to $198.6 million, $225.4 million and $118.9 million at December 31, 2004, 2003 and 2002, respectively. The decrease in cash, cash equivalents and investments during 2004 compared to 2003, was primarily due to the repurchase of $58.8 million principal amount of the 5.5% convertible subordinated notes for $58.2 million. This was partially offset by positive cash from operations in the amount of $24.7 million in 2004. The increase in cash, cash equivalents and investments during 2003 compared to 2002, was primarily due to the issuance of our 1.375% convertible senior notes resulting in net proceeds of $97 million and generation of $18.3 million of cash flows from operations in 2003. In 2003, we sold our Des Moines, Iowa facility to a third party for $8.5 million, generating positive cash flow amounting to $360 thousand. In 2003, we repurchased $10.3 million of the 5.5% convertible subordinated notes for $9.2 million.

      We generated net cash from operations in excess of net income in 2004, and we continued to improve our cash cycle time, primarily by increasing inventory turns and decreasing the days that customer accounts receivable are outstanding. We believe that cash flows from operations, available cash and investment balances, and short-term borrowings will be sufficient to fund our operating liquidity needs for the short-term and long-term. In 2004, we obtained board authorization to repurchase all remaining convertible subordinated notes, and we may elect to use a portion of the cash, cash equivalents and investment balances to repurchase additional amounts of the convertible subordinated notes.

      In the following discussion of our financial condition and results of operations, we intend to provide information that will assist in understanding our financial statements, changes in certain key items in those

financial statements from year to year, and the primary factors that accounted for those changes, as well as how certain accounting principles, policies and estimates affect our financial statements.

Critical Accounting Policies and Estimates

      Management’s discussion and analysis of our financial condition and results of operations are based upon the Consolidated Financial Statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these financial statements requires management to make estimates and judgments that may affect the reported amounts of assets, liabilities, and revenues and expenses. On an on-going basis, management evaluates its estimates. Management bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

      An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and if different estimates that reasonably could have been used, or changes in the accounting estimates that are reasonably likely to occur periodically, could materially impact the financial statements. Management believes the following critical accounting policies reflect the more significant estimates and assumptions used in the preparation of the Consolidated Financial Statements.

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

      During the fourth quarter of 2003, we revised our excess and obsolete inventory reserve calculation to more accurately reflect our true exposure to losses associated with excess and obsolete (“E&O”) inventory moving forward. We previously estimated our required reserve for excess inventory based on a forward projection of excess material beyond 12 months demand. This resulted in a reserve estimate that was higher than the actual E&O losses for products where our demand and orders are more sporadic. Our revised process combines the historical view of demand over the prior six months with a prospective view of demand over 12 months. We tested the revised method against prior periods and found it to be a more accurate predictor of excess inventory. This change resulted in a reduction to the E&O provision to the inventory reserve of approximately $500 thousand in the fourth quarter of 2003.

      We provide for the estimated cost of product warranties at the time revenue is recognized. Our standard product warranty terms generally include post-sales support and repairs or replacement of a product at no additional charge for a specified period of time, which is generally 24 months after shipment. The workmanship of our products produced by contract manufacturers is covered under warranties provided by the contract manufacturer for a specified period of time ranging from 12 to 15 months. We engage in extensive product quality programs and processes, including actively monitoring and evaluating

the quality of our component suppliers. Our estimated warranty obligation is based upon ongoing product failure rates, internal repair costs, contract manufacturing repair charges for repairs not covered by the warranty provided by the contract manufacturer, product call rates, average cost per call and current period product shipments. If actual product failure rates, repair rates, service delivery costs, or post-sales support costs differ from our estimates, revisions to the estimated warranty liability would be required. Additionally, we accrue warranty costs for specific customer product repairs that are in excess of our warranty obligation calculation described above.

      We assess impairment of property and equipment and definite-lived intangible assets whenever changes in circumstances indicate that the carrying values of the assets may not be recoverable. During 2003, we reviewed property and equipment and identifiable intangible assets for impairment due to several events, including the sale of the Savvi business, the restructuring event in the first quarter, and the sale of our facility in Des Moines Iowa. As a result of the sale of the Savvi business, we recorded an impairment of our intangible assets of $1.7 million. This impairment charge is included in the loss from discontinued operations related to the Savvi business in 2003. The Company disposed of $8.8 million of net book value associated with the building and other office equipment as a result of the sale of the Des Moines, Iowa facility. The write off of the net book value associated with building and office equipment is included in loss on building sale in 2003. Also in 2003, we performed a fixed asset physical inventory count, during which we evaluated whether the carrying value of the property and equipment would be recoverable. We recorded write-offs of $240 thousand as a result of the fixed asset physical inventory.

      Goodwill represents the excess of cost over the assigned value of the net assets in connection with prior acquisitions. Conditions that would trigger an impairment assessment include, but are not limited to, a significant adverse change in legal factors or in the business climate that could affect the value of an asset or an adverse action or assessment by a regulator. Goodwill is required to be tested for impairment at least annually and whenever events or changes in circumstances indicate the carrying value of goodwill may not be recoverable. Goodwill will be written down when impaired, rather than be amortized as previous standards required.

      We completed our annual goodwill impairment analysis as of September 30, 2004 and concluded that as of September 30, 2004, there was no goodwill impairment. To determine whether or not goodwill may be impaired, we compare our book value to our market capitalization. If the trading price or the average trading price of our common stock is below the book value per share for a sustained period, a goodwill impairment test will be performed by comparing book value to estimated market value. Our book value per share was $9.50 at September 30, 2004. Additionally, we perform other tests, such as the multiple of revenues and present value of future cash flows to further validate the fair market value of the goodwill. Management concluded there was no indication of material changes requiring an updated goodwill impairment analysis as of December 31, 2004. We may be required, under certain circumstances, to update our impairment analysis, which may result in losses on acquired goodwill. As a result of the sale of the Savvi business in 2003, we recorded $2.4 million in write-offs of goodwill. This impairment charge is included in the loss from discontinued operations related to the Savvi business in 2003.

      When we determine that the carrying value of property and equipment, identifiable intangible assets, or goodwill will not be recoverable, we calculate and record impairment losses based upon future estimates of cash flows. We estimate future cash flows using assumptions about our expected future operating performance. Our estimates of future cash flows may differ from actual cash flow due to, among other things, technological changes, economic conditions, or changes to our business operations.

      We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the carrying amounts and tax bases of the assets and liabilities. The Company records a valuation

allowance to reduce deferred tax assets to the amount expected to “more likely than not” be realized in its future tax returns. Should we determine that we would not be able to realize all or part of our net deferred tax assets in the future, adjustments to the valuation allowance for deferred tax assets may be required. The net deferred tax assets amounted to $27.4 million as of December 31, 2004. As of December 31, 2004 we estimate utilization of the net deferred tax assets will require that we generate $73.7 million in taxable income prior to the expiration of net operating loss carryforwards which will occur between 2005 and 2023. We may record a valuation allowance against the deferred tax assets if our expectations of future taxable income are not achieved. If we were to record a valuation allowance, the allowance could include the entire balance of net deferred tax assets as any significant departures from expected future taxable income could suggest uncertainty in our business and therefore we may determine that there is no reasonable basis to calculate a partial valuation allowance. On the other hand, if we generate taxable income in excess of our future expectations, the valuation allowance may be reduced accordingly.

