-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, HA8G1oW7ZOE3d2JEKH7rJ+fHNCtY91ZjpC9Y7vC6vKV0RwG+9Zbc/ahXI3n02iQj O2qhe6g3un3HH37e6pObzg== 0000912057-00-014495.txt : 20000411 0000912057-00-014495.hdr.sgml : 20000411 ACCESSION NUMBER: 0000912057-00-014495 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19991231 FILED AS OF DATE: 20000329 FILER: COMPANY DATA: COMPANY CONFORMED NAME: APPLIED MICROSYSTEMS CORP /WA/ CENTRAL INDEX KEY: 0001000787 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-COMPUTER INTEGRATED SYSTEMS DESIGN [7373] IRS NUMBER: 911074996 STATE OF INCORPORATION: WA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-26778 FILM NUMBER: 583715 BUSINESS ADDRESS: STREET 1: 5020 148TH AVE NE STREET 2: P O BOX 97002 CITY: REDMOND STATE: WA ZIP: 98073-9702 BUSINESS PHONE: 2068822000 MAIL ADDRESS: STREET 1: 5020 148TH AVE NE CITY: REDMOND STATE: WA ZIP: 98073-9702 10-K 1 10-K =============================================================================== UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K ----------------------- (Mark One) [ X ] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the fiscal year ended December 31, 1999 or [ ] Transition report pursuant to section 13 or 15(d) of the Securities Exchange Act of 1934. For the transition period from ______ to ______ COMMISSION FILE NUMBER 0-26778 ----------------------- APPLIED MICROSYSTEMS CORPORATION (Exact name of registrant as specified in its charter) ----------------------- WASHINGTON 91-1074996 (State of incorporation) (I.R.S. Employer Identification Number) 5020 148TH AVENUE N.E., REDMOND, WASHINGTON 98052-5172 (425) 882-2000 (Address, including zip code, of Registrant's principal executive offices and telephone number, including area code) ----------------------- Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No --- --- Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this form 10-K. Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date. Common stock: 6,885,951 shares outstanding as of March 17, 2000. The aggregate market value of the common stock held by non-affiliates of the registrant, based on the closing price on March 17, 2000, as reported on Nasdaq, was $82,795,304. (1) (1) Excludes shares held of record on that date by directors, executive officers and greater than 10% shareholders of the Registrant. Exclusion of such shares should not be construed to indicate that any such person directly or indirectly possesses the power to direct or cause the direction of the management of the policies of the registrant. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement relating to the registrant's 2000 Annual Meeting of Shareholders to be held on May 23, 2000, are incorporated by reference into Part III of this Report. =============================================================================== TABLE OF CONTENTS
PAGE PART I ITEM 1. Business......................................................................... 1 ITEM 2. Properties....................................................................... 9 ITEM 3. Legal Proceedings................................................................ 10 ITEM 4. Submission of Matters to a Vote of Security Holders.............................. 10 PART II ITEM 5. Market for Registrant's Common Equity and Related Stockholder Matters............ 10 ITEM 6. Selected Consolidated Financial Data............................................. 11 ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations....................................................................... 12 ITEM 7A. Qualitative and Quantitative Disclosures about Market Risk....................... 19 ITEM 8. Financial Statements and Supplementary Data...................................... 20 ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....................................................................... 40 PART III ITEM 10. Directors and Executive Officers of the Registrant............................... 40 ITEM 11. Executive Compensation........................................................... 40 ITEM 12. Security Ownership of Certain Beneficial Owners and Management................... 40 ITEM 13. Certain Relationships and Related Transactions................................... 40 PART IV ITEM 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................. 41
i PART I ITEM 1. BUSINESS The following Business section includes "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. The Act provides a "safe harbor" for forward-looking statements to encourage companies to provide prospective information about themselves so long as they identify these statements as forward-looking and provide meaningful cautionary statements identifying important factors that could cause actual results to differ from the projected results. All statements other than statements of historical fact the Company makes in this document or in any document incorporated by reference are forward-looking. In particular, the statements herein regarding industry prospects and the Company's future results of operations or financial position are forward-looking statements. Forward-looking statements reflect management's current expectations and are inherently uncertain. The Company's actual results may differ significantly from expectations. The section entitled "Factors Affecting Future Results and Forward-Looking Statements" describes some, but not all, of the factors that could cause these differences. OVERVIEW Applied Microsystems Corporation ("Applied" or the "Company") is a leader and innovator in software tools and technologies. Applied's products and services help customers bring products to market faster by providing innovative tools to develop, debug, and test products faster, more reliably, and at a lower cost. The Company's products have historically been targeted to meet the needs of embedded systems markets, and Applied develops, markets and supports a comprehensive suite of software and hardware-enhanced development and test tools for the development of complex embedded microprocessor-based applications. Embedded systems are used extensively in the new Internet device industry, telecommunications, internetworking, avionics, computer peripherals, office products, medical instrumentation and industrial process control. Embedded systems are also found in consumer markets such as the automotive and entertainment industries. A wide variety of products use embedded systems, such as hand-held computing devices, cellular telephones, set-top boxes, automated teller machines, hospital patient monitors, airplane flight control systems, automotive braking systems, modems, facsimile machines, video games, and so forth. The Company is pursuing development efforts to leverage its expertise in traditional embedded systems markets to apply its development and performance-enhancement solutions more specifically to complex Internet infrastructure needs. The Company expects that traditional embedded systems tools may become the tools of choice for creating modern Internet applications and establishing and maintaining Internet infrastructure because these tools are uniquely suited to creating applications that are highly reliable. Such tools are also able to handle real-time operating requirements and complex hardware/software integration. The Company's solutions enhance manufacturers' productivity by providing a set of solutions that span a product's lifecycle. Applied's current products and services assist customers with the development of software and the integration of software and hardware in creating embedded products. The Company's new software analysis tools include the CodeOPTIX-TM- family of high-level software visibility tools for application software verification, analysis and test as well as providing the ability to add executable code to programs running in the target systems. Applied provides development tools for third-party operating systems such as Microsoft Corporation's Windows-Registered Trademark- CE, WindRiver Systems' VxWorks-Registered Trademark- and pSOS-TM-, Sun Microsystems' ChorusOS-TM-, and Lynx Real-Time Systems' LynxOS-TM- operating systems; support for development, debug and testing of a wide range of microprocessors; and custom engineering capability to provide customers with specialized tools, intellectual property and design services. 1 Applied distributes its development solutions primarily through a network of direct sales and service offices located in the United States, Japan, and Europe and distributors throughout the rest of the world, as well as through partnerships with third-party developers of integrated development environments. Applied was incorporated in Washington in 1979 and is headquartered at 5020 148th Avenue NE, Redmond, Washington. The Company is ISO 9002 certified. For more information, visit Applied's home page on the World Wide Web: http://www.amc.com. BACKGROUND Applied has developed significant expertise in providing development solutions to the embedded systems marketplace. Embedded systems generally include an embedded microprocessor (often referred to as a microcontroller or "MCU"), a read-only memory ("ROM"), real-time operating system ("RTOS") software, and custom software to implement assigned applications. Embedded systems are incorporated within electronic devices and are dedicated to performing specific tasks quickly and reliably in response to rapidly occurring external events. Manufacturers worldwide are making increasing use of embedded systems to enhance the functionality and performance, reduce the cost and size, and improve the reliability of a broad variety of products. Manufacturers are faced with an expanding competitive market that requires them to bring increasingly complex products to market faster and at reduced costs. As the computing power of embedded microprocessors has grown, and as unit prices for embedded microprocessors have declined, manufacturers have been able to incorporate vastly improved features, speed and reliability into their products. This additional sophistication has resulted in significantly larger and more complicated application software and increased challenges associated with delivering a product on schedule. The development of embedded systems using today's high-speed microprocessors requires the design, debugging and testing of substantial amounts of complex custom application software, which is typically written in a high-level programming language. As the complexity and volume of such software increases, so also increases the potential for programming errors, the need to eliminate performance shortcomings, and the difficulty of thoroughly testing the complete system. In their efforts to remain competitive, manufacturers are increasingly faced with the demands of conflicting pressures. As they incorporate advanced microprocessors into their products, these manufacturers must hire more software engineers, develop more embedded software, and intensify their debugging and testing efforts, all of which tend to lengthen product development cycles and/or increase development costs. At the same time, competitive demands for lower-cost, technologically superior products create pressures to minimize development costs and time-to-market. Applied's current development solutions are designed to help customers respond successfully to these conflicting demands. PRODUCTS Applied develops, markets and supports a comprehensive suite of software and hardware-enhanced development and test tools for the development of complex embedded microprocessor-based applications. Applied's current development solutions are targeted principally to software engineers in the development of embedded software and associated products. Applied designs its products to support major market segments over a broad range of 16- and 32-bit embedded microprocessors primarily manufactured by Advanced Micro Devices, Inc., Hitachi, Intel Corporation, MIPS Technologies, Inc., and Motorola, Inc. 2 The Company's products generally enable engineers to perform debugging functions in high-level programming languages and operate on IBM-compatible personal computers or engineering workstations produced by Hewlett-Packard or Sun Microsystems. The Company's tools also enable engineers to observe software interaction and functions with several commercially available RTOS products and to read file format output from compatible compilers. The Company's current products can be classified into three broad categories: hardware-enhanced debugging tools, software analysis tools, and game development systems. HARDWARE-ENHANCED DEBUGGING TOOLS The Company manufactures a wide range of hardware-enhanced software tools for the design and debugging of embedded software. These in-circuit microprocessor and ROM emulators are utilized primarily by software engineers during the highly iterative software development and system integration phases of the embedded systems development process. To a lesser extent, they are also used by software engineers for low-level testing of software functions and by hardware engineers in system integration and troubleshooting their designs. The Company's emulators perform four basic functions or subsets thereof, depending on product configuration: - DOWNLOAD AND RUN CONTROL -- the ability to load the developer's software program into the system under development; to specify predetermined events or problems that may occur in the course of software execution; to stop system operation upon such an occurrence; and to resume operation at the desired point after any alterations have been made to the system or software. - EXECUTION TRACE -- the ability to detect, observe and provide an execution history of detailed software instructions and flow by collecting this data in a minimally intrusive manner in the probe's random access memory, which is a capability particularly important in identifying bugs or timing problems or in reconstructing the events leading up to a system failure. - OVERLAY MEMORY -- the ability to replace the target system's memory with memory residing in the emulator where embedded software can be debugged and modified easily before it is permanently "burned into" the target system's ROM. - HIGH-LEVEL LANGUAGE DEBUGGING -- the ability to display source code, data and relevant RTOS information, and to control each of the development tool's other basic functions through a high-level language interface to the target system under development. Applied offers a broad selection of hardware-enhanced software design and debugging tools with a variety of features and prices. The tools are accessed through a high-level language debugger human interface licensed from CAD-UL, Mentor Graphics Corporation, Metrowerks (now Motorola), or Paradigm and generally resold with Applied's product. These hardware-enhanced debugging products are available in two categories: (1) lower-priced, feature-focused products and (2) high-end, higher-priced products based on traditional embedded architecture. 3 The lower-priced, feature-focused products include CodeTAP-Registered Trademark-, PowerTAP-TM-, and SuperTAP-TM- tools that are pocket sized and provide a full range of feature capabilities; this category also includes NetROM-TM-, which provides cost-efficient target ethernet access and memory substitution. These tools support the latest generation of microprocessors primarily from Motorola, Intel, Hitachi, Advanced Micro Devices, and MIPS. This product group represented the largest revenue category for Applied in 1999, totaling more than 60% of revenues for the year. Prices for these development solutions range from $3,000 to $30,000, depending on the model and configuration. The high-end, higher-priced products include Applied's EL Series and CodeICE-TM- emulators that represent previous-generation technology. These full-featured products support older families of microprocessors from Motorola (680X0 series) and Intel (80960 series). Based upon a shift in designs to newer microprocessors, demand for these products has declined in recent years and represented less than 10% of the Company's revenues in 1999. Applied plans to continue to support its hardware-enhanced debugging tools and expects to develop additional products in 2000 to support existing and future microprocessors, as well as to continue to enhance and broaden its user-interface technology with third parties. The process of developing such additional products is subject to the challenges and uncertainties normally associated with product development, and there can be no assurance that the Company will be able to complete these development efforts successfully or in a timely manner. SOFTWARE ANALYSIS TOOLS The Company's software analysis tools include the CodeOPTIX family of high-level software visibility tools based on instrumentation for application software verification, analysis and test as well as providing the ability to add executable code to programs running in the target systems. Applied is focused on growing this portion of its business, and software analysis tools have increased from approximately 10% of revenues in 1997 to more than 25% of revenues in 1999. Applied's CodeTEST-Registered Trademark- includes a line of software testing tools which are designed specifically to offer a broad range of optimization and testing capabilities to software developers. These tools measure the performance and reliability of software, as well as the adequacy of the test process itself, in a minimally intrusive manner. The measurements are then displayed in an intuitive format. Software engineers use these products during the full range of system development - beginning with initial software development, extending to system integration, and then to final system test and validation. CodeTEST software analysis tools currently include the following modules: - COVERAGE ANALYSIS - Basic Block Coverage: the ability to measure the percentage of a software program's routines actually exercised by certain tests; to identify redundancies among tests; to identify the optimal set of tests to maximize the percentage of code tested in the shortest test period; and to determine the point at which the cost of continued testing is likely to exceed the benefits to be derived. - ADVANCED COVERAGE TOOLS - adds a finer degree of granularity for analyzing test execution to the Statement, Decision and Modified Condition Decision Coverage levels. For certain industries such as avionics, government regulations mandate test methodologies for each type of software application based on the criticality of that application. Advanced Coverage Tools show what conditions, decision paths, and code statements have been tested. - PERFORMANCE ANALYSIS - the ability to measure the time that a software program takes to perform a particular function and the degree of embedded microprocessor utilization; to identify any hindrances to high-speed processing so that system reaction times and compliance with performance specifications can be optimized. 4 - MEMORY ALLOCATION ANALYSIS - the ability to monitor the use of memory during software execution; to identify likely "memory leaks" and other memory allocation errors in order to improve programming reliability and aid in minimizing the size and cost of the target system's memory. - SOFTWARE EXECUTION TRACE - the ability to observe software functions from the source code level to the task level at any point in execution history to address software performance or memory problems. The CodeTEST product line currently includes software modules sold separately or with a separate hardware probe. CodeTEST supports the most popular 32-bit microprocessors from Motorola, Intel, Hitachi, Applied Micro Devices, and MIPS, as well as the VME Bus computer architecture. Applied plans to support additional embedded microprocessors with additional releases during 2000, but there can be no assurance as to the success or timeliness of such development efforts. In 1997, Applied entered into an OEM agreement with a third-party developer of real time operating systems for integration of certain CodeTEST modules within its integrated development environment. In 1998, Applied released and began shipping a software-only version of two CodeTEST modules, Basic Block Coverage and Memory Allocation Analysis, through this third party. This agreement remained in place throughout 1999. The modules run on the embedded target within the third party's integrated development environment. Applied plans to expand its software-only CodeTEST with additional module releases and distribution channels during 2000. In December 1999, Applied began shipping LiveCODE-TM-, the industry's first interactive run-time tracing system. LiveCODE incorporates Applied's automated instrumentation technology, which allows users to interactively debug their software while the application runs in the target. With LiveCODE, developers can graphically display program execution at a high level to quickly understand its operation, trace details in areas of interest and insert code to diagnose problems. All of this can be done without recompiling or stopping the program. Interactively debugging software while the application runs in the target means developers can significantly reduce the time spent debugging and spend more time on developing code. GAME DEVELOPMENT SYSTEMS In August 1999, Applied and Nintendo of America, Inc. announced an agreement whereby Applied would develop software and hardware for Nintendo's next-generation gaming system, code-named "Dolphin." During the latter part of 1999 and into 2000, Applied continued the development effort and anticipates initial shipments of Nintendo development kits in 2000. Based in part on the Company's growing expertise in developing tools for complex gaming systems, Applied announced in March 2000 that it had joined PowerPlay - an initiative designed to identify and establish a set of known operating standards for Internet Service Providers and other service and equipment providers. The goal of PowerPlay is to help create open standards that improve the performance of multi-player games on the Internet. Other corporate members of the initiative include Internet infrastructure companies, Internet service providers and game developers. Applied expects to focus increasingly greater resources on the development and support of games development tools. CUSTOMERS The Company's sales are presently concentrated primarily in the internetworking, telecommunications and computer peripherals segments of the electronics industry. Sales to Lucent Technologies Inc. accounted for 10% of consolidated revenues in 1999. The Company expects that a substantial portion of its revenues will continue to be concentrated among a relatively limited number of customers for the foreseeable future. Sales are generally made pursuant to customer purchase orders. 5 SALES, MARKETING AND CUSTOMER SUPPORT Applied distributes its development solutions primarily through a network of direct sales and service offices located in the United States, Japan, and Europe, and distributors throughout the rest of the world, as well as through partnerships with third-party developers of integrated development environments. As of December 31, 1999, the Company had 78 sales and support employees worldwide, including 44 field sales engineers, inside sales specialists and application engineers located at the Company's headquarters and in direct or home sales offices throughout North America, and in the Company's wholly owned subsidiaries in Japan, Germany, France and the United Kingdom. Due to the technical nature of its products, the Company believes that an important aspect of its direct sales strategy is the technical support and training provided to customers. In addition, a high level of customer service and support is critical to customer adoption and successful utilization of design, debugging and testing technology. The Company's field application engineers offer product support and assist customers in incorporating Applied's design, debugging and testing tools into their design process. The Company maintains international distribution agreements covering various countries. These agreements generally have a term of 12 months and are exclusive on a country-by-country basis. The sale of software development tools in foreign countries involves risks associated with currency exchange rate fluctuations and restrictions, export-import regulations, customs matters, potentially longer payment cycles, differing collection issues, and military, political and transportation risks. The Company's sales through its foreign subsidiaries are generally denominated in foreign currencies. As a result, fluctuations in currency exchange rates can have a significant effect on the Company's sales, even in the absence of an increase or decrease in unit sales to foreign customers. In addition, foreign sales involve uncertainties arising from local business practices and cultural considerations, and risks associated with international trade tensions. The Company expects that international sales will continue to account for a significant portion of Applied's net sales in the future. Applied participates in cooperative marketing activities with other embedded systems development tools providers and embedded microprocessor manufacturers. These relationships enable the Company to further leverage its technical capabilities, customer relationships and international sales and support infrastructure. The Company believes that developing and maintaining these relationships is important to its ability to achieve broad market penetration. Applied's marketing efforts also include attending trade shows, publishing articles, and advertising in trade magazines and journals, direct mail and product demonstrations. The time between order and delivery of the Company's products is often quite short. The number of orders, as well as the size of individual orders, can vary substantially from month to month. Because of the short period between order receipt and shipment of products, the Company typically does not have a meaningful backlog of unfilled orders and believes a backlog is neither significant to an understanding of its business nor representative of potential revenue for any future period. COMPETITION The traditional market for embedded software development solutions is fragmented and highly competitive, with many providers offering technical solutions to address the design, debugging, testing and service needs of embedded software developers. This market is also subject to rapid change, as technological developments create new needs and render prior technical solutions obsolete. The Company's ability to compete successfully in this market will depend on its ability to develop and introduce new products and features that address the increasingly sophisticated needs of its customers, to implement business relationships that enable it to broaden its product offerings, to provide worldwide customer service and support, and to respond to technological advances, emerging industry standards and practices and competitive developments. 