----

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**UNITED STATESSECURITIES AND EXCHANGE COMMISSION****Washington,D.C. 20549**

**FORM 10–Q**

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

**For thequarterly period ended June 30, 2001**

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

**For thetransition period from ______ to ______**

**Commission File Number 0-26778**

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**APPLIED  MICROSYSTEMS  CORPORATION**(Exact name of registrant as specified inits charter)

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| **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  of principal executive offices, including zip code; registrant’s telephone  number, including area code)                                                                                                                                                                                                                                                  |
|                                                                                                                                                                                                                                                                                                                                                                     |

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             Indicate by check mark whether theregistrant (1) has filed all reports required to be filed by Section 13 or15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (orfor 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 ý            No o

             Indicate the number of sharesoutstanding of each of the issuer’s classes of common stock, as of the latestpracticable date.

Commonstock, $.01 par value: 7,127,490 shares outstanding as of August 3, 2001.

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**APPLIED MICROSYSTEMS CORPORATION**

**FORM 10-Q**

**QUARTER ENDED JUNE 30, 2001**

**INDEX**

| **PART I:**  | **FINANCIAL INFORMATION**                                                                                |
|--------------|----------------------------------------------------------------------------------------------------------|
|         |                                                                                                     |
| Item 1.      | Financial Statements:                                                                                    |
|         |                                                                                                     |
|         | Consolidated Balance  Sheets as of June 30, 2001 and December 31, 2000                                   |
|         |                                                                                                     |
|         | Consolidated  Statements of Operations for the three months and six months ended June 30,  2001 and 2000 |
|         |                                                                                                     |
|         | Consolidated  Statements of Cash Flows for the six months ended June 30, 2001 and 2000                   |
|         |                                                                                                     |
|         | Notes  to Consolidated Financial Statements                                                              |
|         |                                                                                                     |
| Item  2.     | Management’s  Discussion and Analysis of Financial Condition and Results of Operations              |
|         |                                                                                                     |
| Item  3.     | Quantitative  and Qualitative Disclosures About Market Risk                                              |
|         |                                                                                                     |
| **PART II:** | **OTHER INFORMATION**                                                                                    |
|         |                                                                                                     |
| Item  4.     | Submission  of Matters to a Vote of Security Holders                                                     |
|         |                                                                                                     |
| Item 5.      | Other Information                                                                                        |
|         |                                                                                                     |
| Item  6.     | Exhibits  and Reports on Form 8-K                                                                        |
|         |                                                                                                     |
|         | Signatures                                                                                               |

**PART I- FINANCIAL INFORMATION**

**Item 1.**              **Financial Statements**

**APPLIED MICROSYSTEMSCORPORATION**

**CONSOLIDATED BALANCE SHEETS**

|                                            |                                        |    |                   |    |
|-------------------------------------------------|---------------------------------------------|---------|------------------------|---------|
|                                            | **June 30,  2001**                          |    | **December 31,  2000** |    |
|                                            | ****                                        |    | ****                   |    |
|                                            | **(unaudited)**                             |    |                   |    |
|                                            | **(in thousands)**                          |    |
|                                            |                                        |    |                   |    |
| ASSETS                                          |                                        |    |                   |    |
|                                            |                                        |    |                   |    |
| Current assets:                                 |                                        |    |                   |    |
|                                            | Cash and cash  equivalents                  | $       | 4,002                  |    | $ | 7,956 |   |
|                                            | Securities  available-for-sale              | 5,079   |                   | 2,526   |   |
|                                            | Accounts  receivable, net                   | 5,716   |                   | 5,729   |   |
|                                            | Inventories                                 | 2,181   |                   | 2,358   |   |
|                                            | Prepaid  and other current assets           | 408     |                   | 314     |   |
|                                            |                                        |         |                   |         |   |
|                                            | Total  current assets                       | 17,386  |                   | 18,883  |   |
|                                            |                                        |    |                   |    |
| Property  and equipment, net                    | 1,883                                       |    | 2,109                  |    |
| Other  assets                                   | 411                                         |    | 461                    |    |
|                                            |                                             |    |                        |    |
|                                            | Total  assets                               | $       | 19,680                 |    | $ | 21,453 |   |
|                                            |                                             |    |                        |    |
|                                            |                                        |    |                   |    |
|                                            | LIABILITIES  AND SHAREHOLDERS' EQUITY       |    |                   |    |   |
|                                            |                                        |    |                   |    |
| Current  liabilities:                           |                                        |    |                   |    |
|                                            | Accounts  payable                           | $       | 2,225                  |    | $ | 2,954 |   |
|                                            | Accrued  payroll                            | 1,998   |                   | 1,993   |   |
|                                            | Other  accrued expenses                     | 1,048   |                   | 1,029   |   |
|                                            | Deferred  revenue                           | 3,607   |                   | 4,654   |   |
|                                            |                                        |         |                   |         |   |
|                                            | Total  current liabilities                  | 8,878   |                   | 10,630  |   |
|                                            |                                        |    |                   |    |
| Capital  lease obligation, less current portion | 197                                         |    | -                      |    |
|                                            |                                        |    |                   |    |
| Shareholders'  equity:                          |                                        |    |                   |    |
|                                            | Preferred  stock, par value $0.01           | -       |                   | -       |   |
|                                            | Common  stock, par value $0.01              | 26,708  |                   | 26,360  |   |
|                                            | Accumulated  other comprehensive loss       | (813    | )                      | (879    | ) |
|                                            | Accumulated  deficit                        | (15,290 | )                      | (14,658 | ) |
|                                            |                                        |         |                   |         |   |
|                                            | Total  shareholders' equity                 | 10,605  |                   | 10,823  |   |
|                                            |                                        |         |                   |         |   |
|                                            | Total  liabilities and shareholders' equity | $       | 19,680                 |    | $ | 21,453 |   |
|                                            |                                        |         |                   |         |   |
|                                            |                                        |    |                   |    |   |
| See accompanying  notes.                        |                                        |
|                                                 |                                             |         |                        |         |  |  |  |  |  |

