UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)
[X]	Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934
	For the quarterly period ended March 31, 2003
	or
[   ]	Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from ______ to ______

Commission File Number 0-26778

APPLIED MICROSYSTEMS CORPORATION

(Exact name of registrant as specified in its charter)

Washington	91-1074996
(State of incorporation)	(I.R.S. Employer Identification Number)
16770 NE 79th Street, #103, Redmond, Washington 98052 (425) 883-1606 (Address of principal executive offices, including zip code; registrant’s telephone number, including area code)

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

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

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

Common stock, $.01 par value: 7,597,303 shares outstanding as of April 15, 2003.

TABLE OF CONTENTS

	Item 1. Financial Statements
	CONSOLIDATED BALANCE SHEETS
	CONSOLIDATED STATEMENTS OF OPERATIONS
	CONSOLIDATED STATEMENTS OF CASH FLOWS
	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
	Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II — OTHER INFORMATION
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
Exhibit 99.1
Exhibit 99.2

APPLIED MICROSYSTEMS CORPORATION

FORM 10-Q

QUARTER ENDED MARCH 31, 2003

INDEX

		Page
PART I:	FINANCIAL INFORMATION
Item 1.	Financial Statements:
	Consolidated Balance Sheets as of March 31, 2003 (unaudited) and December 31, 2002	3
	Consolidated Statements of Operations for the three months ended March 31, 2003 and 2002 (unaudited)	4
	Consolidated Statements of Cash Flows for the three months ended March 31, 2003 and 2002 (unaudited)	5
	Notes to Consolidated Financial Statements (unaudited)	6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	11
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	25
Item 4.	Controls and Procedures	25
PART II:	OTHER INFORMATION
Item 6.	Exhibits and Reports on Form 8-K	26
	Signatures	26
	Certifications	27

-2-

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

APPLIED MICROSYSTEMS CORPORATION

CONSOLIDATED BALANCE SHEETS

		March 31,			December 31,
		2003			2002
		(unaudited)
		(in thousands)
ASSETS
Current assets:
	Cash and cash equivalents	$	2,203		$	3,600
	Securities available-for-sale		—			299
	Accounts receivable, net		2			280
	Note receivable		500			500
	Prepaid and other current assets		238			449
	Property and equipment held for sale		84			91
Total assets		$	3,027		$	5,219
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
	Accounts payable	$	495		$	744
	Accrued payroll		348			1,143
	Other accrued expenses		538			765
	Deferred revenue		325			325
	Capital lease obligation		175			175
	Notes payable		187			185
Total current liabilities			2,068			3,337
Commitments and contingencies			—			—
Shareholders’ equity:
Preferred stock, $0.01 par value; 5,000,000 shares authorized; none issued and outstanding			—			—
Common stock, $0.01 par value; 25,000,000 shares authorized; 7,597,000 shares issued and outstanding at March 31, 2003 and December 31, 2002			27,233			27,233
Accumulated deficit			(26,274	)		(25,351	)
Total shareholders’ equity			959			1,882
Total liabilities and shareholders’ equity		$	3,027		$	5,219

See accompanying notes.

-3-

APPLIED MICROSYSTEMS CORPORATION

CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)

		Three Months Ended March 31,
		2003			2002
		(in thousands, except per-share amounts)
Net sales		$	—		$	4,865
Cost of sales			—			1,795
Gross profit			—			3,070
Operating expenses:
	Sales, general and administrative		685			2,655
	Research and development		300			1,656
	Total operating expenses		985			4,311
Loss from operations			(985	)		(1,241	)
Interest income and other, net			62			29
Net loss		$	(923	)	$	(1,212	)
Per-share amounts:
Basic and diluted loss per share		$	(0.12	)	$	(0.17	)
Shares used in per-share calculation			7,597			7,171

See accompanying notes.

-4-

APPLIED MICROSYSTEMS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

				Three Months Ended March 31,
				2003			2002
				(in thousands)
Operating activities
Net loss				$	(923	)	$	(1,212	)
Adjustments to reconcile net loss to net cash used in operating activities:
	Depreciation and amortization				7			203
	Net change in operating accounts:
		Accounts receivable			332			740
		Inventories			—			432
		Prepaid and other assets			159			(84	)
		Accounts payable, accrued expenses, and accrued
		business restructuring			(1,271	)		(440	)
		Deferred revenue			—			(659	)
			Net cash used in operating activities		(1,696	)		(1,020	)
Investing activities
	Purchases of securities available-for-sale				—			(1,979	)
	Maturities of securities available-for-sale				299			1,975
	Additions to property and equipment				—			(35	)
			Net cash provided by (used in) investing activities		299			(39	)
Financing activities
	Sale of common stock to employees				—			47
	Payments on capital lease obligation				—			(11	)
			Net cash provided by financing activities		—			36
Effects of foreign currency exchange rate changes on cash					—			(9	)
Net decrease in cash and cash equivalents					(1,397	)		(1,032	)
Cash and cash equivalents at beginning of period					3,600			2,971
Cash and cash equivalents at end of period				$	2,203		$	1,939

See accompanying notes.

-5-

APPLIED MICROSYSTEMS CORPORATION

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)

1. Basis of Presentation

     The accompanying unaudited consolidated financial statements have been prepared by Applied Microsystems Corporation (“Applied” or the “Company”) in accordance with accounting principles generally accepted in the United States of America for interim financial information and according to the rules and regulations of the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements. In the opinion of management, all adjustments (which include only normal recurring adjustments) considered necessary for a fair presentation have been included. The balance sheet at December 31, 2002 has been derived from the audited financial statements included in the Company’s Annual Report on Form 10-K for the year then ended. The results of operations for the three-month period ended March 31, 2003, are not necessarily indicative of results to be expected for the entire year ending December 31, 2003 or for any other fiscal period. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2002.

     On December 16, 2002, the Company announced that the board of directors had unanimously decided to recommend to shareholders that Applied be liquidated. The Company scheduled a shareholder meeting for April 30, 2003 to consider and vote on the proposed dissolution and liquidation; however, a quorum was not present at the meeting, and the Company adjourned the meeting until May 22, 2003. The Company’s consolidated financial statements for all periods presented have been prepared using guidance from Emerging Issues Task Force (“EITF”) 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring);” therefore, certain costs that do not meet the criteria of exit activities under EITF 94-3, or cannot be reasonably estimated, are not accrued for as of March 31, 2003. Such costs are recognized as incurred.

2. Computation of Loss Per Share

     Basic loss per share is computed using the weighted-average number of common shares outstanding during the period. Diluted loss per share is computed using the weighted-average number of common shares and dilutive common stock equivalent shares outstanding during the period. Common stock equivalent shares are excluded from the computation of diluted loss per share if their effect is antidilutive; therefore, due to the Company’s net losses, basic and diluted loss per share are determined excluding common stock equivalents. At March 31, 2003 and March 31, 2002, options to purchase 55,000 and 1,449,000 shares of common stock, respectively, were outstanding; however, all stock options were excluded from the calculation of loss per share in the three month periods ended March 31, 2003 and 2002, because their effect was antidilutive.