6 The principal competition for the Company's hardware-enhanced debugging tools comes primarily from Agilent Technologies, Inc. (formed from a spin-off of various business units of Hewlett-Packard), Lauterbach GmbH, and Embedded Support Tools Corporation, and from various other domestic and international providers of in-circuit emulators, many of which focus primarily on developing products to support specific microprocessors, and, to a lesser extent, from domestic providers of embedded microprocessor simulators, RTOS debugging software, logic analyzers, ROM monitors and ROM emulators. Competition for Applied's software analysis tools comes principally from domestic providers of embedded debug software, emulators and logic analyzers, which are generally able to perform only portions of the software testing functions offered by the Company's CodeOPTIX tools. The Company has also historically experienced competition from the engineering departments of major manufacturers, which occasionally develop internal technical solutions to their design, debugging or testing problems. Competition among providers of embedded software design, debugging, testing and services focuses on a variety of factors, including the availability of tools that are compatible with the customer's chosen embedded microprocessor, engineering workstation and other software development equipment; performance characteristics and features such as high-speed processing, real-time visibility and control, high-level programming language and ease-of-use; product reliability; price/performance characteristics; customer service and worldwide support; and product availability and delivery time. The Company believes that the relative importance of each of these factors to a prospective customer varies for each development project, depending upon the complexity of the embedded system design, the microprocessor to be used, the project development schedule, and the engineering team's budget and experience level. The Company anticipates that the embedded systems development market is likely to experience continued consolidation as companies strive to broaden their product offerings. For example, in February 2000, Wind River announced plans to purchase Embedded Support Tools Corporation. The Company expects competition to increase from both established and emerging companies. The Company believes that much of its competition is now, and will increasingly be, from larger companies having substantially greater technical, financial and marketing resources, as well as larger customer bases and greater name recognition, than Applied. MANUFACTURING The Company maintains manufacturing operations to support its hardware-enhanced development solutions. The manufacturing operations consist of the procurement and inspection of parts and components, assembly, software duplication, and extensive testing of components and finished products. Applied's products incorporate the Company's proprietary software, as well as software licensed from others. The Company conducts virtually all steps of the assembly process, including board assembly, at its facility in Redmond, Washington. The Company has a computerized manufacturing inventory control system that integrates and monitors purchasing, inventory control and production. The Company thoroughly inspects and tests its manufactured products during the manufacturing process and tests finished products using tests designed and developed internally based on the custom requirements and functionality of the product. In addition, the Company's products undergo thorough quality inspection and testing, including "burn-in" procedures throughout the manufacturing process to ensure the quality and reliability of the Company's products. Applied also requires that all employees involved in the assembly process undergo thorough training. The Company has maintained its ISO 9002 certification since December 1995. The Company generally warrants that its hardware, software and mechanical parts will be free from defects in materials and workmanship for 90 days domestically and from 90 days to one year internationally, depending on the product and location. 7 The Company pursues a strategy of using the latest high-performance hardware components in the manufacture of its development tools. A number of these product components, such as microprocessors, ASICs, standard integrated circuits, memory chips, connectors and cables, are available only from a single source or a limited number of distributors. The Company has entered into agreements with a number of its vendors that include provisions requiring the vendor to maintain specified levels of key parts and components. In addition, due to fluctuating demand levels and limits on production, it is typical for a number of key components to be on "allocation" at any given time. There can be no assurance that the Company will be able to obtain key components in the future in a timely manner, in sufficient quantities, and/or on favorable price terms. The Company has a limited ability to avoid or offset future price increases by suppliers of key components. If the Company were to experience significant future delays, interruptions, or reductions in its supply of key components, or unfavorable price terms, its business, financial condition, and results of operations could be materially adversely affected. Although the Company's customers occasionally forecast projected purchase requirements in advance of shipment dates, customers more frequently order on an as-needed basis, and products are often shipped within a few weeks after an order is received. As a result, the Company's ability to plan production and inventory levels is limited. The need for immediate delivery by many customers, as well as the numerous products and configurations sold by the Company, require the Company to maintain a relatively high level of parts in inventory. The Company is subject to a variety of federal, state and local governmental regulations related to the storage, use, discharge and disposal of toxic, volatile or otherwise hazardous chemicals used in its manufacturing process. The Company may be subject to future environmental regulations that may impose the need for additional capital equipment or other requirements. Any failure by the Company to control the use of, or adequately to restrict the discharge of, hazardous substances under present or future regulations could subject the Company to liability. The company is not aware of any significant liability related to environmental issues. RESEARCH AND DEVELOPMENT Applied believes that continued investment in research and development is critical to the Company's future success. Applied continues to make substantial investments in the development of new technologies and products. Because of the competitive importance of offering development solutions that are compatible with particular microprocessors and other equipment to be used in developing embedded systems, solutions providers such as Applied are under continuing pressure to support major new families of embedded microprocessors, as well as advances in other development software and hardware. Applied believes that its future growth and financial performance will depend heavily on its ability to enhance its existing products, develop and introduce new products and features that address the increasingly sophisticated needs of its customers, and respond to technological advances, emerging industry standards and practices, and competitive developments. Applied's engineering and development group includes 96 full-time employees. During 1999, research and development expenses were $11.4 million, compared to $10.4 million in 1998 and $8.5 million in 1997. PROPRIETARY RIGHTS The Company's success will depend in part on its ability to protect its technology and to preserve its trade secrets. Although the Company relies primarily upon continuing technological innovations, trade secrets and know-how to develop and maintain its competitive position, it also relies on a combination of patent, copyright and trademark laws, confidentiality procedures, and contractual provisions to protect its proprietary rights. The Company has limited patent protection, and there can be no assurance that any patents will provide a competitive advantage or will afford protection against competitors with similar technology, or will not be successfully challenged or circumvented by competitors. The Company's policies and other measures designed to protect trade secrets and propriety rights may 8 not be adequate to prevent or deter misappropriation of its technology; in addition, competitors may be able to independently develop technologies having similar functions or performance characteristics. The laws of some foreign countries do not protect the Company's proprietary rights to the same extent as do the laws of the United States. The Company may not have an adequate legal remedy to prevent or seek redress for future unauthorized misappropriations of the Company's technology. The embedded systems development market is characterized by rapid technological change, with frequent introductions of new products and technologies. As a result, industry participants often find it necessary to develop products and features similar to those introduced by others, increasing the risk that their products and processes may give rise to claims that they infringe the patents of others. Accordingly, the Company's current and future products and processes within the traditional embedded markets or in new markets may conflict with patents that have been granted or may be granted to competitors or others. Such competitors or others could bring legal actions against the Company or its customers, claiming damages and seeking to enjoin manufacturing, marketing or use of the affected product or processes. Similarly, the Company may in the future find it necessary to commence litigation in order to enforce and protect its proprietary rights. If the Company becomes involved in such litigation, it could consume a substantial portion of the Company's resources and result in a significant diversion of management attention. If the outcome of any such litigation were adverse to the Company or its customers, the Company's business, financial condition and results of operations could be materially and adversely affected. The Company believes that it currently owns or has adequate rights to utilize all material technologies relating to its existing products; however, as it continues to develop new products and features, the Company anticipates that it may find it desirable or necessary to obtain nonexclusive or exclusive licenses from third parties entitling it to use certain technologies or software solutions. Such licenses may not be available to the Company on acceptable terms, if at all. The Company currently has licenses to several software programs that are used in its design, debugging and testing products. Termination of any such agreement, or failure to renew any such agreement upon its expiration with respect to products the Company intended to continue to market, would require product redesign and could significantly increase the cost to the Company of manufacturing such products and have a material adverse effect on the Company's business, financial condition and results of operations. The Company's loss of or inability to obtain necessary or desirable licenses from third parties could have a material adverse effect on the Company's business, financial condition and results of operations. EMPLOYEES As of December 31, 1999, the Company had 251 employees, of whom 221 were based in the United States and 30 were based internationally. Of the total, 121 were engaged in Sales, General and Administrative, 96 were in research and development and 34 were in manufacturing. None of the Company's employees is represented by a labor union. The Company has not experienced any work stoppages and considers its relations with its employees to be good. ITEM 2. PROPERTIES The Company's principal administrative, sales, marketing, research and development and manufacturing facility is located in an approximately 59,000 square-foot building in Redmond, Washington that is leased through May 31, 2001. The Company also leases nine other domestic sales and support offices in the United States and five international sales offices in Japan, France, Germany and the United Kingdom. The Company believes that its facilities are adequate to satisfy its projected requirements, including its requirements for production capacity into 2000, and that additional space will be available as needed. 9 ITEM 3. LEGAL PROCEEDINGS From time to time, Applied is involved in legal proceedings, none of which is currently considered material to the Company's business. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS No matters were submitted to a vote of security holders during the fourth quarter of 1999. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Applied Microsystems' common stock trades on The Nasdaq Stock Market-Registered Trademark-("Nasdaq") under the symbol "APMC." The Company estimates that at March 17, 2000, there were approximately 3,000 beneficial owners of the Company's common stock, as estimated by the number of record holders including participants in security positions listings. The closing price of the Company's common stock as reported by Nasdaq on March 17, 2000 was $19.63 per share. The price per share in the following table sets forth the low and high closing prices on Nasdaq for the quarter indicated:
LOW HIGH ------- ------ 1997 First quarter $ 4.88 $ 16.00 Second quarter 3.88 10.50 Third quarter 8.00 12.88 Fourth quarter 5.00 12.63 1998 First quarter $ 4.50 $ 8.88 Second quarter 3.81 7.63 Third quarter 2.63 4.63 Fourth quarter 2.13 4.75 1999 First quarter $ 2.75 $ 4.81 Second quarter 2.50 3.44 Third quarter 2.19 4.13 Fourth quarter 3.56 13.75
The Company has not paid dividends and does not plan to pay dividends on its common stock in the foreseeable future. 10 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEAR ENDED DECEMBER 31, --------------------------------------------------------------- 1999 1998 1997 1996 1995 -------- -------- -------- -------- -------- (in thousands, except per-share amounts) STATEMENT OF OPERATIONS DATA: Net sales $ 33,241 $ 37,020 $ 39,124 $ 38,662 $ 31,039 Cost of sales 8,664 9,587 10,532 10,793 9,530 -------- -------- -------- -------- -------- Gross profit 24,577 27,433 28,592 27,869 21,509 Operating expenses: Sales, general and administrative 18,929 18,104 18,542 15,142 13,321 Research and development 11,435 10,438 8,468 7,988 6,275 -------- -------- -------- -------- -------- Total operating expenses 30,364 28,542 27,010 23,130 19,596 -------- -------- -------- -------- -------- Income (loss) from operations (5,787) (1,109) 1,582 4,739 1,913 Interest income and other, net 706 783 669 559 (154) -------- -------- -------- -------- -------- Income (loss) before income taxes (5,081) (326) 2,251 5,298 1,759 Income taxes -- 19 349 1,582 305 -------- -------- -------- -------- -------- Net income (loss) $ (5,081) $ (345) $ 1,902 $ 3,716 $ 1,454 ======== ======== ======== ======== ======== Basic earnings (loss) per share $ (0.76) $ (0.05) $ 0.28 $ 0.57 $ 0.94 Shares used in basic per-share calculation 6,727 6,811 6,769 6,545 1,551 Diluted earnings (loss) per share $ (0.76) $ (0.05) $ 0.26 $ 0.52 $ 0.27 Shares used in diluted per-share calculation 6,727 6,811 7,297 7,097 5,329
DECEMBER 31, --------------------------------------------------------------- 1999 1998 1997 1996 1995 -------- -------- -------- -------- -------- (in thousands) BALANCE SHEET DATA: Working capital $ 16,311 $ 20,116 $ 20,547 $ 19,415 $ 15,756 Total assets 28,042 33,290 32,582 30,824 26,846 Long-term debt, net of current portion -- -- -- 15 68 Shareholders' equity 19,187 23,931 24,291 22,607 18,654
11 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS OVERVIEW Applied Microsystems Corporation is a leader and innovator in software tools and technologies. Applied's products help customers bring products to market faster by providing innovative tools to develop, debug, and test products faster, more reliably, and at a lower cost. The Company's products have historically been targeted to meet the needs of embedded systems markets, and Applied develops, markets and supports a comprehensive suite of software and hardware-enhanced development and test tools for the development of complex embedded microprocessor-based applications. Embedded systems are used extensively in the new Internet device industry, telecommunications, internetworking, avionics, computer peripherals, office products, medical instrumentation and industrial process control. Embedded systems are also found in consumer markets such as the automotive and entertainment industries. A wide variety of products use embedded systems, such as hand-held computing devices, cellular telephones, set-top boxes, automated teller machines, hospital patient monitors, airplane flight control systems, automotive braking systems, modems, facsimile machines, video games, and so forth. The Company is pursuing development efforts to leverage its expertise in traditional embedded systems markets to apply its development and performance-enhancement solutions more specifically to complex Internet infrastructure needs. The Company expects that traditional embedded systems tools may become the tools of choice for creating modern Internet applications and establishing and maintaining Internet infrastructure because these tools are uniquely suited to creating applications that are highly reliable. Such tools are also able to handle real-time operating requirements and complex hardware/software integration. RESULTS OF OPERATIONS
CHANGE FROM CHANGE FROM (DOLLARS IN THOUSANDS) 1999 PRIOR YEAR 1998 PRIOR YEAR 1997 - -------------------------------------------------------------------------------------------------- NET SALES $33,241 $(3,779) $37,020 $(2,104) $39,124 (10%) (5%)
The Company generally recognizes revenues from product sales upon shipment, unless the Company has obligations remaining under a sale or licensing agreement, in which case revenue is deferred until earned. Revenues from sales of product support contracts are deferred and recognized ratably over the contract period, which is typically 12 months. See Note 1 of Notes to Consolidated Financial Statements. The Company's net sales are presently derived primarily from sales of software design, debugging, and testing solutions, as well as product support and consulting services. During 1998 and 1999, the Company experienced continuing declines in sales volumes of its higher-priced "high-end" emulator products as the overall market demand for this type of product decreased at a more rapid pace than anticipated. High-end debug products accounted for over 40% of net sales in 1997, but have since declined to less than 10% of net sales in 1999. The Company's lower-priced, hardware-based debug products have increased as a percentage of net sales from 43% of net sales in 1997 to nearly 60% of net sales in 1999. The Company's new software analysis tools, including CodeTEST and the recently released LiveCODE products, have increased from approximately 10% of net sales in 1997 to more than 25% of net sales in 1999. The Company's net sales also include product support revenues, which are included within the aforementioned major categories of Applied's products. These support revenues represented 14% of net sales in 1999, compared to 13% in 1998 and 12% in 1997. 12 The decrease in net sales in 1999 as compared to 1998 was primarily attributable to a decrease in unit sales of high-end debug products and decreases in unit sales of certain older lower-priced debug products. The overall lower net sales were partially offset by increased sales of software analysis tools, primarily from the CodeTEST product line, and increased consulting revenues as the Company progressed under its agreement with Nintendo to provide development kits for Nintendo's next-generation gaming system. Applied also had improved sales in 1999 of certain lower-priced debug products, including PowerTAP, and favorable year-over-year currency exchange rate fluctuations affecting the dollar value of international sales. The decrease in net sales in 1998 as compared to 1997 was primarily attributable to a decline in unit sales of high-end debug products and to a lesser extent currency exchange rate fluctuations unfavorably affecting the dollar value of international sales. These decreases were partially offset by an increase in unit sales and average selling price of lower-priced debug products, and to a lesser extent on increased patent license royalties and consulting services. International sales represented 38% of net sales in 1999, compare to 44% in 1998 and 49% in 1997. In U.S. dollars, international sales outside of North America decreased 22% in 1999, as compared to 1998. International sales decreased 16% in 1998, as compared to net sales in 1997. The decreases in 1999 and 1998 were attributable primarily to a reduction in unit sales and average selling price of the Company's products internationally, particularly as the Asian economies have experienced overall weakness. The decrease in 1998 was partially offset by an increase in unit sales in Europe. Applied's sales through its foreign subsidiaries are generally denominated in local currencies; as a result, fluctuations in currency exchange rates can have a significant effect on the Company's reported net sales. Had the average exchange rates in 1999 remained constant from 1998, the dollar amount of overall Company net sales would have decreased 13% instead of the reported 10% decrease. Had the average exchange rates in 1998 remained constant from 1997, the dollar amount of overall Company sales would have decreased 3% instead of the reported 5% decrease. The Company is unable to predict currency exchange rate fluctuations and anticipates that such fluctuations will continue to affect its net sales to varying degrees in the future. While international sales have decreased over the past three years in total and as a percentage of revenues, the Company expects international sales to continue to account for a significant percentage of its net sales.
PERCENTAGE OF PERCENTAGE OF PERCENTAGE OF (DOLLARS IN THOUSANDS) 1999 NET SALES 1998 NET SALES 1997 NET SALES - ----------------------------------------------------------------------------------------------------------------- COST OF SALES $8,664 26% $9,587 26% $10,532 27% GROSS PROFIT $24,577 74% $27,433 74% $28,592 73%
Cost of sales includes materials, labor and overhead incurred in the manufacturing of products as well as the cost of providing professional services and estimated warranty. The Company performs periodic assessments of required reserves for potential inventory obsolescence, and corresponding adjustments to such reserves are included within cost of sales. The dollar amounts of cost of sales and gross profit fluctuate based on the volume of corresponding net sales. 13 Overall, cost of sales and gross profit as a percentage of net sales have remained constant over the reporting periods, despite the change in product mix toward software analysis tools and lower-priced debug products. Software analysis tools generally have a higher gross profit percentage than the Company's traditional debug products. However, the increased gross profit on software analysis tools was offset by additional required inventory reserves for high-end inventory, the allocation of overhead expenses over a lower volume of production as unit sales have decreased, and lower comparative margins on consulting services. The Company expects its gross profit to fluctuate based upon its product mix, geographic mix, product and patent license royalties and variances in volume and related absorption of factory overhead costs. Accordingly, there can be no assurance that the Company will be able to sustain its recent gross profit percentages.
CHANGE FROM CHANGE FROM (DOLLARS IN THOUSANDS) 1999 PRIOR YEAR 1998 PRIOR YEAR 1997 - ----------------------------------------------------------------------------------------------------------------- SALES, GENERAL AND ADMINISTRATIVE EXPENSES $18,929 $825 $18,104 $(438) $18,542 5% (2%)
The increase in sales, general, and administrative expenses in 1999 was due primarily to higher marketing expenditures incurred as the Company launched its CodeOPTIX product family, as well as certain higher personnel-related expenditures. Expenses in 1999 also included accelerated amortization on certain purchased technology. The higher overall expenses for the year were offset in part by lower sales commissions, commensurate with lower reported revenues in 1999, as well as certain lower consulting expenses. The decrease in 1998 in comparison to 1997 was due primarily to a reduction in foreign currency exchange losses as well as a reduction in general operating expenses. These lower expenditure levels were partially offset by increased headcount, compensation-related expenses, and promotional costs in connection with the company's expansion of its sales and marketing efforts. The Company expects its sales and marketing expenditures to increase in the future as it introduces and markets new products and continues to expand its sales, general and administrative organization. Foreign exchange gains and losses are included in sales, general and administrative expenses. In order to mitigate certain intercompany risks associated with exchange rate fluctuations, the Company at times hedges a portion of its foreign exchange risk in Japan as it relates to the trade debt the Company's Japanese subsidiary owes to the Company. No such hedging activities were in effect during 1999. Although the Company may engage in exchange-rate hedging activities with respect to certain exchange-rate risks, there can be no assurance that it will do so or that any such activities will successfully protect the Company against such risks. 14
CHANGE FROM CHANGE FROM (DOLLARS IN THOUSANDS) 1999 PRIOR YEAR 1998 PRIOR YEAR 1997 - ---------------------------------------------------------------------------------------------------------------- RESEARCH AND DEVELOPMENT EXPENSES $11,435 $997 $10,438 $1,970 $8,468 10% 23%
The increase in research and development expenses in 1999, as compared to 1998, was primarily attributable to increased engineering headcount and correspondingly higher compensation-related expenses. These increased expenses were a direct result of the Company's investment in strategic new initiatives, including the development of LiveCODE, which was first commercially shipped in December 1999. LiveCODE enables developers to trace and analyze the execution history of their application software as it is running in the target system. This new product also gives developers the capability to interact with the program as it is being executed without interrupting execution or having to recompile the application. Research and development expenses increased in 1998 as compared to 1997 due primarily to an increase in contract labor, headcount and compensation-related expenses, which were partially offset by lower prototype expenses. The Company believes that its continued investment in focused research and development activities is critical to Applied's future success, and that the Company's engineering resources represent a competitive advantage. Therefore, the Company intends to continue to make substantial investments in product development. These efforts may include development of software design, debugging and test tools for additional embedded microprocessors as well as continued advanced development in new products for current and new market opportunities. As a result, the Company anticipates that research and development expenses will increase in 2000.