      We have a relatively small set of multinational customers that typically make up the majority of our accounts receivable balance. Our allowance for doubtful accounts is determined using a combination of factors to ensure that our trade receivables balances are not overstated. We record reserves for individual accounts when we become aware of a customer’s inability to meet its financial obligations to us, such as in the case of bankruptcy filings or deterioration in the customer’s operating results or financial position. If circumstances related to customers change, our estimates of the recoverability of receivables would be further adjusted. At December 31, 2004, 63.3% of our accounts receivable was due from our five largest customers. If one of these large customers or a number of our smaller customers files for bankruptcy or otherwise is unable to pay us the amounts due the current allowance for doubtful accounts may not be adequate. At December 31, 2002, we specifically identified and reserved for one international customer that filed for bankruptcy. At December 31, 2002, we recorded a reserve for this customer’s account in the amount of approximately $500 thousand and, subsequently, in 2003 we wrote-off the account as we had determined that this account was uncollectible. During 2003 we improved our international credit policies. During the year ended December 31, 2004 there were no significant account balances reserved for and the allowance for doubtful accounts decreased by $413 thousand as a result of the write-off of previously specifically identified account balances.

      We maintain a non-specific bad debt reserve for all customers based on a variety of factors, including the length of time receivables are past due, trends in overall weighted average risk rating of the total portfolio, macroeconomic conditions, significant one-time events and historical experience. Typically, this non-specific bad debt reserve amounts to approximately 1% of quarterly revenues.

      We have engaged, and may continue to engage, in restructuring actions, which require us 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 to generate sublease income, as well as our ability to terminate lease obligations at the amounts we have estimated; and other exit costs. Should the actual amounts differ from our estimates, the amount of the restructuring charges could be materially impacted. For a description of our restructuring actions, refer to our discussion of restructuring charges in the Results of Operations section.

      We enter into contracts to sell our products and services, and, while the majority of our sales agreements contain standard terms and conditions under which we recognize revenue upon shipment of product, there are agreements that contain non-standard terms and conditions. Non-standard terms and conditions can include, but are not limited to, customer acceptance criteria or other post-delivery obligations. As a result, significant contract interpretation is sometimes required to determine the appropriate timing of revenue recognition.

      We currently account for the expense associated with our stock-based compensation plans using the intrinsic value method. We provide pro forma disclosures of net income (loss) and net income (loss) per common share as if the fair value method had been applied in measuring compensation expense. Equity instruments are granted to employees, directors, and consultants in certain instances, as defined in the respective plan agreements. We currently use the Black-Scholes model to measure our stock-based compensation expense for the pro forma disclosures. In December 2004, the Financial Accounting Standards Board (“FASB”) issued its final determination on the issue of stock-based compensation, requiring companies to account for stock-based compensation based on the fair value method, which replaces the intrinsic value method. For periods prior to the effective date of this change, pro forma disclosures will be an alternative to recognition in the financial statements. We will be required to adopt this pronouncement in the third quarter of fiscal 2005, beginning July 1, 2005. We must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used at date of adoption. The transition methods include prospective and retroactive adoption alternatives. Under the retroactive option, prior periods may be restated either as of the beginning of the year of adoption or for all periods presented. The prospective method requires that compensation expense be recorded for all unvested stock options and restricted stock at the beginning of the first quarter of adoption, while the retroactive methods would require reporting compensation expense for all unvested stock options and restricted stock beginning with the first period restated. RadiSys is evaluating the requirements of the pronouncement and expects that the adoption of the pronouncement will have a material impact on RadiSys’ consolidated results of operations and earnings per share. RadiSys has not yet determined the method of adoption or the effect of the pronouncement, and has not determined whether the adoption will result in amounts that are similar to the current pro forma disclosures.

      To determine the fair value of our stock-based compensation plans, we currently take into consideration the following:

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

Results of Operations

      The following table sets forth certain operating data as a percentage of revenues for the years ended December 31, 2004, 2003 and 2002.

      Revenues. Revenues increased by $43.0 million, or 21.2%, from $202.8 million in 2003 to $245.8 million in 2004. Included in the revenues in the first and fourth quarter of 2004, are end of life component inventory sales to two of our major customers amounting to $3.1 million and $1.4 million, respectively. These inventory sales were recorded as revenues but did not generate any gross profit since the inventory was sold at cost. As of December 31, 2004 and December 31, 2003, backlog was approximately $22.6 million and $31.8 million, respectively. Generally, the increase in revenues in 2004 compared to 2003 is attributable to sales volume increases and new product sales in the end markets as described below.

      The increase in revenues in 2004 compared to 2003 is due to an increase in revenues in the service provider systems, commercial systems and enterprise systems markets of $30.6 million, $12.0 million and $350 thousand, respectively. The end of life component inventory sales discussed above were included in the service provider systems market revenues in 2004.

      Revenues in the service provider systems market increased in 2004 compared to the same periods in 2003, primarily because we continue to design and supply more content within our customers’ 2.5G and 3G wireless infrastructure products. The increase was also attributable to improved economic conditions causing market growth in the wireless infrastructure sub-market.

      Revenue in the commercial systems market increased approximately $12.0 million from 2003 levels to 2004 levels due to new product development projects ramping into production volumes and the economic recovery early in 2004 which buoyed demand in cyclical sub-markets. The test and measurement and industrial automation sub-markets grew in response to strengthening market and global economic conditions. Test and measurement and medical sub-markets also benefited from product development projects which ramped to production volumes in 2003 and 2004. Increased revenues from medical, industrial automation and test and measurement were partially offset by lower revenues from the transaction terminals sub-market as legacy business in that area decreased for products reaching or nearing end of life.

      Revenues in the enterprise systems market increased in 2004 compared to 2003, primarily due to increased sales to the datacom sub-market. This is due to the ramp of a new product in this sub-market into full-production in mid-2004. Partially offsetting this growth is a year-over-year decline in the telephony sub-market.

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

      From a geographic perspective, in 2004 compared to 2003 the overall increase in revenues was concentrated in EMEA, which experienced an increase in revenues of $38.6 million. The increase in the revenues in EMEA in 2004 compared to 2003, is primarily attributable to higher sales of wireless infrastructure products to Nokia. Included in EMEA revenues in 2004 is $4.5 million end of life component inventory sales to two of our major customers. We currently expect continued quarterly fluctuations in the percentage of revenue from each geographic region.

      Gross Margin. Gross margin for 2004 was 32.2% compared to 32.1% for 2003. In 2004, cost of sales includes $235 thousand of stock-based compensation expense which is discussed in “Stock-based Compensation Expense” below.

      The following items affected gross margin as a percentage of revenues for 2004 compared to 2003. The E&O reserve requirements, including transfers from adverse purchase commitments, decreased as a percentage of revenues from 2.1% in 2003 to 1.2% in 2004 primarily because during the fourth quarter of 2003, we revised the E&O reserve calculation. We previously estimated the required reserve for excess inventory based on a forward projection of excess material beyond 12 months demand. The revised process combines the historical view of demand over the prior six months with a prospective view of demand over 12 months. We tested the revised method against prior periods and found it to be a better indicator of excess inventory. Additionally, the E&O inventory reserve requirements have decreased due to increasing demand and consumption for some of our older products. Warranty expenses have also decreased as a percentage of revenues from 2.0% in 2003 to 1.1% in 2004 due to a few unique, specifically-identified warranty-related issues that made up a large portion of the warranty expense in 2003. The improvement in our gross margin from 2003 to 2004 which resulted from the decreases in E&O inventory reserves and warranty reserves as a percentage of revenues was almost entirely offset by a shift in sales to higher volume products which have lower margins. These lower margin products are primarily associated with sales to our larger customers that receive volume discounts. Further, during the first and fourth quarters of 2004 we had end of life component inventory sales to two of our major customers amounting to $3.1 million and $1.4 million, respectively. These inventory sales did not generate any gross profit as the inventory was sold at cost. Our long-term gross margin target range continues to be 32% to 35%, excluding any impact from the implementation of an accounting standard that will require the recognition of stock-based compensation expense associated with employee stock options effective in the latter half of 2005. Among other factors, our long-term gross margin range is dependent upon successful execution of our outsourcing strategy.