 

**APPLIEDMICROSYSTEMS CORPORATION**

**CONSOLIDATED STATEMENTS OF OPERATIONS****(UNAUDITED)**

|                                                                                         | **Three  Months ended  June 30,**        |       | **Six  Months ended  June 30,** |   |
|----------------------------------------------------------------------------------------------|------------------------------------------|------------|---------------------------------|--------|
|                                                                                         | ****                                     |       | ****                            |   |
|                                                                                         | **2001**                                 |       | **(Restated)****2000**          |   | **2001** |   | **(Restated)****2000** |   |
|                                                                                         | ****                                     |       | ****                            |   | **** |   | **** |   |
|                                                                                         | (in thousands, except per-share amounts) | ** ** |
|                                                                                         |                                     |       |
|                                                                                         |                                     |       |                            |   |   |   |   |   |
| Net sales                                                                                    | $                                        | 8,840      |                            | $      | 7,862 |   | $ | 18,954 |   | $ | 15,545 |   |
| Cost of sales                                                                                | 2,516                                    |       | 2,538                           |   | 5,323 |   | 4,642 |   |
|                                                                                         |                                          |       |                                 |   |  |   |  |   |
| Gross profit                                                                                 | 6,324                                    |       | 5,324                           |   | 13,631 |   | 10,903 |   |
|                                                                                         |                                     |       |                            |   |   |   |   |   |
| Operating expenses:                                                                          |                                     |       |                            |   |   |   |   |   |
|                                                                                         | Sales, general and  administrative       | 4,004      |                            | 4,249  |   | 7,888 |   | 8,741 |   |
|                                                                                         | Research and  development                | 3,295      |                            | 3,347  |   | 6,559 |   | 6,428 |   |
|                                                                                         |                                     |            |                            |        |   |  |   |  |   |
| Total operating  expenses                                                                    | 7,299                                    |       | 7,596                           |   | 14,447 |   | 15,169 |   |
|                                                                                         |                                          |       |                                 |   |  |   |  |   |
| Loss from operations                                                                         | (975                                     | )          | (2,272                          | )      | (816 | ) | (4,266 | ) |
| Interest income and  other, net                                                              | 83                                       |       | 177                             |   | 184 |   | 360 |   |
|                                                                                         |                                          |       |                                 |   |  |   |  |   |
| Loss before cumulative  effect of change in accounting principle                             | (892                                     | )          | (2,095                          | )      | (632 | ) | (3,906 | ) |
|                                                                                         |                                          |       |                                 |   |  |   |  |   |
| Cumulative effect of  change in accounting principle                                         | -                                        |       | -                               |   | - |   | (1,110 | ) |
|                                                                                         |                                          |       |                                 |   |  |   |  |   |
| Net loss                                                                                     | $                                        | (892       | )                               | $      | (2,095 | ) | $ | (632 | ) | $ | (5,016 | ) |
|                                                                                         |                                          |       |                                 |   |  |   |  |   |
| Basic and diluted loss  per share before cumulative effect of change in accounting principle | $                                        | (0.13      | )                               | $      | (0.30 | ) | $ | (0.09 | ) | $ | (0.57 | ) |
| Cumulative effect of  change in accounting principle                                         | -                                        |       | -                               |   | - |   | (.16 | ) |
|                                                                                         |                                          |       |                                 |   |  |   |  |   |
| Basic and diluted net  loss per share                                                        | $                                        | (0.13      | )                               | $      | (0.30 | ) | $ | (0.09 | ) | $ | (0.73 | ) |
|                                                                                         |                                          |       |                                 |   |  |   |  |   |
| Shares used in  per-share calculation                                                        | 7,055                                    |       | 6,909                           |   | 7,023 |   | 6,858 |   |
|                                                                                         |                                     |       |                            |   |   |   |   |   |
|                                                                                         |                                     |       |                            |   |   |   |   |   |
| See  accompanying notes.                                                                     |                                     |

 

 