CHANGE FROM CHANGE FROM (DOLLARS IN THOUSANDS) 1999 PRIOR YEAR 1998 PRIOR YEAR 1997 - ---------------------------------------------------------------------------------------------------------------- INTEREST INCOME AND OTHER, NET $706 $(77) $783 $114 $669 (10%) 17%
The Company's interest income and other, net, decreased in 1999 in comparison to 1998 due primarily to a decrease in cash available for short-term investments. In like manner, interest income and other, net, increased in 1998 in comparison to 1997 primarily as a result of a higher level of cash available for short-term investing. INCOME TAXES As of December 31, 1999 the Company had net operating loss carryforwards of approximately $6.0 million and research and development credit carryforwards of approximately $1.9 million for federal income tax purposes, both of which expire in various amounts through 2019. The utilization of some of these carryforwards is subject to an annual limit of approximately $392,000 under rules of the Internal Revenue Code. 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 the Company's ability to utilize its net deferred tax assets, including its 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. See Note 6 of Notes to Consolidated Financial Statements. 15 QUARTERLY RESULTS OF OPERATIONS The Company's results of operations have historically fluctuated significantly from quarter to quarter, and the Company expects that such fluctuations may continue as a result of a variety of factors. These factors include the following: product and price competition, fluctuating levels of internal research and development expenses, the volume and timing of customer development projects and orders, seasonality of customer orders, introductions of new embedded microprocessors, announcements or introductions of new products or technologies by the Company or its competitors, fluctuations in foreign currency exchange rates, fluctuating levels of required investments in marketing and distribution, price increases by the Company's suppliers, potential parts shortages, general conditions in the Company's target markets, and national and global economic conditions. Therefore, the Company's quarterly results of operations are not necessarily indicative of results for any future period. Moreover, a significant portion of the Company's quarterly net sales have historically been generated from shipments during the last few weeks of the quarter, thereby adding to the potential for future fluctuations in operating performance. LIQUIDITY AND CAPITAL RESOURCES As of December 31, 1999, the Company had $16.3 million in cash, cash equivalents, and short-term investments, compared to $17.1 million as of December 31, 1998. Applied maintains a revolving line of credit with a commercial bank whereby the Company may borrow up to $7.0 million at either the bank's prime rate or LIBOR plus 1.45%. Any such amounts borrowed would be due at the expiration of the line of credit on May 31, 2000. The line of credit is secured by all of the Company's inventories, chattel paper, accounts receivable and general intangible assets and includes certain financial covenants. There were no amounts outstanding as of December 31, 1999 nor at any time during 1999, and Applied was in compliance with all applicable financial covenants. The Company requires capital primarily for the financing of inventories and accounts receivable, sales and marketing efforts, product development activities, and capital equipment purchases. As a result of its operating losses, Applied used cash of $404,000 for operating activities in 1999, compared to generating $1.8 million cash from operating activities in 1998 and $5.3 million in 1997. The Company purchased $729,000 in equipment during 1999, compared to purchasing $1.3 million in 1998 and $1.5 million in 1997. As of December 31, 1999, the Company had no significant commitments with regard to capital purchases, but expects to spend approximately $1.2 million in 2000 for new capital items. The Company anticipates that its annual capital needs will increase in the future as a function of replacement cycles and anticipated growth of Applied's business. The Company believes that its existing working capital, together with amounts anticipated from operations and its available revolving credit line, will provide the Company with sufficient funds to finance its operations for at least the next 12 months. The Company's future capital requirements will depend on a number of factors, including costs associated with sales and marketing programs, product development efforts, the success of the commercial introduction of new Applied products, and the potential use of funds for strategic purposes. To the extent additional capital is required, the Company may sell additional equity, debt or convertible securities, or obtain additional credit facilities. IMPACT OF YEAR 2000 In the years leading up to the Year 2000, the Company performed a comprehensive analysis of its exposure to potential Year 2000 problems and took necessary action to address identified problems. The Company estimates that it spent less than $200,000 in assessing and addressing internal Year 2000 issues, in addition to system upgrades that were made as part of standard system maintenance. To date, Applied has not experienced any known Year 2000 issues and has been informed by material suppliers and vendors that they have also not experienced material Year 2000 issues. The Company will continue to monitor its position with respect to Year 2000 issues. 16 FACTORS AFFECTING FUTURE RESULTS AND FORWARD-LOOKING STATEMENTS The preceding "Business" section and other areas within this document contain forward-looking statements that involve risks and uncertainties. The statements in this document that are not purely historical are forward-looking statements. Words such as "anticipates," "expects," "intends," "plans," "believes," "seeks," "estimates," and similar expressions identify forward-looking statements, but the absence of these words does not mean the statement is not forward-looking. The Company cannot guarantee these statements, which are subject to risks, uncertainties, and assumptions that are difficult to predict. The Company's 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. The Company will not update any forward-looking statements due to new information, future events or otherwise. RECENT OPERATING LOSSES. The Company's revenues declined in 1999 and 1998, and Applied incurred corresponding operating losses in both of these years. Applied put a new management team in place during 1999 and has taken steps to improve its financial performance and long-term strategic direction; however, the Company's future success is not assured. RAPIDLY CHANGING TECHNOLOGY. The introduction of products embodying new technologies and the emergence of new industry standards and practices can render existing products obsolete and unmarketable. The Company's declining sales of its high-end debug products are indicative of this type of change in market requirements. The Company's future business, financial condition and results of operations will depend upon its ability to anticipate market demand for specific development solutions, develop new products and features that address the increasingly sophisticated needs of its customers, and respond to technological advances and emerging industry standards and practices. MANUFACTURING AND PRODUCT SHIP SCHEDULES. A number of the Company's components are manufactured by a single source or distributed through a limited number of outlets. The Company may be unable to obtain key components in a timely manner, in sufficient quantities, or on favorable price terms. In addition, delays in new-product introductions could delay the Company's expected revenue growth rates and cause its customer base to become dissatisfied and erode. DESIGN STARTS. The Company's development solutions span a wide range of microprocessors, real-time operating systems, and development environments. However, a substantial decline in the number of design starts for 16-bit or 32-bit embedded microprocessors supported by Applied, or delays by semiconductor manufacturers in the release of embedded microprocessors for which the Company has developed tools, could have an adverse effect on the Company's revenues. RELATIONSHIP WITH SEMICONDUCTOR MANUFACTURERS. The Company's ability to provide timely new products to its customers is enhanced by Applied's relationship with major semiconductor manufacturers. With access to new embedded microprocessor technology, Applied is able to adapt its tools to these new designs and make its tools available at the time the Company's customers begin to incorporate the new microprocessors into their product designs. Should Applied be unable to obtain timely access to new embedded microprocessor technology, the Company's operating results and market share could suffer. INDUSTRY FOCUS. The Company's sales are currently derived primarily from the telecommunications, internetworking, and avionics markets, and negative events affecting these markets could have an adverse effect on the Company's revenues. COMPETITION. The Company has historically participated in the embedded systems development tools market. This market is rapidly evolving and intensely competitive. Applied has also entered into new markets, such as providing development solutions to the gaming industry through its initial agreement with Nintendo. Competitors may develop and offer products and services similar to Applied's current or planned product offerings. Applied's business would be harmed if the Company is not able to compete successfully against current or future competitors. 17 Increased competition may result in price reductions, reduced gross margins, and loss of market share, any of which could harm Applied's business. The Company's competitors may be able to devote significantly greater resources to marketing campaigns, adopt more aggressive pricing policies and may expend substantially more resources on product development. If Applied is unable to compete effectively, the Company's revenues and earnings may suffer. DEPENDENCE ON KEY PERSONNEL. The Company believes that its future success will depend significantly on its ability to retain and attract key personnel and skilled employees. There is intense competition for qualified management, engineering and sales and marketing personnel, and the Company's failure to recruit, retain, and motivate such skilled employees could affect the Company's ability to develop new products and increase revenues. The Company's employees are not subject to employee contracts and are free to leave at any time. To date, the Company has been successful in meeting its requirements for highly skilled sales and support personnel and research and development engineers. However, competition for these personnel is intense and likely to become more so in the future. MANAGEMENT OF GROWTH. The Company seeks to grow its business by strengthening its sales and marketing programs, expanding its product lines, and providing development solutions to new markets. Such growth, if achieved, would place additional burden on management and increase the requirement to recruit and retain personnel with the right skill sets, as well as require additional infrastructure expenditures. The Company is unable to assure that it will increase its revenues, nor that it will be able to expand its management and operational infrastructure to manage such growth successfully. INTELLECTUAL PROPERTY RIGHTS AND LITIGATION. The Company relies on a combination of patent, copyright, trademark and trade secret laws and restrictions on disclosure to protect its intellectual property rights. The Company also enters into nondisclosure agreements with its employees, consultants and corporate partners, and controls access to proprietary information. Litigation may be necessary in order to enforce the Company's intellectual property rights, to protect its trade secrets, to determine the validity and scope of the proprietary rights of others or to defend against claims of infringement. Litigation could result in substantial costs and diversion of resources and could have a material adverse effect on the Company's business, financial condition and results of operations. Although the Company is not aware of any significant third-party intellectual property rights that would prevent the use and sale of Applied products, the Company may unknowingly infringe the proprietary rights of others. Any infringement could result in significant liability to the Company. PRODUCT LIABILITY. The Company's products and services may result in exposure to product liability claims in the event that the Company's development solutions are deemed to pose a risk of injury or harm. The Company maintains product liability insurance; however, such insurance may be inadequate for all potential claims. INTERNATIONAL OPERATIONS. A significant portion of the Company's business occurs outside of North America. Economic difficulties in any of these regions, particularly in Japan and Europe, could have a material adverse effect on the Company's business. As a result of the Company's international operations, the Company incurs certain expenses in foreign currencies. The Company's operating results are therefore subject to foreign exchange rate fluctuations, which are difficult to predict. POTENTIAL FLUCTUATIONS IN QUARTERLY OPERATING RESULTS AND VOLATILITY OF STOCK PRICE. The Company's future earnings and stock price may be subject to significant volatility, particularly on a quarterly basis, due to a variety of factors, some of which are outside of the Company's control. Any shortfall in revenue or earnings from levels expected by securities analysts could have an immediate and significant adverse effect on the trading price of the Company's common stock in any given period. Additionally, the Company often does not learn of such shortfalls until late in the fiscal quarter, at which time budgeted expenses have already been committed, which could result in an even more immediate and adverse effect on the trading price of the Company's common stock. The Company participates in a highly dynamic industry, which often results in significant volatility of the Company's common stock price. Consequently, purchasing or holding of the Company's stock involves a high degree of risk. 18 ITEM 7A. QUALITATIVE AND QUANTITATIVE DISCLOSURES ABOUT MARKET RISK Applied develops products in the United States and sells primarily in North America, Asia and Europe. As a result, financial results could be affected by factors such as changes in foreign currency exchange rates or weak economic conditions in foreign markets. Since the Company's products are generally initially priced in U.S. Dollars and translated to local currency amounts, a strengthening of the dollar could make the Company's products less competitive in foreign markets. The Company is exposed to market risk related to changes in interest rates, which could adversely affect the value of the Company's short-term investments. Applied maintains a short-term investment portfolio consisting of interest bearing securities with an average maturity of less than one year. These securities are classified as "available-for-sale" securities. These interest-bearing securities are subject to interest rate risk and will fall in value if market interest rates increase. If market interest rates were to increase immediately and uniformly by 10% from levels at December 31, 1999, the fair value of the portfolio would decline by an immaterial amount. The Company does not expect its operating results or cash flows to be affected to any significant degree by a sudden change in market interest rates. 19 ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA APPLIED MICROSYSTEMS CORPORATION INDEX TO FINANCIAL STATEMENTS
AUDITED ANNUAL FINANCIAL STATEMENTS: PAGE Report of Ernst & Young LLP, Independent Auditors............................ 21 Consolidated Balance Sheets as of December 31, 1999 and 1998................. 22 Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998 and 1997........................................... 23 Consolidated Statements of Shareholders' Equity for the Years Ended December 31, 1999, 1998 and 1997..................................... 24 Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997........................................... 25 Notes to Consolidated Financial Statements................................... 26
20 REPORT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS Shareholders and Board of Directors Applied Microsystems Corporation We have audited the accompanying consolidated balance sheets of Applied Microsystems Corporation as of December 31, 1999 and 1998, and the related consolidated statements of operations, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1999. Our audits also included the financial statement schedule listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of Applied Microsystems Corporation at December 31, 1999 and 1998, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 1999, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. ERNST & YOUNG LLP Seattle, Washington February 2, 2000 21 APPLIED MICROSYSTEMS CORPORATION CONSOLIDATED BALANCE SHEETS
DECEMBER 31, ------------------------- 1999 1998 ---------- ---------- (in thousands) ASSETS Current assets: Cash and cash equivalents $ 5,682 $ 6,041 Securities available-for-sale 10,664 11,101 Accounts receivable, net 5,848 8,483 Inventories 2,471 3,332 Prepaid and other current assets 501 518 ---------- ---------- Total current assets 25,166 29,475 Property and equipment, net 2,372 2,918 Other assets 504 897 ---------- ---------- Total assets $ 28,042 $ 33,290 ========== ========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Accounts payable $ 2,494 $ 3,283 Accrued payroll 1,704 1,840 Other accrued expenses 1,058 1,129 Deferred revenue 3,599 3,107 ---------- ---------- Total current liabilities 8,855 9,359 Commitments and contingencies Shareholders' equity: Preferred stock, $0.01 par value; 5,000,000 authorized; none issued and outstanding -- -- Common stock, $0.01 par value; 25,000,000 shares authorized; 6,830,000 and 6,681,000 shares issued and outstanding at December 31, 1999 and 1998, respectively 25,792 25,383 Accumulated other comprehensive income 48 120 Accumulated deficit (6,653) (1,572) ---------- ---------- Total shareholders' equity 19,187 23,931 ---------- ---------- Total liabilities and shareholders' equity $ 28,042 $ 33,290 ========== ==========
See accompanying notes. 22 APPLIED MICROSYSTEMS CORPORATION CONSOLIDATED STATEMENTS OF OPERATIONS
YEAR ENDED DECEMBER 31, ---------------------------------------- 1999 1998 1997 ---------- ---------- ---------- (in thousands, except per-share amounts) Net sales $ 33,241 $ 37,020 $ 39,124 Cost of sales 8,664 9,587 10,532 ---------- ---------- ---------- Gross profit 24,577 27,433 28,592 Operating expenses: Sales, general and administrative 18,929 18,104 18,542 Research and development 11,435 10,438 8,468 ---------- ---------- ---------- Total operating expenses 30,364 28,542 27,010 ---------- ---------- ---------- Income (loss) from operations (5,787) (1,109) 1,582 Interest income and other, net 706 783 669 ---------- ---------- ---------- Income (loss) before income taxes (5,081) (326) 2,251 Income taxes -- 19 349 ---------- ---------- ---------- Net income (loss) $ (5,081) $ (345) $ 1,902 ========== ========== ========== Basic earnings (loss) per share $ (0.76) $ (0.05) $ 0.28 Shares used in basic per-share calculation 6,727 6,811 6,769 Diluted earnings (loss) per share $ (0.76) $ (0.05) $ 0.26 Shares used in diluted per-share calculation 6,727 6,811 7,297
See accompanying notes. 23 APPLIED MICROSYSTEMS CORPORATION CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
ACCUMULATED COMMON STOCK OTHER TOTAL --------------------- ACCUMULATED COMPREHENSIVE SHAREHOLDERS' SHARES AMOUNT DEFICIT INCOME (LOSS) EQUITY ------ -------- ----------- -------------- ------------- (in thousands) Balance at December 31, 1996 6,634 $ 26,068 $ (3,129) $ (332) $ 22,607 Issuance of common stock upon exercise of common stock warrants 59 -- -- -- -- Stock options exercised 88 17 -- -- 17 Income tax benefit from stock plans -- 55 -- -- 55 Sale of common stock to employees 46 247 -- -- 247 Net income -- -- 1,902 -- 1,902 Foreign currency translation adjustment -- -- -- (537) (537) --------- Comprehensive income 1,365 ------ -------- -------- -------- --------- Balance at December 31, 1997 6,827 26,387 (1,227) (869) 24,291 Stock options exercised 126 12 -- -- 12 Sale of common stock to employees 55 194 -- -- 194 Common stock repurchased (327) (1,210) -- -- (1,210) Net loss -- -- (345) -- (345) Foreign currency translation adjustment -- -- -- 989 989 --------- Comprehensive income 644 ------ -------- -------- -------- --------- Balance at December 31, 1998 6,681 25,383 (1,572) 120 23,931 Stock options exercised 80 228 -- -- 228 Sale of common stock to employees 69 181 -- -- 181 Net loss -- -- (5,081) -- (5,081) Foreign currency translation adjustment -- -- -- (72) (72) --------- Comprehensive loss (5,153) ------ -------- -------- -------- --------- Balance at December 31, 1999 6,830 $ 25,792 $ (6,653) $ 48 $ 19,187 ====== ======== ======== ======== =========
See accompanying notes. 24 APPLIED MICROSYSTEMS CORPORATION CONSOLIDATED STATEMENTS OF CASH FLOWS
YEAR ENDED DECEMBER 31, ------------------------------------------------------ 1999 1998 1997 ---------- ---------- ---------- (in thousands) OPERATING ACTIVITIES Net income (loss) $ (5,081) $ (345) $ 1,902 Adjustments to reconcile net income (loss) to net cash provided by (used in) operating activities: Depreciation and amortization 1,671 1,219 1,148 Net change in operating accounts: Accounts receivable 2,635 (742) 2,520 Inventories 861 133 (268) Prepaid and other current assets 17 433 69 Other assets (3) (13) (217) Accounts payable and accrued expenses (996) 773 82 Deferred revenue 492 310 101 ---------- ---------- ---------- Net cash provided by (used in) operating activities (404) 1,768 5,337 INVESTING ACTIVITIES Purchases of securities available-for-sale (14,477) (16,871) (12,175) Maturities and sales of securities available-for-sale 14,914 16,115 7,761 Additions to property and equipment (729) (1,277) (1,469) ---------- ---------- ---------- Net cash used in investing activities (292) (2,033) (5,883) FINANCING ACTIVITIES Sale of common stock to employees 181 194 247 Stock options exercised 228 12 17 Common stock repurchased -- (1,210) -- Payments on long-term obligations -- (15) (53) ---------- ---------- ---------- Net cash provided by (used in) financing activities 409 (1,019) 211 Effects of foreign currency exchange rate changes on cash (72) 989 (537) ---------- ---------- ---------- Net decrease in cash and cash equivalents (359) (295) (872) Cash and cash equivalents at beginning of year 6,041 6,336 7,208 ---------- ---------- ---------- Cash and cash equivalents at end of year $ 5,682 $ 6,041 $ 6,336 ========== ========== ========== Supplemental disclosure of cash paid for income taxes $ -- $ 128 $ 642