3. Comprehensive Loss

     As defined by applicable accounting and reporting standards, Applied’s comprehensive loss is comprised of net loss and the effects of current-period translation adjustments, which are recorded directly

-6-

to equity. Assets and liabilities of foreign subsidiaries are translated to U.S. dollars at the exchange rates on the balance sheet date. Revenues and expenses of foreign subsidiaries are translated at the average rates of exchange prevailing during the year. The cumulative translation adjustments resulting from this process have historically been accumulated in other comprehensive loss. As a result of the Company’s sale of its embedded systems development tools business and assets in November 2002, and the subsequent announcement that Applied would seek corporate liquidation, the Company’s international operations were substantially closed by the end of the year. The Company therefore recognized a charge of $593,000 in the fourth quarter of 2002 relating to the write-off of foreign currency translation adjustments that had accumulated for these subsidiaries, and the Company had no recorded change in translation adjustments during the quarter ended March 31, 2003. During the first quarter of 2002, comprehensive loss amounted to $1.2 million.

4. Sale of Embedded Systems Development Tools Business and Assets

     Effective November 1, 2002, the Company sold its embedded systems development tools business and assets to Metrowerks Corporation, a wholly owned subsidiary of Motorola, Inc. The purchase price was $3.9 million, which included payment for certain inventories and tangible assets, as well as all intellectual property related to the Company’s embedded systems development tools business. In addition, Metrowerks assumed certain customer warranty and support obligations. The Company received $3.4 million at closing, with the remaining $500,000 subject to a one-year holdback to secure certain indemnification obligations. Certain other indemnification obligations relating to title to the assets sold, compliance with laws, and certain matters relating to taxes continue until the expiration of the statute of limitations applicable to claims with respect to such matters.

     As of the November 1, 2002 transaction date, the carrying amount of assets and liabilities included in the sale transaction were as follows (in thousands):

Assets
	Inventories	$	910
	Prepaid and other current assets		54
	Fixed assets		84
		$	1,048
Liabilities — deferred revenue and warranty		$	1,433

     The fourth quarter 2002 gain in the Company’s sale of its embedded systems development tools business and is summarized as follows (in thousands):

Cash received at closing		$	3,352
Holdback note receivable			500
Liabilities assumed by purchaser			1,433
	Total proceeds		5,285
Carrying value of assets sold			1,048
Transaction and other accrued expenses, net			654
	Gain on sale	$	3,583

-7-

5. Business Restructuring Activities

     In August 2001, in response to economic uncertainty and reduced revenue streams, Applied implemented a restructuring plan designed to reduce operating costs. The restructuring plan included a reduction of approximately 90 full-time employees worldwide across the Company’s functional organizations, or 39% of the workforce; discontinuance or reallocation of selected projects and activities not essential to the Company’s long-term goals; abandonment of excess space at the Company’s headquarters; as well as other cost reduction and control measures. The charge for abandoned facilities related to amounts accrued for estimated losses on lease commitments for facilities that Applied had abandoned in connection with the August 2001 restructuring. As a result of adopting the restructuring plan, Applied recorded a restructuring charge of $2.3 million in the third quarter of 2001.

     In May 2002, the Company announced further plans to reduce expenses through a reduction in personnel and realignment of business objectives. The cost reductions consisted primarily of a reduction of approximately 45 full-time employees worldwide across the Company’s functional organizations, as well as a write-off of certain assets for which the book value was deemed in excess of net realizable value under accounting rules. As a result, the Company recognized a charge of $602,000 for severance and related expenses and $67,000 for asset write-offs in the second quarter of 2002. The Company also reassessed the potential exposure for losses for the abandoned space identified in the August 2001 restructuring in light of revised estimates of the timeframe and terms under which a sublease could be negotiated. As a result, the Company recognized an additional charge of $480,000 in the second quarter of 2002.

     In the fourth quarter of 2002, after announcing on December 16, 2002 that the Company’s board of directors had unanimously decided to recommend to shareholders that Applied be liquidated, Applied further recognized $906,000 in restructuring charges associated with severance and benefits for the remaining 26 personnel. Also during the fourth quarter of 2002, the Company entered into an agreement to terminate its headquarters facility lease by paying a lease termination fee of approximately $1.0 million. The lease termination fee was less than the Company had reserved for abandoned space in the accrued restructuring reserve; therefore, Applied recognized a net benefit of $351,000 in the restructuring charge in the fourth quarter of 2002 relating to the elimination of the reserve for abandoned space.

     The restructuring charges and related activity for the three months ended March 31, 2003 are as follows:

	Accrued Balance at December 31, 2002		Additional Charges		Amounts Paid or Charged Off, Net		Accrued Balance at March 31, 2003
Severance and related expenses	$	783	$	—	$	506	$	277
Abandoned facilities		96		—		69		27
	$	879	$	—	$	575	$	304

-8-

     As of December 31, 2002, the accrued restructuring liabilities consisted of accrued payroll of $775,000, accounts payable of $96,000, and other accrued expenses of $8,000. As of March 31, 2003, the accrued restructuring liabilities consisted of accrued payroll of $277,000, and accounts payable of $27,000.

6. Acquisition of REBA Technologies, Inc.

     In May 2002, the Company announced that it had completed the acquisition of REBA Technologies, Inc. (“REBA”). REBA’s patent-pending technology is focused on enhancing the operation of server farms for enterprises, application service providers and network service providers. The acquisition consideration consisted of an aggregate of approximately 350,000 shares of the Company’s common stock, valued at $315,000, plus an aggregate principal amount of $178,000 of promissory notes, due May 2004, and bearing interest at the rate of 6% annually. The Company did not acquire any personnel, tangible assets or known liabilities in the transaction. As a result of the acquisition, the Company recognized in-process research and development expenses of $621,000 in the second quarter of 2002, representing the entire purchase price (including transaction-related expenses).

     Because Lary L. Evans was a director of the Company at the time of the transaction and was the holder of approximately 86% of REBA’s outstanding shares, the negotiation of the terms of the acquisition was handled by an independent committee of the Company’s board of directors composed of disinterested directors. This committee engaged an independent valuation firm to provide a basis for negotiations, and ultimately recommended that the transaction be approved by the Company’s entire board of directors. Mr. Evans resigned from the board of directors on December 13, 2002, and has had no further involvement in the operations of the Company.

     At closing of the transaction, 50% of the merger consideration was placed into an escrow for the purpose of securing the indemnification obligations of the REBA shareholders under the merger agreement. Those shares and notes will remain in escrow for a period of three years from the closing date and until all pending claims for indemnification, if any, have been resolved. In a liquidation of Applied Microsystems, the Company would seek to sell the remaining corporate assets, including the intellectual property acquired in the REBA transaction. The sale of such intellectual property would, of necessity, also address the terms of the escrow agreement, including payment of merger consideration held in escrow.

7. Stock-Based Compensation

     The Company has the following shareholder-approved stock option plans that provide for option grants to employees, directors, and others: the Applied Microsystems Corporation 1992 Performance Stock Plan (the “1992 Plan”), the Applied Microsystems 2001 Stock Option Plan (the “2001 Plan”), and the Applied Microsystems Corporation Director Stock Option Plan (the “Director Plan”). The exercise price of options granted under these plans has been at fair market value on the date of grant. Options are not transferable, and expire no later than ten years following the grant date.

     As a result of the Company’s sale of its embedded systems development tools business and assets in November 2002, all vesting for stock options under the 1992 Plan and the 2001 Plan was accelerated so that all outstanding options under these plans were fully exercisable as of the closing of the transaction. Because all such unvested options had exercise prices substantially above the trading price of the Company’s common stock as of the closing of the transaction, no options were exercised as a result of the accelerated vesting, and all such options were subsequently terminated. The only options

-9-

that remain outstanding as of March 31, 2003 are those granted under the Director Plan; however, the Company’s board of directors has determined that such options will terminate effective as of the date that shareholders approve the liquidation of the Company.

     The following table illustrates the effect on net loss and loss per share if the Company had applied the fair value recognition provisions of SFAS 123 to its stock-based awards.

		Three Months Ended			Three Months Ended
		March 31,			March 31,
		2003			2002
		(in thousands)
	Net loss, as reported	$	(923	)	$	(1,212	)
	Total stock-based compensation expense determined under fair-value-based method		(34	)		(115	)
	Pro forma net loss	$	(957	)	$	(1,327	)
Net loss per share as reported		$	(0.12	)	$	(0.17	)
Pro forma net loss per share		$	(0.13	)	$	(0.18	)

8. Recent Accounting Pronouncements

     In June 2002, the FASB issued SFAS 146, “Accounting for Exit or Disposal Activities.” SFAS 146 addresses issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company’s current exit activities were initiated in 2002, and the Company is applying the guidance of Emerging Issues Task Force (“EITF”) 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS 146 is not expected to have a material impact on the Company’s financial statements because the Company does not expect to initiative future exit activities as a result of the Company’s liquidation plan.

-10-

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

     This quarterly report on Form 10-Q contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements include without limitation statements regarding our expectations and beliefs about the market and industry, our goals, plans, and expectations regarding our plans to liquidate the Company, our beliefs and expectations regarding our remaining corporate obligations (including indemnification obligations arising from the sale of our embedded systems development tools business and assets in November 2002), our beliefs and expectations regarding the timing and amount of any potential distribution to shareholders, our beliefs regarding period-to-period results of operations, our expectations regarding future financial results, our beliefs regarding our results of operation and financial position, our beliefs and expectations regarding liquidity and capital resources, and our expectations regarding the impact of recent accounting pronouncements. These statements are subject to risks and uncertainties that could cause actual results and events to differ materially from those anticipated. These risks and uncertainties include, without limitation, those identified in the section of this quarterly report on Form 10-Q entitled “Certain Factors That May Affect Future Results of Operations” below, and the section of our annual report on Form 10-K for the fiscal year ended December 31, 2002 entitled “Risk Factors That May Affect Future Results.” Applied undertakes no obligation to update forward-looking statements to reflect events or circumstances occurring after the date of this quarterly report on Form 10-Q.

     The following management’s discussion and analysis of financial conditions should be read in conjunction with management’s discussion and analysis of financial condition and results of operations included in our Annual Report on Form 10-K for the year ended December 31, 2002.

     As used in this quarterly report on Form 10-Q, unless the context otherwise requires, the terms “we,” “us,” “the Company,” and “Applied” refer to Applied Microsystems Corporation, a Washington corporation, and its subsidiaries.

Overview

     Applied Microsystems Corporation historically created solutions to expedite the development, test and deployment of business and safety-critical embedded systems. We developed, marketed and supported a comprehensive suite of software and hardware-enhanced development, test, and verification tools for the development of complex embedded microprocessor-based applications. Using these tools, engineers develop, test, debug, emulate and verify embedded software found in a wide variety of products, including voice and data communications networks, console games, avionics systems, automotive systems, medical devices, and consumer electronics.

     On November 1, 2002, we completed the sale of our embedded systems development tools business and assets to Metrowerks Corporation, a wholly owned subsidiary of Motorola, Inc. The purchase price was $3.9 million, which included payment for certain inventories and tangible assets, as well as all intellectual property related to our embedded systems development tools business. In addition, Metrowerks assumed certain customer warranty and support obligations. We received $3.4 million at closing, with the remaining $500,000 subject to a one-year holdback to secure certain indemnification obligations. Certain other indemnification obligations relating to our title to the assets sold, compliance with laws, and certain matters relating to taxes continue until the expiration of the statute of limitations applicable to claims with respect to such matters.

-11-

     With the sale of our historical revenue-generating assets completed, we had planned to pursue the development of new hardware and software products through our Libra Networks division. Libra Networks was formed as a result of our acquisition of REBA Technologies in May 2002. We planned to focus our Libra Networks development on delivering innovative technology that improves the way Web Services and other enterprise applications are managed in enterprise data centers.

     During the fourth quarter of 2002 we aggressively pursued funding for the Libra Networks business. Feedback from various funding sources produced consistent themes, including concern over Applied’s capital structure as a publicly held entity, concern over the timing and amount of Libra Networks’ projected funding needs, and varying levels of interest in Libra Networks’ overall market opportunity. We also noted a softening in market projections for the adoption of InfiniBand technology in the data center, on which the Libra Networks technology is based.

     As a result, our board of directors concluded that there was a low probability that Libra Networks could achieve timely and sufficient funding to reasonably support its business plan. Therefore, on December 16, 2002, we announced that our board of directors had unanimously decided to recommend to shareholders that Applied be liquidated. Liquidation of a corporation is a complex process, and requires a shareholder vote and presents other complexities, with significant uncertainties surrounding the timing and amount of any distribution to shareholders.

     Since December 16, 2002, we have taken steps to reduce our expenses, to prepare our Libra Networks assets for sale, and to prepare a proxy statement and related materials in connection with submitting the proposal to liquidate and dissolve Applied to our shareholders for vote at a meeting of shareholders. We scheduled a shareholder meeting for April 30, 2003 to consider and vote on the proposed dissolution and liquidation; however, a quorum was not present at the meeting, and we adjourned the meeting until May 22, 2003. We have reduced our workforce from 33 full-time personnel on December 16, 2002, to two remaining administrative personnel and no remaining development personnel as of April 30, 2003. In an effort to further trim expenses, in the fourth quarter of 2002, we entered into an agreement to terminate our headquarters facilities lease. We paid an early termination fee of approximately $1 million to Teachers Insurance & Annuity Association of America, the landlord under the lease, in exchange for termination of any further obligations under the lease. In December 2002, we entered into an agreement to sublease approximately 7,200 square feet in Redmond, Washington, and took possession of the premises later that month. On February 27, 2003, we provided notice of our intent to terminate the sublease in Redmond as of March 31, 2003. We then secured needed office facilities, consisting of approximately 650 square feet, in the Redmond area on a monthly rental basis.

