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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549


FORM 10-Q




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|           |  |                                                                                        
|---------- |  | ---------------------------------------------------------------------------------------
|(Mark One)
|[X]        |  | Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2003

or

|     |  |                                                                                         
|---- |  | ----------------------------------------------------------------------------------------
|[  ] |  | Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from
________________ to ________________

Commission File Number 0-26778



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APPLIED MICROSYSTEMS CORPORATION

(Exact name of registrant as specified in its charter)




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

16770 NE 79th Street, #103, Redmond, Washington 98052
(425) 883-1606
(Address of principal executive offices, including zip code; registrants telephone number, including area code)



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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 July 31, 2003.



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TABLE OF CONTENTS



|                               |                                                                                               |                                                                                                                                                                     |  |  |  |  |  | 
|------------------------------ | --------------------------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  |  |  |  |  | 
|PART I  FINANCIAL INFORMATION
|                               | Item 1. Financial Statements                                                                 
|                               |                                                                                               | CONSOLIDATED STATEMENT OF NET ASSETS IN LIQUIDATION AS OF JUNE 30, 2003, AND CONSOLIDATEDBALANCE SHEET AS OF DECEMBER 31, 2002                                     
|                               |                                                                                               | 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   
|                               | Item 4. Submission of Matters to a Vote of Security Holders                                  
|                               | Item 6. Exhibits and Reports on Form 8-K                                                     
|SIGNATURES                    
|EXHIBIT 31.1                  
|EXHIBIT 31.2                  
|EXHIBIT 32.1                  
|EXHIBIT 32.2                  



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APPLIED MICROSYSTEMS CORPORATION

FORM 10-Q

QUARTER ENDED JUNE 30, 2003

INDEX

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

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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 SHEET AS OF DECEMBER 31, 2002

|                                                                                                                                            |                                      |   |                |       |              |   |         |       | 
|------------------------------------------------------------------------------------------------------------------------------------------- | ------------------------------------ | - | -------------- | ----- | ------------ | - | ------- | ----- | 
|                                                                                                                                            |                                      |   | June 30,       |       | December 31,
|                                                                                                                                            |                                      |   | 2003           |       | 2002        
|                                                                                                                                            |                                      |   |                |       |             
|                                                                                                                                            |                                      |   | (unaudited)    |       |              |   |        
|                                                                                                                                            |                                      |   | (in thousands)
|ASSETS                                                                                                                                      |                                      |   |                |       |              |   |         |      
|Current assets:                                                                                                                             |                                      |   |                |       |              |   |         |      
|                                                                                                                                            | Cash and cash equivalents            |   | $              | 1,510 |              |   | $       | 3,600 | 
|                                                                                                                                            | Securities available-for-sale        |   |                |      |              |   |         | 299   | 
|                                                                                                                                            | Accounts receivable, net             |   |                |      |              |   |         | 280   | 
|                                                                                                                                            | Note receivable                      |   |                | 500   |              |   |         | 500   | 
|                                                                                                                                            | Prepaid and other current assets     |   |                | 161   |              |   |         | 449   | 
|                                                                                                                                            | Property and equipment held for sale |   |                | 58    |              |   |         | 91    | 
|                                                                                                                                            |                                      |   |                |       |              |   |         |       | 
|Total assets                                                                                                                                |                                      | $ | 2,229          |       |              | $ | 5,219   |      
|                                                                                                                                            |                                      |   |                |       |              |   |         |       | 
|LIABILITIES AND SHAREHOLDERS EQUITY                                                                                                        |                                      |   |                |       |              |   |         |      
|Current liabilities:                                                                                                                        |                                      |   |                |       |              |   |         |      
|                                                                                                                                            | Accounts payable                     |   | $              | 293   |              |   | $       | 744   | 
|                                                                                                                                            | Accrued payroll                      |   |                | 42    |              |   |         | 1,143 | 
|                                                                                                                                            | Other accrued expenses               |   |                | 482   |              |   |         | 765   | 
|                                                                                                                                            | Deferred revenue                     |   |                | 325   |              |   |         | 325   | 
|                                                                                                                                            | Capital lease obligation             |   |                | 171   |              |   |         | 175   | 
|                                                                                                                                            | Notes payable                        |   |                | 190   |              |   |         | 185   | 
|                                                                                                                                            |                                      |   |                |       |              |   |         |       | 
|Total current liabilities                                                                                                                   |                                      |   | 1,503          |       |              |   | 3,337   |      
|Commitments and contingencies                                                                                                               |                                      |   |               |       |              |   |        |      
|Shareholders equity:                                                                                                                       |                                      |   |                |       |              |   |         |      
|Preferred stock, $0.01 par value;
5,000,000 shares authorized; none issued
and outstanding                                                  |                                      |   |               |       |              |   |        |      
|Common stock, $0.01 par value; 25,000,000
shares authorized; 7,597,000 shares
issued and outstanding at June 30, 2003
and December 31, 2002 |                                      |   | 27,233         |       |              |   | 27,233  |      
|Accumulated deficit                                                                                                                         |                                      |   | (26,507        | )     |              |   | (25,351 | )    
|                                                                                                                                            |                                      |   |                |       |              |   |         |       | 
|Total shareholders equity                                                                                                                  |                                      |   | 726            |       |              |   | 1,882   |      
|                                                                                                                                            |                                      |   |                |       |              |   |         |       | 
|Total liabilities and shareholders equity                                                                                                  |                                      | $ | 2,229          |       |              | $ | 5,219   |      
|                                                                                                                                            |                                      |   |                |       |              |   |         |       | 

See accompanying notes.

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APPLIED MICROSYSTEMS CORPORATION

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)

|                                                                            |                                                                        |                                                                        |                                           |     |                           |        |        |        |        |        |  
|--------------------------------------------------------------------------- | ---------------------------------------------------------------------- | ---------------------------------------------------------------------- | ----------------------------------------- | --- | ------------------------- | ------ | ------ | ------ | ------ | ------ | -
|                                                                            |                                                                        |                                                                        |                                           |     | Six Months Ended June 30,
|                                                                            |                                                                        |                                                                        |                                           |     |                          
|                                                                            |                                                                        |                                                                        |                                           |     | 2003                      |        | 2002  
|                                                                            |                                                                        |                                                                        |                                           |     |                           |        |       
|                                                                            |                                                                        |                                                                        |                                           |     | (in thousands)           
|Operating activities                                                        |                                                                        |                                                                        |                                           |     |                           |        |        |       
|Net loss                                                                    |                                                                        | $                                                                      | (1,156                                    | )   |                           | $      | (4,635 | )     
|Adjustments to reconcile net loss to net cash used in operating activities: |                                                                        |                                                                        |                                           |     |                           |        |        |       
|                                                                            | Depreciation and amortization                                          |                                                                        |                                           | 8   |                           |        |        | 394    |       
|                                                                            | In-process research and development                                    |                                                                        |                                           |    |                           |        |        | 621    |       
|                                                                            | (Gain) loss on write-off and/or disposal or sale of assets             |                                                                        |                                           | (33 | )                         |        |        | 72     |       
|                                                                            | Net change in operating accounts:                                      |                                                                        |                                           |     |                           |        |        |        |       
|                                                                            |                                                                        | Accounts receivable                                                    |                                           |     | 280                       |        |        |        | 1,945  |       
|                                                                            |                                                                        | Inventories                                                            |                                           |     |                          |        |        |        | 475    |       
|                                                                            |                                                                        | Prepaid and other assets                                               |                                           |     | 288                       |        |        |        | (14    | )     
|                                                                            |                                                                        | Accounts payable, accrued expenses, and accrued business
restructuring |                                           |     | (1,834                    | )      |        |        | 174    |       
|                                                                            |                                                                        | Deferred revenue                                                       |                                           |     |                          |        |        |        | (1,216 | )     
|                                                                            |                                                                        |                                                                        |                                           |     |                           |        |        |       
|                                                                            |                                                                        |                                                                        | Net cash used in operating activities     |     |                           | (2,447 | )      |        |        | (2,184 | )
|Investing activities                                                        |                                                                        |                                                                        |                                           |     |                           |        |        |       
|                                                                            | Purchases of securities available-for-sale                             |                                                                        |                                           |    |                           |        |        | (2,275 | )     
|                                                                            | Maturities of securities available-for-sale                            |                                                                        |                                           | 299 |                           |        |        | 3,483  |       
|                                                                            | Net proceeds from sale and disposal of long-lived assets held for
sale |                                                                        |                                           | 58  |                           |        |        |       |       
|                                                                            | Additions to property and equipment                                    |                                                                        |                                           |    |                           |        |        | (72    | )     
|                                                                            |                                                                        |                                                                        |                                           |     |                           |        |        |       
|                                                                            |                                                                        |                                                                        | Net cash provided by investing activities |     |                           | 357    |        |        |        | 1,136  |  
|Financing activities                                                        |                                                                        |                                                                        |                                           |     |                           |        |        |       
|                                                                            | Sale of common stock to employees                                      |                                                                        |                                           |    |                           |        |        | 48     |       
|                                                                            | Payments on capital lease obligation                                   |                                                                        |                                           |    |                           |        |        | (22    | )     
|                                                                            |                                                                        |                                                                        |                                           |     |                           |        |        |       
|                                                                            |                                                                        |                                                                        | Net cash provided by financing activities |     |                           |       |        |        |        | 26     |  
|Effects of foreign currency exchange rate changes on cash                   |                                                                        |                                                                        |                                          |     |                           |        | 69     |       
|                                                                            |                                                                        |                                                                        |                                           |     |                           |        |        |       
|Net decrease in cash and cash equivalents                                   |                                                                        |                                                                        | (2,090                                    | )   |                           |        | (953   | )     
|Cash and cash equivalents at beginning of period                            |                                                                        |                                                                        | 3,600                                     |     |                           |        | 2,971  |       
|                                                                            |                                                                        |                                                                        |                                           |     |                           |        |        |       
|Cash and cash equivalents at end of period                                  |                                                                        | $                                                                      | 1,510                                     |     |                           | $      | 2,018  |       
|                                                                            |                                                                        |                                                                        |                                           |     |                           |        |        |       

See accompanying notes.

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APPLIED MICROSYSTEMS CORPORATION




NOTES TO CONSOLIDATED FINANCIAL
STATEMENTS
(UNAUDITED)

1.     Basis of Presentation

The accompanying unaudited consolidated financial statements have been
prepared by Applied Microsystems Corporation (Applied or the Company) in
accordance with accounting principles generally accepted in the United States
of America for interim financial information and according to the rules and
regulations of the Securities and Exchange Commission. Accordingly, they do
not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (which
include only normal recurring adjustments) considered necessary for a fair
presentation have been included. The balance sheet at December 31, 2002, has
been derived from the audited financial statements included in the Companys
Annual Report on Form 10-K for the year then ended. The changes in net assets
in liquidation for the three-month and six-month periods ended June 30, 2003,
are not necessarily indicative of results to be expected for the entire year
ending December 31, 2003, or for any other fiscal period. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2002.

On December 16, 2002, the Company announced that the board of directors
had unanimously decided to recommend to shareholders that Applied be
liquidated. 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
June 30, 2003, no stock options remained outstanding, and as of June 30, 2002,
options to purchase 1,377,000 shares of common stock were outstanding; however,
all stock options were excluded from the calculation of loss per share in the
three and six-month periods ended June 30, 2003, and 2002, because their effect
was antidilutive.

3.     Comprehensive Loss

As defined by applicable accounting and reporting standards, Applieds
comprehensive loss is comprised of net loss and the effects of current-period
translation adjustments, which are recorded directly to equity. Assets and
liabilities of foreign subsidiaries are translated to U.S. dollars at the
exchange rates on the balance sheet date. Revenues and expenses of foreign
subsidiaries are translated at the average rates of exchange prevailing during
the year. The cumulative translation adjustments resulting from this process
have historically been accumulated in other comprehensive loss. As a result of
the Companys sale of its embedded systems development tools business and
assets in November 2002, and the subsequent announcement that Applied would
seek corporate liquidation, the Companys international operations were
substantially closed by the end of 2002. The Company therefore recognized a
charge of $593,000 in the fourth quarter of 2002 relating to the write-off of
foreign currency translation adjustments that had accumulated for these
subsidiaries, and the Company had no recorded change in translation adjustments
during the six-months ended June 30, 2003. During the three months ended June
30, 2002, comprehensive loss amounted to $3.4 million. During the six months
ended June 30, 2002, comprehensive loss amounted to $4.6 million.

4.     Sale of Embedded Systems Development Tools Business and Assets

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

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

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

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

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

5.     Business Restructuring Activities

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

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

In the fourth quarter of 2002, after announcing on December 16, 2002 that
the Companys board of directors had unanimously decided to recommend to
shareholders that Applied be liquidated, Applied

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further recognized $906,000 in restructuring charges associated with severance
and benefits for the Companys remaining 26 personnel. Also during the fourth
quarter of 2002, the Company entered into an agreement to terminate its
headquarters facility lease by paying a lease termination fee of approximately
$1.0 million. The lease termination fee was less than the Company had reserved
for abandoned space in the accrued restructuring reserve; therefore, Applied
recognized a net benefit of $351,000 in the restructuring charge in the fourth
quarter of 2002 relating to the elimination of the reserve for abandoned space.

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

|                               |  |              |     |            |  |            |   |              |  |            |     |         |  |   |    | 
|------------------------------ |  | ------------ | --- | ---------- |  | ---------- | - | ------------ |  | ---------- | --- | ------- |  | - | -- | 
|                               |  | 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 of December 31, 2002, the accrued restructuring liabilities consisted
of accrued payroll of $775,000, accounts payable of $96,000, and other accrued
expenses of $8,000. As of June 30, 2003, the accrued restructuring liabilities
consisted of accrued payroll of $25,000, and accounts payable of $27,000.

6.     Acquisition of REBA Technologies, Inc.

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

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

At closing of the transaction, 50% of the merger consideration was placed
into an escrow for the purpose of securing the indemnification obligations of
the REBA shareholders under the merger

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agreement. Those shares and notes will remain in escrow for a period of three
years from the closing date and until all pending claims for indemnification,
if any, have been resolved. In 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.     Stock-Based Compensation

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

As a result of the Companys sale of its embedded systems development
tools business and assets in November 2002, vesting for all stock options under
the 1992 Plan and the 2001 Plan was accelerated so that all outstanding options
under these plans were fully exercisable as of the closing of the transaction.
Because all such unvested options had exercise prices substantially above the
trading price of the Companys common stock as of the closing of the
transaction, no options were exercised as a result of the accelerated vesting,
and all such options were subsequently terminated. Remaining options that had
been granted under the Director Plan were terminated effective as of May 22,
2003, the date that Applieds shareholders approved the liquidation of the
Company. The Company has no remaining stock options outstanding, and does not
intend to grant any additional stock options.

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

|                                                                                |  |                                          |       |                  |  |      |        |      |  |   |        |   |  |   |        |  
|------------------------------------------------------------------------------- |  | ---------------------------------------- | ----- | ---------------- |  | ---- | ------ | ---- |  | - | ------ | - |  | - | ------ | -
|                                                                                |  | Three Months ended                       |       | 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  | )
|                                                                                |  |                                          |       |                  |  |      |        |      |  |   |        |   |  |   |        |  

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8.     Recent Accounting Pronouncements

In April 2003, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 149, 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 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 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.

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

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

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

Overview

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

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

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

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

As a result, our board of directors concluded that there was a low
probability that Libra Networks could achieve timely and sufficient funding to
reasonably support its business plan. Therefore, on December 16, 2002, we
announced that our board of directors had unanimously decided to recommend to
shareholders that Applied be liquidated. Liquidation of a corporation is a
complex process, and 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 accounting for the sale of
our embedded systems development tools assets and business in November 2002,
our plans approved by shareholders on May 22, 2003 to liquidate the Company,
revenue recognition, inventories, accounting for acquisitions such as the May
2002 REBA acquisition, and restructuring activities. We base our estimates and
our future expectations on historical experience and on various other
assumptions that we believe to be reasonable under the circumstances, the
results of which form the basis for making judgments about the carrying values
of assets and liabilities that are not readily apparent from other sources.
Actual results may differ from these estimates under different assumptions or
conditions.

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

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

Our policies with regard to accounting and presentation are based on
Statement of Financial Accounting Standards (SFAS) No. 144, Accounting for
the Impairment or Disposal of Long-Lived Assets. The long-lived corporate
assets relating to the Companys embedded systems development tools business
meet the criteria of long-lived assets to be disposed of by sale, as defined in
SFAS 144. Most such assets were sold prior to the end of 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

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

We also determined that, under the provisions of SFAS 144, many of our
remaining fixed assets as of the end of 2002 were impaired. We therefore
recognized an impairment loss and wrote down our fixed assets to fair value, in
accordance with SFAS 144. No further impairments were recognized in the three
or six months ended June 30, 2003.

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.

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

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

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

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

Consolidated Changes in Net Assets in Liquidation for the Periods Ended June
30, 2003, and Consolidated Results of Operations for the Periods Ended June 30, 2002

|                               |                                     |   |                    |     |                  |   |        |       |      |   |        |       |  |   |        |       | 
|------------------------------ | ----------------------------------- | - | ------------------ | --- | ---------------- | - | ------ | ----- | ---- | - | ------ | ----- |  | - | ------ | ----- | 
|                               |                                     |   | Three Months ended |     | Six Months ended
|                               |                                     |   | June 30,           |     | June 30,        
|                               |                                     |   |                    |     |                 
|                               |                                     |   | 2003               |     | 2002             |   | 2003   |       | 2002
|                               |                                     |   |                    |     |                  |   |        |       |     
|                               |                                     |   | (in thousands)    
|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 | )    
|                               |                                     |   |                    |     |                  |   |        |       |      |   |        |       |  |   |        |      

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

|                                  |                 |      |                    |      |                  |      |       |       |  |   |   |   |  |   |       |       | 
|--------------------------------- | --------------- | ---- | ------------------ | ---- | ---------------- | ---- | ----- | ----- |  | - | - | - |  | - | ----- | ----- | 
|                                  |                 |      | Three Months Ended |      | 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 | 
|                                  |                 |      |                    |      |                  |      |       |       |  |   |   |   |  |   |       |      

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 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 performed periodic
assessments of required reserves for potential inventory obsolescence, and
corresponding adjustments to such reserves were included within cost of sales.

Sales, General and Administrative Expenses. Sales, general, and
administrative expenses decreased $2.1 million, or 85%, in the three months
ended June 30, 2003, as compared to the three months ended June 30, 2002.
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 personnel and infrastructure levels that have resulted
after the sale, and further cost-cutting and elimination of most operations
relating to our Libra Networks business and decision to liquidate the Company.
As of July 31, 2003, we employ one full-time administrative person, and we
maintain 650 square feet of office space on a monthly rental basis; however, we
anticipate that we will incur various ongoing and additional costs in the
future as we continue to implement the corporate liquidation.

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.

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During a portion of the first quarter of 2003, we
worked to complete documentation and otherwise
prepare the Libra Networks intellectual property for sale. As of July 31,
2003, we do not have a definitive buyer for such intellectual property.

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.

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 and six-month periods ended June 30, 2003, and 2002.

Liquidity and Capital Resources

As of June 30, 2003, we had $1.5 million in cash, cash equivalents, and
short-term investments, compared to $3.9 million as of December 31, 2002.
Because our shareholders approved our plan to liquidate the Company, we no
longer require capital for the financing of inventories and accounts
receivable, sales and marketing efforts, product development activities, and
capital equipment purchases. Rather, we expect to use our remaining cash to
wind-down operations, satisfy our known and unknown obligations and, if cash is
available, distribute remaining amounts to our shareholders. As part of the
agreement to sell our embedded systems development tools business, we agreed to
indemnify Metrowerks for specified items  $500,000 of the agreed-upon purchase
price was held back to secure certain of these indemnification obligations, and
that portion of the holdback not subject to claims for indemnification is due
to be received in November 2003. Certain other indemnification obligations
relating to our title to the assets sold, compliance with laws, and certain
matters relating to taxes continue until the expiration of the statute of
limitations applicable to claims with respect to such matters. These
indemnification obligations, other known or unknown obligations, the actual
cost of meeting legal and regulatory requirements in the United States and in
other jurisdictions to liquidate Applieds legal entities, and other factors
are expected to affect the timing and/or the amount of any distribution to
shareholders.

We used cash of $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.

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We received no funds in the first six months of 2003 from the sale of our
common stock to personnel through an employee stock purchase plan and the
exercise of employee stock options,
compared to receiving $48,000 in the first six months of 2002. We do not
anticipate future funds from this source.

We believe that our existing working capital will provide us with
sufficient funds to effect an orderly liquidation; however, the timing and
amount of any distribution to shareholders is subject to significant
uncertainty. If we are unable to effect an orderly liquidation, we could be
required to seek protection under the laws of bankruptcy. Our stock is no
longer publicly traded, and we do not believe we could successfully raise
additional funds under our corporate circumstances, either through a debt or
equity offering.

Accounting Pronouncements

In April 2003, the FASB issued Statement of Financial Accounting Standards
(SFAS) No. 149, 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 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 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.

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Certain Factors That May Affect Future Results of Operations

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

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

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

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

The timing of liquidating payments and total value shareholders receive upon
liquidation is subject to many variables and risks.

Shareholders may receive distributions from us or a liquidating trust, as
the case may be, the timing of which will be at the discretion of management or
the trustee or trustees, unless it is determined that any such distribution
would be inconsistent with the purposes of the Plan of Complete Liquidation and
Dissolution. The distribution of our assets to shareholders may be delayed for
a number of reasons, including statutes of limitation with respect to certain
claims and the risk that one or more of our creditors might seek an injunction
against our making the proposed distributions to shareholders under the terms
of the Plan of Complete Liquidation and Dissolution. The value of what
shareholders receive will be a product of various factors and risks, including
the proceeds received from the sale or other disposition of our remaining
assets, and the amount of Applieds actual and potential liabilities. If our
liabilities prove to be higher than anticipated, additional creditors appear,
or legal action is brought against us by creditors or others, it is possible
that the planned distribution to shareholders could be delayed or reduced, or
there could be nothing remaining available for distribution to shareholders.

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

Washington law provides that we can dispose of any known claims against us
by providing written notice to our known creditors of the planned dissolution
of Applied, and paying or making adequate provision for the debts of the
Company within the time allowed by law. However, an unpaid

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creditor or a
creditor that was not known to us can still, within two years of our
dissolution, bring a
lawsuit against Applied and its former shareholders for any amount unpaid. All
shareholders who receive proceeds from the liquidation may be liable to a
creditor who has a valid claim that exceeds the amount retained by us or the
liquidating trust for the purpose of settling claims, up to the amount they
received in the liquidation.

We may be required to pay up to $3.3 million to Metrowerks Corporation for
potential breaches of our representations in the asset purchase agreement dated
as of September 3, 2002.

Under the terms of the asset purchase agreement that we entered into on
September 3, 2002, we have an obligation to indemnify Metrowerks for any losses
from potential breaches of our representations or warranties that are asserted
within 12 months after the closing date of the asset sale or within the
applicable statute of limitations period for claims relating to our ownership
of our assets, payment of our taxes, and our compliance with applicable laws,
if longer. Our indemnification obligations are limited to an overall amount of
$3.3 million. Although we currently are not aware of any material breaches of
our representations or warranties, the payment of any such indemnification
obligations would decrease the amount of cash we would have available to
distribute to shareholders in the liquidation and it is very likely that there
would be nothing remaining available for distribution to shareholders.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

We are exposed to market risk related to changes in interest rates, which
could adversely affect the value of our short-term investments. We maintain a
short-term investment portfolio consisting of interest bearing securities with
an average maturity of less than one year. Certain of these securities may be
classified as available-for-sale securities, though no such securities met
that classification as of June 30, 2003. These interest-bearing securities are
subject to interest rate risk and will fall in value if market interest rates
increase. If market interest rates were to increase immediately and uniformly
to 110% of their levels at June 30, 2003, the fair value of the portfolio would
decline by an immaterial amount. We do not expect our operating results or
cash flows to be affected to any significant degree by a sudden change in
market interest rates.




Item 4. Controls and Procedures

Under the supervision and with the participation of our management,
including our principal executive officer and principal financial officer, we
evaluated the effectiveness of our disclosure controls and procedures, as such
term is defined under Rule 13a-15(e) promulgated under the Securities Exchange
Act of 1934, as amended. Based on this evaluation, our principal executive
officer and principal accounting officer concluded that our disclosure controls
and procedures were effective as of the end of the period covered by their
quarterly report.

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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.
| | --- |  | --------------------------------------------------------

| |  |  |      |  |  |                                                                                                   
| |  |  | ---- |  |  | --------------------------------------------------------------------------------------------------
| |  |  | 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
(Registrant)
|                      |  |                                               |  |                                                                                                                                                                   
|Date: August 19, 2003 |  | By:                                           |  | /s/ Robert C. Bateman                                                                                                                                             
|                      |  |                                               |  |                                                                                                                                                                   
|                      |  |                                               |  | Robert C. BatemanVice President, Chief Financial Officer,
Secretary and Treasurer
(Principal Financial and Accounting Officer
and Duly Authorized Signing Officer)

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