See accompanying notes. 25 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 1 DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BUSINESS Applied Microsystems Corporation ("Applied" or the "Company") is a developer and manufacturer of software tools and technologies. The Company's products and services are currently targeted to meet the needs of embedded systems markets, and Applied develops, markets and supports a comprehensive suite of software and hardware-enhanced development and test tools for the development of complex embedded microprocessor-based applications. Applied markets its products and services primarily through its domestic and international direct sales organizations in the United States, Japan, the United Kingdom, Germany, and France, and through distributors in key markets throughout the rest of the world. The Company also markets its products through partnerships with third-party developers of integrated development environments. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries: Applied Microsystems Corporation Limited, a United Kingdom corporation; Applied Microsystems Japan Limited, a Japanese corporation; Applied Microsystems Gmbh, a German corporation; Applied Microsystems SARL, a French corporation; and Applied Microsystems Foreign Sales Corporation. All significant intercompany accounts and transactions are eliminated in consolidation. CASH EQUIVALENTS The Company considers all highly liquid investments purchased with a remaining maturity of three months or less at the date of purchase to be cash equivalents. Cash equivalents are carried at cost, which approximates market value. SECURITIES AVAILABLE-FOR-SALE Applied's investment portfolio is classified as available-for-sale, and such securities are stated at fair value based on quoted market prices. Interest earned on securities available-for-sale is included in interest income. The amortized cost of investments in this category is adjusted for amortization of premiums and accretion of discounts to maturity. Such amortization and accretion are included in interest income. Realized gains and losses and declines in value judged to be other than temporary, if any, are also included in interest income. The cost of securities sold is calculated using the specific identification method. FAIR VALUE OF FINANCIAL INSTRUMENTS The Company's financial instruments consist of cash and cash equivalents, securities available-for-sale, accounts receivable, accounts payable, and short-term borrowings, if any. The recorded value of these instruments approximates their fair value due to their short maturities. 26 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) CONCENTRATION OF CREDIT RISK Applied's financial instruments that are exposed to concentrations of credit risk consist primarily of cash, cash equivalents, securities available-for-sale, and accounts receivable. The Company's investment policy limits Applied's exposure to concentration of credit risk by limiting the amounts that may be invested in similar investment categories. The Company's accounts receivable result primarily from sales to a broad customer base, both domestically and internationally, and are typically unsecured. Applied performs on-going credit evaluations of its customers' financial condition, limits the amount of credit when deemed necessary, and maintains allowances for potential credit losses; historically, such losses have been immaterial. As a consequence, concentrations of credit risk are limited. INVENTORIES Inventories are stated at the lower of cost (first-in, first-out basis) or market. PROPERTY AND EQUIPMENT Property and equipment are carried at cost. The Company provides for depreciation and amortization using the straight-line method for financial reporting purposes and accelerated methods for income tax purposes. Leasehold improvements are amortized over the lesser of their estimated useful lives or the term of the lease. The estimated useful lives of equipment for financial reporting purposes are as follows: Machinery and equipment...........................3 to 5 years Office furniture.................................5 to 15 years ACQUIRED TECHNOLOGY Costs to acquire technology are capitalized to the extent the products are technologically feasible. Such amounts are included in other assets on the balance sheet. The Company amortizes these costs to match the anticipated revenue stream for the products incorporating the acquired technology. As of December 31, 1999 and 1998, the Company had recorded acquired technology with a net book value of $270,000 and $553,000, respectively, and a corresponding accumulated amortization balance of $583,000 at December 31, 1999 and $139,000 at December 31, 1998. Amortization expense was $444,000 in 1999, compared to amortization expense of $150,000 in 1998 and $92,000 in 1997. Research and development costs are expensed as incurred. The effects of financial accounting rules requiring capitalization of certain internally developed software costs have not been material to date. 27 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) LONG-LIVED ASSETS Applied evaluates the recoverability of its long-lived assets in accordance with Statement of Financial Accounting Standard ("SFAS") 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." SFAS 121 requires recognition of impairment of long-lived assets in the event the net book value of such assets exceeds the future undiscounted cash flows attributable to such assets. Accordingly, the Company evaluates asset recoverability at each balance sheet date or when an event occurs that may impair recoverability of the asset. Applied's recoverability analysis may include a review of the following factors: the undiscounted value of expected operating cash flows in relation to its net capital investments, the estimated useful or contractual life of the intangible asset, the contract or product supporting the intangible asset, and in the case of purchased technology, the Company periodically reviews the recoverability of the assets value by evaluating its products with respect to technological advances, competitive products and the needs of its customers. REVENUE RECOGNITION The Company generally recognizes revenues from product sales upon shipment, unless the Company has obligations remaining under a sale or licensing agreement, in which case revenue is deferred until earned. Revenues from sales of product support contracts are deferred and recognized ratably over the contract period, which is typically 12 months. Revenues from support contracts in 1999, 1998, and 1997 were $4,716,000, $4,671,000, and $4,644,000, respectively. Revenues from consulting services are recognized as performed. In 1998, the Company adopted the software revenue recognition rules under Statement of Position ("SOP") 97-2, "Software Revenue Recognition," as amended by SOP 98-4 and SOP 98-9. SOP 97-2 supersedes SOP 91-1, the former literature on software revenue recognition. The adoption of this statement did not have a material impact on the financial position or results of operations of the Company. ADVERTISING EXPENSES Advertising costs are expensed as incurred. Total advertising expenses incurred during 1999, 1998 and 1997 were $900,000, $766,000, and $815,000, respectively. FOREIGN CURRENCIES Assets and liabilities denominated in foreign currencies are translated to U.S. dollars at the exchange rates on the balance sheet date. Revenues and expenses are translated at the average rates of exchange prevailing during the year. The cumulative translation adjustments resulting from this process are accumulated in other comprehensive income. Gains and losses on foreign currency transactions are netted and included in other income. 28 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The Company may enter into foreign currency forward contracts to hedge anticipated foreign currency transactions, primarily intercompany transactions resulting from sales to international subsidiaries. Such forward contracts typically mature within three months. Gains and losses on contracts that are designated and effective as hedges of such transactions are deferred and recognized in income in the same period as the hedged transactions. No such contracts were outstanding as of December 31, 1999 or 1998, respectively. BASIC AND DILUTED EARNINGS (LOSS) PER SHARE Basic earnings (loss) per share excludes any dilutive effects of stock options. Basic earnings (loss) per share is computed using the weighted-average number of common shares outstanding during the period. Diluted earnings (loss) per share is computed using the weighted-average number of common shares and dilutive common stock equivalent shares outstanding during the period. STOCK-BASED COMPENSATION Applied has elected to follow the intrinsic value method prescribed by Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees," and related Interpretations in accounting for its stock options. Because the exercise price of the Company's common stock options equals the market price of the underlying stock on the date of grant, no corresponding compensation expense has been recognized. (See Note 8 for SFAS 123, "Accounting for Stock-Based Compensation," pro forma disclosures.) RECENT ACCOUNTING PRONOUNCEMENT In June 1998, the FASB issued SFAS 133, "Accounting for Derivative Instruments and Hedging Activities." SFAS 133 requires companies to record derivatives on the balance sheet as assets or liabilities, measured at fair value. Gains or losses resulting from changes in the fair values of those derivatives would be accounted for in current earnings unless specific hedge criteria are met. The key criterion for hedge accounting is that the hedging relationship must be highly effective in achieving offsetting changes in fair value or cash flows. Applied must formally document, designate, and assess the effectiveness of transactions that receive hedge accounting, if any. SFAS 133 will be effective for the Company's consolidated financial statements for the fiscal year ending December 31, 2001. The Company has not yet determined the impact, if any, of adopting this Statement. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. RECLASSIFICATIONS Certain prior-year amounts have been reclassified to conform to the current-year presentation. 29 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 2. SECURITIES AVAILABLE-FOR-SALE Securities available-for-sale consist of the following:
DECEMBER 31, 1999 --------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE --------------------------------------------------------------- (in thousands) U.S. Treasury and other U.S. Government obligations $ 5,023 $ 9 $ -- $ 5,032 Corporate debt securities 5,623 9 -- 5,632 ---------- ---------- ---------- ---------- $ 10,646 $ 18 $ -- $ 10,664 ========== ========== ========== ==========
DECEMBER 31, 1998 --------------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED COST GAINS LOSSES FAIR VALUE --------------------------------------------------------------- (in thousands) U.S. Treasury and other U.S. Government obligations $ 8,135 $ 8 $ -- $ 8,143 Corporate debt securities 2,958 -- -- 2,958 ---------- ---------- ---------- ---------- $ 11,093 $ 8 $ -- $ 11,101 ========== ========== ========== ==========
As of December 31, 1999, the Company's securities available-for-sale had average contractual maturities of less than one year. Expected maturities may differ from contractual maturities because issuers may have the right to prepay obligations. 30 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 3. BALANCE SHEET INFORMATION Detailed balance sheet data is as follows:
DECEMBER 31, -------------------------------- 1999 1998 ----------- ----------- (in thousands) ACCOUNTS RECEIVABLE Receivables $ 5,940 $ 8,660 Allowance for sales returns and doubtful accounts (92) (177) ----------- ----------- $ 5,848 $ 8,483 =========== =========== INVENTORIES Finished goods $ 557 $ 1,501 Work in process 60 28 Purchased parts 1,854 1,803 ----------- ----------- $ 2,471 $ 3,332 =========== =========== PROPERTY AND EQUIPMENT Machinery and equipment $ 3,095 $ 3,529 Office furniture 2,855 2,802 ----------- ----------- Total property and equipment 5,950 6,331 Accumulated depreciation (3,578) (3,413) ----------- ----------- $ 2,372 $ 2,918 =========== ===========
4. REVOLVING LINE OF CREDIT AGREEMENT In May 1999 the Company renewed its revolving line of credit with a commercial bank. Under the terms of the line of credit, Applied may borrow up to $7.0 million at either the bank's prime rate or LIBOR plus 1.45%. Any such amounts borrowed would be due at the expiration of the line of credit on May 31, 2000. The line of credit is secured by all of the Company's inventories, chattel paper, accounts receivable and general intangible assets and includes certain financial covenants. There were no amounts outstanding during 1998 or 1998. APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 5. COMMITMENTS AND CONTINGENCIES The Company leases office space and equipment under noncancelable operating leases, including certain leases that contain renewal options. Minimum future payments as of December 31, 1999 are as follows (in thousands): 2000 $ 1,388 2001 617 2002 140 2003 110 2004 90 Thereafter 342 -------- $ 2,687 ========
Total rent expense in 1999 was $1,393,000, as compared to rent expense of $1,393,000 in 1998 and $1,378,000 in 1997. 31 6. INCOME TAXES The provision for income taxes is as follows:
YEAR ENDED DECEMBER 31, ---------------------------------------------- 1999 1998 1997 --------- --------- --------- (in thousands) Federal $ (12) $ (9) $ 179 Foreign -- 28 105 State 12 -- 65 --------- --------- --------- $ -- $ 19 $ 349 ========= ========= =========
APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) The provision for income taxes differs from the amount computed using the statutory federal income tax rate as follows:
YEAR ENDED DECEMBER 31, ---------------------------------------------- 1999 1998 1997 --------- --------- --------- (in thousands) Tax at U.S. statutory rate $ (1,727) $ (114) $ 788 Utilization of net operating loss and tax credit carryforwards -- -- (137) Benefit of foreign sales corporation -- -- (122) Foreign taxes -- 28 105 State taxes, net of federal benefit 12 10 42 Foreign losses with no tax benefit 91 132 404 Loss on deemed liquidation of subsidiaries -- -- (845) Tax credits (429) (429) -- Foreign currency 143 375 -- Change in deferred tax valuation allowance 1,868 (42) -- Other 42 59 114 --------- --------- --------- $ -- $ 19 $ 349 ========= ========= =========
Effective April 1, 1997, the Company elected to treat its wholly-owned subsidiaries in the United Kingdom, Germany, and France as branches for U.S. tax purposes. The effect of such election was a deemed liquidation of each subsidiary, allowing its tax attributes to be utilized by the Company and thereby reducing the 1997 tax provision by $845,000. 32 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 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. Significant components of the Company's deferred income taxes are as follows:
DECEMBER 31, ---------------------------- 1999 1998 --------- --------- (in thousands) Deferred tax assets: Reserves for sales returns and doubtful accounts $ 215 $ 211 Accrued and other expenses 212 357 Inventories and other 689 448 Net operating loss carryforwards 2,047 1,274 Tax credit carryforwards 1,914 1,485 --------- --------- 5,077 3,775 Deferred tax liabilities: Depreciation 87 116 Foreign currency 38 467 Intangible and other assets -- 108 --------- --------- 125 691 Valuation allowance (4,952) (3,084) --------- --------- Net deferred taxes $ -- $ -- ========= =========
Due to the uncertainty of the Company's ability to generate sufficient taxable income to realize its deferred tax assets, a valuation allowance has been established for financial reporting purposes equal to the amount of the net deferred tax assets. The valuation allowance increased $1.9 million in 1999, and decreased $42,000 in 1998. As of December 31, 1999, the Company had net operating loss carryforwards for federal tax purposes of approximately $6.0 million available to offset future taxable income. The Company also had research and development credits of approximately $1.9 million that may be carried forward, subject to certain limitations, to offset future tax liabilities. The net operating loss and research and development tax credit carryforwards expire in various amounts from 2000 to 2019. Due to the issuance and sale of shares of preferred stock in 1992, the Company incurred "ownership changes" pursuant to applicable regulations in effect under the Internal Revenue Code of 1986, as amended. Therefore, the Company's use of losses incurred through the date of the ownership change will be limited during the carryforward period to approximately $392,000 per year. 33 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 7. EARNINGS (LOSS) PER SHARE The following table sets forth the computation of basic and diluted earnings (loss) per share:
YEAR ENDED DECEMBER 31, ------------------------------------------- 1999 1998 1997 ---------- ---------- ---------- (in thousands, except per-share amounts) Numerator: Net income (loss) $ (5,081) $ (345) $ 1,902 ========= ========== ========== Denominator: Denominator for basic earnings (loss) per share - weighted average common shares outstanding 6,727 6,811 6,769 Incremental shares from assumed conversions of dilutive stock options and warrants -- -- 528 --------- ---------- ---------- Denominator for diluted earnings (loss) per share 6,727 6,811 7,297 ========= ========== ========== Basic earnings (loss) per share $ (0.76) $ (0.05) $ 0.28 ========= ========== ========== Diluted earnings (loss) per share $ (0.76) $ (0.05) $ 0.26 ========= ========== ==========
For the years ended December 31, 1999 and 1998, weighted average options to purchase 254,070 and 239,086 shares of common stock, respectively, were excluded from the calculation of earnings (loss) per share because their effect was antidilutive. 8. SHAREHOLDERS' EQUITY STOCK OPTIONS The Company has stock option plans that provide for option grants to employees, directors, and others. 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. Options granted under the Applied Microsystems Corporation 1992 Performance Stock Plan (the "1992 Plan") have generally been immediately exercisable, but then subject to the Company's rights to repurchase any shares of common stock received upon exercise in the event that the optionee's employment with the Company should terminate. Such repurchase rights generally lapse at a rate of 25% per year from the date of grant. For presentation purposes, options that are subject to repurchase rights are treated as unvested. In April 1999, the Company issued a nonqualified stock option to its new President and Chief Executive Officer from a specific-purpose stock option plan. The option was issued with characteristics similar to options granted under the 1992 Plan. Options granted under the Applied Microsystems Corporation Director Stock Option Plan generally vest one year following grant date. 34 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) A summary of the Company's stock option activity and related information is as follows:
YEAR ENDED DECEMBER 31, ----------------------------------------------------------------------------------------- 1999 1998 1997 -------------------------- -------------------------- -------------------------- OPTIONS WEIGHTED-AVERAGE OPTIONS WEIGHTED-AVERAGE OPTIONS WEIGHTED-AVERAGE (000) EXERCISE PRICE (000) EXERCISE PRICE (000) EXERCISE PRICE ------- ---------------- ------- ---------------- ------- ---------------- Outstanding at beginning of year 1,114 $ 3.79 864 $ 3.13 729 $ 5.99 Granted 642 3.19 525 4.45 631 4.62 Canceled (295) 4.17 (149) 5.34 (408) 11.19 Exercised (80) 2.85 (126) 0.10 (88) 0.20 ------- ------- ------- Outstanding at end of year 1,381 $ 3.49 1,114 $ 3.79 864 $ 3.13 ======= ======= ======= Vested options 360 $ 3.05 290 $ 2.34 262 $ 0.67 ======= ======= =======
The weighted average fair value of options granted during 1999, 1998, and 1997 using the Black-Scholes multiple option pricing model was $2.47, $3.39, and $3.19, respectively. As of December 31, 1999, 420,464 options were available for grant. The following table summarizes information related to outstanding and vested options at December 31, 1999:
OUTSTANDING VESTED ----------------------------------- --------------------- WEIGHTED WEIGHTED WEIGHTED AVERAGE AVERAGE AVERAGE SHARES EXERCISE REMAINING SHARES EXERCISE RANGE OF EXERCISE PRICES (000) PRICE TERM (000) PRICE - ------------------------ ------ -------- --------- ------ -------- $ 0.02 - 2.00 139 $ 0.21 3.8 139 $ 0.21 2.01 - 4.00 636 3.06 9.2 3 2.84 4.01 - 7.00 590 4.41 7.4 210 4.38 7.01 - 17.50 16 14.87 8.1 8 17.13 ----- -------- 0.02 - 17.50 1,381 3.49 7.8 360 3.05 ===== ========
35 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) Pro forma information regarding net income (loss) and net income (loss) per share is required by SFAS 123 and has been determined as if the Company had accounted for its stock options under the fair value method of SFAS 123. The fair value for these options was estimated at the date of grant using a Black-Scholes multiple option pricing model with the following weighted-average assumptions:
1999 1998 1997 --------- ---------- ---------- Annualized volatility factor 0.979 0.947 0.939 Risk-free interest rate 5.7% 5.0% 6.0% Expected life of options 5.2 years 5.4 years 4.0 years Expected dividend rate nil nil nil
The Black-Scholes option value model was developed for use in estimating the fair value of traded options that have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions, including the expected stock price volatility. Because the Company's stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management's opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its stock options. For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options' vesting period. The Company's pro forma information follows:
1999 1998 1997 --------- ---------- ---------- (in thousands, except per-share data) Net income (loss), as reported $ (5,081) $ (345) $ 1,902 Pro forma net income (loss) (5,482) (883) 1,580 Diluted net income (loss) per share as reported (0.76) (0.05) 0.26 Pro forma Diluted net income (loss) per share (0.81) (0.13) 0.22
SFAS 123 pro forma disclosures above are not necessarily indicative of future pro forma disclosures because of the manner in which SFAS 123 calculations are phased in over time. STOCK WARRANTS In 1992, in connection with an equity financing, the Company granted stock warrants to purchase 114,563 shares of Series I preferred stock at $4.12 per share, expiring after five years. In connection with the Company's initial public offering in 1995, these outstanding preferred stock warrants converted to common stock warrants. In 1997, all of these remaining outstanding warrants were exercised on a "net exercise" basis, resulting in the issuance of 58,941 shares of common stock, with no corresponding proceeds to the Company. 36 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) STOCK REPURCHASE PLAN In 1998, the Board of Directors authorized the Company to repurchase up to 500,000 shares of its common stock in an effort to offset dilution associated with stock options issued under the Company's stock incentive programs and for general corporate purposes. During 1998, the Company repurchased a total of 327,000 shares for $1,210,000. The repurchase plan was subsequently suspended, and no further repurchases have been made. COMMON STOCK RESERVED At December 31, 1999, common stock was reserved for future issuance as follows (in thousands): Employee Stock Purchase Plan 63 Stock options 1,801 ----- 1,864 =====
9. EMPLOYEE BENEFITS The Company has a retirement plan covering substantially all U.S. employees that provides for voluntary salary deferral contributions on a pre-tax basis in accordance with Section 401(k) of the Internal Revenue Code. The Company provides matching contributions based on a defined formula, and may also make discretionary contributions. During 1999, the Company made contributions of $219,000, as compared to contributions of $192,000 in 1998 and $162,000 in 1997. The Company also has an employee stock purchase plan (the "ESPP") initially approved by the Company's shareholders in May 1996 through which the Company is authorized to issue up to 250,000 shares of common stock. The ESPP permits eligible Company personnel to purchase Applied common stock at not less than 85% of fair market value as defined in the ESPP through payroll deductions of up to 10% of their compensation, provided that no employee may purchase common stock worth more than $25,000 in any calendar year. 37 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 10. SEGMENT AND RELATED INFORMATION Through 1999, the Company was engaged in a single line of business: the design, manufacture, and distribution of development and test hardware and software tools for embedded product manufacturers. Sales to Lucent Technologies Inc. accounted for 10% of consolidated revenues in 1999. No customers accounted for more than 10% of net sales in 1998 or 1997. Certain operating information by geographic area is provided in the table below, based on the location of the Company's facilities. Sales are not recognized for financial statement purposes until there has been a sale to an unaffiliated customer.