**APPLIED MICROSYSTEMSCORPORATION**

**CONSOLIDATED STATEMENTS OF CASH FLOWS****(UNAUDITED)**

** **

|                                                                                                                       | **Six Months Ended June 30,**                        |       |
|----------------------------------------------------------------------------------------------------------------------------|------------------------------------------------------|------------|
|                                                                                                                       | ****                                                 |       |
|                                                                                                                       | **2001**                                             |       | **(Restated)  2000** |   |
|                                                                                                                       | ****                                                 |       | **** |   |
|                                                                                                                       | **(in thousands)**                                   |       |
|                                                                                                                       |                                                 | ** ** |   | ** ** |
| *Operating activities*                                                                                                     |                                                 |       |   |   |
| Net  loss                                                                                                                  | $                                                    | (632       | ) | $ | (5,016 | ) |
| Adjustments  to reconcile net loss to net cash used in operating activities:                                               |                                                 |       |   |   |
|                                                                                                                       | Depreciation  and amortization                       | 540        |   | 517 |   |
|                                                                                                                       | Cumulative  effect of change in accounting principle | -          |   | 1,110 |   |
|                                                                                                                       | Net  change in operating accounts:                   |       |   |   |   |
|                                                                                                                       | Accounts  receivable                                 | (162       | ) | - |   |
|                                                                                                                       | Inventories                                          | 397        |   | (369 | ) |
|                                                                                                                       | Prepaid  and other current assets                    | (90        | ) | 16 |   |
|                                                                                                                       | Other  assets                                        | 15         |   | (5 | ) |
|                                                                                                                       | Accounts  payable and accrued expenses               | (586       | ) | 827 |   |
|                                                                                                                       | Deferred  revenue                                    | (1,010     | ) | (775 | ) |
|                                                                                                                       |                                                 |            |   |  |   |
|                                                                                                                       | Net  cash used in operating activities               | (1,528     | ) | (3,695 | ) |
|                                                                                                                       |                                                 |       |   |   |
| *Investing  activities*                                                                                                    |                                                 |       |   |   |
|                                                                                                                       | Purchases  of securities available-for-sale          | (4,522     | ) | (3,697 | ) |
|                                                                                                                       | Maturities  of securities available-for-sale         | 1,969      |   | 9,693 |   |
|                                                                                                                       | Additions  to property and equipment                 | (119       | ) | (313 | ) |
|                                                                                                                       |                                                 |            |   |  |   |
|                                                                                                                       | Net  cash provided by (used in) investing activities | (2,672     | ) | 5,683 |   |
|                                                                                                                       |                                                 |       |   |   |
| *Financing  activities*                                                                                                    |                                                 |       |   |   |
|                                                                                                                       | Sale  of common stock to employees                   | 151        |   | 338 |   |
|                                                                                                                       | Stock  options exercised                             | 197        |   | 60 |   |
|                                                                                                                       |                                                 |            |   |  |   |
|                                                                                                                       | Net  cash provided by financing activities           | 348        |   | 398 |   |
|                                                                                                                       |                                                 |       |   |   |
| Effects  of foreign exchange rate changes on cash                                                                          | (102                                                 | )          | (104 | ) |
|                                                                                                                       |                                                      |       |  |   |
| Net  increase (decrease) in cash and cash equivalents                                                                      | (3,954                                               | )          | 2,282 |   |
| Cash  and cash equivalents at beginning of period                                                                          | 7,956                                                |       | 5,682 |   |
|                                                                                                                       |                                                      |       |  |   |
| Cash  and cash equivalents at end of period                                                                                | $                                                    | 4,002      |   | $ | 7,964 |   |
|                                                                                                                       |                                                      |       |  |   |
|                                                                                                                       |                                                 |       |   |   |
| *Supplemental disclosure of non-cash activities:*                                                                          |                                                 | * *   |   | * * |
| During  the first quarter of 2001, the Company obtained equipment under a five-year  capital lease obligation of $250,000. |                                                 |       |   |   |
|                                                                                                                       |                                                 |       |   |   |
| See accompanying  notes.                                                                                                   |                                                 |
|                                                                                                                            |                                                      |            |  |  |  |  |  |  |  |

**APPLIED MICROSYSTEMS CORPORATION**

**NOTES TO CONSOLIDATED FINANCIALSTATEMENTS****(UNAUDITED)**

**1.**          **Basis of Presentation**

             The accompanying unauditedconsolidated financial statements have been prepared by Applied MicrosystemsCorporation (“Applied” or the “Company”) in accordance with generally acceptedaccounting principles for interim financial information and according to therules and regulations of the Securities and Exchange Commission.  Accordingly, they do not include all of theinformation and footnotes required by generally accepted accounting principlesfor complete financial statements. In the opinion of management, alladjustments (which include only normal recurring adjustments) considerednecessary for a fair presentation have been included.  The balance sheet at December 31, 2000 has been derived from theaudited financial statements included in the Company’s Form 10-K for the yearthen ended.  The results of operationsfor the three-month and six-month periods ended June 30, 2001, are notnecessarily indicative of results to be expected for the entire year endingDecember 31, 2001 or for any other fiscal period.  For further information, refer to the consolidated financial statementsand footnotes thereto included in the Company's Form 10-K for the year endedDecember 31, 2000.

**2.**          **Computation of Loss Per Share**

             Basicand diluted loss per share is computed using the weighted-average number ofcommon shares outstanding during the period. Common stock equivalent shares are excluded from the computation ofdiluted loss per share because their effect is antidilutive due to theCompany’s net losses.

**3.**          **Comprehensive Loss**

             As defined by applicable accountingand reporting standards, Applied's comprehensiveloss is comprised of net loss and the effects of current-period translationadjustments, which are recorded directly to equity.  During the second quarter of 2001, comprehensive loss amounted to$409,000, compared to comprehensive loss of $2.4 million for the second quarterof 2000.  For the six months ended June30, 2001, comprehensive loss amounted to $566,000, compared to comprehensiveloss of $5.6 million for the six months ended June 30, 2000.