      Research and Development. Research and development expenses consist primarily of salary, bonuses, and benefits for product development staff, and cost of design and development supplies and equipment. Research and development expenses increased $5.4 million, or 23.5%, from $22.8 million in 2003 to $28.2 million in 2004. In 2004, research and development expenses include $343 thousand of stock-based compensation expense which is discussed in “Stock-based Compensation Expense” below. The increase in research and development expenses in 2004 compared to 2003 is due mainly to an increase in payroll-related expenses, fees to outside contractors, and other costs associated with research and development programs, including materials for prototypes and beta versions of our products. Payroll-related expenses increased due to additional personnel focused on research and development efforts, merit-related salary increases and profit-dependent compensation expenses. During 2004, we increased our investment in the development of standards-based platforms, such as ATCA. Fees to outside contractors increased as we were working to meet several project deadlines to capitalize on customer and market opportunities. We expect to continue to incur fees for outside contractors as we execute on our strategy to develop standards-based platforms. We completed the infrastructure and entity establishment work for our Shanghai research and development design center, and in 2004 we began hiring additional staff for the design center. Our long-term target for research and development expenses continues to be 10-12% of revenues, excluding any impact from the implementation of an accounting standard that will require the recognition of stock-based compensation expense associated with employee stock options effective in the latter half of 2005.

      Selling, General, and Administrative. Selling, general and administrative (“SG&A”) expenses consist primarily of salary, commissions, bonuses and benefits for sales, marketing, executive, and administrative personnel, as well as the costs of professional services and costs of other general corporate activities. SG&A expenses increased $3.4 million, or 12.6%, from $27.0 million in 2003 to $30.4 million in 2004. In 2004, SG&A expenses included $263 thousand of stock-based compensation expense which is discussed in “Stock-based Compensation Expense” below. The increase in SG&A expenses in 2004 compared to 2003 is primarily attributable to an increase in payroll-related expenses, costs associated with the implementation of the Sarbanes-Oxley Act, costs associated with establishing our presence in China and an increase in sales and marketing expenses. Payroll-related expenses have increased due to merit-related salary increases and profit-dependent compensation expenses. Costs associated with the implementation of the Sarbanes-Oxley Act include fees to outside contractors and service providers. Costs associated with establishing our presence in China include legal fees and other administrative costs. Sales and marketing activities have increased to support our increasing investment in standards-based platforms. SG&A expenses in 2004 also includes $619 thousand associated with a potential acquisition that was ultimately abandoned. Our long-term goal for SG&A expenses is 10-12% of revenues, excluding any impact from the implementation of an accounting standard that will require the recognition of stock-based compensation expense associated with employee stock options effective in the latter half of 2005.

      Stock-based Compensation Expense. In 2004, we incurred $841 thousand of stock-based compensation expense, associated with shares issued pursuant to our 1996 Employee Stock Purchase Plan (“ESPP”). We incurred stock-based compensation expense because the original number of ESPP shares approved by the shareholders was insufficient to meet employee demand for an ESPP offering consummated in February 2003 and ending in August 2004. We subsequently received shareholder approval for additional ESPP shares in May 2003. The shares issued in the February 2003 ESPP offering in excess of the original number of ESPP shares approved at the beginning of the offering (the “shortfall”) triggers recognition of stock-based compensation expense under the intrinsic value method. The shortfall amounted to 138 thousand and 149 thousand shares in May 2004 and August 2004, respectively.

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

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

      We currently do not anticipate incurring stock-based compensation expense subsequent to 2004 associated with our ESPP plan under the intrinsic value method.

      Intangible Assets Amortization. Intangible assets consist of purchased technology, patents and other identifiable intangible assets. Intangible assets amortization expense was $2.2 million and $3.1 million in 2004 and 2003, respectively. Intangible assets amortization decreased due to certain intangible assets becoming fully amortized during the first and second quarters of 2004. We expect intangible assets amortization expense to decrease slightly in 2005 compared to 2004 due to certain intangible assets becoming fully amortized during 2004. Goodwill has been and will be periodically evaluated for impairment. We perform reviews for impairment of goodwill and all purchased intangible assets whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. We completed our annual goodwill impairment analysis as of September 30, 2004 and concluded that as of September 30, 2004, there was no goodwill impairment. We are required under certain circumstances, to update our impairment analysis, which may result in losses on acquired goodwill.

      Restructuring and Other Charges. We evaluate the adequacy of accrued restructuring and other charges on a quarterly basis. We record certain reclassifications and reversals to accrued restructuring and other charges based on the results of the evaluation. The total accrued restructuring and other charges for each restructuring event are not affected by reclassifications. Reversals are recorded in the period in which we determine that expected restructuring and other obligations are less than the amounts accrued. Tables summarizing the activity in the accrued liability for each restructuring event are contained in Note 9 of the Notes to the Consolidated Financial Statements. During 2004 and 2003, we recorded restructuring and other charges and reversals as described below.

      In October 2004, we announced plans to eliminate approximately 55 to 65 positions during the fourth quarter of 2004 and to record a restructuring charge in the fourth quarter of 2004. These reductions were a result of the increase in outsourced manufacturing as well as to continue our shift of skills required to develop, market, sell, and support more advanced embedded platforms and solutions. We expect the workforce reduction to be substantially completed by March 31, 2005. The restructuring charge includes severance and other employee-related separation costs of $1.6 million for 61 employees and associated legal fees of $20 thousand.

      In August 2004, we announced plans to close our Birmingham UK office and eliminate approximately 14 engineering and marketing positions during the fourth quarter of 2004. We are integrating the work done by these employees into other RadiSys locations. In conjunction with this elimination of positions, some R&D spending will be re-directed to align our strategy to deliver more integrated standards-based solutions. In connection with the third quarter 2004 restructuring event, we incurred employee termination and related costs of approximately $434 thousand, of which $94 thousand was reversed as two of the affected employees are relocating to continue their employment with us. Employee termination and related costs primarily includes employee severance. In connection with the third quarter 2004 restructuring event, we incurred other charges of approximately $48 thousand and expect to incur an additional $35 thousand

associated with the cost of relocating certain employees. Other charges include legal fees, human resource consulting fees and the costs of relocation. Additionally, we will incur additional costs to relocate property and equipment and may write off certain property and equipment with a net book value of approximately $20 thousand. A provision or impairment charge for these costs will be recorded in the period in which they are incurred. We expect to complete these restructuring activities in the first quarter of 2005.

      In March 2003, we recorded a restructuring charge of $1.8 million as a result of our continued efforts to increase profitability and market diversification. The restructuring charge included a net workforce reduction of 103 employee positions. The 103 employee positions eliminated included 53 from manufacturing operations, 42 from shifts in portfolio investments, and eight in support functions.