YEAR ENDED DECEMBER 31, --------------------------------------------- 1999 1998 1997 --------- --------- --------- (in thousands) NET SALES United States $ 21,720 $ 22,325 $ 22,247 Japan 7,820 10,664 13,132 Europe 3,701 4,031 3,745 --------- --------- --------- Consolidated $ 33,241 $ 37,020 $ 39,124 ========= ========= ========= Export sales to unaffiliated customers $ 1,147 $ 1,597 $ 2,446 ========= ========= ========= INCOME (LOSS) BEFORE INCOME TAXES United States $ (3,867) $ 1,139 $ 4,121 Japan (175) 34 107 Europe (982) (1,037) (623) Corporate eliminations (57) (462) (1,354) --------- --------- --------- Consolidated $ (5,081) $ (326) $ 2,251 ========= ========= =========
DECEMBER 31, --------------------------- 1999 1998 --------- --------- (in thousands) LONG-LIVED ASSETS Property and equipment, net United States $ 2,284 $ 2,797 Japan 41 50 Europe 47 71 --------- --------- Consolidated $ 2,372 $ 2,918 ========= ========= Other assets, net United States $ 326 $ 723 Japan 145 131 Europe 33 43 --------- --------- Consolidated $ 504 $ 897 ========= =========
38 APPLIED MICROSYSTEMS CORPORATION NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (CONTINUED) 11. QUARTERLY FINANCIAL INFORMATION (UNAUDITED) Summarized quarterly financial information for 1999 and 1998 is as follows:
QUARTERS ENDED IN 1999 ------------------------------------------------------------ MARCH 31 JUNE 30 SEP. 30 DEC. 31 -------- ------- ------- ------- (In thousands, except per-share data) Net sales $ 8,518 $ 7,435 $ 8,328 $ 8,960 Gross profit 6,472 5,463 5,995 6,647 Net loss (934) (2,107) (1,423) (617) Diluted loss per share $ (0.14) $ (0.31) $ (0.21) $ (0.09) Shares used in diluted per-share calculation 6,703 6,708 6,738 6,752
QUARTERS ENDED IN 1998 ------------------------------------------------------------ MARCH 31 JUNE 30 SEP. 30 DEC. 31 -------- ------- ------- ------- (In thousands, except per-share data) Net sales $ 8,251 $ 9,157 $ 9,957 $ 9,655 Gross profit 5,938 6,832 7,432 7,231 Net Income (loss) (559) 58 113 43 Diluted income (loss) per share $ (0.08) $ 0.01 $ 0.02 $ 0.01 Shares used in diluted per-share calculation 6,878 7,113 6,983 6,832
39 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item is incorporated by reference to the information contained in the sections captioned "Board of Directors - Nominees for Director," "Voting Securities and Principal Holders - Section 16(a) Beneficial Ownership Reporting Compliance," and "Management Information, Compensation, and Benefits - Executive Officers" in the definitive Proxy Statement for the Company's Annual Meeting of Shareholders scheduled to be held on May 23, 2000 (the "Proxy Statement"). Such Proxy Statement will be filed within 120 days of the Company's last fiscal year end, December 31, 1999. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item is incorporated by reference to the information contained in the section captioned "Compensation and Benefits" of the Proxy Statement. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item is incorporated by reference to the information contained in the section captioned "Voting Securities and Principal Holders" of the Proxy Statement. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Not applicable. 40 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) INDEX TO LIST OF DOCUMENTS FILED AS PART OF THIS REPORT (1) FINANCIAL STATEMENTS - See Index to Financial Statements at Item 8 of this report. (2) FINANCIAL STATEMENT SCHEDULES Schedule II: Valuation and Qualifying Accounts All other schedules have been omitted because they were not applicable or were not required under the applicable regulations of the Securities and Exchange Commission. (3) EXHIBITS
EXHIBIT NO. DESCRIPTION 3.1 (1) Second Restated Articles of Incorporation of Registrant 3.2 (1) Restated Bylaws of Registrant 10.3 (1) 1992 Performance Stock Plan 10.4 (1) 1995 Directors Stock Option Plan 10.7 (1) Lease Agreement between W.R.C. Properties, Inc. and the Registrant dated February 27, 1989; and Amendments to Lease Agreement dated November 7, 1990, May 11, 1992, August 18, 1993 and March 31, 1994 10.8 (1) Third Amended and Restated Investment Agreement dated as of September 15, 1995 10.12 (1) ** Source License and Distribution Agreement between the Registrant and Microtec Research, Inc. dated August 1, 1994 10.16 Business Loan Agreement between the Registrant and U.S. Bank National Association dated May 31, 1999; Alternative Rate Options Promissory Note dated May 31, 1995 10.17 (2) Employment Agreement by and between Robert L. Deinhammer and the Registrant, dated January 4, 1999 10.18 (3) Employment Agreement by and between Stephen J. Verleye and the Registrant, dated April 1, 1999 21 Subsidiaries of the Registrant 23 Consent of Ernst & Young LLP, Independent Auditors 27 Financial Data Schedule
------------------ (1) Incorporated by reference from the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002) (2) Incorporated by reference from the Registrant's March 31, 1999 Form 10-Q filed with the Securities and Exchange Commission (3) Incorporated by reference from the Registrant's June 30, 1999 and September 30, 1999 reports on Form 10-Q filed with the Securities and Exchange Commission ** Confidential treatment has been granted for portions of this exhibit. 41 (b) REPORTS ON FORM 8-K None. SIGNATURES Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Seattle, State of Washington, on March 28, 2000. APPLIED MICROSYSTEMS CORPORATION By /s/ Robert C. Bateman ------------------------ Robert C. Bateman VICE PRESIDENT, CHIEF FINANCIAL OFFICER, CORPORATE SECRETARY, AND TREASURER (PRINCIPAL FINANCIAL AND ACCOUNTING OFFICER) Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed by the following persons on behalf of the Registrant and in the capacities and on the dates indicated. SIGNATURE TITLE DATE /s/ Stephen J. Verleye President, Chief Executive Officer March 28, 2000 - ------------------------- and Director (Principal Stephen J. Verleye Executive Officer) /s/ Robert C. Bateman Vice President, Chief Financial March 28, 2000 - ------------------------- Officer, Corporate Secretary, Robert C. Bateman and Treasurer (Principal Financial and Accounting Officer) /s/ Robert L. Deinhammer Chairman of the Board March 28, 2000 - ------------------------ Robert L. Deinhammer /s/ Lary L. Evans Director March 28, 2000 - ------------------------ Lary L. Evans /s/ Charles H. House Director March 28, 2000 - ------------------------ Charles H. House /s/ Elwood D. Howse, Jr. Director March 28, 2000 - ------------------------ Elwood D. Howse, Jr. /s/ Anthony Miadich Director March 28, 2000 - ------------------------ Anthony Miadich 42 EXHIBIT INDEX
EXHIBIT NO. DESCRIPTION 3.1 (1) Second Restated Articles of Incorporation of Registrant 3.2 (1) Restated Bylaws of Registrant 10.3 (1) 1992 Performance Stock Plan 10.4 (1) 1995 Directors Stock Option Plan 10.7 (1) Lease Agreement between W.R.C. Properties, Inc. and the Registrant dated February 27, 1989; and Amendments to Lease Agreement dated November 7, 1990, May 11, 1992, August 18, 1993 and March 31, 1994 10.8 (1) Third Amended and Restated Investment Agreement dated as of September 15, 1995 10.12 (1) ** Source License and Distribution Agreement between the Registrant and Microtec Research, Inc. dated August 1, 1994 10.16 Business Loan Agreement between the Registrant and U.S. Bank National Association dated May 31, 1999; Alternative Rate Options Promissory Note dated May 31, 1995 10.17 (2) Employment Agreement by and between Robert L. Deinhammer and the Registrant, dated January 4, 1999 10.18 (3) Employment Agreement by and between Stephen J. Verleye and the Registrant, dated April 1, 1999 21 Subsidiaries of the Registrant 23 Consent of Ernst & Young LLP, Independent Auditors 27 Financial Data Schedule
- ------------------ (1) Incorporated by reference from the Registrant's Registration Statement on Form S-1 filed with the Securities and Exchange Commission on September 15, 1995 (File No. 33-97002) (2) Incorporated by reference from the Registrant's March 31, 1999 Form 10-Q filed with the Securities and Exchange Commission (3) Incorporated by reference from the Registrant's June 30, 1999 and September 30, 1999 reports on Form 10-Q filed with the Securities and Exchange Commission ** Confidential treatment has been granted for portions of this exhibit. SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS APPLIED MICROSYSTEMS CORPORATION YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
- ---------------------------------------------------------------------------------------------------------------------- COL A. COL B. COL C. COL D. COL E. - ---------------------------------------------------------------------------------------------------------------------- ADDITIONS --------------------------- (1) (2) CHARGED TO CHARGED TO BALANCE AT COSTS OTHER BALANCE AT BEGINNING AND ACCOUNTS: DEDUCTIONS: END OF DESCRIPTION OF PERIOD EXPENSES DESCRIBE DESCRIBE PERIOD - ---------------------------------------------------------------------------------------------------------------------- Year ended December 31, 1999: Deducted from asset accounts: Allowance for sales returns and doubtful accounts 177,000 1,000 92,000 (B) (178,000) (A) 92,000 Year ended December 31, 1998: Deducted from asset accounts: Allowance for sales returns and doubtful accounts 337,000 12,000 (56,000) (B) (116,000) (A) 177,000 Year ended December 31, 1997: Deducted from asset accounts: Allowance for sales returns and doubtful accounts 264,000 32,000 396,000 (B) (355,000) (A) 337,000
(A) Uncollectible accounts written off, net of recoveries, and actual sales returns (B) Estimated future sales returns charged to revenue EX-10.16 2 EX-10.16 EXHIBIT 10.16 USBANK BUSINESS LOAN AGREEMENT
- -------------------------------------------------------------------------------------------------------------------- Principal Loan Date Maturity Loan No Call Collateral Account Officer Initials $7,000,000.00 05-31-99 05-31-00 391-75 70 0339586566 ABC03 - --------------------------------------------------------------------------------------------------------------------
References in the shaded area are for Lender's use only and do not limit the applicability of this document to any particular loan or item. Borrower: APPLIED MICROSYSTEMS CORPORATION 5020 148TH AVENUE NORTHEAST REDMOND, WA 98073 Lender: U.S. Bank National Association East King County Corporate Banking 10800 NE 8th Street, Suite 1000 Bellevue, WA 98004 THIS BUSINESS LOAN AGREEMENT between APPLIED MICROSYSTEMS CORPORATION ("Borrower") and U.S. Bank National Association ("Lender") is made and executed on the following terms and conditions. Borrower has received prior commercial loans from Lender or has applied to Lender for a commercial loan or loans and other financial accommodations, including those which may be described on any exhibit or schedule attached to this Agreement. All such loans and financial accommodations, together with all future loans and financial accommodations from Lender to Borrower, are referred to in this Agreement individually as the "Loan" and collectively as the "Loans." Borrower understands and agrees that: (a) in granting, renewing, or extending any Loan, Lender Is relying upon Borrower's representations, warranties, and agreements, as set forth In this Agreement: (b) the granting, renewing, or extending of any Loan by Lender at all times shall be subject to Lender's sole judgment and discretion; and (c) all such Loans shall be and shall remain subject to the following terms and conditions of this Agreement. TERM. This Agreement shall be effective as of May 31, 1999, and shall continue thereafter until all Indebtedness of Borrower to Lender has been performed in full and the parties terminate this Agreement in writing. DEFINITIONS. The following words shall have the following meanings when used in this Agreement. Terms not otherwise defined in this Agreement shall have the meanings attributed to such terms in the Uniform Commercial Code. All references to dollar amounts shall mean amounts in lawful money of the United States of America. Agreement. The word "Agreement" means this Business Loan Agreement, as this Business Loan Agreement may be amended or modified from time to time, together with all exhibits and schedules attached to this Business Loan Agreement from time to time. Borrower. The word "Borrower" means APPLIED MICROSYSTEMS CORPORATION. The word "Borrower" also includes, as applicable, all subsidiaries and affiliates of Borrower as provided below in the paragraph titled "Subsidiaries and Affiliates." CERCLA. The word "CERCLA" means the Comprehensive Environmental Response, Compensation, and Liability Act of 1980, as amended. Cash Flow. The words "Cash Flow" mean net income after taxes, and exclusive of extraordinary gains and income, plus depreciation and amortization, Collateral. The word "Collateral" means and includes without limitation all property and assets granted as collateral security for a Loan, whether real or personal property, whether granted directly or indirectly, whether granted now or in the future, and whether granted in the form of a security interest, mortgage, deed of trust, assignment, pledge, chattel mortgage, chattel trust, factor's lien, equipment trust, conditional sale, trust receipt, lien, charge, lien or title retention contract, lease or consignment intended as a security device, or any other security or lien interest whatsoever, whether created by law, contract, or otherwise. Debt. The word "Debt" means all of Borrower's liabilities excluding Subordinated Debt. ERISA, The word "ERISA" means the Employee Retirement Income Security Act of 1974, as amended. Event of Default, The words "Event of Default" mean and include without limitation any of the Events of Default set forth below in the section titled "EVENTS OF DEFAULT." Grantor. The word "Grantor" means and includes without limitation each and all of the persons or entities granting a Security Interest in any Collateral for the indebtedness, including without limitation all Borrowers granting such a Security Interest. Guarantor, The word "Guarantor" means and includes without limitation each and all of the guarantors, sureties, and accommodation parties in connection with any Indebtedness. Indebtedness, The word "Indebtedness" means and includes without limitation all Loans, together with all other obligations, debts and liabilities of Borrower to Lender, or any one or more of them, as well as all claims by Lender against Borrower, or any one or more of them; whether now or hereafter existing, voluntary or involuntary, due or not due, absolute or contingent, liquidated or unliquidated; whether Borrower may be liable individually or jointly with others; whether Borrower may be obligated as a guarantor, surety, or otherwise: whether recovery upon such Indebtedness may be or hereafter may become barred by any statute of limitations; and whether such Indebtedness may be or hereafter may become otherwise unenforceable. Lender, The word "Lender" means U.S. Bank National Association, its successors and assigns. Liquid Assets, The words "Liquid Assets" mean Borrower's cash on hand plus Borrower's readily marketable securities. Loan. The word "Loan" or "Loans" means and includes without limitation any and all commercial loans and financial accommodations from Lender to Borrower, whether now or hereafter existing, and however evidenced, including without limitation those loans and financial accommodations described herein or described on any exhibit or schedule attached to this Agreement from time to time. Note. The word "Note" means and Includes without limitation Borrower's promissory note or notes, if any, evidencing Borrower's Loan obligations in favor of Lender, as welt as any substitute, replacement or refinancing note or notes therefor. Permitted Liens. The words "Permitted Liens" mean: (a) liens and security interests securing Indebtedness owed by Borrower to Lender; (b) liens for taxes, assessments, or similar charges either not yet due or being contested in good faith; (c) liens of materialmen, mechanics, warehousemen, or carriers, or other like liens arising in the ordinary course of business and securing obligations which are not yet delinquent; (d) purchase money liens or purchase money security interests upon or in any property acquired or held by Borrower in the ordinary course of business to secure indebtedness outstanding on the date of this Agreement or permitted to be incurred under the paragraph of this Agreement titled "Indebtedness and Liens"; (e) liens and security interests which, as of the date of this Agreement, have been disclosed to and approved by the Lender in writing: and (I) those liens and security interests which in the aggregate constitute an immaterial and insignificant monetary amount with respect to the net value of Borrower's assets. Related Documents. The words "Related Documents" mean and include without limitation all promissory notes, credit agreements, loan agreements, environmental agreements, guaranties, security agreements, mortgages, deeds of trust, and all other instruments, agreements and documents, whether now or hereafter existing, executed in connection with the indebtedness. Security Agreement The words "Security Agreement" mean and include without limitation any agreements, promises, covenants, arrangements, understandings or other agreements, whether created by law, contract, or otherwise, evidencing, governing, representing, or creating a Security Interest. Security Interest. The words "Security Interest" mean and include without limitation any type of collateral security, whether in the form of a lien, charge, mortgage, deed of trust, assignment, pledge, chattel mortgage, chattel trust, factor's lien, equipment trust, conditional sale, trust receipt, lien or title retention contract, lease or consignment intended as a security device, or any other security or lien interest whatsoever, whether created by law, contract, or otherwise. SARA, The word "SARA" means the Superfund Amendments and Reauthorization Act of 1986 as now or hereafter amended. Subordinated Debt. The words "Subordinated Debt" mean indebtedness and liabilities of Borrower which have been subordinated by written agreement to indebtedness owed by Borrower to Lender in form and substance acceptable to Lender. Tangible Net Worth. The words "Tangible Net Worth" mean Borrower's total assets excluding all intangible assets (i.e., goodwill, trademarks, patents, copyrights, organizational expenses, and similar intangible items, but including leaseholds and leasehold improvements) less total Debt. Working Capital. The words "Working Capital" mean Borrower's current assets, excluding prepaid expenses, less Borrower's current liabilities. CONDITIONS PRECEDENT TO EACH ADVANCE. Lender's obligation to make the initial Loan Advance and each subsequent Loan Advance under this Agreement shall be subject to the fulfillment to Lender's satisfaction of all of the conditions set forth in this Agreement and in the Related Documents. Loan Documents. Borrower shall provide to Lender in form satisfactory to Lender the following documents for the Loan: (a) the Note, (b) Security Agreements granting to Lender security interests in the Collateral, (c) Financing Statements perfecting Lender's Security Interests: (d) evidence of insurance as required below: and (e) any other documents required under this Agreement or by Lender or its counsel. [Page 1] Borrower's Authorization. Borrower shall have provided in form and substance satisfactory to Lender properly certified resolutions, duty authorizing the execution and delivery of this Agreement, the Note and the Related Documents, and such other authorizations and other documents and instruments as Lender or its counsel, in their sole discretion, may require. Payment of Fees and Expenses. Borrower shall have paid to Lender all fees, charges, and other expenses which are then due and payable as specified in this Agreement or any Related Document. Representations and Warranties. The representations and warranties set forth in this Agreement, in the Related Documents, and in any document or certificate delivered to Lender under this Agreement are true and correct. No Event of Default. There shall not exist at the time of any advance a condition which would constitute an Event of Default under this Agreement. REPRESENTATIONS AND WARRANTIES. Borrower represents and warrants to Lender, as of the date of this Agreement, as of the date of each disbursement of Loan proceeds, as of the date of any renewal, extension or modification of any Loan, and at all times any indebtedness exists: Organization. Borrower is a corporation which is duly organized, validly existing, and in good standing under the laws of the State of Washington and is validly existing and in good standing in all states in which Borrower is doing business. Borrower has the full power and authority to own its properties and to transact the businesses in which it is presently engaged or presently proposes to engage. Borrower also is duly qualified as a foreign corporation and is in good standing in all states in which the failure to so quality would have a material adverse effect on its businesses or financial condition. Authorization. The execution, delivery, and performance of this Agreement and all Related Documents by Borrower, to the extent to be executed, delivered or performed by Borrower, have been duly authorized by all necessary action by Borrower: do not require the consent or approval of any other person, regulatory authority or governmental body: and do not conflict with, result in a violation of, or constitute a default under (a) any provision of its articles of incorporation or organization, or bylaws, or any agreement or other instrument binding upon Borrower or (b) any law, governmental regulation, court decree, or order applicable to Borrower. Financial Information. Each financial Statement of Borrower supplied to Lender truly and completely disclosed Borrower's financial condition as of the date of the Statement, and there has been no material adverse change in Borrower's financial condition subsequent to the dale of the most recent financial Statement supplied to Lender. Borrower has no material contingent obligations except as disclosed in such financial Statements. Legal Effect. This Agreement constitutes, and any instrument or agreement required hereunder to be given by Borrower when delivered will constitute, legal, valid and binding obligations of Borrower enforceable against Borrower in accordance with their respective terms. Properties. Except as contemplated by this Agreement or as previously disclosed in Borrower's financial statements or in writing to Lender and as accepted by Lender, and except for property