     If shareholders approve the liquidation of Applied and the Plan of Liquidation and Dissolution (the “Plan of Dissolution”), we will file articles of dissolution with the Secretary of State of the State of Washington promptly after the shareholder vote, and attempt to convert our remaining assets, including our Libra Networks assets, into cash and settle our liabilities as expeditiously as possible. Some or all of our assets may be held in a contingency reserve for the satisfaction of certain liabilities.

     On September 16, 2002, our common stock was transferred from the Nasdaq National Market to the Nasdaq SmallCap Market. Our common stock was involuntarily delisted from the Nasdaq SmallCap Market effective as of the opening of business on January 3, 2003, as a result of our failure to meet the minimum required bid price, market value of public float, and shareholders’ equity requirements for continued listing on the SmallCap Market, and our common stock has been quoted on the OTC Bulletin Board since January 3, 2003.

-12-

Critical Accounting Policies and Estimates

     This discussion and analysis of financial condition and results of operations are based upon our 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 us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosure of contingent assets and liabilities. On an on-going basis, we evaluate our critical accounting policies and estimates, including those related to accounting for the sale of our embedded systems development tools assets and business in November 2002, our plans announced December 16, 2002 to seek shareholder approval to pursue a corporate liquidation, revenue recognition, inventories, accounting for acquisitions such as the May 2002 REBA acquisition, and restructuring activities. We base our estimates and our future expectations on historical experience and on various other assumptions that we believe 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.

     We believe the following accounting policies are the most critical to aid in fully understanding and evaluating our more significant judgments and estimates used in the preparation of our consolidated financial statements.

     Sale of embedded systems development tools assets and business. Effective November 1, 2002, we completed the sale of our embedded systems development tools business and assets to Metrowerks. We accounted for the sale by removing sold assets and assumed liabilities at their corresponding carrying amounts on the closing date, recognizing the cash proceeds, recognizing the $500,000 holdback receivable, recognizing the corresponding transaction expenses (either as a reduction in previously capitalized transaction expenses, or as a liability for yet-to-be-paid items), and making other transaction-related adjustments as deemed appropriate in the circumstances. As a result, we recognized a net gain on the transaction.

     Our policies with regard to accounting and presentation are based on Statement of Financial Accounting Standards (“SFAS”) No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets.” The long-lived corporate assets relating to the Company’s embedded systems development tools business meet the criteria of long-lived assets to be disposed of by sale, as defined in SFAS 144. Most such assets were sold prior to the end of the year, either in the sale to Metrowerks or through an auction held December 10, 2002 at our former corporate headquarters facility.

     Corporate liquidation. On December 16, 2002, we announced that our board of directors had unanimously decided to recommend to shareholders that Applied be liquidated. Our critical accounting policies with regard to this announced plan to seek liquidation are based on guidance from Emerging Issues Task Force (“EITF”) 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” Therefore, as of March 31, 2003, we have accrued certain costs relating to employee severance and related benefits, as well as other expenses to terminate our business activities. Ongoing expenses to operate the business during the wind-down are treated as period expenses and were not accrued as of March 31, 2003. In June 2002, the FASB issued SFAS 146, “Accounting for Exit or Disposal Activities.” SFAS 146 addresses issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities. SFAS 146 is effective for exit or disposal

-13-

activities that are initiated after December 31, 2002. Our current exit activities were initiated in 2002, and we are applying the guidance of EITF 94-3.

     We also determined that, under the provisions of SFAS 144, many of our remaining fixed assets as of the end of 2002 were impaired. We therefore recognized an impairment loss and wrote down our fixed assets to fair value, in accordance with SFAS 144. No further impairments were recognized in the three months ended March 31, 2003.

     Although we have announced our intent to seek corporate liquidation, such liquidation requires that we obtain shareholder approval, which is not assured. Therefore, our consolidated financial statements for all periods presented have been prepared in accordance with accounting principles generally accepted in the United States of America, and not specifically on the liquidation basis of accounting.

     Revenue recognition. We historically earned revenue on the sale of hardware and software products. We also earned revenue on the sale of services, including hardware and software support, installation, training, and professional engineering services. Revenue from the sale or licensing of products was recognized when persuasive evidence of an arrangement existed, delivery of the product had occurred, the fee was fixed or determinable, and collectibility was probable. If the fee due from a customer was not fixed or determinable, revenue was recognized as payments became due from a customer. If customers had inspection or acceptance rights beyond standard warranty provisions, revenue was recognized when formal notification of inspection or acceptance had been received from the customer. Due to business customs in Japan and our interpretation of Japanese law, product sales in Japan were recognized when the customer notified us that it had inspected and accepted the product. In the absence of receiving written notification of inspection and acceptance, we recognized revenue in Japan on receipt of payment by the customer as an indication of acceptance. When products were sold with significant installation services, all revenue was deferred until installation was completed. Revenue from training and contract engineering services was generally recognized as the services were performed. Revenue from longer-term agreements to perform development services was recognized under the percentage-of-completion method, measured based on labor effort or cost incurred to total estimated labor effort or cost (assuming other revenue recognition criteria were met).

     Inventories. We wrote down our inventories for estimated obsolescence or unmarketable inventories equal to the difference between cost and the estimated net realizable value based on assumptions about future demand and market conditions. Changes in those underlying assumptions – including the impact of the November 2002 asset sale – also resulted in additional write-downs of inventories. While inventories have historically been a material component of our financial statements, we had no remaining inventories by the end of 2002 because all inventories had been sold or otherwise disposed of prior to the end of 2002.

     Acquisitions. In May 2002, we announced our acquisition of REBA Technologies, Inc. Applied does not have a history of acquiring companies; therefore, the accounting policies relating to acquisitions depend on the facts and circumstances of the specific transaction. In this case, we assessed the proper allocation of the purchase price in light of the circumstances and determined that the entire purchase consideration be allocated to in-process research and development, based primarily on the fact that we acquired patent-pending technology (and we acquired no other significant tangible or intangible assets).

     Restructuring activities. In the third quarter of 2001, we implemented a restructuring plan designed to reduce operating costs. Again in the second quarter of 2002, we implemented further cost

-14-

reductions. These restructuring plans included reductions in full-time employees worldwide across our functional organizations; discontinuance or reallocation of selected projects and activities not essential to our long-term goals; abandonment of excess space at our headquarters; as well as other cost reduction and control measures. In the fourth quarter of 2002, after announcing plans to seek shareholder approval for corporate liquidation, we recognized further restructuring charges associated with severance and benefits for remaining personnel. We used estimates to establish accruals in connection with the restructuring plans, particularly with regard to our contractual lease obligations for abandoned facilities, and the timing and market rates that may be available if we successfully sublease the excess space. In October 2002 we signed a lease termination agreement with the landlord of our headquarters facility whereby we paid an early termination fee of approximately $1 million to the landlord in exchange for the termination of any further obligations under the lease.

Results of Operations

		Three Months Ended March 31,
		2003			2002
		(in thousands)
Net sales		$	—		$	4,865
Cost of sales			—			1,795
Gross profit		$	—			3,070
Operating expenses:
	Sales, general and administrative		685			2,655
	Research and development		300			1,656
	Total operating expenses		985			4,311
Loss from operations			(985	)		(1,241	)
Interest income and other, net			62			29
Net loss		$	(923	)	$	(1,212	)

     Net Sales. Prior to the November 2002 sale of our embedded systems development tools business and assets, our revenues could be classified into three broad categories: hardware-enhanced debugging tools, software analysis tools, and game development systems. The following table provides revenue information for each of these categories.

		Three Months Ended		Three Months Ended
		March 31,		March 31,
(in thousands)		2003		2002
Hardware-enhanced debugging tools		$	—	$	1,629
Software analysis tools			—		1,613
Game development systems			—		1,623
	Total net sales	$	—	$	4,865

     Net sales decreased to zero in 2003 due to the sale of the Company’s embedded systems development tools business and assets in November 2002. Our net sales formerly included product

-15-

support revenues, which are included within the aforementioned major categories of our products. These support revenues totaled approximately $600,000 in the three months ended March 31, 2002. International sales were 28% of net sales in the first quarter of 2002.

     Cost of Sales and Gross Profit. Gross profit was 63% of net sales in the three months ended March 31, 2002. Cost of sales included materials, labor and overhead incurred in the manufacturing of products as well as the cost of providing professional services, performing non-recurring engineering, and estimated warranty costs. We performed periodic assessments of required reserves for potential inventory obsolescence, and corresponding adjustments to such reserves were included within cost of sales.

     Sales, General and Administrative Expenses. Sales, general, and administrative expenses decreased $2.0 million, or 74%, in the three months ended March 31, 2003, as compared to the three months ended March 31, 2002. The decrease was primarily the result of our November 2002 sale of our embedded systems development tools business and assets, the correspondingly significantly lower personnel and infrastructure levels that have resulted after the sale, and further cost-cutting relating to our Libra Networks business and decision to seek corporate liquidation. As of April 30, 2003, we employ two full-time administrative personnel, and we maintain 650 square feet of office space on a monthly rental basis; however, we anticipate that we will incur various ongoing and additional costs in the future as we implement our plans to liquidate the corporation.

     Research and Development Expenses. Research and development expenses decreased $1.4 million, or 82%, in the three months ended March 31, 2003, as compared to the three months ended March 31, 2002. The decrease was primarily the result of our November 2002 sale of our embedded systems development tools business and assets, the correspondingly significantly lower personnel and infrastructure levels that have resulted from the sale, and further cost-cutting relating to our Libra Networks business. During a portion of the first quarter of 2003, we worked to complete documentation and otherwise prepare the Libra Networks intellectual property for sale. As of April 30, 2003, we do not have a buyer for such intellectual property.

     Interest Income and Other, Net. Interest income and other, net, increased $33,000, or 114%, in the three months ended March 31, 2003, as compared to the three months ended March 31, 2002. The amount in the first quarter of 2003 includes $50,000 relating to a patent licensing fee that had been negotiated prior to the sale of our embedded systems development tools business and assets, but for which payment was uncertain. We recognized the amount in the first quarter of 2003 because we received a significant portion of the outstanding balance. Absent the license fee, interest income and other, net, decreased due to lower cash balances available for investment purposes.

Income Taxes

     Applicable accounting standards require that we calculate an estimated annual effective tax rate and apply such tax rate to the pre-tax operating results of interim periods. Deferred income taxes reflect the net tax effects of temporary differences between the tax basis of assets and liabilities and the corresponding financial statement amounts. Due to the uncertainty of our ability to utilize our net deferred tax assets, including our net operating losses and research and development credits, a valuation allowance has been established for financial reporting purposes equal to the amount of the net deferred tax assets. Accordingly, no income tax provision or benefit is recorded for the three-month periods ended March 31, 2003 and 2002.

-16-

Liquidity and Capital Resources

     As of March 31, 2003, we had $2.2 million in cash, cash equivalents, and short-term investments compared to $3.9 million as of December 31, 2002. If shareholders approve our plan to liquidate the Company, we would no longer require capital for the financing of inventories and accounts receivable, sales and marketing efforts, product development activities, and capital equipment purchases. Rather, we would expect to use the remaining cash to wind-down operations, satisfy our known and unknown obligations and, if cash is available, distribute remaining amounts to shareholders. As part of the agreement to sell our embedded systems development tools business, we agreed to indemnify Metrowerks for specified items – $500,000 of the agreed-upon purchase price was held back to secure certain of these indemnification obligations, and this amount is due to be received in November 2003. Certain other indemnification obligations relating to our title to the assets sold, compliance with laws, and certain matters relating to taxes continue until the expiration of the statute of limitations applicable to claims with respect to such matters. These indemnification obligations, other known or unknown obligations, the actual cost of meeting legal and regulatory requirements in the United States and in other jurisdictions to liquidate Applied’s legal entities, and other factors are expected to affect the timing and/or the amount of any distribution to shareholders.

     We used cash of $1.7 million for operating activities in the first three months of 2003, compared to using $1.0 million for operating activities in the first three months of 2002. Investing activities provided $0.3 million in cash in the three months ended March 31, 2003, compared to our using $39,000 for investing activities in the three months ended March 31, 2002.

     We received no funds in the first three months of 2003 from the sale of our common stock to personnel through an employee stock purchase plan and the exercise of employee stock options, compared to receiving $47,000 in the first three months of 2002. We do not anticipate future funds from this source.

     We believe that our existing working capital will provide us with sufficient funds to effect an orderly liquidation, if our shareholders approve a corporate liquidation; however, the timing and amount of any distribution to shareholders is subject to significant uncertainty. If we are unable to effect an orderly liquidation, we could be required to seek protection under the laws of bankruptcy. Our stock is currently quoted on the OTC Bulletin Board, and we do not believe we could successfully raise additional funds under our corporate circumstances, either through a debt or equity offering.

Accounting Pronouncements

     In June 2002, the FASB issued SFAS 146, “Accounting for Exit or Disposal Activities.” SFAS 146 addresses issues regarding the recognition, measurement, and reporting of costs that are associated with exit and disposal activities, including restructuring activities. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company’s current exit activities were initiated in 2002, and the Company is applying the guidance of Emerging Issues Task Force (“EITF”) 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring).” SFAS 146 is not expected to have a material impact on the Company’s financial statements because the Company does not expect to initiative future exit activities as a result of the Company’s liquidation plan.

-17-

Certain Factors That May Affect Future Results of Operations

     Our actual results may differ materially from those anticipated due to a variety of factors, including those set forth in the following risk factors and elsewhere in this document. We will not update any forward-looking statements due to new information, future events or otherwise.

Risks Related to the Plan of Dissolution

If our shareholders do not approve the voluntary liquidation and dissolution of Applied, we will not have the resources to continue operations without seeking additional capital, which we believe will be very difficult to obtain, and our resources may diminish completely.

     We have limited cash resources, and these resources continue to diminish. We recorded a net loss of nearly $1 million and consumed $1.7 million of our cash in operating activities during the first three months of 2003. We expect that our cash resources will continue to diminish. If our shareholders do not approve the Plan of Dissolution, our board of directors will determine an appropriate course of action, which could include continuing to preserve our Libra Networks assets and technology and continue to seek financing for our Libra Networks business or a sale of our Libra Networks assets and technology, using a minimum of our resources until our resources are completely depleted. Considering our recent financial performance and the difficulty we have had in obtaining financing, it is unlikely that we would be able to obtain additional equity or debt financing. If we were to be unable to obtain sufficient capital, we would deplete our available resources and would be required to discontinue operation of our business.

We might not be able to sell certain of our assets or to receive reasonable value from the sale of our assets.

     The value that shareholders ultimately realize as a result of the sale of our assets and the liquidation of Applied is dependent in part on the proceeds received from the sale of the assets or other disposition of our operating assets. Our assets include certain technology and intellectual property for which we may not be able to find a buyer. Despite our ongoing efforts to sell our Libra Networks assets and technology and certain other intellectual property, we currently do not have a buyer for these assets. We may be unable to sell certain of our assets and may not realize any value from these assets. In addition it may be difficult to obtain a favorable return when selling our operating assets in connection with the liquidation and dissolution of Applied. Because we are seeking to consummate the liquidation of our operating assets in the near to short term in order to minimize the losses associated with operating Applied, we may not realize as much value for these assets as we might have if we had been able to sell our business as a going concern.

     We do not plan to obtain a fairness opinion with respect to the sale of our Libra Networks technology and assets; therefore, we cannot assure shareholders that the price we may negotiate for these assets is the best possible price we could obtain. While we will attempt to obtain the best price in connection with the sale of our Libra Networks technology and assets, there can be no assurance that the value we realize from the sale of these assets will reflect the potential future value of these assets.

     The timing of liquidating payments and total value shareholders receive upon liquidation is subject to many variables and risks, many of which will not be known at the time of the vote.

     Shareholders may receive distributions from us or a liquidating trust, as the case may be, the timing of which will be at the discretion of management or the trustee or trustees, unless it is

-18-

determined that any such distribution would be inconsistent with the purposes of the Plan of Dissolution. The distribution of our assets to shareholders may be delayed for a number of reasons, including the risk that one or more of our creditors might seek an injunction against our making the proposed distributions to shareholders under the terms of the Plan of Dissolution. The value of what shareholders receive will be a product of various factors and risks, including the proceeds received from the sale or other disposition of our operating assets, and the amount of Applied’s actual and potential liabilities. If our liabilities prove to be higher than anticipated, additional creditors appear, or legal action is brought against us by creditors or others, it is possible that the planned distribution to shareholders could be delayed or reduced, or there could be nothing remaining available for distribution to shareholders.

Shareholders could be liable under Washington law to return some or all of the cash they may receive from us if we do not provide for all of our liabilities and expenses.

     Washington law provides that we can dispose of any known claims against us by providing written notice to our known creditors of the planned dissolution of Applied, and paying or making adequate provision for the debts of the company within the time allowed by law. However, an unpaid creditor or a creditor that was not known to us can still, within two years of our dissolution, bring a lawsuit against Applied and its former shareholders for any amount unpaid. All shareholders who receive proceeds from the liquidation may be liable to a creditor who has a valid claim that exceeds the amount retained by us or the liquidating trust for the purpose of settling claims, up to the amount they received in the liquidation.

We may be required to pay up to $3.3 million to Metrowerks Corporation, a Texas corporation that is a wholly-owned subsidiary of Motorola, Inc., for potential breaches of our representations in the asset purchase agreement dated as of September 3, 2002.

     Under the terms of the asset purchase agreement that we entered into on September 3, 2002, we have an obligation to indemnify Metrowerks for any losses from potential breaches of our representations or warranties that are asserted within 12 months after the closing date of the asset sale or within the applicable statute of limitations period for claims relating to our ownership of our assets, payment of our taxes, and our compliance with applicable laws, if longer. Our indemnification obligations are limited to an overall amount of $3.3 million. Although we currently are not aware of any material breaches of our representations or warranties, the payment of any such indemnification obligations would decrease the amount of cash we would have available to distribute to shareholders in the liquidation.

Risks Related to Applied’s Continuing Business Operations

     If the Plan of Dissolution is not approved by our shareholders, we would face the following risks and uncertainties in connection with continuing to pursue our Libra Networks business.

We do not have any immediate source of revenue and we expect to incur significant losses for an indefinite period of time.

     Our Libra Networks business involves the development of a new and as yet unreleased product line with no market penetration in a highly competitive market sector typified by rapid changes in technology and competitive products. We do not expect our Libra Networks business to produce any revenues in the near term, and if we were to continue pursuing the Libra Networks business, we would expect to operate at a loss until at least 2004. We cannot predict when or to what extent Libra Networks might begin to produce revenues, or whether it would ever reach profitability. If we were unable to

-19-

achieve significant levels of recurring revenue from our Libra Networks business, our losses would likely continue indefinitely. If this were to occur the market price of our common stock could suffer as well as our viability as a going concern.

Due to our lack of available resources, and to preserve available resources to satisfy our liabilities, we have terminated a significant number of our personnel and therefore have limited ability to pursue the Libra Networks business.

     Due to our lack of available resources to fully pursue the Libra Networks business plan, we have terminated a significant number of our staff, including Libra development personnel and senior management who would be critical to the success of the Libra business. As of April 30, 2003, we had two remaining administrative personnel, and no remaining development staff. Libra’s success depends to a significant degree on our ability to attract and retain highly skilled and experienced technical, managerial, sales and marketing personnel. There can be no assurance that we would be successful in recruiting new personnel or in retaining existing personnel. Our inability to attract additional qualified employees would have a material adverse effect on our business, results of operations and financial condition.

We do not have sufficient working capital to fund our Libra Networks business, and we believe it is likely that we would be unable to obtain additional capital. If we raise additional financing, shareholders may suffer significant dilution.

     If the Plan of Dissolution is not approved, we would need to seek a third party investment as soon as possible in order to provide additional working capital for our Libra Networks business. We have previously contacted more than 30 potential funding sources, but have received overall negative feedback from these funding sources, including concern over our capital structure as a publicly held entity, concern over the timing and amount of our projected funding needs, and the size and timing of our overall market opportunity.

     We expect the funding climate to remain difficult, and we cannot be certain that financing from third parties will be available on acceptable terms to us or at all. The extent and timing of our future capital requirements would depend upon several factors, including the rate of market acceptance of our products, the degree of competition for our products, our ability to build and expand an efficient indirect distribution system, and our level of expenditures for product development, sales and marketing. If we are unable to raise funds on acceptable terms, we may not be able to develop our products and services, take advantage of future opportunities or respond to competitive pressures or unanticipated requirements, any of which would have a material adverse effect on our ability to establish a viable business. Further, if we were to issue equity securities, shareholders would experience severe dilution of their ownership percentage, and the new equity securities may have rights, preferences or privileges senior to those of our common stock.

The emergence of InfiniBand, the switch fabric communication technology that is planned to be incorporated in our initial Libra Networks product release, as a worldwide standard is uncertain.

     Our initial Libra Networks products are being developed using InfiniBand architecture. We believe that InfiniBand is currently the only new Switch Fabric technology currently available for widespread usage. In 2002, Microsoft and Intel each announced that they will limit further investments in InfiniBand-based products. Specifically, Intel announced that it would stop developing host channel adapter chips for InfiniBand; and Microsoft stated that it no longer plans to incorporate InfiniBand into

-20-

its next-generation server operating system, the Windows.Net Server, although it will continue to assist companies offering InfiniBand products that plug into Microsoft products. These announcements have created doubt regarding the feasibility and likelihood of InfiniBand’s acceptance as the worldwide standard for server-to-server, and network-to-server interconnect solutions. If InfiniBand is not accepted as a standard in the marketplace, our planned products would have to be redesigned to operate under a different architecture, and delays in product releases and slower revenue growth would be likely. Industry analysts have recently published adverse revisions to their earlier projections for market adoption of InfiniBand switch fabric technology, on which Libra Networks’ contemplated products were initially to be based.

We are dependent on a single line of business that currently has no products or revenues. We cannot predict our future results because our Libra Networks business has no operating history.

     Our only remaining line of business is the development of the Libra Networks products and technology. We have not yet developed any products based on this technology and consequently there are currently no revenues from this line of business. Furthermore, we do not know whether any products will be developed on this technology or the timing of such developments if a product is created. Given the lack of operating history in the Libra Networks business it is difficult to predict our future results. The Libra Networks business is characterized by rapid technological change, new product development, a new and unproven business model, and evolving industry standards. Shareholders should consider the risks and uncertainties that we may encounter as a pre-revenue-stage company in a new and rapidly evolving market. These uncertainties include:

• our ability to design and engineer products having the technological features planned for the Libra Networks product line;

• consumer demand for, and acceptance of, the Libra Networks business products;

• our ability to establish relationships with OEMs, VARs, system integrators and other channel partners needed to drive sales;

• our ability to demonstrate the benefits of our products and services to end user data center managers;

• our unproven and evolving business model;

• unfavorable economic conditions in the technology industry;

• decreased spending on technology due to adverse economic conditions; and

• global economic conditions.

Our Libra Networks technology and products are not fully developed, are untested, and remain subject to significant uncertainty. Rapid technological change could render our products and services obsolete.

     Our Libra Networks technology and products are in the development stage and have not been completed or proven. The market for products related to data management is characterized by rapid technological innovation, sudden changes in user and customer requirements and preferences, frequent new product and service introductions and the emergence of new industry standards and practices. Each of these characteristics could render our Libra Networks products, intellectual property and systems obsolete. The rapid evolution of our market requires that we improve continually the performance, features and reliability of our products and services, particularly in response to competitive offerings. The successful development of our products is subject to the risks that:

-21-

• any or all of our proposed products are found to be ineffective for their intended purposes;

• the proposed products or procedures are uneconomical to manufacture or market or do not achieve broad market acceptance;

• third parties hold proprietary rights that preclude us from marketing them; or

• third parties market a superior or equivalent product.

     Significant undetected errors or delays in new products or releases may affect market acceptance of our products. There can be no assurance that, despite our testing, errors would not be found in new products or releases after commencement of commercial shipments, resulting in loss of customers or failure to achieve market acceptance.

     In addition, our Libra Networks technology and products would need to be compatible with a broad array of disparate technologies in order to be interoperable with other products routinely used in corporate data centers such as routers, switches, operating systems and systems management software. This interoperability may depend on partnerships with third parties such as Cisco, Dell, IBM, Sun, BEA, BMC and Microsoft. We currently do not have any partnerships with such third parties. Without such partnerships, we would likely not be able to achieve market acceptance or demand for our products within our target base of customers, because our products would not operate with many of the applications they currently use.

Our Libra Networks business would have to rely on third parties to provide certain components and software for its products. If our vendors were to fail to deliver their products in a reliable, timely and cost-efficient manner, our business would suffer.

     Our Libra Networks business would depend upon relationships with third parties who may be sole source providers of key, leading-edge hardware and software components critical for some of the products being developed by our Libra Networks business. If these providers of exclusive proprietary technology do not produce these components or software modules on a timely basis or if the components or software modules do not meet our specifications or are otherwise flawed, we may have to delay product delivery, recall or replace unacceptable products. As a result, we could lose existing and potential customers and any revenues that we may have at that time may decline dramatically.

We may not be able to meet our product development objectives or market expectations.

     Our Libra Networks product development efforts are inherently difficult to manage and keep on schedule and there can be no assurance that we would be able to meet our development objectives or to meet market expectations. In addition to development delays, we may experience substantial cost overruns in completing development of our products. The technological feasibility for some of the products that we envision is not completely established. We may be unable, for technological or other reasons, to develop and introduce products in a timely manner in response to changing customer requirements. Further, there can be no assurance that while we were attempting to finish development of our products, a competitor might not introduce similar products thus diminishing our technological advantage, or a superior alternative to ours, rendering our products and technologies partially or wholly obsolete, or at least requiring substantial re-engineering in order to become commercially acceptable. Our failure to maintain our product development schedules, avoid cost overruns and undetected errors or introduce a product that is superior to competing products would have a materially adverse effect on our business, financial condition and results of operations.

-22-

We may not be able to successfully compete in the highly competitive and rapidly evolving data center management market.

     The market for products that enhance the speed, capacity and efficiency of enterprise data centers is still developing, and there can be no assurance that our products would ever achieve market acceptance. Since we have no existing customers with respect to the Libra Networks business, we would need to convince enterprise corporate data center managers that have no history of buying products from us to buy Libra Networks products, including additional follow-on products or product updates. To the extent we do not achieve growth, it would be difficult for us to generate meaningful revenue or to achieve profitability.

     The market for data center management products is intensely competitive, evolving and subject to rapid technological change. The competition for Libra Networks’ planned suite of products would likely come from three types of competitors:

• manufacturers of existing load-balancing switches, such as F5 Networks, Inc., Cisco Systems Inc., Extreme Networks, Inc., and Foundry Networks, Inc.;

• vendors of TCP/IP-to-InfiniBand gateways, such as Voltaire, Inc., and TopSpin Communications, Inc.; and

• companies offering load-balancing capabilities for Web Services standards, such as Sarvega, Inc., DataPower Technology, Inc. and Forum Systems, Inc.

     Some of our current and potential competitors have longer operating histories, significantly greater financial, technical, marketing and other resources, significantly greater name recognition and a substantially larger installed base of customers than we do. We expect the intensity of competition in this market to increase in the future. Increased competition is likely to result in price reductions, and may result in reduced or negative margins and difficulty in gaining market share. Any of these effects could seriously harm our business.

We may not be successful in developing or maintaining strong distribution channels for our Libra Networks products.

     The success of the Libra Networks business depends on developing strong OEM relationships with system vendors who are selling servers and other network management equipment and technologies to end-users. The Libra business plan would rely primarily on OEM relationships to initially market our Libra Networks products, although our OEM sales would be expected to be augmented by a direct sales force working closely with indirect channel partners such as value-added resellers and other resellers and integrators. If we were not successful in creating a strong national distribution channel in a timely manner, we may not gain significant sales.

We may not be able to protect intellectual property of our Libra Networks business against third-party infringements or claims of infringement.

     Failure to protect our intellectual property rights may result in a loss of our exclusivity or the right to use our Libra Networks technology. We rely on patent, trade secret, trademark and copyright law to protect our Libra Networks intellectual property. Our patent position is subject to complex factual or legal issues that may give rise to uncertainty as to the validity, scope and enforceability of a particular patent. Accordingly, there can be no assurance that any patents will be issued pursuant to our current or

-23-

future patent applications or that patents issued pursuant to such applications will not be invalidated, circumvented or challenged. Moreover, there can be no assurance that the rights granted under any such patents will provide competitive advantages to us or be adequate to safeguard and maintain our proprietary rights. In addition, effective patent, trademark, copyright and trade secret protection may be unavailable, limited or not applied for in certain foreign countries.

     Although patent applications have been filed with respect to certain aspects of our Libra Networks technology, some of our Libra Networks intellectual property is not covered by any patent or patent application and includes trade secrets and other know-how that is not patentable. We also seek to protect our proprietary intellectual property, including intellectual property that may not be patented or patentable, in part by confidentiality agreements and, if applicable, inventor’s rights agreements with our current and future strategic partners and employees. We cannot assure you that these agreements will not be breached, that we will have adequate remedies for any breach or that such persons or institutions will not assert rights to intellectual property arising out of these relationships.

     Some of our Libra Networks intellectual property includes technologies and processes that may be similar to the patented technologies and processes of third parties. If we do not adequately assure our freedom to use our Libra Networks technology, we may have to pay others for rights to use their intellectual property, pay damages for infringement or misappropriation or be enjoined from using such intellectual property.

We would be dependent on third parties for manufacturing our Libra Networks products.

     We have yet to develop a manufacturing plan for Libra Networks products. However, we would expect to rely on one or more third party manufacturers for our manufacturing needs. We may be unable to engage a third party manufacturer on a timely basis or on terms favorable to us which could limit our ability to sell our products and generate revenues. Furthermore, the failure of such third party manufacturers to deliver products to us in a timely manner or in accordance with our quality control standards could damage our reputation and could adversely affect our operating results.

Our common stock currently trades on the OTC Bulletin Board; if shareholders approve our plan to dissolve and liquidate the Company, then it is likely that we will close our transfer books and restrict transfers of our common stock – shareholders would experience a lack of liquidity as a result.

     Our common stock was transferred from the Nasdaq National Market to the Nasdaq SmallCap Market effective as of September 16, 2002. Our common stock was involuntarily delisted from the Nasdaq SmallCap Market effective as of the opening of business on January 3, 2003, as a result of our failure to meet the minimum required bid price, market value of public float, and shareholders’ equity requirements of the SmallCap Market, and our common stock has been quoted on the OTC Bulletin Board since January 3, 2003. As part of our liquidation plan, we may close our stock transfer books and the prices of our common stock would cease to be quoted on the OTC Bulletin Board, and shareholders would experience a lack of liquidity as a result.

-24-

Item 3. Quantitative and Qualitative Disclosures About Market Risk

     We are exposed to market risk related to changes in interest rates, which could adversely affect the value of our short-term investments. We maintain a short-term investment portfolio consisting of interest bearing securities with an average maturity of less than one year. Certain of these securities may be classified as “available-for-sale” securities, though no such securities met that classification as of March 31, 2003. These interest-bearing securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly to 110% of their levels at March 31, 2003, the fair value of the portfolio would decline by an immaterial amount. We do not expect our operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates.

Item 4. Controls and Procedures

     (a)  Under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, we conducted an evaluation of our disclosure controls and procedures, as such term is defined under Rule 13a-14(c) promulgated under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), within 90 days of the filing date of this report. Based on their evaluation, our principal executive officer and principal accounting officer concluded that our disclosure controls and procedures are effective.

     (b)  There have been no significant changes (including corrective actions with regard to significant deficiencies or material weaknesses) in our internal controls or in other factors that could significantly affect these controls subsequent to the date of the evaluation referenced in paragraph (a) above.

-25-

PART II — OTHER INFORMATION

Item 6. Exhibits and Reports on Form 8-K

(A)	The following exhibits are filed as part of this report.
99.1	Certification of Chief Executive Officer
99.2	Certification of Chief Financial Officer
(B)	Reports on Form 8-K
	We filed a report on Form 8-K dated February 20, 2003, in which we provided additional information on our tentative liquidation timeframe and other measures taken to reduce our expenses.
	We filed a report on Form 8-K dated April 30, 2003, in which we disclosed that the special meeting of shareholders scheduled for April 30, 2003 has been adjourned until May 22, 2003.

SIGNATURES

     Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

		APPLIED MICROSYSTEMS CORPORATION (Registrant)
Date:	May 14, 2003	By:	/s/ Robert C. Bateman
			Robert C. Bateman Vice President, Chief Financial Officer, Secretary and Treasurer (Principal Financial and Accounting Officer and Duly Authorized Signing Officer)

-26-

Section 302(a) Certifications

I, Robert C. Bateman, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Applied Microsystems Corporation;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 14, 2003

/s/ Robert C. Bateman Robert C. Bateman
Vice President, Chief Financial Officer,
Secretary and Treasurer

-27-

I, Stephen J. Verleye, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of Applied Microsystems Corporation;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:

a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent functions):

a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: May 14, 2003

/s/ Stephen J. Verleye Stephen J. Verleye
President and Chief Executive Officer

-28-