      We recorded reversals amounting to $1.1 million during 2004 related primarily to a buy-out of the remaining lease obligations on our Houston manufacturing facility, which was vacated as a result of various restructuring events. The reversals also include various amounts originally accrued for certain non-cancelable leases for facilities vacated as a result of the restructuring events. We entered into subleasing arrangements for a portion of these remaining facilities and during 2004 updated our analysis of the subleasing arrangements. As a result of this analysis we reversed a portion of restructuring reserves in connection with increased anticipated sublease income as well as previously unbilled charges owed from our sublease tenants.

      (Loss) Gain on the Repurchase of Convertible Notes. In the second quarter of 2004, we repurchased $58.8 million principal amount of the outstanding convertible subordinated notes, with an associated discount of $897 thousand. We repurchased the notes in the open market for $58.2 million and, as a result, recorded a loss of $387 thousand. In the first quarter of 2003, we repurchased $10.3 million principal amount of the convertible subordinated notes, with an associated discount of $212 thousand. We repurchased the notes in the open market for $9.2 million and, as a result, recorded a gain of $825 thousand. We may elect to use a portion of our cash, cash equivalents and investment balances to buy back additional amounts of the convertible subordinated notes.

      Interest Expense. Interest expense primarily includes interest expense incurred on convertible senior and subordinated notes. Interest expense decreased $1.3 million, or 26.6%, from $4.9 million in 2003 to $3.6 million in 2004.

      The decrease in interest expense in 2004 compared to 2003 is due to the $2.2 million decrease in interest expense associated with the convertible subordinated notes and a decrease in interest expense associated with a mortgage payable in the amount of $505 thousand, partially offset by $1.4 million of additional interest incurred on our convertible senior notes issued in November 2003. The decrease in the interest expense associated with our convertible subordinated notes is due to a decrease in the balance of outstanding convertible subordinated notes as a result of the repurchase of the notes during the first quarter of 2003 and the second quarter of 2004. In December 2003, we sold our Des Moines, Iowa facility. As a result, we paid the mortgage payable in full. We expect our interest expense to decrease to approximately $2.2 million in 2005 due to the decrease in the outstanding balance of the convertible subordinated notes as a result of the repurchase of the notes during the second quarter of 2004.

      Interest Income. Interest income increased $790 thousand, or 30.1%, from $2.6 million in 2003 to $3.4 million in 2004. Interest income increased primarily because of the increase in the amount of cash available to invest. The cash available to invest increased due to the net proceeds from the offering of our convertible senior notes completed in November 2003 in the amount of $97 million. Additionally, we experienced an increase in the average yield on investments in 2004 as a result of the increased interest rate environment in the United States.

      Other Expense, net. Other expense, net, primarily includes foreign currency exchange gains and losses and unusual items. Other expense, net, was $472 thousand in 2004 compared to $1.3 million in 2003.

      Foreign currency exchange rate fluctuations resulted in a net loss of $317 thousand in 2004 compared to a net loss of $787 thousand in 2003. The decrease in the foreign currency exchange rate net loss is primarily due to decreased weakening of the US dollar relative to European currencies in 2004 compared to 2003.

      Net of the change in net losses related to foreign currency exchange rate fluctuations, the change in Other expense, net, in 2004 compared to 2003, is primarily attributable to a loss related to an other-than-temporary decline in value on the investment in shares of GA eXpress (“GA”) common stock amounting to $358 thousand recorded in 2003. We hold shares in GA as a result of the 1996 sale of Texas Micro’s Sequoia Enterprise Systems business unit to GA in exchange for stock. We acquired Texas Micro in 1999. Factors we considered when we determined the decline in value on the investment in GA shares was other than temporary, include, but are not limited to, the likelihood that the related company would have insufficient cash flows to operate for the next 12 months, significant changes in the operating performance or operating model and/or changes in market conditions. As of December 31, 2004, the estimated fair value of this investment is zero. Additionally, we recorded a loss on the disposal of fixed assets recorded in the first quarter of 2003 of $240 thousand as a result of a fixed asset physical inventory count.

      Income Tax Provision. We recorded a tax provision of $3.3 million from continuing operations and no income tax provision or benefit from discontinued operations for the year ended December 31, 2004. For the year ended December 31, 2003, we recorded a tax provision of $22 thousand from continuing operations and no tax provision or benefit from discontinued operations. Our effective tax rate was 20.0% in 2004 compared to 1.6% in 2003. Our current effective tax rate differs from the statutory rate due to the tax impact of income associated with foreign jurisdictions, tax benefits related to certain foreign sales, tax credits and other permanent differences.

      We currently estimate that our effective tax rate for 2005 will be approximately 27%. The 2005 estimated effective tax rate is based on current tax law and the current expected income, and assumes that the company continues to receive the tax benefits associated with certain income associated with foreign jurisdictions. The tax rate may be affected by potential acquisitions, restructuring events or divestitures, the jurisdictions in which profits are determined to be earned and taxed, and the ability to realize deferred tax assets.

      On October 22, 2004, the President of the United States signed the American Jobs Creation Act of 2004 (the “Act”). One of the key provisions of the Act includes a repeal of the extraterritorial income exclusion with certain transitional rules. In its place, the Act provides a relief provision for domestic manufacturers by providing a new domestic manufacturing deduction. The Act also includes a temporary incentive for U.S. multinationals to repatriate foreign earnings and other international tax reforms designed to improve the global competitiveness of U.S. multinationals. We are currently evaluating the impact of the Act on our effective tax rate, cash flows and financial statements. On October 4, 2004 the Working Families Tax Relief Act of 2004 was enacted which extended several expired business related tax breaks, including the research and development tax credit. Under the new law the research and development tax credit was retroactively reinstated to June 30, 2004 and is available through December 31, 2005. For the year ended December 31, 2004 we recorded a research and development tax credit in the amount of $407 thousand, a portion of which would not have been recorded had the Working Families Tax Relief Act of 2004 not been enacted.

      FASB Staff Position (“FSP”) No. 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the Act (“FSP 109-2”), provides guidance under FASB Statement No. 109, “Accounting for Income Taxes,” with respect to recording the potential impact of the repatriation provisions of the Act on enterprises’ income tax expense and deferred tax liability. FSP 109-2 states that an enterprise is allowed time beyond the financial reporting period of enactment to evaluate the effect of the Act on its plan for reinvestment or repatriation of foreign earnings for purposes of

applying FASB Statement No. 109. The Company has not yet completed evaluating the impact of the repatriation provisions. Given the preliminary stage of our evaluation, it is not possible at this time to determine what impact the repatriation provisions will have on our consolidated tax accruals or our effective tax rate. Accordingly, as provided for in FSP 109-2, the Company has not adjusted its tax expense or deferred tax liability to reflect the repatriation provisions of the Act.

      At December 31, 2004, we had net deferred tax assets of $27.4 million. Valuation allowances of $15.9 million and $17.4 million, as of December 31, 2004 and 2003, respectively, have been provided for deferred income tax assets related primarily to net operating loss and tax credit carryforwards that may not be realized. The decrease in valuation allowance of $1.5 million for the year ended December 31, 2004 compared to the year ended December 31, 2003 is primarily attributable to the expiration of certain foreign net operating loss carryforwards in 2004. As of December 31, 2004 we estimate utilization of the net deferred tax assets will require that we generate $73.7 million in taxable income prior to the expiration of net operating loss carryforwards which will occur between 2005 and 2023. Management expects to return to significant levels of profitability, and therefore believes it is more likely than not that we will utilize a portion of the net deferred tax assets. We cannot provide absolute assurance that we will generate sufficient taxable income to fully utilize the net deferred tax assets, and accordingly, we may record a valuation allowance against the deferred tax assets if our expectations of future taxable income are not achieved. If we were to record a valuation allowance, the allowance could include the entire balance of net deferred tax assets as any significant departures from expected future taxable income could suggest uncertainty in our business and therefore we may determine that there is no reasonable basis to calculate a partial valuation allowance. Any tax benefit subsequently recognized from the acquired net operating loss carryforwards of Microware would be allocated to goodwill.