**4.**          **Inventories**

Inventories consist of the following:

|             | **June 30,  2001** |       | **December  31,  2000** |   |
|------------------|--------------------|------------|-------------------------|--------|
|             | ****               |       | ****                    |   |
|             | **(in thousands)** | ** ** |
|             |               |       |                    |   |
| Finished  goods  | $                  | 723        |                    | $      | 794 |   |
| Work  in process | 103                |       | 72                      |   |
| Purchased  parts | 1,355              |       | 1,492                   |   |
|             |                    |       |                         |   |
|             | $                  | 2,181      |                    | $      | 2,358 |   |
|             |                    |       |                         |   |

**5.**          **Cumulative Effect of Change in Accounting Principle**           

             Inthe fourth quarter of 2000, the Company implemented the Securities and ExchangeCommission’s Staff Accounting Bulletin (“SAB”) No. 101, “Revenue Recognition inFinancial Statements.”  SAB 101 providesguidance related to revenue recognition based upon interpretations andpractices followed by the SEC.  As aresult of the Company’s assessment of these new guidelines, Applied changed itsrevenue recognition practices for sales in Japan to reflect revenues upon theearlier of customer inspection and acceptance or, in the absence ofnotification of inspection and acceptance, upon receipt of payment.  Applied adopted SAB 101 under the cumulativecatch-up method of accounting, which is the manner prescribed under applicableaccounting and reporting rules.  Underthese rules, the cumulative effect of a change in accounting principle isrecognized as an additional item on the Company’s statement of operations inthe first quarter of the year in which the change is made.

             Applied’sadoption of this new standard resulted in a $1.1 million cumulative adjustmentincreasing the Company’s Q1 2000 net loss. Revenues and cost of goods sold in each of the 2000 quarters werelikewise restated as if the new accounting principle had been adopted since January1, 2000.  Deferred revenue at January 1,2000 included $1,406,000 related to goods that were shipped and previouslyrecognized as revenue but do not meet the new criteria for revenue recognition.  During the second quarter of 2000, $551,000of the amount deferred was recognized as revenue.  During the six months ended June 30, 2000, the entire amountdeferred was recognized as revenue.

**6.**          **Subsequent Event**

             OnAugust 1, 2001, Applied announced a plan to lower its costs, including areduction of approximately 90 full-time employees worldwide; a temporary 10%reduction in salaries for executive personnel; a closure of company facilitiesfor one week during the third quarter; as well as other cost reduction andcontrol measures.  After the staffreduction, Applied employs approximately 140 personnel worldwide.  The Company expects to take a restructuringcharge of $1.5 - $2.0 million in the third quarter related to itscost-reduction plan.

**7.**          **Recent Accounting Pronouncements**

             InJune 1998, the Financial Accounting Standards Board issued Statement ofFinancial Accounting Standards (“SFAS”) 133, “Accounting for DerivativeInstruments and Hedging Activities.” SFAS 133 requires companies to record derivatives on the balance sheetas assets or liabilities, measured at fair value.  Gains or losses resulting from changes in the fair values ofthose derivatives would be accounted for in current earnings unless specifichedge criteria are met.  The keycriterion for hedge accounting is that the hedging relationship must be highlyeffective 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, ifany.  SFAS 133 is effective for theCompany’s consolidated financial statements for the year ending December 31,2001.  No hedging activities were ineffect during the first six months of 2001, nor at any time during 2000;therefore, the adoption of this Statement is not expected to have a material effecton the Company’s operations.

**8.**          **Reclassifications**

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

**Item 2.**              **Management'sDiscussion and Analysis of Financial Condition and Results of Operations**

**Overview**

             AppliedMicrosystems Corporation is a leader and innovator in software developmenttools and technologies. Applied’s products and services help customers bringproducts to market faster by providing innovative tools to develop, debug, andtest products faster, more reliably, and at a lower cost.  For more than 20 years, the Company hastargeted its products to meet the needs of embedded systems markets and hasdeveloped significant experience and expertise in high-end microprocessors,real-time systems, and software analysis technology – three key competenciesthat position the Company to meet the needs of software developers.  Applied develops, markets and supports acomprehensive suite of software and hardware-enhanced development and testtools for the development of complex embedded microprocessor-basedapplications.  The embedded systemsmarket has in recent years expanded from its traditional base of industrialautomation, medical devices, and avionic applications to include marketsegments such as Internet devices, high-speed networking, wirelesstechnologies, game consoles, and set top boxes.

             OnAugust 1, 2001, the Company announced that, similar to other companies thatsell to the telecommunications industry, it experienced project and order delaysand cancellations among Applied’s networking customer base during the quarterended June 30, 2001.  As a result, theCompany expects that overall revenues in the second half of 2001 will besignificantly lower than the first half of 2001 due to expected continuedweakness in the networking space as well as reduced revenue expected from gamedevelopment tools after shipping initial orders for Microsoft’s Xbox videogaming system in the first half of 2001. As a result of these business circumstances, Applied has taken measuresto lower its costs, including a reduction of approximately 90 full-timeemployees worldwide; a temporary 10% reduction in salaries for executivepersonnel; a closure of company facilities for one week during the thirdquarter; as well as other cost reduction and control measures.  After the staff reduction, Applied employsapproximately 140 personnel worldwide. The Company expects to take a restructuring charge of $1.5 - $2.0million in the third quarter related to its cost-reduction plan.

