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

~~[X]~~For ~~Quarterly report pursuant to Section 13 or 15(d) of~~ the ~~Securities~~quarterly ~~Exchange~~period ~~Act~~ended ofJune 30, ~~1934~~2003

For the quarterly period ended September 30, 2002


[ ]		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 (State of incorporation) 91-1074996 (I.R.S. Employer Identification Number)


Washington		91-1074996
(State of incorporation)		(I.R.S. Employer Identification Number)

~~5020~~16770 ~~148th~~NE ~~Avenue~~79th ~~N.E.~~Street, #103, Redmond, Washington 98052~~-5172~~ (425) ~~882~~883-~~2000~~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 [ ]

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

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

Common stock, $.01 par value: 7,597,303 shares outstanding as of ~~November~~July 431, ~~2002~~ 2003.

TABLE OF CONTENTS

PART I — FINANCIAL INFORMATION
	Item 1. Financial Statements
		CONSOLIDATED BALANCE SHEETS
		CONSOLIDATED STATEMENT OF NET ASSETS IN LIQUIDATION AS OF JUNE 30, 2003, AND CONSOLIDATEDBALANCE SHEET AS OF DECEMBER 31, 2002
		CONSOLIDATED STATEMENTS OF OPERATIONS
		CONSOLIDATED CHANGES IN NET ASSETS IN LIQUIDATION FOR THE PERIODS ENDEDJUNE 30, 2003, AND CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE PERIODS ENDED JUNE 30, 2002
		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
PART II - OTHER INFORMATION
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
Section 302(a) Certifications
EXHIBIT 31.1
EXHIBIT 99.1
EXHIBIT 31.2
EXHIBIT 99.2
EXHIBIT 32.1
EXHIBIT 32.2

APPLIED MICROSYSTEMS CORPORATION

FORM 10-Q

QUARTER ENDED ~~SEPTEMBER~~JUNE 30, ~~2002~~2003

INDEX

		~~Page~~	Page
PART I:	~~FINANCIAL INFORMATION~~	FINANCIAL INFORMATION
Item 1.	~~Financial Statements:~~	Financial Statements:
	Consolidated Balance Sheets as of September 30, 2002 (unaudited) and December 31, 2001	3
		Consolidated Statement of Net Assets in Liquidation as of June 30, 2003 (unaudited), and Consolidated Balance Sheet as of December 31, 2002		3
	Consolidated Statements of Operations for the three months and nine months ended September 30, 2002 and 2001 (unaudited)	4
		Consolidated Changes in Net Assets in Liquidation for the three months and six months ended June 30, 2003, and Consolidated Statements of Operations for the three months and six months ended June 30, 2002 (unaudited)		4
	Consolidated Statements of Cash Flows for the nine months ended September 30, 2002 and 2001 (unaudited)	5
		Consolidated Statements of Cash Flows for the six months ended June 30, 2003 and 2002 (unaudited)		5
	~~Notes to Consolidated Financial Statements (unaudited)~~	6Notes to Consolidated Financial Statements (unaudited)		6
Item 2.	~~Management’s Discussion and Analysis of Financial Condition and Results of Operations~~	11Management’s Discussion and Analysis of Financial Condition and Results of Operations		12
Item 3.	~~Quantitative and Qualitative Disclosures About Market Risk~~	26Quantitative and Qualitative Disclosures About Market Risk		22
Item 4.	~~Controls and Procedures~~	26Controls and Procedures		22
PART II:	~~OTHER INFORMATION~~	OTHER INFORMATION
Item 4.	~~Submission of Matters to a Vote of Security Holders~~	26Submission of Matters to a Vote of Security Holders		23
Item 6.	~~Exhibits and Reports on Form 8-K~~	27Exhibits and Reports on Form 8-K		23
	~~Signatures~~	27Signatures		24
	Certifications	28

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PART I —- FINANCIAL INFORMATION

Item 1. Financial Statements

APPLIED MICROSYSTEMS CORPORATION

CONSOLIDATED STATEMENT OF NET ASSETS IN LIQUIDATION AS OF JUNE 30, 2003, AND CONSOLIDATED BALANCE ~~SHEETS~~SHEET AS OF DECEMBER 31, 2002

				September 30,				December 31,
			June 30,				December 31,
				2002				2001
			2003				2002
			(unaudited)	~~(unaudited)~~
			(in thousands)	~~(in thousands)~~
ASSETS
Current assets:
	Cash and cash equivalents		$	$1,510	~~2,239~~		$	$3,600	~~2,971~~
	Securities available-for-sale			—	~~298~~			299	~~3,997~~
	Restricted investment				—				400
	Accounts receivable, net			—				280
	Accounts receivable, net				1,940				3,594
	Note receivable			500				500
	Inventories				1,614				1,959
	Prepaid and other current assets			161				449
	Prepaid and other current assets				657				429
	Property and equipment held for sale			58				91
		Total current assets			6,748				13,350
Total assets			$	2,229			$	5,219
Property and equipment, net					1,012				1,358
LIABILITIES AND SHAREHOLDERS’ EQUITY
Other assets					537				316
Current liabilities:
		Total assets		$	8,297			$	15,024
	Accounts payable		$	293			$	744
LIABILITIES AND SHAREHOLDERS’ EQUITY
	Accrued payroll			42				1,143
Current liabilities:
	Other accrued expenses			482				765
	Accounts payable			$	1,419			$	1,704
	Deferred revenue			325				325
	Accrued payroll				827				1,178
	Capital lease obligation			171				175
	Other accrued expenses				1,713				1,453
	Notes payable			190				185
	Deferred revenue				1,812				3,253
Total current liabilities				1,503				3,337
		Total current liabilities			5,771				7,588
Commitments and contingencies				—				—
Capital lease obligation, less current portion					139				175
Shareholders’ equity:
Notes payable					178				—
Preferred stock, $0.01 par value; 5,000,000 shares authorized; none issued and outstanding				—				—
Accrued cost of business restructuring					917				719
Common stock, $0.01 par value; 25,000,000 shares authorized; 7,597,000 shares issued and outstanding at June 30, 2003 and December 31, 2002				27,233				27,233
		Total long-term liabilities			1,234				894
Accumulated deficit				(26,507	)			(25,351	)
Shareholders’ equity:
Total shareholders’ equity				726				1,882
	Preferred stock, $0.01 par value; 5,000,000 shares authorized; none issued and outstanding				—				—
Total liabilities and shareholders’ equity			$	2,229			$	5,219
	Common stock, $0.01 par value; 25,000,000 shares authorized; 7,597,000 and 7,149,000 shares issued and outstanding at September 30, 2002 and December 31, 2001, respectively				27,234				26,857
	Accumulated other comprehensive loss				(583	)			(636	)
	Accumulated deficit				(25,359	)			(19,679	)
		Total shareholders’ equity			1,292				6,542
		Total liabilities and shareholders’ equity		$	8,297			$	15,024

See accompanying notes.

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APPLIED MICROSYSTEMS CORPORATION ~~CONSOLIDATED STATEMENTS OF OPERATIONS~~ ~~(UNAUDITED)~~

		Three Months ended						Nine Months ended
		September 30,						September 30,
		2002			2001			2002			2001
		(in thousands, except per-share amounts)
Net sales		$	2,781		$	4,605		$	10,917		$	23,559
Cost of sales			908			1,181			3,644			6,504
Gross profit			1,873			3,424			7,273			17,055
Operating expenses:
	Sales, general and administrative		1,657			2,971			6,729			10,859
	Research and development		1,249			2,182			4,488			8,741
	In-process research and development		—			—			621			—
	Business restructuring		—			2,289			1,149			2,289
Total operating expenses			2,906			7,442			12,987			21,889
Loss from operations			(1,033	)		(4,018	)		(5,714	)		(4,834	)
Interest income and other, net			(12	)		50			34			234
Net loss		$	(1,045	)	$	(3,968	)	$	(5,680	)	$	(4,600	)
Per-share amounts:
Basic and diluted net loss per share		$	(0.14	)	$	(0.56	)	$	(0.77	)	$	(0.65	)
Shares used in per-share calculation			7,553			7,113			7,355			7,053

CONSOLIDATED CHANGES IN NET ASSETS IN LIQUIDATION FOR THE PERIODS ENDED
JUNE 30, 2003, AND
CONSOLIDATED STATEMENTS OF OPERATIONS FOR THE PERIODS ENDED
JUNE 30, 2002
(UNAUDITED)


		Three Months ended						Six Months ended
		June 30,						June 30,

		2003			2002			2003			2002

		(in thousands, except per-share amounts)
Net sales		$	—		$	3,271		$	—		$	8,136
Cost of sales			—			941			—			2,736

Gross profit			—			2,330			—			5,400
Operating expenses:
	Sales, general and administrative		361			2,417			1,046			5,072
	Research and development		3			1,583			303			3,239
	In-process research and development		—			621			—			621
	Business restructuring		—			1,149			—			1,149

Total operating expenses			364			5,770			1,349			10,081

Loss from operations			(364	)		(3,440	)		(1,349	)		(4,681	)
Interest income and other, net			131			17			193			46

Net loss		$	(233	)	$	(3,423	)	$	(1,156	)	$	(4,635	)

Per-share amounts:
Basic and diluted net loss per share		$	(0.03	)	$	(0.47	)	$	(0.15	)	$	(0.64	)

Shares used in per-share calculation			7,597			7,338			7,597			7,255

See accompanying notes.

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APPLIED MICROSYSTEMS CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)

				Nine Months Ended September 30,
				Six Months Ended June 30,
				2002			2001
				2003			2002
				(in thousands)
Operating activities
Net loss				$	(51,~~680~~156	)	$	(4,~~600~~635	)
Adjustments to reconcile net loss to net cash used in operating activities:
	Depreciation and amortization				~~579~~8			~~774~~394
	In-process research and development				~~621~~—			—621
	Loss on write off and/or disposal of assets				72			148
	(Gain) loss on write-off and/or disposal or sale of assets				(33	)		72
	Net change in operating accounts:
		Accounts receivable			~~1,738~~280			1,~~935~~945
		Inventories			~~381~~—			49475
		Prepaid and other assets			~~(220~~288	)		(7614	)
		Accounts payable, accrued expenses, and accrued business restructuring			(~~466~~1,834	)		~~(637~~174	)
		Deferred revenue			~~(1,385~~—	)		(~~963~~1,216	)
			Net cash used in operating activities		(42,~~360~~447	)		(32,~~370~~184	)
Investing activities
	Purchases of securities available-for-sale				~~(2,275~~—	)		(62,~~026~~275	)
	Maturities of securities available-for-sale				~~5,974~~299			43,~~447~~483
	Additions to property and equipment				(118	)		(180	)
	Net proceeds from sale and disposal of long-lived assets held for sale				58			—
			Net cash provided by (used in) investing activities		3,581			(1,759	)
	Additions to property and equipment				—			(72	)
			Net cash provided by investing activities		357			1,136
Financing activities
	Sale of common stock to employees				57—			~~287~~48
	Stock options exercised				2			209
	Payments on capital lease obligation				—			(22	)
	Payments on capital lease obligation				(33	)		(20	)
			Net cash provided by financing activities		—			26
			Net cash provided by financing activities		26			476
Effects of foreign currency exchange rate changes on cash					—			69
Effects of foreign exchange rate changes on cash					21			305
Net decrease in cash and cash equivalents					(2,090	)		(953	)
Net decrease in cash and cash equivalents					(732	)		(4,348	)
Cash and cash equivalents at beginning of period					3,600			2,971
Cash and cash equivalents at beginning of period					2,971			7,956
Cash and cash equivalents at end of period				$	1,510		$	2,018
Cash and cash equivalents at end of period				$	2,239		$	3,608

Supplemental disclosure of non-cash activities:

During the first quarter of 2001, the Company obtained equipment under a five-year capital lease obligation of $250,000.

See accompanying notes.

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APPLIED MICROSYSTEMS CORPORATION ~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~ ~~(UNAUDITED)~~

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, ~~2001~~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~~changes ofin ~~operations~~net assets in liquidation for the three-month and ~~nine~~six-month periods ended ~~September~~June 30, ~~2002~~2003, are not necessarily indicative of results to be expected for the entire year ~~ending~~ ending December 31, ~~2002~~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, ~~2001~~2002.