      In 2004 the IRS completed an examination of our federal income tax returns for the years 1996 through 2002. The final audit report resulted in no negative consequences and was issued during the first quarter of 2004. We have agreed to the IRS’s proposed audit adjustments for all years under audit. The proposed adjustments will result in an increase of $241 thousand in the net operating loss carryforwards for the year 2003. There are no additional taxes, penalties and/or interest related to the proposed audit adjustments. However, the final results of the examination are subject to review and approval by the Joint Committee of Taxation. We do not expect the report on the final results of the examination as reviewed by the Joint Committee of Taxation to differ from the audit report issued by the IRS.

      Discontinued Operations. On March 14, 2003, we completed the sale of the Savvi business resulting in a loss of $4.3 million. As a result of this transaction, we recorded $4.1 million in write-offs of goodwill and intangible assets. The total $4.7 million loss from discontinued operations recorded in the first quarter of 2003 includes the $4.3 million loss on the sale of the Savvi business as well as $393 thousand of net losses incurred by the business unit during the quarter, before the business unit was sold.

      Revenues. Revenues increased slightly by $2.7 million, or 1.4%, from $200.1 million in 2002 to $202.8 million in 2003. The increase in revenues in 2003, compared to 2002, is primarily due to an increase in revenues in the service provider systems market of $4.1 million and an increase in the enterprise market of $6.1 million offset by a decrease in revenues in the commercial systems market of $7.4 million. Revenues in the service provider systems market increased in 2003, compared to 2002, primarily due to increased shipments of 2, 2.5 and 3G wireless infrastructure products. Revenues in the enterprise market increased in 2003, compared to 2002, due to several enterprise design wins from 2002 ramping into production in 2003 generating additional revenues. These design wins primarily relate to the security and converged networks sub-markets of the enterprise market. Revenues in the commercial systems market decreased in 2003, compared to 2002, primarily due to sporadic demand in the industrial automation and gaming sub-markets within the commercial systems market. Additionally, the decrease in the commercial systems market can be attributable to an increase in the number of product end-of-life orders fulfilled in 2002. Given the dynamics of these markets, we may experience general fluctuations in the percentage of revenue attributable to each market. We currently expect that, on average, each of the

three markets will represent a significant portion of total revenues. As of December 31, 2003, backlog was approximately $31.8 million, compared to $23.8 million as of December 31, 2002.

      Additionally in 2003, compared to 2002, the overall increase in revenues was concentrated in the EMEA and Asia Pacific regions which experienced an increase in revenues of $11.8 million, partially offset by a decrease in North American revenues of $9.1 million.

      Gross Margin. Gross margin for 2003 was 32.1%, compared to 29.7% for 2002. The increase in gross margin as a percentage of revenues for 2003, compared to 2002, was primarily due to improvements in our manufacturing cost structure as a result of the restructuring events in the first quarter of 2003 and the second quarter of 2002. In addition, early in 2002, we began an aggressive strategic plan to reduce material costs, which began to produce benefits in the latter half of 2002. During the fourth quarter of 2003, we revised our excess and obsolete inventory reserve calculation to more accurately reflect our true exposure to losses associated with excess and obsolete (“E&O”) inventory moving forward. We estimate that this change resulted in a reduction to the E&O provision to the inventory reserve of approximately $500 thousand in the fourth quarter of 2003.

      Research and Development. Research and development expenses consist primarily of salary, bonuses, and benefits for product development staff, and cost of design and development supplies and equipment. Research and development expenses decreased $4.9 million, or 17.6%, from $27.7 million in 2002 to $22.8 million in 2003. The decrease in research and development expenses is due mainly to a reduction in payroll-related expenses of $5.2 million in 2003, compared to 2002. The reduction in payroll expenses is a result of decreases in headcount, primarily associated with the restructuring events in the first quarter of 2003 and the second quarter of 2002. In addition, the overall decrease in research and development expenses is a result of cost cutting measures undertaken in 2002 and 2003, including office closures and tighter controls on discretionary spending.

      Selling, General, and Administrative. Selling, general and administrative (“SG&A”) expenses consist primarily of salary, commissions, bonuses and benefits for sales, marketing, executive, and administrative personnel, as well as the costs of professional services and costs of other general corporate activities. SG&A expenses decreased $3.1 million, or 10.2%, from $30.1 million for 2002 to $27.0 million for 2003. The decrease in SG&A expenses in 2003, compared to 2002, was primarily due to decreased severance and relocation charges incurred in 2002 and a reduction in payroll expenses. Specifically, in June 2002, we incurred $1.2 million of severance-related expenses paid to a former executive. The reduction in payroll expenses is a result of decreases in headcount, primarily associated with the restructuring events in the first quarter of 2003 and the second quarter of 2002. In addition, the overall decrease in SG&A expenses is a result of cost cutting measures undertaken in 2002 and 2003, including office closures and tighter controls on discretionary spending.

      Intangible Assets Amortization. Intangible assets amortization expense was flat at $3.1 million for 2003 and 2002. Intangible assets consist of purchased technology, patents and other identifiable intangible assets. Goodwill and all other intangible assets have been and will periodically be evaluated for impairment. We completed an annual goodwill impairment analysis as of September 30, 2003 and concluded that as of September 30, 2003, there was no goodwill impairment. We concluded there was no indication of material changes requiring an updated goodwill impairment analysis as of December 31, 2003. We may be required under certain circumstances, to update our impairment analysis, which may result in losses on acquired goodwill.

      Gain on Multibus Sale. In November 2002, we completed the sale of the Multibus business unit recording a gain of $1.2 million, net of expenses arising from the disposal. The gain was included in income from operations in accordance with the provisions of SFAS No. 144.

      Loss on Building Sale. In December 2003, we sold the Des Moines, Iowa facility to a third party for $8.5 million. As a result, we disposed of $8.8 million of net book value associated with building, land and other office equipment and paid the mortgage payable in full. In addition, we incurred a prepayment penalty on the mortgage payable amounting to $1.1 million and incurred additional fees of approximately

$353 thousand associated with the sale. The sale resulted in a loss of $1.8 million recorded in Income from operations in the Consolidated Statement of Operations for the year ended December 31, 2003.

      Restructuring Charges. We evaluate the adequacy of the accrued restructuring charges on a quarterly basis. We record certain reclassifications and reversals to the accrued restructuring charges based on the results of the evaluation. The total accrued restructuring charges for each restructuring event are not affected by reclassifications. Reversals are recorded in the period in which we determine that expected restructuring obligations are less than the amounts accrued. Tables summarizing the activity in the accrued liability for each restructuring event are contained in Note 9 of the Notes to the Consolidated Financial Statements. During 2003 and 2002, we recorded restructuring charges and reversals as described below.

      In March 2003, we recorded a restructuring charge of $1.8 million as a result of our continued efforts to improve profitability and market diversification. The restructuring charge includes a net workforce reduction of 103 employee positions. The 103 employee positions eliminated included 53 from manufacturing operations, 42 from shifts in portfolio investments, and eight in support functions.