**Results of Operations**

 

|                       | **Three  Months Ended June 30,** |   | **Six  Months Ended June 30,** |   |
|----------------------------|----------------------------------|--------|--------------------------------|--------|
|                       | ****                             |   | ****                           |   |
| **(dollars in thousands)** | **2001**                         |   | **Change**                     |   | **2000** |   | **2001** |   | **Change** |   | **2000** |   |
| ****                       |                             |
|                       |                             |   |                           |   |   |   |   |   |   |   |   |   |
| *Net  sales*               | $                                | 8,840  |                           | $      | 978 |   | $ | 7,862 |   | $ | 18,954 |   | $ | 3,409 |   | $ | 15,545 |   |
|                       |                             |   | 12                             | %      |   |   |   |   | 22 | % |   |   |
|                            |                                  |        |                                |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

             TheCompany earns revenue on the sale of hardware and software products.  The Company also earns revenue on the saleof services, including hardware and software support, installation, training,and professional engineering services. As further described under “Cumulative effect of change in accountingprinciple,” in the fourth quarter of 2000 the Company adopted the Securitiesand Exchange Commission’s Staff Accounting Bulletin No. 101 (“SAB 101”),“Revenue Recognition in Financial Statements,” effective retroactive to January1, 2000.

 

             The12% increase in net sales in the second quarter was led by increased sales ofgame development tools, as was the 22% increase in net sales for the six monthsended June 30, 2001, as compared to the three and six month periods in2000.   Game development tools revenueaccounted for $3.7 million in the second quarter of 2001, compared to $615,000in the second quarter of 2000.  Gamedevelopment tools revenue totaled $8.2 million in the first half of 2001,compared to $1.4 million in the six months ended June 30, 2000.  Game development tools revenue in 2001 hasbeen comprised primarily of shipments of game development tools for Microsoft’sXbox video gaming system.  This newrevenue source was a direct result of Applied’s development initiatives thatbegan in early 1999 to extend the Company’s technology to meet the needs ofgame developers.  These initiatives ledto agreements with Nintendo and Microsoft to develop and manufacture gamedevelopment tools for Nintendo’s GameCube and Microsoft’s Xbox video consolesystems.

             Applied’ssoftware analysis tools revenues were $2.2 million in the second quarter of2001, compared to $1.2 million in the second quarter of 2000; software analysisrevenues were $4.1 million in the first six months of 2001, compared to $2.6million in the six months ended June 30, 2000. These increases were due in part to the timing of license orders from athird-party developer of integrated development environments.  In addition, the Company completed softwaredevelopment under an amended customer contract and recognized $600,000 inrevenue in the second quarter of 2001. A significant portion of Applied’s software analysis tools business hasbeen with networking customers; due to an expected weak networking market inthe second half of 2001, the Company’s software analysis revenues may decrease.

             Salesof hardware-enhanced debug, test, and performance solutions totaled $3.0million in the second quarter of 2001, compared to $6.0 million in the secondquarter of the prior year.  Sales ofthese “run control” products were $6.6 million in the six months ended June 30,2001, compared to $11.5 million in the first six months of 2000.   These decreases were due primarily togenerally soft demand from telecommunications customers, the Company’s focus ondeveloping products and channels for software analysis tools, andslower-than-anticipated unit volumes through new run-control distributionchannels.

             TheCompany's net sales also include product support revenues, which are includedwithin the aforementioned major categories of Applied’s products.  These support revenues totaled $0.9 millionin the second quarter of 2001, compared to $1.1 million in the second quarterof 2000. Support revenues were $1.8 million in the six months ended June 30,2001, compared to $2.2 million in the six-month period ended June 30,2000.  The declines were due primary toa decrease in run control product sales, for which support contracts are oftensold.

             Internationalsales were 18% of net sales in the second quarter of 2001, as compared to 40%of net sales in the second quarter of 2000. For the six-month period ended June 30, 2001, international salesaccounted for 23% of net sales, as compared to 41% of net sales for the sixmonths ended June 30, 2000.  Applied’ssecond quarter 2001 and year-to-date international revenues were lower in Japanand Europe, than in the comparable periods in 2000, primarily due to the previouslymentioned slowdown among telecommunications customers.  The higher level of revenues from gamedevelopment tools sold domestically in 2001 also contributed to the lowerpercentage of international revenues in 2001, as compared to periods in theprior year.

             Applied’ssales through its foreign subsidiaries are generally denominated in localcurrencies; as a result, fluctuations in currency exchange rates can have asignificant effect on the Company's reported net sales.  The Company is unable to predict currencyexchange rate fluctuations and anticipates that such fluctuations will continueto affect its net sales to varying degrees in the future.

 

|                        | **Three  Months Ended  June 30,** |   | **Six  Months Ended  June 30,** |   |
|-----------------------------|-----------------------------------|--------|---------------------------------|--------|
|                        | ****                              |   | ****                            |   |
| **(dollars  in thousands)** | **2001**                          |   | **2000**                        |   | **2001** |   | **2000** |   |
| ****                        | ****                              | ****   | ****                            | ****   | **** | **** | **** |   |
|                        |                              |   |                            |   |   |   |   |   |
| *Cost  of Sales*            | $                                 | 2,516  |                            | $      | 2,538 |   | $ | 5,323 |   | $ | 4,642 |   |
|                        | *% of net sales*                  | 28     | %                               | 32     | % | 28 | % | 30 | % |
|                        |                              |   |                            |   |   |   |   |   |
| *Gross  profit*             | $                                 | 6,324  |                            | $      | 5,324 |   | $ | 13,631 |   | $ | 10,903 |   |
|                        | *% of net sales*                  | 72     | %                               | 68     | % | 72 | % | 70 | % |

             Applied’sgross profit percentage in the three and six months ended June 30, 2001 werehigher than the 2000 periods due in large part to increased throughput in theCompany’s manufacturing operations that resulted from initial production andshipment of game development tools for Microsoft’s Xbox.  In addition, increased software analysistools revenues in 2001 – including $600,000 in software development revenue inthe second quarter of 2001 for which expenses had been recognized in priorperiods – also supported a higher gross profit percentage.

             TheCompany expects its gross profit percentage to fluctuate based upon its productand service mix, potential changes in material and labor costs, geographic mix,foreign currency fluctuations, product and patent license royalties, andvariances in volume and related absorption of overhead costs.  Absent the benefit of increased throughputin the Company’s manufacturing operations on overhead absorption rates, thesales of game development kits would result in lower margins than the Companyhas historically maintained, thus adding to the potential for futurefluctuations in gross profit percentages.

 

|                                          | **Three  Months Ended June 30,** |   | **Six  Months Ended June 30,** |   |
|-----------------------------------------------|----------------------------------|--------|--------------------------------|--------|
|                                          | ****                             |   | ****                           |   |
| **(dollars in thousands)**                    | **2001**                         |   | **Change**                     |   | **2000** |   | **2001** |   | **Change** |   | **2000** |   |
|                                               |                             |   |
|                                          |                             |   |                           |   |   |   |   |   |   |   |   |   |
| *Sales,  general and administrative expenses* | $                                | 4,004  |                           | $      | (245 | ) | $ | 4,249 |   | $ | 7,888 |   | $ | (853 | ) | $ | 8,741 |   |
|                                          |                             |   | (6                             | )%     |   |   |   |   | (10 | )% |   |   |
|                                               |                                  |        |                                |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

             Applied’stotal operating expenses – sales, general and administrative expenses, combinedwith research and development expenses – were $7.3 million in the secondquarter of 2001.  Total operatingexpenses have fluctuated within a narrow range of $7.1 to $7.7 million perquarter over the past twelve quarters. Over that same period of time, Applied’s management team has shiftedoperating resources to pursue potential high-growth market opportunities byinvesting in new product development and expanding Applied’s existingtechnology.  That shift is reflected ina consistent decrease in sales, general and administrative expenses, with ageneral increase in research and development expenses over that time period,though quarterly research and development expenses have leveled off sincemid-2000.  The Company’s cost-reductionplan announced in August 2001 is expected to lower operating expenses by morethan $2.2 million per quarter; however, the full savings are not expected to berealized until the fourth quarter of 2001 because the Company maintained higherspending levels in the third quarter of 2001 prior to the implementation of thecost-reduction plan.

             Thedecreases in sales, general and administrative expenses in the second quarterand the six-month period ending June 30, 2001, as compared to the comparableperiods in 2000, were primarily due to lower personnel-related expenditures.  Sales of game development tools, which havelower sales-related expenses than Applied’s other hardware and softwareproducts, also contributed to lower expense levels in 2001.

 

             Whenincurred, minor foreign exchange gains and losses are included in sales,general and administrative expenses. In order to mitigate certain intercompanyrisks associated with exchange rate fluctuations, the Company may choose tohedge a portion of its foreign exchange risk as it relates to the debt theCompany’s foreign subsidiaries owe to the Company.  No such hedging activities were in effect during the first sixmonths of 2001, nor in the prior two years. Although the Company may engage in exchange-rate hedging activities withrespect to certain exchange-rate risks, there can be no assurance that it willdo so or that any such activities will successfully protect the Company againstsuch risks.

|                                 | **Three  Months Ended June 30,** |   | **Six  Months Ended June 30,** |   |
|--------------------------------------|----------------------------------|--------|--------------------------------|--------|
|                                 | ****                             |   | ****                           |   |
| **(dollars  in thousands)**          | **2001**                         |   | **Change**                     |   | **2000** |   | **2001** |   | **Change** |   | **2000** |   |
| ****                                 | ****                             | ****   | ****                           | ****   | **** | **** | **** | **** | **** | **** | **** |   |
|                                 |                             |   |                           |   |   |   |   |   |   |   |   |   |
| *Research  and development expenses* | $                                | 3,295  |                           | $      | (52 | ) | $ | 3,347 |   | $ | 6,559 |   | $ | 131 |   | $ | 6,428 |   |
|                                 |                             |   | (2%                            | )      |   |   |   |   | 2 | % |   |   |
|                                      |                                  |        |                                |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

             Theminor fluctuations in 2001 research and development expenses, as compared tothe prior-year periods, are primarily the result of the timing of customerdevelopment projects under contract.

             TheCompany believes that its continued investment in focused research anddevelopment activities is critical to Applied’s future success.  Despite an overall reduction in resourcesavailable for research and development (as a result of the Company’scost-cutting efforts), the Company intends to continue to make substantialinvestments in product development.  Research and development expenses may fluctuate to the extent that Applied’sengineering resources are utilized to fulfill the needs of customers undercontractual research and development arrangements.  In such cases, engineering costs are charged to costs of goodssold.

|                              | **Three  Months Ended June 30,** |   | **Six  Months Ended June 30,** |   |
|-----------------------------------|----------------------------------|--------|--------------------------------|--------|
|                              | ****                             |   | ****                           |   |
| **(dollars  in thousands)**       | **2001**                         |   | **Change**                     |   | **2000** |   | **2001** |   | **Change** |   | **2000** |   |
| ****                              |                             |
|                              |                             |   |                           |   |   |   |   |   |   |   |   |   |   |
| *Interest  income and other, net* | $                                | 83     |                           | $      | (94 | ) | $ | 177 |   | $ | 184 |   | $ | (176 | ) | $ | 360 |   |   |
|                              |                             |   | (53                            | )%     |   |   |   |   | (49 | )% |   |   |   |
|                                   |                                  |        |                                |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

             TheCompany’s interest income and other, net, decreased from the prior year’speriods due primarily to a decrease in the Company’s cash available forshort-term investments.

 

|                                                   | **Three  Months Ended June 30,** |   | **Six  Months Ended June 30,** |   |
|--------------------------------------------------------|----------------------------------|--------|--------------------------------|--------|
|                                                   | ****                             |   | ****                           |   |
| **(dollars  in thousands)**                            | **2001**                         |   | **Change**                     |   | **2000** |   | **2001** |   | **Change** |   | **2000** |   |   |
| ****                                                   |                             |   |
|                                                   |                             |   |                           |   |   |   |   |   |   |   |   |   |   |
| *Cumulative  Effect of Change in Accounting Principle* | $                                | -      |                           | $      | - |   | $ | - |   | $ | - |   | $ | (1,110 | ) | $ | (1,110 | ) |   |
|                                                   |                             |   |                           |   |   |   |   |   | (100 | )% |   |   |   |
|                                                        |                                  |        |                                |        |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

             Appliedimplemented SAB 101 in the fourth quarter of 2000, effective retroactive toJanuary 1, 2000.  SAB 101 providesguidance related to revenue recognition policies based on interpretations andpractices followed by the SEC.  As aresult of the Company’s assessment of these new guidelines, Applied changed itsrevenue recognition practices for sales in Japan to reflect revenues upon theearlier of customer inspection and acceptance or, in the absence ofnotification of inspection and acceptance, upon receipt of payment.  Applied adopted SAB 101 under the cumulativecatch-up method of accounting, which is the manner prescribed under applicableaccounting and reporting rules.  Underthese rules, the cumulative effect of a change in accounting principle isrecognized as an additional item on the Company’s statement of operations inthe first quarter of the year in which the change is made.  Applied’s adoption of this new standardresulted in a $1.1 million cumulative adjustment increasing the Company’s firstquarter 2000 net loss.  Revenues andexpenses in each of the 2000 quarters were likewise adjusted as if the newaccounting principle had been adopted since January 1, 2000.

**IncomeTaxes**

             Applicableaccounting standards require that the Company calculate an estimated annualeffective tax rate and apply such tax rate to the pre-tax income (loss) ofinterim periods.  Deferred income taxesreflect the net tax effects of temporary differences between the tax basis ofassets and liabilities and the corresponding financial statement amounts.  Due to the uncertainty of the Company’sability to utilize its net deferred tax assets, including its net operatinglosses and research and development credits, a valuation allowance has beenestablished for financial reporting purposes equal to the amount of the netdeferred tax assets.  Accordingly, noincome tax provision or benefit is recorded for the three and six-month periodsended June 30, 2001 and 2000.

**Liquidityand Capital Resources**

             As of June 30, 2001, the Companyhad $9.1 million in cash, cash equivalents, and short-term investments,compared to $10.5 million as of December 31, 2000.  The Company requires capital primarily for the financing ofinventories and accounts receivable, sales and marketing efforts, productdevelopment activities, capital equipment purchases, and to fund operatinglosses.  Applied used cash of $1.5million for operating activities in the first six months of 2001, compared tousing $3.7 million for operating activities in the first six months of theprior year.  The Company purchased$119,000 in property and equipment in the first six months of 2001, compared topurchasing $313,000 in the first six months of 2000.

             The Company believes that itsexisting working capital, together with amounts anticipated from operationsafter the Company has implemented its cost reduction plan, will provide the Companywith sufficient funds to finance its operations for at least the next 12months.  The Company's future capitalrequirements will depend on a number of factors, including the duration ofweakness in certain customer sectors and in international sales, our ability tomanage the Company to breakeven or better during continued slow marketconditions, costs associated with sales and marketing programs, productdevelopment efforts, and the use of funds for strategic purposes.  To the extent additional funds are required,the Company may sell additional equity, debt or convertible securities, orobtain credit facilities; however, there can be no assurance that the Companywill be able to obtain such funds or on terms that are acceptable.

**CertainFactors That May Affect Future Results of Operations**

             This report containsforward-looking statements reflecting management’s current forecast of certainaspects of the Company’s future.  Suchstatements are based on current information, which management has assessed butwhich by its nature is dynamic and subject to rapid and even abruptchanges.  Forward-looking statementsinclude statements regarding the Company’s cost-reduction plan, intent topursue new market and product opportunities, estimates of future operatingtrends, and optimism about improved operating performance.

             TheCompany’s actual results could differ materially from those stated or impliedby such forward-looking statements due to risks and uncertainties associatedwith the Company’s business which include, but are not limited to, theCompany’s recent operating losses, potential adverse consequences arising fromcorporate restructuring, dependence on industries characterized by rapidlychanging technology, manufacturing and product ship schedules, customer designstarts utilizing environments served by Applied, relationships withsemiconductor manufacturers, Applied’s focus on a few key markets,relationships with a few key game console developers for sale of gamedevelopment tools, competition, dependence on key personnel, intellectualproperty rights and the potential for corresponding litigation, the potentialfor product liability, uncertainties surrounding international operations,potential fluctuations in quarterly operating results, and potential continuedvolatility of stock price.  Theforward-looking statements should be considered in the context of these andother risk factors disclosed in the Company’s most recent filings with theSecurities and Exchange Commission and the Company’s 2000 Annual Report on Form10-K.

**Item 3.**              **Quantitative and Qualitative DisclosuresAbout Market Risk**

             Applieddevelops products in the United States and sells primarily in North America,Asia and Europe.  As a result, financialresults could be affected by factors such as changes in foreign currencyexchange rates or weak economic conditions in foreign markets.  Since the Company’s products are generallyinitially priced in U.S. Dollars and translated to local currency amounts, astrengthening of the dollar could make the Company’s products less competitivein foreign markets.

             TheCompany is exposed to market risk related to changes in interest rates, whichcould adversely affect the value of the Company's short-term investments.  Applied maintains a short-term investmentportfolio consisting of interest bearing securities with an average maturity ofless than one year.  These securitiesare classified as “available-for-sale” securities.  These interest-bearing securities are subject to interest raterisk and will fall in value if market interest rates increase.  If market interest rates were to increaseimmediately and uniformly by 10% from levels at June 30, 2001, the fair valueof the portfolio would decline by an immaterial amount.  The Company does not expect its operatingresults or cash flows to be affected to any significant degree by a suddenchange in market interest rates.

**PART II - OTHER INFORMATION**

**Item 4.**              **Submission of matters to a vote ofsecurity holders**

             The Company’s Annual Meeting ofShareholders was held on May 22, 2001. The following summarizes the results of matters voted upon at the AnnualMeeting.

(1)         The following persons were elected toserve as directors until the next Annual Meeting of Shareholders or until theirearlier retirement, resignation or removal:

| Nominee               | For       |   | Withheld |
|-----------------------|-----------|--------|----------|
|                       |           |   |          |
|                  |      |   |     |
| Lary  L. Evans        | 6,680,655 |   | 29,457   |
| Charles  H. House     | 6,623,106 |   | 87,006   |
| Elwood  D. Howse, Jr. | 6,680,455 |   | 29,657   |
| Anthony  Miadich      | 6,680,455 |   | 29,657   |
| Stephen  J. Verleye   | 6,678,490 |   | 31,622   |

(2)         The shareholders voted 3,625,593 sharesin the affirmative, 195,952 shares in the negative, 11,818 shares abstained,and 3,170,558 other shares were unvoted relative to the approval of the AppliedMicrosystems Corporation 2001 Stock Option Plan with an initial number ofshares issuable thereunder of 300,000.

(3)         The shareholders voted 3,691,188 sharesin the affirmative, 134,647 shares in the negative, 7,528 shares abstained, and3,170,558 other shares were unvoted relative to the approval to amend theApplied Microsystems Corporation Director Stock Option Plan to increase thenumber of shares issuable thereunder from 45,000 shares to 105,000 shares andto increase the number of shares automatically granted each year tonon-employee directors of the Company from 2,500 to 5,000.

(4)         The shareholders voted 6,662,715 sharesin the affirmative, 11,250 shares in the negative, 36,147 shares abstained, and293,809 other shares were unvoted relative to ratification of the appointmentof Ernst & Young LLP as independent auditors for the Company’s fiscal yearending December 31, 2001.

**Item 5.**              **Other Information**

             Anthony Miadich resigned fromApplied’s board of directors effective July 17, 2001.

**Item 6.**              **Exhibits and Reports on Form 8-K**

             (A)       The following exhibits are filed as partof this report.

                           10.1      Form of Change of Control Agreement forvice president officers, adopted by the Board of Directors April 23, 2001.

             (B)        Report on Form 8-K

                           Theregistrant did not file any reports on Form 8-K during the quarter ended June30, 2001.

 

**SIGNATURES**

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

|                                          |   | **APPLIED MICROSYSTEMS CORPORATION**                                 |
|-----------------------------------------------|--------|----------------------------------------------------------------------|
|                                          |   | (Registrant)                                                         |
|                                          |   |                                                                 |   |
| Date:     August 10, 2001 |   | By:       /s/   Robert C. Bateman |
|                                          |   |                                                                 | Robert C. Bateman |
|                                          |   |                                                                 | *Vice President, Chief Financial Officer,* |
|                                          |   |                                                                 | *Secretary and Treasurer* |
|                                          |   |                                                                 | *(Principal Financial and Accounting Officer* |
|                                          |   |                                                                 | * and Duly  Authorized Signing Officer)* |
|                                               |        |                                                                      |  |  |