On December 16, 2002, the Company announced that the board of directors had unanimously decided to recommend to shareholders that Applied be liquidated. On May 22, 2003, Applied’s shareholders approved and adopted a plan for the complete liquidation and dissolution of the Company, including the disposition of any remaining assets. On June 30, 2003, the Company filed articles of dissolution with the State of Washington, and the Company continues to exist under Washington law only for the limited purpose of winding up and liquidating its business and affairs. The Company directed its transfer agent to close its stock transfer books as of the close of business on June 30, 2003, and the Company further notified the OTC Bulletin Board that the Company’s shares could no longer be traded. The Company’s financial statements as of June 30, 2003, and for the three and six-month periods then ended, are prepared on a liquidation basis of accounting in accordance with accounting principles generally accepted in the United States of America. The Company’s consolidated financial statements as of December 31, 2002, and for the three and six-month periods ended June 30, 2002, have been prepared in accordance with accounting principles generally accepted in the United States of America.

Under the liquidation basis of accounting, assets are stated at estimated net realizable value, with the exception that prepaid corporate insurance amounts are carried at their amortized cost because they continue to provide protection to corporate interests. Liabilities are generally stated at historical amounts unless the Company has negotiated a legal settlement, at which time the liabilities are adjusted to the negotiated amount. In early July 2003, the Company sent notification letters to known and potential creditors informing them of the Company’s liquidation and stating that any claims must be made by providing appropriate supporting documentation to the Company by the end of October 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,

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or cannot be reasonably estimated, are not accrued for as of June 30, 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 ~~September~~June 30, ~~2002~~2003, no stock options remained outstanding, and ~~September~~as of June 30, ~~2001~~2002, options to purchase 1,~~237~~377,000 ~~and 1,214,000~~ shares of common stock, ~~respectively,~~ were outstanding; however, ~~all~~ all stock options were excluded from the calculation of loss per share in the ~~three~~ three and ~~nine~~six-month periods ended ~~September~~June 30, ~~2002~~2003, and ~~2001~~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 to equity. ~~During~~Assets and liabilities of foreign subsidiaries are translated to U.S. dollars at the ~~third~~exchange ~~quarter~~rates on the balance sheet date. Revenues and expenses of ~~2002,~~foreign subsidiaries ~~comprehensive~~are ~~loss~~translated ~~amounted~~at tothe $1average rates of exchange prevailing during the year.~~0 million~~ ~~compared~~The tocumulative translation adjustments resulting from this process have historically been accumulated in other comprehensive loss. As a result of the $4Company’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 2002.~~0 million~~ ~~for~~The Company therefore recognized a charge of $593,000 in the ~~third~~fourth quarter of ~~2001.~~2002 ~~For~~relating to the ~~nine~~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 six-months ended ~~September~~June 30, ~~2002,~~2003. ~~comprehensive~~During ~~loss~~the ~~amounted~~three tomonths ~~$5.6 million,~~ended June ~~compared~~30, to2002, comprehensive loss ofamounted to $43.54 million. ~~for~~During the ~~nine~~six months ~~ended~~ ~~September~~ended June 30, ~~2001~~2002, comprehensive loss amounted to $4.6 million.

~~-6-~~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.

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

Inventories consist of the following:


Assets
	Inventories	$	910
	Prepaid and other current assets		54
	Fixed assets		84

		$	1,048

Liabilities — deferred revenue and warranty		$	1,433

	September 30,		December 31,
	2002		2001
	(in thousands)
Finished goods	$	1,008	$	999
Work in process		32		55
Purchased parts		574		905
	$	1,614	$	1,959

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

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 ~~the Company believed were~~ not essential to ~~its~~the Company’s long-term goals; abandonment of excess space at the Company’s headquarters; as well as other cost reduction and ~~control~~ 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.

~~The~~In ~~charge~~May ~~for~~2002, ~~abandoned~~the ~~facilities~~Company ~~relates~~announced tofurther ~~amounts~~plans ~~accrued~~to ~~for~~reduce expenses ~~estimated~~through ~~losses~~a onreduction ~~lease~~in ~~commitments~~personnel ~~for~~and ~~facilities~~realignment ~~that~~of ~~Applied~~business ~~has~~objectives. ~~abandoned~~The incost ~~connection~~reductions ~~with~~consisted ~~the~~primarily ~~restructuring;~~of ~~the~~a ~~corresponding~~reduction ~~accrued~~of ~~liability~~approximately ~~will~~45 befull-time ~~reduced~~employees asworldwide across the Company’s ~~pays~~functional ~~its~~organizations, ~~lease~~as well ~~commitments~~as a write-off of certain assets for which the book value was deemed in excess of net realizable value under accounting rules. ~~During~~As a result, the Company ~~second~~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~~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 ~~three~~second ~~months~~quarter ~~ended~~of ~~June 30,~~ 2002.

In ~~May 2002,~~ the ~~Company~~fourth ~~announced~~quarter ~~further plans to reduce expenses through a reduction in personnel and realignment~~ of ~~business~~2002, ~~objectives.~~after ~~The cost~~announcing ~~reductions~~on ~~consisted~~December 16, ~~primarily~~2002 ~~of a reduction of approximately 45~~that ~~full-time employees worldwide across~~ the Company’s ~~functional~~board ~~organizations, as well as a write-off~~ of ~~certain~~directors ~~assets~~had ~~for~~unanimously ~~which~~decided ~~the~~to ~~book~~recommend ~~value was deemed in~~to ~~excess~~shareholders ofthat ~~net~~Applied ~~realizable~~be ~~value under accounting rules. As a result~~liquidated, ~~the~~Applied ~~Company recognized a charge of $602,000 for severance and related expenses and~~ ~~$67,000 for asset write-offs in the three months ended June 30, 2002.~~

-7 8 -

~~Restructuring~~further ~~charge~~recognized ~~activity~~$906,000 in restructuring charges associated with severance and benefits for the Company’s remaining 26 personnel. Also during the ~~nine-month~~fourth quarter ~~period~~of ~~ended~~2002, ~~September~~the Company entered into an agreement to terminate its 30headquarters 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 ~~was~~relating asto ~~follows:~~the elimination of the reserve for abandoned space.

	Accrued									Accrued
	Balance at				Amounts Paid					Balance at
	December 31,		Additional		or Charged		Amounts			September 30,
	2001		Charges		Off		Reclassified			2002
	(in thousands)
Severance and related expenses	$	64	$	602	$	617	$	30		$	79
Asset write-offs		—		67		67		—			—
Abandoned facilities		1,094		480		241		(30	)		1,303
	$	1,158	$	1,149	$	925	$	—		$	1,382

The restructuring charges and related activity for the six months ended June 30, 2003 are as follows:

A portion of the accrued restructuring liabilities in the amount of $917,000 as of September 30, 2002 is classified as long term on the Company’s balance sheet, compared to $719,000 classified as long term as of December 31, 2001. The remaining $465,000 in accrued restructuring liabilities as of September 30, 2002 is classified within current liabilities, and consists of accrued payroll of $79,000, and accrued expenses of $386,000. As of December 31, 2001, current business restructuring liabilities consisted of accounts payable of $3,000, accrued payroll of $12,000, and other accrued expenses of $424,000.


	Accrued						Accrued
	Balance at				Amounts Paid		Balance at
	December 31,		Additional		or Charged		June 30,
	2002		Charges		Off, Net		2003

Severance and related expenses	$	783	$	—	$	758	$	25
Abandoned facilities		96		—		69		27

	$	879	$	—	$	827	$	52

As ~~a result~~ of ~~terminating~~December 31, ~~its~~2002, ~~headquarters~~the ~~lease~~accrued ~~obligation~~restructuring ~~(see~~liabilities consisted ~~Termination~~of accrued payroll of ~~Headquarters~~$775,000, ~~Lease)~~accounts ~~the~~payable ~~Company’s~~of ~~restructuring~~$96,000, ~~liabilities relating~~and toother ~~abandoned~~accrued expenses ~~facilities~~of is$8,000. ~~expected~~As toof beJune 30, ~~eliminated~~2003, ~~with~~the noaccrued restructuring liabilities ~~remaining~~consisted ~~obligation~~of ~~expected~~accrued aspayroll of ~~December 31~~$25,000, ~~2002~~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 iswas 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~~ board of ~~Directors~~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~~board of directors. Mr. Evans ~~Directors~~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.~~

-8 9 -

7agreement. ~~Asset~~Those ~~Sale~~shares ~~Transaction~~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 connection with the liquidation of Applied Microsystems, the Company intends to dispose of its 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. OnStock-Based ~~September 3, 2002, Applied announced that it had entered into an~~Compensation ~~agreement to sell its embedded systems development tools business and assets to~~ Metrowerks Corporation, a wholly owned subsidiary of Motorola, Inc. Applied’s shareholders approved the transaction at a special shareholder meeting held on October 29, 2002, and Applied and Metrowerks subsequently satisfied the remaining closing requirements. The purchase price was $3.9 million, which included payment for certain inventories and tangible assets, as well as all intellectual property related to Applied’s embedded systems development tools business. In addition, Metrowerks assumed certain customer warranty and support obligations, and offered employment to 26 Applied personnel. Applied received $3.4 million at closing, with the remaining $500,000 held back for one year to secure certain indemnification obligations.

AsThe ofCompany ~~September 30,~~has ~~2002,~~ the ~~Company~~following ~~had~~shareholder-approved ~~deferred~~stock ~~approximately~~option ~~$270,000~~plans that inprovide ~~transaction-related~~for ~~expenses~~option ~~and~~grants ~~included~~to ~~such~~employees, ~~amounts~~directors, ~~within~~and ~~prepaid~~others: ~~and~~the Applied ~~other~~Microsystems ~~current~~Corporation ~~assets.~~1992 ~~The~~Performance ~~Company~~Stock ~~will~~Plan ~~account~~(the ~~for~~“1992 Plan”), the Applied ~~sale~~Microsystems ~~transaction~~2001 ~~during the~~Stock ~~fourth~~Option ~~quarter~~Plan of(the ~~2002~~“2001 Plan”), and ~~expects~~the toApplied Microsystems ~~recognize~~Corporation aDirector ~~net~~Stock ~~gain~~Option onPlan (the ~~transaction.~~ ~~During~~“Director ~~the~~Plan”). ~~fourth~~The exercise ~~quarter~~price of ~~2002,~~options ~~the~~granted ~~Company~~under ~~also~~these plans tohas been at fair market ~~assess~~value ~~asset~~on ~~carrying~~the ~~values~~date ~~and~~of ~~required~~grant. ~~reserve~~Options ~~balances~~are not transferable, inand ~~light~~expire ofno ~~the~~later ~~transaction~~than ten years following the grant date.

As ~~part~~a result of the Company’s sale ~~transaction,~~of ~~the~~its ~~Company~~embedded ~~requested~~systems ~~that certain~~development ~~customers~~tools business and ~~licensors~~assets ofin ~~third-party~~November ~~technology~~2002, ~~assign~~vesting ~~contractual~~for ~~rights~~all ~~to Metrowerks.~~stock ~~Applied~~options ~~maintained~~under the a1992 ~~contractual~~Plan ~~relationship~~and ~~with~~the ~~Microsoft whereby~~2001 ~~Applied~~Plan ~~provided~~was ~~development~~accelerated ~~tools~~so ~~for~~that ~~Microsoft’s~~all ~~Xbox™~~outstanding ~~video gaming~~options ~~system.~~under ~~Microsoft~~these ~~elected~~plans towere ~~exercise~~fully ~~their~~exercisable ~~contractual~~as ~~rights~~of ~~under~~the closing of the transaction. ~~agreement~~Because ~~with~~all ~~Applied~~such tounvested ~~withdraw~~options ~~certain~~had ~~technology~~exercise ~~held~~prices insubstantially ~~escrow~~above in the ~~event~~trading ~~that~~price ~~Applied~~of ~~sold~~the aCompany’s ~~significant~~common ~~portion~~stock as of ~~its~~the ~~business.~~closing ~~Microsoft~~of ~~also~~the ~~accelerated~~transaction, ~~certain~~no ~~purchase~~options ~~requirements~~were ~~for~~exercised ~~development~~as ~~tools,~~a ~~and~~result ~~Applied delivered~~of ~~such~~the ~~development~~accelerated ~~tools~~vesting, and inall ~~October~~such ~~2002,~~options ~~prior~~were tosubsequently ~~closing~~terminated. ~~the~~Remaining ~~asset~~options that had ~~sale~~been ~~transaction.~~granted ~~Because~~under the ~~order~~Director ~~was~~Plan ~~accelerated~~were toterminated ~~occur~~effective ~~prior~~as toof ~~closing~~May 22, ~~the transaction~~2003, ~~Applied~~the ~~and~~date ~~Metrowerks~~that ~~agreed~~Applied’s toshareholders ~~share~~approved the ~~gross~~liquidation ~~margin~~of the ~~realized~~Company. ~~under~~The ~~the~~Company ~~sale~~has ofno ~~those~~remaining ~~specific~~stock ~~development~~options ~~tools~~outstanding, and ~~Applied~~does not ~~expects~~intend to ~~pay~~grant ~~Metrowerks~~any ~~approximately~~additional ~~$350,000~~stock ~~during the fourth quarter of 2002 as a one-time payment~~options.