      In June 2002, we recorded a restructuring charge of $4.4 million as a result of our continued efforts to improve cost structure and consolidate redundant functions and facilities. The restructuring charge includes a net workforce reduction of 80 employee positions, the closure of the Houston, Texas Design Center, and the consolidation of certain domestic and international sales and service offices. The 80 employee positions eliminated included 46 engineering positions, 19 sales positions, and 15 administrative positions.

      Costs included in the charges were: (i) employee termination and related costs, (ii) facility charges related to vacating various domestic and international locations, (iii) write-downs of property and equipment impaired as a result of the restructuring, and (iv) other charges including legal and accounting fees. We realized reduced quarterly operating expenses of approximately $2.2 million as a result of these actions.

      Employee termination and related costs consist of severance, insurance benefits, and other related costs associated with the elimination of 60 domestic positions and 20 international positions. Included in the facility charges are expenses related to the decision to vacate leased spaces at two of our domestic locations and four international locations. Lease costs for these facilities are charged against the restructuring accrual on a monthly basis upon vacation of the premises until the lease contracts expire or the facilities are sub-leased.

      The property and equipment charge is comprised of the net book value of the remaining computer hardware, manufacturing test equipment, and furniture and fixtures at the Houston, Texas facility and the net book value of furniture and fixtures, computer hardware, and computer software at Netherlands, Germany, and one of the United Kingdom facilities. Our decision to completely vacate these facilities during the second quarter prompted the need to write-off the net book value of part or all of the remaining assets at these locations.

      Other charges include legal and accounting fees related to the restructuring activities.

      We recorded reversals amounting to $208 thousand and $188 thousand during 2003 and 2002, respectively, related primarily to accruals for certain non-cancelable leases for facilities vacated as a result of the restructuring events. During 2002 and 2003, we entered into subleasing arrangements for a portion of these facilities, and as result, we reduced the restructuring accruals.

      Gain on Repurchase of Convertible Subordinated Notes. In 2003, we repurchased $10.3 million principal amount of the convertible subordinated notes, with an associated discount of $212 thousand. We repurchased the notes in the open market for $9.2 million and, as a result, recorded a gain of $825 thousand.

      In 2002, we repurchased $21.0 million principal amount of the convertible subordinated notes, with an associated discount of $587 thousand for $17.5 million in cash as part of negotiated transactions with third parties. The early extinguishments of the notes resulted in a gain of $3.0 million.

      Interest Expense. Interest expense, for 2003 and 2002 primarily includes interest expense incurred on convertible subordinated notes. Interest expense decreased $775 thousand, or 13.8%, from $5.6 million in 2002 to $4.9 million in 2003. The decrease in interest expense is due to a decrease in the balance of outstanding convertible subordinated notes as a result of the repurchases of the convertible subordinated notes on various dates in 2003 and 2002.

      Interest Income. Interest income decreased $379 thousand, or 12.6%, from $3.0 million in 2002 to $2.6 million in 2003. Interest income decreased as a result of lower yields earned on investments. We experienced lower yields on our investments due to declining interest rates in 2003.

      Other Expense, net. Other expense, net, primarily includes foreign currency exchange gains and losses and unusual items. Other expense, net, increased $213 thousand, or 18.8%, from $1.1 million in 2002 to $1.3 million in 2003. Foreign currency exchange rate fluctuations resulted in expenses of $787 thousand in 2003 compared to $1.3 million in 2002. The foreign exchange losses are primarily a result of a weak US dollar relative to European currencies.

      Net of the change in expenses related to foreign currency exchange rate fluctuations, the increase in other expense, net, in 2003, compared to 2002, is attributable to several unusual items. Specifically, in 2003, we recorded a loss related to an other-than-temporary decline in value on the investment in shares of GA eXpress (“GA”) common stock amounting to $358 thousand. We hold shares in GA as a result of the 1996 sale of Texas Micro’s Sequoia Enterprise Systems business unit to GA in exchange for stock. The Company acquired Texas Micro in 2001. Factors the Company considered when it determined the decline in value on the investment in GA shares was other than temporary, include, but are not limited to, the likelihood that the related company would have insufficient cash flows to operate for the next 12 months, significant changes in the operating performance or operating model and/or changes in market conditions. As of December 31, 2003 the estimated fair value of this investment is zero. In 2003, we performed a fixed asset physical inventory count resulting in write-offs of $240 thousand, which are included in other expenses. In 2002, other expense included a gain on the sale of an investment in the amount of $69 thousand and we recorded other income in the amount of $189 thousand related to an insurance reimbursement.

      Income Tax Provision (Benefit). We recorded a tax provision of $22 thousand from continuing operations and no tax provision or benefit from discontinued operations for the year ended December 31, 2003. For the year ended December 31, 2002, we recorded a $2.7 million income tax benefit and a $2.4 million income tax benefit from continuing and discontinued operations, respectively. Our effective tax rate was 1.6% in 2003 compared to (60.7%) in 2002. Our current effective tax rate differs from the statutory rate primarily due to the tax impact of income associated with foreign jurisdictions, the loss on disposition of a foreign subsidiary and the impact of the increase in valuation allowance related to tax attributes generated in 2003.

      At December 31, 2003, we had net deferred tax assets of $28.8 million. Valuation allowances of $17.4 million and $16.2 million, as of December 31, 2003 and 2002, respectively, have been provided for deferred income tax assets related primarily to net operating loss and tax credit carryforwards that may not be realized. The increase in valuation allowance of $1.2 million for the year ended December 31, 2003 compared to the year ended December 31, 2002 is primarily attributable to the change in net deferred tax assets generated in 2003.

      Discontinued Operations. On March 14, 2003, we completed the sale of the Savvi business resulting in a loss of $4.3 million. As a result of this transaction, we recorded $4.1 million in write-offs of goodwill and intangible assets. The total $4.7 million loss from discontinued operations recorded in 2003 includes a $4.3 million loss on the sale of the Savvi business as well as $393 thousand of net losses incurred by the business unit during the quarter, before the business unit was sold. For 2002, $3.9 million of revenues and expenses and $2.4 million of tax benefit were reclassified from continuing operations to losses from discontinued operations as a result of the sale of the Savvi business in the first quarter of 2003.

Liquidity and Capital Resources

      The following table summarizes selected financial information for each of the years ended on the dates indicated:

      Cash and cash equivalents decreased by $69.4 million from $149.9 million at December 31, 2003 to $80.6 million at December 31, 2004. Activities impacting cash and cash equivalents are as follows:

      We have generated annual cash provided by operating activities in amounts greater than net income (loss) in 2004, 2003, and 2002, driven mainly by improved management of our working capital. We currently believe that cash flows from operations, available cash balances, and short-term borrowings will be sufficient to fund our operating liquidity needs.

      During 2004, we used net cash provided by operating activities to fund the repurchases of our 5.5% convertible subordinated notes and for capital expenditures. Capital expenditures increased in 2004 compared to 2003 as a result of investments in equipment to support the development of RadiSys standards-based products, such as ATCA, investments in equipment to support the Company’s China-based manufacturing partner and capital expenditures associated with the Company’s new China Development Center which opened during 2004.