tax liens for taxes not presently due and payable, Borrower owns and has good title to all of Borrower's properties free and clear of all Security Interests, and has not executed any Security documents or financing statements relating to such properties. All of Borrower's properties are titled in Borrower's legal name, and Borrower has not used, or filed a financing statement under, any other name for at least the last five (5) years. Hazardous Substances. The terms "hazardous waste," "hazardous substance," "disposal," "release," and "threatened release," as used in this Agreement, shall have the same meanings as set forth in the "CERCLA," "SARA," the Hazardous Materials Transportation Act, 49 U.S.C. Section 1801, et seq., the Resource Conservation and Recovery Act, 42 U.S.C. Section 6901, et seq., or other applicable State or Federal laws, rules, or regulations adopted pursuant to any of the foregoing. Except as disclosed to and acknowledged by Lender in writing, Borrower represents and warrants that: (a) During the period of Borrower's ownership of the properties, there has been no use, generation, manufacture, storage, treatment, disposal, release or threatened release of any hazardous waste or substance by any person on, under, about or from any of the properties. (b) Borrower has no knowledge of, or reason to believe that there has been (i) any use, generation, manufacture, storage, treatment, disposal, release, or threatened release of any hazardous waste or substance on, under, about or from the properties by any prior owners or occupants of any of the properties, or (ii) any actual or threatened litigation or claims of any kind by any person relating to such matters. (c) Neither Borrower nor any tenant, contractor, agent or other authorized user of any of the properties shall use, generate, manufacture, store, treat, dispose of, or release any hazardous waste or substance on, under, about or from any of the properties; and any such activity shall be conducted in compliance with all applicable federal, slate, and local laws, regulations, and ordinances, including without limitation those laws, regulations and ordinances described above. Borrower authorizes Lender and its agents to enter upon the properties to make such inspections and tests, as Lender may deem appropriate to determine compliance of the properties with this Section of the Agreement. Any inspections or tests made by Lender shall be at Borrower's expense and for Lender's purposes only and shall not be construed to create any responsibility or liability on the part of Lender to Borrower or to any other person. The representations and warranties contained herein are based on Borrower's due diligence in investigating the properties for hazardous waste and hazardous substances. Borrower hereby (a) releases and waives any future claims against Lender for indemnity or contribution in the event Borrower becomes liable for cleanup or other costs under any such laws, and (b) agrees to indemnity and hold harmless Lender against any and all claims, losses, liabilities, damages, penalties, and expenses which Lender may directly or indirectly sustain or suffer resulting from a breach of this section of the Agreement or as a consequence of any use, generation, manufacture, storage, disposal, release or threatened release of a hazardous waste or substance on the properties. The provisions of this section of the Agreement, including the obligation to indemnify, shall survive the payment of the Indebtedness and the termination or expiration of this Agreement and shall not be affected by Lender's acquisition of any interest in any of the properties, whether by foreclosure or otherwise. Litigation and Claims. No litigation, claim, investigation, administrative proceeding or similar action (including those for unpaid taxes) against Borrower is pending or threatened, and no other event has occurred which may materially adversely affect Borrower's financial condition or properties, other than litigation, claims, or other events, if any, that have been disclosed to and acknowledged by Lender in writing. Taxes To the best of Borrower's knowledge, all tax returns and reports of Borrower that are or were required to be filed, have been filed, and all taxes, assessments and other governmental charges have been paid in full, except those presently being or to be contested by Borrower in good faith in the ordinary course of business and for which adequate reserves have been provided. Lien Priority. Unless otherwise previously disclosed to Lender in writing, Borrower has not entered into or granted any Security Agreements, or permitted the filing or attachment of any Security Interests on or affecting any of the Collateral directly or indirectly securing repayment of Borrower's Loan and Note, that would be prior or that may in any way be superior to Lender's Security Interests and rights in and to such Collateral. Binding Effect. This Agreement, the Note, all Security Agreements directly or indirectly securing repayment of Borrower's Loan and Note and all of the Related Documents are binding upon Borrower as well as upon Borrower's Successors, representatives and assigns, and are legally enforceable in accordance with their respective terms. Commercial Purposes. Borrower intends to use the Loan proceeds solely for business or commercial related purposes. Employee Benefit Plans, Each employee benefit plan as to which Borrower may have any liability complies in all material respects with all applicable requirements of law and regulations, and (i) no Reportable Event nor Prohibited Transaction (as defined in ERISA) has occurred with respect to any such plan, (ii) Borrower has not withdrawn from any such plan or initialed steps to do so, (iii) no steps have been taken to terminate any Such plan, and (iv) there are no unfunded liabilities other than those previously disclosed to Lender in writing. Location of Borrower's Offices and Records, Borrower's place of business, or Borrower's Chief executive office, if Borrower has more than one place of business, is located at 5020 148TH AVENUE NORTHEAST, REDMOND, WA 98073. Unless Borrower has designated otherwise in writing this location is also the office or offices where Borrower keeps its records concerning the Collateral. Information. All information heretofore or contemporaneously herewith furnished by Borrower to Lender for the purposes of or in connection with this Agreement or any transaction contemplated hereby is, and all information hereafter furnished by or on behalf of Borrower to Lender will be, true and accurate in every material respect on the date as of which such information is dated or certified and none of such information is or will be incomplete by omitting to state any material fact necessary to make such information not misleading. Survival of Representations and Warranties. Borrower understands and agrees that Lender, without independent investigation, is relying upon the above representations and warranties in extending Loan Advances to Borrower. Borrower further agrees that the foregoing representations and warranties shall be continuing in nature and shall remain in full force and effect until such time as Borrower's Indebtedness shall be paid in full, or until this Agreement shall be terminated in the manner provided above, whichever Is the last to occur, AFFIRMATIVE COVENANTS. Borrower covenants and agrees with Lender that, while this Agreement is in effect, Borrower will:" Litigation. Promptly inform Lender in writing of (a) all material adverse changes in Borrower's financial condition, and (b) all existing and all threatened litigation, claims, investigations, administrative proceedings or Similar actions affecting Borrower or any Guarantor which could materially affect the financial condition of Borrower or the financial condition of any Guarantor. Financial Records. Maintain its books and records in accordance with generally accepted accounting principles, applied on a consistent basis, and permit Lender to examine and audit Borrower's books and records at all reasonable times. [Page 2] Financial Statements. Furnish Lender with, as soon as available, but in no event later than one hundred twenty (120) days after the end of each fiscal year. Borrower's balance sheet and income statement for the year ended, audited by a certified public accountant satisfactory to Lender, and, as soon as available, but in no event later than sixty (60) days after the end of each fiscal quarter, Borrower's balance sheet and profit and loss statement for the period ended, prepared and certified as correct to the best knowledge and belief by Borrower's chief financial officer or other officer or person acceptable to Lender. All financial reports required to be provided under this Agreement shall be prepared in accordance with generally accepted accounting principles, applied on a consistent basis, and certified by Borrower as being true and correct. Additional Information. Furnish such additional information and statements, lists of assets and liabilities, agings of receivables and payables, inventory schedules, budgets, forecasts, tax returns, and other reports with respect to Borrower's financial condition and business operations as Lender may request from time to time. Financial Covenants and Ratios. Comply with the following covenants and ratios: Tangible Net Worth. Maintain a minimum Tangible Net Worth of not less than $10,000,000.00. Working Capital. Maintain Working Capital in excess of $10,000,000.00 Cash Flow Requirements. Maintain Cash Flow at not less than the following level: 1.20 TO 1.00, DEFINED AS (NET PROFIT PLUS NON-CASH EXPENSE PLUS INTEREST EXPENSE PLUS CASH INJECTIONS MINUS UNFUNDED CAPITAL EXPENDITURES MINUS DIVIDENDS/WITHDRAWALS) DIVIDED BY (CURRENT PORTION LONG TERM DEBT PLUS INTEREST EXPENSE). THIS CASH FLOW COVERAGE REOUIREMENT OF 1.20 TO 1.00 WILL BE ESTABLISHED IF TERM OUT OPTION IS SELECTED. THIS DEFINITION SHALL SUPERSEDE ANY INCONSISTENT DEFINITION IN THIS AGREEMENT. The following provisions shall apply for purposes of determining compliance with the foregoing financial covenants and ratios: Compliance with all covenants and ratios shall be determined by calculating the ratios/amounts as of the end of each fiscal quarter. Except as provided above, all computations made to determine compliance with the requirements contained in this paragraph shall be made in accordance with generally accepted accounting principles, applied on a consistent basis, and certified by Borrower as being true and correct. Insurance. Maintain fire and other risk insurance, public liability insurance, and such other insurance as Lender may require with respect to Borrower's properties and operations, in form, amounts, coverages and with insurance companies reasonably acceptable to Lender. Borrower, upon request of Lender, will deliver to Lender from time to time the policies or certificates of insurance in form satisfactory to Lender, Including stipulations that coverages will not be canceled or diminished without at least ten (10) days" prior written notice to Lender. Each insurance policy also shall include an endorsement providing that coverage in favor of Lender will not be impaired in any way by any act, omission or default of Borrower or any other person. In connection with all policies covering assets in which Lender holds or is offered a security interest for the Loans, Borrower will provide Lender with such loss payable or other endorsements as Lender may require. Insurance Reports. Furnish to Lender, upon request of Lender, reports on each existing insurance policy showing such information as Lender may reasonably request, including without limitation the following: (a) the name of the insurer: (b) the risks insured: (c) the amount of the policy: (d) the properties insured: (e) the then current property values on the basis of which insurance has been obtained, and the manner of determining those values: and (t) the expiration date of the policy. In addition, upon request of Lender (however not more often than annually), Borrower will have an independent appraiser satisfactory to Lender determine, as applicable, the actual cash value or replacement cost of any Collateral. The cost of such appraisal shall be paid by Borrower. Other Agreements. Comply with all terms and conditions of all other agreements, whether now or hereafter existing, between Borrower and any other party and notify Lender immediately in writing of any default in connection with any other such agreements. Loan Proceeds. Use all Loan proceeds solely for Borrowers business operations, unless specifically consented to the contrary by Lender in writing. Taxes, Charges and Liens. Pay and discharge when due all of its indebtedness and obligations, including without limitation all assessments, taxes, governmental charges, levies and liens, of every kind and nature, imposed upon Borrower or its properties, income, or profits, prior to the date on which penalties would attach, and all lawful claims that, if unpaid, might become a lien or charge upon any of Borrower's properties, income, or profits. Provided however, Borrower will not be required to pay and discharge any such assessment, tax, charge, levy, lien or claim so long as (a) the legality of the same shall be contested in good faith by appropriate proceedings, and (b) Borrower shall have established on its books adequate reserves with respect to such contested assessment, tax, charge, levy, lien, or claim in accordance with generally accepted accounting practices. Borrower, upon demand of Lender, will furnish to Lender evidence of payment of the assessments, taxes, charges, levies, liens and claims and will authorize the appropriate governmental official to deliver to Lender at any time a written statement of any assessments, taxes, charges, levies, liens and claims against Borrower's properties. Income, or profits. Performance. Perform and comply with aft terms, conditions, and provisions set forth in this Agreement and in the Related Documents in a timely manner, and promptly notify Lender if Borrower learns of the occurrence of any event which constitutes an Event of Default under this Agreement or under any of the Related Documents. Operations. Maintain executive and management personnel with substantially the same qualifications and experience as the present executive and management personnel: provide written notice to Lender of any change in executive and management personnel; conduct its business affairs in a reasonable and prudent manner and in compliance with all applicable federal, state and municipal laws, ordinances, rules and regulations respecting its properties, charters, businesses and operations, including without limitation, compliance with the Americans With Disabilities Act and with all minimum funding standards and other requirements of ERISA and other laws applicable to Borrower's employee benefit plans. Inspection. Permit employees or agents of Lender at any reasonable lime to inspect any and all Collateral for the Loan or Loans and Borrower's other properties and to examine or audit Borrower's books, accounts, and records and to make copies and memoranda of Borrower's books, accounts, and records. If Borrower now or at any time hereafter maintains any records (including without limitation computer generated records and computer software programs for the generation of such records) in the possession of a third party, Borrower, upon request of Lender, shall notify such party to permit Lender free access to such records at all reasonable times and to provide Lender with copies of any records it may request, all at Borrowers expense. Compliance Certificate. Unless waived in writing by Lender, provide Lender OUARTERLY and at the time of each disbursement of Loan proceeds with a certificate executed by Borrower's chief financial officer, or other officer or person acceptable to Lender, certifying that the representations and warranties set forth in this Agreement are true and correct as of the date of the certificate and further certifying that, as of the date of the certificate, no Event of Default exists under this Agreement. Environmental Compliance and Reports. Borrower shall comply in all respects with all environmental protection federal, state and local laws, statutes, regulations and ordinances; not cause or permit to exist, as a result of an intentional or unintentional action or omission on its part or on the part of any third party, on property owned and/or occupied by Borrower, any environmental activity where damage may result to the environment, unless such environmental activity is pursuant to and in compliance with the conditions of a permit issued by the appropriate federal, state or local governmental authorities; shall furnish to Lender promptly and in any event within thirty (30) days after receipt thereof a copy of any notice, summons, lien, citation, directive, letter or other communication from any governmental agency or instrumentality concerning any intentional or unintentional action or omission on Borrower's part in connection with any environmental activity whether or not there is damage to the environment and/or other natural resources. Additional Assurances. Make, execute and deliver to Lender such promissory notes, mortgages, deeds of trust, security agreements, financing statements, instruments, documents and other agreements as Lender or its attorneys may reasonably request to evidence and secure the Loans and to perfect all Security Interests. NEGATIVE COVENANTS. Borrower covenants and agrees with Lender that while this Agreement is in effect, Borrower shall not, without the prior written consent of Lender: Indebtedness and Liens. (a) Except for trade debt incurred in the normal course of business and indebtedness to Lender contemplated by this Agreement, create, incur or assume indebtedness for borrowed money, Including capital leases, (b) except as allowed as a Permitted Lien, sell, transfer, mortgage, assign, pledge, lease, grant a security interest in, or encumber any of Borrower's assets, or (c) sell with recourse any of Borrower's accounts, except to Lender. Continuity of Operations. (a) Engage in any business activities substantially different than those in which Borrower is presently engaged, (b) cease operations, liquidate, merge, transfer, acquire or consolidate with any other entity, change ownership, change its name, dissolve or transfer or sell Collateral out of the ordinary course of business, (c) pay any dividends on Borrower's stock (other than dividends payable in its stock), provided, however that notwithstanding the foregoing, but only so long as no Event of Default has occurred and is continuing or would result from the payment of dividends, if Borrower is a "Subchapter S Corporation" (as defined in the Internal Revenue Code of 1986, as amended), Borrower may pay cash dividends on its stock to its shareholders from time to time in amounts necessary to enable the shareholders to pay income taxes and make estimated Income tax payments to satisfy their liabilities under federal and state law which arise solely from their status as Shareholders of a Subchapter S Corporation because of their ownership of shares of stock of Borrower, or (d) purchase or retire any of Borrower's outstanding shares or alter or amend Borrower's capital structure. [Page 3] Loans, Acquisitions and Guaranties. (a) Loan, invest in or advance money or assets, (b) purchase, create or acquire any interest in any other enterprise or entity, or (c) incur any obligation as surety or guarantor other than in the ordinary course of business. CESSATION OF ADVANCES. If Lender has made any commitment to make any Loan to Borrower, whether under this Agreement or under any other agreement, Lender shall have no obligation to make Loan Advances or to disburse Loan proceeds if: (a) Borrower or any Guarantor is in default under the terms of this Agreement or any of the Related Documents or any other agreement that Borrower or any Guarantor has with Lender; (b) Borrower or any Guarantor becomes insolvent, files a petition in bankruptcy or similar proceedings, or is adjudged a bankrupt; (c) there occurs a material adverse change in Borrower's financial condition, in the financial condition of any Guarantor, or in the value of any Collateral securing any Loan; (d) any Guarantor seeks, claims or otherwise attempts to limit, modify or revoke such Guarantor's guaranty of the Loan or any other loan with Lender; or (e) Lender in good faith deems itself insecure, even though no Event of Default shall have occurred. DISCLOSURE, ORAL AGREEMENTS OR COMMITMENTS TO LOAN MONEY, EXTEND CREDIT OR FORBEAR FROM ENFORCING REPAYMENT OF A DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON LAW. YEAR 2000. Borrower has reviewed and assessed its business operations and computer systems and applications to address the "year 2000 problem" (that is that computer applications and equipment used by Borrower, directly or indirectly through third parties, may be unable to properly perform date-sensitive functions before, during and after January 1, 2000). Borrower reasonably believes that the year 2000 problem will not result in a material adverse change in Borrower's business condition (financial or otherwise), operations, properties or prospects or ability to repay Lender. Borrower agrees that this representation will be true and correct on and shall be deemed made by Borrower on each date Borrower requests any advance under this Agreement or Note or delivers any information to Lender. Borrower will promptly deliver to Lender such information relating to this representation as Lender requests from time to time. MAXIMUM QUARTERLY LOSS, BORROWER AND LENDER AGREE THE MAXIMUM QUARTERLY LOSS WILL BE $5,000,000.00. RIGHT OF SETOFF. Borrower grants to Lender a contractual security interest in, and hereby assigns, conveys, delivers, pledges, and transfers to Lender all Borrower's right, title and interest in and to, Borrower's accounts with Lender (whether checking, savings, or some other account), including without limitation all accounts held jointly with someone else and all accounts Borrower may open in the future, excluding however all IRA and Keogh accounts, and all trust accounts for which the grant of a security interest would be prohibited by law. Borrower authorizes Lender, to the extent permitted by applicable law, to charge or setoff all sums owing on the Indebtedness against any and all such accounts, and, at Lender's option, to administratively freeze all such accounts to allow Lender to protect Lender's charge and setoff rights provided on this paragraph. EVENTS OF DEFAULT. Each of the following shall constitute an Event of Default under this Agreement: Default on Indebtedness. Failure of Borrower to make any payment when due on the Loans. Other Defaults, Failure of Borrower or any Grantor to comply with or to perform when due any other term, obligation, covenant or condition contained in this Agreement or in any of the Related Documents, or failure of Borrower to comply with or to perform any other term, obligation, covenant or condition contained in any other agreement between Lender and Borrower. Default In Favor of Third Parties. Should Borrower or any Grantor default under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that may materially affect any of Borrower's property or Borrower's or any Grantor's ability to repay the Loans or perform their respective obligations under this Agreement or any of the Related Documents. False Statements, Any warranty, representation or statement made or furnished to Lender by or on behalf of Borrower or any Grantor under this Agreement or the Related Documents is false or misleading in any material respect at the time made or furnished, or becomes false or misleading at any time thereafter. Defective Collateralization. This Agreement or any of the Related Documents ceases to be in full force and effect (including failure of any Security Agreement to create a valid and perfected Security Interest) at any time and for any reason. Insolvency. The dissolution or termination of Borrower's existence as a going business, the insolvency of Borrower, the appointment of a receiver for any part of Borrower's property, any assignment for the benefit of creditors, any type of creditor workout, or the commencement of any proceeding under any bankruptcy or insolvency laws by or against Borrower. Creditor or Forfeiture Proceedings. Commencement of foreclosure or forfeiture proceedings, whether by judicial proceeding, self-help, repossession or any other method, by any creditor of Borrower, any creditor of any Grantor against any collateral securing the Indebtedness, or by any governmental agency. This includes a garnishment, attachment, or levy on or of any of Borrower's deposit accounts with Lender. Events Affecting Guarantor; Any of the preceding events occurs with respect to any Guarantor of any of the Indebtedness or any Guarantor dies or becomes incompetent, or revokes or disputes the validity of, or liability under, any Guaranty of the Indebtedness. Change In Ownership. Any change in ownership of twenty-five percent (25%) or more of the common stock of Borrower. Adverse Change. A material adverse change occurs in Borrower's financial condition, or Lender believes the prospect of payment or performance of the indebtedness is impaired. Insecurity. Lender, in good faith, deems itself insecure. EFFECT OF AN EVENT OF DEFAULT. If any Event of Default shall occur, except where otherwise provided in this Agreement or the Related Documents, all commitments and obligations of Lender under this Agreement or the Related Documents or any other agreement immediately will terminate (including any obligation to make Loan Advances or disbursements), and, at Lender's Option, all Indebtedness immediately will become due and payable, all without notice of any kind to Borrower, except that in the case of an Event of Default of the type described in the "Insolvency" subsection above, such acceleration shall be automatic and not optional. In addition, Lender shall have all the rights and remedies provided In the Related Documents or available at law, in equity, or otherwise. Except as may be prohibited by applicable law, all of Lender's rights and remedies shall be cumulative and may be exercised singularly or concurrently. Election by Lender to pursue any remedy shall not exclude pursuit of any other remedy, and an election to make expenditures or to take action to perform an obligation of Borrower or of any Grantor shall not affect Lender's right to declare a default and to exercise its rights and remedies. MISCELLANEOUS PROVISIONS. The following miscellaneous provisions are a part of this Agreement: Amendments. This Agreement, together with any Related Documents, constitutes the entire understanding and agreement of the parties as to the matters set forth in this Agreement. No alteration of or amendment to this Agreement shall be effective unless given in writing and signed by the party or parties sought to be charged or bound by the alteration or amendment. Applicable Law. This Agreement has been delivered to Lender and accepted by Lender In the State of Washington. If there is a lawsuit, Borrower agrees upon Lender's request to submit to the jurisdiction of the courts of King County, the Slate of Washington. Subject to the provisions on arbitration, this Agreement shall be governed by and construed In accordance with the laws of the State of Washington. Arbitration; Lender and Borrower agree that all disputes, claims and controversies between them, whether individual, joint, or class in nature, arising from this Agreement or otherwise, including without limitation contract and tort disputes, shall be arbitrated pursuant to the Rules of the American Arbitration Association, upon request of either party. No act to take or dispose of any Collateral shall constitute a waiver of this arbitration agreement or be prohibited by this arbitration agreement. This includes, without limitation, obtaining injunctive relief or a temporary restraining order; invoking a power of sale under any deed of trust or mortgage; obtaining a writ of attachment or imposition of a receiver; or exercising any rights relating to personal property, including taking or disposing of such property with or without judicial process pursuant to Article 9 of the Uniform Commercial Code. Any disputes, claims, or controversies concerning the lawfulness or reasonableness of any act, or exercise of any right, concerning any Collateral, including any claim to rescind, reform, or otherwise modify any agreement relating to the Collateral, shall also be arbitrated, provided however that no arbitrator shall have the right or the power to enjoin or restrain any act of any party. Judgment upon any award rendered by any arbitrator may be entered in any court having jurisdiction. Nothing in this Agreement shall preclude any party from seeking equitable relief from a court of competent jurisdiction. The statute of limitations, estoppel, waiver, laches, and similar doctrines which would otherwise be applicable in an action brought by a party shall be applicable in any arbitration proceeding, and the commencement of an arbitration proceeding shall be deemed the commencement of an action for these purposes. The Federal Arbitration Act shall apply to the construction, interpretation, and enforcement of this arbitration provision. Caption Headings. Caption headings in this Agreement are for convenience purposes only and are not to be used to interpret or define the provisions of this Agreement. Multiple Parties; Corporate Authority. All obligations of Borrower under this Agreement shall be joint and several, and all references to Borrower shall mean each and every Borrower. This means that each of the persons signing below is responsible for all obligations in this Agreement. Consent to Loan Participation. Borrower agrees and consents to Lender's sale or transfer, whether now or later, of one or more participation interests in the Loans to one or more purchasers, whether related or unrelated to Lender. Lender may provide, without any limitation whatsoever, to any one or more purchasers, or potential purchasers, any information or knowledge Lender may have about Borrower or about any other matter relating to the Loan, and Borrower hereby waives any rights to privacy it may have with respect to such matters. Borrower additionally waives any and all notices of sale of participation interests, as well as all notices of any repurchase of such participation interests. Borrower also agrees that [Page 4] The purchasers of any such participation interests will be considered as the absolute owners of such interests in the Loans and will have all the rights granted under the participation agreement or agreements governing the sale of such participation interests. Borrower further waives all rights of offset or counterclaim that it may have now or later against Lender or against any purchaser of such a participation interest and unconditionally agrees that either Lender or such purchaser may enforce Borrower's obligation under the Loans irrespective of the failure or insolvency of any holder of any interest in the Loans. Borrower further agrees that the purchaser of any such participation interests may enforce its interests irrespective of any personal claims or defenses that Borrower may have against Lender. COSTS AND EXPENSES. Borrower agrees to pay upon demand all of Lender's expenses, including without limitation attorneys' fees, incurred in connection with the preparation, execution, enforcement, modification and collection of this Agreement or in connection with the Loans made pursuant to this Agreement. Lender may pay someone else to help collect the Loans and to enforce this Agreement, and Borrower will pay that amount. This includes, subject to any limits under applicable law, Lender's attorneys' fees and Lender's legal expenses, whether or not there is a lawsuit, including attorneys' fees for bankruptcy proceedings (including efforts to modify or vacate any automatic stay or injunction), appeals, and any anticipated post-judgment collection services. Borrower also will pay any court costs, in addition to all other sums provided by law. NOTICES. All notices required to be given under this Agreement shall be given in writing, may be sent by telefacsimile (unless otherwise required by law), and shall be effective when actually delivered or when deposited with a nationally recognized overnight courier or deposited in the United States mail, first class, postage prepaid, addressed to the party to whom the notice is to be given at the address shown above. Any party may change its address for notices under this Agreement by giving formal written notice to the other parties, specifying that the purpose of the notice is to change the party's address. To the extent permitted by applicable law, if there is more than one Borrower, notice to any Borrower will constitute notice to all Borrowers. For notice purposes, Borrower will keep Lender informed at all times of Borrower's current address(es). SEVERABILITY. It a court of competent jurisdiction finds any provision of this Agreement to be invalid or unenforceable as to any person or circumstance, such finding shall not render that provision invalid or unenforceable as to any other persons or circumstances. If feasible, any such offending provision shall be deemed to be modified to be within the limits of enforceability or validity; however, if the offending provision cannot be so modified, it shall be stricken and all other provisions of this Agreement in all other respects shall remain valid and enforceable. SUBSIDIARIES AND AFFILIATES OF BORROWER. To the extent the context of any provisions of this Agreement makes it appropriate, including without limitation any representation, warranty or covenant, the word "Borrower" as used herein shall include all subsidiaries and affiliates of Borrower. Notwithstanding the foregoing however, under no circumstances shall this Agreement be construed to require Lender to make any Loan or other financial accommodation to any subsidiary or affiliate of Borrower. SUCCESSORS AND ASSIGNS. All covenants and agreements contained by or on behalf of Borrower shall bind its successors and assigns and shall inure to the benefit of Lender, its successors and assigns. Borrower shall not, however, have the right to assign its rights under this Agreement or any interest therein, without the prior written consent of Lender. SURVIVAL. All warranties, representations, and covenants made by Borrower in this Agreement or in any certificate or other instrument delivered by Borrower to Lender under this Agreement shall be considered to have been relied upon by Lender and will survive the making of the Loan and delivery to Lender of the Related Documents, regardless of any investigation made by Lender or on Lender's behalf. WAIVER. Lender shall not be deemed to have waived any rights under this Agreement unless such waiver is given in writing and signed by Lender. No delay or omission on the part of Lender in exercising any right shall operate as a waiver of such right or any other right. A waiver by Lender of a provision of this Agreement shall not prejudice or constitute a waiver of Lender's right otherwise to demand strict compliance with that provision or any other provision of this Agreement. No prior waiver by Lender, nor any course of dealing between Lender and Borrower, or between Lender and any Grantor, shall constitute a waiver of any of Lender's rights or of any obligations of Borrower or of any Grantor as to any future transactions. Whenever the consent of Lender is required under this Agreement, the granting of such consent by Lender in any instance shall not constitute continuing consent in subsequent instances where such consent is required, and in all cases such consent may be granted or withheld in the sole discretion of Lender. BORROWER ACKNOWLEDGES HAVING READ ALL THE PROVISIONS OF THIS BUSINESS LOAN AGREEMENT, AND BORROWER AGREES TO ITS TERMS. THIS AGREEMENT IS DATED AS OF MAY 31, 1999. BORROWER: APPLIED MICROSYSTEMS CORPORATION By: /s/ Robert L. Deinhammer ------------------------ ROBERT L. DEINHAMMER, CHAIRMAN OF THE BOARD By: /s/ Stephen J. Verleye ----------------------- STEPHEN J. VERLEYE, PRESIDENT/CHIEF EXECUTIVE OFFICER LENDER: U.S. Bank National Association By: /s/ Ann B.Caldwell ------------------ Authorized Officer [Page 5] ALTERNATIVE RATE OPTIONS PROMISSORY NOTE (PRIME RATE1 LIBOR) $7,000,000.00 Dated as of: 05/31/99 APPLIED MICROSYSTEMS CORPORATION ("Borrower") U.S. BANK NATIONAL ASSOCIATION ("Lender") 1. TYPE OF CREDIT. This note is given to evidence Borrower's obligation to repay all sums which Lender may from time to time advance to Borrower ("Advances") under a: / / single disbursement loan. Amounts loaned to Borrower hereunder will be disbursed in a single Advance in the amount shown in Section 2. X revolving line of credit. No Advances shall be made which create a maximum amount outstanding at any one time which exceeds the maximum amount shown in Section 2. However, Advances hereunder may be borrowed, repaid and reborrowed, and the aggregate Advances loaned hereunder from time to time may exceed such maximum amount. non-revolving line of credit. Each Advance made from time to time hereunder shall reduce the maximum amount available shown in Section 2. Advances loaned hereunder which are repaid may not be reborrowed. 2. PRINCIPAL BALANCE. The unpaid principal balance of all Advances outstanding under this note ("Principal Balance") at one time shall not exceed $7,000,000.00 3. PROMISE TO PAY. For value received Borrower promises to pay to Lender or order at COMMERCIAL LOAN SERVICE CENTER-WEST, the Principal Balance of this note, with interest thereon at the rate(s) specified in Sections 4 and 11 below. 4. INTEREST RATE. The interest rate on the Principal Balance outstanding may vary from time to time pursuant to the provisions of this note. Subject to the provisions of this note, Borrower shall have the option from time to time of choosing to pay interest at the rate or rates and for the applicable periods of time based on the rate options provided herein; PROVIDED, however, that once Borrower notifies Lender of the rate option chosen in accordance with the provisions of this note, such notice shall be irrevocable. The rate options are the Prime Borrowing Rate and the LIBOR Borrowing Rate, each as defined herein. (a) Definitions. The following terms shall have the following meanings: "Business Day" means any day other than a Saturday, Sunday, or other day that commercial banks in Portland, Oregon or New York City are authorized or required by law to close; provided, however that when used in connection with a LIBOR Rate, LIBOR Amount or LIBOR Interest Period such term shall also exclude any day on which dealings in U.S. dollar deposits ARE not carried on in the London interbank market. "LIBOR Amount" means each principal amount for which Borrower chooses to have the LIBOR Borrowing Rate apply for any specified LIBOR Interest Period. "LIBOR Interest Period" means as to any LIBOR Amount, a period of 1,2,3,6 or 12 months commencing on the date the LIBOR Borrowing Rate becomes applicable thereto; PROVIDED, however, that; (i) the first day of each LIBOR Interest Period must be a Business Day; (ii) no LIBOR Interest Period shall be selected which would extend beyond MAY 31, 2000: (iii) no LIBOR Interest Period shall extend beyond the date of any principal payment required under Section 6 of this note, unless the sum of the Prime Rate Amount, plus LIBOR Amounts with LIBOR Interest Periods ending on or before the scheduled date of such principal payment, plus principal amounts remaining unborrowed under a tine of credit, equals or exceeds the amount of such principal payment; (iv) any LIBOR Interest Period which would otherwise expire on a day which is not a Business Day, shall be extended to the next succeeding Business Day, unless the result of such extension would be to extend such LIBOR Interest Period into another calendar month, in which event the LIBOR Interest Period shall end on the immediately preceding Business Day; and (v) any LIBOR Interest Period that begins on the last Business Day of a calendar month (or on a day for which there is no numerically corresponding day in the calendar month at the end of such LIBOR Interest Period) shall end on the last Business Day of a calendar month. "LIBOR Rate" means, for any LIBOR Interest Period, the rate per annum (computed on the basis of a 360-day year and the actual number of days elapsed and rounded upward to the nearest 1/16 of 1%) established by Lender as its LIBOR Rate, based on Lender's determination, on the basis of such factors as Lender deems relevant, of the rate of Interest at which U.S. dollar deposits would be offered to U.S. Bank National Association In the London interbank market at approximately 11 a.m. London time on the date which is two Business Days prior to the first day of such LIBOR Interest Period for delivery on the first day of such LIBOR Interest Period for the number of months therein; PROVIDED, however, that the LIBOR Rate shall be adjusted to take into account the maximum reserves required to be maintained for Eurocurrency liabilities by banks during each such LIBOR Interest Period as specified in Regulation D of the Board of Governors of the Federal Reserve System or any successor regulation. "Prime Rate" means the rate of interest which Lender from time to time establishes as its prime rate and is not, for example, the lowest rate of interest which Lender collects from any borrower or class of borrowers. When the Prime Rate is applicable under Section 4(b) or 11(b), the Interest rate hereunder shall be adjusted without notice effective on the day the Prime Rate changes, but in no event shall the rate of interest be higher than allowed by law. "Prime Rate Amount" means any portion of the Principal Balance bearing interest at the Prime Borrowing Rate. (b) The Prime Borrowing Rate. (i) The Prime Borrowing Rate is a per annum rate equal to the Prime Rate plus 0.000% per annum. (ii) Whenever Borrower desires to use the Prime Borrowing Rate option, Borrower shall give Lender notice orally or in writing in accordance with Section 15 of this note, which notice shall specify the requested effective date (which must be a Business Day) and principal amount of the Advance or increase in the Prime Rate Amount, and whether Borrower is requesting a new Advance under a line of credit or conversion of a LIBOR Amount to the Prime Borrowing Rate. (iii) Subject to Section 11 of this note, interest shall accrue on the unpaid Principal Balance at the Prime Borrowing Rate unless and except to the extent that the LIBOR Borrowing Rate is in effect. (c) The LIBOR Borrowing Rate. (i) The LIBOR Borrowing Rate is the LIBOR Rate plus 1.450% per annum. (ii) Borrower may obtain LIBOR Borrowing Rate quotes from Lender between 8:00 a.m. and 10:00 a.m. (Portland, Oregon time) on any Business Day. Borrower may request an Advance, conversion of any portion of the Prime Rate Amount to a LIBOR Amount or a new LIBOR Interest Period for an existing LIBOR Amount, at such rate only by giving Lender notice in accordance with Section 4 (c) (iii) before 10:00 a.m. (Portland, Oregon time) on such day. [Page 1] (iii) whenever Borrower desires to use the LIBOR Borrowing Rate option, Borrower shall give Lender irrevocable notice (either in writing or orally and promptly confirmed in writing) between 8:00 a.m. and 10:00 a.m. (Portland, Oregon time) two (2) Business Days prior to the desired effective date of such rate. Any oral notice shall be given by. and any written notice or confirmation of an oral notice shall be signed by, the person(s) authorized in Section 15 of this note, and shall specify the requested effective date of the rate, LIBOR Interest Period and LIBOR Amount, and whether Borrower is requesting a new Advance at the LIBOR Borrowing Rate under a line of credit, conversion of all or any portion of the Prime Rate Amount to a LIBOR Amount, or a new LIBOR Interest Period for an outstanding LIBOR Amount. Notwithstanding any other term of this note, Borrower may elect the LIBOR Borrowing Rate in the minimum principal amount of $500,000.00 and in multiples of $100,000.00 above such amount; PROVIDED, however, that no more than FIVE separate LIBOR Interest Periods may be in effect at any one time. (iv) If at any time the LIBOR Rate is unascertainable or unavailable to Lender or if LIBOR Rate loans become unlawful, the option to select the LIBOR Borrowing Rate shall terminate immediately. If the LIBOR Borrowing Rate is then in effect, (A) it shall terminate automatically with respect to all LIBOR Amounts (i) on the last day of each then applicable LIBOR Interest Period, if Lender may lawfully continue to maintain such loans, or (ii) immediately if Lender may not lawfully continue to maintain such loans through such day, and (B) Subject to Section 11, the Prime Borrowing Rate automatically shall become effective as to such amounts upon such termination. (v) If at any time after the date hereof (A) any revision in or adoption of any applicable law, rule, or regulation or in the interpretation or administration thereof (i) shall subject Lender or its Eurodollar lending office to any tax, duty, or other charge, or change the basis of taxation of payments to Lender with respect to any loans bearing interest based on the LIBOR Rate, or (ii) shall impose or modify any reserve, insurance, special deposit, or similar requirements against assets of, deposits with or for the account of, or credit extended by Lender or its Eurodollar lending office, or impose on Lender or its Eurodollar lending office any other condition affecting any such loans, and (B) the result of any of the foregoing is (i) to increase the cost to Lender of making or maintaining any such loans or (ii) to reduce the amount of any sum receivable under this note by Lender or its Eurodollar lending office, Borrower shall pay Lender within 15 days after demand by Lender such additional amount as will compensate Lender for such increased cost or reduction. The determination hereunder by Lender of such additional amount shall be conclusive in the absence of manifest error. If Lender demands compensation under this Section 4(c)(v), Borrower may upon three (3) Business Days' notice to Lender pay the accrued interest on all LIBOR Amounts, together with any additional amounts payable under Section 4(c)(vi). Subject to Section 11, upon Borrower's paying such accrued interest and additional costs, the Prime Borrowing Rate immediately shall be effective with respect to the unpaid principal balance of such LIBOR Amounts. (vi) Borrower shall pay to Lender, on demand, such amount as Lender reasonably determines (determined as though 100% of the applicable LIBOR Amount had been funded in the London interbank market) is necessary to compensate Lender for any direct or indirect losses, expenses, liabilities, costs, expenses or reductions in yield to Lender, whether incurred in connection with liquidation or re-employment of funds or otherwise, incurred or sustained by Lender as a result of: (A) Any payment or prepayment of a LIBOR Amount, termination of the LIBOR Borrowing Rate or conversion of a LIBOR Amount to the Prime Borrowing Rate on a day other than the last day of the applicable LIBOR Interest Period (including as a result of acceleration or a notice pursuant to Section 4(c)(v)); or (B) Any failure of Borrower to borrow, continue or prepay any LIBOR Amount or to convert any portion of the Prime Rate Amount to a LIBOR Amount after Borrower has given a notice thereof to Lender. (vii) If Borrower chooses the LIBOR Borrowing Rate, Borrower shall pay interest based on such rate, plus any other applicable taxes or charges hereunder, even though Lender may have obtained the funds loaned to Borrower from sources other than the London interbank market. Lender's determination of the LIBOR Borrowing Rate and any such taxes or charges shall be conclusive in the absence of manifest error. (viii) Notwithstanding any other term of this note, Borrower may not select the LIBOR Borrowing Rate if an event of default hereunder has occurred and is continuing. (ix) Nothing contained in this note, including without limitation the determination of any LIBOR Interest Period or Lender's quotation of any LIBOR Borrowing Rate, shall be construed to prejudice Lender's right, if any to decline to make any requested Advance or to require payment on demand. 5. COMPUTATION OF INTEREST. All interest under Section 4 and Section 11 will be computed at the applicable rate based on a 360-day year and applied to the actual number of days elapsed. 6. PAYMENT SCHEDULE. (a) Principal. Principal shall be paid: on demand. on demand, or if no demand, on _____, X on May 31, 2000 subject to Section 8, in installments of ______ each, plus accrued interest, beginning on ______ and on the same day of each ______ thereafter until when the entire Principal Balance plus interest thereon shall be due and payable. (b) Interest (i) Interest on the Prime Rate Amount shall be paid: X on the LAST day of JUNE, 1999 and on the same day of each MONTH thereafter prior to maturity and at maturity. at maturity. at the time each principal installment is due and at maturity. (ii) Interest on all LIBOR Amounts shall be paid: on the last day of the applicable LIBOR Interest Period, and if such LIBOR Interest Period is longer than three months, on the last day of each three-month period occurring during such LIBOR Interest Period, and at maturity. X on the LAST day of JUNE, 1999 and on the same day of each MONTH thereafter prior to maturity and at maturity. at maturity. at the time each principal installment is due and at maturity. 7. PREPAYMENT. (a) Prepayments of all or any part of the Prime Rate Amount may be made at any time without penalty. (b) Except as otherwise specifically set forth herein, Borrower may not prepay all or any part of any LIBOR Amount or terminate any LIBOR Borrowing Rate, except on the last day of the applicable LIBOR Interest Period. [Page 2] (c) Principal prepayments will not postpone the date of or change the amount of any regularly scheduled payment. At the time of any principal prepayment, all accrued interest, fees, costs and expenses shall also be paid. 8. CHANGE IN PAYMENT AMOUNT. Each time the interest rate on this note changes the holder of this note may. from time to time, in holder's sole discretion, increase or decrease the amount of each of the installments remaining unpaid at the time of such change in rate to an amount holder in its sole discretion deems necessary to continue amortizing the Principal Balance at the same rate established by the installment amounts specified in Section 6(a). whether or not a "balloon" payment may also be due upon maturity of this note. Holder shall notify the undersigned of each such change in writing. Whether or not the installment amount is increased under this Section 8, Borrower understands that, as a result of increases in the rate of interest the final payment due. whether or not a "balloon" payment, shall include the entire Principal Balance and interest thereon then outstanding, and may be substantially more than the installment specified in Section 6. 9. ALTERNATE PAYMENT DATE. Notwithstanding any other term of this note, if in any month there is no day on which a scheduled payment would otherwise be due (e.g. February 31), such payment shall be paid on the last banking day of that month. 10. PAYMENT BY AUTOMATIC DEBIT. X Borrower hereby authorizes Lender to automatically deduct the amount of all principal and interest payments from account number XXXXXXXXXXXX. If there are insufficient funds in the account to pay the automatic deduction in full, Lender may allow the account to become overdrawn, or Lender may reverse the automatic deduction. Borrower will pay all the fees on the account which result from the automatic deductions, including any overdraft and non-sufficient funds charges. If for any reason Lender does not charge the account for a payment, or if an automatic payment is reversed, the payment is still due according to this note. If the account is a Money Market Account, the number of withdrawals from that account is limited as set out in the account agreement Lender may cancel the automatic deduction at any time in its discretion. Provided, however, if no account number is entered above, Borrower does not want to make payments by automatic debit. 11. DEFAULT. (a) Without prejudice to any right of Lender to require payment on demand or to decline to make any requested Advance, each of the following shall be an event of default: (i) Borrower fails to make any payment when due. (ii) Borrower fails to perform or comply with any term, covenant or obligation in this note or any agreement related to this note, or in any other agreement or loan Borrower has with Lender. (iii) Borrower defaults under any loan, extension of credit, security agreement, purchase or sales agreement, or any other agreement, in favor of any other creditor or person that may materially affect any of Borrower's property or Borrower's ability to repay this note or perform Borrower's obligations under this note or any related documents. (iv) Any representation or statement made or furnished to Lender by Borrower or on Borrower's behalf is false or misleading in any material respect either now or at the time made or furnished. (v) Borrower dies, becomes insolvent, liquidates or dissolves, a receiver is appointed for any part of Borrower's property, Borrower makes an assignment for the benefit of creditors, or any proceeding is commenced either by Borrower or against Borrower under any bankruptcy or insolvency laws. (vi) My creditor tries to take any of Borrower's property on or in which Lender has a lien or security interest. This includes a garnishment of any of Borrower's accounts with Lender. (vii) Any of the events described in this default section occurs with respect to any general partner in Borrower or any guarantor of this note, or any guaranty of Borrower's indebtedness to Lender ceases to be, or is asserted not to be, in full force and effect. (viii) There is any material adverse change in the financial condition or management of Borrower or Lender in good faith deems itself insecure with respect to the payment or performance of Borrower's obligations to Lender. If this note is payable on demand, the inclusion of specific events of default shall not prejudice Lender's right to require payment on demand or to decline to make any requested Advance. (b) Without prejudice to any right of Lender to require payment on demand, upon the occurrence of an event of default, Lender may declare the entire unpaid Principal Balance on this note and all accrued unpaid interest immediately due and payable, without notice. Upon default, including failure to pay upon final maturity, Lender, at its option, may also, if permitted under applicable law, increase the interest rate on this note to a rate equal to the Prime Borrowing Rate plus 5%. The interest rate will not exceed the maximum rate permitted by applicable law. In addition, if any payment of principal or interest is 19 or more days past due, Borrower will be charged a late charge of 5% of the delinquent payment. 12. EVIDENCE OF PRINCIPAL BALANCE; PAYMENT ON DEMAND. Holder's records shall, at any time, be conclusive evidence of the unpaid Principal Balance and interest owing on this note. Notwithstanding any other provisions of this note, in the event holder makes Advances hereunder which result in an unpaid Principal Balance on this note which at any time exceeds the maximum amount specified in Section 2, Borrower agrees that all such Advances, with interest, shall be payable on demand. 13. LINE OF CREDIT PROVISIONS. If the type of credit indicated in Section 1 is a revolving line of credit or a non-revolving line of credit, Borrower agrees that Lender is under no obligation and has not committed to make any Advances hereunder. Each Advance hereunder shall be made at the sole option of Lender. 14. DEMAND NOTE. If this note is payable on demand, Borrower acknowledges and agrees that (a) Lender is entitled to demand Borrower's immediate payment in full of all amounts owing hereunder and (b) neither anything to the contrary contained herein or in any other loan documents (including but not limited to, provisions relating to defaults, rights of cure, default rate of interest, installment payments, late charges, periodic review of Borrower's financial condition, and covenants) nor any act of Lender pursuant to any such provisions shall limit or impair Lender's right or ability to require Borrower's payment in full of all amounts owing hereunder immediately upon Lender's demand. 15. REQUESTS FOR ADVANCES. (a) Advances under this Note, may be requested orally or in writing by Borrower or by an authorized person. Lender may, but need not, require that all oral requests be confirmed in writing. Borrower agrees to be liable for all sums either: (a) advanced in accordance with the e instructions of an authorized person or (b) credited to any of Borrower's accounts with Lender. The unpaid principal balance owing on this Note at any time may be evidenced by endorsements on this Note or by Lender's internal records, including daily computer print-outs. (b) All Advances shall be disbursed by deposit directly to Borrower's account number XXXXXXXXXXX or by cashier's check issued to Borrower. (c) Borrower agrees that Lender shall have no obligation to verify the identity of any person making any request pursuant to this Section 15, and Borrower assumes all risks of the validity and authorization of such requests. In consideration of Lender agreeing, at its sole discretion, to make Advances upon such requests, Borrower promises to pay holder, in accordance with the provisions of this note, the Principal Balance together with interest thereon and other sums due hereunder, although any Advances may have been requested by a person or persons not authorized to do so. 16. PERIODIC REVIEW, Lender will review Borrower's credit accommodations periodically. At the time of the review, Borrower will furnish Lender with any additional information regarding Borrower's financial condition and business operations that Lender requests. This information may include but is not limited to, financial statements, tax returns, lists of assets and liabilities, agings of receivables and payables, inventory schedules, budgets and forecasts. If upon review, Lender, in its sole discretion, determines that there has been a material adverse change in Borrower's financial condition, Borrower will be in default. Upon default, Lender shall have all rights specified herein. 17. NOTICES. Any notice hereunder may be given by ordinary mail, postage paid and addressed to Borrower at the last known address of Borrower as shown on holder's records. If Borrower consists of more than one person, notification of any of said persons shall be complete notification of all. 18. ATTORNEY FEES. Whether or not litigation or arbitration is commenced, Borrower promises to pay all costs of collecting overdue amounts. Without limiting the foregoing, in the event that holder consults an attorney regarding the enforcement of any of its rights under this note or any document securing the same, or if this note is placed in the hands of an attorney for collection or if suit or litigation is brought to enforce this note or any document securing the same, Borrower promises to pay all costs thereof including such additional sums as the court or arbitrator(s) may adjudge reasonable as attorney fees, including without imitation, costs and attorney fees incurred in any appellate court, in any proceeding under the bankruptcy code, or in any receivership and post-judgment attorney fees incurred in enforcing any judgment. [Page 3] 19. WAIVERS; CONSENT. Each party hereto, whether maker, co-maker, guarantor or otherwise, waives diligence, demand, presentment for payment, notice of non-payment, protest and notice of protest and waives all defenses based on suretyship or impairment of collateral. Without notice to Borrower and without diminishing or affecting Lender's rights or Borrower's obligations hereunder, Lender may deal in any manner with any person who at any time is liable for, or provides any real or personal property collateral for, any indebtedness of Borrower to Lender, including the indebtedness evidenced by this note. Without limiting the foregoing, Lender may, in its sole discretion: (a) make secured or unsecured loans to Borrower and agree to any number of waivers, modifications, extensions and renewals of any length of such loans, including the loan evidenced by this note; (b) impair, release (with or without substitution of new collateral), fail to perfect a security interest in, fail to preserve the value of, fail to dispose of in accordance with applicable law, any collateral provided by any person; (c) sue, fail to sue, agree not to sue, release, and settle or compromise with, any person. 20. JOINT AND SEVERAL LIABILITY. All undertakings of the undersigned Borrowers are joint and several and are binding upon any marital community of which any of the undersigned are members. Holder's rights and remedies under this note shall be cumulative. 21. SEVERABILITY. If any term or provision of this note is declared by a court of competent jurisdiction to be illegal. invalid or unenforceable for any reason whatsoever, such illegality, invalidity or unenforceability shall not affect the balance of the terms and provisions hereof, which terms and provisions shall remain binding and enforceable, and this note shall be construed as if such illegal, invalid or unenforceable provision had not been contained herein. 22. ARBITRATION. (a) Either Lender or Borrower may require that all disputes, claims, counterclaims and defenses, including those based on or arising from any alleged tort ("Claims") relating in any way to this note or any transac tion of which this note is a part (the "Loan"), be settled by binding arbitration in accordance with the Commercial Arbitration Rules of the American Arbitration Association and Title 9 of the U.S. Code. All Claims will be subject to the statutes of limitation applicable if they were litigated. This provision is void if the Loan, at the time of the proposed submission to arbitration, is secured by real property located outside of Oregon or Washington, or if the effect of the arbitration procedure (as opposed to any Claims of Borrower) would be to materially impair Lender's ability to realize on any collateral securing the Loan. (b) If arbitration occurs and each party's Claim is less than $100,000, one neutral arbitrator will decide all issues; if any party's Claim is $100,000 or more, three neutral arbitrators will decide all issues. All arbitrators will be active Washington State Bar members in good standing. All arbitration hearings will be held in Seattle, Washington. In addition to all other powers. the arbitrator(s) shall have the exclusive right to determine all issues of arbitrability. Judgment on any arbitration award may be entered in any court with jurisdiction. (c) If either party institutes any judicial proceeding relating to the Loan, such action shall not be a waiver of the right to submit any Claim to arbitration. In addition, each has the right before, during and after any arbitration to exercise any number of the following remedies, in any order or concurrently: (i) setoff; (ii) self-help repossession; (iii) judicial or non-judicial foreclosure against real or personal property collateral; and (iv) provisional remedies, including injunction, appointment of receiver, attachment, claim and delivery and replevin. 23. GOVERNING LAW. This note shall be governed by and construed and enforced in accordance with the laws of the State of Washington without regard to conflicts of law principles: provided, however, that to the extent that Lender has greater rights or remedies under Federal law, this provision shall not be deemed to deprive Lender of such rights and remedies as may be available under Federal law. 24. YEAR 2000. Borrower has reviewed and assessed its business operations and computer systems and applications to address the "year 2000 problem" (that is, that computer applications and equipment used by Borrower, directly or indirectly through third parties, may be unable to properly perform date-sensitive functions before, during and after January 1.2000). Borrower reasonably believes that the year 2000 problem will not result in a material adverse change in Borrower's business condition (financial or otherwise), operations. properties or prospects or ability to repay Lender. Borrower agrees that this representation will be true and correct on and shall be deemed made by Borrower on each date Borrower requests any advance under this Agreement or Note or delivers any information to Lender. Borrower will promptly deliver to Lender such information relating to this representation as Lender requests from time to time. 25. RENEWAL AND EXTENSION. This Note is given in renewal and extension and not in novation of the following described indebtedness: That certain Promissory Note dated May 31, 1998, in the amount of $7,000,000.00 executed by Borrower payable to Lender. It is further agreed that all liens and security interest securing said indebtedness are hereby renewed and extended to secure the Note and all renewals, extensions and modifications thereof. 26. DISCLOSURE. ORAL AGREEMENTS OR ORAL COMMITMENTS TO LOAN MONEY, EXTEND CREDIT, OR TO FOREBEAR FROM ENFORCING REPAYMENT OF A DEBT ARE NOT ENFORCEABLE UNDER WASHINGTON LAW. EACH OF THE UNDERSIGNED HEREBY ACKNOWLEDGES RECEIPT OF A COMPLETED COPY OF THIS DOCUMENT. APPLIED MICROSYSTEMS CORPORATION Borrower Name (Corporation, Partnership or other Entity) By: /s/ Robert L. Deinhammer ------------------------ ROBERT L. DEINHAMMER Title: CHAIRMAN OF THE BOARD By: /s/ Stephen J. Verleye ---------------------- STEPHEN J. VERLEYE Title: PRESIDENT/CHIEF EXECUTIVE OFFICER For valuable consideration, Lender agrees to the terms of the arbitration provision set forth in this note. Lender Name: U.S. Bank National Association ------------------------------ By: /s/ Ann B.Caldwell ------------------ ANN B. CALDWELL Title Vice President -------------- [Page 4] EX-21 3 EX-21 EXHIBIT 21 Applied Microsystems Corporation SUBSIDIARIES Applied Microsystems Corporation, Ltd., organized under the laws of England and Wales Applied Microsystems GmbH, organized under the laws of the Federal Republic of Germany Applied Microsystems Japan, Ltd., organized under the laws of Japan Applied Microsystems Foreign Sales Corporation, a Washington Corporation Applied Microsystems S.A.R.L., organized under the laws of France EX-23 4 EX-23 EXHIBIT 23 CONSENT OF ERNST & YOUNG LLP, INDEPENDENT AUDITORS We consent to the incorporation by reference in the Registration Statement (Form S-8 No. 333-07331) pertaining to the Applied Microsystems Corporation 1996 Employee Stock Purchase Plan, the Registration Statement (Form S-8 No. 333-03396) pertaining to the Applied Microsystems Corporation 1990 Stock Benefit Plan, the Applied Microsystems Corporation 1992 Performance Stock Plan, and the Applied Microsystems Corporation Director Stock Option Plan and the Registration Statement (Form S-8 No. 333-14823) pertaining to the Applied Microsystems Corporation 1992 Performance Stock Plan of our report dated February 2, 2000 with respect to the consolidated financial statements and schedule of Applied Microsystems Corporation included in the Annual Report (Form 10-K) for the year ended December 31, 1999. ERNST & YOUNG LLP Seattle, Washington March 28, 2000 EX-27 5 EX-27
5 THIS SCHEDULE CONTAINS SUMMARY FINANCIAL INFORMATION EXTRACTED FROM THE FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 1999, AND IS QUALIFIED IN ITS ENTIRETY BY REFERENCE TO SUCH FINANCIAL STATEMENTS AND FOOTNOTES. 1,000 YEAR DEC-31-1999 JAN-01-1999 DEC-31-1999 5,682 10,664 5,848 0 2,471 25,166 2,372 0 28,042 8,855 0 0 0 25,792 (6,605) 28,042 33,241 33,241 8,664 30,364 (706) 0 0 (5,081) 0 (5,081) 0 0 0 (5,081) (.76) (.76)
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