~~With~~The ~~the~~following ~~sale~~table ofillustrates the ~~historical~~effect ~~revenue-generating~~on ~~assets~~net ~~now~~loss ~~completed, the Company plans to pursue the development of hardware~~ and ~~software~~loss ~~products aimed~~per ~~at end-user markets — specifically, corporate data centers — through~~share ~~Applied’s~~if ~~Libra~~the ~~Networks~~Company ~~division.~~had ~~Libra~~applied ~~Networks~~the ~~was~~fair ~~formed~~value asrecognition aprovisions ~~result~~ of ~~the~~ ~~Company’s~~SFAS ~~acquisition~~123 ofto its ~~REBA~~stock-based ~~Technologies in May 2002~~awards.

8. Termination of Headquarters Lease


	Three Months ended						Six Months ended
	June 30,						June 30,

	2003			2002			2003			2002

	(in thousands, except per-share amounts)
Net loss, as reported	$	(233	)	$	(3,423	)	$	(1,156	)	$	(4,635	)
Total stock-based compensation expense determined under fair-value-based method		(22)			(95)			(52)			(202)

Pro forma net loss	$	(255	)	$	(3,518	)	$	(1,208	)	$	(4,837	)

Net loss per share as reported	$	(0.03	)	$	(0.47	)	$	(0.15	)	$	(0.64	)

Pro forma net loss per share	$	(0.03	)	$	(0.48	)	$	(0.16	)	$	(0.67	)

On- ~~October 15,~~10 ~~2002, Applied entered into a Lease Termination Agreement~~- ~~(the “Termination Agreement”), by and between Applied and Teachers Insurance &~~ Annuity Association of America (“TIAA”), the landlord under the Company’s current headquarters facilities lease. Pursuant to the Termination Agreement, Applied paid an early termination fee of approximately $1 million to TIAA in exchange for the termination of any further obligations of Applied under the lease. As of the date of the Termination Agreement, Applied’s remaining lease obligation extended through 2007 and was in excess of $6 million. The Termination Agreement requires that Applied vacate the leased premises no later than December 31, 2002. Applied plans to relocate its offices to a smaller facility in the same geographic region.

In order to secure favorable lease terms, the Company had agreed to maintain an irrevocable

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~~letter of credit in favor of TIAA during the lease term~~8. Recent ~~The~~Accounting ~~letter of credit~~Pronouncements ~~was initially established at $325,000; to secure the letter of credit, the~~ Company had pledged a $400,000 certificate of deposit with a bank, which amount was subject to withdrawal restrictions. The certificate of deposit is classified within other long-term assets as a restricted investment on the balance sheet at September 30, 2002, and was classified as a current restricted investment as of December 31, 2001. These funds will become available to the Company in the fourth quarter of 2002 as a result of the Termination Agreement, cancellation of the letter of credit requirement, and elimination of withdrawal restrictions on the certificate of deposit.

9 In April 2003, the FASB issued Statement of Financial Accounting Standards (“SFAS”) No. 149, ~~Recent~~“Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” SFAS 149 amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under SFAS No. 133, “Accounting ~~Pronouncements~~for Derivative Instruments and Hedging Activities.” SFAS 149 is generally effective for contracts entered into or modified after June 30, 2003, and for hedging relationships designated after June 30, 2003. The Company does not expect the adoption of SFAS 149 to have a significant impact on its financial position or results of operations.

In ~~August~~May ~~2001~~2003, the FASB issued SFAS ~~144~~No. 150, “Accounting for ~~the~~Certain ~~Impairment~~Financial orInstruments ~~Disposal~~with Characteristics of ~~Long-Lived~~both ~~Assets~~Liabilities and Equity.” SFAS ~~144~~150 establishes ~~clarifies~~standards ~~the~~for ~~model~~how toan beissuer ~~used~~classifies ~~for long-lived~~and ~~assets~~measures tocertain financial beinstruments ~~disposed~~with characteristics of, ~~thus~~both ~~providing~~liabilities and equity. SFAS 150 is effective for ~~greater~~financial ~~consistency~~instruments entered into or modified after May ~~among~~31, ~~companies~~2003, and ~~also~~otherwise ~~clarifies~~is ~~other~~effective ~~implementation~~at ~~issues~~the ~~related~~beginning toof the ~~impairment~~ ~~and~~first ~~disposal~~interim period ofbeginning ~~long-lived~~after ~~assets~~June 15, 2003. SFAS ~~144~~150 is ~~effective~~to ~~for~~be implemented by reporting the cumulative effect of a change in an accounting principle for ~~Company’s~~financial ~~year~~instruments ~~ending~~created ~~December 31,~~before ~~2002,~~the ~~and~~issuance isdate ~~not~~of ~~expected~~the tostatement ~~materially~~and ~~affect~~still existing at the beginning of the interim period of adoption. The Company’s does not expect the adoption of SFAS 150 to have a significant impact on its financial ~~statements~~position or results of operations.

In- ~~June~~11 ~~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, and early application is~~ ~~encouraged. The Company is currently assessing the impact of SFAS 146 on its~~ ~~financial statements.~~

10. Reclassifications

Certain prior-period amounts have been reclassified to conform to the current-period presentation.

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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 ~~our intent to pursue new~~ market and ~~product~~industry, ~~opportunities through~~ our ~~Libra~~goals, ~~Networks division~~plans, ~~our beliefs~~ and expectations regarding ~~future~~ ~~operating trends,~~ our ~~expectations~~plans to ~~and~~liquidate ~~beliefs about~~ the ~~market and industry~~Company, our ~~goals,~~beliefs ~~plans,~~ and expectations regarding our ~~products and~~remaining ~~services~~corporate ~~and~~obligations ~~product~~(including ~~development,~~indemnification ~~our~~obligations ~~intent~~arising tofrom ~~continue~~the sale toof ~~invest~~our ~~resources~~embedded ~~in research~~systems ~~and~~ development, ~~our~~tools ~~beliefs~~business and ~~expectations~~assets ~~regarding~~in ~~quotation of~~November 2002), our ~~common~~beliefs ~~stock~~and onexpectations regarding the ~~Nasdaq~~timing ~~SmallCap Market~~ and ~~the~~amount ~~impact~~ of ~~potential~~any ~~delisting~~potential distribution to shareholders, our beliefs regarding period-to-period results of operations, ~~our expectations~~and ~~regarding~~changes ~~future~~in ~~financial~~net ~~performance~~assets in liquidation, our expectations ~~and beliefs~~ regarding ~~revenue~~future ~~and~~financial ~~revenue trends~~results, our beliefs ~~and expectations~~ regarding ~~fluctuations in revenues and operating results,~~ our ~~expectations~~ ~~regarding~~results ~~development~~of ~~costs,~~operation ~~our~~(or ~~beliefs~~changes ~~and~~in ~~expectations~~net ~~regarding~~assets ~~our~~in ~~results of~~liquidation) ~~operation~~ and financial position, our beliefs and expectations regarding liquidity and capital resources, and our expectations regarding the impact of recent accounting pronouncements ~~and revenue recognition matters~~. 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, ~~those identified in the section entitled “Risks Related to Applied’s Continuing Business Operations” in the Proxy Statement mailed to shareholders on our about September 26, 2002,~~ and the section of our annual report on Form 10-K for the fiscal year ended December 31, ~~2001~~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, ~~2001~~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 ~~has~~ 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 ~~September~~November 31, 2002, we ~~announced~~completed ~~that~~the wesale ~~had~~of ~~entered into an agreement to sell~~ our embedded systems development tools business and assets to Metrowerks Corporation, a wholly owned subsidiary of Motorola, Inc. ~~Applied’s~~The purchase price was $3.9 million, which ~~shareholders~~included ~~approved~~payment ~~the~~for ~~transaction~~certain atinventories aand ~~special~~tangible ~~shareholder~~assets, ~~meeting~~as ~~held~~well onas all ~~October 29,~~intellectual ~~2002,~~property ~~and~~related ~~Applied~~to ~~and~~our ~~Metrowerks~~embedded ~~subsequently~~systems ~~satisfied~~development ~~the~~tools ~~remaining~~business. ~~closing~~In ~~requirements.~~addition, ~~The~~Metrowerks ~~purchase~~assumed ~~price~~certain ~~was~~customer warranty and support obligations. We received $3.94 million at closing, ~~which~~with the remaining ~~included~~$500,000 ~~payment~~subject ~~for~~to a one-year holdback to secure certain ~~inventories~~indemnification obligations. ~~and~~Certain ~~tangible~~other indemnification obligations relating to our title to the assets sold, ascompliance ~~well~~with aslaws, ~~all~~and certain matters relating to taxes ~~intellectual~~continue ~~property~~until ~~related~~the expiration of the statute of limitations applicable to claims ~~Applied’s~~with ~~embedded~~respect ~~systems~~to such matters.

-11 12 -

~~development~~ With ~~tools~~the ~~business.~~sale Inof ~~addition,~~our ~~Metrowerks~~historical ~~assumed~~revenue-generating ~~certain~~assets completed, we ~~customer~~had ~~warranty~~planned ~~and~~to ~~support~~pursue ~~obligations,~~the development of new hardware and ~~offered~~software ~~employment~~products through toour 26Libra ~~Applied~~Networks division. Libra Networks was formed as a result of ~~personnel~~our acquisition of REBA Technologies in May 2002. We ~~received~~planned ~~$3.4 million~~to atfocus ~~closing,~~our Libra ~~with~~Networks ~~the~~development ~~remaining~~on ~~$500,000~~delivering innovative technology that improves ~~held~~the ~~back~~way ~~for~~web ~~one~~services ~~year~~and toother ~~secure~~enterprise ~~certain~~applications ~~indemnification~~are ~~obligations~~managed in enterprise data centers.

~~With~~During the ~~sale~~fourth quarter of ~~the~~2002 ~~historical revenue-generating assets now completed,~~ we ~~plan~~aggressively topursued ~~pursue~~funding ~~the~~for ~~development of hardware and software products aimed at~~the ~~end-user markets — specifically, corporate data centers — through our~~ Libra ~~Networks~~ ~~division. Libra~~ Networks ~~was formed as a result of the Company’s acquisition of REBA Technologies in May 2002~~business. ~~The~~Feedback ~~Company~~from isvarious ~~also~~funding ~~evaluating whether~~sources ~~the value deliverable to shareholders might be optimized by liquidating~~produced ~~the~~consistent ~~Company~~themes, ~~rather~~including ~~than~~concern ~~continuing~~over toApplied’s ~~pursue~~capital ~~the~~structure ~~Libra~~as ~~Networks opportunity. Liquidation of~~ a ~~corporation is not a simple process, and would require a~~ ~~shareholder~~publicly ~~vote~~held ~~and present other complexities~~entity, ~~with~~concern ~~significant~~over ~~uncertainties surrounding~~ the timing and amount of ~~any~~Libra ~~distribution~~Networks’ projected tofunding ~~shareholders.~~needs, Inand ~~view of~~varying ~~our~~levels ~~ongoing consumption~~ of ~~cash~~interest ~~during~~in ~~every month that we search for venture funding to finance our~~ Libra Networks ~~business, our board of directors~~’ ~~has~~overall ~~determined~~market ~~that~~opportunity. weWe ~~should~~also ~~accelerate~~noted ~~our~~a ~~search~~softening ~~for~~in ~~funding,~~market ~~and continue~~projections tofor ~~carefully~~the ~~manage~~adoption ~~our~~of ~~cash~~InfiniBand ~~consumption,~~technology ~~until~~in ~~such~~the ~~time~~data ascenter, weon ~~have~~which ~~a fixed~~the ~~determination~~Libra asNetworks totechnology ~~which~~is ~~of these two alternatives better optimizes shareholder value~~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 presents various 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. On May 22, 2003, Applied’s shareholders approved the Plan of Complete Liquidation and Dissolution. On June 30, 2003, we filed articles of dissolution with the State of Washington, and Applied continues to exist under Washington law only for the limited purpose of winding up and liquidating its business and affairs.

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 was quoted on the OTC Bulletin Board from January 3, 2003, until June 30, 2003. We directed our transfer agent to close our stock transfer books as of the close of business on June 30, 2003, and we further notified the OTC Bulletin Board that our shares could no longer be traded.

We have reduced our workforce from 33 full-time personnel on December 16, 2002, to one remaining full-time administrative person and no remaining development personnel as of July 31, 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.

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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 ~~revenue~~accounting ~~recognition,~~for the sale of ~~inventories,~~our ~~accounting~~embedded ~~for~~systems ~~acquisitions~~development ~~such~~tools asassets ~~the~~and ~~May~~business ~~2002~~in ~~REBA~~November ~~acquisition~~2002, ~~accounting~~our ~~for~~plans ~~dispositions~~approved ~~such~~by asshareholders ~~the~~on ~~sale~~May 22, of2003 ~~our~~to ~~embedded~~liquidate ~~systems~~the Company, ~~development~~revenue ~~tools~~recognition, ~~assets~~inventories, ~~and~~accounting ~~business~~for acquisitions such as the May 2002 REBA acquisition, and restructuring ~~costs~~activities. We base our estimates and our future expectations on historical experience and on various ~~other~~ 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. ~~Our critical accounting policies are expected to change in the~~ ~~near future as a result of the sale of our embedded systems development tools~~ ~~business and assets.~~

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.

~~Revenue~~Sale ~~recognition.~~of Weembedded ~~have~~systems ~~historically~~development ~~earned~~tools ~~revenue~~assets ~~on the sale of hardware~~ and ~~software products~~business. WeEffective November 1, ~~also~~2002, ~~earn~~we ~~revenue~~completed on the sale of ~~services, including~~our ~~hardware~~embedded ~~and~~systems ~~software~~development tools ~~support,~~business ~~installation, training,~~ and ~~professional~~ ~~engineering~~assets ~~services~~to Metrowerks. ~~Revenue~~We ~~from~~accounted for the sale orby ~~licensing of~~removing ~~products~~sold isassets ~~recognized~~and ~~when~~assumed ~~persuasive~~liabilities ~~evidence~~at oftheir ancorresponding ~~arrangement~~carrying ~~exists, delivery~~amounts of on the ~~product~~closing ~~has occurred~~date, recognizing the ~~fee~~cash isproceeds, ~~fixed~~recognizing orthe ~~determinable~~$500, ~~and~~000 ~~collectibility~~holdback isreceivable, ~~probable.~~recognizing If the ~~fee~~corresponding ~~due~~transaction ~~from~~expenses ~~a customer is not fixed or~~(either ~~determinable, revenue is recognized~~ as ~~payments become due from~~ a ~~customer.~~reduction ~~If customers~~in ~~have~~previously ~~inspection~~capitalized ortransaction ~~acceptance rights beyond standard warranty provisions~~expenses, ~~revenue~~or isas ~~recognized when formal notification of inspection or~~a ~~acceptance~~liability ~~has~~for ~~been received from the customer. Due~~ yet-to-be-paid ~~business~~items), ~~customs in Japan~~ and ~~our~~making ~~interpretation~~other oftransaction-related adjustments ~~Japanese~~as ~~law,~~deemed ~~product~~appropriate ~~sales~~ in ~~Japan are recognized when~~ the ~~customer notifies us that it has inspected and accepted the product~~circumstances. InAs ~~the~~a ~~absence of receiving written notification of inspection and acceptance~~result, we recognized ~~recognize~~a ~~revenue~~net ingain ~~Japan~~ on ~~receipt of payment by~~ 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-12Lived 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 2002, 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 shareholders subsequently approved the Plan of Complete Liquidation and Dissolution on May 22, 2003. Our critical accounting policies with regard to the Plan of Complete Liquidation and Dissolution 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 June 30, 2003, we have certain amounts that remain accrued for 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 June 30, 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 activities that are initiated after

- 14 -

~~customer as an indication of acceptance. When products are sold with significant installation services~~December 31, ~~all revenue is deferred until installation is completed~~2002. ~~Revenue~~Our ~~from~~current ~~training and contract engineering services is~~exit ~~generally~~activities ~~recognized~~were asinitiated the services are performed. Revenue from longer-term agreements to perform development services is 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 are met). Revenue results are difficult to predict, and any shortfall in ~~revenue or delay in recognizing revenue could cause our operating results to vary significantly from quarter to quarter~~2002, and ~~could result~~we ~~in future operating losses, though our near-term Libra Networks operations~~ are ~~not~~applying ~~expected~~the toguidance ~~immediately~~of ~~generate revenues~~EITF 94-3.

~~Inventories.~~ We ~~write~~also ~~down~~determined ~~our~~that, ~~inventories~~under ~~for~~the ~~estimated~~provisions ~~obsolescence~~of ~~or unmarketable~~SFAS ~~inventories~~144, ~~equal~~many toof ~~the~~our remaining ~~difference~~fixed ~~between~~assets ~~cost~~as ~~and~~of the ~~estimated net~~end ~~realizable~~of ~~value~~2002 ~~based~~were onimpaired. ~~assumptions~~We ~~about~~therefore recognized ~~future~~an ~~demand~~impairment loss and ~~market conditions.~~wrote ~~Changes~~down inour ~~those~~fixed ~~underlying~~assets ~~assumptions~~to —fair ~~including~~value, ~~the impact of~~in ~~the~~accordance ~~recently~~with ~~completed~~SFAS ~~asset~~144. ~~sale~~No —further ~~could~~impairments ~~result~~were recognized in ~~additional~~the ~~write-downs of~~three ~~inventories~~or six months ended June 30, 2003.

~~Acquisitions.~~The InCompany’s ~~May~~financial ~~2002,~~statements weas ~~announced our acquisition~~ of ~~REBA Technologies~~June 30, ~~Inc. Applied does not have a history of acquiring companies; therefore~~2003, ~~the~~and ~~accounting~~for ~~policies relating to acquisitions depend on~~ the ~~facts~~three and ~~circumstances~~six-month ofperiods ~~the~~then ~~specific~~ended, ~~transaction.~~are Inprepared ~~this~~on ~~case,~~a weliquidation ~~assessed~~basis ~~the~~of ~~proper~~accounting ~~allocation~~in ofaccordance ~~the~~with ~~purchase~~accounting ~~price~~principles ingenerally ~~light~~accepted ofin the ~~circumstances and~~ ~~determined~~United ~~that~~States ~~the~~of ~~entire~~America. ~~purchase~~The ~~consideration~~Company’s beconsolidated ~~allocated~~financial tostatements ~~in-process~~as ~~research~~of ~~and~~December 31, ~~development~~2002, ~~based~~and ~~primarily~~for on the ~~fact~~three ~~that~~and ~~we acquired patent~~six-~~pending~~month ~~technology~~periods ~~(and~~ended ~~we acquired no other significant tangible or~~June 30, ~~intangible~~2002, ~~assets).~~have ~~Future~~been ~~acquisitions,~~prepared ifin ~~any,~~accordance ~~could~~with ~~result~~accounting inprinciples ~~different~~generally ~~accounting~~accepted ~~treatment~~in ~~depending on~~ the ~~relevant~~United ~~facts~~States ~~and~~of ~~circumstances~~America.

~~Dispositions~~Revenue recognition. AsWe ~~noted~~historically ~~previously~~earned revenue on the sale of hardware and software products. We also earned revenue on the sale of services, ~~subsequent~~including tohardware ~~September 30~~and software support, ~~2002~~installation, wetraining, and ~~completed~~professional engineering services. Revenue from the sale or licensing of products ~~our~~was ~~embedded~~recognized ~~systems~~when ~~development~~persuasive ~~tools~~evidence ~~business.~~of Wean ~~will~~arrangement existed, ~~account~~delivery ~~for~~of the ~~sale~~product ~~transaction~~had ~~during~~occurred, the ~~fourth~~fee ~~quarter~~was offixed ~~2002~~or determinable, and collectibility ~~expect~~was probable. If the fee due from a customer was not fixed or todeterminable, ~~recognize~~revenue was recognized as payments became due from a ~~net~~customer. If ~~gain~~customers onhad inspection or acceptance rights beyond standard warranty provisions, revenue was recognized when formal notification of inspection or acceptance had been received from the ~~transaction~~customer. ~~During~~Due ~~the~~to ~~fourth~~business ~~quarter~~customs in Japan and our interpretation of ~~2002~~Japanese law, product sales in Japan were werecognized ~~also~~when ~~plan~~the tocustomer ~~assess~~notified ~~asset~~us ~~carrying~~that ~~values~~it had inspected and ~~required~~accepted ~~reserve~~the product. ~~balances~~In the absence of receiving written notification of inspection and acceptance, we recognized revenue in Japan on receipt of payment by the ~~light~~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 ~~transaction~~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).

~~Restructuring costs~~Inventories. InWe ~~the~~wrote ~~third~~down ~~quarter~~our ofinventories ~~2001,~~for weestimated ~~implemented~~obsolescence aor ~~restructuring~~unmarketable ~~plan~~inventories ~~designed~~equal to ~~reduce operating costs. Again in~~ the ~~second quarter~~difference ofbetween ~~2002, we implemented further~~ cost ~~reductions. These restructuring plans included reductions in full-time employees worldwide across our functional organizations; discontinuance or reallocation of selected projects~~ and ~~activities~~the ~~not essential to our long-term goals; abandonment of excess~~estimated ~~space~~net atrealizable ~~our~~value ~~headquarters;~~based ason ~~well~~assumptions asabout ~~other~~future ~~cost~~demand ~~reduction~~ and ~~control~~market ~~measures~~conditions. WeChanges ~~used estimates to establish accruals~~ in ~~connection~~those ~~with~~underlying ~~the restructuring~~assumptions ~~plans,~~– ~~particularly~~including ~~with regard to our contractual lease obligations for abandoned facilities, and~~ the ~~timing~~impact ~~and market rates that may~~of ~~be available if we successfully sublease~~ the ~~excess~~November ~~space. In October~~ 2002 ~~we signed~~asset asale ~~lease~~– ~~termination~~also ~~agreement~~resulted ~~(the~~in ~~“Termination~~additional ~~Agreement”)~~write-downs ~~with the landlord~~ of ~~our headquarters facility whereby we paid an early termination fee~~ ofinventories. ~~approximately~~While ~~$1 million~~inventories tohave ~~the~~historically ~~landlord~~been ina ~~exchange~~material ~~for~~component ~~the termination~~ of ~~any~~our ~~further~~financial ~~obligations~~statements, ~~under~~we ~~the~~had ~~lease.~~no Asremaining ofinventories by the ~~date~~end of ~~the Termination~~2002 ~~Agreement,~~because ~~Applied’s~~all ~~remaining~~inventories ~~obligation~~had ~~extended~~been ~~through~~sold ~~2007~~or ~~and~~otherwise ~~was~~disposed ~~in excess~~ of ~~$6 million.~~prior Weto ~~will assess~~ the ~~impact of changes in the underlying~~end ~~assumptions for any remaining required restructuring liabilities in light~~ of ~~the~~ ~~Termination Agreement~~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-~~13-~~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).

- 15 -

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

~~Our~~Consolidated ~~revenues~~Changes ~~can~~in beNet ~~classified~~Assets ~~into~~in ~~three~~Liquidation ~~broad~~for ~~categories: hardware-enhanced~~the ~~debugging~~Periods ~~tools~~Ended June 30, ~~software analysis tools~~2003, and ~~game development~~Consolidated ~~systems.~~Results ~~The~~of ~~following~~Operations ~~table~~for ~~provides~~the ~~revenue~~Periods ~~information~~Ended ~~for~~June 30, ~~each~~2002 ~~of these categories.~~

		Three Months Ended September 30,												Nine Months Ended September 30,
			Three Months ended								Six Months ended
(dollars in thousands)		2002				Change				2001				2002				Change			2001
			June 30,								June 30,
Hardware-enhanced debugging tools		$	1,454			$	(908	)		$	2,362			$	4,577			$	(4,375	)	$	8,952
			2003				2002				2003				2002
Software analysis tools			873				(1,364	)			2,237				3,936				(2,434	)		6,370
			(in thousands)
Game development systems			454				448				6				2,404				(5,833	)		8,237
Net sales			$	—			$	3,271			$	—			$	8,136
Total net sales		$	2,781			$	(1,824	)		$	4,605			$	10,917			$	(12,642	)	$	23,559
Cost of sales				—				941				—				2,736
							(40	%)											(54	%)
Gross profit				—				2,330				—				5,400
Operating expenses:
	Sales, general and administrative			361				2,417				1,046				5,072
	Research and development			3				1,583				303				3,239
	In-process research and development			—				621				—				621
	Business restructuring			—				1,149				—				1,149
Total operating expenses				364				5,770				1,349				10,081
Loss from operations				(364	)			(3,440	)			(1,349	)			(4,681	)
Interest income and other, net				131				17				193				46
Net loss			$	(233	)		$	(3,423	)		$	(1,156	)		$	(4,635	)

We- ~~have~~16 ~~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.~~

The overall decline in hardware-enhanced debugging, or “run control,” tools and software analysis tools revenues in the three and nine-month periods ended September 30, 2002, in comparison to the same periods in 2001, were attributable primarily to continued lower demand from telecommunications customers; lower volume of software licenses sold through third-party developers of integrated development environments; a continued low level of technology spending in the major geographies in which we do business; the effect of our cost-control measures that forced us to choose development projects among each of our product categories, thereby eliminating some potential revenue-generating opportunities; and our announced asset sale in early September that caused customer uncertainty in the last month of our quarter (historically, a high percentage of our quarterly revenues occurs in the third month of each quarter). Some software analysis tools customers also delayed purchasing products in the third quarter of 2002 due to expected new product releases in the fourth quarter of 2002.

The Company’s game development tools relate to agreements with Nintendo and Microsoft to provide game development tools for Nintendo’s GameCube™ and Microsoft’s Xbox™ video gaming systems. Game development systems revenues were particularly strong in the first half of 2001 due primarily to shipments to Microsoft in anticipation of the November 2001 retail launch of the Xbox; however, quarterly game development system revenues have fluctuated significantly depending on order cycles from Microsoft and Nintendo.

Our net sales also include product support revenues, which are included within the aforementioned major categories of our products. These support revenues totaled $530,000 in the third quarter of 2002, compared to $760,000 in the third quarter of 2001. Support revenues were $1.7 million in the nine months ended September 30, 2002, compared to $2.5 million in the same period in 2001. These declines were due primarily to lower run control product sales, for which support contracts are often sold.

-14-

~~International~~Net ~~sales~~Sales. ~~were~~Prior ~~39%~~to ~~of net sales in~~ the ~~third~~November ~~quarter of~~ 2002~~, compared~~ tosale ~~45% in the third quarter~~ of ~~2001.~~our ~~International~~embedded ~~sales represented~~systems ~~31%~~development oftools ~~net~~business ~~sales~~and inassets, ~~the~~our ~~nine~~revenues ~~months~~could ~~ended~~be ~~September 30,~~classified ~~2002, compared to 27%~~into inthree ~~the~~broad ~~same~~categories: ~~period~~hardware-enhanced indebugging ~~2001. In dollars~~tools, ~~international~~software ~~revenues declined 48% in~~analysis ~~the third quarter of 2002~~tools, and ~~declined~~game ~~46%~~development ~~in the nine months ended September 30, 2002, compared to the same periods in 2001~~systems. The ~~declines~~following intable ~~international revenues~~provides ~~were due primarily to the previously mentioned slowdown among~~revenue ~~telecommunications~~information ~~customers, as well as continued overall unfavorable economic conditions~~ for ~~the~~each ~~sale~~ of ~~our~~these ~~products in Japan and Europe~~categories.

Our sales through our foreign subsidiaries are generally denominated in local currencies. As a result, fluctuations in currency exchange rates can have a significant effect on our reported net sales; however, exchange-rate fluctuations did not materially impact our operating results in the first nine months of 2002. We are unable to predict currency exchange rate fluctuations and anticipate that such fluctuations may affect our net sales to varying degrees in the future.


		Three Months Ended				Six Months Ended
		June 30,				June 30,

(in thousands)		2003		2002		2003		2002

Hardware-enhanced debugging tools		$	—	$	1,494	$	—	$	3,123
Software analysis tools			—		1,450		—		3,063
Game development systems			—		327		—		1,950

	Total net sales	$	—	$	3,271	$	—	$	8,136

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
(dollars in thousands)		2002			2001			2002			2001
Cost of Sales		$	908		$	1,181		$	3,644		$	6,504
	% of net sales		33	%		26	%		33	%		28	%
Gross profit		$	1,873		$	3,424		$	7,273		$	17,055
	% of net sales		67	%		74	%		67	%		72	%

Net sales decreased to zero in 2003 due to the sale of our embedded systems development tools business and assets in November 2002. Our net sales formerly included product support revenues, which are included within the aforementioned major categories of our products. These support revenues totaled $560,000 in the three months ended June 30, 2002, and $1.2 million in the six months ended June 30, 2002. International sales were 30% of net sales in the second quarter of 2002, and 29% in the first six months of 2002.

Cost of Sales and Gross Profit. Because we had no revenues in 2003, we had no cost of sales ~~includes~~or gross profit in the three and six months ended June 30, 2003. Gross profit was 71% of net sales in the three months ended June 30, 2002, compared to 66% in the six months ended June 30, 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 ~~perform~~performed periodic assessments of required reserves for potential inventory obsolescence, and corresponding adjustments to such reserves ~~are~~were included within cost of sales. ~~The dollar amounts of cost of sales and gross profit~~ ~~fluctuate based on a number of factors, including the volume of corresponding~~ ~~net sales and vendor pricing pressures.~~

~~The~~Sales, ~~gross~~General ~~profit~~and ~~percentages~~Administrative Expenses. Sales, general, and administrative expenses decreased $2.1 million, or 85%, in the three ~~and~~months ended ~~nine-month~~June 30, ~~periods~~2003, as compared to the three months ended June 30, 2002. ~~September~~Sales, general, and administrative expenses decreased $4.0 million, or 79%, in the six months ended June 30, 2003, as compared to the six months ended June 30, 2002. The decreases were primarily the result of our November 2002 sale of our embedded systems development tools business and assets, the correspondingly significantly lower ~~than~~personnel inand infrastructure levels that have resulted after the ~~comparable~~sale, ~~periods~~and infurther ~~2001~~cost-cutting ~~due~~and elimination of most operations ~~primarily~~relating to ~~lower~~our ~~production~~Libra ~~volumes~~Networks business and ~~differences~~decision into liquidate the ~~overall~~Company. As ~~sales~~of ~~mix~~July 31, 2003, we employ one full-time administrative person, and we ~~between~~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 ~~two~~as ~~periods~~we continue to implement the corporate liquidation.

	Three Months Ended September 30,							Nine Months Ended September 30,
(dollars in thousands)	2002		Change			2001		2002		Change			2001
Sales, general and administrative expenses	$	1,657	$	(1,314	)	$	2,971	$	6,729	$	(4,130	)	$	10,859
				(44	%)						(38	%)

Research and Development Expenses. Research and development expenses decreased $1.6 million, or nearly 100%, in the three months ended June 30, 2003, as compared to the three months ended June 30, 2002. Research and development expenses decreased $2.9 million, or 91%, in the six months ended June 30, 2003, as compared to the six months ended June 30, 2002. The decreases were 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 and elimination of operations relating to our Libra Networks business.

~~The decreases in sales, general and administrative expenses in the third quarter and year~~-~~to-date~~ ~~2002~~17 ~~periods, as compared to the same periods in 2001, were due primarily to our adoption of cost~~-~~reduction plans in August 2001 and~~ ~~May 2002, which resulted in significantly lower personnel-related expenses.~~ ~~The cost reduction plans, and lower revenue levels, also have resulted in lower infrastructure and commission expenses.~~

-15-

~~When~~During incurred, minor foreign exchange gains and losses are included in sales, general and administrative expenses. In order to mitigate certain intercompany risks associated with exchange rate fluctuations, we may choose to hedge a portion of ~~our foreign exchange risk. No such hedging activities were in effect during~~ the first ~~nine~~quarter ~~months~~ of ~~2002~~2003, ~~nor~~we worked into ~~the~~complete ~~prior~~documentation ~~three~~and ~~years.~~otherwise ~~Although~~prepare wethe ~~may~~Libra ~~engage~~Networks inintellectual ~~exchange-rate~~property ~~hedging~~for ~~activities~~sale. ~~with~~As ~~respect~~of toJuly 31, ~~certain exchange-rate risks~~2003, ~~there can be no assurance that~~ we ~~will~~ do sonot ~~or that~~have ~~any~~a ~~such~~definitive ~~activities~~buyer ~~will~~for ~~successfully protect us against~~ such ~~risks~~intellectual property.

	Three Months Ended September 30,							Nine Months Ended September 30,
(dollars in thousands)	2002		Change			2001		2002		Change			2001
Research and development expenses	$	1,249	$	(933	)	$	2,182	$	4,488	$	(4,253	)	$	8,741
				(43	%)						(49	%)

Interest Income and Other, Net. Interest income and other, net, increased $114,000, or 671%, in the three months ended June 30, 2003, as compared to the three months ended June 30, 2002. Interest income and other, net, increased $147,000, or 320%, in the six months ended June 30, 2003, as compared to the six months ended June 30, 2002. The amount in the second quarter of 2003 includes $71,000 relating to favorable settlements of certain accrued obligations, as well gains recognized on the sale of certain tangible and intangible corporate assets. The year-to-date 2003 amount also includes $50,000 recognized in the first quarter of 2003 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.

The decreases in research and development expenses in the three and nine-month periods ended September 30, 2002, as compared to the same periods in 2001, were primarily due to our adoption of cost-reduction plans in August 2001 and May 2002. These plans led to reductions in certain development projects and reductions in development personnel and related expenditures.

	Three Months Ended September 30,						Nine Months Ended September 30,
(dollars in thousands)	2002		Change		2001		2002		Change		2001
In-process research and development	$	—	$	—	$	—	$	621	$	621	$	—

In May 2002, we announced that we had completed the acquisition of REBA Technologies, Inc., and formed Libra Networks, a division of Applied Microsystems, to pursue development of the acquired technology. This 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 plus an aggregate principal amount of $178,000 of promissory notes, due May 2004, and bearing interest at the rate of 6% annually. We did not acquire any personnel, tangible assets or known liabilities in the transaction. As a result of the acquisition, we 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 is a director of the Company 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 our 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 our entire Board of Directors.

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.

-16-

	Three Months Ended September 30,							Nine Months Ended September 30,
(dollars in thousands)	2002		Change			2001		2002		Change			2001
Business restructuring	$	—	$	(2,289	)	$	2,289	$	1,149	$	(1,140	)	$	2,289
				(100	%)						(50	%)

In August 2001, we implemented a restructuring plan designed to reduce operating costs. The restructuring plan included an abandonment of excess space at the Company’s headquarters; as well as other cost reduction and control measures. During the second quarter of 2002, we 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, we recognized an additional charge of $480,000 in the second quarter of 2002.

In May 2002, we 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, we recognized $669,000 in restructuring charges during the second quarter of 2002.

	Three Months Ended September 30,								Nine Months Ended September 30,
(dollars in thousands)	2002			Change			2001		2002		Change			2001
Interest income and other, net	$	(12	)	$	(62	)	$	50	$	34	$	(200	)	$	234
					(124	%)						(86	%)

Our interest income and other, net, decreased from the prior-year periods due primarily to a decrease in our cash available for short-term investments.

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~~ and ~~nine~~six-month periods ended ~~September~~June 30, ~~2002~~ 2003, and ~~2001~~2002.

Liquidity and Capital Resources

As of ~~September~~June 30, ~~2002~~2003, we had $21.5 million in cash, cash equivalents, ~~and~~ and short-term investments, compared to $73.49 million as of December 31, ~~2001~~2002. ~~The~~Because ~~December 31~~our shareholders approved our plan to liquidate the Company, ~~2001~~we ~~amount~~no longer ~~includes~~require ~~$400~~capital for the financing of inventories and accounts receivable,~~000~~ ~~subject~~sales toand ~~withdrawal~~marketing efforts, product development activities, and ~~restrictions~~capital equipment purchases. Rather, we expect to ~~secure~~use aour ~~letter~~remaining ofcash ~~credit~~to wind-down ~~relating~~operations, ~~primarily~~satisfy our known and unknown obligations and, if cash is available, distribute remaining amounts to our ~~lease~~shareholders. onAs part of the agreement to sell our ~~headquarters~~embedded ~~facility;~~systems ~~this~~development ~~amount~~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 that portion of the holdback not subject to claims for indemnification is ~~included~~due to be received in ~~long-term~~November 2003. Certain other indemnification obligations relating to our title to the assets assold, compliance with laws, and certain matters relating to taxes continue until the expiration of ~~September 30~~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.

~~-17-~~ We used cash of $2.5 million for operating activities in the first six months of 2003, compared to using $2.2 million for operating activities in the first six months of 2002. Investing activities provided $0.4 million in cash in the six months ended June 30, 2003, compared to our using $1.1 million for investing activities in the six months ended June 30, 2002.

- 18 -

~~2002,~~ We ~~but~~received ~~will~~no befunds ~~available to Applied~~ in the ~~fourth~~first ~~quarter~~six ofmonths ~~2002 as a result~~ of ~~our~~2003 ~~terminating~~from ~~our headquarters facilities lease and~~ the ~~corresponding~~ ~~cancellation of the letter of credit. As a result of the~~ sale of ~~our~~ ~~embedded systems development tools assets, we received $3.4 million in~~our ~~November~~common ~~2002~~stock ~~(the~~to ~~remaining~~personnel ~~$500,000~~through ofan ~~the~~employee ~~agreed-upon~~stock purchase ~~price~~plan isand ~~held back for one year to secure certain indemnification obligations). After closing~~ the ~~asset sale transaction, we paid a $1 million lease termination fee~~ toexercise ~~the landlord~~ of ~~our~~employee ~~headquarters~~stock ~~facility~~options, ~~and have transaction and other~~ ~~liabilities~~compared ~~from the embedded systems development tools business that will need~~ to bereceiving ~~satisfied.~~$48,000 ~~These~~in ~~obligations are expected to be offset somewhat by~~ the ~~collection~~ offirst ~~accounts~~six ~~receivable~~months ~~and the sale~~ of ~~excess~~2002. ~~assets~~We do not anticipate ~~needed~~future ~~for the~~funds ~~Libra~~from ~~Networks~~this ~~business~~source.

~~The~~We ~~Libra~~believe ~~Networks~~that ~~business~~our ~~initially~~existing ~~requires~~working capital ~~primarily~~will ~~for~~provide ~~the~~us with ~~financing~~sufficient offunds ~~product~~to ~~development~~effect ~~activities,~~an ~~capital~~orderly ~~equipment~~liquidation; ~~purchases~~however, ~~and to fund required corporate infrastructure. We have historically required capital primarily for~~ the ~~financing~~timing ~~of inventories~~ and ~~accounts receivable,~~ ~~sales~~amount ~~and~~of ~~marketing~~any ~~efforts,~~distribution ~~product~~to ~~development~~shareholders ~~activities,~~is ~~capital~~subject ~~equipment purchases, and~~ to ~~fund operating losses~~significant uncertainty. WeIf ~~used~~we ~~cash~~are ofunable ~~$4.4 million~~to ~~for operating~~effect ~~activities~~an inorderly ~~the first nine months of 2002~~liquidation, ~~compared~~we tocould ~~using $3.4~~be ~~million~~required ~~for~~to ~~operating~~seek ~~activities~~protection inunder the ~~first~~laws ~~nine months~~ of ~~the prior year~~bankruptcy. We ~~used~~Our ~~cash~~stock tois ~~purchase $118,000 in property and equipment in the first nine~~no ~~months~~longer ofpublicly ~~2002~~traded, ~~compared~~and towe ~~purchasing~~do ~~$180,000~~not inbelieve ~~the~~we ~~first~~could ~~nine~~successfully ~~months of~~raise ~~2001~~additional ~~(excluding~~funds ~~an equipment purchase of $250,000 in 2001, financed~~ under ~~a long-term capital lease). As of September 30, 2002, we had no significant commitments with regard to new capital purchases. As a result of terminating~~ our ~~headquarters~~corporate ~~facility lease~~circumstances, weeither ~~have~~through ~~no significant remaining long-term operating lease commitments. We have commitments under~~ a ~~capital~~debt ~~lease~~or ~~obligation~~equity ~~of up to $62,000 per year through 2006~~offering.

WeAccounting ~~received funds totaling $59,000 in the first nine months of 2002 from~~Pronouncements ~~the sale of our common stock to personnel through an employee stock purchase~~ ~~plan and the exercise of employee stock options, compared to receiving $496,000~~ in the same period of the prior year. Receipt of such funds depends on many factors, including factors outside our control; therefore, these funding sources may not provide meaningful cash to us in the future.

WeIn ~~believe~~April ~~that~~2003, wethe ~~will~~FASB ~~need~~issued toStatement ~~supplement our existing cash and cash equivalents through the infusion~~ of ~~additional~~Financial ~~capital~~Accounting ~~by the first half of~~Standards ~~2003~~(“SFAS”) ~~to meet our anticipated cash needs~~No. ~~However~~ 149, ~~any~~“Amendment ~~projections~~ of ~~future cash~~Statement ~~needs~~133 ~~and~~on ~~cash~~Derivative ~~flows~~Instruments ~~are subject to substantial uncertainty. We have continued to post operating losses, despite significant cost reductions, due primarily to declines in revenues,~~ and ~~have now sold our embedded systems~~ ~~development~~Hedging ~~tools business and assets~~Activities.” ~~The~~SFAS ~~Company’s~~149 ~~losses~~amends ~~have~~and ~~led~~clarifies ~~to steadily~~financial ~~lower~~accounting ~~resources available to fund operations,~~ and ~~call into question~~ ~~our~~reporting ~~ability~~for toderivative ~~fund operations over the next 12 months. We are actively seeking new sources of financing. Our future capital requirements will depend on a number of factors~~instruments, including ~~the~~certain ~~costs~~derivative ~~of fully meeting our remaining~~instruments ~~obligations from the~~ embedded ~~systems~~in ~~development~~other ~~tools~~contracts ~~business,~~and ~~any indemnification~~for ~~claims~~hedging ~~that~~activities ~~might be made~~ under ~~the~~SFAS ~~terms of the asset sale agreement~~No. 133, “Accounting ~~our~~for ~~success~~Derivative inInstruments ~~developing~~ and ~~marketing~~Hedging ~~Libra~~Activities.” ~~Networks~~SFAS ~~products,~~149 ~~and~~is ~~the~~generally ~~potential~~effective ~~use of funds~~ for ~~strategic~~contracts ~~purposes.~~entered Ininto ~~seeking~~or ~~additional funds,~~modified weafter ~~may sell additional equity~~June 30, ~~debt~~2003, ~~or convertible securities, attempt~~ toand ~~obtain~~for ~~credit~~hedging ~~facilities,~~relationships ordesignated ~~seek~~after ~~to derive cash from the licensing or sale of remaining assets; however~~June 30, ~~there can be no assurance that we will be able to obtain such funds or on terms that are acceptable~~2003. ~~Our~~The ~~stock~~Company ~~is currently~~does ~~trading~~not atexpect ~~prices less than $1 per share. If our stock continues to trade at this level, our stock could be delisted from~~ the ~~Nasdaq~~adoption ~~SmallCap~~of ~~Market~~SFAS ~~and~~149 ~~our ability~~ to ~~obtain~~have ~~financing may suffer as~~ a ~~result.~~significant Inimpact ~~addition,~~on ~~if we are~~its ~~unable~~financial toposition ~~raise~~or ~~sufficient~~results ~~additional capital by the first half~~ of ~~2003, we could be required to sell or discontinue our business~~ operations.

~~-18-~~ In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity.” SFAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. SFAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003. SFAS 150 is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the statement and still existing at the beginning of the interim period of adoption. The Company does not expect the adoption of SFAS 150 to have a significant impact on its financial position or results of operations.

- 19 -

Certain Factors That May Affect Future Results of Operations

Our actual results ~~could~~may differ materially from those anticipated ~~or stated or implied by forward-looking statements in this report~~ due to a ~~variety~~ variety of factors, including those ~~risks~~set ~~and~~forth ~~uncertainties~~in ~~associated~~the ~~with~~following ~~our business which include, but are not limited to, those~~ risk factors ~~disclosed~~and ~~below,~~elsewhere in ~~our~~this ~~most~~document. ~~recent~~We ~~filings~~will ~~with~~not ~~the~~update ~~Securities~~any ~~and~~forward-looking ~~Exchange Commission~~statements ~~(the~~due ~~“SEC”),~~to ~~and~~new ininformation, ~~our~~future ~~2001~~events ~~Annual~~or ~~Report on Form 10-K filed with the SEC on March 28, 2002~~otherwise.

~~Our~~We ~~embedded~~might ~~systems~~not ~~development~~be ~~tools~~able ~~business~~to ~~has~~sell ~~accounted~~certain ~~for all~~ of our ~~revenues~~ toassets ~~date;~~or weto doreceive ~~not have any immediate source of revenue, and we expect~~reasonable tovalue ~~incur~~from ~~significant~~the ~~losses~~sale ~~for an indefinite period~~ of ~~time~~our assets.

The ~~embedded~~value ~~systems~~that ~~development~~shareholders ~~tools~~ultimately ~~business~~realize weas ~~sold~~a ~~has~~result ~~historically accounted~~of ~~for~~the ~~all~~sale of our ~~revenue.~~assets ~~Our~~and ~~Libra~~the ~~Networks~~liquidation ~~business~~of ~~involves~~Applied is dependent in part on the proceeds ~~development~~received offrom athe ~~new~~sale ~~and~~of asthe ~~yet~~assets ~~unreleased~~or ~~product~~other ~~line~~disposition ~~with~~of noour ~~market~~operating ~~penetration~~assets. inOur aassets ~~highly~~include ~~competitive~~certain ~~market~~technology ~~sector~~and ~~typified~~intellectual byproperty ~~rapid~~for which ~~changes~~we ~~in technology~~may ~~and~~not ~~competitive~~be ~~products~~able to find a buyer. WeDespite doour ~~not~~ongoing ~~expect~~efforts to sell our Libra Networks ~~business~~ toassets ~~produce~~and ~~any~~technology ~~revenues~~and incertain ~~the~~other ~~near term~~intellectual property, ~~and~~ we ~~plan~~currently todo ~~operate~~not athave a ~~loss~~ ~~until~~buyer atfor ~~least~~these ~~2004~~assets. We ~~can~~may ~~provide~~be nounable to ~~assurance~~sell ~~regarding~~certain ~~when~~of orour toassets and may not realize any value from these assets. ~~what~~In ~~extent~~addition ~~Libra~~it ~~Networks~~may ~~will~~be ~~begin~~difficult to ~~produce~~obtain ~~revenues,~~a orfavorable ~~whether~~return wewhen ~~will~~selling our ~~ever~~operating ~~reach~~assets ~~profitability.~~in Ifconnection with the liquidation and dissolution of Applied. Because we are ~~unable~~seeking to ~~achieve~~consummate ~~significant~~the ~~levels~~liquidation of our remaining assets ~~recurring~~in ~~revenue~~the ~~from~~near ~~our~~to ~~Libra~~short ~~Networks~~term ~~business,~~in ~~our~~order to minimize the losses ~~will~~associated ~~likely~~with ~~continue~~operating ~~indefinitely.~~Applied, Ifwe ~~this~~may ~~occurs,~~not ~~the~~realize ~~market~~as ~~price~~much ofvalue ~~our~~for ~~common~~these ~~stock~~assets as we ~~could~~might ~~suffer~~have asif ~~well~~we ashad been able to sell our ~~viability~~business as a going concern.

InWe ~~addition,~~do wenot ~~have~~plan ~~certain~~to ~~remaining~~obtain ~~obligations~~a infairness ~~connection~~opinion with ~~our embedded~~respect ~~systems~~to ~~development~~the ~~tools~~sale ~~business that are not needed for~~ of our Libra Networks ~~business.~~technology ~~These~~and ~~obligations~~assets; ~~were not transferred in the asset sale~~therefore, ~~and~~ we ~~will~~cannot ~~continue~~assure shareholders tothat ~~bear~~ the ~~costs~~price ofwe ~~these~~may ~~commitments~~negotiate ~~even~~for ~~though~~these ~~the development~~assets ofis the ~~Libra~~best possible ~~Networks~~price ~~business~~we ~~will~~could ~~not~~obtain. ~~benefit~~While ~~from~~we ~~such commitments.~~will Weattempt ~~also~~to ~~have~~obtain ~~certain~~the ~~foreign~~best ~~subsidiaries~~price in ~~that~~connection ~~are~~with ~~unnecessary in~~ the ~~operation~~sale of ~~the~~our Libra Networks ~~business.~~technology Weand ~~anticipate incurring costs in connection with winding down these subsidiaries~~assets, ~~including but not limited to~~there ~~severance~~can ~~obligations~~be ~~and~~no ~~lease~~assurance ~~terminations.~~that Wethe ~~also~~value ~~have~~we ~~remaining~~realize ~~certain severance~~from ~~expenses~~the ~~related~~sale toof ~~U.S.~~these ~~personnel who were not employed by~~assets ~~Metrowerks~~will ~~and~~reflect ~~were~~the ~~not~~potential ~~required~~future ~~for~~value ~~the~~of ~~Libra~~these ~~business~~assets.

WeThe dotiming ~~not~~of ~~currently~~liquidating ~~have~~payments ~~sufficient~~and ~~working~~total ~~capital~~value toshareholders ~~fund~~receive ~~our Libra Networks~~upon ~~business,~~liquidation ~~and~~is wesubject ~~may be unable~~ to ~~obtain~~many ~~additional~~variables ~~capital.~~and ~~If we raise additional financing, you may suffer significant dilution~~risks.

WeShareholders ~~anticipate~~may ~~that~~receive wedistributions ~~will~~from ~~need~~us or a ~~third-party~~liquidating ~~investment~~trust, inas the case may be, the ~~first~~timing ~~half~~ of ~~2003~~which towill ~~provide~~be ~~additional~~at ~~working~~the ~~capital~~discretion ~~for~~of ~~our~~management ~~Libra~~or the ~~Networks~~trustee ~~business. We~~or ~~cannot~~trustees, beunless ~~certain~~it ~~that~~is ~~financing~~determined ~~from~~that ~~third~~any ~~parties~~such ~~will~~distribution would be ~~available~~inconsistent ~~on acceptable~~with ~~terms~~the topurposes usof orthe atPlan ~~all.~~of ~~The~~Complete ~~extent~~Liquidation and Dissolution. ~~timing~~The distribution of our ~~future~~assets ~~capital requirements~~to ~~will~~shareholders ~~depend~~may ~~upon~~be ~~several~~delayed ~~factors,~~for a ~~including~~number ~~the rate~~ of ~~market acceptance of our products~~reasons, ~~the~~including ~~degree~~statutes of ~~competition~~limitation ~~for~~with ~~our~~respect ~~products,~~to ~~our~~certain ~~ability~~claims ~~to build~~ and ~~expand~~the anrisk ~~efficient~~that ~~indirect~~one ~~distribution~~or ~~system,~~more ~~and~~of our ~~level~~ ofcreditors ~~expenditures~~might ~~for~~seek ~~product~~an ~~development, sales, and marketing activities.~~injunction Ifagainst our ~~capital~~making ~~requirements~~the ~~vary~~proposed ~~materially~~distributions ~~from~~to ~~those~~shareholders ~~currently~~under ~~planned,~~the weterms ~~may~~of ~~require~~the ~~financing~~Plan ~~sooner~~of ~~than~~Complete ~~anticipated~~Liquidation and Dissolution. The ~~level~~value of ~~funding of~~what ~~pre-revenue-stage~~shareholders ~~companies~~receive ~~generally~~will bybe ~~both~~a ~~venture~~product ~~funds~~of various factors and ~~strategic~~risks, including ~~investors~~the ~~has~~proceeds ~~fallen~~received ~~dramatically~~from in the ~~past~~sale ~~two~~or ~~years,~~other ~~and~~disposition ~~this~~of isour ~~equally~~remaining ~~true~~assets, inand the ~~interconnect~~amount ~~and~~of ~~networking~~Applied’s ~~technologies~~actual ~~space~~and potential liabilities. If ~~we cannot raise~~our ~~funds~~liabilities onprove ~~acceptable~~to ~~terms, we may not~~ be ~~able~~higher tothan ~~develop~~anticipated, ~~our~~additional ~~products~~creditors ~~and services~~appear, or ~~take~~legal ~~advantage~~action ofis ~~future~~brought ~~opportunities,~~against orus ~~respond~~by tocreditors ~~competitive pressures~~ or ~~unanticipated requirements~~others, ~~any~~it ofis ~~which could have a material~~possible ~~adverse~~that ~~effect~~the onplanned ~~our~~distribution ~~ability~~ to ~~grow~~shareholders ~~our~~could ~~business.~~be Indelayed ~~addition~~or reduced, weor there ~~may~~could be ~~required~~ tonothing ~~sell~~remaining oravailable ~~discontinue~~for distribution to shareholders.

~~-19-~~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

- 20 -

~~operations~~creditor ofor ~~our~~a creditor ~~business.~~that ~~Further,~~was ifnot weknown ~~issue~~to ~~equity~~us ~~securities~~can still, ~~you~~within ~~may experience~~two ~~severe~~years ~~dilution~~ of ~~your ownership percentage~~our dissolution, ~~and~~bring ~~the new equity~~a ~~securities~~lawsuit ~~may~~against ~~have~~Applied ~~rights,~~and ~~preferences~~its orformer ~~privileges~~shareholders ~~senior~~for toany ~~those~~amount ofunpaid. ~~our~~All ~~common~~shareholders ~~stock.~~who Ifreceive ~~our~~proceeds ~~common~~from ~~stock~~the isliquidation ~~listed~~may onbe ~~The~~liable ~~Nasdaq~~to ~~SmallCap Market at~~a ~~the~~creditor ~~time~~who ofhas a ~~proposed~~valid ~~equity~~claim ~~financing~~that ~~resulting~~exceeds in the ~~sale~~amount ~~and~~retained ~~issuance~~by ~~of twenty~~us ~~percent~~ or ~~more of~~ the ~~outstanding shares of our capital stock, we will~~ beliquidating ~~required~~trust tofor ~~obtain~~the ~~shareholder~~purpose ~~approval~~ of ~~such~~settling ~~issuance.~~claims, ~~There~~up ~~can be no assurance that we will be able~~ to ~~obtain~~the ~~any~~amount ~~necessary shareholder approval,~~they ~~and~~received in the ~~failure to obtain such approval could limit our ability to obtain needed capital~~liquidation.

We ~~are~~may ~~dependent~~be onrequired ato ~~single~~pay ~~line~~up ofto ~~business~~$3.3 million ~~that~~to ~~currently~~Metrowerks ~~has~~Corporation ~~no products or~~for ~~revenues.~~potential Webreaches ~~cannot~~of ~~predict~~ our ~~future~~representations ~~results~~in ~~because~~the ~~our~~asset ~~Libra~~purchase ~~Networks~~agreement dated ~~business~~as ~~has~~of noSeptember 3, ~~operating history~~2002.

~~Our~~Under ~~only~~the ~~line~~terms of ~~business~~the isasset ~~the~~purchase ~~development~~agreement ofthat ~~the~~we ~~Libra~~entered ~~Networks~~into on ~~products~~September 3, ~~and~~2002, ~~technology.~~we We have ~~not~~an ~~yet~~obligation ~~developed~~to ~~any~~indemnify ~~products~~Metrowerks ~~based~~for onany ~~this~~losses ~~technology,~~from ~~and~~potential ~~consequently~~breaches ~~there~~of ~~are~~our ~~currently~~representations noor ~~revenues~~warranties ~~from~~that ~~this~~are ~~line of~~asserted ~~business.~~within ~~Furthermore,~~12 months weafter ~~cannot~~the ~~provide~~closing ~~assurance~~date ~~that~~of ~~any~~the ~~products~~asset ~~will~~sale ~~be developed on this technology~~ or within the applicable ~~timing~~statute of ~~such~~limitations ~~developments~~period iffor aclaims ~~product~~relating isto our ownership ~~created.~~of ~~Given~~our ~~the~~assets, ~~lack~~payment of ~~operating~~our ~~history~~taxes, inand ~~the~~our ~~Libra~~compliance ~~Networks~~with ~~business~~applicable laws, itif islonger. ~~difficult~~Our toindemnification ~~predict~~obligations ~~our~~are ~~future~~limited ~~results.~~to ~~The~~an ~~Libra~~overall ~~Networks~~amount ~~business is~~of ~~characterized~~$3.3 million. byAlthough ~~rapid~~we ~~technological~~currently ~~change,~~are ~~new~~not ~~product~~aware ~~development,~~of aany ~~new~~material ~~and~~breaches of ~~unproven~~our ~~business~~representations ~~model~~or warranties, ~~and~~the ~~evolving~~payment ~~industry~~of ~~standards.~~any ~~You~~such ~~should consider~~indemnification ~~the~~obligations ~~risks~~would ~~and~~decrease ~~uncertainties~~the ~~that~~amount weof ~~may~~cash ~~encounter~~we aswould ahave ~~pre-revenue-stage~~available to ~~company~~distribute to shareholders in athe ~~new~~liquidation and ~~rapidly~~it ~~evolving~~is ~~market.~~very ~~These~~likely ~~uncertainties~~that ~~include:~~there would be nothing remaining available for distribution to shareholders.

• our ability to design and engineer products having the technological features planned for the Libra Networks product line; • customer 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~~21 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.-

We may be required to pay up to $3.3 million to Metrowerks for breaches of our representations in the asset sale agreement.

We have an obligation to indemnify Metrowerks for any losses from breaches of our representations or warranties in the asset sale agreement that occur 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 by an overall cap of $3.3 million on the amount of the indemnification. Although we know of no breaches of our representations or warranties, the payment of any such indemnification obligations would adversely impact our cash resources and our ability to pursue our Libra Networks business, or the timing and amount of any distribution to shareholders in the event of liquidation of the Company.

-20-

Following the asset sale, our cash resources are limited and could be diminished due to our inability to collect on our accounts receivable and utilize or liquidate inventory not sold to Metrowerks.

The proceeds from the asset sale along with our current working capital are not sufficient to fund our continuing business. After closing the asset sale, we have limited cash resources, which we will need to manage carefully until we are able to raise additional capital. After the asset sale, we expect to collect cash from certain accounts receivable that we retained. If we are unable to collect upon these accounts, our cash resources will be less than we anticipate. Our debtors may not pay us due to their insolvency, bankruptcy, lack of funds, or refusal to pay. As a result of the asset sale, our business relationship with many of our debtors has been terminated, and some of our debtors may be more likely to delay payments or attempt to renegotiate amounts owing. There can be no assurance that Metrowerks will cooperate with us to collect these accounts. Furthermore, the transition from our historical business of developing tools for embedded software systems to our Libra Networks business may prevent us from utilizing certain inventories that could otherwise have been revenue-producing, and we may be unable to sell such inventories to third parties, or such sales may be at distressed prices.

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:

• 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 will 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 will 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 may not achieve market acceptance or demand for our products within our target base of customers, because our products will not operate with many of the applications they currently use.

-21-

If we are unable to secure funding for Libra Networks, or the outlook for funding represents unacceptable risks, we may choose to liquidate the Company, and any distribution to shareholders is subject to significant uncertainty.

The Company is focusing effort on raising funds for Libra Networks; however, the Company is also considering whether the value deliverable to shareholders might be optimized by liquidating the company rather than continuing to pursue the Libra Networks opportunity. Liquidation of a corporation is not a simple process, and would require a shareholder vote. Even after shareholder approval, liquidation distributions to shareholders might have to be delayed for a lengthy period of time, so that assets remaining after the asset sale can be sold, so that known and contingent creditors can be satisfied, and so that the indemnification obligations in favor of Metrowerks can expire or be otherwise provided for. A liquidation of Applied would also involve numerous other complexities, including tax consequences to shareholders and potential severance obligations to certain company executives and to other Applied personnel. The process of liquidation, including the satisfaction or settlement of our contingent liabilities and indemnification obligations, presents significant uncertainties surrounding the timing and amount of any distribution to shareholders. In the event of liquidation, there can be no assurance that any assets will be available for distribution to shareholders.

If we are unable to derive revenue from new products or services, our revenues, operating results, earnings, or future projections may be adversely affected and our business would be harmed.

Our revenues have declined the past three years and in the quarter ended September 30, 2002, and we incurred corresponding operating losses in each of these periods. In addition, we have now sold the assets that provided our historical revenue base. We believe that our success will depend in large part on our ability to improve our financial performance and long-term strategic direction, including the introduction of new products and services. In May 2002, we announced that we had acquired REBA Technologies, Inc., and formed Libra Networks, a division of Applied Microsystems. We have historically been a developer of tools for use by embedded systems developers, and the REBA acquisition represents an expansion into development of hardware and software products aimed at end-user markets — specifically, corporate data centers, in which we have limited experience. As we enter new lines of business, we also expect to encounter new competitors and different business challenges. Factors that may affect our ability to improve our financial performance include, but are not limited to:

• our ability to manage our limited cash resources long enough for us to improve our financial performance; • our ability to integrate REBA into our Libra Networks business and to expand into development of hardware and software products aimed at end-user markets; • the introduction of our Libra Networks products or our competitors’ products; • the mix of our Libra Networks products and services sold; • the mix of our domestic and international sales; • unfavorable economic conditions in the technology industry; • decreased spending on technology due to adverse economic conditions; • changes in accounting pronouncements applicable to us; and • global economic conditions.

-22-

If we are unable to derive revenue from new products or services, our revenues, operating results, earnings, or future projections may be adversely affected. In addition, if our operating results are below the levels expected by investors or securities analysts, the price of our common stock could decline.

If we are unable to meet the listing requirements for the Nasdaq SmallCap Market, we may be delisted, which would likely have a material adverse impact on our share price and our ability to obtain additional funding.

The Company’s common stock is currently quoted on the Nasdaq SmallCap Market (the “SmallCap Market”). However, in order to continue to be included in the SmallCap Market, a company must maintain, among other things, a minimum closing bid price of $1.00 per share and a $1,000,000 market value of the total outstanding shares, excluding those held by officers, directors or beneficial owners of ten percent or more of the outstanding shares. The closing price of our common stock was $0.16 per share on November 4, 2002, with a corresponding total market value on that date of $1.2 million. In order to maintain compliance with the SmallCap Market listing requirements, we may be required to take various measures including, but not limited to, raising additional capital and implementing a reverse split of the Company’s common stock. Certain of such measures, including any reverse stock split, would require shareholder approval. Failure to meet any of the SmallCap Market maintenance criteria in the future may result in the delisting of the Company’s common stock from the SmallCap Market. The delisting of the Company’s common stock would have an adverse impact on the market price and liquidity of the Company’s securities and may adversely affect the Company’s ability to obtain additional financing. As a result of such delisting, an investor may find it more difficult to dispose of, or to obtain accurate quotations as to the market value of, the Company’s common stock.

The emergence of InfiniBand, the Switch Fabric communication technology that will 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. InfiniBand is currently the only new Switch Fabric technology available for widespread usage. Libra Networks is an active member of the InfiniBand Trade Association (IBTA) — an organization founded by major technology companies such as Compaq Computer Corp., Dell Computer Corp., Hewlett-Packard Co., IBM Corp., Intel Corp., Microsoft Corp., and Sun Microsystems Inc., to jointly develop InfiniBand specifications and to promote its adoption as a worldwide standard for server-to-server, and network-to-server interconnect solutions.

In the second quarter of 2002, Microsoft and Intel each announced that they will limit further investments in InfiniBand-based products. Specifically, Intel announced that it will stop developing host channel adapter chips for InfiniBand; and Microsoft stated that it no longer plans to incorporate InfiniBand into 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. It is unclear whether these announcements reflect a loss of confidence in the InfiniBand technology as a potential worldwide interconnect standard, or are merely financial decisions based upon uncertainties as to how quickly the market for InfiniBand products will materialize or based upon other internal resource-allocation considerations. If InfiniBand is not accepted as a standard in the marketplace, our products will have to be redesigned to operate under a different architecture. While we plan to incorporate other emerging switch fabric technologies in future releases of our Libra Networks products, delays in product releases and slower revenue growth would be likely since no other switch fabric alternatives are expected

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to be available in the same time frame as InfiniBand.

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

We expect to depend on relationships with third parties such as Intel, Mellanox, and others who may be sole source providers of key, leading-edge hardware and software components critical for some of the products we are developing in 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 will 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. The products being developed by us may contain undetected flaws when introduced. There can be no assurance that, despite testing by us and by potential customers, flaws will not be found in the products, resulting in loss of or delay in market acceptance. 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 are attempting to finish development of our products, a competitor will 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.

We are highly dependent on our key personnel to manage our business, and because of competition for qualified personnel we may not be able to recruit or retain necessary personnel.

Our continued growth and success depend to a significant degree on the continued services of our senior management and other key employees and our ability to attract and retain highly skilled and experienced technical, managerial, sales, and marketing personnel. We have historically been a developer of tools for use by embedded software systems developers. Our Libra Networks business represents an expansion into development of hardware and software products aimed at end-user markets — specifically, corporate data centers — in which we have limited experience. As we enter this new line of business, we also expect to encounter new product development challenges, new customer requirements, new competitors and other new business challenges, with which our existing management may be unfamiliar. Our management may lack the necessary knowledge, strategic and customer contacts, and experience to effectively meet the demands of the market our Libra Networks business targets, and competition for such personnel is intense. There can be no assurance that we will be successful in recruiting new personnel or in retaining existing personnel. Except for Stephen J. Verleye, our President and Chief Executive Officer, none of our employees is subject to a long-term employment agreement. The loss of one or more key employees or our inability to attract additional qualified employees could

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have a material adverse effect on our business, results of operations and financial condition. In addition, we may experience increased compensation costs in order to attract and retain skilled employees.

If we are unable to manage our potential growth or our cost-reduction and restructuring plans, our competitive position, results of operations and financial condition could suffer.

We seek to grow our business by providing solutions to new markets. Such growth, if achieved, would place additional burdens on our management and increase the requirement to recruit and retain personnel with the right skill sets, as well as require additional infrastructure expenditures. This growth also would place a significant strain on our financial, operational, management, marketing, and sales systems and resources, especially after our implementation of our restructuring plans that included a significant reduction in personnel and the further significant reduction in personnel after selling our embedded systems development tools assets. If we are unable to effectively manage such potential growth, our business, competitive position, results of operations, and financial condition could suffer.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

We ~~develop~~are ~~products~~exposed into ~~the~~market ~~United~~risk ~~States~~related ~~and~~to ~~sell~~changes ~~primarily~~ in ~~North America~~interest rates, ~~Asia~~which could ~~and~~adversely ~~Europe~~affect the value of our short-term investments. AsWe maintain a short-term ~~result,~~investment ~~financial~~portfolio ~~results~~consisting ~~could~~of beinterest ~~affected~~bearing bysecurities with ~~factors~~an ~~such~~average asmaturity ~~changes~~of inless ~~foreign~~than ~~currency~~one ~~exchange~~year. ~~rates~~Certain orof ~~weak~~these ~~economic~~securities may be ~~conditions~~classified inas ~~foreign~~“available-for-sale” ~~markets~~securities, though no such securities met that classification as of June 30, 2003. ~~Since~~These ~~our~~interest-bearing ~~products~~securities are subject ~~generally~~to ~~initially priced~~interest rate risk and will fall in Uvalue if market interest rates increase.S. ~~Dollars~~If ~~and~~market ~~translated~~interest rates were to ~~local~~increase ~~currency~~immediately ~~amounts,~~and auniformly ~~strengthening~~to 110% of their levels at June 30, 2003, the ~~dollar~~fair ~~could~~value ~~make~~of the portfolio would decline by an immaterial amount. We do not expect our ~~products~~operating ~~less~~results ~~competitive~~or cash inflows ~~foreign~~to be affected to any significant degree by a sudden change in ~~markets~~market interest rates.

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. These securities are classified as “available-for-sale” securities. 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 September 30, 2002, 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~~evaluated anthe ~~evaluation~~effectiveness of our disclosure controls and procedures, as such ~~term~~ term is defined under Rule 13a-1415(ce) promulgated under the Securities Exchange ~~Act~~ Act of 1934, as amended ~~(the “Exchange Act”), within 90 days of the filing date of this report~~. Based on ~~their~~this evaluation, our principal executive officer and principal accounting officer concluded that our disclosure controls ~~and~~ and procedures ~~are~~were effective as of the end of the period covered by their quarterly report.

~~(b) There~~- ~~have~~22 ~~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.~~

PART II — OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

A Special Meeting of Shareholders was held on October 29, 2002. The following summarizes the results of matters voted upon at the Annual Meeting:

The shareholders voted 4,529,911 shares in the affirmative, 173,093 shares in the negative, and 10,453 shares abstained relative to approval of the Asset Purchase Agreement dated as of September 3, 2002, by and between Metrowerks Corporation, a Texas corporation and wholly owned subsidiary of Motorola, Inc., a Delaware corporation, and Applied Microsystems Corporation, a Washington corporation, and to approve the proposed sale of Applied’s embedded systems development tools business and assets to Metrowerks.

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PART II - OTHER INFORMATION

Item 4. Submission of Matters to a Vote of Security Holders

We held a special meeting of shareholders on April 30, 2003, which was reconvened on May 22, 2003. The purpose of the meeting was to consider a proposal to voluntarily dissolve the Company and to authorize, approve, and adopt the Plan of Complete Liquidation and Dissolution of Applied. The shareholders approved the Plan of Complete Liquidation and Dissolution on May 22, 2003.

The following summarizes the results of the matter considered at the special meeting:


			Percentage of Shares
		Votes	Outstanding

	For	4,050,844		53.32	%
Against		39,964		0.53	%
Abstain		8,160		0.11	%

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 September 3, 2002, regarding the execution of an agreement to sell our embedded systems development tools business to Metrowerks Corporation, a wholly owned subsidiary of Motorola, Inc.
			We filed a report on Form 8-K dated September 12, 2002, regarding our notification that Nasdaq approved our application to transfer Applied’s common stock to the Nasdaq SmallCap Market.
			We filed a report on Form 8-K dated October 15, 2002, regarding an agreement to terminate our headquarters facility lease.
			We filed a report on Form 8-K dated November 4, 2002, regarding our closing the sale of our embedded systems development tools business to Metrowerks.

(a)

The following exhibits are filed as part of this report.


			31.1			Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

			31.2			Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

			32.1			Certification of Chief Executive Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

			32.2			Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

	(b)		Reports on Form 8-K

			We filed a current report on Form 8-K on May 1, 2003 in which we disclosed that the special meeting of shareholders scheduled for April 30, 2003, had been adjourned until May 22, 2003.

			We filed a current report on Form 8-K on May 27, 2003, in which we reported that the shareholders adopted the Plan of Complete Liquidation and Dissolution of Applied.

			We filed a current report on Form 8-K on July 1, 2003, in which we disclosed that we filed Articles of Dissolution which became effective upon filing. We also instructed our transfer agent to close the share transfer records of the Company as of the close of business on June 30, 2003, and to no longer recognize or record any transfers of shares of Applied’s common stock.

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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
	APPLIED MICROSYSTEMS CORPORATION (Registrant)
	(Registrant)
Date: August 19, 2003	By:	/s/ Robert C. Bateman
Date: November 13, 2002	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)

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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.

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Date:		November 13, 2002
/s/ Robert C. Bateman
Robert C. Bateman Vice President, Chief Financial Officer, Secretary and Treasurer

I, Stephen J. Verleye, certify that:

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Date:		November 13, 2002
/s/ Stephen J. Verleye
Stephen J. Verleye President and Chief Executive Officer

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