      During 2003, we used net cash provided by operating activities to fund the repurchases of our 5.5% convertible subordinated notes and for capital expenditures. During 2003, we implemented an upgrade to our Enterprise Resource Planning (“ERP”) system and, as a result, capital expenditures increased in 2003, compared to 2002. In addition, we received net proceeds of $360 thousand related to the sale of the Des Moines, Iowa facility in December 2003 and net proceeds of $360 thousand related to the sale of our Savvi business in March 2003. Finally, in November 2003, we completed the sale of our 1.375% Convertible Senior Notes with net proceeds amounting to $97 million.

      During 2002, we used net cash provided by operating activities to fund the repurchases of our 5.5% convertible subordinated notes, for capital expenditures and for repurchases of our common stock. During 2002, capital expenditures were primarily attributable to improvements in information technology infrastructure.

      Working capital decreased $35.7 million from $222.3 million at December 31, 2003 to $186.6 million at December 31, 2004. Working capital decreased primarily due to repurchasing $58.8 million principal amount of the convertible subordinated notes in the open market for $58.2 million. This was partially offset by cash from operations in the amount of $24.7 million. Working capital increased $89.9 million from $132.5 million at December 31, 2002 to $222.3 million at December 31, 2002. Working capital increased due to the issuance of our 1.375% Convertible Senior Notes for net proceeds of $97 million in November, 2003. This was partially offset by the use of cash to repurchase $9.2 million of our convertible subordinated notes. Additionally, we generated net positive cash flow for the year.

      Short-term and long-term investments reported as (in thousands):

      We invest excess cash in debt instruments of the U.S. Government and its agencies, and those of high-quality corporate issuers. As of December 31, 2004 we had $61.0 million investments classified as available-for-sale. As of December 31, 2004 we had $57.1 million investments classified as held-to-maturity. As of December 31, 2004, our long-term held-to-maturity investments had maturities ranging from 15.3 months to 19.7 months. Our investment policy requires that the total investment portfolio, including cash and investments, not exceed a maximum weighted-average maturity of 18 months. In addition, the policy mandates that an individual investment must have a maturity of less than 36 months, with no more than 20% of the total portfolio exceeding 24 months. As of December 31, 2004, we were in compliance with our investment policy.

      The Company’s 2001 stock repurchase program expired during the third quarter of 2002. During the years ended December 31, 2002 and 2001, we repurchased 147,000 and 74,000 of outstanding shares, respectively, in the open market or through privately negotiated transactions for $1.1 million and $1.0 million, respectively. The timing and size of any future stock repurchases are subject to approval by the Board of Directors, market conditions, stock prices, cash position, and other cash requirements.

      During the first quarter of 2004, we renewed our line of credit facility, which expires on March 31, 2005, for $20.0 million at an interest rate based upon the lower of the London Inter-Bank Offered Rate (“LIBOR”) plus 1.0% or the bank’s prime rate. The line of credit is collateralized by our non-equity investments and is reduced by any standby letters of credit. At December 31, 2004, we had a standby letter of credit outstanding related to one of our medical insurance carriers for $105 thousand. The market value of non-equity investments must exceed 125.0% of the borrowed facility amount, and the investments must meet specified investment grade ratings. We plan to renew our line of credit in the first quarter of 2005.

      As of December 31, 2004 and December 31, 2003, there were no outstanding balances on the standby letter of credit or line of credit and we were in compliance with all debt covenants.

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

      Convertible senior notes are unsecured obligations convertible into our Common Stock and rank equally in right of payment with all of our existing and future obligations that are unsecured and unsubordinated. Interest on the senior notes accrues at 1.375% per year and is payable semi-annually on May 15 and November 15. The convertible senior notes are payable in full in November 2023. The notes are convertible, at the option of the holder, at any time on or prior to maturity under certain circumstances, unless previously redeemed or repurchased, into shares of our Common Stock at a conversion price of $23.57 per share, which is equal to a conversion rate of 42.4247 shares per $1,000

principal amount of notes. The notes are convertible prior to maturity into shares of our Common Stock under certain circumstances that include but are not limited to (i) conversion due to the closing price of our Common Stock on the trading day prior to the conversion date reaching 120% or more of the conversion price of the notes on such trading date and (ii) conversion due to the trading price of the notes falling below 98% of the conversion value. We may redeem all or a portion of the notes at our option on or after November 15, 2006 but before November 15, 2008 provided that the closing price of our Common Stock exceeds 130% of the conversion price for at least 20 trading days within a period of 30 consecutive trading days ending on the trading day before the date of the notice of the provisional redemption. On or after November 15, 2008, we may redeem the notes at any time. On November 15, 2008, November 15, 2013, and November 15, 2018, holders of the convertible senior notes will have the right to require the Company to purchase, in cash, all or any part of the notes held by such holder at a purchase price equal to 100% of the principal amount of the notes being purchased, together with accrued and unpaid interest and additional interest, if any, up to but excluding the purchase date.

      As of December 31, 2004 and December 31, 2003 the Company had outstanding convertible senior notes with a face value of $100 million. As of December 31, 2004 and December 31, 2003 the book value of the convertible senior notes was $97.1 million and $97.0 million respectively, net of unamortized discount of $2.9 million and $3.0 million, respectively. The estimated fair value of the convertible senior notes was $106.8 million and $98.0 million at December 31, 2004 and December 31, 2003, respectively.

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

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

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

      In 2003, we repurchased $10.3 million principal amount of the convertible subordinated notes, with an associated discount of $212 thousand. We repurchased the notes in the open market for $9.2 million and, as a result, recorded a gain of $825 thousand.

      In 2002, we repurchased $21.0 million principal amount of the convertible subordinated notes, with an associated discount of $587 thousand for $17.5 million in cash as part of negotiated transactions with third parties. The early extinguishments of the notes resulted in a gain of $3.0 million.

      In 2000, we purchased $20.0 million principal amount of the convertible subordinated notes, with an associated discount of $581 thousand for $14.3 million as part of a negotiated transaction with a third party. The early extinguishment of the notes resulted in a gain of $5.1 million.

      As of December 31, 2004 and December 31, 2003 the Company had outstanding convertible subordinated notes with a face value of $10.0 million and $68.7 million, respectively. As of December 31,

2004 and December 31, 2003 the book value of the convertible subordinated notes was $9.9 million and $67.6 million, respectively, net of amortized discount of $126 thousand and $1.2 million, respectively. The estimated fair value of the convertible subordinated notes was $10.0 million and $65.7 million at December 31, 2004 and December 31, 2003, respectively.

      We have obtained board authorization to repurchase all remaining convertible subordinated notes. We may elect to use a portion of our cash and cash equivalents and investment balances to buy back additional amounts of the convertible subordinated notes.

      Through the purchase of Microware, RadiSys assumed a long-term mortgage payable to GMAC Commercial Mortgage Company in the amount of $6.7 million. The mortgage payable was secured by Microware’s facility in Des Moines, Iowa. In accordance with the provisions of the mortgage agreement, we issued an irrevocable standby letter of credit in the amount of $865 thousand, used as collateral and we also had $865 thousand of restricted cash at December 31, 2002 relating to the standby letter of credit.

      In December 2003, we sold the Des Moines, Iowa facility, and as a result, we paid the mortgage payable in full. The loss on the sale of this facility was $1.8 million as a result of prepayment penalties on the mortgage and related transaction costs.

      During the years ended December 31, 2003 and 2002, we paid $66 thousand and $87 thousand of principal, respectively, on the mortgage payable along with interest at 7.46%.

      The following summarizes RadiSys’ contractual obligations at December 31, 2004 and the effect of such on its liquidity and cash flows in future periods (in thousands).

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

      We believe that our current cash, cash equivalents and investments, net, amounting to $198.6 million at December 31, 2004 and the cash generated from operations will satisfy our short and long-term expected working capital needs, capital expenditures, stock repurchases, and other liquidity requirements associated with our existing business operations. Capital expenditures are expected to range from $1 million to $1.5 million per quarter.

      See Note 1 to the Consolidated Financial Statements for a full description of recent accounting pronouncements including the respective expected dates of adoption and effects on results of operations and financial condition.

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

      Interest Rate Risk. We invest excess cash in debt instruments of the U.S. Government and its agencies, and those of high-quality corporate issuers. We attempt to protect and preserve our invested funds by limiting default, market, and reinvestment risk. Investments in both fixed rate and floating rate interest earning instruments carry a degree of interest rate risk. Fixed rate securities may have their fair value adversely affected due to a rise in interest rates while floating rate securities may produce less income than expected if interest rates decline. Due to the short duration of most of the investment portfolio, an immediate 10% change in interest rates would not have a material effect on the fair value of our investment portfolio. Additionally, the interest rate changes affect the fair market value but do not necessarily have a direct impact on our earnings or cash flows. Therefore, we would not expect our operating results or cash flows to be affected, to any significant degree, by the effect of a sudden change in market interest rates on the securities portfolio. The estimated fair value of our debt securities that we have invested in at December 31, 2004 and December 31, 2003 was $168.4 million and $209.1 million, respectively. The effect of an immediate 10% change in interest rates would not have a material effect on our operating results or cash flows.

      Foreign Currency Risk. We pay the expenses of our international operations in local currencies, namely, the Euro, British Pound, New Shekel, Japanese Yen and Canadian Dollar. The international operations are subject to risks typical of an international business, including, but not limited to: differing economic conditions, changes in political climate, differing tax structures, foreign exchange rate volatility and other regulations and restrictions. Accordingly, future results could be materially and adversely affected by changes in these or other factors. We are also exposed to foreign exchange rate fluctuations as the balance sheets and income statements of our foreign subsidiaries are translated into U.S. dollars during the consolidation process. Because exchange rates vary, these results, when translated, may vary from expectations and adversely affect overall expected profitability. Foreign currency exchange rate fluctuations resulted in a net loss of $317 thousand, $787 thousand and $1.3 million for the years ended December 31, 2004, 2003, and 2002, respectively.

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

      Convertible senior notes are unsecured obligations convertible into our Common Stock and rank equally in right of payment with all of our existing and future obligations that are unsecured and unsubordinated. Interest on the senior notes accrues at 1.375% per year and is payable semi-annually on

May 15 and November 15. The convertible senior notes are payable in full in November 2023. The notes are convertible, at the option of the holder, at any time on or prior to maturity, unless previously redeemed or repurchased, into shares of our Common Stock at a conversion price of $23.57 per share, which is equal to a conversion rate of 42.4247 shares per $1,000 principal amount of notes. The notes are convertible prior to maturity into shares of our Common Stock under certain circumstances that include but are not limited to (i) conversion due to the closing price of our Common Stock on the trading day prior to the conversion date reaching 120% or more of the conversion price of the notes on such trading date and (ii) conversion due to the trading price of the notes falling below 98% of the conversion value. We may redeem all or a portion of the notes at our option on or after November 15, 2006 but before November 15, 2008 provided that the closing price of our Common Stock exceeds 130% of the conversion price for at least 20 trading days within a period of 30 consecutive trading days ending on the trading day before the date of the notice of the provisional redemption. On or after November 15, 2008, we may redeem the notes at any time. On November 15, 2008, November 15, 2013, and November 15, 2018, holders of the convertible senior notes will have the right to require the Company to purchase, in cash, all or any part of the notes held by such holder at a purchase price equal to 100% of the principal amount of the notes being purchased, together with accrued and unpaid interest and additional interest, if any, up to but excluding the purchase date.

      The fair value of the convertible senior notes is sensitive to interest rate changes. Interest rate changes would result in increases or decreases in the fair value of the convertible senior notes, due to differences between market interest rates and rates in effect at the inception of the obligation. Unless we elect to repurchase our convertible senior notes in the open market, changes in the fair value of convertible senior notes have no impact on our cash flows or consolidated financial statements. The estimated fair value of the convertible senior notes was $106.8 million and $98.0 million at December 31, 2004 and December 31, 2003, respectively.

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

      The fair value of the convertible subordinated notes is sensitive to interest rate changes. Interest rate changes would result in increases or decreases in the fair value of the convertible subordinated notes, due to differences between market interest rates and rates in effect at the inception of the obligation. Unless we elect to repurchase our convertible subordinated notes in the open market, changes in the fair value of convertible subordinated notes have no impact on our cash flows or consolidated financial statements. The estimated fair value of the convertible subordinated notes was $10 million and $65.7 million at December 31, 2004 and December 31, 2003, respectively.

      We have cumulatively repurchased convertible subordinated notes in the amount of $110 million, face value, for $99.5 million. These repurchases were financed from our investment portfolio and cash from operations. We have obtained board authorization to repurchase all remaining convertible subordinated notes. We may elect to use a portion of our cash and cash equivalents and investment balances to buy back additional amounts of the convertible subordinated notes. As of December 31, 2004, our aggregate cash and cash equivalents and investments were $198.6 million.

Part II, Item 8.     Financial Statements and Supplementary Data

Quarterly Financial Data (unaudited)

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

      The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rules 13a-15(f) and 15d-15(f) under the Securities Exchange Act of 1934. The Company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding reliability of financial reporting and the preparation and fair presentation of published financial statements for external purposes in accordance with generally accepted accounting principles.

      Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

      Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004. In making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control — Integrated Framework. Based on our assessment, we conclude that, as of December 31, 2004, the Company’s internal control over financial reporting is effective based on those criteria to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles.

      Management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2004, has been audited by PricewaterhouseCoopers, LLP, the independent registered public accounting firm who also audited the Company’s consolidated financial statements included in this Item 8, as stated in the report which appears on page 44 hereof.

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To The Board of Directors and Shareholders

of RadiSys Corporation:

      We have completed an integrated audit of RadiSys Corporation’s 2004 consolidated financial statements and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Our opinions, based on our audits, are presented below.

Consolidated financial statements and financial statement schedule

      In our opinion, the consolidated financial statements listed in the index appearing under Item 15(a)(1) present fairly, in all material respects, the financial position of RadiSys Corporation and its subsidiaries at December 31, 2004 and 2003, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2004 in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, the financial statement schedule listed in the index appearing under Item 15(a)(2) presents fairly, in all material respects, the information set forth therein when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements and financial statement schedule based on our audits. We conducted our audits of these statements in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

Internal control over financial reporting

      Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial Reporting appearing under Item 8, that the Company maintained effective internal control over financial reporting as of December 31, 2004 based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects, based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on Internal Control — Integrated Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.

      A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the

assets of the company; (ii) 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 the company are being made only in accordance with authorizations of management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

      Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

/s/ PRICEWATERHOUSECOOPERS LLP

PricewaterhouseCoopers LLP

Portland, Oregon

March 7, 2005

RADISYS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS

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

RADISYS CORPORATION

CONSOLIDATED BALANCE SHEETS

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

RADISYS CORPORATION

CONSOLIDATED STATEMENT OF CHANGES IN SHAREHOLDERS’ EQUITY

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

RADISYS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS